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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

☒  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016

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: 001-37658
SUFFOLK BANCORP
(Exact name of registrant as specified in its charter)

New York
 
11-2708279
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
4 West Second Street, P.O. Box 9000, Riverhead, NY
 
11901
(Address of Principal Executive Offices)
 
(Zip Code)

Registrant’s Telephone Number, Including Area Code: (631) 208-2400

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Common Stock, par value $2.50 per share
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  ☐    NO  ☒

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  YES  ☐   NO  ☒

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ☒   NO  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)    YES  ☒    NO ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ☒

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ☐    Accelerated filer  ☒    Non-accelerated filer  ☐   Smaller reporting company  ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ☐    NO  ☒

The aggregate market value of the common equity held by non-affiliates of the Registrant as of the last business day of the Registrant’s most recently completed second fiscal quarter was $359 million.

As of February 10, 2017, there were 11,943,789 shares of Registrant’s Common Stock outstanding.
 


SUFFOLK BANCORP
Annual Report on Form 10-K
For the Year Ended December 31, 2016

Table of Contents

   
Page
     
 
PART I
 
     
Item 1.
3
     
Item 1A.
7
     
Item 1B.
13
     
Item 2.
14
     
Item 3.
14
     
Item 4.
14
     
 
PART II
 
     
Item 5.
14
     
Item 6.
17
     
Item 7.
18
     
Item 7A.
34
     
Item 8.
37
     
Item 9.
76
     
Item 9A.
76
     
Item 9B.
78
     
 
PART III
 
     
Item 10.
78
     
Item 11.
81
     
Item 12.
99
     
Item 13.
100
     
Item 14.
101
     
 
PART IV
 
     
Item 15.
103
     
Item 16. Form 10-K Summary 103
     
 
104
 
PART I

ITEM 1.
BUSINESS

Suffolk Bancorp (the “Company”) was incorporated in 1985 as a bank holding company. The Company currently owns all of the outstanding capital stock of Suffolk County National Bank (the “Bank”). The Bank was organized under the national banking laws of the United States in 1890. The Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the extent provided by law. The income of the Company is primarily derived through the operations of the Bank and its subsidiaries, consisting of the real estate investment trust (“REIT”) Suffolk Greenway, Inc., an insurance agency and two corporations used to acquire foreclosed real estate. The insurance agency and the two corporations used to acquire foreclosed real estate are immaterial to the Company’s operations. The Company had 296 full-time equivalent employees as of December 31, 2016.

On June 26, 2016, the Company entered into an Agreement and Plan of Merger (the “merger agreement”) with People’s United Financial, Inc. (“People’s United”) pursuant to which the Company will merge into People’s United (the “merger”). People’s United will be the surviving corporation in the merger. Subject to the terms and conditions of the merger agreement, the Company’s shareholders will have the right to receive 2.225 shares of People’s United common stock in exchange for each share of Company common stock. The merger agreement was adopted by the Company’s shareholders, and both the Office of the Comptroller of the Currency (the “OCC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) have approved the merger. The merger remains subject to other customary conditions to closing.

The Bank is a full-service bank serving the needs of its local residents through 27 branch offices in Nassau, Suffolk and Queens Counties, New York and loan production offices in Garden City, Melville and Long Island City. The Bank offers a full line of domestic commercial and retail banking services. The Bank makes commercial real estate floating and fixed rate loans, multifamily and mixed use commercial loans primarily in the boroughs of New York City, commercial and industrial loans to manufacturers, wholesalers, distributors, developers/contractors and retailers and agricultural loans. The Bank also makes loans secured by residential mortgages, and both floating and fixed rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered.

One of the largest community banks headquartered on Long Island, the Company serves clients in its traditional markets on the east end of Long Island, western Suffolk County and in its newer markets of Nassau County and New York City. The Company considers its business to be highly competitive in its market area with numerous competitors for its core niche of small business and middle market clients, as well as retail clients ancillary to these commercial relationships. The Company competes with local, regional and national depository financial institutions, including commercial banks, savings banks, insurance companies, credit unions and money market funds, and other businesses with respect to its lending services and in attracting deposits. Although the New York metropolitan area has a high density of financial institutions, a number of which are significantly larger than the Company, the core deposit franchise the Company has built over its more than 125 years of doing business by focusing its deposit gathering efforts on low cost deposits is unique in the local marketplace and gives it a significant competitive advantage on cost of funds. In addition to serving the banking needs of the communities in its market area, the Company is also known, along with its employees, for its active community involvement.

At December 31, 2016, the Company, on a consolidated basis, had total assets of approximately $2.1 billion, total deposits of approximately $1.8 billion and stockholders’ equity of approximately $215 million.

Unless the context otherwise requires, references herein to the Company include the Company and the Bank on a consolidated basis.

Business Segment Reporting

The Bank is a community bank, which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers and operations are managed and financial performance is evaluated on a Company-wide basis. As a result, the Company, the only reportable segment, is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change.

Available Information

The Company files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A, and any amendments to those reports, with the United States Securities and Exchange Commission (“SEC”). The public may read and copy any of these materials at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330 (1-800-732-0330). The SEC also maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The Company also makes these reports available free of charge through its Internet website (www.scnb.com) as soon as practicably possible after the Company files these reports electronically with the SEC. Information on the Company’s website is not incorporated by reference into this Form 10-K.
 
Supervision and Regulation

References in this section to applicable statutes and regulations are brief summaries only and do not purport to be complete. It is suggested that the reader review such statutes and regulations in their entirety for a full understanding.

As a consequence of the extensive regulation of commercial banking activities in the United States, the business of the Company and the Bank is particularly susceptible to federal and state legislation that may affect the cost of doing business, modifying permissible activities or enhancing the competitive position of other financial institutions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) signed into law in 2011 makes extensive changes to the laws regulating financial services firms. The Dodd-Frank Act also requires significant rulemaking and mandates multiple studies which could result in additional legislative or regulatory action. Under the Dodd-Frank Act, federal banking regulatory agencies are required to draft and implement enhanced supervision, examination and capital standards for depository institutions and their holding companies. The enhanced requirements include, among other things, changes to capital, leverage and liquidity standards and numerous other requirements. The Dodd-Frank Act authorizes various new assessments and fees, expands supervision and oversight authority over non-bank subsidiaries, increases the standards for certain covered transactions with affiliates and requires the establishment of minimum leverage and risk-based capital requirements for insured depository institutions. The Dodd-Frank Act also established a new federal Consumer Financial Protection Bureau with broad authority and permits states to adopt stricter consumer protection laws and enforce consumer protection rules issued by the Consumer Financial Protection Bureau. Due to the passage of the Dodd-Frank Act, the standard deposit insurance amount is $250 thousand per depositor per insured bank for each account ownership category. In addition, the FDIC assessment is now based on the Bank’s total average assets less tier 1 capital, instead of deposits, and is computed at lower rates.  Following the 2016 U.S. elections, it is possible that the new administration may seek to revise or repeal certain regulations adopted pursuant to the Dodd-Frank Act, although the extent of any such change remains uncertain.

Bank Holding Company Regulation

The Company is a bank holding company registered under the Bank Holding Company Act (“BHC Act”) and is subject to supervision and regulation by the Federal Reserve Board. Federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions, for violation of laws and policies.

Activities Closely Related to Banking

The BHC Act prohibits a bank holding company, with certain limited exceptions, from acquiring direct or indirect ownership or control of any voting shares of any company that is not a bank or from engaging in any activities other than those of banking, managing or controlling banks and certain other subsidiaries or furnishing services to or performing services for its subsidiaries. Bank holding companies also may engage in or acquire interests in companies that engage in a limited set of activities that are closely related to banking or managing or controlling banks. If a bank holding company has become a financial holding company (an “FHC”), it may engage in a broader set of activities, including insurance underwriting and broker-dealer services as well as activities that are jointly determined by the Federal Reserve Board and the Treasury Department to be financial in nature or incidental to such financial activity. FHCs may also engage in activities that are determined by the Federal Reserve to be complementary to financial activities. The Company has not elected to be an FHC at this time but may make such an election at any time so long as the statutory criteria are satisfied.  In order to become an FHC, the bank holding company and all subsidiary depository institutions must be well managed and well capitalized. Additionally, all subsidiary depository institutions must have received at least a “satisfactory” rating on its most recent Community Reinvestment Act (“CRA”) examination. At December 31, 2016, the Bank’s CRA rating was “outstanding.”

Safe and Sound Banking Practices

Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve Board may order a bank holding company to terminate an activity or control of a nonbank subsidiary if such activity or control constitutes a significant risk to the financial safety, soundness or stability of a subsidiary bank and is inconsistent with sound banking principles. Regulation Y also requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company’s consolidated net worth.

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations. Notably, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) provides that the Federal Reserve Board can assess civil money penalties for such practices or violations which can be as high as $1 million per day. FIRREA contains expansive provisions regarding the scope of individuals and entities against which such penalties may be assessed.
 
Annual Reporting and Examinations

The Company is required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require pursuant to the BHC Act. The Federal Reserve Board may examine a bank holding company or any of its subsidiaries and charge the company for the cost of such an examination. The Company is also subject to reporting and disclosure requirements under state and federal securities laws.

Rules on Regulatory Capital

Regulatory capital rules, released in July 2013, implement higher minimum capital requirements for bank holding companies and banks. The rules include a common equity tier 1 capital requirement and establish criteria that instruments must meet in order to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. These enhancements are expected to both improve the quality and increase the quantity of capital required to be held by banking organizations, better equipping the U.S. banking system to deal with adverse economic conditions. The capital rules require banks and bank holding companies to maintain a minimum common equity tier 1 capital ratio of 4.5%, a tier 1 capital ratio of 6%, a total capital ratio of 8% and a leverage ratio of 4%. Bank holding companies are also required to hold a capital conservation buffer of common equity tier 1 capital of 2.5% to avoid limitations on capital distributions and executive compensation payments. The capital rules also require banks to maintain a common equity tier 1 capital ratio of 6.5%, a tier 1 capital ratio of 8%, a total capital ratio of 10% and a leverage ratio of 5% to be deemed “well capitalized” for purposes of certain rules and prompt corrective action requirements.

The rules attempt to improve the quality of capital by implementing changes to the definition of capital. Among the most important changes are stricter eligibility criteria for regulatory capital instruments that would disallow the inclusion of instruments, such as trust preferred securities, in tier 1 capital going forward and constraints on the inclusion of minority interests, mortgage-servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions. In addition, the rules require that most regulatory capital deductions be made from common equity tier 1 capital.

Under the rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. This buffer will help to ensure that banking organizations conserve capital when it is most needed, allowing them to better weather periods of economic stress. The buffer is measured relative to risk-weighted assets.

Community banks, such as the Bank, began transitioning to these rules on January 1, 2015. The new minimum capital requirements were effective on January 1, 2015, whereas the capital conservation buffer and the deductions from common equity tier 1 capital phase in over time. Phase-in of the capital conservation buffer requirements was effective January 1, 2016. The Company’s and the Bank’s capital buffers are in excess of both the current and fully phased-in requirements.

The Federal Reserve Board may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements in order to meet well capitalized standards and future regulatory changes could impose higher capital standards as a routine matter.  The Company’s regulatory capital ratios and those of the Bank are in excess of the levels established for “well capitalized” institutions.

Imposition of Liability for Undercapitalized Subsidiaries

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multifamily mortgages. In accordance with the law, each federal banking agency has specified, by regulation, the levels at which an insured institution would be considered well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. As of December 31, 2016, the Bank exceeded the capital levels required in order to be deemed well capitalized.

By statute and regulation a bank holding company must serve as a source of financial and managerial strength to each bank that it controls and, under appropriate circumstances, may be required to commit resources to support each such controlled bank. This support may be required at times when the bank holding company may not have the resources to provide the support.

