10-K 1 d259887d10k.htm 10-K 10-K
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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, 2011   

OR

 

[    ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE   
   SECURITIES EXCHANGE ACT OF 1934   
   For the transition period from      to        

Commission file number 0-15366

ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

New York

      

16-1276885

    
(State or Other Jurisdiction of Incorporation or Organization)      (I.R.S. Employer Identification No.)   

120 Madison Street, 18th Floor, Syracuse, NY 13202

(Address of principal executive offices, including zip code)

Registrant’s telephone number including area code: (315) 475-2100

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class: Common Stock, $1.00 par value per share

Name of each exchange on which registered: The NASDAQ Stock Market LLC

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          No   X    

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes        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      

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  X      No      

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. [  ]

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 definition of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer [  ]            Accelerated Filer [X]            Non-accelerated filer [  ]             Smaller Reporting Company [  ]

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

As of June 30, 2011, the aggregate market value of the voting stock held by non-affiliates of the registrant was $130.3 million based on the closing sale price as reported on the NASDAQ Global Market.

The number of outstanding shares of our common stock, $1.00 par value per share, on March 9, 2012 was 4,784,648 shares.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the proxy statement for the 2012 annual meeting of shareholders (the “Proxy Statement”) are incorporated by reference in Part III of this Annual Report on Form 10-K.


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TABLE OF CONTENTS

FORM 10-K ANNUAL REPORT

FOR THE YEAR ENDED

DECEMBER 31, 2011

ALLIANCE FINANCIAL CORPORATION

 

                  Page

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

   i  
PART I   
 

Item 1.

    

Business

     1
 

Item 1A.

    

Risk Factors

     6
 

Item 1B.

    

Unresolved Staff Comments

   12
 

Item 2.

    

Properties

   12
 

Item 3.

    

Legal Proceedings

   12
 

Item 4.

    

Mine Safety Disclosures

   12

PART II

  
 

Item 5.

    

Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

   13
 

Item 6.

    

Selected Financial Data

   15
 

Item 7.

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   19
 

Item 7A.

    

Quantitative and Qualitative Disclosures about Market Risk

   38
 

Item 8.

    

Financial Statements and Supplementary Data

   40
 

Item 9.

    

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   40
 

Item 9A.

    

Controls and Procedures

   40
 

Item 9B.

    

Other Information

   40

PART III

  
 

Item 10.

    

Directors, Executive Officers and Corporate Governance

   41
 

Item 11.

    

Executive Compensation

   41
 

Item 12.

    

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

   41
 

Item 13.

    

Certain Relationships and Related Transactions and Director Independence

   41
 

Item 14.

    

Principal Accountant Fees and Services

   41

PART IV

  
 

Item 15.

    

Exhibits and Financial Statement Schedules

   42


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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

We may, from time to time, make written or oral “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in our filings with the Securities and Exchange Commission (the “SEC”), our reports to shareholders and in other communications by us. This Annual Report on Form 10-K contains “forward-looking statements” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, statements of our goals, intentions and expectations, statements regarding our business plans and prospects and growth and operating strategies, estimates of our risks, and future costs and benefits that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

 

  ¡  

an increase in competitive pressure in the banking industry;

 

  ¡  

changes in interest rates;

 

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changes in the regulatory environment;

 

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general economic conditions, both nationally and regionally, resulting, among other things, in a deterioration in credit quality;

 

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changes in business conditions and inflation;

 

  ¡  

changes in the securities markets;

 

  ¡  

changes in technology used in the banking business;

 

  ¡  

changes in laws and regulations to which we are subject;

 

  ¡  

our ability to maintain and increase market share and control expenses; and

 

  ¡  

other factors detailed from time to time in our SEC filings.

Any or all of our forward-looking statements in this Annual Report on Form 10-K, and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We disclaim any obligation to subsequently revise any forward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events.

Unless the context indicates otherwise, all references in this Annual Report on Form 10-K to “Alliance” “we,” “us,” “our company,” “corporation” and “our” refer to Alliance Financial Corporation and its subsidiaries Alliance Bank, N.A., our wholly owned bank subsidiary (the “Bank”) and Alliance Agency Inc.

 

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PART I

Item 1. Business

General

Alliance Financial Corporation is a New York corporation and a registered financial holding company formed on November 25, 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc. Alliance is the holding company of Alliance Bank, N.A. which was formed as the result of the merger of First National Bank of Cortland and Oneida Valley National Bank in 1999.

We provide financial services from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Our primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, trust and investment management services. The Bank has a substantially wholly owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly owned subsidiary, Alliance Leasing, Inc.

Our corporate and administrative offices are located on the 18th Floor, AXA Tower II, 120 Madison St., Syracuse, New York. Banking services are provided at the administrative offices as well as at Alliance’s 29 customer service facilities.

We formed Alliance Financial Capital Trust I and Alliance Financial Capital Trust II (collectively “Capital Trusts”) for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of Alliance.

At December 31, 2011, we had 328 full-time equivalent employees. Our employees are not represented by any collective bargaining group. We consider our employee relations to be good.

The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System, and its deposits are insured by the Federal Deposit Insurance Corporation up to applicable limits.

Services

We offer full-service banking with a broad range of financial products to meet the needs of our commercial, retail, government, and investment management customers. Depository account services include interest and non-interest-bearing checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. Our lending activities include the making of residential and commercial mortgage loans, business lines of credit, working capital facilities and business term loans, as well as installment loans, home equity loans, and personal lines of credit to individuals. Investment management and trust services include personal trust, employee benefit trust, investment management, custodial, and financial planning. Through UVEST Financial Services, a subsidiary of LPL Financial Institution Services and member NASD/SIPC, we provide financial counseling and brokerage services. We also offer safe deposit boxes, wire transfers, collection services, drive-up banking facilities, 24-hour night depositories, automated teller machines, 24-hour telephone banking, and on-line internet banking.

Competition

Our business is extremely competitive. We compete not only with other commercial banks, but also with other financial institutions such as thrifts, credit unions, money market and mutual funds, insurance companies, brokerage firms, and a variety of other financial services companies.

Supervision and Regulation

The following discussion summarizes some of the laws and regulations applicable to bank holding companies and national banks and provides certain specific information relevant to Alliance. This regulatory framework is primarily intended for the protection of depositors, consumers, and the deposit insurance funds that insure bank

 

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deposits, and not for the protection of shareholders or creditors of bank holding companies and banks. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Moreover, Congress, regulatory agencies, and state legislatures frequently propose changes to the law and regulations affecting the banking industry. The likelihood and timing of any changes and the impact such changes might have on us are impossible to accurately predict. A change in the statutes, regulations, or regulatory policies applicable to us or our subsidiaries may have a material adverse effect on our business.

Recent Legislative and Regulatory Changes

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”), passed into law on July 21, 2010, is a broad-ranging financial reform law that affects numerous aspects of the U.S. financial regulatory system. It calls for over 200 rulemakings by numerous federal agencies, some of which have begun to issue rules. However, numerous rules have yet to be proposed or finalized. The Dodd-Frank Act covers subject matter including, but not limited to, systemic risk, corporate governance, executive compensation, credit rating agencies, capital and derivatives. Many of Dodd-Frank’s effects will not be known for months or years to come, pending, for instance, the issuance of final regulations implementing all of its provisions.

The Dodd-Frank Act also created a Bureau of Consumer Financial Protection (“CFPB”) as an independent bureau of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). The CFPB has the authority to write regulations on consumer financial products and services that will apply to depository institutions and many other entities that provide consumer financial products and services. The CFPB began operations on July 21, 2011.

Bank Holding Company Regulation

General

Alliance is a bank holding company registered under the Bank Holding Company Act of 1956 and, as such, is subject to supervision, regulation and examination by the Federal Reserve Board. The Bank Holding Company Act and other federal laws and regulations subject bank holding companies to restrictions on the types of activities in which they may engage, as well as to a supervisory regime that provides for possible regulatory enforcement actions for violations of laws and regulations. Alliance elected to also become a financial holding company on June 21, 2006. A bank holding company that also qualifies as a financial holding company can expand into a wide variety of services that are deemed by the Federal Reserve Board to be financial in nature, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting; and merchant banking. In order for a bank holding company to qualify for, and retain, financial holding company status, the holding company must be deemed to be “well managed” and “well capitalized” and each one of the bank holding company’s subsidiary depository institutions must be deemed “well capitalized” and “well managed” by regulators and must have received at least a “Satisfactory” rating on its last Community Reinvestment Act (“CRA”) examination.

The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider factors including the financial and managerial resources and future prospects of the bank holding company and the banks concerned; the convenience and needs of the communities to be served; and competitive factors. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank or bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. In addition, any entity is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of our outstanding common stock, or otherwise obtaining control or a “controlling influence” over us.

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe or unsound practices or which constitute violations of laws or regulations, and can bring enforcement actions, including the assessment of civil money penalties, for certain violations or practices.

 

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Under Federal Reserve Board regulations, a bank holding company is expected to act as a source of financial and managerial strength to each of its banking subsidiaries and to commit resources to their support. The Federal Reserve Board may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any capital loans by Alliance to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of the subsidiary bank.

Our ability to pay dividends to our shareholders is primarily dependent on the ability of the Bank to pay dividends to us. The ability of both Alliance and the Bank to pay dividends is limited by federal statutes, regulations and policies. For example, it is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the holding company’s expected future needs and financial condition. The policy provides that holding companies should not maintain a level of cash dividends that undermines the holding company’s ability to serve as a source of strength to its banking subsidiaries.

Furthermore, the Bank must obtain the prior approval of the Office of the Comptroller of the Currency (“OCC”) for the payment of dividends if the total of all dividends declared in any calendar year would exceed the sum of the Bank’s net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits the Bank from paying a dividend in an amount greater than its undivided profits after deducting statutory bad debt in excess of the Bank’s allowance for loan losses, as defined by applicable regulations.

Capital Adequacy Guidelines for Bank Holding Companies

The Federal Reserve Board has established risk-based capital guidelines that are applicable to bank holding companies. The guidelines apply on a consolidated basis and require bank holding companies to maintain a minimum ratio of Tier 1 capital to total assets (“leverage ratio”) of 4%. For the most highly rated bank holding companies, the minimum ratio is 3%. The Federal Reserve Board 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%. Any bank 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 Federal Reserve Board for achieving capital adequacy. In addition, an undercapitalized company's ability to pay dividends to its shareholders and expand its lines of business through the acquisition of new banking or non-banking subsidiaries also could be restricted by the Federal Reserve Board. The Federal Reserve Board may set higher minimum capital requirements for bank holding companies where circumstances warrant, such as companies anticipating significant growth or facing unusual risks. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.” Alliance’s Tier 1 and total risk-based capital ratios as of December 31, 2011 were 14.72% and 15.97%, respectively. In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier 1 capital to total assets (“Tier 1 leverage ratio”) of 3.00% for the bank holding companies with the highest supervisory ratings. All other bank holding companies are required to maintain a Tier 1 leverage ratio of at least 4.00%. Alliance’s Tier 1 leverage ratio as of December 31, 2011 was 9.09%. The guidelines also provide that banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing internal growth, are expected to maintain capital ratios well above the minimum supervisory levels.

On March 1, 2005 the Federal Reserve Board issued a final rule allowing the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies within certain limits. At December 31, 2011, Alliance’s trust preferred securities comprised 20% of the sum of Alliance’s Tier 1 capital. However, pursuant to the Dodd-Frank Act, the ability of bank holding companies to continue to include trust preferred securities in Tier 1 capital will be limited in the future. Under Section 171 of the Dodd-Frank Act, the Federal Reserve must promulgate regulations implementing capital requirements for bank holding companies with assets greater than $500 million that are no less stringent than those applicable to insured depository institutions. Since depository institutions may not count trust preferred securities in Tier 1 capital (but may count them in Tier 2 capital), bank holding companies with over $500 million in assets will no longer be able to do so. Thus, trust preferred securities issued on or after May 19, 2010 may no longer be counted in Tier 1 capital of bank holding companies with over $500 million in assets. Trust preferred securities issued before May 19, 2010 by bank holding companies with assets of less than $15 billion as of year-end 2009 may continue to be included in Tier 1 capital until their original maturity. Alliance’s trust preferred securities are scheduled to mature in 2034 and 2036.

 

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Transactions with Affiliates

The Bank’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve Board’s Regulation W. In general, these transactions must be on terms that are at least as favorable to the Bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the Bank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the Bank.

