FISI Financial Institutions Inc

Table of Contents

 

 

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 June 30, 2015

or

 

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

For the transition period from                      to                     

Commission File Number: 000-26481

 

 

 

(Exact name of registrant as specified in its charter)

 

 

 

NEW YORK		16-0816610
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
220 LIBERTY STREET, WARSAW, NEW YORK		14569
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (585) 786-1100

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller company)		Smaller reporting company		¨

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

The registrant had 14,184,235 shares of Common Stock, $0.01 par value, outstanding as of July 31, 2015.

 

 

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC.

Form 10-Q

For the Quarterly Period Ended June 30, 2015

TABLE OF CONTENTS

 

				PAGE
PART I.		FINANCIAL INFORMATION
ITEM 1.		Financial Statements
		Consolidated Statements of Financial Condition - at June 30, 2015 (Unaudited) and December 31, 2014			3
		Consolidated Statements of Income (Unaudited) - Three and six months ended June 30, 2015 and 2014			4
		Consolidated Statements of Comprehensive Income (Unaudited) - Three and six months ended June 30, 2015 and 2014			5
		Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) - Six months ended June 30, 2015 and 2014			6
		Consolidated Statements of Cash Flows (Unaudited) - Six months ended June 30, 2015 and 2014			7
		Notes to Consolidated Financial Statements (Unaudited)			8
ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			31
ITEM 3.		Quantitative and Qualitative Disclosures About Market Risk			51
ITEM 4.		Controls and Procedures			52
PART II.		OTHER INFORMATION
ITEM 1.		Legal Proceedings			53
ITEM 1A.		Risk Factors			53
ITEM 2.		Unregistered Sales of Equity Securities and Use of Proceeds			53
ITEM 6.		Exhibits			54
		Signatures			55

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.

Financial Statements

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

 

(Dollars in thousands, except share and per share data)		June 30,				December 31,
		2015				2014
		(Unaudited)
ASSETS
Cash and cash equivalents		$	52,554			$	58,151
Securities available for sale, at fair value			772,639				622,494
Securities held to maturity, at amortized cost (fair value of $324,873 and $298,695, respectively)			320,820				294,438
Loans held for sale			448				755
Loans (net of allowance for loan losses of $27,500 and $27,637, respectively)			1,981,773				1,884,365
Company owned life insurance			61,998				61,004
Premises and equipment, net			37,110				36,394
Goodwill and other intangible assets, net			68,158				68,639
Other assets			63,959				63,281
Total assets		$	3,359,459			$	3,089,521
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand		$	602,143			$	571,260
Interest-bearing demand			530,861				490,190
Savings and money market			910,215				795,835
Certificates of deposit			613,019				593,242
Total deposits			2,656,238				2,450,527
Short-term borrowings			350,600				334,804
Long-term borrowings, net of issuance costs of $1,045			38,955				—
Other liabilities			29,231				24,658
Total liabilities			3,075,024				2,809,989
Shareholders’ equity:
Series A 3% preferred stock, $100 par value; 1,533 shares authorized and 1,492 shares issued and outstanding			149				149
Series B-1 8.48% preferred stock, $100 par value; 200,000 shares authorized and 171,906 shares issued and outstanding			17,191				17,191
Total preferred equity			17,340				17,340
Common stock, $0.01 par value; 50,000,000 shares authorized and 14,397,509 shares issued and outstanding			144				144
Additional paid-in capital			72,279				72,955
Retained earnings			210,337				203,312
Accumulated other comprehensive loss			(11,682	)			(9,011	)
Treasury stock, at cost – 213,374 and 279,461 shares, respectively			(3,983	)			(5,208	)
Total shareholders’ equity			284,435				279,532
Total liabilities and shareholders’ equity		$	3,359,459			$	3,089,521

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

 

(In thousands, except per share amounts)		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Interest income:
Interest and fees on loans		$	20,446			$	20,230			$	40,583			$	40,497
Interest and dividends on investment securities			5,513				4,653				10,373				9,445
Total interest income			25,959				24,883				50,956				49,942
Interest expense:
Deposits			1,827				1,577				3,447				3,102
Short-term borrowings			213				203				443				462
Long-term borrowings			515				—				515				—
Total interest expense			2,555				1,780				4,405				3,564
Net interest income			23,404				23,103				46,551				46,378
Provision for loan losses			1,288				1,758				4,029				3,864
Net interest income after provision for loan losses			22,116				21,345				42,522				42,514
Noninterest income:
Service charges on deposits			1,964				2,241				3,843				4,491
Insurance income			1,057				16				2,665				57
ATM and debit card			1,283				1,257				2,476				2,431
Investment advisory			541				561				1,028				1,123
Company owned life insurance			493				425				960				828
Investments in limited partnerships			55				81				529				707
Loan servicing			96				176				263				330
Net gain on sale of loans held for sale			39				50				108				155
Net gain on disposal of investment securities			—				949				1,062				1,262
Net gain (loss) on disposal of other assets			16				24				20				(11	)
Other			911				797				1,798				1,561
Total noninterest income			6,455				6,577				14,752				12,934
Noninterest expense:
Salaries and employee benefits			10,606				9,063				20,829				18,319
Occupancy and equipment			3,375				3,139				7,074				6,374
Professional services			866				1,384				1,834				2,356
Computer and data processing			810				777				1,512				1,500
Supplies and postage			508				535				1,071				1,047
FDIC assessments			415				388				833				810
Advertising and promotions			238				214				477				393
Other			2,418				2,308				4,617				4,222
Total noninterest expense			19,236				17,808				38,247				35,021
Income before income taxes			9,335				10,114				19,027				20,427
Income tax expense			2,750				3,082				5,641				6,176
Net income		$	6,585			$	7,032			$	13,386			$	14,251
Preferred stock dividends			366				365				731				731
Net income available to common shareholders		$	6,219			$	6,667			$	12,655			$	13,520
Earnings per common share (Note 3):
Basic		$	0.44			$	0.48			$	0.90			$	0.98
Diluted		$	0.44			$	0.48			$	0.90			$	0.98
Cash dividends declared per common share		$	0.20			$	0.19			$	0.40			$	0.38
Weighted average common shares outstanding:
Basic			14,078				13,791				14,071				13,782
Diluted			14,121				13,838				14,118				13,831

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

 

(Dollars in thousands)		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Net income		$	6,585			$	7,032			$	13,386			$	14,251
Other comprehensive income (loss), net of tax:
Net unrealized (losses) gains on securities available for sale			(6,207	)			2,684				(2,946	)			6,428
Pension and post-retirement obligations			140				20				275				39
Total other comprehensive income (loss), net of tax			(6,067	)			2,704				(2,671	)			6,467
Comprehensive income		$	518			$	9,736			$	10,715			$	20,718

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

Six months ended June 30, 2015 and 2014

 

(Dollars in thousands, except per share data)		Preferred Equity				Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Loss				Treasury Stock				Total Shareholders’ Equity
Balance at January 1, 2014		$	17,342			$	142			$	67,574			$	186,137			$	(10,187	)		$	(6,169	)		$	254,839
Comprehensive income:
Net income			—				—				—				14,251				—				—				14,251
Other comprehensive income, net of tax			—				—				—				—				6,467				—				6,467
Purchases of common stock for treasury			—				—				—				—				—				(195	)			(195	)
Repurchase of Series B-1 8.48% preferred stock			(2	)															—				—				(2	)
Share-based compensation plans:
Share-based compensation			—				—				305				—				—				—				305
Stock options exercised			—				—				(1	)			—				—				133				132
Restricted stock awards issued, net			—				—				(655	)			—				—				655				—
Cash dividends declared:
Series A 3% Preferred-$1.50 per share			—				—				—				(2	)			—				—				(2	)
Series B-1 8.48% Preferred-$4.24 per share			—				—				—				(729	)			—				—				(729	)
Common-$0.38 per share			—				—				—				(5,239	)			—				—				(5,239	)
Balance at June 30, 2014		$	17,340			$	142			$	67,223			$	194,418			$	(3,720	)		$	(5,576	)		$	269,827
Balance at January 1, 2015		$	17,340			$	144			$	72,955			$	203,312			$	(9,011	)		$	(5,208	)		$	279,532
Comprehensive income:
Net income			—				—				—				13,386				—				—				13,386
Other comprehensive income, net of tax			—				—				—				—				(2,671	)			—				(2,671	)
Purchases of common stock for treasury			—				—				—				—				—				(41	)			(41	)
Share-based compensation plans:
Share-based compensation			—				—				370				—				—				—				370
Stock options exercised			—				—				2				—				—				163				165
Restricted stock awards issued, net			—				—				(1,060	)			—				—				1,060				—
Excess tax benefit on share-based compensation			—				—				1				—				—				—				1
Stock awards			—				—				11				—				—				43				54
Cash dividends declared:
Series A 3% Preferred-$1.50 per share			—				—				—				(2	)			—				—				(2	)
Series B-1 8.48% Preferred-$4.24 per share			—				—				—				(729	)			—				—				(729	)
Common-$0.40 per share			—				—				—				(5,630	)			—				—				(5,630	)
Balance at June 30, 2015		$	17,340			$	144			$	72,279			$	210,337			$	(11,682	)		$	(3,983	)		$	284,435

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in thousands)		Six months ended
		June 30,
		2015				2014
Cash flows from operating activities:
Net income		$	13,386			$	14,251
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			2,671				2,061
Net amortization of premiums on securities			1,547				1,582
Provision for loan losses			4,029				3,864
Share-based compensation			370				305
Deferred income tax expense			202				1,066
Proceeds from sale of loans held for sale			7,321				7,705
Originations of loans held for sale			(6,906	)			(5,223	)
Increase in company owned life insurance			(960	)			(828	)
Net gain on sale of loans held for sale			(108	)			(155	)
Net gain on disposal of investment securities			(1,062	)			(1,262	)
Net (gain) loss on sale and disposal of other assets			(20	)			11
Decrease in other assets			1,009				288
Increase (decrease) in other liabilities			820				(249	)
Net cash provided by operating activities			22,299				23,416
Cash flows from investing activities:
Purchases of available for sale securities			(241,906	)			(125,419	)
Purchases of held to maturity securities			(39,570	)			(28,594	)
Proceeds from principal payments, maturities and calls on available for sale securities			57,787				83,904
Proceeds from principal payments, maturities and calls on held to maturity securities			16,394				16,491
Proceeds from sales of securities available for sale			29,508				61,428
Net loan originations			(101,567	)			(65,937	)
Purchases of company owned life insurance			(34	)			(34	)
Proceeds from sales of other assets			167				623
Purchases of premises and equipment			(2,891	)			(2,371	)
Net cash used in investing activities			(282,112	)			(59,909	)
Cash flows from financing activities:
Net increase in deposits			205,711				130,022
Net increase (decrease) in short-term borrowings			15,796				(82,359	)
Issuance of long-term debt			40,000				—
Debt issuance costs			(1,060	)			—
Repurchase of preferred stock			—				(2	)
Purchase of common stock for treasury			(41	)			(195	)
Proceeds from stock options exercised			165				132
Excess tax benefit on share-based compensation, net			1				—
Cash dividends paid to common and preferred shareholders			(6,356	)			(5,965	)
Net cash provided by financing activities			254,216				41,633
Net (decrease) increase in cash and cash equivalents			(5,597	)			5,140
Cash and cash equivalents, beginning of period			58,151				59,692
Cash and cash equivalents, end of period		$	52,554			$	64,832
Supplemental information:
Cash paid for interest		$	3,166			$	3,313
Cash paid for income taxes			1,539				8,313
Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans			130				311
Accrued and declared unpaid dividends			3,182				2,986
Increase in net unsettled security purchases			4,023				2,260
Loans transferred from held for sale to held for investment			—				853

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1.) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Financial Institutions, Inc., (the “Parent” or the “Company”) is a financial holding company organized in 1931 under the laws of New York State. The Company offers a broad array of deposit, lending and other financial services to individuals, municipalities and businesses in Western and Central New York through its wholly-owned New York chartered banking subsidiary, Five Star Bank (the “Bank”). The Company has also expanded its indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern Pennsylvania. On August 1, 2014, the Company acquired Scott Danahy Naylon Co., Inc., a full service insurance agency located in Amherst, New York. The Company provides insurance and risk consulting services through its wholly-owned insurance subsidiary, Scott Danahy Naylon, LLC (“SDN”).

Basis of Presentation

The consolidated financial statements include the accounts of Financial Institutions, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accounting and reporting policies conform to U.S. generally accepted accounting principles (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been condensed or omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary for a fair presentation of the consolidated statements of financial condition, income, comprehensive income, changes in shareholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. Prior years’ consolidated financial statements are re-classified whenever necessary to conform to the current year’s presentation. These consolidated financial statements should be read in conjunction with the Company’s 2014 Annual Report on Form 10-K for the year ended December 31, 2014. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

Subsequent Events

The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued and determined that there were no subsequent events.

Use of Estimates

The preparation of these financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates relate to the determination of the allowance for loan losses, the carrying value of goodwill and deferred tax assets, the valuation and other than temporary impairment (“OTTI”) considerations related to the securities portfolio, and assumptions used in the defined benefit pension plan accounting.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The effective date was recently deferred for one year to the interim and annual periods beginning on or after December 15, 2017. Early adoption is permitted as of the original effective date – interim and annual periods beginning on or after December 15, 2016. The Company is evaluating the potential impact of ASU 2014-09 on the Company’s financial statements.

In June 2014, the FASB issued ASU 2014-12, Compensation—Stock Compensation (Topic 718). The pronouncement was issued to clarify the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. ASU 2014-12 will be effective for the Company beginning January 1, 2016, though early adoption is permitted. The adoption of ASU 2014-12 is not expected to have a significant impact on the Company’s financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(1.) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

In January 2015, the FASB issued ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20) – Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. ASU 2015-01 eliminates from U.S. GAAP the concept of extraordinary items, which, among other things, required an entity to segregate extraordinary items considered to be unusual and infrequent from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. ASU 2015-01 will be effective for the Company beginning January 1, 2016, though early adoption is permitted. ASU 2015-01 is not expected to have a significant impact on the Company’s financial statements.

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs. Under ASU 2015-03 the Company will present debt issuance costs in the balance sheet as a reduction from the related debt liability rather than as an asset. Amortization of such costs will continue to be reported as interest expense. ASU 2015-03 will be effective for the Company beginning January 1, 2016, though early adoption is permitted. Retrospective adoption is required. The Company early adopted this standard during the quarter ended June 30, 2015, concurrent with the issuance of the Subordinated Notes described in Note 7. Unamortized debt issuance costs of $1.0 million are included in the net balance of long-term borrowings reported on the Consolidated Statements of Financial Condition. Retrospective application of this standard did not impact previously issued financial statements.

(2.) BUSINESS COMBINATIONS

SDN Acquisition

On August 1, 2014, the Company completed the acquisition of Scott Danahy Naylon Co., Inc., a full service insurance agency located in Amherst, New York. Consideration for the acquisition included both cash and stock totaling $16.9 million, including up to $3.4 million of future payments, contingent upon SDN meeting certain revenue targets through 2017. The estimated fair value of the contingent consideration at the date of acquisition was $3.2 million, which was estimated using a probability-weighted discounted cash flow model. As a result of the acquisition, the Company recorded goodwill of $12.6 million and other intangible assets of $6.6 million. The goodwill is not expected to be deductible for income tax purposes. Pro forma results of operations for this acquisition have not been presented because the effect of this acquisition was not material to the Company’s consolidated financial statements.

This acquisition was accounted for under the acquisition method in accordance with FASB ASC Topic 805. Accordingly, the assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition date. The following table summarizes the consideration paid for Scott Danahy Naylon Co., Inc. and the amounts of the assets acquired and liabilities assumed.

 

Consideration paid:
Cash		$	8,100
Stock			5,400
Contingent consideration			3,227
Fair value of total consideration transferred			16,727
Fair value of assets acquired:
Cash			105
Identified intangible assets			6,640
Premises and equipment, accounts receivable and other assets			1,094
Total identifiable assets acquired			7,839
Fair value of liabilities assumed:
Deferred tax liability			2,556
Other liabilities			1,173
Total liabilities assumed			3,729
Fair value of net assets acquired			4,110
Goodwill resulting from acquisition		$	12,617

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(3.) EARNINGS PER COMMON SHARE (“EPS”)

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS (in thousands, except per share amounts).

 

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Net income available to common shareholders		$	6,219			$	6,667			$	12,655			$	13,520
Weighted average common shares outstanding:
Total shares issued			14,398				14,162				14,398				14,162
Unvested restricted stock awards			(100	)			(67	)			(87	)			(65	)
Treasury shares			(220	)			(304	)			(240	)			(315	)
Total basic weighted average common shares outstanding			14,078				13,791				14,071				13,782
Incremental shares from assumed:
Exercise of stock options			22				28				22				25
Vesting of restricted stock awards			21				19				25				24
Total diluted weighted average common shares outstanding			14,121				13,838				14,118				13,831
Basic earnings per common share		$	0.44			$	0.48			$	0.90			$	0.98
Diluted earnings per common share		$	0.44			$	0.48			$	0.90			$	0.98
For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:
Stock options			—				—				—				7
Restricted stock awards			3				3				2				1
			3				3				2				8

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES

The amortized cost and fair value of investment securities are summarized below (in thousands):

 

		Amortized Cost				Unrealized Gains				Unrealized Losses				Fair Value
June 30, 2015
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	271,774			$	777			$	2,474			$	270,077
Mortgage-backed securities:
Federal National Mortgage Association			227,129				1,933				2,307				226,755
Federal Home Loan Mortgage Corporation			28,840				501				204				29,137
Government National Mortgage Association			43,804				1,728				—				45,532
Collateralized mortgage obligations:
Federal National Mortgage Association			83,447				514				1,132				82,829
Federal Home Loan Mortgage Corporation			95,268				186				2,752				92,702
Government National Mortgage Association			23,828				470				39				24,259
Privately issued			—				1,123				—				1,123
Total collateralized mortgage obligations			202,543				2,293				3,923				200,913
Total mortgage-backed securities			502,316				6,455				6,434				502,337
Asset-backed securities			—				225				—				225
Total available for sale securities		$	774,090			$	7,457			$	8,908			$	772,639
Securities held to maturity:
State and political subdivisions			289,713				4,790				451				294,052
Mortgage-backed securities:
Federal National Mortgage Association			9,280				6				86				9,200
Government National Mortgage Association			21,827				5				211				21,621
Total mortgage-backed securities			31,107				11				297				30,821
Total held to maturity securities		$	320,820			$	4,801			$	748			$	324,873
December 31, 2014
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	160,334			$	1,116			$	975			$	160,475
Mortgage-backed securities:
Federal National Mortgage Association			184,857				2,344				1,264				185,937
Federal Home Loan Mortgage Corporation			29,478				799				7				30,270
Government National Mortgage Association			48,800				2,022				—				50,822
Collateralized mortgage obligations:
Federal National Mortgage Association			76,247				489				944				75,792
Federal Home Loan Mortgage Corporation			89,623				199				2,585				87,237
Government National Mortgage Association			29,954				598				40				30,512
Privately issued			—				1,218				—				1,218
Total collateralized mortgage obligations			195,824				2,504				3,569				194,759
Total mortgage-backed securities			458,959				7,669				4,840				461,788
Asset-backed securities			—				231				—				231
Total available for sale securities		$	619,293			$	9,016			$	5,815			$	622,494
Securities held to maturity:
State and political subdivisions			277,273				4,231				120				281,384
Mortgage-backed securities:
Federal National Mortgage Association			3,279				24				—				3,303
Government National Mortgage Association			13,886				122				—				14,008
Total mortgage-backed securities			17,165				146				—				17,311
Total held to maturity securities		$	294,438			$	4,377			$	120			$	298,695

Investment securities with a total fair value of $846.9 million at June 30, 2015 were pledged as collateral to secure public deposits and for other purposes required or permitted by law.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

Sales and calls of securities available for sale were as follows (in thousands):

 

		Three months ended								Six months ended
		June 30,								June 30,
		2015				2014				2015				2014
Proceeds from sales		$	—			$	41,958			$	29,508			$	61,428
Gross realized gains			—				949				1,073				1,262
Gross realized losses			—				—				11				—

The scheduled maturities of securities available for sale and securities held to maturity at June 30, 2015 are shown below (in thousands). Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

 

		Amortized Cost				Fair Value
Debt securities available for sale:
Due in one year or less		$	30,008			$	30,008
Due from one to five years			166,519				166,266
Due after five years through ten years			328,808				328,993
Due after ten years			248,755				247,372
		$	774,090			$	772,639
Debt securities held to maturity:
Due in one year or less		$	24,064			$	24,158
Due from one to five years			161,041				164,083
Due after five years through ten years			107,099				108,259
Due after ten years			28,616				28,373
		$	320,820			$	324,873

Unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands):

 

		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
June 30, 2015
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	162,940			$	2,110			$	24,637			$	364			$	187,577			$	2,474
Mortgage-backed securities:
Federal National Mortgage Association			93,817				1,779				34,433				528				128,250				2,307
Federal Home Loan Mortgage Corporation			6,005				204				—				—				6,005				204
Collateralized mortgage obligations:
Federal National Mortgage Association			24,181				271				19,886				861				44,067				1,132
Federal Home Loan Mortgage Corporation			21,765				484				61,553				2,268				83,318				2,752
Government National Mortgage Association			—				—				2,306				39				2,306				39
Total collateralized mortgage obligations			45,946				755				83,745				3,168				129,691				3,923
Total mortgage-backed securities			145,768				2,738				118,178				3,696				263,946				6,434
Total available for sale securities			308,708				4,848				142,815				4,060				451,523				8,908
Securities held to maturity:
State and political subdivisions			35,997				451				—				—				35,997				451
Mortgage-backed securities:											—				—
Federal National Mortgage Association			5,724				86				—				—				5,724				86
Government National Mortgage Association			15,328				211				—				—				15,328				211
Total held to maturity securities			57,049				748				—				—				57,049				748
Total temporarily impaired securities		$	365,757			$	5,596			$	142,815			$	4,060			$	508,572			$	9,656

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
December 31, 2014
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	34,995			$	77			$	41,070			$	898			$	76,065			$	975
Mortgage-backed securities:
Federal National Mortgage Association			2,242				8				62,592				1,256				64,834				1,264
Federal Home Loan Mortgage Corporation			3,387				7				—				—				3,387				7
Collateralized mortgage obligations:
Federal National Mortgage Association			11,228				24				25,644				920				36,872				944
Federal Home Loan Mortgage Corporation			—				—				76,126				2,585				76,126				2,585
Government National Mortgage Association			—				—				2,510				40				2,510				40
Total collateralized mortgage obligations			11,228				24				104,280				3,545				115,508				3,569
Total mortgage-backed securities			16,857				39				166,872				4,801				183,729				4,840
Total available for sale securities			51,852				116				207,942				5,699				259,794				5,815
Securities held to maturity:
State and political subdivisions			18,036				120				—				—				18,036				120
Total temporarily impaired securities		$	69,888			$	236			$	207,942			$	5,699			$	277,830			$	5,935

The total number of security positions in the investment portfolio in an unrealized loss position at June 30, 2015 was 243 compared to 122 at December 31, 2014. At June 30, 2015, the Company had positions in 32 investment securities with a fair value of $142.8 million and a total unrealized loss of $4.1 million that have been in a continuous unrealized loss position for more than 12 months. At June 30, 2015, there were a total of 211 securities positions in the Company’s investment portfolio with a fair value of $365.8 million and a total unrealized loss of $5.6 million that had been in a continuous unrealized loss position for less than 12 months. At December 31, 2014, the Company had positions in 51 investment securities with a fair value of $207.9 million and a total unrealized loss of $5.7 million that have been in a continuous unrealized loss position for more than 12 months. At December 31, 2014, there were a total of 71 securities positions in the Company’s investment portfolio with a fair value of $69.9 million and a total unrealized loss of $236 thousand that had been in a continuous unrealized loss position for less than 12 months. The unrealized loss on investment securities was predominantly caused by changes in market interest rates subsequent to purchase. The fair value of most of the investment securities in the Company’s portfolio fluctuates as market interest rates change. The Company reviews investment securities on an ongoing basis for the presence of OTTI with formal reviews performed quarterly. When evaluating debt securities for OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the debt security or whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information then available to management. There was no impairment recorded during the six months ended June 30, 2015 and 2014.

Based on management’s review and evaluation of the Company’s debt securities as of June 30, 2015, the debt securities with unrealized losses were not considered to be OTTI. As of June 30, 2015, the Company did not intend to sell any of the securities in a loss position and believes that it is not likely that it will be required to sell any such securities before the anticipated recovery of amortized cost. Accordingly, as of June 30, 2015, management has concluded that unrealized losses on its investment securities are temporary and no further impairment loss has been realized in the Company’s consolidated statements of income.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS

The Company’s loan portfolio consisted of the following as of the dates indicated (in thousands):

 

		Principal Amount Outstanding				Net Deferred Loan Costs (Fees)				Loans, Net
June 30, 2015
Commercial business		$	292,674			$	117			$	292,791
Commercial mortgage			538,034				(1,444	)			536,590
Residential mortgage			95,259				(97	)			95,162
Home equity			391,645				7,209				398,854
Consumer indirect			641,871				24,679				666,550
Other consumer			19,141				185				19,326
Total		$	1,978,624			$	30,649				2,009,273
Allowance for loan losses											(27,500	)
Total loans, net										$	1,981,773
December 31, 2014
Commercial business		$	267,377			$	32			$	267,409
Commercial mortgage			476,407				(1,315	)			475,092
Residential mortgage			100,241				(140	)			100,101
Home equity			379,774				6,841				386,615
Consumer indirect			636,357				25,316				661,673
Other consumer			20,915				197				21,112
Total		$	1,881,071			$	30,931				1,912,002
Allowance for loan losses											(27,637	)
Total loans, net										$	1,884,365

Loans held for sale (not included above) were comprised entirely of residential real estate mortgages and totaled $448 thousand and $755 thousand as of June 30, 2015 and December 31, 2014, respectively.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Past Due Loans Aging

The Company’s recorded investment, by loan class, in current and nonaccrual loans, as well as an analysis of accruing delinquent loans is set forth as of the dates indicated (in thousands):

 

		30-59 Days Past Due				60-89 Days Past Due				Greater Than 90 Days				Total Past Due				Nonaccrual				Current				Total Loans
June 30, 2015
Commercial business		$	605			$	—			$	—			$	605			$	4,643			$	287,426			$	292,674
Commercial mortgage			606				—				—				606				3,070				534,358				538,034
Residential mortgage			192				—				—				192				1,628				93,439				95,259
Home equity			454				78				—				532				619				390,494				391,645
Consumer indirect			1,708				364				—				2,072				728				639,071				641,871
Other consumer			86				52				9				147				11				18,983				19,141
Total loans, gross		$	3,651			$	494			$	9			$	4,154			$	10,699			$	1,963,771			$	1,978,624
December 31, 2014
Commercial business		$	28			$	—			$	—			$	28			$	4,288			$	263,061			$	267,377
Commercial mortgage			83				—				—				83				3,020				473,304				476,407
Residential mortgage			321				—				—				321				1,194				98,726				100,241
Home equity			799				67				—				866				463				378,445				379,774
Consumer indirect			2,429				402				—				2,831				1,169				632,357				636,357
Other consumer			148				48				8				204				11				20,700				20,915
Total loans, gross		$	3,808			$	517			$	8			$	4,333			$	10,145			$	1,866,593			$	1,881,071

There were no loans past due greater than 90 days and still accruing interest as of June 30, 2015 and December 31, 2014. There were $9 thousand and $8 thousand in consumer overdrafts which were past due greater than 90 days as of June 30, 2015 and December 31, 2014, respectively. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not accrue interest.

Troubled Debt Restructurings

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession. Commercial loans modified in a TDR may involve temporary interest-only payments, term extensions, reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, collateral concessions, forgiveness of principal, forebearance agreements, or substituting or adding a new borrower or guarantor.

The following table presents information related to loans modified in a TDR during the quarterly periods indicated (dollars in thousands).

 

		Quarter-to-Date												Year-to-Date
		Number of Contracts				Pre- Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment				Number of Contracts				Pre-Modification Outstanding Recorded Investment				Post- Modification Outstanding Recorded Investment
June 30, 2015
Commercial business			2			$	1,342			$	1,342				2			$	1,342			$	1,342
Commercial mortgage			—				—				—				1				682				330
Total			2			$	1,342			$	1,342				3			$	2,024			$	1,672
June 30, 2014
Commercial business			1			$	1,381			$	1,381				1			$	1,381			$	1,381
Commercial mortgage			—				—				—				—				—				—
Total			1			$	1,381			$	1,381				1			$	1,381			$	1,381

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

The loans identified as a TDR by the Company during the six month periods ended June 30, 2015 and 2014 were previously on nonaccrual status and reported as impaired loans prior to restructuring. The modifications during the reported periods primarily related to extending amortization periods, forebearance agreements, requesting additional collateral and, in one instance, forgiveness of principal. Nonaccrual loans that are restructured remain on nonaccrual status, but may move to accrual status after they have performed according to the restructured terms for a period of time. The TDR classification did not have a material impact on the Company’s determination of the allowance for loan losses because the modified loans were impaired and evaluated for a specific reserve both before and after restructuring.

