Tompkins Financial Corporation (“Tompkins” or the “Company”) is headquartered in Ithaca, New York and is registered as a Financial Holding Company with the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. The Company is a locally oriented, community-based financial services organization that offers a full array of products and services, including commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, and insurance. At December 31, 2016,2018, the Company’s subsidiaries included: four wholly-owned banking subsidiaries, Tompkins Trust Company (the “Trust Company”), The Bank of Castile (DBA Tompkins Bank of Castile), Mahopac Bank (DBA Tompkins Mahopac Bank), VIST Bank (DBA Tompkins VIST Bank); and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). The Trust Company provides a full array of trust and investment services under the Tompkins Financial Advisors brand, including investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. The Company’s principal offices are located at The Commons,118 E. Seneca St., P.O. Box 460, Ithaca, New York, 14851,14850, and its telephone number is (888) 503-5753. The Company’s common stock is traded on the NYSE MKT LLCAmerican under the Symbolsymbol “TMP.”

 

 

Although Tompkins is a corporate entity, legally separate and distinct from its affiliates, bank holding companies such as Tompkins are generally required to act as a source of financial strength for their banking subsidiaries. Tompkins’ principal source of income is dividends from its subsidiaries. There are certain regulatory restrictions on the extent to which these subsidiaries can pay dividends or otherwise supply funds to Tompkins. See the section “Supervision and Regulation” for further details.

 

Information about the Company’s business segments is included in “Note 22 Segment and Related Information” in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Report. The Company has identified three business segments, consisting of banking, insurance and wealth management.

 

The Company’s principal expenses are interest on deposits, interest on borrowings, and operating and general administrative expenses, as well as provisions for loan and lease losses. Funding sources, other than deposits, include borrowings, securities sold under agreements to repurchase, and cash flow from lending and investing activities. The Company’s principal source of incomerevenue is interest income on loans and securities.

 

The Company maintains a portfolio of securities such as obligations of U.S. government agencies and U.S. government sponsored entities, obligations of states and political subdivisions thereof, and equity securities. Management typically invests in securities with short to intermediate average lives in order to better match the interest rate sensitivities of its assets and liabilities. Investment decisions are made within policy guidelines established by the Company’s Board of Directors. The investment policy is based on the asset/liability management goals of the Company, and is monitored by the Company’s Asset/Liability Management Committee. The intent of the policy is to establish a portfolio of high quality diversified securities, which optimizes net interest income within safety and liquidity limits deemed acceptable by the Asset/Liability Management Committee.

 

The Company has operated its insurance agency subsidiary, Tompkins Insurance Agencies Inc., since 2001. Insurance services include property and casualty insurance, employee benefit consulting, life, long-term care and disability insurance. Tompkins Insurance is headquartered in Batavia, New York. Over the years, Tompkins Insurance has acquired smaller insurance agencies in the market areas served by the Company’s banking subsidiaries and successfully consolidated them into Tompkins Insurance. The VIST Financial acquisition in 2012, which included VIST Insurance, nearly doubled the Company’s annual insurance revenues. Tompkins Insurance offers services to customers of the Company’s banking subsidiaries by sharing offices with Tompkins Bank of Castile, the Trust Company, and Tompkins VIST Bank. In addition to these shared offices, Tompkins Insurance has sixfive stand-alone offices in Western New York, and one stand-alone office in Tompkins County, New York and one stand-alone office in Montgomery County, Pennsylvania.York.

 

 

 

The Trust Company is a New York State-chartered commercial bank that has operated in Ithaca, New York and surrounding communities since 1836. The Trust Company provides wealth management services through Tompkins Financial Advisors (“TFA”), a division of Tompkins Trust Company. The Trust Company operates 14 banking offices, including one limited-service banking office in the counties of Tompkins Cayuga, Cortland, Onondaga and Schuyler,County, in New York. The Trust Company’s largest market area is Tompkins County, which has a population of approximately 104,000.105,000. Education plays a significant role in the Tompkins County economy with Cornell University and Ithaca College being two of the county’s major employers. The Trust Company has a full-service office in Cortland, New York and a full-service office in Auburn, New York. Both of these offices are located in counties contiguous to Tompkins County. In 2016, theThe Trust Company expanded into Onondaga County, opening its firstalso has a full service branch in that county.Fayetteville, New York which is located in Onondaga County. As of December 31, 2016,2018, the Trust Company had total assets of $2.0$2.1 billion, total loans of $1.2$1.3 billion and total deposits of $1.5$1.6 billion.

 

Tompkins Bank of Castile is a New York State-chartered commercial bank and conducts its operations through its 1718 banking offices, in towns situated in and around the areas commonly known as the Genesee Valley region of New York State. The main business office for Tompkins Bank of Castile is located in Batavia, New York and is shared with Tompkins Insurance. Tompkins Bank of Castile serves a five-countysix-county market, much of which is rural in nature, but also includes Monroe County (population approximately 750,000)748,000), where the city of Rochester is located.located, and Erie County (population 923,000) located near Buffalo, New York. The population of the counties served by Tompkins Bank of Castile, other than Monroe and Erie , is approximately 205,000.206,000. In 2018, Tompkins Bank of Castile opened a banking office in Amherst, New York, which is in Erie County and located near Buffalo, New York. As of December 31, 2016,2018, Tompkins Bank of Castile had total assets of $1.5 billion, total loans of $1.2 billion and total deposits of $1.2 billion.

Tompkins Mahopac Bank is a New York State-chartered commercial bank that operates 14 banking offices. The 14 banking offices include 5 full-service offices in Putnam County, New York, 3 full-service offices in Dutchess County, New York, and 6 full-service offices in Westchester County, New York. Putnam County has a population of approximately 99,000 and is about 60 miles north of Manhattan. Dutchess County has a population of approximately 294,000, and Westchester County has a population of approximately 975,000. As of December 31, 2018, Tompkins Mahopac Bank had total assets of $1.4 billion, total loans of $1.0 billion and total deposits of $1.1$1.0 billion.

Tompkins Insurance is headquartered in Batavia, New York. Insurance services include property and casualty insurance, employee benefit consulting, and life, long-term care and disability insurance. Over the past fifteen17 years, Tompkins Insurance has acquired smaller insurance agencies in the market areas serviced by the Company's banking subsidiaries and successfully consolidated them into Tompkins Insurance. Tompkins Insurance offers services to customers of the Company's banking subsidiaries by sharing offices with Tompkins Bank of Castile, Trust Company, and Tompkins VIST Bank. In addition to these shared offices, Tompkins Insurance has five stand-alone offices in Western New York, and two stand-alone offices in Tompkins County, New York and one stand-alone office in Montgomery County, Pennsylvania.Tompkins County.

Sleepy Hollow Capital Trust I, a Delaware statutory business trust, was formed in 2003 and issued $4.0 million of floating rate (three-month LIBOR plus 305 basis points)3.05%) trust preferred securities. The Company acquired Sleepy Hollow Capital Trust I through the acquisition of Sleepy Hollow Bancorp, Inc. in 2008.

 

Leesport Capital Trust II, a Delaware statutory business trust, was formed in 2002 and issued $10.0 million of mandatory redeemable capital securities carrying a floating interest rate of three monththree-month LIBOR plus 3.45%. The Company assumed the rights and obligations of VIST Financial Corporation ("VIST Financial") pertaining to the Leesport Capital Trust II through the Company’s acquisition of VIST Financial in 2012.

 

Madison Statutory Trust I, a Connecticut statutory business trust formed in 2003, issued $5.0 million of mandatory redeemable capital securities carrying a floating interest rate of three monththree-month LIBOR plus 3.10%. VIST Financial assumed Madison Statutory Trust I pursuant to the purchase of Madison Bancshares Group, Ltd in 2004. The Company assumed the rights and obligations of VIST Financial pertaining to the Madison Statutory Trust I through the Company’s acquisition of VIST Financial in 2012.

