10-K 1 form10k.htm NBT BANCORP, INC 10-K 12-31-2016

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016
COMMISSION FILE NUMBER: 0-14703

NBT BANCORP INC.
(Exact name of registrant as specified in its charter)

Delaware
 
16-1268674
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

52 SOUTH BROAD STREET
NORWICH, NEW YORK 13815
(Address of principal executive office) (Zip Code)
(607) 337-2265 (Registrant’s telephone number, including area code)
  
Securities registered pursuant to section 12(b) of the Act:
  
Title of each class:
 
Name of each exchange on which registered:
Common Stock, par value $0.01 per share
 
The NASDAQ Stock Market LLC
 
Securities registered pursuant to section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes   No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.  Yes   No
 
Indicate  by  check mark whether the registrant (1) has filed all reports required to  be  filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the  preceding  12  months  (or  for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for  the  past  90  days.  Yes   No  
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will  not be contained, to the best of the registrant’s knowledge, in definitive Proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes   No
 
Based on the closing price of the registrant’s common stock as of June 30, 2016, the aggregate market value of the voting stock, common stock, par value, $0.01 per share, held by non-affiliates of the registrant is $1,187,578,681.
 
The number of shares of common stock outstanding as of February 10, 2017, was 43,393,972.
 


DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 23, 2017 are incorporated by reference into Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

NBT BANCORP INC.
FORM 10-K – Year Ended December 31, 2016
 
TABLE OF CONTENTS
 
PART I
     
       
ITEM 1
 
4
       
ITEM 1A
 
14
       
ITEM 1B
 
20
       
ITEM 2
 
21
       
ITEM 3
 
22
       
ITEM 4
 
22
       
PART II
     
       
ITEM 5
 
22
       
ITEM 6
 
24
       
ITEM 7
 
26
       
ITEM 7A
 
43
       
ITEM 8
 
45
   
45
   
46
   
47
   
48
   
49
   
50
   
51
       
ITEM 9
 
92
       
ITEM 9A
 
92
       
ITEM 9B
 
95
       
PART III
     
       
ITEM 10
 
95
       
ITEM 11
 
95
       
ITEM 12
 
95
       
ITEM 13
 
95
       
ITEM 14
 
95
       
PART IV
     
       
ITEM 15
 
96
       
ITEM 16
 
98
       
99
 
PART I

ITEM 1.      Business
 
NBT Bancorp Inc. (the “Registrant” or the “Company”) is a registered financial holding company incorporated in the state of Delaware in 1986, with its principal headquarters located in Norwich, New York. The Company, on a consolidated basis, at December 31, 2016 had assets of $8.9 billion and stockholders’ equity of $913.3 million.  
 
The principal assets of the Registrant consist of all of the outstanding shares of common stock of its subsidiaries, including:  NBT Bank, National Association (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), NBT Holdings, Inc. (“NBT Holdings”), Hathaway Agency, Inc., CNBF Capital Trust I, NBT Statutory Trust I, NBT Statutory Trust II, Alliance Financial Capital Trust I, and Alliance Financial Capital Trust II (collectively, the “Trusts”).  The Company’s principal sources of revenue are the management fees and dividends it receives from the Bank, NBT Financial and NBT Holdings.
 
The Company’s business, primarily conducted through the Bank but also through its other subsidiaries, consists of providing commercial banking and financial services primarily to customers in its market area, which includes central and upstate New York, northeastern Pennsylvania, southern New Hampshire, western Massachusetts, Vermont, and the greater Portland, Maine area.  The Company has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services.  The Company’s business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial, and municipal customers.  The financial condition and operating results of the Company are dependent on its net interest income which is the difference between the interest and dividend income earned on its earning assets, primarily loans and investments, and the interest expense paid on its interest bearing liabilities, primarily consisting of deposits and borrowings. Among other factors, net income is also affected by provisions for loan losses and noninterest income, such as service charges on deposit accounts, insurance and other financial services fees, trust revenue, and gains/losses on securities sales, bank owned life insurance income, ATM and debit card fees, and retirement plan administration fees as well as noninterest expense, such as salaries and employee benefits, occupancy, equipment, data processing and communications, professional fees and outside services, office supplies and postage, amortization, loan collection and other real estate owned ("OREO") expenses, advertising, FDIC expenses, and other expenses.

Like much of the nation, some of the market areas that the Company serves are still experiencing economic challenges and volatility.  A variety of factors (e.g., any substantial rise in inflation or rise in unemployment rates, decrease in consumer confidence, adverse international economic conditions, natural disasters, war, or political instability) may affect both the Company’s markets and the national market.  The Company will continue to emphasize managing its funding costs and lending and investment rates to effectively maintain profitability.  In addition, the Company will continue to seek and maintain relationships that can generate noninterest income.  We anticipate that this approach should help mitigate profit fluctuations that are caused by movements in interest rates, business and consumer loan cycles, and local economic factors.

NBT Bank, N.A.

The Bank is a full service commercial bank formed in 1856, which provides a broad range of financial products to individuals, corporations and municipalities throughout the central and upstate New York, northeastern Pennsylvania, western Massachusetts, southern New Hampshire, Vermont, and the greater Portland, Maine market areas.

Through its network of branch locations, the Bank offers a wide range of products and services tailored to individuals, businesses, and municipalities.  Deposit products offered by the Bank include demand deposit accounts, savings accounts, negotiable order of withdrawal (“NOW”) accounts, money market deposit accounts (“MMDA”), and certificate of deposit (“CD”) accounts.  The Bank offers various types of each deposit account to accommodate the needs of its customers with varying rates, terms, and features.  Loan products offered by the Bank include consumer loans, home equity loans, mortgages, business banking loans and commercial loans, with varying rates, terms and features to accommodate the needs of its customers.  The Bank also offers various other products and services through its branch network such as trust and investment services and financial planning and life insurance services.  In addition to its branch network, the Bank also offers access to certain products and services electronically enabling customers to check balances, transfer funds, pay bills, view statements, apply for loans and access various other product and service information.  The Bank provides 24-hour access to an automated telephone line whereby customers can check balances, obtain account information, transfer funds, request statements, and perform various other activities.

NBT Financial Services, Inc.

Through NBT Financial Services, the Company operates EPIC Advisors, Inc. (“EPIC”), a retirement plan administrator.  Through EPIC, the Company offers services including retirement plan consulting and recordkeeping services.  EPIC’s headquarters are located in Rochester, New York.
 
NBT Holdings, Inc.

Through NBT Holdings, the Company operates NBT-Mang Insurance Agency, LLC (“Mang”), a full-service insurance agency acquired by the Company on September 1, 2008.  Mang’s headquarters are in Norwich, New York.  Through Mang, the Company offers a full array of insurance products, including personal property and casualty, business liability and commercial insurance, tailored to serve the specific insurance needs of individuals as well as businesses in a range of industries operating in the markets served by the Company.

The Trusts

The Trusts were organized to raise additional regulatory capital and to provide funding for certain acquisitions.  CNBF Capital Trust I (“Trust I”) and NBT Statutory Trust I are Delaware statutory business trusts formed in 1999 and 2005, respectively, for the purpose of issuing trust preferred securities and lending the proceeds to the Company. In connection with the acquisition of CNB Bancorp, Inc., the Company formed NBT Statutory Trust II (“Trust II”) in February 2006 to fund the cash portion of the acquisition as well as to provide regulatory capital. In connection with the acquisition of Alliance Financial Corporation (“Alliance”), the Company acquired two statutory trusts, Alliance Financial Capital Trust I and Alliance Financial Capital Trust II, which were formed in 2003 and 2006, respectively. The Company guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities. The Trusts are variable interest entities for which the Company is not the primary beneficiary, as defined by Financial Accounting Standards Board ("FASB") Accounting Standards Codification (“ASC”).  In accordance with ASC, the accounts of the Trusts are not included in the Company’s consolidated financial statements.

Operating Subsidiaries of the Bank

The Bank has seven operating subsidiaries, NBT Capital Corp., Broad Street Property Associates, Inc., NBT Services, Inc., CNB Realty Trust, Alliance Preferred Funding Corp., Alliance Leasing, Inc. and Columbia Ridge Capital Management, Inc. NBT Capital Corp., formed in 1998, is a venture capital corporation formed to assist young businesses to develop and grow primarily in the markets they serve. Broad Street Property Associates, Inc., formed in 2004, is a property management company.  NBT Services, Inc., formed in 2004, has a 44% ownership interest in Land Record Services, LLC.  Land Record Services, LLC, a title insurance agency, offers mortgagee and owner’s title insurance coverage to both retail and commercial customers.  CNB Realty Trust, formed in 1998, is a real estate investment trust.  Alliance Preferred Funding Corp., formed in 1999, is a real estate investment trust.  Alliance Leasing, Inc. was formed in 2002 to provide equipment leasing services. Columbia Ridge Capital Management, Inc. was acquired in 2016 and is a registered investment advisor that provides investment advice and financial consulting services.

Competition

The financial services industry, including commercial banking, is highly competitive, and we encounter strong competition for deposits, loans and other financial products and services in our market area.  The increasingly competitive environment is the result of the continued low rate environment, changes in regulation, changes in technology and product delivery systems, additional financial service providers, and the accelerating pace of consolidation among financial services providers.  The Company competes for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

Some of the Company’s nonbanking competitors have fewer regulatory constraints and may have lower cost structures.  In addition, some of the Company’s competitors have assets, capital and lending limits greater than that of the Company, have greater access to capital markets and offer a broader range of products and services than the Company.  These institutions may have the ability to finance wide-ranging advertising campaigns and may also be able to offer lower rates on loans and higher rates on deposits than the Company can offer.  Some of these institutions offer services, such as credit cards and international banking, which the Company does not directly offer.

Various in-state market competitors and out-of-state banks continue to enter or have announced plans to enter or expand their presence in the market areas in which the Company currently operates.  With the addition of new banking presences within our market, the Company expects increased competition for loans, deposits, and other financial products and services.

