10-K 1 form10k.htm NBT BANCORP INC 10-K 12-31-2012 form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012
COMMISSION FILE NUMBER: 0-14703

NBT BANCORP INC.
(Exact name of registrant as specified in its charter)
Delaware
 
16-1268674
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
52 SOUTH BROAD STREET
NORWICH, NEW YORK 13815
(Address of principal executive office) (Zip Code)
(607) 337-2265 (Registrant’s telephone number, including area code)
 
Securities registered pursuant to section 12(b) of the Act:
 
Title of each class:
Name of each exchange on which registered:
 
Common Stock, par value $0.01 per share
The NASDAQ Stock Market LLC
 
Stock Purchase Rights Pursuant to Stockholders Rights Plan
 
Securities registered pursuant to section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes x  No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.  Yes o  No x
 
Indicate  by  check mark whether the registrant (1) has filed all reports required to  be  filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the  preceding  12  months  (or  for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for  the  past  90  days.  Yes  x  No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate  by  check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will  not be contained, to the best of the registrant’s knowledge, in definitive proxy  or  information  statements incorporated by reference in Part III of this Form  10-K  or  any  amendment  to  this  Form  10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes  x No
 
Based on the closing price of the registrant’s common stock as of June 30, 2012, the aggregate market value of the voting stock, common stock, par value, $0.01 per share, held by non-affiliates of the registrant is $688,194,085.
 
The number of shares of common stock outstanding as of February 15, 2013, was 33,795,298.
 


 
 

 

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions  of the registrant’s definitive Proxy Statement for its Annual Meeting  of Stockholders to be held on May 7, 2013 are incorporated by reference into  Part  III,  Items  10,  11,  12,  13  and  14  of  this  Form  10-K.
 
 
2

 
 
NBT BANCORP INC.
FORM 10-K – Year Ended December 31, 2012


PART I
   
     
ITEM 1
5
     
ITEM 1A
19
     
ITEM 1B
27
     
ITEM 2
28
     
ITEM 3
29
     
ITEM 4
29
     
PART II    
   
     
ITEM 5
29
     
ITEM 6
32
     
ITEM 7
34
     
ITEM 7A
60
     
ITEM  8
62
  62
  63
  64
  65
  66
  67
  69
     
ITEM 9
124
 
 

 
PART I
 
ITEM 1.
 
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 Company, on a consolidated basis, at December 31, 2012 had assets of $6.0 billion and stockholders’ equity of $582.3 million.  Return on average assets and return on average equity were 0.93% and 9.72%, respectively, for the year ending December 31, 2012.  The Company had net income of $54.6 million or $1.62 per diluted share for 2012 and the fully taxable equivalent (“FTE”) net interest margin was 3.86% for the same year.
 
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 and NBT Statutory 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, southern New Hampshire, western Massachusetts and the greater Burlington, Vermont area.  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.  The financial condition and operating results of the Company are dependent on its net interest income which is the difference between the interest and dividend income earned on its earning assets, primarily loans and investments, and the interest expense paid on its interest bearing liabilities, primarily consisting of deposits and borrowings. Among other factors, net income is also affected by provisions for loan losses and noninterest income, such as service charges on deposit accounts, insurance and other financial services fees, trust revenue, and gains/losses on securities sales, bank owned life insurance income, ATM and debit card fees, and retirement plan administration fees as well as noninterest expense, such as salaries and employee benefits, occupancy, equipment, data processing and communications, professional fees and outside services, office supplies and postage, amortization, loan collection and other real estate owned expenses, advertising, FDIC expenses, and other expenses.
 
Substantially all of the Company’s business activities are with customers located in the United States and are summarized by state below:
 
   
Interest 
Income
   
Noninterest
Income
   
Total
Revenue
 
New York
    55 %     27 %     82 %
Pennsylvania
    7 %     4 %     11 %
New Hampshire
    2 %     0 %     2 %
Vermont
    3 %     0 %     3 %
Massachusetts
    1 %     1 %     2 %
      68 %     32 %     100 %
 
 
   
Commercial
   
Consumer
   
Residential Real Estate
   
Total Loan Portfolio
 
New York
    35 %     30 %     10 %     75 %
Pennsylvania
    5 %     6 %     3 %     14 %
New Hampshire
    4 %     0 %     1 %     5 %
Vermont
    3 %     1 %     1 %     5 %
Massachusetts
    0 %     1 %     0 %     1 %
      47 %     38 %     15 %     100 %
 
   
Secured By
   
Not Secured
 
   
Real Estate
   
By Real Estate
 
             
New York
    55 % (a)   45 %
Pennsylvania
    69 % (b)   31 %
New Hampshire
    86 % (c)   14 %
Vermont
    55 % (d)   45 %
Massachusetts
    80 % (e)   20 %

(a)  Loans secured by real estate primarily in central and upstate New York
(b)  Loans secured by real estate primarily in northeastern Pennsylvania
(c)  Loans secured by real estate primarily in southern New Hampshire
(d)  Loans secured by real estate primarily in the Burlington, Vermont area
(e)  Loans secured by real estate primarily in western Massachusetts
 
Like the rest of the nation, the market areas that the Company serves are still experiencing economic challenges.  A variety of factors (e.g., any substantial rise in inflation or rise in unemployment rates, decrease in consumer confidence, international economic conditions, natural disasters, war, or political instability) may affect both the Company’s markets and the national market.  The Company will continue to emphasize managing its funding costs and lending and investment rates to effectively maintain profitability.  In addition, the Company will continue to seek and maintain relationships that can generate fee income that is not directly tied to lending relationships.  We anticipate that this approach should help mitigate profit fluctuations that are caused by movements in interest rates, business and consumer loan cycles, and local economic factors.

On June 8, 2012, the Company acquired all of the outstanding common shares of Hampshire First Bank ("Hampshire First").  The five banking centers operated by Hampshire First located in Manchester, Londonderry, Nashua, Keene and Portsmouth, New Hampshire continue to do business under the Hampshire First name as a division of the Bank.  This business combination is a strategic extension of the Company’s franchise.
 
On October 7, 2012, the Company and Alliance Financial Corporation (“Alliance”) entered into a definitive agreement and plan of merger pursuant to which Alliance will merge with and into NBT Bancorp, with NBT Bancorp continuing as the surviving corporation.  The agreement also provides for Alliance Bank, National Association, a wholly owned subsidiary of Alliance, to be merged with and into the Bank following completion of the merger.  Alliance, with assets of approximately $1.4 billion at December 31, 2012, is headquartered in Syracuse, New York.  Its primary subsidiary, Alliance Bank, National Association, is a nationally chartered community bank with 26 banking locations in central New York.  The transaction is valued at approximately $233.4 million, to be paid in the form of shares of the Company’s common stock.  Subject to the required approvals of NBT Bancorp and Alliance shareholders, requisite regulatory approvals (which were received in the first quarter of 2013) and other customary closing conditions, the merger is expected to be completed in March 2013.

 
NBT Bank, N.A.
 
The Bank is a full service commercial bank formed in 1856, which provides a broad range of financial products to individuals, corporations and municipalities throughout the central and upstate New York, northeastern Pennsylvania, western Massachusetts, southern New Hampshire and greater Burlington, Vermont market areas.
 
Through its network of branch locations, the Bank offers a wide range of products and services tailored to individuals, businesses, and municipalities.  Deposit products offered by the Bank include demand deposit accounts, savings accounts, negotiable order of withdrawal (“NOW”) accounts, money market deposit accounts (“MMDA”), and certificate of deposit (“CD”) accounts.  The Bank offers various types of each deposit account to accommodate the needs of its customers with varying rates, terms, and features.  Loan products offered by the Bank include consumer loans, home equity loans, mortgages, small business loans and commercial loans, with varying rates, terms and features to accommodate the needs of its customers.  The Bank also offers various other products and services through its branch network such as trust and investment services and financial planning and life insurance services.  In addition to its branch network, the Bank also offers access to certain products and services online enabling customers to check balances, transfer funds, pay bills, view statements, apply for loans and access various other product and service information.  The Bank provides 24-hour access to an automated telephone line whereby customers can check balances, obtain interest information, transfer funds, request statements, and perform various other activities.
 
The Bank conducts business through three geographic divisions, NBT Bank, Pennstar Bank, and Hampshire First Bank.  At year end 2012, the NBT Bank division had 95 divisional offices and 115 automated teller machines (ATMs), located primarily in central and upstate New York, the Burlington, Vermont area, and Berkshire County, Massachusetts.  At December 31, 2012, the NBT Bank division had total loans of approximately $3.5 billion, or 81% of total loans, and total deposits of $3.7 billion, or 77% of total deposits.  Revenue for the NBT Bank division totaled $224 million for the year ended December 31, 2012.  At year end 2012, the Pennstar Bank division had 35 divisional offices and 44 ATMs, located primarily in northeastern Pennsylvania.  At December 31, 2012, the Pennstar Bank division had total loans of $587 million, or 14% of total loans, and total deposits of $949 million, or 20% of total deposits. Revenue for the Pennstar Bank division totaled $34 million for the year ended December 31, 2012.  At year end 2012, the Hampshire First Bank division had five divisional offices and four ATMs, located primarily in southern New Hampshire.  At December 31, 2012, the Hampshire First Bank division had total loans of approximately $217 million, or 5% of total loans, and total deposits of $202 million, or 4% of total deposits.  Revenue for the Hampshire First Bank division totaled $7 million for the year ended December 31, 2012.
 
NBT Financial Services, Inc.
 
Through NBT Financial Services, the Company operates EPIC Advisors, Inc. (“EPIC”), a retirement plan administrator.  Through EPIC, the Company offers services including retirement plan consulting and recordkeeping services.  EPIC’s headquarters are located in Rochester, New York.
 
