10-K 1 form10k.htm NBT BANCORP INC 10-K 12-31-2013

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, 2013
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, 2013, the aggregate market value of the voting stock, common stock, par value, $0.01 per share, held by non-affiliates of the registrant is $887,440,734.
 
The number of shares of common stock outstanding as of February 14, 2014, was 43,867,910.
 


DOCUMENTS INCORPORATED BY REFERENCE
 
Portions  of the registrant’s definitive Proxy Statement for its Annual Meeting  of Stockholders to be held on May 6, 2014 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, 2013

TABLE OF CONTENTS

PART I
 
 
 
 
 
ITEM 1
5
 
 
 
ITEM 1A
18
 
 
 
ITEM 1B
26
 
 
 
ITEM 2
27
 
 
 
ITEM 3
28
 
 
 
ITEM 4
28
 
 
 
PART II
 
 
 
 
 
ITEM 5
28
 
 
 
ITEM 6
31
 
 
 
ITEM 7
33
 
 
 
ITEM 7A
57
 
 
 
ITEM  8
59
 
59
 
60
 
61
 
62
 
63
 
64
 
66
 
 
 
ITEM 9
125

PART I

ITEM 1.   Business

NBT Bancorp Inc. (the “Registrant” or the “Company”) is a registered financial holding company incorporated in the state of Delaware in 1986, with its principal headquarters located in Norwich, New York. The Company, on a consolidated basis, at December 31, 2013 had assets of $7.7 billion and stockholders’ equity of $816.6 million.  Return on average assets and return on average equity were 0.85% and 8.09%, respectively, for the year ending December 31, 2013.  The Company had net income of $61.7 million or $1.46 per diluted share for 2013 and the fully taxable equivalent (“FTE”) net interest margin was 3.66% 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.  Percentage of revenue and loan composition by state is summarized below:

 
 
Interest and Fee Income
   
Noninterest Income
   
Total Revenue
 
New York
   
58
%
   
25
%
   
83
%
Pennsylvania
   
7
%
   
3
%
   
10
%
New Hampshire
   
3
%
   
0
%
   
3
%
Vermont
   
3
%
   
0
%
   
3
%
Massachusetts
   
1
%
   
0
%
   
1
%
 
   
72
%
   
28
%
   
100
%

 
 
Commercial
   
Consumer
   
Residential Real Estate
   
Total Loan Portfolio
 
New York
   
33
%
   
29
%
   
15
%
   
77
%
Pennsylvania
   
4
%
   
4
%
   
3
%
   
11
%
New Hampshire
   
4
%
   
0
%
   
1
%
   
5
%
Vermont
   
3
%
   
2
%
   
1
%
   
6
%
Massachusetts
   
0
%
   
1
%
   
0
%
   
1
%
 
   
44
%
   
36
%
   
20
%
   
100
%
 
Percentage of total loan portfolio secured by real estate is summarized below:

 
 
 
Secured By Real Estate
   
Not Secured By Real Estate
 
New York
   
56
%
   
44
%
Pennsylvania
   
68
%
   
32
%
New Hampshire
   
94
%
   
6
%
Vermont
   
57
%
   
43
%
Massachusetts
   
74
%
   
26
%

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, adverse 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 noninterest income.  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 March 8, 2013, the Company acquired Alliance Financial Corporation (“Alliance”), the parent company of Alliance Bank, N.A., for total consideration of $226 million.  As part of the acquisition, Alliance was merged with and into the Company and Alliance Bank, with 26 branch locations in the central New York counties of Onondaga, Cortland, Madison, Oneida and Oswego, was merged with and into the Bank.  The merger with Alliance enabled the Company to expand its footprint into demographically attractive and contiguous markets located in the aforementioned New York counties.  The results of Alliance’s operations are included in the Consolidated Statements of Income from the date of acquisition.

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 electronically 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 account information, transfer funds, request statements, and perform various other activities.
The Bank conducts business through two geographic divisions, NBT Bank and Pennstar Bank.  At year end 2013, the NBT Bank division had 125 divisional offices and 145 automated teller machines (ATMs).  At December 31, 2013, the NBT Bank division had total loans of approximately $4.8 billion, or 89% of total loans, and total deposits of $5.0 billion, or 84% of total deposits.  Revenue for the NBT Bank division totaled $335 million for the year ended December 31, 2013.  At year end 2013, the Pennstar Bank division had 32 divisional offices and 42 ATMs, located primarily in northeastern Pennsylvania.  At December 31, 2013, the Pennstar Bank division had total loans of $577 million, or 11% of total loans, and total deposits of $932 million, or 16% of total deposits. Revenue for the Pennstar Bank division totaled $37 million for the year ended December 31, 2013.  In the first quarter of 2014, Pennstar Bank will begin doing business as NBT Bank as part of the Bank’s rebranding initiative.
 
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 the continued low rate environment, 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 nonbanking 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, 2013.  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
 
