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NBTB > SEC Filings for NBTB > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for NBT BANCORP INC



Annual Report

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

Certain statements in this filing and future filings by the Company with the SEC, in the Company's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, 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," "will," "can," "would," "should," "could," "may," 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 possibilities: (1) local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company's assessment of that impact; (2) changes in the level of non-performing assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war or terrorism; (8) the timely development and acceptance of new products and services and perceived overall value of these products and services by users;
(9) changes in consumer spending, borrowings and savings habits; (10) changes in the financial performance and/or condition of the Company's borrowers; (11) technological changes; (12) acquisitions and integration of acquired businesses;
(13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply including those under the Dodd-Frank Act; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
(17) changes in the Company's organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; and (20) the Company's success at managing the risks involved in the foregoing items.

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, but not limited to, those described above, 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.

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


The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of the Company and its wholly owned subsidiaries, the Bank, NBT Financial Services and NBT Holdings during 2013 and, in summary form, the preceding two years. Collectively, the Registrant and its subsidiaries are referred to herein as "the Company." Net interest margin is presented in this discussion on a fully taxable equivalent (FTE) basis. Average balances discussed are daily averages unless otherwise described. The audited consolidated financial statements and related notes as of December 31, 2013 and 2012 and for each of the years in the three-year period ended December 31, 2013 should be read in conjunction with this review. Amounts in prior period consolidated financial statements are reclassified whenever necessary to conform to the 2013 presentation.

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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 impairment of 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 policy would also require additional provision for loan losses.

Management is required to make various assumptions in valuing its 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 effect on the Company's results of operations.

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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, provision for income taxes and intangible assets are disclosed in Note 1 to the consolidated financial statements. A more detailed description of the allowance for loan losses is included in the "Risk Management" section of this Form 10-K. All significant pension accounting assumptions, income tax assumptions, and intangible asset assumptions and detail are disclosed in Notes 13, 12 and 7, respectively, to the consolidated financial statements. 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.

Non-GAAP Measures

This Annual Report on Form 10-K 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 to exclude the effects of sales of securities and certain non-recurring and merger-related expenses. Where non-GAAP disclosures are used in this Annual Report on Form 10-K, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying table. Management believes that these non-GAAP measures provided 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 a substitute 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.


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, 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 fiscal year ended December 31, 2013:

Reported net income for 2013 was $61.7 million, up from $54.6 million in 2012. Reported results for 2013 include the impact of the acquisition of Alliance Financial Corporation ("Alliance") since March 8, 2013, including $12.4 million in merger related expenses for 2013.

Core net income was $69.9 million for 2013 up 27.5% from $54.8 million for 2012. Core diluted earnings per share for 2013 was $1.65 up from $1.63 for 2012. Core return on average assets and return on average equity were 0.96% and 9.16%, respectively, for 2013, compared with 0.93% and 9.77%, respectively for 2012 (A reconciliation of these "core" results is presented in the following table).

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  Reconciliation of Non-GAAP Financial Measures:
  (dollars in thousands except per share data)                   2013         2012
  Reported net income (GAAP)                                   $ 61,747     $ 54,558
  Adj: (Gain) / Loss on sale of securities, net (net of tax)       (990 )       (421 )
  Adj: Other adjustments (net of tax)                               512         (382 )
  Plus: Merger related expenses (net of tax)*                     8,588        1,836
  Reversal of uncertain tax position                                  -         (790 )
  Total Adjustments                                               8,110          243
  Core net income                                              $ 69,857     $ 54,801
  Core Diluted Earnings per Share                              $   1.65     $   1.63
  Core Return on Average Assets                                    0.96 %       0.93 %
  Core Return on Average Equity                                    9.16 %       9.77 %
  Core Return on Average Tangible Common Equity                   14.76 %      14.20 %

* Reorganization expenses for 2013; prepayment penalty income and flood insurance recoveries, partially offset by an other asset write-down for 2012

Significant strategic expansion during 2013:

Acquired Alliance Financial Corporation, a $1.4 billion financial holding company headquartered in Syracuse, N.Y. on March 8, 2013.

Net interest margin for 2013 declined 20 basis points as a result of the continued low rate environment on loans and investments.

2013 organic loan growth of 5.3%, offsetting aforementioned margin compression, driven by:

Consumer loan growth of 4.8%; and

Commercial loan growth of 5.5%.

Asset quality indicators showed stability or improvement from last year:

Net charge-off ratio was 0.44%, down from 0.55% for last year;

Nonperforming loans to total loans was 0.99%, up slightly from 0.98% for last year.

