EX-13 12 ex13.txt EXHIBIT 13 Exhibit 13 TRUSTCO Bank Corp NY Annual Report 2005 [LOGO] TRUSTCO Bank Corp NY TrustCo Bank Corp NY is a savings and loan holding company headquartered in Glenville, New York. The Company is the largest financial services company headquartered in the Capital Region of New York State. The Company's principal subsidiary, Trustco Bank, operates 83 community banking offices and 81 Automatic Teller Machines throughout the Bank's market area. The Company serves four states and 18 counties with a broad range of community banking services. Financial Highlights
(dollars in thousands, except per share data) Years ended December 31, Percent 2005 2004 Change Income: Net interest income (Taxable Equivalent)...................................... $ 107,948 105,024 2.78% Net income.................................................................... 58,989 56,540 4.33 Per Share: Basic earnings................................................................ .787 .761 3.42 Diluted earnings.............................................................. .782 .753 3.85 Tangible book value........................................................... 3.05 3.02 0.99 Average Balances: Assets........................................................................ 2,844,974 2,828,195 0.59 Loans, net.................................................................... 1,336,899 1,176,856 13.60 Deposits...................................................................... 2,505,967 2,474,179 1.28 Shareholders' equity.......................................................... 226,571 223,719 1.27 Financial Ratios: Return on average assets...................................................... 2.07% 2.00 3.50 Return on average equity (1).................................................. 26.07 26.65 (2.18) Consolidated tier 1 capital to: Total average assets (leverage)............................................. 8.04 7.74 3.88 Risk-adjusted assets........................................................ 16.58 17.09 (2.98) Total capital to risk-adjusted assets......................................... 17.85 18.37 (2.83) Net loans charged off (recovered) to average loans............................ (.17) (.02) 750.00 Allowance for loan losses to nonperforming loans.............................. 14.1x 15.6x (9.62) Efficiency ratio.............................................................. 38.29% 38.78 1.26 Dividend payout ratio......................................................... 77.46 78.83 (1.74)
Per share information of common stock
Tangible Range of Stock Basic Diluted Cash Book Price Earnings Earnings Dividend Value High Low 2004 First quarter.......................................... $ .191 .188 .150 3.15 14.00 12.64 Second quarter......................................... .193 .191 .150 2.89 13.79 11.87 Third quarter.......................................... .205 .203 .150 3.02 13.21 12.17 Fourth quarter......................................... .172 .171 .150 3.02 14.18 12.80 2005 First quarter.......................................... .199 .197 .150 2.99 13.87 11.20 Second quarter......................................... .200 .199 .150 3.12 13.25 10.73 Third quarter.......................................... .210 .208 .150 3.07 13.66 12.15 Fourth quarter......................................... .179 .178 .160 3.05 13.47 11.40 (1) Excludes the market adjustment on securities available for sale.
1 [GRAPHIC - MAP] 2 [LOGO] TRUSTCO Bank Corp NY Table of Contents Financial Highlights..................................................... 1 President's Message...................................................... 4 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 6 Average Balances, Yields and Net Interest Margins.............................................. 13 Glossary of Terms....................................................... 26 Management's Report on Internal Control Over Financial Reporting.............................................. 27 Reports of Independent Registered Public Accounting Firm............. 28-29 Consolidated Financial Statements and Notes............................. 30 Branch Locations..................................................... 48-49 Officers and Board of Directors......................................... 50 General Information..................................................... 51 TrustCo Mission Statement: TrustCo will be the low cost provider of high quality services to our customers in the communities we serve and return to our owners an above average return on their investment. 3 [LOGO] TRUSTCO Bank Corp NY President's Message Dear Shareholder: We are pleased to report that 2005 marked another year of record results at TrustCo. Our net income reached a new all-time high and we continued to grow our branch network. We are grateful to our shareholders, board of directors, and employees for their support and enthusiasm, ensuring our continued strong performance. TrustCo's branch office expansion continues. We have now opened twenty-three offices in new markets since announcing our growth plans. These openings have been concentrated in downstate New York and Florida. We currently have fourteen offices in Florida, nine in downstate New York and recently celebrated the simultaneous grand openings of four locations. This brings our total branch offices to 83. We plan an aggressive branch expansion program in both of these markets along with a continued evaluation of opportunities in the upstate New York region. The excellent reception we have received at our new offices gives us confidence that our expansion into these areas positions TrustCo very well for the future. During 2005, we made an offer to purchase Ballston Spa Bancorp, Inc., which was rejected. We continue to evaluate acquisition opportunities as they arise, careful to avoid diluting shareholder value of the existing TrustCo franchise. TrustCo continues to receive positive external recognition in the financial industry. In a recent Barron's article (a leading financial publication), our Company has been recognized as one of the top companies maintaining over ten straight years of uninterrupted growth in earnings per share. During 2005, the board of directors approved a 7% increase to our quarterly cash dividend. Our total annual dividend is now $0.64 resulting in a 5.1% annual yield based on 2005's average stock price. It continues to be our philosophy to return excess capital to shareholders in the form of dividends. We also believe that it is prudent to retain sufficient capital to support our growth goals and to remain well-capitalized for regulatory purposes. Despite a difficult overall banking environment, given the flattening interest rate yield curve, TrustCo's operating results nonetheless continued in the right direction in 2005 with net income increasing to $59 million. TrustCo's most important ratio, return on average equity, was 26.07% for 2005. We are committed to ensuring that our return on average equity compares favorably with any peer group. In 2005, TrustCo showed impressive growth in its loan portfolio. Loans grew by $230.7 million, a strong 18.6% compared to 2004. The majority of this growth occurred in our residential mortgage portfolio. Customers in our new markets have commented that our competitive rates, combined with a simple application process and great customer service, make Trustco Bank an outstanding choice when purchasing or refinancing their home. 4 [LOGO] TRUSTCO Bank Corp NY President's Message (continued) Two members were added to the Board of Directors in 2005. The addition of Thomas O. Maggs, President of Maggs & Associates and myself brings the total number of directors to seven. There were also a number of other senior staff changes during the year. Eric W. Schreck was elevated to Administrative Vice President and Paul D. Matthews was named Vice President. Our future should continue to benefit from the solid performance of the employee team at TrustCo, which has always been a hallmark of our success. For 2005, the often quoted efficiency ratio of our Company was 38.3% at a time when many banking companies struggle to reach 60.0%. This level of performance in efficiency will benefit us through reduced operating expenses for years to come. Community needs continue to expand and TrustCo has responded. We established, in 2005, a new charitable entity called the Trustco Charitable Foundation, and through our Winter Warmth Fund, TrustCo was able to help hundreds of families with heating assistance during the winter months. TrustCo also increased its overall charitable contributions in 2005, and our employees donated thousands of hours of community services in all of the areas we serve. We are very proud of our results last year. As we look forward to 2006, a difficult year is expected. In 2005, we made several moves resulting in one-time gains. These included securities transactions, and the sale of our Trust Building, Canajoharie office, and credit card portfolio. In all likelihood, events of this nature will not be repeated in 2006. The second item we are concerned over is the difficult rate environment all banks are facing. The previously referenced flat/inverted yield curve has resulted in tight loan and deposit pricing. This causes margin pressure and stress on net income. We should rest assured our Company is well positioned for these difficulties. The plans we have in place, combined with our hawkish approach to expense control, will see us through these times. On behalf of the board of directors and employees of our Bank, we thank our shareholders for their continued support. We are proud of the 2005 results and look forward to seeing our Company through a challenging 2006. Sincerely, /s/ Robert J. McCormick Robert J. McCormick President & Chief Executive Officer TrustCo Bank Corp NY 5 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis of Financial Condition and Results of Operations The financial review which follows will focus on the factors affecting the financial condition and results of operations of TrustCo Bank Corp NY (the Company", "TrustCo" or the "Bank"), during 2005 and, in summary form, the two preceding years. Net interest income and net interest margin are presented in this discussion on a taxable equivalent basis. Balances discussed are daily averages unless otherwise described. The consolidated financial statements and related notes and the quarterly reports to shareholders for 2005 should be read in conjunction with this review. Certain amounts in years prior to 2005 have been reclassified to conform with the 2005 presentation. Overview TrustCo recorded net income of $59.0 million or $0.782 of diluted earnings per share for the year ended December 31, 2005, compared to $56.5 million or $0.753 of diluted earnings per share for the year ended December 31, 2004. This represents an increase of 4.3% in net income between 2004 and 2005. During 2005, the following had a significant effect on net income: o an increase of $2.9 million in taxable equivalent net interest income compared to 2004, as a result of an increase in the average balance of interest earning assets of $37.9 million coupled with an increase of five basis points ("bp") in the net interest margin, o a reduction in the provision for loan losses from $450,000 expense in 2004 to $6.3 million credit in 2005 and, o the recognition of net securities gains of $6.0 million in 2005 compared to $13.7 million recorded in 2004. Return on Equity 2003 26.21% 2004 26.65% 2005 26.07% MIX OF AVERAGE EARNING ASSETS
(dollars in thousands) 2005 2004 Components of vs. vs. Total Earning Assets 2005 2004 2003 2004 2003 2005 2004 2003 Loans, net of unearned income..... $1,336,899 1,176,856 1,275,023 160,043 (98,167) 48.3% 43.1% 48.9 Securities available for sale: U.S. Treasuries and agencies.... 1,059 634 2,930 425 (2,296) -- -- 0.1 Government sponsored enterprises................... 667,967 713,969 503,678 (46,002) 210,291 24.2 26.2 19.3 States and political subdivisions.................. 127,704 168,723 203,718 (41,019) (34,995) 4.6 6.2 7.8 Mortgage-backed securities and collateralized mortgage obligations................... 210,720 149,298 60,248 61,422 89,050 7.6 5.5 2.3 Other........................... 16,734 25,221 63,331 (8,487) (38,110) 0.6 0.9 2.5 Total securities available for sale...................... 1,024,184 1,057,845 833,905 (33,661) 223,940 37.0 38.8 32.0 Federal funds sold and other short-term investments........ 406,131 494,579 497,364 (88,448) (2,785) 14.7 18.1 19.1 Total earning assets.............. $2,767,214 2,729,280 2,606,292 37,934 122,988 100.0% 100.0 100.0
6 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) In addition to these items the Company recognized certain non-recurring transactions that had a significant impact on the net income for 2005. These items include the sale of the former operations center in Schenectady at a net gain of approximately $600 thousand, the sale of the credit card portfolio for a net gain of approximately $1.4 million and the sale of the Canajoharie Branch for a net gain of approximately $600 thousand. These items are not expected to re-occur in 2006. TrustCo has performed well with respect to a number of key performance ratios during 2005 and 2004, including: o return on average equity of 26.07% for 2005 and 26.65% for 2004, o return on average assets of 2.07% for 2005 and 2.00% for 2004, and o an efficiency ratio of 38.29% for 2005 and 38.78% for 2004. TrustCo's operations focus on providing high quality service to the communities served by the branch-banking network. The financial results for the Company are influenced by economic events that affect those communities,as well as national economic trends, primarily interest rates, affecting the entire banking industry. TrustCo continues to open new branch locations. During 2005 a net increase of five new branches were added to the franchise. The new branch locations continue the plan established several years ago to expand the franchise to areas experiencing economic growth. In 2006, this strategy will lead to the opening of seven to ten new branches. Management believes that expanding into central and western Florida and the downstate region of New York has been a success. The new branches have the same products and features found at our other locations. With a combination of competitive rates, excellent service and convenient locations, management believes that the new branches will attract deposit and loan customers and be a welcome addition to these communities. Overall, 2005 was marked by growth in each of the key drivers of performance. Deposits ended 2005 at $2.56 billion, an increase from the prior year, and the loan portfolio grew to a total of $1.47 billion, an increase of $230.7 million over the 2004 year end balance. Likewise there was an increase of $188.1 million in the year end balance of securities available for sale. The increase in deposits and loans reflect the success the Company has had in attracting new customers to the Bank both in new branch locations LOAN PORTFOLIO
(dollars in thousands) As of December 31, 2005 2004 2003 Amount Percent Amount Percent Amount Percent Commercial................... $ 202,570 13.8% $ 193,188 15.6% $ 190,501 16.4% Real estate -- construction.. 22,123 1.5 20,148 1.6 7,476 0.6 Real estate -- mortgage...... 1,047,994 71.2 822,103 66.3 779,227 67.0 Home equity lines of credit.. 192,291 13.1 191,242 15.4 171,078 14.7 Installment loans............ 5,741 0.4 13,384 1.1 13,984 1.3 Total loans.................. 1,470,719 100.0% 1,240,065 100.0% 1,162,266 100.0% Less: Allowance for loan losses................ 45,377 49,384 48,739 Net loans $1,425,342 $1,190,681 $1,113,527
Average Balances 2005 2004 2003 2002 2001 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent Commercial................... $ 192,378 14.4% $ 189,179 16.1% $ 199,729 15.7% $ 198,566 13.1% $ 195,152 12.8% Real estate -- construction.. 18,893 1.4 12,430 1.1 6,684 0.5 9,752 0.6 14,526 1.0 Real estate -- mortgage...... 922,875 69.0 780,777 66.3 899,415 70.5 1,156,779 76.5 1,161,521 76.5 Home equity lines of credit.. 192,819 14.4 181,948 15.5 155,185 12.2 129,847 8.6 125,778 8.3 Installment loans............ 9,934 0.8 12,522 1.0 14,010 1.1 17,504 1.2 21,791 1.4 Total loans.................. 1,336,899 100.0% 1,176,856 100.0% 1,275,023 100.0% 1,512,448 100.0% 1,518,768 100.0% Less: Allowance for loan losses................ 47,653 49,299 51,311 56,525 57,398 Net loans.................... $1,289,246 $1,127,557 $1,223,712 $1,455,923 $1,461,370
7 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) Taxable Equivalent Net Interest Income (dollars in millions) 2003 $102.8 2004 $105.0 2005 $107.9 as well as overall. Management believes that TrustCo's success is predicated on providing core banking services to a wider number of customers. Asset/Liability Management In managing its balance sheet, TrustCo utilizes funding and capital sources within sound credit, investment, interest rate, and liquidity risk guidelines established by management and approved by the Board of Directors. Loans and securities (including federal funds sold) are the Company's primary earning assets. Average interest earning assets were 97.3% and 96.5% of average total assets for 2005 and 2004, respectively. TrustCo, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit banking products offered within the markets served by the Company. TrustCo does not actively seek to attract out-of-area deposits or so called hot money; rather the Company focuses on core relationships with both depositors and borrowers. TrustCo's objectives in managing its balance sheet are to limit the sensitivity of net interest income to actual or potential changes in interest rates and to enhance profitability through strategies that should provide sufficient reward for understood and controlled risk. The Company is deliberate in its effort to maintain adequate liquidity under prevailing and projected economic conditions and to maintain an efficient and appropriate mix of core deposit relationships. The Company relies on traditional banking investment instruments and its large base of core deposits to help in asset/liability management. Interest Rates TrustCo competes with other financial service providers based upon many factors including quality of service, convenience of operations, and rates paid on deposits and charged on loans. The absolute level of interest rates, changes in rates, and customers' expectations with respect to the direction of interest rates have a significant impact on the volume of loan and deposit originations in any particular year. Interest rates have a significant impact on the operations and financial results of all financial services companies. One of the most important interest rates used to control national economic policy is the "federal funds" rate. This is the interest rate utilized within the banking system for overnight borrowings for institutions with the highest credit rating. The federal funds rate increased by 200 basis points during 2005 from 2.25% at the beginning of the year to 4.25% by year end. For 2004 the federal funds rate began the year at 1.00% and ended 2004 at 2.25%, an increase of 125 basis points. Therefore the federal funds rate has increased by a total of 325 basis points between January 1,2004 and December 31, 2005. Traditionally bank deposit accounts are heavily influenced by the federal funds rate. Consequently the cost of deposits during this time period also increased. During this same time period the 10 year treasury bond rate did not change consistent with the increased federal funds rate. The 10 year treasury was 4.22% at the beginning of 2005 and ended the year at 4.36%. Likewise in 2004 the 10 year treasury began the year at 4.25% and ended 2004 at 4.22%. Therefore for the period from January 1, 2004 to December 31, 2005 the 10 year treasury increased by 11 basis points as compared to the 325 basis points increase in the federal funds rate. The rate on the 10 year treasury bond is a significant influence on the rates for new residential real estate loans. These changes in interest rates have an effect on the Company relative to the interest income on loans, securities and federal funds sold and other short term instruments as well as on interest expense on deposits and borrowings. Residential real estate loans and longer-term investments are most affected by the changes in longer term market interest rates such as the 10 year treasury. The federal funds sold portfolio and other short term investments are affected primarily by changes in the federal funds target rate. Deposit interest rates are most affected by short term market interest rates. Also, changes in interest rates have an effect on the recorded balance of securities available for sale portfolio, which is recorded at fair market value. Generally, as interest rates increase the fair market value of the securities available for sale portfolio will decrease. Interest rates on new residential real estate loan originations are also influenced by the rates established by secondary market participants 8 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
(dollars in thousands) December 31, 2005 After 1 Year In 1 Year But Within After or Less 5 Years 5 Years Total Commercial................................................ $ 72,513 68,720 61,337 202,570 Real estate construction.................................. 22,123 -- -- 22,123 Total..................................................... 94,636 68,720 61,337 224,693 Predetermined rates....................................... 25,390 68,699 61,337 155,426 Floating rates............................................ 69,246 21 -- 69,267 Total..................................................... $ 94,636 68,720 61,337 224,693