Under the prompt corrective action provisions of FDICIA, if a controlled bank is undercapitalized, then the regulators could require the bank holding company to guarantee the bank’s capital restoration plan. In addition, if the Federal Reserve Board believes that a bank holding company’s activities, assets or affiliates represent a significant risk to the financial safety, soundness or stability of a controlled bank, then the Federal Reserve Board could require the bank holding company to terminate the activities, liquidate the assets or divest the affiliates. The regulators may require these and other actions in support of controlled banks even if such actions are not in the best interests of the bank holding company or its stockholders.
 
The appropriate federal banking agency may also require a holding company to provide financial assistance to a bank with impaired capital. Under this requirement, in the future the Company could be required to provide financial assistance to the Bank should it experience financial distress. Based on our ownership of a national bank subsidiary, the OCC could assess us if the capital of the Bank were to become impaired. If we failed to pay the assessment within three months, the OCC could order the sale of our stock in the Bank to cover the deficiency.

Additionally, FDICIA requires bank regulators to take prompt corrective action to resolve problems associated with insured depository institutions. In the event an institution becomes undercapitalized, it must submit a capital restoration plan. If an institution becomes significantly undercapitalized or critically undercapitalized, additional and significant limitations are placed on the institution. The capital restoration plan of an undercapitalized institution will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan until it becomes adequately capitalized. The Company has control of the Bank for the purpose of this statute.

Acquisitions by Bank Holding Companies

The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank or ownership or control of any voting shares of any bank if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the bank holding company and banks concerned, the convenience and needs of the communities to be served and the effect on competition. The Attorney General of the United States may, within 30 days after approval of an acquisition by the Federal Reserve Board, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts. Under certain circumstances, the 30-day period may be shortened to 15 days.

Interstate Acquisitions

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act (“Riegle-Neal Act”), a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company’s initial entry into the state, more than 30% of such deposits in the state (or such lesser or greater amount set by the state). The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. The Dodd-Frank Act permits a national or state bank, with the approval of its regulator, to open a branch in any state if the law of the state in which the branch is located would permit the establishment of the branch if the bank were a bank chartered in that state. National banks may provide trust services in any state to the same extent as a trust company chartered by that state.

Bank Regulation

The Bank is a national bank, which is subject to regulation and supervision primarily by the OCC and secondarily by the Federal Reserve Board and the FDIC. The Bank is subject to requirements and restrictions under federal law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the Bank.

The OCC regularly examines the Bank and records of the Bank. The FDIC may also periodically examine and evaluate insured banks.

Standards for Safety and Soundness

As part of FDICIA’s efforts to promote the safety and soundness of depository institutions and their holding companies, appropriate federal banking regulators are required to have in place regulations specifying operational and management standards (addressing internal controls, loan documentation, credit underwriting and interest rate risk), asset quality and earnings. As discussed above, the Federal Reserve Board, the OCC, and the FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties of up to $1 million per day, issue cease-and-desist or removal orders, seek injunctions and publicly disclose such actions.

Restrictions on Transactions with Affiliates

Section 23A of the Federal Reserve Act imposes quantitative and qualitative limits on transactions between a bank and any affiliate and requires certain levels of collateral for such loans. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of the Company. Section 23B of the Federal Reserve Act requires that certain transactions between the Bank and its affiliates must be on terms substantially the same, or at least as favorable, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. In the absence of such comparable transactions, any transaction between the Bank and its affiliates must be on terms and under circumstances, including credit standards, which in good faith would be offered to or would apply to nonaffiliated companies.
 
Governmental Monetary Policies and Economic Conditions

The principal sources of funds essential to the business of banks and bank holding companies are deposits, stockholders’ equity and borrowed funds. The availability of these various sources of funds and other potential sources, such as preferred stock or commercial paper, and the extent to which they are utilized depends on many factors, the most important of which are the Federal Reserve Board’s monetary policies and the relative costs of different types of funds. An important function of the Federal Reserve Board is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressure. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open market operations in United States government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of the recent changes in regulations affecting commercial banks and other actions and proposed actions by the federal government and its monetary and fiscal authorities, no prediction can be made as to future changes in interest rates, availability of credit, deposit balances or the overall performance of banks generally or the Company and the Bank in particular.

ITEM 1A.
RISK FACTORS

Because the market price of People’s United common stock will fluctuate, the Company’s shareholders cannot be certain of the market value of the merger consideration they will receive.

Upon completion of the merger, each outstanding share of Company common stock (except for certain shares specified in the merger agreement) will be converted into the right to receive 2.225 shares of People’s United common stock. The market value of the People’s United common stock to be issued in the merger will depend upon the market price of People’s United common stock. This market price may vary from the closing price of People’s United common stock on the date the merger was announced, on the date that the proxy statement/prospectus relating to the merger was mailed to the Company’s shareholders and on the date on which Company shareholders voted to adopt the merger agreement at a special meeting of shareholders. There will be no adjustment to the consideration paid to Company shareholders in the merger for changes in the market price of either shares of People’s United common stock or Company common stock.

The market price of People’s United common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding People’s United’s operations or business prospects, including market sentiment regarding People’s United’s entry into the merger agreement. These risks may be affected by:

·
operating results that vary from the expectations of People’s United’s management or of securities analysts and investors;

·
developments in People’s United’s business or in the financial services sector generally;

·
regulatory or legislative changes affecting People’s United’s industry generally or its business and operations;

·
operating and securities price performance of companies that investors consider to be comparable to People’s United;

·
changes in estimates or recommendations by securities analysts or rating agencies;

·
announcements of strategic developments, acquisitions, dispositions, financings and other material events by People’s United or its competitors; and

·
changes in global financial markets and economies and general market conditions, such as interest or foreign exchange rates, stock, commodity, credit or asset valuations or volatility.

Accordingly, at the time Company shareholders decided to adopt the merger agreement at the special meeting, they did not necessarily know or were not able to calculate the value of the merger consideration they would be entitled to receive upon completion of the merger. Company shareholders are encouraged to obtain current market quotations for both People’s United common stock and Company common stock.

The merger agreement may be terminated in accordance with its terms, and the merger may not be completed.

The merger agreement is subject to a number of conditions that must be fulfilled in order to complete the merger. These conditions to the closing of the merger may not be fulfilled in a timely manner or at all, and, accordingly, the merger may be delayed or may not be completed. In addition, if the merger is not completed by June 26, 2017, either People’s United or the Company may choose not to proceed with the merger, and the parties may mutually decide to terminate the merger agreement at any time. In addition, People’s United and the Company may elect to terminate the merger agreement in certain other circumstances and the Company may be required to pay a termination fee.
 
Failure to complete the merger could negatively impact the stock price, future business and financial results of the Company.

If the merger is not completed, the ongoing business of the Company may be adversely affected, and the Company will be subject to several risks, including the following:

·
the Company may be required, under certain circumstances, to pay People’s United a termination fee of $16 million under the merger agreement;

·
the Company will be required to pay certain costs relating to the merger, whether or not the merger is completed, such as legal, accounting, financial advisor and printing fees;

·
under the merger agreement, the Company is subject to certain restrictions on the conduct of its business prior to completing the merger, which may adversely affect its ability to execute certain of its business strategies; and

·
matters relating to the merger may require substantial commitments of time and resources by Company management, which could otherwise have been devoted to other opportunities that may have been beneficial to the Company.

In addition, if the merger is not completed, the Company may experience negative reactions from the financial markets and from its customers and employees. For example, the Company’s business may be impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. The market price of Company common stock could decline to the extent that the current market price reflects a market assumption that the merger will be completed. The Company also could be subject to litigation related to any failure to complete the merger or to proceedings commenced against the Company to perform its obligations under the merger agreement. If the merger is not completed, the Company cannot assure its shareholders that the risks described above will not materialize and will not materially affect the business, financial results and stock price of the Company.

Lawsuits challenging the merger have been filed against the Company, the Company’s board of directors and People’s United, and an adverse judgment in any such lawsuit or any future similar lawsuits could prevent or delay completion of the merger and result in substantial costs to the Company, including any costs associated with the indemnification of directors and officers.

The Company, its board of directors and People’s United are named as defendants in two purported class action lawsuits in the Supreme Court of the State of New York, Suffolk County, and one purported class action lawsuit in the federal district court for the Eastern District of New York, challenging the merger and seeking, among other things, to enjoin the defendants from completing the merger on the agreed-upon terms, and rescission of the merger and/or awarding of damages to the extent the merger is completed. The parties to these actions have entered into a memorandum of understanding regarding a settlement—which, if finally approved by the court, would resolve and release all claims that were brought or could have been brought in these actions—although there can be no assurance that the court will approve such settlement.  In addition, additional plaintiffs may also file lawsuits against the Company or People’s United and/or their directors and officers in connection with the merger. The outcome of any such litigation is uncertain. If the cases are not resolved, these lawsuits could prevent or delay completion of the merger and result in substantial costs to the Company, including any costs associated with the indemnification of directors and officers.

One of the conditions to the closing of the merger is that no order, injunction or decree issued by any court or agency of competent jurisdiction or other legal restraint or prohibition that prevents the consummation of the merger or any of the other transactions contemplated by the merger agreement be in effect. If any plaintiff were successful in obtaining an injunction prohibiting the Company or People’s United from completing the merger on the agreed upon terms, then such injunction may prevent the merger from becoming effective or from becoming effective within the expected timeframe.

The Company will be subject to business uncertainties and contractual restrictions while the merger is pending.

Uncertainty about the effect of the merger on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the merger is completed and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. Retention of certain employees may be challenging while the merger is pending, as certain employees may experience uncertainty about their future roles with the combined company. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the combined company, the Company’s business could be harmed. In addition, the merger agreement restricts the Company from making certain acquisitions and taking other specified actions until the merger occurs without the consent of People’s United. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the merger.
 
If the merger is not completed, the Company will have incurred substantial expenses without realizing the expected benefits of the merger.

The Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement. If the merger is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the merger.

The Company’s results may be adversely affected if it suffers higher than expected losses on its loans or is required to increase its allowance for loan losses.

The Company assumes credit risk from the possibility that it will suffer losses because borrowers, guarantors and related parties fail to perform under the terms of their loans. Management tries to minimize and monitor this risk by adopting and implementing what management believes are effective underwriting and credit policies and procedures, including how the Company establishes and reviews the allowance for loan losses. The allowance for loan losses is determined by continuous analysis of the loan portfolio and the analytical process is regularly reviewed and adjustments may be made based on the assessments of internal and external influences on credit quality. Those policies and procedures may still not prevent unexpected losses that could adversely affect the Company’s results. Weak economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of collateral securing those loans. In particular, earlier this year the Company saw worrisome signs of certain commercial real estate markets becoming overheated, and a decline in property values could materially and adversely affect the value of the collateral securing the Company’s commercial real estate loans. In addition, deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, changes in regulation and regulatory interpretation and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan losses.

The Company operates in a highly regulated environment and its operations and income may be affected adversely by changes in laws and regulations governing its operations. The Company may be unable to satisfy the individual minimum capital requirements imposed by the OCC, and lack of compliance may result in regulatory enforcement actions and adversely impact the Company’s business, financial condition or results of operations.

The Company is subject to extensive regulation and supervision by the Federal Reserve Board, the OCC and the FDIC. Such regulators govern the activities in which the Company may engage. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on a bank’s operations, limit growth rates, reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. Any change in such regulation and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could materially and adversely impact on the Company’s business, financial condition or results of operations. Any new laws, rules and regulations could also make compliance more difficult or expensive or otherwise materially and adversely affect the Company’s business, financial condition or results of operations. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things.

As a result of its commercial real estate concentrations, the OCC established individual minimum capital ratios for the Bank that require it to maintain a tier 1 leverage ratio of at least 9%, a tier 1 risk-based capital ratio of at least 11% and a total risk-based capital ratio of at least 12%. There is no guarantee that the Bank will be able to maintain compliance with these heightened capital ratios. Any failure by the Bank to comply with these individual minimum capital ratios (including as a result of increases to the Bank’s allowance for loan losses), may result in regulatory enforcement actions and adversely impact the Company’s business, financial condition or results of operations.

