Corporate Overview and Strategic Initiatives
Tompkins Financial Corporation("Tompkins" or the "Company") is headquartered in Ithaca, New Yorkand is registered as a Financial Holding Companywith the Federal Reserve Boardunder the Bank Holding Company Act of 1956, as amended. The Company is a locally oriented, community-based financial services organization that offers a full array of products and services, including commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, insurance, and brokerage services. At June 30, 2014, the Company's subsidiaries included: four wholly-owned banking subsidiaries, Tompkins Trust Company(the " Trust Company"), The Bank of Castile( DBA Tompkins Bank of Castile), Mahopac Bank(formerly known as Mahopac National Bank, DBA Tompkins Mahopac Bank), VIST Bank( DBA Tompkins VIST Bank); and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc.(" Tompkins Insurance"). TFA Wealth Management and the trust division of the Trust Companyprovide a full array of investment services under the TompkinsFinancial Advisors brand, including investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. The Company's principal offices are located at The Commons, Ithaca, New York, 14851, and its telephone number is (888) 503-5753. The Company's common stock is traded on the NYSE MKT LLCunder the Symbol "TMP." The Company's strategic initiatives include diversification within its markets, growth of its fee-based businesses, and growth internally and through acquisitions of financial institutions, branches, and financial services businesses. As such, the Company from time to time considers acquiring banks, thrift institutions, branch offices of banks or thrift institutions, or other businesses within markets currently served by the Company or in other locations that would complement the Company's business or its geographic reach. The Company generally targets merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale and expanded services. The Company has pursued acquisition opportunities in the past, and continues to review new opportunities. Acquisitions On January 31, 2014, Tompkins Insuranceacquired certain assets of Breakthrough Benefits, LLC, an employee benefits company located in Downingtown, Pennsylvania, in a cash transaction. The principal partner continued as an employee of Tompkins Insuranceafter the acquisition. The aggregate purchase price for the assets was $350,000. In addition to $210,000paid at closing, consideration includes two annual post-closing payments of $70,000payable on subsequent anniversary dates. Payment is contingent upon certain criteria being met, which Tompkinsconsiders to be likely. The purchase price was allocated as follows: goodwill of $103,000, customer related intangibles of $102,000and a covenant-not-to-compete of $142,000. The value of the customer related intangible is being amortized over 15 years, while the covenant-not-to-compete will be amortized over 5 years commencing with the departure of the principal. The goodwill is not being amortized but will be evaluated annually for impairment. Business Segments Banking services consist primarily of attracting deposits from the areas served by the Company's four banking subsidiaries 66 banking offices (46 offices in New Yorkand 20 offices in Pennsylvaniaand using those deposits to originate a variety of commercial loans, consumer loans, real estate loans (including commercial loans collateralized by real estate), and leases. The Company's lending function is managed within the guidelines of a comprehensive Board-approved lending policy. Reporting systems are in place to provide management with ongoing information related to loan production, loan quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. Banking services also include a full suite of products such as debit cards, credit cards, remote deposit, electronic banking, mobile banking, cash management, and safe deposit services. Wealth management services consist of investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. Wealth management services are under the trade name Tompkins Financial Advisors. Tompkins Financial Advisorshas office locations at all four of the Company's subsidiary banks. 48 Insurance services include property and casualty insurance, employee benefit consulting, and life, long-term care and disability insurance. Tompkins Insuranceis headquartered in Batavia, New York. Over the past thirteen years, Tompkins Insurancehas acquired smaller insurance agencies in the market areas serviced by the Company's banking subsidiaries and successfully consolidated them into Tompkins Insurance. The VIST Financialacquisition in 2012, which included VIST Insurance, nearly doubled the Company's annual insurance revenues. In the first quarter of 2014, Tompkins Insuranceacquired certain assets of Breakthrough Benefits, LLC, an employee benefits company located in Downingtown, Pennsylvania. Details of this transaction are discussed above. Tompkins Insuranceoffers services to customers of the Company's banking subsidiaries by sharing offices with The Bank of Castile, Trust Company, and VIST Bank. In addition to these shared offices, Tompkins Insurancehas five stand-alone offices in Western New York, two stand-alone offices in Tompkins County, New Yorkand one stand-alone office in Montgomery County, Pennsylvania.
The Company's principal expenses are interest on deposits, interest on borrowings, and operating and general administrative expenses, as well as provisions for loan and lease losses. Funding sources, other than deposits, include borrowings, securities sold under agreements to repurchase, and cash flow from lending and investing activities.
Competition for commercial banking and other financial services is strong in the Company's market areas. In one or more aspects of its businesses, the Company's subsidiaries compete with other commercial banks, savings and loan associations, credit unions, finance companies, Internet-based financial services companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Some of these competitors have substantially greater resources and lending capabilities and may offer service that the Company does not currently provide. In addition, many of the Company's non-bank competitors are not subject to the same extensive Federal regulations that govern financial holding companies and Federally-insured banks. Management believes that a community based financial organization is better positioned to establish personalized financial relationships with both commercial customers and individual households. The Company's community commitment and involvement in its primary market areas, as well as its commitment to quality and personalized financial services, are factors that contribute to the Company's competitiveness. Management believes that each of the Company's subsidiary banks can compete successfully in its primary market areas by making prudent lending decisions quickly and more efficiently than its competitors, without compromising asset quality or profitability, although no assurances can be given that such factors will assure success.
Banking, insurance services and wealth management are highly regulated. As a financial holding company with four community banks, a registered investment advisor, and an insurance agency subsidiary, the Company and its subsidiaries are subject to examination and regulation by the
Federal Reserve Board("FRB"), Securities and Exchange Commission("SEC"), the Federal Deposit Insurance Corporation("FDIC"), the New York State Department of Financial Services, Pennsylvania Department of Banking and Securities, Financial Industry Regulatory Authority, and the Pennsylvania Insurance Department.
Other Factors Affecting Performance
Other external factors affecting the Company's operating results are market rates of interest, the condition of financial markets, inflation, economic growth, unemployment, regulatory actions and policies. Historically low interest rates and weak economic conditions have put pressure on the Company's net interest margin in recent years. The Company has offset some of this pressure with strategic deposit pricing and growth in average earning assets. Weak economic conditions beginning in 2008 contributed to increases in the Company's past due loans and leases, nonperforming assets, and net loan and lease losses, as well as decreases in certain fee-based products and services. Gradual improvement in the economy as evidenced by a rebound in housing market, lower unemployment and higher equities markets, have contributed to improvement in the Company's credit quality metrics in recent quarters, including decreases in the level of internally classified assets and nonperforming assets. With the strength of the economic recovery uncertain, there is no assurance that these conditions may not adversely affect the credit quality of the Company's loans and leases, results of operations, and financial condition going forward. Refer to the section captioned "Financial Condition- Allowance for Loan and Lease Losses" below for further details on asset quality.
OTHER IMPORTANT INFORMATION
The following discussion is intended to provide an understanding of the consolidated financial condition and results of operations of the Company for the three and six months ended
June 30, 2014. It should be read in conjunction with the Company's Audited Consolidated Financial Statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, and the Unaudited Consolidated Financial Statements and notes thereto included in Part I of this Quarterly Report on Form 10-Q. 49 Forward-Looking Statements
The Company is making this statement in order to satisfy the "Safe Harbor" provision contained in the Private Securities Litigation Reform Act of 1995. The statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. Such forward-looking statements are made based on management's expectations and beliefs concerning future events impacting the Company and are subject to certain uncertainties and factors relating to the Company's operations and economic environment, all of which are difficult to predict and many of which are beyond the control of the Company. These uncertainties and factors that could cause actual results of the Company to differ materially from those matters expressed and/or implied by such forward-looking statements. The following factors are among those that could cause actual results to differ materially from the forward-looking statements: changes in general economic, market and regulatory conditions; the development of an interest rate environment that may adversely affect the Company's interest rate spread, other income or cash flow anticipated from the Company's operations, investment and/or lending activities; changes in laws and regulations affecting banks, insurance companies, bank holding companies and/or financial holding companies, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act and Basel III; technological developments and changes; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; governmental and public policy changes, including environmental regulation; protection and validity of intellectual property rights; reliance on large customers; financial resources in the amounts, at the times and on the terms required to support the Company's future businesses; and other factors discussed elsewhere in this Quarterly Report on Form 10-Q and in other reports we file with the
SEC, in particular the "Risk Factors" discussed in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. In addition, such forward-looking statements could be affected by general industry and market conditions and growth rates, general economic and political conditions, including interest rate and currency exchange rate fluctuations, and other factors.
