UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended JUNE 30, 2013

Commission File No. 000-13580

SUFFOLK BANCORP

(Exact Name of Registrant as Specified in Its Charter)

NEW YORK	11-2708279
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

4 WEST SECOND STREET, RIVERHEAD, NEW YORK 11901

(Address of Principal Executive Offices) (Zip Code)

(631) 208-2400

(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting companyo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso No x

As of July 24, 2013, there were 11,573,014 shares of registrant’s Common Stock outstanding.

SUFFOLK BANCORP

Form 10-Q

For the Quarterly Period Ended June 30, 2013

Table of Contents

		Page
	PART I
Item 1.	Financial Statements
	Condensed Consolidated Statements of Condition (Unaudited) as of June 30, 2013 and December 31, 2012	2
	Condensed Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 2013 and 2012	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the Three and Six Months Ended June 30, 2013 and 2012	4
	Condensed Consolidated Statements of Stockholders’ Equity (Unaudited) for the Six Months Ended June 30, 2013 and 2012	4
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2013 and 2012	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 4.	Controls and Procedures	41
	PART II
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults upon Senior Securities	41
Item 4.	Mine Safety Disclosures	41
Item 5.	Other Information	41
Item 6.	Exhibits	42
	Signatures	43

1

PART I

ITEM 1. – FINANCIAL STATEMENTS

SUFFOLK BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CONDITION (UNAUDITED)

June 30, 2013 and December 31, 2012

(dollars in thousands, except per share data)

	June 30, 2013			December 31, 2012
ASSETS
Cash and cash equivalents
Cash and non-interest-bearing deposits due from banks	$	57,423		$	80,436
Interest-bearing deposits due from banks		161,973			304,220
Federal funds sold		1,000			1,150
Total cash and cash equivalents		220,396			385,806
Interest-bearing time deposits in other banks		10,000			-
Federal Reserve Bank,  Federal Home Loan Bank and other stock		2,916			3,043
Investment securities:
Available for sale, at fair value		429,843			402,353
Held to maturity (fair value of $8,024 and $8,861, respectively)		7,364			8,035
Total investment securities		437,207			410,388
Loans		895,451			780,780
Allowance for loan losses		17,293			17,781
Net loans		878,158			762,999
Loans held-for-sale		1,262			907
Premises and equipment, net		27,048			27,656
Bank owned life insurance		38,042			-
Deferred taxes		16,129			11,385
Income tax receivable		5,366			5,406
Other real estate owned ("OREO")		-			1,572
Accrued interest and loan fees receivable		5,022			4,883
Goodwill and other intangibles		2,950			2,670
Other assets		3,801			5,749
TOTAL ASSETS	$	1,648,297		$	1,622,464
LIABILITIES & STOCKHOLDERS' EQUITY
Demand deposits	$	597,735		$	615,120
Saving, N.O.W. and money market deposits		621,918			572,263
Time certificates of $100,000 or more		172,988			165,731
Other time deposits		72,813			78,000
Total deposits		1,465,454			1,431,114
Unfunded pension liability		7,749			7,781
Capital leases		4,655			4,688
Other liabilities		11,407			14,896
TOTAL LIABILITIES		1,489,265			1,458,479
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Common stock (par value $2.50; 15,000,000 shares authorized; 13,738,752 shares and 13,732,085 shares issued at June 30, 2013 and December 31, 2012, respectively;11,573,014 shares and 11,566,347 shares outstanding at June 30, 2013 and December 31, 2012, respectively)		34,347			34,330
Surplus		42,899			42,628
Retained earnings		95,033			89,555
Treasury stock at par (2,165,738 shares)		(5,414	)		(5,414	)
Accumulated other comprehensive (loss) income, net of tax		(7,833	)		2,886
TOTAL STOCKHOLDERS' EQUITY		159,032			163,985
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY	$	1,648,297		$	1,622,464

See accompanying notes to unaudited condensed consolidated financial statements.

2

SUFFOLK BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

For the Three and Six Months Ended June 30, 2013 and 2012

(dollars in thousands, except per share data)

	Three Months Ended June 30,					Six Months Ended June 30,
	2013		2012			2013		2012
INTEREST INCOME
Loans and loan fees	$	11,250	$	12,927		$	22,332	$	25,321
U.S. Government agency obligations		480		4			813		4
Obligations of states and political subdivisions		1,489		1,526			2,989		3,052
Collateralized mortgage obligations		546		1,199			1,381		2,393
Mortgage-backed securities		474		19			839		26
Corporate bonds		96		16			213		16
Federal funds sold and interest-bearing deposits due from banks		189		137			362		214
Dividends		36		17			75		63
Total interest income		14,560		15,845			29,004		31,089
INTEREST EXPENSE
Saving, N.O.W. and money market deposits		294		303			580		620
Time certificates of $100,000 or more		294		406			594		845
Other time deposits		159		258			341		538
Total interest expense		747		967			1,515		2,003
Net interest income		13,813		14,878			27,489		29,086
Provision (credit) for loan losses		-		(2,400	)		-		(2,400	)
Net interest income after provision (credit) for loan losses		13,813		17,278			27,489		31,486
NON-INTEREST INCOME
Service charges on deposit accounts		951		1,000			1,875		1,950
Other service charges, commissions and fees		813		846			1,523		1,596
Fiduciary fees		263		208			536		409
Net gain on sale of securities available for sale		33		-			392		-
Net gain on sale of portfolio loans		3		-			445		-
Net gain on sale of mortgage loans originated for sale		305		222			831		419
Income from bank owned life insurance		42		-			42		-
Other operating income		54		125			137		282
Total non-interest income		2,464		2,401			5,781		4,656
OPERATING EXPENSES
Employee compensation and benefits		6,746		8,875			15,328		17,459
Occupancy expense		1,658		1,276			3,202		2,730
Equipment expense		557		491			1,129		1,003
Consulting and professional services		573		696			1,146		1,640
FDIC assessment		524		478			1,041		548
Data processing		749		725			1,216		1,094
Accounting and audit fees		178		159			199		743
Other operating expenses		1,707		1,439			3,232		3,527
Total operating expenses		12,692		14,139			26,493		28,744
Income before income tax expense		3,585		5,540			6,777		7,398
Income tax expense		816		1,340			1,299		2,030
NET INCOME	$	2,769	$	4,200		$	5,478	$	5,368
EARNINGS PER COMMON SHARE - BASIC	$	0.24	$	0.43		$	0.47	$	0.55
EARNINGS PER COMMON SHARE - DILUTED	$	0.24	$	0.43		$	0.47	$	0.55
WEIGHTED AVERAGE NUMBER OF COMMON SHARES - BASIC		11,570,450		9,726,814			11,568,410		9,726,814
WEIGHTED AVERAGE NUMBER OF COMMON SHARES - DILUTED		11,576,170		9,726,814			11,568,415		9,726,814

See accompanying notes to unaudited condensed consolidated financial statements.

3

SUFFOLK BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

For the Three and Six Months Ended June 30, 2013 and 2012

(dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Net income	$	2,769		$	4,200		$	5,478		$	5,368
Other comprehensive loss, net of taxes and reclassification adjustments:
Net change in unrealized gain (loss) on securities available for sale arising during the period		(9,222	)		(1,087	)		(10,442	)		(2,660	)
Pension and post-retirement plan benefit obligation		(277	)		-			(277	)		(255	)
Total other comprehensive loss, net of taxes		(9,499	)		(1,087	)		(10,719	)		(2,915	)
Total comprehensive (loss) income	$	(6,730	)	$	3,113		$	(5,241	)	$	2,453

See accompanying notes to unaudited condensed consolidated financial statements.

SUFFOLK BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)

For the Six Months Ended June 30, 2013 and 2012

(dollars in thousands)

	Six Months Ended June 30,
	2013			2012
Common stock
Balance, January 1	$	34,330		$	34,330
Stock options exercised		17			-
Ending balance		34,347			34,330
Surplus
Balance, January 1		42,628			24,010
Stock options exercised		73			-
Stock-based compensation		198			91
Ending balance		42,899			24,101
Retained earnings
Balance, January 1		89,555			91,303
Net income		5,478			5,368
Ending balance		95,033			96,671
Treasury stock
Balance, January 1		(5,414	)		(10,013	)
Ending balance		(5,414	)		(10,013	)
Accumulated other comprehensive loss, net of tax
Balance, January 1		2,886			(3,070	)
Other comprehensive loss		(10,719	)		(2,915	)
Ending balance		(7,833	)		(5,985	)
Total stockholders' equity	$	159,032		$	139,104

See accompanying notes to unaudited condensed consolidated financial statements.

4

SUFFOLK BANCORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

For the Six Months Ended June 30, 2013 and 2012

(dollars in thousands)

	Six Months Ended June 30,
	2013			2012
NET INCOME	$	5,478		$	5,368
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Provision (credit) for loan losses		-			(2,400	)
Depreciation and amortization		1,382			1,296
Stock-based compensation		198			91
Net amortization of premiums		664			896
Originations of mortgage loans for sale		(32,570	)		(16,816	)
Proceeds from sale of mortgage loans originated for sale		36,719			17,235
Gain on sale of mortgage loans originated for sale		(831	)		(419	)
Gain on sale of portfolio loans		(445	)		-
Increase in other intangibles		(280	)		-
Deferred tax expense		1,212			3,368
Decrease (increase) in income tax receivable		40			(1,339	)
(Increase) decrease in accrued interest and loan fees receivable		(139	)		1,629
Decrease in other assets		1,948			584
Adjustment to unfunded pension liability		(32	)		2,074
Decrease in other liabilities		(3,765	)		(583	)
Income from bank owned life insurance		(42	)		-
Loss on sale of OREO		47			-
Gain on sale of securities available for sale		(392	)		-
Net cash provided by operating activities		9,192			10,984
CASH FLOWS FROM INVESTING ACTIVITIES
Principal payments on investment securities		37,438			14,867
Proceeds from sale of investment securities - available for sale		13,427			-
Maturities of investment securities - available for sale		20,780			32,123
Purchases of investment securities - available for sale		(115,803	)		(60,879	)
Maturities of investment securities - held to maturity		1,268			1,957
Purchases of investment securities -  held to maturity		(600	)		(740	)
Increase in interest-bearing time deposits in other banks		(10,000	)		-
Decrease in Federal Reserve Bank, Federal Home Loan Bank and other stock		127			160
Proceeds from sale of portfolio loans		1,349			-
Loan (originations) repayments - net		(119,736	)		105,227
Proceeds from sale of OREO		1,525			-
Increase in bank owned life insurance		(38,000	)		-
Purchases of premises and equipment - net		(774	)		(1,053	)
Net cash (used in) provided by investing activities		(208,999	)		91,662
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposit accounts		34,340			69,894
Proceeds from stock options exercised		90			-
Decrease  in capital lease payable		(33	)		(11	)
Net cash provided by financing activities		34,397			69,883
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(165,410	)		172,529
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		385,806			172,559
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	220,396		$	345,088
SUPPLEMENTAL DATA:
Interest paid	$	1,540		$	2,026
Income taxes paid	$	41		$	-
Loans transferred to held-for-sale	$	-		$	22,757
Loans transferred to OREO	$	-		$	372

See accompanying notes to unaudited condensed consolidated financial statements.

5

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. FINANCIAL STATEMENT PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The unaudited interim condensed consolidated financial statements include the accounts of Suffolk Bancorp (the “Company”) and its wholly owned subsidiary, the Suffolk County National Bank of Riverhead and its subsidiaries (the “Bank”). The Bank formed Suffolk Greenway, Inc., a real estate investment trust, and owns 100% of an insurance agency and two corporations used to acquire foreclosed real estate. The insurance agency and the two corporations used to acquire foreclosed real estate are immaterial to the Company’s operations. Suffolk Bancorp and subsidiaries are collectively referred to hereafter as the “Company.” All material intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of the Company’s management, the preceding unaudited interim condensed consolidated financial statements contain all adjustments, consisting of normal accruals, necessary for a fair presentation of its condensed consolidated statements of condition as of June 30, 2013 and December 31, 2012, its condensed consolidated statements of operations for the three and six months ended June 30, 2013 and 2012, its condensed consolidated statements of comprehensive income (loss) for the three and six months ended June 30, 2013 and 2012, its condensed consolidated statements of stockholders’ equity for the six months ended June 30, 2013 and 2012 and its condensed consolidated statements of cash flows for the six months ended June 30, 2013 and 2012. The preceding unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X, as well as in accordance with predominant practices within the banking industry. They do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results of operations to be expected for the remainder of the year. For further information, please refer to the audited consolidated financial statements and footnotes thereto included in the Company’s 2012 Annual Report on Form 10-K.

Termination of Formal Agreement with the Comptroller of the Currency - On May 29, 2013, the Bank was informed by its primary regulator, the Office of the Comptroller of the Currency (the “OCC”), that the formal written agreement between the Bank and the OCC, dated October 25, 2010 (the “Agreement”), was terminated effective immediately. In addition, the Bank was informed by the OCC that it was no longer subject to the individual minimum capital ratios (the “IMCRs”) established for the Bank. 

Loans and Loan Interest Income Recognition - Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned discounts, deferred loan fees and costs.  Unearned discounts on installment loans are credited to income using methods that result in a level yield. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the respective term of the loan without anticipating prepayments.

Interest income is accrued on the unpaid loan principal balance.  Recognition of interest income is discontinued when reasonable doubt exists as to whether principal or interest due can be collected. Loans of all classes will generally no longer accrue interest when over 90 days past due unless the loan is well-secured and in process of collection. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current-year interest income. Interest received on such loans is applied against principal or interest, according to management’s judgment as to the collectability of the principal, until qualifying for return to accrual status. Loans start accruing interest again when they become current as to principal and interest for at least six months, and when, after a well-documented analysis by management, the loans can be collected in full.  For all classes of loans, an impaired loan is defined as a loan for which it is probable that the lender will not collect all amounts due under the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties are considered troubled debt restructurings (“TDRs”) and are classified as impaired. Generally, TDRs are initially classified as non-accrual until sufficient time has passed to assess whether the restructured loan will continue to perform. For impaired, accruing loans, interest income is recognized on an accrual basis with cash offsetting the recorded accruals upon receipt. Interest received on non-accrual, impaired loans is applied against principal or interest according to management’s judgment as to the collectibility of the principal.

