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CHEMUNG FINANCIAL CORP - Quarter Report: 2013 March (Form 10-Q)

chmg10q03312013.htm
 
 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
 
FORM 10-Q
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For Quarterly period ended March 31, 2013
Or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File No. 0-13888
 
CHEMUNG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
New York
16-1237038
(State or other jurisdiction of incorporation or organization)
I.R.S. Employer Identification No.
 
One Chemung Canal Plaza, P.O. Box 1522, Elmira, NY
14902
(Address of principal executive offices)
(Zip Code)
 
(607) 737-3711 or (800) 836-3711
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES:    X         NO:____
 
Indicate by check mark 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:    X        NO:____
 
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 definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[   ]
Non-accelerated filer
[   ]
Accelerated filer
[X]
Smaller reporting company
[   ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
YES:             NO:  X
 
The number of shares of the registrant's common stock, $.01 par value, outstanding on May 8, 2013 was 4,592,756.

 
 

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX

PART I.
FINANCIAL INFORMATION
PAGE
     
Item 1:
Financial Statements – Unaudited
 
     
 
Consolidated Balance Sheets
3
 
Consolidated Statements of Income
4
 
Consolidated Statements of Comprehensive Income
5
 
Consolidated Statements of Shareholders’ Equity
6
 
Consolidated Statements of Cash Flows
7
     
 
Notes to Unaudited Consolidated Financial Statements
9
     
Item 2:
Management's Discussion and Analysis of Financial Condition
and Results of Operations
34
     
Item 3:
Quantitative and Qualitative Disclosures About Market Risk
48
     
Item 4:
Controls and Procedures
48
     
PART II.
OTHER INFORMATION
48
     
Item 1:  Legal Proceedings 48
     
Item 1A:
Risk Factors
48
     
Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
48
     
Item 6:
Exhibits
49
     
SIGNATURES
 
50
     
EXHIBIT INDEX
 


 
2

 

PART I. FINANCIAL INFORMATION
Item 1: Financial Statements

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
   
MARCH 31,
   
DECEMBER 31,
 
   
2013
   
2012
 
ASSETS
           
Cash and due from financial institutions
 
$
27,756,637
   
$
29,239,309
 
Interest-bearing deposits in other financial institutions
   
18,380,230
     
11,001,912
 
     Total cash and cash equivalents
   
46,136,867
     
40,241,221
 
                 
Trading assets, at fair value
   
384,051
     
348,241
 
                 
Securities available for sale, at estimated fair value
   
235,306,634
     
239,685,763
 
Securities held to maturity, estimated fair value of $10,611,045
  at March 31, 2013 and $6,421,486 at December 31, 2012
   
9,898,212
     
5,748,453
 
Federal Home Loan Bank and Federal Reserve Bank
  Stock, at cost
   
4,607,050
     
4,710,300
 
Loans, net of deferred origination fees and costs,
  and unearned income
   
921,432,619
     
893,516,941
 
Allowance for loan losses
   
(10,824,693
)
   
(10,432,650
)
Loans, net
   
910,607,926
     
883,084,291
 
Loans held for sale
   
785,550
     
1,057,309
 
Premises and equipment, net
   
24,800,480
     
25,484,385
 
Goodwill
   
21,824,443
     
21,824,443
 
Other intangible assets, net
   
4,909,219
     
5,143,820
 
Bank owned life insurance
   
2,732,329
     
2,711,681
 
Accrued interest receivable and other assets
   
17,979,031
     
18,119,801
 
                 
     Total assets
 
$
1,279,971,792
   
$
1,248,159,708
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits:
               
  Non-interest-bearing
 
$
296,360,585
   
$
300,610,463
 
  Interest-bearing
   
780,738,490
     
744,123,551
 
     Total deposits
   
1,077,099,075
     
1,044,734,014
 
                 
Securities sold under agreements to repurchase
   
31,427,348
     
32,710,650
 
Federal Home Loan Bank term advances
   
27,157,760
     
27,225,363
 
Accrued interest payable and other liabilities
   
11,379,260
     
12,374,744
 
     Total liabilities
   
1,147,063,443
     
1,117,044,771
 
                 
Shareholders' equity:
               
Common stock, $.01 par value per share, 10,000,000
  shares authorized; 5,310,076 issued at March 31, 2013
  and December 31, 2012
   
53,101
     
53,101
 
Additional-paid-in capital
   
45,473,445
     
45,357,073
 
Retained earnings
   
108,295,833
     
107,078,182
 
Treasury stock, at cost (717,320 shares at March 31, 2013,
  728,680 shares at December 31, 2012)
   
(18,290,832
)
   
(18,566,490
)
Accumulated other comprehensive loss
   
(2,623,198
)
   
(2,806,929
)
                 
     Total shareholders' equity
   
132,908,349
     
131,114,937
 
                 
     Total liabilities and shareholders' equity
 
$
1,279,971,792
   
$
1,248,159,708
 
See accompanying notes to unaudited consolidated financial statements.
 

 
3

 


CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
   
THREE MONTHS ENDED
   
MARCH 31,
Interest and dividend income:
 
2013
     
2012
 
Loans, including fees
 
$
11,304,008
 
$
11,670,912
 
Taxable securities
   
1,131,053
     
1,486,351
 
Tax exempt securities
   
305,142
     
340,622
 
Interest-bearing deposits
   
7,983
     
41,782
 
  Total interest and dividend income
   
12,748,186
     
13,539,667
 
                 
Interest expense:
               
Deposits
   
624,081
     
912,649
 
Securities sold under agreements to repurchase
   
219,349
     
282,772
 
Borrowed funds
   
187,789
     
313,039
 
  Total interest expense
   
1,031,219
     
1,508,460
 
Net interest income
   
11,716,967
     
12,031,207
 
Provision for loan losses
   
431,010
     
477,305
 
  Net interest income after provision for loan losses
   
11,285,957
     
11,553,902
 
                 
Other operating income:
               
  Wealth management group fee income
   
1,750,178
     
1,775,576
 
  Service charges on deposit accounts
   
968,772
     
991,880
 
  Net gain on securities transactions
   
-
     
297,169
 
  Net gain on sales of loans held for sale
   
111,916
     
65,340
 
  Casualty gains
   
-
     
758,857
 
  Net losses on sales of other real estate owned
   
-
     
(6,459
)
  Income from bank owned life insurance
   
20,647
     
21,525
 
  Other
   
1,170,064
     
986,510
 
     Total other operating income
   
4,021,577
     
4,890,398
 
                 
Other operating expenses:
               
  Salaries and wages
   
4,818,229
     
4,492,675
 
  Pension and other employee benefits
   
1,424,476
     
1,289,940
 
  Net occupancy expenses
   
1,361,584
     
1,294,877
 
  Furniture and equipment expenses
   
518,499
     
518,366
 
  Data processing expense
   
1,112,933
     
1,078,931
 
  Professional services
   
329,023
     
150,213
 
  Amortization of intangible assets
   
234,601
     
284,140
 
  Marketing and advertising expense
   
287,577
     
289,239
 
  Other real estate owned expenses
   
35,672
     
43,479
 
  FDIC insurance
   
216,860
     
226,631
 
  Loan expense
   
143,101
     
180,147
 
  Other
   
1,242,202
     
1,082,583
 
     Total other operating expenses
   
11,724,757
     
10,931,221
 
Income before income tax expense
   
3,582,777
     
5,513,079
 
Income tax expense
   
1,171,009
     
1,898,546
 
     Net income
 
$
2,411,768
   
$
3,614,533
 
Weighted average shares outstanding
   
4,655,862
     
4,642,012
 
Basic and diluted earnings per share
 
$
0.52
   
$
0.78
 
   
See accompanying notes to unaudited consolidated financial statements.
 

 
4

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
   
THREE MONTHS ENDED
MARCH 31,
 
   
2013
   
2012
 
             
Net income
 
$
2,411,768
   
$
3,614,533
 
                 
Other comprehensive income
               
Unrealized holding (losses) gains on securities available for sale
   
(70,164
)
   
514,361
 
Reclassification adjustment gains realized in net income
   
-
     
(297,169
)
Net unrealized (losses) gains
   
(70,164
)
   
217,192
 
Less:  Tax effect
   
(26,971
)
   
115,666
 
Net of tax amount
   
(43,193
)
   
101,526
 
                 
Change in funded status of defined benefit pension plan and other benefit plans:
               
Reclassification adjustment for amortization of prior service costs
   
(20,786
)
   
(20,786
)
Reclassification adjustment for amortization of net actuarial gain
   
389,409
     
335,548
 
Total before tax effect
   
368,623
     
314,762
 
Less:  Tax effect
   
141,699
     
120,994
 
Net of tax amount
   
226,924
     
193,768
 
                 
Total other comprehensive income
   
183,731
     
295,294
 
                 
Comprehensive income
 
$
2,595,499
   
$
3,909,827
 
                 
                 
See accompanying notes to unaudited consolidated financial statements.
 


 
5

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 (UNAUDITED)
   
Common Stock
   
Additional Paid-in Capital
   
Retained Earnings
   
Treasury Stock
   
Accumulated Other Comprehensive Income (Loss)
   
Total
 
Balances at December 31, 2011
 
$
53,101
   
$
45,582,861
   
$
100,628,900
   
$
(18,894,044
)
 
$
(1,441,378
)
 
$
125,929,440
 
Net income
   
-
     
-
     
3,614,533
     
-
     
-
     
3,614,533
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
295,294
     
295,294
 
Restricted stock awards
   
-
     
15,922
     
-
     
-
     
-
     
15,922
 
Restricted stock units for directors' deferred compensation plan
   
-
     
21,340
     
-
     
-
     
-
     
21,340
 
Cash dividends declared ($.25 per share)
   
-
     
-
     
(1,143,923
)
   
-
     
-
     
(1,143,923
)
Distribution of 10,238 shares of treasury stock for directors'
  compensation
   
-
     
(28,121
)
   
-
     
261,069
     
-
     
232,948
 
Distribution of 3,453 shares of treasury stock for employee
  compensation
   
-
     
(8,052
)
   
-
     
88,052
     
-
     
80,000
 
Distribution of 1,079 shares of treasury stock for employee
    restricted stock awards
   
-
     
(27,514
)
   
-
     
27,514
     
-
     
-
 
Purchase of 8,654 shares of treasury stock
   
-
     
-
     
-
     
(216,808
)
   
-
     
(216,808
)
Balances at March 31, 2012
 
$
53,101
   
$
45,556,436
   
$
103,099,510
   
$
(18,734,217
)
 
$
(1,146,084
)
 
$
128,828,746
 
                                                 
Balances at December 31, 2012
 
$
53,101
   
$
45,357,073
   
$
107,078,182
   
$
(18,566,490
)
 
$
(2,806,929
)
 
$
131,114,937
 
Net income
   
-
     
-
     
2,411,768
     
-
     
-
     
2,411,768
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
183,731
     
183,731
 
Restricted stock awards
   
-
     
60,078
     
-
     
-
     
-
     
60,078
 
Restricted stock units for directors' deferred compensation plan
   
-
     
24,602
     
-
     
-
     
-
     
24,602
 
Cash dividends declared ($.26 per share)
   
-
     
-
     
(1,194,117
)
   
-
     
-
     
(1,194,117
)
Distribution of 7,969 shares of treasury stock for directors'
  compensation
   
-
     
13,896
     
-
     
203,050
     
-
     
216,946
 
Distribution of 4,116 shares of treasury stock for employee
  compensation
   
-
     
7,278
     
-
     
104,876
     
-
     
112,154
 
Purchase of 3,094 shares of treasury stock
   
-
     
-
     
-
     
(92,630
)
   
-
     
(92,630
)
Sale of 2,369 shares of treasury stock
   
-
     
10,518
     
-
     
60,362
     
-
     
70,880
 
Balances at March 31, 2013
 
$
53,101
   
$
45,473,445
   
$
108,295,833
   
$
(18,290,832
)
 
$
(2,623,198
)
 
$
132,908,349
 
   
See accompanying notes to unaudited consolidated financial statements.
 

 
6

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
   
THREE MONTHS ENDED
MARCH 31,
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
2013
   
2012
 
Net income
 
$
2,411,768
   
$
3,614,533
 
Adjustments to reconcile net income to net cash provided
  by operating activities:
               
Amortization of intangible assets
   
234,601
     
284,140
 
Provision for loan losses
   
431,010
     
477,305
 
Depreciation and amortization of fixed assets
   
748,874
     
740,442
 
Amortization of premiums on securities, net
   
537,793
     
415,183
 
Gains on sales of loans held for sale, net
   
(111,916
)
   
(65,340
)
Proceeds from sales of loans held for sale
   
3,454,691
     
2,345,590
 
Loans originated and held for sale
   
(3,071,016
)
   
(2,710,673
)
Net gains on trading assets
   
(18,490
)
   
(13,122
)
Net gains on securities transactions
   
-
     
(297,169
)
Proceeds from sales of trading assets
   
-
     
72,646
 
Purchase of trading assets
   
(17,320
)
   
(19,386
)
Net losses on sale of other real estate owned
   
-
     
6,459
 
(Increase) decrease in other assets
   
(57,762
)
   
2,329,896
 
Decrease in prepaid FDIC assessment
   
198,532
     
207,849
 
Decrease in accrued interest payable
   
(63,909
)
   
(124,364
)
Expense related to restricted stock units for directors'
  deferred compensation plan
   
24,602
     
21,340
 
Expense related to employee stock compensation
   
112,154
     
80,000
 
Expense related to employee stock awards
   
60,078
     
15,922
 
Decrease in other liabilities
   
(1,644,334
)
   
(2,218,951
)
Income from bank owned life insurance
   
(20,647
)
   
(21,525
)
     Net cash provided by operating activities
   
3,208,709
     
5,140,775
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from sales and calls of securities available for sale
   
10,500,000
     
52,579,688
 
Proceeds from maturities and principal collected on securities available for sale
   
20,374,472
     
6,881,564
 
Proceeds from maturities and principal collected on securities held to maturity
   
257,179
     
1,090,104
 
Purchases of securities available for sale
   
(27,103,300
)
   
(37,942,141
)
Purchases of securities held to maturity
   
(4,406,938
)
   
(225,000
)
Purchase of Federal Home Loan Bank and Federal Reserve Bank stock
   
(916,550
)
   
(1,550
)
Redemption of Federal Home Loan Bank and Federal Reserve Bank stock
   
1,019,800
     
75,100
 
Purchases of premises and equipment
   
(64,969
)
   
(954,974
)
Proceeds from sales of other real estate owned
   
-
     
34,555
 
Net increase in loans
   
(27,954,645
)
   
(5,695,251
)
     Net cash (used) provided by investing activities
   
(28,294,951
)
   
15,842,095
 
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in demand deposits, interest-bearing demand accounts,
  savings accounts, and insured money market accounts
   
36,964,050
     
54,238,429
 
Net decrease in time deposits
   
(4,598,989
)
   
(14,025,878
)
Net decrease in securities sold under agreements to repurchase
   
(1,283,302
)
   
(2,108,399
)
Repayments of Federal Home Loan Bank long term advances
   
(67,603
)
   
(116,577
)
Purchase of treasury stock
   
(92,630
)
   
(216,808
)
Sale of treasury stock
   
60,362
     
-
 
Cash dividends paid
   
-
     
(1,141,081
)
     Net cash provided by financing activities
   
30,981,888
     
36,629,686
 
Net increase in cash and cash equivalents
   
5,895,646
     
57,612,556
 
Cash and cash equivalents, beginning of period
   
40,241,221
     
52,901,853
 
Cash and cash equivalents, end of period
 
$
46,136,867
   
$
110,514,409
 

 
7

 

(continued)

Supplemental disclosure of cash flow information:
               
Cash paid during the year for:
               
  Interest
 
$
1,095,128
   
$
1,648,158
 
  Income Taxes
 
$
167,549
   
$
875
 
Supplemental disclosure of non-cash activity:
               
  Transfer of loans to other real estate owned
 
$
-
   
$
116,800
 
  Dividends declared, not yet paid    $   1,194,117      $   1,143,923  
                 
See accompanying notes to unaudited consolidated financial statements.
               

