ALNC Alliance Financial Corp. (MM)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-15366

 

 

ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

 

New York		16-1276885
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification Number)

 

120 Madison Street , Syracuse, New York 13202
(Address of Principal Executive Offices) (Zip Code)

(315) 475-2100

(Registrant’s Telephone Number including area code)

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer		¨		Accelerated Filer		x
Non-accelerated filer		¨		Smaller Reporting Company		¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

The number of shares outstanding of the Registrant’s common stock, $1.00 par value, on November 2, 2012 was 4,782,185 shares.

 

 

 

---

Table of Contents

TABLE OF CONTENTS

 

						Page Number(s)
Forward-Looking Statements						i
Part I.		FINANCIAL INFORMATION
		Item 1.		Financial Statements (All Unaudited)
				Consolidated Balance Sheets		1
				Consolidated Statements of Comprehensive Income		2
				Consolidated Statements of Changes in Shareholders’ Equity		3
				Consolidated Statements of Cash Flow		4
				Notes to Consolidated Financial Statements		5-22
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		23-39
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk		40
		Item 4.		Controls and Procedures		41
Part II.		OTHER INFORMATION
		Item 1.		Legal Proceedings		42
		Item 1A.		Risk Factors		42-44
		Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		44
		Item 3.		Defaults Upon Senior Securities		44
		Item 4.		Mine Safety Disclosures		44
		Item 5.		Other Information		44
		Item 6.		Exhibits		44
		Signatures
		Exhibits

---

Table of Contents

Throughout this report, the terms “Company,” “Alliance,” “we,” “our” and “us” refers to the consolidated entity of Alliance Financial Corporation, its wholly owned subsidiaries, including Alliance Bank, N.A. (the “Bank”) and the Alliance Agency Inc., formerly Ladd’s Agency, Inc. (“Ladd’s”), and the Bank’s subsidiaries, Alliance Preferred Funding Corp. and Alliance Leasing, Inc. Alliance is a New York corporation, which was formed in November 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to the financial conditions, results of operations and business of Alliance. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following:

 

•

changes in the interest rate environment that reduce margins;

 

•

changes in the regulatory environment;

 

•

the highly competitive industry and market area in which we operate;

 

•

general economic conditions, either nationally or regionally, resulting in, among other things, a deterioration in credit quality;

 

•

changes in business conditions and inflation;

 

•

changes in credit market conditions;

 

•

changes in the securities markets which affect investment management revenues;

 

•

increases in Federal Deposit Insurance Corporation (“FDIC”) deposit insurance premiums and assessments could adversely affect our financial condition;

 

•

changes in technology used in the banking business;

 

•

the soundness of other financial services institutions which may adversely affect our credit risk;

 

•

certain of our intangible assets may become impaired in the future;

 

•

our controls and procedures may fail or be circumvented;

 

•

new line of business or new products and services which may subject us to additional risks;

 

•

changes in key management personnel which may adversely impact our operations;

 

•

the effect on our operations of recent legislative and regulatory initiatives that were or may be enacted in response to the ongoing financial crisis;

 

•

severe weather, natural disasters, acts of war or terrorism and other external events which could significantly impact our business;

 

•

risks related to the merger with NBT Bancorp Inc. as described in Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q; and

 

•

other factors detailed from time to time in our Securities and Exchange Commission (“SEC”) filings.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

i

---

Table of Contents

PART I. FINANCIAL INFORMATION

Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

(In thousands, except share data)

 

		September 30, 2012				December 31, 2011
Assets
Cash and due from banks		$	88,703			$	52,802
Securities available-for-sale			343,211				374,306
Federal Home Loan Bank of New York (“FLHB”) and Federal Reserve Bank (“FRB”) stock			7,983				8,478
Loans and leases held-for-sale			359				1,217
Loans and leases, net of unearned income and deferred costs			906,383				872,721
Allowance for credit losses			(8,483	)			(10,769	)
Net loans and leases			897,900				861,952
Premises and equipment, net			16,879				17,541
Accrued interest receivable			4,134				3,960
Bank-owned life insurance			30,172				29,430
Goodwill			30,844				30,844
Intangible assets, net			7,029				7,694
Other assets			18,826				20,866
Total assets		$	1,446,040			$	1,409,090
Liabilities and shareholders’ equity
Liabilities
Deposits:
Non-interest-bearing deposits		$	212,437			$	185,736
Interest-bearing deposits			913,966				897,329
Total deposits			1,126,403				1,083,065
Borrowings			127,134				136,310
Accrued interest payable			723				1,578
Other liabilities			17,628				18,366
Junior subordinated obligations issued to unconsolidated subsidiary trusts			25,774				25,774
Total liabilities			1,297,662				1,265,093
Shareholders’ equity
Preferred stock – par value $1.00 per share; 900,000 shares authorized, none issued and outstanding			—				—
Preferred stock – par value $1.00 per share; 100,000 shares authorized, Series A, junior preferred stock, none issued and outstanding			—				—
Common stock – par value $1.00; 10,000,000 shares authorized, 5,104,497 and 5,091,553 shares issued; and 4,782,185 and 4,769,241 shares outstanding, respectively			5,104				5,092
Surplus			47,651				47,147
Undivided profits			103,225				99,879
Accumulated other comprehensive income			4,808				3,951
Directors’ stock-based deferred compensation plan (144,926 and 134,260 shares, respectively)			(3,754	)			(3,416	)
Treasury stock, at cost: 322,312 shares			(8,656	)			(8,656	)
Total shareholders’ equity			148,378				143,997
Total liabilities & shareholders’ equity		$	1,446,040			$	1,409,090

The accompanying notes are an integral part of the consolidated financial statements.

 

1

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

(In thousands, except per share data)

 

		Three months ended September 30,								Nine months ended September 30,
		2012				2011				2012				2011
Interest income:
Interest and fees on loans and leases		$	9,727			$	10,448			$	29,270			$	31,731
Federal funds sold and interest bearing deposits			28				—				103				5
Interest and dividends on taxable securities			1,596				2,880				5,275				8,849
Interest and dividends on nontaxable securities			628				733				2,011				2,232
Total interest income			11,979				14,061				36,659				42,817
Interest expense:
Deposits:
Savings accounts			30				54				85				166
Money market accounts			249				377				779				1,271
Time accounts			812				1,404				2,843				4,337
NOW accounts			30				49				96				179
Total deposits			1,121				1,884				3,803				5,953
Borrowings:
Repurchase agreements			210				206				622				619
FHLB advances			524				816				1,920				2,486
Junior subordinated obligations issued to unconsolidated subsidiary trusts			170				158				514				473
Total interest expense			2,025				3,064				6,859				9,531
Net interest income			9,954				10,997				29,800				33,286
Provision for credit losses			—				750				(300	)			1,110
Net interest income after provision for credit losses			9,954				10,247				30,100				32,176
Non-interest income:
Investment management income			1,831				1,948				5,636				5,850
Service charges on deposit accounts			1,074				1,194				3,167				3,299
Card-related fees			688				687				2,059				2,039
Income from bank-owned life insurance			250				258				742				768
Gain on the sale of loans			508				245				1,214				621
Gain on sale of securities available-for-sale			—				1,325				—				1,325
Other non-interest income			233				262				767				1,038
Total non-interest income			4,584				5,919				13,585				14,940
Non-interest expense:
Salaries and employee benefits			5,761				5,573				17,103				16,407
Occupancy and equipment expense			1,770				1,833				5,365				5,479
Communication expense			153				124				469				448
Office supplies and postage expense			298				283				905				868
Marketing expense			152				193				651				673
Amortization of intangible assets			222				241				665				722
Professional fees			1,615				736				3,220				2,420
FDIC insurance premium			216				49				642				844
Other non-interest expense			1,526				2,107				4,598				5,080
Total non-interest expense			11,713				11,139				33,618				32,941
Income before income tax expense			2,825				5,027				10,067				14,175
Income tax expense			540				1,360				2,224				3,723
Net income		$	2,285			$	3,667			$	7,843			$	10,452
Net income per share:
Basic earnings per share		$	0.48			$	0.77			$	1.64			$	2.20
Diluted earnings per share		$	0.48			$	0.77			$	1.64			$	2.20
Cash dividends declared per share		$	0.32			$	0.31			$	0.94			$	0.91
Comprehensive income		$	2,997			$	4,286			$	8,700			$	13,916

The accompanying notes are an integral part of the consolidated financial statements.

 

2

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(In thousands, except per share data)

 

		Issued and Outstanding Common Shares				Common Stock				Surplus				Undivided Profits				Accumulated Other Comprehensive Income				Treasury Stock				Directors’ Deferred Stock				Total
Balance at January 1, 2011			4,729,035			$	5,051			$	45,620			$	92,380			$	1,713			$	(8,656	)		$	(2,977	)		$	133,131
Net income			—				—				—				10,452				—				—				—				10,452
Change in unrealized appreciation in available-for-sale securities (net of tax)			—				—				—				—				3,371				—				—				3,371
Change in accumulated unrealized losses and prior service costs for retirement plans (net of tax)			—				—				—				—				93				—				—				93
Retirement of common stock			(3,447	)			(3	)			(100	)			—				—				—				—				(103	)
Issuance of restricted stock			17,839				18				(18	)			—				—				—				—				—
Forfeiture of restricted stock			(200	)			—				(1	)			—				—				—				—				(1	)
Amortization of restricted stock			—				—				367				—				—				—				—				367
Stock options exercised			4,385				4				98				—				—				—				—				102
Tax benefit of stock-based compensation			—				—				43				—				—				—				—				43
Cash dividend $0.91 per common share			—				—				—				(4,318	)			—				—				—				(4,318	)
Directors’ deferred stock plan purchase			—				—				350				—				—				—				(350	)			—
Directors’ deferred stock plan distribution			—				—				(23	)			—				—				—				23				—
Balance at September 30, 2011			4,747,612			$	5,070			$	46,336			$	98,514			$	5,177			$	(8,656	)		$	(3,304	)		$	143,137
Balance at January 1, 2012			4,769,241			$	5,092			$	47,147			$	99,879			$	3,951			$	(8,656	)		$	(3,416	)		$	143,997
Net income			—				—				—				7,843				—				—				—				7,843
Change in unrealized appreciation in available-for-sale securities (net of tax)			—				—				—				—				694				—				—				694
Change in accumulated unrealized losses and prior service costs for retirement plans (net of tax)			—				—				—				—				163				—				—				163
Retirement of common stock			(4,971	)			(5	)			(160	)			—				—				—				—				(165	)
Issuance of restricted stock			18,465				18				(18	)			—				—				—				—				—
Forfeiture of restricted stock			(550	)			(1	)			—				—				—				—				—				(1	)
Amortization of restricted stock			—				—				382				—				—				—				—				382
Tax benefit of stock-based compensation			—				—				(38	)			—				—				—				—				(38	)
Cash dividend $0.94 per common share			—				—				—				(4,497	)			—				—				—				(4,497	)
Directors’ deferred stock plan purchase			—				—				362				—				—				—				(362	)			—
Directors’ deferred stock plan distribution			—				—				(24	)			—				—				—				24				—
Balance at September 30, 2012			4,782,185			$	5,104			$	47,651			$	103,225			$	4,808			$	(8,656	)		$	(3,754	)		$	148,378

The accompanying notes are an integral part of the consolidated financial statements.

