EX-13 2 ex13.htm EXHIBIT 13

Exhibit 13
 
 
TrustCo Bank Corp NY (the “Company,” or “TrustCo”) 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, and its principal subsidiary, Trustco Bank (the “Bank” or “Trustco”), operates 145 community banking offices and 157 Automatic Teller Machines throughout the Bank’s market areas. The Company serves 5 states and 32 counties with a broad range of community banking services.
 
Financial Highlights
 
(dollars in thousands, except per share data)
 
Years ended December 31,
 
   
2017
     
2016
     
Percent Change
 
Income:
                     
Net interest income
 
$
154,368
     
$
146,055
       
5.69
%
Net Income
   
43,145
       
42,601
       
1.28
 
Per Share:
                           
Basic earnings
   
0.449
       
0.446
       
0.65
 
Diluted earnings
   
0.448
       
0.445
       
0.76
 
Book value at period end
   
4.76
       
4.52
       
5.30
 
Average Balances:
                           
Assets
   
4,875,668
       
4,790,701
       
1.77
 
Loans, net
   
3,514,900
       
3,348,324
       
4.97
 
Deposits
   
4,171,396
       
4,149,201
       
0.53
 
Shareholders' equity
   
447,680
       
428,389
       
4.50
 
Financial Ratios:
                           
Return on average assets
   
0.88
 
%    
0.89
 
%
   
(1.12
)
Return on average equity
   
9.64
       
9.94
       
(3.02
)
Consolidated tier 1 capital to:
                           
Total assets (leverage)
   
9.45
       
9.11
       
3.72
 
Risk-adjusted assets
   
18.02
       
17.78
       
1.34
 
Common equity tier 1 capital ratio
   
18.02
       
17.78
       
1.34
 
Total capital to risk-adjusted assets
   
19.28
       
19.04
       
1.27
 
Net loans charged off to average loans
   
0.05
       
0.11
       
(57.13
)
Allowance for loan losses to nonperforming loans
   
1.81
 
x
   
1.75
 
x
   
3.54
 
Efficiency ratio*
   
53.75
 
%
   
55.67
 
%
   
3.45
 
Dividend Payout ratio
   
58.44
       
58.88
       
(0.75
)
 
*
Non-GAAP figure; refer to Non-gaap financial measures reconciliation section for definition
 
Per Share information of common stock
 
    
Basic
Earnings
   
Diluted
Earnings
   
Cash
Dividend
   
Book
Value
   
Range of Stock
Price
 
High
   
Low
 
                                     
2017
                                   
First quarter
 
$
0.114
   
$
0.114
   
$
0.0656
   
$
4.57
   
$
8.00
   
$
7.80
 
Second quarter
   
0.127
     
0.127
     
0.0656
     
4.66
     
7.75
     
7.58
 
Third quarter
   
0.131
     
0.131
     
0.0656
     
4.73
     
9.10
     
8.85
 
Fourth quarter
   
0.077
     
0.076
     
0.0656
     
4.76
     
9.30
     
9.15
 
                                                 
2016
                                               
First quarter
 
$
0.109
   
$
0.109
   
$
0.0656
   
$
4.44
   
$
6.63
   
$
5.60
 
Second quarter
   
0.110
     
0.109
     
0.0656
     
4.51
     
6.37
     
5.17
 
Third quarter
   
0.114
     
0.114
     
0.0656
     
4.56
     
7.25
     
6.13
 
Fourth quarter
   
0.113
     
0.113
     
0.0656
     
4.52
     
8.85
     
6.60
 

*Certain of the financial measures used in this report, such as Tax-Equivalent Net Interest Income and Tax-Equivalent Net Interest Margin, Tangible Book Value Per Share and the Efficiency Ratio, are determined by methods other than in accordance with generally accepted accounting principles (“GAAP”). A reconciliation of these measures to the closest comparable GAAP financial measures is presented herein.
 
Page 1 of 106

Financial Highlights
1
   
President’s Message
3-4
   
Management’s Discussion and Analysis of Financial Condition and Results of Operations
5
   
Glossary of Terms
34
   
Management’s Report on Internal Control Over Financial Reporting
37
   
Report of Independent Registered Public Accounting Firm
38
   
Consolidated Financial Statements and Notes
39-94
   
Branch Locations
95-100
   
Officers and Board of Directors
101-102
   
General Information
103-107
   
Share Price Information
105
 
TrustCo Bank Corp NY Mission
 
The Mission of TrustCo Bank Corp NY is to provide an above-average return to our owners in a manner consistent with our commitment to all stakeholders of the Company and its primary subsidiary, Trustco Bank, including customers, employees, community, regulators and shareholders.
 
Page 2 of 106

 
President’s Message
 
Dear fellow shareholders:
 
Thank you for being part of the continued success of TrustCo.  The Company made significant progress in key areas during 2017.  Average residential loans, our primary lending focus, were up more than 8% in 2017 and reached an all-time high.  Our deposit base and liquid balance sheet continued to provide funding for the expansion of our loan portfolio.  Over 74% of our deposit base is comprised of core accounts, which contributes to both strong financial stability and a low cost of funds.  These elements, along with our continued focus on managing costs, combined to help generate a 12.4% increase in pretax earnings.  As you will see in the report, our return on average equity, efficiency ratio and other key metrics remain strong. We were pleased to share this success by giving every single employee of the company a bonus.  TrustCo continues to provide its owners with a solid cash dividend, building on a record that reaches back well over one hundred years.

We have taken significant steps to enhance our ability to deliver banking services over a variety of technological platforms, but we remain strongly committed to our branch network as a key differentiator.  Our branches are the preferred venue for many of our customers to conduct business and we view each branch as a hub to acquire an additional share of existing customers’ financial business, as well as a key tool to attract new customers.  To that end, we have continued to invest in the relocation and refurbishment of branches throughout our network, and will continue to selectively open new offices in attractive locations in or near our existing markets.  Our branch system has significant capacity to add customers to fuel the continued expansion of our balance sheet and profits going forward.  We continually work toward maximizing the value of TrustCo, and our efforts in growing our customer base are a key element in achieving that goal.

We are pleased to report that the bank's primary regulator, the Comptroller of the Currency, has released Trustco from the formal agreement it entered in 2015. We are very proud of each and every member of our team who heard the guidance that our regulators were giving and spared no effort in doing what needed to be done. A lesser team might have faltered under the burden, but our team, and our company, flourished.  I believe that TrustCo emerges as a fundamentally stronger institution, well positioned to face the challenges that lie ahead and, importantly, to take advantage of the opportunities we develop.

Investors are taking an increasingly broad view when they choose where and how to deploy their assets. We value all of our shareholders and engage with our owners on key issues.  We believe our investors know that TrustCo is a good corporate citizen, with a demonstrated record of offering branch services and lending in all areas of our footprint, not just cherry picking elite sections. We do this because it is both the right thing to do and it is the right thing for our business. The diversity of the TrustCo workforce, our extensive charitable giving, and numerous initiatives in environmental responsibility and good corporate governance further demonstrate TrustCo’s commitment the principles of "ESG" - environmental, social and governance.  I believe all of these elements will contribute to the sustainable growth of the value of our Company.
Page 3 of 106

President’s Message (continued)
 
This year saw the retirement of two of our stalwarts - former Chief Operating Officer Bob Cushing and Director William Purdy. Sadly, Bill passed shortly after his retirement. He is missed. Upon Bob's retirement, we wish him Godspeed as he enters the adventure of a new chapter in his life. Additionally, it has been my privilege to promote several key people who have, for years, brought professional competence and diversity of perspective to our management team. Carly Batista and Michelle Simmonds were named Administrative Vice Presidents. Ann Gough was promoted to Vice President and Andrea McGuire joined us as Accounting Vice President. I am also very pleased that we were able to add Lisa Reutter to our Board of Directors. We look forward to sharing in Lisa's experience and insight. Please join me in celebrating the achievements of these exceptional women.

