10-Q 1 prtr10q063005.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 June 30, 2005

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: 001-31277

PARTNERS TRUST FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

Delaware

75-2993918

(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification Number)

233 Genesee Street, Utica, NY 13501

(Address of Principal Executive Offices) (Zip Code)

(315) 768-3000

(Registrant's Telephone Number Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, par value $0.0001 per share

(Title of Class)

 

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 twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days.

YES X NO _____

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES X NO _____

As of July 18, 2005, there were issued and outstanding 50,085,784 shares of the Registrant's Common Stock.

 

 

TABLE OF CONTENTS
       
       

Part I.

FINANCIAL INFORMATION

  
       
 

Item 1.

Interim Financial Statements (Unaudited)

  
       
   

Consolidated Balance Sheets

1
   

Consolidated Statements of Income

2
   

Consolidated Statements of Changes in Shareholders' Equity

3
   

Condensed Consolidated Statements of Cash Flows

4
   

Consolidated Statements of Comprehensive Income (Loss)

5
   

Notes to Unaudited Consolidated Financial Statements

6
       
 

Item 2.

Management's Discussion and Analysis of

  
   

Financial Condition and Results of Operations

10
       
 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

22
       
 

Item 4.

Controls and Procedures

23
       

Part II.

OTHER INFORMATION

  
       
 

Item 5.

Submission of Matters to a Vote of Security Holders

24
       
 

Item 6.

Exhibits

24
       
 

Signature Page

  

25
       
 

Index to Exhibits

  

26
       
       

 

 

Partners Trust Financial Group, Inc. and Subsidiary

Consolidated Balance Sheets (Unaudited)

June 30,

December 31,

2005

2004

Assets

(In thousands, except share data)

Cash and due from banks

$ 60,622

$ 54,633

Federal funds sold

-

30,848

60,622

85,481

Securities available-for-sale, at fair value

1,184,511

1,064,070

Securities held-to-maturity (fair value of $829 at June 30, 2005 and $1,241 at

December 31, 2004)

829

1,241

Federal Home Loan Bank of New York ("FHLB") stock

38,142

36,394

Loans held for sale

929

1,107

Loans receivable

2,070,124

2,092,351

Less: Allowance for loan losses

(43,709)

(42,716)

Net loans receivable

2,026,415

2,049,635

Premises and equipment, net

28,165

29,187

Land and buildings held for sale

758

1,400

Accrued interest receivable

13,924

13,333

Bank-owned life insurance

69,416

68,079

Other real estate owned and repossessed assets

134

1,055

Goodwill

244,716

245,892

Other intangible assets, net

24,246

28,889

Other assets

46,356

25,864

Total Assets

$ 3,739,163

$ 3,651,627

Liabilities and Shareholders' Equity

Liabilities:

Deposits:

Non-interest bearing

$ 249,761

$ 235,994

Interest bearing

2,030,807

2,001,521

Total deposits

2,280,568

2,237,515

Borrowings

800,473

776,813

Mortgagors' escrow funds

21,524

18,691

Other liabilities

44,021

35,757

Junior subordinated obligations issued to unconsolidated subsidiary

trusts (Junior subordinated obligations)

43,202

43,202

Total Liabilities

3,189,788

3,111,978

Shareholders' Equity:

Preferred stock, $0.0001 par value, 10,000,000 shares authorized, none issued

-

-

Common stock, $0.0001 par value, 190,000,000 shares authorized and

50,061,180 and 49,722,984 shares issued at June 30, 2005 and December 31,

2004, respectively

5

5

Additional paid-in capital

444,562

435,604

Retained earnings

126,952

120,597

Accumulated other comprehensive (loss) income

(518)

394

Treasury stock (73,233 and 60,971 shares at June 30, 2005 and December 31,

2004, respectively)

(724)

(593)

Unallocated ESOP shares (1,661,181 and 1,769,688 shares at June 30, 2005

and December 31, 2004, respectively)

(13,442)

(14,293)

Unearned restricted stock awards

(7,460)

(2,065)

Total shareholders' equity

549,375

539,649

Total Liabilities and Shareholders' Equity

$ 3,739,163

$ 3,651,627

See accompanying notes to unaudited consolidated financial statements.

 

Partners Trust Financial Group, Inc. and Subsidiary

Consolidated Statements of Income (Unaudited)

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

(In thousands, except share data)

Interest income:

Loans, including fees

$ 28,501

$ 11,966

$ 56,812

$ 24,171

Federal funds sold and interest bearing deposits

45

102

325

141

Securities

13,273

3,152

25,064

6,642

Total interest income

41,819

15,220

82,201

30,954

Interest expense:

Deposits:

Savings accounts

244

127

486

239

Money market accounts

1,908

273

3,537

555

Time accounts

7,808

1,785

15,032

3,689

NOW accounts

117

41

227

80

10,077

2,226

19,282

4,563

Borrowings:

Repurchase agreements

73

23

156

93

FHLB advances

5,766

2,347

11,500

4,699

Mortgagors' escrow funds

70

27

117

45

5,909

2,397

11,773

4,837

Junior subordinated obligations

753

-

1,462

-

Total interest expense

16,739

4,623

32,517

9,440

Net interest income

25,080

10,597

49,684

21,554

Provision for loan losses

-

(460)

-

(460)

Net interest income after provision for loan losses

25,080

11,057

49,684

22,014

Non-interest income:

Service fees

4,066

1,972

7,815

3,703

Trust and investment services

870

420

1,656

920

Income from bank-owned life insurance

676

289

1,337

576

Net gain on sale of securities available-for-sale

76

-

76

-

Net gain on sale of loans

30

12

89

115

Other income

142

15

347

29

Total non-interest income

5,860

2,708

11,320

5,343

Non-interest expense:

Salaries and employee benefits

9,880

4,871

19,901

9,782

Occupancy and equipment expense

2,011

991

4,031

1,981

Marketing expense

677

343

1,538

596

Professional services

1,079

329

1,881

728

Technology expense

2,028

997

3,976

1,698

Amortization of intangible assets

2,291

217

4,581

434

Acquisition and conversion expense

-

653

-

766

Other expense

2,347

1,185

4,915

2,379

Total non-interest expense

20,313

9,586

40,823

18,364

Income before income tax expense

10,627

4,179

20,181

8,993

Income tax expense

3,683

1,515

7,044

3,137

Net income

$ 6,944

$ 2,664

$ 13,137

$ 5,856

Basic earnings per share

$ 0.15

$ 0.10

$ 0.28

$ 0.22

Diluted earnings per share

$ 0.14

$ 0.10

$ 0.27

$ 0.22

All per share amounts have been restated giving effect to the 1.9502 exchange ratio in the Company's second step conversion on July 14, 2004.

See accompanying notes to unaudited consolidated financial statements.