In order to compete with other financial services providers, the Company stresses the community nature of its banking operations and principally relies upon local promotional activities, personal relationships established by officers, directors, and employees with their customers, and specialized services tailored to meet the needs of the communities served.  We also offer certain customer services, such as agricultural lending, that many of our larger competitors do not offer.  While the Company’s position varies by market, the Company’s management believes that it can compete effectively as a result of local market knowledge, local decision making, and awareness of customer needs.
 
The table below summarizes the Bank’s deposits and market share by the thirty-eight counties of New York, Pennsylvania, New Hampshire, Massachusetts, Vermont, and Maine in which it had customer facilities as of June 30, 2016.  Market share is based on deposits of all commercial banks, credit unions, savings and loans associations, and savings banks.
 
County
State
 
Deposits
in thousands*
   
Market Share
   
Market
Rank
   
Number of
Branches*
   
Number of ATMs*
 
Chenango
NY
 
$
877,049
     
91.26
%
   
1
     
11
     
13
 
Fulton
NY
   
450,106
     
61.45
%
   
1
     
5
     
6
 
Schoharie
NY
   
208,325
     
48.03
%
   
1
     
4
     
4
 
Hamilton
NY
   
44,543
     
45.02
%
   
2
     
1
     
1
 
Cortland
NY
   
276,064
     
40.09
%
   
1
     
5
     
7
 
Montgomery
NY
   
256,385
     
36.44
%
   
2
     
5
     
4
 
Otsego
NY
   
340,762
     
33.20
%
   
2
     
8
     
12
 
Delaware
NY
   
315,836
     
32.48
%
   
1
     
5
     
4
 
Essex
NY
   
186,437
     
27.89
%
   
2
     
3
     
5
 
Madison
NY
   
221,459
     
25.35
%
   
2
     
4
     
6
 
Susquehanna
PA
   
162,173
     
19.81
%
   
2
     
5
     
7
 
Saint Lawrence
NY
   
158,982
     
13.76
%
   
4
     
5
     
5
 
Oneida
NY
   
453,441
     
13.19
%
   
5
     
7
     
11
 
Broome
NY
   
345,188
     
13.09
%
   
2
     
8
     
10
 
Pike
PA
   
80,147
     
11.79
%
   
5
     
2
     
2
 
Wayne
PA
   
115,200
     
9.09
%
   
4
     
3
     
4
 
Herkimer
NY
   
51,319
     
8.29
%
   
4
     
2
     
1
 
Lackawanna
PA
   
416,307
     
8.02
%
   
6
     
13
     
16
 
Tioga
NY
   
35,031
     
7.98
%
   
5
     
1
     
1
 
Clinton
NY
   
104,792
     
7.92
%
   
5
     
3
     
2
 
Oswego
NY
   
133,627
     
7.58
%
   
5
     
4
     
6
 
Franklin
NY
   
30,099
     
5.90
%
   
4
     
1
     
1
 
Schenectady
NY
   
148,378
     
5.57
%
   
5
     
2
     
2
 
Onondaga
NY
   
422,290
     
4.38
%
   
7
     
11
     
13
 
Saratoga
NY
   
151,210
     
3.55
%
   
8
     
4
     
4
 
Greene
NY
   
37,633
     
3.05
%
   
5
     
2
     
2
 
Berkshire
MA
   
117,648
     
2.94
%
   
7
     
6
     
6
 
Monroe
PA
   
76,817
     
2.93
%
   
8
     
4
     
4
 
Warren
NY
   
47,105
     
2.77
%
   
7
     
2
     
3
 
Chittenden
VT
   
79,324
     
1.85
%
   
7
     
3
     
3
 
Cheshire
NH
   
25,705
     
1.82
%
   
7
     
1
     
-
 
Albany
NY
   
219,906
     
1.40
%
   
9
     
4
     
5
 
Luzerne
PA
   
80,788
     
1.38
%
   
13
     
4
     
6
 
Rensselaer
NY
   
12,199
     
0.59
%
   
11
     
1
     
1
 
Hillsborough
NH
   
64,879
     
0.57
%
   
11
     
2
     
2
 
Rutland
VT
   
3,543
     
0.36
%
   
9
     
1
     
1
 
Rockingham
NH
   
16,360
     
0.24
%
   
19
     
1
     
2
 
Cumberland
ME
   
5,776
     
0.06
%
   
16
     
1
     
-
 
      
$
6,772,833
                     
154
     
182
 

Source: SNL Financial LLC
* Branch and ATM data is as of December 31, 2016.
 
Supervision and Regulation

The Company, the Bank and certain of its non-banking subsidiaries are subject to extensive regulation under federal and state laws.  The regulatory framework applicable to bank holding companies and their subsidiary banks is intended to protect depositors, federal deposit insurance funds, and the stability of the U.S. banking system. This system is not designed to protect equity investors in bank holding companies, such as the Company.

Set forth below is a summary of the significant laws and regulations applicable to the Company and its subsidiaries. The description that follows is qualified in its entirety by reference to the full text of the statutes, regulations, and policies that are described. Such statutes, regulations, and policies are subject to ongoing review by Congress and state legislatures and federal and state regulatory agencies.  A change in any of the statutes, regulations, or regulatory policies applicable to the Company and its subsidiaries could have a material effect on the results of the Company.

Overview

The Company is a registered bank holding company and financial holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is subject to the supervision of and regular examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”) as its primary federal regulator.  The Company is also subject to the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and other regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC. The Company's common stock is listed on the NASDAQ Global Select market under the ticker symbol, “NBTB,” and the Company is subject to the NASDAQ stock market rules.

The Bank is chartered as a national banking association under the National Bank Act.  The Bank is subject to the supervision of, and to regular examination by, the Office of the Comptroller of the Currency (“OCC”) as its chartering authority and primary federal regulator.  The Bank is also subject to the supervision and regulation, to a limited extent, of the Federal Deposit Insurance Corporation (“FDIC”) as its deposit insurer.  Financial products and services offered by the Company and the Bank are subject to federal consumer protection laws and implementing regulations promulgated by the Consumer Financial Protection Bureau (“CFPB”).  The Company and the Bank are also subject to oversight by state attorneys general for compliance with state consumer protection laws.  The Bank's deposits are insured by the FDIC up to the applicable deposit insurance limits in accordance with FDIC laws and regulations.  The non-bank subsidiaries of the Company and the Bank are subject to federal and state laws and regulations, including regulations of the FRB and the OCC, respectively.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) has significantly changed the financial regulatory landscape in the U.S.  Several provisions of the Dodd-Frank Act are subject to further rulemaking, guidance and interpretation by the federal banking agencies. Considering the recent changes in administration and controlling party in the U.S., Congress, state legislatures and financial regulatory agencies may introduce various legislative and regulatory initiatives that are likely to impact the financial services industry, generally. However, it is not clear whether such changes will be introduced at all or will be implemented successfully.  As a result, management cannot predict the ultimate impact of the Dodd-Frank Act or potential additional reforms in the regulation of financial institutions,  or the extent to which they could affect operations of the Company and the Bank.

Federal Bank Holding Company Regulation

The Company is a bank holding company as defined by the BHC Act.  The BHC Act generally limits the business of the Company to banking, managing or controlling banks, and other activities that the FRB has determined to be so closely related to banking “as to be a proper incident thereto.” The Company has also qualified for and elected to be a financial holding company.  Financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity that is either (i) financial in nature or incidental to such financial activity (as determined by the FRB in consultation with the Secretary of the Treasury), or (ii) complementary to a financial activity, and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system (as solely determined by the FRB).  If a bank holding company seeks to engage in the broader range of activities permitted under the BHC Act for financial holding companies, (i) the bank holding company and all of its depository institution subsidiaries must be “well-capitalized” and “well-managed,” as defined in the FRB's Regulation Y, and (ii) it must file a declaration with the FRB that it elects to be a “financial holding company.” In order for a financial holding company to commence any activity that is financial in nature, incidental thereto, or complementary to a financial activity, or to acquire a company engaged in any such activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the Community Reinvestment Act of 1977 (the “CRA”).  See the section titled “Community Reinvestment Act of 1977” for further information relating to the CRA.
 
Regulation of Mergers and Acquisitions

The BHC Act, the Bank Merger Act, and other federal and state statutes regulate acquisitions of depository institutions and their holding companies. The BHC Act requires prior FRB approval for a bank holding company to acquire, directly or indirectly, 5% or more of any class of voting securities of a commercial bank or its parent holding company and for a company, other than a bank holding company, to acquire 25% or more of any class of voting securities of a bank or bank holding company.  Under the Change in Bank Control Act, any person, including a company, may not acquire, directly or indirectly, control of a bank without providing 60 days’ prior notice and receiving a non-objection from the appropriate federal banking agency.

Under the Bank Merger Act, prior approval of the OCC is required for a national bank to merge with another bank where the national bank is the surviving bank or to purchase the assets or assume the deposits of another bank.  In reviewing applications seeking approval of merger and acquisition transactions, the federal banking agencies will consider, among other criteria, the competitive effect and public benefits of the transactions, the capital position of the combined banking organization, the applicant's performance record under the CRA, and the effectiveness of the subject organizations in combating money laundering activities.

As a financial holding company, the Company is permitted to acquire control of non-depository institutions engaged in activities that are financial in nature and in activities that are incidental and complementary to financial activities without prior FRB approval.  However, the BHC Act, as amended by the Dodd-Frank Act, requires prior written approval from the FRB or prior written notice to the FRB before a financial holding company may acquire control of a company with consolidated assets of $10 billion or more.

Capital Distributions

The principal source of the Company's liquidity is dividends from the Bank. The OCC oversees the ability of the Bank to make capital distributions, including dividends.  The OCC generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the bank would thereafter be undercapitalized.  The OCC’s prior approval is required if the total of all dividends declared by a national bank in any calendar year would exceed the sum of the bank's net income for that year and its undistributed net income for the preceding two calendar years, less any required transfers to surplus.   The National Bank Act also prohibits national banks from paying dividends that would be greater than the bank's undivided profits after deducting statutory bad debt in excess of the bank's allowance for loan losses.

The federal banking agencies have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings.  The appropriate federal regulatory authority is authorized to determine, based on the financial condition of a bank holding company or a bank, that the payment of dividends would be an unsafe or unsound practice and to prohibit such payment.

