10-Q 1 form10q.htm NBT BANCORP INC 10-Q 9-30-2011 form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011.
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
 
COMMISSION FILE NUMBER 0-14703
 
NBT BANCORP INC.
(Exact Name of Registrant as Specified in its Charter)
 
DELAWARE   16-1268674
(State of Incorporation)   (I.R.S. Employer Identification No.)
                                                
52 SOUTH BROAD STREET, NORWICH, NEW YORK 13815
(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (607) 337-2265

None
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 (Section 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. (Check One):
 
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o   No   x

As of October 31, 2011, there were 33,106,729 shares outstanding of the Registrant's common stock, $0.01 par value per share.



 
 

 

NBT BANCORP INC.
FORM 10-Q--Quarter Ended September 30, 2011
 
TABLE OF CONTENTS
 
PART I
FINANCIAL INFORMATION
Page 
     
Item 1
3
     
  3
     
  4
     
  5
     
  6
     
  5
     
  8
     
Item 2
37
     
Item 3
57
     
Item 4
58
     
PART II
OTHER INFORMATION
 
     
Item 1
58
Item 1A
58
Item 2
59
Item 3
59
Item 4
59
Item 5
59
Item 6
60
     
  61
     
  62
 
 
Item 1 – FINANCIAL STATEMENTS

NBT Bancorp Inc. and Subsidiaries
           
Consolidated Balance Sheets (unaudited)
           
   
September 30,
   
December 31,
 
(In thousands, except share and per share data)
 
2011
   
2010
 
             
Assets
           
Cash and due from banks
  $ 121,976     $ 99,673  
Short-term interest bearing accounts
    69,969       69,119  
Securities available for sale, at fair value
    1,169,552       1,129,368  
Securities held to maturity (fair value $74,448 and $98,759, respectively)
    72,959       97,310  
Trading securities
    2,965       2,808  
Federal Reserve and Federal Home Loan Bank stock
    27,020       27,246  
Loans and leases
    3,708,090       3,610,006  
Less allowance for loan and lease losses
    71,334       71,234  
Net loans and leases
    3,636,756       3,538,772  
Premises and equipment, net
    69,092       67,404  
Goodwill
    116,127       114,841  
Intangible assets, net
    17,620       17,543  
Bank owned life insurance
    77,669       75,301  
Other assets
    96,746       99,471  
Total assets
  $ 5,478,451     $ 5,338,856  
                 
Liabilities
               
Demand (noninterest bearing)
  $ 1,028,553     $ 911,741  
Savings, NOW, and money market
    2,365,359       2,291,833  
Time
    871,152       930,778  
Total deposits
    4,265,064       4,134,352  
Short-term borrowings
    158,285       159,434  
Long-term debt
    370,347       369,874  
Trust preferred debentures
    75,422       75,422  
Other liabilities
    70,485       66,202  
Total liabilities
    4,939,603       4,805,284  
                 
Stockholders’ equity
               
Preferred stock, $0.01 par value. Authorized 2,500,000 shares at September 30, 2011 and December 31, 2010
    -       -  
Common stock, $0.01 par value. Authorized 50,000,000 shares at September 30, 2011 and December 31, 2010; issued 38,035,539 at September 30, 2011 and December 31, 2010
    380       380  
Additional paid-in-capital
    316,039       314,023  
Retained earnings
    323,400       299,797  
Accumulated other comprehensive income (loss)
    3,639       (5,335 )
Common stock in treasury, at cost, 4,932,213 and 3,532,732 shares at September 30, 2011 and December 31, 2010, respectively
     (104,610      (75,293
Total stockholders’ equity
    538,848       533,572  
Total liabilities and stockholders’ equity
  $ 5,478,451     $ 5,338,856  
 
See accompanying notes to unaudited interim consolidated financial statements.

 
NBT Bancorp Inc. and Subsidiaries
 
Three months ended
September 30,
   
Nine months ended
 September 30,
 
Consolidated Statements of Income (unaudited)
 
2011
   
2010
   
2011
   
2010
 
(In thousands, except per share data)
                       
Interest, fee, and dividend income
                       
Interest and fees on loans and leases
  $ 50,991     $ 53,301     $ 152,977     $ 160,496  
Securities available for sale
    7,771       8,621       23,622       28,223  
Securities held to maturity
    680       908       2,225       3,123  
Other
    342       482       1,275       1,547  
Total interest, fee, and dividend income
    59,784       63,312       180,099       193,389  
Interest expense
                               
Deposits
    5,352       7,174       17,690       23,627  
Short-term borrowings
    56       91       166       338  
Long-term debt
    3,621       4,374       10,783       14,289  
Trust preferred debentures
    394       1,046       1,683       3,106  
Total interest expense
    9,423       12,685       30,322       41,360  
Net interest income
    50,361       50,627       149,777       152,029  
Provision for loan and lease losses
    5,175       7,529       15,161       23,122  
Net interest income after provision for loan and lease losses
    45,186       43,098       134,616       128,907  
Noninterest income
                               
Service charges on deposit accounts
    5,532       5,953       16,059       18,384  
Insurance and other financial services revenue
    5,127       4,595       15,925       14,540  
Trust
    2,090       1,786       6,384       5,461  
Net securities gains
    12       1,120       98       1,211  
Bank owned life insurance
    674       655       2,369       2,444  
ATM and debit card fees
    3,135       2,660       8,731       7,489  
Retirement plan administration fees
    2,295       2,612       6,734       7,597  
Other
    1,329       1,610       3,881       4,526  
Total noninterest income
    20,194       20,991       60,181       61,652  
Noninterest expense
                               
Salaries and employee benefits
    25,068       24,090       74,107       70,518  
Occupancy
    3,887       3,709       12,396       11,527  
Equipment
    2,288       2,053       6,658       6,194  
Data processing and communications
    3,054       2,971       9,085       9,454  
Professional fees and outside services
    2,215       2,068       6,369       6,543  
Office supplies and postage
    1,531       1,542       4,418       4,538  
Amortization of intangible assets
    782       767       2,286       2,328  
Loan collection and other real estate owned
    676       548       1,838       2,275  
Advertising
    685       730       2,286       2,221  
FDIC expenses
    920       1,621       3,381       4,734  
Prepayment penalty on long-term debt
    -       1,205       -       1,205  
Other
    3,940       3,380       10,440       9,504  
Total noninterest expense
    45,046       44,684       133,264       131,041  
Income before income tax expense
    20,334       19,405       61,533       59,518  
Income tax expense
    5,117       4,835       17,354       16,548  
Net income
  $ 15,217     $ 14,570     $ 44,179     $ 42,970  
Earnings per share
                               
Basic
  $ 0.46     $ 0.42     $ 1.30     $ 1.25  
Diluted
  $ 0.45     $ 0.42     $ 1.29     $ 1.25  
 
See accompanying notes to unaudited interim consolidated financial statements.

 
   
Three months ended September 30,
   
Nine months ended September 30,
 
 
2011
   
2010
   
2011
   
2010
 
(In thousands)
                       
Net income
  $ 15,217     $ 14,570     $ 44,179     $ 42,970  
Other comprehensive (loss) income, net of tax
                               
Unrealized net holding gains (losses) arising during the period (pre-tax amounts of $5,978, ($62), $13,719 and $5,681)
    3,609       (42 )     8,284       3,426  
Reclassification adjustment for net gains related to securities available for sale included in net income (pre-tax amounts of ($12), ($1,120), ($98) and ($1,211))
    (7 )     (672 )     (59 )     (727 )
Pension and other benefits:
                               
Amortization of prior service cost and actuarial gains (pre-tax amounts of $417, $288, $1,248 and $1,075)
    250       173       749       645  
Total other comprehensive income
    3,852       (541 )     8,974       3,344  
Comprehensive income
  $ 19,069     $ 14,029     $ 53,153     $ 46,314  
 
See accompanying notes to unaudited interim consolidated financial statements
 
NBT Bancorp Inc. and Subsidiaries
         
Consolidated Statements of Stockholders’ Equity (unaudited)
         

   
Common
Stock
   
Additional
Paid-in-
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Common
Stock
in Treasury
   
Total
 
(in thousands, except share and per share data)
                                   
                                     
Balance at December 31, 2009
  $ 380     $ 311,164     $ 270,232     $ 1,163     $ (77,816 )   $ 505,123  
Net income
    -       -       42,970       -       -       42,970  
Cash dividends - $0.60 per share
    -       -       (20,678 )     -       -       (20,678 )
Purchase of 23,810 treasury shares
    -       -       -       -       (477 )     (477 )
Net issuance of 76,104 shares to employee benefit  plans and other stock plans, including tax benefit
    -       21       (229 )     -       1,619       1,411  
Stock-based compensation
    -       2,558       -       -       -       2,558  
Issuance of 34,323 shares of restricted stock awards
    -       (730 )     (1 )     -       731       -  
Forfeiture of 2,000 shares of restricted stock
    -       46       -       -       (46 )     -  
Other comprehensive income
    -       -       -       3,344       -       3,344  
Balance at September 30, 2010
  $ 380     $ 313,059     $ 292,294     $ 4,507     $ (75,989 )   $ 534,251  
                                                 
Balance at December 31, 2010
  $ 380     $ 314,023     $ 299,797     $ (5,335 )   $ (75,293 )   $ 533,572  
Net income
    -       -       44,179       -       -       44,179  
Cash dividends - $0.60 per share
    -       -       (20,439 )     -       -       (20,439 )
Purchase of 1,458,609 treasury shares
    -       -       -       -       (30,502 )     (30,502 )
Net issuance of 45,116 shares to employee benefit  plans and other stock plans, including tax benefit
    -       (163 )     (137 )     -       928       628  
Stock-based compensation
    -       2,436       -       -       -       2,436  
Issuance of 26,012 shares of restricted stock awards
    -       (554 )     -       -       554       -  
Forfeiture of 12,000 shares of restricted stock
    -       297       -       -       (297 )     -  
Other comprehensive income
    -       -       -       8,974       -       8,974  
Balance at September 30, 2011
  $ 380     $ 316,039     $ 323,400     $ 3,639     $ (104,610 )   $ 538,848  
 
See accompanying notes to unaudited interim consolidated financial statements.
 

NBT Bancorp Inc. and Subsidiaries
 
Nine Months Ended September 30,
 
Consolidated Statements of Cash Flows (unaudited)
 
2011
   
2010
 
(In thousands, except per share data)
           
Operating activities
           
Net income
  $ 44,179     $ 42,970  
Adjustments to reconcile net income to net cash provided by operating activities
               
Provision for loan and lease losses
    15,161       23,122  
Depreciation and amortization of premises and equipment
    4,023       3,991  
Net accretion on securities
    939       890  
Amortization of intangible assets
    2,286       2,328  
Stock based compensation
    2,436       2,558  
Bank owned life insurance income
    (2,368 )     (2,444 )
Purchases of trading securities
    (404 )     (152 )
Unrealized losses in trading securities
    247       12  
Deferred income tax benefit
    (4,003 )     (14,619 )
Proceeds from sales of loans held for sale
    3,257       69,815  
Originations and purchases of loans held for sale
    (2,445 )     (68,756 )
Net gains on sales of loans held for sale
    (2 )     (672 )
Net security gains
    (98 )     (1,211 )
Net gain on sales of other real estate owned
    (712 )     (344 )
Net decrease in other assets
    3,499       4,667  
Net increase in other liabilities
    1,531       6,400  
Net cash provided by operating activities
    67,526       68,555  
Investing activities
               
Securities available for sale:
               
Proceeds from maturities, calls, and principal paydowns
    360,358       420,119  
Proceeds from sales
    118       5,352  
Purchases
    (387,855 )     (384,044 )
Securities held to maturity:
               
Proceeds from maturities, calls, and principal paydowns
    39,766       97,094  
Purchases
    (14,580 )     (40,444 )
Net (increase) decrease in loans
    (115,065 )     4,910  
Net decrease in Federal Reserve and FHLB stock
    226       6,051  
Proceeds from bank owned life insurance
    -       2,767  
Purchases of premises and equipment
    (5,677 )     (4,372 )
Proceeds from sales of other real estate owned
    2,073       2,496  
Net cash used in acquisition
    (1,000 )     -  
Net cash (used in) provided by investing activities
    (121,636 )     109,929  
Financing activities
               
Net increase in deposits
    130,712       109,575  
Net (decrease) increase in short-term borrowings
    (1,149 )     10,487  
Repayments of long-term debt
    (2,143 )     (125,230 )
Issuance of long-term debt
    156       -  
Excess tax (obligation) benefit from exercise of stock options
    (95 )     123  
Proceeds from the issuance of shares to employee benefit plans and other stock plans
    723       1,288  
Purchase of treasury stock
    (30,502 )     (477 )
Cash dividends and payment for fractional shares
    (20,439 )     (20,678 )
Net cash provided by (used in) financing activities
    77,263       (24,912 )
Net increase in cash and cash equivalents
    23,153       153,572  
Cash and cash equivalents at beginning of period
    168,792       187,161  
Cash and cash equivalents at end of period
  $ 191,945     $ 340,733  
 
See accompanying notes to unaudited interim consolidated financial statements.
 
 
Supplemental disclosure of cash flow information
     
Cash paid during the period for:
           
Interest
  $ 30,774     $ 42,409  
Income taxes paid
    22,537       28,797  
Noncash investing activities:
               
Loans transferred to OREO
  $ 1,110     $ 937  
Acquisitions:
               
Fair value of assets acquired
  $ 3,460     $ -  
Goodwill and identifiable intangible assets recognized in purchase combination
    3,426       -  
Fair value of debt issued in purchase combination
    2,460       -  
 
See accompanying notes to unaudited interim consolidated financial statements.
 
 
NBT BANCORP INC. and Subsidiaries
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Note 1.                      Description of Business

NBT Bancorp Inc. (the “Registrant”) is a registered financial holding company incorporated in the State of Delaware in 1986, with its principal headquarters located in Norwich, New York. The Registrant is the parent holding company of NBT Bank, N.A. (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), NBT Holdings, Inc. (“NBT Holdings”), CNBF Capital Trust I, NBT Statutory Trust I and NBT Statutory Trust II (the “Trusts”).  Through the Bank, the Company is focused on community banking operations.  Through NBT Financial, the Company operates EPIC Advisors, Inc. (“EPIC”), a retirement plan administrator.  Through NBT Holdings, the Company operates Mang Insurance Agency, LLC (“Mang”), a full-service insurance agency.  The Trusts were organized to raise additional regulatory capital and to provide funding for certain acquisitions. The Registrant’s primary business consists of providing commercial banking and financial services to customers in its market area. The principal assets of the Registrant are all of the outstanding shares of common stock of its direct subsidiaries, and its principal sources of revenue are the management fees and dividends it receives from the Bank, NBT Financial, and NBT Holdings.

The Bank is a full service commercial bank formed in 1856, which provides a broad range of financial products to individuals, corporations and municipalities throughout the upstate New York, northeastern Pennsylvania, northwestern Vermont, and western Massachusetts market areas.

Note 2.                      Basis of Presentation

The accompanying unaudited interim consolidated financial statements include the accounts of the Registrant and its wholly owned subsidiaries, the Bank, NBT Financial and NBT Holdings.  Collectively, the Registrant and its subsidiaries are referred to herein as “the Company.”  All intercompany transactions have been eliminated in consolidation. Amounts in the prior period financial statements are reclassified whenever necessary to conform to current period presentation.
 
Note 3.                      Use of Estimates

Preparing financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan and lease losses, other real estate owned (“OREO”), income taxes, pension expense, fair values of financial instruments and status of contingencies are particularly susceptible to material change in the near term.

The allowance for loan and lease losses is the amount which, in the opinion of management, is necessary to absorb probable losses inherent in the loan and lease portfolio. The allowance is determined based upon numerous considerations, including local and national economic conditions, the growth and composition of the loan portfolio with respect to the mix between the various types of loans and their related risk characteristics, a review of the value of collateral supporting the loans, comprehensive reviews of the loan portfolio by the independent loan review staff and management, as well as consideration of volume and trends of delinquencies, nonperforming loans, and loan charge-offs.  As a result of the review of these factors and historical and current indicators, required additions or reductions to the allowance for loan and lease losses are made periodically by charges or credits to the provision for loan and lease losses.
 
 
The allowance for loan and lease losses related to impaired loans is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain loans where repayment of the loan is expected to be provided solely by the underlying collateral (collateral dependent loans). The Company’s impaired loans are generally collateral dependent loans. The Company considers the estimated cost to sell, on a discounted basis, when determining the fair value of collateral in the measurement of impairment if those costs are expected to reduce the cash flows available to repay or otherwise satisfy the loans.

Management believes that the allowance for loan and lease losses is adequate. While management uses available information to recognize loan and lease losses, future additions or reductions to the allowance for loan and lease losses may be necessary based on changes in economic conditions or changes in the values of properties securing loans in the process of foreclosure. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to recognize additions to the allowance for loan and lease losses based on their judgments about information available to them at the time of their examination which may not be currently available to management.  In determining that we will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreements, we consider factors such as payment history and changes in the financial condition of individual borrowers, local economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated.