Loans to Insiders

The Bank’s authority to extend credit to its directors, executive officers and principal shareholders, as well as to entities controlled by such persons (collectively, “insiders”), is governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders: (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions for credit in excess of established limits must be approved by the Bank’s Board of Directors.

Bank Regulation

As a national bank, the Bank is subject to primary supervision, regulation, and examination by the OCC. The Bank must file periodic reports with the OCC concerning its activities and financial condition, and must obtain regulatory approval to enter into certain transactions or conduct certain activities. Like other federal banking regulators, the OCC has broad authority to examine and supervise the Bank and to evaluate the Bank’s compliance with applicable laws, regulations and guidance. The OCC may initiate enforcement actions to sanction, remedy, or prevent unsafe or unsound banking practices, breaches of fiduciary duty, and/or violations of law.

The Bank is subject to a wide variety of statutes and regulations that significantly affect its business and activities. Such statutes and regulations include those relating to capital requirements, allowable investments, underwriting of loans, reserves against deposits, trust activities, mergers and consolidations, payment of dividends, establishment of branches and certain other facilities, limitations on loans to one borrower and loans to affiliated persons, and numerous other aspects of the business of banks. Additionally, bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Consumer Compliance

The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Fair Credit Reporting Act, provisions of the Gramm-Leach-Bliley Act of 1999 relating to privacy and safeguarding of consumer information, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act. These laws and regulations mandate certain disclosures and, in certain cases, restrict the terms on which the Bank may offer products and services to consumers.

Community Reinvestment

Additionally, the Bank is subject to the Community Reinvestment Act of 1977 (“CRA”) and the regulations issued thereunder, which are intended to encourage banks to help meet the credit needs of their service area, including low-to-moderate-income (“LMI”) neighborhoods, consistent with safe and sound operations. The CRA also provides for regulatory assessment of a bank’s record in meeting the needs of its service area when considering applications regarding establishing branches, mergers or other bank or branch acquisitions. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The Bank received a rating of “Satisfactory” at its last CRA exam.

 

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Anti-money Laundering

Alliance and the Bank are also subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and mandatory transaction reporting obligations. For example, the Bank Secrecy Act imposes an affirmative obligation on the Bank to report currency transactions that exceed certain thresholds and to report other transactions determined to be suspicious. Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other provisions, the USA PATRIOT Act and the related regulations require banks operating in the United States to supplement and enhance the anti-money laundering compliance programs, due diligence policies and controls required by the Bank Secrecy Act and Office of Foreign Assets Control regulations to ensure the detection and reporting of money laundering.

The Bank has in place a comprehensive program to ensure compliance with these requirements. In 2011, the Bank engaged in a very limited number of transactions of any kind with foreign financial institutions or foreign persons.

Capital and Prompt Corrective Action

Under the Prompt Corrective Action (“PCA”) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), federal banking regulators are required to take “prompt corrective action” regarding depository institutions that do not meet certain minimum capital requirements. The PCA provisions impose progressively more restrictive constraints on banks as their capital levels decline. The PCA provisions identify the following capital categories for financial institutions: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Rules adopted by the federal banking agencies implementing PCA provide that an institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement, capital directive, or PCA directive to meet and maintain a specific level for any capital measure. Additionally, 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 above certain levels.

At December 31, 2011, Alliance and the Bank were in the “well capitalized” category.

Insurance of Deposits

The deposits of the Bank are insured up to the applicable limits established by law and are subject to the deposit insurance premium assessments of the Deposit Insurance Fund (“DIF”). Under Dodd-Frank, the standard deposit insurance amount has been permanently increased to $250,000. The FDIC currently maintains a risk-based assessment system under which assessment rates vary based on the level of risk posed by the institution to the DIF.

In February 2011, the FDIC adopted a final rule making certain changes to the deposit insurance assessment system, many of which were made as a result of provisions of the Dodd-Frank Act. The final rule also revised the assessment rate schedule effective April 1, 2011, and adopted additional rate schedules that will go into effect when the DIF reserve ratio reaches various milestones. The final rule changed the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. In addition, the rule will suspend FDIC dividend payments if the DIF reserve ratio exceeds 1.5 percent at the end of any year but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds.

In calculating assessment rates, the rule adopts a new “scorecard” assessment scheme for insured depository institutions with $10 billion or more in assets. It retains the risk category system for insured depository institutions with less than $10 billion in assets, assigning each institution to one of four risk categories based upon the institution’s capital evaluation and supervisory evaluation, as defined by the rule.

 

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Monetary and Fiscal Policies

The earnings of Alliance are significantly affected by the monetary and fiscal policies of governmental authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. government securities and federal funds, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect that they may have on Alliance’s business and earnings.

The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) also imposes numerous requirements designed to address corporate and accounting fraud. Sarbanes-Oxley requires chief executive officers and chief financial officers, or their equivalent, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under Sarbanes-Oxley, legal counsel is required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to the chief executive officer or chief financial officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the Board of Directors or the Board itself. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted.

Available Information

We file annual reports, quarterly reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934 (the “Exchange Act"). The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including Alliance, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at www.sec.gov.

We also make available, free of charge through our website (www.alliancebankna.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnishes it to, the SEC.

Item 1A. Risk Factors

There are risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.

We Are Subject to Interest Rate Risk

Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic and credit market conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could not only influence the interest we receive on loans and securities

 

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and the amount of interest we pay on deposits and borrowings, but could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates earned on loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates earned on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our 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 our management of interest rate risk.

We Are Subject to Lending Risk

There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic or credit market conditions in the markets where we operate as well as the State of New York and the entire United States. Increases in interest rates and/or weakening economic or credit market conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action that could result in the assessment of significant civil money penalties against us.

As of December 31, 2011, approximately 35% of our loan and lease portfolio consisted of commercial loans and leases net of unearned income. These types of loans are generally viewed as having more risk of default than conventional residential real estate loans or most consumer loans. Commercial loans are also typically larger than residential real estate loans and consumer loans. Because our loan portfolio contains a significant number of commercial 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 credit losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

See the section captioned “Loans and Leases” 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 loans and leases.

Our Allowance for Credit Losses May Be Insufficient

We maintain an allowance for credit losses, which is a reserve established through a provision for credit losses charged to expense, that represents management’s best estimate of probable losses incurred within the existing portfolio of loans and leases. The allowance is necessary to provide for estimated credit losses and risks inherent in the loan and lease portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan and lease portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan and lease portfolio. The determination of the appropriate level of the allowance for credit losses inherently involves a significant degree of subjectivity and requires us to make estimates of current credit risks, 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 our control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review our allowance for credit losses and may require an increase in the provision for credit 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 credit losses, we will need additional provisions to increase the allowance for credit losses. These increases in the allowance for credit losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.

 

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See the section captioned “Asset Quality and the Allowance for Credit Losses” 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 our process for determining the appropriate level of the allowance for credit losses.

Our Profitability Depends Significantly on Economic Conditions in Upstate New York

Our profitability depends significantly on the general economic conditions of Upstate New York and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Upstate New York counties of Cortland, Erie, Madison, Oneida, Onondaga, Oswego and nearby counties. The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations.

We Operate in a Highly Competitive Industry and Market Area

We face substantial competition in all areas of our 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 where we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring 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. 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. Many of our 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 we can. Our ability to compete successfully depends on a number of factors, including, among other things:

 

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The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe and sound practices.

 

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The ability to maintain high asset quality.

 

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The ability to expand our market position.

 

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The scope, relevance and pricing of products and services offered to meet customer needs and demands.

 

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The rate at which we introduce new products and services relative to our competitors.

 

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Customer satisfaction with our level of service.

 

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Industry and general economic trends.

 

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Our ability to upgrade and acquire technology and information systems to support the sales and service of deposit and loan products.

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

We Are Subject to Extensive Government Regulation and Supervision

We are 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 our lending practices, capital structure, investment practices, dividend policy and growth,

 

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among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for areas warranting changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we 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, private lawsuits, and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have 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” in Item 1. Business, which is located elsewhere in this report, for further discussion.

Compliance with the Dodd-Frank Act Will Increase Our Regulatory Compliance Burdens, and May Increase Our Operating Costs and/or Adversely Impact Our Earnings and/or Capital Ratios

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial-services industry. Among other things, the Dodd-Frank Act creates a new federal CFPB, tightens capital standards, imposes clearing and margining requirements on many derivatives activities, and generally increases oversight and regulation of financial institutions and financial activities.

The CFPB began operations on July 21, 2011. It has broad authority to write regulations regarding consumer financial products and services. These regulations will apply to numerous types of entities, including insured depository institutions such as the Bank, and mortgage servicing providers. It is impossible to predict at this time the content or number of such regulations.

The Dodd-Frank Act also requires depository institution holding companies with assets greater than $500 million to be subject to capital requirements at least as stringent as to those applicable to insured depository institutions, meaning, for instance, that such holding companies will no longer be able to count trust preferred securities issued on or after May 19, 2010 as Tier 1 capital. Holding companies with total consolidated assets of less than $15 billion will be allowed to continue to count securities, including trust preferred securities, issued before May 19, 2010 in Tier 1 capital if the securities qualified as Tier 1 capital on that date for the remaining life of the security. Holding companies with total consolidated assets of $15 billion or greater will be required to phase out existing trust preferred and other non-qualifying securities from Tier 1 capital over a 3-year period beginning on January 1, 2013. Moreover, agreements among bank regulators across the world (including the United States) known as the Basel III capital accord also call for the removal of trust preferred securities from Tier 1 capital, encourage more reliance on common equity as the main component of capital, and call for increased levels of capital. Rules implementing Basel III have not be yet been proposed in the United States.

In addition to the self-implementing provisions of the statute, the Dodd-Frank Act calls for over 200 administrative rulemakings by various federal agencies to implement various parts of the legislation. While some rules have been finalized and/or issued in proposed form, many have yet to be proposed. It is impossible to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

The Dodd-Frank Act and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and/or our ability to conduct business.

We Cannot Predict the Effect On Our Operations of Any Future Legislative or Regulatory Initiatives

We cannot predict what, if any, additional legislative or regulatory initiatives any governmental entity may undertake in the future, and what, if any, effects such initiatives may have on our operations. The U.S. federal and state governments and many foreign governments have taken or are considering extraordinary actions in response to the worldwide financial crisis and the severe decline in the global economy.

There can be no assurance that the enactment or adoption of any such initiative will be effective at dealing with the ongoing economic crisis or will have the effect of improving economic conditions globally, nationally or in our markets, or that any such initiative will not have adverse consequences to us.

 

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A Change to the Conservatorship of Fannie Mae and Freddie Mac and Related Actions, Along with Any Changes in Laws and Regulations Affecting the Relationship Between Fannie Mae and Freddie Mac and the U.S. Federal Government, Could Adversely Affect Our Business

There continues to be substantial uncertainty regarding the future of GSEs Fannie Mae and Freddie Mac, including whether they both will continue to exist in their current form. We sell the majority of our residential mortgages to Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. Our ability to sell our residential mortgages into the secondary market is an important part of our overall interest rate risk, liquidity risk and capital management strategies.

Due to increased market concerns about the ability of Fannie Mae and Freddie Mac to withstand future credit losses associated with securities on which they provide guarantees and loans held in their investment portfolios without the direct support of the U.S. federal government, in September 2008, the Federal Housing Finance Agency (the “FHFA”) placed Fannie Mae and Freddie Mac into conservatorship and, together with the U.S. Treasury, established a program designed to boost investor confidence in Fannie Mae and Freddie Mac by supporting the availability of mortgage financing and protecting taxpayers. The U.S. government program includes contracts between the U.S. Treasury and each of Fannie Mae and Freddie Mac that seek to ensure that each GSE maintains a positive net worth by providing for the provision of cash by the U.S. Treasury to Fannie Mae and Freddie Mac if FHFA determines that its liabilities exceed its assets. Although the U.S. government has described some specific steps that it intends to take as part of the conservatorship process, efforts to stabilize these entities may not be successful and the outcome and impact of these events remain highly uncertain.

Future legislation could further change the relationship between Fannie Mae and Freddie Mac and the U.S. government, could change their business charters or structure, or could nationalize or eliminate such entities entirely. We cannot predict whether, or when, any such legislation may be enacted.

The Soundness of Other Financial Services Institutions May Adversely Affect Our Credit Risk

We rely on other financial services institutions through trading, clearing, counterparty, and other relationships. We maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or counterparties. These losses could adversely affect our results of operations and financial condition.

