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<CIK> 0000796317
<NAME> ALLIANCE FINANCIAL CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 23,431
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<FED-FUNDS-SOLD> 10,700
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 158,801
<INVESTMENTS-CARRYING> 2,630
<INVESTMENTS-MARKET> 2,681
<LOANS> 264,102
<ALLOWANCE> 3,001
<TOTAL-ASSETS> 471,705
<DEPOSITS> 413,594
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<LIABILITIES-OTHER> 6,191
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<INTEREST-DEPOSIT> 13,300
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<INTEREST-INCOME-NET> 18,815
<LOAN-LOSSES> 770
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</TABLE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] 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 0-15366
ALLIANCE FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
State of incorporation: New York
I.R.S. Employer Identification No.: 16-1276885
Address of principal executive offices: 65 Main Street, Cortland, NY 13045
Registrant's telephone number including area code: (607) 756-2831
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$1.00 par value.
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on March 12, 1999 was $64,851,608.
The number of shares outstanding of the Registrant's common stock on March 12,
1999: Common Stock, $1.00 Par Value --- 3,594,811 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual shareholders' meeting to be held
April 28, 1999 (the Proxy Statement), are incorporated by reference in Part III.
Page 1 of 71. Exhibit Index is located on Page 68.
1
<PAGE>
TABLE OF CONTENTS
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED
DECEMBER 31, 1998
ALLIANCE FINANCIAL CORPORATION
Page
PART I
Item 1. Business 3
Item 2. Properties 5
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II
Item 5. Market for the Registrants Common Stock and
Related Shareholder Matters 7
Item 6. Selected Financial Data 9
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 8. Financial Statements and Supplementary Data 37
Item 9. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure 67
PART III
Item 10. Directors and Executive Officers of the Registrant 67
Item 11. Executive Compensation 67
Item 12. Security Ownership of Certain Beneficial Owners and
Management 67
Item 13. Certain Relationships and Related Transactions 67
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 67
2
<PAGE>
PART I
This Annual Report on Form 10-K contains certain forward-looking statements with
respect to the financial condition, results of operations and business of
Alliance Financial Corporation and its subsidiaries. These forward- looking
statements involve certain risks and uncertainties. Factors that may cause
actual results to differ materially from those contemplated by such
forward-looking statements include, among others, the following possibilities:
(1) expected cost savings from the merger described herein cannot be fully
realized or cannot be realized as quickly as anticipated; (2) the planned
expansion into the Syracuse market is not completed on schedule or on budget or
the new branches do not attract the expected loan and deposit customers; (3)
competitive pressure in the banking industry increases significantly; (4) costs
or difficulties related to the integration of the businesses of Cortland First
Financial Corporation and Oneida Valley Bancshares, Inc. are greater than
expected; (5) changes in the interest rate environment reduce margins; (6)
general economic conditions, either nationally or regionally, are less favorable
than expected, resulting in, among other things, a deterioration in credit
quality; (7) changes occur in the regulatory environment; (8) changes occur in
business conditions and inflation; and (9) changes occur in the securities
markets.
Item 1 -- Description of the Business
General
Alliance Financial Corporation ("Company") is a New York registered bank holding
company formed November 25, 1998 as a result of the merger of Cortland First
Financial Corporation and Oneida Valley Bancshares, Inc. which were incorporated
in May 30, 1986 and October 31, 1984, respectively. The Company is the parent
holding company of First National Bank of Cortland and Oneida Valley National
Bank which have received approval from the Office of the Comptroller of the
Currency to merge under the name Alliance Bank, N.A. The merger of the banks is
expected to take place in April 1999. Unless the context otherwise provides,
references herein to the "Company" mean Alliance Financial Corporation and the
Banks.
The Company provides banking services through dual headquarter offices
located at 65 Main Street, Cortland, NY and 160 Main Street, Oneida, NY, as well
as through 15 customer service facilities located in Cortland, Madison, southern
and eastern Onondaga, northern Broome, and western Oneida counties.
At December 31, 1998, the Company had 228 full-time employees and 35
part-time employees.
The Banks are members of the Federal Reserve System and the Federal
Home Loan Bank System, and their deposits are insured by the Federal Deposit
Insurance Corporation ("FDIC") up to applicable limits.
Services
The Company offers full service banking with a broad range of financial products
to meet the needs of its commercial, retail, government, and trust customers.
Depository account services include interest and non-interest bearing checking
accounts, money market accounts, savings accounts, time deposit accounts, and
individual retirement accounts. The Company's
3
<PAGE>
lending activities include the making of residential and commercial mortgage
loans, business lines of credit and business term loans, working capital
facilities and accounts receivable financing programs, as well as installment
loans, student loans, and personal lines of credit to individuals. Trust
department services include personal trust, employee benefit trust, investment
management, financial planning and custodial services. The Company also offers
safe deposit boxes, travelers checks, money orders, wire transfers, collection
services, drive-in facilities, automatic teller machines, 24-hour telephone
banking, and 24-hour night depositories.
Competition
The Company's business is extremely competitive. The Company competes not only
with other commercial banks but also with other financial institutions such as
thrifts, credit unions, money market and mutual funds, insurance companies,
brokerage firms, and a variety of other companies offering financial services.
Supervision and Regulation
The Company is registered as a bank holding company under the Bank Holding
Company Act of 1956, as amended (the "Act") and as such is subject to regulation
by the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board"). As a bank holding company, the Company's activities and those of its
subsidiaries are limited to the business of banking and activities closely
related or incidental to banking. The Act requires the prior approval of the
Federal Reserve Board in any case where a bank holding company proposes to
acquire direct or indirect ownership or control of more than 5% of any class of
the voting shares of, or substantially all of the assets of, any bank (unless it
owns a majority of such bank's voting shares) or otherwise to control a bank or
to merge or consolidate with any other bank holding company. The Act also
prohibits a bank holding company, with certain exceptions, from acquiring more
than 5% of the voting shares of any company that is not a bank.
The Company is a legal entity separate and distinct from its bank
subsidiaries. The principal source of the Company's income is earnings from the
Company's subsidiaries, and the principal source of its cash flow is dividends
from the subsidiary banks. Federal laws impose limitations on the ability of the
subsidiary banks to pay dividends as discussed in the Notes to Consolidated
Financial Statements. Federal Reserve Board policy requires bank holding
companies to serve as a source of financial strength to their subsidiary banks
by standing ready to use available resources to provide adequate capital funds
to their subsidiary banks during periods of financial stress or adversity.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") substantially revised the depository institution regulatory and
funding provisions of the Federal Deposit Insurance Act and made revisions to
several other federal banking statutes. Among other things, federal banking
regulators are required to take prompt corrective action in respect of
depository institutions that do not meet minimum capital requirements. FDICIA
identifies the following capital categories for financial institutions: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized. Rules adopted by the federal
banking agencies under FDICIA provide that an institution is deemed to be well
capitalized if the institution has a total
4
<PAGE>
risk-based capital ratio of 10.0% or greater, a Tier I risk-based ratio of 6.0%
or greater, and a leverage ratio of 5.0% or greater, and the institution is not
subject to an order, written agreement, capital directive, or prompt corrective
action directive to meet and maintain a specific level for any capital measure.
FDICIA imposes progressively more restrictive constraints on operation,
management, and capital distributions, depending on the capital category in
which an institution is classified. At December 31, 1998, the Company and its
subsidiary banks fell into the well capitalized category based on the ratios and
guidelines noted above.
The Company's subsidiary banks are supervised and regularly examined by
the Office of the Comptroller of the Currency (OCC). The various laws and
regulations administered by the OCC affect corporate practices such as payment
of dividends, incurring debt, and acquisition of financial institutions and
other companies, and affect business practices, such as payment of interest on
deposits, the charging of interest on loans, the types of business conducted,
and location of offices. The Company's regulators have broad authority to
initiate proceedings designed to prohibit its subsidiary banks from engaging in
unsafe and unsound banking practices. There are no regulatory orders or
outstanding issues resulting from regulatory examinations of the Company's
subsidiary banks.
Item 2 -- Properties
The Registrant operates the following branches:
Name of Office Location County Date Established
Home Office 65 Main Street Cortland March 1, 1869
Cortland, NY
Canastota Stroud Street & Route 5 Madison December 7, 1974
Canastota, NY
Cincinnatus 2743 NYS Route 26 Cortland January 1, 1943
Cincinnatus, NY
Groton Avenue 1125 Groton Avenue Cortland June 22, 1987
Cortland, NY
Hamilton 1 Madison Street Madison December 7, 1949
Hamilton, NY
Hamilton 38-40 Utica Street Madison January 26, 1976
Drive-Up Hamilton, NY
Manlius 201 Fayette Street Onondaga October 19, 1994
Manlius, NY
Marathon 14 E. Main Street Cortland August 15, 1957
Marathon, NY
5
<PAGE>
McGraw 30 Main Street Cortland May 1, 1967
McGraw, NY
North Main North Main Street Madison September 9, 1966
Oneida, NY
Oneida 160 Main Street Madison December 12, 1851
Oneida, NY
Sherrill 628 Sherrill Road Oneida April 2, 1954
Sherrill, NY
TOPS Plaza Route 5 and Route 46 Madison January 7, 1988
Oneida, NY
Tully Route 80 at I-81 Onondaga January 26, 1989
Tully, NY
Whitney Point 2950 NYS Route 11 Broome April 7, 1994
Whitney Point, NY
Wal-Mart 872 NYS Route 13 Cortland March 10, 1997
(Cortland) Cortland, NY
Wal-Mart 1294 Lenox Avenue Madison July 17, 1996
(Oneida) Oneida, NY
The TOPS Plaza, Tully, Whitney Point, and both Wal-Mart offices are leased. The
other banking premises are owned.
Item 3 -- Legal Proceedings
In December 1998, the Oneida Indian Nation ("The Nation") and the U.S. Justice
Department filed motions to amend a long outstanding claim against the State of
New York to include a class of 20,000 unnamed defendants who own real property
in Madison and Oneida Counties. If the motion is granted to amend the claim,
litigation could involve assets of the Company. The United States District Court
is scheduled to hear arguments on the matter on March 26, 1999. "The Nation" has
represented that the legal action currently being undertaken is to force the
State of New York to negotiate an equitable settlement of their original claim
which was ruled on by the United States Supreme Court in favor of "The Nation"
over 13 years ago. Management believes that ultimately the State of New York
will be held responsible for these claims, and this matter will be settled
without adversely impacting the Company.
There are no other pending legal proceedings, other than routine
litigation incidental to the business of the subsidiary banks, to which the
Company or its subsidiary banks are a party or to which their property is the
subject. In management's opinion, no pending action, if adversely decided, would
materially affect the banks or the Company's financial condition.
6
<PAGE>
Item 4 -- Submission of Matters to a Vote of Security Holders
A Special Meeting of the Shareholders of Cortland First Financial Corporation
was held on November 16, 1998 for the purpose of considering and voting on the
following two proposals:
Proposal 1: Approval and Adoption of an Agreement and Plan of
Reorganization and the related Plan of Merger among Cortland
First Financial Corporation (Cortland), First National Bank
of Cortland, Oneida Valley Bancshares, Inc. (Oneida), and
Oneida Valley National Bank pursuant to which, among other
things, Cortland and Oneida will merge under the name
"Alliance Financial Corporation."
Proposal 2: Approval of the Alliance Financial Corporation 1998 Long
Term Incentive Compensation Plan.
The voting results are as follows:
Proposal 1: Votes For 1,757,929
Votes Against or Withheld 46,430
Absentees and Broker Non-Votes 165,417
Proposal 2: Votes For 1,616,866
Votes Against or Withheld 187,490
Absentees and Broker Non-Votes 165,420
Pursuant to the Plan of Merger approved in Item 1, all members of the Boards of
Directors of Cortland and Oneida continued as members of the Board of Directors
of Alliance Financial Corporation.
PART II
Item 5 -- Market for Registrant's Common Stock and Related Shareholders
Matters
Common Stock Data:
The common stock of the Company is listed for quotation on the Nasdaq National
Market System under the symbol ALNC. Prior to January 1999, the common stock of
the Company was listed for quotation on the OTC Bulletin Board of The Nasdaq
Stock Market (the "Bulletin Board"). Market makers for the stock are Ryan, Beck
& Company (800-342-2325), Tucker Anthony (800-343- 3036), and First Albany
Corporation (800-336-3245). There were 978 shareholders of record as of December
31, 1998. The following table presents stock prices for Alliance Financial
Corporation for the fourth quarter of 1998 (on and after November 25, 1998), and
for Cortland First Financial Corporation for the four quarters of 1997 and the
first three quarters of 1998. Dividends paid have been restated to reflect the
combined dividends of Cortland First Financial Corporation and Oneida Valley
National Bancshares, Inc. Stock prices below are based on high bid and low bid
prices for the quarter.
7
<PAGE>
1998 High Low Dividend Paid
- ---- ------- ------- -------------
1st Quarter $ 29.25 $ 27.00 $ .14
2nd Quarter 29.25 29.25 .14
3rd Quarter 30.50 25.00 .14
4th Quarter 31.25 25.00 .25
1997 High Low Dividend Paid
- ---- ------- ------- -------------
1st Quarter $ 20.50 $ 20.00 $ .14
2nd Quarter 21.50 21.25 .14
3rd Quarter 22.50 22.25 .14
4th Quarter 26.00 22.25 .46
The transfer agent for the stock is American Stock Transfer & Trust Company
(ASTC). They can be contacted at the following address:
Registrar and Transfer Agent
American Stock Transfer & Trust Company
40 Wall Street - 46th Floor
New York, NY 10005
Automatic Dividend Reinvestment Plan
This plan is administered by ASTC, as your agent. It offers a convenient way for
shareholders to increase their investment in the Company. The plan enables
certain shareholders to reinvest cash dividends on all or part of their common
stock in additional shares of the Company's common stock without paying
brokerage commissions or service charges. Shareholders who are interested in
this program may receive a Plan Prospectus and enrollment card by writing or
calling ASTC Dividend Reinvestment at 1-800-278-4353.
