# Tompkins Financial Corp: Form 10-Q for the period ended Mar 31, 2019

- Company: [Tompkins Financial Corp](/companies/tmp.md) (CIK 1005817)
- Form: 10-Q
- Filed: 2019-05-08
- Accepted by EDGAR: May 8, 2019, 16:13 ET
- Period: 2019-03-31
- Accession: 0001005817-19-000005
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1005817/000100581719000005/tmp2019-03x3110q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1005817/000100581719000005/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2019-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2019-01-01 to 2019-03-31 | $17.2m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Interest expense | 3 months, 2019-01-01 to 2019-03-31 | $13.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2019-01-01 to 2019-03-31 | $5.6m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2019-01-01 to 2019-03-31 | $21.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2019-01-01 to 2019-03-31 | $1.37 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2019-01-01 to 2019-03-31 | $1.37 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2019-01-01 to 2019-03-31 | 15,136,523 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Capital expenditure | 3 months, 2019-01-01 to 2019-03-31 | $1.6m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2019-01-01 to 2019-03-31 | $7.7m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2019-01-01 to 2019-03-31 | $0 | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2019-03-31 | $70.6m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2019-03-31 | $6.74bn | us-gaap:Assets |
| Total liabilities | at 2019-03-31 | $6.09bn | us-gaap:Liabilities |
| Shareholders' equity | at 2019-03-31 | $645.8m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 71,639 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, 2019, 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 118 E. Seneca Street, Ithaca, New York, 14850, and its telephone number is (888) 503-5753. The Company’s common stock is traded on the NYSE American under the symbol “TMP.”

The Tompkins strategy centers around our core values and a commitment to delivering long-term value to our clients, communities, and shareholders. To achieve this, the Company has developed a variety of strategic initiatives focused on delivering high quality products and services, a continual focus on improving operational effectiveness, investing in our people through talent management and development, maintaining appropriate risk management programs, and delivering profitable growth across all of our business lines. The Company's growth strategy includes initiatives to grow organically through our current businesses, as well as through possible acquisitions of financial institutions, branches, and financial services businesses. As such, the Company has acquired, and from time to time considers acquiring, banks, thrift institutions, branch offices of banks or thrift institutions, or other businesses 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.

### Business Segments

Banking services consist primarily of attracting deposits from the areas served by the Company’s four banking subsidiaries’ 66 banking offices (46 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 to all customers at the Company's four 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 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, and one stand-alone office in Tompkins County, New York.

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.

Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans and other credit and service charges, the quality and scope of the services rendered, the convenience of facilities and services, and, in the case of loans to commercial borrowers, relative lending limits. 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. In addition, the Company focuses on providing unparalleled customer service, which includes offering a strong suite of products and services. Although management feels that this business model has caused the Company to grow its customer base in recent years and allows it to compete effectively in the markets it serves, we cannot assure you that such factors will result in future 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, the 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, 2019. 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, 2018, 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, which 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, 2018 (the most recent report available). Although the peer group data is presented based upon financial information that is one fiscal quarter behind the financial information included in this report, the Company believes that it is relevant to include certain peer group information for comparison to current quarter numbers.

### 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, 2018, 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, 2018. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2018. 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.

### RESULTS OF OPERATION

### Performance Summary

Net income for the first quarter of 2019 was $21.0 million or $1.37 diluted earnings per share, compared to $20.4 million or $1.33 diluted earnings per share for the same period in 2018.

Return on average assets (“ROA”) for the quarter ended March 31, 2019 was 1.27%, compared to 1.25% for the quarter ended March 31, 2018. Return on average shareholders’ equity (“ROE”) for the first quarter of 2019 was 13.53%, compared to 14.41% for the same period in 2018. Tompkins’ year-to-date ROA and ROE compare to the most recent peer average ratios of 1.22% and 10.86%, 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 $18.8 million for the first quarter of 2019, up $232,000 or 1.2% from net income of $18.6 million for the same period in 2018.

Net interest income of $51.9 million for the first quarter of 2019 was down $773,000 or 1.5% from the same period in 2018. The decrease in net interest income was mainly a result of higher funding costs exceeding the increase in interest income compared to the first quarter of 2018 as discussed below. Higher funding costs were largely driven by the higher market interest rate environment.

The provision for loan and lease losses was $445,000 for the three months ended March 31, 2019, which was down $122,000 or 21.5% compared to the same period in 2018. The decrease in provision expense is mainly due to slower loan growth and stable asset quality.

Noninterest income of $7.6 million for the three months ended March 31, 2019 was up $1.2 million or 18.0% compared to the same period in 2018. The increase in the three month results for 2019 over 2018 includes: card services income (up $644,000) and other income (up $481,000). Card services income in the first quarter of 2019 included a one-time incentive payment of $500,000 related to the Company's merchant card business.

Noninterest expense of $35.3 million for the first quarter of 2019 was up $570,000 or 1.6% from the same period in 2018. The increase was mainly attributable to higher health insurance costs and higher post-retirement benefit costs.