$
571,113
     
85.38
%
   
1
     
11
     
13
 
Fulton
NY
   
391,437
     
58.07
%
   
1
     
6
     
6
 
Schoharie
NY
   
207,935
     
50.44
%
   
1
     
4
     
4
 
Hamilton
NY
   
36,766
     
49.14
%
   
2
     
1
     
1
 
Cortland
NY
   
255,419
     
39.43
%
   
1
     
5
     
6
 
Montgomery
NY
   
227,978
     
35.44
%
   
2
     
5
     
4
 
Delaware
NY
   
304,853
     
31.81
%
   
1
     
5
     
5
 
Otsego
NY
   
317,187
     
31.73
%
   
2
     
9
     
12
 
Essex
NY
   
138,346
     
24.33
%
   
2
     
3
     
5
 
Madison
NY
   
231,480
     
22.78
%
   
2
     
4
     
6
 
Susquehanna
PA
   
151,227
     
20.63
%
   
2
     
5
     
7
 
Wayne
PA
   
158,107
     
12.41
%
   
4
     
3
     
4
 
Broome
NY
   
271,802
     
11.93
%
   
3
     
8
     
11
 
Oneida
NY
   
322,084
     
11.72
%
   
4
     
7
     
12
 
Oswego
NY
   
139,950
     
11.53
%
   
5
     
4
     
6
 
Saint Lawrence
NY
   
121,393
     
10.60
%
   
4
     
5
     
6
 
Pike
PA
   
56,423
     
9.52
%
   
5
     
2
     
2
 
Tioga
NY
   
32,499
     
8.14
%
   
6
     
1
     
1
 
Lackawanna
PA
   
385,841
     
7.84
%
   
7
     
14
     
18
 
Clinton
NY
   
90,801
     
7.55
%
   
5
     
3
     
2
 
Herkimer
NY
   
41,617
     
7.08
%
   
5
     
2
     
1
 
Franklin
NY
   
27,332
     
6.18
%
   
5
     
1
     
1
 
Schenectady
NY
   
114,815
     
4.71
%
   
6
     
3
     
2
 
Onondaga
NY
   
398,144
     
4.56
%
   
8
     
12
     
13
 
Greene
NY
   
38,972
     
3.64
%
   
7
     
3
     
3
 
Berkshire
MA
   
111,313
     
3.62
%
   
7
     
5
     
5
 
Monroe
PA
   
85,303
     
3.48
%
   
8
     
4
     
5
 
Saratoga
NY
   
122,803
     
3.34
%
   
10
     
3
     
4
 
Warren
NY
   
45,482
     
3.08
%
   
7
     
2
     
3
 
Cheshire
NH
   
25,234
     
2.03
%
   
7
     
1
     
-
 
Luzerne
PA
   
113,294
     
1.96
%
   
14
     
4
     
6
 
Chittenden
VT
   
48,975
     
1.25
%
   
7
     
3
     
3
 
Albany
NY
   
160,616
     
1.14
%
   
10
     
4
     
5
 
Hillsborough
NH
   
85,404
     
0.82
%
   
9
     
2
     
2
 
Rensselaer
NY
   
13,198
     
0.72
%
   
12
     
1
     
1
 
Rockingham
NH
   
20,907
     
0.38
%
   
17
     
2
     
2
 
 
  
 
$
5,866,050
                     
157
     
187
 

Deposit market share data is based on the most recent data available (as of June 30, 2013).  Source: SNL Financial LLC
* Branch and ATM data is as of December 31, 2013.

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 to a limited extent by the Federal Deposit Insurance Corporation (“FDIC”) as its deposit insurer.  The Bank also is subject to certain regulations promulgated by the FRB and  the Bureau of Consumer Financial Protection (“CFPB”).

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, 2013, the Company’s leverage ratio was 8.93%, its ratio of Tier 1 capital to risk-weighted assets was 11.74%, and its ratio of qualifying total capital to risk-weighted assets was 12.99%. 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, 2013, 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 8.47%, its ratio of Tier 1 capital to risk-weighted assets was 11.16%, and its ratio of qualifying total capital to risk-weighted assets was 12.41%.

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.
 
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.  The Bank’s FDIC assessment expenses increased to approximately $4.6 million in 2013 as compared with $3.5 million in 2012 primarily due to the increase in asset size.

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 $0.4 million in FICO expenses in 2013 and $0.3 million in 2012.

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, 2013, the Bank’s total brokered deposits were $59.1 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, 2013.

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. Certain of these rules have not yet been finalized and many remain unwritten.

The 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. This rule has not yet been finalized.
 
The Dodd-Frank Act created the 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 cards 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, at a minimum, they 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.

Changes to Capital Adequacy Requirements and Prompt Corrective Action
 
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 July 2013, the FRB, the OCC and the FDIC approved final rules (the “New Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The New Capital Rules generally implement the Basel Committee’s December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The New Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and the Bank, as compared to the current U.S. general risk-based capital rules. The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The New Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach, which was derived from Basel I, with a more risk-sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 “Basel II” capital accords. In addition, the New Capital Rules implement certain provisions of the Dodd-Frank Act, including the requirements of Section 939A to remove references to credit ratings from the federal banking agencies’ rules. The New Capital Rules are effective for the Company on January 1, 2015, subject to phase-in periods for certain components and other provisions.
 
The New Capital Rules: (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. Under the New Capital Rules, for most banking organizations, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock and the most common forms of Tier 2 capital are subordinated notes and a portion of the allocation for loan and lease losses, in each case, subject to the New Capital Rules’ specific requirements.
 
Pursuant to the New Capital Rules, the minimum capital ratios as of January 1, 2015 will be as follows:
 
· 4.5% CET1 to risk-weighted assets;
 
· 6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets;
 
· 8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
 
· 4.0% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).
 
The New Capital Rules also introduce a new “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity and other capital instrument repurchases and compensation based on the amount of the shortfall. Thus, when fully phased-in on January 1, 2019, the capital standards applicable to the Company will include an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios inclusive of the capital conservation buffer of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.
The New Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks 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 items, in the aggregate, exceed 15% of CET1.
 
