# Tompkins Financial Corp: Form 10-Q for the period ended Mar 31, 2010

- Company: [Tompkins Financial Corp](/companies/tmp.md) (CIK 1005817)
- Form: 10-Q
- Filed: 2010-05-07
- Accepted by EDGAR: May 7, 2010, 19:07 ET
- Period: 2010-03-31
- Accession: 0001019056-10-000595
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/1005817/000101905610000595/tompkins_1q10.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1005817/000101905610000595/

## Management's discussion and analysis

As filed, 65,645 characters.

### BUSINESS

Tompkins Financial Corporation (“Tompkins” or the “Company”) is a registered financial holding company incorporated in 1995 under the laws of the State of New York and its common stock is listed on the NYSE-Amex (Symbol: TMP). Tompkins is headquartered at The Commons, Ithaca, New York. Tompkins is the corporate parent of three community banks: Tompkins Trust Company (“Trust Company”), The Bank of Castile and The Mahopac National Bank; an insurance agency, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”); and a fee-based financial planning and wealth management firm, AM&M Financial Services, Inc. (“AM&M”). Unless the context otherwise requires, the term “Company” refers collectively to Tompkins Financial Corporation and its subsidiaries.

The Company operates in two business segments, banking and financial services. Financial services activities include the results of the Company’s trust, financial planning, wealth management and broker-dealer services, risk management, and insurance agency operations. All other activities are considered banking. Information about the Company’s business segments is included in Note 11 “Segment and Related Information,” in the Notes to Unaudited Condensed Consolidated Financial Statements contained in Part I of this Quarterly Report on Form 10-Q.

Banking services consist primarily of attracting deposits from the areas served by the Company’s 45 banking offices 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. Residential real estate mortgage loans are generally underwritten in accordance with Federal Home Loan Mortgage Corporation (“FHLMC”) guidelines, which enhance the liquidity of these lending products. The Company’s subsidiary banks have sold residential mortgage loans to FHLMC over the past several years to manage exposure to changing interest rates and to take advantage of favorable market conditions. The Company’s subsidiary banks retain the servicing of the loans sold to FHLMC and record a servicing asset at the time of sale.

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.

The Company provides trust and investment services through Tompkins Investment Services (“TIS”), a division of Trust Company, and investment services through AM&M. TIS, with office locations at all three of the Company’s subsidiary banks, provides a full range of money management services, including: investment management accounts, custody accounts, trusts, retirement plans and rollovers, estate settlement, and financial planning; and retail brokerage services. AM&M provides fee-based financial planning for small business owners, professionals and corporate executives and other individuals with complex financial needs. AM&M also provides wealth management services and operates a broker-dealer subsidiary, which is an outsourcing company for financial planners and investment advisors.

The Company provides property and casualty insurance services and employee benefit consulting through Tompkins Insurance and life, long-term care and disability insurance through AM&M. Tompkins Insurance is headquartered in Batavia, New York, and offers property and casualty insurance to individuals and businesses primarily in Western New York. Over the past several years, Tompkins Insurance has acquired smaller insurance agencies in the market areas serviced by the Company’s banking subsidiaries. Tompkins Insurance offers services to customers of the Company’s banking subsidiaries by sharing offices with The Bank of Castile and Trust Company. In addition to these shared offices, Tompkins Insurance has five stand-alone offices in Western New York, and two stand-alone offices in Tompkins County, New York.

AM&M is headquartered in Pittsford, New York and offers fee-based financial planning services through three operating companies: (1) AM&M Planners, Inc., which provides fee based financial planning and wealth management services for corporate executives, small business owners and high net worth individuals; (2) Ensemble Financial Services, Inc., an independent broker-dealer and a leading outsourcing company for financial planners and investment advisors; and (3) Ensemble Risk Solutions, Inc., which creates customized risk management plans using life, disability and long-term care insurance products.

Competition for commercial banking and other financial services is strong in the Company’s market area. Competition includes other commercial banks, savings and loan associations, credit unions, finance companies, Internet-based financial services companies, mutual funds, insurance companies, brokerage and investment companies, and other financial intermediaries. The Company differentiates itself from its competitors through its full complement of banking and related financial services, and through its community commitment and involvement in its primary market areas, as well as its commitment to quality and personalized banking services.

Banking and financial services are highly regulated. As a financial holding company with three community banks, the Company and its subsidiaries are subject to examination and regulation by the Federal Reserve Board (“FRB”), the Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency, and the New York State Banking Department. Additionally, the Company is subject to examination and regulation from the New York State Insurance Department, the Securities and Exchange Commission and the Financial Industry Regulatory Authority.

Other external factors affecting the Company’s operating results are market rates of interest, the condition of financial markets, and both national and regional economic conditions. Weak economic conditions over the past several years has contributed to increases in the Company’s past due loans and leases, nonperforming assets, and net loan and lease losses, as well as decreases in certain fee-based products and services. While Tompkins operates in markets that have been impacted to a lesser extent than many areas around the country, there is no assurance that these conditions may not adversely affect the credit quality on the Company’s loans and leases, results of operation, and financial condition going forward. Refer to the section captioned “Financial Condition- Allowance for Loan and Lease Losses and Nonperforming Assets” below for further details on asset quality.

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, 2010. 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, 2009, and the Unaudited Condensed Consolidated Financial Statements and notes thereto included in Part I of this Quarterly Report on Form 10-Q.

### Forward-Looking Statements

The Company is making this statement in order to satisfy the “Safe Harbor” provision contained in the Private Securities Litigation Reform Act of 1995. The statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. Such 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 matters expressed and/or implied by such forward-looking statements. The following factors 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, insurance companies, bank holding companies and/or financial holding companies; 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; protection and validity of intellectual property rights; 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. In addition, such forward-looking statements could be affected by general industry and market conditions and growth rates, general economic and political conditions, including interest rate and currency exchange rate fluctuations, and other factors.

### 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 makes 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”), pension and postretirement benefits 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 Financials Statements to the Company’s Audited 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, 2009. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2009. Refer to Note 3 – “Accounting Pronouncements” in the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q for a discussion of recent accounting guidelines.

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 92 domestic bank holding companies with $3 billion to $10 billion in total consolidated assets as identified in the FRB’s “Bank Holding Company Performance Report” for December 31, 2009 (the most recent report available).