Allowance for Loan Losses - The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a continuous analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company’s own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all TDRs are evaluated individually for impairment. Management will use judgment to determine if there are other loans outside of these two categories that fit the definition of impaired. All other loans are generally evaluated as homogeneous pools with similar risk characteristics. In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics; e.g., commercial and industrial, commercial real estate, real estate construction, residential mortgages (1^st and 2^nd liens), home equity and consumer loans.

6

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on their collateral and the estimated time required to recover the Company’s investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan’s effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the collectability of the loan class not captured by historical loss data.  These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. These adjustments reflect management’s overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

Loans Held-For-Sale – Loans held-for-sale are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from third parties. Changes in fair value of loans held-for-sale are recognized in earnings.  

Bank Owned Life Insurance - Bank owned life insurance is recorded at the lower of the cash surrender value or the amount that can be realized under the insurance policy and is included as an asset in the consolidated statements of condition. Changes in the cash surrender value and insurance benefit payments are recorded in non-interest income in the consolidated statements of operations.

Dividend Restriction - Banking regulations require maintaining certain capital levels and impose limitations on dividends paid by the Bank to the Company and by the Company to stockholders. (See also Regulatory Matters footnote contained herein.)

Recent Accounting Guidance – On July 18, 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, Income Taxes (Topic 740), “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists,” to clarify the balance sheet presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists.  The ASU requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Management intends to adopt ASU 2013-111 effective January 1, 2014, and does not believe that the adoption will have a material effect on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220), “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This standard is effective prospectively for public entities for annual and interim reporting periods beginning after December 15, 2012. Being disclosure-related only, the Company’s adoption of ASU 2013-02 on January 1, 2013 did not have a material effect on the Company’s results of operations or financial condition.

7

Reclassifications — Certain reclassifications have been made to prior period information in order to conform to the current period’s presentation. Such reclassifications had no impact on the Company’s consolidated results of operations or financial condition.

2. ACCUMULATED OTHER COMPREHENSIVE INCOME (“AOCI”)

The changes in the Company’s AOCI by component, net of tax, for the three and six months ended June 30, 2013 and 2012 follow (in thousands). The decrease in net unrealized gains on available for sale securities for both the three and six months ended June 30, 2013 resulted solely from the negative impact of higher interest rates in 2013.

	Three Months Ended June 30, 2013									Three Months Ended June 30, 2012
	Unrealized Gains and Losses on Available for Sale Securities			Pension and Post-Retirement Plan Items			Total			Unrealized Gains and Losses on Available for Sale Securities			Pension and Post- Retirement Plan Items			Total
Beginning balance	$	9,333		$	(7,667	)	$	1,666		$	10,300		$	(15,198	)	$	(4,898	)
Other comprehensive loss before reclassifications		(9,201	)		(277	)		(9,478	)		(1,087	)		-			(1,087	)
Amounts reclassified from AOCI		(21	)		-			(21	)		-			-			-
Net other comprehensive loss		(9,222	)		(277	)		(9,499	)		(1,087	)		-			(1,087	)
Ending balance	$	111		$	(7,944	)	$	(7,833	)	$	9,213		$	(15,198	)	$	(5,985	)

	Six Months Ended June 30, 2013									Six Months Ended June 30, 2012
	Unrealized Gains and Losses on Available for Sale Securities			Pension and Post-Retirement Plan Items			Total			Unrealized Gains and Losses on Available for Sale Securities			Pension and Post-Retirement Plan Items			Total
Beginning balance	$	10,553		$	(7,667	)	$	2,886		$	11,873		$	(14,943	)	$	(3,070	)
Other comprehensive loss before reclassifications		(10,192	)		(277	)		(10,469	)		(2,660	)		(255	)		(2,915	)
Amounts reclassified from AOCI		(250	)		-			(250	)		-			-			-
Net other comprehensive loss		(10,442	)		(277	)		(10,719	)		(2,660	)		(255	)		(2,915	)
Ending balance	$	111		$	(7,944	)	$	(7,833	)	$	9,213		$	(15,198	)	$	(5,985	)

The table below presents reclassifications out of AOCI for the three and six months ended June 30, 2013 (in thousands).

	Amount Reclassified from AOCI
Details about AOCI Components	Three Months Ended June 30, 2013			Six Months Ended June 30, 2013			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains and losses on available for sale securities	$	33		$	392		Net gain on sale of securities available for sale
		(12	)		(142	)	Income tax expense
Total reclassifications, net of tax	$	21		$	250

3. INVESTMENT SECURITIES

At the time of purchase of a security, the Company designates the security as either available for sale or held to maturity, depending upon investment objectives, liquidity needs and intent. Securities held to maturity are stated at cost, adjusted for premium amortized or discount accreted, if any. The Company has the positive intent and ability to hold such securities to maturity. Securities available for sale are stated at estimated fair value. Unrealized gains and losses are excluded from income and reported net of tax as accumulated other comprehensive income (loss) as a separate component of stockholders’ equity until realized. Changes in unrealized gains and losses are reported, net of tax, in the consolidated statements of comprehensive income (loss). Interest earned on securities is included in interest income. Realized gains and losses on the sale of securities are reported in the consolidated statements of operations and determined using the adjusted cost of the specific security sold.

8

The amortized cost, estimated fair value and gross unrealized gains and losses of the Company’s investment securities available for sale and held to maturity at June 30, 2013 and December 31, 2012 follow (in thousands).

	June 30, 2013									December 31, 2012
			Gross		Gross			Estimated				Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
Available for sale:
U.S. Treasury securities	$	-	$	-	$	-		$	-	$	500	$	-	$	-		$	500
U.S. Government agency securities		109,375		-		(5,582	)		103,793		65,085		70		(77	)		65,078
Obligations of states and political subdivisions		152,297		9,423		-			161,720		155,121		13,314		-			168,435
Collateralized mortgage obligations		47,516		1,026		(537	)		48,005		87,624		2,148		(80	)		89,692
Mortgage-backed securities		104,909		33		(4,194	)		100,748		61,750		766		(66	)		62,450
Corporate bonds		15,572		247		(242	)		15,577		15,701		497		-			16,198
Total available for sale securities		429,669		10,729		(10,555	)		429,843		385,781		16,795		(223	)		402,353
Held to maturity:
Obligations of states and political subdivisions		7,364		660		-			8,024		8,035		826		-			8,861
Total investment securities	$	437,033	$	11,389	$	(10,555	)	$	437,867	$	393,816	$	17,621	$	(223	)	$	411,214

At June 30, 2013 and December 31, 2012, investment securities carried at $293 million and $286 million, respectively, were pledged to secure trust deposits and public funds on deposit.

The amortized cost, contractual maturities and estimated fair value of the Company’s investment securities at June 30, 2013 (in thousands) are presented in the table below. Collateralized mortgage obligations (“CMOs”) and mortgage-backed securities (“MBS”) assume maturity dates pursuant to average lives.

	June 30, 2013
	Amortized		Estimated
	Cost		Fair Value
Securities available for sale:
Due in one year or less	$	28,985	$	29,472
Due from one to five years		121,180		127,163
Due from five to ten years		251,643		247,017
Due after ten years		27,861		26,191
Total securities available for sale		429,669		429,843
Securities held to maturity:
Due in one year or less		837		854
Due from one to five years		6,262		6,889
Due from five to ten years		265		281
Total securities held to maturity		7,364		8,024
Total investment securities	$	437,033	$	437,867

The proceeds from sales of securities available for sale and the associated net realized gains follow (in thousands):

9

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Proceeds	$	2,952	$	-	$	13,427	$	-
Gross realized gains	$	33	$	-	$	392	$	-
Gross realized losses		-		-		-		-
Net realized gains	$	33	$	-	$	392	$	-

The table below indicates the length of time individual securities, both held to maturity and available for sale, have been held in a continuous unrealized loss position at the date indicated (in thousands).

	Less than 12 months				12 months or longer				Total
June 30, 2013	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
Type of securities	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	103,793	$	5,582	$	-	$	-	$	103,793	$	5,582
Collateralized mortgage obligations		9,179		537		-		-		9,179		537
Mortgage-backed securities		100,371		4,194		-		-		100,371		4,194
Corporate bonds		8,683		242		-		-		8,683		242
Total	$	222,026	$	10,555	$	-	$	-	$	222,026	$	10,555

	Less than 12 months				12 months or longer				Total
December 31, 2012	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
Type of securities	Fair value		Losses		Fair value		Losses		Fair value		Losses
U.S. Government agency securities	$	28,958	$	77	$	-	$	-	$	28,958	$	77
Collateralized mortgage obligations		7,878		80		-		-		7,878		80
Mortgage-backed securities		14,098		66		-		-		14,098		66
Total	$	50,934	$	223	$	-	$	-	$	50,934	$	223

The Company’s management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. All of the Company’s investment securities classified as available-for-sale or held-to-maturity are evaluated for OTTI under FASB Accounting Standards Codification (“ASC”) 320, “Accounting for Certain Investments in Debt and Equity Securities.” In determining OTTI under ASC 320, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on information available to management at a point in time. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

When an OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost and its estimated fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost less any current-period loss, the OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable tax benefit. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

Upon review of the considerations mentioned here, no OTTI was deemed to be warranted at June 30, 2013.

10

4. LOANS

At June 30, 2013 and December 31, 2012, net loans disaggregated by class consisted of the following (in thousands):

	June 30, 2013			December 31, 2012
Commercial and industrial	$	179,785		$	168,709
Commercial real estate (1)		481,840			369,271
Real estate construction		10,294			15,469
Residential mortgages (1st and 2nd liens)		150,616			146,575
Home equity		60,951			66,468
Consumer		11,965			14,288
Gross loans		895,451			780,780
Allowance for loan losses		(17,293	)		(17,781	)
Net loans at end of period	$	878,158		$	762,999

(1) Includes multifamily loans of $82,079 and $9,261 at June 30, 2013 and December 31, 2012, respectively.

For the three and six months ended June 30, 2013 and 2012, the activity in the allowance for loan losses disaggregated by class is shown below (in thousands).

	Commercial and industrial			Commercial real estate			Real estate construction			Residential mortgages (1st and 2nd liens)			Home equity			Consumer			Unallocated			Total
Three months ended June 30, 2013
Balance at beginning of period	$	5,345		$	6,570		$	845		$	2,441		$	924		$	245		$	1,464		$	17,834
Charge-offs		(1,279	)		-			-			(74	)		-			(111	)		-			(1,464	)
Recoveries		911			1			-			-			1			10			-			923
(Credit) provision for loan losses		(199	)		659			(567	)		(26	)		134			103			(104	)		-
Balance at end of period	$	4,778		$	7,230		$	278		$	2,341		$	1,059		$	247		$	1,360		$	17,293
Three months ended June 30, 2012
Balance at beginning of period	$	23,793		$	8,879		$	579		$	2,035		$	1,255		$	354		$	3,113		$	40,008
Charge-offs		(790	)		(7,692	)		-			(193	)		(532	)		(50	)		-			(9,257	)
Recoveries		769			-			80			1			-			26			-			876
(Credit) provision for loan losses		(8,690	)		6,994			(496	)		(209	)		1,285			(154	)		(1,130	)		(2,400	)
Balance at end of period	$	15,082		$	8,181		$	163		$	1,634		$	2,008		$	176		$	1,983		$	29,227

11

	Commercial and industrial			Commercial real estate			Real estate construction			Residential mortgages (1st and 2nd liens)			Home equity			Consumer			Unallocated			Total
Six months ended June 30, 2013
Balance at beginning of period	$	6,181		$	6,149		$	141		$	1,576		$	907		$	189		$	2,638		$	17,781
Charge-offs		(1,627	)		-			-			(74	)		-			(122	)		-			(1,823	)
Recoveries		1,210			73			-			1			2			49			-			1,335
(Credit) provision for loan losses		(986	)		1,008			137			838			150			131			(1,278	)		-
Balance at end of period	$	4,778		$	7,230		$	278		$	2,341		$	1,059		$	247		$	1,360		$	17,293
Six months ended June 30, 2012
Balance at beginning of period	$	25,047		$	11,029		$	623		$	2,401		$	512		$	313		$	33		$	39,958
Charge-offs		(1,127	)		(7,692	)		-			(588	)		(593	)		(82	)		-			(10,082	)
Recoveries		1,624			-			80			2			-			45			-			1,751
(Credit) provision for loan losses		(10,462	)		4,844			(540	)		(181	)		2,089			(100	)		1,950			(2,400	)
Balance at end of period	$	15,082		$	8,181		$	163		$	1,634		$	2,008		$	176		$	1,983		$	29,227

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered TDRs and classified as impaired. Generally, TDRs are initially classified as non-accrual until sufficient time has passed to assess whether the restructured loan will continue to perform. Generally, the Company returns a TDR to accrual status upon six months of performance under the new terms.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Management has determined that all TDRs and all non-accrual loans are impaired; however, non-accrual loans with an impaired balance of $250 thousand or less will be evaluated under ASC 450 with other groups of smaller or homogeneous loans with similar risk characteristics. Management will use judgment to determine if there are other loans outside of these two categories that fit the definition of impaired. If a loan is impaired, a specific reserve is recorded so that the loan is reported, net, at the present value of estimated future cash flows including balloon payments, if any, using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of homogeneous loans with smaller individual balances, such as consumer and residential real estate loans, are generally evaluated collectively for impairment, and accordingly, are not separately identified for impairment disclosures. TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be “collateral-dependent,” the loan is reported at the fair value of the collateral net of estimated costs to sell.  For TDRs that subsequently default, the Company determines the allowance amount in accordance with its accounting policy for the allowance for loan losses.

12

The general component of the allowance covers non-impaired loans and is based on historical loss experience, adjusted for qualitative factors.  The historical loss experience is determined by loan class, and is based on the actual loss history experienced by the Company over a rolling twelve quarter period. This actual loss experience is supplemented with other qualitative factors based on the risks present for each loan class.  These qualitative factors include consideration of the following:  levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability, and depth of lending management and other relevant staff; local, regional and national economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following loan classes have been identified: commercial and industrial, commercial real estate, real estate construction, residential mortgages (1^st and 2^nd liens), home equity and consumer loans. For performing loans, an estimate of adequacy of the general component of the allowance is made by applying qualitative factors specific to the portfolio to the period-end balances. Consideration is also given to the type and collateral of the loans with particular attention paid to commercial real estate construction loans, due to the inherent risk of this type of loan. Specific and general reserves are available for any identified loss.