### Insurance Segment

The insurance segment reported net income of $1.4 million for the three months ended March 31, 2019, which was up $482,000 or 53.6% compared to the first quarter of 2018. Noninterest income was up $660,000 or 8.8% in the first quarter of 2019, compared to the same period in 2018. The increase in noninterest income reflects higher contingency revenue and growth in personal, commercial and life and health business lines over prior year. Noninterest expenses were up $38,000 or 0.6% compared to the first quarter of 2018.

### Wealth Management Segment

The wealth management segment reported net income of $815,000 for the three months ended March 31, 2019, which was down $110,000 or 11.9% compared to the first quarter of 2018. The decrease in net income for the three month period ended March 31, 2019, was attributable to a decrease in Estate & Terminating Trust fees. These fee types are unpredictable in amounts and timing, as they are tied to the execution of the underlying terms of the estate or trust and, at times, court approval. Noninterest expense for the first quarter of 2019 was down 2.8% compared to the same period in 2018. The decrease was mainly in salary and wages, primarily due to open positions during the first quarter 2019.

### Net Interest Income

The following tables show average interest-earning assets and interest-bearing liabilities, and the corresponding yield or cost associated with each for the three month periods ended March 31, 2019 and 2018.

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

*(Dollar amounts in thousands)*

| ASSETS Interest-earning assets | Quarter Ended March 31, 2019 Average Balance (QTD) | Interest |  | Quarter Ended March 31, 2018 Average Balance (QTD) | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing balances due from banks | $2,334 | $10 | 1.74% | $2,565 | $7 | 1.11% |
| Securities (1) |  |  |  |  |  |  |
| U.S. Government securities | 1,409,305 | 8,172 | 2.35% | 1,454,229 | 7,954 | 2.22% |
| State and municipal (2) | 94,609 | 626 | 2.68% | 99,766 | 643 | 2.61% |
| Other securities (2) | 3,415 | 41 | 4.87% | 3,571 | 35 | 3.97% |
| Total securities | 1,507,329 | 8,839 | 2.38% | 1,557,566 | 8,632 | 2.25% |
| FHLBNY and FRB stock | 48,055 | 878 | 7.41% | 49,509 | 737 | 6.04% |
| Total loans and leases, net of unearned income (2)(3) | 4,792,607 | 55,614 | 4.71% | 4,688,087 | 51,229 | 4.43% |
| **Total interest-earning assets** | **6,350,325** | **65,341** | **4.17%** | **6,297,727** | **60,605** | **3.90%** |
| Other assets | 393,035 |  |  | 355,036 |  |  |
| **Total assets** | **6,743,360** |  |  | **6,652,763** |  |  |
| **LIABILITIES & EQUITY** |  |  |  |  |  |  |
| Deposits |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Interest bearing checking, savings, & money market | 2,940,416 | 4,470 | 0.62% | 2,796,197 | 1,646 | 0.24% |
| Time deposits | 645,144 | 2,127 | 1.34% | 717,617 | 1,123 | 0.63% |
| Total interest-bearing deposits | 3,585,560 | 6,597 | 0.75% | 3,513,814 | 2,769 | 0.32% |
| Federal funds purchased & securities sold under agreements to repurchase | 72,664 | 44 | 0.25% | 75,167 | 46 | 0.25% |
| Other borrowings | 993,773 | 6,044 | 2.47% | 1,053,311 | 4,359 | 1.68% |
| Trust preferred debentures | 16,878 | 329 | 7.90% | 16,706 | 279 | 6.77% |
| **Total interest-bearing liabilities** | **4,668,875** | **13,014** | **1.13%** | **4,658,998** | **7,453** | **0.65%** |
| Noninterest bearing deposits | 1,338,623 |  |  | 1,351,307 |  |  |
| Accrued expenses and other liabilities | 105,131 |  |  | 67,495 |  |  |
| **Total liabilities** | 6,112,629 |  |  | 6,077,800 |  |  |
| Tompkins Financial Corporation Shareholders’ equity | 629,305 |  |  | 573,536 |  |  |
| Noncontrolling interest | 1,426 |  |  | 1,427 |  |  |
| **Total equity** | **630,731** |  |  | **574,963** |  |  |
| **Total liabilities and equity** | **$6,743,360** |  |  | **$6,652,763** |  |  |
| Interest rate spread |  |  | **3.04%** |  |  | **3.25%** |
| Net interest income/margin on earning assets |  | **52,327** | **3.34%** |  | **53,152** | **3.42%** |
| Tax Equivalent Adjustment |  | **(413)** |  |  | **(465)** |  |
| Net interest income per consolidated financial statements |  | **$51,914** |  |  | **$52,687** |  |

#### 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 2019 and 2018 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, 2018.*

### Net Interest Income

Net interest income is the Company’s largest source of revenue, representing 72.8% of total revenues for the three months ended March 31, 2019, compared to 74.7% for the same period in 2018. 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, 2019, was down 1.5% over the same period in 2018. The decrease compared to the prior year was mainly due to higher costs associated with interest bearing liabilities, which was largely driven by the higher market interest rate environment, more than offsetting growth in interest income. However, 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, 2019, average loans represented 75.5% of average earning assets compared to 74.4% for the same period in 2018. With the recent increases in market interest rates, funding costs have risen at a faster pace than the Company's asset yields, resulting in a decline in net interest margin. Net interest margin for the three months ended March 31, 2019 was 3.34% compared to 3.42% for the same period in 2018.