such as Freddie Mac and Fannie Mae. Because TrustCo is a portfolio lender and does not sell loans into the secondary market, the Company establishes rates that management determines are appropriate in light of the long-term nature of residential real estate loans while remaining competitive with the secondary market rates. The net effect of these interest rate changes is that the yields earned on short term investments have increased while longer term investment yields have remained relatively flat, and deposit costs have risen. Earning Assets Average earning assets during 2005 were $2.77 billion, which was an increase of $37.9 million from the prior year. This increase was primarily the result of growth in the average balance of loans by $160.0 million offset by a $33.7 million decrease in securities available for sale and a decrease of $88.4 million of federal funds sold and other short term investments between 2004 and 2005. The increase in the loan portfolio is primarily the result of the $148.6 million increase in real estate loans. This increase in real estate loans is a result of aggressive marketing of this product throughout the TrustCo branch network, an effective marketing campaign and competitive rates and closing costs. Total average assets were $2.84 billion for 2005 and $2.83 billion for 2004. The table "Mix of Average Earning Assets" shows how the mix of the earning assets has changed over the last three years. While the growth in earning assets is critical to improved profitability, changes in the mix also have a significant impact on income levels, as discussed below. Loans Average loans increased $160.0 million during 2005. Interest income on the loan portfolio also increased to $86.7 million in 2005 from $75.2 million in 2004. The average yield increased from 6.39% in 2004 to 6.48% in 2005. Historically, TrustCo has distinguished itself as a principal originator of residential real estate loans. Through marketing and pricing and a customer-friendly service delivery network, TrustCo has attempted to limit the amount of mortgage loans refinanced with other institutions. The uniqueness of the loan products was highlighted by TrustCo in an effort to differentiate them from those of other lenders. Specifically, low closing costs, no escrow or private mortgage insurance and quick loan approvals were identified and marketed. The fact that the Company holds mortgages in its loan portfolio rather than selling them into secondary markets was also highlighted. The average balance of residential real estate loans was $930.7 million in 2005 and $787.3 million in 2004. Income on real estate loans increased to $58.9 million in 2005 from $52.7 million in 2004. The yield on the portfolio decreased from 6.69% for 2004 to 6.33% in 2005 due to changes in retail rates in the marketplace. Residential real estate loans at December 31, 2005 were $1.06 billion compared to $833.7 million at year end 2004, an increase of $224.2 million. The overwhelming majority of TrustCo's real estate loans are secured by properties within the Bank's market area. During 2005, management continued its established practice of retaining all new loan originations in the Bank's portfolio rather than selling them in the secondary market. Average commercial loans of $203.4 million in 2005 increased by $8.4 million from $195.1 million in 2004. The average yield on the commercial loan portfolio increased to 7.26% for 2005 from 6.88% in 2004. This resulted in income on commercial loans of $14.8 million in 2005 and $13.4 million in 2004. TrustCo strives to maintain strong asset quality in all segments of its loan portfolio, especially commercial loans. Competition for commercial loans 9 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) continues to be very intense in the Bank's market region. The Bank competes with large money center and regional banks as well as with smaller locally based banks and thrifts. Over the last several years, competition for commercial loans has intensified as smaller banks and thrifts have tried to develop commercial loan portfolios. TrustCo's commercial lending activities are focused on balancing the Company's commitment to meeting the credit needs of businesses in its market area with the necessity of managing its credit risk. In accordance with these goals, the Company has consistently emphasized the origination of loans within its market area. The portfolio contains no foreign loans, nor does it contain any significant concentrations of credit to any single borrower or industry. The commercial loan portfolio reflects the diversity of businesses found in the Capital Region's economy. Light manufacturing, retail, service, and real estate related business are a few examples of the types of businesses located in the Company's market area. TrustCo has a leadership position in the home equity credit line product in its market area. TrustCo was one of the first financial institutions in the Capital Region to aggressively market and originate this product, and management believes, has developed significant expertise with respect to its risks and rewards. During 2005, the average balance of home equity credit lines was $192.8 million, an increase from $181.9 million in 2004. The home equity credit line product has developed into a significant business line for most financial services companies. Trustco Bank competes with both regional and national concerns for these lines of credit and faces stiff competition with respect to interest rates, closing costs, and customer service for these loans. TrustCo continuously reviews changes made by competitors with respect to the home equity credit line product and adjusts its offerings to remain competitive. The average yield increased to 6.11% for 2005 from 4.23% in 2004. This resulted in interest income on home equity credit lines of $11.8 million in 2005, compared to $7.7 million in 2004. The average balance of installment loans, net of unearned income, decreased to $9.9 million in 2005 from $12.5 million in 2004. The yield on installment loans increased to 12.26% in 2005 from 11.63% in 2004, resulting in interest income of $1.2 million. During the third quarter of 2005 the Company sold approximately $7.4 million of credit card receivables and entered into a marketing arrangement with a third party credit card servicer. As a result of this sale the Company recognized a net gain of $1.4 million and will have continuing income from credit cards for new card originations. Securities available for sale: The portfolio of securities available for sale is designed to provide a stable source of interest income and liquidity. The portfolio is also managed by the Company to take advantage of changes in interest rates. The securities available for sale portfolio is managed under a policy detailing the types, duration, and interest rates acceptable in the portfolio. The designation of "available for sale" is made at the time of purchase, based upon management's intent to hold the securities for an indefinite period of time. The Company currently has no intent to sell securities with temporary impairment. However, these securities are available for sale in response to changes in market interest rates, related changes in prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments. At December 31, 2004, securities available for sale amounted to $896.0 million, compared to $1.08 billion at year end 2005. For 2005, the average balance of securities available for sale was $1.02 billion with an average yield of 5.36%, compared to an average balance in 2004 of $1.06 billion with an average yield of 5.85%. The taxable equivalent income earned on the securities portfolio in 2004 was $61.9 million, compared to $54.9 million earned in 2005. Yields earned on securities available for sale were down for 2005 compared to 2004 due primarily to additional investments made in the mortgage-backed securities and collateralized mortgage obligations portfolio. These additional investments were made at relatively low interest rates as compared to the remainder of the portfolio and have an anticipated shorter average life. Increases in the year-end 2005 balance of securities available for sale were the result of efforts to invest federal funds sold and other short term investments along with deposit inflows into relatively higher yielding assets. The interest rates on the securities purchased during the year were attractive as compared to investing the funds in overnight federal funds and other short term investments and compared to the Company's overall cost of funding. Federal funds sold and other short-term investments yielded an average rate of return of 2.96% for the year. Interest income was positively affected by investing the funds in the securities available for sale portfolio at higher interest rates. All security purchases are made in accordance with management's long standing investment policies. Management believes these additional investments offered the best combination of yield and credit protection. During 2005, TrustCo recognized approximately $6.0 million of net gains from securities transactions, compared to approximately $13.7 million in 2004. The Company recognized these transactions in response to lower interest rates in the marketplace, which had the effect of increasing the value of these securities. TrustCo has not invested in any exotic investment products such as interest rate swaps, forward 10 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) placement contracts, or other instruments commonly referred to as derivatives. By actively managing a portfolio of high quality securities, TrustCo can meet the objectives of asset/liability management and liquidity, while at the same time producing a reasonably predictable earnings stream. Securities available for sale are recorded at their fair value, with any unrealized gains or losses, net of taxes, recognized as a component of shareholders' equity. Average balances of securities available for sale are stated at amortized cost. At December 31, 2005 and 2004, the market value of TrustCo's portfolio of securities available for sale carried net unrealized losses of approximately $10.1 million and net unrealized gains of approximately $7.4 million, respectively. Maturity and call dates of securities: Many of the securities in the investment portfolio have a call date in addition to the stated maturity date. Call dates allow the issuer to redeem the bonds prior to maturity at specified dates and at predetermined prices. Normally, securities are redeemed at the call date when the issuer can reissue the security at a lower interest rate. Therefore, for cash flow, liquidity and interest rate management purposes, it is important to monitor both maturity dates and call dates. The table below details the portfolio of securities available for sale by both maturity date and call date as of December 31, 2005. Mortgage-backed securities are reported using an estimate of average life; equity securities are excluded. The table, "Securities Portfolio Maturity Distribution and Yield," distributes the securities available for sale portfolio as of December 31, 2005, based on the final maturity of the securities. Mortgage-backed securities are stated using estimated average life, and equity securities are excluded. Actual maturities may differ from contractual maturities because of securities' prepayments and the right of certain issuers to call or prepay their obligations without penalty. Federal funds sold and other short-term investments: During 2005, the average balance of federal funds sold and other short-term investments was $406.1 million, a decrease from $494.6 million in 2004. The average rate earned on these assets was 2.96% in 2005 and 1.35% in 2004. TrustCo utilizes this category of earning assets as a means of SECURITIES AVAILABLE FOR SALE
(dollars in thousands) As of December 31, 2005 2004 2003 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value U.S. Treasuries and agencies................. $ 499 498 500 500 998 1,001 Government sponsored enterprises............. 756,525 743,265 521,078 517,061 862,530 862,658 States and political subdivisions............ 115,010 118,950 147,988 154,939 182,118 191,727 Mortgage-backed securities and collateralized mortgage obligations....................... 202,007 200,963 201,579 201,623 64,718 66,322 Other........................................ 685 681 685 685 685 685 Total debt securities available for sale... 1,074,726 1,064,357 871,830 874,808 1,111,049 1,122,393 Equity securities............................ 19,418 19,719 16,741 21,181 30,880 54,533 Total securities available for sale........ $1,094,144 1,084,076 888,571 895,989 1,141,929 1,176,926
SECURITIES PORTFOLIO MATURITY AND CALL DATE DISTRIBUTION Debt securities available for sale:
(dollars in thousands) As of December 31, 2005 Based on Based on Final Maturity Call Date Amortized Fair Amortized Fair Cost Value Cost Value Within 1 year.................................................... $ 26,490 26,347 772,215 758,952 1 to 5 years..................................................... 341,367 338,942 195,854 195,510 5 to 10 years.................................................... 138,355 136,778 100,598 103,574 After 10 years................................................... 568,514 562,290 6,059 6,321 Total debt securities available for sale....................... $ 1,074,726 1,064,357 1,074,726 1,064,357
11 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) maintaining strong liquidity as interest rates change. During 2005, the target federal funds rate set by the Federal Open Market Committee (FOMC) changed significantly as described previously. The federal funds sold and other short-term investments portfolio is significantly affected by changes in the target federal funds rate as are virtually all interest sensitive instruments. The year end balance of federal funds sold and other short term investments was $257.2 million for 2005 compared to $642.2 million for year end 2004. The year end balance for 2004 is significantly higher than the average balance for the year of $494.6 million due to the proceeds of sales of securities available for sale executed near year end 2004. Management anticipates evaluating the overall level of the federal funds sold and other short term investments portfolio for 2006 and will make appropriate adjustments based upon market opportunities and interest rates. Funding Sources TrustCo utilizes various traditional sources of funds to support its asset portfolio. The table, "Mix of Average Sources of Funding," presents the various categories of funds used and the corresponding average balances for each of the last three years. Deposits: Average total deposits (including time deposits greater than $100 thousand) were $2.51 billion in 2005, compared to $2.47 billion in 2004, an increase of $31.8 million. Increases were noted primarily in the demand deposits and time account categories. The average balance of interest bearing checking accounts decreased by $10.6 million to $318.2 million in 2005. Money market accounts had an average balance of $157.4 million in 2004 compared to $153.8 million in 2005. Savings account balances decreased from $809.4 million in 2004 to $783.4 million in 2005. Time deposits increased on average by $49.1 million and demand deposits increased by $22.9 million during 2005 compared to 2004. SECURITIES PORTFOLIO MATURITY DISTRIBUTION AND YIELD Debt securities available for sale:
(dollars in thousands) As of December 31, 2005 Maturing: After 1 After 5 Within But Within But Within After 1 Year 5 Years 10 Years 10 Years Total U.S. Treasuries and agencies Amortized cost........................ $ 499 -- -- -- 499 Fair value............................ 498 -- -- -- 498 Weighted average yield................ 1.63% -- -- -- 1.63 Government sponsored enterprises Amortized cost........................ $15,000 159,155 109,883 472,487 756,525 Fair value............................ 14,951 157,530 108,542 462,242 743,265 Weighted average yield................ 3.48% 4.57 5.11 5.41 5.15 States and political subdivisions Amortized cost........................ $ 285 16,988 2,635 95,102 115,010 Fair value............................ 286 16,859 2,686 99,119 118,950 Weighted average yield................ 4.50% 3.39 5.35 4.89 4.68 Mortgage-backed securities and collateralized mortgage obligations Amortized cost........................ $10,706 164,589 25,787 925 202,007 Fair value............................ 10,612 163,922 25,500 929 200,963 Weighted average yield................ 4.62% 4.70 4.58 6.85 4.69 Other Amortized cost........................ $ -- 635 50 -- 685 Fair value............................ -- 631 50 -- 681 Weighted average yield................ --% 4.43 5.49 -- 4.50 Total debt securities available for sale Amortized cost........................ $26,490 341,367 138,355 568,514 1,074,726 Fair value............................ 26,347 338,942 136,778 562,290 1,064,357 Weighted average yield................ 3.95% 4.57 5.02 5.33 5.01
Weighted average yields have not been adjusted for any tax-equivalent factor. Government sponsored enterprises maturing after 10 years have final maturities of less than 15 years. States and political subdivisions maturing after 10 years generally have final maturities of less than 20 years. 12 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) AVERAGE BALANCES, YIELDS AND NET INTEREST MARGINS
(dollars in thousands) 2005 2004 2003 Interest Interest Interest Average Income/ Average Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate Balance Expense Rate Assets Loans, net of unearned income........ $1,336,899 86,669 6.48% 1,176,856 75,232 6.39% 1,275,023 87,669 6.88% Securities available for sale: U.S. Treasuries and agencies....... 1,059 28 2.64 634 11 1.74 2,930 209 7.13 Government sponsored enterprises... 667,967 34,478 5.16 713,969 39,785 5.57 503,678 25,780 5.12 States and political subdivisions.. 127,704 9,658 7.56 168,723 13,302 7.88 203,718 16,131 7.92 Mortgage-backed securities and collateralized mortgage obligations...................... 210,720 9,738 4.62 149,298 7,032 4.71 60,248 3,618 6.01 Other.............................. 16,734 1,025 6.12 25,221 1,744 6.92 63,331 4,430 7.00 Total securities available for sale......................... 1,024,184 54,927 5.36 1,057,845 61,874 5.85 833,905 50,168 6.01 Federal funds sold and other short-term investments........... 406,131 12,009 2.96 494,579 6,675 1.35 497,364 5,654 1.14 Total interest earning assets...... 2,767,214 153,605 5.55% 2,729,280 143,781 5.27% 2,606,292 143,491 5.50% Allowance for loan losses............ (47,653) (49,299) (51,311) Cash and noninterest earning assets.. 125,413 148,214 155,194 Total assets....................... $2,844,974 2,828,195 2,710,175 Liabilities and shareholders' equity Interest bearing deposits: Interest bearing checking accounts. $ 318,167 1,376 0.43% 328,804 1,586 0.48% 320,179 1,678 0.52% Savings............................ 783,410 6,769 0.86 809,438 7,968 0.98 759,308 8,795 1.16 Time deposits and money markets.... 1,169,018 35,481 3.04 1,123,474 28,223 2.51 1,072,078 29,370 2.74 Total interest bearing deposits.... 2,270,595 43,626 1.92 2,261,716 37,777 1.67 2,151,565 39,843 1.85 Short-term borrowings................ 83,381 2,026 2.43 100,855 972 0.96 107,799 877 0.81 Long-term debt....................... 99 5 5.22 151 8 5.40 326 19 5.80 Total interest bearing liabilities. 2,354,075 45,657 1.94% 2,362,722 38,757 1.64% 2,259,690 40,739 1.80% Demand deposits...................... 235,372 212,463 189,262 Other liabilities.................... 28,956 29,291 36,178 Shareholders' equity................. 226,571 223,719 225,045 Total liabilities and shareholders' equity............. $2,844,974 2,828,195 2,710,175 Net interest income.................... 107,948 105,024 102,752 Net interest spread.................... 3.61% 3.63% 3.70% Net interest margin (net interest income to total interest earning assets).... 3.90 3.85 3.94
Portions of income earned on certain commercial loans, U.S. Government obligations, obligations of states and political subdivisions, and equity securities are exempt from federal and/or state taxation. Appropriate adjustments have been made to reflect the equivalent amount of taxable income that would have been necessary to generate an equal amount of after tax income. Federal and New York State tax rates used to calculate income on a tax equivalent basis were 35.0% and 7.5% for 2005, 2004, and 2003. The average balances of securities available for sale were calculated using amortized costs for these securities. Included in the average balance of shareholders' equity is $0.3 million, $11.5 million, and $22.7 million in 2005, 2004, and 2003, respectively, net of unrealized appreciation, net of tax, in the available for sale securities portfolio. Nonaccrual loans are included in average loans. 13 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) The increase in deposits reflects the impact of new branches opened over the last several years, and the continuing focus at TrustCo on providing core banking services better, faster and cheaper than its competitors. Management believes that another contributing factor to the increase in deposits is the overall increase in the rates paid on deposit accounts. As noted previously the largest growth in deposits is in the category of time deposits which carries the highest cost in terms of interest rates while at the same time the Company experienced a deposit outflow in savings accounts which is a relatively low cost source of deposits. The increasing rates on time deposits is attracting customers away from other investment opportunitites. TrustCo, with its expanding branch network, is well positioned to attract these new deposits. The overall cost of interest bearing deposits was 1.92% in 2005 compared to 1.67% in 2004. The increase in the average balance of interest bearing deposits, coupled with a 25 basis point increase in the average cost, resulted in an increase of approximately $5.9 million in interest expense to $43.6 million in 2005. The Company strives to maintain competitive rates on deposit accounts and to attract customers through a combination of competitive interest rates, quality customer service, and convenient banking locations. In this fashion, management believes, TrustCo is able to attract deposit customers looking for a long-term banking relationship, and to cross sell banking services utilizing the deposit account relationship as the starting point. MATURITY OF TIME DEPOSITS OVER $100 THOUSAND (dollars in thousands) As of December 31, 2005 Under 3 months.............................. $ 22,981 3 to 6 months .............................. 10,909 6 to 12 months ............................. 55,891 Over 12 months.............................. 135,830 Total....................................... $225,611 Other funding sources: The Company had $83.4 million of average short-term borrowings outstanding during 2005 compared to $100.9 million in 2004. The average cost of short-term borrowings was 2.43% in 2005 and 0.96% in 2004. This resulted in interest expense of approximately $2.0 million in 2005. The increase in the rate paid on these funds is a result of the increase in the target federal funds rate during 2004 and 2005. Capital Resources Consistent with its long-term goal of operating a sound and profitable financial organization, TrustCo strives to maintain strong capital ratios and to qualify as a well capitalized bank in accordance with federal regulatory requirements. Historically, most of the Company's capital requirements have been provided through retained earnings generated. New issues of equity securities have not been required to support the Company's growth. A basic element of TrustCo's operating philosophy is that the Company will not retain excess capital. Capital generated by the Company that is in excess of the levels considered by management to be necessary for the safe and sound operation of the Company has been distributed to the shareholders in the form of cash dividends. Consequently, the capital ratios that are maintained are adequate, in MIX OF AVERAGE SOURCES OF FUNDING