OREO consists of properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure. These assets are recorded at the lower of fair value of the asset acquired less estimated costs to sell or “cost” (cost is defined as the fair value less costs to sell at initial foreclosure). At the time of foreclosure, or when foreclosure occurs in-substance, the excess, if any, of the loan over the fair value of the assets received, less estimated selling costs, is charged to the allowance for loan and lease losses and any subsequent valuation write-downs are charged to other expense. Operating costs associated with the properties are charged to expense as incurred. Gains on the sale of OREO are included in income when title has passed and the sale has met the minimum down payment requirements prescribed by U.S. GAAP.

Income taxes are accounted for under the asset and liability method. The Company files consolidated tax returns on the accrual basis. Deferred income taxes are recognized for the future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income within the available carryback period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Based on available carrybacks and expected future income, gross deferred tax assets will ultimately be realized and a valuation allowance was not deemed necessary at September 30, 2011 or December 31, 2010. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date.  Uncertain tax positions are recognized only when it is more likely than not (likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities.  Tax positions that meet the more than likely than not threshold are measured using a probability-weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement.

Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected long-term rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various assumptions used to compute pension expense. The Company also considers relevant indices and market interest rates in selecting an appropriate discount rate. A cash flow analysis for expected benefit payments from the plan is performed each year to assist in selecting the discount rate.  In addition, the Company reviews expected inflationary and merit increases to compensation in determining the expected rate of increase in future compensation levels.
 
 
Management is required to make various assumptions in determining the fair values of financial instruments.  Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Management is required to make various assumptions in determining the credit risk involved in issuing contingent obligations such as standby letters of credit, commercial letters of credit, and other lines of credit.  Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments.  Based on historical experience and economic factors, the Company makes estimates of future cash commitments from these contingent obligations to determine their fair value and establish an allowance if necessary.

Note 4.                      Commitments and Contingencies

The Company is a party to financial instruments in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuating interest rates. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  Commitments to extend credit and unused lines of credit totaled $749.2 million at September 30, 2011 and $643.6 million at December 31, 2010.  Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management’s credit evaluation of the borrower and may include accounts receivable, inventory, property, land and other items.

The Company guarantees the obligations or performance of customers by issuing standby letters of credit to third parties. These standby letters of credit are frequently issued in support of third party debt, such as corporate debt issuances, industrial revenue bonds and municipal securities. The credit risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash commitments. Standby letters of credit totaled $26.0 million at September 30, 2011 and $26.2 million at December 31, 2010. As of September 30, 2011, the fair value of standby letters of credit was not significant to the Company’s consolidated financial statements.

The Company has also entered into commercial letter of credit agreements on behalf of its customers.  Under these agreements, the Company, on the request of its customer, opens the letter of credit and makes a commitment to honor draws made under the agreement, whereby the beneficiary is normally the provider of goods and/or services and the Company essentially replaces the customer as the payee.  The credit risk involved in issuing commercial letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination guidelines, portfolio maintenance and management procedures as other credit and off-balance sheet products.  
 
 
Typically, these agreements vary in terms and the total amounts do not necessarily represent future cash commitments.  Commercial letters of credit totaled $15.7 million at September 30, 2011 and $16.3 million at December 31, 2010.  As of September 30, 2011, the fair value of commercial letters of credit was not significant to the Company’s consolidated financial statements.

Note  5.                     Allowance for Loan and Lease Losses and Credit Quality of Loans and Leases

Allowance for Loan and Lease Losses

The allowance for loan and lease losses is maintained at a level estimated by management to provide adequately for risk of probable losses inherent in the current loan and lease portfolio. The adequacy of the allowance for loan and lease losses is continuously monitored.  It is assessed for adequacy using a methodology designed to ensure the level of the allowance reasonably reflects the loan and lease portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan and lease portfolio.

To develop and document a systematic methodology for determining the allowance for loan and lease losses, the Company has divided the loan portfolio into three portfolio segments, each with different risk characteristics and methodologies for assessing risk.  Each portfolio segment is broken down into class segments where appropriate.  Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan and lease losses.  Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class segment.  The following table illustrates the portfolio and class segments for the Company’s loan portfolio:

Portfolio
Class
Commercial Loans
Commercial
 
Commercial Real Estate
 
Agricultural
 
Agricultural Real Estate
 
Business Banking
   
Consumer Loans
Indirect
 
Home Equity
 
Direct
   
Residential Real Estate Mortgages
 

CommercialThe Company offers a variety of loan options to meet the specific needs of our commercial customers including term loans, time notes and lines of credit.  Such loans are made available to businesses for working capital such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment or other assets owned by the borrower.  These loans carry a higher risk than commercial real estate loans due to the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable and is generally less liquid than real estate. To reduce the risk, management also attempts to secure real estate as collateral and obtain personal guarantees of the borrowers.

Commercial Real Estate – The Company offers commercial real estate loans to finance real estate purchases, refinancings, expansions and improvements to commercial properties.  Commercial real estate loans are made to finance the purchases of real property which generally consists of real estate with completed structures. These commercial real estate loans are secured by first liens on the real estate, which may include apartments, commercial structures, housing businesses, healthcare facilities, and other non owner-occupied facilities.  These loans are typically less risky than commercial loans, since they are secured by real estate and buildings. The Company’s underwriting analysis includes credit verification, independent appraisals, a review of the borrower's financial condition, and a detailed analysis of the borrower’s underlying cash flows. These loans are typically originated in amounts of no more than 80% of the appraised value of the property.
 
 
Agricultural – The Company offers a variety of agricultural loans to meet the needs of our agricultural customers including term loans, time notes, and lines of credit.  These loans are made to purchase livestock, purchase and modernize equipment, and finance seasonal crop expenses.  Generally, a collateral lien is placed on the livestock, equipment, produce inventories, and/or receivables owned by the borrower.  These loans may carry a higher risk than commercial and agricultural real estate loans due to the industry price volatility, and in some cases, the perishable nature of the underlying collateral.  To reduce these risks, management may attempt to secure these loans with additional real estate collateral, obtain personal guarantees of the borrowers, or obtain government loan guarantees to provide further support.

Agricultural Real Estate – The Company offers real estate loans to our agricultural customers to finance farm related real estate purchases, refinancings, expansions, and improvements to agricultural properties such as barns, production facilities, and land.  The agricultural real estate loans are secured by first liens on the farm real estate.  Because they are secured by land and buildings, these loans may be less risky than agricultural loans.  The Company's underwriting analysis includes credit verification, independent appraisals, a review of the borrower's financial condition, and a detailed analysis of the borrower’s underlying cash flows.  These loans are typically originated in amounts of no more than 75% of the appraised value of the property.  Government loan guarantees may be obtained to provide further support.

Business Banking - The Company offers a variety of loan options to meet the specific needs of our small business customers including term loans, small business mortgages and lines of credit.  Such loans are generally less than $350 thousand and are made available to businesses for working capital such as inventory and receivables, business expansion, equipment purchases, and agricultural needs.  Generally, a collateral lien is placed on equipment or other assets owned by the borrower such as inventory and/or receivables.  These loans carry a higher risk than commercial loans due to the smaller size of the borrower and lower levels of capital.  To reduce the risk, the Company obtains personal guarantees of the owners for a majority of the loans.

Indirect – The Company maintains relationships with many dealers primarily in the communities that we serve.  Through these relationships, the company finances the purchases of automobiles and recreational vehicles (such as campers, boats, etc.) indirectly through dealer relationships.  Approximately 70% of the indirect relationships represent automobile financing.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from three to six years, based upon the nature of the collateral and the size of the loan. The majority of indirect consumer loans are underwritten on a secured basis using the underlying collateral being financed.
 
Home Equity The Company offers fixed home equity loans as well as home equity lines of credit to consumers to finance home improvements, debt consolidation, education and other uses.  Consumers are able to borrow up to 85% of the equity in their homes.  The Company originates home equity lines of credit and second mortgage loans (loans secured by a second [junior] lien position on one-to-four-family residential real estate).  These loans carry a higher risk than first mortgage residential loans as they are in a second position with respect to collateral.  Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.
 
 
Direct – The Company offers a variety of consumer installment loans to finance vehicle purchases, mobile home purchases and personal expenditures.  Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to ten years, based upon the nature of the collateral and the size of the loan. The majority of consumer loans are underwritten on a secured basis using the underlying collateral being financed or a customer's deposit account. In addition to installment loans, the Company also offers personal lines of credit and overdraft protection.  A minimal amount of loans are unsecured, which carry a higher risk of loss.

Residential Real Estate – Residential real estate loans consist primarily of loans secured by first or second deeds of trust on primary residences.  We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage.  These loans are collateralized by owner-occupied properties located in the Company’s market area. When market conditions are favorable, for longer term, fixed-rate residential mortgages without escrow, the Company retains the servicing, but sells the right to receive principal and interest to Freddie Mac.   This practice allows the Company to manage interest rate risk, liquidity risk, and credit risk.  Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 85% of the purchase price or appraised value (whichever is lower), or have private mortgage insurance.  Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period.

Allowance for Loan and Lease Loss Calculation
Management considers the accounting policy related to the allowance for loan and lease losses to be a critical accounting policy given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the consolidated results of operations.

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectibility of the portfolio.  For individually analyzed loans, these include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans and leases, estimates of the Company’s exposure to credit loss reflect a current assessment of a number of factors, which could affect collectibility.  These factors include:  past loss experience;  size, trend, composition, and nature of loans;  changes in lending policies and procedures, including underwriting standards and collection,  charge-offs  and  recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market;  portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff. In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan and lease losses.  Such agencies may require the Company to make loan grade changes as well as recognize additions to the allowance based on their examinations.

After a thorough consideration of the factors discussed above, any required additions or reductions to the allowance for loan and lease losses are made periodically by charges or credits to the provision for loan and lease losses. These charges or credits are necessary to maintain the allowance at a level which management believes is reasonably reflective of overall inherent risk of probable loss in the portfolio. While management uses available information to recognize losses on loans and leases, additions and reductions of the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.  The following table illustrates the changes in the allowance for loan and lease losses by portfolio segment for the three and nine months ended September 30, 2011 and September 30, 2010:

 
Allowance for Loan and Lease Losses
(in thousands)
 
   
Commercial
Loans
   
Consumer
Loans
   
Residential
Real Estate
Mortgages
   
Unallocated
   
Total
 
Balance as of June 30, 2011
  $ 39,147     $ 25,718     $ 5,373     $ 246     $ 70,484  
Charge-offs
    (1,694 )     (3,526 )     (45 )     -       (5,265 )
Recoveries
    367       571       2       -       940  
Provision
    1,073       3,533       588       (19 )     5,175  
Ending Balance as of September 30, 2011
  $ 38,893     $ 26,296     $ 5,918     $ 227     $ 71,334  
                                         
Balance as of June 30, 2010
  $ 38,885     $ 27,832     $ 3,295     $ 288     $ 70,300  
Charge-offs
    (2,904 )     (3,846 )     (132 )     -       (6,882 )
Recoveries
    348       572       8       -       928  
Provision
    4,517       2,359       611       42       7,529  
Ending Balance as of September 30, 2010
  $ 40,846     $ 26,917     $ 3,782     $ 330     $ 71,875  
 
Nine months ended September 30                                  
   
Commercial
Loans
   
Consumer
Loans
   
Residential
Real Estate
Mortgages
   
Unallocated
   
Total
 
Balance as of December 31, 2010
  $ 40,101     $ 26,126     $ 4,627     $ 380     $ 71,234  
Charge-offs
    (7,153 )     (10,420 )     (558 )     -       (18,131 )
Recoveries
    1,262       1,803       5       -       3,070  
Provision
    4,683       8,787       1,844       (153 )     15,161  
Ending Balance as of September 30, 2011
  $ 38,893     $ 26,296     $ 5,918     $ 227     $ 71,334  
                                         
Balance as of December 31, 2009
  $ 36,598     $ 26,664     $ 3,002     $ 286     $ 66,550  
Charge-offs
    (9,040 )     (11,776 )     (655 )     -       (21,471 )
Recoveries
    1,580       2,080       14       -       3,674  
Provision
    11,708       9,949       1,421       44       23,122  
Ending Balance as of September 30, 2010
  $ 40,846     $ 26,917     $ 3,782     $ 330     $ 71,875  

 
The following tables illustrate the allowance for loan and lease losses and the recorded investment by portfolio segment as of September 30, 2011 and December 31, 2010:
 
Allowance for Loan and Lease Losses and Recorded Investment in Loans and Leases
(in thousands)
 
   
Commercial
Loans
   
Consumer
Loans
   
Residential
Real Estate
Mortgages
   
Unallocated
   
Total
 
As of September 30, 2011
                             
Allowance for loan and lease losses
  $ 38,893     $ 26,296     $ 5,918     $ 227     $ 71,334  
                                         
Allowance for loans and leases individually evaluated for impairment
  $ 248     $ -     $ -             $ 248  
                                         
Allowance for loans and leases collectively evaluated for impairment
  $ 38,645     $ 26,296     $ 5,918     $ 227     $ 71,086  
                                         
                                         
Ending balance of loans and leases
  $ 1,647,734     $ 1,489,908     $ 570,448             $ 3,708,090  
                                         
Ending balance of loans and leases individually evaluated for impairment
  $ 7,207     $ -     $ -             $ 7,207  
                                         
Ending balance of loans and leases collectively evaluated for impairment
  $ 1,640,527     $ 1,489,908     $ 570,448             $ 3,700,883  
 
As of December 31, 2010
                                       
Allowance for loan and lease losses
  $ 40,101     $ 26,126     $ 4,627     $ 380     $ 71,234  
                                         
Allowance for loans and leases individually evaluated for impairment
  $ 2,211     $ -     $ -             $ 2,211  
                                         
Allowance for loans and leases collectively evaluated for impairment
  $ 37,890     $ 26,126     $ 4,627     $ 380     $ 69,023  
                                         
                                         
Ending balance of loans and leases
  $ 1,580,371     $ 1,481,241     $ 548,394             $ 3,610,006  
                                         
Ending balance of loans and leases individually evaluated for impairment
  $ 11,419     $ -     $ -             $ 11,419  
                                         
Ending balance of loans and leases collectively evaluated for impairment
  $ 1,568,952     $ 1,481,241     $ 548,394             $ 3,598,587  

Credit Quality of Loans and Leases
Loans and leases are placed on nonaccrual status when timely collection of principal and interest in accordance with contractual terms is doubtful. Loans and leases are transferred to nonaccrual status generally when principal or interest payments become ninety days delinquent, unless the loan is well secured and in the process of collection, or sooner when management concludes or circumstances indicate that borrowers may be unable to meet contractual principal or interest payments.  When a loan or lease is transferred to a nonaccrual status, all interest previously accrued in the current period but not collected is reversed against interest income in that period. Interest accrued in a prior period and not collected is charged-off against the allowance for loan and lease losses.  The Company’s nonaccrual policies are the same for all classes of financing receivable.
 
 
If ultimate repayment of a nonaccrual loan is expected, any payments received are applied in accordance with contractual terms. If ultimate repayment of principal is not expected, any payment received on a nonaccrual loan is applied to principal until ultimate repayment becomes expected.  Nonaccrual loans are returned to accrual status when they become current as to principal and interest and demonstrate a period of performance under the contractual terms and, in the opinion of management, are fully collectible as to principal and interest.  When in the opinion of management the collection of principal appears unlikely, the loan balance is charged-off in total or in part.  For loans in all portfolios, the principal amount is charged off in full or in part as soon as management determines, based on available facts, that the collection of principal in full is improbable.  For commercial loans, management considers specific facts and circumstances relative to individual credits in making such a determination.  For consumer and residential loan classes, management uses specific guidance and thresholds from the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy.
 
