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ALNC > SEC Filings for ALNC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ALLIANCE FINANCIAL CORP /NY/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ALLIANCE FINANCIAL CORP /NY/


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Highlights and Overview

Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on our loans and leases and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for credit losses, securities and loan sale activities, loan servicing activities, service charges and fees collected on our deposit accounts, income collected from trust and investment advisory services and the income earned on our investment in bank-owned life insurance. Our expenses primarily consist of salaries and employee benefits, occupancy and equipment expense, marketing expense, professional services, technology expense, amortization of intangible assets, other expense and income tax expense. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, inflation, government policies and the actions of regulatory authorities.

The following is a summary of key financial results for the quarter and nine months ended September 30, 2012:

Total assets were $1.4 billion and total deposits were $1.1 billion at September 30, 2012, compared with $1.4 billion and $1.1 billion at December 31, 2011, respectively.

Net income was $2.3 million for the three months ended September 30, 2012, compared with $3.7 million for the same period in 2011. For the nine months ended September 30, 2012, net income was $7.8 million compared with $10.5 million for the first nine months of 2011. Pre-tax merger related expenses were $991,000 in the three and nine months ended September 30, 2012.

Net income per diluted share was $0.48 and $0.77 for the three months ending September 30, 2012 and 2011, respectively. Net income per diluted share was $1.64 for the nine months ending September 30, 2012 compared with $2.20 per share for the same period in 2011.

The tax-equivalent net interest margin was 3.23% in the third quarter of 2012 compared with 3.48% in the third quarter of 2011.

Provision for credit losses of $0 in the quarter and a negative provision for credit losses of $300,000 for the nine months ended September 30, 2012, compared with provision expense of $750,000 and $1.1 million in the year ago periods, respectively.

Total non-performing assets were $5.1 million or 0.35% of total assets at September 30, 2012 compared with $12.9 million, or 0.90% at September 30, 2011 and $11.7 million or 0.83% at December 31, 2011.

Non-interest income was 31.3% of total revenue in the first nine months of 2012 compared with 29.0% in the year ago period.

Our efficiency ratio was 77.5% in the nine months ended September 30, 2012 compared with 70.2% for the same period in 2011.

The following discussion is intended to assist in understanding our financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and accompanying notes contained elsewhere in this report.

Pending Merger

On October 8, we announced that we entered into a definitive agreement with NBT under which we will merge with and into NBT. The merger is valued at approximately $233.4 million and is expected to close in early 2013 subject to customary closing conditions, including receipt of regulatory approvals and approvals by NBT and Alliance stockholders. Under the terms of the merger agreement, each outstanding share of our common stock will be converted into the right to receive 2.1779 shares of NBT common stock upon completion of the merger. The transaction is valued at $48.00 per Alliance share based on NBT's average closing stock price of $22.04 for the five-day trading period ending on October 5, 2012.

Recent Legislative Updates

In June 2012, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued three proposals that would amend the existing regulatory risk-based capital adequacy requirements of banks and bank holding companies. The proposed rules implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. The Basel III proposal would increase the minimum levels of required capital, narrow the definition of capital, and places much greater emphasis on common equity. The comment period for the proposed rules ended October 22, 2012.


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The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would refine the definition of what constitutes "capital" for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to us and the Bank under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

The proposed rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, such as trust preferred securities, which would be phased out over time. Although the Dodd-Frank Act only required the phase out of such instruments for institutions with total consolidated assets of $15 billion or more, the proposed rules would require almost all institutions to phase out instruments that will no longer qualify as Tier 1 capital, albeit on a longer time frame than for institutions with total consolidated assets of $15 billion or more.

The federal bank regulatory agencies also proposed revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions would take effect January 1, 2015. We are still in the process of assessing the impacts of these complex proposals.

Comparison of Operating Results for the Three and Nine Months Ended September 30, 2012 and 2011

General

Net income for the quarter ended September 30, 2012 was $2.3 million or $0.48 per diluted share compared with $3.7 million or $0.77 per diluted share in the year-ago quarter. The return on average assets and return on average shareholders' equity were 0.64% and 6.32%, respectively, for the third quarter of 2012, compared with 1.01% and 10.69%, respectively, for the third quarter of 2011. Securities gains in the third quarter of 2011, when netted against a fixed asset write-down, totaled $472,000 after tax or $0.10 per share. Third quarter results for 2012 included costs associated with the recently announced acquisition of Alliance by NBT of $598,000 after tax or $0.13 per share.

