# Tompkins Financial Corp: Form 10-Q for the period ended Mar 31, 2018

- Company: [Tompkins Financial Corp](/companies/tmp.md) (CIK 1005817)
- Form: 10-Q
- Filed: 2018-05-09
- Accepted by EDGAR: May 9, 2018, 15:11 ET
- Period: 2018-03-31
- Accession: 0001005817-18-000006
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1005817/000100581718000006/tmp2018-03x3110q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1005817/000100581718000006/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-01-01 to 2018-03-31 | $16.2m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Interest expense | 3 months, 2018-01-01 to 2018-03-31 | $7.5m | us-gaap:InterestExpense |
| Income tax | 3 months, 2018-01-01 to 2018-03-31 | $5.8m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-01-01 to 2018-03-31 | $20.4m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-01-01 to 2018-03-31 | $1.33 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-01-01 to 2018-03-31 | $1.34 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-01-01 to 2018-03-31 | 15,112,518 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2018-01-01 to 2018-03-31 | $19.1m | us-gaap:NetCashProvidedByUsedInOperatingActivitiesContinuingOperations |
| Capital expenditure | 3 months, 2018-01-01 to 2018-03-31 | $7.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2018-01-01 to 2018-03-31 | $7.3m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2018-01-01 to 2018-03-31 | $1.2m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2018-03-31 | $68.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2018-03-31 | $6.65bn | us-gaap:Assets |
| Total liabilities | at 2018-03-31 | $6.07bn | us-gaap:Liabilities |
| Shareholders' equity | at 2018-03-31 | $578.0m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 69,654 characters.

### BUSINESS

### Corporate Overview and Strategic Initiatives

Tompkins Financial Corporation (“Tompkins” or the “Company”) is headquartered in Ithaca, New York and is registered as a Financial Holding Company with the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. The Company is a locally oriented, community-based financial services organization that offers a full array of products and services, including commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, and insurance services. At March 31, 2018, the Company’s subsidiaries included: four wholly-owned banking subsidiaries, Tompkins Trust Company (the “Trust Company”), The Bank of Castile (DBA Tompkins Bank of Castile), Mahopac Bank (DBA Tompkins Mahopac Bank), VIST Bank (DBA Tompkins VIST Bank); and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). The trust division of the Trust Company provides a full array of investment services, including investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. The Company’s principal offices are located at The Commons, Ithaca, New York, 14851, and its telephone number is (888) 503-5753. The Company’s common stock is traded on the NYSE American under the Symbol “TMP.”

The Company’s strategic initiatives include diversification within its markets, growth of its fee-based businesses, and growth internally and through acquisitions of financial institutions, branches, and financial services businesses. As such, the Company from time to time considers acquiring banks, thrift institutions, branch offices of banks or thrift institutions, or other businesses within markets currently served by the Company or in other locations that would complement the Company’s business or its geographic reach. The Company generally targets merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company has pursued acquisition opportunities in the past, and continues to review new opportunities.

### Business Segments

Banking services consist primarily of attracting deposits from the areas served by the Company’s four banking subsidiaries’ 65 banking offices (45 offices in New York and 20 offices in Pennsylvania) and using those deposits to originate a variety of commercial loans, consumer loans, real estate loans (including commercial loans collateralized by real estate), and leases. The Company’s lending function is managed within the guidelines of a comprehensive Board-approved lending policy. Reporting systems are in place to provide management with ongoing information related to loan production, loan quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. Banking services also include a full suite of products such as debit cards, credit cards, remote deposit, electronic banking, mobile banking, cash management, and safe deposit services.

Wealth management services consist of investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. Wealth management services are provided by the Trust Company under the trade name Tompkins Financial Advisors. Tompkins Financial Advisors has office locations, and services are available, at all four of the Company’s subsidiary banks.

Insurance services include property and casualty insurance, employee benefit consulting, and life, long-term care and disability insurance. Tompkins Insurance is headquartered in Batavia, New York. Over the past fourteen years, Tompkins Insurance has acquired smaller insurance agencies in the market areas serviced by the Company’s banking subsidiaries and successfully consolidated them into Tompkins Insurance. Tompkins Insurance offers services to customers of the Company’s banking subsidiaries by sharing offices with The Bank of Castile, Trust Company, and VIST Bank. In addition to these shared offices, Tompkins Insurance has five stand-alone offices in Western New York, two stand-alone offices in Tompkins County, New York and one stand-alone office in Montgomery County, Pennsylvania.

The Company’s principal expenses are interest on deposits, interest on borrowings, and operating and general administrative expenses, as well as provisions for loan and lease losses. Funding sources, other than deposits, include borrowings, securities sold under agreements to repurchase, and cash flow from lending and investing activities.

### Competition

Competition for commercial banking and other financial services is strong in the Company’s market areas. In one or more aspects of its businesses, the Company’s subsidiaries compete with other commercial banks, savings and loan associations, credit unions, finance companies, Internet-based financial services companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Some of these competitors have substantially greater resources and lending capabilities and may offer services that the Company does not currently provide. In addition, many of the Company’s non-bank competitors are not subject to the same extensive Federal regulations that govern financial holding companies and Federally-insured banks.

Management believes that a community based financial organization is better positioned to establish personalized financial relationships with both commercial customers and individual households. The Company’s community commitment and involvement in its primary market areas, as well as its commitment to quality and personalized financial services, are factors that contribute to the Company’s competitiveness. Management believes that each of the Company’s subsidiary banks can compete successfully in its primary market areas by making prudent lending decisions quickly and more efficiently than its competitors, without compromising asset quality or profitability, although no assurances can be given that such factors will assure success.

### Regulation

Banking, insurance services and wealth management are highly regulated. As a financial holding company with four community banks, a registered investment advisor, and an insurance agency subsidiary, the Company and its subsidiaries are subject to examination and regulation by the Federal Reserve Board (“FRB”), Securities and Exchange Commission (“SEC”), the Federal Deposit Insurance Corporation (“FDIC”), the New York State Department of Financial Services, Pennsylvania Department of Banking and Securities, Financial Industry Regulatory Authority, and the Pennsylvania Insurance Department.

### OTHER IMPORTANT INFORMATION

The following discussion is intended to provide an understanding of the consolidated financial condition and results of operations of the Company for the three months ended March 31, 2018. It should be read in conjunction with the Company’s Audited Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, and the Unaudited Consolidated Financial Statements and notes thereto included in Part I of this Quarterly Report on Form 10-Q.

In this Report, there are comparisons of the Company’s performance to that of a peer group. Unless otherwise stated, this peer group is comprised of the group of 148 domestic bank holding companies with $3 billion to $10 billion in total assets as defined in the Federal Reserve’s “Bank Holding Company Performance Report” for December 31, 2017 (the most recent report available).

### Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The statements contained in this Report that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. Forward-looking statements may be identified by use of such words as "may", "will", "estimate", "intend", "continue", "believe", "expect", "plan", or "anticipate", and other similar words. Examples of forward-looking statements may include statements regarding the asset quality of the Company's loan portfolios; the level of the Company's allowance for loan losses; the sufficiency of liquidity sources; the Company's exposure to changes in interest rates; the impact of changes in accounting standards; and trends, plans, prospects, growth and strategies. Forward-looking statements are made based on management’s expectations and beliefs concerning future events impacting the Company and are subject to certain uncertainties and factors relating to the Company’s operations and economic environment, all of which are difficult to predict and many of which are beyond the control of the Company, that could cause actual results of the Company to differ materially from those expressed and/or implied by forward-looking statements. The following factors, in addition to those listed as Risk Factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, are among those that could cause actual results to differ materially from the forward-looking statements: changes in general economic, market and regulatory conditions; the development of an interest rate environment that may adversely affect the Company’s interest rate spread, other income or cash flow anticipated from the Company’s operations, investment and/or lending activities; changes in laws and regulations affecting banks, bank holding companies and/or financial holding companies, such as the Dodd-Frank Act and Basel III; technological developments and changes; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; governmental and public policy changes, including environmental regulation; reliance on large customers; and financial resources in the amounts, at the times and on the terms required to support the Company’s future businesses.