 
8

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1                      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

To assist the reader, the Corporation has provided the following list of commonly used acronyms and abbreviations included in the Notes to Unaudited Consolidated Financial Statements.

FASB:  Financial Accounting Standards Board
OTTI:  Other-than-temporary impairment
FDIC:  Federal Deposit Insurance Corporation
PCI:  Purchased credit impaired
FHLB:  Federal Home Loan Bank
SEC:  Securities and Exchange Commission
GAAP:  U.S. generally accepted accounting principles
CDO: Collateralized Debt Obligation

Organization and Principles of Consolidation

Chemung Financial Corporation (the “Corporation”) is a bank holding company headquartered in Elmira, New York.  The Corporation provides a wide range of financial and fiduciary services through its wholly-owned subsidiaries, Chemung Canal Trust Company (the “Bank”), a state chartered bank, and CFS Group, Inc., a non-bank financial services company.  The Corporation and the Bank are subject to the regulation of certain federal and state agencies and undergo periodic examinations by those regulatory authorities.  The unaudited consolidated financial statements include the accounts of the Corporation, the Bank and CFS Group, Inc.  All significant intercompany accounts and transactions have been eliminated in consolidation.  Certain reclassifications of prior period amounts have been made to conform with the current period presentation.  These reclassifications had no impact on previously reported net income.

Basis of Presentation

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC in Article 10 of Regulation S-X and in accordance with the instructions to Form 10-Q and GAAP for interim financial information.  Certain information, accounting policies and footnote disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations.  These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s annual report on Form 10-K for the year ended December 31, 2012.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes.  Primary areas involving the use of estimates and assumptions include the allowance for loan losses, other-than-temporary impairment of securities, the carrying amount of goodwill and the amortization of other intangible assets.  Actual results could differ from those estimates.  In the opinion of management, all adjustments considered necessary, consisting of normal recurring items, have been included for a fair presentation of the accompanying unaudited consolidated financial statements.  Operating results for the three months ended March 31, 2013, are not necessarily indicative of the results that may be expected for the full year or future periods.

Subsequent Events

The Corporation has evaluated events and transactions through the time the unaudited consolidated financial statements were issued.  Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the SEC.  In conjunction with applicable accounting standards, all material subsequent events have been either recognized in the unaudited consolidated financial statements or disclosed in the notes to the unaudited consolidated financial statements.


 
9

 


NOTE 2                      EARNING PER COMMON SHARE

Basic earnings per share is net income divided by the weighted average number of common shares outstanding during the period.  Issuable shares, including those related to directors’ restricted stock units and directors’ stock compensation, are considered outstanding and are included in the computation of basic earnings per share.  All outstanding unvested share based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Restricted stock awards are grants of participating securities.  The impact of the participating securities on earnings per share is not material.  Earnings per share information is adjusted to present comparative results for stock splits and stock dividends that occur.  Earnings per share were computed by dividing net income by 4,655,862 and 4,642,012 weighted average shares outstanding for the three-month periods ended March 31, 2013 and 2012, respectively.  There were no dilutive common stock equivalents during the three-month periods ended March 31, 2013 or 2012.


NOTE 3                      ADOPTION OF NEW ACCOUNTING STANDARDS

In February 2013, the FASB issued Accounting Standards Update (“ASU”) No. 2013-02, “Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.”  ASU 2013-02 amends recent guidance related to the reporting of comprehensive income to enhance the transparency of the reporting of reclassifications out of accumulated other comprehensive income.  ASU 2013-02 became effective for the Corporation on January 1, 2013 and did not have a material impact on the Corporation’s financial statements.  The additional disclosures are included in Note 8 Accumulated Other Comprehensive Income or Loss.


NOTE 4                      SECURITIES

Amortized cost and estimated fair value of securities available for sale are as follows:

   
March 31, 2013
 
   
Amortized
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of U.S. Government and U.S.
  Government sponsored enterprises
 
$
139,225,086
   
$
3,294,760
   
$
22,104
   
$
142,497,742
 
Mortgage-backed securities, residential
   
25,488,094
     
1,668,233
     
-
     
27,156,327
 
Collateralized mortgage obligations
   
2,912,794
     
37,515
     
-
     
2,950,309
 
Obligations of states and political subdivisions
   
38,450,901
     
1,579,392
     
927
     
40,029,366
 
Corporate bonds and notes
   
11,409,872
     
201,644
     
-
     
11,611,516
 
SBA loan pools
   
1,601,918
     
38,541
     
-
     
1,640,459
 
Trust Preferred securities
   
2,521,276
     
130,561
     
132,200
     
2,519,637
 
Corporate stocks
   
734,384
     
6,168,863
     
1,969
     
6,901,278
 
     Total
 
$
222,344,325
   
$
13,119,509
   
$
157,200
   
$
235,306,634
 

   
December 31, 2012
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of U.S. Government and U.S.
  Government sponsored enterprises
 
$
138,041,393
   
$
3,549,821
   
$
-
   
$
141,591,214
 
Mortgage-backed securities, residential
   
29,591,883
     
1,923,366
     
-
     
31,515,249
 
Collateralized mortgage obligations
   
3,494,642
     
48,718
     
-
     
3,543,360
 
Obligations of states and political subdivisions
   
39,174,595
     
1,641,510
     
1,383
     
40,814,722
 
Corporate bonds and notes
   
11,412,167
     
239,468
     
-
     
11,651,635
 
SBA loan pools
   
1,682,736
     
41,404
     
-
     
1,724,140
 
Trust preferred securities
   
2,519,379
     
134,959
     
183,425
     
2,470,913
 
Corporate stocks
   
736,495
     
5,645,753
     
7,718
     
6,374,530
 
     Total
 
$
226,653,290
   
$
13,224,999
   
$
192,526
   
$
239,685,763
 

 
10

 


Amortized cost and estimated fair value of securities held to maturity are as follows:

   
March 31, 2013
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of states and political subdivisions
 
$
7,626,274
   
$
679,909
   
$
-
   
$
8,306,183
 
Time deposits with other financial institutions
   
2,271,938
     
32,924
     
-
     
2,304,862
 
     Total
   
9,898,212
     
712,833
     
-
     
10,611,045
 


 
 
December 31, 2012
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of states and political subdivisions
 
$
5,748,453
   
$
673,033
   
$
-
   
$
6,421,486
 

The amortized cost and estimated fair value of debt securities are shown below by expected maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity date are shown separately:

   
March 31, 2013
 
   
Available for Sale
   
Held to Maturity
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
Within One Year
 
$
26,909,544
   
$
27,093,364
   
$
4,869,367
   
$
4,943,587
 
After One, But Within Five Years
   
158,776,821
     
163,250,188
     
3,494,451
     
3,792,420
 
After Five, But Within Ten Years
   
5,291,745
     
5,817,884
     
1,534,394
     
1,875,038
 
After Ten Years
   
629,025
     
496,825
     
-
     
-
 
     
191,607,135
     
196,658,261
     
9,898,212
     
10,611,045
 
Mortgage-backed securities, residential
   
25,488,094
     
27,156,327
     
-
     
-
 
Collateralized mortgage obligations
   
2,912,794
     
2,950,309
     
-
       
-
SBA loan pools
   
1,601,918
     
1,640,459
       
-
     
-
     Total
 
$
221,609,941
   
$
228,405,356
   
$
9,898,212
   
$
10,611,045
 

The proceeds from sales and calls of securities resulting in gains or losses at March 31, 2013 and March 31, 2012 are listed below:
   
2013
   
2012
Proceeds
$
-
 
$
25,679,688
Gross gains
$
-
 
$
297,169
Gross losses
$
-
 
$
-
Tax expense
$
-
 
$
115,666

The following tables summarize the investment securities available for sale with unrealized losses at March 31, 2013 and December 31, 2012 by aggregated major security type and length of time in a continuous unrealized loss position:

   
Less than 12 months
   
12 months or longer
   
Total
 
March 31, 2013
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
Obligations of U.S.
  Government and U.S.
  Government sponsored
  enterprises
 
$
21,733,280
   
$
22,104
   
$
-
   
$
-
   
$
21,733,280
   
$
22,104
 
Obligations of states and
  political subdivisions
   
-
     
-
     
250,645
     
927
     
250,645
     
927
 
Trust preferred securities
   
-
     
-
     
496,825
     
132,200
     
496,825
     
132,200
 
Corporate stocks
   
-
     
-
     
1,669
     
1,969
     
1,669
     
1,969
 
     Total temporarily
        impaired securities
 
$
21,733,280
   
$
22,104
   
$
749,139
   
$
135,096
   
$
22,482,419
   
$
157,200
 


 
11

 



   
Less than 12 months
   
12 months or longer
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
December 31, 2012
Obligations of states and
  political subdivisions
 
$
-
   
$
-
   
$
430,166
   
$
1,383
   
$
430,166
   
$
1,383
 
Trust preferred securities
   
-
     
-
     
445,600
     
183,425
     
445,600
     
183,425
 
Corporate stocks
   
-
     
-
     
45,912
     
7,718
     
45,912
     
7,718
 
     Total temporarily
        impaired securities
 
$
-
   
$
-
   
$
921,678
   
$
192,526
   
$
921,678
   
$
192,526
 

Other-Than-Temporary Impairment

As of March 31, 2013, the majority of the Corporation's unrealized losses in the investment securities portfolio related to a CDO consisting of a pool of trust preferred securities. The decline in fair value on this security is primarily attributable to the financial crisis and resulting credit deterioration and financial condition of the underlying issuers, all of which are financial institutions.  This deterioration may affect the future receipt of both principal and interest payments on this security.  This fact combined with the current illiquidity in the market makes it unlikely that the Corporation would be able to recover its investment in this security if it was sold at this time.

Our analysis of this investment includes a $629,025 amortized cost of a CDO consisting of a pool of trust preferred securities.  This security was rated high quality at inception, but at March 31, 2013 Moody's rated this security as Caa3, which is defined as substantial risk of default.  The Corporation uses the OTTI evaluation model to compare the present value of expected cash flows to the previous estimate to determine if there are adverse changes in cash flows during each quarter. The OTTI model considers the structure and term of the CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities.  Assumptions used in the model include expected future default rates and prepayments.  We assume no recoveries on defaults and treat all interest payment deferrals as defaults.

Upon completion of the March 31, 2013 analysis, our model indicated no additional OTTI on this CDO.  This security remained classified as available for sale and represented $132,200 of the unrealized losses reported at March 31, 2013.  Quarterly interest payments continue to be made on this security.

When conducting the March 31, 2013 analysis, the present value of expected future cash flows using a discount rate equal to the yield in effect at the time of purchase was compared to the previous quarters' analysis.  The analysis indicated no further decline in value attributed to credit related factors stemming from further deterioration in the underlying collateral payment streams.  Additionally, to estimate fair value the present value of the expected future cash flows was calculated using a current estimated discount rate that a willing market participant might use to value the security based on current market conditions and interest rates.  Changes in credit quality may or may not correlate to changes in the overall fair value of the impaired securities as the change in credit quality is only one component in assessing the overall fair value of the impaired securities.  Therefore, the recognition of additional credit related OTTI could result in a gain reported in other comprehensive income.  Total OTTI recognized in accumulated other comprehensive income was $85,239 and $188,878, net of tax for securities available for sale at March 31, 2013 and 2012, respectively.

 
12

 


The tables below present a roll forward of the cumulative credit losses recognized in earnings for the three-month periods ending March 31, 2013 and 2012:
   
2013
   
2012
 
Beginning balance, January 1,
 
$
3,506,073
   
$
3,506,073
 
Amounts related to credit loss for which an other-than-temporary
     impairment was not previously recognized
   
-
     
-
 
Additions/Subtractions:
               
  Amounts realized for securities sold during the period
   
-
     
-
 
  Amounts related to securities for which the company intends to sell
     or that it will be more likely than not that the company will be required to
     sell prior to recovery of amortized cost basis
   
-
     
-
 
  Reductions for increase in cash flows expected to be collected that are
     recognized over the remaining life of the security
   
-
     
-
 
  Increases to the amount related to the credit loss for which other-than-temporary
     impairment was previously recognized
   
-
     
-
 
Ending balance, March 31,
 
$
3,506,073
   
$
3,506,073
 


NOTE 5                      LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and cost, and unearned income is summarized as follows:

 
March 31, 2013
   
December 31, 2012
 
   
Originated Loans
   
Acquired Loans
   
Total Loans
   
Originated Loans
   
Acquired Loans
   
Total Loans
 
Commercial and agricultural:
                                               
  Commercial and industrial
 
$
131,700,539
   
$
8,546,599
   
$
140,247,138
 
$
 
121,660,755
 
$
 
11,493,860
 
$
 
133,154,615
 
  Agricultural
   
816,452
     
-
     
816,452
     
696,666
     
-
     
696,666
 
Commercial mortgages:
  Construction
   
38,184,636
     
4,602,846
     
42,787,4822
     
36,893,367
     
6,375,936
     
43,269,303
 
  Commercial mortgages
   
245,542,922
     
51,669,742
     
297,212,664
     
222,161,130
     
54,766,993
     
276,928,123
 
Residential mortgages
   
189,888,106
     
12,225,963
     
202,114,069
     
187,820,984
     
12,654,113
     
200,475,097
 
Consumer loans:
                                               
  Credit cards
   
1,733,411
     
-
     
1,733,411
     
1,851,145
     
-
     
1,851,145
 
  Home equity lines and loans
   
81,969,483
     
4,426,562
     
86,396,045
     
82,216,284
     
4,829,137
     
87,045,421
 
  Indirect consumer loans
   
132,063,809
     
-
     
132,063,809
     
130,573,200
     
-
     
130,573,200
 
  Direct consumer loans
   
17,987,749
     
73,800
     
18,061,549
     
19,440,549
     
82,822
     
19,523,371
 
     Total loans, net
   
839,887,107
     
81,545,512
     
921,432,619
     
803,314,080
     
90,202,861
     
893,516,941
 
Interest receivable on loans
   
2,178,063
     
324,450
     
2,502,513
     
1,989,271
     
394,727
     
2,383,998
 
     Total recorded investment
       in loans
 
$
842,065,170
   
$
81,869,962
   
$
923,935,132
 
$
 
805,303,351
 
$
 
90,597,588
 
$
 
895,900,939
 


The Corporation's concentrations of credit risk by loan type are reflected in the preceding table.  The concentrations of credit risk with standby letters of credit, committed lines of credit and commitments to originate new loans generally follow the loan classifications in the table above.

 
13

 


The following tables present the activity in the allowance for loan losses by portfolio segment for the three-month periods ending March 31, 2013 and 2012.  Loans originated by the Corporation are referred to as “Originated” loans and loans acquired in the merger with Fort Orange Financial Corp. (“FOFC”), which are referred to as “Acquired” loans.
   
