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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITIONS REPORTS PURSUANT TO SECTIONS
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
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Commission File Number 0-26481
FINANCIAL INSTITUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
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(State of Incorporation) (I.R.S. Employer Identification Number)
220 Liberty Street Warsaw, NY 14569
----------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act: Title of Class:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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 twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days.
YES[X] NO[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [ ]
As of March 1, 2002 there were issued and outstanding, exclusive of treasury
shares, 11,009,761 shares of the Registrant's Common Stock.
The aggregate market value of the 7,760,764 shares of voting stock held by
non-affiliates of the Registrant was $219,397,000, as computed by reference to
the last sales price on March 1, 2002, as reported by the Nasdaq National
Market. Solely for purposes of this calculation, all persons who are directors
and executive officers of the Registrant and all persons who are believed by the
Registrant to be beneficial owners of more than 5% of its outstanding stock have
been deemed to be affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's proxy statement filed with the Securities and
Exchange Commission in connection with the 2002 Annual Meeting of Shareholders
is incorporated by reference in Part III of this Annual Report on Form 10-K.
FINANCIAL INSTITUTIONS, INC.
2001 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
PART I
Item 1. Business of the Company 3
Item 2. Properties 18
Item 3. Legal Proceedings 19
Item 4. Submission of Matters for a Vote by
Security Holders 19
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters 19
Item 6. Selected Financial Data Management Discussion 20
Item 7. and Analysis of Financial Condition
and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosure
About Market Risk 36
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 68
PART III
Item 10. Directors and Executive Officers of
the Registrant 68
Item 11. Executive Compensation 68
Item 12. Security Ownership of Certain Beneficial
Owners and Management 68
Item 13. Certain Relationships and Related Transactions 68
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 69
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PART I
ITEM I. BUSINESS OF THE COMPANY
GENERAL
Financial Institutions, Inc. (the "Company" or "FII") is a financial holding
company headquartered in Warsaw, New York, which is located 45 miles southwest
of Rochester and 45 miles southeast of Buffalo. The Company operates a
super-community bank holding company - a bank holding company that owns multiple
community banks that are separately managed. The Company owns five commercial
banks that provide consumer, commercial and agricultural banking services in
Western and Central New York State: Wyoming County Bank ("WCB"), The National
Bank of Geneva ("NBG"), The Pavilion State Bank ("PSB"), First Tier Bank & Trust
("FTB") and Bath National Bank ("BNB"), collectively referred to as the "Banks".
The Company was formed in 1931 to facilitate the management of three of these
banks that had been primarily owned by the Humphrey family during the late 1800s
and early 1900s. In recent years, the Company has grown through a combination of
internal growth, the opening of new branch offices and acquisitions. The Company
became qualified in May 2000 as a financial holding company (see
Gramm-Leach-Bliley Act discussion beginning on page 14), and has since
incorporated two financial services subsidiaries into its operations: Burke
Group, Inc. ("BGI") and The FI Group, Inc. ("FIGI"), collectively referred to as
the "Financial Services Group". BGI is an employee benefits and compensation
consulting firm acquired by the Company in October 2001. FIGI is a brokerage
subsidiary that commenced operations as a start-up company in March 2000. In
February 2001, the Company formed FISI Statutory Trust I ("FISI"), to
accommodate the private placement of $16.2 million in capital securities, the
proceeds of which were utilized to partially fund the acquisition of Bath
National Corporation ("BNC"). The capital securities are identified on the
balance sheet as guaranteed preferred beneficial interests in corporation's
junior subordinated debentures.
As a super-community bank holding company, the Company's strategy has been to
manage its bank subsidiaries on a decentralized basis. This strategy provides
the Banks the flexibility to efficiently serve their markets and respond to
local customer needs. While generally operating on a decentralized basis, the
Company has consolidated selected lines of business, operations and support
functions in order to achieve economies of scale, greater efficiency and
operational consistency. By increasing the use of existing technology and by
further centralizing back-office operations, management believes substantial
additional growth can be accomplished without incurring proportionately greater
operational costs.
The relative sizes and profitability of the Company's operating subsidiaries as
of and for the year ended December 31, 2001, are depicted in the following
table:
Percent Percent
Subsidiary Assets of Total Net Income of Total
------------------------------------------------------------------------------------------------
(Dollars in thousands)
Wyoming County Bank $ 551,346 31% $ 8,424 40%
The National Bank of Geneva 546,539 30 8,322 39
Bath National Bank 362,645 20 1,142 * 5
The Pavilion State Bank 177,000 10 2,674 13
First Tier Bank & Trust 161,763 9 1,827 9
Parent, non-bank subsidiaries
and eliminations, net (4,997) - (1,176) (6)
------------ ------ ---------- --------
Total $ 1,794,296 100 $ 21,213 100
========= ====== ====== =======
* From date of acquisition (May 1, 2001)
MERGERS AND ACQUISITIONS
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The
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Company paid $48.00 per share in cash for each of the outstanding shares of BNC
common stock with an aggregate purchase price of approximately $62.6 million.
The acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired, less liabilities assumed,
has been recorded as goodwill. Goodwill recognized with respect to the merger
was approximately $37.2 million. Goodwill was amortized in 2001 using the
straight-line method over 15 years, since the transaction was consummated prior
to June 30, 2001, the effective date of SFAS No. 142. However, in accordance
with SFAS No. 142, the Company ceased goodwill amortization on January 1, 2002
and will evaluate goodwill for impairment annually. The results of operations
for BNB are included in the income statement from the date of acquisition (May
1, 2001) to the end of the period.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable assets acquired, less liabilities assumed, has been recorded as
goodwill, after recognizing an intangible asset separate from goodwill in
accordance with SFAS No. 141. Goodwill recognized with respect to the merger was
approximately $1.3 million. In accordance with SFAS No. 142, the Company is not
required to amortize goodwill on this acquisition, but evaluates goodwill for
impairment on an annual basis. The Company also recorded a $500,000 intangible
asset which is being amortized using the straight-line method over five years.
The results of operations for BGI are included in the income statement from the
date of acquisition (October 22, 2001) to the end of the period.
In July 2001, the FASB issued SFAS Nos. 141, "Business Combinations" and 142,
"Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business
combinations be accounted for under the purchase method, use of the
pooling-of-interests method is no longer permitted for business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including
goodwill reported in prior acquisitions) no longer be amortized to earnings, but
instead be reviewed for impairment annually, with impairment losses charged to
earnings when they occur. The Company is required to adopt SFAS No. 142
effective January 1, 2002. The results of operations for year ended December 31,
2001 include goodwill amortization from the BNB acquisition of $1,653,000. The
amortization of goodwill ceased effective January 1, 2002.
On January 11, 2002, FII reached a definitive agreement to acquire all of the
outstanding stock of the Bank of Avoca ("BOA"). BOA is a retail oriented
institution with its main office located in Avoca, New York, as well as, a
branch located in Cohocton, New York. Total assets of BOA approximated $17.9
million as of December 31, 2001. FII will fund the transaction using $1.5
million in FII stock, based on the average sales price of FII stock for the 30
trading days immediately prior to the closing date. The acquisition which is
subject to approval by BOA shareholders and by various regulatory agencies, will
be accounted for using the purchase method of accounting and is currently
scheduled to be completed in the second quarter of 2002. Subsequently, BOA will
merge with and into BNB.
FORWARD LOOKING STATEMENTS
This Report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), that involve substantial risks and uncertainties. When used in this
report, or in the documents incorporated by reference herein, the words
"anticipate", "believe", "estimate", "expect", "intend", "may", and similar
expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. These
forward-looking statements are based on the current expectations of the Company
or the Company's management and are subject to a number of risks and
uncertainties, including but not limited to, economic, competitive, regulatory,
and other factors affecting the Company's operations, markets, products and
services, as well as expansion
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strategies and other factors discussed elsewhere in this report filed by the
Company with the Securities and Exchange Commission. Many of these factors are
beyond the Company's control.
MARKET AREA AND COMPETITION
The Company operates 41 branches and has 55 ATMs in twelve contiguous counties
of Western and Central New York State: Allegany, Cattaraugus, Erie, Genesee,
Livingston, Monroe, Ontario, Schuyler, Seneca, Steuben, Wyoming and Yates
Counties.
The Company's market area is geographically and economically diversified in that
it serves both rural markets and, increasingly, the larger more affluent markets
of suburban Rochester and suburban Buffalo. Rochester and Buffalo are the two
largest cities in New York State outside of New York City, with combined
metropolitan area populations of over two million people. The Company
anticipates increasing its presence in the markets around these two cities.
The Company faces significant competition in both making loans and attracting
deposits, as Western and Central New York have a high density of financial
institutions. The Company's competition for loans comes principally from
commercial banks, savings banks, savings and loan associations, mortgage banking
companies, credit unions, insurance companies and other financial service
companies. Its most direct competition for deposits has historically come from
savings and loan associations, savings banks, commercial banks and credit
unions. The Company faces additional competition for deposits from
non-depository competitors such as the mutual fund industry, securities and
brokerage firms and insurance companies.