NBT Holdings, Inc.
 
Through NBT Holdings, the Company operates Mang Insurance Agency, LLC (“Mang”), a full-service insurance agency acquired by the Company on September 1, 2008.  Mang’s headquarters are in Norwich, New York.  Through Mang, the Company offers a full array of insurance products, including personal property and casualty, business liability and commercial insurance, tailored to serve the specific insurance needs of individuals as well as businesses in a range of industries operating in the markets served by the Company.
 
 
The Trusts
 
The Trusts were organized to raise additional regulatory capital and to provide funding for certain acquisitions.  CNBF Capital Trust I (“Trust I”) and NBT Statutory Trust I are Delaware statutory business trusts formed in 1999 and 2005, respectively, for the purpose of issuing trust preferred securities and lending the proceeds to the Company. In connection with the acquisition of CNB Bancorp, Inc., the Company formed NBT Statutory Trust II (“Trust II”) in February 2006 to fund the cash portion of the acquisition as well as to provide regulatory capital. The Company raised $51.5 million through Trust II in February 2006. The Company guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities. The Trusts are variable interest entities (VIEs) for which the Company is not the primary beneficiary, as defined by Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”).  In accordance with FASB ASC, the accounts of the Trusts are not included in the Company’s consolidated financial statements.
 
Operating Subsidiaries of the Bank
 
The Bank has five operating subsidiaries, NBT Capital Corp., Pennstar Bank Services Company, Broad Street Property Associates, Inc., NBT Services, Inc., and CNB Realty Trust. NBT Capital Corp., formed in 1998, is a venture capital corporation formed to assist young businesses to develop and grow primarily in the markets they serve. Pennstar Bank Services Company, formed in 2002, provides administrative and support services to the Pennstar Bank division of the Bank.  Broad Street Property Associates, Inc., formed in 2004, is a property management company.  NBT Services, Inc., formed in 2004, has a 44% ownership interest in Land Record Services, LLC.  Land Record Services, LLC, a title insurance agency, offers mortgagee and owner’s title insurance coverage to both retail and commercial customers.  CNB Realty Trust, formed in 1998, is a real estate investment trust.
 
 
Competition
 
The financial services industry, including commercial banking, is highly competitive, and we encounter strong competition for deposits, loans and other financial products and services in our market area.  The increasingly competitive environment is the result of changes in regulation, changes in technology and product delivery systems, additional financial service providers, and the accelerating pace of consolidation among financial services providers.  The Company competes for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers.  
 
The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.
 
Some of the Company’s competitors have fewer regulatory constraints and may have lower cost structures.  In addition, some of the Company’s competitors have assets, capital and lending limits greater than that of the Company, have greater access to capital markets and offer a broader range of products and services than the Company.  These institutions may have the ability to finance wide-ranging advertising campaigns and may also be able to offer lower rates on loans and higher rates on deposits than the Company can offer.  Some of these institutions offer services, such as credit cards and international banking, which the Company does not directly offer.
 
Various in-state market competitors and out-of-state banks continue to enter or have announced plans to enter or expand their presence in the market areas in which the Company currently operates.  With the addition of new banking presences within our market, the Company expects increased competition for loans, deposits, and other financial products and services.

In order to compete with other financial services providers, the Company stresses the community nature of its banking operations and principally relies upon local promotional activities, personal relationships established by officers, directors, and employees with their customers, and specialized services tailored to meet the needs of the communities served.  We also offer certain customer services, such as agricultural lending, that many of our larger competitors do not offer.  While the Company’s position varies by market, the Company’s management believes that it can compete effectively as a result of local market knowledge, local decision making, and awareness of customer needs.
 
 
The table below summarizes the Bank’s deposits and market share by the twenty-eight counties of New York, Pennsylvania, New Hampshire, Vermont, and Massachusetts in which it had customer facilities as of June 30, 2012.  Market share is based on deposits of all commercial banks, credit unions, savings and loans associations, and savings banks.
 
County
State
 
Deposits
(in thousands)
   
Market
Share
   
Market
Rank
   
Number of
Branches*
   
Number of ATMs*
 
Chenango
NY
  $ 485,750       81.73 %     1       11       13  
Fulton
NY
    372,524       57.99 %     1       7       8  
Schoharie
NY
    188,604       48.54 %     1       4       4  
Hamilton
NY
    34,091       46.88 %     2       1       1  
Delaware
NY
    299,970       32.43 %     1       5       5  
Montgomery
NY
    211,783       32.00 %     2       5       5  
Otsego
NY
    302,772       30.64 %     2       9       12  
Essex
NY
    143,527       25.37 %     2       3       6  
Susquehanna
PA
    144,957       20.75 %     2       6       7  
Wayne
PA
    153,294       11.81 %     4       3       4  
Broome
NY
    258,967       11.45 %     3       8       11  
Saint Lawrence
NY
    125,478       11.19 %     3       5       6  
Pike
PA
    56,976       9.72 %     5       2       2  
Oneida
NY
    288,848       9.52 %     6       6       12  
Lackawanna
PA
    384,710       7.97 %     7       15       18  
Tioga
NY
    32,002       7.88 %     6       1       1  
Clinton
NY
    88,913       7.41 %     5       3       2  
Herkimer
NY
    37,182       6.34 %     6       2       1  
Franklin
NY
    27,082       5.96 %     5       1       1  
Schenectady
NY
    104,883       4.40 %     7       2       2  
Berkshire
MA
    130,493       4.24 %     7       5       5  
Greene
NY
    41,872       4.19 %     5       3       3  
Saratoga
NY
    127,962       3.65 %     10       3       4  
Monroe
PA
    86,385       3.63 %     8       5       7  
Warren
NY
    51,153       3.59 %     7       3       3  
Cheshire
NH
    27,177       2.15 %     7       1       0  
Luzerne
PA
    114,030       1.99 %     15       4       6  
Hillsborough
NH
    167,887       1.54 %     7       2       2  
Albany
NY
    141,956       1.12 %     10       4       6  
Chittenden
VT
    41,032       1.05 %     7       3       3  
Rensselaer
NY
    12,106       0.62 %     12       1       1  
Rockingham
NH
    25,864       0.49 %     15       2       2  
      $ 4,710,230                       135       163  
 
Deposit market share data is based on the most recent data available (as of June 30, 2012).  Source: SNL Financial LLC
 
* Branch and ATM data is as of December 31, 2012.
 
Supervision and Regulation
 
As a bank holding company, the Company is subject to extensive regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”) as its primary federal regulator. The Company also has qualified for and elected to be registered with the FRB as a financial holding company. The Bank, as a nationally chartered bank, is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) as its primary federal regulator and, as to certain matters, by the FRB, the Bureau of Consumer Financial Protection (“CFPB”), and the Federal Deposit Insurance Corporation (“FDIC”).
 

The Company is also under the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC.  A summary of material information regarding the laws and regulations applicable to the Company are below.  This summary is not complete and the reader should refer to these laws and regulations for more information.  Failure to comply with applicable laws and regulations could result in a range of sanctions and enforcement actions, including the imposition of civil money penalties, formal agreements and cease and desist orders. Applicable laws and regulations may change in the future and any such change could have a material adverse impact on the Company.

Federal Bank Holding Company Regulation

Transactions between the Bank and any of its affiliates, including the Company, are governed by sections 23A and 23B of the Federal Reserve Act (“FRA”) and the FRB’s implementing Regulation W. An “affiliate” of a bank includes any company or entity that controls, is controlled by, or is under common control with the bank. A subsidiary of a bank that is not also a depository institution is not treated as an affiliate of the bank for purposes of sections 23A and 23B, unless the subsidiary is also controlled through a non-bank chain of ownership by affiliates or controlling shareholders of the bank, the subsidiary is a financial subsidiary that operates under the expanded authority granted to national banks under the Financial Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (“GLB Act”), or the subsidiary engages in other activities that are not permissible for a bank to engage in directly (except insurance agency subsidiaries). Generally, sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates, by placing quantitative and qualitative limitations on covered transactions between a bank and with any one affiliate as well as all affiliates of the bank in the aggregate, and requiring that such transactions be on terms that are consistent with safe and sound banking practices.

Under the GLB Act, a financial holding company may engage in certain financial activities that a bank holding company may not otherwise engage in under the Bank Holding Company Act (“BHC Act”). In addition to engaging in banking and activities closely related to banking as determined by the FRB by regulation or order prior to November 11, 1999, a financial holding company may engage in activities that are financial in nature or incidental to financial activities, or activities that are complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

The GLB Act and the rules promulgated thereunder require all financial institutions, including the Company and the Bank, to adopt privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer’s request, and establish procedures and practices to protect customer data from unauthorized access. In addition, the Fair Credit Reporting Act (“FCRA”), as amended by the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”), includes many provisions affecting the Company, Bank, and/or their affiliates, including provisions concerning obtaining consumer reports, furnishing information to consumer reporting agencies, maintaining a program to prevent identity theft, sharing of certain information among affiliated companies, and other provisions. The FACT Act requires persons subject to FCRA to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available. The CFPB and the Federal Trade Commission (“FTC”) have extensive rulemaking authority under the FACT Act, and the Company and the Bank are subject to the rules that have been promulgated under the FACT Act, including rules regarding limitations on affiliate marketing and implementation of programs to identify, detect and mitigate certain identity theft red flags. The Company has developed policies and procedures for itself and its subsidiaries, including the Bank, and believes it is in compliance with all privacy, information sharing, and notification provisions of the GLB Act and the FACT Act.  The Bank is also subject to data security standards and data breach notice requirements, chiefly those issued by the OCC.
 