In the strong and deep tradition of TrustCo, however, we will not rest based on our success in 2017. Changes in the tax laws will provide a welcome boost going forward, but at the same time there are always new challenges to be met and new opportunities to capitalize on.  We fully intend to meet those challenges and leverage these opportunities into growth in the balance sheet. We look forward to great things in the coming years and enthusiastically embrace the promise of a bright future.
 
Sincerely,
 

Robert J. McCormick
President and Chief Executive Officer
TrustCo Bank Corp NY
 
Page 4 of 106

 
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 during 2017 and, in summary form, the two preceding years. Unless otherwise indicated, 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 2017 should be read in conjunction with this review. Reclassifications of prior year data are made where necessary to conform to the current year’s presentation.
 
TrustCo made significant progress in 2017 despite a challenging operating environment and mixed economic conditions. Among the key results for 2017, in management’s view:
 
·
Net income before taxes increased 12.4% in 2017 versus 2016;
 
·
Net income increased in 2017 versus 2016 despite a $5.1 million cost related to the implementation of the Tax Cuts and Jobs Act (the "Tax Act") that was signed into law on December 22, 2017 (see details under “Tax Cuts and Jobs Act”);
 
·
Period-end loans were up $206 million for 2017 compared to the prior year;
 
·
Period-end core (non-maturity) deposits were up $70 million for 2017 compared to the prior year;
 
·
Nonperforming assets declined $1.7 million or 5.8% to $27.6 million from year-end 2016 to year-end 2017;
 
·
Net interest margin improved 11 basis points to 3.22% in 2017 versus 2016;
 
·
At 53.7%, the efficiency ratio remained substantially better than peer-group  levels (see Non-GAAP Financial Measures Reconciliation), and;
 
·
The regulatory capital levels of both the Company and the Bank improved at December 31, 2017 relative to the prior year, and the Bank continues to meet the definition of “well capitalized” for regulatory purposes.
 
Management believes that the Company was able to achieve these accomplishments, despite a continued mixed economy and increased regulatory expectations, by executing its long term plan focused on traditional lending criteria and balance sheet management. Achievement of specific business goals such as the continued expansion of loans and deposits, along with tight control of operating expenses and manageable levels of nonperforming assets, is fundamental to the long term success of the Company as a whole.
 
Return on average equity was 9.64% in 2017 compared to 9.94% in 2016, while return on average assets was 0.88% in 2017 as compared to 0.89% in 2016.  Both return on average equity and return on average assets were affected by the noted $5.1 million item related to the Tax Cuts and Jobs Act.
 
The economic and business environment generally improved during 2017 but remains mixed. Real gross domestic product (“GDP”) increased 2.3% in 2017 and 1.5% in 2016, based on the advance estimate published on January 26, 2018, with stronger growth during the middle of the year than in the first and fourth quarters. This annual rate of growth remains well below the range exhibited during more robust periods of economic activity, such as the 4% to 6% range experienced during the 1990s. Equity markets were very strong in 2017 with the Dow Jones Industrial Average up 25.1%, the S&P 500 up 19.4% and the Russell 2000 index up 13.1%. The bulk of the gains came later in the year, particularly in the fourth quarter.  United States Treasuries saw significant price changes over the course of 2017, with the slope of the yield curve shifting considerably. Yields were generally stable for the first two months of the year for most maturities, but began to diverge thereafter with that divergence accelerating late in the year.  Short term yields responded to the increases in the target Federal funds range by rising relatively sharply; however, mid-term yields rose to a lesser degree, and yields from 10 years and out were flat or down.  The net result was that the steepness of the yield curve, as measured by the spread between longer term (10 year) and shorter term (2 year) yields declined during the year, from 125 basis points going into 2017 to 51 basis points at the end of the year.  On average, the spread declined from 102 basis points to 93 basis points.  Most overseas markets experienced better conditions in 2017 than in recent years, but generally remain in low growth modes with less than full employment and a lack of demand for much of the year, however conditions generally improved over the course of the year resulting in a more optimistic outlook for 2018.  The outlook for the United States economy in 2017 is complicated by political factors; however, many observers expect slightly better GDP growth in 2018 than was reported for 2017, and the Tax Act should result in stronger corporate profits even without consideration for economic improvement.  Proposed spending on infrastructure could contribute to improved conditions while other initiatives, such as potentially adding barriers to trade, could do the opposite and may have unintended effects on American consumers.  Employment increased and the unemployment rate declined, although labor force participation remains an ongoing issue. Wage growth also remains mixed, with some progress but with real wages remaining below expectations in an economy with a low unemployment level. The recently weakened dollar provides some significant benefits in terms of making US products more competitive overseas, but also makes imported goods and services more expensive. Regulatory changes put in place in response to the 2007-2008 financial crisis have added significant cost to the banking industry.  The new administration has made some progress in reducing that regulatory burden but has yet to achieve wholesale changes.  More significant changes could benefit the banking industry both in terms of cost structure and in terms of operational efficiency.
 
Page 5 of 106

Management believes that TrustCo’s long-term focus on traditional banking services has enabled the Company to avoid significant impact from asset quality problems, and the Company’s strong liquidity and solid capital positions have allowed the Company to continue to conduct business in a manner consistent with past practice. TrustCo has not engaged in the types of high risk loans and investments that often led to industry problems in prior years. While we continue to adhere to prudent underwriting standards, as a lender, we may be adversely impacted by general economic weaknesses and by a downturn in the housing market in the areas we serve.
 
Regulatory Agreement
 
Trustco Bank entered into an agreement with its primary regulator, the Office of the Comptroller of the Currency (OCC), on July 21, 2015. The agreement calls for the Bank to take various actions in areas such as compliance, corporate governance, audit, capital planning including dividends, and strategic planning, among others. The agreement followed the completion of the OCC’s regularly scheduled exam of the Bank. Since the completion of the examination, the Bank has been working to address the issues raised. The Bank’s Board of Directors and management remain committed to fully addressing all provisions of the agreement.
 
Termination of Regulatory Agreement
 
On February 14, 2018, the Office of the Comptroller of the Currency (OCC) notified Trustco Bank that it had terminated the July 21, 2015 agreement between the OCC and the Bank effective February 7, 2018. The agreement had required the Bank to take various actions in areas such as compliance, corporate governance, audit, capital planning including dividends, and strategic planning, among others.
 
Tax Cuts and Jobs Act
 
On December 22, 2017 the Tax Cuts and Jobs Act (the "Tax Act") was signed into law.  The Tax Act makes broad and complex changes to the U.S. tax code that affected our 2017 results and that will affect future periods. Among the Tax Act’s changes is a reduction of the statutory corporate tax rate from 35% to 21%.  The lower tax rate will have a significant beneficial impact on the Company’s results going forward, but also resulted in the revaluation of net deferred tax assets on our balance sheet as of December 31, 2017, based on the lower tax rate. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. Deferred tax assets and liabilities are adjusted through income tax expense as changes in tax laws are enacted.  The rate reduction is effective January 1, 2018. Included in results for the fourth quarter and full year 2017 is a reduction in the value of net deferred tax assets of $5.1 million, which was recorded as additional income tax expense for the quarter ended December 31, 2017. This charge had a negative impact on reported net income, earnings per share, return on average equity and return on average assets for the quarter and year ended December 31, 2017.  Given the short time frame since enactment, we cannot predict whether, or to what extent, the Tax Act will affect any of our product and service offerings.
 
