UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016.
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
 
COMMISSION FILE NUMBER 0-14703
 
NBT BANCORP INC.
(Exact Name of Registrant as Specified in its Charter)
 
DELAWARE
 
16-1268674
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
52 SOUTH BROAD STREET, NORWICH, NEW YORK 13815
(Address of Principal Executive Offices) (Zip Code)
 
Registrant's Telephone Number, Including Area Code: (607) 337-2265
 
None
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes    No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   No
 
As of October 31, 2016, there were 43,160,455 shares outstanding of the Registrant's common stock, $0.01 par value per share.
 


 
NBT BANCORP INC.
FORM 10-Q--Quarter Ended September 30, 2016

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

Item 1
Financial Statements
 
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
9
     
Item 2
42
     
Item 3
58
     
Item 4
58
     
PART II
OTHER INFORMATION
 
     
Item 1
59
Item 1A
 
Item 2
59
Item 3
59
Item 4
59
Item 5
59
Item 6
60
 
61
 
62


2

 
Item 1 – FINANCIAL STATEMENTS
 
NBT Bancorp Inc. and Subsidiaries
           
Consolidated Balance Sheets (unaudited)
           
 
 
September 30
   
December 31
 
   
2016
   
2015
 
(In thousands, except share and per share data)
           
 Assets
           
Cash and due from banks
 
$
167,138
   
$
130,593
 
Short-term interest bearing accounts
   
21,299
     
9,704
 
Securities available for sale, at fair value
   
1,288,899
     
1,174,544
 
Securities held to maturity (fair value $495,596 and $473,140, respectively)
   
485,877
     
471,031
 
Trading securities
   
8,852
     
8,377
 
Federal Reserve and Federal Home Loan Bank stock
   
42,318
     
36,673
 
Loans
   
6,160,185
     
5,883,133
 
Less allowance for loan losses
   
65,668
     
63,018
 
Net loans
   
6,094,517
     
5,820,115
 
Premises and equipment, net
   
84,153
     
88,826
 
Goodwill
   
264,689
     
265,957
 
Intangible assets, net
   
15,899
     
17,265
 
Bank owned life insurance
   
164,464
     
117,044
 
Other assets
   
134,919
     
122,517
 
Total assets
 
$
8,773,024
   
$
8,262,646
 
                 
Liabilities
               
Demand (noninterest bearing)
 
$
2,146,229
   
$
1,998,165
 
Savings, NOW and money market
   
3,921,922
     
3,697,851
 
Time
   
881,087
     
908,827
 
Total deposits
   
6,949,238
     
6,604,843
 
Short-term borrowings
   
585,027
     
442,481
 
Long-term debt
   
114,144
     
130,447
 
Junior subordinated debt
   
101,196
     
101,196
 
Other liabilities
   
114,070
     
101,675
 
Total liabilities
   
7,863,675
     
7,380,642
 
                 
Stockholders’ equity
               
Preferred stock, $0.01 par value. Authorized 2,500,000 shares at September 30, 2016 and December 31, 2015
   
-
     
-
 
Common stock, $0.01 par value. Authorized 100,000,000 shares at September 30, 2016 and December 31, 2015; issued 49,651,494 at September 30, 2016 and December 31, 2015
   
497
     
497
 
Additional paid-in-capital
   
573,658
     
576,726
 
Retained earnings
   
492,130
     
462,232
 
Accumulated other comprehensive loss
   
(11,980
)
   
(22,418
)
Common stock in treasury, at cost, 6,507,270 and 6,220,792 shares at September 30, 2016 and December 31, 2015, respectively
   
(144,956
)
   
(135,033
)
Total stockholders’ equity
   
909,349
     
882,004
 
Total liabilities and stockholders’ equity
 
$
8,773,024
   
$
8,262,646
 
 
See accompanying notes to unaudited interim consolidated financial statements.
 
3


NBT Bancorp Inc. and Subsidiaries
 
Three months ended September 30,
   
Nine months ended September 30,
 
Consolidated Statements of Income (unaudited)
 
2016
   
2015
   
2016
   
2015
 
(In thousands, except per share data)
                       
Interest, fee and dividend income
                       
Interest and fees on loans
 
$
63,414
   
$
61,656
   
$
187,093
   
$
181,047
 
Securities available for sale
   
6,013
     
5,125
     
17,976
     
15,214
 
Securities held to maturity
   
2,544
     
2,318
     
7,328
     
6,916
 
Other
   
538
     
401
     
1,441
     
1,276
 
Total interest, fee and dividend income
   
72,509
     
69,500
     
213,838
     
204,453
 
Interest expense
                               
Deposits
   
3,607
     
3,554
     
10,809
     
10,644
 
Short-term borrowings
   
761
     
296
     
1,668
     
561
 
Long-term debt
   
819
     
845
     
2,425
     
2,507
 
Junior subordinated debt
   
660
     
560
     
1,920
     
1,645
 
Total interest expense
   
5,847
     
5,255
     
16,822
     
15,357
 
Net interest income
   
66,662
     
64,245
     
197,016
     
189,096
 
Provision for loan losses
   
6,388
     
4,966
     
17,266
     
12,506
 
Net interest income after provision for loan losses
   
60,274
     
59,279
     
179,750
     
176,590
 
Noninterest income
                               
Insurance and other financial services revenue
   
6,114
     
5,862
     
18,685
     
18,072
 
Service charges on deposit accounts
   
4,354
     
4,349
     
12,459
     
12,706
 
ATM and debit card fees
   
5,063
     
4,780
     
14,580
     
13,707
 
Retirement plan administration fees
   
4,129
     
3,249
     
11,937
     
10,011
 
Trust
   
4,535
     
4,611
     
13,848
     
14,257
 
Bank owned life insurance
   
1,336
     
931
     
3,898
     
3,418
 
Net securities gains
   
-
     
3
     
30
     
43
 
Gain on the sale of equity investment
   
-
     
4,179
     
-
     
4,179
 
Other
   
4,113
     
3,297
     
12,188
     
9,617
 
Total noninterest income
   
29,644
     
31,261
     
87,625
     
86,010
 
Noninterest expense
                               
Salaries and employee benefits
   
32,783
     
30,227
     
98,155
     
91,240
 
Occupancy
   
5,035
     
5,326
     
15,780
     
16,804
 
Data processing and communications
   
4,183
     
4,207
     
12,354
     
12,598
 
Professional fees and outside services
   
3,343
     
3,137
     
9,905
     
10,029
 
Equipment
   
3,656
     
3,352
     
10,663
     
9,917
 
Office supplies and postage
   
1,438
     
1,576
     
4,661
     
4,822
 
FDIC expenses
   
1,287
     
1,355
     
3,838
     
3,833
 
Advertising
   
634
     
421
     
1,733
     
1,874
 
Amortization of intangible assets
   
952
     
1,165
     
2,976
     
3,636
 
Loan collection and other real estate owned, net
   
985
     
699
     
2,535
     
1,593
 
Other
   
5,318
     
8,426
     
15,683
     
19,211
 
Total noninterest expense
   
59,614
     
59,891
     
178,283
     
175,557
 
Income before income tax expense
   
30,304
     
30,649
     
89,092
     
87,043
 
Income tax expense
   
10,303
     
10,798
     
30,291
     
29,745
 
Net income
 
$
20,001
   
$
19,851
   
$
58,801
   
$
57,298
 
Earnings per share
                               
Basic
 
$
0.46
   
$
0.45
   
$
1.36
   
$
1.30
 
Diluted
 
$
0.46
   
$
0.45
   
$
1.35
   
$
1.29
 

See accompanying notes to unaudited interim consolidated financial statements.
 
4


NBT Bancorp Inc. and Subsidiaries
 
Three months ended September 30,
   
Nine months ended September 30,
 
Consolidated Statements of Comprehensive Income (unaudited)
 
2016
   
2015
   
2016
   
2015
 
(In thousands)
                       
Net income
 
$
20,001
   
$
19,851
     
58,801
   
$
57,298
 
Other comprehensive income, net of tax:
                               
Unrealized net holding (losses) gains arising during the period (pre-tax amounts of ($2,931), $3,801, $14,009 and $3,367)
   
(1,790
)
   
2,323
     
8,560
     
2,057
 
Reclassification adjustment for net gains related to securities available for sale included in net income (pre-tax amounts of $-, $3, $30 and $43)
   
-
     
(2
)
   
(19
)
   
(26
)
Unrealized losses on derivatives (cash flow hedges)  (pre-tax amounts of $782, $-, $719 and $-)
   
478
     
-
     
439
     
-
 
Amortization of unrealized net gains and losses related to the reclassification of available for sale investment securities to held to maturity (pre-tax amounts of $267, $328, $843 and $999)
   
162
     
200
     
515
     
610
 
Pension and other benefits:
                               
Amortization of prior service cost and actuarial gains (pre-tax amounts of $519, $551, $1,544 and $1,673)
   
317
     
337
     
943
     
1,021
 
Total other comprehensive (loss) income
   
(833
)
   
2,858
     
10,438
     
3,662
 
Comprehensive income
 
$
19,168
   
$
22,709
     
69,239
   
$
60,960
 
 
See accompanying notes to unaudited interim consolidated financial statements.
 
5


NBT Bancorp Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity (unaudited)
 
   
Common Stock
   
Additional Paid-in-
Capital
   
Retained Earnings
   
Accumulated Other Comprehensive (Loss) Income
   
Common Stock in Treasury
   
Total
 
(In thousands, except share and per share data)
                                   
Balance at December 31, 2014
 
$
497
   
$
576,504
   
$
423,956
   
$
(17,027
)
 
$
(119,749
)
 
$
864,181
 
Net income
   
-
     
-
     
57,298
     
-
     
-
     
57,298
 
Cash dividends - $0.65 per share
   
-
     
-
     
(28,553
)
   
-
     
-
     
(28,553
)
Purchase of 1,047,152 treasury shares
   
-
     
-
     
-
     
-
     
(26,797
)
   
(26,797
)
Net issuance of 336,959 shares to employee benefit plans and other stock plans, including tax benefit
   
-
     
(3,423
)
   
-
     
-
     
6,451
     
3,028
 
Stock-based compensation
   
-
     
3,397
     
-
     
-
     
-
     
3,397
 
Other comprehensive income
   
-
     
-
     
-
     
3,662
     
-
     
3,662
 
Balance at September 30, 2015
 
$
497
   
$
576,478
   
$
452,701
   
$
(13,365
)
 
$
(140,095
)
 
$
876,216
 
 
                                               
Balance at December 31, 2015
 
$
497
   
$
576,726
   
$
462,232
   
$
(22,418
)
 
$
(135,033
)
 
$
882,004
 
Net income
   
-
     
-
     
58,801
     
-
     
-
     
58,801
 
Cash dividends - $0.67 per share
   
-
     
-
     
(28,903
)
   
-
     
-
     
(28,903
)
Purchase of 675,535 treasury shares
   
-
     
-
     
-
     
-
     
(17,193
)
   
(17,193
)
Net issuance of 389,058 shares to employee benefit plans and other stock plans, including tax benefit
   
-
     
(6,164
)
   
-
     
-
     
7,270
     
1,106
 
Stock-based compensation
   
-
     
3,096
     
-
     
-
     
-
     
3,096
 
Other comprehensive income
   
-
     
-
     
-
     
10,438
     
-
     
10,438
 
Balance at September 30, 2016
 
$
497
   
$
573,658
   
$
492,130
   
$
(11,980
)
 
$
(144,956
)
 
$
909,349
 
 
See accompanying notes to unaudited interim consolidated financial statements.
 
6


NBT Bancorp Inc. and Subsidiaries
 
Nine months ended September 30,
 
Consolidated Statements of Cash Flows (unaudited)
 
2016
   
2015
 
(In thousands)
           
Operating activities
           
Net income
 
$
58,801
   
$
57,298
 
Adjustments to reconcile net income to net cash provided by operating activities
               
Provision for loan losses
   
17,266
     
12,506
 
Depreciation and amortization of premises and equipment
   
6,765
     
6,494
 
Net accretion on securities
   
3,781
     
1,851
 
Amortization of intangible assets
   
2,976
     
3,636
 
Stock-based compensation
   
3,096
     
3,397
 
Bank owned life insurance income
   
(3,898
)
   
(3,418
)
Purchases of trading securities
   
(34
)
   
(767
)
(Gains) losses on trading securities
   
(441
)
   
660
 
Proceeds from sales of loans held for sale
   
71,170
     
50,998
 
Originations and purchases of loans held for sale
   
(73,393
)
   
(49,125
)
Net gains on sales of loans held for sale
   
(459
)
   
(108
)
Net security gains
   
(30
)
   
(43
)
Net gain on sales of other real estate owned
   
(625
)
   
(1,241
)
Gain on the sale of equity investment
   
-
     
(4,179
)
Gain on asset sold
   
(2,462
)
   
-
 
Impairment write-down
   
2,565
     
-
 
Net (increase) decrease in other assets
   
(16,599
)
   
8,846
 
Net increase in other liabilities
   
11,395
     
6,252
 
Net cash provided by operating activities
   
79,874
     
93,057
 
Investing activities
               
Net cash used in acquisitions
   
(2,000
)
   
-
 
Securities available for sale:
               
Proceeds from maturities, calls and principal paydowns
   
250,441
     
229,347
 
Proceeds from sales
   
48
     
-
 
Purchases
   
(352,056
)
   
(272,596
)
Securities held to maturity:
               
Proceeds from maturities, calls and principal paydowns
   
76,676
     
61,379
 
Purchases
   
(90,476
)
   
(74,951
)
Other:
               
Net increase in loans
   
(291,349
)
   
(294,187
)
Proceeds from FHLB stock redemption
   
108,227
     
39,740
 
Purchases of Federal Reserve and FHLB stock
   
(113,872
)
   
(41,115
)
Proceeds from settlement of bank owned life insurance
   
1,478
     
1,541
 
Purchase of bank owned life insurance
   
(45,000
)
   
-
 
Purchases of premises and equipment
   
(4,652
)
   
(4,999
)
Proceeds from sale of equity investment
   
-
     
4,179
 
Proceeds from the sales of other real estate owned
   
5,153
     
3,049
 
Net cash used in investing activities
   
(457,382
)
   
(348,613
)
Financing activities
               
Net increase in deposits
   
344,395
     
301,022
 
Net increase in short-term borrowings
   
142,546
     
45,530
 
Proceeds from issuance of long-term debt
   
3,880
     
-
 
Repayments of long-term debt
   
(20,183
)
   
(310
)
Proceeds from the issuance of shares to employee benefit plans and other stock plans
   
1,106
     
3,028
 
Purchase of treasury stock
   
(17,193
)
   
(26,797
)
Cash dividends
   
(28,903
)
   
(28,553
)
Net cash provided by financing activities
   
425,648
     
293,920
 
Net increase in cash and cash equivalents
   
48,140
     
38,364
 
Cash and cash equivalents at beginning of period
   
140,297
     
146,636
 
Cash and cash equivalents at end of period
 
$
188,437
   
$
185,000
 
 
7


Supplemental disclosure of cash flow information
 
Nine months ended September 30,
 
Cash paid during the period for:
 
2016
   
2015
 
Interest
 
$
17,269
   
$
16,252
 
Income taxes paid
   
29,173
     
19,027
 
Noncash investing activities:
               
Loans transferred to other real estate owned
 
$
2,363
   
$
2,699
 
Acquisitions:
               
Fair value of assets acquired
 
$
1,703
   
$
-
 
 
See accompanying notes to unaudited interim consolidated financial statements.
 
8


NBT BANCORP INC. and Subsidiaries
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2016
 
Note 1.
Description of Business
 
NBT Bancorp Inc. (the “Registrant” or the “Company”) is a registered financial holding company incorporated in the state of Delaware in 1986, with its principal headquarters located in Norwich, New York.  The principal assets of the Registrant consist of all of the outstanding shares of common stock of its subsidiaries, including:  NBT Bank, National Association (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), NBT Holdings, Inc. (“NBT Holdings”), Hathaway Agency, Inc. and CNBF Capital Trust I, NBT Statutory Trust I, NBT Statutory Trust II, Alliance Financial Capital Trust I and Alliance Financial Capital Trust II (collectively, the “Trusts”).  The Company’s principal sources of revenue are the management fees and dividends it receives from the Bank, NBT Financial and NBT Holdings.
 
The Company’s business, primarily conducted through the Bank but also through its other subsidiaries, consists of providing commercial banking and financial services to customers in its market area, which includes central and upstate New York, northeastern Pennsylvania, northwestern Vermont, western Massachusetts, southern New Hampshire and southern Maine.  The Company has been and intends to continue to be, a community-oriented financial institution offering a variety of financial services.  The Company’s business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial and municipal customers.

