UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10‑Q
 
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2014.
 
OR
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________.
 
COMMISSION FILE NUMBER 0-14703
 
NBT BANCORP INC.
(Exact Name of Registrant as Specified in its Charter)
 
DELAWARE
 
16-1268674
(State of Incorporation)
 
(I.R.S. Employer Identification No.)

52 SOUTH BROAD STREET, NORWICH, NEW YORK 13815
(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (607) 337-2265

None
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

As of July 31, 2014, there were 43,704,282 shares outstanding of the Registrant's common stock, $0.01 par value per share.
 


NBT BANCORP INC.
FORM 10-Q--Quarter Ended June 30, 2014
 
TABLE OF CONTENTS
 
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1
Financial Statements
 
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
7
 
 
 
 
9
 
 
 
Item 2
42
 
 
 
Item 3
60
 
 
 
Item 4
60
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1
61
Item 1A
61
Item 2
61
Item 3
61
Item 4
61
Item 5
61
Item 6
62
 
 
 
63
 
 
 
64
2

PART I FINANCIAL INFORMATION

Item 1 – FINANCIAL STATEMENTS
 
NBT Bancorp Inc. and Subsidiaries
Consolidated Balance Sheets (unaudited)
 
 
June 30,
   
December 31,
 
(In thousands, except share and per share data)
 
2014
   
2013
 
Assets
 
   
 
Cash and due from banks
 
$
178,539
   
$
157,625
 
Short-term interest bearing accounts
   
4,798
     
1,301
 
Securities available for sale, at fair value
   
1,378,799
     
1,364,881
 
Securities held to maturity (fair value $123,376 and $113,276, respectively)
   
125,965
     
117,283
 
Trading securities
   
7,355
     
5,779
 
Federal Reserve and Federal Home Loan Bank stock
   
49,093
     
46,864
 
Loans
   
5,574,488
     
5,406,795
 
Less allowance for loan losses
   
69,534
     
69,434
 
Net loans
   
5,504,954
     
5,337,361
 
Premises and equipment, net
   
87,972
     
88,327
 
Goodwill
   
263,634
     
264,997
 
Intangible assets, net
   
22,819
     
25,557
 
Bank owned life insurance
   
116,007
     
114,966
 
Other assets
   
129,577
     
127,234
 
Total assets
 
$
7,869,512
   
$
7,652,175
 
Liabilities
               
Demand (noninterest bearing)
 
$
1,676,246
   
$
1,645,641
 
Savings, NOW, and money market
   
3,363,911
     
3,223,441
 
Time
   
1,002,431
     
1,021,142
 
Total deposits
   
6,042,588
     
5,890,224
 
Short-term borrowings
   
534,478
     
456,042
 
Long-term debt
   
251,125
     
308,823
 
Junior subordinated debt
   
101,196
     
101,196
 
Other liabilities
   
82,984
     
79,321
 
Total liabilities
   
7,012,371
     
6,835,606
 
Stockholders’ equity
               
Preferred stock, $0.01 par value. Authorized 2,500,000 shares at June 30, 2014 and December 31, 2013
   
-
     
-
 
Common stock, $0.01 par value. Authorized 100,000,000 shares at June 30, 2014 and December 31, 2013; issued 49,651,494 at June 30, 2014 and December 31, 2013
   
497
     
497
 
Additional paid-in-capital
   
574,002
     
574,152
 
Retained earnings
   
413,011
     
385,787
 
Accumulated other comprehensive loss
   
(6,555
)
   
(16,765
)
Common stock in treasury, at cost, 5,952,696 and 6,138,444 shares at June 30, 2014 and December 31, 2013, respectively
   
(123,814
)
   
(127,102
)
Total stockholders’ equity
   
857,141
     
816,569
 
Total liabilities and stockholders’ equity
 
$
7,869,512
   
$
7,652,175
 
 
See accompanying notes to unaudited interim consolidated financial statements.

3

NBT Bancorp Inc. and Subsidiaries
 
Three months ended June 30,
   
Six months ended June 30,
 
Consolidated Statements of Income (unaudited)
 
2014
   
2013
   
2014
   
2013
 
(In thousands, except per share data)
 
   
   
   
 
Interest, fee, and dividend income
 
   
   
   
 
Interest and fees on loans
 
$
60,559
   
$
62,031
   
$
120,574
   
$
115,726
 
Securities available for sale
   
6,612
     
6,537
     
13,369
     
12,283
 
Securities held to maturity
   
783
     
548
     
1,551
     
1,073
 
Other
   
502
     
488
     
1,039
     
891
 
Total interest, fee, and dividend income
   
68,456
     
69,604
     
136,533
     
129,973
 
Interest expense
                               
Deposits
   
3,000
     
4,296
     
6,284
     
8,446
 
Short-term borrowings
   
209
     
67
     
440
     
109
 
Long-term debt
   
2,135
     
3,026
     
4,642
     
6,635
 
Junior subordinated debt
   
538
     
560
     
1,076
     
988
 
Total interest expense
   
5,882
     
7,949
     
12,442
     
16,178
 
Net interest income
   
62,574
     
61,655
     
124,091
     
113,795
 
Provision for loan losses
   
4,166
     
6,402
     
7,762
     
12,060
 
Net interest income after provision for loan losses
   
58,408
     
55,253
     
116,329
     
101,735
 
Noninterest income
                               
Insurance and other financial services revenue
   
5,594
     
5,755
     
12,331
     
12,648
 
Service charges on deposit accounts
   
4,397
     
4,933
     
8,766
     
9,256
 
ATM and debit card fees
   
4,357
     
4,044
     
8,429
     
7,286
 
Retirement plan administration fees
   
2,977
     
2,957
     
5,895
     
5,639
 
Trust
   
4,953
     
4,699
     
9,399
     
7,612
 
Bank owned life insurance
   
978
     
886
     
2,360
     
1,735
 
Net securities gains (losses)
   
14
     
(61
)
   
21
     
1,084
 
Gain on the sale of equity investment
   
19,401
     
-
     
19,401
     
-
 
Other
   
3,356
     
2,324
     
5,702
     
5,506
 
Total noninterest income
   
46,027
     
25,537
     
72,304
     
50,766
 
Noninterest expense
                               
Salaries and employee benefits
   
31,142
     
29,160
     
60,676
     
56,207
 
Occupancy
   
5,435
     
5,219
     
11,661
     
10,196
 
Data processing and communications
   
4,015
     
3,854
     
8,016
     
7,309
 
Professional fees and outside services
   
3,752
     
3,237
     
7,167
     
6,138
 
Equipment
   
3,132
     
2,910
     
6,248
     
5,492
 
Office supplies and postage
   
1,803
     
1,656
     
3,488
     
3,246
 
FDIC expenses
   
1,229
     
1,273
     
2,507
     
2,403
 
Advertising
   
726
     
1,000
     
1,465
     
1,723
 
Amortization of intangible assets
   
1,236
     
1,351
     
2,546
     
2,202
 
Loan collection and other real estate owned
   
801
     
421
     
1,841
     
1,139
 
Merger expenses
   
-
     
1,269
     
-
     
11,950
 
Prepayment penalties on long-term debt
   
4,554
     
-
     
4,554
     
-
 
Other
   
4,911
     
5,100
     
10,084
     
9,150
 
Total noninterest expense
   
62,736
     
56,450
     
120,253
     
117,155
 
Income before income tax expense
   
41,699
     
24,340
     
68,380
     
35,346
 
Income tax expense
   
14,059
     
7,424
     
22,731
     
10,781
 
Net income
 
$
27,640
   
$
16,916
   
$
45,649
   
$
24,565
 
Earnings per share
                               
Basic
 
$
0.63
   
$
0.39
   
$
1.04
   
$
0.61
 
Diluted
 
$
0.62
   
$
0.38
   
$
1.03
   
$
0.61
 
 
See accompanying notes to unaudited interim consolidated financial statements.
4

NBT Bancorp Inc. and Subsidiaries
 
Three months ended June 30,
   
Six months ended June 30,
 
Consolidated Statements of Comprehensive Income (unaudited)
 
2014
   
2013
   
2014
   
2013
 
(In thousands)
 
 
   
 
   
 
   
 
 
Net income
 
$
27,640
   
$
16,916
   
$
45,649
   
$
24,565
 
Other comprehensive income (loss), net of tax
                               
Unrealized net holding gains (losses) arising during the period (pre-tax amounts of $8,267, ($24,712), $16,892 and ($26,464))
   
4,992
     
(14,923
)
   
10,200
     
(15,978
)
Reclassification adjustment for net gains related to securities available for sale included in net income (pre-tax amounts of $14, ($61), $21 and $1,084)
   
(8
)
   
37
     
(13
)
   
(650
)
Pension and other benefits:
                               
Amortization of prior service cost and actuarial gains (pre-tax amounts of $19, $710, $38 and $1,536)
   
11
     
426
     
23
     
922
 
Total other comprehensive income (loss)
   
4,995
     
(14,460
)
   
10,210
     
(15,706
)
Comprehensive income
 
$
32,635
   
$
2,456
   
$
55,859
   
$
8,859
 

See accompanying notes to unaudited interim consolidated financial statements
5

NBT Bancorp Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity (unaudited)
 
 
   
   
   
Accumulated
   
   
 
 
 
   
Additional
   
   
Other
   
Common
   
 
 
 
Common
   
Paid-in-
   
Retained
   
Comprehensive
   
Stock
   
 
 
 
Stock
   
Capital
   
Earnings
   
Income (Loss)
   
in Treasury
   
Total
 
(in thousands, except share and per share data)
 
   
   
   
   
   
 
Balance at December 31, 2012
 
$
393
   
$
346,692
   
$
357,558
   
(5,880
)
 
(116,490
)
 
$
582,273
 
Net income
   
-
     
-
     
24,565
     
-
     
-
     
24,565
 
Cash dividends - $0.40 per share
   
-
     
-
     
(15,568
)
   
-
     
-
     
(15,568
)
Purchase of 267,425 treasury shares
   
-
     
-
     
-
     
-
     
(5,460
)
   
(5,460
)
Issuance of 10,346,363 shares, net of 408,957treasury shares, for acquisition
   
104
     
225,447
     
-
     
-
     
(5,779
)
   
219,772
 
Net issuance of 89,338 shares to employee benefit plans and other stock plans, including tax benefit
   
-
     
(2,506
)
   
-
     
-
     
1,479
     
(1,027
)
Stock-based compensation
   
-
     
2,726
     
-
     
-
     
-
     
2,726
 
Other comprehensive loss
   
-
     
-
     
-
     
(15,706
)
   
-
     
(15,706
)
Balance at June 30, 2013
 
$
497
   
$
572,359
   
$
366,555
   
(21,586
)
 
(126,250
)
 
$
791,575
 
 
                                               
Balance at December 31, 2013
 
$
497
   
$
574,152
   
$
385,787
   
(16,765
)
 
(127,102
)
 
$
816,569
 
Net income
   
-
     
-
     
45,649
     
-
     
-
     
45,649
 
Cash dividends - $0.42 per share
   
-
     
-
     
(18,425
)
   
-
     
-
     
(18,425
)
Purchase of 3,288 treasury shares
   
-
     
-
     
-
     
-
     
(72
)
   
(72
)
Net issuance of 189,036 shares to employee benefit plans and other stock plans, including tax benefit
   
-
     
(2,232
)
   
-
     
-
     
3,360
     
1,128
 
Stock-based compensation
   
-
     
2,082
     
-
     
-
     
-
     
2,082
 
Other comprehensive income
   
-
     
-
     
-
     
10,210
     
-
     
10,210
 
Balance at  June 30, 2014
 
$
497
   
$
574,002
   
$
413,011
   
(6,555
)
 
(123,814
)
 
$
857,141
 

See accompanying notes to unaudited interim consolidated financial statements.
6

NBT Bancorp Inc. and Subsidiaries
 
Six Months Ended June 30,
 
Consolidated Statements of Cash Flows (unaudited)
 
2014
   
2013
 
(In thousands, except per share data)
 
   
 
Operating activities
 
   
 
Net income
 
$
45,649
   
$
24,565
 
Adjustments to reconcile net income to net cash provided by operating activities
               
Provision for loan losses
   
7,762
     
12,060
 
Depreciation and amortization of premises and equipment
   
4,105
     
3,828
 
Net accretion on securities
   
1,883
     
2,811
 
Amortization of intangible assets
   
2,546
     
2,202
 
Stock based compensation
   
2,082
     
2,726
 
Increase in surrender value of bank owned life insurance
   
(1,392
)
   
(1,735
)
Purchases of trading securities
   
(1,485
)
   
(949
)
Unrealized (gains) losses in trading securities
   
(91
)
   
(225
)
Deferred income tax benefit
   
(1,654
)
   
(519
)
Proceeds from sales of loans held for sale
   
1,922
     
39,060
 
Originations and purchases of loans held for sale
   
(3,701
)
   
(40,233
)
Net gains on sales of loans held for sale
   
(3
)
   
(817
)
Net security gains
   
(21
)
   
(1,084
)
Net gain on sales of other real estate owned
   
(212
)
   
(571
)
Gains on bank owned life insurance settlement
   
(414
)
   
-
 
Gain on sale of equity investment
   
(19,401
)
   
-
 
Prepayment penalties on long-term debt
   
4,554
     
-
 
Net decrease in other assets
   
9,261
     
9,144
 
Net decrease in other liabilities
   
(8,421
)
   
(8,333
)
Net cash provided by operating activities
   
42,969
     
41,930
 
Investing activities
               
Net cash used in acquisitions
   
-
     
80,909
 
Securities available for sale:
               
Proceeds from maturities, calls, and principal paydowns
   
119,680
     
234,543
 
Proceeds from sales
   
-
     
26,236
 
Purchases
   
(116,594
)
   
(219,000
)
Securities held to maturity:
               
Proceeds from maturities, calls, and principal paydowns
   
14,835
     
16,822
 
Purchases
   
(17,363
)
   
(71,988
)
Proceeds from FHLB stock redemption
   
37,179
     
-
 
Purchases of Federal Reserve and FHLB stock
   
(39,408
)
   
(5,584
)
Net increase in loans
   
(174,358
)
   
(119,872
)
Proceeds from settlement of bank owned life insurance
   
765
     
-
 
Purchases of premises and equipment
   
(3,498
)
   
(2,272
)
Proceeds from sales of other real estate owned
   
1,919
     
2,122
 
Proceeds from the sale of equity investment
   
19,639
     
-
 
Net cash used in investing activities
   
(157,204
)
   
(58,084
)
Financing activities
               
Net increase (decrease) in deposits
   
152,364
     
(19,593
)
Net increase in short-term borrowings
   
78,436
     
201,066
 
Issuance of long-term debt
   
120,000
     
-
 
Repayments of long-term debt
   
(194,785
)
   
(163,307
)
Proceeds from the issuance of shares to employee benefit plans and other stock plans
   
1,128
     
(965
)
Purchase of treasury stock
   
(72
)
   
(5,460
)
Cash dividends and payment for fractional shares
   
(18,425
)
   
(15,568
)
Net cash provided by (used in) financing activities
   
138,646
     
(3,827
)
Net increase (decrease) in cash and cash equivalents
   
24,411
     
(19,981
)
Cash and cash equivalents at beginning of period
   
158,926
     
163,668
 
Cash and cash equivalents at end of period
 
$
183,337
   
$
143,687
 

See accompanying notes to unaudited interim consolidated financial statements.
7

Supplemental disclosure of cash flow information
 
Six Months Ended June 30,
 
Cash paid during the period for:
 
2014
   
2013
 
Interest
 
$
13,405
   
$
16,853
 
Income taxes paid
   
19,496
     
4,525
 
Noncash investing activities:
               
Loans transferred to other real estate owned
 
$
785
   
$
3,031
 
Acquisitions:
               
Fair value of assets acquired
 
$
-
   
$
1,503,810
 
Fair value of liabilities assumed
   
-
     
1,284,038
 

See accompanying notes to unaudited interim consolidated financial statements.
8

NBT BANCORP INC. and Subsidiaries
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014

Note 1. Description of Business

NBT Bancorp Inc. (the “Registrant” or the “Company”) is a registered financial holding company incorporated in the state of Delaware in 1986, with its principal headquarters located in Norwich, New York.  The principal assets of the Registrant consist of all of the outstanding shares of common stock of its subsidiaries, including:  NBT Bank, National Association (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), NBT Holdings, Inc. (“NBT Holdings”), Hathaway Agency, Inc., and CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II (collectively, the “Trusts”).  The Company’s principal sources of revenue are the management fees and dividends it receives from the Bank, NBT Financial and NBT Holdings.
 