Critical Accounting Policies
The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in
the United Statesand to general practices within the financial services industry. In the course of normal business activity, management must select and apply many accounting policies and methodologies and make estimates and assumptions that lead to the financial results presented in the Company's consolidated financial statements and accompanying notes. There are uncertainties inherent in making these estimates and assumptions, which could materially affect the Company's results of operations and financial position. Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company's financial statements. Management considers the accounting policies relating to the allowance for loan and lease losses ("allowance"), pension and postretirement benefits, the review of the securities portfolio for other-than-temporary impairment, and acquired loans to be critical accounting policies because of the uncertainty and subjectivity involved in these policies and the material effect that estimates related to these areas can have on the Company's results of operations. For additional information on critical accounting policies and to gain a greater understanding of how the Company's financial performance is reported, refer to Note 1 - "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements, and the section captioned "Critical Accounting Policies" in Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes in the Company's application of critical accounting policies since December 31, 2013. Refer to Note 3 - "Accounting Standards Updates" in the Notes to Unaudited Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q for a discussion of recent accounting updates. In this Report there are comparisons of the Company's performance to that of a peer group. Unless otherwise stated, this peer group is comprised of the group of 117 domestic bank holding companies with $3 billionto $10 billionin total assets as defined in the Federal Reserve's "Bank Holding Company Performance Report" for March 31, 2014(the most recent report available). 50 OVERVIEW Net income for the second quarter was $13.1 millionor $0.87diluted earnings per share, compared to $11.0 millionor $0.75diluted earnings per share for the same period in 2013. Net income for the first six months of 2014 was $25.6 millionor $1.72diluted earnings per share, compared to $22.5 millionor $1.55diluted earnings per share in the first six months of 2013. Return on average assets ("ROA") for the quarter ended June 30, 2014was 1.04%, compared to 0.89% for the quarter ended June 30, 2013. Return on average shareholders' equity ("ROE") for the second quarter of 2014 was 10.91%, compared to 9.87%, for the same period in 2013. Tompkins'first quarter ROA and ROE compare to the most recent peer average ratios of 0.91% and 9.13%, respectively, published, published as of March 31, 2014by the Federal Reserve, ranking Tompkins'ROA in the 62rd percentile and ROE in the 56rd percentile of the
peer group. The Company's operating net income (Non-GAAP) for the six month period ending
June 30, 2014was $25.6 million, or $1.72diluted per share, compared to $22.5 million, or $1.56diluted per share for the same period in 2013. Operating (Non-GAAP) income excludes after-tax merger and acquisition integration expense of $0and $140,000for the six months ended June 30, 2014and 2013, respectively. The following table summarizes our results of operations for the periods indicated on a GAAP basis and on an operating (Non-GAAP) basis for the periods indicated. Our operating results exclude merger and acquisition integration expenses. The Company believes this non-GAAP measure provides a meaningful comparison of our underlying operational performance and facilitates managements' and investors' assessments of business and performance trends in comparison to others in the financial services industry. In addition, the Company believes the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations (in thousands). These non-GAAP financial measures should not be considered in isolation or as a measure of the Company's profitability or liquidity; they are in addition to, and are not a substitute for, financial measures under GAAP. Net operating income as presented herein may be different from non-GAAP financial measures used by other companies, and may not be comparable to similarly titled measures reported by other companies. Further, the Company may utilize other measures to illustrate performance in the future. Non-GAAP financial measures have limitations since they do not reflect all of the amounts associated with the Company's results of operations as determined in accordance with GAAP. 51 Three months ended Six months ended (in thousands) 06/30/2014 06/30/2013 06/30/2014 06/30/2013 Net income attributable to Tompkins Financial Corporation $ 13,061 $ 11,007 $ 25,630 $ 22,516Adjustments for non-operating income and expense, net of tax: Merger and acquisition integration related expenses 0 22 0 140 Total adjustments, net of tax 0 22 0 140 Net operating income (Non-GAAP) 13,061 11,029 25,630 22,656 Amortization of intangibles, net of tax 315 328 631 662 Adjusted net operating income (Non-GAAP) 13,376 11,357 26,261 23,318 Average total assets 5,030,395 4,965,895 5,006,349 4,932,993 Less - Average goodwill and intangibles 108,019 110,037 108,227 110,361 Average tangible assets 4,922,376 4,855,858 4,898,122 4,822,632 Adjusted operating return on average shareholders' tangible assets (annualized) (Non-GAAP) 1.09 % 0.94 % 1.08 % 0.97 % Average total shareholders' equity 480,063 447,088 474,321 445,192 Less - Average goodwill and intangibles 108,019 110,037 108,227 110,361 Average shareholders' tangible equity (Non-GAAP) 372,044 337,051 366,094 334,831 Adjusted operating return on average shareholders' tangible equity (annualized) (Non-GAAP) 14.42 % 13.48 % 14.48 % 13.93 % Segment Reporting The Company operates in the following three business segments, banking, insurance, and wealth management. Insurance is comprised of property and casualty insurance services and employee benefit consulting operated under the Tompkins Insurance Agencies, Inc.subsidiary. Wealth management activities include the results of the Company's trust, financial planning, and wealth management services, and risk management operations organized under the TompkinsFinancial Advisors brand. All other activities are considered banking.
The banking segment reported net income of
$11.5 millionfor the second quarter of 2014, up $2.1 millionor 22.3% from net income of $9.4 millionfor the same period in 2013. For the six months ended June 30, 2014, the banking segment reported net income of $22.3 million, up $3.1 millionor 16.2% from the same period in 2013. Net interest income of $40.5 millionfor the second quarter and $80.5 millionfor the six month period ended June 30, 2014was up 1.8% and 3.2%, respectively over the same periods in 2013. Growth in average earning assets and lower funding costs more than offset the lower asset yields and contributed to favorable year-over-year comparisons. Net interest margin for the six months ended June 30, 2014was 3.58% compared to 3.59% for the same period prior year. The provision for loan and lease losses totaled $67,000for the three months ended June 30, 2014and $2.5 millionfor the same period in 2013. For the six month period ending June 30, 2014, provision expense decreased $2.7 millionor 77.0% compared to the same period prior year. The decrease in provision expense was largely attributable improvements in credit quality, partially offset by growth in total loans over prior year. Noninterest income for the three months ended June 30, 2014of $6.9 millionwas up $1.1 millionor 18.9% compared to the same period in 2013. For the six months ended June 30, 2014, noninterest income of $13.2 millionwas up $773,000or 6.2% compared to the same period in 2013. The main drivers behind the year-to-date increase in noninterest income included; card services income (up $604,000), service charges on deposit accounts (up $572,000), and net mark to market loss on trading securities (down $292,000). Partially offsetting these items were realized gains on securities transactions (down $313,000), and net mark to market gain on liabilities held at fair value (down $296,000). Noninterest expenses for the second quarter ended June 30, 2014of $30.6 millionwere up $982,000or 3.3% from the same period in 2013. For the six months ended June 30, 2014, noninterest expenses were up $1.4 millionor 2.4% compared to the same period prior year. This increase was primarily related to an increase in the number of employees, normal annual merit and market increases and higher incentive accruals. 52 Insurance Segment
The insurance segment reported net income of
