sept30201110q.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 September 30, 2011
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
[   ]
Smaller reporting company
[X]
 
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 October 31, 2011 was 4,569,710.


 
 

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX

PART I.
FINANCIAL INFORMATION
PAGE
     
Item 1:
Financial Statements - Unaudited
 
     
 
Consolidated Balance Sheet
3
 
Consolidated Statements of Income
4
 
Consolidated Statements of Shareholders’ Equity and Comprehensive Income
5
 
Consolidated Statements of Cash Flows
6
     
 
Notes to Unaudited Consolidated Financial Statements
8
     
Item 2:
Management's Discussion and Analysis of Financial Condition and Results of Operations
37
     
Item 3:
Quantitative and Qualitative Disclosures About Market Risk
52
     
Item 4:
Controls and Procedures
52
     
PART II.
OTHER INFORMATION
53
     
Item 1A:
Risk Factors
53
     
Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
53
     
Item 6:
Exhibits
53
     
SIGNATURES
 
54
     
INDEX TO EXHIBITS
 


 
2

 

PART I. FINANCIAL INFORMATION
Item 1: Financial Statements

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
   
SEPTEMBER 30, 2011
   
DECEMBER, 31, 2010
 
ASSETS
           
Cash and due from financial institutions
 
$
30,748,786
   
$
16,540,095
 
Interest-bearing deposits in other financial institutions
   
87,723,958
     
44,079,682
 
     Total cash and cash equivalents
   
118,472,744
     
60,619,777
 
                 
Securities available for sale, at estimated fair value
   
279,078,596
     
223,544,961
 
Securities held to maturity, estimated fair value of $8,483,553
  at September 30, 2011 and $8,297,392 at December 31, 2010
   
7,585,671
     
7,715,123
 
Federal Home Loan Bank and Federal Reserve Bank Stock, at cost
   
5,672,450
     
3,328,900
 
                 
Loans, net of deferred origination fees and costs, and unearned income
   
788,458,576
     
613,684,369
 
Allowance for loan losses
   
(9,676,923
)
   
(9,498,131
)
Loans, net
   
778,781,653
     
604,186,238
 
                 
Loans held for sale
   
74,412
     
486,997
 
Premises and equipment, net
   
24,250,065
     
24,192,593
 
Goodwill
   
22,157,213
     
9,872,375
 
Other intangible assets, net
   
6,478,541
     
4,655,900
 
Bank owned life insurance
   
2,602,647
     
2,536,715
 
Other assets
   
20,768,574
     
17,187,706
 
                 
     Total assets
 
$
1,265,922,566
   
$
958,327,285
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits:
               
  Non-interest-bearing
 
$
261,945,489
   
$
197,322,036
 
  Interest-bearing
   
780,260,416
     
589,036,816
 
     Total deposits
   
1,042,205,905
     
786,358,852
 
                 
Securities sold under agreements to repurchase
   
41,453,658
     
44,774,615
 
Federal Home Loan Bank term advances
   
43,936,174
     
20,000,000
 
Accrued interest payable
   
822,970
     
784,351
 
Dividends payable
   
1,142,015
     
881,203
 
Other liabilities
   
7,674,121
     
8,119,701
 
     Total liabilities
   
1,137,234,843
     
860,918,722
 
                 
Shareholders' equity:
               
Common stock, $.01 par value per share, 10,000,000 shares authorized;
  5,310,076 issued at September 30, 2011 and 4,300,134 issued at
  December 31, 2010
   
53,101
     
43,001
 
Additional-paid-in capital
   
45,709,779
     
22,022,122
 
Retained earnings
   
98,808,285
     
94,407,620
 
Treasury stock, at cost (742,518 shares at September 30, 2011;
  749,880 shares at December 31, 2010)
   
(18,948,660
)
   
(19,166,655
)
Accumulated other comprehensive income
   
3,065,218
     
102,475
 
                 
     Total shareholders' equity
   
128,687,723
     
97,408,563
 
                 
     Total liabilities and shareholders' equity
 
$
1,265,922,566
   
$
958,327,285
 
See accompanying notes to unaudited consolidated financial statements.
 

 
3

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
 
Nine Months Ended
   
Three Months Ended
   
September 30,
   
September 30,
   
September 30,
     
September 30,
 
INTEREST AND DIVIDEND INCOME
 
2011
   
2010
   
2011
     
2010
 
Loans, including fees
 
$
31,456,406
   
$
26,412,468
   
$
11,673,215
   
$
8,742,046
 
Taxable securities
   
4,347,409
     
4,968,287
     
1,504,393
     
1,555,301
 
Tax exempt securities
   
1,035,068
     
888,938
     
350,557
     
300,917
 
Interest-bearing deposits
   
166,955
     
123,984
     
65,139
     
41,709
 
Total interest and dividend income
   
37,005,838
     
32,393,677
     
13,593,304
     
10,639,973
 
                                 
INTEREST EXPENSE
                               
Deposits
   
3,325,900
     
4,452,535
     
1,138,130
     
1,335,770
 
Borrowed funds
   
783,022
     
711,231
     
285,084
     
239,634
 
Securities sold under agreements to repurchase
   
1,056,095
     
1,257,428
     
326,542
     
383,095
 
Total interest expense
   
5,165,017
     
6,421,194
     
1,749,756
     
1,958,499
 
Net interest income
   
31,840,821
     
25,972,483
     
11,843,548
     
8,681,474
 
Provision for loan losses
   
833,333
     
1,125,000
     
583,333
     
375,000
 
Net interest income after provision for loan losses
   
31,007,488
     
24,847,483
     
11,260,215
     
8,306,474
 
                                 
Other operating income:
                               
  Wealth management group fee income
   
5,131,119
     
6,256,974
     
1,746,958
     
2,183,765
 
  Service charges on deposit accounts
   
3,180,733
     
3,428,277
     
1,130,824
     
1,106,415
 
  Net gain on securities transactions
   
1,108,091
     
451,094
     
428,882
     
-
 
  Other-than-temporary loss on investment securities:
                               
  Total impairment losses
   
(67,400
)
   
(393,005
)
   
(67,400
)
   
(56,380
)
  Loss recognized in other comprehensive income
   
-
     
-
     
-
     
-
 
    Net impairment loss recognized in earnings
   
(67,400
)
   
(393,005
)
   
(67,400
)
   
(56,380
)
  Net gain on sales of loans held for sale
   
132,902
     
166,247
     
53,571
     
32,681
 
  Credit card merchant earnings
   
162,215
     
148,107
     
57,153
     
48,937
 
  Gains on sales of other real estate owned
   
89,404
     
33,550
     
442
     
-
 
  Income from bank owned life insurance
   
65,932
     
65,213
     
22,321
     
22,075
 
  Other
   
3,617,016
     
2,750,745
     
955,712
     
909,951
 
Total other operating income
   
13,420,012
     
12,907,202
     
4,328,463
     
4,247,444
 
                                 
Other operating expenses:
                               
  Salaries and wages
   
12,534,214
     
11,362,716
     
4,272,612
     
3,768,761
 
  Pension and other employee benefits
   
3,296,814
     
2,828,493
     
1,172,044
     
809,940
 
  Net occupancy expenses
   
3,663,005
     
3,272,432
     
1,230,490
     
1,065,930
 
  Furniture and equipment expenses
   
1,549,048
     
1,441,030
     
486,518
     
465,262
 
  Data processing expense
   
2,881,150
     
2,457,347
     
976,050
     
822,341
 
  Amortization of intangible assets
   
753,192
     
550,531
     
288,001
     
180,363
 
  Losses on sales of other real estate owned
   
1,671
     
17,983
     
-
     
(7,575
)
  Other real estate owned expenses
   
86,040
     
305,147
     
37,549
     
112,307
 
  FDIC insurance
   
737,281
     
912,652
     
294,897
     
287,298
 
  Merger related expenses
   
2,243,919
     
-
     
20,500
     
-
 
  Other
   
5,515,652
     
4,395,221
     
1,838,726
     
1,378,395
 
Total other operating expenses
   
33,261,986
     
27,543,552
     
10,617,387
     
8,883,022
 
                                 
Income before income tax expense
   
11,165,514
     
10,211,133
     
4,971,291
     
3,670,896
 
Income tax expense
   
3,589,455
     
3,157,001
     
1,680,351
     
1,119,960
 
Net income
 
$
7,576,059
   
$
7,054,132
   
$
3,290,940
   
$
2,550,936
 
                                 
Weighted average shares outstanding
   
4,297,777
     
3,604,502
     
4,637,392
     
3,602,277
 
                                 
Basic and diluted earnings per share
 
$
1.76
   
$
1.96
   
$
0.71
   
$
0.71
 
See accompanying notes to unaudited consolidated financial statements.

 
4

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(UNAUDITED)
   
Common Stock
   
Additional Paid-in Capital
   
Retained Earnings
   
Treasury Stock
   
Accumulated Other Comprehensive Income (Loss)
   
Total
 
Balances at December 31, 2009
 
$
43,001
   
$
22,806,829
   
$
87,826,331
   
$
(20,024,661
)
 
$
(565,835
)
 
$
90,085,665
 
Comprehensive Income:
                                               
  Net income
   
-
     
-
     
7,054,132
     
-
     
-
     
7,054,132
 
  Change in unrealized gains(losses) on securities AFS, net
   
-
     
-
     
-
     
-
     
2,633,416
     
2,633,416
 
  Change in funded status of Employers' Accounting for Defined
    Benefit Pension and Other Benefit Plans, net
   
-
     
-
     
-
     
-
     
231,937
     
231,937
 
Total comprehensive income (loss)
   
-
     
-
     
-
     
-
     
-
     
9,919,485
 
Restricted stock units for directors' deferred compensation plan
   
-
     
83,311
     
-
     
-
     
-
     
83,311
 
Cash dividends declared ($.75 per share)
   
-
     
-
     
(2,639,382
)
   
-
     
-
     
(2,639,382
)
Distribution of 10,082 shares of treasury stock for directors’
  compensation
   
-
     
(44,677
)
   
-
     
258,906
     
-
     
214,229
 
Distribution of 2,750 shares of treasury stock for employee
  compensation
   
-
     
(15,537
)
   
-
     
70,537
     
-
     
55,000
 
Purchase of 20,260 shares of treasury stock
   
-
     
-
     
-
     
(425,566
)
   
-
     
(425,566
)
Balances at September 30, 2010
 
$
43,001
   
$
22,829,926
   
$
92,241,081
   
$
(20,120,784
)
 
$
2,299,518
   
$
97,292,742
 
Balances at December 31,  2010
 
$
43,001
   
$
22,022,122
   
$
94,407,620
   
$
(19,166,655
)
 
$
102,475
   
$
97,408,563
 
Comprehensive Income:
                                               
  Net income
   
-
     
-
     
7,576,059
     
-
     
-
     
7,576,059
 
  Change in unrealized gains (losses) on securities AFS, net
           
-
     
-
     
-
     
2,678,187
     
2,678,187
 
  Change in funded status of Employers' Accounting for Defined
    Benefit Pension and Other Benefit Plans, net
   
-
     
-
     
-
     
-
     
284,556
     
284,556
 
Total comprehensive income (loss)
   
-
     
-
     
-
     
-
     
-
     
10,538,802
 
Restricted stock awards
   
-
     
21,226
     
-
     
-
     
-
     
21,226
 
Restricted stock units for directors' deferred compensation plan
   
-
     
61,129
     
-
     
-
     
-
     
61,129
 
Cash dividends declared ($.75 per share)
   
-
     
-
     
(3,175,394
)
   
-
     
-
     
(3,175,394
)
Distribution of 10,378 shares of treasury stock for directors'
  compensation
   
-
     
(33,831
)
   
-
     
265,262
     
-
     
231,431
 
Distribution of 2,392 shares of treasury stock for employee
  compensation
   
-
     
(6,140
)
   
-
     
61,140
     
-
     
55,000
 
Distribution of 286 shares of treasury stock for director’s deferred
    compensation
   
-
     
(7,364
)
   
-
     
7,310
     
-
     
(54
)
Distribution of 4,387 shares of treasury stock for employee
    restricted stock warrants
   
-
     
(60,800
)
   
-
     
112,090
     
-
     
51,290
 
Purchase of 13,981 shares of treasury stock
   
-
     
-
     
-
     
(327,413
)
   
-
     
(327,413
)
Sale of 3,900 shares of treasury stock
   
-
     
(10,101
)
   
-
     
99,606
     
-
     
89,505
 
Issuance of 1,009,942 shares related to FOFC Merger
   
10,100
     
23,723,538
     
-
     
-
     
-
     
23,733,638
 
Balances at September 30, 2011
 
$
53,101
   
$
45,709,779
   
$
98,808,285
   
$
(18,948,660
)
 
$
3,065,218
   
$
128,687,723
 
See accompanying notes to unaudited consolidated financial statements.
 

 
5

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
   
Nine Months Ended
 
   
September 30,
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
2011
   
2010
 
Net income
 
$
7,576,059
   
$
7,054,132
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of intangible assets
   
753,192
     
550,531
 
Provision for loan losses
   
833,333
     
1,125,000
 
Depreciation and amortization of fixed assets
   
2,129,738
     
2,057,825
 
Amortization of premiums on securities, net
   
960,973
     
489,661
 
Gains on sales of loans held for sale, net
   
(132,902
)
   
(166,247
)
Proceeds from sales of loans held for sale
   
5,523,214
     
5,686,897
 
Loans originated and held for sale
   
(4,977,727
)
   
(5,906,757
)
Net gain on sale of other real estate owned
   
(87,733
)
   
(15,568
)
Net gains on securities transactions
   
(1,108,091
)
   
(451,094
)
Net impairment loss recognized on investment securities
   
67,400
     
393,005
 
Decrease in other assets
   
2,752,047
     
671,468
 
(Increase) decrease in prepaid FDIC assessment
   
(49,464
)
   
819,241
 
Decrease in accrued interest payable
   
(265,000
)
   
(235,220
)
Expense related to restricted stock units for directors' deferred compensation plan
   
61,129
     
83,311
 
Expense related to employee stock compensation
   
55,000
     
55,000
 
Expense related to employee stock awards
   
21,226
     
-
 
Decrease in other liabilities
   
(2,243,010
)
   
(2,987,293
)
Income from bank owned life insurance
   
(65,932
)
   
(65,213
)
Proceeds from sales of student loans
   
-
     
137,509
 
     Net cash provided by operating activities
   
11,803,452
     
9,296,188
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from sales and calls of securities available for sale
   
67,741,210
     
50,440,459
 
Proceeds from maturities and principal collected on securities available for sale
   
23,608,123
     
49,260,195
 
Proceeds from maturities and principal collected on securities held to maturity
   
3,448,732
     
9,561,278
 
Purchases of securities available for sale
   
(95,911,022
)
   
(110,793,064
)
Purchases of securities held to maturity
   
(3,319,281
)
   
(5,429,297
)
Purchase of Federal Home Loan Bank and Federal Reserve Bank stock
   
(1,002,500
)
   
(58,200
)
Redemption of Federal Home Loan Bank and Federal Reserve Bank stock
   
237,250
     
-
 
Purchases of premises and equipment
   
(1,307,723
)
   
(1,230,458
)
Cash paid Fort Orange Financial Corp. acquisition
   
(8,137,816
)
   
-
 
Cash received Fort Orange Financial Corp. acquisition
   
33,284,995
     
-
 
Proceeds from sale of other real estate owned
   
356,207
     
236,102
 
Net (increase) decrease in loans
   
(10,967,168
)
   
3,210,362
 
     Net cash provided (used) by investing activities
   
8,031,007
     
(4,802,623
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in demand deposits, NOW accounts, savings accounts,
     and insured money market accounts
   
70,452,474
     
17,197,567
 
Net decrease in time deposits and individual retirement accounts
   
(15,073,756
)
   
(14,749,680
)
Net decrease in securities sold under agreements to repurchase
   
(13,889,730
)
   
(10,497,579
)
Net decrease in Federal Home Loan Bank long term advances
   
(317,990
)
   
-
 
Purchase of treasury stock
   
(327,413
)
   
(425,566
)
Sale of treasury stock
   
89,505
     
-
 
Cash dividends paid
   
(2,914,582
)
   
(2,641,239
)
     Net cash provided (used) by financing activities
   
38,018,508
     
(11,116,497
)
Net increase (decrease) in cash and cash equivalents
   
57,852,967
     
(6,622,932
)
Cash and cash equivalents, beginning of period
   
60,619,777
     
79,738,396
 
Cash and cash equivalents, end of period
 
$
118,472,744
   
$
73,115,464
 
See accompanying notes to unaudited consolidated financial statements.
               