Net income for the nine months ended September 30, 2012 was $7.8 million or $1.64 per diluted share compared with $10.5 million or $2.20 per diluted share in the year ago period. The return on average assets and return on average shareholders' equity were 0.74% and 7.34%, respectively, for the first nine months of 2012, compared with 0.95% and $10.47%, respectively, for the first nine months of 2011.

Net interest income decreased $1.0 million and $3.5 million in the three and nine month periods ended September 30, 2012, respectively, compared with the year-ago periods due to the continuing pressure on our net interest margin caused by the exceptionally low interest rate environment, which was partially mitigated by higher loan balances.

Net Interest Income

Net interest income totaled $10.0 million in the three months ended September 30, 2012, compared with $11.0 million in the year-ago quarter, and $10.0 million in the second quarter of 2012. The tax-equivalent net interest margin decreased 25 basis points in the third quarter compared with the year-ago quarter due to the effect of persistently low interest rates on our interest-earning assets. The net interest margin decreased 3 basis points from the second to the third quarter of 2012 with most of the decrease attributable to the net effect of interest income recognition on non-accrual loans which were returned to performing status in each of the second and third quarters of 2012.

The net interest margin on a tax-equivalent basis was 3.23% in the third quarter of 2012, compared with 3.48% in the year-ago quarter and 3.26% in the second quarter of 2012. The decrease in the net interest margin compared with the third quarter of 2011 was the result of a decrease in the tax-equivalent earning asset yield of 55 basis points in the third quarter compared with


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the year-ago quarter, which was partially offset by a decrease in the cost of interest-bearing liabilities of 33 basis points over the same period. On a linked-quarter basis, the decline in our earning-assets yield was 9 basis points in the third quarter, which was partially offset by a 6 basis-point drop in the cost of our interest-bearing liabilities.

Average interest-earning assets were $1.3 billion in the third quarter, which was a decrease of 2.6% from the year-ago quarter but was unchanged from the second quarter of 2012. Most of the decline from the year-ago quarter occurred in our securities portfolio, with the average balance down 24% due to our decision to temporarily shrink the portfolio in the second half of 2011 due to the very low yields available on the types of securities in which we invest. Average loans and leases increased $25.2 million or 2.9% in the third quarter compared with the year-ago quarter as growth in our average commercial loan and consumer loan portfolios offset lower average lease balances. Total average loans and leases were 69.8% of total interest-earning assets in the third quarter of 2012, compared with 66.1% in the year-ago quarter and 68.4% in the second quarter of 2012.

Net interest income for the nine months ended September 30, 2012 totaled $29.8 million, which was down $3.5 million or 10.5% compared with the year-ago period. The tax equivalent net interest margin was 3.24% for the nine months ended September 30, 2012, compared to 3.49% for the first nine months of 2011. The tax-equivalent earning asset yield decreased 49 basis points in the first nine months of 2012 compared with the year-ago period, which was partially offset by a decrease of 26 basis points in the cost of interest-bearing liabilities over the same period.

Average interest-earning assets were $1.3 billion in the first nine months of 2012, which was a decrease of 3.5% from the first nine months of 2011. The changes in the average balances of securities and loans for the first nine months of 2012 compared with the year-ago period were similar to that as discussed above for the third quarter. Total average loans and leases were 68.4% of total interest-earning assets in the first nine months of 2012, compared with 65.8% in the year-ago period.

Since December 2008 the Federal Reserve has maintained its target fed funds rate between zero and 0.25%, and has carried out a number of policy actions designed to lower long-term interest rates. These monetary policy actions, along with volatility in equity markets, weak economic conditions and federal government economic stimulus efforts, among other factors, have caused yields on U.S. Treasury securities to drop to exceptionally low levels throughout much of the past four years. This persistently low interest rate environment has caused an ongoing decline over the past four years in the returns on our interest-earning assets, consistent with much of the financial industry. As a result the tax-equivalent yield on our securities portfolio decreased 61 basis points in the third quarter of 2012 compared to the year-ago quarter. The yield on our commercial loans, residential loans and consumer (including indirect) loans decreased 6 basis points, 35 basis points and 86 basis points, respectively, in the third quarter of 2012 compared to the third quarter of 2011.