Affiliate and Insider Transactions

Transactions between the Bank and its affiliates, including the Company, are governed by sections 23A and 23B of the Federal Reserve Act (the “FRA”) and the FRB’s implementing Regulation W.  An “affiliate” of a bank includes any company or entity that controls, is controlled by, or is under common control with the Bank.  In a bank holding company context, at a minimum, the parent holding company of a bank, and any companies which are controlled by such parent holding company, are affiliates of the bank. Generally, sections 23A and 23B of the FRA are intended to protect insured depository institutions from losses in transactions with affiliates.  These sections place quantitative and qualitative limitations on covered transactions between the Bank and its affiliates, and require that all transactions between a bank and its affiliates occur on market terms that are consistent with safe and sound banking practices.

Section 22(h) of the FRA and its implementing Regulation O restricts loans to directors, executive officers, and principal stockholders (“Insiders”).  Under Section 22(h), loans to Insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution's total capital and surplus. Loans to Insiders above specified amounts must receive the prior approval of the Bank’s board of directors. Further, under Section 22(h) of the FRA, loans to directors, executive officers, and principal stockholders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the Bank’s employees and does not give preference to the insider over the employees. Section 22(g) of the FRA places additional limitations on loans to executive officers.

Federal Deposit Insurance and Brokered Deposits

The FDIC’s deposit insurance limit is $250,000 per depositor, per insured bank, for each account ownership category.  The Bank’s deposit accounts are fully insured by the FDIC Deposit Insurance Fund (the “DIF”) up to the deposit insurance limits in accordance with applicable laws and regulations.

The FDIC uses a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level and supervisory rating (“CAMELS rating”).  The risk matrix uses different risk categories distinguished by capital levels and supervisory ratings.  As a result of the Dodd-Frank Act, the base for deposit insurance assessments is now consolidated average assets less average tangible equity.  Assessment rates are calculated using formulas that take into account the risk of the institution being assessed.  In addition to deposit insurance assessments, the Federal Deposit Insurance Act (“FDIA”) provides for additional assessments to be imposed on insured depository institutions to pay for the cost of Financing Corporation funding. Financing Corporation is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Company.  The Financing Corporation assessments are adjusted quarterly to reflect changes in the assessment base of the DIF and do not vary depending upon a depository institution’s capitalization or supervisory evaluation.  
 
Under FDIC laws and regulations, no FDIC-insured depository institution can accept brokered deposits unless it is well-capitalized, or unless it is adequately capitalized and receives a waiver from the FDIC. Applicable laws and regulations also prohibit any depository institution that is not well-capitalized from paying an interest rate on brokered deposits in excess of three-quarters of one percentage point over certain prevailing market rates.

The Dodd-Frank Act requires that the FDIC raise the minimum reserve ratio of the DIF from 1.15 percent to 1.35 percent, and that the FDIC offset the effect of this increase on insured depository institutions with total consolidated assets of less than $10 billion. In March 2016, the FDIC issued a final rule affecting insured depository institutions with total consolidated assets of more than $10 billion.  The final rule imposes a surcharge of 4.5 cents per $100 of the institution’s assessment base on deposit insurance assessment rates paid by these larger institutions.  If the reserve ratio does not reach 1.35% by December 31, 2018, through implementation of the surcharge, the FDIC will impose an additional, one-time shortfall assessment on insured depository institutions with more than $10 billion in assets on March 31, 2019, to be paid by June 30, 2019.  The FDIC also has authority to further increase deposit insurance assessments.  At this time, the Bank is not subject to this surcharge.

Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The Bank's management is not aware of any practice, condition, or violation that might lead to the termination of its deposit insurance.

Federal Home Loan Bank System

The Bank is also a member of the Federal Home Loan Bank (“FHLB”) of New York, which provides a central credit facility primarily for member institutions for home mortgage and neighborhood lending. The Bank is subject to the rules and requirements of the FHLB, including the requirement to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, up to a maximum of $25.0 million. The Bank was in compliance with FHLB rules and requirements as of December 31, 2016.

Debit Card Interchange Fees

The Dodd-Frank Act requires that any interchange transaction fee charged for a debit transaction be reasonable and proportional to the cost incurred by the issuer for the transaction.  FRB regulations mandated by the Dodd-Frank Act limit interchange fees on debit cards to a maximum of 21 cents per transaction plus 5 basis points of the transaction amount.  The rule also permits a fraud-prevention adjustment of 1 cent per transaction conditioned upon an issuer developing, implementing, and updating reasonably designed fraud-prevention policies and procedures.  Issuers that, together with their affiliates, have less than $10 billion of assets, such as the Company, are exempt from the debit card interchange fee standards.  However, FRB regulations prohibit all issuers, including the Company and the Bank, from restricting the number of networks over which electronic debit transactions may be processed to less than two unaffiliated networks.

Source of Strength Doctrine

FRB policy requires bank holding companies to act as a source of financial and managerial strength to their subsidiary banks.  Section 616 of the Dodd-Frank Act codifies the requirement that bank holding companies serve as a source of financial strength to their subsidiary depository institutions.  As a result, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources.  Any capital loan by the Company to the Bank is subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks.  The U.S. Bankruptcy Code provides that, in the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

In addition, under the National Bank Act, if the Bank’s capital stock is impaired by losses or otherwise, the OCC is authorized to require payment of the deficiency by assessment upon the Company.  If the assessment is not paid within three months, the OCC could order a sale of Bank stock held by the Company to cover any deficiency.
 
Capital Adequacy and Prompt Corrective Action

In July 2013, the FRB, the OCC and the FDIC approved final rules (the “Capital Rules”) that established a new capital framework for U.S. banking organizations. The Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach with a more risk-sensitive approach.

The Capital Rules: (i) require a capital measure called “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. Under the Capital Rules, for most banking organizations, including the Company, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock and the most common forms of Tier 2 capital are subordinated notes and a portion of the allocation for loan losses, in each case, subject to the Capital Rules’ specific requirements.
  
Pursuant to the Capital Rules, the minimum capital ratios as of January 1, 2015 are:
 
4.5% CET1 to risk-weighted assets;
 
6.0% Tier 1 capital (CET1 plus Additional Tier 1 capital) to risk-weighted assets;
 
8.0% Total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
 
4.0% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).

The Capital Rules also require a “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity and other capital instrument repurchases and compensation based on the amount of the shortfall. When fully phased-in on January 1, 2019, the capital standards applicable to the Company and the Bank will include an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios inclusive of the capital conservation buffer of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.  The risk-weighting categories in the Capital Rules are standardized and include a risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset classes.

The Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.  The deductions and adjustments will be incrementally phased in between January 1, 2015 and January 1, 2019.

In addition, under the prior general risk-based capital rules, the effects of accumulated other comprehensive income or loss (“AOCI”) items included in stockholders’ equity (for example, marks-to-market of securities held in the available-for-sale portfolio) under GAAP were excluded for the purposes of determining regulatory capital ratios. Under the Capital Rules, the effects of certain AOCI items are not excluded; however, banking organizations not using the advanced approaches, including the Company, and the Bank, were permitted to make a one-time permanent election to continue to exclude these items in January 2015. The Capital Rules also preclude certain hybrid securities, such as trust preferred securities issued after May 19, 2010, from inclusion in bank holding companies’ Tier 1 capital.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, are phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019.

Management believes that the Company is in compliance, and will continue to be in compliance, with the targeted capital ratios as such requirements are phased in.
 
Prompt Corrective Action and Safety and Soundness

Pursuant to Section 38 of the Federal Deposit Insurance Act (“FDIA”), federal banking agencies are required to take “prompt corrective action” (“PCA”) should an insured depository institutions fail to meet certain capital adequacy standards.  At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits. Furthermore, if an insured depository institution is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the appropriate federal banking agency, and the holding company must guarantee the performance of that plan. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

For purposes of PCA, to be: (i) well-capitalized, an insured depository institution must have a total risk based capital ratio of at least 10%, a Tier 1 risk based capital ratio of at least 8%, a CET1 risk based capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%; (ii) adequately capitalized, an insured depository institution must have a total risk based capital ratio of at least 8%, a Tier 1 risk based capital ratio of at least 6%, a CET1 risk based capital ratio of at least 4.5%, and a Tier 1 leverage ratio of at least 4%; (iii)  undercapitalized, an insured depository institution would have a total risk based capital ratio of less than 8%, a Tier 1 risk based capital ratio of less than 6%, a CET1 risk based capital ratio of less than 4.5%, and a Tier 1 leverage ratio of less than 4%; (iv) significantly undercapitalized, an insured depository institution would have a total risk based capital ratio of less than 6%, a Tier 1 risk based capital ratio of less than 4%, a CET1 risk based capital ratio of less than 3%, and a Tier 1 leverage ratio of less than 3%.; (v) critically undercapitalized, an insured depository institution would have a ratio of tangible equity to total assets that is less than or equal to 2%.

Bank holding companies and insured depository institutions may also be subject to potential enforcement actions of varying levels of severity for unsafe or unsound practices in conducting their business, or for violation of any law, rule, regulation, condition imposed in writing by the agency or term of a written agreement with the agency. In more serious cases, enforcement actions may include the issuance of directives to increase capital; the issuance of formal and informal agreements; the imposition of civil monetary penalties; the issuance of a cease and desist order that can be judicially enforced; the issuance of removal and prohibition orders against officers, directors, and other institution−affiliated parties; the termination of the insured depository institution’s deposit insurance; the appointment of a conservator or receiver for the insured depository institution; and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the FDIC, as receiver, would be harmed if such equitable relief was not granted.

Volcker Rule

Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, restricts the ability of banking entities, such as the Company, from: (i) engaging in “proprietary trading” and (ii) investing in or sponsoring certain covered funds, subject to certain limited exceptions.  Under the Volcker Rule, the term "covered funds" is defined as any issuer that would be an investment company under the Investment Company Act but for the exemptions in section 3(c)(1) or 3(c)(7) of that Act, which includes collateralized loan obligation (“CLO”) and collateralized debt obligation securities. The regulation also provides an exemption for CLOs meeting certain requirements.  Compliance with the Volcker Rule is generally required by July 21, 2017. Given the Company’s size and the scope of its activities, the Company does not believe the implementation of the Volcker Rule will have a significant effect on its consolidated financial statements.