Taxable-equivalent interest income for the three months ended March 31, 2019, was $65.3 million, up 7.8% compared to the same period in 2018. The increase in taxable-equivalent interest income was mainly the result of an increase in average loans, as well as higher average yields on loans. Average loan balances for the three months ended March 31, 2019, were up $104.5 million or 2.2%, and the average yield on loans increased to 4.71% for the first quarter of 2019, up 28 basis points compared to the first quarter of 2018. Average securities balances for the three months ended March 31, 2019, were down $50.2 million or 3.2%, while the average yield on securities was up 13 basis points compared to the same period in 2018.

Interest expense for the three months ended March 31, 2019, increased by $5.6 million or 74.6% compared to the same period in 2018, driven mainly by increased balances in average interest bearing deposits, combined with increases in market rates that resulted in higher average rates paid on interest bearing deposits and borrowings. The average cost of interest bearing deposits was 0.75% during the first quarter of 2019, which was up 43 basis points from the average cost in the first quarter of 2018. The average cost of interest bearing liabilities increased to 1.13% for the first quarter of 2019 from 0.65% for the first quarter of 2018. Average interest bearing deposits for the first quarter of 2019 were up $71.7 million or 2.0% compared to the same period in 2018. Average other borrowings for the three months ended March 31, 2019 were down $59.5 million or 5.7% compared to the same period in 2018. Interest expense for the first three months of 2019 and 2018 was positively impacted by $142,000 and $502,000, respectively, 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 appropriate level. The provision for loan and lease losses for the three months ended March 31, 2019 was $445,000 which was down compared to the same period in 2018. The decrease in provision expense was mainly due to slower loan growth and stable asset quality. The section captioned “Financial Condition – The Allowance for Loan and Lease Losses” below has further details on the allowance for loan and lease losses and asset quality metrics.

### Noninterest Income

Noninterest income was $19.4 million for the first quarter of 2019, which was up 8.8% compared to the same period prior year. Noninterest income represented 27.2% of total revenue for the three months ended March 31, 2019, compared to 25.3% for the same period in 2018.

Insurance commissions and fees, the largest component of noninterest income, were $8.0 million for the first quarter of 2019, an increase of $651,000 or 8.8% from the same period prior year. The increase in insurance revenues in the first quarter of 2019 compared to the same period in 2018 reflects growth in contingency revenue and in all business lines (personal, commercial and life and health) over prior year.

Investment services income of $4.1 million in the first quarter of 2019 was down $162,000 or 3.8% compared to the first quarter of 2018. 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 $4.0 billion at March 31, 2019, compared to $4.1 billion for the same period in 2018. The fair value at March 31, 2019 includes $1.1 billion of Company-owned securities where Tompkins Trust Company is custodian.

Card services income of $2.8 million in the first quarter of 2019 was up $644,000 or 30.0% compared to the same period in 2018. Contributing to the increase over the prior year was a one-time incentive payment of $500,000 (pre-tax) related to our merchant card business.

Other income of $2.5 million in the first quarter of 2019 was up 38.6% compared to the same period in 2018. The increase in the first quarter of 2019 compared to the first quarter of 2018 was mainly a result of an increase in other service charges (up $85,000), the cash surrender value of bank owned life insurance (up $126,000), gains on sales of residential mortgage loans (up $73,000), and other income (up $406,000), which included approximately $200,000 in fees related to a large credit relationship that paid off during the quarter and a $272,000 partial reversal of an accrual established in 2018 for estimated exposure on a letter of credit.

### Noninterest Expense

Noninterest expense was $44.2 million for the first quarter of 2019, up 1.1% compared to the same period in 2018. Noninterest expense as a percentage of total revenue for the first quarter of 2019 and 2018 was 62.0%.

Expenses associated with salaries and wages and employee benefits are the largest component of noninterest expense, representing 60.4% of total noninterest expense for the three months ended March 31, 2019 and 60.3% for the three months ended March 31, 2018. Salaries and wages expense for the three months ended March 31, 2019 was relatively flat compared to the same period in 2018. Other employee benefits increased by $0.2 million or 4.4% in the first quarter of 2019 over the same period of 2018, mainly due to increased costs in health insurance and post-retirement benefits.

Other expense categories, not related to compensation and benefits, for the three months ended March 31, 2019, were in line with the same period in 2018. The significant components of other operating expense are professional fees, technology, and marketing expenses. Technology expense for the first quarter of 2019 was up $0.2 million or 7.5% over the same period prior year, mainly as a result of investments in strengthening the Company's compliance and information security infrastructure. Professional fees and marketing expenses for the first quarter of 2019 were in line with prior year.

