Item 1. Business
General
FNB Rochester Corp. (the "Company") is a bank holding company. First National Bank of Rochester ("First National" or the "Bank") is its only subsidiary. The Company was organized under the New York Business Corporation Law and commenced operations on September 10, 1984. At December 31, 1998, the Company had consolidated assets and deposits of $587.9 million and $501.4 million, respectively. The Bank is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation ("FDIC").
The Bank was established in 1965, in Rochester, New York as a national bank. It provides a full range of commercial banking, trust, and consumer banking services to businesses and individuals.
On December 9, 1998, the Company announced that an Agreement and Plan of Reorganization dated as of December 9, 1998 had been entered into among the Company, M&T Bank Corporation, a New York corporation ("M&T") and Olympia Financial Corp., a Delaware corporation and wholly-owned subsidiary of M&T ("Olympia") pursuant to which the Company will be merged with and into Olympia pursuant to the terms of an Agreement and Plan of Merger dated as of December 9, 1998 between the Company and Olympia and joined in by M&T (the "Merger"). The proposed merger is subject to various conditions, including the approval of the shareholders of the Company and the receipt of all requisite regulatory approvals. It is expected that the Merger will be completed in the second quarter of 1999. Following the consummation of the Merger, the Bank will be merged with and into Manufacturers and Traders Trust Company, a New York State chartered banking subsidiary of Olympia.
Market Area
The Company's business is conducted from its corporate headquarters located in the Powers Building at the corner of State and Main Streets in downtown Rochester, New York. The Bank's eighteen banking offices are located in Monroe, Ontario, Chemung, Erie, and Onondaga Counties in New York State. The Bank sold its Odessa office in Schuyler County in 1996 and its Shop City office in Onondaga County in 1994, but still provides services in Onondaga County through its Downtown Syracuse office. The Bank expanded into the metropolitan Buffalo area in 1993 with the addition of a loan production office in a suburban section of Erie County. In August 1994, the Buffalo office became a full service branch. A new loan production office was opened in the suburban Buffalo community of Orchard Park in 1997. The Buffalo and Downtown Syracuse offices focus their sales and service efforts on business and professional customers. Three new banking offices were opened in 1998, two in Monroe County and one in Ontario County. In November 1998, the Bank entered into an agreement for the sale of its Southport Community Banking Office in Chemung County to The Elmira Savings Bank, FSB. That transaction is expected to close near the end of the first quarter of 1999.
The Bank considers its primary service and market area to be the City of Rochester and surrounding towns, which have a total population of approximately 1 million. Rochester, located in the western part of New York State on the south shore of Lake Ontario, is the third largest city in New York State. Greater Rochester has a diversified manufacturing base. Four national firms with significant manufacturing facilities and other major business operations in the Greater Rochester area are Eastman Kodak Company, Xerox Corporation, Bausch & Lomb Inc. and General Motors Corporation. Rochester is the home of the corporate headquarters of both Eastman Kodak and Bausch & Lomb. Other institutions that add stability to the area's employment include the University of Rochester, Rochester Institute of Technology, eight other institutions of higher education, and seven large hospitals. Although primarily agricultural and residential in nature, the surrounding communities served by the Company also have office, commercial, educational, retail, and light industrial facilities. Businesses in these communities constitute an important part of the Bank's customer base.
Banking Services
First National's services are provided through sixteen full-service community banking offices, fourteen of which have drive-up facilities, plus the Buffalo and Syracuse offices. Automated teller machines ("ATMs") are located at thirteen of the fourteen Monroe County banking offices, and customers may use ATMs throughout the United States and abroad through ATM networks. The Bank opened its three newest banking offices in the Rochester area in 1998. They are located in the Town of Victor, the Village of Brockport and in a supermarket in the City of Rochester.
The Bank is engaged in general commercial banking, providing a wide range of loan and deposit services. As of December 31, 1998, the Bank had 53,415 deposit accounts and 14,299 loans outstanding. The Bank offers a wide range of retail services, including installment loans, credit cards, checking accounts, savings accounts, money market accounts, and various types of time-deposit instruments. Mortgage lending activities include commercial, industrial, and residential loans secured by real estate. Commercial lending activities include originating secured and unsecured loans and lines of credit and accounts receivable financing services to a variety of businesses. The Bank also provides cash management services to businesses and professionals. The Bank's consumer loan department makes direct auto, home equity, home improvement, and personal loans to individuals. The Bank offers safe deposit box services at fourteen of the banking offices.
The Trust & Investment Division of First National was expanded in 1993. The Trust & Investment Division at First National Bank acts as executor and/or trustee and provides administration, record-keeping, and professional portfolio management for individuals, corporations, institutions, and not-for-profits. The market value of assets under management increased $43.8 million, or 62.6%, from $70.0 million at year end 1997 to $113.8 million at year end 1998, through product offerings such as 401(k) plans, investment management, corporate and cash management services, mutual funds, annuities, and traditional trust and record-keeping services. The Trust & Investment Division has established various strategic alliances with service partners to reduce costs, provide better and more efficient services, obtain access to other markets and enhance its capabilities and product offerings. As with any major business expansion, this is a long-term commitment on the part of the Bank.
Employees
At December 31, 1998, the Company had 279 employees of whom 56 worked on a part-time basis. None of the employees are covered by a collective bargaining agreement. The Company considers its relations with its employees to be good.
Competition
The Bank is one of approximately twelve commercial and savings institutions competing for deposits and loans in Monroe County. Approximately ten commercial and savings institutions compete in Chemung County. The Bank considers its business to be highly competitive in its service areas. Many of the competitors are larger than First National in terms of number of offices, assets, and resources, and many have higher lending limits than First National.
The primary competition for the Trust & Investment Division comes from investment advisory and brokerage firms, as well as other bank trust departments in the Bank's primary market area.
In recent years, non-bank financial institutions such as credit unions, money market funds, stock brokerage firms, insurance companies, and mortgage banking firms have been an increased source of competition. Non-bank financial institutions continue to be subject to less regulation than commercial banks in certain areas.
Supervision and Regulation
As a bank holding company, the Company is subject to the Bank Holding Company Act of 1956, as amended (the "Act"), and is required to file annual reports and such additional information as may be required by the Federal Reserve Board (the "FRB") pursuant to the Act. The FRB has the authority to examine the Company and its subsidiaries.
The Act and regulations thereunder limit, with certain exceptions, the business which a bank holding company may engage in, directly or indirectly through subsidiaries, to banking, managing or controlling banks, furnishing or performing services for banks controlled by the Company, and services incident thereto. In addition, the Act and regulations thereunder require the prior approval of the FRB for the acquisition of a bank or bank holding company if thereafter the bank holding company will, directly or indirectly, control more than 5% of the voting stock of such bank or bank holding company, or substantially all the assets of such bank or bank holding company.
Among the activities permitted bank holding companies is the ownership of shares of any company which engages in activities that the FRB determines to be so closely related to banking, managing, or controlling banks as to be a proper incident thereto. The FRB has determined a number of activities to be closely related to banking, and has proposed others for consideration. Such activities include leasing real or personal property under certain conditions; operating as a mortgage financing or factoring company; servicing loans and other extensions of credit; acting as a fiduciary; acting as an investment or financial advisor under certain conditions; acting as an insurance agent or broker principally in connection with the extension of credit by the bank holding company or any subsidiary; acting as underwriter for credit life insurance and credit accident and health insurance that is directly related to extension of credit by the bank holding company or any subsidiary; providing bookkeeping or data processing services for the bank holding company, its affiliates, other financial institutions and others, with certain limitations; making certain equity and debt investments in community rehabilitation and development corporations; and providing certain kinds of management consulting advice to unaffiliated banks.
The Federal Reserve Act imposes restrictions on extensions of credit by subsidiary banks of a bank holding company to the bank holding company or any of its subsidiaries, or investments in the stock or other securities of the holding company, and on the use of such stock or securities as collateral for loans to any borrower. Further, under the FRB's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services.
From time to time the FRB may adopt further regulations pursuant to the Act. The Company cannot predict whether any further regulations will be adopted or how such regulations will affect the consolidated operating results or business of the Company.
The primary supervisory authority of the Bank is the Office of the Comptroller of the Currency (the " OCC"), which regularly examines such risk areas as capital adequacy, reserves, loans, investments, management practices, and other aspects of the Bank's operations. In addition to these regular examinations, the Bank must furnish quarterly and annual reports to the OCC. The OCC has the authority to issue cease-and-desist orders to prevent a bank from engaging in an unsafe or an unsound practice or violating the law in conducting its business.
The Bank is also a member of the Federal Reserve System, and as such, is subject to certain laws and regulations administered by the FRB. As a member of the Federal Reserve System, the Bank is required to maintain non-interest bearing reserves against certain accounts. The amount of reserves required to be maintained is established by regulations of the FRB and is subject to adjustment from time to time.
The Bank's deposits are insured by the Bank Insurance Fund (BIF) of the FDIC up to a maximum of $100,000 per insured deposit account, subject to the rules and regulations of the FDIC. For this protection, the Bank pays a quarterly statutory assessment.
The policies of regulatory authorities have had a significant effect on the operating results of commercial banks in the past, and are expected to do so in the future. An important function of the Federal Reserve System is to regulate aggregate national credit and money supply through such means as open market dealings in securities, establishment of the discount rate on bank borrowing, changes in reserve requirements against bank deposits, and limitations on the deposits on which a bank may pay interest. Policies of these agencies may be influenced by many factors including inflation, unemployment, short-term and long-term changes in the international trade balance, and fiscal policies of the United States Government. Supervision, regulation, or examination of the Company by bank regulatory agencies is not intended for the protection of the Company's shareholders.
Loans made by the Bank are also subject to numerous other federal and state laws and regulations, including the Truth in Lending Act, the Community Reinvestment Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.
The United States Congress has periodically considered and adopted legislation that has resulted in deregulation of both banks and other financial institutions. Congress has adopted further legislation to modify or eliminate geographic restrictions on banks and bank holding companies, and could modify or eliminate current prohibitions against banks engaging in one or more non-banking activities. Such legislative changes could place the Bank in more direct competition with other financial institutions including mutual funds, securities brokerage firms, insurance companies, and investment banking firms. The effect of any such legislation on the business of the Bank cannot be predicted.
Statistical data required to be disclosed by bank holding companies is included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 hereof.
Item 2.
Item 2. Properties
The Bank operates eighteen banking offices and one loan production office. Ten of the offices are owned (seven are on leased land) and eight are leased, including an office in a City of Rochester supermarket. The loan production office is leased for one year. The Bank also owns the building at 35 State Street, Rochester, New York and leases additional office space in the adjacent Powers Building. The leases are long-term and non-cancelable and expire at various dates from 2000 through 2018 with optional renewal terms of five to ten years and rent escalation clauses. Some of the leases also provide for contingency rent to be paid annually based upon increases in deposits or the cost of living. The properties are as follows:
The Banking Offices in the above table range in size from approximately 285 square feet to 4,500 square feet.
The Bank took occupancy of 36,000 square feet in the Powers Building during 1994 and vacated two floors (approximately 9,800 square feet) in the Wilder Building at 1 E. Main Street, consolidating all operations including the banking office into the Powers Building and the adjacent 35 State Street Building. These consolidated facilities have increased efficiency and are strategically located in downtown Rochester. With new leases signed in the first quarter of 1998 the Powers Building space has increased to approximately 44,000 square feet. The space in the Wilder Building that the Bank continues to lease is approximately 4,700 square feet and all of that space is sublet.
Item 3.
Item 3. Legal Proceedings
None
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 1998, no matter was submitted for a vote of Company's shareholders.
PART II _______
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
Dividends Paid and Market Prices of Registrant's Stock
The following table displays the range of bid price quotations and dividends declared for the Company's common stock for the years ended December 31, 1998 and December 31, 1997. The dividends were declared during the last month of the applicable fiscal quarters indicated and were paid to shareholders of record during the calendar month following such quarter. The Company's common stock is listed on the Nasdaq National Market System under the symbol FNBR.
Price Quotations Dividends Bid Price (low-high) Declared ____________________ _________
____
First quarter $ 15.25 - 22.75 $ .08 Second quarter 19.75 - 24.50 .08 Third quarter 16.00 - 24.88 .08 Fourth quarter 16.38 - 33.00 $ .08 _____ _____
$ 15.25 - 33.00 ===== =====
____
First quarter $ 12.00 - 15.75 n/a Second quarter 12.25 - 15.13 $ .07 Third quarter 14.00 - 17.50 n/a Fourth quarter 16.00 - 20.25 $ .10 _____ _____
$ 12.00 - 20.25 ===== =====
The above prices were furnished by Nasdaq, and such quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commissions. The prices may not reflect actual transactions.
At the close of business on March 10, 1999, the Company had 694 shareholders of record.
Item 6.
Item 6. Selected Financial Data
Five-Year Summary of Selected Financial Information
This table represents a summary of selected components of the Company's consolidated statements of financial condition and consolidated statements of operations for each of the years in the five-year period ended December 31, 1998. All information concerning the Company should be read in conjunction with consolidated financial statements and related notes included elsewhere herein.
Notes:
(1) Non-performing assets (non-accrual loans, loans past due 90 days or more, and real estate acquired by foreclosure) divided by total loans and real estate acquired by foreclosure.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
Statements included in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this document that do not relate to present or historical conditions are "forward looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and of Section 21F of the Securities Exchange Act of 1934, as amended. Additional oral or written forward looking statements may be made by the Company from time to time, and such statements may be included in documents that are filed with the Securities Exchange Commission. Such forward looking statements involve risks and uncertainties which could cause results or outcomes to differ materially from those expressed in such forward looking statements. Among the important factors on which such statements are based are assumptions concerning the business environment in those counties in New York State where the Bank operates, changes in interest rates, changes in the banking industry in general and particularly in the competitive environment in which the Bank operates, and changes in inflation.
Proposed Merger
In December 1998 FNB Rochester Corp. entered into a definitive agreement with M & T Bank Corporation ("M&T") for a merger of the Company into a subsidiary of M&T (the "Merger"). The Merger is subject to the satisfaction of certain conditions, including approval by shareholders of FNB Rochester Corp. and various regulatory agencies. This transaction is expected to be completed in the second quarter of 1999.