There were two commercial business loans with an aggregate pre-default balance of $1.3 million restructured in the 12 months prior to June 30, 2015 that went into default during the six months ended June 30, 2015. There were no loans modified as a TDR within the previous 12 months that defaulted during the six months ended June 30, 2014. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower becomes 90 days past due.

Impaired Loans

Management has determined that specific commercial loans on nonaccrual status and all loans that have had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents the recorded investment, unpaid principal balance and related allowance of impaired loans as of the dates indicated, and average recorded investment and interest income recognized on impaired loans for the six month periods ended as of the dates indicated (in thousands):

 

		Recorded Investment(1)				Unpaid Principal Balance(1)				Related Allowance				Average Recorded Investment				Interest Income Recognized
June 30, 2015
With no related allowance recorded:
Commercial business		$	1,348			$	2,807			$	—			$	1,461			$	—
Commercial mortgage			1,159				1,708				—				1,171				—
			2,507				4,515				—				2,632				—
With an allowance recorded:
Commercial business			3,295				3,295				1,247				3,093				—
Commercial mortgage			1,911				1,911				707				2,121				—
			5,206				5,206				1,954				5,214				—
		$	7,713			$	9,721			$	1,954			$	7,846			$	—
December 31, 2014
With no related allowance recorded:
Commercial business		$	1,408			$	1,741			$	—			$	1,431			$	—
Commercial mortgage			781				920				—				1,014				—
			2,189				2,661				—				2,445				—
With an allowance recorded:
Commercial business			2,880				2,880				1,556				1,998				—
Commercial mortgage			2,239				2,239				911				1,560				—
			5,119				5,119				2,467				3,558				—
		$	7,308			$	7,780			$	2,467			$	6,003			$	—

 

(1)	Difference between recorded investment and unpaid principal balance represents partial charge-offs.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors such as the fair value of collateral. The Company analyzes commercial business and commercial mortgage loans individually by classifying the loans as to credit risk. Risk ratings are updated any time the situation warrants. The Company uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans that do not meet the criteria above that are analyzed individually as part of the process described above are considered “uncriticized” or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.

The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of the dates indicated (in thousands):

 

		Commercial Business				Commercial Mortgage
June 30, 2015
Uncriticized		$	275,639			$	523,226
Special mention			5,078				6,015
Substandard			11,957				8,793
Doubtful			—				—
Total		$	292,674			$	538,034
December 31, 2014
Uncriticized		$	250,961			$	460,880
Special mention			5,530				5,411
Substandard			10,886				10,116
Doubtful			—				—
Total		$	267,377			$	476,407

The Company utilizes payment status as a means of identifying and reporting problem and potential problem retail loans. The Company considers nonaccrual loans and loans past due greater than 90 days and still accruing interest to be non-performing. The following table sets forth the Company’s retail loan portfolio, categorized by payment status, as of the dates indicated (in thousands):

 

		Residential Mortgage				Home Equity				Consumer Indirect				Other Consumer
June 30, 2015
Performing		$	93,631			$	391,026			$	641,143			$	19,121
Non-performing			1,628				619				728				20
Total		$	95,259			$	391,645			$	641,871			$	19,141
December 31, 2014
Performing		$	99,047			$	379,311			$	635,188			$	20,896
Non-performing			1,194				463				1,169				19
Total		$	100,241			$	379,774			$	636,357			$	20,915

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Allowance for Loan Losses

Loans and the related allowance for loan losses are presented below as of the dates indicated (in thousands):

 

		Commercial Business				Commercial Mortgage				Residential Mortgage				Home Equity				Consumer Indirect				Other Consumer				Total
June 30, 2015
Loans:
Ending balance		$	292,674			$	538,034			$	95,259			$	391,645			$	641,871			$	19,141			$	1,978,624
Evaluated for impairment:
Individually		$	4,643			$	3,070			$	—			$	—			$	—			$	—			$	7,713
Collectively		$	288,031			$	534,964			$	95,259			$	391,645			$	641,871			$	19,141			$	1,970,911
Allowance for loan losses:
Ending balance		$	5,334			$	9,358			$	465			$	1,198			$	10,676			$	469			$	27,500
Evaluated for impairment:
Individually		$	1,247			$	707			$	—			$	—			$	—			$	—			$	1,954
Collectively		$	4,087			$	8,651			$	465			$	1,198			$	10,676			$	469			$	25,546
June 30, 2014
Loans:
Ending balance		$	277,609			$	469,936			$	106,342			$	363,243			$	626,418			$	21,205			$	1,864,753
Evaluated for impairment:
Individually		$	3,589			$	2,734			$	—			$	—			$	—			$	—			$	6,323
Collectively		$	274,020			$	467,202			$	106,342			$	363,243			$	626,418			$	21,205			$	1,858,430
Allowance for loan losses:
Ending balance		$	5,402			$	7,633			$	618			$	1,607			$	11,446			$	460			$	27,166
Evaluated for impairment:
Individually		$	1,056			$	432			$	—			$	—			$	—			$	—			$	1,488
Collectively		$	4,346			$	7,201			$	618			$	1,607			$	11,446			$	460			$	25,678

The following table sets forth the changes in the allowance for loan losses for the three and six month periods ended June 30, 2015 (in thousands):

 

		Commercial Business				Commercial Mortgage				Residential Mortgage				Home Equity				Consumer Indirect				Other Consumer				Total
Three months ended June 30, 2015
Beginning balance		$	5,395			$	8,156			$	558			$	1,430			$	11,205			$	447			$	27,191
Charge-offs			13				201				22				154				1,841				154				2,385
Recoveries			86				7				13				9				1,196				95				1,406
Provision (credit)			(134	)			1,396				(84	)			(87	)			116				81				1,288
Ending balance		$	5,334			$	9,358			$	465			$	1,198			$	10,676			$	469			$	27,500
Six months ended June 30, 2015
Beginning balance		$	5,621			$	8,122			$	570			$	1,485			$	11,383			$	456			$	27,637
Charge-offs			1,154				810				77				238				4,263				413				6,955
Recoveries			134				96				46				19				2,301				193				2,789
Provision			733				1,950				(74	)			(68	)			1,255				233				4,029
Ending balance		$	5,334			$	9,358			$	465			$	1,198			$	10,676			$	469			$	27,500

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

The following table sets forth the changes in the allowance for loan losses for the three and six month periods ended June 30, 2014 (in thousands):

 

		Commercial Business				Commercial Mortgage				Residential Mortgage				Home Equity				Consumer Indirect				Other Consumer				Total
Three months ended June 30, 2014
Beginning balance		$	4,689			$	7,980			$	672			$	1,371			$	11,984			$	456			$	27,152
Charge-offs			3				165				69				156				2,331				224				2,948
Recoveries			68				6				8				29				995				98				1,204
Provision (credit)			648				(188	)			7				363				798				130				1,758
Ending balance		$	5,402			$	7,633			$	618			$	1,607			$	11,446			$	460			$	27,166
Six months ended June 30, 2014
Beginning balance		$	4,273			$	7,743			$	676			$	1,367			$	12,230			$	447			$	26,736
Charge-offs			71				165				147				262				4,786				493				5,924
Recoveries			97				13				29				40				2,100				211				2,490
Provision			1,103				42				60				462				1,902				295				3,864
Ending balance		$	5,402			$	7,633			$	618			$	1,607			$	11,446			$	460			$	27,166

Risk Characteristics

Commercial business loans primarily consist of loans to small to midsize businesses in our market area in a diverse range of industries. These loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. Risk arises primarily due to a difference between expected and actual cash flows of the borrowers. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than residential mortgage loans, potentially resulting in higher losses on an individual customer basis. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real estate market could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential mortgage loans and home equities (comprised of home equity loans and home equity lines) are generally made on the basis of the borrower’s ability to make repayment from his or her employment and other income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.

Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities, particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances such as job loss, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(6.) GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying amount of goodwill totaled $61.2 million as of June 30, 2015 and December 31, 2014. The Company performs a goodwill impairment test on an annual basis or more frequently if events and circumstances warrant.

The Company has other intangible assets that are amortized, consisting of core deposit intangibles and other intangibles (primarily related to customer relationships acquired in connection with the Company’s insurance agency acquisition). Changes in the gross carrying amount, accumulated amortization and net book value, were as follows (in thousands):

 

		June 30, 2015				December 31, 2014
Other intangibles assets:
Gross carrying amount		$	8,682			$	8,682
Accumulated amortization			(1,677	)			(1,196	)
Net book value		$	7,005			$	7,486

Amortization expense for total other intangible assets was $238 thousand and $481 thousand for the three and six months ended June 30, 2015, and $87 thousand and $176 thousand for the three and six months ended June 30, 2014, respectively. As of June 30, 2015, the estimated amortization expense of other intangible assets for the remainder of 2015 and each of the next five years is as follows (in thousands):

 

2015 (remainder of year)		$	461
2016			864
2017			778
2018			689
2019			611
2020			533

(7.) BORROWINGS

The Company classifies borrowings as short-term or long-term in accordance with the original terms of the agreement. Outstanding borrowings consisted of the following as of the dates indicated (in thousands):

 

		June 30, 2015				December 31, 2014
Short-term borrowings:
Short-term FHLB borrowings		$	350,600			$	295,300
Repurchase agreements			—				39,504
Total short-term borrowings			350,600				334,804
Long-term borrowings:
Subordinated notes, net			38,955				—
Total borrowings		$	389,555			$	334,804

Subordinated Notes

On April 15, 2015, the Company issued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the “Subordinated Notes”) to certain accredited investors. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to the April 15, 2030 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. The Subordinated Notes are redeemable by the Company at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. Proceeds, net of debt issuance costs of $1.1 million, were $38.9 million. The net proceeds from this offering were used for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both organic growth and opportunistic acquisitions. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.

The Company adopted ASU 2015-03 that requires debt issuance costs to be reported as a direct deduction from the face of the Notes and not as a deferred charge. Refer to Note 1 for additional information. The debt issuance costs will be amortized as an adjustment to interest expense over 15 years.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) SHAREHOLDERS’ EQUITY

Common Stock

The changes in shares of common stock were as follows for the six month periods ended June 30, 2015 and 2014:

 

		Outstanding				Treasury				Issued
June 30, 2015
Shares outstanding at December 31, 2014			14,118,048				279,461				14,397,509
Restricted stock awards issued			59,834				(59,834	)			—
Restricted stock awards forfeited			(3,041	)			3,041				—
Stock options exercised			8,722				(8,722	)			—
Treasury stock purchases			(1,791	)			1,791				—
Stock awards			2,363				(2,363	)			—
Shares outstanding at June 30, 2015			14,184,135				213,374				14,397,509
June 30, 2014
Shares outstanding at December 31, 2013			13,829,355				332,242				14,161,597
Restricted stock awards issued			43,242				(43,242	)			—
Restricted stock awards forfeited			(8,144	)			8,144				—
Stock options exercised			7,125				(7,125	)			—
Treasury stock purchases			(9,102	)			9,102				—
Shares outstanding at June 30, 2014			13,862,476				299,121				14,161,597

(9.) ACCUMULATED OTHER COMPREHENSIVE LOSS

The following table presents the components of other comprehensive income (loss) for the six month periods ended June 30, 2015 and 2014 (in thousands):

 

		Pre-tax Amount				Tax Effect				Net-of-tax Amount
June 30, 2015
Securities available for sale and transferred securities:
Change in unrealized gain/loss during the period		$	(3,590	)		$	(1,386	)		$	(2,204	)
Reclassification adjustment for net gains included in net income (1)			(1,208	)			(466	)			(742	)
Total securities available for sale and transferred securities			(4,798	)			(1,852	)			(2,946	)
Amortization of pension and post-retirement items:
Prior service credit			(24	)			(9	)			(15	)
Net actuarial losses			471				181				290
Total pension and post-retirement obligations			447				172				275
Other comprehensive loss		$	(4,351	)		$	(1,680	)		$	(2,671	)
June 30, 2014
Securities available for sale and transferred securities:
Change in unrealized gain/loss during the period		$	12,168			$	4,821			$	7,347
Reclassification adjustment for net gains included in net income (1)			(1,521	)			(602	)			(919	)
Total securities available for sale and transferred securities			10,647				4,219				6,428
Amortization of pension and post-retirement items:
Prior service credit			(24	)			(9	)			(15	)
Net actuarial losses			88				34				54
Total pension and post-retirement obligations			64				25				39
Other comprehensive income		$	10,711			$	4,244			$	6,467

 

(1)

Includes amounts related to the amortization/accretion of unrealized net gains and losses resulting from the Company’s reclassification of available for sale investment securities to the held to maturity category. The unrealized net gains/losses will be amortized/accreted over the remaining life of the investment securities as an adjustment of yield.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) ACCUMULATED OTHER COMPREHENSIVE LOSS (Continued)

 

Activity in accumulated other comprehensive loss, net of tax, for the six month periods ended June 30, 2015 and 2014 was as follows (in thousands):

 

		Securities Available for Sale and Transferred Securities				Pension and Post- retirement Obligations				Accumulated Other Comprehensive Loss
June 30, 2015
Balance at beginning of year		$	1,625			$	(10,636	)		$	(9,011	)
Other comprehensive income before reclassifications			(2,204	)			—				(2,204	)
Amounts reclassified from accumulated other comprehensive loss			(742	)			275				(467	)
Net current period other comprehensive income (loss)			(2,946	)			275				(2,671	)
Balance at end of period		$	(1,321	)		$	(10,361	)		$	(11,682	)
June 30, 2014
Balance at beginning of year		$	(5,337	)		$	(4,850	)		$	(10,187	)
Other comprehensive income before reclassifications			7,347				—				7,347
Amounts reclassified from accumulated other comprehensive loss			(919	)			39				(880	)
Net current period other comprehensive income			6,428				39				6,467
Balance at end of period		$	1,091			$	(4,811	)		$	(3,720	)

The following table presents the amounts reclassified out of each component of accumulated other comprehensive loss for six month periods ended June 30, 2015 and 2014 (in thousands):

 

Details About Accumulated Other Comprehensive Loss Components		Amount Reclassified from Accumulated Other Comprehensive Loss								Affected Line Item in the Consolidated Statement of Income
		Six months ended June 30,
		2015				2014
Realized gain on sale of investment securities		$	1,062			$	1,262			Net gain on disposal of investment securities
Amortization of unrealized holding gains (losses) on investment securities transferred from available for sale to held to maturity			146				259			Interest income
			1,208				1,521			Total before tax
			(466	)			(602	)		Income tax expense
			742				919			Net of tax
Amortization of pension and post-retirement items:
Prior service credit (1)			24				24			Salaries and employee benefits
Net actuarial losses (1)			(471	)			(88	)		Salaries and employee benefits
			(447	)			(64	)		Total before tax
			172				25			Income tax benefit
			(275	)			(39	)		Net of tax
Total reclassified for the period		$	467			$	880

 

(1)	These items are included in the computation of net periodic pension expense. See Note 11 – Employee Benefit Plans for additional information.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(10.) SHARE-BASED COMPENSATION PLANS

The Company maintains certain stock-based compensation plans that were approved by the Company’s shareholders and are administered by the Company’s Board of Directors, or the Management Development and Compensation Committee of the Board. The share-based compensation plans were established to allow for the grant of compensation awards to attract, motivate and retain employees, executive officers and non-employee directors who contribute to the success and profitability of the Company by giving such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.

The Company awarded grants of 36,384 shares of restricted common stock to certain members of management during the six months ended June 30, 2015. Thirty percent of the shares subject to each grant will be earned based upon achievement of an EPS performance requirement for the Company’s fiscal year ended December 31, 2015. The remaining seventy percent of the shares will be earned based on the Company’s achievement of a relative total shareholder return (“TSR”) performance requirement, on a percentile basis, compared to the SNL Small Cap Bank & Thrifts Index over a three-year performance period ended December 31, 2017. The shares earned based on the achievement of the EPS and TSR performance requirements, if any, will vest on February 25, 2018 assuming the recipient’s continuous service to the Company.

The grant-date fair value of the TSR portion of the award granted during the six month period ended June 30, 2015 was determined using the Monte Carlo simulation model on the date of grant, assuming the following (i) expected term of 2.85 years, (ii) risk free interest rate of 0.92%, (iii) expected dividend yield of 3.53% and (iv) expected stock price volatility over the expected term of the TSR award of 26.8%. The grant-date fair value of all other restricted stock awards is equal to the closing market price of the Company’s common stock on the date of grant.

The Company granted 12,700 additional shares of restricted common stock to management during the six months ended June 30, 2015. These shares will vest after completion of a three-year service requirement. The average market price of the restricted stock awards on the date of grant was $22.79.

During the six months ended June 30, 2015, the Company issued a total of 2,363 shares of common stock in-lieu of cash for the annual retainer of three non-employee directors and granted a total of 10,750 restricted shares of common stock to non-employee directors, of which 5,380 shares vested immediately and 5,370 shares will vest after completion of a one-year service requirement. The market price of the stock and restricted stock on the date of grant was $23.25.

The restricted stock awards granted to management and directors in 2015 do not have rights to dividends or dividend equivalents.

The following is a summary of restricted stock award activity for the six month period ended June 30, 2015:

 

						Weighted
						Average
						Market
		Number of Shares				Price at Grant Date
Outstanding at beginning of year			59,113			$	17.24
Granted			59,834				17.66
Vested			(16,458	)			20.80
Forfeited			(3,041	)			20.39
Outstanding at end of period			99,448			$	16.81

As of June 30, 2015, there was $1.1 million of unrecognized compensation expense related to unvested restricted stock awards that is expected to be recognized over a weighted average period of 2.1 years.

The Company amortizes the expense related to restricted stock awards over the vesting period. Share-based compensation expense is recorded as a component of salaries and employee benefits in the consolidated statements of income for awards granted to management and as a component of other noninterest expense for awards granted to directors. The share-based compensation expense included in the consolidated statements of income is as follows (in thousands):

 

		Three months ended								Six months ended
		June 30,								June 30,
		2015				2014				2015				2014
Salaries and employee benefits		$	113			$	75			$	191			$	156
Other noninterest expense			154				127				179				149
Total share-based compensation expense		$	267			$	202			$	370			$	305

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(10.) SHARE-BASED COMPENSATION PLANS (Continued)

 

The Company uses the Black-Scholes valuation method to estimate the fair value of its stock option awards. There were no stock options awarded during 2015 or 2014. The following is a summary of stock option activity for the six months ended June 30, 2015 (dollars in thousands, except per share amounts):

 

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Number of				Exercise				Contractual				Intrinsic
		Options				Price				Term				Value
Outstanding at beginning of year			135,416			$	19.25
Exercised			(8,722	)			18.96
Expired			(12,645	)			20.15
Outstanding and exercisable at end of period			114,049			$	19.17				1.7			$	646

The aggregate intrinsic value (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) of option exercises for the six months ended June 30, 2015 and 2014 was $39 thousand and $32 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for the six months ended June 30, 2015 and 2014 was $165 thousand and $132 thousand, respectively.

(11.) EMPLOYEE BENEFIT PLANS

The components of the Company’s net periodic benefit expense for its pension and post-retirement obligations were as follows (in thousands):

 

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Service cost		$	581			$	480			$	1,162			$	959
Interest cost on projected benefit obligation			583				573				1,166				1,147
Expected return on plan assets			(1,205	)			(1,030	)			(2,410	)			(2,059	)
Amortization of prior service credit			(12	)			(12	)			(24	)			(24	)
Amortization of net actuarial losses			235				44				471				88
Net periodic pension expense		$	182			$	55			$	365			$	111

The net periodic benefit expense is recorded as a component of salaries and employee benefits in the consolidated statements of income. The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of the Internal Revenue Code. The Company has no minimum required contribution for the 2015 fiscal year.

(12.) COMMITMENTS AND CONTINGENCIES

The Company has financial instruments with off-balance sheet risk established in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk extending beyond amounts recognized in the Company’s financial statements.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved with extending loans to customers. The Company uses the same credit underwriting policies in making commitments and conditional obligations as for on-balance sheet instruments.

Off-balance sheet commitments consist of the following (in thousands):

 

		June 30, 2015				December 31, 2014
Commitments to extend credit		$	487,114			$	450,343
Standby letters of credit			10,296				8,578

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses which may require payment by the customer

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

of a termination fee. Commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.

The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements, the Company may enter into forward commitments to sell individual residential mortgages. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value. Forward sales commitments totaled $274 thousand and $1.2 million at June 30, 2015 and December 31, 2014, respectively. In addition, the net change in the fair values of these derivatives was recognized as other noninterest income or other noninterest expense in the consolidated statements of income.

(13.) FAIR VALUE MEASUREMENTS

Determination of Fair Value – Assets Measured at Fair Value on a Recurring and Nonrecurring Basis

Valuation Hierarchy

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. There have been no changes in the valuation techniques used during the current period. The fair value hierarchy is as follows:

 

•

Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

•

Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

•

Level 3 - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Transfers between levels of the fair value hierarchy are recorded as of the end of the reporting period.

(13.) FAIR VALUE MEASUREMENTS (Continued)

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the issuer’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities available for sale: Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. 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.

 

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Notes to Consolidated Financial Statements (Unaudited)

 

Loans held for sale: The fair value of loans held for sale is determined using quoted secondary market prices and investor commitments. Loans held for sale are classified as Level 2 in the fair value hierarchy.

Collateral dependent impaired loans: Fair value of impaired loans with specific allocations of the allowance for loan losses is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and collateral value is determined based on appraisals performed by qualified licensed appraisers hired by the Company. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

Loan servicing rights: Loan servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of loan servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates. The significant unobservable inputs used in the fair value measurement of the Company’s loan servicing rights are the constant prepayment rates and weighted average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they will generally move in opposite directions. Loan servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other real estate owned (Foreclosed assets): Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Commitments to extend credit and letters of credit: Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value. The fair value of commitments is not material.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(13.) FAIR VALUE MEASUREMENTS (Continued)

Assets Measured at Fair Value

The following tables present for each of the fair-value hierarchy levels the Company’s assets that are measured at fair value on a recurring and non-recurring basis as of the dates indicated (in thousands).

 

		Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total
June 30, 2015
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	—			$	270,077			$	—			$	270,077
Mortgage-backed securities			—				502,337				—				502,337
Asset-backed securities			—				225				—				225
		$	—			$	772,639			$	—			$	772,639
Measured on a nonrecurring basis:
Loans:
Loans held for sale		$	—			$	448			$	—			$	448
Collateral dependent impaired loans			—				—				3,252				3,252
Other assets:
Loan servicing rights			—				—				1,289				1,289
Other real estate owned			—				—				165				165
		$	—			$	448			$	4,706			$	5,154
December 31, 2014
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises		$	—			$	160,475			$	—			$	160,475
Mortgage-backed securities			—				461,788				—				461,788
Asset-backed securities			—				231				—				231
		$	—			$	622,494			$	—			$	622,494
Measured on a nonrecurring basis:
Loans:
Loans held for sale		$	—			$	755			$	—			$	755
Collateral dependent impaired loans			—				—				2,652				2,652
Other assets:
Loan servicing rights			—				—				1,359				1,359
Other real estate owned			—				—				194				194
		$	—			$	755			$	4,205			$	4,960

There were no transfers between Levels 1 and 2 during the six months ended June 30, 2015 and 2014. There were no liabilities measured at fair value on a recurring or nonrecurring basis during the six month periods ended June 30, 2015 and 2014.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(13.) FAIR VALUE MEASUREMENTS (Continued)

 

The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis for which the Company has utilized Level 3 inputs to determine fair value (dollars in thousands).

 

Asset		Fair Value				Valuation Technique		Unobservable Input		Unobservable Input Value or Range
Collateral dependent impaired loans		$	3,252			Appraisal of collateral (1)		Appraisal adjustments (2)		0% - 100% discount
						Discounted cash flow		Discount rate		4.4%(3)
								Risk premium rate		10.0%(3)
Loan servicing rights			1,289			Discounted cash flow		Discount rate		5.1%(3)
								Constant prepayment rate		12.9%(3)
Other real estate owned			165			Appraisal of collateral (1)		Appraisal adjustments (2)		19% - 53 % discount

 

(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.

(2)	Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

(3)	Weighted averages.

Changes in Level 3 Fair Value Measurements

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of or during the six months ended June 30, 2015.

Disclosures about Fair Value of Financial Instruments

The assumptions used below are expected to approximate those that market participants would use in valuing these financial instruments.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

The estimated fair value approximates carrying value for cash and cash equivalents, Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock, accrued interest receivable, non-maturity deposits, short-term borrowings and accrued interest payable. Fair value estimates for other financial instruments not included elsewhere in this disclosure are discussed below.

Securities held to maturity: The fair value of the Company’s investment securities held to maturity is primarily measured using information from a third-party pricing service. 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.

Loans: The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made for the same remaining maturities. Loans were first segregated by type such as commercial, residential mortgage, and consumer, and were then further segmented into fixed and variable rate and loan quality categories. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time deposits: The fair value of time deposits was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments. The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Long-term borrowings: Long-term borrowings consist of $40 million of subordinated notes issued during the second quarter of 2015. The subordinated notes are publicly traded and are valued based on market prices, which are characterized as Level 2 liabilities in the fair value hierarchy.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(13.) FAIR VALUE MEASUREMENTS (Continued)

 

The following presents (in thousands) the carrying amount, estimated fair value, and placement in the fair value measurement hierarchy of the Company’s financial instruments as of the dates indicated.

 

		Level in		June 30, 2015								December 31, 2014
		Fair Value						Estimated								Estimated
		Measurement		Carrying				Fair				Carrying				Fair
		Hierarchy		Amount				Value				Amount				Value
Financial assets:
Cash and cash equivalents		Level 1		$	52,554			$	52,554			$	58,151			$	58,151
Securities available for sale		Level 2			772,639				772,639				622,494				622,494
Securities held to maturity		Level 2			320,820				324,873				294,438				298,695
Loans held for sale		Level 2			448				448				755				755
Loans		Level 2			1,978,521				1,987,842				1,881,713				1,887,959
Loans (1)		Level 3			3,252				3,252				2,652				2,652
Accrued interest receivable		Level 1			8,623				8,623				8,104				8,104
FHLB and FRB stock		Level 2			21,558				21,558				19,014				19,014
Financial liabilities:
Non-maturity deposits		Level 1			2,043,219				2,043,219				1,857,285				1,857,285
Time deposits		Level 2			613,019				614,066				593,242				593,793
Short-term borrowings		Level 1			350,600				350,600				334,804				334,804
Long-term borrowings		Level 2			38,955				38,555				—				—
Accrued interest payable		Level 1			5,101				5,101				3,862				3,862

 

(1)	Comprised of collateral dependent impaired loans.

(14.) SEGMENT REPORTING

The Company has two reportable operating segments, banking and insurance, which are delineated by the consolidated subsidiaries of Financial Institutions, Inc. The banking segment includes all of the Company’s retail and commercial banking operations. The insurance segment includes the activities of SDN, a full service insurance agency that provides a broad range of insurance services to both personal and business clients. The Company operated as one business segment until the acquisition of SDN on August 1, 2014, at which time the new “Insurance” segment was created for financial reporting purposes. Holding company amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the “Holding Company and Other” column below, along with amounts to eliminate balances and transactions between segments.

The following tables present information regarding the Company’s business segments as of and for the periods indicated (in thousands).

 

		Banking				Insurance				Holding Company and Other				Consolidated Totals
June 30, 2015
Goodwill		$	48,536			$	12,617			$	—			$	61,153
Other intangible assets, net			972				6,033				—				7,005
Total assets			3,337,787				20,960				712				3,359,459
December 31, 2014
Goodwill		$	48,536			$	12,617			$	—			$	61,153
Other intangible assets, net			1,125				6,361				—				7,486
Total assets			3,065,109				20,368				4,044				3,089,521

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(14.) SEGMENT REPORTING (Continued)

 

		Banking				Insurance				Holding Company and Other				Consolidated Totals
Three months ended June 30, 2015
Net interest income		$	23,919			$	—			$	(515	)		$	23,404
Provision for loan losses			(1,288	)			—				—				(1,288	)
Noninterest income			5,522				1,033				(100	)			6,455
Noninterest expense			(17,668	)			(1,050	)			(518	)			(19,236	)
Income (loss) before income taxes			10,485				(17	)			(1,133	)			9,335
Income tax (expense) benefit			(3,107	)			5				352				(2,750	)
Net income (loss)		$	7,378			$	(12	)		$	(781	)		$	6,585
Six months ended June 30, 2015
Net interest income		$	47,066			$	—			$	(515	)		$	46,551
Provision for loan losses			(4,029	)			—				—				(4,029	)
Noninterest income			12,353				2,626				(227	)			14,752
Noninterest expense			(34,947	)			(2,237	)			(1,063	)			(38,247	)
Income (loss) before income taxes			20,443				389				(1,805	)			19,027
Income tax (expense) benefit			(6,056	)			(154	)			569				(5,641	)
Net income (loss)		$	14,387			$	235			$	(1,236	)		$	13,386

 

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ITEM 2.