In addition, under the current general risk-based capital rules, the effects of accumulated other comprehensive income or loss (“AOCI”) items included in shareholders’ equity (for example, marks-to-market of securities held in the available-for-sale portfolio) under U.S. GAAP are reversed for the purposes of determining regulatory capital ratios. Pursuant to the New Capital Rules, the effects of certain AOCI items are not excluded; however, banking organizations not using the advanced approaches, including the Company, may make a one-time permanent election to continue to exclude these items. This election must be made concurrently with the first filing of certain of the Company's periodic regulatory reports in the beginning of 2015. The New Capital Rules also preclude certain hybrid securities, such as trust preferred securities issued after May 19, 2010, from inclusion in bank holding companies’ Tier 1 capital.
 
Implementation of the deductions and other adjustments to CET1 will begin on January 1, 2015 and will be phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019.
 
With respect to the Bank, the New Capital Rules revise the “prompt corrective action” (“PCA”) regulations adopted pursuant to Section 38 of the Federal Deposit Insurance Act (“FDIA”), by: (i) introducing a CET1 ratio requirement at each PCA category (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized. The New Capital Rules do not change the total risk-based capital requirement for any PCA category.
 
The New Capital Rules prescribe a new standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset classes.
 
We believe that the Company will be able to comply with the targeted capital ratios upon implementation of the revised requirements, as finalized.

Volcker Rule

In December, 2013, the federal banking agencies jointly adopted final rules implementing Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule.  The Volcker Rule restricts the ability of banking entities, such as the Company, to engage in proprietary trading or to own, sponsor or have certain relationships with hedge funds or private equity funds—so-called “Covered Funds.”  The final rule definition of Covered Fund includes investments such as certain collateralized loan obligation (“CLO”) and collateralized debt obligation (“CDO”) securities. The Company does not believe the implementation of the Volcker Rule will have a significant effect on its financial statements.

Consumer Protection Laws

Financial institutions are prohibited 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.

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 became 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, 2013, 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”.
 
Employees
 
At December 31, 2013, the Company had 1,742 full-time equivalent employees. The Company’s employees are not presently represented by any collective bargaining group.
 
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. Risk Factors

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.

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 bps, 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 bps 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, 2013, approximately 44% 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 has 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.
 
The Dodd-Frank Act also weakened the federal preemption rules that have been applicable to national banks and federal savings associations, gave state attorneys general certain powers to enforce rules issued by the CFPB.
 
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 implemented 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 stockholder 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 results of operations.

The business strategy of the Company has included and may continue to include growth through acquisition.  Any future acquisitions 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 such 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 significant portion of our loan portfolio at December 31, 2013 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 $30.8 million as of December 31, 2013.

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.

ITEM 1B.  Unresolved Staff Comments

None.
ITEM 2.  Properties

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, 2013:

County
Branches
ATMs
 
County
Branches
ATMs
NBT Bank Division
 
 
 
Pennstar Bank Division
 
 
New York
 
 
 
Pennsylvania
 
 
Albany County
4
5
 
Lackawanna County
14
18
Broome County
8
11
 
Luzerne County
4
6
Chenango County
11
13
 
Monroe County
4
5
Clinton County
3
2
 
Pike County
2
2
Cortland County
5
6
 
Susquehanna County
5
7
Delaware County
5
5
 
Wayne County
3
4
Essex County
3
5
 
 
 
 
Franklin County
1
1
 
 
 
 
Fulton County
6
6
 
 
 
 
Greene County
3
3
 
 
 
 
Hamilton County
1
1
 
 
 
 
Herkimer County
2
1
 
 
 
 
Madison County
4
6
 
 
 
 
Montgomery County
5
4
 
 
 
 
Oneida County
7
12
 
 
 
 
Onondaga County
12
13
 
 
 
 
Oswego County
4
6
 
 
 
 
Otsego County
9
12
 
 
 
 
Rensselaer County
1
1
 
 
 
 
Saratoga County
3
4
 
 
 
 
Schenectady County
3
2
 
 
 
 
Schoharie County
4
4
 
 
 
 
St. Lawrence County
5
6
 
 
 
 
Tioga County
1
1
 
 
 
 
Warren County
2
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 64 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.

ITEM 3.  Legal Proceedings
 
The Bank has received preliminary approval of a proposed settlement in connection with the previously disclosed class action lawsuit arising from its assessment and collection of fees on its checking account customers.  The complaint had been filed in the Supreme Court of the State of New York, County of Delaware, on September 12, 2011 and alleged that the Bank engaged in certain unfair practices and failed to make adequate disclosure to customers concerning its overdraft fee assessment practices.  The complaint sought certification of a class of national checking account holders who had incurred overdraft fees and a subclass of such customers who reside in New York.  In addition, the complaint sought 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.  On December 12, 2013, the Court preliminarily approved the proposed settlement under which the Bank would pay an aggregate of $625,000, which if and when finally approved would entirely dispose of the action.  A hearing with respect to such approval has been scheduled for June 27, 2014.  The Company has accrued for the full amount of the settlement as of December 31, 2013.

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.

ITEM 4.  Mine Safety Disclosures

None.

PART  II

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder matters and Issuer Purchases of Equity Securities

 
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
 
2013
 
   
   
 
1st quarter
 
$
22.37
   
$
20.15
   
$
0.20
 
2nd quarter
   
22.23
     
19.45
     
0.20
 
3rd quarter
   
23.25
     
21.06
     
0.20
 
4th quarter
   
26.59
     
22.09
     
0.21
 
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
 

The closing price of the Common Stock on February 14, 2014 was $23.20.
As of February 14, 2014, there were 7,207 shareholders of record of Common Stock.  No unregistered securities were sold by the Company during the year ended December 31, 2013.
 
