10-Q 1 w52554e10-q.txt FORM 10-Q 1 Central National Bank, Canajoharic Form 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly period ending June 30, 2001 Commission File Number 000-23730 CNB FINANCIAL CORP. ------------------- (Exact name of registrant as specified in its charter) New York 22-3203747 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 24 Church Street, Canajoharie N.Y. 13317 ---------------------------------------- (Address of principal executive offices - Zip code) Registrant's telephone number, include area code (518) 673-3243 --------------- Indicated by a check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the bank was required to file such reports), and (2) has been subjected to such filing requirements for the past 90 days. Yes X No -------- -------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

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-2- 3 Part 1. Financial Information Item 1. Consolidated Financial Statements CNB FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)

See accompanying notes to unaudited consolidated interim financial statements. 3 4 CNB FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)

See accompanying notes to unaudited consolidated interim financial statements. 4 5 CNB FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

Supplemental non-cash activity: During the quarter ended March 31, 2001, the Company transferred $3.804 of securities available for sale to trading securities. At the time of transfer, the securities' total amortized cost approximated total fair value. 5 6 CNB FINANCIAL CORP. NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS 1. The accompanying unaudited consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring accruals) considered necessary for a fair presentation have been included. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the Company's Annual Report on Form 10-K as of, and for, the year ended December 31, 2000. Operating results for the six-month and three-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the full year or any other interim period. 2. EARNINGS PER SHARE - Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (such as the Company's stock options). The following table provides the calculation of basic and diluted EPS for the three and six months ended June 30:

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The weighted-average number of options excluded from the computation of diluted EPS during the three and six months ended June 30, 2001 because the options' exercise price was greater than the average market price of the common stock for the three and six months ended June 30, 2001 was 45,000, with a weighted-average exercise price of $16.34. At June 30, 2001, options to purchase 1,500 shares of common stock at a weighted-average exercise price of $19.75 per share were outstanding and anti-dilutive. 3. RECENT ACCOUNTING PRONOUNCEMENTS: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective January 1, 2001. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of the derivative financial instruments are reported in either net income or as a component of other comprehensive income, depending on the use of the derivative and whether or not it qualifies for hedge accounting. Consequently, there may be increased volatility in net 7 8 income, other comprehensive income and stockholders' equity on an ongoing basis as a result of accounting for derivatives in accordance with SFAS No. 133. Special hedge accounting treatment is permitted only if specific criteria are met, including a requirement that the hedging relationship be highly effective both at inception and on an ongoing basis. Accounting for hedges varies based on the type of hedge - fair value or cash flow. Results of effective hedges are recognized in current earnings for fair value hedges and in other comprehensive income for cash flow hedges. Ineffective portions of hedges are recognized immediately in earnings and are not deferred. As of January 1, 2001, the Company held certain debt securities with embedded derivative instruments. The purpose of these embedded derivatives was to hedge against the exposure associated with certain of the Company's variable rate debt securities that would experience a decrease in interest payments in a falling interest rate environment. As of January 1, 2001, management determined that these embedded derivatives qualified for hedge accounting treatment under SFAS No. 133 using the cash flow hedging model. Accordingly, to the extent that this cash flow hedge was effective, the embedded derivatives were recorded at their estimated fair value with the fair value adjustment, net of tax, included in stockholders' equity as a component of accumulated other comprehensive income or loss. However, any ineffectiveness of this cash flow hedge would result in recognizing a corresponding portion of the estimated fair value adjustment in current earnings. In addition, if the cash flows resulting from the embedded derivatives changed by less than 80% or more than 125% of the change in the cash flows from the hedged items, the hedge would no longer be considered effective and the entire fair value adjustment related to the embedded derivatives would be recorded as an adjustment to current earnings. As of January 1, 2001, the amortized cost and estimated fair value of the debt securities with the embedded derivatives amounted to approximately $3.833 million and $3.410 million, respectively. At January 1, 2001, management considered the embedded derivatives to be highly effective in hedging changes in the cash flows associated with the hedged items and, accordingly, there was no effect on the Company's results of operations from the adoption of SFAS No. 133 with respect to these embedded derivatives. During the three months ended March 31, 2001, the Company discontinued the cash flow hedge noted above. The cash flow hedge was discontinued at a time when the amortized cost of the debt securities with the embedded derivatives approximated fair value ($3.804 million). The debt securities with the embedded derivatives were concurrently transferred from securities available for sale to trading securities, with subsequent changes in the fair value of the debt securities recorded in net gain (loss) on securities transactions in the consolidated statement of income for the six months ended June 30, 2001. During the six months ended June 30, 2001, the Company purchased an additional $6.194 million of debt securities with similar embedded derivatives, which were classified as trading securities at purchase. As a result of the decreasing rate environment during the six months ended June 30, 2001, the Company recognized $327,000 in fair value appreciation from these trading securities in net gain (loss) on securities transactions. For the three months ended June 30, 2001, the Company recognized $86,000 in fair value appreciation from these trading securities 8 9 in net gain (loss) on securities transactions. Management provides reports regarding the debt securities with embedded derivatives to the Company's Board of Directors on a monthly basis. The Company also has certain other embedded derivative instruments related to a deposit product and two debt securities that have costs and returns linked to the performance of the NASDAQ 100-index. Management has determined that these debt securities and the deposit product do not qualify for hedge accounting under SFAS No. 133. The embedded derivatives have been separated from the underlying host instruments for financial reporting purposes and accounted for at fair value. In connection with the adoption of SFAS No. 133 as of January 1, 2001, the Company recorded a charge to earnings for a transition adjustment of $159,000 ($95,000, after-tax) for the net impact of recording these embedded derivatives on the consolidated balance sheet at fair value. This transition adjustment (net of tax) is reflected in the consolidated statement of income for the six months ended June 30, 2001 as the cumulative effect of a change in accounting principle. As of June 30, 2001, the total amortized cost and estimated fair value of these two debt securities (including the embedded derivatives, which are classified in the consolidated balance sheet with the underlying host instrument) is $7.000 million and $6.485 million, respectively. The securities' rate of return is based on an original NASDAQ 100-index value, with the index value resetting annually over a five-year period. The rate of return is capped on these debt securities as follows: $3.000 million have a 35% annual rate of return cap and $4.000 million have a 25% annual rate of return cap. The $4.000 million security has a guaranteed rate of return of 2% regardless of the performance of the NASDAQ 100-index over its five-year period. The securities are scheduled to mature in 2005 and the Company is guaranteed to receive the face value of the securities at maturity. These two debt securities are valued similar to zero coupon bonds coupled with the value of NASDAQ 100-futures contracts. The primary purpose of these debt securities is to provide a certain level of hedging related to a deposit product the Company offered in 2000 that has similar characteristics to the bonds. As of June 30, 2001, the face value of the NASDAQ 100-deposit product was $1.397 million, with an estimated value (including the embedded derivative, which is classified in the consolidated balance sheet with the underlying host instrument ) of $1.174 million. The NASDAQ 100-deposit product is a five-year certificate of deposit with a maturity date in July 2005. The deposit's interest rate is based on an original NASDAQ 100-index value, with the index value resetting annually over a five-year period. The maximum annual interest rate is 20%, and the Company has guaranteed the return of the original deposit balance to the customer (i.e. the minimum rate for the five period cannot be negative). The Company does not currently offer the NASDAQ 100-deposit product. However, it may again offer this product if market conditions warrant. During the three and six months ended June 30, 2001, the Company recorded a $141,000 and $233,000 net loss, respectively, related to the adjustment of the embedded derivatives to estimated fair value, which was recorded in net gain (loss) on securities transactions on the consolidated statement of income. As of June 30, 2001, 9 10 the estimated fair value of the embedded derivatives related to the debt securities and time deposit product linked to the NASDAQ 100-index was $474,000 and $93,000, respectively. As of January 1, 2001, the estimated fair value of the embedded derivatives related to the debt securities and time deposit product linked to the NASDAQ 100-index was $774,000 and $160,000, respectively. These embedded derivatives may result in increased volatility in net income on an ongoing basis based on movements in the NASDAQ 100-index. Management provides reports regarding the embedded derivatives related to the NASDAQ 100-index to the Company's Board of Directors on a monthly basis. BUSINESS COMBINATIONS AND ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS In July 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 142 applies to all purchase method business combinations completed after June 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company is required to adopt the provisions of SFAS 141 immediately, except with regard to business combinations initiated prior to July 1, 2001, which it expects to account for using the pooling-of-interests method, and SFAS 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of SFAS 142. SFAS 141 will require upon adoption of SFAS 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria in SFAS 141 for recognition apart from goodwill. Upon adoption of SFAS 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of SFAS 142 within the first interim period. Any impairment loss will 10 11 be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. In connection with the transitional goodwill impairment evaluation, SFAS 142 will require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption, based upon the criteria in the standard. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company's consolidated statement of income. As of the date of adoption, the Company expects to have unamortized goodwill in the amount of $16.808 million, which will be subject to the transition provisions of SFAS 141 and 142. Amortization expense related to goodwill was $1.327 million and $663,000 for the year ended December 31, 2000 and the six months ended June 30, 2001, respectively. Because of the extensive effort needed to comply with adopting SFAS 141 and 142, it is not practicable to reasonably estimate the full impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle. 4. COMPREHENSIVE INCOME - Comprehensive income represents the sum of net income and items of other comprehensive income or loss, which are reported directly in stockholders' equity, net of tax, such as the change in the net unrealized gain or loss on securities available for sale. Accumulated other comprehensive income or loss, which is included in stockholders' equity, net of tax, represents the net unrealized gain or loss on securities available for sale. Total comprehensive income for the six months ended June 30, 2001 and 2000 was $4.698 million and $1.694 million, respectively, and total comprehensive income for the three months ended June 30, 2001 and 2000 was $1.924 million and $394,000, respectively. 5. MERGERS - On June 19, 2001, the Company and NBT Bancorp Inc. ("NBT") announced that the Company entered into a definitive agreement to merge with and into NBT. Holders of the Company's common stock will receive 1.2 shares of NBT common stock for each share of the Company's stock and cash in lieu of fractional shares. NBT expects to account for the transaction as a pooling-of-interests. Consummation of the transaction is subject to a number of conditions, including approvals from bank regulatory authorities, approval by each company's shareholders, receipt of opinions as to the tax treatment of the transaction and certain other conditions. The transaction is expected to close in the fourth quarter of 2001. In connection with the proposed merger, NBT and the Company have entered into a Service and Non-competition Agreement with Mr. Donald L. Brass, President of the Company. See Exhibit 10.3 to this report. 11 12 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL CNB Financial Corp. (the Company) is a one-bank holding company, registered under the Bank Holding Company Act of 1956, as amended. It was organized under the laws of the State of New York and became a bank holding company on January 5, 1993 through the consummation of a reorganization plan with Central National Bank, Canajoharie, (the Bank) which became the wholly owned subsidiary of the Company. The Company maintains its headquarters in Canajoharie, New York. The principal business of the Company is to provide, through the Bank, comprehensive banking services through its network of twenty nine branches and two financial services centers located in Central New York in the counties of Montgomery, Fulton, Chenango, Herkimer, Oneida, Otsego, Schoharie, Saratoga and Schenectady. In 1996, Central Asset Management, Inc. (CAM) was formed as a second subsidiary of the Company. The main business activity of CAM is to offer investment management services for a fee to a focused customer base of high net worth individuals and businesses. On May 31, 2001, Colonial Financial Services, Inc. (CFS) was formed as a subsidiary of the Bank. The main business activity of CFS is to offer insurance products, annuities, mutual funds, and other financial service related products in the Bank's primary market area. CFS is currently in negotiations with an insurance company to enter into an agreement to service a number of insurance accounts located in CFS primary market area. The agreement is expected to close in the third quarter of 2001. The Company's principal business is attracting deposits from customers within its market area and investing those funds primarily in mortgage loans, consumer loans and leases, commercial and agricultural loans, and government and corporate debt securities. The financial condition and operating results of the Company are dependent on its net interest income which is the difference between the interest and dividend income earned on its assets, primarily loans and investments, and the interest expense paid on its liabilities, primarily deposits and borrowings. Net income is also affected by other operating income, such as fees on deposit related services, loan servicing income, and fiduciary activities; other operating expenses, such as salaries and benefits, occupancy expenses, and data processing expense; the provision for loan and lease losses; and federal and state income taxes. The Company's results of operations are significantly affected by general economic and competitive conditions (particularly changes in market interest rates), government polices, changes in accounting standards and actions of regulatory agencies. Future changes in applicable laws, regulations or government policies may have a material impact on the Company. The demand for and supply of real estate, competition among lenders, the level of interest rates and the availability of funds substantially influence lending activities. The ability to gather deposits and the cost of funds are influenced by prevailing market interest rates, fees and terms on deposit products, as well as the availability of alternative investments, including mutual funds and stocks. 12 13 FORWARD LOOKING STATEMENTS The Company may from time to time make written or oral "forward-looking statements", including statements contained in its filings with the Securities and Exchange Commission (SEC) (including this quarterly report on Form 10-Q and the Exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors some of which are beyond the Company's control. The words "may", "could", "should", "would", "believe", "anticipate", "estimate", "expect", "intend", "plan" and similar expressions are intended to identify forward-looking statements. The important factors we discuss below and elsewhere in this document, as well as other factors discussed and identified in our filings with the SEC and those presented elsewhere by our management from time to time, could cause actual results to differ materially from those indicated by the forward-looking statements made in this report: - the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; - the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; - inflation, interest rate, market and monetary fluctuations; - the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; - the willingness of users to substitute competitors' products and services for the Company's products and services; - the success of the Company in gaining regulatory approval of its products and services, when required; - the impact of changes in financial services' laws and regulations (including laws concerning taxes, banking, securities, agriculture and insurance); - technological changes; - delay of or failure to complete the proposed merger with NBT Bancorp Inc.; - changes in consumer spending and saving habits; and 13 14 - the success of the Company at managing the risks involved in the foregoing. The Company wishes to caution readers that such forward-looking statements speak only as of the date made. The Company does not undertake, and expressly disclaims any intent or obligation, to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company. 14 15 RESULTS OF OPERATIONS The following tables show earnings per share (EPS) data and selected ratios for the period ended or at the dates indicated: (dollars in thousands except for EPS and where appropriate, ratios have been annualized)