The merger will result in substantial legal, accounting, professional, investment advisory and other expense to be incurred by FNB Rochester Corp. in 1999. This expense is estimated to be approximately $2.5 to $3 million and will be recognized prior to the effective date of the merger. This expense would also include costs associated with the core banking conversion as explained in more detail under Results of Operations, Non-Interest Expense, below.
Overview
On November 30, 1998, First National announced an agreement for the sale of its Southport Office. At December 31, 1998, the office had deposits of approximately $14 million. The closing is expected to take place before the end of the first quarter of 1999.
The Company has continued its growth in 1998, and much of the growth is the result of banking office expansion in the Rochester area. Three new banking offices were opened in 1998 and four new banking offices were opened in 1995 and 1996. Two existing facilities were also replaced with new "customer friendly" facilities. The Company continues to emphasize a high level of customer service, establishing total financial service relationships with customers, and providing convenience through location and extended hours. The new banking offices were opened with modern technology, on-line teller automation, as well as new automated teller machines. On-line teller systems were installed in all other banking offices during 1996. With the use of new technology and more efficient systems, the Company has been able to continue to expand with only a minimal increase in the number of employees.
Net income increased $517,000, or 11.4%, in 1998. The Company's deposits increased $31.5 million, or 6.7%, from December 31, 1997 to December 31, 1998, and the Bank's sweep product increased securities sold under agreement to repurchase by $10.1 million, or 75.4%. Loan growth was strong in 1998 although with lower interest rates more businesses and consumers opted for fixed rate rather than variable rate loans. At December 31, 1998, total loans were up $63.1 million, or 19%, as compared to an increase of $27.9 million from 1996 to 1997. $30 million of the 1998 increase was in commercial loans, $26.6 was in residential mortgages, and home equity lines of credit outstanding ("home equity") increased $7.5 million. Consumer loans showed a slight decline. The Company's investments in securities available-for-sale increased by $11.8 million, or 9.8% from year end 1997 to year end 1998.
Growth objectives are expected to be realized in 1999 by continuing to increase the Company's deposit base, continuing to make high-quality loans, and using the available-for-sale securities portfolio and short term borrowing to provide liquidity and improve margins. In order to accomplish its growth objectives, the Company must continue to increase its market share. The additional new banking offices have helped the Company attain its goals. The growth in deposits in 1998 has been in demand, savings and money market accounts. During the third and fourth quarters of 1998 the Bank borrowed $20 million from the Federal Home Loan Bank to help interest rate sensitivity and match fund longer term assets. This has lessened the Bank's dependency on certificates of deposit and as a result certificates of less than $100,000 declined $7.1 million, or 4.7%, during the year and certificates over $100,000 declined $4.8 million, or 5.2%.
Results of Operations Net Interest Income ___________________
The following table reflects the net interest margin and interest rate spread for the years shown. Average amounts are based upon average daily balances. No tax equivalent adjustments have been made because they are not considered material.
Notes:(1) Non-accrual loans have been included in the average balances. (2) Securities available-for-sale are included at amortized cost.
Net interest income, the difference between interest income and interest expense, increased $1,937,000, or 9.3%, from 1997, which had an increase of $2,099,000, or 11.2%, over 1996's net interest income. Average earning assets increased $69,786,000, or 15.2%, from 1997 to 1998 and increased $68,641,000, or 17.6%, from 1996 to 1997. The growth in assets was funded by growth in deposits, borrowings and retained earnings.
Loans represent the majority of the Company's interest-earning assets. The increases in interest income noted in both 1998 and 1997 were primarily due to both loan and investment security volume increases. Loan increases were primarily in commercial real estate, conventional commercial loans and residential mortgage loans and the securities increases were in available-for-sale securities. Average net loan balances increased $44,902,000 from 1997 to 1998, while they increased $34,296,000 from 1996 to 1997. The loan volume increases in 1997 and 1998 are related to sales efforts and emphasis on making new loans. The average rate earned on loans in 1998 was 8.52% compared to 8.87% in 1997 and 8.94% in 1996. Average investment securities volumes increased $24,835,000 from 1997 to 1998 and increased $30,998,000 from 1996 to 1997. The average rate earned on taxable securities, which makes up most of the portfolio, declined from 6.74% in 1997 to 6.42% in 1998.
Average Federal Funds Sold remained constant through 1997 and 1998. The decline in net interest margin is primarily the result of lower rates for both loans and investments.
Interest expense is a function of the volume of, and rates paid for, interest-bearing liabilities. Interest expense increased in 1998 primarily because of an increase in average interest bearing liabilities. Interest rates on interest bearing liabilities declined only slightly in 1998.
The interest spread is the difference between average rates earned on assets and average rates paid on interest-bearing sources of funds. Interest spread declined in 1998 to 3.60% from 3.87% in 1997 and 4.20% in 1996. The interest margin, which is the difference between interest income and interest expense divided by average interest-earning assets, was 4.30% in 1998, 4.53% in 1997, and 4.79% in 1996. The decline in both the spread and the margin from 1997 is primarily due to lower earning asset rates.
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. Volume changes are computed by multiplying the volume difference by the prior year's rate. Rate changes are computed by multiplying the rate difference by the prior year's balance. The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the dollar amounts of the change in each.
Non-interest Income
Non-interest income is comprised of service charges, trust fees, credit card fees, loan servicing fees, and gains on sales of securities, mortgages, and other assets. The following table sets forth certain information on non-interest income for the years indicated:
Non-Interest Income
1998 1997 1996 ____ ____ ____
(in thousands)
Service charges on deposit accounts $ 2,110 $ 1,720 $ 1,547 Credit card fees 690 715 740 Gain on sale of mortgages 159 73 65 Gain (loss) on sale of securities available-for-sale 24 (8) (45) Loan servicing fees 266 262 263 Gain on sale of banking office - - 621 Other operating income 1,081 647 616 _____ ___ ___
Total non-interest income $ 4,330 $ 3,409 $ 3,807 ===== ===== =====
Non-interest income increased $921,000, or 27%, from 1997 to 1998 and declined $398,000, or 10.5%, from 1996 to 1997. 1996 non-interest income included a $621,000 gain on the sale of the Odessa banking office. Without the 1996 gain, 1997 would have reflected an increase of $223,000, or 7.0%, in non-interest income. Service charges on deposit accounts showed improvement in 1998 with an increase of $390,000, or 22.7%, over 1997 resulting from both increased volumes and increased pricing. Loan servicing fees have remained relatively constant over the three-year period. $143,000 of the increase in other operating income from 1997 to 1998 was the result of an increase in trust commissions and fees.
The Company continues to explore new ways to increase non-interest income and to monitor fees and service charges.
Non-interest Expense
Non-interest expense, or overhead, consists of salaries and benefits, occupancy, insurance, and other operating costs. The following table sets forth certain information on operating expenses for the years indicated:
Non-Interest Expense
1998 1997 1996 ____ ____ ____
(in thousands)
Salaries and employee benefits $ 10,915 $ 9,618 $ 9,227 Occupancy 4,008 3,561 3,448 Marketing and public relations 721 610 489 Office supplies, postage and printing 771 624 637 Processing fees 1,184 1,075 1,018 FDIC assessments 57 52 2 Net cost of operation of other real estate 26 16 2 Legal 240 192 190 Other 2,216 1,746 1,637 _____ _____ _____
Total non-interest expense $ 20,138 $ 17,494 $ 16,650 ====== ====== ======
Non-interest expense for 1998 increased $2,644,000, or 15.1%, from 1997 when it increased $844,000, or 5.1%, from 1996. The increases in 1997 and 1998 are primarily due to the growth of the Company. Much of the increase in both years is attributable to the salaries, benefits, occupancy expenses and other expenses associated with the new banking offices and the increased volume of business they have generated.
Salaries and benefits are the largest component of non-interest expense. The Bank operates in a metropolitan market unlike most community banks of similar size, and its cost for personnel tends to exceed that of typical community banks. Salaries and benefits increased $1,297,000, or 13.5%, from 1997, and $391,000, or 4.2%, from 1996 to 1997. The 1998 increase was primarily caused by the addition of personnel to staff the new offices opened in 1998 and additional operational support and lending staff needed for the increasing volume of business. The 1997 increase was primarily caused by normal raises, promotions and some staff additions.
Occupancy expense, the other significant non-interest expense, increased $447,000, or 12.6%, in 1998 as compared to $113,000, or 3.3%, from 1996 to 1997. Occupancy expense is expected to continue to increase with the addition of additional leased space at the Bank's headquarters and as the Bank has expanded its service delivery network with three new community banking offices opened in 1998. The full annual expense effect of these new offices will not be realized until 1999 and beyond. A new core banking system which was to have become operational in the fourth quarter of 1998 has been postponed due to the planned merger of the Company. If the Merger is approved, much of the cost incurred to date related to the new system, approximately $774,000, will need to be recognized as expense rather than be capitalized as the new core system will not be utilized. If the Merger does not take place, the Bank plans to continue with its conversion to the new system.
Marketing expense increased $111,000, or 18.2%, from 1997 to 1998. The Bank continued radio, television, and newspaper advertising in 1998. Marketing efforts were focused on the annual "Money Sale", home equity loans, grand openings for the new offices, image enhancement and customer awareness of the Bank as well as extended business hours. Also, as part of its sales efforts, the Company has continued with its interdivisional sales teams which conduct sales "blitzes" throughout the year.
Office supplies, printing and postage increased $147,000, or 23.6%, in 1998 as a result of increased business after a small decline from 1996 to 1997. Other operating expense increased $470,000, or 26.9%, from 1997 to 1998. Among the largest other operating expense increases were telephone, ATM, travel and entertainment costs, and loan filing fees.
Income Taxes
The Company and the Bank file a consolidated tax return. The provision for 1998 income taxes was $1,728,000, compared to $2,126,000 and $1,710,000 in 1997 and 1996, respectively. The Company's effective tax rates were 25.5%, 32% and 29% for 1998, 1997 and 1996, respectively.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income within the carry back period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of the deferred tax liabilities, the level of historical taxable income, and projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets will be deductible. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowance of $54,000 at December 31, 1998. Income tax expense was affected in 1998, 1997 and 1996 by reductions in the valuation allowance of $722,000, $469,000 and $660,000 respectively due to the generation of sufficient taxable income to support the realization of differences.
At December 31, 1998, the Company had a net deferred tax asset of $1,356,000 as compared to a net deferred tax asset of $554,000 at December 31, 1997. The 1997 deferred tax asset is attributable principally to the difference between book and tax allowance for loan losses.
Analysis of Financial Condition
Securities Portfolio
The primary purposes of the securities portfolio are to produce interest income and provide liquidity through structured maturities. Investments in securities are also made to provide collateral to secure local municipal deposits, to manage risk by diversifying credit risk and positioning the balance sheet for interest rate sensitivity, to support local communities, and to meet tax planning strategies. The total securities portfolio increased $5,429,000, or 3.6% from December 31, 1997 to December 31, 1998 and increased $47,247,000, or 46.4%, from December 31, 1996 to December 31, 1997.
The available-for-sale portfolio includes short-term Treasuries, U.S. Government Agency Notes and mortgage-backed securities not classified as held-to-maturity. During 1998, the Bank continued to classify most of its purchases of securities as available-for-sale.
Unrealized gains on available-for-sale securities included in accumulated other comprehensive income as a component of equity at December 31, 1998 amounted to $627,000, net of taxes, as compared to unrealized gains of $896,000, net of taxes, at December 31, 1997.
At December 31, 1998, 28.2% of the Bank's securities had maturities of five years or less, while 38.7% had maturities of five years or less at the end of 1997, and 50.6% had maturities of five years or less at the end of 1996. The decline in maturities of five years or less was caused by the Bank increasing its mortgage backed securities and SBA pools by approximately $29.3 million from 1996 to 1997 and by an additional $5.7 million from 1997 to 1998. At December 31, 1998 the average life of the Bank's amortizing securities such as mortgage pools and SBA pools was less than three years. The majority of the securities portfolio consists of U.S. Treasury Notes, U.S. Government Agency Notes, SBA pools and sequential pay mortgage-backed securities issued by U.S. government agencies. Since 1994 the Company has been decreasing its available-for-sale holdings of short-term treasuries and replacing them with medium term U.S. government agencies and longer-term variable and fixed rate mortgage-backed securities. Management believes that while this shift has helped the Bank to maintain its interest rate margins, a comparison of the interest rate sensitivity of all of its assets and liabilities suggests that the Bank's interest rate risks continue to be at appropriate levels. See "Management of Interest Rate Risk," below.
The following tables summarize the Company's carrying value of securities available-for-sale and the carrying value of securities held-to-maturity, and their maturities and weighted average yields at December 31, 1998, 1997, and 1996.
Carrying Value of Securities Available-for-Sale
December 31, ____________
1998 1997 1996 ____ ____ ____ (in thousands) Treasury $ 16,265 $ 25,403 $ 23,576 U.S. Government agency 43,863 34,346 9,967 Mortgage-backed securities 69,653 61,070 38,775 Other 2,883 - - _____ _ _
Total $ 132,664 $ 120,819 $ 72,318 ======= ======= ======
Notes: (1) The above figures are stated at fair value. The available-for-sale portfolio had net unrealized gains of $1,045,000, $1,491,000, and $447,000 at December 31, 1998, 1997 and 1996, respectively. Totals exclude Federal Reserve Bank stock and Federal Home Loan Bank stock of $2,188,000, $1,655,000 and $1,516,000 at December 31, 1998, 1997 and 1996, respectively.
Carrying Value of Securities Held-to-Maturity
December 31,
1998 1997 1996 ____ ____ ____ (in thousands)
U.S. Treasury $ 8,047 $ 8,079 $ 8,108 U.S. Government agency 127 5,252 5,293 Mortgage-backed securities 6,929 10,721 12,909 Obligations of state and municipal subdivisions 6,409 3,876 2,872 Other 350 350 350 ___ ___ ___
Total $ 21,862 $ 28,278 $ 29,532 ====== ====== ======
Notes: (1) Mortgage-backed securities and SBA pools are reported at final maturity notwithstanding the fact that amortization is received regularly on some securities substantially reducing the effective maturities.