Note 2.
Basis of Presentation
 
The accompanying unaudited interim consolidated financial statements include the accounts of the Registrant and its wholly owned subsidiaries, the Bank, NBT Financial and NBT Holdings.  Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.”  The interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods in accordance with generally accepted accounting principles in the United States of America (“GAAP”).  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2015 Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.  All intercompany transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.  The Company has evaluated subsequent events for potential recognition and/or disclosure and there were none identified.
 
9


Note 3.
Securities
 
The amortized cost, estimated fair value and unrealized gains and losses of securities available for sale are as follows:
 
(In thousands)
 
Amortized
cost
   
Unrealized
gains
   
Unrealized
losses
   
Estimated
fair value
 
September 30, 2016
                       
Federal Agency
 
$
255,115
   
$
1,006
   
$
(28
)
 
$
256,093
 
State & municipal
   
38,327
     
357
     
(30
)
   
38,654
 
Mortgage-backed:
                               
Government-sponsored enterprises
   
356,484
     
8,969
     
-
     
365,453
 
U.S. government agency securities
   
6,418
     
506
     
(13
)
   
6,911
 
Collateralized mortgage obligations:
                               
Government-sponsored enterprises
   
536,694
     
4,580
     
(189
)
   
541,085
 
U.S. government agency securities
   
59,931
     
478
     
(24
)
   
60,385
 
Other securities
   
16,744
     
4,720
     
(1,146
)
   
20,318
 
Total securities available for sale
 
$
1,269,713
   
$
20,616
   
$
(1,430
)
 
$
1,288,899
 
December 31, 2015
                               
Federal Agency
 
$
312,580
   
$
203
   
$
(1,511
)
 
$
311,272
 
State & municipal
   
31,208
     
446
     
(17
)
   
31,637
 
Mortgage-backed:
                               
Government-sponsored enterprises
   
398,086
     
4,141
     
(1,068
)
   
401,159
 
U.S. government agency securities
   
8,191
     
560
     
(14
)
   
8,737
 
Collateralized mortgage obligations:
                               
Government-sponsored enterprises
   
364,936
     
931
     
(1,828
)
   
364,039
 
U.S. government agency securities
   
40,699
     
348
     
(115
)
   
40,932
 
Other securities
   
13,637
     
3,249
     
(118
)
   
16,768
 
Total securities available for sale
 
$
1,169,337
   
$
9,878
   
$
(4,671
)
 
$
1,174,544
 
 
Other securities primarily represent marketable equity securities.
 
10


The amortized cost, estimated fair value and unrealized gains and losses of securities held to maturity are as follows:
 
(In thousands)
 
Amortized
cost
   
Unrealized
gains
   
Unrealized
losses
   
Estimated
fair value
 
September 30, 2016
                       
Mortgage-backed:
                       
     Government-sponsored enterprises
 
$
49,229
   
$
617
   
$
-
   
$
49,846
 
     U.S. government agency securities
   
549
     
101
     
-
     
650
 
Collateralized mortgage obligations:
                               
     Government-sponsored enterprises
   
237,819
     
5,314
     
(386
)
   
242,747
 
State & municipal
   
198,280
     
4,130
     
(57
)
   
202,353
 
Total securities held to maturity
 
$
485,877
   
$
10,162
   
$
(443
)
 
$
495,596
 
December 31, 2015
                               
Mortgage-backed:
                               
     Government-sponsored enterprises
 
$
9,432
   
$
-
   
$
(107
)
 
$
9,325
 
     U.S. government agency securities
   
611
     
95
     
-
     
706
 
Collateralized mortgage obligations:
                               
     Government-sponsored enterprises
   
272,550
     
1,411
     
(1,560
)
   
272,401
 
State & municipal
   
188,438
     
2,288
     
(18
)
   
190,708
 
Total securities held to maturity
 
$
471,031
   
$
3,794
   
$
(1,685
)
 
$
473,140
 

Securities with amortized costs totaling $1.6 billion at September 30, 2016 and $1.4 billion at December 31, 2015 were pledged to secure public deposits and for other purposes required or permitted by law.  At September 30, 2016 and December 31, 2015, securities with an amortized cost of $223.8 million and $205.9 million, respectively, were pledged as collateral for securities sold under repurchase agreements.
 
11


The following table sets forth information with regard to investment securities with unrealized losses for the periods presented (dollars in thousands):
 
 
 
Less than 12 months
   
12 months or longer
   
Total
 
Security Type:
 
Fair Value
   
Unrealized losses
   
Number of Positions
   
Fair Value
   
Unrealized losses
   
Number of Positions
   
Fair Value
   
Unrealized losses
   
Number of Positions
 
 
                                                     
September 30, 2016
                                                     
Investment securities available for sale:
                                                     
Federal agency
 
$
9,955
   
$
(28
)
   
1
   
$
-
   
$
-
     
-
   
$
9,955
   
$
(28
)
   
1
 
State & municipal
   
7,659
     
(28
)
   
12
     
488
     
(2
)
   
1
     
8,147
     
(30
)
   
13
 
Mortgage-backed
   
-
     
-
     
-
     
996
     
(13
)
   
4
     
996
     
(13
)
   
4
 
Collateralized mortgage obligations
   
56,083
     
(213
)
   
8
     
-
     
-
     
-
     
56,083
     
(213
)
   
8
 
Other securities
   
174
     
(26
)
   
1
     
4,746
     
(1,120
)
   
2
     
4,920
     
(1,146
)
   
3
 
Total securities with unrealized losses
 
$
73,871
   
$
(295
)
   
22
   
$
6,230
   
$
(1,135
)
   
7
   
$
80,101
   
$
(1,430
)
   
29
 
 
                                                                       
                                                                         
Investment securities held to maturity:
                                                                       
Collateralized mortgage obligations
 
$
-
   
$
-
     
-
   
$
37,888
   
$
(386
)
   
4
   
$
37,888
   
$
(386
)
   
4
 
State & municipal
   
5,501
     
(57
)
   
9
     
-
     
-
     
-
     
5,501
     
(57
)
   
9
 
Total securities with unrealized losses
 
$
5,501
   
$
(57
)
   
9
   
$
37,888
   
$
(386
)
   
4
   
$
43,389
   
$
(443
)
   
13
 
                                                                         
December 31, 2015
                                                                       
Investment securities available for sale:
                                                                       
Federal agency
 
$
186,685
   
$
(1,312
)
   
15
   
$
19,801
   
$
(199
)
   
2
   
$
206,486
   
$
(1,511
)
   
17
 
State & municipal
   
4,599
     
(14
)
   
7
     
502
     
(3
)
   
1
     
5,101
     
(17
)
   
8
 
Mortgage-backed
   
177,270
     
(1,068
)
   
33
     
1,066
     
(14
)
   
5
     
178,336
     
(1,082
)
   
38
 
Collateralized mortgage obligations
   
256,265
     
(1,889
)
   
24
     
5,218
     
(54
)
   
2
     
261,483
     
(1,943
)
   
26
 
Other securities
   
-
     
-
     
-
     
3,235
     
(118
)
   
2
     
3,235
     
(118
)
   
2
 
Total securities with unrealized losses
 
$
624,819
   
$
(4,283
)
   
79
   
$
29,822
   
$
(388
)
   
12
   
$
654,641
   
$
(4,671
)
   
91
 
 
                                                                       
                                                                         
Investment securities held to maturity:
                                                                       
Mortgage-backed
 
$
9,325
   
$
(107
)
   
1
   
$
-
   
$
-
     
-
   
$
9,325
   
$
(107
)
   
1
 
Collateralized mortgage obligations
   
105,604
     
(281
)
   
12
     
41,523
     
(1,279
)
   
4
     
147,127
     
(1,560
)
   
16
 
State & municipal
   
2,200
     
(18
)
   
3
     
-
     
-
     
-
     
2,200
     
(18
)
   
3
 
Total securities with unrealized losses
 
$
117,129
   
$
(406
)
   
16
   
$
41,523
   
$
(1,279
)
   
4
   
$
158,652
   
$
(1,685
)
   
20
 
 
12


Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses or in other comprehensive income, depending on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment's amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be separated into (a) the amount representing the credit loss and (b) the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss shall be recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes.  As of September 30, 2016 and December 31, 2015, management believes the impairments detailed in the table above are temporary and no other-than-temporary impairment losses have been realized in the Company’s consolidated statements of income.

In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer and (iii) the historical and implied volatility of the fair value of the security.

Management has the intent to hold the securities classified as held to maturity until they mature, at which time it is believed the Company will receive full value for the securities. Furthermore, as of September 30, 2016, management also has the intent to hold and will not be required to sell, the securities classified as available for sale for a period of time sufficient for a recovery of cost, which may be until maturity.  The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. When necessary, the Company has performed a discounted cash flow analysis to determine whether or not it will receive the contractual principal and interest on certain securities.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  As of September 30, 2016 and December 31, 2015, management believes the impairments detailed in the table above are temporary and no other-than-temporary impairment losses have been realized in the Company’s consolidated statements of income.
 
The following tables set forth information with regard to contractual maturities of debt securities at September 30, 2016:
 
(In thousands)
 
Amortized cost
   
Estimated fair value
 
Debt securities classified as available for sale
           
Within one year
 
$
39,403
   
$
39,495
 
From one to five years
   
245,571
     
247,544
 
From five to ten years
   
153,633
     
156,600
 
After ten years
   
814,362
     
824,942
 
 
 
$
1,252,969
   
$
1,268,581
 
Debt securities classified as held to maturity
               
Within one year
 
$
34,787
   
$
34,790
 
From one to five years
   
25,392
     
25,639
 
From five to ten years
   
123,615
     
126,865
 
After ten years
   
302,083
     
308,302
 
 
 
$
485,877
   
$
495,596
 
 
Maturities of mortgage-backed and collateralized mortgage obligations are stated based on their estimated average lives.  Actual maturities may differ from estimated average lives or contractual maturities because, in certain cases, borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
Except for U.S. Government securities, there were no holdings, when taken in the aggregate, of any single issuer that exceeded 10% of consolidated stockholders’ equity at September 30, 2016 and December 31, 2015.
 
13


Note  4.
Allowance for Loan Losses and Credit Quality of Loans

Allowance for Loan Losses

The allowance for loan losses is maintained at a level estimated by management to provide adequately for probable incurred losses inherent in the current loan portfolio. The adequacy of the allowance for loan losses is continuously monitored.  It is assessed for adequacy using a methodology designed to ensure the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan portfolio.
 
To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into three segments, each with different risk characteristics and methodologies for assessing risk.  Those segments are further segregated between our loans accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired in a business combination (referred to as “acquired” loans).  Each portfolio segment is broken down into class segments where appropriate.  Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses.  Unique characteristics such as borrower type, loan type, collateral type and risk characteristics define each class segment.  The following table illustrates the portfolio and class segments for the Company’s loan portfolio:
  
Portfolio
Class
Commercial Loans
Commercial
 
Commercial Real Estate
 
Agricultural
 
Agricultural Real Estate
 
Business Banking
Consumer Loans
Indirect
 
Home Equity
 
Direct
Residential Real Estate Mortgages
 
 
Commercial Loans
 
The Company offers a variety of commercial loan products including commercial (non-real estate), commercial real estate, agricultural, agricultural real estate, and business banking loans.  The Company’s underwriting analysis for commercial loans typically includes credit verification, independent appraisals, a review of the borrower’s financial condition and a detailed analysis of the borrower’s underlying cash flows.
 
Commercial The Company offers a variety of loan options to meet the specific needs of our commercial customers including term loans, time notes and lines of credit.  Such loans are made available to businesses for working capital needs such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets owned by the borrower.  These loans carry a higher risk than commercial real estate loans due to the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable. To reduce the risk, management also attempts to secure real estate as collateral and obtain personal guarantees of the borrowers.
 
14


Commercial Real Estate – The Company offers commercial real estate loans to finance real estate purchases, refinancings, expansions and improvements to commercial properties.  Commercial real estate loans are made to finance the purchases of real estate, generally with completed structures. These commercial real estate loans are secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and other non owner-occupied facilities.  These loans are typically less risky than commercial loans, since they are secured by real estate and buildings and are generally originated in amounts of no more than 80% of the appraised value of the property.

Agricultural – The Company offers a variety of agricultural loans to meet the needs of our agricultural customers including term loans, time notes and lines of credit.  These loans are made to purchase livestock, purchase and modernize equipment and finance seasonal crop expenses.  Generally, a collateral lien is placed on the livestock, equipment, produce inventories and/or receivables owned by the borrower.  These loans may carry a higher risk than commercial and agricultural real estate loans due to the industry price volatility and in some cases, the perishable nature of the underlying collateral.  To reduce these risks, management may attempt to secure these loans with additional real estate collateral, obtain personal guarantees of the borrowers or obtain government loan guarantees to provide further support.
 
Agricultural Real Estate – The Company offers real estate loans to our agricultural customers to finance farm related real estate purchases, refinancings, expansions and improvements to agricultural properties such as barns, production facilities and land.  The agricultural real estate loans are secured by first liens on the farm real estate.  Because they are secured by land and buildings, these loans may be less risky than agricultural loans.  These loans are typically originated in amounts of no more than 75% of the appraised value of the property.  Government loan guarantees may be obtained to provide further support.
 
Business Banking  The Company offers a variety of loan options to meet the specific needs of our business banking customers including term loans, business banking mortgages and lines of credit.  Such loans are generally less than $0.8 million and are made available to businesses for working capital such as inventory and receivables, business expansion, equipment purchases and agricultural needs.  Generally, a collateral lien is placed on equipment or other assets owned by the borrower such as inventory and/or receivables.  These loans carry a higher risk than commercial loans due to the smaller size of the borrower and lower levels of capital.  To reduce these risks, the Company obtains personal guarantees of the owners for a majority of the loans.
 
Consumer Loans
 
The Company offers a variety of consumer loan products including indirect, home equity and direct loans.
 
Indirect – The Company maintains relationships with many dealers primarily in the communities that we serve.  Through these relationships, the Company primarily finances the purchases of automobiles and recreational vehicles (such as campers, boats, etc.) indirectly through dealer relationships.  Approximately 75% of the indirect relationships represent automobile financing.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from three to six years, based upon the nature of the collateral and the size of the loan. The majority of indirect consumer loans are underwritten on a secured basis using the underlying collateral being financed.
 
Home Equity The Company offers fixed home equity loans as well as home equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses.  Consumers are able to borrow up to 85% of the equity in their homes.  The Company originates home equity lines of credit and second mortgage loans (loans secured by a second junior lien position on one-to-four-family residential real estate).  These loans carry a higher risk than first mortgage residential loans as they are in a second position with respect to collateral.  Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.
 
15


Direct – The Company offers a variety of consumer installment loans to finance vehicle purchases, mobile home purchases and personal expenditures.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to ten years, based upon the nature of the collateral and the size of the loan. The majority of consumer loans are underwritten on a secured basis using the underlying collateral being financed or a customer's deposit account. In addition to installment loans, the Company also offers personal lines of credit and overdraft protection.  A minimal amount of loans are unsecured, which carry a higher risk of loss.

Residential Real Estate Mortgages

Residential real estate loans consist primarily of loans secured by first or second deeds of trust on primary residences.  We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage.  These loans are collateralized by owner-occupied properties located in the Company’s market area.  Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 85% of the purchase price or appraised value (whichever is lower) or have private mortgage insurance.  The Company’s underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals and a review of the borrower’s financial condition.  Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period.
 
For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectability of the portfolio.  For individually analyzed loans, these include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans, estimates of the Company’s exposure to credit loss reflect a current assessment of a number of factors, which could affect collectability.  These factors include:  past loss experience, loss emergence period, size, trend, composition and nature of loans;  changes in lending policies and procedures, including underwriting standards and collection,  charge-offs  and  recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market;  portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability and depth of lending management and staff. In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to make loan grade changes as well as recognize additions to the allowance based on their examinations.
 
After a thorough consideration of the factors discussed above, any required additions or reductions to the allowance for loan losses are made periodically by charges or credits to the provision for loan losses. These charges or credits are necessary to maintain the allowance at a level which management believes is reasonably reflective of overall inherent risk of probable loss in the portfolio. While management uses available information to recognize losses on loans, additions and reductions of the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.
 