Partners Trust Financial Group, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

Accumulated

Unearned

Additional

Other

Unallocated

Restricted

Common

Paid-in

Retained

Comprehensive

Treasury

ESOP

Stock

Stock

Capital

Earnings

Income (Loss)

Stock

Shares

Awards

Total

(In thousands, except share data)

Balance at December 31, 2003

$ 1,422

$ 63,410

$ 115,561

$ 1,902

$ (450)

$ (4,094)

$ (2,416)

$ 175,335

Net income

-

-

5,856

-

-

-

-

5,856

Other comprehensive loss, net of tax

-

-

-

(3,918)

-

-

-

(3,918)

Cash dividends ($0.24 per minority share)

-

-

(1,485)

-

-

-

-

(1,485)

ESOP shares committed to be released for

allocation (25,590 shares)

-

532

-

-

-

256

-

788

Stock awarded under the Management

Recognition Plan (12,000 shares)

-

259

-

-

224

-

(483)

-

Amortization of unearned restricted stock awards

-

-

-

-

-

-

362

362

Stock options exercised (20,147 shares)

1

108

-

-

171

-

-

280

Tax benefit of stock options exercised

-

62

-

-

-

-

-

62

Balance at June 30, 2004

$ 1,423

$ 64,371

$ 119,932

$ (2,016)

$ (55)

$ (3,838)

$ (2,537)

$ 177,280

Balance at December 31, 2004

$ 5

$ 435,604

$ 120,597

$ 394

$ (593)

$ (14,293)

$ (2,065)

$ 539,649

Net income

-

-

13,137

-

-

-

-

13,137

Other comprehensive loss, net of tax

-

-

-

(912)

-

-

-

(912)

Cash dividends ($0.14 per share)

-

-

(6,782)

-

-

-

-

(6,782)

ESOP shares committed to be released for

allocation (108,507 shares)

-

298

-

-

-

851

-

1,149

Stock awarded under the Management

Recognition Plan (594,997 shares)

-

5,938

-

-

-

-

(5,938)

-

Amortization of unearned restricted stock awards

-

-

-

-

-

-

543

543

Tax effect of MRP vesting

-

(18)

-

-

-

-

-

(18)

Purchase of treasury stock (12,262 shares)

-

-

-

-

(131)

-

-

(131)

Stock options exercised (338,196 shares)

-

2,152

-

-

-

-

-

2,152

Tax benefit of stock options exercised

-

588

-

-

-

-

-

588

Balance at June 30, 2005

$ 5

$ 444,562

$ 126,952

$ (518)

$ (724)

$ (13,442)

$ (7,460)

$ 549,375

All share and per share amounts have been restated giving effect to the 1.9502 exchange ratio in the Company's second step conversion on July 14, 2004.

See accompanying notes to unaudited consolidated financial statements.

Partners Trust Financial Group, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows (Unaudited)

Six months ended June 30,

2005

2004

(In thousands)

Net cash provided by operating activities

$ 26,907

$ 6,408

Investing activities:

Purchases of securities held-to-maturity

-

(319)

Proceeds from redemptions, maturities and principal

collected on securities held-to-maturity

412

220

Purchases of securities available-for-sale

(287,851)

(50,240)

Proceeds from redemptions, maturities and principal

collected on securities available-for-sale

131,180

49,467

Proceeds from sales of securities available-for-sale

17,198

-

Purchases of FHLB stock

(12,639)

(650)

Redemptions of FHLB stock

10,891

700

Net loans repaid by (made to) customers

22,649

(11,918)

Purchases of premises and equipment

(1,004)

(1,345)

Proceeds from sale of building held for sale

665

-

Proceeds from sales of other real estate owned

1,948

859

Net cash used in investing activities

(116,551)

(13,226)

Financing activities:

Net increase in deposits

43,053

15,161

Stock subscriptions received

-

41,761

Net increase in mortgagors' escrow funds

2,833

374

Net increase (decrease) in borrowings

23,660

(3,988)

Cash dividends

(6,782)

(1,485)

Purchase of treasury stock

(131)

-

Proceeds from exercise of stock options

2,152

280

Net cash provided by financing activities

64,785

52,103

Net (decrease) increase in cash and cash equivalents

(24,859)

45,285

Cash and cash equivalents at beginning of period

85,481

40,507

Cash and cash equivalents at end of period

$ 60,622

$ 85,792

Supplemental disclosures:

Cash paid during the period for:

Interest on deposits and borrowings

$ 32,056

$ 9,383

Income taxes

5,689

2,496

Non-cash investing activities:

Increase in liability for securities purchased not settled

(10,779)

-

Increase in receivable for securities sold not settled

27,317

-

Transfer of loans to other real estate owned

571

668

Transfer of buildings held for sale into premises and equipment

-

3,045

See accompanying notes to unaudited consolidated financial statements.

Partners Trust Financial Group, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

(In thousands)

Net income

$ 6,944

$ 2,664

$ 13,137

$ 5,856

Other comprehensive income (loss), net of tax:

Unrealized holding gains (losses) on securities

available-for-sale (pre-tax, $12,175, ($8,540), ($1,440) and ($6,532))

7,320

(5,124)

(866)

(3,918)

Reclassification adjustment for net gain on available- for-sale securities realized in net income (pre-tax amounts of $76, $ - , $76, and $ - )

(46)

-

(46)

-

Total other comprehensive income (loss)

7,274

(5,124)

(912)

(3,918)

Comprehensive income (loss)

$ 14,218

$ (2,460)

$ 12,225

$ 1,938

See accompanying notes to unaudited consolidated financial statements.

Partners Trust Financial Group, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Partners Trust Financial Group, Inc. (the "Company" or "Partners Trust"), its wholly owned subsidiary Partners Trust Bank (the "Bank") (formerly SBU Bank) and the Bank's wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management the unaudited consolidated financial statements include all necessary adjustments, consisting of normal recurring accruals, necessary for a fair presentation for the periods presented. The results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year or any other interim period.

The data in the consolidated balance sheet for December 31, 2004 was derived from the Company's 2004 Annual Report on Form 10-K, which includes the Company's audited consolidated financial statements as of December 31, 2004 and 2003, and for each of the years in the three-year period ended December 31, 2004. That data, along with the interim financial information presented in the consolidated balance sheet, statements of income, statements of changes in shareholders' equity, condensed statements of cash flows and statements of comprehensive income (loss) should be read in conjunction with the 2004 consolidated financial statements, including the notes thereto.

Amounts in prior periods' consolidated financial statements are reclassified when necessary to conform to the current period's presentation.

2. Conversion and Business Combination

On July 14, 2004, Partners Trust completed its "second step" conversion from the mutual holding company form of organization to the stock holding company form of organization. Immediately upon completion of the second step conversion transaction, Partners Trust also completed its acquisition of BSB Bancorp, Inc. ("BSB").

In the conversion, the Company sold 14,875,000 shares of common stock at $10.00 per share and issued 12,872,594 shares to former minority shareholders of the Company at an exchange ratio of 1.9502 shares of Partners Trust stock for each minority share. The net proceeds received in the conversion, after direct offering expenses were $142.4 million. The reorganization was accounted for as a change in corporate form with no resulting change in the historical basis of the Company's assets, liabilities and equity.

In the BSB acquisition, Partners Trust paid approximately $135.1 million in cash and issued 20,270,464 shares of Partners Trust common stock with a market value of $202.7 million (based on the price of common stock sold in the second step conversion immediately prior to the acquisition) to the former BSB shareholders as consideration for the acquisition. BSB Bancorp, Inc. stock options were exchanged for Partners Trust stock options at an estimated value of $11.9 million. At the time of the acquisition, BSB had $2.2 billion in assets, $1.4 billion in gross loans, and $1.5 billion in deposits. In the acquisition, BSB was merged into Partners Trust, and BSB's wholly owned subsidiary bank, BSB Bank & Trust Company, was merged into Partners Trust Bank.

3. Earnings Per Share

Basic earnings per share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed in a manner similar to that of basic earnings per share except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares (such as stock options and unearned restricted stock awards) were issued during the period, computed using the treasury stock method. Unallocated shares held by the Company's ESOP are not included in the weighted average number of shares outstanding for either the basic or diluted earnings per share calculations. All share and per share amounts have been restated giving effect to the 1.9502 exchange ratio in the Company's second step conversion on July 14, 2004.