### Income Tax Expense

The provision for income taxes was $5.6 million for an effective rate of 21.0% for the first quarter of 2019, compared to tax expense of $5.8 million and an effective rate of 22.0% for the same quarter in 2018. The effective rates differ from the U.S. statutory rate primarily due to the effect of tax-exempt income from loans, securities and life insurance assets, and the income tax effects associated with stock based compensation.

### FINANCIAL CONDITION

Total assets were $6.7 billion at March 31, 2019, which were in line with December 31, 2018. Total originated loan balances were $4.5 billion at March 31, 2019 compared to $4.6 billion at year-end 2018. Total acquired loans of $256.9 million were down $8.3 million or 3.1% from December 31, 2018, due to expected run-off in the acquired portfolio. Total deposits were up $101.0 million or 2.1% from December 31, 2018. Other borrowings decreased $152.6 million or 14.2% from December 31, 2018, as a result of deposit growth outpacing loan growth in the period.

### Securities

As of March 31, 2019, the Company’s securities portfolio was $1.48 billion or 22.0% of total assets, compared to $1.47 billion or 21.8% of total assets at year-end 2018. The following table details the composition of available-for-sale and held-to-maturity securities.

*(in thousands)*

| Available-for-Sale Securities | March 31, 2019 Amortized Cost | Fair Value | December 31, 2018 Amortized Cost | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| U.S. Treasuries | **$280** | **$280** | 289 | 289 |
| Obligations of U.S. Government sponsored entities | **478,819** | **475,745** | 493,371 | 485,898 |
| Obligations of U.S. states and political subdivisions | **87,459** | **87,778** | 86,260 | 85,440 |
| Mortgage-backed securities - residential, issued by |  |  |  |  |
| U.S. Government agencies | **147,971** | **146,010** | 131,831 | 128,267 |
| U.S. Government sponsored entities | **642,054** | **631,328** | 649,620 | 630,558 |
| Non-U.S. Government agencies or sponsored entities | **19** | **19** | 31 | 31 |
| U.S. corporate debt securities | **2,500** | **2,450** | 2,500 | 2,175 |
| **Total available-for-sale securities** | **1,359,102** | **1,343,610** | 1,363,902 | 1,332,658 |

*(in thousands)*

| Held-to-Maturity Securities | March 31, 2019 Amortized Cost | Fair Value | December 31, 2018 Amortized Cost | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| Obligations of U.S. Government sponsored entities | **$131,205** | **$131,985** | $131,306 | $130,108 |
| Obligations of U.S. states and political subdivisions | **$8,437** | **$8,437** | $9,273 | $9,269 |
| Total held-to-maturity debt securities | **$139,642** | **$140,422** | **$140,579** | **$139,377** |

The decrease in unrealized losses, which reflects the amount that 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 2019. 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, 2019 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 as of the end of the first quarter and prior year-end periods were as follows:*

*(in thousands)*

| Commercial and industrial | March 31, 2019 Originated | Acquired | Total Loans and Leases | December 31, 2018 Originated | Acquired | Total Loans and Leases |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Agriculture | **$94,737** | **$0** | **$94,737** | $107,494 | $0 | $107,494 |
| Commercial and industrial other | **910,784** | **42,665** | **953,449** | 926,429 | 43,712 | 970,141 |
| Subtotal commercial and industrial | **1,005,521** | **42,665** | **1,048,186** | 1,033,923 | 43,712 | 1,077,635 |
| Commercial real estate |  |  |  |  |  |  |
| Construction | **167,181** | **1,361** | **168,542** | 164,285 | 1,384 | 165,669 |
| Agriculture | **170,528** | **219** | **170,747** | 170,005 | 224 | 170,229 |
| Commercial real estate other | **1,834,496** | **172,169** | **2,006,665** | 1,827,279 | 177,484 | 2,004,763 |
| Subtotal commercial real estate | **2,172,205** | **173,749** | **2,345,954** | 2,161,569 | 179,092 | 2,340,661 |
| Residential real estate |  |  |  |  |  |  |
| Home equity | **203,538** | **19,586** | **223,124** | 208,459 | 21,149 | 229,608 |
| Mortgages | **1,070,806** | **20,086** | **1,090,892** | 1,083,802 | 20,484 | 1,104,286 |
| Subtotal residential real estate | **1,274,344** | **39,672** | **1,314,016** | 1,292,261 | 41,633 | 1,333,894 |
| Consumer and other |  |  |  |  |  |  |
| Indirect | **13,430** | **0** | **13,430** | 12,663 | 0 | 12,663 |
| Consumer and other | **55,885** | **811** | **56,696** | 57,565 | 761 | 58,326 |
| Subtotal consumer and other | **69,315** | **811** | **70,126** | 70,228 | 761 | 70,989 |
| Leases | **15,164** | **0** | **15,164** | 14,556 | 0 | 14,556 |
| Total loans and leases | **4,536,549** | **256,897** | **4,793,446** | 4,572,537 | 265,198 | 4,837,735 |
| Less: unearned income and deferred costs and fees | **(3,746)** | **0** | **(3,746)** | (3,796) | 0 | (3,796) |
| Total loans and leases, net of unearned income and deferred costs and fees | **$4,532,803** | **$256,897** | **$4,789,700** | $4,568,741 | $265,198 | $4,833,939 |