The Company’s business, primarily conducted through the Bank but also through its other subsidiaries, consists of providing commercial banking and financial services to customers in its market area, which includes central and upstate New York, northeastern Pennsylvania, southern New Hampshire, western Massachusetts and the greater Burlington, Vermont area.  The Company has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services.  The Company’s business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial, and municipal customers. 

Note 2. Basis of Presentation

The accompanying unaudited interim consolidated financial statements include the accounts of the Registrant and its wholly owned subsidiaries, the Bank, NBT Financial and NBT Holdings.  Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.”  The interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods in accordance with generally accepted accounting principles (“GAAP”).  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2013 Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.  All intercompany transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.  The Company has evaluated subsequent events for potential recognition and/or disclosure and there were none identified.
9

Note 3. Securities

The amortized cost, estimated fair value, and unrealized gains and losses of securities available for sale are as follows:

(In thousands)
 
Amortized
cost
   
Unrealized
gains
   
Unrealized
losses
   
Estimated
fair value
 
June 30, 2014
 
   
   
   
 
U.S. Treasury
 
$
33,129
   
$
195
   
$
-
   
$
33,324
 
Federal Agency
   
310,181
     
478
     
3,518
     
307,141
 
State & municipal
   
103,253
     
2,267
     
172
     
105,348
 
Mortgage-backed:
                               
Government-sponsored enterprises
   
368,988
     
8,473
     
428
     
377,033
 
U.S. government agency securities
   
19,527
     
921
     
94
     
20,354
 
Collateralized mortgage obligations:
                               
Government-sponsored enterprises
   
480,694
     
2,315
     
11,816
     
471,193
 
U.S. government agency securities
   
48,065
     
610
     
59
     
48,616
 
Other securities
   
12,962
     
3,025
     
197
     
15,790
 
Total securities available for sale
 
$
1,376,799
   
$
18,284
   
$
16,284
   
$
1,378,799
 
December 31, 2013
                               
U.S. Treasury
 
$
43,279
   
$
337
   
$
-
   
$
43,616
 
Federal Agency
   
285,880
     
343
     
7,308
     
278,915
 
State & municipal
   
113,435
     
1,842
     
1,612
     
113,665
 
Mortgage-backed:
                               
Government-sponsored enterprises
   
337,666
     
5,788
     
2,131
     
341,323
 
U.S. government agency securities
   
21,924
     
1,002
     
85
     
22,841
 
Collateralized mortgage obligations:
                               
Government-sponsored enterprises
   
521,257
     
1,777
     
18,141
     
504,893
 
U.S. government agency securities
   
43,943
     
794
     
102
     
44,635
 
Other securities
   
12,367
     
2,854
     
228
     
14,993
 
Total securities available for sale
 
$
1,379,751
   
$
14,737
   
$
29,607
   
$
1,364,881
 
 
Other securities primarily represent marketable equity securities.

There were no sales of securities available for sale during the six months ended June 30, 2014.  Proceeds from the sales of securities available for sale were $26.2 million during the six months ended June 30, 2013, and gains on the sales were $1.1 million.
 
Securities with amortized costs totaling $1.4 billion at June 30, 2014 and $1.4 billion at December 31, 2013 were pledged to secure public deposits and for other purposes required or permitted by law.  At June 30, 2014 and December 31, 2013, securities with an amortized cost of $225.9 million and $218.4 million, respectively, were pledged as collateral for securities sold under repurchase agreements.
10

The amortized cost, estimated fair value, and unrealized gains and losses of securities held to maturity are as follows:

 
 
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
(In thousands)
 
cost
   
gains
   
losses
   
fair value
 
June 30, 2014
 
   
   
   
 
Mortgage-backed
 
$
853
   
$
125
   
$
-
   
$
978
 
Collateralized mortgage obligations
   
59,792
     
-
     
3,139
     
56,653
 
State & municipal
   
65,320
     
425
     
-
     
65,745
 
Total securities held to maturity
 
$
125,965
   
$
550
   
$
3,139
   
$
123,376
 
December 31, 2013
                               
Mortgage-backed
 
$
953
   
$
128
   
$
-
   
$
1,081
 
Collateralized mortgage obligations
   
62,025
     
-
     
4,569
     
57,456
 
State & municipal
   
54,305
     
442
     
8
     
54,739
 
Total securities held to maturity
 
$
117,283
   
$
570
   
$
4,577
   
$
113,276
 

11

The following table sets forth information with regard to investment securities with unrealized losses at June 30, 2014 and December 31, 2013:

 
 
Less than 12 months
   
12 months or longer
   
Total
 
Security Type:
 
Fair Value
   
Unrealized
losses
   
Number
of
Positions
   
Fair Value
   
Unrealized
losses
   
Number
of
Positions
   
Fair Value
   
Unrealized
losses
   
Number
of
Positions
 
 
 
   
   
   
   
   
   
   
   
 
June 30, 2014
 
   
   
   
   
   
   
   
   
 
Investment securities available for sale:
 
   
   
   
   
   
   
   
   
 
 
 
   
   
   
   
   
   
   
   
 
Federal agency
 
$
14,584
     
(17
)
   
2
   
$
227,183
   
$
(3,501
)
   
19
   
$
241,767
   
$
(3,518
)
   
21
 
State & municipal
   
8,256
     
(22
)
   
28
     
20,416
     
(150
)
   
70
     
28,672
     
(172
)
   
98
 
Mortgage-backed
   
1,523
     
(6
)
   
12
     
49,695
     
(516
)
   
36
     
51,218
     
(522
)
   
48
 
Collateralized mortgage obligations
   
89,915
     
(542
)
   
12
     
269,579
     
(11,333
)
   
23
     
359,494
     
(11,875
)
   
35
 
Other securities
   
2,553
     
(34
)
   
1
     
3,191
     
(163
)
   
2
     
5,744
     
(197
)
   
3
 
Total securities with unrealized losses
 
$
116,831
   
$
(621
)
   
55
   
$
570,064
   
$
(15,663
)
   
150
   
$
686,895
   
$
(16,284
)
   
205
 
 
                                                                       
June 30, 2014
                                                                       
Investment securities held to maturity:
                                                                       
Collateralized mortgage obligations
   
56,653
     
(3,139
)
   
5
     
-
     
-
     
-
   
$
56,653
     
(3,139
)
   
5
 
 
                                                                       
December 31, 2013
                                                                       
Investment securities available for sale:
                                                                       
Federal agency
 
$
233,935
   
$
(6,927
)
   
20
   
$
9,619
   
$
(381
)
   
1
   
$
243,554
   
$
(7,308
)
   
21
 
State & municipal
   
50,328
     
(1,612
)
   
177
     
-
     
-
     
-
     
50,328
     
(1,612
)
   
177
 
Mortgage-backed
   
143,080
     
(2,216
)
   
79
     
-
     
-
     
-
     
143,080
     
(2,216
)
   
79
 
Collateralized mortgage obligations
   
379,273
     
(18,243
)
   
36
     
-
     
-
     
-
     
379,273
     
(18,243
)
   
36
 
Other securities
   
5,490
     
(203
)
   
2
     
223
     
(25
)
   
1
     
5,713
     
(228
)
   
3
 
Total securities with unrealized losses
 
$
812,106
   
$
(29,201
)
   
314
   
$
9,842
   
$
(406
)
   
2
   
$
821,948
   
$
(29,607
)
   
316
 
 
                                                                       
December 31, 2013
                                                                       
Investment securities held to maturity:
                                                                       
Collateralized mortgage obligations
 
$
57,456
   
$
(4,569
)
   
5
   
$
-
   
$
-
     
-
   
$
57,456
   
$
(4,569
)
   
5
 
State & municipal
   
1,012
     
(8
)
   
1
     
-
     
-
     
-
     
1,012
     
(8
)
   
1
 
Total securities with unrealized losses
 
$
58,468
   
$
(4,577
)
   
6
   
$
-
   
$
-
     
-
   
$
58,468
   
$
(4,577
)
   
6
 

12

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses or in other comprehensive income, depending on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss.  If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  If the Company does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be separated into (a) the amount representing the credit loss and (b) the amount related to all other factors.  The amount of the total other-than-temporary impairment related to the credit loss shall be recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes.

In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the historical and implied volatility of the fair value of the security.

Management has the intent to hold the securities classified as held to maturity until they mature, at which time it is believed the Company will receive full value for the securities. Furthermore, as of June 30, 2014, management also had the intent to hold, and will not be required to sell, the securities classified as available for sale for a period of time sufficient for a recovery of cost, which may be until maturity.  The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. When necessary, the Company has performed a discounted cash flow analysis to determine whether or not it will receive the contractual principal and interest on certain securities.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  As of June 30, 2014, management believes the impairments detailed in the table above are temporary and no other-than-temporary impairment losses have been realized in the Company’s consolidated statements of income.

The following tables set forth information with regard to contractual maturities of debt securities at June 30, 2014:

(In thousands)
 
Amortized
cost
   
Estimated fair
value
 
Debt securities classified as available for sale
 
   
 
Within one year
 
$
29,964
   
$
30,109
 
From one to five years
   
359,226
     
358,895
 
From five to ten years
   
215,602
     
220,020
 
After ten years
   
759,045
     
753,985
 
 
 
$
1,363,837
   
$
1,363,009
 
Debt securities classified as held to maturity
               
Within one year
 
$
30,983
   
$
31,083
 
From one to five years
   
17,462
     
17,651
 
From five to ten years
   
15,636
     
15,772
 
After ten years
   
61,884
     
58,870
 
 
 
$
125,965
   
$
123,376
 

Maturities of mortgage-backed, collateralized mortgage obligations and asset-backed securities are stated based on their estimated average lives.  Actual maturities may differ from estimated average lives or contractual maturities because, in certain cases, borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
13

Except for U.S. Government securities, there were no holdings, when taken in the aggregate, of any single issuer that exceeded 10% of consolidated stockholders’ equity at June 30, 2014.

Note  4. Allowance for Loan Losses and Credit Quality of Loans

Allowance for Loan Losses
The allowance for loan losses is maintained at a level estimated by management to provide adequately for risk of probable losses inherent in the current loan portfolio. The adequacy of the allowance for loan losses is continuously monitored.  It is assessed for adequacy using a methodology designed to ensure the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan portfolio.

To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into three segments, each with different risk characteristics and methodologies for assessing risk.  Those segments are further segregated between our loans accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired in a business combination (referred to as “acquired” loans).  Each portfolio segment is broken down into class segments where appropriate.  Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses.  Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class segment.  The following table illustrates the portfolio and class segments for the Company’s loan portfolio:
 
Portfolio
Class
Commercial Loans
Commercial
 
Commercial Real Estate
 
Agricultural
 
Agricultural Real Estate
 
Business Banking
 
 
Consumer Loans
Indirect
 
Home Equity
 
Direct
 
 
Residential Real Estate Mortgages
 

Commercial Loans

The Company offers a variety of commercial loan products including commercial (non-real estate), commercial real estate, agricultural, agricultural real estate, and business banking loans.  The Company’s underwriting analysis for commercial loans typically includes credit verification, independent appraisals, a review of the borrower’s financial condition, and a detailed analysis of the borrower’s underlying cash flows.

CommercialThe Company offers a variety of loan options to meet the specific needs of our commercial customers including term loans, time notes and lines of credit.  Such loans are made available to businesses for working capital needs such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets owned by the borrower.  These loans carry a higher risk than commercial real estate loans due to the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable. To reduce the risk, management also attempts to secure real estate as collateral and obtain personal guarantees of the borrowers.
14

Commercial Real Estate – The Company offers commercial real estate loans to finance real estate purchases, refinancings, expansions and improvements to commercial properties.  Commercial real estate loans are made to finance the purchases of real estate, generally with completed structures. These commercial real estate loans are secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and other non owner-occupied facilities.  These loans are typically less risky than commercial loans, since they are secured by real estate and buildings, and are generally originated in amounts of no more than 80% of the appraised value of the property.

Agricultural – The Company offers a variety of agricultural loans to meet the needs of our agricultural customers including term loans, time notes, and lines of credit.  These loans are made to purchase livestock, purchase and modernize equipment, and finance seasonal crop expenses.  Generally, a collateral lien is placed on the livestock, equipment, produce inventories, and/or receivables owned by the borrower.  These loans may carry a higher risk than commercial and agricultural real estate loans due to the industry price volatility, and in some cases, the perishable nature of the underlying collateral.  To reduce these risks, management may attempt to secure these loans with additional real estate collateral, obtain personal guarantees of the borrowers, or obtain government loan guarantees to provide further support.

Agricultural Real Estate – The Company offers real estate loans to our agricultural customers to finance farm related real estate purchases, refinancings, expansions, and improvements to agricultural properties such as barns, production facilities, and land.  The agricultural real estate loans are secured by first liens on the farm real estate.  Because they are secured by land and buildings, these loans may be less risky than agricultural loans.  These loans are typically originated in amounts of no more than 75% of the appraised value of the property.  Government loan guarantees may be obtained to provide further support.

Business Banking - The Company offers a variety of loan options to meet the specific needs of our business banking customers including term loans, business banking mortgages and lines of credit.  Such loans are generally less than $0.5 million and are made available to businesses for working capital such as inventory and receivables, business expansion, equipment purchases, and agricultural needs.  Generally, a collateral lien is placed on equipment or other assets owned by the borrower such as inventory and/or receivables.  These loans carry a higher risk than commercial loans due to the smaller size of the borrower and lower levels of capital.  To reduce the risk, the Company obtains personal guarantees of the owners for a majority of the loans.

Consumer Loans

The Company offers a variety of consumer loan products including indirect, home equity, and direct loans.

Indirect – The Company maintains relationships with many dealers primarily in the communities that we serve.  Through these relationships, the company primarily finances the purchases of automobiles and recreational vehicles (such as campers, boats, etc.) indirectly through dealer relationships.  Approximately 75% of the indirect relationships represent automobile financing.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from three to six years, based upon the nature of the collateral and the size of the loan. The majority of indirect consumer loans are underwritten on a secured basis using the underlying collateral being financed.

Home Equity The Company offers fixed home equity loans as well as home equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses.  Consumers are able to borrow up to 85% of the equity in their homes.  The Company originates home equity lines of credit and second mortgage loans (loans secured by a second junior lien position on one-to-four-family residential real estate).  These loans carry a higher risk than first mortgage residential loans as they are in a second position with respect to collateral.  Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.
15

Direct – The Company offers a variety of consumer installment loans to finance vehicle purchases, mobile home purchases and personal expenditures.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to ten years, based upon the nature of the collateral and the size of the loan. The majority of consumer loans are underwritten on a secured basis using the underlying collateral being financed or a customer's deposit account. In addition to installment loans, the Company also offers personal lines of credit and overdraft protection.  A minimal amount of loans are unsecured, which carry a higher risk of loss.

Residential Real Estate Mortgages
Residential real estate loans consist primarily of loans secured by first or second deeds of trust on primary residences.  We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage.  These loans are collateralized by owner-occupied properties located in the Company’s market area.  Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 85% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance.  The Company’s underwriting analysis for residential mortgage loans typically includes credit verification, independent appraisals, and a review of the borrower’s financial condition.  Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period.

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectability of the portfolio.  For individually analyzed loans, these include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans, estimates of the Company’s exposure to credit loss reflect a current assessment of a number of factors, which could affect collectability.  These factors include:  past loss experience;  size, trend, composition, and nature of loans;  changes in lending policies and procedures, including underwriting standards and collection,  charge-offs  and  recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market;  portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff. In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to make loan grade changes as well as recognize additions to the allowance based on their examinations.