Notes: (1) See note (1) above.
Loan Portfolio
The loan portfolio increased $63,146,000, or 19.1%, from 1997 to 1998. This compares to an increase from 1996 to 1997 of $27,860,000, or 9.2%. The growth of the loan portfolio in both 1998 and 1997 was the result of a planned business development program soliciting small businesses and professionals and increases in residential mortgages with terms of 15 years or less. Of the total 1998 year-end loan portfolio, $291,903,000, or 74%, is secured by either commercial or residential real estate.
The majority of the Company's loans continue to be commercial. Commercial loans increased $29,994,000, or 14.9%, from 1997, as compared to an increase of $14,001,000, or 7.5%, from 1996 to 1997. At year-end 1998, 57.1% of commercial loans were secured by commercial real estate. Of the commercial real estate securing those loans, 55.8% was owner occupied. Through expanded sales efforts, the Bank expects to continue to grow commercial loans, although at a somewhat slower rate. Competition for high quality loans is intense. The Bank is establishing itself in the small to medium-size business and professional markets. While its primary market is the Rochester area, the Business and Professional Banking Division has established a presence in the Syracuse and Buffalo markets with offices in Downtown Syracuse and in metropolitan Buffalo. Furthermore, the Bank has access to the Elmira area through its two community banking offices.
Residential mortgage loans increased $26,635,000, or 32%, from 1997 to 1998, as compared to an increase of $11,850,000, or 16.6%, from 1996 to 1997. With lower interest rates in 1998, the Bank experienced increased refinancing activity, and much of that was directed into 15-year or less fixed rate mortgages. It is expected that the Bank may continue to hold a major portion of its 15-year originations in portfolio rather than selling them. When commercial and consumer loan demand is not sufficient to offset deposit increases management looks to the shorter term maturity and variable rate residential mortgages to fill that need.
As a result of marketing promotions, home equity loans increased by $7,540,000, or 32.1%, from 1997 to 1998 and $2,219,000, or 10.4%, from 1996 to 1997. While home equity loans are attractive to borrowers who have equity in their homes, demand for this product is influenced by the residential mortgage refinance market. In the lower rate environment, many homeowners are choosing to refinance their mortgages resulting in the early repayment of home equity loans. Many of these homeowners take out new home equity loans and with increased marketing the Bank has been able to take advantage of the new home equity business this refinancing has created.
Consumer loans declined in 1998 and 1997 by $863,000 and $267,000 respectively. Annual "Money Sale" promotions and other initiatives for new consumer loans have failed to generate enough business to offset the increased payoffs of existing loans. More and more borrowers now seem to use home equity financing for their consumer needs.
It is the policy of the Bank to place loans, except consumer and residential mortgage loans, on non-accrual status when payment of principal or interest becomes 90 days delinquent or when, in management's judgment, the collection of principal or interest appears uncertain. Any interest income accrued during the reporting period, but not received at the time the loan is placed on non-accrual status, is reversed in the reporting period to the extent considered uncollectible. Interest accrued in prior years, the collection of which appears uncertain, is charged off. Interest on loans categorized as non-accrual may be recognized as income when the payments are received or applied as a reduction to principal.
Installment loans are not ordinarily placed on non-accrual status. Installment loans past due 120 days are generally charged off. At that time, all previously accrued or uncollected interest is reversed and charged against current earnings. Residential mortgage and home equity loans are placed on non-accrual status when they become 180 days past-due.
The following table summarizes the Company's non-performing assets at the dates indicated:
Total non-performing assets increased $1,802,000, or 67.3%, in 1998 from 1997 and total non-performing assets increased $569,000, or 27% in 1997 from 1996. The primary reason for the increase in loans past due 90 days or more is an increased delinquency rate in a pool of mortgage loans. These mortgages, totaling $8.2 million, were originated from 1995 to 1997 under special underwriting guidelines which targeted certain City of Rochester neighborhoods. The Bank has assigned an allocation of its reserve for loan losses to these loans and the allocation will be periodically evaluated and adjusted based on future delinquency rates and loss experience. The loans comprise $740,000 of the 90 days or more past due total and $203,000 of the non-accrual total.
Loans in non-accrual status increased $731,000 from 1997 to 1998 and increased $681,000 from 1996 to 1997. Of the $2,831,000 in non-accrual loans, $1,250,000 is secured by real estate and $623,000 is guaranteed by the U.S. government. Non-performing assets represent 1.13% of total loans and real estate acquired by foreclosure at the end of 1998 compared to 0.81% in 1997 and 0.69% in 1996.
Provision and Allowance for Loan Losses
The allowance for loan loss is available to absorb charge-offs from any loan category and is restored by charges to income or recoveries of loans previously charged off. Management undertakes a quarterly analysis to assess the adequacy of the allowance taking into account non-performing and delinquent loans, internally criticized loans, historical trends, economic factors, and overall credit administration. Based on this analysis, the allowance is considered adequate at December 31, 1998 to absorb anticipated losses inherent in the portfolio.
The following table summarizes the changes in the allowance for loan losses for 1994 through 1998:
The increases in the loan portfolios and nonperforming loans required that some provision be made in 1998 and 1997. The lack of provision in 1996 and 1995 as well as the decrease in provision in 1994 was the result of reductions in the level of criticized and non-performing loans, and increased collection efforts resulting in significant recoveries. The recovery of provision recorded in 1994 was the result of reversing an excess allowance at Atlanta National Bank just prior to the time of its sale.
At December 31, 1998, the Bank's internally criticized loans were $18,694,000 as compared to $15,194,000 at December 31, 1997 and $14,084,000 at December 31, 1996. Internally criticized loans increased $3,500,000, or 23%, from 1997 to 1998 and increased $1,110,000, or 7.9% from 1996 to 1997. As a percent of total loans, internally criticized loans remained almost unchanged. Internally criticized loans as a percent of total loans were 4.7%, 4.6%, and 4.6% for the years ended 1998, 1997 and 1996, respectively.
Below is an allocation of the allowance for loan losses and the percentage of loans in each category to total loans. In addition to an allocation for specific problem loans, each category includes a portion of the unallocated allowance for loan losses based on loans outstanding, credit risks, and historical charge-offs. Notwithstanding the following allocation, the entire allowance for loan losses is available to absorb charge-offs in any category of loans.
1995 1994 ____ ____
Allowance % (1) Allowance % (1) _________ _____ _________ _____ (in thousands)
Commercial, financial & agricultural $ 4,275 65.2% $ 5,384 66.4% Real estate, residential mortgage 706 19.6 294 15.3 Home equity 208 7.4 220 10.2 Installment, net 587 7.8 554 8.1 ___ ___ ___ ___
Total $ 5,776 100.0% $ 6,452 100.0% ===== ====== ===== ======
Notes:
(1) Percentage of loans in each category to total loans
Deposits
The fundamental source of funds to support lending activities continues to be the Bank's deposit base, which consists of demand deposits, certificates of deposit, savings, and money market accounts. The ability of management to attract and retain depositors is key to sustaining the Company's growth. The emphasis continues to be on a high level of customer service and cross-selling of products and services. Total deposits in 1998 increased $31,540,000, or 6.7%, from 1997, while average deposits per banking office have increased from $26,574,000 for the month of December 1996 to $30,033,000 for December 1997 and declined to $27,992,000 for December 1998. The December 1996 and 1997 monthly averages include the four new banking offices that were opened in 1995 and 1996 and the 1998 average includes the three new banking offices opened in 1998. Average December 1998 deposits per branch, without the three new offices opened in 1998, were $32,189,000.
In the years 1996 through 1998 the Bank has experienced increases in non-interest bearing demand deposits due in large part to accounts established with new loan relationships, accounts associated with the new banking offices, and increased public fund relationships. 1998 non-interest demand deposits grew 21.5% to $86,057,000 from $70,831,000 in 1997. 1997 non-interest bearing accounts increased $14.7 million, or 26.2%, over 1996 and for the period ended December 31, 1996, the increase was $10.1 million, or 21.8%, over 1995. Interest bearing demand deposits increased $13,879,000, or 20.5%, from December 31,1997 to December 31, 1998 and savings and money market deposits increased $14,325,000, or 16.1%, for the same period.
In 1998, to help control interest costs, management has funded the Bank's growth with less expensive long-term debt and savings, interest checking and money market accounts rather than certificates of deposit. As a result, certificate of deposit volumes declined in the second half of 1998. As compared to December 31, 1997, certificates of deposit declined $11,890,000, or 4.9%. $4,831,000 of the decline was in certificates of deposit of $100,000 or more. From 1996 to 1997, certificates of deposit over $100,000 increased $30,041,000, or 48.1%. In 1997 management sought to increase certificates of deposit over $100,000 as a short-term leverage strategy to increase interest income. $14.0 million of the increase in certificates over $100,000 was the result of an increase in one municipal relationship.
The Company has been taking a number of steps to better position itself to compete in a market which is experiencing disintermediation and movement from low-interest bearing accounts into certificates of deposit. The addition of the three new community banking offices in 1995, a fourth in 1996 and an additional three in 1998 as well as the replacement of two existing offices has significantly improved the Company's retail outlets and has extended services to areas that it previously could not service effectively.
The following tables summarize the daily average deposits of the Company for the years 1998, 1997, and 1996, categories in which those deposits were held in 1998 and 1997, and the maturity distribution of certificates of deposit and public funds of $100,000 or more for the year-end December 31, 1998.
Period End Deposits
For Years _________
1998 1997 ____ ____ (in thousands) Deposit category: Non-interest-bearing demand $ 86,057 $ 70,831 Interest-bearing demand 81,731 67,852 Savings 46,601 42,266 Money market 56,948 46,958 CDS less than $100,000 141,813 148,613 CDS greater than $100,000 41,186 40,836 Public funds less than $100,000 565 824 Public funds greater than $100,000 46,460 51,641 ______ ______
Total $ 501,361 $ 469,821 ======= =======
Maturity Distribution of Certificates of Deposits and Public Funds Greater Than $100,000
December 31, 1998 _________________
Maturity range (in thousands)
less than 3 months $ 38,790 3 to 6 months 15,772 6 to 12 months 23,196 12 months or more 9,888 _____
Total $ 87,646 ======
Securities with an amortized cost of $132,862,000 at December 31, 1998 were pledged as collateral for municipal deposits and short-term borrowing.
Short-Term Borrowings
The following table describes the Company's short-term borrowings at the dates indicated:
December 31, ____________
1998 1997 1996 ____ ____ ____ (In thousands)
Securities sold under agreements to repurchase $ 23,566 $ 13,436 - Other short-term borrowing 274 800 786 ___ ___ ___
Total $ 23,840 $ 14,236 $ 786 ====== ====== ===
The Bank had no securities sold under agreements to repurchase at December 31, 1996. The maximum amount outstanding at any one month-end and average amount for securities sold under agreements to repurchase were $23,566,000 and $22,333,000, respectively for 1998 and $13,436,000 and $5,173,000, respectively for 1997 and $4,348,000 and $704,000, respectively for 1996. The increase in 1997 and 1998 was the result of the introduction of a sweep account for business customers. Interest expense on securities sold under agreements to repurchase averaged 4.90% for 1998, 5.08% for 1997, and 5.82% for 1996.
The other short-term borrowing represents the Bank's Note Option as a Treasury, Tax, and Loan Depository for Federal
Tax Deposits. Securities with a carrying value of $2,970,000 at December 31, 1998 are held under the control of the Federal Reserve Bank of New York to secure Federal Tax Deposits in amounts in excess of FDIC insurance limits.
Capital Resources
Total shareholders' equity increased $4,132,000 from 1997. This increase is due to net income for 1998 of $5,036,000 and $522,000 for option and employee purchase common shares issued offset by a decrease in the fair value of securities available-for-sale of $269,000 and dividends paid on common stock of $1,157,000. Under SFAS 115, the net unrealized gain or loss on securities held in the available-for-sale portfolio is recorded in equity, net of taxes. In 1997, this resulted in an increase in shareholder's equity of $628,000 from the period ended December 31, 1996. The SFAS 115 adjustment is not considered in computing regulatory capital.
Both the Federal Reserve Board and the Office of the Comptroller of the Currency have issued risk-based capital guidelines which went into full effect December 31, 1992. The Company presently is deemed well-capitalized under these guidelines.
The numerator of risk-based capital ratios for bank holding companies includes Tier I capital, consisting of common shareholders' equity and qualifying cumulative and noncumulative preferred stock; and Tier II capital, consisting of a menu of internationally accepted items, including preferred stock, reserve for loan losses, and certain subordinated and term-debt capital. The denominator, or asset portion, of the risk-based ratio aggregates generic classes of balance sheet and off-balance sheet exposures, each weighted by one of four factors ranging from 0% to 100%, based on relative risk of the exposure class. This ratio assesses both the capital adequacy of the Company and the risk profiles of the Bank.
The prompt corrective action regulations of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) established specific capital categories based on an institution's capital ratios. To be considered "adequately capitalized" a bank must generally have a Leverage Ratio of at least 4%, a Tier I Risk-Based Capital Ratio of at least 4%, and a total Risk-Based Capital Ratio of 8%. At December 31, 1998, the Leverage, Tier-I Risk-Based Capital, and Total Risk-Based Capital Ratios of the Company and the Bank were as follows:
Capital Ratios
Tier-I Total Leverage Risk-Based Risk-Based Capital Ratio Capital Ratio Capital Ratio
FNB Rochester Corp. 6.4% 9.9% 11.2% First National Bank of Rochester 6.0% 9.3% 10.6% Regulatory guidelines: Well capitalized 5.0% 6.0% 10.0% Adequately capitalized 4.0% 4.0% 8.0%
Maintaining adequate capital ratios is a clearly defined objective of management. A number of steps have been taken by management to monitor capital adequacy. This effort becomes particularly important in light of the growth expectations for the Bank. An early warning system is part of the Company's business planning process. In addition to carefully monitoring performance and its impact on capital ratios, management re-forecasts the Company's balance sheet, income statement, and measures of capital adequacy at least quarterly. Furthermore, each year the entire business plan is revised to reflect actual results and project another year into the future. These measures serve to alert management to potential capital adequacy problems so that appropriate action could be formulated and addressed in advance.