Certain of Our Intangible Assets May Become Impaired in the Future

Intangible assets are tested for impairment on a periodic basis. Impairment testing incorporates the current market price of our common stock, the estimated fair value of our assets and liabilities, and certain information of similar companies. It is possible that future impairment testing could result in a decline in value of our intangibles which may be less than the carrying value, which may adversely affect our financial condition. If we determine that an impairment exists at a given point in time, our earnings and the book value of the related intangibles will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on our intangible assets have no impact on our tangible book value or regulatory capital levels.

Our Controls and Procedures May Fail or Be Circumvented

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 our 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.

New Lines of Business or New Products and Services May Subject Us to Additional Risks

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may

 

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not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.

We Rely on Dividends from the Bank for Most of Our Revenue

We receive substantially all of our revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to us. Also, our 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 us, we may not be able to service debt, pay obligations or pay dividends on our common stock.

The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. See the section captioned “Supervision and Regulation” in Item 1. Business and Note 16 – Dividends and Restrictions in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.

We May Not Be Able to Attract and Retain Skilled People

Our success depends, in large part, on our ability to attract and retain key human resource talent. Competition for the best employees in most activities and functions we are engaged in can be intense and we may not be able to hire employees or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Our Information Systems May Experience an Interruption or Breach in Security

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny and/or enforcement actions, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

We Continually Encounter Technological Changes

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. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological enhancements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Our Articles of Incorporation, By-Laws and Shareholder Rights Plan As Well As Certain Banking Laws May Have an Anti-Takeover Effect

Provisions of our articles of incorporation and by-laws, federal banking laws, including regulatory approval requirements, and our stock purchase rights plan could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions effectively

 

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inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

We conduct business in Upstate New York through 29 banking offices and two administrative centers. We lease our corporate headquarters located in Syracuse, NY. Eleven banking offices and one of the administrative centers are subject to leases and/or long-term land leases. The remaining banking offices and administrative center are owned.

Item 3. Legal Proceedings

We are subject to various claims, legal proceedings and matters that arise in the ordinary course of business. In management’s opinion, no pending action, if adversely decided, would materially affect our financial condition. See Note 15 to our consolidated financial statements contained elsewhere in this report for additional information.

Item 4. Mine Safety Disclosures

None.

 

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PART II

Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Common Stock Data

Our common stock is listed on the NASDAQ Global Market under the symbol “ALNC.” There were 834 shareholders of record as of December 31, 2011. The following table presents the high and low sales price during the periods indicated, as well as dividends declared.

 

     2011    2010
           High                Low                Dividend      
Declared
         High                Low                Dividend      
Declared

1st Quarter

   $33.89    $29.50    $0.30    $29.50    $26.25    $0.28

2nd Quarter

   $33.44    $27.34    $0.30    $31.00    $26.78    $0.28

3rd Quarter

   $32.83    $26.37    $0.31    $31.55    $27.57    $0.30

4th Quarter

   $32.93    $27.62    $0.31    $33.40    $29.11    $0.30

Dividends

We have historically paid regular quarterly cash dividends on our common stock, and the Board of Directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. However, because substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition and its need for funds. Furthermore, there are a number of federal banking policies and regulations that restrict our ability to pay dividends. In particular, because the Bank is a depository institution whose deposits are insured by the FDIC, it may not pay dividends or distribute capital assets if it is in default on any assessment due the FDIC. Also, as a national bank, the Bank is subject to OCC regulations which impose certain minimum capital requirements that would affect the amount of cash available for distribution to us. In addition, under Federal Reserve policy, we are required to maintain adequate regulatory capital, are expected to serve as a source of financial strength to the Bank and to commit resources to support the Bank. These policies and regulations may have the effect of reducing the amount of dividends that we can declare to our shareholders.

Automatic Dividend Reinvestment Plan

We have an automatic dividend reinvestment plan which is administered by our transfer agent, American Stock Transfer & Trust Company. The plan offers a convenient way for shareholders to increase their investment in us by enabling them to reinvest cash dividends on all or part of their common stock in additional shares of our common stock without paying brokerage commissions or service charges. Shareholders who are interested in this program may visit the Shareholder Services section of American Stock Transfer & Trust Company’s website for more information (www.amstock.com). Shareholders may also receive a Plan Prospectus and enrollment card by calling ASTC Dividend Reinvestment at 1-800-278-4353, or writing to the following address:

Dividend Reinvestment

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Sales of Unregistered Securities and Purchases of Equity Securities

There were no sales by us of unregistered securities during the year ended December 31, 2011. There were no purchases made by or on behalf of us of our common stock during the fourth quarter of 2011.

 

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Stock Performance Graph

The graph below matches our cumulative 5-year total shareholder return on common stock with the cumulative total returns of the Russell 3000 index and the SNL Bank NASDAQ index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/2006 to 12/31/2011.

 

 

Alliance Financial Corporation

 

LOGO

 

     Period Ending  
  Index    12/31/06      12/31/07      12/31/08      12/31/09      12/31/10      12/31/11  

  Alliance Financial Corporation

     100.00         84.42         80.46         96.08         119.03         118.25   

  SNL Bank NASDAQ

     100.00         78.51         57.02         46.25         54.57         48.42   

  Russell 3000

     100.00         105.14         65.92         84.60         98.92         99.93   

 

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Item 6. Selected Financial Data

The summary information presented below at or for each of the years presented is derived in part from our consolidated financial statements. The following information is only a summary, and you should read it in conjunction with our consolidated financial statements and notes beginning on page F-1.

 

(In thousands) (In thousands) (In thousands) (In thousands) (In thousands)
     Year ended December 31,  
     2011      2010      2009      2008      2007  

Selected Financial Condition Data

     (In thousands)   

Total assets

     $1,409,090           $1,454,622           $1,417,244           $1,367,358           $1,307,014   

Loans & leases, net of unearned income

     872,721           898,537           914,162           910,755           895,533   

Allowance for credit losses

     10,769           10,683           9,414           9,161           8,426   

Securities available-for-sale

     374,306           414,410           362,158           310,993           282,220   

Goodwill

     30,844           30,844           32,073           32,073           32,187   

Intangible assets, net

     7,694           8,638           10,075           11,528           13,183   

Deposits

     1,083,065           1,134,598           1,075,671           937,882           945,230   

Borrowings

     136,310           142,792           172,707           238,972           200,757   

Junior subordinated obligations

     25,774           25,774           25,774           25,774           25,774   

Shareholders’ equity

     143,997           133,131           123,935           144,481           115,560   

Common shareholders’ equity

     143,997           133,131           123,935           117,563           115,560   
Investment assets under management (Market value, not included in total assets)      $   827,504           $   829,426           $   786,302           $   726,019           $   971,078   

 

(In thousands) (In thousands) (In thousands) (In thousands) (In thousands)
     Year ended December 31,  
     2011      2010      2009      2008      2007  
     (In thousands, except share and per share data)  

Selected Operating Data

              

Interest income

     $55,759           $60,342           $63,962           $67,964           $71,032   

Interest expense

     12,459           16,053           20,581           30,267           38,550   

Net interest income

     43,300           44,289           43,381           37,697           32,482   

Provision for credit losses

     1,910           4,085           6,100           5,502           3,790   
Net interest income after provision for credit losses      41,390           40,204           37,281           32,195           28,692   

Non-interest income

     20,002           20,505           20,811           20,360           21,292   

Total operating income

     61,392           60,709           58,092           52,555           49,984   

Non-interest expense

     43,581           44,480           43,208           39,378           37,638   

Income before taxes

     17,811           16,229           14,884           13,177           12,346   

Income tax expense

     4,514           4,605           3,436           2,820           2,869   

Net income

     $13,297           $11,624           $11,448           $10,357           $  9,477   
Dividends and accretion of discount on preferred stock      —           —           1,084           47           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net income available to common shareholders      $13,297           $11,624           $10,364           $10,310           $9,477     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Stock and Per Share Data

              

Basic earnings per common share

     $    2.80           $    2.49           $    2.25           $    2.23           $    1.98   

Diluted earnings per common share

     $    2.80           $    2.48           $    2.24           $    2.21           $    1.96   
Basic weighted average common shares outstanding      4,670,052           4,619,718           4,514,268           4,542,957           4,710,530   
Diluted weighted average common shares outstanding      4,675,212           4,640,096           4,543,069           4,565,709           4,754,045   

Cash dividends declared

     $    1.22           $    1.16           $    1.08           $    1.00           $    0.90   

Dividend payout ratio(1)

     43.6%           46.8%           48.2%           44.6%           45.5%   

Common book value

     $  30.19           $  28.15           $  26.86           $  25.67           $  24.53   

Tangible common book value(2)

     $  22.11           $  19.80           $  17.72           $  16.15           $  14.90   

 

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     Year ended December 31,  

Selected Financial and Other Data(3)

       2011              2010              2009              2008              2007      

Performance Ratios

              
Return on average assets      0.92%           0.81%           0.81%           0.78%           0.74%     
Return on average equity      9.88%           9.17%           8.68%           8.77%           8.48%     
Return on average common equity      9.88%           9.17%           8.46%           8.80%           8.48%     
Return on average tangible common equity      13.91%           13.64%           13.02%           14.19%           14.77%     
Non-interest income to total income(4)      30.14%           30.44%           30.06%           34.86%           39.29%     
Efficiency ratio(5)      70.32%           69.86%           69.66%           68.04%           70.35%     

Rate/Yield Information

              
Yield on interest-earning assets (tax equivalent)      4.37%           4.78%           5.15%           5.88%           6.36%     
Cost of interest-bearing liabilities      1.11%           1.42%           1.85%           2.87%           3.78%     
Net interest rate spread      3.26%           3.36%           3.30%           3.01%           2.58%     
Net interest margin (tax equivalent)(6)      3.43%           3.55%           3.55%           3.35%           3.02%     

 

     At or for the Year Ended December 31,  
         2011              2010              2009              2008              2007      

Asset Quality Ratios

              
Nonperforming loans and leases to total loans and leases      1.30%           0.95%           0.94%           0.49%           0.75%   
Nonperforming assets to total assets      0.84%           0.63%           0.64%           0.38%           0.53%   
Allowance for credit losses to nonperforming loans and leases      95.4%           125.8%           109.7%           204.6%           125.7%   
Allowance for credit losses to total loans and leases      1.24%           1.19%           1.03%           1.01%           0.94%   
Net charge-offs to average loans and leases      0.21%           0.31%           0.63%           0.53%           0.27%   

Equity Ratios

              
Total common shareholders’ equity to total assets      10.22%           9.15%           8.74%           8.60%           8.84%   
Tangible common equity to tangible assets(8)      7.69%           6.62%           5.95%           5.59%           5.56%   

Regulatory Ratios

              
Consolidated:               
Tier 1 (core) capital      9.09%           8.28%           7.55%           9.59%           7.53%   
Tier 1 risk-based capital      14.72%           13.43%           12.07%           14.05%           10.64%   
Tier 1 risk based common capital(7)      11.81%           10.56%           9.22%           11.24%           8.76%   
Total risk-based capital      15.97%           14.65%           13.14%           15.08%           11.59%   
Bank:               
Tier 1 (core) capital      8.50%           7.72%           7.14%           8.97%           7.26%   
Tier 1 risk-based capital      13.80%           12.56%           11.47%           13.15%           10.34%   
Total risk-based capital      15.05%           13.79%           12.55%           14.19%           11.30%   

 

  (1)

Cash dividends declared per share divided by diluted earnings per share.

 

  (2)

Common shareholders’ equity less goodwill and intangible assets divided by common shares outstanding.

 

  (3)

Averages presented are daily averages.

 

  (4)

Non-interest income (net of realized gains and losses on securities and non-recurring items) divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items).

 

  (5)

Non-interest expense divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items).

 

  (6)

Tax equivalent net interest income divided by average interest-earning assets.

 

  (7)

Tier 1 capital excluding junior subordinated obligations issued to unconsolidated trusts divided by total risk-adjusted assets.