(Cash Flow continued)

 
6

 


                 
Supplemental disclosure of cash flow information:
               
Cash paid during the year for:
               
  Interest
 
$
5,126,397
   
$
6,656,414
 
  Income Taxes
 
$
3,340,847
   
$
4,575,675
 
Supplemental disclosure of non-cash activity:
               
  Transfer of loans to other real estate owned
 
$
308,976
   
$
554,246
 
   
See accompanying notes to unaudited consolidated financial statements.
 

 
7

 

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.           Basis of Presentation

Chemung Financial Corporation (the "Corporation"), through its wholly owned subsidiaries, Chemung
Canal Trust Company (the "Bank") and CFS Group, Inc., a financial services company, provides a wide
range of banking, financing, fiduciary and other financial services to its local market area.  The
consolidated financial statements include the accounts of the Corporation and its wholly owned
subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.

The data in the consolidated balance sheet as of December 31, 2010 was derived from the audited
consolidated financial statements in the Corporation's 2010 Annual Report on Form 10-K, which was
filed with the Securities and Exchange Commission on March 16, 2011.  That data, along with the other
interim financial information presented in the consolidated balance sheets, statements of income,
shareholders' equity and comprehensive income, and cash flows should be read in conjunction with the
audited consolidated financial statements, including the notes thereto, contained in the 2010 Annual
Report on Form 10-K.  Amounts in prior periods' consolidated interim financial statements are
reclassified whenever necessary to conform to the current period's presentation.

The consolidated financial statements included herein reflect all adjustments which are, in the opinion of
management, of a normal recurring nature and necessary to present fairly the Corporation's financial
position as of September 30, 2011 and December 31, 2010, and results of operations for the three and
nine-month periods ended September 30, 2011 and 2010, and changes in shareholders' equity and cash
flows for the nine-month periods ended September 30, 2011 and 2010. Subsequent events were
evaluated for any required recognition or disclosure. 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.


2.           Earnings 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 as they are earned.  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 4,297,777 and 3,604,502 weighted average shares outstanding for the nine-month periods
ended September 30, 2011 and 2010, and 4,637,392 and 3,602,277 weighted average shares outstanding
for the three-month periods ended September 30, 2011 and 2010, respectively.  There were no dilutive
common stock equivalents during the three and nine-month periods ended September 30, 2011 or 2010.


 
8

 

3.           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.

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 has developed an internal model for pricing these securities. This is the same model
used in determining other-than-temporary impairment (“OTTI”) as further described in Note 8.  
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.

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally
based on recent real estate appraisals and collateral evaluations. The 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 third party appraisers to adjust for
differences between the comparable sales and income data available.  Such adjustments are typically
significant and result in a Level 3 classification of the inputs for determining fair value.

 
9

 

Non-recurring adjustments to certain commercial and residential real estate properties classified as other
real estate owned ("OREO") are measured at the lower of carrying amount or fair value, less costs to
sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3
classification.  In cases where the carrying amount exceeds the fair value less costs to sell, an
impairment loss is recognized.

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

     
Fair Value Measurement at September 30, 2011
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
 
$
142,948,508
   
$
36,088,000
   
$
106,860,508
   
$
-
 
Mortgage-backed securities, residential
   
57,220,655
     
-
     
57,220,655
     
-
 
Obligations of states and political subdivisions
   
46,636,291
     
-
     
46,636,291
     
-
 
Trust Preferred securities
   
2,280,848
     
-
     
1,985,938
     
294,910
 
Corporate bonds and notes
   
13,792,147
     
-
     
13,792,147
     
-
 
CMO’s
   
8,468,507
     
-
     
8,468,507
     
-
 
SBA Pool’s
   
2,305,718
     
-
     
2,305,718
     
-
 
Corporate stocks
   
5,425,922
     
4,741,501
     
684,421
     
-
 
Total available for sale securities
 
$
279,078,596
   
$
40,829,501
   
$
237,954,185
   
$
294,910
 

     
Fair Value Measurement at December 31, 2010 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
 
$
102,131,517
   
$
40,581,250
   
$
61,550,267
   
$
-
 
Mortgage-backed securities, residential
   
62,761,633
     
-
     
62,761,633
     
-
 
Obligations of states and political subdivisions
   
38,765,092
     
-
     
38,765,092
     
-
 
Trust Preferred securities
   
2,344,094
     
-
     
2,009,509
     
334,585
 
Corporate bonds and notes
   
11,694,190
     
-
     
11,694,190
     
-
 
Corporate stocks
   
5,848,435
     
5,209,069
     
639,366
     
-
 
Total available for sale securities
 
$
223,544,961
   
$
45,790,319
   
$
177,420,057
   
$
334,585
 

 
10

 

The table below presents a reconciliation of all assets measured at fair value on a recurring basis
 using significant unobservable inputs (Level 3) for the nine-month periods ending September 30,
2011 and 2010:

   
Fair Value Measurement nine-months ended September 30, 2011 Using Significant Unobservable Inputs (Level 3)
   
Fair Value Measurement nine-months ended September 30, 2010 Using Significant Unobservable Inputs (Level 3)
 
Investment Securities Available for Sale
           
Beginning balance
 
$
334,585
   
$
511,480
 
Total gains/losses (realized/unrealized):
               
  Included in earnings:
               
    Income on securities
   
-
     
-
 
    Impairment charge on investment securities
   
(67,400
)
   
(393,005
)
  Included in other comprehensive income
   
27,725
     
172,340
 
Transfers in and/or out of Level 3
   
-
     
-
 
Ending balance September 30
 
$
294,910
   
$
290,815
 

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

     
Fair Value Measurement at September 30, 2011
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, financial and agricultural:
                               
  Commercial and industrial
 
$
701,710
   
$
-
   
$
-
   
$
701,710
 
Commercial mortgages:
   
407,551
     
-
     
-
     
407,551
 
  Other
   
392,257
     
-
     
-
     
392,257
 
     Total Impaired Loans
 
$
1,501,578
   
$
-
   
$
-
   
$
1,501,578
 
                                 
Other real estate owned, net
 
$
661,475
   
$
-
   
$
-
   
$
661,475
 

     
Fair Value Measurement at December 31, 2010
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 mortgages:
                               
  Construction
 
$
72,211
   
$
-
   
$
-
   
$
72,211
 
  Other
   
580,329
     
-
     
-
     
580,329
 
     Total Impaired Loans
 
$
652,540
   
$
-
   
$
-
   
$
652,540
 
                                 
Other real estate owned, net
 
$
740,620
   
$
-
   
$
-
   
$
740,620
 


 
11

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral
dependent loans, had a carrying amount of $3,088,321 with a valuation allowance of $1,586,743 as of
September 30, 2011, resulting in a $833,333 provision for loan losses for the nine-month period ending
September 30, 2011.  Impaired loans had a carrying amount of $892,298, with a valuation allowance of
$239,758 as of December 31, 2010, resulting in no additional provision for loan losses for the year
ending December 31, 2010.

OREO, which is measured by the lower of carrying or fair value less costs to sell, had a net carrying
amount of $661,475 at September 30, 2011.  The net carrying amount reflects the outstanding balance of
$784,162 net of a valuation allowance of $122,687 at September 30, 2011 which resulted in write downs
of $12,120 for the nine-month period ending September 30, 2011.  OREO had a net carrying amount of
$740,620 at December 31, 2010.  The net carrying amount reflected an outstanding balance of $909,947,
net of a valuation allowance of $169,327 at December 31, 2010 which resulted in write downs of
$169,327 for the year ending December 31, 2010.

The carrying amounts and estimated fair values of other financial instruments, at September 30, 2011 and December 31, 2010, are as follows:

(dollars in thousands)
 
September 30, 2011
   
December 31, 2010
 
Financial assets:
 
Carrying Amount
   
Estimated Fair Value (1)
   
Carrying Amount
   
Estimated Fair Value (1)
 
Cash and due from financial institutions
 
$
30,749
   
$
30,749
   
$
16,540
   
$
16,540
 
Interest-bearing deposits in other financial institutions
   
87,724
     
87,724
     
44,080
     
44,080
 
Securities available for sale
   
279,079
     
279,079
     
223,545
     
223,545
 
Securities held to maturity
   
7,586
     
8,484
     
7,715
     
8,297
 
Federal Home Loan and Federal Reserve Bank stock
   
5,672
     
N/A
     
3,329
     
N/A
 
Net loans
   
778,782
     
798,889
     
604,186
     
618,859
 
Loans held for sale
   
74,412
     
74,412
     
487
     
487
 
Accrued interest receivable
   
4,001
     
4,001
     
2,713
     
2,713
 
Financial liabilities:
                               
Deposits:
                               
  Demand, savings, and insured money market accounts
   
736,711
     
736,711
     
532,555
     
532,555
 
  Time deposits
   
305,495
     
307,978
     
253,804
     
256,281
 
Securities sold under agreements to repurchase
   
41,454
     
43,975
     
44,775
     
46,667
 
Federal Home Loan Bank advances
   
43,936
     
47,452
     
20,000
     
21,609
 
Accrued interest payable
   
823
     
823
     
784
     
784
 
Dividends payable
   
1,142
     
1,142
     
881
     
881
 
                                 
(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.
 


 
12

 

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and due from financial institutions, interest bearing
deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate
loans or deposits that reprice frequently and fully.  The methods for determining the fair values for
securities were described previously.  For fixed rate loans or deposits and for variable rate loans or
deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using
current market rates applied to the estimated life and credit risk.  Fair value of debt is based on current
rates for similar financing.  It was not practicable to determine the fair value of FHLB stock due to
restrictions placed on its transferability.  The fair value of off-balance-sheet items is not considered
material.
 

4.           Goodwill and Intangible Assets

The changes in goodwill included in the core banking segment during the periods ending September 30,
2011 and 2010 were as follows:

 
2011
   
2010
 
Beginning of year
 
$
9,872,375
   
$
9,872,375
 
Acquired goodwill
   
12,284,838
     
-
 
September 30,
 
$
22,157,213
   
$
9,872,375
 

Acquired intangible assets were as follows at September 30, 2011 and December 31, 2010:

 
 
At September 30, 2011
   
At December 31, 2010
 
   
Balance Acquired
   
Accumulated Amortization
   
Balance Acquired
   
Accumulated Amortization
 
Core deposit intangibles
 
$
3,819,798
   
$
1,050,211
   
$
1,174,272
   
$
674,141
 
Other customer relationship intangibles
   
6,063,423
     
2,354,469
     
6,133,116
     
1,977,347
 
Total
 
$
9,883,221
   
$
3,404,680
   
$
7,307,388
   
$
2,651,488
 

Aggregate amortization expense was $753,192 and $550,531 for the-nine month periods ended
September 30, 2011 and 2010, respectively.

The remaining estimated aggregate amortization expense at September 30, 2011 is listed below:

Year
 
Estimated Expense
 
2011
 
$
288,001
 
2012
   
1,046,720
 
2013
   
876,524
 
2014
   
777,801
 
2015
   
681,176
 
2016 and thereafter
   
2,808,319
 
  Total
 
$
6,478,541
 


 
13

 

5.           Business Combinations

Acquisition of Fort Orange Financial Corp.

On April 8, 2011, the Corporation completed its merger with Fort Orange Financial Corp. (“FOFC”), the
holding company of Capital Bank & Trust Company (“Capital Bank”) based in Albany, New York, with
FOFC being merged with and into the Corporation, and the Corporation being the surviving entity.  
Immediately following the merger, Capital Bank was merged with and into the Bank.

As of the date of the merger, Capital Bank’s unaudited balance sheet included approximately $254
million in assets, a loan portfolio approximating $171 million and deposits of $199 million.  With the
completion of the acquisition, the Corporation became a $1.2 billion financial institution with 28 offices
located in eight New York counties, as well as Bradford County in Pennsylvania.  The Capital Bank
branch locations are in Albany, Clifton Park, Latham and Slingerlands.

Under the terms of an Agreement and Plan of Merger (the “Agreement”) entered into on October 14,
2010, the Corporation purchased all of the outstanding shares of FOFC common stock in a stock and
cash transaction valued at $31.9 million, based upon the Corporation’s closing stock price on April 8,
2011 of $23.50.  For each share of FOFC common stock outstanding immediately prior to the merger,
each FOFC shareholder had the right to elect to receive: (i) all cash in the amount of $7.50 per share
(“Cash Consideration”), (ii) all stock at an exchange ratio of 0.3571 of a share of the Corporation’s
common stock for each share of FOFC common stock (“Stock Consideration”) or (iii) a mix of Cash
Consideration for 25% of their shares and Stock Consideration for 75% of their shares.  The total
consideration to be paid by the Corporation was subject to the requirement that 25% of the FOFC
common stock be acquired for the Cash Consideration and 75% be acquired for the Stock Consideration.  
As a result of the merger, the Corporation issued approximately 1.01 million additional shares of its
common stock.

The table below illustrates the reconciliation of shares outstanding and the calculation of the
consideration effectively transferred.

 
Reconciliation of Shares Outstanding
FOFC shares outstanding at April 8, 2011
   
3,771,425
 
Percentage of stock consideration
   
75
%
FOFC shares exchanged for stock
   
2,828,569
 
Exchange Ratio
   
0.3571
 
Chemung Financial shares issued to FOFC shareholders (excludes fractional shares)
   
1,009,942
 
         
Chemung Financial shares outstanding April 8, 2011
   
3,565,610
 
Total Chemung Financial Shares at April 8, 2011 following the consummation
  of the transaction
   
4,575,552
 
         
Ownership % held by FOFC shareholders
   
22
%
Ownership % held by legacy Chemung Financial shareholders
   
78
%


 
14

 


Purchase Price Consideration (dollar amounts in thousands, except per share data)
FOFC shares outstanding at April 8, 2011
   
3,771,425
 
Percentage of stock consideration
   
75
%
FOFC shares exchanged for stock
   
2,828,569
 
Exchange Ratio
   
0.3571
 
Chemung Financial shares issued to FOFC shareholders (excludes fractional shares)
   
1,009,942
 
Purchase price per Chemung Financial common share
 
$
23.50
 
Total stock consideration paid
 
$
23,734
 
Total cash consideration paid
   
6,939
 
Cash paid for fractional shares
   
3
 
Cash paid for the settlement of FOFC stock options
   
545
 
Cash paid for severance payments
   
650
 
Total consideration paid
 
$
31,871
 

As a result of the FOFC merger, we recognized assets acquired and liabilities assumed at their acquisition date fair value as presented below: (in thousands).