After a thorough consideration of the factors discussed above, any required additions or reductions to the allowance for loan losses are made periodically by charges or credits to the provision for loan losses. These charges or credits are necessary to maintain the allowance at a level which management believes is reasonably reflective of overall inherent risk of probable loss in the portfolio. While management uses available information to recognize losses on loans, additions and reductions of the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.
16

The following tables illustrate the changes in the allowance for loan losses by our portfolio segments for the three and six months ended June 30, 2014 and 2013:

 
 
   
   
Residential
   
   
 
Three months ended June 30
 
Commercial
   
Consumer
   
Real Estate
   
   
 
 
 
Loans
   
Loans
   
Mortgages
   
Unallocated
   
Total
 
Balance as of March 31, 2014
 
$
34,437
   
$
28,436
   
$
6,225
   
$
336
   
$
69,434
 
Charge-offs
   
(1,427
)
   
(3,648
)
   
(165
)
   
-
     
(5,240
)
Recoveries
   
314
     
714
     
146
     
-
     
1,174
 
Provision
   
1,799
     
2,471
     
(1
)
   
(103
)
   
4,166
 
Ending Balance as of June 30, 2014
 
$
35,123
   
$
27,973
   
$
6,205
   
$
233
   
$
69,534
 
 
                                       
Balance as of March 31, 2013
 
$
35,358
   
$
26,285
   
$
6,708
   
$
383
   
$
68,734
 
Charge-offs
   
(1,198
)
   
(3,653
)
   
(302
)
   
-
     
(5,153
)
Recoveries
   
416
     
696
     
89
     
-
     
1,201
 
Provision
   
3,128
     
3,128
     
311
     
(165
)
   
6,402
 
Ending Balance as of June 30, 2013
 
$
37,704
   
$
26,456
   
$
6,806
   
$
218
   
$
71,184
 

 
 
   
   
Residential
   
   
 
Six months ended June 30,
 
Commercial
   
Consumer
   
Real Estate
   
   
 
 
 
Loans
   
Loans
   
Mortgages
   
Unallocated
   
Total
 
Balance as of December 31, 2013
 
$
35,090
   
$
27,694
   
$
6,520
   
$
130
   
$
69,434
 
Charge-offs
   
(1,906
)
   
(7,680
)
   
(484
)
   
-
     
(10,070
)
Recoveries
   
713
     
1,455
     
240
     
-
     
2,408
 
Provision
   
1,226
     
6,504
     
(71
)
   
103
     
7,762
 
Ending Balance as of June 30, 2014
 
$
35,123
   
$
27,973
   
$
6,205
   
$
233
   
$
69,534
 
 
                                       
Balance as of December 31, 2012
 
$
35,624
   
$
27,162
   
$
6,252
   
$
296
   
$
69,334
 
Charge-offs
   
(4,520
)
   
(7,376
)
   
(973
)
   
-
     
(12,869
)
Recoveries
   
883
     
1,673
     
103
     
-
     
2,659
 
Provision
   
5,717
     
4,997
     
1,424
     
(78
)
   
12,060
 
Ending Balance as of June 30, 2013
 
$
37,704
   
$
26,456
   
$
6,806
   
$
218
   
$
71,184
 

For acquired loans, to the extent that we experience deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to 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.  As of June 30, 2014, included in the above tables, there was $1.5 million in the allowance for loan losses related to an acquired commercial loan.  There was no allowance as of June 30, 2013 related to acquired loans.  Net charge-offs related to acquired loans totaled approximately $0.1 million and $0.2 million during the three months ended June 30, 2014 and 2013, respectively, and are included in the table above.  Net charge-offs related to acquired loans totaled approximately $0.2 million and $0.4 million during the six months ended June 30, 2014 and 2013, respectively, and are included in the table above.

17

The following tables illustrate the allowance for loan losses and the recorded investment by portfolio segments as of June 30, 2014 and December 31, 2013:
 
Allowance for Loan Losses and Recorded Investment in Loans
(in thousands)
 
 
 
   
   
Residential
   
   
 
 
 
Commercial
   
Consumer
   
Real Estate
   
   
 
 
 
Loans
   
Loans
   
Mortgages
   
Unallocated
   
Total
 
As of June 30, 2014
 
   
   
   
   
 
Allowance for loan losses
 
$
35,123
   
$
27,973
   
$
6,205
   
$
233
   
$
69,534
 
 
                                       
Allowance for loans individually evaluated for impairment
   
2,100
     
-
     
-
             
2,100
 
 
                                       
Allowance for loans collectively evaluated for impairment
 
$
33,023
   
$
27,973
   
$
6,205
   
$
233
   
$
67,434
 
 
                                       
Ending balance of loans
 
$
2,476,246
   
$
2,025,035
   
$
1,073,207
           
$
5,574,488
 
 
                                       
Ending balance of originated loans individually evaluated for impairment
   
13,874
     
5,600
     
2,738
             
22,212
 
Ending balance of acquired loans individually evaluated for impairment
   
9,672
     
-
     
-
             
9,672
 
Ending balance of acquired loans collectively evaluated for impairment
   
367,818
     
179,253
     
289,405
             
836,476
 
Ending balance of originated loans collectively evaluated for impairment
 
$
2,084,882
   
$
1,840,182
   
$
781,064
           
$
4,706,128
 
 
                                       
As of December 31, 2013
                                       
Allowance for loan losses
 
$
35,090
   
$
27,694
   
$
6,520
   
$
130
   
$
69,434
 
 
                                       
Allowance for loans individually evaluated for impairment
   
715
     
-
     
-
             
715
 
 
                                       
Allowance for loans collectively evaluated for impairment
 
$
34,375
   
$
27,694
   
$
6,520
   
$
130
   
$
68,719
 
 
                                       
Ending balance of loans
 
$
2,392,621
   
$
1,972,537
   
$
1,041,637
           
$
5,406,795
 
 
                                       
Ending balance of originated loans individually evaluated for impairment
   
16,120
     
3,248
     
2,012
             
21,380
 
Ending balance of acquired loans individually evaluated for impairment
   
10,060
     
-
     
-
             
10,060
 
Ending balance of acquired loans collectively evaluated for impairment
   
392,329
     
219,587
     
308,416
             
920,332
 
Ending balance of originated loans collectively evaluated for impairment
 
$
1,974,112
   
$
1,749,702
   
$
731,209
           
$
4,455,023
 

18

Credit Quality of Loans
Loans are placed on nonaccrual status when timely collection of principal and interest in accordance with contractual terms is doubtful. Loans are transferred to nonaccrual status generally when principal or interest payments become ninety days delinquent, unless the loan is well secured and in the process of collection, or sooner when management concludes or circumstances indicate that borrowers may be unable to meet contractual principal or interest payments.  When a loan is transferred to a nonaccrual status, all interest previously accrued in the current period but not collected is reversed against interest income in that period. Interest accrued in a prior period and not collected is charged-off against the allowance for loan losses.  The Company’s nonaccrual policies are the same for all classes of financing receivable.

If ultimate repayment of a nonaccrual loan is expected, any payments received are applied in accordance with contractual terms. If ultimate repayment of principal is not expected, any payment received on a nonaccrual loan is applied to principal until ultimate repayment becomes expected.  Nonaccrual loans are returned to accrual status when they become current as to principal and interest and demonstrate a period of performance under the contractual terms and, in the opinion of management, are fully collectible as to principal and interest.  When in the opinion of management the collection of principal appears unlikely, the loan balance is charged-off in total or in part.  For loans in all portfolios, the principal amount is charged off in full or in part as soon as management determines, based on available facts, that the collection of principal in full is improbable.  For commercial loans, management considers specific facts and circumstances relative to individual credits in making such a determination.  For consumer and residential loan classes, management uses specific guidance and thresholds from the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy.
19

The following table illustrates the Company’s nonaccrual loans by loan class:

Loans on Nonaccrual Status as of:
 
(In thousands)
 
June 30, 2014
   
December 31, 2013
 
ORIGINATED
 
   
 
Commercial Loans
 
   
 
Commercial
 
$
3,885
   
$
3,669
 
Commercial Real Estate
   
6,616
     
7,834
 
Agricultural
   
1,343
     
1,135
 
Agricultural Real Estate
   
1,590
     
961
 
Business Banking
   
6,008
     
5,701
 
 
   
19,442
     
19,300
 
 
               
Consumer Loans
               
Indirect
   
1,359
     
1,461
 
Home Equity
   
7,772
     
5,931
 
Direct
   
67
     
86
 
 
   
9,198
     
7,478
 
 
               
Residential Real Estate Mortgages
   
7,711
     
7,105
 
 
               
 
 
$
36,351
   
$
33,883
 
 
               
ACQUIRED
               
Commercial Loans
               
Commercial
 
$
6,339
   
$
6,599
 
Commercial Real Estate
   
3,429
     
3,559
 
Business Banking
   
954
     
1,340
 
 
   
10,722
     
11,498
 
 
               
Consumer Loans
               
Indirect
   
118
     
93
 
Home Equity
   
514
     
570
 
Direct
   
31
     
49
 
 
   
663
     
712
 
 
               
Residential Real Estate Mortgages
   
3,498
     
3,872
 
 
               
 
 
$
14,883
   
$
16,082
 
 
               
TOTAL NONACCRUAL LOANS
 
$
51,234
   
$
49,965
 
20

The following tables set forth information with regard to past due and nonperforming loans by loan class as of June 30, 2014 and December 31, 2013:

Age Analysis of Past Due Financing Receivables
As of June 30, 2014
(in thousands)
 
 
 
   
   
Greater Than
   
   
   
   
 
 
 
31-60 Days
   
61-90 Days
   
90 Days
   
Total
   
   
   
Recorded
 
 
 
Past Due
   
Past Due
   
Past Due
   
Past Due
   
   
   
Total
 
 
 
Accruing
   
Accruing
   
Accruing
   
Accruing
   
Non-Accrual
   
Current
   
Loans
 
ORIGINATED
 
   
   
   
   
   
   
 
Commercial Loans
 
   
   
   
   
   
   
 
Commercial
 
$
53
   
$
-
   
$
-
   
$
53
   
$
3,885
   
$
653,268
   
$
657,206
 
Commercial Real Estate
   
-
     
-
     
-
     
-
     
6,616
     
994,773
     
1,001,389
 
Agricultural
   
170
     
-
     
-
     
170
     
1,343
     
55,572
     
57,085
 
Agricultural Real Estate
   
4
     
-
     
-
     
4
     
1,590
     
40,768
     
42,362
 
Business Banking
   
869
     
451
     
-
     
1,320
     
6,008
     
333,386
     
340,714
 
 
   
1,096
     
451
     
-
     
1,547
     
19,442
     
2,077,767
     
2,098,756
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
12,444
     
2,015
     
1,100
     
15,559
     
1,359
     
1,265,140
     
1,282,058
 
Home Equity
   
4,470
     
995
     
839
     
6,304
     
7,772
     
494,123
     
508,199
 
Direct
   
529
     
138
     
27
     
694
     
67
     
54,764
     
55,525
 
 
   
17,443
     
3,148
     
1,966
     
22,557
     
9,198
     
1,814,027
     
1,845,782
 
Residential Real Estate Mortgages
   
3,082
     
594
     
119
     
3,795
     
7,711
     
772,296
     
783,802
 
 
 
$
21,621
   
$
4,193
   
$
2,085
   
$
27,899
   
$
36,351
   
$
4,664,090
   
$
4,728,340
 
 
                                                       
ACQUIRED
                                                       
Commercial Loans
                                                       
Commercial
 
$
14
   
$
-
   
$
-
   
$
14
   
$
6,339
     
92,335
   
$
98,688
 
Commercial Real Estate
   
582
     
-
     
-
     
582
     
3,429
     
210,204
     
214,215
 
Business Banking
   
441
     
-
     
-
     
441
     
954
     
63,192
     
64,587
 
 
   
1,037
     
-
     
-
     
1,037
     
10,722
     
365,731
     
377,490
 
Consumer Loans
                                                       
Indirect
   
481
     
114
     
54
     
649
     
118
     
91,212
     
91,979
 
Home Equity
   
370
     
204
     
36
     
610
     
514
     
80,068
     
81,192
 
Direct
   
73
     
6
     
11
     
90
     
31
     
5,961
     
6,082
 
 
   
924
     
324
     
101
     
1,349
     
663
     
177,241
     
179,253
 
Residential Real Estate Mortgages
   
1,317
     
-
     
-
     
1,317
     
3,498
     
284,590
     
289,405
 
 
 
$
3,278
   
$
324
   
$
101
   
$
3,703
   
$
14,883
   
$
827,562
   
$
846,148
 
Total Loans
 
$
24,899
   
$
4,517
   
$
2,186
   
$
31,602
   
$
51,234
   
$
5,491,652
   
$
5,574,488
 

21

Age Analysis of Past Due Financing Receivables
As of December 31, 2013
(in thousands)
 
 
 
   
   
Greater Than
   
   
   
   
 
 
 
31-60 Days
   
61-90 Days
   
90 Days
   
Total
   
   
   
Recorded
 
 
 
Past Due
   
Past Due
   
Past Due
   
Past Due
   
   
   
Total
 
 
 
Accruing
   
Accruing
   
Accruing
   
Accruing
   
Non-Accrual
   
Current
   
Loans
 
ORIGINATED
 
   
   
   
   
   
   
 
Commercial Loans
 
   
   
   
   
   
   
 
Commercial
 
$
105
   
$
247
   
$
-
   
$
352
   
$
3,669
   
$
612,402
   
$
616,423
 
Commercial Real Estate
   
1,366
     
-
     
-
     
1,366
     
7,834
     
925,116
     
934,316
 
Agricultural
   
150
     
21
     
-
     
171
     
1,135
     
63,856
     
65,162
 
Agricultural Real Estate
   
519
     
-
     
-
     
519
     
961
     
35,172
     
36,652
 
Business Banking
   
1,228
     
122
     
105
     
1,455
     
5,701
     
330,523
     
337,679
 
 
   
3,368
     
390
     
105
     
3,863
     
19,300
     
1,967,069
     
1,990,232
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
14,093
     
2,878
     
1,583
     
18,554
     
1,461
     
1,141,829
     
1,161,844
 
Home Equity
   
6,033
     
1,888
     
1,115
     
9,036
     
5,931
     
517,856
     
532,823
 
Direct
   
679
     
125
     
46
     
850
     
86
     
57,347
     
58,283
 
 
   
20,805
     
4,891
     
2,744
     
28,440
     
7,478
     
1,717,032
     
1,752,950
 
Residential Real Estate Mortgages
   
3,951
     
379
     
808
     
5,138
     
7,105
     
720,978
     
733,221
 
 
 
$
28,124
   
$
5,660
   
$
3,657
   
$
37,441
   
$
33,883
   
$
4,405,079
   
$
4,476,403
 
 
ACQUIRED
                                                       
Commercial Loans
                                                       
Commercial
 
$
24
   
$
-
   
$
-
   
$
24
   
$
6,599
   
$
96,603
   
$
103,226
 
Commercial Real Estate
   
-
     
-
     
-
     
-
     
3,559
     
225,455
     
229,014
 
Business Banking
   
320
     
2
     
-
     
322
     
1,340
     
68,487
     
70,149
 
 
   
344
     
2
     
-
     
346
     
11,498
     
390,545
     
402,389
 
 
                                                       
Consumer Loans
                                                       
Indirect
   
939
     
113
     
71
     
1,123
     
93
     
123,870
     
125,086
 
Home Equity
   
753
     
63
     
-
     
816
     
570
     
85,690
     
87,076
 
Direct
   
76
     
56
     
9
     
141
     
49
     
7,235
     
7,425
 
 
   
1,768
     
232
     
80
     
2,080
     
712
     
216,795
     
219,587
 
Residential Real Estate Mortgages
   
1,725
     
-
     
-
     
1,725
     
3,872
     
302,819
     
308,416
 
 
 
$
3,837
   
$
234
   
$
80
   
$
4,151
   
$
16,082
   
$
910,159
   
$
930,392
 
Total Loans
 
$
31,961
   
$
5,894
   
$
3,737
   
$
41,592
   
$
49,965
   
$
5,315,238
   
$
5,406,795
 

There were no material commitments to extend further credit to borrowers with nonperforming loans.
22

Impaired Loans
The methodology used to establish the allowance for loan losses on impaired loans incorporates specific allocations on loans analyzed individually.  Classified and nonperforming loans with outstanding balances of $0.5 million or more and all troubled debt restructured loans (“TDR”) are evaluated for impairment through the Company’s quarterly status review process.  In determining that we will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreements, we consider factors such as payment history and changes in the financial condition of individual borrowers, local economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated.  For loans that are impaired as defined by accounting standards, impairment is measured by one of three methods: 1) the fair value of collateral less cost to sell, 2) present value of expected future cash flows or 3) the loan’s observable market price.  All impaired loans are reviewed on a quarterly basis for changes in the measurement of impairment.  Any change to the previously recognized impairment loss is recognized as a change to the allowance account and recorded in the consolidated statement of income as a component of the provision for loan losses.
23

The following table provides information on loans specifically evaluated for impairment as of June 30, 2014 and December 31, 2013:
 
 
 
June 30, 2014
   
December 31, 2013
 
 
 
Recorded
   
Unpaid
   
   
Recorded
   
Unpaid
   
 
 
 
Investment
   
Principal
   
   
Investment
   
Principal
   
 
 
 
Balance
   
Balance
   
Related
   
Balance
   
Balance
   
Related
 
(in thousands)
 
(Book)
   
(Legal)
   
Allowance
   
(Book)
   
(Legal)
   
Allowance
 
ORIGINATED
 
   
   
   
   
   
 
With no related allowance recorded:
 
   
   
   
   
   
 
Commercial Loans
 
   
   
   
   
   
 
