# Tompkins Financial Corp: Form 10-Q for the period ended Mar 31, 2013

- Company: [Tompkins Financial Corp](/companies/tmp.md) (CIK 1005817)
- Form: 10-Q
- Filed: 2013-05-10
- Accepted by EDGAR: May 10, 2013, 19:35 ET
- Period: 2013-03-31
- Accession: 0001387131-13-001690
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1005817/000138713113001690/tmp-10q_033113.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1005817/000138713113001690/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2013-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2013-01-01 to 2013-03-31 | $6.3m | us-gaap:InterestExpense |
| Income tax | 3 months, 2013-01-01 to 2013-03-31 | $5.5m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2013-01-01 to 2013-03-31 | $11.5m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.79 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.80 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2013-01-01 to 2013-03-31 | 14,436,757 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2013-01-01 to 2013-03-31 | $21.4m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2013-01-01 to 2013-03-31 | $1.6m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2013-01-01 to 2013-03-31 | $5.5m | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2013-03-31 | $99.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2013-03-31 | $4.99bn | us-gaap:Assets |
| Total liabilities | at 2013-03-31 | $4.54bn | us-gaap:Liabilities |
| Shareholders' equity | at 2013-03-31 | $445.3m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 100,891 characters.

### BUSINESS

### Corporate Overview and Strategic Initiatives

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 MKT LLC (Symbol: TMP). Tompkins is headquartered at The Commons, Ithaca, New York. The Company is a locally-oriented, community-based financial services organization that offers a full array of financial products and services, including commercial and consumer banking, leasing, trust and investment services, financial planning and wealth management, insurance and brokerage services. At March 31, 2013, Tompkins subsidiaries included: four wholly-owned community banking subsidiaries, Tompkins Trust Company (the “Trust Company”), The Bank of Castile, Mahopac National Bank and VIST Bank; a wholly-owned registered investment advisor subsidiary, TFA Wealth Management, Inc. (“TFA Wealth Management”), previously known as AM&M Financial Services, Inc.; and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). TFA Wealth Management and the trust division of the Trust Company provide a full suite of investment services under the Tompkins Financial Advisors brand, including investment management, trust and estate, financial and tax planning as well as life, disability and long term care insurance services. VIST Bank, through its VIST Capital Management brand provides investment advisory, retirement planning solutions, and brokerage services to our customers in southeastern Pennsylvania. Unless the context otherwise requires, the term “Company” refers collectively to Tompkins Financial Corporation and its subsidiaries.

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

In the second quarter of 2012, the Company completed a capital raise through a registered public offering of shares of its common stock. The Company believes that this capital raise helped position the Company for future growth, including its recently completed acquisition of VIST Financial Corp. (“VIST Financial”), described below. After transaction costs, net proceeds from the capital raise were approximately $38.0 million, and resulted in the issuance of 1,006,250 shares of Tompkins common stock on April 3, 2012.

### Recent Acquisitions

On August 1, 2012, Tompkins completed its acquisition of VIST Financial, a financial holding company headquartered in Wyomissing, Pennsylvania, and parent to VIST Bank, VIST Insurance, LLC (“VIST Insurance”), and VIST Capital Management, LLC. On the acquisition date, VIST Financial had $1.4 billion in total assets, $889.3 million in loans, and $1.2 billion in deposits. Following its merger with a wholly-owned subsidiary of Tompkins, VIST Financial was merged into Tompkins. VIST Bank, a Pennsylvania state-chartered commercial bank, became a wholly-owned subsidiary of Tompkins and will continue to operate as a separate subsidiary bank of Tompkins. VIST Insurance was merged into Tompkins Insurance Agencies, Inc., and the VIST Capital Management, LLC business was moved to VIST Bank under the brand name “VIST Capital Management.” The acquisition expands the Company’s presence into the southeastern region of Pennsylvania.

The VIST acquisition was a stock transaction. Under the terms of the merger agreement, each share of VIST Financial common stock was cancelled and converted into the right to receive 0.3127 shares of Tompkins common stock, with any fractional share entitlement paid in cash, resulting in the Company issuing 2,093,689 shares at a fair value of $82.2 million. The Company also paid $1.2 million to retire outstanding VIST Financial employee stock options; while other VIST Financial employee stock options were converted into options to purchase Tompkins’ common stock, with an aggregate fair value of $1.1 million, as of the acquisition date. In addition, immediately prior to the completion of the merger, Tompkins purchased from the United States Department of the Treasury the issued and outstanding shares of VIST Financial Fixed Rate Cumulative Perpetual Preferred Stock, Series A, as well as the warrant to purchase shares of VIST Financial common stock issued in connection with the issuance of the preferred stock (the “TARP Purchase”) plus the accrued and unpaid dividends therein, for an aggregate purchase price of $26.5 million. The securities purchased in the TARP Purchase were cancelled in connection with the consummation of the VIST Acquisition.

The VIST Acquisition was accounted for under the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at their estimated fair values as of acquisition date. VIST Financial’s assets and liabilities were recorded at their preliminary estimated fair values as of August 1, 2012, the acquisition date, and VIST Financial’s results of operations have been included in the Company’s Consolidated Statements of Income since that date.

### Business Segments

The Company has identified three business segments, banking, insurance and wealth management. Insurance services activities include the results of the Company’s property and casualty insurance services and employee benefits consulting operations. Wealth management activities include the results of the Company’s trust, financial planning, wealth management services and risk management operations. All other activities are considered banking. Information about the Company’s business segments is included in Note 14 “Segment and Related Information,” in the Notes to Unaudited Consolidated Financial Statements contained in Part I of this Quarterly Report on Form 10-Q.

### Business Overview

Banking services consist primarily of attracting deposits from the areas served by the Company’s 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, and concentrations of credit, loan delinquencies, and nonperforming and potential problem loans.

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 without recourse and in accordance with standard secondary market loan sale agreements. The Company primarily sells loans to the Federal Home Loan Mortgage Corporation, and retains servicing rights on the sold loans. These residential real estate loans are subject to normal representations and warranties, including representations and warranties related to gross fraud and incompetence. The Company has not had to repurchase any loans as a result of these representations and warranties. The Company reviews the risks in residential real estate lending related to representations and warranties, title issues, and servicing. The Company determined that these risks are immaterial and do not require any reserves on the Company’s statements of condition.

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.

Wealth management consists of providing trust, financial planning, wealth management services and risk management operations to individuals and businesses in the Company’s market areas. In 2010, the Company unified the branding of its trust and investment services businesses and began marketing these services under the name “Tompkins Financial Advisors”. Tompkins Financial Advisors has office locations at all three of the Company’s subsidiary banks in New York, and VIST Capital Management has offices at VIST bank.

Insurance services provide property and casualty insurance services, employee benefit consulting, and life, long-term care and disability insurance. Tompkins Insurance is headquartered in Batavia, New York. Over the past twelve 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. As part of the Company’s August 1, 2012 acquisition of VIST Financial, VIST Insurance was merged with and into Tompkins Insurance and is expected to nearly double annual insurance revenues. 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 two stand-alone offices in Tompkins County, New York and one stand-alone office in Montgomery County, Pennsylvania.

### 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 service that the Company does not currently provide. In addition, may of the Company’s non-ban 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, in the case of the 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, although no assurances can be given that such factors will assure success.

### Regulation

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

### Other Factors Affecting Performance

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. The low market interest rates continue to put pressure on the Company’s net interest margin. The Company has offset some of this pressure with strategic deposit pricing and growth in average earning assets. Weak economic conditions beginning in 2008 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. The Company has seen some signs of improving economic conditions within the market areas in which it operates, which have contributed to improvement in its credit quality metrics in recent quarters including decreases in the level of internally classified assets and nonperforming assets. With the strength of the economic recovery uncertain, there is no assurance that these conditions may not adversely affect the credit quality of the Company’s loans and leases, results of operations, and financial condition going forward. Refer to the section captioned “Financial Condition- Allowance for Loan and Lease Losses” below for further details on asset quality.

### 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, 2013. 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, 2012, and the Unaudited 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, such as the Dodd-Frank Wall Street Reform and Consumer Protection 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; protection and validity of intellectual property rights; reliance on large customers; financial resources in the amounts, at the times and on the terms required to support the Company’s future businesses, and other factors discussed elsewhere in this Quarterly Report on Form 10-Q and in other reports we file with the SEC, in particular the “Risk Factors” discussed in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. 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 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”), pension and postretirement benefits, the review of the securities portfolio for other-than-temporary impairment, and acquired loans 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, 2012. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2012. 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.