### OVERVIEW

Net income for the first quarter of 2010 was $8.4 million, an increase of 9.2% over $7.7 million for the first quarter of 2009. Diluted earnings per share of $0.78 for the first quarter of 2010 were up 8.3% over $0.72 for the first quarter of 2009. Growth in average earning assets and deposits, lower funding costs, as well as improved investment services revenue contributed to the improved performance for the first quarter of 2010 compared to the first quarter of 2009.

Return on average assets (“ROA”) for the quarter ended March 31, 2010 was 1.08% compared to 1.07% for the quarter ended March 31, 2009. Return on average shareholders’ equity (“ROE”) for the first quarter of 2010 was 13.68%, compared to 14.02% for the same period in 2009. Tompkins’ ROA and ROE continue to compare favorably to peer ratios, ranking in the 83rd percentile for ROA and the 89th percentile for ROE of its peer group. The peer group is from the Federal Reserve Board and represents banks and bank holding companies with assets between $3.0 billion and $10.0 billion.

Total revenues, consisting of net interest income and noninterest income, were $39.3 million in the first quarter of 2010, up 6.7% over the comparable period in 2009. Both periods benefited from growth in net interest income, a result of lower funding costs and growth in average earning assets. Noninterest income was up $387,000 or 3.5% in the first quarter of 2010 compared with the first quarter of 2009, driven by higher investment services income.

Noninterest expenses of $24.5 million in the first quarter of 2010 were up 5.2% compared to the first quarter of 2009. Salaries and wages, and employee benefits were up 10.3% compared to the same period in 2009, which was driven by an increase in FTEs, annual salary adjustments, and higher health insurance and pension cost in 2010.

### Segment Reporting

The Company operates in two business segments, banking and financial services. Financial services activities consist of the results of the Company’s trust, financial planning and wealth management, broker-dealer services, and risk management operations. All other activities are considered banking.

#### Banking Segment

The banking segment reported net income of $7.5 million for the first quarter of 2010, up $637,000 or 9.2% from net income of $6.9 million in 2009. The increase in net income in the first quarter of 2010 over the same period in 2009 was mainly the result of an increase in net interest income due to an improved net interest margin and growth in average earning assets as discussed in more detail below under “Net Interest Income”. The Company’s net interest margin has benefited from funding costs decreasing more rapidly than asset yields.

Net interest income for the first quarter of 2010 was up $2.1 million or 8.0%, over the same period in 2009, driven by growth in average earning assets and a decrease in funding costs.

The provision for loan and lease losses for the three months ended March 31, 2010 was $2.2 million compared to $2.0 million for the same period in 2009. An increase in net charge-offs and nonperforming assets, combined with weak general economic conditions all contributed to the higher provision expense.

First quarter 2010 noninterest income of $4.7 million is down $103,000 or 2.2% compared to the first quarter of 2009. Lower service charges on deposit accounts, net mark-to-market losses on liabilities held at fair value, and gains on sales of residential mortgage loans were partially offset by increases in card services income, other service charges, gains on securities transactions and earnings on corporate-owned life insurance.

Noninterest expenses for the three months ended March 31, 2010 totaled $19.1 million, an increase of $821,000 or 4.5% over the comparable year ago period. The increase was mainly in salaries and other benefit related accruals, reflecting additional headcount, annual merit increase, and increases in healthcare insurance and pension costs.

#### Financial Services Segment

The financial services segment had net income of $881,000 in the first quarter of 2010, an increase of $69,000 or 8.5% from net income of $812,000 in the same quarter of the prior year. Noninterest income for the three months ended March 31, 2010 was up $569,000 or 9.0% and over the same period in 2009. The increase in noninterest income was mainly a result of higher investment services fees. Investment services fees are largely based on the market value of assets within each managed account. The market value of assets is up over the prior year, driven by the increase in stock market indices, account retention and new account generation. Noninterest expenses of $5.6 million for first quarter of 2010 were up $463,000 or 9.0% over the first quarter of 2009. The increase was mainly in salary and wages, reflecting annual merit increases and other incentive compensation accruals.