16


The following tables illustrate the changes in the allowance for loan losses by our portfolio segments for the three and nine months ended September 30, 2016 and 2015 (in thousands):
 
Three months ended September 30,
 
Commercial Loans
   
Consumer Loans
   
Residential Real Estate Mortgages
   
Unallocated
   
Total
 
Balance as of June 30, 2016
 
$
25,222
   
$
31,471
   
$
7,875
   
$
-
   
$
64,568
 
Charge-offs
   
(637
)
   
(6,046
)
   
(142
)
   
-
     
(6,825
)
Recoveries
   
512
     
898
     
127
     
-
     
1,537
 
Provision
   
1,514
     
6,078
     
(1,481
)
   
277
     
6,388
 
Ending Balance as of September 30, 2016
 
$
26,611
   
$
32,401
   
$
6,379
   
$
277
   
$
65,668
 
 
                                       
Balance as of June 30, 2015
 
$
28,326
   
$
28,314
   
$
8,281
   
$
38
   
$
64,959
 
Charge-offs
   
(1,333
)
   
(4,530
)
   
(511
)
   
-
     
(6,374
)
Recoveries
   
258
     
889
     
161
     
-
     
1,308
 
Provision
   
(2,800
)
   
7,333
     
51
     
382
     
4,966
 
Ending Balance as of September 30, 2015
 
$
24,451
   
$
32,006
   
$
7,982
   
$
420
   
$
64,859
 

Nine months ended September 30,
 
Commercial Loans
   
Consumer Loans
   
Residential Real Estate Mortgages
   
Unallocated
   
Total
 
Balance as of December 31, 2015
 
$
25,545
   
$
29,253
   
$
7,960
   
$
260
   
$
63,018
 
Charge-offs
   
(1,723
)
   
(16,409
)
   
(1,119
)
   
-
     
(19,251
)
Recoveries
   
1,616
     
2,779
     
240
     
-
     
4,635
 
Provision
   
1,173
     
16,778
     
(702
)
   
17
     
17,266
 
Ending Balance as of September 30, 2016
 
$
26,611
   
$
32,401
   
$
6,379
   
$
277
   
$
65,668
 
 
                                       
Balance as of December 31, 2014
 
$
32,433
   
$
26,720
   
$
7,130
   
$
76
   
$
66,359
 
Charge-offs
   
(2,715
)
   
(13,183
)
   
(1,524
)
   
-
     
(17,422
)
Recoveries
   
772
     
2,334
     
310
     
-
     
3,416
 
Provision
   
(6,039
)
   
16,135
     
2,066
     
344
     
12,506
 
Ending Balance as of September 30, 2015
 
$
24,451
   
$
32,006
   
$
7,982
   
$
420
   
$
64,859
 

Included in the above table there was $0.7 million and $1.9 million in the allowance for loan losses related to acquired commercial loans as of September 30, 2016 and September 30, 2015, respectively.  Net charge-offs related to acquired loans totaled approximately $0.1 million and $0.5 million during the three months ended September 30, 2016 and 2015, respectively and approximately $0.4 million and $1.2 million during the nine months ended September 30, 2016 and 2015, respectively and are included in the table above. 
 
17


The following tables illustrate the allowance for loan losses and the recorded investment by portfolio segments as of September 30, 2016 and December 31, 2015:
 
Allowance for Loan Losses and Recorded Investment in Loans
(In thousands)
 
 
 
Commercial Loans
   
Consumer Loans
   
Residential Real Estate Mortgages
   
Unallocated
   
Total
 
As of September 30, 2016
                             
Allowance for loan losses
 
$
26,611
   
$
32,401
   
$
6,379
   
$
277
   
$
65,668
 
 
                                       
Allowance for loans individually evaluated for impairment
   
3,372
     
-
     
-
     
-
     
3,372
 
 
                                       
Allowance for loans collectively evaluated for impairment
 
$
23,239
   
$
32,401
   
$
6,379
   
$
277
   
$
62,296
 
 
                                       
Ending balance of loans
 
$
2,781,143
   
$
2,138,705
   
$
1,240,337
           
$
6,160,185
 
 
                                       
Ending balance of originated loans individually evaluated for impairment
   
21,594
     
8,502
     
6,088
             
36,184
 
Ending balance of acquired loans individually evaluated for impairment
   
1,205
     
-
     
-
             
1,205
 
Ending balance of acquired loans collectively evaluated for impairment
   
252,414
     
69,173
     
207,289
             
528,876
 
Ending balance of originated loans collectively evaluated for impairment
 
$
2,505,930
   
$
2,061,030
   
$
1,026,960
           
$
5,593,920
 
 
                                       
As of December 31, 2015
                                       
Allowance for loan losses
 
$
25,545
   
$
29,253
   
$
7,960
   
$
260
   
$
63,018
 
 
                                       
Allowance for loans individually evaluated for impairment
   
2,005
     
-
     
-
     
-
     
2,005
 
 
                                       
Allowance for loans collectively evaluated for impairment
 
$
23,540
   
$
29,253
   
$
7,960
   
$
260
   
$
61,013
 
 
                                       
Ending balance of loans
 
$
2,589,707
   
$
2,096,646
   
$
1,196,780
           
$
5,883,133
 
 
                                       
Ending balance of originated loans individually evaluated for impairment
   
12,253
     
7,693
     
6,017
             
25,963
 
Ending balance of acquired loans individually evaluated for impairment
   
1,205
     
-
     
-
             
1,205
 
Ending balance of acquired loans collectively evaluated for impairment
   
284,524
     
95,427
     
230,358
             
610,309
 
Ending balance of originated loans collectively evaluated for impairment
 
$
2,291,725
   
$
1,993,526
   
$
960,405
           
$
5,245,656
 
 
18


Credit Quality of Loans
 
Loans are placed on nonaccrual status when timely collection of principal and interest in accordance with contractual terms is doubtful. Loans are transferred to nonaccrual status generally when principal or interest payments become 90 days delinquent, unless the loan is well secured and in the process of collection or sooner when management concludes or circumstances indicate that borrowers may be unable to meet contractual principal or interest payments.  When a loan is transferred to a nonaccrual status, all interest previously accrued in the current period but not collected is reversed against interest income in that period. Interest accrued in a prior period and not collected is charged-off against the allowance for loan losses.  The Company’s nonaccrual policies are the same for all classes of financing receivable.
 
If ultimate repayment of a nonaccrual loan is expected, any payments received are applied in accordance with contractual terms. If ultimate repayment of principal is not expected, any payment received on a nonaccrual loan is applied to principal until ultimate repayment becomes expected.  Nonaccrual loans are returned to accrual status when they become current as to principal and interest and demonstrate a period of performance under the contractual terms and, in the opinion of management, are fully collectible as to principal and interest.  When in the opinion of management the collection of principal appears unlikely, the loan balance is charged-off in total or in part. For loans in all portfolios, the principal amount is charged off in full or in part as soon as management determines, based on available facts, that the collection of principal in full is improbable.  For commercial loans, management considers specific facts and circumstances relative to individual credits in making such a determination.  For consumer and residential loan classes, management uses specific guidance and thresholds from the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy.
 
19

 
The following tables set forth information with regard to past due and nonperforming loans by loan class as of September 30, 2016 and December 31, 2015:
 
Age Analysis of Past Due Financing Receivables
As of September 30, 2016
(In thousands)
 
   
31-60 Days Past Due Accruing
   
61-90 Days Past Due Accruing
   
Greater Than 90 Days Past Due Accruing
   
Total Past Due Accruing
   
Nonaccrual
   
Current
   
Recorded Total Loans
 
ORIGINATED
                                         
Commercial Loans
                                         
Commercial
 
$
416
   
$
6
   
$
-
   
$
422
   
$
3,188
   
$
676,143
   
$
679,753
 
Commercial Real Estate
   
-
     
152
     
-
     
152
     
13,748
     
1,301,079
     
1,314,979
 
Agricultural
   
-
     
-
     
-
     
-
     
1,069
     
36,236
     
37,305
 
Agricultural Real Estate
   
-
     
-
     
-
     
-
     
1,686
     
30,710
     
32,396
 
Business Banking
   
1,622
     
598
     
-
     
2,220
     
3,969
     
456,902
     
463,091
 
 
   
2,038
     
756
     
-
     
2,794
     
23,660
     
2,501,070
     
2,527,524
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
14,618
     
3,559
     
2,412
     
20,589
     
1,830
     
1,523,881
     
1,546,300
 
Home Equity
   
3,420
     
864
     
383
     
4,667
     
3,083
     
452,056
     
459,806
 
Direct
   
413
     
171
     
38
     
622
     
82
     
62,722
     
63,426
 
 
   
18,451
     
4,594
     
2,833
     
25,878
     
4,995
     
2,038,659
     
2,069,532
 
Residential Real Estate Mortgages
   
2,400
     
151
     
489
     
3,040
     
6,579
     
1,023,429
     
1,033,048
 
 
 
$
22,889
   
$
5,501
   
$
3,322
   
$
31,712
   
$
35,234
   
$
5,563,158
   
$
5,630,104
 
 
                                                       
ACQUIRED
                                                       
Commercial Loans
                                                       
Commercial
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
59,215
   
$
59,215
 
Commercial Real Estate
   
-
     
-
     
834
     
834
     
1,898
     
140,390
     
143,122
 
Business Banking
   
887
     
64
     
-
     
951
     
403
     
49,928
     
51,282
 
 
   
887
     
64
     
834
     
1,785
     
2,301
     
249,533
     
253,619
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
64
     
29
     
6
     
99
     
53
     
12,157
     
12,309
 
Home Equity
   
239
     
9
     
34
     
282
     
321
     
53,003
     
53,606
 
Direct
   
11
     
-
     
-
     
11
     
42
     
3,205
     
3,258
 
 
   
314
     
38
     
40
     
392
     
416
     
68,365
     
69,173
 
Residential Real Estate Mortgages
   
822
     
127
     
248
     
1,197
     
2,765
     
203,327
     
207,289
 
   
$
2,023
   
$
229
   
$
1,122
   
$
3,374
   
$
5,482
   
$
521,225
   
$
530,081
 
Total Loans
 
$
24,912
   
$
5,730
   
$
4,444
   
$
35,086
   
$
40,716
   
$
6,084,383
   
$
6,160,185
 
 
20

 
Age Analysis of Past Due Financing Receivables
As of December 31, 2015
(In thousands)
 
   
31-60 Days Past Due Accruing
   
61-90 Days Past Due Accruing
   
Greater Than 90 Days Past Due Accruing
   
Total Past Due Accruing
   
Nonaccrual
   
Current
   
Recorded Total Loans
 
ORIGINATED
                                         
Commercial Loans
                                         
Commercial
 
$
782
   
$
23
   
$
-
   
$
805
   
$
2,817
   
$
640,696
   
$
644,318
 
Commercial Real Estate
   
39
     
32
     
-
     
71
     
5,546
     
1,189,280
     
1,194,897
 
Agricultural
   
94
     
-
     
-
     
94
     
897
     
33,633
     
34,624
 
Agricultural Real Estate
   
-
     
-
     
-
     
-
     
1,046
     
28,172
     
29,218
 
Business Banking
   
912
     
394
     
-
     
1,306
     
4,247
     
395,368
     
400,921
 
 
   
1,827
     
449
     
-
     
2,276
     
14,553
     
2,287,149
     
2,303,978
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
15,731
     
2,963
     
2,271
     
20,965
     
1,786
     
1,454,499
     
1,477,250
 
Home Equity
   
3,396
     
1,671
     
340
     
5,407
     
4,835
     
454,473
     
464,715
 
Direct
   
425
     
201
     
28
     
654
     
49
     
58,551
     
59,254
 
 
   
19,552
     
4,835
     
2,639
     
27,026
     
6,670
     
1,967,523
     
2,001,219
 
Residential Real Estate Mortgages
   
3,301
     
365
     
696
     
4,362
     
7,713
     
954,347
     
966,422
 
 
 
$
24,680
   
$
5,649
   
$
3,335
   
$
33,664
   
$
28,936
   
$
5,209,019
   
$
5,271,619
 
                                                         
ACQUIRED
                                                       
Commercial Loans
                                                       
Commercial
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
68,991
   
$
68,991
 
Commercial Real Estate
   
-
     
-
     
-
     
-
     
1,313
     
165,630
     
166,943
 
Business Banking
   
288
     
-
     
-
     
288
     
307
     
49,200
     
49,795
 
 
   
288
     
-
     
-
     
288
     
1,620
     
283,821
     
285,729
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
143
     
11
     
1
     
155
     
104
     
27,516
     
27,775
 
Home Equity
   
327
     
132
     
-
     
459
     
457
     
62,811
     
63,727
 
Direct
   
76
     
20
     
-
     
96
     
43
     
3,786
     
3,925
 
     
546
     
163
     
1
     
710
     
604
     
94,113
     
95,427
 
Residential Real Estate Mortgages
   
1,443
     
293
     
326
     
2,062
     
2,584
     
225,712
     
230,358
 
 
 
$
2,277
   
$
456
   
$
327
   
$
3,060
   
$
4,808
   
$
603,646
   
$
611,514
 
Total Loans
 
$
26,957
   
$
6,105
   
$
3,662
   
$
36,724
   
$
33,744
   
$
5,812,665
   
$
5,883,133
 

There were no material commitments to extend further credit to borrowers with nonperforming loans.
 
21


Impaired Loans
 
The methodology used to establish the allowance for loan losses on impaired loans incorporates specific allocations on loans analyzed individually.  Classified and nonperforming loans with outstanding balances of $0.8 million or more and all troubled debt restructured loans (“TDRs”) are evaluated for impairment through the Company’s quarterly status review process.  In determining that we will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreements, we consider factors such as payment history and changes in the financial condition of individual borrowers, local economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated.  For loans that are impaired as defined by accounting standards, impairment is measured by one of three methods: 1) the fair value of collateral less cost to sell, 2) present value of expected future cash flows discounted at the loan's original effective interest rate or 3) the loan’s observable market price.  All impaired loans are reviewed on a quarterly basis for changes in the level of impairment.  Any change to the previously recognized impairment loss is recognized as a change to the allowance account and recorded in the unaudited interim consolidated statements of income as a component of the provision for loan losses.

The following table provides information on loans specifically evaluated for impairment as of September 30, 2016 and December 31, 2015:
 
  
 
September 30, 2016
   
December 31, 2015
 
(In thousands)
 
Recorded Investment Balance (Book)
   
Unpaid Principal Balance (Legal)
   
Related Allowance
   
Recorded Investment Balance (Book)
   
Unpaid Principal Balance (Legal)
   
Related Allowance
 
ORIGINATED
                                   
With no related allowance recorded:
                                   
Commercial Loans
                                   
Commercial
 
$
2,174
   
$
2,441
         
$
2,244
   
$
2,490
       
Commercial Real Estate
   
8,469
     
8,602
           
3,165
     
3,175
       
Agricultural
   
133
     
139
           
576
     
1,164
       
Agricultural Real Estate
   
1,457
     
1,583
           
618
     
744
       
Business Banking
   
665
     
732
           
983
     
1,033
       
Total Commercial Loans
   
12,898
     
13,497
           
7,586
     
8,606
       
 
                                           
Consumer Loans
                                           
Indirect
   
7
     
17
           
12
     
21
       
Home Equity
   
8,495
     
9,463
           
7,681
     
8,574
       
Direct
   
-
     
-
           
-
     
-
       
Total Consumer Loans
   
8,502
     
9,480
           
7,693
     
8,595
       
 
                                           
Residential Real Estate Mortgages
   
6,088
     
6,910
           
6,017
     
6,627
       
Total
   
27,488
     
29,887
           
21,296
     
23,828
       
 
                                           
With an allowance recorded:
                                           
Commercial Loans
                                           
Commercial
   
1,014
     
1,022
   
$
555
     
457
     
457
   
$
300
 
Commercial Real Estate
   
7,476
     
9,324
     
2,035
     
4,210
     
6,059
     
970
 
Agricultural
   
50
     
50
     
37
     
-
     
-
     
-
 
Agricultural Real Estate
   
156
     
156
     
54
     
-
     
-
     
-
 
Total Commercial Loans
   
8,696
     
10,552
     
2,681
     
4,667
     
6,516
     
1,270
 
                                                 
ACQUIRED
                                               
With an allowance recorded:
                                               
Commercial Loans
                                               
Commercial Real Estate
   
1,205
     
1,321
     
691
     
1,205
     
1,321
     
735
 
Total Commercial Loans
   
1,205
     
1,321
     
691
     
1,205
     
1,321
     
735
 
                                                 
Total:
 
$
37,389
   
$
41,760
   
$
3,372
   
$
27,168
   
$
31,665
   
$
2,005
 
 
22

 
The following tables summarize the average recorded investments on impaired loans specifically evaluated for impairment and the interest income recognized for the three and nine months ended September 30, 2016 and 2015:
 
 
 
For the three months ended
 
 
 
September 30, 2016
   
September 30, 2015
 
(In thousands)
 