Overview
 
2017 results were marked by continued growth in the Company’s loan portfolio. The loan portfolio grew to a total of $3.64 billion, an increase of $205.8 million or 6.0% over the 2016 year-end balance. Deposits ended 2017 at $4.17 billion, down slightly from $4.20 billion the prior year-end, however core (non-maturity) deposits rose $69.7 million over the period as the company focused efforts on these lower cost funding sources. The year-over-year increases in loans and core deposits reflect the success the Company has had in attracting customers to the Bank, both in newer branch locations as well as in its established offices. Management believes that TrustCo’s success is predicated on providing core banking services to a wider number of customers and continuing to provide added services to existing customers where possible. Growing the customer base should contribute to continued growth of loans and deposits, as well as net interest income and non-interest income.
 
Page 6 of 106

TrustCo recorded net income of $43.1 million or $0.448 of diluted earnings per share for the year ended December 31, 2017, compared to $42.6 million or $0.445 of diluted earnings per share for the year ended December 31, 2016.   Net income before taxes was $76.7 million in 2017 compared to $68.3 million in 2016.
 
During 2017, the following had a significant effect on net income:
 
·
an increase of $8.3 million in net interest income from 2016 to 2017 as a result of a combination of 2.0% growth in average interest earning assets and an 11 basis point increase in the net interest margin to 3.22%;
 
·
a decrease of $950 thousand in the provision for loan losses to $2.0 million in 2017;
 
·
the recognition of zero net gains on securities transactions in 2017 compared to net securities gains of $668 thousand recorded in 2016;
 
·
an increase of just $167 thousand in total non-interest expense, as compared to 2016, and;
 
·
an increase of $7.9 million in income tax expense from $25.7 million in 2016 to $33.6 million in 2017.
 
TrustCo performed well in comparison to its peers with respect to a number of key performance ratios during 2017 and 2016, including:
 
·
return on average equity of 9.64% for 2017 and 9.94% for 2016, compared to medians of 8.37% in 2017 and 9.21% in 2016 for a peer group comprised of all publicly traded banks and thrifts tracked by S&P Global Market Intelligence Financial with assets of $2 billion to $10 billion, and
 
·
an efficiency ratio, as calculated by S&P Global Market Intelligence, of 53.72% for 2017 and 55.66% for 2016, compared to the peer group medians of 58.62% in 2017 and 60.08% in 2016.  Note that the S&P calculation differs slightly from our calculation.
 
During 2017, TrustCo’s results were positively affected by the growth of low-cost core deposits, strong loan growth and a shift in asset mix. Despite the changes in the interest rate environment during 2017, the Company was able to continue to attract deposits at relatively low yields. On average for 2017, non-maturity deposits were 73.7% of total deposits, up from 72.0% in 2016. Overall, the cost of interest bearing liabilities decreased 3 basis points to 0.36% in 2017 as compared to 2016. Average loan balances increased 5.0% from 2016 to 2017, while the total of short-term investments, available for sale securities and held to maturity securities decreased 11.1%, resulting in average loans growing to 73.4% of average earning assets in 2017 from 71.3% in 2016. Given that loan yields were approximately 200 basis points above the yield on the total of short-term investments and securities, this shift, combined with the growth of average earning assets, the increase in the Federal funds target rate and the decline in funding cost, contributed to the $8.3 million increase in net interest income from 2016 to 2017. The Company has traditionally maintained a high liquidity position, and taken a conservative stance in its investment portfolio through the use of relatively short-term securities. The changing rate environment in 2017 resulted in maturing and called securities being reinvested, as noted, in loans as well as into a combination of Federal funds and bonds. The Federal Reserve Board’s (“FRB”) continued accommodative monetary policy, despite the increases in the target Federal funds range, along with modest economic growth domestically and low rates in other nations, were key drivers of the rate environment during 2017. The 2007-2008 easing of monetary policy by the FRB included a particularly sharp reduction in the Federal Funds rate in 2008, from the 4.25% rate at the beginning of the year to a target range of between 0.00% to 0.25% by year-end. That target range was in place throughout most of 2015. The FRB increased the target range several times beginning in December of 2015, with the target range now at 1.25% to 1.50%. The FRB Federal Open Market Committee (“FOMC” or “Committee”) affirmed in its January 31, 2018 press release that it would maintain “the target range for the federal funds rate at 1.25% to 1.50%. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.  In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”  Most economists currently believe that there will likely be two or three increases in the target rate in 2018, very much subject to what new data indicates about the strength of the economy.”
 
Page 7 of 106

As discussed previously, some market interest rates moved significantly during the course of 2017, with shorter term rates rising sharply but longer term rates remaining roughly flat versus year-end 2016.  Overall, trends in market rates caused a flattening of the yield curve, on average, during the year.   The average daily spread between the ten year Treasury and the two year Treasury was 93 basis points in 2017, down from an average of 102 basis points in 2016 and 145 basis points in 2015. The spread narrowed more significantly later in the year, ending 2017 at 51 basis points. A more positive slope in the yield curve is generally beneficial for the Company’s earnings derived from its core mix of loans and deposits. The tables below illustrate the range of key Treasury bond interest rates during 2016 and 2017.

    
3 Month T
Bill (BEY)
Yield(%)
   
2 Year T
Note
Yield(%)
   
5 Year T
Note
Yield(%)
   
10 Year T
Note
Yield(%)
   
10 Year -
2 Year
Spread(%)
 
2017                              
Beginning of Year     0.51      
1.20
     
1.93
     
2.45
     
1.25
 
Peak     1.47      
1.92
     
2.26
     
2.62
     
1.30
 
Trough    
0.50
     
1.12
     
1.63
     
2.05
     
0.51
 
End of Year    
1.39
     
1.89
     
2.20
     
2.40
     
0.51
 
Average    
0.95
     
1.40
     
1.91
     
2.33
     
0.93
 
Median    
1.01
     
1.34
     
1.90
     
2.34
     
0.91
 
                                         
2016                                        
Beginning of Year    
0.16
     
1.06
     
1.76
     
2.27
     
1.21
 
Peak    
0.55
     
1.29
     
2.10
     
2.60
     
1.34
 
Trough     0.16      
0.56
     
0.94
     
1.37
     
0.76
 
End of Year     0.51      
1.20
     
1.93
     
2.45
     
1.25
 
Average     0.31      
0.84
     
1.35
     
1.86
     
1.02
 
Median     0.30      
0.81
     
1.26
     
1.79
      1.00  
 
Source: S&P Global Market Intelligence
 
In addition to changes in interest rates, economic conditions have a significant impact on the allowance for loan losses. The decrease in the provision for loan losses from $3.0 million in 2016 to $2.0 million in 2017 positively affected net income. Net charge-offs decreased from $3.8 million in 2016 to $1.7 million in 2017. Nonperforming loans decreased from $25.1 million to $24.4 million, and the nature of these loans remained relatively consistent in terms of both geographic location and loan type from year-to-year. Details on nonperforming loans and net charge-offs are included in the notes to the financial statements. The decline in the provision for loan losses is primarily a reflection of the improvement in the performance of the loan portfolio and economic conditions, with reductions in both nonperforming loans (“NPLs”) and charge-offs.
 