 

  (8)

We use certain non-GAAP U.S. generally accepted accounting principles or GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. We believe TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a company’s financial condition and capital strength. TCE, as defined by us, represents common equity less goodwill and intangible assets. A reconciliation from our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio is presented below (dollars in thousands):

 

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Table of Contents
     Year ended December 31,  
         2011              2010              2009              2008              2007      
Total assets      $1,409,090           $1,454,622           $1,417,244           $1,367,358           $1,307,014     
Less: Goodwill and intangible assets, net      38,538           39,482           42,148           43,601           45,370     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Tangible assets (non-GAAP)      1,370,552           1,415,140           1,375,096           1,323,757           1,261,644     
Total Common Equity      143,997           133,131           123,935           117,563           115,560     
Less: Goodwill and intangible assets, net      38,538           39,482           42,148           43,601           45,370     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Tangible Common Equity (non-GAAP)      105,459           93,649           81,787           73,962           70,190     
Total Equity/Total Assets      10.22%           9.15%           8.74%           8.60%           8.84%     
Tangible Common Equity/Tangible Assets (non-GAAP)      7.69%           6.62%           5.95%           5.59%           5.56%     

 

17


Table of Contents

Summarized quarterly financial information for the years ended December 31, 2011 and 2010 is as follows:

 

Year ended Year ended Year ended Year ended Year ended
     Year ended      Three months ended  
         12/31/11              12/31/11              9/30/11              6/30/11              3/31/11      
  

 

 

    

 

 

 
            (Dollars in thousands, except share and per share data)  
Total interest income      $55,759           $12,942           $14,061           $14,494           $14,262     
Total interest expense      12,459           2,928           3,064           3,188           3,279     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net interest income      43,300           10,014           10,997           11,306           10,983     
Provision for credit losses      1,910           800           750           160           200     
Non-interest income      20,002           5,062           5,919           4,435           4,586     
Non-interest expense      43,581           10,640           11,139           10,823           10,979     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Income before income taxes      17,811           3,636           5,027           4,758           4,390     
Income tax expense      4,514           791           1,360           1,279           1,084     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net Income      $13,297           $2,845           $3,667           $3,479           $3,306     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net Income available to common shareholders      $13,297           $2,845           $3,667           $3,479           $3,306     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Basic earnings per share      $2.80           $0.60           $0.77           $0.73           $0.70     
Diluted earnings per share      $2.80           $0.60           $0.77           $0.73           $0.70     
Basic weighted average shares outstanding      4,670,052           4,687,802           4,667,355           4,662,752           4,662,044     
Diluted weighted average shares outstanding      4,675,212           4,689,427           4,673,908           4,670,530           4,670,674     
Cash dividends declared per share      $1.22           $0.31           $0.31           $0.30           $0.30     
Net interest margin (tax equivalent)      3.43%           3.24%           3.48%           3.53%           3.44%     
Return on average assets      0.92%           0.80%           1.01%           0.95%           0.90%     
Return on average equity      9.88%           8.19%           10.69%           10.45%           10.27%     
Return on average tangible common equity      13.91%           11.34%           14.91%           14.80%           14.80%     
Non-interest income to total income      30.10%           33.58%           29.47%           28.17%           29.46%     
Efficiency ratio      70.35%           70.58%           71.45%           68.76%           70.52%     

 

Year ended Year ended Year ended Year ended Year ended
     Year ended      Three months ended  
         12/31/10              12/31/10              9/30/10              6/30/10              3/31/10      
  

 

 

    

 

 

 
            (Dollars in thousands, except share and per share data)  
Total interest income      $60,342           $14,406           $15,102           $15,378           $15,456     
Total interest expense      16,053           3,588           3,942           4,188           4,335     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net interest income      44,289           10,818           11,160           11,190           11,121     
Provision for credit losses      4,085           800           1,095           1,095           1,095     
Non-interest income      20,505           5,946           5,139           4,859           4,561     
Non-interest expense      44,480           11,346           11,210           10,963           10,961     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Income before income taxes      16,229           4,618           3,994           3,991           3,626     
Income tax expense      4,605           1,825           904           999           877     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net Income      $11,624           $ 2,793           $ 3,090           $ 2,992           $ 2,749     
Net Income available to common shareholders      $11,624           $ 2,793           $ 3,090           $ 2,992           $ 2,749     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Basic earnings per share      $    2.49           $  0.59           $  0.66           $  0.64           $  0.59     
Diluted earnings per share      $    2.48           $  0.59           $  0.66           $  0.64           $  0.59     
Basic weighted average shares outstanding      4,619,718           4,646,934           4,624,819           4,622,660           4,583,617     
Diluted weighted average shares outstanding      4,640,097           4,660,463           4,646,889           4,643,679           4,614,060     
Cash dividends declared per share      $    1.16           $  0.30           $  0.30           $  0.28           $  0.28     
Net interest margin (tax equivalent)      3.55%           3.45%           3.57%           3.56%           3.61%     
Return on average assets      0.81%           0.77%           0.86%           0.83%           0.77%     
Return on average equity      9.17%           8.59%           9.57%           9.62%           8.93%     
Return on average tangible common equity      13.64%           12.51%           14.09%           14.48%           13.55%     
Non-interest income to total income      30.44%           32.17%           30.21%           30.28%           29.08%     
Efficiency ratio      69.86%           71.14%           70.10%           68.31%           69.90%     

 

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Table of Contents

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

2011 Highlights and Overview

Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on our loans and leases and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for credit losses, securities and loan sale activities, loan servicing activities, service charges and fees collected on our deposit accounts, income collected from trust and investment advisory services and the income earned on our investment in bank-owned life insurance. Our expenses primarily consist of salaries and employee benefits, occupancy and equipment expense, marketing expense, professional services, technology expense, amortization of intangible assets, other expense and income tax expense. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, inflation, government policies and the actions of regulatory authorities.

The following is a summary of key financial results for the year ended December 31, 2011:

 

   

At December 31, 2011, total assets were $1.4 billion and total deposits were $1.1 billion.

 

   

Net income was $13.3 million in 2011, compared to $11.6 million in 2010.

 

   

Net income per diluted common share was $2.80 in 2011, compared with $2.48 in 2010.

 

   

Net interest income was $43.3 million in 2011, compared to $44.3 million in 2010.

 

   

The tax-equivalent net interest margin was 3.43% in 2011 and 3.55% in 2010.

 

   

Provision for credit losses was $1.9 million in 2011, compared to $4.1 million in 2010.

 

   

Total nonperforming assets were $11.7 million or 0.83% of total assets at December 31, 2011 compared with $9.1 million or 0.63% at December 31, 2010.

 

   

Non-interest income, excluding securities gains, was 30.1% of total revenue in 2011 compared with 30.4% in 2010.

 

   

Our efficiency ratio was 70.3% in 2011 compared with 69.9% in 2010.

The following discussion is intended to assist in understanding our financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and accompanying notes contained elsewhere in this report.

 

19


Table of Contents

Average Balance Sheet

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and yield information is adjusted for items exempt from federal income taxes and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.

 

     Years ended December 31,  
     2011     2010     2009  
    

Avg.

Balance

     Amt. of
Interest
    

Avg.

Yield/

Rate

   

Avg.

Balance

    

Amt. of

Interest

    

Avg.

Yield/

Rate

   

Avg.

Balance

    

Amt. of

Interest

    

Avg.

Yield/

Rate

 
     (Dollars in thousands)  

Assets:

                        

Interest-earning assets:

                        

Federal funds sold

       $ 15,890             $ 22           0.14       $ 8,823             $ 8           0.10       $ 13,084             $ 15           0.11

Taxable investment securities

     342,781           10,470           3.04     314,271           10,795           3.43     256,494           10,143           3.95

Nontaxable investment securities

     79,785           4,480           5.62     74,456           4,352           5.84     85,173           5,172           6.07

FHLB and FRB stock

     8,842           433           4.90     9,005           499           5.54     10,875           558           5.13

Residential real estate loans

     329,773           17,108           5.19     351,922           18,731           5.32     344,707           19,087           5.54

Commercial loans

     243,871           11,868           4.87     209,574           11,084           5.29     202,020           11,221           5.55

Non-taxable commercial loans

     9,197           492           5.35     8,639           478           5.53     9,449           570           6.03
Taxable leases (net of unearned income)      21,455           1,272           5.93     39,978           2,384           5.96     68,334           4,068           5.95
Nontaxable leases (net of unearned income)      11,685           752           6.44     13,908           900           6.47     16,472           1,069           6.49

Indirect auto loans

     165,880           7,214           4.35     182,085           9,194           5.05     187,919           10,339           5.50

Consumer loans

     90,621           3,594           3.97     91,389           3,865           4.23     91,387           4,036           4.42
  

 

 

      

 

 

      

 

 

    
Total interest-earning assets      1,319,780           57,705           4.37     1,304,050           62,290           4.78     1,285,914           66,278           5.15
Non-interest-earning assets:                         
Other assets      132,816                137,803                136,512           
Allowance for credit losses      (10,933)                (10,370)                (9,990)           
Net unrealized gains on available-for-sale securities      10,532                9,610                6,912           
  

 

 

         

 

 

         

 

 

       
Total        $ 1,452,195                  $ 1,441,093                  $ 1,419,348           
  

 

 

         

 

 

         

 

 

       
Liabilities & Shareholders’ Equity:                         
Demand deposits        $ 147,236             $ 225           0.15       $ 141,124             $ 490           0.35       $ 117,113             $ 531           0.45
Savings deposits      106,279           210           0.20     99,799           377           0.38     92,114           454           0.49
MMDA deposits      364,800           1,609           0.44     357,572           2,675           0.75     303,344           3,347           1.10
Time deposits      333,138           5,673           1.70     359,532           7,216           2.01     382,420           9,622           2.52
  

 

 

      

 

 

      

 

 

    
Total interest-bearing deposits      951,453           7,717           0.81     958,027           10,758           1.13     894,991           13,954           1.56
Borrowings      143,439           4,104           2.86     146,296           4,650           3.18     193,648           5,819           3.01

Junior subordinated obligations issued to unconsolidated subsidiary trusts

     25,774           638           2.47     25,774           645           2.50%        25,774           808           3.13
  

 

 

      

 

 

      

 

 

    
Total interest-bearing liabilities      1,120,666           12,459           1.11     1,130,097           16,053           1.42%        1,114,413           20,581           1.85
Non-interest-bearing liabilities:                         
Demand deposits      181,039                167,912                156,396           

Other liabilities

     15,917                16,383                16,685           

Shareholders’ equity

     134,573                126,701                131,854           
  

 

 

         

 

 

         

 

 

       
Total        $ 1,452,195                  $ 1,441,093                  $ 1,419,348           
  

 

 

         

 

 

         

 

 

       
Net interest income (tax equivalent)           $ 45,246                  $ 46,237                  $ 45,697        
     

 

 

         

 

 

         

 

 

    

Net interest rate spread

           3.26           3.36%              3.30
Net interest margin (tax equivalent)            3.43           3.55%              3.55
Federal tax exemption on nontaxable investment securities, loans and leases included in interest income         1,946                1,948                2,316        
     

 

 

         

 

 

         

 

 

    

Net interest income

          $ 43,300                  $ 44,289                  $ 43,381        
     

 

 

         

 

 

         

 

 

    

 

20


Table of Contents

Rate/Volume Analysis

The following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest-earning assets and interest-bearing liabilities, and from changes in rates. Volume changes are computed by multiplying the volume difference by the prior year’s rate. Rate changes are computed by multiplying the rate difference by the prior year’s volume. The change in interest due to both rate and volume has been allocated proportionally between the volume and rate variances.

 

     2011 Compared to 2010      2010 Compared to 2009  
     Increase (decrease) due to      Increase (decrease) due to  
     Volume      Rate     

Net    

Change    

     Volume      Rate     

Net    

Change    

 
  

 

 

    

 

 

 
     (In thousands)  
Federal funds sold            $        8         $         6         $      14           $        (5)         $        (2)         $         (7)     
Taxable investment securities      944         (1,269)         (325)           2,095         (1,443)         652     
Non-taxable investment securities      298         (170)         128           (630)         (190)         (820)     
FHLB and FRB stock      (9)         (57)         (66)           (101)         42         (59)     
Residential real estate loans      (1,169)         (454)         (1,623)           401         (757)         (356)     
Commercial loans      1,713         (929)         784           405         (542)         (137)     
Non-taxable commercial loans      30         (16)         14           (47)         (45)         (92)     

Taxable leases (net of unearned income)

     (1,100)         (12)         (1,112)           (1,691)         7         (1,684)     

Non-taxable leases (net of unearned income)

     (144)         (4)         (148)           (166)         (3)         (169)     
Indirect loans      (774)         (1,206)         (1,980)           (315)         (830)         (1,145)     
Consumer loans      (33)         (238)         (271)                   (171)         (171)     
  

 

 

    

 

 

 

Total interest-earning assets

     (236)         (4,349)         (4,585)           (54)         (3,934)         (3,988)     
Interest-bearing demand deposits      21         (286)         (265)           93         (134)         (41)     
Savings deposits      23         (190)         (167)           34         (111)         (77)     
MMDA deposits      54         (1,120)         (1,066)           522         (1,194)         (672)     
Time deposits      (498)         (1,045)         (1,543)           (549)         (1,857)         (2,406)     
Borrowings      (89)         (457)         (546)           (1,485)         316         (1,169)     

Junior subordinated obligations issued to unconsolidated subsidiary trusts

             (7)         (7)                   (163)         (163)     
  

 

 

    

 

 

 
Total interest-bearing liabilities      (489)         (3,105)         (3,594)           (1,385)         (3,143)         (4,528)     
Net interest income (tax equivalent)          $    253         $(1,244)         $  (991)               $    1,331         $    (791)         $        540     
  

 

 

    

 

 

 

Comparison of Operating Results for the Years Ended December 31, 2011 and 2010

General

Net income was $13.3 million or $2.80 per diluted share for the year ended December 31, 2011, compared with $11.6 million or $2.48 per diluted share in 2010. The increase in net income in 2011 resulted from a $2.2 million decline in the provision for credit losses and an $899,000 decrease in non-interest expenses partially offset by a $989,000 decrease in net interest income and a $503,000 decrease in non-interest income.