Average Recorded Investment
   
Interest Income Recognized
   
Average Recorded Investment
   
Interest Income Recognized
 
ORIGINATED
                       
Commercial Loans
                       
Commercial
 
$
3,204
   
$
-
   
$
2,469
   
$
42
 
Commercial Real Estate
   
15,799
     
48
     
8,560
     
42
 
Agricultural
   
85
     
-
     
19
     
-
 
Agricultural Real Estate
   
935
     
11
     
626
     
11
 
Business Banking
   
743
     
-
     
1,003
     
3
 
Consumer Loans
                               
Indirect
   
8
     
-
     
20
     
-
 
Home Equity
   
8,401
     
116
     
7,432
     
134
 
Direct
   
-
     
-
     
-
     
-
 
Residential Real Estate Mortgage
   
6,141
     
76
     
5,564
     
37
 
Total Originated
 
$
35,316
   
$
251
   
$
25,693
   
$
269
 
 
                               
ACQUIRED
                               
Commercial Loans
                               
Commercial
   
-
     
-
     
2,531
     
-
 
Commercial Real Estate
   
1,205
     
-
     
6,918
     
-
 
Total Acquired
 
$
1,205
   
$
-
   
$
9,449
   
$
-
 
Total Loans
 
$
36,521
   
$
251
   
$
35,142
   
$
269
 

 
 
For the nine months ended
 
 
 
September 30, 2016
   
September 30, 2015
 
(In thousands)
 
Average Recorded Investment
   
Interest Income Recognized
   
Average Recorded Investment
   
Interest Income Recognized
 
ORIGINATED
                       
Commercial Loans
                       
Commercial
 
$
3,041
   
$
-
   
$
2,026
   
$
128
 
Commercial Real Estate
   
14,782
     
122
     
8,884
     
124
 
Agricultural
   
101
     
1
     
19
     
1
 
Agricultural Real Estate
   
742
     
33
     
630
     
34
 
Business Banking
   
882
     
7
     
952
     
9
 
Consumer Loans
                               
Indirect
   
9
     
-
     
14
     
-
 
Home Equity
   
8,207
     
357
     
6,869
     
298
 
Direct
   
-
     
-
     
1
     
-
 
Residential Real Estate Mortgage
   
6,147
     
211
     
4,857
     
100
 
Total Originated
 
$
33,911
   
$
731
   
$
24,252
   
$
694
 
                                 
ACQUIRED
                               
Commercial Loans
                               
Commercial
   
-
     
-
     
2,658
     
-
 
Commercial Real Estate
   
1,205
     
-
     
7,070
     
-
 
Total Acquired
 
$
1,205
   
$
-
   
$
9,728
   
$
-
 
Total Loans
 
$
35,116
   
$
731
   
$
33,980
   
$
694
 
 
23

 
Credit Quality Indicators
 
The Company has developed an internal loan grading system to evaluate and quantify the Company’s loan portfolio with respect to quality and risk.  The system focuses on, among other things, financial strength of borrowers, experience and depth of borrower’s management, primary and secondary sources of repayment, payment history, nature of the business and outlook on particular industries.  The internal grading system enables the Company to monitor the quality of the entire loan portfolio on a consistent basis and provide management with an early warning system, enabling recognition and response to problem loans and potential problem loans.
 
Commercial Grading System
 
For commercial and agricultural loans, the Company uses a grading system that relies on quantifiable and measurable characteristics when available.  This would include comparison of financial strength to available industry averages, comparison of transaction factors (loan terms and conditions) to loan policy and comparison of credit history to stated repayment terms and industry averages. Some grading factors are necessarily more subjective such as economic and industry factors, regulatory environment, and management.  Classified commercial loans consist of loans graded substandard and below.  The grading system for commercial and agricultural loans is as follows:

Doubtful
A doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as a loss is deferred. Doubtful borrowers are usually in default, lack adequate liquidity or capital and lack the resources necessary to remain an operating entity. Pending events can include mergers, acquisitions, liquidations, capital injections, the perfection of liens on additional collateral, the valuation of collateral and refinancing. Generally, pending events should be resolved within a relatively short period and the ratings will be adjusted based on the new information. Nonaccrual treatment is required for doubtful assets because of the high probability of loss.
 
Substandard
Substandard loans have a high probability of payment default or they have other well-defined weaknesses. They require more intensive supervision by bank management. Substandard loans are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants. For some Substandard loans, the likelihood of full collection of interest and principal may be in doubt and those loans should be placed on nonaccrual. Although Substandard assets in the aggregate will have a distinct potential for loss, an individual asset’s loss potential does not have to be distinct for the asset to be rated Substandard.
 
Special Mention
Special Mention loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weakness does not yet justify a Substandard classification. Borrowers may be experiencing adverse operating trends (declining revenues or margins) or may be struggling with an ill-proportioned balance sheet (e.g., increasing inventory without an increase in sales, high leverage, tight liquidity). Adverse economic or market conditions, such as interest rate increases or the entry of a new competitor, may also support a Special Mention rating. Although a Special Mention loan has a higher probability of default than a pass asset, its default is not imminent.
 
Pass
Loans graded as Pass encompass all loans not graded as Doubtful, Substandard or Special Mention.  Pass loans are in compliance with loan covenants and payments are generally made as agreed.  Pass loans range from superior quality to fair quality.
 
24


Business Banking Grading System
 
Business banking loans are graded as either Classified or Non-classified:

Classified
Classified loans are inadequately protected by the current worth and paying capacity of the obligor or, if applicable, the collateral pledged.   These loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt, or in some cases make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.   Classified loans have a high probability of payment default or a high probability of total or substantial loss.  These loans require more intensive supervision by management and are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity or marginal capitalization.  Repayment may depend on collateral or other credit risk mitigants.  When the likelihood of full collection of interest and principal may be in doubt; classified loans are considered to have a nonaccrual status.   In some cases, Classified loans are considered uncollectible and of such little value that their continuance as assets is not warranted.
 
Non-classified
Loans graded as Non-classified encompass all loans not graded as Classified.  Non-classified loans are in compliance with loan covenants and payments are generally made as agreed and it is expected that such timely payments of principal and interest will continue.
 
Consumer and Residential Mortgage Grading System
 
Consumer and Residential Mortgage loans are graded as either Performing or Nonperforming.   Nonperforming loans are loans that are 1) over 90 days past due and interest is still accruing, 2) on nonaccrual status or 3) restructured.  All loans not meeting any of these three criteria are considered Performing.
 
25


The following tables illustrate the Company’s credit quality by loan class as of September 30, 2016 and December 31, 2015:
 
Credit Quality Indicators
As of September 30, 2016
(In thousands)
 
ORIGINATED
                             
Commercial Credit Exposure By Internally Assigned Grade:
 
Commercial
   
Commercial Real Estate
   
Agricultural
   
Agricultural Real Estate
   
Total
 
Pass
 
$
631,244
   
$
1,262,056
   
$
36,493
   
$
29,254
   
$
1,959,047
 
Special Mention
   
9,307
     
13,110
     
1
     
1,480
     
23,898
 
Substandard
   
39,202
     
39,813
     
806
     
1,662
     
81,483
 
Doubtful
   
-
     
-
     
5
     
-
     
5
 
Total
 
$
679,753
   
$
1,314,979
   
$
37,305
   
$
32,396
   
$
2,064,433
 
 
                                       
Business Banking Credit Exposure By Internally Assigned Grade:
 
Business Banking
                           
Total
 
Non-classified
 
$
449,947
                           
$
449,947
 
Classified
   
13,144
                             
13,144
 
Total
 
$
463,091
                           
$
463,091
 
 
                                       
Consumer Credit Exposure By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
 
$
1,542,058
   
$
456,340
   
$
63,306
           
$
2,061,704
 
Nonperforming
   
4,242
     
3,466
     
120
             
7,828
 
Total
 
$
1,546,300
   
$
459,806
   
$
63,426
           
$
2,069,532
 
 
                                       
Residential Mortgage Credit Exposure By Payment Activity:
 
Residential Mortgage
                           
Total
 
Performing
 
$
1,025,980
                           
$
1,025,980
 
Nonperforming
   
7,068
                             
7,068
 
Total
 
$
1,033,048
                           
$
1,033,048
 
 
26


Credit Quality Indicators
As of September 30, 2016
(In thousands)
 
ACQUIRED
                       
Commercial Credit Exposure By Internally Assigned Grade:
 
Commercial
   
Commercial Real Estate
         
Total
 
Pass
 
$
57,040
   
$
131,985
         
$
189,025
 
Special Mention
   
171
     
1,248
           
1,419
 
Substandard
   
2,004
     
9,889
           
11,893
 
Total
 
$
59,215
   
$
143,122
         
$
202,337
 
 
                             
Business Banking Credit Exposure By Internally Assigned Grade:
 
Business Banking
                 
Total
 
Non-classified
 
$
47,983
                 
$
47,983
 
Classified
   
3,299
                   
3,299
 
Total
 
$
51,282
                 
$
51,282
 
 
                             
Consumer Credit Exposure By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
   
Total
 
Performing
 
$
12,250
   
$
53,251
   
$
3,216
   
$
68,717
 
Nonperforming
   
59
     
355
     
42
     
456
 
Total
 
$
12,309
   
$
53,606
   
$
3,258
   
$
69,173
 
 
                               
Residential Mortgage Credit Exposure By Payment Activity:
 
Residential Mortgage
                   
Total
 
Performing
 
$
204,276
                   
$
204,276
 
Nonperforming
   
3,013
                     
3,013
 
Total
 
$
207,289
                   
$
207,289
 
 
27


Credit Quality Indicators
As of December 31, 2015
(In thousands)
 
ORIGINATED
                             
Commercial Credit Exposure By Internally Assigned Grade:
 
Commercial
   
Commercial Real Estate
   
Agricultural
   
Agricultural Real Estate
   
Total
 
Pass
 
$
604,405
   
$
1,144,832
   
$
33,565
   
$
27,320
   
$
1,810,122
 
Special Mention
   
9,726
     
21,587
     
311
     
429
     
32,053
 
Substandard
   
30,187
     
28,478
     
740
     
1,469
     
60,874
 
Doubtful
   
-
     
-
     
8
     
-
     
8
 
Total
 
$
644,318
   
$
1,194,897
   
$
34,624
   
$
29,218
   
$
1,903,057
 
 
                                       
Business Banking Credit Exposure By Internally Assigned Grade:
 
Business Banking
                           
Total
 
Non-classified
 
$
386,397
                           
$
386,397
 
Classified
   
14,524
                             
14,524
 
Total
 
$
400,921
                           
$
400,921
 
Total
                                       
Consumer Credit Exposure By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
 
$
1,473,193
   
$
459,540
   
$
59,177
           
$
1,991,910
 
Nonperforming
   
4,057
     
5,175
     
77
             
9,309
 
Total
 
$
1,477,250
   
$
464,715
   
$
59,254
           
$
2,001,219
 
 
                                       
Residential Mortgage Credit Exposure By Payment Activity:
 
Residential Mortgage
                           
Total
 
Performing
 
$
958,013
                           
$
958,013
 
Nonperforming
   
8,409
                             
8,409
 
Total
 
$
966,422
                           
$
966,422
 
 
28


Credit Quality Indicators
As of December 31, 2015
(In thousands)
 
 ACQUIRED
                       
Commercial Credit Exposure By Internally Assigned Grade:
 
Commercial
   
Commercial Real Estate
         
Total
 
Pass
 
$
67,241
   
$
154,871
         
$
222,112
 
Special Mention
   
802
     
2,174
           
2,976
 
Substandard
   
948
     
9,898
           
10,846
 
Total
 
$
68,991
   
$
166,943
         
$
235,934
 
 
                             
Business Banking Credit Exposure By Internally Assigned Grade:
 
Business Banking
                 
Total
 
Non-classified
 
$
46,032
                 
$
46,032
 
Classified
   
3,763
                   
3,763
 
Total
 
$
49,795
                 
$
49,795
 
 
                             
Consumer Credit Exposure By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
   
Total
 
Performing
 
$
27,670
   
$
63,270
   
$
3,882
   
$
94,822
 
Nonperforming
   
105
     
457
     
43
     
605
 
Total
 
$
27,775
   
$
63,727
   
$
3,925
   
$
95,427
 
 
                               
Residential Mortgage Credit Exposure By Payment Activity:
 
Residential Mortgage
                   
Total
 
Performing
 
$
227,448
                   
$
227,448
 
Nonperforming
   
2,910
                     
2,910
 
Total
 
$
230,358
                   
$
230,358
 
  
Troubled Debt Restructured Loans
 
The Company’s loan portfolio includes certain loans that have been modified where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.  Substantially all of these modifications included one or a combination of the following: an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; temporary reduction in the interest rate; or change in scheduled payment amount.
 
When the Company modifies a loan, management evaluates any possible impairment based on the present value of the expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral.  In these cases, management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows.  If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.  
 
29


The following tables illustrate the recorded investment and number of modifications for modified loans, including the recorded investment in the loans prior to a modification and the recorded investment in the loans after restructuring for the three and nine months ended September 30, 2016 and 2015 (dollars in thousands):
 
   
Three months ended September 30, 2016
 
   
Number of contracts
   
Pre-Modification Outstanding Recorded Investment
   
Post-Modification Outstanding Recorded Investment
 
Consumer
                 
Home Equity
   
10
   
$
580
   
$
556
 
Total Consumer
   
10
     
580
     
556
 
Residential Real Estate
   
4
     
230
     
126
 
Total Troubled Debt Restructurings
   
14
   
$
810
   
$
682
 
 
 
 
Three months ended September 30, 2015
 
  
 
Number of contracts
   
Pre-Modification Outstanding Recorded Investment
   
Post-Modification Outstanding Recorded Investment
 
Consumer
                 
Home Equity
   
12
   
$
863
   
$
802
 
Total Consumer
   
12
     
863
     
802
 
Residential Real Estate
   
16
     
1,293
     
1,191
 
Total Troubled Debt Restructurings
   
28
   
$
2,156
   
$
1,993
 
 
30

 
   
Nine months ended September 30, 2016
 
  
 
Number of contracts
   
Pre-Modification Outstanding Recorded Investment
   
Post-Modification Outstanding Recorded Investment
 
Consumer
                 
Home Equity
   
24
   
$
1,690
   
$
1,567
 
Total Consumer
   
24
     
1,690
     
1,567
 
Residential Real Estate
   
10
     
914
     
692
 
Total Troubled Debt Restructurings
   
34
   
$
2,604
   
$
2,259
 

   
Nine months ended September 30, 2015
 
  
 
Number of contracts
   
Pre-Modification Outstanding Recorded Investment
   
Post-Modification Outstanding Recorded Investment
 
Commercial
                 
Commercial
   
1
   
$
1,250
   
$
186
 
Business Banking
   
1
     
220
     
173
 
Total Commercial
   
2
     
1,470
     
359
 
Consumer
                       
Home Equity
   
43
     
3,321
     
3,017
 
Total Consumer
   
43
     
3,321
     
3,017
 
Residential Real Estate
   
32
     
3,066
     
2,854
 
Total Troubled Debt Restructurings
   
77
   
$
7,857
   
$
6,230
 
 

31


The following table illustrates the recorded investment and number of modifications for TDRs within the three and nine months ended September 30, 2016 and 2015 where a concession has been made and subsequently defaulted during the period (dollars in thousands):

   
Three months ended September 30, 2016
   
Three months ended September 30, 2015
 
(Dollars in thousands)
 
Number of contracts
   
Recorded Investment
   
Number of contracts
   
Recorded Investment
 
Consumer
                       
Home Equity
   
2
   
$
121
     
-
   
$
-
 
 
                               
Residential Real Estate
   
1
     
121
     
2
     
174
 
 
                               
Total Troubled Debt Restructurings
   
3
   
$
242
     
2
   
$
174
 

   
Nine months ended September 30, 2016
   
Nine months ended September 30, 2015
 
   
Number of contracts
   
Recorded Investment
   
Number of contracts
   
Recorded Investment
 
Consumer
                       
Home Equity
   
2
   
$
121
     
4
   
$
343
 
 
                               
Residential Real Estate
   
2
     
296
     
2
     
174
 
 
                               
Total Troubled Debt Restructurings
   
4
   
$
417
     
6
   
$
517
 
 
32


Note 5.
Defined Benefit Postretirement Plans
 
The Company has a qualified, noncontributory, defined benefit pension plan (“the Plan”) covering substantially all of its employees at September 30, 2016.  Benefits paid from the plan are based on age, years of service, compensation and social security benefits and are determined in accordance with defined formulas. The Company’s policy is to fund the pension plan in accordance with Employee Retirement Income Security Act of 1974 (“ERISA”) standards. Assets of the plan are invested in publicly traded stocks and bonds.  The Company is not required to make contributions to the Plan in 2016. However, the Company made contributions to the plan totaling $5.6 million during the nine months ended September 30, 2016.
 