Depositor Preference

The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution.  If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Consumer Protection and CFPB Supervision

The Dodd-Frank Act centralized responsibility for consumer financial protection by creating the CFPB, an independent agency charged with responsibility for implementing, enforcing, and examining compliance with federal consumer financial laws. The CFPB has examination authority over all banks and savings institutions with more than $10 billion in assets.  As the Company is below this threshold, the OCC continues to exercise primary examination authority over the Bank with regard to compliance with federal consumer financial laws and regulations.  Under the Dodd-Frank Act state attorneys general are empowered to enforce rules issued by the CFPB.
 
The Company is subject to federal consumer financial statutes and the regulations promulgated thereunder including, but not limited to:

the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

the Equal Credit Opportunity Act (“ECOA”), prohibiting discrimination in connection with the extension of credit;

the Home Mortgage Disclosure Act (“HMDA”), requiring home mortgage lenders, including the Bank, to make available to the public expanded information regarding the pricing of home mortgage loans, including the “rate spread” between the annual percentage rate and the average prime offer rate for mortgage loans of a comparable type;

the Fair Credit Reporting Act (“FCRA”), governing the provision of consumer information to credit reporting agencies and the use of consumer information; and

the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies.

The Bank’s failure to comply with any of the consumer financial laws can result in civil actions, regulatory enforcement action by the federal banking agencies and the U.S. Department of Justice.

USA PATRIOT Act

The Bank Secrecy Act (“BSA”), as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”), imposes obligations on U.S. financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism.  The USA PATRIOT Act requires all financial institutions, including the Company and the Bank, to identify their customers, adopt formal and comprehensive anti-money laundering programs, scrutinize or prohibit altogether certain transactions of special concern, and be prepared to respond to inquiries from U.S. law enforcement agencies concerning their customers and their transactions. The USA PATRIOT Act also encourages information-sharing among financial institutions, regulators, and law enforcement authorities by providing an exemption from the privacy provisions of the GLB Act for financial institutions that comply with this provision. The effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to the Bank, or the BHC Act, which applies to the Company. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences.  As of December 31, 2016, the Company and the Bank believe that they are in compliance with the BSA and the USA PATRIOT Act, and implementing regulations thereunder.

Identity Theft Prevention

The Fair Credit Reporting Act’s (“FCRA”) Red Flags Rule requires financial institutions with covered accounts (e.g., consumer bank accounts and loans) to develop, implement, and administer an identity theft prevention program. This program must include reasonable policies and procedures to detect suspicious patterns or practices that indicate the possibility of identity theft, such as inconsistencies in personal information or changes in account activity.

Office of Foreign Assets Control Regulation

The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals, and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons).  Blocked assets (property and bank deposits) cannot be paid out, withdrawn, set off, or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
 
Financial Privacy and Data Security

The Company and the Bank are subject to federal laws, including the Gramm-Leach-Bliley Act (“GLBA”) and certain state laws containing consumer privacy protection provisions. These provisions limit the ability of banks and other financial institutions to disclose nonpublic information about consumers to affiliated and non-affiliated third parties and limit the reuse of certain consumer information received from nonaffiliated financial institutions. These provisions require notice of privacy policies to clients and, in some circumstances, allow consumers to prevent disclosure of certain nonpublic personal information to affiliates or non-affiliated third parties by means of “opt out” or “opt in” authorizations.

The GLBA requires that financial institutions implement comprehensive written information security programs that include administrative, technical, and physical safeguards to protect consumer information. Further, pursuant to interpretive guidance issued under the GLBA and certain state laws, financial institutions are required to notify clients of security breaches resulting in unauthorized access to their personal information.  The Bank believes it is in compliance with all GLBA obligations.

The Bank is also subject to data security standards, privacy and data breach notice requirements, primarily those issued by the OCC.

Community Reinvestment Act of 1977

The Bank has a responsibility under the CRA, as implemented by OCC regulations, to help meet the credit needs of its communities, including low- and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. Regulators periodically assess the Bank’s record of compliance with the CRA. In addition, the ECOA and the Fair Housing Act prohibit discrimination in lending practices on the basis of characteristics specified in those statutes. The Bank’s failure to comply with the CRA could, at a minimum, result in regulatory restrictions on its activities and the activities of the Company. The Bank’s latest CRA rating was “Satisfactory.”

Future Legislative Initiatives

Congress, state legislatures, and financial regulatory agencies are expected to introduce various legislative and regulatory initiatives that are likely to impact the financial services industry, generally. Such initiatives may include proposals to expand or contract the powers of bank holding companies and/or depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it or any implementing regulations would have on the financial condition or results of operations of the Company. A change in statutes, regulations, or regulatory policies applicable to the Company or any of its subsidiaries could have a material effect on the business of the Company.

Employees

At December 31, 2016, the Company had 1,704 full-time equivalent employees. The Company’s employees are not presently represented by any collective bargaining group.

Available Information

The Company’s website is http://www.nbtbancorp.com. The Company makes available free of charge through its website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed or furnished with the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act. We also make available through our website other reports filed with or furnished to the SEC under the Exchange Act, including our proxy statements and reports filed by officers and directors under Section 16(a) of that Act, as well as our Code of Business Conduct and Ethics and other codes/committee charters. The references to our website do not constitute incorporation by reference of the information contained in the website and such information should not be considered part of this document.

Any materials we file with the SEC may be read and copied at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC, 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
 
ITEM 1A.   Risk Factors
 
There are risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Any of the following risks could affect the Company’s financial condition and results of operations and could be material and/or adverse in nature.  You should consider all of the following risks together with all of the other information in this Annual Report on Form 10-K.

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

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

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

Variations in interest rates may negatively affect our financial performance.

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

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

Changes in the economy or the financial markets could materially affect our financial performance.

Downturns in the United States or global economies or financial markets could adversely affect the demand for and income received from the Company's fee-based services. Revenues from the trust and benefit plan administration businesses depend in large part on the level of assets under management and administration.  Market volatility that leads customers to liquidate investments, as well as lower asset values, can reduce our level of assets under management and administration and thereby decrease our investment management and administration revenues.

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

As of December 31, 2016, approximately 45% of the Company’s loan portfolio consisted of commercial and industrial, agricultural, commercial construction and commercial real estate loans. These types of loans generally expose a lender to greater risk of non-payment and loss than residential real estate loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Because the Company’s loan portfolio contains a significant number of commercial and industrial, agricultural, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in nonperforming loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and/or an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Loans” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial and industrial, agricultural, construction and commercial real estate loans.
 
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease.

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

Strong competition within our industry and market area could hurt our performance and slow our growth.

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

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

Failure to perform in any of these areas could significantly weaken the Company’s competitive position, which could adversely affect the Company’s growth and profitability, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.
 
We are subject to extensive government regulation and supervision, which may interfere with our ability to conduct our business and may negatively impact our financial results.

We, primarily through the Bank and certain non-bank subsidiaries, are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, the Federal Deposit Insurance Fund and the safety and soundness of the banking system as a whole, not stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer, and/or limit the pricing the Company may charge on certain banking services, among other things. Compliance personnel and resources may increase our costs of operations and adversely impact our earnings.

Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.   See the section captioned “Supervision and Regulation” in Item 1. Business of this report for further information.

We will be subject to heightened regulatory requirements if we exceed $10 billion in total consolidated assets.

Based on our historical growth rates and current size, it is possible that our total assets could exceed $10 billion dollars in the near future.  The Dodd-Frank Act and its implementing regulations impose enhanced supervisory requirements on bank holding companies with more than $10 billion in total consolidated assets.  For bank holding companies with more than $10 billion but less than $50 billion in total consolidated assets such requirements include, among other things:

compliance with the FRB’s annual stress testing requirements;

increased capital, leverage, liquidity and risk management standards;

examinations by the CFPB for compliance with federal consumer financial protection laws and regulations;

limits on interchange fees on debit cards; and

changes to the FDIC deposit insurance assessments calculation that would increase our insurance premium costs.

Federal financial regulators may require us to take actions to prepare for compliance before we exceed $10 billion in total consolidated assets.  Our regulators may consider our preparation for compliance with these regulatory requirements when examining our operations or considering any request for regulatory approval.  We may, therefore, incur compliance costs before we reach $10 billion in total consolidated assets and may be required to maintain the additional compliance procedures even if we do not grow at the anticipated rate or at all.

Failure to comply with these new requirements may negatively impact the results of our operations and financial condition.  To ensure compliance, we will be required to investment significant resources, which may necessitate hiring additional personnel and implementing additional internal controls. These additional compliance costs may have a material adverse effect on our business, results of operations and financial condition.

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

The purpose of the Company’s liquidity management is to meet the cash flow obligations of its customers for both deposits and loans.  The primary liquidity measurement the Company utilizes is called basic surplus, which captures the adequacy of the Company’s access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  This approach recognizes the importance of balancing levels of cash flow liquidity from short and long-term securities with the availability of dependable borrowing sources which can be accessed when necessary.   However, competitive pressure on deposit pricing could result in a decrease in the Company’s deposit base or an increase in funding costs.  In addition, liquidity will come under additional pressure if loan growth exceeds deposit growth.  These scenarios could lead to a decrease in the Company’s basic surplus measure below the minimum policy level of 5%.  To manage this risk, the Company has the ability to purchase brokered time deposits, borrow against established borrowing facilities with other banks (Federal funds) and enter into repurchase agreements with investment companies.  Depending on the level of interest rates, the Company’s net interest income, and therefore earnings, could be adversely affected.  See the section captioned “Liquidity Risk” in Item 7.
 
Our ability to service our debt, pay dividends and otherwise pay our obligations as they come due is substantially dependent on capital distributions from our subsidiaries.

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

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

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

The Company may be adversely affected by fraud.

As a financial institution, the Company is inherently exposed to operational risk in the form of theft and other fraudulent activity by employees, customers, and other third parties targeting the Company and/or the Company’s customers or data. Such activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts.
Although the Company devotes substantial resources to maintaining effective policies and internal controls to identify and prevent such incidents, given the increasing sophistication of possible perpetrators, the Company may experience financial losses or reputational harm as a result of fraud.