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 89 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, 2012 (most recent report available).

### OVERVIEW

Net income for the first quarter was $11.5 million, or $0.79 diluted earnings per share, compared to $7.8 million, or $0.70 diluted earnings per share for the same period in 2012. Income statement and Balance Sheet comparisons to the same period last year are impacted by the acquisition of VIST Financial Corporation on August 1, 2012.

Return on average equity was 10.53% for the quarter, compared to 10.35% for the first quarter 2012. Return on average assets was 0.95% for the quarter compared to 0.91% for the first quarter of 2012. The Company’s operating (Non-GAAP) net income for the first quarter was $11.6 million, or $0.81 diluted per share, compared to $7.9 million, or $0.71 diluted per share for the first quarter of 2012. Operating (Non-GAAP) income excludes after-tax merger and acquisition integration expense of $118,000 and $75,000 for the three months ended March 31, 2013 and 2012, respectively.

The following table summarizes our results of operations for the periods indicated on a GAAP basis and on an operating (non-GAAP) basis for the periods indicated. Our operating results exclude the merger and acquisition integration expenses. The Company believes this non-GAAP measure provides a meaningful comparison of our underlying operational performance and facilitates managements’ and investors’ assessments of business and performance trends in comparison to others in the financial services industry. In addition the Company believes the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations (in thousands). These non-GAAP financial measures should not be considered in isolation or as a measure of the Company’s profitability or liquidity; they are in addition to, and are not a substitute for, financial measures under GAAP. Net operating income and adjusted diluted earnings per share as presented herein may be different from non-GAAP financial measures used by other companies, and may not be comparable to similarly titled measures reported by other companies. Further, the Company may utilize other measures to illustrate performance in the future. Non-GAAP financial measures have limitations since they do not reflect all of the amounts associated with the Company’s results of operations as determined in accordance with GAAP.

|  | Three months ended 03/31/2013 | 03/31/2012 |
| --- | ---: | ---: |
| Net Income (GAAP) | $11,510 | $7,811 |
| Diluted earnings per share (GAAP) | 0.80 | 0.70 |
| Adjustments for non-operating income and expense, net of tax: |  |  |
| Merger and acquisition integration related expenses | 118 | 75 |
| Total adjustments, net of tax | 118 | 75 |
| Net operating income (Non-GAAP) | 11,628 | 7,886 |
| Adjusted diluted earnings per share (Non-GAAP) | 0.81 | 0.71 |

|  | Three months ended 03/31/2013 | 03/31/2012 |
| --- | ---: | ---: |
| Net Income (GAAP) | $11,510 | $7,811 |
| Adjustments for non-operating income and expense, net of tax: |  |  |
| Merger and acquisition integration related expenses | 118 | 75 |
| Total adjustments, net of tax | 118 | 75 |
| Net operating income (Non-GAAP) | 11,628 | 7,886 |
| Amortization of intangibles, net of tax | 334 | 80 |
| Adjusted net operating income | 11,962 | 7,966 |
| Average total shareholders' equity | 443,277 | 303,546 |
| Average goodwill and intangibles | 110,687 | 47,922 |
| Average shareholders' tangible equity | 332,590 | 255,624 |
| Adjusted operating return on average shareholders' tangible equity (annualized) | 14.39% | 12.53% |

|  | Three months ended 03/31/2013 | 03/31/2012 |
| --- | ---: | ---: |
| Net Income (GAAP) | $11,510 | $7,811 |
| Adjustments for non-operating income and expense, net of tax: |  |  |
| Merger and acquisition integration related expenses | 118 | 75 |
| Total adjustments, net of tax | 118 | 75 |
| Net operating income (Non-GAAP) | 11,628 | 7,886 |
| Amortization of intangibles, net of tax | 334 | 80 |
| Adjusted net operating income | 11,962 | 7,966 |
| Average total assets | 4,899,727 | 3,464,917 |
| Average goodwill and intangibles | 110,687 | 48,433 |
| Average tangible assets | 4,789,040 | 3,416,484 |
| Adjusted operating return on average shareholders' tangible assets (annualized) | 1.00% | 0.93% |

46

### Segment Reporting

The Company operates in 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, and risk management operations organized under the Tompkins Financial Advisors brand. All other activities are considered banking.

### Banking Segment

The banking segment reported net income of $9.8 million for the first quarter of 2013, up $2.8 million or 39.8% from net income of $7.0 million for the same period in 2012. The acquisition of VIST Bank contributed to the increase over prior period.

Net interest income of $38.1 million for the first quarter of 2013 was up 39.2% over the same period in 2012. Growth in average earning assets and lower funding costs more than offset the lower asset yields and contributed to favorable year-over-year comparisons. The net interest margin for the three months ended March 31, 2013 was 3.57% compared to 3.51% for the same period prior year.

The provision for loan and lease losses totaled $1.0 million for the three months ended March 31, 2013 and $1.1 million for the same period in 2012.

Noninterest income for the three months ended March 31, 2013, was up $1.8 million or 37.1% compared to the same period in 2012, primarily due to the VIST acquisition. The main drivers behind the increase were net gains on securities transactions up ($365,000), card services income up ($169,000), cash surrender value of corporate owned life insurance up ($126,000), and service charges on deposit accounts up ($123,000). Partially offsetting these items were lower net gains on the sale of loans down ($71,000) due to lower volumes of loans sold.

Noninterest expenses for the three months ended March 31, 2013, were up $8.7 million or 42.1% from the same period in 2012. The increase was mainly due to the VIST Financial acquisition. Most expense categories increased over the same period last year, reflecting the operational costs of a larger organization with the inclusion of VIST Bank.

### Insurance Segment

The insurance segment reported net income of $877,000 for the three months ended March 31, 2013, up $448,000 or 104.4% from the first quarter of 2012. Noninterest income for the three months ended March 31, 2013, was up $3.6 million compared to the same period in 2012. Commercial and personal insurance lines; in addition to, life and health insurance commissions experienced the most growth in revenues for the first quarter of 2013 compared to the same period last year. Noninterest expenses for the three months ended March 31, 2013, were up $2.8 million compared to the first quarter of 2012. Salaries and benefits costs were the largest contributors to the increase in noninterest expense compared to the same period last year. Increases in noninterest income and noninterest expense were mainly attributed to the addition of VIST Insurance pursuant to the VIST Financial acquisition. The operating results of VIST Insurance have been consolidated into the operating results of Tompkins Insurance Agencies, Inc.

### Wealth Management Segment

The wealth management segment reported net income of $791,000 for the three ended March 31, 2013, up $449,000 or 131.3% compared to the first quarter of 2012. Noninterest income for the three months ended March 31, 2013, was up $502,000 compared to the same period in 2012. The increase in noninterest income compared to the first three months of 2012 is mainly a result of an increase in investment management and brokerage income which benefited from the growth in assets under management and improved market conditions. Noninterest expenses for the three months ended March 31, 2013, were down $202,000 compared to the same periods of 2012 due to lower marketing and external broker commission payouts. The 2013 results include VIST Capital Management, which was acquired as part of the VIST Financial acquisition.