8
<PAGE>
Item 6 -- Selected Financial Data (Dollars in thousands except per-share data)
Five Year Comparative Summary
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Assets and Deposits 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Loans $261,101 $247,821 $240,603 $231,114 $224,813
Investment Securities 161,431 152,001 145,255 142,159 136,495
Deposits 413,594 377,927 372,588 360,376 353,155
Total Assets 471,705 436,430 428,310 412,808 399,663
Trust Dept Assets 147,244 145,487 125,833 103,448 85,427
(not included in Total Assets)
Shareholders' Equity 51,168 49,750 50,177 47,542 41,465
(Capital, Surplus & Undivided Profits)
Operating Income & Expenses
Total Interest Income 32,213 31,791 31,016 30,449 28,139
Total Interest Expense 13,398 12,984 12,194 12,013 9,503
Net Interest Income 18,815 18,807 18,822 18,436 18,636
Provision for Possible
Loan Losses 770 625 633 475 340
Net Interest Income
after Provision for
Possible Loan Losses 18,045 18,182 18,189 17,961 18,296
Other Operating Income 3,989 3,866 3,387 3,168 2,915
Total Operating Income 22,034 22,048 21,576 21,129 21,211
Salaries & Related
Expense 8,712 8,206 7,695 7,543 7,071
Occupancy & Equipment
Expense 2,607 2,412 2,265 2,188 2,060
Other Operating
Expense 6,178 4,077 3,828 3,850 4,175
Total Operating
Expense 17,497 14,695 13,788 13,581 13,306
Income Before Taxes 4,537 7,353 7,788 7,548 7,905
Provision for Income
Taxes 1,104 2,220 2,434 2,410 2,604
----- ----- ----- ----- -----
Net Income 3,433 5,133 5,354 5,138 5,301
Per-Share Statistics
Net Income $ 0.95 $ 1.40 $ 1.43 $ 1.37 $ 1.41
Book Value at Year End 14.23 13.82 13.47 12.67 11.05
Cash Dividends
Declared 0.67 0.88 0.56 0.51 0.50
</TABLE>
9
<PAGE>
Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operation
MANAGEMENT'S DISCUSSION & ANALYSIS OF
THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION
INTRODUCTION
Alliance Financial Corporation (the Company) is a New York Corporation,
which was formed in November 1998 as a result of the merger of Cortland First
Financial Corporation (Cortland) and Oneida Valley Bancshares, Inc.(Oneida). The
Company is a bank holding company, which owns and operates two financial
institutions, First National Bank of Cortland and Oneida Valley National Bank.
Pursuant to the terms of the merger, each share of Cortland stock was exchanged
for one share of the Company's stock and each share of Oneida stock was
exchanged for 1.8 shares of the Company's stock. The merger constituted a
tax-free reorganization and has been accounted for as a pooling of interests
under Accounting Principals Board Opinion No. 16.
The following discussion and analysis reviews the Company's business
and provides information that has been restated to include the combined results
of operations and financial condition of Cortland and Oneida for all periods
presented. Certain reclassifications were made to Cortland and Oneida's prior
years financial statements to conform to the Company's presentation. The Office
of the Comptroller of the Currency has approved an application to merge the
First National Bank of Cortland and the Oneida Valley National Bank under the
name Alliance Bank, N.A. The banks expect to complete the merger on or about
April 15, 1999. This discussion should be read in conjunction with the
consolidated financial statements and accompanying notes, and other statistical
information included elsewhere in this 1998 Annual Report.
RESULTS OF OPERATIONS Net income for 1998 was $3.433 million, or $0.95 per
share, compared to $5.133 million, or $1.40 per share, in 1997. The 1998 net
income reflects the consolidated earnings of the Company's two wholly owned
subsidiaries, the First National Bank of Cortland and the Oneida Valley National
Bank, both of which operated independently throughout 1998. The Company incurred
the operating expenses of both subsidiaries along with associated costs of the
merger in 1998, with the benefits resulting from the business combination
expected in 1999. In connection with the merger, the Company recorded a
non-recurring charge in 1998 to operating expenses of $1.701 million which had
the effect of reducing net income after tax by $1.022 million and earnings per
share by $0.28. The Company also recorded other nonrecurring charges to
operating expense of approximately $250 thousand in connection with fees
associated with defending a hostile takeover attempt and the formation of a Real
Estate Investment Trust. Although the Company increased average earning assets
by $17.095 million, or 4.2% compared to the prior year, net interest income
increased less than 1% as declining market interest rates and a flat U.S.
Treasury yield curve in 1998 put pressures on the Company's asset yields.
Non-interest income in 1998 was up 3.2% compared to the previous year while
non-interest expense excluding nonrecurring charges was up 5.7%. Net income in
1997 declined $221 thousand, $0.03 per share, compared to net income of $5.354
million in 1996.
10
<PAGE>
Selected Performance Measures
Return on average assets, return on average equity, dividend payout and equity
to asset ratios for the years indicated are as follows:
1998 1997 1996
---- ---- ----
Percentage of net income to
Average total assets 0.74% 1.17% 1.26%
Percentage of net income to
Average shareholders' equity 6.91% 10.25% 11.04%
Percentage of dividends declared
to net income 70.20% 62.32% 38.94%
Percentage of average
shareholders' equity to
average total assets 10.95% 11.50% 11.43%
NET INTEREST INCOME
Net interest income is the Company's principal source of operating
income for payment of overhead and providing for possible loan losses. It is the
amount that interest and fees on loans, investments, and other earning assets
exceeds the cost of deposits and other interest-bearing liabilities.
Net interest income on a tax equivalent basis increased $168 thousand,
to $19.983 million in 1998. The growth in net interest income resulted from
increases in 1998's average earning assets offsetting a net interest margin that
continued to decline. Declining market interest rates, including the prime rate,
reduced yields in the Company's investment and loan portfolios. In 1997 net
interest income increased only $10 thousand as the margin decline offset nearly
all benefits of growth in earning assets during the year.
Loans represented the majority of the Company's interest earning assets
and have remained stable at 60.4% of earning assets over the past two years.
Although average loans increased $10.433 million in 1998, yields declined 22
basis points to 8.89%, with declines in commercial and residential mortgage loan
yields most significant. Interest income on loans in 1998 was up $397 thousand
compared to 1997. Average loans in 1997 increased $7.003 million compared to
1996 while average loan yields declined 10 basis points primarily due to the
decline in the real estate mortgage loan portfolio yields. Interest income on
loans was also up $397 thousand in 1997 compared to 1996.
Average investments in 1998 increased by $1.804 million, however, tax
equivalent interest income from investments was $75 thousand less than 1997. In
comparison, average investment securities increased $5.544 million in 1997
compared to 1996 with tax equivalent interest income up $591 thousand. Interest
income in 1998 from the sale of federal funds in the amount of $754 thousand,
was $260 thousand greater than the amount earned in 1997. Tax equivalent
interest income for 1998 at $33.381 million, was
11
<PAGE>
$582 thousand more than 1997, although the 1998 tax equivalent yield on average
earning assets was 7.86%, 19 basis points less than 1997. Average earning assets
for 1998 were $424.426 million, up $17.095 million compared to 1997, and
represented 93.5% of total average assets in 1998. Average earning assets in
1997 were 93.6% of total average assets.
During 1998, average interest-bearing liabilities increased by $14.190
million to $344.900 million. The cost of interest-bearing liabilities declined 5
basis points from 3.93% in 1997, to 3.88% in 1998. The Company's interest
expense, which is a function of the volume of, and rates paid for interest
bearing liabilities, increased $414 thousand, or 3.19% in 1998. The increase was
primarily a result of volume increases in interest-bearing demand deposits and
time deposits, which were partially offset by lower rates paid on both time and
savings deposit accounts. By comparison, interest expense increased $791
thousand, or 6.49% in 1997 as a result of increased time deposit balances and
higher rates paid on both time and money market savings deposits. Average
interest-bearing liabilities increased $9.644 million, or 3.0%, in 1997 compared
to 1996.
The Company's net interest margin (federal tax equivalent net interest
income divided by average earning assets) declined 15 basis points, from 4.86%
in 1997, to 4.71% in 1998.
The following table sets forth information concerning average interest-earning
assets and interest-bearing liabilities and the yields and rates thereon.
Interest income and yield information is adjusted for items exempt from federal
income taxes and assumes a 34% tax rate. Non-accrual loans have been included in
the average balances. Securities are shown at average amortized cost.
12
<PAGE>
Average Balances And Net Interest Income
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
---- ---- ----
(000's omitted except yields and rates)
Avg. Amt. Of Avg. Avg. Amt. of Avg. Avg. Amt. Of Avg.
alance Interest Yield/ Balance Interest Yield/ Balance Interest Yield/
Rate Rate Rate
Paid Paid Paid
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Federal Funds Sold $ 14,005 $ 754 5.38% $ 9,147 $ 494 5.40% $12,924 $ 681 5.27%
Taxable investment
securities 114,545 7,075 6.18% 117,433 7,440 6.34% 113,736 6,997 6.15%
Nontaxable investment
securities 39,426 2,752 6.98% 34,734 2,462 7.09% 32,887 2,314 7.04%
Loans (net of unearned
discount) 256,450 22,800 8.89% 246,017 22,403 9.11% 239,014 22,006 9.21%
-------- ------ ----- -------- ------ ----- -------- ------ -----
Total interest-earning
assets 424,426 33,381 7.86% 407,331 32,799 8.05% 398,561 31,998 8.03%
Noninterest earning
assets:
Other Assets 31,078 30,714 28,721
Less: Allowance for
loan losses (2,933) (2,980) (2,963)
Net unrealized gains on
available for-sale
portfolio 1,229 225 23
----- --- --
Total $453,800 $435,290 $424,342
======== ======== ========
13
<PAGE>
Liabilities and
Shareholder Equity:
Interest Bearing
Liabilities
Demand deposits $ 61,228 $ 1,191 1.95% $ 54,493 $1,017 1.87% $ 52,506 945 1.80%
Savings deposits 141,285 4,763 3.37% 140,041 4,821 3.44% 142,204 4,680 3.29%
Time deposits 140,639 7,346 5.22% 134,710 7,066 5.25% 125,407 6,526 5.20%
Short-term borrowings 1,748 98 5.60% 1,466 80 5.46% 949 42 4.43%
-------- ------- ----- ------- ------ ----- -------- ------ -----
Total interest-bearing
liabilities 344,900 13,398 3.88% 330,710 12,984 3.93% 321,066 12,193 3.80%
Noninterest bearing
liabilities:
Demand deposits 53,675 49,634 50,279
Other liabilities 5,553 4,887 4,495
Shareholder's equity 49,672 50,059 48,502
------ ------ ------
Total $453,800 $435,290 $424,342
======== ======== ========
Net interest earnings $ 19,983 $19,815 $19,805
======= ======= =======
Net yield on interest-
earning assets 4.71% 4.86% 4.97%
</TABLE>
14
<PAGE>
The following table sets forth the dollar volume of increase (decrease)
in interest income and interest expense resulting from changes in the volume of
earning assets and interest-bearing liabilities, and from changes in rates.
Volume changes are computed by multiplying the volume difference by the prior
year's rate. Rate changes are computed by multiplying the rate difference by the
prior year's balance. The change in interest due to both rate and volume has
been allocated equally between the volume and rate variances.
Volume And Rate Variances
<TABLE>
<CAPTION>
1998 Compared to 1997 1997 Compared to 1996
--------------------- ---------------------
Increase (Decrease) Due To Increase (Decrease) Due To
(000,s omitted) Volume Rate Net Change Volume Rate Net Change
<S> <C> <C> <C> <C> <C> <C>
Interest earned on:
Federal funds sold and time
deposits in other banks $ 264 $ (4) $ 260 $(204) $ 17 $(187)
Taxable investment securities (230) (135) (365) 245 198 443
Nontaxable investment
securities 316 (26) 290 108 40 148
Loans (net of unearned
discount) 952 (555) 397 634 (237) 397
Total interest earning assets $1,302 $(720) $ 582 $ 783 $ 18 $ 801
Interest paid on:
Interest bearing demand
deposits $ 159 $ 15 174 $ 53 $ 19 $ 72
Savings deposits (12) (46) (58) 4 137 141
Time deposits 355 (75) 280 478 62 540
Short-term borrowings 19 (1) 18 25 13 38
Total interest-bearing
liabilities $ 521 $(107) $ 414 $ 560 $ 231 $ 791
Net interest earnings (FTE) $ 781 $(613) $ 168 $ 223 $(213) $ 10
</TABLE>
15
<PAGE>
NON-INTEREST INCOME
Non-interest income for 1998 was $3.989 million, which was up 3.2%, or
$123 thousand, compared to 1997. Non-interest income increased 14.1%, or $479
thousand in 1997. The Company's non-interest income is composed of recurring
fees from normal banking operations, trust and data processing department fees,
and net gains/losses from sales of investment securities. Income from service
charges on deposits at $1.706 million, up 10.1% from the prior year following an
8.1% increase in 1997, was the principal source of the bank's non-interest
income. Trust department income increased only 1.8% in 1998 compared to an
increase of 4.7% in 1997, as a result of minimal income from estate
administration fees in 1998. Service fee income from data processing service
contracts continued to contribute significantly to other income. The Company
took minimal gains from the sale of investment securities in 1998. Gains on
sales of securities in 1998 of $26 thousand compared to $115 thousand in 1997.
Significant contributions to the Company's non-interest income were derived from
electronic banking service fees, the sale of mortgages and associated servicing
fees, and dividends received from the credit insurance programs offered through
the Company's subsidiary banks.
The following table sets forth certain information on non-interest income for
the years indicated.