The Company’s loan portfolio has a high concentration of commercial real estate loans (inclusive of multifamily and mixed use commercial loans), and its business may be adversely affected by credit risk associated with commercial real estate and a decline in property values. The Company’s limitation on the growth of its commercial real estate loan portfolio due to the Company’s concentrated position in such assets could materially and adversely affect the Company’s ability to generate interest income and the Company’s business, financial condition and results of operations.

At December 31, 2016, $1.2 billion, or 72% of the Company’s total gross loan portfolio, was comprised of commercial real estate (inclusive of multifamily and mixed use commercial loans). This type of lending is generally sensitive to regional and local economic conditions. Unlike larger national or regional banks that serve a broader and more diverse geographic region, the Company’s business depends significantly on general economic conditions in the New York metropolitan and Long Island markets, where the majority of the properties securing the multifamily and commercial real estate loans the Company originates, and the businesses of the customers to whom the Company makes its C&I loans, are located. Accordingly, the ability of borrowers to repay their loans, and the value of the collateral securing such loans, may be significantly affected by economic conditions in this region, including changes in the local real estate market, making loan loss levels difficult to predict and increasing the risk that the Company would incur material losses if borrowers default on their loans. A decline in general economic conditions could therefore have an adverse effect on the Company’s business, financial condition and results of operations. In addition, because multifamily and CRE loans represent the large majority of the Company’s loan portfolio, a decline in tenant occupancy or rents could adversely impact the ability of borrowers to repay their loans on a timely basis, which could have a negative impact on the Company’s net income, as well as the Company’s ability to maintain or increase the level of cash dividends it currently pays to its stockholders. While the Company seeks to minimize these risks through its underwriting policies, which generally require that such loans be qualified on the basis of the collateral property’s cash flows, appraised value and debt service coverage ratio, among other factors, there can be no assurance that the Company’s underwriting policies will protect it from credit-related losses or delinquencies.
 
Furthermore, during 2016, the Company became increasingly concerned with conditions in many of its local CRE markets, particularly those in the boroughs of New York City. The Company saw worrisome signs of markets that were becoming overheated. As a result of these concerns, the Company stopped accepting new applications for multifamily loans in the boroughs of New York City during the first quarter of 2016. The CRE lending market is also an area which has attracted significant regulatory scrutiny. The OCC, the Company’s primary bank regulator, has publicly expressed broadly applicable concerns over the last year about overheated conditions in many CRE markets. The OCC established individual minimum capital ratios for the Bank as a result of its concentration of CRE loans. In response, the Company decided to temporarily pull back from the CRE lending markets, which could have a material and adverse impact on the Company’s net income and the Company’s business, financial condition and results of operation. Following the Company’s implementation of enhanced risk management processes in order to remain compliant with applicable regulatory guidance, the Company re-entered certain commercial real estate markets that it backed away from, although it has no plans to re-enter the multifamily lending markets in New York City.

Recent financial reforms and related regulations may affect our results of operations, financial condition or liquidity.

The Dodd-Frank Act could result in additional legislative or regulatory action. For a description of the Dodd-Frank Act see Part I, Item 1. Business, Supervision and Regulation contained in this Form 10-K. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations will impact the Company’s business. However, compliance with these new laws and regulations have resulted in and will likely continue to result in additional costs and these additional costs may adversely impact our results of operations, financial condition or liquidity.

As a bank holding company that conducts substantially all of its operations through its banking subsidiary, our ability to pay dividends to stockholders depends upon the results of operations of the Bank and its ability to pay dividends to the Company. Dividends paid by the Bank are subject to limits imposed by law and regulation.

Substantially all of the Company’s activities are conducted through the Bank, and the Company receives substantially all of its funds (other than the net proceeds of any capital raising transactions that the Company may undertake) through dividends from the Bank. The Company’s ability to pay dividends to stockholders depends primarily on the Bank’s ability to pay dividends to the Company. Various laws and regulations limit the amount of dividends that the Bank may pay to the Company. If the Bank is unable to pay dividends to the Company, the Company may not be able to pay dividends to its stockholders.

Changes in interest rates could adversely affect the Company’s results of operations and financial condition.

The Company’s ability to generate net income depends primarily upon our net interest income. Net interest income is income that remains after deducting from total income generated by earning assets the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities and short-term investments. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and the levels of non-performing loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of non-interest-bearing demand deposits and equity capital.

Different types of assets and liabilities may react differently, at different times, to changes in market interest rates. Management expects that the Company will periodically experience gaps in the interest-rate sensitivities of its assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. Management is unable to predict changes in market interest rates which are affected by many factors beyond our control including inflation, recession, unemployment, money supply and other governmental monetary and fiscal policies, domestic and international events and changes in the United States and other financial markets. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, client loan and deposit preferences and the timing of changes in these variables.

Management attempts to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate-sensitive assets and interest rate-sensitive liabilities. Management reviews the Company's interest rate risk position and modifies its strategies based on projections to minimize the impact of future interest rate changes. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial condition.
 
The Company is subject to risks associated with taxation that could adversely affect the Company’s results of operations and financial condition.

The amount of income taxes the Company is required to pay on its earnings is based on federal, state and city laws and regulations. The Company provides for current and deferred taxes in its financial statements, based on its results of operations, business activity, legal structure, interpretation of tax statutes, assessment of risk of adjustment upon audit and application of financial accounting standards. The Company may take tax return filing positions for which the final determination of tax is uncertain. The Company’s net income and earnings per share may be reduced if a federal, state or local authority assesses additional taxes that have not been provided for in the consolidated financial statements. There can be no assurance that the Company will achieve its anticipated effective tax rate either due to a change in tax law, a change in regulatory or judicial guidance or an audit assessment that denies previously recognized tax benefits.  The new tax provisions of New York State Article 9A allow banking corporations to exclude from income 160% of the dividends it has received from subsidiaries such as a REIT, which is now included in the mandatory combined group. Going forward, the Company may not realize the benefits of the exclusion from income of 160% of the dividends received from the REIT, if the bank’s assets were in excess of $8 billion, resulting in a higher effective state income tax rate. The occurrence of any of these tax-related risks could adversely affect the Company’s results of operations and financial condition.

The Company’s financial condition and results of operations are dependent on the economy, as well as competition from other banks. Changing economic conditions could adversely impact the Company’s earnings and increase the credit risk of the Company’s loan portfolio.

The Company’s primary market area includes Suffolk County, Nassau County and New York City. Adverse economic conditions in that market area could reduce the Company’s rate of growth, affect customers’ ability to repay loans and result in higher levels of loan delinquencies, problem assets and foreclosures and a decline in the values of the collateral (including residential and commercial real estate) securing the Company’s loans, any of which could have a material adverse effect on the Company’s business, financial condition and results of operations. General economic conditions, including inflation, unemployment and money supply fluctuations, also may adversely affect the Company’s business, financial condition and results of operations. In addition, competition in the banking industry is intense and the Company’s profitability depends upon its continued ability to successfully compete in its market.

The Company may not be able to maintain a strong core deposit base or other low-cost funding sources.

The Company expects to depend on checking, savings and money market deposit account balances and other forms of deposits as the primary source of funding for its lending activities. The Company’s future growth will largely depend on its ability to maintain a strong core deposit base. There may be competitive pressures to pay higher interest rates on deposits, which would increase the Company’s funding costs. If deposit clients move money out of bank deposits and into other investments (or into similar products at other institutions that may provide a higher rate of return), the Company could lose a relatively low cost source of funds, increasing its funding costs and reducing net interest income and net income. Additionally, any such loss of funds could result in reduced loan originations, which could adversely impact the Company’s results of operations and financial condition.

The Company is subject to significant operational risks that could result in charges, increased operational costs, harm to the Company’s reputation or foregone business opportunities.

Operational risk is the risk of loss from operations, including fraud by employees or outside persons, employees’ execution of incorrect or unauthorized transactions and breaches of internal control systems. Operational risk also encompasses technology, compliance and legal risk, which is the risk of loss from violations of, or noncompliance with, laws, rules, regulations, prescribed practices or ethical standards, as well as the risk of our noncompliance with contractual and other obligations. The Company is also exposed to operational risk through its outsourcing arrangements and the effect that changes in circumstances or capabilities of its outsourcing vendors can have on the Company’s ability to continue to perform operational functions necessary to its business. Control weaknesses or failures or other operational risks could result in charges, increased operational costs, harm to the Company’s reputation or foregone business opportunities.

A failure in or breach of the Company’s security systems or infrastructure, or those of our third-party service providers, could result in financial losses or in the disclosure or misuse of confidential or proprietary information, including client information.

As a financial institution, the Company may be the target of fraudulent activity that may result in financial losses to the Company and its clients, privacy breaches against its clients or damage to its reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, unauthorized intrusion into or use of the Company’s systems and other dishonest acts. The Company provides its customers with the ability to bank remotely, including online over the Internet. The secure transmission of confidential information is a critical element of remote banking. The Company’s network could be vulnerable to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches. The Company may be required to spend significant capital and other resources to protect against the threat of cybersecurity breaches and computer viruses, or to alleviate problems caused by such breaches or viruses. Given the volume of Internet transactions, certain errors may be repeated or compounded before they can be discovered and rectified. To the extent that the Company’s activities or the activities of its customers involve the storage and transmission of confidential information, security breaches and viruses could expose the Company to claims, litigation and other possible liabilities. Any inability to prevent cybersecurity breaches or computer viruses could also cause existing customers to lose confidence in the Company’s systems and could adversely affect its reputation, results of operations and ability to attract and maintain customers and businesses. In addition, a security breach could also subject the Company to additional regulatory scrutiny, expose it to civil litigation and possible financial liability and cause reputational damage. The Company’s risk and exposure to these matters remains heightened because of the evolving nature and complexity of the threats from organized cybercriminals and hackers, and the Company’s plans to continue to provide electronic banking services to its customers.
 
The Company depends on its key employees.

The Company’s success will, to some extent, depend on the continued employment of its executive officers. The unexpected loss of the services of any of these individuals could have a detrimental effect on the Company’s business. No assurance can be given that these individuals will continue to be employed by the Company. The loss of any of these individuals could negatively affect the Company’s ability to achieve its growth strategy and could have a material adverse effect on the Company’s results of operations and financial condition.

Liquidity risk could impair the Company’s ability to fund operations and jeopardize its financial condition.

Liquidity is essential to the Company’s business. An inability to raise funds through deposits, borrowings, the sale of loans or securities and other sources could have a substantial negative effect on the Company’s liquidity. The Company’s access to funding sources in amounts adequate to finance its activities or on terms that are acceptable to it could be impaired by factors that affect the Company specifically or the banking industry or economy in general. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of its business activity as a result of a downturn in the markets in which its loans are concentrated or adverse regulatory action against the Company. The Company’s ability to borrow could also be impaired by factors that are not specific to it, such as a disruption in the financial markets or negative views and expectations about the prospects for the banking or financial services industries.

The Company may elect or be compelled to seek additional capital in the future, but that capital may not be available when it is needed.

The Company is required by federal regulatory authorities to maintain adequate levels of capital to support its operations. At some point, the Company may need to raise additional capital. If the Company raises additional capital, it may seek to do so through the issuance of, among other things, its common stock. The issuance of additional shares of common stock or convertible securities to new stockholders would be dilutive to the Company’s current stockholders.

The Company’s ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside the Company’s control, and on the Company’s financial performance. Accordingly, the Company cannot be assured of its ability to raise additional capital if needed or to raise capital on terms acceptable to the Company. If the Company cannot raise additional capital when needed, its ability to further expand its operations could be materially impaired and its financial condition and liquidity could be materially and adversely affected.

The Company is subject to risks associated with litigation that could have a material adverse effect on the Company’s business and financial condition and cause significant reputational harm to the Company.