### Critical Accounting Policies

The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. In the course of normal business activity, management must select and apply many accounting policies and methodologies and make estimates and assumptions that lead to the financial results presented in the Company’s consolidated financial statements and accompanying notes. There are uncertainties inherent in making these estimates and assumptions, which could materially affect the Company’s results of operations and financial position.

Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements. Management considers the accounting policies relating to the allowance for loan and lease losses (“allowance”), and the review of the securities portfolio for other-than-temporary impairment to be critical accounting policies because of the uncertainty and subjectivity involved in these policies and the material effect that estimates related to these areas can have on the Company’s results of operations.

For additional information on critical accounting policies and to gain a greater understanding of how the Company’s financial performance is reported, refer to Note 1 – “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements, and the section captioned “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2017. Refer to Note 3 – “Accounting Standards Updates” in the Notes to Unaudited Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q for a discussion of recent accounting updates.

### OVERVIEW

Net income for the first quarter of 2018 was $20.4 million or $1.33 diluted earnings per share, compared to $15.7 million or $1.03 diluted earnings per share for the same period in 2017. Net interest income of $52.7 million for the quarter ended March 31, 2018 was up 9.7% compared to the $48.0 million reported for the same period in 2017.

Return on average assets (“ROA”) for the quarter ended March 31, 2018 was 1.25%, compared to 1.02% for the quarter ended March 31, 2017. Return on average shareholders’ equity (“ROE”) for the first quarter of 2017 was 14.41%, compared to 11.47%, for the same period in 2017. Tompkins’ year-to-date ROA and ROE compares to the most recent peer average ratios of 0.95% and 8.67%, respectively.

### Segment Reporting

The Company operates in the following three business segments, banking, insurance, and wealth management. Insurance is comprised of property and casualty insurance services and employee benefit consulting operated under the Tompkins Insurance Agencies, Inc. subsidiary. Wealth management activities include the results of the Company’s trust, financial planning, and wealth management services, organized under the Tompkins Financial Advisors brand. All other activities are considered banking.

### Banking Segment

The banking segment reported net income of $18.6 million for the first quarter of 2018, up $4.1 million or 28.3% from net income of $14.5 million for the same period in 2017.

Net interest income of $52.7 million for the first quarter of 2018 was up $4.7 million or 9.7% over the same period in 2017. The Company’s growth in average earning assets and stable funding costs contributed to favorable year-over-year comparisons in net interest income. Net interest margin for the three months ending March 31, 2018 was 3.42% compared to 3.38% for the same period in the prior year. Interest expense on deposits for the first quarter of 2018 benefited from accelerated accretion of purchase accounting deposit discounts related to certain time deposits acquired in the acquisition of VIST Financial Corp in 2012.

The provision for loan and lease losses was $567,000 for the three months ended March 31, 2018, which was down $202,000 compared to the same period in 2017. The lower provision expense was largely attributable to lower net charge-offs in the first quarter of 2018 ($127,000) compared to the first quarter of 2017 ($358,000) and stable credit quality.

Noninterest income of $6.4 million for the three months ended March 31, 2018 was flat compared to the same period in 2017. Increases in the first quarter of 2018 included: card services income (up $137,000) and gains on the sale of available for sale securities (up $124,000) which were partially offset by a $127,000 one-time gain on the sale of OREO in the first quarter of the previous year.

Noninterest expense of $34.8 million for the three months ended March 31, 2018 was up $2.3 million or 7.0% from the same period in 2017. The quarterly increase was attributed to an increase in salary and wages and employee benefits reflecting normal annual merit and incentive adjustments over the prior year.

### Insurance Segment

The insurance segment reported net income of $900,000 for the three months ended March 31, 2018, which was up $138,000 or 18.1% compared to the first quarter of 2017. Noninterest income was up $172,000 or 2.4% in the first quarter of 2018, compared to the same period in 2017. Increases in personal insurance product lines and life and health insurance commissions drove the improvement in non-interest income in the first quarter of 2018 compared to the same period in the prior year. Noninterest expenses for the three months ended March 31, 2018 were up $159,000 or 2.6% compared to the first quarter of 2017. The increase in 2018 over 2017 reflects increases in salaries and wages, reflecting annual merit increases and sales commissions.

### Wealth Management Segment

The wealth management segment reported net income of $925,000 for the three months ended March 31, 2018, which was up $446,000 or 93.1% compared to the first quarter of 2017. Noninterest income for the first quarter of 2018 was up $498,000 or 12.7% compared to the same period prior year. The increase over the prior year was mainly a result of an increase in assets under management. Noninterest expenses for the three months ended March 31, 2018 were flat compared to the same period in 2017. A reduction in headcount in 2018 compared to 2017 offset annual merit increases and higher sales commissions paid out due to the growth in assets under management.

*Average Consolidated Statements of Condition and Net Interest Analysis (Unaudited)*

*(Dollar amounts in thousands)*

| ASSETS Interest-earning assets | Quarter Ended March 31, 2018 Average Balance (QTD) | Interest | Average Yield/Rate | Quarter Ended March 31, 2017 Average Balance (QTD) | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing balances due from banks | $2,565 | $7 | 1.11% | $5,214 | $2 | 0.16% |
| Securities (1) |  |  |  |  |  |  |
| U.S. Government securities | 1,454,229 | 7,954 | 2.22% | 1,479,516 | 7,659 | 2.10% |
| State and municipal (2) | 99,766 | 643 | 2.61% | 100,698 | 840 | 3.38% |
| Other securities (2) | 3,571 | 35 | 3.97% | 3,613 | 31 | 3.48% |
| Total securities | 1,557,566 | 8,632 | 2.25% | 1,583,827 | 8,530 | 2.18% |
| FHLBNY and FRB stock | 49,509 | 737 | 6.04% | 38,105 | 468 | 4.98% |
| Total loans and leases, net of unearned income (2)(3) | 4,688,087 | 51,229 | 4.43% | 4,263,799 | 45,675 | 4.34% |
| **Total interest-earning assets** | **6,297,727** | **60,605** | **3.90%** | **5,890,945** | **54,675** | **3.76%** |
| Other assets | 355,036 |  |  | 350,443 |  |  |
| **Total assets** | **6,652,763** |  |  | **6,241,388** |  |  |
| **LIABILITIES & EQUITY** |  |  |  |  |  |  |
| Deposits |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Interest bearing checking, savings, & money market | 2,796,197 | 1,646 | 0.24% | 2,664,848 | 1,061 | 0.16% |
| Time deposits | 717,617 | 1,123 | 0.63% | 869,949 | 1,727 | 0.81% |
| Total interest-bearing deposits | 3,513,814 | 2,769 | 0.32% | 3,534,797 | 2,788 | 0.32% |
| Federal funds purchased & securities sold under agreements to repurchase | 75,167 | 46 | 0.25% | 77,980 | 108 | 0.56% |
| Other borrowings | 1,053,311 | 4,359 | 1.68% | 791,136 | 2,324 | 1.19% |
| Trust preferred debentures | 16,706 | 279 | 6.77% | 23,588 | 367 | 6.31% |
| **Total interest-bearing liabilities** | **4,658,998** | **7,453** | **0.65%** | **4,427,501** | **5,587** | **0.51%** |
| Noninterest bearing deposits | 1,351,307 |  |  | 1,188,568 |  |  |
| Accrued expenses and other liabilities | 67,495 |  |  | 69,426 |  |  |
| **Total liabilities** | 6,077,800 |  |  | 5,685,495 |  |  |
| Tompkins Financial Corporation Shareholders’ equity | 573,536 |  |  | 554,424 |  |  |
| Noncontrolling interest | 1,427 |  |  | 1,469 |  |  |
| **Total equity** | **574,963** |  |  | **555,893** |  |  |
| **Total liabilities and equity** | **$6,652,763** |  |  | **$6,241,388** |  |  |
| Interest rate spread |  |  | **3.25%** |  |  | **3.25%** |
| Net interest income/margin on earning assets |  | **53,152** | **3.42%** |  | **49,088** | **3.38%** |
| Tax Equivalent Adjustment |  | **(465)** |  |  | **(1,054)** |  |
| Net interest income per consolidated financial statements |  | **$52,687** |  |  | **$48,034** |  |