 

3

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flow (Unaudited)

(In thousands)

 

		Nine months ended September 30,
		2012				2011
Operating Activities:
Net Income		$	7,843			$	10,452
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses			(300	)			1,110
Depreciation expense			1,478				1,632
Increase in surrender value of life insurance			(742	)			(768	)
Provision (benefit) for deferred income taxes			963				(1,560	)
Amortization of investment security discounts and premiums, net			2,812				2,381
Net gain on sale of securities available-for-sale			—				(1,325	)
Net gain on sale of premises and equipment			—				2
Proceeds from the sale of loans held-for-sale			46,811				30,369
Origination of loans held-for-sale			(45,073	)			(28,593	)
Gain on sale of loans held-for-sale			(1,214	)			(621	)
Gain on foreclosed real estate			(50	)			(61	)
Amortization of capitalized servicing rights			361				278
Amortization of intangible assets			665				722
Restricted stock expense, net			381				366
Amortization of prepaid FDIC insurance premium			557				764
Impairment loss on fixed asset			—				570
Change in other assets and liabilities			(748	)			(292	)
Net cash provided by operating activities			13,744				15,426
Investing Activities:
Proceeds from maturities, redemptions, calls and principal repayments of investment securities available-for-sale			84,979				73,299
Proceeds from sales of investment securities available-for-sale			—				57,824
Purchase of investment securities available-for-sale			(55,547	)			(121,427	)
Purchase of FHLB and FRB stock			(63	)			(13,093	)
Redemption of FHLB stock			558				13,298
Net (increase) decrease in loans and leases			(36,684	)			24,213
Purchases of premises and equipment			(863	)			(1,022	)
Proceeds from the sale of premises and equipment			47				—
Proceeds from disposition of foreclosed assets			579				703
Net cash provided by (used in) investing activities			(6,994	)			33,795
Financing Activities:
Net increase (decrease) in checking, savings and money market accounts			99,037				(10,981	)
Net decrease in time accounts			(55,699	)			(15,556	)
Net (decrease) increase in short-term borrowings			824				(2,611	)
Payments on long-term borrowings			(10,000	)			(15,000	)
Proceeds from long-term borrowings			—				10,000
Proceeds from the exercise of stock options			—				102
Retirement of common stock			(165	)			(103	)
Tax (provision) benefit for stock-based compensation			(38	)			43
Purchase of shares for directors’ deferred stock-based plan			(362	)			(350	)
Cash dividends paid to common shareholders			(4,446	)			(4,265	)
Net cash provided by (used in) financing activities			29,151				(38,721	)
Net increase in cash and cash equivalents			35,901				10,500
Cash and cash equivalents at beginning of period			52,802				32,501
Cash and cash equivalents at end of period		$	88,703			$	43,001
Supplemental Disclosures of Cash Flow Information:
Interest received during the period		$	36,485			$	42,521
Interest paid during the period			7,714				9,779
Income taxes			213				5,048
Non-cash investing and financing activities:
Change in unrealized gain on available-for-sale securities			1,149				5,497
Transfer of loans to other real estate			1,036				659
Common dividend declared and unpaid			1,530				1,472

The accompanying notes are an integral part of the consolidated financial statements.

 

4

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

 

1. Basis of Presentation and Significant Accounting Policies

Nature of Operations

Alliance Financial Corporation (the “Company” or “Alliance”) is a financial holding company which owns and operates Alliance Bank, N.A. (the “Bank”), Alliance Financial Capital Trust I, Alliance Financial Capital Trust II (collectively the “Capital Trusts”) and the Alliance Agency Inc., formerly Ladd’s Agency, Inc. (“Ladd’s”). The Company provides financial services through the Bank from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga and Oswego, and from a Trust Administration Center in Buffalo, NY. Primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, and investment management services. The Capital Trusts were formed for the purpose of issuing company-obligated mandatorily redeemable capital securities to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The Bank has a substantially wholly-owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly-owned subsidiary, Alliance Leasing, Inc., which was engaged in commercial equipment financing activity in over thirty states until the third quarter of 2008, at which time Alliance Leasing, Inc. ceased the origination of new leases.

 

1.	Basis of Presentation and Significant Accounting Policies

The accompanying unaudited financial statements were prepared in accordance with the instructions for Form 10-Q and Regulation S-X and, therefore, do not include information for footnotes necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The material under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is written with the presumption that the users of the interim financial statements have read, or have access to, the latest audited financial statements and notes thereto of Alliance, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2011, and for the three-year period then ended, included in Alliance’s Annual Report on Form 10-K for the year ended December 31, 2011. Accordingly, only material changes in the results of operations and financial condition are discussed in the remainder of Part I. Certain amounts from prior year periods are reclassified, when necessary, to conform to the current period presentation.

All adjustments, consisting of only normal recurring items, that in the opinion of management are necessary for a fair presentation of the financial statements have been included in the results of operations for the nine months ended September 30, 2012 and 2011. The results of operations for the nine months ended September 30, 2012 are not necessarily indicative of the results anticipated for the year.

 

2.	Securities

The amortized cost and estimated fair value of securities for the dates indicated (in thousands):

 

		September 30, 2012
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Debt Securities:
Obligations of U.S. government-sponsored corporations		$	1,489			$	10			$	—			$	1,499
Obligations of states and political subdivisions			68,900				5,059				—				73,959
Mortgage-backed securities – residential			257,435				7,293				145				264,583
Total debt securities			327,824				12,362				145				340,041
Stock Investments:
Mutual funds			3,000				170				—				3,170
Total available-for-sale		$	330,824			$	12,532			$	145			$	343,211

 

5

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

		December 31, 2011
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Debt Securities:
Obligations of U.S. government-sponsored corporations		$	3,134			$	56			$	—			$	3,190
Obligations of states and political subdivisions			77,541				4,759				1				82,299
Mortgage-backed securities – residential			279,393				6,483				170				285,706
Total debt securities			360,068				11,298				171				371,195
Stock Investments:
Mutual funds			3,000				113				2				3,111
Total available-for-sale		$	363,068			$	11,411			$	173			$	374,306

As of September 30, 2012 and December 31, 2011, the mortgage-backed securities portfolio was comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, which in turn, are backed by the U.S. government.

At September 30, 2012 and December 31, 2011, securities with a carrying value of $296.2 million and $361.8 million, respectively, were pledged as collateral for certain deposits and for other purposes as required or permitted by law.

There were no securities sales during the first nine months of 2012. Alliance recognized gross gains on sales of securities of $1.3 million with a related tax provision of $513,000 for the three and nine months ended September 30, 2011.

The carrying value and estimated fair value of debt securities for the dates indicated, by contractual maturity, are shown below (in thousands). The maturities of mortgage-backed securities are based on the average life of the security. All other expected maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		September 30, 2012
		Amortized Cost				Estimated Fair Value
Due in one year or less		$	88,378			$	90,769
Due after one year through five years			162,627				167,900
Due after five years through ten years			59,854				63,645
Due after ten years			16,965				17,727
Total debt securities		$	327,824			$	340,041

Securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated are as follows (in thousands):

 

		September 30, 2012
		Less than 12 Months								12 Months or Longer								Total
Type of Security		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
Mortgage-backed securities – residential		$	16,240			$	76			$	1,047			$	69			$	17,287			$	145

 

6

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

		December 31, 2011
		Less than 12 Months								12 Months or Longer								Total
Type of Security		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
Obligations of states and political subdivisions		$	192			$	1			$	—			$	—			$	192			$	1
Mortgage-backed securities – residential			28,746				70				4,144				100				32,890				170
Subtotal debt securities			28,938				71				4,144				100				33,082				171
Mutual funds			497				2				—				—				497				2
Total temporarily impaired securities		$	29,435			$	73			$	4,144			$	100			$	33,579			$	173

Management does not believe any individual unrealized loss as of September 30, 2012 represents an other-than-temporary impairment. A total of 12 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 2 securities for 12 months or longer. The unrealized losses relate primarily to securities issued by FNMA, GNMA and FHLMC. These unrealized losses are primarily attributable to changes in interest rates and other market conditions. Alliance does not intend to sell these securities and does not believe it will be required to sell them prior to recovery of the amortized cost.

 

3.	Loans and Leases

Major classifications of loans and leases at the dates indicated (in thousands):

 

		September 30,				December 31,
		2012				2011
Residential real estate		$	327,454			$	316,823
Commercial loans			147,677				151,420
Commercial real estate			126,783				126,863
Leases			13,726				28,842
Consumer other
Indirect auto			199,419				158,813
Home equity			78,572				78,624
Other consumer			10,167				11,152
Loans and leases			903,798				872,537
Less: Unearned income			(1,915	)			(3,206	)
Net deferred loan costs			4,500				3,390
Total loans and leases			906,383				872,721
Allowance for credit losses			(8,483	)			(10,769	)
Net loans and leases		$	897,900			$	861,952

 

7

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

Non-accrual and Past Due Loans and Leases

Non-accrual loans and leases and loans greater than 90 days past due and still accruing include both smaller balance homogeneous loans and leases that are collectively evaluated for impairment and individually classified as impaired loans. The following tables present non-accrual loans and leases that are greater than 90 days past due and still accruing and non-performing at the dates indicated (in thousands):

 

		September 30, 2012
		Non-accrual				Greater than 90 Days Past Due and Still Accruing				Non-performing Loans and Leases
Commercial loans		$	579			$	—			$	579
Commercial real estate			505				—				505
Leases, net of unearned income			52				—				52
Residential real estate			2,302				—				2,302
Consumer other:
Indirect			220				—				220
Home equity			361				—				361
Other			85				—				85
Total		$	4,104			$	—			$	4,104

 

		December 31, 2011
		Non-accrual				Greater than 90 Days Past Due and Still Accruing				Non-performing Loans and Leases
Commercial loans		$	3,401			$	—			$	3,401
Commercial real estate			4,051				—				4,051
Leases, net of unearned income			107				—				107
Residential real estate			3,062				—				3,062
Consumer other:
Indirect			293				—				293
Home equity			270				—				270
Other			103				—				103
Total		$	11,287			$	—			$	11,287

The following tables present the aging of past due loans and leases, including non-performing loans and leases, at the dates indicated (in thousands):

 

		September 30, 2012
		30-59 Days Past Due				60-89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Loans Not Past Due				Total Loans and Leases
Commercial loans		$	378			$	34			$	564			$	976			$	146,701			$	147,677
Commercial real estate			713				57				333				1,103				125,680				126,783
Leases, net			14				18				15				47				11,764				11,811
Residential real estate			2,667				1,659				2,244				6,570				320,884				327,454
Consumer other:
Indirect			398				62				94				554				198,865				199,419
Home equity			124				36				53				213				78,359				78,572
Other			131				19				2				152				10,015				10,167
Total		$	4,425			$	1,885			$	3,305			$	9,615			$	892,268			$	901,883

 

8

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

		December 31, 2011
		30-59 Days Past Due				60-89 Days Past Due				Greater than 90 Days Past Due				Total Past Due				Loans Not Past Due				Total Loans and Leases
Commercial loans		$	390			$	173			$	1,327			$	1,890			$	149,530			$	151,420
Commercial real estate			262				—				1,873				2,135				124,728				126,863
Leases, net			39				—				18				57				25,579				25,636
Residential real estate			3,743				377				3,062				7,182				309,641				316,823
Consumer other:
Indirect			728				76				67				871				157,942				158,813
Home equity			141				33				123				297				78,327				78,624
Other			80				53				6				139				11,013				11,152
Total		$	5,383			$	712			$	6,476			$	12,571			$	856,760			$	869,331

Allowance for Credit Losses

The following tables summarize activity in the allowance for credit losses for the periods indicated (in thousands):

 

		Three months ended September 30, 2012
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Unallocated				Total
Allowance for credit losses:
Beginning balance		$	4,974			$	167			$	855			$	937			$	701			$	1,258			$	8,892
Charge-offs			(367	)			—				(12	)			(16	)			(226	)							(621	)
Recoveries			14				45				3				25				125								212
Net charge-offs			(353	)			45				(9	)			9				(101	)							(409	)
Provision			180				79				111				108				82				(560	)			—
Ending Balance		$	4,801			$	291			$	957			$	1,054			$	682			$	698			$	8,483

 

		Three months ended September 30, 2011
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Unallocated				Total
Allowance for credit losses:
Beginning balance		$	6,338			$	853			$	767			$	779			$	751			$	1,195			$	10,683
Charge-offs			(81	)			(1	)			—				(105	)			(310	)							(511	)
Recoveries			14				178				3				73				104								372
Net charge-offs			(67	)			163				3				(32	)			(206	)							(139	)
Provision			824				(381	)			(8	)			68				220				27				750
Ending Balance		$	7,095			$	635			$	762			$	815			$	765			$	1,222			$	11,294

 