LENDING ACTIVITIES
General. The Company, through its banking subsidiaries, offers a broad range of
loans including commercial and agricultural working capital and revolving lines
of credit, commercial and agricultural mortgages, equipment loans, crop and
livestock loans, residential mortgage loans and home equity lines of credit,
home improvement loans, student loans, automobile loans, personal loans and
credit cards. The Company sells most of its newly originated fixed rate
residential mortgage loans in the secondary market. Under the Company's
decentralized management philosophy, each of the banks determines individually
which loans are sold and which are retained for the portfolio. The Company
retains the servicing rights on most mortgage loans it sells and realizes
monthly service fee income.
Underwriting Standards. The Company's loan policy establishes the general
parameters of the types of loans that are desirable, emphasizing cash flow and
collateral coverage. Under the decentralized management structure, credit
decisions are made at the subsidiary bank level by officers who generally have
had long personal experience with most of their commercial and many of their
individual borrowers, helping to ensure thorough underwriting and sound credit
decisions. Each subsidiary bank approves its own loan policy that must comply
with the Company's overall loan policy. These policies establish the lending
authority of individual loan officers as well as the loan authority of the
banks' loan committees. The subsidiary bank CEO and Senior Loan Administrator
each have loan authority up to $250,000 while other lending authorities are
$100,000 or less. The CEO and Senior Loan Administrator can approve up to
$500,000 jointly. Each bank subsidiary has a loan committee, which includes
outside members of the subsidiary bank's Board of Directors, with the authority
to approve loans up to the subsidiaries legal lending limit. To assure the
maximum salability of the residential loan products for possible resale into the
secondary mortgage markets, the Company has formally adopted the underwriting,
appraisal, and servicing guidelines of the Federal Home Loan Mortgage
Corporation ("Freddie Mac") as part of its standard loan policy and procedures
manual.
Commercial Loans. The Company, through its banking subsidiaries,
originates commercial loans in its primary market areas and underwrites them
based on the borrower's ability to service the loan from operating income. The
Company, through its banking subsidiaries, offers a broad range of commercial
lending products, including term loans and lines of credit. Short- and
medium-term commercial loans, primarily collateralized, are made available to
businesses for working capital (including inventory and receivables), business
expansion (including acquisition of real estate, expansion and improvements) and
the purchase of equipment. As a general practice, a collateral lien is placed on
any available real estate,
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equipment or other assets owned by the borrower and a personal guarantee of the
borrower is obtained. At December 31, 2001, $45.8 million, or 19.7%, of the
aggregate commercial loan portfolio was at fixed rates while $186.6 million, or
80.3%, was at variable rates. The Company also utilizes government loan
guarantee programs offered by the Small Business Administration (or "SBA") and
Rural Economic and Community Development (or "RECD") when appropriate. See
"Government Guarantee Programs" below.
Commercial Real Estate Loans. In addition to commercial loans secured
by real estate, the Company, through its banking subsidiaries, makes commercial
real estate loans to finance the purchase of real property which generally
consists of real estate with completed structures. Commercial real estate loans
are secured by first liens on the real estate, typically have variable interest
rates and are amortized over a 10 to 20 year period. The underwriting analysis
includes credit verification, appraisals and a review of the borrower's
financial condition. At December 31, 2001, $48.0 million, or 17.5%, of the
aggregate commercial real estate loan portfolio was at fixed rates while $226.7
million, or 82.5%, was at variable rates.
Agricultural Loans. Agricultural loans are offered for short-term crop
production, farm equipment and livestock financing and agricultural real estate
financing, including term loans and lines of credit. Short- and medium-term
agricultural loans, primarily collateralized, are made available for working
capital (crops and livestock), business expansion (including acquisition of real
estate, expansion and improvement) and the purchase of equipment. The Banks also
closely monitor commodity prices and inventory build-up in various commodity
categories to better anticipate price changes in key agricultural products that
could adversely affect the borrowers' ability to repay their loans. At December
31, 2001, $18.8 million, or 10.1%, of the agricultural loan portfolio was at
fixed rates while $167.8 million, or 89.9%, was at variable rates. The Banks
utilize government loan guarantee programs offered by the SBA and the Farm
Service Agency (or "FSA") of the United States Department of Agriculture where
available and appropriate. See "Government Guarantee Programs" below.
Residential Real Estate Loans. The Banks originate fixed and variable
rate one-to-four family residential real estate loans collateralized by
owner-occupied properties located in its market areas. A variety of real estate
loan products which generally are amortized over five to 30 years are offered.
Loans collateralized by one-to-four family residential real estate generally
have been originated in amounts of no more than 80% of appraised value or have
mortgage insurance. Mortgage title insurance and hazard insurance is normally
required. The Company sells most newly originated fixed rate one-to-four family
residential mortgages to Freddie Mac and retains the rights to service the
mortgages. At December 31, 2001, the servicing portfolio totaled $246.0 million
in residential mortgages, all of which have been sold to Freddie Mac. At
December 31, 2001, $163.9 million, or 68.3%, of residential real estate loans
retained in portfolio was at fixed rates while $76.2 million, or 31.7%, was at
variable rates.
Consumer and Home Equity Loans. The Banks originate direct and indirect
credit automobile loans, recreational vehicle loans, boat loans, home
improvement loans, fixed and open-ended home equity loans, personal loans
(collateralized and uncollateralized), student loans and deposit account
collateralized loans. Visa cards that provide consumer credit lines are also
issued. The terms of these loans typically range from 12 to 120 months and vary
based upon the nature of the collateral and the size of loan. The majority of
the consumer lending program is underwritten on a secured basis using the
customer's home or the financed automobile, mobile home, boat or recreational
vehicle as collateral. At December 31, 2001, $175.2 million, or 75.5%, of
aggregate consumer and home equity loans was at fixed rates while $57.0 million,
or 24.5%, was at variable rates.
Government Guarantee Programs. The Banks participate in government loan
guarantee programs offered by the SBA, RECD and FSA. At December 31, 2001, the
Banks had loans with an aggregate principal balance of $39.4 million that were
covered by guarantees under these programs. The guarantees only cover a certain
percentage of these loans. By participating in these programs, the Banks are
able to broaden their base of borrowers while minimizing credit risk.
Delinquencies and Nonperforming Assets. The Banks have several procedures in
place to assist in maintaining the overall quality of the Company's loan
portfolio. Specific underwriting guidelines have
6
been established to be followed by the lending officers. The Company monitors
each bank subsidiary's delinquency levels on a monthly basis for any adverse
trends.
Classification of Assets. Through the loan review process, the Banks maintain
internally classified loan lists which, along with delinquency reporting, helps
management assess the overall quality of the loan portfolio and the adequacy of
the allowance for loan losses. Loans classified as "substandard" are those loans
with clear and defined weaknesses such as a higher leveraged position,
unfavorable financial ratios, uncertain repayment sources or poor financial
condition, which may jeopardize recoverability of the debt. Loans classified as
"doubtful" are those loans which have characteristics similar to substandard
accounts but with an increased risk that a loss may occur, or at least a portion
of the loan may require a charge-off if liquidated at present. Loans classified
as "loss" are those loans which are in the process of being charged-off.
A loan is generally placed on nonaccrual status and ceases accruing interest
when the payment of principal or interest is delinquent for 90 days, or earlier
in some cases, unless the loan is in the process of collection and the
underlying collateral further supports the carrying value of the loan.
Allowance for Loan Losses. The allowance for loan losses is established through
charges to earnings in the form of a provision for loan losses. The allowance
reflects management's estimate of the amount of reasonably foreseeable losses,
based on the following factors:
o the amount of historical charge-off experience;
o the evaluation of the loan portfolio by the loan review function;
o levels and trends in delinquencies and non-accruals;
o trends in volume and terms;
o effects of changes in lending policy;
o experience, ability and depth of management;
o national and local economic trends and conditions; and
o concentration of credit.
Charge-offs occur when loans are deemed to be uncollectible.
Management presents a quarterly review of the allowance for loan losses to each
subsidiary bank's Board of Directors as well as to the Company's Board of
Directors, indicating any change in the allowance since the last review and any
recommendations as to adjustments in the allowance.
In order to determine the adequacy of the allowance for loan losses, the risk
classification and delinquency status of loans and other factors are considered,
such as collateral value, government guarantees, portfolio composition, trends
in economic conditions and the financial strength of borrowers. Specific
allowances for loans which have been individually evaluated for impairment are
established when required. An allowance is also established for groups of loans
with similar risk characteristics, based upon average historical charge-off
experience taking into account levels and trends in delinquencies, loan volumes,
economic and industry trends and concentrations of credit.
INVESTMENT ACTIVITIES
General. The Company's investment securities policy is contained within the
overall Asset-Liability Management and Investment Policy. This policy dictates
that investment decisions will be made based on the safety of the investment,
liquidity requirements, potential returns, cash flow targets, need for
collateral and desired risk parameters. In pursuing these objectives, the
Company considers the ability of
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an investment to provide earnings consistent with factors of quality, maturity,
marketability and risk diversification. The Board of each subsidiary bank adopts
an asset/liability policy containing an investment securities policy within the
parameters of the Company's overall asset/liability policy. The FII Treasurer,
guided by the separate ALCO Committees of each subsidiary bank, is responsible
for securities portfolio decisions within the established policies.