The Company is subject to litigation risks as a result of a number of factors and from various sources, including the highly regulated nature of the banking industry. Given the inherent uncertainties involved in litigation, and the large or indeterminate damages that may be sought, there can be significant uncertainty as to the ultimate liability the Company may incur from litigation matters. Substantial liability against the Company could have a material adverse effect on the Company’s business and financial condition and cause significant reputational harm to the Company, which could seriously harm the Company’s business.

The price of the Company’s common stock may fluctuate significantly, making it difficult to resell shares of the Company’s common stock at times and prices that stockholders may find attractive.

The Company cannot predict how its common stock will trade in the future. The market value of the Company’s common stock will likely continue to fluctuate in response to a number of factors including the following, many of which are beyond the Company’s control, as well as the other risk factors described herein:

the market price of People’s United’s common stock, upon which the consideration to be paid to the Company’s stockholders in the merger is based;
 
actual or anticipated quarterly fluctuations in the Company’s operating and financial results;

developments related to investigations, proceedings or litigation involving the Company;

changes in financial estimates and recommendations by financial analysts;

dispositions, acquisitions and financings;

actions of the Company’s current stockholders, including sales of common stock by existing stockholders and the Company’s directors and executive officers;

fluctuations in the stock price and operating results of the Company’s competitors;

regulatory developments; and

developments related to the financial services industry.

The market value of the Company’s common stock may also be affected by conditions affecting the financial markets in general, including price and trading fluctuations. These conditions may result in volatility in the market prices of stocks generally and, in turn, the Company’s common stock and sales of substantial amounts of the Company’s common stock in the market, in each case that could be unrelated or disproportionate to changes in the Company’s operating performance. These broad market fluctuations may adversely affect the market value of the Company’s common stock.

There may be future sales of additional common stock or other dilution of the Company’s stockholders’ equity, which may adversely affect the market price of the Company’s common stock.

Subject to the limitations under the rules of the New York Stock Exchange and the number of shares of the Company’s authorized capital stock, the Company is not restricted from issuing additional common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or any substantially similar securities. The market value of the Company’s common stock could decline as a result of sales by the Company of a large number of shares of common stock or similar securities in the market or the perception that such sales could occur.

Anti-takeover provisions could negatively impact the Company’s stockholders.

Provisions in the Company’s charter and bylaws, the corporate law of the State of New York and federal laws and regulations could delay, defer or prevent a third party from acquiring the Company, despite the possible benefit to its stockholders, or otherwise adversely affect the market price of the Company’s common stock. These provisions include the election of directors to staggered terms of three years, advance notice requirements for nominations for election to the Company’s Board of Directors and for proposing matters that stockholders may act on at stockholder meetings and the requirement that directors fill vacancies on the Company’s Board of Directors. In addition, the BHC Act, as amended, and the Change in Bank Control Act of 1978, as amended, together with federal regulations, require that, depending on the particular circumstances, either regulatory approval must be obtained or notice must be furnished to the appropriate regulatory agencies and not disapproved prior to any person or entity acquiring control of a national bank, such as the Bank. These provisions may prevent a merger or acquisition that may be attractive to stockholders and could limit the price investors would be willing to pay in the future for the Company’s common stock. These provisions could also discourage proxy contests and make it more difficult for holders of the Company’s common stock to elect directors other than the candidates nominated by the Company’s Board of Directors.

ITEM 1B.
UNRESOLVED STAFF COMMENTS  None.
 
ITEM 2.
PROPERTIES

The following table sets forth certain information relating to properties owned or used in the Company’s banking activities at December 31, 2016:

Location
Primary Use
Owned or Leased
4 West Second Street, Riverhead, NY
Corporate Headquarters
Owned
3880 Veterans Memorial Highway, Bohemia, NY
Branch Office
Owned
351 Pantigo Road, East Hampton, NY
Branch Office
Owned
168 West Montauk Highway, Hampton Bays, NY
Branch Office
Owned
746 Montauk Highway, Montauk, NY
Branch Office
Owned
135 West Broadway, Port Jefferson, NY
Branch Office
Owned
1201 Ostrander Avenue, Riverhead, NY
Branch Office
Owned
6 West Second Street, Riverhead, NY
Branch Office
Owned
17 Main Street, Sag Harbor, NY
Branch Office
Owned
295 North Sea Road, Southampton, NY
Branch Office
Owned
2065 Wading River-Manor Road, Wading River, NY
Branch Office
Owned
144 Sunset Avenue, Westhampton Beach, NY
Branch Office
Owned
206 Griffing Avenue, Riverhead, NY
Administrative Office
Owned
400 Merrick Road, Amityville, NY
Branch Office
Leased
502 Main Street, Center Moriches, NY
Branch Office
Leased
31525 Main Road, Cutchogue, NY
Branch Office
Leased
21 East Industry Court, Deer Park, NY
Branch Office
Leased
99 Newtown Lane, East Hampton, NY
Branch Office
Leased
110 Marcus Boulevard, Hauppauge, NY
Branch Office
Leased
2801 Route 112, Medford, NY
Branch Office
Leased
159 Route 25A, Miller Place, NY
Branch Office
Leased
228 East Main Street, Port Jefferson, NY
Branch Office
Leased
161 North Main Street, Sayville, NY
Branch Office
Leased
9926 Route 25A, Shoreham, NY
Branch Office
Leased
222 Middle Country Road, Smithtown, NY
Branch Office
Leased
955 Little East Neck Road, West Babylon, NY
Branch Office
Leased
1055 Franklin Avenue, Garden City, NY
Loan Production and Branch Office
Leased
290 Broad Hollow Road, Melville, NY
Loan Production and Branch Office
Leased
31-00 47th Avenue, Long Island City, NY
Loan Production and Branch Office
Leased

ITEM 3.
LEGAL PROCEEDINGS

See the information set forth in Note 17. Legal Proceedings in the Notes to Consolidated Financial Statements under Part II, Item 8, which information is incorporated by reference in response to this item.

ITEM 4.
MINE SAFETY DISCLOSURES  Not applicable.

PART II

ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

At December 31, 2016, the approximate number of common equity stockholders was as follows:

Title of Class: Common Stock
Number of Record Holders: 1,190

The Company’s common stock commenced trading on the New York Stock Exchange under the symbol SCNB on December 18, 2015. Prior to that date, it traded on the NASDAQ Global Select Market under the symbol SUBK. Following are quarterly high and low sale prices of the Company’s common stock for the years ended December 31, 2016 and 2015.
 
2016
 
High Sale
   
Low Sale
 
1st Quarter
 
$
28.14
   
$
23.80
 
2nd Quarter
   
31.36
     
22.88
 
3rd Quarter
   
35.80
     
30.45
 
4th Quarter
   
44.70
     
33.58
 

2015
 
High Sale
   
Low Sale
 
1st Quarter
 
$
23.89
   
$
20.66
 
2nd Quarter
   
26.14
     
23.05
 
3rd Quarter
   
29.99
     
23.91
 
4th Quarter
   
31.75
     
25.97
 

The following schedule summarizes the Company’s dividends paid for the years ended December 31, 2016 and 2015.

Record Date
Dividend Payment Date
 
Cash Dividends Paid
Per Common Share
 
November 9, 2016
November 23, 2016
 
$
0.10
 
August 10, 2016
August 24, 2016
   
0.10
 
May 11, 2016
May 25, 2016
   
0.10
 
February 10, 2016
February 24, 2016
   
0.10
 
November 11, 2015
November 25, 2015
   
0.10
 
August 12, 2015
August 26, 2015
   
0.10
 
May 13, 2015
May 27, 2015
   
0.06
 
February 11, 2015
February 25, 2015
   
0.06
 
 
The following Performance Graph compares the yearly percentage change in the Company’s cumulative total stockholder return on its common stock with the cumulative total return of the S&P 500 index and the cumulative total return of the SNL Bank $1B - $5B index.


         
Period Ending
 
Index
   
12/31/11
   
12/31/12
   
12/31/13
   
12/31/14
   
12/31/15
   
12/31/16
 
Suffolk Bancorp
     
100.00
     
121.41
     
192.77
     
211.60
     
267.30
     
409.37
 
SNL Bank $1B-$5B
     
100.00
     
123.31
     
179.31
     
187.48
     
209.86
     
301.92
 
S&P 500      
100.00
     
116.00
     
153.57
     
174.60
     
177.01
     
198.18
 

Source: Performance Graph prepared by SNL Financial, Charlottesville, VA

For information about the Company’s equity compensation plans, please see Part III, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters contained in this Form 10-K.
 
ITEM 6.
SELECTED FINANCIAL DATA

The Company’s selected financial data for the last five years follows.

FIVE-YEAR SUMMARY (dollars in thousands, except per share data)

As of or for the year ended December 31,
 
2016
   
2015
   
2014
   
2013
   
2012
 
OPERATING RESULTS:
                             
Interest income
 
$
77,719
   
$
72,780
   
$
65,053
   
$
59,678
   
$
60,447
 
Interest expense
   
3,929
     
3,247
     
2,519
     
2,930
     
3,719
 
Net interest income
   
73,790
     
69,533
     
62,534
     
56,748
     
56,728
 
(Credit) provision for loan losses
   
(500
)
   
600
     
1,000
     
1,250
     
8,500
 
Net interest income after (credit) provision
   
74,290
     
68,933
     
61,534
     
55,498
     
48,228
 
Non-interest income
   
8,483
     
8,594
     
10,900
     
19,507
     
10,881
 
Operating expenses
   
55,320
     
53,954
     
53,419
     
58,565
     
61,571
 
Income (loss) before income taxes
   
27,453
     
23,573
     
19,015
     
16,440
     
(2,462
)
Provision (benefit) for income taxes
   
7,622
     
5,886
     
3,720
     
3,722
     
(714
)
Net income (loss)
 
$
19,831
   
$
17,687
   
$
15,295
   
$
12,718
   
$
(1,748
)
FINANCIAL CONDITION:
                                       
Investment securities
 
$
198,022
   
$
308,408
   
$
360,940
   
$
412,446
   
$
410,388
 
Loans
   
1,676,564
     
1,666,447
     
1,355,427
     
1,068,848
     
780,780
 
Total assets
   
2,092,291
     
2,168,592
     
1,895,283
     
1,699,816
     
1,622,464
 
Total deposits
   
1,838,182
     
1,780,623
     
1,556,060
     
1,510,061
     
1,431,114
 
Borrowings
   
15,000
     
165,000
     
130,000
     
-
     
-
 
Stockholders' equity
   
215,028
     
197,258
     
182,733
     
167,198
     
163,985
 
SELECTED FINANCIAL RATIOS:
                                       
Performance:
                                       
Return on average assets
   
0.90
%
   
0.89
%
   
0.87
%
   
0.76
%
   
(0.11
)%
Return on average stockholders' equity
   
9.54
     
9.27
     
8.57
     
7.78
     
(1.22
)
Net interest margin (taxable-equivalent)
   
3.77
     
3.98
     
4.07
     
3.91
     
4.19
 
Efficiency ratio
   
64.49
     
65.64
     
68.41
     
73.64
     
86.22
 
Average stockholders' equity to average assets
   
9.47
     
9.61
     
10.14
     
9.83
     
9.30
 
Dividend payout ratio
   
24.10
     
21.48
     
9.16
     
-
     
-
 
Asset quality:
                                       
Non-performing loans to total loans (1)
   
0.33
     
0.33
     
0.96
     
1.42
     
2.10
 
Non-performing assets to total assets
   
0.30
     
0.25
     
0.68
     
0.89
     
1.17
 
Allowance for loan losses to non-performing loans (1)
   
362
     
374
     
148
     
114
     
108
 
Allowance for loan losses to total loans (1)
   
1.20
     
1.24
     
1.42
     
1.62
     
2.28
 
Net charge-offs (recoveries)/average loans
   
0.00
     
(0.06
)
   