Non-Interest Income
Years ended December 31,
(000's omitted) 1998 1997 1996
---- ---- ----
Trust department services $ 789 $ 775 $ 740
Service charges on deposit accounts 1,706 1,550 1,434
Data processing services 257 244 239
Investment securities gains/(losses) 26 115 (27)
Other operating income 1,211 1,182 1,001
----- ----- -----
Total non-interest income $3,989 $3,866 $3,387
NON-INTEREST EXPENSE
Operating expense in 1998, excluding nonrecurring merger-related and
other charges, increased $839 thousand, or 5.7%, in 1998 compared to an increase
of $907 thousand or 6.6% in 1997. Salaries and associated benefit expenses were
up $506 thousand, or 6.2%, compared to a 6.6% increase in 1997, and represented
the majority of the increase. Increases in salary and benefits were in part
attributed to the employment of an additional commercial loan officer, who
contributed substantially to the growth in the loan portfolio. Above average
increases in the Company's employee insurance programs also contributed to the
increase in salaries and benefits. The Company's occupancy and equipment expense
increased $195 thousand or 8.1% in 1998 as increases in the Company's service
contracts on data processing equipment increased. The consolidation of the
Company's data processing departments is expected to reduce equipment expense in
1999. Other operating expenses including legal, audit, and outside services
increased $343 thousand or 12.7% in 1998. Significant increases resulted from
16
<PAGE>
outsourcing the trust department accounting system, which will provide enhanced
customer information as well as allow for future trust department growth. Audit
costs increased as a result of the Company outsourcing the majority of its audit
function in 1998.
Total operating expense in 1998 included nonrecurring merger-related
expenses of $1.701 million, which consisted of $951 thousand in fees paid to
attorneys, accountants, and financial consultants as well as $750 thousand in
restructuring costs. Restructuring costs included the write-down of computer
equipment that will no longer be used, in the amount of $279 thousand, and
employee severance costs of $471 thousand. The severance costs resulted from an
early retirement program offered to employees, which will result in annual
salary and benefit savings of approximately $525 thousand. The Company expects
to begin to realize the savings from the early retirement program in the second
quarter of 1999.
Non-Interest Expense
Years ended December 31,
(000's omitted) 1998 1997 1996
---- ---- ----
Salaries, wages, and
employee benefits $ 8,712 $ 8,206 $ 7,695
Building, occupancy and equipment 2,607 2,412 2,265
Supplies, advertising and
communication expense 1,424 1,367 1,262
Legal, audit and outside services 2,139 1,857 1,634
Merger related expenses 1,701 -- --
Other operating expense 914 853 932
------ ------ ------
Total non-interest expense $17,497 $14,695 $13,788
ANALYSIS OF FINANCIAL CONDITION
INVESTMENT SECURITIES
The investment portfolio is designed to meet the Company's liquidity
needs when loans expand or deposits contract while, at the same time, generating
a favorable return on low-risk, high quality investments. In connection with its
merger, the Company elected in 1998 to reclassify the majority of its
held-to-maturity investment securities to available-for- sale, to support and
maintain the Company's interest risk objectives. The Company classified 98% of
its investment portfolio as available-for-sale at year-end 1998. Unrealized
gains in the Company's available-for-sale portfolio were $1.815 million at
December 31,1998 compared to $1.002 million at December 31, 1997. The Company
does not engage in securities trading or derivatives activities in carrying out
its investment strategies.
17
<PAGE>
The Company's book value of investment securities increased $8.617
million in the 12 months ending December 31, 1998 to a total of $159.616 million
compared to an increase of $6.237 million in 1997. The average tax equivalent
yield of the portfolio declined 13 basis points, from 6.51% in 1997 to 6.38% in
1998. The portfolio yield had increased 16 basis points in 1997 compared to
1996.
The composition of the portfolio as of December 31, 1998 consisted of
U.S. Treasury and Agency Securities representing 31% of the total,
mortgage-backed securities at 35%, tax-exempt investments at 26%, and other
securities representing 8% of the total. Investment purchases in 1998 were
diversified, with the Company increasing its portfolio holdings of 3 - 5 year
average life mortgage-backed securities and high grade corporate securities with
similar maturities. Gains on sales of investment securities in 1998 were $26
thousand compared to $115 thousand in 1997.
18
<PAGE>
The following table sets forth the amortized cost and market value for the
Company's held to maturity investment securities portfolio:
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
---- ---- ----
(000's omitted) Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Government agencies $ 500 $ 501 $10,028 $10,076 $10,074 $10,068
Mortgage-backed securities -- -- 6,070 6,104 6,296 6,279
Obligations of states and
political subdivisions 2,130 2,180 9,822 10,051 11,361 11,483
Other securities -- -- 2,516 2,538 1,947 1,935
----- ----- ------ ------ ------ ------
TOTAL $2,630 $2,681 $28,436 $28,769 $29,678 $29,765
====== ====== ======= ======= ======= =======
</TABLE>
19
<PAGE>
The following table sets forth the amortized cost and market value for the
Company's available-for- sale investment portfolio:
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996
---- ---- ----
(000's omitted) Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury and other
U.S. Government agencies $ 49,461 $ 49,870 $ 46,534 $ 46,694 $ 51,512 $ 51,736
Mortgage-backed securities 56,169 56,402 45,464 45,707 36,624 36,544
Obligations of states and
political subdivisions 39,168 40,315 28,129 28,720 24,566 24,912
Other securities 12,188 12,214 2,436 2,444 2,382 2,386
------- ------- ------- ------- ------- -------
TOTAL $156,986 $158,801 $122,563 $123,565 $115,084 $115,578
======== ======== ======== ======== ======== ========
Net unrealized gains on
available-for-sale
portfolio $ 1,815 $ 1,002 $ 493
-------- -------- --------
Total Carrying Value $158,801 $123,565 $115,577
======== ======== ========
</TABLE>
20
<PAGE>
The following table sets forth as of December 31, 1998, the maturities
of investment securities and the weighted-average yields of such securities,
which have been calculated on the basis of the cost, weighted for scheduled
maturity of each security, and adjusted to a fully tax- equivalent basis:
<TABLE>
<CAPTION>
At December 31, 1998
Amount Amount Amount Amount Total
Maturing Maturing Maturing Maturing Cost
Within After One After Five After Ten
One Year Year but Years but Years
or Less Within Five Within Ten
(000's omitted) Years Years
<S> <C> <C> <C> <C> <C>
Held-To-Maturity Portfolio
U.S. Treasury and other
U.S. Government agencies $ 0 $ 500 $ 0 $ 0 $ 500
States and political subdivisions 1,025 370 735 0 2,130
------ ----- ----- ----- -------
Total held-to-maturity
portfolio value $ 1,025 $ 870 $ 735 $ 0 $ 2,630
------- ------ ------ ------ --------
Weighted average yield at
year end (1) 5.78% 6.80% 7.28% 0.00% 6.54%
Available-for-Sale Portfolio:
U.S. Treasury and other
U.S. Government agencies $12,536 $21,833 $10,697 $4,395 $ 49,461
Mortgage-backed securities 6,770 41,020 8,379 0 56,169
States and political subdivisions 4,399 17,875 11,088 5,806 39,168
Other 1,923 8,509 851 905 12,188
------ ------ ------ ----- -------
Total available-for-sale
portfolio value $25,628 $89,237 $31,015 $11,106 $156,986
======= ======= ======= ======= ========
Weighted average yield at
year end (1) 6.12% 6.40% 6.51% 6.40% 6.39%
</TABLE>
(1) Weighted average yields on the tax-exempt obligations have been computed on
a fully tax equivalent basis assuming a marginal federal tax rate of 34%. These
yields are an arithmetic computation of interest income divided by average
balance and may differ from the yield to maturity which considers the time value
of money.
21
<PAGE>
LOANS
The loan portfolio is the largest component of the Company's earning
assets and accounts for the greatest portion of total interest income. The
Company provides a full range of loan products delivered through its branch
network. Consistent with the focus on providing community banking services, the
Company generally does not attempt to diversify geographically by making a
significant amount of loans to borrowers outside of the primary service area.
Loans are internally generated and lending activity is primarily confined to
Cortland, Madison, southern and eastern Onondaga, northern Broome, and western
Oneida counties. The Company does not engage in highly leveraged transactions or
foreign lending activities.
The following table sets forth the composition of the Company's loan
portfolio at the dates indicated.
<TABLE>
<CAPTION>
Composition of the Loan Portfolio
Years ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial,
Financial, and
Agricultural $ 75,845 29.0% $ 62,802 25.3% $ 55,979 23.3% $ 52,842 22.9% $ 51,218 22.8%
Real Estate
Mortgage 128,652 49.3% 120,894 48.8% 120,863 50.2% 117,799 51.0% 118,218 52.6%
Consumer 61,817 23.7% 70,169 28.3% 70,595 29.3% 67,072 29.0% 61,710 27.4%
Gross Loans 266,314 102.0% 253,865 102.4% 247,437 102.8% 237,713 102.9% 231,146 102.8%
Less:
Unearned
Discount (2,212) (0.8%) (3,087) (1.2%) (3,809) (1.5%) (3,732) (1.7%) (3,497) (1.5%)
Allowance for
Loan Losses (3,001) (1.2%) (2,957) (1.2%) (3,025) (1.3%) (2,867) (1.2%) (2,836) (1.3%)
Net Loans $261,101 100.0% $247,821 100.0% $240,603 100.0% $231,114 100.0% $224,813 100.0%
</TABLE>
22
<PAGE>
On December 31, 1998 loans (net of unearned discount) were $264.102 million,
increasing $13.324 million, or 5.3%, during the year. Loans increased $7.150
million, or 2.9% in 1997. Although the majority of the Company's loans continue
to be residential mortgage loans on our customers' primary residences,
increasing emphasis has been placed on growing the commercial loan portfolio.
Residential mortgage loans, which represent 49.3% of gross loans, increased
$7.758 million, or 6.4% during 1998. The mortgage portfolio consists of 85%
fixed-rate loans, and 15% with rates that adjust on an annual basis. The Company
originated $46.398 million in mortgage loans during 1998, selling $8.653 million
in the secondary market. As of December 31, 1998, the Company was servicing
mortgage loans sold in the secondary market with balances of $15.133 million.
Consumer loans, net of unearned discount, which include home equity and
revolving credit loans, declined 11.1%, or $7.477 million, to $59.605 million as
of December 31, 1998. The decline in consumer loans occurred as home equity
borrowers consolidated balances with primary mortgage loans and refinanced on
lower fixed rate terms. Consumer loans also declined as the Company tightened
underwriting standards to reduce the increasing trend of charge-offs on consumer
loans.
Loans in the commercial category consist primarily of short-term and/or
floating rate loans made to small and medium-sized companies. Commercial loans
in 1998 increased $13.043 million, or 20.8% to $75.845 million. A large
percentage of the growth in the commercial loan portfolio resulted from new
business relationships developed in the southern and eastern Onondaga county
markets. Commercial loans also include short-term loans to local municipalities
which as of December 31, 1998 were $9.410 million, representing 12.4% of
commercial loans.
23
<PAGE>
The following table shows the amount of loans outstanding as of December 31,
1998, which, based on remaining scheduled payments of principal, are due in the
periods indicated.
At December 31, 1998
(000's omitted) Maturing Maturing Maturing Maturing
in One After One After Five After
Year or but Within but Within Ten
Less Five Years Ten Years Years Total
Commercial, financial
and agricultural $32,343 $22,176 $9,449 $11,877 $75,845
Real estate mortgage 16,939 50,827 35,205 25,681 128,652
Consumer, net of
unearned discount 14,848 36,565 7,147 1,045 59,605
------ ------ ----- ----- ------
Total loans net of
unearned discount $64,130 $109,568 $51,801 $38,603 $264,102
======= ======== ======= ======= ========
The following table sets forth the sensitivity of the loan amounts due after one
year to changes in interest rates:
At December 31, 1998
(000's omitted) Fixed Rate Variable Rate
Due after one year, but
within five years $82,388 $27,180
Due after five years $66,759 $23,645
LOAN QUALITY AND THE ALLOWANCE FOR LOAN LOSSES
The following table represents information concerning the aggregate amount of
nonperforming assets:
<TABLE>
<CAPTION>
Years ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a
nonaccrual basis $ 552 $ 525 $ 819 $ 582 $544
Accruing loans which are
contractually past due 90 days or
more as to principal or interest
payments 298 1,204 597 389 232
Other Real Estate Owned 257 363 0 135 0
----- ----- ----- ------ ---
Total nonperforming loans and assets $1,107 $2,092 $1,416 $1,106 $776
====== ====== ====== ====== ====
Ratio of allowance for loan losses
to period-end nonperforming loans 353.06% 171.02% 213.63% 295.28% 365.48%
Ratio of nonperforming assets to
period-end total loans and other
real estate owned 0.42% 0.84% 0.59% 0.48% 0.35%
</TABLE>
24
<PAGE>
Nonperforming assets, defined as nonaccruing loans plus loans 90 days
or more past due along with other real estate owned, as of December 31,1998 were
$1.107 million, declining $985 thousand, or 47.1%, compared to year-end 1997.
The ratio of nonperforming assets to year-end loans and other real estate owned
declined from 0.84% at December 31, 1997 to 0.42% at December 31, 1998.
Excluding other real estate owned, the ratio of nonperforming loans to total
loans declined from 0.69% at December 31, 1997 to 0.32% at December 31, 1998.
The Company's past due loans in excess of 90 days past due declined dramatically
in 1998 as a result of increased collection activity.
The Company's policy is to place a loan on nonaccrual status and
recognize income on a cash basis when it is more than ninety days past due,
unless in the opinion of management, the loan is well secured and in the process
of collection. The impact of interest not recognized on nonaccrual loans was
immaterial in 1998. The Company considers a loan impaired when, based on current
information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. The measurement of impaired loans
is generally based upon the present value of future cash flows discounted at the
historical effective interest rate, except that all collateral-dependent loans
are measured for impairment based on fair value of the collateral. As of
December 31, 1998, the total of impaired loans for which specific valuation
allowances has been recorded is insignificant.