#### 1 Average balances and yields on available-for-sale securities are based on historical amortized cost

*2 Interest income includes the tax effects of taxable-equivalent adjustments using an effective income tax rate of 21% in 2018 and 40% in 2017 to increase tax exempt interest income to taxable-equivalent basis.*

*3 Nonaccrual loans are included in the average asset totals presented above. Payments received on nonaccrual loans have been recognized as disclosed in Note 1 of the Company’s consolidated financial statements included in Part 1 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.*

### Net Interest Income

Net interest income is the Company’s largest source of revenue, representing 74.7% of total revenues for the three months ended March 31, 2018, compared to 73.6% for the same period in 2017. Net interest income is dependent on the volume and composition of interest earning assets and interest-bearing liabilities and the level of market interest rates. The above table shows average interest-earning assets and interest-bearing liabilities, and the corresponding yield or cost associated with each.

Taxable-equivalent net interest income for the three months ended March 31, 2018, was up 8.3% over the same period in 2017, benefiting from growth in average earning assets, a slightly improved net interest margin and growth in noninterest bearing deposits. Net interest income benefited from a slight shift in the composition of average earning assets, with loans, which carry higher average yields than securities, comprising an increased percentage of average earning assets. For the three months ended March 31, 2018, average loans represented 74.4% of average earning assets compared to 72.4% for the same period in 2017.

Taxable-equivalent interest income for the three month period ended March 31, 2018, was $60.6 million, up $5.9 million or 10.8% compared to the same period in 2017. The increase in taxable-equivalent interest income was mainly the result of an increase in average loans, as well as an increase in the yield on average loans. Average loan balances for the three months ended March 31, 2018, were up $424.3 million or 10.0%, and the average yield on loans increased 9 basis points from the same period in 2017. Average securities balances for the three months ended March 31, 2018, were down by $26.3 million or 1.7%, while the average yield on securities for the three month period was up 7 basis points compared to the same period in 2017. The average yield on securities for the first quarter of 2018 benefited from higher market interest rates as well as slower amortizations of premiums during the quarter.

Interest expense for the three months ended March 31, 2018, increased by $1.9 million or 33.4% compared to the same period in 2017, reflecting and increased volume of borrowings as well as higher interest rates. Interest bearing deposits for the first quarter of 2018 were down compared to the same period in 2017. Other borrowings for the three months ended March 31, 2018 were up $277.8 million or 38.7% compared to the same period in 2017; this increase was mainly in overnight borrowings with the FHLB. Interest expense for the first quarter of 2018 was positively impacted by lower interest expense on time deposits, which benefited from $502,000 of accelerated accretion of purchase accounting deposit discounts from certain deposits acquired in the Company's acquisition of VIST Financial Corp in 2012.

### Provision for Loan and Lease Losses

The provision for loan and lease losses represents management’s estimate of the amount necessary to maintain the allowance for loan and lease losses at an adequate level. The provision for loan and lease losses was $567,000 for the first quarter of 2018 compared to $769,000 for the same period in 2017. The section captioned “Financial Condition – Allowance for Loan and Lease Losses and Nonperforming Assets” below has further details on the allowance for loan and lease losses and asset quality metrics.

### Noninterest Income

Noninterest income was $17.8 million for the first quarter of 2018, relatively flat compared to $17.2 million for the same period prior year. Noninterest income represented 25.3% of total revenue for the first quarter of 2018, compared to 26.4% for the same period in 2017.

Insurance commissions and fees, the largest component of noninterest income, were $7.4 million for the first quarter of 2018, an increase of 3.9% from the same period prior year. The increase in revenues in the first quarter of 2018 compared to the first quarter of 2017 was mainly in health and life commissions and personal lines revenue.

Investment services income of $4.2 million in the first quarter of 2018 was up $455,000 or 12.0% compared to the first quarter of 2017. Investment services income includes trust services, financial planning, wealth management services, and brokerage related services. With fees largely based on the market value and the mix of assets managed, the general direction of the stock market can have a considerable impact on fee income. The fair value of assets managed by, or in custody of, Tompkins was $4.1 billion at March 31, 2018, up 2.5% from $4.0 billion at March 31, 2017. These figures include $1.1 billion of Company-owned securities where Tompkins Trust Company is custodian.

Service charges on deposit accounts were down $35,000 or 1.6% for the first quarter of 2018 compared to the same period in 2017. Net overdraft fees, the largest component of service charges on deposit accounts, were up 7.6%, offset by a decrease in service fees on personal and commercial accounts of 16.0% for the three months ended March 31, 2018 compared to the same period in 2017. The overall decline in fees was primarily attributable to customer behaviors.

Card services income for the three months ended March 31, 2018 was up $137,000 or 6.8% compared to the same period in 2017. The primary components of card services income are fees related to interchange income and transaction fees for debit card transactions, credit card transactions and ATM usage. Increased revenue was largely driven by increased transaction volumes.

Other income of $1.8 million in the first quarter of 2018 was down 17.0% compared to the same period in 2017. The significant components of other income are other service charges, increases in cash surrender value of corporate owned life insurance ("COLI"), gains on sales of residential mortgage loans, and income from miscellaneous equity investments. The decrease in the first quarter of 2018 over the same quarter of 2017 was mainly a result of gains on sales of other real estate owned of $172,000 in 2017. There were no such gains recognized in the first quarter of 2018.

### Noninterest Expense

Noninterest expense was $43.7 million for the first quarter of 2018, up $2.4 million or 5.7% compared to the same period in 2017.

Expenses associated with compensation and benefits are the largest component of noninterest expense, representing 60.3% of total noninterest expense for the three months ended March 31, 2018. Salaries and wages expense for the three months ended March 31, 2018 increased by $1.4 million or 6.9% compared to the same period in 2017. The increase is mainly due to an increase in the number of employees, and normal merit and market adjustments, as well as higher incentive based compensation expense. Other employee related benefits were down $258,000 or 4.6% compared to the same period in 2017, mainly as a result of lower health insurance costs.

Other expenses of $4.4 million for the first quarter of 2018 were up $267,000 or 6.5% compared to the same period in 2017. The majority of the increase was related to losses associated with checking account related fraud.

### Income Tax Expense

The provision for income taxes was $5.8 million for an effective rate of 22.0% for the first quarter of 2018, compared to tax expense of $7.4 million and an effective rate of 31.9% for the same quarter in 2017. The decrease is a direct result of The Tax Cuts and Jobs Act of 2017, which reduced the Federal statutory tax rate from 35% in 2017, to 21% in 2018.