Total loans and leases of $4.8 billion at March 31, 2019 were down $44.2 million or 0.9% from December 31, 2018. The decrease is partially due to higher than expected paydowns/payoffs as a result of competitive market conditions. On August 1, 2012, the Company acquired $889.3 million of loans in the VIST Financial acquisition. These loans are shown in the table under the acquired loan heading. All other loans, including loans originated by VIST Bank since the acquisition date of August 1, 2012, are considered originated loans. Originated loan balances at March 31, 2019 were down $35.9 million or 0.8% from year-end 2018. As of March 31, 2019, total loans and leases represented 71.1% of total assets compared to 71.5% of total assets at December 31, 2018.

Residential real estate loans, including home equity loans, were $1.3 billion at March 31, 2019, down $19.9 million or 1.5% compared to December 31, 2018, and comprised 27.4% of total loans and leases at March 31, 2019. Changes in residential loan balances are 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 2019 and 2018, the Company sold $8.5 million and $0.8 million, respectively, of residential real estate loans and recognized gains on these sales of $94,000 and $21,000, 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 totaled $0.9 million at March 31, 2019 and $0.8 million at December 31, 2018.

Commercial real estate loans and commercial and industrial loans totaled $2.3 billion and $1.1 billion, respectively, and represented 48.7% and 22.1%, respectively of total loans as of March 31, 2019. The commercial real estate portfolio was in line with year-end 2018, while commercial and industrial loans were down 1.7%.

As of March 31, 2019, agriculturally-related loans totaled $265.5 million or 5.5% of total loans and leases, compared to $277.7 million or 5.7% of total loans and leases at December 31, 2018. 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 $10.8 million at March 31, 2019 as compared to $11.0 million at December 31, 2018. 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 $246.1 million at March 31, 2019, compared to $254.2 million at December 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, 2018. 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, 2019, 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 those 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 | 3/31/2019 | 12/31/2018 | 3/31/2018 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | $11,523 | $11,217 | $12,431 |
| Commercial real estate | 21,045 | 23,483 | 20,402 |
| Residential real estate | 6,404 | 7,317 | 5,972 |
| Consumer and other | 1,273 | 1,304 | 1,302 |
| **Total** | **$40,245** | **$43,321** | **$40,107** |

54

*(in thousands)*

| Allowance for acquired loans | 3/31/2019 | 12/31/2018 | 3/31/2018 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | 0 | 55 | 25 |
| Commercial real estate | 25 | 0 | 0 |
| Residential real estate | 58 | 28 | 73 |
| Consumer and other | 0 | 6 | 6 |
| **Total** | **83** | **89** | **104** |

As of March 31, 2019, the total allowance for loan and lease losses was $40.3 million, which included $40.2 million of allowance for originated loans and leases and $0.1 million of allowance for acquired loans. The $3.1 million decrease in the allowance at March 31, 2019, compared to year-end 2018 was mainly due to a $3.1 million write-down of a single commercial real estate relationship. This relationship was downgraded in the fourth quarter of 2018 and an impairment reserve was established at that time. This impairment reserve contributed to the increase in the allowance for loan and lease losses at year-end 2018. Asset quality metrics remained favorable at March 31, 2019, with lower levels of internally-classified Special Mention or Substandard loans, nonperforming loans and leases and past due loans and leases compared to year-end 2018 and March 31, 2018. Loans internally-classified Special Mention or Substandard were down from year end 2018 by $2.7 million or 3.6%. Nonperforming loans and leases were down $239,000 or 1.9% from year end 2018 and represented 0.48% of total loans at March 31, 2019 compared to 0.55% at December 31, 2018. The allowance for loan and lease losses covered 175.51% of nonperforming loans and leases as of March 31, 2019, compared to 163.25% at December 31, 2018.

The Company’s allowance for originated loan and lease losses totaled $40.2 million at March 31, 2019, which represented 0.89% of total originated loans, down from 0.95% at December 31, 2018, and 0.91% at March 31, 2018. The decrease in the dollar balance of the originated allowance at March 31, 2019, compared to year end 2018 was mainly due to the $3.1 million write-down on the commercial real estate relationship mentioned above. Stable asset quality, slower loan growth and favorable qualitative factors contributed to the decrease in the ratio of originated allowance to total originated loans at March 31, 2019 compared to year-end 2018. Nonaccrual originated loans were $15.2 million as of March 31, 2019 compared to $19.3 million at year end 2018, and $18.4 million at March 31, 2018.

The allowance for acquired loans at March 31, 2019 was $83,000, down from $89,000 at year end 2018, and $104,000 at March 31, 2018. 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. Nonaccrual acquired loans were $2.6 million as of March 31, 2019 compared to $2.9 million at year-end 2018, and $3.4 million at March 31, 2018.

Activity in the Company’s allowance for loan and lease losses during the first three months of 2019 and 2018 is illustrated in the table below.