The Company has a loan review program which it believes takes a
conservative approach to evaluating nonperforming loans and the loan portfolio
in general. The loan review program continually audits the loan portfolio to
confirm management's loan risk rating system and track problem loans, to insure
compliance with loan policy underwriting guidelines, and to evaluate the
adequacy of the allowance for loan losses.
Management determines the allowance for loan losses based on a number
of factors including reviewing and evaluating the bank's loan portfolio in order
to identify potential problem loans, concentrations of credit, and risk factors
connected to the portfolio, as well as current local and national economic
conditions. The allowance for loan losses represents management's estimate of an
amount that is adequate to provide for potential losses inherent in the loan
portfolio. Loans are charged against the allowance for loan losses, in
accordance with the Company's loan policy, when they are determined by
management to be uncollectible. Recoveries on loans previously charged-off are
credited to the allowance for loan losses when they are received. When
management determines that the allowance for loan losses is less than adequate
to provide for potential losses, a direct charge is made to operating income.
The Allowance for Loan Losses account at December 31, 1998 was $3.001
million, or 1.14% of loans outstanding compared to $2.957 million, or 1.18% of
loans outstanding at December 31, 1997. The adequacy of the allowance to provide
coverage for nonperforming loans improved to 353% at year-end 1998 compared to
171% at year-end 1997. The provision expense in 1998 of $770 thousand provided
coverage in excess of the $726 thousand in net loans charged off. The ratio of
net charge-offs to average loans outstanding for the years 1998 and 1997 has
been stable at 0.28%. Loan losses in the Company's residential mortgage loan
portfolio continue to be negligible, with commercial loan portfolio net loan
losses in 1998 of $107 thousand,
25
<PAGE>
representing 0.16% of average commercial loans outstanding in 1998. Over the
past two years 74% of total loans charged-off have been consumer loans, with the
majority being installment loans. Net consumer loan losses in 1998 in the amount
of $590 thousand were 0.93% of average consumer loans outstanding for 1998.
Throughout 1998, consumer loans were reviewed and approved with tighter
underwriting guidelines. As a result of the tighter loan underwriting standards
and increased loan reviews, management anticipates improvement in the consumer
loan charge-off trend of the past two years.
A relatively low level of nonperforming loans combined with a stable
and low level of net charge-offs, continues to allow the Company to carry a
reserve for loan losses below peers.
26
<PAGE>
The following table summarizes loan balances at the end of each period
indicated and the daily average amount of loans. Also summarized are changes in
the allowance for possible losses arising from loans charged-off and recoveries
on loans previously charged-off and additions to the allowance, which have been
charged to expenses.
<TABLE>
<CAPTION>
Summary Of Loan Loss Allowance
Years ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Amount of loans outstanding
at end of period (Gross $264,102 $250,778 $243,628 $233,981 $227,649
loans less unearned
discount)
Daily average amount of 256,450 246,017 239,014 230,050 216,386
loans (net of unearned
discounts)
Balance of allowance for 2,957 3,025 2,867 2,836 2,658
possible loan losses at
beginning of period
Loans charged off:
Commercial, financial, 218 148 218 213 130
and agricultural
Real estate mortgage 29 57 0 10 0
Consumer 693 602 385 340 204
Total loans charged off $ 940 $ 807 $ 603 $ 563 $ 334
Recoveries of loans previously charged off:
Commercial, financial, 111 17 36 46 39
and agricultural
Real estate mortgage 0 0 0 0 0
Consumer 103 97 92 73 133
Total recoveries $ 214 $ 114 $ 128 $ 119 $ 172
Net loans charged off $ 726 $ 693 $ 475 $ 444 $ 162
Additions to allowance 770 625 633 475 340
charged to expense
Balance at end of period 3,001 2,957 3,025 2,867 2,836
Ratio of allowance for 1.14% 1.18% 1.24% 1.23% 1.25%
loan losses to period
end loans
Ratio of net chargeoffs to 0.28% 0.28% 0.20% 0.19% 0.07%
average loans outstanding
</TABLE>
27
<PAGE>
The allowance for possible loan losses has been allocated according to the
amount deemed to be reasonably necessary to provide for the possibility of
losses being incurred within the following categories of loans at the dates
indicated.
<TABLE>
<CAPTION>
Allocation Of The Allowance For Loan Losses
Years ended December 31,
1998 1997 1996 1995 1994
Amt. Of Amt. of Amt. of Amt. of Amt. of
(000's omitted) Allowance Percent Allowance Percent Allowance Percent Allowance Percent Allowance Percent
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial,
financial, &
agricultural $1,024 34.12% $ 865 29.25% $ 796 26.31% $ 790 27.55% $ 669 23.59%
Real estate 617 20.56% 624 21.10% 609 20.13% 603 21.04% 639 22.53%
mortgage
Consumer 698 23.26% 906 30.64% 849 28.07% 724 25.25% 610 21.51%
Unallocated 662 22.06% 562 19.01% 771 25.49% 750 26.16% 918 32.37%
Total $3,001 100.00% $2,957 100.00% $3,025 100.00% $2,867 100.00% $2,836 100.00%
</TABLE>
28
<PAGE>
DEPOSITS
The Company's deposit accounts represent its primary source of funds.
The deposit base is comprised of demand deposit, savings and money market
accounts, and other time deposits which are provided by individuals, businesses,
and local governments within the communities served. The Company continuously
monitors market pricing, competitors' rates, and internal interest rate spreads
to maintain and promote growth and profitability.
Average deposits for 1998 increased $17.949 million, or 4.7%, to
$396.827 million, compared to an $8.482 million, or 2.3%, increase in 1997.
Compared to December 31, 1997, deposits as of December 31, 1998 of $413.594
million were up $35.667 million. The Company's deposit mix has been relatively
stable over three years, with changes in 1998 reflecting a slight shift from
regular savings to money market savings accounts, on which the Company paid
higher interest rates. The Company's demand deposits, including both
interest-bearing and non interest-bearing accounts, reflected an increase in
average outstanding balances of $10.776 million, or 10.3%, during 1998. These
core transactional accounts continue to provide the Company with an important
low cost source of funds. Time deposits in excess of $100 thousand, which are
more volatile and sensitive to interest rates, totaled $57.922 million at
year-end, 38.7% of time deposits and 14% of total deposits, compared to 29.5%
and 10.5% respectively at year-end 1997. The Company became more aggressive in
acquiring large balance time deposits during 1998, matching the liabilities with
assets that have similar interest rate risk characteristics. The Company's total
municipal deposits of $82.086 million on December 31, 1998 represented 19.8% of
total deposits compared to $63.856 million or 16.9% on December 31, 1997.
29
<PAGE>
The average daily amount of deposits, the average rate paid, and the percentage
of deposits on each of the following deposit categories is summarized below for
the years indicated.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
Avg. Avg. Percent Avg. Avg. Percent Avg. Avg. Percent
Balance Rate of Balance Rate of Balance Rate of
Paid Deposits Paid Deposits Paid Deposits
(000,s omitted)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand
deposits $ 53,675 0.00% 13.53% $ 49,634 0.00% 13.10% $ 50,279 0.00% 13.57%
Interest-bearing demand
deposits 61,228 1.95% 15.43% 54,493 1.87% 14.39% 52,506 1.80% 14.18%
Regular savings accounts 79,817 2.68% 20.11% 83,778 2.86% 22.11% 84,900 2.92% 22.92%
Money market savings 61,468 4.26% 15.49% 56,263 4.27% 14.65% 57,304 3.85% 15.47%
Time deposits 140,639 5.22% 35.44% 134,710 5.25% 35.55% 125,407 5.20% 33.86%
Total average daily amount
of domestic deposits $396,827 3.35% 100.00% $378,878 3.41% 100.00% $370,396 3.29% 100.00%
</TABLE>
30
<PAGE>
The following table indicates the amount of the Company's time deposits of
$100,000 or more by time remaining until maturity as of December 31, 1998.
(000's omitted)
Less than three months $41,748
Three months to six months 7,356
Six months to one year 2,832
Over one year 5,986
------
Total $57,922
CAPITAL
Total shareholder's equity increased 2.9% from $49.750 million as of
December 31, 1997 to $51.168 million as of December 31, 1998. In 1998, the
Company added $3.433 million into equity through net income and returned $2.410
million to its shareholders in the form of dividends. The lower growth rate in
shareholders equity, as well as the above average dividend pay-out rate of 70%
in 1998 were both affected by the nonrecurring merger- related expenses incurred
during the year. The Company's ratio of shareholders equity to assets of 10.85%
at December 31, 1998 compares to 11.40% at December 31, 1997.
The Company's goal is to maintain a strong capital position, consistent
with the risk profile of its subsidiary banks, that supports growth and
expansion activities while at the same time exceeding regulatory standards.
Capital adequacy in the banking industry is evaluated primarily by the use of
ratios which measure capital against total assets, as well as against total
assets that are weighted based on defined risk characteristics. At December 31,
1998, the Company exceeded all regulatory required minimum capital ratios and
met the regulatory definition of a "well capitalized institution". A more
comprehensive analysis of regulatory capital requirements, including ratios for
the Company and its subsidiary banks, is included in Note 16 in the Consolidated
Financial Statements section of the Annual Report.
The Company paid cash dividends equal to $0.67 per share in 1998. In
December 1998, the Company's Board of Directors established a regular quarterly
dividend of $0.175 per share which the Company expects will reflect a dividend
pay-out ratio in the 40% range and which is consistent with its average pay-out
ratio over the past five years.
LIQUIDITY Liquidity is the ability of the Company to generate and maintain
sufficient cash flows to fund its operations and to meet customer's loan demands
or deposit withdrawals. Maintaining a stable core deposit base is one of the
fundamentals in the Company's liquidity management policy. It is the Company's
goal to raise cash when needed, at the most reasonable cost, with a minimum of
loss. Management carefully monitors its liquidity position and seeks to maintain
adequate liquidity to meet its needs. The Company meets its liquidity needs by
balancing levels of cash flow from the sale or maturity of available-for-sale
investment securities and loan amortizing payments and maturities, as well as
with the availability of dependable borrowing sources which can be accessed when
needed. Lines of credit with the bank's primary correspondent and the Federal
Home Loan Bank as of year-end were $46.3 million. There were no balances
outstanding against such lines at year-end 1998.
31
<PAGE>
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates or prices such as interest rates, foreign
currency exchange rates, commodity prices, and equity prices. The Company's
market risk arises principally from interest rate risk in its lending, deposit
and borrowing activities. Other types of market risks do not arise in the normal
course of the Company's business activities. Management actively monitors and
manages its interest rate risk exposure. Although the Company manages other
risks, as in credit quality and liquidity risk, in the normal course of
business, management considers interest rate risk to be its most significant
market risk and could potentially have the largest material effect on the
Company's financial condition and results of operations. The Company's
profitability is affected by fluctuations in interest rates. Management's goal
is to maintain a reasonable balance between exposure to interest rate
fluctuations and earnings. A sudden and substantial change in interest rates may
adversely impact the Company's earnings to the extent that the interest rates on
interest-earning assets and interest-bearing liabilities do not change at the
same speed, to the same extent or on the same basis. The Company monitors the
impact of changes in interest rates on its net interest income using a computer
simulation model
The model measures the change in net interest income which results when
market interest rates change. As of December 31, 1998, an instantaneous 200
basis point increase in market interest rates was estimated to have a negative
impact of 4.46% on net interest income over the next twelve-month period, while
a 200 basis point decrease in market interest rates was estimated to have a
positive impact of 2.55% on the Company's net interest income. The potential
change in net interest income resulting from this analysis falls within the
Company's interest rate risk policy guidelines.
Computation of prospective effects of hypothetical interest rate
changes are based on numerous assumptions, including relative levels of market
interest rates, loan prepayments and deposit rate changes, and should not be
relied upon as indicative of actual results.
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<PAGE>
The following table shows the Company's financial instruments that are
sensitive to changes in interest rates, categorized by expected maturity, and
the instruments' fair values at December 31, 1998.
<TABLE>
<CAPTION>
Expected Maturity/Principal Repayments at December 31, 1998
Average
There- Interest Fair
1999 2000 2001 2002 2003 after Total Rate Value
---- ---- ---- ---- ---- ----- ----- ---- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Rate Sensitive
Assets
Loans $89,751 $41,139 $17,526 $41,391 $ 9,467 $ 64,828 $264,102 8.62% $267,994
Investments 31,083 23,270 18,608 16,899 12,140 57,616 159,616 6.05% 161,482
Federal Funds 10,700 0 0 0 0 0 10,700 5.28% 10,700
------ ------ ------ ------ ------ ------- ------- ----- -------
Total Rate
Sensitive Assets $131,534 $64,409 $36,134 $58,290 $21,607 $122,444 $434,418 $440,176
======== ======= ======= ======= ======= ======== ======== ========
Rate Sensitive
Liabilities
Savings, Money
Market, and NOW
Accounts $48,467 $ 0 $ 0 $ 0 $ 0 $155,035 $203,502 2.81% $203,502
Time Deposits 115,232 20,271 6,074 7,378 88 515 149,558 5.18% 150,356
Short Term
Borrowings 752 0 0 0 0 0 752 5.06% 752
------- ------ ------ ------ ------ ------- ------- ----- -------
Total Rate
Sensitive
Liabilities $164,451 $20,271 $ 6,074 $ 7,378 $ 88 $155,550 $353,812 $354,610
======== ======= ======= ======= ======= ======== ======== ========
</TABLE>
33
<PAGE>
Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon contractual
maturity, projected repayments and prepayment of principal. The prepayment
experience reflected herein is based on the Company's historical experience. The
actual maturities and run-off of loans could vary substantially if future
prepayments differ from the Company's historical experience. For liabilities,
Savings, Money Market, and Now Accounts of individuals, partnerships and
corporations, are considered to be 90% core (maturing in over five years), with
10% assumed to mature in one year. Savings, Money Market, and Now Accounts of
municipalities are considered 50% core (maturing in over five years), with 50%
assumed to mature in one year.