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

*(Dollar amounts in thousands)*

| ASSETS Interest-earning assets | Year to Date Period Ended March 31, 2013 Average Balance (YTD) | Interest | Average Yield/Rate | Year to Date Period Ended March 31, 2012 Average Balance (YTD) | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Interest-bearing balances due from banks | $3,908 | $7 | 0.73% | $38,652 | $3 | 0.03% |
| Money market funds | - | - | 0.00% | 73 | - | 0.00% |
| Securities (1) |  |  |  |  |  |  |
| U.S. Government securities | 1,297,578 | 6,794 | 2.12% | 1,061,800 | 6,577 | 2.49% |
| Trading securities | 16,126 | 165 | 4.15% | 19,352 | 198 | 4.12% |
| State and municipal (2) | 100,089 | 1,299 | 5.26% | 83,113 | 1,129 | 5.46% |
| Other securities (2) | 9,158 | 90 | 3.99% | 12,051 | 139 | 4.64% |
| Total securities | 1,422,951 | 8,348 | 2.38% | 1,176,316 | 8,043 | 2.75% |
| Federal Funds Sold | - | - | 0.00% | 7,376 | 2 | 0.11% |
| FHLBNY and FRB stock | 18,859 | 185 | 3.98% | 16,722 | 221 | 5.32% |
| Total loans and leases, net of unearned income (3) | 2,963,737 | 36,567 | 5.00% | 1,972,394 | 25,439 | 5.19% |
| **Total interest-earning assets** | **4,409,455** | 45,107 | **4.15%** | **3,211,533** | **33,708** | **4.22%** |
| Other assets | 490,272 |  |  | 253,384 |  |  |
| **Total assets** | **4,899,727** |  |  | **3,464,917** |  |  |
| **LIABILITIES & EQUITY** |  |  |  |  |  |  |
| Deposits |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Interest bearing checking, savings, & money market | 2,269,900 | 1,418 | 0.25% | 1,458,332 | 1,004 | 0.28% |
| Time deposits | 979,860 | 1,968 | 1.02% | 715,159 | 1,757 | 1.96% |
| Total interest-bearing deposits | 3,249,760 | 3,386 | 0.42% | 2,173,491 | 2,761 | 0.51% |
| Federal funds purchased & securities sold under agreements to repurchase | 198,707 | 1,010 | 2.06% | 169,903 | 1,092 | 2.59% |
| Other borrowings | 119,606 | 1,168 | 3.96% | 138,687 | 1,429 | 4.14% |
| Trust preferred debentures | 43,675 | 687 | 6.38% | 25,065 | 405 | 6.50% |
| **Total interest-bearing liabilities** | **3,611,748** | **6,251** | **0.70%** | **2,507,146** | **5,687** | **0.91%** |
| Noninterest bearing deposits | 771,761 |  |  | 596,416 |  |  |
| Accrued expenses and other liabilities | 72,941 |  |  | 57,809 |  |  |
| **Total liabilities** | 4,456,450 |  |  | 3,161,371 |  |  |
| Tompkins Financial Corporation Shareholders’ equity | 441,810 |  |  | 302,077 |  |  |
| Noncontrolling interest | 1,467 |  |  | 1,469 |  |  |
| **Total equity** | **443,277** |  |  | **303,546** |  |  |
| **Total liabilities and equity** | **$4,899,727** |  |  | **$3,464,917** |  |  |
| Interest rate spread |  |  | **3.45%** |  |  | **3.31%** |
| Net interest income/margin on earning assets |  | **38,856** | **3.57%** |  | **28,021** | **3.51%** |
| Tax Equivalent Adjustment |  | **(650)** |  |  | **(580)** |  |
| Net interest income per consolidated financial statements |  | **$38,206** |  |  | **$27,441** |  |

(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 rat 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 condensed consolidated financial statement included in Part I of the Company's annual report on Form 10-K for the fiscal year ended December 31, 2012.

48

### Net Interest Income

Net interest income is the Company’s largest source of revenue, representing 68.7% of total revenues for the three months ended March 31, 2013, compared to 70.2% for the same period in 2012. 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 Company’s net interest income over the past several years has benefitted from steady growth in average earning assets, as well as lower funding costs. However, with deposit rates at historically low levels, the downward pricing of these liabilities has slowed, while interest earning assets continue to price down at a steady rate. This has placed pressure on net interest margin. The taxable equivalent net interest margin of 3.57% for the three month period ended March 31, 2013 is above the net interest margin of 3.51% for the same period in 2012. The improvement in the first quarter 2013 net interest margin compared to the first quarter of 2012 was mainly a result of lower funding costs, which were partially offset by lower yields on earning assets. The impact of lower market rates on the first quarter 2013 yield on average earning assets was lessened by the increase in average loan balances as a percentage of total average earning assets. Average loan balances represented about 67.2% of average earning assets in the first quarter of 2013, up from 61.4% in the first quarter of 2012.

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 ended March 31, 2013 was $38.2 million up 39.2% when compared to the same period in 2012. The increase is due primarily to the VIST Financial acquisition.

Taxable-equivalent interest income for the first quarter of 2013 was $45.1 million, up 33.8% when compared to the first quarter of 2012. The increase in taxable-equivalent interest income for the quarter was mainly a result of the $1.3 billion in earning assets acquired in the acquisition of VIST Financial in August 2012, as well as organic growth. This increase in average balances was partially offset by a decline in the yield on average earning assets. For the three months ended March 31, 2013, the yield on average earning assets was down 7 basis points to 4.15% compared to the same period in 2012. Average earning asset yields were impacted by the low rate environment as cash flows from existing higher yielding assets are reinvested at lower rates. The impact of the lower market rates on the overall yield on average earning assets in the first quarter of 2013 compared to the same period in 2012 was partially offset by the mix of earnings assets acquired in the VIST acquisition, which was more heavily weighted in loans than securities. Average loan balances for the three ended March 31, 2013 were up $991.3 million or 50.3%, while average yields were down 19 basis points to 5.00% from the same period in 2012. Average securities balances for the first quarter of 2013 were up $246.6 million or 21.0% over average balances in the first quarter of 2012, while the average yield was down 37 basis points to 2.38%.

Interest expense for the first quarter of 2013 was up $563,000 or 9.9% compared to the first quarter of 2012, reflecting lower average rates paid on deposits and borrowings offset by an increase in interest bearing liabilities, largely deposits of $1.2 billion, acquired from VIST Bank. The average rate paid on interest bearing deposits during the first quarter of 2013 was 0.42% or 9 basis points lower than the average rate paid in the first quarter of 2012. The rates paid were lower in both the interest bearing checking, savings and money market accounts and time deposit. Time deposits were the most significant component of this change as the average rate declined 94 basis points compared to the first quarter of 2012. The decline in time deposit rates were primarily attributed to the repricing of maturing deposits at renewal. Average interest-bearing deposit balances in the first quarter of 2013 increased by $1.1 billion or 49.5% compared to the same period in 2012. Total funding costs also benefitted from the growth in and acquisition of average noninterest bearing deposit balances. $129.5 million in non interest bearing deposits were acquired from VIST Bank. For the three months ended March 31, 2013, average noninterest bearing deposits of $771.8 million were up 29.4% over the same period in 2012. YTD Average other borrowings were down $19.1 million or 13.7% compared to the first quarter of 2012 due to paydowns.

### 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 $1.0 million for the first quarter of 2013, flat compared to $1.1 million for the same period in 2012. The relatively flat provision for loan and lease losses for the three month comparative periods is mainly a result of improvements in credit quality. Over the past several quarters, the Company has reported improvements in asset quality metrics; current levels of nonperforming loans and criticized and classified loans are down from the same period prior year. The allowance for loan and lease losses as a percentage of period end originated loans and leases was 1.11% at March 31, 2013, compared to 1.36% at March 31, 2012.

### Noninterest Income

Noninterest income totaled $17.4 million for the three months ended March 31, 2013, compared with $11.7 million for the same period in 2012. Noninterest income represented 31.3% of total revenues for the three ended March 31, 2013 up from 29.8% for the same period in 2012.

Investment services income was $3.8 million in first quarter of 2013, an increase of 11.5% from $3.4 million in the first quarter of 2012. The increase was mainly attributed to changes in the pricing structure of brokerage related fees instituted in the second quarter of 2012, increases in assets under management and the VIST Financial acquisition. 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 $3.4 billion at March 31, 2013, up 7.1% from $3.2 billion at March 31, 2012. These figures include $1.1 billion and $1.0 billion, respectively, of Company-owned securities where Tompkins Financial Advisors is custodian. The increase in fair value of assets also reflects successful business development initiatives resulting in customer retention and the VIST Financial acquisition.

Insurance commissions and fees for the three months ended March 31, 2013 increased by $3.6 million or 99.6% as compared to the same period in 2011. Revenues for commercial insurance lines, personal insurance lines, and health and benefit related insurance products were up for the quarter compared to the same period in 2012 with $3.1 million of the total commissions and fees increase being attributable to the VIST Insurance acquisition. Health and benefit related insurance products continue to grow in 2013, increasing by $1.6 million or 429.5% for the first quarter over last year; primarily driven by the VIST Insurance acquisition.