### FINANCIAL CONDITION

Total assets of $6.6 billion at March 31, 2018, were in line with December 31, 2017. Total loans grew by 0.8% over December 31, 2017, while total security balances were down 1.38% over the same period. Total deposits increased $92.1 million or 1.9% compared to December 31, 2017. Other borrowings decreased $76.7 million or 7.2% from December 31, 2017, as a result of deposit growth outpacing loan growth in the quarter.

### Securities

As of March 31, 2018, the Company’s securities portfolio was $1.51 billion or 22.7% of total assets, compared to $1.53 billion or 23.0% of total assets at year-end 2017. The following table details the composition of available-for-sale and held-to-maturity securities.

*(in thousands)*

| Available-for-Sale Securities | 3/31/2018 Amortized Cost | Fair Value | 12/31/2017 Amortized Cost | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| Obligations of U.S. Government sponsored entities | $498,644 | $489,847 | $507,248 | $504,193 |
| Obligations of U.S. states and political subdivisions | 91,623 | 90,348 | 91,659 | 91,519 |
| Mortgage-backed securities - residential, issued by |  |  |  |  |
| U.S. Government agencies | 133,524 | 129,680 | 139,747 | 137,735 |
| U.S. Government sponsored entities | 681,110 | 658,655 | 667,767 | 656,178 |
| Non-U.S. Government agencies or sponsored entities | 64 | 64 | 75 | 75 |
| U.S. corporate debt securities | 2,500 | 2,175 | 2,500 | 2,162 |
| Total debt securities | 1,407,465 | 1,370,769 | 1,408,996 | 1,391,862 |
| Equity securities | 895 | 895 | 1,000 | 913 |
| **Total available-for-sale securities** | **$1,408,360** | **$1,371,664** | **$1,409,996** | **$1,392,775** |

52

*(in thousands)*

| Held-to-Maturity Securities | 3/31/2018 Amortized Cost | Fair Value | 3/31/2017 Amortized Cost | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| Obligations of U.S. Government sponsored entities | $131,607 | $130,280 | $131,707 | $132,720 |
| Obligations of U.S. states and political subdivisions | $7,524 | $7,563 | $7,509 | $7,595 |
| **Total held-to-maturity debt securities** | **$139,131** | **$137,843** | **$139,216** | **$140,315** |

The increase in unrealized losses, which reflects the amount by which amortized cost exceeds fair value, related to the available-for-sale portfolio was due primarily to changes in market interest rates during the first three months of 2018. Management’s policy is to purchase investment grade securities that on average have relatively short duration, which helps mitigate interest rate risk and provides sources of liquidity without significant risk to capital.

Quarterly, the Company evaluates all investment securities with a fair value less than amortized cost to identify any other-than-temporary impairment as defined under generally accepted accounting principles. As a result of the other-than-temporary impairment review process, the Company does not consider any investment security held at March 31, 2018 to be other-than-temporarily impaired. Future changes in interest rates or the credit quality and credit support of the underlying issuers may reduce the market value of these and other securities. If such decline is determined to be other than temporary, the Company will record the necessary charge to earnings and/or accumulated other comprehensive income to reduce the securities to their then current fair value.

*Loans and Leases*

*Loans and leases at March 31, 2018 and December 31, 2017 were as follows:*

*(in thousands)*

| Commercial and industrial | 3/31/2018 Originated | Acquired | Total Loans and Leases | 12/31/2017 Originated | Acquired | Total Loans and Leases |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Agriculture | **$93,896** | **$0** | **$93,896** | $108,608 | $0 | $108,608 |
| Commercial and industrial other | **916,520** | **50,529** | **967,049** | 932,067 | 50,976 | 983,043 |
| Subtotal commercial and industrial | **1,010,416** | **50,529** | **1,060,945** | 1,040,675 | 50,976 | 1,091,651 |
| Commercial real estate |  |  |  |  |  |  |
| Construction | **200,185** | **1,456** | **201,641** | 202,486 | 1,480 | 203,966 |
| Agriculture | **135,484** | **241** | **135,725** | 129,712 | 247 | 129,959 |
| Commercial real estate other | **1,726,674** | **195,346** | **1,922,020** | 1,660,782 | 206,020 | 1,866,802 |
| Subtotal commercial real estate | **2,062,343** | **197,043** | **2,259,386** | 1,992,980 | 207,747 | 2,200,727 |
| Residential real estate |  |  |  |  |  |  |
| Home equity | **211,444** | **26,084** | **237,528** | 212,812 | 28,444 | 241,256 |
| Mortgages | **1,051,711** | **22,204** | **1,073,915** | 1,039,040 | 22,645 | 1,061,685 |
| Subtotal residential real estate | **1,263,155** | **48,288** | **1,311,443** | 1,251,852 | 51,089 | 1,302,941 |
| Consumer and other |  |  |  |  |  |  |
| Indirect | **11,921** | **0** | **11,921** | 12,144 | 0 | 12,144 |
| Consumer and other | **49,907** | **905** | **50,812** | 50,214 | 765 | 50,979 |
| Subtotal consumer and other | **61,828** | **905** | **62,733** | 62,358 | 765 | 63,123 |
| Leases | **13,818** | **0** | **13,818** | 14,467 | 0 | 14,467 |
| Covered loans | **0** | **0** | **0** | 0 | 0 | 0 |
| Total loans and leases | **4,411,560** | **296,765** | **4,708,325** | 4,362,332 | 310,577 | 4,672,909 |
| Less: unearned income and deferred costs and fees | **(3,479)** | **0** | **(3,479)** | (3,789) | 0 | (3,789) |
| Total loans and leases, net of unearned income and deferred costs and fees | **$4,408,081** | **$296,765** | **$4,704,846** | $4,358,543 | $310,577 | $4,669,120 |

Residential real estate loans, including home equity loans were $1.3 billion at March 31, 2018, up $8.5 million or 0.7% compared to December 31, 2017, and comprised 27.9% of total loans and leases at March 31, 2018. Growth in residential loan balances is impacted by the Company’s decision to retain these loans or sell them in the secondary market due to interest rate considerations. The Company’s Asset/Liability Committee meets regularly and establishes standards for selling and retaining residential real estate mortgage originations.

The Company may sell residential real estate loans in the secondary market based on interest rate considerations. These residential real estate loans are generally sold to Federal Home Loan Mortgage Corporation (“FHLMC”) or State of New York Mortgage Agency (“SONYMA”) without recourse in accordance with standard secondary market loan sale agreements. These residential real estate loans also are subject to customary representations and warranties made by the Company, including representations and warranties related to gross incompetence and fraud. The Company has not had to repurchase any loans as a result of these representations and warranties.

During the first three months of 2018 and 2017, the Company retained the vast majority of residential mortgage loans originated, selling only $285,000 and $40,000, respectively, during these two quarters, recognizing gains on these sales of $21,000 and $13,000, respectively. These residential real estate loans were sold without recourse in accordance with standard secondary market loan sale agreements. When residential mortgage loans are sold, the Company typically retains all servicing rights, which provides the Company with a source of fee income. Mortgage servicing rights, at amortized basis, totaled $0.6 million at March 31, 2018 and $0.7 million at December 31, 2017.

Commercial real estate loans and commercial and industrial loans totaled $2.3 billion and $1.1 billion, and represented 48.0% and 22.6%, respectively of total loans as of March 31, 2018. The commercial real estate portfolio was up 2.7% over year-end 2017, while commercial and industrial loans were down 2.8%. As of March 31, 2018, agriculturally-related loans totaled $229.4 million or 4.9% of total loans and leases, compared to $238.6 million or 5.1% of total loans and leases at December 31, 2017. Agriculturally-related loans include loans to dairy farms and cash and vegetable crop farms. Agriculturally-related loans are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral, personal guarantees, and government related guarantees. Agriculturally-related loans are generally secured by the assets or property being financed or other business assets such as accounts receivable, livestock, equipment or commodities/crops.