After a four year suspension, the Company declared a common stock cash dividend in December 1996. The suspension was based on the belief of the Company's Board of Directors that until capital was sufficient to sustain the anticipated growth, earnings should be retained in the Company to support that growth. The Board declared cash dividends on the Company's common stock in June and December of 1997 and quarterly cash dividends in 1998.
Liquidity
Liquidity measures the ability to meet maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund operations, and to provide for customers' credit needs. Management carefully monitors its liquidity position and seeks to maintain adequate liquidity to meet its needs. All internal liquidity measures exceed minimum levels established by the Bank. The fundamental source of liquidity will continue to be core deposits. Available sources of asset liquidity include short-term investments, loan repayments, and securities held in the available-for-sale portfolio. Additionally, the Company has the ability to pledge securities to secure short-term borrowing. The Bank is a member of the Federal Home Loan Bank which provides additional source of funding if needed. At December 31, 1998, the Bank had available $30.8 million out of a total line of $50.8 million. The Federal Home Loan Bank line is secured by residential mortgages.
The Bank has agreements under which it may obtain funds for short-term liquidity needs by selling securities under agreements to repurchase. Additionally the Bank began selling securities under agreements to repurchase to business customers in 1997 under a cash management sweep account arrangement.
The majority of the Company's assets are held by the Bank. Dividends and cash advances to the Company from the Bank are subject to standard regulatory constraints. Based on an analysis of projected expenses and cash flows, management believes that the Company has sufficient cash to meet its anticipated cash obligations.
Management of Interest Rate Risk
An objective of the Company's asset/liability management policy is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. The Asset/Liability Management Committee is responsible for managing interest rate risks.
The Company uses a variety of methods to manage its interest rate risk and does not rely solely on one method. One such method used to manage interest rate risk involves the measurement of interest rate gap. Interest rate gap is the amount by which a bank's rate sensitive assets differ from its rate sensitive liabilities. A positive gap exists when rate sensitive assets exceed rate sensitive liabilities, indicating that a greater volume of assets than liabilities will reprice during a given period. Theoretically, this mismatch will enhance earnings in a rising rate environment and inhibit earnings when rates decline. Conversely, when rate sensitive liabilities exceed rate sensitive assets, the gap is negative, indicating that a greater volume of liabilities than assets will reprice during the period. Theoretically, in this case, a rising rate environment will inhibit earnings and declining rates will enhance earnings. The Rate Sensitivity Schedule that follows illustrates the measurement of interest rate gap at December 31, 1998.
Notes: (1) Fixed rate home equity loans are included with residential mortgage loans for rate sensitivity and with other consumer loans for financial statement purposes. The home equity category above includes only lines of credit.
(2) Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.
As measured by the cumulative sensitivity gap at December 31, 1998, the maturity and repricing of the Company's interest earning assets and interest bearing liabilities showed a negative gap in the one year period. Interest checking, savings and money market deposits are assigned one day to three months repricing and while these deposits can be repriced in that time period they may react very differently to various interest rate scenarios. Management does not believe this rate sensitivity schedule accurately reflects the true interest rate risk of the Company because changes in interest rates do not affect all categories of assets and liabilities equally as implied by this schedule.
Quantitative and Qualitative Disclosures About Market Risk
On a quarterly basis, sensitivity to changes in interest rates is also measured using a simulation model. The model estimates changes in net interest income and net income under a variety of possible interest rate scenarios. By performing these simulations and comparing them to established policy limits, management has an opportunity to plan for changes in the asset/liability mix, or to take other steps that may be necessary to lessen interest rate risk. Based on management's assumptions built into the simulation model and the current mix of the Company's assets and liabilities, management's assessment is that its negative gap position will not have a material adverse effect on its operating results or liquidity in the event of reasonably foreseeable changes in interest rates during 1999. These simulations are based on numerous assumptions regarding the timing and extent of repricing characteristics. Assumptions include prepayments of mortgage assets, cash flows from other financial instruments and loan and deposit pricing maturities. Actual results may differ significantly.
The following table shows the Company's estimated earnings sensitivity profile as of December 31, 1998.
Changes in Interest Rates Percentage Change in Net Interest Income (basis points) 12 Months 24 Months ____________ _________ __________
+ 200 over one year -0.8 -2.8 +100 over one year 0.0 -0.6 - - 100 over one year -0.3 0.9 - - 200 over one year 0.0 3.0
Impact of Inflation
The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with generally accepted accounting principles, consistently applied. These principles require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. Management believes that it needs to manage the rates, liquidity, and interest sensitivity of the assets and liabilities to help generate an acceptable return.
Year 2000
For quite some time, First National has been aware of the complexity and magnitude of the Year 2000 (Y2K) issue. As a result, First National, with the support and direction of its Board of Directors and Senior Management, has dedicated resources and formally adopted strategies to work towards resolving all potential Year 2000 issues.
On December 9, 1998, the proposed Merger of First National Bank of Rochester into M & T Bank was announced. The Merger is subject to regulatory and shareholder approvals and is expected to be completed by June 1, 1999 at which time all First National systems will be converted into M & T Bank systems. First National, however, is continuing its preparations for the Year 2000 date change in the event the Merger is not completed.
Since October 1996, First National has been developing its strategy to address the data processing and business impacts that are expected to be encountered. First National is also including environmental systems in its analysis. As is the case with many other financial institutions, First National has opted to follow the six phase format suggested by the Federal Financial Institutions Examination Council (FFIEC). The FFIEC is a joint effort of the Comptroller of the Currency, Federal Reserve, Office of Thrift Supervision and the Federal Deposit Insurance Corporation, the primary regulators of financial institutions in the United States. These phases are discussed below.
Awareness Phase - This is an ongoing phase to educate employees, customers and the community to year 2000 issues, FNB's strategies and plans for renovation. First National created a Y2K task force in October 1996 which consists of the Electronic Data Processing Auditor, Senior Vice President of Operations, Vice President of Information Services, Vice President of Risk Management and the Year 2000 Project Coordinator. This task force is charged with developing and implementing an overall strategy to review systems, services and conduct continuing education. In March 1998, First National held a Year 2000 seminar for customers of the Business & Professional Lending division. Each customer attending was given a "Year 2000 Awareness Kit." In the last quarter of 1998, First National updated customers and shareholders on the progress of the Year 2000 efforts in the quarterly publication, "FNB Focus".
Assessment Phase - In this phase, First National has determined the size and complexity of the problem by identifying all hardware, software, networks, ATMs, facilities and other devices that may be affected by the Y2K date change. An initial inventory was taken starting in October 1996. At the same time, preliminary correspondence was sent to vendors advising the vendors of First National's concerns about the Y2K issue and the possible impact of Y2K on the vendors. In July 1997, a second (updated) inventory was performed and a second letter with an attached survey was sent to vendors as part of continuing efforts to assess the Y2K preparedness of vendors. Based on the results of the inventory process, First National has prioritized its list of applications and systems to be addressed in the Y2K project. To date, First National believes that substantially all possible Year 2000 situations have been identified. First National has started a "due diligence process" for assessing the Year 2000 customer impact. The results of that review are being used to monitor risks to the Bank presented by customers who might be adversely affected by Year 2000 issues.
A Year 2000 uncertainty that could have a material effect on the Bank's results of operations or financial condition is the risk associated with commercial borrowers. A risk assessment for commercial borrowers is substantially complete with 94% of the borrowers evaluated and rated as either high, moderate, or low risk. For purposes of Year 2000, the Bank has defined large commercial borrowers as those with relationships at or above $500,000. Relationships below $500,000 are considered low risk. Certain industries, such as residential construction were also evaluated and classified as low risk for Year 2000. Surveys sent to large commercial borrowers will be rated high risk until information is received. Of the respondents, 14 totaling $13.1 million were rated high risk. Management intends to follow the progress of each high and moderate risk customer and to update risk ratings throughout 1999. New and renewed commercial borrowers are also being assigned a risk rating and are being required to sign a Y2K addendum where the borrower agrees to take all measures necessary to assure information technology utilized by the borrower is Y2K compliant.
A large deposit outflow in the year 2000 could impact First National's liquidity. A review of large depositors indicates approximately $40 million in balances that could be at risk due to Y2K. However, First National does not believe that the loss of any one single deposit balance could have a material impact on liquidity. First National has borrowing lines and unencumbered investments that could be used to offset these deposits should they leave the Bank.
Renovation Phase - First National does not write programs or create its own software. Therefore, it must rely on vendors and software suppliers to provide appropriate enhancements in a timely manner. As First National continues to monitor the progress of vendors, it has also begun the process of creating contingency plans for all applications that do not meet First National's deadline for compliance. First National has implemented an aggressive vendor contact schedule and maintains all vendor correspondence to monitor vendor progress.
Validation Phase - This is the most labor intensive and critical phase and requires a written test plan for each system that will be in use at the turn of the century. First National has opted not to rely entirely on vendor testing or third party certification as acceptable validation for systems processed in-house. As vendors provide upgraded software or enhancements, testing will be conducted to determine if the software or enhancements meet First National's requirements for Year 2000 readiness. Test plans have been written for mission critical systems and testing is in process. First National intends to review proxy testing completed for service bureau arrangements and certain purchased software and use those results to the extent proxy testing is appropriate and reliable. Additional independent critical testing will be completed as necessary based on proxy test results. In view of the proposed Merger, validation of several mission critical systems has been rescheduled. In the event that the proposed Merger is not completed by June 1, 1999, the validation of all mission critical systems will be scheduled so that the validation can be completed by June 30, 1999.
As a result of the proposed Merger, First National postponed the conversion of its core processing systems and has extended its contract for use of the Jack Henry Associates Liberty System. Jack Henry Associates advises that the Liberty System is Year 2000 ready with the installation of the latest update release which was installed in December, 1998. In the first quarter of 1999, First National will review the results of proxy testing completed by various Liberty system users and will purchase a copy of the third party review of the proxy testing process by McGladdery and Pullen, a national accounting and consulting firm.
Implementation Phase - By January 1, 2000, First National will have tested each mission critical application. In addition, First National will have contingency plans in place for any application that does not meet Year 2000 compliance. The contingency plans will address key dates such as 12/31/1999, 1/01/2000 and 2/29/2000. Throughout the year 2000, First National will be conducting a quality review to insure that its systems are functioning properly.
Business Resumption Continuity and Planning Phase - The Bank has contracted with a technology consulting firm to develop a business resumption plan that can be implemented in the event the Bank experiences failures to systems or other interruptions to services as a result of Year 2000 issues. Management has successfully completed organizational planning guidelines and business impact analysis concerning the Y2K business resumption contingency plan. The Bank will have finalized the business recovery contingency plan by June 30, 1999 if the pending Merger with M&T Bank is delayed or does not occur.
Management continues to quantify the expenses of resolving Year 2000 problems, including problems relating to its own systems and those relating to third party customers and vendors, or the materiality of the effect of such expenses on its results of operations, capital resources or liquidity. For 1998, the Bank incurred expense of approximately $147,000. In addition, management has identified probable expenses for the years 1999 and 2000 of approximately $395,000 and $67,000, respectively. The $67,000 expense for the year 2000 is primarily for contingency planning. Of the total projected expense of $609,000, testing, remediation and staff expense is projected to be $225,000, or 37%. Software and equipment purchases are expected to be approximately $192,000, or 31.5% of the total and contingency planning is projected at $192,000, or 31.5%. All expenses related to the year 2000 are expected to be paid out of First National's earnings.
First National's objective is to migrate to the year 2000 with minimal impact on its customers and to achieve compliance before the ultimate deadline of January 1, 2000.
Recently Issued Accounting Pronouncements
Effective January 1, 1998, the Company adopted the remaining provisions of SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which relate to the accounting for securities lending, repurchase agreements and other secured financing activities. These provisions, which were delayed for implementation by SFAS No. 127, did not have a material impact on the Company.
The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information in 1998. SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue producing segments of the entity for which such information is available and is utilized by the chief operating decision maker.
Specific information to be reported for individual segments includes profit or loss, certain specific revenue and expense items, and total assets. The Company did not identify any separate operating segments requiring disclosure, therefore SFAS No. 131 did not have an impact on the Company's statement of financial condition or statement of operations.
The Company adopted SFAS No. 132, Employers Disclosure about Pensions and Other Postretirement Benefits in 1998. This statement revises employers' disclosures about pension and other postretirement benefit plans. SFAS No. 132 does not change the expense measurement or recognition of these plans. SFAS No. 132 did not have an impact on the Company's statement of financial condition or statement of operations.
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement requires the Company to recognize all derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for gains and losses results from changes in fair value of the derivative instrument depends on the intended use of the derivative and the type of risk being hedged. The statement is effective for fiscal years beginning after June 15, 1999 although earlier adoption is permitted. Based upon current activities, the adoption of the statement will not have an effect on the Company's financial position or results of operation.
In October 1998, the FASB issued SFAS No. 134, Accounting for Mortgage Backed Securities Retained after the Securitization or Mortgage Loans Held for Sale by a Mortgage Banking Enterprise, which amends SFAS No. 65, Accounting for Certain Mortgage Banking Activities. This statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the accounting for such securities by a non mortgage banking enterprise. This statement is effective for the first quarter beginning January 1, 1999 and this statement will not have any impact on the Company's financial position or results of operation as the Company does not currently securitize mortgage loans.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See the information provided above under the caption "Quantitative and Qualitative Disclosures About Market Risk" in Item 7 of this report.
Item 8.
Item 8. Consolidated Financial Statements and Supplementary Data
Consolidated Financial Statements
Independent Auditors' Report
The Board of Directors and Shareholders FNB Rochester Corp.:
We have audited the consolidated statements of financial condition of FNB Rochester Corp. and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FNB Rochester Corp. and subsidiary at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.
/S/ KPMG LLP
January 25, 1999 Rochester, New York
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements
FNB ROCHESTER CORP. AND SUBSIDIARY Notes to Consolidated Financial Statements December 31, 1998, 1997, and 1996
(1) Summary of Significant Accounting Policies
Business
FNB Rochester Corp. (the Company) provides a full range of banking and trust services to individual and corporate customers. The Company generates interest income by accepting deposits and investing those deposits, together with funds from borrowings and ongoing operations in a variety of loans and investment securities. The most significant source of revenue for the Company is net interest income - the difference between interest income earned on loans and investments and interest expense incurred on deposits and borrowings. The Company, operating primarily in western New York, is headquartered in Rochester, New York, the third largest city in the state. The Company is subject to competition from other financial institutions. The Company is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.