		Nine months ended September 30, 2012
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Unallocated				Total
Allowance for credit losses:
Beginning balance		$	6,994			$	503			$	750			$	784			$	747			$	991			$	10,769
Charge-offs			(2,134	)			—				(102	)			(126	)			(616	)							(2,978	)
Recoveries			276				257				13				99				347								992
Net charge-offs			(1,858	)			257				(89	)			(27	)			(269	)							(1,986	)
Provision			(335	)			(469	)			296				297				204				(293	)			(300	)
Ending Balance		$	4,801			$	291			$	957			$	1,054			$	682			$	698			$	8,483

 

9

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

		Nine months ended September 30, 2011
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Unallocated				Total
Allowance for credit losses:
Beginning balance		$	5,568			$	1,583			$	946			$	933			$	779			$	874			$	10,683
Charge-offs			(136	)			(331	)			(150	)			(243	)			(704	)							(1,564	)
Recoveries			130				365				42				150				378								1,065
Net charge-offs			(6	)			34				(108	)			(93	)			(326	)							(499	)
Provision			1,533				(982	)			(76	)			(25	)			312				348				1,110
Ending Balance		$	7,095			$	635			$	762			$	815			$	765			$	1,222			$	11,294

Impaired Loans and Leases

The following table presents information related to impaired loans and leases by type as of the dates indicated (in thousands):

 

		September 30, 2012												December 31, 2011
		Unpaid Contractual Principal Balance (1)				Recorded Investment				Related Allowance				Unpaid Contractual Principal Balance (1)				Recorded Investment				Related Allowance
With no related allowance recorded:
Commercial and commercial real estate		$	1,157			$	817							$	1,962			$	1,143
Leases, net			116				54								191				83
Residential real estate			1,264				1,559								1,533				1,457
Consumer other			34				34								41				41
			2,571				2,464								3,727				2,724
With an allowance recorded:
Commercial and commercial real estate			566				485			$	19				7,150				5,932			$	2,077
Leases, net			—				—				—				40				24				10
Residential real estate			998				601				38				405				405				11
			1,564				1,086				57				7,595				6,361				2,098
Total:
Commercial and commercial real estate			1,723				1,302				19				9,112				7,075				2,077
Leases, net			116				54				—				231				107				10
Residential real estate			2,262				2,160				38				1,938				1,862				11
Consumer other			34				34				—				41				41				—
		$	4,135			$	3,550			$	57			$	11,322			$	9,085			$	2,098

 

(1)	Unpaid contractual principal balance has not been reduced by any partial charge-offs taken on loans and leases.

 

10

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The allocation of the allowance for credit losses summarized on the basis of Alliance’s impairment methodology was as follows at the dates indicated (in thousands):

 

		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Total
September 30, 2012
Individually evaluated for impairment		$	19			$	—			$	38			$	—			$	—			$	57
Collectively evaluated for impairment			4,782				291				919				1,054				682				7,728
Allocated		$	4,801			$	291			$	957			$	1,054			$	682				7,785
Unallocated																							698
Total																						$	8,483
December 31, 2011
Individually evaluated for impairment		$	2,077			$	10			$	11			$	—			$	—			$	2,098
Collectively evaluated for impairment			4,917				493				739				784				747				7,680
Allocated		$	6,994			$	503			$	750			$	784			$	747				9,778
Unallocated																							991
Total																						$	10,769

The recorded investment in loans and leases summarized on the basis of Alliance’s impairment methodology at the dates indicated was as follows (in thousands):

 

		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Indirect				Consumer Other				Total
September 30, 2012
Individually evaluated for impairment		$	1,302			$	54			$	2,160			$	—			$	34			$	3,550
Collectively evaluated for impairment			273,158				11,757				325,294				199,419				88,705				898,333
Total		$	274,460			$	11,811			$	327,454			$	199,419			$	88,739			$	901,883
December 31, 2011
Individually evaluated for impairment		$	7,075			$	107			$	1,862			$	—			$	41			$	9,085
Collectively evaluated for impairment			271,208				25,529				314,961				158,813				89,735				860,246
Total		$	278,283			$	25,636			$	316,823			$	158,813			$	89,776			$	869,331

The following table presents the average recorded investment in impaired loans and leases for the periods indicated (in thousands):

 

		For the three months ended September 30,								For the nine months ended September 30,
		2012				2011				2012				2011
Commercial and commercial real estate		$	2,132			$	5,612			$	4,145			$	3,893
Leases, net			61				188				78				304
Residential real estate			2,177				1,127				2,054				1,212
Consumer other			35				—				38				—
Total		$	4,405			$	6,927			$	6,315			$	5,409

 

11

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The following table presents interest income recognized on impaired loans while they were considered to be impaired for the periods indicated (in thousands):

 

		For the three months ended September 30, 2012				For the three months ended September 30, 2011				For the nine months ended September 30, 2012				For the nine months ended September 30, 2011
Commercial and commercial real estate		$	69			$	1			$	75			$	2
Residential real estate			26				15				73				48
Consumer other			1				—				2				—
Total		$	96			$	16			$	150			$	50

Troubled Debt Restructurings

The following table presents the recorded investment in troubled debt restructured loans and leases as of September 30, 2012 and December 31, 2011 based on payment performance status (in thousands):

 

		September 30, 2012
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Other				Total
Performing		$	681			$	—			$	1,989			$	34			$	2,704
Non-performing			210				6				191				—				407
Total		$	891			$	6			$	2,180			$	34			$	3,111
		December 31, 2011
		Commercial & Commercial Real Estate				Leases, net				Residential Real Estate				Consumer Other				Total
Performing		$	211			$	—			$	1,401			$	41			$	1,653
Non-performing			2,216				33				461				—				2,710
Total		$	2,427			$	33			$	1,862			$	41			$	4,363

Troubled debt restructured loans and leases are considered impaired and are included in the previous impaired loans and leases disclosures in this footnote. As of September 30, 2012, the Company has not committed to lend additional amounts to customers with outstanding loans and leases that are classified as troubled debt restructurings.

During the three and nine month periods ending September 30, 2012 and September 30, 2011, certain loans and lease modifications were executed which constituted troubled debt restructurings. Substantially all of these modifications included one or a combination of the following: an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; temporary reduction in the interest rate; change in scheduled payment amount; permanent reduction of the principal of the loan; or an extension of additional credit for payment of delinquent real estate taxes.

 

12

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The following table summarizes troubled debt restructurings that occurred during the periods indicated (in thousands):

 

		For the three months ending September 30, 2012
		Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and commercial real estate			1			$	206			$	206
			1			$	206			$	206
		For the three months ending September 30, 2011
		Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and commercial real estate			1			$	3,000			$	3,000
			1			$	3,000			$	3,000
		For the nine months ending September 30, 2012
		Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and commercial real estate			3			$	577			$	577
Residential real estate			3				306				351
			6			$	883			$	928
		For the nine months ending September 30, 2011
		Number of Loans				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and commercial real estate			4			$	3,318			$	3,330
Leases, net			2				121				121
Residential real estate			5				385				436
			11			$	3,824			$	3,887

The troubled debt restructurings described above required a net allocation of the allowance for credit losses of $49,000 and $1.3 million at September 30, 2012 and September 30, 2011, respectively. Charge-offs of $1.5 million and $42,000 were recorded during the nine month periods ending September 30, 2012 and September 30, 2011.

 

13

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The following table summarizes the troubled debt restructurings for which there was a payment default within 12 months following the date of the restructuring for the periods indicated (in thousands):

 

		For the three months ending September 30, 2012								For the three months ending September 30, 2011
		Number of Loans				Recorded Investment				Number of Loans				Recorded Investment
Commercial and commercial real estate			1			$	—				2			$	3,062
Residential real estate			2				191				2				236
			3			$	191				4			$	3,298
		For the nine months ending September 30, 2012								For the nine months ending September 30, 2011
		Number of Loans				Recorded Investment				Number of Loans				Recorded Investment
Commercial and commercial real estate			2			$	—				2			$	3,062
Residential real estate			2				191				2				236
			4			$	191				4			$	3,298

Loans and leases are considered to be in payment default once it is greater than 30 days contractually past due under the modified terms. The troubled debt restructurings described above that subsequently defaulted resulted in a net allocation of the allowance for credit losses of $0 and $1.7 million at September 30, 2012 and September 30, 2011, respectively. Charge-offs of $210,000 and $1.5 million for the three and nine months ended September 30, 2012, respectively, were recorded on these defaulted troubled debt restructurings. There were no charge-offs recorded on defaulted troubled debt restructurings during the three and nine months ended September 30, 2011.

Credit Quality Indicators

Alliance establishes a risk rating at origination for commercial loan, commercial real estate and commercial lease relationships over $250,000 based on relevant information about the ability of the borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Commercial relationship managers monitor the loans and leases in their portfolios on an ongoing basis for any changes in the borrower’s ability to service their debt and affirm the risk ratings for the loans and leases in their respective portfolios on a quarterly basis.

Alliance uses the risk rating system to identify criticized and classified loans and leases. Commercial relationships within the criticized and classified risk ratings are analyzed quarterly. Alliance uses the following definitions for criticized and classified loans and leases which are consistent with regulatory guidelines:

Special Mention

A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date.

Substandard

A substandard loan is inadequately protected by the current paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

14

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

Doubtful

A loan classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss

Loans classified as Loss are considered non-collectable and of such little value that their continuance as bankable assets are not warranted.

Loans and leases not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans and leases. Commercial loans and leases listed as not rated are credits less than $250,000 or further segregated into smaller homogeneous pools based on similar risk and loss characteristics. In some instances, the commercial loans and lease portfolios were further segmented from their risk grade categories into groups of homogeneous pools based on similar risk and loss characteristics.

As of the dates indicated and based on the most recent analysis performed, the recorded investment by risk category and class of loans and leases is as of the dates indicated (in thousands):

 

		September 30, 2012								December 31, 2011
		Commercial & Commercial Real Estate				Commercial Leases, net				Commercial & Commercial Real Estate				Commercial Leases, net
Credit risk profile by internally assigned grade:
Pass		$	229,162			$	3,629			$	220,226			$	13,759
Special mention			6,063				—				13,421				259
Substandard			8,771				1,676				10,074				371
Substandard individually evaluated for impairment			1,103				54				7,075				107
Not rated			29,361				6,452				27,487				11,140
		$	274,460			$	11,811			$	278,283			$	25,636

For residential real estate and consumer loan classes, Alliance evaluates credit quality primarily based upon the aging status of the loan, which was previously presented, and by payment activity.

The following table presents the recorded investment in residential real estate and consumer loans based on payment activity as of the dates indicated (in thousands):

 

		September 30, 2012
		Residential Real Estate				Consumer Indirect				Consumer Home Equity				Consumer Other
Performing		$	325,152			$	199,199			$	78,211			$	10,082
Non-performing			2,302				220				361				85
Total		$	327,454			$	199,419			$	78,572			$	10,167
		December 31, 2011
		Residential Real Estate				Consumer Indirect				Consumer Home Equity				Consumer Other
Performing		$	313,761			$	158,520			$	78,354			$	11,049
Non-performing			3,062				293				270				103
Total		$	316,823			$	158,813			$	78,624			$	11,152

 

15

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

4.

Deposits

Deposits consisted of the following at the periods indicated (in thousands):

 

		September 30, 2012				December 31, 2011
Non-interest-bearing checking		$	212,437			$	185,736
Interest-bearing checking			159,680				145,885
Savings accounts			115,229				107,311
Money market accounts			380,623				330,000
Time accounts			258,434				314,133
Total deposits		$	1,126,403			$	1,083,065

 

5.	Earnings Per Share

Alliance has granted stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method as required by Accounting Standards Codification Topic 260-10-45. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards and warrants, but excludes awards considered participating securities.