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

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

The Company relies on third parties to provide key components of its business infrastructure.

The Company relies on third parties to provide key components for its business operations, such as data processing and storage, recording and monitoring transactions, online banking interfaces and services, internet connections, and network access. While the Company selects these third-party vendors carefully, it does not control their actions. Any problems caused by these third parties, including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, cyber-attacks and security breaches at a vendor, failure of a vendor to provide services for any reason, or poor performance of services by a vendor, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business. Financial or operational difficulties of a third-party vendor could also hurt the Company’s operations if those difficulties interfere with the vendor's ability to serve the Company. Replacing these third party vendors also could create significant delays and expense that adversely affect the Company’s business and performance.
 
The possibility of the economy’s return to recessionary conditions and the possibility of further turmoil or volatility in the financial markets would likely have an adverse effect on our business, financial position and results of operations.

The economy in the United States and globally has experienced volatility in recent years and may continue to do so for the foreseeable future. There can be no assurance that economic conditions will not worsen.  Unfavorable or uncertain economic conditions can be caused by declines in economic growth, business activity or investor or business confidence, limitations on the availability or increases in the cost of credit and capital, increases in inflation or interest rates, the timing and impact of changing governmental policies, natural disasters, terrorist attacks, acts of war or a combination of these or other factors. A worsening of business and economic conditions recovery could have adverse effects on our business, including the following:

investors may have less confidence in the equity markets in general and in financial services industry stocks in particular, which could place downward pressure on the Company’s stock price and resulting market valuation; 

economic and market developments may further affect consumer and business confidence levels and may cause declines in credit usage and adverse changes in payment patterns, causing increases in delinquencies and default rates; 

the Company’s ability to assess the creditworthiness of its customers may be impaired if the models and approaches the Company uses to select, manage and underwrite its customers become less predictive of future behaviors;

the Company could suffer decreases in demand for loans or other financial products and services or decreased deposits or other investments in accounts with the Company; 

customers of the Company's trust and benefit plan administration business may liquidate investments, which together with lower asset values, may reduce the level of assets under management and administration and thereby decrease the Company's investment management and administration revenues; 

competition in the financial services industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions or otherwise; and; 

the value of loans and other assets or collateral securing loans may decrease.

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

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

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

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

The business strategy of the Company has included and may continue to include growth through acquisition.  Any future acquisitions will be accompanied by the risks commonly encountered in acquisitions.  These risks may include, among other things:

our ability to realize anticipated cost savings;

the difficulty of integrating operations and personnel, the loss of key employees;

the potential disruption of our or the acquired company’s ongoing business in such a way that could result in decreased revenues, the inability of our management to maximize our financial and strategic position;

the inability to maintain uniform standards, controls, procedures and policies; and

the impairment of relationships with the acquired company’s employees and customers as a result of changes in ownership and management.
 
We cannot provide any assurance that we will be successful in overcoming these risks or any other problems encountered in connection with acquisitions. Our inability to overcome these risks could have an adverse effect on the achievement of our business strategy and results of operations.

There are substantial risks and uncertainties associated with the introduction or expansion of lines of business or new products and services within existing lines of business.

From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove attainable.  External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Company’s business, results of operations, and financial condition.

Our controls and procedures may fail or be circumvented, which may result in a material adverse effect on our business.

Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

We are exposed to risk of environmental liabilities with respect to properties to which we obtain title.

A significant portion of our loan portfolio at December 31, 2016 was secured by real estate. In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. We may be held liable to a government entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation and remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect our business, results of operations and prospects.

We may be adversely affected by the soundness of other financial institutions including the FHLB of New York.

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

The Company owns common stock of FHLB of New York in order to qualify for membership in the FHLB system, which enables it to borrow funds under the FHLB of New York’s advance program.  The carrying value and fair market value of our FHLB of New York common stock was $31.8 million as of December 31, 2016.  There are 11 branches of the FHLB, including New York, which are jointly liable for the consolidated obligations of the FHLB system.  To the extent that one FHLB branch cannot meet its obligations to pay its share of the system’s debt, other FHLB branches can be called upon to make the payment.  Any adverse effects on the FHLB of New York could adversely affect the value of our investment in its common stock and negatively impact our results of operations.
 
Provisions of our certificate of incorporation and bylaws, as well as Delaware law and certain banking laws, could delay or prevent a takeover of us by a third party.

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

The Company’s common stock price may fluctuate significantly.

The Company’s common stock price constantly changes, and has increased substantially since the U.S. Presidential election in November 2016. The market price of the Company's common stock may continue to fluctuate significantly in response to a number of factors including, but not limited to:

The political climate and whether the proposed policies of the new Presidential administration in the U.S. that have affected market prices for financial institution stocks are successfully implemented;

Changes in securities analysts’ recommendations or expectations of financial performance;

Volatility of stock market prices and volumes;

Incorrect information or speculation;

Changes in industry valuations;

Variations in operating results from general expectations;

Actions taken against the Company by various regulatory agencies;

Changes in authoritative accounting guidance;

Changes in general domestic economic conditions such as inflation rates, tax rates, unemployment rates, labor and healthcare cost trend rates, recessions and changing government policies, laws and regulations; and

Severe weather, natural disasters, acts of war or terrorism and other external events.
 
There may be future sales or other dilution of the Company's equity, which may adversely affect the market price of the Company's stock.

The Company is not restricted from issuing additional common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock.  The Company also grants a significant number of shares of common stock to employees and directors under the Company's incentive plan each year.  The issuance of any additional shares of the Company's common stock or preferred stock or securities convertible into, exchangeable for or that represent the right to receive common stock, or the exercise of such securities could be substantially dilutive to stockholders of the Company's common stock.  Holders of the Company's common stock have no preemptive rights that entitle such holders to purchase their pro rata share of any offering of shares or any class or series.  Because the Company's decision to issue securities in any future offering will depend on market conditions, its acquisition activity and other factors, the Company cannot predict or estimate the amount, timing or nature of its future offerings.  Thus, the Company's stockholders bear the risk of the Company's future offerings reducing the market price of the Company's common stock and diluting their stock holdings in the Company.

ITEM 1B.   Unresolved Staff Comments
 
None.
 
ITEM 2.      Properties
 
The Company owns its headquarters located at 52 South Broad Street, Norwich, New York 13815.  The Company operated the following community banking branches and ATMs as of December 31, 2016:

County
 
Branches
   
ATMs
 
County
 
Branches
   
ATMs
 
New York 
           
Pennsylvania
           
Albany
   
4
     
5
 
Lackawanna
   
13
     
16
 
Broome
   
8
     
10
 
Luzerne
   
4
     
6
 
Chenango
   
11
     
13
 
Monroe
   
4
     
4
 
Clinton
   
3
     
2
 
Pike
   
2
     
2
 
Cortland
   
5
     
7
 
Susquehanna
   
5
     
7
 
Delaware
   
5
     
4
 
Wayne
   
3
     
4
 
Essex
   
3
     
5
                   
Franklin
   
1
     
1
 
New Hampshire
               
Fulton
   
5
     
6
 
Cheshire
   
1
     
0
 
Greene
   
2
     
2
 
Hillsborough
   
2
     
2
 
Hamilton
   
1
     
1
 
Rockingham
   
1
     
2
 
Herkimer
   
2
     
1
                   
Madison
   
4
     
6
 
Vermont
               
Montgomery
   
5
     
4
 
Chittenden
   
3
     
3
 
Oneida
   
7
     
11
 
Rutland
   
1
     
1
 
Onondaga
   
11
     
13
                   
Oswego
   
4
     
6
 
Massachusetts
               
Otsego
   
8
     
12
 
Berkshire
   
6
     
6
 
Rensselaer
   
1
     
1
                   
Saint Lawrence
   
5
     
5
 
Maine
               
Saratoga
   
4
     
4
 
Cumberland
   
1
     
0
 
Schenectady
   
2
     
2
                   
Schoharie
   
4
     
4
                   
Tioga
   
1
     
1
                   
Warren
   
2
     
3
                   
                                   
                 
Total
   
154
     
182
 

The Company leases 66 of the above listed branches from third parties.  The Company owns all other banking premises. The Company believes that its offices are sufficient for its present operations.  All of the above ATMs are owned by the Company.
 
ITEM 3.      Legal Proceedings
 
There are no material legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is subject.

ITEM 4.      Mine Safety Disclosures
 
None.
 
PART II

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

The common stock of the Company, par value $0.01 per share (the “Common Stock”), is quoted on the Nasdaq Global Select Market under the symbol “NBTB.” The following table sets forth the high and low sales prices and dividends declared for the Common Stock for the periods indicated:

 
 
High
   
Low
   
Dividend
 
2016
                 
1st quarter
 
$
27.50
   
$
23.81
   
$
0.22
 
2nd quarter
   
29.55
     
25.67
     
0.22
 
3rd quarter
   
33.04
     
27.31
     
0.23
 
4th quarter
   
42.49
     
32.26
     
0.23
 
2015
                       
1st quarter
 
$
26.46
   
$
22.97
   
$
0.21
 
2nd quarter
   
26.89
     
23.75
     
0.22
 
3rd quarter
   
27.72
     
24.91
     
0.22
 
4th quarter
   
30.52
     
25.58
     
0.22
 

The closing price of the Common Stock on February 10, 2017 was $40.08.

As of February 10, 2017, there were 6,412 stockholders of record of Common Stock.  No unregistered securities were sold by the Company during the year ended December 31, 2016.
 
Stock Performance Graph

The following stock performance graph compares the cumulative total stockholder return (i.e., price change, reinvestment of cash dividends and stock dividends received) on our Common Stock against the cumulative total return of the NASDAQ Stock Market (U.S. Companies) Index and the KBW Regional Bank Index (Peer Group).  The stock performance graph assumes that $100 was invested on December 31, 2011.  The graph further assumes the reinvestment of dividends into additional shares of the same class of equity securities at the frequency with which dividends are paid on such securities during the relevant fiscal year.  The yearly points marked on the horizontal axis correspond to December 31 of that year.  We calculate each of the referenced indices in the same manner.  All are market-capitalization-weighted indices, so companies judged by the market to be more important (i.e., more valuable) count for more in all indices.
 
