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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER: 00-25439
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TROY FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 16-1559508
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(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
32 SECOND STREET 12180
TROY, NEW YORK ----------
--------------------------------------- (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
(518) 270-3313
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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(NOT APPLICABLE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
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COMMON STOCK ($0.0001 PAR VALUE 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 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Based upon the closing price of the registrant's common stock as of December 18,
2003, the aggregate market value of the voting stock held by non-affiliates of
the registrant is $249.8 million
The number of shares outstanding of each of the registrant's classes of
common stock as of the latest practicable date is:
CLASS: COMMON STOCK, PAR VALUE $0.0001 PER SHARE
OUTSTANDING AT DECEMBER 18, 2003: 9,351,539 SHARES
DOCUMENTS INCORPORATED BY REFERENCE
(NOT APPLICABLE)
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PART I
ITEM 1. BUSINESS
BUSINESS OF TROY FINANCIAL CORPORATION
Troy Financial Corporation ("Troy Financial" or the "Company") is a Delaware
corporation and the bank holding company for The Troy Savings Bank (the "Savings
Bank") and The Troy Commercial Bank (the "Commercial Bank") (collectively, the
"Banks"). Troy Financial's primary business is the business of the Banks.
Presently, Troy Financial and the Commercial Bank have no plans to own or lease
any property, but instead use the premises and equipment of the Savings Bank.
Troy Financial and the Commercial Bank do not employ any persons other than
certain officers of the Savings Bank who are not separately compensated by Troy
Financial or the Commercial Bank. Troy Financial and the Commercial Bank may
utilize the support staff of the Savings Bank from time to time, if needed, and
additional employees will be hired as appropriate to the extent Troy Financial
or the Commercial Bank expand their business in the future. Troy Financial was
incorporated in 1998.
Troy Financial is subject to regulation and supervision by the Board of
Governors of the Federal Reserve System (the "Federal Reserve"). See
"Regulation."
The Savings Bank is a community-based savings bank headquartered in Troy, New
York. The Savings Bank operates through 21 full service branch offices in an
eight-county market area. As a full service financial institution, the Savings
Bank places a particular emphasis on residential and commercial real estate loan
products, as well as retail and business banking products and services. The
Savings Bank and its subsidiaries also offer a complete range of trust,
insurance and investments services, including securities brokerage, annuity and
mutual funds sales, money management and retirement plan services, and other
traditional investment/brokerage activities to individuals, families and
businesses throughout the eight New York State counties of Albany, Greene,
Rensselaer, Saratoga, Schenectady, Schoharie, Warren and Washington.
In August 2000, the Company established the Commercial Bank, which is a special
purpose commercial bank headquartered in Troy, New York. The Commercial Bank's
primary purpose is to generate municipal deposits, which under New York State
law cannot be collected by the Savings Bank.
On November 10, 2000, the Company acquired Catskill Financial Corporation
("Catskill") in a cash transaction for $23.00 per share, for a total transaction
value of approximately $89.8 million. The seven former offices of Catskill
Savings Bank are now full-service offices of the Savings Bank. In accordance
with the purchase method of accounting for business combinations, the assets
acquired and liabilities assumed were recorded by the Company at their estimated
fair value. Related operating results have been included in the Company's
consolidated financial statements from the date of acquisition.
On August 10, 2003, the Company and First Niagara Financial Group, Inc. ("First
Niagara") entered into an Agreement and Plan of Merger (the "Agreement") which
provides for, among other things, the acquisition of the Company by First
Niagara. Contemporaneous with the completion of the acquisition, The Troy
Savings Bank, a wholly-owned subsidiary of the Company, will merge with and into
First Niagara Bank, a wholly-owned subsidiary of First Niagara. The Agreement
provides that shareholders of the Company will receive either First Niagara
stock, cash or a combination of First Niagara stock and cash for each share of
Company common stock. The Boards of Directors of the Company and First Niagara
expect the transaction to close in January 2004.
Prior to the merger, the Company's goal has been to be the primary source of
financial products and services for its business, retail, and municipal
customers. The Company's business strategy is to serve as a community-based,
full-service financial services firm offering a wide variety of business,
retail, municipal banking, trust, insurance, investment management and brokerage
services throughout its market area.
The Company delivers its products and services and interacts with its customers
primarily through its 21 branches and 23 proprietary automated teller machines
("ATMs") and its 24-hour telephone banking service ("Time$aver"). The Company's
branches are staffed by managers, branch operations supervisors and customer
sales and service representatives ("CSSRs") who are trained and compensated to
market and service the Company's products, including those of the Company's
nonbanking subsidiaries.
3
The Company makes its periodic and current reports available, free of charge, on
its website, www.troysavingsbank.com, as soon as reasonably practicable after
such material is electronically filed with the Securities and Exchange
Commission ("SEC").
The Savings Bank and the Commercial Bank are subject to regulation, examination
and supervision by Federal Deposit Insurance Corporation (the "FDIC") and the
New York State Banking Department ("NYSBD"). Deposits in the Banks are insured
by the FDIC to the maximum extent provided by law. See "Regulation." The Savings
Bank is a member of the Federal Home Loan Bank System ("FHLB System").
LENDING ACTIVITY
The Company focuses its lending activity primarily on the origination of
commercial real estate, commercial business, residential mortgage and consumer
loans. The types of loans that the Company may originate are subject to federal
and state law and regulations. Interest rates charged by the Company on loans
are affected principally by the demand for such loans, the supply of funds
available for lending purposes and the rates offered by its competitors. These
factors are, in turn, affected by general and economic conditions, monetary
policies of the Federal government, including the Federal Reserve, legislative
tax policies and governmental budget matters. All loan approvals are made
locally, by individual loan officers, or loan committees, depending upon the
size of the loan. The Company makes every effort to respond to all loan requests
in a prompt and timely manner.
LOAN PORTFOLIO COMPOSITION. At September 30, 2003 the Company's loan portfolio
totaled $759.5 million, or 55.6% of total assets, and consisted primarily of
commercial real estate, construction, commercial business, single-family
residential mortgages and consumer loans.
The commercial real estate loan portfolio totaled $356.7 million, or 46.9% of
the Company's total loans and 26.1% of total assets, at September 30, 2003. Of
the loans managed by the Company's commercial real estate department,
approximately 71.5% of the loans are secured by properties located in the
Company's eight county market area, and an additional 9.0% and 8.5% are secured
by properties located elsewhere in Upstate New York and in the New York City
area, respectively. Approximately 29.4% of the properties securing the loans are
office buildings and warehouses, 26.7% are apartment buildings and cooperatives,
and 26.4% are retail buildings. The Company's commercial real estate loans range
in size up to $13.2 million, and the average principal balance outstanding at
September 30, 2003 was approximately $1.0 million. The 20 largest commercial
real estate loans range in size from $3.5 million to $13.2 million, and the
Company had 88 loans with outstanding balances of more than $1.0 million at
September 30, 2003. The Company's largest commercial real estate exposure
involving a single relationship was $35.4 million, all of which was outstanding
at September 30, 2003, to Morris Massry and his related real estate interests
with whom the Company has had a sixteen-year lending relationship. Mr. Massry is
a director of the Company and is a local real estate developer. All of the real
estate loans are secured by garden style apartment buildings.
The commercial business loan portfolio totaled $111.5 million, or 14.6% of the
Company's loans and 8.2% of total assets, at September 30, 2003. The loans
managed by the Company's commercial business department include fixed and
adjustable rate loans, as well as adjustable rate lines of credit to a diverse
customer base, including educational institutions, manufacturers, retailers,
wholesalers, service providers, and government-funded entities. The Company's
commercial business loans range in size up to $5.5 million, with an average
principal balance outstanding of approximately $155 thousand at September 30,
2003. The Company's 20 largest commercial business loans at that date ranged in
terms of total exposure, including balances outstanding and unfunded
commitments, from $868 thousand to $10.0 million.
The Company's portfolio of single family residential mortgage loans totaled
$239.7 million, or 31.5% of total loans and 17.6% of total assets, at September
30, 2003. The portfolio consisted primarily of fixed rate and adjustable rate
loans secured by detached, single family homes located in the Company's market
area, as well as home improvement loans. As of September 30, 2003, the Company's
largest single-family residential mortgage loan had an outstanding balance of
$820 thousand. As of that date, the typical residential mortgage loan held by
the Company in its portfolio had an average principal balance of approximately
$62.6 thousand, with an initial loan-to-value ("LTV") ratio of 80%, secured by
detached single family homes.
The consumer loan portfolio totaled $37.9 million, or 5.0% of total loans and
2.8% of total assets, at September 30, 2003. The Company's consumer loan
portfolio includes home equity lines of credit, auto loans, fixed rate consumer
loans, overdraft protection and "Creative Loans", which start with a modest,
below market interest rate that increases each year. The Company's home equity
lines of credit represented 74.1% of the Company's consumer loan portfolio and
its auto loans represented 10.5% of the portfolio, at September 30, 2003.