The following table illustrates the Company’s nonaccrual loans by loan class:
Loans on Nonaccrual Status
 
(In thousands)
 
September 30, 2011
   
December 31, 2010
 
Commercial Loans
           
Commercial
  $ 2,044     $ 5,837  
Commercial Real Estate
    5,324       5,687  
Agricultural
    3,467       4,065  
Agricultural Real Estate
    1,890       2,429  
Business Banking
    7,728       7,033  
      20,453       25,051  
                 
Consumer Loans
               
Indirect
    1,323       1,971  
Home Equity
    8,352       6,395  
Direct
    396       399  
      10,071       8,765  
                 
Residential Real Estate Mortgages
    9,228       8,651  
                 
Total Nonaccrual
  $ 39,752     $ 42,467  

 
The following tables set forth information with regard to past due and nonperforming loans by loan class as of September 30, 2011 and December 31, 2010:
 
Age Analysis of Past Due Financing Receivables
As of September 30, 2011
(in thousands)
 
   
31-60 Days
Past Due
Accruing
   
61-90 Days
Past Due
Accruing
   
Greater Than
90 Days
Past Due
Accruing
   
Total
Past Due
Accruing
   
Non-Accrual
   
Current
   
Recorded
Total
Loans and
Leases
 
Commercial
                                         
Commercial
  $ 169     $ 233     $ 44     $ 446     $ 2,044     $ 506,716     $ 509,206  
Commercial
                                                       
Real Estate
    277       391       195       863       5,324       782,378       788,565  
Agricultural
    64       13       -       77       3,467       61,050       64,594  
Agricultural
                                                       
Real Estate
    -       -       -       -       1,890       31,116       33,006  
Business Banking
    1,730       359       -       2,089       7,728       242,547       252,364  
      2,240       996       239       3,475       20,453       1,623,806       1,647,734  
                                                         
Consumer
                                                       
Indirect
    7,904       1,780       1,427       11,111       1,323       851,111       863,545  
Home Equity
    4,249       887       1,050       6,186       8,352       538,387       552,925  
Direct
    672       194       175       1,041       396       72,002       73,439  
      12,825       2,861       2,652       18,338       10,071       1,461,499       1,489,908  
                                                         
Residential Real Estate Mortgages
    1,349       250       1,634       3,233       9,228       557,987       570,448  
    $ 16,414     $ 4,107     $ 4,525     $ 25,046     $ 39,752     $ 3,643,292     $ 3,708,090  
 
 
Age Analysis of Past Due Loans
As of December 31, 2010
(in thousands)
 
   
31-60 Days
Past Due
Accruing
   
61-90 Days
Past Due
Accruing
   
Greater
Than
91 Days
Past Due
Accruing
   
Total
Past Due
Accruing
   
Non-Accrual
   
Current
   
Recorded
Total
Loans and
Leases
 
                                           
Commercial
                                         
Commercial
  $ 136     $ 55     $ 94     $ 285     $ 5,837     $ 461,633     $ 467,755  
Commercial
                                                       
Real Estate
    1,263       -       -       1,263       5,687       730,285       737,235  
Agricultural
    63       92       -       155       4,065       63,336       67,556  
Agricultural
                                                       
Real Estate
    108       -       -       108       2,429       33,400       35,937  
Business Banking
    2,570       1,183       -       3,753       7,033       261,102       271,888  
      4,140       1,330       94       5,564       25,051       1,549,756       1,580,371  
                                                         
Consumer
                                                       
Indirect
    9,307       2,193       862       12,362       1,971       814,594       828,927  
Home Equity
    5,740       1,756       396       7,892       6,395       561,391       575,678  
Direct
    927       158       54       1,139       399       75,098       76,636  
      15,974       4,107       1,312       21,393       8,765       1,451,083       1,481,241  
                                                         
Residential Real  Estate Mortgages
    3,002       126       919       4,047       8,651       535,696       548,394  
    $ 23,116     $ 23,116     $ 2,325     $ 31,004     $ 42,467     $ 3,536,535     $ 3,610,006  

There were no material commitments to extend further credit to borrowers with nonperforming loans. Within nonaccrual loans, there were approximately $4.6 million and $1.0 million of troubled debt restructured (“TDR”) loans at September 30, 2011 and December 31, 2010, respectively.

Impaired loans, which primarily consist of nonaccruing commercial, commercial real estate, agricultural, agricultural real estate and business banking loans, as well as certain consumer loans that have been modified in a TDR were $23.7 million at September 30, 2011 and $25.4 million at December 31, 2010.

The methodology used to establish the allowance for loan and lease losses on impaired loans incorporates specific allocations on loans analyzed individually.  Classified loans with outstanding balances of $500 thousand or more are evaluated for impairment through the Company’s quarterly status review process.  In determining that we will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreements, we consider factors such as payment history and changes in the financial condition of individual borrowers, local economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated.  For loans that are evaluated for impairment, impairment is measured by one of three methods: 1) the fair value of collateral less cost to sell, 2) present value of expected future cash flows or 3) the loan’s observable market price.  These impaired loans are reviewed on a quarterly basis for changes in the measurement of impairment.  For impaired loans measured using the present value of expected cash flow method, any change to the previously recognized impairment loss is recognized as a change to the allowance account and recorded in the consolidated statement of income as a component of the provision for credit losses.  At September 30, 2011, $0.5 million of the total impaired loans had a specific reserve allocation of $0.2 million compared to $5.7 million of impaired loans at December 31, 2010 which had a specific reserve allocation of $2.2 million.
 
 
The following table provides additional information on impaired loans and specific reserve allocations as of September 30, 2011 and December 31, 2010:

Impaired Loans
                                   
   
September 30, 2011
   
December 31, 2010
 
 
(in thousands)
 
Recorded
Investment
Balance
(Book)
   
Unpaid
Principal
Balance
(Legal)
     
Related
Allowance
   
Recorded
Investment
Balance
(Book)
   
Unpaid
Principal
Balance
(Legal)
     
Related
Allowance
 
With no related allowance recorded:
                                   
Commercial Loans
                                   
Commercial
  $ 1,540     $ 3,465           $ 2,112     $ 2,459        
Commercial Real Estate
    5,324       7,386             5,687       6,654        
Agricultural
    3,444       4,277             2,394       2,865        
Agricultural Real Estate
    1,890       2,093             1,701       1,883        
Business Banking
    7,728       10,411             7,033       9,395        
Total Commercial Loans
    19,926       27,632             18,927       23,256        
                                             
Consumer Loans
                                           
Home Equity
    2,188       2,273             -       -        
                                             
Residential Real Estate Mortgages
    1,055       1,125             313       339        
      23,169       31,030             19,240       23,595        
                                             
With an allowance recorded:
                                           
Commercial Loans
                                           
Commercial
  $ 504     $ 839     $ 225     $ 3,725     $ 4,762     $ 1,907  
Commercial Real Estate
    -       -       -       -       -       -  
Agricultural
    23       28       23       1,671       1,918       281  
Agricultural Real Estate
    -       -       -       728       784       23  
Total Commercial Loans
    527       867       248       6,124       7,464       2,211  
                                                 
Total:
  $ 23,696     $ 31,897     $ 248     $ 25,364     $ 31,059     $ 2,211  


The following table summarizes the average recorded investments on impaired loans and the interest income recognized for the three months ended September 30, 2011 and September 30, 2010:

   
For the three months ended
 
   
September 30, 2011
   
September 30, 2010
 
   
Average
Recorded
Investment
   
Interest
 Income
Recognized
   
Average
Recorded
Investment
   
Interest
 Income
Recognized
 
(in thousands)
       
Accrual
   
Cash
         
Accrual
   
Cash
 
With no related allowance recorded:
                                   
Commercial Loans
                                   
Commercial
  $ 1,794     $ 3     $ 3     $ 2,119     $ 34     $ 34  
Commercial Real Estate
    6,106       14       14       4,612       70       70  
Agricultural
    3,516       59       59       3,233       17       17  
Agricultural Real Estate
    1,874       34       34       1,538       66       66  
Business Banking
    7,655       101       101       6,458       107       107  
Total Commercial Loans
    20,945       211       211       17,960       294       294  
                                                 
Consumer Loans
                                               
Home Equity
    2,312       26       26       -       -       -  
                                                 
Residential Real Estate Mortgages
    1,059       26       26       212       5       5  
    $ 24,316     $ 263     $ 263     $ 18,172     $ 299     $ 299  
                                                 
With an allowance recorded:
                                               
Commercial Loans
                                               
Commercial
  $ 520     $ 19     $ 19     $ 1,635     $ 69     $ 69  
Commercial Real Estate
    -       -       -       721       -       -  
Agricultural
    23       1       1       1,199       46       46  
Agricultural Real Estate
    -       -       -       826       12       12  
Total Commercial Loans
  $ 543     $ 20     $ 20     $ 4,381     $ 127     $ 127  
                                                 
Total:
  $ 24,859     $ 283     $ 283     $ 22,553     $ 426     $ 426  
 

The following table summarizes the average recorded investments on impaired loans and the interest income recognized for the nine months ended September 30, 2011 and September 30, 2010:

   
For the nine months ended
 
   
September 30, 2011
   
September 30, 2010
 
   
Average
Recorded
Investment
   
Interest
 Income
Recognized
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
(in thousands)
       
Accrual
   
Cash
         
Accrual
   
Cash
 
With no related allowance recorded:
                                   
Commercial Loans
                                   
Commercial
  $ 2,625     $ 76     $ 76     $ 1,915     $ 63     $ 63  
Commercial Real Estate
    4,728       59       59       4,060       84       84  
Agricultural
    2,903       104       104       2,754       45       45  
Agricultural Real Estate
    1,622       72       72       2,053       130       130  
Business Banking
    5,662       203       203       4,149       154       154  
Total Commercial Loans
    17,540       514       514       14,931       476       476  
                                                 
Consumer Loans
                                               
Home Equity
    1,851       84       84       -       -       -  
                                                 
Residential Real Estate Mortgages
    887       53       53       71       5       5  
    $ 20,278     $ 651     $ 651     $ 15,002     $ 481     $ 481  
                                                 
With an allowance recorded:
                                               
Commercial Loans
                                               
Commercial
  $ 991     $ 68     $ 68     $ 2,196     $ 70     $ 70  
Commercial Real Estate
    382       -       -       1,645       -       -  
Agricultural
    1,055       68       68       1,657       104       104  
Agricultural Real Estate
    475       18       18       792       54       54  
Total Commercial Loans
  $ 2,903     $ 154     $ 154     $ 6,290     $ 228     $ 228  
                                                 
Total:
  $ 23,181     $ 805     $ 805     $ 21,292     $ 709     $ 709  

There has been significant disruption and volatility in the financial and capital markets since the second half of 2008.  Turmoil in the mortgage industry adversely impacted both domestic and global economies and led to a significant credit and liquidity crisis in many domestic markets.  These conditions were attributable to a variety of factors, in particular the fallout associated with subprime mortgage loans (a type of lending we have never actively pursued).  The disruption was exacerbated by the decline of the real estate and housing market.  However, in the markets in which the Company does business, the disruption has been somewhat delayed and less significant than in the national market.  For example, our real estate market has not suffered the extreme declines seen nationally and our unemployment rate, while notably higher than in prior periods, is still below the national average.

While we continue to adhere to prudent underwriting standards, as a lender we may be adversely impacted by general economic weaknesses and, in particular, a sharp downturn in the housing market nationally.  Decreases in real estate values could adversely affect the value of property used as collateral for our loans.  Adverse changes in the economy may have a negative effect on the ability of our borrowers to make timely loan payments, which would have an adverse impact on our earnings.  An adverse impact on loan delinquencies would decrease our net interest income and adversely impact our loan loss experience, causing increases in our provision and allowance for loan and lease losses.
 
 
The Company has developed an internal loan grading system to evaluate and quantify the Bank’s loan portfolio with respect to quality and risk.  The system focuses on, among other things, financial strength of borrowers, experience and depth of borrower’s management, primary and secondary sources of repayment, payment history, nature of the business, and outlook on particular industries.  The internal grading system enables the Company to monitor the quality of the entire loan portfolio on a consistent basis and provide management with an early warning system, enabling recognition and response to problem loans and potential problem loans.
 
Commercial Grading System
 
For commercial and agricultural loans, the Company uses a grading system that relies on quantifiable and measurable characteristics when available.  This would include comparison of financial strength to available industry averages, comparison of transaction factors (loan terms and conditions) to loan policy, and comparison of credit history to stated repayment terms and industry averages. Some grading factors are necessarily more subjective such as economic and industry factors, regulatory environment, and management.  Classified commercial loans consist of loans graded substandard and below.  All classified loans with outstanding balances of $500 thousand or more are evaluated individually for impairment through the quarterly review process.  The grading system for commercial and agricultural loans is as follows:
 
 
·
Doubtful
 
A doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as a loss is deferred. Doubtful borrowers are usually in default, lack adequate liquidity or capital, and lack the resources necessary to remain an operating entity. Pending events can include mergers, acquisitions, liquidations, capital injections, the perfection of liens on additional collateral, the valuation of collateral, and refinancing. Generally, pending events should be resolved within a relatively short period and the ratings will be adjusted based on the new information. Nonaccrual treatment is required for doubtful assets because of the high probability of loss.
 
 
·
Substandard
 
Substandard loans have a high probability of payment default, or they have other well-defined weaknesses. They require more intensive supervision by bank management. Substandard loans are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants. For some Substandard loans, the likelihood of full collection of interest and principal may be in doubt and should be placed on nonaccrual. Although Substandard assets in the aggregate will have a distinct potential for loss, an individual asset’s loss potential does not have to be distinct for the asset to be rated Substandard.
 
 
·
Special Mention
 
Special Mention loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weakness does not yet justify a Substandard classification. Borrowers may be experiencing adverse operating trends (declining revenues or margins) or may be struggling with an ill-proportioned balance sheet (e.g., increasing inventory without an increase in sales, high leverage, tight liquidity). Adverse economic or market conditions, such as interest rate increases or the entry of a new competitor, may also support a Special Mention rating. Although a Special Mention loan has a higher probability of default than a pass asset, its default is not imminent.
 
 
 
·
Pass
 
Loans graded as Pass encompass all loans not graded as Doubtful, Substandard, or Special Mention.  Pass loans are in compliance with loan covenants, and payments are generally made as agreed.  Pass loans range from superior quality to fair quality.
 
Business Banking Grading System
 
Business Banking loans are graded as either Classified or Non-classified:
 
 
·
Classified
 
Classified loans are inadequately protected by the current worth and paying capacity of the obligor or, if applicable, the collateral pledged.   These loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt, or in some cases make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.   Classified loans have a high probability of payment default, or a high probability of total or substantial loss.  These loans require more intensive supervision by management and are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization.  Repayment may depend on collateral or other credit risk mitigants.  When the likelihood of full collection of interest and principal may be in doubt; classified loans are considered to have a nonaccrual status.   In some cases, Classified loans are considered uncollectible and of such little value that their continuance as assets is not warranted.
 
 
·
Non-classified
 
Loans graded as Non-classified encompass all loans not graded as Classified.  Non-classified loans are in compliance with loan covenants, and payments are generally made as agreed.
 
Consumer and Residential Mortgage Grading System
 
Consumer and Residential Mortgage loans are graded as either Performing or Nonperforming.   Nonperforming loans are loans that are 1) over 90 days past due and interest is still accruing, 2) on nonaccrual status or 3) restructured.  All loans not meeting any of these three criteria are considered Performing.

 
The following tables illustrate the Company’s credit quality by loan class as of September 30, 2011 and December 31, 2010:

Credit Quality Indicators
As of September 30, 2011
 
Commercial Credit Exposure
 
 
   
Commercial
   
 
   
Agricultural
       
By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Real Estate
   
Total
 
Pass
  $ 472,797     $ 704,232     $ 55,156     $ 28,100     $ 1,260,285  
Special Mention
    4,616       29,881       1,163       73       35,733  
Substandard
    31,289       54,452       8,199       4,833       98,773  
Doubtful
    504       -       76       -       580  
Total
  $ 509,206     $ 788,565     $ 64,594     $ 33,006     $ 1,395,371  
                                         
Business Banking Credit Exposure
                                       
By Internally Assigned Grade:
 
Business Banking
                           
Total
 
Non-classified
  $ 234,337                             $ 234,337  
Classified
    18,027                               18,027  
Total
  $ 252,364                             $ 252,364  
                                         
Consumer Credit Exposure
                                       
By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
  $ 860,868     $ 543,596     $ 72,869             $ 1,477,332  
Nonperforming
    2,677       9,329       570               12,576  
Total
  $ 863,545     $ 552,925     $ 73,439             $ 1,489,908  
                                         
Residential Mortgage Credit Exposure
 
Residential
                                 
By Payment Activity:
 
Mortgage
                           
Total
 
Performing
  $ 559,974                             $ 559,974  
Nonperforming
    10,474                               10,474  
Total
  $ 570,448                             $ 570,448  

 
Credit Quality Indicators
As of December 31, 2010
 
                               
Commercial Credit Exposure
 
 
   
Commercial
   
 
   
Agricultural
       
  By Internally Assigned Grade:
 
Commercial
   
Real Estate
   
Agricultural
   
Real Estate
   
Total
 
Pass
  $ 441,834     $ 654,974     $ 61,195     $ 30,483     $ 1,188,486  
Special Mention
    4,830       35,461       660       936       41,887  
 Substandard
    21,091       46,800       5,606       4,518       78,015  
 Doubtful
    -       -       95       -       95  
Total
  $ 467,755     $ 737,235     $ 67,556     $ 35,937     $ 1,308,483  
                                         
Business Banking Credit Exposure
                                       
  By Internally Assigned Grade:
 
Business Banking
                           
Total
 
Non-classified
  $ 253,120                             $ 253,120  
Classified
    18,768                               18,768  
Total
  $ 271,888                             $ 271,888  
                                         
Consumer Credit Exposure
                                       
  By Payment Activity:
 
Indirect
   
Home Equity
   
Direct
           
Total
 
Performing
  $ 826,956     $ 569,283     $ 76,237             $ 1,472,476  
 Nonperforming
    1,971       6,395       399               8,765  
Total
  $ 828,927     $ 575,678     $ 76,636             $ 1,481,241  
                                         
Residential Mortgage Credit Exposure
 
Residential
                                 
  By Payment Activity:
 
Mortgage
                           
Total
 
Performing
  $ 539,743                             $ 539,743  
 Nonperforming
    8,651                               8,651  
Total
  $ 548,394                             $ 548,394  
 
Modifications
 
The Company’s loan portfolio includes certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.
 
When the Company modifies a loan, management evaluates any possible impairment based on the present value of the expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral.  In these cases, management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows.  If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized by segment or class of loan as applicable, through an allowance estimate or a charge-off to the allowance.  Segment and class status is determined by the loan’s classification at origination.
 
