News Column

SUFFOLK BANCORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

July 30, 2014

Safe Harbor Statement Pursuant to the Private Securities Litigation Reform Act of 1995 - Certain statements contained in this discussion are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These can include remarks about the Company, the banking industry, the economy in general, expectations of the business environment in which the Company operates, projections of future performance, and potential future credit experience. These remarks are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond the Company's control and are subject to a variety of uncertainties that could cause future results to vary materially from the Company's historical performance, or from current expectations. These remarks may be identified by such forward-looking statements as "should," "expect," "believe," "view," "opportunity," "allow," "continues," "reflects," "typically," "usually," "anticipate," or similar statements or variations of such terms. Factors that could affect the Company include particularly, but are not limited to: increased capital requirements mandated by the Company's regulators; the Company's ability to raise capital; competitive factors, including price competition; changes in interest rates; increases or decreases in retail and commercial economic activity in the Company's market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations or changes in law, regulations or regulatory practices; the Company's ability to attract and retain key management and staff; any failure by the Company to maintain effective internal control over financial reporting; larger-than-expected losses from the sale of assets; and the potential that net charge-offs are higher than expected or for further increases in our provision for loan losses. Further, it could take the Company longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require the Company to change its practices in ways that materially change the results of operations. We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. For more information, see the risk factors described in the Company's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. 29 -------------------------------------------------------------------------------- Table of Contents Non-GAAP Disclosure - This discussion includes a non-GAAP financial measure of the Company's tangible common equity ("TCE") ratio. A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with U.S. GAAP. The Company believes that this non-GAAP financial measure provides both management and investors a more complete understanding of the underlying operational results and trends and the Company's marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with U.S. GAAP and may not be comparable to similarly titled measures used by other financial institutions. Executive Summary - The Company is a one-bank holding company incorporated in 1985. The Company operates as the parent for its wholly owned subsidiary, the Bank, a national bank founded in 1890. The income of the Company is primarily derived through the operations of the Bank and the REIT. The Bank is a full-service bank serving the needs of its local residents through 26 branches, in Nassau and Suffolk Counties, New York and loan production offices in Garden City and Melville, New York. The Bank's 26 branches include the two recently opened in Melville and Garden City in June 2014 and December 2013, respectively. The Bank offers a full line of domestic commercial and retail banking services and wealth management services. The Bank's primary lending area includes all of Suffolk County and the adjacent markets of Nassau County and New York City. The Bank makes commercial real estate floating and fixed rate loans, commercial and industrial loans to manufacturers, wholesalers, distributors, developers/contractors and retailers and agricultural loans. The Bank also makes loans secured by residential mortgages, and both fixed and floating rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered. In order to expand the Company geographically into western Suffolk and Nassau Counties and to diversify the lending business of the Company, loan production offices were opened in Garden City and Melville in 2013 and 2012, respectively. As part of our strategy to move westward, the loan production office in Garden City serves the major business markets in central and western Long Island. Seasoned banking professionals have joined the Company to augment both interest and fee income through the origination of commercial and industrial loans, the generation of high quality multifamily and jumbo mortgages to be retained in the portfolio and conforming mortgages for sale in secondary markets. The Bank finances most of its activities with deposits, including demand, saving, N.O.W. and money market deposits, as well as time deposits. It may also rely on other sources of funds, including inter-bank overnight loans. The Company's chief competition includes local banks within its market area, as well as New York City money center banks and regional banks. 30



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Table of Contents Financial Performance Summary As of or for the quarters and six months ended June 30, 2014 and 2013 (dollars in thousands, except per share data) Over/ Over/ Quarters ended June 30, (under) Six months ended June 30, (under) 2014 2013 2013 2014 2013 2013 Revenue (1) $ 18,220$ 16,277 11.9 % $ 36,610$ 33,270 10.0 % Operating expenses (2) $ 13,152$ 12,692 3.6 %



$ 26,461$ 26,493 (0.1 %) Provision for loan losses $ 250 $ -

N/ M (3 ) $ 500 $ - N/ M (3 ) Net income $ 3,771$ 2,769 36.2 % $ 7,491$ 5,478 36.7 % Net income per common share - diluted $ 0.32$ 0.24 33.3 %



$ 0.64$ 0.47 36.2 % Return on average assets

0.87 % 0.68 % 19 b p 0.88 % 0.68 % 20 b p Return on average stockholders' equity 8.55 % 6.71 % 184 b p 8.68 % 6.70 % 198 b p Tier 1 leverage ratio 10.27 % 9.76 % 51 b p 10.27 % 9.76 % 51 b p Tier 1 risk-based capital ratio 13.28 % 14.73 % (145 ) b p 13.28 % 14.73 % (145 ) b p Total risk-based capital ratio 14.53 % 15.99 % (146 ) b p 14.53 % 15.99 % (146 ) b p Tangible common equity ratio (non-GAAP) 10.06 % 9.49 % 57 b p 10.06 % 9.49 % 57 b p bp - denotes basis points; 100 bp equals 1%. (1) Represents net interest income plus total non-interest income.



(2) Results for the 2013 quarter and six-month period are net of a $1,659

non-recurring gain arising from the termination of post-retirement life

insurance benefits during the second quarter of 2013.

(3) N/M - denotes % variance not meaningful for statistical purposes.