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

This Quarterly Report on Form 10-Q should be read in conjunction with the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2014. In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.

FORWARD LOOKING INFORMATION

Statements and financial analysis contained in this document that are based on other than historical data are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:

 

•

statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Financial Institutions, Inc. and our subsidiaries; and

 

•

statements preceded by, followed by or that include the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “projects,” or similar expressions.

These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this document and our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which we refer to as the Form 10-K, including, but not limited to, those presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations. Factors that might cause such differences include, but are not limited to:

 

•

greater credit losses than anticipated;

 

•

changes in our tax strategies and the value of our deferred tax assets;

 

•

limited geographic concentration;

 

•

failure to obtain accurate and complete information about or from customers and counterparties;

 

•

insurance industry risks on our insurance brokerage subsidiary;

 

•

environmental liability risk associated with our lending activities;

 

•

changes in the quality or composition of our loan or investment portfolios;

 

•

risks through our indirect lending;

 

•

changes in banking laws, regulations and regulatory practices;

 

•

new or changing tax and accounting rules and interpretations;

 

•

legal and regulatory proceedings and related matters;

 

•

a breach in security of our information systems, including the occurrence of a cyber incident or a deficiency in cyber security;

 

•

technological changes;

 

•

failure of other companies to provide key components of our business infrastructure;

 

•

incorrect modeling assumptions for business planning purposes;

 

•

the failure to attract and retain skilled people;

 

•

interest rate risk, changes in interest rate risk and changes in real estate values;

 

•

conditions in the financial markets and economic conditions generally;

 

•

the fiscal and monetary policies of the federal government and its agencies;

 

•

goodwill impairment;

 

•

competition in our market area; and

 

•

severe weather, natural disasters, acts of war or terrorism, and other external events.

We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advise readers that various factors, including those described above, could affect our financial performance and could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected. See also Item 1A, Risk Factors in the Form 10-K for further information. Except as required by law, we do not undertake, and specifically disclaim any obligation 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.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

GENERAL

Financial Institutions, Inc. (the “Parent”) is a financial holding company headquartered in New York State, providing banking and nonbanking financial services to individuals, municipalities and businesses primarily in Western and Central New York. We offer a broad array of deposit, lending and other financial services to individuals, municipalities and businesses primarily in Western and Central New York through our wholly-owned New York chartered banking subsidiary, Five Star Bank. Our indirect lending network includes relationships with franchised automobile dealers in Western and Central New York, the Capital District of New York and Northern Pennsylvania. We also offer insurance services through our wholly-owned insurance subsidiary, Scott Danahy Naylon, LLC (“SDN”), a full service insurance agency which we acquired during the third quarter of 2014. References in this report to “the Company”, “we”, “our” or “us” mean the consolidated reporting entity and references to “the Bank” mean Five Star Bank.

Our primary sources of revenue are net interest income (interest earned on our loans and securities, net of interest paid on deposits and other funding sources) and noninterest income, particularly fees and other revenue from insurance and financial services provided to customers or ancillary services tied to loans and deposits. Business volumes and pricing drive revenue potential, and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth, and competitive conditions within the marketplace. We are not able to predict market interest rate fluctuations with certainty and our asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on our results of operations and financial condition.

Our business strategy has been to maintain a community bank philosophy, which consists of focusing on and understanding the individualized banking needs of individuals, municipalities and businesses of the local communities surrounding our primary service areas. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service that differentiates us from larger competitors, resulting in long-standing and broad based banking relationships. Our core customers are primarily small to medium-sized businesses, individuals and community organizations, which prefer to build banking and insurance relationships with a community bank that combines high quality, competitively-priced products and services with personalized service. Because of our identity and origin as a locally operated bank, we believe that our level of personal service provides a competitive advantage over larger banks, which tend to consolidate decision-making authority outside local communities.

A key aspect of our current business strategy is to foster a community-oriented culture where our customers and employees establish long-standing and mutually beneficial relationships. We believe that we are well-positioned to be a strong competitor within our market area because of our focus on community banking needs and customer service, our comprehensive suite of deposit, loan and insurance products typically found at larger banks, our highly experienced management team and our strategically located banking centers. We believe that the foregoing factors all help to grow our core deposits, which supports a central element of our business strategy - the growth of a diversified and high-quality loan portfolio.

EXECUTIVE OVERVIEW

Summary of 2015 Second Quarter Results

Net income decreased $447 thousand or 6% to $6.6 million for the second quarter of 2015 compared to $7.0 million for the second quarter of 2014. Net income available to common shareholders for the second quarter of 2015 was $6.2 million, or $0.44 per diluted share, compared with $6.7 million, or $0.48 per diluted share, for the second quarter of last year. Return on average common equity was 9.24% and return on average assets was 0.81% for the second quarter of 2015 compared to 10.66% and 0.95%, respectively, for the second quarter of 2014.

Competitive pricing pressure in all loan categories and the continuation of a low interest-rate environment, along with our diminishing ability to reduce our cost of funds, continues to place pressure on our net interest margin and net interest income. Net interest income totaled $23.4 million in the second quarter 2015, up from $23.1 million in the second quarter 2014. Average earning assets were up $240.8 million, led by a $153.8 million increase in investment securities and an $87.1 million increase in loans in the second quarter of 2015 compared to the same quarter in 2014. The growth in earning assets was partially offset by a lower net interest margin. Second quarter 2015 net interest margin was 3.24%, a decrease of 23 basis points from 3.47% reported in the second quarter of 2014. The decrease in net interest margin reflects lower yields on average earning assets as a result of the low interest rate environment, a slight shift in the composition of average earnings assets as well as increased interest expense related to the subordinated debt issued in April 2015. Average loans and average securities totaled 65.6% and 34.4%, respectively, of average earning assets for the quarter ended June 30, 2015, compared with 68.2% and 31.8%, respectively for the quarter ended June 30, 2014. The $40.0 million subordinated debt issuance completed in April 2015 strengthened the Bank’s capital ratios but reduced the net interest margin in the second quarter by approximately 8 basis points.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The provision for loans losses was $1.3 million in the second quarter of 2015 compared to $1.8 million in the second quarter of 2014, primarily a result of a decrease in net charge-offs when comparing the same periods. Net charge-offs were $979 thousand during the second quarter of 2015, a $765 thousand decrease from the second quarter of 2014. Net charge-offs expressed as an annualized percentage of average loans outstanding were 0.20% during the second quarter of 2015 compared with 0.37% in the second quarter of 2014. See the “Allowance for Loan Losses” and “Non-Performing Assets and Potential Problem Loans” sections of this Management’s Discussion and Analysis for further discussion regarding the decreases in the provision for loan losses and net-charge-offs.

Noninterest income totaled $6.5 million in the second quarter of 2015, compared to $6.6 million in the second quarter of 2014. Included in these totals are gains realized from the sale of investment securities. Exclusive of those gains, noninterest income was $6.5 million in the recently completed quarter and $5.6 million in the second quarter of 2014. The higher noninterest income in the second quarter of 2015 compared to the second quarter of 2014 is primarily a result of a $1.0 million increase in insurance income, reflecting the contributions from SDN.

Noninterest expense in the second quarter of 2015 totaled $19.2 million compared with $17.8 million in the second quarter of 2014. The increase in noninterest expense was largely due to expense attributable to SDN, which we did not own until the third quarter of 2014, and the hiring of additional personnel associated with our expansion initiatives.

The regulatory common equity Tier 1 ratio and total risk-based capital ratio were 9.50%, and 13.17%, respectively, for the second quarter of 2015. See the “Liquidity and Capital Management” section of this Management’s Discussion and Analysis for further discussion regarding regulatory capital and the Basel III capital rules, which became effective January 1, 2015.

Issuance of Subordinated Notes

On April 15, 2015, the Parent issued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the “Subordinated Notes”) to certain accredited investors. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to April 15, 2030, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. The Subordinated Notes are redeemable by us at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. The net proceeds from this offering were intended for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both organic growth as well as opportunistic acquisitions. The Parent company contributed $34.0 million of net proceeds from this offering to the Bank as capital to support general corporate purposes. The notes qualify as Tier 2 capital for regulatory purposes.

We utilized the proceeds of the Subordinated Notes to purchase high-quality investment securities, comprised of mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. All of the securities purchased were of high credit quality with a low to moderate duration. The issuance of the Subordinated Notes decreased second quarter 2015 net interest margin by approximately 8 basis points.

RESULTS OF OPERATIONS

Net Interest Income and Net Interest Margin

Net interest income is the primary source of our revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities and repricing frequencies.

Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and shareholders’ equity, also support earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt investment securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table reconciles interest income per the consolidated statements of income to interest income adjusted to a fully taxable equivalent basis (dollars in thousands):

 

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Interest income per consolidated statements of income		$	25,959			$	24,883			$	50,956			$	49,942
Adjustment to fully taxable equivalent basis			777				701				1,529				1,396
Interest income adjusted to a fully taxable equivalent basis			26,736				25,584				52,485				51,338
Interest expense per consolidated statements of income			2,555				1,780				4,405				3,564
Net interest income on a taxable equivalent basis		$	24,181			$	23,804			$	48,080			$	47,774

2015 Leverage Strategy

During the second quarter of 2015, we utilized the proceeds of short-term FHLB advances to purchase high-quality investment securities of approximately $50 million. Our purchase of investment securities was comprised of mortgage-backed securities, U.S. Government agencies and sponsored enterprise bonds and tax-exempt municipal bonds. All of the securities purchased were of high credit quality with a low to moderate duration. This strategy allowed us to increase net interest income by taking advantage of the positive interest rate spread between the FHLB advances and the newly acquired investment securities.

Analysis of Net Interest Income for the Three Months ended June 30, 2015 and 2014

Net interest income on a taxable equivalent basis for the three months ended June 30, 2015, was $24.2 million, an increase of $377 thousand or 2% versus the comparable quarter last year. The increase in net interest income was due to an increase in average earning assets of $240.8 million or 9% compared to the second quarter of 2014. The increase in earning assets included an $87.1 million increase in average loans and a $153.8 million increase in average investment securities.

The net interest margin for the second quarter of 2015 was 3.24%, 23 basis points lower than 3.47% for the same period in 2014. This comparable period decrease was a function of a 25 basis point decrease in interest rate spread, partially offset by a higher contribution from net free funds of 2 basis points (due principally to lower rates on interest-bearing liabilities reducing the value of noninterest-bearing deposits and other net free funds). The lower interest rate spread was a result of a 15 basis point decrease in the yield on earning assets and a 10 basis point increase in the cost of interest-bearing liabilities. As previously discussed, the issuance of the Subordinated Notes reduced the net interest margin for the second quarter of 2015 by approximately 8 basis points.

For the second quarter of 2015, the yield on average earning assets of 3.58% was 15 basis points lower than the second quarter of 2014. Loan yields decreased 14 basis points during the second quarter of 2015 to 4.18%. Commercial business and commercial mortgage loan yields in particular, down 13 and 23 basis points, respectively, experienced lower yields because of competitive pricing pressures in a low interest rate environment. The yield on investment securities decreased 1 basis point during the second quarter of 2015 to 2.44%. Overall, the earning asset rate changes reduced interest income by $619 thousand during the second quarter of 2015, but that was more than offset by a favorable volume variance that increased interest income by $1.8 million, which collectively drove a $1.2 million increase in interest income.

The cost of average interest-bearing liabilities of 0.43% in the second quarter of 2015 was 10 basis points higher than the second quarter of 2014. The cost of average interest-bearing deposits and short-term borrowings each increased 2 basis points to 0.35% and 0.38%, respectively, in the second quarter of 2015 compared to the same quarter of 2014. The cost of long-term borrowings for the second quarter of 2015 was 6.23% due to the issuance of the Subordinated Notes in April. Overall, interest-bearing liability rate and volume increases resulted in $775 thousand of higher interest expense.

Average interest-earning assets were $2.99 billion for the second quarter 2015, an increase of $240.8 million or 9% from the comparable quarter last year, with average loans up $87.1 million and average securities up $153.8 million. The growth in average loans was comprised of increases in most loan categories, with consumer and commercial loans up $54.3 million and $44.9 million, respectively, partially offset by a $12.1 million decrease in residential mortgage loans. Loans represented 65.6% of average interest-earning assets during second quarter of 2015 compared to 68.2% during the second quarter of 2014. The yield on average loans was 4.18% for the second quarter of 2015, a decrease of 14 basis points compared to 4.32% for the second quarter of 2014. The yield on average loans was negatively impacted by lower average spreads due to increased competition in loan pricing during 2015 compared to 2014. The growth in average securities was primarily a result of securities purchased with proceeds from our previously described leverage strategy and issuance of the Subordinated Notes. Securities represented 34.4% of average interest-earning assets during second quarter of 2015 compared to 31.8% during the second quarter of 2014. The increase in the volume of average securities resulted in a $920 thousand increase in interest income, coupled with a $16 thousand increase due to the favorable rate variance.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Average interest-bearing liabilities of $2.37 billion in the second quarter of 2015 were $212.9 million or 10% higher than the second quarter of 2014. On average, interest-bearing deposits grew $178.1 million, while noninterest-bearing demand deposits (a principal component of net free funds) were up $49.5 million. The increase in average deposits was largely due to an increase in deposits from our Insured Cash Sweep (“ICS”) programs. For further discussion of the Certificate of Deposit Account Registry Service (“CDARS”) and ICS programs, refer to the “Funding Activities - Deposits” section of this Management’s Discussion and Analysis. Overall, interest-bearing deposit rate and volume changes resulted in $250 thousand of higher interest expense during the second quarter of 2015. Average short-term and long-term borrowings increased $1.8 million and $33.1 million, respectively, between the second quarter periods. The increase in average long-term borrowings for the second quarter of 2015 was due to the issuance of the Subordinated Notes in April.

Analysis of Net Interest Income for the Six Months ended June 30, 2015 and June 30, 2014

Net interest income on a taxable equivalent basis for the first six months of 2015 was $48.1 million compared to $47.8 million for the same period last year. The increase in net interest income was due to an increase in average earning assets of $155.4 million or 6% compared to the first six months of 2014.

The net interest margin for the first six months of 2015 was 3.33%, 16 basis points lower than 3.49% for the same period last year. This comparable period decrease was a function of an 18 basis point decrease in interest rate spread to 3.25% during the first six months of 2015, partially offset by a 2 basis point higher contribution from net free funds. The lower interest rate spread was a net result of a 13 basis point decrease in the yield on earning assets and a 5 basis point increase in the cost of interest-bearing liabilities.

The yield on earning assets was 3.63% for the first six months of 2015, 13 basis points lower than the same period last year, primarily attributable to a decrease in the yields on the loan portfolio during the period (down 17 basis points to 4.22%), partially offset by an increase in the yields on the investment securities portfolio (up 2 basis points, to 2.46%). Overall, earning asset rate changes reduced interest income by $1.3 million during the first half of 2015, but that was more than offset by a favorable volume variance that increased interest income by $2.4 million, which collectively drove a $1.1 million increase in interest income.

The cost on interest-bearing liabilities of 0.38% for the first six months of 2015 was 5 basis points higher than the same period in 2014. Rates on interest-bearing deposits were up 1 basis point to 0.34%. The cost of long-term borrowings for the first half of 2015 was 6.20% due to the issuance of the Subordinated Notes in April. Overall, interest-bearing liability rate and volume increases resulted in $841 thousand of higher interest expense.

Average interest-earning assets were $2.91 billion for the first six months of 2015, an increase of $155.4 million or 6% from the comparable period last year, with average loans up $76.6 million and average securities up $79.0 million. The growth in average loans was comprised of increases in most loan categories, with commercial and consumer loans up $25.4 million and $64.3 million, respectively, partially offset by a $13.1 million decrease in residential mortgage loans.

Average interest-bearing liabilities of $2.31 billion in the first six months of 2015 were $146.4 million or 7% higher than the first six months of 2014. On average, interest-bearing deposits grew $140.2 million, while noninterest-bearing demand deposits were up $44.9 million and average short-term borrowings decreased $10.4 million. Average long-term borrowings increased $16.6 million during the first half of 2015 due to the issuance of the Subordinated Notes in April.

 

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The following tables set forth certain information relating to the consolidated balance sheets and reflects the average yields earned on interest-earning assets, as well as the average rates paid on interest-bearing liabilities for the periods indicated (in thousands).

 

		Three months ended June 30,
		2015												2014
		Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate
Interest-earning assets:
Federal funds sold and interest-earning deposits		$	26			$	—				0.39	%		$	94			$	—				0.07	%
Investment securities (1):
Taxable			741,355				4,069				2.20				621,967				3,353				2.16
Tax-exempt (2)			288,285				2,221				3.08				253,888				2,001				3.15
Total investment securities			1,029,640				6,290				2.44				875,855				5,354				2.45
Loans:
Commercial business			284,535				2,922				4.12				275,105				2,912				4.25
Commercial mortgage			509,317				5,823				4.59				473,883				5,692				4.82
Residential mortgage			96,474				1,134				4.70				108,535				1,306				4.81
Home equity			390,135				3,733				3.84				346,911				3,428				3.96
Consumer indirect			664,222				6,281				3.79				651,150				6,297				3.88
Other consumer			18,848				553				11.76				20,855				595				11.44
Total loans			1,963,531				20,446				4.18				1,876,439				20,230				4.32
Total interest-earning assets			2,993,197				26,736				3.58				2,752,388				25,584				3.73
Allowance for loan losses			(27,924	)											(27,551	)
Other noninterest-earning assets			297,838												248,898
Total assets		$	3,263,111											$	2,973,735
Interest-bearing liabilities:
Deposits:
Interest-bearing demand		$	561,570			$	197				0.14	%		$	509,398			$	151				0.12	%
Savings and money market			929,701				289				0.12				789,956				232				0.12
Time deposits			616,145				1,341				0.87				629,945				1,194				0.76
Total interest-bearing deposits			2,107,416				1,827				0.35				1,929,299				1,577				0.33
Short-term borrowings			226,577				213				0.38				224,801				203				0.36
Long-term borrowings			33,053				515				6.23				—				—				—
Total borrowings			259,630				728				1.12				224,801				203				0.36
Total interest-bearing liabilities			2,367,046				2,555				0.43				2,154,100				1,780				0.33
Noninterest-bearing demand deposits			587,396												537,895
Other noninterest-bearing liabilities			21,320												13,583
Shareholders’ equity			287,349												268,157
Total liabilities and shareholders’ equity		$	3,263,111											$	2,973,735
Net interest income (tax-equivalent)						$	24,181											$	23,804
Interest rate spread											3.15	%											3.40	%
Net earning assets		$	626,151											$	598,288
Net interest margin (tax-equivalent)											3.24	%											3.47	%
Ratio of average interest-earning assets to average interest-bearing liabilities											126.45	%											127.77	%

 

(1)	Investment securities are shown at amortized cost and include non-performing securities.

(2)	The interest on tax-exempt securities is calculated on a tax equivalent basis assuming a Federal tax rate of 35%.

 

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		Six months ended June 30,
		2015												2014
		Average								Average				Average								Average
		Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Federal funds sold and interest-earning deposits		$	75			$	—				0.23	%		$	204			$	—				0.08	%
Investment securities (1):
Taxable			686,299				7,532				2.20				638,151				6,854				2.15
Tax-exempt (2)			282,792				4,370				3.09				251,917				3,987				3.17
Total investment securities			969,091				11,902				2.46				890,068				10,841				2.44
Loans:
Commercial business			274,729				5,646				4.14				270,148				5,823				4.35
Commercial mortgage			494,095				11,374				4.64				473,312				11,198				4.77
Residential mortgage			97,861				2,308				4.72				110,949				2,679				4.83
Home equity			388,102				7,445				3.87				337,922				6,711				4.00
Consumer indirect			662,982				12,707				3.86				646,720				12,881				4.02
Other consumer			19,290				1,103				11.53				21,455				1,205				11.32
Total loans			1,937,059				40,583				4.22				1,860,506				40,497				4.39
Total interest-earning assets			2,906,225				52,485				3.63				2,750,778				51,338				3.76
Allowance for loan losses			(27,904	)											(27,153	)
Other noninterest-earning assets			311,400												245,966
Total assets		$	3,189,721											$	2,969,591
Interest-bearing liabilities:
Deposits:
Interest-bearing demand		$	556,564			$	353				0.13	%		$	510,231			$	311				0.12	%
Savings and money market			884,709				506				0.12				775,956				467				0.12
Time deposits			609,169				2,588				0.86				624,068				2,324				0.75
Total interest-bearing deposits			2,050,442				3,447				0.34				1,910,255				3,102				0.33
Short-term borrowings			239,103				443				0.37				249,470				462				0.37
Long-term borrowings			16,618				515				6.20				—				—				—
Total borrowings			255,721				958				0.75				249,470				462				0.37
Total interest-bearing liabilities			2,306,163				4,405				0.38				2,159,725				3,564				0.33
Noninterest-bearing demand deposits			576,011												531,158
Other noninterest-bearing liabilities			21,386												13,800
Shareholders’ equity			286,161												264,908
Total liabilities and shareholders’ equity		$	3,189,721											$	2,969,591
Net interest income (tax-equivalent)						$	48,080											$	47,774
Interest rate spread											3.25	%											3.43	%
Net earning assets		$	600,062											$	591,053
Net interest margin (tax-equivalent)											3.33	%											3.49	%
Ratio of average interest-earning assets to average interest-bearing liabilities											126.02	%											127.37	%

 

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The following table presents, on a tax equivalent basis, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest income not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

 

		Three months ended June 30, 2015 vs. 2014												Six months ended June 30, 2015 vs. 2014
		Volume				Rate				Total				Volume				Rate				Total
Increase (decrease) in:
Interest income:
Federal funds sold and interest-earning deposits		$	—			$	—			$	—			$	—			$	—			$	—
Investment securities:
Taxable			654				62				716				526				152				678
Tax-exempt			266				(46	)			220				479				(96	)			383
Total investment securities			920				16				936				1,005				56				1,061
Loans:
Commercial business			98				(88	)			10				98				(275	)			(177	)
Commercial mortgage			413				(282	)			131				483				(307	)			176
Residential mortgage			(143	)			(29	)			(172	)			(310	)			(61	)			(371	)
Home equity			417				(112	)			305				969				(235	)			734
Consumer indirect			125				(141	)			(16	)			319				(493	)			(174	)
Other consumer			(59	)			17				(42	)			(124	)			22				(102	)
Total loans			851				(635	)			216				1,435				(1,349	)			86
Total interest income			1,771				(619	)			1,152				2,440				(1,293	)			1,147
Interest expense:
Deposits:
Interest-bearing demand			16				30				46				29				13				42
Savings and money market			42				15				57				63				(24	)			39
Time deposits			(27	)			174				147				(56	)			320				264
Total interest-bearing deposits			31				219				250				36				309				345
Short-term borrowings			2				8				10				(19	)			—				(19	)
Long-term borrowings			258				257				515				258				257				515
Total borrowings			260				265				525				239				257				496
Total interest expense			291				484				775				275				566				841
Net interest income		$	1,480			$	(1,103	)		$	377			$	2,165			$	(1,859	)		$	306

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. There were provisions for loan losses of $1.3 million and $4.0 million for the three and six month periods ended June 30, 2015, compared with provisions of $1.8 million and $3.9 million for the corresponding periods in 2014, respectively. See the “Allowance for Loan Losses” and “Non-Performing Assets and Potential Problem Loans” sections of this Management’s Discussion and Analysis for further discussion.

 

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Noninterest Income

The following table details the major categories of noninterest income for the periods presented (in thousands):

 

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Service charges on deposits		$	1,964			$	2,241			$	3,843			$	4,491
Insurance income			1,057				16				2,665				57
ATM and debit card			1,283				1,257				2,476				2,431
Investment advisory			541				561				1,028				1,123
Company owned life insurance			493				425				960				828
Investments in limited partnerships			55				81				529				707
Loan servicing			96				176				263				330
Net gain on sale of loans held for sale			39				50				108				155
Net gain on disposal of investment securities			—				949				1,062				1,262
Net gain (loss) on disposal of other assets			16				24				20				(11	)
Other			911				797				1,798				1,561
Total noninterest income		$	6,455			$	6,577			$	14,752			$	12,934

Service charges on deposit accounts decreased $277 thousand or 12% in the second quarter of 2015 and $648 thousand or 14% for the six months ended June 30, 2015, compared to the same periods a year earlier. The decreases were primarily due to a decrease in the amount of checking account overdraft activity.

Insurance income increased $1.0 million and $2.6 million for the three and six months ended June 30, 2015, respectively, over the same periods in 2014. The increases reflect the contributions from SDN, which was acquired during the third quarter 2014 as part of the Company’s strategy to diversify its business lines and increase noninterest income through additional fee-based services.

Investment advisory income decreased $20 thousand or 4% and $95 thousand or 8%, in the three and six months ended June 30, 2015, respectively, compared to the same periods of 2014. Investment advisory income fluctuates mainly due to sales volume, which decreased during the first half of 2015.

Company owned life insurance increased by $68 thousand or 16% in the second quarter of 2015 and $132 thousand or 16% for the six months ended June 30, 2015, compared to the same periods a year earlier. The increases were primarily due to new policies purchased during the third and fourth quarters of 2014.

We have investments in limited partnerships, primarily small business investment companies, and account for these investments under the equity method. Income from investments in limited partnerships was $55 thousand and $529 thousand for the three and six months ended June 30, 2015, respectively. The income from these equity method investments fluctuates based on the performance of the underlying investments.

Loan servicing income decreased $80 thousand and $67 thousand during the three and six months ended June 30, 2015, compared to the same periods a year earlier, primarily due to lower fees collected as a result of a decrease in the sold and serviced portfolio.

During the first quarter of 2015 we recognized net gains on investment securities totaling $1.1 million from the sale of six agency securities and nine mortgage backed securities. There were no sales of securities during the second quarter of 2015. We recognized pre-tax gains on investment securities of $313 thousand from the sale of 6 securities during the first quarter of 2014 and gains of $949 thousand from the sale of 15 securities during the second quarter of 2014. The amount and timing of our sale of investments securities is dependent on a number of factors, including our prudent efforts to realize gains while managing duration, premium and credit risk.

Other noninterest income increased $114 thousand or 14% in the second quarter of 2015 and $237 thousand or 15% for the six months ended June 30, 2015, compared to the same periods a year earlier. Merchant services income and credit card correspondent income comprised the majority of the comparable increases.

 

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Noninterest Expense

The following table details the major categories of noninterest expense for the periods presented (in thousands):

 

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Salaries and employee benefits		$	10,606			$	9,063			$	20,829			$	18,319
Occupancy and equipment			3,375				3,139				7,074				6,374
Professional services			866				1,384				1,834				2,356
Computer and data processing			810				777				1,512				1,500
Supplies and postage			508				535				1,071				1,047
FDIC assessments			415				388				833				810
Advertising and promotions			238				214				477				393
Other			2,418				2,308				4,617				4,222
Total noninterest expense		$	19,236			$	17,808			$	38,247			$	35,021

During the three and six month periods ended June 30, 2015, salaries and employee benefits increased by $1.5 million and $2.5 million, respectively, when compared to the same periods one year earlier. Salaries expense increased $1.0 million and $2.1 million for the three and six months ended June 30, 2015, respectively, when compared to the same periods one year earlier. The increases in salaries expense reflect the SDN acquisition and the hiring of additional personnel associated with our expansion initiatives, both of which occurred during the second half of 2014. Employee benefits expense increased $537 thousand and $456 thousand for the three and six months ended June 30, 2015, respectively, when compared to the same periods one year earlier. The increases in employee benefits expense were primarily due to higher medical expenses and higher expense related to our defined benefit retirement plan. We typically experience higher medical claims in the second quarter each year under the Company’s self-insured plan as more employees have converted to high-deductible heath plans. We recognized a combined net periodic pension expense of $182 thousand and $365 thousand on our pension and post-retirement obligations during the three and six months ended June 30, 2015, respectively, compared to $55 thousand and $111 thousand during the three and six months ended June 30, 2014, respectively. Defined benefit pension expense increased during the three and six months ended June 30, 2015 compared to the same periods in 2014 primarily due to increased benefit plan cost from the use of a lower discount rate and the impact of changes in mortality assumptions.

Occupancy and equipment expense increased by $236 thousand in the second quarter of 2015 and $700 thousand for the six months ended June 30, 2015, when compared to the same periods one year earlier. The increases were primarily related to higher contractual service expenses and incremental expenses from the SDN facility.

Professional fees decreased $518 thousand in the second quarter of 2015 and $522 thousand in the six months ended June 30, 2015, compared to the same periods a year earlier. The second quarter of 2014 professional fees expense included professional services associated with the acquisition of SDN.

FDIC assessments increased $27 thousand or 7% in the second quarter of 2015 and $23 thousand or 3% for the six months ended June 30, 2015, compared to the same periods a year earlier. The increased assessments are a direct result of the growth in our balance sheet.