The Company recorded no consolidated provision for loan losses for the three months ended June 30, 2013 as compared to a $2.4 million credit to the provision for loan losses for the three months ended June 30, 2012. The $2.4 million credit to the provision for loan losses during the second quarter of 2012 resulted from workout and asset disposition activities undertaken in that period. For the three months ended June 30, 2013, the Company decreased its allowance for loan losses allocated to commercial and industrial (“C&I”) and real estate construction loans by $199 thousand and $567 thousand, respectively, while increasing its allowance allocation to commercial real estate (“CRE”) by $659 thousand.

The decrease in the allowance for loan losses allocated to C&I loans during the first quarter of 2013 reflected a 0.18% reduction in the ASC 450-20 historical loss factors rate on unimpaired pass rated C&I loans, a $7 million decrease in the balance of unimpaired pass rated C&I loans and a decrease of $60 thousand in specific reserves for C&I loans as computed under ASC 310-10 at June 30, 2013 as compared to March 31, 2013.

The decrease to the allowance allocated to real estate construction loans was largely due to a decrease in the ASC 450-20 historical loss factors for such loans of 1.34% when compared to March 31, 2013. The increase in the allowance for loan losses allocated to CRE loans was primarily due to an $84 million increase in the balance of unimpaired pass rated CRE loans, reflecting growth in multi-family lending, versus March 31, 2013.

Effective with the March 31, 2013 calculation, the ASC 450-20 loss factors rates incorporate an expansion of the look back period used in calculating historical losses to a rolling twelve quarter period (from an eight quarter period) for each loan segment. This change resulted from the Company’s effort to improve the granularity of its individual loan segment charge-off history. Additionally, the expansion of the look back period reduces the volatility associated with improperly weighting short-term trends in this calculation. These changes more accurately represent the Company’s incurred and expected losses by individual loan segment.

At June 30, 2013 and December 31, 2012, the ending balance in the allowance for loan losses disaggregated by class and impairment methodology follows below (in thousands). Also shown below are total loans at June 30, 2013 and December 31, 2012 disaggregated by class and impairment methodology (in thousands).

June 30, 2013	Commercial and industrial		Commercial real estate		Real estate construction		Residential mortgages  (1st and 2nd liens)		Home equity		Consumer		Unallocated		Total
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	377	$	-	$	-	$	605	$	351	$	52	$	-	$	1,385
Ending balance: collectively evaluated for impairment		4,401		7,230		278		1,736		708		195		1,360		15,908
Ending balance	$	4,778	$	7,230	$	278	$	2,341	$	1,059	$	247	$	1,360	$	17,293
Loan balances:
Ending balance: individually evaluated for impairment	$	13,355	$	8,474	$	-	$	5,292	$	999	$	228	$	-	$	28,348
Ending balance: collectively evaluated for impairment		166,430		473,366		10,294		145,324		59,952		11,737		-		867,103
Ending balance	$	179,785	$	481,840	$	10,294	$	150,616	$	60,951	$	11,965	$	-	$	895,451

13

December 31, 2012	Commercial and industrial		Commercial real estate		Real estate construction		Residential mortgages (1st and  2nd liens)		Home equity		Consumer		Unallocated		Total
Allowance for loan losses:
Ending balance: individually evaluated for impairment	$	340	$	22	$	1	$	575	$	86	$	-	$	-	$	1,024
Ending balance: collectively evaluated for impairment		5,841		6,127		140		1,001		821		189		2,638		16,757
Ending balance	$	6,181	$	6,149	$	141	$	1,576	$	907	$	189	$	2,638	$	17,781
Loan balances:
Ending balance: individually evaluated for impairment	$	10,369	$	9,443	$	1,961	$	4,660	$	502	$	21	$	-	$	26,956
Ending balance: collectively evaluated for impairment		158,340		359,828		13,508		141,915		65,966		14,267		-		753,824
Ending balance	$	168,709	$	369,271	$	15,469	$	146,575	$	66,468	$	14,288	$	-	$	780,780

The following table presents certain information pertaining to the Company’s impaired loans disaggregated by class at June 30, 2013 and December 31, 2012 (in thousands):

	June 30, 2013						December 31, 2012
	Unpaid Principal Balance		Recorded Balance		Allowance Allocated		Unpaid Principal Balance		Recorded Balance		Allowance Allocated
With no allowance recorded:
Commercial and industrial	$	9,458	$	9,155	$	-	$	7,913	$	7,492	$	-
Commercial real estate		8,941		8,474		-		8,859		7,282		-
Real estate construction		-		-		-		1,334		1,305		-
Residential mortgages (1st and 2nd liens)		2,726		2,597		-		1,918		1,788		-
Home equity		572		572		-		418		416		-
Consumer		166		74		-		21		21		-
Subtotal		21,863		20,872		-		20,463		18,304		-
With an allowance recorded:
Commercial and industrial		5,106		4,200		377		2,884		2,877		340
Commercial real estate		-		-		-		2,161		2,161		22
Real estate construction		-		-		-		656		656		1
Residential mortgages (1st and 2nd liens)		2,895		2,695		605		3,015		2,872		575
Home equity		428		427		351		86		86		86
Consumer		155		154		52		-		-		-
Subtotal		8,584		7,476		1,385		8,802		8,652		1,024
Total	$	30,447	$	28,348	$	1,385	$	29,265	$	26,956	$	1,024

Shown below is additional information pertaining to the Company’s impaired loans disaggregated by class for the three and six months ended June 30, 2013 and 2012 (in thousands):

14

	Three Months Ended June 30, 2013						Three Months Ended June 30, 2012
	Average recorded investment in impaired loans		Interest income recognized on impaired loans		Interest income recognized on a cash basis on impaired loans		Average recorded investment in impaired loans		Interest income recognized on impaired loans		Interest income recognized on a cash basis on impaired loans
Commercial and industrial	$	14,146	$	175	$	-	$	28,398	$	315	$	-
Commercial real estate		8,532		76		-		54,531		259		-
Real estate construction		420		14		-		18,093		338		-
Residential mortgages (1st and 2nd liens)		5,442		52		-		1,898		85		-
Home equity		950		1		-		3,863		-		-
Consumer		277		3		-		624		-		-
Total	$	29,767	$	321	$	-	$	107,407	$	997	$	-

	Six Months Ended June 30, 2013						Six Months Ended June 30, 2012
	Average recorded investment in impaired loans		Interest income recognized on impaired loans		Interest income recognized on a cash basis on impaired loans		Average recorded investment in impaired loans		Interest income recognized on impaired loans		Interest income recognized on a cash basis on impaired loans
Commercial and industrial	$	14,682	$	232	$	-	$	31,425	$	315	$	-
Commercial real estate		8,589		145		-		60,363		259		-
Real estate construction		981		14		-		18,557		338		-
Residential mortgages (1st and 2nd liens)		5,476		94		-		8,287		85		-
Home equity		951		4		-		3,900		-		-
Consumer		279		8		-		641		-		-
Total	$	30,958	$	497	$	-	$	123,173	$	997	$	-

TDRs involve modifications or renewals where the Company has granted a concession to a borrower in financial distress. The Company reviews all modifications and renewals for determination of TDR status. The Company allocated $973 thousand and $800 thousand of specific reserves to customers whose loan terms have been modified as TDRs as of June 30, 2013 and December 31, 2012, respectively. These loans involved the restructuring of terms to allow customers to mitigate the risk of default by meeting a lower payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.

A total of $40 thousand and $35 thousand were committed to be advanced in connection with TDRs as of June 30, 2013 and December 31, 2012, respectively, representing the amount the Company is legally required to advance under existing loan agreements. These loans are not in default under the terms of the loan agreements and are accruing interest. It is the Company’s policy to evaluate advances on such loans on a case by case basis. Absent a legal obligation to advance pursuant to the terms of the loan agreement, the Company generally will not advance funds for which it has outstanding commitments, but may do so in certain circumstances.

The following tables present certain information regarding outstanding TDRs at June 30, 2013 and December 31, 2012 (dollars in thousands), TDRs executed during the three and six months ended June 30, 2013 and 2012 (dollars in thousands) and TDRs with payment defaults of 90 days or more within twelve months of restructuring during the three and six months ended June 30, 2013 and 2012 (dollars in thousands):

15

	June 30, 2013				December 31, 2012
Total TDRs	Number of Loans		Outstanding Recorded Balance		Number of Loans		Outstanding Recorded Balance
Commercial and industrial		42	$	6,490		41	$	6,468
Commercial real estate		7		4,998		9		6,238
Residential mortgages (1st and 2nd liens)		17		4,144		15		3,587
Consumer		5		229		5		311
		71	$	15,861		70	$	16,604

	Three months ended June 30, 2013						Three months ended June 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
New TDRs	Loans		Balance		Balance		Loans		Balance		Balance
Commercial and industrial		2	$	572	$	572		5	$	2,140	$	2,272
Residential mortgages (1st and 2nd liens)		-		-		-		1		81		81
Consumer		-		-		-		1		49		49
		2	$	572	$	572		7	$	2,270	$	2,402

	Six months ended June 30, 2013						Six months ended June 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
New TDRs	Loans		Balance		Balance		Loans		Balance		Balance
Commercial and industrial		4	$	892	$	892		14	$	5,456	$	5,588
Residential mortgages (1st and 2nd liens)		3		905		905		1		81		81
Consumer		1		17		17		1		49		49
		8	$	1,814	$	1,814		16	$	5,586	$	5,718

	Three months ended June 30, 2013				Three months ended June 30, 2012
			Outstanding				Outstanding
	Number		Recorded		Number		Recorded
Defaulted TDRs	of Loans		Balance		of Loans		Balance
Commercial and industrial		-	$	-		1	$	1,127
		-	$	-		1	$	1,127

16

	Six months ended June 30, 2013				Six months ended June 30, 2012
			Outstanding				Outstanding
	Number		Recorded		Number		Recorded
Defaulted TDRs	of Loans		Balance		of Loans		Balance
Commercial and industrial		-	$	-		2	$	2,508
Commercial real estate		-		-		1		-
Real estate construction		-		-		1		1,646
Residential mortgages (1st and 2nd liens)		-		-		1		488
		-	$	-		5	$	4,642

Not all loan modifications are TDRs. In some cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate.

Information regarding modifications and renewals executed during the three and six months ended June 30, 2013 and 2012 that are not considered TDRs is shown below (dollars in thousands):

	Three months ended June 30, 2013				Three months ended June 30, 2012
			Outstanding				Outstanding
	Number		Recorded		Number		Recorded
Non-TDR Modifications	of Loans		Balance		of Loans		Balance
Commercial and industrial		8	$	4,501		5	$	1,958
Commercial real estate		9		6,415		7		6,936
		17	$	10,916		12	$	8,894

	Six months ended June 30, 2013				Six months ended June 30, 2012
			Outstanding				Outstanding
	Number		Recorded		Number		Recorded
Non-TDR Modifications	of Loans		Balance		of Loans		Balance
Commercial and industrial		8	$	4,501		6	$	2,538
Commercial real estate		20		26,118		9		10,115
		28	$	30,619		15	$	12,653

The following is a summary of information pertaining to non-performing assets at June 30, 2013 and December 31, 2012 (in thousands):

	June 30, 2013		December 31, 2012
Non-accrual loans	$	17,183	$	16,435
Non-accrual loans held-for-sale		-		907
Loans 90 days past due and still accruing		-		-
OREO		-		1,572
Total non-performing assets	$	17,183	$	18,914
TDRs accruing interest	$	9,843	$	9,954
TDRs non-accruing	$	6,018	$	6,650

17

The following table summarizes non-accrual loans by loan class at June 30, 2013 and December 31, 2012 (dollars in thousands):

	June 30, 2013										December 31, 2012
								% of										% of
			% of			Total		Total					% of			Total		Total
			Total			Loans		Loans					Total			Loans		Loans
Commercial and industrial	$	9,597		55.9	%	$	179,785		1.1	%	$	6,529		39.8	%	$	168,709		0.8	%
Commercial real estate (1)		4,227		24.6			481,840		0.4			5,192		31.6			369,271		0.7
Real estate construction		-		-			10,294		-			1,961		11.9			15,469		0.3
Residential mortgages (1st and 2nd liens)		2,617		15.2			150,616		0.3			2,466		15.0			146,575		0.3
Home equity		664		3.9			60,951		0.1			266		1.6			66,468		-
Consumer		78		0.4			11,965		-			21		0.1			14,288		-
Total	$	17,183		100.0	%	$	895,451		1.9	%	$	16,435		100.0	%	$	780,780		2.1	%

(1) At June 30, 2013, there were no non-accrual multifamily loans.

For the non-accrual loans outstanding at the end of the reported periods, additional interest income of approximately $280 thousand and $1.4 million would have been recorded on non-accrual loans during the three months ended June 30, 2013 and 2012, respectively, and $686 thousand and $2.8 million during the six months ended June 30, 2013 and 2012, respectively, if the loans had performed in accordance with their original terms.

The following table details the collateral value securing non-accrual loans at June 30, 2013 and December 31, 2012 (in thousands):

	June 30, 2013				December 31, 2012
	Principal Balance		Collateral Value		Principal Balance		Collateral Value
Commercial and industrial (1)	$	9,597	$	6,000	$	6,529	$	4,400
Commercial real estate		4,227		10,750		5,192		12,675
Real estate construction		-		-		1,961		3,661
Residential mortgages (1st and 2nd liens)		2,617		4,749		2,466		5,141
Home equity		664		2,294		266		849
Consumer		78		-		21		-
Total	$	17,183	$	23,793	$	16,435	$	26,726

(1) Repayment of commercial and industrial loans is expected primarily from the cash flow of the business. The collateral typically securing these loans is a lien on all corporate assets via a blanket UCC filing and does not usually include real estate. For purposes of this disclosure, the Company has ascribed no value to the non-real estate collateral for this class of loans.