At June 30, 2014, the Company, on a consolidated basis, had total assets of $1.8 billion, total deposits of $1.6 billion and stockholders' equity of $180 million. The Company recorded net income of $3.8 million, or $0.32 per diluted common share, for the second quarter of 2014, compared to $2.8 million, or $0.24 per diluted common share, for the same period in 2013. The 36.2% improvement in second quarter 2014 earnings versus 2013 resulted from several factors, most notably a $1.7 million increase in net interest income in 2014 coupled with a $214 thousand increase in non-interest income versus the comparable 2013 period. Partially offsetting these positive factors was an increase in operating expenses in 2014 when compared to the prior year largely due to a $1.7 million expense credit recorded in the second quarter of 2013 resulting from the termination of a post-retirement life insurance plan in that period and an increase in the provision for loan losses of $250 thousand in the second quarter of 2014.



The Company's return on average assets and return on average common stockholders' equity were 0.87% and 8.55%, respectively, in the second quarter of 2014 versus 0.68% and 6.71%, respectively, in the second quarter of 2013.

The Company experienced an increase in the total loan portfolio of $66 million, from $1.13 billion at March 31, 2014 to $1.20 billion at June 30, 2014, a 5.8% quarterly growth rate. The geographic and product diversification strategies implemented in our lending businesses are working well. Each of our lending businesses, commercial, multifamily and residential, are contributing to this momentum. The Company is increasing market share by preserving our eastern Suffolk lending franchise while simultaneously expanding west. The Company's core deposit franchise continues to be among the best in the region. Core deposits, consisting of demand, N.O.W., saving and money market deposits, totaled $1.3 billion at June 30, 2014, representing 85% of total deposits at that date. Demand deposits totaled $676 million at June 30, 2014 and represented 43% of total deposits at that date. The deposit product mix continues to be an important strength of the Company and resulted in an average cost of funds of 16 basis points during the second quarter of 2014. Management continues to make progress on operating expenses, which have been reduced even as loan and deposit growth has increased, and despite the additional investments the Company has made in people, office space and technology upgrades to support its western expansion. Several of the major projects previously announced on the expense reduction side are performing better than expected. During 2013 the Company announced the phased-in closing of six branches in Suffolk County that, once fully implemented, would reduce annual operating expenses by an estimated $2.4 million. The assumptions used in deciding to close these branches relating to deposit runoff and expense savings are proving to be conservative. The Company's management team is committed to continued expense reductions and improvement in the operating efficiency ratio. Critical Accounting Policies, Judgments and Estimates - The Company's accounting and reporting policies conform to U.S. GAAP and general practices within the banking industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. 31 -------------------------------------------------------------------------------- Table of Contents Allowance for Loan Losses - In management's opinion, one of the most critical accounting policies impacting the Company's financial statements is the evaluation of the allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a quarterly analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company's own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all TDRs are evaluated individually for impairment. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics. These classes are commercial and industrial, commercial real estate, multifamily, mixed use commercial, real estate construction, residential mortgages, home equity and consumer loans. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment or liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on the fair market value of collateral and the estimated time required to recover the Company's investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan's effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the estimated collectability of the loan class not captured by historical loss data. These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. There are no formulas for translating them into a specific basis point adjustment of the Company's historical loss rate for a pool of loans having similar risk characteristics. These adjustments reflect management's overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan's effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. Deferred Tax Assets and Liabilities - Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities, computed using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers all relevant positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and available tax planning strategies. OTTI of Investment Securities - Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of operations and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings. 32 -------------------------------------------------------------------------------- Table of Contents Material Changes in Financial Condition - Total assets of the Company were $1.8 billion at June 30, 2014. When compared to December 31, 2013, total assets increased by $65 million. This change largely reflects an increase in loans of $127 million, partially offset by a decline in cash and cash equivalents of $34 million as redeployment of lower-yielding overnight interest-bearing deposits into higher yielding assets continued coupled with a decline in investment securities of $29 million. Total loans were $1.20 billion at June 30, 2014 compared to $1.07 billion at December 31, 2013. The increase in the loan portfolio largely reflects growth of multifamily, CRE, mixed use commercial and C&I loans of $60 million, $23 million, $21 million and $10 million, respectively, during the first half of 2014. Total investment securities were $383 million at June 30, 2014 and $412 million at December 31, 2013. The decrease in the investment portfolio largely reflects sales of corporate bonds, MBS of U.S. Government-sponsored enterprises and U.S. Government agency securities of $9 million, $6 million and $5 million, respectively. In addition, principal paydowns of CMOs and MBS of U.S. Government-sponsored enterprises totaled $7 million and maturities and calls of municipal obligations and U.S. Government agency securities totaled $13 million during the first half of 2014. These were partially offset by purchases of municipal obligations totaling $4 million. A reduction in interest rates in 2014 had a positive impact of $4 million on the fair value of the Company's available for sale investment portfolio. At June 30, 2014, total deposits were $1.6 billion, an increase of $58 million when compared to December 31, 2013. This increase was primarily due to higher balances of demand deposits, money market deposits and higher-cost time certificates of $100,000 or more of $48 million, $19 million and $9 million, respectively, partially offset by decreases in N.O.W. deposits, other time deposits and saving deposits of $11 million, $5 million and $2 million, respectively. Core deposit balances, which consist of demand, saving, N.O.W. and money market deposits, represented 85% of total deposits at June 30, 2014 and December 31, 2013. Demand deposit balances represented 43% and 42% of total deposits at June 30, 2014 and December 31, 2013, respectively. The Company had no borrowed funds outstanding at either June 30, 2014 or December 31, 2013. Liquidity and Capital Resources - Liquidity management is defined as both the Company's and the Bank's ability to meet their financial obligations on a continuous basis without material loss or disruption of normal operations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, funding new and existing loan commitments and the ability to take advantage of business opportunities as they arise. Asset liquidity is provided by short-term investments and the marketability of securities available for sale. The Company may also leave excess reserve balances at the FRB if the rate being paid is higher than would be available from other short-term investments. Liquid assets, consisting of federal funds sold, securities available for sale and balances at the FRB, decreased to $355 million at June 30, 2014 compared to $462 million at December 31, 2013 as the Company continued to redeploy its lower-yielding cash balances into loans. These liquid assets may include assets that have been pledged against municipal deposits or short-term borrowings. In addition, the Company has pledged U.S. Government agency securities held in its available for sale portfolio, with a market value of approximately $3 million at June 30, 2014, as collateral for the derivative swap contracts. Liquidity is also provided by the maintenance of a base of core deposits, maturing short-term assets including cash and due from banks, the ability to sell or pledge