### Average Consolidated Balance Sheet and Net Interest Analysis

*(Dollar amounts in thousands)*

| ASSETS Interest-earning assets | Year to Date Period Ended March 31, 2010 Average Balance (YTD) | Interest | Average Yield/Rate | Year to Date Period Ended March 31, 2009 Average Balance (YTD) | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing balances due from banks | $37,885 | $12 | 0.13% | $9,302 | $8 | 0.35% |
| Money market funds | 100 | 0 | 0.00% | 17,024 | 18 | 0.43% |
| Securities (1) |  |  |  |  |  |  |
| U.S. Government Securities | 827,808 | 8,219 | 4.03% | 672,855 | 7,781 | 4.69% |
| Trading Securities | 31,279 | 309 | 4.01% | 37,506 | 362 | 3.91% |
| State and municipal (2) | 105,139 | 1,573 | 6.07% | 117,235 | 1,766 | 6.11% |
| Other Securities (2) | 18,563 | 224 | 4.89% | 21,068 | 282 | 5.43% |
| Total securities | 982,789 | 10,325 | 4.26% | 848,664 | 10,191 | 4.87% |
| Federal Funds Sold | 9,080 | 4 | 0.18% | 8,547 | 5 | 0.24% |
| FHLB and FRB stock | 19,633 | 284 | 5.87% | 20,658 | 29 | 0.57% |
| Loans, net of unearned income (3) |  |  |  |  |  |  |
| Real Estate | 1,327,849 | 18,840 | 5.75% | 1,261,159 | 18,930 | 6.09% |
| Commercial Loans (2) | 472,900 | 6,260 | 5.37% | 448,136 | 6,101 | 5.52% |
| Consumer Loans | 84,083 | 1,460 | 7.04% | 87,661 | 1,517 | 7.02% |
| Direct Lease Financing | 11,634 | 176 | 6.14% | 13,518 | 201 | 6.03% |
| Total loans, net of unearned income | 1,896,466 | 26,736 | 5.72% | 1,810,474 | 26,749 | 5.99% |
| **Total interest-earning assets** | **2,945,953** | **37,361** | **5.14%** | **2,714,669** | **37,000** | **5.53%** |
| Other assets | 227,111 |  |  | 204,477 |  |  |
| **Total assets** | **3,173,064** |  |  | **2,919,146** |  |  |
| **LIABILITIES & EQUITY** |  |  |  |  |  |  |
| Deposits |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Interest bearing checking, savings, & money market | 1,229,168 | 1,790 | 0.59% | 1,085,475 | 2,366 | 0.88% |
| Time Dep \> $100,000 | 335,260 | 1,178 | 1.42% | 276,391 | 1,489 | 2.18% |
| Time Dep \< $100,000 | 429,464 | 1,873 | 1.77% | 417,859 | 2,528 | 2.45% |
| Brokered Time Dep \< $100,000 | 37,242 | 164 | 1.79% | 42,688 | 241 | 2.29% |
| Total interest-bearing deposits | 2,031,134 | 5,005 | 1.00% | 1,822,413 | 6,624 | 1.47% |
| Federal funds purchased & securities sold under agreements to repurchase | 187,753 | 1,425 | 3.08% | 188,204 | 1,565 | 3.37% |
| Other borrowings | 199,202 | 1,893 | 3.85% | 225,176 | 2,158 | 3.89% |
| Trust preferred debentures | 25,056 | 367 | 5.94% | 3,890 | 53 | 5.53% |
| **Total interest-bearing liabilities** | **2,443,145** | **8,690** | **1.44%** | **2,239,683** | **10,400** | **1.88%** |
| Noninterest bearing deposits | 440,113 |  |  | 417,932 |  |  |
| Accrued expenses and other liabilities | 40,220 |  |  | 38,574 |  |  |
| **Total liabilities** | 2,923,478 |  |  | 2,696,189 |  |  |
| Tompkins Financial Corporation Shareholders’ equity | 248,119 |  |  | 221,490 |  |  |
| Noncontrolling interest | 1,467 |  |  | 1,467 |  |  |
| **Total equity** | **249,586** |  |  | **222,957** |  |  |
| **Total liabilities and equity** | **$3,173,064** |  |  | **$2,919,146** |  |  |
| Interest rate spread |  |  | **3.70%** |  |  | 3.65% |
| Net interest income/margin on earning assets |  | **28,671** | **3.95%** |  | **26,600** | 3.97% |
| Tax Equivalent Adjustment |  | **(727)** |  |  | **(749)** |  |
| Net interest income per consolidated financial statements |  | **$27,944** |  |  | **$25,851** |  |

(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 a combined New York State and Federal effective income tax rate of 40% 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 unaudited condensed consolidated financial statements included in Part I of the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2009.

27

### Net Interest Income

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 first quarter of 2010 was $28.7 million, an increase of $2.1 million, or 7.8%, compared to the same period in 2009. The favorable quarter over quarter increase was mainly a result of growth in average earning assets and deposits and lower funding costs. For the first quarter of 2010, average earning assets were up $231.3 million or 8.5%, over the same period in 2009. Average interest bearing deposit balances grew by $208.7 million over March 31, 2009, while noninterest bearing deposits were up over the first quarter of 2009 by $22.2 million or 5.3%. The 3.95% net interest margin for the first quarter of 2010 is up from 3.89% for the fourth quarter of 2009, and is in line with 3.97% for the first quarter of 2009.

Taxable-equivalent interest income was up about 1.0% in the first quarter of 2010 over the same period of 2009 as growth in average earning assets offset the effects of lower asset yields resulting from historically low short-term market interest rates. The majority of the growth in average earning assets was in investment securities. Average securities balances for the first quarter 2010 were up over the same period in 2009 by $134.1 million or 15.8%, while average yields were down 61 basis points. The growth in investment securities was mainly in obligations of U.S. government entities. Average loan balances were up $86.0 million or 4.7% in the first quarter of 2010 over the same period in 2009, while the average yield on loans decreased 27 basis points to 5.72%. Growth in first quarter 2010 average loan balances included a 5.3% increase in real estate loans, and a 5.5% increase in commercial loans.

Interest expense for the first quarter of 2010 was down $1.7 million or 16.4% compared to March 31, 2009, reflecting lower average rates paid on deposits and borrowings, partially offset by growth in average balances. Lower market interest rates and continued disciplined deposit pricing resulted in a 47 basis point decrease in the average rate paid on interest bearing deposits during the first quarter of 2010 compared to the average rate paid in the first quarter of 2009. Average interest bearing deposits increased $208.7 million or 11.5% in the first quarter of 2010 compared to the same period in 2009. Average interest and checking, savings and money market deposit balances made up $143.7 million or 13.2% of the quarter-over-quarter increase, and time deposits of $100,000 or more also increased by $58.9 million or 21.3%. Average noninterest deposit balances for the first quarter 2010 were up $22.2 million or 5.3% compared to the first quarter 2009.

### 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 $2.2 million in the first quarter of 2010, compared to $2.0 million in the first quarter of 2009, an increase of 7.2%. The increase in the provision for 2010 over 2009 reflects the increase in net charge-offs and nonperforming loans, growth in total loans and leases, as well as concerns over weak economic conditions and uncertain real estate markets. The allowance for loan and lease losses as a percentage of period end loans was 1.34% at March 31, 2010, compared to 1.10% at March 31, 2009. 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.

### Noninterest Income

Noninterest income is a significant source of income for the Company, representing 28.8% of total revenues for the first quarter of 2010, compared to 29.7% in the first quarter of 2009. The decrease in noninterest income as a percentage of revenues in the first quarter of 2010 compared to the same period in 2009 was due to the increase in net interest income outpacing the growth in noninterest income. Noninterest income for the three months ended March 31, 2010 was $11.3 million, an increase of 3.5% from the same period in 2009.

Investment services income was $3.7 million in first quarter of 2010, an increase of 16.7% from $3.2 million in the first quarter of 2009. 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 $2.57 billion at March 31, 2010, up 16.4% from $2.21 billion at March 31, 2009. These figures include $758.0 million and $654.4 million, respectively, of Company-owned securities where TIS is custodian. The increase in the market value of assets reflects the increase in stock market indices as well as successful business development initiatives and customer retention.

Insurance commissions and fees were $3.2 million in the first quarter of 2010, an increase of $47,000 or 1.5% over the first quarter of 2009. The growth was mainly in health and benefit related insurance products. Revenues for personal and commercial lines were slightly ahead of the prior year.

