Document


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

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarterly period ended March 31, 2017
Or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File No. 000-13888
chemungfinanciallogo.jpg
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, Elmira, NY
 
14901
(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, smaller reporting company, or an emerging growth company.  See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[   ]
Non-accelerated filer
 
[   ]
Accelerated filer
[X]
Smaller reporting company
 
[   ]
 
 
 
Emerging growth company
 
[   ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [   ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
YES:             NO:  X

The number of shares of the registrant's common stock, $.01 par value, outstanding on May 2, 2017 was 4,732,550.




CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX


 
 
PAGES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



GLOSSARY OF ABBREVIATIONS AND TERMS

To assist the reader the Corporation has provided the following list of commonly used abbreviations and terms included in the Notes to the Unaudited Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Abbreviations
ALCO
Asset-Liability Committee
ASU
Accounting Standards Update
Bank
Chemung Canal Trust Company
Basel III
The Third Basel Accord of the Basel Committee on Banking Supervision
Board of Directors
Board of Directors of Chemung Financial Corporation
CDARS
Certificate of Deposit Account Registry Service
CDO
Collateralized Debt Obligation
CECL
Current expected credit loss
CFS
CFS Group, Inc.
Corporation
Chemung Financial Corporation
CRM
Chemung Risk Management, Inc.
Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act
EPS
Earnings per share
Exchange Act
Securities Exchange Act of 1934
FASB
Financial Accounting Standards Board
FDIC
Federal Deposit Insurance Corporation
FHLBNY
Federal Home Loan Bank of New York
FRB
Board of Governors of the Federal Reserve System
FRBNY
Federal Reserve Bank of New York
Freddie Mac
Federal Home Loan Mortgage Corporation
GAAP
U.S. Generally Accepted Accounting Principles
ICS
Insured Cash Sweep Service
IFRS
International Financial Reporting Standards
MD&A
Management’s Discussion and Analysis of Financial Condition and Results of Operations
NAICS
North American Industry Classification System
N/M
Not meaningful
OPEB
Other postemployment benefits
OREO
Other real estate owned
OTTI
Other-than-temporary impairment
PCI
Purchased credit impaired
ROA
Return on average assets
ROE
Return on average equity
RWA
Risk-weighted assets
SBA
Small Business Administration
SEC
Securities and Exchange Commission
Securities Act
Securities Act of 1933
TDRs
Troubled debt restructurings
WMG
Wealth Management Group

Terms
Allowance for loan losses to total loans
Represents period-end allowance for loan losses divided by retained loans.

3



Assets under administration
Represents assets that are beneficially owned by clients and all investment decisions pertaining to these assets are also made by clients.
Assets under management
Represents assets that are managed on behalf of clients.
Basel III
A comprehensive set of reform measures designed to improve the regulation, supervision, and risk management within the banking sector. The reforms require banks to maintain proper leverage ratios and meet certain capital requirements.
Benefit obligation
Refers to the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for OPEB plans.
Capital Bank
Division of Chemung Canal Trust Company located in the “Capital Region” of New York State and includes the counties of Albany and Saratoga.
CDARS
Product involving a network of financial institutions that exchange certificates of deposits among members in order to ensure FDIC insurance coverage on customer deposits above the single institution limit.  Using a sophisticated matching system, funds are exchanged on a dollar-for-dollar basis, so that the equivalent of an original deposit comes back to the originating institution.
Captive insurance company
A company that provides risk-mitigation services for its parent company.
Collateralized debt obligation
A structured financial product that pools together cash flow-generating assets, such as mortgages, bonds, and loans.
Collateralized mortgage obligations
A type of mortgage-backed security with principal repayments organized according to their maturities and into different classes based on risk.  The mortgages serve as collateral and are organized into classes based on their risk profile.
Dodd-Frank Act
The Dodd-Frank Act was enacted on July 21, 2010 and significantly changed the bank regulatory landscape and has impacted and will continue to impact the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress.
Fully taxable equivalent basis
Income from tax-exempt loans and investment securities that have been increased by an amount equivalent to the taxes that would have been paid if this income were taxable at statutory rates; the corresponding income tax impact related to tax-exempt items is recorded within income tax expense.
GAAP
Accounting principles generally accepted in the United States of America.
Holding company
Consists of the operations for Chemung Financial Corporation (parent only).
ICS
Product involving a network of financial institutions that exchange interest-bearing money market deposits among members in order to ensure FDIC insurance coverage on customer deposits above the single institution limit.  Using a sophisticated matching system, funds are exchanged on a dollar-for-dollar basis, so that the equivalent of an original deposit comes back to the originating institution.
Loans held for sale
Residential real estate loans originated for sale on the secondary market with maturities from 15-30 years.
Long term lease obligation
An obligation extending beyond the current year, which is related to a long term capital lease that is considered to have the economic characteristics of asset ownership.
Mortgage-backed securities
A type of asset-backed security that is secured by a collection of mortgages.
Municipal clients
A political unit, such as a city, town, or village, incorporated for local self-government.
N/A
Data is not applicable or available for the period presented.
N/M
Not meaningful.
Non-GAAP
A calculation not made according to GAAP.
Obligations of state and political subdivisions
An obligation that is guaranteed by the full faith and credit of a state or political subdivision that has the power to tax.
Obligations of U.S. Government
A federally guaranteed obligation backed by the full power of the U.S. government, including Treasury bills, Treasury notes and Treasury bonds.
Obligations of U.S. Government sponsored enterprise obligations
Obligations of agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government.

4



OREO
Represents real property owned by the Corporation, which is not directly related to its business and is most frequently the result of a foreclosure on real property.
OTTI
Impairment charge taken on a security whose fair value has fallen below the carrying value on the balance sheet and whose value is not expected to recover through the holding period of the security.
PCI loans
Represents loans that were acquired in the Fort Orange Financial Corp. transaction and deemed to be credit-impaired on the acquisition date in accordance with the guidance of FASB.
Political subdivision
A county, city, town, or other municipal corporation, a public authority, or a publicly-owned entity that is an instrumentality of a state or a municipal corporation.
Pre-provision profit/(loss)
Represents total net revenue less noninterest expense, before income tax expense (benefit).  The Corporation believes that this financial measure is useful in assessing the ability of a bank to generate income in excess of its provision for credit losses.
RWA
Risk-weighted assets consist of on- and off-balance sheet assets that are assigned to one of several broad risk categories and weighted by factors representing their risk and potential for default.  On-balance sheet assets are risk-weighted based on the perceived credit risk associated with the obligor or counterparty, the nature of any collateral, and the guarantor, if any.  Off-balance sheet assets such as lending-related commitments, guarantees, derivatives and other applicable off-balance sheet positions are risk-weighted by multiplying the contractual amount by the appropriate credit conversion factor to determine the on-balance sheet credit equivalent amount, which is then risk-weighted based on the same factors used for on-balance sheet assets.  Risk-weighted assets also incorporate a measure for market risk related to applicable trading assets-debt and equity instruments.  The resulting risk-weighted values for each of the risk categories are then aggregated to determine total risk-weighted assets.
SBA loan pools
Business loans partially guaranteed by the SBA.
Securities sold under agreements to repurchase
Sale of securities together with an agreement for the seller to buy back the securities at a later date.
TDR
A TDR is deemed to occur when the Corporation modifies the original terms of a loan agreement by granting a concession to a borrower that is experiencing financial difficulty.
Trust preferred securities
A hybrid security with characteristics of both subordinated debt and preferred stock which allows for early redemption by the issuer, makes fixed or variable payments, and matures at face value.
Unaudited
Financial statements and information that have not been subjected to auditing procedures sufficient to permit an independent certified public accountant to express an opinion.
WMG
Provides services as executor and trustee under wills and agreements, and guardian, custodian, trustee and agent for pension, profit-sharing and other employee benefit trusts, as well as various investment, financial planning, pension, estate planning and employee benefit administration services.


5



 
CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands, except share and per share data)
 
March 31,
2017
 
December 31,
2016
ASSETS
 
 
 
 
Cash and due from financial institutions
 
$
26,275

 
$
28,205

Interest-bearing deposits in other financial institutions
 
99,410

 
45,957

Total cash and cash equivalents
 
125,685

 
74,162

 
 
 
 
 
Trading assets, at fair value
 
826

 
774

 
 
 
 
 
Securities available for sale, at estimated fair value
 
302,581

 
303,402

Securities held to maturity, estimated fair value of $3,912 at March 31, 2017
  and $4,912 at December 31, 2016
 
3,721

 
4,705

FHLBNY and FRBNY Stock, at cost
 
3,597

 
4,041

 
 
 
 
 
Loans, net of deferred loan fees
 
1,234,251

 
1,200,290

Allowance for loan losses
 
(14,960
)
 
(14,253
)
Loans, net
 
1,219,291

 
1,186,037

 
 
 
 
 
Loans held for sale
 
20

 
412

Premises and equipment, net
 
28,206

 
28,923

Goodwill
 
21,824

 
21,824

Other intangible assets, net
 
2,719

 
2,945

Bank-owned life insurance
 
2,929

 
2,912

Accrued interest receivable and other assets
 
24,701

 
27,042

 
 
 
 
 
Total assets
 
$
1,736,100

 
$
1,657,179

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 

Deposits:
 
 
 
 

Non-interest-bearing
 
$
432,062

 
$
417,812

Interest-bearing
 
1,112,189

 
1,038,531

Total deposits
 
1,544,251

 
1,456,343

 
 
 
 
 
Securities sold under agreements to repurchase
 
15,215

 
27,606

FHLBNY term advances
 
9,065

 
9,093

Long term capital lease obligation
 
4,671

 
4,722

Dividends payable
 
1,230

 
1,225

Accrued interest payable and other liabilities
 
13,411

 
14,442

Total liabilities
 
1,587,843

 
1,513,431

 
 
 
 
 
Shareholders' equity:
 
 
 
 

Common stock, $0.01 par value per share, 10,000,000 shares authorized;
  5,310,076 issued at March 31, 2017 and December 31, 2016
 
53

 
53

Additional paid-in capital
 
45,901

 
45,603

Retained earnings
 
125,860

 
124,111

Treasury stock, at cost; 579,140 shares at March 31, 2017 and 597,843
  shares at December 31, 2016
 
(14,801
)
 
(15,265
)
Accumulated other comprehensive loss
 
(8,756
)
 
(10,754
)
Total shareholders' equity
 
148,257

 
143,748

 
 
 
 
 
Total liabilities and shareholders' equity
 
$
1,736,100

 
$
1,657,179


See accompanying notes to unaudited consolidated financial statements.
6



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(in thousands, except per share data)
 
2017
 
2016
Interest and dividend income:
 
 
 
 
Loans, including fees
 
$
12,499

 
$
12,246

Taxable securities
 
1,422

 
1,437

Tax exempt securities
 
238

 
254

Interest-bearing deposits
 
155

 
12

Total interest and dividend income
 
14,314

 
13,949

Interest expense:
 
 

 
 

Deposits
 
538

 
507

Securities sold under agreements to repurchase
 
193

 
211

Borrowed funds
 
89

 
206

Total interest expense
 
820

 
924

Net interest income
 
13,494

 
13,025

Provision for loan losses
 
1,040

 
595

Net interest income after provision for loan losses
 
12,454

 
12,430

 
 
 
 
 
Non-interest income:
 
 

 
 

WMG fee income
 
2,109

 
2,012

Service charges on deposit accounts
 
1,184

 
1,135

Interchange revenue from debit card transactions
 
920

 
893

Net gains on securities transactions
 

 
908

Net gains on sales of loans held for sale
 
69

 
61

Net gains (losses) on sales of other real estate owned
 
17

 
(5
)
Income from bank-owned life insurance
 
17

 
18

Other
 
531

 
579

Total non-interest income
 
4,847

 
5,601

 
 
 
 
 
Non-interest expenses:
 
 

 
 

Salaries and wages
 
5,275

 
5,183

Pension and other employee benefits
 
1,218

 
1,675

Net occupancy expenses
 
1,606

 
1,906

Furniture and equipment expenses
 
682

 
772

Data processing expense
 
1,604

 
1,714

Professional services
 
300

 
341

Amortization of intangible assets
 
226

 
258

Marketing and advertising expenses
 
249

 
222

Other real estate owned expenses
 
19

 
52

FDIC insurance
 
325

 
294

Loan expense
 
116

 
112

Other
 
1,425

 
1,479

Total non-interest expenses
 
13,045

 
14,008

Income before income tax expense
 
4,256

 
4,023

Income tax expense
 
1,277

 
1,316

Net income
 
$
2,979

 
$
2,707

 
 
 
 
 
Weighted average shares outstanding
 
4,790

 
4,750

Basic and diluted earnings per share
 
$
0.62

 
$
0.57


See accompanying notes to unaudited consolidated financial statements.
7



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(in thousands)
 
2017
 
2016
Net income
 
$
2,979

 
$
2,707

Other comprehensive income
 
 

 
 

Unrealized holding gains on securities available for sale
 
3,166

 
3,109

Reclassification adjustment for gains realized in net income
 

 
(908
)
Net unrealized gains
 
3,166

 
2,201

Tax effect
 
1,189

 
830

Net of tax amount
 
1,977

 
1,371

 
 
 
 
 
Change in funded status of defined benefit pension plan and other benefit plans:
 
 

 
 

Reclassification adjustment for amortization of prior service costs
 
(55
)
 
(22
)
Reclassification adjustment for amortization of net actuarial loss
 
88

 
396

Total before tax effect
 
33

 
374

Tax effect
 
12

 
141

Net of tax amount
 
21

 
233

 
 
 
 
 
Total other comprehensive income
 
1,998

 
1,604

 
 
 
 
 
Comprehensive income
 
$
4,977

 
$
4,311


See accompanying notes to unaudited consolidated financial statements.
8



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(in thousands, except share and per share data)
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Treasury Stock
 
Accumulated Other Comprehensive Loss
 
Total
Balances at January 1, 2016
$
53

 
$
45,537

 
$
118,973

 
$
(16,379
)
 
$
(10,942
)
 
$
137,242

Net income

 

 
2,707

 

 

 
2,707

Other comprehensive income

 

 

 

 
1,604

 
1,604

Restricted stock awards

 
48

 

 

 

 
48

Restricted stock units for directors' deferred compensation plan

 
23

 

 

 

 
23

Cash dividends declared ($0.26 per share)

 

 
(1,220
)
 

 

 
(1,220
)
Distribution of 9,532 shares of treasury stock for directors' compensation

 
19

 

 
243

 

 
262

Distribution of 7,661 shares of treasury stock for employee compensation

 
15

 

 
195

 

 
210

Sale of 6,252 shares of treasury stock (a)

 
10

 

 
160

 

 
170

Balances at March 31, 2016
$
53

 
$
45,652

 
$
120,460

 
$
(15,781
)
 
$
(9,338
)
 
$
141,046

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances at January 1, 2017
$
53

 
$
45,603

 
$
124,111

 
$
(15,265
)
 
$
(10,754
)
 
$
143,748

Net income

 

 
2,979

 

 

 
2,979

Other comprehensive income

 

 

 

 
1,998

 
1,998

Restricted stock awards

 
52

 

 

 

 
52

Restricted stock units for directors' deferred compensation plan

 
24

 

 

 

 
24

Cash dividends declared ($0.26 per share)

 

 
(1,230
)
 

 

 
(1,230
)
Distribution of 7,880 shares of treasury stock for directors' compensation

 
68

 

 
201

 

 
269

Distribution of 5,861 shares of treasury stock for employee compensation

 
50

 

 
150

 

 
200

Sale of 6,101 shares of treasury stock (a)

 
61

 

 
156

 

 
217

Forfeiture of 1,139 shares of restricted stock awards

 
43

 

 
(43
)
 

 

Balances at March 31, 2017
$
53

 
$
45,901

 
$
125,860

 
$
(14,801
)
 
$
(8,756
)
 
$
148,257

(a) All treasury stock sales were completed at arm's length for adequate consideration with the Chemung Canal Trust Company Profit Sharing, Savings, and Investment Plan and the Chemung Canal Trust Company - Finger Lakes Profit Sharing, Savings, and Investment Plan, which are defined contribution plans sponsored by the Bank.

See accompanying notes to unaudited consolidated financial statements.
9



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
Three Months Ended 
 March 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
2017
 
2016
Net income
$
2,979

 
$
2,707

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Amortization of intangible assets
226

 
258

Provision for loan losses
1,040

 
595

Depreciation and amortization of fixed assets
960

 
1,114

Amortization of premiums on securities, net
357

 
478

Gains on sales of loans held for sale, net
(69
)
 
(61
)
Proceeds from sales of loans held for sale
3,634

 
2,823

Loans originated and held for sale
(3,173
)
 
(2,279
)
Net gains on trading assets
(32
)
 
(9
)
Net gains on securities transactions

 
(908
)
Net (gains) losses on sales of other real estate owned
(17
)
 
5

Purchase of trading assets
(20
)
 
(24
)
Expense related to restricted stock units for directors' deferred compensation plan
24

 
23

Expense related to employee stock compensation
200

 
210

Expense related to employee restricted stock awards
52

 
48

Income from bank-owned life insurance
(17
)
 
(18
)
Decrease in other assets and accrued interest receivable
2,290

 
2,107

Decrease in accrued interest payable
(38
)
 
(2
)
Decrease in other liabilities
(1,892
)
 
(1,246
)
Net cash provided by operating activities
6,504

 
5,821

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 

 
 

Proceeds from sales and calls of securities available for sale

 
15,422

Proceeds from maturities and principal collected on securities available for sale
9,289

 
7,545

Proceeds from maturities and principal collected on securities held to maturity
1,164

 
586

Purchases of securities available for sale
(5,659
)
 

Purchases of securities held to maturity
(180
)
 
(597
)
Purchase of FHLBNY and FRBNY stock
(6
)
 
(5,146
)
Redemption of FHLBNY and FRBNY stock
450

 
5,764

Purchases of premises and equipment
(243
)
 
(337
)
Proceeds from sales of other real estate owned
101

 
34

Net increase in loans
(34,327
)
 
(18,739
)
Net cash (used in) provided by investing activities
(29,411
)
 
4,532

 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Net increase in demand deposits, interest-bearing demand accounts,
  savings accounts, and insured money market accounts
91,400

 
36,495

Net decrease in time deposits
(3,492
)
 
(2,538
)
Net increase (decrease) in securities sold under agreements to repurchase
(12,391
)
 
372

Repayments of FHLBNY overnight advances, net

 
(13,900
)
Repayments of FHLBNY long term advances
(28
)
 
(28
)
Payments made on capital lease
(51
)
 
(36
)
Sale of treasury stock
217

 
170

Cash dividends paid
(1,225
)
 
(1,214
)
Net cash provided by financing activities
74,430

 
19,321

Net increase in cash and cash equivalents
51,523

 
29,674

Cash and cash equivalents, beginning of period
74,162

 
26,185

Cash and cash equivalents, end of period
$
125,685

 
$
55,859

(continued)
 
 
 

See accompanying notes to unaudited consolidated financial statements.
10



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(UNAUDITED)
(in thousands)
Three Months Ended 
 March 31,
Supplemental disclosure of cash flow information:
2017
 
2016
Cash paid for:
 
 
 
Interest
$
858

 
$
926

Income taxes
$

 
$

Supplemental disclosure of non-cash activity:
 

 
 

  Transfer of loans to other real estate owned
$
33

 
$
151

Dividends declared, not yet paid
$
1,230

 
$
1,220

Distribution of treasury stock for directors' compensation
$
269

 
$
262


See accompanying notes to unaudited consolidated financial statements.
11



CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

The Corporation, through its wholly-owned subsidiaries, the Bank and CFS, provides a wide range of banking, financing, fiduciary and other financial services to its clients.  The Corporation and the Bank are subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities.