marketable assets and access to lines of credit. Liquidity is continuously monitored, thereby allowing management to better understand and react to emerging balance sheet trends, including temporary mismatches with regard to sources and uses of funds. After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost. These funds can be obtained by converting liquid assets to cash or by attracting new deposits or other sources of funding. Many factors affect the Company's ability to meet liquidity needs, including variations in the markets served, loan demand, its asset/liability mix, its reputation and credit standing in its markets and general economic conditions. Borrowings and the scheduled amortization of investment securities and loans are more predictable funding sources. Deposit flows and securities prepayments are somewhat less predictable as they are often subject to external factors. Among these are changes in the local and national economies, competition from other financial institutions and changes in market interest rates. The Company's primary sources of funds are cash provided by deposits and borrowings, proceeds from maturities and sales of securities available for sale and cash provided by operating activities. At June 30, 2014, total deposits were $1.6 billion, an increase of $58 million when compared to December 31, 2013. Of the total time deposits at June 30, 2014, $190 million are scheduled to mature within the next 12 months. Based on historical experience, the Company expects to be able to replace a substantial portion of those maturing deposits with comparable deposit products. At June 30, 2014 and December 31, 2013, there were no borrowings outstanding. For the six months ended June 30, 2014 and 2013, proceeds from sales and maturities of securities available for sale totaled $33 million and $34 million, respectively. The Company's primary uses of funds are for the origination of loans and the purchase of investment securities. For the six months ended June 30, 2014, the Company had net loan originations for portfolio of $126 million compared to $120 million for the same period in 2013. The Company purchased investment securities totaling $4 million and $116 million during the six months ended June 30, 2014 and 2013, respectively. 33 -------------------------------------------------------------------------------- Table of Contents The Bank's Asset/Liability and Funds Management Policy establishes specific policies and operating procedures governing liquidity levels to assist management in developing plans to address future and current liquidity needs. Management monitors the rates and cash flows from the loan and investment portfolios while also examining the maturity structure and volatility characteristics of liabilities to develop an optimum asset/liability mix. Available funding sources include retail, commercial and municipal deposits, purchased liabilities and stockholders' equity. At June 30, 2014, access to approximately $396 million in Federal Home Loan Bank ("FHLB") lines of credit for overnight or term borrowings with maturities of up to thirty years was available. At June 30, 2014, approximately $60 million and $10 million in unsecured and secured lines of credit, respectively, extended by correspondent banks were also available to be utilized, if needed, for short-term funding purposes. At June 30, 2014, no borrowings were outstanding under lines of credit with the FHLB or correspondent banks. The Bank also has the ability to access the brokered deposit market. Deposits gathered through the Certificate of Deposit Account Registry Service ("CDARS") are considered for regulatory purposes to be brokered deposits. At June 30, 2014, the Bank had $4 million in CDARS deposits outstanding. The Company strives to maintain an efficient level of capital, commensurate with its risk profile, on which a competitive rate of return to stockholders will be realized over both the short and long term. Capital is managed to enhance stockholder value while providing flexibility for management to act opportunistically in a changing marketplace. Management continually evaluates the Company's capital position in light of current and future growth objectives and regulatory guidelines. Total stockholders' equity amounted to $180 million at June 30, 2014 and $167 million at December 31, 2013. The increase in stockholders' equity versus December 31, 2013 was due to a combination of net income recorded during the first six months of 2014 coupled with a $5 million decrease in accumulated other comprehensive loss, net of tax. The decrease in accumulated other comprehensive loss at June 30, 2014 resulted almost solely from the positive impact of a reduction in interest rates in 2014 on the value of the Company's available for sale investment portfolio. The Company and the Bank are subject to regulatory capital requirements. The Company's tier 1 leverage, tier 1 risk-based and total risk-based capital ratios were 10.27%, 13.28% and 14.53%, respectively, at June 30, 2014. The Company's capital ratios exceeded all regulatory requirements at June 30, 2014. The Bank's tier 1 leverage, tier 1 risk-based and total risk-based capital ratios were 10.19%, 13.19% and 14.44%, respectively, at June 30, 2014. Each of these ratios exceeds the regulatory guidelines for a well-capitalized institution, the highest regulatory capital category. The Company did not repurchase any shares of its common stock during the first half of 2014. Repurchase of shares will occur only if management believes that the purchase will be at prices that are accretive to earnings per share and is the most efficient use of the Company's capital. The Company's tangible common equity ratio was 10.06% at June 30, 2014 compared to 9.68% at December 31, 2013 and 9.49% at June 30, 2013. The ratio of tangible common equity to tangible assets, or TCE ratio, is calculated by dividing total common stockholders' equity by total assets, after reducing both amounts by intangible assets. The TCE ratio is not required by GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of our capital levels. Since there is no authoritative requirement to calculate the TCE ratio, our TCE ratio is not necessarily comparable to similar capital measures disclosed or used by other companies in the financial services industry. Tangible common equity and tangible assets are non-GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with GAAP or as required by bank regulatory agencies. Set forth below are the reconciliations of tangible common equity to GAAP total common stockholders' equity and tangible assets to GAAP total assets at June 30, 2014 (in thousands): Total stockholders' equity $ 180,305 Less: intangible assets (2,986 ) Tangible common equity $ 177,319 Total assets $ 1,765,239 Less: intangible assets (2,986 ) Tangible assets $ 1,762,253 All dividends must conform to applicable statutory requirements. The Company's ability to pay dividends to stockholders depends on the Bank's ability to pay dividends to the Company. Under 12 USC 56-9, a national bank may not pay a dividend on its common stock if the dividend would exceed net undivided profits then on hand. Further, under 12 USC 60, a national bank must obtain prior approval from the OCC to pay dividends on either common or preferred stock that would exceed the bank's net profits for the current year combined with retained net profits (net profits minus dividends paid during that period) of the prior two years. The ability of the Bank to pay dividends to the Company is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund for the retirement of any preferred stock. In addition, a national bank may not pay dividends in an amount greater than its undivided profits or declare any dividends if such declaration would leave the bank inadequately capitalized. Also, the ability of the Bank to declare dividends will depend on the prior approval of the FRB. 34 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements - The Bank 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 include commitments to extend credit and standby and documentary letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. 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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the customer. Collateral required varies, but may include accounts receivable, inventory, equipment, real estate and income-producing commercial properties. At June 30, 2014 and December 31, 2013, commitments to originate loans and commitments under unused lines of credit for which the Bank is obligated amounted to approximately $127 million and $113 million, respectively. Letters of credit are conditional commitments guaranteeing payments of drafts in accordance with the terms of the letter of credit agreements. Commercial letters of credit are used primarily to facilitate trade or commerce and are also issued to support public and private borrowing arrangements, bond financing and similar transactions. Collateral may be required to support letters of credit based upon management's evaluation of the creditworthiness of each customer. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Most letters of credit expire within one year. At June 30, 2014 and December 31, 2013, letters of credit outstanding were approximately $18 million.