Three Months Ended
 
Originated Loans
 
March 31, 2013
 
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
1,592,869
   
$
3,592,566
   
$
1,565,571
   
$
2,705,639
   
$
26,146
   
$
9,482,791
 
  Charge Offs:
   
(16,612
)
   
-
     
(44,360
)
   
(196,392
)
   
-
     
(257,364
)
  Recoveries:
   
142,425
     
8,975
     
-
     
67,719
     
-
     
219,119
 
     Net recoveries (charge offs)
   
125,813
     
8,975
     
(44,360
)
   
(128,673
)
   
-
     
(38,245
)
  Provision
   
48,088
     
216,758
     
35,887
     
25,108
     
(26,146
)
   
299,695
 
Ending balance
 
$
1,766,770
   
$
3,818,299
   
$
1,557,098
   
$
2,602,074
   
$
-
   
$
9,744,241
 

   
Three Months Ended
 
Acquired Loans
 
March 31, 2013
 
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
114,727
   
$
835,132
   
$
-
   
$
-
   
$
-
   
$
949,859
 
  Charge Offs:
   
-
     
-
     
-
     
(972
)
      -        
(972
)
  Recoveries:
   
-
     
-
     
-
     
250
        -        
250
 
     Net charge-offs
   
-
     
-
     
-
     
(722
)
      -        
(722
)
  Provision
   
111,387
     
19,206
     
-
     
722
        -        
131,315
 
Ending balance
 
$
226,114
   
$
854,338
   
$
-
   
$
-
   
$
  -      
$
1,080,452
 


Originated Loans
 
Three Months Ended
March 31, 2012
 
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
3,143,373
   
$
2,570,149
   
$
1,309,649
   
$
2,192,729
   
$
443,420
   
$
9,659,320
 
  Charge Offs:
   
-
     
-
     
(14,340
)
   
(158,319
)
   
-
     
(172,659
)
  Recoveries:
   
172,603
     
10,235
     
-
     
61,983
     
-
     
244,821
 
     Net charge offs
   
172,603
     
10,235
     
(14,340
)
   
(96,336
)
   
-
     
72,162
 
  Provision
   
(179,519
)
   
373,248
     
121,943
     
4,040
     
(69,712)
     
250,000
 
Ending balance
 
$
3,136,457
   
$
2,953,632
   
$
1,417,252
   
$
2,100,433
   
$
373,708
   
$
9,981,482
 


Acquired loans
 
Three Months Ended
March 31, 2012
 
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Reclassification of acquired loan
  Discount
   
73,228
     
50,332
     
-
     
-
     
-
     
123,560
 
  Charge Offs:
   
-
     
(49,057
)
      -         -      
-
     
(49,057
)
  Recoveries:
   
-
     
-
     
-
     
-
     
-
     
-
 
     Net charge offs
   
-
     
(49,057
)
   
-
     
-
     
-
     
(49,057
)
  Provision
   
151,708
     
75,597
     
-
     
-
     
-
     
227,305
 
Ending balance
 
$
224,936
   
$
76,872
   
$
-
   
$
-
   
$
-
   
$
301,808
 


 
14

 


The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2013 and December 31, 2012:

   
March 31, 2013
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Ending allowance balance
  attributable to loans:
                                   
Individually evaluated for impairment
 
$
168,383
   
$
88,327
   
$
-
   
$
19,167
   
$
-
   
$
275,877
 
Collectively evaluated for impairment
   
1,598,387
     
3,729,972
     
1,557,098
     
2,582,907
     
-
     
9,468,364
 
Acquired
   
226,114
     
854,338
     
-
     
-
     
-
     
1,080,452
 
Total ending allowance balance
 
$
1,992,884
   
$
4,672,637
   
$
1,557,098
   
$
2,602,074
   
$
-
   
$
10,824,693
 

   
December 31, 2012
Allowance for loan losses
 
Commercial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Ending allowance balance attributable to loans:
                                   
Individually evaluated for impairment
 
$
133,437
   
$
59,201
   
$
-
   
$
-
   
$
-
   
$
192,638
 
Collectively evaluated for impairment
   
1,459,432
     
3,533,365
     
1,565,571
     
2,705,639
     
26,146
     
9,290,153
 
Acquired
   
114,727
     
835,132
     
-
     
-
     
-
     
949,859
 
Total ending allowance balance
 
$
1,707,596
   
$
4,427,698
   
$
1,565,571
   
$
2,705,639
   
$
26,146
   
$
10,432,650
 

   
March 31, 2013
 
Loans:
 
Commercial
and
Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Total
 
Originated loans individually evaluated for impairment
 
$
1,858,702
   
$
7,121,372
   
$
128,348
   
$
118,837
   
$
9,227,259
 
Acquired loans individually evaluated for impairment
 
 
73,257
     
3,716,618
     
-
     
-
     
3,789,875
 
Originated loans collectively evaluated for  impairment
   
131,021,951
     
277,358,620
     
190,187,599
     
234,269,741
     
832,837,911
 
Acquired loans collectively evaluated for impairment
   
7,443,334
     
44,472,388
     
12,068,746
     
4,515,625
     
68,500,093
 
Acquired loans with deteriorated credit quality
   
1,057,510
     
8,273,955
     
248,529
     
-
     
9,579,994
 
Total ending loans balance
 
$
141,454,754
   
$
340,942,953
   
$
202,633,222
   
$
238,904,203
   
$
923,935,132
 


   
December 31, 2012
 
Loans:
 
Commercial
and
Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Total
 
Originated loans individually
  evaluated for impairment
 
$
1,831,095
   
$
5,715,324
   
$
131,909
   
$
-
   
$
7,678,328
 
Acquired loans individually
  evaluated for impairment
 
 
76,300
     
4,904,950
     
-
     
-
     
4,981,250
 
Originated loans collectively
  evaluated for  impairment
   
120,828,451
     
253,918,786
     
188,117,526
     
234,760,260
     
 
797,625,023
 
Acquired loans collectively
 evaluated for impairment
   
10,331,884
     
48,088,509
     
12,505,074
     
4,929,195
     
75,854,662
 
Acquired loans with deteriorated
  credit quality
   
1,126,692
     
8,390,716
     
244,268
     
-
     
9,761,676
 
Total ending loans balance
 
$
134,194,422
   
$
321,018,285
   
$
200,998,777
   
$
239,689,455
   
$
895,900,939
 



 
15

 

The following tables present originated loans individually evaluated for impairment recognized by class of loans as of March 31, 2013 and December 31, 2012, the average recorded investment and interest income recognized by class of loans as of the three-month periods ending March 31, 2013 and 2012:


   
March 31, 2013
 
December 31, 2012
 
With no related allowance recorded:
 
Unpaid Principal Balance
   
Recorded Investment
   
Allowance for Loan Losses Allocated
   
Unpaid Principal Balance
   
Recorded Investment
     
Allowance for Loan Losses Allocated
   
Commercial and agricultural:
                                       
  Commercial & industrial
 
$
2,050,222
   
$
1,453,334
   
$
-
   
$
2,059,027
 
$
1,462,157
   
$
-
   
Commercial mortgages:
                                               
  Construction
   
686,918
     
685,752
     
-
     
261,102
   
261,903
     
-
   
  Other
   
6,659,845
     
6,076,523
     
-
     
5,678,565
   
5,090,399
     
-
   
Residential mortgages
   
128,348
     
128,348
     
-
     
131,909
   
131,909
     
-
   
Consumer loans:
                                               
  Home equity lines & loans
   
44,694
     
45,540
     
-
     
-
   
-
     
-
   
With an allowance recorded:
                                               
Commercial and agricultural:
                                               
  Commercial & industrial
   
405,827
     
405,368
     
168,383
     
446,330
   
445,238
     
133,437
   
Commercial mortgages:
                                               
  Construction
   
-
     
-
     
-
     
-
   
-
     
-
   
  Other
   
358,902
     
359,097
     
88,327
     
364,423
   
363,022
     
59,201
   
Consumer loans:
                                               
  Home equity lines & loans
   
57,876
     
58,047
     
4,020
     
-
   
-
     
-
   
  Other
   
15,147
     
15,250
     
15,147
     
-
   
-
     
-
   
Total
 
$
10,407,779
   
$
9,227,259
   
$
275,877
   
$
8,863,964
 
$
7,678,328
   
$
192,638
   

 
16

 

     
Three Months Ended
March 31, 2013
   
Three Months Ended
March 31, 2012
   
With no related allowance recorded:
   
Average Recorded Investment
   
Interest Income Recognized (1)
     
Average Recorded Investment
     
Interest Income Recognized (1)
   
Commercial and agricultural:
                               
  Commercial & industrial
 
$
1,457,745
 
$
17,153
   
$
1,510,362
   
$
-
   
Commercial mortgages:
                               
  Construction
   
473,827
   
-
     
10,454
     
-
   
  Other
   
5,583,461
   
52,542
     
783,410
     
-
   
Residential mortgages
   
130,128
   
-
     
161,034
     
-
   
Consumer loans:
                               
  Home equity lines & loans
   
22,770
   
252
     
29,784
     
1,166
   
With an allowance recorded:
                               
Commercial and agricultural:
                               
  Commercial & industrial
   
387,153
   
-
     
2,362,453
     
-
   
Commercial mortgages:
                               
  Construction
   
-
   
-
     
8,295
     
-
   
  Other
   
361,059
   
-
     
2,595,105
     
-
   
Consumer loans:
                 
-
     
-
   
  Home equity lines & loans
   
29,023
   
166
     
-
     
-
   
  Other
   
7,625
   
-
     
-
     
-
   
Total
 
$
8,452,791
 
$
70,113
   
$
7,460,897
   
$
1,166
   
(1)  
Cash basis interest income approximates interest income recognized.

The following table presents the recorded investment in non- accrual and loans past due over 90 days still on accrual by class of loans as of the periods ending March 31, 2013 and December 31, 2012.  This table includes acquired loans except for those loans with evidence of credit deterioration at the time of the FOFC merger:

   
March 31, 2013
   
December 31, 2012
 
   
Non-Accrual
   
Loans Past Due Over 90 Days Still Accruing
   
Non-Accrual
   
Loans Past Due Over 90 Days Still Accruing
 
Commercial and agricultural:
                       
  Commercial & industrial
 
$
633,595
   
$
1,805
   
$
666,912
   
$
-
 
Commercial mortgages:
                               
  Construction
   
974,349
     
3,208,674
     
434,338
     
4,481,067
 
  Other
   
1,759,626
     
-
     
1,581,643
     
-
 
Residential mortgages
   
2,993,186
     
-
     
2,423,024
     
-
 
Consumer loans:
                               
  Credit cards
   
-
     
8,216
     
-
     
3,307
 
  Home equity lines & loans
   
576,656
     
-
     
571,365
     
-
 
  Indirect consumer loans
   
298,930
     
-
     
335,285
     
-
 
  Other direct consumer loans
   
46,104
     
-
     
19,338
     
-
 
Total
 
$
7,282,446
   
$
3,218,695
   
$
6,031,905
   
$
4,484,374
 














 
17

 

The following tables present the aging of the recorded investment in loans past due (including non-accrual loans) by class of loans as of March 31, 2013 and December 31, 2012 and by Originated loans and Acquired loans:

   
March 31, 2013
 
Originated Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 89 Days Past Due
   
Total Past Due
     
Loans Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial and agricultural:
                                           
  Commercial & industrial
 
$
45,686
   
$
-
   
$
156,774
   
$
202,460
   
$
-
   
$
131,859,479
   
$
132,061,939
 
  Agricultural
   
-
     
-
     
-
     
-
     
-
     
818,714
     
818,714
 
Commercial mortgages:
                                                       
  Construction
   
327,065
     
1,439,960
     
434,338
     
2,201,363
     
-
     
36,114,635
     
38,315,998
 
  Other
   
134,887
     
-
     
448,439
     
583,326
     
-
     
245,580,668
     
246,163,994
 
Residential mortgages
   
1,535,821
     
46,469
     
602,604
     
2,184,894
     
-
     
188,131,053
     
190,315,947
 
Consumer loans:
                                                       
  Credit cards
   
13,623
     
5,976
     
8,216
     
27,815
     
-
     
1,705,596
     
1,733,411
 
  Home equity lines & loans
   
211,946
     
-
     
256,654
     
468,600
     
-
     
81,718,039
     
82,186,639
 
  Indirect consumer loans
   
656,957
     
152,053
     
203,721
     
1,012,731
     
-
     
131,409,349
     
132,422,080
 
  Other direct consumer loans
   
38,811
     
8,093
     
36,904
     
83,808
     
-
     
17,962,640
     
18,046,448
 
  Total
 
$
2,964,796
   
$
1,652,551
   
$
2,147,650
   
$
6,764,997
   
$
-
   
$
835,300,173
   
$
842,065,170
 



   
March 31, 2013
 
Acquired Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 89 Days Past Due
   
Total Past Due
     
Loans Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial and agricultural:
                                         
 
  Commercial & industrial
 
$
335,355
   
$
-
   
$
73,257
   
$
408,612
   
$
1,057,510
   
$
7,107,979
   
$
8,574,101
 
Commercial mortgages:
                                                       
  Construction
   
-
     
-
     
3,497,271
     
3,497,271
     
1,092,861
     
-
     
4,590,132
 
  Other
   
698,182
     
-
     
219,348
     
917,530
     
7,181,094
     
43,774,205
     
51,872,829
 
Residential mortgages
   
532,408
     
313,692
     
199,245
     
1,045,345
     
248,529
     
11,023,401
     
12,317,275
 
Consumer loans:
                                                       
  Home equity lines & loans
   
6,980
     
-
     
-
     
6,980
     
-
     
4,434,395
     
4,441,375
 
  Other direct consumer loans
   
-
     
-
     
-
     
-
     
-
     
74,250
     
74,250
 
  Total
 
$
1,572,925
   
$
313,692
   
$
3,989,121
   
$
5,875,738
   
$
9,579,994
   
$
66,414,230
   
$
81,869,962
 








 
18

 


 
December 31, 2012
Originated Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 89 Days Past Due
   
Total Past Due
   
Loans
Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial and agricultural:
                                         
  Commercial & industrial
 
$
157,903
   
$
-
   
$
154,969
   
$
312,872
 
$
-
   
$
121,648,222
   
$
121,961,094
 
  Agricultural
   
-
     
-
     
-
     
-
   
-
     
698,452
     
698,452
 
Commercial mortgages:
                                                     
  Construction
   
-
     
-
     
10,454
     
10,454
   
-
     
36,988,238
     
36,998,692
 
  Other
   
84,573
     
42,418
     
272,403
     
399,394
   
-
     
222,236,024
     
222,635.418
 
Residential mortgages
   
2,347,927
     
707,386
     
536,169
     
3,591,482
   
-
     
184,657,953
     
188,249,435
 
Consumer loans:
                                                     
  Credit cards
   
5,947
     
5,074
     
3,307
     
14,328
   
-
     
1,836,817
     
1,851,145
 
  Home equity lines & loans
   
200,640
     
102,028
     
297,657
     
600,325
   
-
     
81,823,908
     
82,424,233
 
  Indirect consumer loans
   
798,155
     
79,268
     
267,864
     
1,145,287
   
-
     
129,832,488
     
130,977,775
 
  Other direct consumer loans
   
48,306
     
25,556
     
12,351
     
86,213
   
-
     
19,420,894
     
19,507,107
 
  Total
 
$
3,643,451
   
$
961,730
   
$
1,555,174
   
$
6,160,355
 
$
-
   
$
799,142,996
   
$
805,303,351
 



 
December 31, 2012
Acquired Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 89 Days Past Due
   
Total Past Due
   
Loans Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial and agricultural:
                                         
  Commercial & industrial
 
$
100,399
   
$
-
   
$
242,927
   
$
343,326
 
$
1,126,692
   
$
10,064,858
   
$
11,534,876
 
Commercial mortgages:
                                                     
  Construction
   
-
     
294,565
     
4,904,950
     
5,199,515
   
1,182,020
     
-
     
6,381,535
 
  Other
   
1,046,302
     
647,701
     
-
     
1,694,003
   
7,208,696
     
46,099,941
     
55,002,640
 
Residential mortgages
   
1,348,203
     
329,502
     
467,748
     
2,145,453
   
244,268
     
10,359,621
     
12,749,342
 
Consumer loans:
                                                     
  Home equity lines & loans
   
-
     
-
     
-
     
-
   
-
     
4,845,652
     
4,845,652
 
  Other direct consumer loans
   
-
     
-
     
-
     
-
   
-
     
83,543
     
83,543
 
  Total
 
$
2,494,904
   
$
1,271,768
   
$
5,615,625
   
$
9,382,297
 
$
9,761,676
   
$
71,453,615
   
$
90,597,588
 










 
19

 

Troubled Debt Restructurings:

As of March 31, 2013 and December 31, 2012, the Corporation has a recorded investment in troubled debt restructurings of $7,249,008 and $5,728,610, respectively.  There were specific reserves of $172,403 allocated for troubled debt restructurings at March 31, 2013 and no specific reserves allocated at December 31, 2012.  As of March 31, 2013, troubled debt restructurings totaling $6,297,292 were accruing interest under the modified terms and $951,716 were on non-accrual status.  As of December 31, 2012, troubled debt restructurings totaling $5,363,712 were accruing interest under the modified terms and $364,898 were on non-accrual status.  The Corporation has committed to lend additional amounts totaling up to $72,000 and $130,000 as of March 31, 2013 and December 31, 2012, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

During the three months ended March 31, 2013 and 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: reduced scheduled payments for greater than 3 months or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended March 31, 2013 and March 31, 2012:
March 31, 2013
 
Number of Loans
   
Pre-Modification Outstanding Recorded Investment
   
Post-Modification Outstanding Recorded Investment
   
Troubled debt restructurings:
                   
  Commercial and agricultural:
                         
    Commercial & industrial
   
2
   
$
431,293
   
$
431,293
   
  Consumer loans:
                         
    Home equity lines & loans
   
2
     
103,587
     
103,587
   
Total
   
4
   
$
534,880
   
$
534,880
   
March 31,2012
                         
Troubled debt restructurings:
                   
  Consumer loans:
                         
    Home equity lines & loans
   
1
     
58,823
     
58,823
   
Total
   
1
   
$
58,823
   
$
58,823
   

The troubled debt restructurings described above increased the allowance for loan losses by $38,260 and resulted in no charge offs during the three months ending March 31, 2013.  The troubled debt restructurings described above did not increase the allowance for loan losses and resulted in no charge offs during the three months ending March 31, 2012.