Noninterest income was up 18.2% over last year driven primarily by the acquisition of Alliance and expansion into new markets:

Trust revenue was up $7.5 million, or 81.9%

ATM and debit card fees were up $3.2 million, or 25.9%.

Achieved targeted cost saves from the Alliance acquisition and benefited from other cost save initiatives during 2013.

The Company continued to experience pressure on net interest income in 2013 as low rates continued to have the effect of causing many assets to prepay or to be redeemed. As a result, reinvestment of cash flows in lower yielding assets has been the primary contributor to a decline in interest income in 2013. The yield on interest earning assets decreased from 4.51% in 2012 to 4.12% in 2013, with drops in the yields on loans and securities available for sale being the primary drivers. Rates paid on interest bearing liabilities also decreased in the low rate environment, which partially offset the decrease in earning asset yields. In particular, the decrease in rates paid on time deposits contributed approximately $3.4 million to the decrease in interest expense in 2013 as compared with 2012. Average interest bearing liabilities increased approximately $831.9 million from 2012 to 2013, with the primary driver being the increase in interest bearing deposits from acquisition activity. The Company also took the following steps in 2013 in an effort to help offset the margin pressure created by the low interest rate environment:

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Continued the sale of conforming residential real estate mortgages, taking advantage of favorable interest rate conditions;

Increased efforts to grow noninterest income with focus on organic growth of our trust, financial services, retirement plan administration and insurance businesses; and

Continued strategic expansion into central New York with the acquisition of Alliance.

The Company reported net income of $61.7 million or $1.46 per diluted share for 2013, up 13.2% from net income of $54.6 million or $1.62 per diluted share for 2012. The provision for loan losses totaled $22.4 million for the year ended December 31, 2013, up $2.1 million, or 10.6%, from $20.3 million for the year ended December 31, 2012. The increase in provision is attributable to the ongoing modeling of the required levels of reserves which considers historical charge-offs, loan growth and economic trends and is primarily due to the Company's loan growth. Noninterest income increased $15.9 million, or 18.2%, from 2012 primarily due to an increase in trust revenue of approximately $7.5 million. This increase was due primarily to the acquisition of Alliance in March 2013. In addition, ATM and debit card fees increased $3.2 million due to increased usage from expansion and acquisition activity during 2013. Noninterest expense for the year ended December 31, 2013 was $228.9 million, up from $193.9 million, or 18.1% for the year ended December 31, 2012. This increase was driven primarily by an increase in merger related expenses of approximately $9.8 million over 2012 attributable to the acquisition of Alliance. In addition, salaries and employee benefits were up $8.8 million, or 8.4%, largely due to expansion activity.

2014 Outlook

The Company's 2013 earnings reflected the Company's continued ability to manage through the existing and near future economic conditions and challenges in the financial services industry, while investing in the Company's future. The Company believes effects of the economic crisis still exist and, as a result, there will be certain challenges faced in 2014. Significant items that may have an impact on 2014 results include:

The Company expects that it will experience additional margin compression from the 2013 fourth quarter net interest margin of 3.61%. We expect that payments representing interest and principal on currently outstanding loans and investments will continue to be reinvested at rates that are lower than the rates currently outstanding on those loans and investments. In addition, deposit and borrowing rates are historically low and there are minimal opportunities for them to be lowered. Furthermore, the industry as a whole must focus on asset growth to increase interest income, thereby creating general pricing pressure in the entire industry.

If asset quality trends continue to show improvement, the Company would eventually expect the level of provisioning to decrease. However, the economy may have an adverse affect on asset quality indicators, particularly indicators related to loans secured by real estate, which could adversely affect charge-offs, the allowance for loan losses, and the provision for loan losses.

Compliance with regulatory mandates could continue to negatively impact certain fee generating products as well as increase costs to comply, which could negatively impact noninterest income, noninterest expense and earnings.

Competitive pressure on deposits could result in an increase in interest expense if interest rates begin to rise.

The Company's 2014 outlook is subject to factors in addition to those identified above and those risks and uncertainties that could impact the Company's future results are explained in ITEM 1A. RISK FACTORS.

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Asset/Liability Management

The Company attempts to maximize net interest income and net income, while actively managing its liquidity and interest rate sensitivity through the mix of various core deposit products and other sources of funds, which in turn fund an appropriate mix of earning assets. The changes in the Company's asset mix and sources of funds, and the resulting impact on net interest income, on a fully tax equivalent basis, are discussed below. The following table includes 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%.

