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NBTB > SEC Filings for NBTB > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for NBT BANCORP INC


12-Nov-2013

Quarterly Report


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

The purpose of this discussion and analysis is to provide a concise description of the financial condition and results of operations of NBT Bancorp Inc. and its wholly owned consolidated subsidiaries, NBT Bank, N.A. (the "Bank"), NBT Financial Services, Inc. ("NBT Financial"), and NBT Holdings, Inc. ("NBT Holdings") (collectively referred to herein as the "Company"). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10Q as well as to the Company's Annual Report on Form 10K for the year ended December 31, 2012 for an understanding of the following discussion and analysis.
Operating results for the three and nine month periods ending September 30, 2013 are not necessarily indicative of the results of the full year ending December 31, 2013 or any future period.

Forward-looking Statements
Certain statements in this filing and future filings by the Company with the Securities and Exchange Commission, in the Company's press releases or other public or shareholder communications, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as "anticipate," "believe," "expect," "forecasts," "projects," "could," or other similar terms. There are a number of factors, many of which are beyond the Company's control, that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) revenues may be lower than expected; (3) changes in the interest rate environment may affect interest margins; (4) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduced demand for credit;
(5) legislative or regulatory changes, including changes in accounting standards or tax laws, may adversely affect the businesses in which the Company is engaged; (6) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than the Company; (7) adverse changes may occur in the securities markets or with respect to inflation; (8) acts of war or terrorism; (9) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (10) internal control failures; (11) the successful completion and integration of acquisitions; and (12) the Company's success in managing the risks involved in the foregoing.

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

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


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

Recent Legislation
The following section should be read in conjunction with the Supervision and Regulation section of NBT's 2012 Form 10-K.

On July 2, 2013, the Federal Reserve Board issued final rules, and on July 9, 2013, the Office of the Comptroller of the Currency issued interim final rules that revise the existing regulatory capital requirements to incorporate certain revisions to the Basel capital framework, including Basel III, and to implement certain provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank Act"). The final and interim final rules seek to strengthen the components of regulatory capital, increase risk-based capital requirements, and make selected changes to the calculation of risk-weighted assets. The final and interim final rules, among other things:

revise minimum capital requirements and adjust prompt corrective action thresholds;

revise the components of regulatory capital, add a new minimum common equity Tier 1 capital ratio of 4.5% of risk-weighted assets and increase the minimum Tier 1 capital ratio requirement from 4% to 6%;

retain the existing risk-based capital treatment for 1-4 family residential mortgage exposures;

permit most banking organizations, including the Company, to retain, through a one-time permanent election, the existing capital treatment for accumulated other comprehensive income;

implement a new capital conservation buffer of common equity Tier 1 capital equal to 2.5% of risk-weighted assets, which will be in addition to the 4.5% common equity Tier 1 capital ratio and be phased in over a three year period beginning January 1, 2016 which buffer is generally required to make capital distributions and pay executive bonuses;

increase capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments;

require the deduction of mortgage servicing assets and deferred tax assets that exceed 10% of common equity Tier 1 capital in each category and 15% of common equity Tier 1 capital in the aggregate; and

remove references to credit ratings consistent with the Dodd-Frank Act and establish due diligence requirements for securitization exposures.

Under the final and interim rules, compliance is required beginning January 1, 2015, for most banking organizations including the Company, subject to a transition period for several aspects of the rule, including the new minimum capital ratio requirements, the capital conservation buffer, and the regulatory capital adjustments and deductions. We are still in the process of assessing the impacts of these complex final and interim final rules, however, we believe we will continue to exceed all estimated well-capitalized regulatory requirements on a fully phased-in basis.


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In May 2013, the Securities and Exchange Commission and the Commodity Futures Trading Commission (together, the "Commissions") jointly issued final rules and guidelines to require certain regulated entities to establish programs to address risks of identity theft. The rules and guidelines implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These provisions amend Section 615(e) of the Fair Credit Reporting Act and directed the Commissions to adopt rules requiring entities that are subject to the Commissions' jurisdiction to address identity theft in two ways. First, the rules require financial institutions and creditors to develop and implement a written identity theft prevention program that is designed to detect, prevent, and mitigate identity theft in connection with certain existing accounts or the opening of new accounts. The rules include guidelines to assist entities in the formulation and maintenance of programs that would satisfy the requirements of the rules. Second, the rules establish special requirements for any credit and debit card issuers that are subject to the Commissions' jurisdiction, to assess the validity of notifications of changes of address under certain circumstances.