4
The following table presents the composition of the Company's loan portfolio,
excluding loans held for sale, in dollar amounts and percentages at the dates
indicated:
AT SEPTEMBER 30,
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2003 2002 2001 2000 1999
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PERCENT PERCENT PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
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(Dollars in thousands)
Real estate loans:
Residential $ 239,704 31.5% $ 300,776 39.2% $ 326,074 42.8% $ 226,961 37.9% $ 221,721 39.1%
Commercial 356,688 46.9% 298,995 39.0% 269,520 35.3% 233,334 38.9% 216,700 38.2%
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Construction 15,427 2.0% 17,075 2.3% 16,379 2.2% 7,300 1.2% 13,761 2.4%
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Total real estate loans 611,819 80.4% 616,846 80.5% 611,973 80.3% 467,595 78.0% 452,182 79.7%
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Commerical business loans 111,454 14.6% 118,349 15.4% 109,284 14.3% 95,586 16.0% 72,268 12.7%
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Consumer loans:
Home equity lines 28,045 3.7% 14,796 1.9% 7,108 0.9% 5,019 0.8% 6,776 1.2%
Other consumer 9,816 1.3% 16,678 2.2% 34,192 4.5% 30,901 5.2% 36,087 6.4%
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Total consumer loans 37,861 5.0% 31,474 4.1% 41,300 5.4% 35,920 6.0% 42,863 7.6%
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Gross loans $ 761,134 100.0% $ 766,669 100.0% $ 762,557 100.0% $ 599,101 100.0% $ 567,313 100.0%
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Net deferred loan
fees/costs and
unearned discounts (1,657) (1,602) (1,774) (364) (407)
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Total loans $ 759,477 $ 765,067 $ 760,783 $ 598,737 $ 566,906
Allowance for loan losses (14,646) (14,538) (14,333) (11,891) (10,764)
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Total loans receivable,
net $ 744,831 $ 750,529 $ 746,450 $ 586,846 $ 556,142
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The following table presents as of September 30, 2003, the dollar amount of all
loans in the Company's portfolio, excluding loans held for sale, that are
contractually due after September 30, 2004, and indicates whether such loans
have fixed or adjustable interest rates:
DUE AFTER SEPTEMBER 30, 2004
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FIXED ADJUSTABLE
AMOUNT PERCENT AMOUNT PERCENT TOTAL
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(Dollars in thousands)
Real estate loans:
Residential $ 187,040 26.2% $ 49,599 6.9% $ 236,639
Commercial 301,420 42.2% 42,325 5.9% 343,745
Construction 500 0.1% 1,713 0.2% 2,213
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Total real estate loans 488,960 68.5% 93,637 13.0% 582,597
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Commerical business loans 32,479 4.5% 66,189 9.3% 98,668
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Consumer loans:
Home equity lines -- -- 28,045 3.9% 28,045
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Other consumer 5,578 0.8% 350 0.0% 5,928
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Total consumer loans 5,578 0.8% 28,395 3.9% 33,973
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Total gross loans $ 527,017 73.8% $ 188,221 26.2% $ 715,238
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5
LOAN MATURITY. The following table shows the contractual maturity of the
Company's loan portfolio at September 30, 2003. The table does not include loans
held for sale, possible prepayments or scheduled principal amortization.
AT SEPTEMBER 30, 2003
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HOME
EQUITY
RESIDENTIAL COMMERCIAL COMMERCIAL LINES OF OTHER
MORTGAGE MORTGAGE CONSTRUCTION BUSINESS CREDIT CONSUMER TOTAL
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(Dollars in thousands)
Amounts due:
Within one year $ 3,065 $ 12,943 $ 13,214 $ 12,786 $ -- $ 3,888 $ 45,896
After one year:
one to five years 10,702 112,901 1,713 46,292 -- 5,507 177,115
five to ten years 37,608 182,035 500 18,087 28,045 421 266,696
ten to twenty years 135,488 35,437 -- 2,645 -- -- 173,570
more than twenty years 52,841 13,372 -- 31,644 -- -- 97,857
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Total due after one
year 236,639 343,745 2,213 98,668 28,045 5,928 715,238
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Total amount due $ 239,704 $ 356,688 $ 15,427 $ 111,454 $ 28,045 $ 9,816 $ 761,134
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Less:
Net deferred loan fees/costs
and unearned discounts (1,657)
Allowance for loan losses (14,646)
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Loans receivable, net $ 744,831
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The Company participates with other financial institutions in certain larger
credits (both selling and purchasing interests) and also purchases loans from
other financial institutions and brokers. The Company also sells or enters into
commitments to sell certain fixed rate mortgage loans to Freddie Mac, as well as
to other third parties. Historically, the Company has sold substantially all of
its 30-year conforming fixed rate mortgage loans and, from time to time as
conditions warrant, its 15-year conforming fixed rate mortgage loans into the
secondary mortgage market. During fiscal 2003 and 2002, the Company sold $17.1
million and $10.7 million, respectively, of 30-year fixed-rate mortgage loans in
the secondary mortgage market. The Company enters into mandatory commitments and
option agreements to reduce the interest rate risk associated with mortgage
loans held for sale, outstanding loan commitments and uncommitted loan
applications with rate lock agreements, which are intended to be held for sale.
The Company typically retains servicing rights on loans sold in order to
generate loan servicing fee income. At September 30, 2003, the Company serviced
mortgage loans for others with an aggregate principal balance of $122.5 million,
and had mortgage servicing rights of $641 thousand.
The following is a more detailed discussion of the Company's current lending
practices.
COMMERCIAL REAL ESTATE LENDING. The Company originates commercial real estate
loans primarily in its eight-county market area; as well as, New York City,
central/western New York, Florida and to a lesser extent in other states. The
Metropolitan New York portfolio is secured primarily by apartments and co-op
buildings in the Bronx (56.6%), Queens County (22.5%), Kings County (6.8%) and
Westchester (4.3%). At September 30, 2003, the Company's commercial real estate
loan portfolio by sector is secured as follows: 29.4% by office and warehouse
buildings, 26.7% by apartment buildings and cooperatives; 26.4% by retail
buildings; 1.8% by buildings owned by non-profit organizations; 1.2% by
hospitality industry; and 14.5% by other property types.
The Company's commercial real estate loans outstanding increased $57.7 million
or 19.3%, in fiscal 2003, compared to growth of $29.5 million or 10.9% in fiscal
2002 and $36.2 million or 15.5% in fiscal 2001. Loans originated in fiscal year
2003 and 2002 were $92.3 million and $46.4 million, respectively. The Company's
commercial real estate lending marketing efforts include: loan officers calling
on prospective borrowers, soliciting existing customers for additional business,
referrals from the branch system, networking with professionals within the local
real estate industry and maintaining contacts with other commercial real estate
lenders (banks, insurance companies and the conduits).
6
In addition to business development, the Company's commercial real estate loan
officers are also responsible for the initial review of proposed commercial real
estate loans. Credit memorandums are generally prepared by the department's
underwriting staff. The Company's underwriting standards focus on: a review of
the property's cash flow, appraisal value, leases, occupancy percentages,
physical condition of the property, credit worthiness of major tenants and the
financial condition and credit history of the borrowers and any guarantors.
A few of the important underwriting benchmarks are the property's ability to
support (cover) the annual debt service. Typically the Company looks for at
least a 1.20 debt coverage ratio. Property occupancy percentage generally needs
to be at least at break-even level, though it can be less if the appropriate
risk mitigants are in place. Loan to value ("LTV") ratios (per bank ordered
appraisals) generally do not exceed 75% to 80%. If additional collateral or
credit enhancement is provided, the "LTV" can exceed 80%.
The Company prices its commercial real estate loans using the following indices:
Prime, London Inter-bank Offer Rate ("LIBOR"), the Treasury Constant Maturities
Index and Federal Home Loan Bank of NY borrowing rates. The Company adds a
premium (a "spread") to the index to determine the interest rate. These spreads
vary depending on the risk profile of the credit. Generally, loans have
maturities of five to ten years and are amortized over 10-25 years. Construction
loans are generally written for terms up to twenty-four months. Typically,
construction loans are priced to float over the prime rate or the 30, 60 or 90
day LIBOR, with a spread. Commitment fees may also be earned on new
transactions. Generally fees range from .25% to 1.00% of the commitment amount.
The Company's lending authority empowers the Vice President & Director of
Commercial Mortgage Lending to approve unsecured loans up to $75,000 and up to
$322,700 for loans secured by real estate. The Company's Commercial Mortgage
Credit Committee approves real estate secured loans (and total relationship
exposure) over $322,700 up to $1.5 million. The Committee also reviews and
recommends for approval loans (and total relationship exposure) over $1.5
million; loans in excess of $1.5 million require the approval of the Board of
Directors' Loan Committee.
Department management is responsible for monitoring the Company's commercial
mortgage portfolio. Under management's direction, department staff collect
delinquent loans, review annual financial statements, perform property
inspections and prepare annual loan reviews. The purpose of the annual review is
to determine the property's current status and whether the present loan rating
reflects the current risk. If the loan review warrants a change in loan grade,
it is indicated on the loan review form. The Company employs an outside
consultant, who was previously a senior credit officer for a large commercial
bank, to evaluate the annual loan reviews prepared by the department. The scope
of the consultant's annual review covers approximately 75% to 80% of the
Company's commercial real estate portfolio. The consultant issues his reports as
to the effectiveness of the department's loan review process and renders an
opinion on the risk profile of the overall portfolio.
COMMERCIAL BUSINESS LENDING. The Company has actively sought to originate
commercial business loans in its market area. The Company originated $40.8
million and $51.5 million of commercial business loans in fiscal years 2003 and
2002, respectively. The Company's commercial loans generally range in size up to
$10.0 million, and the borrowers are principally located within the Company's
market area. The Company offers both fixed rate loans, with terms ranging from
three to seven years and adjustable rate lines of credit. At September 30, 2003,
68.0% of the Company's outstanding commercial loan portfolio consisted of
variable rate loans. As a general rule, the Company sets the interest rates on
its loans based on the prime rate, LIBOR, or other index rates, plus a spread,
and its variable-rate loans reprice at least every 90 days. The Company's
commercial loans include loans to finance equipment, working capital and
accounts receivable. These loans are made to a diverse customer base that
includes manufacturers, wholesalers, retailers, service providers, educational
institutions and government funded entities. The Company also participates in
two syndicated credits on businesses located in its market area. At September
30, 2003, the total outstanding balance on these syndicated loans was $10.1
million and the unused commitment available was $10.4 million.
The Company solicits commercial loan business through its commercial loan
officers, who call on potential borrowers and follow up on referrals from other
Company employees. The commercial loan officers market the Company's commercial
loan products by focusing on the Company's competitive pricing, the Company's
reputation for service and the Company's ties to the local business community.
In many cases, the Company's senior management, including the President, meet
with prospective borrowers.
The Company also has a small business lending program whereby the Company lends
money to small, locally-owned and operated businesses. During the fiscal year
ended September 30, 2003, the Company originated $5.1 million of new small
business loans, down from $10.3 million in the prior year. At September 30,
2003, the Company had $23.8 million of such loans outstanding.
7
Approximately 10% of the Company's small business loans are secured by cash
collateral or marketable securities or are guaranteed up to 90% of the principal
amount by the Small Business Administration.