There were no payment defaults on any loans previously modified as troubled debt restructurings during the three months ending March 31, 2013 or March 31, 2012, within twelve months following the modification.  A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

Credit Quality Indicators

The Corporation establishes a risk rating at origination for all commercial loans.  The main factors considered in assigning risk ratings include, but are not limited to: historic and future debt service coverage, collateral position, operating performance, liquidity, leverage, payment history, management ability, and the customer’s industry.  Commercial relationship managers monitor all loans in their respective portfolios for any changes in the borrower’s ability to service their debt and affirm the risk ratings for the loans at least annually.

For the retail loans, which include lines of credit, installment, mortgage, and home equity loans, once a loan is properly approved and closed, the Corporation evaluates credit quality based upon loan repayment.

 
20

 


The Corporation uses the risk rating system to identify criticized and classified loans. Commercial relationships within the criticized and classified risk ratings are analyzed quarterly.  The Corporation uses the following definitions for criticized and classified loans (which are consistent with regulatory guidelines):

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position as some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capability of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be not rated loans.  Based on the analyses performed as of March 31, 2013 and December 31, 2012, the risk category of the recorded investment of loans by class of loans is as follows:


   
March 31, 2013
 
Originated Loans:
 
Not Rated
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
 
Commercial and agricultural:
                             
  Commercial & industrial
 
$
-
   
$
119,188,696
   
$
7,936,351
   
$
4,523,351
   
$
413,097
 
  Agricultural
   
-
     
818,714
     
-
     
-
     
-
 
Commercial mortgages:
                                       
  Construction
   
-
     
35,529,324
     
1,629,655
     
1,157,019
     
-
 
  Other
   
-
     
223,161,425
     
13,586,936
     
9,415,633
     
-
 
Residential mortgages
   
187,572,423
     
-
     
-
     
2,743,524
         
Consumer loans:
                                       
  Credit cards
   
1,733,411
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
81,509,198
     
-
     
-
     
677,441
     
-
 
  Indirect consumer loans
   
132,135,256
     
-
     
-
     
286,824
     
-
 
  Other direct consumer loans
   
17,992,755
     
-
     
-
     
53,693
     
-
 
Total
 
$
420,943,043
   
$
378,698,159
   
$
23,153,386
   
$
18,857,485
   
$
413,097
 



 
March 31, 2013
 
Acquired Loans:
 
Not Rated
   
Pass
   
Loans Acquired with deteriorated credit quality
   
Special Mention
   
Substandard
   
Doubtful
 
Commercial, and agricultural:
                                   
  Commercial & industrial
 
$
-
   
$
6,823,714
   
$
1,057,510
   
$
432,320
   
$
187,300
   
$
73,257
 
Commercial mortgages:
                                               
  Construction
   
-
     
-
     
1,092,861
     
3,208,674
     
288,597
     
-
 
  Other
   
-
     
41,839,853
     
7,181,094
     
2,632,534
     
219,348
     
-
 
Residential mortgages
   
11,819,084
     
-
     
248,529
     
-
     
249,662
     
-
 
Consumer loans:
                                               
  Home equity lines & loans
   
4,415,413
     
-
     
-
     
-
     
25,962
     
-
 
  Other direct consumer loans
   
74,250
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
16,308,747
   
$
48,663,567
   
$
9,579,994
   
$
6,273,528
   
$
970,869
   
$
73,257
 

 
21

 


   
December 31, 2012
 
Originated Loans:
 
Not Rated
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
 
Commercial and agricultural:
                             
  Commercial & industrial
 
$
-
   
$
111,131,147
   
$
7,805,458
   
$
2,606,529
   
$
417,960
 
  Agricultural
   
-
     
698,452
     
-
     
-
     
-
 
Commercial mortgages:
                                       
  Construction
   
-
     
34,588,347
     
1,671,195
     
739,150
     
-
 
  Other
   
-
     
202,157,249
     
10,651,788
     
9,826,381
     
-
 
Residential mortgages
   
186,084,001
     
-
     
-
     
2,165,434
     
-
 
Consumer loans:
                                       
  Credit cards
   
1,851,145
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
81,796,116
     
-
     
-
     
628,117
     
-
 
  Indirect consumer loans
   
130,642,490
     
-
     
-
     
335,285
     
-
 
  Other direct consumer loans
   
19,487,769
     
-
     
-
     
19,338
     
-
 
Total
 
$
419,861,521
   
$
348,575,195
   
$
20,128,441
   
$
16,320,234
   
$
417,960
 


 
December 31, 2012
     
Acquired Loans:
 
Not Rated
   
Pass
   
Loans Acquired with deteriorated credit quality
   
Special Mention
   
Substandard
   
Doubtful
   
Commercial and agricultural:
                                     
  Commercial & industrial
 
$
-
   
$
10,129,340
   
$
1,126,692
   
$
202,544
   
$
-
   
$
76,300
   
Commercial mortgages:
                                                 
  Construction
   
-
     
294,565
     
1,182,020
     
3,482,723
     
1,422,227
     
-
   
  Other
   
-
     
46,471,016
     
7,208,696
     
1,322,928
     
-
     
-
   
Residential mortgages
   
12,252,640
     
-
     
244,268
     
-
     
252,434
     
-
   
Consumer loans
                                                 
  Home equity lines & loans
   
4,819,276
     
-
     
-
     
-
     
26,376
     
-
   
  Other direct consumer loans
   
83,543
     
-
     
-
     
-
     
-
     
-
   
Total
 
$
17,155,459
   
$
56,894,921
   
$
9,761,676
   
$
5,008,195
   
$
1,701,037
   
$
76,300
   


The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  The following table presents the recorded investment in residential and consumer loans based on payment activity as of March 31, 2013 and December 31, 2012:

   
March 31, 2013
         
Consumer Loans
 
Originated Loans:
 
Residential Mortgages
   
Credit Card
   
Home Equity Lines & Loans
   
Indirect Consumer Loans
   
Other Direct Consumer Loans
 
Performing
 
$
187,572,423
   
$
1,725,195
   
$
81,635,945
   
$
132,123,150
   
$
18,000,344
 
Non-Performing
   
2,743,524
     
8,216
     
550,694
     
298,930
     
46,104
 
Total
 
$
190,315,947
   
$
1,733,411
   
$
82,186,639
   
$
132,422,080
   
$
18,046,448
 

Acquired Loans:
                             
Performing
 
$
12,067,613
     
-
   
$
4,415,413
   
$
-
   
$
74,250
 
Non-Performing
   
249,662
     
-
     
25,962
     
-
     
-
 
Total
 
$
12,317,275
   
$
-
   
$
4,441,375
   
$
-
   
$
74,250
 






 
22

 


   
December 31, 2012
         
Consumer Loans
 
Originated Loans:
 
Residential Mortgages
   
Credit Card
   
Home Equity Lines & Loans
   
Indirect Consumer Loans
   
Other Direct Consumer Loans
 
Performing
 
$
186,078,845
   
$
1,847,838
   
$
81,879,244
   
$
130,642,490
   
$
19,487,769
 
Non-Performing
   
2,170,590
     
3,307
     
544,989
     
335,285
     
19,338
 
   
$
188,249,435
   
$
1,851,145
   
$
82,424,233
   
$
130,977,775
   
$
19,507,107
 

Acquired Loans:
                             
Performing
 
$
12,496,908
   
$
-
   
$
4,819,276
   
$
-
   
$
83,543
 
Non-Performing
   
252,434
     
-
     
26,376
     
-
     
-
 
Total
 
$
12,749,342
   
$
-
   
$
4,845,652
   
$
-
   
$
83,543
 

At the time of the merger with FOFC, the Corporation identified certain loans with evidence of deteriorated credit quality, and the probability that the Corporation would be unable to collect all contractually required payments from the borrower.  These loans are called PCI loans and included in Acquired loans.  The Corporation adjusted its estimates of future expected losses, cash flows, and renewal assumptions on the PCI loans during the current year.  These adjustments were made for changes in expected cash flows due to loans refinanced beyond original maturity dates, impairments recognized subsequent to the acquisition, advances made for taxes or insurance to protect collateral held and payments received in excess of amounts originally expected.

The table below summarizes the changes in total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the PCI loans from January 1, 2013 to March 31, 2013:


   
Balance at December 31, 2012
   
Income Accretion
   
All Other Adjustments
   
Balance at March 31,
2013
 
Contractually required principal and interest
 
$
16,896,078
   
$
-
   
$
(1,640,666
)
 
$
15,255,412
 
Contractual cash flows not expected to be collected
  (nonaccretable discount)
   
(4,605,358
)
   
-
     
1,306,583
     
(3,298,775
)
Cash flows expected to be collected
   
12,290,720
     
-
     
(334,083
)
   
11,956,637
 
Interest component of expected cash flows (accretable yield)
   
(2,529,044
)
   
493,820
     
(341,419
)
   
(2,376,643
)
Fair value of loans acquired with deteriorating credit quality
 
$
9,761,676
   
$
493,820
   
$
(675,502
)
 
$
9,579,994
 


NOTE 6                      FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 
23

 


The Corporation used the following methods and significant assumptions to estimate fair value:

Investment Securities:  The fair values of securities available for sale are usually determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

The Corporation's investment in collateralized debt obligations consisting of pooled trust preferred securities which are issued by financial institutions were historically priced using Level 2 inputs.  The lack of observable inputs and market activity in this class of investments has been significant and resulted in unreliable external pricing.  Broker pricing and bid/ask spreads, when available, have varied widely.  The once active market has become comparatively inactive. As a result, these investments are now priced using Level 3 inputs.

The Corporation utilizes an external model for pricing these securities. This is the same model used in determining OTTI as further described in Note 4.  Information such as historical and current performance of the underlying collateral, deferral/default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions, are utilized in determining individual security valuations. Discount rates were utilized along with the cash flow projections in order to calculate an appropriate fair value.  These discount rates were calculated based on industry index rates and adjusted for various credit and liquidity factors.  Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

Trading Assets:  Securities that are held to fund a deferred compensation plan are recorded at fair value with changes in fair value included in earnings.  The fair values of trading assets are determined by quoted market prices (Level 1 inputs).

Impaired Loans:  At the time a loan is considered impaired, it is valued at the lower of cost or fair value.  Impaired loans carried at fair value have been partially charged-off or receive specific allocations as part of the allowance for loan loss accounting.  For collateral dependent loans, fair value is commonly based on real estate appraisals.  These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.  Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, typically resulting in a Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned:  Assets acquired through or instead of loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

 
24

 


Appraisals for both collateral-dependent impaired loans and other real estate owned (“OREO”) are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Corporation.  Once received, appraisals are reviewed for reasonableness of assumptions, approaches utilized, Uniform Standards of Professional Appraisal Practice and other regulatory compliance, as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics.  Appraisals are generally completed within the previous 12 month period prior to a property being placed into OREO.  On impaired loans, appraisal values are adjusted based on the age of the appraisal, the position of the lien, the type of the property and its condition.

Assets and liabilities measured at fair value on a recurring basis are summarized below:

     
Fair Value Measurement at March 31, 2013 Using
 
Financial Assets:
 
Fair Value
   
Quoted Prices
in Active Markets for Identical Assets
(Level 1)
   
Significant
Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Obligations of U.S. Government and U.S.
  Government sponsored enterprises
 
$
142,497,742
   
$
27,545,000
   
$
114,952,742
   
$
-
 
Mortgage-backed securities, residential
   
27,156,327
     
-
     
27,156,327
     
-
 
Obligations of states and political subdivisions
   
40,029,366
     
-
     
40,029,366
     
-
 
Collateralized mortgage obligations
   
2,950,309
     
-
     
2,950,309
     
-
 
Corporate bonds and notes
   
11,611,516
     
-
     
11,611,516
     
-
 
SBA loan pools
   
1,640,459
     
-
     
1,640,459
     
-
 
Trust Preferred securities
   
2,519,637
     
-
     
2,022,812
     
496,825
 
Corporate stocks
   
6,901,278
     
6,245,611
     
655,667
     
-
 
Total available for sale securities
 
$
235,306,634
   
$
33,790,611
   
$
201,019,198
   
$
496,825
 
                                 
Trading assets
 
$
384,051
   
$
384,051
   
$
-
   
$
-
 


     
Fair Value Measurement at December 31, 2012 Using
 
Financial Assets:
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Obligations of U.S. Government and U.S.
  Government sponsored enterprises
 
$
141,591,214
   
$
37,698,000
   
$
103,893,214
   
$
-
 
Mortgage-backed securities, residential
   
31,515,249
     
-
     
31,515,249
     
-
 
Obligations of states and political subdivisions
   
40,814,722
     
-
     
40,814,722
     
-
 
Collateralized mortgage obligations
   
3,543,360
     
-
     
3,543,360
     
-
 
Corporate bonds and notes
   
11,651,635
     
-
     
11,651,635
     
-
 
SBA loan pools
   
1,724,140
     
-
     
1,724,140
     
-
 
Trust Preferred securities
   
2,470,913
     
-
     
2,025,313
     
445,600
 
Corporate stocks
   
6,374,530
     
5,720,533
     
653,997
     
-
 
Total available for sale securities
 
$
239,685,763
   
$
43,418,533
   
$
195,821,630
   
$
445,600
 
                                 
Trading assets
 
$
348,241
   
$
348,241
   
$
-
   
$
-
 

There were no transfers between Level 1 and Level 2 during the three-month period ending March 31, 2013 or the year ending December, 31, 2012.

 
25

 


The significant unobservable inputs used in the fair value measurement of the Corporation’s collateralized debt obligations are probabilities of specific-issuer defaults and deferrals and specific-issuer recovery assumptions.  Significant increases in specific-issuer default assumptions or decreases in specific-issuer recovery assumptions would result in a significantly lower fair value measurement.  Conversely, decreases in specific-issuer default assumptions or increases in specific-issuer recovery assumptions would result in a higher fair value measurement.  The Corporation treats all interest payment deferrals as defaults and assumes no recoveries on defaults.