Service charges on deposit accounts were up $123,000 or 6.9% for the first quarter of 2013 compared to the first quarter of 2012. The largest component of this category is overdraft fees, which is largely driven by customer activity. The increase over prior year reflects overdraft fees at VIST Bank, which are partially offset by lower overdraft fees at the other three banking subsidiaries.

Card services income for the three months ended March 31, 2013 was up $170,000 or 10.8% over the same period in 2012. The increase was mainly in debit card income and was due to the acquisition of VIST Bank. Favorable trends in the number of cards issued and transaction volume have been mainly offset by lower interchange fees as a result of regulatory changes.

Net mark-to-market losses on securities and borrowings held at fair value totaled $38,000 in the first quarter of 2013, compared to net mark-to-market gains of $6,000 in the first quarter of 2012. Mark-to-market losses or gains related to the change in the fair value of trading securities and certain borrowings where the Company has elected the fair value option are unrealized amounts primarily impacted by changes in interest rates.

For the three months ended March 31, 2013, the Company sold three non-agency bonds classified as OTTI for a gain of approximately $94,000. Also for the three months ended March 31, 2013, the Company recognized $273,000 in gains on sales of available-for-sale investment securities as a result of general portfolio maintenance and interest rate risk management, and recognized $2,000 gain for the three month ended March 31, 2012.

Other income was $2.4 million and $1.3 million for the first quarters of 2013 and 2012, respectively. The other significant 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, FDIC Indemnification accretion and income from miscellaneous equity investments, including the Company’s investment in a Small Business Investment Company (“SBIC”). The first quarter of 2013 included $235,000 of income related to an investment in a SBIC. The Company believes that, as of March 31, 2013, there were no impairments with respect to its investment in the SBIC. Most other income categories were up over the same quarter last year due to the VIST Financial acquisition.

Net gains on sale of residential mortgage loans, included in other income on the consolidated statements of income, of $29,000 in the first quarter of 2013 were down by $71,000 or 71.2% compared to the first quarter of 2012. The decrease in gains on sale of residential mortgage loans is mainly due to the lower sales volumes, reflecting a decision to hold certain loans in portfolio. To manage interest rate risk exposures, the Company from time to time sells certain fixed rate loan originations that have rates below or maturities greater than the standards set by the Company’s Asset/Liability Committee for loans held in the portfolio.

### Noninterest Expense

Noninterest expense was $37.5 million for the first quarter of 2013, up $11.1 million or 42.3% compared to the same period prior year. This increase is largely the result of the acquisition of VIST Financial.

Salaries and wages expense increased by $4.3 million or 37.8% in the first quarter of 2013 compared to the same period in 2012. The increase is mainly a result of the additional employees acquired in the VIST acquisition. In addition, annual merit increases and higher accruals for business development activities affected salaries and benefits. Pension and other employee related benefits were up $1.8 million or 41.2% for the first quarter of 2013 compared to the same period in 2012, mainly a result of the VIST acquisition lower interest rates have contributed to the increase in the cost of pension and other postretirement benefit plans. Healthcare insurance is also up over prior year as a result of additional employees and increase in annual premiums.

Net occupancy expense was $3.1 million for the first quarter of 2013, up $1.3 million or 69.6% from the same period in 2012. The acquisition of VIST Financial contributed to the increase in net occupancy expense for the quarter.

Other operating expenses for the first quarter of 2013 increased by $2.7 million or 38.3% compared to the prior year. The acquisition of VIST Financial contributed to this year-over-year increase in other expenses. The following expenses increased during the quarter by the following amounts: professional fees ($468,000), legal fees ($438,000), other real estate expense ($217,000), Pennsylvania share tax ($292,000), software licensing and maintenance ($192,000), and cardholder expense ($166,000). These increases are inclusive of the VIST Financial acquisition.

### Income Tax Expense

The provision for income taxes provides for Federal and New York State income taxes. The provision for income taxes was $5.5 million for an effective rate of 32.3% for the first quarter of 2013, compared to tax expense of $3.8 million and an effective rate of 32.4% for the same quarter in 2012. The effective rates differ from the U.S. statutory rate of 35.0% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance assets.

### FINANCIAL CONDITION

Total assets were $5.0 billion at March 31, 2013, up $150.1 million or 3.1% over December 31, 2012, and up $1.4 billion or 40.6% over March 31, 2012. The majority of the growth is due to the acquisition of VIST, which had total assets of $1.4 billion as of the August 1, 2012 acquisition date. The growth over year-end was mainly in available-for-sale securities, which were up $134.2 million or 9.6% and loans which were up $39.2 million or 1.3%. Total deposits were up $122.2 million or 3.1% over year-end with the majority of growth centered in checking, savings and money market deposits. Deposit growth was used to reduce mainly short-term borrowings with the FHLB while approximately $50.0 million of new borrowings maturing in over 1 year were purchased as a lower cost alternative to various time deposit offerings. Total deposits were up $1,2 billion or 42.4% over March 31, 2012 (VIST Financial had total deposits of $1.2 billion on acquisition date).

### Securities

As of March 31, 2013, total securities were $1.6 billion or 31.1% of total assets, compared to $1.4 billion or 29.3% of total assets at year-end 2012, and $1.3 billion or 36.3% at March 31, 2012. The following table details the composition of securities available-for-sale and securities held-to-maturity.

*(in thousands)*

| Available-for-Sale Securities | 03/31/2013 Amortized Cost1 | Fair Value | 12/31/2012 Amortized Cost1 | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| U.S. Treasury securities | $0 | $0 | $1,001 | $1,004 |
| Obligations of U.S. Government sponsored entities | 586,535 | 607,458 | 570,871 | 593,778 |
| Obligations of U.S. states and political subdivisions | 76,308 | 78,228 | 76,803 | 79,056 |
| Mortgage-backed securities |  |  |  |  |
| U.S. Government agencies | 159,707 | 163,864 | 162,853 | 167,667 |
| U.S. Government sponsored entities | 659,471 | 670,512 | 526,364 | 540,355 |
| Non-U.S. Government agencies or sponsored entities | 395 | 403 | 4,457 | 4,354 |
| U.S. corporate debt securities | 5,007 | 5,074 | 5,009 | 5,083 |
| Total debt securities | 1,487,423 | 1,525,539 | 1,347,358 | 1,391,297 |
| Equity securities | 2,058 | 2,036 | 2,058 | 2,043 |
| **Total available-for-sale securities** | **$1,489,481** | **$1,527,575** | **$1,349,416** | **$1,393,340** |

1 Net of other-than-temporary impairment losses recognized in earnings

*Held-to-Maturity Securities*

*(in thousands)*

|  | 03/31/2013 Amortized Cost | Fair Value | 12/31/2012 Amortized Cost | Fair Value |
| --- | ---: | ---: | ---: | ---: |
| Obligations of U.S. states and political subdivisions | $23,304 | $24,355 | $24,062 | $25,163 |
| **Total held-to-maturity debt securities** | **$23,304** | **$24,355** | **$24,062** | **$25,163** |

The growth in the available-for-sale portfolio was mainly in obligations of U.S. Government sponsored entities and driven by yield and duration considerations. 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. The decrease in the held-to-maturity portfolio was due to maturities and calls during the year.

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 identify any other-than-temporary impairment as defined under generally accepted accounting principles.

As of March 31, 2013, the Company owned one corporate (non-agency) collateralized mortgage obligation issue (“CMO”) in a super senior or senior tranche. At March 31, 2013, this non-agency CMO with an amortized cost basis of $395,000 and a fair value of $403,000 was collateralized by residential real estate and is not currently deferring nor is it in default of interest payments to the Company.

For the three month periods ended March 31, 2013 and 2012, respectively, the Company did not recognize any net credit impairment charge to earnings on any non-agency CMO security and, as a result of the impairment review process, the Company does not consider the non-agency CMO held at March 31, 2013 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 AOCI to reduce the securities to their then current fair value.

During the 1st quarter of 2013, the Company sold three non-agency CMO securities for a gain of approximately $94,000. Prior to the 1st quarter of 2013, these three non-agency CMO securities were determined to be other-than-temporarily impaired and the Company did recognize net credit impairment charges to earnings of $441,000 over the life of these three securities. Also during the 1st quarter of 2013, one non-agency CMO security was repaid in full. The Company did not recognize any net credit impairment charge to earnings for this security.