CRM, a wholly-owned subsidiary of the Corporation which was formed and began operations on May 31, 2016, is a Nevada-based captive insurance company which insures against certain risks unique to the operations of the Corporation and its subsidiaries and for which insurance may not be currently available or economically feasible in today's insurance marketplace. CRM pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. CRM is subject to regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X of the Exchange Act.  These financial statements include the accounts of the Corporation and its subsidiaries, and all significant intercompany balances and transactions are eliminated in consolidation.  Amounts in the prior periods' consolidated financial statements are reclassified whenever necessary to conform to the current period's presentation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) and disclosures necessary for the fair presentation of the accompanying consolidated financial statements have been included.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, an amendment to Revenue from Contracts with Customers (Topic 606). The objective of this amendment is to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS. This update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are in the scope of other standards. In August 2015, the FASB issued ASU 2015-14 to defer for one year the effective date of the new revenue standard. The requirements are effective for annual periods and interim periods within fiscal years beginning after December 15, 2017. During 2016, the FASB issued further implementation guidance regarding revenue recognition. This additional guidance included clarification on certain principal versus agent considerations within the implementation of the guidance as well as clarification related to identifying performance obligations and licensing, assessing collectability, presenting sales taxes, measuring noncash consideration, and certain transition matters. The Corporation intends to adopt the new revenue guidance as of January 1, 2018 and does not expect a significant change upon adoption of the standard, as the new standard will not materially change the way the Corporation currently records revenue for its WMG and fee income from mortgage servicing fees, financial guarantees, and deposit related fees.

In January 2016, the FASB issued ASU 2016-01, an amendment to Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). The objectives of the ASU are to (1) require equity investments to be measured at fair value, with changes in fair value recognized in net income, (2) simplify the impairment assessment of equity investments without readily determinable fair values, (3) eliminate the requirement to disclose methods and significant assumptions used to estimate fair value for financial instruments measured at amortized cost on the balance sheet, (4) require the use of the exit price notion when measuring the fair value of financial instruments, and (5) clarify the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Corporation intends to adopt the new guidance as of January 1, 2018 and believes the ASU will not have a material impact on its consolidated financial statements, as the Corporation's equity investment portfolio is less than $1.0 million as of March 31, 2017.


12



In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires companies that lease valuable assets to recognize on their balance sheets the assets and liabilities generated by contracts longer than a year. The amendments in this update are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, though early adoption is permitted. The Corporation intends to adopt the new lease guidance as of January 1, 2019 and is currently evaluating the impact that adoption of these updates will have on its consolidated financial statements. Currently, the Corporation believes the implementation of this ASU will create a right of use asset of less than $5.0 million for the Corporation's 13 leased facilities and a related capital obligation of the same amount as of January 1, 2019.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The objectives of the ASU are to simplify accounting for a stock payment's tax consequences and amend how excess tax benefits and a business's payments to cover the tax bills for the shares' recipients should be classified. The amendments allow companies to estimate the number of stock awards they expect to vest, and they revise the withholding requirements for classifying stock awards as equity. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2016, though early adoption is permitted. The adoption of ASU 2016-09 did not have a significant impact on the Corporation's consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The objective of the ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2019, though entities may adopt the amendments earlier for fiscal year beginning after December 15, 2018. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements. The Corporation anticipates that the adoption of the CECL model will result in an increase to the Corporation's allowance for loan losses. The Corporation has established a committee to oversee the implementation of CECL. This committee is currently assessing the data and system requirements necessary for adoption. The Corporation plans to run its current incurred loss model and a CECL model concurrently for 12 months prior to the adoption of this guidance on January 1, 2020.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The objective of the ASU is to reduce the existing diversity in practice relating to eight specific cash flow issues: (1) debt prepayment or debt extinguishment costs, (2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, (3) contingent consideration payments made after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests in securitization transactions, and (8) separately identifiable cash flows and application of the predominance principal. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, though early adoption is permitted. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The objective of the ASU is to simplify the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. The amendments in this ASU are effective for annual, or any interim, goodwill impairment tests in fiscal years beginning after December 15, 2019. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.

In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Cost and Net Periodic Postretirement Benefit Cost. The objective of the ASU is to improve guidance related to the presentation of defined benefit costs in the income statement. Specifically, the ASU requires that an employer report the service cost component in the same line item(s) as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. Additionally, the ASU allows only the service cost component to be eligible for capitalization, when applicable. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.


13



In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The objective of the ASU is to align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. The amendment requires that the premium be amortized to the earlies call date, but does not require an accounting change for securities held at a discount, instead, the discount continues to be amortized to maturity. The amendments in this ASU are effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. The adoption of the ASU is not expected to have a significant impact on the Corporation's consolidated financial statements.


NOTE 2        EARNING PER COMMON SHARE (shares in thousands)

Basic earnings per share is net income divided by the weighted average number of common shares outstanding during the period.  Issuable shares, including those related to directors’ restricted stock units and directors’ stock compensation, are considered outstanding and are included in the computation of basic earnings per share.  All outstanding unvested share based payment awards that contain rights to non-forfeitable dividends are considered participating securities for this calculation.  Restricted stock awards are grants of participating securities and are considered outstanding at grant date.  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 4,790 and 4,750 weighted average shares outstanding for the three-month periods ended March 31, 2017 and 2016, respectively. There were no common stock equivalents during the three-month periods ended March 31, 2017 or 2016.


NOTE 3        SECURITIES

Amortized cost and estimated fair value of securities available for sale are as follows (in thousands):
 
 
March 31, 2017
 
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises
 
$
17,295

 
$
145

 
$

 
$
17,440

Mortgage-backed securities, residential
 
244,049

 
319

 
4,690

 
239,678

Obligations of states and political subdivisions
 
44,007

 
288

 
140

 
44,155

Corporate bonds and notes
 
248

 
3

 

 
251

SBA loan pools
 
550

 
1

 
1

 
550

Corporate stocks
 
265

 
242

 

 
507

Total
 
$
306,414

 
$
998

 
$
4,831

 
$
302,581


 
 
December 31, 2016
 
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises
 
$
17,300

 
$
155

 
$

 
$
17,455

Mortgage-backed securities, residential
 
253,156

 
202

 
7,492

 
245,866

Obligations of states and political subdivisions
 
38,843

 
209

 
312

 
38,740

Corporate bonds and notes
 
249

 
1

 

 
250

SBA loan pools
 
568

 
3

 
1

 
570

Corporate stocks
 
285

 
236

 

 
521

Total
 
$
310,401

 
$
806

 
$
7,805

 
$
303,402



14



Amortized cost and estimated fair value of securities held to maturity are as follows (in thousands):
 
 
March 31, 2017
 
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Obligations of states and political subdivisions
 
$
2,741

 
$
194

 
$

 
$
2,935

Time deposits with other financial institutions
 
980

 

 
3

 
977

Total
 
$
3,721

 
$
194

 
$
3

 
$
3,912


 
 
December 31, 2016
 
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
Obligations of states and political subdivisions
 
$
3,725

 
$
206

 
$

 
$
3,931

Time deposits with other financial institutions
 
980

 
1

 

 
981

Total
 
$
4,705

 
$
207

 
$

 
$
4,912


The amortized cost and estimated fair value of debt securities are shown below by expected maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity date are shown separately (in thousands):
 
 
March 31, 2017
 
 
Available for Sale
 
Held to Maturity
 
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Within one year
 
$
8,197

 
$
8,224

 
$
866

 
$
873

After one, but within five years
 
33,091

 
33,411

 
2,583

 
2,729

After five, but within ten years
 
17,184

 
17,168

 
272

 
310

After ten years
 
3,078

 
3,043

 

 

 
 
61,550

 
61,846

 
3,721

 
3,912

Mortgage-backed securities, residential
 
244,049

 
239,678

 

 

SBA loan pools
 
550

 
550

 

 

Total
 
$
306,149

 
$
302,074

 
$
3,721

 
$
3,912


The proceeds from sales and calls of securities resulting in gains or losses for the three months ended March 31, 2017 and 2016 are listed below (in thousands):
 
 
2017
 
2016
Proceeds
 
$

 
$
15,422

Gross gains
 

 
908

Gross losses
 

 

Tax expense
 

 
343


The following tables summarize the investment securities available for sale with unrealized losses at March 31, 2017 and December 31, 2016 by aggregated major security type and length of time in a continuous unrealized loss position (in thousands):

 
Less than 12 months
 
12 months or longer
 
Total
March 31, 2017
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities, residential
$
220,708

 
$
4,690

 
$

 
$

 
$
220,708

 
$
4,690

Obligations of states and political subdivisions
12,815

 
140

 

 

 
12,815

 
140

SBA loan pools

 

 
219

 
1

 
219

 
1

Total temporarily impaired securities
$
233,523

 
$
4,830

 
$
219

 
$
1

 
$
233,742

 
$
4,831


15




 
Less than 12 months
 
12 months or longer
 
Total
December 31, 2016
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities, residential
$
233,843

 
$
7,492

 
$

 
$

 
$
233,843

 
$
7,492

Obligations of states and political subdivisions
25,724

 
312

 

 

 
25,724

 
312

SBA loan pools

 

 
225

 
1

 
225

 
1

Total temporarily impaired securities
$
259,567

 
$
7,804

 
$
225

 
$
1

 
$
259,792

 
$
7,805

 
Other-Than-Temporary Impairment

As of March 31, 2017, the majority of the Corporation’s unrealized losses in the investment securities portfolio related to mortgage-backed securities.  At March 31, 2017, all of the unrealized losses related to mortgage-backed securities were issued by U.S. government sponsored entities, Fannie Mae and Freddie Mac. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because it is not likely that the Corporation will be required to sell these securities before their anticipated recovery, the Corporation does not consider these securities to be other-than-temporarily impaired at March 31, 2017.

NOTE 4        LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and costs, is summarized as follows (in thousands):
 
 
March 31, 2017
 
December 31, 2016
Commercial and agricultural:
 
 
 
 
Commercial and industrial
 
$
177,575

 
$
176,201

Agricultural
 
500

 
360

Commercial mortgages:
 
 

 
 

Construction
 
51,706

 
46,387

Commercial mortgages, other
 
550,906

 
522,269

Residential mortgages
 
198,020

 
198,493

Consumer loans:
 
 

 
 

Credit cards
 
1,409

 
1,476

Home equity lines and loans
 
99,032

 
98,590

Indirect consumer loans
 
138,273

 
139,572

Direct consumer loans
 
16,830

 
16,942

Total loans, net of deferred origination fees and costs
 
$
1,234,251

 
$
1,200,290

Interest receivable on loans
 
3,136

 
3,192

Total recorded investment in loans
 
$
1,237,387

 
$
1,203,482


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


16



The following tables present the activity in the allowance for loan losses by portfolio segment for the three-month periods ended March 31, 2017 and 2016 (in thousands):
 
Three Months Ended March 31, 2017
Allowance for loan losses
Commercial and Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Beginning balance
$
1,589

 
$
7,270

 
$
1,523

 
$
3,871

 
$
14,253

Charge-offs
(5
)
 

 
(12
)
 
(427
)
 
(444
)
Recoveries
24

 
1

 
17

 
69

 
111

Net recoveries (charge-offs)
19

 
1

 
5

 
(358
)
 
(333
)
Provision
42

 
478

 
(16
)
 
536

 
1,040

Ending balance
$
1,650

 
$
7,749

 
$
1,512

 
$
4,049

 
$
14,960

 
Three Months Ended March 31, 2016
Allowance for loan losses
Commercial and Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Beginning balance
$
1,831

 
$
7,112

 
$
1,464

 
$
3,853

 
$
14,260

Charge-offs
(8
)
 

 

 
(443
)
 
(451
)
Recoveries
32

 
7

 

 
84

 
123

Net recoveries (charge-offs)
24

 
7

 

 
(359
)
 
(328
)
Provision
(60
)
 
413

 
18

 
224

 
595

Ending balance
$
1,795

 
$
7,532

 
$
1,482

 
$
3,718

 
$
14,527


The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2017 and December 31, 2016 (in thousands):
 
March 31, 2017
Allowance for loan losses:
Commercial and Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$

 
$
845

 
$

 
$
153

 
$
998

Collectively evaluated for impairment
1,650

 
6,845

 
1,487

 
3,896

 
13,878

Loans acquired with deteriorated credit quality

 
59

 
25

 

 
84

   Total ending allowance balance
$
1,650

 
$
7,749

 
$
1,512

 
$
4,049

 
$
14,960

 
December 31, 2016
Allowance for loan losses:
Commercial and Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$

 
$
735

 
$

 
$
141

 
$
876

Collectively evaluated for impairment
1,589

 
6,476

 
1,498

 
3,730

 
13,293

Loans acquired with deteriorated credit quality

 
59

 
25

 

 
84

   Total ending allowance balance
$
1,589

 
$
7,270

 
$
1,523

 
$
3,871

 
$
14,253


17



 
March 31, 2017
Loans:
Commercial
and
Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Loans individually evaluated for impairment
$
649

 
$
11,969

 
$
390

 
$
432

 
$
13,440

Loans collectively evaluated for  impairment
177,885

 
590,922

 
198,007

 
255,763

 
1,222,577

Loans acquired with deteriorated credit quality

 
1,275

 
95

 

 
1,370

   Total ending loans balance
$
178,534

 
$
604,166

 
$
198,492

 
$
256,195

 
$
1,237,387

 
December 31, 2016
Loans:
Commercial
and
Agricultural
 
Commercial Mortgages
 
Residential Mortgages
 
Consumer Loans
 
Total
Loans individually evaluated for impairment
$
693

 
$
10,382

 
$
396

 
$
455

 
$
11,926

Loans collectively evaluated for  impairment
176,334

 
558,451

 
198,474

 
256,879

 
1,190,138

Loans acquired with deteriorated credit quality

 
1,323

 
95

 

 
1,418

   Total ending loans balance
$
177,027

 
$
570,156

 
$
198,965

 
$
257,334

 
$
1,203,482


The following table presents loans individually evaluated for impairment recognized by class of loans as of March 31, 2017 and December 31, 2016 (in thousands):
 
March 31, 2017
 
December 31, 2016
With no related allowance recorded:
Unpaid Principal Balance
 
Recorded Investment
 
Allowance for Loan Losses Allocated
 
Unpaid Principal Balance
 
Recorded Investment
 
Allowance for Loan Losses Allocated
Commercial and agricultural:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
646

 
$
649

 
$

 
$
690

 
$
693

 
$

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

Construction
1,558

 
1,559

 

 
277

 
278

 

Commercial mortgages, other
6,133

 
6,144

 

 
8,792

 
7,857

 

Residential mortgages
389

 
390

 

 
395

 
396

 

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity lines and loans
72

 
72

 

 
93

 
95

 

With an allowance recorded:
 

 
 

 
 

 
 

 
 

 
 

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

Commercial mortgages, other
5,206

 
4,266

 
845

 
2,245

 
2,247

 
735

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

Home equity lines and loans
360

 
360

 
153

 
360

 
360

 
141

Total
$
14,364

 
$
13,440

 
$
998

 
$
12,852

 
$
11,926

 
$
876



18



The following table presents the average recorded investment and interest income of loans individually evaluated for impairment recognized by class of loans as of the three-month periods ended March 31, 2017 and 2016 (in thousands):

 
 
Three Months Ended 
 March 31, 2017
 
Three Months Ended 
 March 31, 2016
With no related allowance recorded:
 
Average Recorded Investment
 
Interest Income Recognized
(1)
 
Average Recorded Investment
 
Interest Income Recognized
(1)
Commercial and agricultural:
 
 
 
 
 
 
 
 
Commercial and industrial
 
$
671

 
$
9

 
$
1,266

 
$
13

Commercial mortgages:
 
 

 
 

 
 

 
 
Construction
 
919

 
3

 
348

 
4

Commercial mortgages, other
 
7,000

 
59

 
7,395

 
68

Residential mortgages
 
393

 
2

 
273

 

Consumer loans:
 
 

 
 

 
 

 
 

Home equity lines & loans
 
84

 
1

 
107

 
1

With an allowance recorded:
 
 

 
 

 
 

 
 

Commercial and agricultural:
 
 

 
 

 
 

 
 

Commercial and industrial
 

 

 
9

 

Commercial mortgages:
 
 

 
 

 
 

 
 

Commercial mortgages, other
 
3,257

 
1

 
4,845

 
1

Consumer loans:
 
 

 
 

 
 

 
 

Home equity lines and loans
 
360

 

 
364

 

Total
 
$
12,684

 
$
75

 
$
14,607

 
$
87

(1)Cash basis interest income approximates interest income recognized.