(0.08
)
   
0.20
     
3.57
 
CAPITAL RATIOS:
                                       
Tier 1 leverage ratio
   
10.31
%
   
9.77
%
   
10.04
%
   
9.81
%
   
9.79
%
Tier 1 risk-based capital ratio
   
13.50
     
11.68
     
12.10
     
13.77
     
16.89
 
Total risk-based capital ratio
   
14.72
     
12.89
     
13.35
     
15.02
     
18.15
 
Tangible common equity ratio
   
10.16
     
8.98
     
9.50
     
9.68
     
9.96
 
COMMON SHARE DATA:
                                       
Net income (loss) per share - fully diluted
 
$
1.66
   
$
1.49
   
$
1.31
   
$
1.10
   
$
(0.17
)
Cash dividends per share
   
0.40
     
0.32
     
0.12
     
-
     
-
 
Book value per share
   
18.01
     
16.72
     
15.66
     
14.45
     
14.18
 
Tangible book value per share
   
17.79
     
16.47
     
15.40
     
14.19
     
13.95
 
Average common shares outstanding
   
11,882,647
     
11,756,451
     
11,626,354
     
11,570,731
     
10,248,751
 
OTHER INFORMATION:
                                       
Number of full-time-equivalent employees
   
296
     
337
     
333
     
350
     
373
 
Number of branch offices
   
27
     
27
     
26
     
25
     
30
 
Number of ATMs
   
24
     
24
     
24
     
25
     
30
 
 
(1)
Excluding loans held-for-sale.
 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Safe Harbor Statement Pursuant to the Private Securities Litigation Reform Act of 1995

Certain statements contained in this document are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These can include remarks about the Company, the proposed merger with People’s United, the banking industry, the economy in general, expectations of the business environment in which the Company operates, projections of future performance, and potential future credit experience. These remarks are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified, that are beyond the Company’s control and that could cause future results to vary materially from the Company’s historical performance or from current expectations. These remarks may be identified by such forward-looking statements as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Factors that could affect the Company include particularly, but are not limited to: the ability to meet closing conditions to the merger with People’s United; delay in closing the merger; difficulties and delays in integrating the Company’s business or fully realizing cost savings and other benefits of the merger; business disruption following the merger; increased capital requirements mandated by the Company’s regulators, including the individual minimum capital requirements that the OCC established for the Bank; the Bank’s limitation on the growth of its commercial real estate (“CRE”) portfolio and the potentially adverse impact thereof on the Company’s overall business, financial condition and results of operation due to the importance of the Bank’s CRE business to the Company’s overall business, financial condition and results of operation; any failure by the Bank to comply with the individual minimum capital ratios (including as a result of increases to the Bank’s allowance for loan losses), which may result in  regulatory enforcement actions; the duration of the Bank’s limitation on the growth of its CRE portfolio, and the potentially adverse impact thereof on the Company’s overall business, financial condition and results of operation; the cost of compliance and significant amount of time required of management to comply with regulatory  requirements; results of changes in law, regulations or regulatory practices; the Company’s ability to raise capital; competitive factors, including price competition; changes in interest rates; increases or decreases in retail and commercial economic activity in the Company’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; the Company’s ability to attract and retain key management and staff; any failure by the Company to maintain effective internal control over financial reporting; larger-than-expected losses from the sale of assets; and the potential that net charge-offs are higher than expected or for increases in our provision for loan losses. Further, it could take the Company longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require the Company to change its practices in ways that materially change the results of operations. We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. For more information, see the risk factors described in this Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.

Non-GAAP Disclosure

This discussion includes non-GAAP financial measures of the Company’s tangible common equity (“TCE”)  ratio, tangible common equity, tangible assets, core net income, core fully taxable equivalent (“FTE”) net interest income, core FTE net interest margin, core operating expenses, core non-interest income, core FTE non-interest income and core operating efficiency ratio. A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The Company believes that these non-GAAP financial measures provide both management and investors a more complete understanding of the underlying operational results and trends and the Company’s marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with U.S. GAAP and may not be comparable to similarly titled measures used by other financial institutions.

With respect to the calculations and reconciliations of tangible common equity, tangible assets and the TCE ratio, please see Liquidity and Capital Resources contained herein. For the calculation and reconciliation of core FTE net interest margin, please see Material Changes in Results of Operations contained herein. For all other calculations and reconciliations pertaining to non-GAAP financial measures, please see Executive Summary contained herein.

Executive Summary

The Company is a one-bank holding company incorporated in 1985. The Company operates as the parent for its wholly owned subsidiary, the Bank, a national bank founded in 1890. The income of the Company is primarily derived through the operations of the Bank and the REIT.
 
On June 26, 2016, the Company entered into an Agreement and Plan of Merger (the “merger agreement”) with People’s United pursuant to which the Company will merge into People’s United (the “merger”). People’s United will be the surviving corporation in the merger. Subject to the terms and conditions of the merger agreement, the Company’s shareholders will have the right to receive 2.225 shares of People’s United common stock in exchange for each share of Company common stock. The merger agreement was adopted by the Company’s shareholders, and both the OCC and Federal Reserve Board have approved the merger. The merger remains subject to other customary conditions to closing.

The Bank is a full-service bank serving the needs of its local residents through 27 branch offices in Nassau, Suffolk and Queens Counties, New York. The Bank’s 27 branches include business banking centers in Long Island City, Melville and Garden City. In order to expand the Company geographically into western Suffolk, Nassau and Queens Counties and to diversify the lending business of the Company, loan production offices were opened in recent years in Long Island City, Garden City and Melville. As part of the Company’s strategy to move westward, the loan production office and business banking center branch in Long Island City serves Queens and nearby Brooklyn.

The Bank’s primary market area includes Suffolk County, Nassau County and New York City. The Bank offers a full line of domestic commercial and retail banking services. The Bank makes commercial real estate floating and fixed rate loans, multifamily and mixed use commercial loans primarily in the boroughs of New York City, commercial and industrial loans to manufacturers, wholesalers, distributors, developers/contractors and retailers and agricultural loans. The Bank also makes loans secured by residential mortgages, and both floating and fixed rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered.

The Bank finances most of its activities through a combination of deposits, including demand, savings, N.O.W. and money market deposits as well as time deposits, and borrowings which could include federal funds with correspondent banks, securities sold under agreements to repurchase and Federal Home Loan Bank (“FHLB”) short-term and long-term borrowings. The Company’s chief competition includes local banks within its market area, as well as New York City money center banks and regional banks.

During 2016, the Company became increasingly concerned with conditions in many of its local commercial real estate (“CRE”) markets, particularly those in the boroughs of New York City. The Company saw worrisome signs of markets that were becoming overheated and had also observed deterioration in underwriting standards elsewhere in the industry, which had often translated into borrower expectations for loan terms that the Company was not comfortable with. As it has consistently articulated, the Company will compete fiercely for good deals on price because of the significant cost of funds advantage it has over most of the industry. However, the Company will not compromise on credit quality. As a result of these concerns, the Company stopped accepting new applications for multifamily loans in the boroughs of New York City during the first quarter of 2016. The CRE lending market is also an area which has attracted significant regulatory scrutiny. The OCC, the Company’s primary bank regulator, has publicly expressed broadly applicable concerns over the last year about overheated conditions in many CRE markets. The OCC established individual minimum capital ratios for the Bank as a result of its concentration of CRE loans. In response, the Company decided to temporarily pull back from the CRE lending markets. Following the Company’s implementation of enhanced risk management processes in order to remain compliant with applicable regulatory guidance, the Company re-entered certain commercial real estate markets that it had backed away from, although it has no current plans to re-enter the multifamily lending markets in New York City. While this shift in focus could have a negative impact on the Company’s revenue and earnings growth, the Company believes it is prudent in the current environment.

The OCC has established individual minimum capital ratios for the Bank that requires it to maintain a tier 1 leverage ratio of at least 9%, a tier 1 risk-based capital ratio of at least 11% and a total risk-based capital ratio of at least 12%. At December 31, 2016, the Bank satisfied these capital ratios, although there is no guarantee that the Bank will be able to maintain compliance with these heightened capital ratios. The Company is exploring various options to ensure that it remains compliant with these capital requirements, including possible sales of selected investment securities and multifamily loans.

At December 31, 2016, the Company, on a consolidated basis, had total assets of $2.1 billion, total deposits of $1.8 billion and stockholders’ equity of $215 million. The Company recorded net income of $19.8 million during the full year ended December 31, 2016 versus $17.7 million in the comparable 2015 period. Excluding merger-related charges, net non-accrual interest received and OREO expenses incurred, core net income was $21.5 million for the full year of 2016. The improvement in reported 2016 net income resulted principally from a $4.3 million increase in net interest income coupled with a $1.1 million reduction in the provision for loan losses.  Partially offsetting these positive factors was a $1.4 million increase in total operating expenses, a $111 thousand reduction in non-interest income, and a $1.7 million increase in income tax expense reflecting the Company’s higher effective tax rate in 2016. Excluding merger-related expenses incurred in 2016 and systems conversion expenses incurred in 2015, total operating expenses increased by $375 thousand or 0.7% versus 2015.
 
 
(in thousands)
  
Years Ended December 31,
 
2016
   
2015
 
CORE NET INCOME:
           
Net income, as reported
 
$
19,831
   
$
17,687
 
                 
Adjustments:
               
Net non-accrual interest adjustment
   
(298
)
   
(1,248
)
Merger costs
   
2,434
     
-
 
Nonrecurring project costs
   
-
     
1,443
 
OREO-related expenses
   
113
     
-
 
Total adjustments, before income taxes
   
2,249
     
195
 
Adjustment for reported effective income tax rate
   
624
     
49
 
Total adjustments, after income taxes
   
1,625
     
146
 
                 
Core net income
 
$
21,456
   
$
17,833
 

The Company’s return on average assets and return on average common stockholders’ equity were 0.90% and 9.54%, respectively, for the year ended December 31, 2016 versus 0.89% and 9.27%, respectively, for the comparable 2015 period.

Total loans at December 31, 2016 were $1.7 billion, representing a 0.6% increase from the comparable 2015 date. The modest loan growth in 2016 compared to 2015 reflected the Company’s previously announced decision to temporarily pull back from certain commercial lending markets during the middle of 2016. In addition, $77 million in multi-family loans were sold during 2016, including approximately $28 million during the fourth quarter, in order to generate non-interest income, protect net interest margin and avoid becoming too concentrated in a single product line. Notwithstanding these factors, the Company believes it is building a strong and diversified loan pipeline for the future.

The credit quality of the Company’s loan portfolio continues to be strong. Management remains vigilant in ensuring that credit quality is not compromised, with lending and credit teams working together to manage risk and maintain strong credit standards. Total non-accrual loans were $5.6 million or 0.33% of loans outstanding at December 31, 2016 versus $5.5 million or 0.33% of loans outstanding at December 31, 2015. Total accruing loans delinquent 30 days or more were $1.2 million or 0.07% of loans outstanding at December 31, 2016 compared to $1.0 million or 0.06% of loans outstanding at December 31, 2015. The allowance for loan losses totaled $20.1 million at December 31, 2016 versus $20.7 million at December 31, 2015, representing 1.20% and 1.24% of total loans, respectively, at such dates. The allowance for loan losses as a percentage of non-accrual loans was 362% and 374% at December 31, 2016 and 2015, respectively.

Total core deposits, consisting of demand, N.O.W., savings and money market accounts were $1.6 billion at December 31, 2016, representing 89% of total deposits at that date. Total deposits, including time deposits, were $1.8 billion at December 31, 2016, representing a 3.2% increase when compared to December 31, 2015. In addition, at December 31, 2016, 47% of the Company’s total deposits were non-interest bearing demand deposits, resulting in a full year cost of funds of 20 basis points and an FTE net interest margin and core FTE net interest margin of 3.77% and 3.71%, respectively, for the full year of 2016. The Company’s cost of funds and resulting margin compared favorably to most of the industry for the same full year period.
 