In addition to developing business, the Company's commercial loan officers are
responsible for underwriting the commercial loans and monitoring the ongoing
relationship between the borrower and the Company. Following the loan officer's
initial underwriting and preparation of a credit memorandum, the loan
application is reviewed by the Vice President and Director of Commercial
Lending, who has authority to approve loans of less than $250 thousand. Loans
between $250 thousand and $1.0 million require approval of the Company's
Commercial Loan Credit Committee, and loans in excess of $1.0 million require
approval of the Board of Directors' Loan Committee. The Company's underwriting
standards focus on a review of the potential borrower's cash flow, as well as
the borrower's leverage and working capital ratios. To a lesser extent, the
Company will consider the collateral securing the loan and whether there is a
personal guarantee on the loan.
To assist with the initial underwriting and ongoing maintenance of the Company's
commercial loans, the Company employs the same risk rating system used by the
Company's commercial real estate loan department. See "Commercial Real Estate
Lending". At the time a loan is initially underwritten, as well as every time a
loan is reviewed, the Company assigns a risk rating. In addition, the Company
employs an annual review process, in which an outside consultant reviews 75% to
80% of the Company's commercial loan portfolio to confirm the Company's assigned
risk rating and to review the Company's overall monitoring of the loan
portfolio.
The Company monitors its commercial loan portfolio by closely watching all loans
with a risk rating which indicates certain adverse factors, such as insufficient
debt service ratio or cash flow issues. In addition, the Company receives
delinquency reports beginning on the 10th of every month. If a loan payment is
more than 20 days late, the commercial loan officer begins active loan
management, which initially includes calling the borrower or sending a written
notice. Moreover, because the Company's lines of credit expire every 12 months,
or five months after the borrower's fiscal year end, and the borrower is
required to renew the line of credit at such time, the Company, in effect,
re-underwrites the loan annually. A term loan often includes a line of credit,
in which case the status of the borrower and loan is reviewed annually because
of the line of credit review. In all reviews, the Company analyzes the
borrower's most current financial statements, and in most cases will visit the
borrower or inspect the borrower's business and properties.
SINGLE FAMILY RESIDENTIAL LENDING. The Company originated $79.7 million and
$60.2 million of single-family residential real estate loans in fiscal years
2003 and 2002, respectively. Substantially all the Savings Bank's residential
mortgage loans were originated through Family Mortgage Banking Co., Inc.
("FMBC"), the Savings Bank's mortgage banking subsidiary. FMBC currently employs
two full-time and two part-time loan counselors, who are responsible for
developing the Company's mortgage business by meeting with referrals, networking
with representatives of the local real estate industry and sponsoring home
buying seminars. In addition, the Company's CSSRs are trained to refer potential
mortgage customers to FMBC. Although FMBC meets with applicants and assists with
the application process, the Company handles the processing, underwriting,
funding and closing of all residential mortgage loans. Single-family residential
mortgage loans not originated through FMBC generally are originated through
independent mortgage brokers or by the Savings Bank.
The Company currently makes a variety of fixed rate and adjustable rate mortgage
loans ("ARMs"), which are secured by one-to four-family residences located in
the Company's eight-county market area. The Company originates mortgage loans
that conform to Freddie Mac guidelines, as well as jumbo loans, which are loans
in amounts over $322,700, and loans with other non-conforming features. The
Company will underwrite a single family residential mortgage loan with an LTV
ratio of up to 95% with private mortgage insurance, and the Company's fixed rate
mortgages generally have contractual maturities of 10 to 30 years.
The Company offers a variety of ARM programs based on market demand. The Company
generally amortizes an ARM loan over 30 years. On certain ARMs, the Company
offers a conversion option, whereby the borrower, at his or her option, can
convert the loan to a fixed interest rate, after a predetermined period of time,
generally 10 to 57 months. Interest rates are generally adjusted based on a
specified margin over the Constant Treasury Maturity Index. Interest rate
adjustments on such loans are limited by both annual adjustment caps and maximum
rate adjustments over the life of the loan. The origination of ARMs, as opposed
to fixed rate loans, helps reduce the Company's exposure to increases in
interest rates. However, during periods of rising interest rates, ARMs may
increase credit risks not inherent in fixed rate loans, primarily because as
interest rates rise, the payment obligations of the borrower rises, thereby
increasing the potential for default. The annual and lifetime adjustable caps
however, help to reduce this risk. The volume and type of ARMs originated
through FMBC are affected by numerous market factors, including the level of
interest rates, competition, consumer preferences and the availability of funds.
At September 30, 2003, the Company held $49.7 million of ARMs in its loan
portfolio, most of which reprice annually after their initial pricing period,
which can range up to five years.
8
Single-family residential loans are generally underwritten according to Freddie
Mac guidelines. The Company requires borrowers who obtain mortgage loans with an
LTV ratio greater than 80% to obtain private mortgage insurance in an amount
sufficient to reduce the Company's exposure to not more than 80% of the purchase
price or appraised value, whichever is lower. In addition, the Company requires
escrow accounts for the payment of taxes and insurance, if the LTV ratio exceeds
80%, but permits borrowers to request an escrow account waiver, if the LTV ratio
is less than 80%. Substantially all mortgage loans originated by the Company
include due-on-transfer clauses, which generally provide the Company the
contractual right to deem the loan immediately due and payable if the borrower
transfers ownership of the property without the Company's consent. The Company's
staff underwriters have authority to approve loans in amounts up to $322,700.
Loans between $322,700 and $1.5 million require the approval of the Company's
Commercial Mortgage Credit Committee, and loans in excess of $1.5 million
require the approval of the Loan Committee of the Board of Directors.
To help low and moderate income home buyers in the Company's communities, the
Company participates in residential mortgage programs and products sponsored by
the State of New York Mortgage Agency ("SONYMA") and the Federal Housing
Authority ("FHA"). SONYMA and FHA mortgage programs provide low and moderate
income households with smaller down payments and below market interest rates.
The Company sells its SONYMA loans back to SONYMA for resale in the secondary
market. The Company also is a charter member of the Capital District Affordable
Housing Partnership, a local lending consortium that makes mortgage funds
available to homebuyers who are unable to obtain conventional financing. The
Company also participates in the Capital District Community Loan Fund and the
FHLB Home Buyer's Club. Since 1993, the Company has made available to low to
moderate income first-time homebuyers over $15.0 million of conventional no down
payment mortgages.
To complement the Company's portfolio of residential mortgage loan products, the
Company also originates fixed rate home equity mortgage loans. A first or second
mortgage on the owner-occupied property secures these loans. During fiscal 2003,
the Company originated $1.3 million of home equity mortgage loans. As of
September 30, 2003, the average size of the Company's outstanding home equity
mortgage loans in its residential mortgage loan portfolio was $20 thousand.
CONSUMER LENDING. In addition to the Company's residential mortgage loans, the
Company offers a variety of consumer credit products, including home equity
lines of credit, variable rate or Creative Loans, auto loans, fixed rate
consumer loans and overdraft protection. The objective of the Company's consumer
lending program is to maintain a profitable loan portfolio and to serve the
credit needs of the Company's customers and the communities, in which it does
business, while providing for adequate liquidity, higher yielding short duration
assets, as well as portfolio diversification.
The Company offers home equity lines of credit in amounts up to $100,000. During
fiscal year 2003, the Company approved new lines of credit totaling $28.0
million. With the Prime Rate at its lowest point in over forty years, the
Company took this opportunity in fiscal 2003 to generate new home equity credit
lines and loans and has commenced an aggressive campaign to increase
outstandings. These products represent a significant growth opportunity to the
consumer loan portfolio, as rates are very favorable (variable rate funding) and
this type of financing continues to be in high demand, as evidenced by a record
breaking home equity origination in 2003. The campaign was introduced throughout
the Bank's market area (Capital and Catskill Regions) via an internal branch
effort and externally through newspaper, direct mail, radio and billboard. The
home equity lines of credit have variable interest rates and are available only
if the LTV ratio is less than 90%.
The Company's fixed rate consumer loans are typically made to finance the
purchase of new or used automobiles. In such cases, the Company offers 100%
financing on new automobiles for terms up to 60 months and 80% financing on used
automobiles for terms dependent on the age of the vehicle. The Company also
offers unsecured lines of credit or overdraft protection to credit qualified
depositors who maintain checking accounts with the Company. In addition to
covering overdrafts on checking accounts, these unsecured lines of credit are
accessible to borrowers from ATMs throughout the world.
The Company markets its consumer credit products through its branches, local
advertisements and direct mailings. Applications can be completed at any branch
of the Company, and, in most cases, the Company will respond to a customer's
completed credit application within 24 hours, including the funding of approved
loans. Individual authority to approve consumer loans varies by the amount of
the loan and whether it is real estate related. Consumer loans are underwritten
according to the Company's Consumer Loans Underwriting practices, and loan
approval is based primarily on review of the borrower's employment status,
credit report and credit score.
CONSTRUCTION LENDING. The Company offers residential construction loans to
individuals who are constructing their own homes in the Company's market area.
Generally, in these cases, the Company is familiar with the builders utilized by
the Company's borrowers and has a long-standing relationship with them. The
Company's residential mortgage loan origination group monitors the periodic
9
disbursements of all construction loans. Before advances are made, the Company's
independent appraisers provide reports comparing the progress of the
construction to the pre-construction schedule. In many cases, the Company
converts construction loans to traditional residential mortgage loans, following
completion of construction. At September 30, 2003, the Company had $1.7 million
of residential construction loans outstanding, which are reported with
residential mortgage loans.
The Company's construction loans generally have terms up to six months, and
require payment of interest only. If construction is not completed on schedule,
the Company charges the borrower additional fees in connection with an extension
of the loan. The Company's staff underwriters have approval authority of up to
$322,700. Loans in excess of $322,700 require approval of the Commercial
Mortgage Credit Committee, and loans in excess of $1.5 million require approval
of the Loan Committee of the Board of Directors.
Construction lending generally involves greater credit risk than permanent
financing on owner-occupied real estate. The risk of loss is dependent largely
upon the accuracy of the initial estimate of the property's value at completion
of construction, compared to the estimated cost of construction, including
interest, and the ability of the builder to complete the project. If the
estimate of the value proves to be inaccurate, then the Company may be
confronted with a project that, when completed, has a value that is insufficient
to assure full repayment of the loan.