The following tables present the recorded investment in non-accrual and loans past due 90 days or more and still accruing by class of loans as of March 31, 2017 and December 31, 2016 (in thousands):

 
 
Non-accrual
 
Loans Past Due 90 Days or More and Still Accruing
 
 
March 31, 2017
 
December 31, 2016
 
March 31, 2017
 
December 31, 2016
Commercial and agricultural:
 
 
 
 
 
 
 
 
Commercial and industrial
 
$

 
$

 
$
9

 
$
2

Commercial mortgages:
 
 
 
 
 
 
 
 
Construction
 
1,308

 
19

 

 

Commercial mortgages, other
 
5,639

 
5,454

 

 

Residential mortgages
 
3,524

 
4,201

 

 

Consumer loans:
 
 
 
 
 
 
 
 
Credit cards
 

 

 
18

 
11

Home equity lines and loans
 
1,647

 
1,670

 

 

Indirect consumer loans
 
765

 
654

 

 

Direct consumer loans
 
31

 
45

 

 

Total
 
$
12,914

 
$
12,043

 
$
27

 
$
13



19



The following tables present the aging of the recorded investment in loans as of March 31, 2017 and December 31, 2016 (in thousands):
 
March 31, 2017
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 Days or More Past Due
 
Total Past Due
 
Loans Acquired with Deteriorated Credit Quality
 
Loans Not Past Due
 
Total
Commercial and agricultural:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
155

 
$
1

 
$
9

 
$
165

 
$

 
$
177,868

 
$
178,033

Agricultural

 

 

 

 

 
501

 
501

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

 
 
Construction

 

 
1,289

 
1,289

 

 
50,551

 
51,840

Commercial mortgages, other
941

 
3,361

 
2,522

 
6,824

 
1,275

 
544,227

 
552,326

Residential mortgages
2,276

 
254

 
1,758

 
4,288

 
95

 
194,109

 
198,492

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 
 
 
Credit cards
17

 
13

 
18

 
48

 

 
1,361

 
1,409

Home equity lines and loans
289

 
209

 
1,102

 
1,600

 

 
97,691

 
99,291

Indirect consumer loans
1,538

 
313

 
488

 
2,339

 

 
136,264

 
138,603

Direct consumer loans
68

 
2

 
8

 
78

 

 
16,814

 
16,892

Total
$
5,284

 
$
4,153

 
$
7,194

 
$
16,631

 
$
1,370

 
$
1,219,386

 
$
1,237,387




20



 
December 31, 2016
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 Days or More Past Due
 
Total Past Due
 
Loans Acquired with Deteriorated Credit Quality
 
Loans Not Past Due
 
Total
Commercial and agricultural:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
160

 
$
7

 
$
2

 
$
169

 
$

 
$
176,497

 
$
176,666

Agricultural

 

 

 

 

 
361

 
361

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

 
 
Construction

 
1,177

 

 
1,177

 

 
45,333

 
46,510

Commercial mortgages, other
652

 
4,460

 
2,412

 
7,524

 
1,323

 
514,799

 
523,646

Residential mortgages
2,100

 
436

 
2,383

 
4,919

 
95

 
193,951

 
198,965

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 
 
 
Credit cards
3

 
9

 
11

 
23

 

 
1,453

 
1,476

Home equity lines and loans
227

 

 
1,149

 
1,376

 

 
97,477

 
98,853

Indirect consumer loans
1,773

 
287

 
542

 
2,602

 

 
137,391

 
139,993

Direct consumer loans
54

 
7

 
22

 
83

 

 
16,929

 
17,012

Total
$
4,969

 
$
6,383

 
$
6,521

 
$
17,873

 
$
1,418

 
$
1,184,191

 
$
1,203,482


Troubled Debt Restructurings:

A modification of a loan may result in classification as a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession.  The Corporation offers various types of modifications which may involve a change in the schedule of payments, a reduction in the interest rate, an extension of the maturity date, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral, releasing collateral for consideration, substituting or adding a new borrower or guarantor, a permanent reduction of the recorded investment in the loan or a permanent reduction of the interest on the loan.

As of March 31, 2017 and December 31, 2016, the Corporation has a recorded investment in TDRs of $10.3 million and $10.2 million, respectively.  There were specific reserves of $0.9 million allocated for TDRs at both March 31, 2017 and December 31, 2016.  As of March 31, 2017, TDRs totaling $5.9 million were accruing interest under the modified terms and $4.4 million were on non-accrual status.  As of December 31, 2016, TDRs totaling $5.8 million were accruing interest under the modified terms and $4.4 million were on non-accrual status.  The Corporation had committed no additional amounts as of both March 31, 2017 and December 31, 2016, to customers with outstanding loans that are classified as TDRs.

During the three-month periods ended March 31, 2017 and 2016, the terms of certain loans were modified as TDRs. The modification of the terms of a commercial mortgage loan during the three months ended March 31, 2017 included a reduction of the scheduled amortized payments of the loan for greater than a three month period. The modification of the terms of a residential mortgage loan performed during the three-month period ended March 31, 2016 included a reduction in the stated interest rate for three years and a corresponding reduction of the schedule amortized payments of the loan due to the lower interest rate. Additionally, $4 thousand of interest and past due escrow payments were capitalized on the restructured loan.


21



The following table presents loans by class modified as TDRs that occurred during the three months ended March 31, 2017 and March 31, 2016 (dollars in thousands):

March 31, 2017
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
 
 
 
 
 
 
Commercial mortgages:
 
 
 
 
 
 
Commercial mortgages, other
 
1

 
$
166

 
$
166

Total
 
1

 
$
166

 
$
166


March 31, 2016
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
 
 
 
 
 
 
Residential mortgages
 
1

 
$
121

 
$
125

Total
 
1

 
$
121

 
$
125


The TDRs described above did not increase the allowance for loan losses and resulted in no charge-offs during the three-month periods ended March 31, 2017 and March 31, 2016.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no payment defaults on any loans previously modified as TDRs within twelve months following the modification during the three- month period ended March 31, 2017.

The following table presents loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the three months ended March 31, 2016:

 
 
Number of Loans
 
Recorded Investment
Commercial mortgages:
 
 
 
 
Commercial mortgages, other
 
2
 
$
2,145

Total
 
2
 
$
2,145


The TDRs that subsequently defaulted described above did not increase the allowance for loan losses and resulted in no charge offs during the three-month periods ended March 31, 2016

Credit Quality Indicators

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

For the retail loans, which include residential mortgages, indirect and direct consumer loans, home equity lines and loans, and credit cards, once a loan is properly approved and closed, the Corporation evaluates credit quality based upon loan repayment.

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


22



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 at some future date.

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

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

Commercial loans not meeting the criteria above to be considered criticized or classified are considered to be pass rated loans.  Loans listed as not rated are included in groups of homogeneous loans performing under terms of the loan notes.  Based on the analyses performed as of March 31, 2017 and December 31, 2016, the risk category of the recorded investment of loans by class of loans is as follows (in thousands):
 
March 31, 2017
 
Not Rated
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loans acquired with deteriorated credit quality
 
Total
Commercial and agricultural:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$

 
$
172,307

 
$
4,203

 
$
1,523

 
$

 
$

 
$
178,033

Agricultural

 
501

 

 


 

 

 
501

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

 
 
Construction

 
50,281

 
252

 
1,307

 

 

 
51,840

Commercial mortgages

 
525,745

 
8,283

 
15,584

 
1,439

 
1,275

 
552,326

Residential mortgages
194,873

 

 

 
3,524

 

 
95

 
198,492

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

 
 
Credit cards
1,409

 

 

 

 

 

 
1,409

Home equity lines and loans
97,644

 

 

 
1,647

 

 

 
99,291

Indirect consumer loans
137,838

 

 

 
765

 

 

 
138,603

Direct consumer loans
16,861

 

 

 
31

 

 

 
16,892

Total
$
448,625

 
$
748,834

 
$
12,738

 
$
24,381

 
$
1,439

 
$
1,370

 
$
1,237,387


23



 
December 31, 2016
 
Not Rated
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loans acquired with deteriorated credit quality
 
Total
Commercial and agricultural:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$

 
$
172,873

 
$
2,277

 
$
1,516

 
$

 
$

 
$
176,666

Agricultural

 
361

 

 

 

 

 
361

Commercial mortgages:
 

 
 

 
 

 
 

 
 

 
 

 
 
Construction

 
45,055

 
259

 
1,196

 

 

 
46,510

Commercial mortgages

 
496,723

 
8,574

 
15,566

 
1,460

 
1,323

 
523,646

Residential mortgages
194,669

 

 

 
4,201

 

 
95

 
198,965

Consumer loans:
 

 
 

 
 

 
 

 
 

 
 

 
 
Credit cards
1,476

 

 

 

 

 

 
1,476

Home equity lines and loans
97,183

 

 

 
1,670

 

 

 
98,853

Indirect consumer loans
139,339

 

 

 
654

 

 

 
139,993

Direct consumer loans
16,967

 

 

 
45

 

 

 
17,012

Total
$
449,634

 
$
715,012

 
$
11,110

 
$
24,848

 
$
1,460

 
$
1,418

 
$
1,203,482


The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  The following table presents the recorded investment in residential and consumer loans based on payment activity as of March 31, 2017 and December 31, 2016 (in thousands):

 
March 31, 2017
 
 
 
Consumer Loans
 
Residential Mortgages
 
Credit Card
 
Home Equity Lines and Loans
 
Indirect Consumer Loans
 
Other Direct Consumer Loans
Performing
$
194,968

 
$
1,409

 
$
97,644

 
$
137,838

 
$
16,861

Non-Performing
3,524

 

 
1,647

 
765

 
31

 
$
198,492

 
$
1,409

 
$
99,291

 
$
138,603

 
$
16,892

 
December 31, 2016
 
 
 
Consumer Loans
 
Residential Mortgages
 
Credit Card
 
Home Equity Lines and Loans
 
Indirect Consumer Loans
 
Other Direct Consumer Loans
Performing
$
194,764

 
$
1,476

 
$
97,183

 
$
139,339

 
$
16,967

Non-Performing
4,201

 

 
1,670

 
654

 
45

 
$
198,965

 
$
1,476

 
$
98,853

 
$
139,993

 
$
17,012



24



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

The table below summarizes the changes in total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the PCI loans from from January 1, 2017 to March 31, 2017 and January 1, 2016 to March 31, 2016 (in thousands):

Three Months Ended March 31, 2017
 
Balance at December 31, 2016
 
Income Accretion
 
All Other Adjustments
 
Balance at March 31, 2017
Contractually required principal and interest
 
$
1,940

 
$

 
$
(63
)
 
$
1,877

Contractual cash flows not expected to be collected (nonaccretable discount)
 
(352
)
 

 

 
(352
)
Cash flows expected to be collected
 
1,588

 

 
(63
)
 
1,525

Interest component of expected cash flows (accretable yield)
 
(170
)
 
15

 

 
(155
)
Fair value of loans acquired with deteriorating credit quality
 
$
1,418

 
$
15

 
$
(63
)
 
$
1,370


Three Months Ended March 31, 2016
 
Balance at December 31, 2015
 
Income Accretion
 
All Other Adjustments
 
Balance at March 31, 2016
Contractually required principal and interest
 
$
2,912

 
$

 
$
(54
)
 
$
2,858

Contractual cash flows not expected to be collected (nonaccretable discount)
 
(506
)
 

 
1

 
(505
)
Cash flows expected to be collected
 
2,406

 

 
(53
)
 
2,353

Interest component of expected cash flows (accretable yield)
 
(311
)
 
37

 
(1
)
 
(275
)
Fair value of loans acquired with deteriorating credit quality
 
$
2,095

 
$
37

 
$
(54
)
 
$
2,078


For those purchased credit impaired loans disclosed above, the Corporation did not increase the allowance for loan losses during the three months ended March 31, 2017 or 2016. The Corporation did not reverse any allowance for loan losses during the three months ended March 31, 2017 or 2016.


NOTE 5        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.


25



The Corporation used the following methods and significant assumptions to estimate fair value on a recurring basis:

Investment Securities:  The fair values of securities available for sale are usually determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs).

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

Derivatives: The fair values of interest rate swaps are based on valuation models using observable market data as of the measurement date (Level 2 inputs). Derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices, and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The Corporation also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counter-party's nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Corporation has considered the impact of any applicable credit enhancements, such as collateral postings. Although the Corporation has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize credit default rate assumptions (Level 3 inputs).

The fair values of credit risk participations are based on credit default rate assumptions (Level 3 inputs).

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
 
 
Fair Value Measurement at March 31, 2017 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
$
17,440

 
$

 
$
17,440

 
$

Mortgage-backed securities, residential
239,678

 

 
239,678

 

Obligations of states and political subdivisions
44,155

 

 
44,155

 

Corporate bonds and notes
251

 

 

 
251

SBA loan pools
550

 

 
550

 

Corporate stocks
507

 
175

 
332

 

Total available for sale securities
$
302,581

 
$
175

 
$
302,155

 
$
251

 
 
 
 
 
 
 
 
Trading assets
$
826

 
$
826

 
$

 
$

Derivative assets
747

 

 
747

 

 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
812

 
$

 
$
747

 
$
65



26



 
 
Fair Value Measurement at December 31, 2016 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
$
17,455

 
$

 
$
17,455

 
$

Mortgage-backed securities, residential
245,866

 

 
245,866

 

Obligations of states and political subdivisions
38,740

 

 
38,740

 

Corporate bonds and notes
250

 

 

 
250

SBA loan pools
570

 

 
570

 

Corporate stocks
521

 
170

 
351

 

Total available for sale securities
$
303,402

 
$
170

 
$
302,982

 
$
250

 
 
 
 
 
 
 
 
Trading assets
$
774

 
$
774

 
$

 
$

Derivative assets
693

 

 
693

 

 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
761

 
$

 
$
693

 
$
68


There were no transfers between Level 1 and Level 2 during the three-month periods ended March 31, 2017. During the year ended December 31, 2016, the Corporation transferred corporate stocks with a fair market value of $158 thousand at the date of transfer (and $103 thousand at December 31, 2016) from Level 2 to Level 1 due to the corporation's stock becoming publicly listed.

The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three-month periods ended March 31, 2017 and March 31, 2016 (in thousands):

 
 
Assets (Liabilities)
 
 
Corporate Bonds and Notes
 
Derivative Liabilities
 
 
March 31, 2017
 
March 31, 2016
 
March 31, 2017
 
March 31, 2016
Balance of recurring Level 3 assets at January 1
 
$
250

 
$
248

 
$
(68
)
 
$
(48
)
Derivative instruments entered into
 

 

 

 
(2
)
Total gains or losses for the period:
 
 
 
 
 
 
 
 
Included in earnings - other non-interest income
 

 

 
3

 
(34
)
Included in other comprehensive income
 
1

 
4

 

 

Transfers into Level 3
 

 

 

 

Balance of recurring Level 3 assets at March 31
 
$
251

 
$
252

 
$
(65
)
 
$
(84
)





27



The following table presents information related to Level 3 recurring fair value measurements at March 31, 2017 and December 31, 2016 (in thousands):

Description
 
Fair Value at
March 31,
2017
 
Valuation Technique
 
Unobservable Inputs
 
Range
[Weighted Average]
at March 31, 2017
Corporate bonds and notes
 
$
251

 
Discounted cash flow
 
Credit spread
 
1.73% - 1.73%
[1.73%]
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
$
65

 
Historical trend
 
Credit default rate
 
4.92% - 4.92%
[4.92%]

Description
 
Fair Value at
December 31,
2016
 
Valuation Technique
 
Unobservable Inputs
 
Range
[Weighted Average]
at December 31, 2016
Corporate bonds and notes
 
$
250

 
Discounted cash flow
 
Credit spread
 
1.73% - 1.73%
[1.73%]
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
$
68

 
Historical trend
 
Credit default rate
 
4.92% - 4.92%
[4.92%]

The Corporation used the following methods and significant assumptions to estimate fair value on a non-recurring basis:

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

OREO:  Assets acquired through or instead of loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Assets in which the Corporation has accepted a purchase offer are classified as Level 2.

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


28



Assets and liabilities measured at fair value on a non-recurring basis are summarized below (in thousands):
 
 
 
Fair Value Measurement at March 31, 2017 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:
 
 
 
 
 
 
 
Commercial mortgages
$
3,344

 
$

 
$

 
$
3,344

Total impaired loans
$
3,344

 
$

 
$

 
$
3,344

Other real estate owned:
 

 
 

 
 

 
 

Residential mortgages
$
255

 
$

 
$

 
$
255

Total other real estate owned, net
$
255

 
$

 
$

 
$
255


 
 
 
Fair Value Measurement at December 31, 2016 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:
 
 
 
 
 
 
 
Commercial mortgages
$
2,631

 
$

 
$

 
$
2,631

Consumer loans:
 

 
 

 
 

 
 

Home equity lines and loans
219

 

 

 
219

Total impaired loans
$
2,850

 
$

 
$

 
$
2,850

Other real estate owned:
 

 
 

 
 

 
 

Residential mortgages
$
344

 
$

 
$

 
$
344

Total other real estate owned, net
$
344

 
$

 
$

 
$
344


The following tables presents information related to Level 3 non-recurring fair value measurement at March 31, 2017 and December 31, 2016 (in thousands):
Description
 
Fair Value at March 31, 2017
 
Valuation Technique
 
Unobservable Inputs
 
Range
[Weighted Average]
at
March 31, 2017
Impaired loans:
 
 
 
 
 
 
 
 
Commercial mortgages, other
 
$
745

 
Sales comparison
 
Discount to appraised value
 
10.00% - 40.04%
[17.05%]
 
 
2,599

 
Income approach
 
Capitalization Rate
 
9.00% - 10.00%
[9.52%]
 
 
$
3,344

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
OREO:
 
 
 
 
 
 
 
 
Residential mortgages
 
$
255

 
Sales comparison
 
Discount to appraised value
 
20.80% - 36.37%
[29.88%]
 
 
$
255

 
 
 
 
 
 


29



Description
 
Fair Value at December 31, 2016
 
Valuation Technique
 
Unobservable Inputs
 
Range
[Weighted Average]
at
December 31, 2016
Impaired loans:
 
 
 
 
 
 
 
 
Commercial mortgages:
 
 
 
 
 
 
 
 
Commercial mortgages, other
 
$
2,631

 
Income approach
 
Capitalization Rate
 
9.00% - 10.00%
[9.52%]
Consumer loans:
 
 
 
 
 
 
 
 
Home equity lines and loans
 
219

 
Sales comparison
 
Discount to appraised value
 
22.98% - 22.98%
[22.98%]
 
 
$
2,850

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
OREO:
 
 
 
 
 
 
 
 
Residential mortgages
 
$
344

 
Sales comparison
 
Discount to appraised value
 
20.80% - 48.17%
[30.50%]
 
 
$
344

 
 
 
 
 
 

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of each class of financial instruments not already discussed:

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

For those short-term instruments that generally mature in 90 days or less, the carrying value approximates fair value of which non-interest-bearing deposits are classified as Level 1 and interest-bearing deposits with the FHLBNY and FRBNY are classified as Level 1.