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, the KBW Regional Bank Index, and the Index for NASDAQ Financial Stocks.  We have included the KBW Regional Bank Index, which we plan to use as our peer group index going forward, because we have determined that companies included in the KBW Regional Bank Index more closely match our company characteristics than the companies included in the Index for Nasdaq Financial Stocks. The stock performance graph assumes that $100 was invested on December 31, 2008.  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
 
12/31/08
   
12/31/09
   
12/31/10
   
12/31/11
   
12/31/12
   
12/31/13
 
NBT Bancorp
 
$
100.00
   
$
75.60
   
$
92.89
   
$
88.36
   
$
83.99
   
$
111.16
 
KBW Regional Bank Index
 
$
100.00
   
$
77.92
   
$
93.78
   
$
88.97
   
$
100.70
   
$
147.74
 
NASDAQ Financial Stocks
 
$
100.00
   
$
103.43
   
$
118.08
   
$
105.55
   
$
124.25
   
$
176.54
 
NASDAQ Composite Index
 
$
100.00
   
$
145.27
   
$
171.58
   
$
170.25
   
$
200.38
   
$
280.78
 

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 to our shareholders 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, 2013, the Bank was in compliance with all applicable minimum capital requirements and had the ability to pay dividends of $56.7 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 a previously disclosed stock repurchase plan, the Company purchased 584,925 shares of its common stock during the twelve month period ended December 31, 2013, for a total of $12.5 million at an average price of $21.30 per share.  This plan expired on December 31, 2013.  On July 22, 2013, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to an additional 1,000,000 shares, which were all available for repurchase as of December 31, 2013, of its outstanding common stock.  This plan expires on December 31, 2014.

ITEM  6.  Selected Financial Data
 
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 share and per share data)
 
2013
(1)  
2012
(2)  
2011
   
2010
   
2009
 
Interest, fee and dividend income
 
$
268,723
   
$
239,397
   
$
239,997
   
$
255,738
   
$
273,393
 
Interest expense
   
30,644
     
35,194
     
39,721
     
53,210
     
76,924
 
Net interest income
   
238,079
     
204,203
     
200,276
     
202,528
     
196,469
 
Provision for loan and lease losses
   
22,424
     
20,269
     
20,737
     
29,809
     
33,392
 
Noninterest income excluding securities gains
   
101,789
     
86,728
     
80,161
     
80,614
     
79,987
 
Securities gains, net
   
1,426
     
599
     
150
     
3,274
     
144
 
Noninterest expense
   
228,927
     
193,887
     
180,676
     
178,291
     
170,566
 
Income before income taxes
   
89,943
     
77,374
     
79,174
     
78,316
     
72,642
 
Net income
   
61,747
     
54,558
     
57,901
     
57,404
     
52,011
 
 
                                       
Per common share
                                       
Basic earnings
 
$
1.47
   
$
1.63
   
$
1.72
   
$
1.67
   
$
1.54
 
Diluted earnings
   
1.46
     
1.62
     
1.71
     
1.66
     
1.53
 
Cash dividends paid
   
0.81
     
0.80
     
0.80
     
0.80
     
0.80
 
Book value at year-end
   
18.77
     
17.24
     
16.23
     
15.51
     
14.69
 
Tangible book value at year-end
   
12.09
     
12.23
     
11.70
     
11.67
     
10.75
 
Average diluted common shares outstanding
   
42,351
     
33,719
     
33,924
     
34,509
     
33,903
 
 
                                       
Securities available for sale, at fair value
 
$
1,364,881
   
$
1,147,999
   
$
1,244,619
   
$
1,129,368
   
$
1,116,758
 
Securities held to maturity, at amortized cost
   
117,283
     
60,563
     
70,811
     
97,310
     
159,946
 
Loans and leases
   
5,406,795
     
4,277,616
     
3,800,203
     
3,610,006
     
3,645,398
 
Allowance for loan and lease losses
   
69,434
     
69,334
     
71,334
     
71,234
     
66,550
 
Assets
   
7,652,175
     
6,042,259
     
5,598,406
     
5,338,856
     
5,464,026
 
Deposits
   
5,890,224
     
4,784,349
     
4,367,149
     
4,134,352
     
4,093,046
 
Borrowings
   
866,061
     
605,855
     
627,358
     
604,730
     
786,097
 
Stockholders’ equity
   
816,569
     
582,273
     
538,110
     
533,572
     
505,123
 
 
                                       
Key ratios
                                       
Return on average assets
   
0.85
%
   
0.93
%
   
1.06
%
   
1.05
%
   
0.96
%
Return on average equity
   
8.09
     
9.72
     
10.73
     
10.92
     
10.90
 
Average equity to average assets
   
10.50
     
9.55
     
9.90
     
9.63
     
8.79
 
Net interest margin
   
3.66
     
3.86
     
4.09
     
4.15
     
4.04
 
Dividend payout ratio
   
55.48
     
49.38
     
46.78
     
48.19
     
52.29
 
Tier 1 leverage
   
8.93
     
8.54
     
8.74
     
9.16
     
8.35
 
Tier 1 risk-based capital
   
11.74
     
11.00
     
11.56
     
12.44
     
11.34
 
Total risk-based capital
   
12.99
     
12.25
     
12.81
     
13.70
     
12.59
 
 
(1)
Includes the impact of the acquisition of Alliance on March 8, 2013.
 
(2)
Includes the impact of the acquisition of Hampshire First Bank on June 8, 2012.