 

For additional details on the above capital trusts refer to “Note 1110 - Trust Preferred Debentures” in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

 

 

Competition for commercial banking and other financial services is strong in the Company’s market areas. In one or more aspects of its business, the Company’s subsidiaries compete with other commercial banks, savings and loan associations, credit unions, finance companies, Internet-based financial services companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Some of these competitors have substantially greater resources and lending capabilities and may offer services that the Company does not currently provide. In addition, many of the Company’s non-bank competitors are not subject to the same extensive Federal regulations that govern financial holding companies and Federally-insured banks.

 

 

The Company’s banking subsidiaries are subject to examination and comprehensive regulation by various regulatory authorities, including the Federal Deposit Insurance Corporation (“FDIC”), the New York State Department of Financial Services (“NYSDFS”), and the Pennsylvania Department of Banking and Securities (“PDBS”). Each of these agencies issues regulations and requires the filing of reports describing the activities and financial condition of the entities under its jurisdiction. Likewise, such agencies conduct examinations on a recurring basis to evaluate the safety and soundness of the institutions, and to test compliance with various regulatory requirements, including: consumer protection, privacy, fair lending, the Community Reinvestment Act, the Bank Secrecy Act, sales of non-deposit investments, electronic data processing, and trust department activities.

The Company’s banking subsidiaries are also members of the Federal Home Loan Bank (“FHLB”), which provides a central credit facility primarily for member institutions for home mortgage and neighborhood lending. The Company’s banking subsidiaries are subject to the rules and requirements of the FHLB, including the requirement to acquire and hold shares of capital stock in the FHLB in an amount at least equal to the sum of 0.35% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, up to a maximum of $25.0 million. The Company’s banking subsidiaries were in compliance with FHLB rules and requirements as of December 31, 2016.2018.

 

The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which was enacted in July 2010, significantly changed placed U.S. banks and financial services firms under enhanced regulation and oversight. While many provisions of the financialDodd- Frank Act are currently effective, certain provisions of the legislation are still subject to further rulemaking, guidance and interpretation by the federal regulatory landscape in the United States.agencies. The Dodd-Frank Act was designed to enhance supervisory oversightamended on May 24, 2018, when the President signed the Economic Growth, Regulatory Relief, and strengthen the regulation of the financial services industry. These regulations have increased, and will continue to increase, the Company's compliance costs, and they have negatively impacted the Company's revenues; however, because the Company has total consolidated assets of less than $10 billion, it is exempt fromConsumer Protection Act (“EGRRCPA”) into law. The EGRRCPA amended certain provisions of the Dodd-Frank Act and provided targeted modifications to other post-financial-crisis regulatory requirements. In addition, the legislation establishes new consumer protections and amends various securities-related and investment company-related requirements. Some EGRRCPA provisions were immediately effective, some have later-specified effective dates and still others are open-ended and subject to implementation by federal regulatory agency rule-making. EGRRCPA includes a variety of provisions that are likely to affect the Company, including the following:

While EGRRCPA does and will continue to improve regulatory conditions for the Company, many provisions of the Dodd-Frank Act and its subsidiaries are requiredimplementing regulations remain effective and will continue to comply withresult in additional operating and compliance costs that could have a material adverse effect on our business, financial condition and results of operation. In addition, the rulesEGRRCPA requires the enactment of a number of implementing regulations, the CFPB; however, these rules are enforced by our primary regulators,details of which may change how this law ultimately impacts the FRB andCompany. Further, it is possible that the FDIC, notcurrent climate of regulatory reform will lead to new legislation in addition to or supplementing the CFPB.

FRB regulations mandated by the Dodd-Frank Act limit interchange fees on debit cards to a maximum of 21 cents per transaction plus 5 basis points of the transaction amount. Issuers that, together with their affiliates, have less than $10 billion in assets, such as the Company, are exempt from the debit card interchange fee standards. However, FRB regulations prohibit all card issuers, including the Company and its banking subsidiaries, from restricting the number of networks over which electronic debit transactions may be processed to fewer than two unaffiliated networks, or inhibiting a merchant's ability to direct the routing of the electronic debit transaction over any network that the card issuer has enabled to process them.

The Dodd-Frank Act also required the federal financial regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The statutory provision is commonly called the “Volcker Rule.” TheAs of December 31, 2018, the Company hashad outstanding investments of approximately $1.1 million$600,000 in covered funds. Compliance with the Volcker Rule requires that the Company divest its interest in these funds. The original deadline for compliance was July 21, 2015, but the FRB has extended the compliance deadline through July 21, 2017 for certain legacy investments, including the Company's investments in these covered funds. The Company currently has an application pending with the FRB which seeks an extended transition period for compliance which, if granted, would allow us up to five years to identify a suitable buyer for our original $600,000 investment in two of these funds (the "Eligible Funds""Legacy Investments"). Our third investment, in the original amount of $500,000, is not eligible for an extended transition period and which we are currentlywould have been required to divest no later than July 2022 per our interestagreement with the FRB. However, under the newly-enacted EGRRCPA, the Company, as a financial institution with less than $10 billion in this fund prior to July 21, 2017. Similarly, if our application for an extended transition periodtotal consolidated assets, is not approved, we will also need to divest our interest in this $600,000 investment inexempt from meeting the Eligible Funds prior to July 21, 2017. TheVolcker Rule's proprietary trading requirements. Therefore, no further Volcker Rule has not had, and is not expected to have, a material effect ondivestitures are required unless the Company.Company crosses the $10 billion in total assets threshold.

We are a bank holding company subject to regulation under the BHC Act and the examination and reporting requirements of the FRB. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the FRB has determined to be so closely related to banking as to be a proper incident thereto. In addition, bank holding companies that qualifywe qualified for the status of and electelected to be a financial holding companiescompany under the BHC Act and therefore may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the FRB in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board)FRB), without prior approval of the FRB. Activities that are financial

If a bank holding company seeks to engage in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments. The Company is registered as athe broader range of activities permitted under the BHC Act for financial holding companies, as we do, (i) the bank holding company and all of its depository institution subsidiaries must be “well-capitalized” and “well-managed,” as defined in the FRB's Regulation Y and (ii) it must file a declaration with the FRB that it elects to be a “financial holding company.

In order for a financial holding company to commence any new activity permitted by the BHC Act or to acquire a company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the Community Reinvestment Act (“CRA”). See the section captioned “Community Reinvestment Act”, below.

The FRB has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.

Under FRB regulations, the Company may not, without providing prior notice to the FRB, purchase or redeem its own common stock if the gross consideration for the purchase or redemption, combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to ten percent or more of the Company’s consolidated net worth.

 

FRB regulations provide that dividends shall not be paid except out of current earnings and unless the prospective rate of earnings retention by the Company appears consistent with its capital needs, asset quality, and overall financial condition. Tompkins’ primary source of funds to pay dividends on its common stock is dividends from its subsidiary banks. The subsidiary banks are subject to regulations that limit the dividends that they may pay to Tompkins. Member banks may not declare or pay a dividend during the current calendar year that exceeds the sum of the bank's net income during the current calendar year and the retained net income of the prior two calendar years, unless approved by the pertinent regulatory agencies.

 

The Company’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O as promulgated by the FRB. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by the Bank’s board of directors.

The BHC Act, the Bank Merger Act, the Change in Bank Control Act and other federal and state statutes regulate acquisitions of interests in commercial banks. The BHC Act requires the prior approval of the FRB for the direct or indirect acquisition by a bank holding company of more than 5.0% of the voting shares of a commercial bank or its parent holding company and for a person, other than a bank holding company, to acquire 25% or more of any class of voting securities of a bank or bank holding company. Under the Bank Merger Act, the prior approval of the FRB or other appropriate bank regulatory authority is required for a member bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the CRA (see the section captioned “Community Reinvestment Act” included elsewhere in this item) and fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

 

The Dodd-Frank Act codified the FRB’s longstanding policy of requiringrequires bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under this requirement, Tompkins is expected to commit resources to support its banking subsidiaries, including at times when it may not be advantageous for Tompkins to do so. Any capital loans by a bank holding company to any of its subsidiary banks are subordinated in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

FDIC-insured depository institutions can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC due to the default of an FDIC-insured depository institution controlled by the same bank holding company, or for any assistance provided by the FDIC to an FDIC-insured depository institution controlled by the same bank holding company that is in danger of default. “Default” means generally the appointment of a conservator or receiver. “In danger of default” means generally the existence of certain conditions indicating that default is likely to occur in the absence of regulatory assistance.