TrustCo focuses on providing high quality service to the communities served by its 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’s branch network remained at 145 during 2017, with one branch opening and one closing. The Company remains focused on building its customer relationships, deposits and loans throughout its branch network, with a particular emphasis on the branches added during the major branch expansion that was completed in 2010.

Although that specific expansion program is complete, the Company typically opens new offices each year, filling in or extending existing markets. The expansion program was established to expand the franchise to areas experiencing economic growth, specifically in central Florida and the downstate New York region. The Company has experienced significant growth in both markets as measured by deposit balances, and to a lesser extent, by loan balances. All new branches have the same products and features found at other Trustco Bank locations. With a combination of competitive rates, excellent service and convenient locations, management believes that the new branches will continue to attract deposit and loan customers and be a welcome addition to these communities. The branches opened since the expansion program began have continued to add to the Company’s customer base. As expected, some branches have grown more rapidly than others. Generally, new bank branches continue to grow for years after being opened, although there is no specific time frame that could be characterized as typical. The expansion program has contributed significantly to the growth of both deposits and loans, as well as to non-interest income and non-interest expense. The higher costs are offset by net interest income earned on core loans and deposits generated by these branches, as well as associated non-interest income. Revenue growth is expected to continue, as these branches typically continue to add new customers and increase penetration with existing customers over time.
 
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 and other short-term investments) are the Company’s primary earning assets. Average interest earning assets were 98.3% and 98.1% of average total assets for 2017 and for 2016 respectively.
 
Page 8 of 106

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,” but rather 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 predicted and controlled risk. The Company is deliberate in its efforts 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. Predicting the impact of changing rates on the Company’s net interest income and net fair value of its balance sheet is complex and subject to uncertainty for a number of reasons. For example, in making a general assumption that rates will rise, a myriad of other assumptions regarding whether the slope of the yield curve remains the same or changes, whether the spreads of various loans, deposits and investments remain unchanged, widen or narrow and what changes occur in customer behavior all need to be made. The Company routinely models various rate changes and monitors basis changes that may be incorporated into that modeling.
 
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. As noted previously, during 2007-2008 the FRB aggressively reduced the Federal Funds rate, including a decrease from 4.25% at the beginning of 2008 to a target range of 0.00% to 0.25% by the end of 2008. The target range remained at that level until December 2015 when the range was increased to 0.25% to 0.50%.  Subsequent increases have resulted in the current range of 1.25% to 1.50%.
 
The yield on the ten-year Treasury bond decreased by 5 basis points from 2.45% at the beginning of 2017 to the year-end level of 2.40%, despite the increases in short term rates. The rate on the ten year Treasury bond and other long-term interest rates have a significant influence on the rates offered 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 on other short-term instruments as well as the 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 ten-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 the securities available for sale portfolio, which are recorded at fair value. Generally, as market interest rates increase, the fair value of the securities will decrease and the reverse is also generally applicable. Interest rates on new residential real estate loan originations are also influenced by the rates established by secondary market participants 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. Higher market interest rates also generally increase the value of retail deposits.
 
While the increase in the Federal Funds target range had a beneficial impact on earnings on the Company’s cash position, the net effect of market changes in interest rates during 2017 was that yields earned on both the investment portfolios and loans remained quite low in 2017 relative to historic levels, while deposit costs were roughly stable.
 
Earning Assets
 
Average earning assets during 2017 were $4.79 billion, which was an increase of $92.3 million from 2016. This increase was the result of growth in the average balance of net loans of $166.6 million, offset by decreases of $50.9 million in Federal Funds sold and other short-term investments, $13.0 million in held-to-maturity securities and $10.2 million in securities available for sale between 2016 and 2017. The increase in the loan portfolio is the result of a significant increase in residential mortgage loans, which more than offset decreases in each of the other loan categories. The increase in real estate loans is a result of a strategic focus on growth of this product throughout the Trustco Bank branch network through an effective marketing campaign and competitive rates and closing costs.
 
Page 9 of 106

Total average assets were $4.88 billion for 2017 and $4.79 billion for 2016.
 
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.

MIX OF AVERAGE EARNING ASSETS
 
 
(dollars in thousands)
                   
2017
vs.
   
2016
vs.
   
Components of
Total Earning Assets
 
   
2017
   
2016
   
2015
   
2016
   
2015
   
2017
   
2016
   
2015
 
Loans, net
 
$
3,514,900
   
$
3,348,324
     
3,234,806
     
166,576
     
113,518
     
73.4
%
   
71.3
     
69.9
 
                                                                 
Securities available for sale (1):
                                                               
U.S. government sponsored enterprises
   
139,652
     
101,242
     
107,436
     
38,410
     
(6,194
)
   
2.9
     
2.2
     
2.3
 
State and political subdivisions
   
682
     
991
     
1,812
     
(309
)
   
(821
)
   
0.0
     
0.0
     
0.0
 
Mortgage-backed securities and collateralized mortgage obligations-residential
   
350,256
     
410,646
     
439,343
     
(60,390
)
   
(28,697
)
   
7.3
     
8.7
     
9.5
 
Corporate bonds
   
41,946
     
17,088
     
613
     
24,858
     
16,475
     
0.9
     
0.4
     
0.0
 
Small Business Administration-guaranteed participation securities
   
73,996
     
86,407
     
97,496
     
(12,411
)
   
(11,089
)
   
1.5
     
1.8
     
2.1
 
Mortgage-backed securities and collateralized mortgage obligations-commercial
   
9,963
     
10,284
     
10,566
     
(321
)
   
(282
)
   
0.2
     
0.2
     
0.2
 
Other
   
685
     
683
     
685
     
2
     
(2
)
   
0.0
     
0.0
     
0.0
 
Total securities available for sale
   
617,180
     
627,341
     
657,951
     
(10,161
)
   
(30,610
)
   
12.9
     
13.4
     
14.2
 
                                                                 
Held-to-maturity securities:
                                                               
Mortgage-backed securities and collateralized mortgage obligations
   
31,266
     
40,830
     
53,763
     
(9,564
)
   
(12,933
)
   
0.7
     
0.9
     
1.2
 
Corporate bonds
   
6,663
     
10,145
     
9,967
     
(3,482
)
   
178
     
0.1
     
0.2
     
0.2
 
Total held-to-maturity securities
   
37,929
     
50,975
     
63,730
     
(13,046
)
   
(12,755
)
   
0.8
     
1.1
     
1.4
 
                                                                 
Federal Reserve Bank and Federal Home
                                                               
Loan Bank stock
   
9,295
     
9,554
     
9,414
     
(259
)
   
140
     
0.2
     
0.2
     
0.2
 
Federal funds sold and other short-term investments
   
611,586
     
662,436
     
664,516
     
(50,850
)
   
(2,080
)
   
12.8
     
14.1
     
14.4
 
Total earning assets
 
$
4,790,890
   
$
4,698,630
   
$
4,630,417
     
92,260
     
68,213
     
100.0
%
   
100.0
     
100.0
 

(1) The average balances of securities available for sale are presented using amortized cost for these securities.
 