Commercial
 
$
2,000
   
$
2,096
   
   
$
4,721
   
$
4,777
   
 
Commercial Real Estate
   
6,854
     
7,823
   
     
4,613
     
5,164
   
 
Agricultural
   
119
     
189
   
     
125
     
195
   
 
Agricultural Real Estate
   
1,406
     
1,697
   
     
1,431
     
1,708
   
 
Business Banking
   
702
     
1,094
   
     
210
     
602
   
 
Total Commercial Loans
   
11,081
     
12,899
   
     
11,100
     
12,446
   
 
 
                 
                   
 
Consumer Loans
                 
                   
 
Home Equity
   
5,600
     
6,031
   
     
3,248
     
3,472
   
 
 
                 
                   
 
Residential Real Estate Mortgages
   
2,738
     
3,073
   
     
2,012
     
2,255
   
 
Total
   
19,419
     
22,003
   
     
16,360
     
18,173
   
 
 
                 
                   
 
With an allowance recorded:
                 
                   
 
Commercial Loans
                 
                   
 
Commercial Real Estate
   
2,793
     
4,649
     
600
     
5,020
     
6,877
     
715
 
 
                                               
ACQUIRED
                                               
With no related allowance recorded:
                                               
Commercial Loans
                                               
Commercial
   
-
     
-
             
6,501
     
6,538
         
Commercial Real Estate
   
3,430
     
3,836
             
3,559
     
3,842
         
Total Commercial Loans
   
3,430
     
3,836
             
10,060
     
10,380
         
 
                                               
With an allowance recorded:
                                               
Commercial Loans
                                               
Commercial
   
6,242
     
6,496
     
1,500
     
-
     
-
     
-
 
 
                                               
Total:
 
$
31,884
   
$
36,984
   
$
2,100
   
$
31,440
   
$
35,430
   
$
715
 

24

The following tables summarize the average recorded investments on impaired loans specifically evaluated for impairment and the interest income recognized for the three months ended June 30, 2014 and 2013:
 
 
 
For the three months ended
 
 
 
June 30, 2014
   
June 30, 2013
 
 
 
Average
   
   
Average
   
 
 
 
Recorded
   
Interest Income
   
Recorded
   
Interest Income
 
(in thousands)
 
Investment
   
Recognized
   
Investment
   
Recognized
 
ORIGINATED
 
   
   
   
 
Commercial Loans
 
   
   
   
 
Commercial
 
$
2,013
   
$
-
   
$
3,354
   
$
29
 
Commercial Real Estate
   
10,062
     
42
     
11,222
     
(51
)
Agricultural
   
123
     
-
     
201
     
(3
)
Agricultural Real Estate
   
1,412
     
12
     
896
     
12
 
Business Banking
   
548
     
11
     
78
     
3
 
Consumer Loans
                               
Home Equity
   
5,289
     
60
     
2,967
     
29
 
Residential Real Estate Mortgage
   
2,803
     
26
     
1,998
     
17
 
Total Originated
 
$
22,250
   
$
151
   
$
20,716
   
$
36
 
 
                               
ACQUIRED
                               
Commercial Loans
                               
Commercial
   
6,315
     
-
     
-
     
-
 
Commercial Real Estate
   
3,462
     
-
     
-
     
-
 
Total Acquired
 
$
9,777
   
$
-
   
$
-
   
$
-
 
 
                               
Total Loans
 
$
32,027
   
$
151
   
$
20,716
   
$
36
 

 
 
For the six months ended
 
 
 
June 30, 2014
   
June 30, 2013
 
 
 
Average
   
   
Average
   
 
 
 
Recorded
   
Interest Income
   
Recorded
   
Interest Income
 
(in thousands)
 
Investment
   
Recognized
   
Investment
   
Recognized
 
ORIGINATED
 
   
   
   
 
Commercial Loans
 
   
   
   
 
Commercial
 
$
2,025
   
$
-
   
$
4,331
   
$
58
 
Commercial Real Estate
   
10,739
     
84
     
11,361
     
21
 
Agricultural
   
124
     
1
     
270
     
1
 
Agricultural Real Estate
   
1,418
     
23
     
898
     
24
 
Business Banking
   
429
     
23
     
79
     
3
 
Consumer Loans
                               
Home Equity
   
4,959
     
103
     
2,944
     
58
 
Residential Real Estate Mortgage
   
2,778
     
50
     
2,028
     
28
 
Total Originated
   
22,472
     
284
     
21,911
     
193
 
 
                               
ACQUIRED
                               
Commercial Loans
                               
Commercial
   
6,375
     
-
     
-
     
-
 
Commercial Real Estate
   
3,493
     
-
     
-
     
-
 
Total Acquired
 
$
9,868
   
$
-
   
$
-
   
$
-
 
 
                               
Total Loans
 
$
32,340
   
$
284
   
$
21,911
   
$
193
 

25

Credit Quality Indicators
The Company has developed an internal loan grading system to evaluate and quantify the Company’s loan portfolio with respect to quality and risk.  The system focuses on, among other things, financial strength of borrowers, experience and depth of borrower’s management, primary and secondary sources of repayment, payment history, nature of the business, and outlook on particular industries.  The internal grading system enables the Company to monitor the quality of the entire loan portfolio on a consistent basis and provide management with an early warning system, enabling recognition and response to problem loans and potential problem loans.

Commercial Grading System
For commercial and agricultural loans, the Company uses a grading system that relies on quantifiable and measurable characteristics when available.  This would include comparison of financial strength to available industry averages, comparison of transaction factors (loan terms and conditions) to loan policy, and comparison of credit history to stated repayment terms and industry averages. Some grading factors are necessarily more subjective such as economic and industry factors, regulatory environment, and management.  Classified commercial loans consist of loans graded substandard and below.  The grading system for commercial and agricultural loans is as follows:
 
· Doubtful
A doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as a loss is deferred. Doubtful borrowers are usually in default, lack adequate liquidity or capital, and lack the resources necessary to remain an operating entity. Pending events can include mergers, acquisitions, liquidations, capital injections, the perfection of liens on additional collateral, the valuation of collateral, and refinancing. Generally, pending events should be resolved within a relatively short period and the ratings will be adjusted based on the new information. Nonaccrual treatment is required for doubtful assets because of the high probability of loss.

· Substandard
Substandard loans have a high probability of payment default, or they have other well-defined weaknesses. They require more intensive supervision by bank management. Substandard loans are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants. For some Substandard loans, the likelihood of full collection of interest and principal may be in doubt and those loans should be placed on nonaccrual. Although Substandard assets in the aggregate will have a distinct potential for loss, an individual asset’s loss potential does not have to be distinct for the asset to be rated Substandard.

· Special Mention
Special Mention loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weakness does not yet justify a Substandard classification. Borrowers may be experiencing adverse operating trends (declining revenues or margins) or may be struggling with an ill-proportioned balance sheet (e.g., increasing inventory without an increase in sales, high leverage, tight liquidity). Adverse economic or market conditions, such as interest rate increases or the entry of a new competitor, may also support a Special Mention rating. Although a Special Mention loan has a higher probability of default than a pass asset, its default is not imminent.

26

· Pass
Loans graded as Pass encompass all loans not graded as Doubtful, Substandard, or Special Mention.  Pass loans are in compliance with loan covenants, and payments are generally made as agreed.  Pass loans range from superior quality to fair quality.

Business Banking Grading System
Business banking loans are graded as either Classified or Non-classified:

· Classified
Classified loans are inadequately protected by the current worth and paying capacity of the obligor or, if applicable, the collateral pledged.   These loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt, or in some cases make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.   Classified loans have a high probability of payment default, or a high probability of total or substantial loss.  These loans require more intensive supervision by management and are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization.  Repayment may depend on collateral or other credit risk mitigants.  When the likelihood of full collection of interest and principal may be in doubt; classified loans are considered to have a nonaccrual status.   In some cases, Classified loans are considered uncollectible and of such little value that their continuance as assets is not warranted.

· Non-classified
Loans graded as Non-classified encompass all loans not graded as Classified.  Non-classified loans are in compliance with loan covenants, and payments are generally made as agreed.

Consumer and Residential Mortgage Grading System
Consumer and Residential Mortgage loans are graded as either Performing or Nonperforming.   Nonperforming loans are loans that are 1) over 90 days past due and interest is still accruing, 2) on nonaccrual status or 3) restructured.  All loans not meeting any of these three criteria are considered Performing.

27

The following tables illustrate the Company’s credit quality by loan class as of June 30, 2014 and December 31, 2013:
 
Credit Quality Indicators
As of June 30, 2014
 
ORIGINATED
 
   
   
   
   
 
Commercial Credit Exposure
 
   
Commercial
   
   
Agricultural
   
 
By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Real Estate
   
Total
 
Pass
 
$
606,388
   
$
946,883
   
$
52,603
   
$
38,503
   
$
1,644,377
 
Special Mention
   
11,782
     
19,949
     
354
     
7
     
32,092
 
Substandard
   
39,036
     
34,557
     
4,052
     
3,852
     
81,497
 
Doubtful
   
-
     
-
     
76
     
-
     
76
 
Total
 
$
657,206
   
$
1,001,389
   
$
57,085
   
$
42,362
   
$
1,758,042
 
 
                                       
Business Banking Credit Exposure
                                       
By Internally Assigned Grade:
 
Business
Banking
                           
Total
 
Non-classified
 
$
323,200
                           
$
323,200
 
Classified
   
17,514
                             
17,514
 
Total
 
$
340,714
                           
$
340,714
 
 
                                       
Consumer Credit Exposure
                                       
By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
 
$
1,279,599
   
$
499,588
   
$
55,431
           
$
1,834,618
 
Nonperforming
   
2,459
     
8,611
     
94
             
11,164
 
Total
 
$
1,282,058
   
$
508,199
   
$
55,525
           
$
1,845,782
 
 
                                       
Residential Mortgage Credit Exposure
 
Residential
                                 
By Payment Activity:
 
Mortgage
                           
Total
 
Performing
 
$
775,972
                           
$
775,972
 
Nonperforming
   
7,830
                             
7,830
 
Total
 
$
783,802
                           
$
783,802
 
 
28

Credit Quality Indicators
As of June 30, 2014

ACQUIRED
 
   
   
   
 
Commercial Credit Exposure
 
   
Commercial
   
   
 
By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Total
 
Pass
 
$
84,842
   
$
197,499
   
$
-
   
$
282,341
 
Special Mention
   
4,339
     
2,478
     
-
     
6,817
 
Substandard
   
9,507
     
14,238
     
-
     
23,745
 
Total
 
$
98,688
   
$
214,215
   
$
-
   
$
312,903
 
 
                               
Business Banking Credit Exposure
                               
By Internally Assigned Grade:
 
Business
Banking
                   
Total
 
Non-classified
 
$
59,227
                   
$
59,227
 
Classified
   
5,360
                     
5,360
 
Total
 
$
64,587
                   
$
64,587
 
 
                               
Consumer Credit Exposure
                               
By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
   
Total
 
Performing
 
$
91,807
   
$
80,642
   
$
6,040
   
$
178,489
 
Nonperforming
   
172
     
550
     
42
     
764
 
Total
 
$
91,979
   
$
81,192
   
$
6,082
   
$
179,253
 
 
                               
Residential Mortgage Credit Exposure
 
Residential
                         
By Payment Activity:
 
Mortgage
                   
Total
 
Performing
 
$
285,907
                   
$
285,907
 
Nonperforming
   
3,498
                     
3,498
 
Total
 
$
289,405
                   
$
289,405
 

29

Credit Quality Indicators
As of December 31, 2013

ORIGINATED
 
   
   
   
   
 
Commercial Credit Exposure
 
   
Commercial
   
   
Agricultural
   
 
By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Real Estate
   
Total
 
Pass
 
$
576,079
   
$
878,411
   
$
60,043
   
$
33,136
   
$
1,547,669
 
Special Mention
   
16,836
     
22,777
     
381
     
43
     
40,037
 
Substandard
   
23,508
     
33,128
     
4,726
     
3,473
     
64,835
 
Doubtful
   
-
     
-
     
12
     
-
     
12
 
Total
 
$
616,423
   
$
934,316
   
$
65,162
   
$
36,652
   
$
1,652,553
 
 
                                       
Business Banking Credit Exposure
                                       
By Internally Assigned Grade:
 
Business Banking
                           
Total
 
Non-classified
 
$
319,578
                           
$
319,578
 
Classified
   
18,101
                             
18,101
 
Total
 
$
337,679
                           
$
337,679
 
 
                                       
Consumer Credit Exposure
                                       
By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
 
$
1,158,800
   
$
525,777
   
$
58,151
           
$
1,742,728
 
Nonperforming
   
3,044
     
7,046
     
132
             
10,222
 
Total
 
$
1,161,844
   
$
532,823
   
$
58,283
           
$
1,752,950
 
 
                                       
Residential Mortgage Credit Exposure
 
Residential
                                 
By Payment Activity:
 
Mortgage
                           
Total
 
Performing
 
$
725,308
                           
$
725,308
 
Nonperforming
   
7,913
                             
7,913
 
Total
 
$
733,221
                           
$
733,221
 
30

Credit Quality Indicators
As of December 31, 2013

ACQUIRED
 
   
   
   
 
Commercial Credit Exposure
 
   
Commercial
   
   
 
By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Total
 
Pass
 
$
85,692
   
$
205,010
   
$
-
   
$
290,702
 
Special Mention
   
2,230
     
6,183
     
-
     
8,413
 
Substandard
   
15,304
     
17,821
     
-
     
33,125
 
Total
 
$
103,226
   
$
229,014
   
$
-
   
$
332,240
 
 
                               
Business Banking Credit Exposure
                               
By Internally Assigned Grade:
 
Business Banking
                   
Total
 
Non-classified
 
$
65,437
                   
$
65,437
 
Classified
   
4,712
                     
4,712
 
Total
 
$
70,149
                   
$
70,149
 
 
                               
Consumer Credit Exposure
                               
By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
   
Total
 
Performing
 
$
124,922
   
$
86,506
   
$
7,367
   
$
218,795
 
Nonperforming
   
164
     
570
     
58
     
792
 
Total
 
$
125,086
   
$
87,076
   
$
7,425
   
$
219,587
 
 
                               
Residential Mortgage Credit Exposure
 
Residential
                         
By Payment Activity:
 
Mortgage
                   
Total
 
Performing
 
$
304,544
                   
$
304,544
 
Nonperforming
   
3,872
                     
3,872
 
Total
 
$
308,416
                   
$
308,416
 
 
Troubled Debt Restructured Loans
The Company’s loan portfolio includes certain loans that have been modified where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.  Substantially all of these modifications included one or a combination of the following: an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; temporary reduction in the interest rate; or change in scheduled payment amount.
 
When the Company modifies a loan, management evaluates any possible impairment based on the present value of the expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral.  In these cases, management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows.  If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized by segment or class of loan as applicable, through an allowance estimate or a charge-off to the allowance.  Segment and class status is determined by the loan’s classification at origination.
31

TDRs that occurred during the three month period ending June 30, 2014 consisted of 3 home equity loans totaling $0.4 million, 5 direct consumer loans totaling $0.3 million, and 2 residential real estate mortgages totaling $0.2 million.  For all such modifications, the pre and post outstanding recorded investment amount remained unchanged. During the three month period ending June 30, 2014 there were 2 defaults on home equity loan TDRs totaling $0.3 million and one default on a direct consumer loan TDR totaling $34,000.

TDRs that occurred during the six month period ending June 30, 2014 consisted of 5 home equity loans totaling $0.4 million, 25 direct consumer loans totaling $1.3 million, and 15 residential real estate mortgages totaling $1.2 million.  For all such modifications, the pre and post outstanding recorded investment amount remained unchanged. During the six month period ending June 30, 2014 there were 2 defaults on home equity loan TDRs totaling $0.3 million, five defaults on direct consumer loan TDRs totaling $0.2 million, and one default on a residential real estate mortgage TDR totaling $0.1 million.

TDRs that occurred during the three month period ending June 30, 2013 consisted of one commercial real estate loan totaling $0.9 million, 10 home equity loans totaling $0.5 million, and one residential real estate mortgage totaling $0.1 million.  For all such modifications, the pre and post outstanding recorded investment amount remained unchanged. During the three month period ending June 30, 2013 there were three defaults on home equity loan TDRs totaling $0.2 million.

TDRs that occurred during the six month period ending June 30, 2013 consisted of one commercial real estate loan totaling $0.9 million, 14 home equity loans totaling $0.6 million, and one residential real estate mortgage totaling $0.1 million.  For all such modifications, the pre and post outstanding recorded investment amount remained unchanged. During the six month period ending June 30, 2013 there were three defaults on home equity loan TDRs totaling $0.2 million.
32

Note 5. Long-Term Debt

As part of a debt restructuring strategy during the second quarter of 2014, the Company repaid $165.0 million in long-term borrowings, resulting in $17.1 million in prepayment penalties.  Prepayment penalties of $4.6 million were recognized as expense in the second quarter of 2014 and related to the $45.0 million of the long-term debt strategy that was completed during the quarter.  The remaining prepayment penalties of approximately $13 million will be recognized in the third quarter of 2014 upon completion of the restructure strategy.