The Company also makes construction loans on commercial real estate projects
where the borrowers are well known to the Company and have the necessary
liquidity and financial capacity to support the projects through to completion
and the source of permanent financing, whether the Company or another
institution, can be verified. All commercial real estate construction lending is
done on a recourse basis. As of September 30, 2003, the Company had $15.4
million of commercial real estate construction loans outstanding, or 2.0% of the
Company's loans and 1.1% of total assets.
LOAN REVIEW. As part of the portfolio monitoring process, commercial business
loans and commercial real estate loans over $1 million are subjected to an
annual detailed loan review. Classified loans over $100,000 (see below) in both
portfolios are subjected to this process quarterly. Current financial
information is analyzed and the loan rating is evaluated to determine if it
still accurately represents the level of risk posed by the credit. These reviews
are then analyzed by an outside consultant who decides on the reasonableness of
the loan officers' conclusions with respect to the loans risk rating and the
related allowance for loan loss, if any. For classified loans, these reviews are
complemented by a quarterly loan officer meeting with the outside consultant and
the Company's Chief Credit Officer. The conclusions reached at these meetings
become an integral part of the quarterly review of loan loss reserve adequacy.
DELINQUENT LOANS. It is the policy of management to monitor the Company's loan
portfolio to anticipate and promptly address potential and actual delinquencies.
The procedures taken by the Company vary depending on the type of loan.
With respect to single family residential mortgage and consumer loans, when a
borrower fails to make a payment on the loan, the Company takes immediate steps
to have the delinquency cured and the loan restored to current status. On the
15th of every month, the Credit Administration Department prepares delinquency
reports. The Company's collection manager and his staff then contact the
borrower by telephone to ascertain the reason for the delinquency and the
prospects of repayment. Written notices are also sent at that time. The borrower
is again contacted by telephone on the 20th and 26th of the month, if payment
has not been received. After 30 days another notice is sent and the borrower is
reported as delinquent. The Credit Administration Department continues to call
the borrower and if payment has not been received by the 60th day, another
notice is sent informing the borrower that the loan must be brought current
within the next 30 days or foreclosure proceedings will be commenced. Generally,
the Company does not accrue interest on loans more than 90 days past due. The
Company's procedures for single family residential loans which have previously
been sold by the Company, but which the Company currently services are similar
during the first 60 days. After 60 days, the Company follows the Freddie Mac or
applicable investor guidelines and timeframes regarding delinquent loan
accounts.
With respect to commercial real estate and commercial business loans, the Credit
Administration Department delivers delinquency reports to the respective
departments beginning on the 10th of every month. If a loan payment is more than
20 days late, the loan officer begins active loan management.
CLASSIFIED ASSETS. The Company's policies require the classification of loans
and other assets, such as debt and equity securities, considered to be of lesser
quality, as "substandard," "doubtful" or "loss" assets. An asset is considered
"substandard" if it is inadequately protected by the current net worth and
paying capacity of the borrower or of the collateral pledged, if any.
Substandard assets include those characterized by the distinct possibility that
the institution will sustain some loss if the deficiencies are not corrected.
Assets classified as "doubtful" have all of the weaknesses inherent in those
classified as substandard, with the added
10
characteristic that the weaknesses present make collection or liquidation in
full improbable. Assets classified, as "loss" are those considered uncollectible
and of such little value that there continuance as assets without the
establishment of a specific loss reserve is not warranted. At September 30,
2003, the Company had classified $4.0 million of assets as "substandard" and
$714 thousand of assets as "doubtful." At such date, the Company did not have
any assets classified as "loss."
In addition to classified assets, the Company also has certain "special mention"
or "watch list" assets that have characteristics, features or other potential
weaknesses that warrant special attention. At September 30, 2003, that were
twenty loan relationships classified as special mention totaling $13.1 million,
or 1.7% of total loans and 1.0% of total assets. The majority of these twenty
relationships are well secured by real estate or other collateral. The largest
single relationship is approximately $4.9 million and is secured by office
buildings. The credit for this relationship is criticized due to vacancies below
the level needed to service the debt.
NON-PERFORMING ASSETS. The Company places a loan on non-accrual status when the
loan is contractually past due 90 days or more, or when, in the opinion of
management, the collection of principal and/or interest is doubtful. At such
time, all accrued but unpaid interest is reversed against current period income
and as long as the loan remains on non-accrual status, interest is recognized
only when received, if considered appropriate by management. In certain cases,
the Company will not classify a loan that is contractually past due 90 days or
more as non-accruing, if management determines that the particular loan is well
secured and in the process of collection. In such cases, the loan is simply
reported as "past due." Loans are removed from non-accrual status when they
become current as to principal and interest, or when in the opinion of
management, the loans are expected to be fully collectible as to principal and
interest. The Company did not have any loans classified as 90 days past due and
still accruing interest at September 30, 2003. Non-performing loans also include
troubled debt restructurings ("TDRs"). TDRs are loans whose repayment criteria
have been renegotiated to below market terms given the credit risk inherent in
the loan due to the borrowers' inability to repay the loans in accordance with
the loans' original terms. At September 30, 2003, the Company had one commercial
mortgage loan secured by real estate for $500 thousand classified as a TDR.
Additionally, at September 30, 2003, the Company identified approximately $2.7
million of loans that have more than normal credit risk, including the ability
of such borrowers to comply with their present loan repayment terms. This
represents a decrease of $2.7 million from the $5.4 million reported at
September 30, 2002. Substantially all of these loans are unsecured commercial
business loans. The Company believes that if economic or business conditions
deteriorate in its lending area, some of these loans could become
non-performing, however the Company has already considered these loans in
determining the adequacy of its allowance for loan losses.
The Company classifies property that it acquires through foreclosure or
settlement in lieu thereof as other real estate owned ("OREO"). The Company
records OREO at the lower of the unpaid principal balance or fair value less
estimated costs to sell at the date of acquisition and subsequently recognizes
any decrease in fair value by a charge to non-interest expenses. At September
30, 2003, the Company had $129 thousand of OREO resulting from single family
residential mortgage loans, and $287 thousand from commercial real estate loans.
11
The following presents the amounts and categories of non-performing assets at
the dates indicated:
AT SEPTEMBER 30,
- ---------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Non-accrual loans:
Real estate loans:
Residential $ 1,015 $ 1,147 $ 1,825 $ 2,424 $ 2,707
Commercial 366 555 898 2,829 4,210
Construction -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------
Total real estate loans 1,381 1,702 2,723 5,253 6,917
Commercial business loans 717 264 283 103 10
Home equity lines 21 30 83 84 58
Other consumer loans 47 101 160 160 282
- ---------------------------------------------------------------------------------------------------------------------------
Total non-accrual loans 2,166 2,097 3,249 5,600 7,267
- ---------------------------------------------------------------------------------------------------------------------------
Troubled debt restructurings 500 -- -- 53 616
- ---------------------------------------------------------------------------------------------------------------------------
Total non-performing loans 2,666 2,097 3,249 5,653 7,883
- ---------------------------------------------------------------------------------------------------------------------------
Other real estate owned:
Residential real estate 129 227 140 240 76
Commercial real estate 287 125 125 1,033 1,769
- ---------------------------------------------------------------------------------------------------------------------------
Total other real estate owned 416 352 265 1,273 1,845
- ---------------------------------------------------------------------------------------------------------------------------
Total non-performing assets $ 3,082 $ 2,449 $ 3,514 $ 6,926 $ 9,728
===========================================================================================================================
Allowance for loan losses $ 14,646 $ 14,538 $ 14,333 $ 11,891 $ 10,764
- ---------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses as a percentage of
total loans 1.93% 1.90% 1.88% 1.99% 1.90%
Allowance for loan losses as a percentage of
non-performing loans 549.36% 693.28% 441.15% 210.35% 136.55%
Non-performing loans as a percentage of
total loans 0.35% 0.27% 0.43% 0.94% 1.39%
Non-performing assets as a percentage of
total assets 0.23% 0.19% 0.30% 0.75% 1.06%
===========================================================================================================================
For the years ended September 30, 2003, 2002 and 2001, the interest income that
would have been recorded if the non-accrual loans were on an accrual basis, or
had the rate not been reduced with respect to the loans restructured in troubled
debt restructuring, amounted to $148 thousand, $123 thousand, and $210 thousand,
respectively.
ALLOWANCE FOR LOAN LOSSES. In originating loans, there is a substantial
likelihood that loan losses will be experienced. The risk of loss varies with,
among other things, general economic conditions, the type of loan,
creditworthiness of the borrower and in the case of a collateralized loan, the
quality of the collateral securing the loan. In an effort to minimize loan
losses, the Company monitors its loan portfolio by reviewing delinquent loans
and taking appropriate measures. In addition, with respect to the Company's
commercial real estate and commercial business loans, the Company closely
watches all loans with a risk rating that indicates potential adverse factors.
Moreover, on an annual basis, the Company reviews borrowers' financial
statements, including rent rolls if appropriate, and in some cases, inspects
borrowers' properties in connection with the annual renewal of lines of credit.
Furthermore, the Company's outside consultant periodically reviews the credit
quality of the loans in the commercial real estate and commercial business loan
portfolios, and, together with the Company's Commercial Loan Credit Committee,
reviews quarterly, all classified loans over $100,000 with a risk rating that
indicates the loan has certain weaknesses.
Based on management's on-going review of the Company's loan portfolio, including
the inherent risks therein, historical loan loss experience, general economic
conditions, and trends and other factors, the Company maintains an allowance for
loan losses to cover probable loan losses. The allowance for loan losses is
established through a provision for loan losses charged to operations. The
12
provision for loan losses is based on a number of factors including; historical
loan loss experience, changes in the types and volume of the loan portfolio,
overall portfolio quality including past due and non-accrual trends, loan
concentrations, review of specific problem loans, changes in lending policy and
procedures including underwriting, industry trends, and general economic
conditions which may effect the borrowers' ability to pay. Loans are charged
against the allowance for loan losses when management believes that the
collectibility of all or a portion of the principal is unlikely. The allowance
is an amount that management believes will be adequate to absorb probable losses
on existing loans. Based on information currently known, management considers
the current level of reserves adequate to cover probable loan losses, although
there can be no assurance that such reserves will in fact be sufficient to cover
actual losses. At September 30, 2003, the Company's allowance for loan losses
was $14.6 million, or 1.93% of total loans and 549.36% of non-performing loans.