 

The Basel III Capital Rules, among other things, (i) introduced a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specified that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defined CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expanded the scope of the deductions/adjustments as compared to existing regulations.

As fully phased in on January 1, 2019, the Basel III Capital Rules will require Tompkins to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer (which when fully phased in, effectively results in a minimum ratio of CET1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weightedrisk- weighted assets of at least 6.0%, plus the capital conservation buffer (which when fully phased in,phased-in, effectively results in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which when fully phased in, effectively results in a minimum total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.

The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to apply to Tompkins for the foreseeable future.

The Basel III Capital Rules imposed stricter regulatory capital deductions from and adjustments to capital, with most deductions and adjustments taken against CET1 capital. These include, for example, the requirement that (i) mortgage servicing assets, net of associated deferred tax liabilities; (ii) deferred tax assets, which cannot be realized through net operating loss carrybacks, net

of any relative valuation allowances and net of deferred tax liabilities; and (iii) significant investments (i.e. 10% or greater ownership) in unconsolidated financial institutions be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015. The deductions were phased-in over a four-year period, beginning on January 1, 2015 and concluding on January 1, 2019.

Under the Basel III Capital Rules, the effect of certain accumulated other comprehensive items are not excluded, which could result in significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Company’s securities portfolio. Contained within the rule was a one-time option to permanently opt-out of the inclusion of accumulated other comprehensive income in the capital calculation based upon asset size. Tompkins decided to opt out of this requirement in January 2015.

The Basel III Capital Rules also required the phase-out of certain hybrid securities, such as trust preferred securities, as Tier 1 capital of bank holding companies in equal installments between 2013 and 2016. Trust preferred securities no longer included in Tier 1 capital may nonetheless be included as a component of Tier 2 capital.companies. However, because the trust preferred securities ofheld by Tompkins were issued prior to May 19, 2010, and because Tompkins’ total consolidated assets were less than $15.0 billion as of December 31, 2009, ourthese trust preferred securities are permanently grandfathered under the final rule and may continue to be included as Tier 1 capital.

 

In addition, the Basel III Capital Rules provide more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.

 

With respect to the Company’s banking subsidiaries, the Basel III Capital Rules revised the “prompt corrective action” (“PCA”)PCA regulations, adopted pursuant to Section 38 of the FDIA, by: (i) introducing a CET1 ratio requirement at each PCA category (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to 6%); and (iii) eliminating the provision that permitted a bank with a composite supervisory rating of 1 and a 3% leverage ratio to be considered adequately capitalized. The Basel III Capital Rules did not change the total risk-basedrisk- based capital requirement for any PCA category. Additionally, Bank holding companies and insured depository institutions may also be subject to potential enforcement actions of varying levels of severity for unsafe or

unsound practices in conducting their business or for violation of any law, rule, regulation, condition imposed in writing by federal banking agencies or term of a written agreement with such agency. The Company is in compliance, and management believes that the Company will continue to be in compliance, with the targeted capital ratios as such requirements are phased in.

For further information concerning the regulatory capital requirements, actual capital amounts and the ratios of Tompkins and its bank subsidiaries, see the discussion in “Note 20 - Regulations and Supervision” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

 

Substantially all of the deposits of the Company’s banking subsidiaries are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance to $250,000 per deposit category, per depositor, per institution retroactive to January 1, 2008.

 

The Company’s banking subsidiaries pay deposit insurance premiums to the FDIC based on assessment rates established by the FDIC. The assessment rates are based upon the riskasset size and other risks the institution poses to the Deposit Insurance Fund, or DIF. Under this assessment system, risk is defined and measured using an institution’s supervisory ratings with other risk measures, including financial ratios. The current total base assessment rates on an annualized basis range from 2.51.5 basis points for certain “well-capitalized,” “well-managed” banks, with the highest ratings, to 4540 basis points for institutions posing the most risk to the DIF. The FDIC may raise or lower these assessment rates on a quarterly basis based on various factors to achieve a reserve ratio, which the Dodd-Frank Act has mandated to be no less than 1.35 percent of insured deposits. In 2011, the FDIC redefined the deposit insurance assessment base to equal average consolidated total assets minus average tangible equity as required by the Dodd-Frank Act.

 

FDIC insurance expense totaled $2.6 million, $2.5 million and $3.0 million $3.0 millionin 2018, 2017 and $2.9 million in 2016, 2015 and 2014, respectively. FDIC insurance expense includes deposit insurance assessments, assessments related to participation in the Temporary Liquidity Guaranty Program (“TLGP”) program, and Financing Corporation (“FICO”) assessments related to outstanding FICO bonds. FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings & Loan Insurance Corporation.

 

The Federal Deposit Insurance ActFDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, such as the Company’s subsidiary banks, the claims of depositors of the institution, including the claims of the FDIC, as subrogee of the insured depositors, and certain claims for administrative expenses of the FDIC as receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institutions.

The Company’s subsidiary banks are subject to the CRA and the regulations issued thereunder are intended to certain fair lending and reporting requirements that relateencourage banks to home mortgage lending. The CRA requires the federal banking regulators to assess the record of a financial institution in meetinghelp meet the credit needs of the local communities,their entire service area, including low-and moderate-incomelow and moderate income neighborhoods, consistent with the safe and sound operationoperations of such banks. These regulations also provide for regulatory assessment of a bank’s record in meeting the bank. The federal agencies consider an institution’s performance underneeds of its service area when considering applications to establish branches, merger applications and applications to acquire the CRA in evaluating applications for mergersassets and acquisitions, and new offices. The ratings assigned byassume the federal agencies are publicly disclosed.liabilities of another bank. As of December 31, 20162018, the Company’s subsidiary banks all had ratings of satisfactory or better.

The common stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company is subject to the reporting, information disclosure, proxy solicitation and other requirements imposed on public companies by the SEC under the Exchange Act. Additionally, Company insiders are subject to security trading limitations and are required to file insider ownership reports with the SEC. The SEC and NYSE American have adopted regulations under the Sarbanes-Oxley Act of 2002

(3) standards for auditors and regulation of audits; (4) disclosure and reporting requirements for the reporting company and directors and executive officers; and (5) a range of civil and criminal penalties for fraud and other violations of securities laws.

 

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”), the Bank Secrecy Act, the Money Laundering Control Act, and other federal laws, collectively impose obligations on all financial institutions, including the Company, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

 

In accordance with theThe Gramm-Leach-Bliley Act of 1999 (“GLBA”) requires that financial institutions implement comprehensive written information security programs that include administrative, technical and physical safeguards designed to protect consumer information. Under the GLBA, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to non-affiliated third parties. These limitations require disclosure of privacy policies and certain security breaches to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a non-affiliated third party. These provisions affect, among other things, how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions take many forms. Generally, however, they includecontain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest.

In connection with their lending and leasing activities, the Company’s banking subsidiaries are subject to a number of federal and state laws designed to protect borrowers and promote lending. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transaction Act of 2003, Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Truth in Lending Act, the Truth in Savings Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and similar laws at the state level. The Company’s failure to comply with any of the consumer financial laws can result in civil actions, regulatory enforcement action by the federal banking agencies and the U.S. Department of Justice.

On January 10, 2013, the CFPB issued a final rule implementing the ability-to-repay and qualified mortgage provisions of the Truth in Lending Act, as amended byAdditionally, the Dodd-Frank Act (the “QM Rule”established a new Bureau of Consumer Financial Protection (“CFPB”). with broad powers to supervise and enforce consumer protection laws. The QM Rule providesCFPB has broad rule-making authority for a wide range of consumer protection laws that a lender making a special type of loan, known as a “Qualified Mortgage”, is entitledapply to presume thatall banks and savings institutions, including the loan compliesauthority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. The Company and its subsidiaries are required to comply with the “ability to repay” safe harbor requirements. The QM Rule establishes different typesrules of Qualified Mortgages,the CFPB; however, these rules are generally identified as loans with restrictions on loan features, limits or fees being chargedenforced by our primary regulators, the FRB and underwriting requirements.the FDIC.