The tables below present a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three-month periods ending March 31, 2013 and 2012:

   
Fair Value Measurement for Three-Months Ended March 31, 2013 Using Significant Unobservable Inputs (Level 3)
   
Fair Value Measurement for Three-Months Ended March 31, 2012 Using Significant Unobservable Inputs (Level 3)
 
Trust Preferred Securities Available for Sale
           
Beginning balance
 
$
445,600
   
$
294,910
 
Total gains/losses (realized/unrealized):
               
  Included in earnings:
               
    Income on securities
   
-
     
-
 
    Impairment charge on investment securities
   
-
     
-
 
  Included in other comprehensive income
   
51,225
     
51,300
 
Transfers in and/or out of Level 3
   
-
     
-
 
Ending balance March 31
 
$
496,825
   
$
346,210
 


Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

     
Fair Value Measurement at March 31, 2013 Using
 
Financial Assets:
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Impaired Loans:
                               
Commercial and agricultural:
                               
  Commercial &industrial
 
$
237,444
   
$
-
   
$
-
   
$
237,444
 
Commercial mortgages:
           
-
     
-
         
  Other
   
270,575
     
-
     
-
     
270,575
 
Consumer loans:
                               
  Home equity lines & loans
   
53,856
     
-
     
-
     
53,856
 
     Total Impaired Loans
 
$
561,875
   
$
-
   
$
-
   
$
561,875
 
                                 
Other real estate owned:
                               
Commercial and agricultural:
                               
  Commercial and industrial
 
$
101,200
   
$
-
   
$
-
   
$
101,200
 
Commercial mortgages:
                               
  Other
   
257,702
     
-
     
-
     
257,702
 
Residential mortgages
   
201,679
     
-
     
-
     
201,679
 
Consumer loans:
                               
  Home equity lines & loans
   
4,000
     
-
     
-
     
4,000
 
     Total Other real estate owned, net
 
$
564,581
   
$
-
   
$
-
   
$
564,581
 


 
26

 


     
Fair Value Measurement at December 31, 2012 Using
 
Financial Assets:
 
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Impaired Loans:
                               
Commercial and agricultural:
                               
  Commercial & industrial
 
$
235,501
   
$
-
   
$
-
   
$
235,501
 
Commercial mortgages:
           
-
     
-
         
  Other
   
305,222
     
-
     
-
     
305,222
 
     Total Impaired Loans
 
$
540,723
   
$
-
   
$
-
   
$
540,723
 
                                 
Other real estate owned:
                               
Commercial and agricultural:
                               
  Commercial and industrial
 
$
101,200
   
$
-
   
$
-
   
$
101,200
 
Commercial mortgages:
                               
  Other
   
257,702
     
-
     
-
     
257,702
 
Residential mortgages
   
201,679
     
-
     
-
     
201,679
 
Consumer loans:
                               
  Home equity lines & loans
   
4,000
     
-
     
-
     
4,000
 
     Total Other real estate owned, net
 
$
564,581
   
$
-
   
$
-
   
$
564,581
 

The following table presents information related to Level 3 non-recurring fair value measurement at March 31, 2013 and December 31, 2012:
Description
 
Fair Value
at March 31, 2013
   
Technique
   
Unobservable Inputs
 
Impaired loans
 
$
561,875
   
Third party real estate and a 100% discount of personal property
   
1
Management discount based on underlying collateral characteristics and market conditions
 
                       
Other real estate owned
 
$
564,581
   
Third party appraisals
   
1
Estimated holding  period
 
                 
2
Estimated closing costs
 

Description
 
Fair Value at December 31, 2012
   
Technique
   
Unobservable Inputs
 
Impaired loans
 
$
540,723
   
Third party real estate and a 100% discount of personal property
   
1
Management discount based on underlying collateral characteristics and market conditions
 
                       
Other real estate owned
 
$
564,581
   
Third party appraisals
   
1
Estimated holding  period
 
                 
2
Estimated closing costs
 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $837,752 with a valuation allowance of $275,877 as of March 31,2013, resulting in $83,239 of additional provision for loan losses for the three-month period ended March 31, 2013.  Impaired loans had a principal balance of $733,361, with a valuation allowance of $192,638 as of December 31, 2012, resulting in no additional provision for loan losses for the year ending December 31, 2012.

OREO, which is measured by the lower of carrying or fair value less costs to sell, had a net carrying amount of $564,581 at March 31, 2013.  The net carrying amount reflects the outstanding balance of $756,948 net of a valuation allowance of $192,367 at March 31, 2013. There were no write downs for the three-month period ending March 31, 2013.  OREO had a net carrying amount of $564,581 at December 31, 2012.  The net carrying amount reflects the outstanding balance of $756,948 net of a valuation allowance of $192,367 at December 31, 2012, which resulted in write downs of $116,840 for the year ending December 31, 2012.

 
27

 


The carrying amounts and estimated fair values of other financial instruments, at March 31, 2013 and December 31, 2012, are as follows (dollars in thousands):

   
Fair Value Measurements at March 31, 2013 Using
Financial assets:
 
Carrying Amount
   
Quoted Prices
 in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Estimated Fair Value (1)
Cash and due from financial
  Institutions
 
$
27,757
   
$
27,757
   
$
-
$
-
 
$
27,757
Interest-bearing deposits in other
   financial institutions
   
18,380
     
18,380
     
-
 
-
   
18,380
Trading assets
   
384
     
384
     
-
 
-
   
384
Securities available for sale
   
235,307
     
33,791
     
201,019
 
497
   
235,307
Securities held to maturity
   
9,898
     
-
     
10,611
 
-
   
10,611
Federal Home Loan and Federal
  Reserve Bank stock
   
4,607
     
-
     
-
 
-
   
N/A
Net loans
   
910,608
     
-
     
-
 
942,247
   
942,247
Loans held for sale
   
786
     
-
     
786
 
-
   
786
Accrued interest receivable
   
4,530
     
328
     
1,724
 
2,478
   
4,530
                                 
Financial liabilities:
                               
Deposits:
                               
Demand, savings, and insured
  money market accounts
   
845,008
     
845,008
     
-
 
-
   
845,008
Time deposits
   
232,091
     
-
      233,391  
-
   
233,391
Securities sold under agreements
  to repurchase
   
31,427
     
-
      33,780  
-
   
33,780
Federal Home Loan Bank
  advances
   
27,158
     
-
     
29,440
 
-
   
29,440
Accrued interest payable
   
389
     
16
     
206
 
167
   
389

(1) Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

 
28

 


   
Fair Value Measurements at December 31, 2012
 
Financial Assets:
 
Carrying Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Estimated Fair Value (1)
 
Cash and due from financial institutions
$
29,239
 
$
29,239
 
$
-
 
$
 
-
 
$
29,239
 
Interest-bearing deposits in other financial institutions
 
11,002
   
8,645
   
2,357
     
-
   
11,002
 
Trading assets
 
348
   
348
   
-
     
-
   
348
 
Securities available for sale
 
239,686
   
43,419
   
195,822
     
445
   
239,686
 
Securities held to maturity
 
5,748
   
-
   
6,421
     
-
   
6,421
 
Federal Home Loan and Federal
  Reserve Bank stock
 
4,710
   
-
   
-
     
-
   
N/A
 
Net loans
 
883,084
   
-
   
-
     
916,289
   
916,289
 
Loans held for sale
 
1,057
   
-
   
1,057
     
-
   
1,057
 
Accrued interest receivable
 
3,788
   
175
   
1,257
     
2,356
   
3,788
 
Financial liabilities:
                               
Deposits:
                               
Demand, savings, and insured money market accounts
$
808,044
 
$
808,044
 
$
-
   
$
-
 
$
808,044
 
Time deposits
 
236,690
   
-
   
238,245
     
-
   
238,245
 
Securities sold under agreements to repurchase
 
32,711
   
-
   
35,260
     
-
   
35,260
 
Federal Home Loan Bank advances
 
27,225
   
-
   
29,688
     
-
   
29,688
 
Accrued interest payable
 
453
   
12
   
279
     
162
   
453
 
(1) Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.
 
The methods and assumptions used to estimate fair value are described as follows:

Cash, Due From and Interest-Bearing Deposits in Other Financial Institutions

For those short-term instruments that generally mature in 90 days or less, the carrying value approximates fair value of which non interest-bearing deposits are classified as Level 1 and interest-bearing deposits with the Federal Home Loan Bank of New York (“FHLB”) and Federal Reserve Bank of New York (“FRB”) are classified as Level 1.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its transferability.

Loans Receivable

For variable-rate loans that reprice frequently, fair values approximate carrying values.  The fair values for other loans are estimated through discounted cash flow analysis using interest rates currently being offered for loans with similar terms and credit quality.  Loans are classified as Level 3.  The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.  Loans held for sale are classified as Level 2.

 
29

 

Deposits

The fair values disclosed for demand deposits, savings accounts and money market accounts are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying values) and classified as Level 1.

The fair value of certificates of deposits is estimated using a discounted cash flow approach that applies interest rates currently being offered on certificates to a schedule of the weighted-average expected monthly maturities and classified as Level 2.

Securities Sold Under Agreements to Repurchase (Repurchase Agreements)

These instruments bear both variable and fixed rates of interest.  Therefore, the carrying value approximates fair value for the variable rate instruments and the fair value of fixed rate instruments is based on discounted cash flows to maturity.  These are classified as Level 2.

Federal Home Loan Bank Advances

These instruments bear a stated rate of interest to maturity and, therefore, the fair value is based on discounted cash flows to maturity and classified as Level 2.

Accrued Interest Receivable and Payable

For these short-term instruments, the carrying value approximates fair value resulting in a classification of Level 1, Level 2 or Level 3 depending upon the classification of the asset/liability they are associated with.


NOTE 7                      GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill included in the core banking segment during the periods ending March 31, 2013 and 2012 were as follows:

 
2013
   
2012
 
Beginning of year
 
$
21,824,443
   
$
21,983,617
 
Acquired goodwill
   
-
         
Adjustment of Acquired goodwill (1)
   
-
     
(159,174
)
March 31,
 
$
21,824,443
   
$
21,824,443
 
   
(1) Adjustment related to Fort Orange Financial Corp. acquisition.
 


Acquired intangible assets were as follows at March 31, 2013 and December 31, 2012:

   
At March 31, 2013
   
At December 31, 2012
 
   
Balance Acquired
   
Accumulated Amortization
   
Balance Acquired
   
Accumulated Amortization
 
Core deposit intangibles
 
$
3,819,798
   
$
1,934,940
   
$
3,819,798
   
$
1,796,853
 
Other customer relationship intangibles
   
6,063,423
     
3,039,062
     
6,063,423
     
2,942,548
 
Total
 
$
9,883,221
   
$
4,974,002
   
$
9,883,221
   
$
4,739,401
 

Aggregate amortization expense was $234,601 and $284,140 for the three-month periods ended March 31, 2013 and 2012, respectively.

 
30

 


The remaining estimated aggregate amortization expense at March 31, 2013 is listed below:

Year
 
Estimated Expense
 
2013
 
$
641,923
 
2014
   
777,801
 
2015
   
681,176
 
2016
   
607,713
 
2017
   
557,893
 
2018 and thereafter
   
1,642,713
 
   Total
 
$
4,909,219
 

NOTE 8                      ACCUMULATED OTHER COMPREHENSIVE INCOME OR LOSS

Accumulated other comprehensive income or loss represents the net unrealized holding gains or losses on securities available for sale and the funded status of the Corporation's defined benefit pension plan and other benefit plans, as of the consolidated balance sheet dates, net of the related tax effect.

The following is a summary of the changes in accumulated other comprehensive income or loss by component, net of tax, for the periods indicated:
 
   
Unrealized Gains and Losses on Securities Available for Sale
   
Defined Benefit and Other Benefit Plans
   
Total
 
Balance at December 31, 2012
 
$
8,022,790
   
$
(10,829,719
)
 
$
(2,806,929
)
Other comprehensive income before
  reclassification
   
(43,193
)
   
-
     
(43,193
)
Amounts reclassified from accumulated other
  comprehensive income
   
-
     
226,924
     
226,924
 
Net current period other comprehensive income
   
(43,193
)
   
226,924
     
183,731
 
Balance at March 31, 2013
 
$
7,979,597
   
$
(10,602,795
)
 
$
(2,623,198
)

   
Unrealized Gains and Losses on Securities Available for Sale
   
Defined Benefit and Other Benefit Plans
   
Total
 
Balance at December 31, 2011
 
$
7,987,055
   
$
(9,428,433
)
 
$
(1,441,378
)
Other comprehensive income before
  reclassification
   
284,463
     
-
     
284,463
 
Amounts reclassified from accumulated other
  comprehensive income
   
(182,937
)
   
193,768
     
10,831
 
Net current period other comprehensive income
   
101,526
     
193,768
     
295,924
 
Balance at March 31, 2012
 
$
8,088,581
   
$
(9,234,665
)
 
$
(1,146,084
)

The following is the reclassification out of accumulated other comprehensive income for the periods indicated:

Details about Accumulated Other Comprehensive Income Components
Three Months Ended March 31,
 
Affected Line Item
 in the Statement Where
Net Income is Presented
     
2013
     
2012
   
Unrealized gains and losses on securities
  available for sale:
                 
Realized gains on securities available for sale
 
$
-
   
$
297,169
 
Net gains on securities transactions
Income tax expense
   
-
     
114,232
 
Income tax expense
Net of tax
   
-
     
182,937
   
Amortization of defined pension plan
  and other benefit plan items:
                 
Prior service costs (a)
   
20,786
     
20,786
 
Pension and other employee benefits
Actuarial losses (a)
   
(389,409
)
   
(335,548
)
Pension and other employee benefits
Income tax benefit
   
141,699
     
120,994
 
Income tax expense
Net of tax
   
(226,924
)
   
(193,798
)
 
Total reclassification for the period, net of tax
$
$
(226,924
)
 
$
(10,831
)
 
(a) These accumulated other comprehensive income components are included in the computation of net periodic pension and other benefit plan costs (see Note 10 for additional information).

 
31

 


NOTE 9                      COMMITMENTS AND CONTINGENCIES

The Corporation is a party to certain financial instruments with off-balance sheet risk such as commitments under standby letters of credit, unused portions of lines of credit, overdraft protection and commitments to fund new loans.  In accordance with U.S. GAAP, these financial instruments are not recorded in the financial statements.  The Corporation's policy is to record such instruments when funded.  These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk.  Such transactions are generally used by the Corporation to manage clients' requests for funding and other client needs.

The Bank is a party in two legal proceedings involving its Wealth Management Group Services. In both proceedings, the Bank, as trustee pursuant to written trust instruments, has sought judicial settlement of trust accounts in the New York Surrogate’s Court for Chemung County. Individuals who are beneficiaries under the trusts have filed formal objections and/or demand letters with the Court in both of these accounting proceedings, objecting to the final settlement of the trust accounts. The objectants primarily assert that the Bank acted imprudently by failing to diversify the trusts’ investments and they claim $9.6 million and $24.1 million, consisting of damages and disallowed trustee’s commissions, plus unspecified legal fees in the respective proceedings. These proceedings are pending in the Surrogate’s Court and are now in the discovery phase. While the outcome of litigation is not predictable the Bank believes that the claims are without merit and is vigorously defending them.  As of March 31, 2013, no amount has been accrued for potential losses related to these proceedings as a potential loss is not considered probable or reasonably estimable in the opinion of management.

In the normal course of business, there are various outstanding claims and legal proceedings involving the Corporation or its subsidiaries.  Except for the above matter, we believe that we are not a party to any pending legal, arbitration, or regulatory proceedings that could have a material adverse impact on our financial results or liquidity.

NOTE 10      COMPONENTS OF QUARTERLY AND YEAR TO DATE NET PERIODIC BENEFIT COSTS

 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Qualified Pension
           
Service cost, benefits earned during the period
  $ 349,404     $ 323,351  
Interest cost on projected benefit obligation
    408,621       406,110  
Expected return on plan assets
    (727,172 )     (663,493 )
Amortization of unrecognized transition obligation
    -       -  
Amortization of unrecognized prior service cost
    3,464       3,464  
Amortization of unrecognized net loss
    379,990       330,568  
  Net periodic pension expense
  $ 414,307     $ 400,000  
                 
Supplemental Pension
               
Service cost, benefits earned during the period
  $ 9,618     $ 8,692  
Interest cost on projected benefit obligation
    11,513       12,773  
Expected return on plan assets
    -       -  
Amortization of unrecognized prior service cost
    -       -  
Amortization of unrecognized net loss
    8,244       4,980  
  Net periodic supplemental pension expense
  $ 29,375     $ 26,445  
                 
Postretirement, Medical and Life
               
Service cost, benefits earned during the period
  $ 11,002     $ 8,750  
Interest cost on projected benefit obligation
    14,573       18,000  
Expected return on plan assets
    -       -  
Amortization of unrecognized prior service benefit
    (24,250 )     (24,250 )
Amortization of unrecognized net loss
    1,175       -  
  Net periodic postretirement, medical
      and life expense
  $ 2,500     $ 2,500  


 
32

 


NOTE 11                      SEGMENT REPORTING

The Corporation manages its operations through two primary business segments:  core banking and wealth management group services.  The core banking segment provides revenues by attracting deposits from the general public and using such funds to originate consumer, commercial, commercial real estate, and residential mortgage loans, primarily in the Corporation’s local markets and to invest in securities.  The wealth management group services segment provides revenues by providing trust and investment advisory services to clients.