The cost of our interest-bearing liabilities decreased in the third quarter of 2012 compared to the year-ago quarter due to a combination of the low interest rate environment, our deposit pricing strategies and a deposit mix that remains heavily weighted in low-cost interest-bearing transaction accounts (demand, savings and money market) whose rates can be immediately changed at our discretion. However we have not been able to reduce our cost of our interest-bearing liabilities sufficient to offset our declining asset yields in recent quarters due to the absolute low levels of our deposit rates. The average cost of money market and time deposits dropped 16 basis points and 46 basis points, respectively in the third quarter compared to the year-ago quarter. Average interest-bearing transaction accounts comprised 70.6% of total average interest-bearing deposits in the third quarter, compared to 64.2% in the year-ago period. We also reduced our cost of borrowings by 23 basis points in the third quarter compared to the third quarter of 2011 primarily through a restructuring of FHLB advances totaling $50.0 million in June 2012. The restructurings resulted in prepayment penalties of $2.1 million which will be amortized as an adjustment to interest expense over the remaining term of the restructured debt in accordance with U.S. generally accepted accounting principles. The restructuring had the effect of extending the maturities of the restructured borrowings by 3.3 years and lowering the annual average effective cost by 148 basis points.

Our liability mix remained favorably weighted towards transaction accounts (including non-interest bearing demand deposits) in the third quarter as retail and municipal depositors continue to refrain from investing funds in time accounts at very low, yet competitive rates, and also because of the buildup of cash on corporate customers' balance sheets. The aggregate average balance of transaction accounts was $845.6 million or 76.2% of total deposits in the third quarter, compared with $778.7 million or 70.1% in the year-ago quarter. Average time account balances in the third quarter were $263.6 million or 23.8% of total average deposits, compared with $332.1 million or 29.9% in the year-ago quarter. Our ability to gather and retain transaction deposits in recent years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of our brand. Environmental factors such as equity market volatility and risk aversion among retail investors have also played a role in the growth in our transaction accounts.


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Our tax-equivalent net interest margin declined in recent quarters as decreases in the cost of our interest-bearing liabilities did not keep pace with declines in the yield on our interest-earning assets. The declining trend in our net interest margin that we have experienced in recent quarters is likely to continue in coming quarters as the persistently low interest rate environment continues to negatively affect the return on our loan and investment portfolios, while our ability to further reduce our funding costs is limited. The pressure on our net interest margin along with weak economic conditions, uneven loan demand and competition may result in further declines in net interest income in coming quarters.


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Average Balance Sheet and Net Interest Analysis

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the average yields and rates thereon for the periods indicated. Interest income and yield information is adjusted for items exempt from federal income taxes ("nontaxable") and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.

                                                            For the three months ended September 30,
                                                        2012                                        2011
                                                        Interest                                    Interest
                                         Average         Earned/       Yield         Average         Earned/       Yield
                                         Balance          Paid          Rate         Balance          Paid          Rate
                                                                     (Dollars in thousands)
Assets:
Interest earning assets:
Federal funds sold and interest
bearing deposits                       $    50,376      $      28        0.22 %    $     3,310      $      -         0.06 %
Taxable investment securities              261,090          1,501        2.30 %        354,363          2,775        3.13 %
Nontaxable investment securities            69,035            951        5.50 %         80,086          1,111        5.55 %
FHLB and FRB stock                           7,977             95        4.75 %          9,759            104        4.25 %
Residential real estate loans(1)           325,720          3,952        4.85 %        331,977          4,314        5.20 %
Commercial loans                           134,037          1,427        4.26 %        125,697          1,377        4.38 %
Nontaxable commercial loans                 12,171            173        5.67 %          8,811            121        5.48 %
Commercial real estate                     128,719          1,707        5.30 %        120,059          1,600        5.33 %
Taxable leases (net of unearned
discount)                                    4,272             76        7.15 %         19,770            294        5.95 %
Nontaxable leases (net of unearned
discount)                                    8,119            133        6.54 %         11,220            182        6.47 %
Indirect auto loans                        194,717          1,541        3.17 %        162,439          1,757        4.33 %
Consumer loans                              88,522            821        3.72 %         91,087            906        3.98 %

Total interest-earning assets          $ 1,284,755      $  12,405        3.86 %    $ 1,318,578      $  14,541        4.41 %

Non-interest earning assets:
Other assets                               135,043                                     131,530
Less: Allowance for credit losses           (8,866 )                                   (10,711 )
Net unrealized gains on securities
available-for-sale                          11,999                                      11,263

Total assets                           $ 1,422,931                                 $ 1,450,660

Liabilities and shareholders'
equity:
Interest bearing liabilities:
Demand deposits                        $   155,062      $      30        0.08 %    $   139,035      $      49        0.14 %
Savings deposits                           117,732             30        0.10 %        108,969             54        0.20 %
MMDA deposits                              358,951            249        0.28 %        346,779            377        0.44 %
Time deposits                              263,632            812        1.23 %        332,054          1,404        1.69 %
Borrowings                                 127,210            734        2.31 %        160,943          1,022        2.54 %
Junior subordinated obligations
issued to unconsolidated trusts             25,774            170        2.64 %         25,774            158        2.45 %