Basic and diluted net income per common share calculations are as follows (in thousands, except per share data):

 

		For the three months ended September 30,								For the nine months ended September 30,
		2012				2011				2012				2011
Basic:
Net income		$	2,285			$	3,667			$	7,843			$	10,452
Less: dividends and undistributed earnings allocated to unvested restricted shares			(37	)			(61	)			(132	)			(175	)
Net earnings allocated to common shareholders		$	2,248			$	3,606			$	7,711			$	10,277
Weighted average common shares outstanding, including shares considered participating securities			4,783,546				4,747,870				4,780,826				4,743,021
Less: average participating securities			(81,252	)			(80,515	)			(80,202	)			(78,951	)
Weighted average shares			4,702,294				4,667,355				4,700,624				4,664,070
Net income per common share – basic		$	0.48			$	0.77			$	1.64			$	2.20
Diluted:
Net earnings allocated to common shareholders		$	2,248			$	3,606			$	7,711			$	10,277
Weighted average common shares outstanding for basic earnings per common share			4,702,294				4,667,355				4,700,624				4,664,070
Incremental shares from assumed conversion of stock options and warrants			—				6,553				—				7,618
Average common shares outstanding – diluted			4,702,294				4,673,908				4,700,624				4,671,688
Net income per common share – diluted		$	0.48			$	0.77			$	1.64			$	2.20

Dividends of $24,000 and $23,000 were paid on unvested shares with non-forfeitable dividend rights for the quarters ending September 30, 2012 and 2011, respectively. Dividends of $76,000 and $72,000 for the nine months ended September 30, 2012 and 2011, respectively, were paid on unvested shares with non-forfeitable dividend rights. There were no options outstanding at September 30, 2012. There were no anti-dilutive stock options for the three months and nine months ended September 30, 2011.

 

16

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

6.	Employee and Director Benefit Plans

Defined Benefit Plan and Post-Retirement Benefits

Alliance has a noncontributory defined benefit pension plan (“Pension Plan”) which it assumed from Bridge Street Financial Inc. (“Bridge Street”). The plan covers substantially all former Bridge Street full-time employees who met eligibility requirements on October 6, 2006, at which time all benefits were frozen. Under the plan, retirement benefits are primarily a function of both the years of service and the level of compensation. The amount contributed to the plan is determined annually on the basis of (a) the maximum amount that can be deducted for federal income tax purposes, or (b) the amount certified by an actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974.

Post-retirement medical and life insurance benefits (“Post-retirement Plan”) are available to certain retirees and their spouses, if applicable.

Supplemental Retirement Plans

Alliance has supplemental executive retirement plans (“SRP”) for our current Chief Executive Officer and five former employees.

Directors Retirement Plan

Alliance has a noncontributory defined benefit retirement plan for non-employee directors (the “Directors Plan”). The Directors Plan provides for a cash benefit equivalent to 35% of their average annual director’s fees, subject to increases based on the director’s length and extent of service, payable in a number of circumstances, including normal retirement, death or disability and a change in control. Upon termination of service, the normal retirement benefit is payable in a lump sum or in ten equal installments.

The components of all of the plans’ net periodic costs for the three months ended September 30, 2012 and 2011 are as follows (in thousands):

 

		Pension Plan								Post-retirement Plan								SRP Plan								Directors Retirement Plan
		2012				2011				2012				2011				2012				2011				2012				2011
Service cost		$	—			$	—			$	—			$	—			$	22			$	22			$	18			$	23
Interest cost			67				72				44				56				43				48				12				14
Expected return on assets			(87	)			(97	)			—				—				—				—				—				—
Amortization of unrecognized actuarial loss			55				31				5				5				17				1				7				7
Amortization of unrecognized prior service cost			—				—				(11	)			(11	)			6				6				12				12
Net periodic plan cost		$	35			$	6			$	38			$	50			$	88			$	77			$	49			$	56

The components of all of the plans’ net periodic costs for the nine months ended September 30, 2012 and 2011 are as follows (in thousands):

 

		Pension Plan								Post-retirement Plan								SRP Plan								Directors Retirement Plan
		2012				2011				2012				2011				2012				2011				2012				2011
Service cost		$	—			$	—			$	—			$	—			$	66			$	67			$	53			$	68
Interest cost			201				216				133				168				128				143				36				42
Expected return on assets			(261	)			(290	)			—				—				—				—				—				—
Amortization of unrecognized actuarial loss			165				92				13				14				51				3				21				22
Amortization of unrecognized prior service cost			—				—				(33	)			(33	)			17				17				36				36
Net periodic plan cost		$	105			$	18			$	113			$	149			$	262			$	230			$	146			$	168

 

17

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

7.	Fair Value Measurements

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets Measured on a Recurring Basis

The fair values of debt securities available-for-sale are determined by obtaining matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). The fair value of mutual fund securities available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available (Level 1). There were no transfers between fair value measurement levels during the most recent quarter.

Assets measured at fair value on a recurring basis are summarized below (in thousands):

 

						Fair Value Measurements at September 30, 2012 Using
		Fair Value				Quoted market prices in active markets for identical assets (Level 1)				Significant other observable inputs (Level 2)
Debt Securities:
Obligations of U.S. government-sponsored Corporations		$	1,499			$	—			$	1,499
Obligations of states and political subdivisions			73,959				—				73,959
Mortgage-backed securities – residential			264,583				—				264,583
Total debt securities			340,041				—				340,041
Stock Investments:
Mutual Funds			3,170				3,170				—
Total available-for-sale		$	343,211			$	3,170			$	340,041
						Fair Value Measurements at December 31, 2011 Using
		Fair Value				Quoted market prices in active markets for identical assets (Level 1)				Significant other observable inputs (Level 2)
Debt Securities:
Obligations of U.S. government-sponsored Corporations		$	3,190			$	—			$	3,190
Obligations of states and political subdivisions			82,299				—				82,299
Mortgage-backed securities – residential			285,706				—				285,706
Total debt securities			371,195				—				371,195
Stock Investments:
Mutual Funds			3,111				3,111				—
Total available-for-sale		$	374,306			$	3,111			$	371,195

 

18

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

Assets Measured on a Non-Recurring Basis

Impaired loans and leases – At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Assets measured at fair value on a non-recurring basis by fair value measurement used are summarized below (in thousands):

 

		At September 30, 2012								At December 31, 2011
		Fair Value				Significant unobservable inputs (Level 3)				Fair Value				Significant unobservable inputs (Level 3)
Impaired loans and leases:
Commercial and commercial real estate		$	190			$	190			$	3,855			$	3,855
Leases, net			—				—				14				14
		$	190			$	190			$	3,869			$	3,869

Impaired loans and leases, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $196,000 with a valuation allowance of $6,000 at September 30, 2012. At December 31, 2011, impaired loans had a carrying amount of $6.0 million with a valuation allowance of $2.1 million. Changes in fair value recognized for partial charge-offs of loans and leases and impairment reserves on loans and leases was a net increase of $347,000 and $1.8 million for the nine months ended September 30, 2012 and 2011, respectively.

The fair value of one impaired commercial real estate loan at September 30, 2012 was measured based upon a real estate appraisal. Unobservable inputs included adjustments by the appraiser for differences between the comparable sales averaging 10%. In addition, the appraised real estate value was discounted 20% by management due to the appraisal being greater than 2 years old. For a commercial impaired loan, the fair value of the equipment and inventory collateral was based upon customer prepared interim financial statements that management discounted 40% and 70% for the equipment and inventory, respectively.

 

19

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The carrying amounts and estimated fair value of financial instruments at September 30, 2012 are as follows (in thousands):

 

		Fair Value Measurements Using:
		Quoted market prices in active markets for identical assets Level 1				Significant other observable inputs Level 2				Significant unobservable inputs Level 3				Carrying Amount
Financial Assets:
Cash and cash equivalents		$	88,703			$	—			$	—			$	88,703
FHLB and FRB stock			N/A				N/A				N/A				7,983
Loans held for sale			—				359				—				359
Net loans and leases (1)			—				—				936,356				897,900
Accrued interest receivable			—				1,628				2,506				4,134
Financial Liabilities:
Deposits			867,969				259,734				—				1,126,403
Borrowings			—				131,986				—				127,134
Junior subordinated obligations			—				—				9,830				25,774
Accrued interest payable			3				642				78				723

 

(1)	includes impaired loans and leases

The carrying amounts and estimated fair values of financial instruments at December 31, 2011 are as follows (in thousands):

 

		Estimated Fair  Value				Carrying Amount
Financial Assets:
Cash and cash equivalents		$	52,802			$	52,802
FHLB and FRB stock			N/A				8,478
Loans held for sale			1,217				1,217
Net loans and leases (1)			907,357				861,952
Accrued interest receivable			3,960				3,960
Financial Liabilities:
Deposits		$	1,085,608			$	1,083,065
Borrowings			143,150				136,310
Junior subordinated obligations			10,979				25,774
Accrued interest payable			1,578				1,578

 

(1)	includes impaired loans and leases

The fair value of commitments to extend credit and standby letters of credit is not significant.

Alliance’s fair value estimates are based on our existing on and off balance sheet financial instruments without attempting to estimate the value of any anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on our fair value estimates and have not been considered in these estimates.

The fair value estimates are made as of a specific point in time, based on relevant market information and information about the financial instruments, including our judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in our assumptions could significantly affect the estimates.

 

20

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

The Company used the following methods and assumptions in estimating our fair value disclosures for financial instruments:

Cash and Cash Equivalents

The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets’ fair value and are classified as Level 1.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its transferability.

Loans and Leases

The fair value of our fixed-rate and adjustable-rate loans and leases were calculated by discounting scheduled cash flows through the estimated maturity using current origination rates, credit adjusted for delinquent loans and leases resulting in a Level 3 classification. Our estimate of maturity is based on the contractual cash flows adjusted for prepayment estimates based on current economic and lending conditions. The fair value of loans held for sale approximates carrying value resulting in a Level 2 classification.

Accrued Interest Receivable

The fair value of accrued interest approximates carrying value. The fair value level classification is consistent with the related financial instrument.

Deposits

The fair values disclosed for non-interest-bearing accounts and accounts with no stated maturity are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The fair value of time deposits was estimated by discounting expected monthly maturities at interest rates approximating those currently being offered at the FHLB on similar terms resulting in a Level 2 classification.

Borrowings

The fair value of borrowings are estimated using discounted cash flow analysis, based on interest rates approximating those currently being offered for borrowings with similar terms resulting in a Level 2 classification.

Junior Subordinated Obligations

The fair value of trust preferred debentures has been estimated using a discounted cash flow analysis to maturity resulting in a Level 3 classification.

Accrued Interest Payable

The fair value of accrued interest approximates carrying value. The fair value level classification is consistent with the related financial instrument.

Off-Balance-Sheet Instruments

Off-balance-sheet financial instruments consist of commitments to extend credit and standby letters of credit, with fair value based on fees currently charged to enter into agreements with similar terms and credit quality. Amounts are not significant.

 

21

---

Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements

 

8.	Subsequent Event

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

 

22

---

Table of Contents

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Highlights and Overview

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

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

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

Pending Merger

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

Recent Legislative Updates

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

 

23

---

Table of Contents

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

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

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

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

General

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

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

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

Net Interest Income

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

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

 

24

---

Table of Contents

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

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

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

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

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

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

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

 

25

---

Table of Contents

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

 

26

---

Table of Contents

Average Balance Sheet and Net Interest Analysis

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

 