Partners Trust Financial Group, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

3. Earnings Per Share (continued)

The following summarizes the computation of earnings per share for the three months and six months ended June 30, 2005 and 2004 (in thousands except per share data):

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

Basic earnings per share:

Income available to common shareholders

$ 6,944

$ 2,664

$ 13,137

$ 5,856

Weighted average basic shares outstanding

47,481

26,554

47,600

26,527

Basic earnings per share

$ 0.15

$ 0.10

$ 0.28

$ 0.22

Diluted earnings per share:

Income available to common shareholders

$ 6,944

$ 2,664

$ 13,137

$ 5,856

Weighted average basic shares outstanding

47,481

26,554

47,600

26,527

Effect of dilutive securities:

Stock options

633

331

676

411

Unearned restricted stock awards

141

151

127

164

Weighted average diluted shares outstanding

48,255

27,036

48,403

27,102

Diluted earnings per share

$ 0.14 

$ 0.10

$ 0.27

$ 0.22

The computation of the number of dilutive securities for the three months and six months ended June 30, 2005 excludes 825,848 and 836,955 options ("anti-dilutive options"), respectively, because the exercise prices of these options was greater than the average market price for the respective periods. There were no anti-dilutive options in the three and six months ended June 30, 2004.

4. Employee Benefit Plans

The composition of the net periodic benefit plan (credit) cost for the three and six months ended June 30, 2005 and 2004 is as follows (in thousands):

Pension Benefits

Pension Benefits

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

Interest cost

$ 551

$ 144

$ 1,101

$ 288

Expected return on plan assets

(783)

(202)

(1,566)

(404)

Amortization of unrecognized

actuarial loss

8

-

16

-

Net periodic benefit plan credit

$ (224)

$ (58)

$ (449)

$ (116)

Postretirement Benefits

Postretirement Benefits

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

Service cost

$ 48

$ 15

$ 96

$ 30

Interest cost

131

41

262

82

Amortization of unrecognized

actuarial gain

(6)

(26)

(12)

(52)

Amortization of unrecognized

prior service cost

10

5

20

10

Net periodic benefit plan cost

$ 183

$ 35

$ 366

$ 70

The Company does not expect to make any contributions to its pension plans in 2005. The Company expects to contribute approximately $455,000 to its post-retirement plan in 2005.

 

Partners Trust Financial Group, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

5. Stock-Based Compensation

The Company has granted options under the Long-Term Equity Compensation Plan (the "LTEC Plan") at various times since the LTEC Plan's implementation in October 2002. The options vest over a five year period. The Company accounts for stock options granted under its LTEC Plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, for fixed stock option awards, compensation expense is recognized only if the exercise price of the option is less than the fair value of the underlying stock at the grant date. All options granted under the LTEC Plan have exercise prices equal to the stock's fair market value at the time of grant. Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," requires entities to provide pro forma disclosures of net income and earnings per share as if the fair value of all stock-based awards was recognized as compensation expense over the vesting period of the awards. The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model.

The following table presents the weighted-average assumptions and estimated weighted-average fair value of options granted in 2005 and 2004.

2005

2004

Dividend yield

2.33%

1.48%

Expected volatility

23.65%

55.28%

Risk-free interest rate

3.92%

2.96%

Expected life, in years

5

5

Estimated weighted-average fair value

$ 2.65

$ 8.09

Restricted stock awards granted under the LTEC Plan are also accounted for in accordance with APB Opinion No. 25. The fair value of the shares awarded, measured as of the grant date, is recognized as unearned compensation (a component of shareholders' equity) and amortized on a straight-line basis to compensation expense over the vesting period of the awards.

Pro forma disclosures for the three months and six months ended June 30, 2005 and 2004, utilizing the estimated fair value of the options granted, are as follows (dollars in thousands, except per share data):

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

Net income, as reported

$ 6,944

$ 2,664

$ 13,137

$ 5,856

Add: Stock-based compensation expense related

to restricted stock awards included in reported

net income, net of related tax effects

225

111

326

218

Deduct: Total stock-based compensation expense

determined under fair value based method for all

awards, net of related tax effects

(403)

(211)

(610)

(418)

Pro forma net income

$ 6,766

$ 2,564

$ 12,853

$ 5,656

Basic earnings per share:

As reported

$ 0.15

$ 0.10

$ 0.28

$ 0.22

Pro forma

$ 0.14

$ 0.10

$ 0.27

$ 0.22

Diluted earnings per share:

As reported

$ 0.14

$ 0.10

$ 0.27

$ 0.22

Pro forma

$ 0.14

$ 0.10

$ 0.27

$ 0.21

The pro forma effect on reported net income and earnings per share for the three months and six months ended June 30, 2005 and 2004 should not be considered representative of the pro forma effects on reported net income and earnings per share for future periods.

 

Partners Trust Financial Group, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

6. Guarantees

The Company does not issue any guarantees that would require liability-recognition or disclosure, other than commercial and standby letters of credit. Commercial letters of credit are issued to facilitate the movement of goods, typically to an offshore supplier, and generally are short-term (six months or less) in nature. Longer maturities may be considered if multiple shipments of goods are to be covered. A general security interest in the borrower's inventory is typically held as collateral for commercial letters of credit.

Standby letters of credit are issued to insure performance by Bank customers who are in business contracts with third parties. Such instruments are frequently used in construction contracts, but are occasionally used to support the ongoing obligations of other types of business. Cash collateral is generally required for standby letters of credit, although other collateral may also be considered, including a security interest in the business assets of the Borrower.

The Company had approximately $7.1 million of standby letters of credit on June 30, 2005. The fair value of the Company's standby letters of credit at June 30, 2005 was insignificant.

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

Forward Looking Statements

This Form 10-Q contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include:

  • statements of our goals, intentions and expectations;

  • statements regarding our business plans and prospects and growth and operating strategies;

  • statements regarding the asset quality of our loan and investment portfolios; and

  • estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:

  • charge-offs of loans, particularly those acquired from BSB Bancorp ("BSB"), may be higher than anticipated;

  • significantly increased competition among depository and other financial institutions;

  • changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

  • general economic conditions, either nationally or in our market areas, that are worse than expected;

  • adverse changes in the securities markets;

  • legislative or regulatory changes that adversely affect our business;

  • our ability to enter new markets successfully and capitalize on growth opportunities;

  • changes in consumer spending, borrowing and savings habits;

  • changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and

  • changes in our organization, compensation and benefit plans.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

General

Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on interest earning assets, consisting primarily of our loans 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 loan 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, technology expense, other expense and income tax expense. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and the actions of regulatory authorities.

Comparison of Financial Condition at June 30, 2005 and December 31, 2004

General. Total assets were $3.7 billion at June 30, 2005 and December 31, 2004.

Securities. Securities available-for-sale increased $120.4 million to $1.2 billion at June 30, 2005 as the Company increased its portfolio of short-term collateralized mortgage obligations, callable federal agency bonds, and adjustable rate mortgage-backed securities, to take advantage of market rate increases at various times. These purchases were funded with a combination of cash and debt.

Loans. The following table sets forth the composition of the Company's loan portfolio (dollars in thousands):

June 30, 2005

December 31, 2004

Amount

Percent

Amount

Percent

Residential real estate

$ 1,076,502

52.2%

$ 1,081,256

51.8%

Commercial real estate

312,674

15.2%

339,587

16.3%

Commercial and industrial (C&I)

176,117

8.5%

180,897

8.7%

Consumer, including home equity loans

495,950

24.1%

485,057

23.2%

Total loans receivable

2,061,243

100.0%

2,086,797

100.0%

Plus (less):

Net deferred loan costs

8,881

5,554

Allowance for loan losses

(43,709)

(42,716)

Net loans receivable

$ 2,026,415

$ 2,049,635

Total loans (including net deferred loan costs) decreased $22.2 million from year end to June 30, 2005, but increased $8.6 million from March 31, 2005 to June 30, 2005. The increase during the second quarter reflects strong consumer loan growth and a slowing of the rate of decline in the commercial (real estate and C&I) portfolio. Consumer loans increased $10.9 million in the six months ended June 30, 2005, due primarily to growth in the Company's indirect auto lending business during the second quarter. Indirect auto loans totaled $260.3 million at June 30, 2005, representing 52.5% of total consumer loans. We manage the credit risk of indirect auto lending by maintaining relationships with well established dealers in our lending area and by directly underwriting the applications from the dealers, with an emphasis on loans with credit scores above 700.