Note 6. Defined Benefit Postretirement Plans

The Company has a qualified, noncontributory, defined benefit pension plan (“the Plan”) covering substantially all of its employees at June 30, 2014.  Benefits paid from the plan are based on age, years of service, compensation and social security benefits, and are determined in accordance with defined formulas. The Company’s policy is to fund the pension plan in accordance with Employee Retirement Income Security Act of 1974 (“ERISA”) standards. Assets of the plan are invested in publicly traded stocks and bonds.  The Company is not required to make contributions to the Plan in 2014, and did not do so during the six months ended June 30, 2014.

The Company assumed a noncontributory, defined benefit pension plan in the Alliance Financial Corporation (“Alliance”) acquisition.  This plan covers certain Alliance full-time employees who met eligibility requirements on October 6, 2006, at which time all benefits were frozen.  Under the plan, retirement benefits are primarily a function of both the years of service and the level of compensation.  Effective May 1, 2013, this plan was merged into the Plan.

Market conditions can result in an unusually high degree of volatility and increase the risks and short term liquidity associated with certain investments held by the Plan which could impact the value of these investments.

In addition to the Plan, the Company also provides supplemental employee retirement plans to certain current and former executives.  These supplemental employee retirement plans and the Plan are collectively referred to herein as “Pension Benefits.”

Also, the Company provides certain health care benefits for retired employees.  Benefits are accrued over the employees’ active service period. Only employees that were employed by the Company on or before January 1, 2000 are eligible to receive postretirement health care benefits.  This health care benefits plan is contributory for participating retirees, requiring participants to absorb certain deductibles and coinsurance amounts with contributions adjusted annually to reflect cost sharing provisions and benefit limitations called for in the plan.  Eligibility is contingent upon the direct transition from active employment status to retirement without any break in employment from the Company.  Employees also must be participants in the Company’s medical plan prior to their retirement.  The Company funds the cost of postretirement health care as benefits are paid. The Company elected to recognize the transition obligation on a delayed basis over twenty years.  In addition, the Company assumed post-retirement medical life insurance benefits for certain Alliance employees, retirees and their spouses, if applicable, in the Alliance acquisition.  These postretirement benefits are referred to herein as “Other Benefits.”  The components of expense for Pension Benefits and Other Benefits are set forth below (in thousands):

33

 
 
Pension Benefits
   
Other Benefits
 
 
 
Three months ended June 30,
   
Three months ended June 30,
 
Components of net periodic benefit cost:
 
2014
   
2013
   
2014
   
2013
 
Service cost
 
$
587
   
$
604
   
$
4
   
$
6
 
Interest cost
   
1,040
     
830
     
90
     
75
 
Expected return on plan assets
   
(2,175
)
   
(1,929
)
   
-
     
-
 
Net amortization
   
25
     
711
     
(6
)
   
(1
)
Total cost (benefit)
 
$
(523
)
 
$
216
   
$
88
   
$
80
 

 
 
Pension Benefits
   
Other Benefits
 
 
 
Six months ended June 30,
   
Six months ended June 30,
 
Components of net periodic benefit cost:
 
2014
   
2013
   
2014
   
2013
 
Service cost
 
$
1,174
   
$
1,209
   
$
8
   
$
12
 
Interest cost
   
2,080
     
1,659
     
180
     
150
 
Expected return on plan assets
   
(4,350
)
   
(3,858
)
   
-
     
-
 
Net amortization
   
50
     
1,314
     
(12
)
   
222
 
Total cost (benefit)
 
$
(1,046
)
 
$
324
   
$
176
   
$
384
 
34

Note 7. Earnings Per Share

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (such as the Company’s dilutive stock options and restricted stock units).

The following is a reconciliation of basic and diluted earnings per share for the periods presented in the consolidated statements of income.

Three months ended June 30,
 
2014
   
2013
 
(in thousands, except per share data)
 
   
 
Basic EPS:
 
   
 
Weighted average common shares outstanding
   
43,865
     
43,923
 
Net income available to common shareholders
   
27,640
     
16,916
 
Basic EPS
 
$
0.63
   
$
0.39
 
Diluted EPS:
               
Weighted average common shares outstanding
   
43,865
     
43,923
 
Dilutive effect of common stock options and restricted stock
   
498
     
393
 
Weighted average common shares and common share equivalents
   
44,363
     
44,316
 
Net income available to common shareholders
   
27,640
     
16,916
 
Diluted EPS
 
$
0.62
   
$
0.38
 

Six months ended June 30,
 
2014
   
2013
 
(in thousands, except per share data)
 
   
 
Basic EPS:
 
   
 
Weighted average common shares outstanding
   
43,829
     
40,187
 
Net income available to common shareholders
   
45,649
     
24,565
 
Basic EPS
 
$
1.04
   
$
0.61
 
Diluted EPS:
               
Weighted average common shares outstanding
   
43,829
     
40,187
 
Dilutive effect of common stock options and restricted stock
   
500
     
388
 
Weighted average common shares and common share equivalents
   
44,329
     
40,575
 
Net income available to common shareholders
   
45,649
     
24,565
 
Diluted EPS
 
$
1.03
   
$
0.61
 

There were 503,058 stock options for the quarter ended June 30, 2014 and 1,231,395 stock options for the quarter ended June 30, 2013 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

There were 500,541 stock options for the six months ended June 30, 2014 and 1,203,046 stock options for the six months ended June 30, 2013 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

35

Note 8. Reclassification Adjustments Out of Other Comprehensive Income (Loss)

The following table summarizes the reclassification adjustments out of accumulated other comprehensive income (loss) (in thousands):

Detail About Accumulated Other Comprehensive
Income (Loss) Components
 
Amount reclassified from accumulated other
comprehensive income (loss)
 
Affected line item in the
consolidated statement of
comprehensive income (loss)
 
 
Three months ended
 
 
 
 
June 30, 2014
   
June 30, 2013
 
Available for sale securities:
 
   
 
   
(Gains) losses on available for sale securities
 
$
(14
)
 
$
61
 
Net securities (gains) losses
Tax expense (benefit)
   
6
     
(24
)
Income tax expense
Net of tax
 
$
(8
)
 
$
37
 
 
 
               
    
Pension and other benefits:
               
   
Amortization of net gains
 
$
74
   
$
765
 
Salaries and employee benefits
Amortization of prior service costs
   
(55
)
   
(55
)
Salaries and employee benefits
Tax benefit
   
8
     
284
 
Income tax expense
Net of tax
 
$
11
   
$
426
 
 
 
               
    
Total reclassifications during the period, net of tax
 
$
3
   
$
463
 
 
 
Detail About Accumulated Other Comprehensive
Income (Loss) Components
 
Amount reclassified from accumulated other
comprehensive income (loss)
 
Affected line item in the
consolidated statement of
comprehensive income (loss)
 
 
Six months ended
 
 
 
 
June 30, 2014
   
June 30, 2013
 
Available for sale securities:
       
       
Gains on available for sale securities
 
$
(21
)
 
$
(1,084
)
Net securities gains
Tax expense
   
8
     
434
 
Income tax expense
Net of tax
 
$
(13
)
 
$
(650
)
 
 
               
         
Pension and other benefits:
               
       
Amortization of net gains
 
$
148
   
$
1,647
 
Salaries and employee benefits
Amortization of prior service costs
   
(110
)
   
(111
)
Salaries and employee benefits
Tax benefit
   
15
     
614
 
Income tax expense
Net of tax
 
$
23
   
$
922
 
 
 
               
         
Total reclassifications during the period, net of tax
 
$
10
   
$
272
 
 
36

Note  9. Fair Value Measurements and Fair Value of Financial Instruments

U.S. GAAP states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  Fair value measurements are not adjusted for transaction costs.  A fair value hierarchy exists within U.S. GAAP that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 -  Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, many other sovereign government obligations, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within level 1 or level 2 of the fair value hierarchy.  The Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid agency securities, less liquid listed equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within level 2 of the fair value hierarchy.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

For the six month period ending June 30, 2014, the Company has made no transfers of assets between Level 1 and Level 2, and has had no Level 3 activity.
37

The following tables set forth the Company’s financial assets and liabilities measured on a recurring basis that were accounted for at fair value.  Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands):

June 30, 2014:

 
 
Quoted Prices in
   
Significant
   
Significant
   
 
 
 
Active Markets for
   
Other
   
Unobservable
   
Balance
 
 
 
Identical Assets
   
Observable Inputs
   
Inputs
   
as of
 
 
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
June 30, 2014
 
Assets:
 
   
   
   
 
Securities Available for Sale:
 
   
   
   
 
U.S. Treasury
 
$
33,324
   
$
-
   
$
-
   
$
33,324
 
Federal Agency
   
-
     
307,141
     
-
     
307,141
 
State & municipal
   
-
     
105,348
     
-
     
105,348
 
Mortgage-backed
   
-
     
397,387
     
-
     
397,387
 
Collateralized mortgage obligations
   
-
     
519,809
     
-
     
519,809
 
Other securities
   
7,511
     
8,279
     
-
     
15,790
 
Total Securities Available for Sale
 
$
40,835
   
$
1,337,964
   
$
-
   
$
1,378,799
 
Trading Securities
   
7,355
     
-
     
-
     
7,355
 
Interest Rate Swaps
   
-
     
2,799
     
-
     
2,799
 
Total
 
$
48,190
   
$
1,340,763
   
$
-
   
$
1,388,953
 
 
                               
Liabilities:
                               
Interest Rate Swaps
 
$
-
   
$
2,799
   
$
-
   
$
2,799
 
Total
 
$
-
   
$
2,799
   
$
-
   
$
2,799
 
 
December 31, 2013:

 
 
Quoted Prices in
   
Significant
   
Significant
   
 
 
 
Active Markets for
   
Other
   
Unobservable
   
Balance
 
 
 
Identical Assets
   
Observable Inputs
   
Inputs
   
as of
 
 
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
December 31, 2013
 
Assets:
 
   
   
   
 
Securities Available for Sale:
 
   
   
   
 
U.S. Treasury
 
$
43,616
   
$
-
   
$
-
   
$
43,616
 
Federal Agency
   
-
     
278,915
     
-
     
278,915
 
State & municipal
   
-
     
113,665
     
-
     
113,665
 
Mortgage-backed
   
-
     
364,164
     
-
     
364,164
 
Collateralized mortgage obligations
   
-
     
549,528
     
-
     
549,528
 
Other securities
   
6,796
     
8,197
     
-
     
14,993
 
Total Securities Available for Sale
 
$
50,412
   
$
1,314,469
   
$
-
   
$
1,364,881
 
Trading Securities
   
5,779
     
-
     
-
     
5,779
 
Interest Rate Swaps
   
-
     
281
     
-
     
281
 
Total
 
$
56,191
   
$
1,314,750
   
$
-
   
$
1,370,941
 
 
                               
Liabilities:
                               
Interest Rate Swaps
 
$
-
   
$
281
   
$
-
   
$
281
 
Total
 
$
-
   
$
281
   
$
-
   
$
281
 

38

Certain common equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices).  The majority of the other investment securities are reported at fair value utilizing Level 2 inputs.  The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities.  Prices obtained from these sources include prices derived from market quotations and matrix pricing.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.  Management reviews the methodologies used in pricing the securities by its third party providers.

U.S. GAAP requires disclosure of assets and liabilities measured and recorded at fair value on a nonrecurring basis such as goodwill, loans held for sale, other real estate owned, collateral-dependent impaired loans, mortgage servicing rights, and held-to-maturity securities.  The only nonrecurring fair value measurement recorded during the six month period ended June 30, 2014 was related to impaired loans.  During the six month period ending June 30, 2014, the Company recorded $9.0 million of loans at fair value resulting in a loss of $1.7 million.  The Company uses the fair value of underlying collateral, less costs to sell, to estimate the specific reserves for collateral dependent impaired loans.  The appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses ranging from 10% to 35%.  Based on the valuation techniques used, the fair value measurements for collateral dependent impaired loans are classified as Level 3.

The following table sets forth information with regard to estimated fair values of financial instruments at June 30, 2014 and December 31, 2013.  This table excludes financial instruments for which the carrying amount approximates fair value.  Financial instruments for which the fair value approximates carrying value include cash and cash equivalents, securities available for sale, trading securities, accrued interest receivable, non-maturity deposits, short-term borrowings, accrued interest payable, and interest rate swaps.

 
 
   
June 30, 2014
   
December 31, 2013
 
(In thousands)
 
Fair
Value
Hierarchy
   
Carrying
amount
   
Estimated
fair value
   
Carrying
amount
   
Estimated
fair value
 
Financial assets
 
   
   
   
   
 
Securities held to maturity
   
2
   
$
125,965
   
$
123,376
   
$
117,283
   
$
113,276
 
Net loans
   
3
     
5,504,954
     
5,552,074
     
5,337,361
     
5,386,520
 
Financial liabilities
                                       
Time deposits
   
2
   
$
1,002,431
   
$
999,513
   
$
1,021,142
   
$
1,023,982
 
Long-term debt
   
2
     
251,125
     
254,321
     
308,823
     
325,195
 
Junior subordinated debt
   
2
     
101,196
     
108,079
     
101,196
     
105,121
 

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
39

Fair value estimates are based on existing on and off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has a substantial trust and investment management operation that contributes net fee income annually. The trust and investment management operation is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities include the benefits resulting from the low-cost funding of deposit liabilities as compared to the cost of borrowing funds in the market, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimate of fair value.

Securities Held to Maturity
The fair value of the Company’s investment securities held to maturity is primarily measured using information from a third party pricing service.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Net Loans
The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made for the same remaining maturities.  Loans were first segregated by type, and then further segmented into fixed and variable rate and loan quality categories.  Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time Deposits
The fair value of time deposits was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.  The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.
 
Long-Term Debt
The fair value of long-term debt was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.

Junior Subordinated Debt
The fair value of junior subordinated debt has been estimated using a discounted cash flow analysis.
 
Note 10. Commitments and Contingencies

The Company is a party to financial instruments in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuating interest rates. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  Commitments to extend credit and unused lines of credit totaled $1.1 billion at June 30, 2014 and December 31, 2013.  Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management’s credit evaluation of the borrower and may include accounts receivable, inventory, property, land and other items.
40

The Company guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are frequently issued in support of third party debt, such as corporate debt issuances, industrial revenue bonds and municipal securities. The credit risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash commitments. Standby letters of credit totaled $38.5 million at June 30, 2014 and $36.8 million at December 31, 2013.  As of June 30, 2014, the fair value of standby letters of credit was not significant to the Company’s consolidated financial statements.

The Company has also entered into commercial letter of credit agreements on behalf of its customers.  Under these agreements, the Company, on the request of its customer, opens the letter of credit and makes a commitment to honor draws made under the agreement, whereby the beneficiary is normally the provider of goods and/or services and the Company essentially replaces the customer as the payee.  The credit risk involved in issuing commercial letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  Typically, these agreements vary in terms and the total amounts do not necessarily represent future cash commitments.  Commercial letters of credit totaled $39.2 million at June 30, 2014 and $41.3 million at December 31, 2013.  As of June 30, 2014, the fair value of commercial letters of credit was not significant to the Company’s consolidated financial statements.

Note  11. Sale of Equity Investment

On April 17, 2014, NBT Capital Corp., a wholly-owned subsidiary of NBT, sold to LendingClub Corporation, its 20% ownership interest in Springstone Financial, LLC, which NBT originally acquired in exchange for a $3 million investment, as part of LendingClub’s acquisition of all of the outstanding equity in Springstone.  In total, LendingClub paid the group of selling equityholders a purchase price equal to $140 million in cash and preferred stock.  As a result of this sale, the Company recognized a gain of $19.4 million during the second quarter of 2014.

41

Item 2 ‑‑ MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of this discussion and analysis is to provide a concise description of the financial condition and results of operations of NBT Bancorp Inc. and its wholly owned consolidated subsidiaries, NBT Bank, N.A. (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), and NBT Holdings, Inc. (“NBT Holdings”) (collectively referred to herein as the “Company”). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10‑Q as well as to the Company's Annual Report on Form 10‑K for the year ended December 31, 2013 for an understanding of the following discussion and analysis.  Operating results for the six-month period ending June 30, 2014 are not necessarily indicative of the results of the full year ending December 31, 2014 or any future period.