 
Modifications made during the three month period ending September 30, 2011 consisted of three commercial loans totaling $0.7 million.   Modifications made during the nine month period ending September 30, 2011 consisted of twenty-five home equity modifications totaling $2.4 million and four residential real estate mortgages totaling $0.8 million, in addition to the three aforementioned commercial loan modifications.  For all such modifications, the pre and post outstanding recorded investment amount remained unchanged.  During the three month period ending September 30, 2011 there were no subsequent defaults on previously modified loans.  During the nine months ended September 30, 2011, there were six home equity loans classified as TDRs totaling $0.6 million and two residential real estate loans classified as TDRs totaling $0.4 million that subsequently defaulted on their renegotiated terms.

As a result of adopting the amendments in Accounting Standards Update (“ASU”) No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (Topic 310)”, the Company reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as TDRs.  The Company identified as TDRs certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology.  Upon identifying those receivables as TDRs, the Company identified them as impaired under the guidance in Section 310-10-35 and evaluated TDRs for impairment in accordance with the Company’s methodology used to establish the allowance for loan and lease losses on impaired loans. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired.  Adoption of this amendment had no material impact on the Company’s measured of impairment on these loans.

 
Note 6.                      Earnings Per Share

Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (such as the Company’s dilutive stock options and restricted stock units).

The following is a reconciliation of basic and diluted earnings per share for the periods presented in the consolidated statements of income.

Three months ended September 30,
 
2011
   
2010
 
(in thousands, except per share data)
           
Basic EPS:
           
Weighted average common shares outstanding
    33,324       34,296  
Net income available to common shareholders
    15,217       14,570  
Basic EPS
  $ 0.46     $ 0.42  
Diluted EPS:
               
Weighted average common shares outstanding
    33,324       34,296  
Dilutive effect of common stock options and restricted stock
    243       217  
Weighted average common shares and common share equivalents
    33,567       34,513  
Net income available to common shareholders
    15,217       14,570  
Diluted EPS
  $ 0.45     $ 0.42  
 
Nine months ended September 30,
    2011       2010  
(in thousands, except per share data)
               
Basic EPS:
               
Weighted average common shares outstanding
    33,897       34,271  
Net income available to common shareholders
    44,179       42,970  
Basic EPS
  $ 1.30     $ 1.25  
Diluted EPS:
               
Weighted average common shares outstanding
    33,897       34,271  
Dilutive effect of common stock options and restricted stock
    262       211  
Weighted average common shares and common share equivalents
    34,159       34,482  
Net income available to common shareholders
    44,179       42,970  
Diluted EPS
  $ 1.29     $ 1.25  

There were 1,651,159 stock options for the quarter ended September 30, 2011 and 1,476,461 stock options for the quarter ended September 30, 2010 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

There were 1,239,021 stock options for the nine months ended September 30, 2011 and 1,433,276 stock options for the nine months ended September 30, 2010 that were not considered in the calculation of diluted earnings per share since the stock options’ exercise price was greater than the average market price during these periods.

 
Note 7.                      Defined Benefit Postretirement Plans

The Company has a qualified, noncontributory, defined benefit pension plan covering substantially all of its employees at September 30, 2011.  Benefits paid from the plan are based on age, years of service, compensation and social security benefits, and are determined in accordance with defined formulas. The Company’s policy is to fund the pension plan in accordance with Employee Retirement Income Security Act (“ERISA”) standards. Assets of the plan are invested in publicly traded stocks and bonds and mutual funds. Prior to January 1, 2000, the Company’s plan was a traditional defined benefit plan based on final average compensation.  On January 1, 2000, the plan was converted to a cash balance plan with grandfathering provisions for existing participants.

In addition to the pension plan, the Company also provides supplemental employee retirement plans to certain current and former executives.  These supplemental employee retirement plans and the defined benefit pension plan are collectively referred to herein as “Pension Benefits.”

Also, the Company provides certain health care benefits for retired employees.  Benefits are accrued over the employees’ active service period. Only employees that were employed by the Company on or before January 1, 2000 are eligible to receive postretirement health care benefits.  The plan is contributory for participating retirees, requiring participants to absorb certain deductibles and coinsurance amounts with contributions adjusted annually to reflect cost sharing provisions and benefit limitations called for in the plan.  Eligibility is contingent upon the direct transition from active employment status to retirement without any break in employment from the Company.  Employees also must be participants in the Company’s medical plan prior to their retirement.  The Company funds the cost of postretirement health care as benefits are paid. The Company elected to recognize the transition obligation on a delayed basis over twenty years.  These postretirement benefits are referred to herein as “Other Benefits.”

The components of expense for Pension Benefits and Other Benefits are set forth below (in thousands):

   
Pension Benefits
   
Other Benefits
 
   
Three months ended September 30,
   
Three months ended September 30,
 
Components of net periodic benefit cost:
 
2011
   
2010
   
2011
   
2010
 
Service cost
  $ 668     $ 749     $ 5     $ 2  
Interest cost
    874       966       57       65  
Expected return on plan assets
    (1,914 )     (1,568 )     -       -  
Net amortization
    408       273       9       15  
Total cost (benefit)
  $ 36     $ 420     $ 71     $ 82  
 
   
Pension Benefits
   
Other Benefits
 
   
Nine months ended September 30,
   
Nine months ended September 30,
 
Components of net periodic benefit cost:
    2011       2010       2011       2010  
Service cost
  $ 2,003     $ 1,674     $ 15     $ 12  
Interest cost
    2,621       2,710       171       171  
Expected return on plan assets
    (5,742 )     (5,124 )     -       -  
Net amortization
    1,221       1,076       27       (1 )
Total cost (benefit)
  $ 103     $ 336     $ 213     $ 182  

The Company is not required to make contributions to the plans in 2011, and did not do so during the nine months ended September 30, 2011.  The Company recorded approximately $0.3 million and $0.7 million, net of tax, as amortization of pension amounts previously recognized in Accumulated Other Comprehensive Income during the three and nine months ended September 30, 2011, respectively.
 
 
Market conditions can result in an unusually high degree of volatility and increase the risks and short term liquidity associated with certain investments held by the Company’s defined benefit pension plan (“the Plan”) which could impact the value of these investments.

Note 8.                      Trust Preferred Debentures

CNBF Capital Trust I is a Delaware statutory business trust formed in 1999, for the purpose of issuing $18 million in trust preferred securities and lending the proceeds to the Company. NBT Statutory Trust I is a Delaware statutory business trust formed in 2005, for the purpose of issuing $5 million in trust preferred securities and lending the proceeds to the Company.  NBT Statutory Trust II is a Delaware statutory business trust formed in 2006, for the purpose of issuing $50 million in trust preferred securities and lending the proceeds to the Company to provide funding for the acquisition of CNB Bancorp, Inc. These three statutory business trusts are collectively referred herein to as “the Trusts.”  The Company guarantees, on a limited basis, payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities.  The Trusts are variable interest entities (“VIEs”) for which the Company is not the primary beneficiary, as defined by U.S. GAAP.  In accordance with U.S. GAAP, the accounts of the Trusts are not included in the Company’s consolidated financial statements.  On January 1, 2010, the Company adopted ASU 2009-17, Consolidations: Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“Topic 810”), which had no impact on the Company’s financial statements.

As of September 30, 2011, the Trusts had the following issues of trust preferred debentures, all held by the Trusts, outstanding (dollars in thousands):

Description
Issuance Date
 
Trust Preferred Securities Outstanding
 
Interest Rate
 
Trust
Preferred
Debt
Owed To
 Trust
 
Final Maturity
date
CNBF Capital Trust I
June 1999
    18,000  
3-month
LIBOR plus
2.75%
  $ 18,720  
August 2029
                       
NBT Statutory Trust I
November 2005
    5,000  
3-month
LIBOR plus
1.40%
    5,155  
December 2035
                       
NBT Statutory Trust II
February 2006
    50,000  
3-month
LIBOR plus
1.40%
    51,547  
March 2036

The Company owns all of the common stock of the Trusts, which have issued trust preferred securities in conjunction with the Company issuing trust preferred debentures to the Trusts. The terms of the trust preferred debentures are substantially the same as the terms of the trust preferred securities.

Note 9.                      Fair Value Measurements and Fair Value of Financial Instruments

U.S. GAAP states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  Fair value measurements are not adjusted for transaction costs.  A fair value hierarchy exists within U.S. GAAP that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:
 
 
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2 -  Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities, many other sovereign government obligations, liquid mortgage products, active listed equities and most money market securities. Such instruments are generally classified within level 1 or 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 most investment-grade and high-yield corporate bonds, less liquid mortgage products, less liquid agency securities, less liquid listed equities, state, municipal and provincial obligations, and certain physical commodities. Such instruments are generally classified within level 2 of the fair value hierarchy.

Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate will be used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Subsequent to inception, management only changes level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows.

For the nine months ended September 30, 2011, the Company has made no transfers of assets between Level 1 and Level 2, and has had no Level 3 activity.

The following tables set forth the Company’s financial assets and liabilities measured on a recurring basis that were accounted for at fair value.  Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands):
 
 
September 30, 2011:
 
Quoted Prices in
Active Marketsfor
Identical Assets
(Level 1)
   
Significant
Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Balance
as of
September30,2011
 
Assets:
                       
Securities Available for Sale:
                       
U.S. Treasury
    82,342       -       -       82,342  
Federal Agency
    -       220,649       -       220,649  
State & municipal
    -       107,762       -       107,762  
Mortgage-backed
    -       323,429       -       323,429  
Collateralized mortgage obligations
    -       404,928       -       404,928  
Corporate
    -       20,097       -       20,097  
Other securities
    8,283       2,062       -       10,345  
Total Securities Available for Sale
  $ 90,625     $ 1,078,927     $ -     $ 1,169,552  
                                 
Trading Securities
    2,965       -       -       2,965  
Total
  $ 93,590     $ 1,078,927     $ -     $ 1,172,517  
 
December 31, 2010:
 
Quoted Prices in
Active Marketsfor
Identical Assets
(Level 1)
   
Significant
Other
Observable Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
   
Balance
as of
December 31, 2010
 
Assets:
                       
Securities Available for Sale:
                       
U.S. Treasury
  $ 91,280     $ -     $ -     $ 91,280  
Federal Agency
    -       349,750       -       349,750  
State & municipal
    -       114,937       -       114,937  
Mortgage-backed
    -       244,808       -       244,808  
Collateralized mortgage obligations
    -       297,888       -       297,888  
Corporate
    -       20,489       -       20,489  
Other securities
    8,190       2,026       -       10,216  
Total Securities Available for Sale
  $ 99,470     $ 1,029,898     $ -     $ 1,129,368  
                                 
Trading Securities
    2,808       -       -       2,808  
Total
  $ 102,278     $ 1,029,898     $ -     $ 1,132,176  

Certain common equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices).  The majority of the other investment securities are reported at fair value utilizing Level 2 inputs.  The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom the Company has historically transacted both purchases and sales of investment securities.  Prices obtained from these sources include prices derived from market quotations and matrix pricing.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.  Management reviews the methodologies used in pricing the securities by its third party providers.
 
 
U.S. GAAP requires disclosure of assets and liabilities measured and recorded at fair value on a nonrecurring basis such as goodwill, loans held for sale, other real estate owned, lease residuals, collateral-dependent impaired loans, mortgage servicing rights, and held-to-maturity securities.  The only nonrecurring fair value measurement recorded during the nine month period ended September 30, 2011 was related to impaired loans.  During the nine month period ended September 30, 2011, the Company did not establish additional specific reserves on impaired loans.  The Company uses the fair value of underlying collateral, less costs to sell, to estimate the specific reserves for collateral dependent impaired loans.  Based on the valuation techniques used, the fair value measurements for collateral dependent impaired loans are classified as Level 3.
 
The following table sets forth information with regard to estimated fair values of financial instruments at September 30, 2011 and December 31, 2010:
 
   
September 30, 2011
   
December 31, 2010
 
(In thousands)
 
Carrying amount
   
Estimated fair value
   
Carrying amount
   
Estimated fair value
 
Financial assets
                       
Cash and cash equivalents
  $ 191,945     $ 191,945     $ 168,792     $ 168,792  
Securities available for sale
    1,169,552       1,169,552       1,129,368       1,129,368  
Securities held to maturity
    72,959       74,448       97,310       98,759  
Trading securities
    2,965       2,965       2,808       2,808  
Loans (1)
    3,708,090       3,733,216       3,610,006       3,626,603  
Less allowance for loan losses
    71,334       -       71,234       -  
Net loans
    3,636,756       3,733,216       3,538,772       3,626,603  
Accrued interest receivable
    17,336       17,336       19,130       19,130  
Financial liabilities
                               
Savings, NOW, and money market
  $ 2,365,359     $ 2,365,359     $ 2,291,833     $ 2,291,833  
Time deposits
    871,152       881,194       930,778       943,988  
Noninterest bearing
    1,028,553       1,028,553       911,741       911,741  
Short-term borrowings
    158,285       158,285       159,434       159,434  
Long-term debt
    370,347       430,745       369,874       423,350  
Accrued interest payable
    3,904       3,904       4,356       4,356  
Trust preferred debentures
    75,422       75,422       75,422       71,148  
 
(1)  Lease receivables, although excluded from the scope of ASC 825-10-50-10, are included in the estimated fair value  amounts at their carrying amounts.
 
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has a substantial trust and investment management operation that contributes net fee income annually. The trust and investment management operation is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities include the benefits resulting from the low-cost funding of deposit liabilities as compared to the cost of borrowing funds in the market, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimate of fair value.
 
 
Note 10.           Securities

The amortized cost, estimated fair value, and unrealized gains and losses of securities available for sale are as follows:

(In thousands)
 
Amortized cost
   
Unrealized gains
   
Unrealized losses
   
Estimated fair value
 
September 30, 2011
                       
U.S. Treasury
  $ 81,088     $ 1,254     $ -     $ 82,342  
Federal Agency
    219,800       940       91       220,649  
State & municipal
    103,281       4,610       129       107,762  
Mortgage-backed
    307,996       15,433       -       323,429  
Collateralized mortgage obligations
    396,763       8,203       38       404,928  
Corporate
    20,000       97       -       20,097  
Other securities
    8,926       1,654       235       10,345  
Total securities available for sale
  $ 1,137,854     $ 32,191     $ 493     $ 1,169,552  
December 31, 2010
                               
U.S. Treasury
  $ 91,338     $ 424     $ 482     $ 91,280  
Federal Agency
    350,641       1,905       2,796       349,750  
State & municipal
    113,821       1,771       655       114,937  
Mortgage-backed
    233,861       11,666       719       244,808  
Collateralized mortgage obligations
    293,565       6,574       2,251       297,888  
Corporate
    20,005       484       -       20,489  
Other securities
    8,059       2,162       5       10,216  
Total securities available for sale
  $ 1,111,290     $ 24,986     $ 6,908     $ 1,129,368  

In the available for sale category at September 30, 2011, federal agency securities were comprised of Government-Sponsored Enterprise (“GSE”) securities; mortgaged-backed securities were comprised of GSE securities with an amortized cost of $286.5 million and a fair value of $300.0 million and US Government Agency securities with an amortized cost of $21.5 million and a fair value of $23.5 million; collateralized mortgage obligations were comprised of GSE securities with an amortized cost of $329.4 million and a fair value of $334.8 million and US Government Agency securities with an amortized cost of $67.4 million and a fair value of $70.1 million.

In the available for sale category at December 31, 2010, federal agency securities were comprised of GSE securities; mortgaged-backed securities were comprised of GSE securities with an amortized cost of $208.9 million and a fair value of $217.9 million and US Government Agency securities with an amortized cost of $25.0 million and a fair value of $26.9 million; collateralized mortgage obligations were comprised of GSE securities with an amortized cost of $206.0 million and a fair value of $207.0 million and US Government Agency securities with an amortized cost of $87.6 million and a fair value of $90.8 million.

Others securities primarily represent marketable equity securities.
 
 
Proceeds from the sales of securities available for sale were nominal during the nine months ended September 30, 2011, and gains on the sales were negligible.  Proceeds from the sales of securities available for sale totaled $5.4 million during the nine month period ending September 30, 2010.  Gains on these sales totaled $1.2 million for the nine months ended September 30, 2010.
 
Securities available for sale with amortized costs totaling $1.2 billion at September 30, 2011 and $0.9 billion at December 31, 2010, were pledged to secure public deposits and for other purposes required or permitted by law.  Additionally, at September 30, 2011 and December 31, 2010, securities available for sale with an amortized cost of $208.4 million and $187.7 million, respectively, were pledged as collateral for securities sold under repurchase agreements.