Commercial loans decreased $31.7 million in the first half of 2005 due primarily to our continued efforts to reduce the Company's exposure to specific higher risk assets acquired in the BSB acquisition. The rate of decline ($11.1 million) in the commercial portfolio in the second quarter of 2005 slowed considerably from the $76.6 million cumulative decrease experienced in the two previous quarters as our successful workout efforts allow us to begin to focus more resources on business development activities. Commercial lending is an important part of our business plan. As we continue to reduce exposure to specified loans acquired in the BSB transaction, we nonetheless plan to focus on growth in this portion of the loan portfolio consistent with our historical underwriting standards.

Asset Quality. Non-performing loans totaled $8.9 million or 0.43% of loans at June 30, 2005, compared to $12.1 million or 0.58% of loans at December 31, 2004. Other real estate owned (ORE) totaled $134,000 at June 30, 2005, a decrease of $921,000 from December 31, 2004. The improvement in non-performing assets occurred as a result of the sale of two parcels of ORE, and through a combination of charge-offs and payments on loans as we work to resolve troubled assets acquired from BSB.

The following table sets forth information regarding non-performing assets (dollars in thousands):

June 30,

December 31,

2005

2004

Non-accruing loans:

Residential real estate

$ 2,183

$ 1,885

Commercial real estate

2,014

5,525

Commercial and industrial

3,863

3,178

Consumer (1)

639

642

Total non-accruing loans

8,699

11,230

Accruing loans delinquent 90 days or more

249

871

Total non-performing loans

8,948

12,101

Other real estate owned and repossessed assets

134

1,055

Total non-performing assets

$ 9,082

$ 13,156

Total non-performing loans to total loans

0.43%

0.58%

Total non-performing assets to total assets

0.24%

0.36%

Allowance for loan losses to non-performing loans

488.48%

353.00%

Allowance for loan losses to total loans (2)

2.12%

2.05%

_________________________________

(1)

Includes home equity loans.

(2)

Total loans excludes loans held for sale.

The largest non-performing lending relationship is $1.9 million of C&I loans that were added to non-performing status in the second quarter. The remaining $1.9 million in non-accruing C&I loans is comprised of 18 relationships averaging $107,000 each.

Non-performing commercial real estate loans are comprised of 10 relationships, the largest of which is a $574,000 loan secured by an office building in western New York.

In addition to the non-performing loans, we have identified through normal internal credit review, loans totaling $17.9 million that warrant increased attention at June 30, 2005 compared with $24.4 million at December 31, 2004. These loans are classified as substandard or worse as they exhibit certain risk factors which have the potential to cause them to become non-performing. Accordingly, these credits are reviewed on at least a quarterly basis and were considered in our evaluation of the allowance for loan losses at June 30, 2005. None of these loans were considered impaired and as such, no specific impairment allowance was established for these loans.

Changes in the allowance for loan losses for the periods indicated are as follows (dollars in thousands):

Three months ended June 30,

Six months ended June 30,

2005

2004

2005

2004

Allowance for loan losses at beginning of period

$ 42,796

$ 8,324

$ 42,716

$ 8,608

Charge-offs

(4,097)

(572)

(7,871)

(1,413)

Recoveries

5,010

144

8,864

701

Provision for loan losses

-

(460)

-

(460)

Allowance for loan losses at end of period

$ 43,709

$ 7,436

$ 43,709

$ 7,436

Net recoveries (charge-offs) to average loans (annualized)

0.18%

(0.21%)

0.10%

(0.18%)

The increased level of charge-offs and recoveries in 2005 reflects the impact of the higher credit risk in the BSB loan portfolio, and the vigorous collection efforts that we continue to apply to these troubled loans. The high level of recoveries relative to charge-offs in 2005 reflects the resolution of certain large loans under terms more favorable than anticipated.

Deposits. The following table summarizes the composition of our deposits at the dates indicated (dollars in thousands).

June 30, 2005

December 31, 2004

Amount

Percent

Amount

Percent

Non-interest bearing checking

$ 249,761

11.0%

$ 235,994

10.5%

Interest bearing-checking

234,651

10.2%

227,341

10.2%

Total checking

484,412

21.2%

463,335

20.7%

Savings

298,967

13.1%

300,678

13.4%

Money market

523,942

23.0%

543,591

24.3%

Time

973,247

42.7%

929,911

41.6%

Total deposits

$ 2,280,568

100.0%

$ 2,237,515

100.0%

Total deposits increased $43.1 million, or 1.9% to $2.3 billion at June 30, 2005. An increase in time deposits of $43.3 million was partially offset by a decrease in money market accounts of $19.7 million, both of which were due primarily to seasonal municipal deposit activity. Checking accounts increased $21.1 million as we experienced growth in both retail and commercial accounts.

Shareholders' Equity. Shareholders' equity increased $9.7 million from December 31, 2004 to $549.4 million at June 30, 2005. Net income was $13.1 million in the six months ended June 30, 2005, which was partially offset by other comprehensive loss, net of tax, totaling $912,000 as higher short-term market interest rates reduced the market value of our securities portfolio. In addition, we paid $6.8 million in dividends, which reduced equity, and recorded $2.7 million and $1.7 million, respectively, of additions to equity related to the exercise of stock options and to the vesting of stock under the Company's ESOP and restricted stock plans.

Average Balance Sheet and Net Interest Analysis

The following tables set forth certain information for the three months and six months ended June 30, 2005 and 2004. For the periods indicated, the total dollar amount of interest income from average earning assets and the resultant yields, as well as the interest expense on average interest bearing liabilities, are expressed both in dollars and rates. No tax equivalent adjustments were made. Average balances are daily averages.

For the Three Months Ended June 30,

2005

2004

Average

Average

Outstanding

Interest

Yield/

Outstanding

Interest

Yield/

Balance

Earned/Paid

Rate

Balance

Earned/Paid

Rate

(Dollars in thousands)

Earning assets:

Federal funds sold and interest bearing

deposits

$ 6,734

$ 45

2.68%

$ 42,717

$ 102

0.96%

Securities (1)

1,200,613

13,273

4.43%

349,647

3,152

3.63%

Loans (2)

2,059,281

28,501

5.55%

802,605

11,966

6.00%

Total earning assets

3,266,628

41,819

5.13%

1,194,969

15,220

5.12%

Non-earning assets

407,926

117,089

Total assets

$ 3,674,554

$ 1,312,058

Interest bearing liabilities:

Savings deposits

$ 299,773

$ 244

0.33%

$ 162,924

$ 127

0.31%

Money market accounts

534,674

1,908

1.43%

176,042

273

0.62%

NOW accounts

235,580

117

0.20%

97,717

41

0.17%

Time accounts

991,772

7,808

3.16%

281,172

1,785

2.55%

Borrowings (3)

750,268

5,909

3.16%

295,573

2,397

3.26%

Junior subordinated obligations issued to

unconsolidated subsidiary trusts

43,202

753

6.99%

-

-

-

Total interest bearing liabilities

2,855,269

16,739

2.35%

1,013,428

4,623

1.83%

Non-interest bearing deposits

235,277

101,154

Non-interest bearing liabilities

40,212

15,331

Total liabilities

3,130,758

1,129,913

Shareholders' equity

543,796

182,145

Total liabilities and shareholders'

equity

$ 3,674,554

$ 1,312,058

Net interest income

$ 25,080

$ 10,597

Net interest rate spread

2.78%

3.29%

Net earning assets

$ 411,359

$ 181,541

Net interest margin

3.08%

3.57%

Ratio of earning assets to total

interest bearing liabilities

114.41%

117.91%

(1) The amounts shown are amortized cost and include FHLB stock.