The Bank is also subject to data security standards and privacy and data breach notice requirements as established by federal and state regulators. Federal banking regulators issued several statements in 2015 advising bankingagencies, through the Federal Financial Institutions Examination Council, have adopted guidelines to encourage financial institutions regarding steps they should be taking to prevent and address cybersecurity issues. In March 2015,risks and identify, assess and mitigate these risks, both internally and at critical third party service providers. For example, federal banking regulators issued two related statements regarding cybersecurity. One statement indicatedhave highlighted that financial institutions should design multiple layers of security controls to establish several lines of defense and to ensure thatdesign their risk management processes alsoto address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing thecredentials. Further, financial institution’s Internet-based services of the financial institution. The other statement indicated that a financial institution’s management isinstitutions are expected to maintain sufficient business continuity planning processes designed to ensure the rapidfacilitate a recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. The statement further indicated that financial institutions should develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data ifcyber-attack.

Additionally, the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties. Finally, in November 2015, federal banking regulators issuedCompany must comply with a statement alerting financial institutions to the increasing frequency and severity of cyber attacks involving extortion. The statement indicated that financial institutions should address this threat by developing and implementing effective programs to ensure the institutions are able to identify, protect, detect, respond to, and recover from these types of attacks.

 

The FRB reviews, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews are tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives are included in reports of examination. Deficiencies are incorporated intoexamination and deficiencies can lead to limitations on the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitionsCompany’s abilities and take othereven enforcement actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk

The Company is also subject to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

At December 31, 2016,2018, the Company had 1,0461,035 employees, approximately 115116 of whom were part-time. No employees are covered by a collective bargaining agreement and the Company believes its employee relations are excellent.

Our Company's success is dependent on management's ability to identify and manage the risks inherent in our financial services business. These risks include credit risk, market risk, liquidity risk, operational risk, model risk, compliance and legal risk, and strategic and reputation risk. We list below the material risk factors we face. Any of these risks could result in a material adverse impact on our business, operating results, financial condition, liquidity, and cash flow, or may cause our results to vary materially from recent results, or from the results implied by any forward-looking statements made by us.

 

The Company offers different types of commercial loans to a variety of businesses.businesses, and we believe commercial loans will continue to comprise a significant concentration of our loan portfolio in 2019 and beyond. Real estate lending is generally considered to be collateral basedcollateral-based lending with loan amounts based on predetermined loan to collateralloan-to-collateral values. As such, declines in real estate valuations in the Company’s market area would lower the value of the collateral securing these loans. Additionally, the Company has experienced, and expects to continue experiencing, increased competition in commercial real estate lending. This increased competition may inhibit the Company's ability to generate additional commercial real estate loans or maintain its current inventory of commercial real estate loans. The Company’s commercial business loans are made based primarily on the cash flow and creditworthiness of the borrower and secondarily on the underlying collateral provided by the borrower, with liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. The borrowers’ cash flow may be difficult to predict, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment. As of December 31, 2016,2018, commercial and commercial real estate loans totaled $3.0$3.4 billion or 69.6%70.7% of total loans.

As part of the Company’s commercial business lending activities, the Company originates agricultural loans, consisting of agricultural real estate loans and agricultural operating loans. As of December 31, 2016, $221.02018, $277.7 million or 5.2%5.7% of the Company’s total loan portfolio consisted of agriculturally-related loans, including $102.8$170.2 million in agricultural real estate loans and $118.2$107.5 million in agricultural operating loans. Payments on agricultural loans are dependent on the profitable operation or management of the related farm property. The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of governmental regulations and subsidies (including changes in price supports and environmental regulations). Many farms are dependent upon a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. While agricultural operating loans are generally secured by a blanket lien on the farm’s operating assets, any repossessed collateral in respect of a defaulted loan may not provide an adequate source of repayment of the outstanding balance.

A majority of the Company’s investment portfolio is comprised of securities which are collateralized by residential mortgages. These residential mortgage-backed securities include securities of U.S. government agencies, U.S. government-sponsored entities, and private-label collateralized mortgage obligations. The Company’s securities portfolio also includes obligations of

U.S. government-sponsored entities, obligations of states and political subdivisions thereof, U.S. corporate debt securities and equity securities. A more detailed discussion of the investment portfolio, including types of securities held, the carrying and fair values, and contractual maturities is provided in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Report. Gains or losses on these instruments may have a direct impact on the results of operations, including higher or lower income and earnings, unless we adequately hedge our positions. The fair value of investments may be affected by factors other than the underlying performance of the issuer or composition of the obligations themselves, such as rating downgrades, adverse changes in the business climate, and a lack of liquidity for resale of certain investment securities and changes in interest rates. For example, decreases in interest rates and increases in mortgage prepayment speeds, which are influenced by interest rates and other factors, could adversely impact the value of our securities collateralized by residential mortgages, causing a significant acceleration of purchase premium amortization on our mortgage portfolio because a decline in long-term interest rates shortens the expected lives of the securities. Conversely, increases in interest rates may result in a decrease in residential mortgage loan originations and mortgage prepayment speeds, directly impacting the value of these securities collateralized by residential mortgages. The Company periodically, but not less than quarterly, evaluates investments and other assets for impairment indicators in accordance with U.S. generally accepted accounting principles.principles (“GAAP”). A decline in the fair value of the securities in our investment portfolio could result in an other-than temporary impairment (“OTTI”) write-down that wouldcould reduce our earnings. Further, given the significant judgments involved, if we are incorrect in our assessment of OTTI, this error could have a material adverse effect on our results of operation, financial condition, and cash flows.

As of December 31, 2016,2018, the Company had $104.0$99.9 million of goodwill and other intangible assets. The Company is required to test its goodwill and intangible assets for impairment on a periodic basis. A significant decline in the Company’s expected future cash flows, a significant adverse change in business climate, slower growth rates or a significant and sustained decline in the price of the Company’s common stock, may necessitate our taking charges in the future related to the impairment of the Company’s goodwill and intangible assets. If we make an impairment determination in a future reporting period, the Company’s earnings and the book value of these intangible assets would be reduced by the amount of the impairment. Further, a goodwill impairment charge could significantly restrict the ability of our banking subsidiaries to make dividend payments to us without prior regulatory approval, which could have a material adverse effect on our financial condition and results of operations.

Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry. The most important counterparty for the Company, in terms of liquidity, is the Federal Home Loan Bank of New York (“FHLBNY”). The Company also has a relationship with the Federal Home Loan Bank of Pittsburgh (“FHLBPITT”). The Company uses FHLBNY as its primary source of overnight funds and also has long-term advances and repurchase agreements with FHLBNY. The Company has placed sufficient collateral in the form of commercial and residential real estate loans at FHLBNY. In addition, the Company is required to hold stock in FHLBNY and FHLBPITT. The amount of borrowed funds and repurchase agreements with the FHLBNY and FHLBPITT, and the amount of FHLBNY and FHLBPITT stock held by the Company, at its most recent fiscal year-end are discussed in Part II, Item 8 of this Report on Form 10-K.

 

Systemic weakness in the FHLB could result in higher costs of FHLB borrowings, reduced value of FHLB stock, and increased demand for alternative sources of liquidity that are more expensive, such as brokered time deposits, the discount window at the Federal Reserve, or lines of credit with correspondent banks. Any of these scenarios could adversely affect our liquidity, the value of our investment in FHLB common stock and our financial condition.

The Company is a financial holding company whose principal assets and sources of income are its wholly-owned subsidiaries. The Company is a separate and distinct legal entity from its subsidiaries, and therefore the Company relies primarily on dividends from these banking and other subsidiaries to meet its obligations and to provide funds for the payment of dividends to the Company’s shareholders, to the extent declared by the Company’s board of directors. Various federal and state laws and regulations limit the amount of dividends that a bank may pay to its parent company and impose regulatory capital and liquidity requirements on the Company and its banking subsidiaries. Further, as a holding company, the Company’s right to participate in a distribution of assets upon the liquidation or reorganization of a subsidiary is subject to the prior claims of the subsidiary’s creditors (including, in the case of the Company’s banking subsidiaries, the banks’ depositors). If the Company were unable to receive dividends from its subsidiaries it would materially and adversely affects the Company’s liquidity and its ability to service its debt, pay its other obligations, or pay cash dividends on its common stock.