$782,000for the three months ended June 30, 2014, down $293,000or 27.3% from the second quarter of 2013. For the first six months ended June 30, 2014, net income was down $273,000or 14.0% from the same period in 2013. Noninterest income was down $113,000or 1.6% for the second quarter and flat for the first six months ended June 30, 2014, compared to the same periods in 2013. Noninterest expenses for the three months ended June 30, 2014, were up $345,000or 6.3% compared to the second quarter of 2013. Noninterest expenses for the first six months ending June 30, 2014were $507,000or 4.6% above the same period in 2013. Salaries and benefits costs were the largest contributors to the increase in noninterest expense compared to the same period last year. The increase reflects normal annual merit adjustments and
higher incentive accruals. Wealth Management Segment
The wealth management segment reported net income of
$793,000for the three months ended June 30, 2014, up $223,000or 39.1% compared to the second quarter of 2013. Net income for the six months ended June 30, 2014of $1.7 millionwas $270,000or 19.8% above the same period prior year. Noninterest income for the second quarter and six months ended June 30, 2014was $4.0 millionand $8.2 million, respectively, which is up $268,000or 7.2% and up $307,000or 3.9%, respectively, compared to the same periods of 2013. Noninterest expenses of $2.8 millionfor the three months ended June 30, 2014, were down $103,000or 3.5% compared to the same period of 2013, and down $161,000or 2.7% for the six month period ended June 30, 2014compared to the same periods in 2013. The decline compared to the same periods last year was mainly due to lower incentive based compensation. 53 Average Consolidated Statements of Condition and Net Interest Analysis (Unaudited) Quarter Ended Year to Date Period Ended Year to Date Period Ended June 30, 2014 June 30, 2014 June 30, 2013 Average Average Average (Dollar amounts Balance Average Balance Average Balance Average in thousands) (QTD) Interest Yield/Rate (YTD) Interest Yield/Rate (YTD) Interest Yield/Rate ASSETS Interest-earning assets Interest-bearing balances due from banks Securities (1) $ 746 $ 00.23 % $ 885 $ 10.23 % $ 2,760 $ 80.58 % U.S. Government securities 1,317,080 7,504 2.29 % 1,301,015 14,877 2.31 % 1,342,524 14,060 2.11 % Trading securities 10,338 107 4.15 % 10,584 219 4.17 % 15,732 325 4.17 % State and municipal (2) 91,870 1,017 4.44 % 89,964 2,127 4.77 % 99,179 2,558 5.20 % Other securities (2) 4,269 32 3.01 % 4,729 76 3.24 % 8,295 150 3.65 % Total securities 1,423,557 8,660 2.44 % 1,406,292 17,299 2.48 % 1,465,730 17,093 2.35 % FHLBNY and FRB stock 21,196 194 3.67 % 20,670 404 3.94 % 20,942 345 3.32 % Total loans and leases, net of unearned income (2)(3) 3,221,223 37,762 4.70 % 3,206,950 75,161 4.73 % 3,001,458 74,906 5.03 % Total interest-earning assets 4,666,722 46,616 4.01 %
4,634,797 92,865 4.04 % 4,490,890 92,352 4.15 % Other assets 363,673 371,552 442,103 Total assets 5,030,395 5,006,349 4,932,993 LIABILITIES & EQUITY Deposits Interest-bearing deposits Interest bearing checking, savings, & money market 2,257,254 1,114 0.20 % 2,272,478 2,211 0.20 % 2,255,128 2,682 0.24 % Time deposits 901,602 1,663 0.74 % 895,073 3,308 0.75 % 970,239 3,959 0.82 %
Total interest-bearing deposits 3,158,856 2,777 0.35 %
3,167,551 5,519 0.35 % 3,225,367 6,641 0.42 % Federal funds purchased & securities sold under agreements to repurchase 145,623 763 2.10 % 153,939 1,580 2.07 % 187,289 1,976 2.13 % Other borrowings 278,424 1,192 1.72 % 263,633 2,401 1.84 % 181,292 2,391 2.66 % Trust preferred debentures 37,227 571 6.15 % 37,205 1,141 6.18 % 43,683 1,377 6.36 % Total interest-bearing liabilities 3,620,130 5,303 0.59 % 3,622,328 10,641 0.59 % 3,637,631 12,385 0.69 % Noninterest bearing deposits 877,219 856,161 778,201 Accrued expenses and other liabilities 52,983 53,539 71,969 Total liabilities 4,550,332 4,532,028 4,487,801
Tompkins Financial CorporationShareholders' equity 478,561 472,836 443,708 Noncontrolling interest 1,502 1,485 1,484 Total equity 480,063 474,321 445,192
Total liabilities and equity
$ 5,030,395 $ 5,006,349 $ 4,932,993Interest rate spread 3.42 % 3.45 % 3.46 % Net interest income/margin on earning assets 41,313 3.55 % 82,224 3.58 % 79,967
Tax Equivalent Adjustment (797 ) (1,681 ) (1,935 ) Net interest income per consolidated financial statements
$ 40,516 $ 80,543 $ 78,032
1 Average balances and yields on available-for-sale securities are based on historical amortized cost
2 Interest income includes the tax effects of taxable-equivalent adjustments using a combined
New York Stateand Federal effective income tax rate of 40% to increase tax exempt interest income to taxable-equivalent basis. 3 Nonaccrual loans are included in the average asset totals presented above. Payment received on nonaccrual loans have been recognized as disclosed in Note 1 of the Company's condensed consolidated financial statements included in Part 1 of the Company's annual report on Form 10-K for the fiscal year ended December 31, 2013. 54 Net Interest Income Net interest income is the Company's largest source of revenue, representing 69.6% of total revenues for the three and six month periods ended June 30, 2014, compared to 70.7% and 69.7% for the same periods in 2013. Net interest income is dependent on the volume and composition of interest earning assets and interest-bearing liabilities and the level of market interest rates. The above table shows average interest-earning assets and interest-bearing liabilities, and the corresponding yield or cost associated with each. Taxable-equivalent net interest income for the three and six months ended June 30, 2014was up 1.2% and 2.8%, respectively, over the same periods in 2013. Taxable-equivalent net interest income in 2014 benefitted from growth in average earning assets, an increase in average loan balances as a percentage of average earning assets, and growth in noninterest bearing deposits. These factors have help to lessen the impact of lower asset yields and maintain a relatively stable net interest margin compared to prior year. The taxable equivalent net interest margin was 3.55% for the three month period and 3.58% for the six month period ended June 30, 2014compared to 3.58% and 3.59%, respectively, for the same periods in 2013. Taxable-equivalent interest income for the three and six month periods ended June 30, 2014was $46.6 millionand $92.9 million, respectively, which is in line with the same periods in 2013. Growth in average earning assets and a higher concentration of loans helped to offset lower asset yields. Average loan balances for the three months ended June 30, 2014were up $182.5 millionor 6.0% while the average yield was down 32 basis points to 4.70% for the same period. Average loan balances for the six months ended June 30, 2014were up $205.5 millionor 6.9%, while the average yield was down 30 basis points. Average loan balances represented about 69.0% and 69.2% of average earning assets for the three and six months ended June 30, 2014, up from 66.5% and 66.8%, respectively, for the same periods in 2013. Average securities balances for the three and six months ended June 30, 2014decreased by $84.5 millionand $59.4 million, respectively, while the average yield for the three month period was in line with prior year and the average yield for year-to-date was up 13 basis points or 5.5%.
Interest expense for the three and six months ended
June 30, 2014decreased by $831,000or 13.6% and $1.7 millionor 14.1%, respectively, compared to the same periods in 2013, reflecting lower average rates paid on deposits and borrowings. The average rate paid on interest bearing deposits during the three and six months ended June 30, 2014was 0.35%, down 6 and 7 basis points, respectively, from the same periods in 2013. Average interest bearing deposits for the second quarter of 2014 were down $42.4 millionor 1.3% compared to the same period in 2013, while year-to-date average interest bearing deposits were down $57.8 millionor 1.8% compared to the same period in 2013. Average noninterest bearing deposits for the three and six month periods ended June 30, 2014were up $92.6 millionor 11.8% and $78.0 millionor 10.0%, respectively, compared to the same period in 2013. Year-to-date average other borrowings increased by $82.3 millionor 45.4% compared to the same period in 2013, and was mainly in overnight borrowings with the FHLB, which contributed to the decrease in average funding cost in this category in 2014.
Provision for Loan and Lease Losses
The provision for loan and lease losses represents management's estimate of the amount necessary to maintain the allowance for loan and lease losses at an adequate level. The provision for loan and lease losses was
$67,000for the second quarter of 2014 and $810,000for the six months ended June 30, 2014, compared to $2.5 millionand $3.5 millionfor the respective periods in 2013. The decrease in provision expense was mainly a result of improved asset quality metrics and recoveries received on previously charged off credits. The section captioned "Financial Condition - Allowance for Loan and Lease Losses and Nonperforming Assets" below has further details on the allowance for loan and lease losses and asset quality metrics.