Advertising and promotions costs were up $24 thousand in the second quarter of 2015 and $84 thousand for the six months ended June 30, 2015, compared to the same periods a year earlier, due to the timing of marketing campaigns and promotions We proactively market our products but vary the timing based on projected benefits and needs.

Other noninterest expense was $2.4 million in the second quarter of 2015 and $4.6 million for the six months ended June 30, 2015, representing increases of $110 thousand and $395 thousand, respectively, from the same periods in 2014. Other noninterest expense for the three and six months ended June 30, 2015 included increases of $152 thousand and $304 thousand, respectively, in intangible asset amortization attributable to the SDN acquisition.

The efficiency ratio for the second quarter of 2015 was 62.00% compared with 60.15% for the second quarter of 2014, and 61.13% for the six months ended June 30, 2015, compared to 58.54% for the same period a year ago. The efficiency ratio is calculated by dividing total noninterest expense, excluding other real estate expense and amortization of intangible assets, by net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains and impairment charges on investment securities. The broadening of our financial services and accompanying increased spending has resulted in a shift in our efficiency ratio as a measure of productivity. As we begin to provide more diversified financial services our efficiency ratio is expected to be in the low 60% range. This approach will decrease our sensitivity to traditional banking revenues which are subject to interest rate changes.

 

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Income Taxes

We recorded income tax expense of $2.8 million in the second quarter of 2015, compared to of $3.1 million in the second quarter of 2014. For the six months ended June 30, 2015, income tax expense totaled $5.6 million compared to $6.2 million in the same period of 2014. The effective tax rates for the three and six month periods ended June 30, 2015 were 29.5% and 29.6%, respectively, in comparison to 30.5% and 30.2% for the three and six months ended June 30, 2014, respectively. The decreases in income tax expense were primarily due to lower pre-tax income. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt securities and earnings on company owned life insurance. In addition, our effective tax rate reflects the New York State tax savings generated by our real estate investment trust, which commenced operations during February 2014.

In March 2014, the New York legislature approved changes in the state tax law that will be phased-in over two years, beginning in 2015. The primary changes that impact us include the repeal of the Article 32 franchise tax on banking corporations (“Article 32”) for 2015, expanded nexus standards for 2015 and a reduction in the corporate tax rate for 2016. We expect the repeal of Article 32 and the expanded nexus standards to lower our taxable income apportioned to New York to 85% in 2015 from 100% in 2014. In addition, the New York state income tax rate will be reduced from 7.1% to 6.5% in 2016.

 

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ANALYSIS OF FINANCIAL CONDITION

INVESTING ACTIVITIES

Investment Securities

The following table sets forth selected information regarding the composition of our investment securities portfolio as of the dates indicated (in thousands):

 

		Investment Securities Portfolio Composition
		June 30, 2015								December 31, 2014
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
Securities available for sale:
U.S. Government agencies and government-sponsored enterprise securities		$	271,774			$	270,077			$	160,334			$	160,475
Mortgage-backed securities:
Agency mortgage-backed securities			502,316				501,214				458,959				460,570
Non-Agency mortgage-backed securities			—				1,123				—				1,218
Asset-backed securities			—				225				—				231
Total available for sale securities			774,090				772,639				619,293				622,494
Securities held to maturity:
State and political subdivisions			289,713				294,052				277,273				281,384
Mortgage-backed securities			31,107				30,821				17,165				17,311
Total held to maturity securities			320,820				324,873				294,438				298,695
Total investment securities		$	1,094,910			$	1,097,512			$	913,731			$	921,189

The available for sale (“AFS”) investment securities portfolio increased $150.1 million or 24%, from $622.5 million at December 31, 2014 to $772.6 million at June 30, 2015. The AFS portfolio had net unrealized losses totaling $1.5 million at June 30, 2015 and unrealized gains totaling $3.2 million at December 31, 2014, respectively. The unrealized losses in the AFS portfolio were predominantly caused by changes in market interest rates. The fair value of most of the investment securities in the AFS portfolio fluctuates as market interest rates change.

Impairment Assessment

We review investment securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”) with formal reviews performed quarterly. 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 to the extent the impairment is related to credit losses or the security is intended to be sold or will be required to be sold. The amount of the impairment related to non-credit related factors is recognized in other comprehensive income. Evaluating whether the impairment of a debt security is other than temporary involves assessing the intent to sell the debt security or the likelihood of being required to sell the security before the recovery of its amortized cost basis. In determining whether the OTTI includes a credit loss, we use our best estimate of the present value of cash flows expected to be collected from the debt security considering factors such as: the length of time and the extent to which the fair value has been less than the amortized cost basis, adverse conditions specifically related to the security, an industry, or a geographic area, the historical and implied volatility of the fair value of the security, the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of the security by a rating agency, and recoveries or additional declines in fair value subsequent to the balance sheet date. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

Securities Deemed to be Other-Than-Temporarily Impaired

There were no securities deemed to be other-than-temporarily impaired during the six month periods ended June 30, 2015 and 2014.

 

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LENDING ACTIVITIES

The following table sets forth selected information regarding the composition of our loan portfolio as of the dates indicated (in thousands).

 

		Loan Portfolio Composition
		June 30, 2015								December 31, 2014
		Amount				% of Total				Amount				% of Total
Commercial business		$	292,791				14.6	%		$	267,409				14.0	%
Commercial mortgage			536,590				26.7				475,092				24.9
Total commercial			829,381				41.3				742,501				38.9
Residential mortgage			95,162				4.7				100,101				5.2
Home equity			398,854				19.8				386,615				20.2
Consumer indirect			666,550				33.2				661,673				34.6
Other consumer			19,326				1.0				21,112				1.1
Total consumer			1,084,730				54.0				1,069,400				55.9
Total loans			2,009,273				100.0	%			1,912,002				100.0	%
Allowance for loan losses			27,500								27,637
Total loans, net		$	1,981,773							$	1,884,365

Total loans increased $97.3 million, or 5%, to $2.00 billion at June 30, 2015 from $1.91 billion at December 31, 2014. The increase in loans was attributable to organic growth, primarily in the commercial loan portfolios.

Commercial loans increased $86.9 million and represented 41.3% of total loans as of June 30, 2015, a result of our continued commercial business development efforts.

Residential mortgage loans decreased $4.9 million to $95.2 million as of June 30, 2015 in comparison to $100.1 million as of December 31, 2014. This category of loans decreased as we continue to sell the majority of our newly originated and refinanced residential mortgages to the secondary market rather than adding them to our portfolio.

Our home equity portfolio, which consists of home equity loans and lines, totaled $398.9 million and represented 19.8% of total loans as of June 30, 2015. Approximately 81% of the loans in the home equity portfolio were first lien positions as of June 30, 2015.

The consumer indirect portfolio totaled $666.6 million as of June 30, 2015 and represented 33.2% of total loans as of June 30, 2015. During the first six months of 2015, we originated $149.3 million in indirect auto loans with a mix of approximately 41% new auto and 59% used auto. This compares with $158.7 million in indirect auto loans with a mix of approximately 42% new auto and 58% used auto for the same period in 2014. Our origination volumes and mix of new and used vehicles financed fluctuates depending on general market conditions.

Loans Held for Sale and Loan Servicing Rights

Loans held for sale (not included in the loan portfolio composition table) were entirely comprised of residential real estate mortgages and totaled $448 thousand and $755 thousand as of June 30, 2015 and December 31, 2014, respectively.

We sell certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, which are not included in the consolidated statements of financial condition, amounted to $204.9 million and $215.2 million as of June 30, 2015 and December 31, 2014, respectively, as runoff outpaced production in the first six months of 2015.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Allowance for Loan Losses

The following table sets forth an analysis of the activity in the allowance for loan losses for the periods indicated (in thousands).

 

		Loan Loss Analysis
		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Balance as of beginning of period		$	27,191			$	27,152			$	27,637			$	26,736
Charge-offs:
Commercial business			13				3				1,154				71
Commercial mortgage			201				165				810				165
Residential mortgage			22				69				77				147
Home equity			154				156				238				262
Consumer indirect			1,841				2,331				4,263				4,786
Other consumer			154				224				413				493
Total charge-offs			2,385				2,948				6,955				5,924
Recoveries:
Commercial business			86				68				134				97
Commercial mortgage			7				6				96				13
Residential mortgage			13				8				46				29
Home equity			9				29				19				40
Consumer indirect			1,196				995				2,301				2,100
Other consumer			95				98				193				211
Total recoveries			1,406				1,204				2,789				2,490
Net charge-offs			979				1,744				4,166				3,434
Provision for loan losses			1,288				1,758				4,029				3,864
Balance at end of period		$	27,500			$	27,166			$	27,500			$	27,166
Net loan charge-offs to average loans (annualized)			0.20	%			0.37	%			0.43	%			0.37	%
Allowance for loan losses to total loans			1.37	%			1.43	%			1.37	%			1.43	%
Allowance for loan losses to non-performing loans			257	%			306	%			257	%			306	%

The allowance for loan losses represents the estimated amount of probable credit losses inherent in our loan portfolio. We perform periodic, systematic reviews of the loan portfolio to estimate probable losses in the respective loan portfolios. In addition, we regularly evaluate prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. Based on this analysis, we believe the overall allowance for loan losses is adequate as of June 30, 2015.

Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing a variety of factors, including the risk-profile of our loan products and customers.

The adequacy of the allowance for loan losses is subject to ongoing management review. While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to increase the allowance based on their judgments about information available to them at the time of their examination.

Net charge-offs of $979 thousand in the second quarter of 2015 represented 0.20% of average loans on an annualized basis compared to $1.7 million or 0.37% in the second quarter of 2014. For the six months ended June 30, 2015 net charge-offs of $4.2 million represented 0.43% of average loans compared to $3.4 million or 0.37% of average loans for same period in 2014. The year-to-date increase in net charge-offs was primarily driven by the charge-off during the first quarter of 2015 of two commercial loan relationships totaling $1.7 million that had been previously reserved by the Company.

The allowance for loan losses was $27.5 million at June 30, 2015, compared with $27.6 million at December 31, 2014. The ratio of the allowance for loan losses to total loans was 1.37% at June 30, 2015, compared with 1.45% at December 31, 2014. The ratio of allowance for loan losses to non-performing loans was 257% at June 30, 2015, compared with 272% at December 31, 2014.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Non-Performing Assets and Potential Problem Loans

The table below sets forth the amounts and categories of our non-performing assets at the dates indicated (in thousands).

 

		Non-Performing Assets
		June 30,				December 31,
		2015				2014
Nonaccrual loans:
Commercial business		$	4,643			$	4,288
Commercial mortgage			3,070				3,020
Residential mortgage			1,628				1,194
Home equity			619				463
Consumer indirect			728				1,169
Other consumer			11				11
Total nonaccrual loans			10,699				10,145
Accruing loans 90 days or more delinquent			9				8
Total non-performing loans			10,708				10,153
Foreclosed assets			165				194
Total non-performing assets		$	10,873			$	10,347
Non-performing loans to total loans			0.53	%			0.53	%
Non-performing assets to total assets			0.32	%			0.33	%

Changes in the level of nonaccrual loans typically represent increases for loans that reach a specified past due status, offset by reductions for loans that are charged-off, paid down, sold, transferred to foreclosed real estate, or are no longer classified as nonaccrual because they have returned to accrual status. Activity in nonaccrual loans for the three and six months ended June 30, 2015 was as follows (in thousands):

 

		Three months				Six months
		ended				ended
		June 30, 2015				June 30, 2015
Nonaccrual loans, beginning of period		$	11,064			$	10,145
Additions			3,611				10,383
Payments			(1,295	)			(2,587	)
Charge-offs			(2,313	)			(6,759	)
Returned to accruing status			(289	)			(353	)
Transferred to other real estate or repossessed assets			(79	)			(130	)
Nonaccrual loans, end of period		$	10,699			$	11,699

Non-performing assets include non-performing loans and foreclosed assets. Non-performing assets at June 30, 2015 were $10.9 million, an increase of $526 thousand from $10.3 million at December 31, 2014. The primary component of non-performing assets is non-performing loans, which were $10.7 million or 0.53% of total loans at June 30, 2015, an increase of $554 thousand from $10.1 million or 0.53% of total loans at December 31, 2014. Included in non-performing loans at June 30, 2015 is one $2.5 million commercial credit relationship which we placed on nonaccrual status during the first quarter of 2015. This downgrade resulted in an increase in our provision for losses of approximately $800 thousand during the first quarter of 2015. The loans comprising this credit relationship are performing in accordance with their contractual terms as of June 30, 2015 and the Company continues to monitor this relationship closely.

Approximately $4.1 million, or 38%, of the $10.7 million in non-performing loans as of June 30, 2015 were current with respect to payment of principal and interest, but were classified as non-accruing because repayment in full of principal and/or interest was uncertain. Included in nonaccrual loans are troubled debt restructurings (“TDRs”) of $3.3 million and $3.0 million at June 30, 2015 and December 31, 2014, respectively. We had no TDRs that were accruing interest as of June 30, 2015 or December 31, 2014.

Foreclosed assets consist of real property formerly pledged as collateral for loans, which we have acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Foreclosed asset holdings represented four properties totaling $165 thousand at June 30, 2015 and four properties totaling $194 thousand at December 31, 2014.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Potential problem loans are loans classified as substandard that are currently performing, but information known about possible credit problems of the borrowers causes us to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. We identified $13.0 million and $13.7 million in loans that continued to accrue interest which were classified as substandard as of June 30, 2015 and December 31, 2014, respectively.

FUNDING ACTIVITIES

Deposits

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

 

		Deposit Composition
		June 30, 2015								December 31, 2014
		Amount				% of Total				Amount				% of Total
Noninterest-bearing demand		$	602,143				22.6	%		$	571,260				23.3	%
Interest-bearing demand			530,861				20.0				490,190				20.0
Savings and money market			910,215				34.3				795,835				32.5
Certificates of deposit < $100,000			348,002				13.1				347,899				14.2
Certificates of deposit of $100,000 or more			265,017				10.0				245,343				10.0
Total deposits		$	2,656,238				100.0	%		$	2,450,527				100.0	%

We offer a variety of deposit products designed to attract and retain customers, with the primary focus on building and expanding long-term relationships. At June 30, 2015, total deposits were $2.66 billion, representing an increase of $205.7 million in comparison to $2.45 billion as of December 31, 2014. Certificates of deposit were approximately 23% and 24% of total deposits at June 30, 2015 and December 31, 2014, respectively. Depositors remain hesitant to invest in time deposits, such as certificates of deposit, for long periods due to the low interest rate environment. This has resulted in lower amounts being placed in time deposits for generally shorter terms.

Nonpublic deposits, the largest component of our funding sources, totaled $1.95 billion and $1.84 billion at June 30, 2015 and December 31, 2014, respectively, and represented 74% and 75% of total deposits as of the end of each period, respectively. We have managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high cost deposit account.

As an additional source of funding, we offer a variety of public (municipal) deposit products to the towns, villages, counties and school districts within our market. Public deposits generally range from 20% to 30% of our total deposits. There is a high degree of seasonality in this component of funding, because the level of deposits varies with the seasonal cash flows for these public customers. We maintain the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. Total public deposits were $701.3 million and $607.5 million at June 30, 2015 and December 31, 2014, respectively, and represented 26% and 25% of total deposits as of the end of each period, respectively. The increase in public deposits during 2015 was due mainly higher municipal deposits resulting from successful business development efforts.

We had no traditional brokered deposits at June 30, 2015 or December 31, 2014; however, we do participate in the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) programs, which enable depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. CDARS and ICS deposits are considered brokered deposits for regulatory reporting purposes. Through these programs, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. Reciprocal CDARS deposits and ICS deposits totaled $79.9 million and $119.2 million, respectively, at June 30, 2015, compared to $79.7 million and $67.1 million, respectively, at December 31, 2014. The year-to-date increase in ICS deposits is primarily due to customer balances transferred from the customer repurchase agreement product. See the “Borrowings” section below for further discussion.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Borrowings

The Company classifies borrowings as short-term or long-term in accordance with the original terms of the applicable agreement. Outstanding borrowings consisted of the following as of the dates indicated (in thousands):

 

		June 30,				December 31,
		2015				2014
Short-term borrowings:
Short-term FHLB borrowings		$	350,600			$	295,300
Repurchase agreements			—				39,504
Total short-term borrowings			350,600				334,804
Long-term borrowings:
Subordinated notes			38,955				—
Total borrowings		$	389,555			$	334,804

Short-term Borrowings

We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $29 million of immediate credit capacity with the FHLB as of June 30, 2015. We had approximately $490 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) discount window, none of which was outstanding at June 30, 2015. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had approximately $120 million of credit available under unsecured federal funds purchased lines with various banks as of June 30, 2015. Additionally, we had approximately $199 million of unencumbered liquid securities available for pledging.

Federal funds purchased are short-term borrowings that typically mature within one to ninety days. Short-term repurchase agreements are secured overnight borrowings with customers. Short-term FHLB borrowings have original maturities of up to one year and include overnight borrowings which we typically utilize to address short term funding needs as they arise. Short-term FHLB borrowings at June 30, 2015 consisted of $169.0 million in overnight borrowings and $181.6 million in short-term advances. Short-term FHLB borrowings at December 31, 2014 consisted of $129.0 million in overnight borrowings and $166.3 million in short-term advances. During the second quarter of 2015, we discontinued the customer repurchase agreement product and transferred most of those customers into the ICS deposit product.

The Parent has a revolving line of credit with a commercial bank allowing borrowings up to $20.0 million in total as an additional source of working capital. At June 30, 2015, no amounts have been drawn on the line of credit.

Long-term Borrowings

On April 15, 2015, the Company issued the Subordinated Notes to certain accredited investors. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to April 15, 2030, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. The Subordinated Notes are redeemable by the Company at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. Debt issuance costs totaled $1.1 million and are being amortized as an adjustment to interest expense over 15 years. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes. The net proceeds from this offering were intended for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both organic growth and opportunistic acquisitions.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

LIQUIDITY AND CAPITAL MANAGEMENT

Liquidity

The objective of maintaining adequate liquidity is to assure that we meet our financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. We achieve liquidity by maintaining a strong base of core customer funds, maturing short-term assets, our ability to sell or pledge securities, lines-of-credit, and access to the financial and capital markets.

Liquidity for the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions, the FHLB and the FRB. The primary source of our non-deposit borrowings is FHLB advances, of which we had $350.6 million outstanding at June 30, 2015. In addition to this amount, we have additional collateralized wholesale borrowing capacity of $639 million from various funding sources which include the FHLB, Federal Reserve Bank, and commercial banks that we can use to fund lending activities, liquidity needs, and/or to adjust and manage our asset and liability position.

The Parent’s funding requirements consist primarily of dividends to shareholders, debt service, income taxes, operating expenses, funding of nonbank subsidiaries, repurchases of our stock, and acquisitions. The Parent obtains funding to meet obligations from dividends received from the Bank, net taxes collected from subsidiaries included in the federal consolidated tax return, and the issuance of debt and equity securities. In addition, the Parent maintains a revolving line of credit with a commercial bank for an aggregate amount of up to $20.0 million, all of which was available at June 30, 2015. The line of credit has a one year term and matures in May 2016. Funds drawn will be used for general corporate purposes and backup liquidity.

Cash and cash equivalents were $52.6 million as of June 30, 2015, a decrease of $5.6 million from $58.2 million as of December 31, 2014. Net cash provided by operating activities totaled $22.3 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items. Net cash used in investing activities totaled $282.1 million, which included outflows of $101.6 million for net loan originations and $177.8 million from net investment securities transactions. Net cash provided by financing activities of $254.2 million was attributed to a $205.7 million increase in deposits, net proceeds of $38.9 million from the Subordinated Notes issuance and a $15.8 million increase in short-term borrowings, partly offset by $6.4 million in dividend payments.

Capital Management

We actively manage capital, commensurate with our risk profile, to enhance shareholder value. We also seek to maintain capital levels for the Company and the Bank at amounts in excess of the regulatory “well-capitalized” thresholds. Periodically, we may respond to market conditions by implementing changes to our overall balance sheet positioning to manage our capital position.

Banks and financial holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material impact on our consolidated financial statements. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

On April 15, 2015, the Parent issued the Subordinated Notes to certain accredited investors. See the “Executive Overview” section of this Management’s Discussion and Analysis for further discussion regarding the issuance of the Subordinated Notes. The Parent contributed $34.0 million of the net proceeds from the Subordinated Notes offering to the Bank as capital to support both organic growth and opportunistic acquisitions.

Shareholders’ equity was $284.4 million at June 30, 2015, an increase of $4.9 million from $279.5 million at December 31, 2014. Net income for the year increased shareholders’ equity by $13.4 million, which was partially offset by common and preferred stock dividends declared of $6.4 million. Accumulated other comprehensive income included in shareholders’ equity decreased $2.7 million during the first six months of 2015 due primarily to higher net unrealized losses on securities available for sale.

The final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks became effective for the Company on January 1, 2015, with full compliance with all of the final requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of June 30, 2015, the Company’s capital levels remained characterized as “well-capitalized” under the new rules. We continue to evaluate the potential impact that regulatory rules may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. See the “Basel III Capital Rules “ section below for further discussion.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table reflects the ratios and their components (dollars in thousands):

 

		June 30,				December 31,
		2015				2014
Common shareholders’ equity		$	267,095			$	262,192
Less: Goodwill and other intangible assets (1)			62,244				68,639
Net unrealized (loss) gain on investment securities (2)			(1,321	)			1,625
Net periodic pension & postretirement benefits plan adjustments			(10,361	)			(10,636	)
Other			150				—
Common equity Tier 1 (“CET1”) capital			216,383				n/a
Plus: Preferred stock			17,340				17,340
Less: Other			225				—
Tier 1 Capital			233,498				219,904
Plus: Qualifying allowance for loan losses			27,500				26,262
Subordinated Notes			38,955				—
Total regulatory capital (3)		$	299,953			$	246,166
Adjusted average total assets (for leverage capital purposes) (3)		$	3,196,238			$	2,993,050
Total risk-weighted assets (3)		$	2,278,114			$	2,099,626
Regulatory Capital Ratios (3)
Tier 1 leverage (Tier 1 capital to adjusted average assets)			7.31	%			7.35	%
CET1 capital (CET1 capital to total risk-weighted assets)			9.50				n/a
Tier 1 capital (Tier 1 capital to total risk-weighted assets)			10.25				10.47
Total risk-based capital (Total risk-based capital to total risk-weighted assets)			13.17				11.72

 

(1)	June 30, 2015 calculated net of deferred tax liabilities.

(2)	Includes unrealized gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category.

(3)	June 30, 2015 calculated under Basel III rules, which became effective January 1, 2015.

The Company’s and the Bank’s actual and required regulatory capital ratios were as follows (dollars in thousands):

 

												For Capital
				Actual								Adequacy Purposes								Well Capitalized
				Amount				Ratio				Amount				Ratio				Amount				Ratio
June 30, 2015
Tier 1 leverage:		Company		$	233,498				7.31	%		$	127,850				4.00	%		$	159,812				5.00	%
		Bank			257,220				8.06				127,851				4.00				159,476				5.00
CET1 capital:		Company			216,383				9.50				102,515				4.50				148,077				6.50
		Bank			257,220				11.33				102,183				4.50				147,598				6.50
Tier 1 capital:		Company			233,498				10.25				136,687				6.00				182,249				8.00
		Bank			257,220				11.33				136,244				6.00				181,659				8.00
Total risk-based capital:		Company			299,953				13.17				182,249				8.00				227,811				10.00
		Bank			284,720				12.54				181,659				8.00				227,074				10.00
December 31, 2014
Tier 1 leverage:		Company		$	219,904				7.35	%		$	119,722				4.00	%		$	149,653				5.00	%
		Bank			215,672				7.21				119,671				4.00				149,588				5.00
Tier 1 capital:		Company			219,904				10.47				83,985				4.00				125,977				6.00
		Bank			215,672				10.28				83,889				4.00				125,834				6.00
Total risk-based capital:		Company			246,166				11.72				167,970				8.00				209,962				10.00
		Bank			241,905				11.53				167,779				8.00				209,723				10.00

As previously discussed, the Parent company contributed $34.0 million of net proceeds from the Subordinated Notes offering to the Bank as capital to support both organic growth and opportunistic acquisitions. The Bank’s leverage ratio and total risk-based capital ratio increased to 8.06% and 12.54%, respectively, at June 30, 2015, compared to 7.21% and 11.53%, respectively, at December 31, 2014, all of which exceeded the regulatory thresholds required to be classified as a “well capitalized” institution as established by the Bank’s primary banking regulators.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Basel III Capital Rules

In July 2013, the FRB and the FDIC approved the final rules implementing the BCBS’s capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of total capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revise the definition and calculation of Tier 1 capital, total capital, and risk-weighted assets.

The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of June 30, 2015, the Company’s capital levels remained characterized as “well-capitalized” under the new rules.

Dividend Restrictions

In the ordinary course of business we are dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.

 

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ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosures about market risk were presented at December 31, 2014 in Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission on March 6, 2015. The following is an update of the discussion provided therein.

Portfolio Composition

With the exception of the $40.0 million of 6.0% fixed to floating rate subordinated notes issued by the Company on April 15, 2015, there was no material change in the composition of assets, deposit liabilities or borrowings from December 31, 2014 to June 30, 2015. See the section titled “Analysis of Financial Condition” in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of asset, deposit and borrowing activity during the period.

Net Interest Income at Risk

A primary tool used to manage interest rate risk is “rate shock” simulation, which measures rate sensitivity. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income as well as economic value of equity. At June 30, 2015, the Company was generally neutral to slightly liability sensitive, meaning that, in most cases, net interest income tends to remain relatively unchanged or in certain rising rate conditions, decline slightly.

Net interest income at risk is measured by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of 12 months. The following table sets forth the estimated changes to net interest income over the 12-month period ending June 30, 2016 assuming instantaneous changes in interest rates for the given rate shock scenarios (dollars in thousands):

 

		Changes in Interest Rate
		-100 bp				+100 bp				+200 bp				+300 bp
Change in net interest income		$	(902	)		$	(47	)		$	599			$	(1,103	)
% Change			(0.92	)%			(0.05	)%			0.61	%			(1.13	)%

In addition to the changes in interest rate scenarios listed above, other scenarios are typically modeled to measure interest rate risk. These scenarios vary depending on the economic and interest rate environment.

The simulations referenced above and below are based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates. Further, it assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of the future results and is based on many assumptions that, if changed, could cause a different outcome.

Economic Value of Equity At Risk

The economic (or “fair”) value of financial instruments on our balance sheet will also vary under the interest rate scenarios previously discussed. This is measured by simulating changes in our economic value of equity (“EVE”), which is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while fair values of non-financial assets and liabilities are assumed to equal book value and do not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of our balance sheet evolve and as interest rate and yield curve assumptions are updated.

The amount of change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical data (back-testing).

 

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Table of Contents

The analysis that follows presents the estimated EVE resulting from market interest rates prevailing at a given quarter-end (“Pre-Shock Scenario”), and under other interest rate scenarios (each a “Rate Shock Scenario”) represented by immediate, permanent, parallel shifts in interest rates from those observed at June 30, 2015 and December 31, 2014. The analysis additionally presents a measurement of the interest rate sensitivity at June 30, 2015 and December 31, 2014. EVE amounts are computed under each respective Pre- Shock Scenario and Rate Shock Scenario. An increase in the EVE amount is considered favorable, while a decline is considered unfavorable.

 

		June 30, 2015												December 31, 2014
		EVE				Change				Percentage Change				EVE				Change				Percentage Change
Rate Shock Scenario:
Pre-Shock Scenario		$	502,621											$	476,735
- 100 Basis Points			514,277			$	11,656				2.32	%			489,184			$	12,449				2.61	%
+ 100 Basis Points			478,066				(24,555	)			(4.89	)			466,983				(9,752	)			(2.05	)
+ 200 Basis Points			451,020				(51,601	)			(10.27	)			453,868				(22,867	)			(4.80	)

The Pre-Shock Scenario EVE was $502.6 million at June 30, 2015, compared to $476.7 million at December 31, 2014. The increase in the Pre-Shock Scenario EVE at June 30, 2015, compared to December 31, 2014 resulted primarily from a more favorable valuation of non-maturity deposits and commercial mortgages that reflected alternative funding and investment rate changes used for discounting future cash flows.

The +200 basis point Rate Shock Scenario EVE decreased from $453.9 million at December 31, 2014 to $451.0 million at June 30, 2015, reflecting less favorable asset valuations that reflected investment rate changes offset by more favorable valuation of non-maturity deposits. The percentage change in the EVE amount from the Pre-Shock Scenario to the +200 basis point Rate Shock Scenario decreased from to (4.80)% at December 31, 2014 to (10.27)% at June 30, 2015. The decrease in sensitivity resulted from a reduced benefit in the asset valuations in the +200 basis point Rate Shock Scenario EVE as of June 30, 2015, compared to December 31, 2014.

 

ITEM 4.