The Company maintains a trading portfolio with a fair value of $15.6 million as of March 31, 2013, compared to $16.5 million at December 31, 2012. The decrease in the trading portfolio reflects maturities or payments during 2013. For the three months ended March 31, 2013, net mark-to-market losses related to the securities trading portfolio were $115,000, compared to net mark-to-market losses of $82,000 for the same period in 2012.

Loans and Leases at March 31, 2013 and December 31, 2012 were as follows:

*(in thousands)*

| Commercial and industrial | March 31, 2013 Originated | Acquired | Total Loans and Leases | December 31, 2012 Originated | Acquired | Total Loans and Leases |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Agriculture | **$63,469** | **$0** | **$63,469** | $77,777 | $0 | $77,777 |
| Commercial and industrial other | **468,297** | **154,177** | **622,474** | 446,876 | 167,427 | 614,303 |
| Subtotal commercial and industrial | **531,766** | **154,177** | **685,943** | 524,653 | 167,427 | 692,080 |
| Commercial real estate |  |  |  |  |  |  |
| Construction | **41,304** | **29,216** | **70,520** | 41,605 | 43,074 | 84,679 |
| Agriculture | **46,677** | **3,178** | **49,855** | 48,309 | 3,247 | 51,556 |
| Commercial real estate other | **763,876** | **445,133** | **1,209,009** | 722,273 | 445,359 | 1,167,632 |
| Subtotal commercial real estate | **851,857** | **477,527** | **1,329,384** | 812,187 | 491,680 | 1,303,867 |
| Residential real estate |  |  |  |  |  |  |
| Home equity | **159,538** | **77,888** | **237,426** | 159,720 | 81,657 | 241,377 |
| Mortgages | **604,593** | **39,159** | **643,752** | 573,861 | 41,618 | 615,479 |
| Subtotal residential real estate | **764,131** | **117,047** | **881,178** | 733,581 | 123,275 | 856,856 |
| Consumer and other |  |  |  |  |  |  |
| Indirect | **25,125** | **18** | **25,143** | 26,679 | 24 | 26,703 |
| Consumer and other | **31,418** | **1,376** | **32,794** | 32,251 | 1,498 | 33,749 |
| Subtotal consumer and other | **56,543** | **1,394** | **57,937** | 58,930 | 1,522 | 60,452 |
| Leases | **5,109** | **0** | **5,109** | 4,618 | 0 | 4,618 |
| Covered loans |  | **35,304** | **35,304** | 0 | 37,600 | 37,600 |
| Total loans and leases | **2,209,406** | **785,449** | **2,994,855** | 2,133,969 | 821,504 | 2,955,473 |
| Less: unearned income and deferred costs and fees | **(1,060)** | **0** | **(1,060)** | (863) | 0 | (863) |
| Total loans and leases, net of unearned income and deferred costs and fees | **$2,208,346** | **$785,449** | **$2,993,795** | $2,133,106 | $821,504 | $2,954,610 |

Total loans and leases of $3.0 billion at March 31, 2013 were up $39.2 million or 1.3% from December 31, 2012. Increases in commercial and residential mortgages were partially offset by declines in agricultural, construction and consumer loans. As of March 31, 2013 total loans and leases represented 60.0% of total assets compared to 61.1% of total assets at December 31, 2012.

Residential real estate loans, including home equity loans, of $881.2 million at March 31, 2013 increased by $24.3 million or 2.8% from $856.9 million at year-end 2012, and comprised 29.4% of total loans and leases at March 31, 2013. The growth in residential real estate loan balances reflects higher origination volumes due to the low interest rate environment as well as a decision to retain certain residential mortgages in portfolio rather than 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.

Prior to August 2012, loans were generally sold to Federal Home Loan Mortgage Corporation (“FHLMC”) or State of New York Mortgage Agency (“SONYMA”). With the acquisition to VIST on August 1, 2012, the Company also sells loans to other third parties, including money center banks. These residential real estate loans are generally sold 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 general representations and warranties. While in the past in rare circumstances the Company agreed to sell residential real estate loans with recourse, the Company has not done so in the past several years and the amount of such loans included on the Company’s balance sheet at March 31, 2013 is insignificant. The Company has never had to repurchase a loan sold with recourse.

During the first three months of 2013 and 2012, the Company sold residential mortgage loans totaling $720,000 and $4.3 million, respectively, and realized gains on these sales of $29,000 and $100,000, respectively. These residential real estate loans were sold without recourse in accordance with standard secondary market loan sale agreements. When residential mortgage loans are sold, the Company typically retains all servicing rights, which provides the Company with a source of fee income. Mortgage servicing rights, at amortized basis, totaled $1.1 million at March 31, 2013 down from $1.2 million at December 31, 2012.

The Company has not originated any hybrid loans, such as payment option ARMs. The Company underwrites residential real estate loans in accordance with secondary market standards in effect at the time of origination, including loan-to-value (“LTV”) and documentation requirements. The Company does not underwrite low or reduced documentation loans other than those that meet secondary market standards for low or reduced documentation loans. In those instances, W-2’s and paystubs are used instead of sending Verification of Employment forms to employers to verify income and bank deposit statements are used instead of Verification of Deposit forms mailed to financial institutions to verify deposit balances.

Commercial real estate loans increased by $25.5 million or 2.0% compared to December 31, 2012. Commercial real estate loans represented 44.4% of total loans as of March 31, 2013. Commercial and industrial loans of $685.9 million at March 31, 2013, are in line with December 31, 2012 balances. Demand for commercial loans continued to be soft in the first quarter of 2013, reflecting weak economic conditions. As of March 31, 2013, agriculturally-related loans totaled $113.3 million or 3.8% of total loans and leases, down from $129.3 million or 4.4% of total loans and leases at December 31, 2012. 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 consumer loan portfolio includes personal installment loans, indirect automobile financing, and overdraft lines of credit. Consumer and other loans were $57.9 million at March 31, 2013, in line with $60.5 million at December 31, 2012. The decrease is mainly in indirect automobile loans and reflects increased competition.

The lease portfolio increased by 10.6% to $5.1 million at March 31, 2013 from $4.6 million at December 31, 2012. The lease portfolio has traditionally consisted of leases on vehicles for consumers and small businesses. Management continues to review leasing opportunities, primarily commercial leasing and municipal leasing. As of March 31, 2013, commercial leases and municipal leases represented 99.6% of total leases, while consumer leases made up the remaining percentage, unchanged from the percentages at December 31, 2012.

At March 31, 2013, the Company had $785.4 million of acquired loans as a result of the Company’s acquisition of VIST Financial 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 acquired and accounted for in accordance with ASC Subtopic 310-30, “Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality,” was $76.1 million at March 31, 2013 as compared to $92.3 million at acquisition date of August 1, 2012, and the net reduction reflects payments. Under ASC Subtopic 310-30, loans may be aggregated and accounted for as pools of loans if the loans being aggregated have common risk characteristics. The Company elected to account for the loans with evidence of credit deterioration individually rather than aggregate them into pools. The difference between the undiscounted cash flows expected at acquisition and the investment in the acquired loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment, as a loss accrual or as a valuation allowance.

Increases in expected cash flows subsequent to the acquisition are recognized prospectively through an adjustment of the yield on the loans over the remaining life. Subsequent decreases to the expected cash flows require us to evaluate the need for an addition to the allowance for loan losses. Valuation allowances (recognized in the allowance for loan losses) on these impaired loans reflect only losses incurred after the acquisition (representing all cash flows that were expected at acquisition but currently are not expected to be received).

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 $709.4 million at March 31, 2013. The fair value of the acquired loans not exhibiting evidence of credit impairment was determined by projecting contractual cash flows discounted at risk-adjusted interest rates.

The carrying value of the acquired loans reflects management’s best estimate of the amount to be realized from the acquired loan and lease portfolios. However, the amounts the Company actually realizes on these loans could differ materially from the carrying value reflected in these financial statements, based upon the timing of collections on the acquired loans in future periods, underlying collateral values and the ability of borrowers to continue to make payments.

Purchased performing loans were recorded at fair value, including a credit discount. Credit losses on acquired performing loans are estimated based on analysis of the performing portfolio. The purchased performing portfolio also included a general interest rate mark (premium). Both the credit discount and interest rate mark are accreted/amortized as a yield adjustment over the estimated lives of the loans. Interest is accured daily on the outstanding principal balances of purchased performing loans.