Noninterest income was
$17.7 millionfor the second quarter of 2014 and $35.2 millionfor the first six months of 2014. This represents an increase of 7.1% for the quarter and 3.6% for the year-to-date period compared to the same periods in 2013. Noninterest income represented 30.4% of total revenue for both the three months and six months ended June 30, 2014compared to 29.4% and 30.3%, respectively, for the same period in 2013. Insurance commissions and fees were $7.0 millionfor the second quarter of 2014, which was down 1.7% compared to same period in 2013. Insurance commissions were down primarily due to the loss of two large accounts from the Pennsylvaniamarket in the second half of 2013. 55 Investment services income was $3.9 millionin second quarter of 2014, an increase of 5.5% from $3.7 millionin the second quarter of 2013. Investment services income of $7.9 millionfor the first six months of 2014 was up 5.7% from the comparable period in 2013. The increase was mainly attributed to increases in assets under management, reflecting new business and higher equities markets. Investment services income includes trust services, financial planning, wealth management services, and brokerage related services. With fees largely based on the market value and the mix of assets managed, the general direction of the stock market can have a considerable impact on fee income. The fair value of assets managed by, or in custody of, Tompkinswas $3.6 billionat June 30, 2014, up 8.4% from $3.3 billionat June 30, 2013. These figures include $989.7 millionand $982.4 million, respectively, of Company-owned securities where Tompkins Financial Advisorsis custodian. Service charges on deposit accounts were up $364,000or 18.0% for the second quarter of 2014 compared to the second quarter of 2013 and up $572,000or 14.6% for the six months ended June 30, 2014compared to the same period in 2013. The increase was mainly due to growth in noninterest bearing accounts, and account analysis fees that reflect fee increases on certain types of deposit accounts. Overdraft fees, the largest component of service charges on deposits accounts, were up 4.1% and 1.8% for the three and six months ended June 30, 2014compared to the same periods in 2013. Card services income for the three months and six months ended June 30, 2014was up $230,000or 13.6% and $604,000or 17.6% over the same periods in 2013. Debit card income, the largest component of card services income, benefitted in the first quarter of 2014 from the termination of the Company's debit card reward program at year-end 2013, as final redemption rates came in below management's estimates. Favorable trends in the number of debit cards issued and transaction volume have been partially offset by lower interchange fees. The Company recognized gains on the sales/calls of available-for-sale securities of $35,000and $129,000for the three and six months ended June 30, 2014, which was down from gains of $75,000and $442,000, respectively, for the same periods in 2013. Sales of available-for-sale securities are generally the result of general portfolio maintenance and interest rate risk management. Other income of $2.4 millionin the second quarter of 2014 was up 32.6% over the second quarter of 2013. For the first six months of 2014, other income was $4.2 million, up 1.5% over the same period in 2013. The significant components of other income are other service charges, increases in cash surrender value of corporate owned life insurance ("COLI"), gains on the sales of residential mortgage loans, FDIC Indemnification accretion and income from miscellaneous equity investments. The increase in other income in the second quarter of 2014 compared to the same period in 2013 was mainly due to increased loan related fee income and gains on the sale of residential mortgage loans.
Noninterest expense was
$38.9 millionfor the second quarter of 2014, up 3.1% compared to the second quarter of 2013 and $77.1 millionfor the six months ended June 30, 2014, up 2.4% compared to the first six months of 2013. The increase in noninterest expense compared to the same period prior year is mainly a result of higher salary and wages expense. Salaries and wages expense for the three and six months ended June 30, 2014were up by $1.4 millionor 8.4% and $2.4 millionor 7.7%, respectively, over the same periods in 2013. The increase reflects additional employees, annual merit increases and higher accruals for incentive compensation. Pension and other employee related benefits were down 6.7% for the second quarter of 2014 and down 3.4% for the six months ended June 30, 2014compared to the same periods in 2013. Decreases in pension and other post-retirement benefit expenses were partially offset by higher health care expenses.
Overall, all other expense categories remained relatively flat compared to the same period prior year.
Income Tax Expense The provision for income taxes was
$6.1 millionfor an effective rate of 32.0% for the second quarter of 2014, compared to tax expense of $5.1 millionand an effective rate of 31.4% for the same quarter in 2013. For the first six months of 2014, the tax provision was $12.1 millionfor an effective rate of 31.9% compared to a tax provision of $10.6 millionand an effective rate of 31.9% for the same period in 2013. The effective rates differ from the U.S. statutory rate of 35.0% during the comparable periods primarily due to the effect of tax-exempt income from loans, securities and life insurance assets. FINANCIAL CONDITION Total assets were $5.1 billionat June 30, 2014, up $54.8 millionor 1.1% over December 31, 2013. The growth over year-end was primarily attributable to growth in originated loans, which were up $83.0 millionor 3.3%, growth in available-for-sale securities, which were up $24.4 millionor 1.8%, and growth in held-to-maturity securities which were up $12.0 millionor 63.1%. This growth was partially offset by a decrease in acquired loans, which were down $48.4 millionor 7.3%. Total deposits increased $97.2 millionor 2.5% compared to December 31, 2013, mainly a result of an inflow of municipal deposits. Other borrowings decreased $44.4 millionor 13.4% from December 31, 2013, as a result of the paydown of short-term advances with the FHLB. 56 Securities
Available-for-Sale Securities 06/30/2014 12/31/2013 (in thousands) Amortized Cost Fair Value Amortized Cost Fair Value
U.S. Governmentsponsored entities $ 553,105 $ 559,083 $ 558,130 $ 556,345Obligations of U.S. states and political subdivisions 65,862 66,545 68,216 67,962 Mortgage-backed securities U.S. Government agencies 132,754 134,132 147,766 146,678 U.S. Governmentsponsored entities 617,258 615,649 587,843 577,472 Non- U.S. Governmentagencies or sponsored entities 289 294 306 311 U.S. corporate debt securities 2,500 2,125 5,000 4,633 Total debt securities 1,371,768 1,377,828 1,367,261 1,353,401 Equity securities 1,475 1,426 1,475 1,410 Total available-for-sale securities $ 1,373,243 $ 1,379,254 $ 1,368,736 $ 1,354,811 Held-to-Maturity Securities06/30/2014 12/31/2013 (in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Obligations of U.S. Government sponsored entities $ 14,793 $ 14,825$ 0 $ 0 Obligations of U.S. states and political subdivisions $ 16,170 $ 16,804 $ 18,980 $ 19,625Total held-to-maturity debt securities $ 30,963 $ 31,629 $ 18,980 $ 19,625
The increase in the fair value of the available-for-sale portfolio was due to the changes in interest rates during the first six months of 2014. The decrease in interest rates during 2014 resulted in an increase in the unrealized gains in the available-for-sale portfolio. Management's policy is to purchase investment grade securities that on average have relatively short duration, which helps mitigate interest rate risk and provides sources of liquidity without significant risk to capital. The increase in the held-to-maturity portfolio was due to purchases of Obligations of
U.S. Governmentsponsored entities during the three month period ended June 30, 2014. The Company has no investments in preferred stock of U.S. government sponsored entities and no investments in pools of Trust Preferred securities. Quarterly, the Company evaluates all investment securities with a fair value less than amortized cost to identify any other-than-temporary impairment as defined under generally accepted accounting principles. As a result of the other-than-temporarily impairment review process, the Company does not consider any investment security held at June 30, 2014to be other-than-temporarily impaired. Future changes in interest rates or the credit quality and credit support of the underlying issuers may reduce the market value of these and other securities. If such decline is determined to be other than temporary, the Company will record the necessary charge to earnings and/or accumulated other comprehensive income to reduce the securities to their then current fair value. The Company maintains a trading portfolio with a fair value of $10.0 millionas of June 30, 2014, compared to $11.0 millionat December 31, 2013. The decrease in the trading portfolio reflects maturities or payments during the three and six months ended June 30, 2014. For the three and six months ended June 30, 2014, net mark-to-market losses related to the securities trading portfolio were $34,000and $93,000, respectively, compared to net mark-to-market losses for the three and six months ended June 30, 2013of $270,000and $385,000, respectively. 57 Loans and Leases
Loans and leases at
06/30/2014 12/31/2013 Total Loans and Total Loans and (in thousands) Originated Acquired Leases Originated Acquired Leases Commercial and industrial Agriculture