Controls and Procedures

Evaluation of disclosure controls and procedures

As of June 30, 2015, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Table of Contents

PART II. OTHER INFORMATION

 

ITEM 1.

Legal Proceedings

The Company has experienced no material developments in its legal proceedings from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission.

 

ITEM 1A.

Risk Factors

The Company has experienced no material changes in its risk factors from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission.

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

On May 6, 2015, the Company issued a total of 2,363 shares of our common stock as the stock component of our annual retainer to three non-employee directors and 10,750 restricted shares of our common stock as our annual stock award to each of our non-employee directors without registration under the Securities Act of 1933, as amended (the “Securities Act”). These shares were issued under our 2015 Long-Term Incentive Plan (the “Plan”), which was approved by our shareholders at the annual meeting on May 6, 2015, but prior to our filing of a Form S-8 registration statement under the Securities Act for the Plan. These shares of common stock are subject to the resale prohibition under the Securities Act and may not be sold or transferred without registration except in accordance with Rule 144 of the Securities Act.

The issuances of securities set forth above were made without registration under the Securities Act in reliance on the exemption from registration pursuant to Section 4(a)(2) of the Securities Act based on our directors’ financial sophistication and knowledge of the Company.

 

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Table of Contents

ITEM 6.

Exhibits

 

(a)

The following is a list of all exhibits filed or incorporated by reference as part of this Report:

 

Exhibit Number		Description		Location
1.1		Underwriting Agreement, dated April 9, 2015, by and among Financial Institutions, Inc., and Sterne Agee & Leach, Inc.		Incorporated by reference to Exhibit 1.1 of the Form 8-K, dated April 10, 2015
4.1		Subordinated Indenture, dated as of April 15, 2015, between Financial Institutions, Inc. and Wilmington Trust, National Association, as Trustee.		Incorporated by reference to Exhibit 4.1 of the Form 8-K, dated April 15, 2015
4.2		First Supplemental Indenture, dated as of April 15, 2015, between Financial Institutions, Inc. and Wilmington Trust, National Association, as Trustee.		Incorporated by reference to Exhibit 4.2 of the Form 8-K, dated April 15, 2015
4.3		Form of Global Note to represent the 6.00% Fixed-to-Floating Rate Subordinated Notes due April 15, 2030.		Incorporated by reference to Exhibit 4.3 of the Form 8-K, dated April 15, 2015
10.1		Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.2		Form of Director Annual Restricted Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.3		Form of Director “In Lieu of Cash Fees” Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.4		Form of Restricted Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.5		Form of Performance Stock Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.6		Form of Restricted Stock Unit Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
10.7		Form of Performance Stock Unit Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan		Filed Herewith
31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Executive Officer		Filed Herewith
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Principal Financial Officer		Filed Herewith
32		Certification pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		Filed Herewith
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

 

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Table of Contents

SIGNATURES

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

 

FINANCIAL INSTITUTIONS, INC.
/s/ Martin K. Birmingham		, August 5, 2015
Martin K. Birmingham
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Kevin B. Klotzbach		, August 5, 2015
Kevin B. Klotzbach
Executive Vice President, Chief Financial Officer and Treasurer
(Principal Financial Officer)
/s/ Michael D. Grover		, August 5, 2015
Michael D. Grover
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)

 

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Exhibit 10.1

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

Approved by the MD&C Committee: January 14, 2015

Approved by the Board for Directors: January 28, 2015

Approved by Shareholders: May 6, 2015

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FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

TABLE OF CONTENTS

 

				Page
ARTICLE I PURPOSE AND EFFECTIVE DATE					1
1.1		Purpose			1
1.2		Effective & Expiration Date			1
1.3		Successor Plan			1
ARTICLE II DEFINITIONS					1
2.1		Award			1
2.2		Award Agreement			1
2.3		Board			1
2.4		Cash Awards			1
2.5		Cause			1
2.6		Change in Control			2
2.7		Code			2
2.8		Committee			2
2.9		Common Stock			2
2.10		Company			2
2.11		Director			2
2.12		Director Awards			2
2.13		Disability			2
2.14		Effective Date			2
2.15		Employee			2
2.16		Exchange Act			2
2.17		Exercise Price			2
2.18		Fair Market Value			2
2.19		Good Reason			3
2.20		Incentive Stock Option			3
2.21		Incumbent Board			3
2.22		Indemnified Person			3
2.23		Involuntary Termination			3
2.24		Non-Qualified Stock Option			3
2.25		Option			3
2.26		Over 10% Owner			3
2.27		Participant			3
2.28		Performance Goal			3
2.29		Performance Period			3
2.30		Performance Stock Award			3
2.31		Performance Stock Unit Award			4
2.32		Plan			4
2.33		Plan Year			4
2.34		Prior Plans			4
2.35		Replaced Award			4
2.36		Replacement Award			4
2.37		Reporting Person			4
2.38		Restricted Period			4
2.39		Restricted Stock Award			4
2.40		Restricted Stock Unit Award			4
2.41		Stock Appreciation Right			4
2.42		Strike Price			4
2.43		Subsidiary			4

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TABLE OF CONTENTS

(continued)

 

				Page
2.44		Termination of Employment			4
ARTICLE III ELIGIBILITY AND PARTICIPATION					4
3.1		Eligibility			4
3.2		Participation			4
ARTICLE IV STOCK SUBJECT TO PLAN					5
4.1		Types of Shares			5
4.2		Aggregate Limit			5
4.3		Calculation of Shares			5
4.4		Participant Limits			5
ARTICLE V ADMINISTRATION					6
5.1		Action of the Committee			6
5.2		Duties and Powers of the Committee			6
5.3		Delegation			6
5.4		No Liability; Indemnification			6
ARTICLE VI AWARDS UNDER THE PLAN					7
6.1		Terms and Conditions of All Awards.			7
6.2		Options			8
6.3		Stock Appreciation Rights			10
6.4		Restricted Stock Awards			10
6.5		Restricted Stock Unit Awards			11
6.6		Qualified Performance Awards, Including Cash Awards			12
6.7		Director Awards			13
6.8		Other Awards			13
ARTICLE VII CHANGE IN CONTROL					13
7.1		Effect of a Change in Control			13
7.2		Definition			14
ARTICLE VIII TERMINATION AND AMENDMENT					15
8.1		Termination and Amendment of Plan			15
8.2		Amendment of Award Agreements			15
8.3		No Repricing			15
ARTICLE IX GENERAL PROVISIONS					16
9.1		Changes in Capitalization; Merger; Liquidation			16
9.2		Code Section 409A			16
9.3		Right to Terminate Employment or Service			16
9.4		Non-Alienation of Benefits			16
9.5		Restrictions on Delivery and Sale of Shares; Legends			17
9.6		FDIA Limitations			17
9.7		Compensation Recovery Policy			17
9.8		Listing and Legal Compliance			17
9.9		Choice of Law			17
9.10		Plan Binding on Successors			17
9.11		Interpretation			17

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FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

Financial Institutions, Inc. (the “Company”) hereby establishes the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”) for the benefit of eligible Employees and Directors.

ARTICLE I

PURPOSE AND EFFECTIVE DATE

1.1 Purpose. The purpose of the Plan is to advance the interests of the Company, its Subsidiaries, and its stockholders and to promote the growth and profitability of the Company and its Subsidiaries by (a) providing incentives to certain Employees and Directors of the Company and its Subsidiaries to stimulate their efforts toward the continued success of the Company and to operate and manage the business affairs of the Company in a manner that will provide for the long-term growth and profitability of the Company; (b) providing certain Employees and Directors with a means to acquire a proprietary interest in the Company, acquire shares of Common Stock, or to receive compensation which is based upon appreciation in the value of Common Stock; and (c) providing a means of obtaining, rewarding, and retaining Employees and Directors.

1.2 Effective & Expiration Date. The Plan shall become effective as of May 6, 2015 (the “Effective Date”), upon the approval of the Plan by the Company’s stockholders on that date. No Award will be granted under the Plan more than ten (10) years after the Effective Date, but all Awards granted on or prior to such date will continue in effect thereafter subject to the terms thereof and of the Plan.

1.3 Successor Plan. The Plan is established as a successor to the 2009 Management Incentive Plan and 2009 Directors’ Stock Incentive Plan (the “Prior Plans”). No additional awards shall be made under the Prior Plans after the Effective Date. As provided by Section 4.2, shares of Common Stock authorized under the Prior Plans as of the Effective Date shall be available for issuance or transfer under this Plan. Outstanding awards under the Prior Plans shall continue in effect according to their terms as in effect before the Effective Date (subject to such amendments as the Committee determines, consistent with the Prior Plans, as applicable).

ARTICLE II

DEFINITIONS

2.1 Award. Award shall mean, collectively, the Options, Restricted Stock Awards, Restricted Stock Unit Awards, Stock Appreciation Rights, Cash Awards, Director Awards, and other equity awards that may be granted under the Plan.

2.2 Award Agreement. Award Agreement shall mean a written or electronic agreement entered into between the Company and a Participant setting forth the terms and conditions of an Award made to such Participant under this Plan, such Award Agreement to be in such form as shall be prescribed by the Committee from time to time.

2.3 Board. Board shall mean the board of directors of the Company.

2.4 Cash Awards. Cash Awards shall mean the cash awards that may be made to an eligible Participant pursuant to Section 6.6.

2.5 Cause. Cause as a reason for the termination of a Participant’s employment shall have the meaning assigned such term in the executive, employment, severance or similar agreement, if any, between the Participant and the Company or a Subsidiary. If the Participant is not a party to an executive, employment, severance, or similar agreement with the Company or a Subsidiary in which such term is defined, then unless otherwise defined in the applicable Award Agreement, Cause shall mean the commission by the Participant of, or the determination by the Board, based on reasonable evidence of misconduct as presented by a law enforcement agency, or as a result of an internal or external audit or investigation, that the Participant has committed: (a) a criminal offense involving the violation of state or federal law; (b) a breach of fiduciary duty; (c) an act of

 

1

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dishonesty, fraud, or material misrepresentation; or (d) any act of moral turpitude which the Board determines has or may be reasonably expected to have a detrimental impact on the Company’s business or operations, or which may prevent, because of its demonstrated or demonstrable effect on employees, regulatory agencies, or customers, the Participant from effectively performing his duties. Any reference to the Company in this definition includes each of its Subsidiaries.

2.6 Change in Control. Change in Control shall have the meaning specified in Section 7.2.

2.7 Code. Code shall mean the Internal Revenue Code of 1986, as amended from time to time, and the regulations and other guidance issued thereunder, as such law, regulations, and guidance may be amended from time to time.

2.8 Committee. Committee shall mean the Management Development & Compensation Committee of the Board, each member of which is a “non-employee director” within the meaning of Rule 16b-3 under the Exchange Act, is an “outside director” within the meaning of Code Section 162(m) and meets the independence requirements of the Nasdaq Stock Market listing standards.

2.9 Common Stock. Common Stock shall mean the common stock of the Company, $0.01 par value per share.

2.10 Company. Company shall mean Financial Institutions, Inc., a New York corporation, and its successors and assigns.

2.11 Director. Director shall mean any non-employee member of the board of directors of the Company or a Subsidiary.

2.12 Director Awards. Director Awards shall mean the director awards that may be made to an eligible Director pursuant to Section 6.7.

2.13 Disability. Except as otherwise provided by this Section 2.13, Disability shall have the meaning assigned such term in the executive, employment, severance, or similar agreement, if any, between the Participant and the Company or a Subsidiary, and if the Participant is not a party to an executive, employment, severance, or similar agreement with the Company or a Subsidiary in which such term is defined, then unless otherwise defined in the applicable Award Agreement and except as otherwise provided by this Section 2.13, Disability shall have the meaning assigned such term in the long-term disability plan or policy maintained, or if applicable, most recently maintained, by the Company or any Subsidiary for the Participant. If no long-term disability plan or policy was ever maintained on behalf of the Participant, or if the determination of Disability relates to an Incentive Stock Option, Disability shall mean the condition described in Code Section 22(e)(3).

2.14 Effective Date. Effective Date shall have the meaning specified in Section 1.2.

2.15 Employee. Employee shall mean an employee of the Company or a Subsidiary.

2.16 Exchange Act. Exchange Act shall mean the Securities Exchange Act of 1934, as amended from time to time, and the rules and regulations thereunder, as such law, rules and regulations may be amended from time to time.

2.17 Exercise Price. Exercise Price shall mean the price at which a share of Common Stock may be purchased by a Participant pursuant to the exercise of an Option.

2.18 Fair Market Value. Fair Market Value of Common Stock shall mean the closing price of the Common Stock as reported on the Nasdaq Stock Market on the relevant valuation date or, if there were no Common Stock transactions on such day, on the next preceding date on which there were Common Stock transactions.

 

2

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2.19 Good Reason. Good Reason as a reason for a Participant’s termination of employment shall have the meaning assigned such term in the executive, employment, severance, or similar agreement, if any, between the Participant and the Company or a Subsidiary. If the Participant is not a party to an executive, employment, severance, or similar agreement with the Company or a Subsidiary in which such term is defined, then unless otherwise defined in the applicable Award Agreement, “Good Reason” shall mean (a) a material diminution in the Participant’s base salary from the level immediately prior to the Change in Control; or (b) a material change in the geographic location at which the Participant must primarily perform the Participant’s services (which shall in no event include a relocation of the Participant’s current principal place of business to a location less than fifty (50) miles away) from the geographic location immediately prior to the Change in Control; provided, however, no termination shall be deemed to be for Good Reason unless (i) the Participant provides the Company with written notice setting forth the specific facts or circumstances constituting Good Reason within ninety (90) days after the initial existence of the occurrence of such facts or circumstances, (ii) to the extent curable, the Company has failed to cure such facts or circumstances within thirty (30) days of its receipt of such written notice, and (iii) the effective date of the termination for Good Reason occurs no later than one hundred eighty (180) days after the initial existence of the facts or circumstances constituting Good Reason.

2.20 Incentive Stock Option. Incentive Stock Option shall mean an Option to purchase Common Stock which is granted under the Plan with the intention that it qualify as an “incentive stock option” as that term is defined under Code Section 422.

2.21 Incumbent Board. Incumbent Board shall have the meaning specified in Section 7.2(d).

2.22 Indemnified Person. Indemnified Person shall have the meaning specified in Section 5.4(a).

2.23 Involuntary Termination. Involuntary Termination shall mean termination of a Participant’s employment or service by the Company or a Subsidiary without Cause or by the Participant for Good Reason. For avoidance of doubt, an Involuntary Termination shall not include a termination of the Participant’s employment or service by the Company or a Subsidiary for Cause or due to the Participant’s death, Disability, or voluntary resignation other than for Good Reason.

2.24 Non-Qualified Stock Option. Non-Qualified Stock Option shall mean an Option to purchase Common Stock which is granted under the Plan and that is not an Incentive Stock Option.

2.25 Option. Option shall mean a Non-Qualified Stock Option or an Incentive Stock Option granted pursuant to Section 6.2.

2.26 Over 10% Owner. Over 10% Owner shall mean an individual who, at the time an Incentive Stock Option is granted to such individual, owns Common Stock possessing more than ten percent (10%) of the total combined voting power of the Company or one of its Subsidiaries, determined by applying the attribution rules of Code Section 424(d).

2.27 Participant. Participant shall mean an Employee or Director who has been granted an Award.

2.28 Performance Goal. Performance Goal shall mean a performance goal for a Cash Award, Performance Stock Award or Performance Stock Unit Award that is intended to satisfy the requirements for “performance-based compensation” under Code Section 162(m), and shall mean a performance goal described in Section 6.6(d).

2.29 Performance Period. Performance Period shall mean a performance period for a Cash Award, Performance Stock Award or Performance Stock Unit Award that is intended to satisfy the requirements for “performance-based compensation” under Code Section 162(m), and shall mean a performance period described in Section 6.6(c).

2.30 Performance Stock Award. Performance Stock Award shall mean an Award as described in Section 6.4(c).

 

3

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2.31 Performance Stock Unit Award. Performance Stock Unit Award shall mean an Award as described in Section 6.5(b).

2.32 Plan. Plan shall have the meaning assigned to such term in the Preamble hereof.

2.33 Plan Year. Plan Year shall mean the calendar year.

2.34 Prior Plans. Prior Plans shall have the meaning specified in Section 1.3.

2.35 Replaced Award. Replaced Award shall have the meaning specified in Section 7.1(a).

2.36 Replacement Award. Replacement Award shall have the meaning specified in Section 7.1(a).

2.37 Reporting Person. Reporting Person shall mean an officer or director of the Company or a Subsidiary subject to the reporting requirements of Section 16 of the Exchange Act.

2.38 Restricted Period. Restricted Period shall mean the period of time during which Restricted Stock Awards granted pursuant to Section 6.4 or Restricted Stock Unit Awards granted pursuant to Section 6.5 are subject to restrictions.

2.39 Restricted Stock Award. Restricted Stock Award shall mean an Award of Common Stock subject to restrictions determined by the Committee as described in Section 6.4.

2.40 Restricted Stock Unit Award. Restricted Stock Unit Award shall mean an Award as described in Section 6.5.

2.41 Stock Appreciation Right. Stock Appreciation Right shall mean an Award of a stock appreciation right as described in Section 6.3.

2.42 Strike Price. Strike Price shall mean the measuring price per share of Common Stock for a Stock Appreciation Right used to determine the payment of such Stock Appreciation Right.

2.43 Subsidiary. Subsidiary shall mean any corporation or other entity, whether domestic or foreign, in which the Company has or obtains, directly or indirectly, a proprietary interest of more than fifty percent (50%) by reason of stock ownership or otherwise.

2.44 Termination of Employment. Termination of Employment shall mean the termination of the employment or other service relationship between a Participant and the Company and its Subsidiaries, regardless of whether severance or similar payments are made to the Participant, for any reason, including, but not by way of limitation, a termination by resignation, discharge, death, Disability, or retirement, as determined by the Committee pursuant to Section 6.1(i)(3).

ARTICLE III

ELIGIBILITY AND PARTICIPATION

3.1 Eligibility. Subject to the limitation on eligibility for Awards of Incentive Stock Options set forth in Section 6.2(g), any Employee or Director of the Company or a Subsidiary, who is selected by the Committee is eligible to receive an Award under the Plan.

3.2 Participation. Unless otherwise determined by the Committee, as a condition precedent to participation in the Plan, each Employee or Director selected to receive an Award shall enter into an Award Agreement with the Company, agreeing to the terms and conditions of the Plan and the Award granted.

 

4

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ARTICLE IV

STOCK SUBJECT TO PLAN

4.1 Types of Shares. The shares of Common Stock subject to the provisions of this Plan shall either be shares of authorized but unissued Common Stock, shares of Common Stock held as treasury stock or previously issued shares of Common Stock reacquired by the Company, including shares purchased on the open market.

4.2 Aggregate Limit. Subject to adjustment in accordance with Section 9.1, the maximum number of shares of Common Stock reserved exclusively for issuance upon an award of or exercise or payment pursuant to Awards under the Plan shall be the sum of the following: (a) the number of shares remaining available for issuance under the Prior Plans on the Effective Date; and (b) any shares of Common Stock that are subject to outstanding awards under the Prior Plans on the Effective Date that are subsequently canceled, expired, forfeited, or otherwise not issued or are settled in cash. All or any of this maximum number of shares of Common Stock reserved under the Plan may be issued pursuant to Awards of Incentive Stock Options or pursuant to any one or more other Awards.

4.3 Calculation of Shares.

(a) For purposes of calculating the total number of shares of Common Stock available for grants of Awards hereunder, the following shall apply:

(1) The number of shares of Common Stock available for grants of Awards hereunder shall be reduced by the number of shares for which Awards are actually granted; and

(2) The grant of a Performance Stock Award or Performance Stock Unit Award shall be deemed to be equal to the maximum number of shares of Common Stock which may be issued under such Award.

(b) Shares Added Back. If less than the maximum number of shares of Common Stock which may be issued under a Performance Stock Award or Performance Stock Unit Award are earned and issued, only the number of shares of Common Stock actually issued shall count against the above limit, and the excess of the maximum over the actual number of shares of Common Stock issued shall again become available for grants under the Plan. Further, if any Award under the Plan shall expire, terminate, be canceled (including cancellation upon the Participant’s exercise of a related Award), or is unsettled for any reason without having been exercised in full, or if any Award shall be forfeited to the Company, the unexercised, unsettled, or forfeited Award, shall not count against the aggregate limitations under Section 4.2 and shall again become available for grants under the Plan.

(c) Shares NOT Added Back. Shares of Common Stock equal in number to the shares tendered or withheld in payment of an Option Exercise Price or in settlement of any other Award, and shares of Common Stock that are tendered or withheld in order to satisfy any federal, state, or local tax liability, shall count against the aggregate limitations in Section 4.2 and shall not become available again for grants under the Plan. Provided further, the full number of shares of Common Stock subject to a Stock Appreciation Right shall count against the above limit, and any shares that were estimated to be used for such purposes and were not in fact so used shall not become available again for grants under the Plan.

(d) Cash settlements of Awards will not count against the above limits.

4.4 Participant Limits.

(a) Subject to adjustment in accordance with Section 9.1, the total number of shares of Common Stock for which Awards may be granted in any Plan Year to any Employee shall not exceed three hundred thousand (300,000) shares of Common Stock.

 

5

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(b) The aggregate grant date fair value of Awards granted in any Plan Year to any Director shall not exceed one hundred thousand dollars ($100,000); provided, however, such limit shall not apply to Awards granted to Directors pursuant to Section 6.7 in lieu of cash-based director fees that the Director elects to receive in the form of shares of Common Stock equal in value to the cash-based director fees that the Director would otherwise have received.

ARTICLE V

ADMINISTRATION

5.1 Action of the Committee. The Plan shall be administered by the Committee. In administering the Plan, the Committee’s actions, determinations, and interpretations made in good faith shall not be subject to review and shall be final, binding, and conclusive on all interested parties.

5.2 Duties and Powers of the Committee. The Committee shall have the power to grant Awards in accordance with the provisions of the Plan and may grant Awards singly, in combination, or in tandem. Subject to the provisions of the Plan, including the prohibition against repricing set forth in Section 8.3, the Committee shall have the discretion and authority to determine: (a) the Employees and Directors to whom Awards will be granted; (b) the number of shares of Common Stock subject to each Award; (c) the terms and conditions of each Award, including, without limitation, the applicable vesting schedule and forfeiture provisions of the Award, Exercise Price, Strike Price, performance goals, performance periods; Restriction Periods and exercise periods; (d) the acceleration of vesting, exercise, or payment and/or any other consequence under the Award in the event of an occurrence of a Change in Control; and (e) such other matters applicable to an Award as are permissible under the Plan. Except as otherwise required by the Plan, the Committee shall have the authority to interpret and construe the provisions of the Plan and the Award Agreements, and to make determinations pursuant to any Plan provision or Award Agreement which shall be final and binding on all persons.

5.3 Delegation. The Committee may designate and authorize individual officers or employees of the Company or a Subsidiary who are not members of the Committee to carry out its responsibilities hereunder under such conditions or limitations as the Committee may set, other than its authority and responsibility with regard to Awards granted to a Reporting Person or Awards that are intended to satisfy the requirements for “performance-based compensation” under Code Section 162(m). References in the Plan to Committee shall include the individuals to whom the Committee has delegated to the extent of the authority so delegated.

5.4 No Liability; Indemnification.

(a) No Director, member of the Committee, or officer or employee to whom any duty or power relating to the administration or interpretation of the Plan has been delegated (each, an “Indemnified Person”), shall be liable to any person for any act or determination made in good faith with respect to the Plan or any Award.

(b) Each Indemnified Person shall be indemnified and held harmless by the Company against and from any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by such Indemnified Person in connection with or resulting from any claim, action, suit or proceeding to which the Indemnified Person may be a party or in which the Indemnified Person may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid by the Indemnified Person in settlement thereof, with the Company’s approval, or paid by the Indemnified Person in satisfaction of any judgment in any such action, suit, or proceeding against him or her, provided the Indemnified Person shall give the Company an opportunity, at its own expense, to handle, and defend the same before the Indemnified Person undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such Indemnified Persons may be entitled under the Company’s Certificate of Incorporation or policies, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless.

 

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ARTICLE VI

AWARDS UNDER THE PLAN

6.1 Terms and Conditions of All Awards.

(a) Shares and Cash Awards Subject to Grant. The number of shares of Common Stock and/or the amounts of Cash Awards as to which an Award may be granted will be determined by the Committee in its sole discretion, subject to the Participant limits in Section 4.4 and Section 6.6.

(b) Award Agreement. Each Award Agreement is subject to the terms of the Plan and any provisions contained in the Award Agreement that are inconsistent with the Plan shall be superseded by the terms of the Plan.

(c) Date of Grant. The date as of which an Award is granted will be the date on which the Committee has approved the terms and conditions of the Award and has determined the recipient of the Award and the number of shares of Common Stock or amount of cash covered by the Award, and has taken all such other actions necessary to complete the grant of the Award.

(d) Transfer and Exercise. Awards are not transferable or assignable except by will or by the laws of descent and distribution and are exercisable, during a Participant’s lifetime, only by the Participant, or in the event of the Disability of the Participant, by the Participant or the legal representative of the Participant, or in the event of the death of the Participant, by the legal representative of the Participant’s estate, or if no legal representative has been appointed, by the successor in interest determined under the Participant’s will. Any transfer or attempted transfer of an Award by a Participant not made in accordance with the Plan and the applicable Award Agreement will be void and of no effect, and the Company will not recognize, or have the duty to recognize, any transfer not made in accordance with the Plan and the applicable Award Agreement, and an Award attempted to be transferred will continue to be bound by the Plan and the applicable Award Agreement.

(e) Payment. Awards for which any payment is due from a Participant including, without limitation, the Exercise Price of an Option or the tax withholding required with respect to an Award pursuant to Section 6.1(g), may be made in any form or manner authorized by the Committee in the Award Agreement or by amendment thereto, including, but not limited to:

(i) U.S. dollars by personal check, bank draft, or money order payable to the Company, by money transfer or direct account debits;

(ii) Delivery to the Company of a number of shares of Common Stock having an aggregate fair market value of not less than the aggregate Exercise Price or minimum tax withholding required for the Award;

(iii) Involvement of a stockbroker in accordance with the federal margin rules set forth in Regulation T;

(iv) A cashless exercise if and to the extent permissible by applicable law; or

(v) Any combination of the above forms and methods.

(f) Dividend Equivalents. If the Committee so determines and provides in an Award Agreement, Participants may be credited with any dividends paid with respect to the shares of Common Stock underlying an Award (other than an Option or Stock Appreciation Right) in a manner determined by the Committee in its sole discretion. The Committee may apply any restrictions to such dividend equivalents that the Committee deems appropriate. The Committee, in its sole discretion, may determine the form of payment of dividend equivalents, including cash or shares of Common Stock. Notwithstanding the foregoing, any dividend equivalents on an Award the vesting or payment of which is dependent upon

 

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the achievement of one or more performance goals shall accrue and be paid only if and to the extent the shares of Common Stock underlying the Award become vested or payable.

(g) Withholding. The Company shall deduct from all cash payments under the Plan the amount of any federal, state, or local taxes required to be withheld. Whenever the Company proposes or is required to issue or transfer shares of Common Stock under the Plan, or upon the vesting of any Restricted Stock Award, the Company has the right to require the recipient to remit to the Company an amount sufficient to satisfy the amount of any federal, state, or local taxes required to be withheld as a condition of and prior to the delivery or release of such shares.

(h) Deferred Compensation. Notwithstanding the Committee’s discretion to determine the terms and conditions of Awards under the Plan, the Committee may require or permit the deferral of the receipt of Awards (other than an Option or Stock Appreciation Right) upon such terms as the Committee deems appropriate and in accordance with the requirements of Code Section 409A.

(i) Treatment of Awards upon Termination of Employment.

(1) All Awards granted under the Plan, including all unexercised Options whether vested or non-vested, shall immediately be forfeited and may not thereafter vest or be exercised in the event a Participant incurs a Termination of Employment for Cause.

(2) Except as otherwise provided by Section 6.1(i)(1), any Award under the Plan to a Participant who has experienced a Termination of Employment or termination of some other service relationship with the Company and its Subsidiaries may be cancelled, accelerated, paid or continued, as provided in the applicable Award Agreement or as the Committee may otherwise determine to the extent not prohibited by or inconsistent with the provisions of the Plan, taking into consideration such other factors as the Committee determines are relevant to its decision whether to continue an Award.

(3) Subject to Section 6.1(i)(1), the Committee will, in its absolute discretion, determine the effect of all matters and questions relating to a Termination of Employment as it affects an Award, including, but not by way of limitation, the question of whether a leave of absence constitutes a Termination of Employment.