Service charges on deposit accounts were $2.1 million in the first quarter of 2010, down 7.3% compared to $2.2 million in the first quarter of 2009. The largest component of this category is overdraft fees, which is largely driven by customer activity.

Net mark-to-market gains on securities and borrowing held at fair value totaled $38,000 in the first quarter of 2010, down 100.0% compared to the same period prior year. Mark-to-market gains or losses relate to the change in the fair value of securities and borrowings where the Company has elected the fair value option. The favorable quarter-over-quarter variance is due to improved market conditions.

Other income of $1.3 million in the first quarter of 2010 is up 1.7% over the first quarter of 2009. The primary components of other income are other service charges, increases in cash surrender value of corporate owned life insurance (“COLI”), gains on the sales of residential mortgage loans and income from miscellaneous equity investments, including the Company’s investment in a Small Business Investment Company (“SBIC”).

Other service charge income of $593,000 in the first quarter of 2010 was up $151,000 or 34.2% from the same period in 2009. The growth over the first quarter of 2009 was mainly in safe deposit income, loan servicing income and loan related fees.

Increases in COLI, net of mortality expenses, were $393,000 in the first quarter of 2010, up $171,000 or 77.0% from the first quarter of 2009. COLI relates to life insurance policies covering certain senior officers of the Company and its subsidiaries. The Company’s average investment in COLI was $36.1 million during the first three months of 2010, compared to $34.9 million during the first three months of 2009.

For the first quarter of 2010, net gains on the sales of residential mortgage loans totaled $192,000, compared to net gains of $401,000 for the first quarter of 2009. Low market interest rates have contributed to a strong volume of residential mortgage originations/refinancing in 2009 and 2010. To manage interest rate risk exposures, the Company sells certain fixed rate loan originations that have rates below or maturities greater than the standards set by the Company’s Asset/Liability Committee.

Other income includes income from the Company’s miscellaneous equity investments, including its investment in an SBIC. For the first quarter of 2010, income related to these investments totaled $9,000 compared to $29,000 in the first quarter of 2009. The Company believes that, as of March 31, 2010, there was no impairment with respect to its investment in the SBIC.

For the three months ended March 31, 2010, net gains from securities transactions totaled $118,000, up $111,000 compared to the same period in 2009. Management may periodically sell available-for-sale securities for liquidity purposes, to improve yields, or to adjust the risk profile of the portfolio.

### Noninterest Expense

Noninterest expense for the first quarter of 2010 was $24.5 million, an increase of $1.2 million or 5.2% over noninterest expense of $23.3 million for the first quarter of 2009.

Personnel-related expense increased by $1.3 million or 10.3% in the first quarter of 2010 over the same period in 2009. Salaries and wages were up $811,000 or 8.5%, reflecting an increase in average full time equivalents (“FTE”), and annual merit increases. Year-to-date March 31, 2010 average FTEs of 725 were up from 711 at March 31, 2009. Pension and other employee related benefits were up $524,000 or 15.5% in the first quarter compared to the first quarter of 2009. Contributing to the increase over the prior year was pension (up $161,000), and health and dental insurance (up $134,000)

FDIC deposit insurance expense increased by $557,000 in the three months ended March 31, 2010, over the same prior year period reflecting higher insurance rates and increases in insurable deposits.

Other operating expenses decreased by $573,000 or 8.6% in the first quarter of 2010 compared to the first quarter of 2009. The primary components of other operating expense are marketing expense, professional fees, software licensing and maintenance, cardholder expense and other.

Marketing expense for the first quarter of 2010 increased by $210,000 or 23.6% compared to the same period in 2009. New marketing campaigns for television and radio in the first quarter of 2010 resulted in the increased expense.

Software licensing and maintenance fee expense increased by $119,000 or 15.2% in the first quarter of 2010 compared with the first quarter of 2009. New software purchases as well as software upgrades accounted for the increase over March 31, 2009

Cardholder expenses totaled $417,000 in the first quarter of 2010, an increase of $92,000 or 28.3% over the first quarter of 2009. The increase is mainly due to a higher volume of customer transactions.

Additional items contributing to the change in other operating expenses were the following: education and training (down $52,000), legal expense (down $76,000) and telephone expense (down $208,000).

### Income Tax Expense

The provision for income taxes provides for Federal and New York State income taxes. The provision for the first quarter of 2010 was $4.1 million, compared to $3.7 million for the same period in 2009. The Company’s effective tax rate for the first quarter of 2010 was 32.9% compared to 32.4% for the first quarter of 2009. The increase in the effective rate in 2010 compared to 2009 was primarily the result of a lower proportion of tax advantaged income as a percentage of total pre-tax income.

### FINANCIAL CONDITION

Total assets were $3.2 billion at March 31, 2010, up $53.5 million or 1.7% over December 31, 2009, and up $213.5 million or 7.1% over March 31, 2009. Asset growth over year-end 2009 was mainly in cash and equivalents, which were up $71.2 million and available-for-sale securities, which were up $23.6 million. Total deposits at March 31, 2010 were up $72.3 million or 3.0% over December 31, 2009 driven by an increase in municipal deposits.

Loans and leases totaled $1.89 billion or 58.8% of total assets at March 31, 2010, compared to $1.91 billion or 60.7% of total assets at December 31, 2009. The $27.8 million or 1.5% decrease in total loans and leases from year-end 2009 was across all loan categories with the exception of commercial real estate loans. In general, weak economic conditions have strained some borrowers and softened the demand for lending products. Commercial real estate loans at March 31, 2010 were up $28.4 million or 4.4% over December 31, 2009. Commercial loans are down $35.4 million or 7.2%, reflecting paydowns and some seasonality in agricultural lending. Residential mortgage loan volume has been strong over the past year, largely driven by the current low interest rate environment. However, residential portfolio balances are down from year end and from prior year, as the Company decided to sell certain fixed rate residential mortgage loans in the secondary market because of the interest rate risk considerations. The Company originated $11.2 million of residential mortgage loans for sale during the first three months of 2010 and sold $11.6 million during the same period. The consumer and leasing portfolios are down 5.6% and 0.63% at March 31, 2010 compared to year-end 2009.