		For the three months ended September 30,
		2012												2011
		Average Balance				Interest Earned/ Paid				Yield Rate				Average Balance				Interest Earned/ Paid				Yield Rate
		(Dollars in thousands)
Assets:
Interest earning assets:
Federal funds sold and interest bearing deposits		$	50,376			$	28				0.22	%		$	3,310			$	—				0.06	%
Taxable investment securities			261,090				1,501				2.30	%			354,363				2,775				3.13	%
Nontaxable investment securities			69,035				951				5.50	%			80,086				1,111				5.55	%
FHLB and FRB stock			7,977				95				4.75	%			9,759				104				4.25	%
Residential real estate loans (1)			325,720				3,952				4.85	%			331,977				4,314				5.20	%
Commercial loans			134,037				1,427				4.26	%			125,697				1,377				4.38	%
Nontaxable commercial loans			12,171				173				5.67	%			8,811				121				5.48	%
Commercial real estate			128,719				1,707				5.30	%			120,059				1,600				5.33	%
Taxable leases (net of unearned discount)			4,272				76				7.15	%			19,770				294				5.95	%
Nontaxable leases (net of unearned discount)			8,119				133				6.54	%			11,220				182				6.47	%
Indirect auto loans			194,717				1,541				3.17	%			162,439				1,757				4.33	%
Consumer loans			88,522				821				3.72	%			91,087				906				3.98	%
Total interest-earning assets		$	1,284,755			$	12,405				3.86	%		$	1,318,578			$	14,541				4.41	%
Non-interest earning assets:
Other assets			135,043												131,530
Less: Allowance for credit losses			(8,866	)											(10,711	)
Net unrealized gains on securities available-for-sale			11,999												11,263
Total assets		$	1,422,931											$	1,450,660
Liabilities and shareholders’ equity:
Interest bearing liabilities:
Demand deposits		$	155,062			$	30				0.08	%		$	139,035			$	49				0.14	%
Savings deposits			117,732				30				0.10	%			108,969				54				0.20	%
MMDA deposits			358,951				249				0.28	%			346,779				377				0.44	%
Time deposits			263,632				812				1.23	%			332,054				1,404				1.69	%
Borrowings			127,210				734				2.31	%			160,943				1,022				2.54	%
Junior subordinated obligations issued to unconsolidated trusts			25,774				170				2.64	%			25,774				158				2.45	%
Total interest-bearing liabilities		$	1,048,361			$	2,025				0.77	%		$	1,113,554			$	3,064				1.10	%
Non-interest bearing liabilities:
Demand deposits			213,883												183,920
Other liabilities			16,083												15,957
Shareholders’ equity			144,604												137,229
Total liabilities and shareholders’ equity		$	1,422,931											$	1,450,660
Net interest income						$	10,380											$	11,477
Net interest rate spread											3.09	%											3.31	%
Net interest margin											3.23	%											3.48	%
Federal tax exemption on non-taxable investment securities, loans and leases included in interest income							(426	)											(480	)
Net interest income						$	9,954											$	10,997

 

(1)	Includes loans held-for-sale

 

27

---

Table of Contents

		For the nine months ended September 30,
		2012												2011
		Average Balance				Interest Earned/ Paid				Yield Rate				Average Balance				Interest Earned/ Paid				Yield Rate
		(Dollars in thousands)
Assets:
Interest earning assets:
Federal funds sold and interest bearing deposits		$	58,175			$	103				0.24	%		$	8,124			$	5				0.09	%
Taxable investment securities			265,167				4,970				2.50	%			358,394				8,521				3.17	%
Nontaxable investment securities			73,740				3,046				5.51	%			80,110				3,381				5.63	%
FHLB and FRB stock			8,093				305				5.03	%			8,963				328				4.88	%
Residential real estate loans (1)			319,769				11,876				4.95	%			331,727				12,980				5.22	%
Commercial loans			133,983				4,244				4.22	%			121,437				3,966				4.35	%
Nontaxable commercial loans			12,010				515				5.71	%			9,104				359				5.25	%
Commercial real estate			127,336				5,009				5.25	%			118,615				4,862				5.47	%
Taxable leases (net of unearned discount)			7,586				342				6.01	%			23,293				1,031				5.90	%
Nontaxable leases (net of unearned discount)			9,268				448				6.45	%			11,961				577				6.43	%
Indirect auto loans			179,188				4,663				3.47	%			167,649				5,569				4.43	%
Consumer loans			88,608				2,501				3.76	%			90,596				2,706				3.98	%
Total interest-earning assets		$	1,282,923			$	38,022				3.95	%		$	1,329,973			$	44,285				4.44	%
Non-interest earning assets:
Other assets			134,757												132,458
Less: Allowance for credit losses			(9,652	)											(10,815	)
Net unrealized gains on securities available-for-sale			11,765												8,184
Total assets		$	1,419,793											$	1,459,800
Liabilities and shareholders’ equity:
Interest bearing liabilities:
Demand deposits		$	152,660			$	96				0.08	%		$	148,445			$	179				0.16	%
Savings deposits			113,275				85				0.10	%			106,527				166				0.21	%
MMDA deposits			363,154				779				0.29	%			368,670				1,271				0.46	%
Time deposits			276,668				2,843				1.37	%			337,480				4,337				1.71	%
Borrowings			128,820				2,542				2.63	%			145,895				3,105				2.84	%
Junior subordinated obligations issued to unconsolidated trusts			25,774				514				2.66	%			25,774				473				2.44	%
Total interest-bearing liabilities		$	1,060,351			$	6,859				0.86	%		$	1,132,791			$	9,531				1.12	%
Non-interest bearing liabilities:
Demand deposits			200,399												178,124
Other liabilities			16,545												15,814
Shareholders’ equity			142,498												133,071
Total liabilities and shareholders’ equity		$	1,419,793											$	1,459,800
Net interest income (tax-equivalent)						$	31,163											$	34,754
Net interest rate spread											3.09	%											3.32	%
Net interest margin (tax-equivalent)											3.24	%											3.49	%
Federal tax exemption on non-taxable investment securities, loans and leases included in interest income							(1,363	)											(1,468	)
Net interest income						$	29,800											$	33,286

 

(1)	Includes loans held-for-sale

 

28

---

Table of Contents

Rate/Volume Analysis

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

 

		For the three months ended September 30, 2012 Compared to September 30, 2011 Increase/(Decrease) Due To												For the nine months ended September 30, 2012 Compared to September 30, 2011 Increase/(Decrease) Due To
		Volume				Rate				Net Change				Volume				Rate				Net Change
Federal funds sold		$	24			$	4			$	28			$	74			$	24			$	98
Taxable investment securities			(635	)			(639	)			(1,274	)			(1,959	)			(1,592	)			(3,551	)
Non-taxable investment securities			(150	)			(10	)			(160	)			(264	)			(71	)			(335	)
FHLB and FRB stock			(65	)			56				(9	)			(38	)			15				(23	)
Residential real estate loans			(79	)			(283	)			(362	)			(453	)			(651	)			(1,104	)
Commercial loans			249				(199	)			50				461				(183	)			278
Non-taxable commercial loans			48				4				52				122				34				156
Commercial real estate			166				(59	)			107				432				(285	)			147
Taxable leases (net of unearned income)			(551	)			333				(218	)			(720	)			31				(689	)
Non-taxable leases (net of unearned income)			(62	)			13				(49	)			(132	)			3				(129	)
Indirect auto loans			1,513				(1,729	)			(216	)			558				(1,464	)			(906	)
Consumer loans			(26	)			(59	)			(85	)			(58	)			(147	)			(205	)
Total interest-earning assets			432				(2,568	)			(2,136	)			(1,977	)			(4,286	)			(6,263	)
Interest-bearing demand deposits			31				(50	)			(19	)			8				(91	)			(83	)
Savings deposits			27				(51	)			(24	)			17				(98	)			(81	)
MMDA deposits			86				(214	)			(128	)			(19	)			(473	)			(492	)
Time deposits			(255	)			(337	)			(592	)			(710	)			(784	)			(1,494	)
Borrowings			(201	)			(87	)			(288	)			(345	)			(218	)			(563	)
Junior subordinated obligations issued to unconsolidated subsidiary trusts			—				12				12				—				41				41
Total interest-bearing liabilities			(312	)			(727	)			(1,039	)			(1,049	)			(1,623	)			(2,672	)
Net interest income (tax-equivalent)		$	744			$	(1,841	)		$	(1,097	)		$	(928	)		$	(2,663	)		$	(3,591	)

Asset Quality and the Allowance for Credit Losses

The following table summarizes delinquent loans and leases grouped by the number of days delinquent at the dates indicated:

 

Delinquent loans and leases		September 30, 2012								June 30, 2012								December 31, 2011
		$				% (1)				$				% (1)				$				% (1)
		(Dollars in thousands)
30 days past due		$	4,152				0.46	%		$	5,220				0.58	%		$	5,202				0.60	%
60 days past due			1,812				0.20	%			732				0.08	%			584				0.06	%
90 days past due and still accruing			—				—				—				—				—				—
Non-accrual			4,104				0.46	%			6,660				0.75	%			11,287				1.30	%
Total		$	10,068				1.12	%		$	12,612				1.41	%		$	17,073				1.96	%

 

(1)	As a percentage of total loans and leases, excluding deferred costs

 

29

---

Table of Contents

The following table represents information concerning the aggregate amount of non-performing assets (in thousands):

 

		September 30, 2012				June 30, 2012				December 31, 2011
Non-accruing loans and leases:
Residential real estate		$	2,302			$	2,549			$	3,062
Commercial loans			579				1,464				3,401
Commercial real estate			505				1,879				4,051
Leases			52				74				107
Indirect auto			220				288				293
Other consumer loans			446				406				373
Total non-accruing loans and leases			4,104				6,660				11,287
Accruing loans and leases delinquent 90 days or more			—				—				—
Total non-performing loans and leases			4,104				6,660				11,287
Other real estate and repossessed assets			985				51				485
Total non-performing assets		$	5,089			$	6,711			$	11,772

Delinquent loans and leases (including non-performing) decreased to $10.1 million at September 30, 2012, compared to $12.6 million at June 30, 2012 and $17.1 million at December 31, 2011. The largest decline in delinquent loans in the third quarter occurred in loans delinquent 90 days or more or on non-accrual status, which declined $2.6 million or 38.4% from the end of the second quarter. Non-performing assets were $5.1 million or 0.35% of total assets compared with $6.7 million or 0.47% of total assets at June 30, 2012 and $11.8 million or 0.84% of total assets at December 31, 2011. The decline in non-performing assets in the third quarter resulted primarily from non-accrual loans returning to accrual status during the quarter as a result of satisfactory payment performance, charge-offs and pay-offs of non-performing loans. Included in non-performing assets at the end of the third quarter are non-performing loans and leases totaling $4.1 million, compared with $6.7 million at June 30, 2012 and $11.3 million at December 31, 2011.

Conventional residential mortgages comprised $2.3 million (37 loans) or 56.1% of non-performing loans and leases, and commercial loans and mortgages totaled $1.1 million (17 loans) or 26.4% of non-performing loans and leases at the end of the third quarter.

As a recurring part of our portfolio management program, we identified approximately $8.9 million in potential problem loans at September 30, 2012, compared with $8.1 million in potential problem loans at June 30, 2012 and $10.2 million at December 31, 2011. Potential problem loans are loans that are currently performing, but where the borrower’s operating performance or other relevant factors could result in potential credit problems, and are typically classified by our loan rating system as “substandard.” At September 30, 2012, potential problem loans primarily consisted of commercial real estate, commercial loans and leases. There can be no assurance that additional loans will not become non-performing, require restructuring, or require increased provision for loan losses.

We have a loan and lease monitoring program that evaluates non-performing loans and leases and the loan and lease portfolio in general. The loan and lease review program audits the loan and lease portfolio to confirm management’s loan and lease risk rating system, and systematically tracks such problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses.

The allowance for credit losses represents management’s best estimate of probable incurred losses in our loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease portfolio segment. Our portfolio segments are as follows: commercial loan and commercial real estate loans, commercial leases, residential real estate, indirect consumer loans and other consumer loans. Our allowance for credit losses consists of specific valuation allowances based on probable incurred credit losses on specific loans, historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends and general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the organization.

Historical valuation allowances are calculated for commercial loans and leases based on the historical loss experience of specific types of loans and leases and the internal risk grade 24 months prior to the time they were charged off. The internal credit risk grading process evaluates, among other things, the borrower’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. Historical valuation allowances for residential real estate and consumer loan segments are based on the average loss rates for each class of loans for the time period that includes the current year and two full prior years. We calculate historical loss ratios for pools of similar consumer loans based upon the product of the historical loss ratio and the principal balance of the loans in the pool. Historical loss ratios are updated quarterly based on actual loss experience. Our general valuation allowances are based on general economic conditions and other

 

30

---

Table of Contents

qualitative risk factors which affect our Company. Factors considered include trends in our delinquency rates, macro-economic and credit market conditions, changes in asset quality, changes in loan and lease portfolio volumes, concentrations of credit risk, the changes in internal loan policies, procedures and internal controls, experience and effectiveness of lending personnel. Management evaluates the degree of risk that each one of these components has on the quality of the loan and lease portfolio on a quarterly basis.

During the third quarter of 2012, we added a qualitative factor to address the potential risk of credit losses that could result from conversion related distractions and potential turnover that may occur in connection with the merger with NBT, and the potential effects on the underwriting processes and relationship management. Management believes the development of a qualitative factor for this potential risk is appropriate since the risk of such negative events occurring cannot be eliminated. Management is committed to the continuation of loan portfolio monitoring and underwriting standards that was in place prior to the merger announcement. The merger related qualitative factor increased our qualitative allocation by $274,000.