The Company's investment securities strategy centers on providing liquidity to
meet loan demand and redeeming liabilities, meeting pledging requirements,
managing overall interest rate risk and maximizing portfolio yield. Subsidiary
bank policies generally limit security purchases to the following:
o U.S. treasury securities;
o U.S. government agency and government sponsored agency
securities;
o mortgage-backed pass-through securities and collateralized
mortgage obligations ("CMOs") issued by the Federal National
Mortgage
Association ("FNMA"), the Government National Mortgage
Association ("GNMA") and Freddie Mac ("FHLMC");
o investment grade municipal securities, including tax, revenue
and bond anticipation notes and general obligation and revenue
notes and bonds;
o certain creditworthy un-rated securities issued by
municipalities; and
o investment grade corporate debt.
The Company currently does not participate in hedging programs, interest rate
swaps, or other activities involving the use of off-balance sheet derivative
financial instruments. Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities," requires
recognition of derivatives as either assets or liabilities, with the instruments
measured at fair value. The accounting for gains and losses resulting from
changes in fair value of the derivative instrument depends on the intended use
of the derivative and the type of risk being hedged. The Company adopted SFAS
No. 133 on January 1, 2001. The adoption of this statement did not have a
material effect on the Company's financial position or results of operations.
Additionally, the Company's investment policy limits investments in corporate
bonds to no more than 10% of total investments and to bonds rated at the time of
purchase as Baa or better by Moody's Investor Services, Inc. or BBB or better by
Standard & Poor's Ratings Services.
SOURCES OF FUNDS
General. Deposits and borrowed funds, primarily Federal Home Loan Bank ("FHLB")
advances and sweep repurchase agreements, are the primary sources of the
Company's funds for use in lending, investing and for other general purposes. In
addition, repayments on loans, proceeds from sales of loans and securities, and
cash flows from operations provide additional sources of funds.
Deposits. The Company, through its banking subsidiaries, offers a variety of
deposit account products with a range of interest rates and terms. The deposit
accounts consist of savings, interest-bearing checking accounts, checking
accounts, money market accounts, savings, club accounts and certificates of
deposit. The Company offers certificates of deposit with balances in excess of
$100,000 at preferential rates (jumbo certificates) to local municipalities,
businesses, and individuals as well as Individual Retirement Accounts ("IRAs")
and other qualified plan accounts. To enhance its deposit product offerings, the
Company provides commercial checking accounts for small to moderately-sized
commercial businesses, as well as a low-cost checking account service for
low-income customers.
The flow of deposits is influenced significantly by general economic conditions,
changes in money market rates, prevailing interest rates and competition. The
Banks' deposits are obtained predominantly from the areas in which the Banks'
branch offices are located. The Banks rely primarily on competitive pricing of
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their deposit products, customer service and long-standing relationships with
customers to attract and retain these deposits.
Borrowed Funds. Borrowings consist primarily of advances entered into with the
FHLB and repurchase agreements. The Company anticipates the continued use of
borrowings as a source of funding loan growth.
Guaranteed Preferred Beneficial Interests in Corporation's Junior Subordinated
Debentures. The Company formed a trust in February 2001 to accommodate the
private placement of $16.2 million in capital securities, the proceeds of which
were utilized to partially fund the acquisition of BNC.
SUPERVISION AND REGULATION
The supervision and regulation of bank holding companies and their subsidiaries
is intended primarily for the protection of depositors, the deposit insurance
funds regulated by the FDIC and the banking system as a whole, and not for the
protection of shareholders or creditors of bank holding companies. The various
bank regulatory agencies have broad enforcement power over bank holding
companies and banks, including the power to impose substantial fines,
operational restrictions and other penalties for violations of laws and
regulations.
The following description summarizes some of the laws to which the Company and
its subsidiaries are subject. References to applicable statutes and regulations
are brief summaries and do not claim to be complete. They are qualified in their
entirety by reference to such statutes and regulations. Management believes the
Company is in compliance in all material respects with these laws and
regulations. Changes in the laws, regulations or policies that impact the
Company cannot necessarily be predicted, but they may have a material effect on
the business and earnings of the Company.
THE COMPANY
The Company is a bank holding company registered under the Bank Holding Company
Act of 1956, as amended, and is subject to supervision, regulation and
examination by the Federal Reserve Board. The Bank Holding Company Act and other
federal laws subject bank holding companies to particular restrictions on the
types of activities in which they may engage, and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength. It is the policy of
the Federal Reserve Board that bank holding companies should pay cash dividends
on common stock only out of income available over the past year, and only if
prospective earnings retention is consistent with the holding company's expected
future needs and financial condition. The policy provides that bank holding
companies should not maintain a level of cash dividends that undermines the bank
holding company's ability to serve as a source of strength to its banking
subsidiaries.
Under Federal Reserve Board policy, a bank holding company is expected to act as
a source of financial strength to each of its banking subsidiaries and commit
resources to their support. Such support may be required at times when, absent
this Federal Reserve Board policy, a holding company may not be inclined to
provide it. As discussed below, a bank holding company in certain circumstances
could be required to guarantee the capital plan of an undercapitalized banking
subsidiary.
Safe and Sound Banking Practices. Bank holding companies are not permitted to
engage in unsafe and unsound banking practices. The Federal Reserve Board's
Regulation Y, for example, generally requires a holding company to give the
Federal Reserve Board prior notice of any redemption or repurchase of its own
equity securities, if the consideration to be paid, together with the
consideration paid for any repurchases or redemptions in the preceding year, is
equal to 10% or more of the company's consolidated net worth. The Federal
Reserve Board may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or
regulation.
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Depending upon the circumstances, the Federal Reserve Board could take the
position that paying a dividend would constitute an unsafe or unsound banking
practice.
The Federal Reserve Board has broad authority to prohibit activities of bank
holding companies and their non-banking subsidiaries which represent unsafe and
unsound banking practices or which constitute violations of laws or regulations,
and can assess civil money penalties for certain activities conducted on a
knowing and reckless basis, if those activities caused a substantial loss to a
depository institution. The penalties can be as high as $1,000,000 for each day
the activity continues.
Anti-Tying Restrictions. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system
using risk-based capital guidelines to evaluate the capital adequacy of bank
holding companies. Under the guidelines, specific categories of assets are
assigned different risk weights, based generally on the perceived credit risk of
the asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of December 31, 2001, the Company's ratio of Tier 1 capital to total
risk-weighted assets was 9.81% and the ratio of total capital to total
risk-weighted assets was 11.37%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Financial Condition-Capital
Resources."
In addition to the risk-based capital guidelines, the Federal Reserve Board uses
a leverage ratio as an additional tool to evaluate the capital adequacy of bank
holding companies. The leverage ratio is a company's Tier 1 capital divided by
three-month average consolidated assets. Certain highly-rated bank holding
companies may maintain a minimum leverage ratio of 3.0%, but other bank holding
companies may be required to maintain a leverage ratio of up to 200 basis points
above the regulatory minimum. As of December 31, 2001, the Company's leverage
ratio was 7.02%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
Federal Reserve Board guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are
required to take "prompt corrective action" to resolve problems associated with
insured depository institutions whose capital declines below certain levels. In
the event an institution becomes "undercapitalized," it must submit a capital
restoration plan. The capital restoration plan will not be accepted by the
regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve
Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
10
Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires
every bank holding company to obtain the prior approval of the Federal Reserve
Board before it may acquire all or substantially all of the assets of any bank,
or ownership or control of any voting shares of any bank, if after such
acquisition it would own or control, directly or indirectly, more than 5% of the
voting shares of such bank. In approving bank acquisitions by bank holding
companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the
banks concerned, the convenience and needs of the communities to be served, and
various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group
of persons from acquiring "control" of a bank holding company unless the Federal
Reserve Board has been notified and has not objected to the transaction. Under a
rebuttable presumption established by the Federal Reserve Board, the acquisition
of 10% of more of a class of voting stock of a bank holding company with a class
of securities registered under Section 12 of the Exchange Act, would, under the
circumstances set forth in the presumption, constitute acquisition of control of
the Company.
In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the
case of an acquirer that is a bank holding company) or more of the Company's
outstanding common stock, or otherwise obtaining control or a "controlling
influence" over the Company.
THE BANKS
Wyoming County Bank ("WCB"), Pavilion State Bank ("PSB") and First Tier Bank &
Trust ("FTB") are New York State-chartered banks. National Bank of Geneva
("NBG") and Bath National Bank ("BNB") are national banks chartered by the
Office of the Comptroller of Currency. All of the deposits of the five
subsidiary banks are insured by the FDIC through the Bank Insurance Fund. FTB is
a member of the Federal Reserve System. The Banks are subject to supervision and
regulation that subject them to special restrictions, requirements, potential
enforcement actions and periodic examination by the FDIC, the Federal Reserve
Board and the New York State Banking Department (in the case of the
state-chartered banks) and the Office of the Comptroller of Currency (in the
case of the national banks). Because the Federal Reserve Board regulates the
bank holding company parent of the Banks, the Federal Reserve Board also has
supervisory authority which directly affects the banks.