At June 30, 2013 and December 31, 2012, past due loans disaggregated by class were as follows (in thousands):

	Past Due
June 30, 2013	30 - 59 days		60 - 89 days		90 days and over		Total		Current		Total
Commercial and industrial	$	51	$	53	$	9,597	$	9,701	$	170,084	$	179,785
Commercial real estate (1)		643		317		4,227		5,187		476,653		481,840
Real estate construction		-		-		-		-		10,294		10,294
Residential mortgages
(1st and 2nd liens)		1,291		364		2,617		4,272		146,344		150,616
Home equity		773		400		664		1,837		59,114		60,951
Consumer		16		5		78		99		11,866		11,965
Total	$	2,774	$	1,139	$	17,183	$	21,096	$	874,355	$	895,451

(1) At June 30, 2013, there were no past due multifamily loans.

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	Past Due
December 31, 2012	30 - 59 days		60 - 89 days		90 days and over		Total		Current		Total
Commercial and industrial	$	6,591	$	1,274	$	6,529	$	14,394	$	154,315	$	168,709
Commercial real estate		1,145		329		5,192		6,666		362,605		369,271
Real estate construction		1,382		-		1,961		3,343		12,126		15,469
Residential mortgages
(1st and 2nd liens)		2,867		6		2,466		5,339		141,236		146,575
Home equity		261		100		266		627		65,841		66,468
Consumer		189		18		21		228		14,060		14,288
Total	$	12,435	$	1,727	$	16,435	$	30,597	$	750,183	$	780,780

The Bank utilizes an eight-grade risk-rating system for commercial and industrial loans, commercial real estate and construction loans. Loans in risk grades 1- 4 are considered “pass” loans. The Bank’s risk grades are as follows:

Risk Grade 1 – Excellent. Loans secured by liquid collateral such as certificates of deposit, reputable bank letters of credit, or other cash equivalents; loans that are guaranteed or otherwise backed by the full faith and credit of the United States government or an agency thereof, such as the Small Business Administration; or loans to any publicly held company with a current long-term debt rating of A or better.

Risk Grade 2 – Good. Loans to businesses that have strong financial statements containing an unqualified opinion from a CPA firm and at least three consecutive years of profits; loans supported by un-audited financial statements containing strong balance sheets, five consecutive years of profits, a five-year satisfactory relationship with the Bank, and key balance sheet and income statement trends that are either stable or positive; loans secured by publicly traded marketable securities where there is no impediment to liquidation; loans to individuals backed by liquid personal assets, established credit history, and unquestionable character; or loans to publicly held companies with current long-term debt ratings of Baa or better.

Risk Grade 3 – Satisfactory. Loans supported by financial statements (audited or un-audited) that indicate average or slightly below average risk and having some deficiency or vulnerability to changing economic conditions; loans with some weakness but offsetting features of other support are readily available; loans that are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered. Loans may be graded Satisfactory when there is no recent information on which to base a current risk evaluation and the following conditions apply:

· At inception, the loan was properly underwritten, did not possess an unwarranted level of credit risk, and the loan met the above criteria for a risk grade of Excellent, Good, or Satisfactory.

· At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss.

· The loan has exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

· During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or

· The borrower is in an industry known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Risk Grade 4 - Satisfactory/Monitored. Loans in this category are considered to be of acceptable credit quality, but contain greater credit risk than satisfactory loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in a Satisfactory/Monitored loan is within acceptable underwriting guidelines so long as the loan is given the proper level of management supervision.

Risk Grade 5 - Special Mention. Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered “potential,” not “defined,” impairments to the primary source of repayment.

19

Risk Grade 6 – Substandard. One or more of the following characteristics may be exhibited in loans classified Substandard:

· Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

· Loans are inadequately protected by the current net worth and paying capacity of the obligor.

· The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

· Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

· Unusual courses of action are needed to maintain a high probability of repayment.

· The borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments.

· The lender is forced into a subordinated or unsecured position due to flaws in documentation.

· Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.

· The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

· There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

Risk Grade 7 – Doubtful. One or more of the following characteristics may be present in loans classified Doubtful:

· Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

· The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

· The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Risk Grade 8 – Loss. Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

At June 30, 2013 and December 31, 2012, based upon the most recent analysis performed, the following table presents the Company’s loan portfolio credit risk profile by internally assigned grade disaggregated by class of loan (in thousands):

June 30, 2013	Commercial and industrial		Commercial real estate (1)		Real estate construction		Residential mortgages (1st and 2nd liens)		Home equity		Consumer		Total
Grade:
Pass	$	157,222	$	437,700	$	10,294	$	145,383	$	60,202	$	11,731	$	822,532
Special mention		5,970		19,495		-		-		-		-		25,465
Substandard		16,593		24,645		-		5,233		749		234		47,454
Total	$	179,785	$	481,840	$	10,294	$	150,616	$	60,951	$	11,965	$	895,451

(1) At June 30, 2013, there were no special mention or substandard grade multifamily loans.

20

December 31, 2012	Commercial and industrial		Commercial real estate		Real estate construction		Residential mortgages (1st and 2nd liens)		Home equity		Consumer		Total
Grade:
Pass	$	143,804	$	311,123	$	4,790	$	141,915	$	65,966	$	14,267	$	681,865
Special mention		5,995		38,670		-		-		-		-		44,665
Substandard		18,910		19,478		10,679		4,660		502		21		54,250
Total	$	168,709	$	369,271	$	15,469	$	146,575	$	66,468	$	14,288	$	780,780

The Bank annually reviews the ratings on all commercial and industrial, commercial real estate and real estate construction loans greater than $1 million. Semi-annually, the Bank engages an independent third-party to review a significant portion of loans within these loan classes. Management uses the results of these reviews as part of its ongoing review process.

5. EMPLOYEE BENEFITS

Retirement Plan- The Company’s retirement plan is noncontributory and covers substantially all eligible employees. The plan conforms to the provisions of the Employee Retirement Income Security Act of 1974, as amended, and the Pension Protection Act of 2006, which requires certain funding rules for defined benefit plans. The Company’s policy is to accrue for all pension costs and to fund the maximum amount allowable for tax purposes. Actuarial gains and losses that arise from changes in assumptions concerning future events are amortized over a period that reflects the long-term nature of pension expense used in estimating pension costs.

The Company accounts for its retirement plan in accordance with ASC 715, “Compensation – Retirement Benefits” and ASC 960, “Plan Accounting – Defined Benefit Pension Plans,” which require an employer that is a business entity and sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan in its statement of financial position; recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost; measure defined benefit plan assets and obligation as of the date of fiscal year-end statement of financial position (with limited exceptions); and disclose in the notes to financial statements additional information about certain effects of net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset and obligation. Plan assets and benefit obligations shall be measured as of the date of its statement of financial position and in determining the amount of net periodic benefit cost. The codification also requires an employer to use the same date for the measurement of plan assets as for the statement of condition.

On December 31, 2012, certain provisions of the Company’s retirement plan were changed which affected all participants in this plan and froze the participation of new entrants into the pension plan for all remaining employees in 2012. These changes froze the plan such that no additional pension benefits would accumulate.

The following table presents information concerning net periodic defined benefit pension (income) expense for the three and six months ended June 30, 2013 and 2012 (in thousands):

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Service cost	$	-		$	603		$	-		$	1,206
Interest cost		498			554			996			1,109
Expected return on plan assets		(575	)		(527	)		(1,150	)		(1,054	)
Net amortization		61			654			122			814
Net periodic benefit (income) expense	$	(16	)	$	1,284		$	(32	)	$	2,075

In December 2012, the Company made an annual minimum contribution of $1 million for the plan year ending September 30, 2013. There is no additional minimum required contribution for the plan year ending September 30, 2013.

Post-Retirement Benefits other than Pension - The Company provides life insurance benefits to employees meeting eligibility requirements. Employees hired after December 31, 1997 are not eligible for retiree life insurance. No other welfare benefits are provided. In the second quarter of 2013, the Company terminated all post-retirement life insurance benefits and recorded a non-recurring gain of $1.7 million as a credit to employee compensation and benefits expense in the Company’s consolidated statements of operations.

21

6. STOCK-BASED COMPENSATION

Under the terms of the Company’s stock option plans adopted in 1999 and 2009, options have been granted to key employees and directors to purchase shares of the Company’s stock. Under the 2009 Stock Incentive Plan (“the Plan”), there are 500,000 shares of the Company’s common stock reserved for issuance, of which 185,000 had been granted as of June 30, 2013. There are no remaining shares reserved for issuance under the 1999 Stock Option Plan. Options are awarded by the Compensation Committee of the Board of Directors. Both plans provide that the option price shall not be less than the fair value of the common stock on the date the option is granted. All options are exercisable for a period of ten years or less. Options granted prior to 2010 vest after one year. No options were granted in 2010. Options granted in 2011 are exercisable over a three-year period commencing three years from the date of grant at a rate of one third per year.  Options granted in 2012 and 2013 are exercisable over a three-year period commencing one year from the date of grant at a rate of one third per year.

Both plans provide for but do not require the grant of stock appreciation rights (“SARs”) that the holder may exercise instead of the underlying option. At June 30, 2013, there were 6,000 SARs outstanding related to options granted before 2011. The SARs had no intrinsic value at June 30, 2013. When the SAR is exercised, the underlying option is canceled. The optionee receives shares of common stock or cash with a fair market value equal to the excess of the fair value of the shares subject to the option at the time of exercise (or the portion thereof so exercised) over the aggregate option price of the shares set forth in the option agreement. The exercise of SARs is treated as the exercise of the underlying option.

In 2011 the Company granted an award of 30,000 non-qualified stock options at an exercise price of $10.79 per share to its President and Chief Executive Officer as a material inducement to employment with the Company.  The non-qualified options were not issued as part of any of the Company’s registered stock-based compensation plans. The options are exercisable over a three-year period commencing three years from the date of grant at a rate of one third per year.

A summary of stock option activity follows:

				Weighted-Average
	Number			Exercise Price
	of Shares			Per Share
Outstanding, January 1, 2013		211,500		$	15.41
Granted		35,000		$	14.92
Exercised		(6,667	)	$	13.44
Forfeited or expired		(25,333	)	$	15.50
Outstanding, June 30, 2013		214,500		$	15.38

The following table presents information regarding stock options granted in 2013:

Black-Scholes Assumptions for Options Granted During the Six Months Ended June 30, 2013:
Risk-free interest rate	0.82	%
Expected dividend yield	-
Expected life in years	10
Expected volatility	43.13	%

The following summarizes shares subject to purchase from stock options outstanding and exercisable as of June 30, 2013:

22

		Outstanding					Exercisable
				Weighted-Average					Weighted-Average
Range of				Remaining	Weighted-Average				Remaining	Weighted-Average
Exercise Prices		Shares		Contractual Life	Exercise Price		Shares		Contractual Life	Exercise Price
$	10.79 - $12.44		100,000	8.7 years	$	11.49		13,334	8.8 years	$	12.33
$	13.13 - $17.00		85,000	9.2 years	$	14.16		13,334	8.7 years	$	13.29
$	28.30 - $31.83		15,000	3.9 years	$	30.24		15,000	3.9 years	$	30.24
$	32.90 - $34.95		14,500	2.6 years	$	34.01		14,500	2.6 years	$	34.01
			214,500	8.1 years	$	15.38		56,168	5.9 years	$	22.93

The Company accounts for stock-based compensation on a modified prospective basis with the fair value of grants of employee stock options recognized in the financial statements. Compensation expense related to stock-based compensation amounted to approximately $198 thousand and $91 thousand for the six months ended June 30, 2013 and 2012, respectively. The remaining unrecognized compensation cost of approximately $610 thousand at June 30, 2013 will be expensed over the remaining weighted average vesting period of approximately 2.7 years.

7. INCOME TAXES

The Company uses an asset and liability approach to accounting for income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. The Company accounts for income taxes in accordance with ASC 740, “Income Taxes,” which prescribes the recognition and measurement criteria related to tax positions taken or expected to be taken in a tax return. The Company had unrecognized tax benefits including interest of approximately $34 thousand as of June 30, 2013. The Company recognizes interest and penalties accrued relating to unrecognized tax benefits in income tax expense.

The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. The Company can apply a carryback of the net operating losses for 2012 which resulted in $5 million included in income tax receivable in the accompanying consolidated statements of condition. The Company has net operating loss carryforwards of approximately $15 million and $24 million for Federal and New York State (“NYS”) income tax purposes, respectively, which may be applied against future taxable income. In 2012, the Company established a full valuation allowance of $558 thousand, tax effected, on the NYS net operating loss due to the Company’s significant tax-exempt investment income in NYS. The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or when the Company returns to consistent, taxable earnings in NYS. Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets. Both the Federal and NYS unused net operating loss carryforwards are expected to expire in varying amounts in the years 2032-2033. It is anticipated that the Federal carryforward will be utilized prior to its expiration based on the Company’s future years’ projected earnings.

8. REGULATORY MATTERS

The Company 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 additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital requirements that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and the Bank’s classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital, as defined in the federal banking regulations, to risk-weighted assets and of Tier 1 capital to adjusted average assets (leverage). Management believes, as of June 30, 2013, that the Company and the Bank met all such capital adequacy requirements to which it is subject.

The Bank’s capital amounts and ratios were as follows (dollars in thousands):

23

						Minimum					Minimum to be "Well
						for capital					Capitalized" under prompt
	Actual capital ratios					adequacy					corrective action provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2013
Total capital to risk-weighted assets	$	170,570		15.89	%	$	85,874		8.00	%	$	107,343		10.00	%
Tier 1 capital to risk-weighted assets		157,101		14.64	%		42,937		4.00	%		64,406		6.00	%
Tier 1 capital to adjusted average assets (leverage)		157,101		9.69	%		64,828		4.00	%		81,036		5.00	%
December 31, 2012
Total capital to risk-weighted assets	$	162,458		18.05	%	$	72,020		8.00	%	$	90,025		10.00	%
Tier 1 capital to risk-weighted assets		151,121		16.79	%		36,010		4.00	%		54,015		6.00	%
Tier 1 capital to adjusted average assets (leverage)		151,121		9.74	%		62,092		4.00	%		77,615		5.00	%

The Company’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 9.76%, 14.73% and 15.99%, respectively, at June 30, 2013.

The ability of the Bank to pay dividends to the Company is subject to certain regulatory restrictions. Generally, dividends declared in a given year by a national bank are limited to its net profit, as defined by regulatory agencies, for that year, combined with its retained net income for the preceding two years, less any required transfer to surplus or to fund the retirement of any preferred stock, of which the Bank had none as of June 30, 2013. In addition, a national bank may not pay any dividends in an amount greater than its undivided profits and a national bank may not declare any dividends if such declaration would leave the Bank inadequately capitalized. Therefore, the ability of the Bank to declare dividends will depend on its future net income and capital requirements.