(dollars in thousands) 2005 2004 Components of vs. vs. Total Funding 2005 2004 2003 2004 2003 2005 2004 2003 Demand deposits........................ $ 235,372 212,463 189,262 22,909 23,201 9.1% 8.3 7.7 Retail deposits: Savings.............................. 783,410 809,438 759,308 (26,028) 50,130 30.3 31.4 31.0 Time deposits under $100 thousand.... 813,751 789,211 767,505 24,540 21,706 31.4 30.6 31.3 Interest bearing checking accounts... 318,167 328,804 320,179 (10,637) 8,625 12.3 12.8 13.1 Money market deposits................ 153,838 157,418 149,520 (3,580) 7,898 5.9 6.1 6.1 Total retail deposits................ 2,069,166 2,084,871 1,996,512 (15,705) 88,359 79.9 80.9 81.5 Total core deposits.................. 2,304,538 2,297,334 2,185,774 7,204 111,560 89.0 89.2 89.2 Time deposits over $100 thousand....... 201,429 176,845 155,053 24,584 21,792 7.8 6.9 6.4 Short-term borrowings.................. 83,381 100,855 107,799 (17,474) (6,944) 3.2 3.9 4.4 Long-term debt......................... 99 151 326 (52) (175) -- -- -- Total purchased liabilities.......... 284,909 277,851 263,178 7,058 14,673 11.0 10.8 10.8 Total sources of funding............. $2,589,447 2,575,185 2,448,952 14,262 126,233 100.0% 100.0 100.0
14 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) AVERAGE DEPOSITS BY TYPE OF DEPOSITOR
(dollars in thousands) Years Ended December 31, 2005 2004 2003 2002 2001 Individuals, partnerships and corporations............... $2,485,922 2,453,843 2,318,424 2,150,986 1,947,700 U.S. Government.......................................... 72 70 73 35 83 States and political subdivisions........................ 4,875 5,539 9,802 48,049 64,811 Other (certified and official checks, etc.).............. 15,098 14,727 12,528 13,370 15,056 Total average deposits by type of depositor............ $2,505,967 2,474,179 2,340,827 2,212,440 2,027,650
the view of management, but not excessive. This philosophy has led to a dividend payout ratio of 77.5% of net income in 2005, 78.8% of net income in 2004, and 84.0% for 2003. These are significant payouts to the Company's shareholders and are considered by management to be a prudent use of excess capital. As to the likelihood of future dividends, it is currently anticipated that the philosophy stated above will continue. TrustCo's Tier 1 capital was 16.58% of risk-adjusted assets at December 31, 2005, and 17.09% of risk-adjusted assets at December 31, 2004. Tier 1 capital to average assets at December 31, 2005 was 8.04%, as compared to 7.74% at year end 2004. At December 31, 2005 and 2004, TrustCo and Trustco Bank met their respective regulators' definition of a well capitalized institution. Risk Management The responsibility for balance sheet risk management oversight is the function of the Asset Allocation Committee. This committee meets monthly and includes the executive officers of the Company as well as other department managers as appropriate. The meetings include a review of balance sheet structure, formulation of strategy in light of anticipated economic conditions, and comparison to established guidelines to control exposures to various types of risk. Credit Risk Credit risk is managed through a network of loan officer authorities, review committees, loan policies, and oversight from the senior executives of the Company. Management follows a policy of VOLUME AND YIELD ANALYSIS
(dollars in thousands) 2005 vs. 2004 2004 vs. 2003 Increase Due to Due to Increase Due to Due to (Decrease) Volume Rate (Decrease) Volume Rate Interest income (TE): Federal funds sold and other short-term investments........... $ 5,334 (941) 6,275 1,021 (32) 1,053 Securities available for sale: Taxable........................... (3,302) (153) (3,149) 14,535 12,791 1,744 Tax-exempt........................ (3,665) (3,123) (522) (2,829) (2,756) (73) Total securities available for sale........................ (6,947) (3,276) (3,671) 11,706 10,035 1,671 Loans............................... 11,437 9,596 1,841 (12,437) (7,553) (4,884) Total interest income............. 9,824 5,379 4,445 290 2,450 (2,160) Interest expense: Interest bearing checking accounts.. (210) (50) (160) (92) 55 (147) Savings............................. (1,199) (249) (950) (827) 640 (1,467) Time deposits and money markets................ 7,258 1,376 5,882 (1,147) 1,654 (2,801) Short-term borrowings............... 1,054 (134) 1,188 95 (49) 144 Long-term debt...................... (3) (3) -- (11) (10) (1) Total interest expense............ 6,900 940 5,960 (1,982) 2,290 (4,272) Net interest income (TE).......... $ 2,924 4,439 (1,515) 2,272 160 2,112
Increases and decreases in interest income and interest expense due to both rate and volume have been allocated to the two categories of variances (volume and rate) based on the percentage relationship of such variances to each other. 15 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) continually identifying, analyzing, and evaluating the credit risk inherent in the loan portfolio. As a result of management's ongoing reviews of the loan portfolio, loans are placed in nonaccrual status, either due to the delinquent status of the principal and/or interest payments, or based on a judgment by management that, although payment of principal and/or interest is current, such action is prudent. Thereafter, no interest is taken into income unless received in cash or until such time as the borrower demonstrates a sustained ability to make scheduled payments of interest and principal. Management has also developed policies and procedures to monitor the credit risk in relation to the federal funds sold portfolio. TrustCo monitors the credit rating and capital levels of the third party banks that they sell federal funds to. Only banks with the highest rating from the credit rating agency selected are included in the list for federal funds transactions. Nonperforming Assets Nonperforming assets include loans in nonaccrual status, loans that have been treated as troubled debt restructurings, loans past due three payments or more and still accruing interest, and foreclosed real estate properties. Nonperforming assets at year end 2005 and 2004 totaled $3.2 million. Nonperforming loans as a percentage of the total loan portfolio were 0.22% in 2005 and 0.26% in 2004. Included in nonperforming loans at year end 2005 were $1.7 million of residential mortgage loans in nonaccrual status as compared to $557 thousand at year end 2004. There were no loans past due three payments or more and still accruing interest at year end 2004 and $35 thousand at year end 2005. Restructured loans at year end 2004 were $2.6 million, compared to $1.5 million at year end 2005. Adherence to sound underwriting standards, vigorous loan collection efforts and timely charge-offs have been cornerstones of the operating philosophy of TrustCo. All of the $3.2 million of nonperforming loans at December 31, 2005 are residential real estate or retail consumer loans. A significant portion of the charge-offs for 2005 and 2004 occurred in the residential real estate and retail consumer loan portfolios. During 2005, gross charge-offs of these types of loans were $1.6 million (which represented 63% of total gross charge-offs). In 2004, charge-offs for these types of loans were $5.5 million. The reduction in gross charge offs in the residential real estate portfolio between 2004 and 2005 reflects the economic improvements in this area and the positive effect of prior collection actions. Since 2000, there has been a shift of charge-offs to the residential real estate and retail consumer loan portfolios for several reasons, including: o the overall emphasis within TrustCo on residential real estate originations, o the relatively weak economic environment in the Upstate New York territory, and o the relative slow growth in real estate values in many of TrustCo's lending areas that has occurred since the middle of the 1990's, thereby limiting the collateral value that supports the real estate loans. Consumer defaults and bankruptcies had increased over the last several years, and this led to an increase in defaults on loans. However, beginning in 2004 the number of new bankruptcy filings in the Capital District area decreased from the prior year as compared to state wide trends which continued to show increases year over year in new bankruptcy filings. This trend, along with the decrease in residential real estate and consumer loan charge-offs may be indicators of future economic stability for this region and a continued lessening of charge-offs in the residential real estate portfolio. Ongoing portfolio management is intended to result in early identification and disengagement from deteriorating credits. TrustCo has a diversified loan portfolio that includes a significant balance of residential mortgage loans to borrowers in the Capital Region and avoids concentrations to any one borrower or any single industry. Management is aware of no other loans in the Bank's portfolio that pose significant risk of the eventual non-collection of principal and interest. As of December 31, 2005, there were no other loans classified for regulatory purposes that management reasonably expects will materially impact future operating results, liquidity, or capital resources. TrustCo has no advances to borrowers or projects located outside the United States. TrustCo has identified nonaccrual commercial and commercial real estate loans, as well as all loans restructured since 1995 under a troubled debt restructuring, as impaired loans. At year end 2005 and 2004, there were $1.5 and $2.6 million, respectively, of impaired loans. The average balances of impaired loans were $1.9 million during 2005 and $2.9 million during 2004. The Company recognized approximately $201 thousand of interest income on these loans in 2005 and $314 thousand in 2004. Allowance for Loan Losses The allowance for loan losses is available to absorb losses on loans that management determines are uncollectible. The balance of the allowance is maintained at a level that is, in management's judgment, representative of the loan portfolio's inherent risk. 16 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) In deciding on the adequacy of the allowance for loan losses, management reviews past due information, historical charge-off data, and nonperforming loan activity. Also, there are a number of other factors that are taken into consideration, including: o the magnitude and nature of loan charge-offs, and recoveries, Allowance for Loan Losses (dollars in millions) 2003 $48.7 2004 $49.4 2005 $45.4 o the change in the loan portfolio and the implication that it has in relation to the economic climate in the Bank's business territory, o significant growth in the level of losses associated with bankruptcies in New York State over the last several years and the time period needed to foreclose, secure and dispose of collateral, and o the relatively weak economic environment in the Upstate New York territory over the last several years. Though the economic climate in the upstate New York area has suffered over the last several years, resulting in higher bankruptcies and relatively flat real estate prices, overall economic trends in the last two years have been improving. As noted previously, bankruptcies in the Capital District area have decreased relative to state wide trends recently and general housing prices have continued to increase. These positive trends have helped marginal credits better manage their debt load. Because of continued improvements in nearly all of the indicators of the Company's credit quality and management's assessment of economic conditions and risk, combined with the significant increase in the level of net recoveries from $195 thousand in 2004 to $2.3 million in 2005, as well as the impact of the sale of the credit card portfolio in 2005, a negative provision of $6.3 million was recognized in 2005. Management continues to monitor these trends in determining future provisions or credits for loan losses in relation to loan charge offs, recoveries and the level and trends of nonperforming loans. The table, "Summary of Loan Loss Experience", includes an analysis of the changes to the allowance for the past five years. Loans charged off in 2005 and 2004 were $2.5 million and $5.8 million, respectively. Recoveries were $4.7 million in 2005 and $6.0 million in 2004. The provision recorded in 2004 was $450,000 compared to a recovery of this provision of $6.3 million in 2005. The reduction in the provision for loan losses over the last several years is a result of the allowance for loan losses being considered adequate by management in relation to the overall loan portfolio. The level of loan charge offs decreased by approximately $3.3 million between 2004 and 2005 while at the same time the level of nonperforming loans remained relatively constant between the two years. Market Risk The Company's principal exposure to market risk is with respect to interest rate risk. Interest rate risk NONPERFORMING ASSETS
(dollars in thousands) As of December 31, 2005 2004 2003 2002 2001 Loans in nonaccrual status........................... $ 1,662 557 -- 615 1,090 Loans contractually past due 3 payments or more and still accruing interest........................ 35 -- -- -- 801 Restructured loans................................... 1,518 2,610 3,260 4,303 5,159 Total nonperforming loans............................ 3,215 3,167 3,260 4,918 7,050 Foreclosed real estate............................... 23 -- -- 86 603 Total nonperforming assets........................... $ 3,238 3,167 3,260 5,004 7,653 Allowance for loan losses............................ $45,377 49,384 48,739 52,558 57,203 Allowance coverage of nonperforming loans............ 14.11x 15.59 14.95 10.69 8.11 Nonperforming loans as a % of total loans............ 0.22% 0.26 0.28 0.35 0.45 Nonperforming assets as a % of total assets.......... 0.11 0.11 0.12 0.19 0.30
17 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) is the potential for economic loss due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current market value. Quantitative and Qualitative Disclosure about Market Risk TrustCo realizes income principally from the difference or spread between the interest earned on loans, investments and other interest-earning assets and the interest paid on deposits and borrowings. Loan volume and yield, as well as the volume of and rates on investments, deposits and borrowings are affected by market interest rates. Additionally, because of the terms and conditions of many of the loan documents and deposit accounts, a change in interest rates could also affect the projected maturities of the loan portfolio and/or the deposit base. Accordingly, TrustCo considers interest rate risk to be a market risk for the Company. Interest rate risk management focuses on maintaining adequate levels of net interest income and the fair value of capital in varying interest rate cycles within Board-approved policy limits. Interest rate risk management also must take into consideration, among other factors, the Company's overall credit, operating income, operating cost, and capital profile. The Asset Allocation Committee, which includes all members of executive management and reports quarterly to the Board of Directors, monitors and manages interest rate risk to maintain an acceptable level of potential change in the fair value of capital as a result of changes in market interest rates. The Company uses an internal model as the primary tool to identify, quantify and project changes in interest rates and the impact on the balance sheet. The model utilizes assumptions with respect to cash flows and prepayment speeds taken both from industry sources and internally generated data based upon historical trends in the Bank's balance sheet. Assumptions based on the historical behavior of deposit rates and balances in relation to changes in market interest rates are also incorporated into the model. This model assumes a fair value amount with respect to non-time deposit categories since these deposits are part of the core deposit products of the Company. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure the fair value of capital or precisely predict the impact of fluctuations in interest rates on the fair value of capital. Using this internal model, the fair values of capital projections as of December 31, 2005 are referenced below. The base case scenario shows the present estimate of the fair value of capital assuming no change in the operating environment or operating strategies and no change in interest rates from those existing in the marketplace as of December 31, 2005. The table indicates the impact on the fair value of capital assuming interest rates were to instantaneously increase by 100 bp and 200 bp or to decrease by 100 bp and 200 bp. Estimated Percentage of Fair value of Capital to As of December 31, 2005 Fair value of Assets +200 BP 13.58% +100 BP 14.85 Current rates 16.22 -100 BP 15.09 -200 BP 13.37 At December 31, 2005 the book value of capital (excluding the market adjustment on securities available for sale) to assets was 8.04%. The fair value of capital is calculated as the fair value of assets less the fair value of liabilities in the interest ratio scenario presented. The fair value of capital in the current rate environment is 16.22% of assets whereas the current book value of capital to assets is 8.04% at December 31, 2005. The significant difference between these two capital ratios reflects the impact that a fair value calculation can have on the capital ratios of a company. The fair value of capital calculations take into consideration the fair value of deposits, including those deposits considered core deposits, along with the fair value of assets such as the loan portfolio. A secondary method to identify and manage the interest rate risk profile is the static gap analysis. Interest sensitivity gap analysis measures the difference between the assets and liabilities repricing or maturing within specific time periods. An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing within specific time periods, which would generally imply a favorable impact on net interest income in periods of rising interest rates and a negative impact in periods of falling rates. A liability-sensitive position would generally imply a negative impact on net interest income in periods of rising rates and a positive impact in periods of falling rates. Static gap analysis has limitations because it cannot measure precisely the effect of interest rate movements, and competitive pressures on the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. In addition, a significant portion of the interest sensitive assets are fixed rate securities with relatively long lives whereas the interest-bearing liabilities are not subject to these same limitations. As a result, certain assets and liabilities may in fact reprice at different times and at different volumes than the static gap analysis would indicate. The Company recognizes the relatively long-term nature of the fixed rate residential loan portfolio. To 18 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) SUMMARY OF LOAN LOSS EXPERIENCE
(dollars in thousands) 2005 2004 2003 2002 2001 Amount of loans outstanding at end of year (less unearned income).......................... $1,470,719 1,240,065 1,162,266 1,422,301 1,556,686 Average loans outstanding during year (less average unearned income).................. 1,336,899 1,176,856 1,275,023 1,512,448 1,518,768 Balance of allowance at beginning of year......... 49,384 48,739 52,558 57,203 56,298 Loans charged off: Commercial...................................... 656 335 432 997 1,084 Real estate..................................... 1,561 5,054 8,651 6,648 5,383 Installment..................................... 247 408 515 705 561 Total......................................... 2,464 5,797 9,598 8,350 7,028 Recoveries of loans previously charged off: Commercial...................................... 440 446 1,393 803 1,664 Real estate..................................... 4,121 5,334 3,003 1,285 1,106 Installment..................................... 156 212 183 197 223 Total......................................... 4,717 5,992 4,579 2,285 2,993 Net loans charged off (recovered)................. (2,253) (195) 5,019 6,065 4,035 Provision (credit) for loan losses ............... (6,260) 450 1,200 1,420 4,940 Balance of allowance at end of year............... $ 45,377 49,384 48,739 52,558 57,203 Net charge offs (recoveries) as a percent of average loans outstanding during year (less average unearned income).................. (.17)% (.02) .39 .40 .27 Allowance as a percent of loans outstanding at end of year.................................. 3.09 3.98 4.17 3.70 3.67
fund those long-term assets the Company cultivates long-term deposit relationships (often called core deposits). These core deposit relationships tend to be longer term in nature and not as susceptible to changes in interest rates. Core deposit balances allow the Company to take on certain interest rate risk with respect to the asset side of the balance sheet. The table "Interest Rate Sensitivity" presents an analysis of the interest-sensitivity gap position at December 31, 2005. All interest-earning assets and interest-bearing liabilities are shown based upon their contractual maturity or repricing date adjusted for forecasted prepayment rates. Asset prepayment and liability repricing periods are selected after considering the current rate environment, industry prepayment and data specific to the Company. The interest rate sensitivity table indicates that TrustCo is asset sensitive throughout virtually all of the time periods presented. The effect of being asset sensitive is that should interest rates increase the Company would be able to reinvest these assets at higher rates. Conversely, should interest rates fall, the Company would record less interest income due to reinvesting the assets in a lower interest rate environment. There are several significant shortcomings inherent in the gap analysis. For example, although certain assets and liabilities have similar periods to maturity or to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while other assets and liabilities may lag behind changes in market interest rates. Management takes these factors, and others, into consideration when reviewing the Bank's gap position and establishing its asset/liability strategy. Liquidity Risk TrustCo seeks to obtain favorable funding sources and to maintain prudent levels of liquid assets in order to satisfy various liquidity demands. In addition to serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the ability to meet liquidity needs, including changes in the markets served by the Bank's network of branches, the mix of assets and liabilities, and general economic conditions. The Company actively manages its liquidity position through target ratios established under its Asset/ Liability Management policies. Continual monitoring of these ratios, both historically and through forecasts under multiple interest rate scenarios, allows TrustCo to employ strategies necessary to maintain adequate liquidity levels. Management has also developed various liquidity alternatives should abnormal situations develop. The Company achieves its liability-based liquidity 19 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) INTEREST RATE SENSITIVITY