The Company’s core operating efficiency ratio improved during the full year of 2016 to 61.9%, from 64.9% in the comparable 2015 period.

 
(dollars in thousands)
  
Years Ended December 31,
 
2016
   
2015
 
             
Core operating expenses:
           
Total operating expenses
 
$
55,320
   
$
53,954
 
Adjust for merger costs
   
(2,434
)
   
-
 
Adjust for nonrecurring project costs
   
-
     
(1,443
)
Adjust for OREO-related expenses
   
(113
)
   
-
 
Core operating expenses
   
52,773
     
52,511
 
Core non-interest income:
               
Total non-interest income
   
8,483
     
8,594
 
Adjustments
   
-
     
-
 
Core non-interest income
   
8,483
     
8,594
 
Adjust for tax-equivalent basis
   
898
     
833
 
Core FTE non-interest income
   
9,381
     
9,427
 
Core operating efficiency ratio:
               
Core operating expenses
   
52,773
     
52,511
 
Core FTE net interest income
   
76,543
     
71,845
 
Core FTE non-interest income
   
9,381
     
9,427
 
Adjust for net gain on sale of securities available for sale
   
(617
)
   
(319
)
Core total FTE revenue
   
85,307
     
80,953
 
Core operating expenses/core total FTE revenue
   
61.86
%
   
64.87
%

The Company believes it has made significant progress toward ensuring a smooth and successful integration in connection with the pending merger with People’s United. With an effort toward leveraging the strengths of the combined institutions for the benefit of all current and future stakeholders, respective teams from both institutions have continued to work closely and cooperatively.

Critical Accounting Policies, Judgments and Estimates

The Company’s accounting and reporting policies conform to U.S. GAAP and general practices within the banking industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

Allowance for Loan Losses  - One  of  the  most  critical  accounting policies impacting the Company’s financial statements is the evaluation of the allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a quarterly analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company’s own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate, multifamily, mixed use commercial, real estate construction and residential mortgages loan classes and all troubled debt restructurings (“TDRs”) are evaluated individually for impairment. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics. These classes are commercial and industrial, commercial real estate, multifamily, mixed use commercial, real estate construction, residential mortgages, home equity and consumer loans.

The allowance for loan losses consists of specific and general components, as well as an unallocated component. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment or liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on the fair market value of collateral and the estimated time required to recover the Company’s investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan’s effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the estimated collectability of the loan class not captured by historical loss data. These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors include consideration of the following: levels and trends in various risk rating categories; levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability, and depth of lending management and other relevant staff; local, regional and national economic trends and conditions; industry conditions; and effects of changes in credit concentrations. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. These adjustments reflect management’s overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
Deferred Tax Assets and Liabilities – Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities, computed using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.  The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers all relevant positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and available tax planning strategies.

Other-Than-Temporary Impairment (“OTTI”) of Investment Securities – Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of income and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

Material Changes in Financial Condition

Total assets of the Company were $2.1 billion at December 31, 2016. When compared to December 31, 2015, total assets decreased by $76 million. This change was primarily due to a decrease in the investment portfolio of $110 million, partially offset by loan growth and an increase in total cash and cash equivalents of $10 million and $27 million, respectively.

Total investment securities were $198 million at December 31, 2016 and $308 million at December 31, 2015. The decrease in the investment portfolio largely reflected maturities and calls of municipal obligations and U.S. Government agency securities totaling $105 million, coupled with principal paydowns of CMOs and MBS of U.S. Government-sponsored enterprises totaling $8 million and sales of municipal obligations totaling $7 million during 2016. These decreases were partially offset by purchases of CMOs and MBS of U.S. Government-sponsored enterprises, corporate bonds and municipal obligations totaling $13 million during the same period. The available for sale securities portfolio had an unrealized pre-tax gain of $172 thousand at December 31, 2016 compared to a gain of $2.4 million at year-end 2015.

Total loans were $1.7 billion at December 31, 2016, an increase of 0.6% when compared to December 31, 2015. The modest increase in the loan portfolio was primarily due to the $35 million growth in commercial real estate loans, partially offset by a decrease in multifamily loans of $24 million in 2016.

At December 31, 2016, total deposits were $1.8 billion, an increase of $58 million when compared to December 31, 2015. This increase was primarily due to an increase in core deposit balances of $85 million, partially offset by a decrease in time deposit balances of $27 million over the same period. Core deposit balances, which consist of demand, N.O.W., savings and money market deposits, represented 89% of total deposits at December 31, 2016 and 87% of total deposits at December 31, 2015. Demand deposit balances represented 47% and 44% of total deposits at December 31, 2016 and 2015, respectively. At December 31, 2016 and 2015, the Company had $15 million and $165 million, respectively, in borrowings.
 
Material Changes in Results of Operations

2016 versus 2015

The Company recorded net income of $19.8 million during the full year ended December 31, 2016 versus $17.7 million in the comparable 2015 period. Excluding merger-related charges, net non-accrual interest received and OREO expenses incurred, core net income was $21.5 million for the full year of 2016. The improvement in reported 2016 net income resulted principally from a $4.3 million increase in net interest income coupled with a $1.1 million reduction in the provision for loan losses.  Partially offsetting these positive factors was a $1.4 million increase in total operating expenses, a $111 thousand reduction in non-interest income, and a $1.7 million increase in income tax expense reflecting the Company’s higher effective tax rate in 2016. Excluding merger-related expenses incurred in 2016 and systems conversion expenses incurred in 2015, total operating expenses increased by $375 thousand or 0.7% versus 2015.

The $4.3 million or 6.1% improvement in full year 2016 net interest income resulted from a $201 million increase in average total interest-earning assets, offset in part by a 21 basis point contraction of the Company’s net interest margin to 3.77% in 2016 from 3.98% in 2015. (See also Distribution of Assets, Liabilities and Stockholders’ Equity: Net Interest Income and Rates and Analysis of Changes in Net Interest Income contained herein.) Excluding the impact of net non-accrual interest received in each full year period, the Company’s core FTE net interest margin was 3.71% in 2016 versus 3.91% in 2015.

   
Years Ended December 31,
 
($ in thousands)
 
2016
   
2015
 
CORE NET INTEREST INCOME/MARGIN:
                       
Net interest income/margin (FTE)
 
$
76,841
     
3.77
%
 
$
73,093
     
3.98
%
                                 
Net non-accrual interest adjustment
   
(298
)
   
(0.06
%)
   
(1,248
)
   
(0.07
%)
                                 
Core net interest income/margin (FTE)
 
$
76,543
     
3.71
%
 
$
71,845
     
3.91
%

The Company’s full year 2016 average total interest-earning asset yield was 3.96% versus 4.15% in the comparable 2015 period. A lower average yield on the Company’s loan portfolio in 2016 versus the comparable 2015 period, down 13 basis points to 4.17%, was the primary driver of the reduction in the interest-earning asset yield. The Company’s average loan portfolio increased by $230 million (15.6%) versus 2015 while the average securities portfolio decreased by $86 million (25.4%) to $251 million in the same period.  The average yield on the investment portfolio was 3.58% in 2016 versus 3.71% a year ago.

The Company’s average cost of total interest-bearing liabilities increased by three basis points to 0.35% in 2016 versus 0.32% in the comparable 2015 full year period. The Company’s total cost of funds increased by two basis points to 0.20% in 2016 versus 2015. Average core deposits increased by $214 million (14.6%) to $1.7 billion during the 2016 full year period compared to 2015, with average demand deposits representing 44% of full year 2016 average total deposits. Average total deposits increased by $205 million or 12.1% to $1.9 billion during in 2016 versus 2015. Average core deposit balances represented 88% of average total deposits in 2016 compared to 86% in the year ago period.

The Company recorded a $500 thousand credit to the provision for loan losses during 2016 versus a provision expense of $600 thousand a year ago.

Total operating expenses increased by $1.4 million (2.5%) in the full year 2016 versus 2015 principally due to $2.4 million in merger-related expenses coupled with growth in employee compensation and benefits expense (up $1.6 million), offset in part by reductions in non-recurring project costs (systems conversion expenses) and data processing costs of $1.4 million and $1.3 million, respectively.

The Company recorded income tax expense of $7.6 million in the 2016 full year period resulting in an effective tax rate of 27.8% versus income tax expense of $5.9 million and an effective tax rate of 25.0% in the comparable 2015 period. The increase in the effective tax rate in 2016 versus 2015 resulted primarily from a decrease in tax-exempt municipal securities income due to a significant amount of bonds maturing during 2016.

2015 versus 2014

The Company recorded net income of $17.7 million during the full year ended December 31, 2015 versus $15.3 million in the comparable 2014 period.  The 15.6% improvement in 2015 net income resulted principally from a $7.0 million increase in net interest income coupled with a $400 thousand decline in the provision for loan losses. Partially offsetting these positive factors was a $2.3 million reduction in non-interest income, an increase in total operating expenses of $535 thousand and a higher effective tax rate in 2015.  Excluding the after-tax impact of the $1.4 million fourth quarter 2015 systems conversion expense, net income in 2015 would have been $18.8 million, an increase of 22.7% versus the 2014 full year period.
 
The $7.0 million or 11.2% improvement in 2015 net interest income resulted from a $206 million increase in average total interest-earning assets, offset in part by a nine basis point contraction of the Company’s net interest margin to 3.98% in 2015 from 4.07% in 2014. Adjusting for the impact of net non-accrual interest received in each period, the Company’s core net interest margin was 3.91% for the year ended December 31, 2015 versus 4.02% for the comparable 2014 period.

The Company’s full year 2015 average total interest-earning asset yield was 4.15% versus 4.23% in the comparable 2014 period. A lower average yield on the Company’s loan portfolio in 2015 versus the comparable 2014 period, down 24 basis points to 4.30%, was the primary contributing factor in the reduction in the interest-earning asset yield.  The Company’s average balance sheet mix continued to improve in 2015 as average loans increased by $284 million (23.8%) versus the 2014 full year and low-yielding overnight interest-bearing deposits, federal funds sold and securities purchased under agreements to resell declined by $27 million during the same period. The average securities portfolio decreased by $54 million to $337 million in 2015 versus 2014.  The average yield on the investment portfolio was 3.71% in the 2015 period versus 3.73% in 2014.

The Company’s average cost of total interest-bearing liabilities increased by four basis points to 0.32% in 2015 versus 0.28% in the comparable 2014 period. The Company’s total cost of funds was 0.18% in 2015 versus 0.16% in 2014. Average core deposits increased by $140 million to $1.5 billion during 2015 versus the comparable 2014 period, with average demand deposits representing 44% of full year 2015 average total deposits. Average total deposits increased by $143 million or 9.2% to $1.7 billion during 2015 versus 2014. Average core deposit balances represented 86% of average total deposits during the 2015 period. Average borrowings increased by $62 million during 2015 compared to 2014 and represented 4.2% of total average funding during 2015.

Due to a combination of improved credit metrics coupled with $885 thousand in 2015 full year net loan recoveries, the Company’s provision for loan losses declined by $400 thousand in 2015 versus 2014.

Non-interest income declined by $2.3 million or 21.2% in the 2015 full year period when compared to 2014.  This reduction was due to several factors, most notably reductions in net gain on sale of premises and equipment (down $751 thousand), fiduciary fees (down $1.0 million), service charges on deposit accounts (down $639 thousand) and other service charges, commissions and fees (down $366 thousand). The reduction in net gain on sale of premises and equipment resulted from gains recorded in 2014 on the sale of two bank properties. Fiduciary fees declined as a result of the Company’s sale of its wealth management business in 2014. Deposit service charges declined principally due to a reduction in overdraft and demand deposit account analysis fees in 2015. Other service charges, commissions and fees were lower than the comparable 2014 period primarily as the result of a reduction in income from the sale of investment products through the Company’s branch network. Partially offsetting the foregoing reductions in non-interest income were increases in net gain on sale of securities available for sale (up $300 thousand) and net gain on sale of portfolio loans (up $351 thousand).