9. FAIR VALUE

The Company records investments available for sale, loans held-for-sale, certain impaired loans, OREO and mortgage servicing rights at fair value. Fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability in an exchange. The definition of fair value includes the exchange price which is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the principal market for the asset or liability. Market participant assumptions include assumptions about risk, the risk inherent in a particular valuation technique used to measure fair value and/or the risk inherent in the inputs to the valuation technique, as well as the effect of credit risk on the fair value of liabilities. The Company uses three levels of the fair value inputs to measure assets, as described below.

Basis of Fair Value Measurement:

Level 1 – Valuations based on quoted prices in active markets for identical investments.

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 2 inputs include: (i) quoted prices for similar investments in active markets, (ii) quoted prices for identical investments traded in non-active markets (i.e., dealer or broker markets) and (iii) inputs other than quoted prices that are observable or inputs derived from or corroborated by market data for substantially the full term of the investment.

Level 3 – Valuations based on inputs that are unobservable, supported by little or no market activity, and significant to the overall fair value measurement.

The types of instruments valued based on quoted market prices in active markets include most U.S. Treasury securities. Such instruments are generally classified within Level 1 and Level 2 of the fair value hierarchy. The Company does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include U.S. Government agency securities, state and municipal obligations, MBS, CMOs and corporate bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy.

The types of instruments valued based on significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability are generally classified within Level 3 of the fair value hierarchy.

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ASC 820, “Fair Value Measurements and Disclosures,” presents requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” ASC 820 provides additional guidance in determining fair values when the volume and level of activity for the asset or liability have significantly decreased, particularly when there is no active market or where the price inputs being used represent distressed sales. It also provides guidelines for making fair value measurements more consistent with principles, reaffirming the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets become inactive.

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments (in thousands).

	Level in	June 30, 2013					December 31, 2012
	Fair Value	Carrying		Estimated			Carrying		Estimated
	Heirarchy	Amount		Fair Value			Amount		Fair Value
Cash and due from banks	Level 1	$	219,396	$	219,396		$	384,656	$	384,656
Cash equivalents	Level 2		1,000		1,000			1,150		1,150
Interest-bearing time deposits in other banks	Level 2		10,000		10,000			-		-
Federal Reserve Bank, Federal Home Loan Bank and other stock	N/A		2,916		N/	A		3,043		N/	A
Investment securities held to maturity	Level 2		7,364		8,024			8,035		8,861
Investment securities available for sale	Level 2		429,843		429,843			402,353		402,353
Loans held-for-sale	Level 3		1,262		1,262			907		907
Loans, net of allowance	Level 2, 3 (1)		878,158		886,645			762,999		787,597
Bank owned life insurance	Level 3		38,042		38,042			-		-
Accrued interest and loan fees receivable	Level 2		5,022		5,022			4,883		4,883
Non-maturity deposits	Level 2		1,219,653		1,219,653			1,187,383		1,187,383
Time deposits	Level 2		245,801		246,836			243,731		245,595
Accrued interest payable	Level 2		212		212			237		237

(1) Impaired loans are generally classified within Level 3 of the fair value hierarchy.

Fair value estimates are made at a specific point in time and may be based on judgments regarding losses expected in the future, risk, and other factors that are subjective in nature. The methods and assumptions used to produce the fair value estimates follow.

For cash and due from banks, cash equivalents, interest-bearing time deposits in other banks, bank owned life insurance, accrued interest and loan fees receivable, non-maturity deposits and accrued interest payable, the carrying amount is a reasonable estimate of fair value. Time deposits are valued using a replacement cost of funds approach.

Fair values are estimated for portfolios of loans with similar characteristics. The fair value of performing loans was calculated by discounting projected cash flows through their estimated maturity using market discount rates that reflect the general credit and interest rate characteristics of the loan category. The maturity horizon is based on the Bank’s history of repayments for each type of loan and an estimate of the effect of current economic conditions. Fair value for significant non-performing loans is based on recent external appraisals of collateral, if any. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the associated risk. Assumptions regarding credit risk, cash flows, and discount rates are made using availablemarket information and specific borrower information.

OREO properties are initially recorded at fair value, less estimated costs to sell when acquired, establishing a new cost basis. Adjustments to OREO are measured at fair value, less estimated costs to sell. Fair values are generally based on third party appraisals or realtor evaluations of the property. These appraisals and evaluations 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 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. In cases where the carrying amount exceeds the fair value, less estimated costs to sell, an impairment loss is recognized through a valuation allowance, and the property is reported as non-recurring Level 3.

Loans identified as impaired are measured using one of three methods: the loan’s observable market price, the fair value of collateral or the present value of expected future cash flows. Those measured using the loan’s observable market price or the fair value of collateral are recorded at fair value. For each period presented, no impaired loans were measured using the loan’s observable market price. If an impaired loan has had a charge-off or if the fair value of the collateral is less than the recorded investment in the loan, the Company establishes a specific reserve and reports the loan as non-recurring Level 3. The fair value of collateral of impaired loans is generally 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 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.

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The fair value of loans held-for-sale is based upon binding contracts from third parties.

The fair value of commitments to extend credit was estimated by either discounting cash flows or using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the current creditworthiness of the counter-parties. The estimated fair value of written financial guarantees and letters of credit is based on fees currently charged for similar agreements. The fees charged for the commitments were not material in amount.

Assets measured at fair value on a recurring basis are as follows (in thousands):

			Fair Value Measurements Using
			Significant Other		Significant
			Observable Inputs		Unobservable Inputs
Assets:	June 30, 2013		(Level 2)		(Level 3)
U.S. Government agency securities	$	103,793	$	103,793	$	-
Corporate bonds		15,577		15,577		-
Collateralized mortgage obligations		48,005		48,005		-
Mortgage-backed securities		100,748		100,748		-
Obligations of states and political subdivisions		161,720		161,720		-
Loans held-for-sale		1,262		-		1,262
Mortgage servicing rights		2,136		-		2,136
Total	$	433,241	$	429,843	$	3,398

			Fair Value Measurements Using
			Significant Other		Significant
			Observable Inputs		Unobservable Inputs
Assets:	December 31, 2012		(Level 2)		(Level 3)
U.S. Treasury securities	$	500	$	500	$	-
U.S. Government agency securities		65,078		65,078		-
Corporate bonds		16,198		16,198		-
Collateralized mortgage obligations		89,692		89,692		-
Mortgage-backed securities		62,450		62,450		-
Obligations of states and political subdivisions		168,435		168,435		-
Loans held-for-sale		907		-		907
Mortgage servicing rights		1,856		-		1,856
Total	$	405,116	$	402,353	$	2,763

Assets measured at fair value on a non-recurring basis are as follows (in thousands):

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Assets:	June 30, 2013		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Impaired loans	$	13,861	$	13,861
Total	$	13,861	$	13,861

Assets:	December 31, 2012		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Impaired loans	$	9,390	$	9,390
OREO		1,572		1,572
Total	$	10,962	$	10,962

10. LEGAL PROCEEDINGS

On July 11, 2011, a shareholder derivative action, Robert J. Levy v. J. Gordon Huszagh, et al., No. 11 Civ. 3321 (JS), was filed in the U.S. District Court for the Eastern District of New York against certain current and former directors of the Company and a former officer of the Company.  The Company was named as a nominal defendant.  The complaint seeks damages against the individual defendants in an unspecified amount, and alleges that the individual defendants breached their fiduciary duties by making improper statements regarding the sufficiency of the Company’s allowance for loan losses and loan portfolio credit quality, and by failing to establish sufficient allowances for loan losses and to establish effective credit risk management policies.  On September 30, 2011, the Company and the current and former director defendants filed a motion to dismiss the complaint. On September 28, 2012, the court granted the motion to dismiss and granted the plaintiff leave to file an amended complaint. On May 14, 2013, the parties to the Levy action, the parties to the Forbush action, described below, along with an additional shareholder who had previously made a litigation demand on the Company’s board of directors, entered into stipulation of compromise and settlement providing for the settlement of the two actions. On May 24, 2013, the Levy court granted the parties’ joint request that the action be stayed until entry in the Forbush action of a final order and judgment approving the proposed settlement. Management does not believe that the ultimate resolution of this matter will have a material adverse impact on the consolidated financial statements.

On October 28, 2011, a separate shareholder derivative action, Susan Forbush v. Edgar F. Goodale, et al., No. 33538/11, was filed in the Supreme Court of the State of New York for the County of Suffolk, against certain current and former directors of the Company and a former officer of the Company. The Company was named as a nominal defendant. The complaint asserts claims that are substantially similar to those asserted in the Levy action. On February 17, 2012, the defendants filed a motion to dismiss the complaint. On February 4, 2013, the Supreme Court denied the defendants’ motion to dismiss. On May 14, 2013, as also described above, the parties to the Levy and Forbush actions, along with an additional shareholder, entered into stipulation of compromise and settlement providing for the settlement of the two actions. On July 11, 2013, the plaintiff filed an unopposed motion in the Forbush action requesting an order preliminarily approving the proposed settlement, directing publication of notice of the proposed settlement, and scheduling a hearing on whether the settlement should be finally approved by the court. On July 24, 2013, the Supreme Court granted that motion, and scheduled a final approval hearing for September 25, 2013. Management does not believe that the ultimate resolution of this matter will have a material adverse impact on the consolidated financial statements.

On October 20, 2011, a putative shareholder class action, James E. Fisher v. Suffolk Bancorp, et al., No. 11 Civ. 5114 (SJ), was filed in the U.S. District Court for the Eastern District of New York against the Company, its former chief executive officer, and a former chief financial officer of the Company.  The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by knowingly or recklessly making false statements about, or failing to disclose accurate information about, the Company’s financial results and condition, loan loss reserves, impaired assets, internal and disclosure controls, and banking practices.  The complaint seeks damages in an unspecified amount on behalf of purchasers of the Company’s common stock between March 12, 2010 and August 10, 2011 (the “Class Members”). On October 15, 2012, the defendants filed a motion to dismiss the complaint. On April 8, 2013, the parties entered into an agreement to settle the action, subject to the approval of the court, and on April 10, 2013, the lead plaintiff filed an unopposed motion requesting an order preliminarily approving the proposed settlement, directing dissemination and publication of notice of the proposed settlement to Class Members, and scheduling a hearing on whether the settlement should be finally approved by the court. On July 18, 2013, the court granted the motion, and scheduled a final settlement approval hearing for October 24, 2013. Management does not believe that the ultimate resolution of this matter will have a material adverse impact on the consolidated financial statements.

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The SEC’s New York regional office has formally requested certain loan files, other records and information from the Company, and the Company has provided this information. The SEC has not asserted that any federal securities law violation has occurred. The Company believes it is in compliance with all federal securities laws and is cooperating with the SEC’s inquiry.

The Company assesses its liabilities and contingencies in connection with legal proceedings on an ongoing basis. For those matters where it is probable that the Company will incur losses and the amounts of the losses can be reasonably estimated, the Company records an expense and corresponding liability in its consolidated financial statements. We have concluded that an amount for such a loss contingency is not to be accrued at this time.

11. SUBSEQUENT EVENTS

The Company recently provided notice to our primary regulator and affected customers that we will be closing our Water Mill and Middle Island branches in October 2013.  The Company expects to record a one-time pre-tax charge of approximately $0.6 million during the third quarter of 2013 in connection with the closing of these two branches.  The Company also anticipates selling the Water Mill branch later this year. The current appraised value of the Water Mill branch is well in excess of its carrying amount on the Company’s statement of condition. Once implemented, these branch closings are expected to reduce total operating expenses by approximately $0.8 million per year.

The Bank was a member of the former Visa, Inc. payments organization and was issued Class B shares in 2008 when Visa, Inc. was organized.  Approximately 39% of those shares were redeemed in connection with Visa, Inc.’s initial public offering in March 2008.  The remaining shares that the Bank received have been restricted because of unsettled litigation pending against Visa, Inc. At its discretion, Visa, Inc. may redeem additional shares in order to resolve pending litigation. Accordingly, the Company has recorded these shares at zero in the accompanying statement of condition.

On July 30, 2013, the Bank sold 50,000 Visa Class B shares at a gross pre-tax gain of approximately $3.8 million, which will be recorded in non-interest income in the Company’s statement of operations in the third quarter of 2013.  The Company will also record its current estimate of the related liability of approximately $0.5 million arising from the sale of these shares as it retains the risk of future additions to the Visa, Inc. litigation reserve. The Company will record an operating expense in the third quarter in connection with this liability.

The Company continues to own 88,638 Visa Class B shares subsequent to the sale described above.  These shares remain restricted because of the continuing uncertainty of the litigation pending against Visa, Inc.  Accordingly, the Company continues to record its Visa Class B shares at zero pending the outcome of the litigation. To the extent that the Company continues to own Visa Class B shares in the future, the Company expects to record the fair value of those shares upon expiration of the foregoing restriction.

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

Safe Harbor Statement Pursuant to the Private Securities Litigation Reform Act of 1995 - Certain statements contained in this discussion are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These can include remarks about the Company, the banking industry, the economy in general, expectations of the business environment in which the Company operates, projections of future performance, and potential future credit experience. These remarks are based upon current management expectations, and may, therefore, involve risks and uncertainties that cannot be predicted or quantified and are beyond the Company’s control and are subject to a variety of uncertainties that could cause future results to vary materially from the Company’s historical performance, or from current expectations. These remarks may be identified by such forward-looking statements as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Factors that could affect the Company include particularly, but are not limited to: a failure by the Company to meet the deadlines under SEC rules for filing its periodic reports (or any permitted extension thereof); increased capital requirements mandated by the Company’s regulators; the Company’s ability to raise capital; changes in interest rates; increases or decreases in retail and commercial economic activity in the Company’s market area; variations in the ability and propensity of consumers and businesses to borrow, repay, or deposit money, or to use other banking and financial services; results of regulatory examinations; any failure by the Company to maintain effective internal control over financial reporting; larger-than-expected losses from the sale of assets; potential litigation or regulatory action relating to the matters resulting in the Company’s failure to file on time its Quarterly Report on Form 10-Q for the quarters ended March 31, 2011, June 30, 2011, and September 30, 2011 or resulting from the revisions to earnings previously announced on April 12, 2011 or the restatement of its financial statements for the quarterly period ended September 30, 2010 and year ended December 31, 2010; and the potential that net charge-offs are higher than expected or for further increases in our provision for loan losses. Further, it could take the Company longer than anticipated to implement its strategic plans to increase revenue and manage non-interest expense, or it may not be possible to implement those plans at all. Finally, new and unanticipated legislation, regulation, or accounting standards may require the Company to change its practices in ways that materially change the results of operations. We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. For more information, see the risk factors described in the Company’s Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.