General economic conditions impact the banking and financial services industry. The U.S. and global economies have experienced volatility in recent years and may continue to do so for the foreseeable future. There can be no assurance that economic conditions will not deteriorate. Unfavorable or uncertain economic conditions can be caused by many macro and micro factors, including declines in economic growth, business activity or investor or business confidence, limitations on the availability or increases in the cost of credit and capital, increases in inflation or interest rates, the timing and impact of changing governmental policies and other factors. The Company is particularly affected by U.S domestic economic conditions, including U.S. interest rates, the

Our operations are heavily concentrated in the New York State and, to a lesser extent, Pennsylvania and, as a result, our financial condition, results of operations and cash flows are significantly impacted by changes in the economic conditions in those areas. Therefore, the Company’s financial performance generally, and in particular, the ability of borrowers to pay interest on and repay the principal of outstanding loans and the value of collateral securing these loans, is highly dependent upon the business environment in the markets where the Company operates. The Company serves numerous market areas withinoperates, particularly New York State and Pennsylvania, and the Company is dependent on the economic conditions of these two states. Unfavorable or uncertain economic and market conditions could lead to credit quality concerns related to repayment ability and collateral protection as well as reduced demand for the services offered by the Company’s three business segments. In recent years there has been gradual improvement in the U.S. economy as evidenced by a rebound in the housing market, lower unemployment and higher equities markets; however economic growth has been uneven and opinions vary on the strength and direction of the economy.  A downturn in the economy or financial markets could adversely affect the credit quality of the Company’s loan portfolio, results of operations and financial condition.

 

The Company is subject to extensive state and federal laws and regulations, supervision and legislation that affect how it

conducts its business. The majority of these laws and regulations are for the protection of consumers, depositors and the deposit insurance funds. The regulations influence such things as the Company’s lending practices, capital structure, investment practices, and dividend policy. The Dodd-Frank Act, enacted in July 2010, represented a comprehensive overhaul of the financial services industry in the United States and required federal agencies to implement many new rules. This legislationwhich established the Consumer Financial Protection Bureau ("CFPB"), whichCFPB, and enacted other reforms, has broad authority to regulate the consumer financial products and services we offer. Within the Dodd-Frank Act, the Volcker Rule prohibits banking entities from sponsoring or investing in covered funds, and we are required to divest our interest in such covered funds prior to July 21, 2017. We have requested an extended compliance period for certain of these investments and our application is pending with the Federal Reserve Board. While most of the provisions of the Dodd-Frank Act are now in effect, others are still subject to rules that have yet to be adopted or implemented. Reforms, both under the Dodd-Frank Act and otherwise, have had, and will continue to have, a significant effect on the entire financial services industry. Compliance with these regulations and other initiatives negatively impacts revenue and increases the cost of doing business both in terms of transition expenses and on an ongoing basis. Any newFurther, under the current climate of regulatory reform, the future of currently effective, proposed and potential future regulations and legislation is unclear. New regulatory requirements or changes to existing requirements could requirenecessitate changes to the Company’s businesses, result in increased compliance costs and affect the profitability of such businesses. Refer to “Supervision and Regulation” in Part I, Item 1 - “Business” of this Report on Form 10‑K for additional information on material laws and regulations impacting the Company’s business.

As discussed above under the “Supervision and Regulation” section, under Basel III and the Dodd-Frank Act the federal banking agencies established stricter risk-based capital requirements and leverage limits to apply to banks and bank holding companies. These requirements, and any additional requirements adopted in the future, could adversely affect the Company’s ability to pay dividends, or could require it to reduce business levels or to raise capital, including in ways that may adversely affect its results of operations or financial condition.

Additionally, banking regulators are authorized to take supervisory actions that may restrict or limit a financial institution's activities. The financial services supervisory environment has become significantly more demanding and restrictive since the financial crisis of 2008. Regulatory restrictions on our activities could adversely affect our costs and revenues, and may impair our ability to execute our strategic plans. In addition, if our regulators identify a compliance failure, we may be assessed a fine, prohibited from completing a strategic acquisition or divestiture, or subject to other actions imposed by the regulatory authorities. The recent regulatory activity and increased scrutiny have resulted, and may continue to result, in increases in our costs of doing business, and could result in decreased revenues and net income, reduce our ability to effectively compete to attract and retain customers, or make it less attractive for us to continue providing certain products and services. Any future changes in federal or state law and regulations, as well as the interpretations and implementations, or modifications or repeals, of such laws and regulations, could have a material adverse effect on our business, financial condition or results of operations.

 

We are required to comply with anti-money laundering and anti-terrorism laws. These laws and regulations require us, among things, to enact policies and procedures to confirm the identity of our customers, and to report suspicious transactions to regulatory agencies. These laws and regulations are complex and require costly, sophisticated monitoring systems and qualified personnel. The policies and procedures that we have adopted in order to detect and prevent such illegal transactions may not be successful in eliminating all instances of such transactions. To the extent we fail to fully comply with applicable laws and regulations, we face the possibility of fines or other penalties, such as restrictions on our business activities, and we may also suffer reputational harm, all of which could have a material adverse effect on our business, results of operations and financial condition. Refer to “Supervision and Regulation” in Part I, Item 1 - “Business” of this Report on Form 10‑K for additional information on anti-money laundering and anti-terrorism laws impacting the Company’s business.

Based on our historical growth rates and current size, it is possible that our total assets could exceed $10 billion dollars in the future. Our total consolidated assets on December 31, 2018 were $6.8 billion. The Dodd-Frank Act and its implementing regulations impose enhanced supervisory requirements on bank holding companies with more than $10 billion in total consolidated assets.

In addition to the additional regulatory requirements that we will become subject to upon crossing this asset threshold, federal financial regulators may require the Company to, or the Company may proactively, take actions to prepare for compliance with such increased regulations before we exceed $10 billion in total consolidated assets. We may, therefore, incur significant compliance costs in an effort to ensure compliance before we reach $10 billion in total consolidated assets. These additional compliance costs, if they occur, may adversely affect us.our business, results of operations and financial condition.

Competition for commercial banking and other financial services is strong in the Company’s market areas. In one or more aspects of its business, the Company’s subsidiaries compete with other commercial banks, savings and loan associations, credit unions, finance companies, Internet-based financial services companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. In addition, a number of out-of-state financial intermediaries have opened production offices, or otherwise solicit deposits, or have announced plans to do so in the Company’s market areas. Some of these competitors have substantially greater resources and lending capabilities than the Company and may offer services that the Company does not currently provide. In addition, many of the Company’s non-bank competitors are not subject to the same extensive Federal regulations that govern financial holding companies and Federally insuredFederally-insured banks. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Additionally, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Failure to compete effectively to attract new and

retain current customers could adversely affect our growth and profitability, which could have a materially adverse effect on our business, financial condition and results of operations.

As a financial institution, the Company is inherently exposed to operational risk in the form of theft and telecommunications systemsother fraudulent activity by employees, customers and third-party servicers,other third parties targeting the Company and/or the Company’s customers or data. Such activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and failures, interruptionsother dishonest acts. Although the Company devotes substantial resources to maintaining effective policies and internal controls to identify and prevent such incidents, given the increasing sophistication of possible perpetrators, the Company may experience financial losses or breachesreputational harm as a result of security in these systemsfraud. Fraudulent activity could have ana material adverse effect on ourthe Company’s business, financial condition and results of operations.