Total Purchase Price
       
$
31,871
 
               
Net assets acquired:
             
Cash and due from banks
 
$
33,285
         
Securities available for sale
   
46,525
         
Federal Home Loan Bank Stock
   
1,578
         
Loans
   
164,153
         
Accrued Interest Receivable
   
864
         
Premises and equipment
   
879
         
Core deposit intangible
   
2,646
         
Deferred tax asset
   
2,466
         
Other assets
   
3,530
         
Deposits
   
(200,468
)
       
Borrowings
   
(34,823
)
       
Accrued Interest Payable
   
(304
)
       
Other liabilities
   
(745
)
       
                 
Net assets acquired
         
$
19,586
 
                 
Goodwill resulting from the FOFC merger
         
$
12,285
 

The goodwill generated by the FOFC merger consists of, among other things, synergies and increased
economies of scale, including the ability to offer more diverse and profitable products, greater diversity
in the branch system which may lead to lower cost deposits, and an increased legal lending limit.  We
expect that no goodwill recognized as a result of the FOFC merger will be deductible for income tax
purposes.  Purchase accounting adjustments are subject to refinement as management finalizes their fair
value measurements, including their analysis of identifiable intangible assets.  Since the branches
acquired were merged into the Bank, there is no segment impact of the FOFC merger.

 
15

 

The fair value of the financial assets acquired included loans receivable with an unpaid principal balance
of $170.7 million.  U.S. generally accepted accounting principles (“U.S. GAAP”) prohibits carrying
over an allowance for loan losses for loans purchased in the merger.  The table below illustrates the fair
value adjustments made to the unpaid principal balance in order to present a fair value of the loans
acquired (in thousands).

Gross loans-unpaid principal balance at April 8, 2011
 
$
170,682
 
Fair value adjustment on pools of homogeneous loans
   
(1,619
)
Credit fair value adjustment on loans with deteriorating credit quality
   
(4,820
)
Fair value of purchased loans at April 8, 2011
 
$
164,243
 

The fair value adjustment on pools of homogeneous loans represents adjustments a prospective acquirer
would make to the unpaid principal balance to account for differences between the contractual yield on
the portfolio and market interest rates, for credit, and for liquidity.  The market rate adjustment
represents the movement in market interest rates, irrespective of credit adjustments, compared to the
stated rates of the acquired loans.  The credit adjustment made on pools of homogeneous loans
represents the changes in credit quality of the underlying borrowers from the loan inception to the
merger date.  The credit adjustment on loans with deteriorating credit quality is derived in accordance
with Accounting Standard Codification 310-30, “Loans and Debt Securities Acquired with Deteriorated
Credit Quality” and represents the portion of the loan balance that has been deemed uncollectible
based on our expectations of future cash flows for each respective loan.

The information below presents the recorded fair value on April 8, 2011 of the Corporation’s purchased
impaired loans with the accretable and non-accretable related adjustments from the perspective of total
contractual cash flows (in thousands).

Contractually required principal and interest at acquisition
 
$
25,718
 
Contractual cash flows not expected to be collected (nonaccretable discount)
   
(5,849
)
Expected cash flows at acquisition
   
19,869
 
Interest component of expected cash flows (accretable yield)
   
(1,861
)
Fair value of loans acquired with deteriorating credit quality
 
$
18,008
 

The results of operations of the merged entity have been reflected in Chemung Financial Corporation’s
consolidated statements of income beginning as of the acquisition date.  Pro forma condensed
consolidated income statements for the three and nine months ended September 30, 2011 and 2010 as if
the merger occurred at the beginning of each period presented are as follows (in thousands):



   
Nine Months Ended
September 30,
 
Financial assets:
 
2011
   
2010
 
Interest and dividend income
 
$
40,414
   
$
42,529
 
Interest expense
   
6,025
     
9,660
 
  Net interest income
   
34,389
     
32,869
 
Provision for loan losses
   
1,808
     
2,375
 
  Net interest income after provision for loan losses
   
32,581
     
30,494
 
Non-interest income
 
$
13,472
   
$
13,349
 
Non-interest expense
   
32,777
     
32,117
 
  Income before income taxes
   
13,276
     
11,726
 
Income tax expense
   
4,406
     
3,742
 
  Net income
 
$
8,870
   
$
7,984
 
                 
Weighted average shares outstanding
   
4,629
     
4,614
 
Basic and diluted earnings per share
 
$
1.92
   
$
1.73
 


 
16

 

The consolidated income statement for the Corporation includes $5.654 million of net interest income,
$72 thousand of non-interest income and net income of $2.314 million of the acquiree since
the acquisition date.


6.           Comprehensive Income

Comprehensive income or loss of the Corporation represents net income plus other comprehensive
income or loss, which consists of the net change in unrealized holding gains or losses on securities
available for sale and the change in the funded status of the Corporation's defined benefit pension plan
and other benefit plans, net of the related tax effect.  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.

Comprehensive income for the three and nine-month periods ended September 30, 2011 was $3,297,441
and $10,538,802, respectively.  Comprehensive income for the three and nine-month periods ended
September 30, 2010 was $3,393,701 and $9,919,485, respectively.  The following summarizes the
components of other comprehensive income:

     
Nine Months Ended
September 30,
   
Three Months Ended
September 30,
 
Other Comprehensive Income
   
2011
   
2010
   
2011
   
2010
 
Unrealized holding gains on securities available for sale
   
$
5,448,351
   
$
4,573,717
   
$
294,210
   
$
1,400,082
 
Change in unrealized gains (losses) on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in earnings, net of reclassification
     
27,725
     
172,340
     
(9,425
)
   
(50,760
)
Reclassification adjustment net gains realized in net
  income
     
(1,108,091
)
   
(451,094
)
   
(428,882
)
   
-
 
Net unrealized gains (losses)
     
4,367,985
     
4,294,963
     
(144,097
)
   
1,349,322
 
Tax effect
     
1,689,798
     
1,661,547
     
(55,746
)
   
521,998
 
Net of tax amount
   
$
2,678,187
   
$
2,633,416
   
$
(88,351
)
 
$
827,324
 
Change in funded status of defined benefit pension plan
  and other benefit plans
     
464,097
     
378,277
     
154,699
     
25,183
 
Tax effect
     
179,541
     
146,340
     
59,847
     
9,742
 
Net of tax amount
     
284,556
     
231,937
     
94,852
     
15,441
 
Total other comprehensive income
   
$
2,962,743
   
$
2,865,353
   
$
6,501
   
$
842,765
 

The following is a summary of the accumulated other comprehensive income balance, net of tax:

 
Balance at
December 31, 2010
 
Current Period Change
 
Balance at
September 30, 2011
Unrealized gains on securities available for sale
 
$
5,661,013
   
$
2,678,187
   
$
8,339,200
 
Unrealized loss on pension plans and other benefit
  plans
   
(5,558,538
)
   
284,556
     
(5,273,982
)
     Total
 
$
102,475
   
$
2,962,743
   
$
3,065,218
 


 
17

 

7.           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.

Also in the normal course of business, there are various outstanding claims and legal proceedings
involving the Corporation or its subsidiaries.  On February 14 and April 14, 2011, the Bank received
separate settlement demands from representatives of beneficiaries of certain trusts for which the Bank
has acted as trustee.  The settlement demands relate to alleged claims of, among other things, breach of
the Bank’s fiduciary duties as trustee, including the Bank’s alleged failure to adequately diversify the
relevant trust portfolios. The beneficiaries seek aggregate damages of up to approximately $27.0 million. 
On September 16, 2011, the beneficiaries objected in the Surrogate’s Court of the State of New York,
County of Chemung (the “Surrogate’s Court”) to accountings with respect to the above-mentioned trusts
provided by the Bank, based on allegations similar to those offered in the settlement demands.  Although
these matters are inherently unpredictable, management will defend against these claims vigorously.  
Management has concluded that it is reasonably possible, but not probable, that the financial position,
results of operations or cash flows of the Corporation could be materially adversely affected in any
particular period by the unfavorable resolution of these claims.  An amount of loss or range of loss
cannot be reasonably estimated at this time. 

 

8.           Securities

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

   
September 30, 2011
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of U.S. Government and U.S. Government
  sponsored enterprises
 
$
139,497,422
   
$
3,476,346
   
$
25,260
   
$
142,948,508
 
Mortgage-backed securities, residential
   
54,007,115
     
3,214,050
     
510
     
57,220,655
 
Collateralized Mortgage obligations
   
8,285,864
     
183,403
     
760
     
8,468,507
 
Obligations of states and political subdivisions
   
44,622,411
     
2,017,069
     
3,189
     
46,636,291
 
Corporate bonds and notes
   
13,475,088
     
476,400
     
159,341
     
13,792,147
 
SBA loan pools
   
2,265,412
     
40,306
     
-
     
2,305,718
 
Trust Preferred securities
   
2,536,347
     
105,236
     
360,735
     
2,280,848
 
Corporate stocks
   
788,129
     
4,652,367
     
14,574
     
5,425,922
 
     Total
 
$
265,477,788
   
$
14,165,177
   
$
564,369
   
$
279,078,596
 


 
18

 


       
   
December 31, 2010
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of U.S. Government and U.S. Government
  sponsored enterprises
 
$
101,426,799
   
$
916,547
   
$
211,829
   
$
102,131,517
 
Mortgage-backed securities, residential
   
60,379,269
     
2,385,036
     
2,672
     
62,761,633
 
Obligations of states and political subdivisions
   
38,143,972
     
672,067
     
50,947
     
38,765,092
 
Corporate bonds and notes
   
11,019,343
     
674,847
     
-
     
11,694,190
 
Trust Preferred securities
   
2,597,993
     
134,561
     
388,460
     
2,344,094
 
Corporate stocks
   
744,763
     
5,112,755
     
9,082
     
5,848,435
 
     Total
 
$
214,312,139
   
$
9,895,813
   
$
662,990
   
$
223,544,961
 

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

   
September 30, 2011
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
Obligations of states and political subdivisions
 
$
7,585,671
   
$
897,882
   
$
-
   
$
8,483,553
 
                                 
     Total
 
$
7,585,671
   
$
897,882
   
$
-
   
$
8,483,553
 

 
 
December 31, 2010
 
   
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Estimated Fair Value
 
                         
Obligations of states and political subdivisions
 
$
7,715,123
   
$
582,269
   
$
-
   
$
8,297,392
 
                                 
     Total
 
$
7,715,123
   
$
582,269
   
$
-
   
$
8,297,392
 

The amortized cost and estimated fair value of debt securities are shown 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:

   
September 30, 2011
 
   
Available for Sale
   
Held to Maturity
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
Within One Year
 
$
45,528,688
   
$
45,906,777
   
$
2,048,903
   
$
2,083,328
 
After One, But Within Five Years
   
193,393,110
     
200,601,911
     
3,580,269
     
4,007,464
 
After Five, But Within Ten Years
   
21,308,173
     
22,862,763
     
1,956,499
     
2,392,761
 
After Ten Years
   
4,459,688
     
4,281,223
     
-
     
-
 
     Total
 
$
264,689,659
   
$
273,652,674
   
$
7,585,671
   
$
8,483,553
 


 
19

 

Proceeds from sales and calls of securities available for sale for the three and nine months ended
September 30, 2011 were $11,085,156 and $67,741,210, respectively.  Realized gross gains on these
sales and calls were $428,882 and $1,108,091 during the three and nine month periods ended September
30, 2011, respectively.  There were no sales or calls of securities available for sale that resulted in losses
for the three or nine-months ended September 30, 2011.

Proceeds from sales and calls of securities available for sale for the three and nine months ended
September 30, 2010, were $20,000,000 and $50,440,459, respectively.  There were no realized gross
gains on these sales and calls were during the three month period ended September 30, 2010 and
realized gross gains on these sales and calls were $451,094 during nine month period ended September
30, 2010.  There were no sales or calls of securities available for sale that resulted in losses for the three
or nine-months ended September 30, 2010.

The following table summarizes the investment securities available for sale and held to maturity with
unrealized losses at September 30, 2011 and December 31, 2010 by aggregated major security type and
length of time in a continuous unrealized loss position:

   
Less than 12 months
   
12 months or longer
   
Total
 
September 30, 2011
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
Obligations of U.S. Government and U.S. Government sponsored enterprises
 
$
14,874,740
     
25,260
   
$
-
   
$
-
   
$
14,874,740
   
$
25,260
 
Mortgage-backed securities, residential
   
187,675
   
$
510
     
-
     
-
     
187,675
     
510
 
Collateralized mortgage obligations
   
1,167,696
     
760
     
-
     
-
     
1,167,696
     
760
 
Obligations of states and political subdivisions
   
363,989
     
3,189
     
-
     
-
     
363,989
     
3,189
 
Corporate bonds and notes
   
5,308,085
     
159,341
     
-
     
-
     
5,308,085
     
159,341
 
Trust preferred securities
   
-
     
-
     
294,910
     
360,735
     
294,910
     
360,735
 
Corporate stocks
   
3,353
     
285
     
35,703
     
14,289
     
39,056
     
14,574
 
Total temporarily impaired securities
 
$
21,905,538
   
$
189,345
   
$
330,613
   
$
375,024
   
$
22,236,151
   
$
564,369
 


   
   
Less than 12 months
   
12 months or longer
   
Total
 
December 31, 2010
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
Obligations of U.S. Government and U.S. Government sponsored enterprises
 
$
25,543,154
   
$
211,829
   
$
-
   
$
-
   
$
25,543,154
   
$
211,829
 
Mortgage-backed securities, residential
   
844,587
     
2,672
     
-
     
-
     
844,587
     
2,672
 
Obligations of states and  political subdivisions
   
7,746,912
     
50,947
     
-
     
-
     
7,746,912
     
50,947
 
Trust preferred securities
   
-
     
-
     
334,585
     
388,460
     
334,585
     
388,460
 
Corporate stocks
   
-
     
-
     
40,910
     
9,082
     
40,910
     
9,082
 
   
$
34,134,653
   
$
265,448
   
$
375,495
   
$
397,542
   
$
34,510,148
   
$
662,990
 


 
20

 

Other-Than-Temporary Impairment

In determining OTTI for debt securities, management considers many factors, including: (1) the length
of time and the extent to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic
conditions, and (4) whether the Corporation has the intent to sell the debt security or more likely than
not will be required to sell the debt security before its anticipated recovery. The assessment of whether
an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based
on the information available to management at a point in time.

In order to determine OTTI for purchased beneficial interests, the Corporation compares the present
value of the remaining cash flows as estimated at the preceding evaluation date to the current expected
remaining cash flows.  OTTI is deemed to have occurred if there has been an adverse change in the
remaining expected future cash flows.

When OTTI occurs, for either debt securities or purchased beneficial interests, the amount of the OTTI
recognized in earnings depends on whether an entity intends to sell the security or more likely than not
will be required to sell the security before recovery of its amortized cost basis, less any current-period
credit loss. If an entity intends to sell or more likely than not will be required to sell the security before
recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in
earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at
the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not
that the entity will be required to sell the security before recovery of its amortized cost basis less any
current-period loss, the OTTI shall be separated into the amount representing the credit loss and the
amount related to all other factors. The amount of the total OTTI related to the credit loss is determined
based on the present value of cash flows expected to be collected and is recognized in earnings. The
amount of the total OTTI related to other factors is recognized in other comprehensive income, net of
applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the
new amortized cost basis of the investment.

As of September 30, 2011, the majority of the Corporation's unrealized losses in the investment
securities portfolio related to two pooled trust preferred securities. The decline in fair value on these
securities 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 these securities.  This fact combined with
the current illiquidity in the market makes it unlikely that the Corporation would be able to recover its
investment in these securities if the securities were sold at this time.  One of these securities has been
previously written down through the income statement to an amount considered to be immaterial to the
financial statements.  Therefore management is no longer analyzing this security for further impairment.

Our analysis of these investments includes $629 thousand book value of a collateralized debt obligation
("CDO") consisting is a pooled trust preferred security. This security was rated high quality at inception, but
at September 30, 2011 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 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. 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.