Selected Quarterly Financial Data
 
 
 
2013
   
2012
 
(Dollars in thousands, except share and per share data)
 
Fourth
   
Third
   
Second
   
First
   
Fourth
   
Third
   
Second
   
First
 
Interest, fee and dividend income
 
$
69,181
   
$
69,569
   
$
69,604
   
$
60,369
   
$
60,857
   
$
61,287
   
$
58,647
   
$
58,606
 
Interest expense
   
7,123
     
7,343
     
7,949
     
8,229
     
8,404
     
8,680
     
8,896
     
9,214
 
Net interest income
   
62,058
     
62,226
     
61,655
     
52,140
     
52,453
     
52,607
     
49,751
     
49,392
 
Provision for loan and lease losses
   
5,166
     
5,198
     
6,402
     
5,658
     
6,940
     
4,755
     
4,103
     
4,471
 
Noninterest income excluding net securities gains (losses)
   
25,289
     
26,818
     
25,598
     
24,084
     
21,941
     
21,601
     
20,585
     
22,601
 
Net securities gains (losses)
   
13
     
329
     
(61
)
   
1145
     
21
     
26
     
97
     
455
 
Noninterest expense
   
55,486
     
56,286
     
56,450
     
60,705
     
48,592
     
49,431
     
47,390
     
48,474
 
Net income
   
17,925
     
19,257
     
16,916
     
7,649
     
13,116
     
14,535
     
13,257
     
13,650
 
Basic earnings per share
 
$
0.41
   
$
0.44
   
$
0.39
   
$
0.21
   
$
0.39
   
$
0.43
   
$
0.40
   
$
0.41
 
Diluted earnings per share
 
$
0.41
   
$
0.44
   
$
0.38
   
$
0.21
   
$
0.39
   
$
0.43
   
$
0.40
   
$
0.41
 
Annualized net interest margin
   
3.61
%
   
3.65
%
   
3.69
%
   
3.68
%
   
3.83
%
   
3.90
%
   
3.82
%
   
3.90
%
Annualized return on average assets
   
0.94
%
   
1.01
%
   
0.90
%
   
0.48
%
   
0.86
%
   
0.97
%
   
0.92
%
   
0.97
%
Annualized return on average equity
   
8.81
%
   
9.62
%
   
8.42
%
   
4.83
%
   
9.01
%
   
10.13
%
   
9.66
%
   
10.12
%
Average diluted common shares outstanding
   
44,121
     
44,135
     
44,317
     
36,794
     
33,987
     
33,961
     
33,493
     
33,442
 

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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  2013  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, 2013 and 2012 and for each of the years in the three-year period ended December 31, 2013 should be read in conjunction with this review. Amounts in  prior  period  consolidated  financial  statements are reclassified whenever necessary  to  conform  to  the  2013  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 impairment of 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 13, 12 and 7, 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.

Non-GAAP Measures

This Annual Report on Form 10-K contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (GAAP).  These measures adjust GAAP to exclude the effects of sales of securities and certain non-recurring and merger-related expenses.  Where non-GAAP disclosures are used in this Annual Report on Form 10-K, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying table. Management believes that these non-GAAP measures provided useful information that is important to an understanding of the operating results of the Company’s core business due to the non-recurring nature of the excluded items.  Non-GAAP measures should not be considered a substitute for financial measures determined in accordance with GAAP and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company.

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, 2013:
 
· Reported net income for 2013 was $61.7 million, up from $54.6 million in 2012.  Reported results for 2013 include the impact of the acquisition of Alliance Financial Corporation (“Alliance”) since March 8, 2013, including $12.4 million in merger related expenses for 2013.
 
· Core net income was $69.9 million for 2013 up 27.5% from $54.8 million for 2012.  Core diluted earnings per share for 2013 was $1.65 up from $1.63 for 2012.  Core return on average assets and return on average equity were 0.96% and 9.16%, respectively, for 2013, compared with 0.93% and 9.77%, respectively for 2012 (A reconciliation of these "core" results is presented in the following table).

Reconciliation of Non-GAAP Financial Measures:
 
(dollars in thousands except per share data)
 
2013
   
2012
 
Reported net income (GAAP)
 
$
61,747
   
$
54,558
 
Adj: (Gain) / Loss on sale of securities, net (net of tax)
   
(990
)
   
(421
)
Adj: Other adjustments (net of tax)
   
512
     
(382
)
Plus: Merger related expenses (net of tax)*
   
8,588
     
1,836
 
Reversal of uncertain tax position
   
-
     
(790
)
Total Adjustments
   
8,110
     
243
 
Core net income
 
$
69,857
   
$
54,801
 
Profitability:
               
Core Diluted Earnings per Share
 
$
1.65
   
$
1.63
 
Core Return on Average Assets
   
0.96
%
   
0.93
%
Core Return on Average Equity
   
9.16
%
   
9.77
%
Core Return on Average Tangible Common Equity
   
14.76
%
   
14.20
%
 
 
*
Reorganization expenses for 2013; prepayment penalty income and flood insurance recoveries, partially offset by an other asset write-down for 2012
 
· Significant strategic expansion during 2013:
 
§ Acquired Alliance Financial Corporation, a $1.4 billion financial holding company headquartered in Syracuse, N.Y. on March 8, 2013.
 
· Net interest margin for 2013 declined 20 basis points as a result of the continued low rate environment on loans and investments.
 
· 2013 organic loan growth of 5.3%, offsetting aforementioned margin compression, driven by:
 
§ Consumer loan growth of 4.8%; and
 
§ Commercial loan growth of 5.5%.
 
· Asset quality indicators showed stability or improvement from last year:
 
§ Net charge-off ratio was 0.44%, down from 0.55% for last year;
 
§ Nonperforming loans to total loans was 0.99%, up slightly from 0.98% for last year.
 
· Noninterest income was up 18.2% over last year driven primarily by the acquisition of Alliance and expansion into new markets:
 
§ Trust revenue was up $7.5 million, or 81.9%
 
§ ATM and debit card fees were up $3.2 million, or 25.9%.
 
· Achieved targeted cost saves from the Alliance acquisition and benefited from other cost save initiatives during 2013.