Securities Held to Maturity

For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs).

FHLBNY and FRBNY Stock

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

Loans, Net

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

Loans Held for Sale

Certain mortgage loans are originated with the intent to sell.  Loans held for sale are recorded at the lower of cost or market and are classified as Level 2.

Deposits

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

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

30




Securities Sold Under Agreements to Repurchase

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

FHLBNY Overnight Advances and FHLBNY Term Advances

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

Accrued Interest Receivable and Payable

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

The carrying amounts and estimated fair values of other financial instruments, at March 31, 2017 and December 31, 2016, are as follows (in thousands):
 
March 31, 2017
Financial assets:
Carrying Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Estimated Fair Value
(1)
Cash and due from financial institutions
$
26,275

 
$
26,275

 
$

 
$

 
$
26,275

Interest-bearing deposits in other financial institutions
99,410

 
99,410

 

 

 
99,410

Trading assets
826

 
826

 

 

 
826

Securities available for sale
302,581

 
175

 
302,155

 
251

 
302,581

Securities held to maturity
3,721

 

 
977

 
2,935

 
3,912

FHLBNY and FRBNY stock
3,597

 

 

 

 
N/A

Loans, net
1,219,291

 

 

 
1,229,871

 
1,229,871

Loans held for sale
20

 

 
20

 

 
20

Accrued interest receivable
4,066

 
4

 
909

 
3,153

 
4,066

Derivative assets
747

 

 
747

 

 
747

 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

Demand, savings, and insured money market accounts
$
1,403,637

 
$
1,403,637

 
$

 
$

 
$
1,403,637

Time deposits
140,614

 

 
140,934

 

 
140,934

Securities sold under agreements to repurchase
15,215

 

 
15,398

 

 
15,398

FHLBNY term advances
9,065

 

 
9,138

 

 
9,138

Accrued interest payable
172

 
23

 
149

 

 
172

Derivative liabilities
812

 

 
747

 
65

 
812

(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.

31



 
December 31, 2016
Financial assets:
Carrying Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Estimated Fair Value
(1)
Cash and due from financial institutions
$
28,205

 
$
28,205

 
$

 
$

 
$
28,205

Interest-bearing deposits in other financial institutions
45,957

 
45,957

 

 

 
45,957

Trading assets
774

 
774

 

 

 
774

Securities available for sale
303,402

 
170

 
302,982

 
250

 
303,402

Securities held to maturity
4,705

 

 
981

 
3,931

 
4,912

FHLBNY and FRBNY stock
4,041

 

 

 

 
N/A

Loans, net
1,186,037

 

 

 
1,205,814

 
1,205,814

Loans held for sale
412

 

 
412

 

 
412

Accrued interest receivable
4,000

 
9

 
784

 
3,207

 
4,000

Derivative assets
693

 

 
693

 

 
693

 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 

 
 

 
 

 
 

 
 

Deposits:
 

 
 

 
 

 
 

 
 

Demand, savings, and insured money market accounts
$
1,312,237

 
$
1,312,237

 
$

 
$

 
$
1,312,237

Time deposits
144,106

 

 
144,460

 

 
144,460

Securities sold under agreements to repurchase
27,606

 

 
27,880

 

 
27,880

FHLBNY term advances
9,093

 

 
9,189

 

 
9,189

Accrued interest payable
210

 
25

 
185

 

 
210

Derivative liabilities
761

 

 
693

 
68

 
761

(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.


NOTE 6        GOODWILL AND INTANGIBLE ASSETS

The changes in goodwill included in the core banking segment during the periods ended March 31, 2017 and 2016 were as follows (in thousands):
 
 
2017
 
2016
Beginning of year
 
$
21,824

 
$
21,824

Acquired goodwill
 

 

Ending balance March 31,
 
$
21,824

 
$
21,824


Acquired intangible assets were as follows at March 31, 2017 and December 31, 2016 (in thousands):
 
 
At March 31, 2017
 
At December 31, 2016
 
 
Balance Acquired
 
Accumulated Amortization
 
Balance Acquired
 
Accumulated Amortization
Core deposit intangibles
 
$
5,975

 
$
4,827

 
$
5,975

 
$
4,689

Other customer relationship intangibles
 
5,633

 
4,062

 
5,633

 
3,974

Total
 
$
11,608

 
$
8,889

 
$
11,608

 
$
8,663


Aggregate amortization expense was $0.2 million and $0.3 million for the three month periods ended March 31, 2017 and 2016, respectively.

32




The remaining estimated aggregate amortization expense at March 31, 2017 is listed below (in thousands):
Year
 
Estimated Expense
2017
 
$
634

2018
 
734

2019
 
609

2020
 
484

2021
 
258

Total
 
$
2,719



NOTE 7        SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

A summary of securities sold under agreements to repurchase as of March 31, 2017 and December 31, 2016 is as follows (in thousands):
 
March 31, 2017
 
Overnight and Continuous
 
Up to 1 Year
 
1 - 3 Years
 
3+ Years
 
Total
Mortgage-backed securities, residential
$
8,097

 
$

 
$
13,690

 
$

 
$
21,787

Excess collateral held
(2,882
)
 

 
(3,690
)
 

 
(6,572
)
Gross amount of recognized liabilities for repurchase agreements
$
5,215

 
$

 
$
10,000

 
$

 
$
15,215


 
December 31, 2016
 
Overnight and Continuous
 
Up to 1 Year
 
1 - 3 Years
 
3+ Years
 
Total
Obligations of U.S. Government and U.S. Government sponsored enterprises
$

 
$
1,276

 
$

 
$

 
$
1,276

Mortgage-backed securities, residential
13,092

 
9,664

 
14,244

 

 
37,000

Total
13,092

 
10,940

 
14,244

 

 
38,276

Excess collateral held
(5,486
)
 
(940
)
 
(4,244
)
 

 
(10,670
)
Gross amount of recognized liabilities for repurchase agreements
$
7,606

 
$
10,000

 
$
10,000

 
$

 
$
27,606


The Corporation enters into sales of securities under agreements to repurchase and the amounts received under these agreements represent borrowings and are reflected as a liability in the consolidated balance sheets.  The securities underlying these agreements are included in investment securities in the consolidated balance sheets.

The Corporation has no control over the market value of the securities which fluctuate due to market conditions, however, the Corporation is obligated to promptly transfer additional securities if the market value of the securities falls below the repurchase agreement price.  The Corporation manages this risk by utilizing highly marketable and easily priced securities, monitoring these securities for significant changes in market valuation routinely, and maintaining an unpledged securities portfolio believed to be sufficient to cover a decline in the market value of the securities sold under agreements to repurchase.


NOTE 8        ACCUMULATED OTHER COMPREHENSIVE LOSS

Accumulated other comprehensive 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.


33



The following is a summary of the changes in accumulated other comprehensive loss by component, net of tax, for the periods indicated (in thousands):
 
 
Unrealized Gains and Losses on Securities Available for Sale
 
Defined Benefit and Other Benefit Plans
 
Total
Balance at January 1, 2017
 
$
(4,356
)
 
$
(6,398
)
 
$
(10,754
)
Other comprehensive income before reclassification
 
1,977

 

 
1,977

Amounts reclassified from accumulated other comprehensive income
 

 
21

 
21

Net current period other comprehensive income
 
1,977

 
21

 
1,998

Balance at March 31, 2017
 
$
(2,379
)
 
$
(6,377
)
 
$
(8,756
)

 
 
Unrealized Gains and Losses on Securities Available for Sale
 
Defined Benefit and Other Benefit Plans
 
Total
Balance at January 1, 2016
 
$
210

 
$
(11,152
)
 
$
(10,942
)
Other comprehensive loss before reclassification
 
1,936

 

 
1,936

Amounts reclassified from accumulated other comprehensive income
 
(565
)
 
233

 
(332
)
Net current period other comprehensive income
 
1,371

 
233

 
1,604

Balance at March 31, 2016
 
$
1,581

 
$
(10,919
)
 
$
(9,338
)

The following is the reclassification out of accumulated other comprehensive income for the periods indicated (in thousands):
Details about Accumulated Other Comprehensive Income Components
 
Three Months Ended 
 March 31,
 
Affected Line Item
in the Statement Where
Net Income is Presented
 
 
2017
 
2016
 
 
Unrealized gains and losses on securities available for sale:
 
 
 
 
 
     
Realized gains on securities available for sale
 
$

 
$
(908
)
 
Net gains (losses) on securities transactions
Tax effect
 

 
343

 
Income tax expense
Net of tax
 

 
(565
)
 
 
Amortization of defined pension plan and other benefit plan items:
 
 

 
 

 
     
Prior service costs (a)
 
(55
)
 
(22
)
 
Pension and other employee benefits
Actuarial losses (a)
 
88

 
396

 
Pension and other employee benefits
Tax effect
 
(12
)
 
(141
)
 
Income tax expense
Net of tax
 
21

 
233

 
 
Total reclassification for the period, net of tax
 
$
21

 
$
(332
)
 
 
(a) These accumulated other comprehensive income components are included in the computation of net periodic pension and other benefit plan costs (see Note 10 for additional information).




34



NOTE 9        COMMITMENTS AND CONTINGENCIES

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

The following table lists the contractual amounts of financial instruments with off-balance sheet risk at March 31, 2017 and December 31, 2016 (in thousands):
 
March 31, 2017
 
December 31, 2016
 
Fixed Rate
 
Variable Rate
 
Fixed Rate
 
Variable Rate
Commitments to make loans
$
35,706

 
$
29,629

 
$
38,246

 
$
33,189

Unused lines of credit
913

 
209,879

 
610

 
208,124

Standby letters of credit

 
14,156

 

 
14,241


On March 23, 2016, the Bank received a summons and complaint for an action brought in the State of New York Supreme Court for the County of Tompkins, regarding its lease of 202 East State Street, Ithaca, NY. The owner of the leased premises has alleged that the Bank has breached its contract and is requesting a judgment declaring that the term of the lease runs through December 31, 2025 or a judgment in his favor in the amount of $4.0 million. On July 25, 2016, the Corporation received Notice of Entry of the decision and order of the New York Supreme Court for the County of Tompkins, involving claims by the owner of the leased premises at 202 East State Street, Ithaca, New York against the Bank. The Court granted, in part, partial summary judgment in favor of the plaintiff - on the issue of liability only- for anticipatory breach and breach of contract. The fraud claims were dismissed, and summary judgment was denied on the plaintiff’s trespass claims. The Court set the matter down for an inquest on damages at a later date, with the original claim by the plaintiff seeking $4.0 million in damages. The Corporation has filed an appeal to the court determination which has been perfected in the Appellate Division, Third Department of State Supreme Court. The briefing process has not been completed, although the Record on Appeal and the Corporation's brief have both been filed with the Appellate Division. The Corporation established a legal reserve of $1.2 million in connection with this case during the second quarter of 2016. which the Corporation has deemed sufficient as of March 31, 2017.

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



35



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

The components of net periodic expense for the Corporation’s pension and other benefit plans for the periods indicated are as follows (in thousands):
 
 
Three Months Ended 
 March 31,
 
 
2017
 
2016
Qualified Pension Plan
 
 
 
 
Service cost, benefits earned during the period
 
$

 
$
296

Interest cost on projected benefit obligation
 
403

 
470

Expected return on plan assets
 
(785
)
 
(755
)
Amortization of unrecognized transition obligation
 

 

Amortization of unrecognized prior service cost
 

 
2

Amortization of unrecognized net loss
 
58

 
384

Net periodic pension cost
 
$
(324
)
 
$
397

 
 
 
 
 
Supplemental Pension Plan
 
 

 
 

Service cost, benefits earned during the period
 
$

 
$
11

Interest cost on projected benefit obligation
 
12

 
13

Expected return on plan assets
 

 

Amortization of unrecognized prior service cost
 

 

Amortization of unrecognized net loss
 
1

 
6

Net periodic supplemental pension cost
 
$
13

 
$
30

 
 
 
 
 
Postretirement Plan, Medical and Life
 
 

 
 

Service cost, benefits earned during the period
 
$

 
$
12

Interest cost on projected benefit obligation
 
4

 
17

Expected return on plan assets
 

 

Amortization of unrecognized prior service cost
 
(55
)
 
(24
)
Amortization of unrecognized net loss
 
29

 
6

Net periodic postretirement, medical and life cost
 
$
(22
)
 
$
11



NOTE 11    SEGMENT REPORTING

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

Accounting policies for the segments are the same as those described in Note 1 of the Corporation’s 2016 Annual Report on Form 10-K, which was filed with the SEC on March 8, 2017. Summarized financial information concerning the Corporation’s reportable segments and the reconciliation to the Corporation’s consolidated results are shown in the following table.  Income taxes are allocated based on the separate taxable income of each entity and indirect overhead expenses are allocated based on reasonable and equitable allocations applicable to the reportable segment.  CFS amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the Holding Company, CFS, and CRM column below, along with amounts to eliminate transactions between those segments (in thousands). CRM was formed during the second quarter of 2016, therefore, is not included within prior year comparative information.


36



 
 
Three months ended March 31, 2017
 
 
Core Banking
 
WMG
 
Holding Company, CFS, and CRM
 
Consolidated Totals
Interest and dividend income
 
$
14,311

 
$

 
$
3

 
$
14,314

Interest expense
 
820

 

 

 
820

Net interest income
 
13,491

 

 
3

 
13,494

Provision for loan losses
 
1,040

 

 

 
1,040

Net interest income after provision for loan losses
 
12,451

 

 
3

 
12,454

Other non-interest income
 
2,605

 
2,109

 
133

 
4,847

Other non-interest expenses
 
11,444

 
1,305

 
296

 
13,045

Income (loss) before income tax expense (benefit)
 
3,612

 
804

 
(160
)
 
4,256

Income tax expense (benefit)
 
1,048

 
305

 
(76
)
 
1,277

Segment net income (loss)
 
$
2,564

 
$
499

 
$
(84
)
 
$
2,979

 
 
 
 
 
 
 
 
 
Segment assets
 
$
1,729,057

 
$
4,270

 
$
2,773

 
$
1,736,100


 
 
Three months ended March 31, 2016
 
 
Core Banking
 
WMG
 
Holding Company And CFS
 
Consolidated Totals
Interest and dividend income
 
$
13,949

 
$

 
$

 
$
13,949

Interest expense
 
924

 

 

 
924

Net interest income
 
13,025

 

 

 
13,025

Provision for loan losses
 
595

 

 

 
595

Net interest income after provision for loan losses
 
12,430

 

 

 
12,430

Other non-interest income
 
3,416

 
2,012

 
173

 
5,601

Other non-interest expenses
 
12,252

 
1,389

 
367

 
14,008

Income (loss) before income tax expense (benefit)
 
3,594

 
623

 
(194
)
 
4,023

Income tax expense (benefit)
 
1,170

 
235

 
(89
)
 
1,316

Segment net income
 
$
2,424

 
$
388

 
$
(105
)
 
$
2,707

 
 
 
 
 
 
 
 
 
Segment assets
 
$
1,637,242

 
$
4,668

 
$
1,316

 
$
1,643,226



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

During January 2017 and 2016, 7,880 and 9,532 shares, respectively, were re-issued from treasury to fund the stock component of directors' compensation.  An expense of $79 thousand and $67 thousand related to this compensation was recognized during the three-month periods ended March 31, 2017 and 2016, respectively. This expense is accrued as shares are earned.


37



Restricted Stock Plan

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

A summary of restricted stock activity for the three month period ended March 31, 2017 is presented below:
 
 
Shares
 
Weighted–Average Grant Date Fair Value
Nonvested at January 1, 2017
 
23,794

 
$
29.90

Granted
 

 

Vested
 
(415
)
 
26.59

Forfeited or cancelled
 
(1,139
)
 
29.97

Nonvested at March 31, 2017
 
22,240

 
$
29.96


As of March 31, 2017, there was $607 thousand 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 3.58 years.  The total fair value of shares vested was $16 thousand and $11 thousand for the three month periods ended March 31, 2017 and 2016, respectively.


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

Introduction

The following is the MD&A of the Corporation in this Form 10-Q for the three months ended March 31, 2017 and 2016.  Reference should be made to the accompanying unaudited consolidated financial statements and footnotes, and the Corporation’s 2016 Annual Report on Form 10-K, which was filed with the SEC on March 8, 2017, for an understanding of the following discussion and analysis.  See the list of commonly used abbreviations and terms on pages 3–5.

The MD&A included in this Form 10-Q contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the current beliefs and expectations of the Corporation's management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements. For a discussion of those risks and uncertainties and the factors that could cause the Corporation’s actual results to differ materially from those risks and uncertainties, see Forward-looking Statements below and Part I, Item 1A, Risk Factors, on pages 17–22 of the Corporation’s 2016 Annual Report.  For a discussion of use of non-GAAP financial measures, see pages 60–63 of the Corporation's 2016 Annual Report or pages 58-61 in this Form 10-Q.