The acquired loans in the above table reflect loans acquired in the acquisition of VIST Financial Corp. during the third quarter of 2012. The acquired loans were recorded at fair value pursuant to the purchase accounting guidelines in FASB ASC 805 – “Fair Value Measurements and Disclosures” (as determined by the present value of expected future cash flows) with no valuation allowance (i.e., the allowance for loan losses). Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality”.

The carrying value of acquired loans accounted for in accordance with this guidance was $11.8 million at March 31, 2018 as compared to $12.0 million at December 31, 2017. The carrying value of loans not exhibiting evidence of credit impairment at the time of the acquisition (i.e. loans outside of the scope of ASC 310-30) was $285.0 million at March 31, 2018.

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures. Management reviews these policies and procedures on a regular basis. The Company discussed its lending policies and underwriting guidelines for its various lending portfolios in Note 3 – “Loans and Leases” in the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. There have been no significant changes in these policies and guidelines since the date of that report. Therefore, both new originations as well as those balances held at March 31, 2018, reflect these policies and guidelines. The Company’s Board of Directors approves the lending policies at least annually. The Company recognizes that exceptions to policy guidelines may occasionally occur and has established procedures for approving exceptions to these policy guidelines. Management has also implemented reporting systems to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans.

The Company’s loan and lease customers are located primarily in the New York and Pennsylvania communities served by its four subsidiary banks. Although operating in numerous communities in New York State and Pennsylvania, the Company is still dependent on the general economic conditions of these states and the local economic conditions of the communities within these states in which the Company does business. Other than geographic and general economic risks, management is not aware of any material concentrations of credit risk to any industry or individual borrower.

### The Allowance for Loan and Lease Losses

The tables below provide, as of the dates indicated, an allocation of the allowance for probable and inherent loan losses by type. The allocation is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category.

*(in thousands)*

| Allowance for originated loans and leases | 3/31/2018 | 12/31/2017 | 3/31/2017 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | $12,431 | $11,812 | $10,273 |
| Commercial real estate | 20,402 | 20,412 | 19,114 |
| Residential real estate | 5,972 | 6,161 | 5,386 |
| Consumer and other | 1,302 | 1,301 | 1,142 |
| **Total** | **$40,107** | **$39,686** | **$35,915** |

55

*(in thousands)*

| Allowance for acquired loans | 3/31/2018 | 12/31/2017 | 3/31/2017 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | $25 | $25 | $0 |
| Commercial real estate | 0 | 0 | 76 |
| Residential real estate | 73 | 54 | 169 |
| Consumer and other | 6 | 6 | 6 |
| **Total** | **$104** | **$85** | **$251** |

As of March 31, 2018, the total allowance for loan and lease losses was $40.2 million, which increased by $440,000 or 1.1% over year-end 2017. The increase in the allowance compared to year-end was mainly due to growth in the originated loan portfolio. Loans internally-classified Special Mention or Substandard were up from year end 2017 by $1.7 million or 2.3%, while nonperforming loans and leases were up 8.9% from year-end 2017. The allowance for loan and lease losses covered 159.34% of nonperforming loans and leases as of March 31, 2018, compared to 172.8% at December 31, 2017. The ratio of nonperforming loans and leases to total loans and leases was 0.54% at March 31, 2018 compared to 0.49% at December 31, 2017.

The Company’s allowance for originated loan and lease losses totaled $40.1 million at March 31, 2018, which represented 0.91% of total originated loans, unchanged from December 31, 2017, and down slightly from 0.92% at March 31, 2017. The increase in the balance of the originated allowance compared to year-end was mainly due to growth in the originated loan portfolio. Originated loans internally-classified as Special Mention, Substandard and Doubtful totaled $70.3 million at March 31, 2018, up from $66.7 million at year-end 2017, and $39.8 million at March 31, 2017. Nonaccrual originated loans were $18.4 million as of March 31, 2018 compared to $16.3 million at year-end 2017, and $13.8 million at March 31, 2017.

The allowance for acquired loans at March 31, 2018 was $104,000, up $19,000 compared to year-end 2017 and down $147,000 compared to March 31, 2017. As part of the determination of the fair value of acquired loans at the time of acquisition, the Company established a credit mark to provide for future credit losses in the acquired portfolio. To the extent that credit quality deteriorates subsequent to acquisition, such deterioration will result in the establishment of an allowance for the acquired portfolio. The amount of acquired loans internally-classified as Special Mention, Substandard and Doubtful totaled $3.9 million at March 31, 2018, down from $5.9 million at year-end 2017 and $10.1 million at March 31, 2017. Loan pay downs coupled with charge offs contributed to the decrease from the same quarter prior year and year-end 2017. Nonaccrual acquired loans were $3.4 million as of March 31, 2018 compared to $3.3 million at year-end 2017, and $3.4 million at March 31, 2017.

Activity in the Company’s allowance for loan and lease losses during the first three months of 2018 and 2017 is illustrated in the table below.

*Analysis of the Allowance for Originated Loan and Lease Losses*

*(in thousands)*

|  | 3/31/2018 | 3/31/2017 |
| --- | ---: | ---: |
| Average originated loans outstanding during period | **$4,383,075** | $3,880,262 |
| Balance of originated allowance at beginning of year | **$39,686** | $35,598 |
| **ORIGINATED LOANS CHARGED-OFF:** |  |  |
| Commercial and industrial | **3** | 75 |
| Commercial real estate | **0** | 21 |
| Residential real estate | **185** | 374 |
| Consumer and other | **292** | 280 |
| **Total loans charged-off** | **$480** | $750 |
| **RECOVERIES OF ORIGINATED LOANS PREVIOUSLY CHARGED-OFF:** |  |  |
| Commercial and industrial | **6** | 76 |
| Commercial real estate | **170** | 235 |
| Residential real estate | **42** | 27 |
| Consumer and other | **75** | 127 |
| **Total loans recoveries** | **$293** | $465 |
| Net loans charged-off (recovered) | **187** | 285 |
| Additions to originated allowance charged to operations | **608** | 602 |
| **Balance of originated allowance at end of period** | **$40,107** | $35,915 |
| **Allowance for originated loans and leases as a percentage of originated loans and leases** | **0.91%** | 0.92% |
| **Annualized net charge-offs (recoveries) on originated loans to average total originated loans and leases during the period** | **0.02%** | 0.03% |

*Analysis of the Allowance for Acquired Loan Losses*

*(in thousands)*

|  | 3/31/2018 | 3/31/2017 |
| --- | ---: | ---: |
| Average acquired loans outstanding during period | **$305,012** | $383,537 |
| Balance of acquired allowance at beginning of year | **85** | 157 |
| **ACQUIRED LOANS CHARGED-OFF:** |  |  |
| Commercial and industrial | **1** | 9 |
| Commercial real estate | **0** | 74 |
| **Total loans charged-off** | **$1** | $83 |
| Commercial and industrial | **20** | 0 |
| Commercial real estate | **8** | 10 |
| Residential real estate | **33** | 0 |
| **Total loans recovered** | **$61** | $10 |
| Net loans charged-off | **(60)** | 73 |
| Additions to acquired allowance charged to operations | **(41)** | 167 |
| **Balance of acquired allowance at end of period** | **$104** | $251 |
| **Allowance for acquired loans as a percentage of acquired loans outstanding acquired loans and leases** | **0.03%** | 0.07% |
| **Annualized net (recoveries) charge-offs on acquired loans as a percentage of average acquired loans and leases outstanding during the period** | **(0.08)%** | 0.08% |
| **Annualized total net charge-offs as a percentage of average loans and leases outstanding during the period** | **0.01%** | 0.03% |

57

Net loan and lease chargeoffs totaled $127,000 for the three months ended March 31, 2018, compared to $358,000 for the same period in 2017. Annualized net chargeoffs were 0.02% of average total loans and leases, down from 0.03% for the same period in 2017.