Total operating expenses increased by $535 thousand in 2015 versus 2014 principally due to the $1.4 million fourth quarter 2015 systems conversion expense coupled with a $449 thousand branch consolidation expense credit recorded in 2014.  Excluding the impact of these two items, total operating expenses would have declined by $1.4 million or 2.5% when compared to 2014.  The net reduction in operating expenses, excluding these items, resulted from reductions in several categories, most notably employee compensation and benefits (down $1.1 million) and consulting and professional services (down $467 thousand). The decrease in employee compensation and benefits reflected lower expense levels for incentive compensation, pension, 401(k) and medical insurance in 2015.

The Company recorded income tax expense of $5.9 million in 2015 resulting in an effective tax rate of 25.0% versus an income tax expense of $3.7 million and an effective tax rate of 19.6% in the comparable 2014 period. The increase in the 2015 effective tax rate resulted from growth in pre-tax income taxed at the 35% federal rate, coupled with a reduction in tax-exempt income versus the comparable 2014 period. The 2014 effective tax rate also reflected a net tax benefit arising from changes in New York State tax law made in that period coupled with an adjustment related to stock-based compensation.
 
Distribution of Assets, Liabilities and Stockholders’ Equity: Net Interest Income and Rates

The following table presents the average daily balances of the Company’s assets, liabilities and stockholders’ equity, together with an analysis of net interest earnings and average rates, for each major category of interest-earning assets and interest-bearing liabilities. Interest and average rates are computed on a fully taxable-equivalent basis (dollars in thousands):
For the Years Ended December 31,
 
2016
   
2015
   
2014
 
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
 
Interest-earning assets
                                                     
Securities:
                                                     
Taxable
 
$
154,425
   
$
3,712
     
2.40
%
 
$
202,399
   
$
4,750
     
2.35
%
 
$
226,603
   
$
5,369
     
2.37
%
Tax-exempt
   
96,894
     
5,283
     
5.45
     
134,651
     
7,752
     
5.76
     
164,439
     
9,200
     
5.59
 
Total securities
   
251,319
     
8,995
     
3.58
     
337,050
     
12,502
     
3.71
     
391,042
     
14,569
     
3.73
 
Federal Reserve and Federal Home Loan Bank stock and other investments
   
6,488
     
332
     
5.12
     
6,505
     
280
     
4.30
     
3,511
     
152
     
4.33
 
Federal funds sold, securities purchased under agreements to resell and interest-bearing deposits due from banks
   
74,443
     
354
     
0.48
     
18,649
     
62
     
0.33
     
45,436
     
150
     
0.33
 
Loans and performing loans held for sale (including non-accrual loans):
                                                                       
Taxable
   
1,660,020
     
68,642
     
4.14
     
1,448,851
     
62,023
     
4.28
     
1,167,719
     
52,766
     
4.52
 
Tax-exempt
   
46,243
     
2,447
     
5.29
     
26,922
     
1,473
     
5.47
     
23,972
     
1,287
     
5.37
 
Total loans
   
1,706,263
     
71,089
     
4.17
     
1,475,773
     
63,496
     
4.30
     
1,191,691
     
54,053
     
4.54
 
Total interest-earning assets
   
2,038,513
   
$
80,770
     
3.96
%
   
1,837,977
   
$
76,340
     
4.15
%
   
1,631,680
   
$
68,924
     
4.23
%
Cash and due from banks
   
71,727
                     
70,995
                     
57,917
                 
Other non-interest-earning assets
   
84,159
                     
75,608
                     
71,910
                 
Total assets
 
$
2,194,399
                   
$
1,984,580
                   
$
1,761,507
                 
                                                                         
Interest-bearing liabilities
                                                                       
Savings, N.O.W. and money market deposits
 
$
846,543
   
$
2,084
     
0.25
%
 
$
721,989
   
$
1,383
     
0.19
%
 
$
665,626
   
$
1,162
     
0.17
%
Time deposits
   
221,695
     
1,305
     
0.59
     
230,546
     
1,422
     
0.62
     
226,998
     
1,309
     
0.58
 
Total savings and time deposits
   
1,068,238
     
3,389
     
0.32
     
952,535
     
2,805
     
0.29
     
892,624
     
2,471
     
0.28
 
Federal funds purchased
   
3
     
-
     
0.76
     
3
     
-
     
0.45
     
8
     
-
     
0.46
 
Other borrowings
   
62,315
     
540
     
0.87
     
74,743
     
442
     
0.59
     
13,051
     
48
     
0.37
 
Total interest-bearing liabilities
   
1,130,556
     
3,929
     
0.35
     
1,027,281
     
3,247
     
0.32
     
905,683
     
2,519
     
0.28
 
Total cost of funds
                   
0.20
                     
0.18
                     
0.16
 
Rate spread
                   
3.61
                     
3.83
                     
3.95
 
Demand deposits
   
832,266
                     
742,876
                     
659,463
                 
Other non-interest-bearing liabilities
   
23,684
                     
23,638
                     
17,812
                 
Total liabilities
   
1,986,506
                     
1,793,795
                     
1,582,958
                 
Stockholders' equity
   
207,893
                     
190,785
                     
178,549
                 
Total liabilities and stockholders' equity
 
$
2,194,399
                   
$
1,984,580
                   
$
1,761,507
                 
Net interest income (taxable- equivalent basis) and interest rate margin
           
76,841
     
3.77
   
%
       
73,093
     
3.98
%
           
66,405
     
4.07
%
Less: taxable-equivalent basis adjustment
           
(3,051
)
                   
(3,560
)
                   
(3,871
)
       
Net interest income
         
$
73,790
                   
$
69,533
                   
$
62,534
         

Interest income on a taxable-equivalent basis includes the additional amount of interest income that would have been earned if the Company’s investment in tax-exempt securities and loans had been subject to federal and New York State income taxes yielding the same after-tax income. The rate used for this adjustment was approximately 35% for federal income taxes in 2016, 2015 and 2014, 4.5% for New York State income taxes in 2016 and 2015, and 3.5% for New York State income taxes in 2014. Loan fees included in interest income amounted to $1.9 million, $1.8 million and $1.5 million in 2016, 2015 and 2014, respectively.
 
Analysis of Changes in Net Interest Income

The following table presents a comparative analysis of the changes in the Company’s interest income and interest expense due to the changes in the average volume and the average rates earned on interest-earning assets and due to the changes in the average volume and the average rates paid on interest-bearing liabilities. Interest and average rates are computed on a fully taxable-equivalent basis. Variances in rate/volume relationships have been allocated proportionately to the amount of change in average volume and average rate (in thousands):
 
 
In 2016 over 2015
Changes Due to
   
In 2015 over 2014
Changes Due to
 
   
Volume
   
Rate
   
Net
Change
   
Volume
   
Rate
   
Net
Change
 
Interest-earning assets
                                   
Securities:
                                   
Taxable
 
$
(1,145
)
 
$
107
   
$
(1,038
)
 
$
(568
)
 
$
(51
)
 
$
(619
)
Tax-exempt
   
(2,074
)
   
(395
)
   
(2,469
)
   
(1,708
)
   
260
     
(1,448
)
Total securities
   
(3,219
)
   
(288
)
   
(3,507
)
   
(2,276
)
   
209
     
(2,067
)
Federal Reserve and Federal Home Loan Bank stock and other investments
   
(1
)
   
53
     
52
     
129
     
(1
)
   
128
 
Federal funds sold, securities purchased under agreements to resell and interest-bearing deposits due from banks
   
255
     
37
     
292
     
(88
)
   
-
     
(88
)
Loans and performing loans held for sale (including non-accrual loans):
                                               
Taxable
   
8,778
     
(2,159
)
   
6,619
     
12,171
     
(2,914
)
   
9,257
 
Tax-exempt
   
1,023
     
(49
)
   
974
     
161
     
25
     
186
 
Total loans
   
9,801
     
(2,208
)
   
7,593
     
12,332
     
(2,889
)
   
9,443
 
Total interest-earning assets
   
6,836
     
(2,406
)
   
4,430
     
10,097
     
(2,681
)
   
7,416
 
                                                 
Interest-bearing liabilities
                                               
Savings, N.O.W. and money market deposits
   
251
     
450
     
701
     
101
     
120
     
221
 
Time deposits
   
(47
)
   
(70
)
   
(117
)
   
28
     
85
     
113
 
Total savings and time deposits
   
204
     
380
     
584
     
129
     
205
     
334
 
Federal funds purchased
   
-
     
-
     
-
     
-
     
-
     
-
 
Other borrowings
   
(84
)
   
182
     
98
     
350
     
44
     
394
 
Total interest-bearing liabilities
   
120
     
562
     
682
     
479
     
249
     
728
 
Net change in net interest income (taxable-equivalent basis)
 
$
6,716
   
$
(2,968
)
 
$
3,748
   
$
9,618
   
$
(2,930
)
 
$
6,688
 

Investment Securities

The Company’s investment policy is conservative in nature and investment securities are purchased only after a disciplined evaluation to ensure that they are the most appropriate asset available given the Company’s objectives. Several key factors are considered before executing any transaction including:

·
Liquidity – the ease with which the security can be pledged or sold.

·
Credit quality – the likelihood the security will perform according to its original terms with timely payments of principal and interest.

·
Yield – the rate of return on the investment balanced against liquidity and credit quality.

The Company also considers certain key risk factors in its selection of investment securities:

·
Market risk – can be defined as the sensitivity of the portfolio’s market value to changes in the level of interest rates.  Generally, the market value of fixed-rate securities increases when interest rates fall and decreases when interest rates rise. The longer the duration of the security, the greater sensitivity to changes in interest rates.

·
Income risk – is identified as the time period over which fixed payments associated with an investment security can be assured. Generally, the shorter the duration of the security, the greater this risk.

·
Asset/liability management – seeks to limit the change in net interest income as a result of changing interest rates.  In a rising rate environment when the maturities or the intervals between the repricing of investments are longer than those of the liabilities that fund them, net interest income will decline. This is referred to as a liability-sensitive position. Conversely, when investments mature or are repriced sooner than their funding sources, net interest income will increase as interest rates rise. This is known as an asset-sensitive position. Asset/liability management attempts to manage the duration of the loan and investment portfolios, as well as that of all funding, to minimize the risk to net interest income while maximizing returns. Security selection is governed by the Company’s investment policy and serves to supplement the Company’s asset/liability position.
 
The Company seeks to create an investment portfolio that is diversified across different classes of assets. At December 31, 2016, the majority of the Company’s portfolio consisted of investments in municipal securities and mortgage-backed securities (“MBS”). To a lesser extent, the Company also has CMOs, corporate bonds and U,S, Government agency obligations. MBS are backed by a pool of mortgages in which investors share payments based on the percentage of the pool they own. The cash flows associated with CMOs are assigned to specific securities, or tranches, in the order in which they are received. Analysis of CMOs requires careful due diligence of the mortgages that serve as the underlying collateral. The Company does not own any mortgage obligations with underlying collateral that could be classified as sub-prime. Tranche structure, final maturity and credit support also provide improved assurance of repayment. The investment portfolio provides collateral for various liabilities to municipal depositors as well as enhances the Company’s liquidity position through cash flows and the ability to pledge these assets to secure various borrowing lines. Management has determined that no OTTI was present at December 31, 2016.

The Company’s average investment portfolio decreased by $86 million to $251 million in 2016 compared to $337 million in 2015. The decrease in the investment portfolio largely reflected maturities and calls of municipal obligations and U.S. Government agency securities totaling $105 million, coupled with principal paydowns of CMOs and MBS of U.S. Government-sponsored enterprises totaling $8 million and sales of municipal obligations totaling $7 million during 2016. These decreases were partially offset by purchases of CMOs and MBS of U.S. Government-sponsored enterprises, corporate bonds and municipal obligations totaling $13 million during the same period. The components of the average investment portfolio and the year-over-year net changes in average balances are presented below (in thousands).
 