The Corporation has been a financial holding company since 2000, the Bank was established in 1833, CFS in 2001, and CRM in 2016.  Through the Bank and CFS, the Corporation provides a wide range of financial services, including demand, savings and time deposits, commercial, residential and consumer loans, interest rate swaps, letters of credit, wealth management services, employee benefit plans, insurance products, mutual funds and brokerage services.  The Bank relies substantially on a foundation of locally generated deposits.  The Corporation, on a stand-alone basis, has minimal results of operations.  The Bank derives its income primarily from interest and fees on loans, interest income on investment securities, WMG fee income, and fees received in connection with deposit and other services.  The Bank’s operating expenses are interest expense paid on deposits and borrowings, salaries and employee benefit plans, and general operating expenses. CRM is a Nevada-based captive insurance company which insures against certain risks unique to the operations of the Corporation and its subsidiaries and for which insurance may not be currently available or economically feasible in today's insurance marketplace. CRM pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.


38



Forward-looking Statements

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. 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 the Corporation’s growth, competition, changes in law or the regulatory environment, including the Dodd-Frank Act, and changes in general business and economic trends. Information concerning these and other factors can be found in the Corporation’s periodic filings with the SEC, including the discussion under the heading “Item 1A. Risk Factors” in the Corporation’s 2016 Annual Report on Form 10-K.  These filings are available publicly on the SEC’s web site at http://www.sec.gov, on the Corporation's web site at http://www.chemungcanal.com or upon request from the Corporate Secretary at (607) 737-3746. Except as otherwise required by law, the Corporation undertakes no obligation to publicly update or revise its forward-looking statements, whether as a result of new information, future events or otherwise.



39



Consolidated Financial Highlights
 
 
 
As of or for the Three Months Ended
 
March 31,
 
Dec. 31,
 
Sept. 30,
 
June 30,
 
March 31,
 
2017
 
2016
 
2016
 
2016
 
2016
(in thousands, except per share data)
RESULTS OF OPERATIONS
 
 
 
 
 
 
 
 
 
Interest income
$
14,314

 
$
14,269

 
$
14,025

 
$
13,925

 
$
13,949

Interest expense
820

 
973

 
985

 
957

 
924

Net interest income
13,494

 
13,296

 
13,040

 
12,968

 
13,025

Provision for loan losses
1,040

 
404

 
1,050

 
388

 
595

Net interest income after provision for loan losses
12,454

 
12,892

 
11,990

 
12,580

 
12,430

Non-interest income
4,847

 
4,897

 
5,435

 
5,216

 
5,601

Non-interest expense
13,045

 
13,561

 
13,471

 
15,570

 
14,008

Income before income tax expense
4,256

 
4,228

 
3,954

 
2,226

 
4,023

Income tax expense
1,277

 
1,274

 
1,209

 
605

 
1,316

Net income
$
2,979

 
$
2,954

 
$
2,745

 
$
1,621

 
$
2,707

 
 
 
 
 
 
 
 
 
 
Basic and diluted earnings per share
$
0.62

 
$
0.62

 
$
0.58

 
$
0.34

 
$
0.57

Average basic and diluted shares outstanding
4,790

 
4,773

 
4,765

 
4,760

 
4,750

 
PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average assets
0.71
%
 
0.69
%
 
0.65
%
 
0.39
%
 
0.67
%
Return on average equity
8.24
%
 
8.20
%
 
7.55
%
 
4.57
%
 
7.73
%
Return on average tangible equity (a)
9.90
%
 
9.92
%
 
9.14
%
 
5.55
%
 
9.45
%
Efficiency ratio (a) (b)
69.25
%
 
72.63
%
 
71.28
%
 
77.00
%
 
76.89
%
Non-interest expense to average assets
3.12
%
 
3.18
%
 
3.20
%
 
3.75
%
 
3.48
%
Loans to deposits
79.93
%
 
82.42
%
 
80.62
%
 
81.83
%
 
82.75
%
 
YIELDS / RATES - Fully Taxable Equivalent
 
 
 
 
 
 
 
 
 
Yield on loans
4.19
%
 
4.16
%
 
4.16
%
 
4.17
%
 
4.21
%
Yield on investments
2.00
%
 
1.75
%
 
1.73
%
 
1.81
%
 
2.07
%
Yield on interest-earning assets
3.66
%
 
3.57
%
 
3.58
%
 
3.60
%
 
3.72
%
Cost of interest-bearing deposits
0.20
%
 
0.21
%
 
0.21
%
 
0.21
%
 
0.20
%
Cost of borrowings
3.04
%
 
3.13
%
 
3.15
%
 
3.16
%
 
2.66
%
Cost of interest-bearing liabilities
0.30
%
 
0.35
%
 
0.36
%
 
0.35
%
 
0.35
%
Interest rate spread
3.36
%
 
3.22
%
 
3.22
%
 
3.25
%
 
3.37
%
Net interest margin, fully taxable equivalent
3.45
%
 
3.33
%
 
3.33
%
 
3.36
%
 
3.47
%
 
CAPITAL
 
 
 
 
 
 
 
 
 
Total equity to total assets at end of period
8.54
%
 
8.67
%
 
8.38
%
 
8.52
%
 
8.58
%
Tangible equity to tangible assets at end of period (a)
7.23
%
 
7.29
%
 
7.03
%
 
7.12
%
 
7.14
%
 
 
 
 
 
 
 
 
 
 
Book value per share
$
30.93

 
$
30.07

 
$
30.37

 
$
30.12

 
$
29.64

Tangible book value per share
25.81

 
24.89

 
25.13

 
24.81

 
24.28

Period-end market value per share
39.50

 
36.35

 
28.99

 
29.35

 
26.35

Dividends declared per share
0.26

 
0.26

 
0.26

 
0.26

 
0.26

 
AVERAGE BALANCES
 
 
 
 
 
 
 
 
 
Loans and loans held for sale (c)
$
1,215,445

 
$
1,210,922

 
$
1,199,367

 
$
1,192,786

 
$
1,175,051

Earning assets
1,605,460

 
1,607,287

 
1,577,348

 
1,573,306

 
1,527,656

Total assets
1,694,199

 
1,699,059

 
1,674,492

 
1,669,654

 
1,620,547

Deposits
1,495,724

 
1,483,348

 
1,456,622

 
1,457,173

 
1,404,487

Total equity
146,642

 
143,388

 
144,631

 
142,746

 
140,864

Tangible equity (a)
121,988

 
118,502

 
119,504

 
117,374

 
115,240


40



 
ASSET QUALITY
 
 
 
 
 
 
 
 
 
Net charge-offs
$
333

 
$
1,476

 
$
393

 
$
247

 
$
328

Non-performing loans (d)
12,914

 
12,043

 
12,903

 
12,429

 
12,774

Non-performing assets (e)
13,251

 
12,431

 
13,270

 
12,822

 
14,416

Allowance for loan losses
14,960

 
14,253

 
15,325

 
14,668

 
14,527

 
 
 
 
 
 
 
 
 
 
Annualized net charge-offs to average loans
0.11
%
 
0.48
%
 
0.13
%
 
0.08
%
 
0.11
%
Non-performing loans to total loans
1.05
%
 
1.00
%
 
1.06
%
 
1.03
%
 
1.08
%
Non-performing assets to total assets
0.76
%
 
0.75
%
 
0.77
%
 
0.76
%
 
0.88
%
Allowance for loan losses to total loans
1.21
%
 
1.19
%
 
1.26
%
 
1.22
%
 
1.22
%
Allowance for loan losses to non-performing loans
115.84
%
 
118.35
%
 
118.77
%
 
118.01
%
 
113.72
%
 
 
 
 
 
 
 
 
 
 
(a) See the GAAP to Non-GAAP reconciliations.
(b) Efficiency ratio is non-interest expense less merger and acquisition expenses less amortization of intangible assets less legal reserve divided by the total of fully taxable equivalent net interest income plus non-interest income less net gains on securities transactions.
(c) Loans and loans held for sale do not reflect the allowance for loan losses.
(d) Non-performing loans include non-accrual loans only.
(e) Non-performing assets include non-performing loans plus other real estate owned.

In addition to analyzing the Corporation’s results on a reported basis, management uses certain non-GAAP financial measures, because it believes these non-GAAP financial measures provide information to investors about the underlying operational performance and trends of the Corporation and, therefore, facilitate a comparison of the Corporation with the performance of its competitors. Non-GAAP financial measures used by the Corporation may not be comparable to similarly named non-GAAP financial measures used by other companies. Refer to pages 58-61 for further explanation and reconciliation of the Corporation’s use of non-GAAP measures.

Executive Summary

This executive summary of the MD&A includes selected information and may not contain all of the information that is important to readers of this Form 10-Q. For a complete description of the trends and uncertainties, as well as the risks and critical accounting estimates affecting the Corporation, this Form 10-Q should be read in its entirety.

The following table presents selected financial information for the periods indicated, and the dollar and percent change (in thousands, except per share and ratio data):
 
 
Three Months Ended 
 March 31,
 
 
 
 
 
 
2017
 
2016
 
Change
 
Percentage Change
Net interest income
 
$
13,494

 
$
13,025

 
$
469

 
3.6
 %
Non-interest income
 
4,847

 
5,601

 
(754
)
 
(13.5
)%
Non-interest expense
 
13,045

 
14,008

 
(963
)
 
(6.9
)%
Pre-provision income
 
5,296

 
4,618

 
678

 
14.7
 %
Provision for loan losses
 
1,040

 
595

 
445

 
74.8
 %
Income tax expense
 
1,277

 
1,316

 
(39
)
 
(3.0
)%
Net income
 
$
2,979

 
$
2,707

 
$
272

 
10.0
 %
 
 
 
 
 
 
 
 
 
Basic and diluted earnings per share
 
$
0.62

 
$
0.57

 
$
0.05

 
8.8
 %
 
 
 
 
 
 
 
 
 
Selected financial ratios:
 
 

 
 

 
 

 
 

Return on average assets
 
0.71
%
 
0.67
%
 
 

 
 

Return on average equity
 
8.24
%
 
7.73
%
 
 

 
 

Net interest margin, fully taxable equivalent
 
3.45
%
 
3.47
%
 
 

 
 

Efficiency ratio
 
69.25
%
 
76.89
%
 
 

 
 

Non-interest expense to average assets
 
3.12
%
 
3.48
%
 
 

 
 



41



Net income for the three months ended March 31, 2017 was $3.0 million, or $0.62 per share, compared with a net income of $2.7 million, or $0.57 per share, for the same period in the prior year.  Return on equity for the three months ended March 31, 2017 was 8.24%, compared with 7.73% for the same period in the prior year.  The increase in net income from the prior year was driven by an increase in net interest income and decreases in non-interest expense and income tax expense, offset by a decrease in non-interest income and an increase in the provision for loan losses.

Net interest income
Net interest income increased $0.5 million, or 3.6%, compared with the same period in the prior year. The increase was due primarily to interest income from the commercial loan portfolio and interest-bearing deposits and a decrease in interest expense on borrowed funds.

Non-interest income
Non-interest income decreased $0.8 million, or 13.5%, compared to the same period in the prior year.  The decrease was due primarily to net gains on securities transactions during the first quarter of 2016, offset by an increase in WMG fee income.

Non-interest expenses
Non-interest expenses decreased $1.0 million, or 6.9%, compared to the same period in the prior year.  The decrease was due primarily to decreases in pension and other employee benefits, net occupancy expense, and data processing expense, offset by an increase in salaries and wages. For the three months ended March 31, 2017, non-interest expenses to average assets was 3.12%, compared with 3.48% for the same period in the prior year.

Provision for loan losses
The provision for loan losses increased $0.4 million, or 74.8%, compared to the same period in the prior year.  The increase was due primarily to growth in the commercial mortgages portfolio and additional reserves on problem assets previously identified during the three months ended March 31, 2017.  Net charge-offs were $0.3 million, compared with $0.3 million for the same period in the prior year.

Consolidated Results of Operations

The following section of the MD&A provides a comparative discussion of the Corporation’s Consolidated Results of Operations on a reported basis for the three months ended March 31, 2017 and 2016. For a discussion of the Critical Accounting Policies, Estimates and Risks and Uncertainties that affect the Consolidated Results of Operations, see page 58 of this Form 10-Q and pages 60 of the Corporation’s 2016 Annual Report.

Net Interest Income

The following table presents net interest income for the periods indicated, and the dollar and percent change (in thousands):
 
Three Months Ended
March 31,
 
 
 
 
 
2017
 
2016
 
Change
 
Percentage Change
Interest and dividend income
$
14,314

 
$
13,949

 
$
365

 
2.6
 %
Interest expense
820

 
924

 
(104
)
 
(11.3
)%
Net interest income
$
13,494

 
$
13,025

 
$
469

 
3.6
 %

Net interest income for the three months ended March 31, 2017 totaled $13.5 million compared with $13.0 million for the same period in the prior year, an increase of $0.5 million, or 3.6%.  Fully taxable equivalent net interest margin was 3.45% for the three months ended March 31, 2017 compared with 3.47% for the same period in the prior year.  The increase in net interest income was due primarily to an increase of $77.8 million in interest-earning assets.  The yield on average interest-earning assets decreased six basis points, while the cost of interest-bearing liabilities decreased five basis points compared to the same period in the prior year. The decline in the yield on interest-earning assets can be mostly attributed to a two basis point decline in the yield on loans and a seven basis point decline in the yield on investments.


42



Average Consolidated Balance Sheet and Interest Analysis

The following tables present certain information related to the Corporation’s average consolidated balance sheets and its consolidated statements of income for the three months ended March 31, 2017 and 2016.  For the purpose of the table below, non-accruing loans are included in the daily average loan amounts outstanding.  Daily balances were used for average balance computations.  Investment securities are stated at amortized cost.  Tax equivalent adjustments have been made in calculating yields on obligations of states and political subdivisions, tax-free commercial loans and dividends on equity investments.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
(in thousands)
Three Months Ended
March 31, 2017
 
Three Months Ended
March 31, 2016
 
Average Balance
 
Interest
 
Yield/ Rate
 
Average Balance
 
Interest
 
Yield/ Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Commercial loans
$
761,216

 
$
8,030

 
4.28
%
 
$
709,541

 
$
7,758

 
4.40
%
Mortgage loans
198,373

 
1,887

 
3.86
%
 
196,600

 
1,940

 
3.97
%
Consumer loans
255,856

 
2,642

 
4.19
%
 
268,911

 
2,598

 
3.89
%
Taxable securities
272,580

 
1,424

 
2.12
%
 
294,319

 
1,438

 
1.97
%
Tax-exempt securities
44,757

 
345

 
3.13
%
 
48,138

 
367

 
3.07
%
Interest-bearing deposits
72,678

 
155

 
0.86
%
 
10,147

 
12

 
0.48
%
Total interest-earning assets
1,605,460

 
14,483

 
3.66
%
 
1,527,656

 
14,113

 
3.72
%
 
 
 
 
 
 
 
 
 
 
 
 
Non-earning assets:
 

 
 

 
 

 
 

 
 

 
 

Cash and due from banks
25,885

 
 

 
 

 
26,676

 
 

 
 

Premises and equipment, net
28,655

 
 

 
 

 
29,199

 
 

 
 

Other assets
53,954

 
 

 
 

 
48,846

 
 

 
 

Allowance for loan losses
(14,349
)
 
 

 
 

 
(14,346
)
 
 

 
 

AFS valuation allowance
(5,406
)
 
 

 
 

 
2,516

 
 

 
 

Total assets
$
1,694,199

 
 

 
 

 
$
1,620,547

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing demand deposits
$
152,954

 
$
36

 
0.10
%
 
$
142,117

 
$
40

 
0.11
%
Savings and insured money market deposits
783,330

 
375

 
0.19
%
 
704,587

 
317

 
0.18
%
Time deposits
141,250

 
127

 
0.36
%
 
164,580

 
150

 
0.37
%
FHLBNY advances, securities sold under agreements to repurchase, and other debt
37,666

 
282

 
3.04
%
 
63,092

 
417

 
2.66
%
Total interest-bearing liabilities
1,115,200

 
820

 
0.30
%
 
1,074,376

 
924

 
0.35
%
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Demand deposits
418,190

 
 

 
 

 
393,202

 
 

 
 

Other liabilities
14,167

 
 

 
 

 
12,105

 
 

 
 

Total liabilities
1,547,557

 
 

 
 

 
1,479,683

 
 

 
 

Shareholders' equity
146,642

 
 

 
 

 
140,864

 
 

 
 

Total liabilities and shareholders’ equity
$
1,694,199

 
 

 
 

 
$
1,620,547

 
 

 
 

Fully taxable equivalent net interest income
 

 
13,663

 
 

 
 

 
13,189

 
 

Net interest rate spread (1)
 

 
 

 
3.36
%
 
 

 
 

 
3.37
%
Net interest margin, fully taxable equivalent (2)
 

 
 

 
3.45
%
 
 

 
 

 
3.47
%
Taxable equivalent adjustment
 

 
(169
)
 
 

 
 

 
(164
)
 
 

Net interest income
 

 
$
13,494

 
 

 
 

 
$
13,025

 
 

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


43



Changes Due to Rate and Volume

Net interest income can be analyzed in terms of the impact of changes in rates and volumes.  The tables below illustrate the extent to which changes in interest rates and the volume of average interest-earning assets and interest-bearing liabilities have affected the Corporation’s interest income and interest expense during the three months ended March 31, 2017 and 2016.  Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rates (changes in rates multiplied by prior volume); and (iii) the net changes.  For purposes of this table, changes that are not due solely to volume or rate changes have been allocated to these categories based on the respective percentage changes in average volume and rate.  Due to the numerous simultaneous volume and rate changes during the periods analyzed, it is not possible to precisely allocate changes between volume and rates.  In addition, average interest-earning assets include non-accrual loans and taxable equivalent adjustments were made.
 