For commercial loan and lease segments, we maintain a specific allocation methodology for those classified in our internal risk grading system as substandard, doubtful or loss with a principal balance in excess of $200,000. A loan or lease is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on the estimated fair value of the collateral. Loans with modified terms in which a concession to the borrower has been made that we would not otherwise consider unless the borrower was experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. As of September 30, 2012, there were $3.6 million in impaired loans for which $57,000 in related allowance for credit losses was allocated. There were $9.1 million in impaired loans for which $2.1 million in related allowance for credit losses was allocated as of December 31, 2011.

Loans and leases are charged against the allowance for credit losses, in accordance with our loan and lease policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for probable incurred losses, a direct charge to operating income is recorded.

The following table summarizes changes in the allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense (in thousands):

 

		Three months ended September 30,								Nine months ended September 30,
		2012				2011				2012				2011
Balance at beginning of year		$	8,892			$	10,683			$	10,769			$	10,683
Loans and leases charged-off:
Residential real estate			(12	)			—				(102	)			(150	)
Commercial loans			(211	)			(1	)			(1,852	)			(56	)
Commercial real estate			(156	)			(80	)			(281	)			(80	)
Leases			—				(15	)			—				(331	)
Indirect auto			(16	)			(105	)			(126	)			(243	)
Consumer			(226	)			(310	)			(617	)			(704	)
Total loans and leases charged off			(621	)			(511	)			(2,978	)			(1,564	)
Recoveries of loans and leases previously charged off:
Residential real estate			3				3				13				42
Commercial loans			10				14				268				125
Commercial real estate			4				—				8				5
Leases			45				178				257				365
Indirect auto			25				73				101				150
Consumer			125				104				345				378
Total recoveries			212				372				992				1,065
Net loans and leases charged off			(409	)			(139	)			(1,986	)			(499	)
Provision for credit losses			—				750				(300	)			1,110
Balance at end of year		$	8,483			$	11,294			$	8,483			$	11,294

 

31

---

Table of Contents

Net charge-offs were $409,000 and $2.0 million in the three months and nine months ended September 30, 2012, respectively, compared with $139,000 and $499,000 in the year-ago periods, respectively. Charge-offs for the third quarter included a $365,000 write down of a $1.3 million commercial relationship to the real estate collateral’s estimated fair value, which was foreclosed on and transferred to other real estate owned in the third quarter. This commercial relationship was placed on non-performing status in the third quarter of 2011, with a total outstanding balance at that time of $3.6 million. As was previously disclosed in our 2011 Form 10-K and quarterly reports on Form 10-Q, we recorded write-downs on this relationship totaling $2.3 million between the fourth quarter of 2011 and the second quarter of 2012. Approximately $1.5 million or 52% of the gross charge-offs recognized in the first nine months of 2012 were on loans that were considered impaired at the end of 2011 and for which impairment reserves were largely established due to the identification of probable “loss events” in the fourth quarter of 2011. Charge-offs on these impaired credits were recognized in 2012 upon the occurrence of events confirming the existence of the losses, including further deterioration in the respective borrower’s financial condition and negotiated settlements. A substantial portion of the allowance allocated to these impaired credits in 2011 came from the release of a portion of the general allowance for our lease portfolio. During 2011, approximately $1.2 million of the allowance that had been allocated from our lease portfolio prior to 2011 was released due to a substantial decline in charge-offs in our lease portfolio in 2011 compared with 2010 and 2009 (the years in which provisions for possible lease losses were charged to earnings) and to a $16.8 million decrease in the balance of that portfolio during 2011.

Net charge-offs (annualized) equaled 0.18% and 0.30% of average loans and leases in the three months and nine months ended September 30, 2012, respectively, compared to 0.06% and 0.08%, respectively, in the year ago periods. Gross charge-offs were $621,000 and recoveries were $212,000 in the third quarter of 2012. Our annualized net charge-off rate has averaged 0.31% over the past five quarters, of which all but 7 basis points is attributable to the losses recognized in 2012 on the previously mentioned

$3.6 million commercial relationship.

No provision for credit losses was recorded in the third quarter compared to a negative provision expense of $300,000 in the second quarter, and provision expense of $750,000 in the year-ago quarter. The provision for credit losses as a percentage of net charge-offs was 0% in the third quarter of 2012. The provision for credit losses as a percentage of net charge-offs was not meaningful for the nine months ended September 30, 2012 due to the negative provision that was recorded in that quarter. The provision for credit losses as a percentage of net charge-offs was 103.2% and 100.0%, respectively, in the quarter and nine months ended September 30, 2011. The high level of provision as a percentage of net charge-offs in the third quarter of 2011 resulted primarily from the establishment of an impairment allowance on the $3.6 million commercial relationship previously discussed.

The allowance for credit losses was $8.5 million at September 30, 2012, compared with $8.9 million at June 30, 2012 and $10.8 million at December 31, 2011. The ratio of the allowance for credit losses to total loans and leases was 0.94% at September 30, 2012, compared with 0.99% at June 30, 2012 and 1.24% at December 31, 2011. The ratio of the allowance for credit losses to non-performing loans and leases was 207% at September 30, 2012, compared with 134% at June 30, 2012 and 96% at December

31, 2011.

As discussed above, we assess a number of quantitative and qualitative factors at the individual portfolio level in determining the adequacy of the allowance for credit losses and the required provision expense each quarter. In addition, we analyze certain broader, non-portfolio specific factors in assessing the adequacy of the allowance for credit losses, such as the allowance as a percentage of total loans and leases, the allowance as a percentage of non-performing loans and leases and the provision expense as a percentage of net charge-offs. This portion of the allowance has been considered “unallocated,” which means it is not based on either quantitative or qualitative factors. At September 30, 2012, $698,000 or 8.2% of the allowance for credit losses was considered to be “unallocated,” compared to $991,000 or 9% at December 31, 2011. Consistent with the improvement in the our asset quality metrics and net charge-off levels in recent quarters (excluding the charge-offs related to the $3.6 million commercial relationship discussed above), the relative level of unallocated allowance to the total allowance has trended downward each quarter in 2012. Absent any material deterioration in credit quality or material growth in the loan and lease portfolio, some portion of this “unallocated” allowance may be reduced by future probable credit losses, if any, which would have the effect of lowering the amount of provision expense relative to net charge-offs compared with past quarters, which was the case in the third quarter of 2012.

 

32

---

Table of Contents

The following table presents certain asset quality ratios for the periods indicated:

 

		For three months ended September 30,								For nine months ended September 30,
		2012				2011				2012				2011
Net loans and leases charged-off to average loans and leases, annualized			0.18	%			0.06	%			0.30	%			0.08	%
Provision for credit losses to average loans and leases, annualized			—	%			0.34	%			(0.05	)%			0.17	%
Allowance for credit losses to period-end loans and leases			0.94	%			1.30	%			0.94	%			1.30	%
Allowance for credit losses to non-performing loans and leases			206.7	%			92.60	%			206.7	%			92.60	%
Non-performing loans and leases to period-end loans and leases			0.46	%			1.40	%			0.46	%			1.40	%
Non-performing assets to period-end assets			0.35	%			0.90	%			0.35	%			0.90	%

Non-interest Income

The following table sets forth certain information on non-interest income for the periods indicated, dollars in thousands:

 

		Three months ended September 30,																Nine months ended September 30,
										Change																Change
		2012				2011				$				%				2012				2011				$				%
Investment management income		$	1,831			$	1,948			$	(117	)			(6.0	)%		$	5,636			$	5,850			$	(214	)			(3.7	)%
Service charges on deposit accounts			1,074				1,194				(120	)			(10.1	)%			3,167				3,299				(132	)			(4.0	)%
Card-related fees			688				687				1				0.1	%			2,059				2,039				20				1.0	%
Bank-owned life insurance			250				258				(8	)			(3.1	)%			742				768				(26	)			(3.4	)%
Gain on the sale of loans			508				245				263				107.3	%			1,214				621				593				95.5	%
Gain on sale of securities			—				1,325				(1,325	)			(100.0	)%			—				1,325				(1,325	)			(100.0	)%
Other non-interest income			233				262				(29	)			(11.1	)%%			767				1,038				(271	)			(26.1	)%
Total non-interest income		$	4,584			$	5,919			$	(1,335	)			22.6	%		$	13,585			$	14,940			$	(1,355	)			(9.1	)%

Non-interest income was $4.6 million in the third quarter of 2012, compared with $5.9 million in the year-ago quarter. We did not sell securities in the third quarter of 2012 and therefore gains on sales of investment securities decreased $1.3 million compared with the third quarter of 2011. Gains on the sale of loans increased $263,000 compared with the third quarter of 2011 due to higher volumes of mortgages originated and sold in 2012.

Non-interest income (excluding gains on securities sales) accounted for 31.5% of total revenue in the third quarter of 2012, compared with 29.5% in the year-ago quarter. Non-interest income (excluding gains on securities sales) accounted for 31.3% of total revenue in the first nine months of 2012, compared with 29.0% in the year-ago period.

 

33

---

Table of Contents

Non-interest Expenses

The following table sets forth certain information on non-interest expenses for the periods indicated, dollars in thousands:

 

		For three months ended September 30,																For nine months ended September 30,
										Change																Change
		2012				2011				$				%				2012				2011				$				%
Salaries and benefits		$	5,761			$	5,573			$	188				3.4	%		$	17,103			$	16,407			$	696				4.2	%
Occupancy and equipment			1,770				1,833				(63	)			(3.4	)%			5,365				5,479				(114	)			(2.1	)%
Communication expense			153				124				29				23.4	%			469				448				21				4.7	%
Office supplies and postage			298				283				15				5.3	%			905				868				37				4.3	%
Marketing expense			152				193				(41	)			(21.2	)%			651				673				(22	)			(3.3	)%
Amortization of intangible assets			222				241				(19	)			(7.9	)%			665				722				(57	)			(7.9	)%
Professional fees			1,615				736				879				119.4	%			3,220				2,420				800				33.1	%
FDIC insurance			216				49				167				340.8	%			642				844				(202	)			(23.9	)%
Other operating expenses			1,526				2,107				(581	)			(27.6	)%			4,598				5,080				(482	)			(9.5	)%
Total operating expenses		$	11,713			$	11,139			$	574				5.2	%		$	33,618			$	32,941				677				2.1	%

Non-interest expenses were $11.7 million in the quarter ended September 30, 2012, compared with $11.1 million in the year-ago quarter and $11.0 million in the second quarter of 2012. Other operating expenses in 2011 included a $555,000 write-down of a vacant bank-owned building to its estimated fair value. FDIC insurance expense increased $167,000 compared with the year-ago quarter primarily due to an adjustment to the prepaid FDIC insurance assessment in the third quarter of 2011 in connection with the change by the FDIC to an asset-based assessment system, which became effective in the second quarter of 2011. Merger related costs (pre-tax) of $991,000 were incurred in the third quarter of 2012 and are included in professional fees. We expect additional merger costs to lower our earnings in the quarters leading up to the close of the transaction. Non-interest expenses were $33.6 million in the nine months ended September 30, 2012, compared with $32.9 million in the first nine months of 2011.

Our efficiency ratio was 80.6% in the third quarter of 2012, compared with 71.5% in the year-ago quarter. Our efficiency ratio was 77.5% in the nine months ended September 30, 2012, compared with 70.2% in the year-ago period. Excluding the merger related costs, the efficiency ratio was 73.8% and 75.2%, respectively, for the three and nine month period ending September 30, 2012.

Income Taxes

Our effective tax rate was 19.1% and 22.1% for the three and nine months ended September 30, 2012, respectively, compared with 27.1% and 26.3% in the year-ago periods, respectively. The decrease in our effective tax rate from 2011 was due to a higher level of tax-exempt income as a percentage to total taxable income.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

General

Total assets were $1.4 billion at September 30, 2012, which was an increase of $37.0 million from December 31, 2011. Total loans and leases (net of unearned income) increased $7.9 million in the third quarter to $906.4 million at September 30, 2012.