$ 46,677 $ 0 $ 46,677 $ 74,788 $ 0 $ 74,788Commercial and industrial other 608,596 120,316 728,912 562,439 128,503 690,942 Subtotal commercial and industrial 655,273 120,316 775,589 637,227 128,503 765,730 Commercial real estate Construction 46,082 44,557 90,639 46,441 39,353 85,794 Agriculture 63,419 3,173 66,592 52,627 3,135 55,762 Commercial real estate other 940,626 331,642 1,272,268 903,320 366,438 1,269,758 Subtotal commercial real estate 1,050,127 379,372 1,429,499
1,002,388 408,926 1,411,314 Residential real estate Home equity 178,433 61,564 239,997 171,809 67,183 238,992 Mortgages 668,643 34,145 702,788 658,966 35,336 694,302 Subtotal residential real estate 847,076 95,709 942,785 830,775 102,519 933,294 Consumer and other Indirect 19,385 0 19,385 21,202 5 21,207 Consumer and other 33,502 1,117 34,619 32,312 1,219 33,531 Subtotal consumer and other 52,887 1,117 54,004 53,514 1,224 54,738 Leases 6,574 0 6,574 5,563 0 5,563 Covered loans 0 22,165 22,165 0 25,868 25,868
Total loans and leases 2,611,937 618,679 3,230,616
2,529,467 667,040 3,196,507 Less: unearned income and deferred costs and fees (1,648 ) 0 (1,648 ) (2,223 ) 0 (2,223 ) Total loans and leases, net of unearned income and deferred costs and
$ 2,610,289 $ 618,679 $ 3,228,968 $ 2,527,244 $ 667,040 $ 3,194,284
Residential real estate loans, including home equity loans at
June 30, 2014were $942.8 million, and comprised 29.2% of total loans and leases. Balances were comparable to year-end 2013. Growth in residential loan balances is impacted by the Company's decision to retain these loans or sell them in the secondary market due to interest rate considerations. The Company's Asset/Liability Committee meets regularly and establishes standards for selling and retaining residential real estate mortgage originations. Prior to August 2012, any residential real estate loans that were sold were generally sold to Federal Home Loan Mortgage Corporation ("FHLMC") or State of New York Mortgage Agency("SONYMA"). With the acquisition of VIST on August 1, 2012, the Company also sells loans to other third parties, including money center banks. Residential real estate loans are generally sold without recourse in accordance with standard secondary market loan sale agreements and are also subject to customary representations and warranties made by the Company, including representations and warranties related to gross incompetence and fraud. The Company has not had to repurchase any loans as a result of these general representations and warranties. While in the past in rare circumstances the Company agreed to sell residential real estate loans with recourse, the Company has not done so in the past several years and the amount of such loans included on the Company's balance sheet at June 30, 2014is insignificant. The Company has never had to repurchase a loan sold with recourse. During the first six months of 2014 and 2013, the Company sold residential mortgage loans totaling $8.2 millionand $1.8 million, respectively, and realized gains on these sales of $221,000and $97,000, respectively. These residential real estate loans were sold without recourse in accordance with standard secondary market loan sale agreements. When residential mortgage loans are sold, the Company typically retains all servicing rights, which provides the Company with a source of fee income. Mortgage servicing rights, at amortized basis, totaled $1.0 millionat June 30, 2014and December 31, 2013. The Company has not originated any hybrid loans, such as payment option ARMs. The Company underwrites residential real estate loans in accordance with secondary market standards in effect at the time of origination, including loan-to-value ("LTV") and documentation requirements. The Company does not underwrite low or reduced documentation loans other than those that meet secondary market standards for low or reduced documentation loans. In those instances, W-2's and paystubs are used instead of sending Verification of Employment forms to employers to verify income and bank deposit statements are used instead of Verification of Deposit forms mailed to financial institutions to verify deposit balances. 58 Commercial real estate loans were $1.4 billion, and represented 44.3% of total loans as of June 30, 2014. Commercial and industrial loans at June 30, 2014were $775.6 million, and represented 24.0% of total loans. As of June 30, 2014, agriculturally-related loans totaled $113.3 millionor 3.5% of total loans and leases, down from $130.6 millionor 4.1% of total loans and leases at December 31, 2013. There is generally an increase in agriculturally-related loans at year end related to tax planning and these loans are typically paid down over the first part of the year. Agriculturally-related loans include loans to dairy farms and cash and vegetable crop farms. Agriculturally-related loans are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral, personal guarantees, and government related guarantees. Agriculturally-related loans are generally secured by the assets or property being financed or other business assets such as accounts receivable, livestock, equipment or commodities/crops. The acquired loans in the above table reflect loans acquired in the acquisition of VIST Financial Corp.during the third quarter of 2012. The acquired loans were recorded at fair value pursuant to the purchase accounting guidelines in FASB ASC 805 - "Fair Value Measurements and Disclosures" (as determined by the present value of expected future cash flows) with no valuation allowance (i.e., the allowance for loan losses). Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, "Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality". The carrying value of the acquired loans reflects management's best estimate of the amount to be realized from the acquired loan and lease portfolios. However, the amounts the Company actually realizes on these loans could differ materially from the carrying value reflected in these financial statements, based upon the timing of collections on the acquired loans in future periods, underlying collateral values and the ability of borrowers to continue to make payments. The carrying value of acquired loans acquired and accounted for in accordance with ASC Subtopic 310-30, "Receivables Loans and Debt Securities Acquired with Deteriorated Credit Quality," was $40.0 millionat June 30, 2014, as compared to $46.8 millionat December 31, 2013. Under ASC Subtopic 310-30, loans may be aggregated and accounted for as pools of loans if the loans being aggregated have common risk characteristics. The Company elected to account for the loans with evidence of credit deterioration individually rather than aggregate them into pools. The difference between the undiscounted cash flows expected at acquisition and the investment in the acquired loans, or the "accretable yield," is recognized as interest income utilizing the level-yield method over the life of each loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the "non-accretable difference," are not recognized as a yield adjustment, as a loss accrual or as a valuation allowance. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through an adjustment of the yield on the loans over the remaining life. Subsequent decreases to the expected cash flows require us to evaluate the need for an addition to the allowance for loan losses. Valuation allowances (recognized in the allowance for loan losses) on these impaired loans reflect only losses incurred after the acquisition (representing all cash flows that were expected at acquisition but currently are not expected to be received). The carrying value of loans not exhibiting evidence of credit impairment at the time of the acquisition (i.e. loans outside of the scope of ASC 310-30) was $578.6 millionat June 30, 2014. At acquisition, these loans were recorded at fair value, including a credit discount. Credit losses on acquired performing loans are estimated based on analysis of the performing portfolio. The purchased performing portfolio also included a general interest rate mark (premium). Both the credit discount and interest rate mark are accreted/amortized as a yield adjustment over the estimated lives of the loans. Interest is accrued daily on the outstanding principal balance of purchased performing loans. At June 30, 2014, acquired loans included $22.2 millionof covered loans. VIST Financial Corphad acquired these loans in an FDICassisted transaction in the fourth quarter of 2010. In accordance with loss sharing agreements with the FDIC, certain losses and expenses relating to covered loans may be reimbursed by the FDICat 70% or, if certain levels of reimbursement are reached, 80%. See Note 7 - "FDIC Indemnification Asset Related to Covered Loans" in the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q. The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures. Management reviews these policies and procedures on a regular basis. The Company discussed its lending policies and underwriting guidelines for its various lending portfolios in Note 4 - "Loans and Leases" in the Notes to Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes in these policies and guidelines. As such, these policies are reflective of new originations as well as those balances held at June 30, 2014. The Company's Board of Directors approves the lending policies at least annually. The Company recognizes that exceptions to policy guidelines may occasionally occur and has established procedures for approving exceptions to these policy guidelines. Management has also implemented reporting systems to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans. 59 The Company's loan and lease customers are located primarily in the New Yorkand Pennsylvaniacommunities served by its four subsidiary banks. Although operating in numerous communities in New York Stateand Pennsylvania, the Company is still dependent on the general economic conditions of these states. Other than geographic and general economic risks, management is not aware of any material concentrations of credit risk to any industry or individual borrower.