Federal Reserve System Regulation

The Company is subject to capital adequacy guidelines of the FRB. The guidelines apply on a consolidated basis and require bank holding companies to maintain a minimum ratio of Tier 1 capital to total average assets (or “leverage ratio”) of 4%. For the most highly rated bank holding companies, the minimum ratio is 3%. The FRB capital adequacy guidelines also require bank holding companies to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 4% and a minimum ratio of qualifying total capital to risk-weighted assets of 8%. As of December 31, 2012, the Company’s leverage ratio was 8.54%, its ratio of Tier 1 capital to risk-weighted assets was 11.00%, and its ratio of qualifying total capital to risk-weighted assets was 12.25%. The FRB may set higher minimum capital requirements for bank holding companies whose circumstances warrant it, such as companies anticipating significant growth or facing unusual risks. The FRB has not advised the Company of any special capital requirement applicable to it.

Any holding company whose capital does not meet the minimum capital adequacy guidelines is considered to be undercapitalized and is required to submit an acceptable plan to the FRB for achieving capital adequacy. Such a company’s ability to pay dividends to its shareholders and expand its lines of business through the acquisition of new banking or nonbanking subsidiaries also could be restricted.

Pursuant to Federal Reserve Board regulations and supervisory policies that were largely codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), bank holding companies also are expected to serve as a source of financial and managerial strength to their subsidiary depository institutions.  Therefore, to the extent the Bank is in need of capital, the Company could be expected to provide additional capital to the Bank, including, potentially, raising new capital for that purpose.

Office of Comptroller of the Currency Regulation

The Bank is supervised and regularly examined by the OCC.  The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt, and acquisition of financial institutions and other companies.  It also affects business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices.  The OCC generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized.  Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan to the OCC.  If a depository institution fails to submit an acceptable capital restoration plan, it is treated as if it is “significantly undercapitalized.” Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

The Bank is subject to leverage and risk-based capital requirements and minimum capital guidelines of the OCC that are similar to those applicable to the Company.  As of December 31, 2012, the Bank was in compliance with all minimum capital requirements and met the requirements to be considered well-capitalized.  As of that date, the Bank’s leverage ratio was 7.62%, its ratio of Tier 1 capital to risk-weighted assets was 9.83%, and its ratio of qualifying total capital to risk-weighted assets was 11.08%.
 

Insurance of Deposit Accounts

The Bank is a member of the Deposit Insurance Fund (“DIF”) and deposit accounts at the Bank are insured by the FDIC, generally up to the maximum amount permitted by law. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor per insured institution, retroactive to January 1, 2008.  Under the Dodd-Frank Act, qualifying non-interest bearing transaction accounts had unlimited deposit insurance through December 31, 2012, but these accounts now return to general deposit insurance limits.

The deposits of the Bank are insured up to regulatory limits by the FDIC. The Federal Deposit Insurance Reform Act of 2005 gave the FDIC increased flexibility in assessing premiums on banks and savings associations, including the Bank, to pay for deposit insurance and in managing its deposit insurance reserves. The FDIC currently maintains a risk-based assessment system under which assessment rates vary based on the level of risk posed by institutions to the DIF.  In February 2011, the FDIC issued new rules that took effect April 1, 2011 to change the way the FDIC differentiates risk and sets appropriate assessment rates.

Those rules also redefined the deposit insurance assessment base, as required by the Dodd-Frank Act, from an institution’s domestic deposits to an institution’s average consolidated total assets minus average tangible equity.  FDIC assessment expenses totaled approximately $3.5 million in 2012 as compared with $3.8 million 2011.

In addition to the FDIC deposit insurance, the Federal Deposit Insurance Act provides for additional assessments to be imposed on insured depository institutions to pay for the cost of Financing Corporation (“FICO”) funding.  The FICO assessments are adjusted quarterly to reflect changes in the assessment base of the DIF and do not vary depending upon a depository institution’s capitalization or supervisory evaluation.  The Company incurred approximately $0.3 million in FICO expenses in 2012 and $0.4 million in 2011.

Under FDIC regulations, no FDIC-insured bank can accept brokered deposits unless it is well capitalized, or is adequately capitalized and receives a waiver from the FDIC. In addition, these regulations prohibit any bank that is not well capitalized from paying an interest rate on brokered deposits in excess of three-quarters of one percentage point over certain prevailing market rates. As of December 31, 2012, the Bank’s total brokered deposits were $68.2 million.

Federal Home Loan Bank

The Bank is also a member of the Federal Home Loan Bank (“FHLB”) of New York, which provides a central credit facility primarily for member institutions for home mortgage and neighborhood lending. The Bank is subject to the rules and requirements of the FHLB, including the requirement to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year. The Bank was in compliance with the rules and requirements of the FHLB at December 31, 2012.

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

On July 21, 2010, President Obama signed into law the Dodd-Frank Act.  This law significantly changed the bank regulatory landscape and impacted and will continue to impact the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress.
 

The so-called Collins Amendment to the Dodd-Frank Act requires bank holding companies with assets greater than $500 million to be subject to the same capital requirements as insured depository institutions, meaning, for instance, that such bank holding companies will not be able to count trust preferred securities issued after May 19, 2010 as Tier 1 capital. The Company has not issued any trust preferred securities after May 19, 2010. The Collins Amendment also directs the appropriate federal banking supervisors, subject to recommendations by the Financial Stability Oversight Council, to develop capital requirements for all insured depository institutions, depository institution holding companies and systemically important non-bank financial companies to address systemically risky activities.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments.  The legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using the company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules requiring the reporting of incentive-based compensation and prohibiting excessive incentive-based compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not.  In April 2011, the FRB, along with other federal banking supervisors, issued a joint notice of proposed rulemaking implementing those requirements.
 
The Dodd-Frank Act created the new CFPB with wide-ranging powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. As the Company is below this threshold, the OCC continues to exercise primary examination authority over the Bank with regard to compliance with federal consumer protection laws and regulations.  The Dodd-Frank Act also weakened the federal preemption rules that have been applicable to national banks and federal savings associations, and gave state attorneys general certain powers to enforce rules issued by the CFPB.  Further, pursuant to Federal Reserve regulations mandated by the Dodd-Frank Act, effective October 1, 2011, interchange fees on debit card are limited to a maximum of 21 cents per transaction plus 5 basis points of the transaction amount. A debit card issuer may recover an additional one cent per transaction for fraud prevention purposes if the issuer complies with certain fraud-related requirements prescribed by the Federal Reserve. Issuers that, together with their affiliates, have less than $10 billion in assets, such as the Company, are exempt from the debit card interchange fee standards.  The FRB also adopted requirements in the final rule that issuers include two unaffiliated networks for routing debit transactions that are applicable to the Company and the Bank.
 
The scope and impact of many of the Dodd-Frank Act’s provisions will be determined over time as regulations are issued and become effective. As a result, we cannot predict the ultimate impact of the Act on the Company or the Bank at this time, including the extent to which it could increase costs or limit our ability to pursue business opportunities in an efficient manner, or otherwise adversely affect our business, financial condition and results of operations. Nor can we predict the impact or substance of other future legislation or regulation. However, it is expected that they at a minimum will increase our operating and compliance costs.  As continued rules and regulations are issued, the Company may need to dedicate additional resources to ensure compliance, which may increase its costs of operations and adversely impact its earnings.

Basel III Amendments to Capital Adequacy Requirements
 
The current U.S. federal bank regulatory agencies' risk-based capital guidelines are based upon the 1988 capital accord (“Basel I”) of the Basel Committee on Banking Supervision (“Basel Committee”). The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that meet under the auspices of the Bank for International Settlements in Basel, Switzerland to develop broad policy guidelines for use by each country's supervisors in determining the supervisory policies they apply.
 
 
In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III.” Basel III, when implemented by the U.S. bank regulatory agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. The Basel III final capital framework, among other things, introduces as a new capital measure “Common Equity Tier 1”, or “CET1”, specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and expands the scope of the adjustments as compared to existing regulations.
While the Basel Committee initially called for the implementation of the Basel III final framework to commence January 1, 2013, final rules have not yet been implemented in the United States.
 
In June 2012, the Federal Banking Agencies issued a notice of proposed rulemaking (“NPR”) to implement Basel III in the United States.  The Basel III NPR closely followed the Basel Committee’s Basel III proposal in most respects.  Although the NPR calls for implementation to begin in 2013, the Federal Banking Agencies have not yet finalized the proposal.  The NPR would initially require banks and bank holding companies to meet the following minimum requirements:
 
 
3.5% CET1 to risk-weighted assets;
 
 
4.5% Tier 1 capital to risk-weighted assets; and
 
 
8.0% Total capital to risk-weighted assets.
 
Under the Basel III NPR, the minimum capital requirements would, in 2019, increase to the following:
 
 
4.5% CET1 to risk-weighted assets;
 
 
6.0% Tier 1 capital to risk-weighted assets; and
 
 
8.0% Total capital to risk-weighted assets.
 
The Basel III final framework and the NPR provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
 
In addition to the Basel III NPR, the Federal Banking Agencies also released an NPR to implement the Basel II Standardized approach in the United States and make it applicable to almost all banking organizations in the United States.  It incorporates aspects of the Basel Committee’s Basel II standardized framework and provides alternatives to credit ratings for the treatment of certain exposures, consistent with the Dodd-Frank Act.  The Standardized Approach NPR would increase the risk sensitivity of the Federal Banking Agencies’ general risk-based capital requirements for determining risk-weighted assets (i.e., the denominator of a banking organization’s risk-based capital ratios) by proposing revised methodologies for determining risk-weighted assets for:
 
 
Residential mortgage exposures by applying a more risk-sensitive treatment that would risk-weight an exposure based on certain loan characteristics, underwriting standards, and its loan-to-value ratio in a range between 35% and 200%, compared to current classification at 50%;
 
 
 
Certain commercial real estate credit facilities that finance the acquisition, development, or construction of real property by assigning a higher 150% risk weight;
 
 
Exposures that are more than 90 days past due or on nonaccrual (excluding sovereign and residential mortgage exposures) by assigning a higher 150% risk weight;
 
 
Exposures to foreign sovereigns, foreign banks, and foreign public sector entities by basing the risk weight for each exposure type on the OECD’s country risk classification of the sovereign entity so as to follow Dodd-Frank’s requirement not to use credit ratings; and
 
 
More favorable capital treatment for derivatives and repo-style transactions cleared through central counterparties.
 