 
 
 
Period Ending
 
Index
 
12/31/11
   
12/31/12
   
12/31/13
   
12/31/14
   
12/31/15
   
12/31/16
 
NBT Bancorp
 
$
100.00
   
$
95.06
   
$
125.80
   
$
132.08
   
$
144.83
   
$
223.79
 
KBW Regional Bank Index
 
$
100.00
   
$
113.18
   
$
166.06
   
$
170.01
   
$
180.18
   
$
250.39
 
NASDAQ Composite Index
 
$
100.00
   
$
117.70
   
$
164.92
   
$
189.32
   
$
202.81
   
$
220.91
 

Source:  Bloomberg, L.P.

Dividends

We depend primarily upon dividends from our subsidiaries for a substantial part of our revenue.  Accordingly, our ability to pay dividends to our stockholders depends primarily upon the receipt of dividends or other capital distributions from our subsidiaries.  Payment of dividends to the Company from the Bank is subject to certain regulatory and other restrictions.  Under OCC regulations, the Bank may pay dividends to the Company without prior regulatory approval so long as it meets its applicable regulatory capital requirements before and after payment of such dividends and its total dividends do not exceed its net income to date over the calendar year plus retained net income over the preceding two years.  At December 31, 2016, the Bank was in compliance with all applicable minimum capital requirements and had the ability to pay dividends of $102.5 million to the Company without the prior approval of the OCC.

If the capital of the Company is diminished by depreciation in the value of its property or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets, no dividends may be paid out of net profits until the deficiency in the amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets has been repaired.  See the section captioned “Supervision and Regulation” in Item 1. Business and Note 15 to the consolidated financial statements is included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.

Stock Repurchase

The Company purchased 675,535 shares of its common stock during the year ended December 31, 2016 at an average price of $25.45 per share under a previously announced plan that expired on December 31, 2016.  On March 28, 2016, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to 1,000,000 shares of its outstanding stock. This plan expires on December 31, 2017. The Company did not purchase any shares of its common stock during the fourth quarter of 2016.
 
ITEM  6.     Selected Financial Data
 
The following summary of financial and other information about the Company is derived from the Company’s audited consolidated financial statements for each of the last five fiscal years ended December 31 and should be read in conjunction with Item 7 and the Company’s consolidated financial statements and accompanying notes, included elsewhere in this report:

   
Year ended December 31,
 
(In thousands except share and per share data)
 
2016
   
2015
   
2014
   
2013(1)
   
2012(2)
 
Interest, fee and dividend income
 
$
286,947
   
$
273,224
   
$
275,081
   
$
268,723
   
$
239,397
 
Interest expense
   
22,506
     
20,616
     
23,203
     
30,644
     
35,194
 
Net interest income
   
264,441
     
252,608
     
251,878
     
238,079
     
204,203
 
Provision for loan losses
   
25,431
     
18,285
     
19,539
     
22,424
     
20,269
 
Noninterest income excluding  securities 
                                       
  gains
   
116,357
     
115,394
     
125,935
     
101,789
     
86,728
 
Securities (losses) gains, net
   
(644
)
   
3,087
     
92
     
1,426
     
599
 
Noninterest expense
   
235,922
     
236,176
     
246,063
     
228,927
     
193,887
 
Income before income taxes
   
118,801
     
116,628
     
112,303
     
89,943
     
77,374
 
Net income
   
78,409
     
76,425
     
75,074
     
61,747
     
54,558
 
                                         
Per common share
                                       
Basic earnings
 
$
1.81
   
$
1.74
   
$
1.71
   
$
1.47
   
$
1.63
 
Diluted earnings
   
1.80
     
1.72
     
1.69
     
1.46
     
1.62
 
Cash dividends paid
   
0.90
     
0.87
     
0.84
     
0.81
     
0.80
 
Book value at year-end
   
21.11
     
20.31
     
19.69
     
18.77
     
17.24
 
Tangible book value at year-end (3)
   
14.61
     
13.79
     
13.22
     
12.09
     
12.23
 
Average diluted common shares outstanding
   
43,622
     
44,389
     
44,395
     
42,351
     
33,719
 
                                         
Securities available for sale, at fair value
 
$
1,338,290
   
$
1,174,544
   
$
1,013,171
   
$
1,364,881
   
$
1,147,999
 
Securities held to maturity, at amortized cost
   
527,948
     
471,031
     
454,361
     
117,283
     
60,563
 
Loans
   
6,198,057
     
5,883,133
     
5,595,271
     
5,406,795
     
4,277,616
 
Allowance for loan losses
   
65,200
     
63,018
     
66,359
     
69,434
     
69,334
 
Assets
   
8,867,268
     
8,262,646
     
7,807,340
     
7,652,175
     
6,042,259
 
Deposits
   
6,973,688
     
6,604,843
     
6,299,605
     
5,890,224
     
4,784,349
 
Borrowings
   
886,986
     
674,124
     
548,943
     
866,061
     
605,855
 
Stockholders’ equity
   
913,316
     
882,004
     
864,181
     
816,569
     
582,273
 
                                         
Key ratios
                                       
Return on average assets
   
0.92
%
   
0.96
%
   
0.97
%
   
0.85
%
   
0.93
%
Return on average equity
   
8.74
%
   
8.70
%
   
8.84
%
   
8.09
%
   
9.72
%
Average equity to average assets
 
   
10.49
%
   
10.98
%
   
10.95
%
   
10.50
%
   
9.55
%
Net interest margin
   
3.43
%
   
3.50
%
   
3.61
%
   
3.66
%
   
3.86
%
Dividend payout ratio
   
50.00
%
   
49.92
%
   
49.16
%
   
55.48
%
   
49.38
%
Tier 1 leverage
   
9.11
%
   
9.44
%
   
9.39
%
   
8.93
%
   
8.54
%
Common equity tier 1 capital ratio
   
9.98
%
   
10.20
%
   
N/A
     
N/A
%
   
N/A
 
Tier 1 risk-based capital
   
11.42
%
   
11.73
%
   
12.32
%
   
11.74
%
   
11.00
%
Total risk-based capital
   
12.39
%
   
12.74
%
   
13.50
%
   
12.99
%
   
12.25
%

(1)
Includes the impact of the acquisition of Alliance Financial Corporation ("Alliance") on March 8, 2013.
(2)
Includes the impact of the acquisition of Hampshire First Bank on June 8, 2012.
(3)
Tangible book value calculation (non-GAAP):
 
   
Year ended December 31,
 
(In thousands except share and per share data)
 
2016
   
2015
   
2014
   
2013
   
2012
 
Stockholders' equity
 
$
913,316
   
$
882,004
   
$
864,181
   
$
816,569
   
$
582,273
 
Intangibles
   
281,254
     
283,222
     
283,951
     
290,554
     
169,335
 
Tangible equity
   
632,062
     
598,782
     
580,229
     
526,015
     
412,938
 
Diluted common shares outstanding
   
43,258
     
43,431
     
43,896
     
43,513
     
33,775
 
Tangible book value
 
$
14.61
   
$
13.79
   
$
13.22
   
$
12.09
   
$
12.23
 
 
Selected Quarterly Financial Data
 
   
2016
   
2015
 
(Dollars in thousands except share and per share data)
 
Fourth
   
Third
   
Second
   
First
   
Fourth
   
Third
   
Second
   
First
 
Interest, fee and dividend income
 
$
73,109
   
$
72,509
   
$
71,375
   
$
69,954
   
$
68,771
   
$
69,500
   
$
67,727
   
$
67,226
 
Interest expense
   
5,684
     
5,847
     
5,598
     
5,377
     
5,259
     
5,255
     
5,042
     
5,060
 
Net interest income
   
67,425
     
66,662
     
65,777
     
64,577
     
63,512
     
64,245
     
62,685
     
62,166
 
Provision for loan losses
   
8,165
     
6,388
     
4,780
     
6,098
     
5,779
     
4,966
     
3,898
     
3,642
 
Noninterest income excluding net securities gains
   
28,762
     
29,644
     
29,613
     
28,338
     
29,427
     
31,258
     
28,189
     
26,520
 
Net securities (losses) gains
   
(674
)
   
-
     
1
     
29
     
3,044
     
3
     
26
     
14
 
Noninterest expense
   
57,639
     
59,614
     
60,445
     
58,224
     
60,619
     
59,891
     
57,964
     
57,702
 
Net income
   
19,608
     
20,001
     
19,909
     
18,891
     
19,127
     
19,851
     
19,281
     
18,166
 
Basic earnings per share
 
$
0.45
   
$
0.46
   
$
0.46
   
$
0.44
   
$
0.44
   
$
0.45
   
$
0.44
   
$
0.41
 
Diluted earnings per share
 
$
0.45
   
$
0.46
   
$
0.46
   
$
0.43
   
$
0.43
   
$
0.45
   
$
0.43
   
$
0.41
 
Annualized net interest margin
   
3.41
%
   
3.40
%
   
3.44
%
   
3.47
%
   
3.42
%
   
3.48
%
   
3.51
%
   
3.60
%
Annualized return on average assets
   
0.89
%
   
0.92
%
   
0.94
%
   
0.92
%
   
0.93
%
   
0.97
%
   
0.97
%
   
0.94
%
Annualized return on average equity
   
8.54
%
   
8.80
%
   
9.00
%
   
8.63
%
   
8.58
%
   
8.97
%
   
8.81
%
   
8.46
%
Weighted average diluted common shares outstanding
   
43,703
     
43,562
     
43,454
     
43,707
     
44,072
     
44,262
     
44,530
     
44,642
 
 
ITEM 7.      Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements

Certain statements in this filing and future filings by the Company with the SEC, in the Company’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,” “projects,” “will,” “can,” “would,” “should,” “could,” “may,” or other similar terms. There are a number of factors, many of which are beyond the Company’s control that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact; (2) changes in the level of nonperforming assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply including those under the Dodd-Frank Act; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the FASB and other accounting standard setters; (17) changes in the Company’s organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; and (20) the Company’s success at managing the risks involved in the foregoing items.
 