Market conditions can result in an unusually high degree of volatility and increase the risks and short-term liquidity associated with certain investments held by the Plan which could impact the value of these investments.

In addition to the Plan, the Company also provides supplemental employee retirement plans to certain current and former executives.  These supplemental employee retirement plans and the Plan are collectively referred to herein as “Pension Benefits.”

Also, the Company provides certain health care benefits for retired employees. Benefits are accrued over the employees’ active service period. Only employees that were employed by the Company on or before January 1, 2000 are eligible to receive postretirement health care benefits. In addition, the Company assumed post-retirement medical life insurance benefits for certain Alliance employees, retirees and their spouses, if applicable, in the Alliance acquisition. These postretirement benefits are referred to herein as “Other Benefits.” The components of expense for Pension Benefits and Other Benefits are set forth below (in thousands):

 
 
Pension Benefits
   
Other Benefits
 
 
 
Three months ended September 30,
   
Three months ended September 30,
 
Components of net periodic (benefit) cost:
 
2016
   
2015
   
2016
   
2015
 
Service cost
 
$
534
   
$
669
   
$
3
   
$
4
 
Interest cost
   
1,050
     
996
     
89
     
101
 
Expected return on plan assets
   
(1,857
)
   
(2,147
)
   
-
     
-
 
Net amortization
   
504
     
550
     
15
     
1
 
Total cost
 
$
231
   
$
68
   
$
107
   
$
106
 

 
 
Pension Benefits
   
Other Benefits
 
 
 
Nine months ended September 30,
   
Nine months ended September 30,
 
Components of net periodic (benefit) cost:
 
2016
   
2015
   
2016
   
2015
 
Service cost
 
$
1,654
   
$
1,979
   
$
10
   
$
12
 
Interest cost
   
3,151
     
2,992
     
277
     
283
 
Expected return on plan assets
   
(5,527
)
   
(6,447
)
   
-
     
-
 
Net amortization
   
1,471
     
1,642
     
73
     
31
 
Total cost
 
$
749
   
$
166
   
$
360
   
$
326
 
 
33


Note 6.
Earnings Per Share
 
Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (such as the Company’s dilutive stock options and restricted stock units).
 
The following is a reconciliation of basic and diluted earnings per share for the periods presented in the unaudited interim consolidated statements of income.
 
Three months ended September 30,
 
2016
   
2015
 
(In thousands, except per share data)
           
Basic EPS:
           
Weighted average common shares outstanding
   
43,200
     
43,692
 
Net income
 
$
20,001
   
$
19,851
 
Basic EPS
 
$
0.46
   
$
0.45
 
                 
Diluted EPS:
               
Weighted average common shares outstanding
   
43,200
     
43,692
 
Dilutive effect of common stock options and restricted stock
   
362
     
570
 
Weighted average common shares and common share equivalents
   
43,562
     
44,262
 
Net income
 
$
20,001
   
$
19,851
 
Diluted EPS
 
$
0.46
   
$
0.45
 
 
Nine months ended September 30,
 
2016
   
2015
 
(In thousands, except per share data)
           
Basic EPS:
           
Weighted average common shares outstanding
   
43,214
     
43,949
 
Net income
 
$
58,801
   
$
57,298
 
Basic EPS
 
$
1.36
   
$
1.30
 
                 
Diluted EPS:
               
Weighted average common shares outstanding
   
43,214
     
43,949
 
Dilutive effect of common stock options and restricted stock
   
366
     
519
 
Weighted average common shares and common share equivalents
   
43,580
     
44,468
 
Net income
 
$
58,801
   
$
57,298
 
Diluted EPS
 
$
1.35
   
$
1.29
 

There were no stock options for the quarter ended September 30, 2016 and 36,360 stock options for the quarter ended September 30, 2015 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

There were 36,865 and 334,759 stock options for the nine months ended September 30, 2016 and September 30, 2015 respectively, that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.
 
34


Note 7.
Reclassification Adjustments Out of Other Comprehensive Income (Loss)

The following table summarizes the reclassification adjustments out of accumulated other comprehensive income (loss) (in thousands):
 
Detail About Accumulated Other Comprehensive Income (Loss) Components
 
Amount reclassified from accumulated other comprehensive income (loss)
 
Affected line item in the consolidated statement of comprehensive income (loss)
 
 
Three months ended
 
 
 
 
September 30, 2016
   
September 30, 2015
 
 
Securities:
           
     
Gains on available for sale securities
 
$
-
   
$
(3
)
Net securities gains
Amortization of unrealized gains and losses related to securities transfer
   
267
     
328
 
Interest income
Tax benefit
   
(105
)
   
(127
)
Income tax expense
Net of tax
 
$
162
   
$
198
 
 
 
               
      
Pension and other benefits:
               
     
Amortization of net losses
 
$
565
   
$
566
 
Salaries and employee benefits
Amortization of prior service costs
   
(46
)
   
(15
)
Salaries and employee benefits
Tax benefit
   
(202
)
   
(214
)
Income tax expense
Net of tax
 
$
317
   
$
337
 
 
 
               
      
Total reclassifications during the period, net of tax
 
$
479
   
$
535
 
 
 
Detail About Accumulated Other Comprehensive Income (Loss) Components
 
Amount reclassified from accumulated other comprehensive income (loss)
 
Affected line item in the consolidated statement of comprehensive income (loss)
 
 
Nine months ended
 
 
 
 
September 30, 2016
   
September 30, 2015
 
 
Securities:
           
      
Gains on available for sale securities
 
$
(30
)
   
(43
)
Net securities gains
Amortization of unrealized gains and losses related to securities transfer
   
843
     
999
 
Interest income
Tax benefit
   
(317
)
   
(372
)
Income tax expense
Net of tax
 
$
496
   
$
584
 
 
 
               
       
Pension and other benefits:
               
      
Amortization of net losses
 
$
1,595
   
$
1,697
 
Salaries and employee benefits
Amortization of prior service costs
   
(51
)
   
(24
)
Salaries and employee benefits
Tax benefit
   
(601
)
   
(652
)
Income tax expense
Net of tax
 
$
943
   
$
1,021
 
 
 
               
       
Total reclassifications during the period, net of tax
 
$
1,439
   
$
1,605
 
 
 
35


Note 8.
Fair Value Measurements and Fair Value of Financial Instruments
 
GAAP states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  Fair value measurements are not adjusted for transaction costs.  A fair value hierarchy exists within GAAP that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
 
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
 
Level 2 -  Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;
 
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
 
The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, many other sovereign government obligations, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within Level 1 or Level 2 of the fair value hierarchy.  The Company does not adjust the quoted prices for such instruments.
 
The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid agency securities, less liquid listed equities, state, municipal and provincial obligations and certain physical commodities. Such instruments are generally classified within Level 2 of the fair value hierarchy.
 
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets and changes in financial ratios or cash flows.
 
For the nine month period ending September 30, 2016, the Company has made no transfers of assets between Level 1 and Level 2 and has had no Level 3 activity.
 
36


The following tables set forth the Company’s financial assets and liabilities measured on a recurring basis that were accounted for at fair value.  Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands):
 
September 30, 2016:
 
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance as of
September 30, 2016
 
Assets:
                       
Securities Available for Sale:
                       
Federal Agency
 
$
-
   
$
256,093
   
$
-
   
$
256,093
 
State & municipal
   
-
     
38,654
     
-
     
38,654
 
Mortgage-backed
   
-
     
372,364
     
-
     
372,364
 
Collateralized mortgage obligations
   
-
     
601,470
     
-
     
601,470
 
Other securities
   
10,964
     
9,354
     
-
     
20,318
 
Total Securities Available for Sale
 
$
10,964
   
$
1,277,935
   
$
-
   
$
1,288,899
 
Trading Securities
   
8,852
     
-
     
-
     
8,852
 
Interest Rate Swaps
   
-
     
18,977
     
-
     
18,977
 
Total
 
$
19,816
   
$
1,296,912
   
$
-
   
$
1,316,728
 
 
                               
Liabilities:
                               
Interest Rate Swaps
 
$
-
   
$
18,258
   
$
-
   
$
18,258
 
Total
 
$
-
   
$
18,258
   
$
-
   
$
18,258
 
 
December 31, 2015:
 
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Balance as of
December 31, 2015
 
Assets:
                       
Securities Available for Sale:
                       
Federal Agency
 
$
-
   
$
311,272
   
$
-
   
$
311,272
 
State & municipal
   
-
     
31,637
     
-
     
31,637
 
Mortgage-backed
   
-
     
409,896
     
-
     
409,896
 
Collateralized mortgage obligations
   
-
     
404,971
     
-
     
404,971
 
Other securities
   
7,526
     
9,242
     
-
     
16,768
 
Total Securities Available for Sale
 
$
7,526
   
$
1,167,018
   
$
-
   
$
1,174,544
 
Trading Securities
   
8,377
     
-
     
-
     
8,377
 
Interest Rate Swaps
   
-
     
6,224
     
-
     
6,224
 
Total
 
$
15,903
   
$
1,173,242
   
$
-
   
$
1,189,145
 
 
                               
Liabilities:
                               
Interest Rate Swaps
 
$
-
   
$
6,224
   
$
-
   
$
6,224
 
Total
 
$
-
   
$
6,224
   
$
-
   
$
6,224
 
 
37


Certain common equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices).  The majority of the other investment securities are reported at fair value utilizing Level 2 inputs.  The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities.  Prices obtained from these sources include prices derived from market quotations and matrix pricing.  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.  Management reviews the methodologies used in pricing the securities by its third party providers. 

GAAP requires disclosure of assets and liabilities measured and recorded at fair value on a nonrecurring basis such as goodwill, loans held for sale, other real estate owned, collateral-dependent impaired loans, mortgage servicing rights and held to maturity securities. The Company had two nonrecurring fair value measurements recorded during the nine month period ended September 30, 2016 related to impairment of goodwill and impaired loans. As a result of the disposition of a line of business, the Company performed a goodwill impairment test which resulted in an impairment charge; the impairment charge was offset by an increase in goodwill resulting from the acquisition of a subsidiary causing goodwill to decrease by $1.2 million during the three months ended September 30, 2016.  For the nine month periods ending September 30, 2016 and September 30, 2015, the Company had $9.9 million of loans recorded at fair value resulting in specific allowance reserves of $3.2 million and $3.4 million, respectively.  The Company uses the fair value of underlying collateral, less costs to sell, to estimate the specific reserves for collateral dependent impaired loans.  The appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses ranging from 10% to 35%. Based on the valuation techniques used, the fair value measurements for collateral dependent impaired loans are classified as Level 3.

The following table sets forth information with regard to estimated fair values of financial instruments at September 30, 2016 and December 31, 2015.  This table excludes financial instruments for which the carrying amount approximates fair value.  Financial instruments for which the fair value approximates carrying value include cash and cash equivalents, securities available for sale, trading securities, accrued interest receivable, non-maturity deposits, short-term borrowings, accrued interest payable and interest rate swaps.
 
 
       
September 30, 2016
   
December 31, 2015
 
(In thousands)
 
Fair Value Hierarchy
   
Carrying amount
   
Estimated fair value
   
Carrying amount
   
Estimated fair value
 
Financial assets
                             
Securities held to maturity
   
2
   
$
485,877
   
$
495,596
   
$
471,031
   
$
473,140
 
Net loans
   
3
     
6,094,517
     
6,251,740
     
5,820,115
     
5,958,427
 
Financial liabilities
                                       
Time deposits
   
2
   
$
881,087
   
$
883,221
   
$
908,827
   
$
903,501
 
Long-term debt
   
2
     
114,144
     
115,840
     
130,447
     
131,268
 
Junior subordinated debt
   
2
     
101,196
     
101,141
     
101,196
     
97,346
 

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
 
38


Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has a substantial trust and investment management operation that contributes net fee income annually. The trust and investment management operation is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities include the benefits resulting from the low-cost funding of deposit liabilities as compared to the cost of borrowing funds in the market and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimate of fair value.

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.
 
Net 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 and 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.
 
Long-Term Debt
 
The fair value of long-term debt was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.
 
Junior Subordinated Debt
 
The fair value of junior subordinated debt has been estimated using a discounted cash flow analysis.

Interest Rate Swaps
 
The Company enters into interest rate swaps to facilitate customer transactions and meet their financing needs. These swaps are considered derivatives, but are not designated in hedging relationships. These instruments have interest rate and credit risk associated with them. To mitigate the interest rate risk, the Company enters into offsetting interest rate swaps with counterparties. The counterparty swaps are also considered derivatives and are also not designated in hedging relationships. Interest rate swaps are recorded within other assets or other liabilities on the consolidated balance sheet at their estimated fair value. Changes to the fair value of assets and liabilities arising from these derivatives are included, net, in other operating income in the consolidated statement of income. The notional amount of these customer derivative agreement and the offsetting derivative counterparty positions each totaled $344.4 million at September 30, 2016. Fair values included in other assets and other liabilities on the consolidated balance sheet applicable to these agreements amounted to $18.3 million. At December 31, 2015, the notional amount of these customer derivate agreements and the offsetting derivative counterparty positions each totaled $192.6 million. At December 31, 2015, fair values included in other assets and other liabilities on the consolidated balance sheet applicable to these agreements amounted to $6.2 million.

In June 2016, the Company entered into interest rate swaps to modify the interest rate characteristics of certain short-term FHLB advances from variable rate to fixed rate in order to reduce the impact of changes in future cash flows due to market interest rate changes. These agreements are designated as cash flow hedges. The notional amount of these interest rate derivative agreements total $150 million at September 30, 2016. Fair values included in other assets on the consolidated balance sheet applicable to these agreements amounted to $0.7 million at September 30, 2016.
 
39


Note 9.
Commitments and Contingencies
 
The Company is a party to financial instruments in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuating interest rates. These financial instruments include commitments to extend credit, unused lines of credit and standby letters of credit. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  Commitments to extend credit and unused lines of credit totaled $1.4 billion at September 30, 2016 and $1.3 billion at December 31, 2015.  Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management’s credit evaluation of the borrower and may include accounts receivable, inventory, property, land and other items.
 
The Company guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are frequently issued in support of third party debt, such as corporate debt issuances, industrial revenue bonds and municipal securities. The credit risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash commitments. Standby letters of credit totaled $38.8 million at September 30, 2016 and $31.5 million at December 31, 2015.  As of September 30, 2016, the fair value of standby letters of credit was not significant to the Company’s unaudited interim consolidated financial statements.
 
The Company has also entered into commercial letter of credit agreements on behalf of its customers.  Under these agreements, the Company, on the request of its customer, opens the letter of credit and makes a commitment to honor draws made under the agreement, whereby the beneficiary is normally the provider of goods and/or services and the Company essentially replaces the customer as the payee.  The credit risk involved in issuing commercial letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  Typically, these agreements vary in terms and the total amounts do not necessarily represent future cash commitments.  There were no commercial letters of credit at September 30, 2016 and $11.3 million at December 31, 2015.  

Note 10.
Recent Accounting Pronouncements

In August 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments). ASU 2016-15 addresses diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This standard addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for the Company on January 1, 2018. Early adoption is permitted, including adoption in an interim period. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-16 amends the accounting for credit losses on available for sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 is effective for the Company on January 1, 2020. Early adoption is permitted for all organizations for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.
 
40

 
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 simplifies the accounting for stock-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for the Company on January 1, 2017. Early adoption is permitted in any interim or annual period. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-07, Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 eliminates the requirement for an investor to adjust an equity method investment, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held as a result of an increase in the level of ownership interest or degree of influence. Additionally, an entity that has an available for sale equity security that becomes qualified for the equity method of accounting must recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. ASU 2016-07 is effective for the Company on January 1, 2017. Early adoption is permitted in any interim or annual period. Management does not believe the guidance will have a material impact on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-06, Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments. ASU 2016-06 clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence.  The amendments in this ASU clarify what steps are required when assessing whether the economic characteristics and risks of call (put) options are clearly and closely related to the economic characteristics and risks of their debt hosts, which is one of the criteria for bifurcating an embedded derivative. Consequently, when a call (put) option is contingently exercisable, an entity does not have to assess whether the event that triggers the ability to exercise a call (put) option is related to interest rates or credit risks. The amendments are an improvement to GAAP because they eliminate diversity in practice in assessing embedded contingent call (put) options in debt instruments.  ASU 2016-07 is effective for the Company on January 1, 2017. Early adoption is permitted in any interim or annual period. Management does not believe this guidance will have a material impact on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. ASU 2016-05 clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. ASU 2016-05 is effective for the Company on January 1, 2017. Early adoption is permitted in any interim or annual period. Management does not believe this guidance will have a material impact on the consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASU 2016-02 requires lessees to recognize right of use assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize a right of use asset and lease liability. Additionally, when measuring assets and liabilities arising from a lease, optional payments should be included only if the lessee is reasonable certain to exercise an option to extend the lease, exercise a purchase option or not exercise an option to terminate the lease. ASU 2016-07 is effective for the Company on January 1, 2019. Early adoption is permitted in any interim or annual period. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments and requires entities to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value. Any changes in fair value will be recognized in net income unless the investments qualify for a new practicability exception. This ASU also requires entities to recognize changes in instrument-specific credit risk related to financial liabilities measured under the fair value option in other comprehensive income. No changes were made to the guidance for classifying and measuring investments in debt securities and loans. ASU 2016-01 is effective for the Company on January 1, 2018. Early adoption is permitted in any interim or annual period. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.