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

*(in thousands)*

|  | 3/31/2019 | 3/31/2018 |
| --- | ---: | ---: |
| Average originated loans outstanding during period | **$4,531,940** | $4,383,075 |
| Balance of originated allowance at beginning of year | **$43,321** | $39,686 |
| ORIGINATED LOANS CHARGED-OFF: |  |  |
| Commercial and industrial | **380** | 3 |
| Commercial real estate | **3,343** | 0 |
| Residential real estate | **18** | 185 |
| Consumer and other | **180** | 292 |
| Total loans charged-off | **$3,921** | $480 |
| RECOVERIES OF ORIGINATED LOANS PREVIOUSLY CHARGED-OFF: |  |  |
| Commercial and industrial | **43** | 6 |
| Commercial real estate | **1** | 170 |
| Residential real estate | **226** | 42 |
| Consumer and other | **95** | 75 |
| Total loans recoveries | **$365** | $293 |
| Net loans charged-off | **3,556** | 187 |
| Additions to originated allowance charged to operations | **480** | 608 |
| Balance of originated allowance at end of period | **$40,245** | $40,107 |
| Allowance for originated loans and leases as a percentage of originated loans and leases | **0.89%** | 0.91% |
| Annualized net charge-offs on originated loans to average total originated loans and leases during the period | **0.32%** | 0.02% |

56

*Analysis of the Allowance for Acquired Loan Losses*

*(in thousands)*

|  | 3/31/2019 | 3/31/2018 |
| --- | ---: | ---: |
| Average acquired loans outstanding during period | **$260,667** | $305,012 |
| Balance of acquired allowance at beginning of year | **89** | 85 |
| ACQUIRED LOANS CHARGED-OFF: |  |  |
| Commercial and industrial | **0** | 1 |
| Commercial real estate | **0** | 0 |
| Residential real estate | **0** | 0 |
| Consumer and other | **0** | 0 |
| Total loans charged-off | **$0** | $1 |
| RECOVERIES OF ACQUIRED LOANS PREVIOUSLY CHARGED-OFF: |  |  |
| Commercial and industrial | **16** | 20 |
| Commercial real estate | **6** | 8 |
| Residential real estate | **7** | 33 |
| Consumer and other | **$0** | $0 |
| Total loans recovered | **$29** | $61 |
| Net loans (recovered) charged-off | **(29)** | (60) |
| Additions to acquired allowance charged to operations | **(35)** | (41) |
| Balance of acquired allowance at end of period | **$83** | $104 |
| Allowance for acquired loans as a percentage of acquired loans outstanding acquired loans and leases | **0.03%** | 0.03% |
| Annualized net charge-offs (recoveries) on acquired loans as a percentage of average acquired loans and leases outstanding during the period | **(0.05)%** | (0.08)% |
| Annualized total net charge-offs as a percentage of average loans and leases outstanding during the period | **0.30%** | 0.01% |

Net loan and lease chargeoffs totaled $3.5 million for the three months ended March 31, 2019, compared to net charge-offs of $127,000 for the same period in 2018. The year-over-year increase was mainly due to the $3.1 million write-down of one relationship in the commercial real estate loan portfolio. This relationship was downgraded in the fourth quarter of 2018 and an impairment reserve was established at that time. Annualized net charge-offs were 0.30% of average total loans and leases, compared to 0.01% for the same period in 2018.

The provision for loan and lease losses was $445,000 for the three months ended March 31, 2019, compared to $567,000 for the same period in 2018. The provision for loan and lease losses is based upon the Company's quarterly evaluation of the appropriateness of the allowance for loan and lease losses. Slower loan growth and stable asset quality measures contributed to the decrease in the provision for loan and lease losses for the three months ended March 31, 2019 compared to the same period of 2018.

*(in thousands)*

| Analysis of Past Due and Nonperforming Loans Loans 90 days past due and accruing | 3/31/2019 | 12/31/2018 | 3/31/2018 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | **$0** | 0 | 0 |
| Consumer and other | **0** | 0 | 0 |
| Total loans 90 days past due and accruing | **$0** | 0 | 0 |
| Nonaccrual loans |  |  |  |
| Commercial and industrial | **1,933** | 1,883 | 4,681 |
| Commercial real estate | **3,742** | 8,007 | 5,720 |
| Residential real estate | **11,833** | 12,072 | 11,140 |
| Consumer and other | **236** | 234 | 240 |
| Total nonaccrual loans | **$17,744** | 22,196 | 21,781 |
| Troubled debt restructurings not included above | **5,234** | 4,395 | 3,455 |
| Total nonperforming loans and leases | **$22,978** | 26,591 | 25,236 |
| Other real estate owned | **1,595** | 1,595 | 2,047 |
| Total nonperforming assets | **$24,573** | $28,186 | $27,283 |
| Allowance as a percentage of nonperforming loans and leases | **175.51%** | 163.25% | 159.34% |
| Total nonperforming loans and leases as percentage of total loans and leases | **0.48%** | 0.55% | 0.54% |
| Total nonperforming assets as percentage of total assets | **0.36%** | 0.42% | 0.41% |