Forward-looking Statements
Certain statements in this filing and future filings by the Company with the SEC, in the Company’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,”  “projects,”  “will,”  “can,” “would,” “should,” “could,” “may,” or other similar terms. There are a number of factors, many of which are beyond the Company’s control that could cause actual results to differ materially from those contemplated by the forward looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact; (2) changes in the level of non-performing assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply including those under the Dodd-Frank Act; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (17) changes in the Company’s organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; and (20) the Company’s success at managing the risks involved in the foregoing items.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the Securities and Exchange Commission, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.
42

Unless required by law, the Company does not undertake, and specifically disclaims any obligations to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Non-GAAP Measures
This Quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (GAAP).  These measures adjust GAAP measures to exclude the effects of sales of securities and certain non-recurring and merger-related expenses.  Where non-GAAP disclosures are used in this Quarterly Report on Form 10-Q, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying tables.  Management believes that these non-GAAP measures provide useful information that is important to an understanding of the operating results of the Company’s core business due to the non-recurring nature of the excluded items.  Non-GAAP measures should not be considered substitutes for financial measures determined in accordance with GAAP and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company.

Critical Accounting Policies
The Company has identified policies as being critical because they require management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the allowance for loan losses, pension accounting, other-than-temporary impairment, provision for income taxes and intangible assets.

Management  of  the  Company  considers  the  accounting  policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty  in  evaluating  the level of the allowance required to cover credit losses inherent in the loan portfolio and the material effect that such judgments can have on the results of operations. While management’s current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance may need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provision for loan losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Company’s nonperforming loans and potential problem loans have a significant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral values were significantly lower, the Company’s allowance for loan loss policy would also require additional provision for loan losses.

Management is required to make various assumptions in valuing the Company’s pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers the Citigroup Pension Liability Index, market interest rates and discounted cash flows in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

Management of the Company considers the accounting policy relating to other-than-temporary impairment to be a critical accounting policy.  Management systematically evaluates certain assets for other-than-temporary declines in fair value, primarily investment securities.  Management considers historical values and current market conditions as a part of the assessment.  The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is generally recognized in other comprehensive income, net of applicable taxes.
43

The Company is subject to examinations from various taxing authorities.  Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions.  Management believes that the assumptions and judgments used to record tax-related assets or liabilities have been appropriate.  Should tax laws change or the taxing authorities determine that management’s assumptions were inappropriate, an adjustment may be required which could have a material adverse effect on the Company’s results of operations.

Another critical accounting policy is the policy for acquired loans. Acquired loans are initially recorded at their acquisition date fair values.  The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date.  Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.  Subsequent to the acquisition of acquired impaired loans, applicable accounting guidance requires the continued estimation of expected cash flows to be received.  This estimation involves the use of key assumptions and estimates, similar to those used in the initial estimate of fair value.  Changes in expected cash flows could result in the recognition of impairment through provision for credit losses.   Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for the non-impaired acquired loans is similar to originated loans.

As a result of acquisitions, the Company has acquired goodwill and identifiable intangible assets.  Goodwill represents the cost of acquired companies in excess of the fair value of net assets at the acquisition date.  Goodwill is evaluated at least annually or when business conditions suggest that an impairment may have occurred.  Goodwill will be reduced to its carrying value through a charge to earnings if impairment exists.  Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives.  The determination of whether or not impairment exists is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows.  It also requires them to select a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums and Company-specific risk indicators, all of which are susceptible to change based on changes in economic conditions and other factors.  Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company’s results of operations.

The Company’s policies on the allowance for loan losses, pension accounting, acquired loans, provision for income taxes and intangible assets are disclosed in Note 1 to the consolidated financial statements presented in our 2013 Annual Report on Form 10-K.  All accounting policies are important, and as such, the Company encourages the reader to review each of the policies included in Note 1 to obtain a better understanding of how the Company’s financial performance is reported.

Overview
Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to:  net income and earnings per share, return on average assets, equity and tangible common equity, net interest margin, noninterest income, operating expenses, certain core results, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons.  The following information should be considered in connection with the Company's results for the first six months of 2014:
44

· Strong organic loan growth continued in the second quarter of 2014 annualized at 6.8%.

· Past due loans to total loans was 0.57% for the second quarter of 2014, consistent with the previous quarter, and down from 0.77% at the end of 2013.

· Sold 20% ownership interest in Springstone LLC (“Springstone”) recognizing a $19.4 million gain (non-core) during the quarter.

· Restructured $165 million in long-term borrowings, resulting in $4.6 million in prepayment penalties (non-core) recognized in the second quarter of 2014 and expecting to recognize additional prepayment penalties (non-core) in the third quarter of 2014 upon completion of the restructure strategy.  The fully executed strategy is expected to lower the cost of the restructured long-term debt by approximately 200 basis points and improve our interest rate risk profile.

45

The following table depicts several annualized measurements of performance using core and GAAP net income that management reviews in analyzing the Company’s performance. Returns on average assets and average equity measure how effectively an entity utilizes its total resources and capital, respectively.
 
(Dollars in thousands)
 
For the three months ended
June 30,
   
For the six months ended
June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
Reconciliation of Non-GAAP Financial Measures:
 
   
   
   
 
Reported net income (GAAP)
 
$
27,640
   
$
16,916
   
$
45,649
   
$
24,565
 
Adj: (Gain) / Loss on sale of securities, net (net of tax)
   
(8
)
   
37
     
(14
)
   
(650
)
Adj: Other adjustments (net of tax) (1)
   
(315
)
   
-
     
115
     
-
 
Adj: Gain on sale of Springstone (net of tax and related incentive compensation)
   
(11,168
)
   
-
     
(11,168
)
   
-
 
Adj: Prepayment penalties related to debt restructuring (net of tax)
   
2,925
     
-
     
2,925
     
-
 
Plus: Merger related expenses (net of tax)
   
-
     
882
     
-
     
8,202
 
Total Adjustments
   
(8,566
)
   
919
     
(8,142
)
   
7,552
 
Core net income
 
$
19,074
   
$
17,835
   
$
37,507
   
$
32,117
 
 
                               
Performance measures:
                               
Core Return on Average Assets (2)
   
0.99
%
   
0.95
%
   
0.98
%
   
0.93
%
Return on Average Assets (2)
   
1.43
%
   
0.90
%
   
1.20
%
   
0.71
%
Core Return on Average Equity (2)
   
9.06
%
   
8.88
%
   
9.04
%
   
8.93
%
Return on Average Equity (2)
   
13.12
%
   
8.42
%
   
11.00
%
   
6.83
%
Core Return on Average Tangible Common Equity (2)(3)
   
14.27
%
   
14.57
%
   
14.38
%
   
14.11
%
Return on Average Tangible Common Equity (2)(3)
   
20.43
%
   
13.85
%
   
17.37
%
   
10.93
%

(1) Primarily net gain on settlement of litigation and reorganization expenses for 2014 and reorganization expenses for 2013
(2) Annualized
(3) Excludes amortization of intangible assets (net of tax) from net income and average tangible common equity is calculated as follows:
 
 
 
For the three months ended
June 30,
   
For the six months ended
June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
Average stockholders' equity
 
$
844,707
   
$
806,200
   
$
836,692
   
$
724,898
 
Less: average goodwill and other intangibles
   
287,366
     
292,775
     
288,685
     
247,031
 
Average tangible common equity
 
$
557,341
   
$
513,425
   
$
548,007
   
$
477,867
 

46

Results of Operations

Net income for the three months ended June 30, 2014 was $27.6 million, up from $18.0 million for the previous quarter, and up from $16.9 million for the same period last year.  Reported net income included an $11.2 million net gain (after taxes and related incentive compensation) on the sale of our ownership interest in Springstone, partially offset by $2.9 million in prepayment penalties, net of tax, related to our long-term debt restructure strategy.  Reported earnings per diluted share for the three months ended June 30, 2014 was $0.62 as compared to $0.41 for the previous quarter and $0.38 for the same period in 2013.

Core net income for the three months ended June 30, 2014 was $19.1 million, up 3.5% from $18.4 million for the previous quarter and up 6.9% from $17.8 million for the same period in 2013.  Core diluted earnings per share for the three months ended June 30, 2014 was $0.43, up from $0.42 for the previous quarter and up from $0.40 for the same period in 2013.

Reported net income for the six months ended June 30, 2014 was $45.6 million, up from $24.6 million for the same period last year, which included the aforementioned net Springstone gain and long-term prepayment penalties in 2014 and approximately $12.0 million in merger-related expenses in 2013.  Reported earnings per diluted share for the six months ended June 30, 2014 was $1.03 as compared to $0.61 for the same period in 2013.

Core net income for the six months ended June 30, 2014 was $37.5 million, up 16.8% from $32.1 million for the same period in 2013.  Core diluted earnings per share for the six months ended June 30, 2014 was $0.85, up from $0.79 for the same period in 2013.

Net Interest Income
Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and borrowings.  Net interest income is affected by the interest rate spread, the difference between the yield on earning assets and cost of interest bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the key determining factors in a financial institution’s performance as it is the principal source of earnings.

Net interest income was $62.6 million for the second quarter of 2014, up 1.7% from the previous quarter, and up 1.5% from the same period last year.  Fully taxable equivalent (“FTE”) net interest margin was 3.60% for the three months ended June 30, 2014, down from 3.63% from the prior quarter, and down from 3.69% for the second quarter of 2013.  Average interest earning assets were up $90.9 million, or 1.3%, for the second quarter of 2014 as compared to the prior quarter, driven primarily by organic loan production.  Slight rate compression on earning assets continued to negatively impact net interest margin in the second quarter of 2014 as evidenced by decreasing loan yields from 4.50% for the first quarter of 2014 to 4.42% for the second quarter of 2014.  Average interest bearing liabilities increased $37.1 million, or 0.7%, from the first quarter of 2014 to the second quarter of 2014.  The rates paid on interest bearing liabilities decreased by 7 basis points from the first quarter of 2014 to the second quarter of 2014.  This decrease was primarily driven by a decrease of 4 basis points in rates paid on deposits as well as a 34 basis point decrease in the rate paid on long-term debt resulting from the aforementioned debt restructuring in the second quarter of 2014.

Net interest income was $124.1 million for the six months ended June 30, 2014, up 9.0% from the same period in 2013.  FTE net interest margin was 3.62% for the six months ended June 30, 2014, down from 3.68% from the six months ended June 30, 2013.  Average interest earning assets were up $683.5 million, or 10.8%, for the six months ended June 30, 2014 as compared to the same period in 2013.  This increase was driven primarily by the acquisition of Alliance in March 2013 as well as organic loan production during the past several quarters.  The yield on earning assets for the six months ended June 30, 2014 was down 22 basis points from the same period in 2013, driven primarily by the decrease in loan yields from 4.81% for the first six months of 2013 to 4.46% for the first six months of 2014.  Average interest bearing liabilities increased $396.4 million, or 8.3%, for the first six months of 2014 as compared to the same period in 2013.  This increase was due primarily to an increase in deposits resulting from organic deposit growth as well as the aforementioned acquisition of Alliance.  The rates paid on interest bearing liabilities for the first half of 2014 decreased by 19 basis points from the first six months of 2013.  This decrease was primarily driven by a decrease of 12 basis points in rates paid on deposits as well as a 51 basis point decrease in the rate paid on long-term debt due primarily to maturity of long-term debt in the prior year, as well as the aforementioned debt restructuring in the second quarter of 2014.

47

Average Balances and Net Interest Income

The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest bearing liabilities on a taxable equivalent basis. Interest income for tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.

Three Months ended June 30,
 
   
   
   
   
   
 
 
 
 
   
2014
   
 
   
     
   
2013
   
 
 
 
 
Average
   
   
Yield/
   
Average
   
   
Yield/
 
(dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
 
   
   
   
   
   
 
Short-term interest bearing accounts
 
$
3,915
   
$
7
     
0.76
%
 
$
41,313
   
$
59
     
0.57
%
Securities available for sale (1)(2)
   
1,376,314
     
7,027
     
2.05
%
   
1,428,864
     
7,033
     
1.97
%
Securities held to maturity (1)
   
121,042
     
1,037
     
3.43
%
   
62,463
     
815
     
5.23
%
Investment in FRB and FHLB Banks
   
42,965
     
496
     
4.63
%
   
35,497
     
430
     
4.85
%
Loans (3)
   
5,517,315
     
60,770
     
4.42
%
   
5,243,534
     
62,268
     
4.76
%
Total interest earning assets
 
$
7,061,551
   
$
69,337
     
3.94
%
 
$
6,811,671
   
$
70,605
     
4.16
%
Other assets
   
680,059
                     
705,869
                 
Total assets
 
$
7,741,610
                   
$
7,517,540
                 
 
                                               
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
 
$
1,441,284
   
$
539
     
0.15
%
 
$
1,402,429
   
$
524
     
0.15
%
NOW deposit accounts
   
960,698
     
132
     
0.06
%
   
927,037
     
443
     
0.19
%
Savings deposits
   
1,040,528
     
186
     
0.07
%
   
983,413
     
209
     
0.09
%
Time deposits
   
971,595
     
2,143
     
0.88
%
   
1,136,511
     
3,120
     
1.10
%
Total interest bearing deposits
 
$
4,414,105
   
$
3,000
     
0.27
%
 
$
4,449,390
   
$
4,296
     
0.39
%
Short-term borrowings
   
383,480
     
209
     
0.22
%
   
229,906
     
67
     
0.12
%
Junior subordinated debt
   
101,196
     
538
     
2.13
%
   
101,196
     
560
     
2.22
%
Long-term debt
   
290,791
     
2,135
     
2.95
%
   
355,702
     
3,026
     
3.41
%
Total interest bearing liabilities
 
$
5,189,572
   
$
5,882
     
0.45
%
 
$
5,136,194
   
$
7,949
     
0.62
%
Demand deposits
   
1,620,488
                     
1,496,486
                 
Other liabilities
   
86,843
                     
78,660
                 
Stockholders' equity
   
844,707
                     
806,200
                 
Total liabilities and stockholders' equity
 
$
7,741,610
                   
$
7,517,540
                 
Net interest income (FTE)
           
63,455
                     
62,656
         
Interest rate spread
                   
3.49
%
                   
3.54
%
Net interest margin
                   
3.60
%
                   
3.69
%
Taxable equivalent adjustment
           
881
                     
1,001
         
Net interest income
         
$
62,574
                   
$
61,655
         
 
(1) Securities are shown at average amortized cost
(2) Excluding unrealized gains or losses
(3) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding

48

Six Months ended June 30,
 
 
   
 
     
   
 
   
 
   
 
 
 
 
     
     
2014
   
    
   
    
   
2013
   
    
 
 
 
Average
   
   
Yield/
   
Average
   
   
Yield/
 
(dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
 
   
   
   
   
   
 
Short-term interest bearing accounts
 
$
3,328
   
$
14
     
0.87
%
 
$
58,118
   
$
98
     
0.34
%
Securities available for sale (1)(2)
   
1,379,014
     
14,212
     
2.08
%
   
1,313,691
     
13,212
     
2.03
%
Securities held to maturity (1)
   
118,840
     
2,048
     
3.48
%
   
57,710
     
1,605
     
5.61
%
Investment in FRB and FHLB Banks
   
43,279
     
1,028
     
4.79
%
   
33,416
     
796
     
4.80
%
Loans (3)
   
5,471,879
     
121,002
     
4.46
%
   
4,869,896
     
116,171
     
4.81
%
Total interest earning assets
 
$
7,016,340
   
$
138,304
     
3.98
%
 
$
6,332,831
   
$
131,882
     
4.20
%
Other assets
   
679,654
                     
630,532
                 
Total assets
 
$
7,695,994
                   
$
6,963,363
                 
 
                                               
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
 
$
1,426,446
   
$
1,066
     
0.15
%
 
$
1,297,077
   
$
934
     
0.15
%
NOW deposit accounts
   
946,691
     
256
     
0.05
%
   
863,481
     
889
     
0.21
%
Savings deposits
   
1,020,391
     
369
     
0.07
%
   
877,574
     
354
     
0.08
%
Time deposits
   
985,510
     
4,593
     
0.94
%
   
1,076,445
     
6,269
     
1.17
%
Total interest bearing deposits
 
$
4,379,038
   
$
6,284
     
0.29
%
 
$
4,114,577
   
$
8,446
     
0.41
%
Short-term borrowings
   
391,173
     
440
     
0.23
%
   
199,513
     
109
     
0.11
%
Junior subordinated debt
   
101,196
     
1,076
     
2.14
%
   
91,798
     
988
     
2.17
%
Long-term debt
   
299,726
     
4,642
     
3.12
%
   
368,867
     
6,635
     
3.63
%
Total interest bearing liabilities
 
$
5,171,133
   
$
12,442
     
0.49
%
 
$
4,774,755
   
$
16,178
     
0.68
%
Demand deposits
   
1,605,261
                     
1,390,700
                 
Other liabilities
   
82,908
                     
73,010
                 
Stockholders' equity
   
836,692
                     
724,898
                 
Total liabilities and stockholders' equity
 
$
7,695,994
                   
$
6,963,363
                 
Net interest income (FTE)
           
125,862
                     
115,704
         
Interest rate spread
                   
3.49
%
                   
3.52
%
Net interest margin
                   
3.62
%
                   
3.68
%
Taxable equivalent adjustment
           
1,771
                     
1,909
         
Net interest income
         
$
124,091
                   
$
113,795
         
 
(1) Securities are shown at average amortized cost
(2) Excluding unrealized gains or losses
(3) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding

49

The following table presents changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume), and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.