Net charge-offs during the year ended September 30, 2003 were $452 thousand,
down $509 thousand or 53.0%, from fiscal 2002. The Company continues to monitor
and modify its allowance for loan losses as conditions dictate. The following
table is a summary of the activity in the Company's allowance for loan losses
over the last five years:
FOR THE YEARS ENDED SEPTEMBER 30,
- ---------------------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Total loans outstanding at end of period $ 759,477 $ 765,067 $ 760,783 $ 598,737 $ 566,906
- ---------------------------------------------------------------------------------------------------------------------------
Average total loans outstanding $ 770,507 $ 761,682 $ 741,709 $ 594,570 $ 505,489
- ---------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of year $ 14,538 $ 14,333 $ 11,891 $ 10,764 $ 8,260
Loan charge-offs:
Residential real estate (154) (120) (258) (412) (362)
Commercial real estate (4) (128) (20) (550) (252)
Construction -- -- (89) (375) --
Commercial business (93) (374) (184) (40) (75)
Home equity lines -- -- -- -- --
Other consumer loans (343) (595) (1,041) (565) (306)
- ---------------------------------------------------------------------------------------------------------------------------
Total charge-offs (594) (1,217) (1,592) (1,942) (995)
- ---------------------------------------------------------------------------------------------------------------------------
Loan recoveries:
Residential real estate 4 19 26 84 40
Commercial real estate 5 4 71 155 176
Construction 17 31 32 219 13
Commercial business 19 69 22 6 8
Home equity lines -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------
Other consumer loans 97 133 201 42 12
- ---------------------------------------------------------------------------------------------------------------------------
Total recoveries 142 256 352 506 249
- ---------------------------------------------------------------------------------------------------------------------------
Net charge-offs (452) (961) (1,240) (1,436) (746)
- ---------------------------------------------------------------------------------------------------------------------------
Provision for loan losses 560 1,166 1,498 2,563 3,250
- ---------------------------------------------------------------------------------------------------------------------------
Allowance acquired -- -- 2,184 -- --
- ---------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of year $ 14,646 $ 14,538 $ 14,333 $ 11,891 $ 10,764
===========================================================================================================================
Net charge-offs to average loans 0.06% 0.13% 0.17% 0.24% 0.15%
- ---------------------------------------------------------------------------------------------------------------------------
Allowance as a percentage of non-performing loans 549.36% 693.28% 441.15% 210.35% 136.55%
- ---------------------------------------------------------------------------------------------------------------------------
Allowance as a percentage of period-end loans 1.93% 1.90% 1.88% 1.99% 1.90%
- ---------------------------------------------------------------------------------------------------------------------------
13
The following table presents an allocation of the Company's allowance for loan
losses, the percent of allowance for loan losses to total allowance and the
percent of loans to total loans in each of the categories listed at the dates
indicated. This allocation is management's assessment of the risk
characteristics of each of the component parts of the total loan portfolio
outstanding and is subject to change. The allocation is neither indicative of
the specific amounts or the loan categories in which future charge-offs may
occur nor is it an indicator of future loss trends. The allocation of the
allowance to each category does not restrict the use of the allowance to absorb
losses in any category.
AT SEPTEMBER 30,
- -----------------------------------------------------------------------------------------------------------------------
2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS
PERCENT OF IN EACH PERCENT OF IN EACH PERCENT OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
- -----------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Allocation of allowance
for loan losses:
Real estate loans:
Residential mortgage $ 1,072 7.3% 31.5% $ 1,444 9.9% 39.2% $ 2,085 14.5% 42.8%
Commercial mortgage 6,630 45.3% 46.9% 6,548 45.1% 39.0% 5,504 38.4% 35.3%
Construction 439 3.0% 2.0% 454 3.1% 2.3% 470 3.3% 2.2%
Commercial business loans 2,823 19.3% 14.6% 2,723 18.7% 15.4% 2,636 18.4% 14.3%
Home equity lines of
credit 701 4.8% 3.7% 406 2.8% 1.9% 211 1.4% 0.9%
Other consumer loans 238 1.6% 1.3% 468 3.2% 2.2% 1,012 7.1% 4.5%
Unallocated 2,743 18.7% 2,495 17.2% 2,415 16.9%
- -----------------------------------------------------------------------------------------------------------------------
Total $ 14,646 100.0% 100.0% $ 14,538 100.0% 100.0% $ 14,333 100.0% 100.0%
=======================================================================================================================
- --------------------------------------------------------------------------------------------------
2000 1999
- --------------------------------------------------------------------------------------------------
PERCENT PERCENT
OF LOANS OF LOANS
PERCENT OF IN EACH PERCENT OF IN EACH
ALLOWANCE CATEGORY ALLOWANCE CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL
AMOUNT ALLOWANCE LOANS AMOUNT ALLOWANCE LOANS
- --------------------------------------------------------------------------------------------------
Allocation of allowance
for loan losses:
Real estate loans:
Residential mortgage $ 2,062 17.3% 37.9% $ 1,967 18.2% 39.1%
Commercial mortgage 5,533 46.5% 38.9% 5,379 50.0% 38.2%
Construction 297 2.5% 1.2% 95 0.9% 2.4%
Commercial business loans 2,059 17.3% 16.0% 1,716 15.9% 12.7%
Home equity lines of
credit 128 1.1% 0.8% 117 1.1% 1.2%
Other consumer loans 685 5.8% 5.2% 534 5.0% 6.4%
Unallocated 1,127 9.5% 956 8.9%
- --------------------------------------------------------------------------------------------------
Total $ 11,891 100.0% 100.0% $ 10,764 100.0% 100.0%
==================================================================================================
14
SECURITIES
The Company's securities portfolio is comprised of securities available for sale
and securities held to maturity. At September 30, 2003, the Company had $414.3
million, or 30.3% of total assets, in securities available for sale and $661
thousand, or less than 0.1% of total assets, in securities held to maturity. The
portfolios consist primarily of U.S. government securities and agency
obligations, corporate debt securities, municipal securities, mortgage-backed
securities, mutual funds and equity securities. Management determines the
appropriate classification of securities at the time of purchase. If management
has the positive intent and ability to hold debt securities to maturity, then
they are classified as securities held to maturity and are carried at amortized
cost. Securities if any, that are identified as trading account assets for
resale over a short period are stated at fair value with unrealized gains and
losses reflected in current earnings. All other debt and equity securities are
classified as securities available for sale and are reported at fair value, with
net unrealized gains or losses reported, net of income taxes, as a separate
component of equity. At September 30, 2003, the Company did not hold any
securities considered to be trading securities. As a member of the FHLB of New
York ("FHLB"), the Company is also required to hold FHLB stock, which is carried
at cost because the FHLB stock is not transferable and may only be redeemed by
the FHLB. At September 30, 2003, the Company did not hold the securities of any
one issuer in an amount that exceeded 10% of the Company's equity, except for
securities issued by the U.S. Government, or its agencies.
The Company's investment policy focuses investment decisions on maintaining a
balance of high quality, diversified investments. In making its investments, the
Company also considers optimal balance sheet structure, including repricing,
liquidity, collateral for pledging purposes, and earnings. Investment decisions
are made by the Company's Chief Financial Officer who has authority to purchase,
sell or trade securities qualifying as eligible investments under applicable law
and in conformity with the Company's investment policy. In addition, the
Company's Vice President and Director of Municipal Finance is authorized to
purchase municipal securities for the Commercial Bank's portfolio.
Under the Company's investment policy, eligible securities include: U.S.
Treasury obligations, securitized loans from the Company's loan portfolio,
municipal securities, corporate debt securities, mutual funds, common stock,
preferred stock, convertible preferred stock, convertible notes and bonds, U.S.
governmental agency or agency-sponsored obligations, collateralized mortgage
obligations and REMICs, banker's acceptances and commercial paper, certificates
of deposit and federal funds.
The following table presents the composition of the Company's securities
available for sale and securities held to maturity in dollar amounts and
percentages at the dates indicated.
AT SEPTEMBER 30,
- ------------------------------------------------------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
CARRYING PERCENT CARRYING PERCENT CARRYING PERCENT
VALUE OF TOTAL VALUE OF TOTAL VALUE OF TOTAL
- ------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Securities available for sale (at fair value)
U.S. Government securities and agency obligations $ 84,958 20.5% $ 146,313 37.1% $ 60,463 24.3%
Obligations of states and political subdivisions 262,714 63.4% 143,989 36.5% 87,308 35.1%
Mortgage-backed securities 34,364 8.3% 47,471 12.1% 50,312 20.3%
Corporate debt securities 19,897 4.8% 25,274 6.4% 13,639 5.5%
Mutual funds and marketable equity securities 3,750 0.9% 25,717 6.5% 28,669 11.5%
Non-marketable equity securities 8,582 2.1% 5,303 1.4% 8,078 3.3%
- ------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale 414,265 100.0% 394,067 100.0% 248,469 100.0%
- ------------------------------------------------------------------------------------------------------------------------------
Securities held to maturity (at amortized cost):
Mortgage-backed securities 661 100.0% 883 100.0% 1,130 53.1%
Corporate and other debt securities -- 0.0% -- 0.0% 1,000 46.9%
- -----------------------------------------------------------------------------------------------------------------------------
Total securities held to maturity 661 100.0% 883 100.0% 2,130 100.0%
- ------------------------------------------------------------------------------------------------------------------------------
Total securities portfolio $414,926 $ 394,950 $ 250,599
==============================================================================================================================
15
The following table presents information regarding the amortized cost, weighted
average yields and contractual maturities of the Company's securities available
for sale and securities held to maturity debt portfolios (excludes mutual fund
shares and equities) as of September 30, 2003. Weighted average yields are based
on amortized cost.