6.2 Options. At the time any Option is granted, the Committee will determine whether the Option is to be an Incentive Stock Option or a Non-Qualified Stock Option. Each Incentive Stock Option granted under the Plan shall be clearly identified as to its status as an Incentive Stock Option and the applicable Award Agreement shall reflect such status. Subject to the special conditions applicable to Incentive Stock Options set forth in Section 6.2(g) and the special conditions applicable to substitute Options set forth in Section 6.2(f), Options awarded under the Plan shall be subject to the following terms and conditions:

(a) Exercise Price. Subject to adjustment in accordance with Section 9.1, the Exercise Price per share of Common Stock purchasable under any Option shall be determined by the Committee in its sole discretion and set forth in the applicable Award Agreement; provided, however, the Exercise Price may not be less than the Fair Market Value of the Common Stock subject to the Option on the date the Option is granted.

(b) Option Term. The exercise period for each Option granted under the Plan shall be determined by the Committee in its sole discretion and set forth in the applicable Award Agreement.

(c) Conditions to Exercise. The Committee may impose such conditions and restrictions on the exercise of an Option as it may deem appropriate. Each Option granted under the Plan shall be exercisable at such time or times, or upon the occurrence of such event or events, and for such number of shares of Common Stock as determined by the Committee in its sole discretion and set forth in the applicable Award Agreement.

 

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(d) Exercise of Option. An Option shall be exercised by (i) delivery to the Company of a written notice of exercise (on the form or in the manner specified by the Company for such notice) with respect to all or a specified number of shares of Common Stock subject to the Option, and (ii) payment to the Company of the full amount of the Exercise Price in a manner permissible under Section 6.1(e) and the applicable Award Agreement.

(e) No Rights as a Stockholder. The holder of an Option, as such, shall have none of the rights of a stockholder of the Company with respect to the shares of Common Stock underlying such Option until such time as the Option vests, is exercised and the shares of Common Stock are issued to the holder of the Option.

(f) Special Provisions for Substitute Options. Notwithstanding anything to the contrary in this Section 6.2, any Option issued in substitution for an option previously issued by another entity, which substitution occurs in connection with a corporate transaction, may provide for an Exercise Price and may contain such other terms and conditions as the Committee may prescribe to cause such substitute Option to contain as nearly as possible the same terms and conditions (including the applicable vesting and termination provisions) as those contained in the previously issued option being replaced thereby; provided, however, the number of shares of Common Stock and the Exercise Price of any Option issued in substitution for an option previously issued by another entity shall be determined in accordance with the requirements of Code Section 409A.

(g) Special Conditions for Incentive Stock Options. Notwithstanding anything to the contrary in Section 6.1 or this Section 6.2, Incentive Stock Options shall be subject to the following terms and conditions:

(i) Incentive Stock Options may only be granted to Employees of the Company or of a Subsidiary that qualifies as a “subsidiary corporation” within the meaning given such term by Code Section 424.

(ii) The aggregate Fair Market Value (determined as of the date an Incentive Stock Option is granted) of the shares of Common Stock with respect to which Options intended to meet the requirements of Code Section 422 become exercisable for the first time by an Employee during any calendar year (under all plans of the Company and its Subsidiaries) may not exceed one hundred thousand dollars ($100,000); provided, however, if such limitation is exceeded, the portion of such Incentive Stock Option(s) which cause the limitation to be exceeded will be treated as Non-Qualified Stock Option(s).

(iii) No Incentive Stock Option may be granted after ten (10) years from the date that the Plan is approved by the Company’s stockholders.

(iv) With respect to each grant of an Incentive Stock Option to a Participant who is an Over 10% Owner, the Exercise Price may not be less than one hundred ten percent (110%) of the Fair Market Value of the Common Stock subject to the Incentive Stock Option on the date the Incentive Stock Option is granted.

(v) The exercise period for an Incentive Stock Option must be no longer than ten (10) years from the date that the Incentive Stock Option is granted, or in the case of an Incentive Stock Option granted to an Over 10% Owner, the exercise period may be no longer than five (5) years after the date that the Incentive Stock Option is granted.

(vi) For an Incentive Stock Option issued in substitution for an incentive stock option previously issued by another entity, which substitution occurs in connection with a transaction to which Code Section 424(a) is applicable, both the number of shares of Common Stock and the Exercise Price of the substitute Incentive Stock Option shall be computed in accordance with Code Section 424.

 

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(vii) Incentive Stock Options granted under the Plan are intended to comply with Code Section 422, and the provisions of the Plan and the Award Agreements for any Incentive Stock Options granted under the Plan shall be construed in such manner as to effectuate that intent.

6.3 Stock Appreciation Rights. A Stock Appreciation Right shall entitle the Participant to receive at the time of payment or exercise, for a specified or determinable number of shares of the Common Stock, an amount equal to a percentage (not to exceed 100%) of the excess of Fair Market Value of a share of Common Stock over the applicable Strike Price per share of Common Stock. Each Stock Appreciation Right shall be subject to the following terms and conditions:

(a) Strike Price. Subject to adjustment in accordance with Section 9.1, the Strike Price per share of Common Stock under any Stock Appreciation Right shall be determined by the Committee in its sole discretion and set forth in the applicable Award Agreement; provided, however, the Strike Price may not be less than the Fair Market Value of the Common Stock subject to the Stock Appreciation Right on the date the Stock Appreciation Right is granted.

(b) Conditions to Exercise. The Committee may impose such conditions and restrictions on the exercise of a Stock Appreciation Right as it may deem appropriate. Each Stock Appreciation Right granted under the Plan shall be exercisable or payable at such time or times, or upon the occurrence of such event or events, and in such amounts as determined by the Committee in its sole discretion, and set forth in the applicable Award Agreement.

(c) No Rights as a Stockholder. The holder of a Stock Appreciation Right, as such, shall have none of the rights of a stockholder of the Company with respect to the shares of Common Stock underlying such Stock Appreciation Right until such time as the Stock Appreciation Right vests, is exercised, or paid and the shares of Common Stock are issued to the holder of the Stock Appreciation Right.

(d) Settlement. Upon settlement of a Stock Appreciation Right, the Company shall pay to the Participant the appreciation in cash, shares of Common Stock (valued at the aggregate fair market value), or a combination thereof, as provided in the Award Agreement or, in the absence of such provision, as the Committee may determine.

6.4 Restricted Stock Awards. Each Restricted Stock Award shall be made in such number of shares of Common Stock, upon such terms and conditions on such shares, for such Restricted Period and with such dividend or voting rights during the Restricted Period as determined by the Committee in its sole discretion and set forth in the applicable Award Agreement. Restricted Stock Awards shall be subject to the following terms and conditions:

(a) Consideration. The Committee may require a payment from the Participant in exchange for the grant of a Restricted Stock Award or may grant a Restricted Stock Award without any consideration from the Participant other than his service to or on behalf of the Company or its Subsidiaries.

(b) Shares. A Restricted Stock Award granted pursuant to the Plan may be evidenced by book entry or in such manner as the Committee shall determine, and the Committee may take any action it deems necessary or advisable to reflect that the shares of Common Stock that are part of the Restricted Stock Award are subject to its applicable terms, conditions, and restrictions applicable, until the restrictions thereon shall have lapsed.

(c) Vesting. Each Restricted Stock Award shall vest over a Restricted Period based upon the passage of time or upon the achievement of performance goals (or a combination of both), as determined by the Committee. Restricted Stock Awards subject to performance goals may be designated as Performance Stock Awards. A Restricted Stock Award may also, in the Committee’s discretion, provide

 

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for earlier termination of the Restricted Period in the event of the retirement, death, or Disability of the Participant, or in the event of a Change in Control.

(d) Rights as Stockholder. Unless otherwise determined by the Committee and set forth in the applicable Award Agreement, a grant of a Restricted Stock Award shall immediately entitle the Participant to voting and dividend rights with respect to the shares of Common Stock subject to the Award. In addition, the Committee may determine and set forth in an Award Agreement that any dividends or other distributions on the shares of Common Stock subject to the Award be deferred or that the Award be credited with an additional number of shares of Restricted Stock determined using the amount of dividends that would have been paid on the number of shares of Common Stock underlying the Award and the Fair Market Value of a share of Common Stock on the applicable dividend payment date, and in each case subject to the same vesting and forfeiture restrictions that apply to the shares of Common Stock subject to the Award; provided, however, with respect to a Restricted Stock Award the vesting of which is based on the achievement of performance goals, the dividends and other distributions on the shares of Common Stock subject to the Award shall in all cases either (i) be deferred and payment thereof contingent on the vesting of the shares of Common Stock with respect to which such dividends and other distributions are paid, or (ii) be credited with additional shares of Restricted Stock with the same vesting and forfeiture restrictions that apply to the shares of Common Stock subject to the Award with respect to which such dividends and other distributions are paid.

(e) Qualified Performance Awards. The Committee may, but is not required to, structure any Performance Stock Award so as to qualify as “performance-based compensation” under Code Section 162(m) by granting such Award pursuant to and in accordance with the requirements of Section 6.6.

6.5 Restricted Stock Unit Awards. Restricted Stock Unit Awards shall entitle the Participant to receive, at a specified future date or event, payment of a specified number of shares of Common Stock or an amount equal to all or a portion of the Fair Market Value of a specified number of shares of Common Stock at the end of the applicable Restricted Period. Each Restricted Stock Unit Award shall be made in such number of shares of Common Stock, upon such terms and conditions, for such Restricted Period and with such dividend equivalent rights during the Restricted Period as determined by the Committee in its sole discretion and set forth in the applicable Award Agreement. Restricted Stock Unit Awards shall be subject to the following terms and conditions:

(a) Consideration. The Committee may require a payment from the Participant in consideration of a payment of a Restricted Stock Unit Award or may grant a Restricted Stock Unit Award without any consideration from the Participant other than his service to or on behalf of the Company or its Subsidiaries.

(b) Vesting. Each Restricted Stock Unit Award shall vest over a Restricted Period based upon the passage of time or upon the achievement of performance goals (or a combination of both), as determined by the Committee. Restricted Stock Unit Awards subject to performance goals may be designated as Performance Stock Unit Awards. A Restricted Stock Unit Award may also, in the Committee’s discretion, provide for earlier termination of the Restricted Period in the event of the retirement, death, or Disability of the Participant, or in the event of a Change in Control.

(c) No Rights as a Stockholder. The holder of a Restricted Stock Unit Award, as such, shall have none of the rights of a stockholder of the Company with respect to the shares of Common Stock underlying such Restricted Stock Unit Award until such time as the Restricted Stock Unit Award vests, is paid and the shares of Common Stock are issued to the holder of the Restricted Stock Unit Award.

(d) Settlement. A Restricted Stock Unit Award may be settled by the delivery of shares of Common Stock, their cash equivalent Fair Market Value, any combination thereof or in any other form of consideration, as determined by the Committee and set forth in the applicable Award Agreement.

(e) Qualified Performance Awards. The Committee may, but is not required to, structure any Performance Stock Unit Award so as to qualify as “performance-based compensation” under Code Section 162(m) by granting such Award pursuant to and in accordance with the requirements of Section 6.6

 

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6.6 Qualified Performance Awards, Including Cash Awards. The Committee may grant Performance Stock Awards, Performance Stock Unit Awards, and/or Cash Awards that are intended to qualify as “performance-based compensation” under Code Section 162(m) by conditioning the Award on the attainment of Performance Goals; provided that the Committee shall establish the Performance Goals at such time required under Code Section 162(m), while the outcome of the Performance Goals are substantially uncertain. At the time of the grant of a Cash Award, Performance Stock Award or Performance Stock Unit Award pursuant to this Section 6.6, the Committee will determine the following:

(a) Amount or Number of Shares. Subject to Section 6.6(b), the Committee will determine and specify the dollar value of the Cash Award or the number of shares of the Performance Stock Award or Performance Stock Unit Award that will become payable upon the achievement of specified Performance Goals during a specified Performance Period.

(b) Award Limits. The maximum amount payable under the Plan to a Participant as a Cash Award for any Performance Period that is intended to satisfy the requirements for “performance-based compensation” under Code Section 162(m) shall be five hundred thousand dollars ($500,000) per calendar year. In the case of an Award with a multiyear Performance Period, this dollar limit shall apply separately to each calendar year (or portion thereof) in the Performance Period of such Cash Award. The grant of any Performance Stock Award or Performance Stock Unit Award that is intended to satisfy the requirements for “performance-based compensation” under Code Section 162(m) shall be subject to the limit set forth in Section 4.4(a).

(c) Performance Period. The Committee will determine at the time of grant of an Award under this Section 6.6, the Performance Period applicable to the Award during which the Performance Goals shall be measured, which may be subject to earlier lapse or other modification in the event of the retirement, death, or Disability of the Participant, or in the event of a Change in Control, provided, however, that no such adjustment will be made where such action would result in the loss of the otherwise available exemption of the Award under Code Section 162(m).

(d) Performance Goals. Any grant of an Award under this Section 6.6 will specify one or more Performance Goals established by the Committee which, if achieved, will result in payment of the Award, and may specify in respect of any such specified Performance Goal a minimum acceptable level or levels of achievement and a formula for determining the number of shares or amount of the Award that will be earned if performance is at or above the specified minimum or threshold level or levels, or is at or above the target level or levels, but falls short of the specified maximum level or levels. The grant of an Award under this Section 6.6 will specify that, before the Award will be earned and paid, the Committee must determine and certify that the Performance Goals and other material terms of the Award have been satisfied, and if applicable, the level of performance achieved. Performance Goals shall mean any one or more of the following criteria:

(i) Share price, including market price per share and share price appreciation.

(ii) Earnings, including (a) earnings per share; (b) gross or pre-tax profits; (c) post-tax profits; (d) operating profit; (e) operating earnings; (f) growth in earnings or growth in earnings per share; and (g) total earnings.

(iii) Return on equity, including (a) return on invested capital; (b) return or net return on assets or net assets; (c) return on investment; (d) return on capital; (e) financial return ratios; (f) value of assets; and (g) change in assets.

(iv) Cash flow(s), including (a) operating cash flow; (b) net cash flow; (c) free cash flow; and (d) cash flow on investment.

(v) Revenue, including gross or net revenue and changes in annual revenues.

 

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(vi) Margins, including adjusted pre-tax margin and operating margins.

(vii) Income, including net income and consolidated net income.

(viii) Costs and expenses, including (a) operating or administrative expenses; (b) expense or cost levels; (c) reduction of losses, loss ratios, or expense ratios; (d) reduction in fixed costs; (e) expense reduction levels; (f) operating cost management; and (g) cost of capital.

(ix) Financial ratings, including (a) credit rating; (b) capital expenditures; (c) debt; (d) debt reduction; (e) working capital; (f) capital ratios; (g) average invested capital; and (h) attainment of balance sheet or income statement objectives.

(x) Market share, including (a) volume; and (b) market share or market penetration with respect to specific geographic areas.

(xi) Shareholder return, including (a) total shareholder return; (b) shareholder return based on growth measures or the attainment of a specified share price for a specified period of time; and (c) dividends.

Such Performance Goals may be particular to an Employee or Director or the division, department, branch or line of business, Subsidiary, or other unit in which the Employee works, or may be based on the performance of the Company generally. In addition, the Committee shall, in its discretion and to the extent consistent with Code Section 162(m), if applicable, include or exclude from a Performance Goal any of the following items: (1) asset write-downs; (2) litigation or claim judgments or settlements; (3) the effect of changes in tax laws, accounting principles, regulations, or other laws or regulations affecting reported results; (4) any reorganization and restructuring programs; (5) acquisitions or divestitures; (6) unusual nonrecurring or extraordinary items identified in the Company’s audited financial statements, including footnotes; (7) annual incentive payments or other bonuses; or (8) capital charges

6.7 Director Awards. Subject to the limitations in Section 4.4(b), in addition to the ability of Directors to receive Options, Stock Appreciation Rights, Restricted Stock Awards, Restricted Stock Unit Awards, or other Awards under this Article VI, Directors may also (a) receive Awards of outright shares of Common Stock, and (b) be permitted to elect to receive, pursuant to procedures established by the Committee, Awards of outright shares of Common Stock in lieu of cash-based director fees that the Director elects to receive in the form of shares of Common Stock with a fair market value equal to the cash-based director fees that the Director would otherwise have received.

6.8 Other Awards. Subject to applicable law and the limits set forth in Article IV, the Committee may grant to any Participant such other Awards that may be denominated or payable in, valued in whole or in part by reference to, or otherwise based on, or related to, shares of Common Stock or factors that may influence the value of such shares, including, without limitation, convertible or exchangeable debt securities, other rights convertible or exchangeable into shares of Common Stock, purchase rights for shares of Common Stock, Awards with value and payment contingent upon performance of the Company or specified Subsidiaries, affiliates or other business units thereof or any other factors designated by the Committee, and Awards valued by reference to the book value of shares of Common Stock or the value of securities of, or the performance of specified Subsidiaries or affiliates or other business units of the Company. The Committee will determine the terms and conditions of such Awards. Shares of Common Stock delivered pursuant to an Award in the nature of a purchase right granted under this Section will be purchased for such consideration, paid for at such time, by such methods, and in such forms, including, without limitation shares of Common Stock, notes or other property, as the Committee determines.

ARTICLE VII

CHANGE IN CONTROL

7.1 Effect of a Change in Control. In the event of a Change in Control, unless otherwise set forth in the applicable Award Agreement, or as provided in an executive, employment, severance, or similar agreement, if

 

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any, between the Participant and the Company or a Subsidiary, the following acceleration, exercisability, and valuation provisions will apply:

(a) Upon a Change in Control, each then-outstanding Option and Stock Appreciation Right will become fully vested and exercisable, and the restrictions applicable to each outstanding Restricted Stock Award, Restricted Stock Unit, Other Award, or Cash Award will lapse, and each Award will be fully vested (with any applicable performance goals deemed to have been achieved at a target level as of the date of such vesting), except to the extent that an Award meeting the requirements of Section 7.1(b) (a “Replacement Award”) is provided to the Participant holding such Award in accordance with Section 7.1(b) to replace or adjust such outstanding Award (a “Replaced Award”);

(b) An Award meets the conditions of this Section 7.1(b) (and hence qualifies as a Replacement Award) if (i) it is of the same type (e.g., stock option for Option, restricted stock award for Restricted Stock Award, restricted stock unit award for Restricted Stock Unit Award, etc.) as the Replaced Award, (ii) it has a value at least equal to the value of the Replaced Award, (iii) it relates to publicly traded equity securities of the Company or its successor in the Change in Control or another entity that is affiliated with the Company or its successor following the Change in Control, (iv) the federal tax consequences to the Participant holding the Replaced Award of the Replacement Award are not less favorable to such Participant than the federal tax consequences of the Replaced Award, and (v) its other terms and conditions are not less favorable to the Participant holding the Replaced Award than the terms and conditions of the Replaced Award (including, but not limited to, the provisions that would apply in the event of a subsequent Change in Control). Without limiting the generality of the foregoing, the Replacement Award may take the form of a continuation of the Replaced Award if the requirements of the preceding sentence are satisfied. The determination of whether the conditions of this Section 7.1(b) are satisfied will be made by the Committee, as constituted immediately before the Change in Control, in its sole discretion (taking into account the requirements of Treasury Regulation 1.409A-3(i)(5)(iv)(B) and exemption or compliance of the Replaced Award or Replacement Award from or with Code Section 409A). Without limiting the generality of the foregoing, the Committee may determine the value of Replaced Awards and Replacement Awards that are stock options by reference to either their intrinsic value or their fair value; and

(c) Upon the Involuntary Termination, during the period of two (2) years immediately following a Change in Control, of a Participant holding Replacement Awards, (i) all Replacement Awards held by the Participant will become fully vested and, if applicable, exercisable and free of restrictions (with any applicable performance goals deemed to have been achieved at a target level as of the date of such vesting), and (ii) all Options and Stock Appreciation Rights held by the Participant immediately before such Involuntary Termination that the Participant also held as of the date of the Change in Control and all stock options and stock appreciation rights that constitute Replacement Awards will remain exercisable for a period of 90 days following such Involuntary Termination or until the expiration of the stated term of such stock option or stock appreciation right, whichever period is shorter (provided, however, if the applicable Award Agreement provides for a longer period of exercisability, that provision will control).

7.2 Definition. For purposes of this Plan, a “Change in Control” of the Company shall be deemed to have occurred upon the happening of any of the following events:

(a) There shall be consummated (i) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which any shares of the Company’s common stock are to be converted into cash, securities or other property, provided that the consolidation or merger is not with a corporation which was a wholly owned subsidiary of the Company immediately before the consolidation or merger, or (ii) any sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company;

(b) The stockholders of the Company approve any plan or proposal for the liquidation or dissolution of the Company;

(c) Any person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) shall become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act), directly or

 

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indirectly, of twenty percent (20%) or more of the Company’s then-outstanding common stock, provided that such person shall not be a wholly-owned subsidiary of the Company immediately before it becomes such twenty percent (20%) beneficial owner; or

(d) Individuals who constitute the Board on the date hereof (the “Incumbent Board”) cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s stockholders, was approved by a vote of at least three quarters of the Directors comprising the Incumbent Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without objection to such nomination) shall be, for purposes of this clause (d), considered as though such person were a member of the Incumbent Board.

ARTICLE VIII

TERMINATION AND AMENDMENT

8.1 Termination and Amendment of Plan.

(a) Subject to the limitations of Section 8.3, the Board may amend or terminate the Plan at any time; provided, however, the Board shall obtain stockholder approval for any amendment to the Plan that increases the number of shares of Common Stock available under the Plan, materially expands the classes of individuals eligible to receive Awards, materially expands the type of awards available for issuance under the Plan, or would otherwise require stockholder approval under the Code or other applicable laws, or the Nasdaq Stock Market listing standards.

(b) Notwithstanding Section 8.1(a), without the consent of the holder of an Award, no such termination or amendment of the Plan may adversely affect the then value of the Award or the rights of the holder of such Award, and with respect to any Award which provides for the deferral of compensation subject to the provisions of Code Section 409A, no termination or amendment of the Plan shall have the effect of accelerating the payment of such Award if and to the extent that such accelerated payment would violate Code Section 409A.

8.2 Amendment of Award Agreements. Subject to the limitations of Section 8.3, the Board or the Committee may amend an Award Agreement at any time, in their sole discretion; provided, however, without the consent of the holder of an Award, no such amendment of an Award Agreement may adversely affect the then value of the Award or the rights of the holder of such Award, and with respect to any Award which provides for the deferral of compensation subject to the provisions of Code Section 409A, no amendment of the Award Agreement shall have the effect of accelerating the payment of such Award if and to the extent that such accelerated payment would violate Code Section 409A.

8.3 No Repricing. Except as provided by Section 9.1, without the approval of the Company’s stockholders, the Exercise Price of an Option or the Strike Price of a Stock Appreciation Right may not be amended or modified after the grant of the Option or Stock Appreciation Right, and an Option or Stock Appreciation Right may not be surrendered or cancelled in consideration of, or in exchange for, cash, other Awards, or the grant of a new Option or Stock Appreciation Right having an Exercise Price or Strike Price below that of the Option or Stock Appreciation Right that was surrendered or cancelled, and without the approval of the Company’s stockholders, neither the Board nor the Committee may take any other action with respect to an Option or Stock Appreciation Right that would be treated as a repricing under the rules and regulations of the principal securities exchange on which the shares of Common Stock are traded.

 

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ARTICLE IX

GENERAL PROVISIONS

9.1 Changes in Capitalization; Merger; Liquidation.

(a) The aggregate number of shares of Common Stock reserved for the grant of Awards, for issuance upon the exercise or payment, as applicable, of each outstanding Award and upon vesting of an Award; the annual limit per Participant; the Exercise Price of each outstanding Option; the Strike Price of each outstanding Stock Appreciation Right and the specified number of shares of Common Stock to which each outstanding Award pertains shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company.

(b) In the event of a merger, consolidation, reorganization, extraordinary dividend, spin-off, sale of substantially all of the Company’s assets, other change in capital structure of the Company, or tender offer for shares of Common Stock, the Committee may make such adjustments with respect to awards and take such other action as it deems necessary or appropriate, including, without limitation, the substitution of new Awards, or the adjustment of outstanding Awards, the acceleration of Awards, the removal of restrictions on outstanding Awards, or the termination of outstanding Awards in exchange for the cash value determined in good faith by the Committee of the vested or unvested portion of the Award, all as may be provided in the applicable Award Agreement or, if not expressly addressed therein, as the Committee subsequently may determine in its sole discretion. Any adjustment pursuant to this Section may provide, in the Committee’s discretion, for the elimination without payment therefor of any fractional shares that might otherwise become subject to any Award, but, except as set forth in this Section, may not otherwise diminish the then value of the Award.

(c) The existence of the Plan and the Awards granted pursuant to the Plan shall not affect in any way the right or power of the Company or a Subsidiary to make or authorize any adjustment, reclassification, reorganization or other change in its capital or business structure, any merger or consolidation of the Company or a Subsidiary, any issue of debt or equity securities having preferences or priorities as to the Common Stock or the rights thereof, the dissolution or liquidation of the Company or a Subsidiary, any sale or transfer of all or any part of its business or assets, or any other corporate act or proceeding.

9.2 Code Section 409A. Options, Stock Appreciation Rights, Restricted Stock Awards, and Director Awards granted under the Plan are intended to be exempt from Code Section 409A, and Restricted Stock Unit Awards, Cash Awards, dividend equivalents, and all other Awards awarded under the Plan are intended to be exempt from or comply with Code Section 409A, and the Plan, Award Agreements and the terms of Awards shall be administered and interpreted consistent with such intention. In the event any provisions of the Plan or any Award Agreement are determined by the Committee potentially to violate Code Section 409A, such provisions shall be amended, as necessary, to be exempt from or comply with Section 409A; and until adoption of any such amendment, the provisions shall be construed and interpreted, to the extent possible, to be exempt from or comply with Section 409A. Notwithstanding the foregoing, the Company makes no representations that the payments and benefits provided under the Plan are exempt from or comply with Section 409A, and in no event will the Company be liable for all or any portion of any taxes, penalties, interest, or other expenses that may be incurred by a Participant on account of non-compliance with Section 409A.

9.3 Right to Terminate Employment or Service. Nothing in the Plan or in any Award Agreement confers upon any Participant the right to continue as an officer, employee, director, consultant or other service provider of the Company or any of its Subsidiaries or affects the right of the Company or any of its Subsidiaries to terminate a Participant’s employment or services at any time.

9.4 Non-Alienation of Benefits. Except as otherwise expressly provided by the Plan, no Award or benefit under the Plan may be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge,

 

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attachment, encumbrance, or charge; and any attempt to do so shall be void. No such Award or benefit may, prior to receipt by the Participant, be in any manner liable for or subject to the debts, contracts, liabilities, engagements, or torts of the Participant.

9.5 Restrictions on Delivery and Sale of Shares; Legends. Each Award is subject to the condition that if at any time the Committee, in its discretion, shall determine that the listing, registration, or qualification of the shares of Common Stock covered by such Award upon any securities exchange or under any federal or state law is necessary or desirable as a condition of or in connection with the granting of such Award or the purchase or delivery of shares thereunder, the delivery of any or all shares of Common Stock pursuant to such Award may be withheld unless and until such listing, registration, or qualification shall have been effected. If a registration statement is not in effect under the Securities Act of 1933 or any applicable state securities laws with respect to the shares of Common Stock purchasable or otherwise deliverable under Awards then outstanding, the Committee may require, as a condition of exercise of any Option or as a condition to any other delivery of Common Stock pursuant to an Award, that the Participant or other recipient of an Award represent, in writing, that the shares received pursuant to the Award are being acquired for investment and not with a view to distribution and agree that the shares will not be disposed of except pursuant to an effective registration statement, unless the Company shall have received an opinion of counsel that such disposition is exempt from such requirement under the Securities Act of 1933 and any applicable state securities laws. The Company may include on certificates representing shares delivered pursuant to an Award such legends referring to the foregoing representations or restrictions or any other applicable restrictions on resale as the Company, in its discretion, shall deem appropriate.

9.6 FDIA Limitations. Any actions by the Company under the Plan or any Award Agreement must comply with the law, including regulations and other interpretive action, of the Federal Deposit Insurance Act, Federal Deposit Insurance Corporation, or other entities that supervise any of the activities of the Company. Specifically, any payments to the Participant by the Company, whether pursuant to the Plan, an Award Agreement, or otherwise, are subject to and conditioned upon their compliance with Section 18(k) of the Federal Deposit Insurance Act, 12. U.S.C. Section 1828(k), and the regulations promulgated thereunder in 12 C.F.R. Part 359.

9.7 Compensation Recovery Policy. Notwithstanding any provision of the Plan or an Award Agreement, the amount of any cash paid under an Award, any shares of Common Stock granted or issued under an Award, and any amount received with respect to any sale of any such shares of Common Stock, shall be subject to potential cancellation, recoupment, rescission, payback, or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time, and the Committee shall include a provision in Award Agreements to give effect to such policy.

9.8 Listing and Legal Compliance. The Committee may suspend the exercise or payment of any Award so long as it determines that securities exchange listing or registration or qualification under any securities laws is required in connection therewith and has not been completed on terms acceptable to the Committee.

9.9 Choice of Law. The laws of the State of New York shall govern the Plan, to the extent not preempted by federal law, without reference to the principles of conflict of laws.