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

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

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

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

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


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

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

The Company's policies on the allowance for loan losses, pension accounting, acquired loans, provision for income taxes and intangible assets are disclosed in Note 1 to the consolidated financial statements presented in our 2012 Annual Report on Form 10-K. All accounting policies are important, and as such, the Company encourages the reader to review each of the policies included in Note 1 to obtain a better understanding of how the Company's financial performance is reported.

Overview
Significant factors management reviews to evaluate the Company's operating results and financial condition include, but are not limited to: net income and earnings per share, return on assets and equity, tangible common equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons. The following information should be considered in connection with the Company's results for the first nine months of 2013:

Reported net income for the nine months ended September 30, 2013 was $43.8 million, up from $41.4 for the same period in 2013. Reported results for the nine months ending September 30, 2013 include the impact of the acquisition of Alliance Financial Corporation ("Alliance") since March 8, 2013, including $12.3 million in merger related expenses for the nine months ended September 30, 2013.

Core net income was $51.5 million for the nine months ended September 30, 2013, up 24.9% from $41.2 million for the same period in 2012. Core diluted earnings per share for the nine months ended September 30, 2013 was $1.23, equivalent to the same period in 2012. Core annualized return on average assets and return on average equity were 0.96% and 9.20%, respectively, for the nine months ended September 30, 2013, compared with 0.95% and 9.91%, respectively, for the nine months ended September 30, 2012. (A reconciliation of "core" is presented on the following table)


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Net interest margin (on a fully taxable equivalent basis ("FTE")) was 3.67% for the nine months ended September 30, 2013 as compared to 3.87% for the same period in 2012.

Annualized loan growth for the first nine months of 2013 was 5.8%.

Past due loans as a percentage of total loans were 0.70% at September 30, 2013 as compared to 0.71% at December 31, 2012.

Net charge-offs, annualized, were 0.44% of average loans for the first nine months of 2013, compared to 0.55% for the year ended December 31, 2012.

The following table depicts several annualized measurements of performance using core and U.S. GAAP net income that management reviews in analyzing the Company's performance. Returns on average assets and average equity measure how effectively an entity utilizes its total resources and capital, respectively.


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                                               For the three months               For the nine months
(Dollars in thousands)                          ended September 30,               ended September 30,
                                               2013             2012             2013             2012
Reconciliation of Non-GAAP Financial
Measures:
Reported net income (GAAP)                 $     19,257     $     14,535     $     43,822     $     41,442
Adj: Gain on sale of securities, net
(net of tax)                                       (228 )            (18 )           (981 )           (405 )
Adj: Other adjustments (net of tax) (1)             110              239              110             (365 )
Plus: Merger related expenses (net of
tax)                                                224              388            8,529            1,322
Reversal of uncertain tax position                    -             (790 )              -             (790 )
Total Adjustments                                   106             (181 )          7,658             (238 )
Core net income                            $     19,363     $     14,354     $     51,480     $     41,204

Weighted Average Diluted Shares              44,135,114       33,961,375       41,768,796       33,626,071
Core Diluted Earnings Per Share            $       0.44     $       0.42     $       1.23     $       1.23

Performance measures:
Core Return on Average Assets (2)                  1.02 %           0.96 %           0.96 %           0.95 %
Core Return on Average Equity (2)                  9.67 %          10.00 %           9.20 %           9.91 %
Core Return on Average Tangible Common
Equity (2)(3)                                     15.95 %          14.74 %          14.75 %          14.37 %

(1) Primarily reorganization expenses for 2013; prepayment penalty income and flood insurance recoveries, partially offset by an other asset write-down for 2012
(2) Annualized
(3) Excludes amortization of intangible assets (net of tax) from net income and average tangible common equity is calculated as follows:

                                                 For the three months          For the nine months
                                                  ended September 30,          ended September 30,
                                                  2013           2012           2013          2012

Average stockholders equity                    $   794,273     $ 570,880     $  748,277     $ 555,182
Less: average goodwill and other intangibles       292,271       169,445        262,277       158,035
Average tangible common equity                 $   502,002     $ 401,435     $  486,000     $ 397,147