Total interest-bearing liabilities     $ 1,048,361      $   2,025        0.77 %    $ 1,113,554      $   3,064        1.10 %

Non-interest bearing liabilities:
Demand deposits                            213,883                                     183,920
Other liabilities                           16,083                                      15,957
Shareholders' equity                       144,604                                     137,229

Total liabilities and shareholders'
equity                                 $ 1,422,931                                 $ 1,450,660

Net interest income                                     $  10,380                                   $  11,477

Net interest rate spread                                                 3.09 %                                      3.31 %
Net interest margin                                                      3.23 %                                      3.48 %
Federal tax exemption on non-taxable
investment securities, loans and
leases included in interest income                           (426 )                                      (480 )

Net interest income                                     $   9,954                                   $  10,997

(1) Includes loans held-for-sale


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                                                            For the nine months ended September 30,
                                                        2012                                        2011
                                                        Interest                                    Interest
                                         Average         Earned/       Yield         Average         Earned/       Yield
                                         Balance          Paid          Rate         Balance          Paid          Rate
                                                                     (Dollars in thousands)
Assets:
Interest earning assets:
Federal funds sold and interest
bearing deposits                       $    58,175      $     103        0.24 %    $     8,124      $       5        0.09 %
Taxable investment securities              265,167          4,970        2.50 %        358,394          8,521        3.17 %
Nontaxable investment securities            73,740          3,046        5.51 %         80,110          3,381        5.63 %
FHLB and FRB stock                           8,093            305        5.03 %          8,963            328        4.88 %
Residential real estate loans(1)           319,769         11,876        4.95 %        331,727         12,980        5.22 %
Commercial loans                           133,983          4,244        4.22 %        121,437          3,966        4.35 %
Nontaxable commercial loans                 12,010            515        5.71 %          9,104            359        5.25 %
Commercial real estate                     127,336          5,009        5.25 %        118,615          4,862        5.47 %
Taxable leases (net of unearned
discount)                                    7,586            342        6.01 %         23,293          1,031        5.90 %
Nontaxable leases (net of unearned
discount)                                    9,268            448        6.45 %         11,961            577        6.43 %
Indirect auto loans                        179,188          4,663        3.47 %        167,649          5,569        4.43 %
Consumer loans                              88,608          2,501        3.76 %         90,596          2,706        3.98 %

Total interest-earning assets          $ 1,282,923      $  38,022        3.95 %    $ 1,329,973      $  44,285        4.44 %

Non-interest earning assets:
Other assets                               134,757                                     132,458
Less: Allowance for credit losses           (9,652 )                                   (10,815 )
Net unrealized gains on securities
available-for-sale                          11,765                                       8,184

Total assets                           $ 1,419,793                                 $ 1,459,800

Liabilities and shareholders'
equity:
Interest bearing liabilities:
Demand deposits                        $   152,660      $      96        0.08 %    $   148,445      $     179        0.16 %
Savings deposits                           113,275             85        0.10 %        106,527            166        0.21 %
MMDA deposits                              363,154            779        0.29 %        368,670          1,271        0.46 %
Time deposits                              276,668          2,843        1.37 %        337,480          4,337        1.71 %
Borrowings                                 128,820          2,542        2.63 %        145,895          3,105        2.84 %
Junior subordinated obligations
issued to unconsolidated trusts             25,774            514        2.66 %         25,774            473        2.44 %

Total interest-bearing liabilities     $ 1,060,351      $   6,859        0.86 %    $ 1,132,791      $   9,531        1.12 %

Non-interest bearing liabilities:
Demand deposits                            200,399                                     178,124
Other liabilities                           16,545                                      15,814
Shareholders' equity                       142,498                                     133,071

Total liabilities and shareholders'
equity                                 $ 1,419,793                                 $ 1,459,800

Net interest income (tax-equivalent)                    $  31,163                                   $  34,754

Net interest rate spread                                                 3.09 %                                      3.32 %
Net interest margin (tax-equivalent)                                     3.24 %                                      3.49 %
Federal tax exemption on non-taxable
investment securities, loans and
leases included in interest income                         (1,363 )                                    (1,468 )

Net interest income                                     $  29,800                                   $  33,286

(1) Includes loans held-for-sale


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Rate/Volume Analysis

The following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of earning assets and interest-bearing liabilities, and from changes in rates for the periods indicated. Volume changes are computed by multiplying the volume difference by the prior period's rate. Rate changes are computed by multiplying the rate difference by the prior period's balance. The change in interest income and expense due to both rate and volume has been allocated proportionally between the volume and rate variances (in thousands).

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