(dollars in thousands) At December 31, 2005 Repricing in: 0-90 91-365 1-5 Over 5 Rate days days years years Insensitive Total Total assets........................ $617,305 260,134 923,273 998,401 113,646 2,912,759 Cumulative total assets............. $617,305 877,439 1,800,712 2,799,113 2,912,759 Total liabilities and shareholders' equity........... $274,633 533,844 1,273,199 497,115 333,968 2,912,759 Cumulative total liabilities and shareholders' equity........... $274,633 808,477 2,081,676 2,578,791 2,912,759 Cumulative interest sensitivity gap.................... $342,672 68,962 (280,964) 220,322 Cumulative gap as a % of interest earning assets for the period...... 55.51% 7.86 (15.60) 7.87 Cumulative interest sensitive assets to liabilities.............. 224.77 108.53 86.50 108.54
objectives in a variety of ways. Liabilities can be classified into three categories for the purposes of managing liability-based liquidity: core deposits, purchased money, and capital market funds. TrustCo seeks deposits that are dependable and predictable and that are based as much on the level and quality of service as they are on interest rate. Average core deposits (total deposits less time deposits greater than $100 thousand) amounted to $2.30 billion in 2005 and 2004. Average balances of core deposits are detailed in the table "Mix of Average Sources of Funding." In addition to core deposits, another source of liability-based funding available to TrustCo is purchased money, which consists of long-term and short-term borrowings, federal funds purchased, securities sold under repurchase agreements, and time deposits greater than $100 thousand. The average balances of these purchased liabilities are detailed in the table "Mix of Average Sources of Funding." During 2005, the average balance of purchased liabilities was $284.9 million, compared with $277.9 million in 2004. TrustCo also has a line of credit available with the Federal Home Loan Bank of New York. Off-Balance Sheet Risk Commitments to extend credit: The Bank makes contractual commitments to extend credit, and extends lines of credit which are subject to the Bank's credit approval and monitoring procedures. At December 31, 2005 and 2004, commitments to extend credit in the form of loans, including unused lines of credit, amounted to $306.7 million and $313.3 million, respectively. In management's opinion, there are no material commitments to extend credit that represent unusual risk. The Company has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $2.8 million and $3.6 million at December 31, 2005 and 2004, respectively, and represent the maximum potential future payments the Company could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on- balance sheet instruments. Company policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of the Company's standby letters of credit at December 31, 2005 and 2004 was insignificant. Other off-balance sheet risk: TrustCo does not engage in activities involving interest rate swaps, forward placement contracts, or any other instruments commonly referred to as derivatives. Management believes these instruments pose a high degree of risk, and that investing in them is unnecessary. TrustCo has no off-balance sheet partnerships, joint ventures, or other risk sharing entities. 20 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) Noninterest Income and Expense Noninterest income: Noninterest income is a significant source of revenue for the Company and an important factor in overall results. Total noninterest income was $27.6 million in 2005, $32.0 million in 2004 and $29.6 million in 2003. Included in the 2005 results are $6.0 million of net securities gains compared with net gains of approximately $13.7 million in 2004 and $9.8 million in 2003. Excluding securities transactions, noninterest income was $21.6 million in 2005, and $18.3 million in 2004 and $19.8 million in 2003. The Trust Department contributes a large recurring portion of noninterest income through fees generated by providing fiduciary and investment management services. Income from these fiduciary activities totalled $6.0 million in 2005, $5.9 million in 2004, and $6.0 million in 2003. Trust fees are generally calculated as a percentage of the assets under management by the Trust Department. Assets under management by the Trust Department are not included on the Company's consolidated financial statements because the Trust Department holds these assets in a fiduciary capacity. At December 31, 2005 and 2004 assets under management by the Trust Department were approximately $886.5 million and $992.3 million, respectively. Changes in fees for services to customers reflect changes in the fee scale used for pricing the services and the volume of services customers utilized. Included in the category of other noninterest income are certain non-recurring transactions that occurred in 2005 as follows: o the sale of the former operations center in Schenectady at a net gain of approximately $600 thousand, o the sale of the credit card portfolio for a net gain of approximately $1.4 million and o the sale of the Canajoharie Branch for a net gain of approximately $600 thousand. These items are not expected to recur in 2006. Noninterest expense: Noninterest expense was $48.6 million in 2005, compared with $48.2 million in 2004 and $48.5 million in 2003. TrustCo's operating philosophy stresses the importance of monitoring and controlling the level of noninterest expense. The efficiency ratio is a strong indicator of how well controlled and monitored these expenses are for a banking enterprise. A low ratio indicates highly efficient performance. TrustCo's efficiency ratio was 38.3% in 2005, 38.8% in 2004 and 38.3% in 2003. Excluded from the efficiency ratio calculation was $3.2 million, $248 thousand, and $255 thousand of non-recurring income and $812 thousand, $1.2 million, and $1.9 million of non-recurring expenses for 2005, 2004 and 2003, respectively. Salaries and employee benefits are the most significant component of noninterest expense. For 2005, these expenses amounted to $20.6 million, compared with $20.7 million in 2004, and $20.4 million in 2003. Net occupancy expense increased $707 thousand between 2004 and 2005 due primarily to new branch openings during 2004 and 2005. Equipment expense, increased $438 thousand for 2005 to $2.7 million as compared to $2.3 million in 2004. The increase in net occupancy expense is the result of new equipment purchased for the branch expansion program and upgrades to the ATM equipment. Professional services expense decreased to $3.4 million in 2005 compared to $3.7 million in 2004 and $3.0 million in 2003. Decrease in professional service expense is due primarily to contract negotiations in 2004 related to computer services. Outsourced service expense was $4.1 million in 2005 compared to $4.3 million in 2004. The decrease is the result of new processing contracts in 2004. Changes in other components of noninterest expense are the results of normal banking activities and the increased activities associated with new branching facilities. Income Tax In 2005, TrustCo recognized income tax expense of $30.8 million, as compared to $26.8 million in 2004 and $23.3 million in 2003. The tax expense on the Company's income was different than tax expense at the federal statutory rate of 35%, due primarily to tax exempt income and, to a lesser extent, the effect of New York State income taxes. Deferred tax assets are recognized subject to management's judgment that realization is more likely than not. Based primarily on the sufficiency of historical and future taxable income, management believes it is more likely than not that the net deferred tax assets of $30.2 million and $33.1 million at December 31, 2005 and 2004, respectively, will be realized. NONINTEREST INCOME
(dollars in thousands) For the year ended December 31, 2005 vs. 2004 2005 2004 2003 Amount Percent Trust department income............................. $ 6,009 5,869 6,046 140 2.4% Fees for services to customers...................... 10,529 10,486 10,896 43 0.4 Net gains on securities transactions................ 5,999 13,712 9,807 (7,713) (56.3) Other............................................... 5,110 1,898 2,900 3,212 169.2 Total noninterest income.......................... $27,647 31,965 29,649 (4,318) (13.5)%
21 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) NONINTEREST EXPENSE
(dollars in thousands) For the year ended December 31, 2005 vs. 2004 2005 2004 2003 Amount Percent Salaries and employee benefits...................... $20,622 20,697 20,449 (75) (0.4)% Net occupancy expense............................... 7,308 6,601 6,265 707 10.7 Equipment expense................................... 2,721 2,283 3,078 438 19.2 Professional services............................... 3,372 3,685 3.040 (313) (8.5) Outsourced services................................. 4,093 4,348 5,601 (255) (5.9) Other real estate income, net....................... (617) (739) (457) 122 (16.5) Other............................................... 11,091 11,290 10,510 (199) (1.8) Total noninterest expense......................... $48,590 48,165 48,486 425 0.9%
Contractual Obligations The Company is contractually obligated to make the following payments on long-term debt and leases as of December 31, 2005: (dollars in thousands) Payments Due by Period: Less Than 1-3 3-5 More Than 1 Year Years Years 5 Years Total Federal Home Loan Bank borrowings........ $ 28 59 -- -- 87 Operating leases.... 2,534 5,473 5,482 31,879 45,368 Total............... $ 2,562 5,532 5,482 31,879 45,455 In addition, the Company is contractually obligated to pay data processing vendors approximately $4 million to $5 million per year through 2013. Impact of Inflation and Changing Prices The consolidated financial statements for the years ended 2005, 2004 and 2003 have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increasing cost of operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary. As a result, changes in interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation, because interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Stock Options In the fourth quarter of 2005 the Board of Director's of the Company approved the accelerated vesting of all outstanding unvested stock options to purchase shares of common stock. These options were previously awarded to executive officers and employees under the 1995 and 2004 Stock Option Plans. By accelerating the vesting of these options the Company estimates that approximately $1.3 million of future compensation expense, net of tax, will be eliminated in anticipation of the adoption of FASB Statement 123R which the Company will adopt as of January 1, 2006. Options to purchase 882,100 shares of the Company's common stock, which would otherwise have vested from time to time over the next four years, became immediately exercisable as a result of this action. The number of shares and the exercise prices of the options subject to the acceleration remained unchanged. Also, all of the other terms of the options remain the same. The Company recorded $127,000 of expense related to this acceleration based upon an analysis performed in accordance with APB Opinion 25. The accelerated options included 749,500 options held by executive officers and 132,600 options held by other employees. Based upon the Company's closing stock price of $12.76 price per share on the date of accelerated vesting certain of the options were below and other above the closing market price as follows: Efficiency Ratio 2003 38.3% 2004 38.8% 2005 38.3% 22 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) Grant Accelerated Exercise Date Vesting Shares Price 2005 411,200 $12.15 2004 394,500 $13.55 2002 76,400 $11.83 ------- 882,100 The decision to accelerate the vesting of these options was made primarily to reduce non-cash compensation expense that would have been recorded in its income statement in future periods upon the adoption of FASB Statement No. 123R (Share-Based Payment) in January 2006. Impact of New Accounting Standards SFAS No. 123R In 2004, the FASB issued a statement to revise Statement of Financial Accounting Standards ("SFAS") No. 123 and SFAS No. 95, "Share-Based Payment," that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The Statement will eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees," and will require instead that such transactions be accounted for using a fair-value-based method. The FASB had indicated that the Statement would be effective for any interim or annual period beginning after June 15, 2005, meaning that an entity should apply the statement to all employee awards of share-based payment granted, modified, or settled in any interim or annual period beginning after June 15, 2005. On April 14, 2005, the Securities and Exchange Commission (SEC) announced the adoption of a new rule that amends the compliance dates for SFAS No. 123R. The SEC's new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. The Company will adopt the provisions of SFAS No. 123R using the modified prospective method of transition beginning January 1, 2006. Under this method, SFAS No. 123R will apply to new awards and to awards that are outstanding on the effective date and are subsequently modified or cancelled. Compensation expense for outstanding awards for which the requisite service period had not been rendered as of the effective date will be recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under SFAS No. 123. Based on stock-based compensation plans outstanding as of December 31, 2005, management does not expect that the impact of SFAS No. 123R will be material to the Company's consolidated financial condition or results of operations. See Note 1, Stock Option Plans, for pro-forma earnings per share for stock-based compensation and information on the acceleration of vesting periods that occurred in 2005. EITF Issue No. 03-1 The Emerging Issues Task Force ("EITF") reached consensus in March 2004 regarding guidance provided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The purpose of EITF Issue No. 03-1 is to determine the meaning of other-than-temporary impairment and its application to certain securities, including debt and equity securities that are within the scope of SFAS No. 115. Guidance in EITF Issue No. 03-1 should be used to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impaired loss. This guidance also includes accounting considerations for securities subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary. Portions of this guidance were effective for reporting periods beginning after June 15, 2004 and other portions will be deliberated further. This delay does not suspend the current requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The Company has not identified any other-than-temporary impairment in its securities portfolio as of December 31, 2005. Subsequent to the FASB final deliberations, the Company will evaluate the potential impact on its process of identifying other-than-temporary declines in value of its debt and equity securities. Management does not believe that the provisions, as currently written, will have a material impact on the results of future operations. SFAS No. 150 In 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liability and equity. SFAS No. 150 has not had a significant impact on the Company's consolidated financial condition or results of operations. SFAS No. 154 In 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error Corrections." This statement replaces Accounting Principles Board Opinion No. 20 "Accounting Changes", and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements" and changes the requirements for the accounting for and reporting of 23 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION (dollars in thousands, except per share data)
2005 2004 Q1 Q2 Q3 Q4 Year Q1 Q2 Q3 Q4 Year Income statement: Interest income........ $34,885 37,016 38,433 39,840 150,174 34,409 34,105 34,951 35,320 138,786 Interest expense....... 10,025 10,308 11,501 13,823 45,657 9,346 9,439 9,797 10,174 38,757 Net interest income ... 24,860 26,708 26,932 26,017 104,517 25,063 24,666 25,154 25,146 100,029 Provision (credit) for loan losses.......... (1,500) (1,580) (1,680) (1,500) (6,260) 150 150 150 -- 450 Net interest income after provision for loan losses.......... 26,360 28,288 28,612 27,517 110,777 24,913 24,516 25,004 25,146 99,579 Noninterest income..... 8,138 6,900 7,102 5,507 27,647 8,721 8,375 8,990 5,879 31,965 Noninterest expense.... 11,730 12,223 11,481 13,156 48,590 12,508 11,699 11,483 12,475 48,165 Income before income taxes......... 22,768 22,965 24,233 19,868 89,834 21,126 21,192 22,511 18,550 83,379 Income tax expense..... 7,861 7,980 8,514 6,490 30,845 6,993 6,821 7,298 5,727 26,839 Net income............. $14,907 14,985 15,719 13,378 58,989 14,133 14,371 15,213 12,823 56,540 Per share data: Basic earnings......... $ .199 .200 .210 .179 .787 .191 .193 .205 .172 .761 Diluted earnings....... .197 .199 .208 .178 .782 .188 .191 .203 .171 .753 Cash dividends declared............. .150 .150 .150 .160 .610 .150 .150 .150 .150 .600
a change in accounting principle. SFAS No. 154 shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Therefore, the Company will adopt this statement, as applicable, on January 1, 2006. Critical Accounting Policies Pursuant to recent SEC guidance, management of the Company is encouraged to evaluate and disclose those accounting policies that are judged to be critical policies -- those most important to the portrayal of the Company's financial condition and results, and that require management's most difficult subjective or complex judgments. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the results of operations. Included in Note 1 to the Consolidated Financial Statements contained in the Company's 2005 Annual Report on Form 10-K is a description of the significant accounting policies that are utilized by the Company in the preparation of the Consolidated Financial Statements. Forward-Looking Statements Statements included in this review and in future filings by TrustCo with the Securities and Exchange Commission, in TrustCo's press releases, and in oral statements made with the approval of an authorized executive officer, which are not historical or current facts, are "forward-looking statements" made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. TrustCo wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The following important factors, among others, in some cases have affected and in the future could affect TrustCo's actual results, and could cause TrustCo's actual financial performance to differ materially from that expressed in any forward-looking statement: (1) credit risk, (2) interest rate risk, (3) competition, (4) changes in the regulatory environment, and (5) changes in local market area and general business and economic trends. The foregoing list should not be construed as exhaustive, and the Company disclaims 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. 24 [LOGO] TRUSTCO Bank Corp NY Management's Discussion and Analysis (continued) FIVE YEAR SUMMARY OF FINANCIAL DATA
(dollars in thousands, except per share data) Years Ended December 31, 2005 2004 2003 2002 2001 Statement of income data: Interest income................................. $ 150,174 138,786 137,130 153,735 168,660 Interest expense................................ 45,657 38,757 40,739 58,020 72,763 Net interest income............................. 104,517 100,029 96,391 95,715 95,897 Provision (credit) for loan losses.............. (6,260) 450 1,200 1,420 4,940 Net interest income after provision for loan losses............................... 110,777 99,579 95,191 94,295 90,957 Noninterest income.............................. 21,648 18,253 19,842 19,799 21,285 Net gain on securities transactions............. 5,999 13,712 9,807 7,499 4,517 Noninterest expense............................. 48,590 48,165 48,486 55,326 51,313 Income before income taxes...................... 89,834 83,379 76,354 66,267 65,446 Income taxes.................................... 30,845 26,839 23,323 17,023 19,936 Net income...................................... $ 58,989 56,540 53,031 49,244 45,510 Share data: Average equivalent diluted shares (in thousands)................................ 75,397 75,081 75,306 74,618 73,673 Tangible book value............................. $ 3.05 3.02 3.06 3.16 2.88 Cash dividends.................................. .610 .600 .600 .600 .541 Basic earnings.................................. .787 .761 .713 .678 .640 Diluted earnings................................ .782 .753 .704 .660 .618 Financial: Return on average assets........................ 2.07% 2.00 1.96 1.83 1.83 Return on average shareholders' equity ......... 26.07 26.65 26.21 26.08 25.31 Cash dividend payout ratio...................... 77.46 78.83 83.98 88.60 84.58 Tier 1 capital to average assets (leverage ratio).............................. 8.04 7.74 7.53 7.78 7.72 Tier 1 capital as a % of total risk adjusted assets........................................ 16.58 17.09 16.54 15.48 13.58 Total capital as a % of total risk adjusted assets........................................ 17.85 18.37 17.82 16.77 14.86 Efficiency ratio................................ 38.29 38.78 38.33 36.66 38.96 Net interest margin............................. 3.90% 3.85 3.94 4.00 4.31 Average balances: Total assets.................................... $2,844,974 2,828,195 2,710,175 2,693,505 2,488,169 Earning assets.................................. 2,767,214 2,729,280 2,606,292 2,579,379 2,376,359 Loans, net...................................... 1,336,899 1,176,856 1,275,023 1,512,448 1,518,768 Allowance for loan losses....................... (47,653) (49,299) (51,311) (56,525) (57,398) Securities available for sale................... 1,024,184 1,057,845 833,905 568,056 581,669 Deposits........................................ 2,505,967 2,474,179 2,340,827 2,212,440 2,027,650 Short-term borrowings........................... 83,381 100,855 107,799 210,363 205,821 Long-term debt.................................. 99 151 326 510 758 Shareholders' equity............................ 226,571 223,719 225,045 214,963 202,848