In the ordinary course of business we rely on electronic communications and information systems, both internal and provided by external third parties, to conduct our operations and to store, process, and/or transmit sensitive data.  Any failure, interruptiondata on a variety of computing platforms and networks and over the Internet. We cannot be certain that all of our systems, or breach in security of thesethird-party systems could result in significant disruptionupon which we rely, are free from vulnerability to our operations.attack or other technological difficulties or failures. Information security breaches and cybersecurity-related incidents may include attempts to access information, including customer and company information, malicious code, computer viruses, andphishing, denial of service attacks and other means of intrusion that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer or employee information), account takeovers, unavailability of service or other events. These types of threats may derive from human error, fraud or malice on the part of external or internal parties, or may result from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. Our technologies, systems, networksIf information security is breached or difficulties or failures occur, despite the controls we and software,our third party vendors have instituted, information may be lost or misappropriated, resulting in financial loss or costs, reputational harm or damages and thoselitigation, regulatory investigation costs or remediation costs to us or others. While we maintain specific “cyber” insurance coverage, which would apply in the event of othermany breach scenarios, the amount of coverage may not be adequate in any particular case. Furthermore, because cyber threat scenarios are inherently difficult to predict and can take many forms, some breaches may not be covered under our cyber insurance coverage. Any of these consequences could have a material adverse effect on our financial institutions have been,condition and are likely to continue to be, the targetresults of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us.  operations.

The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, has significantly increased, in part due to the expansion of new technologies, the increased use of the Internet and mobile services and the increased intensity and sophistication of attempted attacks and intrusions from around the world. The threat from cyber-attacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. Our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Our technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats as well as the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers. As cyber threats continue to evolve, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate any information security vulnerabilities.

The Company’s strategic initiatives include diversification within its markets, growth of its fee-based businesses, and growth internally and through acquisitions of financial institutions, branches, and financial services businesses. As such, the Company has acquired, and from time to time considers acquiring, banks, thrift institutions, branch offices of banks or thrift institutions, or other businesses within markets currently served by the Company or in other locations that would complement the Company’s business or its geographic reach. In 2018, the Company did not initiate or complete any acquisitions considering, in part, the increased competition with other regional banks for strategic acquisitions. Additionally, future acquisitions will be accompanied by the risks commonly encountered in acquisitions. These risks include: the difficulty of integrating operations and personnel, the potential disruption of our ongoing business, the inability of management to realize or maximize anticipated financial and strategic positions, increased operating costs, the inability to maintain uniform standards, controls, procedures and policies, the difficulty and cost of obtaining adequate financing, the potential for litigation risk, the potential loss of members of a key executive management group, the potential reputational damage and the impairment of relationships with employees and customers as a result of changes in ownership and management. Further, the asset quality or other financial characteristics of an acquired company may deteriorate after the acquisition agreement is signed or after the acquisition closes. We cannot provide any assurance that we will be successful in overcoming these risks or any other problems encountered in connection with acquisitions and any of these risks, if realized, could have an adverse effect on our results of operations and financial condition.

The Company relies on certain external vendors to provide products and services necessary to maintain the day-to-day operations of the Company. Some of the products and services provided by vendors include key components of our business infrastructure including data processing and storage and internet connections and network access, among other products and services. Accordingly, the Company’s operations are exposed to the risk that these vendors will not perform in accordance with the contracted arrangements or under service level agreements. The failure of an external vendor to perform in accordance with the contracted arrangements or under service level agreements, because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could disrupt the Company’s operations. If we are unable to find alternative sources for our vendors’ services and products quickly and cost-effectively, the failures of our vendors could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.

Additionally, our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

 

The Company’s stock price can fluctuate widely in response to a variety of factors, including: actual or anticipated variations in our operating results; recommendations by securities analysts; significant acquisitions or business combinations; operating and stock price performance of other companies that investors deem comparable to Tompkins; new technology used, or services offered by our competitors; news reports relating to trends, concerns and other issues in the financial services industry; and changes in government regulations. Other factors, including general market fluctuations, industry-wide factors and economic and general political conditions and events, including foreign and national governmental policy decisions, terrorist attacks, economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations, may adversely affect the Company’s stock price even though they do not directly pertain to the Company’s operating results.

 

 

The Company’s common stock is traded on the NYSE MKT LLC.American. The trading volume in the Company’s common stock is less than that of larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of the Company’s common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.

 

 

The Company’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in the Company’s common stock is inherently risky for the reasons described in this “Risk Factors” section and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire the Company’s common stock, you may lose some or all of your investment.

 

Holders of Tompkins’ common stock are only entitled to receive such dividends as its board of directors may declare out of funds legally available for such payments. While Tompkins has a long history of paying dividends on its common stock, Tompkins is not required to pay dividends on its common stock and could reduce or eliminate its common stock dividend in the future. This could adversely affect the market price of Tompkins’ common stock. Also, Tompkins is a bank holding company, and its ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends. See “Supervision and Regulation” for a description of certain material limitations on the Company’s ability to pay dividends to shareholders.

 

The Company’s executive offices are located at 110 North Tioga118 East Seneca Street in Ithaca. Our new headquarters was completed at this location in the second quarter of 2018, resulting in the consolidation of some staff and operations into a single location; and enabling the Company to sell two previously-owned buildings in Ithaca, New York.

The Company’s banking subsidiaries have 6566 branch offices, of which 3334 are owned and 32 are leased at market rents. The Company’s insurance subsidiary has 95 stand-alone offices, of which 63 are owned by the Company and 32 are leased at market rents. The Company’s wealth management and financial planning division has 2 offices which are leased at a market rent, and shares other locations with the Company’s other subsidiaries. Management believes the current facilities are suitable for their present and intended purposes. The Company is, however, in process of building a new headquarters at 118 East Seneca Street in Ithaca, which is expected to be completed in 2018. The new facility will replace leased space at 215 East State Street, Ithaca NY, which currently houses the Company's operations center, and will also consolidate staff from a number of other Ithaca locations into a single facility. For additional information about the Company’s facilities, including rental expenses, see “Note 76 Premises and Equipment” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

The Company is subject to various claims and legal actions that arise in the ordinary course of conducting business. Management does not expect the ultimate disposition of these matters to have a material adverse impact on the Company’s financial statements.

 

The Company’s common stock is traded under the symbol “TMP” on the NYSE MKT LLC (the “Exchange”). The high and low closing sale prices, which represent actual transactions as quotedAmerican.

While the Company has a long history of paying cash dividends on the Exchange,shares of the Company’sits common stock, for each quarterly period in 2015 and 2016 are presented below. The per share dividends paid by the Company in each quarterly period in 2015 and 2016 and the payment dates of these dividends are also presented below. 

The following table reflects all Company repurchases, including those made pursuant to publicly announced plans or programs, during the quarter ended December 31, 2016.2018. 

Included above are 1,3331,258 shares purchased in October 2016,2018, at an average cost of $77.25,$78.92, and 461547 shares purchased in November 2016,2018, at an average cost of $79.56,$78.35, by the trustee of the rabbi trust established by the Company under the Company’s Stock Retainer Plan For Eligible Directors of Tompkins Financial Corporation and Participating Subsidiaries, which were part of the director deferred compensation under that plan.  In addition, the table includes 4,94311,779 shares delivered to the Company in November 20162018 at an average cost of $84.76$77.02 to satisfy mandatory tax withholding requirements upon vesting of restricted stock under the Company's 2009 Equity Plan.

 

On July 21, 2016,19, 2018, the Company’s Board of Directors authorized a share repurchase plan for the Company to repurchase up to 400,000 shares of the Company’s common stock. Purchases may be made over the 24 months following adoption of the plan. The repurchase program may be suspended, modified or terminated by the Board of Directors at any time for any reason. NoThis plan replaced the Company's 400,000 share plan announced on July 21, 2016 which expired in July 2018. Under the current plan, the Company repurchased 16,983 shares have been repurchased under this plan asthrough December 31, 2018, at an average cost of the date of this Report.$73.17.

The following graph compares the Company’s cumulative total stockholder return over the five-year period from December 31, 20112013 through December 31, 2016,2018, with (1) the total return index for the NASDAQ Composite and (2) the total return index for SNL Bank Index. The graph assumes $100.00 was invested on December 31, 2011,2013, in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. 