IMPACT OF THE YEAR 2000
The State of Readiness. The Company has been evaluating its Year 2000
readiness through utilization of a five phase approach since early 1997. The
process is overseen by a management committee chaired by the Company's Senior
Vice President who reports monthly progress to the Board of Directors.
The Awareness phase, which included creating a Year 2000 committee and
explaining the problem to the Board of Directors and Senior Management, was
completed on December 31, 1997. The Assessment phase, identified all equipment,
software, and related vendors that could have a potential adverse effect on the
Company's service or operations. In this phase, the Company completed an
analysis of all data obtained, and created a prioritized list of systems
requiring modification and validation. The prioritization resulted in thirteen
systems that the Company considered critical to its continued operations. The
two most critical systems relate to the operation of the Company's data
processing facilities that utilize Unisys Computer Systems and Information
Technology, Inc. application software. In the Renovation phase, the Company
completed modifications to its affected systems, communicated with all vendors
who provide systems that may cause the Company Year 2000 problems, and
established a tracking system to monitor vendor responses indicating the state
of their systems' or equipments' Year 2000 compliance. The Renovation phase was
completed on September 30, 1998. The Validation and Testing phase is considered
80% complete as of December 31, 1998. The Company has been able to test both its
information technology systems and non-information technology systems without
significant added cost. As a result of the November 1998 merger, the Company
decided to upgrade and expand the capacity of its Unisys Computer System,
purchasing a new processing system that will be installed on or before March 31,
1999. The Company expects to complete testing of the new system within 30 days
following installation. Testing of all mission critical systems is expected to
be complete by April 30, 1999. The Implementation phase, which places into
service all of the systems and equipment necessary to reduce the Year 2000 risk
to a minimum, is considered 80% complete as of December 31, 1998. The
Implementation phase is expected to be complete by June 30, 1999.
In addition to the Company's assessment of its own state of readiness,
the Company has completed an assessment of the risk in
34
<PAGE>
connection with credit extensions to its larger commercial customers, to
determine if the loan portfolio quality will be adversely affected. The Company
assigned risk assessments of low, medium, or high following an analysis of the
customers' exposure to Year 2000 risk. The Company has concluded that the loan
portfolio will not be adversely affected by the risks that commercial customers
face in connection with their Year 2000 risks. The Company has also surveyed its
largest depositors and believes that Year 2000 risks do not present any
significant liquidity concerns. The Company, however, has plans to increase its
liquidity as the Year 2000 approaches to provide for uncertainties that may
arise. The Company has in place, and will continue throughout 1999, a customer
awareness program to inform its customers of its state of readiness.
Year 2000 Costs. As of December 31, 1998 the Company estimates that it
has expensed $60,000 in connection with testing and software purchases. Based on
management's' best estimates, additional costs for remediation that are expected
to be expensed in 1999 are $30,000. In addition to these costs, the bank will be
capitalizing $40,000 over the next three years in connection with the purchase
of software that had not previously been budgeted. The Company also accelerated
the purchase of six replacement ATM machines that had previously been scheduled
for purchase in 1999 and 2000. The equipment will be capitalized over five
years. The Company expects that the total costs of completing the project will
have no material affect on the results of operations and financial condition,
although actual results may differ pending the completion of the Validation and
Implementation phases.
Risk Assessment and Contingency Plans. As of December 31, 1998 the
Company believes that the progress that it has made to date, along with the
expected completion of mission critical testing in 1999, will result in the
Company being well prepared to meet the Year 2000. The reliance on third party
information, however, which may be inaccurate and unverifiable, such as the
continuation of a reliable power source, has required contingency planning. The
Company has established contingency plans for all of its mission critical
systems as of year-end 1998, and will evaluate the implementation of such plans
during 1999.
OTHER INFORMATION
In December 1998, the Oneida Indian Nation("The Nation") and the U.S.
Justice Department filed motions to amend a long outstanding claim against the
State of New York to include a class of 20,000 unnamed defendants who own real
property in Madison and Oneida Counties. If the motion is granted to amend the
claim, litigation could involve assets of the Company. The United States
District Court is scheduled to hear arguments on the matter on March 26, 1999.
"The Nation" has represented that the legal action currently being undertaken is
to force the State of New York to negotiate an equitable settlement of their
original claim which was ruled on by the United States Supreme Court in favor of
"The Nation" over 13 years ago. Management believes that ultimately the State of
New York will be held responsible for these claims, and this matter will be
settled without adversely impacting the Company.
35
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In June of 1998, the Financial Accounting Standards Account Board
(FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activity". This statement requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. This statement is effective for all fiscal quarters of fiscal
years beginning after June 30, 1999. Since the Company does not presently
utilize any derivative instruments or hedges, management believes there will be
no effect on the Company.
36
<PAGE>
Item 8 -- Financial Statements and Supplementary Data
CONSOLIDATED STATEMENTS OF CONDITION (In thousands)
ASSETS Dec. 31, 1998 Dec. 31, 1997
- ------ ------------- -------------
Cash and due from banks $ 23,431 $ 19,889
Federal funds sold 10,700 1,100
Total Cash and Cash Equivalents 34,131 20,989
Held to maturity investment securities 2,630 28,436
Available-for-sale investment securities 158,801 123,565
Total Investment Securities 161,431 152,001
(fair value - $161,482 for 1998
and $152,334 for 1997)
Total Loans 266,314 253,865
Less: Unearned income 2,212 3,087
Less: Allowance for possible
loan losses 3,001 2,957
Net Loans 261,101 247,821
Bank premises, furniture
and equipment 8,289 8,955
Accrued interest receivable 2,884 2,899
Other assets 3,869 3,765
Total Assets $471,705 $436,430
LIABILITIES AND SHAREHOLDERS' EQUITY (In thousands)
Noninterest-bearing deposits $ 60,534 $ 53,158
Interest-bearing deposits 353,060 324,769
Total Deposits 413,594 377,927
Short-term borrowings 752 4,008
Other liabilities 6,191 4,745
Total Liabilities 420,537 386,680
Shareholders' equity:
Preferred stock - Par value $25.00 a share;
1,000,000 shares authorized, none issued
Common stock - Par value $1.00 a share;
10,000,000 shares authorized, 3,641,178
and 3,645,502 shares issued, and 3,594,954
and 3,599,278 shares outstanding for
1998 and 1997, respectively 3,641 3,646
Surplus 3,641 3,646
Undivided profits 43,864 42,917
Accumulated comprehensive income 1,088 607
Treasury stock, at cost; 46,224 shares (1,066) (1,066)
Total Shareholders' Equity 51,168 49,750
Total Liabilities and
Shareholders' Equity $471,705 $436,430
The accompanying notes are an integral part of the consolidated financial
statements.
37
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME (In thousands)
<TABLE>
<CAPTION>
INTEREST INCOME Years ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
----------- ------------- ------------- -------------
<S> <C> <C> <C>
Interest and fees on loans $22,542 $22,205 $21,791
Interest on investment securities:
U.S. Government and
Agency Obligations 6,370 6,888 6,468
Obligations of State
and political subdivisions 1,972 1,774 1,679
Other 577 430 398
Interest on federal funds sold 752 494 680
Total Interest Income 32,213 31,791 31,016
INTEREST EXPENSE
Interest on deposits 13,300 12,904 12,152
Interest on short-term
borrowings 98 80 42
Total Interest Expense 13,398 12,984 12,194
Net Interest Income 18,815 18,807 18,822
Provision for possible
loan losses 770 625 633
Net Interest Income After
Provision For Loan Losses 18,045 18,182 18,189
OTHER INCOME
Trust department services 789 775 740
Service charges on deposit
accounts 1,706 1,550 1,434
Data processing services 257 244 239
Investment securities
gains/(losses) 26 115 (27)
Other operating income 1,211 1,182 1,001
Total Other Income 3,989 3,866 3,387
Total Operating Income 22,034 22,048 21,576
OTHER EXPENSES
Salaries, wages and
employee benefits 8,712 8,206 7,695
Building occupancy and
equipment 2,607 2,412 2,265
Supplies, advertising and
communication expense 1,424 1,367 1,262
Legal, audit and outside
services 2,139 1,857 1,634
Merger related expense 1,701 --- ---
Other operating expense 914 853 932
Total Other Expenses 17,497 14,695 13,788
Income Before Income Taxes 4,537 7,353 7,788
Provision for income taxes 1,104 2,220 2,434
Net Income $ 3,433 $ 5,133 $ 5,354
Net Income Per Common
Share - Basic and Diluted $ 0.95 $ 1.40 $ 1.43
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
38
<PAGE>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME: (In thousands)
Years ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
------------- ------------- -------------
Net Income $ 3,433 $ 5,133 $ 5,354
Other comprehensive income
net of taxes:
Unrealized gains on
securities:
Unrealized holding gains
(losses) arising during
period 839 625 (215)
Less: Reclassification
adjustment for (gains)
losses included in net
income (26) (115) 27
813 510 (188)
Income tax (provision) benefit (332) (190) 80
Other comprehensive income
(loss), net of tax 481 320 (108)
Comprehensive Income $ 3,914 $ 5,453 $ 5,246
The accompanying notes are an integral part of the consolidated financial
statements.
39
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY:
(Dollars in thousands)
<TABLE>
<CAPTION>
Accumulated
Issued Other
For the years ended Common Common Undivided Comprehensive Treasury
Dec. 31, 1998, 1997, 1996 Shares Stock Surplus Profits Income Stock Total
- ------------------------- ------ ----- ------- ------- ------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996
as previously reported 2,016,000 $3,360 $3,360 $16,438 $ 496 $ --- $23,654
Adjustments for pooling
of interests 1,736,532 393 393 23,203 (101) --- 23,888
Balance at January 1, 1996
as restated 3,752,532 3,753 3,753 39,641 395 --- 47,542
Net income for the year 5,354 5,354
Change in unrealized net
(loss) on investment
securities (108) (108)
Cash dividends, $.56 per share (2,085) (2,085)
Purchase and retirement
of common shares (27,000) (27) (27) (472) (526)
Balance at December 31,1996 3,725,532 3,726 3,726 42,438 287 --- 50,177
Net income for the year 5,133 5,133
Change in unrealized net
gain on investment
securities 320 320
Treasury stock purchased (1,119) (1,119)
Treasury stock sold 9 53 62
Cash dividends, $.88 per share (3,199) (3,199)
Purchase and retirement
of common shares (80,030) (80) (80) (1,464) (1,624)
Balance at December 31,1997 3,645,502 3,646 3,646 42,917 607 (1,066) 49,750
Net income for the year 3,433 3,433
Change in unrealized net
gain on investment
securities 481 481
Cash dividends, $.67 per share (2,410) (2,410)
Purchase and retirement
of common shares (4,324) (5) (5) (76) (86)
Balance at December 31,1998 3,641,178 $3,641 $3,641 $43,864 $1,088 $(1,066) $51,168
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
40
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS:
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (In thousands)
OPERATING ACTIVITIES
Years ended: Dec. 31, 1998 1997 1996
---- ---- ----
Net income $ 3,433 $ 5,133 $ 5,354
Adjustments to reconcile net
income to net cash provided by
operating activities:
Provision for loan losses 770 625 633
Provision for depreciation 1,376 1,059 906
Benefit for deferred
income taxes (628) (8) (81)
Amortization of investment
security premiums, net 520 316 378
Realized investment security
(gains) losses (26) (115) 27
Loss on disposal of
bank equipment --- 10 18
Change in other assets
and liabilities 1,501 (463) 931
Net Cash Provided by
Operating Activities 6,946 6,557 8,166
INVESTING ACTIVITIES
Proceeds from maturities of
investment securities,
available-for-sale 48,943 21,797 20,311
Proceeds from maturities of
investment securities,
held-to-maturity 6,674 11,693 16,564
Proceeds from sales of
investment securities 5,374 15,794 1,970
Purchase of investment securities,
available-for-sale (68,055) (50,701) (34,579)
Purchase of investment securities,
held-to-maturity (2,047) (5,020) (7,955)
Net increase in loans (14,120) (8,118) (10,122)
Purchases of premises and
equipment (710) (1,827) (1,376)
Proceeds from disposition of
bank equipment --- 51 ---
Net Cash Used by Investing
Activities (23,941) (16,331) (15,187)
41
<PAGE>
FINANCING ACTIVITIES
Years ended: Dec. 31, 1998 1997 1996
---- ---- ----
Net increase in demand
deposits, NOW accounts
and savings accounts 20,169 472 3,953
Net increase in
time deposits 15,498 4,866 8,259
Net (decrease) increase in
short-term borrowings (3,256) 3,169 314
Treasury stock purchased --- (1,119) ---
Treasury stock sold --- 62 ---
Retirement of common shares (86) (1,624) (526)
Cash dividends (2,188) (3,219) (2,063)
Net Cash Provided by
Financing Activities 30,137 2,607 9,937
Increase (Decrease) in Cash
and Cash Equivalents 13,142 (7,167) 2,916
Cash and Cash Equivalents at
Beginning of Year 20,989 28,156 25,240
Cash and Cash Equivalents
at End of Year 34,131 20,989 28,156
Supplemental Disclosures of
Cash Flow Information:
Cash paid during the year for:
Interest on deposits and
short-term borrowings 13,435 12,874 12,518
Income taxes 1,663 2,264 2,312
Non-cash investing activity:
Change in unrealized gain/
(losses) on available-for-sale
securities (813) (510) 188
Transfer to other real estate
owned 70 275 ---
Non-cash financing activity:
Dividend declared and unpaid 629 407 427
The accompanying notes are an integral part of the consolidated financial
statements.