Restrictions on Transactions with Affiliates and Insiders. Transactions between
the holding company and its subsidiaries, including the Banks, are subject to
Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits
on the amount of such transactions, and also requires certain levels of
collateral for loans to affiliated parties. It also limits the amount of
advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal Reserve
Act which generally requires that certain transactions between the holding
company and its affiliates be on terms substantially the same, or at least as
favorable to the banks, as those prevailing at the time for comparable
transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
shareholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the FDIC may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends
paid by the Banks have provided a substantial part of the Company's operating
funds and, for the foreseeable future, it is
11
anticipated that dividends paid by the Banks will continue to be its principal
source of operating funds. Capital adequacy requirements serve to limit the
amount of dividends that may be paid by the subsidiaries. Under federal law, the
subsidiaries cannot pay a dividend if, after paying the dividend, a particular
subsidiary will be "undercapitalized." The FDIC may declare a dividend payment
to be unsafe and unsound even though the bank would continue to meet its capital
requirements after the dividend.
Because the Company is a legal entity separate and distinct from its
subsidiaries, the Company's right to participate in the distribution of assets
of any subsidiary upon the subsidiary's liquidation or reorganization will be
subject to the prior claims of the subsidiary's creditors. In the event of a
liquidation or other resolution of an insured depository institution, the claims
of depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its shareholders, including any depository bank holding company
(such as the Company) or any shareholder or creditor thereof.
Examinations. The New York State Banking Department (in the case of WCB, PSB and
FTB), the Office of the Comptroller of the Currency (in the case of NBG and
BNB), the Federal Reserve Board and the FDIC periodically examine and evaluate
the Banks. Based upon such examinations, the appropriate regulator may revalue
the assets of the institution and require that it establish specific reserves to
compensate for the difference between what the regulator determines the value to
be and the book value of such assets.
Audit Reports. Insured institutions with total assets of $500 million or more at
the beginning of a fiscal year must submit annual audit reports prepared by
independent auditors to federal and state regulators. In some instances, the
audit report of the institution's holding company can be used to satisfy this
requirement. Auditors must receive examination reports, supervisory agreements
and reports of enforcement actions. In addition, financial statements prepared
in accordance with generally accepted accounting principles, management's
certifications concerning responsibility for the financial statements, internal
controls and compliance with legal requirements designated by the FDIC, and an
attestation by the auditor regarding the statements of management relating to
the internal controls must be submitted. The FDIC Improvement Act of 1991
requires that independent audit committees be formed, consisting of outside
directors only. The committees of institutions with assets of more than $3
million must include members with experience in banking or financial management,
must have access to outside counsel and must not include representatives of
large customers.
Capital Adequacy Requirements. The FDIC has adopted regulations establishing
minimum requirements for the capital adequacy of insured institutions. The FDIC
may establish higher minimum requirements if, for example, a bank has previously
received special attention or has a high susceptibility to interest rate risk.
The FDIC's risk-based capital guidelines generally require state banks to have a
minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a
ratio of total capital to total risk-weighted assets of 8.0%. The capital
categories have the same definitions for the Company. As of December 31, 2001,
the ratio of Tier 1 capital to total risk-weighted assets for the Banks was
8.95% for WCB, 9.24% for NBG, 14.18% for BNB, 9.14% for PSB and 8.94% for FTB,
and the ratio of total capital to total risk-weighted assets was 10.21% for WCB,
10.50% for NBG, 15.43% for BNB, 10.40% for PSB and 10.20% for FTB. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
The FDIC's leverage guidelines require state banks to maintain Tier 1 capital of
no less than 4.0% of average total assets, except in the case of certain highly
rated banks for which the requirement is 3.0% of average total assets. As of
December 31, 2001, the ratio of Tier 1 capital to average total assets (leverage
ratio) was 6.56% for WCB, 6.96% for NBG, 8.43% for BNB, 7.02% for PSB and 6.08%
for FTB. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
12
Corrective Measures for Capital Deficiencies. The federal banking regulators are
required to take "prompt corrective action" with respect to capital-deficient
institutions. Agency regulations define, for each capital category, the levels
at which institutions are "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." A "well-capitalized" bank has a total risk-based capital
ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a
leverage ratio of 5.0% or higher; and is not subject to any written agreement,
order or directive requiring it to maintain a specific capital level for any
capital measure. An "adequately capitalized" bank has a total risk-based capital
ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a
leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a
composite 1 in its most recent examination report and is not experiencing
significant growth); and does not meet the criteria for a well-capitalized bank.
A bank is "undercapitalized" if it fails to meet any one of the ratios required
to be adequately capitalized.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
As an institution's capital decreases, the FDIC's enforcement powers become more
severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management and other restrictions. The FDIC has only
very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums
may also be subject to certain administrative actions, including the termination
of deposit insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no tangible
capital.
Deposit Insurance Assessments. The bank subsidiaries must pay assessments to the
FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based
assessment system as required by the FDIC Improvement Act. Under this system,
FDIC-insured depository institutions pay insurance premiums at rates based on
their risk classification. Institutions assigned to higher risk classifications
(that is, institutions that pose a greater risk of loss to their respective
deposit insurance funds) pay assessments at higher rates than institutions that
pose a lower risk. An institution's risk classification is assigned based on its
capital levels and the level of supervisory concern the institution poses to the
regulators. In addition, the FDIC can impose special assessments in certain
instances.
The FDIC maintains a process for raising or lowering all rates for insured
institutions semi-annually if conditions warrant a change. Under this system,
the FDIC has the flexibility to adjust the assessment rate schedule twice a year
without seeking prior public comment, but only within a range of five cents per
$100 above or below the premium schedule adopted. Changes in the rate schedule
outside the five cent range above or below the current schedule can be made by
the FDIC only after a full rulemaking with opportunity for public comment.
The Deposit Insurance Fund Act of 1996 contained a comprehensive approach to
recapitalizing the Savings Association Insurance Fund and to assuring the
payment of the Financing Corporation's bond obligations. Under this law, banks
insured under the Bank Insurance Fund are required to pay a portion of the
interest due on bonds that were issued by the Financing Corporation in 1987 to
help shore up the ailing Federal Savings and Loan Insurance Corporation.
Enforcement Powers. The FDIC and the other federal banking agencies have broad
enforcement powers, including the power to terminate deposit insurance, impose
substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. Failure to comply with applicable laws, regulations and
supervisory agreements could subject the Company or its banking subsidiaries, as
well
13
as the officers, directors and other institution-affiliated parties of these
organizations, to administrative sanctions and potentially substantial civil
money penalties.
Brokered Deposit Restrictions. Adequately capitalized institutions cannot
accept, renew or roll over brokered deposits except with a waiver from the FDIC,
and are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or roll over
brokered deposits.
Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which
generally makes commonly controlled insured depository institutions liable to
the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA") and
the regulations issued thereunder are intended to encourage banks to help meet
the credit needs of their service area, including low and moderate income
neighborhoods, consistent with the safe and sound operations of the banks. These
regulations also provide for regulatory assessment of a bank's record in meeting
the needs of its service area when considering applications regarding
establishing branches, mergers or other bank or branch acquisitions. FIRREA
requires federal banking agencies to make public a rating of a bank's
performance under the CRA. In the case of a bank holding company, the CRA
performance record of the banks involved in the transaction are reviewed in
connection with the filing of an application to acquire ownership or control of
shares or assets of a bank or to merge with any other bank holding company. An
unsatisfactory record can substantially delay or block the transaction.
Consumer Laws and Regulations. In addition to the laws and regulations discussed
herein, the subsidiary banks are also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include, among others, the Truth in Lending Act, the Truth in Savings Act, the
Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal
Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act
and the Real Estate Settlement Procedures Act. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which
financial institutions must deal with customers when taking deposits or making
loans to such customers. The Banks must comply with the applicable provisions of
these consumer protection laws and regulations as part of their ongoing customer
relations.
CHANGING REGULATORY STRUCTURE
GRAMM LEACH-BLILEY ACT
The Gramm-Leach-Bliley Act ("Gramm-Leach") was signed into law on November 12,
1999. Gramm-Leach permits, subject to certain conditions, combinations among
banks, securities firms and insurance companies beginning March 11, 2000. Under
Gramm-Leach, bank holding companies are permitted to offer their customers
virtually any type of financial service including banking, securities
underwriting, insurance (both underwriting and agency), and merchant banking. In
order to engage in these additional financial activities, a bank holding company
must qualify and register with the Board of Governors of the Federal Reserve
System as a "financial holding company" by demonstrating that each of its bank
subsidiaries is "well capitalized," "well managed," and has at least a
"satisfactory" rating under the CRA. On May 12, 2000 the Company received
approval from the Federal Reserve Bank of New York to become a financial holding
company. Gramm-Leach establishes that the federal banking agencies will regulate
the banking activities of financial holding companies and banks' financial
subsidiaries, the U.S. Securities and Exchange Commission will regulate their
securities activities and state insurance regulators will regulate their
insurance activities. Gramm-Leach also provides new protections against the
transfer and use by financial institutions of consumers' nonpublic, personal
information.