The Company has recorded a liability of $255 thousand for unfunded commitments at June 30, 2014.

Material Changes in Results of Operations - Comparison of the Quarters Ended June 30, 2014 and 2013 - The Company recorded net income of $3.8 million during the second quarter of 2014 versus $2.8 million in the comparable 2013 period. The improvement in 2014 net income resulted principally from a $1.7 million increase in net interest income in the second quarter of 2014 coupled with an increase in non-interest income of $214 thousand and a lower effective tax rate versus the comparable 2013 period. Partially offsetting these positive factors were increases in total operating expenses of $460 thousand and the provision for loan losses of $250 thousand in the second quarter of 2014. The $1.7 million or 12.5% improvement in second quarter 2014 net interest income resulted from a $64 million increase in average total interest-earning assets, coupled with a 30 basis point improvement in the Company's net interest margin to 4.13% in 2014 versus 3.83% in 2013. The Company's second quarter 2014 average total interest-earning asset yield was 4.29% versus 4.02% for the comparable 2013 period. Despite a lower average yield on the Company's loan portfolio, down 64 basis points, in 2014 versus 2013, the Company's average balance sheet mix continued to improve as average loans increased by $294 million (34.5%) versus second quarter 2013 and low-yielding overnight interest-bearing deposits declined by $204 million (80.5%) during the same period. Liquid investments represented 3% of average total interest-earning assets in the first quarter of 2014 versus 16% a year ago. The average securities portfolio decreased by $26 million to $407 million in the second quarter of 2014 versus the comparable 2013 period. The average yield on the investment portfolio was 3.71% in the second quarter of 2014 versus 3.68% a year ago. The Company's average cost of total interest-bearing liabilities declined by seven basis points to 0.28% in the second quarter of 2014 versus 0.35% in the second quarter of 2013. The Company's total cost of funds, historically among the lowest in the industry, declined to 0.16% in the second quarter of 2014 from 0.21% a year ago. The Company's lower funding cost resulted largely from average core deposits of $1.3 billion in 2014, with average demand deposits representing 42% of second quarter average total deposits. Total deposits increased by $103 million or 7.0% to $1.6 billion at June 30, 2014 versus June 30, 2013. Core deposit balances, which represented 85.4% of total deposits at June 30, 2014, grew by $120 million or 9.8% during the same period. 35