| Loan and Lease Portfolio Balances (in thousands) | 03/31/2010 | % of Total Loans | 12/31/2009 | % of Total Loans |
| --- | ---: | ---: | ---: | ---: |
| Residential real estate | $613,718 | 32.5% | $623,863 | 32.6% |
| Commercial real estate | 670,180 | 35.5% | 641,737 | 33.5% |
| Real estate construction | 52,378 | 2.8% | 58,125 | 3.0% |
| Commercial | 457,280 | 24.2% | 492,647 | 25.7% |
| Consumer and other | 81,771 | 4.3% | 86,661 | 4.5% |
| Leases | 11,711 | 0.6% | 11,785 | 0.6% |
| **Total loans and leases, net of unearned income** | **$1,887,038** |  | **$1,914,818** |  |

Nonperforming loans (loans in nonaccrual status, loans past due 90 days or more and still accruing interest, and loans restructured in a troubled debt restructuring) were $33.3 million at March 31, 2010, down from $34.9 million at December 31, 2009, and up from $16.2 million at March 31, 2009. Nonperforming loans represented 1.76% of total loans at March 31, 2010, compared to 1.82% of total loans at December 31, 2009, and 0.89% of total loans at March 31, 2009. For the first quarter of 2010, net charge-offs were $1.2 million, up from $728,000 in the same period of 2009, and down slightly from $1.2 million for the fourth quarter of 2009. In general, the increase in nonperforming loans is reflective of the current weak economic conditions. A more detailed discussion of nonperforming loans is provided below in this section under the caption “Allowance for Loan and Lease Losses”.

As of March 31, 2010, total securities were $1.03 billion or 32.0% of total assets, compared to $1.01 billion or 31.9% of total assets at December 2009. The portfolio is comprised primarily of mortgage-backed securities, obligations of U.S. government sponsored entities, and obligations of U.S. states and political subdivisions. The Company has no investments in preferred stock of U.S. government sponsored entities and no investments in pools of Trust Preferred securities. Quarterly, the Company evaluates all investment securities with a fair value less than amortized cost to determine if there exists other-than-temporary impairment as defined under generally accepted accounting principles. The Company maintains a trading portfolio valued at a fair value of $30.5 million as of March 31, 2010, compared to $31.7 million at December 31, 2009. The decrease in the trading portfolio reflects maturities or payments during 2010. For the three months ended March 31, 2010, mark-to-market gains related to the securities trading portfolio were $90,000.

Total deposits were $2.5 billion at March 31, 2010, up $72.3 million or 3.0% over December 31, 2009, and up $176.3 million or 7.6% over March 31, 2009. The growth in total deposits from December 31, 2009 was mainly in checking, money market and savings balances, which were up $73.8 million or 16.2%. The increase in money market and savings balances was mainly in municipal deposits and is partially due to the seasonal nature of these deposits. Time deposit balances were up $21.4 million or 2.7% at March 31, 2010 compared to December 31, 2009. Other funding sources include Federal funds purchased, securities sold under agreements to repurchase, other borrowings, and trust preferred debentures. These funding sources totaled $396.9 million at March 31, 2010, down $29.9 million or 7.0% from $426.8 million at December 31, 2009. A more detailed discussion of deposits and borrowings is provided below in this section under the caption “Deposits and Other Liabilities”.

### Capital

Total equity was $254.4 million at March 31, 2010, an increase of $9.4 million or 3.9% from December 31, 2009, mainly a result of net income of $8.5 million less cash dividends paid of $3.3 million. The Company also paid a 10% stock dividend in the first quarter of 2010, which resulted in a $35.4 million decrease in retained earnings and a $35.3 million increase in additional paid-in capital.

Additional paid-in capital increased by $37.8 million, from $155.6 million at December 31, 2009, to $193.4 million at March 31, 2010, reflecting the $35.3 million related to the 10% stock dividend, $1.3 million related to shares issued for the employee stock ownership plan, $640,000 related to shares issued for dividend reinvestment plans, $360,000 related to stock option exercises and related tax benefits, and $288,000 related to stock-based compensation. Retained earnings decreased by $30.3 million from $92.4 million at December 31, 2009, to $62.1 million at March 31, 2010, reflecting net income of $8.4 million less dividends paid of $3.3 million, and $35.4 million related to the 10% stock dividend. Accumulated other comprehensive loss declined from a net unrealized loss of $3.1 million at December 31, 2009, to a net unrealized loss of $1.4 million at March 31, 2010, reflecting an increase in unrealized gains on available-for-sale securities due to lower market rates, offset by amounts recognized in other comprehensive income related to postretirement benefit plans. Under regulatory requirements, 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 2010 totaled approximately $3.3 million, representing 39.4% of year to date 2010 earnings. Cash dividends of $0.31 per common share paid in the first three months of 2010 were flat compared to cash dividends of $0.31 per common share paid in the first three months of 2009. Cash dividends per share were retroactively adjusted to reflect the 10% stock dividend paid on February 15, 2010.

On July 22, 2008, the Company’s Board of Directors approved a stock repurchase plan (the “2008 Plan”). The 2008 Plan authorizes the repurchase of up to 150,000 shares of the Company’s outstanding common stock over a two-year period. The Company did not repurchase any shares during the first quarter of 2010. Since inception of the 2008 Plan, the Company has repurchased 6,500 shares at an average price of $36.21.

During 2009, the Company issued $20.5 million aggregate liquidation amount of 7.0% cumulative trust preferred securities through a newly-formed subsidiary, Tompkins Capital Trust I, a wholly-owned Delaware statutory trust (“Tompkins Capital Trust I”). The Trust Preferred Securities were offered and sold in reliance upon the exemption from registration provided by Rule 506 of Regulation D of the Securities Act of 1933, as amended (the “Securities Act”). The proceeds from the issuance of the Trust Preferred Securities, together with the Company’s capital contribution of $636,000 to the trust, were used to acquire the Company’s Subordinated Debentures that are due concurrently with the Trust Preferred Securities. The net proceeds of the offering are being used to support business growth and for general corporate purposes.

In accordance with the applicable accounting standards related to variable interest entities, the accounts of Tompkins Capital Trust I will not be included in the Company’s consolidated financial statements. However, $20.5 million in Tompkins’ Subordinated Debentures issued to Tompkins Capital Trust I will be included in the Tier 1 capital of the Company for regulatory capital purposes pursuant to regulatory guidelines.