 
21

 

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.

In determining the amount of "currently performing" collateral for the purposes of modeling the
expected future cash flows, management analyzed the default and deferral history over the past 3 years.
This review indicated significant increases in the number and amount of defaults and deferrals by the
issuers.  Additionally, management has noted the correlation between the rising levels of non-
performing loans as a percent of tangible equity plus loan loss reserves by those issuers that have
defaulted and/or deferred interest payments.  Therefore management has used this ratio as a primary
indicator to project the levels of future defaults for modeling purposes.  Management recognizes the
potential of defaults and deferrals to continue over the next 12 to 24 months.  The operating environment
remains difficult for community and regional banks in many parts of the country, which could lead to
higher default and deferral levels.  Seventy-four depository institutions were closed by regulators during
the first nine months of 2011.

The following table provides detailed information related to the pooled trust preferred security analyzed
at September 30, 2011:

Description
Actual Deferrals as % of Outstanding Collateral
Actual Defaults as % of Original Collateral
Excess Subordination as % of Performing Collateral
Expected Additional Defaults as % of Performing Collateral
         
TPREF Funding II, Ltd. (Class B)
17.90%
16.06%
-44.27%
16.14%

In the table above, "Excess Subordination as % of Performing Collateral" was calculated by dividing the
difference between the total face value of performing collateral less the face value of all outstanding
note balances not subordinate to our investment, by the total face value of performing collateral.  This
ratio measures the extent to which there may be tranches within a pooled trust preferred structure
available to absorb credit losses before the Corporation’s security would be impacted.  As mentioned
earlier, the levels of defaults and deferrals in this pool has increased significantly in recent months,
which have resulted in a significant reduction in the amount of performing collateral.  As a result, the
negative Excess Subordination as a % of Performing Collateral percentages shown above indicate there
is no support from subordinate tranches available to absorb losses before the Corporation’s security
would be impacted.  A negative ratio is not the only factor to consider when determining if OTTI should
be recorded.  Other factors affect the timing and amount of cash flows available for payments to
investors such as the excess interest paid by the issuers, as issuers typically pay higher rates of interest
than are paid out to investors.

Upon completion of the September 30, 2011 analysis, our model indicated an additional other-than-
temporary impairment of $67 thousand on the TPREF Funding II security.  This security remained
classified as available for sale and represented $352 thousand of the unrealized losses reported at
September 30, 2011.  Payments continue to be made as agreed on the TPREF Funding II security.

 
22

 


When the analysis was conducted at September 30, 2011, 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. This analysis indicated a 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.  This comparison indicated a slight decrease in value during the
quarter, based on factors other than credit, which resulted in a loss reported in other comprehensive
income.  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 other-than-temporary impairment
recognized in accumulated other comprehensive income was $220,459 and $265,018 for securities
available for sale at September 30, 2011 and September 30, 2010, respectively.

The table below presents a roll forward of the cumulative credit losses recognized in earnings for the
three and nine-month periods ending September 30, 2011 and 2010:

   
2011
   
2010
 
Beginning balance, January 1,
 
$
3,438,673
   
$
3,045,668
 
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
   
67,400
     
393,005
 
                 
Ending balance, September 30,
 
$
3,506,073
   
$
3,438,673
 

Beginning balance, July 1,
 
$
3,438,673
   
$
3,382,293
 
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
   
67,400
     
56,380
 
                 
Ending balance, September 30,
 
$
3,506,073
   
$
3,438,673
 


 
23

 

9.           Loans and Allowance for Loan Losses

The composition of the loan portfolio is summarized as follows:

   
September 30, 2011
   
December 31, 2010
 
Commercial, financial and agricultural
 
$
147,815,433
   
$
114,697,440
 
Commercial mortgages
   
250,030,218
     
133,070,484
 
Residential mortgages
   
194,260,610
     
173,467,806
 
Indirect consumer loans
   
96,093,955
     
98,940,854
 
Consumer loans
   
100,258,360
     
93,507,785
 
                 
   
$
788,458,576
   
$
613,684,369
 

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.  The allowance is an amount that
management believes will be adequate to absorb probable incurred losses on existing loans.  
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 and review of specific problem loans (including evaluations of the underlying
collateral).  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 a borrower's ability to repay its
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.  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 real estate loans, are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.  Troubled debt restructurings are separately identified
for impairment disclosures and are measured at the present value of estimated future cash flows using
the loan’s effective rate at inception.  If a troubled debt restructuring is considered to be a collateral
dependent loan, the loan is reported, net, at the fair value of the collateral.  For troubled debt
restructurings that subsequently default, the Corporation determines the amount of reserve in accordance
with the accounting policy for the allowance for loan losses.

 
24

 

The general component of the allowance for loan losses 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: levels of and trends in
delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume
and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in
lending policies, procedures, and practices; experience, ability, and depth of lending management and
other relevant staff; national and local economic trends and conditions; industry conditions; and effects
of changes in credit concentrations. The following portfolio segments have been identified:  commercial,
financial and agricultural; commercial mortgages; residential mortgages; and consumer loans.

Risk Characteristics

Commercial, financial and agricultural loans primarily consist of loans to small to mid-sized businesses
in our market area in a diverse range of industries.  These loans are of higher risk and typically are made
on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  
Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may
fluctuate in value.  The credit risk related to commercial loans is largely influenced by general economic
conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral,
if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than
residential mortgage loans, inferring higher potential losses on an individual customer basis.  Loan
repayment is often dependent on the successful operation and management of the properties and/or the
businesses occupying the properties, as well as on the collateral securing the loan.  Economic events or
conditions in the real estate market could have an adverse impact on the cash flows generated by
properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential mortgage loans are generally made on the basis of the borrower’s ability to make repayment
from his or her employment and other income, but are secured by real property whose value tends to be
more easily ascertainable.  Credit risk for these types of loans is generally influenced by general
economic conditions, the characteristics of individual borrowers and the nature of the loan collateral.

The consumer loan segment includes home equity lines of credit and home equity loans, which exhibit
many of the same risk characteristics as residential mortgages.  Indirect and other consumer loans may
entail greater credit risk than residential mortgage and home equity loans, particularly in the case of
other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by
depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment of the outstanding loan balance.  In
addition, consumer loan collections are dependent on the borrower’s continuing financial stability, thus
are more likely to be affected by adverse personal circumstances such as job loss, illness or personal
bankruptcy.  Furthermore, the application of various federal and state laws, including bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.

No allowance for loan losses was recorded as of September 30, 2011 for loans acquired as part of the
FOFC merger.  These loans were recorded at fair value at the time of the acquisition.

 
25

 

Activity in the allowance for loan losses by portfolio segment was as follows:

   
Nine Months Ended
September 30, 2011
 
Allowance for loan losses
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
2,118,299
   
$
2,575,058
   
$
1,301,780
   
$
2,727,022
   
$
775,972
   
$
9,498,131
 
  Charge Offs:
   
(593,995
)
   
(3,764
)
   
(39,312
)
   
(542,621
)
   
-
     
(1,179,692
)
  Recoveries:
   
314,797
     
33,304
     
30,324
     
146,726
     
-
     
525,151
 
     Net charge offs
   
(279,198
)
   
29,540
     
(8,988
)
   
(395,895
)
   
-
     
(654,541
)
  Provision
   
1,444,245
     
(69,375
)
   
(61,068
)
   
(184,348
)
   
(296,121
)
   
833,333
 
Ending balance
 
$
3,283,346
   
$
2,535,223
   
$
1,231,724
   
$
2,146,779
   
$
479,851
   
$
9,676,923
 


   
Three Months Ended
September 30, 2011
 
Allowance for loan losses
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Beginning balance:
 
$
3,081,433
   
$
2,612,655
   
$
1,246,880
   
$
2,297,459
   
$
517,245
   
$
9,755,672
 
  Charge Offs:
   
(590,992
)
   
-
     
(39,312
)
   
(201,966
)
   
-
     
(832,270
)
  Recoveries:
   
109,391
     
7,201
     
-
     
53,596
     
-
     
170,188
 
     Net charge offs
   
(481,601
)
   
7,201
     
(39,312
)
   
(148,370
)
   
-
     
(662,082
)
  Provision
   
683,514
     
(84,633
)
   
24,156
     
(2,310
)
   
(37,394
)
   
583,333
 
Ending balance
 
$
3,283,346
   
$
2,535,223
   
$
1,231,724
   
$
2,146,779
   
$
479,851
   
$
9,676,923
 


   
Three Months Ended September 30, 2010
   
Nine Months Ended September 30, 2010
 
Beginning balance:
 
$
10,447,291
   
$
9,967,223
 
  Charge offs:
   
(1,298,599
)    
(1,883,840
)
  Recoveries:
   
136,369
     
451,678
 
     Net charge offs
   
(1,162,230
)
   
(1,432,162
)
  Provision
   
375,000
     
1,125,000
 
Ending balance
 
$
9,660,061
   
$
9,660,061
 


 
26

 

The following tables present the balance in the allowance for loan losses and the recorded investment in
loans by portfolio segment based on impairment method as of September 30, 2011 and December 31,
2010.  The recorded investment excludes loans acquired in the FOFC merger.

   
September 30, 2011
Allowance for loan losses
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Ending allowance balance attributable to loans:
                                   
Individually evaluated for impairment
 
$
1,302,878
   
$
283,865
   
$
-
   
$
-
   
$
-
   
$
1,586,743
 
Collectively evaluated for impairment
   
1,980,468
     
2,251,358
     
1,231,724
     
2,146,779
     
479,851
     
8,090,180
 
Total ending allowance balance
 
$
3,283,346
   
$
2,535,223
   
$
1,231,724
   
$
2,146,779
   
$
479,851
   
$
9,676,923
 


 
December 31, 2010
Allowance for loan losses
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Unallocated
   
Total
 
Ending allowance balance attributable to loans:
                                   
Individually evaluated for impairment
 
$
23,524
   
$
216,234
   
$
-
   
$
-
   
$
-
   
$
239,758
 
Collectively evaluated for impairment
   
2,094,775
     
2,358,824
     
1,301,780
     
2,727,022
     
775,972
     
9,258,373
 
Total ending allowance balance
 
$
2,118,299
   
$
2,575,058
   
$
1,301,780
   
$
2,727,022
   
$
775,972
   
$
9,498,131
 


   
September 30, 2011
 
Loans:
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Total
 
Loans individually evaluated for impairment
 
$
4,975,639
   
$
4,399,423
   
$
182,117
   
$
-
   
$
9,557,179
 
Loans collectively evaluated for impairment
   
114,832,632
     
153,065,673
     
173,346,567
     
190,465,243
   
$
631,710,115
 
  Total ending loans balance
 
$
119,808,271
   
$
157,465,096
   
$
173,528,684
   
$
190,465,243
   
$
641,267,294
 


   
December 31, 2010
 
Loans:
 
Commercial, Financial and Agricultural
   
Commercial Mortgages
   
Residential Mortgages
   
Consumer Loans
   
Total
 
Loans individually evaluated for impairment
 
$
3,215,761
   
$
4,450,882
   
$
408,392
   
$
-
   
$
8,075,035
 
Loans collectively evaluated for impairment
   
111,778,238
     
128,963,664
     
173,465,831
     
193,098,341
     
607,306,074
 
  Total ending loans balance
 
$
114,993,999
   
$
133,414,546
   
$
173,874,223
   
$
193,098,341
   
$
615,381,109
 


 
27

 

The following tables present loans individually evaluated for impairment recognized by class of loans as
of September 30, 2011 and December 31, 2010, the average recorded investment and interest income
recognized by class of loans as of the three and nine month periods ending September 30, 2011:

   
September 30, 2011
 
Nine Months Ended
September 30, 2011
 
Three Months Ended
September 30, 2011
 
   
Unpaid Principal Balance
   
Allowance for Loan Losses Allocated
   
Recorded Investment
   
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
 
With no related allowance recorded:
                                 
Commercial, financial and agricultural:
                                 
  Commercial & industrial
 
$
2,968,386
   
$
-
   
$
2,971,036
   
$
3,100,655
   
$
25,049
   
$
3,032,483
   
$
6,290
 
Commercial mortgages:
                                                       
  Construction
 
 
10,739
     
-
     
10,739
     
24,490
     
-
     
20,602
     
-
 
  Other
   
3,310,502
     
-
     
3,307,483
     
3,447,948
     
-
     
3,397,079
     
-
 
Residential mortgages
   
181,705
     
-
     
182,117
     
307,997
     
-
     
257,799
     
-
 
With an allowance recorded:
                                                       
Commercial, financial and agricultural:
                                                       
  Commercial & industrial
 
 
2,004,588
     
1,302,878
     
2,004,603
     
1,953,474
     
82,548
     
2,918,444
     
82,548
 
Commercial mortgages:
                                                       
  Construction
   
11,261
     
11,261
     
11,261
     
27,351
     
-
     
15,557
     
-
 
  Other
   
1,072,472
     
272,604
     
1,069,940
     
821,994
     
17,070
     
823,995
     
17,070
 
  Total
 
$
9,559,653
   
$
1,586,743
   
$
9,557,179
   
$
9,683,909
   
$
124,667
   
$
10,465,959
   
$
105,908
 


   
December 31, 2010
 
   
Unpaid Principal Balance
   
Allowance for Loan Losses Allocated
   
Recorded Investment
   
Average Recorded Investment
   
Interest Income Recognized
 
With no related allowance recorded:
                             
Commercial, financial and agricultural:
                             
  Commercial & industrial
 
$
4,334,095
   
$
-
   
$
3,192,227
   
$
1,876,603
   
$
73,657
 
Commercial mortgages:
                                       
  Construction
   
32,266
     
-
     
32,266
     
8,067
     
-
 
  Other
   
4,148,423
     
-
     
3,549,686
     
3,374,678
     
63,061
 
Residential mortgages
   
407,105
     
-
     
408,392
     
309,537
     
21,324
 
With an allowance recorded:
                                       
Commercial, financial and agricultural:
                                       
  Commercial & industrial
   
23,524
     
23,524
     
23,534
     
1,393,995
     
386
 
  Agricultural
   
-
     
-
     
-
     
6,211
     
453
 
Commercial mortgages:
                                       
  Construction
   
50,939
     
43,514
     
50,939
     
215,901
     
-
 
  Other
   
838,277
     
172,720
     
817,991
     
1,378,687
     
969
 
Residential mortgages
   
-
     
-
     
-
     
215,299
     
6,470
 
  Total
 
$
9,834,629
   
$
239,758
   
$
8,075,035
   
$
8,778,978
   
$
166,320
 

 
28

 


The following table presents the recorded investment in non accrual and loans past due over 90 days still
on accrual by class of loans.  This table includes loans acquired in the FOFC merger, except those loans
with evidence of credit deterioration at the time of the merger.