The Allowance for Loan and Lease Losses
Originated Loans and Leases
Management reviews the appropriateness of the allowance for loan and lease losses ("allowance") on a regular basis. Management considers the accounting policy relating to the allowance to be a critical accounting policy, given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that assumptions could have on the Company's results of operations. The Company has developed a methodology to measure the amount of estimated loan loss exposure inherent in the loan portfolio to assure that an appropriate allowance is maintained. The Company's methodology is based upon guidance provided in
SECStaff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues and allowance allocations are calculated in accordance with ASC Topic 310, Receivables and ASC Topic 450, Contingencies. The Company's methodology for determining and allocating the allowance for loan and lease losses focuses on ongoing reviews of larger individual loans and leases, historical net charge-offs, delinquencies in the loan and lease portfolio, the level of impaired and nonperforming loans, values of underlying loan and lease collateral, changes in anticipated cash flows of acquired loans, the overall risk characteristics of the portfolios, changes in character or size of the portfolios, geographic location, current economic conditions, changes in capabilities and experience of lending management and staff, and other relevant factors. The various factors used in the methodologies are reviewed on a regular basis. At least annually, management reviews all commercial and commercial real estate loans exceeding a certain threshold and assigns a risk rating. The Company uses an internal loan rating system of pass credits, special mention loans, substandard loans, doubtful loans, and loss loans (which are fully charged off). The definitions of "special mention", "substandard", "doubtful" and "loss" are consistent with banking regulatory definitions. Factors considered in assigning loan ratings include: the customer's ability to repay based upon the customer's expected future cash flow, operating results, and financial condition; value of the underlying collateral, if any; and the economic environment and industry in which the customer operates. Special mention loans have potential weaknesses that if left uncorrected may result in deterioration of the repayment prospects and a downgrade to a more severe risk rating. A substandard loan credit has a well-defined weakness which makes payment default or principal exposure likely, but not yet certain. There is a possibility that the Company will sustain some loss if the deficiencies are not corrected. A doubtful loan has a high possibility of loss, but the extent of the loss is difficult to quantify because of certain important and reasonably specific pending factors. At least quarterly, management reviews all commercial and commercial real estate loans and leases and agriculturally related loans with an outstanding principal balance of over $500,000that are internally risk rated as special mention or worse, giving consideration to payment history, debt service payment capacity, collateral support, strength of guarantors, local market trends, industry trends, and other factors relevant to the particular borrowing relationship. Through this process, management identifies impaired loans. For loans and leases considered impaired, estimated exposure amounts are based upon collateral values or present value of expected future cash flows discounted at the original effective rate of each loan. For commercial loans, commercial mortgage loans, and agricultural loans not specifically reviewed, and for homogenous loan portfolios such as residential mortgage loans and consumer loans, estimated exposure amounts are assigned based upon historical net loss experience and current charge-off trends, past due status, and management's judgment of the effects of current economic conditions on portfolio performance. Since the methodology is based upon historical experience and trends as well as management's judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in the local area, concentration of risk, changes in interest rates, and declines in local property values. Based on its evaluation of the allowance as of June 30, 2014, management considers the allowance to be appropriate. Under adversely different conditions or assumptions, the Company would need to increase or decrease the allowance. 60
Acquired Loans and Leases
Acquired loans accounted for under ASC 310-30
For our acquired loans, our allowance for loan losses is estimated based upon our expected cash flows for these loans. To the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
Acquired loans accounted for under ASC 310-20
We establish our allowance for loan losses through a provision for credit losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses. The tables below provide, as of the dates indicated, an allocation of the allowance for probable and inherent loan losses by type. The allocation is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category. (in thousands) 06/30/2014 12/31/2013 06/30/2013 Allowance for originated loans and leases Commercial and industrial
$ 8,562 $ 8,406 $ 6,955Commercial real estate 10,389 10,459 10,409 Residential real estate 5,445 5,771 5,273 Consumer and other 2,356 2,059 2,195 Leases 0 5 21 Total $ 26,752 $ 26,700 $ 24,853(in thousands) 06/30/2014 12/31/2013 06/30/2013 Allowance for acquired loans Commercial and industrial $ 159 $ 168 $ 64Commercial real estate 460 770 381 Residential real estate 49 274 126 Consumer and other 97 58 34 Total $ 765 $ 1,270 $ 605As of June 30, 2014, the total allowance for loan and lease losses was $27.5 million, which was down 1.6% compared to year-end 2013. The favorable impact on the allowance of improved asset quality was partially offset by growth in the originated loan portfolio. Loans internally-classified Special Mention, Substandard and Doubtful were down from prior year as were the level of nonperforming loans and leases. The allowance for loan and lease losses covered 103.1% of nonperforming loans and leases as of June 30, 2014, compared to 71.65% at December 31, 2013, and 65.0% at June 30, 2013. The Company's allowance for originated loan and lease losses totaled $26.8 millionat June 30, 2014, which represented 1.02% of total originated loans, compared to 1.04% at March 31, 2014and 1.08% at June 30, 2013. Originated loans internally-classified as Special Mention, Substandard and Doubtful totaled $56.7 millionat June 30, 2014, which were in down $20.9 millionor 26.9% compared to prior quarter, and down $28.3 millionor 33.3% compared to June 30, 2013. The decrease is mainly due to paydowns of classified assets and upgrades of risk ratings in our commercial real estate, agriculture loan, and commercial real estate construction portfolios as a result of improving financial conditions of our commercial and agricultural customers. The allocations in the above table are fairly consistent between March 31, 2014and June 30, 2013. The decrease in the residential real estate allocation reflected slower growth, lower nonperforming loans and overall improvement in the housing market. The increase in the allocation for commercial and industrial loans was mainly a result of a slight uptick in the historical loss component, which is based on average losses in the portfolio. 61 The allowance for acquired loans at June 30, 2014was $765,000down $505,000or 39.8% compared to year-end 2013. The amount of acquired loans internally-classified as Special Mention, Substandard and Doubtful totaled $42.4 millionat June 30, 2014, down from $49.7 millionat year-end 2013 and $84.4 millionat June 30, 2013. Loan pay downs, the movement of loans to other real estate owned, and charge offs have contributed to the decrease from both year-end and the same quarter prior year. Nonaccrual loans in the acquired portfolio decreased from $8.5 millionat year-end 2013 to $5.9 millionat June 30, 2014.
Activity in the Company's allowance for loan and lease losses during the six months of 2014 and 2013 is illustrated in the table below.
Analysis of the Allowance for Originated Loan and Lease Losses
(in thousands) 06/30/2014 06/30/2013 Average originated loans outstanding during period
$ 2,559,332 $ 2,161,200Balance of originated allowance at beginning of year $ 26,700 $ 24,643ORIGINATED LOANS CHARGED-OFF: Commercial and industrial 254 432 Commercial real estate 613 490 Residential real estate 267 339 Consumer and other 666 462 Total loans charged-off $ 1,800 $ 1,723RECOVERIES OF ORIGINATED LOANS PREVIOUSLY CHARGED-OFF: Commercial and industrial 489 1,442 Commercial real estate 562 436 Residential real estate 86 29 Consumer and other 260 200 Total loans recoveries $ 1,397 $ 2,107
Net loans charged-off (recovered) 403 (384 ) Additions (reductions) to originated allowance charged to operations 455 (174 ) Balance of originated allowance at end of period
$ 26,752 $ 24,853Allowance for originated loans and leases as a percentage of originated loans and leases 1.02 % 1.08 % Annualized net charge-offs (recoveries) on originated loans to average total originated loans and leases during the period 0.03 % (0.07 %) 62
Analysis of the Allowance for Acquired Loan Losses
(in thousands) 06/30/2014 12/31/2013
Average acquired loans outstanding during period
$ 647,618 $ 746,045 $ 785,910Balance of acquired allowance at beginning of year 1,270 0 0 ACQUIRED LOANS CHARGED-OFF: Commercial and industrial 25 2,991 2,929 Commercial real estate 551 179 32 Residential real estate 277 696 110 Consumer and other 7 25 25 Total loans charged-off $ 860 $ 3,891 $ 3,096Net loans charged-off 860 3,891 3,096 Additions to acquired allowance charged to operations 355 5,161
Balance of acquired allowance at end of period $ 765
$ 1,270$ 605 Allowance for acquired loans as a percentage of acquired loans outstanding acquired loans and leases 0.12 % 0.17 % 0.08 % Annualized net charge-offs on acquired loans as a percentage of average acquired loans and leases outstanding during the period 0.25 % 0.52 % 0.79 % Annualized total net charge-offs as a percentage of average loans and leases outstanding during the period 0.08 % 0.09 %
0.18 % Net loan and lease charge-offs totaled
$565,000and $1.3 millionfor the three and six months ended June 30, 2014, compared to $1.7 millionand $2.7 millionfor the same periods in 2013. Annualized net charge offs for the period ended June 30, 2014as a percentage of average total loans and leases was 0.08% compared to 0.09% for the twelve months ended December 31, 2013and 0.18% for the six months ended June 30, 2013. The most recent peer percentage is 0.16%. The peer data is from the Federal Reserve Boardand represents banks or bank holding companies with assets between $3.0 billionand $10.0 billion. The peer data is as of March 31, 2014, the most recent data available. The $551,000in commercial real estate in the acquired commercial real estate portfolio is mainly related to one loan that was previously provided for in the allowance calculation and that was charged-off in the current quarter. The provision for loan and lease losses was $67,000and $810,000for the three and six months ended June 30, 2014, compared to $2.5 millionand $3.5 millionfor the same periods in 2013. Positive credit quality trends, including reductions in classified loans and nonperforming loans, and recoveries of previously charged of credits, are the main reasons for the lower provision expense compared to the same period last year. 63 Analysis of Past Due and Nonperforming Loans (in thousands) 06/30/20141 12/31/20131
Loans 90 days past due and accruing Commercial and industrial $ 0 $ 0 $ 0 Commercial real estate 1 161 0 Residential real estate 542 446 156 Total loans 90 days past due and accruing 543 607 156 Nonaccrual loans2 Commercial and industrial 1,758 1,679 1,552 Commercial real estate 10,008 23,364 25,039 Residential real estate 10,490 13,086 12,013 Consumer and other 569 254 412 Total nonaccrual loans 22,825 38,383 39,016 Troubled debt restructurings not included above 3,327 45 0 Total nonperforming loans and leases 26,695 39,035
39,172 Other real estate owned 6,795 4,253 4,918 Total nonperforming assets
$ 33,490 $ 43,288 $ 44,090Allowance as a percentage of nonperforming loans and leases 103.08 % 71.65 % 64.99 % Total nonperforming loans and leases as percentage of total loans and leases 0.83 % 1.22 % 1.28 % Total nonperforming assets as percentage of total assets 0.66 % 0.87 % 0.89 % 1 The June 30, 2014, December 31, 2013, and June 30, 2013columns in the above table exclude $4.0 million, $7.0 million, and $17.8 million, respectively, of acquired loans that are 90 days past due and accruing interest. These loans were originally recorded at fair value on the acquisition date of August 1, 2012. These loans are considered to be accruing as we can reasonably estimate future cash flows on these acquired loans and we expect to fully collect the carrying value of these loans. Therefore, we are accreting the difference between the carrying value of these loans and their expected cash flows into interest income.