The provision for loan and lease losses was $567,000 for the three months ended March 31, 2018, compared to $769,000 for the same period in 2017. The lower provision expense was largely attributable to lower net charge-offs in the first quarter of 2018 ($127,000) compared to the first quarter of 2017 ($358,000) and stable credit quality.

*(in thousands)*

| Analysis of Past Due and Nonperforming Loans | 3/31/2018 | 12/31/2017 | 3/31/2017 |
| --- | ---: | ---: | ---: |
| Loans 90 days past due and accruing | **$0** | $44 | $0 |
| Total loans 90 days past due and accruing | **0** | 44 | 0 |
| Nonaccrual loans |  |  |  |
| Commercial and industrial | **4,681** | 2,852 | 570 |
| Commercial real estate | **5,720** | 5,948 | 7,319 |
| Residential real estate | **11,140** | 10,363 | 9,074 |
| Consumer and other | **240** | 354 | 179 |
| Total nonaccrual loans | **21,781** | 19,517 | 17,142 |
| Troubled debt restructurings not included above | **3,455** | 3,449 | 2,948 |
| **Total nonperforming loans and leases** | **25,236** | 23,010 | 20,090 |
| Other real estate owned | **2,047** | 2,047 | 2,520 |
| **Total nonperforming assets** | **$27,283** | $25,057 | $22,610 |
| **Allowance as a percentage of nonperforming loans and leases** | **159.34%** | 172.84% | 180.02% |
| **Total nonperforming loans and leases as percentage of total loans and leases** | **0.54%** | 0.49% | 0.47% |
| **Total nonperforming assets as percentage of total assets** | **0.41%** | 0.38% | 0.36% |

*1 The March 31, 2018, December 31, 2017, and March 31, 2017 columns in the above table exclude $1.1 million, $1.1 million, and $2.7 million, respectively, of acquired loans that are 90 days past due and accruing interest. These loans were originally recorded at fair value on the acquisition date of August 1, 2012. These loans are considered to be accruing as we can reasonably estimate future cash flows on these acquired loans and we expect to fully collect the carrying value of these loans. Therefore, we are accreting the difference between the carrying value of these loans and their expected cash flows into interest income.*

Nonperforming assets include nonaccrual loans, troubled debt restructurings (“TDR”), and foreclosed real estate/other real estate owned. Nonperforming assets represented 0.41% of total assets at March 31, 2018, up from 0.38% as of December 31, 2017, and up from 0.36% at March 31, 2017. The Company’s ratio of nonperforming assets to total assets continues to compare favorably to our peer group’s most recent ratio of 0.63% at December 31, 2017. Total nonperforming assets of $27.3 million at March 31, 2018 were up 8.9% compared to December 31, 2017. The quarter-over-quarter increase was mainly due to one large commercial and industrial relationship, totaling $2.9 million, being moved to nonaccrual in the first quarter of 2018.

Total nonperforming loans and leases of $25.2 million were up $2.2 million from year end 2017, and up $5.1 million from March 31, 2017. A breakdown of nonperforming loans by portfolio segment is shown above. The decrease in nonaccrual commercial real estate loans is mainly due to the movement of a larger commercial real estate loan from nonaccrual status to other real estate owned.

Loans are considered modified in a TDR when, due to a borrower’s financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider and the borrower could not obtain elsewhere. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity. TDRs are included in the above table within the following categories: “loans 90 days past due and accruing”, “nonaccrual loans”, or “troubled debt restructurings not included above”. Loans in the latter category include loans that meet the definition of a TDR but are performing in accordance with the modified terms and therefore classified as accruing loans. At March 31, 2018, the Company had $6.9 million in TDRs, and of that total $3.4 million were reported as nonaccrual and $3.5 million were considered performing and included in the table above.

In general, the Company places a loan on nonaccrual status if principal or interest payments become 90 days or more past due and/or management deems the collectability of the principal and/or interest to be in question, as well as when required by applicable regulations. Although in nonaccrual status, the Company may continue to receive payments on these loans. These payments are generally recorded as a reduction to principal, and interest income is recorded only after principal recovery is reasonably assured.

The Company’s recorded investment in loans and leases that are considered impaired totaled $18.6 million at March 31, 2018, compared to $15.8 million at December 31, 2017 and $15.7 million at March 31, 2017. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans consist of our non-homogenous nonaccrual loans, and all TDRs. Specific reserves on individually identified impaired loans that are not collateral dependent are measured based on the present value of expected future cash flows discounted at the original effective interest rate of each loan. For loans that are collateral dependent, impairment is measured based on the fair value of the collateral less estimated selling costs, and such impaired amounts are generally charged off.

The average recorded investment in impaired loans and leases was $17.2 million at March 31, 2018, compared to $17.1 million at March 31, 2017. At March 31, 2018, there was a specific reserve of $496,000 on impaired loans compared to $466,000 of specific reserves at December 31, 2017. The specific reserve of $496,000 at March 31, 2018 includes specific reserves of $471,000 for the originated portfolio, and specific reserves of $25,000 for the acquired portfolio. The majority of impaired loans are collateral dependent impaired loans that have limited exposure or require limited specific reserve because of the amount of collateral support with respect to these loans and previous charge-offs. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured. In these cases, interest is recognized on a cash basis.

The ratio of the allowance to nonperforming loans (loans past due 90 days and accruing, nonaccrual loans and restructured troubled debt) was 159.34% at March 31, 2018, compared to 172.84% at December 31, 2017, and 180.02% at March 31, 2017. The Company’s nonperforming loans are mostly made up of collateral dependent impaired loans with limited exposure or require limited specific reserve due to the level of collateral available with respect to these loans and/or previous charge-offs.

Management reviews the loan portfolio continuously for evidence of potential problem loans and leases. Potential problem loans and leases are loans and leases that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the related borrowers causes management to have doubt as to the ability of such borrowers to comply with the present loan payment terms and may result in such loans and leases becoming nonperforming at some time in the future. Management considers loans and leases classified as Substandard, which continue to accrue interest, to be potential problem loans and leases. The Company, through its internal loan review function, identified 34 commercial relationships from the originated portfolio and 9 commercial relationships from the acquired portfolio totaling $24.3 million and $1.6 million, respectively at March 31, 2018 that were potential problem loans. At December 31, 2017, the Company had identified 28 relationships totaling $11.2 million in the originated portfolio and 10 relationships totaling $3.6 million in the acquired portfolio that were potential problem loans. Of the 34 commercial relationships in the originated portfolio at March 31, 2018 that were Substandard, there were 7 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $17.6 million, the largest of which was $3.6 million. Of the 9 commercial relationships from the acquired loan portfolio at March 31, 2018 that were Substandard, there no relationships that equaled or exceeded $1.0 million. The Company continues to monitor these potential problem relationships; however, management cannot predict the extent to which continued weak economic conditions or other factors may further impact borrowers. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and personal or government guarantees. These factors, when considered in the aggregate, give management reason to believe that the current risk exposure on these loans does not warrant accounting for these loans as nonperforming. However, these loans do exhibit certain risk factors, which have the potential to cause them to become nonperforming. Accordingly, management’s attention is focused on these credits, which are reviewed on at least a quarterly basis.

### Capital

Total equity was $579.4 million at March 31, 2018, an increase of $3.2 million or 0.6% from December 31, 2017. The increase reflects growth in retained earnings, and additional paid-in capital; partially offset by an increase in other comprehensive losses.