The Standardized Approach NPR would also generally replace the use of credit ratings for securitization exposures with a formula-based approach under the existing gross up approach, or a new simplified supervisory formula approach (SSFA). The Standardized Approach NPR notes that the SSFA would generally result in relatively higher capital requirements for the more risky junior tranches of securitizations and relatively lower capital requirements for the most senior tranches.  The Standardized Approach NPR would also provide greater recognition of credit risk mitigants, such as collateral and guarantees. For assets with newly eligible guarantees and eligible collateral, this will result in lower capital requirements.  The changes in the Standardized Approach NPR are proposed to take effect January 1, 2015. However, banking organizations may choose to comply with the proposed requirements prior to that date.
 
The Dodd-Frank Act requires the Federal Reserve to adopt regulations imposing a continuing “floor” of the Basel I-based capital requirements in cases where the Basel II-based capital requirements and any changes in capital regulations resulting from Basel III otherwise would permit lower requirements. In June 2011, the Federal Reserve finalized regulations implementing this requirement.
 
Given that the Basel III rules are subject to implementation and change and the scope and content of capital regulations that U.S. federal banking agencies may adopt under the Dodd-Frank Act is uncertain, we cannot be certain of the impact new capital regulations will have on our capital ratios.

Consumer Protection Laws

Effective July 1, 2010, a new federal banking rule under the Electronic Fund Transfer Act prohibits financial institutions from charging consumers fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions.  Overdrafts on the payment of checks and regular electronic bill payments are not covered by this new rule.  The adoption of this regulation by the Bank had a negative impact on the Company’s service charge income of approximately $1.9 million in 2011.
 
Home mortgage lenders, including banks, are required under the Home Mortgage Disclosure Act to make available to the public expanded information regarding the pricing of home mortgage loans, including the “rate spread” between the annual percentage rate and the average prime offer rate for mortgage loans of a comparable type. The availability of this information has led to increased scrutiny of higher-priced loans at all financial institutions to detect illegal discriminatory practices and to the initiation of a limited number of investigations by federal banking agencies and the U.S. Department of Justice. The Company has no information that it or its affiliates is the subject of any HMDA investigation.
 
In addition, the Company is also subject to federal consumer protection statutes and regulations promulgated under these laws, including, but not limited to:
 
 
·
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
 
 
 
·
Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information; and
 
·
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies.

On January 10, 2013, the CFPB issued a final rule implementing the ability-to-repay and qualified mortgage (QM) provisions of the Truth in Lending Act, as amended by the Dodd-Frank Act (the “QM Rule”).  The ability-to-repay provision requires creditors to make reasonable, good faith determinations that borrowers are able to repay their mortgages before extending the credit based on a number of factors and consideration of financial information about the borrower from reasonably reliable third-party documents. Under the Dodd-Frank Act and the QM Rule, loans meeting the definition of “qualified mortgage” are entitled to a presumption that the lender satisfied the ability-to-repay requirements.  The presumption is a conclusive presumption/safe harbor for prime loans meeting the QM requirements, and a rebuttable presumption for higher-priced/subprime loans meeting the QM requirements.  The definition of a “qualified mortgage” incorporates the statutory requirements, such as not allowing negative amortization or terms longer than 30 years. The QM Rule also adds an explicit maximum 43% debt-to-income ratio for borrowers if the loan is to meet the QM definition, though some mortgages that meet GSE, FHA and VA underwriting guidelines may, for a period not to exceed seven years, meet the QM definition without being subject to the 43% debt-to-income limits.  The QM Rule will become effective January 10, 2014.

USA PATRIOT Act

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) imposes obligations on U.S. financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism.  Under Title III of the USA PATRIOT Act all financial institutions, including the Company and the Bank, are required in general to identify their customers, adopt formal and comprehensive anti-money laundering programs, scrutinize or prohibit altogether certain transactions of special concern, and be prepared to respond to inquiries from U.S. law enforcement agencies concerning their customers and their transactions. The USA PATRIOT Act also encourages information-sharing among financial institutions, regulators, and law enforcement authorities by providing an exemption from the privacy provisions of the GLB Act for financial institutions that comply with this provision. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to the Bank, or the BHC Act, which applies to the Company. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences for the institution. As of December 31, 2012, the Company and the Bank believe they are in compliance with the USA PATRIOT Act and regulations thereunder.

Community Reinvestment Act of 1977

The Bank has a responsibility under the Community Reinvestment Act of 1977 (“CRA”) to help meet the credit needs of its communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. Regulators assess the Bank’s record of compliance with the CRA. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit discrimination in lending practices on the basis of characteristics specified in those statutes. The Bank’s failure to comply with the provisions of the CRA could, at a minimum, result in regulatory restrictions on its activities and the activities of the Company. The Bank’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions against it by its regulators as well as other federal regulatory agencies and the Department of Justice. The Bank’s latest CRA rating was “Satisfactory”.
 

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (“SOX”) implemented a broad range of measures to increase corporate responsibility, enhance penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of corporate disclosures pursuant to federal securities laws. SOX applies generally to companies that have securities registered under the Exchange Act, including publicly held bank holding companies such as the Company.  SOX and/or its implementing regulations have, among other things, established new membership requirements and additional responsibilities for our audit committee, imposed restrictions on the relationship between us and our outside auditors (including restrictions on the types of non-audit services our auditors may provide to us), imposed additional responsibilities for our external financial statements on our chief executive officer and chief financial officer, expanded the disclosure requirements for our corporate insiders, required our management to evaluate our disclosure controls and procedures and our internal control over financial reporting, and required our auditors to issue a report on our internal control over financial reporting.  In addition, the federal banking regulators have adopted generally similar requirements concerning the certification of financial statements by bank officials.
 
Employees
 
At December 31, 2012, the Company had 1,581 full-time equivalent employees. The Company’s employees are not presently represented by any collective bargaining group.  The Company considers its employee relations to be good.
 
Available Information
 
The Company’s website is http://www.nbtbancorp.com. The Company makes available free of charge through its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed or furnished with the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act. We also make available through our website other reports filed with or furnished to the SEC under the Exchange Act, including our proxy statements and reports filed by officers and directors under Section 16(a) of that Act, as well as our Code of Business Conduct and Ethics and other codes/committee charters. The references to our website do not constitute incorporation by reference of the information contained in the website and such information should not be considered part of this document.
 
Any materials we file with the SEC may be read and copied at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC, 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
 
 
ITEM 1A.

There are risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Any of the following risks could affect the Company’s financial condition and results of operations and could be material and/or adverse in nature.

Deterioration in local economic conditions may negatively impact our financial performance.

The Company’s success depends primarily on the general economic conditions of central and upstate New York, northeastern Pennsylvania, southern New Hampshire, western Massachusetts and Burlington, Vermont and the specific local markets in which the Company operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the upstate New York areas of Norwich, Oneonta, Amsterdam-Gloversville, Albany, Binghamton, Utica-Rome, Plattsburg, Glens Falls. and Ogdensburg-Massena, the northeastern Pennsylvania areas of Scranton, Wilkes-Barre and East Stroudsburg, Berkshire County, Massachusetts, southern New Hampshire and the greater Burlington, Vermont area.  The local economic conditions in these areas have a significant impact on the demand for the Company’s products and services as well as the ability of the Company’s customers to repay loans, the value of the collateral securing loans and the stability of the Company’s deposit funding sources.

As a lender with the majority of our loans secured by real estate or made to businesses in New York, Pennsylvania, Massachusetts, New Hampshire and Vermont, a downturn in these local economies could cause significant increases in nonperforming loans, which could negatively impact our earnings. Declines in real estate values in our market areas could cause any of our loans to become inadequately collateralized, which would expose us to greater risk of loss. Additionally, a decline in real estate values could adversely impact our portfolio of residential and commercial real estate loans and could result in the decline of originations of such loans, as most of our loans, and the collateral securing our loans, are located in those areas.

Following completion of the Alliance merger, the Company will have more significant operations in central New York and be further subjected to such risks with respect to economic conditions in that area.

Variations in interest rates may negatively affect our financial performance.
 
The Company’s earnings and financial condition are largely dependent upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads could adversely affect the Company’s earnings and financial condition. The Company cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the FRB, affect interest income and interest expense.  High interest rates could also affect the amount of loans that the Company can originate because higher rates could cause customers to apply for fewer mortgages or cause depositors to shift funds from accounts that have a comparatively lower cost to accounts with a higher cost.  The Company may also experience customer attrition due to competitor pricing. With short-term interest rates at historic lows and the current Federal Funds target rate at 25 bp, the Company’s interest-bearing deposit accounts, particularly core deposits, are repricing at historic lows as well.  With the current outlook of the FRB to maintain the Fed Funds target rate at 25 bp for another 24 to 28 months, the Company’s challenge will be managing the magnitude and scope of the repricing.  If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, net interest income will be negatively affected. Changes in the asset and liability mix may also affect net interest income. Similarly, lower interest rates cause higher yielding assets to prepay and floating or adjustable rate assets to reset to lower rates. If the Company is not able to reduce its funding costs sufficiently, due to either competitive factors or the maturity schedule of existing liabilities, then the Company’s net interest margin will decline.
 