Accounting policies for the segments are the same as those described in Note 1. Summarized financial information concerning the Corporation’s reportable segments and the reconciliation to the Corporation’s consolidated results are shown in the following table.  Income taxes are allocated based on the separate taxable income of each entity and indirect overhead expenses are allocated based on reasonable and equitable allocations applicable to the reportable segment.  Holding company amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the Holding Company and Other column below, along with amounts to eliminate transactions between segments.

Three Months Ended March 31, 2013
 
Core Banking
   
Wealth Management Group
   
Holding Company And Other
   
Consolidated Totals
 
Net interest income
 
$
11,715,328
   
$
-
   
$
1,639
   
$
11,716,967
 
Provision for loan losses
   
431,010
     
-
     
-
     
431,010
 
Net interest income after provision for loan losses
   
11,284,318
     
-
     
1,639
     
11,285,957
 
Other operating income
   
1,994,572
     
1,750,178
     
276,827
     
4,021,577
 
Other operating expenses
   
9,938,054
     
1,526,556
     
260,147
     
11,724,757
 
Income before income tax expense
   
3,340,836
     
223,622
     
18,319
     
3,582,777
 
Income tax expense
   
1,077,515
     
85,960
     
7,534
     
1,171,009
 
Segment net income
 
$
2,263,321
   
$
137,662
   
$
10,785
   
$
2,411,768
 
                                 
Segment assets
 
$
1,272,340,074
   
$
5,117,704
   
$
2,514,014
   
$
1,279,971,792
 

Three Months Ended March 31, 2012
 
Core Banking
   
Wealth Management Group
   
Holding Company And Other
   
Consolidated Totals
 
Net interest income
 
$
12,027,531
   
$
-
   
$
3,676
   
$
12,031,207
 
Provision for loan losses
   
477,305
     
-
     
-
     
477,305
 
Net interest income after provision for loan losses
   
11,550,226
     
-
     
3,676
     
11,553,902
 
Other operating income
   
3,070,033
     
1,775,576
     
44,789
     
4,890,398
 
Other operating expenses
   
9,313,097
     
1,435,036
     
183,088
     
10,931,221
 
Income (loss) before income tax expense
   
5,307,162
     
340,540
     
(134,623
)
   
5,513,079
 
Income tax expense (benefit)
   
1,837,871
     
130,904
     
(70,229
)
   
1,898,546
 
Segment net income (loss)
 
$
3,469,291
   
$
209,636
   
$
(64,394
)
 
$
3,614,533
 
                                 
Segment assets
 
$
1,245,867,473
   
$
5,687,189
   
$
2,940,284
   
$
1,254,494,946
 


NOTE 12                      STOCK BASED COMPENSATION

Board of Director’s Stock Compensation

Members of the Board of Directors receive common shares of the Corporation equal in value to the amount of fees individually earned during the previous year for service as a director.  The common shares are distributed to the Corporation's individual board members from treasury shares of the Corporation on or about January 15 following the calendar year of service.

Additionally, the President and Chief Executive Officer of the Corporation, who does not receive cash compensation as a member of the Board of Directors, is awarded common shares equal in value to the average of those awarded to board members not employed by the Corporation who have served for 12 months during the prior year.

 
33

 


During January 2013 and 2012, 7,969 and 10,238 shares, respectively, were re-issued from treasury to fund the stock component of directors' compensation.  An expense of $135,375 and $54,388 related to this compensation was recognized during the period ending March 31, 2013 and March 31, 2012, respectively.  This expense is accrued as shares are earned.

Restricted Stock Plan

Pursuant to the Corporation’s Restricted Stock Plan (the “Plan”), the Corporation may make discretionary grants of restricted stock to officers other than the Corporation's Chief Executive Officer.  Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date.

A summary of restricted stock activity from December 31, 2012 to March 31, 2013 is presented below:
 
   
Shares
   
Weighted–Average Grant Date Fair Value
 
Nonvested at December 31, 2012
    20,009     $ 23.84  
  Granted
    -       -  
  Vested
    1,794       22.33  
  Forfeited or Cancelled
    -       -  
Nonvested at March 31, 2013
    18,215     $ 23.98  

As of March 31, 2013, there was $404,518 of total unrecognized compensation cost related to nonvested shares granted under the Plan.  The cost is expected to be recognized over a weighted-average period of 4.13 years.  The total fair value of shares vested during the three months ended March 31, 2013 was $53,838.

Item 2:                      Management's Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this review is to focus on information about the financial condition and results of operations of Chemung Financial Corporation (the “Corporation”) for the three month periods ended March 31, 2013 and 2012.  The following discussion and unaudited consolidated interim financial statements and related notes included in this report should be read in conjunction with our 2012 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2013.  The results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year or any other interim period.

To assist the reader, the Corporation has provided the following list of commonly used acronyms and abbreviations included in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

CDO: Collateralized Debt Obligation
OTTI:  Other-than-temporary Impairment
FASB:  Financial Accounting Standards Board
PCI:  Purchased Credit Impaired
FDIC:  Federal Deposit Insurance Corporation
SEC:  Securities and Exchange Commission
FHLB:  Federal Home Loan Bank
TDR:  Troubled Debt Restructurings
GAAP:  U.S. generally accepted accounting principles
 

Forward-looking Statements

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  The Corporation intends its forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections.  All statements regarding, among other things, the Corporation's expected financial condition and results of operations, the Corporation's business strategy, the Corporation's financial plans, forecasted demographic and economic trends relating to the Corporation's industry and similar matters are forward-looking statements.  These statements can sometimes be identified by the Corporation's use of forward-looking words such as "may," "will," "anticipate," "estimate," "expect,"

 
34

 


or "intend."  The Corporation cannot promise that its expectations in such forward-looking statements will turn out to be correct.  The Corporation's actual results could be materially different from expectations because of various factors, including changes in economic conditions or interest rates, credit risk, difficulties in managing the Corporation’s growth, competition, changes in law or the regulatory environment, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, and changes in general business and economic trends.  Information concerning these and other factors can be found in the Corporation’s periodic filings with the Securities and Exchange Commission, including in our 2012 Annual Report on Form 10-K.  These filings are available publicly on the SEC's website at http://www.sec.gov, on the Corporation's website at http://www.chemungcanal.com or upon request from the Corporate Secretary at (607) 737-3746.  Except as otherwise required by law, the Corporation undertakes no obligation to publicly update or revise its forward-looking statements, whether as a result of new information, future events, or otherwise.

Critical Accounting Policies, Estimates and Risks and Uncertainties

Critical accounting policies include the areas where the Corporation has made what it considers to be particularly difficult, subjective or complex judgments concerning estimates, and where these estimates can significantly affect the Corporation's financial results under different assumptions and conditions.  The Corporation prepares its financial statements in conformity with GAAP.  As a result, the Corporation is required to make certain estimates, judgments and assumptions that it believes are reasonable based upon the information available at that time. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented.  Actual results could be different from these estimates.

Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover probable incurred credit losses inherent in the loan portfolio, and the material effect that such judgments can have on the Corporation's results of operations.  While management's current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions the allowance would need to be increased.  For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provisions for loan losses would be required to increase the allowance.  In addition, the assumptions and estimates used in the internal reviews of the Corporation's non-performing loans and potential problem loans, and the associated evaluation of the related collateral coverage for these loans, has a significant impact on the overall analysis of the adequacy of the allowance for loan losses.  Real estate values in the Corporation’s market area did not increase dramatically in the prior several years, and, as a result, any declines in real estate values have been modest.  While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral evaluations were significantly lowered, the Corporation's allowance for loan losses policy would also require additional provisions for loan losses.

Management also considers the accounting policy relating to OTTI of investment securities to be a critical accounting policy.  The determination of whether a decline in market value is other-than-temporary is necessarily a matter of subjective judgment. The timing and amount of any realized losses reported in the Corporation's financial statements could vary if management's conclusions were to change as to whether other-than-temporary impairment exists.  The Corporation 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 these criteria is met, the entire difference between amortized cost and fair value is recognized through a charge to earnings.  For those securities that do not meet the aforementioned criteria, such as those that management has determined to be other-than-temporarily impaired, the amount of impairment charged to earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.  The Corporation uses an OTTI evaluation model to compare the present value of expected cash flows to the previous estimate to determine if there are adverse changes in cash flows during the quarter.  The OTTI model considers the structure and term of the CDO and the financial condition of the underlying issuers.  Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes.

 
35

 


The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities.  Assumptions used in the model include expected future default rates and prepayments.  We assume no recoveries on defaults and treat all interest payment deferrals as defaults.  Additional default assumptions were made based on credit quality ratios and performance measures of the remaining financial institutions in the pool, as well as overall default rates based on historical bank debt default rate averages.

Management also considers the accounting policy relating to the valuation of goodwill and other intangible assets to be a critical accounting policy.  The initial carrying value of goodwill and other intangible assets is determined using estimated fair values developed from various sources and other generally accepted valuation techniques.  Estimates are based upon financial, economic, market and other conditions as they existed as of the date of a particular acquisition.  These estimates of fair value are the results of judgments made by the Corporation based upon estimates that are inherently uncertain and changes in the assumptions upon which the estimates were based may have a significant impact on the resulting estimates.  In addition to the initial determination of the carrying value, on an ongoing basis management must assess whether there is any impairment of goodwill and other intangible assets that would require an adjustment in carrying value and recognition of a loss in the consolidated statement of income.

Financial Condition

Summary

Assets totaled $1.280 billion at March 31, 2013 compared with $1.248 at December 31, 2012, an increase of $31.8 million, or 2.5%.  The growth was primarily due to increases of $27.9 million, or 3.1%, in total portfolio loans and $5.9 million in cash and cash equivalents.  The increase in portfolio loans was due to strong growth of $27.0 million in commercial loans.

Total liabilities totaled $1.147 billion at March 31, 2013 compared with $1.117 billion at December 31, 2012, an increase of $30.0 million, or 2.7%.  The increase was primarily due to an increase of $32.4 million in deposits, partially offset by a decrease of $1.3 million in borrowings.

Total equity was $132.9 million at March 31, 2013 compared with $131.1 million at December 31, 2012.  The increase was primarily due to net income of $2.4 million for the three months ended March 31, 2013, partially offset by dividends declared of $1.2 million.  The total equity to total assets ratio was 10.38% at March 31, 2013 compared with 10.50% at December 31, 2012.  The tangible equity to tangible assets ratio was 8.47% at March 31, 2013 compared with 8.53% at December 31, 2012.

The market value of total assets under management or administration in the Corporation’s Wealth Management Group was $1.833 billion at March 31, 2013 compared with $1.735 billion at December 31, 2012.

Cash and Cash Equivalents

Total cash and cash equivalents increased $5.9 million since December 31, 2012, primarily due to a $7.4 million increase in interest-bearing deposits in other financial institutions, partially offset by a $1.5 million decrease in cash and due from financial institutions.  The increase in interest-bearing deposits in other financial institutions was a result of the significant increase in deposits.  The Corporation continues to evaluate alternative investment of these funds with caution, given the low interest rate environment and the inherent interest rate risk associated with longer term securities portfolio investments.

 
36

 


Securities

The Corporation’s Funds Management Policy includes an investment policy that in general, requires debt securities purchased for the bond portfolio to carry a minimum agency rating of "A".  After a credit analysis is performed, the policy also allows the Corporation to purchase local municipal obligations that are not rated.  The Corporation intends to maintain a reasonable level of securities to provide adequate liquidity and in order to have securities available to pledge to secure public deposits, repurchase agreements and other types of transactions.  Fluctuations in the fair value of the Corporation’s securities relate primarily to changes in interest rates.

Marketable securities are classified as Available for Sale, while investments in local municipal obligations are generally classified as Held to Maturity.  The composition of the available for sale segment of the securities portfolio is summarized as follows (in thousands of dollars):

   
March 31, 2013
   
December 31, 2012
 
Securities Available for Sale
 
Amortized Cost
   
Estimated Fair Value
   
Unrealized Gains (Losses)
   
Amortized Cost
   
Estimated Fair Value
   
Unrealized Gains (Losses)
 
Obligations of U.S. Government and
  U.S Government sponsored enterprises
 
$
139,225
   
$
142,498
   
$
3,273
   
$
138,041
   
$
141,591
   
$
3,550
 
Mortgage-backed securities, residential
   
25,488
     
27,156
     
1,668
     
29,592
     
31,515
     
1,923
 
Collateralized mortgage obligations
   
2,913
     
2,950
     
37
     
3,495
     
3,543
     
48
 
Obligations of states and political
  Subdivisions
   
38,451
     
40,029
     
1,578
     
39,175
     
40,815
     
1,640
 
Corporate bonds and notes
   
11,410
     
11,612
     
202
     
11,412
     
11,652
     
240
 
SBA loan pools
   
1,602
     
1,641
     
39
     
1,683
     
1,724
     
41
 
Trust preferred securities
   
2,521
     
2,520
     
(1
)
   
2,519
     
2,471
     
(48
)
Corporate stocks
   
734
     
6,901
     
6,167
     
736
     
6,375
     
5,639
 
     Totals
 
$
222,344
   
$
235,307
   
$
12,963
   
$
226,653
   
$
239,686
   
$
13,033
 

The available for sale segment of the securities portfolio totaled $235.3 million at March 31, 2013, a decrease of $4.4 million, or 1.8%, from $239.7 million at December 31, 2012.  The decrease resulted primarily from sales and calls of $10.5 million, and maturities and principal collected of $20.4 million.  These items were partially offset by purchases of $27.1 million.  The decrease in securities available for sale was used to help fund the increase in portfolio loans.

The held to maturity segment of the securities portfolio consists of obligations of political subdivisions in the Corporation’s market areas.  These securities totaled $9.9 million at March 31, 2013, an increase of $4.1 million due primarily to the purchase of securities, from December 31, 2012.

Loans

The composition of the loan portfolio, net of deferred origination fees and costs, and unearned income is summarized as follows (in thousands of dollars):

   
March 31, 2013
   
December 31, 2012
 
Commercial and agricultural
 
$
141,063
   
$
133,851
 
Commercial mortgages
   
340,000
     
320,198
 
Residential mortgages
   
202,114
     
200,475
 
Indirect consumer loans
   
132,064
     
130,573
 
Direct and other consumer loans
   
106,192
     
108,420
 
Total loans, net
 
$
921,433
   
$
893,517
 


 
37

 


Portfolio loans totaled $921.4 million at March 31, 2013, an increase of $27.9 million, or 3.1%, from $893.5 million at December 31, 2012.  The increase in portfolio loans was due to strong growth of $27.0 million, or 5.9%, in commercial loans.  The growth in commercial loans was primarily due to an increase in commercial mortgages in the Albany, New York region, of the Corporation’s Capital Bank division.

Residential mortgage loans totaled $202.1 million at March 31, 2013, an increase of $1.6 million, or 0.8%, from December 31, 2012.  In addition, during the three months ended March 31, 2013, $3.3 million of newly originated residential mortgages were sold in the secondary market to Federal Home Loan Mortgage Corporation, with an additional $0.3 million originated and sold to the State of New York Mortgage Agency.  During the twelve months ended December 31, 2012, $15.8 million of residential mortgages were sold in the secondary market.

The Corporation anticipates that future growth in portfolio loans will continue to be in commercial mortgages and indirect consumer loans.

Non-Performing Assets

Non-performing assets consist of (i) non-accrual loans, (ii) non-accrual troubled debt restructurings, (iii) accruing troubled debt restructurings, (iv) accruing loans past due 90 days or more and (v) other real estate owned that has been acquired in partial or full satisfaction of loan obligations or upon foreclosure.