The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors including, but not limited to, those described above, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.
 
 Except as required by law, the Company does not undertake, and specifically disclaims any obligations to, publicly release any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

General

The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of the Company and its wholly-owned subsidiaries, the Bank, NBT Financial Services and NBT Holdings during 2016 and, in summary form, the preceding two years. Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.” Net interest margin is presented in this discussion on a fully taxable equivalent ("FTE") basis. Average balances discussed are daily averages unless otherwise described. The audited consolidated financial statements and related notes as of December 31, 2016 and 2015 and for each of the years in the three-year period ended December 31, 2016 should be read in conjunction with this review. Amounts in prior period consolidated financial statements are reclassified whenever necessary to conform to the 2016 presentation.

Critical Accounting Policies

The Company has identified policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, pension accounting, provision for income taxes and impairment of goodwill and intangible assets.

Management of the Company considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio and the material effect that such judgments can have on the results of operations. While management’s current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance may need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provision for loan losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Company’s nonperforming loans and potential problem loans have a significant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral values were significantly lower, the Company’s allowance for loan loss policy would also require additional provision for loan losses.
 
Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Citigroup Pension Liability Index, market interest rates and discounted cash flows in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

The Company is subject to examinations from various taxing authorities. Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions. Management believes that the assumptions and judgments used to record tax-related assets or liabilities have been appropriate. Should tax laws change or the taxing authorities determine that management’s assumptions were inappropriate, an adjustment may be required which could have a material effect on the Company’s results of operations.

As a result of acquisitions, the Company has acquired goodwill and identifiable intangible assets. Goodwill represents the cost of acquired companies in excess of the fair value of net assets at the acquisition date. Goodwill is evaluated at least annually or when business conditions suggest that an impairment may have occurred. Goodwill will be reduced to its carrying value through a charge to earnings if impairment exists. Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives. The determination of whether or not impairment exists is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires them to select a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums and Company-specific risk indicators, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company’s results of operations.

The Company’s policies on the allowance for loan losses, pension accounting, provision for income taxes, goodwill and intangible assets are disclosed in Note 1 to the consolidated financial statements. A more detailed description of the allowance for loan losses is included in the section captioned “Risk Management – Credit Risk” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K. All significant pension accounting assumptions, income tax assumptions, and intangible asset assumptions and detail are disclosed in Notes 13, 12 and 7 to the consolidated financial statements, respectively. All accounting policies are important, and as such, the Company encourages the reader to review each of the policies included in Note 1 to obtain a better understanding of how the Company’s financial performance is reported.

Non-GAAP Measures

This Annual Report on Form 10-K contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America ("GAAP"). These measures adjust GAAP measures to exclude the effects of acquisition related intangible amortization expense on earnings and equity as well as providing a fully taxable equivalent yield on securities and loans. Where non-GAAP disclosures are used in this Annual Report on Form 10-K, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying tables. Management believes that these non-GAAP measures provide useful information that is important to an understanding of the operating results of the Company’s core business as well as provide information standard in the financial institution industry. Non-GAAP measures should not be considered a substitute for financial measures determined in accordance with GAAP and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company.

Overview

Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to: net income and earnings per share, return on assets and equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons. The following information should be considered in connection with the Company's results for the fiscal year ended December 31, 2016:
   
Net income for 2016 was $78.4 million, the highest in the Company's history, and up from $76.4 million in 2015.
 
Net interest margin for 2016 declined 7 basis points as a result of the continued low rate environment on loans and investments.
 
Asset quality indicators showed stability from last year:
 
Nonperforming loans were 0.65% at December 31, 2016 compared to 0.64% at December 31, 2015;
 
Past due loans to total loans increased to 0.64% at December 31, 2016 from 0.62% at December 31, 2015; and
 
Net charge-offs to average loans were 0.39% for 2016 compared to 0.38% in 2015.
 
Continued demand deposit growth strategies resulting in 10.1% growth in average deposits from 2015 to 2016.
 
Increased efforts to grow noninterest income with focus on organic growth of our wealth management businesses; and
 
Improved operating efficiencies resulting in flat noninterest expense year over year.
 
The Company reported net income of $78.4 million or $1.80 per diluted share for 2016, up 2.6% from net income of $76.4 million or $1.72 per diluted share for 2015. Net interest income was $264.4 million for the year ended December 31, 2016, up $11.8 million, or 4.7% from $252.6 million in 2015.  FTE net interest margin was 3.43% for the year ended December 31, 2016, down from 3.50% for the year ended December 31, 2015.  Average interest earning assets were up $510.5 million, or 7.0%, for the year ended December 31, 2016 as compared to 2015. The provision for loan losses totaled $25.4 million for the year ended December 31, 2016, up $7.1 million, or 39.1%, from $18.3 million for the year ended December 31, 2015.
 
2017 Outlook
 
The Company’s 2016 earnings reflected the Company’s continued ability to manage through the existing economic conditions and challenges in the financial services industry, while investing in the Company’s future. Since the 2016 U.S. Presidential election, financial services stock prices have increased substantially based in part on assumptions related to interest rates, deregulation and tax policy, the extent, timing and impact of which remains uncertain. Significant items that may have an impact on 2017 results include:
 
Improving economic conditions may cause interest rates to rise.  This would result in principal and interest payments on currently outstanding loans and investments being reinvested at higher rates. In addition, rising market rates would likely increase deposit and borrowing costs from current low levels. This could potentially offset or more than offset the benefits of higher rates on our earning assets.  The magnitude and timing of interest rate increases, along with the shape of the yield curve, will impact net interest income in 2017.

The new administration's proposed regulatory relief and income tax reform could have positive impacts on compliance costs and income tax expense for both the Company and our customers.  The extent and speed of these potential reforms will determine the significance of the potential benefits in 2017.

Generally, political turmoil, both in the United States and globally, may give rise to continued market volatility that could impact both the Company’s stock price and interest rates.

The Company's continued focus on long-term strategies including growth in the New England markets, diversification of revenue, improving operating efficiencies and investing in technology.

The Company’s 2017 outlook is subject to factors in addition to those identified above and those risks and uncertainties that could impact the Company’s future results are explained in ITEM 1A. RISK FACTORS.

Asset/Liability Management
 
The Company attempts to maximize net interest income and net income, while actively managing its liquidity and interest rate sensitivity through the mix of various core deposit products and other sources of funds, which in turn fund an appropriate mix of earning assets. The changes in the Company’s asset mix and sources of funds, and the resulting impact on net interest income, on a fully tax equivalent basis, are discussed below.  The following table includes the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest bearing liabilities on a taxable equivalent basis. Interest income for tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.
 
Average Balances and Net Interest Income
 
   
2016
   
2015
   
2014
 
   
Average
         
Yield/
   
Average
         
Yield/
   
Average
         
Yield/
 
(Dollars in thousands)
 
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
   
Balance
   
Interest
   
Rate
 
ASSETS
                                                     
Short-term interest bearing accounts
 
$
16,301
   
$
95
     
0.58
%
 
$
10,157
   
$
33
     
0.33
%
 
$
4,344
   
$
28
     
0.65
%
Securities available for sale (1)(2)
   
1,237,930
     
24,450
     
1.98
%
   
1,059,284
     
20,888
     
1.97
%
   
1,258,999
     
25,760
     
2.05
%
Securities held to maturity (1) 
   
487,837
     
12,255
     
2.51
%
   
459,589
     
11,296
     
2.46
%
   
233,465
     
6,558
     
2.81
%
Investment in FRB and FHLB Banks
   
38,867
     
1,973
     
5.08
%
   
33,044
     
1,712
     
5.18
%
   
39,290
     
2,005
     
5.10
%
Loans (3) 
   
6,035,513
     
251,723
     
4.17
%
   
5,743,860
     
242,587
     
4.22
%
   
5,528,015
     
244,162
     
4.42
%
 Total interest earning assets
 
$
7,816,448
   
$
290,496
     
3.72
%
 
$
7,305,934
   
$
276,516
     
3.78
%
 
$
7,064,113
   
$
278,513
     
3.94
%
Other assets
   
740,506
                     
691,583
                     
691,934
                 
Total assets
 
$
8,556,954
                   
$
7,997,517
                   
$
7,756,047
                 
                                                                         
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
 
$
1,668,555
   
$
3,599
     
0.22
%
 
$
1,582,078
   
$
3,351
     
0.21
%
 
$
1,457,770
   
$
2,532
     
0.17
%
NOW deposit accounts
   
1,077,581
     
546
     
0.05
%
   
987,638
     
515
     
0.05
%
   
949,759
     
509
     
0.05
%
Savings deposits
   
1,135,182
     
652
     
0.06
%
   
1,071,753
     
651
     
0.06
%
   
1,020,974
     
760
     
0.07
%
Time deposits
   
905,126
     
9,569
     
1.06
%
   
960,188
     
9,740
     
1.01
%
   
1,015,748
     
9,837
     
0.97
%
  Total interest bearing deposits
 
$
4,786,444
   
$
14,366
     
0.30
%
 
$
4,601,657
   
$
14,257
     
0.31
%
 
$
4,444,251
   
$
13,638
     
0.31
%
Short-term borrowings
   
497,654
     
2,309
     
0.46
%
   
339,885
     
783
     
0.23
%
   
382,451
     
845
     
0.22
%
Long-term debt
   
118,860
     
3,204
     
2.70
%
   
130,705
     
3,355
     
2.57
%
   
224,556
     
6,555
     
2.92
%
Junior subordinated debt
   
101,196
     
2,627
     
2.60
%
   
101,196
     
2,221
     
2.19
%
   
101,196
     
2,165
     
2.14
%
  Total interest bearing liabilities
 
$
5,504,154
   
$
22,506
     
0.41
%
 
$
5,173,443
   
$
20,616
     
0.40
%
 
$
5,152,454
   
$
23,203
     
0.45
%
Demand deposits
   
2,045,465
                     
1,857,027
                     
1,670,188
                 
Other liabilities
   
110,105
                     
88,937
                     
83,940
                 
Stockholders' equity
   
897,230
                     
878,110
                     
849,465
                 
Total liabilities and stockholders' equity
 
$
8,556,954
                   
$
7,997,517
                   
$
7,756,047
                 
  Net interest income (FTE)
           
267,990
                     
255,900
                     
255,310
         
Interest rate spread
                   
3.31
%
                   
3.38
%
                   
3.49
%
Net interest margin
                   
3.43
%
                   
3.50
%
                   
3.61
%
Taxable equivalent adjustment 
           
3,549
                     
3,292
                     
3,432
         
Net interest income
         
$
264,441
                   
$
252,608
                   
$
251,878
         
 
(1)
Securities are shown at average amortized cost.
(2)
Excluding unrealized gains or losses.
(3)
For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding.
Note:
Interest income for tax-exempt securities and loans has been adjusted to a Fully Taxable-Equivalent ("FTE") basis using the statutory Federal income tax rate of 35%.
 