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the Company’s results of operations, any substantial or unexpected change in, or prolonged change in market interest rates could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Net Interest Income” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosure About Market Risk located elsewhere in this report for further discussion related to the Company’s management of interest rate risk.

Changes in the equity markets could materially affect the level of assets under management and the demand for other fee-based services.

Economic downturns could affect the volume of income from and demand for fee-based services.  Revenues from the trust and benefit plan administration businesses depend in large part on the level of assets under management and administration.  Market volatility that leads customers to liquidate investments, as well as lower asset values, can reduce our level of assets under management and administration and thereby decrease our investment management and administration revenues.

Our lending, and particularly our emphasis on commercial lending, exposes us to the risk of losses upon borrower default.

There are inherent risks associated with the Company’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Company operates as well as those across the States of New York, Pennsylvania, Massachusetts, New Hampshire and Vermont, and the entire United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Company.

As of December 31, 2012, approximately 47% of the Company’s loan portfolio consisted of commercial and industrial, agricultural, commercial construction and commercial real estate loans. These types of loans generally expose a lender to greater risk of non-payment and loss than residential real estate loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Because the Company’s loan portfolio contains a significant number of commercial and industrial, agricultural, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in nonperforming loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and/or an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Loans” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial and industrial, agricultural, construction and commercial real estate loans.
 

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease.

The Company maintains an allowance for loan losses, which is an allowance established through a provision for loan losses charged to expense, that represents management’s best estimate of probable losses that could be incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political, environmental, and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses. These potential increases in the allowance for loan losses would result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Risk Management – Credit Risk” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s process for determining the appropriate level of the allowance for loan losses.
 
Strong competition within our industry and market area could hurt our performance and slow our growth.

The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets in which the Company operates. Additionally, various banks continue to enter or have announced plans to enter the market areas in which the Company currently operates. The Company also faces competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking.  Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Company’s competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Company can.

The Company’s ability to compete successfully depends on a number of factors, including, among other things:

 
·
the ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets;
 
·
the ability to expand the Company’s market position;
 
·
the scope, relevance and pricing of products and services offered to meet customer needs and demands;
 
·
the rate at which the Company introduces new products and services relative to its competitors;
 
·
customer satisfaction with the Company’s level of service;
 
·
industry and general economic trends; and
 
·
the ability to attract and retain talented employees.

Failure to perform in any of these areas could significantly weaken the Company’s competitive position, which could adversely affect the Company’s growth and profitability, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.
 

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

The Company, primarily through the Bank and certain non-bank subsidiaries, is subject to extensive federal regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned “Supervision and Regulation” which is located in Item 1. Business in the Company’s Annual Report on Form 10-K.

Compliance with the Dodd-Frank Act and other regulatory reforms may increase our costs of operations and adversely impact our earnings and capital ratios

On July 21, 2010, President Obama signed the Dodd-Frank Act into law.  The Dodd-Frank Act represented a significant overhaul of many aspects of the regulation of the financial services industry, and has significantly changed the bank regulatory landscape and impacted and will continue to impact the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  Among other things, the Dodd-Frank Act creates a new federal financial consumer protection agency, tightens capital standards, imposes clearing and margining requirements on many derivatives activities, and generally increases oversight and regulation of financial institutions and financial activities.  It requires bank holding companies with assets greater than $500 million to be subject to minimum leverage and risk-based capital requirements and phases out the ability for bank holding companies to count trust preferred securities issued after May 19, 2010 as Tier 1 capital.  The Company has not issued any trust preferred securities after May 19, 2010.

In addition, the Dodd-Frank Act significantly rolls back the federal preemption of state consumer protection laws that is currently enjoyed by federal savings associations and national banks by requiring that a state consumer financial law prevent or significantly interfere with the exercise of a federal savings association’s or national bank’s powers before it can be preempted, mandating that any preemption decision be made on a case by case basis rather than a blanket rule, and ending the applicability of preemption to subsidiaries and affiliates of national banks and federal savings associations.  As a result, we may now be subject to state consumer protection laws in each state where we do business, and those laws may be interpreted and enforced differently in different states.

The scope and impact of many of the Dodd-Frank Act’s provisions will be determined over time as regulations are issued and become effective. As a result, we cannot predict the ultimate impact of the Dodd-Frank Act on us at this time, including the extent to which it could increase costs or limit our ability to pursue business opportunities in an efficient manner, or otherwise adversely affect our business, financial condition and results of operations. However, it is expected that at a minimum they will increase our operating and compliance costs.  The financial reform legislation and any rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and our business. We will apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.
 

The Company is subject to liquidity risk which could adversely affect net interest income and earnings

The purpose of the Company’s liquidity management is to meet the cash flow obligations of its customers for both deposits and loans.  The primary liquidity measurement the Company utilizes is called Basic Surplus which captures the adequacy of the Company’s access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  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.   However, competitive pressure on deposit pricing could result in a decrease in the Company’s deposit base or an increase in funding costs.  In addition, liquidity will come under additional pressure if loan growth exceeds deposit growth.  These scenarios could lead to a decrease in the Company’s basic surplus measure below the minimum policy level of 5%.  To manage this risk, the Company has the ability to purchase brokered time deposits, borrow against established borrowing facilities with other banks (Federal funds), and enter into repurchase agreements with investment companies.  Depending on the level of interest rates, the Company’s net interest income, and therefore earnings, could be adversely affected.  See the section captioned “Liquidity Risk” in Item 7.

Our ability to service our debt, pay dividends and otherwise pay our obligations as they come due is substantially dependent on capital distributions from our subsidiaries.

The Company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on the Company’s common stock and interest and principal on the Company’s debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. Also, the Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations or pay dividends on the Company’s common stock. The inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations.

A breach of information security, including as a result of cyber attacks, could disrupt our business and impact our earnings.

We depend upon data processing, communication and information exchange on a variety of computing platforms and networks, and over the internet.  In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs.  Despite existing safeguards, we cannot be certain that all of our systems are free from vulnerability to attack or other technological difficulties or failures.  If information security is breached or difficulties or failures occur, despite the controls we and our third party vendors have instituted, information can be lost or misappropriated, resulting in financial loss or costs to us or damages to others. Such costs or losses could exceed the amount of insurance coverage, if any, which would adversely affect our earnings.

We continually encounter technological change and the failure to understand and adapt to these changes could hurt our business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological changes affecting the financial services industry could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.
 

Provisions of our certificate of incorporation, bylaws and stockholder rights plan, as well as Delaware law and certain banking laws, could delay or prevent a takeover of us by a third party.

Provisions of the Company’s certificate of incorporation and bylaws, the Company’s stock purchase rights plan, the corporate law of the State of Delaware and state and federal banking laws, including regulatory approval requirements, could delay, defer or prevent a third party from acquiring the Company, despite the possible benefit to the Company’s stockholders, or otherwise adversely affect the market price of the Company’s common stock. These provisions include: supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to the Company’s board of directors and for proposing matters that stockholders may act on at stockholder meetings. In addition, the Company is subject to Delaware law, which among other things prohibits the Company from engaging in a business combination with any interested stockholder for a period of three years from the date the person became an interested stockholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discouraging bids for the Company’s common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of the Company’s common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors other than candidates nominated by the Board.

Negative developments in the housing market, financial industry and the domestic and international credit markets may adversely affect our operations and results.

Dramatic declines in the housing market over the past few years, with falling home prices and increasing foreclosures, continued high unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions.

The economic pressure experienced by consumers during the recent fiscal recession and lack of confidence in the financial markets has adversely affected our business, financial condition and results of operations. In particular, we have seen increases in foreclosures in our markets, increases in expenses such as loan collection and OREO expenses, and a low reinvestment rate environment.  While believe the financial crisis is slowly recovering, but we have not yet hit the bottom in many northeast markets.  Therefore, we do not expect that the challenging conditions in the financial and housing markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions. In particular, we may be affected in one or more of the following ways:

 
·
We currently face increased regulation of our industry and compliance with such regulation may increase our costs and limit our ability to pursue business opportunities;
 
 
·
Our ability to borrow from other financial institutions or to access the debt or equity capital markets on favorable terms or at all could be adversely affected by further disruptions in the capital markets; or
 
 
·
Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions.
 

We are subject to other-than-temporary impairment risk which could negatively impact our financial performance.

The Company recognizes an impairment charge when the decline in the fair value of equity, debt securities and cost-method investments below their cost basis are judged to be other-than-temporary. Significant judgment is used to identify events or circumstances that would likely have a significant adverse effect on the future use of the investment. The Company considers various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, forecasted recovery, the financial condition and near-term prospects of the investee, and whether the Company has the intent to sell and whether it is more likely than not it will be forced to sell the security in question. Information about unrealized gains and losses is subject to changing conditions. The values of securities with unrealized gains and losses will fluctuate, as will the values of securities that we identify as potentially distressed. Our current evaluation of other-than-temporary impairments reflects our intent to hold securities for a reasonable period of time sufficient for a forecasted recovery of fair value. However, our intent to hold certain of these securities may change in future periods as a result of facts and circumstances impacting a specific security. If our intent to hold a security with an unrealized loss changes, and we do not expect the security to fully recover prior to the expected time of disposition, we will write down the security to its fair value in the period that our intent to hold the security changes.

The process of evaluating the potential impairment of goodwill and other intangibles is highly subjective and requires significant judgment. The Company estimates the expected future cash flows of its various businesses and determines the carrying value of these businesses.  The Company exercises judgment in assigning and allocating certain assets and liabilities to these businesses. The Company then compares the carrying value, including goodwill and other intangibles, to the discounted future cash flows. If the total of future cash flows is less than the carrying amount of the assets, an impairment loss is recognized based on the excess of the carrying amount over the fair value of the assets. Estimates of the future cash flows associated with the assets are critical to these assessments. Changes in these estimates based on changed economic conditions or business strategies could result in material impairment charges and therefore have a material adverse impact on the Company’s financial condition and performance.