9.10 Plan Binding on Successors. The Plan shall be binding upon the successors and assigns of the Company.

9.11 Interpretation. Whenever used in the Plan, nouns in the singular shall include the plural and the plural shall include the singular, and the masculine pronoun shall include the feminine gender. Headings of Articles and Sections in the Plan are inserted for convenience and reference only, and they do not constitute part of the Plan.

*        *        *         *        *

 

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				FINANCIAL INSTITUTIONS, INC.
Dated: May 6, 2015				By:		/s/ Martin K. Birmingham
				Name:		Martin K. Birmingham
				Title:		President & Chief Executive Officer

Date of Stockholder Approval: May 6, 2015

 

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Exhibit 10.2

DIRECTOR ANNUAL RESTRICTED STOCK AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Director:
Date of Grant:
Number of Shares:
Vesting Schedule:		The Vested Percentage of the Number of Shares set forth above shall be determined as of the following Vesting Date(s):
		Vesting Date		Vested Percentage
		Date of Grant			50	%
		The day prior to the Company’s first annual meeting of shareholders following the Date of Grant			Remaining 50	%

This RESTRICTED STOCK AWARD AGREEMENT (this “Agreement”), dated as of [DATE], is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Director”) to record the grant to the Director of a Restricted Stock Award (the “Award”) on the Date of Grant set forth above pursuant to Section 6.4 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Director hereby agree as follows:

Section 1. Grant of Shares. The Company hereby grants to the Director, as of the Date of Grant, subject to and in accordance with the terms and conditions of the Plan and this Agreement, a Restricted Stock Award for the Number of Shares set forth above (the “Shares”).

Section 2. Vesting of Shares. Subject to Section 3 below, provided that the Director provides continuous services as a director of the Company through the Vesting Date(s) set forth above, ownership of the Shares shall vest pursuant to the Vesting Schedule set forth above. If the Director ceases to be a director of the Company for any reason before the Shares vest, the Shares shall be immediately forfeited to the Company.

Section 3. Change in Control. Subject to the terms of the Plan, if prior to the latest of the Vesting Dates set forth above there is a Change in Control, then all of the Director’s unvested Shares that have not been forfeited shall fully vest as of the date of the Change in Control except to the extent that a Replacement Award is provided to the Director to replace the unvested Shares. Upon the Director’s Involuntary Termination, during the period of two (2) years immediately following a Change in Control, any Replacement Award held by the Director will become fully vested and, if applicable, free of restrictions.

Section 4. Dividends. Notwithstanding Section 6.4(d) of the Plan, no dividends shall accrue or be paid to the Director with respect to any Shares subject to the Award that have not become vested Shares or that are subject to any restrictions or conditions on the record date for dividend.

Section 5. Rights as Shareholder. Except for the transfer and other restrictions set forth elsewhere in this Agreement (including the limitations on dividends set forth in Section 4 above) and in the Plan, the Director, as record holder of the Shares, shall possess all the rights of a holder of the Company’s Common Stock (including voting); provided, however, that prior to becoming vested and transferable the certificates representing such Shares shall be held by the Company for the benefit of the Director. As the Shares become vested Shares, the Company shall, as applicable, either remove the notations on any Shares issued in book entry form which have vested or deliver to the Director a certificate or certificates evidencing the number of vested Shares. As noted above, the Director shall not receive any dividends on unvested Shares, and such dividends shall be permanently forfeited.

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Section 6. Legend. Each share certificate representing the Shares shall bear a legend indicating that such Shares are “Restricted Stock” and are subject to the provisions of this Agreement and the Plan and a legend indicating that the Shares were granted in reliance on an exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”) and are subject to the restrictions on transferability under the Securities Act as set forth in Section 8 below.

Section 7. No Transferability. The Shares may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated until they become fully vested and transferable in accordance with Section 2 of this Agreement and then only to the extent permitted under this Agreement and the Plan and by applicable securities laws. Prior to full vesting and transferability, all rights with respect to the Shares granted to a Director under the Plan shall be available, during such Director’s lifetime, only to such Director, or in the event of the Disability of the Director, by the Director or the legal representative of the Director, or in the event of the death of the Director, by the legal representative of the Director’s estate, or if no legal representative has been appointed by the successor in interest determined under the Director’s will.

Section 8 Securities Law Matters.

(a) The Director understands that the issuance of the Shares have not been registered under the Securities Act by reason of the exemption in Section 4(a)(2) of the Securities Act which depends on his or her intention to hold the Shares for investment purposes. The Director understands that the Shares must be held in a manner consistent with the rules and regulations of the Securities and Exchange Commission unless they are subsequently registered under the Securities Act or an exemption from registration is available, and that the Company is under no obligation to register the Shares or to effect compliance with any exemption from such registration requirements.

(b) As a precondition to the Company’s execution of this Agreement and the grant of the Restricted Stock hereunder, the Director represents to the Company that the Shares are being acquired by the Director solely for investment and not with a view to, or for sale in connection with, any distribution thereof, nor with any present intention of selling, transferring or disposing of the same.

(c) The Director acknowledges and agrees that the Shares may not be offered for sale, sold, pledged, hypothecated or otherwise transferred or disposed of in any manner inconsistent with this Agreement or the Plan unless (i) a registration statement with respect to the sale or transfer of the Shares shall then be effective under the Securities Act, or (ii) the Company shall have received an opinion of counsel in form and substance satisfactory to counsel for the Company that the proposed sale or transfer of the Shares is exempt from the registration requirements of the Securities Act and may otherwise be effected in compliance with any other applicable law, including all applicable state securities laws.

Section 9. Stock Power. Concurrently with the execution of this Agreement, the Director shall deliver to the Company a stock power, endorsed in blank, relating to the Shares. Such stock power shall be in the form attached hereto as Exhibit A. The stock power with respect to any certificate representing Shares that do not vest shall be completed in the name of the Company by an officer of the Company, and the Shares shall be returned to either authorized but unissued shares or treasury shares, depending on their original source.

Section 10. Adjustment of Shares. As provided by the Plan, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company, the specified number of Shares shall be proportionately adjusted to prevent dilution or enlargement of the rights granted to, or available for, the Director hereunder.

 

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Section 11 No Continued Service Rights. Nothing in the Plan or this Agreement confers upon the Director any right with respect to continuance as a director of the Company or any of its Subsidiaries, or affects the right of the Company or any of its Subsidiaries may have to terminate the Director’s position as a director at any time.

Section 12. Coordination with Plan. The Director hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all of the terms and provisions thereof including any that may conflict with those contained in this Agreement.

Section 13. Notices. All notices to the Company shall be in writing and sent to the Company’s Director of Human Resources at the Company’s offices. Notices to the Director shall be addressed to the Director at the Director’s address as it appears on the Company’s records.

Section 14. Amendment. The Company may alter, amend or terminate this Agreement only with the Director’s consent, except as otherwise expressly provided by the Plan or this Agreement.

Section 15. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

Section 16. Compensation Recovery Policy. Any Shares granted or issued under this Award Agreement shall be subject to potential cancellation, recoupment, rescission, payback, or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time.

IN WITNESS WHEREOF, the Company and the Director have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				DIRECTOR:
				By:
				Name:

 

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EXHIBIT A

STOCK POWER

FOR VALUE RECEIVED, the undersigned does hereby sell, assign and transfer to Financial Institutions, Inc. (the “Company”), XXXX shares of the Company’s common stock represented by Certificate No. XXXXXXX. The undersigned authorizes the Secretary of the Company to transfer the stock on the books of the Company in the event of the forfeiture of any shares issued under the Restricted Stock Award Agreement dated as of [DATE], between the Company and the undersigned.

 

Dated:
Name

 

4

Exhibit 10.3

DIRECTOR “IN LIEU OF CASH FEES” STOCK AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Director:

Date of Grant:

Number of Shares:

Share Value on Date of Grant:

This STOCK AWARD AGREEMENT (this “Agreement”), dated as of May 6, 2015 is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Director”) to record the grant to the Director of an award of shares of Common Stock (the “Award”) on the Date of Grant set forth above pursuant to Section 6.7 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Director hereby agree as follows:

Section 1. Grant of Shares. In lieu of payment to the Director of cash fees in an amount equal to the Number of Shares multiplied by the Share Value on the Date of Grant, each as set forth above, which the Director would otherwise be entitled to receive for his or her services as a director of the Company, the Company hereby grants to the Director as of the Date of Grant, an Award for the Number of Shares set forth above of shares of Common Stock (the “Shares”), subject to and in accordance with the terms and conditions of the Plan and this Agreement. The Shares shall be 100% vested as of the Date of Grant.

Section 2. Rights as Shareholder. The Director, as record holder of the Shares, shall possess all the rights of a holder of Common Stock.

Section 3. Securities Law Matters.

(a) The Director understands that the issuance of the Shares have not been registered under the Securities Act of 1933, as amended (the “Securities Act”) by reason of the exemption in Section 4(a)(2) of the Securities Act which depends on his or her intention to hold the Shares for investment purposes. The Director understands that the Shares must be held in a manner consistent with the rules and regulations of the Securities and Exchange Commission unless they are subsequently registered under the Securities Act or an exemption from registration is available, and that the Company is under no obligation to register the Shares or to effect compliance with any exemption from such registration requirements.

(b) As a precondition to the Company’s execution of this Agreement and the grant of the Restricted Stock hereunder, the Director represents to the Company that the Shares are being acquired by the Director solely for investment and not with a view to, or for sale in connection with, any distribution thereof, nor with any present intention of selling, transferring or disposing of the same.

(c) The Director acknowledges and agrees that the Shares may not be offered for sale, sold, pledged, hypothecated or otherwise transferred or disposed of in any manner inconsistent with this Agreement or the Plan unless (i) a registration statement with respect to the sale or transfer of the Shares shall then be effective under the Securities Act, or (ii) the Company shall have received an opinion of counsel in form and substance satisfactory to counsel for the Company that the proposed sale or transfer of the Shares is exempt from the registration requirements of the Securities Act and may otherwise be effected in compliance with any other applicable law, including all applicable state securities laws.

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(d) Each share certificate representing the Shares shall bear a legend indicating that such Shares were granted in reliance on an exemption from registration under the Securities Act and are subject to the restrictions on transferability under the Securities Act as set forth in this Section 3.

4. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

IN WITNESS WHEREOF, the Company and the Director have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				DIRECTOR:
				By:
				Name:

Exhibit 10.4

RESTRICTED STOCK AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Participant:
Date of Grant:
Number of Shares:
Vesting Schedule:		The Vested Percentage of the Number of Shares set forth above shall be determined as of the following Vesting Date(s):
		Vesting Date		Vested Percentage
		Third anniversary of the Date of Grant			100	%

This RESTRICTED STOCK AWARD AGREEMENT (this “Agreement”), dated as of [DATE], is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Participant”) to record the grant to the Participant of a Restricted Stock Award (the “Award”) on the Date of Grant set forth above pursuant to Section 6.4 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Participant hereby agree as follows:

Section 1. Grant of Shares. The Company hereby grants to the Participant, as of the Date of Grant, subject to and in accordance with the terms and conditions of the Plan and this Agreement, a Restricted Stock Award for the Number of Shares set forth above (the “Shares”).

Section 2. Vesting of Shares. Subject to Section 3 below, provided that the Participant provides substantial services and remains in continuous employment with the Company or a Subsidiary through the Vesting Date(s) set forth above, the Shares shall vest pursuant to the Vesting Schedule set forth above. Except as otherwise provided by Section 3 below, if the Participant ceases to provide substantial services or remain in continuous employment with the Company or a Subsidiary for any reason before the Shares vest, the Shares shall be immediately forfeited to the Company.

Section 3. Effects of Certain Events.

 

(a)

Change in Control. Subject to the terms of the Plan, if prior to the latest of the Vesting Dates set forth above there is a Change in Control:

 

(i)

if Replacement Awards are not provided to the Participant to replace unvested Shares, then all of the Participant’s unvested Shares that have not been forfeited shall fully vest as of the date of the Change in Control.

 

(ii)

if Replacement Awards are provided to the Participant to replace unvested Shares, then in the event of the Participant’s Involuntary Termination during the period of two (2) years immediately following the Change in Control, the unvested Shares under such Replacement Awards shall become fully vested and, if applicable, free of restrictions, as of the date of the Involuntary Termination.

 

(b)

Death or Disability. If prior to the latest of the Vesting Dates set forth above, the Participant’s employment with the Company or a Subsidiary terminates due to death or Disability, then all Shares not yet vested shall become immediately vested.

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Section 4. Dividends. Notwithstanding Section 6.4(d) of the Plan, no dividends shall accrue or be paid to the Participant with respect to any Shares subject to the Award that have not become vested Shares or that are subject to any restrictions or conditions on the record date for dividends.

Section 5. Rights as Shareholder. Except for the transfer and other restrictions set forth elsewhere in this Agreement (including the limitations on dividends set forth in Section 4 above) and in the Plan, the Participant, as record holder of the Shares, shall possess all the rights of a holder of Common Stock (including voting); provided, however, that prior to becoming vested and transferable the certificates representing such Shares shall be held by the Company for the benefit of the Participant. As the Shares become vested Shares, the Company shall, as applicable, either remove the notations on any Shares issued in book entry form which have vested or deliver to the Participant a certificate or certificates evidencing the number of vested Shares. As noted above, the Participant shall not receive any dividends on unvested Shares, and such dividends shall be permanently forfeited.

Section 6. Legend. Each share certificate representing the Shares shall bear a legend indicating that such Shares are “Restricted Stock” and are subject to the provisions of this Agreement and the Plan.

Section 7. No Transferability. The Shares may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated until they become fully vested and transferable in accordance with Section 2 of this Agreement and then only to the extent permitted under this Agreement and the Plan and by applicable securities laws. Prior to full vesting and transferability, all rights with respect to the Shares granted to a Participant under the Plan shall be available, during such Participant’s lifetime, only to such Participant, or in the event of the Disability of the Participant, to the Participant or the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed to the successor in interest determined under the Participant’s will.

Section 8. Stock Power. Concurrently with the execution of this Agreement, the Participant shall deliver to the Company a stock power, endorsed in blank, relating to the Shares. Such stock power shall be in the form attached hereto as Exhibit A. The stock power with respect to any certificate representing Shares that do not vest shall be completed in the name of the Company by an officer of the Company, and the Shares shall be returned to either authorized but unissued shares or treasury shares, depending on their original source.

Section 9. Withholding Taxes. As a condition of and prior to the delivery or release of any Shares, the Company shall be entitled to require the Participant to remit to the Company an amount sufficient to satisfy the amount of any federal, state, or local taxes required to be withheld with respect to the transfer or vesting of the Shares, or any other taxable event related thereto. The Committee may permit the Participant to make such payment in any form or manner authorized by the Committee in its sole discretion, including, but not limited to one or more of the forms specified below:

 

(a)

U.S. dollars by personal check, bank draft, or money order payable to the Company, by money transfer or direct account debits;

 

(b)

Delivery to the Company of a number of shares of Common Stock having an aggregate fair market value of not less than the minimum tax withholding required for the Award;

 

(c)

Involvement of a stockbroker in accordance with the federal margin rules set forth in Regulation T;

 

(d)

A cashless exercise if and to the extent permissible by applicable law; or

 

(e)

Any combination of the above forms and methods.

In the event the Participant fails to provide timely payment of all sums required by the Company pursuant to this Section 9, the Company shall have the right and option, but not obligation, to treat such failure as an election by the Participant to provide all or any portion of such required payment by means of tendering Shares.

 

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Section 10. Adjustment of Shares. As provided by the Plan, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company, the specified number of Shares shall be proportionately adjusted to prevent dilution or enlargement of the rights granted to, or available for, the Participant hereunder.

Section 11. No Employment Rights. Nothing in the Plan or this Agreement confers upon the Participant any right with respect to continuance of employment by the Company or any of its Subsidiaries, or affects the right of the Company or any of its Subsidiaries may have to terminate the Participant’s employment at any time.

Section 12. Coordination with Plan. The Participant hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all of the terms and provisions thereof including any that may conflict with those contained in this Agreement.

Section 13. Notices. All notices to the Company shall be in writing and sent to the Company’s Director of Human Resources at the Company’s offices. Notices to the Participant shall be addressed to the Participant at the Participant’s address as it appears on the Company’s records.

Section 14. Amendment. The Company may alter, amend or terminate this Agreement only with the Participant’s consent, except as otherwise expressly provided by the Plan or this Agreement.

Section 15. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

Section 16. Compensation Recovery Policy. Notwithstanding any other provision of this Agreement to the contrary, any Shares granted and/or issued hereunder, and/or any amount received with respect to any sale of any such Shares, shall be subject to potential cancellation, recoupment, rescission, payback or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time (the “Policy”). The Participant agrees and consents to the Company’s application, implementation and enforcement of (i) the Policy that may apply to the Participant and (ii) any provision of applicable law relating to cancellation, rescission, payback or recoupment of compensation, including, but not limited to Section 10D of the Exchange Act, and expressly agrees that the Company may take such actions as are necessary to effectuate the Policy or applicable law without further consent or action being required by the Participant. To the extent that the terms of this Agreement and the Policy or any similar policy conflict, then the terms of such policy shall prevail.

Section 17. Excise Tax Cap. In the event that a Participant becomes entitled to any payment or benefit under this Agreement (such benefits together with any other payments or benefits payable to the Participant under any other agreement with the Participant, or plan or policy of the Company, are referred to in the aggregate as the “Total Payments”), if all or any part of the Total Payments will be subject to the tax imposed by Code Section 4999, or any similar tax that may hereafter be imposed (the “Excise Tax”), then:

 

(a)

Within 30 days following the Participant’s termination of employment, the Company will notify the Participant in writing: (1) whether the payments and benefits under this Agreement, when added to any other payments and benefits making up the Total Payments, exceed an amount equal to 299% of the Participant’s “base amount” as defined in Code Section 280G(b)(3) (the “299% Amount”); and (2) the amount that is equal to the 299% Amount.

 

(b)

The payments and benefits under this Agreement shall be reduced such that the Total Payments do not exceed the 299% Amount, so that no portion of the payments and benefits under this Agreement will be subject to the Excise Tax. Any payment or benefit so reduced will be permanently forfeited and will not be paid to the Participant.

 

3

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(c)

The calculation of the 299% Amount and the determination of how much the Participant’s payments and benefits must be reduced in order to avoid application of the Excise Tax will be made by the Company’s public accounting firm prior to the Participant’s termination of employment, which firm must be reasonably acceptable to the Participant (the “Accounting Firm”). The Company will cause the Accounting Firm to provide detailed supporting calculations of its determinations to the Company and the Participant. Notice must be given to the Accounting Firm within 15 business days after an event entitling the Participant to a payment under this Agreement. All fees and expenses of the Accounting Firm will be borne solely by the Company.

 

(d)

For purposes of making the reduction of amounts payable under this Agreement, such amounts will be eliminated in compliance with the requirements of Code Section 409A, to the extent applicable.

IN WITNESS WHEREOF, the Company and the Participant have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				PARTICIPANT:
				By:
				Name:

 

4

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EXHIBIT A

STOCK POWER

FOR VALUE RECEIVED, the undersigned does hereby sell, assign and transfer to Financial Institutions, Inc. (the “Company”), XXXX shares of the Company’s common stock represented by Certificate No. XXXXXXX. The undersigned authorizes the Secretary of the Company to transfer the stock on the books of the Company in the event of the forfeiture of any shares issued under the Restricted Stock Award Agreement dated as of [DATE], between the Company and the undersigned.

 

Dated:
Name

 

5

Exhibit 10.5

[YEAR] PERFORMANCE STOCK AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Participant:
Date of Grant:
Number of Shares:
Service Period:		The three-year period beginning on [DATE] and ending on [DATE]
Earned Shares and Vesting Schedule:		The Number of Shares set forth above shall become Earned Shares based on the achievement of the applicable Performance Goals during the applicable Performance Period and shall vest based on completion of the Service Period in accordance with Exhibit B.

This PERFORMANCE STOCK AWARD AGREEMENT (this “Agreement”), dated as of [DATE], is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Participant”) to record the grant to the Participant of a Performance Stock Award (the “Award”) on the Date of Grant set forth above pursuant to Section 6.4 and Section 6.6 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). The Award is intended to qualify as “performance-based compensation” under Code Section 162(m), and will be interpreted and administered accordingly. Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Participant hereby agree as follows:

Section 1. Grant of Shares. The Company hereby grants to the Participant, as of the Date of Grant, subject to and in accordance with the terms and conditions of the Plan and this Agreement, a Performance Stock Award for the Number of Shares set forth above (the “Shares”).

Section 2. Achievement and Vesting of Shares. Subject to Section 3 below, and the achievement of the applicable Performance Goals during the applicable Performance Period (both as set forth on Exhibit B), provided that the Participant provides substantial services and remains in continuous employment with the Company or a Subsidiary through the end of the Service Period set forth above, the Earned Shares shall vest on the last day of the Service Period. Except as otherwise provided by Section 3 below, if the Participant ceases to provide substantial services or remain in continuous employment with the Company or a Subsidiary for any reason before the completion of the Service Period, the Shares shall be immediately forfeited to the Company. Notwithstanding the foregoing, before the Award will be earned, the Committee must determine and certify in accordance with the requirements of Code Section 162(m), that the Performance Goals and other material terms of the Award have been satisfied, and if applicable, the level of performance achieved.

Section 3. Effects of Certain Events.

 

(a)

Change in Control. Subject to the terms of the Plan, if prior to the completion of the Service Period set forth above there is a Change in Control:

 

(i)

if Replacement Awards are not provided to the Participant to replace unvested Shares, then the number of the Participant’s Earned Shares shall be determined at the target level of performance, and such Earned Shares shall vest as of such date.

 

(ii)

if Replacement Awards are provided to the Participant to replace unvested Shares, then in the event of the Participant’s Involuntary Termination during the period of two (2) years immediately following the Change in Control, the number of Earned Shares under such Replacement Awards shall be determined at the target level of performance, and such Earned Shares shall become fully vested and, if applicable, free of restrictions as of such date.

---

(b)

Death or Disability. If during the Service Period, the Participant’s employment with the Company or a Subsidiary terminates due to death or Disability, then performance shall be determined as of the date of the Participant’s termination of employment due to death or Disability, and the Earned Shares, if any, from such performance, shall vest on a pro-rata basis on the date of termination of employment due to death or Disability. The pro-rata portion shall be determined by multiplying the number of Earned Shares by a fraction, the numerator of which is the number of completed months in the Service Period during which the participant was employed by the Company or a Subsidiary, and the denominator of which is the number of months in the Service Period.

 

(c)

Retirement. If a Participant terminates employment during the Service Period due to Retirement, then the Award shall continue and a pro-rata number of Earned Shares shall vest at the time specified by Section 2 above based on actual performance through the end of the applicable Performance Period. Unless Exhibit B provides otherwise, the pro-rata portion shall be determined by multiplying the number of Earned Shares by a fraction, the numerator of which is the number of completed months in the Service Period during which the participant was employed by the Company or a Subsidiary, and the denominator of which is the number of months in the Service Period.

“Retirement” shall mean the resignation or voluntary termination of employment after attainment of age 65 and ten or more years of service with the Company or a Subsidiary.

Section 4. Dividends. Notwithstanding Section 6.4(d) of the Plan, no dividends shall accrue or be paid to the Participant with respect to any Shares subject to the Award that have not become vested Shares or that are subject to any restrictions or conditions on the record date for dividends.

Section 5. Rights as Shareholder. Except for the transfer and other restrictions set forth elsewhere in this Agreement (including the limitations on dividends set forth in Section 4 above) and in the Plan, the Participant, as record holder of the Shares, shall possess all the rights of a holder of Common Stock (including voting); provided, however, that prior to becoming vested and transferable the certificates representing such Shares shall be held by the Company for the benefit of the Participant. As the Shares become vested Shares, the Company shall, as applicable, either remove the notations on any Shares issued in book entry form which have vested or deliver to the Participant a certificate or certificates evidencing the number of vested Shares. As noted above, the Participant shall not receive any dividends on unvested Shares, and such dividends shall be permanently forfeited.

Section 6. Legend. Each share certificate representing the Shares shall bear a legend indicating that such Shares are “Restricted Stock” and are subject to the provisions of this Agreement and the Plan.

Section 7. No Transferability. The Shares may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated until they become fully vested and transferable in accordance with Section 2 of this Agreement and then only to the extent permitted under this Agreement and the Plan and by applicable securities laws. Prior to full vesting and transferability, all rights with respect to the Shares granted to a Participant under the Plan shall be available, during such Participant’s lifetime, only to such Participant, or in the event of the Disability of the Participant, to the Participant or the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed to the successor in interest determined under the Participant’s will.

Section 8. Stock Power. Concurrently with the execution of this Agreement, the Participant shall deliver to the Company a stock power, endorsed in blank, relating to the Shares. Such stock power shall be in the form attached hereto as Exhibit A. The stock power with respect to any certificate representing Shares that do not vest shall be completed in the name of the Company by an officer of the Company, and the Shares shall be returned to either authorized but unissued shares or treasury shares, depending on their original source.

Section 9. Withholding Taxes. As a condition of and prior to the delivery or release of any Shares, the Company shall be entitled to require the Participant to remit to the Company an amount sufficient to satisfy the amount of any federal, state, or local taxes required to be withheld with respect to the transfer or vesting of the Shares, or any other taxable event related thereto. The Committee may permit the Participant to make such payment in any form or manner authorized by the Committee in its sole discretion, including, but not limited to one or more of the forms specified below:

 

2

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(a)

U.S. dollars by personal check, bank draft, or money order payable to the Company, by money transfer or direct account debits;

 

(b)

Delivery to the Company of a number of shares of Common Stock having an aggregate fair market value of not less than the minimum tax withholding required for the Award;

 

(c)

Involvement of a stockbroker in accordance with the federal margin rules set forth in Regulation T;

 

(d)

A cashless exercise if and to the extent permissible by applicable law; or

 

(e)

Any combination of the above forms and methods.

In the event the Participant fails to provide timely payment of all sums required by the Company pursuant to this Section 9, the Company shall have the right and option, but not obligation, to treat such failure as an election by the Participant to provide all or any portion of such required payment by means of tendering Shares.

Section 10. Adjustments. As provided by the Plan, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company, the specified number of Shares shall be proportionately adjusted to prevent dilution or enlargement of the rights granted to, or available for, the Participant hereunder. Furthermore, if and to the extent permissible for purposes of the “performance-based compensation” exception under Code Section 162(m), the Committee shall adjust the Performance Goals to the extent (if any) it determines that the adjustment is necessary or advisable to preserve the intended incentives and benefits to reflect any material change in corporate capitalization, any material corporate transaction (such as a reorganization, combination, separation, merger, acquisition, or any combination of the foregoing), or any complete or partial liquidation of the Company, or any other similar special circumstances, including the issuance of a significant number of shares of Common Stock.

Section 11. No Employment Rights. Nothing in the Plan or this Agreement confers upon the Participant any right with respect to continuance of employment by the Company or any of its Subsidiaries, or affects the right of the Company or any of its Subsidiaries may have to terminate the Participant’s employment at any time.

Section 12. Coordination with Plan. The Participant hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all of the terms and provisions thereof including any that may conflict with those contained in this Agreement.

Section 13. Notices. All notices to the Company shall be in writing and sent to the Company’s Director of Human Resources at the Company’s offices. Notices to the Participant shall be addressed to the Participant at the Participant’s address as it appears on the Company’s records.

Section 14. Amendment. The Company may alter, amend or terminate this Agreement only with the Participant’s consent, except as otherwise expressly provided by the Plan or this Agreement.

Section 15. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

Section 16. Compensation Recovery Policy. Notwithstanding any other provision of this Agreement to the contrary, any Shares granted and/or issued hereunder, and/or any amount received with respect to any sale of any such Shares, shall be subject to potential cancellation, recoupment, rescission, payback or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time (the “Policy”). The Participant agrees and consents to the Company’s application, implementation and enforcement of (i) the Policy that may apply to the Participant and (ii) any provision of applicable law relating to cancellation, rescission, payback or recoupment of compensation, including, but not limited to Section 10D of the Exchange Act, and expressly agrees that the Company may take such actions as are necessary to effectuate the Policy or applicable law without further consent or action being required by the Participant. To the extent that the terms of this Agreement and the Policy or any similar policy conflict, then the terms of such policy shall prevail.

 

3

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Section 17. Excise Tax Cap. In the event that a Participant becomes entitled to any payment or benefit under this Agreement (such benefits together with any other payments or benefits payable to the Participant under any other agreement with the Participant, or plan or policy of the Company, are referred to in the aggregate as the “Total Payments”), if all or any part of the Total Payments will be subject to the tax imposed by Code Section 4999, or any similar tax that may hereafter be imposed (the “Excise Tax”), then:

 

(a)

Within 30 days following the Participant’s termination of employment, the Company will notify the Participant in writing: (1) whether the payments and benefits under this Agreement, when added to any other payments and benefits making up the Total Payments, exceed an amount equal to 299% of the Participant’s “base amount” as defined in Code Section 280G(b)(3) (the “299% Amount”); and (2) the amount that is equal to the 299% Amount.