In May 2014, the FASB issued ASU No. 2014-09 - Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. ASU 2014-09 was initially effective for the Company on January 1, 2017; however, in August 2015, the FASB issued ASU No. 2015-14 - Revenue from Contracts with Customers - Deferral of the Effective Date, which deferred the effective date to January 1, 2018. Early adoption is not permitted.  In addition, the FASB has begun to issue targeted updates to clarify specific implementation issues of ASU 2014-09. These updates include ASU No. 2016-08 - Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU No. 2016-10 - Identifying Performance Obligations and Licensing and ASU No. 2016-12 - Narrow-Scope Improvements and Practical Expedients. Management is evaluating the effect that this guidance will have on the consolidated financial statements and related disclosures.
 
41

 
NBT BANCORP INC. AND SUBSIDIARIES
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The purpose of this discussion and analysis is to provide a concise description of the financial condition and results of operations of NBT Bancorp Inc. and its wholly owned consolidated subsidiaries, including NBT Bank, N.A. (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”) and NBT Holdings, Inc. (“NBT Holdings”) (collectively referred to herein as the “Company”). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10Q as well as to the Company's Annual Report on Form 10K for the year ended December 31, 2015 for an understanding of the following discussion and analysis.  Operating results for the nine-month period ending September 30, 2016 are not necessarily indicative of the results of the full year ending December 31, 2016 or any future period.

Forward-looking Statements

Certain statements in this filing and future filings by the Company with the SEC, in the Company’s press releases or other public or shareholder communications or in oral statements made with the approval of an authorized executive officer, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,”  “projects,”  “will,”  “can,” “would,” “should,” “could,” “may,” or other similar terms. There are a number of factors, many of which are beyond the Company’s control that could cause actual results to differ materially from those contemplated by the forward looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact; (2) changes in the level of nonperforming assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply including those under the Dodd-Frank Act; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board ("FASB") and other accounting standard setters; (17) changes in the Company’s organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; and (20) the Company’s success at managing the risks involved in the foregoing items.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made and advises readers that various factors, including those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the Securities and Exchange Commission, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.

Unless required by law, the Company does not undertake and specifically disclaims any obligations 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.
 
42


Non-GAAP Measures

This Quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America ("GAAP").  These measures adjust GAAP measures to exclude the effects of acquisition-related intangible amortization expense on earnings and equity as well as providing a fully taxable equivalent yield on securities and loans. Where non-GAAP disclosures are used in this Form 10-Q, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying tables.  Management believes that these non-GAAP measures provide useful information that is important to an understanding of the results of the NBT’s core business as well as provide information standard in the financial institution industry. Non-GAAP measures should not be considered substitutes for financial measures determined in accordance with GAAP and investors should consider NBT’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of NBT.

Critical Accounting Policies

The Company has identified policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, pension accounting, other-than-temporary impairment, provision for income taxes and intangible assets.

Management  of  the  Company  considers  the  accounting  policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty  in  evaluating  the level of the allowance required to cover credit losses inherent in the loan portfolio and the material effect that such judgments can have on the results of operations. While management’s current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance may need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provision for loan losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Company’s nonperforming loans and potential problem loans have a significant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral values were significantly lower, the Company’s allowance for loan loss policy would also require additional provision for loan losses.

Management is required to make various assumptions in valuing the Company’s pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Citigroup Pension Liability Index, market interest rates and discounted cash flows in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

The Company is subject to examinations from various taxing authorities.  Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions.  Management believes that the assumptions and judgments used to record tax related assets or liabilities have been appropriate.  Should tax laws change or the taxing authorities determine that management’s assumptions were inappropriate, an adjustment may be required which could have a material adverse effect on the Company’s results of operations.

Another critical accounting policy is the policy for acquired loans. Acquired loans are initially recorded at their acquisition date fair values.  The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date.  Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.  Subsequent to the acquisition of acquired impaired loans, applicable accounting guidance requires the continued estimation of expected cash flows to be received.  This estimation involves the use of key assumptions and estimates, similar to those used in the initial estimate of fair value.  Changes in expected cash flows could result in the recognition of impairment through provision for credit losses.   Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for the non-impaired acquired loans is similar to originated loans.
 
43


As a result of acquisitions, the Company has acquired goodwill and identifiable intangible assets.  Goodwill represents the cost of acquired companies in excess of the fair value of net assets at the acquisition date.  Goodwill is evaluated at least annually or when business conditions suggest that an impairment may have occurred.  Goodwill will be reduced to its carrying value through a charge to earnings if impairment exists.  Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives.  The determination of whether or not impairment exists is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows.  It also requires selection of a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums and Company-specific risk indicators, all of which are susceptible to change based on changes in economic conditions and other factors.  Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company’s results of operations.

The Company’s policies on the allowance for loan losses, pension accounting, provision for income taxes, acquired loans and goodwill and intangible assets are disclosed in Note 1 to the consolidated financial statements presented in our 2015 Annual Report on Form 10-K.  All accounting policies are important and as such, the Company encourages the reader to review each of the policies included in Note 1 to obtain a better understanding of how the Company’s financial performance is reported.

Overview

Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to:  net income and earnings per share, return on average assets, equity and tangible common equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons.  The following information should be considered in connection with the Company's results for the first nine months of 2016:

·
Net income for the nine months ended September 30, 2016 is up 2.6% compared to the same period in 2015.

·
Year to date loan growth was 6.3% (annualized)

·
Average demand deposits for the nine months ended September 30, 2016 were up 10.3% from the same period in 2015.

Results of Operations

Net income for the three months ended September 30, 2016 was $20.0 million, up from $19.9 million for the same period last year. Earnings per diluted share for the three months ended September 30, 2016 was $0.46, up from $0.45 for the third quarter of 2015. Return on average assets (annualized) was 0.92% for the three months ended September 30, 2016 as compared to 0.97% for the same period last year. Return on average equity (annualized) was 8.80% for the three months ended September 30, 2016 as compared to 8.97% for the three months ended September 30, 2015. Return on average tangible common equity (annualized) was 13.16% for the three months ended September 30, 2016 as compared to 13.66% for the three months ended September 30, 2015.

Net income for the nine months ended September 30, 2016 was $58.8 million, up from $57.3 million for the same period last year. Earnings per diluted share for the nine months ended September 30, 2016 was $1.35, up from $1.29 for the same period last year. Return on average assets (annualized) was 0.92% for the nine months ended September 30, 2016 as compared to 0.96% for the same period last year. Return on average equity (annualized) was 8.81% for the nine months ended September 30, 2016 as compared to 8.75% for the nine months ended September 30, 2015. Return on average tangible common equity (annualized) was 13.29% for the nine months ended September 30, 2016 as compared to 13.41% for the nine months ended September 30, 2015.

Return on average tangible common equity is a non-GAAP measure and excludes amortization of intangible assets (net of tax) from net income and average tangible equity calculated as follows:

   
Three months ended September 30,
   
Nine months ended September 30,
 
(In thousands)
 
2016
   
2015
   
2016
   
2015
 
Net Income
 
$
20,001
   
$
19,851
   
$
58,801
   
$
57,298
 
Amortization of intangible assets (net of tax)
   
582
     
712
     
1,818
     
2,221
 
   
$
20,583
   
$
20,563
   
$
60,619
   
$
59,519
 
                                 
Average stockholders' equity
 
$
904,445
   
$
878,305
   
$
891,650
   
$
875,874
 
Less: average goodwill and other intangibles
   
282,307
     
281,048
     
282,255
     
282,267
 
Average tangible common equity
 
$
622,138
   
$
597,257
   
$
609,395
   
$
593,607
 
 
44


Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities and interest expense on interest bearing liabilities, primarily deposits and borrowings.  Net interest income is affected by the interest rate spread, the difference between the yield on earning assets and cost of interest bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the key determining factors in a financial institution’s performance as it is the principal source of earnings.

Net interest income was $66.7 million for the third quarter of 2016, up $0.9 million, or 1.3%, from the previous quarter and up $2.4 million, or 3.8%, from the third quarter of 2015.  Fully taxable-equivalent ("FTE") net interest margin was 3.40% for the three months ended September 30, 2016, down from 3.44% for the previous quarter and down from 3.48% for the third quarter of 2015.  Average interest earning assets were up $120.4 million, or 1.5%, for the third quarter of 2016 as compared to the prior quarter and up $499.7 million, or 6.7%, from the same period in 2015.  This increase from the second quarter of 2016 and third quarter of 2015 were driven primarily by loan production.  Annualized loan growth of 8.0% during the third quarter of 2016 was driven by growth in the commercial loan portfolio.  Yields on earning assets decreased by 4 basis points (“bps”) from 3.73% during the second quarter of 2016 to 3.69% for the third quarter of 2016.  Average interest bearing liabilities increased $17.8 million, or 0.3%, from the second quarter of 2016 to the third quarter of 2016, which was driven by a $126.7 million, or 26.2%, increase in short-term borrowings, partially offset by a $0.1 million, or 2.0%, decrease in interest bearing deposits as a result of normal seasonal deposit flows.  The rate paid on interest bearing liabilities of 0.42% during the third quarter of 2016 increased 1 bp from the second quarter of 2016 and increased 2 bps from the 0.40% paid during the third quarter of 2015 due primarily to an increase in borrowing costs.

Net interest income was $197.0 million for the nine months ended September 30, 2016, up $7.9 million, or 4.2%, from the same period in 2015.  FTE net interest margin was 3.44% for the nine months ended September 30, 2016, down from 3.53% for the nine months ended September 30, 2015.  Average interest earning assets were up $507.0 million, or 7.0%, for the nine months ended September 30, 2016 as compared to the same period in 2015.  This increase from last year was driven primarily by 6.3% annualized loan growth during the first nine months of 2016.  The increase in average interest earning assets was partly offset by a decrease in yields on earning assets from 3.81% during the first nine months of 2015 to 3.73% for the first nine months of 2016.  The decreasing earning asset yield was driven by an 8 bp decrease in loan yields from the first nine months of 2015 to the first nine months of 2016.  Average interest bearing liabilities increased $325.7 million, or 6.3%, from the nine months ended September 30, 2015 to the nine months ended September 30, 2016.  Total average deposits increased $375.4 million, or 5.9%, for the nine months ended September 30, 2016 as compared to the same period last year driven primarily by growth in non-interest bearing demand deposits of $187.5 million, or 10.3%, combined with a $187.9 million, or 4.1%, increase in interest bearing deposits due to growth in money market deposit accounts, NOW accounts and savings accounts.  In addition, average short-term borrowings increased $146.6 million, or 42.8%, for the nine months ended September 30, 2016 as compared to the same period last year. The rates paid on interest bearing liabilities increased by 1 bp for the nine months ended September 30, 2016 to 0.41% as compared to the 0.40% paid in the same period in 2015.  This increase resulted primarily from slightly higher rates paid on short-term borrowings and a change in the mix of interest bearing deposits.
 

45


Average Balances and Net Interest Income

The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest bearing liabilities on a taxable equivalent basis. Interest income for tax-exempt securities and loans has been adjusted to a FTE basis using the statutory Federal income tax rate of 35%.

Three months ended
                                   
   
September 30, 2016
   
September 30, 2015
 
   
Average
         
Yield/
   
Average
         
Yield/
 
(Dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
                                   
Short-term interest bearing accounts
 
$
21,279
   
$
29
     
0.54
%
 
$
8,100
   
$
6
     
0.32
%
Securities available for sale (1)(2)
   
1,257,335
     
6,112
     
1.93
%
   
1,079,206
     
5,230
     
1.92
%
Securities held to maturity (1) 
   
494,400
     
3,158
     
2.54
%
   
460,252
     
2,835
     
2.44
%
Investment in FRB and FHLB Banks
   
43,552
     
509
     
4.65
%
   
37,358
     
395
     
4.19
%
Loans (3)
   
6,092,371
     
63,601
     
4.15
%
   
5,824,311
     
61,848
     
4.21
%
Total interest earning assets
   
7,908,937
   
$
73,409
     
3.69
%
   
7,409,227
   
$
70,314
     
3.77
%
Other assets
   
754,813
                     
690,768
                 
Total assets
 
$
8,663,750
                   
$
8,099,995
                 
                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
 
$
1,636,815
   
$
888
     
0.22
%
 
$
1,577,651
   
$
859
     
0.22
%
NOW deposit accounts
   
1,053,590
     
134
     
0.05
%
   
963,744
     
126
     
0.05
%
Savings deposits
   
1,146,013
     
169
     
0.06
%
   
1,085,680
     
168
     
0.06
%
Time deposits
   
902,185
     
2,416
     
1.07
%
   
939,542
     
2,401
     
1.01
%
Total interest bearing deposits
 
$
4,738,603
   
$
3,607
     
0.30
%
 
$
4,546,617
   
$
3,554
     
0.31
%
Short-term borrowings
   
611,339
     
761
     
0.50
%
   
456,663
     
296
     
0.26
%
Long-term debt
   
110,703
     
819
     
2.94
%
   
130,680
     
845
     
2.56
%
Junior subordinated debt
   
101,196
     
660
     
2.59
%
   
101,196
     
560
     
2.20
%
Total interest bearing liabilities
 
$
5,561,841
   
$
5,847
     
0.42
%
 
$
5,235,156
   
$
5,255
     
0.40
%
Demand deposits
   
2,079,266
                     
1,894,555
                 
Other liabilities
   
118,198
                     
91,979
                 
Stockholders' equity
   
904,445
                     
878,305
                 
Total liabilities and stockholders' equity
 
$
8,663,750
                   
$
8,099,995
                 
Net interest income (FTE)
           
67,562
                     
65,059
         
Interest rate spread
                   
3.27
%
                   
3.37
%
Net interest margin
                   
3.40
%
                   
3.48
%
Taxable equivalent adjustment 
           
900
                     
814
         
Net interest income
         
$
66,662
                   
$
64,245
         
 
(1) Securities are shown at average amortized cost
(2) Excluding unrealized gains or losses
(3) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding
 

46


Nine months ended
                                   
   
September 30, 2016
   
September 30, 2015
 
   
Average
         
Yield/
   
Average
         
Yield/
 
(Dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
                                   
Short-term interest bearing accounts
 
$
17,009
   
$
72
     
0.57
%
 
$
9,033
   
$
22
     
0.33
%
Securities available for sale (1)(2)
   
1,224,500
     
18,286
     
1.99
%
   
1,055,456
     
15,579
     
1.97
%
Securities held to maturity (1) 
   
486,299
     
9,111
     
2.50
%
   
456,072
     
8,415
     
2.47
%
Investment in FRB and FHLB Banks
   
38,672
     
1,369
     
4.73
%
   
33,308
     
1,254
     
5.03
%
Loans (3)
   
5,995,063
     
187,629
     
4.18
%
   
5,700,673
     
181,619
     
4.26
%
Total interest earning assets
   
7,761,543
   
$
216,467
     
3.73
%
   
7,254,542
   
$
206,889
     
3.81
%
Other assets
   
733,771
                     
690,774
                 
Total assets
 
$
8,495,314
                   
$
7,945,316
                 
                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
 
$
1,666,687
   
$
2,720
     
0.22
%
 
$
1,567,060
   
$
2,462
     
0.21
%
NOW deposit accounts
   
1,059,787
     
400
     
0.05
%
   
970,139
     
375
     
0.05
%
Savings deposits
   
1,131,768
     
491
     
0.06
%
   
1,069,056
     
492
     
0.06
%
Time deposits
   
910,034
     
7,198
     
1.06
%
   
974,110
     
7,315
     
1.00
%
Total interest bearing deposits
 
$
4,768,276
   
$
10,809
     
0.30
%
 
$
4,580,365
   
$
10,644
     
0.31
%
Short-term borrowings
   
488,906
     
1,668
     
0.46
%
   
342,293
     
561
     
0.22
%
Long-term debt
   
121,950
     
2,425
     
2.66
%
   
130,767
     
2,507
     
2.56
%
Junior subordinated deb
   
101,196
     
1,920
     
2.53
%
   
101,196
     
1,645
     
2.17
%
Total interest bearing liabilities
 
$
5,480,328
   
$
16,822
     
0.41
%
 
$
5,154,621
   
$
15,357
     
0.40
%
Demand deposits
   
2,014,963
                     
1,872,441
                 
Other liabilities
   
108,373
                     
87,380
                 
Stockholders' equity
   
891,650
                     
875,874
                 
Total liabilities and stockholders' equity
 
$
8,495,314
                   
$
7,945,316
                 
Net interest income (FTE)
           
199,645
                     
191,532
         
Interest rate spread
                   
3.32
%
                   
3.41
%
Net interest margin
                   
3.44
%
                   
3.53
%
Taxable equivalent adjustment 
           
2,629
                     
2,436
         
Net interest income
         
$
197,016
                   
$
189,096
         
 
(1) Securities are shown at average amortized cost
(2) Excluding unrealized gains or losses
(3) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding
 

47


The following table presents changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume) and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.