Loans
 
In 2017, the Company experienced another year of significant loan growth. The $205.8 million increase in the Company’s gross loan portfolio from December 31, 2016 to December 31, 2017 was due to higher residential mortgage balances, which offset lower balances in other loan categories. Average loans increased $166.6 million during 2017 to $3.51 billion. Interest income on the loan portfolio increased to $148.2 million in 2017 from $143.7 million in 2016. The average yield declined 7 basis points to 4.22% in 2017 compared to 2016.
 
Page 10 of 106

LOAN PORTFOLIO
 
(dollars in thousands)
 
As of December 31,
 
   
2017
   
2016
   
2015
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Commercial
 
$
176,385
     
4.9
%
 
$
182,653
     
5.3
%
 
$
192,789
     
5.9
%
Real estate - construction
   
30,946
     
0.9
     
24,826
     
0.7
     
26,594
     
0.8
 
Real estate - mortgage
   
3,111,397
     
85.6
     
2,879,448
     
83.9
     
2,705,205
     
82.1
 
Home equity lines of credit
   
308,916
     
8.5
     
334,841
     
9.8
     
359,325
     
10.9
 
Installment loans
   
8,763
     
0.2
     
8,818
     
0.3
     
9,391
     
0.3
 
Total loans
   
3,636,407
     
100.0
%
   
3,430,586
     
100.0
%
   
3,293,304
     
100.0
%
Less: Allowance for loan losses
   
44,170
             
43,890
             
44,762
         
Net loans (1)
 
$
3,592,237
           
$
3,386,696
           
$
3,248,542
         

   
Average Balances
 
   
2017
   
2016
   
2015
   
2014
   
2013
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
Commercial
 
$
175,596
     
5.0
%
 
$
186,800
     
5.6
%
 
$
195,265
     
6.0
%
 
$
201,317
     
6.7
%
 
$
193,065
     
7.0
%
Real estate - construction
   
26,616
     
0.8
     
23,645
     
0.7
     
29,101
     
0.9
     
35,109
     
1.2
     
36,689
     
1.3
 
Real estate - mortgage
   
2,985,870
     
84.9
     
2,779,451
     
83.0
     
2,647,265
     
81.8
     
2,428,383
     
80.6
     
2,201,348
     
79.4
 
Home equity lines of credit
   
318,660
     
9.1
     
350,004
     
10.5
     
354,718
     
11.0
     
343,264
     
11.4
     
335,409
     
12.1
 
Installment loans
   
8,158
     
0.2
     
8,424
     
0.3
     
8,457
     
0.3
     
6,083
     
0.2
     
5,152
     
0.2
 
                                                                                 
Total loans
   
3,514,900
     
100.0
%
   
3,348,324
     
100.0
%
   
3,234,806
     
100.0
%
   
3,014,156
     
100.0
%
   
2,771,663
     
100.0
%
Less: Allowance for loan losses
   
44,319
             
44,718
             
46,023
             
47,409
             
48,452
         
Net loans (1)
 
$
3,470,581
           
$
3,303,606
           
$
3,188,783
           
$
2,966,747
           
$
2,723,211
         

(1)
Presented net of deferred direct loan origination fees and costs.
 
Through marketing, pricing and a customer-friendly service delivery network, TrustCo has attempted to distinguish itself from other mortgage lenders by highlighting the uniqueness of its loan products. Specifically, low closing costs, no escrow or private mortgage insurance, quick loan decisions and fast closings 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 mortgage loans was $3.00 billion in 2017 and $2.79 billion in 2016. Income on real estate loans increased to $125.0 million in 2017 from $119.8 million in 2016. The yield on the portfolio decreased from 4.29% in 2016 to 4.16% in 2017 due to changes in retail rates in the marketplace. The vast majority of TrustCo’s real estate loans are secured by properties within the Bank’s market area.
 
TrustCo does not make subprime loans or purchase investments collateralized by subprime loans. A loan may be considered subprime for a number of reasons, but effectively subprime loans are loans where the certainty of repayment of principal and interest is lower than for a traditional prime loan due to the structure of the loan itself, the credit worthiness of the borrower, the underwriting standards of the lender or some combination of these. For instance, adjustable loans underwritten at initial low “teaser” rates instead of the fully indexed rate and loans to borrowers with poor payment history would generally be classified as subprime. Other than for it’s small credit card portfolio, TrustCo underwrites its loan originations in a traditional manner, focusing on key factors that have proven to result in good credit decisions, rather than relying on automated systems or basing decisions primarily on one factor, such as a borrower’s credit score.
 
Average commercial loans of $185.4 million in 2017 decreased by $10.7 million from $196.1 million in 2016.  Average commercial loans included $9.8 million and $9.3 million of commercial real estate construction loans in 2017 and 2016, respectively.   The average yield on the commercial loan portfolio decreased to 5.25% for 2017 from 5.27% in 2016, which, coupled with the lower average balance resulted in interest income on commercial loans of $9.7 million in 2017 and $10.3 million in 2016.
 
TrustCo’s commercial lending activities are focused on balancing the Company’s commitment to meeting the credit needs of businesses in its market areas 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. TrustCo’s commercial loan portfolio contains no foreign loans, nor does it contain any significant concentrations of credit to any single borrower or industry. The Capital Region commercial loan portfolio reflects the diversity of businesses found in the market area, including light manufacturing, retail, service, and real estate-related businesses. Commercial loans made in the downstate New York market area and in the central Florida market area also reflect the businesses in those areas, with a focus on real estate.
 
TrustCo strives to maintain strong asset quality in all segments of its loan portfolio, especially commercial loans. There is significant competition for commercial loans continues to be intense in the Bank’s market regions.
 
Page 11 of 106

TrustCo has a strong position in the home equity credit line product in its market area. During 2017, the average balance of home equity credit lines was $318.7 million, a decrease from $350.0 million in 2016. 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 while meeting evolving needs. Changes in consumer behavior have resulted in this product being somewhat less popular in recent years.  TrustCo’s average yield on this portfolio was 3.98% for 2017 and 3.65% in 2016. This resulted in interest income on home equity credit lines of $12.7 million in 2017, compared to $12.8 million in 2016.

MATURITIES AND SENSITIVITIES OF LOANS TO CHANGE IN INTEREST RATES
 
(dollars in thousands)
 
December 31, 2017
 
 
In 1 Year
or Less
   
After 1 Year
But Within
5 Years
   
After
5 Years
   
Total
 
Commercial
 
$
46,094
     
44,367
     
85,924
     
176,385
 
Real estate construction
   
30,946
     
-
     
-
     
30,946
 
                                 
Total
   
77,040
     
44,367
     
85,924
     
207,331
 
                                 
Predetermined rates
   
38,256
     
44,367
     
85,924
     
168,547
 
Floating rates
   
38,784
     
-
     
-
     
38,784
 
                                 
Total
 
$
77,040
     
44,367
     
85,924
     
207,331
 

At December 31, 2017 and 2016, the Company had approximately $30.9 million and $24.8 million of real estate construction loans, respectively. Of the $30.9 million in real estate construction loans at December 31, 2017, approximately $21.1 million were secured by first mortgages to residential borrowers with the remaining $9.8 million were loans to commercial borrowers for residential construction projects.  Of the $24.8 million in real estate construction loans at December 31, 2016, approximately $16.3 million were secured by first mortgages to residential borrowers while approximately $8.5 million were to commercial borrowers for residential construction projects.  The vast majority of the Company’s construction loans are in the Company’s New York market.