(2) Net of net deferred loan fees and costs.

(3) Borrowings include mortgagors' escrow funds.

 

For the Six Months Ended June 30,

2005

2004

Average

Average

Outstanding

Interest

Yield/

Outstanding

Interest

Yield/

Balance

Earned/Paid

Rate

Balance

Earned/Paid

Rate

(Dollars in thousands)

Earning assets:

Federal funds sold and interest bearing

deposits

$ 25,768

$ 325

2.54%

$ 29,906

$ 141

0.95%

Securities (1)

1,152,297

25,064

4.39%

354,815

6,642

3.76%

Loans (2)

2,066,125

56,812

5.54%

802,719

24,171

6.06%

Total earning assets

3,244,190

82,201

5.11%

1,187,440

30,954

5.24%

Non-earning assets

414,862

111,319

Total assets

$ 3,659,052

$ 1,298,759

Interest bearing liabilities:

Savings deposits

$ 299,082

$ 486

0.33%

$ 159,256

$ 239

0.30%

Money market accounts

534,433

3,537

1.33%

170,335

555

0.66%

NOW accounts

230,435

227

0.20%

95,175

80

0.17%

Time accounts

976,255

15,032

3.11%

286,389

3,689

2.59%

Borrowings (3)

756,365

11,773

3.14%

295,933

4,837

3.29%

Junior subordinated obligations issued to

unconsolidated subsidiary trusts

43,202

1,462

6.82%

-

-

-

Total interest bearing liabilities

2,839,772

32,517

2.31%

1,007,088

9,400

1.88%

Non-interest bearing deposits

234,816

95,646

Non-interest bearing liabilities

38,969

14,970

Total liabilities

3,113,557

1,117,704

Shareholders' equity

545,495

181,055

Total liabilities and shareholders'

equity

$ 3,659,052

$ 1,298,759

Net interest income

$ 49,684

$ 21,554

Net interest rate spread

2.80%

3.36%

Net earning assets

$ 404,418

$ 180,352

Net interest margin

3.09%

3.65%

Ratio of earning assets to total

interest bearing liabilities

114.24%

117.91%

(1) The amounts shown are amortized cost and include FHLB stock.

(2) Net of net deferred loan fees and costs.

(3) Borrowings include mortgagors' escrow funds.

 

Rate/Volume Analysis

The following table presents the extent to which changes in interest rates and changes in the volume of earning assets and interest bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

For the Three Months

For the Six Months

Ended June 30,

Ended June 30,

2005 vs. 2004

2005 vs. 2004

Rate

Volume

Total

Rate

Volume

Total

(In thousands)

Earning assets:

Federal funds sold and interest-bearing

deposits

$ 78

$ (135)

$ (57)

$ 205

$ (21)

$ 184

Securities

840

9,281

10,121

1,278

17,144

18,422

Loans, net

(962)

17,497

16,535

(2,238)

34,879

32,641

Total earning assets

(44)

26,643

26,599

(755)

52,002

51,247

Interest bearing liabilities:

Savings accounts

8

109

117

26

221

247

Money market accounts

640

995

1,635

960

2,022

2,982

NOW accounts

8

68

76

16

131

147

Time accounts

521

5,502

6,023

872

10,471

11,343

Borrowings

(76)

3,588

3,512

(230)

7,166

6,936

Junior subordinated obligations issued to

unconsolidated subsidiary trusts

-

753

753

-

1,462

1,462

Total interest bearing liabilities

1,101

11,015

12,116

1,644

21,473

23,117

Net interest income

$ (1,145)

$ 15,628

$ 14,483

$ (2,399)

$ 30,529

$ 28,130

Comparison of Operating Results for the Three Months Ended June 30, 2005 and 2004

General. Net income for the three months ended June 30, 2005 was $6.9 million, or $0.14 per diluted share, compared with $2.7 million, or $0.10 per diluted share for the same period in 2004. The increase in net income is primarily attributable to the acquisition of BSB in July 2004. Return on assets was 0.76% and 0.82% for the three months ended June 30, 2005 and 2004, respectively. Return on equity and return on tangible equity were 5.12% and 10.21%, respectively, for the three months ended June 30, 2005, respectively, compared to 5.88% and 7.41%, respectively, for the same period in 2004.

Net Interest Income. Net interest income for the three months ended June 30, 2005 totaled $25.1 million, an increase of $14.5 million, or 136.6% from the $10.6 million for the same period in 2004. The increase in net interest income reflects the substantial increase in net earning assets resulting from the BSB acquisition. The net interest rate spread for the three months ended June 30, 2005 was 2.78% compared to 3.29% for the same period in 2004. The net interest margin for the three months ended June 30, 2005 and 2004 was 3.08% and 3.57%, respectively. As discussed below, the decrease in spread and margin occurred primarily as a result of the BSB acquisition, and was further negatively impacted by higher deposit rates in 2005 due to competitive pressures.

The average yield on total loans acquired from BSB was below that of Partners Trust before the acquisition and BSB's cost of funds was also higher. This, in conjunction with the net earning assets of BSB being approximately twice as much as that of Partners Trust at the time of the acquisition, resulted in a significant reduction of our margin. Furthermore, our net interest margin was negatively impacted in 2005 by amortization of the market value adjustments recorded in the acquisition (net premiums on loans, securities, deposits, and borrowings). A reduction of $923,000 in net interest income was recorded in the quarter ended June 30, 2005 representing the net amortization of the purchase accounting adjustments related to the BSB acquisition. This equated to an 11 basis point reduction in net interest margin.

In addition, the Company is slightly sensitive to increases in interest rates, as the amount of our liabilities whose rates adjust within one year exceeds that of our assets that reprice during the same period. As a result, the significant flattening of the treasury yield curve over the past year combined with competitive pressures has caused our cost of funds to increase by a larger magnitude than our asset yields, causing further margin compression.

The flat yield curve and increasing competitive pressures on deposit rates in our markets during 2005 has caused the spread between the rates at which we lend versus the cost of deposits and borrowings to narrow. Additional margin compression may occur in the future if the current interest rate and competitive environments continue.

Provision for Loan Losses. We establish provisions for loan losses, which are charged or credited to operations, in order to maintain the allowance for loan losses at a level management considers necessary to absorb probable credit losses in the current loan portfolio. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or later events occur. Management assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses in order to adjust the allowance, when necessary.

No provision for loan losses was recorded for the quarter ended June 30, 2005. A negative provision (recapture) of $460,000 was recorded in the second quarter of 2004. This reflected the continued improvement in asset quality as we experienced decreases in non-performing loans and potential problem loans during both periods.

Non-Interest Income. The following table summarizes changes in the major components of non-interest income (dollars in thousands):

Three months ended June 30,

2005

2004

$ Change

% Change

Service fees

$ 4,066

$ 1,972

$ 2,094

106.2%

Trust and investment services

870

420

450

107.1%

Income from bank-owned life insurance

676

289

387

133.9%

Net gain on sale of securities available-for-sale

76

-

76

-%

Net gain on sale of loans

30

12

18

150.0%

Other income

142

15

127

846.7%

Total non-interest income

$ 5,860

$ 2,708

$ 3,152

116.4%

Non-interest income increased $3.2 million or 116.4% for the three months ended June 30, 2005 compared with the same period in 2004, which primarily reflects the increased revenues derived from the larger customer base and increased investment in bank-owned life insurance that resulted from the BSB acquisition. We had approximately 345,000 customer accounts at June 30, 2005, an increase of approximately 133.6% from 148,000 customer accounts at June 30, 2004.