 
Three Months Ended
March 31, 2017 vs. 2016
 
 
Increase/(Decrease)
 
 
Total Change
 
Due to Volume
 
Due to Rate
(in thousands)
 
Interest and dividend income on:
 
 
 
 
 
 
Commercial loans
 
$
272

 
$
504

 
$
(232
)
Mortgage loans
 
(53
)
 
13

 
(66
)
Consumer loans
 
44

 
(137
)
 
181

Taxable investment securities
 
(14
)
 
(114
)
 
100

Tax-exempt investment securities
 
(22
)
 
(28
)
 
6

Interest-earning deposits
 
143

 
128

 
15

Total interest and dividend income
 
370

 
366

 
4

 
 
 
 
 
 
 
Interest expense on:
 
 
 
 
 
 
Interest-bearing demand deposits
 
(4
)
 
2

 
(6
)
Savings and insured money market deposits
 
58

 
39

 
19

Time deposits
 
(23
)
 
(19
)
 
(4
)
FHLBNY advances, securities sold under agreements to repurchase and other debt
 
(135
)
 
(187
)
 
52

Total interest expense
 
(104
)
 
(165
)
 
61

Net interest income, fully taxable equivalent
 
$
474

 
$
531

 
$
(57
)

Provision for loan losses

Management performs an ongoing assessment of the adequacy of the allowance for loan losses based upon a number of factors including an analysis of historical loss factors, collateral evaluations, recent charge-off experience, credit quality of the loan portfolio, current economic conditions and loan growth. Based on this analysis, the provision for loan losses for the three months ended March 31, 2017 and 2016 were $1.0 million and $0.6 million, respectively. Net charge-offs for the three months ended March 31, 2017 and 2016 were $0.3 million and $0.3 million, respectively. The increase in the provision for loan losses for the three months ended March 31, 2017, compared to the same period in the prior year, was due to increases in the commercial mortgage portfolio and additional reserves on problem assets previously identified.


44



Non-interest income

The following table presents non-interest income for the periods indicated, and the dollar and percent change (in thousands):
 
 
Three Months Ended
March 31,
 
 
 
 
 
 
2017
 
2016
 
Change
 
Percentage Change
WMG fee income
 
$
2,109

 
$
2,012

 
$
97

 
4.8
 %
Service charges on deposit accounts
 
1,184

 
1,135

 
49

 
4.3
 %
Interchange revenue from debit card transactions
 
920

 
893

 
27

 
3.0
 %
Net gains on securities transactions
 

 
908

 
(908
)
 
(100.0
)%
Net gains on sales of loans held for sale
 
69

 
61

 
8

 
13.1
 %
Net gains (losses) on sales of other real estate owned
 
17

 
(5
)
 
22

 
N/M

Income from bank owned life insurance
 
17

 
18

 
(1
)
 
(5.6
)%
CFS fee and commission income
 
139

 
173

 
(34
)
 
(19.7
)%
Other
 
392

 
406

 
(14
)
 
(3.4
)%
Total non-interest income
 
$
4,847

 
$
5,601

 
$
(754
)
 
(13.5
)%

Total non-interest income for the three months ended March 31, 2017 decreased $0.8 million compared with the same period in the prior year.  The decrease was mostly due to a decrease in net gains on securities transactions, offset by an increase in WMG fee income.

WMG fee income
WMG fee income increased compared to the same period in the prior year due to an increase in assets under management or administration.

Net gains on securities transactions
Net gains on securities transactions decreased compared to the same period in the prior year due to a $0.9 million net gain on the sale $14.5 million of U.S. Treasuries during the same period in the prior year.


45



Non-interest expense

The following table presents non-interest expense for the periods indicated, and the dollar and percent change (in thousands):
 
 
Three Months Ended
March 31,
 
 
 
 
 
 
2017
 
2016
 
Change
 
Percentage Change
Compensation expense:
 
 
 
 
 
 
 
 
Salaries and wages
 
$
5,275

 
$
5,183

 
$
92

 
1.8
 %
Pension and other employee benefits
 
1,218

 
1,675

 
(457
)
 
(27.3
)%
Total compensation expense
 
6,493

 
6,858

 
(365
)
 
(5.3
)%
 
 
 
 
 
 
 
 
 
Non-compensation expenses:
 
 

 
 

 
 

 
 

Net occupancy expenses
 
1,606

 
1,906

 
(300
)
 
(15.7
)%
Furniture and equipment expenses
 
682

 
772

 
(90
)
 
(11.7
)%
Data processing expenses
 
1,604

 
1,714

 
(110
)
 
(6.4
)%
Professional services
 
300

 
341

 
(41
)
 
(12.0
)%
Amortization of intangible assets
 
226

 
258

 
(32
)
 
(12.4
)%
Marketing and advertising expenses
 
249

 
222

 
27

 
12.2
 %
Other real estate owned expenses
 
19

 
52

 
(33
)
 
(63.5
)%
FDIC insurance
 
325

 
294

 
31

 
10.5
 %
Loan expense
 
116

 
112

 
4

 
3.6
 %
Other
 
1,425

 
1,479

 
(54
)
 
(3.7
)%
Total non-compensation expenses
 
6,552

 
7,150

 
(598
)
 
(8.4
)%
Total non-interest expenses
 
$
13,045

 
$
14,008

 
$
(963
)
 
(6.9
)%

Total non-interest expenses for the three months ended March 31, 2017 decreased $1.0 million compared with the same period in the prior year.  The decrease was due to decreases in compensation expense and non-compensation expenses.

Compensation expense
Compensation expense decreased compared to the same period in the prior year due to a decrease in pension and other employee benefits, offset by an increase in salaries and wages. The decrease in pension and other employee benefits can be attributed to the freezing of accruals for the pension and post-retirement health care plans during the fourth quarter of 2016. The increase in salaries and wages can be attributed to annual merit increases that occur throughout the year, offset by a decline in average full-time equivalent employees.

Non-compensation expenses
Non-compensation expenses decreased compared to the same period in the prior year due primarily to decreases in net occupancy expenses, furniture and equipment expenses, and data processing expenses. The decrease in net occupancy expenses and furniture and equipment expenses can be attributed to the closure of the branch office at 202 East State Street in Ithaca, NY at the end of May 2016 and the related $0.1 million of additional depreciation expense recognized during the first quarter of 2016. The decrease in data processing expenses can be attributed to the renegotiation of contracts and changing of vendors for certain data processing communication lines.


46



Income tax expense

The following table presents income tax expense and the effective tax rate for the periods indicated, and the dollar and percent change (in thousands):
 
 
Three Months Ended
March 31,
 
 
 
 
 
 
2017
 
2016
 
Change
 
Percentage Change
Income before income tax expense
 
$
4,256

 
$
4,023

 
$
233

 
5.8
 %
Income tax expense
 
1,277

 
1,316

 
(39
)
 
(3.0
)%
Effective tax rate
 
30.0
%
 
32.7
%
 
 

 
 


The decrease in the effective tax rate can be attributed to changes in the mix of income and expense subject to U.S. federal, state, and local income taxes. These changes include an increase in the income generated by CCTC Funding, Corp., a real estate investment trust subsidiary of the Bank, and a tax exclusion for insurance premiums within CRM.

Financial Condition

The following table presents selected financial information for the periods indicated, and the dollar and percent change (in thousands):
 
 
March 31,
2017
 
December 31, 2016
 
Change
 
Percentage Change
ASSETS
 
 
 
 
 
 
 
 
Total cash and cash equivalents
 
$
125,685

 
$
74,162

 
$
51,523

 
69.5
 %
Total investment securities
 
309,899

 
312,148

 
(2,249
)
 
(0.7
)%
 
 
 
 
 
 
 
 
 
Loans, net of deferred loan fees
 
1,234,251

 
1,200,290

 
33,961

 
2.8
 %
Allowance for loan losses
 
(14,960
)
 
(14,253
)
 
(707
)
 
5.0
 %
Loans, net
 
1,219,291

 
1,186,037

 
33,254

 
2.8
 %
 
 
 
 
 
 
 
 
 
Goodwill and other intangible assets, net
 
24,543

 
24,769

 
(226
)
 
(0.9
)%
Other assets
 
56,682

 
60,063

 
(3,381
)
 
(5.6
)%
Total assets
 
$
1,736,100

 
$
1,657,179


$
78,921

 
4.8
 %
 
 
 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 

 
 

 
 

 
 

Total deposits
 
$
1,544,251

 
$
1,456,343

 
$
87,908

 
6.0
 %
FHLBNY advances and other debt
 
28,951

 
41,421

 
(12,470
)
 
(30.1
)%
Other liabilities
 
14,641

 
15,667

 
(1,026
)
 
(6.5
)%
Total liabilities
 
1,587,843

 
1,513,431

 
74,412

 
4.9
 %
 
 
 
 
 
 
 
 
 
Total shareholders’ equity
 
148,257

 
143,748

 
4,509

 
3.1
 %
Total liabilities and shareholders’ equity
 
$
1,736,100

 
$
1,657,179

 
$
78,921

 
4.8
 %

Cash and cash equivalents
The increase in cash and cash equivalents can be mostly attributed to an increase in deposits, offset by an increase in total loans and the maturity of one $10.0 million repurchase agreement.

Investment securities
The decrease in investment securities can be mostly attributed to maturities and calls of securities available for sale and securities held to maturity, offset by additional purchases and a decline in realized losses in the securities available for sale portfolio.


47



Loans, net
The increase in total loans can be attributed to increases of $34.0 million in commercial mortgages and $1.5 million in commercial and agriculture loans, offset by a decrease of $1.3 million in indirect consumer loans. The increase in the allowance for loan losses can be mostly attributed to an increase in the commercial loan portfolio and additional reserves on problem assets previously identified.

Goodwill and other intangible assets, net
The decrease in goodwill and other intangible assets, net can be attributed to the amortization of intangible assets.

Other assets
The decrease in other assets can be mostly attributed to a decline in the deferred tax asset.

Deposits
The increase in deposits can be attributed to increases of $14.3 million in non-interest bearing demand deposits, $18.0 million in interest-bearing demand deposits, $48.6 million in money market accounts, and $10.5 million in savings deposits. Partially offsetting the increases noted above was a decrease of $3.5 million in time deposits. The changes in money market accounts and demand deposits can be mostly attributed to new municipal clients, along with the seasonal inflow of deposits from existing municipal clients.

FHLBNY advances and other debt
The decrease in FHLBNY advances and other debt can be mostly attributed to the maturity of one $10.0 million repurchase agreement during the first quarter of 2017.

Other liabilities
The decrease in other liabilities can be mostly attributed to payment of 2016 annual employee incentives and employer retirement contribution during the first quarter.

Shareholders’ equity
The increase in shareholders’ equity was primarily due to earnings of $3.0 million, a reduction of $0.5 million in treasury stock, and a decrease of $2.0 million in accumulated other comprehensive loss, mostly attributable to the increase in the fair market value of the securities portfolio, offset by $1.2 million in dividends declared during the year.

Assets under management or administration
The market value of total assets under management or administration in our WMG was $1.803 billion at March 31, 2017, including $327.5 million of assets held under management or administration for the Corporation, compared with $1.721 billion at December 31, 2016, including $294.9 million of assets held under management or administration for the Corporation, an increase of $81.6 million, or 4.7%.

Securities

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


48



Marketable securities are classified as Available for Sale, while investments in local municipal obligations are generally classified as Held to Maturity.  The composition of the available for sale segment of the securities portfolio is summarized in the table as follows (in thousands):
SECURITIES AVAILABLE FOR SALE
 
 
March 31, 2017
 
December 31, 2016
 
 
Amortized Cost
 
Estimated Fair Value
 
Percent of Total Estimated Fair Value
 
Amortized Cost
 
Estimated Fair Value
 
Percent of Total Estimated Fair Value
Obligations of U.S. Government sponsored enterprises
 
$
17,295

 
$
17,440

 
5.8
%
 
$
17,300

 
$
17,455

 
5.8
%
Mortgage-backed securities, residential and collateralized mortgage obligations
 
244,049

 
239,678

 
79.2
%
 
253,156

 
245,866

 
81.0
%
Obligations of states and political subdivisions
 
44,007

 
44,155

 
14.6
%
 
38,843

 
38,740

 
12.8
%
Other securities
 
1,063

 
1,308

 
0.4
%
 
1,102

 
1,341

 
0.4
%
Total
 
$
306,414

 
$
302,581

 
100.0
%
 
$
310,401

 
$
303,402

 
100.0
%

The available for sale segment of the securities portfolio totaled $302.6 million at March 31, 2017, a decrease of $0.8 million, or 0.3%, from $303.4 million at December 31, 2016.  The decrease can be mostly attributed to maturities and calls, offset by additional purchases and a decline in unrealized losses.

The held to maturity segment of the securities portfolio consists of obligations of political subdivisions in the Corporation’s market areas.  These securities totaled $3.7 million at March 31, 2017, a decrease of $1.0 million, or 20.9%, from $4.7 million at December 31, 2016.

Loans

The Corporation has reporting systems to monitor: (i) loan origination and concentrations, (ii) delinquent loans, (iii) non-performing assets, including non-performing loans, troubled debt restructurings, and other real estate owned, (iv) impaired loans, and (v) potential problem loans.  Management reviews these systems on a regular basis.

The table below presents the Corporation’s loan composition by segment for the periods indicated, and the dollar and percent change from December 31, 2016 to March 31, 2017 (in thousands):

LOANS
 
March 31, 2017
 
December 31, 2016
 
Dollar Change
 
Percentage Change
Commercial and agricultural
$
178,075

 
$
176,561

 
$
1,514

 
0.9
 %
Commercial mortgages
602,612

 
568,656

 
33,956

 
6.0
 %
Residential mortgages
198,020

 
198,493

 
(473
)
 
(0.2
)%
Indirect consumer loans
138,273

 
139,572

 
(1,299
)
 
(0.9
)%
Other consumer loans
117,271

 
117,008

 
263

 
0.2
 %
Total loans, net of deferred loan fees
$
1,234,251

 
$
1,200,290

 
$
33,961

 
2.8
 %

Portfolio loans totaled $1.234 billion at March 31, 2017, an increase of $34.0 million, or 2.8%, from $1.200 billion at December 31, 2016.  The increase in loans can be attributed to increases of $1.5 million in commercial and agricultural loans, $34.0 million in commercial mortgages, and $0.3 million in other consumer loans, offset by decreases of $0.5 million in residential mortgages and $1.3 million in indirect consumer loans. The growth in commercial mortgages was due primarily to an increase in the Capital Bank division in the Albany, New York region. 

Residential mortgage loans totaled $198.0 million at March 31, 2017, a decline of $0.5 million, or 0.2%, from December 31, 2016.  In addition, during the three months ended March 31, 2017, $3.4 million of newly originated residential mortgages were sold in the secondary market to Freddie Mac and $0.1 million of residential mortgages were sold to the State of New York Mortgage Agency. 

49




The Corporation anticipates that future growth in portfolio loans will continue to be in commercial mortgages and commercial and industrial loans, especially within the Capital Bank division of the Bank. The table below presents the Corporation’s outstanding loan balance by bank division (in thousands):
LOANS BY DIVISION
 
March 31, 2017
 
December 31, 2016
 
December 31, 2015
 
December 31, 2014
 
December 31, 2013
Chemung Canal Trust Company*
$
630,930

 
$
636,836

 
$
683,137

 
$
724,099

 
$
687,256

Capital Bank Division
603,321

 
563,454

 
485,496

 
397,475

 
308,610

Total loans
$
1,234,251

 
$
1,200,290

 
$
1,168,633

 
$
1,121,574

 
$
995,866

* All loans, excluding those originated by the Capital Bank division.

Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions.  Specific industries are identified using NAICS codes.  The Corporation monitors specific NAICS industry classifications of commercial loans to identify concentrations greater than 10.0% of total loans.  At March 31, 2017 and December 31, 2016, commercial loans to borrowers involved in the real estate, and real estate rental and lending businesses were 44.7% and 43.9% of total loans, respectively.  No other concentration of loans existed in the commercial loan portfolio in excess of 10.0% of total loans as of March 31, 2017 and December 31, 2016.

Non-Performing Assets

Non-performing assets consist of non-accrual loans, non-accrual troubled debt restructurings and other real estate owned that has been acquired in partial or full satisfaction of loan obligations or upon foreclosure.

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

The following table summarizes the Corporation's non-performing assets, excluding acquired PCI loans (in thousands):
NON-PERFORMING ASSETS
 
March 31, 2017
 
December 31, 2016
Non-accrual loans
$
8,500

 
$
7,649

Non-accrual troubled debt restructurings
4,414

 
4,394

Total non-performing loans
12,914

 
12,043

Other real estate owned
337

 
388

Total non-performing assets
$
13,251

 
$
12,431

 
 
 
 
Ratio of non-performing loans to total loans
1.05
%
 
1.00
%
Ratio of non-performing assets to total assets
0.76
%
 
0.75
%
Ratio of allowance for loan losses to non-performing loans
115.84
%
 
118.35
%
 
 
 
 
Accruing loans past due 90 days or more (1)
$
27

 
$
13

Accruing troubled debt restructurings (1)
5,890

 
5,839

(1) These loans are not included in non-performing assets above.
 
 
 

Non-Performing Loans

50




Non-performing loans totaled $12.9 million at March 31, 2017, or 1.05% of total loans, compared with $12.0 million at December 31, 2016, or 1.00% of total loans. The increase in non-performing loans at March 31, 2017 was primarily in commercial mortgage, offset by residential mortgage. Non-performing assets, which are comprised of non-performing loans and other real estate owned, was $13.3 million, or 0.76% of total assets, at March 31, 2017, compared with $12.4 million, or 0.75% of total assets, at December 31, 2016.

Not included in non-performing loan totals are $1.3 million of acquired loans which the Corporation has identified as PCI loans.  The PCI loans are accounted for under separate accounting guidance, Accounting Standards Codification (“ASC”) Subtopic 310-30, “Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality” as disclosed in Note 4 of the financial statements.

Accruing Loans Past due 90 Days or More

The recorded investment in accruing loans past due 90 days or more totaled $27.0 thousand at March 31, 2017, an increase of $14.0 thousand from December 31, 2016.