The risks presented by acquisitions could adversely affect our financial condition and result of operations.

The business strategy of the Company has included and may continue to include growth through acquisition from time to time.  Any future acquisitions, including our pending acquisition of Alliance Bank, will be accompanied by the risks commonly encountered in acquisitions.  These risks may include, among other things: our ability to realize anticipated cost savings, the difficulty of integrating operations and personnel, the loss of key employees, the potential disruption of our or the acquired company’s ongoing business in sucha a way that could result in decreased revenues, the inability of our management to maximize our financial and strategic position, the inability to maintain uniform standards, controls, procedures and policies, and the impairment of relationships with the acquired company’s employees and customers as a result of changes in ownership and management.

Our controls and procedures may fail or be circumvented, which may result in a material adverse effect on our business.
 
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
 
 
We are exposed to risk of environmental liabilities with respect to properties to which we obtain title.
 
A portion of our loan portfolio at December 31, 2012 was secured by real estate. In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a government entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation and remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business, results of operations and prospects.
 
We may be adversely affected by the soundness of other financial institutions including the FHLB of New York.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated if the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our business, financial condition or results of operations.

The Company owns common stock of FHLB of New York in order to qualify for membership in the FHLB system, which enables it to borrow funds under the FHLB of New York’s advance program.  The carrying value and fair market value of our FHLB of New York common stock was $21.9 million as of December 31, 2012.

There are 12 branches of the FHLB, including New York.  The 12 FHLB branches are jointly liable for the consolidated obligations of the FHLB system.  To the extent that one FHLB branch cannot meet its obligations to pay its share of the system’s debt, other FHLB branches can be called upon to make the payment.  Any such adverse effects on the FHLB of New York could adversely affect the value of our investment in its common stock and negatively impact our results of operations.

Trading activity in the Company’s common stock could result in material price fluctuations.

The market price of the Company’s common stock may fluctuate significantly in response to a number of factors including, but not limited to:

 
·
Changes in securities analysts’ expectations of financial performance;
 
·
Volatility of stock market prices and volumes;
 
·
Incorrect information or speculation;
 
·
Changes in industry valuations;
 
·
Variations in operating results from general expectations;
 
 
 
·
Actions taken against the Company by various regulatory agencies;
 
·
Changes in authoritative accounting guidance by the Financial Accounting Standards Board or other regulatory agencies;
 
·
Changes in general domestic economic conditions such as inflation rates, tax rates, unemployment rates, labor and healthcare cost trend rates, recessions, and changing government policies, laws and regulations; and
 
·
Severe weather, natural disasters, acts of war or terrorism and other external events.


None.
 
 
ITEM 2.
 
The Company’s headquarters are located at 52 South Broad Street, Norwich, New York 13815.  The Company operated the following community banking branches and ATMs as of December 31, 2012:
 
County
Branches
ATMs
 
County
Branches
ATMs
NBT Bank Division
 
Pennstar Bank Division
         
New York
 
Pennsylvania
   
Albany County
4
6
 
Lackawanna County
15
18
Broome County
8
11
 
Luzerne County
4
6
Chenango County
11
13
 
Monroe County
5
7
Clinton County
3
2
 
Pike County
2
2
Delaware County
5
5
 
Susquehanna County
6
7
Essex County
3
6
 
Wayne County
3
4
Franklin County
1
1
       
Fulton County
7
8
   
 
 
Greene County
3
3
       
Hamilton County
1
1
       
Herkimer County
2
1
       
Montgomery County
5
5
       
Oneida County
6
12
       
Otsego County
9
12
       
Rensselaer County
1
1
       
Saratoga County
3
4
       
Schenectady County
2
2
       
Schoharie County
4
4
       
St. Lawrence County
5
6
       
Tioga County
1
1
       
Warren County
3
3
       
             
Vermont
 
 
       
Chittenden County
3
3
       
             
Massachusetts
 
 
       
Berkshire County
5
5
       
             
New Hampshire
 
 
       
Cheshire
1
0
       
Hillsborough
2
2
       
Rockingham
2
2
       
 
The Company leases 53 of the above listed branches from third parties.  The Company owns all other banking premises. The Company believes that its offices are sufficient for its present operations.  All of the above ATMs are owned by the Company.
 
 
 
The Bank has been named as a defendant in a purported class action lawsuit arising from its assessment and collection of overdraft fees on its checking account customers. The complaint was filed in the Supreme Court of the State of New York, County of Delaware, on September 12, 2011 and alleges that the Bank engaged in certain unfair practices and failed to make adequate disclosure to customers concerning its overdraft fee assessment practices.  The complaint seeks certification of a class of national checking account holders who have incurred overdraft fees and a subclass of such customers who reside in New York.  In addition, the complaint seeks actual and punitive damages, disgorgement, interest and costs including attorneys' fees.  On May 15, 2012, Acting Supreme Court Judge for Delaware County, New York, John F. Lambert, dismissed in its entirety the plaintiff`s case.  On June 20, 2012, the plaintiffs filed an appeal to the Appellate Division, Third Department.  The Company believes the claims to be without merit and intends to defend the action vigorously.
 
There are no other 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.
 
None.

PART  II
Market Information
 
The common stock of the Company, par value $0.01 per share (the “Common Stock”), is quoted on the Nasdaq Global Select Market under the symbol “NBTB.” The following table sets forth the high and low sales prices and dividends declared for the Common Stock for the periods indicated:
 
 
 
High
   
Low
   
Dividend
 
2012
                 
1st quarter
  $ 24.10     $ 20.75     $ 0.20  
2nd quarter
    22.50       19.19       0.20  
3rd quarter
    22.89       19.91       0.20  
4th quarter
    22.45       18.92       0.20  
2011
                       
1st quarter
  $ 24.98     $ 21.55     $ 0.20  
2nd quarter
    23.32       20.62       0.20  
3rd quarter
    23.25       17.05       0.20  
4th quarter
    22.63       17.47       0.20  
 
The closing price of the Common Stock on February 15, 2013 was $20.92.
 
 
As of February 15, 2013, there were 6,582 shareholders of record of Common Stock.  No unregistered securities were sold by the Company during the year ended December 31, 2012.

Stock Performance Graph

The following stock performance graph compares the cumulative total stockholder return (i.e., price change, reinvestment of cash dividends and stock dividends received) on our Common Stock against the cumulative total return of the NASDAQ Stock Market (U.S. Companies) Index and the Index for NASDAQ Financial Stocks.  The stock performance graph assumes that $100 was invested on December 31, 2007.  The graph further assumes the reinvestment of dividends into additional shares of the same class of equity securities at the frequency with which dividends are paid on such securities during the relevant fiscal year.  The yearly points marked on the horizontal axis correspond to December 31 of that year.  We calculate each of the referenced indices in the same manner.  All are market-capitalization-weighted indices, so companies judged by the market to be more important (i.e., more valuable) count for more in all indices.
 

   
Period Ending
 
Index
 
12/31/07
   
12/31/08
   
12/31/09
   
12/31/10
   
12/31/11
   
12/31/12
 
NBT Bancorp
  $ 100.00     $ 126.56     $ 95.68     $ 117.56     $ 111.83     $ 106.30  
NASDAQ Financial Stocks
  $ 100.00     $ 70.88     $ 73.31     $ 83.70     $ 74.82     $ 88.10  
NASDAQ Composite Index
  $ 100.00     $ 60.04     $ 87.23     $ 103.04     $ 102.25     $ 120.35  
 
Source:  Bloomberg, L.P.
 

Dividends

We depend primarily upon dividends from our subsidiaries for a substantial part of our revenue.  Accordingly, our ability to pay dividends depends primarily upon the receipt of dividends or other capital distributions from our subsidiaries.  Payment of dividends to the Company from the Bank is subject to certain regulatory and other restrictions.  Under OCC regulations, the Bank may pay dividends to the Company without prior regulatory approval so long as it meets its applicable regulatory capital requirements before and after payment of such dividends and its total dividends do not exceed its net income to date over the calendar year plus retained net income over the preceding two years.  At December 31, 2012, the Bank was in compliance with all applicable minimum capital requirements and had the ability to pay dividends of $21.3 million to the Company without the prior approval of the OCC.

If the capital of the Company is diminished by depreciation in the value of its property or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets, no dividends may be paid out of net profits until the deficiency in the amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets has been repaired.  See the section captioned “Supervision and Regulation” in Item 1. Business and Note 16 – Stockholders’ Equity in the notes to consolidated financial statements in included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.

Stock Repurchase

Under previously disclosed stock repurchase plans, the Company purchased 769,568 shares of its common stock during the year ended December 31, 2012, for a total of $15.5 million at an average price of $20.13 per share.  At December 31, 2012, there were 748,013 shares available for repurchase under a previously disclosed repurchase plan, which expires on December 31, 2013.  There were no purchases during the fourth quarter of 2012.
 