*1 The March 31, 2019, December 31, 2018, and March 31, 2018 columns in the above table exclude $1.2 million, $1.3 million, and $1.1 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. Total nonperforming assets of $24.6 million at March 31, 2019 were down $3.6 million or 12.8% compared to December 31, 2018, and $2.7 million or 9.9% compared to March 31, 2018. Nonperforming assets represented 0.36% of total assets at March 31, 2019, down from 0.42% at December 31, 2018, and 0.41% at March 31, 2018. The Company’s ratio of nonperforming assets to total assets continues to compare favorably to our peer group’s most recent ratio of 0.59% at December 31, 2018. Total nonperforming loans and leases of $23.0 million were down $3.6 million or 13.6% from year end 2018, and $2.3 million or 8.9% from March 31, 2018. Contributing to the decrease in nonperforming loans and leases was the $3.1 million write-down of a single commercial real estate relationship during the first quarter of 2019. This relationship was downgraded and placed on nonaccrual status during the fourth quarter of 2018 and an impairment reserve was established at that time. A breakdown of nonperforming loans and leases by portfolio segment is above.

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, 2019, the Company had $6.9 million in TDRs, and of that total $1.7 million were reported as nonaccrual and $5.2 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 $14.5 million at March 31, 2019, compared to $17.6 million at December 31, 2018 and $18.6 million at March 31, 2018. 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 year to date average recorded investment in impaired loans and leases was $16.0 million at March 31, 2019, compared to $17.2 million at March 31, 2018. At March 31, 2019 and December 31, 2018, there was a specific reserve of $435,000 and $3.8 million, respectively, on impaired loans. The specific reserve of $435,000 at March 31, 2019 was for impaired loans in the originated portfolio; there were no specific reserves for impaired loans in the acquired portfolio. The specific reserve of $3.8 million reported at December 31, 2018 was primarily related to one commercial loan relationship in the originated loan portfolio, which was charged down in the first quarter of 2019. The majority of impaired loans were 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 and leases (loans past due 90 days and accruing, nonaccrual loans and restructured troubled debt) was 175.51% at March 31, 2019, compared to 163.25% at December 31, 2018, and 159.34% at March 31, 2018. The Company’s nonperforming loans and leases are mostly made up of collateral dependent impaired loans with limited exposure or loans that 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 27 commercial relationships from the originated portfolio and 6 commercial relationships from the acquired portfolio totaling $29.0 million and $1.2 million, respectively at March 31, 2019 that were potential problem loans. At December 31, 2018, the Company had identified 29 relationships totaling $33.7 million in the originated portfolio and 6 relationships totaling $1.2 million in the acquired portfolio that were potential problem loans. Of the 27 commercial relationships in the originated portfolio at March 31, 2019 that were Substandard, there were 10 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $25.9 million, the largest of which was $9.0 million. Of the 6 commercial relationships from the acquired loan portfolio at March 31, 2019 that were Substandard, there were 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 $647.3 million at March 31, 2019, an increase of $26.4 million or 4.3% from December 31, 2018. The increase reflects growth in retained earnings and a decline in accumulated other comprehensive losses.

Additional paid-in capital remained relatively flat, increasing slightly from $366.6 million at December 31, 2018, to $367.2 million at March 31, 2019. The slight increase was primarily attributable to $1.0 million related to stock based compensation, partially offset by $0.2 million related to the exercise of stock options and $0.1 million related to the Company's director deferred compensation plan. Retained earnings increased by $13.4 million from $319.4 million at December 31, 2018, to $332.8 million at March 31, 2019, reflecting net income of $21.0 million less dividends paid of $7.7 million. Accumulated other comprehensive loss decreased from a net loss of $63.2 million at December 31, 2018, to a net loss of $51.0 million at March 31, 2019, reflecting an $11.9 million decrease in unrealized losses on available-for-sale securities due to changes in market rates coupled with a $0.3 million decrease related to post-retirement benefit plans. In connection with the effectiveness of the 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 2019 totaled approximately $7.7 million or $0.50 per common share, representing 36.4% of year to date 2019 earnings through March 31, 2019, and were up 4.2% over cash dividends of $7.3 million or $0.48 per common share paid in the first three months of 2018.

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 was phased in over a 3-year period that began on January 1, 2016, and was fully phased-in on January 1, 2019 at 2.5%.

The following table provides a summary of the Company’s capital ratios as of March 31, 2019.