 

(b)

The payments and benefits under this Agreement shall be reduced such that the Total Payments do not exceed the 299% Amount, so that no portion of the payments and benefits under this Agreement will be subject to the Excise Tax. Any payment or benefit so reduced will be permanently forfeited and will not be paid to the Participant.

 

(c)

The calculation of the 299% Amount and the determination of how much the Participant’s payments and benefits must be reduced in order to avoid application of the Excise Tax will be made by the Company’s public accounting firm prior to the Participant’s termination of employment, which firm must be reasonably acceptable to the Participant (the “Accounting Firm”). The Company will cause the Accounting Firm to provide detailed supporting calculations of its determinations to the Company and the Participant. Notice must be given to the Accounting Firm within 15 business days after an event entitling the Participant to a payment under this Agreement. All fees and expenses of the Accounting Firm will be borne solely by the Company.

 

(d)

For purposes of making the reduction of amounts payable under this Agreement, such amounts will be eliminated in compliance with the requirements of Code Section 409A, to the extent applicable.

IN WITNESS WHEREOF, the Company and the Participant have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				PARTICIPANT:
				By:
				Name:

 

4

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EXHIBIT A

STOCK POWER

FOR VALUE RECEIVED, the undersigned does hereby sell, assign and transfer to Financial Institutions, Inc. (the “Company”), XXXX shares of the Company’s common stock represented by Certificate No. XXXXXXX. The undersigned authorizes the Secretary of the Company to transfer the stock on the books of the Company in the event of the forfeiture of any shares issued under the Performance Stock Award Agreement dated as of [DATE], between the Company and the undersigned.

 

Dated:
Name

 

5

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EXHIBIT B

PERFORMANCE PERIOD AND PERFORMANCE GOALS

Performance Period

The three-year period beginning on January 1, [YEAR] and ending on December 31, [YEAR].

Performance Goals

XXX

Definitions.

XXX

Pro-Ration of Earned Shares

XXX

 

6

Exhibit 10.6

RESTRICTED STOCK UNIT AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Participant:
Date of Grant:
Number of Restricted Stock Units:
Vesting Schedule:		The Vested Percentage of the Number of Restricted Stock Units set forth above shall be determined as of the following Vesting Date(s):
		Vesting Date		Vested Percentage
		Third anniversary of the Date of Grant			100	%

This RESTRICTED STOCK UNIT AWARD AGREEMENT (this “Agreement”), dated as of [DATE], is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Participant”) to record the grant to the Participant of a Restricted Stock Unit Award (the “Award”) on the Date of Grant set forth above pursuant to Section 6.5 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Participant hereby agree as follows:

Section 1. Grant of Restricted Stock Units. The Company hereby grants to the Participant, as of the Date of Grant, subject to and in accordance with the terms and conditions of the Plan and this Agreement, a Restricted Stock Unit Award for the Number of Restricted Stock Units set forth above (the “Restricted Stock Units”).

Section 2. Vesting of Restricted Stock Units. Subject to Section 4 below, provided that the Participant provides substantial services and remains in continuous employment with the Company or a Subsidiary through the Vesting Date(s) set forth above, the Restricted Stock Units shall vest pursuant to the Vesting Schedule set forth above. Except as otherwise provided by Section 4 below, if the Participant ceases to provide substantial services or remain in continuous employment with the Company or a Subsidiary for any reason before the Restricted Stock Units vest, the unvested Restricted Stock Units shall be immediately forfeited.

Section 3. Timing and Form of Payout. Except as otherwise provided by Section 4 below and subject to Section 8 below, as soon as practicable following the Vesting Date (the “Payment Date”), but no later than the end of the calendar year in which the Payment Date occurs, or if later, by the 15^th day of the third month following the Payment Date, the vested Restricted Stock Units shall be paid to the Participant, at the Company’s option (i) by the Company delivering to the Participant a number of shares of Common Stock equal to the number of vested Restricted Stock Units as of the Payment Date or (ii) in a lump sum cash payment equal in the aggregate to the Fair Market Value of a share of Common Stock on the Payment Date multiplied by the number of such vested Restricted Stock Units as of the Payment Date. If the Restricted Stock Units are paid in shares of Common Stock, the Company shall issue the shares of Common Stock either (a) in certificate form or (b) in book entry form, registered in the name of the Participant. Notwithstanding anything herein to the contrary, the Company shall have no obligation to issue shares of Common Stock in payment of the Restricted Stock Units unless such issuance and such payment shall comply with all relevant provisions of law and the requirements of any Stock Exchange on which the shares of Common Stock are traded.

Section 4. Effects of Certain Events.

 

(a)

Change in Control. Subject to the terms of the Plan, if prior to the latest of the Vesting Dates set forth above there is a Change in Control:

---

(i) if Replacement Awards are not provided to the Participant to replace unvested Restricted Stock Units, then all of the Participant’s unvested Restricted Stock Units that have not been forfeited shall fully vest as of the date of the Change in Control. If the Change in Control qualifies as a “change in control” for purposes of Code Section 409A, then subject to Section 8 below, such vested Restricted Stock Units shall be paid to the Participant as soon as practicable following the Change in Control, but no later than the end of the calendar year in which the Change in Control occurs, or if later, by the 15^th day of the third month following the Change in Control. Otherwise such vested Restricted Stock Units shall be paid at the time specified under Section 3 above.

(ii) if Replacement Awards are provided to the Participant to replace unvested Restricted Stock Units, then in the event of the Participant’s Involuntary Termination during the period of two (2) years immediately following the Change in Control, such Replacement Awards shall become fully vested as of the date of the Involuntary Termination, and subject to Section 8 below, shall be paid to the Participant as soon as practicable following the Involuntary Termination, but no later than the end of the calendar year in which the Involuntary Termination occurs, or if later, by the 15^th day of the third month following the Involuntary Termination.

 

(b)

Death or Disability. If prior to the latest of the Vesting Dates set forth above, the Participant’s employment with the Company or a Subsidiary terminates due to death or Disability, then all Restricted Stock Units not yet vested shall become immediately vested, and subject to Section 8 below, shall be paid to the Participant (or in the event of the Disability of the Participant, to the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed, to the successor in interest determined under the Participant’s will) as soon as practicable following such termination due to death or Disability, but no later than the end of the calendar year in which the termination due to death or Disability occurs, or if later, by the 15th day of the third month following the termination due to death or Disability.

Section 5. Dividend Equivalents. No dividend equivalents shall accrue or be paid to the Participant with respect to any Restricted Stock Units.

Section 6. Rights as Shareholder. In addition to the transfer and other restrictions set forth elsewhere in this Agreement and in the Plan, the Participant, as holder of the Restricted Stock Units, shall not possess any rights of a holder of Common Stock (including voting and dividend rights) with respect to the shares of Common Stock underlying such Restricted Stock Unit Award until such time as the Restricted Stock Unit Award vests, is paid and the shares of Common Stock are issued to the holder of the Restricted Stock Unit Award.

Section 7. No Transferability. The Restricted Stock Units may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated other than by will or the laws of descent and distribution. Restricted Stock Units shall be payable only to the Participant during the Participant’s lifetime, or in the event of the Disability of the Participant, to the Participant or the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed to the successor in interest determined under the Participant’s will.

Section 8. Withholding Taxes. As a condition of and prior to the payout of any Restricted Stock Units, the Company shall be entitled to require the Participant to remit to the Company an amount sufficient to satisfy the amount of any federal, state, or local taxes required to be withheld with respect to the vesting and payout of the Restricted Stock Units, or any other taxable event related thereto. The Committee may permit the Participant to make such payment in any form or manner authorized by the Committee in its sole discretion, including, but not limited to one or more of the forms specified below:

 

(a)

U.S. dollars by personal check, bank draft, or money order payable to the Company, by money transfer or direct account debits;

 

2

---

(b)

Delivery to the Company of a number of shares of Common Stock having an aggregate fair market value of not less than the minimum tax withholding required for the Award;

 

(c)

Involvement of a stockbroker in accordance with the federal margin rules set forth in Regulation T;

 

(d)

A cashless exercise if and to the extent permissible by applicable law; or

 

(e)

Any combination of the above forms and methods.

In the event the Participant fails to provide timely payment of all sums required by the Company pursuant to this Section 8, the Company shall have the right and option, but not obligation, to treat such failure as an election by the Participant to provide all or any portion of such required payment by means of tendering vested shares of Common Stock.

Section 9. Adjustment of Restricted Stock Units. As provided by the Plan, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company, the specified number of Restricted Stock Units shall be proportionately adjusted to prevent dilution or enlargement of the rights granted to, or available for, the Participant hereunder.

Section 10. No Employment Rights. Nothing in the Plan or this Agreement confers upon the Participant any right with respect to continuance of employment by the Company or any of its Subsidiaries, or affects the right of the Company or any of its Subsidiaries may have to terminate the Participant’s employment at any time.

Section 11. Coordination with Plan. The Participant hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all of the terms and provisions thereof including any that may conflict with those contained in this Agreement.

Section 12. Notices. All notices to the Company shall be in writing and sent to the Company’s Director of Human Resources at the Company’s offices. Notices to the Participant shall be addressed to the Participant at the Participant’s address as it appears on the Company’s records.

Section 13. Amendment. The Company may alter, amend or terminate this Agreement only with the Participant’s consent, except as otherwise expressly provided by the Plan or this Agreement.

Section 14. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

Section 15. Compensation Recovery Policy. Notwithstanding any other provision of this Agreement to the contrary, any Restricted Stock Units granted and/or shares of Common Stock issued hereunder, and/or any amount received with respect to any sale of any such shares of Common Stock, shall be subject to potential cancellation, recoupment, rescission, payback or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time (the “Policy”). The Participant agrees and consents to the Company’s application, implementation and enforcement of (i) the Policy that may apply to the Participant and (ii) any provision of applicable law relating to cancellation, rescission, payback or recoupment of compensation, including, but not limited to Section 10D of the Exchange Act, and expressly agrees that the Company may take such actions as are necessary to effectuate the Policy or applicable law without further consent or action being required by the Participant. To the extent that the terms of this Agreement and the Policy or any similar policy conflict, then the terms of such policy shall prevail.

Section 16. Excise Tax Cap. In the event that a Participant becomes entitled to any payment or benefit under this Agreement (such benefits together with any other payments or benefits payable to the Participant under any other agreement with the Participant, or plan or policy of the Company, are referred to in the aggregate as the “Total Payments”), if all or any part of the Total Payments will be subject to the tax imposed by Code Section 4999, or any similar tax that may hereafter be imposed (the “Excise Tax”), then:

 

3

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(a)

Within 30 days following the Participant’s termination of employment, the Company will notify the Participant in writing: (1) whether the payments and benefits under this Agreement, when added to any other payments and benefits making up the Total Payments, exceed an amount equal to 299% of the Participant’s “base amount” as defined in Code Section 280G(b)(3) (the “299% Amount”); and (2) the amount that is equal to the 299% Amount.

 

(b)

The payments and benefits under this Agreement shall be reduced such that the Total Payments do not exceed the 299% Amount, so that no portion of the payments and benefits under this Agreement will be subject to the Excise Tax. Any payment or benefit so reduced will be permanently forfeited and will not be paid to the Participant.

 

(c)

The calculation of the 299% Amount and the determination of how much the Participant’s payments and benefits must be reduced in order to avoid application of the Excise Tax will be made by the Company’s public accounting firm prior to the Participant’s termination of employment, which firm must be reasonably acceptable to the Participant (the “Accounting Firm”). The Company will cause the Accounting Firm to provide detailed supporting calculations of its determinations to the Company and the Participant. Notice must be given to the Accounting Firm within 15 business days after an event entitling the Participant to a payment under this Agreement. All fees and expenses of the Accounting Firm will be borne solely by the Company.

 

(d)

For purposes of making the reduction of amounts payable under this Agreement, such amounts will be eliminated in compliance with the requirements of Code Section 409A, to the extent applicable.

Section 17. Section 409A. This Agreement and the Restricted Stock Units hereunder are intended to comply with Code Section 409A, and this Agreement shall be administered and interpreted consistent with such intention. Notwithstanding the foregoing, the Company makes no representations to the Participant regarding the taxation of the Restricted Stock Units under this Agreement, including, but not limited to, the tax effects of Code Section 409A, and the Participant shall be solely responsible for the taxes imposed upon him or her with respect to the Restricted Stock Units. References to “termination of employment” and similar terms used in this Agreement mean, to the extent necessary to comply with Code Section 409A, the date that the Participant first incurs a “separation from service” within the meaning of Code Section 409A. Notwithstanding anything in this Agreement to the contrary, if at the time of the Participant’s separation from service, the Participant is a “specified employee” for purposes of Code Section 409A, and payment under this Agreement as a result of such separation from service is required by Code Section 409A to be delayed by six months, then the Company shall make such payment on the day following the six-month anniversary of the Participant’s separation from service to the extent required to comply with Code Section 409A.

IN WITNESS WHEREOF, the Company and the Participant have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				PARTICIPANT:
				By:
				Name:

 

4

Exhibit 10.7

[YEAR] PERFORMANCE STOCK UNIT AWARD AGREEMENT

Pursuant to the

FINANCIAL INSTITUTIONS, INC.

2015 LONG-TERM INCENTIVE PLAN

 

Name of Participant:
Date of Grant:
Number of Restricted Stock Units:
Service Period:		The three-year period beginning on [DATE] and ending on [DATE]
Earned RSUs and Vesting Schedule:		The Number of Restricted Stock Units set forth above shall become Earned RSUs based on the achievement of the applicable Performance Goals during the applicable Performance Period and shall vest based on completion of the Service Period in accordance with Exhibit A.

This PERFORMANCE STOCK UNIT AWARD AGREEMENT (this “Agreement”), dated as of [DATE], is made between Financial Institutions, Inc. (the “Company”) and the above-named individual (the “Participant”) to record the grant to the Participant of a Performance Stock Unit Award (the “Award”) on the Date of Grant set forth above pursuant to Section 6.5 and Section 6.6 of the Financial Institutions, Inc. 2015 Long-Term Incentive Plan (the “Plan”). The Award is intended to qualify as “performance-based compensation” under Code Section 162(m), and will be interpreted and administered accordingly. Capitalized terms not defined in this Agreement shall have the meaning given to such terms under the Plan.

The Company and the Participant hereby agree as follows:

Section 1. Grant of Restricted Stock Units. The Company hereby grants to the Participant, as of the Date of Grant, subject to and in accordance with the terms and conditions of the Plan and this Agreement, a Performance Stock Unit Award for the Number of Restricted Stock Units set forth above (the “Restricted Stock Units”).

Section 2. Achievement and Vesting of Restricted Stock Units. Subject to Section 4 below, and the achievement of the applicable Performance Goals during the applicable Performance Period (both as set forth on Exhibit A), provided that the Participant provides substantial services and remains in continuous employment with the Company or a Subsidiary through the end of the Service Period set forth above, the Earned RSUs shall vest on the last day of the Service Period. Except as otherwise provided by Section 4 below, if the Participant ceases to provide substantial services or remain in continuous employment with the Company or a Subsidiary for any reason before the completion of the Service Period, the unvested Restricted Stock Units shall be immediately forfeited. Notwithstanding the foregoing, before the Award will be earned and paid, the Committee must determine and certify in accordance with the requirements of Code Section 162(m) that the Performance Goals and other material terms of the Award have been satisfied, and if applicable, the level of performance achieved.

Section 3. Timing and Form of Payout. Except as otherwise provided by Section 4 below and subject to Section 8 below, as soon as practicable following the last day of the Service Period (the “Payment Date”), but no later than the end of the calendar year in which the Payment Date occurs or if later, by the 15^th day of the third month following the Payment Date, the vested Earned RSUs shall be paid to the Participant, at the Company’s option (i) by the Company delivering to the Participant a number of shares of Common Stock equal to the number of vested Earned RSUs as of the Payment Date or (ii) in a lump sum cash payment equal in the aggregate to the Fair Market Value of a share of Common Stock on the Payment Date multiplied by the number of such vested Earned RSUs as of the Payment Date. If the Earned RSUs are paid in shares of Common Stock, the Company shall issue the shares of Common Stock either (a) in certificate form or (b) in book entry form, registered in the name of the Participant. Notwithstanding anything herein to the contrary, the Company shall have no obligation to issue shares of Common Stock in payment of the Earned RSUs unless such issuance and such payment shall comply with all relevant provisions of law and the requirements of any Stock Exchange on which the shares of Common Stock are traded.

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Section 4. Effects of Certain Events.

 

(a)

Change in Control. Subject to the terms of the Plan, if prior to the completion of the Service Period set forth above there is a Change in Control:

 

(i)

if Replacement Awards are not provided to the Participant to replace unvested Restricted Stock Units, then the number of the Participant’s Earned RSUs shall be determined at the target level of performance, and such Earned RSUs shall vest as of such date. If the Change in Control qualifies as a “change in control” for purposes of Code Section 409A, then subject to Section 8 below, such vested Earned RSUs shall be paid to the Participant as soon as practicable following the Change in Control, but no later than the end of the calendar year in which the Change in Control occurs, or if later, by the 15th day of the third month following the Change in Control. Otherwise such vested Earned RSUs shall be paid at the time specified under Section 3 above.

 

(ii)

if Replacement Awards are provided to the Participant to replace unvested Restricted Stock Units, then in the event of the Participant’s Involuntary Termination during the period of two (2) years immediately following the Change in Control, the number of Earned Shares under such Replacement Awards shall be determined at the target level of performance, and such Earned RSUs shall vest as of such date, and subject to Section 8 below, shall be paid to the Participant as soon as practicable following the Involuntary Termination, but no later than the end of the calendar year in which the Involuntary Termination occurs, or if later, by the 15th day of the third month following the Involuntary Termination.

 

(b)

Death or Disability. If during the Service Period, the Participant’s employment with the Company or a Subsidiary terminates due to death or Disability, then performance shall be determined as of the date of the Participant’s termination of employment due to death or Disability, and the Earned RSUs, if any, from such performance, subject to Section 8 below, shall vest and be paid to the Participant (or in the event of the Disability of the Participant, to the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed, to the successor in interest determined under the Participant’s will) on a pro-rata basis as soon as practicable following the Participant’s termination of employment due to death or Disability, but no later than the end of the calendar year in which the termination of employment due to death or Disability occurs, or if later, by the 15th day of the third month following the termination of employment due to death or Disability. The pro-rata portion shall be determined by multiplying the number of Earned RSUs by a fraction, the numerator of which is the number of completed months in the Service Period during which the participant was employed by the Company or a Subsidiary, and the denominator of which is the number of months in the Service Period.

 

(c)

Retirement. If a Participant terminates employment during the Service Period due to Retirement, then the Award shall continue and a pro-rata number of Earned RSUs shall vest and be paid at the time and form of payment specified by Section 2 and Section 3 above based on actual performance through the end of the applicable Performance Period. Unless Exhibit A provides otherwise, the pro-rata portion shall be determined by multiplying the number of Earned RSUs by a fraction, the numerator of which is the number of completed months in the Service Period during which the participant was employed by the Company or a Subsidiary, and the denominator of which is the number of months in the Service Period.

“Retirement” shall mean the resignation or voluntary termination of employment after attainment of age 65 and ten or more years of service with the Company or a Subsidiary.

Section 5. Dividend Equivalents. No dividend equivalents shall accrue or be paid to the Participant with respect to any Restricted Stock Units.

Section 6. Rights as Shareholder. In addition to the transfer and other restrictions set forth elsewhere in this Agreement and in the Plan, the Participant, as holder of the Restricted Stock Units, shall not possess any rights of a holder of Common Stock (including voting and dividend rights) with respect to the shares of Common Stock underlying such Restricted Stock Unit Award until such time as the Restricted Stock Unit Award vests, is paid and the shares of Common Stock are issued to the holder of the Restricted Stock Unit Award.

 

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Section 7. No Transferability. The Restricted Stock Units may not be sold, transferred, pledged, assigned, encumbered, or otherwise alienated or hypothecated other than by will or the laws of descent and distribution. Earned RSUs shall be payable only to the Participant during the Participant’s lifetime, or in the event of the Disability of the Participant, to the Participant or the legal representative of the Participant, or in the event of the death of the Participant, to the legal representative of the Participant’s estate, or if no legal representative has been appointed to the successor in interest determined under the Participant’s will.

Section 8. Withholding Taxes. As a condition of and prior to the payout of any Restricted Stock Units, the Company shall be entitled to require the Participant to remit to the Company an amount sufficient to satisfy the amount of any federal, state, or local taxes required to be withheld with respect to the vesting and payout of the Earned RSUs, or any other taxable event related thereto. The Committee may permit the Participant to make such payment in any form or manner authorized by the Committee in its sole discretion, including, but not limited to one or more of the forms specified below:

 

(a)

U.S. dollars by personal check, bank draft, or money order payable to the Company, by money transfer or direct account debits;

 

(b)

Delivery to the Company of a number of shares of Common Stock having an aggregate fair market value of not less than the minimum tax withholding required for the Award;

 

(c)

Involvement of a stockbroker in accordance with the federal margin rules set forth in Regulation T;

 

(d)

A cashless exercise if and to the extent permissible by applicable law; or

 

(e)

Any combination of the above forms and methods.

In the event the Participant fails to provide timely payment of all sums required by the Company pursuant to this Section 8, the Company shall have the right and option, but not obligation, to treat such failure as an election by the Participant to provide all or any portion of such required payment by means of tendering vested shares of Common Stock.

Section 9. Adjustments. As provided by the Plan, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, stock dividend, combination or exchange of shares, exchange for other securities, reclassification, reorganization, recapitalization, or any other increase or decrease in the number of outstanding shares of Common Stock effected without consideration to the Company, the specified number of Restricted Stock Units shall be proportionately adjusted to prevent dilution or enlargement of the rights granted to, or available for, the Participant hereunder. Furthermore, if and to the extent permissible for purposes of the “performance-based compensation” exception under Code Section 162(m), the Committee shall adjust the Performance Goals to the extent (if any) it determines that the adjustment is necessary or advisable to preserve the intended incentives and benefits to reflect any material change in corporate capitalization, any material corporate transaction (such as a reorganization, combination, separation, merger, acquisition, or any combination of the foregoing), or any complete or partial liquidation of the Company, or any other similar special circumstances, including the issuance of a significant number of shares of Common Stock.

Section 10. No Employment Rights. Nothing in the Plan or this Agreement confers upon the Participant any right with respect to continuance of employment by the Company or any of its Subsidiaries, or affects the right of the Company or any of its Subsidiaries may have to terminate the Participant’s employment at any time.

Section 11. Coordination with Plan. The Participant hereby acknowledges receipt of a copy of the Plan and agrees to be bound by all of the terms and provisions thereof including any that may conflict with those contained in this Agreement.

Section 12. Notices. All notices to the Company shall be in writing and sent to the Company’s Director of Human Resources at the Company’s offices. Notices to the Participant shall be addressed to the Participant at the Participant’s address as it appears on the Company’s records.

Section 13. Amendment. The Company may alter, amend or terminate this Agreement only with the Participant’s consent, except as otherwise expressly provided by the Plan or this Agreement.

 

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Section 14. Governing Law. This Agreement shall be governed by the laws of the State of New York to the extent not preempted by federal law, without reference to principles of conflict of laws, and construed accordingly.

Section 15. Compensation Recovery Policy. Notwithstanding any other provision of this Agreement to the contrary, any Restricted Stock Units granted and/or shares of Common Stock issued hereunder, and/or any amount received with respect to any sale of any such shares of Common Stock, shall be subject to potential cancellation, recoupment, rescission, payback or other action in accordance with the terms of the Company’s compensation recovery policy, if any, or any similar policy that the Company may adopt from time to time (the “Policy”). The Participant agrees and consents to the Company’s application, implementation and enforcement of (i) the Policy that may apply to the Participant and (ii) any provision of applicable law relating to cancellation, rescission, payback or recoupment of compensation, including, but not limited to Section 10D of the Exchange Act, and expressly agrees that the Company may take such actions as are necessary to effectuate the Policy or applicable law without further consent or action being required by the Participant. To the extent that the terms of this Agreement and the Policy or any similar policy conflict, then the terms of such policy shall prevail.

Section 16. Excise Tax Cap. In the event that a Participant becomes entitled to any payment or benefit under this Agreement (such benefits together with any other payments or benefits payable to the Participant under any other agreement with the Participant, or plan or policy of the Company, are referred to in the aggregate as the “Total Payments”), if all or any part of the Total Payments will be subject to the tax imposed by Code Section 4999, or any similar tax that may hereafter be imposed (the “Excise Tax”), then:

 

(a)

Within 30 days following the Participant’s termination of employment, the Company will notify the Participant in writing: (1) whether the payments and benefits under this Agreement, when added to any other payments and benefits making up the Total Payments, exceed an amount equal to 299% of the Participant’s “base amount” as defined in Code Section 280G(b)(3) (the “299% Amount”); and (2) the amount that is equal to the 299% Amount.

 

(b)

The payments and benefits under this Agreement shall be reduced such that the Total Payments do not exceed the 299% Amount, so that no portion of the payments and benefits under this Agreement will be subject to the Excise Tax. Any payment or benefit so reduced will be permanently forfeited and will not be paid to the Participant.

 

(c)

The calculation of the 299% Amount and the determination of how much the Participant’s payments and benefits must be reduced in order to avoid application of the Excise Tax will be made by the Company’s public accounting firm prior to the Participant’s termination of employment, which firm must be reasonably acceptable to the Participant (the “Accounting Firm”). The Company will cause the Accounting Firm to provide detailed supporting calculations of its determinations to the Company and the Participant. Notice must be given to the Accounting Firm within 15 business days after an event entitling the Participant to a payment under this Agreement. All fees and expenses of the Accounting Firm will be borne solely by the Company.

 

(d)

For purposes of making the reduction of amounts payable under this Agreement, such amounts will be eliminated in compliance with the requirements of Code Section 409A, to the extent applicable.

Section 17. Section 409A. This Agreement and the Restricted Stock Units hereunder are intended to comply with Code Section 409A, and this Agreement shall be administered and interpreted consistent with such intention. Notwithstanding the foregoing, the Company makes no representations to the Participant regarding the taxation of the Restricted Stock Units under this Agreement, including, but not limited to, the tax effects of Code Section 409A, and the Participant shall be solely responsible for the taxes imposed upon him or her with respect to the Restricted Stock Units. References to “termination of employment” and similar terms used in this Agreement mean, to the extent necessary to comply with Code Section 409A, the date that the Participant first incurs a “separation from service” within the meaning of Code Section 409A. Notwithstanding anything in this Agreement to the contrary, if at the time of the Participant’s separation from service, the Participant is a “specified employee” for purposes of Code Section 409A, and payment under this Agreement as a result of such separation from service is required by Code Section 409A to be delayed by six months, then the Company shall make such payment on the day following the six-month anniversary of the Participant’s separation from service to the extent required to comply with Code Section 409A.

 

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IN WITNESS WHEREOF, the Company and the Participant have caused this Agreement to be executed on the date set forth opposite their respective signatures, but effective as of the Date of Grant.

 

Dated:				FOR THE COMPANY:
				By:
				Name:
				Title:
Dated:				PARTICIPANT:
				By:
				Name:

 

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EXHIBIT A

PERFORMANCE PERIOD AND PERFORMANCE GOALS

Performance Period

The three-year period beginning on January 1, [YEAR] and ending on December 31, [YEAR].

Performance Goals

XXX

Definitions.

XXX

Pro-Ration of Earned RSUs

XXX

 

6

Exhibit 31.1

Certification of Principal Executive Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Martin K. Birmingham, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Financial Institutions, Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 5, 2015						/s/ Martin K. Birmingham
						Martin K. Birmingham
						President and Chief Executive Officer

Exhibit 31.2

Certification of Principal Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Kevin B. Klotzbach, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Financial Institutions, Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 5, 2015						/s/ Kevin B. Klotzbach
						Kevin B. Klotzbach
						Chief Financial Officer

Exhibit 32

Certification pursuant to

18 U.S.C. Section 1350,

as adopted pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

Martin K. Birmingham, President and Chief Executive Officer, and Kevin B. Klotzbach, Chief Financial Officer of Financial Institutions, Inc. (the “Company”), each certify in his capacity as an officer of the Company that he has reviewed the Quarterly Report of the Company on Form 10-Q for the period ended June 30, 2015 and that to the best of his knowledge:

 

1.

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

		Date: August 5, 2015				/s/ Martin K. Birmingham
						Martin K. Birmingham
						President and Chief Executive Officer
						(Principal Executive Officer)
		Date: August 5, 2015				/s/ Kevin B. Klotzbach
						Kevin B. Klotzbach
						Chief Financial Officer
						(Principal Financial Officer)

The purpose of this statement is solely to comply with Title 18, Chapter 63, Section 1350 of the United States Code, as amended by Section 906 of the Sarbanes-Oxley Act of 2002. A signed original of this written statement required by Section 906 has been provided to Financial Institutions, Inc. and will be retained by Financial Institutions, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.