The major provisions of Gramm-Leach are:
14
Financial Holding Companies and Financial Activities. Title I establishes a
comprehensive framework to permit affiliations among commercial banks, insurance
companies, securities firms, and other financial service providers by revising
and expanding the Bank Holding Company Act framework to permit a holding company
system to engage in a full range of financial activities through qualification
as a new entity known as a financial holding company. A bank holding company
that qualifies as a financial holding company can expand into a wide variety of
services that are financial in nature, provided that its subsidiary depository
institutions are well-managed, well-capitalized and have received at least a
"satisfactory" rating on their last CRA examination. Services that have been
deemed to be financial in nature include securities underwriting, dealing and
market making, sponsoring mutual funds and investment companies, insurance
underwriting and agency activities and merchant banking.
Title I also required the FDIC to adopt regulations implementing Section 121 of
Title I, regarding permissible activities and investments of insured state
banks. Final regulations adopted by the FDIC in January 2001, in the form of
amendments to Part 362 of the FDIC rules and regulations, provide the framework
for subsidiaries of state nonmember banks to engage in financial activities that
Gramm-Leach permits national banks to conduct through a financial subsidiary.
The regulations require that prior to commencing such financial activities, a
state nonmember bank must notify the FDIC of its intent to do so, and must
certify that it is well-managed and that it and all of its subsidiary insured
depository institutions are well-capitalized after deducting its investment in
the new subsidiary. Furthermore, the regulations require that the notifying bank
must, and must continue to, (i) disclose the capital deduction in published
financial statements, and (ii) comply with sections 23A and 23B of the Federal
Reserve Act and (iii) comply with all required financial and operational
safeguards.
Activities permissible for financial subsidiaries of national banks, and,
pursuant to Section 362 of the FDIC rules and regulations, also permissible for
financial subsidiaries of state nonmember banks, include, but are not limited
to, the following: (a) Lending, exchanging, transferring, investing for others,
or safeguarding money or securities; (b) Insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness, disability, or death, or providing and
issuing annuities, and acting as principal, agent, or broker for purposes of the
foregoing, in any State; (c) Providing financial, investment, or economic
advisory services, including advising an investment company; (d) Issuing or
selling instruments representing interests in pools of assets permissible for a
bank to hold directly; and (e) Underwriting, dealing in, or making a market in
securities.
Securities Activities. Title II narrows the exemptions from the securities laws
previously enjoyed by banks, requires the Federal Reserve Board and the SEC to
work together to draft rules governing certain securities activities of banks
and creates a new, voluntary investment bank holding company.
Insurance Activities. Title III restates the proposition that the states are the
functional regulators for all insurance activities, including the insurance
activities of federally-chartered banks, and bars the states from prohibiting
insurance activities by depository institutions. The law encourages the states
to develop uniform or reciprocal rules for the licensing of insurance agents.
Privacy. Under Title V, federal banking regulators were required to adopt rules
that have limited the ability of banks and other financial institutions to
disclose non-public information about consumers to nonaffiliated third parties.
These limitations require disclosure of privacy policies to consumers and, in
some circumstances, allow consumers to prevent disclosure of certain personal
information to a nonaffiliated third party. Federal banking regulators issued
final rules on May 10, 2000 to implement the privacy provisions of Title V.
Under the rules, financial institutions must provide:
- initial notices to customers about their privacy policies, describing
the conditions under which they may disclose nonpublic personal
information to nonaffiliated third parties and affiliates;
- annual notices of their privacy policies to current customers; and
- a reasonable method for customers to "opt out" of disclosures to
nonaffiliated third parties.
15
Compliance with the rules is mandatory after July 1, 2001. The Company and the
banks were in full compliance with the rules as of or prior to their respective
effective dates.
Safeguarding Confidential Customer Information. Under Title V, federal banking
regulators are required to adopt rules requiring financial institutions to
implement a program to protect confidential customer information. In January
2000, the federal banking agencies adopted guidelines requiring financial
institutions to establish an information security program to:
- identify and assess the risks that may threaten customer information;
- develop a written plan containing policies and procedures to manage and
control these risks;
- implement and test the plan; and
- adjust the plan on a continuing basis to account for changes in
technology, the sensitivity of customer information and internal or
external threats to information security.
The Banks approved security programs appropriate to their size and complexity
and the nature and scope of their operations prior to the July 1, 2001 effective
date of the regulatory guidelines, and are implementating the programs on an
ongoing basis.
Community Reinvestment Act Sunshine Requirements. In February 2001, the federal
banking agencies adopted final regulations implementing Section 711 of Title
VII, the CRA Sunshine Requirements. The regulations require nongovernmental
entities or persons and insured depository institutions and affiliates that are
parties to written agreements made in connection with the fulfillment of the
institution's CRA obligations to make available to the public and the federal
banking agencies a copy of each agreement. The regulations impose annual
reporting requirements concerning the disbursement, receipt and use of funds or
other resources under these agreements. The effective date of the regulations
was April 1, 2001. Neither the Company nor the banks is a party to any agreement
that would be the subject of reporting pursuant to the CRA Sunshine
Requirements.
The Company continues to evaluate the strategic opportunities presented by the
broad powers granted to bank holding companies that elect to be treated as
financial holding companies. In the event that the Company determines that
access to the broader powers of a financial holding company is in the best
interests of the Company, its shareholders and the banks, the Company will file
the appropriate election with the Federal Reserve Board.
The Company and the Banks intend to comply with all provisions of Gramm-Leach
and all implementing regulations as they become effective.
USA PATRIOT ACT
As part of the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 ("USA Patriot Act"),
signed into law on October 26, 2001, Congress adopted the International Money
Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLAFATA").
IMLAFATA authorizes the Secretary of the Treasury, in consultation with the
heads of other government agencies, to adopt special measures applicable to
banks, bank holding companies, or other financial institutions. These measures
may include enhanced recordkeeping and reporting requirements for certain
financial transactions that are of primary money laundering concern, due
diligence requirements concerning the beneficial ownership of certain types of
accounts, and restrictions or prohibitions on certain types of accounts with
foreign financial institutions. Covered financial institutions also are barred
from dealing with foreign "shell" banks. In addition, IMLAFATA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours.
16
Treasury regulations implementing the due diligence requirements must be issued
no later than April 24, 2002. Whether or not regulations are adopted, the law
becomes effective July 23, 2002. Additional regulations are to be adopted during
2002 to implement minimum standards to verify customer identity, to encourage
cooperation among financial institutions, federal banking agencies, and law
enforcement authorities regarding possible money laundering or terrorist
activities, to prohibit the anonymous use of "concentration accounts," and to
require all covered financial institutions to have in place a Bank Secrecy Act
compliance program. IMLAFATA also amends the Bank Holding Company Act and the
Bank Merger Act to require the federal banking agencies to consider the
effectiveness of a financial institution's anti-money laundering activities when
reviewing an application under these acts.
The Banks have in place a Bank Secrecy Act compliance program, and it engages in
very few transactions of any kind with foreign financial institutions or foreign
persons.
EXPANDING ENFORCEMENT AUTHORITY
The Federal Reserve Board, the Office of the Comptroller of Currency, the New
York State Superintendent of Banks and the FDIC possess extensive authority to
police unsafe or unsound practices and violations of applicable laws and
regulations by depository institutions and their holding companies. For example,
the FDIC may terminate the deposit insurance of any institution which it
determines has engaged in an unsafe or unsound practice. The agencies can also
assess civil money penalties, issue cease and desist or removal orders, seek
injunctions, and publicly disclose such actions.
EFFECT ON ECONOMIC ENVIRONMENT
The policies of regulatory authorities, including the monetary policy of the
Federal Reserve Board, have a significant effect on the operating results of
bank holding companies and their subsidiaries. Among the means available to the
Federal Reserve Board to affect the money supply are open market operations in
U.S. Government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth and
distribution of bank loans, investments and deposits, and their use may affect
interest rates charged on loans or paid for deposits. Federal Reserve Board
monetary policies have materially affected the operating results of commercial
banks in the past and are expected to continue to do so in the future.