   
September 30, 2011
   
December 31, 2010
 
   
Non-Accrual
   
Loans Past Due Over 90 Days Still Accruing
   
Non-Accrual
   
Loans Past Due Over 90 Days Still Accruing
 
Commercial, financial and agricultural:
                       
  Commercial & industrial
 
$
5,251,391
   
$
3,643
   
$
2,938,174
   
$
-
 
  Commercial mortgages
   
-
     
-
     
-
     
-
 
  Construction
   
22,000
     
7,059,479
     
83,204
     
-
 
  Other
   
6,030,548
     
-
     
4,230,701
     
-
 
Residential mortgages
   
2,357,889
     
-
     
2,558,534
     
-
 
Consumer loans
                               
  Credit cards
   
-
     
5,512
     
-
     
11,174
 
  Home equity lines & loans
   
526,052
     
-
     
545,039
     
-
 
  Indirect consumer loans
   
16,196
     
-
     
180,632
     
-
 
  Other direct consumer loans
   
159,244
     
-
     
61,601
     
-
 
Total
 
$
14,363,320
   
$
7,068,634
   
$
10,597,886
   
$
11,174
 

 
29

 

The following tables present the aging of the recorded investment in loans past due (including non-accrual loans) by class of loans as of
September 30, 2011 and December 31, 2010 and by loans originated by the Corporation (referred to as “Legacy” loans) and loans acquired in
the FOFC merger (referred to as “Acquired” loans) which are further discussed in Note 5:
   
September 30, 2011
 
Legacy Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
     
Loans Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial, financial and agricultural:
                                           
  Commercial & industrial
 
$
139,590
   
$
7,743
   
$
2,918,608
   
$
3,065,941
   
$
-
   
$
116,236,537
   
$
119,302,478
 
  Agricultural
   
-
     
-
     
-
     
-
     
-
     
505,792
     
505,792
 
Commercial mortgages:
                                                       
  Construction
   
-
     
-
     
-
     
-
     
-
     
7,525,126
     
7,525,126
 
  Other
   
88,266
     
-
     
3,103,796
     
3,192,062
     
-
     
146,747,908
     
149,939,970
 
Residential mortgages
   
1,547,675
     
455,525
     
938,554
     
2,941,754
     
-
     
170,586,931
     
173,528,685
 
Consumer loans:
                                                       
  Credit cards
   
3,558
     
2,767
     
5,511
     
11,836
     
-
     
1,857,860
     
1,869,696
 
  Home equity lines & loans
   
140,297
     
-
     
260,318
     
400,615
     
-
     
77,462,639
     
77,863,254
 
  Indirect consumer loans
   
342,674
     
90,812
     
141,792
     
575,278
     
-
     
95,813,548
     
96,388,826
 
  Other direct consumer loans
   
64,409
     
7,980
     
2,835
     
75,224
     
-
     
14,268,243
     
14,343,467
 
  Total
 
$
2,326,469
   
$
564,827
   
$
7,371,414
   
$
10,262,710
   
$
-
   
$
631,004,584
   
$
641,267,294
 

   
September 30, 2011
 
Acquired Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
     
Loans Acquired with deteriorated credit quality
   
Loans Not Past Due
   
Total
 
Commercial, financial and agricultural:
                                         
 
  Commercial & industrial
 
$
230,548
   
$
984,202
   
$
198,877
   
$
1,413,627
   
$
1,591,772
   
$
26,996,570
   
$
30,001,969
 
  Agricultural
   
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Commercial mortgages:
                                                       
  Construction
   
18,884
     
423,882
     
7,059,479
     
7,502,245
     
2,305,549
     
2,907,182
     
12,714,976
 
  Other
   
154,383
     
197,441
     
1,653,124
     
2,004,948
     
11,248,658
     
65,645,166
     
78,898,772
 
Residential mortgages
   
474,152
     
65,364
     
85,181
     
624,697
     
222,580
     
20,547,566
     
21,394,843
 
Consumer loans:
                                                       
  Credit cards
   
-
     
-
     
-
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
-
     
-
     
-
     
-
     
-
     
6,199,175
     
6,199,175
 
  Indirect consumer loans
   
-
     
-
     
-
     
-
     
-
     
-
     
-
 
  Other direct consumer loans
   
-
     
-
     
-
     
-
     
-
     
139,238
     
139,238
 
  Total
 
$
877,967
   
$
1,670,889
   
$
8,996,661
   
$
11,545,517
   
$
15,368,559
   
$
122,434,897
   
$
149,348,973
 


 
30

 


   
December 31, 2010
 
Legacy Loans:
 
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater than 90 Days Past Due
   
Total Past Due
   
Loans Not Past Due
   
Total
 
Commercial, financial and agricultural
                                   
  Commercial & industrial
 
$
33,434
   
$
17,351
   
$
2,914,640
   
$
2,965,425
   
$
111,202,073
   
$
114,167,498
 
  Agricultural
   
-
     
-
     
-
     
-
     
826,501
     
826,501
 
Commercial mortgages
                                               
  Construction
   
-
     
-
     
63,102
     
63,102
     
9,029,450
     
9,092,552
 
  Other
   
116,432
     
-
     
2,913,525
     
3,029,957
     
121,292,041
     
124,321,998
 
Residential mortgages
   
1,851,412
     
277,276
     
1,404,067
     
3,532,755
     
170,341,467
     
173,874,222
 
Consumer loans
                                               
  Credit cards
   
4,889
     
16,635
     
11,174
     
32,698
     
1,989,199
     
2,021,897
 
  Home equity lines & loans
   
550,134
     
79,910
     
321,116
     
951,160
     
76,052,290
     
77,003,450
 
  Indirect consumer loans
   
465,818
     
154,969
     
146,221
     
767,008
     
98,571,142
     
99,338,150
 
  Other direct consumer loans
   
51,125
     
12,502
     
41,964
     
105,591
     
14,629,253
     
14,734,844
 
  Total
 
$
3,073,244
   
$
558,643
   
$
7,815,809
   
$
11,447,696
   
$
603,933,416
   
$
615,381,112
 

Troubled Debt Restructurings:

The Corporation has not allocated any specific reserves to customers whose loan terms have been
modified in troubled debt restructurings as of September 30, 2011 or December 31, 2010.  The
Corporation has not committed to lend any additional amounts as of September 30, 2011 or December
31, 2010 to customers with outstanding loans that are classified as trouble debt restructurings.

During the three and nine months ended September 30, 2011, no loans were modified as troubled debt
restructurings by the Corporation.  Additionally, there were no payment defaults on any loans previously
modified as troubled debt restructurings 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 categorizes loans into risk categories based on relevant information about the ability of
borrowers to service their debt such as: current financial information, historical payment experience,
credit documentation, public information, and current economic trends, among other factors.  The
Corporation analyzes loans individually by classifying the loans as to credit risk.  This analysis includes
new consumer, mortgage and home equity loans and lines with outstanding balances greater than $50
thousand, $250 thousand and $100 thousand, respectively, along with a sample of existing loans and
non-homogeneous loans, such as commercial and commercial real estate loans.  The loans meeting these
criteria are reviewed at least annually.  The Corporation uses the following definitions for risk rating:

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.

 
31

 

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 pass rated loans.  Based on the analysis’s performed as of September 30,
2011 and December 31, 2010, the risk category of the recorded investment of loans by class of loans is
 as follows:

   
September 30, 2011
 
Legacy Loans:
 
Not Rated
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
 
Commercial, financial and agricultural:
                             
  Commercial & industrial
 
$
-
   
$
98,332,680
   
$
12,549,673
   
$
4,865,665
   
$
3,554,460
 
  Agricultural
   
-
     
505,792
     
-
     
-
     
-
 
Commercial mortgages:
                                       
  Construction
   
-
     
6,492,114
     
211,583
     
481,927
     
339,502
 
  Other
   
-
     
134,922,194
     
6,805,611
     
7,660,502
     
551,663
 
Residential mortgages
   
171,275,866
     
-
     
-
     
2,252,819
     
-
 
Consumer loans:
                                       
  Credit cards
   
1,869,696
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
77,337,201
     
-
     
-
     
526,053
     
-
 
  Indirect consumer loans
   
96,223,075
     
-
     
-
     
165,751
     
-
 
  Other direct consumer loans
   
14,327,271
     
-
     
-
     
16,196
     
-
 
  Total
 
$
361,033,109
   
$
240,252,780
   
$
19,566,867
   
$
15,968,913
   
$
4,445,625
 

Acquired Loans:
                             
Commercial, financial and agricultural:
                             
  Commercial & industrial
 
$
-
   
$
27,771,057
   
$
617,784
   
$
21,356
   
$
-
 
  Agricultural
   
-
     
-
     
-
     
-
     
-
 
Commercial mortgages:
                                       
  Construction
   
-
     
5,360,446
     
3,858,838
     
1,190,143
     
-
 
  Other
   
-
     
65,659,894
     
636,087
     
1,354,133
     
-
 
Residential mortgages
   
21,087,082
     
-
     
-
     
85,181
     
-
 
Consumer loans:
                                       
  Credit cards
   
-
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
6,199,175
     
-
     
-
     
-
     
-
 
  Indirect consumer loans
   
-
     
-
     
-
     
-
     
-
 
  Other direct consumer loans
   
139,238
     
-
     
-
     
-
     
-
 
  Total
 
$
27,425,495
   
$
98,791,397
   
$
5,112,709
   
$
2,650,813
   
$
-
 

   
December  31, 2010
 
Legacy Loans:
 
Not Rated
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
 
Commercial, financial and agricultural:
                             
  Commercial & industrial
 
$
-
   
$
90,887,538
   
$
16,946,891
   
$
4,770,276
   
$
1,562,794
 
  Agricultural
   
-
     
824,882
     
1,619
     
-
     
-
 
Commercial mortgages:
                                       
  Construction
   
-
     
7,497,488
     
672,136
     
922,928
     
-
 
  Other
   
-
     
108,732,393
     
7,245,641
     
8,343,964
     
-
 
Residential mortgages
   
171,024,544
     
-
     
-
     
2,849,678
     
-
 
Consumer loans:
                                       
  Credit cards
   
2,021,896
     
-
     
-
     
-
     
-
 
  Home equity lines & loans
   
76,458,414
     
-
     
-
     
545,037
     
-
 
  Indirect consumer loans
   
99,155,306
     
-
     
-
     
77,883
     
-
 
  Other direct consumer loans
   
14,656,690
     
-
     
-
     
182,844
     
-
 
  Total
 
$
363,317,120
   
$
207,942,301
   
$
24,866,287
   
$
17,692,610
   
$
1,562,794
 

 
32

 

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
September 30, 2011 and December 31, 2010:

   
September 30, 2011
         
Consumer Loans
 
Legacy Loans:
 
Residential Mortgages
   
Credit Card
   
Home Equity Lines & Loans
   
Indirect Consumer Loans
   
Other Direct Consumer Loans
 
Performing
 
$
171,255,977
   
$
1,864,184
   
$
77,337,202
   
$
96,229,582
   
$
14,327,271
 
Non-Performing
   
2,272,707
     
5,512
     
526,052
     
159,244
     
16,196
 
     
173,528,684
     
1,869,696
     
77,863,254
     
96,388,826
     
14,343,467
 

Acquired Loans:
                             
Performing
 
$
21,309,662
   
$
-
   
$
6,199,175
   
$
-
   
$
139,238
 
Non-Performing
   
85,181
     
-
     
-
     
-
     
-
 
Total
 
$
21,394,843
   
$
-
   
$
6,199,175
   
$
-
   
$
139,238
 

   
December 31, 2010
 
         
Consumer Loans
 
Legacy Loans:
 
Residential Mortgages
   
Credit Card
   
Home Equity Lines & Loans
   
Indirect Consumer Loans
   
Other Direct Consumer Loans
 
Performing
 
$
171,070,881
   
$
2,010,723
   
$
76,458,413
   
$
99,157,518
   
$
14,673,243
 
Non-Performing
   
2,803,342
     
11,174
     
545,037
     
186,632
     
61,601
 
Total
 
$
173,874,223
   
$
2,021,897
   
$
77,003,450
   
$
99,338,150
   
$
14,734,844
 


 
33

 

10.           Components of Quarterly and Year-to-Date Net Periodic Benefit Costs

   
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
   
2011
     
2010
 
2011
     
2010
   
Qualified Pension
                           
Service cost, benefits earned during the period
 
$
777,402
   
$
677,654
   
$
259,134
   
$
144,938
   
Interest cost on projected benefit obligation
   
1,178,868
     
1,137,613
     
392,956
     
179,589
   
Expected return on plan assets
   
(1,757,019
)
   
(1,690,066
)
   
(585,673
)
   
(301,794
)
 
Amortization of unrecognized transition obligation
   
-
     
-
     
-
     
-
   
Amortization of unrecognized prior service cost
   
22,410
     
34,417
     
7,470
     
6,021
   
Amortization of unrecognized net loss
   
507,339
     
410,788
     
169,113
     
41,652
   
  Net periodic pension expense
 
$
729,000
   
$
570,406
   
$
243,000
   
$
70,406
   
                                   
Supplemental Pension
                                 
Service cost, benefits earned during the period
 
$
22,968
   
$
23,314
     
7,656
   
$
6,800
   
Interest cost on projected benefit obligation
   
40,330
     
42,949
     
13,443
     
12,525
   
Expected return on plan assets
   
-
     
-
     
-
     
-
   
Amortization of unrecognized prior service cost
   
-
     
-
     
-
     
-
   
Amortization of unrecognized net loss
   
7,098
     
4,322
     
2,366
     
1,260
   
  Net periodic supplemental pension expense
 
$
70,396
   
$
70,585
   
$
23,465
   
$
20,585
   
                                   
Postretirement, Medical and Life
                                 
Service cost, benefits earned during the period
 
$
24,750
   
$
22,500
     
8,250
   
$
7,500
   
Interest cost on projected benefit obligation
   
56,250
     
56,250
     
18,750
     
18,750
   
Expected return on plan assets
   
-
     
-
     
-
     
-
   
Amortization of unrecognized prior service cost
   
(72,750
)
   
(71,250
)
   
(24,250
)
   
(23,750
)
 
Amortization of unrecognized net gain
   
-
     
-
     
-
           
  Net periodic postretirement, medical and life expense
 
$
8,250
   
$
7,500
   
$
2,750
   
$
2,500
   

On April 21, 2010, the Corporation's Board of Directors approved an amendment to the Corporation’s
Defined Benefit Pension Plan.  Under the amendment, which became effective on July 1, 2010, new
employees hired on or after the effective date will not be eligible to participate in the plan, however,
existing participants at that time will continue to accrue benefits.  The Corporation anticipates that over
time the amendment will result in a decrease in the future benefit obligations of the plan and the
corresponding net periodic benefit cost associated with the plan.


 
34

 

11.           Segment Reporting
The Corporation manages its operations through two primary business segments: core banking and trust and investment advisory 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 trust and investment advisory
services segment provides revenues by providing trust and investment advisory services to clients.