Three months ended June 30,
 
  
   
  
   
  
 
 
 
Increase (Decrease)
 
 
 
2014 over 2013
 
(in thousands)
 
Volume
   
Rate
   
Total
 
 
 
   
   
 
Short-term interest bearing accounts
 
$
(64
)
 
$
12
   
$
(52
)
Securities available for sale
   
(263
)
   
257
     
(6
)
Securities held to maturity
   
572
     
(350
)
   
222
 
Investment in FRB and FHLB Banks
   
87
     
(21
)
   
66
 
Loans and leases
   
3,153
     
(4,651
)
   
(1,498
)
Total interest income
   
3,485
     
(4,753
)
   
(1,268
)
 
                       
Money market deposit accounts
   
15
     
-
     
15
 
NOW deposit accounts
   
16
     
(327
)
   
(311
)
Savings deposits
   
12
     
(35
)
   
(23
)
Time deposits
   
(415
)
   
(562
)
   
(977
)
Short-term borrowings
   
62
     
80
     
142
 
Junior subordinated debt
   
-
     
(22
)
   
(22
)
Long-term debt
   
(509
)
   
(382
)
   
(891
)
Total interest expense
   
(819
)
   
(1,248
)
   
(2,067
)
  
                              
Change in FTE net interest income
 
$
4,304
   
$
(3,505
)
 
$
799
 
 
Six months ended June 30,
                  
 
 
Increase (Decrease)
 
 
 
2014 over 2013
 
(in thousands)
 
Volume
   
Rate
   
Total
 
 
           
Short-term interest bearing accounts
 
$
(146
)
 
$
62
   
$
(84
)
Securities available for sale
   
668
     
332
     
1,000
 
Securities held to maturity
   
1,224
     
(781
)
   
443
 
Investment in FRB and FHLB Banks
   
234
     
(2
)
   
232
 
Loans and leases
   
13,701
     
(8,870
)
   
4,831
 
Total interest income
   
15,681
     
(9,259
)
   
6,422
 
 
                       
Money market deposit accounts
   
96
     
36
     
132
 
NOW deposit accounts
   
78
     
(711
)
   
(633
)
Savings deposits
   
54
     
(39
)
   
15
 
Time deposits
   
(498
)
   
(1,178
)
   
(1,676
)
Short-term borrowings
   
157
     
174
     
331
 
Junior subordinated debt
   
100
     
(12
)
   
88
 
Long-term debt
   
(1,144
)
   
(849
)
   
(1,993
)
Total interest expense
   
(1,157
)
   
(2,579
)
   
(3,736
)
                           
Change in FTE net interest income
 
$
16,838
   
$
(6,680
)
 
$
10,158
 

50

Noninterest Income
Noninterest income is a significant source of revenue for the Company and an important factor in the Company’s results of operations.  The following table sets forth information by category of noninterest income for the periods indicated:

 
 
Three months ended June 30,
   
Six months ended June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
(in thousands)
 
   
   
   
 
Insurance and other financial services revenue
 
$
5,594
   
$
5,755
   
$
12,331
   
$
12,648
 
Service charges on deposit accounts
   
4,397
     
4,933
     
8,766
     
9,256
 
ATM and debit card fees
   
4,357
     
4,044
     
8,429
     
7,286
 
Retirement plan administration fees
   
2,977
     
2,957
     
5,895
     
5,639
 
Trust
   
4,953
     
4,699
     
9,399
     
7,612
 
Bank owned life insurance
   
978
     
886
     
2,360
     
1,735
 
Net securities gains
   
14
     
(61
)
   
21
     
1,084
 
Gain on the sale of Springstone investment
   
19,401
     
-
     
19,401
     
-
 
Other
   
3,356
     
2,324
     
5,702
     
5,506
 
Total noninterest income
 
$
46,027
   
$
25,537
   
$
72,304
   
$
50,766
 
 
Noninterest income for the three months ended June 30, 2014 was $46.0 million, up $19.8 million from the previous quarter, and up $20.5 million from the same period in 2013.  The increase from the prior quarter and 2013 was primarily driven by a $19.4 million gain from the previously disclosed sale of our ownership interest in Springstone.  Excluding this gain, noninterest income for the three months ended June 30, 2014 was $26.6 million, up $0.3 million, or 1.3%, from the previous quarter, and up $1.1 million, or 4.3%, from the same period in 2013.

Noninterest income for the six months ended June 30, 2014 was $72.3 million, up $21.5 million, or 42.4%, from the same period in 2013.  The increase from 2013 was primarily driven by the aforementioned $19.4 million gain recorded in the second quarter of 2014.  Excluding this gain, noninterest income for the six months ended June 30, 2014 was $52.9 million, up $2.1 million, or 4.2%, from the same period in 2013.  This increase from 2013 was due primarily to increases in trust and ATM and debit card fees, due in large part to the full impact from Alliance in 2014.   These increases were partially offset by decreases in service charges on deposit accounts and net securities gains for the first six months of 2014 as compared with the same period in 2013.  The decrease in service charges on deposit accounts from the prior year was due primarily to lower nonsufficient funds fees recorded during the first six months of 2014.

Noninterest Expense
Noninterest expenses are also an important factor in the Company’s results of operations.  The following table sets forth the major components of noninterest expense for the periods indicated:

51

 
 
Three months ended June 30,
   
Six months ended June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
(in thousands)
 
   
   
   
 
Salaries and employee benefits
 
$
31,142
   
$
29,160
   
$
60,676
   
$
56,207
 
Occupancy
   
5,435
     
5,219
     
11,661
     
10,196
 
Data processing and communications
   
4,015
     
3,854
     
8,016
     
7,309
 
Professional fees and outside services
   
3,752
     
3,237
     
7,167
     
6,138
 
Equipment
   
3,132
     
2,910
     
6,248
     
5,492
 
Office supplies and postage
   
1,803
     
1,656
     
3,488
     
3,246
 
FDIC expenses
   
1,229
     
1,273
     
2,507
     
2,403
 
Advertising
   
726
     
1,000
     
1,465
     
1,723
 
Amortization of intangible assets
   
1,236
     
1,351
     
2,546
     
2,202
 
Loan collection and other real estate owned
   
801
     
421
     
1,841
     
1,139
 
Merger
   
-
     
1,269
     
-
     
11,950
 
Prepayment penalty on long term debt
   
4,554
     
-
     
4,554
     
-
 
Other
   
4,911
     
5,100
     
10,084
     
9,150
 
Total noninterest expense
 
$
62,736
   
$
56,450
   
$
120,253
   
$
117,155
 

Noninterest expense for the three months ended June 30, 2014 was $62.7 million, up $5.2 million from the previous quarter, and up $6.3 million from the same period in 2013.  This increase from the prior quarter and 2013 was due primarily to $4.6 million of prepayment penalties from the aforementioned strategic long-term debt restructuring in the second quarter of 2014.  Excluding these prepayment penalties, noninterest expense for the three months ended June 30, 2014 was $58.2 million, up $0.7 million, or 1.2% from the previous quarter, and up $1.7 million, or 3.1%, from the same period in 2013.  This increase from the prior year was due primarily to a $2.0 million increase in salaries and employee benefits driven by an increase in incentive compensation related to the Springstone transaction.

Noninterest expense for the six months ended June 30, 2014 was $120.3 million, up $3.1 million from the same period in 2013.  Excluding the aforementioned $4.6 million prepayment penalties in 2014 and the merger related expenses totaling $12.0 million in the first six months of 2013, noninterest expense for the six months ended June 30, 2014 was $115.7 million, up $10.5 million, or 10.0% from the same period in 2013.  This increase from the six months ended June 30, 2013 was due primarily to 2014 including the full six months of Alliance expenses including occupancy, salaries and employee benefits, data processing, professional fees, and equipment.  In addition, the increase in salaries and benefits included incremental incentive compensation related to the Springstone transaction, partially offset by lower retirement plan expenses due mainly to plan asset performance and a previous plan amendment.

Income Taxes
The effective tax rate was 33.7% for the second quarter of 2014, 32.5% for the first quarter of 2014, and 30.5% for the second quarter of 2013.    The effective tax rate was 33.2% for the six months ended June 30, 2014, as compared to 30.5% for the first six months of 2013.  The increases in the effective tax rate for the three and six month periods ending June 30, 2014 were primarily due to a higher level of taxable income as a percentage of total income as compared to the same periods in 2013.

ANALYSIS OF FINANCIAL CONDITION

Securities
Total securities increased $24.2 million, or 1.6%, from December 31, 2013 to June 30, 2014.  Held to maturity securities increased $8.7 million, or 7.4%, over the same period as cash flows from maturing available for sale securities have been reinvested into held to maturity securities.  The securities portfolio represents 19.2% of total assets as of June 30, 2014 as compared to 19.4% as of December 31, 2013.
52

The following table details the composition of securities available for sale, securities held to maturity and regulatory investments for the periods indicated:

 
 
June 30,
2014
   
December 31,
2013
 
Mortgage-backed securities:
 
   
 
With maturities 15 years or less
   
25
%
   
23
%
With maturities greater than 15 years
   
1
%
   
1
%
Collateral mortgage obligations
   
37
%
   
40
%
Municipal securities
   
11
%
   
11
%
US agency notes
   
22
%
   
21
%
Other
   
4
%
   
4
%
Total
   
100
%
   
100
%

The Company’s mortgage backed securities, U.S. agency notes, and collateralized mortgage obligations are all “prime/conforming” and are guaranteed by Fannie Mae, Freddie Mac, Federal Home Loan Bank, Federal Farm Credit Banks, or Ginnie Mae (“GNMA”).  GNMA securities are considered equivalent to U.S. Treasury securities, as they are backed by the full faith and credit of the U.S. government.  Currently, there are no subprime mortgages in our investment portfolio.

Loans
A summary of loans, net of deferred fees and origination costs, by category for the periods indicated follows:

(In thousands)
 
June 30,
2014
   
December 31,
2013
 
Residential real estate mortgages
 
$
1,073,207
   
$
1,041,637
 
Commercial
   
895,128
     
859,026
 
Commercial real estate mortgages
   
1,378,065
     
1,328,313
 
Real estate construction and development
   
94,019
     
93,247
 
Agricultural and agricultural real estate mortgages
   
109,035
     
112,035
 
Consumer
   
1,435,643
     
1,352,638
 
Home equity
   
589,391
     
619,899
 
Total loans
 
$
5,574,488
   
$
5,406,795
 

Total loans increased by $167.7 million, or 3.1%, at June 30, 2014 from December 31, 2013, or 6.3% annualized during the six months ended June 30, 2014.  The increase is due to organic loan growth within the Bank’s footprint through both legacy and newer markets.  Loans represent approximately 70.9% of assets as of June 30, 2014, as compared to 70.7% as of December 31, 2013.  Growth in commercial and commercial real estate loans for the first six months of 2014 totaled $85.9 million and growth in consumer loans totaled $83.0 million for the first six months of 2014 and is attributed primarily to growth in the indirect consumer loan portfolio.

53

Allowance for Loan Losses, Provision for Loan Losses, and Nonperforming Assets

The allowance for loan losses is maintained at a level estimated by management to provide adequately for risk of probable losses inherent in the current loan portfolio.  The adequacy of the allowance for loan losses is continuously monitored using a methodology designed to ensure that the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan portfolio.

Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the degree of judgment exercised in evaluating the level of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the consolidated results of operations.

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectability of the portfolio.  For individually analyzed loans, these factors include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date.  For homogeneous pools of loans, estimates of the Company’s exposure to credit loss reflect a thorough current assessment of a number of factors, which could affect collectability. These factors include: past loss experience; the size, trend, composition, and nature of the loans; changes in lending policies and procedures, including underwriting  standards and collection, charge-off and recovery practices;  trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market; portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff.  In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to recognize additions to the allowance based on their judgment about information available to them at the time of their examination, which may not be currently available to management.

After a thorough consideration and validation of the factors discussed above, required additions or reductions to the allowance for loan losses are made periodically by charges or credits to the provision for loan losses.  These charges are necessary to maintain the allowance at a level which management believes is reasonably reflective of the overall inherent risk of probable loss in the portfolio.  While management uses available information to recognize losses on loans, additions or reductions to the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.  Management considers the allowance for loan losses to be adequate based on evaluation and analysis of the loan portfolio.

The following table reflects changes to the allowance for loan losses for the periods presented. The allowance is increased by provisions for losses charged to operations and is reduced by net charge-offs. Charge-offs are made when the ability to collect loan principal within a reasonable time becomes unlikely. Any recoveries of previously charged-off loans are credited directly to the allowance for loan losses.
54

Allowance For Loan Losses
 
 
   
 
   
 
   
 
 
 
 
Three months ended
 
(dollars in thousands)
 
June 30, 2014
   
 
   
June 30, 2013
   
 
Balance, beginning of period
 
$
69,434
   
 
   
$
68,734
   
 
Recoveries
   
1,174
   
 
     
1,201
   
 
Chargeoffs
   
(5,240
)
 
 
     
(5,153
)
 
 
Net chargeoffs
   
(4,066
)
 
     
(3,952
)
 
 
Provision for loan losses
   
4,166
   
     
     
6,402
   
 
Balance, end of period
 
$
69,534
   
   
$
71,184
   
 
Composition of Net Chargeoffs
            
    
           
 
 
Commercial and agricultural
 
(1,113
)
   
27
%
 
(782
)
   
20
%
Real estate mortgage
   
(19
)
   
0
%
   
(213
)
   
5
%
Consumer
   
(2,934
)
   
73
%
   
(2,957
)
   
75
%
Net chargeoffs
 
(4,066
)
   
100
%
 
(3,952
)
   
100
%
Annualized net chargeoffs to average loans
   
0.30
%
           
0.30
%
        
 
 
 
Six months ended
 
(dollars in thousands)
 
June 30, 2014
         
June 30, 2013
       
Balance, beginning of period
 
$
69,434
       
$
69,334
       
Recoveries
   
2,408
         
2,659
     
Chargeoffs
   
(10,070
)
         
(12,869
)
     
Net chargeoffs
   
(7,662
)
       
(10,210
)
   
Provision for loan losses
   
7,762
           
12,060
       
Balance, end of period
 
$
69,534
         
$
71,184
       
Composition of Net Chargeoffs
                           
Commercial and agricultural
 
$
(1,193
)
   
16
%
 
$
(3,637
)
   
36
%
Real estate mortgage
   
(244
)
   
3
%
   
(870
)
   
9
%
Consumer
   
(6,225
)
   
81
%
   
(5,703
)
   
55
%
Net chargeoffs
 
$
(7,662
)
   
100
%
 
$
(10,210
)
   
100
%
Annualized net chargeoffs to average loans
   
0.28
%
             
0.42
%
       
 
Net charge-offs were $4.1 million for the second quarter of 2014, up from $3.6 million for the first quarter of 2014, and up slightly from $4.0 million for the second quarter of 2013.  Net charge-offs to average loans for the second quarter of 2014 was 0.30%, compared to 0.27% for the first quarter of 2014 and 0.30% for the same period in 2013.  NBT recorded a provision for loan losses of $4.2 million for the three months ended June 30, 2014, compared with $3.6 million for the previous quarter, and $6.4 million for the same period in 2013.

Nonperforming loans to total loans was 0.96% at June 30, 2014, down from 0.99% at March 31, 2014 and December 31, 2013.  Past due loans as a percentage of total loans was 0.57% for the second quarter of 2014, which was equivalent to the first quarter of 2014, and down from 0.77% as of December 31, 2013.