The Company continued to experience pressure on net interest income in 2013 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 2013.  The yield on interest earning assets decreased from 4.51% in 2012 to 4.12% in 2013, 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 time deposits contributed approximately $3.4 million to the decrease in interest expense in 2013 as compared with 2012.  Average interest bearing liabilities increased approximately $831.9 million from 2012 to 2013, with the primary driver being the increase in interest bearing deposits from acquisition activity.  The Company also took the following steps in 2013 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, taking advantage of favorable interest rate conditions;
 
· Increased efforts to grow noninterest income with focus on organic growth of our trust, financial services, retirement plan administration and insurance businesses; and
 
· Continued strategic expansion into central New York with the acquisition of Alliance.

The Company reported net income of $61.7 million or $1.46 per diluted share for 2013, up 13.2% from net income of $54.6 million or $1.62 per diluted share for 2012.  The provision for loan losses totaled $22.4 million for the year ended December 31, 2013, up $2.1 million, or 10.6%, from $20.3 million for the year ended December 31, 2012.  The increase in provision is attributable to the ongoing modeling of the required levels of reserves which considers historical charge-offs, loan growth and economic trends and is primarily due to the Company’s loan growth.  Noninterest income increased $15.9 million, or 18.2%, from 2012 primarily due to an increase in trust revenue of approximately $7.5 million.  This increase was due primarily to the acquisition of Alliance in March 2013.  In addition, ATM and debit card fees increased $3.2 million due to increased usage from expansion and acquisition activity during 2013.  Noninterest expense for the year ended December 31, 2013 was $228.9 million, up from $193.9 million, or 18.1% for the year ended December 31, 2012.  This increase was driven primarily by an increase in merger related expenses of approximately $9.8 million over 2012 attributable to the acquisition of Alliance.  In addition, salaries and employee benefits were up $8.8 million, or 8.4%, largely due to expansion activity.

2014 Outlook

The Company’s 2013 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 2014.  Significant items that may have an impact on 2014 results include:

· The Company expects that it will experience additional margin compression from the 2013 fourth quarter net interest margin of 3.61%. 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.

· 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.

· Compliance with regulatory mandates could continue to negatively impact certain fee generating products as well as increase costs to comply, which could negatively impact noninterest income, noninterest expense and earnings.

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

The Company’s 2014 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%.

Average Balances and Net Interest Income
 
 
 
2013
   
2012
   
2011
 
 
 
Average
   
   
Yield/
   
Average
   
   
Yield/
   
Average
   
   
Yield/
 
(Dollars in thousands)
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
ASSETS
 
   
   
   
   
   
   
   
   
 
Short-term interest bearing accounts
 
$
30,522
   
$
116
     
0.38
%
 
$
66,207
   
$
179
     
0.27
%
 
$
101,224
   
$
269
     
0.27
%
Securities available for sale (1)
   
1,349,887
     
27,357
     
2.03
%
   
1,177,969
     
28,904
     
2.45
%
   
1,123,215
     
33,319
     
2.97
%
Securities held to maturity (1)
   
88,193
     
3,692
     
4.19
%
   
65,582
     
3,583
     
5.46
%
   
81,558
     
4,350
     
5.33
%
Investment in FRB and FHLB Banks
   
37,998
     
1,771
     
4.66
%
   
28,358
     
1,378
     
4.86
%
   
27,089
     
1,389
     
5.13
%
Loans and leases (2)
   
5,106,607
     
239,572
     
4.69
%
   
4,053,420
     
209,370
     
5.17
%
   
3,677,931
     
205,318
     
5.58
%
Total interest earning assets
 
$
6,613,207
   
$
272,508
     
4.12
%
 
$
5,391,536
   
$
243,414
     
4.51
%
 
$
5,011,017
   
$
244,645
     
4.88
%
Other assets
   
653,432
                     
483,248
                     
434,924
                 
Total assets
 
$
7,266,639
                   
$
5,874,784
                   
$
5,445,941
                 
 
                                                                       
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                       
Money market deposit accounts
 
$
1,343,801
   
$
2,004
     
0.15
%
 
$
1,116,583
   
$
2,054
     
0.18
%
 
$
1,070,003
   
$
3,592
     
0.34
%
NOW deposit accounts
   
882,629
     
1,468
     
0.17
%
   
709,889
     
1,854
     
0.26
%
   
685,542
     
2,313
     
0.34
%
Savings deposits
   
929,226
     
789
     
0.08
%
   
680,092
     
522
     
0.08
%
   
602,918
     
635
     
0.11
%
Time deposits
   
1,069,228
     
12,029
     
1.13
%
   
993,117
     
14,418
     
1.45
%
   
913,330
     
16,480
     
1.80
%
Total interest bearing deposits
 
$
4,224,884
   
$
16,290
     
0.39
%
 
$
3,499,681
   
$
18,848
     
0.54
%
 
$
3,271,793
   
$
23,020
     
0.70
%
Short-term borrowings
   
280,848
     
515
     
0.18
%
   
165,742
     
188
     
0.11
%
   
153,965
     
205
     
0.13
%
Trust preferred debentures
   
96,536
     
2,084
     
2.16
%
   
75,422
     
1,730
     
2.29
%
   
75,422
     
2,092
     
2.77
%
Long-term debt
   
338,697
     
11,755
     
3.47
%
   
368,270
     
14,428
     
3.92
%
   
370,035
     
14,404
     
3.89
%
Total interest bearing liabilities
 
$
4,940,965
   
$
30,644
     
0.62
%
 
$
4,109,115
   
$
35,194
     
0.86
%
 
$
3,871,215
   
$
39,721
     
1.03
%
Demand deposits
   
1,484,193
                     
1,139,896
                     
966,282
                 
Other liabilities
   
78,455
                     
64,551
                     
69,063
                 
Stockholders' equity
   
763,026
                     
561,222
                     
539,381
                 
Total liabilities and stockholders' equity
 
$
7,266,639
                   
$
5,874,784
                   
$
5,445,941
                 
Net interest income (FTE)
           