The Company and its banking subsidiaries are subject to various regulatory capital requirements administered by Federal banking agencies. The table below reflects the Company’s capital position at March 31, 2010, compared to the regulatory capital requirements for “well capitalized” institutions.

*REGULATORY CAPITAL ANALYSIS March 31, 2010*

*(Dollar amounts in thousands)*

|  | Actual Amount | Ratio | Well Capitalized Requirement Amount | Ratio |
| --- | ---: | ---: | ---: | ---: |
| Total Capital (to risk weighted assets) | $261,094 | 12.56% | $207,577 | 10.00% |
| Tier 1 Capital (to risk weighted assets) | $235,622 | 11.40% | $124,546 | 6.00% |
| Tier 1 Capital (to average assets) | $235,622 | 7.48% | $157,452 | 5.00% |

As illustrated above, the Company’s capital ratios on March 31, 2010 remain above the minimum requirements for well capitalized institutions. Total capital as a percent of risk weighted assets increased 46 basis points from 12.1% at December 31, 2009. Tier 1 capital as a percent of risk weighted assets increased 50 basis points from 10.9% at the end of 2009. Tier 1 capital as a percent of average assets increased 10 basis points from 7.4% at December 31, 2009. The increase in capital ratios over year-end 2009 reflects growth in retained earnings and the issuance of trust preferred securities.

During the first quarter of 2010, the Comptroller of the Currency (“OCC”) notified the Company that it was requiring Mahopac National Bank, one of the Company’s three banking subsidiaries, to maintain certain minimum capital ratios at levels higher than those otherwise required by applicable regulations. The OCC is requiring Mahopac to maintain a Tier 1 capital to average assets ratio of 8.0%, a Tier 1 risk-based capital to risk-weighted capital ratio of 10.0% and a Total risk-based capital to risk-weighted assets ratio of 12.0%. Mahopac exceeded these minimum requirements at the time of the notification and continues to maintain ratios above these minimums. As of March 31, 2010, Mahopac had a Tier 1 capital to average assets ratio of 8.3%, a Tier 1 risk-based capital to risk-weighted capital ratio of 11.6% and a Total risk-based capital to risk-weighted assets ratio of 12.8%.

As of March 31, 2010, the capital ratios for the Company’s other two subsidiary banks also exceeded the minimum levels required to be considered well capitalized.

### Allowance for Loan and Lease Losses and Nonperforming Assets

Management reviews the adequacy of the allowance for loan and lease losses (“allowance”) on a regular basis. Management considers the accounting policy relating to the allowance to be a critical accounting policy, given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that assumptions could have on the Company’s results of operations. The Company’s methodology for determining and allocating the allowance for loan and lease losses focuses on ongoing reviews of larger individual loans and leases, historical net charge-offs, delinquencies in the loan and lease portfolio, the level of impaired and nonperforming assets, values of underlying loan and lease collateral, the overall risk characteristics of the portfolios, changes in character or size of the portfolios, geographic location, current economic conditions, changes in capabilities and experience of lending management and staff, and other relevant factors. The various factors used in the methodologies are reviewed on a periodic basis.

The Company has developed a methodology to measure the amount of estimated loan loss exposure inherent in the loan portfolio to assure that an adequate allowance is maintained. The Company’s methodology is based upon guidance provided in SEC Staff Accounting Bulletin No. 102, *Selected Loan Loss Allowance Methodology and Documentation Issues* and includes an estimate of exposure for the following: specifically reviewed and graded loans; historical loss experience by product type; past due and nonperforming loans; and other internal and external factors such as local and regional economic conditions, growth trends, and credit policy and underwriting standards.

At least annually, management reviews all commercial and commercial real estate loans exceeding a certain threshold and assigns a risk rating grade. At least quarterly, management reviews all loans and leases over a certain dollar threshold that are internally risk rated below a predetermined grade, giving consideration to payment history, debt service payment capacity, collateral support, strength of guarantors, industry trends, and other factors relevant to the particular borrowing relationship. Through this process, management identifies impaired loans. For loans and leases considered impaired, estimated exposure amounts are based upon collateral values or discounted cash flows. For internally reviewed commercial and commercial real estate loans that are not impaired but whose internal risk rating is below a certain level, estimated exposures are assigned based upon several factors, including the borrower’s financial condition, payment history, collateral adequacy, and business conditions, and historical loss factors.

For commercial loans and commercial mortgage loans not specifically reviewed, and for homogenous loan portfolios such as residential mortgage loans and consumer loans, estimated exposure amounts are assigned based upon historical loss experience and current charge-off trends, past due status, and management’s judgment of the effects of current economic conditions on portfolio performance.

In addition to the above components, amounts are maintained based upon management’s judgment and assessment of other quantitative and qualitative factors such as regional and local economic conditions, concentrations of credit, industry concerns, adverse market changes in estimated or appraised collateral value, and portfolio growth trends.

Based upon consideration of the above factors, management believes that the allowance is adequate to provide for the risk of loss inherent in the current loan and lease portfolio as of March 31, 2010. Should any of the factors considered by management in evaluating the adequacy of the allowance change, the Company’s estimate of probable loan losses could also change, which could affect the level of future provisions for possible loan and lease losses.

Activity in the Company’s allowance for loan and lease losses during the first three months of 2010 and 2009 and for the 12 months ended December 31, 2009, is illustrated in the table below.

*ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (In thousands)*

|  | Three months ended 03/31/2010 | Twelve months ended 12/31/2009 | Three months ended 03/31/2009 |
| --- | ---: | ---: | ---: |
| Average loans and leases outstanding during the period | $1,896,466 | $1,850,453 | $1,810,474 |
| Total loans and leases outstanding at end of period | $1,887,038 | $1,914,818 | $1,811,792 |
| **ALLOWANCE FOR LOAN AND LEASE LOSSES** |  |  |  |
| Beginning balance | $24,350 | $18,672 | $18,672 |
| Provision for loan and lease losses | 2,183 | 9,288 | 2,036 |
| Loans charged off | (1,403) | (4,234) | (902) |
| Loan recoveries | 236 | 624 | 174 |
| Net charge-offs | (1,167) | (3,610) | (728) |
| Ending balance | $25,366 | $24,350 | $19,980 |
| Allowance for loan and lease losses to total loans and leases | 1.34% | 1.27% | 1.10% |
| Annualized net charge-offs to average loans and leases | 0.25% | 0.20% | 0.16% |

As of March 31, 2010, the allowance was $25.4 million or 1.34% of total loans and leases outstanding. This represents an increase of 7 basis points from December 31, 2009 and an increase of 24 basis points from March 31, 2009. The increase in the allowance and the ratio of allowance to total loans and leases outstanding is consistent with the increase in nonperforming loans, net charge-offs and internally criticized and classified loans as well as overall weakness in the economy. The provision for loan and lease losses was $2.2 million for the three months ended March 31, 2010, compared to $2.0 million for the three months ended March 31, 2009, and $2.8 million for the three months ended December 31, 2009.