Trust and investment services income increased $450,000 or 107.1% due primarily to the increase of approximately $278.5 million in trust assets under management and an increase in the sale of non-deposit investment products resulting from the BSB acquisition.

Our non-interest income amounted to 18.9% and 20.4% of total revenues (which is comprised of total net interest income and non-interest income), for the three months ended June 30, 2005 and 2004, respectively.

Non-Interest Expense. The following table summarizes changes in the major components of non-interest expense (dollars in thousands):

Three months ended June 30,

2005

2004

$ Change

% Change

Salaries and employee benefits

$ 9,880

$ 4,871

$ 5,009

102.8%

Occupancy and equipment expense

2,011

991

1,020

102.9%

Marketing expense

677

343

334

97.4%

Professional services

1,079

329

750

228.0%

Technology expense

2,028

997

1,031

103.4%

Amortization of intangible assets

2,291

217

2,074

955.8%

Acquisition and conversion expense

-

653

(653)

(100.0%)

Other expense

2,347

1,185

1,162

98.1%

Total non-interest expense

$ 20,313

$ 9,586

$ 10,727

111.9%

Non-interest expense increased $10.7 million, or 111.9% to $20.3 million for the three months ended June 30, 2005, compared to $9.6 million for the same period in 2004. The increase reflects the impact of operating a much larger entity.

The increase in salaries and employee benefits reflects the higher employment level of the merged Company. The number of full time equivalent employees increased 105.0% to 742 at June 30, 2005 from 362 at June 30, 2004.

The Company's branch network grew from 16 to 36 with the acquisition of BSB, and occupancy and equipment expense increased accordingly.

Marketing expense increased $334,000 or 97.4% due to our larger geographic presence and increased business development efforts. Furthermore, greater emphasis was placed on advertising in our markets in an effort to increase our brand recognition.

Professional services increased $750,000 or 228.0% to $1.1 million for the three months ended June 30, 2005. Legal expense increased $215,000 due primarily to collection activities related to troubled loans acquired from BSB. Accounting and audit fees increased $198,000 and is directly related to the increase in the size of the Company, along with increased financial reporting requirements. Other professional services increased $255,000 due to the cost of processing system enhancements in the second quarter of 2005.

Technology expense increased due to the increased data processing cost associated with running a bank with a much larger customer base that offers a wider variety of products and services.

We recorded $2.3 million of amortization on acquisition-related intangibles for the quarter ended June 30, 2005, primarily for the $23.7 million core deposit intangible recorded in the BSB acquisition.

Acquisition and conversion expense was $653,000 in the second quarter of 2004 related to the BSB acquisition. The Company had no such expenses in 2005.

Other expense increased $1.2 million or 98.1% due to increases in various expense categories, such as postage, supplies, telephone, and insurance, reflecting the larger size of the Company following the BSB acquisition.Non-interest expenses, excluding acquisition and conversion expenses, as a percent of average total assets decreased to 2.21% (annualized) for the second quarter of 2005, compared to 2.72% for the second quarter of 2004, primarily reflecting our continuing focus on expense control.

Income Tax Expense. Income tax expense was $3.7 million on income before taxes of $10.6 million for the three months ended June 30, 2005, resulting in an effective tax rate of 34.9% compared to income tax expense of $1.5 million on income before taxes of $4.2 million for the same period in 2004, resulting in an effective tax rate of 35.7%.

Supplemental Reporting of Non-GAAP Results of Operations. In addition to results presented in accordance with Generally Accepted Accounting Principles ("GAAP"), we are providing in this report certain non-GAAP financial measures. We believe that providing certain non-GAAP financial measures provides the reader with information useful in understanding our financial performance, our performance trends and financial position. Specifically, we provide measures based on "core operating earnings," which reflects what we view as income from continuing operations. Core operating earnings is net income adjusted to exclude net amortization of fair market value adjustments on net assets acquired in mergers, acquisition and conversion expenses, amortization of intangibles and the covenant-not-to-compete expense. These non-GAAP measures should not be considered a substitute for GAAP basis measures and results.

Our core operating earnings rose 171.1% to $8.9 million or $0.19 per diluted share in the second quarter of 2005, compared to $3.3 million or $0.12 per diluted share for the second quarter of 2004.

The following table reconciles core operating earnings to net income in accordance with GAAP.

Core Operating Earnings

Three Months Ended

(In thousands, except per share data)

June 30,

2005

2004

Net Income as Reported (GAAP)

$ 6,944

$ 2,664

Adjustments

Net amortization of premium on net assets acquired in mergers

1,036

187

Acquisition and conversion expense

-

653

Amortization of core deposit & trust intangibles

2,202

217

Covenant-not-to-compete expense

89

-

Total adjustments pre-tax

3,327

1,057

Related income taxes

1,326

421

Total adjustments after-tax

2,001

636

Core Operating Earnings

$ 8,945

$ 3,300

Diluted EPS using Core Operating Earnings

$ 0.19

$ 0.12

Comparison of Operating Results for the Six Months Ended June 30, 2005 and 2004

General. Net income for the six months ended June 30, 2005 was $13.1 million, or $0.27 per diluted share, compared with $5.9 million, or $0.22 per diluted share for the same period in 2004. The increase in net income is primarily attributable to the acquisition of BSB in July 2004. Return on assets was 0.72% and 0.91% for the six months ended June 30, 2005 and 2004, respectively. Return on equity and return on tangible equity were 4.86% and 9.70%, respectively, for the six months ended June 30, 2005, respectively, compared to 6.50% and 8.21%, respectively, for the same period in 2004.

Net Interest Income. Net interest income for the six months ended June 30, 2005 totaled $49.7 million, an increase of $28.1 million, or 130.5% from the $21.6 million for the same period in 2004. The increase in net interest income reflects the substantial increase in net earning assets resulting from the BSB acquisition. The net interest rate spread for the six months ended June 30, 2005 was 2.80% compared to 3.36% for the same period in 2004. The net interest margin for the six months ended June 30, 2005 and 2004 was 3.09% and 3.65%, respectively. The decrease in spread and margin reflects the same factors discussed in the section of this report titled Comparison of Operating Results for the Three Months Ended June 30, 2005 and 2004.

Provision for Loan Losses. No provision for loan losses was recorded for the six months ended June 30, 2005. A negative provision (recapture) of $460,000 was recorded in the six months ended June 30, 2004. This reflected the continued improvement in asset quality as we experienced decreases in non-performing loans and potential problem loans during both periods.

Non-Interest Income. The following table summarizes changes in the major components of non-interest income (dollars in thousands):

Six months ended June 30,

2005

2004

$ Change

% Change

Service fees

$ 7,815

$ 3,703

$ 4,112

111.1%

Trust and investment services

1,656

920

736

80.0%

Income from bank-owned life insurance

1,337

576

761

132.1%

Net gain on sale of securities available-for-sale

76

-

76

-

Net gain on sale of loans

89

115

(26)

(22.6%)

Other income

347

29

318

1,096.6%

Total non-interest income

$ 11,320

$ 5,343

$ 5,977

111.9%

Non-interest income increased $6.0 million or 111.9% for the six months ended June 30, 2005 compared with the same period in 2004, which primarily reflects the increased revenues derived from the larger customer base and increased investment in bank-owned life insurance that resulted from the BSB acquisition, as more fully described in the section of this report titled Comparison of Operating Results for the Three Months Ended June 30, 2005 and 2004.

Our non-interest income amounted to 18.6% and 19.9% of total revenues (which is comprised of total net interest income and non-interest income), for the six months ended June 30, 2005 and 2004, respectively.