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Table of Contents NET INTEREST INCOME ANALYSIS For the Three Months Ended June 30, 2014 and 2013 (unaudited, dollars in thousands) 2014 2013 Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Assets: Interest-earning assets: Investment securities (1) $ 406,732$ 3,758 3.71 % $ 432,880$ 3,976 3.68 % Federal Reserve Bank, Federal Home Loan Bank and other stock 3,442 35 4.08 2,926 36 4.93 Federal funds sold and interest-bearing deposits 49,562 42 0.34 253,912 189 0.30 Loans (2) 1,144,006 13,316 4.67 850,470 11,252 5.31 Total interest-earning % % assets 1,603,742 $ 17,151 4.29 1,540,188 $ 15,453 4.02 Non-interest-earning assets 131,559 102,758 Total assets $ 1,735,301$ 1,642,946 Liabilities and stockholders' equity: Interest-bearing liabilities: Saving, N.O.W. and money % % market deposits $ 655,367$ 287 0.18 $ 609,812$ 294 0.19 Time deposits 232,235 337 0.58 249,790 453 0.73 Total saving and time deposits 887,602 624 0.28 859,602 747 0.35 Borrowings 5,878 5 0.35 - - - Total interest-bearing liabilities 893,480 629 0.28 859,602 747 0.35 Demand deposits 648,957 593,437 Other liabilities 16,015 24,456 Total liabilities 1,558,452 1,477,495 Stockholders' equity 176,849 165,451 Total liabilities and stockholders' equity $ 1,735,301$ 1,642,946 Total cost of funds 0.16 % 0.21 % Net interest rate spread 4.01 % 3.67 % Net interest % income/margin 16,522 4.13 % 14,706 3.83 Less tax-equivalent basis adjustment (980 ) (893 ) Net interest income $ 15,542$ 13,813



(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $867 and $891 in 2014 and 2013, respectively. (2) Interest on loans includes the effects of tax-equivalent basis adjustments of $113 and $2 in 2014 and 2013, respectively.

The $250 thousand provision for loan losses recorded during the second quarter of 2014 was due to the growth in the loan portfolio experienced during the past twelve months. The Company did not record a provision for loan losses in the second quarter of 2013. The adequacy of the provision and the resulting allowance for loan losses, which was $18.5 million at June 30, 2014, is determined by management's ongoing review of the loan portfolio, including identification and review of individual problem situations that may affect a borrower's ability to repay, delinquency and non-performing loan data including the current status of criticized and classified loans, collateral values and changes in the size and mix of the loan portfolio. (See also Critical Accounting Policies, Judgments and Estimates and Asset Quality contained herein.) Non-interest income increased by $214 thousand in the second quarter of 2014 versus the comparable 2013 period. This improvement was primarily due to a $324 thousand increase in income from the Company's investment in bank owned life insurance ("BOLI"). The Company made its initial BOLI investment in June 2013. Also contributing to the growth in non-interest income in 2014 was a $110 thousand net gain on sale of premises and equipment and growth in other service charges, commissions and fees (up $79 thousand), principally investment services income and wire transfer fees. Somewhat offsetting these positive factors was a decline in the net gain on the sale of mortgage loans originated for sale of $235 thousand or 77.0%. 36



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Table of Contents Non-Interest Income For the quarters and six months ended June 30, 2014 and 2013 (dollars in thousands) Over/ Over/ Quarters ended June 30, (under) Six months ended June 30, (under) 2014 2013 2013 2014 2013 2013 Service charges on deposit accounts $ 944$ 951 (0.7 ) % $ 1,947$ 1,875 3.8 % Other service charges, commissions and fees 892 813 9.7 1,571 1,523 3.2 Fiduciary fees 280 263 6.5 559 536 4.3 Net (loss) gain on sale of securities available for sale (23 ) 33 N/M (1) (23 ) 392 N/M (1) Net gain on sale of portfolio loans - 3 (100.0 ) - 445 (100.0 ) Net gain on sale of mortgage loans originated for sale 70 305 (77.0 ) 163 831 (80.4 ) Net gain on sale of premises and equipment 110 - N/M (1) 752 - N/M (1) Income from bank owned life insurance 366 42 771.4 720 42 1,614.3 Other operating income 39 54 (27.8 ) 81 137 (40.9 )



Total non-interest income $ 2,678$ 2,464 8.7

% $ 5,770$ 5,781 (0.2 ) %

(1) N/M - denotes % variance not meaningful for statistical purposes.