Net charge-offs for the first quarter of 2010 totaled $1.2 million compared to $728,000 in the comparable year ago period. Annualized net charge-offs for the first three months of 2010 represented 0.25% of average loans, up from 0.16% for the first three months of 2009, but is favorable to a peer ratio of 1.58%. The peer data is from the Federal Reserve Board and represents banks or bank holding companies with assets between $3 billion and $10.0 billion. The peer ratio is as of December 31, 2009, the most recent data available from the Federal Reserve Board.

The allowance coverage of nonperforming loans (loans past due 90 days and accruing, nonaccrual loans, and restructured troubled debt) was 0.76 times at March 31, 2010, compared to 0.70 times at December 31, 2009, and 1.24 times at March 31, 2009. Although nonperforming loans are up over prior year, the Company’s loss experience continues to be low compared to industry levels.

*NONPERFORMING ASSETS (in thousands)*

|  | 03/31/2010 | 12/31/2009 | 03/31/2009 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans and leases | $29,521 | $31,289 | $15,478 |
| Loans past due 90 days and accruing | 51 | 369 | 677 |
| Troubled debt restructuring not included above | 3,703 | 3,265 | 0 |
| Total nonperforming loans | 33,275 | 34,923 | 16,155 |
| Other real estate, net of allowances | 558 | 299 | 103 |
| Total nonperforming assets | $33,833 | $35,222 | $16,258 |
| Total nonperforming loans and leases as a percentage of total loans and leases | 1.76% | 1.82% | 0.89% |
| Total nonperforming assets as a percentage of total assets | 1.06% | 1.12% | 0.54% |

Nonperforming assets include nonaccrual loans, troubled debt restructurings (“TDR”) and foreclosed real estate. The level of nonperforming assets at March 31, 2010, and 2009, and December 31, 2009 is illustrated in the table above. Nonperforming assets of $33.8 million at March 31, 2010, were down from December 31, 2009, and up from March 31, 2009. The decrease in nonperforming assets compared to year-end 2009 was mainly due to one commercial relationship that was paid down as a result of the liquidation of collateral. In general, the increase in nonperforming assets from March 31, 2010 is reflective of the weak economic conditions that have persisted over the past few years, which have pressured real estate values in some markets and stressed the financial conditions of various commercial and residential borrowers. Approximately $5.1 million of nonperforming loans at March 31, 2010, were secured by U.S. government guarantees, while $4.3 million were secured by one-to-four family residential properties.

| Nonperforming Loans by Type (in thousands) | 03/31/2010 | % of Total Loans | 12/31/2009 | % of Total Loans |
| --- | ---: | ---: | ---: | ---: |
| Residential real estate | $4,283 | 0.23% | $6,396 | 0.33% |
| Commercial real estate | 21,810 | 1.16% | 19,714 | 1.03% |
| Real estate construction | 178 | 0.01% | 964 | 0.05% |
| Commercial | 6,458 | 0.34% | 7,223 | 0.38% |
| Consumer and other | 521 | 0.03% | 598 | 0.03% |
| Leases | 25 | 0.00% | 28 | 0.00% |
| **Total loans and leases, net of unearned income** | **$33,275** | **1.77%** | **$34,923** | **1.82%** |

Nonperforming assets represented 1.06% of total assets at March 31, 2010, compared to 1.12% at December 31, 2009, and 0.54% at March 31, 2009. Although higher than the same period prior year, the Company’s ratio of nonperforming assets to total assets of 1.06% continues to compare favorably to our peer group ratio of 3.36% at December 31, 2009.

As of March 31, 2010, the Company’s recorded investment in loans and leases that are considered impaired totaled $28.7 million compared to $30.0 million at December 31, 2009, and $15.5 million at March 31, 2009. 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 loans that are 90 days or more past due, and accruing and all loans restructured in a troubled debt restructuring, and other loans for which the Company determine that noncompliance with contractual terms of the loan agreement is probable. Losses 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. At March 31, 2010 $12.7 million of impaired loans had specific reserve allocations of $931,000, and $16.0 million had no specific reserve allocation.

Potential problem loans and leases are loans and leases that are currently performing, 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 disclosure of such loans and leases as nonperforming at some time in the future. Management considers loans and leases classified as Substandard that continue to accrue interest to be potential problem loans and leases. At March 31, 2010, the Company’s internal loan review function had identified 72 commercial relationships, totaling $89.1 million, which it classified as Substandard, which continue to accrue interest. As of December 31, 2009, the Company’s internal loan review function had classified 67 commercial relationships as Substandard totaling $83.9 million, which continued to accrue interest. Of the 72 commercial relationships, there are 17 relationships that equal or exceed $1.0 million, which in aggregate total $75.3 million. The Company has seen an increase in potential problem loans over the past few years as weak economic conditions have strained borrowers’ cash flows and collateral values. 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 is not significant. 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 loans, which are reviewed at least quarterly. Management cannot predict the extent to which continued weak economic conditions or other factors may further impact its borrowers. The increase in the dollar amount of commercial relationships classified as Substandard and still accruing interest between December 31, 2009 and March 31, 2010 was mainly due to the addition of one larger commercial relationships totaling $2.9 million that was classified as Substandard and accruing at March 31, 2010, and were not classified as Substandard at December 31, 2009.