At March 31, 2013, acquired loans included $35.3 million of covered loans. VIST Financial had acquired these loans in an FDIC assisted transaction in the fourth quarter of 2010. In accordance with loss sharing agreements with the FDIC, certain losses and expenses relating to covered loans may be reimbursed by the FDIC at 70% or, if certain levels of reimbursement are reached, 80%. See Note 8 – “FDIC Indemnification Asset Related to Covered Loans” in the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q.

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 5 – “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, 2012. There have been no significant changes in these policies and guidelines. As such, these policies are reflective of new originations as well as those balances held at March 31, 2013. 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. 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

### Originated Loans and Leases

Management reviews the appropriateness 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 has developed a methodology to measure the amount of estimated loan loss exposure inherent in the loan portfolio to assure that an appropriate 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 allowance allocations are calculated in accordance with ASC Topic 310, *Receivables* and ASC Topic 450, *Contingencies.*

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 loans, 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 regular basis.

At least annually, management reviews all commercial and commercial real estate loans exceeding a certain threshold and assigns a risk rating. The Company uses an internal loan rating system of pass credits, special mention loans, substandard loans, doubtful loans, and loss loans (which are fully charged off). The definitions of “special mention”, “substandard”, “doubtful” and “loss” are consistent with banking regulatory definitions. Factors considered in assigning loan ratings include: the customer’s ability to repay based upon the customer’s expected future cash flow, operating results, and financial condition; value of the underlying collateral, if any; and the economic environment and industry in which the customer operates. Special mention loans have potential weaknesses that if left uncorrected may result in deterioration of the repayment prospects and a downgrade to a more severe risk rating. A substandard loan credit has a well-defined weakness which makes payment default or principal exposure likely, but not yet certain. There is a possibility that the Company will sustain some loss if the deficiencies are not corrected. A doubtful loan has a high possibility of loss, but the extent of the loss is difficult to quantify because of certain important and reasonably specific pending factors.

At least quarterly, management reviews all commercial and commercial real estate loans and leases and agriculturally related loans with an outstanding principal balance of over $500,000 that are internally risk rated as special mention or worse, giving consideration to payment history, debt service payment capacity, collateral support, strength of guarantors, local market trends, 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 present value of expected future cash flows discounted at the original effective rate of each loan. For commercial loans, commercial mortgage loans, and agricultural 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 net loss experience and current charge-off trends, past due status, and management’s judgment of the effects of current economic conditions on portfolio performance.

Since the methodology is based upon historical experience and trends as well as management’s judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in the local area, concentration of risk, changes in interest rates, and declines in local property values. Based on its evaluation of the allowance as of March 31, 2013, management considers the allowance to be appropriate. Under adversely different conditions or assumptions, the Company would need to increase the allowance.

### Acquired Loans and Leases

#### Acquired loans accounted for under ASC 310-30

For our acquired loans, our allowance for loan losses is estimated based upon our expected cash flows for these loans. To the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.

#### Acquired loans accounted for under ASC 310-20

We establish our allowance for loan losses through a provision for credit losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan 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)*

| Originated | 03/31/2013 | 12/31/2012 | 03/31/2012 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | $7,037 | $7,533 | $8,270 |
| Commercial real estate | 10,644 | 10,184 | 12,314 |
| Residential real estate | 5,036 | 4,981 | 4,491 |
| Consumer and other | 1,879 | 1,940 | 1,868 |
| Leases | 2 | 5 | 5 |
| **Total** | **$24,598** | **$24,643** | **$26,948** |

56

*(in thousands)*

| Acquired | 03/31/2013 | 12/31/2012 | 03/31/2012 |
| --- | ---: | ---: | ---: |
| Commercial real estate | 63 | 0 | 0 |
| **Total** | **$63** | **$0** | **$0** |

As of March 31, 2013, the allowance is in line with year-end 2012. The amount of loans internally-classified as Special Mention, Substandard and Doubtful totaled $91.9 million at March 31, 2013 compared to $101.4 million at December 31, 2012 and $122.3 million at March 31, 2012. While the overall strength of the economy remains uncertain, there are signs of improvement in national and local economic conditions, which have contributed to some improvements in the financial conditions of several of the Company’s commercial and agricultural customers. This has led to upgrades of the risk ratings of individual credits which is evidenced by the overall decrease in loans classified Special Mention and Substandard. In addition to upgrades, charge-offs have contributed to the decrease in total internally classified loans and leases. The decrease in the allocation for commercial and industrial loans was mainly a result of a decrease in the level of classified commercial and industrial loans. The increase in reserve allocations for commercial real estate loans was mainly due to growth in the portfolio over year-end 2012. Reserve allocations for residential real estate loans and consumer loans were relatively unchanged compared to December 31, 2012. The reserve allocation for acquired commercial real estate loans is related to one credit and is based on an evaluation of collateral securing the credit.

Activity in the Company’s allowance for loan and lease losses during the first three months of 2013 and 2012, and for the twelve months ended December 31, 2012 is illustrated in the table below.

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

*(in thousands)*

|  | 03/31/2013 | 12/31/2012 | 03/31/2012 |
| --- | ---: | ---: | ---: |
| Average originated loans outstanding during year | **$2,161,200** | $2,301,901 | $1,972,394 |
| Balance of originated allowance at beginning of year | **24,643** | 27,593 | 27,593 |
| **ORIGINATED LOANS CHARGED-OFF:** |  |  |  |
| Commercial and industrial | **390** | 5,328 | 252 |
| Commercial real estate | **346** | 3,977 | 969 |
| Residential real estate | **192** | 2,390 | 409 |
| Consumer and other | **264** | 826 | 259 |
| **Total loans charged-off** | **$1,192** | $12,521 | $1,889 |

| ORIGINATED RECOVERIES OF LOANS PREVIOUSLY CHARGED-OFF: |  |  |  |
| --- | ---: | ---: | ---: |
| Commercial and industrial | **160** | 198 | 19 |
| Commercial real estate | **78** | 200 | 0 |
| Residential real estate | **2** | 30 | 0 |
| Consumer and other | **87** | 306 | 100 |
| **Total loans recovered** | **$327** | $734 | $119 |
| Net loans charged-off | **865** | 11,787 | 1,770 |
| Additions to originated allowance charged to operations | **820** | 8,837 | 1,125 |
| **Balance of originated allowance at end of year** | **$24,598** | $24,643 | $26,948 |
| **Annualized net charge-offs on originated loans to average total originated loans and leases** | **0.16%** | 0.51% | 0.36% |
| **Originated allowance as a percentage of originated loans and leases outstanding** | **1.11%** | 1.16% | 1.36% |

57

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

*(in thousands)*

|  | 03/31/2013 | 12/31/2012 | 03/31/2012 |
| --- | ---: | ---: | ---: |
| Average acquired loans outstanding during year | **$802,437** | $0 | $0 |
| Balance of acquired allowance at beginning of year | **0** | 0 | 0 |
| **ACQUIRED LOANS CHARGED-OFF:** |  |  |  |
| Commercial and industrial | **23** | 0 | 0 |
| Residential real estate | **107** | 0 | 0 |
| Consumer and other | **25** | 0 | 0 |
| **Total loans charged-off** | **$155** | $0 | $0 |
| Net loans charged-off | **155** | 0 | 0 |
| Additions to acquired allowance charged to operations | **218** | 0 | 0 |
| **Balance of acquired allowance at end of year** | **$63** | $0 | $0 |
| **Annualized net charge-offs of acquired loans to average total acquired loans and leases** | **0.08%** | 0.00% | 0.00% |

There was no allowance, charge-offs, or recoveries for acquired loans accounted for in accordance with ASC Topic 805 for the periods ending December 31, 2012 and March 31, 2012.

As of March 31, 2013, the allowance for originated loans and leases was $24.6 million or 1.11% of total originated loans and leases outstanding, compared with $24.6 million or 1.16% at December 31, 2012 and $26.9 million or 1.36% at March 31, 2012. The provision for originated loan and lease losses was $820,000 for the three months ended March 31, 2013, compared to $1.1 million for the same period in 2012. Net originated loan and lease charge-offs of $865,000 were down compared to the $1.8 million for the first quarter of 2012. The Company has seen improvement in credit quality metrics over the past several quarter and current levels of nonperforming loans and criticized and classified loans are down from prior year end.