The amortized cost, estimated fair value, and unrealized gains and losses of securities held to maturity are as follows:

   
Amortized
   
Unrealized
   
Unrealized
   
Estimated
 
(In thousands)
 
cost
   
gains
   
losses
   
fair value
 
September 30, 2011
                       
Mortgage-backed
  $ 1,520     $ 206     $ -     $ 1,726  
State & municipal
    71,439       1,283       -       72,722  
Total securities held to maturity
  $ 72,959     $ 1,489     $ -     $ 74,448  
December 31, 2010
                               
Mortgage-backed
  $ 1,719     $ 200     $ -     $ 1,919  
State & municipal
    95,591       1,249       -       96,840  
Total securities held to maturity
  $ 97,310     $ 1,449     $ -     $ 98,759  
 
 
The following table sets forth information with regard to investment securities with unrealized losses at September 30, 2011 and December 31, 2010:

   
Less than 12 months
   
12 months or longer
   
Total
 
Security Type:
 
Fair Value
   
Unrealized losses
   
Number
of
Positions
   
Fair Value
   
Unrealized losses
   
Number
of
Positions
   
Fair Value
   
Unrealized losses
   
Number
of
Positions
 
                                                       
September 30, 2011
                                                     
U.S. Treasury
  $ -     $ -       -     $ -     $ -       -     $ -     $ -       -  
Federal agency
    19,909       (91 )     2       -       -       -       19,909       (91 )     2  
State & municipal
    1,145       (10 )     3       5,819       (119 )     15       6,964       (129 )     18  
Mortgage-backed
    -       -       -       -       -       -       -       -       -  
Collateralized mortgage obligations
    19,487       (38 )     1       -       -       -       19,487       (38 )     1  
Other securities
    2,012       (235 )     5       -       -       -       2,012       (235 )     5  
Total securities with unrealized losses
  $ 42,553     $ (374 )     11     $ 5,819     $ (119 )     15     $ 48,372     $ (493 )     26  
                                                                         
December 31, 2010
                                                                       
U.S. Treasury
  $ 40,741     $ (482 )     4     $ -     $ -       -     $ 40,741     $ (482 )     4  
Federal agency
    147,012       (2,796 )     12       -       -       -       147,012       (2,796 )     12  
State & municipal
    22,273       (317 )     31       7,533       (338 )     19       29,806       (655 )     50  
Mortgage-backed
    44,340       (719 )     3       -       -       -       44,340       (719 )     3  
Collateralized mortgage obligations
    72,595       (2,251 )     3       -       -       -       72,595       (2,251 )     3  
Other securities
    95       (5 )     1       -       -       -       95       (5 )     1  
Total securities with unrealized losses
  $ 327,056     $ (6,570 )     54     $ 7,533     $ (338 )     19     $ 334,589     $ (6,908 )     73  

Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses or in other comprehensive income, depending on whether the Company 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 the Company 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, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  If the Company 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 basis less any current-period credit loss, the other-than-temporary impairment shall be separated into (a) the amount representing the credit loss and (b) the amount related to all other factors.  The amount of the total other-than-temporary impairment related to the credit loss shall be recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes.

In estimating other-than-temporary impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the historical and implied volatility of the fair value of the security.
 
 
Management has the intent to hold the securities classified as held to maturity until they mature, at which time it is believed the Company will receive full value for the securities. Furthermore, as of September 30, 2011, management also had the intent to hold, and will not be required to sell, the securities classified as available for sale for a period of time sufficient for a recovery of cost, which may be until maturity.  The unrealized losses are due to increases in market interest rates over the yields available at the time the underlying securities were purchased. When necessary, the Company has performed a discounted cash flow analysis to determine whether or not it will receive the contractual principal and interest on certain securities.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  As of September 30, 2011, management believes the impairments detailed in the table above are temporary and no other-than-temporary impairment losses have been realized in the Company’s consolidated statements of income.

The following tables set forth information with regard to contractual maturities of debt securities at September 30, 2011:

(In thousands)
 
Amortized
cost
   
Estimated fair value
 
Debt securities classified as available for sale
           
Within one year
  $ 43,783     $ 43,991  
From one to five years
    279,220       281,774  
From five to ten years
    250,065       260,303  
After ten years
    555,860       573,139  
    $ 1,128,928     $ 1,159,207  
Debt securities classified as held to maturity
               
Within one year
  $ 26,115     $ 26,163  
From one to five years
    35,194       36,284  
From five to ten years
    8,035       8,179  
After ten years
    3,615       3,822  
    $ 72,959     $ 74,448  

Maturities of mortgage-backed, collateralized mortgage obligations and asset-backed securities are stated based on their estimated average lives.  Actual maturities may differ from estimated average lives or contractual maturities because, in certain cases, borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

Except for U.S. Government related securities, there were no holdings, when taken in the aggregate, of any single issuer that exceeded 10% of consolidated stockholders’ equity at September 30, 2011.

 
NBT BANCORP INC. AND SUBSIDIARIES
Item 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of this discussion and analysis is to provide a concise description of the financial condition and results of operations of NBT Bancorp Inc. and its wholly owned consolidated subsidiaries, NBT Bank, N.A. (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”), and NBT Holdings, Inc. (“NBT Holdings”) (collectively referred to herein as the “Company”). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company's consolidated financial statements and footnotes thereto included in this Form 10-Q as well as to the Company's Annual Report on Form 10-K for the year ended December 31, 2010 for an understanding of the following discussion and analysis.  Operating results for the three and nine month periods ended September 30, 2011 are not necessarily indicative of the results of the full year ending December 31, 2011 or any future period.

Forward-looking Statements

Certain statements in this filing and future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or shareholder communications, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,” “projects,” “could,” or other similar terms.   There are a number of factors, many of which are beyond the Company’s control, that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) revenues may be lower than expected; (3) changes in the interest rate environment may affect interest margins; (4) general economic conditions, either nationally or regionally, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduced demand for credit; (5) legislative or regulatory changes, including changes in accounting standards or tax laws, may adversely affect the businesses in which the Company is engaged; (6) competitors may have greater financial resources and develop products that enable such competitors to compete more successfully than the Company; (7) adverse changes may occur in the securities markets or with respect to inflation; (8) acts of war or terrorism; (9) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; (10) internal control failures; and (11) the Company’s success in managing the risks involved in the foregoing.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the Securities and Exchange Commission, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.

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

 
Critical Accounting Policies

Management of the Company considers the accounting policy relating to the allowance for loan and lease losses to be a critical accounting policy given the judgment in evaluating the level of the allowance required to cover credit losses inherent in the loan and lease portfolio and the material effect that such judgments can have on the results of operations. While management’s current evaluation of the allowance for loan and lease losses indicates that the allowance is adequate, under different conditions or assumptions, the allowance may need to be increased or decreased. For example, if historical loan and lease loss experience significantly changed or if current economic conditions deteriorated or improved, particularly in the Company’s primary market area, provisions for loan and lease losses may be increased or decreased to adjust the allowance. In addition, the assumptions and estimates relating to loss experience, ability to collect and economic conditions used in the internal reviews of the Company’s nonperforming loans and potential problem loans has a significant impact on the overall analysis of the adequacy of the allowance for loan and lease losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral valuations were significantly changed, the Company’s allowance for loan and lease policy may require increases or decreases in the provision for loan and lease losses.

Management of the Company considers the accounting policy relating to pension accounting to be a critical accounting policy. Management is required to make various assumptions in valuing its pension assets and liabilities. These assumptions include the expected rate of return on plan assets, the discount rate, and the rate of increase in future compensation levels. Changes to these assumptions could impact earnings in future periods. The Company takes into account the plan asset mix, funding obligations, and expert opinions in determining the various rates used to estimate pension expense. The Company also considers relevant indices and market interest rates in setting the appropriate discount rate. In addition, the Company reviews expected inflationary and merit increases to compensation in determining the rate of increase in future compensation levels.

Management of the Company considers the accounting policy relating to other-than-temporary impairment to be a critical accounting policy.  Management systematically evaluates certain assets for other-than-temporary declines in fair value, primarily investment securities.  Management considers historical values and current market conditions as a part of the assessment.  The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes.

Overview

Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to:  net income and earnings per share, return on assets and equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons.  The following information should be considered in connection with the Company's results for the first nine months of 2011:
 
 
·
Net income for the nine months ended September 30, 2011 was $44.2 million, up $1.2 million, or 2.8%, from the nine months ended September 30, 2010.  Net income per diluted share for the nine months ended September 30, 2011 was $1.29 per share, up $0.04 from the nine months ended September 30, 2010.
 
 
·
Net interest margin (on a fully taxable equivalent basis (“FTE”)) was 4.13% for the nine months ended September 30, 2011 as compared to 4.17% for the same period in 2010.
 
 
·
Certain capital ratios decreased slightly during the nine months ended September 30, 2011 due in large part to the repurchase of approximately $30.5 million of common stock:
 
 
 
Tier 1 Leverage ratio increased from 9.16% to 9.21%
 
 
Tier 1 Capital ratio decreased from 12.44% to 12.00%
 
 
Total Risk-Based Capital Ratio decreased from 13.70% to 13.25%
 
 
·
Past due loans as a percentage of total loans improved notably to 0.68% at September 30, 2011, as compared with 0.86% at December 31, 2010.
 
 
·
Net charge-offs were 0.55% of average loans and leases for the first nine months of 2011, down 10 bps from 0.65% for the first nine months of 2010.
 
 
·
The provision for loan and lease losses was $15.2 million for the nine months ended September 30, 2011, down from $23.1 million for the same period in 2010.
 
 
·
Annualized return on average assets was 1.09% for the nine months ended September 30, 2011, up from 1.05% for the nine months ended September 30, 2010.
 
 
·
Noninterest income decreased slightly from $61.7 million for the nine months ended September 30, 2010 to $60.2 million for the nine months ended September 30, 2011.  Service charges on deposit accounts were down $2.3 million, or 12.6%, for the nine months ended September 30, 2011 as compared with the nine months ended September 30, 2010 as a result of the effects of implementing new regulations regarding overdraft fees in the third quarter of 2010.  This decrease was offset by increases in insurance and other financial services revenue, trust income, and ATM and debit card fees.
 
 
·
Continued strategic expansion with the successful acquisition of four branches in Berkshire County, Massachusetts on October 21, 2011, and the announcement of the purchase of three additional branches in Greene County, New York and deposits and loans in Schoharie County, New York on October 25, 2011.  This transaction is expected to close during the first quarter of 2012, subject to regulatory approval

The following table depicts several annualized measurements of performance using U.S. GAAP net income that management reviews in analyzing the Company’s performance. Returns on average assets and average equity measure how effectively an entity utilizes its total resources and capital, respectively. Net interest margin, which is the net federal taxable equivalent (FTE) interest income divided by average earning assets, is a measure of an entity's ability to utilize its earning assets in relation to the cost of funding. Interest income for tax-exempt securities and loans is adjusted to a taxable equivalent basis using the statutory Federal income tax rate of 35%.
 
2011
 
First
 Quarter
   
Second
 Quarter
   
Third
Quarter
   
Nine
 Months
 
Return on average assets (ROAA)
    1.08 %     1.09 %     1.12 %     1.09 %
Return on average equity (ROAE)
    10.78 %     10.86 %     11.21 %     10.95 %
Net Interest Margin
    4.11 %     4.13 %     4.14 %     4.13 %
                                 
2010
                               
Return on average assets (ROAA)
    1.03 %     1.06 %     1.07 %     1.05 %
Return on average equity (ROAE)
    11.05 %     11.09 %     10.89 %     11.01 %
Net Interest Margin
    4.21 %     4.14 %     4.15 %     4.17 %

 
Net Interest Income

Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and borrowings.  Net interest income is affected by the interest rate spread, the difference between the yield on earning assets and cost of interest bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the key determining factors in a financial institution’s performance as it is the principal source of earnings.

FTE net interest income decreased $0.4 million, or 0.8%, during the three months ended September 30, 2011, compared to the same period of 2010.  The decrease in FTE net interest income resulted primarily from a decrease in the yield on interest earning assets of 27 bp to 4.90% for the three months ended September 30, 2011 from 5.17% for the same period in 2010.  This decrease was partially offset by a decrease of 28 bp on the rate paid on interest bearing liabilities for the three months ended September 30, 2011 period as compared to the same period in 2010. The interest rate spread increased to 3.91% during the three months ended September 30, 2011 compared to 3.90% for the same period in 2010.  The net interest margin decreased by 1 bp to 4.14% for the three months ended September 30, 2011, compared with 4.15% for the same period in 2010.

For the three months ended September 30, 2011, total interest income decreased $3.5 million, or 5.6%, from the same period in 2010 primarily as a result of the decrease in the yield earned on earning assets.  The yield on securities available for sale decreased 54 bp to 2.95% for the three months ended September 30, 2011 from 3.49% for the three months ended September 30, 2010.  This decrease was due to the decreasing rate environment from September 30, 2010 to September 30, 2011 resulting in reinvestment of cash flows from maturing securities into lower yielding securities.  In addition, the yield on loans and leases decreased 34 bp to 5.51% for the three months ended September 30, 2011 from 5.85% for the three months ended September 30, 2010.  Average interest earning assets decreased approximately $25.8 million, or 0.5%, for the three months ended September 30, 2011 as compared to the same period in 2010, which also contributed to the decrease in total interest income.

For the three months ended September 30, 2011, total interest expense decreased $3.3 million, or 25.7%, from the three months ended September 30, 2010.  This decrease was due in large part to a decrease in average interest bearing liabilities of $177.1 million, or 4.5%, for the three months ended September 30, 2011 as compared with the three months ended September 30, 2010.  The lower average balance was due primarily to a decrease in average long-term debt for the three months ended September 30, 2011 as the Company paid down long term borrowings in the second half of 2010, in addition to lower total average interest bearing deposits, which decreased $115.6 million, or 3.5%, for the three months ended September 30, 2011 when compared to the same period in 2010.

The aforementioned decrease in total interest expense was also due to the decrease in the rate paid on average interest bearing liabilities from 1.27% for the three months ended September 30, 2010 to 0.99% for the three months ended September 30, 2011.  The rate paid on average interest bearing deposits decreased 20 bp from 0.87% for the three months ended September 30, 2010 to 0.67% for the same period in 2011.  The rate paid on average time deposits decreased from 2.00% for the three months ended September 30, 2010 to 1.75% for the three months ended September 30, 2011.  The rate paid on average money market deposit accounts decreased from 0.53% for the three months ended September 30, 2010 to 0.31% for the three months ended September 30, 2011.  Going forward, additional rate reductions on deposits could be more difficult as deposit rates are at or near their floors.

Total average borrowings, including trust preferred debentures, decreased $61.4 million, or 9.0%, for the three months ended September 30, 2011 compared with the same period in 2010, primarily due to the aforementioned pay down of long term borrowings.  Given the funds sold position, the Company elected to prepay FHLB borrowings during 2009 and 2010.  The rate paid on long-term debt decreased slightly to 3.88% for the three months ended September 30, 2011 as compared to 3.90% for the three months ended September 30, 2010.  As a result of the decrease in the average balance, interest paid on long-term debt decreased $0.8 million, or 17.2%, for the three months ended September 30, 2011 as compared to the same period in 2010.
 
 
FTE net interest income decreased $3.0 million, or 1.9%, during the nine months ended September 30, 2011, compared to the same period of 2010.  The decrease in FTE net interest income resulted primarily from a decrease in the yield on interest earning assets of 33 bp to 4.94% for the nine months ended September 30, 2011 from 5.27% for the same period in 2010.  This decrease was partially offset by a decrease of 31 bp on the rate paid on interest bearing liabilities for the nine months ended September 30, 2011 period as compared to the same period in 2010. The interest rate spread decreased 2 bp during the nine months ended September 30, 2011 compared to the same period in 2010.  The net interest margin decreased by 4 bp to 4.13% for the nine months ended September 30, 2011, compared with 4.17% for the same period in 2010.

For the nine months ended September 30, 2011, total interest income decreased $13.3 million, or 6.9%, from the same period in 2010 primarily as a result of the decrease in the yield earned on earning assets.  The yield on securities available for sale decreased 68 bp to 3.06% for the nine months ended September 30, 2011 from 3.74% for the nine months ended September 30, 2010.  This decrease was due to the decreasing rate environment from September 30, 2010 to September 30, 2011 resulting in reinvestment of cash flows from maturing securities into lower yielding securities.  In addition, the yield on loans and leases decreased 29 bp to 5.63% for the nine months ended September 30, 2011 from 5.92% for the nine months ended September 30, 2010.  Average interest earning assets decreased approximately $48.9 million, or 1.0%, for the nine months ended September 30, 2011 as compared to the same period in 2010, which also contributed to the decrease in total interest income.

For the nine months ended September 30, 2011, total interest expense decreased $11.0 million, or 26.7%, from the nine months ended September 30, 2010.  This decrease was due in large part to a decrease in average interest bearing liabilities of $217.8 million, or 5.4%, for the nine months ended September 30, 2011 as compared with the nine months ended September 30, 2010.  The lower average balance was due primarily to a decrease in average long-term debt for the nine months ended September 30, 2011 as the Company paid down long term borrowings in the second half of 2010, in addition to lower total average interest bearing deposits, which decreased $94.7 million, or 2.8%, for the nine months ended September 30, 2011 when compared to the same period in 2010.