INVESTMENT SECURITIES
 
(dollars in thousands)
 
As of December 31,
 
   
2017
   
2016
   
2015
 
    
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
Securities available for sale:
                                   
U. S. government sponsored enterprises
 
$
139,890
     
137,851
     
119,887
     
117,266
     
86,899
     
86,737
 
State and political subdivisions
   
515
     
525
     
873
     
886
     
1,270
     
1,290
 
Mortgage backed securities and collateralized mortgage obligations-residential
   
320,614
     
315,983
     
378,068
     
372,308
     
416,625
     
411,729
 
Corporate bonds
   
40,270
     
40,162
     
40,956
     
40,705
     
-
     
-
 
Small Business Adminstration-guaranteed participation securities
   
68,921
     
67,059
     
81,026
     
78,499
     
92,620
     
90,416
 
Mortgage backed securities and collateralized mortgage obligations-commercial
   
9,810
     
9,700
     
10,130
     
10,011
     
10,422
     
10,180
 
Other
   
650
     
650
     
650
     
650
     
650
     
650
 
Total debt securities available for sale
   
580,670
     
571,930
     
631,590
     
620,325
     
608,486
     
601,002
 
Equity securities
   
35
     
35
     
35
     
35
     
35
     
35
 
Total securities available for sale
   
580,705
     
571,965
     
631,625
     
620,360
     
608,521
     
601,037
 
Held to maturity securities:
                                               
Mortgage backed securities and collateralized mortgage obligations-residential
   
27,551
     
28,701
     
35,500
     
37,236
     
46,490
     
48,798
 
Corporate bonds
   
-
     
-
     
9,990
     
10,290
     
9,975
     
10,641
 
Total held to maturity securities
   
27,551
     
28,701
     
45,490
     
47,526
     
56,465
     
59,439
 
Total investment securities
 
$
608,256
     
600,666
     
677,115
     
667,886
     
664,986
     
660,476
 

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 and is particularly important in providing greater flexibility in the current low interest rate environment. The securities available for sale portfolio is managed under a policy detailing the types and characteristics acceptable in the portfolio. Mortgage backed securities and collateralized mortgage obligations held in the portfolio include only pass-throughs issued by United States government agencies or sponsored enterprises.
 
Page 12 of 106

Holdings of various types of securities may vary from year-to-year depending on management’s assessment of relative risk and reward, and also due to timing issues of call, maturities, prepayments and purchases.  Holdings of both municipal and corporate securities are subject to additional monitoring requirements under current regulations, adding to the costs of owning those securities.
 
Proceeds from sales, calls and maturities of securities available for sale have been invested in higher yielding assets, such as loans, or temporarily held in Federal Funds sold and other short term investments until deployed to fund future loan growth or future investment opportunities.
 
The designation of securities as “available for sale” is made at the time of purchase, based upon management’s intent and ability to hold the securities for an indefinite period of time. 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, 2017 some securities in this portfolio had fair values that were less than the amortized cost due to changes in interest rates and market conditions and not related to the credit condition of the issuers. At December 31, 2017, the Company did not intend to sell, and it is not likely that the Company will be required to sell these securities before market recovery. Accordingly, at December 31, 2017 the Company did not consider any of the unrealized losses to be other than temporary.
 
At December 31, 2017, the carrying value of securities available for sale amounted to $572.0 million, compared to $620.4 million at year end 2016. For 2017, the average balance of securities available for sale was $617.2 million with an average yield of 1.95%, compared to an average balance in 2016 of $627.3 million with an average yield of 1.87%. The taxable equivalent income earned on the securities available for sale portfolio in 2016 was $11.7 million, compared to $12.1 million earned in 2017.
 
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, 2017, the fair value of TrustCo’s portfolio of securities available for sale carried gross unrealized gains of approximately $120 thousand and gross unrealized losses of approximately $8.9 million. At December 31, 2016, the fair value of the company’s portfolio of securities available for sale carried gross unrealized gains of approximately $136 thousand and gross unrealized losses of approximately $11.4 million. As previously noted, in both periods, unrealized losses were related to market interest rate levels and were not credit related.
 
Held to Maturity Securities: At December 31, 2017 the Company held $27.6 million of held to maturity securities, compared to $45.5 million at December 31, 2016. For 2017, the average balance of held to maturity securities was $37.9 million, compared to $51.0 million in 2016. Similar to securities available for sale, cash flow from these securities has been reinvested in higher yielding assets, such as loans, or temporarily held in Federal Funds sold and other short term investments to fund future loan growth or future investment opportunities. The average yield on held to maturity securities increased from 4.06% in 2016 to 4.11% in 2017 as the mix within the portfolio changed due primarily to paydowns and prepayments on the mortgage-backed securities held in the portfolio. The maturity of a corporate bond with a relatively high yield will impact the overall yield on this portfolio in 2018.  Interest income on held to maturity securities declined from $2.1 million in 2016 to $1.6 million in 2017, reflecting the decline in average balances. Held to maturity securities are recorded at amortized cost. The fair value of these securities as of December 31, 2017 was $28.7 million.
 
The designation of securities as “held to maturity” is made at the time of purchase, based upon management’s intent and ability to hold the securities until final maturity. At December 31, 2017 none of the securities in this portfolio had fair values that were less than the amortized cost.
 
Securities Gains: During 2017, TrustCo did not recognize any net gains from securities transactions, compared to net gains of $668 thousand in 2016 and $251 thousand in 2015. There were no sales or transfers of held to maturity securities in 2017, 2016 and 2015.
 
TrustCo has not invested in any exotic investment products such as interest rate swaps, forward placement contracts, or other instruments commonly referred to as derivatives. In addition, the Company has not invested in securities backed by subprime mortgages or in collateralized debt obligations (CDOs). By actively managing a portfolio of high quality securities, TrustCo believes it can meet the objectives of asset/liability management and liquidity, while at the same time producing a reasonably predictable earnings stream.
 
Page 13 of 106

SECURITIES PORTFOLIO MATURITY DISTRIBUTION AND YIELD
 
(dollars in thousands)
 
As of December 31, 2017
 
    
Maturing:
 
     
Within
1 Year
   
After 1
But Within
5 Years
   
After 5
But Within
10 Years
   
After
10 Years
   
Total
 
                               
Debt securities available for sale:
                             