25 [LOGO] TRUSTCO Bank Corp NY Glossary of Terms Allowance for Loan Losses A balance sheet account which represents management's estimate of probable credit losses in the loan portfolio. The provision for loan losses is added to the allowance account, charge offs of loans decrease the allowance balance and recoveries on previously charged off loans serve to increase the balance. Basic Earnings Per Share Net income divided by the weighted average number of common shares outstanding during the period. Cash Dividends Per Share Total cash dividends for each share outstanding on the record dates. Comprehensive Income Net income plus the change in selected items recorded directly to capital such as the net change in unrealized market gains and losses on securities available for sale. Core Deposits Deposits that are traditionally stable, including all deposits other than time deposits of $100,000 or more. Derivative Investments Investments in futures contracts, forwards, swaps, or other investments with similar characteristics. Diluted Earnings Per Share Net income divided by the weighted average number of common shares outstanding during the period, taking into consideration the effect of any dilutive stock options. Earning Assets The sum of interest-bearing deposits with banks, securities available for sale, investment securities, loans, net of unearned income, and federal funds sold and other short term investments. Efficiency Ratio Noninterest expense (excluding nonrecurring charges, and other real estate expense) divided by taxable equivalent net interest income plus noninterest income (excluding securities transactions and other non-recurring income items). This is an indicator of the recurring total cost of operating the Company in relation to the recurring total income generated. Federal Funds Sold A short term (generally one business day) investment of excess cash reserves from one bank to another. Government Sponsored Enterprises (GSE) Government Sponsored Enterprises are corporations sponsored by the United States government and include the Federal Home Loan Bank (FHLB), the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), and the Federal National Mortgage Association (FNMA or Fannie Mae). Obligations of these enterprises are not guaranteed by the full faith and credit of the United States. Impaired Loans Loans, principally commercial, where it is probable that the borrower will be unable to make the principal and interest payments according to the contractual terms of the loan, and all loans restructured subsequent to January 1, 1995. Interest Bearing Liabilities The sum of interest bearing deposits, federal funds purchased, securities sold under agreements to repurchase, short-term borrowings, and long-term debt. Interest Rate Spread The difference between the taxable equivalent yield on earning assets and the rate paid on interest bearing liabilities. Liquidity The ability to meet loan commitments, deposit withdrawals, and maturing borrowings as they come due. Net Interest Income The difference between income on earning assets and interest expense on interest bearing liabilities. Net Interest Margin Fully taxable equivalent net interest income as a percentage of average earning assets. Net Loans Charged Off Reductions to the allowance for loan losses written off as losses, net of the recovery of loans previously charged off. Nonaccrual Loans Loans for which no periodic accrual of interest income is recognized. Nonperforming Assets The sum of nonperforming loans plus foreclosed real estate properties. Nonperforming Loans The sum of loans in a nonaccrual status (for purposes of interest recognition), plus loans whose repayment criteria have been renegotiated to less than market terms due to the inability of the borrowers to repay the loan in accordance with its original terms, plus accruing loans three payments or more past due as to principal or interest payments. Parent Company A company that owns or controls a subsidiary through the ownership of voting stock. Real Estate Owned Real estate acquired through foreclosure proceedings. Restructured Loans A refinanced loan in which the bank allows the borrower certain concessions that would normally not be considered. The concessions are made in light of the borrower's financial difficulties and the bank's objective to maximize recovery on the loan. Return on Average Assets Net income as a percentage of average total assets. Return on Average Equity Net income as a percentage of average equity, excluding the impact of the mark to market adjustment for securities available for sale. Risk-Adjusted Assets A regulatory calculation that assigns risk factors to various assets on the balance sheet. Risk-Based Capital The amount of capital required by federal regulatory standards, based on a risk-weighting of assets. Tangible Book Value Per Share Total shareholders' equity (less goodwill) divided by shares outstanding on the same date. This provides an indication of the tangible book value of a share of stock. Taxable Equivalent (TE) Tax exempt income that has been adjusted to an amount that would yield the same after tax income had the income been subject to taxation at the statutory federal and/or state income tax rates. Tier 1 Capital Total shareholders' equity excluding the market value adjustment of securities available for sale. 26 [LOGO] TRUSTCO Bank Corp NY Management's Report on Internal Control over Financial Reporting The management of TrustCo Bank Corp NY is responsible for establishing and maintaining adequate internal control over financial reporting. TrustCo's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management has completed an assessment of TrustCo Bank Corp NY's internal control over financial reporting as of December 31, 2005. In making this assessment, we used the criteria set forth by the "Internal Control -- Integrated Framework" promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the "COSO" criteria. Based on our assessment, we believe that, as of December 31, 2005, the Company maintained effective internal control over financial reporting. Management's assessment of the effectiveness of TrustCo Bank Corp NY's internal control over financial reporting and the effectiveness of the Company's internal control over financial reporting as of December 31, 2005 has been audited by KPMG LLP, the Company's independent registered public accounting firm, as stated in their attestation report which is included herein. /s/ Robert J. McCormick Robert J. McCormick President and Chief Executive Officer /s/ Robert T. Cushing Robert T. Cushing Executive Vice President and Chief Financial Officer /s/ Scot R. Salvador Scot R. Salvador Executive Vice President and Chief Banking Officer February 24, 2006 27 [LOGO] TRUSTCO Bank Corp NY Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders TrustCo Bank Corp NY: We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that TrustCo Bank Corp NY (the Company) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that TrustCo Bank Corp NY maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of condition of TrustCo Bank Corp NY and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated February 24, 2006, expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Albany, New York February 24, 2006 28 [LOGO] TRUSTCO Bank Corp NY Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders TrustCo Bank Corp NY: We have audited the accompanying consolidated statements of condition of TrustCo Bank Corp NY and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of TrustCo Bank Corp NY and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2006, expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP Albany, New York February 24, 2006 29 [LOGO] TRUSTCO Bank Corp NY Consolidated Statements of Income
(dollars in thousands, except per share data) Years Ended December 31, 2005 2004 2003 Interest income: Interest and fees on loans...................................................... $ 86,636 75,194 87,614 Interest and dividends on: U.S. Treasuries and agencies.................................................. 34,506 39,795 25,985 States and political subdivisions............................................. 6,301 8,666 10,718 Mortgage-backed securities and collateralized mortgage obligations............ 9,738 7,032 3,618 Other......................................................................... 984 1,424 3,541 Interest on federal funds sold and other short-term investments................. 12,009 6,675 5,654 Total interest income....................................................... 150,174 138,786 137,130 Interest expense: Interest on deposits............................................................ 43,626 37,777 39,843 Interest on short-term borrowings............................................... 2,026 972 877 Interest on long-term debt.................................................... 5 8 19 Total interest expense...................................................... 45,657 38,757 40,739 Net interest income......................................................... 104,517 100,029 96,391 Provision (credit) for loan losses................................................ (6,260) 450 1,200 Net interest income after provision for loan losses......................... 110,777 99,579 95,191 Noninterest income: Trust department income......................................................... 6,009 5,869 6,046 Fees for services to customers.................................................. 10,529 10,486 10,896 Net gain on securities transactions............................................. 5,999 13,712 9,807 Other........................................................................... 5,110 1,898 2,900 Total noninterest income.................................................... 27,647 31,965 29,649 Noninterest expense: Salaries and employee benefits.................................................. 20,622 20,697 20,449 Net occupancy expense........................................................... 7,308 6,601 6,265 Equipment expense............................................................... 2,721 2,283 3,078 Professional services........................................................... 3,372 3,685 3,040 Outsourced services............................................................. 4,093 4,348 5,601 Other real estate income, net................................................... (617) (739) (457) Other........................................................................... 11,091 11,290 10,510 Total noninterest expense................................................... 48,590 48,165 48,486 Income before income taxes ....................................................... 89,834 83,379 76,354 Income taxes...................................................................... 30,845 26,839 23,323 Net income........................................................................ $ 58,989 56,540 53,031 Earnings per share: Basic........................................................................... $ .787 .761 .713 Diluted......................................................................... .782 .753 .704
See accompanying notes to consolidated financial statements. 30 [LOGO] TRUSTCO Bank Corp NY Consolidated Statements of Condition
(dollars in thousands, except share data) As of December 31, 2005 2004 ASSETS Cash and due from banks................................................................. $ 55,667 54,222 Federal funds sold and other short-term investments..................................... 257,196 642,208 Total cash and cash equivalents................................................... 312,863 696,430 Securities available for sale........................................................... 1,084,076 895,989 Loans................................................................................... 1,470,719 1,240,065 Less: Allowance for loan losses....................................................... 45,377 49,384 Net loans....................................................................... 1,425,342 1,190,681 Bank premises and equipment............................................................. 21,734 22,479 Other assets............................................................................ 68,744 58,255 Total assets...................................................................... $2,912,759 2,863,834 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand................................................................................ $ 251,012 237,423 Savings .............................................................................. 725,336 820,593 Interest bearing checking accounts.................................................... 309,668 336,538 Money market deposit accounts......................................................... 190,560 155,299 Certificates of deposit (in denominations of $100,000 or more)........................ 225,611 178,021 Other time accounts................................................................... 860,300 799,228 Total deposits.................................................................... 2,562,487 2,527,102 Short-term borrowings................................................................... 87,935 77,979 Long-term debt.......................................................................... 87 114 Accrued expenses and other liabilities.................................................. 33,589 32,807 Total liabilities................................................................. 2,684,098 2,638,002 Shareholders' equity: Capital stock; $1 par value. 100,000,000 shares authorized, 82,119,360 and 81,727,754 shares issued at December 31, 2005 and 2004, respectively................ 82,120 81,728 Surplus............................................................................... 117,770 114,218 Undivided profits..................................................................... 103,315 90,018 Accumulated other comprehensive income/(loss): Net unrealized (loss)/gain on securities available for sale, net of tax............. (6,054) 4,459 Treasury stock; 7,343,783 and 7,187,784 shares, at cost, at December 31, 2005 and 2004, respectively.............................................................. (68,490) (64,591) Total shareholders' equity........................................................ 228,661 225,832 Total liabilities and shareholders' equity........................................ $2,912,759 2,863,834
See accompanying notes to consolidated financial statements. 31 [LOGO] TRUSTCO Bank Corp NY Consolidated Statements of Changes in Shareholders' Equity
(dollars in thousands, except per share data) Three Years Ended December 31, 2005 Accumulated Other Compre- Capital Undivided Comprehensive hensive Treasury Stock Surplus Profits Income (Loss) Income Stock Total Beginning balance, January 1, 2003 $79,108 92,009 69,553 27,277 (33,103) 234,844 Comprehensive income Net income -- 2003...................... -- -- 53,031 -- 53,031 -- 53,031 Other comprehensive loss, net of tax: Unrealized net holding loss arising during the year, net of tax (pre-tax loss $1,059)...... -- -- -- -- (608) -- -- Reclassification adjustment for net gain realized in net income during the year (pre-tax gain $9,807)................. -- -- -- -- (5,627) -- -- Other comprehensive loss................ -- -- -- (6,235) (6,235) -- (6,235) Comprehensive income...................... 46,796 Cash dividend declared, $.600 per share... -- -- (44,533) -- -- (44,533) Stock options exercised and related tax benefits................ 1,603 10,481 -- -- -- 12,084 Treasury stock purchased (2,525,000 shares)...................... -- -- -- -- (30,034) (30,034) Sale of treasury stock (690,181 shares)... -- 1,121 -- -- 6,484 7,605 Ending balance, December 31, 2003......... 80,711 103,611 78,051 21,042 (56,653) 226,762 Comprehensive income Net income -- 2004...................... -- -- 56,540 -- 56,540 -- 56,540 Other comprehensive loss, net of tax: Unrealized net holding loss arising during the year, net of tax (pre-tax loss of $13,868).. -- -- -- -- (8,335) -- -- Reclassification adjustment for net gain realized in net income during the year (pre-tax gain $13,712)................ -- -- -- -- (8,248) -- -- Other comprehensive loss................ -- -- -- (16,583) (16,583) -- (16,583) Comprehensive income...................... 39,957 Cash dividend declared, $.600 per share... -- -- (44,573) -- -- (44,573) Stock options exercised and related tax benefits................ 1,017 8,264 -- -- -- 9,281 Treasury stock purchased (1,021,397 shares)...................... -- -- -- -- (13,482) (13,482) Sale of treasury stock (598,732 shares)... -- 2,343 -- -- 5,544 7,887 Ending balance, December 31, 2004......... 81,728 114,218 90,018 4,459 (64,591) 225,832 Comprehensive income Net income -- 2005...................... -- -- 58,989 -- 58,989 -- 58,989 Other comprehensive loss, net of tax: Unrealized net holding loss arising during the year, net of tax (pre-tax loss $11,487)..... -- -- -- -- (6,905) -- -- Reclassification adjustment for net gain realized in net income during the year (pre-tax gain $5,999)................. -- -- -- -- (3,608) -- -- Other comprehensive loss................ -- -- -- (10,513) (10,513) -- (10,513) Comprehensive income...................... 48,476 Cash dividend declared, $.610 per share... -- -- (45,692) -- -- (45,692) Stock options exercised and related tax benefits.................... 392 3,426 -- -- -- 3,818 Non-cash stock based compensation expense net of tax...................... -- 77 -- -- -- 77 Treasury stock purchased (1,172,366 shares)...................... -- -- -- -- (14,846) (14,846) Sale of treasury stock (1,016,367 shares)...................... -- 49 -- -- 10,947 10,996 Ending balance, December 31, 2005......... $82,120 117,770 103,315 (6,054) (68,490) 228,661
See accompanying notes to consolidated financial statements. 32 [LOGO] TRUSTCO Bank Corp NY Consolidated Statements of Cash Flows
(dollars in thousands) Years Ended December 31, 2005 2004 2003 Increase/(decrease) in cash and cash equivalents Cash flows from operating activities: Net income................................................................... $ 58,989 56,540 53,031 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization........................................... 2,690 1,898 2,492 Net gain on sales of real estate owned.................................. (690) (893) (522) Net (gain)/loss on sales of bank premises and equipment................. (665) 55 (263) (Credit)/provision for loan losses...................................... (6,260) 450 1,200 Deferred tax expense/(benefit).......................................... 2,874 3,106 (2,645) Net gain on securities transactions..................................... (5,999) (13,712) (9,807) Decrease/(increase) in taxes receivable................................. 2,760 (2,424) 3,356 (Increase)/decrease in interest receivable.............................. (3,761) 2,864 (2,837) Increase/(decrease) in interest payable................................. 659 75 (507) (Increase)/decrease in other assets..................................... (5,289) 5,011 (1,761) Decrease in accrued expenses............................................ (665) (8,037) (3,636) Total adjustments.................................................... (14,346) (11,607) (14,930) Net cash provided by operating activities............................ 44,643 44,933 38,101 Cash flows from investing activities: Proceeds from sales and calls of securities available for sale............. 275,855 1,155,807 1,064,580 Proceeds from maturities of securities available for sale.................. 1,781 881 3,573 Purchases of securities available for sale................................. (477,210) (889,618) (1,592,974) Net (increase)/decrease in loans .......................................... (228,457) (77,604) 255,016 Proceeds from sales of real estate owned .................................. 723 893 608 Proceeds from sales of bank premises and equipment......................... 2,576 23 271 Purchases of bank premises and equipment................................... (3,855) (4,287) (2,953) Net cash (used in) provided by investing activities........................ (428,587) 186,095 (271,879) Cash flows from financing activities: Net increase in deposits................................................... 35,385 107,292 145,542 Net increase (decrease) in short-term borrowings........................... 9,956 (12,629) (50,623) Repayment of long-term debt................................................ (27) (125) (188) Proceeds from exercise of stock options and related tax benefits........... 3,818 9,281 12,084 Proceeds from sales of treasury stock...................................... 10,996 7,887 7,605 Payments to acquire treasury stock......................................... (14,846) (13,482) (30,034) Dividends paid............................................................. (44,905) (44,504) (45,008) Net cash provided by financing activities.................................. 377 53,720 39,378 Net (decrease)/increase in cash and cash equivalents......................... (383,567) 284,748 (194,400) Cash and cash equivalents at beginning of year............................... 696,430 411,682 606,082 Cash and cash equivalents at end of year..................................... $ 312,863 696,430 411,682 SUPPLEMENTAL INFORMATION: Interest paid................................................................ $ 44,998 38,681 41,246 Income taxes paid............................................................ 27,388 24,038 18,865 Transfer of loans to real estate owned....................................... 56 -- -- Increase/(decrease) in dividends payable..................................... 787 69 (475) Change in unrealized gain on securities available for sale -- gross.......... (17,486) (27,579) 10,865 Change in deferred tax effect on unrealized gain on securities available for sale......................................................... 6,973 10,996 (4,630) Non-cash stock-based compensation expense, net of tax........................ 77 -- --