Additional paid-in capital increased by $2.6 million, from $364.0 million at December 31, 2017, to $366.7 million at March 31, 2018. The increase is primarily attributable to the following: $3.1 million related to shares issued under the employee stock ownership plan and $855,000 related to stock based compensation; partially offset by $1.2 million in planned repurchases of Company stock in connection with its stock repurchase plan. Retained earnings increased by $14.9 million from $265.0 million at December 31, 2017, to $279.9 million at March 31, 2018, reflecting net income of $20.4 million less dividends paid of $7.3 million. Accumulated other comprehensive loss increased from a net loss of $51.3 million at December 31, 2017, to a net loss of $65.6 million at March 31, 2018, reflecting a $14.6 million increase in unrealized losses on available-for-sale securities due to changes in market rates, and a $318,000 decrease related to post-retirement benefit plans. In connection with the adoption of Basel III Capital Rules on January 1, 2015, the Company elected to opt-out of the requirement to include most components of other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss related to net unrealized gain or loss on available-for-sale securities and the funded status of the Company’s defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios.

Cash dividends paid in the first three months of 2018 totaled approximately $7.3 million, representing 35.9% of year to date 2018 earnings. Cash dividends of $0.48 per common share paid in the first three months of 2018 were up 6.3% over cash dividends of $0.45 per common share paid in the first three months of 2017.

On July 21, 2016, the Company’s Board of Directors authorized a stock repurchase plan for the Company to repurchase up to 400,000 shares of the Company’s common stock (the "2016 Repurchase Plan"). Purchases may be made over the 24 months following adoption of the plan. The repurchase program may be suspended, modified or terminated by the Board of Directors at any time for any reason.

As of March 31, 2018, the Company had repurchased 15,500 shares at an average price of $77.85 under the 2016 Repurchase Plan.

The Company and its subsidiary banks are subject to various regulatory capital requirements administered by Federal bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s business, results of operation and financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (PCA), banks must meet specific guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and its subsidiary banks are also subject to qualitative judgments by regulators concerning components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios of common equity Tier 1 capital, Total capital and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes that the Company and its subsidiary banks meet all capital adequacy requirements to which they are subject.

In addition to setting higher minimum capital ratios, the Basel III Capital Rules introduced a capital conservation buffer, which must be added to each of the minimum capital ratios and is designed to absorb losses during periods of economic stress. The capital conservation buffer is being phased-in over five years beginning on January 1, 2016 and ranges from 0.625% in 2016, to 1.25% in 2017, to 1.875% in 2018 and to 2.5% when fully phased-in on January 1, 2019.

The following table provides a summary of the Company’s capital ratios as of March 31, 2018.

*REGULATORY CAPITAL ANALYSIS*

*(dollar amounts in thousands)*

| March 31, 2018 | Actual Amount | Ratio | Minimum Capital Required - Basel III Fully Phased-In Amount | Ratio | Well Capitalized Requirement Amount | Ratio |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Total Capital (to risk weighted assets) | $601,773 | 12.50% | $505,315 | 10.50% | $481,253 | 10.00% |
| Tier 1 Capital (to risk weighted assets) | $559,811 | 11.63% | $409,065 | 8.50% | $385,002 | 8.00% |
| Tier 1 Common Equity (to risk weighted assets) | $543,077 | 11.28% | $336,877 | 7.00% | $312,814 | 6.50% |
| Tier 1 Capital (to average assets) | $559,811 | 8.53% | $262,530 | 4.00% | $328,163 | 5.00% |

On March 31, 2018, the Company’s capital ratios exceeded the minimum required capital ratios plus the required conservation buffer, the minimum required capital ratios plus the fully phased-in capital conservation buffer, and the minimum required capital ratios for well capitalized institutions. The capital levels required to be considered well capitalized, presented in the above table, are based upon prompt corrective action regulations, as amended to reflect the changes under Basel III Capital Rules.

Total capital as a percent of risk weighted assets increased to 12.5% at March 31, 2018, compared with 12.3% as of December 31, 2017. Tier 1 capital as a percent of risk weighted assets increased slightly from 11.4% at the end of 2017 to 11.6% as of March 31, 2018. Tier 1 capital as a percent of average assets was 8.5% at March 31, 2018, which is up from 8.4% as of December 31, 2017. Common equity tier 1 capital was 11.3% at the end of the first quarter of 2018, up slightly from 11.1% at the end of 2017.

On January 31, 2017, the Company redeemed all of the trust preferred of Tompkins Capital Trust I for an aggregate of $20.5 million, at a redemption price equal to 100% of the liquidation amount of the securities ($1,000 per security), plus any accrued and unpaid interest up to the redemption date.

As of March 31, 2018, the capital ratios for the Company’s subsidiary banks also exceeded the minimum required capital ratios plus the required conservation buffer, the minimum required capital ratios plus the fully phased-in capital conservation buffer, and the minimum required capital ratios for well capitalized institutions.

### Deposits and Other Liabilities

Total deposits of $4.9 billion at March 31, 2018 increased $92.1 million or 1.9% from December 31, 2017. The increase from year-end 2017 was comprised mainly of increases in money market and savings deposits (up $242.0 million). The growth in deposits reflects increases in municipal balances as well as both personal and business balances over year end.

The most significant source of funding for the Company is core deposits. The Company defines core deposits as total deposits less time deposits of $250,000 or more, brokered deposits, national deposit listing services and municipal money market deposits. Core deposits were flat when compared to year-end 2017. Core deposits represented 81.8% of total deposits at March 31, 2018, compared to 82.6% of total deposits at December 31, 2017.

Municipal money market savings and interest checking accounts totaled $1.0 billion at March 31, 2018 which was an increase of 20.0% compared to year-end 2017. In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances tend to increase throughout the fall and into the winter months from tax deposits and an additional inflow at the end of March from the electronic deposit of state funds.

The Company uses both retail and wholesale repurchase agreements. Retail repurchase agreements are arrangements with local customers of the Company, in which the Company agrees to sell securities to the customer with an agreement to repurchase those securities at a specified later date. Retail repurchase agreements totaled $69.1 million at March 31, 2018, and $75.2 million at December 31, 2017. Management generally views local repurchase agreements as an alternative to large time deposits.

The Company’s other borrowings totaled $995.1 million at March 31, 2018, down $76.7 million or 7.2% from $1.1 billion at December 31, 2017. Deposit growth supported asset growth and the partial paydown of borrowings. Borrowings at March 31, 2018 included $511.0 million in FHLB overnight advances, $475.0 million of FHLB term advances, and a $9.0 million advance from a correspondent bank. Borrowings at year-end 2017 included $587.7 million in overnight advances from FHLB, $475.0 million of FHLB term advances, and a $9.0 million advances from a correspondent bank. Of the $475.0 million in FHLB term advances at March 31, 2018, $265.0 million is due in over one year.

### Liquidity

The objective of liquidity management is to ensure the availability of adequate funding sources to satisfy the demand for credit, deposit withdrawals, and business investment opportunities. The Company’s large, stable core deposit base and strong capital position are the foundation for the Company’s liquidity position. The Company uses a variety of resources to meet its liquidity needs, which include deposits, cash and cash equivalents, short-term investments, cash flow from lending and investing activities, repurchase agreements, and borrowings. The Company’s Asset/Liability Management Committee monitors asset and liability positions of the Company’s subsidiary banks individually and on a combined basis. The Committee reviews periodic reports on liquidity and interest rate sensitivity positions. Comparisons with industry and peer groups are also monitored. The Company’s strong reputation in the communities it serves, along with its strong financial condition, provides access to numerous sources of liquidity as described below. Management believes these diverse liquidity sources provide sufficient means to meet all demands on the Company’s liquidity that are reasonably likely to occur.