42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Combination: In November 1998, Cortland First Financial
Corporation (Cortland) completed a merger with Oneida Valley Bancshares, Inc.
(Oneida) and commenced operations under the name Alliance Financial Corporation
(the Company). Pursuant to the terms of the merger, each share of Cortland stock
was exchanged for one share of the Company's stock and each share of Oneida
stock was exchanged for 1.8 shares of the Company's stock. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under Accounting Principles Board Opinion No. 16. Accordingly, the
consolidated financial statements for the periods presented have been restated
to include the combined results of operations, financial position and cash flows
of Cortland and Oneida. There were no transactions between Cortland and Oneida
prior to the merger. Certain reclassifications were made to Cortland's and
Oneida's prior year financial statements to conform to the Company's
presentation.
The result of operations for the separate companies and the combined
amounts presented in the consolidated financial statements below.
11 Mo. Ended Year Ended Year Ended
(In thousands) Nov. 30, 1998 Dec. 31, 1997 Dec. 31, 1996
Net Interest Income
Cortland $ 8,574 $ 9,454 $ 9,412
Oneida $ 8,607 $ 9,353 $ 9,410
Combined $17,181 $18,807 $18,822
Net Income
Cortland $ 1,998 $ 2,619 $ 2,846
Oneida $ 1,871 $ 2,514 $ 2,508
Combined $ 3,869 $ 5,133 $ 5,354
In conjunction with the merger, the Company recorded a 1998 charge to
operating expenses of $1,701 ($1,022 after taxes, or $0.28 per common share) for
direct merger and restructuring costs relating to the merger.
Merger transaction costs consisted primarily of fees for investment
bankers, attorneys, accountants, financial printing, and other related charges.
Restructuring costs included severance of employees electing early retirement
options and exit costs.
Details of the merger related costs follow:
(In thousands)
Merger transaction costs $ 951
Restructuring costs:
Employee Severance $ 471
Exit Costs $ 279
Total $1,701
Restructuring costs primarily relate to the consolidation of
administration and operational functions. These actions will result in the early
retirement of 11 employees on or before March 31, 1999. Exit costs include the
writedown of computer equipment that will no longer be utilized.
Nature of Operations: The Company is a bank holding company which owns and
operates two financial institutions: First National Bank of Cortland and Oneida
Valley National Bank. The two banks have received approval from the Office of
the Comptroller of the Currency to merge under the name Alliance Bank, N.A. and
expect to complete the merger on or about April 15, 1999.
43
<PAGE>
The two subsidiaries provide financial services primarily to
individuals, small to medium sized businesses, and government customers from
seventeen branches in Broome, Cortland, Madison, Oneida, and Onondaga counties.
Principles of Consolidation: The consolidated financial statements
include the accounts of the Company and its two wholly owned subsidiaries after
elimination of inter-company accounts and transactions.
Use of Estimates in the Preparation of Financial Statements: The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents: For purposes of reporting cash flows, cash
and cash equivalents include cash on hand, amounts due from banks, and federal
funds sold. Generally, federal funds are purchased and sold for one-day periods.
Investment Securities: The Company classifies investment securities as
held-to-maturity or available-for-sale. Held-to-maturity securities are those
which the Company has the positive intent and ability to hold to maturity, and
are reported at cost, adjusted for amortization of premiums and accretion of
discounts. Investment securities not classified as held- to-maturity are
classified as available-for-sale and are reported at fair value, with net
unrealized holding gains and losses reflected as a separate component of
stockholders' equity, net of the applicable income tax effect. None of the
Company's investment securities have been classified as trading securities.
Gains and losses on the sale of investment securities are based on the specific
identification method. Premiums and discounts on securities are amortized and
accreted into income using the interest method over the life of the security.
Loans: Loans are stated at unpaid principal balances less the allowance
for loan losses, unearned interest income and net deferred loan origination fees
and costs.
Unearned income on certain installment loans is taken into income on
the actuarial method. Interest on all other loans is based upon the principal
amount outstanding. Interest on loans is accrued except when in management's
opinion the collectibility of principal or interest is doubtful, at which time
the accrual of interest on the loan is discontinued.
Loan origination fees and certain direct loan origination costs are
deferred and the net amount is amortized as a yield adjustment. The Company is
generally amortizing these amounts over the contractual life of the related
loans. However, for certain fixed-rate mortgage loans that are generally made
for a 20-year term, the Company has anticipated prepayments and used an
estimated life of 7.5 years.
Allowance for Credit Losses: The adequacy for the allowance for
possible loan losses is periodically evaluated by the Company in order to
maintain the allowance at a level that is sufficient to absorb probable credit
losses. Management's evaluation of the adequacy of the allowance is based on a
review of the Company's historical loss experience, known and
44
<PAGE>
inherent risks in the loan portfolio, including adverse circumstances that may
affect the ability of the borrower to repay interest and/or principal, the
estimated value of collateral, and an analysis of the levels and trends of
delinquencies, charge-offs, and the risk ratings of the various loan categories.
Such factors as the level and trend of interest rates and the condition of the
national and local economies are also considered.
A loan is considered impaired, based on current information and events,
if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. The measurement of impaired loans is generally based upon
the present value of future cash flows discounted at the historical effective
interest rate, except that all collateral- dependent loans are measured for
impairment based on fair value of the collateral.
Income Recognition on Impaired and Nonaccrual Loans: Loans, including
impaired loans, are generally classified as nonaccrual if they are past due as
to maturity of payment of principal or interest for a period of more than 90
days unless they are well secured and are in the process of collection. While a
loan is classified as nonaccrual and the future collectibility of the recorded
loan balance is doubtful, collections of interest and principal are generally
applied as a reduction to principal outstanding.
Bank Premises, Furniture and Equipment: Bank premises, furniture and
equipment are stated at cost less accumulated depreciation computed principally
using the accelerated depreciation method over the estimated useful lives of the
assets. Maintenance and repairs are charged to operating expenses as incurred.
The asset cost and accumulated depreciation are removed from the accounts for
assets sold or retired and any resulting gain or loss is included in the
determination of the income.
Income Taxes: Provision for income taxes is based on taxes currently
payable or refundable and deferred income taxes on temporary differences between
the tax basis of assets and liabilities and their reported amount in the
financial statements. Deferred tax assets and liabilities are reported in the
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled.
Trust Department Assets: Assets held in fiduciary or agency capacities
for customers are not included in the accompanying consolidated statements of
condition, since such items are not assets of the Company. Fees associated with
providing trust management services are recorded on a cash basis of income
recognition and are included in Other Income.
Earnings Per Share: Basic earnings per share is computed by dividing
net income by the weighted average number of common shares outstanding
throughout each year 3,596,548, 3,660,914 and 3,731,254 for 1998, 1997, and 1996
respectively. Diluted earnings per share gives effect to weight average shares
which would be outstanding assuming the exercise of options using the treasury
stock method. For 1998, the exercise of options would be antidilutive.
New Accounting Pronouncements: Effective January 1, 1998 the
Company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income." This statement required the Company to
45
<PAGE>
report the effects of unrealized investment holding gains or losses during the
year as comprehensive income.
During 1998, the Company adopted SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." This statement standardizes
the disclosure requirements for pension and other postretirement benefits,
requires additional information on changes in benefit obligations and fair value
of plan assets that will facilitate additional analysis, and eliminates certain
disclosures previously required.
In June of 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activity." This
statement requires an entity to recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair value.
This statement is effective for all fiscal quarters of fiscal years beginning
after June 30, 1999. Since the Company does not have any derivative instruments
or hedges, management believes there will be no effect on the Company.
46
<PAGE>
INVESTMENT SECURITIES (In thousands)
The amortized cost and approximate fair value of investment securities at
December 31 are as follows:
<TABLE>
<CAPTION>
Amortized Gross Unreal- Gross Unreal- Estimated
Cost ized Gains ized Losses Fair Value
<S> <C> <C> <C> <C>
Held-to-Maturity -- 1998
U.S. Treasury and other U.S.
government agencies $ 500 $ 1 $--- $ 501
Obligations of states and
political subdivisions 2,130 50 --- 2,180
Total $ 2,630 $ 51 $--- $ 2,681
Available-for-Sale -- 1998
U.S. Treasury and other U.S.
government agencies $ 49,461 $ 471 $ 62 $ 49,870
Obligations of states and
political subdivisions 39,168 1,157 10 40,315
Mortgage-backed securities 56,169 364 131 56,402
Other securities 10,199 79 53 10,225
Total $154,997 $2,071 $256 $156,812
Stock Investments
Federal Home Loan Bank 1,600 --- --- 1,600
Federal Reserve Bank and others 389 --- --- 389
Total stock investment 1,989 --- --- 1,989
Total available-for-sale $156,986 $2,071 $256 $158,801
Net unrealized gain on
available-for-sale 1,815
Grand total carrying value $161,431
47
<PAGE>
Amortized Gross Unreal- Gross Unreal- Estimated
Cost ized Gains ized Losses Fair Value
Held-to-Maturity -- 1997
U.S. Treasury and other U.S.
government agencies $ 10,028 $ 58 $ 10 $ 10,076
Obligations of states and
political subdivisions 9,822 229 --- 10,051
Mortgage-backed securities 6,070 53 19 6,104
Other securities 2,516 25 3 2,538
Total $ 28,436 $ 365 $ 32 $ 28,769
Available-for-Sale -- 1997
U.S. Treasury and other U.S.
government agencies $ 46,534 $ 227 $ 67 $ 46,694
Obligations of states and
political subdivisions 28,129 614 23 28,720
Mortgage-backed securities 45,464 388 145 45,707
Other debt securities 528 8 --- 536
Total $120,655 $1,237 $235 $121,657
Stock Investments
Federal Home Loan Bank 1,519 --- --- 1,519
Federal Reserve Bank and others 389 --- --- 389
Total stock investments $ 1,908 --- --- $ 1,908
Total available-for-sale $122,563 $1,237 $235 $123,565
Net unrealized gain on
available-for-sale $ 1,002
Grand total carrying value $152,001
</TABLE>
As a result of the merger which occurred in 1998 the Oneida Valley National Bank
subsidiary elected to transfer all of its Held-to-Maturity securities to
Available-for-Sale consistent with the practices of First National Bank of
Cortland to support and maintain the Company's interest rate risk position. The
Company transferred securities with amortized cost of $20,692 and related gains
and losses of $466 and $3 respectively. None of these securities were sold
during 1998.
48
<PAGE>
The carrying value and estimated market value of debt securities at December 31,
1998, by contractual maturity, are shown below. The maturities of
mortgage-backed securities are based on the average life of the security. All
other expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
Held-to-Maturity Available-for-Sale
Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value
<S> <C> <C> <C> <C>
Due in one year
or less $1,025 $1,025 $ 25,628 $ 25,748
Due after one year
through five years 870 881 89,237 90,276
Due after five years
through ten years 735 775 31,015 31,548
Due after ten years --- --- 9,117 9,240
Total Investment
Securities $2,630 $2,681 $154,997 $156,812
</TABLE>
At December 31, 1998, and 1997, investment securities with a carrying value of
$100,398 and $90,342, respectively, were pledged as collateral for certain
deposits and other purposes as required or permitted by law.
LOANS (In thousands)
Major classifications of loans at December 31, are as follows:
1998 1997
---- ----
Commercial, financial and agricultural $ 75,845 $ 62,802
Real estate loans 128,652 120,894
Consumer loans 61,817 70,169
Total 266,314 253,865
------- -------
Less: Unearned income 2,212 3,087
Less: Allowance for possible loan losses 3,001 2,957
------- -------
Net loans $261,101 $247,821
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid balances of mortgage
loans serviced for others was $15,133, $7,637 and $4,700 at December 31, 1998,
1997, and 1996, respectively.
49
<PAGE>
ALLOWANCE FOR POSSIBLE LOAN LOSSES (In thousands) Changes in the allowance for
possible loan losses for the years ended December 31, are summarized as follows:
1998 1997 1996
---- ---- ----
Balance at January 1 $2,957 $3,025 $2,867
Provision for possible
loan losses 770 625 633
Recoveries credited 214 114 128
Subtotal 3,941 3,764 3,628
Less: Loans charged off 940 807 603
Balance at December 31 $3,001 $2,957 $3,025
For the years ended December 31, 1998 and 1997, respectively, the average
recorded investment in impaired loans did not exceed $200 and $500,
respectively. None of these loans had a specific valuation allowance recorded.
The Company recognized no interest income on impaired loans during 1998 and
1997.
RELATED PARTY TRANSACTIONS (In thousands)
Directors and executive officers of the Company and their affiliated companies
were customers of, and had other transactions with, the Company in the ordinary
course of business during 1998. It is the Company's policy that all loans and
commitments included in such transactions are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons and do not involve more than the
normal risk of collectibility or present other unfavorable features. Loan
transactions with related parties are summarized as follows:
1998 1997
---- ----
Balance at beginning of year $ 3,403 $ 5,012
New loans and advances 4,152 617
Loan payments (1,852) (2,226)
Balance at end of year $ 5,703 $ 3,403
BANK PREMISES, FURNITURE AND EQUIPMENT (In thousands) Bank premises and
equipment at December 31, consist of the following:
1998 1997
---- ----
Land $ 913 $ 913
Bank premises 8,470 8,560
Furniture and equipment 9,033 8,251
Subtotal 18,416 17,724
Less: Accumulated depreciation 10,127 8,769
Balance at end of year $ 8,289 $ 8,955
50
<PAGE>
DEPOSITS (In thousands)
The carrying amounts of deposits consisted of the following at December 31:
1998 1997
---- ----
Non-interest bearing checking $ 60,534 $ 53,158
Interest bearing checking 68,081 59,228
Savings accounts 78,692 79,332
Money market accounts 56,624 52,044
Time deposits 149,663 134,165
-------- --------
Total deposits $413,594 $377,927
The following table indicates the maturities of the Company's time deposits at
December 31:
1998 1997
---- ----
Due in one year $115,337 $103,076
Due in two years 20,271 17,203
Due in three years 6,074 6,652
Due in four years 7,378 6,434
Due in five years or more 603 800
Total deposits $149,663 $134,165
Total time deposits in excess of $100 as of December 31, 1998 and 1997 were
$57,922 and $39,511, respectively.