241,864
                     
208,220
                     
204,924
         
Interest rate spread
                   
3.50
%
                   
3.65
%
                   
3.85
%
Net interest margin
                   
3.66
%
                   
3.86
%
                   
4.09
%
Taxable equivalent adjustment
           
3,785
                     
4,017
                     
4,648
         
Net interest income
         
$
238,079
                   
$
204,203
                   
$
200,276
         
 
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.
2013 OPERATING RESULTS AS COMPARED TO 2012 OPERATING RESULTS

Net Interest Income

While the rate paid on interest bearing liabilities decreased 24 basis points, the yield on interest earning assets declined 39 basis points compared to the same period for 2012, resulting in margin compression for the year ended December 31, 2013.  The yield on securities available for sale was 2.03% for the year ended December 31, 2013, compared with 2.45% for the year ended December 31, 2012. This decrease was due primarily to the reinvestment of cash flows from maturing securities and cash received from branch acquisitions in 2012 into lower yielding securities in the current rate environment. The average balance of securities available for sale for the year ended December 31, 2013 was $1.3 billion, up approximately $171.9 million, or 14.6%, from the year ended December 31, 2012.  This increase was due primarily to investment of liquidity from acquisition activity and deposit growth. The yield on loans was 4.69% for the year ended December 31, 2013, compared with 5.17% for the year ended December 31, 2012. The average balance of loans for the year ended December 31, 2013 was $5.1 billion, up approximately $1.1 billion (including approximately $904 million of acquired loans from the Alliance acquisition), or 26.0%, from the year ended December 31, 2012.  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 1.13% for the year ended December 31, 2013, compared with 1.45% for the year ended December 31, 2012.  The rate on NOW accounts was 0.17% for the year ended December 31, 2013, compared with 0.26% for the year ended December 31, 2012.   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.
 
Analysis of Changes in Taxable Equivalent Net Interest Income
 
 
 
Increase (Decrease)
   
Increase (Decrease)
 
 
 
2013 over 2012
   
2012 over 2011
 
(In thousands)
 
Volume
   
Rate
   
Total
   
Volume
   
Rate
   
Total
 
Short-term interest-bearing accounts
 
$
(119
)
 
$
56
   
$
(63
)
 
$
(95
)
 
$
5
   
$
(90
)
Securities available for sale
   
3,884
     
(5,431
)
   
(1,547
)
   
1,562
     
(5,977
)
   
(4,415
)
Securities held to maturity
   
1,063
     
(954
)
   
109
     
(871
)
   
104
     
(767
)
Investment in FRB and FHLB Banks
   
451
     
(58
)
   
393
     
63
     
(74
)
   
(11
)
Loans and leases
   
50,712
     
(20,510
)
   
30,202
     
20,057
     
(16,005
)
   
4,052
 
Total interest income
   
55,991
     
(26,897
)
   
29,094
     
20,716
     
(21,947
)
   
(1,231
)
Money market deposit accounts
   
377
     
(427
)
   
(50
)
   
150
     
(1,688
)
   
(1,538
)
NOW deposit accounts
   
385
     
(771
)
   
(386
)
   
80
     
(539
)
   
(459
)
Savings deposits
   
207
     
60
     
267
     
74
     
(187
)
   
(113
)
Time deposits
   
1,042
     
(3,431
)
   
(2,389
)
   
1,353
     
(3,415
)
   
(2,062
)
Short-term borrowings
   
173
     
154
     
327
     
15
     
(32
)
   
(17
)
Trust preferred debentures
   
461
     
(107
)
   
354
     
-
     
(362
)
   
(362
)
Long-term debt
   
(1,104
)
   
(1,569
)
   
(2,673
)
   
(69
)
   
93
     
24
 
Total interest expense
   
1,541
     
(6,091
)
   
(4,550
)
   
1,603
     
(6,130
)
   
(4,527
)
Change in FTE net interest income
 
$
54,450
   
$
(20,806
)
 
$
33,644
   
$
19,113
   
$
(15,817
)
 
$
3,296
 

Loans and Corresponding Interest and Fees on Loans

The average balance of loans increased by approximately $1.1 billion, or 26.0%, from 2012 to 2013.  The yield on average loans decreased from 5.17% in 2012 to 4.69% in 2013, as loan rates declined due to the continued low rate environment in 2013.  Interest income from loans on a FTE basis increased 14.4%, from $209.4 million in 2012 to $239.6 million in 2013.  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 $1.1 billion, or 26.4% (5.3% organic growth) from December 31, 2012 to December 31, 2013.  In March 2013, the Company acquired Alliance, including approximately $904 million in loans, which contributed to this loan growth.  Commercial loans increased $164.2 million, or 23.6%, from $694.8 million at December 31, 2012 to $859.0 million at December 31, 2013, due to strong originations in 2013, particularly in our upstate New York markets and Vermont, as well as from the aforementioned acquisition.  Commercial real estate loans increased $255.5 million, or 23.8%, from $1.1 billion at December 31, 2012 to $1.3 billion at December 31, 2013, in large part due to the acquisition of Alliance as well strong originations in our upstate New York markets and from new markets, particularly Vermont.  The Company acquired approximately $117.8 million in commercial real estate loans from the aforementioned acquisition.  Residential real estate loans increased $390.5 million (including approximately $333.1 million from the aforementioned acquisition), from $651.1 million at December 31, 2012 to $1.0 billion at December 31, 2013.  The Company sold more fixed rate mortgages during 2012 than 2013 as market conditions in 2013 were not as favorable for such sales.  Consumer loans increased $304.8 million from $1.0 billion at December 31, 2012 to $1.4 billion at December 31, 2013 in large part due to the aforementioned acquisition, as well as strong originations in our upstate New York markets and from new markets.  Home equity loans increased modestly in 2013.