Net Interest Income

Net interest income totaled $43.3 million in 2011, which was a decrease of $989,000 or 2.2% compared with $44.3 million in 2010. The decrease in net-interest income resulted from a decline in the net interest margin partially offset by an increase in average interest-earning assets.

Average interest-earning assets increased $14.4 million in 2011 compared with 2010, with a $33.8 million increase in securities offsetting a $25.0 million decrease in loans and leases. The tax-equivalent net interest margin was 3.43% in 2011, compared to 3.55% in 2010. The tax-equivalent yield on interest-earning assets decreased 40 basis points in 2011 compared to 2010, which was partially offset by a 31 basis point decrease in our cost of interest-bearing liabilities over the same period. The tax-equivalent yield on our interest-earning assets was 4.37% in 2011, compared to 4.78% in 2010. Our cost of interest-bearing liabilities was 1.11% in 2011, compared to 1.42% in 2010.

 

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Between September 2007 and December 2008, the Federal Reserve reduced its target fed funds rate from 5.25% to between zero and 0.25%, where the target rate remains. The Federal Reserve’s monetary policy, volatility in equity markets, economic recession and federal government economic stimulus efforts, among other factors, have caused yields on U.S. Treasury securities to drop to exceptionally low levels throughout much of the past four years. The month-end yields on two-year, ten-year and thirty-year treasury securities were lower by 369 basis points, 266 basis points and 192 basis points, respectively at December 31, 2011 compared to September 30, 2007. This persistently low interest rate environment has caused an ongoing decline over the past four years in the returns on our interest-earning assets, consistent with much of the financial industry. Yields on our securities portfolio and on our commercial loans and consumer loans were most affected by the low interest rate environment, due to the significant annual amortization in these portfolios as a result of their relatively shorter duration. Also, our commercial loan and consumer loan portfolios are more sensitive to changes in interest rates due to the variable rate characteristics of a portion of these portfolios. The tax-equivalent yield on our securities portfolio decreased 38 basis points in 2011 compared to 2010. The yield on our commercial loans and consumer (including indirect) loans decreased 42 basis points and 56 basis points, respectively, in 2011.

Changes in our asset mix also contributed to the decline in the interest-earning assets yield in 2011, as securities comprised a larger portion of our earning assets in 2011 as compared to 2010 due to difficulty in growing our loan portfolio as the result of the difficult economic and credit market conditions, and our decision to sell many of our fixed rate residential mortgage originations. The yields on the securities we hold are typically lower than the yields on our loans and leases. Securities comprised 32.0% of average interest-earning assets in 2011, compared with 29.8% in 2010.

The cost of our interest-bearing liabilities decreased 31 basis points in 2011 due to a combination of the low interest rate environment, our deposit pricing strategies and a favorable change in the mix of our interest-bearing liabilities, with lower-cost interest-bearing transaction accounts (savings, demand and money market) comprising a larger portion of our average interest-bearing liabilities in 2011. The average balance of interest-bearing transaction accounts increased $19.8 million or 3.3% in 2011, and totaled $618.3 million or 65.0% of total interest-bearing deposits in 2011, compared to $598.5 million or 62.5% of average interest-bearing deposits in 2011.

Our liability mix remained favorably weighted towards transaction accounts in 2011 as we continued to focus on increasing our transaction account balances and as we refrained from offering premium rates on time accounts. Our effort to increase our transaction account balances has been enhanced by retail and municipal depositor’s reluctance to lock up funds in time accounts at what are very low, yet competitive rates, and to the buildup of cash on corporate customers’ balance sheets. The aggregate average balance of transaction accounts (including non-interest bearing demand deposits) was $799.4 million in 2011, which was an increase of $32.9 million or 4.3% from the aggregate average balances of $766.4 million in 2010. Average transaction account balances comprised 70.6% of total average deposits in 2011, compared with 68.1% in 2010. Average time account balances in 2011 were $333.1 million or 29.4% of total average deposits in 2011, compared with $359.5 million or 31.9% in 2010. Our ability to gather and retain transaction deposits in recent years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of our brand. Environmental factors such as equity market volatility, risk aversion among retail investors and a build-up of cash on corporate balance sheets have also played a role in the growth in our transaction accounts.

Our tax-equivalent net interest margin declined over the course of 2011 as decreases in the cost of our interest-bearing liabilities did not keep pace with declines in the yield on our interest-earning assets. Our tax-equivalent net interest margin was 3.24% in the fourth quarter of 2011, compared with 3.44% in the first quarter of the year. The declining trend in our net interest margin that we have experienced in recent quarters is likely to continue in coming quarters as the persistently low interest rate environment continues to negatively affect the return on our loan and investment portfolios, while our ability to further reduce our funding costs is limited. We expect that weak economic conditions and historically low interest rates will likely weigh on asset growth and earnings in the financial sector for the foreseeable future. We also believe loan demand will remain soft while competition intense in our markets, which will likely inhibit loan portfolio growth in future quarters. In addition, we expect our securities portfolio will decline in coming quarters as we may not reinvest some or all of the portfolio amortization given the very low yields available for the types of shorter-duration, non-corporate securities in which we invest. Should any or all of these expectations be realized, it is likely that net interest income will decline in coming quarters.

 

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Non-Interest Income

Our non-interest income is comprised of service charges on deposits, fees from investment management and brokerage services, mortgage banking operations that include gains from sales and income from servicing, and other recurring operating income fees from normal banking operations, along with non-core components that primarily consist of net gains or losses from sales of investment securities.

The following table sets forth certain information on non-interest income for the years indicated:

 

     Years ended December 31,  
     2011      2010      Change  
     (In thousands)         
Investment management income      $  7,746           $  7,316           $  430           5.9%     
Service charges on deposit accounts      4,463           4,509           (46)           (1.0)%     
Card-related fees      2,701           2,563           138           5.4%     
Insurance agency income      —           1,283           (1,283)             (100.0)%     
Income from bank-owned life insurance      1,018           1,058           (40)           (3.8)%     
Gain on sale of loans      1,283           1,394           (111)           (8.0)%     
Gains on sale of securities available-for-sale      1,325           308           1,017           330.2%     
Other non-interest income      1,466           2,074           (608)           (29.3)%     
  

 

 

    

 

 

    

 

 

    

 

 

 
Total non-interest income        $20,002             $20,505             $(503)           (2.5)%     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest income decreased $503,000 or 2.5% to $20.0 million in 2011. Investment management income increased $430,000 or 5.9% in 2011 primarily as a result of the impact of changes in equity and debt markets over the past two years on the value of assets under management. Insurance agency income decreased $1.3 million due to the sale of our insurance agency operations in December 2010. The elimination of the operating expenses associated with our insurance agency substantially offset the revenue decline in 2011, resulting in no significant net effect on our financial results. Gains on the sale of securities available-for-sale increased to $1.3 million in 2011, compared with $308,000 in 2010 due to increased sales activity in 2011. Other non-interest income decreased $608,000 in 2011 compared to 2010 due primarily to the gain of $815,000 recognized on the sale of the insurance agency in 2010.

Non-interest income (excluding securities gains and the gain on the sale of the insurance agency) comprised 30.1% of total revenue in 2011 compared with 30.4% in 2010.

Non-Interest Expenses

The following table sets forth certain information on non-interest expenses for the years indicated:

 

     Years ended December 31  
     2011      2010      Change  
     (In thousands)         
Salaries and employee benefits      $21,902           $22,319           $(417)           (1.9)%     
Occupancy and equipment expenses      7,283           7,375           (92)           (1.2)%     
Communication expense      599           664           (65)           (9.8)%     
Office supplies and postage expense      1,142           1,158           (16)           (1.4)%     
Marketing expense      898           1,068           (170)           (15.9)%     
Amortization of intangible assets      944           1,127           (183)           (16.2)%     
Professional fees      3,087           3,250           (163)           (5.0)%     
FDIC insurance premium      1,061           1,601           (540)           (33.7)%     
Other non-interest expense      6,665           5,918           747           12.6%     
  

 

 

    

 

 

    

 

 

    

 

 

 
Total non-interest expenses        $43,581             $44,480             $(899)             (2.0)%     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expenses decreased $899,000 or 2.0% to $43.6 million in 2011. Salaries and benefits expense decreased $417,000 or 1.9% due to the discontinuation of salaries and benefits for the insurance agency’s employees in 2011 partially offset by normal base salary increases and higher incentive compensation. FDIC insurance expense decreased $540,000 or 33.7% in 2011 compared with 2010 primarily due to the change implemented by the FDIC in the basis for calculating insurance premiums. Other non-interest expense increased $747,000 or 12.6% in 2011 compared with 2010 due primarily to the $555,000 write-down of vacant bank-owned property recorded in the third quarter of 2011.

 

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Our efficiency ratio was 70.3% in 2011 compared with 69.9% in 2010.

Income Tax Expense

Our effective tax rate (excluding the gain and related tax on the insurance agency transaction in 2010) was 25.3% in 2011 compared to 24.6% in 2010. The effective tax rate for 2010 excludes the $815,000 gain on the sale of the assets of the insurance agency and the related tax expense of $806,000 which result from a difference in the tax basis of such assets versus the book value

Comparison of Operating Results for the Years Ended December 31, 2010 and 2009

General

Net income was $11.6 million for the year ended December 31, 2010, compared with $11.4 million in 2009. Net income available to common shareholders was $11.6 million or $2.48 per diluted share in 2010, compared with $10.4 million or $2.24 per diluted share in 2009. Net income for 2009 included gains on sales of securities totaling $1.3 million after taxes or $0.29 per diluted share which offset non-recurring expenses of approximately $482,000 after taxes or $0.11 per diluted share. Preferred stock dividends and the accretion of the preferred stock discount were $1.1 million or $0.24 per diluted share in 2009.

Net Interest Income

Net interest income totaled $44.3 million in 2010, an increase of $908,000 or 2.1% compared with $43.4 million in 2009. The increase in net interest income resulted from growth in interest-earning assets. Average interest-earning assets increased $18.1 million in 2010 compared with 2009, with a $47.1 million increase in securities offsetting a $22.8 million decrease in loans and leases. The tax-equivalent net interest margin was 3.55% in 2010 and 2009. The tax-equivalent yield on interest-earning assets decreased 37 basis points in 2010 compared to 2009, which was offset by a 43 basis point decrease in our cost of interest-bearing liabilities over the same period. The tax-equivalent yield on our interest-earning assets was 4.78% in 2010 compared with 5.15% in 2009. Our cost of interest-bearing liabilities was 1.42% in 2010 compared to 1.85% in 2009.

The significant easing of monetary policy by the Federal Reserve since September 2007, along with volatility in equity markets, economic recession and federal government monetary and economic stimulus efforts, along with other factors have contributed to a sharp decline in the yields on U.S. Treasury securities. The low interest rate environment during this period resulted in declining yields for all of our interest-earning asset, consistent with much of the financial industry. Yields on our securities portfolio and on our commercial loans and consumer loans were most affected by the low interest rate environment. The tax-equivalent yield on our securities portfolio decreased 58 basis points in 2010 compared to 2009. The yield on our commercial loans and consumer (including indirect) loans decreased 26 basis points and 37 basis points, respectively, in 2010.