The aforementioned decrease in total interest expense was also due to the decrease in the rate paid on average interest bearing liabilities from 1.36% for the nine months ended September 30, 2010 to 1.05% for the nine months ended September 30, 2011.  The rate paid on average interest bearing deposits decreased 21 bp from 0.94% for the nine months ended September 30, 2010 to 0.73% for the same period in 2011.  The rate paid on average time deposits decreased from 2.10% for the nine months ended September 30, 2010 to 1.83% for the nine months ended September 30, 2011.  The rate paid on average money market deposit accounts decreased from 0.62% for the nine months ended September 30, 2010 to 0.37% for the nine months ended September 30, 2011.  Going forward, additional rate reductions on deposits could be more difficult as deposit rates are at or near their floors.

Total average borrowings, including trust preferred debentures, decreased $123.1 million, or 17.0%, for the nine months ended September 30, 2011 compared with the same period in 2010, primarily due to the aforementioned pay down of long term borrowings.  Given the funds sold position, the Company elected to prepay FHLB borrowings during 2009 and 2010.  The rate paid on long-term debt increased slightly to 3.90% for the nine months ended September 30, 2011 as compared to 3.89% for the nine months ended September 30, 2010.  As a result of the decrease in the average balance, interest paid on long-term debt decreased $3.5 million, or 24.5%, for the nine months ended September 30, 2011 as compared to the same period in 2010.
 
 
Average Balances and Net Interest Income
The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest bearing liabilities on a taxable equivalent basis. Interest income for tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.

Three Months ended September 30,
                                   
         
2011
               
2010
       
   
Average
         
Yield/
   
Average
         
Yield/
 
(dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
                                   
Short-term interest bearing accounts
  $ 25,088     $ 11       0.17 %   $ 132,734     $ 77       0.23 %
Securities available for sale (1)(excluding unrealized gains or losses)
    1,120,083       8,317       2.95 %     1,052,985       9,258       3.49 %
Securities held to maturity (1)
    74,482       1,026       5.46 %     111,140       1,364       4.87 %
Investment in FRB and FHLB Banks
    27,022       329       4.84 %     30,638       405       5.23 %
Loans and leases (2)
    3,686,693       51,227       5.51 %     3,631,637       53,506       5.85 %
Total interest earning assets
  $ 4,933,368     $ 60,910       4.90 %   $ 4,959,134     $ 64,610       5.17 %
Other assets
    442,275                       437,542                  
Total assets
  $ 5,375,643                     $ 5,396,676                  
                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
  $ 1,036,572     $ 811       0.31 %   $ 1,078,771     $ 1,445       0.53 %
NOW deposit accounts
    631,284       483       0.30 %     665,893       616       0.37 %
Savings deposits
    615,168       170       0.11 %     564,847       217       0.15 %
Time deposits
    882,896       3,888       1.75 %     972,049       4,896       2.00 %
Total interest bearing deposits
  $ 3,165,920     $ 5,352       0.67 %   $ 3,281,560     $ 7,174       0.87 %
Short-term borrowings
    172,370       56       0.13 %     159,480       91       0.23 %
Trust preferred debentures
    75,422       394       2.07 %     75,422       1,046       5.50 %
Long-term debt
    370,349       3,621       3.88 %     444,681       4,374       3.90 %
Total interest bearing liabilities
  $ 3,784,061     $ 9,423       0.99 %   $ 3,961,143     $ 12,685       1.27 %
Demand deposits
    983,318                       827,358                  
Other liabilities
    69,860                       77,590                  
Stockholders' equity
    538,404                       530,585                  
Total liabilities and stockholders' equity
  $ 5,375,643                     $ 5,396,676                  
Net interest income (FTE)
            51,487                       51,925          
Interest rate spread
                    3.91 %                     3.90 %
Net interest margin
                    4.14 %                     4.15 %
Taxable equivalent adjustment
            1,126                       1,298          
Net interest income
          $ 50,361                     $ 50,627          
 
(1) Securities are shown at average amortized cost
(2) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding
 
 
Nine Months ended September 30,                                    
         
2011
               
2010
       
   
Average
         
Yield/
   
Average
         
Yield/
 
(dollars in thousands)
 
Balance
   
Interest
   
Rates
   
Balance
   
Interest
   
Rates
 
ASSETS
                                   
Short-term interest bearing accounts
  $ 97,973     $ 191       0.26 %   $ 121,211     $ 219       0.24 %
Securities available for sale (1)(excluding unrealized gains or losses)
    1,105,777       25,330       3.06 %     1,085,171       30,326       3.74 %
Securities held to maturity (1)
    84,660       3,353       5.29 %     138,339       4,702       4.54 %
Investment in FRB and FHLB Banks
    27,112       1,084       5.34 %     32,840       1,329       5.40 %
Loans and leases (2)
    3,650,667       153,678       5.63 %     3,637,532       161,097       5.92 %
Total interest earning assets
  $ 4,966,189     $ 183,636       4.94 %   $ 5,015,093     $ 197,673       5.27 %
Other assets
    428,959                       440,752                  
Total assets
  $ 5,395,148                     $ 5,455,845                  
                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Money market deposit accounts
  $ 1,070,971     $ 2,937       0.37 %   $ 1,100,904     $ 5,085       0.62 %
NOW deposit accounts
    667,012       1,745       0.35 %     692,178       2,207       0.43 %
Savings deposits
    599,173       517       0.12 %     551,662       623       0.15 %
Time deposits
    911,161       12,491       1.83 %     998,257       15,712       2.10 %
Total interest bearing deposits
  $ 3,248,317     $ 17,690       0.73 %   $ 3,343,001     $ 23,627       0.94 %
Short-term borrowings
    153,857       166       0.14 %     156,248       338       0.29 %
Trust preferred debentures
    75,422       1,683       2.98 %     75,422       3,106       5.51 %
Long-term debt
    369,930       10,783       3.90 %     490,622       14,289       3.89 %
Total interest bearing liabilities
  $ 3,847,526     $ 30,322       1.05 %   $ 4,065,293     $ 41,360       1.36 %
Demand deposits
    940,332                       789,160                  
Other liabilities
    67,968                       79,531                  
Stockholders' equity
    539,322                       521,861                  
Total liabilities and stockholders' equity
  $ 5,395,148                     $ 5,455,845                  
Net interest income (FTE)
            153,314                       156,313          
Interest rate spread
                    3.89 %                     3.91 %
Net interest margin
                    4.13 %                     4.17 %
Taxable equivalent adjustment
            3,537                       4,284          
Net interest income
          $ 149,777                     $ 152,029          
 
(1) Securities are shown at average amortized cost
(2) For purposes of these computations, nonaccrual loans are included in the average loan balances outstanding
 
 
The following table presents changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume), and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.
 
Analysis of Changes in Taxable Equivalent Net Interest Income
       
                   
Three months ended September 30,
                 
   
Increase (Decrease)
 
   
2011 over 2010
 
(in thousands)
 
Volume
   
Rate
   
Total
 
                   
Short-term interest bearing accounts
  $ (51 )   $ (15 )   $ (66 )
Securities available for sale
    3,047       (3,988 )     (941 )
Securities held to maturity
    (1,213 )     875       (338 )
Investment in FRB and FHLB Banks
    (46 )     (30 )     (76 )
Loans and leases
    4,603       (6,882 )     (2,279 )
Total interest income
    6,340       (10,040 )     (3,700 )
                         
Money market deposit accounts
    (55 )     (579 )     (634 )
NOW deposit accounts
    (31 )     (102 )     (133 )
Savings deposits
    105       (152 )     (47 )
Time deposits
    (425 )     (583 )     (1,008 )
Short-term borrowings
    44       (79 )     (35 )
Trust preferred debentures
    -       (652 )     (652 )
Long-term debt
    (727 )     (26 )     (753 )
Total interest expense
    (1,089 )     (2,173 )     (3,262 )
                         
Change in FTE net interest income
  $ 7,429     $ (7,867 )   $ (438 )
 
Nine months ended September 30,
                       
   
Increase (Decrease)
 
   
2011 over 2010
 
(in thousands)
 
Volume
   
Rate
   
Total
 
                         
Short-term interest bearing accounts
  $ (53 )   $ 25     $ (28 )
Securities available for sale
    917       (5,913 )     (4,996 )
Securities held to maturity
    (2,403 )     1,054       (1,349 )
Investment in FRB and FHLB Banks
    (229 )     (16 )     (245 )
Loans and leases
    945       (8,364 )     (7,419 )
Total interest income
    (823 )     (13,214 )     (14,037 )
                         
Money market deposit accounts
    (135 )     (2,013 )     (2,148 )
NOW deposit accounts
    (78 )     (384 )     (462 )
Savings deposits
    77       (183 )     (106 )
Time deposits
    (1,299 )     (1,922 )     (3,221 )
Short-term borrowings
    (5 )     (167 )     (172 )
Trust preferred debentures
    -       (1,423 )     (1,423 )
Long-term debt
    (3,526 )     20       (3,506 )
Total interest expense
    (4,966 )     (6,072 )     (11,038 )
                         
Change in FTE net interest income
  $ 4,143     $ (7,142 )   $ (2,999 )
 
 
Noninterest Income
Noninterest income is a significant source of revenue for the Company and an important factor in the Company’s results of operations.  The following table sets forth information by category of noninterest income for the periods indicated:

   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
(in thousands)
                       
Service charges on deposit accounts
  $ 5,532     $ 5,953     $ 16,059     $ 18,384  
Insurance and other financial services revenue
    5,127       4,595       15,925       14,540  
Trust
    2,090       1,786       6,384       5,461  
Net securities gains
    12       1,120       98       1,211  
Bank owned life insurance
    674       655       2,369       2,444  
ATM and debit card fees
    3,135       2,660       8,731       7,489  
Retirement plan administration fees
    2,295       2,612       6,734       7,597  
Other
    1,329       1,610       3,881       4,526  
Total noninterest income
  $ 20,194     $ 20,991     $ 60,181     $ 61,652  

Noninterest income for the three months ended September 30, 2011 was $20.2 million, down slightly from $21.0 million for the same period in 2010.  Insurance and other financial services revenue increased approximately $0.5 million for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010, due primarily to the acquisition of an insurance agency during the second quarter of 2011.  ATM and debit card fees also increased approximately $0.5 million for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010 due to an increase in card usage as well as a change in the fee structure on foreign ATM transactions.  Trust revenue increased approximately $0.3 million for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010, due primarily to the addition of new business generated from markets where we have recently expanded, and an increase in the fair market value of trust assets under administration.    These increases were offset by a decrease in service charges on deposit accounts of approximately $0.4 million, or 7.1%, for the three months ended September 30, 2011, as compared with the same period in 2010.  The decrease in service charges was the result of a decrease in overdraft activity due to customer awareness and the current state of the economy.  In addition, retirement plan administration fees decreased by $0.3 million, or 12.1%, for the three months ended September 30, 2011 as compared to the same period in 2010, driven by the loss of one client in the fourth quarter of 2010.  This decrease was partially offset by increases from new business and market-based fees during 2011.  Net securities gains decreased by $1.1 million for the three months ended September 30, 2011 as compared to the same period in 2010 due to gains on certain securities sales during the third quarter of 2010.

Noninterest income for the nine months ended September 30, 2011 was $60.2 million, down slightly from $61.7 million for the same period in 2010.  Insurance and other financial services revenue increased approximately $1.4 million for the nine months ended September 30, 2011, as compared to the nine months ended September 30, 2010, due primarily to the aforementioned acquisition of an insurance agency during the second quarter of 2011 and an increase in brokerage commission revenue due to new business.  ATM and debit card fees increased approximately $1.2 million for the nine months ended September 30, 2011, as compared to the nine months ended September 30, 2010 due to an increase in card usage as well as a change in the fee structure on foreign ATM transactions.  Trust revenue increased approximately $0.9 million for the nine months ended September 30, 2011, as compared to the nine months ended September 30, 2010, due primarily to the addition of new business generated from markets where we have recently expanded, and an increase in the fair market value of trust assets under administration.    These increases were offset by a decrease in service charges on deposit accounts of approximately $2.3 million, or 12.6%, for the nine months ended September 30, 2011, as compared with the same period in 2010.  The decrease in service charges was the result of a decrease in overdraft activity due to the effects of implementing new regulations regarding overdraft fees in the third quarter of 2010, as well as the current state of the economy.  In addition, retirement plan administration fees decreased by $0.9 million, or 11.4%, for the nine months ended September 30, 2011 as compared to the same period in 2010, driven by the loss of one client in the fourth quarter of 2010.  This decrease was partially offset by increases from new business and market-based fees during 2011.  Net securities gains decreased by $1.1 million for the nine months ended September 30, 2011 as compared to the same period in 2010 due to gains on certain securities sales in 2010.
 
 
Noninterest Expense
Noninterest expenses are also an important factor in the Company’s results of operations.  The following table sets forth the major components of noninterest expense for the periods indicated:

   
Three months ended September 30,
   
Nine months ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
(in thousands)
                       
Salaries and employee benefits
  $ 25,068     $ 24,090     $ 74,107     $ 70,518  
Occupancy
    3,887       3,709       12,396       11,527  
Equipment
    2,288       2,053       6,658       6,194  
Data processing and communications
    3,054       2,971       9,085       9,454  
Professional fees and outside services
    2,215       2,068       6,369       6,543  
Office supplies and postage
    1,531       1,542       4,418       4,538  
Amortization of intangible assets
    782       767       2,286       2,328  
Loan collection and other real estate owned
    676       548       1,838       2,275  
Advertising
    685       730       2,286       2,221  
FDIC expenses
    920       1,621       3,381       4,734  
Prepayment penalty on long-term debt
    -       1,205       -       1,205  
Other
    3,940       3,380       10,440       9,504  
Total noninterest expense
  $ 45,046     $ 44,684     $ 133,264     $ 131,041  

Noninterest expense for the three months ended September 30, 2011 was $45.0 million, up slightly from $44.7 million, or 0.8%, for the same period in 2010.  Salaries and employee benefits increased $1.0 million, or 4.1%, for the three months ended September 30, 2011, compared with the same period in 2010.  This increase was due primarily to increases in full-time-equivalent employees, merit increases and other employee benefits.  Other operating expenses increased approximately $0.6 million for the three months ended September 30, 2011, as compared to the same period in 2010, primarily as a result of flood and merger related expenses during the third quarter of 2011.  These increases were offset by a decrease in Federal Deposit Insurance Corporation (FDIC) premium expenses of approximately $0.7 million for the three months ended September 30, 2011 as compared to the same period in 2010, due to the FDIC redefining the deposit insurance assessment base.  In addition, the Company incurred a debt prepayment penalty of $1.2 million to pay off long-term debt during the third quarter of 2010, while no prepayment penalties were incurred for the same period in 2011.

Noninterest expense for the nine months ended September 30, 2011 was $133.3 million, up from $131.0 million, or 1.7%, for the same period in 2010.  Salaries and employee benefits increased $3.6 million, or 5.1%, for the nine months ended September 30, 2011, compared with the same period in 2010.  This increase was due primarily to increases in full-time-equivalent employees, merit increases and other employee benefits.  In addition, occupancy expenses increased approximately $0.9 million for the nine months ended September 30, 2011, as compared to the same period in 2010, primarily due to continued branch expansion and expenses related to the harsh winter.  Other operating expenses increased approximately $0.9 million for the nine months ended September 30, 2011, as compared to the same period in 2010, primarily as a result of flood and merger related expenses during the third quarter of 2011.  
 
 
These increases were partially offset by a decrease in FDIC premium expenses of approximately $1.4 million for the first nine months of 2011 as compared to the same period in 2010 due to the aforementioned FDIC redefined deposit insurance assessment base.  In addition, the Company incurred a debt prepayment penalty of $1.2 million to pay off long-term debt during the third quarter of 2010, while no prepayment penalties were incurred for the same period in 2011.  Data processing and communications expenses decreased approximately $0.4 million for the nine months ended September 30, 2011, as compared to the nine months ended September 30, 2010.  This decrease was due to the renegotiation of a data processing contract resulting in a decrease in processing fees.  In addition, loan collection and other real estate owned expenses decreased approximately $0.4 million for the nine months ended September 30, 2011, as compared to the nine months ended September 30, 2010, due primarily to a reduction in properties classified as other real estate owned resulting in a reduction in maintenance expenses on those properties.

Income Taxes

Income tax expense for the three month period ended September 30, 2011 was $5.1 million, up from $4.8 million for the same period in 2010.  The effective tax rate was 25.2% for the three months ended September 30, 2011, as compared to 24.9% for the same period in 2010.  During the three months ended September 30, 2011, a reduction in the Company’s tax provision was driven by a reduction of tax reserves of $0.8 million, no longer required due to the expiration of the related statute of limitations.

Income tax expense for the nine month period ended September 30, 2011 was $17.4 million, up from $16.5 million for the same period in 2010.  The effective tax rate was 28.2% for the nine months ended September 30, 2011, as compared to 27.8% for the same period in 2010.

ANALYSIS OF FINANCIAL CONDITION

Securities

The Company classifies its securities at date of purchase as available for sale, held to maturity or trading.  Held to maturity debt securities are those that the Company has the ability and intent to hold until maturity.  Held to maturity securities are recorded at amortized cost.  Available for sale securities are recorded at fair value.  Unrealized holding gains and losses, net of the related tax effect, on available for sale securities are excluded from earnings and are reported in stockholders’ equity as a component of accumulated other comprehensive income or loss.  For the securities that the Company does not have the intent to sell and will not be more likely than not required to sell, the amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes.  Securities with an other-than-temporary impairment are generally placed on nonaccrual status.  Trading securities are recorded at fair value, with net unrealized gains and losses recognized currently in income.  Transfers of securities between categories are recorded at fair value at the date of transfer.