17
ITEM 2. PROPERTIES
The Company conducts business through its corporate office, full service bank
offices and branches. The Company's headquarters and operations center is
located in Warsaw, New York. This facility is leased for a nominal rent from the
Wyoming County Industrial Development Agency for local tax reasons and the
Company has the right to purchase it for nominal consideration beginning in
November, 2006. The following table lists the properties of each of the
subsidiary banks:
TYPE OF LEASED OR EXPIRATION
LOCATION FACILITY OWNED OF LEASE
-------- -------- ----- --------
WYOMING COUNTY BANK
Warsaw............................. Main Office Own --
Mount Morris....................... Branch Own --
Lakeville.......................... Branch Own --
Attica............................. Branch Own --
North Java......................... Branch Own --
Wyoming............................ Branch Own --
North Warsaw....................... Branch Own --
Strykersville...................... Branch Own --
Yorkshire.......................... Branch Lease April 2002
Geneseo............................ Branch Own --
Dansville.......................... Branch Lease December 2006
Honeoye Falls...................... Branch Lease April 2008
Williamsville...................... Branch Lease May 2003
THE NATIONAL BANK OF GENEVA
Geneva............................. Main Office Own --
Geneva............................. Drive-up Branch Own --
Geneva (Plaza)..................... Branch Ground Lease December 2006
Canandaigua........................ Branch Own --
Waterloo........................... Branch Own --
Penn Yan........................... Branch Own --
Ovid............................... Branch Own --
BATH NATIONAL BANK
Bath............................... Main Office Own --
Bath............................... Drive-up Branch Own --
Hammondsport....................... Branch Own --
Wayland............................ Branch Own --
Dundee............................. Branch Own --
Hornell............................ Branch Own --
Watkins Glen....................... Branch Lease October 2002
Naples............................. Branch Own --
Erwin.............................. Branch Lease August 2004
THE PAVILION STATE BANK
Pavilion........................... Main Office Own --
Caledonia.......................... Branch Lease April 2006
LeRoy.............................. Branch Own --
Batavia............................ Branch Lease October 2011
Batavia (In-Store)................. Branch Lease August 2008
North Chili........................ Branch Lease July 2015
FIRST TIER BANK & TRUST
Salamanca.......................... Main Office Own --
Ellicottville...................... Branch Own --
Allegany........................... Branch Own --
Olean.............................. Branch Own --
Olean.............................. Drive-up Branch Own --
Cuba............................... Branch Lease November 2007
18
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company and its subsidiaries are parties to or otherwise
involved in legal proceedings arising in the normal course of business.
Management does not believe that there is any pending or threatened proceeding
against the Company or its subsidiaries which, if determined adversely, would
have a material effect on the Company's business, results of operations or
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended December
31, 2001 to a vote of security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded under the symbol of FISI on the Nasdaq
National Market. At March 1, 2002, the Company had 11,009,761 shares of common
stock outstanding (exclusive of treasury shares) and had approximately 1,900
shareholders of record.
The high and low prices listed below represent actual sales transactions as
reported by Nasdaq.
Sales Price Cash Dividends
High Low Close Declared
-----------------------------------------------------
2001
First Quarter $ 20.000 $ 13.000 $ 19.625 $ 0.11
Second Quarter 24.250 18.000 22.400 0.12
Third Quarter 26.650 21.000 23.440 0.12
Fourth Quarter 24.850 17.100 23.400 0.13
2000
First Quarter 13.250 10.375 11.750 0.10
Second Quarter 15.000 11.938 14.000 0.10
Third Quarter 15.438 12.375 14.875 0.11
Fourth Quarter 15.375 13.375 13.609 0.11
19
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in thousands) December 31
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------
SELECTED FINANCIAL CONDITION DATA
Total assets $1,794,296 $1,289,327 $1,136,460 $976,185 $880,512
Loans, net 1,146,976 873,262 752,324 645,857 594,332
Securities available for sale 428,423 257,823 197,134 154,171 107,492
Securities held to maturity 61,281 76,947 81,356 91,016 99,084
Deposits 1,433,658 1,078,111 949,531 850,455 767,726
Borrowed funds 190,389 62,384 56,336 13,862 12,066
Shareholders' equity 149,187 131,618 117,539 96,578 86,843
(Dollars in thousands) For the years ended December 31
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-------------------------------------------------------------------------------
SELECTED OPERATIONS DATA
Interest income $114,468 $96,467 $78,692 $72,660 $66,972
Interest expense 49,694 43,605 31,883 30,958 27,851
--------------- ---------------- --------------- -------------- ---------------
Net interest income 64,774 52,862 46,809 41,702 39,121
Provision for loan losses 4,958 4,211 3,062 2,732 2,829
--------------- ---------------- --------------- -------------- ---------------
Net interest income after
provision for loan loss 59,816 48,651 43,747 38,970 36,292
Noninterest income 15,782 9,409 8,055 6,591 5,929
Noninterest expense 43,352 30,156 27,032 24,602 22,084
--------------- ---------------- --------------- -------------- ---------------
Income before income taxes 32,246 27,904 24,770 20,959 20,137
Income taxes 11,033 9,804 8,813 7,354 7,295
--------------- ---------------- --------------- -------------- ---------------
Net income $21,213 $18,100 $15,957 $13,605 $12,842
=============== ================ =============== ============== ===============
At or for the years ended December 31
-----------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------
PER COMMON SHARE DATA
Net income - diluted $1.77 $1.51 $1.38 $1.22 $1.14
Cash dividends declared 0.48 0.42 0.31 0.26 0.22
Book value 11.93 10.36 9.05 7.94 6.94
Market value 23.40 13.61 12.12 - -
At or for the years ended December 31
-----------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------
SELECTED FINANCIAL RATIOS AND OTHER DATA
Performance Ratios:
Return on common equity 15.84% 15.78% 16.16% 16.28% 17.62%
Return on assets 1.34 1.51 1.54 1.48 1.54
Common dividend payout 26.77 27.81 22.54 21.43 19.28
Net interest rate spread 3.96 3.98 4.19 4.24 4.43
Net interest margin (2) 4.62 4.87 5.00 5.06 5.21
Efficiency ratio 48.49 45.19 45.55 46.64 45.22
Noninterest income to average total assets (3) 0.96 0.76 0.75 0.69 0.69
Noninterest expenses to average total assets 2.73 2.52 2.61 2.68 2.65
Average interest-earning assets to average interest
bearing liabilities 119.67 123.25 124.86 123.05 121.91
Asset Quality Ratios:
Non-performing loans to total loans 0.86% 0.80% 0.75% 0.93% 1.24%
Non-performing assets to total loans and other real 0.94 0.91 0.88 1.24 1.62
estate
Allowance for loan losses to non-performing loans 190.32 195.06 198.83 156.86 108.95
Allowance for loan losses to total loans 1.64 1.56 1.50 1.46 1.35
Net charge-offs during the period to average loans
outstanding during the year 0.23 0.21 0.17 0.21 0.32
Capital ratios:
Equity to total assets 8.31% 10.21% 10.34% 9.89% 9.86%
Average common equity to average assets 7.84 8.78 8.63 8.09 7.70
Other Data:
Number of full-service offices 41 32 29 28 27
Loans serviced for others (in millions) $302.3 $205.2 $200.2 $177.8 $153.2
Full time equivalent employees 608 441 411 384 383
(1) Averages presented are daily averages.
(2) Net interest income divided by average interest earning assets. A tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal tax rate of 35%.
(3) Noninterest income excludes net gain (loss) on sale of securities available for sale.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Net income in 2001 was $21.2 million, or 17% more than the $18.1 million earned
in 2000. In 1999, net income was $16.0 million. Diluted earnings per share for
the year ended December 31, 2001 was $1.77, compared to $1.51 in 2000 and $1.38
in 1999. The return on average common equity in 2001 was 15.84%, compared to
15.78% in 2000 and 16.16% in 1999. The return on average assets in 2001 was
1.34%, compared to 1.51% in 2000 and 1.54% in 1999.
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting. The
results of operations for BNB are included in the income statement from the date
of acquisition (May 1, 2001) to the end of the period.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. Under the terms of the agreement, BGI shareholders received
primarily common stock as consideration for their ownership in BGI. The
acquisition was accounted for under the purchase method of accounting. The
results of operations for BGI are included in the income statement from the date
of acquisition (October 22, 2001) to the end of the period.
The strong performance in 2001 can be attributed to a combination of continued
focus on basic banking principles, expansion of product lines and geographic
presence and the realization of immediate benefits from recent acquisitions.
Each of the subsidiary banks performed very well during the year, including BNB.
Acquired in the second quarter of 2001, BNB was efficiently integrated and
immediately contributed to consolidated results. The Company continued to
penetrate its existing market areas in addition to expanding further in the
suburban Buffalo and Rochester markets. Effective interest margin management,
despite a declining rate environment and a lagging economy, and solid balance
sheet growth were the primary drivers of our results. FII also experienced
continued growth of fee-based services. The Company anticipates further
expansion of the financial services businesses in the coming years as a result
of the fourth quarter acquisition of BGI, the largest independent retirement
plan consulting company in Western and Central New York. The BGI acquisition
enables FII to further diversify its revenue stream and better leverage the
trust and brokerage businesses for future growth.
21
LENDING ACTIVITIES
Set forth below is selected information concerning the composition of the
Company's loan portfolio.
At December 31
-------------------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------------------
Commercial $ 232,379 $ 169,832 $ 140,376 $ 117,750 $ 105,811
Commercial real estate 274,702 166,041 137,648 106,897 99,218
Agricultural 186,623 165,367 151,534 123,754 107,546
Residential real estate 240,141 201,160 189,149 181,828 170,396
Consumer and home equity 232,205 184,745 145,038 125,198 119,506
-------- -------- -------- -------- -------
Total loans, gross 1,166,050 887,145 763,745 655,427 602,477
Allowance for loan losses (19,074) (13,883) (11,421) (9,570) (8,145)
------------ ---------- ---------- ---------- --------
Total loans, net $ 1,146,976 $ 873,262 $ 752,324 $ 645,857 $ 594,332
============ ========== ========== ========== ==========
Total loans increased to $1.2 billion at December 31, 2001 from $887.1 million
at December 31, 2000, an increase of $279.0 million or 31.4%. The acquisition of
BNB accounted for $189.5 million of the loan growth with the balance of $89.5
million generated principally from continued expansion of the commercial loan
portfolio. Commercial loans increased $62.6 million ($40.5 million from the BNB
acquisition) or 36.8%, while commercial real estate loans increased by $108.7
million ($56.9 million from the BNB acquisition) or 65.4%. At December 31, 2001,
commercial loans totaled $232.4 million, representing 19.9% of total loans, and
commercial real estate loans totaled $274.7 million, representing 23.60% of
total loans. The significant increase in commercial loans and commercial real
estate loans reflect the Banks' business development efforts.