*REGULATORY CAPITAL ANALYSIS*

*(dollar amounts in thousands)*

| March 31, 2019 | Actual Amount | Ratio | Minimum Capital Required - Basel III Fully Phased-In Amount | Ratio | Well Capitalized Requirement Amount | Ratio |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Total Capital (to risk weighted assets) | $657,173 | 13.39% | $515,272 | 10.50% | $490,735 | 10.00% |
| Tier 1 Capital (to risk weighted assets) | $614,924 | 12.53% | $417,125 | 8.50% | $392,588 | 8.00% |
| Tier 1 Common Equity (to risk weighted assets) | $598,018 | 12.19% | $343,518 | 7.00% | $318,978 | 6.50% |
| Tier 1 Capital (to average assets) | $614,924 | 9.24% | $266,159 | 4.00% | $332,699 | 5.00% |

As of March 31, 2019, the Company’s capital ratios exceeded 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 13.4% at March 31, 2019, compared with 13.1% as of December 31, 2018. Tier 1 capital as a percent of risk weighted assets increased from 12.2% at the end of 2018 to 12.5% as of March 31, 2019. Tier 1 capital as a percent of average assets was 9.2% at March 31, 2019, which is up from 9.1% at December 31, 2018. Common equity tier 1 capital was 12.2% at the end of the first quarter of 2019, up from 11.8% at the end of 2018.

As of March 31, 2019, 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 $5.0 billion at March 31, 2019 were up $101.0 million or 2.1% from December 31, 2018. The increase from year-end 2018 was primarily in checking, money market and savings balances, which were up $124.4 million or 4.4% from year-end 2018. Non interest bearing deposits and time deposits were down $47.9 million or 3.4% and up $24.4 million or 3.8%, respectively, from year-end 2018.

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 and municipal money market deposits. Core deposits were up by $155.2 million or 3.78% to $4.3 billion at March 31, 2019, from year-end 2018. Core deposits represented 85.4% of total deposits at March 31, 2019, compared to 84.0% of total deposits at December 31, 2018.

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 $66.9 million at March 31, 2019, and $81.7 million at December 31, 2018. Management generally views local repurchase agreements as an alternative to large time deposits.

The Company’s other borrowings totaled $923.4 million at March 31, 2019, down $152.6 million or 14.2% from $1.1 billion at December 31, 2018. Borrowings decreased primarily due to seasonal deposit growth from year-end 2018. Borrowings at March 31, 2019 included $554.4 million in FHLB overnight advances, $365.0 million of FHLB term advances, and a $4.0 million advance from a bank. Borrowings at year-end 2018 included $647.1 million in overnight advances from FHLB, $425.0 million of FHLB term advances, and a $4.0 million advance from a bank. Of the $365.0 million in FHLB term advances at March 31, 2019, $90.0 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 $1.7 billion at March 31, 2019 decreased $221.7 million or 11.4% as compared to year end 2018. The decrease in non-core funding sources reflects mainly a decrease in overnight borrowings with the FHLB compared to year-end 2018. Non-core funding sources, as a percentage of total liabilities, were 28.2% at March 31, 2019, compared to 31.6% at December 31, 2018.

Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $1.2 billion at March 31, 2019 and at $1.2 billion at December 31, 2018, were either pledged or sold under agreements to repurchase. Pledged securities represented 82.4% of total securities at March 31, 2019, compared to 77.8% of total securities at December 31, 2018.

Cash and cash equivalents totaled $70.6 million as of March 31, 2019 which decreased from $80.4 million at December 31, 2018. Short-term investments, consisting of securities due in one year or less, increased from $86.8 million at December 31, 2018, to $125.6 million at March 31, 2019.

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 $777.4 million at March 31, 2019 compared with $758.9 million at December 31, 2018. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $1.4 billion at March 31, 2019, down $20.1 million or 1.4% compared with year end 2018. 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, 2019, the unused borrowing capacity on established lines with the FHLB was $1.2 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, 2019, total unencumbered residential mortgage loans and securities were $680.1 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, 5,742 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 200 basis point parallel change in rates. Based upon the simulation analysis performed as of February 28, 2019, 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 4.0%, while a 200 basis point parallel decline in interest rates over a one-year period would result in an increase in one-year net interest income from the base case of 1.4%. 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 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.

In the down 200 rate scenario net interest income increases in the first year as a result of the Company's assets repricing downward to a lesser degree than the rates on the Company's interest-bearing liabilities, mainly deposits and overnight borrowings. Rates on savings and money market accounts have moved up from the historically low levels, allowing for some interest rate relief in the first year of a declining rate scenario. 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 18 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, 2019. The Company’s one-year net interest rate gap was a negative $918.4 million or 13.63% of total assets at March 31, 2019, compared with a negative $897.7 million or 13.28% of total assets at December 31, 2018. 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, 2019 | Total | 0-3 months | Repricing Interval 3-6 months | 6-12 months | Cumulative 12 months |
| --- | ---: | ---: | ---: | ---: | ---: |
| Interest-earning assets1 | $6,335,575 | $1,228,056 | $281,325 | $535,637 | $2,045,018 |
| Interest-bearing liabilities | 4,646,556 | 2,440,789 | 243,521 | 279,155 | 2,963,465 |
| Net gap position |  | (1,212,733) | 37,804 | 256,482 | (918,447) |
| Net gap position as a percentage of total assets |  | (18.00)% | 0.56% | 3.81% | (13.63)% |

#### 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, 2019. 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, 2019, 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, 2018.

Filed May 8, 2019.
Source: SEC EDGAR, the filing index for accession 0001005817-19-000005. Last ingested by Listed: Oct 31, 2026, 15:15 ET. No prices; not investment advice.