Average total earning securities decreased $30.4 million, or 2.6%, for the three months ended September 30, 2011 when compared to the same period in 2010.  The average balance of securities available for sale increased $67.1 million, or 6.4%, for the three months ended September 30, 2011 when compared to the same period in 2010.  The average balance of securities held to maturity decreased $36.7 million, or 33.0%, for the three months ended September 30, 2011, compared to the same period in 2010.  This decrease was due primarily to the scheduled run-off of municipal securities in the held to maturity portfolio.  The average total securities portfolio represents 24.2% of total average earning assets for the three months ended September 30, 2011, up from 23.5% for the same period in 2010.
 
 
Average total earning securities decreased $33.1 million, or 2.7%, for the nine months ended September 30, 2011 when compared to the same period in 2010.  The average balance of securities available for sale increased $20.6 million, or 1.9%, for the nine months ended September 30, 2011 when compared to the same period in 2010.  The average balance of securities held to maturity decreased $53.7 million, or 38.8%, for the nine months ended September 30, 2011, compared to the same period in 2010.  This decrease was due primarily to the scheduled run-off of municipal securities in the held to maturity portfolio.  The average total securities portfolio represents 24.0% of total average earning assets for the nine months ended September 30, 2011, down from 24.4% for the same period in 2010.

The following table details the composition of securities available for sale, securities held to maturity and regulatory investments for the periods indicated:

   
September 30,
 2011
   
December 31,
2010
 
Mortgage-backed securities:
           
With maturities 15 years or less
    22 %     16 %
With maturities greater than 15 years
    3 %     4 %
Collateral mortgage obligations
    32 %     24 %
Municipal securities
    14 %     17 %
US agency notes
    24 %     35 %
Other
    5 %     4 %
Total
    100 %     100 %

The Company’s mortgage backed securities, U.S. agency notes, and collateralized mortgage obligations are all “prime/conforming” and are guaranteed by Fannie Mae, Freddie Mac, Federal Home Loan Bank, Federal Farm Credit Banks, or Ginnie Mae (“GNMA”).  GNMA securities are considered equivalent to U.S. Treasury securities, as they are backed by the full faith and credit of the U.S. government.  Currently, there are no subprime mortgages in our investment portfolio.

During the nine months ended September 30, 2011, the Company experienced a shift from U.S. agency notes to mortgage-backed securities and collateral mortgage obligations.  As of September 30, 2011, mortgage-backed securities with maturities of 15 years or less comprised 22% of the securities portfolio as compared to 16% as of December 31, 2010.  As of September 30, 2011, US agency notes comprised 24% of the Company’s securities as compared to 35% as of December 31, 2010.

Loans and Leases

A summary of loans and leases, net of deferred fees and origination costs, by category for the periods indicated follows:
 
(In thousands)
 
September 30,
 2011
   
December 31,
2010
 
Residential real estate mortgages
  $ 570,448     $ 548,394  
Commercial
    608,675       577,731  
Commercial real estate mortgages
    867,258       844,458  
Real estate construction and development
    66,054       45,444  
Agricultural and agricultural real estate mortgages
    105,747       112,738  
Consumer
    936,983       905,563  
Home equity
    552,925       575,678  
Total loans and leases
  $ 3,708,090     $ 3,610,006  

Total loans and leases increased by $98.1 million, or 2.7%, at September 30, 2011 from December 31, 2010, and represent approximately 67.7% of assets, as compared to 67.6% of total assets at December 31, 2010.  Commercial loans increased approximately $30.9 million, or 5.4%, from December 31, 2010 to September 30, 2011.  Real estate construction and development loans increased by approximately $20.6 million, or 45.4%, from December 31, 2010 to September 30, 2011, due primarily to the origination of three large construction loans during the nine months ended September 30, 2011.  These increases were slightly offset by a decrease in home equity loans of approximately $22.8 million, or 4.0%, from December 31, 2010 to September 30, 2011.
 
 
Allowance for Loan and Lease Losses, Provision for Loan and Lease Losses, and Nonperforming Assets

The allowance for loan and lease losses is maintained at a level estimated by management to provide adequately for risk of probable losses inherent in the current loan and lease portfolio.  The adequacy of the allowance for loan and lease losses is continuously monitored using a methodology designed to ensure that the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan and lease portfolio.

Management considers the accounting policy relating to the allowance for loan and lease losses to be a critical accounting policy given the degree of judgment exercised in evaluating the level of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the consolidated results of operations.

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectibility of the portfolio.  For individually analyzed loans, these factors include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date.  For homogeneous pools of loans and leases, estimates of the Company’s exposure to credit loss reflect a thorough current assessment of a number of factors, which could affect collectibility. These factors include: past loss experience; the size, trend, composition, and nature of the loans and leases; changes in lending policies and procedures, including underwriting  standards and collection, charge-off and recovery practices;  trends experienced in nonperforming and delinquent loans and leases; current economic conditions in the Company’s market; portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff.  In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan and lease losses.  Such agencies may require the Company to recognize additions to the allowance based on their judgment about information available to them at the time of their examination, which may not be currently available to management.

After a thorough consideration and validation of the factors discussed above, required additions or reductions to the allowance for loan and lease losses are made periodically by charges or credits to the provision for loan and lease losses.  These charges are necessary to maintain the allowance at a level which management believes is reasonably reflective of the overall inherent risk of probable loss in the portfolio.  While management uses available information to recognize losses on loans and leases, additions or reductions to the allowance may fluctuate from one reporting period to another.  These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above.  The allowance for loan and lease losses related to commercial loans decreased by approximately $1.2 million from December 31, 2010 to September 30, 2011 due primarily to the charge-off of one large commercial credit during the period that had been specifically reserved for.  The allowance for loan and lease losses related to residential real estate mortgages increased by $1.3 million from December 31, 2010 to September 30, 2011, due primarily to environmental and economic conditions related to the September 2011 flood within the Company’s footprint.  The allowance for loan and lease losses to outstanding loans and leases decreased slightly to 1.92% as of September 30, 2011 as compared to 1.97% at December 31, 2010.  Management considers the allowance for loan losses to be adequate based on evaluation and analysis of the loan portfolio.
 

The following table reflects changes to the allowance for loan and lease losses for the periods presented. The allowance is increased by provisions for losses charged to operations and is reduced by net charge-offs. Charge-offs are made when the ability to collect loan principal within a reasonable time becomes unlikely. Any recoveries of previously charged-off loans are credited directly to the allowance for loan and lease losses.

Allowance For Loan and Lease Losses
                   
   
Three months ended
 
(dollars in thousands)
 
September 30, 2011
         
September 30, 2010
       
Balance, beginning of period
  $ 70,484           $ 70,300        
Recoveries
    940             929        
Chargeoffs
    (5,265 )           (6,883 )      
Net chargeoffs
    (4,325 )           (5,954 )      
Provision for loan losses
    5,175             7,529        
Balance, end of period
  $ 71,334           $ 71,875    
 
 
Composition of Net Chargeoffs
                           
Commercial and agricultural
  $ (1,327 )     31 %   $ (2,555 )     43 %
Real estate mortgage
    (43 )     1 %     (125 )     2 %
Consumer
    (2,955 )     68 %     (3,274 )     55 %
Net chargeoffs
  $ (4,325 )     100 %   $ (5,954 )     100 %
Annualized net chargeoffs to average loans and leases
    0.47 %             0.65 %        
                                 
Allowance For Loan and Lease Losses
                         
   
Nine months ended
 
(dollars in thousands)
 
September 30, 2011
           
September 30, 2010
         
Balance, beginning of period
  $ 71,234             $ 66,550          
Recoveries
    3,070               3,674          
Chargeoffs
    (18,131 )             (21,471 )        
Net chargeoffs
    (15,061 )             (17,797 )        
Provision for loan losses
    15,161               23,122          
Balance, end of period
  $ 71,334             $ 71,875          
Composition of Net Chargeoffs
                               
Commercial and agricultural
  $ (5,891 )     39 %   $ (7,461 )     42 %
Real estate mortgage
    (553 )     4 %     (640 )     4 %
Consumer
    (8,617 )     57 %     (9,696 )     54 %
Net chargeoffs
  $ (15,061 )     100 %   $ (17,797 )     100 %
Annualized net chargeoffs to average loans and leases
    0.55 %             0.65 %        

 
Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due and still accruing, restructured loans, OREO, and nonperforming securities. Loans are generally placed on nonaccrual when principal or interest payments become ninety days past due, unless the loan is well secured and in the process of collection. Loans may also be placed on nonaccrual when circumstances indicate that the borrower may be unable to meet the contractual principal or interest payments. OREO represents property acquired through foreclosure and is valued at the lower of the carrying amount or fair value, less any estimated disposal costs.  Nonperforming securities include securities which management believes are other-than-temporarily impaired, are carried at their estimated fair value and are not accruing interest.

Nonperforming Assets
                       
   
September 30,
   
December 31,
 
(Dollars in thousands)
 
2011
   
2010
 
Nonaccrual loans
 
Amount
   
%
   
Amount
   
%
 
Commercial and agricultural loans and real estate
  $ 19,202       48 %   $ 24,402       57 %
Real estate mortgages
    8,174       21 %     8,338       20 %
Consumer
    7,882       20 %     8,765       21 %
Troubled debt restructured loans
    4,494       11 %     962       2 %
Total nonaccrual loans
    39,752       100 %     42,467       100 %
Loans 90 days or more past due and still accruing
                               
Commercial and agricultural loans and  real estate
    239       5 %     94       4 %
Real estate mortgages
    1,634       36 %     919       40 %
Consumer
    2,652       59 %     1,312       56 %
Total loans 90 days or more past due and still accruing
    4,525       100 %     2,325       100 %
                                 
Total nonperforming loans
    44,277               44,792          
Other real estate owned (OREO)
    650               901          
Total nonperforming assets
    44,927               45,693          
Total nonperforming loans to total loans and leases
    1.19 %             1.24 %        
Total nonperforming assets to total assets
    0.82 %             0.86 %        
Total allowance for loan and lease losses to nonperforming loans
    161.11 %             159.03 %        

Loans over 60 days past due but not over 90 days past due were 0.11% of total loans as of September 30, 2011, compared to 0.15% of total loans as of December 31, 2010.  In addition to nonperforming loans, the Company has also identified approximately $96.7 million in potential problem loans at September 30, 2011 as compared to $82.2 million at December 31, 2010.  Potential problem loans are loans that are currently performing, but known information about possible credit problems of the borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in classification of such loans as nonperforming at some time in the future.  Potential problem loans are typically defined as loans that are performing but are classified by the Company’s loan rating system as “substandard.”  At September 30, 2011, potential problem loans primarily consisted of commercial real estate and commercial and agricultural loans.  Potential problem loans were up $14.5 million from December 31, 2011, due primarily to the migration of certain commercial credits to classified status, which management believes have been adequately reserved for in the allowance for loan and lease losses.  Nonaccrual home equity loans increased approximately $2.0 million from December 31, 2010 to September 30, 2011, due primarily to economic conditions.  Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans.  Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses.
 
 
The Company recorded a provision for loan and lease losses of $5.2 million during the third quarter of 2011 compared with $7.5 million during the third quarter of 2010.  Annualized net charge-offs to average loans and leases for the three months ended September 30, 2011 were 0.47%, compared with 0.65% for three months ended September 30, 2010.  The Company’s allowance for loan and lease losses decreased slightly to 1.92% of loans and leases at September 30, 2011, compared with 1.97% at December 31, 2010.  Specific reserves on impaired loans totaled $0.2 million at September 30, 2011 and $2.2 million at December 31, 2010.  General allocations increased slightly to $71.1 million at September 30, 2011 from $69.0 million at December 31, 2010.

The Company recorded a provision for loan and lease losses of $15.2 million during the nine months ended September 30, 2011, which included additional provisions as a result of the September 2011 flooding in the Company’s geographic footprint, compared with $23.1 million during the nine months ended September 30, 2010.  Annualized net charge-offs to average loans and leases for the nine months ended September 30, 2011 were 0.55%, compared with 0.65% for nine months ended September 30, 2010.

Subprime mortgage lending, which has been the riskiest sector of the residential housing market, is not a market that the Company has ever actively pursued.  The market does not apply a uniform definition of what constitutes “subprime” lending.  Our reference to subprime lending relies upon the “Statement on Subprime Mortgage Lending” issued by the Office of Thrift Supervision and the other federal bank regulatory agencies, or the Agencies, on June 29, 2007, which further referenced the “Expanded Guidance for Subprime Lending Programs,” or the Expanded Guidance, issued by the Agencies by press release dated January 31, 2001.  In the Expanded Guidance, the Agencies indicated that subprime lending does not refer to individual subprime loans originated and managed, in the ordinary course of business, as exceptions to prime risk selection standards.  The Agencies recognize that many prime loan portfolios will contain such accounts.  The Agencies also excluded prime loans that develop credit problems after acquisition and community development loans from the subprime arena.  According to the Expanded Guidance, subprime loans are other loans to borrowers which display one or more characteristics of reduced payment capacity.  Five specific criteria, which are not intended to be exhaustive and are not meant to define specific parameters for all subprime borrowers and may not match all markets or institutions’ specific subprime definitions, are set forth, including having a FICO score of 660 or below.  Based upon the definition and exclusions described above, management believes that the Company is a prime lender.  Within the loan portfolio, there are loans that, at the time of origination, had FICO scores of 660 or below.  However, since the Company is a portfolio lender, it reviews all data contained in borrower credit reports and does not base underwriting decisions solely on FICO scores.  We believe the aforementioned loans, when made, were amply collateralized and otherwise conformed to our prime lending standards.  The Company has not originated Alt A loans or no interest loans.

Deposits

Total deposits were $4.3 billion at September 30, 2011, up $130.7 million, or 3.2%, from December 31, 2010.  Savings, NOW and money market accounts increased $73.5 million as of September 30, 2011 as compared with December 31, 2010.  Time deposits decreased $59.6 million, or 6.4%, from December 31, 2010 to September 30, 2011.  Demand deposits increased by $116.8 million, or 12.8%, from December 31, 2010 to September 30, 2011.

Total average deposits for the three months ended September 30, 2011 increased $40.3 million, or 1.0%, from the same period in 2010.  The Company experienced a decrease in average money market accounts of $42.2 million, or 3.9%, for the three months ended September 30, 2011 compared to the same period in 2010.  Average NOW accounts decreased $34.6 million, or 5.2%, for the three months ended September 30, 2011 as compared to the same period in 2010.  Average savings accounts increased $50.3 million, or 8.9%, for the three month period ending September 30, 2011 as compared to the same period in 2010.  This increase in average savings accounts was primarily due to a transition from a run-off of time deposit accounts into savings accounts, due to a decline in interest rates offered on time deposits.  Average time deposits decreased $89.2 million, or 9.2%, for the three months ended September 30, 2011 from the same period in 2010.  Average demand deposit accounts increased $156.0 million, or 18.9%, for the three months ended September 30, 2011 as compared to the same period in 2010.  This was due primarily to an increasing customer base, as the Company continues to expand into new markets.
 
 
Total average deposits for the nine months ended September 30, 2011 increased $56.5 million, or 1.4%, from the same period in 2010.  The Company experienced a decrease in average money market accounts of $29.9 million, or 2.7%, for the nine months ended September 30, 2011 compared to the same period in 2010.  Average NOW accounts decreased $25.2 million, or 3.6%, for the nine months ended September 30, 2011 as compared to the same period in 2010.  Average savings accounts increased $47.5 million, or 8.6%, for the nine month period ending September 30, 2011 as compared to the same period in 2010.  This increase in average savings accounts was primarily due to the aforementioned transition from a run-off of time deposit accounts into savings accounts, due to a decline in interest rates offered on time deposits.  Average time deposits decreased $87.1 million, or 8.7%, for the nine months ended September 30, 2011 from the same period in 2010.  Average demand deposit accounts increased $151.2 million, or 19.2%, for the nine months ended September 30, 2011 as compared to the same period in 2010.  This was due primarily to an increasing customer base, as the Company continues to expand into new markets.

Borrowed Funds

The Company's borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $158.3 million at September 30, 2011 compared to $159.4 million at December 31, 2010.  Long-term debt was $370.3 million at September 30, 2011, as compared to $369.9 million at December 31, 2010.  For more information about the Company’s borrowing capacity and liquidity position, see “Liquidity Risk” below.

Capital Resources

Stockholders' equity of $538.8 million represented 9.84% of total assets at September 30, 2011, compared with $533.6 million, or 9.99% as of December 31, 2010.  Under previously disclosed stock repurchase plans, the Company purchased 1,458,609 shares of its common stock during the nine month period ended September 30, 2011, for a total of $30.5 million at an average price of $20.91 per share.  On July 25, 2011, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to 1,000,000 shares (approximately 3%) of its outstanding common stock, effective July 25, 2011, as market conditions warrant in open market and privately negotiated transactions.  At September 30, 2011, there were 517,581 shares available for repurchase under this plan, which expires on December 31, 2013.  On October 24, 2011, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to an additional 1,000,000 shares (approximately 3%) of its outstanding common stock, effective October 24, 2011, as market conditions warrant in open market and privately negotiated transactions.  This plan expires on December 31, 2013.