Past due status on all loans is based on the contractual terms of the loan.  It is generally the Corporation's policy that a loan 90 days past due be placed in non-accrual status unless factors exist that would eliminate the need to place a loan in this status.  A loan may also be designated as non-accrual at any time if payment of principal or interest in full is not expected due to deterioration in the financial condition of the borrower.  At the time loans are placed in non-accrual status, the accrual of interest is discontinued and previously accrued interest is reversed.  All payments received on non-accrual loans are applied to principal.  Loans can be returned to accrual status when they become current as to principal and interest and remain current for a period of six consecutive months or when, in the opinion of management, the Corporation expects to receive all of its original principal and interest.  In the case of non-accrual loans where a portion of the loan has been charged off, the remaining balance is kept in non-accrual status until the entire principal balance has been recovered.

The following table summarizes the Corporation's non-performing assets, excluding acquired PCI loans (in thousands of dollars):
 
 
 
March 31, 2013
 
December 31, 2012
Non-accrual loans
$ 6,331     $ 5,667  
Non-accrual troubled debt restructurings
  952            365  
Accruing troubled debt restructurings
  6,297         5,364  
Accruing loans past due 90 days or more
  3,218         4,484  
Total non-performing loans
$ 16,798     $ 15,880  
Other real estate owned
  565               565  
Total non-performing assets
$ 17,363     $ 16,445  
 
Ratio of non-performing loans to total loans
1.82
%
     1.78  
%
Ratio of adjusted non-performing loans to total loans (1)
0.79
%
     0.68  
%
             
Ratio of non-performing assets to total assets
1.36
%
     1.32  
%
Ratio of adjusted non-performing assets to total assets (2)
0.61
%
     0.53  
%
             
Ratio of allowance for loan losses to adjusted
  non-performing loans
148.63
%
     172.96  
%

(1) Adjusted non-performing loans include total non-performing loans less accruing troubled debt restructurings and accruing loans past due 90 days or more.
(2) Adjusted non-performing assets include total non-performing assets less accruing troubled debt restructurings and accruing loans past due 90 days or more.

 
38

 


Non-Performing Loans

The recorded investment in non-performing loans at March 31, 2013 totaled $16.8 million compared to $15.9 million at December 31, 2012, an increase of $0.9 million.  The increase in non-performing loans was due to increases of $0.7 million in non-accrual loans, $0.6 million in non-accrual troubled debt restructurings and $0.9 million in accruing troubled debt restructurings.  These items were partially offset by a decrease of $1.3 million in accruing loans past due 90 days or more.  The increase in non-accrual loans was primarily due to increases in non-accrual loans in the commercial construction and residential mortgage segments of the loan portfolio.  The decrease in accruing loans past due 90 days or more was primarily due to the payoff of two commercial loans.

The recorded investment in accruing loans past due 90 days or more totaled $3.2 million at March 31, 2013 compared with $4.5 million at December 31, 2012.  The decrease was primarily due to a $1.3 million reduction in acquired construction loans not considered by management to be PCI loans, which for a variety of reasons are 90 days or more past their stated maturity dates.  These loans totaled $3.2 million at March 31, 2013.  However, the borrowers continue to make required interest payments.  Additionally, these loans carry third party credit enhancements, and based upon the strength of those credit enhancements, the Corporation has not identified these loans as PCI loans and expects to incur no losses on these loans.

Not included in non-performing loans at March 31, 2013 are $9.6 million of acquired loans which the Corporation has identified as PCI loans.  The PCI loans are accounted for under separate accounting guidance, Accounting Standards Codification (“ASC”) Subtopic 310-30, “Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality” as disclosed in “Note 5 Loans and Allowance for Loan Losses” to the unaudited interim financial statements.

Troubled Debt Restructurings

The Corporation works closely with borrowers that have financial difficulties to identify viable solutions that minimize the potential for loss.  In that regard, the Corporation modified the terms of select loans to maximize their collectability.  The modified loans are considered TDRs under current accounting guidance.  Modifications generally involve short-term deferrals of principal and/or interest payments, reductions of scheduled payment amounts, interest rates or principal of the loan, and forgiveness of accrued interest.  As of March 31, 2013, the Corporation had $1.0 million of non-accrual TDRs compared with $0.4 million as of December 31, 2012.  As of March 31, 2013, the Corporation had $6.3 million of accruing TDRs compared with $5.4 million as of December 31, 2012.  The increase in total TDRs was primarily due to restructuring the loans of two commercial borrowers that recently experienced financial difficulties.

Impaired Loans

Impaired loans at March 31, 2013 totaled $13.0 million, including performing TDRs of $6.3 million, compared to $12.7 million, including performing TDRs of $5.4 million, at December 31, 2012.  The increase of $0.3 million resulted from increases of $0.2 million in commercial mortgages and $0.1 million in consumer loans.  Included in the impaired loan total at March 31, 2013 are loans totaling $0.8 million for which impairment allowances of $0.3 million have been specifically allocated to the allowance for loan losses.  Included in the impaired loan total at December 31, 2012, are loans totaling $0.7 million for which impairment allowances of $0.2 million have been specifically allocated to the allowance for loan losses.  Not included in the impaired loan totals are acquired loans identified as PCI loans.

 
39

 


The majority of the Corporation's impaired loans are secured and measured for impairment based on collateral evaluations.  It is the Corporation's policy to obtain updated appraisals, by independent third parties, on loans secured by real estate at the time a loan is determined to be impaired.  Prior to the receipt of the updated appraisal, an impairment measurement is performed based upon the most recent appraisal on file to determine the amount of any specific allocation or charge-off.  In determining the amount of any specific allocation or charge-off, the Corporation will make adjustments to reflect the estimated costs to sell the property.  Upon receipt and review of the updated appraisal, an additional measurement is performed to determine if any adjustments are necessary to reflect the proper provisioning or charge-off.  Impaired loans are reviewed on a quarterly basis to determine if any changes in credit quality or market conditions would require any additional allocation or recognition of additional charge-offs.  Real estate values in the Corporation's market area had not increased dramatically in the prior several years and, as a result, declines in real estate values have been modest.  Non-real estate collateral may be valued using (i) an appraisal, (ii) net book value of the collateral per the borrower’s financial statements, or (iii) aging reports, that may be adjusted based on management’s knowledge of the client and client’s business.  If market conditions warrant, future appraisals are obtained for both real estate and non-real estate collateral.

Allowance for Loan Losses

The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans.  The allowance for loan losses is increased through a provision for loan losses charged to operations.  Loans are charged against the allowance for loan losses when management believes that the collectability of all or a portion of the principal is unlikely.  Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic basis and takes into consideration such factors as the credit risk grade assigned to the loan, historical loan loss experience (general component) and review of specific impaired loans (including evaluations of the underlying collateral and expected cash flows).  Historical loss experience is adjusted by management based on their judgment as to the current impact of qualitative factors including changes in the composition and volume of the loan portfolio, overall portfolio quality, and current economic conditions that may affect the borrowers' ability to pay.  Management believes that the allowance for loan losses is adequate to absorb probable incurred losses.  While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation's allowance for loan losses. Such agencies may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Management, after considering current information and events regarding the borrower's ability to repay their obligations, classifies a loan as impaired when it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is determined to be impaired and is placed on nonaccrual status, all future payments received are applied to principal.

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential mortgage loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.  Troubled debt restructurings are impaired loans.

 
40

 


The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors.  Loans not impaired but classified as substandard and special mention use a historical loss factor on a rolling five year history of net losses.  For all other unclassified loans, the historical loss experience is determined by portfolio class and is based on the actual loss history experienced by the Corporation over the most recent two years.  This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio class.  These economic factors include consideration of the following: (1) lending policies and procedures, including underwriting standards and collection, charge-off and recovery policies, (2) national and local economic and business conditions and developments, including the condition of various market segments, (3) loan profiles and volume of the portfolio, (4) the experience, ability, and depth of lending management and staff, (5) the volume and severity of past due, classified and watch-list loans, non-accrual loans and troubled debt restructurings, (6) the quality of the Bank’s loan review system and the degree of oversight by the Bank’s Board of Directors, (7) collateral related issues: secured vs. unsecured, type, declining valuation environment and trend of other related factors, (8) the existence and effect of any concentrations of credit, and changes in the level of such concentrations, (9) the effect of external factors, such as competition and legal and regulatory requirements, on the level of estimated credit losses in the Bank’s current portfolio and (10) the recession threat from United States and European fiscal crises.

The allowance for loan losses was $10.8 million at March 31, 2013, up from $10.4 million at December 31, 2012.  The ratio of allowance for loan losses to total loans was 1.17% at March 31, 2013, level with December 31, 2012.  The increase in the allowance for loan losses was due principally to loan portfolio growth and allowances for this growth after consideration of the factors discussed above.

At March 31, 2013, the Corporation’s allowance for loan losses on originated loans (which are defined as total loans excluding acquired loans) totaled $9.7 million, resulting in a ratio of the allowance for loan losses on originated loans to originated loans of 1.16% compared with 1.18% at December 31, 2012.  The allowance for loan losses on originated loans at March 31, 2013, represents an amount that management believes is adequate to absorb probable incurred loan losses on the Corporation’s originated loan portfolio.

The following table summarizes the activity in the allowance for loan losses for the three months ended March 31, 2013 and 2012 (in thousands of dollars, except ratio data):

   
Three Months Ended
 
   
March 31, 2013
   
March 31, 2012
 
 
Balance at beginning of period
  $ 10,433     $ 9,659  
Reclassification of acquired loan discount
    -       124  
Charge-offs:
               
  Commercial and agricultural
    17       -  
  Commercial mortgages
    -       49  
  Residential mortgages
    44       15  
  Consumer loans
    197       158  
Total charge-offs
    258       222  
Recoveries:
               
  Commercial and agricultural
    142       173  
  Commercial mortgages
    9       10  
  Residential mortgages
    -       -  
  Consumer loans
    68       62  
Total  recoveries
    219       245  
   Net charge-offs (recoveries)
    39       (23 )
   Provision charged to operations
    431       477  
Balance at end of period
  $ 10,825     $ 10,283  
                 
Ratio of net charge-offs (recoveries) to
   average loans outstanding
    0.02 %     (0.01 )%
Ratio of allowance for loan losses to
   total loans outstanding
    1.17 %     1.28 %

 
41

 


Deposits

A summary of deposits at March 31, 2013 and December 31, 2012 is as follows (in thousands of dollars):

   
March 31, 2013
   
December 31, 2012
   
Dollar Change
   
Percent Change
 
Non-interest-bearing demand deposits
 
$
296,361
   
$
300,610
   
$
(4,249
)
   
-1.4
%
Interest-bearing demand deposits
   
102,201
     
90,730
     
11,471
     
12.6
%
Insured money market accounts
   
265,025
     
243,115
     
21,910
     
9.0
%
Savings deposits
   
181,421
     
173,589
     
7,832
     
4.5
%
Time deposits
   
232,091
     
236,690
     
(4,599
)
   
-1.9
%
   Total
 
$
1,077,099
   
$
1,044,734
   
$
32,365
     
3.1
%

The growth in deposits is a result of the Corporation’s deposit strategy, which is to fund the Bank with stable, low-cost deposits, primarily checking account deposits and other low interest-bearing deposit accounts.  A checking account is the driver of a banking relationship and consumers consider the bank where they have their checking account as their primary bank.  These customers will typically turn to their primary bank first when in need of other financial services.  Strategies that have been developed and implemented to generate these deposits include: (i) acquire deposits by entering new markets through de novo branching, (ii) an annual checking account marketing campaign, (iii) training branch employees to identify and meet client financial needs with Bank products and services, (iv) link business and consumer loans to primary checking account at the Bank, (v) aggressively promote direct deposit of client’s payroll checks or benefit checks and (vi) constantly monitor the Corporation’s pricing strategies to ensure competitive products and services.

Sorted by public, commercial and consumer sources, the $32.4 million growth in deposits was due to increases of $31.2 million in public funds and $11.3 million in consumer accounts, partially offset by a decrease of $10.2 million in commercial accounts.  The increase in public funds was primarily due to increases in interest-bearing demand deposits and money market accounts.  The increase in consumer deposits was primarily due to increases in non-interest-bearing demand deposits and savings deposits, partially offset by a decrease in time deposits.  The Corporation had anticipated a decline in time deposits since its strategy was to focus on core checking accounts.  The decrease in commercial deposits was primarily due to a decrease in non-interest-bearing demand deposits, partially offset by an increase in money market accounts.


The Corporation also considers brokered deposits to be an element of its deposit strategy and anticipates that it will continue using brokered deposits as a secondary source of funding to support growth.  The Corporation’s use of brokered deposits as part of its funding strategy complies with the FDIC’s guidance and regulations on the use of brokered deposits by insured banks.  Brokered deposits include funds obtained through brokers, and the Bank’s participation in the Certificate of Deposit Account Registry Service (“CDARS”) program.  The CDARS program involves a network of financial institutions that exchange funds among members in order to ensure FDIC insurance coverage on customer deposits above the single institution limit.  Using a sophisticated matching system, funds are exchanged on a dollar-for-dollar basis, so that the equivalent of an original deposit comes back to the originating institution.  Deposits obtained through brokers were $7.8 million as of March 31, 2013 compared with $8.8 million as of December 31, 2012.  Deposits obtained through the CDARS program were $9.8 million as of March 31, 2013 compared with $8.1 million as of December 31, 2012.  The Corporation plans to offer the CDARS program to local municipalities in 2013.


Borrowings

Both the repayment of FHLB term advances and decline in securities sold under agreement to repurchase reflect the decrease of $1.4 million in borrowings during the three months ended March 31, 2013.  As a result of the increase in deposits during the three months ended March 31, 2013, the Corporation decided not to increase borrowings to help fund loan growth.

 
42

 


Shareholders’ Equity

Total shareholders’ equity was $132.9 million at March 31, 2013 compared with $131.1 million at December 31, 2012.  The increase was primarily due to $2.4 million in net income for 2013, partially offset by dividends of $1.2 million.  The total shareholders’ equity to total assets ratio was 10.38% at March 31, 2013 compared with 10.50% at December 31, 2012.  The tangible equity to tangible assets ratio was 8.47% at March 31, 2013 compared with 8.53% at December 31, 2012.

The Corporation and the Bank are subject to capital adequacy guidelines of the Federal Reserve and establish a framework for the classification of financial holding companies and financial institutions into five categories:  well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.  As of March 31, 2013, both the Corporation’s and the Bank’s capital ratios were in excess of those required to be considered well-capitalized under regulatory capital guidelines.

Results of Operations
First Quarter of 2013 vs. First Quarter of 2012

Net Income

Net income for the three months ended March 31, 2013 was $2.4 million, a decrease of $1.2 million, or 33.3%, compared with $3.6 million for the three months ended March 31, 2012.  Earnings per share for the three months ended March 31, 2013 was $0.52 compared with $0.78 for the three months ended March 31, 2012.  Return on average assets and return on average equity for the three months ended March 31, 2013 were 0.77% and 7.37%, respectively, compared with 1.18% and 11.34%, respectively, for the same period in the prior year.

The decline in 2013 earnings was due primarily to a decrease of $0.3 million in net interest income and reductions of $0.3 million in net gain on securities transactions and $0.8 million in pre-tax casualty gains from insurance reimbursements.  In addition, non-interest expense increased $0.8 million.  These items were partially offset by a reduction of $0.7 million in income taxes.

Net Interest Income

Net interest income, which is the difference between income received on interest-earning assets, such as loans and securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings, is the largest contributor to earnings.

Net interest income for the three months ended March 31, 2013 totaled $11.7 million, a decrease of $0.3 million, or 2.6%, compared with $12.0 million for the same period in the prior year.  Net interest margin was 4.07% for the three months ended March 31, 2013 compared with 4.29% for the same period in the prior year.  The decline in net interest income was primarily due to a 40 basis point decrease in the yield on interest-earning assets, partially offset by an increase of $38.5 million in average earning assets.  The decline in net interest margin was primarily due to yields on interest-earning assets decreasing at a faster rate than the cost of interest-bearing liabilities.  The decrease in yield on interest-earning assets was attributable to an 86 basis point decrease in yield on loans, a result of loans continuing to reprice at current historically low market rates.