Summarized financial information concerning the Corporation’s reportable segments and the reconciliation to the Corporation’s consolidated results is
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.  (dollars in thousands)

   
Three Months Ended September 30, 2011
   
Nine Months Ended September 30, 2011
 
   
Core Banking
   
Trust & Investment Advisory Services
   
Holding Company And Other
   
Consolidated Totals
   
Core Banking
   
Trust & Investment Advisory Services
   
Holding Company And Other
   
Consolidated Totals
 
Net interest income
 
$
11,842
   
$
-
   
$
1
   
$
11,843
   
$
31,834
   
$
-
   
$
6
   
$
31,840
 
Provision for loan losses
   
583
     
-
     
-
     
583
     
833
     
-
     
-
     
833
 
Net interest income after provision for loan losses
   
11,259
     
-
     
1
     
11,260
     
31,001
     
-
     
6
     
31,007
 
Other operating income
   
2,465
     
1,747
     
116
     
4,328
     
7,284
     
5,131
     
1,005
     
13,420
 
Other operating expenses
   
8,638
     
1,843
     
136
     
10,617
     
27,259
     
5,450
     
553
     
33,262
 
Income or (loss) before income tax expense
   
5,086
     
(96
)
   
(19
)
   
4,971
     
11,026
     
(319
)
   
458
     
11,165
 
Income tax expense (benefit)
   
1,742
     
(37
)
   
(25
)
   
1,680
     
3,589
     
(123
)
   
123
     
3,589
 
Segment net income (loss)
 
$
3,344
   
$
(59
)
 
$
6
   
$
3,291
   
$
7,437
   
$
(196
)
 
$
335
   
$
7,576
 
Segment assets
                                 
$
1,257,067
   
$
5,856
   
$
3,001
   
$
1,265,924
 

   
Three Months Ended September 30, 2010
   
Nine Months Ended September 30, 2010
 
   
Core Banking
   
Trust & Investment Advisory Services
   
Holding Company And Other
   
Consolidated Totals
   
Core Banking
   
Trust & Investment Advisory Services
   
Holding Company And Other
   
Consolidated Totals
 
Net interest income
 
$
8,681
   
$
-
   
$
-
   
$
8,681
   
$
25,969
   
$
-
   
$
3
   
$
25,972
 
Provision for loan losses
   
375
     
-
     
-
     
375
     
1,125
     
-
     
-
     
1,125
 
Net interest income after provision for loan losses
   
8,306
     
-
     
-
     
8,305
     
24,844
     
-
     
3
     
24,847
 
Other operating income
   
1,911
     
2,184
     
152
     
4,247
     
6,201
     
6,257
     
449
     
12,907
 
Other operating expenses
   
7,047
     
1,710
     
125
     
8,882
     
21,728
     
5,309
     
506
     
27,543
 
Income or (loss) before income tax expense
   
3,170
     
474
     
(27
)
   
3,671
     
9,317
     
948
     
(54
)
   
10,211
 
Income tax expense (benefit)
   
942
     
183
     
(5
)
   
1,120
     
2,862
     
367
     
(72
)
   
3,157
 
Segment net income (loss)
 
$
2,228
   
$
291
   
$
32
   
$
2,551
   
$
6,455
   
$
581
   
$
(18
)
 
$
7,054
 
Segment assets
                                 
$
962,145
   
$
7,464
   
$
3,091
   
$
972,700
 


 
35

 

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 CEO 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 twelve (12) months
during the prior year.

An expense of $231 thousand related to this compensation was recognized during the year of 2010.  
During January 2011, 10,378 shares were re-issued from treasury to fund the stock component of
directors' compensation.

Restricted Stock Plan

On June 16, 2010, the Corporation's Board of Directors approved the Corporation's Restricted Stock
Plan (the "Plan"), which became effective immediately.  Pursuant to 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.  The maximum number of shares as to which stock awards may be granted under the
Plan is 10,000 per year, with these shares vesting over a 5 year period.

A summary of restricted stock activity from December 31, 2010 to September 30, 2011 is presented below:

 
Shares
 
Weighted–Average Grant Date Fair Value
Nonvested at December 31, 2010
5,886
 
$21.25
  Granted
2,087
 
22.98
  Vested
-
 
-
  Forfeited or Cancelled
-
 
-
Nonvested at September 30, 2011
7,973
 
$21.52

As of September 30, 2011, there was $150,660 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 4.83 years.

 
36

 

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

The review that follows focuses on the significant factors affecting the financial condition and results of
operations of the Corporation during the three and nine-month periods ended September 30, 2011, with
comparisons to the comparable periods in 2010, as applicable. The following discussion and the
unaudited consolidated interim financial statements and related notes included in this report should be
read in conjunction with our 2010 Annual Report on Form 10-K, which was filed with the Securities and
Exchange Commission on March 16, 2011.  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.

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 the Corporation's expected financial position and operating results, 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," 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 our growth, including those in connection with our
April 8, 2011 acquisition of Fort Orange Financial Corporation and the integration of its business with ours,
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 risks facing the Corporation can be found in our periodic filings with the Securities and
Exchange Commission, including in our 2010 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) 737-3788. 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 accounting principles generally
accepted in the United States of America.  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.

 
37

 

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 other-than-temporary impairment ("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 an 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. Our analysis of these investments includes $629 thousand
book value of a collateralized debt obligation ("CDO") which is a pooled trust preferred security.  This
security was rated high quality when purchased, but at September 30, 2011 Moody's rated this security
as Caa3 which is defined as substantial risk of default.  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.  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 pools, as well as overall default rates based on historical bank
debt default rate averages.  For the three and nine-month periods ended September 30, 2011, the
Corporation recognized $67 thousand in OTTI charges.

 
38

 

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

Consolidated assets at September 30, 2011 totaled $1.266 billion, an increase of $307.6 million or
32.1% since December 31, 2010.  As discussed in greater detail below, this increase was due in large
part to the Corporation’s acquisition of Fort Orange Financial Corp. (“FOFC”) and the concurrent
merger of its banking subsidiary, Capital Bank & Trust Company (“Capital Bank”) into the Bank on
April 8, 2011, as well as other organic growth.  The increase was reflected principally in a $174.8
million increase in loans, net of deferred fees and costs and unearned income, a $55.4 million increase in
the securities portfolio, a $57.9 million increase in cash and cash equivalents and increases in goodwill
and other intangible assets totaling $12.3 million and $1.8 million, respectively, as well as a $3.6 million
increase in other assets.

As noted above, total loans, net of deferred fees and costs and unearned income increased $174.8
million or 28.5% from December 31, 2010 to September 30, 2011, principally due to the acquisition of
Capital Bank loans totaling $173.4 million at quarter-end.  The most significant growth was in
commercial loans (including commercial mortgages), which increased $150.1 million, with $145.4
million of this increase associated with the Capital Bank acquisition.  Residential mortgages increased
$20.8 million, including Capital Bank mortgages totaling $21.3 million at September 30, 2011.  Total
consumer loans were up $3.9 million, principally due to a $7.2 million increase in home equity balances,
as home equity loans associated with the acquisition totaled $6.6 million at quarter-end.  This increase
was offset primarily by a $2.8 million decrease in indirect consumer installment loans and a $306
thousand decrease in other consumer installment loans.  During the first nine months of this year,
approximately $5.4 million of newly originated residential mortgages were sold in the secondary market
to Freddie Mac, with an additional $475 thousand originated and sold to the State of New York
Mortgage Agency.


The composition of the loan portfolio is summarized as follows:

   
September 30, 2011
   
December 31, 2010
 
Commercial, financial and agricultural
 
$
147,815,433
   
$
114,697,440
 
Commercial mortgages
   
250,030,218
     
133,070,484
 
Residential mortgages
   
194,260,610
     
173,467,806
 
Indirect Consumer loans
   
96,093,955
     
98,940,854
 
Consumer loans
   
100,258,360
     
93,507,785
 
Total loans, net of deferred origination fees and cost,
  and unearned income
 
$
788,458,576
   
$
613,684,369
 


 
39

 

The available for sale segment of the securities portfolio totaled $279.1 million at September 30, 2011, an
increase of approximately $55.5 million or 24.8% from December 31, 2010.  At amortized cost, the
available for sale portfolio increased $51.1 million, including approximately $41.5 million of bonds related
to the Capital Bank acquisition.  Unrealized appreciation related to the available for sale portfolio increased
$4.4 million since year-end 2010.  The increase in the available for sale portfolio at amortized cost is
reflected principally in a $42.5 million increase in federal agency bonds, with $12.1 million of that total in
Capital Bank bonds.  Municipal bonds were up $6.5 million, including $5.9 million of municipal bonds at
Capital Bank.  Increases in collateralized mortgage obligations and SBA Guaranteed Loan Pools totaling
$8.3 million and $2.3 million, respectively, reflect investments acquired in the acquisition.  A $2.4 million
increase in corporate bonds includes $3.0 million of investments acquired from Capital Bank.  The above
increases were offset in part by a $6.4 million decrease in mortgage-backed securities and a $4.5 million
decrease in US Treasury bonds.  The decrease in mortgage-backed securities reflects paydowns received
since year-end 2010, partially offset by mortgage-backed securities acquired from Capital Bank totaling
$9.9 million at September 30, 2011, while the decrease in US Treasuries was due to the sale of three bonds
during the year, offset in part by purchases totaling $30.3 million.  The increase in unrealized appreciation
related to the available for sale portfolio was due in large part to the impact of lower mid-to long-term rates
on the various bond portfolios, offset in part by a decrease in unrealized gains in the Corporation’s equity
portfolio.  The held to maturity portion of the portfolio, consisting of local municipal obligations,
decreased approximately $129 thousand from $7.7 million at December 31, 2010 to $7.6 million at
September 30, 2011.

As noted above, total cash and cash equivalents increased $57.9 million since December 31, 2010.  With
a significant increase in deposits, as discussed below, exceeding the net increases in loans and securities,
as well as the addition of cash acquired in the Capital Bank acquisition, interest bearing deposits at other
financial institutions have increased $43.6 million since year-end.  Additionally, cash and due from
financial institutions increased $14.2 million primarily due to an increased level of cash items in process
of collection.  With total cash and cash equivalents of $118.5 million at September 30, 2011, the
Corporation continues to maintain a strong liquidity position and we continue 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.

The $12.3 million increase in goodwill as well as the $1.8 million increase in other intangible assets was
directly related to the FOFC acquisition.  The $1.8 million increase, net of amortization, in other
intangible assets includes $2.4 million in other intangibles associated with this acquisition, which the
Corporation is amortizing on an accelerated basis over a 10 year period.

A $3.6 million increase in other assets was due principally to a $1.3 million increase in accrued interest
receivable due in large part to the FOFC acquisition, a $464 thousand increase in net deferred tax assets,
a $687 thousand estimated income tax receivable related to the FOFC acquisition and a $537 thousand
increase in accounts receivable.

 
40

 

Since December 31, 2010, total deposits have increased $255.8 million or 32.5% to $1.042 billion, with
$177.8 million of this increase attributed to the FOFC acquisition, and $78.0 million due to organic
deposit growth. Non-interest bearing demand deposits increased $64.6 million, including balances at the
Capital Bank offices acquired totaling $25.5 million, along with increases in public funds and other non-
interest bearing demand deposits of $4.9 million and $34.2 million, respectively.  A $191.2 million
increase in interest bearing balances was due principally to increases in savings and time deposit
balances of $72.8 million and $51.7 million, respectively, as well as a $47.8 million increase in NOW
accounts and an $18.9 million increase in insured money market account (“IMMA”) balances.  The
$72.8 million increase in savings balances includes $58.9 million related to the FOFC acquisition as
well as increases in public fund and other balances totaling $4.3 million and $9.6 million, respectively,
while the $51.7 million increase in time deposits includes $59.1 million of Capital Bank deposits and a
$13.2 million increase in public fund balances, partially offset by decreases in other personal and non-
personal balances.  The $47.8 million increase in NOW accounts was principally due to Capital Bank
balances totaling $23.0 million as well as a $23.3 million increase in public funds, while the $18.9
million increase in IMMA balances includes $11.3 million in Capital Bank deposits and a $9.9 million
increase in public fund balances offset by decreases in other personal and non-personal balances.

A $23.9 million increase in long term borrowings was due to the Corporation assuming the term debt of
Capital Bank.

The $31.3 million increase in total shareholders equity was due in large part to the issuance of 1,009,942
shares to acquire shares of former FOFC shareholders, which resulted in an increase in common stock and
additional paid-in-capital totaling $23.7 million.  Other significant increases included a $4.4 million
increase in retained earnings and a $3.0 million increase in accumulated other comprehensive income.


Asset Quality
Non-Performing Loans

The recorded investment in non-performing loans at September 30, 2011 totaled $21.488 million
compared to $11.268 million at year-end 2010, an increase $10.220 million.  Not included in the non-
performing loan totals are loans acquired in the FOFC acquisition which the Corporation has identified
as purchased credit impaired (“PCI”) loans totaling $15.369 million at September 30, 2011, which 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 9 of the interim financial statements.  The increase in non-performing loans was due
to increases in non-accrual loans and loans 90 days or more past due totaling $3.765 million and $7.058
million, respectively, partially offset by a $603 thousand decrease in accruing troubled debt
restructurings (“TDRs”).  The $3.765 million increase in non-accrual loans was due to a $4.052 million
increase in non-accruing commercial loans that was primarily due to the addition to non-accrual status
of two legacy loans totaling $2.543 million, as well as the addition to non-accrual status of loans
acquired in the FOFC acquisition totaling $1.980 million.  These increases were offset in part by
principal reductions on other non-accrual commercial loans.  The increase in non-accrual commercial
loans was partially offset by decreases in non-accrual residential mortgages, home equity and other
consumer loans totaling, $201 thousand, $19 thousand and $67 thousand, respectively.  Included in the
non-accrual loan totals are commercial loans to one borrower totaling $5.192 million which carry
guarantees of the United States Department of Agriculture ("USDA") totaling $4.847 million, thereby
reducing the Corporation's remaining exposure on these loans to $345 thousand.  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
 
 
41

 
any time if payment of principal or interest in full is not expected due to deterioration in the financial
condition of the borrower.  Loans remain in non-accrual status until the loans have been brought current
and remain current for a period of six months.  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.

Accruing loans 90 days or more past due totaled $7.069 million at September 30, 2011 compared to $11
thousand at year-end 2010, an increase of $7.058 million.  This increase was due to loans not considered
by management to be PCI loans acquired in the FOFC acquisition, including $7.059 million of
construction loans that for a variety of reasons are 90 days or more past their stated maturity dates,
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.

As noted above, accruing TDRs decreased $603 thousand since December 31, 2010 as during the first
nine months of this year a commercial loan totaling $137 thousand and three residential mortgages
totaling $245 thousand at December 31, 2010 were removed from TDR status in accordance with the
Corporation’s policy that TDRs that have continued to be in compliance with modified terms and
conditions for six months and yield a market rate at the time of restructuring not be reported as TDRs in
years subsequent to the year in which the loan was first reported as TDR.  Additionally, $221 thousand
of principal reductions have been received on a commercial loan TDR.  Concessions made on
commercial loan TDRs generally involve short term deferrals of principal payments, while residential
mortgage restructurings include interest rate and/or payment reductions.  Overall, our past experience in
working with borrowers in restructuring troubled debt has been favorable. TDRs are evaluated for
impairment based upon the present value of expected future cash flows with any changes recorded
through the provision for loan losses.

At September 30, 2011, OREO totaled $661 thousand compared to $741 thousand at December 31,
2010, a decrease of $80 thousand.  During the first nine months of this year four properties totaling $309
thousand were placed in OREO and two properties totaling $268 thousand were sold.  Additionally,
during the third quarter of this year, the Corporation recognized a $12 thousand write-down on one
property following the receipt of an updated appraisal.  The balance of the decrease was due to the
receipt of private mortgage insurance reimbursement on one property.  At September 30, 2011, OREO
properties consisted of five residential properties totaling $349 thousand, two commercial properties
totaling $94 thousand and undeveloped land totaling $218 thousand.

Impaired Loans

Impaired loans, excluding residential real estate loans determined to be troubled debt restructurings, at
September 30, 2011 totaled $9.375 million compared to $7.667 million at December 31, 2010.  Not
included in the impaired loan totals are loans acquired in the FOFC acquisition which the Corporation has
identified as PCI loans as these loans are accounted for under ASC Subtopic 310-30 as noted under the
above discussion of non-performing loans.  The increase of $1.708 million resulted principally from the
above-discussed increase in non-accrual commercial legacy loans, offset in part by decreases in other non-
accrual loans and accruing commercial loan TDR’s.  Included in the impaired loan total are loans totaling
$3.086 million for which impairment allowances of $1.587 million have been specifically allocated to the
allowance for loan losses.  As of December 31, 2010, the impaired loan total included $892 thousand of
loans for which specific impairment allowances of $240 thousand were allocated to the allowance for loan
losses.  The increases in both the amount of impaired loans for which specific allowances were allocated to
the allowance for loan losses and the amount allocated were both primarily due to the above mentioned
 
42

 

addition to non-accrual loans of loans to two borrowers totaling $2.543 million.  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 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.  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.  If market conditions warrant,
future appraisals are obtained.  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.