At December 31, 2001, agricultural loans, which include agricultural real estate
loans, represented 16.0% of the total loan portfolio. During 2001, agricultural
loans increased by $21.2 million ($7.2 million from the BNB acquisition), or
12.9%, to $186.6 million.
As of December 31, 2001, residential real estate loans grew by $39.0 million
($50.5 million from the BNB acquisition) or 19.4% from December 31, 2000, and
totaled $240.1 million or 20.6% of total loans. Considering BNB residential real
estate loans acquired amounted to $50.5 million, the residential real estate
portfolio decreased $11.5 million in 2001. This decrease is a reflection of the
Company's trend towards selling residential real estate mortgages, which is
evidenced by the increase in the sold and serviced residential real estate loan
portfolio during 2001. During 2001 and 2000, the Company sold loans totaling
$117,446,000 and $25,880,000, respectively.
The Company also offers a broad range of consumer loan products. Consumer and
home equity loans grew by $47.5 million ($34.4 million from the BNB acquisition)
or 25.7%, in 2001 and ended the year at $232.2 million, representing 19.9% of
the total loan portfolio.
Total loans increased to $887.1 million at December 31, 2000 from $763.7 million
at December 31, 1999, an increase of $123.4 million or 16.2%. Commercial loans
increased $29.4 million or 20.9%, while commercial real estate loans increased
by $28.4 million or 20.6%. At December 31, 2000, commercial loans totaled $169.8
million, representing 19.1% of total loans, and commercial real estate loans
totaled $166.0 million, representing 18.7% of total loans.
At December 31, 2000, agricultural loans, which include agricultural real estate
loans, represented 18.7% of the total loan portfolio. During 2000, agricultural
loans increased by $13.9 million, or 9.2%, to $165.4 million. As of December 31,
2000, residential real estate loans had grown by $12.1 million or 6.4% from
December 31, 1999, and totaled $201.2 million or 22.7% of the total loan
portfolio. The growth in the portfolio resulted from the Banks' business
development efforts and broad line of variable and fixed-rate mortgage products.
Consumer and home equity loans grew by $39.7 million, or 27.4%, in 2000 and
ended the year at $184.7 million, representing 20.8% of the total loan
portfolio. The majority of the increase in consumer loans was from an expanded
indirect lending program.
22
NONACCRUING LOANS AND NONPERFORMING ASSETS
Nonperforming assets increased $3.0 million to $11.0 million at December 31,
2001 compared to the prior year. The increase in nonperforming assets relates
directly to nonperforming assets acquired with BNB. However, given the
continuing growth of the loan portfolio, the Company's ratio of nonperforming
loans to total loans of 0.86% at December 31, 2001, increased slightly from the
ratio of 0.80% at December 31, 2000. The overall level of nonperforming assets
as a percentage of total loans and other real estate was 0.94% at December 31,
2001, comparable to 0.91% at December 31, 2000.
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets.
At December 31
-------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------
Nonaccruing loans (1)
Commercial $ 2,623 $ 1,044 $ 1,159 $ 1,250 $ 970
Commercial real estate 3,344 1,619 1,373 995 1,648
Agricultural 1,529 2,881 1,455 2,340 2,669
Residential real estate 921 835 413 733 1,325
Consumer and home equity 541 217 375 423 431
-------- --------- --------- --------- ---------
Total nonaccruing loans 8,958 6,596 4,775 5,741 7,043
Accruing loans 90 days or more delinquent 1,064 521 969 360 433
-------- --------- --------- --------- ---------
Total nonperforming loans 10,022 7,117 5,744 6,101 7,476
Other real estate owned 947 932 969 2,084 2,309
-------- --------- --------- --------- ---------
Total nonperforming assets $ 10,969 $ 8,049 $ 6,713 $ 8,185 $ 9,785
======= ======== ======== ======== ========
Total nonperforming loans to total loans 0.86% 0.80% 0.75% 0.93% 1.24%
Total nonperforming assets to total loans
and other real estate 0.94% 0.91% 0.88% 1.24% 1.62%
(1) Loans are placed on nonaccrual status when they become 90 days or more past due or if they have been
identified by the Company as presenting uncertainty with respect to the collectibility of interest or
principal.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents the estimated amount of credit losses
inherent in the Banks' loan portfolios. The Company performs periodic,
systematic reviews of its Banks' portfolios to identify these inherent losses,
and to assess the overall probability of collection of these portfolios. These
reviews result in the identification and quantification of loss factors, which
are used in determining the amount of the allowance for loan losses. In
addition, the Company periodically evaluates prevailing economic and business
conditions, industry concentrations, changes in the size and characteristics of
the portfolio and other pertinent factors. The allowance for loan losses is
allocated to cover the estimated losses inherent in each loan category based on
the results of this detailed review. The process used by the Company to
determine the appropriate overall allowance for loan losses is based on this
analysis, taking into consideration management's judgment. Allowance methodology
is reviewed on a periodic basis and modified as appropriate. Based on this
analysis, the Company believes that the allowance for loan losses is fairly
stated at December 31, 2001.
At December 31, 2001, the Company's allowance for loan losses totaled $19.1
million, an increase of $5.2 million over the previous year end. The allowance
as a percentage of total loans was 1.64% at December 31, 2001, compared to 1.56%
in 2000. The allowance as a percentage of total nonperforming loans was 190.32%
at December 31, 2001, compared to 195.06% at December 31, 2000.
23
The following table sets forth an analysis of the activity in the allowance for
loan losses for the periods indicated.
Years Ended December 31
-------------------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
-------------------------------------------------------------
Balance at beginning of year $ 13,883 $ 11,421 $ 9,570 $ 8,145 $ 7,129
Addition as a result of BNB acquisition 2,686 - - - -
Charge-offs:
Commercial 1,003 466 312 263 500
Commercial real estate 394 629 139 687 746
Agricultural 58 85 12 19 -
Residential real estate 178 113 461 215 131
Consumer and home equity 1,319 905 663 488 620
------- -------- -------- -------- --------
Total charge-offs 2,952 2,198 1,587 1,672 1,997
Recoveries:
Commercial 58 206 88 106 12
Commercial real estate 23 22 23 84 18
Agricultural - 1 - - 1
Residential real estate 19 5 163 42 26
Consumer and home equity 399 215 102 133 127
------- -------- -------- ---------- --------
Total recoveries 499 449 376 365 184
Net charge-offs 2,453 1,749 1,211 1,307 1,813
Provision for loan losses 4,958 4,211 3,062 2,732 2,829
------- -------- -------- ---------- --------
Balance at end of year $ 19,074 $ 13,883 $ 11,421 $ 9,570 $ 8,145
========= ========== ========== ========= =========
Ratio of net charge-offs during the year to
average loans outstanding during the year 0.23% 0.21% 0.17% 0.21% 0.32%
Ratio of allowance for loan losses to total loans 1.64% 1.56% 1.50% 1.46% 1.35%
Ratio of allowance for loan losses to
nonperforming loans 190.32% 195.06% 198.83% 156.86% 108.95%
The following table summarizes the loan delinquencies (excluding nonaccrual) in
the loan portfolio as of December 31, 2001:
60-89 90 Days
(Dollars in thousands) Days or More
---- -------
Commercial $ 446 $ 275
Commercial real estate 674 160
Agricultural - -
Residential real estate 677 357
Consumer and home equity 891 272
-------- -------
Total $ 2,688 $ 1,064
======== =======
24
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
The following table sets forth the allocation of the allowance for loan losses
by loan category at the dates indicated. The allocation is made for analytical
purposes and is not necessarily indicative of the categories in which actual
losses may occur. The total allowance is available to absorb losses from any
segment of the loan portfolio.