Total operating expenses increased by $460 thousand or 3.6% in the second quarter of 2014 versus 2013 as the result of a non-recurring $1.7 million expense credit recorded in the second quarter of 2013 due to the termination of a post-retirement life insurance plan in that period. Excluding this one-time item, total operating expenses would have declined by $1.2 million or 8.4% in the second quarter of 2014 when compared to 2013. Reductions were reflected in several expense categories, most notably branch consolidation costs (down $279 thousand), FDIC assessment (down $256 thousand), occupancy (down $247 thousand), other operating expenses (down $241 thousand) and equipment expense (down $123 thousand). The credit to branch consolidation costs in the second quarter of 2014 resulted from a better than expected outcome on a lease termination negotiation for one of the Bank's closed branches where an expense was recorded in the fourth quarter of 2013. The lower FDIC assessment expense for the second quarter of 2014 compared to the same period in 2013 reflected the Bank's lower assessment rate as it is no longer under a regulatory formal agreement. The lower occupancy and equipment costs in 2014 were largely due to the consolidation of the Company's branch network. The reduction in other operating expenses resulted primarily from lower legal expenses and reduced costs associated with fees and subscriptions and telephone systems. The year over year increase in employee compensation and benefits expense was solely due to the aforementioned $1.7 million expense credit recorded in 2013 for the termination of the former post-retirement life insurance plan. Operating Expenses For the quarters and six months ended June 30, 2014 and 2013 (dollars in thousands) Over/ Over/ Quarters ended June 30, (under) Six months ended June 30, (under) 2014 2013 2013 2014 2013 2013 Employee compensation and benefits (1) $ 8,488$ 6,746 25.8 % $ 17,349$ 15,328 13.2 % Occupancy expense 1,411 1,658 (14.9 ) 2,846 3,202 (11.1 ) Equipment expense 434 557 (22.1 ) 883 1,129 (21.8 ) Consulting and professional services 639 573 11.5 1,190 1,146 3.8 FDIC assessment 268 524 (48.9 ) 535 1,041 (48.6 ) Data processing 559 749 (25.4 ) 1,132 1,216 (6.9 ) Accounting and audit fees 110 178 (38.2 ) 218 199 9.5 Branch consolidation costs (279 ) - N/M (2 ) (449 ) - N/ M (2) Reserve and carrying costs related to Visa shares sold 56 - N/M (2 ) 115 - N/ M (2) Other operating expenses 1,466 1,707 (14.1 ) 2,642 3,232 (18.3 ) Total operating expenses $ 13,152$ 12,692 3.6 % $ 26,461$ 26,493 (0.1 ) %



(1) Results for the 2013 quarter and six-month period are net of a $1,659

non-recurring gain arising from the termination of post-retirement life

insurance benefits during the second quarter of 2013.

(2) N/M - denotes % variance not meaningful for statistical purposes.

37 -------------------------------------------------------------------------------- Table of Contents The Company recorded income tax expense of $1.0 million in the second quarter of 2014 resulting in an effective tax rate of 21.7% versus an income tax expense of $816 thousand and an effective tax rate of 22.8% in the comparable period a year ago. Material Changes in Results of Operations - Comparison of the Six Months Ended June 30, 2014 and 2013 - The Company recorded net income of $7.5 million during the first six months of 2014 versus $5.5 million in the comparable 2013 period. The improvement in 2014 net income resulted principally from a $3.4 million increase in net interest income in the first half of 2014. Partially offsetting these positive factors was a $500 thousand increase in the provision for loan losses in the first six months of 2014, resulting from growth in loans outstanding, coupled with an increase in the Company's effective tax rate in 2014. The $3.4 million or 12.2% improvement in June year-to-date 2014 net interest income resulted from a $67 million increase in average total interest-earning assets, coupled with a 28 basis point improvement in the Company's net interest margin to 4.17% in 2014 versus 3.89% in 2013. The Company's average total interest-earning asset yield during the first six months of 2014 was 4.33% versus 4.09% for the comparable 2013 period. Despite lower average yields on the Company's investment and loan portfolios, down 9 basis points and 74 basis points, respectively, in 2014 versus 2013, the Company's average balance sheet mix continued to improve as average loans increased by $296 million (36.2%) versus first half 2013 and low-yielding overnight interest-bearing deposits declined by $218 million (79.8%) during the same period. Liquid investments represented 3% of average total interest-earning assets in the first quarter of 2014 versus 18% a year ago. The average securities portfolio decreased by $12 million to $411 million in the first half of 2014 versus the comparable 2013 period. The Company's average cost of total interest-bearing liabilities declined by seven basis points to 0.29% in the first six months of 2014 versus 0.36% in the same 2013 period. The Company's total cost of funds, among the lowest in the industry, declined to 0.17% in the first half of 2014 from 0.21% a year ago. The Company's lower funding cost resulted largely from average core deposits of $1.3 billion in 2014, with average demand deposits representing 41% of first half 2014 average total deposits. Average total deposits increased by $89 million or 6.2% during the first six months of 2014 versus 2013. Average core deposit balances represented 84.9% of total deposits during the same 2014 period. 38