 

In accordance with and to the extent permitted by applicable law or regulation, the information set forth below under the heading “Performance Graph” shall not be incorporated by reference into any future filing under the Securities Act or Exchange Act and shall not be deemed to be “soliciting material” or to be “filed” with the SEC under the Securities Act or the Exchange Act, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into such filings. The performance graph represents past performance and should not be considered an indication of future performance.

The following consolidated selected financial data is taken from the Company’s audited financial statements as of and for the five years ended December 31, 2016.2018. The following selected financial data should be read in conjunction with the consolidated financial statements and the notes thereto in Part II, Item 8. of this Report. All of the Company’s acquisitions during the five year period were accounted for using the purchase method. Accordingly, the operating results of the acquired companies are included in the Company’s results of operations since their respective acquisition dates.

The following analysis is intended to provide the reader with a further understanding of the consolidated financial condition and results of operations of the Company and its operating subsidiaries for the periods shown. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with other sections of this Report on Form 10-K, including Part I, “Item 1. Business,” Part II, “Item 6. Selected Financial Data,” and Part II, “Item 8. Financial Statements and Supplementary Data.”

Tompkins Financial Corporation (“Tompkins” or the “Company”) is headquartered in Ithaca, New York and is registered as a Financial Holding Company with the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. The Company is a locally oriented, community-based financial services organization that offers a full array of products and services, including commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, insurance, and brokerage services. At December 31, 2016,2018, the Company’s subsidiaries included: four wholly-owned banking subsidiaries, Tompkins Trust Company (the “Trust Company”), The Bank of Castile (DBA Tompkins Bank of Castile), Mahopac Bank (formerly known as Mahopac National Bank, DBA(DBA Tompkins Mahopac Bank), VIST Bank (DBA Tompkins VIST Bank); and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). The Trust Company provides a full array of trust and investment services under the Tompkins Financial Advisors brand, including investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services.  The Company’s principal offices are located at The Commons,118 E. Seneca Street, P.O. Box 460, Ithaca, New York, 14851,NY, 14850, and its telephone number is (888) 503-5753.503-5753. The Company’s common stock is traded on the NYSE MKT LLCAmerican under the Symbol “TMP.”

This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The statements contained in this Report that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. Forward-looking statements may be identified by use of such words as "may", "will", "estimate", "intend", "continue", "believe", "expect", "plan", or "anticipate", and other similar words. Examples of forward-looking statements may include statements regarding; the asset quality of the Company's loan portfolios; the level of the Company's allowance for loan losses; the sufficiency of liquidity sources; the Company's exposure to changes in interest rates; the impact of changes in accounting standards; the likelihood that deferred tax assets will be realized and plans, prospects, growth and strategies. Forward-looking statements are made based on management’s expectations and beliefs concerning future events impacting the Company and are subject to certain uncertainties and factors relating to the Company’s operations and economic environment, all of which are difficult to predict and many of which are beyond the control of the Company, that could cause actual results of the Company to differ materially from those expressed and/or implied by forward-looking statements. The following factors, in addition to those listed as Risk Factors in Item 1A are among those that could cause actual results to differ materially from the forward-looking statements: changes in general economic, market and regulatory conditions; the development of an interest rate environment that may adversely affect the Company’s interest rate spread, other income or cash flow anticipated from the Company’s operations, investment and/or lending activities; changes in laws and regulations affecting banks, bank holding companies and/or financial holding companies, such as the Dodd-Frank Act, Basel III and Basel III;the Economic Growth, Regulatory Relief, and Consumer Protection Act; technological developments and changes; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; governmental and public policy changes, including environmental regulation; reliance on large customers; and financial resources in the amounts, at the times and on the terms required to support the Company’s future businesses. 

 

In the course of normal business activity, management must select and apply many accounting policies and methodologies and make estimates and assumptions that lead to the financial results presented in the Company’s consolidated financial statements and accompanying notes. There are uncertainties inherent in making these estimates and assumptions, which could materially affect our results of operations and financial position.

 

Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s consolidated financial statements. Management considers the accounting policies relating to the allowance for loan and lease losses (“allowance”), pension and postretirement benefits, and the review of the securities

portfolio for other-than-temporary impairment to be critical accounting policies because of the uncertainty and subjectivity involved in these policies and the material effect that estimates related to these areas can have on the Company’s results of operations.

 

Management considers the accounting policy relating to the allowance to be a critical accounting policy because of the high degree of judgment involved, the subjectivity of the assumptions used and the potential changes in the economic environment that could result in changes to the amount of the allowance.

Although we believe our process for determining the allowance adequately considers all of the factors that would likely result in credit losses, this evaluation is inherently subjective as it requires material estimates, including expected default probabilities, the loss emergence periods, the amounts and timing of expected future cash flows on impaired loans, and estimated losses based on historical loss experience and current economic conditions. All of these factors may be susceptible to significant change. To the extent that actual results differ from management estimates, additional loan loss provisions may be required that would adversely impact earnings for future periods. For example, if historical loan losses significantly worsen, or if current economic conditions significantly deteriorate, an additional provision for loan losses would be required to increase the allowance for loan and lease losses.

 

All accounting policies are important and the reader of the financial statements should review these policies, described in “Note 1 Summary of Significant Accounting Policies” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Form 10-K, to gain a better understanding of how the Company’s financial performance is reported.

The Company reported diluted earnings per share of $3.91$5.35 in 2016,2018, compared to diluted earnings per share of $3.87$3.43 in 2015.2017. Net income for the year ended December 31, 2016,2018, was $59.3$82.3 million, an increase of 1.57%56.8% compared to $58.4$52.5 million in 2015. Results for 2015 had been positively2017. The 2017 results were impacted by the Tax Cuts and Jobs Act of 2017 (the "TCJA"), resulting in a one-time, curtailment gainnon-cash write-down of $3.6 million, after-tax, relatednet deferred tax assets in the amount of $14.9 million. For additional financial information on the impact of the TCJA, refer to changes"Note 15 - Income Taxes" in the Notes to the Company’s defined benefit pension plan. ExclusiveConsolidated Financial Statements in Part II, Item 8. of this one-time gain, net income and diluted earnings per share for 2015 were $54.8 million and $3.63, respectively.Report.

The following table summarizes the Company’s results of operations for the periods indicated on a GAAP basis and on an operating (non-GAAP) basis for the periods indicated. The Company believes the non-GAAP measures provide meaningful comparisons of our underlying operational performance and facilitates management’s and investors’ assessments of business and performance trends in comparison to others in the financial services industry. In addition, the Company believes the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations. Tangible common equity per share is tangible common equity divided by total shares issued and outstanding. Tangible common equity per share is often regarded as a more meaningful comparative ratio than book value per share as calculated under GAAP, that is, total stockholders' equity including intangible assets divided by total shares issued and outstanding. These non-GAAP financial measures should not be considered in isolation or as a measure of the Company’s profitability or liquidity; they are in addition to, and are not a substitute for, financial measures under GAAP. Net operating income, adjusted diluted earnings per share, operating return on average tangible common equity, and tangible common equity per share as presented herein may be different from non-GAAP financial measures used by other companies, and may not be comparable to similarly titled measures reported by other companies. Further, the Company may utilize other measures to illustrate performance in the future. Non-GAAP financial measures have limitations since they do not reflect all of the amounts associated with the Company’s results of operations as determined in accordance with GAAP. 