Provision for Loan Losses

The provision for loan losses for the three months ended March 31, 2013 totaled $0.4 million compared with $0.5 million for the three months ended March 31, 2012.

 
43

 


Non-Interest Income

Non-interest income for the three months ended March 31, 2013 totaled $4.0 million, a decrease of $0.9 million, or 17.8%, compared with $4.9 million for the same period in the prior year.  The decline was primarily due to reductions of $0.8 million in casualty gains from insurance reimbursements and $0.3 million in net gain on securities transactions.  These items were partially offset by an increase of $0.2 million in the Corporation’s equity investments.  Wealth Management Group fee income and service charges on deposit accounts for the three months ended March 31, 2013 did not change from the levels in the prior year.

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2013 totaled $11.7 million, an increase of $0.8 million, or 7.3%, compared with $10.9 million for the same period in the prior year.  The increase was primarily due to increases of $0.3 million in salaries and wages, $0.2 million in professional services and $0.1 million in pension and other employee benefits.  The increase in salaries and wages was primarily due to compensation related to merit increases and incentive compensation.  The increase in pension and other employee benefits was primarily due to higher pension costs and health benefits.

The increase in professional services was primarily due to tax preparation costs for the Wealth Management Group recorded in the first quarter of 2013 compared to the second quarter of the prior year for the same costs.

Income tax expense for the three months ended March 31, 2013 was $1.2 million, a decrease of $0.7 million from $1.9 million for the three months ended March 31, 2012.  Income tax expense reflects an effective tax rate of 32.7% for the three months ended March 31, 2013 compared with 34.4% for the same period in the prior year.  The decrease in the effective tax rate was primarily due to an increase in the relative percentage of tax exempt income to pre-tax income.

 
44

 


Average Consolidated Balance Sheet and Interest Analysis

The following table sets forth certain information related to the Corporation’s average consolidated balance sheets and it’s consolidated statements of income for the periods indicated and reflects the average yield on assets and average cost of liabilities for the periods indicated.  For the purpose of the table below, non-accruing loans are included in the daily average loan amounts outstanding.  Daily balances were used for average balance computations.  Investment securities are stated at amortized cost.  No tax equivalent adjustments have been made in calculating yields on obligations of states and political subdivisions.

(in thousands of dollars)
 
Three Months Ended
March 31, 2013
   
Three Months Ended
March 31, 2012
   
Assets
 
Average Balance
   
Interest
   
Yield/
Rate
   
Average Balance
   
Interest
   
Yield/
Rate
   
Earning assets:
                                     
Loans
 
$
909,166
   
$
11,304
     
5.04
%
 
$
796,035
   
$
11,671
     
5.90
%
 
Taxable securities
   
198,012
     
1,131
     
2.32
%
   
232,673
     
1,486
     
2.57
%
 
Tax-exempt securities
   
46,708
     
305
     
2.65
%
   
52,161
     
341
     
2.63
%
 
Interest-bearing deposits
   
12,704
     
8
     
0.25
%
   
47,178
     
42
     
0.36
%
 
Total earning assets
   
1,166,590
     
12,748
     
4.43
%
   
1,128,047
     
13,540
     
4.83
%
 
                                                   
Non-earning assets:
                                                 
Cash and due from banks
   
24,327
                     
23,904
                   
Premises and equipment, net
   
25,495
                     
24,726
                   
Other assets
   
47,502
                     
54,894
                   
Allowance for loan losses
   
(10,559
)
                   
(9,854
)
                 
AFS valuation allowance
   
13,024
                     
13,736
                   
     Total
 
$
1,266,379
                   
$
1,235,453
                   
                                                   
Liabilities and Shareholders' Equity
                                                 
Interest-bearing liabilities:
                                                 
Interest-bearing demand deposits
 
$
103,752
     
27
     
0.10
%
 
$
80,991
     
21
     
0.11
%
 
Savings and insured money
  market deposits
   
432,779
     
199
     
0.19
%
   
401,287
     
221
     
0.22
%
 
Time deposits
   
233,565
     
398
     
0.69
%
   
269,288
     
671
     
1.00
%
 
Federal Home Loan Bank
  advances and securities sold
    under agreements repurchase
   
59,204
     
407
     
2.79
%
   
80,842
     
596
     
2.96
%
 
Total interest-bearing liabilities
   
829,300
     
1,031
     
0.50
%
   
832,408
     
1,509
     
0.73
%
 
                                                   
Non-interest-bearing liabilities:
                                                 
Demand deposits
   
293,920
                     
266,469
                   
Other liabilities
   
10,376
                     
8,382
                   
Total liabilities
   
1,133,596
                     
1,107,259
                   
Shareholders' equity
   
132,783
                     
128,194
                   
     Total
 
$
1,266,379
                   
$
1,235,453
                   
Net interest income
         
$
11,717
                   
$
12,031
           
Net interest rate spread(1)
                   
3.93
%
                   
4.10
%
 
Net interest margin(2)
                   
4.07
%
                   
4.29
%
 

(1)  Net interest rate spread is the difference in the yield received on earning assets less the rate paid on interest-bearing liabilities.
(2)  Net interest margin is the ratio of net interest income divided by average earning assets.

 
45

 

Changes Due to Volume and Rate

Net interest income can be analyzed in terms of the impact of changes in rates and volumes.  The following table illustrates the extent to which changes in interest rates and in the volume of average interest-earning assets and interest-bearing liabilities have affected the Corporation’s interest income and interest expense during the periods indicated.  Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rates (changes in rates multiplied by prior volume); and (iii) the net changes.  For purposes of this table, changes that are not due solely to volume or rate changes have been allocated to these categories based on the respective percentage changes in average volume and rate.  Due to the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes between volume and rates.  In addition, average earning assets include non-accrual loans and no tax equivalent adjustments were made.

(in thousands of dollars)
 
Three Months Ended March 31, 2013 vs. Three Months Ended March 31, 2012
 
   
Increase/(Decrease)
 
   
Total
   
Due to
   
Due to
 
   
Change
   
Volume
   
Rate
 
Interest income
                 
Loans
 
$
(367
)
 
$
1,486
   
$
(1,853
)
Taxable investment securities
   
(355
)
   
(215
)
   
(140
)
Tax-exempt investment securities
   
(36
)
   
(39
)
   
3
 
Interest-bearing deposits
   
(34
)
   
(24
)
   
(10
)
Total interest income
   
(792
)
   
1,208
     
(2,000
)

Interest expense
                 
Interest-bearing demand deposits
   
6
     
8
     
(2
)
Savings and insured money market deposits
   
(22
)
   
14
     
(36
)
Time deposits
   
(273
)
   
(82
)
   
(191
)
FHLB advances and securities sold under
   agreements to repurchase
   
(189
)
   
(156
)
   
(33
)
Total interest expense
   
(478
)
   
(216
)
   
(262
)
                         
Net interest income
 
$
(314
)
 
$
1,424
   
$
(1,738
)


Liquidity and Capital Resources

Liquidity management involves the ability to meet the cash flow requirements of deposit clients, borrowers, and the operating, investing, and financing activities of the Corporation.  The Corporation uses a variety of resources to meet its liquidity needs.  These include short term investments, cash flow from lending and investing activities, core deposit growth and non-core funding sources, such as time deposits of $100,000 or more, securities sold under agreements to repurchase and other borrowings.

The Corporation is a member of the FHLB, which allows it to access borrowings that enhance management's ability to satisfy future liquidity needs.  Based on available collateral and current advances outstanding, the Corporation was eligible to borrow up to a total of $79.5 million and $104.5 million at March 31, 2013 and December 31, 2012, respectively.  The Corporation also had a total of $28.0 million of unsecured lines of credit with four different financial institutions, all of which was available at March 31, 2013 and December 31, 2012.

During the three months ended March 31, 2013, cash and cash equivalents increased $5.9 million. The major sources of cash included a $32.4 million increase in deposits, proceeds from sales, maturities, calls and principal reductions on securities totaling $31.1 million and $3.2 million provided by operating activities.  These proceeds were used primarily to fund purchases of securities totaling $31.5 million, a $28.0 million net increase in loans and a $1.4 million decrease in borrowings.

 
46

 


Interest Rate Risk

Management considers interest rate risk to be the most significant market risk for the Corporation.  Market risk is the risk of loss from adverse changes in market prices and rates.  Interest rate risk is the exposure to adverse changes in the net income of the Corporation as a result of changes in interest rates.

The Corporation’s primary earnings source is net interest income, which is affected by changes in the level of interest rates, the relationship between rates, the impact of interest rate fluctuations on asset prepayments, the level and composition of deposits and liabilities, and credit quality of earning assets.

The Corporation’s objectives in its asset and liability management are to maintain a strong, stable net interest margin, to utilize its capital effectively without taking undue risks, to maintain adequate liquidity, and to reduce vulnerability of its operations to changes in interest rates.  The Corporation's Asset/Liability Committee (“ALCO”) has the strategic responsibility for setting the policy guidelines on acceptable exposure to interest rate risk.  These guidelines contain specific measures and limits regarding the risks, which are monitored on a regular basis.  The ALCO is made up of the president and chief executive officer, the chief financial officer, the asset liability management officer, and other officers representing key functions.

Interest rate risk is the risk that net interest income will fluctuate as a result of a change in interest rates.  It is the assumption of interest rate risk, along with credit risk, that drives the net interest margin of a financial institution. For that reason, the ALCO has established tolerance limits based upon a 200-basis point change in interest rates.  At March 31, 2013, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the next 12 months net interest income by 9.89% and an immediate 200-basis point increase would negatively impact the next 12 months net interest income by 5.46%.  Both are within the Corporation's policy guideline of 15%. Given the overall low level of current interest rates and the unlikely event of a 200-basis point decline from this point, management additionally modeled an immediate 100-basis point decline and an immediate 300-basis point increase in interest rates. When applied, it is estimated these scenarios would result in negative impacts to net interest income of 4.84% and 8.40%, respectively.  Both are within the Corporation's policy guideline of 15%.

A related component of interest rate risk is the expectation that the market value of the Corporation’s capital account will fluctuate with changes in interest rates.  This component is a direct corollary to the earnings-impact component: an institution exposed to earnings erosion is also exposed to shrinkage in market value.  At March 31, 2013, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the market value of the Corporation’s capital account by 5.68% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 1.63%.  Both are within the Corporation’s policy guideline of 15%.  Management also modeled the impact to the market value of the Corporation’s capital with an immediate 100-basis point decline and an immediate 300-basis point increase in interest rates, based on the current interest rate environment.  When applied, it is estimated these scenarios would result in negative impacts to the market value of the Corporation’s capital of 5.63% and 3.88%, respectively.  Both are within the Corporation's policy guideline of 15%.

Management does recognize the need for certain hedging strategies during periods of anticipated higher fluctuations in interest rates and the Funds Management Policy provides for limited use of certain derivatives in asset liability management. These strategies were not employed during the three months ended March 31, 2013.


 
47

 


ITEM 3:                      QUANTITATVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information required by this Item is set forth herein in Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Interest Rate Risk."


ITEM 4:                      CONTROLS AND PROCEDURES

The Corporation's management, with the participation of our President and Chief Executive Officer, who is the Corporation's principal executive officer, and our Chief Financial Officer and Treasurer, who is the Corporation's principal financial officer, has evaluated the effectiveness of the Corporation's disclosure controls and procedures as of March 31, 2013 pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended.  Based upon that evaluation, the principal executive officer and principal financial officer have concluded that the Corporation's disclosure controls and procedures are effective as of March 31, 2013.  In addition, there have been no changes in the Corporation’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

PART II.
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
 
For information related to this item please see Note 9 to the Corporation’s financial statements included herein.
   
ITEM 1A.
RISK FACTORS
 
There have been no material changes in the risk factors set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission on March 15, 2013.
   
ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
(c)
Issuer Purchases of Equity Securities (1)
   
Period
 
Total number of shares purchased
   
Average price paid per share
   
Total number of shares purchased as part of publicly announced plans or programs
   
Maximum number of shares that may yet be purchased under the plans or programs
1/1/13-1/31/13
   
-
   
$
-
     
-
     
125,000
2/1/13-2/28/13
   
3,094
   
$
29.94
     
3,094
     
121,906
3/1/13-3/31/13
   
-
   
$
-
     
-
     
121,906
Quarter ended 3/31/13
   
3,094
   
$
29.94
     
3,094
     
121,906
 
(1) On December 19, 2012, the Corporation’s Board of Directors approved a stock repurchase plan authorizing the purchase of up to 125,000 shares of the Corporation's outstanding common stock.  This plan replaces the plan approved on November 2009, which expired in November 2012.  Purchases may be made from time to time on the open-market or in private negotiated transactions and will be at the discretion of management.  For the period ending March 31, 2013, a total of 3,094 shares had been purchased under this plan.
 
 

 
48

 


ITEM 6.
EXHIBITS
 
The following exhibits are either filed with this Form 10-Q or are incorporated herein by reference:
   
 
3.1  Certificate of Incorporation of Chemung Financial Corporation dated December 20, 1984.  (Filed as Exhibit 3.1 to Registrant’s Form 10-K filed with the SEC on March 13, 2008 and incorporated herein by reference).
   
 
3.2  Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated March 28, 1988.  (Filed as Exhibit 3.2 to Registrant's Form 10-K filed with the SEC on March 13, 2008 and incorporated herein by reference).
   
 
3.3  Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated May 13, 1998.  (Filed as Exhibit 3.4 of the Registrant's Form 10-K for the year ended December 31, 2005 and incorporated herein by reference).
   
 
3.4  Amended and Restated Bylaws of the Registrant, as amended to May 16, 2012. (Filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on May 18, 2012 and incorporated herein by reference).
   
 
31.1  Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
   
 
31.2  Certification of Chief Financial Officer and Treasurer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
   
 
32.1  Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
   
 
32.2  Certification of Chief Financial Officer and Treasurer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
   
 
101.INS  Instance Document*
   
 
101.SCH  XBRL Taxonomy Schema*
   
 
101.CAL  XBRL Taxonomy Calculation Linkbase*
   
 
101.DEF  XBRL Taxonomy Definition Linkbase*
   
 
101.LAB  XBRL Taxonomy Label Linkbase*
   
 
101.PRE  XBRL Taxonomy Presentation Linkbase*
*
Filed herewith.


 
49

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


CHEMUNG FINANCIAL CORPORATION

DATED:  May 10, 2013
By:  /s/ Ronald M. Bentley
 
Ronald M. Bentley, President and Chief Executive Officer
(Principal Executive Officer)


DATED:  May 10, 2013
By:  /s/ Mark A. Severson
 
Mark A. Severson, Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)


 
50

 

EXHIBIT INDEX

3.1  Certificate of Incorporation of Chemung Financial Corporation dated December 20, 1984.  (Filed as Exhibit 3.1 to Registrant’s Form 10-K filed with the SEC on March 13, 2008 and incorporated herein by reference).
 
3.2  Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated March 28, 1988.  (Filed as Exhibit 3.2 to Registrant's Form 10-K filed with the SEC on March 13, 2008 and incorporated herein by reference).
 
3.3  Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated May 13, 1998.  (Filed as Exhibit 3.4 of the Registrant's Form 10-K for the year ended December 31, 2005 and incorporated herein by reference).
 
3.4  Amended and Restated Bylaws of the Registrant, as amended to May 16, 2012. (Filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on May 18, 2012 and incorporated herein by reference).
 
31.1  Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
31.2  Certification of Chief Financial Officer and Treasurer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
32.1  Certification of President and Chief Executive Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
 
32.2  Certification of Chief Financial Officer and Treasurer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
 
101.INS  Instance Document*
 
101.SCH  XBRL Taxonomy Schema*
 
101.CAL  XBRL Taxonomy Calculation Linkbase*
 
101.DEF  XBRL Taxonomy Definition Linkbase*
 
101.LAB  XBRL Taxonomy Label Linkbase*
 
101.PRE  XBRL Taxonomy Presentation Linkbase*