Securities

Investment securities totaled $343.2 million at September 30, 2012, compared with $374.3 million at December 31, 2011. Our portfolio is comprised entirely of investment grade securities, the majority of which are rated “AAA” by one or more of the nationally recognized rating agencies. The breakdown of the securities portfolio at September 30, 2012 was 77.1% government-sponsored entity guaranteed mortgage-backed securities, 21.5% municipal securities and 0.4% obligations of U.S. government-sponsored corporations. Mortgage-backed securities, which totaled $264.6 million at September 30, 2012, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the U.S. government. Our municipal securities portfolio, which totaled $74.0 million at the end of the third quarter, is primarily comprised of highly rated general obligation bonds issued by local municipalities in New York State.

 

34

---

Table of Contents

We had net unrealized gains of approximately $12.4 million in our securities portfolio at September 30, 2012, compared with net unrealized gains of $11.2 million at December 31, 2011.

Loans and Leases

Total loans and leases, net of unearned income and deferred costs, were $906.4 million at September 30, 2012 compared with $898.5 million at June 30, 2012 and $872.7 million at December 31, 2011. Loan origination volumes in the third quarter increased $27.0 million, or 45%, to $86.5 million, compared with $59.5 million in the year-ago quarter on increased demand in each of our commercial, residential mortgage and indirect lending businesses.

Residential mortgages outstanding increased $6.6 million in the third quarter to $327.5 million. Originations of residential mortgages totaled $38.9 million in the third quarter of 2012, compared with $30.5 million in the year-ago quarter. We retained in portfolio approximately $17.7 million of the third quarter originations that were bi-weekly payment mortgages or monthly payment mortgages with maturities of 15 years or less.

Commercial loans and mortgages decreased $8.6 million in the third quarter and totaled $274.5 million at September 30, 2012, as a $4.9 million decrease in existing lines of credit offset a solid quarter of new loan production. Originations of commercial loans and mortgages in the third quarter (excluding lines of credit) totaled $12.5 million, compared with $10.3 million in the year-ago quarter.

Leases (net of unearned income) decreased $1.8 million in the third quarter as a result of our previously announced decision to cease new lease originations.

Indirect auto loan balances were $199.4 million at the end of the third quarter, which was an increase of $10.7 million from the end of the second quarter of 2012. We originated $33.7 million of indirect auto loans in the third quarter, compared with $17.9 million in the year-ago quarter. The increase in originations this year is attributable to a change in the rate structure designed to increase our market share without lowering its underwriting standards, along with the implementation of an electronic application system. We originate auto loans through a network of reputable, well-established automobile dealers located in central and western New York. Applications received through our indirect lending program are subject to the same comprehensive underwriting criteria and procedures as employed in its direct lending programs.

The following table sets forth the composition of our loan and lease portfolio at the dates indicated, with dollars in thousands:

 

		September 30, 2012				Percent				December 31, 2011				Percent
Residential real estate		$	327,454				36.3	%		$	316,823				36.4	%
Commercial loans			147,677				16.4	%			151,420				17.4	%
Commercial real estate			126,783				14.1	%			126,863				14.6	%
Leases (net of unearned income)			11,811				1.3	%			25,636				3.0	%
Indirect auto			199,419				22.1	%			158,813				18.3	%
Other consumer loans			88,739				9.8	%			89,776				10.3	%
			901,883				100.0	%			869,331				100.0	%
Net deferred loan costs			4,500								3,390
Total loans and leases			906,383								872,721
Allowance for credit losses			(8,483	)							(10,769	)
Net loans and leases		$	897,900							$	861,952

Deposits

Deposits increased $19.8 million in the third quarter, and were $1.1 billion at September 30, 2012. Low-cost transaction accounts comprised 77.1% of total deposits at the end of the third quarter, compared with 75.6% at June 30, 2012. Our liability mix remained favorably weighted towards transaction accounts in the third quarter as retail and municipal depositors continue to prefer transaction accounts over time accounts in the low interest rate environment, and also because of the buildup of cash on commercial customers’ balance sheets.

 

35

---

Table of Contents

The following table sets forth the composition of our deposits by business line at the dates indicated, dollars in thousands:

 

		September 30, 2012
		Retail				Commercial				Municipal				Total				Percent
Non-interest checking		$	53,903			$	152,468			$	6,066			$	212,437				18.9	%
Interest checking			112,495				18,213				28,972				159,680				14.2	%
Total checking			166,398				170,681				35,038				372,117				33.1	%
Savings			98,949				12,369				3,911				115,229				10.2	%
Money market			96,933				140,568				143,122				380,623				33.8	%
Time deposits			179,595				22,195				56,644				258,434				22.9	%
Total deposits		$	541,875			$	345,813			$	238,715			$	1,126,403				100.0	%
		December 31, 2011
		Retail				Commercial				Municipal				Total				Percent
Non-interest checking		$	46,580			$	135,252			$	3,904			$	185,736				17.1	%
Interest checking			110,886				16,831				18,168				145,885				13.5	%
Total checking			157,466				152,083				22,072				331,621				30.6	%
Savings			92,240				11,367				3,704				107,311				9.9	%
Money market			88,056				122,195				119,749				330,000				30.5	%
Time deposits			237,929				26,907				49,297				314,133				29.0	%
Total deposits		$	575,691			$	312,552			$	194,822			$	1,083,065				100.0	%

Liquidity

Alliance’s liquidity primarily reflects the Bank’s ability to provide funds to meet loan and lease fundings, to accommodate possible outflows in deposits, to take advantage of market interest rate opportunities, and to pay dividends to Alliance. Funding loan and lease commitments, providing for deposit outflows, settling other liabilities when they come due and managing of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and leases and investments with specific types of deposits, borrowings and other liabilities. Liquidity is normally considered in terms of the nature and mix of the Bank’s sources and uses of funds. Our Asset Liability Committee (“ALCO”) is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. As of September 30, 2012, liquidity as measured by the Bank is in compliance with and exceeds its policy guidelines.

Our principal sources of funds for operations are cash flows generated from earnings, deposit inflows, loan and lease repayments, investment amortization and maturities, borrowings from the Federal Home Loan Bank of New York (“FHLB”), and securities sold under repurchase agreements. During the nine months ended September 30, 2012, cash and cash equivalents increased by $35.9 million. Net cash provided by operating and financing activities totaling $42.9 million were partly offset by net cash used in investing activities of $7.0 million. Net cash provided by financing activities in the first nine months of 2012 principally reflects a $43.3 million net increase in deposits, partly reduced by a net decrease in borrowings of $9.2 million and cash dividends of $4.4 million. Net cash from operating activities was primarily provided by net income in the amount of $7.8 million and proceeds from sale of loans and leases held-for-sale of $46.8 million, partly reduced by originations of loans held-for-sale of $45.1 million. Net cash used in investing activities primarily resulted from a net increase in loans of $36.7 million partly reduced by $29.4 million in maturities, sales and principal repayments.

As a member of the FHLB, we are eligible to borrow up to a specific credit limit which is determined by the amount of our residential mortgages, commercial mortgages and investment securities that have been pledged as collateral. As of September 30, 2012, our credit limit with the FHLB was $312.2 million. The total of our outstanding borrowings from the FHLB on that date was $100.0 million.

We had a $160.7 million line of credit at September 30, 2012 with the Federal Reserve Bank of New York through its Discount Window. We have pledged indirect auto loans and investment securities totaling $194.7 million and $4.3 million, respectively, at September 30, 2012. At September 30, 2012, we also had available $62.5 million of unsecured federal funds lines of credit with other financial institutions. We did not draw any amounts on any of these lines during the quarter other than an overnight test to confirm their availability. There were no amounts outstanding on any of these lines at September 30, 2012.

 

36

---

Table of Contents

Capital Resources

We use certain non-GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. We believe TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a company’s financial condition and capital strength. TCE, as defined by us, represents common equity less goodwill and intangible assets. A reconciliation from the our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio is presented below, dollars in thousands:

 

		September 30, 2012
Total assets		$	1,446,040
Less: Goodwill and intangible assets, net			37,873
Tangible assets (non-GAAP)		$	1,408,167
Total Common Equity			148,378
Less: Goodwill and intangible assets, net			37,873
Tangible Common Equity (non-GAAP)			110,505
Total Equity/Total Assets			10.26	%
Tangible Common Equity/Tangible Assets (non-GAAP)			7.85	%

Shareholders’ equity was $148.4 million at September 30, 2012, compared with $146.8 million at June 30, 2012. Net income increased shareholders’ equity by $2.3 million during the quarter which was partially offset by dividends declared of $1.5 million or $0.32 per common share.

The Bank’s Tier 1 leverage ratio was 9.38% and its total risk-based capital ratio was 15.75% at the end of the third quarter, both of which comfortably exceeded the regulatory thresholds required to be classified as a “well-capitalized” institution, which are 5.0% and 10.0%, respectively. As provided above, our tangible common equity capital ratio was 7.85% at September 30, 2012.

Alliance and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require Alliance and its subsidiary bank to maintain minimum amounts and ratios (set forth in the following tables) of total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 Capital (as defined) to average assets (as defined).

As of December 31, 2011, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as “well-capitalized,” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the tables below. Management believes that, as of September 30, 2012, Alliance and the Bank met all capital adequacy requirements to which they were subject.

 

37

---

Table of Contents

The following table compares our actual capital amounts and ratios with those needed to qualify for the “well-capitalized” category, which is the highest capital category as defined in the regulations, dollars in thousands:

 

		Actual								For Capital Adequacy Purposes								To Be Well-Capitalized Under Prompt Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of September 30, 2012
Total risk-based capital
Alliance		$	139,216				15.79	%		$	70,538			³	8.00	%			N/A				N/A
Bank			130,856				14.94	%			70,087			³	8.00	%			87,609				³ 10.00	%
Tier 1 capital
Alliance			130,656				14.82	%			35,269			³	4.00	%			N/A				N/A
Bank			122,296				13.96	%			35,043			³	4.00	%			52,565				³ 6.00	%
Leverage
Alliance			130,656				9.43	%			55,435			³	4.00	%			N/A				N/A
Bank			122,296				8.86	%			55,208			³	4.00	%			69,010				³ 5.00	%
As of December 31, 2011
Total risk-based capital
Alliance		$	137,273				15.97	%		$	68,749			³	8.00	%			N/A				N/A
Bank			128,479				15.05	%			68,277			³	8.00	%			85,347				³ 10.00	%
Tier 1 capital
Alliance			126,481				14.72	%			34,374			³	4.00	%			N/A				N/A
Bank			117,759				13.80	%			34,139			³	4.00	%			51,208				³ 6.00	%
Leverage
Alliance			126,481				9.09	%			55,680			³	4.00	%			N/A				N/A
Bank			117,759				8.50	%			55,442			³	4.00	%			69,303				³ 5.00	%

Application of Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP and follow practices accepted within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management.

Our most significant accounting policies are presented in Note 1 to our consolidated financial statements included in the 2011 Annual Report on Form 10-K (the “2011 Consolidated Financial Statements”). These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses, accrued income taxes, and the impairment analysis of goodwill and other intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available.

The allowance for credit losses represents management’s estimate of probable credit losses in the loan and lease portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the 2011 Consolidated Financial Statements describes the methodology used to determine the allowance for credit losses, and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report.

 

38

---

Table of Contents

We account for income taxes using the asset and liability approach. Under this approach, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such amounts are realized or settled. We must assess the likelihood that a portion or all of the deferred tax assets will not be realized. In doing so, judgments and estimates must be made regarding the projection of future taxable income. If necessary, a valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized.

In computing the income tax provision, estimates and assumptions must be made regarding the deductibility of certain expenses. It is possible that these estimates and assumptions may be disallowed as part of an examination by the various taxing authorities that we are subject to, resulting in additional income tax expense in future periods.