 
The following summary of financial and other information about the Company is derived from the Company’s audited consolidated financial statements for each of the last five fiscal years ended December 31 and should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Company’s consolidated financial statements and accompanying notes, included elsewhere in this report:
 
   
Year ended December 31,
 
(In thousands, except per share data)
 
2012
   
2011
   
2010
   
2009
   
2008
 
Interest, fee and dividend income
  $ 239,397     $ 239,997     $ 255,738     $ 273,393     $ 294,414  
Interest expense
    35,194       39,721       53,210       76,924       108,368  
Net interest income
    204,203       200,276       202,528       196,469       186,046  
Provision for loan losses
    20,269       20,737       29,809       33,392       27,181  
Noninterest income excluding  securities gains
    86,728       80,161       80,614       79,987       70,171  
Securities gains, net
    599       150       3,274       144       1,535  
Noninterest expense
    193,887       180,676       178,291       170,566       146,813  
Income before income taxes
    77,374       79,174       78,316       72,642       83,758  
Net income
    54,558       57,901       57,404       52,011       58,353  
                                         
Per common share
                                       
Basic earnings
  $ 1.63     $ 1.72     $ 1.67     $ 1.54     $ 1.81  
Diluted earnings
    1.62       1.71       1.66       1.53       1.80  
Cash dividends paid
    0.80       0.80       0.80       0.80       0.80  
Book value at year-end
    17.24       16.23       15.51       14.69       13.24  
Tangible book value at year-end
    12.23       11.70       11.67       10.75       9.01  
Average diluted common shares outstanding
    33,719       33,924       34,509       33,903       32,427  
                                         
Securities available for sale, at fair value
  $ 1,147,999     $ 1,244,619     $ 1,129,368     $ 1,116,758     $ 1,119,665  
Securities held to maturity, at amortized cost
    60,563       70,811       97,310       159,946       140,209  
Loans
    4,277,616       3,800,203       3,610,006       3,645,398       3,651,911  
Allowance for loan losses
    69,334       71,334       71,234       66,550       58,564  
Assets
    6,042,259       5,598,406       5,338,856       5,464,026       5,336,088  
Deposits
    4,784,349       4,367,149       4,134,352       4,093,046       3,923,258  
Borrowings
    605,855       627,358       604,730       786,097       914,123  
Stockholders’ equity
    582,273       538,110       533,572       505,123       431,845  
                                         
Key ratios
                                       
Return on average assets
    0.93 %     1.06 %     1.05 %     0.96 %     1.11 %
Return on average equity
    9.72       10.73       10.92       10.90       14.16  
Average equity to average assets
    9.55       9.90       9.63       8.79       7.83  
Net interest margin
    3.86       4.09       4.15       4.04       3.95  
Dividend payout ratio
    49.38       46.78       48.19       52.29       44.44  
Tier 1 leverage
    8.54       8.74       9.16       8.35       7.17  
Tier 1 risk-based capital
    11.00       11.56       12.44       11.34       9.75  
Total risk-based capital
    12.25       12.81       13.70       12.59       11.00  

 
Selected Quarterly Financial Data
 
   
2012
   
2011
 
(Dollars in thousands, except share and per share data)
 
Fourth
   
Third
   
Second
   
First
   
Fourth
   
Third
   
Second
   
First
 
Interest, fee and dividend income
  $ 60,857     $ 61,287     $ 58,647     $ 58,606     $ 59,898     $ 59,784     $ 60,258     $ 60,057  
Interest expense
    8,404       8,680       8,896       9,214       9,399       9,423       10,094       10,805  
Net interest income
    52,453       52,607       49,751       49,392       50,499       50,361       50,164       49,252  
Provision for loan losses
    6,940       4,755       4,103       4,471       5,576       5,175       6,021       3,965  
Noninterest income excluding net securities gains
    21,941       21,601       20,585       22,601       20,078       20,182       19,802       20,099  
Net securities gains
    21       26       97       455       52       12       59       27  
Noninterest expense
    48,592       49,431       47,390       48,474       47,412       45,046       43,157       45,061  
Net income
    13,116       14,535       13,257       13,650       13,722       15,217       14,655       14,307  
Basic earnings per share
  $ 0.39     $ 0.43     $ 0.40     $ 0.41     $ 0.42     $ 0.46     $ 0.43     $ 0.42  
Diluted earnings per share
  $ 0.39     $ 0.43     $ 0.40     $ 0.41     $ 0.41     $ 0.45     $ 0.43     $ 0.41  
Annualized net interest margin
    3.83 %     3.90 %     3.82 %     3.90 %     3.98 %     4.14 %     4.13 %     4.11 %
Annualized return on average assets
    0.86 %     0.97 %     0.92 %     0.97 %     0.97 %     1.12 %     1.09 %     1.08 %
Annualized return on average equity
    9.01 %     10.13 %     9.66 %     10.12 %     10.09 %     11.21 %     10.86 %     10.78 %
Average diluted common shares outstanding
    33,987       33,961       33,493       33,442       33,239       33,567       34,320       34,650  
 
 
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 non-performing 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 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, but not limited to, those described above, 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.
 
Except as required by law, the Company does not undertake, and specifically disclaims any obligations to, publicly release any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

General
 
The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of the Company and its wholly owned subsidiaries, the Bank, NBT Financial Services and NBT Holdings during 2012 and, in summary form, the preceding two years. Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.” Net interest margin is presented in this discussion on a fully taxable equivalent (FTE) basis. Average balances discussed are daily averages unless otherwise described. The audited consolidated financial statements and related notes as of December 31, 2012 and 2011 and for each of the years in the three-year period ended December 31, 2012 should be read in conjunction with this review. Amounts in prior period consolidated financial statements are reclassified whenever necessary to conform to the 2012 presentation.
 
 
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 policy would also require additional provision for loan losses.

Management is required to make various assumptions in valuing its 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.

Management of the Company considers the accounting policy relating to other-than-temporary impairment to be a critical accounting policy.  Management systematically evaluates certain assets for other-than-temporary declines in fair value, primarily investment securities.  Management considers historical values and current market conditions as a part of the assessment.  The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is generally recognized in other comprehensive income, net of applicable taxes.

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 effect on the Company’s results of operations.

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 them to select 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 and intangible assets are disclosed in Note 1 to the consolidated financial statements. A more detailed description of the allowance for loan losses is included in the “Risk Management” section of this Form 10-K.  All significant pension accounting assumptions, income tax assumptions, and intangible asset assumptions and detail are disclosed in Notes 18, 15 and 10, respectively, to the consolidated financial statements. 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 assets and 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 fiscal year ended December 31, 2012:
 
 
·
Significant strategic expansion during 2012:
 
 
§
Announced the planned acquisition of Alliance Financial Corporation, a $1.4 billion financial holding company headquartered in Syracuse, N.Y., expected to close in early 2013;
 
 
§
Acquired and successfully integrated Hampshire First Bank during the second quarter of 2012; now operating 5 branches in southern New Hampshire; and
 
 
§
Acquired three branches in Greene County, New York in January 2012.
 
 
·
Net interest margin for 2012 declined 23 basis points as a result of the continued low rate environment on loans and investments.
 
 
·
2012 organic loan growth of 6.8%, offsetting aforementioned margin compression, driven by:
 
 
§
Consumer loan growth of 10.7%; and
 
 
§
Commercial loan growth of 8.7%.
 
 
·
Asset quality indicators showed improvement from last year:
 
 
§
Nonperforming loans to total loans was 0.98%, down from 1.09% for last year;
 
 
§
Past due accruing loans to total loans was 0.71%, down from 0.89% for last year; and
 
 
§
Net charge-off ratio was 0.55%, down from 0.56% for last year.
 
 
·
Service charges on deposit accounts continued to decrease due primarily to a decrease in overdraft activity.

 
The Company continued to experience pressure on net interest income in 2012 as low rates continued to have the effect of causing many assets to prepay or to be redeemed. As a result, reinvestment of cash flows in lower yielding assets has been the primary contributor to a decline in interest income in 2012.  The yield on interest earning assets decreased from 4.88% in 2011 to 4.51% in 2012, with drops in the yields on loans and securities available for sale being the primary drivers.  Rates paid on interest bearing liabilities also decreased in the low rate environment, which partially offset the decrease in earning asset yields.  In particular, the decrease in rates paid on money market deposit accounts and time deposits contributed approximately $5.1 million to the decrease in interest expense in 2012 as compared with 2011.  Average interest bearing liabilities increased approximately $237.9 million from 2011 to 2012, with the primary driver being the increase in interest bearing deposits from acquisition activity and organic deposit growth.  The Company also took the following steps in 2012 in an effort to help offset the margin pressure created by the low interest rate environment:

 
·
Continued the sale of conforming residential real estate mortgages in 2012, taking advantage of favorable interest rate conditions;
 
 
·
Increased efforts to grow noninterest income with focus on organic growth of our trust, financial services and insurance businesses; and
 
 
·
Continued strategic expansion into New Hampshire with the completed acquisition of Hampshire First Bank and into central New York with the planned acquisition of Alliance.
 
The Company reported net income of $54.6 million or $1.62 per diluted share for 2012, down 5.8% from net income of $57.9 million or $1.71 per diluted share for 2011.  The provision for loan losses totaled $20.3 million for the year ended December 31, 2012, down $0.5 million, or 2.3%, from $20.7 million for the year ended December 31, 2011.  The decrease in provision is attributable to the ongoing modeling of the required levels of reserves which considers historical charge-offs, loan growth and economic trends. Noninterest income increased $7.0 million, or 8.7%, from 2011 primarily due to an increase in other noninterest income of approximately $6.1 million.  This increase was due in part to a $1.1 million payoff gain on a purchased commercial real estate loan.  In addition, the Company recognized nonrecurring items totaling approximately $1.4 million during 2012 including a prepayment penalty fee related to a loss of a retirement plan client and flood related recoveries.  Further, mortgage banking revenue increased approximately $2.6 million for the year ended December 31, 2012 as compared to the same period in 2011 as the Company sold certain residential mortgages as market conditions warranted.  Noninterest expense for the year ended December 31, 2012 was $193.9 million, up from $180.7 million, or 7.3% for the year ended December 31, 2011.