The appraisals are performed by independent third parties and reflect the properties market value "as is".
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. In situations where partial charge-offs
have been recognized, any balance remaining continues to be reflected as non-performing until the
loan has been paid in full.  In the case of impaired loans secured by assets other than real estate (i.e. business
assets), a collateral valuation is performed using data from the client's most recently received financial
statements, and applying discount rates based upon the type of collateral.

The following table summarizes the Corporation's recorded investment in non-performing assets:

(dollars in thousands)
 
September 30, 2011
   
December 31, 2010
 
Non-accrual loans
 
$
14,363
   
$
10,598
 
Troubled debt restructurings
   
56
     
659
 
Accruing loans past due 90 days or more
   
7,069
     
11
 
Total non-performing loans
 
$
21,488
   
$
11,268
 
Other real estate owned
   
661
     
741
 
Total non-performing assets
 
$
22,149
   
$
12,009
 

In addition to non-performing loans, as of September 30, 2011, the Corporation has identified
commercial relationships totaling $8.2 million as potential problem loans, as compared to $7.2 million at
December 31, 2010.  This increase of $1.0 million resulted from the addition of three commercial
relationships totaling $4.0 million, including $1.4 million of loans acquired in the FOFC acquisition
which were not considered to be PCI loans, partially offset by downgrades of three relationships to non-
accrual status totaling $2.5 million, as well as principal reductions on other potential problem loans.  
Potential problem loans are loans that are currently performing, but known information about possible
credit problems of the related borrowers causes management to have serious doubts as to the ability of
such borrowers to comply with the present loan repayment terms, which may result in the disclosure of
such loans as non-performing at some time in the future.  Potential problem loans are typically loans that
are performing but are classified in the Corporation's loan rating system as "substandard."  Management
cannot predict the extent to which economic conditions may worsen or other factors which may impact
borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will
not become 90 days or more past due, be placed on non-accrual, be restructured, or require increased
allowance coverage and provisions for loan losses.

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 historical loan loss experience, review of specific
problem loans (including evaluation of the underlying collateral), changes in the composition and
volume of the loan portfolio, recent charge-off experience, overall portfolio quality and current
economic conditions that may affect the borrowers' ability to pay.

 
43

 

While impaired loans increased $1.708 million since year-end 2010, this increase, as noted above, was
due to the addition of two commercial relationships totaling approximately $2.543 million which was
the main factor behind a $1.347 million increase in specific allowances allocated against impaired loans.  
With the exception of these relationships, overall credit quality has remained stable and we continue to
see signs of improvement as evidenced by improved credit quality of non-impaired loans and significant
reductions in net charge-offs with third quarter and year-to date net charge offs decreasing $500
thousand and $778 thousand, respectively, as compared to the corresponding periods in 2010.  Based
upon an analysis of the factors mentioned above, the Corporation’s provision for loan losses for the third
quarter of this year totaled $583 thousand compared to $375 thousand for the third quarter of 2010, with
the year-to-date provision of $833 thousand down $292 thousand when compared to last year.

As noted above, net charge-offs for the first nine months of this year as compared to 2010 improved by
$778 thousand from $1.432 million in net charge-offs during the first nine months of last year to $654
thousand.  This improvement was principally due to decreases in net commercial and consumer loan
charge-offs totaling $613 thousand and $138 thousand, respectively, as well as a $27 thousand decrease
in net residential mortgage charge-offs.  At September 30, 2011, the Corporation's allowance for loan
losses totaled $9.677 million, resulting in a coverage ratio of allowance to non-performing loans of
45.0%.  As noted above, included in non-performing loans at September 30, 2011 were loans which
carried USDA guarantees totaling $4.847 million.  Also included in the non-performing loan totals are
other loans with remaining balances totaling $259 thousand on which the Corporation has previously
recognized partial charge-offs in the amount of $772 thousand.  Excluding the USDA guaranteed
amount and other loans for which partial charge-offs have already been recognized from the non-
performing total, the coverage ratio of allowance to non-performing loans was 59.1%. This ratio as well
as the ratio of allowance to total loans was impacted by the Capital Bank acquisition, as current
accounting rules do not allow the acquirer to transfer the acquiree’s allowance for loan losses to the
acquirer’s balance sheet.  Rather, the acquiree’s overall loan quality is a component in determining the
fair value of loans acquired, which are carried on the balance sheet at fair value.  Excluding acquired
loans reported above as non-performing loans totaling $9.039 million, as well as the aforementioned
USDA guarantee and loans for which partial charge-offs have already been recognized, the allowance to
non-performing loan ratio was 131.8%.  Excluding loans acquired in the Capital Bank acquisition, the
allowance for loan losses to total loans was 1.51% and represents an amount that management believes
is adequate to absorb probable incurred loan losses on the Corporation's legacy loan portfolio.

The allocated portions of the allowance reflect management's estimates of specific known risk elements
in the respective portfolios.  Management's methodology followed in evaluating the allowance for loan
losses includes a detailed analysis of historical loss factors for pools of similarly graded loans, as well as
specific collateral reviews of relationships graded special mention, substandard or doubtful with
outstanding balances of $1.0 million or greater. Among the factors considered in allocating portions of
the allowance by loan type are the current levels of past due, non-accrual and impaired loans, as well as
historical loss experience and the evaluation of collateral.  In addition, management has formally
documented factors considered in determining the appropriate level of general reserves, including
current economic conditions, forecasted trends in the credit quality cycle, loan growth, entry into new
markets, and industry and peer group trends.  These amounts have been included in the allocated portion
of the loan categories to which they relate.

 
44

 

At September 30, 2011, in addition to the qualitative factors allocated within the allowance, the
Corporation maintained $480 thousand of the allowance as unallocated.  While some preliminary
improvements have been seen in the local economy and while some loans have improved, the recovery
is still very fragile and management believes it is prudent to see a longer period of sustained
improvement before completely reflecting this in the allowance.  Additionally, management monitors
coverage ratios of nonperforming loans and total loans compared to peers on a regular basis.  This
analysis also suggests that it would not be prudent to eliminate the unallocated portion of the allowance
at this time.

Activity in the allowance for loan losses was as follows:

(dollars in thousands)
 
Nine Months Ended
September 30,
 
   
2011
   
2010
 
Balance at beginning of period
 
$
9,498
   
$
9,967
 
Charge-offs:
               
  Commercial, financial and agricultural
   
(594
)
   
(1,178
)
  Commercial mortgages
   
(4
)
   
-
 
  Residential mortgages
   
(39
)
   
(36
)
  Consumer loans
   
(543
)
   
(670
)
Total
   
(1,180
)
   
(1,884
)
Recoveries:
               
  Commercial, financial and agricultural
   
315
     
315
 
  Commercial mortgages
   
33
     
-
 
  Residential mortgages
   
30
     
-
 
  Consumer loans
   
148
     
137
 
Total
   
526
     
452
 
   Net charge-offs
   
(654
)
   
(1,432
)
   Provision charged to operations
   
833
     
1,125
 
                 
Balance at end of period
 
$
9,677
   
$
9,660
 


Results of Operations
Third Quarter of 2011 vs. Third Quarter of 2010

Net income for the third quarter of 2011 totaled $3.291 million, an increase of $740 thousand or 29.0%
as compared to third quarter 2010 net income of $2.551 million.  Earnings per share were unchanged at
$0.71 per share on 1,035,115 additional average shares outstanding primarily resulting from the FOFC
acquisition.  The increase in net income can be attributed to the Capital Bank acquisition, particularly
due to the increase in net interest income, as, excluding direct transaction costs during the quarter,
Capital Bank contributed an estimated $1.199 million in net income or $0.26 per share.

Net interest income compared to the third quarter of 2010 increased $3.162 million or 36.4% to $11.844
million, with the net interest margin increasing 33 basis points to 4.11%.  We attribute this increase
principally to the Capital Bank acquisition which had a significant impact on a $230.8 million or 25.3%
increase in average earning assets, as well as a 9 basis point increase in the yield on average earning
assets and a 31 basis point decrease in the cost of average interest bearing liabilities.  The $230.8 million
increase in average earning assets included a $197.0 million increase in average loans, with Capital
Bank loans accounting for $168.8 million of this increase, an $18.6 million increase in the average
investment portfolio and a $15.2 million increase in average interest bearing deposits. The third quarter
increase in the average investment portfolio included $44.9 million of average Capital Bank securities,
partially offset by a $26.3 million decrease in the average balances of other securities.  While average

 
45

 

earning assets increased 25.3%, total interest and dividend income increased 27.8% or $2.953 million
with the yield on average earning assets increasing 9 basis points to 4.72%.

Total average funding liabilities, including non-interest bearing demand deposits, as compared to the third
quarter of last year, increased $218.3 million or 24.5% to $1.109 billion as average deposits and borrowings
increased $196.1 million and $22.2 million, respectively.  In total, average non-interest bearing deposits
increased $57.8 million, with Capital Bank non-interest bearing deposits comprising $24.8 million of that
increase. Average interest bearing deposits increased $138.3 million due to $157.5 million in Capital Bank
average interest bearing deposits, offset by decreases in other average interest bearing balances.  The
increase in average interest bearing deposits was reflected principally in a $73.5 million increase in average
savings account balances, as well as increases in average time deposits and NOW accounts totaling $42.0
million and $29.3 million, respectively.  These increases were partially offset by a $6.4 million decrease in
average IMMA balances.  The increase in average borrowings was due principally to an increase in
borrowings assumed by the Corporation in the Capital Bank acquisition.  While average interest-bearing
liabilities increased $160.5 million, or 23.2%, interest expense decreased $209 thousand or 10.7%, as the
cost of average interest-bearing liabilities decreased 31 basis points to 0.81%.

As discussed under the Asset Quality section of this report, a $208 thousand increase in the provision for
loan losses was principally due to an increase in specific allocations on impaired loans, somewhat offset
by improved credit quality in the remainder of the loan portfolio, as well as a decrease in net charge-
offs, and reflects management's evaluation of the adequacy of the allowance for loan losses based upon a
number of factors, including an analysis of historical loss factors, the evaluation of collateral, recent
charge-off experience, overall credit quality, current economic conditions and loan growth.

Non-interest income during the third quarter of 2011 increased $81 thousand or 1.9% compared to the
third quarter of 2010.  This increase was principally due to a $429 thousand increase in net gains on
securities transactions, as during the quarter the Corporation sold a US Treasury bond resulting in the
above gain.  In addition to the above, check card interchange fee income increased $84 thousand.  These
increases were offset in part primarily by a $437 thousand decrease in Wealth Management Group
(formerly referred to as Trust and Investment Center) fee income, due to the closing of a large estate
during the fourth quarter of 2010.

Third quarter 2011 operating expenses were $1.734 million or 19.5% higher than the comparable period
last year, due in part to the Capital Bank acquisition.  The increase in operating expenses was due in
large part to increases in salaries and benefits totaling $504 thousand and $362 thousand, respectively.  
Other significant increases included a $165 thousand increase in net occupancy costs, a $154 thousand
increase in data processing costs, a $108 thousand increase in amortization of intangible assets, and
increases in marketing and advertising and professional services totaling $84 thousand and $80
thousand, respectively.  The increase in salaries resulted from an increase in staff related to the Capital
Bank acquisition as well as merit increases over the past year, while the increase in employee benefits
was due principally to health insurance costs and pension expense.  Increases in net occupancy costs,
amortization of intangible assets and marketing and advertising were due in large part to the Capital
Bank acquisition, while increases in data processing reflects higher data communication line charges,
Wealth Management Group and check card processing costs.  The above increases were offset in part
primarily by a $75 thousand decrease in OREO expenses.

 
46

 

A $560 thousand increase in income tax expense reflects a $1.300 million increase in pre-tax income,
and an increase in the effective tax rate from 30.5% to 33.8% due to a decrease in the relative percentage
of tax exempt income to pre-tax income, as well as a reduction in third quarter 2010 taxes due to a
statutory change in the New York State bad debt deduction.


Year-to-Date 2011 vs. Year-to-Date 2010

Net income for the nine-month period ended September 30, 2011 totaled $7.576 million, an increase of
$522 thousand or 7.4% compared to the corresponding period in 2010.  Earnings per share decreased
10.2% from $1.96 to $1.76 per share on 693,275 additional average shares outstanding.  The increase in
net income was impacted positively by higher net interest income and non-interest income, as well as a
decrease in the provision for loan loss expense, offset by higher operating expenses, including $2.244
million of direct transaction costs associated with the Capital Bank acquisition.  Excluding the direct
transaction costs noted above, net income for the nine-month period ended September 30, 2011 would
have totaled approximately $9.031 million or $2.10 per share, with Capital Bank contributing an
estimated $2.314 million or $0.54 per share.
 
 
Net interest income compared to the first nine months of 2010 increased $5.868 million or 22.6% with
the net interest margin increasing 20 basis points to 4.02%.  Once again, management attributes this
increase to the Capital Bank acquisition as a $148.3 million or 16.3% increase in average earning assets
and a 36 basis point decrease in the cost of average interest bearing liabilities was partially offset by an 8
basis point decrease in the yield on average earning assets.  The $148.3 million increase in average
earning assets included a $134.5 million increase in average loans, with Capital Bank loans contributing
$107.9 million to this increase, an $8.6 million increase in average interest bearing deposits and a $5.2
million increase in the average investment portfolio due to $29.6 million in Capital bank average
investments.  While on average, earning assets increased 16.3%, total interest and dividend income
increased $4.612 million or 14.2%, with the yield on average earning assets decreasing 8 basis points to
4.68%.

Total average funding liabilities, including non-interest bearing demand deposits, as compared to the first
nine months of last year, increased $135.7 million or 15.2% to $1.028 billion as average deposits and
borrowings increased $125.5 million and $10.2 million, respectively.  In total, average non-interest bearing
deposits increased $42.0 million, with Capital Bank non-interest bearing deposits comprising $16.2
million of that increase.  Average interest bearing deposits increased $83.5 million due to $104.3 million in Capital
Bank average interest bearing deposits, offset by decreases in other average interest bearing balances.  The
increase in average interest bearing deposits was reflected principally in a $50.9 million increase in average
savings account balances, as well as increases in average NOW and time deposits totaling $20.2 million and
$18.8 million, respectively.  These increases were partially offset by a $6.4 million decrease in average
IMMA balances.  The increase in average borrowings was due to borrowings assumed by the Corporation
in the Capital Bank acquisition.  While average interest-bearing liabilities increased $93.7 million or 13.4%,
interest expense decreased $1.256 million or 19.6%, as the cost of average interest-bearing liabilities
decreased 36 basis points to 0.87%.

As discussed under the Asset Quality section of this report, despite an increase in specific allocations for
impaired loans, the year-to-date provision for loan losses decreased $292 thousand due to overall credit
quality improvement in the remainder of the loan portfolio, as well as lower net charge-offs, and reflects
management’s evaluation of the adequacy of the allowance for loan losses based upon a number of
factors, including an analysis of historical loss factors, the evaluation of collateral, recent charge-off
experience, overall credit quality, current economic conditions and loan growth.

 
47

 

Non-interest income for the first nine months of 2011 was $513 thousand or 4.0% higher than the
comparable period last year.  This increase was due in part to a $657 thousand increase in gains on
securities transactions and a $441 thousand increase in revenue from the Corporation’s equity
investment in Cephas Capital Partners, L.P., a small business investment company limited partnership,
due in large part to a gain recognized on the exercise of stock warrants held in one of its investments.  
Additionally impacting the improvement in non-interest income was a $326 thousand decrease in OTTI
charges on trust preferred securities pools held in the Corporation’s investment portfolio, as well as
increases in check card interchange fee income and revenue of CFS Group, Inc. totaling $245 thousand
and $114 thousand, respectively. These increases were partially offset primarily by a $1.126 million
decrease in Wealth Management Group fee income and a $248 thousand decrease in service charges.  
The decrease in Wealth Management Group fee income was due to the previously mentioned closing of
a large estate during the fourth quarter of last year, while the decrease in service charges was primarily
due to lower net overdraft fee income.