For the Years Ended December 31,
 
2016
   
2015
       
   
Average Balance
   
Net Change
 
U.S. Government agency securities
 
$
28,048
   
$
85,034
   
$
(56,986
)
Corporate bonds
   
14,347
     
8,460
     
5,887
 
Collateralized mortgage obligations
   
17,879
     
18,965
     
(1,086
)
Mortgage-backed securities
   
94,151
     
89,940
     
4,211
 
Obligations of states and political subdivisions
   
96,894
     
134,651
     
(37,757
)
Total investment securities
 
$
251,319
   
$
337,050
   
$
(85,731
)

The following table summarizes, at carrying value, the Company’s investment securities available for sale and held to maturity for each period (in thousands):

At December 31,
 
2016
   
2015
 
Investment securities available for sale:
           
U.S. Government agency securities
 
$
-
   
$
28,516
 
Corporate bonds
   
8,535
     
5,910
 
Collateralized mortgage obligations
   
17,452
     
15,549
 
Mortgage-backed securities
   
87,961
     
92,442
 
Obligations of states and political subdivisions
   
65,294
     
104,682
 
Total investment securities available for sale
   
179,242
     
247,099
 
Investment securities held to maturity:
               
U.S. Government agency securities
   
2,380
     
43,570
 
Corporate bonds
   
6,000
     
6,000
 
Obligations of states and political subdivisions
   
10,400
     
11,739
 
Total investment securities held to maturity
   
18,780
     
61,309
 
Total investment securities
 
$
198,022
   
$
308,408
 
 
The following table presents the distribution, by contractual maturity and the approximate weighted-average yields, of the Company’s investment portfolio at December 31, 2016 (dollars in thousands). All securities are presented at their carrying amounts.

   
Maturity (in years)
             
   
Within 1
   
Yield
   
After 1 but
within 5
   
Yield
   
After 5 but
within 10
   
Yield
   
After 10
   
Yield
   
Total
   
Yield
 
Investment securities available for sale:
                                                           
Corporate bonds
 
$
-
     
-
%
 
$
-
     
-
%
 
$
8,535
     
3.69
%
 
$
-
     
-
%
 
$
8,535
     
3.69
%
Collateralized mortgage obligations (1)
   
-
     
-
     
17,452
     
1.89
     
-
     
-
     
-
     
-
     
17,452
     
1.89
 
Mortgage-backed securities (1)
   
6,221
     
1.52
     
70,226
     
2.01
     
11,514
     
2.45
     
-
     
-
     
87,961
     
2.03
 
Obligations of states and political subdivisions (2)
   
20,610
     
6.04
     
44,089
     
5.55
     
595
     
5.71
     
-
     
-
     
65,294
     
5.71
 
Total investment securities available for sale
   
26,831
     
4.99
     
131,767
     
3.18
     
20,644
     
3.06
     
-
     
-
     
179,242
     
3.44
 
Investment securities held to maturity:
                                                                               
U.S. Government agency securities
   
-
     
-
     
-
     
-
     
2,380
     
2.30
     
-
     
-
     
2,380
     
2.30
 
Corporate bonds
   
-
     
-
     
-
     
-
     
6,000
     
5.50
     
-
     
-
     
6,000
     
5.50
 
Obligations of states and political subdivisions (2)
   
2,636
     
6.72
     
1,253
     
4.60
     
-
     
-
     
6,511
     
5.23
     
10,400
     
5.53
 
Total investment securities held to maturity
   
2,636
     
6.72
     
1,253
     
4.60
     
8,380
     
4.59
     
6,511
     
5.23
     
18,780
     
5.11
 
Total investment securities
 
$
29,467
     
5.15
%
 
$
133,020
     
3.19
%
 
$
29,024
     
3.50
%
 
$
6,511
     
5.23
%
 
$
198,022
     
3.59
%
(1)
Assumes maturity dates pursuant to average lives.
(2)
The yields on obligations of states and political subdivisions are on a fully taxable-equivalent basis.

As a member of the Federal Reserve Bank (“FRB”) and the FHLB, the Bank owned 28,960 shares and 27,939 shares of FRB and FHLB stock, respectively, with book values of $1.4 million and $2.8 million, respectively, at December 31, 2016. There is no public market for these shares. The last dividends paid were 6.00% on FRB stock in December 2016 and 5.00% on FHLB stock in November 2016.

The Bank was a member of the Visa USA payment network and was issued Class B shares upon Visa’s initial public offering in March 2008. The Visa Class B shares are transferable only under limited circumstances until they can be converted into shares of the publicly traded class of stock. This conversion cannot happen until the settlement of certain litigation, which is indemnified by Visa members. Since its initial public offering, Visa has funded a litigation reserve based upon a change in the conversion ratio of Visa Class B shares into Visa Class A shares. At its discretion, Visa may continue to increase the conversion rate in connection with any settlements in excess of amounts then in escrow for that purpose and reduce the conversion rate to the extent that it adds any funds to the escrow in the future. Based on the existing transfer restriction and the uncertainty of the litigation, the Company has recorded its Visa Class B shares on its balance sheet at zero value.

In conjunction with the sale of Visa Class B shares in 2013, the Company entered into derivative swap contracts with the purchaser of these Visa Class B shares which provide for settlements between the purchaser and the Company based upon a change in the conversion ratio of Visa Class B shares into Visa Class A shares. At December 31, 2016, the Company still owned 38,638 Visa Class B shares.

Loans and the Allowance for Loan Losses

The following table categorizes the Company’s loan portfolio for each period (dollars in thousands):

At December 31,
 
2016
   
2015
   
2014
   
2013
         
2012
       
Commercial and industrial
 
$
189,410
     
11.3
%
 
$
189,769
     
11.4
%
 
$
177,813
     
13.1
%
 
$
171,199
     
16.0
%
 
$
168,709
     
21.6
%
Commercial real estate
   
731,986
     
43.7
     
696,787
     
41.8
     
560,524
     
41.4
     
464,560
     
43.5
     
359,211
     
46.0
 
Multifamily
   
402,935
     
24.0
     
426,549
     
25.6
     
309,666
     
22.8
     
184,624
     
17.3
     
9,261
     
1.2
 
Mixed use commercial
   
78,807
     
4.7
     
78,787
     
4.7
     
34,806
     
2.6
     
4,797
     
0.4
     
799
     
0.1
 
Real estate construction
   
41,028
     
2.5
     
37,233
     
2.2
     
26,206
     
1.9
     
6,565
     
0.6
     
15,469
     
2.0
 
Residential mortgages
   
185,112
     
11.0
     
186,313
     
11.2
     
187,828
     
13.9
     
169,552
     
15.9
     
146,575
     
18.8
 
Home equity
   
42,419
     
2.5
     
44,951
     
2.7
     
50,982
     
3.8
     
57,112
     
5.3
     
66,468
     
8.5
 
Consumer
   
4,867
     
0.3
     
6,058
     
0.4
     
7,602
     
0.5
     
10,439
     
1.0
     
14,288
     
1.8
 
Total loans
 
$
1,676,564
     
100.0
%
 
$
1,666,447
     
100.0
%
 
$
1,355,427
     
100.0
%
 
$
1,068,848
     
100.0
%
 
$
780,780
     
100.0
%
 
The following table presents the contractual maturities of selected loans and the sensitivities of those loans to changes in interest rates at December 31, 2016 (in thousands):

   
One Year or
Less
   
One Through
Five Years
   
Over Five
Years
   
Total
 
Commercial and industrial
 
$
98,059
   
$
72,106
   
$
19,245
   
$
189,410
 
Real estate construction
   
33,205
     
428
     
7,395
     
41,028
 
Total
 
$
131,264
   
$
72,534
   
$
26,640
   
$
230,438
 
Loans maturing after one year with:
                               
Fixed interest rate
         
$
44,155
   
$
18,468
   
$
62,623
 
Variable interest rate
         
$
28,379
   
$
8,172
   
$
36,551
 

Non-performing loans are defined as non-accrual loans and loans 90 days or more past due and still accruing. Recognition of interest income is discontinued when reasonable doubt exists as to whether principal or interest due can be collected. Loans of all classes will generally no longer accrue interest when over 90 days past due unless the loan is well-secured and in process of collection.

The following table shows non-performing loans for each period (in thousands):

At December 31,
 
2016
   
2015
   
2014
   
2013
   
2012
 
Non-accrual loans
 
$
5,560
   
$
5,528
   
$
12,981
   
$
15,183
   
$
16,435
 
Loans 90 days or more past due and still accruing
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
5,560
   
$
5,528
   
$
12,981
   
$
15,183
   
$
16,435
 

Non-accrual loans totaled $5.6 million or 0.33% of loans outstanding at December 31, 2016 versus $5.5 million or 0.33% of loans outstanding at December 31, 2015. The allowance for loan losses as a percentage of total non-accrual loans amounted to 362% and 374% at December 31, 2016 and December 31, 2015, respectively. Total accruing loans delinquent 30 days or more amounted to $1.2 million or 0.07% of loans outstanding at December 31, 2016 compared to $1.0 million or 0.06% of loans outstanding at December 31, 2015.

Total criticized and classified loans were $30 million at December 31, 2016 versus $21 million at December 31, 2015. Criticized loans are those loans that are not classified but require some degree of heightened monitoring. Classified loans were $25 million at December 31, 2016 as compared to $12 million at December 31, 2015. As a result of the Company’s conservative approach to risk rating its loan portfolio, two performing relationships were downgraded in 2016 which accounted for the majority of the increase in classified loans. The allowance for loan losses as a percentage of total classified loans was 82% and 170%, respectively, at the same dates.

At December 31, 2016, the Company had $12 million in TDRs, primarily consisting of commercial and industrial loans, commercial real estate loans, residential mortgages and home equity loans totaling $4 million, $2 million, $5 million and $1 million, respectively. The Company had TDRs amounting to $12 million at December 31, 2015.

At December 31, 2016, the Company’s allowance for loan losses amounted to $20.1 million or 1.20% of period-end total loans outstanding. The allowance as a percentage of loans outstanding was 1.24% at December 31, 2015.  The Company recorded net loan charge-offs of $68 thousand in 2016 versus net loan recoveries of $885 thousand in 2015. As a percentage of average total loans outstanding, these amounts represented 0.00% and (0.06%), respectively, in 2016 and 2015.
 
The following table presents an analysis of the Company’s allowance for loan losses for each period (dollars in thousands):

   
2016
   
2015
   
2014
   
2013
   
2012
 
Balance, January 1
 
$
20,685
   
$
19,200
   
$
17,263
   
$
17,781
   
$
39,958
 
Charge-offs:
                                       
Commercial and industrial
   
416
     
744
     
420
     
2,867
     
8,534
 
Commercial real estate
   
103
     
-
     
-
     
383
     
15,794
 
Real estate construction
   
-
     
-
     
-
     
-
     
3,671
 
Residential mortgages
   
-
     
-
     
32
     
126
     
3,727
 
Home equity
   
19
     
-
     
-
     
558
     
1,953
 
Consumer
   
72
     
14
     
40
     
166
     
267
 
Total charge-offs
   
610
     
758
     
492
     
4,100
     
33,946
 
Recoveries:
                                       
Commercial and industrial
   
264
     
1,524
     
797
     
2,077
     
2,456
 
Commercial real estate
   
210
     
39
     
519
     
97
     
-
 
Real estate construction
   
-
     
-
     
-
     
-
     
340
 
Residential mortgages
   
42
     
32
     
16
     
5
     
115
 
Home equity
   
13
     
22
     
50
     
32
     
246
 
Consumer
   
13
     
26
     
47
     
121
     
112
 
Total recoveries
   
542
     
1,643
     
1,429
     
2,332