### Deposits and Other Liabilities

Total deposits of $2.5 billion at March 31, 2010 increased $72.3 million or 3.0% from December 31, 2009, due primarily to a $73.8 million increase in interest checking, savings and money market balances, a $21.4 million increase in time deposits offset by a $22.8 million decrease in noninterest bearing deposits. Growth in municipal deposits accounted for a majority of the increase in savings and money market balances from year end 2009. With interest rates on time deposits lower and more in line with money market rates, municipalities are placing tax deposits into money market accounts. Municipal deposit balances are somewhat seasonal, increasing as tax deposits are collected and decreasing as these monies are used by the municipality. Total deposits were up $176.3 million or 7.6% over March 31, 2009. The increase was primarily due to a $97.7 million increase in checking, savings and money market accounts of which $58.6 million was attributable to growth in municipal deposits. Additionally, time deposits increased $50.1 million over March 31, 2009, mainly attributable to growth in time deposits of$100,000 or more.

The Company’s primary funding source is core deposits, defined as total deposits less time deposits of $100,000 or more, brokered time deposits, and municipal money market deposits. Core deposits increased $56.6 million or 3.3% over December 31, 2009 to $1.8 billion, and represented 70.9% of total deposits at March 31, 2010 compared to 70.7% of total deposits at December 31, 2009.

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 $35.7 million at March 31, 2010, and $47.3 million at December 31, 2009. Management generally views local repurchase agreements as an alternative to large time deposits. The Company’s wholesale repurchase agreements are primarily with the FHLB and amounted to $145.5 million at March 31, 2010, comparable to December 31, 2009. Included in the $145.5 million of wholesale repurchase agreements at March 31, 2010, are $5.5 million of repurchase agreements with the FHLB where the Company elected to adopt the fair value option under FASB ASC Topic 825. The fair value of these borrowings increased by $47,000 (net mark-to-market pre-tax loss of $47,000) over the three months ended March 31, 2010.

The Company’s other borrowings totaled $190.5 million at March 31, 2010, down $18.4 million or 8.8% from $209.0 million at December 31, 2009. Borrowings at March 31, 2010 included $165.4 million in FHLB term advances, and a $25.0 million advance from a money center bank. Borrowings at year-end 2009 included $170.3 million in FHLB term advances, $13.5 million of overnight FHLB advances, and a $25.0 million advance from a money center bank. The decrease in borrowings reflects the pay down of FHLB borrowings as a result of deposit growth. Of the $165.4 million in FHLB term advances at March 31, 2010, $131.4 million are due over one year. In 2007, the Company elected the fair value option under FASB ASC Topic 825 for a $10.0 million advance with the FHLB. The fair value of this advance increased by $81,000 (net mark-to-market loss of $81,000) over the three months ended March 31, 2010.

### 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 $100,000 or more, brokered time deposits, municipal money market deposits, securities sold under agreements to repurchase and term advances from the FHLB. Rates and terms are the primary determinants of the mix of these funding sources. Non-core funding sources decreased by $14.2 million or 1.3% from December 31, 2009 to $1.1 billion at March 31, 2010. Non-core funding sources, as a percentage of total liabilities, were 37.3% at March 31, 2010, compared to 38.4% at December 31, 2009. The decrease in non-core funding sources was mainly due to the decline of brokered time deposits, FHLB advances, and securities sold under agreements to repurchase, partially offset by an increase in time deposits of $100,000 or more.

Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $808.8 million and $772.7 million at March 31, 2010 and December 31, 2009, respectively, were either pledged or sold under agreements to repurchase. Pledged securities represented 87.1% of total securities at March 31, 2010, compared to 83.9% of total securities at December 31, 2009.

Cash and cash equivalents totaled $116.6 million as of March 31, 2010, up from $45.5 million at December 31, 2009. Short-term investments, consisting of Federal funds sold and interest-bearing deposit balances of $71.7 million increased by $70.0 million above December 31, 2009 levels. The Company also has $30.5 million of securities designated as trading securities.

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 $465.1 million at March 31, 2010 compared with $477.7 million at December 31, 2009. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $707.2 million at March 31, 2010 as compared to $722.5 million at December 31, 2009. Aggregate amortization from monthly payments on these assets provides significant additional cash flow to the Company.

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, 2010, the unused borrowing capacity on established lines with the FHLB was $521.9 million. As members of the FHLB, the Company’s subsidiary banks can use certain unencumbered mortgage-related assets to secure additional borrowings from the FHLB. At March 31, 2010, total unencumbered residential mortgage loans of the Company were $219.3 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, 5,438 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, 2010, 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 1.74%, while a 100 basis point parallel decline in interest rates over a one-year period would result in a decrease in one-year net interest income from the base case of 0.55%. The simulation assumes no balance sheet growth and no management action to address balance sheet mismatches.

The negative exposure in a rising interest rate environment is mainly driven by the repricing assumptions of the Company’s core deposit base which exceed increases in asset yields in the short-term. Longer-term, the impact of a rising rate environment is positive as the asset base continues to reset at higher levels, while the repricing of the rate sensitive liabilities moderates. The moderate 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 as a result of 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.

In our most recent simulation, the base case scenario, which assumes interest rates remain unchanged from the date of the simulation, showed a slight decline in net interest margin over the next twelve 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, 2010. The Company’s one-year net interest rate gap was a negative $ 113.0 million or 3.53% of total assets at March 31, 2010, compared with a negative $113.0 million or 3.53% of total assets at December 31, 2009. 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 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.

*(Dollar amounts in thousands)*

| Condensed Static Gap – March 31, 2010 | Total | 0-3 months | Repricing Interval 3-6 months | 6-12 months | Cumulative 12 months |
| --- | ---: | ---: | ---: | ---: | ---: |
| Interest-earning assets1 | $2,982,246 | $766,461 | $195,755 | $337,671 | $1,299,887 |
| Interest-bearing liabilities | 2,469,890 | 951,181 | 224,331 | 237,548 | 1,413,060 |
| Net gap position |  | (184,720) | (28,576) | 100,123 | (113,173) |
| Net gap position as a percentage of total assets |  | (5.76%) | (0.89%) | 3.12% | (3.53%) |

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

## Controls and procedures

As filed, 1,483 characters.

### Evaluation of Disclosure Controls and Procedures

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31, 2010. 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 in providing reasonable assurance that any information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that material information relating to the Company and its subsidiaries is made known to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

### 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, 2010, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

## Risk factors

As filed, 180 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 for the fiscal year ended December 31, 2009.

Filed May 7, 2010.
Source: SEC EDGAR, the filing index for accession 0001019056-10-000595. Last ingested by Listed: Oct 31, 2026, 15:15 ET. No prices; not investment advice.