The Board of Directors considers the Company's earnings position and earnings potential when making dividend decisions.  The Company does not have a target dividend pay out ratio.

As the capital ratios in the following table indicate, the Company remained “well capitalized” at September 30, 2011 under applicable bank regulatory requirements.  Capital measurements are well in excess of regulatory minimum guidelines and meet the requirements to be considered well capitalized for all periods presented. Tier 1 leverage, Tier 1 capital and Total risk-based capital ratios have regulatory minimum guidelines of 3%, 4% and 8% respectively, with requirements to be considered well capitalized of 5%, 6% and 10%, respectively.
 
 
Capital Measurements
 
September 30,
2011
   
December 31,
2010
 
Tier 1 leverage ratio
    9.21 %     9.16 %
Tier 1 capital ratio
    12.00 %     12.44 %
Total risk-based capital ratio
    13.25 %     13.70 %
Cash dividends as a percentage of net income
    46.26 %     48.04 %
Per common share:
               
Book value
  $ 16.28     $ 15.51  
Tangible book value
  $ 12.24     $ 11.67  
 
Liquidity and Interest Rate Sensitivity Management

Market Risk

Interest rate risk is the primary market risk affecting the Company.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.  Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest bearing liabilities mature or reprice on a different basis than earning assets.  When interest bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when earning assets mature or reprice more quickly than interest bearing liabilities, falling interest rates could result in a decrease in net interest income.

In an attempt to manage the Company's exposure to changes in interest rates, management monitors the Company’s interest rate risk.  Management’s Asset Liability Committee (“ALCO”) meets monthly to review the Company’s interest rate risk position and profitability, and to recommend strategies for consideration by the Board of Directors.  Management also reviews loan and deposit pricing and the Company’s securities portfolio, formulates investment and funding strategies, and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.

In adjusting the Company’s asset/liability position, the Board and management attempt to manage the Company’s interest rate risk while minimizing net interest margin compression.  At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin.  The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and fluctuations in the difference between long- and short-term interest rates.  Assuming interest rates remain at or near current historical lows, net interest margin will continue to experience compression.  Additional rate reductions on deposits are becoming more difficult as deposit rates are at or near their floors, and with asset yields continuing to reprice at lower rates, this could result in additional margin pressure as well as a decrease in net interest income.

The primary tool utilized by ALCO to manage interest rate risk is a balance sheet/income statement simulation model (interest rate sensitivity analysis).  Information such as principal balance, interest rate, maturity date, cash flows, next repricing date (if needed), and current rates is uploaded into the model to create an ending balance sheet.  In addition, ALCO makes certain assumptions regarding prepayment speeds for loans and leases and mortgage related investment securities along with any optionality within the deposits and borrowings.
 
 
The model is first run under an assumption of a flat rate scenario (i.e. no change in current interest rates) with a static balance sheet over a 12-month period.  Two additional models are run with static balance sheets: (1) a gradual increase of 200 bp, and (2) a gradual decrease of 100 bp taking place over a 12-month period. Under these scenarios, assets subject to prepayments are adjusted to account for faster or slower prepayment assumptions.  Any investment securities or borrowings that have callable options embedded into them are handled accordingly based on the interest rate scenario. The resulting changes in net interest income are then measured against the flat rate scenario.

In the declining rate scenario, net interest income is projected to decrease when compared to the forecasted net interest income in the flat rate scenario through the simulation period. The decrease in net interest income is a result of earning assets repricing downward at a faster rate than interest bearing liabilities. The inability to effectively lower deposit rates will likely reduce or eliminate the benefit of lower interest rates. In the rising rate scenarios, net interest income is projected to experience a decline from the flat rate scenario. Net interest income is projected to remain at lower levels than in a flat rate scenario through the simulation period primarily due to a lag in assets repricing while funding costs increase. The potential impact on earnings is dependent on the ability to lag deposit repricing. If short-term rates continue to increase, the Company expects competitive pressures will likely lead to core deposit pricing increases, which will likely continue compression of the net interest margin.

Net interest income for the next 12 months in the + 200/- 100 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% change in net interest income. The following table summarizes the percentage change in net interest income in the rising and declining rate scenarios over a 12-month period from the forecasted net interest income in the flat rate scenario using the September 30, 2011 balance sheet position:

Interest Rate Sensitivity Analysis
 
Change in interest rates
Percent change in
(in bp points)
net interest income
+200
(1.73%)
-100
(1.06%)

Liquidity Risk

Liquidity involves the ability to meet the cash flow requirements of customers who may be depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. The ALCO is responsible for liquidity management and has developed guidelines which cover all assets and liabilities, as well as off balance sheet items that are potential sources or uses of liquidity.  Liquidity policies must also provide the flexibility to implement appropriate strategies and tactical actions. Requirements change as loans and leases grow, deposits and securities mature, and payments on borrowings are made. Liquidity management includes a focus on interest rate sensitivity management with a goal of avoiding widely fluctuating net interest margins through periods of changing economic conditions.

The primary liquidity measurement the Company utilizes is called the Basic Surplus, which captures the adequacy of its access to reliable sources of cash relative to the stability of its funding mix of average liabilities.  Basic Surplus is calculated by subtracting short-term liabilities from liquid assets.  This approach recognizes the importance of balancing levels of cash flow liquidity from short- and long-term securities with the availability of dependable borrowing sources which can be accessed when necessary.  At September 30, 2011, the Company’s Basic Surplus measurement was 11.1% of total assets or $610 million as compared to the December 31, 2010 Basic Surplus of 9.7% or $517 million, and was above the Company’s minimum of 5% or $274 million set forth in its liquidity policies.  Since March 2009, the Company has been in a Fed Funds sold position as a result of excess liquidity.
 
 
This Basic Surplus approach enables the Company to adequately manage liquidity from both operational and contingency perspectives. By tempering the need for cash flow liquidity with reliable borrowing facilities, the Company is able to operate with a more fully invested and, therefore, higher interest income generating securities portfolio. The makeup and term structure of the securities portfolio is, in part, impacted by the overall interest rate sensitivity of the balance sheet. Investment decisions and deposit pricing strategies are impacted by the liquidity position.

The Company’s primary source of funds is the Bank. Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends. The approval of the Office of Comptroller of the Currency (OCC) is required to pay dividends when a bank fails to meet certain minimum regulatory capital standards or when such dividends are in excess of a subsidiary bank’s earnings retained in the current year plus retained net profits for the preceding two years (as defined in the regulations). At September 30, 2011, approximately $87.9 million of the total stockholders’ equity of the Bank was available for payment of dividends to the Company without approval by the OCC.  The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. The Bank is currently in compliance with these requirements. Under the General Corporation Law of the State of Delaware, the Company may declare and pay dividends either out of its surplus or, in case there is no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

At September 30, 2011 and December 31, 2010, FHLB advances outstanding totaled $343 million.  The Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $328 million at September 30, 2011 and $284 million at December 31, 2010.  In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $276 million at September 30, 2011, or used to collateralize other borrowings, such as repurchase agreements.  At September 30, 2011 the Bank also had additional borrowing capacity from unused collateral at the Federal Reserve of $471 million.

Recent Accounting Pronouncements

In September 2011, the FASB issued ASU No. 2011-08 "Intangibles – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment".  ASU 2011-08 is intended to reduce complexity and costs of performing goodwill impairment tests by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. The amendments in ASU 2011-08 also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Also, the amendments improve the examples of events and circumstances that an entity having a reporting unit with a zero or negative carrying amount should consider in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.  The Company is assessing the impact of ASU 2011-08 on its goodwill impairment testing procedures.

In May 2011, the FASB issued ASU No. 2011-04 "Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs."  ASU 2011-04 changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements.  Consequently, the amendments in this update result in common fair value measurement and disclosure requirements in GAAP and IFRSs (International Financial Reporting Standards).  ASU 2011-04 is effective prospectively during interim and annual periods beginning on or after December 15, 2011.  Early application by public entities is not permitted.  The Company is assessing the impact of ASU 2011-04 on its fair value disclosures.
 
 
In April 2011, the FASB issued ASU No. 2011-03 "Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreement."  ASU 2011-03 removes from the assessment of effective control the criterion relating to the transferor's ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee.  ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011.  The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  The Company believes that the adoption of the standard will not have a significant impact on the Company's consolidated financial statements.

In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (Topic 310)”, was issued in April 2011.  The amendments in this Update provide guidance in evaluating whether a restructuring constitutes a troubled debt restructuring.  A creditor must separately conclude that both of the following exist: 1. The restructuring constitutes a concession. 2. The debtor is experiencing financial difficulties. The amendments to Topic 310 clarify the guidance on a creditor’s evaluation of whether it has granted a concession as follows: 1. If a debtor does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the restructuring would be considered to be at a below-market rate, which may indicate that the creditor has granted a concession. In that circumstance, a creditor should consider all aspects of the restructuring in determining whether it has granted a concession. If a creditor determines that it has granted a concession, the creditor must make a separate assessment about whether the debtor is experiencing financial difficulties to determine whether the restructuring constitutes a troubled debt restructuring. 2. A temporary or permanent increase in the contractual interest rate as a result of a restructuring does not preclude the restructuring from being considered a concession because the new contractual interest rate on the restructured debt could still be below the market interest rate for new debt with similar risk characteristics. In such situations, a creditor should consider all aspects of the restructuring in determining whether it has granted a concession. If a creditor determines that it has granted a concession, the creditor must make a separate assessment about whether the debtor is experiencing financial difficulties to determine whether the restructuring constitutes a troubled debt restructuring. 3. A restructuring that results in a delay in payment that is insignificant is not a concession. However, an entity should consider various factors in assessing whether a restructuring resulting in a delay in payment is insignificant. The amendments include examples illustrating the assessment of whether a restructuring results in a delay in payment that is insignificant. The amendments to Topic 310 also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulties as follows:  A creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default. A creditor should evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without the modification. In addition, the amendments to Topic 310 clarify that a creditor is precluded from using the effective interest rate test in the debtor’s guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring.  The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption.  The amendments in this Update require disclosures consistent with its effective date.  The implementation of this amendment did not have a material effect on the Company’s financial statements, but did have a significant effect on disclosures in our interim and annual reports.

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information called for by Item 3 is contained in the Liquidity and Interest Rate Sensitivity Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.


Item 4.  CONTROLS AND PROCEDURES

The  Company's  management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of  the  Company's  disclosure  controls  and  procedures  (as  defined  in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2011, the Company's disclosure controls and procedures were effective.

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

PART II.  OTHER INFORMATION

Item 1 LEGAL PROCEEDINGS

The Bank has been named as a defendant in a purported class action lawsuit arising from its assessment and collection of overdraft fees on its checking account customers. The complaint was filed in the Supreme Court of the State of New York, County of Delaware, on September 12, 2011 and alleges that the Bank engaged in certain unfair practices and failed to make adequate disclosure to customers concerning its overdraft fee assessment practices.  The complaint seeks certification of a class of national checking account holders who have incurred overdraft fees and a subclass of such customers who reside in New York.  In addition, the complaint seeks actual and punitive damages, disgorgement, interest and costs including attorneys' fees.  The Company believes the claims to be without merit and intends to defend the action vigorously.

There are no other material legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is subject.

Item 1A – RISK FACTORS

Management of the Company does not believe there have been any material changes in the risk factors that were disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission on March 1, 2011.

 
Item 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a)
Not applicable
 
(b)
Not applicable
 
(c)
The table below sets forth the information with respect to purchases made by the Company (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the quarter ended September 30, 2011:

Period
 
Total Number of Shares Purchased
   
Average Price Paid Per Share
   
Total Number of Shares Purchased as Part of Publicly Announced Plans
   
Maximum Number of Shares That May Yet be Purchased Under
The Plans (1)
 
1/1/11 - 1/31/11
    -     $ -       -       976,190  
2/1/11 - 2/28/11
    -       -       -       976,190  
3/1/11 - 3/31/11
    107,871       21.96       107,871       868,319  
4/1/11 - 4/30/11
    21,050       22.29       21,050       847,269  
5/1/11 - 5/31/11
    306,756       21.90       306,756       540,513  
6/1/11 - 6/30/11
    540,513       21.47       540,513       -  
7/1/11 - 7/31/11
    86,288       21.74       86,288       913,712  
8/1/11 - 8/31/11
    36,046       21.97       36,046       877,666  
9/1/11 - 9/30/11
    360,085       18.53       360,085       517,581  
Total
    1,458,609     $ 20.91       1,458,609       517,581  

 
(1)
Under previously disclosed stock repurchase plans, the Company purchased 1,458,609 shares of its common stock during the nine month period ended September 30, 2011, for a total of $30.5 million at an average price of $20.91 per share.  On July 25, 2011, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to 1,000,000 shares (approximately 3%) of its outstanding common stock, effective July 25, 2011, as market conditions warrant in open market and privately negotiated transactions.  At September 30, 2011, there were 517,581 shares available for repurchase under this plan, which expires on December 31, 2013.  On October 24, 2011, the NBT Board of Directors authorized a new repurchase program for NBT to repurchase up to an additional 1,000,000 shares (approximately 3%) of its outstanding common stock, effective October 24, 2011, as market conditions warrant in open market and privately negotiated transactions.  This plan expires on December 31, 2013.
 
Item 3 DEFAULTS UPON SENIOR SECURITIES

None

Item 4 [REMOVED AND RESERVED]

None
 
Item 5 OTHER INFORMATION

None


Item 6 EXHIBITS

3.1   Certificate of Incorporation of NBT Bancorp Inc. as amended through July 23, 2001 (filed as Exhibit 3.1 to Registrant's Form 10-K for the year ended December 31, 2008, filed on March 2, 2009 and incorporated herein by reference).

3.2   By-laws of NBT Bancorp Inc. as amended and restated through July 23, 2001 (filed as Exhibit 3.2 to Registrant's Form 10-K for the year ended December 31, 2008, filed on March 2, 2009 and incorporated herein by reference).

3.3   Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registration's Form 8-K, file Number 0-14703, filed on November 18, 2004, and incorporated herein by reference).

4.1   Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

4.2   Rights Agreement, dated as of November 15, 2004, between NBT Bancorp Inc. and Registrar and Transfer Company, as Rights Agent (filed as Exhibit 4.1 to Registrant's Form 8-K, file number 0-14703, filed on November 18, 2004, and incorporated by reference herein).

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

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

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

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

101  The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets-September 30, 2011 and December 31, 2010; (ii) Unaudited Consolidated Statements of Income-Three months ended September 30, 2011 and 2010; (iii) Unaudited Consolidated Statements of Income-Nine months ended September 30, 2011 and 2010; (iv) Unaudited Consolidated Statements of Stockholder's Equity-Nine months ended September 30, 2011 and 2010; (v) Unaudited Consolidated Statements of Cash Flows-Nine months ended September 30, 2011 and 2010; and (vi) Notes to Unaudited Consolidated Financial Statements.**

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

 
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, this 9th day of November 2011.
 
 
 
NBT BANCORP INC.
 
       
       
  By:   /s/ Michael J. Chewens  
    Michael J. Chewens, CPA  
         Senior Executive Vice President  
    Chief Financial Officer  
 

EXHIBIT INDEX
 
3.1   Certificate of Incorporation of NBT Bancorp Inc. as amended through July 23, 2001 (filed as Exhibit 3.1 to Registrant's Form 10-K for the year ended December 31, 2008, filed on March 2, 2009 and incorporated herein by reference).

3.2   By-laws of NBT Bancorp Inc. as amended and restated through July 23, 2001 (filed as Exhibit 3.2 to Registrant's Form 10-K for the year ended December 31, 2008, filed on March 2, 2009 and incorporated herein by reference).

3.3   Certificate of Designation of the Series A Junior Participating Preferred Stock (filed as Exhibit A to Exhibit 4.1 of the Registration's Form 8-K, file Number 0-14703, filed on November 18, 2004, and incorporated herein by reference).

4.1  Specimen common stock certificate for NBT's common stock (filed as exhibit 4.3 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 filed on December 27, 2005 and incorporated herein by reference).

4.2   Rights Agreement, dated as of November 15, 2004, between NBT Bancorp Inc. and Registrar and Transfer Company, as Rights Agent (filed as Exhibit 4.1 to Registrant's Form 8-K, file number 0-14703, filed on November 18, 2004, and incorporated by reference herein).

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

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

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

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

101  The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets-September 30, 2011 and December 31, 2010; (ii) Unaudited Consolidated Statements of Income-Three months ended September 30, 2011 and 2010; (iii) Unaudited Consolidated Statements of Income-Nine months ended September 30, 2011 and 2010; (iv) Unaudited Consolidated Statements of Stockholder's Equity-Nine months ended September 30, 2011 and 2010; (v) Unaudited Consolidated Statements of Cash Flows-Nine months ended September 30, 2011 and 2010; and (vi) Notes to Unaudited Consolidated Financial Statements.**

**  Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
 
 
62