Troubled Debt Restructurings

The Corporation works closely with borrowers that have financial difficulties to identify viable solutions that minimize the potential for loss.  In that regard, the Corporation modified the terms of select loans to maximize their collectability.  The modified loans are considered TDRs under current accounting guidance.  Modifications generally involve short-term deferrals of principal and/or interest payments, reductions of scheduled payment amounts, interest rates or principal of the loan, and forgiveness of accrued interest.  As of March 31, 2017, the Corporation had $4.4 million of non-accrual TDRs compared with $4.4 million as of December 31, 2016.  As of March 31, 2017, the Corporation had $5.9 million of accruing TDRs compared with $5.8 million as of December 31, 2016.

Impaired Loans

A loan is classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect both the principal and interest due under the contractual terms of the loan agreement.  Impaired loans at March 31, 2017 totaled $14.4 million, including TDRs of $10.3 million, compared to $12.9 million at December 31, 2016, including TDRs of $10.2 million.  Not included in the impaired loan totals are acquired loans 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 in impaired loans was due primarily to an increase in commercial mortgage loans.  Included in the recorded investment of impaired loans at March 31, 2017, are loans totaling $4.6 million for which impairment allowances of $1.0 million have been specifically allocated to the allowance for loan losses.  As of December 31, 2016, the impaired loan total included $2.6 million of loans for which specific impairment allowances of $0.9 million were allocated to the allowance for loan losses.

The majority of the Corporation's impaired loans are secured and measured for impairment based on collateral evaluations.  It is the Corporation's policy to obtain updated appraisals, by independent third parties, on loans secured by real estate at the time a loan is determined to be impaired.  An impairment measurement is performed based upon the most recent appraisal on file to determine the amount of any specific allocation or charge-off.  In determining the amount of any specific allocation or charge-off, the Corporation will make adjustments to reflect the estimated costs to sell the property.  Upon receipt and review of the updated appraisal, an additional measurement is performed to determine if any adjustments are necessary to reflect the proper provisioning or charge-off.  Impaired loans are reviewed on a quarterly basis to determine if any changes in credit quality or market conditions would require any additional allocation or recognition of additional charge-offs.  Real estate values in the Corporation's market area have been holding steady.  Non-real estate collateral may be valued using (i) an appraisal, (ii) net book value of the collateral per the borrower’s financial statements, or (iii) accounts receivable aging reports, that may be adjusted based on management’s knowledge of the client and client’s business.  If market conditions warrant, future appraisals are obtained for both real estate and non-real estate collateral.

Allowance for Loan Losses

The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans.  The allowance is established based on management’s evaluation of the probable incurred losses inherent in our portfolio in accordance with GAAP, and is comprised of both specific valuation allowances and general valuation allowances.


51



A loan is classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect both the principal and interest due under the contractual terms of the loan agreement.  Specific valuation allowances are established based on management’s analyses of individually impaired loans.  Factors considered by management in determining impairment include payment status, evaluations of the underlying collateral, expected cash flows, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  If a loan is determined to be impaired and is placed on non-accrual status, all future payments received are applied to principal and 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.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current qualitative 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 qualitative factors based on the risks present for each portfolio class.  These qualitative factors include consideration of the following: (1) lending policies and procedures, including underwriting standards and collection, charge-off and recovery policies, (2) national and local economic and business conditions and developments, including the condition of various market segments, (3) loan profiles and volume of the portfolio, (4) the experience, ability, and depth of lending management and staff, (5) the volume and severity of past due, classified and watch-list loans, non-accrual loans, troubled debt restructurings, and other modifications (6) the quality of the Bank’s loan review system and the degree of oversight by the Bank’s Board of Directors, (7) collateral related issues: secured vs. unsecured, type, declining valuation environment and trend of other related factors, (8) the existence and effect of any concentrations of credit, and changes in the level of such concentrations, (9) the effect of external factors, such as competition and legal and regulatory requirements, on the level of estimated credit losses in the Bank’s current portfolio and (10) the impact of the global economy.

The allowance for loan losses is increased through a provision for loan losses charged to operations.  Loans are charged against the allowance for loan losses when management believes that the collectability of all or a portion of the principal is unlikely.  Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic basis and takes into consideration such factors as the credit risk grade assigned to the loan, historical loan loss experience and review of specific impaired loans.  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.

The allowance for loan losses was $15.0 million at March 31, 2017, up from $14.3 million at December 31, 2016.  The ratio of allowance for loan losses to total loans was 1.21% at March 31, 2017, up from 1.19% at December 31, 2016, respectively.  Net charge-offs for the three months ended March 31, 2017 and 2016 were $0.3 million and $0.3 million, respectively.

52




The table below summarizes the Corporation’s loan loss experience for the three months ended March 31, 2017 and 2016 (in thousands, except ratio data):
SUMMARY OF LOAN LOSS EXPERIENCE
 
Three Months Ended 
 March 31,
 
2017
 
2016
Balance at beginning of period
$
14,253

 
$
14,260

 
 
 
 
Charge-offs:
 

 
 

Commercial and agricultural
5

 
8

Commercial mortgages

 

Residential mortgages
12

 

Consumer loans
427

 
443

Total charge-offs
444

 
451

 
 
 
 
Recoveries:
 

 
 

Commercial and agricultural
24

 
32

Commercial mortgages
1

 
7

Residential mortgages
17

 

Consumer loans
69

 
84

Total  recoveries
111

 
123

 
 
 
 
Net charge-offs
333

 
328

Provision for loan losses
1,040

 
595

Balance at end of period
$
14,960

 
$
14,527

 
 
 
 
Ratio of net charge-offs to average loans outstanding
0.11
%
 
0.11
%
Ratio of allowance for loan losses to total loans outstanding
1.21
%
 
1.22
%

Deposits

The table below summarizes the Corporation’s deposit composition by segment for the periods indicated, and the dollar and percent change from December 31, 2016 to March 31, 2017 (in thousands):
DEPOSITS
 
March 31, 2017
 
December 31, 2016
 
Dollar Change
 
Percentage Change
Non-interest-bearing demand deposits
$
432,062

 
$
417,812

 
$
14,250

 
3.4
 %
Interest-bearing demand deposits
154,848

 
136,826

 
18,022

 
13.2
 %
Insured money market accounts
597,547

 
548,963

 
48,584

 
8.9
 %
Savings deposits
219,180

 
208,636

 
10,544

 
5.1
 %
Time deposits
140,614

 
144,106

 
(3,492
)
 
(2.4
)%
Total
$
1,544,251

 
$
1,456,343

 
$
87,908

 
6.0
 %

Deposits totaled $1.544 billion at March 31, 2017 compared with $1.456 billion at December 31, 2016, an increase of $87.9 million, or 6.0%. The increase was attributable to increases of $14.3 million in non-interest bearing demand deposits, $18.0 million in interest-bearing demand deposits, $48.6 million in money market accounts, and $10.5 million in savings deposits. These items were offset by a decrease of $3.5 million in time deposits. The changes in money market accounts can be attributed to new municipal clients, along with the seasonal inflow of deposits from current municipal clients.  At March 31, 2017, demand deposit and money market accounts comprised 76.7% of total deposits compared with 75.8% at December 31, 2016.


53



The table below presents the Corporation's deposits balance by bank division (in thousands):
DEPOSITS BY DIVISION
 
March 31, 2017
 
December 31, 2016
 
December 31, 2015
 
December 31, 2014
 
December 31, 2013
Chemung Canal Trust Company*
$
1,346,322

 
$
1,249,870

 
$
1,219,282

 
$
1,119,377

 
$
1,097,920

Capital Bank Division
197,929

 
206,473

 
181,013

 
160,637

 
168,336

Total loans
$
1,544,251

 
$
1,456,343

 
$
1,400,295

 
$
1,280,014

 
$
1,266,256

*All deposits, excluding those originated by the Capital Bank Division.

In addition to consumer, commercial and public deposits, other sources of funds include brokered deposits.  Brokered deposits include funds obtained through brokers, and the Bank’s participation in the CDARS and ICS programs.  There were no deposits obtained through brokers as of March 31, 2017 and December 31, 2016. Deposits obtained through the CDARS and ICS programs were $255.6 million and $203.7 million as of March 31, 2017 and December 31, 2016, respectively.  The increase in CDARS and ICS deposits was due to the Corporation offering the programs to new municipal clients, in addition to the seasonal inflow of current municipal client balances.

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

The Corporation also considers brokered deposits to be an element of its deposit strategy and anticipates that it will continue using brokered deposits as a secondary source of funding to support growth.

Borrowings

Securities sold under agreements to repurchase decreased $12.4 million from $27.6 million at December 31, 2016 to $15.2 million at March 31, 2017.  The decrease in securities sold under agreements to repurchase was related to the maturity of one $10.0 million repurchase agreement and normal fluctuations in client accounts.

Shareholders’ Equity

Shareholders’ equity was $148.3 million at March 31, 2017 compared with $143.7 million at December 31, 2016.  The increase was primarily due to earnings of $3.0 million and a reduction of $0.5 million in treasury stock and a decrease of $2.0 million in accumulated other comprehensive loss, offset by $1.2 million in dividends declared during the three months ended March 31, 2017.  The total shareholders’ equity to total assets ratio was 8.54% at March 31, 2017 compared with 8.67% at December 31, 2016.  The tangible equity to tangible assets ratio was 7.23% at March 31, 2017 compared with 7.29% at December 31, 2016.  Book value per share increased to $30.93 at March 31, 2017 from $30.07 at December 31, 2016.

The Corporation and the Bank are subject to capital adequacy guidelines of the Federal Reserve which establish a framework for the classification of financial holding companies and financial institutions into five categories:  well-capitalized, adequately capitalized, under-capitalized, significantly under-capitalized and critically under-capitalized.  As of March 31, 2017, the Bank’s capital ratios were in excess of those required to be considered well-capitalized under regulatory capital guidelines and the Corporation met capital requirements under regulatory guidelines.

Off-balance Sheet Arrangements

See Note 9 – Commitments and Contingencies in the Notes to Unaudited Consolidated Financial Statements for a discussion of off-balance sheet arrangements.


54



Liquidity

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

The Corporation is a member of the FHLBNY 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 $125.2 million and $131.6 million at March 31, 2017 and December 31, 2016, respectively.  The Corporation also had a total of $28.0 million of unsecured lines of credit with four different financial institutions, all of which was available at March 31, 2017 and December 31, 2016.

Consolidated Cash Flows Analysis

The table below summarizes the Corporation's cash flows for the periods indicated (in thousands):
CONSOLIDATED SUMMARY OF CASH FLOWS
(in thousands)
 
Three Months Ended
March 31,
 
 
2017
 
2016
Net cash provided by operating activities
 
$
6,504

 
$
5,821

Net cash (used in) provided by investing activities
 
(29,411
)
 
4,532

Net cash provided by financing activities
 
74,430

 
19,321

Net increase in cash and cash equivalents
 
$
51,523

 
$
29,674


Operating activities

The Corporation believes cash flows from operations, available cash balances and its ability to generate cash through short- and long-term borrowings are sufficient to fund the Corporation’s operating liquidity needs.

Cash provided by operating activities in the first three months of 2017 and 2016 predominantly resulted from net income after non-cash operating adjustments. 

Investing activities

Cash used by investing activities during the first three months of 2017 predominantly resulted from a net increase in loans and purchases of securities, offset by sales, calls, maturities, and principal collected in securities available for sale. Cash provided by investing activities during the first three months of 2016 predominantly resulted from sales, calls, maturities, and principal collected on securities available for sale, offset by a net increase in loans. 

Financing activities

Cash provided by financing activities during the first three months of 2017 and 2016 predominantly resulted from an increase in deposits, offset by the maturity of one $10.0 million repurchase agreement in 2017 and the redemption of FHLBNY overnight advances that were no longer needed with the inflow of municipal deposit in 2016.

Capital Resources

The Corporation and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel III rules became effective for the Corporation on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Under Basel III rules, the Corporation must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer is being phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2017 is 1.25%.

55



The net unrealized gain or loss on available for sale securities and changes in the funded status of the defined benefit pension plan and other benefit plans are not included in computing regulatory capital. Management believes as of March 31, 2017, the Corporation and the Bank meet all capital adequacy requirements to which they are subject.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. Management believes that, as of March 31, 2017 and December 31, 2016, the Corporation and the Bank met all capital adequacy requirements to which they were subject.

As of March 31, 2017, the most recent notification from the Federal Reserve Bank of New York categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, common equity Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below.  There have been no conditions or events since that notification that management believes have changed the Bank's or the Corporation's capital category.

The regulatory capital ratios as of March 31, 2017 and December 31, 2016 were calculated under Basel III rules. There is no threshold for well-capitalized status for bank holding companies.

The Corporation’s and the Bank’s actual and required regulatory capital ratios were as follows (in thousands, except ratio data):
 
Actual
 
Minimum Capital Adequacy
 
Minimum Capital Adequacy with Capital Buffer
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
As of March 31, 2017
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
Total Capital (to Risk Weighted Assets):
 
Consolidated
$
148,082

 
12.10
%
 
$
97,930

 
8.00
%
 
$
113,231

 
9.250
%
 
 N/A

 
N/A

Bank
$
141,961

 
11.61
%
 
$
97,831

 
8.00
%
 
$
113,117

 
9.250
%
 
$
122,288

 
10.00
%
Tier 1 Capital (to Risk Weighted Assets):
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
133,013

 
10.87
%
 
$
73,447

 
6.00
%
 
$
88,749

 
7.250
%
 
 N/A

 
N/A

Bank
$
126,969

 
10.38
%
 
$
73,373

 
6.00
%
 
$
88,659

 
7.250
%
 
$
97,831

 
8.00
%
Common Equity Tier 1 Capital (to Risk Weighted Assets):
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
133,013

 
10.87
%
 
$
55,086

 
4.50
%
 
$
70,387

 
5.750
%
 
 N/A

 
N/A

Bank
$
126,969

 
10.38
%
 
$
55,030

 
4.50
%
 
$
70,316

 
5.750
%
 
$
79,487

 
6.50
%
Tier 1 Capital (to Average Assets):
 

 
 
 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
133,013

 
7.95
%
 
$
66,964

 
4.00
%
 
N/A

 
N/A

 
 N/A

 
N/A

Bank
$
126,969

 
7.60
%
 
$
66,858

 
4.00
%
 
N/A

 
N/A

 
$
83,573

 
5.00
%


56



 
Actual
 
Required To Be Adequately Capitalized
 
Minimum Capital Adequacy with Capital Buffer
 
Required To Be Well Capitalized
As of December 31, 2016
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
Total Capital (to Risk Weighted Assets):
 
Consolidated
$
145,269

 
12.14
%
 
$
95,748

 
8.00
%
 
$
103,229

 
8.625
%
 
 N/A

 
N/A

Bank
$
140,020

 
11.71
%
 
$
95,640

 
8.00
%
 
$
103,112

 
8.625
%
 
$
119,550

 
10.00
%
Tier 1 Capital (to Risk Weighted Assets):
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
130,911

 
10.94
%
 
$
71,811

 
6.00
%
 
$
79,292

 
6.625
%
 
 N/A

 
N/A

Bank
$
125,736

 
10.52
%
 
$
71,730

 
6.00
%
 
$
79,202

 
6.625
%
 
$
95,640

 
8.00
%
Common Equity Tier 1 Capital (to Risk Weighted Assets):
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
130,911

 
10.94
%
 
$
53,858

 
4.50
%
 
$
61,339

 
5.125
%
 
 N/A

 
N/A

Bank
$
125,736

 
10.52
%
 
$
53,798

 
4.50
%
 
$
61,270

 
5.125
%
 
$
77,708

 
6.50
%
Tier 1 Capital (to Average Assets):
 

 
 
 
 

 
 

 
 
 
 
 
 

 
 

Consolidated
$
130,911

 
7.81
%
 
$
67,031

 
4.00
%
 
N/A

 
N/A

 
 N/A

 
N/A

Bank
$
125,736

 
7.52
%
 
$
66,919

 
4.00
%
 
N/A

 
N/A

 
$
83,649

 
5.00
%

Dividend Restrictions

The Corporation’s principal source of funds for dividend payments is dividends received from the Bank.  Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies.  Under these regulations, the amount of dividends that may be paid in any calendar year is limited to current year’s net income, combined with the retained net income of the preceding two years, subject to the capital requirements in the table below.  At March 31, 2017, the Bank could, without prior approval, declare dividends of approximately $13.4 million.

Adoption of New Accounting Standards

Please refer to Footnote 1, Summary of Significant Accounting Policies - Recent Accounting Pronouncements for a discussion of new accounting standards.

Critical Accounting Policies, Estimates and Risks and Uncertainties

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

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


57



Explanation and Reconciliation of the Corporation’s Use of Non-GAAP Measures

The Corporation prepares its Consolidated Financial Statements in accordance with GAAP; these financial statements appear on pages 6–11. That presentation provides the reader with an understanding of the Corporation’s results that can be tracked consistently from year-to-year and enables a comparison of the Corporation’s performance with other companies’ GAAP financial statements.

In addition to analyzing the Corporation’s results on a reported basis, management uses certain non-GAAP financial measures, because it believes these non-GAAP financial measures provide information to investors about the underlying operational performance and trends of the Corporation and, therefore, facilitate a comparison of the Corporation with the performance of its competitors. Non-GAAP financial measures used by the Corporation may not be comparable to similarly named non-GAAP financial measures used by other companies.

The SEC has adopted Regulation G, which applies to all public disclosures, including earnings releases, made by registered companies that contain “non-GAAP financial measures.”  Under Regulation G, companies making public disclosures containing non-GAAP financial measures must also disclose, along with each non-GAAP financial measure, certain additional information, including a reconciliation of the non-GAAP financial measure to the closest comparable GAAP financial measure and a statement of the Corporation’s reasons for utilizing the non-GAAP financial measure as part of its financial disclosures.  The SEC has exempted from the definition of “non-GAAP financial measures” certain commonly used financial measures that are not based on GAAP.  When these exempted measures are included in public disclosures, supplemental information is not required.  The following measures used in this Report, which are commonly utilized by financial institutions, have not been specifically exempted by the SEC and may constitute "non-GAAP financial measures" within the meaning of the SEC's new rules, although we are unable to state with certainty that the SEC would so regard them.