Non-GAAP Disclosure - This discussion includes a non-GAAP financial measure of the Company’s tangible common equity ratio. A non-GAAP financial measure is a numerical measure of historical or future financial performance, financial position or cash flows that excludes or includes amounts that are required to be disclosed in the most directly comparable measure calculated and presented in accordance with GAAP. The Company believes that this non-GAAP financial measure provides both management and investors a more complete understanding of the underlying operational results and trends and the Company’s marketplace performance. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the numbers prepared in accordance with GAAP.

Executive Summary - The Company is a one-bank holding company engaged in the commercial banking business through the Bank, a full-service commercial bank headquartered in Riverhead, New York. Organized in 1890, the Bank has 30 branch offices in Suffolk County, New York, and is a wholly owned subsidiary of the Company. The Bank offers a full line of domestic commercial and retail banking services and wealth management services. The Bank’s primary lending area includes all of Suffolk County and to a limited degree the adjacent markets of Nassau County and New York City. The Bank makes commercial real estate floating and fixed rate loans, commercial and industrial loans to small manufacturers, wholesalers, builders, farmers, and retailers, including dealer financing. The Bank serves as an indirect lender to the customers of a number of automobile dealers. The Bank also makes loans secured by residential mortgages, and both fixed and floating rate second mortgage loans with a variety of plans for repayment. Real estate construction loans are also offered. In order to expand the Company geographically into western Suffolk and Nassau Counties and to diversify the lending business of the Company, a new loan production office was opened in Melville in 2012. As part of our strategy to move westward, an additional loan production office is planned for Garden City later this year. Seasoned banking professionals have joined the Company to exploit the opportunity available in the local marketplace to augment both interest and fee income through the origination of commercial and industrial loans, the generation of high quality multi-family and jumbo mortgages to be retained in the portfolio and conforming mortgages for sale in secondary markets. The Bank finances most of its activities with deposits, including demand, saving, N.O.W. and money market deposits, as well as time deposits. It may also rely on other sources of funds, including inter-bank overnight loans.

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At June 30, 2013, the Company, on a consolidated basis, had total assets of $1.6 billion, total deposits of $1.5 billion and stockholders’ equity of $159 million. The Company recorded net income of $2.8 million, or $0.24 per diluted common share, for the second quarter of 2013, compared to net income of $4.2 million, or $0.43 per diluted common share, for the second quarter of 2012. The 2012 results were positively impacted by a $2.4 million credit to the provision for loan losses. The Company did not record any provision for loan losses in the second quarter of 2013.

The decline in second quarter 2013 earnings versus 2012 resulted from the aforementioned $2.4 million credit to the provision for loan losses in 2012 coupled with a $1.1 million (7.2%) decline in net interest income in 2013 due to a 56 basis point narrowing of the net interest margin to 3.83% for the second quarter of 2013 from 4.39% for the second quarter of 2012. Generally, the Company’s net interest margin is impacted not only by the average balance and mix of the Company’s interest-earning assets and interest-bearing liabilities, but also by the level of market interest rates. These rates are significantly influenced by the actions of the Federal Open Market Committee of the Board of Governors of the Federal Reserve System (the “FOMC”) policy makers. Partially offsetting these factors was a $1.4 million (10.2%) reduction in total operating expenses, primarily due to a non-recurring gain arising from the termination of post-retirement life insurance benefits, and a $63 thousand (2.6%) increase in non-interest income in the second quarter of 2013.

The Company’s return on average assets and return on average common stockholders’ equity were 0.68% and 6.71%, respectively, for the second quarter of 2013 and 1.10% and 12.39%, respectively, for the second quarter of 2012.

Financial Performance Summary

As of or for the quarters and six months ended June 30, 2013 and 2012

(dollars in thousands, except per share data)

							Over/									Over/
	Quarters ended June 30,						(under)			Six months ended June 30,						(under)
	2013			2012			2012			2013			2012			2012
Revenue (1)	$	16,277		$	17,279			(5.8	%)	$	33,270		$	33,742			(1.4	%)
Operating expenses (2)	$	12,692		$	14,139			(10.2	%)	$	26,493		$	28,744			(7.8	%)
Provision (credit) for loan losses	$	-		$	(2,400	)		(100.0	%)	$	-		$	(2,400	)		(100.0	%)
Net income	$	2,769		$	4,200			(34.1	%)	$	5,478		$	5,368			2.0	%
Net income per common share - diluted	$	0.24		$	0.43			(44.4	%)	$	0.47		$	0.55			(13.9	%)
Return on average assets		0.68	%		1.10	%		(42	)bp		0.68	%		0.71	%		(3	)bp
Return on average stockholders' equity		6.71	%		12.39	%		(568	)bp		6.70	%		7.91	%		(121	)bp
Tier 1 leverage ratio		9.76	%		8.89	%		87	bp		9.76	%		8.89	%		87	bp
Tier 1 risk-based capital ratio		14.73	%		14.32	%		41	bp		14.73	%		14.32	%		41	bp
Total risk-based capital ratio		15.99	%		15.59	%		40	bp		15.99	%		15.59	%		40	bp
Tangible common equity ratio (non-GAAP)		9.49	%		8.78	%		71	bp		9.49	%		8.78	%		71	bp

bp - denotes basis points; 100 bp equals 1%.

(1) Represents net interest income plus total non-interest income.

(2) Results for 2013 are net of a $1,659 non-recurring gain arising from the termination of post-retirement life insurance benefits during the second quarter of 2013.

The Company’s core deposit franchise continues to be among the best in the region. Core deposits, consisting of demand, N.O.W., saving and money market deposits, totaled $1.2 billion at June 30, 2013, representing 83% of total deposits at that date. Demand deposits totaled $598 million at June 30, 2013 and represented 41% of total deposits at that date. The deposit product mix continues to be a primary strength of the Company and resulted in a total cost of funds of approximately 21 basis points during the second quarter of 2013.

The Company experienced sequential quarter growth in our total loan portfolio of $71 million, from $824 million at March 31, 2013 to $895 million at June 30, 2013, an 8.6% quarterly growth rate. The geographic and product diversification strategies implemented in our lending businesses are working well. Further, our current book of approved loans waiting to close, as well as our existing pipeline, are strong and growing. Each of our lending businesses, commercial, multi-family and residential, are contributing to this accelerating momentum. It is clear we are increasing our market share by protecting our eastern Suffolk lending franchise while simultaneously expanding west.

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On the expense side, we are working diligently to balance the increased investments needed to grow our lending businesses with offsetting operating expense reductions in other areas, and believe we will see continued improvement as we move through 2013. We are currently studying our existing branch network for cost saving opportunities. As a result of this work, we recently provided notice to our regulator and affected customers that we will be closing our Water Mill and Middle Island branches later this year. Once implemented, these closings will reduce total operating expenses by approximately $800 thousand per year. We continue to analyze our branch network and each of our lines of business to identify further opportunities for cost savings, which will be an ongoing focus of our management team across our entire Company.

Notwithstanding the strong loan growth described above, we still maintained a relatively large cash position at the end of the second quarter of $172 million in interest-bearing deposits with correspondent banks, or 10% of total assets. Even with this cash position, our net interest margin during the quarter was 3.83%, as we maintained an extraordinarily low cost of funds of 21 basis points. As we continue to redeploy our cash into high quality loans and other interest-earning assets, we believe we have a unique opportunity to improve both our margin and our non-interest income in future periods. As an example of the latter, during the second quarter of 2013, we funded a $38 million investment in bank owned life insurance which, going forward, will initially yield approximately 6.00% on a tax-equivalent basis.

Despite the challenging economic and interest rate environment, we are making significant strides in all phases of our business. We are gratified that the OCC, our primary regulator, recognized what we have accomplished and terminated the Agreement during the second quarter of 2013.

Critical Accounting Policies, Judgments and Estimates - The Company’s accounting and reporting policies conform to U.S. GAAP and general practices within the financial services industry. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

Allowance forLoan Losses - In management’s opinion, one of the most critical accounting policies impacting the Company’s financial statements is the evaluation of the allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred losses, increased by the provision for loan losses and recoveries, and decreased by loan charge-offs. For all classes of loans, when a loan, in full or in part, is deemed uncollectible, it is charged against the allowance for loan losses. This happens when the loan is past due and the borrower has not shown the ability or intent to make the loan current, or the borrower does not have sufficient assets to pay the debt, or the value of the collateral is less than the balance of the loan and is not considered likely to improve soon. The allowance for loan losses is determined by a continuous analysis of the loan portfolio. Such analysis includes changes in the size and composition of the portfolio, the Company’s own historical loan losses, industry-wide losses, current and anticipated economic trends, and details about individual loans. It also includes estimates of the actual value of collateral, other possible sources of repayment and estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and regional economic conditions and other relevant factors. All non-accrual loans over $250 thousand in the commercial and industrial, commercial real estate and real estate construction loan classes and all TDRs are evaluated individually for impairment. Management will use judgment to determine if there are other loans outside of these two categories that fit the definition of impaired. All other loans are generally evaluated as homogeneous pools with similar risk characteristics.  In assessing the adequacy of the allowance for loan losses, management reviews the loan portfolio by separate classes that have similar risk and collateral characteristics; e.g., commercial and industrial, commercial real estate, real estate construction, residential mortgages (1^st and 2^nd liens), home equity and consumer loans.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Specific reserves are established based on an analysis of the most probable sources of repayment and liquidation of collateral. Impaired loans that are collateral dependent are reviewed based on their collateral and the estimated time required to recover the Company’s investment in the loans, as well as the cost of doing so, and the estimate of the recovery. Non-collateral dependent impaired loans are reviewed based on the present value of estimated future cash flows, including balloon payments, if any, using the loan’s effective interest rate. While every impaired loan is evaluated individually, not every loan requires a specific reserve. Specific reserves fluctuate based on changes in the underlying loans, anticipated sources of repayment, and charge-offs. The general component covers non-impaired loans and is based on historical loss experience for each loan class from a rolling twelve quarter period and modifying those percentages, if necessary, after adjusting for current qualitative and environmental factors that reflect changes in the collectability of the loan class not captured by historical loss data.  These factors augment actual loss experience and help estimate the probability of loss within the loan portfolio based on emerging or inherent risk trends. These qualitative factors are applied as an adjustment to historical loss rates and require judgments that cannot be subjected to exact mathematical calculation. There are no formulas for translating them into a specific basis point adjustment of the Company’s historical loss rate for a pool of loans having similar risk characteristics. These adjustments reflect management’s overall estimate of the extent to which current losses on a pool of loans will differ from historical loss experience. These adjustments are subjective estimates and management reviews them on a quarterly basis. TDRs are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

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DeferredTaxAssetsandLiabilities – Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities, computed using enacted tax rates. Deferred tax assets are recognized if it is more likely than not that a future benefit will be realized. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.  The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers all relevant positive and negative evidence, including taxable income in carryback years, scheduled reversals of deferred tax liabilities, expected future taxable income and available tax planning strategies.

OTTIofInvestment Securities – Management evaluates securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the statement of operations and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

Material Changes in Financial Condition - Total assets of the Company were $1.6 billion at June 30, 2013. When compared to December 31, 2012, total assets increased by $26 million. This change largely reflects increases in loans, bank owned life insurance, investment securities and interest-bearing time deposits in other banks of $115 million, $38 million, $27 million and $10 million, respectively, partially offset by a decline in cash and cash equivalents of $165 million as we continue our redeployment of lower-yielding overnight interest-bearing deposits into higher yielding assets. Total loans were $895 million at June 30, 2013 as compared to $781 million at December 31, 2012. Total investment securities increased to $437 million at June 30, 2013 from $410 million at December 31, 2012.

The increase in the loan portfolio largely reflects growth of multifamily and commercial real estate loans of $73 million and $40 million, respectively, during the first half of 2013. The increase in the investment portfolio largely reflects purchases of U.S. Government agency securities and mortgage-backed securities of U.S. Government-sponsored enterprises of $62 million and $44 million, respectively, during the first half of 2013. These were partially offset by sales and principal paydowns of CMOs totaling $44 million and calls of U.S. Government agency securities of $18 million during the same 2013 period. Higher interest rates in 2013 negatively impacted the value of the Company’s available for sale investment portfolio by approximately $16 million at June 30, 2013 when compared to December 31, 2012.

At June 30, 2013, total deposits were $1.5 billion, an increase of $34 million when compared to December 31, 2012. This increase was primarily due to growth in saving, N.O.W. and money market deposits of $50 million, partially offset by lower demand deposit balances of $17 million. Core deposit balances, which consist of demand, saving, N.O.W. and money market deposits, represented 83% of total deposits at June 30, 2013 and December 31, 2012. Demand deposit balances decreased during the first half of 2013, but still represented 41% of total deposits at June 30, 2013 versus 43% at December 31, 2012. The Company had no borrowed funds outstanding at either June 30, 2013 or December 31, 2012.

Liquidity and Capital Resources - Liquidity management is defined as both the Company’s and the Bank’s ability to meet their financial obligations on a continuous basis without material loss or disruption of normal operations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, funding new and existing loan commitments and the ability to take advantage of business opportunities as they arise. Asset liquidity is provided by short-term investments and the marketability of securities available for sale. The Company may also leave excess reserve balances at the Federal Reserve Bank (“FRB”) if the rate being paid is higher than would be available from other short-term investments. Liquid assets, consisting of federal funds sold, securities available for sale and balances at the FRB, were $591 million at June 30, 2013 compared to $706 million at December 31, 2012. These liquid assets may include assets that have been pledged against municipal deposits or other short-term borrowings. Liquidity is also provided by the maintenance of a base of core deposits, maturing short-term assets including cash and due from banks, the ability to sell or pledge marketable assets and access to lines of credit.