On December 9, 1998 a definitive agreement was entered into for a merger between the Company and M&T Bank Corporation, Buffalo, New York. The merger is subject to both shareholder and regulatory approval and it is expected to take place in the second quarter of 1999.
Basis of Presentation
The Company operates as a bank holding company. In 1998 its only subsidiary was First National Bank of Rochester (First National). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, First National. All material intercompany accounts and transactions have been eliminated. The financial statements have been prepared in conformity with generally accepted accounting principles and conform with predominate practices within the banking industry. In preparing these financial statements, management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
Securities
The Company classifies its debt securities as either available-for-sale or held-to-maturity, as the Company does not hold any securities considered to be trading. Held-to-maturity securities are those that the Company has the ability and intent to hold until maturity.
Available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost. Unrealized holding gains and losses, net of related taxes, on available-for-sale securities are excluded from earnings and are reported as a separate component of accumulated other comprehensive income in shareholders' equity until realized.
A decline in the fair value of any security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new basis for the security.
Premiums and discounts are amortized or accreted over the life of the related held-to-maturity security as an adjustment to yield using the interest method. Dividend and interest income are recognized when earned. Realized gains and losses from securities sold are determined using the specific identification method.
The Company's investments in the Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) are required by law and are carried at cost in the consolidated statement of condition. The Company's disposition of these securities is restricted by agreements with the FHLB and FRB.
Loans
Loans are stated at the principal amount outstanding, net of deferred loan origination fees and costs which are accrued to income based on the interest method. The Company originates some residential mortgage loans with the intent to sell. These loans are carried at the lower of aggregate cost or fair value as determined by outstanding commitments from investors or, in the absence of such commitments, the current investor yield requirements calculated on an aggregate basis.
The accrual of interest on commercial loans is discontinued and previously accrued interest is reversed when the loans become 90 days delinquent or earlier if, in management's judgment, the collection of principal and interest is uncertain. Recognition of interest income on non-accrual loans does not resume until management considers principal and interest collectible. Installment loans are generally charged-off upon becoming 120 days past due. Residential mortgage loans are reduced to the fair value of the underlying collateral, as applicable, upon becoming 180 days past due. Fair value is the amount that would reasonably be anticipated in a current sale in which the buyer and seller are each acting prudently, knowledgeably, and under no necessity to buy or sell.
The Company services residential mortgage loans for the Federal Home Loan Mortgage Corporation (Freddie Mac), and earns servicing fees, which are recognized when payments are received, based upon the outstanding principal balance of the loans. The cost of originating these loans is attributed to the loans and is considered in the calculation of the gain or loss on sale of the loans. Due to their immateriality, the right to service the loans is assigned no financial statement value.
Allowance for Loan Losses
The Company provides for loan losses by a charge to current operations to bring the allowance to an appropriate level considering the character of the loan portfolio, economic conditions, analysis of specific loans, and historical loss experience. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Management considers a loan to be impaired if, based on current information, it is probable that the Company will be unable to collect all scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price of the fair value of collateral if the loan is collateral dependent. Management excludes large groups of smaller balance homogeneous loans such as residential mortgages and consumer loans which are collectively evaluated.
When a loan is impaired and the future repayment of the recorded balance is doubtful, interest payments received are applied to principal and no interest income is recognized. If the recorded loan balance is expected to be paid, interest income is recognized on a cash basis.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is provided on the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is provided over the lesser of the term of the lease or the estimated useful lives of the improvements.
The estimated useful lives of the Company's premises and equipment are as follows:
Buildings and improvements 5 - 40 years Furniture, fixtures, and equipment 3 - 7 years Leasehold improvements 3 - 20 years Vehicles 2 - 5 years
Other Real Estate Owned
Real estate acquired through foreclosure or deed in lieu of foreclosure is carried at the lower of the investment in the loan or fair value less estimated costs to dispose. Fair value is determined on an asset by asset basis, primarily through independent third party appraisals. Adjustments to the carrying values of such properties resulting from subsequent declines in fair value are charged to operations in the period in which the declines occur. These adjustments, the net expense of operating other real estate owned and gains and losses on disposition of other real estate owned are included in net cost of operation of other real estate expense. Other real estate owned is included in other assets on the accompanying consolidated statements of financial condition.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Stock Option Plan
The Company continues to account for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of an option's grant only if the current market price of the underlying stock exceeded the exercise price. In accordance with Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation, the Company has elected to provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied.
Pension Plan
First National sponsors a non-contributory defined benefit pension plan covering substantially all of its employees. Benefits are based upon years of service and the employee's average compensation. Average compensation is determined by the average of the highest five consecutive years of service. The cost of this plan is being funded currently.
First National's policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts, subject to IRS limitations, as the Bank may determine to be appropriate from time to time.
Trust Department Income
Assets held in a fiduciary or agency capacity for customers are not included in the accompanying consolidated statements of financial condition, since such assets are not assets of the Company. Fee income is recognized on the cash method. At December 31, 1998 the market value of the assets under management was $113,842,000.
Comprehensive Income
On January 1, 1998, the Company adopted the provisions of SFAS No. 130, Reporting Comprehensive Income. This Statement establishes standards for reporting and display of comprehensive income and its components. Accumulated other comprehensive income consists of net income and the net unrealized holding gains and losses on securities available-for-sale, net of the related tax effect. Prior year financial statements have been reclassified to conform to the requirements of the Statement.
Per Share Data
Basic earnings per share data is based upon the weighted average number of common shares outstanding during each year. Diluted earnings per share data is based upon the weighted average number of common shares outstanding and effect of stock issued upon conversion of equivalents stock options during each year.
Cash Equivalents
For the purpose of reporting cash flows, cash equivalents include due from banks, unrestricted interest bearing deposits with banks, and federal funds sold.
Financial Instruments With Off-Balance Sheet Risk
The Company does not engage in the use of derivative financial instruments and the Company's only financial instruments with off-balance risk are commercial letters of credit and mortgage and commercial loan commitments. These off-balance sheet items are shown in the Company's consolidated statement of financial condition upon funding.
(2) Securities
The aggregate amortized cost and fair value of securities available-for-sale and securities held-to-maturity at December 31, 1998 and 1997 follows (in thousands):
Securities with an amortized cost of $132,862,000 and $105,341,000 at December 31, 1998 and 1997, respectively were pledged as collateral for municipal deposits and to secure short term borrowings.
Gross unrealized gains and losses on securities available-for-sale and securities held-to-maturity at December 31, 1998 and 1997 follows (in thousands):
The amortized cost of securities by contractual years to maturity as of December 31, 1998 are as follows (in thousands):
The fair value of securities by contractual years to maturity as of December 31, 1998 are as follows (in thousands):
Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations without prepayment penalties.
The following table presents the total proceeds from sales of securities available-for-sale for 1998, 1997 and 1996 and the gross realized gains and losses (in thousands):
1998 1997 1996 ____ ____ ____
Proceeds from sales $ 4,427 $ 762 $ 10,097 _____ ___ ______
Gains 24 - 2 Losses - (8) (47) _ _ __
Net $ 24 $ (8) $ (45) == = ==
(3) Loans
The major classifications of loans at December 31, 1998 and 1997 follow (in thousands):
1998 1997 ____ ____
Commercial $ 231,716 $ 201,722 Residential mortgage 104,508 80,083 Residential mortgage loans held for sale 5,240 3,030 Home equity 31,056 23,516 Other consumer 22,023 22,886 ______ ______
Total 394,543 331,237
Net deferred loan costs 123 283 Allowance for loan losses (5,258) (5,580) _____ _____
Loans, net $ 389,408 $ 325,940 ======= =======
The Company considers its primary service and marketing area to be the city of Rochester and its surrounding towns in New York State. The Company also has two full service banking offices in the Elmira area and offices, in both Syracuse and Buffalo, which provide services primarily to professional and business customers. Substantially all of the Company's outstanding loans are with borrowers living or doing business within these areas. The Company's concentrations of credit risk are disclosed in the above loan classifications. Other than general economic risks, management is not aware of any material concentrations of credit risk to any industry or individual borrower.
Loans serviced for others amounting to $92,931,000 and $102,757,000 at December 31, 1998 and 1997, respectively are not included in the consolidated financial statements. Custodial accounts held by First National for these loans amounted to $2,639,000 and $2,193,000 at December 31, 1998 and 1997, respectively.
The Company has an available line of credit with the FHLB of New York, which at December 31, 1998 amounted to approximately $30,750,000. The amount available under the line varies according to a formula which considers the amount of FHLB stock held by the Company, the Company's FHLB borrowings outstanding and the Company's total assets. At December 31, 1998, the Company pledged residential mortgages with a carrying value of $84,016,000 as collateral for this line of credit.
(4) Allowance for Loan Losses
A summary of the changes in the allowance for loan losses follows (in thousands):
The principal balance of loans not accruing interest totaled $2,831,000 and $2,100,000 at December 31, 1998 and 1997 respectively. The effect of non-accrual loans on interest income for the years ended December 31, 1998, 1997, and 1996 was $82,000, $22,000 and $48,000 respectively. Other real estate owned amounted to $85,000, $38,000 and $45,000 at December 31, 1998, 1997 and 1996 respectively.
At December 31, 1998, 1997, and 1996, the recorded investment in loans that are considered to be impaired totaled $1,884,000, $1,160,000, and $2,337,000, respectively, and the impairment allowance associated with these loans is $656,000 for 1998, $125,000 for 1997 and $38,000 for 1996. The average recorded investments in impaired loans during the twelve months ended December 31, 1998, 1997 and 1996 was approximately $1,058,000, $2,882,000 and $913,000, respectively.
For the twelve months ended December 31, 1998, 1997 and 1996 the Company recognized interest income on impaired loans of $58,000, $234,000 and $77,000, respectively.
(5) Premises and Equipment
A summary of premises and equipment follows (in thousands):
December 31, ____________
1998 1997 ____ ____
Land $ 710 $ 710 Building and improvements 2,144 2,091 Furniture, fixtures, equipment and vehicles 11,991 9,472 Leasehold 7,336 5,444 _____ _____
22,181 17,717
Less accumulated depreciation and amortization 10,508 8,904 ______ _____
Premises and equipment, net $ 11,673 $ 8,813 ====== =====
(6) Certificates of Deposit
Certificates of deposit of $100,000 or more amounted to $87,646,000 at December 31, 1998 and $92,477,000 at December 31, 1997. Interest expense on certificates of deposit of $100,000 or more was $4,877,000 in 1998, $4,269,000 in 1997 and $3,225,000 in 1996.
At December 31, 1998, the scheduled maturities of all certificates of deposits are as follows (in thousands):
Year Amount ____ ______
1999 $ 200,991 2000 18,123 2001 5,175 2002 2,005 2003 and thereafter 3,730 _____
Total $ 230,024 =======
(7) Borrowings
The Company had short term borrowings of $23,840,000 and $14,236,000 at December 31, 1998 and 1997 respectively. The December 31, 1998 balance included $23,566,000 of securities sold under agreement to repurchase, with a maturity date of January 4, 1999 and an average rate of 4.33%. The December 31, 1997 balance included $13,436,000 of securities sold under agreement to repurchase, with a maturity date of January 2, 1998 and an average rate of 4.92%. The maximum amount outstanding at any one month-end and average amount for securities sold under agreements to repurchase were $23,566,000 and $22,333,000 respectively for 1998 and $13,436,000 and $5,173,000 respectively for 1997. Interest expense averaged 4.90% for 1998, 5.08% for 1997 and 5.82% for 1996.
Long-term borrowings consist of two Federal Home Loan Bank advances of $10 million each and a $210,000 note to an individual to purchase land for the Bank's Greece Office. The $10 million advances mature on August 28, 2001 and October 2, 2002 and are at interest rates of 5.57% and 4.91% respectively. The $210,000 note matures on February 1, 2001 and has an interest rate of 9.50%.
(8) Income Taxes
Total income taxes for the years ended December 31, 1998, 1997 and 1996 were allocated as follows (in thousands):
For the years ended December 31, 1998, 1997 and 1996, income tax expense (benefit) attributable to income from operations consists of (in thousands):
1998 1997 1996
Current: Federal $ 2,148 $ 2,113 $ 1,648 State 203 561 140 ___ ___ ___
2,351 2,674 1,788 _____ _____ _____
Deferred: Federal (530) (466) (335) State (93) (82) 257 __ __ ___
(623) (548) (78) ___ ___ __
$ 1,728 $ 2,126 $ 1,710 ===== ===== ======
The reconciliation of the statutory federal income tax rate with the actual effective tax rate follows:
1998 1997 1996 ____ ____ ____
Statutory rate 34.0% 34.0% 34.0% Increases (decreases) attributable to: Change in the beginning of the year valuation allowance for deferred tax assets allocated to income tax expense (10.7)% (7.0)%% (11.0) State taxes, net of federal benefit 1.1% 4.7% 5.0 Other items, net 1.1% 0.3% 1.0 ___ ___ ___
25.5% 32.0% 29.0% ==== ==== ====
The significant components of deferred tax expense (benefit) attributable to income from continuing operations at December 31, 1998, 1997 and 1996 are as follows:
1998 1997 1996 ____ ____ ____
Deferred tax expense (benefit) $ 99 $ (79) $ 582 Decrease in valuation allowance for deferred tax assets (722) (469) (660) ___ ___ ___
Net deferred tax benefit $ (623) $ (548) $ (78) === === ==
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998, and 1997 are presented below (in thousands):
The net change in the total valuation allowance for the years ended December 31, 1998, 1997 and 1996 were decreases of $722,000, $469,000 and $660,000 respectively.
Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income within the carry back period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of the deferred tax liabilities, the level of historical taxable income, and projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets will be deductible. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences.