See accompanying notes to consolidated financial statements. 33 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (1) Basis of Presentation The accounting and financial reporting policies of TrustCo Bank Corp NY (Company or TrustCo), ORE Subsidiary Corp., Trustco Charitable Foundation, Inc., Trustco Bank (referred to as Trustco Bank or Bank), and its wholly owned subsidiary, Trustco Vermont Investment Company, and its subsidiary Trustco Realty Corporation conform to general practices within the banking industry and are in conformity with accounting principles generally accepted in the United States of America. A description of the more significant policies follows. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Consolidation The consolidated financial statements of the Company include the accounts of the subsidiaries after elimination of all significant intercompany accounts and transactions. Securities Available for Sale Securities available for sale are carried at approximate market value with any unrealized appreciation or depreciation of value, net of tax, included as an element of accumulated other comprehensive income or loss in shareholders' equity. Management maintains an available for sale portfolio in order to provide maximum flexibility in balance sheet management. The designation of available for sale is made at the time of purchase based upon management's intent to hold the securities for an indefinite period of time. These securities, however, are available for sale in response to changes in market interest rates, related changes in liquidity needs, or changes in the availability of and yield on alternative investments. Unrealized losses on securities that reflect a decline in value which is other than temporary, if any, are charged to income. Nonmarketable equity securities (principally stock of the Federal Reserve Bank and the Federal Home Loan Bank, both of which are required holdings for the Company) are included in securities available for sale at cost since there is no readily available market value. The cost of debt securities available for sale is adjusted for amortization of premium and accretion of discount using the level yield method. Gains and losses on the sale of securities available for sale are based on the amortized cost of the specific security sold at trade date. Loans Loans are carried at the principal amount outstanding net of unearned income and unamortized loan fees and costs, which are recognized as adjustments to interest income over the applicable loan term. Nonperforming loans include nonaccrual loans, restructured loans, and loans which are three payments or more past due and still accruing interest. Generally, loans are placed in nonaccrual status either due to the delinquent status of principal and/or interest payments, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent. Future payments received on nonperforming loans are recorded as interest income or principal reductions based upon management's ultimate expectation for collection. Loans may be removed from nonaccrual status when they become current as to principal and interest and have demonstrated a sustained ability to make loan payments in accordance with the contractual terms of the loan. Loans may also be removed from nonaccrual status when, in the opinion of management, the loan is expected to be fully collectable as to principal and interest. Impaired loans have been defined as commercial and commercial real estate loans in nonaccrual status and restructured loans. Income recognition for impaired loans is consistent with income recognition for nonaccruing loans. Allowance for Loan Losses The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses based on consideration of the credit risk of the loan portfolio, including a review of past experience, current economic conditions, and underlying collateral value. The allowance is increased by provisions charged against income, or decreased by credits added to income, and reduced/increased by net charge offs/recoveries. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to change the allowance based on their judgments of information available to them at the time of their examination. Bank Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization computed on either the straight-line or accelerated methods over the remaining useful lives of the assets. 34 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) Real Estate Owned Real estate owned are assets acquired through foreclosures on loans. Foreclosed assets held for sale are recorded on an individual basis at the lower of (1) fair value minus estimated costs to sell or (2) "cost" (which is the fair value at initial foreclosure). When a property is acquired, the excess of the loan balance over fair value is charged to the allowance for loan losses. Subsequent write downs and gains on sale are included in noninterest expense. Income Taxes Deferred taxes are recorded for the future tax consequences of events that have been recognized in the financial statements or tax returns based upon enacted tax laws and rates. Deferred tax assets are recognized subject to management's judgment that realization is more likely than not. Dividend Restrictions Banking regulations restrict the amount of cash dividends which may be paid during a year by Trustco Bank to the Company without the written consent of the appropriate bank regulatory agency. Based on these restrictions, during 2006 Trustco Bank could pay cash dividends to the Company of $52.5 million plus 2006 year-to-date net profits. Benefit Plans The Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee's compensation. The Company has a postretirement benefit plan that permits retirees under age 65 to participate in the Company's medical plan by which retirees pay all of their premiums. At age 65, the Company provides access to a Medicare Supplemental program for retirees. Stock Option Plans The Company has stock option plans for officers and directors and has adopted the disclosure only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (Statement 123) and Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure" (Statement 148). The Company's stock option plans are accounted for in accordance with the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion 25) and as such, no compensation expense is ordinarily recorded for these plans. In the fourth quarter of 2005 the Board of Director's of the Company approved the accelerated vesting of all outstanding unvested stock option to purchase shares of common stock. These options were previously awarded to executive officers and employees under the 1995 and 2004 Stock Option Plans. By accelerating the vesting of these options the Company estimates that approximately $1.3 million of future compensation expense, net of tax, will be eliminated in anticipation of the adoption of Statement 123R which the Company will adopt as of January 1, 2006. Options to purchase 882,100 shares of the Company's common stock, which would otherwise have vested from time to time over the next four years, became immediately vested and exercisable as a result of this action. The number of shares and exercise prices of the options subject to the acceleration remained unchanged. Also, all of the other terms of the options remain the same. The Company recorded $127 thousand of expense related to this acceleration based upon an analysis performed in accordance with APB Opinion 25. The accelerated options included 749,500 options held by executive officers and 132,600 options held by other employees. Based upon the Company's closing stock price of $12.76 per share on the date of accelerated vesting certain of the options were below and others above the closing market price as follows: Grant Accelerated Exercise Date Vesting Shares Price 2005 411,200 $12.15 2004 394,500 $13.55 2002 76,400 $11.83 ------- 882,100 The decision to accelerate the vesting of these options was made primarily to reduce non-cash compensation expense that would have been recorded in its income statement in future periods upon the adoption of FASB Statement No. 123R (Share-Based Payment) in January 2006. Had compensation expense for the Company's stock option plans been determined consistent with Statement 123, the Company's net income and earnings per share would have been as follows: (dollars in thousands, except per share data) 2005 2004 2003 Net income: As reported................ $58,989 56,540 53,031 Deduct: total stock-based compensation expense, net of related tax effects..... (2,035) (868) (926) Pro forma net income....... $56,954 55,672 52,105 Earnings per share: Basic -- as reported....... $ .787 .761 .713 Basic -- pro forma......... .760 .750 .701 Diluted -- as reported..... .782 .753 .704 Diluted -- pro forma....... .755 .742 .692 35 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) The weighted average fair value of each option as of the grant date, estimated using the Black-Scholes pricing model, and calculated in accordance with Statement 123 was as follows for options granted in the year indicated: Employees' Directors' Plan Plan 2005............................. $1.675 1.480 2004............................. 2.090 1.870 Stock options were not issued in 2003 for officers or directors. The following assumptions were utilized in the calculation of the fair value of the options under Statement 123: Employees' Directors' Plan Plan Expected dividend yield: 2005........................ 4.95% 4.95 2004........................ 4.32 4.32 Risk-free interest rate: 2005........................ 3.91 3.76 2004........................ 3.89 3.71 Expected volatility rate: 2005........................ 21.25 19.76 2004........................ 21.42 20.38 Expected lives................... 7.5 years 6.0 years Earnings Per Share Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares outstanding during the period, taking into consideration the effect of any dilutive stock options. Reclassification of Prior Year Statements It is the Company's policy to reclassify prior year consolidated financial statements to conform to the current year presentation. Segment Reporting The Company's operations are exclusively in the financial services industry and include the provision of traditional banking services. Management evaluates the performance of the Company based on only one business segment, that of community banking. The Company operates primarily in the geographical region of Upstate New York with new Company operations in Florida and the mid-Hudson valley region of New York. In the opinion of management, the Company does not have any other reportable segments as defined by Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information". Cash and Cash Equivalents The Company classifies cash on hand, cash due from banks, federal funds sold, and other short-term investments as cash and cash equivalents for disclosure purposes. Trust Assets Assets under management by the Trust Department are not included on the Company's consolidated financial statements because the Trust Department holds these assets in a fiduciary capacity. Intangible Assets Intangible assets consist of goodwill arising from the acquisition of Landmark Financial Corporation in a purchase business combination during 2000. Due to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" effective January 1, 2002, goodwill is no longer being amortized. The Company considers this intangible asset to be unimpaired at December 31, 2005 and 2004. Goodwill at December 31, 2005 and 2004 was $553 thousand. Comprehensive Income Comprehensive income represents the sum of net income and items of other comprehensive income or loss, which are reported directly in shareholders' equity, net of tax, such as the change in net unrealized gain or loss on securities available for sale. The Company has reported comprehensive income and its components in the Consolidated Statements of Changes in Shareholders' Equity. Accumulated other comprehensive income or loss, which is a component of shareholders' equity, represents the net unrealized gain or loss on securities available for sale, net of tax. (2) Balances at Other Banks The Company is required to maintain certain reserves of vault cash and/or deposits with the Federal Reserve Bank. The amount of this reserve requirement, included in cash and due from banks, was approximately $20.5 million and $19.6 million at December 31, 2005 and 2004, respectively. 36 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) (3) Securities Available for Sale The amortized cost and market value of the securities available for sale are as follows:
(dollars in thousands) December 31, 2005 Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value U.S. Treasuries and agencies..................... $ 499 -- 1 498 Government sponsored enterprises...................... 756,525 -- 13,260 743,265 States and political subdivisions..................... 115,010 4,143 203 118,950 Mortgage-backed securities and collateralized mortgage obligations...................... 202,007 593 1,637 200,963 Other.............................. 685 -- 4 681 Total debt securities....................... 1,074,726 4,736 15,105 1,064,357 Equity securities.................. 19,418 301 -- 19,719 Total securities available for sale............................. $1,094,144 5,037 15,105 1,084,076
(dollars in thousands) December 31, 2004 Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value U.S. Treasuries and agencies..................... $ 500 -- -- 500 Government sponsored enterprises...................... 521,078 98 4,115 517,061 States and political subdivisions..................... 147,988 7,033 82 154,939 Mortgage-backed securities and collateralized mortgage obligations...................... 201,579 1,466 1,422 201,623 Other.............................. 685 -- -- 685 Total debt securities....................... 871,830 8,597 5,619 874,808 Equity securities.................. 16,741 4,440 -- 21,181 Total securities available for sale............................. $888,571 13,037 5,619 895,989
Federal Home Loan Bank stock and Federal Reserve Bank stock included in equity securities at December 31, 2005 and 2004, was $4.7 million and $12.1 million, respectively. The following table distributes the debt securities included in the available for sale portfolio as of December 31, 2005, based on the securities' final maturity (mortgage-backed securities and collateralized mortgage obligations are stated using an estimated average life): (dollars in thousands) Amortized Market Cost Value Due in one year or less.................. $ 26,490 26,347 Due after one year through five years.... 341,367 338,942 Due after five years through ten years... 138,355 136,778 Due after ten years...................... 568,514 562,290 $1,074,726 1,064,357 Actual maturities may differ from contractual maturities because of securities prepayments and the right of certain issuers to call or prepay their obligations without penalty. Gross unrealized losses on investment securities available for sale and the related fair values aggregated by the length of time that individual securities have been in an unrealized loss position, were as follows:
(dollars in thousands) December 31, 2005 Less than 12 months 12 months or more Total Gross Gross Gross Fair Unreal. Fair Unreal. Fair Unreal. Value Loss Value Loss Value Loss U.S. Treasuries and agencies........... $ 498 1 -- -- 498 1 Government sponsored enterprises............ 653,612 10,413 89,653 2,847 743,265 13,260 States and political subdivisions........... 18,024 156 2,808 47 20,832 203 Mortgage-backed securities and collateralized mortgage obligations............ 40,623 537 107,329 1,100 147,952 1,637 Other.................... 596 4 -- -- 596 4 Total.................... $713,353 11,111 199,790 3,994 913,143 15,105
37 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued)
(dollars in thousands) December 31, 2004 Less than 12 months 12 months or more Total Gross Gross Gross Fair Unreal. Fair Unreal. Fair Unreal. Value Loss Value Loss Value Loss Government sponsored enterprises............ $381,738 3,248 82,133 867 463,871 4,115 States and political subdivisions........... 3,046 63 908 19 3,954 82 Mortgage-backed securities and collateralized mortgage obligations............ 125,090 1,419 1,433 3 126,523 1,422 Total.................... $509,874 4,730 84,474 889 594,348 5,619
U.S. Treasuries and agencies,Government sponsored enterprises, and States and political subdivisions: The unrealized losses on these investments were caused by market interest rate increases. The contractual terms of these investments require the issuer to settle the securities at par upon maturity of the investment. Because the Company has the ability to hold these investments until a market price recovery or possibly to maturity and the Company has no current intent to sell these securities, these investments are not considered other-than-temporarily impaired. Mortgage-backed securities and collateralized mortgage obligations: The unrealized losses on investments in mortgage-backed securities and collateralized mortgage obligations were caused by market interest rate increases. The contractual cash flows of these securities or the underlying loans are guaranteed by various government agencies or government sponsored enterprises. Because the decline in fair value is attributable to changes in market interest rates and not credit quality, and because the Company has the ability to hold these investments until a market price recovery or possibly to maturity and the Company has no current intent to sell these securities, these investments are not considered other-than-temporarily impaired. The proceeds from sales and calls of securities, gross realized gains and gross realized losses from sales and calls during 2005, 2004 and 2003 are as follows: (dollars in thousands) December 31, 2005 2004 2003 Proceeds............................ $275,855 1,155,807 1,064,580 Gross realized gains................ 6,297 25,006 22,645 Gross realized losses............... 298 11,294 12,838 The amount of securities available for sale that have been pledged to secure short-term borrowings and for other purposes required by law amounted to $104.7 million and $96.3 million at December 31, 2005 and 2004, respectively. The Company has the following balances of securities available for sale as of December 31, 2005 that represent greater than 10% of shareholders equity: Amortized Market Cost Value Federal Home Loan Bank.............. $211,158 207,726 Federal National Mortgage Association.............. 217,850 215,144 Federal Home Loan Mortgage Corporation.............. 474,167 466,435 Federal Farm Credit Bank............ 24,900 24,469 (4) Loans and Allowance for Loan Losses A summary of loans by category is as follows: (dollars in thousands) December 31, 2005 2004 Commercial.......................... $ 202,570 193,188 Real estate -- construction......... 22,123 20,148 Real estate mortgage................ 1,047,994 822,103 Home equity lines of credit......... 192,291 191,242 Installment loans................... 5,741 13,384 Total loans......................... 1,470,719 1,240,065 Less: Allowance for loan losses..... 45,377 49,384 Net loans........................... $1,425,342 1,190,681 At December 31, 2005 and 2004, loans to executive officers, directors, and to associates of such persons aggregated $3.0 million and $2.0 million, respectively. During 2005, approximately $1.2 million of new loans were made and repayments of loans totalled approximately $263 thousand. In the opinion of management, such loans were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions. These loans do not involve more than normal risk of collectibility or present other unfavorable features. TrustCo lends primarily in the Capital District region of New York State and in the geographic territory surrounding its borders, and to a lesser extent, in Florida and the mid-Hudson Valley region of New York. Although the loan portfolio is diversified, a portion of its debtors' ability to repay depends significantly on the economic conditions prevailing in New York State. 38 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) The following table sets forth information with regard to nonperforming loans: (dollars in thousands) December 31, 2005 2004 2003 Loans in nonaccrual status.......... $1,662 557 -- Loans contractually past due 3 payments or more and still accruing interest............... 35 -- -- Restructured loans.................. 1,518 2,610 3,260 Total nonperforming loans........... $3,215 3,167 3,260 Interest on nonaccrual and restructured loans of $250 thousand in 2005, $377 thousand in 2004, and $500 thousand in 2003 would have been earned in accordance with the original contractual terms of the loans. Approximately $201 thousand, $329 thousand, and $431 thousand of interest on nonaccrual and restructured loans was collected and recognized as income in 2005, 2004, and 2003, respectively. There are no commitments to extend further credit on nonaccrual or restructured loans. Transactions in the allowance for loan losses account are summarized as follows: (dollars in thousands) For the years ended December 31, 2005 2004 2003 Balance at beginning of year........ $49,384 48,739 52,558 Provision (credit) for loan losses.. (6,260) 450 1,200 Loans charged off................... (2,464) (5,797) (9,598) Recoveries on loans previously charged off............ 4,717 5,992 4,579 Balance at year end................. $45,377 49,384 48,739 The Company identifies impaired loans and measures the impairment in accordance with Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" (Statement 114), as amended. A loan is considered impaired when it is probable that the borrower will be unable to repay the loan according to the original contractual terms of the loan agreement or the loan is restructured in a troubled debt restructuring. These standards are applicable principally to commercial and commercial real estate loans; however, certain provisions dealing with restructured loans also apply to retail loan products. There were no nonaccrual commercial and commercial real estate loans classified as impaired loans at December 31, 2005 and 2004. Retail loans totaling $1.5 million as of December 31, 2005, and $2.6 million as of December 31, 2004, were restructured after the effective date of Statement 114 and, accordingly, are identified as impaired loans. None of the allowance for loan losses has been specifically allocated to these retail loans. During 2005, 2004, and 2003, the average balance of impaired loans was $1.9 million, $2.9 million, and $3.7 million, respectively, and there was approximately $201 thousand, $314 thousand, and $380 thousand of interest income recorded on these loans in the accompanying Consolidated Statements of Income. (5) Bank Premises and Equipment A summary of premises and equipment at December 31, 2005 and 2004 follows: (dollars in thousands) 2005 2004 Land......................................... $ 2,413 2,786 Buildings.................................... 23,208 28,038 Furniture, fixtures and equipment............ 25,231 23,318 Leasehold improvements....................... 6,467 6,260 57,319 60,402 Accumulated depreciation and amortization............................... (35,585) (37,923) Total........................................ $ 21,734 22,479 Depreciation and amortization expense approximated $2.7 million, $1.9 million, and $2.5 million for the years 2005, 2004, and 2003, respectively. Occupancy expense of the Bank's premises included rental expense of $2.4 million in 2005, $2.1 million in 2004, and $1.8 million in 2003. (6) Deposits Interest expense on deposits was as follows: (dollars in thousands) For the years ended December 31, 2005 2004 2003 Interest bearing checking accounts................. $ 1,376 1,586 1,678 Savings accounts.................... 6,769 7,968 8,795 Time deposits and money market accounts............. 35,481 28,223 29,370 Total............................... $43,626 37,777 39,843 At December 31, 2005, the maturity of total time deposits is as follows: (dollars in thousands) Under 1 year................................. $538,982 1 to 2 years................................. 172,089 2 to 3 years................................. 183,354 3 to 4 years................................. 109,354 4 to 5 years................................. 79,576 Over 5 years................................. 2,556 $1,085,911 39 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) (7) Short-Term Borrowings Short-term borrowings of the Company were cash management accounts as follows: (dollars in thousands) 2005 2004 Amount outstanding at December 31,...................... $87,935 77,979 Maximum amount outstanding at any month end......................... 87,935 115,681 Average amount outstanding....................... 83,381 100,855 Weighted average interest rate: For the year...................... 2.43 0.96 As of year end.................... 3.32 2.00 The Cash Management Account represents retail deposits with customers for which the Bank has pledged certain assets as collateral. Trustco also has an available line of credit with the Federal Home Loan Bank which approximates the balance of securities pledged against such borrowings. (8) Long-Term Debt Long-term debt at December 31, 2005 and 2004, of $87 thousand and $114 thousand consisted of a FHLB term loan with an interest rate of 5.22% maturing in 2008. This debt was assumed as part of an acquisition during 2000. The FHLB loan is collateralized by approximately $500 thousand in deposits at the FHLB. (9) Income Taxes A summary of income tax expense/(benefit) included in the Consolidated Statements of Income follows: For the years ended December 31, (dollars in thousands) 2005 2004 2003 Current tax expense: Federal........................... $ 26,161 23,337 25,104 State............................. 1,810 396 864 Total current tax expense........... 27,971 23,733 25,968 Deferred tax expense (benefit)...... 2,874 3,106 (2,645) Total income tax expense............ $ 30,845 26,839 23,323 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2005 and 2004, are as follows: December 31, (dollars in thousands) 2005 2004 Deductible Deductible temporary temporary differences differences Benefits and deferred remuneration.................... $ 460 1,632 Deferred loan fees, net............. 15 79 Difference in reporting the allowance for loan losses, net.. 21,676 22,565 Other income or expense not yet reported for tax purposes.................... 5,254 6,633 Depreciable assets.................. 2,253 1,502 Other items......................... 555 676 Net deferred tax asset at end of year.................. 30,213 33,087 Net deferred tax asset at beginning of year............... 33,087 36,193 Deferred tax expense................ $ 2,874 3,106 Deferred tax assets are recognized subject to management's judgment that realization is more likely than not. Based primarily on the sufficiency of historical and expected future taxable income, management believes it is more likely than not that the remaining deferred tax asset of $30.2 million and $33.1 million at December 31, 2005 and 2004, respectively, will be realized. In addition to the deferred tax items described in the preceding table, the Company has a deferred tax asset of $4.0 million and a deferred tax liability of $3.0 million at December 31, 2005 and 2004, relating to the net unrealized losses/gains on securities available for sale, respectively. The effective tax rates differ from the statutory federal income tax rate. The reasons for these differences are as follows: For the years ended December 31, 2005 2004 2003 Statutory federal income tax rate... 35.0% 35.0 35.0 Increase/(decrease) in taxes resulting from: Tax exempt income................ (2.3) (3.5) (4.6) State income tax, net of federal tax benefit............. 1.7 0.8 0.8 Other items...................... (0.1) (0.1) (0.6) Effective income tax rate........... 34.3% 32.2 30.6 40 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) (10) Benefit Plans (a) Retirement Plan The Company maintains a trusteed non-contributory pension plan covering employees that have completed one year of employment and 1,000 hours of service. The benefits are based on the sum of (a) a benefit equal to a prior service benefit plus the average of the employees' highest five consecutive years' compensation in the ten years preceding retirement multiplied by a percentage of service after a specified date plus (b) a benefit based upon career average compensation. The amounts contributed to the plan are determined annually on the basis of (a) the maximum amount that can be deducted for federal income tax purposes or (b) the amount certified by a consulting actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Assets of the plan are administered by Trustco Bank's Trust Department. The following tables set forth the plan's funded status as of a December 31 measurement date and amounts recognized in the Company's consolidated statements of condition at December 31, 2005 and 2004. Change in Projected Benefit Obligation: (dollars in thousands) 2005 2004 Projected benefit obligation at beginning of year.............. $27,581 24,555 Service cost........................ 804 784 Interest cost....................... 1,519 1,499 Benefits paid....................... (1,567) (1,411) Net actuarial loss.................. 205 2,154 Projected benefit obligation at end of year.................... $28,542 27,581 Change in Plan Assets and Reconciliation of Funded Status: (dollars in thousands) 2005 2004 Fair value of plan assets at beginning of year................. $29,242 28,474 Actual gain on plan assets.......... 1,323 2,179 Benefits paid....................... (1,567) (1,411) Fair value of plan assets at end of year.................... 28,998 29,242 Funded status....................... 457 1,661 Unrecognized net actuarial loss..... 746 14 Unrecognized prior service cost..... 1,595 1,702 Net amount recognized............... $2,798 3,377 The accumulated benefit obligation for the plan was $25.8 million and $24.4 million at December 31, 2005 and 2004, respectively. Components of Net Periodic Pension Expense: For the years ended December 31, (dollars in thousands) 2005 2004 2003 Service cost........................ $ 804 784 695 Interest cost....................... 1,519 1,499 1,409 Expected return on plan assets...... (1,850) (1,669) (1,665) Amortization of unrecognized prior service cost................ 106 90 25 Net periodic pension expense........ $ 579 704 464 Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: (dollars in thousands) Year Pension Benefits 2006................................ $1,537 2007................................ 1,500 2008................................ 1,480 2009................................ 1,462 2010................................ 1,467 2011 -- 2015........................ 7,806 The assumptions used to determine benefit obligations at December 31 are as follows: 2005 2004 Discount rate................................ 5.50% 5.75 Rate of increase in future compensation...... 4.00 5.00 The assumptions used to determine net periodic pension expense for the years ended December 31 are as follows: 2005 2004 2003 Discount rate....................... 5.75% 6.00 6.50 Rate of increase in future compensation...................... 4.50 5.00 5.00 Expected long-term rate of return on assets......................... 6.50 6.00 6.50 The Company also has a supplementary pension plan under which additional retirement benefits are accrued for eligible executive officers. The expense recorded for this plan was $581 thousand, $662 thousand, and $1.2 million, in 2005, 2004, and 2003, respectively. This plan supplements the defined benefit retirement plan for eligible employees that are negatively affected by the Internal Revenue Service limit on the amount of pension payments that are allowed from a retirement plan. The supplemental plan provides eligible employees with total benefit payments as calculated by the retirement plan without regard to this limitation. Benefits under this plan are calculated using the same actuarial assumptions and interest rates as used for the retirement plan calculations. 41 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) Rabbi trusts have been established for certain benefit plans. These trust accounts are administered by the Company's Trust Department and invest primarily in money market instruments. These assets are recorded at their market value and are included as other assets in the Consolidated Statements of Condition. As of December 31, 2005 and 2004, the trusts had assets totaling $5.7 million and $5.0 million, respectively. (b) Postretirement Benefits The Company permits retirees under age 65 to participate in the Company's medical plan by making certain payments. At age 65, the Bank provides a Medicare Supplemental program to retirees. Assets of the plan are invested primarily in individual stocks, index funds, and tax exempt bonds. In 2003, the Company amended the medical plan to reflect changes to the retiree medical insurance coverage portion. The Company's subsidy of the retiree medical insurance premiums has been eliminated. The Company continues to provide postretirement medical benefits for a limited number of retired executives in accordance with their employment contracts. The following tables show the plan's funded status as of a December 31 measurement date and amounts recognized in the Company's Consolidated Statements of Condition at December 31, 2005 and 2004. Change in Accumulated Benefit Obligation: (dollars in thousands) 2005 2004 Accumulated benefit obligation at beginning of year....................... $ 891 790 Service cost................................. 35 12 Retiree contributions........................ 176 230 Interest cost................................ 65 31 Benefits paid................................ (221) (324) Net actuarial loss........................... 326 152 Accumulated benefit obligation at end of year............................. $1,272 891 Change in Plan Assets and Reconciliation of Funded Status: (dollars in thousands) 2005 2004 Fair value of plan assets at beginning of year.......................... $11,726 10,986 Actual gain on plan assets................... 491 834 Retiree contributions........................ 176 230 Benefits paid................................ (221) (324) Fair value of plan assets at end of year..... 12,172 11,726 Funded status................................ 10,901 10,835 Unrecognized net actuarial gain.............. (2,680) (3,014) Unrecognized prior service credit............ (6,780) (7,182) Net amount recognized........................ $ 1,441 639 Components of Net Periodic Benefit: For the years ended December 31, (dollars in thousands) 2005 2004 2003 Service cost........................ $ 35 12 4 Interest cost....................... 65 31 46 Expected return on plan assets...... (405) (428) (377) Amortization of net actuarial gain.................... (75) (107) (43) Amortization of prior service credit.................... (403) (403) (403) Net periodic benefit................ $(783) (895) (773) Expected Future Benefit Payments The following benefit payments are expected to be paid: (dollars in thousands) Year Postretirement Benefits 2006................................ $ 43 2007................................ 45 2008................................ 47 2009................................ 48 2010................................ 50 2011 -- 2015........................ 271 The discount rate assumption used to determine benefit obligations at December 31 is as follows: 2005 2004 Discount rate................................ 5.50% 5.75 The assumptions used to determine net periodic pension benefit for the years ended December 31 are as follows: 2005 2004 2003 Discount rate....................... 5.75% 6.00 6.50 Expected long-term rate of return on assets, net of tax............. 3.45 3.90 3.90 For measurement purposes, a graded annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was assumed for 2006 and thereafter. Due to the plan amendment recognized in 2003 relating to the reimbursed portion of the retiree's medical insurance premiums, a one percentage point increase or decrease in the assumed health care cost in each year would have a negligible impact on the accumulated postretirement benefit obligation as of December 31, 2005, and the interest and service components of net periodic postretirement benefit cost for the year ended December 31, 2005. 42 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) (c) Major Categories of Pension and Postretirement Benefit Plan Assets: The asset allocations of the Company's pension and postretirement benefit plans at December 31, were as follows: Pension Benefit Postretirement Benefit Plan Assets Plan Assets 2005 2004 2005 2004 Debt Securities............. 33.00% 33.20 30.72 36.61 Equity Securities........... 64.37 64.52 64.01 61.81 Other....................... 2.63 2.28 5.27 1.58 Total....................... 100.00% 100.00 100.00 100.00 The expected long-term rate-of-return on plan assets, noted in sections (a) and (b) above, reflects long-term earnings expectations on existing plan assets. In estimating that rate, appropriate consideration was given to historical returns earned by plan assets and the rates of return expected to be available for reinvestment. Rates of return were adjusted to reflect current capital market assumptions and changes in investment allocations. The Company's investment policies and strategies for the pension benefit and postretirement benefit plans prescribe a target allocation of 60% equity securities and 40% debt securities for the asset categories. The Company's investment goals are to maximize returns subject to specific risk management policies. Its risk management policies permit direct investments in equity and debt securities and mutual funds while prohibiting direct investment in derivative financial instruments. The Company addresses diversification by the use of mutual fund investments whose underlying investments are in domestic and international debt and equity securities. These mutual funds are readily marketable and can be sold to fund benefit payment obligations as they become payable. The Company does not expect to make any contributions to its pension and postretirement benefit plans in 2006. (d) Incentive and Bonus Plans The Company provides a profit-sharing plan for substantially all employees. The expense of this plan, which is based on management discretion as defined in the plan, and is subject to board approval, amounted to $1.3 million in 2005 and 2004 and $1.1 million in 2003. The Company also has an executive incentive plan. The expense of this plan is based on the Company's performance and estimated distributions to participants are accrued during the year and generally paid in the following year. The expense recorded for this plan was $2.0 million in 2005 and $2.1 million in 2004 and 2003. The Company has awarded 2.7 million performance bonus units to the executive officers and directors. These units become vested and exercisable only under a change of control as defined in the plan. The units were awarded based upon the stock price at the time of grant and, if exercised under a change of control, allow the holder to receive the increase in value offered in the exchange over the stock price at the date of grant for each unit. (e) Stock Option Plans Under the 2004 TrustCo Bank Corp NY Stock Option Plan, the Company may grant options to its eligible employees for up to approximately 2.0 million shares of common stock. Under the 1995 TrustCo Bank Corp NY Stock Option Plan, the Company may grant options to its eligible employees for up to approximately 7.9 million shares of common stock. Under the 2004 Directors Stock Option Plan, the Company may grant options to its directors for up to approximately 200 thousand shares of its common stock. Under the 1993 Directors Stock Option Plan, the Company could have granted options to its directors for up to approximately 531 thousand shares of its common stock. Under each of these plans, the exercise price of each option equals the market price of the Company's stock on the date of grant, and an option's maximum term is ten years. Options vest over five years from the date the options are granted for the employees plans and they are immediately vested under the directors' plan. A summary of the status of TrustCo's stock option plans as of December 31, 2005, 2004 and 2003, and changes during the years then ended, are as follows:
Outstanding Options Exercisable Options Weighted Weighted Average Average Option Option Shares Price Shares Price Balance, January 1, 2003.................. 6,645,820 $ 8.11 5,724,986 $ 7.69 New options awarded -- 2003............... -- -- -- -- Cancelled options -- 2003................. (60,396) 11.07 (60,396) 11.07 Exercised options -- 2003................. (1,645,222) 5.42 (1,645,222) 5.42 Options became exercisable................ -- -- 382,752 10.49 Balance, December 31, 2003................ 4,940,202 8.97 4,402,120 8.74 New options awarded -- 2004............... 677,500 13.55 145,100 13.55 Cancelled options -- 2004................. (28,987) 10.38 (28,987) 10.38 Exercised options -- 2004................. (1,143,605) 7.63 (1,143,605) 7.63 Options became exercisable................ -- -- 333,394 10.63 Balance, December 31, 2004................ 4,445,110 10.00 3,708,022 9.42 New options awarded -- 2005............... 526,000 12.15 114,800 12.15 Cancelled options -- 2005................. (12,000) 13.55 (12,000) 13.55 Exercised options -- 2005................. (781,061) 6.87 (781,061) 6.87 Options became exercisable................ -- -- 1,148,288 12.65 Balance, December 31, 2005................ 4,178,049 $10.85 4,178,049 $10.85
43 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) The following table summarizes information about total stock options outstanding and exercisable at December 31, 2005: Weighted Average Weighted Range of Options Remaining Average Exercise Outstanding Contractual Exercise Price and Exercisable Life Price Less than $7.50.......... 97,232 1.7 years $ 5.75 Between $7.51 and $10.00...... 2,136,317 4.7 years 9.58 Greater than $10.00......... 1,944,500 8.5 years 12.51 Total............... 4,178,049 6.4 years $10.85 As described in Note 1, the Company accelerated all unvested options in December 2005, accordingly there are no unvested options as of December 31, 2005. The decision to accelerate the vesting of these options was made primarily to reduce the non-cash compensation expense that would have been recorded in the Company's consolidated income statement in future periods under the adoption of SFAS 123R. (11) Commitments and Contingent Liabilities (a) Leases The Bank leases certain banking premises. These leases are accounted for as operating leases with minimum rental commitments in the amounts presented below. The majority of these leases contain options to renew. (dollars in thousands) 2006......................................... $ 2,534 2007......................................... 2,732 2008......................................... 2,741 2009......................................... 2,743 2010......................................... 2,739 2011 and after............................... 31,879 $45,368 (b) Litigation Existing litigation arising in the normal course of business is not expected to result in any material loss to the Company. (c) Outsourced Services During the fourth quarter 2001, the Company contracted with third-party service providers to perform certain banking functions beginning 2002. The outsourced services include data and item processing for the Bank and trust operations. The service expense can vary based upon volume and nature of transactions processed. Outsourced service expense was $4.1 million in 2005, $4.3 million in 2004 and $5.6 million in 2003. The Company is contractually obligated to pay these third-party service providers approximately $4 million to $5 million per year through 2013. (12) Earnings Per Share A reconciliation of the component parts of earnings per share for 2005, 2004 and 2003 follows: (dollars in thousands, Weighted except per share data) Average Shares Per share Income Outstanding Amounts For the year ended December 31, 2005: Basic EPS: Income available to common shareholders............ $58,989 74,928 $.787 Effect of Dilutive Securities: Stock Options.................. -- 469 (.005) Diluted EPS...................... $58,989 75,397 $.782 For the year ended December 31, 2004: Basic EPS: Income available to common shareholders............ $56,540 74,278 $.761 Effect of Dilutive Securities: Stock Options.................. -- 803 (.008) Diluted EPS...................... $56,540 75,081 $.753 For the year ended December 31, 2003: Basic EPS: Income available to common shareholders............ $53,031 74,337 $.713 Effect of Dilutive Securities: Stock Options.................. -- 969 (.009) Diluted EPS...................... $53,031 75,306 $.704 As of December 31, 2005, the number of antidulitive stock options excluded from diluted earnings per share was approximately 665 thousand. The number of antidilutive stock options excluded from diluted earnings per share for 2004 and 2003 was not significant. (13) Off-Balance Sheet Financial Instruments Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a fee. Commitments sometimes expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Bank's normal credit policies, including obtaining collateral. The Bank's maximum exposure to credit loss for loan commitments, including unused lines of credit, at December 31, 2005 and 2004, was $306.7 million and $313.3 million, respectively. Approximately 75% of these commitments were for variable rate products at the end of 2005. 