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Table of Contents NET INTEREST INCOME ANALYSIS For the Six Months Ended June 30, 2014 and 2013 (unaudited, dollars in thousands) 2014 2013 Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Assets: Interest-earning assets: Investment securities (1) $ 411,035$ 7,608 3.73 % $ 423,289$ 8,024 3.82 % Federal Reserve Bank, Federal Home Loan Bank and other stock 3,155 73 4.67 2,985 75 5.07 Federal funds sold and interest-bearing deposits 55,026 88 0.32 272,872 362 0.27 Loans (2) 1,116,283 26,292 4.75 819,799 22,334 5.49 Total interest-earning % % assets 1,585,499 $ 34,061 4.33 1,518,945 $ 30,795 4.09 Non-interest-earning assets 129,944 102,722 Total assets $ 1,715,443$ 1,621,667 Liabilities and stockholders' equity: Interest-bearing liabilities: Saving, N.O.W. and money % % market deposits $ 662,116$ 579 0.18 $ 605,287$ 580 0.19 Time deposits 229,229 682 0.60 247,978 935 0.76 Total saving and time deposits 891,345 1,261 0.29 853,265 1,515 0.36 Borrowings 2,955 5 0.35 12 - 0.34 Total interest-bearing liabilities 894,300 1,266 0.29 853,277 1,515 0.36 Demand deposits 629,100 578,286 Other liabilities 18,007 25,194 Total liabilities 1,541,407 1,456,757 Stockholders' equity 174,036 164,910 Total liabilities and stockholders' equity $ 1,715,443$ 1,621,667 Total cost of funds 0.17 % 0.21 % Net interest rate spread 4.04 % 3.73 % Net interest % % income/margin 32,795 4.17 29,280 3.89 Less tax-equivalent basis adjustment (1,955 ) (1,791 ) Net interest income $ 30,840$ 27,489



(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $1,743 and $1,789 in 2014 and 2013, respectively. (2) Interest on loans includes the effects of tax-equivalent basis adjustments of $212 and $2 in 2014 and 2013, respectively.

The $500 thousand provision for loan losses recorded in the first half of 2014 was due to the growth in the loan portfolio experienced during the past twelve months. The Company did not record a provision for loan losses in the comparable 2013 period. Non-interest income declined by $11 thousand in the first half of 2014 versus the comparable 2013 period. This nominal decrease was principally due to reductions in 2014 in net gain on the sale of mortgage loans originated for sale (down $668 thousand), net gain on the sale of portfolio loans (down $445 thousand) and a $23 thousand net loss on the sale of securities available for sale in 2014 versus a net gain of $392 thousand recorded in 2013. These were partially offset by a net gain on the sale of premises and equipment of $752 thousand and a $678 thousand increase in income from the Company's investment in BOLI in 2014.



Total operating expenses declined by $32 thousand in the first half of 2014 versus 2013 as the result of reductions in several categories, most notably other operating expenses (down $590 thousand), FDIC assessment (down $506 thousand), branch consolidation costs (down $449 thousand), occupancy (down $356 thousand) and equipment (down $246 thousand).

The reduction in other operating expenses resulted primarily from lower OREO expenses and reduced costs associated with legal expenses, fees and subscriptions and property appraisals. The lower FDIC assessment expense for the first half of 2014 compared to the same period in 2013 reflected the Bank's lower assessment rate as it is no longer under a regulatory formal agreement. The credit to branch consolidation costs in the first half of 2014 resulted from better than expected outcomes on lease termination negotiations for two of the Bank's closed branches where an expense had previously been recorded in the fourth quarter of 2013. The decreased occupancy and equipment expenses reflected cost savings from the Bank's closing of two branches in the fourth quarter of 2013 and four branches in the first quarter of 2014. 39 -------------------------------------------------------------------------------- Table of Contents Largely offsetting the foregoing improvements was a $2.0 million increase in employee compensation and benefits expense due principally to the previously noted $1.7 million expense credit recorded in 2013. Excluding the impact of the 2013 expense credit, employee compensation and benefits expenses rose by $362 thousand or 2.1% in 2014 versus 2013. The Company recorded income tax expense of $2.2 million in the first six months of 2014 resulting in an effective tax rate of 22.4% versus an income tax expense of $1.3 million and an effective tax rate of 19.2% in the comparable period a year ago. The increase in the Company's effective tax rate in 2014 versus 2013 resulted from growth in taxable income that is taxed at the Company's marginal rate of 39%, partially offset by the net $158 thousand impact of the following two matters. On March 31, 2014, Governor Andrew Cuomo signed legislation to implement the New York State fiscal plan for 2014 - 2015. This legislation encompasses significant changes to New York's bank tax regime, most notably by merging the bank tax into the general corporate tax law. In addition, the new budget law simplifies the code by setting forth a single apportionment factor. The corporate tax rate will be lowered from 7.1% to 6.5% in 2016. Furthermore, for community banks (all banks and thrifts with $8 billion or less in assets) there is a subtraction modification for a portion of interest earned on all residential and small business loans with a principal amount of up to $5 million made to New York borrowers. All banks in this category that have a REIT on April 1, 2014, and in the applicable tax year would instead get a deduction based on their REIT's dividends paid deduction. The Company had a qualifying REIT on April 1, 2014 and is less than $8 billion in assets. If a change in a tax law or rate occurs, any existing deferred tax liability or asset must be adjusted. The effect is reflected in operations in the period of the enactment of the change in the tax law or rate. As such, the Company made an adjustment to increase its DTAs resulting in a net income tax credit of $612 thousand in 2014. Offsetting the net income tax credit was a $454 thousand income tax expense related to an adjustment of the Company's stock based compensation included in the DTAs primarily for stock options that had expired or been forfeited by former employees. The adjustment relates primarily to prior periods, but management has determined that it is not material, and as such, included it in the 2014 first quarter's results. Asset Quality - Non-accrual loans totaled $14 million or 1.16% of total loans outstanding at June 30, 2014 versus $15 million or 1.42% of loans outstanding at December 31, 2013 and $17 million or 1.92% of loans outstanding at June 30, 2013. The allowance for loan losses as a percentage of total non-accrual loans amounted to 133% at June 30, 2014 versus 114% at December 31, 2013 and 101% at June 30, 2013. [[Image Removed]] 40