Changes in our asset mix also contributed to the decline in the interest-earning assets yield in 2010, as securities comprised a larger portion of our earning assets in 2010 as compared to 2009 due to difficulty in growing our loan portfolio as the result of the difficult economic and credit market conditions. The yields on the securities we hold are typically lower than the yields on our loans and leases. Securities comprised 29.8% of average interest-earning assets in 2010, compared with 26.6% in 2009.

The cost of our interest-bearing liabilities decreased in 2010 due to a combination of the low interest rate environment, our deposit pricing strategies and a favorable change in the mix of our interest-bearing liabilities, with lower-cost interest-bearing transaction accounts (savings, demand and money market) comprising a larger portion of our interest-bearing liabilities in 2010. The average balance of interest-bearing transaction accounts increased $85.9 million or 16.8% in 2010. The average cost of money market and time deposits dropped 35 basis points and 51 basis points, respectively in 2010.

Our liability mix changed favorably during 2010 as we continued to focus on increasing our transaction account balances and as we refrained from offering premium rates on time accounts. The aggregate average balance of transaction accounts (including non-interest bearing demand deposits) was $766.4 million in 2010, which was an increase of $97.4 million or 14.6% from the aggregate average balances of $669.0 million in 2009. Average transaction account balances comprised 68.1% of total average deposits in 2010, compared with 63.6% in 2009.

 

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Average time account balances in 2010 were $359.5 million or 31.9% of total average deposits in 2010, compared with $382.4 million or 36.4% in 2009.

Non-Interest Income

The following table sets forth certain information on non-interest income for the years indicated:

 

     Years ended December 31,  
     2010      2009      Change  
     (In thousands)         
Investment management income      $  7,316           $  7,134           $    182           2.6%     
Service charges on deposit accounts      4,509           5,037           (528)           (10.5)%     
Card-related fees      2,563           2,248           315           14.0%     
Insurance agency income      1,283           1,387           (104)           (7.5)%     
Income from bank-owned life insurance      1,058           1,014           44           4.3%     
Gain on sale of loans      1,394           748           646           86.4%     
Gains on sale of securities available-for-sale      308           2,168             (1,860)             (85.8)%     
Other non-interest income      2,074           1,075           999           92.9%     
  

 

 

    

 

 

    

 

 

    

 

 

 
Total non-interest income        $20,505             $20,811           $(306)           (1.5)%     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest income decreased $306,000 or 1.5% to $20.5 million in 2010. Service charges on deposit accounts decreased $528,000 or 10.5% primarily due to the impact of a new regulation covering overdraft protection programs, which took effect in the third quarter of 2010. Gains on sales of loans increased $646,000 or 86.4% as a result of a higher volume of residential mortgage sales in 2010. We sold a larger portion of our originations in 2010 in connection with our balance sheet management activities.

Gains on sales of investment securities decreased $1.9 million or 85.8% on a sharply lower volume of sales in 2010.

In December 2010, we sold substantially all of the assets of our insurance agency subsidiary, and discontinued its operations. A gain of $815,000 was recognized on the sale of the insurance agency and is included in other non-interest income. The gain was nearly entirely offset by taxes of $806,000 resulting from a difference in the tax basis of such assets versus the book value.

Non-interest income (excluding securities gains and the gain on the sale of the insurance agency) comprised 30.4% of total revenue in 2010 compared with 30.1% in 2009.

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:

 

     Years ended December 31  
     2010      2009      Change  
     (In thousands)         
Salaries and employee benefits      $22,319           $20,428           $1,891           9.3%     
Occupancy and equipment expenses      7,375           7,047           328           4.7%     
Communication expense      664           756           (92)           (12.2)%     
Office supplies and postage expense      1,158           1,337           (179)           (13.4)%     
Marketing expense      1,068           932           136           14.6%     
Amortization of intangible assets      1,127           1,453           (326)           (22.4)%     
Professional fees      3,250           2,893           357           12.3%     
FDIC insurance premium      1,601           2,284           (683)             (29.9)%     
Other non-interest expense      5,918           6,078           (160)           (2.6)%     
  

 

 

    

 

 

    

 

 

    

 

 

 
Total non-interest expenses        $44,480             $43,208             $1,272           2.9%     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expenses increased $1.3 million or 2.9% to $44.5 million in 2010. Salaries and benefits expense increased $1.9 million or 9.3% compared to 2009. Approximately $1.3 million or 67% of the increase in salaries and benefits represents incremental recurring expense from a combination of new customer service and business development positions and normal salary increases. As required under generally accepted accounting principles, the deferral of salaries and benefits expense in connection with successfully originated loans was approximately $317,000 or 17% of the increase in salaries and benefits in 2010 compared to the same period in 2009, due to substantially higher residential mortgage origination volume in 2009.

 

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Professional fees increased $357,000 or 12.3% in 2010 due primarily to outside consulting services related to various projects. The FDIC insurance premium decreased $683,000 or 29.9% in 2010 due to a special assessment required of all FDIC-insured banks in 2009. We paid a special assessment of $676,000 in the second quarter of 2009.

Our efficiency ratio was 69.9% in 2010 compared with 69.7% in 2009.

Income Tax Expense

Our effective tax rate (excluding the gain and related tax on the sale of the insurance agency) was 24.6% in 2010 and 23.1% in 2009.

Comparison of Financial Condition at December 31, 2011 and December 31, 2010

General

Total assets were $1.4 billion at December 31, 2011, a decrease of $45.5 million or 3.1% from December 31, 2010. Securities available-for-sale decreased $40.1 million in 2011 to $374.3 million at the end of 2011. Total loans and leases (net of unearned income) decreased $25.8 million to $872.7 million at December 31, 2011. The decrease in our loan and lease portfolio resulted from the planned and actively managed runoff of the lease portfolio and our decision to sell a large portion of our residential mortgage originations, which was substantially offset by strong commercial loan growth.

Securities

The securities portfolio is designed to provide a favorable total return utilizing low-risk, high-quality securities while at the same time assisting in meeting the liquidity needs of our loan and deposit operations, and supporting our interest rate risk objectives. Our securities portfolio is predominately comprised of investment grade mortgage-backed securities, securities issued by U.S. government sponsored corporations and municipal securities. We classify the majority of our securities as available-for-sale. We do not engage in securities trading or derivatives activities in carrying out our investment strategies.

The following table sets forth the amortized cost and market value for our available-for-sale securities portfolio:

 

     At December 31,  
     2011      2010      2009  
         Amortized    
Cost
     Fair
    Value    
         Amortized    
Cost
     Fair
    Value    
         Amortized    
Cost
     Fair
    Value    
 

Securities available for sale:

     (In thousands)   
Debt securities:                  
U.S. Treasury obligations      $        —           $        —           $        —           $        —           $      100           $      101     

Obligations of U.S. government-sponsored corporations

     3,134           3,190           4,020           4,186           5,864           6,129     

Obligations of states and political subdivisions

     77,541           82,299           77,246           78,212           75,104           77,147     

Mortgage-backed securities - residential

     279,393           285,706           324,294           329,010           273,499             275,680     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total debt securities      360,068           371,195           405,560           411,408           354,567           359,057     
Stock investments:                  
Equity securities      —           —           1,852           1,995           1,958           2,104     
Mutual funds      3,000           3,111           1,000           1,007           1,000           997     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total stock investments      3,000           3,111           2,852           3,002           2,958           3,101     
Total available for sale      363,068           374,306           408,412           414,410           357,525           362,158     

Net unrealized gains on available-for-sale securities

     11,238              5,998              4,633        
  

 

 

       

 

 

       

 

 

    
Total carrying value          $374,306                  $414,410                  $362,158        
  

 

 

       

 

 

       

 

 

    

We decreased the size of our securities portfolio in 2011 in order to manage our interest-rate risk, given the very low yields available for the types of shorter-duration, non-corporate securities in which we invest. Our securities

 

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portfolio totaled $374.3 million at December 31, 2011, compared with $414.4 million at December 31, 2010. Our portfolio is comprised entirely of investment grade securities, the majority of which are rated “AAA” by one or more of the nationally recognized rating agencies. The breakdown of our securities portfolio at December 31, 2011 was 76% government-sponsored entity guaranteed mortgage-backed securities, 22% municipal securities and 1% obligations of U.S. government sponsored corporations. Mortgage-backed securities, which totaled $285.7 million at December 31, 2011, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the U.S. government. Our municipal bond portfolio, which totaled $82.3 million at the end of 2011, is comprised primarily of general obligation bonds issued by local municipalities and school districts in New York State. We do not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. We also do not hold any preferred stock, corporate debt or trust preferred securities in our portfolio.

Net unrealized gains in our securities portfolio totaled $11.2 million at December 31, 2011, compared with net unrealized gains of $6.0 million at December 31, 2010.

The following table sets forth as of December 31, 2011, the maturities and the weighted-average yields of our debt securities, which have been calculated on the basis of the amortized cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis (in thousands):

 

     At December 31, 2011  
     Amount
Maturing
Within

     One Year    
or Less
     Amount
Maturing
After One
Year but
Within
    Five Years    
     Amount
Maturing
After Five
Years but
Within
    Ten Years    
     Amount
Maturing
    After Ten    
Years
     Total
    Amortized    

Cost
 
Obligations of U.S. government-sponsored corporations      $    3,134           $         —           $       —           $       —           $    3,134     
Obligations of states and political subdivisions      11,506           19,174           37,200           9,661           77,541     
Mortgage-backed securities      88,578           153,496           29,378           7,941           279,393     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total debt securities available-for-sale          $103,218               $172,670               $66,578               $17,602               $360,068     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Weighted average yield at year end (1)      2.94%           2.91%           3.96%           4.00%           3.16%     

 

(1)

Weighted average yields on the tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a marginal federal tax rate of 34%. These yields are an arithmetic computation of interest income divided by average balance and may differ from the yield to maturity, which considers the time value of money.

Loans and Leases

The loan and lease portfolio is the largest component of our interest-earning assets and it generates the largest portion of our interest income. We provide a full range of credit products through our branch network and through our commercial lending line of business. Consistent with our focus on providing community banking services, we generally do not attempt to diversify geographically by making a significant amount of loans to borrowers outside of our primary service area. Loans are primarily internally generated and the majority of our lending activity takes place in the New York State counties of Cortland, Madison, Onondaga, Oneida, Oswego and nearby counties. In addition, we originate indirect auto loans in the western counties of New York State. In connection with our ongoing strategic planning and balance sheet management processes, Alliance Leasing, Inc. ceased origination of new transactions in the third quarter of 2008. The operations of Alliance Leasing are currently limited to servicing the existing lease portfolio.

Total loans and leases, net of unearned income and deferred costs, were $872.7 million at December 31, 2011, compared with $898.5 million at December 31, 2010.

Residential mortgages totaled $316.8 million at the end of 2011, which was a decrease of $18.1 million or 5.4% from the end of 2010. We originated $107.5 million of residential mortgages in 2011, compared to $119.7 million in 2010. Our portfolio declined in 2011 as we sold a large portion of our originations on the secondary market in order to manage our overall interest rate risk position. Sales of residential mortgages totaled $59.6 million in 2011, compared with $66.2 million in 2010. In the first quarter of 2012 we changed our strategy as it relates to residential mortgages and will retain most fixed rate mortgages with terms of 15 years or less in portfolio for the foreseeable

 

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future. Fixed rate, monthly-payment mortgages with terms greater than 15 years will still be sold in the secondary market. Substantially all our residential mortgage originations are conventional mortgages originated in our market area. We do not originate sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages.

Commercial loans and mortgages increased $28.4 million or 11.4% in 2011 with approximately 70% of the growth resulting from new loans net of portfolio amortization, and the remainder from increased utilization on existing commercial lines of credit. Commercial loan and mortgage originations (excluding lines of credit) for 2011 totaled $75.9 million, compared to 2010’s originations of $80.4 million.

Our lease portfolio (net of unearned income) continued to amortize in 2011 as a result of our previously announced decision to cease new lease originations. Leases decreased $16.8 million or 39.6% in 2011 to $25.6 million at the end of the year. Leases are expected to continue to amortize down at a similar rate in 2012.

Indirect auto loan balances decreased $17.3 million or 9.8% in 2011 due largely to intense rate driven competition. We originated $68.8 million of indirect auto loans in 2011, compared with $79.5 million in 2010. We adjusted our indirect auto rates down in January 2012 with the goal of modestly growing our indirect loan portfolio in 2012. We originate auto loans through a network of reputable, well-established automobile dealers located in central and western New York. Applications received through our indirect lending program are subject to the same comprehensive underwriting criteria and procedures as are employed in its direct lending programs. Credit quality metrics within this portfolio remain stable and compare favorably to the industry.