The Company operates in three business segments: banking, insurance and wealth management. Insurance is comprised of property and casualty insurance services and employee benefit consulting operated under the Tompkins Insurance Agencies, Inc. subsidiary. Wealth management activities include the results of the Company’s trust, financial planning, and wealth management services conducted under the trust departmentprovided by Tompkins Financial Advisors, a division of the Trust Company. All other activities are considered banking. For additional financial information on the Company’s segments, refer to “Note 22 – Segment and Related Information” in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

The banking segment reported net income of $53.7$74.9 million for the year endingended December 31, 2016,2018, representing a $2.0$27.9 million or 3.9%59.3% increase compared to 2015, driven mainly2017. Banking segment earnings in 2018 and 2017 were significantly impacted by growththe Tax Cuts and Jobs Act of 2017.  Due to this legislation, a one-time, $14.9 million write-down was recorded for the remeasurement of net deferred tax assets and is reflected in interest income.the banking segment’s results of operations for the fourth quarter of 2017 as an additional charge to income tax expense. The legislation also decreased the Federal statutory tax rate from 35% in 2017 to 21% in 2018. Net interest income increased $12.4$10.5 million or 7.4%5.2% in 20162018 compared to 2015,2017, due primarily to loan growth, which more than offset lowerand an increase in average loan yields. Interest income increased $14.1$24.8 million or 7.5%,10.9% compared to 2017, while interest expense increased $1.7$14.3 million or 8.5% compared to 2015.56.3%.

The provision for loan and lease losses was $4.3$3.9 million in 2016,2018, compared to $2.9$4.2 million in the prior year. The increase reflectsloan growth rate for 2018 was 3.5% compared to 12.8% for 2017, contributing to the growthyear-over-year decrease in total loans, and is partially offset by the stabilization in credit quality.provision expense.

Noninterest income in the banking segment of $24.4$31.7 million in 2016 decreased2018 increased by $2.7$6.2 million or 9.9%24.5% when compared to 2015. Declines2017. The increase in noninterest income included:was mainly due to gain on sale of other real-estate owned (“OREO”) (down $860,000)fixed assets (up $2.9 million), service chargescollection of fees and nonaccrual interest on deposit accounts (down $532,000)a loan that was charged off in 2010 (up $2.5 million), gainscard services income (up $594,000), net gain on available-for-sale (“AFS”) securities (down $182,000),sale of loans (up $408,000) and other fee income (down $162,000), mark-to-market gain on liabilities held at fair value (down $159,000), and income on miscellaneous investments (down $85,000)(up $281,000). These were partially offset by an increase in card services income (up $221,000), and a decrease in mark-to-market loss on trading securitiesBOLI (down $113,000)$378,000).

Noninterest expenses increased by $7.3$9.3 million or 6.3%6.9% compared to 2015, reflecting increases in salaries and benefits associated with incentive pay and merit increases. In addition, the2017. The increase was relatedmainly attributed to an increase in salary and wages and employee benefits reflecting normal annual merit and incentive adjustments and higher health insurance costs over the impactprior year, write-downs of $2.3 million on leases on space vacated in 2018 following completion of the one-time gain relatedCompany's new headquarters in 2018, total technology expense (up $1.8 million), and professional fees and consulting (up $2.8 million). The increase in technology and professional fees primarily relates to changes toinvestments in strengthening the Company’s pension plan, which resulted in a $5.4 million pre-tax credit to noninterest expense in the second quarter of 2015.Company's compliance and information security infrastructure.

The insurance segment reported net income of $3.3$3.2 million, down 9.6%up 11.9% when compared to 2015.2017.  The yearincrease in net income is mainly a result of the decrease in the Federal statutory tax rate in 2018 described above. Net income before tax decreased by $269,000 or 5.8%,  as a 2.2% increase in noninterest revenue was offset by a 3.8% increase in expenses.  The increase in expenses was mainly attributed to an increase in salary and wages and employee benefits reflecting normal annual merit and incentive adjustments and higher health insurance costs, respectively, over year comparison was negatively impacted bythe prior year. Noninterest income increased $654,000, or 2.2%, when compared to 2017, reflecting increases in all business lines (personal, commercial, and life and health). Revenues for 2017 included a non-recurring items in 2015, including the one-time gain of $462,000 related to changes to the Company’s pension plan, and a pre-tax gain of $329,000 related toon the sale of certain customer relationships in the fourth quarteramount of 2015.

The Wealth Managementwealth management segment reported net income of $2.4$4.2 million for the year ended December 31, 2016, a decrease2018, an increase of 763,000$1.6 million or 24.0%62.0% compared to 2015. Investment services revenue2017. Noninterest income of $15.8$18.0 million decreased $195,000increased $1.7 million or 1.2%10.1% compared to 2015. In addition, noninterest2017. Estate and terminating trust fees were up $1.1 million or 661.3% in 2018 over 2017, benefiting from the settlement of a large estate in 2018. Noninterest expenses increased $832,000 or 7.3%were flat in 2018 compared to 2015,2017, mainly due to increaseslower staffing levels in employee benefits and a one-time gain related2018 compared to changes to the Company’s pension plan, which resulted in a $131,000 credit to noninterest expense in the second quarter of 2015.2017. The market value of assets under management or in custody at December 31, 20162018 totaled $3.9$3.8 billion, an increasea decrease of 2.3%5.3% compared to year-end 2015.2017.

Net interest income is the Company’s largest source of revenue, representing 72.4%73.2% of total revenues for the twelve monthsyear ended December 31, 2016,2018, and 70.1%74.4% of total revenues for the twelve monthsyear ended December 31, 2015.2017. Net interest income in 2018 increased 7.3% in 2016 compared to 2015.5.2% over 2017. Net interest income is dependent on the volume and composition of interest earning assets and interest-bearing liabilities and the level of market interest rates. The Company’s net interest income over the past several years benefited from steady growth in average earning assets, which increased 8.7%5.3% in 20162018 compared to 2015, offsetting a modest decline in net interest margin.2017.

Tax-equivalent interest income increased $14.2$22.3 million or 7.4%9.6% in 20162018 over 2015.2017. The increase in taxable-equivalent interest income was the result of the $442.4reflects a $317.8 million or 8.7%5.3% increase in average interest-earning assets.assets and improved yields. The growthincrease in average interest-earning assets was mainly in average loans and leases, which increased $356.4 million or 8.1% in 2018 compared to 2017. Average loan balances represented 75.0% of average earning assets and the higher concentration of loans helpedin 2018 compared to offset lower asset yields.73.1% in 2017. The average yield on interest earning assets for 2016 declined2018 was 4.0%, which increased by 16 basis points from 2017. The average yield on loans was 4.53% in 2018, an increase of 11 basis points compared to 4.42% in 2017. Average balances on securities decreased $45.4 million or 2.9% compared to 2017, while the average yield on the securities portfolio increased 5 basis points or 1.3% from the prior year. Average loan balances increased $425.3 million or 12.0% in 20162.3% compared to 2015, while the average yields on loans declined 9 basis points or 2.0%. Average loan balances represented 71.4% of earning assets in 2016 compared to 69.3% in 2015. Average balances on securities increased $8.4 million or 0.5% compared to 2015, while the average yields on the securities portfolio declined 9 basis points or 4.1% compared to 2015.2017.

Interest expense for 20162018 increased $1.7$14.3 million or 8.5%56.3% compared to 2015,2017, and average interest bearing liabilities increased $302.8$187.8 million or 7.9%.4.2% over 2017. The increase in interest expense reflects higherwas the result of the increase in the average rates paid on deposits and interest bearing liabilities in 2018 compared to 2017, as well as the growth in average borrowings during 20162018 when compared to 2015.2017. The average rate paid on interest bearing deposits was 0.32%0.48% in 2016, which was flat compared to 2015. Average2018, up 13 basis points from 0.35% in 2017, while the average costs of interest bearing depositsliabilities increased to 0.85% in 2016 increased $142.1 million or 4.4% compared to 2015. Average noninterest bearing deposit balances2018 from 0.57% in 2016 increased $100.9 million or 9.8% over 2015 and represented 24.9% of total deposits compared to 24.0% in 2015.2017. Average other borrowings increased by $198.8$204.6 million or 47.6%23.2% year over year, mainly due to a higher volume of overnight borrowings with the FHLB in 20162018, which were used to fundsupport loan growth that exceeded deposit growth in 2016.2018. Average total deposits were up $89.7 million or 1.9% in 2018 over 2017, with the majority of the growth in average noninterest bearing deposits. Average interest bearing deposits in 2018 decreased $13.9 million or 0.4% compared to 2017. Average noninterest bearing deposit balances in 2018 increased $103.5 million or 8.1% over 2017 and represented 28.4% of average total deposits in 2018 compared to 26.8% in 2017.