2016 OPERATING RESULTS AS COMPARED TO 2015 OPERATING RESULTS

Net Interest Income

Net interest income was $264.4 million for the year ended December 31, 2016, up $11.8 million from 2015.  Fully taxable equivalent (“FTE”) net interest margin was 3.43% for the year ended December 31, 2016, down from 3.50% for the year ended December 31, 2015.  Average interest earning assets were up $510.5 million, or 7.0%, for the year ended December 31, 2016 as compared to 2015.  This increase from last year was driven primarily by $314.9, or 5.4%, period end loan growth and a $220.7 million, or 13.4%, increase in investment securities in 2016.  The benefit of earning asset growth was partially offset by a 6 basis point ("bp") decrease in earning assets yields, driven by a 5 bp decrease in loan yields from 2015 to 2016. Average interest bearing liabilities increased $330.7 million, or 6.4%, from the year ended December 31, 2015 to the year ended December 31, 2016.  Total average deposits increased $373.2 million, or 5.8%, for the year ended December 31, 2016 as compared to the prior year driven primarily by a 10.1% increase in noninterest bearing demand deposits, as well as increases in money market deposit accounts, NOW and savings deposits in 2016.  Average short-term borrowings increased $157.8 million for the year ended December 31, 2016 as compared to the prior year funding earning asset growth.  The rates paid on interest bearing liabilities increased by 1 bp for the year ended December 31, 2016 as compared to 2015.  The following table presents changes in interest income, on a FTE basis, and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume), and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.
 
Analysis of Changes in Fully Taxable Equivalent Net Interest Income
 
   
Increase (Decrease)
   
Increase (Decrease)
 
   
2016 over 2015
   
2015 over 2014
 
(In thousands)
 
Volume
   
Rate
   
Total
   
Volume
   
Rate
   
Total
 
Short-term interest-bearing accounts
 
$
27
   
$
35
   
$
62
   
$
24
   
$
(19
)
 
$
5
 
Securities available for sale
   
3,527
     
35
     
3,562
     
(3,966
)
   
(906
)
   
(4,872
)
Securities held to maturity
   
706
     
253
     
959
     
5,649
     
(911
)
   
4,738
 
Investment in FRB and FHLB Banks
   
296
     
(35
)
   
261
     
(323
)
   
30
     
(293
)
Loans
   
12,194
     
(3,058
)
   
9,136
     
9,337
     
(10,912
)
   
(1,575
)
Total interest income
   
16,750
     
(2,770
)
   
13,980
     
10,721
     
(12,718
)
   
(1,997
)
Money market deposit accounts
   
186
     
62
     
248
     
229
     
590
     
819
 
NOW deposit accounts
   
46
     
(15
)
   
31
     
20
     
(14
)
   
6
 
Savings deposits
   
37
     
(36
)
   
1
     
36
     
(145
)
   
(109
)
Time deposits
   
(572
)
   
401
     
(171
)
   
(552
)
   
455
     
(97
)
Short-term borrowings
   
479
     
1,047
     
1,526
     
(97
)
   
35
     
(62
)
Long-term debt
   
(314
)
   
163
     
(151
)
   
(2,483
)
   
(717
)
   
(3,200
)
Junior subordinated debt
   
-
     
406
     
406
     
0
     
56
     
56
 
Total interest expense
   
(138
)
   
2,028
     
1,890
     
(2,847
)
   
260
     
(2,587
)
Change in FTE net interest income
 
$
16,888
   
$
(4,798
)
 
$
12,090
   
$
13,568
   
$
(12,978
)
 
$
590
 

Loans and Corresponding Interest and Fees on Loans

The average balance of loans increased by approximately $291.7 million, or 5.1%, from 2015 to 2016. The yield on average loans decreased from 4.22% in 2015 to 4.17% in 2016, as loan rates declined due to the continued low rate environment in 2016. FTE interest income from loans increased 3.8%, from $242.6 million in 2015 to $251.7 million in 2016. This increase was due to the decrease in yields, offset by the increase in average loan balances.

Total loans increased $314.9 million, or 5.4%, from December 31, 2015 to December 31, 2016.  Increases in commercial real estate loans and commercial loans were the primary drivers of the increase in total loans from 2015 as the Company experienced strong originations in 2016 in the upstate New York, Pennsylvania and New England markets.
 
The following table reflects the loan portfolio by major categories as of December 31 for the years indicated:
 
Composition of Loan Portfolio
 
   
December 31,
 
(In thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
Residential real estate mortgages
 
$
1,262,614
   
$
1,196,780
   
$
1,115,715
   
$
1,041,502
   
$
651,105
 
Commercial
   
1,242,701
     
1,159,089
     
1,144,761
     
1,180,995
     
964,297
 
Commercial  real estate
   
1,543,301
     
1,430,618
     
1,334,984
     
1,218,988
     
1,040,600
 
Consumer
   
1,641,657
     
1,568,204
     
1,430,216
     
1,345,395
     
1,046,333
 
Home equity
   
507,784
     
528,442
     
569,595
     
619,915
     
575,281
 
Total loans
 
$
6,198,057
   
$
5,883,133
   
$
5,595,271
   
$
5,406,795
   
$
4,277,616
 

Residential real estate mortgages consist primarily of loans secured by first or second deeds of trust on primary residences. Loans in the commercial and agricultural categories, including commercial and agricultural real estate mortgages, consist primarily of short-term and/or floating rate loans made to small and medium-sized entities. Consumer loans include $1.2 billion of indirect installment loans to individuals which is secured by automobiles and other personal property including marine, recreational vehicles and manufactured housing. Consumer loans also consist of direct installment loans to individuals secured by similar collateral. Although automobile loans have generally been originated through dealers, all applications submitted through dealers are subject to the Company’s normal underwriting and loan approval procedures. In addition, the consumer loan portfolio as of December 31, 2016 includes $374.9 million of unsecured consumer loans across a national footprint originated through our relationship with a leading national fintech company that began nine years ago as the result of our investment in Springstone Financial LLC ("Springstone"). Advances of credit through this specialty lending business line are to prime borrowers and are subject to the Company's underwriting standards. Real estate construction and development loans include commercial construction and development and residential construction loans. Commercial construction loans are for small and medium sized office buildings and other commercial properties and residential construction loans are primarily for projects located in upstate New York and northeastern Pennsylvania. 
 
Risks associated with the commercial real estate portfolio include the ability of borrowers to pay interest and principal during the loan’s term, as well as the ability of the borrowers to refinance at the end of the loan term.
 
The following table, Maturities and Sensitivities of Certain Loans to Changes in Interest Rates, summarizes the maturities of the commercial and agricultural and real estate construction and development loan portfolios and the sensitivity of those loans to interest rate fluctuations at December 31, 2016. Scheduled repayments are reported in the maturity category in which the contractual payment is due.
 
Maturities and Sensitivities of Certain Loans to Changes in Interest Rates
 
   
Remaining maturity at December 31, 2016
 
(In thousands)
 
Within One Year
   
After One Year But Within Five Years
   
After Five Years
   
Total
 
Floating/adjustable rate
                       
Commercial, commercial real estate, agricultural, and agricultural real estate
 
$
437,030
   
$
366,779
   
$
1,199,719
   
$
2,003,528
 
Fixed rate
                               
Commercial, commercial real estate, agricultural,  and agricultural real estate
   
64,730
     
366,958
     
350,786
     
782,474
 
  Total
 
$
501,760
   
$
733,737
   
$
1,550,505
   
$
2,786,002
 

Securities and Corresponding Interest and Dividend Income
 
The average balance of securities available for sale ("AFS") increased $178.6 million, or 16.9%, from 2015 to 2016. The yield on average AFS securities was 1.98% for 2016 compared to 1.97% in 2015.
 
The average balance of securities held to maturity ("HTM") increased from $459.6 million in 2015 to $487.8 million in 2016. At December 31, 2016, HTM securities were comprised primarily of tax-exempt municipal securities. The yield on HTM securities increased from 2.46% in 2015 to 2.51% in 2016.
 
The average balance of FRB and FHLB stock increased to $38.9 million in 2016 from $33.0 million in 2015. The yield from investments in FRB and FHLB banks decreased from 5.18% in 2015 to 5.08% in 2016.
 
Securities Portfolio
 
   
As of December 31,
 
   
2016
   
2015
   
2014
 
   
Amortized
   
Fair
   
Amortized
   
Fair
   
Amortized
   
Fair
 
(In thousands)
 
Cost
   
Value
   
Cost
   
Value
   
Cost
   
Value
 
AFS Securities:
                                   
U.S. Treasury
 
$
-
   
$
-
   
$
-
   
$
-
   
$
23,041
   
$
23,111
 
Federal agency
   
175,135
     
174,408
     
312,580
     
311,272
     
332,193
     
329,914
 
State & Municipal
   
47,053
     
46,726
     
31,208
     
31,637
     
37,035
     
37,570
 
Mortgage-backed
   
528,769
     
529,844
     
406,277
     
409,896
     
356,557
     
364,727
 
Collateralized mortgage obligations
   
574,253
     
566,573
     
405,635
     
404,971
     
240,074
     
242,129
 
Other securities
   
15,849
     
20,739
     
13,637
     
16,768
     
12,818
     
15,720
 
  Total AFS securities
 
$
1,341,059
   
$
1,338,290
   
$
1,169,337
   
$
1,174,544
   
$
1,001,718
   
$
1,013,171