At December 31
-----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
of of Loans of of Loans of of Loans of of Loans of of Loans
Allowance in Each Allowance in Each Allowance in Each Allowance in Each Allowance in Each
for Category for Category for Category for Category for Category
Loan to Total Loan to Total Loan to Total Loan to Total Loan to Total
(Dollars in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
---------------------------------------------------------------------------------------------------------
Commercial $ 5,358 19.9% $ 3,402 19.1% $ 2,314 18.4% $ 3,227 17.9% $ 2,406 17.6%
Commercial real estate 3,877 23.6 2,094 18.7 2,181 18.0 1,734 16.3 1,237 16.5
Agricultural 2,586 16.0 2,464 18.7 1,591 19.8 1,288 18.9 1,377 17.8
Residential real estate 1,957 20.6 1,259 22.7 952 24.8 1,489 27.8 1,328 28.3
Consumer and home equity 3,413 19.9 2,449 20.8 1,792 19.0 1,643 19.1 1,490 19.8
Unallocated 1,883 - 2,215 - 2,591 - 189 - 307 -
-------- --- ------- --- ------ --- -------- ---- -------- ---
Total $ 19,074 100% $ 13,883 100% $ 11,421 100% $ 9,570 100% $ 8,145 100%
======== === ======= === ======= === ======== === ======== ===
LOAN MATURITY AND REPRICING SCHEDULE
The following table sets forth certain information as of December 31, 2001,
regarding the amount of loans maturing or repricing in the portfolio. Demand
loans having no stated schedule of repayment and no stated maturity and
overdrafts are reported as due in one year or less. Adjustable and floating-rate
loans are included in the period in which interest rates are next scheduled to
adjust rather than the period in which they contractually mature, and fixed-rate
loans are included in the period in which the final contractual repayment is
due.
At December 31, 2001
---------------------------------------------------------------
One
Within Through After
One Five Five
(Dollars in thousands) Year Years Years Total
------------- ----------- ----------- ------------
Commercial $ 98,986 $ 89,678 $ 43,715 $ 232,379
Commercial real estate 9,134 36,115 229,453 274,702
Agricultural 42,296 50,964 93,363 186,623
Residential real estate 10,168 22,024 207,949 240,141
Consumer and home equity 14,241 138,407 79,557 232,205
------------- ----------- ----------- ------------
Total loans $ 174,825 $ 337,188 $ 654,037 $ 1,166,050
============= =========== =========== ============
Loans maturing after one year:
With a predetermined interest rate $ 216,874 $ 200,068
With a floating or adjustable rate 120,314 453,969
INVESTING ACTIVITIES
U.S. Treasury and Agency Securities. At December 31, 2001, the U.S. Treasury and
Agency securities portfolio totaled $185.4 million ($15.5 million acquired from
BNB at acquisition), of which $183.5 million was classified as available for
sale. The portfolio consisted of $10.8 million in U. S. Treasury securities and
$174.6 million in U. S. federal agency securities. The U. S. federal agency
security portfolio consists almost exclusively of callable securities. These
callable securities provide higher yields than similar securities without call
features. At December 31, 2000, the U. S. Treasury and Agency securities
portfolio totaled $171.2 million of which $169.2 million was classified as
available for sale.
25
State and Municipal Obligations. At December 31, 2001, the portfolio of state
and municipal obligations totaled $202.6 million ($40.2 million acquired in the
BNB acquisition), of which $143.2 million was classified as available for sale.
At that date $59.4 million was classified as held to maturity, with a fair value
of $60.3 million. At December 31, 2000, the portfolio of state and municipal
obligations totaled $123.9 million, of which $48.9 million was classified as
available for sale. At that date, $75.0 million was classified as held to
maturity, with a fair value of $74.9 million. Over the past two years, more
favorable yields on new purchases of these securities, when compared to other
taxable investment alternatives, has led to significant growth in this
portfolio. The increase is also reflective of the growth in public deposits and
the use of these securities to collateralize those deposits.
Mortgage-Backed Securities. At December 31, 2001, the Company had $90.0 million
($23.0 million acquired from BNB at acquisition) in mortgage-backed securities,
all classified as available for sale. At December 31, 2000, the Company had
$29.1 million in mortgage-backed securities, all classified as available for
sale. The significant increase in mortgage-backed securities in 2001 relates to
more favorable yields on new purchases of this class of securities.
Corporate Bonds. The corporate bond portfolio at December 31, 2001 totaled $7.9
million ($3.1 million acquired in the BNB acquisition), all of which was
classified as available for sale. The portfolio was purchased to further
diversify the investment portfolio and increase investment yield. The Company's
investment policy limits investments in corporate bonds to no more than 10% of
total investments and to bonds rated at inception as Baa or better by Moody's
Investors Service, Inc. or BBB or better by Standard & Poor's Ratings Services.
The corporate bond portfolio at December 31, 2000 totaled $9.3 million, all of
which was classified as available for sale.
Equity Securities. At December 31, 2001, equity securities totaled $3.8 million,
all of which was classified as available for sale. Included in the portfolio is
$3.0 million of FHLMC preferred stock. At December 31, 2000, equity securities
totaled $1.2 million, all of which was classified as available for sale.
SECURITY YIELDS AND MATURITIES SCHEDULE
The following table sets forth certain information regarding the carrying value,
weighted average yields and contractual maturities of the Company's debt
securities portfolio as of December 31, 2001. No tax equivalent adjustments were
made to the weighted average yields.
December 31, 2001
---------------------------------------------------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years After Ten Years Total
---------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
---------------------------------------------------------------------------------------------------------
Available for Sale:
US Treasury and Agency $18,361 4.45% $ 49,274 5.91% $ 100,961 5.80% $ 14,216 6.24% $ 182,812 5.73%
Mortgage-backed securities 686 5.89 19,948 6.07 34,944 5.51 33,818 5.59 89,396 5.66
State and municipal
obligations 8,339 4.50 78,753 4.39 48,822 4.40 5,723 4.95 141,637 4.42
Corporate bonds -- -- 3,509 6.61 749 6.22 3,566 8.18 7,824 7.27
-------------------------------------------------------------------------------------------------
Total debt securities
available for sale $27,386 4.50% $ 151,484 5.16% $ 185,476 5.38% $ 57,323 5.85% $ 421,669 5.31%
=================================================================================================
Held to Maturity:
US Treasury and Agency $ 1,950 6.23% $ -- -% $ -- -% $ -- -% $1,950 6.23%
State and municipal
obligations 29,086 3.87 27,438 4.46 2,162 5.33 645 5.94 59,331 4.22
-------------------------------------------------------------------------------------------------
Total debt securities
held to maturity $31,036 4.02% $ 27,438 4.46% $ 2,162 5.33% $ 645 5.94% $ 61,281 4.28%
=================================================================================================
26
FUNDING ACTIVITIES
BORROWINGS
The following table sets forth certain information as to the Company's
short-term borrowings for the periods indicated. Short-term borrowings mature in
less than one year.
As of and for the year ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
--------- --------- ---------
Federal funds purchased and securities
sold under repurchase agreements $ 60,957 $ 15,950 $ 4,596
FHLB advances 42,135 30,953 41,500
Other short-term borrowings 678 - -
-------- ------- --------
Total short-term borrowings $ 103,770 $ 46,903 $ 46,096
========= ========= ========
Average rate at year-end 2.12% 5.75% 5.77%
Average rate during period 3.95% 5.96% 5.02%
The Company had $40.5 million of remaining credit available under lines of
credit with the FHLB at December 31, 2001, which are collateralized by FHLB
stock and real estate mortgage loans. The Company also had $41.0 million of
remaining credit available under unsecured lines of credit with various banks at
December 31, 2001. During 2001, the Company also obtained lines of credit with
Farmer Mac permitting borrowings to a maximum of $50.0 million. However, no
advances were outstanding against those lines at December 31, 2001.
Long-term borrowings are summarized as follows:
As of and for the year ended December 31
--------------------------------------------
(Dollars in thousands) 2001 2000 1999
--------- --------- ---------
FHLB advances $ 65,154 $ 15,382 $ 8,421
10% Notes - - 1,698
Other 5,265 99 121
-------- ------- --------
Total long-term borrowings $ 70,419 $ 15,481 $ 10,240
========= ========= =========
At December 31, 2001 and 2000, long-term borrowings primarily include FHLB
advances with maturities of more than 1 year. The advances mature on various
dates ranging from 2003 through 2011 and bear interest at a fixed weighted
average rate of 5.05% as of December 31, 2001. The Company's FHLB advances
include $20.0 million in fixed-rate callable borrowings, which can be called by
the FHLB on the first anniversary of the borrowing, and quarterly thereafter.
Other long-term borrowings consist primarily of a $5.0 million advance on a
credit agreement with a bank, which was executed to aid in funding the
acquisition of BNB. The credit agreement requires monthly payments of interest
only, at a variable interest rate of 1.50% plus LIBOR, with 5.02% being the rate
in effect at December 31, 2001. The credit agreement expires April 2003.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN CORPORATIONS JUNIOR SUBORDINATED
DEBENTURES On February 22, 2001, the Company established FISI Statutory Trust I
(the "Trust"), which is a statutory business trust formed under Connecticut law,
upon filing a certificate of trust with the Connecticut Secretary of State. The
Trust exists for the exclusive purposes of (i) issuing and selling 30 year
guaranteed preferred beneficial interests in the Corporation's junior
subordinated debentures ("capital securities") in the aggregate amount of $16.2
million at a fixed rate of 10.20%, (ii) using the proceeds from the sale of the
capital securities to acquire the junior subordinated debentures issued by the
Company and (iii) engaging in only those other activities necessary, advisable
or incidental thereto. The junior subordinated debentures are the sole assets of
the Trust and, accordingly, payments under the corporation obligated junior
debentures are the sole revenue of the Trust. All of the common securities of
27
the Trust are owned by the Company. The Company used the net proceeds from the
sale of the capital securities to partially fund the BNB acquisition. As of
December 31,