-------------------------------------------------------------------------------- Table of Contents The Company held no loans 90 days or more past due and still accruing at any of the reported dates. Total loans 30 - 89 days past due and accruing amounted to $4 million or 0.36% of loans outstanding at June 30, 2014 versus $3 million or 0.33% of loans outstanding at December 31, 2013 and $4 million or 0.44% of loans outstanding at June 30, 2013. The Company held no OREO at any of the reported periods. Total criticized and classified loans were $44 million at June 30, 2014, $43 million at December 31, 2013 and $73 million at June 30, 2013. Criticized loans are those loans that are not classified but require some degree of heightened monitoring. Classified loans were $34 million at June 30, 2014, $37 million at December 31, 2013 and $47 million at June 30, 2013. The allowance for loan losses as a percentage of total classified loans was 55%, 47% and 36%, respectively, at the same dates. At June 30, 2014, the Company had $22 million in TDRs, primarily consisting of commercial and industrial loans, commercial real estate loans and residential mortgages totaling $7 million, $11 million and $4 million, respectively. At June 30, 2014, $12 million of the TDRs were on non-accrual status. The Company had TDRs amounting to $16 million at December 31, 2013 and June 30, 2013. Net loan recoveries of $491 thousand were recorded in the second quarter of 2014 versus net loan recoveries of $224 thousand in the first quarter of 2014 and net loan charge-offs of $541 thousand in the second quarter of 2013. As a percentage of average total loans outstanding, these net amounts represented, on an annualized basis, (0.17%) for the second quarter of 2014, (0.08%) for the first quarter of 2014 and 0.26% for the second quarter of 2013.



At June 30, 2014, the Company's allowance for loan losses amounted to $18.5 million or 1.55% of period-end loans outstanding. The allowance as a percentage of loans outstanding was 1.62% at December 31, 2013 and 1.93% at June 30, 2013.

[[Image Removed]] The Company recorded a $250 thousand provision for loan losses for the three months ended June 30, 2014, as compared to no provision for the comparable 2013 period, largely due to growth in the loan portfolio experienced during the past twelve months. The adequacy of the provision and the resulting allowance for loan losses, which was $18.5 million at June 30, 2014, is determined by management's ongoing review of the loan portfolio, including identification and review of individual problem situations that may affect a borrower's ability to repay, delinquency and non-performing loan data including the current status of criticized and classified loans, collateral values and changes in the size and mix of the loan portfolio. Management has determined that the current level of the allowance for loan losses is adequate in relation to the probable inherent losses present in the portfolio. Loan portfolio growth was strong during the second quarter of 2014, primarily in multifamily, C&I, mixed use commercial and CRE loans. At June 30, 2014, the Company's allowance for loan losses included an unallocated portion totaling $1.2 million. Loan growth, including multifamily loans, is expected to continue throughout 2014. An unallocated portion of the reserve is considered a prudent option until these loans to new borrowers establish satisfactory payment patterns. Management considers many factors in this analysis, among them credit risk grades, delinquency trends, concentrations within segments of the loan portfolio, recent charge-off experience, local and national economic conditions, current real estate market conditions in geographic areas where the Company's loans are located, changes in the trend of non-performing loans, changes in interest rates and loan portfolio growth. Changes in one or a combination of these factors may adversely affect the Company's loan portfolio resulting in increased delinquencies, loan losses and future levels of loan loss provisions. Due to these uncertainties, management expects to record loan charge-offs in future periods. (See also Critical Accounting Policies, Judgments and Estimates contained herein.) 41



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Table of Contents ANALYSIS OF NON-PERFORMING ASSETS AND THE ALLOWANCE FOR LOAN LOSSES June 30, 2014 versus December 31, 2013 and June 30, 2013 (dollars in thousands) NON-PERFORMING ASSETS BY TYPE: At 6/30/2014 12/31/2013 6/30/2013 Non-accrual loans $ 13,911$ 15,183$ 17,183 Non-accrual loans held for sale - - - Loans 90 days or more past due and still accruing - - - OREO - - - Total non-performing assets $ 13,911$ 15,183$ 17,183 Gross loans outstanding $ 1,195,496$ 1,068,848$ 895,451 Total loans held for sale $ 573$ 175$ 1,262 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES: Quarter Ended 6/30/2014 12/31/2013 6/30/2013 Beginning balance $ 17,737$ 17,619$ 17,834 Provision 250 1,250 - Charge-offs (234 ) (2,136 ) (1,464 ) Recoveries 725 530 923 Ending balance $ 18,478$ 17,263$ 17,293 KEY RATIOS: At 6/30/2014 12/31/2013 6/30/2013 Allowance as a % of total loans (1) 1.55 %



1.62 % 1.93 %

Non-accrual loans as a % of total loans (1) 1.16 %



1.42 % 1.92 %

Non-performing assets as a % of total loans, loans held for sale and OREO

1.16 %



1.42 % 1.92 %

Allowance for loan losses as a % of non-accrual loans (1) 133 % 114 % 101 %



Allowance for loan losses as a % of non-accrual loans and loans 90 days or more past due and still accruing (1)

133 % 114 % 101 %



(1) Excludes loans held for sale.

42



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