BORROWINGS (In thousands)
The following is a summary of borrowings at December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
Original Original
Amount Rate Term Amount Rate Term
<S> <C> <C> <C> <C> <C> <C>
Short-term borrowings:
Treasury Tax and Loan $752 4.40% Demand $1,108 5.20% Demand
Securities sold under
repurchase agreements --- 0.00% 1,000 5.88% One Year
Federal Home Loan
Bank term advances --- 0.00% 1,000 5.87% Six Months
Federal Home Loan
Bank overnight advances --- 0.00% 900 6.63% Overnight
Balance at end of year $752 $4,008
</TABLE>
Information related to short-term borrowings at December 31 is as follows:
1998 1997
---- ----
Maximum outstanding at any month end $1,712 $4,008
Average amount outstanding during the year $1,743 $1,377
Average interest rate during the year 5.60% 5.47%
Average amounts outstanding and average interest rates are computed using
monthly averages.
At December 31, 1998 and 1997, the Company had available a line of credit with
the Federal Home Loan Bank of New York of $43,800 and $43,100,
51
<PAGE>
respectively, of which $0 and $1,900 was outstanding as of December 31, 1998 and
1997, respectively. The line of credit is secured by mortgage loans contained
within the Company's loan portfolio.
At December 31, 1998 and 1997, the Company also had available a $2,500 line of
credit with another financial institution which was unused.
INCOME TAXES (In thousands)
The provision for income taxes for the years ended December 31, is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current tax expense $1,732 $2,228 $2,515
Deferred tax benefit (628) (8) (81)
Total provision for income taxes $1,104 $2,220 $2,434
The provision for income taxes includes the following:
1998 1997 1996
---- ---- ----
Federal income tax $ 780 $1,693 $1,865
New York State franchise tax 324 527 569
Total $1,104 $2,220 $2,434
</TABLE>
The components of deferred income taxes, included in other assets, at December
31, are as follows:
1998 1997
------ ------
Assets:
Allowance for possible loan losses $ 755 $ 736
Postretirement benefits 822 693
Deferred compensation 583 428
Merger 261 --
Other 8 23
Total Assets $2,429 $1,880
Liabilities:
Investment securities $ 727 $ 396
Accretion 40 98
Prepaid pension 197 188
Depreciation 113 162
Other 19 --
Total Liabilities $1,096 $ 844
Net deferred tax asset $1,333 $1,036
A reconciliation between the statutory federal income tax rate and the effective
income tax rate for 1998, 1997, and 1996 is as follows:
1998 1997 1996
---- ---- ----
Statutory federal income tax rate 34.0% 34.0% 34.0%
State franchise tax, net of
federal tax benefit 4.7% 4.8% 4.9%
Tax exempt income (16.4%) (8.7%) (7.9%)
Other, net 2.0% 0.%1 0.3%
Total 24.3% 30.2% 31.3%
52
<PAGE>
RETIREMENT PLANS AND POSTRETIREMENT BENEFITS (In thousands) As of December 31,
1998, the Company's subsidiaries offered various retirement and employee benefit
plans. The Oneida Valley National Bank subsidiary has a noncontributory defined
benefit pension plan covering substantially all of its employees. The benefits
are based on years of service and a percentage of the employee's average
compensation for the five highest consecutive years in the last ten years of
employment. Each of the Company's subsidiaries currently provides postretirement
medical and life insurance benefit plans covering substantially all of their
respective employees.
The following tables set forth the changes in the plan's benefit obligations,
fair value of plan assets, and prepaid (accrued) benefit cost as of December 31,
1998 and 1997:
Pension Postretirement
Benefits Benefits
1998 1997 1998 1997
------- ------- ------- -------
Change in benefit obligation:
Benefit obligation at
beginning of year $ 4,090 $ 4,169 $ 1,768 $ 1,737
Service cost 228 288 70 55
Interest cost 319 325 122 119
Amendments, curtailments,
special termination -- -- 274 --
Actuarial (gain)/loss 865 (444) 867 (72)
Benefits paid (250) (248) (52) (71)
Benefit obligation at end of year $ 5,252 $ 4,090 $ 3,049 $ 1,768
Pension Postretirement
Benefits Benefits
1998 1997 1998 1997
------- ------- ------- -------
Change in plan assets:
Fair value of plan assets at
beginning of year $ 6,167 $ 5,127 $ 0 $ 0
Actual return on plan assets 273 1,152 -- --
Company contribution -- 136 -- --
Benefits paid (250) (248) -- --
Fair value of plan assets at
end of year $ 6,190 $ 6,167 $ 0 $ 0
Pension Postretirement
Benefits Benefits
1998 1997 1998 1997
------- ------- ------- -------
Components of prepaid/
accrued benefit cost:
Funded status $ 938 $ 2,077 $(3,049) $(1,768)
Unrecognized transition obligation (260) (304) -- --
Unrecognized prior service cost (62) (70) (68) (121)
Unrecognized actuarial net
(gain)/loss (7) (1,140) 903 31
Prepaid/(accrued) benefit cost $ 609 $ 563 $(2,214) $(1,858)
Plan assets consists primarily of various debt and equity securities.
Significant assumptions used in determining the benefit obligation as of
December 31, 1998 and 1997 are as follows:
53
<PAGE>
Pension Postretirement
Benefits Benefits
1998 1997 1998 1997
---- ---- ---- ----
Weighted average discount rate 6.75% 8.00% 6.50% 7.00%
Expected long-term rate of
return on plan assets 8.50% 8.50% --- ---
Rate of increase in future
compensation levels 4.00% 4.00% 5.00% 5.00%
For measurement purposes, with respect to the postretirement benefit plans, a 9
percent annual rate of increase in the per capita cost of covered health care
benefits was assumed for 1998. The rate was assumed to decrease gradually to 5.5
percent by the year 2005 and remain at that level thereafter.
The composition of the net periodic pension cost for the years ended December
31, is as follows:
<TABLE>
<CAPTION>
Pension Postretirement
Benefits Benefits
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Service cost $ 228 $ 288 $ 228 $ 70 $ 55 $ 60
Interest cost 319 325 308 122 119 114
Amortization of
transition obligation (74) (74) (53) --- --- ---
Amortization of
unrecognized prior
service cost (8) (8) --- (10) (14) (14)
Expected return on
plan assets (511) (478) (393) --- --- ---
Special termination
benefits --- --- --- 274 --- ---
Net periodic benefit
cost $ (46) $ 53 $ 90 $ 456 $ 160 $ 160
</TABLE>
Assumed health care cost trend rates have a significant effect on the amounts
reported for health care plans. A one percentage point change in assumed health
care cost trend rates would have the following effects:
One percentage One percentage
point increase point decrease
Effect on total service and
interest cost components 103 (69)
Effect on postretirement
plan obligations 817 (600)
The Company also offers various defined contribution plans. First National Bank
of Cortland has a defined contribution plan covering substantially all of its
employees. Contributions to the plan are determined based on percentages of
compensation for eligible employees and are funded as accrued. Each of the
Company's subsidiaries also has a defined contribution 401(k) plan, with
contributions to the plans determined by the Board of Directors. Company
contributions to these plans were $425, $440, and $452 in 1998, 1997, and 1996,
respectively.
DEFERRED COMPENSATION AND SUPPLEMENTAL RETIREMENT PLANS (In thousands) The
Company maintains optional deferred compensation plans for its directors,
whereby fees normally received are deferred and paid by the Company upon the
retirement of the director. At December 31, 1998 and
54
<PAGE>
1997, other liabilities includes approximately $789 and $631, respectively,
relating to deferred compensation. Deferred compensation expense for the years
ended December 31, 1998, 1997, and 1996 approximated $157, $139, and $119,
respectively.
The Company has supplemental executive retirement plans for certain employees.
The Company has segregated assets of $826 and $760 at December 31, 1998 and
1997, respectively, to fund the estimated benefit obligation. These assets are
included in other assets. At December 31, 1998 and 1997, other liabilities
include approximately $682 and $574, accrued under these plans. Compensation
expense includes approximately $87, $99, and $80 relating to these plans at
December 31, 1998, 1997, and 1996, respectively.
STOCK OPTION PLAN (Options are stated in whole numbers) During 1998,
shareholders approved the 1998 long-term incentive compensation plan. Under this
plan, up to 400,000 options have been authorized for grant of incentive stock
options, non-qualified stock options and restricted stock awards. All options
have a 10-year term and vest and become exercisable ratably over a 3-year
period. Activity in the plan for 1998 is as follows:
Options Option Price Shares
Outstanding Per Share Exercisable
Outstanding at beginning
of year
Granted 100,000 $29.125 ---
Exercised --- --- ---
Forfeited --- --- ---
Outstanding at end
of year 100,000 $29.125 ---
The Company has elected to account for its stock-based compensation plan in
accordance with Accounting Principles Board Opinion No. 25. Pro forma amounts of
net income and earnings per share under Statement of Financial Accounting
Standards No. 123 are as follows:
1998
Net Income:
As reported $3,433
Pro forma $3,415
Earnings per share (basic and diluted):
As reported $.95
Pro forma $.95
The fair value of these options was estimated at the date of grant using a
Black-Scholes options pricing model with the following assumptions: risk- free
interest rate - 4.63%; dividend yield - 2.0%; market price volatility - 22.50%;
weighted average option life - 5 years. For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to expense over the
options' vesting period. Therefore, the foregoing pro forma results are not
likely to be representative of the effects of reported net income of future
periods due to additional years of vesting. The discounted weighted-average fair
value per share of options granted during 1998 is $6.66.
55
<PAGE>
COMMITMENTS AND CONTINGENT LIABILITIES (In thousands)
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments consist primarily of commitments to extend credit
and letters of credit which involve, to varying degrees, elements of credit risk
in excess of amounts recognized in the consolidated statements of condition. The
contract amount of those commitments and letters of credit reflects the extent
of involvement the Company has in those particular classes of financial
instruments. The Company's exposure to credit loss in the event of
nonperformance by the counterparty to the financial instrument for commitments
to extend credit and letters of credit is represented by the contractual amount
of the instruments. The Company uses the same credit policies in making
commitments and letters of credit as it does for on-balance-sheet instruments.
Financial instruments whose contract amounts represent credit risk:
Contract Amount
1998 1997
Commitments to extend credit $38,201 $37,852
Standby letters of credit $ 1,505 $ 1,424
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitment amounts are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Standby letters of credit written are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including bond financing and similar transactions.
The credit risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers. Since the
letters of credit are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
For both commitments to extend credit and letters of credit, the amount of
collateral obtained, if deemed necessary by the Company upon the extension of
credit, is based on management's credit evaluation of the counterparty.
Collateral held varies, but includes residential and commercial real estate.
Principal operating leases are for bank premises. At December 31, 1998,
aggregate future minimum lease payments under non-cancelable operating leases
with initial or remaining terms equal to or exceeding one year consist of the
following: 1999 - $146; 2000 - $146; 2001 - $152; 2002 - $137; 2003 - $106; and
$82 thereafter. Total rental expense amounted to $146 in 1998; $146 in 1997; and
$89 in 1996.
The Company is required to maintain a reserve balance as established by the
Federal Reserve Bank of New York. The required average total reserve for the
14-day maintenance period ended December 31, 1998 was $900.
56
<PAGE>
DIVIDENDS
The primary source of cash to pay dividends to the Company's shareholders is
through dividends from its banking subsidiaries. Banking regulations limit the
amount of dividends that a Bank may pay to its parent company. At December 31,
1998, no additional dividends could have been paid without prior regulatory
approval. There were no loans or advances from the subsidiary Banks to the
Company at December 31, 1998.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, "Disclosures about Fair
Value of Financial Instruments," requires disclosure of fair value information
about financial instruments, whether or not recognized in the statement of
condition, for which it is practicable to estimate that value. In cases where
quoted market prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
57
<PAGE>
The carrying amounts and estimated fair values of financial instruments are as
follows:
<TABLE>
<CAPTION>
(In Thousands)
Dec. 31, 1998 Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1997
Carrying Amount Fair Value Carrying Amount Fair Value
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $ 34,131 $ 34,131 $ 20,989 $ 20,989
Investment securities 161,431 161,482 152,001 152,335
Net Loans 261,101 267,994 247,821 251,975
Total Financial Assets $456,663 $463,607 $420,811 $425,299
Financial Liabilities:
Deposits $413,594 $414,392 $377,927 $367,185
Short-term borrowing 752 752 4,008 4,008
Total Financial Liabilities $414,346 $415,144 $381,935 $371,193
</TABLE>
The fair value of commitments to extend credit and standby letters of credit is
not significant.
58
<PAGE>
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the consolidated
statement of condition for cash and short-term instruments approximate those
assets' fair value.
Investment securities: Fair values for investment securities are based on quoted
market prices or dealer quotes.
Loans: Fair values for loans are estimated using discounted cash flow analysis,
based on interest rates approximating those currently being offered for loans
with similar terms and credit quality. The fair value of accrued interest
approximates carrying value.
Deposits: The fair values disclosed for noninterest-bearing accounts and
accounts with no stated maturity are, by definition, equal to the amount payable
on demand at the reporting date. The fair value of time deposits was estimated
by discounting expected monthly maturities at interest rates approximating those
currently being offered on time deposits of similar terms. The fair value of
accrued interest approximates carrying value.