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


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Net interest income was $62.2 million for the three months ended September 30, 2013, up marginally from the prior quarter, and up $9.6 million from the third quarter of 2012 primarily due to the acquisition of Alliance. Average interest earning assets were up $50.1 million, or 0.7%, for the third quarter of 2013 as compared to the prior quarter, driven primarily by organic loan production during the third quarter. This increase was offset by a decrease in the yields on interest earning assets from 4.16% for the second quarter of 2013 to 4.08% for the third quarter, driven primarily by the 13 basis point ("bp") decrease in loan yields. Average interest bearing liabilities showed a 0.8% decrease from the second quarter of 2013 to the third quarter and rates paid on interest bearing liabilities decreased 5 bps during the same period resulting in a 7.6% decrease in interest expense from the second quarter of 2013 to the third quarter.

The Company's Fully Tax Equivalent ("FTE") net interest margin was 3.65% for the three months ended September 30, 2013, down from 3.69% from the prior quarter, and down from 3.90% for the third quarter of 2012. Rate compression on earning assets continued to negatively impact net interest margin in the third quarter of 2013 as evidenced by decreasing loan yields from 4.76% for the second quarter of 2013 to 4.63% for the third quarter of 2013. The rate compression on earning assets was partially offset by the 5 bp decrease in the rates paid on interest bearing liabilities in the third quarter of 2013 versus the prior quarter. This decrease was primarily driven by decreases in rates paid on long-term debt as maturing higher cost borrowings were replaced with lower rate short term borrowings.

Net interest income was $176.0 million for the nine months ended September 30, 2013, up 16.0% from the same period in 2012. This increase from the prior year was due primarily to the 22.0% increase in average earning assets for the nine months ended September 30, 2013 over the prior year. The acquisition of Alliance in March 2013 as well as the full year impact of 2012 loan growth contributed to the growth in average earning assets. The increase in net interest income was also attributable to the $3.3 million decrease in interest expense due to the 24 bp decrease in rates paid on interest bearing liabilities, partly offset by a 19.7% increase in the average balance of interest bearing liabilities. The ratio of average core deposits in 2013 (noninterest bearing demand deposits, money market, savings and NOW account) increased to 80.8% of total deposits compared to 78.5% in 2012.

The Company's FTE net interest margin was 3.67% for the nine months ended September 30, 2013, down from 3.87% for the same period last year. Rate compression on earning assets continued to negatively impact net interest margin for the first nine months of 2013 as evidenced by decreasing loan yields from 5.21% for the first nine months of 2012 to 4.75% for the first nine months of 2013. In addition, yields on available for sale securities declined 49 bps in the first nine months of 2013 as compared to the same period in 2012. The rate compression on earning assets was partially offset by the 24 bp decrease in the rates paid on interest bearing liabilities in the first nine months of 2013 as compared to the same period in 2012.


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

Three Months ended
September 30,
                                           2013                                          2012
                          Average                        Yield/         Average                        Yield/
(dollars in
thousands)                Balance        Interest        Rates          Balance        Interest        Rates
ASSETS
Short-term interest
bearing accounts        $     1,955     $        9           1.73 %   $    10,392     $       11           0.43 %
Securities available
for sale (1)(2)           1,387,714          6,994           2.00 %     1,168,326          7,023           2.39 %
Securities held to
maturity (1)                118,781          1,059           3.54 %        62,746            861           5.46 %
Investment in FRB and
FHLB Banks                   43,895            465           4.20 %        28,706            337           4.67 %
Loans (3)                 5,309,446         62,008           4.63 %     4,197,046         54,046           5.12 %
Total interest
earning assets          $ 6,861,791     $   70,535           4.08 %   $ 5,467,216     $   62,278           4.53 %
Other assets                671,482                                       504,194
Total assets            $ 7,533,273                                   $ 5,971,410

LIABILITIES AND
STOCKHOLDERS' EQUITY
Money market deposit
accounts                $ 1,360,067     $      528           0.15 %   $ 1,111,624     $      495           0.18 %
NOW deposit accounts        877,387            285           0.13 %       686,768            377           0.22 %
Savings deposits            984,093            227           0.09 %       706,927            149           0.08 %
Time deposits             1,081,549          2,959           1.09 %     1,035,868          3,523           1.35 %
Total interest
bearing deposits        $ 4,303,096     $    3,999           0.37 %   $ 3,541,187     $    4,544           0.51 %
Short-term borrowings       383,238            232           0.24 %       178,277             60           0.13 %
Trust preferred
. . .
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