AT SEPTEMBER 30, 2003
- ---------------------------------------------------------------------------------------------------------------------------------
MORE THAN ONE YEAR MORE THAN FIVE YEARS
ONE YEAR OR LESS TO FIVE YEARS TO TEN YEARS MORE THAN TEN YEARS TOTAL
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD(1) COST YIELD(1) COST YIELD(1) COST YIELD(1) COST YIELD(1)
- ---------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Securities available for
sale:
U.S. Government
securities
and agency obligations $ 84,959 0.96% $ -- $ -- $ -- $ 84,959 0.96%
Obligations of states
and political
subdivisions 161,758 2.35% 94,162 2.63% 5,345 5.72% 50 6.67% 261,315 2.52%
Mortgage-backed
securities 5 6.74% 426 7.01% 1,893 7.16% 30,873 5.02% 33,197 5.17%
Corporate debt
securities -- 12,300 2.55% -- 7,589 2.72% 19,889 2.61%
- ---------------------------------------------------------------------------------------------------------------------------------
Total available for
sale $246,722 1.87% $ 106,888 2.63% $7,238 6.10% $38,512 4.57% $399,360 2.41%
=================================================================================================================================
Securities held to maturity:
Mortgage-backed
securities -- 126 8.21% 535 8.06% 661 8.09%
- ---------------------------------------------------------------------------------------------------------------------------------
Total held to maturity $ -- $ 126 8.21% $ 535 8.06% $ -- $ 661 8.09%
=================================================================================================================================
(1) Weighted average yields are presented on a tax equivalent basis, using an
assumed Federal tax rate of 35%.
The following is a more detailed discussion of the Company's securities
available for sale and securities held to maturity portfolios:
U.S GOVERNMENT SECURITIES AND AGENCY OBLIGATIONS. The Company invests in U.S.
Treasury securities, debt securities and mortgage-backed securities issued by
government agencies and government sponsored entities such as Fannie Mae, the
FHLBs, the Government National Mortgage Association ("Ginnie Mae") and the
Federal Home Loan Mortgage Corporation ("Freddie Mac"). At September 30, 2003,
the Company held, as available for sale, $85.0 million of non-government
guaranteed bonds issued by the FHLBs, Freddie Mac and Fannie Mae. These
securities had an average yield of 0.96%, weighted average life of less than
one-month and were rated "AAA". The Company's investment policy does not limit
the amount of U.S. government and agency obligations that the Company can hold.
OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS. At September 30, 2003, $200.9
million of the Company's securities consisted of tax-exempt municipal bonds and
notes, all of which were classified as available for sale. Of that total, $71.3
million were invested in general and revenue obligations of jurisdictions in the
State of New York representing relationship investments in municipalities,
including counties, cities, school districts, towns, villages and fire
districts. In addition, the Company held $60.4 million in taxable municipal
bonds of various municipalities throughout the United States, of which, $24.5
million were taxable municipal bonds of municipalities within New York State.
The Company's municipal securities have a weighted average maturity of just over
one-year and a taxable equivalent yield of 2.52% at September 30, 2003. Interest
earned on tax-exempt municipal bonds is exempt from Federal income taxes and,
for issues in the State of New York, a portion is excludable from state income
taxes. The Company's investment policy limits the amount of tax-exempt municipal
securities it may hold to 25.0% of the Company's total assets, or approximately
$341.4 million at September 30, 2003, however, the Company continuously monitors
its tax-exempt portfolio to avoid being subject to the alternative minimum tax.
CORPORATE DEBT SECURITIES. The Company's corporate debt securities portfolio at
September 30, 2003 totaled $19.9 million and consisted of general corporate
obligations and an asset-backed security. All of the Company's corporate debt
securities at September 30, 2003, were rated single "A" or higher by at least
one of the rating agencies, and all were classified as available for sale. The
Company's investment policy limits the amount of corporate debt securities to
25.0% of the Company's total assets or approximately $341.4 million at September
30, 2003.
16
MUTUAL FUNDS AND EQUITY SECURITIES. At September 30, 2003, the Company's mutual
funds and equity securities portfolio totaled $12.3 million, all of which were
classified as available for sale. The largest investment in one issuer was $7.7
million in FHLB of New York stock which the Company is required to hold as a
member. Within this portfolio, the Company had $2.0 million of preferred stocks
of a nationally recognized corporation at September 30, 2003.
SOURCES OF FUNDS
The Company's lending and securities activities are primarily funded by
deposits, repayments and prepayments of loans and securities, proceeds from the
sale of loans and securities, proceeds from maturing securities and cash flows
from operations. In addition, the Company borrows from the FHLB of New York to
fund its operations.
DEPOSITS. The Company offers a variety of deposit accounts with a range of
interest rates and terms. The Company's deposit accounts consist of interest
bearing checking, non-interest bearing checking, regular savings, money market
savings and time deposit accounts. The maturities of the Company's time deposit
accounts range from one month to five years. In addition, the Company offers
IRAs and Keogh accounts. To enhance its deposit products and increase its market
share, the Company offers overdraft protection and direct deposit for its retail
banking customers and cash management services for its business customers. In
addition, the Company offers a low-cost interest bearing checking account
service to its customers over 55 years of age. The Company's ALCO Committee sets
the rates for all deposit products.
At September 30, 2003, the Company's deposits totaled $967.0 million or 70.8% of
total assets. At September 30, 2003, the balance of core deposits, which is
defined to include interest bearing checking, money market, savings and
non-interest bearing checking accounts, totaled $723.5 million, or 74.8% of
total deposits and represented 53.0% of total assets. At September 30, 2003, the
Company had a total of $243.5 million in time deposit accounts, or 25.2% of
total deposits and represented 17.8% of total assets. Time deposits of $193.4
million or 79.4% of total time deposits mature in one year, or less.
The flow of deposits is influenced significantly by general economic conditions,
changes in interest rates and competition. The Company's deposits are obtained
primarily from the eight counties in which the Company's branches are located.
The Company relies primarily on competitive pricing of its deposit products and
customer service and long-standing relationships to attract and retain these
deposits, although market interest rates and rates offered by competing
financial institutions affect the Company's ability to attract and retain
deposits. The Company uses traditional means of advertising its deposit
products, including local radio and print media, and does not solicit deposits
from outside its market area. During fiscal 2003, the Company did not use
brokers to obtain deposits, and at September 30, 2003, the Company had no
brokered deposits. However, the Company may, from time to time, consider these
funding opportunities.
At September 30, 2003, the Company's Commercial Bank had municipal deposits of
$153.5 million, an increase of $76.2 million from the prior fiscal year. The
Company expects the Commercial Bank to continue providing an alternative source
of funding through the generation of municipal deposits.
At September 30, 2003, the Company had $243.5 million in time deposit accounts,
with the following maturities:
WEIGHTED
MATURITY PERIOD AMOUNT AVERAGE RATE
- -----------------------------------------------------------------------------
(Dollars in thousands)
Time deposits less than $100,000:
Three months or less $ 54,574 1.96%
Over three months through six months 53,504 1.82%
Over six months through 12 months 55,559 2.01%
Over 12 months 44,395 3.10%
- -----------------------------------------------------------------------------
Total $ 208,032 2.18%
- -----------------------------------------------------------------------------
Time deposits more than $100,000:
Three months or less $ 11,535 1.67%
Over three months through six months 9,973 1.54%
Over six months through 12 months 8,293 1.87%
Over 12 months 5,651 3.33%
- -----------------------------------------------------------------------------
Total $ 35,452 1.94%
- -----------------------------------------------------------------------------
Total time deposits $ 243,484 2.15%
=============================================================================
17
BORROWINGS. The principal source of the Company's borrowings is through the FHLB
and repurchase agreements. The FHLB system functions in a reserve credit
capacity for member savings associations and certain other home financing
institutions. The Company uses FHLB advances as an alternative funding source to
fund its lending activities when it determines that it can profitably invest the
borrowed funds over their term. At September 30, 2003 the Company had $50.0
million in overnight advances from the FHLB and $15.0 million in overnight
federal funds purchased. At September 30, 2003, the Company had long-term
borrowings of $94.9 million outstanding with the FHLB. FHLB long-term fixed rate
borrowings totaled $84.9 million, with a weighted average interest rate of 4.12%
and a weighted average term of 3.6 years. The Company also had $10.0 million of
FHLB long-term borrowings, which adjust monthly at a spread over thirty-day
Libor. In addition, the Company had $12.3 million of long-term non-recourse
mortgage debt associated with the real estate joint venture established in May
2002. The mortgage debt had an original term of 30 years at a fixed rate of
7.48% and at September 30, 2003, has approximately 25 years remaining.
At September 30, 2003, the Company had $34.5 million of borrowed funds in the
form of securities sold under agreements to repurchase, with a weighted average
interest rate of 2.24%. The company had $10.0 million of repurchase agreements
with the FHLB which mature in 2008, and the additional $24.5 million of
repurchase agreements matures within thirty days.
TRUST SERVICES
The Trust Department offers a full range of services, including living trusts,
executor services, testamentary trusts, employee benefit plan management,
custody services and investment management, primarily to individuals,
corporations, unions and other institutions. The Trust Department has retained
the services of two independent investment services firms to provide investment
research. A Trust Committee that consists of the Vice President Trust &
Investment Officer and the President, as well as four members of the Company's
Board of Directors who rotate committee membership on a semi-annual basis,
oversees operations of the Trust Department. The Trust Department markets its
services through its trust officers, who call on the Company's existing
customers, referrals from attorneys and accountants, the Company's CSSRs and
branch managers who cross-sell the Trust Department's services and free seminars
open to the public. As of September 30, 2003, the Trust Department managed over
$374.4 million of assets, which includes $110.1 million over which the Trust
Department has discretionary investment authority. The Trust Department's fee
income, which totaled $715 thousand for the year ended September 30, 2003,
supplements the Company's rate-sensitive interest income.
SAVINGS BANK LIFE INSURANCE
The Company offers a wide variety of low-cost insurance policies, including
whole life, single premium life, senior life and children's term, to its
customers who live or work in the State of New York. Management believes that
offering insurance is beneficial to the Company's relationship with its
customers. The Company receives commission income from the sale and the renewal
of life insurance policies.