Average Balances and Net Interest Income
                                           2013                                         2012                                         2011
                           Average                       Yield/         Average                       Yield/         Average                       Yield/
(Dollars in thousands)     Balance       Interest         Rate          Balance       Interest         Rate          Balance       Interest         Rate
Short-term interest
bearing accounts         $    30,522     $     116           0.38 %   $    66,207     $     179           0.27 %   $   101,224     $     269           0.27 %
Securities available
for sale (1)               1,349,887        27,357           2.03 %     1,177,969        28,904           2.45 %     1,123,215        33,319           2.97 %
Securities held to
maturity (1)                  88,193         3,692           4.19 %        65,582         3,583           5.46 %        81,558         4,350           5.33 %
Investment in FRB and
FHLB Banks                    37,998         1,771           4.66 %        28,358         1,378           4.86 %        27,089         1,389           5.13 %
Loans and leases (2)       5,106,607       239,572           4.69 %     4,053,420       209,370           5.17 %     3,677,931       205,318           5.58 %
Total interest earning
assets                   $ 6,613,207     $ 272,508           4.12 %   $ 5,391,536     $ 243,414           4.51 %   $ 5,011,017     $ 244,645           4.88 %
Other assets                 653,432                                      483,248                                      434,924
Total assets             $ 7,266,639                                  $ 5,874,784                                  $ 5,445,941

Money market deposit
accounts                 $ 1,343,801     $   2,004           0.15 %   $ 1,116,583     $   2,054           0.18 %   $ 1,070,003     $   3,592           0.34 %
NOW deposit accounts         882,629         1,468           0.17 %       709,889         1,854           0.26 %       685,542         2,313           0.34 %
Savings deposits             929,226           789           0.08 %       680,092           522           0.08 %       602,918           635           0.11 %
Time deposits              1,069,228        12,029           1.13 %       993,117        14,418           1.45 %       913,330        16,480           1.80 %
Total interest bearing
deposits                 $ 4,224,884     $  16,290           0.39 %   $ 3,499,681     $  18,848           0.54 %   $ 3,271,793     $  23,020           0.70 %
Short-term borrowings        280,848           515           0.18 %       165,742           188           0.11 %       153,965           205           0.13 %
Trust preferred
debentures                    96,536         2,084           2.16 %        75,422         1,730           2.29 %        75,422         2,092           2.77 %
Long-term debt               338,697        11,755           3.47 %       368,270        14,428           3.92 %       370,035        14,404           3.89 %
Total interest bearing
liabilities              $ 4,940,965     $  30,644           0.62 %   $ 4,109,115     $  35,194           0.86 %   $ 3,871,215     $  39,721           1.03 %
Demand deposits            1,484,193                                    1,139,896                                      966,282
Other liabilities             78,455                                       64,551                                       69,063
Stockholders' equity         763,026                                      561,222                                      539,381
Total liabilities and
stockholders' equity     $ 7,266,639                                  $ 5,874,784                                  $ 5,445,941
Net interest income
(FTE)                                      241,864                                      208,220                                      204,924
Interest rate spread                                         3.50 %                                       3.65 %                                       3.85 %
Net interest margin                                          3.66 %                                       3.86 %                                       4.09 %
Taxable equivalent
adjustment                                   3,785                                        4,017                                        4,648
Net interest income                      $ 238,079                                    $ 204,203                                    $ 200,276

1. Securities are shown at average amortized cost.
2. For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding. The interest collected thereon is included in interest income based upon the characteristics of the related loans.

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Net Interest Income

While the rate paid on interest bearing liabilities decreased 24 basis points, the yield on interest earning assets declined 39 basis points compared to the same period for 2012, resulting in margin compression for the year ended December 31, 2013. The yield on securities available for sale was 2.03% for the year ended December 31, 2013, compared with 2.45% for the year ended December 31, 2012. This decrease was due primarily to the reinvestment of cash flows from maturing securities and cash received from branch acquisitions in 2012 into lower yielding securities in the current rate environment. The average balance of securities available for sale for the year ended December 31, 2013 was $1.3 billion, up approximately $171.9 million, or 14.6%, from the year ended December 31, 2012. This increase was due primarily to investment of liquidity from acquisition activity and deposit growth. The yield on loans was 4.69% for the year ended December 31, 2013, compared with 5.17% for the year ended December 31, 2012. The average balance of loans for the year ended December 31, 2013 was $5.1 billion, up approximately $1.1 billion (including approximately $904 million of acquired loans from the Alliance acquisition), or 26.0%, from the year ended December 31, 2012. The reduction in yields on earning assets was . . .

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