Fully Taxable Equivalent Net Interest Income, Net Interest Margin, and Efficiency Ratio

Net interest income is commonly presented on a tax-equivalent basis.  That is, to the extent that some component of the institution's net interest income, which is presented on a before-tax basis, is exempt from taxation (e.g., is received by the institution as a result of its holdings of state or municipal obligations), an amount equal to the tax benefit derived from that component is added to the actual before-tax net interest income total.  This adjustment is considered helpful in comparing one financial institution's net interest income to that of other institutions or in analyzing any institution’s net interest income trend line over time, to correct any analytical distortion that might otherwise arise from the fact that financial institutions vary widely in the proportions of their portfolios that are invested in tax-exempt securities, and that even a single institution may significantly alter over time the proportion of its own portfolio that is invested in tax-exempt obligations.  Moreover, net interest income is itself a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average interest-earning assets.  For purposes of this measure as well, fully taxable equivalent net interest income is generally used by financial institutions, as opposed to actual net interest income, again to provide a better basis of comparison from institution to institution and to better demonstrate a single institution’s performance over time.  The Corporation follows these practices.

The efficiency ratio is a non-GAAP financial measures which represents the Corporation’s ability to turn resources into revenue and is calculated as non-interest expense divided by total revenue (fully taxable equivalent net interest income and non-interest income), adjusted for one-time occurrences and amortization.  This measure is meaningful to the Corporation, as well as investors and analysts, in assessing the Corporation’s productivity measured by the amount of revenue generated for each dollar spent.
 

58



 
 
 
 
 
 
 
 
 
 
 
As of the Three Months Ended
(in thousands, except ratio data)
March 31,
 
Dec. 31,
 
Sept. 30,
 
June 30,
 
March 31,
2017
 
2016
 
2016
 
2016
 
2016
NET INTEREST MARGIN - FULLY TAXABLE EQUIVALENT AND EFFICIENCY RATIO
 
 
 
 
 
 
 
 
 
Net interest income (GAAP)
$
13,494

 
$
13,296

 
$
13,040

 
$
12,968

 
$
13,025

Fully taxable equivalent adjustment
169

 
154

 
154

 
159

 
164

Fully taxable equivalent net interest income (non-GAAP)
$
13,663

 
$
13,450

 
$
13,194

 
$
13,127

 
$
13,189

 
 
 
 
 
 
 
 
 
 
Non-interest income (GAAP)
$
4,847

 
$
4,897

 
$
5,435

 
$
5,216

 
$
5,601

Less:  net (gains) losses on security transactions

 
(4
)
 
(75
)
 

 
(908
)
Adjusted non-interest income (non-GAAP)
$
4,847

 
$
4,893

 
$
5,360

 
$
5,216

 
$
4,693

 
 
 
 
 
 
 
 
 
 
Non-interest expense (GAAP)
$
13,045

 
$
13,561

 
$
13,471

 
$
15,570

 
$
14,008

Less:  amortization of intangible assets
(226
)
 
(238
)
 
(245
)
 
(245
)
 
(258
)
Less: legal reserve

 

 

 
(1,200
)
 

Adjusted non-interest expense (non-GAAP)
$
12,819

 
$
13,323

 
$
13,226

 
$
14,125

 
$
13,750

 
 
 
 
 
 
 
 
 
 
Average interest-earning assets (GAAP)
$
1,605,460

 
$
1,607,287

 
$
1,577,348

 
$
1,573,306

 
$
1,524,656

 
 
 
 
 
 
 
 
 
 
Net interest margin - fully taxable equivalent (non-GAAP)
3.45
%
 
3.33
%
 
3.33
%
 
3.36
%
 
3.47
%
Efficiency ratio (non-GAAP)
69.25
%
 
72.63
%
 
71.28
%
 
77.00
%
 
76.89
%

Tangible Equity and Tangible Assets (Period-End)

Tangible equity, tangible assets, and tangible book value per share are each non-GAAP financial measures. Tangible equity represents the Corporation’s stockholders’ equity, less goodwill and intangible assets.  Tangible assets represents the Corporation’s total assets, less goodwill and other intangible assets.  Tangible book value per share represents the Corporation’s equity divided by common shares at period-end.  These measures are meaningful to the Corporation, as well as investors and analysts, in assessing the Corporation’s use of equity.
 
 
 
 
 
 
 
 
 
 
 
 
As of or for the Three Months Ended
(in thousands, except per share and ratio data)
March 31,
 
Dec. 31,
 
Sept. 30,
 
June 30,
 
March 31,
2017
 
2016
 
2016
 
2016
 
2016
TANGIBLE EQUITY AND TANGIBLE ASSETS
 
 
 
 
 
 
 
 
 
(PERIOD END)
 
 
 
 
 
 
 
 
 
Total shareholders' equity (GAAP)
$
148,257

 
$
143,748

 
$
144,812

 
$
143,409

 
$
141,046

Less: intangible assets
(24,543
)
 
(24,769
)
 
(25,007
)
 
(25,252
)
 
(25,497
)
Tangible equity (non-GAAP)
$
123,714

 
$
118,979

 
$
119,805

 
$
118,157

 
$
115,549

 
 
 
 
 
 
 
 
 
 
Total assets (GAAP)
$
1,736,100

 
$
1,657,179

 
$
1,728,865

 
$
1,683,932

 
$
1,643,226

Less: intangible assets
(24,543
)
 
(24,769
)
 
(25,007
)
 
(25,252
)
 
(25,497
)
Tangible assets (non-GAAP)
$
1,711,557

 
$
1,632,410

 
$
1,703,858

 
$
1,658,680

 
$
1,617,729

 
 
 
 
 
 
 
 
 
 
Total equity to total assets at end of period (GAAP)
8.54
%
 
8.67
%
 
8.38
%
 
8.52
%
 
8.58
%
Book value per share (GAAP)
$
30.93

 
$
30.07

 
$
30.37

 
$
30.12

 
$
29.64

 
 
 
 
 
 
 
 
 
 
Tangible equity to tangible assets at end of period (non-GAAP)
7.23
%
 
7.29
%
 
7.03
%
 
7.12
%
 
7.14
%
Tangible book value per share (non-GAAP)
$
25.81

 
$
24.89

 
$
25.13

 
$
24.81

 
$
24.28


59



 
Tangible Equity (Average)

Average tangible equity and return on average tangible equity are each non-GAAP financial measures. Average tangible equity represents the Corporation’s average stockholders’ equity, less average goodwill and intangible assets for the period.  Return on average tangible equity measures the Corporation’s earnings as a percentage of average tangible equity.  These measures are meaningful to the Corporation, as well as investors and analysts, in assessing the Corporation’s use of equity.
 
 
 
 
 
 
 
 
 
 
 
As of or for the Three Months Ended
 
March 31,
 
Dec. 31,
 
Sept. 30,
 
June 30,
 
March 31,
(in thousands, except ratio data)
2017
 
2016
 
2016
 
2016
 
2016
TANGIBLE EQUITY (AVERAGE)
 
 
 
 
 
 
 
 
 
Total average shareholders' equity (GAAP)
$
146,642

 
$
143,388

 
$
144,631

 
$
142,746

 
$
140,864

Less: average intangible assets
(24,654
)
 
(24,886
)
 
(25,127
)
 
(25,372
)
 
(25,624
)
Average tangible equity (non-GAAP)
$
121,988

 
$
118,502

 
$
119,504

 
$
117,374

 
$
115,240

 
 
 
 
 
 
 
 
 
 
Return on average equity (GAAP)
8.24
%
 
8.20
%
 
7.55
%
 
4.57
%
 
7.73
%
Return on average tangible equity (non-GAAP)
9.90
%
 
9.92
%
 
9.14
%
 
5.55
%
 
9.45
%

Adjustments for Certain Items of Income or Expense

In addition to disclosures of certain GAAP financial measures, including net income, EPS, ROA, and ROE, we may also provide comparative disclosures that adjust these GAAP financial measures for a particular period by removing from the calculation thereof the impact of certain transactions or other material items of income or expense occurring during the period, including certain nonrecurring items.  The Corporation believes that the resulting non-GAAP financial measures may improve an understanding of its results of operations by separating out any such transactions or items that may have had a disproportionate positive or negative impact on the Corporation’s financial results during the particular period in question. In the Corporation’s presentation of any such non-GAAP (adjusted) financial measures not specifically discussed in the preceding paragraphs, the Corporation supplies the supplemental financial information and explanations required under Regulation G.
 
 
 
 
 
 
 
 
 
 
 
As of or for the Three Months Ended
(in thousands, except per share and ratio data)
March 31,
 
Dec. 31,
 
Sept. 30,
 
June 30,
 
March 31,
2017
 
2016
 
2016
 
2016
 
2016
NON-GAAP NET INCOME
 
 
 
 
 
 
 
 
 
Reported net income (GAAP)
$
2,979

 
$
2,954

 
$
2,745

 
$
1,621

 
$
2,707

Net (gains) losses on security transactions (net of tax)

 
(2
)
 
(47
)
 

 
(565
)
Legal reserve (net of tax)

 

 

 
747

 

Non- GAAP net income
$
2,979

 
$
2,952

 
$
2,698

 
$
2,368

 
$
2,142

 
 
 
 
 
 
 
 
 
 
Average basic and diluted shares outstanding
4,790

 
4,773

 
4,765

 
4,760

 
4,750

 
 
 
 
 
 
 
 
 
 
Reported basic and diluted earnings per share (GAAP)
$
0.62

 
$
0.62

 
$
0.58

 
$
0.34

 
$
0.57

Reported return on average assets (GAAP)
0.71
%
 
0.69
%
 
0.65
%
 
0.39
%
 
0.67
%
Reported return on average equity (GAAP)
8.24
%
 
8.20
%
 
7.55
%
 
4.57
%
 
7.73
%
 
 
 
 
 
 
 
 
 
 
Non-GAAP basic and diluted earnings per share
$
0.62

 
$
0.62

 
$
0.57

 
$
0.50

 
$
0.45

Non-GAAP return on average assets
0.71
%
 
0.69
%
 
0.64
%
 
0.57
%
 
0.53
%
Non-GAAP return on average equity
8.24
%
 
8.19
%
 
7.42
%
 
6.67
%
 
6.12
%
 
 

60



ITEM 3:    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

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

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

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

Interest rate risk is the risk that net interest income will fluctuate as a result of a change in interest rates.  It is the assumption of interest rate risk, along with credit risk, that drives the net interest margin of a financial institution. For that reason, the ALCO has established tolerance limits based upon a 200-basis point change in interest rates, with appropriate floors set for interest-bearing liabilities.  At March 31, 2017, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the next 12 months net interest income by 12.78% and an immediate 200-basis point increase would negatively impact the next 12 months net interest income by 7.80%.  Both are within the Corporation's policy guideline of 15%. Given the overall low level of current interest rates and the unlikely event of a 200-basis point decline from this point, management additionally modeled an immediate 100-basis point decline and an immediate 300-basis point increase in interest rates. When applied, it is estimated these scenarios would result in negative impacts to net interest income of 6.85% and 11.86%, respectively.

A related component of interest rate risk is the expectation that the market value of the Corporation’s capital account will fluctuate with changes in interest rates.  This component is a direct corollary to the earnings-impact component: an institution exposed to earnings erosion is also exposed to shrinkage in market value.  At March 31, 2017, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the market value of the Corporation’s capital account by 11.46% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 4.91%.  Both are within the Corporation’s policy guideline of 15%.  Management also modeled the impact to the market value of the Corporation’s capital with an immediate 100-basis point decline and an immediate 300-basis point increase in interest rates, based on the current interest rate environment.  When applied, it is estimated these scenarios would result in negative impacts to the market value of the Corporation’s capital of 4.92% and 7.43%, respectively.

Management does recognize the need for certain hedging strategies during periods of anticipated higher fluctuations in interest rates and the Funds Management Policy provides for limited use of certain derivatives in asset liability management.

Credit Risk

The Corporation manages credit risk consistent with state and federal laws governing the making of loans through written policies and procedures; loan review to identify loan problems at the earliest possible time; collection procedures (continued even after a loan is charged off); an adequate allowance for loan losses; and continuing education and training to ensure lending expertise.  Diversification by loan product is maintained through offering commercial loans, 1-4 family mortgages, and a full range of consumer loans.

The Corporation monitors its loan portfolio carefully. The Loan Committee of the Corporation's Board of Directors is designated to receive required loan reports, oversee loan policy, and approve loans above authorized individual and Senior Loan Committee lending limits.  The Senior Loan Committee, consisting of the President and Chief Executive Officer, Chief Financial Officer and Treasurer (non-voting member), Chief Risk Officer (non-voting member), Business Client Division Manager, Retail Client Division Manager, Retail Loan Manager, Senior Commercial Real Estate Lender, and Commercial Loan Managers, implements the Board-approved loan policy.



61



ITEM 4:    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Corporation's management, with the participation of its Chief Executive Officer, who is the Corporation's principal executive officer, and its Chief Financial Officer and Treasurer, who is the Corporation's principal financial officer, have evaluated the effectiveness of the Corporation's disclosure controls and procedures as of March 31, 2017 pursuant to Rule 13a-15 of the Exchange, as amended. Based upon that evaluation, the principal executive officer and principal financial officer have concluded that the Corporation's disclosure controls and procedures are effective as of March 31, 2017.  In addition, there have been no changes in the Corporation’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in reports filed by the Corporation under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

62



PART II.    OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

For information related to this item, please see Note 9 to the Corporation’s financial statements included herein.

ITEM 1A.    RISK FACTORS

There have been no material changes in the risk factors set forth in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 8, 2017.

ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds

(c)    Issuer Purchases of Equity Securities (1)
Period
Total number of shares purchased
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans or programs
 
Maximum number of shares that may yet be purchased under the plans or programs
1/1/17-1/31/17

 
$

 

 
121,906

2/1/17-2/28/17

 

 

 
121,906

3/1/17-3/31/17

 

 

 
121,906

Quarter ended 3/31/17

 
$

 

 
121,906

(1) On December 19, 2012, the Corporation’s Board of Directors approved a stock repurchase plan authorizing the purchase of up to 125,000 shares of the Corporation's outstanding common stock. Purchases may be made from time to time on the open market or in private negotiated transactions and will be at the discretion of management. For the three months ended March 31, 2017, no shares had been purchased under this plan. Since inception of the plan, a total of 3,094 shares have been purchased under the plan.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.    MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.    OTHER INFORMATION

Not applicable.


63



ITEM 6.    EXHIBITS

The following exhibits are either filed with this Form 10-Q or are incorporated herein by reference. The Corporation’s Securities Exchange Act File number is 000-13888.

3.1
Certificate of Incorporation of Chemung Financial Corporation dated December 20, 1984 (as incorporated by reference to Exhibit 3.1 to Registrant's Form 10-K for the year ended December 31, 2007 filed with the Commission on March 13, 2008).
 
 
3.2
Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated March 28, 1988 (as incorporated by reference to Exhibit 3.2 to Registrant's Form 10-K for the year ended December 31, 2007 filed with the Commission on March 13, 2008).
 
 
3.3
Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated May 13, 1998 (as incorporated by reference to Exhibit 3.4 to Registrant’s Form 10-K for the year ended December 31, 2005 and filed with the Commission on March 15, 2006).
 
 
3.4
Amended and Restated Bylaws of Chemung Financial Corporation, as amended to December 21, 2016 (as incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed with the Commission on December 23, 2016).
 
 
31.1
Certification of Principal Executive Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
 
31.2
Certification of Principal Financial Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
 
32.1
Certification of Principal 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 Principal Financial Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
 
 
101.INS
Instance Document*
 
 
101.SCH
XBRL Taxonomy Schema*
 
 
101.CAL
XBRL Taxonomy Calculation Linkbase*
 
 
101.DEF
XBRL Taxonomy Definition Linkbase*
 
 
101.LAB
XBRL Taxonomy Label Linkbase*
 
 
101.PRE
XBRL Taxonomy Presentation Linkbase*
 
 
*
Filed herewith.

64



SIGNATURES

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


CHEMUNG FINANCIAL CORPORATION

DATED: May 3, 2017
By:  /s/ Anders M. Tomson
 
Anders M. Tomson
Chief Executive Officer
(Principal Executive Officer)


DATED: May 3, 2017
By:  /s/ Karl F. Krebs
 
Karl F. Krebs
Chief Financial Officer and Treasurer
(Principal Financial Officer)


65



EXHIBIT INDEX

The following exhibits are either filed with this Form 10-Q or are incorporated herein by reference. The Corporation’s Securities Exchange Act File number is 000-13888
3.1
Certificate of Incorporation of Chemung Financial Corporation dated December 20, 1984 (as incorporated by reference to Exhibit 3.1 to Registrant's Form 10-K for the year ended December 31, 2007 filed with the Commission on March 13, 2008).
 
 
3.2
Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated March 28, 1988 (as incorporated by reference to Exhibit 3.2 to Registrant's Form 10-K for the year ended December 31, 2007 filed with the Commission on March 13, 2008).
 
 
3.3
Certificate of Amendment to the Certificate of Incorporation of Chemung Financial Corporation, dated May 13, 1998 (as incorporated by reference to Exhibit 3.4 to Registrant’s Form 10-K for the year ended December 31, 2005 and filed with the Commission on March 15, 2006).
 
 
3.4
Amended and Restated Bylaws of Chemung Financial Corporation, as amended to December 21, 2016 (as incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed with the Commission on December 23, 2016).
 
 
31.1
Certification of Principal Executive Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
 
31.2
Certification of Principal Financial Officer of the Registrant pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.*
 
 
32.1
Certification of Principal 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 Principal Financial Officer of the Registrant pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. §1350.*
 
 
101.INS
Instance Document*
 
 
101.SCH
XBRL Taxonomy Schema*
 
 
101.CAL
XBRL Taxonomy Calculation Linkbase*
 
 
101.DEF
XBRL Taxonomy Definition Linkbase*
 
 
101.LAB
XBRL Taxonomy Label Linkbase*
 
 
101.PRE
XBRL Taxonomy Presentation Linkbase*
 
 
*
Filed herewith.