Non-Interest Expense. The following table summarizes changes in the major components of non-interest expense (dollars in thousands):

Six months ended June 30,

2005

2004

$ Change

% Change

Salaries and employee benefits

$ 19,901

$ 9,782

$ 10,119

103.5%

Occupancy and equipment expense

4,031

1,981

2,050

103.5%

Marketing expense

1,538

596

942

158.1%

Professional services

1,881

728

1,153

158.4%

Technology expense

3,976

1,698

2,278

134.2%

Amortization of intangible assets

4,581

434

4,147

955.5%

Acquisition and conversion expense

-

766

(766)

(100.0%)

Other expense

4,915

2,379

2,536

106.6%

Total non-interest expense

$ 40,823

$ 18,364

$ 22,459

122.3%

Non-interest expense increased $22.5 million, or 122.3% to $40.8 million for the six months ended June 30, 2005, compared to $18.4 million for the same period in 2004. The increase reflects the impact of operating a much larger entity, as more fully described in the section of this report titled Comparison of Operating Results for the Three Months Ended June 30, 2005 and 2004.

Non-interest expenses, excluding acquisition and conversion expenses, as a percent of average total assets decreased to 2.23% (annualized) for the first half of 2005, compared to 2.83% for the same period in 2004.

Income Tax Expense. Income tax expense was $7.0 million on income before taxes of $20.2 million for the six months ended June 30, 2005, resulting in an effective tax rate of 34.9% compared to income tax expense of $3.1 million on income before taxes of $9.0 million for the same period in 2004, resulting in an effective tax rate of 34.9%.

Supplemental Reporting of Non-GAAP Results of Operations. In addition to results presented in accordance with Generally Accepted Accounting Principles ("GAAP"), we are providing in this report certain non-GAAP financial measures. We believe that providing certain non-GAAP financial measures provides the reader with information useful in understanding our financial performance, our performance trends and financial position. Specifically, we provide measures based on "core operating earnings," which reflects what we view as income from continuing operations. Core operating earnings is net income adjusted to exclude net amortization of fair market value adjustments on net assets acquired in mergers, merger and conversion expenses, amortization of intangibles and covenant-not-to-compete expenses. These non-GAAP measures should not be considered a substitute for GAAP basis measures and results.

Our core operating earnings rose 151.9% to $17.1 million or $0.35 per diluted share in the six months ended June 30, 2005, compared to $6.8 million or $0.25 per diluted share for the same period in 2004.

The following table reconciles core operating earnings to net income in accordance with GAAP.

Core Operating Earnings

Six Months Ended

(In thousands, except per share data)

June 30,

2005

2004

Net Income as Reported (GAAP)

$ 13,137

$ 5,856

Adjustments

Net amortization of premium on net assets acquired in mergers

2,072

375

Acquisition and conversion expense

-

766

Amortization of core deposit & trust intangibles

4,403

434

Covenant-not-to-compete expense

178

-

Total adjustments pre-tax

6,653

1,575

Related income taxes

2,652

628

Total adjustments after-tax

4,001

947

Core Operating Earnings

$ 17,138

$ 6,803

Diluted EPS using Core Operating Earnings

$ 0.35

$ 0.25

 

Liquidity and Capital Resources

The objective of liquidity management is to ensure that we have the continuing ability to maintain cash flows that are adequate to fund our operations and meet our debt obligations and other commitments on a timely and cost-effective basis. Our liquidity management is both a daily and long-term function of funds management. If we require funds beyond our ability to generate them internally, various forms of both short-and long-term borrowing provide an additional source of funds.

Liquidity management at the Bank focuses on its ability to generate sufficient cash to meet the funding needs of current loan demand, deposit withdrawals, principal and interest payments with respect to outstanding borrowings and to pay operating expenses. It is the Bank's policy to maintain greater liquidity than required in order to be in a position to fund loan originations and investments. The Bank monitors its liquidity in accordance with guidelines established by its Board of Directors and applicable regulatory requirements. The Bank's need for liquidity is affected by its loan activity, net changes in deposit levels and the scheduled maturities of its borrowings. Liquidity demand resulting from net reductions in deposits is usually caused by factors over which the Bank has limited control. The principal sources of the Bank's liquidity consist of deposits, interest and principal payments and prepayments, its ability to sell assets at market prices and its ability to pledge its unencumbered assets as collateral for borrowings, advances from the FHLB of New York and reverse repurchase agreements. At June 30, 2005, the Bank had $237.9 million in available FHLB borrowing capacity. At June 30, 2005, the Bank had outstanding commitments (including undisbursed loan principal balances) to originate loans of $276.9 million. Certificates of deposit which are scheduled to mature within one year totaled $584.0 million and borrowings that are scheduled to mature within the same period amounted to $299.2 million, in each case excluding purchase accounting adjustments at June 30, 2005.

Deposit flows are affected by the level of interest rates, the interest rates and products offered by competitors and other factors. Based on our deposit retention experience we anticipate that a majority of the time deposits maturing within the next year will be retained. We are committed to maintaining a strong liquidity position and monitor our liquidity position on a daily basis. If deposit outflows occur beyond reasonable levels, we will readjust our deposit pricing strategy or take other measures, such as discontinuing our reinvestment of security payments or increasing borrowings, to ensure ample liquidity. We anticipate that we will have sufficient funds to meet our current funding commitments.

Liquidity management at the holding company focuses on generating sufficient cash flow to pay dividends to common stockholders and to make interest payments on the junior subordinated obligations. At June 30, 2005, the total interest payments due in 2005 on the junior subordinated obligations amounts to approximately $3.1 million in the aggregate, based on the applicable interest rate at that date. The Company's primary sources of funds are net proceeds from capital offerings and dividends from the Bank. At June 30, 2005, the Company had $44.8 million of cash and securities available-for-sale at the holding company level. Under OTS capital distribution regulations, the Bank may pay dividends to the Company without prior regulatory approval so long as the Bank meets its applicable regulatory capital requirements before and after payment of the dividends and its total dividends do not exceed its net income to date over the calendar year plus retained net income over the preceding two years. The OTS has discretion to prohibit any otherwise permissible capital distributions on general safety and soundness grounds, and must be given 30 days advance notice of all capital distributions.

At June 30, 2005, the Bank had the ability to pay dividends of $25.9 million to the Company without the prior approval of the OTS.

On July 20, 2005, the Company announced that its board of directors authorized the repurchase of up to 5 million shares (10%) of its outstanding common stock. Management will use its discretion in determining the timing of the repurchases and the prices at which buybacks will be made. The extent to which shares are repurchased will depend on a number of factors including market trends and prices, economic conditions, internal and regulatory trading quiet periods and alternative uses for capital. The repurchase program is authorized for up to one year, and there can be no assurance that the Company will repurchase all 5 million shares authorized. The primary source of funding for the repurchase program will be dividends available for payment by the Bank to the Company.

At June 30, 2005, the Bank exceeded all the applicable regulatory capital requirements. Although the Office of Thrift Supervision does not impose minimum capital requirements on thrift holding companies, the Company's consolidated regulatory capital amounts and ratios are discussed. The Company's consolidated and the Bank's leverage (Tier 1) capital at June 30, 2005 were $323.1 million and $283.9 million, respectively, or 9.3% and 8.2% of assets, respectively. In order to be classified as "well-capitalized" under federal banking regulations, the Bank was required to have leverage (Tier 1) capital of at least $173.0 million, or 5.0% of assets. To be classified as a well-capitalized bank, the Bank must also have a ratio of total risk-based capital to risk-based assets of at least 10.0%. At June 30, 2005, the Bank's total risk-based capital ratio was 14.3%.

Critical Accounting Policies

Management of the Company considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio and the material effect that such judgments can have on the results of operations. Management also considers the accounting policy relating to the test for impairment of goodwill and intangible assets to be a critical accounting policy due to the subjectivity and judgment involved and the material effect that an impairment loss can have on the results of operations. The Company's policies on the allowance for loan losses and goodwill and intangible assets are disclosed in note 1 to the consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2004. A more detailed description of the Company's methodology for determining the allowance for loan losses is included in the "Asset Quality" section in Part 1, Item 1 of the Company's Form 10-K for the year ended December 31, 2004. All accounting policies are important, and as such, the Company encourages the reader to review each of the policies included in note 1 to the consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2004 to obtain a better understanding of how the Company's financial performance is reported.