As of March 31, 2013, the allowance for acquired loans and leases was $63,000. Although loans within the acquired portfolio were accounted for in accordance with ASC Topic 805, it was determined through impairment testing that one relationship demonstrated further deterioration and a specific reserve was assigned. The Company has seen improvement in credit quality metrics over the past several quarters and current levels of nonperforming loans are down from the same period prior year.

*Analysis of Past Due and Nonperforming Loans*

*(dollar amounts in thousands)*

| Loans 90 days past due and accruing | 03/31/20131 | 12/31/20121 | 03/31/2012 |
| --- | ---: | ---: | ---: |
| Commercial and industrial | **$0** | $0 | $28 |
| Commercial real estate | **0** | 0 | 1,202 |
| Residential real estate | **157** | 257 | 322 |
| Total loans 90 days past due and accruing | **157** | 257 | 1,552 |
| Nonaccrual loans2 |  |  |  |
| Commercial and industrial | **1,299** | 1,340 | 7,292 |
| Commercial real estate | **24,782** | 25,014 | 24,194 |
| Residential real estate | **10,798** | 11,084 | 6,750 |
| Consumer and other | **236** | 302 | 219 |
| Total nonaccrual loans | **37,115** | 37,740 | 38,455 |
| Troubled debt restructurings not included above | **0** | 1,532 | 423 |
| **Total nonperforming loans and leases** | **37,272** | 39,529 | 40,430 |
| Other real estate owned | **3,950** | 4,862 | 1,906 |
| **Total nonperforming assets** | **$41,222** | $44,391 | $42,336 |
| **Allowance as a percentage of nonperforming loans and leases** | **66.16%** | 62.34% | 66.65% |
| **Total nonperforming assets as percentage of total assets** | **0.83%** | 0.92% | 1.19% |

1 The March 31, 2013 and December 31, 2012 columns in the above table exclude $17.8 million and $18.7 million, respectively, of acquired loans that are 90 days past due and accruing interest. These loans were originally recorded at fair value on the acquisition date of August 1, 2012. These loans are considered to be accruing as we can reasonably estimate future cash flows on these acquired loans and we expect to fully collect the carrying value of these loans. Therefore, we are accreting the difference between the carrying value of these loans and their expected cash flows into interest income.

2 Nonaccrual loans at March 31, 2013 and December 31, 2012 include $4.6 million and $4.4 million, respectively, of nonaccrual acquired loans. There were no acquired loans at March 31, 2012.

Nonperforming assets include nonaccrual loans, troubled debt restructurings (“TDR”), and foreclosed real estate. Nonperforming assets represented 0.83% of total assets at March 31, 2013, compared to 0.92% at December 31, 2012, and 1.19% at March 31, 2012. The decrease in nonperforming assets at March 31, 2013, from year-end 2012 was mainly as result of the payoff of the $1.5 million loan reported in the above table in the category, ‘troubled debt restructuring not included above’. The Company’s ratio of nonperforming assets to total assets continues to compare favorably to our peer group’s most recent ratio of 2.16% at December 31, 2012.

Total nonperforming originated loans represented 1.48% of total originated loans at March 31, 2013, compared to 1.65% of total originated loans at December 31, 2012, and 2.04% of total originated loans at March 31, 2012. A breakdown of nonperforming loans by portfolio segment is shown above. Commercial real estate loans represent the largest component of nonperforming loans. Nonperforming commercial real estate loans include two relationships totaling $9.8 million at March 31, 2013 and $10.0 million at December 31, 2012. Both of these relationships are considered impaired and have been charged down to fair value.

Loans past due 30-89 days and accruing interest increased from $13.3 million at December 31, 2012 to $20.1 million at March 31, 2013. Originated loans past due 30-89 days and accruing interest increased by $2.9 million to $10.9 million, while acquired loans past due 30-89 days and accruing increased by $4.0 million to $9.2 million at March 31, 2013. The increase in the originated portfolio was mainly one commercial relationship totaling $3.5 million, which is 90% guaranteed by a U.S. government agency. The increase in the acquired portfolio is mainly a result of matured loans that are in process of being renewed.

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. As mentioned above, the decrease in this category from year-end 2012 reflects the payoff of the $1.5 million loan included at year-end. At March 31, 2013 the Company had $7.4 million in TDRs, all were reported as nonaccrual and included in the table above, and two loans were more than 90 days past due with a total balance of $552,000.

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 $24.3 million March 31, 2013, and $27.1 million at December 31, 2012. 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 $25.8 million at March 31, 2013, $31.8 million at December 31, 2012, and $33.0 million at March 31, 2012. At March 31, 2013 there was a specific reserve of $63,000 on impaired loans compared to $0 specific reserves at December 31, 2012, and $2.5 million of specific reserves at March 31, 2012. The majority of impaired loans are collateral dependent impaired loans that have limited exposure or require limited specific reserve because of the amount of collateral support with respect to these loans and previous charge-offs. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured. In these cases, interest is recognized on a cash basis. There was $35,000 and $48,000 interest income recognized for the periods ended March 31, 2013 and December 31, 2012, respectively, and $0 for March 31, 2012.

The ratio of the allowance to nonperforming loans (loans past due 90 days and accruing, nonaccrual loans and restructured troubled debt) was 66.2 times at March 31, 2013, up from 62.3 times in December 31, 2012, and down from 66.7 times at March 31, 2012. The Company’s nonperforming loans are mostly made up of collateral dependent impaired loans requiring little to no specific allowance due to the level of collateral available with respect to these loans and/or previous charge-offs. The Company’s peer group ratio was 101.15% as of December 31, 2012.

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 45 commercial relationships from the originated portfolio and 43 commercial relationships from the acquired portfolio totaling $20.5 million and $23.8 million, respectively at March 31, 2013 that were potential problem loans. At December 31, 2012, the Company had identified 42 relationships totaling $25.4 million in the originated portfolio and 49 relationships totaling $30.2 million that were potential problem loans. Of the 45 commercial relationships in the originated portfolio that were Substandard, there are 6 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $12.2 million, the largest of which is $2.8 million. Of the 43 commercial relationships from the acquired loan portfolio, there were 9 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $16.7 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 $446.8 million at March 31, 2013, an increase of $5.5 million or 1.2% from December 31, 2012, mainly a result the receipt of net income of $11.5 million less cash dividends of $5.5 million.

Additional paid-in capital increased by $2.4 million, from $334.6 million at December 31, 2012, to $337.1 million at March 31, 2013. The increase is primarily attributable to $968,000 related to shares issued for dividend reinvestment, $715,000 for the issuance of shares under the employee stock ownership plan, $475,000 million increase for the exercise of stock options and $307,000 related to stock-based compensation. Retained earnings increased by $6.0 million from $108.7 million at December 31, 2012, to $114.7 million at March 31, 2013. Accumulated other comprehensive loss increased from a net unrealized loss of $2.1 million at December 31, 2012 to a net unrealized loss of $5.2 million at March 31, 2013; reflecting a $3.5 million decrease in unrealized gains on available-for-sale securities due to market rates, and a $409,000 increase 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 2013 totaled approximately $5.5 million, representing 47.5% of year to date 2013 earnings. Cash dividends of $0.38 per common share paid in the first three months of 2013 were up 5.6% over cash dividends of $0.36 per common share paid in the first three months of 2012.

On October 25, 2011, the Company’s Board of Directors authorized a new stock repurchase plan for the Company to repurchase up to 335,000 shares of the Company’s common stock. Purchases may be made on the open market or in privately negotiated transactions over the 24 months following adoption of the plan. The repurchase program may be suspended, modified, or terminated at any time for any reason. As of the date of this report, no shares have been repurchased under the plan.

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, 2013, compared to the regulatory capital requirements for “well capitalized” institutions.

*(dollar amounts in thousands)*

| REGULATORY CAPITAL ANALYSIS March 31, 2013 | Actual Amount | Ratio | Well Capitalized Requirement Amount | Ratio |
| --- | ---: | ---: | ---: | ---: |
| Total Capital (to risk weighted assets) | $411,419 | 12.93% | $318,073 | 10.00% |
| Tier 1 Capital (to risk weighted assets) | $386,368 | 12.15% | $190,844 | 6.00% |
| Tier 1 Capital (to average assets) | $386,368 | 8.11% | $238,311 | 5.00% |

As illustrated above, the Company’s capital ratios on March 31, 2013 remain above the minimum requirements for well capitalized institutions. Total capital as a percent of risk weighted assets was 12.9% as of December 31, 2012 and March 31, 2013 respectively. Tier 1 capital as a percent of risk weighted assets increased from 12.1% at the end of 2012 to 12.2% as of March 31, 2013. Tier 1 capital as a percent of average assets was 8.1% at March 31, 2013 up from 7.9% at year end December 31, 2012.