SUBSIDIARY ACTIVITIES
The following are descriptions of the Savings Bank's subsidiaries, which are
indirectly owned by Troy Financial.
TROY FINANCIAL INVESTMENT SERVICES GROUP. Troy Financial Investment Services
Group, ("TFISG"), which was incorporated in May 1989, is the Savings Bank's
wholly owned full-service brokerage firm, offering a complete range of
investment products, including mutual funds, debt, equity and government
securities, on a fee-per-transaction basis. TFISG's goal is to market its
products and services to the Company's existing customers who seek alternatives
to traditional financial institution savings products. TFISG has five full time
employees who monitor the Company's branches to facilitate referrals from the
CSSRs and branch managers, as well as two sales support staff who assist
customers with investment decisions and trading. At September 30, 2003, TFISG
managed approximately $90.5 million of customer assets. TFISG is a member of the
National Association of Securities Dealers and is insured by the Securities
Insurance Protection Corporation.
FAMILY MORTGAGE BANKING CO., INC. FMBC, which was incorporated in April 1987, is
the Savings Bank's wholly owned mortgage-banking subsidiary. The Company
originates the majority of its residential real estate and residential
construction loans through applications received from commissioned employees of
FMBC.
INVESTMENT IN REAL ESTATE PARTNERSHIPS. As an extension of the Company's
commercial real estate lending activity, the Company, through its subsidiaries,
has invested in two joint ventures as of September 30, 2003. The Company,
through TSB Real Property, Inc., has a 50% interest in B.A. Park Group, LLC
("B.A. Park"). The carrying amount of the Company's investment at September 30,
2003 was $2.4 million. B.A. Park owns land and office buildings within an office
park. The
18
office park is a suburban Class "A" complex containing approximately 1.2 million
sq.ft. As of September 30, 2003 the park is 95% occupied and its tenant mix
includes large, publicly traded companies as well as regional and local
businesses. B.A. Park owns four office buildings as well as additional land
sufficient to build at least one more office building. The Company, through TSB
Real Property, Inc., is obligated to invest an additional $325,000 upon
completion of the last office building. The last building to be constructed by
B.A. Park is to be larger, approximately 100,000-sq. ft., with a start date yet
to be determined.
The Company, through its subsidiary 32 Second Street Corp., has a 90% percent
ownership interest in Altamont Avenue Associates, with a real estate carrying
value of $17.0 million and a corresponding non-recourse loan payable of $12.3
million at September 30, 2003. Altamont Avenue Associates owns a 209,603 sq.ft.
neighborhood shopping center anchored by a Hannaford Brothers supermarket. At
September 30, 2003, the center was 83% occupied. The tenant mix includes some
national companies as well as many smaller locally owned businesses. The center
is fully developed so no additional equity investment by the Company is
anticipated.
TROY REALTY FUNDING CORP. Troy Realty Funding Corp. ("TRFC") is a real estate
investment trust formed in 1999. The Savings Bank funded TRFC with approximately
$97 million in commercial real estate mortgages. At September 30, 2003 TRFC held
$98.8 million in commercial real estate mortgages. The interest income earned on
those mortgages and any other earning assets, net of expenses, is distributed to
the Savings Bank in the form of dividends.
OTHER SUBSIDIARIES. The Savings Bank has nine other wholly owned subsidiaries.
T.S. Capital Corp., which has investments of $2.5 million at September 30, 2003,
is licensed by the Small Business Administration as a Small Business Investment
Company in order to offer small business loans and make equity investments in
small businesses. The Family Insurance Agency, Inc., which is active, is an
insurance agency that offers a full range of life and health insurance products,
as well as taxed-deferred annuities. The Family Advertising Co. is an inactive
advertising agency. Catskill Financial Services Inc. is an inactive insurance
agency. T.S. Real Property Inc., Troy SB Real Estate Co., Camel Hill
Corporation, 507 Heights and Realty Umbrella, Ltd. are all related to the
management of, or investment in, the Company's foreclosed or purchased real
estate.
COMPETITION
The Company faces significant competition for both deposits and loans. The
deregulation of the financial services industry and the commoditization of
savings and lending products has led to increased competition among banks and
other financial institutions for a significant portion of the deposit and
lending activity that had traditionally been the arena of savings banks and
savings and loan associations. The Company competes for deposits with other
savings banks, savings and loan associations, commercial banks, credit unions,
money market and other mutual funds, insurance companies, brokerage firms and
other financial institutions, many of which are substantially larger in size and
have greater financial resources than the Company.
The Company's competition for loans comes principally from savings banks,
commercial banks, mortgage banks, credit unions, finance companies and other
institutional lenders, many of whom maintain offices in the Company's market
area. The Company's principal strategy to address this competition includes
providing competitive loan and deposit pricing, personalized customer service,
access to senior management of the Company and continuity of banking
relationships.
Although the Company is subject to competition from other financial
institutions, some of which have much greater financial and marketing resources,
the Company believes it benefits by its position as a community oriented
financial services provider with a long history of serving its market area.
Management believes that the variety, depth and stability of the communities
that the Company services support the service and lending activities conducted
by the Company.
REGULATION
Troy Financial, as a bank holding company, is subject to regulation,
supervision, and examination by the Federal Reserve. The Savings Bank, as a New
York State chartered savings bank, and the Commercial Bank, as a New York State
chartered commercial bank, are subject to regulation, supervision, and
examination by the FDIC as their primary federal regulator and by the NYSBD as
their state regulator.
BANK HOLDING COMPANY REGULATION
19
As a bank holding company, Troy Financial is subject to the regulation,
supervision, and examination of the Federal Reserve under the Bank Holding
Company Act. Troy Financial is required to file periodic reports and other
information with the Federal Reserve, and the Federal Reserve may conduct
examinations of Troy Financial.
Troy Financial is subject to capital adequacy guidelines of the Federal Reserve.
The guidelines apply on a consolidated basis and require bank holding companies
to maintain a minimum ratio of tier 1 capital to total assets of 4.0%. The
minimum ratio is 3.0% for the most highly rated bank holding companies. The
Federal Reserve's capital adequacy guidelines also require bank holding
companies to maintain a minimum ratio of qualifying total capital to
risk-weighted assets of 8.0%, and a minimum ratio of tier 1 capital to
risk-weighted assets of 4.0%. As of September 30, 2003, Troy Financial's ratio
of tier 1 capital to total assets was 9.89%, its ratio of tier 1 capital to
risk-weighted assets was 15.35%, and its ratio of qualifying total capital to
risk-weighted assets was 16.61%.
Troy Financial's ability to pay dividends to its shareholders and expand its
line of business through the acquisition of new banking or non-banking
subsidiaries can be restricted if its capital falls below levels established by
the Federal Reserve's guidelines. In addition, any bank holding company whose
capital does not meet the minimum capital adequacy guidelines is considered to
be undercapitalized and is required to submit an acceptable plan to the Federal
Reserve for achieving capital adequacy.
The Federal Reserve is empowered to initiate cease and desist proceedings and
other supervisory actions for violations of the Bank Holding Company Act or the
Federal Reserve's regulations, orders or notices issued thereunder. Federal
Reserve approval is required if Troy Financial seeks to acquire direct or
indirect ownership or control of any voting shares of a bank or bank holding
company if, after such acquisition, Troy Financial would own or control,
directly or indirectly, 5% or more of any class of the voting shares of the bank
or bank holding company. Federal Reserve approval also must be obtained for Troy
Financial to acquire all or substantially all the assets of a bank or merge or
consolidate with another bank holding company. These provisions also would apply
to a bank holding company that sought to acquire 5% or more of the common stock
of or, in the case of First Niagara Financial Group, Inc. to merge or
consolidate with Troy Financial.
Bank holding companies like Troy Financial are currently prohibited from
engaging in activities other than banking and activities so closely related to
banking or managing or controlling banks as to be a proper incident thereto. The
Federal Reserve regulations contain a list of permissible non-banking activities
that are closely related to banking or managing or controlling banks, and the
Federal Reserve has identified a limited number of additional activities by
order. These activities include lending activities, certain data processing
activities, and securities brokerage and investment advisory services, trust
activities and leasing activities. A bank holding company must file an
application or a notice with the Federal Reserve prior to acquiring more than 5%
of the voting shares of a company engaged in such activities. A bank holding
company that is well capitalized and well managed and meets other conditions may
provide notice after making the acquisition.
Under the Gramm-Leach-Bliley Act, bank holding companies that meet certain
conditions and elect to be treated as financial holding companies may engage in
activities that are financial in nature or incidental to financial activities,
or activities that are complementary to a financial activity and do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally. The Act identifies certain activities that are
deemed to be financial in nature, including non-banking activities currently
permissible for bank holding companies to engage in both within and outside the
United States, as well as insurance and securities underwriting and merchant
banking activities. The Federal Reserve is authorized to identify additional
activities that are permissible financial activities, but only after
consultation with the Department of the Treasury. A financial holding company is
not required to provide prior notice to the Federal Reserve to acquire a company
engaged in these activities or to commence these activities directly or
indirectly through a subsidiary.
To qualify as a financial holding company, a bank holding company's depository
institution subsidiaries must be well capitalized and well managed and have at
least a satisfactory record of performance under the Community Reinvestment Act.
Troy Financial has not elected to be treated as a financial holding company
since it has no current plans to use this authority to engage in expanded
activities.
Under the Change in Bank Control Act, persons who intend to acquire control of a
bank holding company, either directly or indirectly or through or in concert
with one or more persons must give 60 days' prior written notice to the Federal
Reserve. "Control" exists when an acquiring party directly or indirectly has
voting control of at least 25% of a class of voting securities of a bank holding
company or the power to direct the management or policies of the company. Under
Federal Reserve regulations, a rebuttable presumption of control arises with
respect to an acquisition when, after the acquisition, the acquiring party has
ownership, control, or the power to vote at least 10% (but less than 25%) of a
class of a bank holding company's common stock.
20
The New York Banking Law requires prior approval of the New York Banking Board
before any action is taken that causes any company to acquire direct or indirect
control of a banking institution that is organized in the State of New York. The
term "control" is defined generally to mean the power to direct or cause the
direction of the management and policies of the banking institution and is
presumed to exist if the company owns, controls or holds with power to vote 10%
or more of the voting stock of the banking institution.