Core deposits, discussed above under “Deposits and Other Liabilities”, are a primary and low cost funding source obtained primarily through the Company’s branch network. In addition to core deposits, the Company uses non-core funding sources to support asset growth. These non-core funding sources include time deposits of $250,000 or more, brokered time deposits, national deposit listing services, municipal money market deposits, bank borrowings, securities sold under agreements to repurchase and overnight and term advances from the FHLB. Rates and terms are the primary determinants of the mix of these funding sources. Non-core funding sources of $2.0 billion at March 31, 2018 decreased $28.1 million or 1.4% as compared to year end 2017. The decrease in non-core funding sources reflects mainly the paydown of overnight borrowings with the FHLB as a result of strong deposit growth during the first quarter of 2018. Non-core funding sources, as a percentage of total liabilities, were 32.3% at March 31, 2018, compared to 32.8% at December 31, 2017.

Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $1.4 billion at March 31, 2018 and $1.3 billion at December 31, 2017, were either pledged or sold under agreements to repurchase. Pledged securities represented 90.0% of total securities at March 31, 2018, compared to 84.3% of total securities at December 31, 2017. The increase is attributable to the growth of deposits from municipal customers and the shift of investment balances into higher yielding loans.

Cash and cash equivalents totaled $68.1 million as of March 31, 2018 which decreased from $84.3 million at December 31, 2017. Short-term investments, consisting of securities due in one year or less, decreased from $57.9 million at December 31, 2017, to $43.4 million on March 31, 2018.

Cash flow from the loan and investment portfolios provides a significant source of liquidity. These assets may have stated maturities in excess of one year, but have monthly principal reductions. Total mortgage-backed securities, at fair value, were $788.4 million at March 31, 2018 compared with $794.0 million at December 31, 2017. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $1.4 billion at March 31, 2018 unchanged from year end 2017. Aggregate amortization from monthly payments on these assets provides significant additional cash flow to the Company.

The Company's liquidity is enhanced by ready access to national and regional wholesale funding sources including Federal funds purchased, repurchase agreements, brokered certificates of deposit, and FHLB advances. Through its subsidiary banks, the Company has borrowing relationships with the FHLB and correspondent banks, which provide secured and unsecured borrowing capacity. At March 31, 2018, the unused borrowing capacity on established lines with the FHLB was $1.1 billion.

As members of the FHLB, the Company’s subsidiary banks can use certain unencumbered mortgage-related assets and securities to secure additional borrowings from the FHLB. At March 31, 2018, total unencumbered residential mortgage loans and securities were $518.4 million. Additional assets may also qualify as collateral for FHLB advances upon approval of the FHLB.

The Company has not identified any trends or circumstances that are reasonably likely to result in material increases or decreases in liquidity in the near term.

## Market risk

As filed, 5,665 characters.

Interest rate risk is the primary market risk category associated with the Company’s operations. Interest rate risk refers to the volatility of earnings caused by changes in interest rates. The Company manages interest rate risk using income simulation to measure interest rate risk inherent in its on-balance sheet and off-balance sheet financial instruments at a given point in time. The simulation models are used to estimate the potential effect of interest rate shifts on net interest income for future periods. Each quarter, the Company’s Asset/Liability Management Committee reviews the simulation results to determine whether the exposure of net interest income to changes in interest rates remains within levels approved by the Company’s Board of Directors. The Committee also considers strategies to manage this exposure and incorporates these strategies into the investment and funding decisions of the Company. The Company does not currently use derivatives, such as interest rate swaps, to manage its interest rate risk exposure, but may consider such instruments in the future.

The Company’s Board of Directors has set a policy that interest rate risk exposure will remain within a range whereby net interest income will not decline by more than 10% in one year as a result of a 100 basis point parallel change in rates. Based upon the simulation analysis performed as of February 28, 2018, a 200 basis point parallel upward change in interest rates over a one-year time frame would result in a one-year decrease in net interest income from the base case of approximately 1.6%, while a 100 basis point parallel decline in interest rates over a one-year period would result in an decrease in one-year net interest income from the base case of 0.8%. The simulation assumes no balance sheet growth and no management action to address balance sheet mismatches.

The decrease in net interest income in the rising rate scenario is a result of the balance sheet showing a more liability sensitive position over a one year time horizon. As such, in the short-term net interest income is expected to trend slightly below the base assumption, as upward adjustments to rate sensitive deposits and short-term funding outpace increases to asset yields which are concentrated in intermediate to longer-term products. As intermediate and longer-term assets continue to reprice/adjust into higher rate environment and funding costs stabilize, net interest income is expected to trend upwards.

The exposure in the 100 basis point decline scenario results from the Company’s assets repricing downward to a greater degree than the rates on the Company’s interest-bearing liabilities, mainly deposits. Rates on savings and money market accounts are at low levels given the historically low interest rate environment experienced in recent years. In addition, the model assumes that prepayments accelerate in the down interest rate environment resulting in additional pressure on asset yields as proceeds are reinvested at lower rates.

The most recent simulation of a base case scenario, which assumes interest rates remain unchanged from the date of the simulation, reflects a net interest margin that is stable to higher over the next 12 to 24 months.

Although the simulation model is useful in identifying potential exposure to interest rate movements, actual results may differ from those modeled as the repricing, maturity, and prepayment characteristics of financial instruments may change to a different degree than modeled. In addition, the model does not reflect actions that management may employ to manage the Company’s interest rate risk exposure. The Company’s current liquidity profile, capital position, and growth prospects, offer a level of flexibility for management to take actions that could offset some of the negative effects of unfavorable movements in interest rates. Management believes the current exposure to changes in interest rates is not significant in relation to the earnings and capital strength of the Company.

In addition to the simulation analysis, management uses an interest rate gap measure. The table below is a Condensed Static Gap Report, which illustrates the anticipated repricing intervals of assets and liabilities as of March 31, 2018. The Company’s one-year net interest rate gap was a negative $804.1 million or 12.09% of total assets at March 31, 2018, compared with a negative $762.6 million or 11.47% of total assets at December 31, 2017. A negative gap position exists when the amount of interest-bearing liabilities maturing or repricing exceeds the amount of interest-earning assets maturing or repricing within a particular time period. This analysis suggests that the Company’s net interest income is moderately more vulnerable to an increasing rate environment than it is to a prolonged declining interest rate environment. An interest rate gap measure could be significantly affected by external factors such as a rise or decline in interest rates, loan or securities prepayments, and deposit withdrawals.

*(in thousands)*

| Condensed Static Gap – March 31, 2018 | Total | 0-3 months | Repricing Interval 3-6 months | 6-12 months | Cumulative 12 months |
| --- | ---: | ---: | ---: | ---: | ---: |
| Interest-earning assets1 | $6,301,063 | $1,246,337 | $287,226 | $516,385 | $2,049,948 |
| Interest-bearing liabilities | 4,660,158 | 2,354,884 | 212,504 | 286,700 | 2,854,088 |
| Net gap position |  | (1,108,547) | 74,722 | 229,685 | (804,140) |
| Net gap position as a percentage of total assets |  | (16.67)% | 1.12% | 3.45% | (12.09)% |

#### 1 Balances of available securities are shown at amortized cost

## Controls and procedures

As filed, 948 characters.

### Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2018. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Report on Form 10-Q, the Company’s disclosure controls and procedures were effective.

### Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2018, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

## Risk factors

As filed, 193 characters.

There have been no material changes in the risk factors previously disclosed under Item 1A. of the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2017.

Filed May 9, 2018.
Source: SEC EDGAR, the filing index for accession 0001005817-18-000006. Last ingested by Listed: Nov 14, 2026, 20:28 ET. No prices; not investment advice.