(9) Shareholders' Equity
Payment of dividends by First National to the Company is limited or restricted in certain circumstances. According to federal banking law, the approval of the Office of the Comptroller of the Currency (OCC) is required for the declaration of dividends by a bank in any year in which the dividend declared will exceed the total of net income for that year plus any retained income for the preceding two years. Dividends approximating $10,750,000 are available from First National at December 31, 1998 without the approval of the OCC.
(10) Stock Option Plans
The Company has two stock option plans. A plan adopted in 1992 (amended May 19, 1998) for employees, authorizes grants of options to purchase up to 525,000 shares of its authorized but unissued common stock. The second plan is the 1995 Non-employee Director Stock Option Plan which was approved by shareholders on May 28, 1996 and authorizes grants of options to purchase up to 25,000 shares of its authorized but unissued common stock. Stock options are granted with an exercise price equal to the stock's fair market value at the date of the grant. All stock options are exercisable over terms not exceeding ten years and at prices equal to the fair market value of the common stock on the date of grant.
The Company applies APB Opinion No. 25 in accounting for its Plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements.
The fair value of each option grant is estimated on the date of grant using an option-pricing model with the following weighted-average assumptions used for grants in 1998: dividend yield of 1.48 percent, risk-free interest rate of 5.65 percent, expected volatility of 35.4 percent, and expected lives of 6.5 years. For grants in 1997: dividend yield of .87 percent, risk-free interest rate of 6.06 percent, expected volatility of 35.6 percent, and expected lives of 10 years. For grants in 1996: dividend yield of .14 percent, risk-free interest rate of 6.1 percent, expected volatility of 40 percent, and expected lives of 8.8 years.
Had the Company determined compensation cost based on the fair value at the grant date for its options under SFAS No. 123, the Company's net income and basic earnings per share would have been reduced to the pro forma amounts indicated below:
Year ended December 31 (net income in thousands)
1998 1997 1996 ____ ____ ____
Net income As reported $ 5,036 $ 4,519 $ 4,133 Pro forma 4,775 4,385 4,003 Basic earnings Per share As reported 1.39 1.26 1.16
Pro forma $ 1.32 $ 1.22 $ 1.12
Pro forma net income and earnings per share reflect only options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1996 is not considered.
A summary of the status of the Company's two fixed stock option plans as of December 31, 1998, 1997 and 1996 and changes during the years ended on those dates is presented below:
The following table summarizes information about fixed stock options outstanding at December 31, 1998:
(11) Leases
The Company leases certain buildings and office space under operating lease arrangements. Rent expense under these arrangements amounted to $1,247,000 in 1998, $1,123,000 in 1997 and $1,110,000 in 1996. Real estate taxes, insurance, maintenance, and other operating expenses associated with the buildings and office space are generally paid by the Company. A summary of non-cancelable long-term operating lease commitments as of December 31, 1998 follows (in thousands):
Year Ending December 31, ________________________
Year Amount ____ ______
1999 $ 1,224 2000 1,249 2001 1,283 2002 1,288 2003 1,239 After 2003 10,130 ______
Total $ 16,413 ======
Several new leases have been signed for additional banking offices and office space. Two 20-year ground leases were signed for new banking offices in the Village of Brockport and the Town of Victor. A 5-year lease has been signed for space in a supermarket located in the City of Rochester and the Bank's Powers Building lease has been amended to include 7,652 square feet of additional space to be used for operations. The new lease amounts are included in the table above.
(12) Commitments and Contingencies
In the normal course of business there are various outstanding commitments to extend credit which are not reflected in the accompanying consolidated financial statements. Because many commitments and almost all letters of credit expire without being funded in whole or in part, the contract amounts are not estimates of actual future cash flows. Loan commitments have off-balance sheet credit risk, because only origination fees are recognized in the balance sheet, until the commitments are fulfilled or expire. The credit risk amounts are equal to the contractual amounts, assuming that the amounts are fully advanced and collateral or other security is of no value. The Company's policy generally requires customers to provide collateral, usually in the form of customers' operating assets or property, prior to the disbursement of approved loans. The contract amounts of these commitments at December 31, 1998 and 1997 are set forth in the table below (in thousands):
1998 1997 ____ ____
Fixed Rate Variable Rate Fixed Rate Variable Rate __________ _____________ __________ _____________
Commercial letters of credit - 4,817 - 2,749 Commercial lines of credit 1,122 55,604 2,362 59,040 Other loan commitments 14,120 26,449 17,184 18,917
For substantially all commercial lines of credit, First National evaluates each customer's creditworthiness annually. Since many of the line of credit commitments are never drawn upon, the total commitment amounts do not necessarily represent future cash flows. Other loan commitments include lines of credit for home equity loans, overdraft protection, and credit cards as well as commitments to extend new loans.
In 1997 the Company committed $1 million to fund a 10% limited partnership investment interest in Cephas Capital Partnership, L.P. This small business investment company was established for the purpose of providing financing to small businesses in conjunction with programs established by the U.S. Small Business Administration. At December 31, 1998, the Company had funded $703,000 of this commitment and carries the investment under the equity method in other assets.
First National is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of such reserve balances for the year ended December 31, 1998 and 1997 was approximately $138,000 and $365,000. Interest bearing deposits with other banks are substantially restricted by balance agreements.
Because the Bank's business involves the deposit, collection, and transfer of checks and similar negotiable instruments and the collection of loans and enforcement of security interests, mortgages, and other liens, the Bank is plaintiff or defendant in various legal proceedings which may be considered as arising in the ordinary course of business. In the opinion of management, after consultation with counsel handling all such litigation, there are no legal proceedings now pending by or against the Bank or the Company, the outcome of which are expected to have a material effect on their businesses, business properties, or financial condition.
(13) Employee Benefit Plans
The Company has a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee's highest average compensation during five consecutive years of employment. The Company's funding policy is to contribute annually an actuarially determined amount to cover current service cost plus amortization of prior service costs.
The following table sets forth (in thousands) the defined benefit pension plan's change in benefit obligation and change in plan assets for the years ended December 1998, 1997 and 1996 using the most recent actuarial data measured at September 30, 1998, 1997 and 1996 as follows:
The projected benefit obligation assumed a long-term rate of increase in future compensation levels was 4.00% for 1998, 5.00% for 1997 and 1996.
First National sponsors a 401(k) plan covering substantially all employees. First National matched eligible employee contributions to the 401(k) plan up to a maximum 1.5 percent of eligible compensation. Expense for the 401(k) amounted to $84,000 in 1998, $77,000 in 1997, and $66,000 in 1996.
(14) Loans to Directors, Officers and Shareholders owning more than 5% of Voting Stock
A summary of the changes in outstanding loans to members of the Board of Directors, officers of the Company and shareholders owning more than 5% of voting stock, or their interests, follows (in thousands):
Years ended December 31, ________________________
1998 1997 ____ ____
Balance of loans outstanding at beginning of year $ 5,941 $ 4,827 New loans and increases in existing loans 2,169 1,496 Loan principal repayments (1,120) (382) _____ ___
Balance at end of year $ 6,990 $ 5,941
Loans to directors, officers and shareholders owning more than 5% of voting stock are believed to have been made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated parties.
(15) Earnings Per Share
Calculation of Basic Earnings Per Share (Basic EPS) and Diluted Earnings Per Share (Diluted EPS) is as follows (income in thousands):
(16) Condensed Financial Information - Parent Company Only
The following presents the financial condition of the Parent Company (FNB Rochester Corp.) as of December 31, 1998 and 1997 and the results of its operations and its cash flows for the years ended December 31, 1998, 1997, and 1996:
Condensed Statements of Financial Condition (in thousands)
Assets 1998 1997 ____ ____
Cash and cash equivalents $ 2,293 $ 996 Investment (at equity) in subsidiary 35,915 33,411 Other assets 306 3
Total assets $ 38,514 $ 34,410 Liabilities and shareholders' equity Accrued interest payable and other liabilities $ 362 $ 390
Total liabilities 362 390 ___ ___
Shareholders' equity 38,152 34,020 ______ ______
Total liabilities and shareholders' equity $ 38,514 $ 34,410 ====== ======
Statement of Income (in thousands)
Years ended December 31, ________________________
1998 1997 1996 ____ ____ ____ Income: Dividends from subsidiary $ 2,352 $ 600 $ 200 Interest and other 67 27 19 __ __ __
Total income 2,419 627 219 _____ ___ ___
Expense: Other 191 118 109 ___ ___ ___
Total expense 191 118 109 ___ ___ ___
Income before taxes and equity in undistributed income of subsidiary 2,228 509 110
Income tax benefit (36) (29) (26) __ __ __
Income before undistributed income of subsidiary 2,264 538 136
Equity in undistributed income of subsidiary 2,772 3,981 3,997 _____ _____ _____
Net income $ 5,036 $ 4,519 $ 4,133 ===== ===== =====
(17) Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
First National is subject to capital adequacy requirements of the Federal Deposit Insurance Corporation. The FDICIA established capital levels for which insured institutions are categorized as (in declining order) well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized. Under the FDICIA, a well capitalized institution must generally have a risk-based capital ratio of at least 10 percent, a Tier 1 risk- based ratio of at least 6 percent and a Tier 1 leverage ratio of at least 5 percent. As of December 31, 1998, First National is a well capitalized institution under the definitions.
First National is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements could cause regulators to initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on First National's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First National must meet specific capital guidelines that involve quantitative measures of First National's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. First National's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require First National to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined). Management believes, as of December 31, 1998, that First National meets all capital adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized First National as (well capitalized) under the regulatory framework for prompt corrective action. To be categorized as (well capitalized) First National must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios set forth in the table. There are no conditions or events since that notification that management believes have changed First National's category.
First National's actual capital amounts and ratios are presented in the following table (in thousands). There was no deduction from capital for interest-rate risk.
The Company's capital amounts and ratios as of December 31, 1998 and 1997 were not materially different from those of First National.
(18) Fair Value of Financial Instruments
The following fair value estimates, methods, and assumptions of each class of the Company's financial instruments were used to estimate the fair value.
Interest Bearing Deposits with Banks and Federal Funds Sold
For these short-term instruments that generally mature in less than 90 days or reprice on a daily basis, the carrying value approximates fair value.
Securities
Fair values for securities are based on quoted market prices or dealer quotes, where available. Variable rate securities that reprice frequently and have no significant credit risk have fair values based on carrying values.
Loans
The fair values of loans are generally estimated using discounted cash flow analyses applying interest rates currently being offered for loans with similar terms and credit quality and employing prepayment assumptions based on available industry information sources.
Delinquent and non-accrual loans are valued using the discounted cash flow methods described above. Credit risk is a component of the discount rate used to value the loans. Delinquent and non-accrual loans are presumed to possess additional risk. Therefore, the discount rates used to value these non-performing loans reflect this additional risk.
Deposits
The fair values disclosed for demand deposits, savings accounts, and money market accounts are equal to their carrying values since these are liabilities that are payable on demand. The fair value of fixed rate certificates of deposit is calculated using a discounted cash flow analysis applying rates currently being offered on certificates to a schedule of weighted average expected monthly maturities on time deposits.
Short-Term Borrowings and Long-Term Debt
Variable rate instruments reprice daily and therefore the carrying value approximates fair value. Fixed rate obligations are valued using a discounted cash flow approach employing a discount rate currently offered for similar instruments.
Off-Balance Sheet
The fair value of commitments to extend credit approximates the fees charged to make these commitments since rates and fees of the contracts approximate those currently charged to originate similar commitments. These commitments are included under loans and loan commitments.
(1) Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
(19) Dispositions
On November 30, 1998, First National announced an agreement for the sale of its Southport Office. At December 31, 1998 the Office had deposits of approximately $14 million. The closing is expected to take place before the end of the first quarter of 1999.
On November 18, 1996, First National sold its Odessa Office. The Office had deposits of $9,633,000 and loans of $1,133,000, and a gain of $621,000 was recognized as a result of the sale.
Supplementary Data
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
Not Applicable.
PART III ________
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Directors
The following persons are currently directors of the Company. Directors are elected annually at the Annual Meeting of Shareholders of the Company.
Director's Name (age) Director Since Principal Occupation _____________________ ______________ ____________________
R. Carlos Carballada (64) 1992 President, Chief Executive Officer, FNB Rochester Corp.
Michael J. Falcone (63) 1978 Chairman, Pioneer Group and Pioneer Development
Joseph M. Lobozzo II (55) 1993 President & CEO, JML Optical Industries, Inc.
Francis T. Lombardi (67) 1978 Vice President, Syracuse Tank & Mfg. Co. Inc.
Carl R. Reynolds (51) 1977 Attorney
H. Bruce Russell (61) 1993 President, Rochester Downtown Development Corp.
James D. Ryan (66) 1992 President and Owner, RYCO Management, Inc.
Linda Cornell Weinstein (54) 1993 Executive Director, Cornell/Weinstein Family Foundation
Other than Mr. Russell, each director of the Company has been engaged in his or her principal occupation or employment as specified above for five years or more.
Each director of the Company is also a director of First National Bank of Rochester (the "Bank").
Mr. Carballada has been employed in the banking business since 1968. He was President and Chief Executive Officer of Citizens Central Bank in Arcade, New York from July 1976 until August 1981, and was President and Chief Executive Officer of Central Trust Company in Rochester, New York, from September, 1981 until May, 1992. Mr. Carballada became the President and Chief Executive Officer of the Company in June of 1992. Mr. Carballada also serves as President and Chief Executive Officer of the Bank.
Mr. Falcone is the Chairman of the Pioneer Group and Pioneer Development Company, a real estate development and management companies headquartered in Syracuse, New York. He has held that position since 1987. Since 1992, Mr. Falcone has served as Chairman of the Board of Directors of the Company and the Bank.
Mr. Lobozzo has been the President, Chief Executive Officer, and principal shareholder of JML Optical Industries, Inc., located in Rochester, New York, since 1972. JML Optical Industries, Inc. manufactures, designs, and imports precision optical systems.
Mr. Lombardi is Vice President of Syracuse Tank & Manufacturing Company, Incorporated, a manufacturer of metal products in Syracuse, New York, and has been associated with the manufacturing company since 1957.