44 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) The Company does not issue any guarantees that require liability-recognition or disclosure, other than its standby letters of credit. The Company has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party. Standby letters of credit generally arise in connection with lending relationships. The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under standby letters of credit totaled approximately $2.8 million and $3.6 million at December 31, 2005 and 2004, respectively, and represent the maximum potential future payments the Company could be required to make. Typically, these instruments have terms of 12 months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Each customer is evaluated individually for creditworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments. Company policies governing loan collateral apply to standby letters of credit at the time of credit extension. Loan-to-value ratios are generally consistent with loan-to-value requirements for other commercial loans secured by similar types of collateral. The fair value of the Company's standby letters of credit at December 31, 2005 and 2004 was insignificant. No losses are anticipated as a result of loan commitments or standby letters of credit. (14) Fair Value of Financial Instruments The fair values shown below represent management's estimates of values at which the various types of financial instruments could be exchanged in transactions between willing, unrelated parties. They do not necessarily represent amounts that would be received or paid in actual transactions. As of (dollars in thousands) December 31, 2005 Carrying Fair Value Value Financial assets: Cash and cash equivalents......... $ 312,863 312,863 Securities available for sale..... 1,084,076 1,084,076 Loans............................. 1,425,342 1,462,679 Accrued interest receivable....... 18,432 18,432 Financial liabilities: Demand deposits................... 251,012 251,012 Interest bearing deposits......... 2,311,475 2,311,475 Short-term borrowings............. 87,935 87,935 Long-term debt.................... 87 87 Accrued interest payable.......... 2,204 2,204 As of (dollars in thousands) December 31, 2004 Carrying Fair Value Value Financial assets: Cash and cash equivalents......... $ 696,430 696,430 Securities available for sale..... 895,989 895,989 Loans............................. 1,190,681 1,254,986 Accrued interest receivable....... 14,671 14,671 Financial liabilities: Demand deposits................... 237,423 237,423 Interest bearing deposits ........ 2,289,679 2,289,679 Short-term borrowings............. 77,979 77,979 Long-term debt.................... 114 114 Accrued interest payable.......... 1,545 1,545 The specific estimation methods and assumptions used can have a substantial impact on the resulting fair values of financial instruments. Following is a brief summary of the significant methods and assumptions used in estimating fair values: Cash and Cash Equivalents The carrying values of these financial instruments approximate fair values. Securities Fair values for all securities portfolios are based upon quoted market prices, where available. The carrying value of certain local, unrated municipal obligations was used as an approximation of fair value. Loans The fair values of all loans are estimated using discounted cash flow analyses with discount rates equal to the interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. 45 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) Deposit Liabilities The fair values disclosed for noninterest bearing deposits, interest bearing checking accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the balance sheet date. The carrying value of all variable rate certificates of deposit approximates fair value. The fair value of fixed rate certificates of deposit is estimated using discounted cash flow analyses with discount rates equal to the interest rates currently being offered on certificates of similar size and remaining maturity. Short-Term Borrowings, Long-Term Debt and Other Financial Instruments The fair value of all short-term borrowings, long-term debt, and other financial instruments approximates the carrying value. Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk. Such financial instruments consist of commitments to extend financing and standby letters of credit. If the commitments are exercised by the prospective borrowers, these financial instruments will become interest earning assets of the Company. If the commitments expire, the Company retains any fees paid by the prospective borrower. The fair value of commitments is estimated based upon fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the present creditworthiness of the borrower. For fixed rate commitments, the fair value estimation takes into consideration an interest rate risk factor. The fair value of these off-balance sheet items approximates the recorded amounts of the related fees, which are considered to be immaterial. The Company does not engage in activities involving interest rate swaps, forward placement contracts, or any other instruments commonly referred to as derivatives. (15) Regulatory Capital Requirements Office of Thrift Supervision (OTS) capital regulations require banks to maintain minimum levels of regulatory capital. Under the regulations in effect at December 31, 2005 and 2004, Trustco Bank was required to maintain a minimum tangible capital of 1.5% of adjusted total assets, a minimum leverage ratio of core capital to adjusted total assets of 4.00% and a minimum ratio of total capital to risk weighted assets of 8.00%. Federal banking regulations also establish a framework for the classification of banks into five categories: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized. Generally, an institution is considered well capitalized if it has a leverage capital ratio of at least 5.0% (based on total adjusted quarterly average assets), a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based capital ratio of at least 10.0%. The foregoing capital ratios are based on specific quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulator about capital components, risk weighting and other factors. Management believes that as of December 31, 2005 and 2004, Trustco Bank met all capital adequacy requirements to which it was subject. Further, the most recent regulator notification categorized the Bank as a well-capitalized institution. There have been no conditions or events since that notification that management believes have changed the Bank's capital classification. Under its prompt corrective action regulations, the OTS is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized institution. Such actions could have a direct material effect on an institution's financial statements. As stated above, the Bank has been classified as well capitalized for regulatory purposes, and therefore, these regulations do not apply. The following is a summary of actual capital amounts and ratios as of December 31, 2005 and 2004, for Trustco Bank: (dollars in thousands) As of December 31, 2005 Amount Ratio Leverage capital:................ $222,327 7.82% Tier 1 risk-based capital:....... 222,327 15.81 Total risk-based capital:........ 240,244 17.09 (dollars in thousands) As of December 31, 2004 Amount Ratio Leverage capital:................ $203,177 7.24% Tier 1 risk-based capital:....... 203,177 15.79 Total risk-based capital:........ 219,668 17.08 The following is a summary of actual capital amounts and ratios as of December 31, 2005 and 2004 for TrustCo on a consolidated basis: (dollars in thousands) As of December 31, 2005 Amount Ratio Leverage capital:................ $234,162 8.04% Tier 1 risk-based capital:....... 234,162 16.58 Total risk-based capital:........ 252,160 17.85 (dollars in thousands) As of December 31, 2004 Amount Ratio Leverage capital:................ $220,819 7.74% Tier 1 risk-based capital:....... 220,819 17.09 Total risk-based capital:........ 237,378 18.37 46 [LOGO] TRUSTCO Bank Corp NY Notes to Consolidated Financial Statements (continued) (16) Parent Company Only The following statements pertain to TrustCo Bank Corp NY (Parent Company): Statements of Income (dollars in thousands) Years Ended December 31, Income: 2005 2004 2003 Dividends and interest from subsidiaries................ $37,733 19,403 31,096 Net gain on sales of securities.... 4,068 21,157 12,952 Income from other investments...... 131 424 1,110 Total income................... 41,932 40,984 45,158 Expense: Operating supplies................. 67 61 75 Professional services.............. 276 203 63 Miscellaneous expense.............. 277 85 95 Total expense................. 620 349 233 Income before income taxes and subsidiaries' undistributed earnings............ 41,312 40,635 44,925 Income tax expense.................. 1,485 8,303 5,267 Income before subsidiaries' undistributed earnings............ 39,827 32,332 39,658 Equity in undistributed earnings of subsidiaries........... 19,162 24,208 13,373 Net income.......................... $58,989 56,540 53,031 Statements of Condition (dollars in thousands) December 31, 2005 2004 Assets: Cash in subsidiary bank..................... $ 12,603 20,530 Investments in subsidiaries................. 216,647 205,522 Securities available for sale............... 6,841 9,106 Other assets................................ 3 824 Total assets............................ $236,094 235,982 Liabilities and shareholders' equity: Accrued expenses and other liabilities..................... 7,433 10,150 Total liabilities....................... 7,433 10,150 Shareholders' equity......................... 228,661 225,832 Total liabilities and shareholders' equity.................. $236,094 235,982 Statements of Cash Flows (dollars in thousands) Years Ended December 31, 2005 2004 2003 Increase/(decrease) in cash and cash equivalents: Cash flows from operating activities: Net income.............................. $58,989 56,540 53,031 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of subsidiaries.......... (19,162) (24,208) (13,373) Net gain on sales of securities...... (4,068) (21,157) (12,952) Net change in other assets and accrued expenses............. (943) 4,764 972 Total adjustments.................. (24,173) (40,601) (25,353) Net cash provided by operating activities........................... 34,816 15,939 27,678 Cash flows from investing activities: Proceeds from sales of securities available for sale................... 14,360 57,997 49,831 Purchases of securities available for sale............................. (12,166) (29,951) (23,475) Net cash provided by investing activities............. 2,194 28,046 26,356 Cash flows from financing activities: Proceeds from exercise of stock options and related tax benefits...... 3,818 9,281 12,084 Dividends paid......................... (44,905) (44,504) (45,008) Payments to acquire treasury stock..... (14,846) (13,482) (30,034) Proceeds from sales of treasury stock................................. 10,996 7,887 7,605 Net cash used in financing activities....................... (44,937) (40,818) (55,353) Net increase/(decrease) in cash and cash equivalents................... (7,927) 3,167 (1,319) Cash and cash equivalents at beginning of year..................... 20,530 17,363 18,682 Cash and cash equivalents at end of year........................... $12,603 20,530 17,363 Supplemental Information Increase (decrease) in dividends payable..................... $ 787 69 (475) Change in unrealized gain on securities available for sale -- gross................................ 4,139 19,328 638 Change in deferred tax effect on unrealized gain on securities available for sale................... (1,651) (7,707) (261) 47 [LOGO] TRUSTCO Bank Corp NY Branch Locations NEW YORK Altamont Ave. Office 1400 Altamont Ave. Schenectady, NY Telephone: (518) 356-1317 Altamont Ave. West Office 1900 Altamont Ave. Rotterdam, NY Telephone: (518) 355-1900 Ballston Spa Office 235 Church Ave. Ballston Spa, NY Telephone: (518) 885-1561 Bedford Hills Office 180 Harris Rd. Bedford Hills, NY Telephone: (914) 666-6230 Brandywine Office State St. at Brandywine Ave. Schenectady, NY Telephone: (518) 346-4295 Briarcliff Manor Office 64 Route 100 Briarcliff Manor, NY Telephone: (914) 762-7133 Central Ave. Office 163 Central Ave. Albany, NY Telephone: (518) 426-7291 Clifton Country Road Office 7 Clifton Country Rd. Clifton Park, NY Telephone: (518) 371-5002 Clifton Park Office 1018 Route 146 Clifton Park, NY Telephone: (518) 371-8451 Cobleskill Office RR #3, Rt. 7 Cobleskill, NY Telephone: (518) 254-0290 Colonie Office 1892 Central Ave. Colonie Plaza, Colonie, NY Telephone: (518) 456-0041 Delmar Office 167 Delaware Ave. Delmar, NY Telephone: (518) 439-9941 East Greenbush Office 501 Columbia Turnpike Rensselaer, NY Telephone: (518) 479-7233 Elmsford Office 100 Clearbrook Rd. Elmsford, NY Telephone: (914) 345-1808 Exit 8/Crescent Rd. Office CVS Plaza Clifton Park, NY Telephone: (518) 383-0039 Fishkill Office 1542 Route 52 Fishkill, NY Telephone: (518) 896-8260 Freemans Bridge Rd. Office Trustco Center Glenville, NY Telephone: (518) 344-7510 Glens Falls Office 3 Warren Street Glens Falls, NY Telephone: (518) 798-8131 Greenwich Office 131 Main St. Greenwich, NY Telephone: (518) 692-2233 Guilderland Office 3900 Carman Rd. Schenectady, NY Telephone: (518) 355-4890 Halfmoon Office Country Dollar Plaza Halfmoon, NY Telephone: (518) 371-0593 Highland Office 3580 Route 9W Highland, NY Telephone: (845) 691-7023 Hoosick Falls Office 47 Main St. Hoosick Falls, NY Telephone: (518) 686-5352 Hudson Office 507 Warren St. Hudson, NY Telephone: (518) 828-9434 Hudson Falls Office 3376 Burgoyne Ave. Hudson Falls, NY Telephone: (518) 747-0886 Latham Office 1 Johnson Rd. Latham, NY Telephone: (518) 785-0761 Loudon Plaza Office 372 Northern Blvd. Albany, NY Telephone: (518) 462-6668 Madison Ave. Office 1084 Madison Ave. Albany, NY Telephone: (518) 489-4711 Malta 4 Corners Office 2471 Route 9 Malta, NY Telephone: (518) 899-1056 Malta Mall Office 43 Round Lake Rd. Ballston Lake, NY Telephone: (518) 899-1558 Mayfair Office 286 Saratoga Rd. Glenville, NY Telephone: (518) 399-9121 Mechanicville Office 9 Price Chopper Plaza Mechanicville, NY Telephone: (518) 664-1059 Milton Office 2 Trieble Ave. Ballston Spa, NY Telephone: (518) 885-0498 Mont Pleasant Office Crane St. at Main Ave. Schenectady, NY Telephone: (518) 346-1267 New Scotland Office 301 New Scotland Ave. Albany, NY Telephone: (518) 438-7838 Newton Plaza Office 588 New Loudon Rd. Latham, NY Telephone: (518) 786-3687 Niskayuna-Woodlawn Office 3461 State St. Schenectady, NY Telephone: (518) 377-2264 Northern Pines Road Office 647 Maple Ave. (Route 9) Wilton, NY Telephone: (518) 583-2634 Pomona Office 1581 Route 202 Pomona, NY Telephone: (518) 354-0176 Poughkeepsie Office 2656 South Rd. (Route 9) Poughkeepsie, NY Telephone: (518) 485-6419 Queensbury Office 118 Quaker Rd. Suite 9, Queensbury, NY Telephone: (518) 798-7226 Rotterdam Office Curry Road Shopping Ctr. Rotterdam, NY Telephone: (518) 355-8330 Rotterdam Square Office 93 W. Campbell Rd. Rotterdam, NY Telephone: (518) 377-2393 Route 2 Office -- Latham 201 Troy-Schenectady Rd. Latham, NY Telephone: (518) 785-7155 Route 7 Office 1156 Troy-Schenectady Rd. Latham, NY Telephone: (518) 785-4744 Saratoga Office 34 Congress St. Saratoga Springs, NY Telephone: (518) 587-3500 Scotia Office 123 Mohawk Ave. Scotia, NY Telephone: (518) 372-9416 Sheridan Plaza Office 1350 Gerling St. Schenectady, NY Telephone: (518) 377-8517 Shoppers' World Office Old Rte. 146 and Plank Rd. Clifton Park, NY Telephone: (518) 383-6850 Slingerlands Office 1569 New Scotland Avenue Slingerlands, NY Telephone: (518) 439-9352 South Glens Falls Office Glengate Shopping Plaza 133 Saratoga Road, Suite 1 South Glens Falls, NY Telephone: (518) 793-7668 State Farm Rd. Office 2050 Western Ave. Guilderland, NY Telephone: (518) 452-6913 State St. Albany Office 112 State St. Albany, NY Telephone: (518) 436-9043 State St. Schenectady Office 320 State St. Schenectady, NY Telephone: (518) 377-3311 Stuyvesant Plaza Office Western Ave. at Fuller Rd. Albany, NY Telephone: (518) 489-2616 Tanners Main Office 345 Main St. Catskill, NY Telephone: (518) 943-2500 48 [LOGO] TRUSTCO Bank Corp NY Branch Locations Tanners West Side Office 238 West Bridge St. Catskill, NY Telephone: (518) 943-5090 Troy Office 5th Ave. and State St. Troy, NY Telephone: (518) 274-5420 Union Street East Office 1700 Union St. Schenectady, NY Telephone: (518) 382-7511 Upper Union Street Office 1620 Union St. Schenectady, NY Telephone: (518) 374-4056 Ushers Road Office 308 Ushers Rd. Ballston Lake, NY Telephone: (518) 877-8069 Valatie Office 2929 Route 9 Valatie, NY Telephone: (518) 758-2265 Wappingers Falls Office 1490 Route 9 Wappingers Falls, NY Telephone: (845) 298-9315 West Sand Lake Office 3707 NY Rt. 43 West Sand Lake, NY Telephone: (518) 674-3327 Wilton Mall Office Route 50 Saratoga Springs, NY Telephone: (518) 583-1716 Wolf Road Office 34 Wolf Rd. Albany, NY Telephone: (518) 458-7761 Wynantskill Office 134-136 Main St., Rt. 66 Wynantskill, NY Telephone: (518) 286-2674 FLORIDA Colonial Drive Office 4450 East Colonial Dr. Orlando, FL Telephone: (407) 895-6393 Curry Ford Road Office Shoppes at Andover, Suite 116 3020 Lamberton Boulevard Orlando, FL Telephone: (407) 277-9663 Dean Road Office 3920 Dean Rd. Orlando, FL Telephone: (407) 657-8001 East Colonial Office 12901 East Colonial Drive Orlando, FL Telephone: (407) 275-3075 Lake Mary Office 350 West Lake Mary Blvd. Sanford, FL Telephone: (407) 330-7106 Longwood Office 1400 West State Rd. Longwood, FL Telephone (407) 339-3396 Maitland Office 9400 US Rt. 17/92, Suite 1008 Maitland, FL Telephone: (407) 332-6071 Osprey Office 1300 South Tamiami Trail Osprey, FL Telephone: (941) 918-9380 Oviedo Office 1875 West County Road 419 Suite 600 Oviedo, FL Telephone: (407) 365-1145 Rinehart Road Office 1185 Rinehart Road Sanford, FL Telephone: (407) 268-3720 Sarasota Office 2704 Bee Ridge Road Sarasota, FL Telephone: (941) 929-9451 South Clermont Office 16908 High Grove Blvd. Clermont, FL Telephone: (352) 243-9511 Tuskawilla Road Office 1295 Tuskawilla Road Winter Springs, FL Telephone: (407) 695-5558 Villaggio Office 851 SR 434 Winter Springs, FL Telephone: (407) 327-6064 NEW JERSEY Ramsey Office 385 N. Franklin Turnpike Ramsey, NJ Telephone: (201) 934-1429 VERMONT Bennington Office 215 North St. Bennington, VT Telephone: (802) 447-4952 49 [LOGO] TRUSTCO Bank Corp NY TrustCo Bank Corp NY Officers and Board of Directors OFFICERS PRESIDENT AND CHIEF EXECUTIVE OFFICER Robert J. McCormick EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Robert T. Cushing EXECUTIVE VICE PRESIDENT AND CHIEF BANKING OFFICER Scot R. Salvador SECRETARY Robert M. Leonard ASSISTANT SECRETARIES Cheri J. Parvis Thomas M. Poitras Directors of TrustCo Bank Corp NY are also Directors of Trustco Bank BOARD OF DIRECTORS Joseph Lucarelli President Traditional Builders Thomas O. Maggs President Maggs & Associates Anthony J. Marinello, M.D., Ph.D. Physician Robert A. McCormick Chairman TrustCo Bank Corp NY Robert J. McCormick President and Chief Executive Officer Trustco Bank William D. Powers Partner Powers & Co., LLC Consulting William J. Purdy President Welbourne & Purdy Realty, Inc. Real Estate HONORARY DIRECTORS Lionel O. Barthold M. Norman Brickman Bernard J. King Nancy A. McNamara William H. Milton, III John S. Morris, Ph.D. James H. Murphy, D.D.S. Richard J. Murray, Jr. Daniel J. Rourke, M.D. Anthony M. Salerno Edwin O. Salisbury William F. Terry Harry E. Whittingham, Jr. Trustco Bank Officers PRESIDENT AND CHIEF EXECUTIVE OFFICER Robert J. McCormick EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Robert T. Cushing EXECUTIVE VICE PRESIDENT AND CHIEF BANKING OFFICER Scot R. Salvador AUDITOR Kenneth E. Hughes, Jr. ACCOUNTING/FINANCE Vice Presidents Michael M. Ozimek Daniel R. Saullo BRANCH ADMINISTRATION Administrative Vice President Eric W. Schreck Vice Presidents Deborah K. Appel Paul D. Matthews Officers John R. George Colleen A. Meliski Michael V. Pitnell Mary Jean Riley COMPLIANCE Vice President Thomas M. Poitras COMMERCIAL LENDING Vice President Patrick M. Canavan Officers Bradley T. Delarm James M. Poole Paul R. Steenburgh MARKETING/PC GROUP/ FACILITIES Administrative Vice President Robert M. Leonard Vice President George W. Wickswat MORTGAGE LOANS Vice President Michael J. Lofrumento Officer Robert O. Breton, Esq. OPERATIONS Administrative Vice President Kevin M. Curley Vice President Christopher L. Cox PERSONNEL/QUALITY CONTROL Vice President Cheri J. Parvis TRUST DEPARTMENT Vice President Patrick J. LaPorta, Esq. Officers Craig C. Chenevert Stephanie A. Duma Richard W. Provost 50 [LOGO] TRUSTCO Bank Corp NY General Information ANNUAL MEETING Monday, May 15, 2006 10:00 AM Mallozzi's Restaurant 1930 Curry Road Schenectady, NY 12303 CORPORATE HEADQUARTERS 5 Sarnowski Drive Glenville, NY 12302 (518) 377-3311 DIVIDEND REINVESTMENT PLAN A Dividend Reinvestment Plan is available to shareholders of TrustCo Bank Corp NY. It provides for the reinvestment of cash dividends and optional cash payments to purchase additional shares of TrustCo stock. The Plan has certain administrative charges and provides a convenient method of acquiring additional shares. Trustco Bank acts as administrator for this service and is the agent for shareholders in these transactions. Shareholders who want additional information may contact the TrustCo Shareholder Services Department at (518) 381-3601. DIRECT DEPOSIT OF DIVIDENDS Electronic deposit of dividends, which offers safety and convenience, is available to TrustCo shareholders who wish to have dividends deposited directly to personal checking, savings or other accounts. Electing direct deposit will not affect the mailing of annual and quarterly reports and proxy materials. If you would like to arrange direct deposit, please write the TrustCo Shareholder Services Department at the corporate headquarters address listed on this page. DUPLICATE MAILING NOTIFICATION If you are a shareholder of record and are currently receiving multiple copies of TrustCo's annual and quarterly reports, please contact the TrustCo Shareholder Services Department at (518) 381-3601, or at the corporate headquarters address listed on this page. EQUAL OPPORTUNITY AT TRUSTCO Trustco Bank is an Affirmative Action Equal Opportunity Employer. FORM 10-K TrustCo Bank Corp NY will provide, without charge, a copy of its Form 10-K upon written request. Requests and related inquiries should be directed to Robert M. Leonard, Secretary, TrustCo Bank Corp NY, P.O. Box 380, Schenectady, New York 12301-0380. CODE OF CONDUCT TrustCo Bank Corp NY will provide, without charge, a copy of its Code of Conduct upon written request. Requests and related inquiries should be directed to Cheri J. Parvis, Vice President-Personnel, TrustCo Bank Corp NY, P.O. Box 1082, Schenectady, New York 12301-1082. NASDAQ SYMBOL: TRST The Corporation's common stock trades on The Nasdaq Stock MarketSM under the symbol TRST. SUBSIDIARIES: Trustco Bank ORE Subsidiary Corp. Glenville, New York Glenville, New York Member FDIC (and its wholly owned subsidiary, Trustco Vermont Investment Company Trustco Charitable Foundation, Inc. Bennington, Vermont) Glenville, New York TRANSFER AGENT Trustco Bank Securities Department P.O. Box 380 Schenectady, New York 12301-0380 Trustco Bank(R) is a registered service mark with the U.S. Patent & Trademark Office. 51