The following table sets forth the composition of our loan and lease portfolio at the dates indicated:

 

     At December 31,  
     2011      2010      2009      2008      2007  
     Amount      Percent      Amount      Percent      Amount      Percent      Amount      Percent      Amount      Percent  
     (Dollars in thousands)  
Residential real estate      $316,823           36.4%           $334,967           37.4%           $356,906           39.2%           $314,039           34.6%           $273,465           30.6%     
Commercial loans      151,420           17.4%           133,787           14.9%           111,243           12.2%           118,756           13.1%           121,204           13.6%     
Commercial real estate      126,863           14.6%           116,066           13.0%           96,753           10.7%           95,559           10.5%           95,932           10.8%     

Leases, net of unearned income

     25,636           3.0%           42,466           4.8%           68,224           7.5%           104,655           11.6%           131,300           14.7%     
Indirect auto loans      158,813           18.3%           176,125           19.7%           184,947           20.3%           182,807           20.2%           176,115           19.7%     
Other consumer loans      89,776           10.3%           91,619           10.2%           92,022           10.1%           90,906           10.0%           94,246           10.6%     
  

 

 

 
     869,331             100.0%           895,030             100.0%           910,095             100.0%           906,722             100.0%           892,262             100.0%     
     

 

 

       

 

 

       

 

 

       

 

 

       

 

 

 
Net deferred loan costs      3,390              3,507              4,067              4,033              3,271        
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

    
Total loans and leases      872,721              898,537              914,162              910,755              895,533        

Allowance for credit losses and lease losses

     (10,769)              (10,683)              (9,414)              (9,161)              (8,426)        
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

    
Net loans and leases          $861,952                  $887,854                  $904,748                  $901,594                  $887,107        
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

    

The following table shows the amount of loans and leases outstanding as of December 31, 2011, which, based on remaining scheduled payments of principal, are due in the periods indicated:

 

     Maturing within
one year  or less
     Maturing
after one but
within five years
     Maturing after
five but
within ten years
     Maturing
after
ten years
     Total  
     (In thousands)  
Residential real estate      $  13,363           $  57,203           $  73,276           $172,981           $316,823     
Commercial loans and commercial real estate      66,614           114,825           51,444           45,400           278,283     
Leases, net of unearned income      9,859           11,136           4,641           —           25,636     
Indirect auto loans      50,511           106,325           1,684           293           158,813     
Other consumer loans      21,104           42,598           22,408           3,666           89,776     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and leases, net of unearned income

                 $161,451                       $332,087                       $153,453               $222,340             $869,331     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the sensitivity to changes in interest rates as of December 31, 2011:

 

         Fixed Rate              Variable Rate          Total  
     (In thousands)  

Due after one year, but within five years

     $224,105           $107,982                       $332,087     

Due after five years

     266,652           109,141           375,793     

 

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Asset Quality and the Allowance for Credit Losses

The following table summarizes delinquent loans and leases grouped by the number of days delinquent at the dates indicated:

 

Delinquent loans and leases

   December 31, 2011      December 31, 2010  
    

$

    

%(1)

    

$

    

%(1)

 
     (Dollars in thousands)  

30 days past due

     $  5,202           0.60%           $  6,711           0.75%     

60 days past due

     584           0.06%           1,083           0.12%     

90 days past due and still accruing

     —           —           19           —  %     

Non-accrual

     11,287           1.30%           8,474           0.95%     
  

 

 

    

 

 

 

Total

             $17,073           1.96%               $16,287           1.82%     
  

 

 

    

 

 

 

(1) As a percentage of total loans and leases, excluding deferred costs

The following table represents information concerning the aggregate amount of nonperforming assets:

 

     December 31,  
     2011      2010      2009      2008      2007  
     (In thousands)  
Non-accrual loans and leases:               

Residential real estate

     $  3,062           $  3,543           $2,843           $1,506           $1,118     

Commercial loans and commercial real estate

     7,452           3,296           4,013           1,997           4,988     

Leases

     107           697           1,418           595           320     

Indirect auto

     293           212           109           101           83     

Consumer

     373           726           199           153           158     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total non-accrual loans and leases      11,287           8,474           8,582           4,352           6,667     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Accruing loans and leases past due 90 days or more      —           19           —           126           39     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total nonperforming loans      11,287           8,493           8,582           4,478           6,706     

Other real estate owned and other repossessed assets

     485           652           445           657           229     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total nonperforming assets          $11,772               $9,145               $9,027               $5,135               $6,935     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Restructured loans not included in above      $  1,653           $1,131           $   110           $    —           $    —     

Total nonperforming loans and leases to total loans and leases

     1.30%           0.95%           0.94%           0.49%           0.75%     
Total nonperforming assets to total assets      0.84%           0.63%           0.64%           0.38%           0.53%     

Allowance for credit losses to nonperforming loans and leases

     95.4%           125.8%           109.7%           204.6%           125.7%     
Allowance for credit losses to total loans and leases      1.24%           1.19%           1.03%           1.01%           0.94%     

Delinquent loans and leases (including nonperforming) totaled $17.1 million at December 31, 2011, compared to $16.3 million at the end of 2010. Nonperforming assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and other repossessed assets were $11.8 million or 0.84% of total assets at December 31, 2011, compared to $9.1 million or 0.63% of total assets at the end of 2010. Included in nonperforming assets at the end of 2011 were nonperforming loans and leases totaling $11.3 million, compared with $8.5 million at the end of 2010. Conventional residential mortgages comprised $3.1 million (48 loans) or 27.1% of nonperforming loans and leases at December 31, 2011. Nonperforming commercial loans and mortgages totaled $7.5 million (38 loans) or 66.0% of nonperforming loans and leases and leases on nonperforming status totaled $107,000 (5 leases) or 0.9% of nonperforming loans and leases at the end of 2011.

As disclosed in our Quarterly Report on Form 10-Q for the period ended September 30, 2011, one commercial relationship totaling $3.6 million was placed on nonperforming status during the third quarter. The relationship is comprised of a $3.0 million secured working capital line of credit and two first mortgages totaling $641,000. The line of credit is secured by receivables of the business and is also collateralized by second lien positions on the real estate securing the two mortgages. During the fourth quarter, the borrower’s business continued to weaken, which led to an increase in our impairment allowance on this relationship by $400,000 to $2.1 million, of which $1.0 million was charged off in the fourth quarter. Our exposure to this borrower, net of the write-down recorded in the fourth quarter and included in nonperforming assets, was $2.6 million at December 31, 2011, and the impairment allowance remaining on this net exposure was $1.1 million at the end of the fourth quarter. The impairment allowance is based on our current estimate of the collectability of receivables, the amount and priority of the borrower’s liabilities and on recently appraised values of the real estate collateral. The impairment allowance may

 

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need to be increased in coming quarters if the borrowers business deteriorates further or if circumstances require negative adjustments to our assumptions as to the collectability of receivables, the amount and priority of the borrower’s liabilities and/or the value of the real estate.

The economy in our market area is a relatively stable, slow growth economy, with few conditions that give rise to boom and bust cycles. The housing market generally does not exhibit significant volatility and is not significantly impacted by speculative influences. These external factors, combined with our disciplined credit culture and consistently sound underwriting guidelines, are the primary reasons that our levels of delinquent loans and nonperforming assets have remained relatively low in recent years despite significant industry-wide asset quality issues.

As a recurring part of our portfolio management program, we have identified approximately $10.2 million in potential problem loans at December 31, 2011, as compared to $16.6 million at December 31, 2010. The average balance of identified potential problem loans was $237,000 and $339,000 at December 31, 2011 and December 31, 2010, respectively. Potential problem loans are loans that are currently performing, but where the borrower’s operating performance or other relevant factors could result in potential credit problems, and are classified by our loan rating system as “substandard.” At December 31, 2011, potential problem loans primarily consisted of commercial loans and leases and commercial real estate. There can be no assurance that additional loans will not become nonperforming, require restructuring, or require increased provision for loan losses.

We have a loan and lease monitoring program that evaluates nonperforming loans and leases and the loan and lease portfolio in general. The loan and lease review program continually audits the loan and lease portfolio to confirm management’s loan and lease risk rating system, and systematically tracks such problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses.

Our policy is to place a loan or lease on non-accrual status and recognize income on a cash basis when a loan or lease is more than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The impact of interest not recognized on non-accrual loans and leases was $301,000 in 2011, $277,000 in 2010, and $342,000 in 2009. We consider a loan or lease impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan or lease agreement.

The allowance for credit losses represents management’s best estimate of probable incurred losses in our loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease portfolio segment. Our portfolio segments are as follows: commercial loan and commercial real estate loans, commercial leases, residential real estate, indirect consumer loans and other consumer loans. Our allowance for credit losses consists of specific valuation allowances based on probable credit losses on specific loans, historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends and general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the organization.

Historical valuation allowances are calculated for commercial loans and leases based on the historical loss experience of specific types of loans and leases and the internal risk grade 24 months prior to the time they were charged off. The internal credit risk grading process evaluates, among other things, the borrower’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. Historical valuation allowances for residential real estate and consumer loan segments are based on the average loss rates for each class of loans for the time period that includes the current year and two full prior years. We calculate historical loss ratios for pools of similar consumer loans based upon the product of the historical loss ratio and the principal balance of the loans in the pool. Historical loss ratios are updated quarterly based on actual loss experience. Our general valuation allowances are based on general economic conditions and other qualitative risk factors which affect our company. Factors considered include trends in our delinquency rates, macro-economic and credit market conditions, changes in asset quality, changes in loan and lease portfolio volumes, concentrations of credit risk, the changes in internal loan policies, procedures and internal controls, experience and effectiveness of lending personnel. Management evaluates the degree of risk that each one of these components has on the quality of the loan and lease portfolio on a quarterly basis.

 

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Table of Contents

For commercial loan and lease segments, we maintain a specific allocation methodology for those classified in our internal risk grading system as substandard, doubtful or loss with a principal balance in excess of $200,000. A loan or lease is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on the estimated fair value of the collateral. Loans with modified terms in which a concession to the borrower has been made that it would not otherwise consider unless the borrower was experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. As of December 31, 2011, there was $9.1 million in impaired loans for which $2.1 million in related allowance for credit losses was allocated. There was $3.9 million in impaired loans for which $421,000 in related allowance for credit losses was allocated as of December 31, 2010.

Loans and leases are charged against the allowance for credit losses, in accordance with our loan and lease policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for probable incurred losses, a direct charge to operating income is recorded.

The following table summarizes changes in the allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense.

 

     Years ended December 31,  
           2011                  2010                  2009                  2008                  2007        
     (In thousands)  
Balance at beginning of year      $10,683           $9,414           $9,161           $8,426           $7,029     
Loans and leases charged-off:               

Residential real estate

     224           322           76           276           103     

Commercial loans and commercial real estate

     1,268           634           1,622           1,940           545     

Leases

     343           1,345           4,122           1,844           881     

Indirect auto

     326           251           317           295           211     

Consumer

     1,010           1,055           1,135           1,284           1,487     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total loans and leases charged off      3,171           3,607           7,272           5,639           3,227     
Recoveries of loans and leases previously charged off:               

Residential real estate

     45           54           59           32           1     

Commercial loans and commercial real estate

     137           34           514           113           48     

Leases

     455           81           165           40           13     

Indirect auto

     192           133           133           91           119     

Consumer

     518           489           554           596           653     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total recoveries      1,347           791           1,425           872           834     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Net loans and leases charged off      1,824           2,816           5,847           4,767           2,393     
Provision for credit losses      1,910           4,085           6,100           5,502           3,790     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Balance at end of year      $10,769           $10,683           $9,414           $9,161           $8,426     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The provision for credit losses decreased 53.2% in 2011 compared to 2010 due primarily to a 35.2% decrease in net charge-offs in 2011 and to relatively low and stable delinquencies. The provision expense was $1.9 million in 2011 compared to $4.1 million in 2010.

Net charge-offs totaled $1.8 million in 2011 compared to $2.8 million in 2010. The decrease in net charge-offs was largely the result of a 74.5% drop in lease charge-offs in 2011 compared to 2010, and a 462% increase in 2011 in recoveries of previously charged-off leases resulting from our ongoing collection efforts. Net recoveries of leases totaled $112,000 in 2011, compared to net charge-offs of $1.3 million in 2010. Net charge-offs in our commercial portfolio increased $530,000 or 89% in 2011 compared to 2010, largely due to the write-down on the $3.6 million impaired credit discussed previously in this report.