In 2011, we performed a qualitative goodwill impairment assessment to determine whether it is more likely than not that the fair value of our reporting unit was less than the carrying amount in accordance with new accounting guidance issued in the current year. In our qualitative assessment analysis we considered several factors including macroeconomic conditions, industry and market considerations, our financial performance and changes in the composition or carrying amount of our reporting unit. In prior years, we utilized significant estimates and assumptions in determining the fair value of our goodwill and intangible assets for purposes of impairment testing. The valuation requires the use of assumptions, including, among others, discount rates, rates of return on assets, account attrition rates and costs of servicing. Impairment testing for goodwill requires that the fair value of each of our reporting units be compared to the carrying amount of its net assets, including goodwill. Determining the fair value of a reporting unit requires us to use a high degree of subjective judgment. We utilize both market-based valuation multiples and discounted cash flow valuation models that incorporate such variables as revenue growth rates, expense trends, interest rates and terminal values. Based upon an evaluation of key data and market factors, we select the specific variables to be incorporated into the valuation model. Future changes in the economic environment or operations of our reporting units could cause changes to these variables, which could result in impairment being identified.

 

39

---

Table of Contents

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. Our market risk arises principally from interest rate risk in its lending, investing, deposit gathering and borrowing activities. Other types of market risks do not arise in the normal course of our business activities.

The Bank’s ALCO is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and manage exposure to interest rate risk. The policies and guidelines established by the ALCO are reviewed and approved by the Company’s Board of Directors annually.

Interest rate risk is monitored primarily through financial modeling of net interest income and net portfolio value estimation (discounted present value of assets minus discounted present value of liabilities). Both measures are highly assumption dependent and change regularly as the balance sheet and interest rates change; however, taken together, they represent a reasonably comprehensive view of the magnitude of interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. The key assumptions employed by these measures are analyzed and reviewed monthly by the ALCO.

The table that follows is provided pursuant to the market risk disclosure rules set forth in Item 305 of Regulation S-K of the SEC. The information provided in the following table is based on significant estimates and assumptions and constitutes, like certain other statements included herein, a forward-looking statement. The base case (no rate change) information in the table shows (1) an estimate of our net portfolio value at September 30, 2012 arrived at by discounting estimated future cash flows at current market rates and (2) an estimate of net interest income for the twelve months ending September 30, 2013 assuming that maturing assets or liabilities are replaced with new balances of the same type, in the same amount, and at current (September 30, 2012) rate levels and repricing balances are adjusted to current (September 30, 2012) rate levels. The rate change information (rate shocks) in the table shows estimates of net portfolio value at September 30, 2012 and net interest income for the twelve months ending September 30, 2013 assuming instantaneous rate changes of up 100, 200, and 300 basis points. Cash flows for non-maturity deposits are based on a decay or runoff rate based on average account age. Rate changes in the rate shock scenario are assumed to be shock or immediate changes and occur uniformly across the yield curve. In projecting future net interest income under the rate shock scenarios, activity is simulated by replacing maturing balances with new balances of the same type, in the same amount, but at the assumed post shock rate levels. Balances that reprice are assumed to reprice at post shock rate levels.

Based on the foregoing assumptions and as depicted in the table that follows, an immediate increase in interest rates of 100, 200, or 300 basis points would have a negative effect on net interest income over a twelve month time period. This is principally because the Bank’s interest-bearing deposit accounts are assumed to reprice faster than its loans and investment securities. However, if the Bank does not increase the rates paid on its deposit accounts as quickly or to the same magnitude as increases in market interest rates, the negative impact on net interest income will likely be lower. Over a longer period of time, and assuming that interest rates remain stable after the initial rate increase and the Bank purchases securities and originates loans at yields higher than those maturing and reprices loans at higher yields, the impact of an increase in interest rates should be positive. This occurs primarily because with the passage of time more loans and investment securities will reprice at the higher rates and there will be no offsetting increase in interest expense for those loans and investment securities funded by noninterest-bearing checking deposits and capital.

 

		Net Portfolio Value at September 30, 2012												Net Interest Income Twelve Months Ending September 30, 2013
						Change from Base												Change from Base
Rate Change Scenario		Amount				Dollar				Percent				Amount				Dollar				Percent
		(Dollars in thousands)
+300 basis point rate shock		$	249,642			$	9,061				3.8	%		$	28,310			$	(10,182	)			(26.5	)%
+200 basis point rate shock			245,051				4,470				1.9	%			31,579				(6,913	)			(18.0	)%
+100 basis point rate shock			236,043				(4,538	)			(1.9	)%			34,494				(3,998	)			(10.4	)%
Base case (no rate change)			240,581				—				—	%			38,492				—				—	%

 

40

---

Table of Contents

Item 4.

Controls and Procedures

Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) ), as of the end of the period covered by this report. Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required, and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely discussion regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

41

---

Table of Contents

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

Neither Alliance nor the Bank has been involved in any legal proceedings other than routine legal proceedings occurring in the ordinary course of business during the quarter ended September 30, 2012. Management believes that such proceedings are, in the aggregate, immaterial to our financial condition and results of operations.

 

Item 1A

Risk Factors

Our operations involve various risks that could have adverse consequences, including those described below and in Part I, Item 1A, “Risk Factors” in our 2011 Annual Report on Form 10-K.

Risks Related to the Merger with NBT Bancorp Inc.

If the merger is not completed, we will have incurred substantial expenses without our shareholders realizing the expected benefits .

We have incurred substantial expenses in connection with the merger transaction. These expenses would likely have a material adverse impact on our operating results because we would not have realized the expected benefits of the merger. There can be no assurance that the merger will be completed.

The merger agreement may be terminated in accordance with its terms and the merger may not be completed.

The merger agreement is subject to a number of conditions which must be fulfilled in order to complete the merger. Those conditions include:

 

•

approval of the merger agreement by NBT and Alliance stockholders;

 

•

the receipt of required regulatory approvals;

 

•

absence of orders prohibiting the completion of the merger;

 

•

effectiveness of the registration statement;

 

•

the continued accuracy of the representations and warranties by both parties and the performance by both parties of their covenants and agreements; and

 

•

the receipt by both parties of legal opinions from their respective tax counsels.

In addition, we may choose to terminate the merger agreement if the average daily closing sales prices of NBT’s common stock during the 10 trading day period ending on the trading day immediately preceding the date of receipt of all required regulatory approvals or the date that NBT and Alliance stockholder approval is obtained, whichever is later, is less than $17.74 and NBT’s common stock underperforms the NASDAQ Bank Index by more than 20%. Any such termination would be subject to the right of NBT to increase the amount of NBT common stock to be provided to our shareholders pursuant to the formula prescribed in the merger agreement.

The need for regulatory approvals may delay the date of completion of the merger or may diminish the benefits of the merger.

NBT is required to obtain the approvals of two bank regulatory agencies prior to completing the merger. Satisfying any requirements of these regulatory agencies may delay the date of completion of the merger. In addition, it is possible that, among other things, restrictions on the combined operations of the two companies, including divestitures, may be sought by governmental agencies as a condition to obtaining the required regulatory approvals. Any regulatory restrictions may diminish the benefits of the merger to NBT. NBT is not required to complete the merger if a governmental agency, as part of its authorization or approval, imposes any term, condition or restriction upon NBT that NBT reasonably determines would prohibit or materially limit the ownership or operation by it of any material portion of our or NBT’s business or assets, or that would compel NBT to dispose or hold separate any material portion of our or NBT’s assets.

 

42

---

Table of Contents

Our directors and executive officers have financial interests in the merger that may be different from, or in addition to, the interests of our shareholders

In considering the information contained in this joint proxy statement/prospectus, you should be aware that Alliance’s executive officers and directors have financial interests in the merger that are different from, or in addition to, the interests of Alliance shareholders generally. These interests include, among other things:

 

•

the accelerated vesting of the outstanding Alliance restricted stock awards in accordance with their existing terms;

 

•

the right to receive cash severance, bonus payments and additional supplemental retirement plan benefits under certain circumstances;

 

•

the right to continued health insurance coverage under certain circumstances;

 

•

the right to continued indemnification and liability insurance coverage by NBT after the merger for acts or omissions occurring before the merger; and

 

•

the right to three seats on the NBT board of directors, and any related compensation for such services, if applicable.

Also, NBT entered into an agreement with Jack H. Webb regarding his continuing role with the combined company following the merger.

We will be subject to business uncertainties and contractual restrictions while the merger is pending.

Uncertainty about the effect of the merger on employees, suppliers and customers may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers, suppliers and others who deal with us to seek to change existing business relationships with Alliance. Our employee retention and recruitment may be particularly challenging prior to the effective time of the merger, as employees and prospective employees may experience uncertainty about their future roles with the combined company.

The pursuit of the merger and the preparation for the integration may place a significant burden on management and internal resources. Any significant diversion of management attention away from ongoing business and any difficulties encountered in the transition and integration process could affect our financial results and, following the merger, the combined company. In addition, the merger agreement requires that we operate in the ordinary course of business consistent with past practice and restricts us from taking certain actions prior to the effective time of the merger or termination of the merger agreement. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger.

The termination fee and the restrictions on solicitation contained in the merger agreement may discourage other companies from trying to acquire Alliance.

Until the completion of the merger, we are prohibited from soliciting, initiating, encouraging, or with some exceptions, considering any inquiries or proposals that may lead to a proposal or offer for a merger or other business combination transaction with any person other than NBT. In addition, we have agreed to pay a termination fee of approximately $9.3 million to NBT in specified circumstances. These provisions could discourage other companies from trying to acquire us even though those other companies might be willing to offer greater value to our shareholders than NBT has offered in the merger. The payment of the termination fee also could have a material adverse effect on our results of operations.

After the merger is completed, our shareholders will become NBT stockholders and will have different rights that may be less advantageous than their current rights.

Upon completion of the merger, our shareholders will become NBT stockholders. Differences in our certificate of incorporation and bylaws and NBT’s certificate of incorporation and bylaws will result in changes to the rights of our shareholders who become NBT stockholders.

 

43

---

Table of Contents

Our shareholders will have a reduced ownership and voting interest after the merger and will exercise less influence over management of the combined organization.

Our shareholders currently have the right to vote in the election of our board of directors and on various other matters affecting our company. After the merger, our shareholders will hold a percentage ownership of the combined organization that is much smaller than such shareholder’s current percentage ownership of Alliance. Accordingly, our shareholders will have less influence on the management and policies of the combined company than they now have on the management and policies of our company.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3 .

Defaults Upon Senior Securities

None.

 

Item 4.

Mine Safety Disclosures

Not applicable.

 

Item 5.

Other Information

None.

 

Item 6.

Exhibits

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Exhibit Index attached hereto and are incorporated herein by reference.

 

44

---

Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				ALLIANCE FINANCIAL CORPORATION
DATE: November 9, 2012				/s/ Jack H. Webb
				Jack H. Webb
				Chairman of the Board, President and Chief Executive Officer
				(Principal Executive Officer)
DATE: November 9, 2012				/s/ J. Daniel Mohr
				J. Daniel Mohr
				Executive Vice President and Chief Financial Officer
				(Principal Financial and Accounting Officer)

---

Table of Contents

EXHIBIT INDEX

 

Exhibit Number		Exhibit
2.1		Agreement and Plan of Merger, dated as of October 7, 2012, by and among NBT Bancorp Inc. and Alliance Financial Corporation (incorporated herein by reference to Exhibit 2.1 to Alliance’s Current Report on Form 8-K filed with the SEC on October 9, 2012)
3.1		Amended and Restated Certificate of Incorporation of Alliance (incorporated herein by reference to Exhibit 3.1 to Alliance’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2011)
3.2		Amended and Restated Bylaws of Alliance (incorporated herein by reference to Exhibit 3.2 to Alliance’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2011)
4.1		Rights Agreement dated October 19, 2001 between Alliance Financial Corporation and American Stock Transfer & Trust Company, including the Certificate of Amendment to Alliance’s Certificate of Incorporation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively (incorporated herein by reference to exhibit 4.1 to Alliance’s Form 8-A12G filed with the SEC on October 25, 2001)
31.1*		Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		Certification of J. Daniel Mohr, Executive Vice President and Chief Financial Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*		Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*		Certification of J. Daniel Mohr, Executive Vice President and Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101**		Financial statements from the Quarterly Report on Form 10-Q of Alliance Financial Corporation for the quarter ended September 30, 2012, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, ii) the Consolidated Statements of Comprehensive Income, (iii) the Consolidated Statements of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flow and (v) Notes to Consolidated Financial Statements.

 

*	Filed herewith.

 

**

Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.