U. S. government sponsored enterprises
                             
Amortized cost
 
$
15,000
     
124,890
     
-
     
-
     
139,890
 
Fair Value
   
14,990
     
122,861
     
-
     
-
     
137,851
 
Weighted average yield
   
1.03
%
   
1.87
     
-
     
-
     
1.78
 
State and political subdivisions
                                       
Amortized cost
 
$
8
     
448
     
59
     
-
     
515
 
Fair Value
   
8
     
458
     
59
     
-
     
525
 
Weighted average yield
   
5.43
%
   
5.09
     
4.90
     
-
     
5.07
 
Mortgage backed securities and collateralized mortgage obligations-residential
                                       
Amortized cost
 
$
1,541
     
177,994
     
141,079
     
-
     
320,614
 
Fair Value
   
1,533
     
175,407
     
139,043
     
-
     
315,983
 
Weighted average yield
   
1.83
%
   
2.28
     
2.34
     
-
     
2.30
 
Corporate bonds
                                       
Amortized cost
 
$
30,175
     
10,095
     
-
     
-
     
40,270
 
Fair Value
   
30,143
     
10,019
     
-
     
-
     
40,162
 
Weighted average yield
   
1.47
%
   
1.46
     
-
     
-
     
1.46
 
Small Business Administration-
                                       
guaranteed participation securities
                                       
Amortized cost
 
$
-
     
14,957
     
53,964
     
-
     
68,921
 
Fair Value
   
-
     
14,463
     
52,596
     
-
     
67,059
 
Weighted average yield
   
-
%
   
1.90
     
2.10
     
-
     
2.06
 
Mortgage backed securities and  collateralized mortgage obligations-commercial
                                       
Amortized cost
 
$
-
     
9,810
     
-
     
-
     
9,810
 
Fair Value
   
-
     
9,700
     
-
     
-
     
9,700
 
Weighted average yield
   
-
%
   
1.68
     
-
     
-
     
1.68
 
Other
                                       
Amortized cost
 
$
600
     
50
     
-
     
-
     
650
 
Fair Value
   
600
     
50
     
-
     
-
     
650
 
Weighted average yield
   
2.57
%
   
1.92
     
-
     
-
     
2.52
 
Total securities available for sale
                                       
Amortized cost
 
$
47,324
     
338,244
     
195,102
     
-
     
580,670
 
Fair Value
   
47,274
     
332,958
     
191,698
     
-
     
571,930
 
Weighted average yield
   
1.34
%
   
2.07
     
2.28
     
-
     
2.08
 
                                         
Held to maturity securities:
                                       
Mortgage backed securities and collateralized mortgage obligations-residential
                                       
Amortized cost
 
$
-
     
25,631
     
1,920
     
-
     
27,551
 
Fair Value
   
-
     
26,638
     
2,063
     
-
     
28,701
 
Weighted average yield
   
-
%
   
3.80
     
5.14
     
-
     
3.89
 
Corporate bonds
                                       
Amortized cost
 
$
-
     
-
     
-
     
-
     
-
 
Fair Value
   
-
     
-
     
-
     
-
     
-
 
Weighted average yield
   
-
%
   
-
     
-
     
-
     
-
 
Total held to maturity securities
                                       
Amortized cost
   
-
     
25,631
     
1,920
     
-
     
27,551
 
Fair Value
   
-
     
26,638
     
2,063
     
-
     
28,701
 
Weighted average yield
   
-
%
   
3.80
     
5.14
             
3.89
 

Weighted average yields have not been adjusted for any tax-equivalent factor.
 
Page 14 of 106

Maturity and call dates of securities: Many of the securities in the Company’s portfolios 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 level of calls in 2017 was lower than the 2016 level, as rising interest rates reduce the probability of calls. The probability of future calls will change depending on market interest rate levels. The tables labeled “Securities Portfolio Maturity and Call Date Distribution,” show the distribution, based on both final maturity and call date of each security, broken out by the available for sale and held to maturity portfolios as of December 31, 2017. Mortgage backed securities, collateralized mortgage obligations and Small Business Administration securities are reported using an estimate of average life. 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. The table, “Securities Portfolio Maturity Distribution and Yield,” shows the distribution of maturities for each of the securities portfolios, based on final maturity, as well as the average yields at December 31, 2017 on each type/maturity grouping.

SECURITIES PORTFOLIO MATURITY AND CALL DATE DISTRIBUTION
 
Debt securities available for sale:
 
(dollars in thousands)
 
As of December 31, 2017
 
 
Based on
Final Maturity
   
Based on
Call Date
 
  
Amortized
Cost
     
Fair
Value
     
Amortized
Cost
     
Fair
Value
 
 
Within 1 year
 
$
45,783
     
45,740
     
107,538
     
106,688
 
1 to 5 years
   
145,355
     
143,151
     
278,054
     
273,569
 
5 to 10 years
   
10,355
     
10,139
     
195,078
     
191,673
 
After 10 years
   
379,177
     
372,900
     
-
     
-
 
Total debt securities available for sale
 
$
580,670
     
571,930
     
580,670
     
571,930
 

Held to maturity securities:
 
(dollars in thousands)
 
As of December 31, 2017
 
 
Based on
Final Maturity
   
Based on
Call Date
 
  
Amortized
Cost
     
Fair
Value
     
Amortized
Cost
     
Fair
Value
  
1 to 5 years
   
-
     
-
     
25,631
     
26,638
 
5 to 10 years
   
1,682
     
1,713
     
1,920
     
2,063
 
After 10 years
   
25,869
     
26,988
     
-
     
-
 
Total held to maturity securities
 
$
27,551
     
28,701
     
27,551
     
28,701
 
 
Federal Funds Sold and Other Short-term Investments
 
During 2017, the average balance of Federal Funds sold and other short-term investments was $611.6 million, a decrease from $662.4 million in 2016. The average rate earned on these assets was 0.50% in 2016 and 1.09% in 2017. The increase in the average rate in 2017 was due to the increases in the Federal Funds target range that were implemented.  The full impact of the increases in the Federal Funds target range that occurred in 2017 will be realized in 2018. TrustCo utilizes this category of earning assets as a means of maintaining strong liquidity. 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 short term interest-sensitive instruments.
 
The year-end balance of Federal Funds sold and other short term investments was $568.6 million for 2017, compared to $658.6 million at year end 2016. While yields on investment securities with acceptable risk characteristics were insufficient to justify shifting overnight liquidity into other investment types during 2017, some funds were shifted into higher yielding loans. Management will continue to evaluate the overall level of the Federal Funds sold and other short-term investments in 2018 and will make appropriate adjustments based upon market opportunities and interest rates.
 
Page 15 of 106

Funding Sources
 
TrustCo utilizes various traditional sources of funds to support its earning 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 were $4.17 billion in 2017, compared to $4.15 billion in 2016, an increase of $22.2 million. Changes in deposit categories (average balances 2017 versus 2016) included: demand deposits up $12.8 million, interest-bearing checking deposits up $79.6 million, savings up $3.3 million, money market down $7.9 million and time deposits down $65.7 million. While many customers remain in one product type for many years, others may move funds between product types to maximize the yield earned or as a result of increased or decreased liquidity needs.  The increase in core deposits reflects the focus on growing these lower costing funding sources by providing core banking services better, faster and cheaper than competitors.  The increase in time deposits over $250 thousand is not the result of any incentive pricing as TrustCo does not offer premium rates on large certificates of deposit.
 
MIX OF AVERAGE SOURCES OF FUNDING
(dollars in thousand)
 
                     
2017
vs.
   
2016
vs.
   