Year-to-date operating expenses were $5.718 million or 20.8% higher than last year, due in large part to
the aforementioned direct acquisition transaction costs totaling $2.244 million.  Excluding these costs,
all other operating expenses increased $3.475 million or 12.6%.  Similar to third quarter results and for
reasons noted above, the major factors affecting this increase include a $1.171 million increase in
salaries, a $468 thousand increase in employee benefits, a $424 thousand increase in data processing
costs, a $391 thousand increase in net occupancy costs and increases in professional services and
amortization of intangible assets totaling $303 thousand and $203 thousand, respectively.  Other factors
include a $139 thousand increase in marketing and advertising expenses related to the Capital Bank
acquisition, as well as increases in stationery and supplies and furniture and equipment expenses totaling
$127 thousand and $108 thousand, respectively.  The above increases were offset in part by a $175
thousand decrease in FDIC insurance assessments and a $219 thousand decrease in OREO expenses.

A $432 thousand increase in income tax expense was principally due to the $954 thousand increase in
pre-tax income, as well as an increase in the effective tax rate from 30.9% to 32.1% due to a decrease in
the relative percentage of tax exempt income to pre-tax income.

 
48

 

Average Consolidated Balance Sheet and Interest Analysis (dollars in thousands)

   
Nine Months Ended
September 30, 2011
   
Nine Months Ended
September 30, 2010
   
Three Months Ended
September 30, 2011
   
Three Months Ended
September 30, 2010
 
Assets
 
Average Balance
   
Interest
   
Yield/
Rate
   
Average Balance
   
Interest
   
Yield/
Rate
   
Average Balance
   
Interest
   
Yield/
Rate
   
Average Balance
   
Interest
   
Yield/
Rate
 
Earning assets:
                                                                       
Loans
 
$
722,583
   
$
31,456
     
5.82
%
 
$
588,109
   
$
26,412
     
6.00
%
 
$
785,193
   
$
11,673
     
5.90
%
 
$
588,179
   
$
8,742
     
5.90
%
Taxable securities
   
208,891
     
4,348
     
2.78
%
   
213,323
     
4,969
     
3.11
%
   
223,282
     
1,504
     
2.67
%
   
215,323
     
1,555
     
2.87
%
Tax-exempt securities
   
51,813
     
1,035
     
2.67
%
   
42,153
     
889
     
2.82
%
   
53,014
     
351
     
2.62
%
   
42,357
     
301
     
2.82
%
Federal funds sold
   
-
     
-
     
N/A
     
-
     
-
     
N/A
     
-
     
-
     
N/A
     
-
     
-
     
N/A
%
Interest-bearing deposits
   
75,012
     
167
     
.30
%
   
66,415
     
124
     
0.25
%
   
81,313
     
65
     
0.32
%
   
66,121
     
42
     
0.25
%
Total earning assets
   
1,058,299
     
37,006
     
4.68
%
   
910,000
     
32,394
     
4.76
%
   
1,142,802
     
13,593
     
4.72
%
   
911,980
     
10,640
     
4.63
%
                                                                                                 
Non-earning assets:
                                                                                               
Cash and due from banks
   
22,380
                     
21,834
                     
23,783
                     
20,899
                 
Premises and equipment, net
   
24,270
                     
24,427
                     
24,327
                     
24,150
                 
Other assets
   
45,863
                     
37,609
                     
51,867
                     
36,700
                 
Allowance for loan losses
   
(9,731
)
                   
(10,281
)
                   
(9,894
)
                   
(10,419
)
               
AFS valuation allowance
   
11,690
                     
9,769
                     
13,727
                     
11,384
                 
     Total
 
$
1,152,771
                   
$
993,358
                   
$
1,246,612
                   
$
994,694
                 
                                                                                                 
Liabilities and Shareholders' Equity
                                                                                               
Interest-bearing liabilities:
                                                                                               
Interest-bearing demand deposits
   
71,906
     
63
     
0.12
%
   
51,718
     
37
     
0.10
%
   
80,665
     
25
     
0.13
%
   
51,382
     
11
     
0.09
%
Savings and insured money market deposits
   
345,040
     
663
     
0.26
%
   
300,554
     
769
     
0.34
%
   
371,306
     
248
     
0.26
%
   
304,231
     
216
     
0.28
%
Time deposits
   
295,080
     
2,600
     
1.18
%
   
276,265
     
3,647
     
1.76
%
   
314,348
     
865
     
1.09
%
   
272,393
     
1,109
     
1.62
%
Federal Home Loan Bank advances and securities sold under agreements to repurchase
   
79,984
     
1,839
     
3.07
%
   
69,779
     
1,969
     
3.77
%
   
86,520
     
612
     
2.80
%
   
64,286
     
623
     
3.84
%
Total interest-bearing liabilities
   
792,010
     
5,165
     
0.87
%
   
698,316
     
6,422
     
1.23
%
   
852,839
     
1,750
     
0.81
%
   
692,292
     
1,959
     
1.12
%
                                                                                                 
Non-interest-bearing liabilities:
                                                                                               
Demand deposits
   
235,656
                     
193,691
                     
255,957
                     
198,167
                 
Other liabilities
   
8,096
                     
7,474
                     
9,511
                     
7,931
                 
Total liabilities
   
1,035,762
                     
899,481
                     
1,118,307
                     
898,390
                 
Shareholders' equity
   
117,009
                     
93,877
                     
128,305
                     
96,304
                 
     Total
 
$
1,152,771
                   
$
993,358
                   
$
1,246,612
                   
$
994,694
                 
Net interest income
         
$
31,841
                   
$
25,972
                   
$
11,843
                   
$
8,681
         
Net interest rate spread
                   
3.81
%
                   
3.53
%
                   
3.91
%
                   
3.51
%
                                                                                                 
Net interest margin
                   
4.02
%
                   
3.82
%
                   
4.11
%
                   
3.78
%


 
49

 

The following table sets forth for the periods indicated, a summary of the changes in interest and
dividends earned and interest paid resulting from changes in volume and changes in rates (dollars
in thousands):

   
Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
   
Three Months Ended September 30,
2011 Compared to Three Months
Ended September 30, 2010
 
   
Increase (Decrease) Due to (1)
   
Increase (Decrease) Due to (1)
 
   
Volume
   
Rate
   
Net
   
Volume
   
Rate
   
Net
 
Interest and dividends earned on:
                                   
Loans
 
$
5,876
   
$
(832
)
 
$
5,044
   
$
2,929
   
$
2
   
$
2,931
 
Taxable securities
   
(102
)
   
(519
)
   
(621
)
   
56
     
(107
)
   
(51
)
Tax-exempt securities
   
195
     
(49
)
   
146
     
72
     
(22
)
   
50
 
Interest-bearing deposits
   
17
     
26
     
43
     
11
     
12
     
23
 
                                                 
  Total earning assets
 
$
5,195
   
$
(583
)
 
$
4,612
   
$
2,741
     
212
     
2,953
 
                                                 
Interest paid on:
                                               
Demand deposits
 
$
17
   
$
9
   
$
26
   
$
8
   
$
6
   
$
14
 
Savings and insured money market deposits
   
103
     
(209
)
   
(106
)
   
45
     
(13
)
   
32
 
Time deposits
   
234
     
(1,281
)
   
(1,047
)
   
153
     
(397
)
   
(244
)
Federal Home Loan Bank advances and securities sold under agreements to repurchase
   
264
   
$
(394
)
 
$
(130
)
   
183
     
(194
)
   
(11
)
                                                 
  Total interest-bearing liabilities
 
$
783
   
$
(2,040
)
 
$
(1,257
)
 
$
397
   
$
(606
)
 
$
(209
)
                                                 
Net interest income
 
$
4,412
   
$
1,457
   
$
5,869
   
$
2,344
   
$
818
   
$
3,162
 
(1)  The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 

Liquidity and Capital Resources

Liquidity management involves the ability to meet the cash flow requirements of deposit customers,
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 Federal Home Loan Bank of New York which allows it to access
borrowings which 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 $68.2
million and $63.0 million at September 30, 2011 and September 30, 2010, respectively.

During the first nine months of 2011, cash and cash equivalents increased $57.9 million as compared to
a decrease of $6.6 million during the first nine months of last year.  In addition to cash provided by
operating activities, major sources of cash during the first nine months of 2011 included proceeds from
sales, maturities, calls and principal reductions on securities totaling $94.8 million, a $55.4 million
increase in deposits and $25.1 million in net cash received in the FOFC acquisition.  These proceeds
were used primarily to fund purchases of securities totaling $99.2 million, a net decrease in securities
sold under agreements to repurchase totaling $13.9 million, a $11.0 million net increase in loans, the
payment of cash dividends in the amount of $2.9 million and purchases of fixed assets totaling $1.3
million, as well as a $765 thousand increase in Federal Home Loan Bank and Federal Reserve Bank
stock and purchases of treasury shares totaling $327 thousand.

 
50

 

In addition to cash provided by operating activities, major sources of cash during the first nine months of
2010 included proceeds from sales, maturities, calls and principal reductions on securities totaling
$109.3 million, a $3.2 million decrease in loans and a $2.4 million increase in deposits.  Proceeds from
the above were used primarily to fund purchases of securities totaling $116.2 million, a $10.5 million
decrease in securities sold under agreements to repurchase, the payment of cash dividends in the amount
of $2.6 million and purchases of fixed assets and treasury shares totaling $1.2 million and $426
thousand, respectively.

As of September 30, 2011, the Bank’s leverage ratio was 7.71%.  The Tier I and Total Risk Adjusted
Capital ratios were 11.30% and 12.74%, respectively. All of the above ratios are in excess of the
requirements for being considered "well capitalized" by the FDIC, the Federal Reserve and the New
York State Banking Department.

During the first nine months of 2011 the Corporation declared cash dividends totaling $0.75 per share,
unchanged from the dividends declared during the first nine months of 2010.

When shares of the Corporation become available in the market, we may purchase them after careful
consideration of our capital position.  On November 17, 2010, the Corporation’s Board of Directors
approved a one year extension of the stock repurchase program that had been initially approved on
November 18, 2009.  The extension authorizes the purchase of up to 90,000 shares of the Corporation’s
outstanding common stock, including those shares purchased during the first year of the plan.  Purchases
may be made from time to time on the open market or in privately negotiated transactions at the discretion
of management.  During the first nine months of 2011, the Corporation purchased 13,981 treasury shares at
an average price of $23.42 per share.  Through September 30, 2011, a total of 34,712 shares had been
purchased under this program.  During the first nine months of 2011, 21,343 shares were re-issued from
treasury to fund the stock component of directors’ 2010 compensation, distributions under the
Corporation’s directors’ deferred stock plan, a stock grant to an executive officer, restricted stock awards to
executive officers and funding for the Corporation’s profit sharing, savings and investment plan.

Interest Rate Risk

As intermediaries between borrowers and savers, commercial banks incur both interest rate risk and
liquidity risk. The Corporation's Asset/Liability Committee (ALCO) has the strategic responsibility for
setting the policy guidelines on acceptable exposure to these areas.  These guidelines contain specific
measures and limits regarding these risks, which are monitored on a regular basis.  The ALCO is made
up of the president & chief executive officer, all executive vice presidents, the chief financial officer, the
asset liability management officer, the senior marketing officer, and others representing key functions.

The ALCO is also responsible for supervising the preparation and annual revisions of the financial
segments of the annual budget, which is built upon the committee's economic and interest-rate
assumptions.  It is the responsibility of the ALCO to modify prudently the Corporation's asset/liability
policies.

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 September 30, 2011, it is estimated that an immediate 200-basis point
decrease in interest rates would negatively impact the next 12 months net interest income by 10.80% and
an immediate 200-basis point increase would negatively impact the next 12 months net interest income
by 0.44%.  Both are within the Corporation's policy guideline of 15% established by ALCO. Given the

 
51

 

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 5.34% and 0.72%, respectively.  Management is comfortable
with the level of exposures at these levels.

A related component of interest rate risk is the expectation that the market value of our 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
September 30, 2011, it is estimated that an immediate 200-basis point decrease in interest rates would
negatively impact the market value of our capital account by 12.14% and an immediate 200-basis point
increase in interest rates would positively impact the market value by 2.16%.  Both are within the
established tolerance limit of 15%.  Management also modeled the impact to the market value of our
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 impacts to the market value of our capital of negative 7.58% and positive 0.91%,
respectively. Management is also comfortable with the level of exposures at these levels.

Management does recognize the need for certain hedging strategies during periods of anticipated higher
fluctuations in interest rates and the Board-approved Funds Management Policy provides for limited use
of certain derivatives in asset liability management. These strategies were not employed during the first
nine months of 2011.

Item 3:                      Quantitative 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 Treasurer and Chief Financial Officer, who
is the Corporation's principal financial officer, has evaluated the effectiveness of the Corporation's
disclosure controls and procedures as of September 30, 2011 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 September 30, 2011.

During the third quarter of 2011, a deficiency in the design and operation of internal controls at the
branch level was identified that permitted an alleged misappropriation of funds to go undetected.  This
deficiency did not have a material affect on the Corporation’s financial condition or results of
operations.  Management has taken appropriate steps to remediate the design and operation of these
controls.

 
52

 


PART II.
OTHER INFORMATION
Item 1.
Legal Proceedings
 
Information related to this item is disclosed in Part 1 Item 1 (Note 7 to the interim consolidated 
financial statements).
   
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, 2010 filed with the Securities and Exchange Commission on March 16,
2011.
   
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
 
7/1/11-7/30/11
       -
$             -
        -
61,425
 
8/1/11-8/31/11
   387
$ 23.4070
    387
61,038
 
9/1/11-9/30/11
5,750
$ 23.4457
5,750
55,288
 
Quarter ended 9/30/11
6,137
$ 23.4432
6,137
55,288
   
 
(1) On November 17, 2010, the Corporation’s Board of Directors approved a one year extension of the stock repurchase program that had been initially approved on November 18, 2009.  The extension authorizes the purchase of up to 90,000 shares of the Corporation's outstanding common stock, including those shares purchased during the first year of the plan  Purchases will be made from time to time on the open-market or in privately negotiated transactions, and will be at the discretion of management.
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 December 15, 2010. Filed as Exhibit 3.4 to Registrant's Form 10-K filed with the SEC on March 16, 2011 and incorporated herein by reference.
   
 
10.15  Settlement Agreement and Waiver and Release dated July 5, 2011 between Chemung Financial Corporation, Chemung Canal Trust Company and Peter D. Cureau.  Filed herewith 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 Treasurer and Chief Financial Officer 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 Treasurer and Chief Financial Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.

 
53

 

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


DATE:
 
November 14, 2011
 
/s/ Ronald M. Bentley
       
Ronald M. Bentley
       
President & Chief Executive Officer
       
(Principal Executive Officer)
         
         
DATE:
 
November 14, 2011
 
/s/ John R. Battersby Jr.
       
John R. Battersby Jr.
       
Treasurer & Chief Financial Officer
       
(Principal Financial and Accounting Officer)

 
54

 

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 December 15, 2010. Filed as Exhibit 3.4 to Registrant's Form 10-K filed with the SEC on March 16, 2011 and incorporated herein by reference.
 
10.15  Settlement Agreement and Waiver and Release dated July 5, 2011 between Chemung Financial Corporation, Chemung Canal Trust Company and Peter D. Cureau.  Filed herewith 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 Treasurer and Chief Financial Officer 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 Treasurer and Chief Financial Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.