31

Liquidity is continuously monitored, thereby allowing management to better understand and react to emerging balance sheet trends, including temporary mismatches with regard to sources and uses of funds. After assessing actual and projected cash flow needs, management seeks to obtain funding at the most economical cost. These funds can be obtained by converting liquid assets to cash or by attracting new deposits or other sources of funding. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served, loan demand, its asset/liability mix, its reputation and credit standing in its markets and general economic conditions. Borrowings and the scheduled amortization of investment securities and loans are more predictable funding sources. Deposit flows and securities prepayments are somewhat less predictable as they are often subject to external factors. Among these are changes in the local and national economies, competition from other financial institutions and changes in market interest rates.

The Company’s primary sources of funds are cash provided by deposits and borrowings, proceeds from maturities and sales of securities available for sale, and cash provided by operating activities. At June 30, 2013, total deposits were $1.5 billion, an increase of $34 million when compared to December 31, 2012. Of the total time deposits at June 30, 2013, $204 million are scheduled to mature within the next 12 months. Based on historical experience, the Company expects to be able to replace a substantial portion of those maturing deposits with comparable deposit products. At June 30, 2013 and December 31, 2012, there were no borrowings outstanding. For the six months ended June 30, 2013 and 2012, proceeds from sales and maturities of securities available for sale totaled $34 million and $32 million, respectively.

The Company’s primary uses of funds are for the origination of loans and the purchase of investment securities. For the six months ended June 30, 2013, the Company had net loan originations for portfolio of $120 million compared to net loan repayments of $105 million for the same period in 2012. The Company purchased investment securities totaling $116 million and $62 million during the six months ended June 30, 2013 and 2012, respectively.

The Company strives to maintain an efficient level of capital, commensurate with its risk profile, on which a competitive rate of return to stockholders will be realized over both the short and long term. Capital is managed to enhance stockholder value while providing flexibility for management to act opportunistically in a changing marketplace. Management continually evaluates the Company’s capital position in light of current and future growth objectives and regulatory guidelines. Total stockholders’ equity amounted to $159 million at June 30, 2013 and $164 million at December 31, 2012, the decrease primarily reflecting an $11 million decrease in accumulated other comprehensive income, net of tax, resulting from the negative impact of higher interest rates in 2013 on the value of the Company’s available for sale investment portfolio. This was partially offset by the Company’s net income for the first half of 2013.

The Company’s tangible common equity ratio was 9.49% at June 30, 2013 compared to 9.96% at December 31, 2012 and 8.78% at June 30, 2012. The ratio of tangible common equity to tangible assets, or TCE ratio, is calculated by dividing total common stockholders’ equity by total assets, after reducing both amounts by intangible assets. The TCE ratio is not required by GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of our capital levels. Since there is no authoritative requirement to calculate the TCE ratio, our TCE ratio is not necessarily comparable to similar capital measures disclosed or used by other companies in the financial services industry. Tangible common equity and tangible assets are non-GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with GAAP or as required by bank regulatory agencies. Set forth below are the reconciliations of tangible common equity to GAAP total common stockholders’ equity and tangible assets to GAAP total assets at June 30, 2013 (in thousands):

Total stockholders' equity	$	159,032
Less: intangible assets		(2,950	)
Tangible common equity	$	156,082
Total assets	$	1,648,297
Less: intangible assets		(2,950	)
Tangible assets	$	1,645,347

The Company’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 9.76%, 14.73% and 15.99%, respectively, at June 30, 2013. The Company’s capital ratios exceeded all regulatory requirements at June 30, 2013.

The Bank’s Tier I leverage, Tier I risk-based and total risk-based capital ratios were 9.69%, 14.64% and 15.89%, respectively, at June 30, 2013. Each of these ratios exceeds the regulatory guidelines for a “well capitalized” institution, the highest regulatory capital category.

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The Company did not repurchase any shares of its common stock during the first six months of 2013 under the existing stock repurchase plan. Repurchase of shares will occur only if management believes that the purchase will be at prices that are accretive to earnings per share and is the most efficient use of the Company’s capital.

Off-Balance Sheet Arrangements - The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby and documentary letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the customer. Collateral required varies, but may include accounts receivable, inventory, equipment, real estate and income-producing commercial properties. At June 30, 2013 and December 31, 2012, commitments to originate loans and commitments under unused lines of credit for which the Bank is obligated amounted to approximately $153 million and $140 million, respectively.

Letters of credit are conditional commitments guaranteeing payments of drafts in accordance with the terms of the letter of credit agreements. Commercial letters of credit are used primarily to facilitate trade or commerce and are also issued to support public and private borrowing arrangements, bond financing and similar transactions. Collateral may be required to support letters of credit based upon management’s evaluation of the creditworthiness of each customer. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Most letters of credit expire within one year. At both June 30, 2013 and December 31, 2012, letters of credit outstanding were approximately $19 million.

The Company has recorded a liability of $255 thousand for unfunded commitments at June 30, 2013.

Material Changes in Results of Operations – Comparison of the Quarters Ended June 30, 2013 and 2012 - The Company recorded net income of $2.8 million during the second quarter of 2013 versus net income of $4.2 million in the comparable 2012 period. The reduction in 2013 net income resulted primarily from the previously noted $2.4 million credit to the provision for loan losses in 2012 and a $1.1 million decrease in net interest income in 2013, partially offset by a $1.4 million reduction in total operating expenses, primarily due to a non-recurring gain arising from the termination of post-retirement life insurance benefits, and a $63 thousand increase in non-interest income in the second quarter of 2013 versus the comparable 2012 period.

As shown in the net interest income analysis table below for the three months ended June 30, 2013 and 2012, net interest income decreased by $1.1 million resulting from a 56 basis point reduction in the Company’s net interest margin to 3.83% in the second quarter of 2013 versus the second quarter of 2012, offset in part by a $104 million increase in average total interest-earning assets. The decrease in the net interest margin was due to the continued low level of interest rates, a shift in the Company’s average balance sheet mix from loans (down 5.8% versus second quarter 2012) into lower-yielding investment securities coupled with a high level of liquid assets in the form of low-yielding overnight interest-bearing deposits which represented 16% of average total interest-earning assets in the second quarter of 2013.

The Company’s second quarter 2013 average total interest-earning asset yield was 4.02%, down 64 basis points from the comparable 2012 period principally due to a 104 basis point reduction in the average yield on the Company’s investment securities portfolio to 3.68% in the second quarter of 2013 from 4.72% in the second quarter of 2012. This is largely a result of principal paydowns of mortgage-backed securities and CMOs of U.S. Government-sponsored enterprises and calls of U.S. Government agency securities, as these securities had higher yields than those of the securities subsequently purchased. The lower yields reflect the lower rate environment that has been prevalent. The average balance of the Company’s securities portfolio increased $130 million for the second quarter of 2013 as compared to the same period in 2012. This was primarily due to purchases of U.S. Government agency securities and mortgage-backed securities of U.S. Government-sponsored enterprises.

The Company’s average cost of total interest-bearing liabilities declined by 13 basis points to 0.35% in the second quarter of 2013 versus 0.48% in the second quarter of 2012. The Company’s lower funding cost resulted largely from average core deposits of $1.2 billion in the second quarter of 2013, with average demand deposits representing 41% of average total deposits. The average cost of time deposits declined 30 basis points in the second quarter of 2013 to 0.73% compared to the same period in 2012. The Company also experienced a $9 million decrease in the average balance of time deposits for the second quarter of 2013 versus the same period in 2012.

33

NET INTEREST INCOME ANALYSIS

For the Three Months Ended June 30, 2013 and 2012

(unaudited, dollars in thousands)

	2013								2012
	Average					Average			Average					Average
	Balance		Interest			Yield/Cost			Balance		Interest			Yield/Cost
Assets:
Interest-earning assets:
Investment securities (1)	$	432,880	$	3,976			3.68	%	$	302,867	$	3,557			4.72	%
Federal Reserve Bank,  Federal Home Loan Bank and other stock		2,926		36			4.93			2,405		17			2.84
Federal funds sold and interest-bearing deposits		253,912		189			0.30			228,505		137			0.24
Loans (2)		850,470		11,252			5.31			902,864		12,927			5.76
Total interest-earning assets		1,540,188	$	15,453			4.02	%		1,436,641	$	16,638			4.66	%
Non-interest-earning assets		102,758								98,079
Total assets	$	1,642,946							$	1,534,720
Liabilities and stockholders' equity:
Interest-bearing liabilities:
Saving, N.O.W. and money market deposits	$	609,812	$	294			0.19	%	$	550,446	$	303			0.22	%
Time deposits		249,790		453			0.73			259,533		664			1.03
Total saving and time deposits		859,602		747			0.35			809,979		967			0.48
Borrowings		-		-			-			233		-			-
Total interest-bearing liabilities		859,602		747			0.35			810,212		967			0.48
Demand deposits		593,437								543,745
Other liabilities		24,456								44,419
Total liabilities		1,477,495								1,398,376
Stockholders' equity		165,451								136,344
Total liabilities and stockholders' equity	$	1,642,946							$	1,534,720
Net interest rate spread							3.67	%							4.18	%
Net interest income/margin				14,706			3.83	%				15,671			4.39	%
Less tax-equivalent basis adjustment				(893	)							(793	)
Net interest income			$	13,813							$	14,878

(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $891 and $793 in 2013 and 2012, respectively.

(2) Interest on loans includes the effect of a tax-equivalent basis adjustment of $2 in 2013.

The Company recorded no consolidated provision for loan losses for the three months ended June 30, 2013. The $2.4 million credit to the provision for loan losses during the second quarter of 2012 resulted from workout and asset disposition activities undertaken in that period. The adequacy of the provision and the resulting allowance for loan losses, which was $17 million at June 30, 2013, is determined by management’s ongoing review of the loan portfolio, including identification and review of individual problem situations that may affect a borrower’s ability to repay, delinquency and non-performing loan data including the current status of criticized and classified loans, collateral values and changes in the size and mix of the loan portfolio. (See also Critical Accounting Policies, Judgments and Estimates and Asset Quality contained herein.)

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Non-Interest Income

For the quarters and six months ended June 30, 2013 and 2012

(dollars in thousands)

					Over/										Over/
	Quarters ended June 30,				(under)						Six months ended June 30,				(under)
	2013		2012		2012						2013		2012		2012
Service charges on deposit accounts	$	951	$	1,000		(4.9	)	%			$	1,875	$	1,950		(3.8	)	%
Other service charges, commissions and fees		813		846		(3.9	)					1,523		1,596		(4.6	)
Fiduciary fees		263		208		26.4						536		409		31.1
Net gain on sale of securities available for sale		33		-		N/	M		(1	)		392		-		N/	M		(1	)
Net gain on sale of portfolio loans		3		-		N/	M		(1	)		445		-		N/	M		(1	)
Net gain on sale of mortgage loans originated for sale		305		222		37.4						831		419		98.3
Income from bank owned life insurance		42		-		N/	M		(1	)		42		-		N/	M		(1	)
Other operating income		54		125		(56.8	)					137		282		(51.4	)
Total non-interest income	$	2,464	$	2,401		2.6		%			$	5,781	$	4,656		24.2		%

(1) N/M - denotes % variance not meaningful for statistical purposes.

Non-interest income increased by $63 thousand or 2.6% for the three months ended June 30, 2013 versus 2012 largely due to increases in net gain on sale of mortgage loans originated for sale of $83 thousand and income from bank owned life insurance of $42 thousand. The growth in income associated with the sale of mortgage loans originated for sale is due to the Company’s commitment to this business which has resulted in significant growth in monthly originations sourced through a dedicated sales staff and branch referral network.

Total operating expenses declined by $1.4 million or 10.2% in 2013 versus 2012 primarily as the result of a reduction in employee compensation and benefits.  Employee compensation and benefits expense declined by $2.1 million or 24.0% in the second quarter of 2013, resulting from a $1.7 million non-recurring gain related to the termination of post-retirement life insurance benefits coupled with lower pension costs in 2013 that resulted from a freezing of the Company’s defined benefit plan at December 31, 2012. These cost savings were partially offset by increases in occupancy (up $382 thousand) and other operating expenses (up $268 thousand). The increase in occupancy expense was due to higher rent and utilities costs, while the increase in other operating expenses reflected higher 2013 costs for marketing and advertising, OREO disposition, commercial insurance and mortgage recording tax. The increase in rent resulted from the opening of a new loan production office in Melville in the fourth quarter of 2012 coupled with a credit for deferred rent in 2012. Higher utilities costs reflected overall utility rate increases in 2013.

Operating Expenses

For the quarters and six months ended June 30, 2013 and 2012

(dollars in thousands)

					Over/							Over/
	Quarters ended June 30,				(under)			Six months ended June 30,				(under)
	2013		2012		2012			2013		2012		2012
Employee compensation and benefits (1)	$	6,746	$	8,875		(24.0	)%	$	15,328	$	17,459		(12.2	)%
Occupancy expense		1,658		1,276		29.9			3,202		2,730		17.3
Equipment expense		557		491		13.4			1,129		1,003		12.6
Consulting and professional services		573		696		(17.7	)		1,146		1,640		(30.1	)
FDIC assessment		524		478		9.6			1,041		548		90.0
Data processing		749		725		3.3			1,216		1,094		11.2
Accounting and audit fees		178		159		11.9			199		743		(73.2	)
Other operating expenses		1,707		1,439		18.6			3,232		3,527		(8.4	)
Total operating expenses	$	12,692	$	14,139		(10.2	)%	$	26,493	$	28,744		(7.8	)%

(1) Results for 2013 are net of a $1,659 non-recurring gain arising from the termination of post-retirement life insurance benefits during the second quarter of 2013.

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The Company recorded income tax expense of $816 thousand in the second quarter of 2013 resulting in an effective tax rate of 22.8% versus $1.3 million and 24.2%, respectively, in the comparable period a year ago.

Material Changes in Results of Operations – Comparison of the Six Months Ended June 30, 2013 and 2012 – The Company recorded net income of $5.5 million during the first six months of 2013 versus net income of $5.4 million in the comparable 2012 period. The increase in 2013 net income primarily reflects a $2.3 million reduction in total operating expenses, resulting from a $1.7 million non-recurring gain related to the termination of post-retirement life insurance benefits, a $1.1 million increase in non-interest income and a lower effective tax rate when compared to last year.  Largely offsetting these improvements were a $1.6 million decrease in net interest income in 2013 and the already noted $2.4 million credit to the provision for loan losses in 2012 as compared to no provision for loan losses recorded in 2013.