The  following  table  reflects  the  loan  portfolio  by major categories  as  of  December  31  for  the  years  indicated:

Composition of Loan Portfolio
 
 
 
December 31,
 
(In thousands)
 
2013
   
2012
   
2011
   
2010
   
2009
 
Residential real estate mortgages
 
$
1,041,637
   
$
651,107
   
$
581,511
   
$
548,394
   
$
618,334
 
Commercial
   
859,026
     
694,799
     
611,298
     
577,731
     
571,107
 
Commercial  real estate
   
1,328,313
     
1,072,807
     
888,879
     
844,458
     
739,395
 
Real estate construction and development
   
93,247
     
123,078
     
93,977
     
45,444
     
67,168
 
Agricultural and agricultural real estate
   
112,035
     
112,687
     
108,423
     
112,738
     
122,466
 
Consumer
   
1,352,638
     
1,047,856
     
946,470
     
905,563
     
923,343
 
Home equity
   
619,899
     
575,282
     
569,645
     
575,678
     
603,585
 
Total loans and leases
 
$
5,406,795
   
$
4,277,616
   
$
3,800,203
   
$
3,610,006
   
$
3,645,398
 

Residential real estate mortgages consist primarily of loans secured by first or second deeds of trust on primary residences. Loans in the commercial and agricultural categories, including commercial and agricultural real estate mortgages, consist primarily of short-term and/or floating rate loans made to small and medium-sized entities.  Consumer loans consist primarily of indirect installment credit to individuals, of which approximately 75% is secured by automobiles and other personal property including marine, recreational vehicles and manufactured housing.  Consumer loans also consist of direct installment loans to individuals secured by similar collateral.  Indirect installment loans represent $1.3 billion of total consumer loans at December 31, 2013, or 95.1%.  Installment credit for automobiles accounts for approximately 70% of total consumer loans.  Although automobile loans have generally been originated through dealers, all applications submitted through dealers are subject to the Company’s normal underwriting and loan approval procedures.  Real estate construction and development loans include commercial construction and development and residential construction loans. Commercial construction loans are for small and medium sized office buildings and other commercial properties and residential construction loans are primarily for projects located in upstate New York and northeastern Pennsylvania.
Risks associated with the commercial real estate portfolio include the ability of borrowers to pay interest and principal during the loan’s term, as well as the ability of the borrowers to refinance at the end of the loan term.
 
The following table, Maturities and Sensitivities of Certain Loans to Changes in Interest Rates, summarizes the maturities of the commercial and agricultural and real estate construction and development loan portfolios and the sensitivity of those loans to interest rate fluctuations at December 31, 2013.  Scheduled repayments are reported in the maturity category in which the contractual payment is due.

Maturities and Sensitivities of Certain Loans to Changes in Interest Rates
 
 
 
Remaining maturity at December 31, 2013
 
 
 
   
After One Year But
   
   
 
(In thousands)
 
Within One Year
   
Within Five Years
   
After Five Years
   
Total
 
Floating/adjustable rate
 
   
   
   
 
Commercial, commercial real estate, agricultural  and agricultural real estate
 
$
445,466
   
$
304,859
   
$
871,602
   
$
1,621,927
 
Real estate construction and development
   
17,126
     
3,564
     
27,863
     
48,553
 
Total floating rate loans
   
462,592
     
308,423
     
899,465
     
1,670,480
 
 
                               
Fixed rate
                               
Commercial, commercial real estate, agricultural  and agricultural real estate
   
71,611
     
364,738
     
241,098
     
677,447
 
Real estate construction and development
   
11,140
     
19,564
     
13,990
     
44,694
 
Total fixed rate loans
   
82,751
     
384,302
     
255,088
     
722,141
 
Total
 
$
545,343
   
$
692,725
   
$
1,154,553
   
$
2,392,621
 

Securities and Corresponding Interest and Dividend Income

The average balance of securities available for sale increased $171.9 million, or 14.6%, from 2012 to 2013.  The yield on average securities available for sale was 2.03% for 2013 compared to 2.45% in 2012.
 
The average balance of securities held to maturity increased from $65.6 million in 2012 to $88.2 million in 2013. At December 31, 2013, securities held to maturity were comprised primarily of tax-exempt municipal securities. The yield on securities held to maturity decreased from 5.46% in 2012 to 4.19% in 2013.
 
The average balance of FRB and FHLB stock increased to $38.0 million in 2013 from $28.4 million in 2012.  The yield from investments in FRB and FHLB banks decreased from 4.86% in 2012 to 4.66% in 2013.

Securities Portfolio
 
 
 
As of December 31,
 
 
 
2013
   
2012
   
2011
 
 
 
Amortized
   
Fair
   
Amortized
   
Fair
   
Amortized
   
Fair
 
(In thousands)
 
Cost
   
Value
   
Cost
   
Value
   
Cost
   
Value
 
Securities available for sale
 
   
   
   
   
   
 
U.S. Treasury
 
$
43,279
   
$
43,616
   
$
63,668
   
$
64,425
   
$
81,006
   
$
82,234
 
Federal Agency
   
285,880
     
278,915
     
281,398
     
282,814
     
254,983