The allowance for loan losses totaled $69.5 million at June 30, 2014, up slightly from $69.4 million at December 31, 2013.  The allowance for loan losses as a percentage of loans was 1.25% (1.44% excluding acquired loans) at June 30, 2014, compared to 1.27% (1.51% excluding acquired loans with no related allowance recorded) at March 31, 2014 and 1.28% (1.55% excluding acquired loans with no related allowance recorded) at December 31, 2013.
55

Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due and still accruing, restructured loans, OREO, and nonperforming securities. Loans are generally placed on nonaccrual when principal or interest payments become ninety days past due, unless the loan is well secured and in the process of collection. Loans may also be placed on nonaccrual when circumstances indicate that the borrower may be unable to meet the contractual principal or interest payments. OREO represents property acquired through foreclosure and is valued at the lower of the carrying amount or fair value, less any estimated disposal costs.  Nonperforming securities, which include securities which management believes are other-than-temporarily impaired, are carried at their estimated fair value and are not accruing interest.
 
Nonperforming Assets
 
   
   
   
 
 
 
June 30,
   
December 31,
 
(Dollars in thousands)
 
2014
   
2013
 
Nonaccrual loans
 
Amount
   
%
   
Amount
   
%
 
Commercial and agricultural loans and real estate
 
$
26,273
     
52
%
 
$
27,033
     
54
%
Real estate mortgages
   
10,450
     
20
%
   
10,296
     
21
%
Consumer
   
7,613
     
15
%
   
7,213
     
14
%
Troubled debt restructured loans
   
6,898
     
13
%
   
5,423
     
11
%
Total nonaccrual loans
   
51,234
     
100
%
   
49,965
     
100
%
Loans 90 days or more past due and still accruing
                               
Commercial and agricultural loans and  real estate
   
-
     
-
%
   
105
     
3
%
Real estate mortgages
   
119
     
5
%
   
808
     
22
%
Consumer
   
2,067
     
95
%
   
2,824
     
75
%
Total loans 90 days or more past due and still accruing
   
2,186
     
100
%
   
3,737
     
100
%
 
                               
Total nonperforming loans
   
53,420
             
53,702
         
Other real estate owned (OREO)
   
1,953
             
2,904
         
Total nonperforming assets
   
55,373
             
56,606
         
Total nonperforming loans to total loans
   
0.96
%
           
0.99
%
       
Total nonperforming assets to total assets
   
0.70
%
           
0.74
%
       
Allowance for loan losses to total nonperforming loans
   
130.16
%
           
129.29
%
       

Past due loans as a percentage of total loans was 0.57% at June 30, 2014, down from 0.77% at December 31, 2013.  In addition to nonperforming loans, the Company has also identified approximately $97.0 million in potential problem loans at June 30, 2014 as compared to $89.9 million at December 31, 2013.  The increase was due to a downgrade of one large commercial loan during the first quarter of 2014.  At June 30, 2014, potential problem loans primarily consisted of commercial real estate and commercial and agricultural loans.  Potential problem loans are loans that are currently performing, but known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in classification of such loans as nonperforming at some time in the future.  Potential problem loans are typically defined as loans that are performing but are classified by the Company’s loan rating system as “substandard.”  Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses.
56

Deposits

Total deposits were $6.0 billion at June 30, 2014, up $152.4 million, or 2.6%, from December 31, 2013, due primarily to growth in NOW and money market accounts.  Total average deposits for the six months ended June 30, 2014 increased $479.0 million, or 8.7%, from the same period in 2013, due primarily to the acquisition of Alliance.

Borrowed Funds

The Company's borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $534.5 million at June 30, 2014 compared to $456.0 million at December 31, 2013.  Long-term debt was $251.1 million at June 30, 2014, as compared to $308.8 million at December 31, 2013.  As part of a debt restructuring strategy during the second quarter of 2014, the Company repaid $165.0 million in long-term borrowings, resulting in $17.1 million in prepayment penalties.  Prepayment penalties of $4.6 million (non-core) was recognized as expense in the second quarter of 2014 and related to the $45.0 million of the long-term debt strategy that was completed during the quarter.  The remaining prepayment penalties of approximately $13 million (non-core) will be recognized in the third quarter of 2014 upon completion of the restructure strategy. The fully executed strategy is expected to lower the cost of the restructured long-term debt by approximately 200 basis points and is expected to improve our interest rate risk profile.

For more information about the Company’s borrowing capacity and liquidity position, see “Liquidity Risk” below.

Capital Resources

Stockholders' equity of $857.1 million represented 10.89% of total assets at June 30, 2014, compared with $816.6 million, or 10.67% as of December 31, 2013.  Net income of $45.6 million and a $10.2 million increase in other comprehensive income due to a decrease in unrealized losses on securities were partially offset by dividends paid of $18.4 million.

The Company purchased 3,288 shares of its common stock during the six months ended June 30, 2014 at an average price of $22.02 per share under a previously announced plan.  As of June 30, 2014, there were 996,712 shares available for repurchase under this plan, which expires on December 31, 2014.

The Board of Directors considers the Company's earnings position and earnings potential when making dividend decisions.  The Board of Directors declared a 2014 third-quarter cash dividend of $0.21 per share at a meeting held on July 28, 2014.  The dividend will be paid on September 15, 2014 to shareholders of record as of September 1, 2014.  The Company does not have a target dividend pay-out ratio.

As the capital ratios in the following table indicate, the Company remained “well capitalized” at June 30, 2014 under applicable bank regulatory requirements.  Capital measurements are well in excess of regulatory minimum guidelines and meet the requirements to be considered well capitalized for all periods presented. Tier 1 leverage, Tier 1 capital and Total risk-based capital ratios have regulatory minimum guidelines of 3%, 4% and 8% respectively, with requirements to be considered well capitalized of 5%, 6% and 10%, respectively.

Capital Measurements
 
June 30,
2014
   
December 31,
2013
 
Tier 1 leverage ratio
   
9.23
%
   
8.93
%
Tier 1 capital ratio
   
11.95
%
   
11.74
%
Total risk-based capital ratio
   
13.18
%
   
12.99
%
Cash dividends as a percentage of net income
   
40.36
%
   
54.28
%
Per common share:
               
Book value
 
$
19.61
   
$
18.77
 
Tangible book value (1)
 
$
13.06
   
$
12.09
 
 
(1) Stockholders' equity less goodwill and intangible assets divided by common shares outstanding
57

Liquidity and Interest Rate Sensitivity Management

Market Risk
Interest rate risk is the primary market risk affecting the Company.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.  Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest bearing liabilities mature or reprice on a different basis than earning assets.  When interest bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when earning assets mature or reprice more quickly than interest bearing liabilities, falling interest rates could result in a decrease in net interest income.

In an attempt to manage the Company's exposure to changes in interest rates, management monitors the Company’s interest rate risk.  Management’s Asset Liability Committee (“ALCO”) meets monthly to review the Company’s interest rate risk position and profitability and to recommend strategies for consideration by the Board of Directors.  Management also reviews loan and deposit pricing and the Company’s securities portfolio, formulates investment and funding strategies, and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential effect of changing interest rates is an uncertainty that can have an adverse effect on net income.

In adjusting the Company’s asset/liability position, the Board and management attempt to manage the Company’s interest rate risk while minimizing net interest margin compression.  At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin.  The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and fluctuations in the difference between long- and short-term interest rates.  Assuming interest rates remain at or near current historical lows, net interest margin will continue to experience compression.  Additional rate reductions on deposits are becoming more difficult as deposit rates are at or near their floors, and with asset yields continuing to reprice at lower rates, this could result in additional margin pressure as well as a decrease in net interest income.

The primary tool utilized by ALCO to manage interest rate risk is a balance sheet/income statement simulation model (interest rate sensitivity analysis).  Information such as principal balance, interest rate, maturity date, cash flows, next repricing date (if needed), and current rates is uploaded into the model to create an ending balance sheet.  In addition, ALCO makes certain assumptions regarding prepayment speeds for loans and mortgage related investment securities along with any optionality within the deposits and borrowings.
58

 
The model is first run under an assumption of a flat rate scenario (i.e. no change in current interest rates) with a static balance sheet over a 12-month period.  Two additional models are run with static balance sheets: (1) a gradual increase of 200 bp, and (2) a gradual decrease of 100 bp taking place over a 12-month period. Under these scenarios, assets subject to prepayments are adjusted to account for faster or slower prepayment assumptions.  Any investment securities or borrowings that have callable options embedded into them are handled accordingly based on the interest rate scenario. The resulting changes in net interest income are then measured against the flat rate scenario.
 
In the declining rate scenario, net interest income is projected to decrease when compared to the forecasted net interest income in the flat rate scenario through the simulation period. The decrease in net interest income is a result of earning assets repricing downward at a faster rate than interest bearing liabilities. The inability to effectively lower deposit rates will likely reduce or eliminate the benefit of lower interest rates. In the rising rate scenarios, net interest income is projected to experience a decline from the flat rate scenario. Net interest income is projected to remain at lower levels than in a flat rate scenario through the simulation period primarily due to a lag in assets repricing while funding costs increase. The potential impact on earnings is dependent on the ability to lag deposit repricing. If short-term rates continue to increase, the Company expects competitive pressures will likely lead to core deposit pricing increases, which will likely continue compression of the net interest margin.

Net interest income for the next 12 months in the + 200/- 100 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% change in net interest income. The following table summarizes the percentage change in net interest income in the rising and declining rate scenarios over a 12-month period from the forecasted net interest income in the flat rate scenario using the June 30, 2014 balance sheet position:

Interest Rate Sensitivity Analysis
 
Change in interest rates
Percent change in
(in bp points)
net interest income
+200
(3.06%)
-100
(1.55%)

Liquidity Risk
Liquidity involves the ability to meet the cash flow requirements of customers who may be depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. The ALCO is responsible for liquidity management and has developed guidelines which cover all assets and liabilities, as well as off balance sheet items that are potential sources or uses of liquidity.  Liquidity policies must also provide the flexibility to implement appropriate strategies and tactical actions. Requirements change as loans grow, deposits and securities mature, and payments on borrowings are made. Liquidity management includes a focus on interest rate sensitivity management with a goal of avoiding widely fluctuating net interest margins through periods of changing economic conditions.

The primary liquidity measurement the Company utilizes is called the Basic Surplus, which captures the adequacy of its access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  Basic Surplus is calculated by subtracting short-term liabilities from liquid assets.  This approach recognizes the importance of balancing levels of cash flow liquidity from short- and long-term securities with the availability of dependable borrowing sources which can be accessed when necessary.  At June 30, 2014, the Company’s Basic Surplus measurement was 8.5% of total assets or approximately $669 million as compared to the December 31, 2013 Basic Surplus of 9.7% or $734 million, and was above the Company’s minimum of 5% or $393 million set forth in its liquidity policies.

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This Basic Surplus approach enables the Company to adequately manage liquidity from both operational and contingency perspectives. By tempering the need for cash flow liquidity with reliable borrowing facilities, the Company is able to operate with a more fully invested and, therefore, higher interest income generating securities portfolio. The makeup and term structure of the securities portfolio is, in part, impacted by the overall interest rate sensitivity of the balance sheet. Investment decisions and deposit pricing strategies are impacted by the liquidity position.
 
The Company’s primary source of funds is the Bank. Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends. The approval of the Office of Comptroller of the Currency (OCC) is required to pay dividends when a bank fails to meet certain minimum regulatory capital standards or when such dividends are in excess of a subsidiary bank’s earnings retained in the current year plus retained net profits for the preceding two years (as defined in the regulations). At June 30, 2014, approximately $76.4 million of the total stockholders’ equity of the Bank was available for payment of dividends to the Company without approval by the OCC.  The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. The Bank is currently in compliance with these requirements. Under the General Corporation Law of the State of Delaware, the Company may declare and pay dividends either out of its surplus or, in case there is no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

At June 30, 2014 and December 31, 2013, FHLB advances outstanding totaled approximately $709 million and $515 million, respectively.  The Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $502 million at June 30, 2014 and $497 million at December 31, 2013.  In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $489 million at June 30, 2014, or used to collateralize other borrowings, such as repurchase agreements.  At June 30, 2014 the Bank also had additional borrowing capacity from unused collateral at the Federal Reserve of $791 million.

Recent Accounting Pronouncements
In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-01 —Investments (Topic 323), Accounting for Investments in Qualified Affordable Housing Projects.  The amendments in this ASU provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU are effective for the Company for annual periods beginning January 1, 2015 and should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments.  The Company does not expect the adoption to have a material impact on the financial statements.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information called for by Item 3 is contained in the Liquidity and Interest Rate Sensitivity Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 4. 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) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, the Company's disclosure controls and procedures were effective.

There  were  no changes made in the Company's internal control over financial  reporting  that  occurred  during  the  Company's  most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

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PART II.  OTHER INFORMATION

Item 1 LEGAL PROCEEDINGS

There are no material legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is subject, except as described in the Company’s 2013 Annual Report on Form 10-K.

Item 1A – RISK FACTORS

There are no material changes to the risk factors as previously discussed in Part I, Item 1A of our 2013 Annual Report on Form 10-K.

Item 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) Not applicable
 
(b) Not applicable
 
(c) The table below sets forth the information with respect to purchases made by the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) of our common stock during the quarter ended June 30, 2014:

Period
 
Total Number of
Shares Purchased
   
Average Price Paid
Per Share
   
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
   
Maximum Number of
Shares That May Yet
be Purchased Under
The Plans (1)
 
4/1/14 - 4/30/14
   
-
   
$
-
     
-
     
1,000,000
 
5/1/14 - 5/31/14
   
3,288
     
22.02
     
3,288
     
996,712
 
6/1/14 - 6/30/14
   
-
     
-
     
-
     
996,712
 
Total
   
3,288
   
$
22.02
     
3,288
     
996,712
 

(1) On July 22, 2013, the NBT Board of Directors authorized a repurchase program for NBT to repurchase up to an additional 1,000,000 shares of its outstanding common stock.  The Company purchased 3,288 shares of its common stock during the six months ended June 30, 2014 at an average price of $22.02 per share under this plan.  As of June 30, 2014, there were 996,712 shares available for repurchase under this plan, which expires on December 31, 2014.

Item 3 DEFAULTS UPON SENIOR SECURITIES
 
None

Item 4 MINE SAFETY DISCLOSURES
 
None

Item 5 OTHER INFORMATION
 
None
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Item 6 EXHIBITS

3.1   Certificate of Incorporation of NBT Bancorp Inc. as amended through May 2, 2012 (filed as Exhibit 3.1 to the Registrant's Form 10-Q for the quarter ended September 30, 2012, filed on November 9, 2012 and incorporated herein by reference).

3.2   Amended and Restated By-laws of NBT Bancorp Inc., effective May 7, 2013 (filed as Exhibit 3.1 to the Registrant's Form 8-K, filed on May 7, 2013 and incorporated herein by reference).

3.3   Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registrant’s Form 8-K, filed on November 18, 2004, and incorporated herein by reference).

4.1   Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

4.2   Rights Agreement, dated as of November 15, 2004, between NBT Bancorp Inc. and Registrar and Transfer Company, as Rights Agent (filed as Exhibit 4.1 to the Registrant's Form 8-K, file number 0-14703, filed on November 18, 2004, and incorporated by reference herein).

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Written Statement of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Written Statement of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS  XBRL Instance Document.

101.SCH  XBRL Taxonomy Extension Schema Document.

101.CAL  XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF  XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB  XBRL Taxonomy Extension Label Linkbase Document.

101.PRE  XBRL Taxonomy Extension Presentation Linkbase Document.
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, this 11th day of August 2014.

 
 
NBT BANCORP INC.
 
 
 
 
 
 
By:
/s/ Michael J. Chewens
 
 
 
Michael J. Chewens, CPA
 
 
 
Senior Executive Vice President
 
 
 
Chief Financial Officer
 

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EXHIBIT INDEX

3.1   Certificate of Incorporation of NBT Bancorp Inc. as amended through May 2, 2012 (filed as Exhibit 3.1 to the Registrant's Form 10-Q for the quarter ended September 30, 2012, filed on November 9, 2012 and incorporated herein by reference).

3.2   Amended and Restated By-laws of NBT Bancorp Inc., effective May 7, 2013 (filed as Exhibit 3.1 to the Registrant's Form 8-K, filed on May 7, 2013 and incorporated herein by reference).

3.3   Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registrant’s Form 8-K, filed on November 18, 2004, and incorporated herein by reference).

4.1   Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

4.2   Rights Agreement, dated as of November 15, 2004, between NBT Bancorp Inc. and Registrar and Transfer Company, as Rights Agent (filed as Exhibit 4.1 to the Registrant's Form 8-K, file number 0-14703, filed on November 18, 2004, and incorporated by reference herein).

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Written Statement of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Written Statement of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS  XBRL Instance Document.

101.SCH  XBRL Taxonomy Extension Schema Document.

101.CAL  XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF  XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB  XBRL Taxonomy Extension Label Linkbase Document.

101.PRE  XBRL Taxonomy Extension Presentation Linkbase Document.
 
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