Three months ended September 30,
                 
 
 
 
Increase (Decrease)
2016 over 2015
 
(In thousands)
 
Volume
   
Rate
   
Total
 
Short-term interest bearing accounts
 
$
15
   
$
8
   
$
23
 
Securities available for sale
   
851
     
31
     
882
 
Securities held to maturity
   
210
     
113
     
323
 
Investment in FRB and FHLB Banks
   
70
     
44
     
114
 
Loans
   
2,679
     
(926
)
   
1,753
 
Total interest income
   
3,825
     
(730
)
   
3,095
 
                         
Money market deposit accounts
   
41
     
(12
)
   
29
 
NOW deposit accounts
   
11
     
(3
)
   
8
 
Savings deposits
   
9
     
(8
)
   
1
 
Time deposits
   
(101
)
   
116
     
15
 
Short-term borrowings
   
125
     
340
     
465
 
Junior subordinated debt
   
-
     
100
     
100
 
Long-term debt
   
(139
)
   
113
     
(26
)
Total interest expense
   
(54
)
   
646
     
592
 
 
                       
Change in FTE net interest income
 
$
3,879
   
$
(1,376
)
 
$
2,503
 
 
Nine months ended September 30,
                       
 
 
 
Increase (Decrease)
2016 over 2015
 
(In thousands)
 
Volume
   
Rate
   
Total
 
Short-term interest bearing accounts
 
$
27
   
$
23
   
$
50
 
Securities available for sale
   
2,534
     
173
     
2,707
 
Securities held to maturity
   
570
     
126
     
696
 
Investment in FRB and FHLB Banks
   
194
     
(79
)
   
115
 
Loans
   
9,383
     
(3,373
)
   
6,010
 
Total interest income
   
12,708
     
(3,130
)
   
9,578
 
                         
Money market deposit accounts
   
162
     
96
     
258
 
NOW deposit accounts
   
34
     
(9
)
   
25
 
Savings deposits
   
28
     
(29
)
   
(1
)
Time deposits
   
(494
)
   
377
     
(117
)
Short-term borrowings
   
313
     
794
     
1,107
 
Junior subordinated debt
   
-
     
275
     
275
 
Long-term debt
   
(172
)
   
90
     
(82
)
Total interest expense
   
(129
)
   
1,594
     
1,465
 
 
                       
Change in FTE net interest income
 
$
12,837
   
$
(4,724
)
 
$
8,113
 
 

48


Noninterest Income

Noninterest income is a significant source of revenue for the Company and an important factor in the Company’s results of operations.  The following table sets forth information by category of noninterest income for the periods indicated:

   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2016
   
2015
   
2016
   
2015
 
(In thousands)
                       
Insurance and other financial services revenue
 
$
6,114
   
$
5,862
   
$
18,685
   
$
18,072
 
Service charges on deposit accounts
   
4,354
     
4,349
     
12,459
     
12,706
 
ATM and debit card fees
   
5,063
     
4,780
     
14,580
     
13,707
 
Retirement plan administration fees
   
4,129
     
3,249
     
11,937
     
10,011
 
Trust
   
4,535
     
4,611
     
13,848
     
14,257
 
Bank owned life insurance
   
1,336
     
931
     
3,898
     
3,418
 
Net securities gains
   
-
     
3
     
30
     
43
 
Gain on sale of equity investment
   
-
     
4,179
     
-
     
4,179
 
Other
   
4,113
     
3,297
     
12,188
     
9,617
 
Total noninterest income
 
$
29,644
   
$
31,261
   
$
87,625
   
$
86,010
 

Noninterest income for the three months ended September 30, 2016 was $29.6 million, unchanged from the prior quarter and down $1.6 million, or 5.2%, from the third quarter of 2015.  The decrease from the third quarter of 2015 was driven primarily by a decrease in other noninterest income due to the contingent gain of $4.2 million recognized in the third quarter of 2015 from the 2014 sale of Springstone LLC (“Springstone”).  This decrease was offset by increases in retirement plan administration fees, other noninterest income, ATM and debit card fees and insurance revenue.  Retirement plan administration fees were up $0.9 million, or 27.1%, for the third quarter of 2016 as compared to the third quarter of 2015 due primarily to the 2015 fourth quarter acquisition of Third Party Administrators, Inc. (“TPA”) and the 2016 third quarter asset acquisition of Actuarial Designs & Solutions, Inc.  Other noninterest income was up $0.8 million, or 24.7%, primarily due to higher swap fee income in 2016 than in 2015.

Noninterest income for the nine months ended September 30, 2016 was $87.6 million, up $1.6 million, or 1.9%, from the same period last year.  The increase from the prior year was driven primarily by increases in other noninterest income, retirement plan administration fees, ATM and debit card fees and insurance revenue. Other noninterest income was up $2.6 million, or 26.7%, for the first nine months of 2016 as compared to the first nine months of 2015 due primarily to an increase in fee income from customer interest rate swaps, an increase in mortgage banking income and a $0.8 million gain on the sale of equity investments for compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Retirement plan administration fees were up $1.9 million, or 19.2%, for the first nine months of 2016 as compared to the same period in 2015 due primarily to the 2015 fourth quarter acquisition of TPA.  ATM and debit card fees were up $0.9 million, or 6.4%, for the first nine months of 2016 as compared to the same period last year due primarily to increases in debit card activity and the number of accounts.  The increases were offset by the above mentioned $4.2 million Springstone gain in 2015.
 

49


Noninterest Expense

Noninterest expenses are also an important factor in the Company’s results of operations.  The following table sets forth the major components of noninterest expense for the periods indicated:

   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2016
   
2015
   
2016
   
2015
 
(In thousands)
                       
Salaries and employee benefits
 
$
32,783
   
$
30,227
   
$
98,155
   
$
91,240
 
Occupancy
   
5,035
     
5,326
     
15,780
     
16,804
 
Data processing and communications
   
4,183
     
4,207
     
12,354
     
12,598
 
Professional fees and outside services
   
3,343
     
3,137
     
9,905
     
10,029
 
Equipment
   
3,656
     
3,352
     
10,663
     
9,917
 
Office supplies and postage
   
1,438
     
1,576
     
4,661
     
4,822
 
FDIC expenses
   
1,287
     
1,355
     
3,838
     
3,833
 
Advertising
   
634
     
421
     
1,733
     
1,874
 
Amortization of intangible assets
   
952
     
1,165
     
2,976
     
3,636
 
Loan collection and other real estate owned
   
985
     
699
     
2,535
     
1,593
 
Other
   
5,318
     
8,426
     
15,683
     
19,211
 
Total noninterest expense
 
$
59,614
   
$
59,891
   
$
178,283
   
$
175,557
 

Noninterest expense for the three months ended September 30, 2016 was $59.6 million, down $0.8 million or 1.4%, from the prior quarter and down $0.3 million, or 0.5%, from the third quarter of 2015.  The decrease from the prior quarter was due primarily to a decrease of $0.6 million, or 10.2%, in other operating expenses. Salaries and employee benefits increased $2.6 million, or 8.5%, from the third quarter of 2015 to the third quarter of 2016 due primarily to the above mentioned TPA acquisition and higher incentive compensation in 2016 as compared to 2015.  The increase was offset by a $3.1 million, or 36.9%, decrease in other operating expenses in the third quarter of 2016 as compared to the third quarter of 2015 primarily due to reorganization expenses incurred during the third quarter of 2015.

Noninterest expense for the nine months ended September 30, 2016 was $178.3 million, up $2.7 million, or 1.6%, from the same period in 2015, primarily due to an increase of $6.9 million, or 7.6% in salaries and benefits expense.  This rise in salaries and medical insurance costs offset by lower pension credit and contract termination costs drove the increase in noninterest expense.  Other noninterest expense decreased by $3.5 million, or 18.4%, primarily due to reorganization expenses incurred during the third quarter of 2015.

Income Taxes
 
Income tax expense for the three month period ended September 30, 2016 was $10.3 million, consistent with the prior quarter and down $0.5 million, or 4.6%, from the third quarter of 2015.  The effective tax rate of 34.0% for the third quarter of 2016 was consistent with the prior quarter and down from 35.2% for the third quarter of 2015.

Income tax expense for the nine month period ended September 30, 2016 was $30.3 million, up $0.5 million, or 1.8%, from the nine month period ended September 30, 2015.  The effective tax rate was 34.0% for the first nine months of 2016, down from 34.2% for the first nine months of 2015.
 
50


ANALYSIS OF FINANCIAL CONDITION

Securities

Total securities increased $129.7 million, or 7.8%, from December 31, 2015 to September 30, 2016.  The securities portfolio represents 20.3% of total assets as of September 30, 2016 as compared to 20.0% as of December 31, 2015.

The following table details the composition of securities available for sale, securities held to maturity and regulatory investments for the periods indicated:

(In thousands)
 
September 30, 2016
   
December 31, 2015
 
Mortgage-backed securities:
           
With maturities 15 years or less
   
21
%
   
25
%
With maturities greater than 15 years
   
3
%
   
1
%
Collateral mortgage obligations
   
48
%
   
41
%
Municipal securities
   
13
%
   
13
%
US agency notes
   
14
%
   
19
%
Other
   
1
%
   
1
%
Total
   
100
%
   
100
%

The Company’s mortgage backed securities, U.S. agency notes and collateralized mortgage obligations are all “prime/conforming” and are guaranteed by Fannie Mae, Freddie Mac, Federal Home Loan Bank, Federal Farm Credit Banks, or Ginnie Mae (“GNMA”).  GNMA securities are considered equivalent to U.S. Treasury securities, as they are backed by the full faith and credit of the U.S. government.  Currently, there are no subprime mortgages in our investment portfolio.  Refer to Note 3 to the Company's unaudited interim consolidated financial statements included in this Form 10-Q for information related to other-than-temporary impairment considerations.

Loans

A summary of loans, net of deferred fees and origination costs, by category for the periods indicated follows:

(In thousands) 
 
September 30, 2016
   
December 31, 2015
 
Residential real estate mortgages
 
$
1,240,337
   
$
1,196,780
 
Commercial
   
1,252,644
     
1,159,089
 
Commercial real estate mortgages
   
1,528,499
     
1,430,618
 
Consumer
   
1,625,293
     
1,568,204
 
Home equity
   
513,412
     
528,442
 
Total loans
 
$
6,160,185
   
$
5,883,133
 

Total loans increased by $277.1 million, or 4.7%, at September 30, 2016 from December 31, 2015, or 6.2% annualized during the nine months ended September 30, 2016.  Loan growth in the first nine months of 2016 resulted from growth in the commercial, residential and consumer portfolios. Consumer loan growth was supplemented with approximately $51.6 million in loans purchased from LendingClub Corporation as part of the Company's ongoing relationship which began with the sale of Springstone LLC in the second quarter of 2014. Total loans represent approximately 70.2% of assets as of September 30, 2016, as compared to 71.2% as of December 31, 2015. 
 
51


Allowance for Loan Losses, Provision for Loan Losses and Nonperforming Assets

The allowance for loan losses is maintained at a level estimated by management to provide adequately for risk of probable losses inherent in the current loan portfolio.  The adequacy of the allowance for loan losses is continuously monitored using a methodology designed to ensure that the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable incurred credit losses inherent in the current loan portfolio.

Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the degree of judgment exercised in evaluating the level of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the consolidated results of operations.

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectability of the portfolio.  For individually analyzed loans, these factors include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date.  For homogeneous pools of loans, estimates of the Company’s exposure to credit loss reflect a thorough current assessment of a number of factors, which affect collectability. These factors include: past loss experience; the size, trend, composition and nature of the loans; changes in lending policies and procedures, including underwriting  standards and collection, charge-off and recovery practices;  trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market; portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability and depth of lending management and staff.  In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to recognize additions to the allowance based on their judgment about information available to them at the time of their examination, which may not be currently available to management.

After a thorough consideration and validation of the factors discussed above, required additions or reductions to the allowance for loan losses are made periodically by charges or credits to the provision for loan losses.  These are necessary to maintain the allowance at a level which management believes is reasonably reflective of the overall inherent risk of probable loss in the portfolio.  While management uses available information to recognize losses on loans, additions or reductions to the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.  Management considers the allowance for loan losses to be adequate based on evaluation and analysis of the loan portfolio.

The following table reflects changes to the allowance for loan losses for the periods presented. The allowance is increased by provisions for losses charged to operations and is reduced by net charge-offs. Charge-offs are made when the ability to collect loan principal within a reasonable time becomes unlikely. Any recoveries of previously charged-off loans are credited directly to the allowance for loan losses.
 
52


Allowance For Loan Losses
                       
   
Three months ended
 
(Dollars in thousands)
 
September 30, 2016
   
September 30, 2015
 
Balance, beginning of period
 
$
64,568
         
$
64,959
       
Recoveries
   
1,537
           
1,308
       
Charge-offs
   
(6,825
)
         
(6,374
)
     
Net charge-offs
   
(5,288
)
         
(5,066
)
     
Provision for loan losses
   
6,388
           
4,966
       
Balance, end of period
 
$
65,668
         
$
64,859
       
Composition of Net Charge-offs
                           
Commercial and agricultural
 
$
(125
)
   
2
%
 
$
(1,075
)
   
21
%
Real estate mortgage
   
(15
)
   
1
%
   
(350
)
   
7
%
Consumer
   
(5,148
)
   
97
%
   
(3,641
)
   
72
%
Net charge-offs
 
$
(5,288
)
   
100
%
 
$
(5,066
)
   
100
%
Annualized net charge-offs to average loans
   
0.35
%
           
0.35
%
       
 
Allowance For Loan Losses
                               
   
Nine months ended
 
 
 
September 30, 2016
   
September 30, 2015
 
Balance, beginning of period
 
$
63,018
           
$
66,359
         
Recoveries
   
4,635
             
3,416
         
Charge-offs
   
(19,251
)
           
(17,422
)
       
Net charge-offs
   
(14,616
)
           
(14,006
)
       
Provision for loan losses
   
17,266
             
12,506
         
Balance, end of period
 
$
65,668
           
$
64,859
         
Composition of Net Charge-offs
                               
Commercial and agricultural
 
$
(107
)
   
1
%
 
$
(1,943
)
   
14
%
Real estate mortgage
   
(879
)
   
6
%
   
(1,214
)
   
9
%
Consumer
   
(13,630
)
   
93
%
   
(10,849
)
   
77
%
Net charge-offs
 
$
(14,616
)
   
100
%
 
$
(14,006
)
   
100
%
Annualized net charge-offs to average loans
   
0.33
%
           
0.33
%
       

Net charge-offs were $5.3 million for the three months ended September 30, 2016, up from $4.5 million for the prior quarter and up slightly from $5.1 million for the third quarter of 2015.  Provision expense was $6.4 million for the three months ended September 30, 2016, as compared with $4.8 million for the prior quarter and $5.0 million for the third quarter of 2015; the increases in provision expense were primarily due to loan growth.  Annualized net charge-offs to average loans for the third quarter of 2016 was 0.35%, compared with 0.30% for the second quarter of 2016 and 0.35% for the third quarter of 2015. Annualized net charge-offs to average loans for the first nine months of 2016 was 0.33%, consistent with the same period of 2015 and down from 0.38% for the year ended December 31, 2015.

Nonperforming loans to total loans was 0.73% at September 30, 2016, up 9 bps from December 31, 2015 and down 6 bps from September 30, 2015.  Past due loans as a percentage of total loans were 0.57% at September 30, 2016, as compared to 0.62% at December 31, 2015 and 0.63% as of September 30, 2015.