During the first quarter of 2010, the OCC notified the Company that it was requiring Mahopac National Bank (“Mahopac”), 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 was 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. During the first quarter of 2013, the Company was notified by the OCC that it was no longer requiring Mahopac to maintain the higher capital ratios agreed to in 2010.

As of March 31, 2013, the capital ratios for the Company’s other four subsidiary banks also exceeded the minimum levels required to be considered well capitalized.

In December 2010, the oversight body of the Basel Committee on Banking Supervision published final rules on capital, leverage and liquidity. Implementation of these new capital and liquidity requirements has created significant uncertainty with respect to future requirements for financial institutions. Currently, the Company has issued $43.7 million of trust preferred securities which is included in the Tier 1 capital of the Company for regulatory capital purposes pursuant to regulatory guidelines. Under the recently enacted “Dodd-Frank Wall Street Reform and Consumer Protection Act,” outstanding trust preferred securities at the effective date of the Act will continue to qualify as Tier 1 capital for bank holding companies with total assets less than $15 billion. Trust preferred securities issued in the future, however, may no longer qualify as Tier 1 capital. The Company continues to monitor and evaluate the impact that Basel III may have on our capital ratios.

### Deposits and Other Liabilities

Total deposits of $4.1 billion at March 31, 2013 increased $122.2 million or 3.1% from December 31, 2012. Growth over year-end 2012 was comprised mainly of increases in municipal interest bearing checking and municipal money market accounts.

Total deposits were up $1.2 billion or 42.4% over March 31, 2012. VIST Bank had total deposits of $1.2 billion as of the acquisition date of August 1, 2012 and was largely responsible for the increase in deposits.

The most significant source of funding for the Company is core deposits. Prior to December 31, 2011, the Company defined core deposits as total deposits less time deposits of $100,000 or more, brokered deposits and municipal money market deposits. A provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) made permanent an increase in the maximum amount of FDIC deposit insurance for financial institutions to $250,000 per depositor. That maximum had been $100,000 per depositor until 2009, when it was temporarily raised to $250,000. As a result of the permanently increased deposit insurance coverage, effective December 31, 2011 the Company defines core deposits as total deposits less time deposits of $250,000 or more (formerly $100,000), brokered deposits and municipal money market deposits.

Core deposits grew by $48.5 million or 1.5% to $3.3 billion at March 31, 2013 from $3.2 billion at year-end 2012. Core deposits represented 80.9% of total deposits at March 31, 2013, compared to 82.2% of total deposits at December 31, 2012.

Municipal money market and interest bearing checking accounts of $483.1 million at March 31, 2013 increased from $424.5 million at year-end 2012. As compared to March 31, 2012, municipal money market accounts and interest bearing checking accounts were up by $206.9 million or 42.0% to $700.0 million at March 31, 2103 largely due to the VIST acquisition. In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances tend to increase throughout the fall and into the winter months from tax deposits and receive an additional inflow at the end of March from the electronic deposit of state funds.

The Company uses both retail and wholesale repurchase agreements. Retail repurchase agreements are arrangements with local customers of the Company, in which the Company agrees to sell securities to the customer with an agreement to repurchase those securities at a specified later date. Retail repurchase agreements totaled $60.8 million at March 31, 2013, and $65.4 million at December 31, 2012. 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 $133.3 million at March 31, 2013, which includes $33.3 million (net of a $3.3 million fair value adjustment) of wholesale repurchase agreements from the VIST Financial acquisition payable to another large financial institution. By comparison, wholesale repurchase agreements totaled $148.5 million at December 31, 2012.

The Company’s other borrowings totaled $156.6 million at March 31, 2013, up $44.8 million or 40.1% from $111.8 million at December 31, 2012. Borrowings at March 31, 2013 included $86.8 million in FHLB term advances, $49.9 million of overnight FHLB advances, and a $20.0 million advance from a bank. Borrowings at year-end 2012 included $111.8 million in FHLB term advances, $91.8 million of overnight FHLB advances, and a $20.0 million advance from a bank. The decrease in borrowings reflects the pay down of FHLB borrowings as a result of deposit growth. Of the $86.8 million in FHLB term advances at March 31, 2013, $81.6 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 decreased by $77,000 (net mark-to-market gain of $77,000) over the three months ended March 31, 2013.

### 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 term advances from the FHLB. Rates and terms are the primary determinants of the mix of these funding sources. Non-core funding sources, at March 31, 2013, increased by $98.6 million or 9.6% from $1.0 billion at December 31, 2012. Non-core funding sources, as a percentage of total liabilities, were 24.8% at March 31, 2013, compared to 23.4% at December 31, 2012. The increase in non-core funding sources was mainly due to increased municipal deposits and overnight borrowings from the FHLB.

Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $1.2 billion and $986.8 million at March 31, 2013 and December 31, 2012, respectively, were either pledged or sold under agreements to repurchase. Pledged securities represented 78.2% of total securities at March 31, 2013, compared to 68.8% of total securities at December 31, 2012.

Cash and cash equivalents totaled $99.2 million as of March 31, 2013, down from $118.9 million at December 31, 2012. Short-term investments, consisting of securities due in one year or less, increased from $53.1 million at December 31, 2012, to $155.0 million on March 31, 2013. The Company also had $15.6 million of securities designated as trading securities at March 31, 2013.

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 $834.8 million at March 31, 2013 compared with $712.4 million at December 31, 2012. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $944.2 million at March 31, 2013 as compared to $796.7 million at December 31, 2012. 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, 2013, the unused borrowing capacity on established lines with the FHLB was $1.1 billion. As members of the FHLB, the Company’s subsidiary banks can use certain unencumbered mortgage-related assets to secure additional borrowings from the FHLB. At March 31, 2013, total unencumbered residential mortgage loans of the Company were $532.5 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.

The Company continues to evaluate the potential impact on liquidity management of regulatory proposals, including Basel III and those required under the Dodd-Frank Act, as they continue to progress through the final rule-making process.

## Market risk

As filed, 4,769 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, 2013 a 200 basis point parallel upward change in interest rates over a one-year time frame would result in a one-year increase in net interest income from the base case of approximately 0.74%, while a 100 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 0.02%. The simulation assumes no balance sheet growth and no management action to address balance sheet mismatches.

In a rising rate environment (ex. Up 200 basis points over 12 months), net interest income is projected to remain slightly above the base case scenario for the first year of the simulation. As market rates begin to stabilize, funding cost increases begin to slow while higher replacement yields on loan and investment cashflows/repricings lead to a stabilization of net interest income in year 2 and a subsequent expansion in balance sheet spread thereafter.

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. *Table 10-Interest Rate Risk Analysis* below is a Condensed Static Gap Report, which illustrates the anticipated repricing intervals of assets and liabilities as of March 31, 2013. The Company’s one-year net interest rate gap was a negative $60.4 million or 1.21% of total assets at March 31, 2013 compared with a negative $72.4 million or 1.50% of total assets at December 31, 2012. 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, 2013 | Total | 0-3 months | Repricing Interval 3-6 months | 6-12 months | Cumulative 12 months |
| --- | ---: | ---: | ---: | ---: | ---: |
| Interest-earning assets1 | $4,543,340 | $1,143,006 | $208,614 | $328,998 | $1,680,618 |
| Interest-bearing liabilities | 3,695,012 | 1,288,304 | 215,894 | 236,843 | 1,741,041 |
| Net gap position |  | (145,298) | (7,280) | 92,155 | (60,423) |
| Net gap position as a percentage of total assets |  | (2.91%) | (0.15%) | 1.85% | (1.21%) |

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

## Controls and procedures

As filed, 967 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 (the “Exchange Act”)) as of March 31, 2013. 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, 2013, 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, 2012.

Filed May 10, 2013.
Source: SEC EDGAR, the filing index for accession 0001387131-13-001690. Last ingested by Listed: Oct 31, 2026, 15:15 ET. No prices; not investment advice.