Short-term borrowings: The carrying amounts of short-term borrowings approximate
their fair value.
Off-balance-sheet instruments: Off-balance-sheet financial instruments consist
of commitments to extend credit and standby letters of credit, with fair value
based on fees currently charged to enter into agreements with similar terms and
credit quality.
REGULATORY MATTERS (In thousands)
The Company and its banking subsidiaries are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines that involve quantitative measures
of the Company's assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in the
tables below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1998, that the
Company and its subsidiary banks meet all capital adequacy requirements to which
they are subject.
As of December 2, 1996 and November 17, 1997, the most recent notification
from the Office of the Comptroller of the Currency for First
59
<PAGE>
National Bank of Cortland and Oneida Valley National Bank, respectively,
categorized the Banks as "well-capitalized," under the regulatory framework for
prompt corrective action. To be categorized as "well-capitalized," the Banks
must maintain total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as
set forth in the tables below. There are no conditions or events since that
notification that management believes have changed the institutions' category.
60
<PAGE>
First National Bank of Cortland's actual capital amounts and ratios are
presented in the following table:
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(>or=) (>or=)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital (to Risk-
Weighted Assets) $23,962 18.76% $10,218 8.00% $12,772 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 22,627 17.72% 5,109 4.00% 7,663 6.00%
Tier 1 Capital (to
Average Assets) 22,627 9.76% 9,270 4.00% 11,587 5.00%
As of December 31, 1997
Total Capital (to Risk-
Weighted Assets) $25,706 21.02% $ 9,426 8.00% $11,782 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 24,466 20.77% 4,713 4.00% 7,069 6.00%
Tier 1 Capital (to
Average Assets) 24,466 11.11% 8,810 4.00% 11,013 5.00%
</TABLE>
61
<PAGE>
Oneida Valley National Bank's actual capital amounts and ratios are presented in
the following table:
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(>or=) (>or=)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital (to Risk-
Weighted Assets) $25,333 18.65% $10,867 8.00% $13,583 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 23,667 17.42% 5,433 4.00% 8,150 6.00%
Tier 1 Capital (to
Average Assets) 23,667 10.23% 9,258 4.00% 11,573 5.00%
As of December 31, 1997
Total Capital (to Risk-
Weighted Assets) $26,245 20.90% $10,037 8.00% $12,546 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 24,677 19.70% 5,018 4.00% 7,527 6.00%
Tier 1 Capital (to
Average Assets) 24,677 11.30% 8,721 4.00% 10,901 5.00%
</TABLE>
62
<PAGE>
The Company's actual capital amounts and ratios are presented in the following
table:
<TABLE>
<CAPTION>
To Be Well Capitalized
For Capital Under Prompt Corrective
Adequacy Purposes Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(>or=) (>or=)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital (to Risk-
Weighted Assets) $53,081 20.14% $21,083 8.00% $26,354 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 50,080 19.00% 10,542 4.00% 15,813 6.00%
Tier 1 Capital (to
Average Assets) 50,080 10.81% 18,528 4.00% 23,160 5.00%
As of December 31, 1997
Total Capital (to Risk-
Weighted Assets) $52,100 21.39% $19,483 8.00% $24,354 10.00%
Tier 1 Capital (to Risk-
Weighted Assets) 49,143 20.18% 9,742 4.00% 14,613 6.00%
Tier 1 Capital (to
Average Assets) 49,143 11.21% 17,530 4.00% 21,912 5.00%
</TABLE>
63
<PAGE>
PARENT COMPANY FINANCIAL INFORMATION (In thousands)
Condensed financial statement information of Alliance Financial Corporation is
as follows:
BALANCE SHEETS Dec. 31, 1998 Dec. 31, 1997
------------- -------------
Assets:
Investment in subsidiary banks $ 47,382 $ 49,650
Cash 4,633 48
Investment Securities 28 28
Other assets -- 431
Total Assets $ 52,043 $ 50,157
Liabilities:
Accounts Payable 246 --
Dividends Payable 629 407
Total Liabilities 875 407
Shareholders' Equity:
Common Stock 3,641 3,646
Surplus 3,641 3,646
Undivided profits 43,864 42,917
Accumulated comprehensive income 1,088 607
Treasury stock (1,066) (1,066)
Total Shareholders' Equity $ 51,168 $ 49,750
Total Liabilities and
Shareholders' Equity $ 52,043 $ 50,157
64
<PAGE>
Statement of Income
Years Ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
----------------------------------------------------------
Dividend income from
subsidiary bank $ 3,781 $ 6,000 $ 2,683
Investment income 2 2 2
Operating expenses (1,036) (58) (71)
2,747 5,944 2,614
Equity (deficit) in
undistributed income
of subsidiaries 686 (811) 2,740
Net Income $ 3,433 $ 5,133 $ 5,354
Statements of Cash Flows
Years Ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
----------------------------------------------------------
Operating Activities
Net Income $ 3,433 $ 5,133 $ 5,354
Adjustments to reconcile net
income to net cash provided
by operating activities:
Equity (deficit) in
undistributed net income
of subsidiaries (686) 811 (2,740)
Decrease (increase) in
other assets 431 (25) --
Increase (decrease) in
other liabilities 246 20 (22)
Net Cash Provided by
Operating Activities 3,424 5,939 2,592
Investing Activities
Dividends received 3,435 -- --
Net Cash Provided by
Investing Activities 3,435 -- --
Financing Activities
Purchase and retirement of
common shares (86) (1,624) (526)
Treasury stock purchased -- (1,119) --
Cash dividends paid (2,188) (3,219) (2,063)
Treasury stock sold -- 62 --
Net Cash used by
Financing Activities (2,274) (5,900) (2,589)
Increase in Cash and
Cash Equivalents 4,585 39 3
Cash and Cash Equivalents
at Beginning of Year 48 9 6
Cash and Cash Equivalents
at End of Year $ 4,633 $ 48 $ 9
Supplemental Disclosures of
Cash Flow Information:
Non-cash investing activities:
Change in unrealized gain (813) (510) 188
Non-cash financing activities:
Dividend declared and unpaid $ 629 $ 407 $ 427
65
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Alliance Financial Corporation
In our opinion, the accompanying consolidated statements of condition and the
related consolidated statements of income, comprehensive income, changes in
shareholders' equity and cash flows present fairly, in all material respects,
the financial position of Alliance Financial Corporation at December 31, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Syracuse, New York
January 15, 1999
66
<PAGE>
Item 9 -- Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10 -- Directors and Executive Officers of the Registrant The information
required by this Item 10 is incorporated herein by reference to the section
entitled "Information Concerning Nominees for Directors and Other Directors" in
the Company's Proxy Statement.
Item 11 -- Executive Compensation
The information required by this Item 11 is incorporated herein by reference to
the section entitled "Executive Compensation" in the Company's Proxy Statement.
Item 12 -- Security Ownership of Certain Beneficial Owners and Management The
information required by this Item 12 is incorporated herein by reference to the
sections entitled "Voting Securities and Principal Holders Thereof" and
"Information Concerning Nominees for Directors and Other
Directors" in the Company's Proxy Statement.
Item 13 -- Certain Relationships and Related Transactions The information
required by this Item 13 is incorporated herein by reference to the section
entitled "Transactions with Management" in the Company's Proxy Statement.
PART IV
Item 14 -- Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents filed as part of this report:
(1) The following financial statements are included in Item 8:
Consolidated Statements of Condition at December 31, 1998 and
1997.
Consolidated Statements of Income For Each of the Three Years
in the Period Ended December 31, 1998.
Consolidated Statements of Shareholders' Equity For Each of
the Three Years in the Period Ended December 31, 1998.
Consolidated Statements of Cash Flows For Each of the Three
Years in the Period Ended December 31, 1998.
Notes to Consolidated Financial Statements.
Independent Accountants' Report.
(2) Financial statement schedules are omitted from this Form 10-K
since the required information is not applicable to the
Registrant.
67
<PAGE>
(3) Listing of Exhibits:
The following documents are attached as Exhibits to this Form
10-K or are incorporated by reference to the prior filings of
the Registrant with the Commission.
FORM 10-K
Exhibit
Number Exhibit
3.1 Amended and Restated Certificate of Incorporation of the
Company(1)
3.2 Amended and Restated Bylaws of the Company(1)
10.1 Stock Option Agreement, dated as of July 10, 1998, between
Cortland First (as the issuer) and Oneida Valley (as the
grantee)(2)
10.2 Stock Option Agreement, dated as of July 10, 1998, between
Oneida Valley (as the issuer) and Cortland First (as the
grantee)(2)
10.3 Form of Voting Agreement, dated as of July 10, 1998, between
Cortland First Directors and Oneida Valley(2)
10.4 Form of Voting Agreement, dated as of July 10, 1998, between
Oneida Valley Directors and Cortland First(2)
10.5 Employment Agreement, dated as of November 25, 1998, between the
Company and David R. Alvord(1)
10.6 Employment Agreement, dated as of November 25, 1998, between the
Company and John C. Mott(1)
10.7 Alliance Financial Corporation 1998 Long Term Incentive
Compensation Plan(1)
21 List of the Company's Subsidiaries(3)
23 Consent of PricewaterhouseCoopers LLP(3)
27 Financial Data Schedule(3)
(1) Incorporated herein by reference to the exhibit with the same number to
the Registration Statement on Form S-4 (Registration No. 333-62623) of
the Company previously filed with the Securities and Exchange
Commission (the "Commission") on August 31, 1998, as amended.
(2) Incorporated herein by reference to the exhibit with the same number to
the Current Report on Form 8-K of Cortland First (File No. 0-15366)
filed with the Commission on July 22, 1998.
68
<PAGE>
(3) Filed herewith.
Item 14 (b) -- Reports on Form 8-K
The Company filed with the Commission on December 1, 1998 a Current
Report on Form 8-K to report the consummation of the merger between Cortland
First Financial Corporation and Oneida Valley Bancshares, Inc. An amendment to
such Current Report was filed with the Commission on February 8, 1999 to include
the required financial statements of Cortland First Financial Corporation and
Oneida Valley Bancshares, Inc.
Item 14 (c)
See Item 14 (a) (3) above.
Item 14 (d)
See Item 14 (a) (2) above.
69
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ALLIANCE FINANCIAL CORPORATION
(Registrant)
March 24, 1999 By /s/ David R. Alvord
- ------------------------------------ -----------------------------------
Date David R. Alvord, President & Co-CEO
March 24, 1999 By /s/ David P. Kershaw
- ------------------------------------ -----------------------------------
Date David P. Kershaw, Treasurer & CFO
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant, and
in the capacities and on the dates indicated.
/s/ David R. Alvord Date March 24, 1999
- ------------------------------------ -----------------------------------
David R. Alvord, President, Co-CEO, and Director
/s/ Donald S. Ames Date March 24, 1999
- ------------------------------------ -----------------------------------
Donald S. Ames, Director
Date
- ------------------------------------ -----------------------------------
John W. Bailey, Director
/s/ Mary Alice Bellardini Date March 25, 1999
- ------------------------------------ -----------------------------------
Mary Alice Bellardini, Director
/s/ John H. Buck Date March 24, 1999
- ------------------------------------ -----------------------------------
John H. Buck, Director
/s/ Donald H. Dew Date March 24, 1999
- ------------------------------------ -----------------------------------
Donald H. Dew, Director
/s/ Peter M. Dunn Date March 24, 1999
- ------------------------------------ -----------------------------------
Peter M. Dunn, Director
Date
- ------------------------------------ -----------------------------------
Robert H. Fearon, Jr., Director
/s/ David P. Kershaw Date March 24, 1999
- ------------------------------------ -----------------------------------
David P. Kershaw, Treasurer, CFO, and Director
Date
- ------------------------------------ -----------------------------------
Robert H. Kuiper, Director
Date
- ------------------------------------ -----------------------------------
Samuel J. Lanzafame, Director
/s/ Robert M. Lovell Date March 26, 1999
- ------------------------------------ -----------------------------------
Robert M. Lovell, Director
70
<PAGE>
/s/ Harry D. Newcomb Date March 24, 1999
- ------------------------------------ -----------------------------------
Harry D. Newcomb, Director
/s/ Garrison A. Marsted Date March 25, 1999
- ------------------------------------ -----------------------------------
Garrison A. Marsted, Director
Date
- ------------------------------------ -----------------------------------
John C. Mott, Co-CEO and Director
Date
- ------------------------------------ -----------------------------------
Charles E. Shafer, Director
/s/ Richard J. Shay Date March 26, 1999
- ------------------------------------ -----------------------------------
Richard J. Shay, Director
/s/ Charles H. Spaulding Date March 24, 1999
- ------------------------------------ -----------------------------------
Charles H. Spaulding, Director
/s/ Richard G. Smith Date March 24, 1999
- ------------------------------------ -----------------------------------
Richard G. Smith, Director
Date
- ------------------------------------ -----------------------------------
David J. Taylor, Director
/s/ Edward W. Thoma Date March 24, 1999
- ------------------------------------ -----------------------------------
Edward W. Thoma, Director
/s/ Stuart E. Young Date March 24, 1999
- ------------------------------------ -----------------------------------
Stuart E. Young, Director
Exhibit 21 -- Subsidiaries
Subsidiaries of the Registrant
First National Bank of Cortland and Oneida Valley National Bank are wholly owned
subsidiaries of Alliance Financial Corporation and each is a national banking
association organized under the laws of the United States.
Exhibit 23 -- Consent of Independent Accountants
We consent to the incorporation by reference in the registration statement of
Alliance Financial Corporation on Form S-3 (File No. 33-65417) of our report
dated January 15, 1999, on our audits of the consolidated financial statements
of Alliance Financial Corporation as of December 31, 1998 and 1997 and for the
years ended December 31, 1998, 1997 and 1996, which report is included in this
Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
Syracuse, New York
March 24, 1999
71