The allowance for loan losses totaled $65.7 million at September 30, 2016, compared to $63.0 million at December 31, 2015 and $64.9 million at September 30, 2015.  The allowance for loan losses as a percentage of loans was 1.07% (1.15% excluding acquired loans with no related allowance recorded) at September 30, 2016, compared to 1.07% (1.18% excluding acquired loans with no related allowance recorded) at December 31, 2015 and 1.10% (1.21% excluding acquired loans with no related allowance recorded) at September 30, 2015.  The decrease in the allowance for loan losses as a percentage of loans from the prior year was due primarily to continued positive trends in asset quality metrics of the originated loan portfolio.
 
53


Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due and still accruing, restructured loans, other real estate owned ("OREO") and nonperforming securities. Loans are generally placed on nonaccrual when principal or interest payments become 90 days past due, unless the loan is well secured and in the process of collection. Loans may also be placed on nonaccrual when circumstances indicate that the borrower may be unable to meet the contractual principal or interest payments. In the third quarter of 2016 the threshold for evaluating classified and nonperfomring loans specifically evaluated for impairment was increased for $0.5 million to $0.8 million. OREO represents property acquired through foreclosure and is valued at the lower of the carrying amount or fair value, less any estimated disposal costs.  Nonperforming securities, which include securities which management believes are other-than-temporarily impaired, are carried at their estimated fair value and are not accruing interest.

(Dollars in thousands)
 
September 30, 2016
   
December 31, 2015
 
Nonaccrual loans
 
Amount
   
%
   
Amount
   
%
 
Commercial and agricultural loans and real estate
 
$
24,300
     
60
%
 
$
14,655
     
43
%
Real estate mortgages
   
4,543
     
11
%
   
8,625
     
26
%
Consumer
   
8,163
     
20
%
   
6,009
     
18
%
Troubled debt restructured loans
   
3,710
     
9
%
   
4,455
     
13
%
Total nonaccrual loans
   
40,716
     
100
%
   
33,744
     
100
%
Loans 90 days or more past due and still accruing
                               
Commercial and agricultural loans and  real estate
   
834
     
19
%
   
-
     
0
%
Real estate mortgages
   
737
     
17
%
   
1,022
     
28
%
Consumer
   
2,873
     
65
%
   
2,640
     
72
%
Total loans 90 days or more past due and still accruing
   
4,444
     
100
%
   
3,662
     
100
%
                                 
Total nonperforming loans
   
45,160
             
37,406
         
OREO
   
2,501
             
4,666
         
Total nonperforming assets
 
$
47,661
           
$
42,072
         
Total nonperforming loans to total loans
   
0.73
%
           
0.64
%
       
Total nonperforming assets to total assets
   
0.54
%
           
0.51
%
       
Allowance for loan losses to total nonperforming loans
   
145.41
%
           
168.47
%
       

Past due loans as a percentage of total loans was 0.57% at September 30, 2016, down from 0.62% at December 31, 2015.  For acquired loans that are not deemed to be impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset.

As a result of the application of this accounting methodology, certain credit-related ratios may not necessarily be directly comparable with periods prior to the acquisition, or comparable with other institutions. The credit metrics most impacted by our acquisitions were the allowance for loans losses to total loans and total allowance for loan losses to nonperforming loans.  As of September 30, 2016, the allowance for loan losses to total originated loans and the total allowance for loan losses to originated nonperforming loans were 1.15% and 1.18%, respectively. As of December 31, 2015, the allowance for loan losses to total originated loans and the total allowance for loan losses to originated nonperforming loans were 168.52% and 193.00%, respectively.

Loans acquired that were not deemed to be impaired at acquisition and were classified as nonaccrual and greater than 90 days past due and still accruing prior to acquisition, continued to be classified as nonaccrual and 90 days past due and still accruing immediately after the acquisition. Loans acquired that were classified as troubled debt restructurings prior to acquisition are no longer classified as such immediately following the acquisition. Acquired credit impaired loans from acquisitions were not classified nonaccrual, even though they may be contractually past due, because we expect to fully collect the recorded investment of such loans.

In addition to nonperforming loans, the Company has also identified approximately $83.0 million in potential problem loans at September 30, 2016 as compared to $73.8 million at December 31, 2015.  At September 30, 2016, potential problem loans primarily consisted of commercial real estate, commercial and agricultural loans.  Potential problem loans are loans that are currently performing, but known information about possible credit problems of the borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms, which may result in classification of such loans as nonperforming at some time in the future.  Potential problem loans are typically defined as loans that are performing but are classified by the Company’s loan rating system as “substandard.”  Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured or require increased allowance coverage and provision for loan losses.
 
54

 
Deposits

Total deposits were $6.9 billion at September 30, 2016, up $344.4 million, or 5.2%, from December 31, 2015.  Total average deposits increased $375.4 million, or 5.9%, for the nine months ended September 30, 2016 as compared to the same period last year driven primarily by growth in non-interest bearing demand deposits of $187.5 million, or 10.3%, combined with a $187.9 million, or 4.1%, increase in interest bearing deposits due to growth in money market deposit accounts, NOW accounts and savings accounts.

Borrowed Funds

The Company's borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $585.0 million at September 30, 2016 compared to $442.5 million at December 31, 2015.  Long-term debt was $114.1 million at September 30, 2016 compared to $130.4 million at December 31, 2015. 

For more information about the Company’s borrowing capacity and liquidity position, see “Liquidity Risk” below.

Capital Resources

Stockholders' equity of $909.3 million represented 10.37% of total assets at September 30, 2016 compared with $882.0 million, or 10.67% as of December 31, 2015.  The increase in stockholders' equity resulted primarily from net income of $58.8 million for the nine months ending September 30, 2016, partially offset by dividends paid of $28.9 million and the stock buyback totaling $17.2 million during the period.

The Company purchased 675,535 shares of its common stock during the nine months ended 2016 at an average price of $25.45 per share under a previously announced plan.  As of September 30, 2016, there were 277,313 shares available for repurchase under this plan announced on July 27, 2015 and set to expire on December 31, 2016.  On March 28, 2016, the Company's Board of Directors authorized a new program for the Company to repurchase up to an additional 1,000,000 shares of its outstanding common stock.  This plan expires on December 31, 2017.

The Board of Directors considers the Company's earnings position and earnings potential when making dividend decisions.  The Company's Board of Directors approved a 2016 fourth-quarter cash dividend of $0.23 per share at a meeting held on October 24, 2016. The dividend will be paid on December 15, 2016 to stockholders of record as of December 1, 2016.  The Company does not have a target dividend pay-out ratio.

As the capital ratios in the following table indicate, the Company remained “well capitalized” at September 30, 2016 under applicable bank regulatory requirements.  Capital measurements are well in excess of regulatory minimum guidelines and meet the requirements to be considered well capitalized for all periods presented. To be considered well capitalized, tier 1 leverage, common equity tier 1 capital, tier 1 capital and total risk-based capital ratios must be 5%, 6.5%, 8% and 10%, respectively.

Capital Measurements
 
September 30, 2016
   
December 31, 2015
 
Tier 1 leverage ratio
   
9.05
%
   
9.44
%
Common equity tier 1 capital ratio
   
9.84
%
   
10.20
%
Tier 1 capital ratio
   
11.28
%
   
11.73
%
Total risk-based capital ratio
   
12.27
%
   
12.74
%
Cash dividends as a percentage of net income
   
49.15
%
   
49.92
%
Per common share:
               
Book value
 
$
21.08
   
$
20.31
 
Tangible book value (1)
 
$
14.57
   
$
13.79
 
 
(1) Stockholders' equity less goodwill and intangible assets divided by common shares outstanding.
 

55


Liquidity and Interest Rate Sensitivity Management

Market Risk

Interest rate risk is the primary market risk affecting the Company.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.  Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest bearing liabilities mature or reprice on a different basis than earning assets.  When interest bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when earning assets mature or reprice more quickly than interest bearing liabilities, falling interest rates could result in a decrease in net interest income.

In an attempt to manage the Company's exposure to changes in interest rates, management monitors the Company’s interest rate risk.  Management’s Asset Liability Committee (“ALCO”) meets monthly to review the Company’s interest rate risk position and profitability and to recommend strategies for consideration by the Board of Directors.  Management also reviews loan and deposit pricing and the Company’s securities portfolio, formulates investment and funding strategies and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential effect of changing interest rates is an uncertainty that can have an adverse effect on net income.

In adjusting the Company’s asset/liability position, the Board and management attempt to manage the Company’s interest rate risk while minimizing net interest margin compression.  At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin.  The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and fluctuations in the difference between long- and short-term interest rates.  Assuming interest rates remain at or near current historical lows, net interest margin will continue to experience compression.  Additional rate reductions on deposits are becoming more difficult as deposit rates are at or near their floors and with asset yields continuing to reprice at lower rates, this could result in additional margin pressure as well as a decrease in net interest income.

The primary tool utilized by ALCO to manage interest rate risk is a balance sheet/income statement simulation model (interest rate sensitivity analysis).  Information, such as principal balance, interest rate, maturity date, cash flows, next repricing date (if needed) and current rates is uploaded into the model to create an ending balance sheet.  In addition, ALCO makes certain assumptions regarding prepayment speeds for loans and mortgage related investment securities along with any optionality within the deposits and borrowings.
 
The model is first run under an assumption of a flat rate scenario (i.e. no change in current interest rates) with a static balance sheet over a 12 month period.  Two additional models are run with static balance sheets: (1) a gradual increase of 200 bp and (2) a gradual decrease of 100 bp taking place over a 12 month period. Under these scenarios, assets subject to prepayments are adjusted to account for faster or slower prepayment assumptions.  Any investment securities or borrowings that have callable options embedded into them are handled accordingly based on the interest rate scenario. The resulting changes in net interest income are then measured against the flat rate scenario.

 In the declining rate scenario, net interest income is projected to decrease when compared to the forecasted net interest income in the flat rate scenario through the simulation period. The decrease in net interest income is a result of earning assets repricing downward at a faster rate than interest bearing liabilities. The inability to effectively lower deposit rates will likely reduce or eliminate the benefit of lower interest rates. In the rising rate scenarios, net interest income is projected to experience a decline from the flat rate scenario. Net interest income is projected to remain at lower levels than in a flat rate scenario through the simulation period primarily due to a lag in assets repricing while funding costs increase. The potential impact on earnings is dependent on the ability to lag deposit repricing. If short-term rates continue to increase, the Company expects competitive pressures will likely lead to core deposit pricing increases, which will likely continue compression of the net interest margin.
 
56


Net interest income for the next 12 months in the + 200/- 100 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% change in net interest income. The following table summarizes the percentage change in net interest income in the rising and declining rate scenarios over a 12-month period from the forecasted net interest income in the flat rate scenario using the September 30, 2016 balance sheet position:

Interest Rate Sensitivity Analysis
 
Change in interest rates
Percent change in
(in bp points)
net interest income
+200
(2.26%)
-100
(2.39%)

Liquidity Risk

Liquidity involves the ability to meet the cash flow requirements of customers who may be depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. ALCO is responsible for liquidity management and has developed guidelines which cover all assets and liabilities, as well as off-balance sheet items that are potential sources or uses of liquidity.  Liquidity policies must also provide the flexibility to implement appropriate strategies and tactical actions. Requirements change as loans grow, deposits and securities mature and payments on borrowings are made. Liquidity management includes a focus on interest rate sensitivity management with a goal of avoiding widely fluctuating net interest margins through periods of changing economic conditions.

The primary liquidity measurement the Company utilizes is called the Basic Surplus, which captures the adequacy of its access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  Basic Surplus is calculated by subtracting short-term liabilities from liquid assets.  This approach recognizes the importance of balancing levels of cash flow liquidity from short- and long-term securities with the availability of dependable borrowing sources, which can be accessed when necessary.  At September 30, 2016, the Company’s Basic Surplus measurement was 13.0% of total assets or approximately $1.1 billion as compared to the December 31, 2015 Basic Surplus of 18.6% or $1.5 billion and was above the Company’s minimum of 5% or $0.4 billion set forth in its liquidity policies.

This Basic Surplus approach enables the Company to adequately manage liquidity from both operational and contingency perspectives. By tempering the need for cash flow liquidity with reliable borrowing facilities, the Company is able to operate with a more fully invested and, therefore, higher interest income generating securities portfolio. The makeup and term structure of the securities portfolio is, in part, impacted by the overall interest rate sensitivity of the balance sheet. Investment decisions and deposit pricing strategies are impacted by the liquidity position.
 
The Company’s primary source of funds is the Bank. Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends. The approval of the Office of Comptroller of the Currency (OCC) is required to pay dividends when a bank fails to meet certain minimum regulatory capital standards or when such dividends are in excess of a subsidiary bank’s earnings retained in the current year plus retained net profits for the preceding two years (as defined in the regulations). At September 30, 2016, approximately $83.4 million of the total stockholders’ equity of the Bank was available for payment of dividends to the Company without approval by the OCC.  The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. The Bank is currently in compliance with these requirements. Under the General Corporation Law of the State of Delaware, the Company may declare and pay dividends either out of its surplus or, in case there is no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

At September 30, 2016 and December 31, 2015, FHLB advances outstanding totaled approximately $494 million and $432 million, respectively.  The Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $1.0 billion at September 30, 2016 and $1.1 billion at December 31, 2015.  In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $501 million at September 30, 2016, or used to collateralize other borrowings, such as repurchase agreements.  At September 30, 2016 the Bank also had additional borrowing capacity from unused collateral at the Federal Reserve of $0.8 billion.
 

57


Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Information called for by Item 3 is contained in the Liquidity and Interest Rate Sensitivity Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Item 4.  CONTROLS AND PROCEDURES
 
The  Company's  management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of  the  Company's  disclosure  controls  and  procedures  (as  defined  in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2016, the Company's disclosure controls and procedures were effective.

There  were  no changes made in the Company's internal control over financial  reporting  that  occurred  during  the  Company's  most recent fiscal quarter that have materially affected or are reasonably likely to materially affect, the Company's internal control over financial reporting.
 
58


PART II.  OTHER INFORMATION
 
Item 1 – LEGAL PROCEEDINGS
 
There are no material legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is subject, except as described in the Company’s 2015 Annual Report on Form 10-K.
 
Item 1A – RISK FACTORS
 
There are no material changes to the risk factors as previously discussed in Part I, Item 1A of our 2015 Annual Report on Form 10-K.
 
Item 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
(a)
Not applicable
 
(b)
Not applicable
 
(c)
None
 
Item 3 – DEFAULTS UPON SENIOR SECURITIES

None
 
Item 4 – MINE SAFETY DISCLOSURES

None
 
Item 5 – OTHER INFORMATION

None
 

59

 
Item 6 – EXHIBITS

3.1
Certificate of Incorporation of NBT Bancorp Inc. as amended through July 1, 2015 (filed as Exhibit 3.1 to the Registrant's Form 10-Q for the quarter ended June 30, 2015, filed on August 10, 2015 and incorporated herein by reference).

3.2
Amended and Restated By-laws of NBT Bancorp Inc., effective July 1, 2015 (filed as Exhibit 3.1 to the Registrant's Form 8-K, filed on July 1, 2015 and incorporated herein by reference).

3.3
Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registrant’s Form 8-K, filed on November 18, 2004 and incorporated herein by reference).

4.1
Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1
Written Statement of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2
Written Statement of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS
XBRL Instance Document.

101.SCH
XBRL Taxonomy Extension Schema Document.

101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB
XBRL Taxonomy Extension Label Linkbase Document.

101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
 

60


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, this 9th day of November 2016.
 
 
 
NBT BANCORP INC.
 
 
 
 
 
 
By: 
/s/ Michael J. Chewens
 
 
 
Michael J. Chewens, CPA
 
 
 
Senior Executive Vice President
 
 
 
Chief Financial Officer
 
 
61


EXHIBIT INDEX
 
3.1
Certificate of Incorporation of NBT Bancorp Inc. as amended through July 1, 2015 (filed as Exhibit 3.1 to the Registrant's Form 10-Q for the quarter ended June 30, 2015, filed on August 10, 2015 and incorporated herein by reference).

3.2
Amended and Restated By-laws of NBT Bancorp Inc., effective July 1, 2015 (filed as Exhibit 3.1 to the Registrant's Form 8-K, filed on July 1, 2015 and incorporated herein by reference).

3.3
Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registrant’s Form 8-K, filed on November 18, 2004 and incorporated herein by reference).

4.1
Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Written Statement of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Written Statement of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS
XBRL Instance Document.

101.SCH
XBRL Taxonomy Extension Schema Document.

101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB
XBRL Taxonomy Extension Label Linkbase Document.

101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
62