Impact of New Accounting Standards

In December of 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." SOP No. 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. This SOP prohibits "carry over" or creation of valuation allowances in the initial accounting of all loans acquired in transfers within the scope of SOP No. 03-3, which includes loans acquired in a purchase business combination. SOP No. 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. We did not adopt SOP No. 03-3 early. The application of SOP No. 03-3 could have an impact on our accounting for future acquisitions.

In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") became law in the United States. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the Medicare benefit. We maintain a postretirement benefit plan (the "Plan") that was impacted by the Act. See footnote 11 to the audited financial statements contained in the Company's 2004 Annual Report on Form 10-K for further information.

To date, guidance has not been finalized on how to measure actuarial equivalence and the corresponding subsidy when employees pay a significant portion of plan costs. Consequently, due to the employee cost-sharing, and the lack of complete guidance on how to treat employee cost-sharing, it is unclear whether the Plan will be deemed to provide prescription drug benefits actuarially equivalent to those to be provided by Medicare. Preliminary estimates of the potential subsidy (if any), indicate that such subsidy would have an immaterial effect on the measurement of costs and liabilities for this plan. The accumulated postretirement benefit obligation and net postretirement benefit cost related to the Plan do not reflect any amount associated with the subsidy because we are unable to conclude whether the benefits provided by the plan are actuarially equivalent to Medicare Part D of the Act.

In December 2004, the FASB issued SFAS No. 123, "Share-Based Payment" SFAS No. 123R. This Statement is a revision of SFAS No. 123, "Accounting for Stock-Based Compensation" and supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and its related implementation guidance. This Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. Excess tax benefits, as defined by this Statement, will be recognized as an addition to paid-in capital. Cash retained as a result of those excess tax benefits will be presented in the statement of cash flows as financing cash inflows. The write-off of deferred tax assets relating to unrealized tax benefits associated with recognized compensation cost will be recognized as income tax expense unless there are excess tax benefits from previous awards remaining in paid-in capital to which it can be offset.

On April 14, 2005, the SEC adopted a rule that amends the compliance dates for revised SFAS No. 123R. The rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005, or December 15, 2005 for small business issuers. As a result, this Statement is effective for the Company as of January 1, 2006, and may be adopted prospectively or retrospectively. Adoption of this statement will affect the Company's results of operations. The method of adoption and extent of the impact has not yet been determined.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This Statement is a replacement of APB Opinion No. 20, "Accounting Changes," and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements," and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine period-specific effects of an accounting change on one or more individual prior periods presented. Then the new accounting principle is applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earning for that period rather that being reported in an income statement. Further, the accounting principle is to be applied prospectively from the earliest date when it is impracticable to determine the effect to all prior periods. The effective date of this statement is for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Therefore, this Statement is effective for the Company as of January 1, 2006. Adoption of this statement could have an impact if there are future voluntary accounting changes and correction of errors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Qualitative Analysis. Our most significant form of market risk is interest rate risk. The primary objective of our interest rate risk policy is to manage the exposure of net interest income to changes in interest rates. We actively monitor interest rate risk in connection with our lending, investing, deposit and borrowing activities.

Quantitative Analysis. Our interest rate sensitivity is monitored through the use of a net interest income simulation model, which generates estimates of the change in our net interest income over a range of interest rate scenarios. The model assumes loan prepayment rates, reinvestment rates and deposit decay rates based on historical experiences and current conditions.

The following sets forth the result of our net interest income simulation model as of June 30, 2005 and December 31, 2004.

Change in Interest

June 30, 2005

December 31, 2004

In Basis Points

Annual Net Interest Income

(Rate Shock)

$ Amount

$ Change

% Change

$ Amount

$ Change

% Change

(Dollars in thousands)

-100

105,394

1,215

1.17%

105,789

(322)

-0.30%

Flat

104,179

-

-

106,111

-

-

+100

103,939

(240)

-0.23%

105,451

(660)

-0.62%

+200

102,576

(1,603)

-1.54%

104,437

(1,674)

-1.58%

+300

102,263

(1,916)

-1.84%

104,101

(2,010)

-1.89%

The above table indicates that as of June 30, 2005, the Company had a relatively well-matched interest rate risk profile. In the event of an immediate 200 basis point increase in interest rates across the yield curve, we estimate that we would experience a 1.5%, or $1.6 million, decrease in net interest income as of June 30, 2005, compared with a decrease of 1.6%, or $1.7 million at December 31, 2004. In the event of an immediate 100 basis point decrease in interest rates, we estimate that we would experience a 1.2%, or $1.2 million, increase in net interest income as of June 30, 2005, compared with a decrease of 0.3%, or $322,000 at December 31, 2004. Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurement. Modeling changes in net interest income requires the making of certain assumptions regarding prepayment and deposit decay rates, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. While we believe such assumptions to be reasonable, there can be no assurance that assumed prepayment rates and decay rates will approximate actual future loan prepayment and deposit withdrawal activity. Moreover, the net interest income table presented assumes that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the net interest income table provides an indication of our interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

ITEM 4. CONTROLS AND PROCEDURES

The Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of June 30, 2005. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms.

There were no changes made in the Company's internal controls over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II

ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its annual meeting of shareholders on April 27, 2005 (the "Meeting").

At the Meeting, Elizabeth B. Dugan, Dwight E. Vicks, Jr., John R. Zapisek, and John A. Zawadzki; each were re-elected to the Board and proposals to (i) ratify the appointment by the Board of Directors of KPMG LLP as independent registered public accounting firm for Partners Trust for the year ending December 31, 2005; and (ii) approve and adopt an amendment to the Company's Long-Term Equity Compensation Plan; were approved. The votes cast for and withheld for the Board nominees, and for and against these proposals, and the number of abstentions and broker non-votes with respect to each were as follows:

 

Votes For

Votes Against

Abstentions and Broker Non-votes

Election of Directors:

      

Elizabeth B. Dugan

44,390,040

1,026,819

-

Dwight E. Vicks, Jr.

44,406,350

1,010,509

-

John R. Zapisek

44,532,198

884,661

-

John A. Zawadzki

44,621,537

795,322

-
       

 

 

Votes For

Votes Against

Abstentions and Broker Non-votes

Proposals:

      

Ratification of KPMG LLP

45,072,389

204,505

139,965

Amendment to the Company's

Long-Term Equity Compensation Plan

26,257,777

6,955,727

12,203,355

ITEM 6. EXHIBITS

Exhibits

3.1 Charter of Partners Trust Financial Group, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

3.2 Bylaws of Partners Trust Financial Group, Inc. (incorporated by reference to Exhibit 3.2 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Written Statement of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Written Statement of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

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.

 

Partners Trust Financial Group, Inc.

By: /s/ John A. Zawadzki Dated August 4, 2005

John A. Zawadzki
President and Chief Executive Officer

/s/ Steven A. Covert Dated August 4, 2005

Steven A. Covert
Executive Vice President, Chief Operating Officer and Chief Financial Officer
(Principal Financial and Accounting Officer)

 

Index to Exhibits

3.1 Charter of Partners Trust Financial Group, Inc. (incorporated by reference to Exhibit 3.1 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

3.2 Bylaws of Partners Trust Financial Group, Inc. (incorporated by reference to Exhibit 3.2 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Company's Form S-1 Registration Statement (No. 333-113119) filed with the Securities and Exchange Commission on February 27, 2004)

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Written Statement of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Written Statement of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.