As shown in the net interest income analysis table below for the six months ended June 30, 2013 and 2012, net interest income decreased $1.6 million resulting from a 44 basis point reduction in the Company’s net interest margin to 3.89% in the first half of 2013 versus the first half of 2012, offset in part by a $93 million increase in average total interest-earning assets. The decrease in the net interest margin was due to the continued low level of interest rates, a shift in the Company’s average balance sheet mix from loans (down 11.6% versus the comparable 2012 period) into lower-yielding investment securities coupled with a high level of liquid assets in the form of low-yielding overnight interest-bearing deposits which represented 18% of average total interest-earning assets in the first half of 2013.

The Company’s average total interest-earning asset yield for the first six months of 2013 was 4.09%, down 52 basis points from the comparable 2012 period principally due to a 76 basis point reduction in the average yield on the Company’s investment securities portfolio to 3.82% in the first half of 2013 from 4.58% in the comparable 2012 period. This is largely a result of principal paydowns and sales of mortgage-backed securities and CMOs of U.S. Government-sponsored enterprises and calls of U.S. Government agency securities, as these securities had higher yields than those of the securities subsequently purchased. The lower yields reflect the lower rate environment that has been prevalent. The average balance of the Company’s securities portfolio increased $112 million for the first six months of 2013 as compared to the same period in 2012. This was primarily due to purchases of U.S. Government agency securities and mortgage-backed securities of U.S. Government-sponsored enterprises.

The Company’s average cost of total interest-bearing liabilities declined by 14 basis points to 0.36% in the first six months of 2013 versus 0.50% in the comparable 2012 period. The Company’s lower funding cost resulted largely from average core deposits of $1.2 billion in the first half of 2013, with average demand deposits representing 40% of average total deposits. The average cost of time deposits declined 31 basis points in the first half of 2013 compared to the same period in 2012. The Company also experienced a $12 million decrease in the average balance of time deposits for the first six months of 2013 versus the same period in 2012.

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NET INTEREST INCOME ANALYSIS

For the Six Months Ended June 30, 2013 and 2012

(unaudited, dollars in thousands)

	2013								2012
	Average					Average			Average					Average
	Balance		Interest			Yield/Cost			Balance		Interest			Yield/Cost
Assets:
Interest-earning assets:
Investment securities (1)	$	423,289	$	8,024			3.82	%	$	311,096	$	7,078			4.58	%
Federal Reserve Bank,  Federal Home Loan Bank and other stock		2,985		75			5.07			2,471		63			5.13
Federal funds sold and interest-bearing deposits		272,872		362			0.27			185,033		214			0.23
Loans (2)		819,799		22,334			5.49			926,933		25,321			5.49
Total interest-earning assets		1,518,945	$	30,795			4.09	%		1,425,533	$	32,676			4.61	%
Non-interest-earning assets		102,722								88,635
Total assets	$	1,621,667							$	1,514,168
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Saving, N.O.W. and money market deposits	$	605,287	$	580			0.19	%	$	545,030	$	620			0.23	%
Time deposits		247,978		935			0.76			260,393		1,383			1.07
Total saving and time deposits		853,265		1,515			0.36			805,423		2,003			0.50
Borrowings		12		-			-			117		-			-
Total interest-bearing liabilities		853,277		1,515			0.36			805,540		2,003			0.50
Demand deposits		578,286								528,611
Other liabilities		25,194								43,617
Total liabilities		1,456,757								1,377,768
Stockholders' equity		164,910								136,400
Total liabilities and stockholders' equity	$	1,621,667							$	1,514,168
Net interest rate spread							3.73	%							4.11	%
Net interest income/margin				29,280			3.89	%				30,673			4.33	%
Less tax-equivalent basis adjustment				(1,791	)							(1,587	)
Net interest income			$	27,489							$	29,086

(1) Interest on securities includes the effects of tax-equivalent basis adjustments of $1,789 and $1,587 in 2013 and 2012, respectively.

(2) Interest on loans includes the effect of a tax-equivalent basis adjustment of $2 in 2013.

The Company recorded no consolidated provision for loan losses for the six months ended June 30, 2013 as compared to a $2.4 million credit to the provision for loan losses during the first six months of 2012. The adequacy of the provision and the resulting allowance for loan losses, which was $17 million at June 30, 2013, is determined by management’s ongoing review of the loan portfolio, including identification and review of individual problem situations that may affect a borrower’s ability to repay, delinquency and non-performing loan data including the current status of criticized and classified loans, collateral values and changes in the size and mix of the loan portfolio. (See also Critical Accounting Policies, Judgments and Estimates and Asset Quality contained herein.)

Non-interest income increased $1.1 million or 24.2% for the six months ended June 30, 2013 versus 2012 largely due to increases in net gain on sale of portfolio loans of $445 thousand, net gain on sale of mortgage loans originated for sale of $412 thousand and net gain on sale of securities available for sale of $392 thousand.

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Total operating expenses declined by $2.3 million or 7.8% in 2013 versus 2012 primarily as the result of reductions in employee compensation and benefits, consulting and professional services and accounting and audit fees. Employee compensation and benefits expense declined by $2.1 million or 12.2% in the first half of 2013, largely due to a $1.7 million non-recurring gain related to the termination of post-retirement life insurance benefits coupled with lower pension costs in 2013 that resulted from a freezing of the Company’s defined benefit plan at December 31, 2012. The Company made significant investments in people and systems over the last year to implement its growth plans. As a result, the Company was able to realize reduced consulting and professional services expenses of $494 thousand in the first half of 2013 as compared to the same 2012 period. The decrease of $544 thousand in accounting and audit fees in the first six months of 2013 versus 2012 was largely due to fees recorded in 2012 and not repeated in 2013 pertaining to the Company’s predecessor independent registered public accounting firm. These cost savings were partially offset by increases in occupancy expense (up $472 thousand) and FDIC assessment expense (up $493 thousand). The increase in occupancy expense was due to higher rent and utilities costs, while the increase in FDIC assessment expense reflected the Company’s first quarter 2012 reassessment of the carrying value of its prepaid FDIC assessment asset with the cumulative expense adjusted downward accordingly in that period. The increase in rent resulted from the opening of a new loan production office in Melville in the fourth quarter of 2012 coupled with a credit for deferred rent in 2012. Higher utilities costs reflected overall utility rate increases in 2013.

The Company recorded income tax expense of $1.3 million in the first six months of 2013 resulting in an effective tax rate of 19.2% versus $2.0 million and 27.4%, respectively, in the comparable 2012 period. The reduction in the Company’s effective tax rate in 2013 versus 2012 resulted from a change in the expected tax rate at which the deferred tax asset will be realized in future periods.

Asset Quality - Non-accrual loans, excluding loans categorized as held-for-sale, totaled $17 million or 1.92% of total loans outstanding at June 30, 2013 versus $16 million or 2.10% of loans outstanding at December 31, 2012 and $54 million or 6.38% of loans outstanding at June 30, 2012. The decrease in non-accrual loans at June 30, 2013 compared to June 30, 2012 resulted primarily from the sales in 2012 of non-performing and other criticized and classified loans as part of management’s strategy to resolve legacy credit issues. The allowance for loan losses as a percentage of total non-accrual loans amounted to 101% at June 30, 2013 versus 108% at December 31, 2012 and 54% at June 30, 2012.

The Company held no loans 90 days or more past due and still accruing at any of the reported dates. Total loans 30 - 89 days past due and accruing amounted to $4 million or 0.44% of loans outstanding at June 30, 2013 versus $14 million or 1.81% of loans outstanding as of December 31, 2012 and $14 million or 1.63% of loans outstanding at June 30, 2012. The Company held no OREO at June 30, 2013. The Company held OREO amounting to $1.6 million and $2.2 million at December 31, 2012 and June 30, 2012, respectively. The Company sold one OREO property at its carrying value of $1.2 million in the first quarter of 2013 and its remaining OREO property during the second quarter of 2013.

Total criticized and classified loans were $73 million at June 30, 2013, $99 million at December 31, 2012 and $179 million at June 30, 2012. Criticized loans are those loans that are not classified but require some degree of heightened monitoring. Classified loans were $47 million at June 30, 2013, $54 million at December 31, 2012 and $130 million at June 30, 2012. The allowance for loan losses as a percentage of total classified loans was 36%, 33% and 23%, respectively, at the same dates. At June 30, 2013, the Company had $16 million in TDRs, primarily consisting of commercial and industrial, commercial real estate and residential mortgage loans. At June 30, 2013, $10 million of the TDRs were current and accruing and $6 million were on non-accrual status. The Company had TDRs amounting to $17 million at December 31, 2012 and $26 million at June 30, 2012.

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Net loan charge-offs of $541 thousand were recorded in the second quarter of 2013 versus net loan recoveries of $53 thousand in the first quarter of 2013 and net loan charge-offs of $8.4 million in the second quarter of 2012. Included in second quarter 2012 net charge-offs were $7.0 million in charge-offs related to loans sold in that period. As a percentage of average total loans outstanding, these net amounts represented, on an annualized basis, 0.26% for the second quarter of 2013, (0.03)% for the first quarter of 2013 and 3.73% for the second quarter of 2012.

At June 30, 2013, the Company’s allowance for loan losses amounted to $17 million or 1.93% of period-end loans outstanding. The allowance as a percentage of loans outstanding was 2.28% at December 31, 2012 and 3.45% at June 30, 2012.

Management has determined that the current level of the allowance for loan losses is adequate in relation to the probable inherent losses present in the portfolio. Management considers many factors in this analysis, among them credit risk grades, delinquency trends, concentrations within segments of the loan portfolio, recent charge-off experience, local and national economic conditions, current real estate market conditions in geographic areas where the Company’s loans are located, changes in the trend of non-performing loans, changes in interest rates and loan portfolio growth. Changes in one or a combination of these factors may adversely affect the Company’s loan portfolio resulting in increased delinquencies, loan losses and future levels of loan loss provisions. Due to these uncertainties, management expects to record loan charge-offs in future periods. (See also Critical Accounting Policies, Judgments and Estimates contained herein.)

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ANALYSIS OF NON-PERFORMING ASSETS

AND THE ALLOWANCE FOR LOAN LOSSES

June 30, 2013 versus December 31, 2012 and June 30, 2012

(dollars in thousands)

NON-PERFORMING ASSETS BY TYPE:

	At
	6/30/2013		12/31/2012		6/30/2012
Non-accrual loans	$	17,183	$	16,435	$	54,079
Non-accrual loans held-for-sale		-		907		7,500
Loans 90 days or more past due and still accruing		-		-		-
OREO		-		1,572		2,172
Total non-performing assets	$	17,183	$	18,914	$	63,751
Gross loans outstanding	$	895,451	$	780,780	$	848,225
Total loans held-for-sale	$	1,262	$	907	$	7,500

ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES:

	Quarter Ended
	6/30/2013			12/31/2012			6/30/2012
Beginning balance	$	17,834		$	21,021		$	40,008
Provision (credit)		-			(1,100	)		(2,400	)
Charge-offs		(1,464	)		(2,526	)		(9,257	)
Recoveries		923			386			876
Ending balance	$	17,293		$	17,781		$	29,227

KEY  RATIOS:

	At
	6/30/2013			12/31/2012			6/30/2012
Allowance as a % of total loans (1)		1.93	%		2.28	%		3.45	%
Non-accrual loans as a % of total loans (1)		1.92	%		2.10	%		6.38	%
Non-performing assets as a % of total loans, loans held-for-sale and OREO		1.92	%		2.41	%		7.43	%
Allowance for loan losses as a % of non-accrual loans (1)		101	%		108	%		54	%
Allowance for loan losses as a % of non-accrual loans and loans 90 days or more past due and still accruing (1)		101	%		108	%		54	%

(1) Excludes loans held-for-sale.

ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company originates and invests in interest-earning assets and solicits interest-bearing deposit accounts. The Company’s operations are subject to market risk resulting from fluctuations in interest rates to the extent that there is a difference between the amounts of interest-earning assets and interest-bearing liabilities that are prepaid, withdrawn, mature, or repriced in any given period of time. The Company’s earnings or the net value of its portfolio will change under different interest rate scenarios. The principal objective of the Company’s asset/liability management program is to maximize net interest income within an acceptable range of overall risk, including both the effect of changes in interest rates and liquidity risk. The Company’s exposure to interest-rate risk has not changed materially since December 31, 2012.

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ITEM 4. – CONTROLS AND PROCEDURES

The Company carried out an evaluation, under the supervision and with the participation of its principal executive officer and principal financial officer, of the effectiveness of the design and operation of its disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in the Company’s periodic reports filed with the SEC. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

There were no changes to the Company’s internal control over financial reporting as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act that occurred in the second quarter of 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

ITEM 1. - LEGAL PROCEEDINGS

See the information set forth in Note 10—Legal Proceedings in the Notes to Unaudited Condensed Consolidated Financial Statements under Part I, Item I, which information is incorporated by reference in response to this item.

ITEM 1A. – RISK FACTORS

There are no material changes from the risks disclosed in the “Risk Factors” section of our annual report on Form 10-K for the year ended December 31, 2012, except as discussed below.

The Company’s loan portfolio has a high concentration of real estate loans, and its business may be adversely affected by credit risk associated with residential and commercial real estate and a decline in property values.

At June 30, 2013, $704 million, or 79% of the Company’s total gross loan portfolio, was comprised of residential and commercial real estate and construction loans and home equity lines of credit. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. Although real estate prices have shown signs of improvement, a decline in real estate values may reduce the value of the real estate collateral securing these types of loans and increase the risk that the Company would incur losses if borrowers default on their loans.

ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. – DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. – MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. – OTHER INFORMATION

Not applicable.

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ITEM 6. – EXHIBITS

31.1	Certification of principal executive officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of principal financial officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of principal executive officer 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 principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

42

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.

SUFFOLK BANCORP
Date: August 5, 2013	/s/ Howard C. Bluver
	Howard C. Bluver
	President & Chief Executive Officer
	(principal executive officer)
Date: August 5, 2013	/s/ Brian K. Finneran
	Brian K. Finneran
	Executive Vice President & Chief Financial Officer
	(principal financial and accounting officer)

43

EXHIBIT INDEX

Exhibit Number	Description
31.1	Certification of principal executive officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of principal financial officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of principal executive officer 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 principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document