Components of
Total Funding
 
 
 
2017
   
2016
   
2015
   
2016
   
2015
   
2017
   
2016
   
2015
 
Retail deposits
 
 
 
   
 
 
     
 
     
 
     
 
     
 
 
   
 
     
 
 
Demand deposits
  $ 382,658      369,820        348,552        12,838        21,268        8.7  %     8.5       8.1   
Savings
   
1,275,268
     
1,272,015
     
1,245,100
     
3,253
     
26,915
     
29.0
     
29.3
     
29.0
 
Time deposits under $250 thousand
   
960,408
     
1,018,571
     
1,075,880
     
(58,163
)
   
(57,309
)
   
21.8
     
23.5
     
25.1
 
Interest bearing checking accounts
   
844,010
     
764,399
     
708,331
     
79,611
     
56,068
     
19.2
     
17.6
     
16.5
 
Money market deposits
   
572,270
     
580,125
     
628,096
     
(7,855
)
   
(47,971
)
   
13.0
     
13.4
     
14.6
 
Total retail deposits
   
4,034,614
     
4,004,930
     
4,005,959
     
29,684
     
(1,029
)
   
91.7
     
92.4
     
93.4
 
Time deposits over $250 thousand
   
136,782
     
144,271
     
97,546
     
(7,489
)
   
46,725
     
3.1
     
3.3
     
2.3
 
Short-term borrowings
   
228,086
     
185,672
     
184,725
     
42,414
     
947
     
5.2
     
4.3
     
4.3
 
Total purchased liabilities
   
364,868
     
329,943
     
282,271
     
34,925
     
47,672
     
8.3
     
7.6
     
6.6
 
Total sources of funding
 
$
4,399,482
   
$
4,334,873
     
4,288,230
     
64,609
     
46,643
     
100.0
%
   
100.0
     
100.0
 
 
Page 16 of 106

AVERAGE BALANCES, YIELDS AND NET INTEREST MARGINS
 
(dollars in thousands)
 
2017
   
2016
   
2015
 
   
Average
Balance
   
Interest
Income/
Expense
   
Average
Rate
   
Average
Balance
   
Interest
Income/
Expense
   
Average
Rate
   
Average
Balance
   
Interest
Income/
Expense
   
Average
Rate
 
Assets
                                                     
Loans, net
 
$
3,514,900
     
148,162
     
4.22
%
 
$
3,348,324
     
143,705
     
4.29
%
 
$
3,234,806
     
141,915
     
4.39
%
                                                                         
Securities available for sale:
                                                                       
U.S. government sponsored enterprises
   
139,652
     
2,281
     
1.63
     
101,242
     
1,489
     
1.47
     
107,436
     
1,418
     
1.32
 
State and political subdivisions
   
682
     
55
     
8.06
     
991
     
80
     
8.07
     
1,812
     
133
     
7.40
 
Mortgage backed securities and collateralized mortgage obligations-residential
   
350,256
     
7,447
     
2.13
     
410,646
     
7,963
     
1.94
     
439,343
     
9,132
     
2.08
 
Corporate bonds
   
41,946
     
606
     
1.44
     
17,088
     
246
     
1.44
     
613
     
1
     
0.16
 
Small Business Administration-guaranteed participation securities
   
73,996
     
1,547
     
2.09
     
86,407
     
1,801
     
2.08
     
97,496
     
2,004
     
2.06
 
Mortgage backed securities and collateralized mortgage obligations-commercial
   
9,963
     
109
     
1.09
     
10,284
     
133
     
1.29
     
10,566
     
149
     
1.41
 
Other
   
685
     
16
     
2.34
     
683
     
16
     
2.34
     
685
     
16
     
2.34
 
Total securities available for sale
   
617,180
     
12,061
     
1.95
     
627,341
     
11,728
     
1.87
     
657,951
     
12,853
     
1.95
 
Held to maturity securities:
                                                                       
Mortgage backed securities and collateralized mortgage obligations-residential
   
31,266
     
1,149
     
3.67
     
40,830
     
1,454
     
3.56
     
53,763
     
1,844
     
3.43
 
Corporate bonds
   
6,663
     
410
     
6.15
     
10,145
     
617
     
6.08
     
9,967
     
615
     
6.17
 
Total held to maturity securities
   
37,929
     
1,559
     
4.11
     
50,975
     
2,071
     
4.06
     
63,730
     
2,459
     
3.86
 
Federal Reserve Bank and Federal Home
                                                                       
Loan Bank stock
   
9,295
     
544
     
5.85
     
9,554
     
502
     
5.25
     
9,414
     
467
     
4.96
 
Federal funds sold and other short-term investments
   
611,586
     
6,679
     
1.09
     
662,436
     
3,407
     
0.50
     
664,516
     
1,725
     
0.26
 
Total interest earning assets
   
4,790,890
     
169,005
     
3.53
%
   
4,698,630
     
161,413
     
3.44
%
   
4,630,417
     
159,419
     
3.44
%
Allowance for loan losses
   
(44,319
)
                   
(44,718
)
                   
(46,023
)
               
Cash and noninterest earning assets
   
129,097
                     
136,789
                     
136,752
                 
Total assets
 
$
4,875,668
                   
$
4,790,701
                   
$
4,721,146
                 
Liabilities and shareholders' equity
                                                                       
Interest bearing deposits:
                                                                       
Interest bearing checking accounts
 
$
844,010
     
478
     
0.06
%
 
$
764,399
     
473
     
0.06
%
 
$
708,331
     
448
     
0.06
%
Savings
   
1,275,268
     
1,729
     
0.14
     
1,272,015
     
2,148
     
0.17
     
1,245,100
     
2,468
     
0.20
 
Time deposits and money markets
   
1,669,460
     
10,983
     
0.66
     
1,742,967
     
11,592
     
0.67
     
1,801,522
     
12,067
     
0.67
 
Total interest bearing deposits
   
3,788,738
     
13,190
     
0.35
     
3,779,381
     
14,213
     
0.38
     
3,754,953
     
14,983
     
0.40
 
Short-term borrowings
   
228,086
     
1,402
     
0.61
     
185,672
     
1,091
     
0.59
     
184,725
     
1,214
     
0.66
 
Total interest bearing liabilities
   
4,016,824
     
14,592
     
0.36
%
   
3,965,053
     
15,304
     
0.39
%
   
3,939,678
     
16,197
     
0.41
%
Demand deposits
   
382,658
                     
369,820
                     
348,552
                 
Other liabilities
   
28,506
                     
27,439
                     
27,155
                 
Shareholders' equity
   
447,680
                     
428,389
                     
405,761
                 
Total liabilities and shareholders' equity
 
$
4,875,668
                   
$
4,790,701
                   
$
4,721,146
                 
Net interest income
           
154,413
                     
146,109
                     
143,222
         
Taxable equivalent adjustment
           
(45
)
                   
(54
)
                   
(74
)
       
Net interest income
           
154,368
                     
146,055
                     
143,148
         
Net interest spread
                   
3.16
%
                   
3.05
%
                   
3.03
%
Net interest margin (net interest income to total interest earnings assets)
                   
3.22
                     
3.11
                     
3.09
 

Portions of income earned on certain commercial loans, 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 state tax rates used to calculate income on a tax equivalent basis were 35.0% and 7.5%, respectively, for 2017, 2016, and 2015. [The average balances of securities available for sale and held to maturity were calculated using amortized costs. Included in the average balance of shareholders’ equity is $754 thousand, $849 thousand, and $3.1 million in 2017, 2016, and 2015, respectively, of net unrealized loss, net of tax, in the available for sale securities portfolio.] The gross amounts of the net unrealized loss has been included in cash and noninterest earning assets. Nonaccrual loans are included in average loans.
 
The overall cost of interest bearing deposits was 0.35% in 2017, down three basis points from 2016. The decrease in the cost of deposits more than offset the impact of the increase in the average balance of interest bearing deposits, resulting in a decrease of approximately $1.0 million in interest expense on deposits to $13.2 million in 2017.
 
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.
 
Other funding sources: The Company had $228.1 million of average short-term borrowings outstanding during 2017, compared to $185.7 million in 2016. These borrowings represent customer repurchase accounts, which behave more like deposit accounts than traditional borrowings. The average cost of short-term borrowings was 0.61% in 2017 and 0.59% in 2016. This resulted in interest expense of approximately $1.4 million in 2017, compared to $1.1 million in 2016.
 
Page 17 of 106

AVERAGE DEPOSITS BY TYPE OF DEPOSITOR