Mr. Reynolds has been an attorney engaged in the general practice of law in Rochester, New York since 1975. Mr. Reynolds is also President and a director of New Sky Communications, Inc., a motion picture production company and Vice President of the Logan Consulting Group, Inc., a Rochester, New York financial and business consulting firm. Since 1992, Mr. Reynolds has served as Vice Chairman of the Board Directors of the Company and the Bank.
Mr. Russell is President of Rochester Downtown Development Corp., in which he has held various leadership positions over a period of seven years. In 1997, he retired from the Eastman Kodak Company. He joined the Finance and Administration Division of the Eastman Kodak Company in Rochester in 1963, and thereafter he held a variety of positions at Kodak, each with increasing responsibility. In 1986, he became a divisional Vice President and Director, Corporate Real Estate Office, a position he held until his retirement.
Mr. Ryan is a Rochester area real estate developer, and since 1969 has been the principal shareholder and president of RYCO Management, Inc., a real property development and management company.
Ms. Weinstein has served as Executive Director of the Cornell/Weinstein Family Foundation, a private non-profit foundation located in Rochester, New York, since 1986.
No family relationships exist among the above-named Directors or Officers of the Company. None of the Directors of the Company holds a directorship in any other publicly traded company, except for Carl R. Reynolds, who is a director of New Sky Communications, Inc., a company registered under Section 15(d) of the Securities and Exchange Act of 1934, as amended.
Executive Officers
The following current officers of the Company or the Bank ("Executive Officers") are deemed to be "executive officers" for purposes of the federal securities laws.
R. Carlos Carballada (64), President and Chief Executive Officer of the Company and the Bank, commencing June 8, 1992. See the information provided under "Directors," above, for a description of employment history and business experience of Mr. Carballada.
Donald R. Aldred (56), Senior Vice President, Business and Professional Banking Division of the Bank, commencing June 23, 1992. From 1987 to 1992, he was Senior Vice President and Manager of the Commercial Banking Division at Central Trust Company. Prior to his time with Central Trust Company, he spent 21 years with Manufacturers and Traders Trust Company progressing through numerous lending/credit functions to the position of Vice President and Manager of Commercial Finance.
Robert B. Bantle (47), Senior Vice President, Community Banking Division of the Bank, commencing July 1, 1992. He was Senior Vice President, Human Resources, at Central Trust Company from 1989 until 1992. Prior to joining Central Trust Company, he spent 15 years with Security Trust/Fleet Bank in various areas, including Human Resources, Branch Administration, and Strategic Planning.
Stacy C. Campbell (62), Senior Vice President and Chief Financial Officer of the Company and the Bank, commencing July 1, 1992. From 1976 to 1992, Mr. Campbell was Senior Vice President and Chief Financial Officer at Central Trust Company. Prior to joining Central Trust Company, he was employed by Marine Midland Bank N.A. in Commercial Lending, Treasury, and Financial positions.
Robert E. Gilbert (51), Senior Vice President, Operations Division of the Bank, commencing June 29, 1992. From 1990 to 1992, he was a Managing Agent at the Resolution Trust Corporation. From 1975 to 1989, he worked in various capacities with Irving Bank Corporation including Executive Vice President and General Manager of Irving Services Corporation, Senior Vice President of Operations at Central Trust Company, and Vice President of Operations at Citizens Central Bank of Arcade, New York.
Theresa B. Mazzullo (46), Senior Vice President, Trust & Investment Division of the Bank, commencing March 10, 1993. She was Vice President and Manager of the Personal Trust and Investment Division of The Chase Manhattan Bank, N.A. in Rochester from March 1992 until March 1993. From 1978 until 1992 she progressed through various trust positions at Central Trust Company to the level of Vice President and Manager of Trust Marketing Sales.
Section 16(a) Beneficial Ownership Reporting Compliance
Under Section 16 of the Securities and Exchange Act of 1934, as amended, Directors, Executive Officers, and certain other persons are required to report their ownership of equity securities of the Company, and any changes in that ownership, to the Securities and Exchange Commission and the Company. Based solely upon a review of reports furnished to the Company by such persons on Forms 3, 4, or 5 for the year ended December 31, 1998 (the "Section 16(a) Reports"), the only omission from or late filing of Section 16(a) Reports known to the Company was one omitted filing of Form 4 by Mr. Russell with respect to two transactions in the Company's stock. The transactions were subsequently reported on Form 5 for 1998.
Item 11.
Item 11. Executive Compensation
Shown below is information concerning annual and long-term compensation to certain Executive Officers for services to the Company for the years ended December 31, 1998, 1997, and 1996. The table includes information on the Company's Chief Executive Officer, Mr. Carballada, and its Chief Financial Officer, Mr. Campbell, and also on Mr. Aldred, Mr. Bantle, and Mr. Gilbert, three of the Bank's Senior Vice Presidents (the "Named Officers").
(1) For 1998, the amount includes $2,519, $875, $1,575, $1,675 and $1,500 for Company contributions to the Company's 401(k) plan on behalf of Messrs. Carballada, Aldred, Bantle, Campbell, and Gilbert, respectively, and $861, $474, $429, $429, and $429 in group term life insurance premiums for Messrs. Carballada, Aldred, Bantle, Campbell, and Gilbert, respectively.
Option Grants and Exercises
Option Grants
The following table details the number and terms of options granted during the last fiscal year to Named Officers. The Company's employee benefit plans do not provide for the grant of stock appreciation rights (SARs).
(1) Grants with expiration dates of 1/30/08 were granted January 30, 1998 at fair market value with one-half exercisable per year commencing January 30, 1999. Assuming 5% and 10% compounded annual appreciation of the stock price over the term of the option, the price per share of common stock would be $30.13 and $47.98 respectively, on January 30, 2008. Grants with expiration dates of 5/19/08 granted May 19, 1998 at fair market value with 25% becoming exercisable when the average trading price of the stock over a 30-day period reaches $25.50, an additional 30% becoming exercisable when the average trading price of the stock over a 30-day period reaches $27.50 and the final 45% becoming exercisable when the average trading price of the stock reaches $33.50. All shares are exercisable no later than May 19, 2007 or upon a change of control of FNB Rochester Corp. Assuming 5% and 10% compounded annual appreciation of the stock price over the term of the option, the price per share of common stock would be $35.02 and $55.77 respectively, on January 30, 2008.
Option Exercises
The following table summarizes aggregate exercises of options by Named Officers, and the number of and the spread on unexercised options that they held at fiscal year end:
(1) Based on the difference between the option exercise prices and $33.00, the closing price of the Company's common stock on 12/31/98 as quoted on the Nasdaq Stock Market.
Retirement Plan
The following table shows the estimated retirement benefits payable under the Bank's plan with the New York State Bankers Retirement System (the "Plan") to Named Officers based upon hypothetical compensation and years of service levels:
Pension Plan Table
Annual Benefits Per Number of Years of Service (1)
Average Compensation
5 8 10 12
$100,000 $7,500 $12,000 $15,000 $18,000 $125,000 $9,375 $15,000 $18,750 $22,500 $150,000 $11,250 $18,000 $22,500 $27,000 $175,000 $13,125 $21,000 $26,250 $31,500
(1) Annual benefits equal 1.5% of Average Compensation at time of retirement multiplied by years of creditable service commencing on or after April 1, 1993. For the purposes of determining benefits under the Plan, Average Annual Compensation is the average annual compensation during the highest five consecutive years in all of the years of creditable service including salary, bonus, and other taxable compensation. Effective October 1, 1994, the maximum amount of annual compensation that is taken into account in determining benefits is $150,000. Because Mr. Carballada presently has 1.5 years of credited service at higher compensation levels, he may be entitled to benefits at retirement based on more than $150,000 of Average Compensation. The annual benefits are not subject to deduction for social security or other offsets. As of March 31, 1999, all of the Named Officers have six years of creditable service. Mr. Carballada reached his normal retirement age as defined in the Plan on April 1, 1997, when he had five years of vesting service and had reached age 62.
Employment Agreement
On June 8, 1992, the Company entered into a three-year employment agreement with Mr. Carballada, which was extended by the mutual consent of the parties on February 22, 1994 and June 27, 1996. The agreement, which contained certain automatic extension provisions, expires on June 30, 2000. This agreement provides for an initial annual base salary of $185,000 plus benefits, with the base amount subject to increases by the Board of Directors based on performance, inflation and other factors. The agreement is terminable by the Company at the direction of the Board of Directors. Under such circumstances, Mr. Carballada would be entitled to salary, benefits, and other compensation for the greater of one year or the remainder of the term unless his employment has been terminated for "cause" as defined in the agreement. If Mr. Carballada resigns for "good reason" as defined in the agreement, he is entitled to salary, benefits, and other compensation for the lesser of one year or the remainder of the term. Payments after termination will cease if Mr. Carballada accepts employment with any other financial institution directly in competition with the Company in one or more contiguous counties. Certain change of control provisions contained in the agreement have been superseded by a Change of Control Employment Agreement entered into between Mr. Carballada and the Company (see "Change of Control Employment Agreements," below).
Change of Control Employment Agreements
On February 1, 1996, the Company entered into Change of Control Employment Agreements (the "Agreements") with Mr. Carballada and with certain other senior officers of the Company, including each of the Executive Officers. The Agreements provide that in the event a "Change of Control" of the Company occurs, the Agreements will become effective and govern the terms and conditions under which the covered officer will continue to be employed by the Company. The Agreements provide that each such officer will then be employed by the Company for a period of 18 months (24 months in the case of Mr. Carballada) in the same position, with the same compensation and benefits, that applied immediately prior to the Change of Control.
Under the Agreements, a Change of Control is generally defined as: (i) the acquisition by any person of beneficial ownership of 35% or more of the combined voting power of the Company's voting securities, (ii) individuals who are on the Board of Directors, or who are nominated by the Board of Directors, ceasing to constitute a majority of the Board, (iii) approval by the shareholders of the Company of a reorganization, merger or consolidation unless following the transaction more than 65% of the common stock and combined voting power of voting stock of the surviving corporation is owned in substantially the same proportions by persons who were stockholders of the Company immediately prior to the transaction, or (iv) approval by the Company's stockholders of any sale, lease, exchange or other transfer of all or substantially all of the assets of the Company other than to a controlled entity.
Generally, the Agreements provide that, if the covered officer is actually or constructively terminated from his or her position during the employment period, he or she will be entitled to receive a severance payment equal to his or her annual compensation (1.67 times annual compensation in the case of Mr. Carballada). In addition, if the officer is still employed by the Company 12 months after the date of the Change of Control, the officer may during a 30 day "Window Period" voluntarily terminate his or her employment and receive a severance payment equal to one-half of annual compensation (full annual compensation in the case of Mr. Carballada).
The Agreements are not intended to deter combinations, but to reduce the uncertainty and stress attendant upon a potential change of control and thereby help to retain the Company's key officers and help to assure the full and impartial consideration of any acquisition proposal by the Company's officers. The Window Period provision is intended to help hold together an effective management team for a one year period during which an acquisition may be pending but before it has been completed.
Director Compensation
For 1998, Directors received compensation of $500 for attendance at each Board of Directors' meeting and $300 for attendance at each Board committee meeting. No executive officer of the Company who also serves as a director receives fees for Board or committee meetings attended. The Company's 1995 Non-Employee Director Plan provides for a one-time grant of options to purchase 2,500 shares of the Company's common stock to (a) each person who was serving as a non-employee director on October 3, 1995, and (b) each person who first becomes a non-employee director after that date. Generally, such options vest over a two-year period, are exercisable at fair market value on the date of grant, and have a term of ten years.
Compensation Committee Interlocks and Insider Participation
Mr. Lobozzo, Mr. Falcone, Mr. Russell and Mr. Ryan are members of the Nominating and Compensation Committee of the Board of Directors. During 1998, each of the Nominating and Compensation Committee members, or members of their immediate families, borrowed or had outstanding, either directly or indirectly, loans in excess of $60,000 from the Bank. In each instance the loans (a) were made in the ordinary course of business, (b) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and (c) did not involve more than the normal risk of collectibility or present other unfavorable features.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Security Ownership of Certain Beneficial Owners
The following table shows the name, address, and beneficial ownership of the Company's common stock as of March 10, 1999 of each person known to the Company to be a beneficial owner, directly or indirectly, of more than 5% of any class of its outstanding securities entitled to vote:
Name and Address of Common Shares Beneficial Owner (1) (2) Beneficially Owned Percent of Class ________________________ __________________ ________________
William Levine 313,057(3) 8.6% c/o Alleson of Rochester 2921 Brighton-Henrietta Town Line Road Rochester, New York 14623
The Banc Funds 326,300(4) 8.9% 208 South LaSalle Street, Suite 200 Chicago, Illinois 60604
John Hancock Advisers, Inc. 252,587(5) 6.9% 101 Huntington Avenue Boston, Massachusetts 02199
(1) Information presented in this table has been obtained from the respective shareholder or from filings made with the Securities and Exchange Commission. Except as otherwise indicated, each holder has sole voting and investment power with respect to the shares indicated.
(2) On December 9, 1998, the Company entered into a merger agreement with M&T Bank Corporation ("M&T") and granted an option to M&T to purchase up to 721,535 shares of the Company's common stock upon the occurrence of certain events, none of which has occurred. The Company's Form 8-K filed on December 17, 1998, which describes the M&T option, is incorporated herein by reference.
(3) Includes 340 shares held by Mr. Levine's wife, 45,000 shares held by the William and Mildred Levine Foundation and 98,343 shares held by Mr. Levine as Trustee for the benefit of certain members of his family.
(4) The Banc Funds share ownership is as follows: 35,302 shares are held by Banc Fund III L.P., an Illinois Limited Partnership; 108,198 shares are held by Banc Fund III Trust, 39,030 shares are held by Banc Fund IV L.P., an Illinois Limited Partnership, 131,270 shares are held by Banc Fund IV Trust and 12,500 shares are held by Banc Fund V L.P., an Illinois Limited Partnership Each of the foregoing entities has sole voting and investment powers with respect to the shares indicated.
(5) John Hancock Advisers, Inc. has sole voting and investment powers with respect to the shares under Advisory Agreements with the following funds: John Hancock Regional Bank Fund (197,837 shares); John Hancock Financial Industries Fund (34,250 shares); and Southeastern Thrift and Bank Fund, Inc. (20,500 shares).