2 Nonaccrual loans at
Nonperforming assets include nonaccrual loans, troubled debt restructurings ("TDR"), and foreclosed real estate/other real estate owned. Nonperforming assets represented 0.66% of total assets at
June 30, 2014, compared to 0.87% at December 31, 2013, and 0.89% at June 30, 2013. The Company's ratio of nonperforming assets to total assets continues to compare favorably to our peer group's most recent ratio of 1.56% at March 31, 2014. Total nonperforming loans and leases were down $12.3 millionor 31.6% from year end 2013, and down $12.5 millionor 31.9% from June 30, 2013. A breakdown of nonperforming loans by portfolio segment is shown above. The decrease in nonperforming commercial real estate loans since year-end 2013 is mainly due to significant payments received on two large commercial relationships during the quarter. In addition, one larger commercial real estate relationship was moved to other real estate owned during the quarter and is thus included in the table above.
Loans are considered modified in a TDR when, due to a borrower's financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider and the borrower could not obtain elsewhere. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity. TDRs are included in the above table within the following categories: "loans 90 days past due and accruing", "nonaccrual loans", or "troubled debt restructurings not included above". Loans in the latter category include loans that meet the definition of a TDR but are performing in accordance with the modified terms and therefore classified as accruing loans. At
June 30, 2014the Company had $5.1 millionin TDRs, of that total $1.8 millionwere reported as nonaccrual and $3.3 millionwere considered performing and included in the table above. In general, the Company places a loan on nonaccrual status if principal or interest payments become 90 days or more past due and/or management deems the collectability of the principal and/or interest to be in question, as well as when required by applicable regulations. Although in nonaccrual status, the Company may continue to receive payments on these loans. These payments are generally recorded as a reduction to principal, and interest income is recorded only after principal recovery is reasonably assured. 64 The Company's recorded investment in loans and leases that are considered impaired totaled $17.5 millionat June 30, 2014, down 34.9% compared to the $26.9 millionreported at December 31, 2013. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans consist of our non-homogenous nonaccrual loans, and all TDRs. Specific reserves on individually identified impaired loans that are not collateral dependent are measured based on the present value of expected future cash flows discounted at the original effective interest rate of each loan. For loans that are collateral dependent, impairment is measured based on the fair value of the collateral less estimated selling costs, and such impaired amounts are generally charged off. The year-to-date average recorded investment in impaired loans and leases was $22.1 millionat June 30, 2014, $29.0 millionat December 31, 2013, and $32.1 millionat June 30, 2013. At June 30, 2014there was a specific reserve of $250,000on impaired loans compared to $250,000of specific reserves at December 31, 2013and $297,000of specific reserves at June 30, 2013. The specific reserve of $250,000reported at June 30, 2014is related to one loan within the acquired loan portfolio with a balance totaling $253,000. The majority of impaired loans are collateral dependent impaired loans that have limited exposure or require limited specific reserve because of the amount of collateral support with respect to these loans and previous charge-offs. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured. In these cases, interest is recognized on a cash basis. The ratio of the allowance to nonperforming loans (loans past due 90 days and accruing, nonaccrual loans and restructured troubled debt) was 103.1% at June 30, 2014, improved from 71.7% at December 31, 2013, and 65.0% at June 30, 2013. The Company's peer group ratio was 125.1% as of March 31, 2014. The Company's nonperforming loans are mostly made up of collateral dependent impaired loans requiring little to no specific allowance due to the level of collateral available with respect to these loans and/or previous charge-offs. Management reviews the loan portfolio continuously for evidence of potential problem loans and leases. Potential problem loans and leases are loans and leases that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the related borrowers causes management to have doubt as to the ability of such borrowers to comply with the present loan payment terms and may result in such loans and leases becoming nonperforming at some time in the future. Management considers loans and leases classified as Substandard, which continue to accrue interest, to be potential problem loans and leases. The Company, through its internal loan review function, identified 28 commercial relationships from the originated portfolio and 25 commercial relationships from the acquired portfolio totaling $14.2 millionand $18.0 million, respectively at June 30, 2014that were potential problem loans. At December 31, 2013, the Company had identified 50 relationships totaling $14.5 millionin the originated portfolio and 29 relationships totaling $11.5 millionin the acquired portfolio that were potential problem loans. Of the 28 commercial relationships in the originated portfolio that were Substandard, there were 4 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $8.9 million, the largest of which is $3.0 million. Of the 25 commercial relationships from the acquired loan portfolio, there were 4 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $6.4 million, the largest of which is $2.5 million. The Company continues to monitor these potential problem relationships; however, management cannot predict the extent to which continued weak economic conditions or other factors may further impact borrowers. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and personal or government guarantees. These factors, when considered in the aggregate, give management reason to believe that the current risk exposure on these loans does not warrant accounting for these loans as nonperforming. However, these loans do exhibit certain risk factors, which have the potential to cause them to become nonperforming. Accordingly, management's attention is focused on these credits, which are reviewed on at least a quarterly basis.
Total equity was
65 Additional paid-in capital increased by
$5.2 million, from $346.1 millionat December 31, 2013, to $351.3 millionat June 30, 2014. The increase is primarily attributable to $2.2 millionrelated to shares issued for dividend reinvestment, $1.5 millionrelated to shares issued under the employee stock ownership plan, $629,000increase for the exercise of stock options, and $697,000related to stock-based compensation. Retained earnings increased by $13.8 millionfrom $137.1 millionat December 31, 2013, to $150.9 millionat June 30, 2014, reflecting net income of $25.6 millionless dividends paid of $11.8 million. Accumulated other comprehensive loss decreased from a net unrealized loss of $25.1 millionat December 31, 2013to a net unrealized loss of $12.8 millionat June 30, 2014, reflecting a $12.0 millionincrease in unrealized gains on available-for-sale securities due to a decrease in market rates, and a $321,000increase related to postretirement benefit plans. Under regulatory requirements, amounts reported as accumulated other comprehensive income/loss related to net unrealized gain or loss on available-for-sale securities and the funded status of the Company's defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios. Cash dividends paid in the first six months of 2014 totaled approximately $11.8 million, representing 46.2% of year to date 2014 earnings. Cash dividends of $0.80per common share paid in the first six months of 2014 were up 5.3% over cash dividends of $0.76per common share paid in the first six months of 2013. On July 24, 2014, the Company's Board of Directors authorized, at the discretion of senior management, the repurchase of up to 400,000 shares of the Company's outstanding common stock. Purchases may be made on the open market or in privately negotiated transactions over the next 24 months.
The Company and its banking subsidiaries are subject to various regulatory capital requirements administered by Federal banking agencies. The table below reflects the Company's capital position at
REGULATORY CAPITAL ANALYSIS June 30, 2014 Actual Well Capitalized Requirement (dollar amounts in thousands) Amount Ratio Amount Ratio Total Capital (to risk weighted assets)
$ 460,41813.92 % $ 330,87810.00 % Tier 1 Capital (to risk weighted assets) $ 432,50413.07 % $ 198,5276.00 % Tier 1 Capital (to average assets) $ 432,5048.79 % $ 246,1585.00 %
As illustrated above, the Company's capital ratios on
June 30, 2014remain above the minimum requirements for well capitalized institutions. Total capital as a percent of risk weighted assets increased from 13.4% as of December 31, 2013to 13.9% at June 30, 2014. Tier 1 capital as a percent of risk weighted assets increased from 12.6% at the end of 2013 to 13.1% as of June 30, 2014. Tier 1 capital as a percent of average assets was 8.8% at June 30, 2014up from 8.5% at year end December 31, 2013.