Total net charge-offs equaled 0.21% of average loans and leases in 2011, compared to 0.31% in 2010. The provision for credit losses as a percentage of net charge-offs was 105% in 2011, compared to 145% in 2010. The allowance for credit losses was $10.8 million at December 31, 2011, compared with $10.7 million at the end of 2010. The ratio of the allowance for credit losses to total loans and leases was 1.24% at December 31, 2011, compared with 1.19% at December 31, 2010. The ratio of the allowance for credit losses to nonperforming loans and leases was 95% at December 31, 2011, compared with 126% at the end of 2010.

 

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The portion of the allowance for credit losses that is based on loans and leases that are evaluated individually for impairment increased $1.7 million or 398% at December 31, 2011 compared to the end of 2010 due primarily to the classification of the $2.6 million commercial relationship as impaired in the third quarter of 2011. Conversely, the portion of the allowance for credit losses that is based on loans and leases evaluated collectively for impairment decreased $1.7 million or 18% over the same period. This decrease was due to a sharp decline in charge-offs in our lease portfolio in 2011 compared to 2010 and 2009 and to a $16.8 million decrease in the balance of our lease portfolio in 2011, which resulted in a reduced collective impairment allowance allocation for this portfolio totaling $1.1 million along with a reduction of $476,000 of allowance out of the collective impairment evaluation category in the third quarter related to the above-mentioned $2.6 million impaired relationship. The $1.1 million reduction in the allowance allocated to our lease portfolio was effectively re-allocated primarily to commercial loans that were placed on non-accrual status in 2011, which is the primary reason that the allowance for credit losses as a percentage of non-performing loans decreased in 2011.

As discussed above, we assess a number of quantitative and qualitative factors at the individual portfolio level in determining the adequacy of the allowance for credit losses each quarter. In addition, we analyze certain broader, non-portfolio specific factors in assessing the adequacy of the allowance for credit losses, such as the allowance as a percentage of total loans and leases, the allowance as a percentage of nonperforming loans and leases and the provision expense as a percentage of net charge-offs. As our asset quality metrics and net charge-off levels have improved in recent quarters, an increasing portion of the allowance for credit losses has been considered “unallocated,” which means it is not based on either quantitative or qualitative factors but on the broader, non-portfolio specific factors. At December 31, 2011, $991,000 or 9.2% of the allowance for credit losses was considered to be “unallocated,” compared to $874,000 or 8.2% of the allowance at December 31, 2010. We consider the current “unallocated” amount to be at or near a maximum level and, absent any material deterioration in credit quality from recent trends, or material growth in the loan and lease portfolio, some portion of this “unallocated” allowance may be reduced by future credit losses, which would have the effect of lowering the amount of provision expense relative to net charge-offs compared to recent quarters (e.g. less than dollar-for-dollar).

The allowance for credit losses has been allocated within the following categories of loans and leases at the dates indicated with the corresponding percent of loans to total loans for each category (dollars in thousands):

 

     At December 31,  
     2011      2010      2009      2008      2007  
    

Amount

of

  Allowance  

    

  Percent  

of

Loans

to

Total

Loans

    

Amount

of

  Allowance  

    

  Percent  

of

Loans

to

Total

Loans

    

Amount

of

  Allowance  

    

  Percent  

of

Loans

to

Total

Loans

    

Amount

of

  Allowance  

    

  Percent  

of

Loans

to

Total

Loans

    

Amount

of

  Allowance  

    

  Percent  

of

Loans

to

Total

Loans

 
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Residential real estate      $     750         36.4%           $    946         37.4%           $   891         39.2%           $   850         34.6%           $   978         30.6%     
Commercial(1)      6,994         32.0%           5,568         27.9%           3,771         22.9%           3,988         23.6%           4,097         24.4%     
Leases      503         3.0%           1,583         4.8%           2,212         7.5%           2,673         11.6%           1,951         14.7%     
Indirect auto      784         18.3%           933         19.7%           973         20.3%           879         20.2%           685         19.7%     
Consumer      747         10.3%           779         10.2%           818         10.1%           771         10.0%           715         10.6%     
Unallocated      991         —%           874         —%           749         —%                   —                   —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total            $10,769         100.0%                 $10,683         100.0%                 $9,414         100.0%                 $9,161         100.0%                 $8,426         100.0%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

(1) includes commercial real estate loans

The allowance for credit losses is allocated according to the amount deemed to be reasonably necessary to provide for the probable incurred losses within each category of loans and leases. Increases in the amount allocated to the commercial and lease portfolios reflect the higher outstanding balances of these portfolios coupled with the higher inherent risk of these portfolios compared with residential and consumer lending.

 

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Deposits

Our primary source of funds is deposits, consisting of demand, savings, money market and time accounts, of retail, commercial and municipal customers gathered through our branch network. We continuously monitor market pricing, competitors’ rates, and internal interest rate spreads to maintain and promote growth and profitability.

The following table sets forth the composition of our deposits by business line at year-end (dollars in thousands):

 

     December 31, 2011  
         Retail              Commercial              Municipal              Total              Percent      
Non-interest checking              $  46,580           $135,252               $    3,904               $    185,736               17.1%     
Interest checking      110,886           16,831           18,168           145,885           13.5%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total checking      157,466           152,083           22,072           331,621           30.6%     
Savings      92,240           11,367           3,704           107,311           9.9%     
Money market      88,056           122,195           119,749           330,000           30.5%     
Time deposits      237,929           26,907           49,297           314,133           29.0%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total deposits      $575,691           $312,552           $194,822           $1,083,065           100.0%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2010  
         Retail              Commercial              Municipal              Total              Percent      
Non-interest checking      $  41,962           $133,979           $    3,977           $    179,918           15.9%     
Interest checking      109,682           12,906           29,306           151,894           13.3%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total checking      151,644           146,885           33,283           331,812           29.2%     
Savings      88,785           11,646           2,668           103,099           9.1%     
Money market      88,870           109,282           159,733           357,885           31.5%     
Time deposits      257,489           23,677           60,636           341,802           30.2%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Total deposits      $586,788           $291,490           $256,320           $1,134,598           100.0%     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total deposits were $1.1 billion at December 31, 2011, which was a decrease of $51.5 million or 4.5% compared with December 31, 2010. Municipal deposits decreased $61.5 million in 2011, following an increase of $52.5 million in 2010, reflecting typical fluctuations of large balance municipal accounts. The deposit growth we experienced in 2009 and 2010 abated in 2011, due to low deposit account rates and a general decline in the flight to safety which drove banking industry deposits substantially higher over the past three years. Our deposit mix at the end of the year continued to be weighted heavily in lower cost demand, savings and money market accounts (transaction accounts). Transaction accounts totaled $768.9 million or 71.0% of total deposits at the end of 2011, compared to $792.8 million or 69.9% at the end of 2010, as a decline in municipal money market accounts offset growth in retail and commercial transaction account balances. Our ability to gather and retain transaction deposits over the past three years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of Alliance’s brand. Environmental factors such as equity market volatility and risk aversion among retail investors, and the buildup of cash on corporate balance sheets have also played a role in the growth in our transaction accounts.

Time deposits in excess of $100,000, which tend to be more volatile and sensitive to interest rates, totaled $123.4 million at December 31, 2011, representing 39.3% of total time deposits and 11.4% of total deposits. These deposits totaled $137.0 million, representing 40.0% of total time deposits and 12.1% of total deposits at year-end 2010.

The following table schedules the amount of our time deposits of $100,000 or more by time remaining until maturity as of December 31, 2011 (in thousands):

 

Less than three months              $  32,792     
Three months to six months      23,779     
Six months to one year      37,665     
Over one year      29,159     
  

 

 

 
Total              $123,395     
  

 

 

 

 

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Borrowings

We offer retail repurchase agreements primarily to our larger business customers. Under the terms of the agreements, we sell investment portfolio securities to the customer and agree to repurchase the securities on the next business day. We use this arrangement as a deposit alternative for our business customers. As of December 31, 2011, retail repurchase agreement balances amounted to $26.3 million compared to balances of $25.8 million at December 31, 2010.

During 2011, we utilized collateralized repurchase agreements with various brokers and advances from the Federal Home Loan Bank of New York (FHLB) as alternative sources of funding and as a liability management tool. At December 31, 2011, the combination of repurchase agreements and FHLB advances was $110.0 million, compared with $117.0 million at December 31, 2010. Detailed information regarding our borrowings is included in Note 7 in the consolidated financial statements contained elsewhere in this report.

Total borrowings decreased $6.5 million or 4.5% in 2011 as we used our net cash inflows from securities and loan and lease amortization to pay down borrowings maturing during the year.

Capital

We use certain non-GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. We believe TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a company’s financial condition and capital strength. TCE, as defined by us, represents common equity less goodwill and intangible assets. A reconciliation from the our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio is presented below:

 

(in thousands)     December 31, 2011     
Total assets     $1,409,090     
Less: Goodwill and intangible assets, net     38,538     
 

 

 

 
Tangible assets (non-GAAP)     1,370,552     
Total Common Equity     143,997     
Less: Goodwill and intangible assets, net     38,538     
 

 

 

 
Tangible Common Equity (non-GAAP)     105,459     
Total Equity/Total Assets     10.22%     
Tangible Common Equity/Tangible Assets (non-GAAP)     7.69%     

Shareholders’ equity was $144.0 million at December 31, 2011, compared with $133.1 million at December 31, 2010. Net income for 2011 increased shareholders’ equity by $13.3 million and was partially offset by common stock dividends declared of $5.8 million or $1.22 per common share. Common stock and paid-in surplus increased $1.6 million in 2011, on the exercise of employee stock options, purchases of our common stock under our Directors’ Stock-Based Deferral Plan and amortization of unvested restricted stock grants. Accumulated other comprehensive income increased $2.2 million due to a $3.2 million increase in unrealized securities gain, net of tax, partially offset by a $1.0 million increase in the unrecognized loss for benefit obligations, net of tax which resulted from a lower discount rate used to calculate our benefit obligations because of lower market interest rates.

Our consolidated Tier 1 leverage ratio was 9.09% and our consolidated total risk-based capital ratio was 15.97% at the end of 2011, both of which exceeded regulatory minimum thresholds for capital adequacy purposes. Our tangible common equity capital ratio was 7.69% at the end of 2011.

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to

 

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ensure capital adequacy require Alliance and the Bank to maintain minimum amounts and ratios, as defined in the regulations, of total and risk-based capital, Tier 1 capital to risk-weighted assets and of Tier 1 Capital to average assets.

As of December 31, 2011, the most recent notification from the OCC categorized the Bank as “well capitalized,” under the regulatory framework for prompt corrective action. Management believes that, as of December 31, 2011, Alliance and the Bank met all capital adequacy requirements to which they were subject. A more comprehensive analysis of regulatory capital requirements, including ratios for Alliance and the Bank, is included in Note 18 of the consolidated financial statements contained elsewhere in this report.

Liquidity and Capital Resources

Our liquidity is primarily measured by our ability to provide funds to meet loan requests, to accommodate possible outflows of deposits, and to take advantage of market interest rate opportunities. Funding of loan commitments, providing for liability outflows, and management of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and investments with specific types of deposits and borrowings. Liquidity is normally considered in terms of the nature and mix of our sources and uses of funds. Our Asset Liability Management Committee (ALCO) is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. Management believes, as of December 31, 2011, that our liquidity measurements are in compliance with our policy guidelines.

Our principal sources of funds for operations are cash flows generated from earnings, deposits, securities, loan and lease repayments, borrowings from the FHLB, and securities sold under repurchase agreements. During the year ended December 31, 2011, cash and cash equivalents increased by $20.3 million, as net cash provided by operating and investing activities of $83.8 million was partially offset by net cash used in financing activities of $63.5 million. Net cash provided by operating activities was primarily provided by net income of $13.3 million. Net cash provided by investing activities primarily resulted from securities sales, maturities and principal repayments exceeding securities purchases by $41.4 million combined with a net decrease in loans and leases of $22.8 million. Net cash used in financing activities primarily resulted from a net decrease in deposits of $51.5 million, $6.5 million in net repayments on borrowings and $5.8 million in cash dividends paid to common shareholders.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of December 31, 2011, the Bank’s credit limit with the FHLB was $287.5 million with outstanding borrowings in the amount of $110.0 million.

The Bank had a $132.9 million line of credit at December 31, 2011 with the Federal Reserve Bank of New York through its Discount Window, and has pledged as collateral indirect auto loans and securities totaling $158.6 million and $4.9 million, respectively, at December 31, 2011. We did not dra