2013 Outlook

The Company’s 2012 earnings reflected the Company’s continued ability to manage through the existing and near future economic conditions and challenges in the financial services industry, while investing in the Company’s future.  The Company believes effects of the economic crisis still exist and, as a result, there will be certain challenges faced in 2013.  Significant items that may have an impact on 2013 results include:

 
·
The Company expects that it will experience additional margin compression from the 2012 fourth quarter net interest margin of 3.83%. We expect that payments representing interest and principal on currently outstanding loans and investments will continue to be reinvested at rates that are lower than the rates currently outstanding on those loans and investments.  In addition, deposit and borrowing rates are historically low and there are minimal opportunities for them to be lowered.  Furthermore, the industry as a whole must focus on asset growth to increase interest income, thereby creating general pricing pressure in the entire industry.
 

 
·
The Company experienced benefits from expiration of the statute of limitations of prior years’ tax filings and state tax audit settlements in past years.  The Company expects the tax rate to be more normalized in 2013 without those benefits.

 
·
If asset quality trends continue to show improvement, the Company would eventually expect the level of provisioning to decrease.  However, the economy may have an adverse affect on asset quality indicators, particularly indicators related to loans secured by real estate, which could adversely affect charge-offs, the allowance for loan losses, and the provision for loan losses.

 
·
The cost of compliance as a result of the Dodd-Frank Act could continue to negatively impact certain fee generating products, which could negatively impact noninterest income and earnings.

 
·
Competitive pressure on non-maturing deposits could result in an increase in interest expense if interest rates begin to rise.

 
·
Our ability to integrate the operations and personnel and realize anticipated cost savings of the pending acquisition of Alliance may affect our results of operations in 2013.

The Company’s 2013 outlook is subject to factors in addition to those identified above and those risks and uncertainties that could impact the Company’s future results are explained in ITEM 1A. RISK FACTORS.
 

Asset/Liability Management

The Company attempts to maximize net interest income and net income, while actively managing its liquidity and interest rate sensitivity through the mix of various core deposit products and other sources of funds, which in turn fund an appropriate mix of earning assets. The changes in the Company’s asset mix and sources of funds, and the resulting impact on net interest income, on a fully tax equivalent basis, are discussed below.  The following table includes 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 taxable-equivalent basis using the statutory Federal income tax rate of 35%.
 
Table 1. Average Balances and Net Interest Income
 
   
2012
   
2011
   
2010
 
   
Average
         
Yield/
   
Average
         
Yield/
   
Average
         
Yield/
 
(Dollars in thousands)
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
ASSETS
                                                     
Short-term interest bearing accounts
  $ 66,207     $ 179       0.27 %   $ 101,224     $ 269       0.27 %   $ 137,818     $ 354       0.26 %
Securities available for sale (1)
    1,177,969       28,904       2.45 %     1,123,215       33,319       2.97 %     1,088,376       38,759       3.56 %
Securities held to maturity (1)
    65,582       3,583       5.46 %     81,558       4,350       5.33 %     128,727       6,104       4.74 %
Investment in FRB and FHLB Banks
    28,358       1,378       4.86 %     27,089       1,389       5.13 %     31,850       1,821       5.72 %
Loans  (2)
    4,053,420       209,370       5.17 %     3,677,931       205,318       5.58 %     3,629,047       214,258       5.90 %
Total interest earning assets
  $ 5,391,536     $ 243,414       4.51 %   $ 5,011,017     $ 244,645       4.88 %   $ 5,015,818     $ 261,296       5.21 %
Other assets
    483,248                       434,924                       438,516                  
Total assets
  $ 5,874,784                     $ 5,445,941                     $ 5,454,334                  
                                                                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                 
Money market deposit accounts
  $ 1,116,583     $ 2,054       0.18 %   $ 1,070,003     $ 3,592       0.34 %   $ 1,092,789     $ 6,273       0.57 %
NOW deposit accounts
    709,889       1,854       0.26 %     685,542       2,313       0.34 %     709,920       2,938       0.41 %
Savings deposits
    680,092       522       0.08 %     602,918       635       0.11 %     552,660       797       0.14 %
Time deposits
    993,117       14,418       1.45 %     913,330       16,480       1.80 %     985,504       20,346       2.06 %
Total interest bearing deposits
  $ 3,499,681     $ 18,848       0.54 %   $ 3,271,793     $ 23,020       0.70 %   $ 3,340,873     $ 30,354       0.91 %
Short-term borrowings
    165,742       188       0.11 %     153,965       205       0.13 %     158,280       402       0.25 %
Trust preferred debentures
    75,422       1,730       2.29 %     75,422       2,092       2.77 %     75,422       4,140       5.49 %
Long-term debt
    368,270       14,428       3.92 %     370,035       14,404       3.89 %     469,509       18,314       3.90 %
Total interest bearing liabilities
  $ 4,109,115     $ 35,194       0.86 %   $ 3,871,215     $ 39,721       1.03 %   $ 4,044,084     $ 53,210       1.32 %
Demand deposits
    1,139,896                       966,282                       805,594                  
Other liabilities
    64,551                       69,063                       79,182                  
Stockholders' equity
    561,222                       539,381                       525,474                  
Total liabilities and stockholders' equity
  $ 5,874,784                     $ 5,445,941                     $ 5,454,334                  
Net interest income (FTE)
            208,220                       204,924                       208,086          
Interest rate spread
                    3.65 %                     3.85 %                     3.89 %
Net interest margin
                    3.86 %                     4.09 %                     4.15 %
Taxable equivalent adjustment
            4,017                       4,648                       5,558          
Net interest income
          $ 204,203                     $ 200,276                     $ 202,528          

1. Securities are shown at average amortized cost.
 
2. For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding. The interest collected thereon is included in interest income based upon the characteristics of the related loans.

 
2012 OPERATING RESULTS AS COMPARED TO 2011 OPERATING RESULTS
 
Net Interest Income
 
While the rate paid on interest bearing liabilities decreased 17 basis points, the yield on interest earning assets declined 37 basis points compared to the same period for 2011, resulting in margin compression for the year ended December 31, 2012.  The yield on securities available for sale was 2.45% for the year ended December 31, 2012, compared with 2.97% for the year ended December 31, 2011. This decrease was due primarily to the reinvestment of cash flows from maturing securities and cash received from branch acquisitions in 2011 and the first quarter of 2012 into lower yielding securities in the current rate environment. The average balance of securities available for sale for the year ended December 31, 2012 was $1.2 billion, up approximately $54.8 million, or 4.9%, from the year ended December 31, 2011. This increase was due primarily to reinvestment of cash flows from held to maturity securities into available for sale securities, and investment of liquidity from branch acquisition activity and deposit growth. The yield on loans was 5.17% for the year ended December 31, 2012, compared with 5.58% for the year ended December 31, 2011. The average balance of loans for the year ended December 31, 2012 was $4.1 billion, up approximately $375.5 million (including approximately $124.3 million from acquisitions), or 10.2%, from the year ended December 31, 2011.  The reduction in yields on earning assets was partially offset by a reduction in rates paid on interest bearing liabilities.  The rate on time deposits was 1.45% for the year ended December 31, 2012, compared with 1.80% for the year ended December 31, 2011.  The rate on money market deposit accounts was 0.18% for the year ended December 31, 2012, compared with 0.34% for the year ended December 31, 2011.   The following table presents changes in interest income, on a FTE basis, 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.
 
Table 2. Analysis of Changes in Taxable Equivalent Net Interest Income
 
   
Increase (Decrease)
   
Increase (Decrease)
 
   
2012 over 2011
   
2011 over 2010
 
(In thousands)
 
Volume
   
Rate
   
Total
   
Volume
   
Rate
   
Total
 
Short-term interest-bearing accounts
  $ (95 )   $ 5     $ (90 )   $ (97 )   $ 12     $ (85 )
Securities available for sale
    1,562       (5,977 )     (4,415 )     1,207       (6,647 )     (5,440 )
Securities held to maturity
    (871 )     104       (767 )     (2,445 )     691       (1,754 )
Investment in FRB and FHLB Banks
    63       (74 )     (11 )     (256 )     (176 )     (432 )
Loans
    20,057       (16,005 )     4,052       2,855       (11,795 )     (8,940 )
Total interest income
    20,716       (21,947 )     (1,231 )     1,264       (17,915 )     (16,651 )
Money market deposit accounts
    150       (1,688 )     (1,538 )     (128 )     (2,553 )     (2,681 )
NOW deposit accounts
    80       (539 )     (459 )     (98 )     (527 )     (625 )
Savings deposits
    74       (187 )     (113 )     68       (230 )     (162 )
Time deposits
    1,353       (3,415 )     (2,062 )     (1,421 )     (2,445 )     (3,866 )
Short-term borrowings
    15       (32 )     (17 )     (11 )     (186 )     (197 )
Trust preferred debentures
    -       (362 )     (362 )     -       (2,048 )     (2,048 )
Long-term debt
    (69 )     93       24       (3,872 )     (38 )     (3,910 )
Total interest expense
    1,603       (6,130 )     (4,527 )     (5,462 )     (8,027 )     (13,489 )
Change in FTE net interest income
  $ 19,113     $ (15,817 )   $ 3,296     $ 6,726     $ (9,888 )   $ (3,162 )

 
Loans and Corresponding Interest and Fees on Loans
 
The average balance of loans increased by approximately $375.5 million, or 10.2%, from 2011 to 2012.  The yield on average loans decreased from 5.58% in 2011 to 5.17% in 2012, as loan rates declined due to the historically low rate environment in 2012.  Interest income from loans on a FTE basis increased 1.97%, from $205.3 million in 2011 to $209.4 million in 2012.  This increase was due to the increase in average loan balances noted above, and was partially offset by the decrease in yields.
 
Total loans increased $477.4 million,