July 9, 2013, the FDIC'sBoard of Directors approved an interim final capital rule titled: Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule. The interim final rule makes several key changes to the regulatory capital framework that are effective for community banks beginning on January 1, 2015, with some items phasing in over a period of time. The primary focus of the new capital rule is to strengthen the quality and loss-absorbency of regulatory capital so as to enhance banks' abilities to continue functioning as financial intermediaries, including during periods of financial stress. Provided below is a brief overview of some key aspects of the new rule. The Company continues to evaluate the provisions of the final rules and their expected impact on the Company's capital ratios. Management believes that, as of June 30, 2014, the Company and its subsidiary banks would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis if such requirements were currently effective. As required under Dodd-Frank, the new rules add a new capital ratio, a "common equity tier 1 capital ratio" (CET1). The primary difference between this ratio and the current tier 1 leverage ratio is that only common equity will qualify as tier 1 capital under the new ratio. The new CET1 ratio also will include most elements of accumulated other comprehensive income, including unrealized securities gains and losses, as part of both total regulatory capital (numerator) and total assets (denominator), although community banks are given the opportunity to make a one-time irrevocable election to include or not to include certain elements of other comprehensive income, most notably unrealized securities gains or losses. 66 In addition to setting higher minimum capital ratios, the new rules, introduce a new concept, a so-called "capital conservation buffer" (set at 2.5%), which must be added to each of the minimum capital ratios (which by themselves are somewhat higher than the current minimum ratios). The capital conservation buffer will be phased-in over five years. When, during economic downturns, an institution's capital begins to erode, the first deductions from a regulatory perspective would be taken against the conservation buffer. To the extent that buffer should erode below the required level, the bank would not necessarily be required to replace the capital deficit immediately but would face restrictions on paying dividends and other negative consequences until it did so. The final rules eliminated the proposed phase-out over 10 years of Trust Preferred Services, or "TRUPs" as tier 1 capital for banks, such as Tompkins, that have less than $15 billionin total assets. Under the final rule, grandfathered TRUPs, such as Tompkins'outstanding TRUP's, would continue to qualify as tier 1 capital until they mature or are redeemed, up to a limit of 25% of tier 1 capital (for grandfathered TRUPs and other grandfathered tier
1 capital components).
The following is a summary of the capital definitions for community banks: Common Equity Tier 1 Capital:The sum of common stock instruments and related surplus net of treasury stock, retained earnings, accumulated other comprehensive income (AOCI), and qualifying minority interests, minus applicable regulatory adjustments and deductions. Such deductions will include AOCI, if the organization exercises its irrevocable option not to include AOCI in capital. Mortgage-servicing assets, deferred tax assets, and investments in financial institutions are limited to 15 percent of CET1 in the aggregate and 10 percent of CET1 for each such item individually.
Additional Tier 1 Capital: The sum of noncumulative perpetual preferred stock, tier 1 minority interests, grandfathered TRUPs, and Troubled Asset Relief Program instruments, minus applicable regulatory adjustments and deductions.
Tier 2 Capital: The sum of subordinated debt and preferred stock, total capital minority interests not included in Tier 1, allowance for loan and lease losses (not exceeding 1.25 percent of risk-weighted assets) minus applicable regulatory adjustments and deductions.
Deposits and Other Liabilities
Total deposits of
$4.0 billionat June 30, 2014increased $97.2 millionor 2.5% from December 31, 2013. The increase from year-end 2013 was comprised mainly of increases in money market savings and interest bearing checking deposit and
time deposit accounts. The most significant source of funding for the Company is core deposits. The Company defines core deposits as total deposits less time deposits of
$250,000or more (formerly $100,000), brokered deposits and municipal money market deposits. Core deposits of $3.3 billionwere relatively flat at June 30, 2014compared to year-end 2013. Core deposits represented 81.7% of total deposits at June 30, 2014, compared to 83.4% of total deposits at December 31, 2013. Municipal money market savings and interest checking accounts of $637.5 millionat June 30, 2014increased $37.2 millionor 6.2% from $600.3 millionat year-end 2013. In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances tend to increase throughout the fall and into the winter months from tax deposits and the Company receives an additional inflow at the end of March from the electronic deposit of state funds. The Company uses both retail and wholesale repurchase agreements. Retail repurchase agreements are arrangements with local customers of the Company, in which the Company agrees to sell securities to the customer with an agreement to repurchase those securities at a specified later date. Retail repurchase agreements totaled $47.9 millionat June 30, 2014, and $55.3 millionat December 31, 2013. Management generally views local repurchase agreements as an alternative to large time deposits. The Company's wholesale repurchase agreements totaled $96.8 millionat June 30, 2014and included $65.0 millionwith the FHLB and $31.8 millionwith a large financial institution. Wholesale repurchase agreements totaled $112.4 millionat December 31, 2013. The Company's other borrowings totaled $287.2 millionat June 30, 2014, down $44.4 millionor 13.4% from $331.5 millionat December 31, 2013. Borrowings at June 30, 2014included $162.5 millionin FHLB overnight advances, $111.2 millionof FHLB term advances, and a $13.5 millionadvance from a bank. Borrowings at year-end 2013 included $215.7 millionin overnight advances from FHLB, $101.3 millionof FHLB term advances, and a $14.5 millionadvance from a bank. The decrease in short term borrowings reflects the repayment of overnight FHLB advances with other funding sources, mainly deposits. Of the $111.2 millionin FHLB term advance at June 30, 2014, $71.2 millionis due over one year. In 2007, the Company elected the fair value option under FASB ASC Topic 825 for a $10.0 millionadvance with the FHLB. The fair value of this advance decreased by $128,000(net mark-to-market gain of $128,000) over the six months ended June 30, 2014. 67 Liquidity The objective of liquidity management is to ensure the availability of adequate funding sources to satisfy the demand for credit, deposit withdrawals, and business investment opportunities. The Company's large, stable core deposit base and strong capital position are the foundation for the Company's liquidity position. The Company uses a variety of resources to meet its liquidity needs, which include deposits, cash and cash equivalents, short-term investments, cash flow from lending and investing activities, repurchase agreements, and borrowings. The Company's Asset/Liability Management Committee monitors asset and liability positions of the Company's subsidiary banks individually and on a combined basis. The Committee reviews periodic reports on liquidity and interest rate sensitivity positions. Comparisons with industry and peer groups are also monitored. The Company's strong reputation in the communities it serves, along with its strong financial condition, provides access to numerous sources of liquidity as described below. Management believes these diverse liquidity sources provide sufficient means to meet all demands on the Company's liquidity that are reasonably likely to occur. Core deposits, discussed above under "Deposits and Other Liabilities", are a primary and low cost funding source obtained primarily through the Company's branch network. In addition to core deposits, the Company uses non-core funding sources to support asset growth. These non-core funding sources include time deposits of $250,000or more, brokered time deposits, national deposit listing services, municipal money market deposits, bank borrowings, securities sold under agreements to repurchase and overnight and term advances from the FHLB. Rates and terms are the primary determinants of the mix of these funding sources. Non-core funding sources of $1.2 billionat June 30, 2014increased $17.7 millionor 1.5% as compared to year end 2013. Non-core funding sources, as a percentage of total liabilities, were 25.7% at June 30, 2014, compared to 25.4% at December 31, 2013. Increases in time deposits of $250,000or more and brokered deposits were mainly offset by declines in FHLB borrowings. Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $1.1 billionand $1.0 billionat June 30, 2014and December 31, 2013, respectively, were either pledged or sold under agreements to repurchase. Pledged securities represented 76.4% of total securities at June 30, 2014, compared to 74.7% of total securities at December 31, 2013. Cash and cash equivalents totaled $83.4 millionas of June 30, 2014which was flat compared to $82.9 millionat December 31, 2013. Short-term investments, consisting of securities due in one year or less, increased from $37.0 millionat December 31, 2013, to $54.2 millionon June 30, 2014. The Company also had $10.0 millionof securities designated as trading securities at June 30, 2014. Cash flow from the loan and investment portfolios provides a significant source of liquidity. These assets may have stated maturities in excess of one year, but have monthly principal reductions. Total mortgage-backed securities, at fair value, were $750.1 millionat June 30, 2014compared with $724.5 millionat December 31, 2013. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $1.0 billionat June 30, 2014as compared to $993.6 millionat December 31, 2013. Aggregate amortization from monthly payments on these assets provides significant additional cash flow
to the Company. Liquidity is enhanced by ready access to national and regional wholesale funding sources including Federal funds purchased, repurchase agreements, brokered certificates of deposit, and FHLB advances. Through its subsidiary banks, the Company has borrowing relationships with the FHLB and correspondent banks, which provide secured and unsecured borrowing capacity. At
June 30, 2014, the unused borrowing capacity on established lines with the FHLB was $1.1 billion. As members of the FHLB, the Company's subsidiary banks can use certain unencumbered mortgage-related assets and securities to secure additional borrowings from the FHLB. At June 30, 2014, total unencumbered residential mortgage loans and securities of the Company were $635.6 million. Additional assets may also qualify as collateral for FHLB advances upon approval of the FHLB. The Company has not identified any trends or circumstances that are reasonably likely to result in material increases or decreases in liquidity in the near term.
The Company continues to evaluate the potential impact on liquidity management of regulatory proposals, including Basel III and those required under the Dodd-Frank Act.