Security Ownership of Directors and Officers
The following table shows the name, address, and beneficial ownership of the Company's common stock as of March 10, 1999 of each Director of the Company, of each executive officer who is named in the Summary Compensation Table ("Named Officer") and of all directors and executive officers of the Company as a group, respectively:
Name and Address* Shares owned Percent of Class ________________ ____________ ________________
R. Carlos Carballada 112,889 (1) 3.0% Michael J. Falcone 131,549 (2) 3.6% Joseph M. Lobozzo II 17,500 (3) ** Francis T. Lombardi 8,224 (2) ** Carl R. Reynolds 18,170 (2,4) ** H. Bruce Russell 7,500 (2) ** James D. Ryan 7,998 (2,5) ** Linda Cornell Weinstein 31,852 (6) ** Donald R. Aldred 31,107 (7) ** Robert B. Bantle 31,289 (7) ** Stacy C. Campbell 30,551 (7) ** Robert E. Gilbert 30,920 (7) ** All directors and executive officers as a group (13 persons) 484,580 (8) 12.4%
* The address of each Director and Named Officer is c/o FNB Rochester Corp., 35 State Street, Rochester, New York 14614.
** Less than 1%.
(1) Includes options to purchase 106,050 common shares that are exercisable within 60 days. (2) Includes options to purchase 2,500 common shares that are exercisable within 60 days. (3) Includes 14,500 shares held by Mr. Lobozzo's spouse, with Mr. Lobozzo sharing investment power. (4) Held jointly with Mr. Reynolds' spouse. (5) Includes 3,499 shares held by Mr. Ryan's spouse. (6)Includes 14,852 shares held by the Cornell/Weinstein Family Foundation, as to which shares Ms. Weinstein has shared voting and investment power, and 5,000 shares held by Ms. Weinstein's spouse. (7) Includes options to purchase 28,825 common shares that are exercisable within 60 days. (8) Except as otherwise indicated above, members of the group have sole voting and investment power with respect to such shares. Includes options exercisable within 60 days to purchase 257,675 shares.
Item 13.
Item 13. Certain Relationships and Related Transactions
The Bank leases the Henrietta Community Banking Office (South Town Plaza), at an annual rental of $100,667, from a partnership that includes a member of the immediate family of William A. Levine, who beneficially owns more than 5% of the Company's outstanding common stock. This lease terminates on January 31, 2016. The lease is believed to be on comparable terms to agreements for similar space similarly situated, and the space is adequate for the Company's needs.
The Bank has from time to time made and has outstanding loans to executive officers, directors and shareholders owning in excess of 5% of the outstanding shares of the Company, and entities related to such persons, which loans (a) were made in the ordinary course of business, (b) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and (c) did not involve more than the normal risk of collectibility or present other unfavorable features. It is anticipated that the Bank will continue to make such loans from time to time in the future.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1.0) Consolidated Financial Statements, as indicated below, are filed as a part of this report at Item 8:
- Independent Auditors' Report.......................................Page 34
- Consolidated Statements of Financial Condition as of December 31, 1998 and 1997.........................................Page 35
- Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996..................................Page 36
- Consolidated Statements of Shareholders' Equity and Comprehensive Income for the Years Ended December 31, 1998, 1997, and 1996..............Page 38
- Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997, and 1996 .................................Page 39
- Notes to Consolidated Financial Statements.........................Page 41
(2.0) Schedules
Schedules are omitted because of the absence of conditions under which they are required or because the required information is provided in the consolidated financial statements or notes thereto.
(3.0) Exhibits
Exhibit incorporation by by Reference or page in sequential numbering where exhibit may be found:
(2.1) Agreement and Plan of Reorganization, Exhibit 2.1 to Form 8-K filed dated as of December 9, 1998, among FNB December 17, 1998 Rochester Corp., M&T Bank Corporation and Olympia Financial Corp.
(3.1) Certificate of Incorporation, of the Exhibits 4.2-4.5 to Registration Registrant, as amended Statement No.33-7244, filed July 22, 1986
(3.2) Amendment to Certificate of Exhibit 3 to Form 10-Q for period Incorporation of Registrant dated ended June 30, 1992 August 6, 1992
(3.3) By-laws of the Registrant, as Exhibit 3.3 to Annual Report on amended Form 10-K for the year ended December 31, 1992
(10.1) 1992 Stock Option Plan (as amended Appendix to Proxy Statement dated May 19, 1998)* April 15, 1998 for Annual Meeting of Shareholders held May 19, 1998
(10.2) 1995 Non-employee Director Stock Exhibit 10.2 to Annual Report on Option Plan* Form 10-K for the year ended December 31, 1997
(10.3) Employment Agreement dated June Exhibit 1 to Form 8-K filed 8, 1992 between the Registrant and R. June 23, 1992 Carlos Carballada*
(10.4) Extension of Employment Exhibit 10.1 to Form 10-Q for Agreement between the Registrant and R. period ended June 30, 1996 Carlos Carballada*
(10.5) Change of Control Employment Exhibit 10.4 to Annual Report on Agreement among the Registrant, Form 10-K for the year ended First National and R. Carlos Carballada* December 31, 1995
(10.6) Form of Change of Control Exhibit 10.5 to Annual Report on Employment Agreement between First Form 10-K for the year ended National and each Executive Officer December 31, 1995 other than R. Carlos Carballada*
(10.7) Forms of Stock Option Agreements Exhibit 4.2 to Form S-8 pursuant to 1992 Stock Option Plan between Registration Statement No. the Registrant and each Executive Officer* 333-66413, filed October 30, 1998
(10.8) Form of Stock Option Agreement Exhibit 4.4 to Form S-8 pursuant to 1995 Non-employee Director Registration Statement No. Stock Option Plan between the Registrant 333-15325, filed November 1,1996 and each outside Director of the Registrant*
(10.9) 401(k) Stock Purchase Plan * Exhibit 4.5 to Form S-8 Registration Statement No. 333-15325, filed November 1, 1996
(10.10) Employee Stock Purchase Plan * Exhibit 4.6 to Form S-8 Registration Statement No. 333-15325, filed November 1, 1996
(10.11) Loan agreement between First Page 83 National and Pyramid Sherlyle Co., related to Michael J. Falcone
(10.12) Loan agreements between First Exhibit 10.19 to Form 8 filed National and Carl R. Reynolds April 22, 1992
(10.13) Commercial Line of Credit Exhibit 10.17 to Annual Report on Form agreements between First 10-K for year ended December 31, National and JML Optical Industries, 1993 Inc., related to Joseph M. Lobozzo II
(10.14) Lease Agreement between Exhibit 10.2 to Form 10-Q for period Southtown Plaza Associates, related to ended June 30, 1995 William Levine, and First National
(10.15) Commercial Line of Credit Exhibit 10.3 to Form 10-Q for Agreement between GLC Outsourcing period ended September 30, 1995 Services, Inc., related to James D. Ryan, and First National
(10.16) Commercial Loan Agreements Exhibit 10.26 to Annual Report Form 10- between Fred Kravetz on Form 10-K for year ended and William Levine Partners, December 31, 1996 related to William Levine, and First National
(10.17) Commercial Line of Credit Exhibit 10.1 to Form 10-Q for Agreement between First National and period ended September 30, 1998 James D. Ryan
(10.18) Commercial Loan Agreement Page 106 between First National and Powder Mill Land Company, related to James D. Ryan
(10.19) Stock Option Agreement, dated Exhibit 10.1 to Form 8-K filed as of December 9, 1998, between FNB December 17, 1998 Rochester 1998 Corp. and M&T Bank Corporation
(10.20) Form of Voting Agreement, dated as Exhibit 99.1 to Form 8-K filed of December 9, 1998, between each director December 17, 1998 of FNB Rochester Corp. and M&T Bank Corporation
(21) Subsidiaries Page 124
(23) Consent of KPMG LLP Page 125
(27) Financial Data Schedule Page 126
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report pursuant to Item 14 (c).
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed on December 17, 1998 to disclose that an Agreement and Plan of Reorganization dated as of December 9, 1998 had been entered into among the Company, M&T Bank Corporation, a New York corporation ("M&T") and Olympia Financial Corp., a Delaware corporation and wholly-owned subsidiary of M&T ("Olympia") pursuant to which the Company will be merged with and into Olympia pursuant to the terms of an Agreement and Plan of Merger dated as of December 9, 1998 between the Company and Olympia and joined in by M&T. The proposed merger is subject to various conditions, including the approval of the shareholders of the Company and the receipt of all requisite regulatory approvals.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FNB ROCHESTER CORP.
March 23, 1999 By: s/ R. Carlos Carballada ________________________ R. Carlos Carballada, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date _________ _____ ____
(I) Principal Executive Officer: President and Chief March 23, 1999 Executive Officer
s/ R. Carlos Carballada _______________________ R. Carlos Carballada)
(ii) Principal Accounting and Senior Vice President and March 23, 1999 Financial Officer: Chief Financial Officer
s/ Stacy C. Campbell _____________________ (Stacy C. Campbell)
(iii) Directors:
s/ R. Carlos Carballada _______________________ Director March 23, 1999 (R. Carlos Carballada)
____________________ Director March __, 1999 (Michael J. Falcone)
s/ Joseph M. Lobozzo II _______________________ Director March 23, 1999 (Joseph M. Lobozzo II)
s/ Francis T. Lombardi ______________________ Director March 23, 1999 (Francis T. Lombardi)
s/ Carl R. Reynolds Director March 23, 1999 ______________________ (Carl R. Reynolds)
s/ James D. Ryan ______________________ Director March 23, 1999 (James D. Ryan)
s/ H. Bruce Russell _____________________ Director March 23, 1999 (H. Bruce Russell)
s/ Linda Cornell Weinstein ___________________________ Director March 23, 1999 (Linda Cornell Weinstein)
INDEX OF EXHIBITS
Exhibit Incorporation by Reference or page in sequential numbering where exhibit may be found:
(2.1) Agreement and Plan of Reorganization, Exhibit 2.1 to Form 8-K filed dated as of December 9, 1998, among FNB December 17, 1998 Rochester 1998 Corp., M&T Bank Corporation and Olympia Financial Corp.
(3.1) Certificate of Incorporation, Exhibits 4.2-4.5 to Registration of the Registrant, as amended Statement No. 33-7244, filed July 22, 1986
(3.2) Amendment to Certificate Exhibit 3 to Form 10-Q for period of Incorporation of Registrant ended June 30, 1992 dated August 6, 1992
(3.3) By-laws of the Registrant, Exhibit 3.3 to Annual Report on as amended Form 10-K for the year ended December 31, 1992
(10.1) 1992 Stock Option Plan Appendix to Proxy Statement dated (as amended May 19, 1998) April 15, 1998 for Annual Meeting of Shareholders held May 19, 1998
(10.2) 1995 Non-employee Director Exhibit 10.2 to Annual Report on Stock Option Plan Form 10-K for the year ended December 31, 1997
(10.3) Employment Agreement dated Exhibit 1 to Form 8-K filed June 8, 1992 between the Registrant June 23, 1992 and R. Carlos Carballada
(10.4) Extension of Employment Agreement Exhibit 10.1 to Form 10-Q for between the Registrant and R. Carlos period ended June 30, 1996 Carballada
(10.5) Change of Control Employment Exhibit 10.4 to Annual Report on Agreement among the Registrant, First Form 10-K for the year ended National and R. Carlos Carballada December 31, 1995
(10.6) Form of Change of Control Exhibit 10.5 to Annual Report on Employment Agreement between First Form 10-K for the year ended National and each Executive Officer December 31, 1995 other than R. Carlos Carballada
(10.7) Forms of Stock Option Agreements Exhibit 4.2 to Form S-8 pursuant to 1992 Stock Option Plan between Registration Statement No. the Registrant and each Executive Officer 333-66413, filed October 30, 1998
(10.8) Form of Stock Option Agreement Exhibit 4.4 to Form S-8 pursuant to 1995 Non-employee Director Registration Statement No. Stock Option Plan between the Registrant 333-15325, filed November 1, 1996 and each outside Director of the Registrant
(10.9) 401(k) Stock Purchase Plan Exhibit 4.5 to Form S-8 Registration Statement No. 333-15325, filed November 1, 1996
(10.10) Employee Stock Purchase Plan Exhibit 4.6 to Form S-8 Registration Statement No. 333-15325, filed November 1, 1996
(10.11) Loan agreements between First Page 83 National and Pyramid Sherlyle Co., related to Michael J.Falcone
(10.12) Loan agreements between Exhibit 10.19 to Form 8 filed First National and Carl R. Reynolds April 22, 1992
(10.13) Line of Credit agreements Exhibit 10.17 to Annual Report on between First National and JML Form 10-K for year ended December Optical Industries, Inc., 31, 1993 related to Joseph M. Lobozzo II
(10.14) Lease Agreement between Exhibit 10.2 to Form 10-Q for Southtown Plaza Associates, period ended June 30, 1995 related to William Levine, and First National
(10.15) Commercial Line of Credit Exhibit 10.3 to Form 10-Q for Agreement between GLC Outsourcing period ended September 30, 1995 Services, Inc., related to James D. Ryan, and First National
(10.16) Commercial Loan Agreements Exhibit 10.26 to Annual Report on between Fred Kravetz and William Form 10-K for year ended Levine Partners, related December 31, 1996 to William Levine, and First National
(10.17) Commercial Line of Credit Exhibit 10.1 to Form 10-Q for Agreement between First National period ended September 30, 1998 and James D. Ryan
(10.18) Commercial Loan Agreement between Page 106 First National and Powder Mill Land Company, related to James D. Ryan
(10.19) Stock Option Agreement, Exhibit 10.1 to Form 8-K filed dated as of December 9, 1998, December 17, 1998 Between FNB Rochester Corp. and M&T Bank Corporation
(10.20) Form of Voting Agreement, Exhibit 99.1 to Form 8-K filed dated as of December 9, 1998, between December 17, 1998 each director of FNB Rochester Corp. and M&T Bank Corporation
(21) Subsidiaries Page 124
(23) Consent of KPMG LLP Page 125
(27) Financial Data Schedule Page 126