BANK REGULATION
The Banks are New York State-chartered institutions, and their deposit accounts
are insured up to applicable limits by the FDIC under the Bank Insurance Fund
("BIF"). The Banks are subject to extensive regulation by the NYSBD as their
chartering agency and by the FDIC as their deposit insurer. The Banks must file
reports with the NYSBD and the FDIC concerning their activities and financial
condition, and they must obtain regulatory approval prior to entering into
certain transactions, such as mergers with, or acquisitions of, other depository
institutions and opening or acquiring branch offices. The NYSBD and the FDIC
conduct periodic examinations to assess the Banks' compliance with various
regulatory requirements. This regulation and supervision is intended primarily
for the protection of the deposit insurance funds and depositors. The regulatory
authorities have extensive discretion in connection with the exercise of their
supervisory and enforcement activities, including the setting of policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes.
The Banks derive their lending, investment and other powers primarily from the
applicable provisions of the New York Banking Law and the regulations adopted
thereunder. Under these laws and regulations, the Savings Bank may invest in
real estate mortgages, consumer and commercial loans, certain types of debt
securities, including certain corporate debt securities and obligations of
federal, state and local governments and agencies, certain types of corporate
equity securities and certain other assets. It also may exercise trust powers
upon approval of the NYSBD. The Commercial Bank currently limits its activities
to accepting municipal deposits and acquiring primarily municipal and other
securities.
Under New York Banking Law, neither Bank is permitted to declare, credit or pay
any dividends if its capital stock is impaired or would be impaired as a result
of the dividend. In addition, the New York Banking Law provides that neither
Bank can declare and pay dividends in any calendar year in excess of its "net
profits" for such year combined with its "retained net profits" of the two
preceding years, less any required transfer to surplus or a fund for the
retirement of preferred stock, without prior regulatory approval.
The Banks are subject to minimum capital requirements imposed by the FDIC that
are substantially similar to the capital requirements imposed on Troy Financial.
The FDIC regulations require that each Bank maintain a minimum ratio of
qualifying total capital to risk-weighted assets of 8.0%, and a minimum ratio of
tier 1 capital to risk-weighted assets of 4.0%. In addition, under the minimum
leverage-based capital requirement adopted by the FDIC, each Bank must maintain
a ratio of tier 1 capital to average total assets (leverage ratio) of at least
3% to 5%, depending on the Banks' CAMELS composite examination rating. At
September 30, 2003, the Savings Bank's ratio of Tier 1 capital to risk-weighted
assets was 9.37%, its ratio of tier 1 capital to risk-weighted assets was
13.28%, and its ratio of tier 1 capital to average total assets was 14.54%. At
September 30, 2003, the Commercial Bank's ratio of Tier 1 capital to
risk-weighted assets was 6.64%, its ratio of tier 1 capital to risk-weighted
assets was 27.96%, and its ratio of tier 1 capital to average total assets was
27.98%. Capital requirements higher than the generally applicable minimum
requirements may be established for a particular bank if the FDIC determines
that a bank's capital is, or may become, inadequate in view of the bank's
particular circumstances. Failure to meet capital guidelines could subject a
bank to a variety of enforcement actions, including actions under the FDIC's
prompt corrective action regulations.
State banks are limited in their investments and the activities they may engage
in as principal to those permissible under applicable state law and those
permissible for national banks and their subsidiaries, unless such investments
and activities are specifically permitted by the Federal Deposit Insurance Act
or the FDIC determines that such activity or investment would pose no
significant risk to the deposit insurance funds. The FDIC has by regulation
determined that certain real estate investment and securities underwriting
activities do not present such a risk, provided they are conducted in accordance
with the regulations. The Gramm-Leach-Bliley Act permits national banks to
engage in the activities that are permissible for financial holding companies,
as noted above, other than insurance underwriting, merchant banking, and real
estate development or investment activities.
The FDIC and the NYSBD have extensive enforcement authority over insured savings
banks and commercial banks. This enforcement authority includes, among other
things, the ability to assess civil money penalties, to issue cease and desist
orders and to remove directors and officers. In general, these enforcement
actions may be initiated in response to violations of laws and regulations and
to unsafe or unsound practices.
21
The Banks are subject to quarterly payments on semiannual insurance premium
assessments for their FDIC deposit insurance. The FDIC implements a risk-based
deposit insurance assessment system. Deposit insurance assessment rates
currently are within a range of $0.00 to $0.27 per $100 of insured deposits,
depending on the assessment risk classification assigned to each institution.
Under current FDIC assessment guidelines, the Banks do not pay any insurance
assessment. However, the deposit insurance assessments are subject to change
based on the level of reserves in the BIF. The Banks are subject to separate
assessments to repay bonds ("FICO bonds") issued in the late 1980s to
recapitalize the former Federal Savings and Loan Insurance Corporation. The
annual rate for the payments on the FICO bonds for the quarter beginning October
1, 2003 is 1.54 basis points of BIF-assessable deposits for both of the Banks.
Transactions between the Banks and any of their affiliates (including Troy
Financial) are governed by Sections 23A and 23B of the Federal Reserve Act. An
affiliate of a bank is any company or entity that controls, is controlled by or
is under common control with the bank. A subsidiary of a bank that is not also a
depository institution is not treated as an affiliate of a bank for purposes of
Sections 23A and 23B unless it engages in activities not permissible for a
national bank to engage in directly. Generally, Sections 23A and 23B (i) limit
the extent to which a bank or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and limit such transactions with all
affiliates as a group to an amount equal to 20% of such capital stock and
surplus, and (ii) require that all such transactions be on terms that are
consistent with safe and sound banking practices. The term "covered transaction"
includes the making of loans to an affiliate, the purchase of or investment in
securities issued by an affiliate, the purchase of assets from an affiliate, the
issuance of a guarantee for the benefit of an affiliate, and similar
transactions. Most loans by a bank to any of its affiliates must be secured by
collateral in amounts ranging from 100 to 130 percent of the loan amount,
depending on the nature of the collateral. In addition, any covered transaction
by a bank with an affiliate and any sale of assets or provision of services to
an affiliate must be on terms that are substantially the same, or at least as
favorable, to the bank as those prevailing at the time for comparable
transactions with nonaffiliated companies. The Banks are also are restricted in
the loans they may make to their executive officers and directors, the executive
officers and directors of Troy Financial and its banking and non-banking
subsidiaries, any owner of 10% or more of their stock or the stock of Troy
Financial, and certain entities affiliated with any such person.
Effective April 1, 2003, the Federal Reserve issued Regulation W, which
comprehensively implements Sections 23A and 23B. The regulation unifies and
updates staff interpretations issued over the years, incorporates several new
interpretative proposals (such as to clarify when transactions with an unrelated
third party will be attributed to an affiliate) and addresses new issues arising
as a result of the expanded scope of non-banking activities engaged in by banks
and bank holding companies in recent years and authorized for financial holding
companies under the Gramm-Leach-Bliley Act.
The Banks are subject to certain FDIC standards designed to maintain the safety
and soundness of individual banks and the banking system. The FDIC has
prescribed safety and soundness guidelines relating to (i) internal controls,
information systems and internal audit systems; (ii) loan documentation; (iii)
credit underwriting; (iv) interest rate exposure; (v) asset growth and quality;
(vi) earnings; and (vii) compensation and benefit standards for officers,
directors, employees and principal stockholders. A state nonmember bank not
meeting one or more of the safety and soundness guidelines may be required to
file a compliance plan with the FDIC.
Under the FDIC's prompt corrective action regulations, an insured depository
institution is considered (i) "well capitalized" if the institution has a total
risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of
6% or greater, and a leverage ratio of 5% or greater (provided that the
institution is not subject to an order, written agreement, capital directive or
prompt corrective action directive to meet and maintain a specified capital
level for any capital measure), (ii) "adequately capitalized" if the institution
has a total risk-based capital ratio of 8% or greater, a Tier 1 risk based
capital ratio of 4% or greater and a leverage ratio of 4% or greater (3% or
greater if the institution is rated composite CAMELS 1 in its most recent report
of examination and is not experiencing or anticipating significant growth),
(iii) "undercapitalized" if the institution has a total risk-based capital ratio
that is less than 8%, or a Tier 1 risk-based ratio of less than 4% and a
leverage ratio that is less than 4% (3% if the institution is rated composite
CAMELS 1 in its most recent report of examination and is not experiencing or
anticipating significant growth), (iv) "significantly undercapitalized" if the
institution has a total risk-based capital ratio that is less than 6%, Tier 1
risk-based capital ratio of less than 3% or a leverage ratio that is less than
3%, and (v) "critically undercapitalized" if the institution has a ratio of
tangible equity to total assets that is equal to or less than 2%. Under certain
circumstances, the FDIC can reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category (except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized). At
September 30, 2003, each Bank was classified as a "well capitalized"
institution.
An institution that is categorized as undercapitalized, significantly
undercapitalized, or critically undercapitalized is required to submit an
acceptable capital restoration plan to its appropriate federal banking agency,
which would be the FDIC for the
22
Banks. An undercapitalized institution also is generally prohibited from
increasing its average total assets, making acquisitions, establishing any
branches, or engaging in any new line of business, except in accordance with an
accepted capital restoration plan or with the approval of the FDIC. In addition,
the FDIC may take any other action that it determines will better carry out the
purpose of prompt corrective action initiatives.
Neither Bank is permitted to pay a dividend if, as a result of the payment, it
would become undercapitalized, as defined in under the FDIC's prompt corrective
action regulations. In addition, if a Bank were to become "undercapitalized"
under these regulations, payment of dividends by the Bank would be prohibited
without the prior approval of the FDIC. Either Bank also could be made subject
to dividend restrictions if the FDIC determines that the Bank was in an unsafe
or unsound condition or was engaging in an unsafe or unsound practice.
Under Federal Reserve regulations, the Banks are required to maintain
non-interest-earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). The Federal Reserve regulations require that
reserves of 3% must be maintained against aggregate transaction accounts up to
$36.1 million (subject to adjustment by the Federal Reserve). Reserves of