(1) Core cash earnings, as reported by the Company, excludes goodwill amortization, write-downs taken for the other-than-temporary impairment on corporate debt securities, and the transition adjustment for the cumulative effect of a change in accounting principle. (2) GAAP is defined as Generally Accepted Accounting Principles (3) Equals non-interest expense less goodwill amortization expense divided by net interest income (FTE) plus non-interest income (excluding net gains or losses on securities transactions). 15 16 Net interest income on a fully tax-equivalent (FTE) basis was $8.112 million for the three months ended June 30, 2001, down $721,000 from the $8.833 million for the same period in 2001. The Company's net interest margin declined 43 basis points (bp), from 3.92% for the three months ended June 30, 2000 to 3.49% for the same period in 2001. For the six months ended June 30, 2001, the Company's net interest margin was 3.54%, down 42 bp from the 3.96% for the same period in 2000. The decline in the Company's net interest margin for the three months ended June 30, 2001 can be attributed to earning assets re-pricing faster than interest-bearing liabilities during the period which experienced a 125 bp reduction in the Federal Reserve Bank's short-term interest rate coupled with a 150 bp reduction for the three months ended March 31, 2001. The Company's yield on earning assets was 7.38% for the three months ended June 30, 2001, a decrease of 20 bp when compared to a yield of 7.58% for the six months ended June 30, 2001. Meanwhile, the Company's rate paid on interest-bearing liabilities decreased 17 bp from 4.59% for the six months ended June 30, 2001 compared to 4.42% for the three months ended June 30, 2001. The primary reason for earning assets re-pricing faster than interest-bearing liabilities is due to approximately $185 million in variable rate loans and $51 million in variable rate taxable securities re-pricing in a rapidly decreasing interest rate environment during the first six months of 2001. Additionally, $32.876 million in taxable securities were called during the first six months of 2001 and re-invested at lower interest rates. These factors coupled with an increase in cashflow from normal loan and investment repayments and re-financing due to a low interest rate environment resulted in interest earning assets re-pricing faster than interest-bearing liabilities during the three months ended June 30, 2001. The Company anticipates an increase in its net interest margin in the near term due to several factors. First, a portion of variable rate loans that re-priced during the six months ended June 30, 2001 re-price on an annual basis. Any further decline in interest rates would not result in an immediate decrease in yield received on these loans. Furthermore, the Company expects to see a continued decline in its cost of interest-bearing liabilities due to maturities of higher costing time deposits that will likely be re-priced at lower interest rates. For more information regarding the Company's net interest income, refer to the section in Management's Discussion and Analysis highlighted as "Net Interest Income" and the table of "Average Balances/Net Interest Margin." The provision for loan and lease losses was $360,000 for the three months ended June 30, 2001, up $40,000 from the $320,000 provided in the same period in 2000. For the six months ended June 30, 2001, the provision for loan and lease losses was $620,000, down $120,000 from the $740,000 provided in the same period in 2000. The primary reason for the decrease in the provision for loan and lease losses for the six months ended June 30, 2001 when compared to the same period in 2000 is a result of a decrease in net charge-offs on loans and leases. Net charge-offs on loans and leases for the six months ended June 30, 2001 were $330,000, down from the $533,000 charged-off in the same period in 2000. Additionally, non-performing loans have remained relatively stable, totaling $5.047 million at June 30, 2001, or 0.92% of total loans compared to $5.178 million at June 30, 2000, or 1.04% of total loans. 16 17 The following table summarizes non-interest income and details the components of net gain (loss) on securities transactions for the periods indicated:

Total non-interest income increased $889,000, from $566,000 for the three months ended June 30, 2000 to $1.455 million for the same period in 2001. Net gains on securities transactions increased $869,000, from a net loss of $645,000 for the three months ended June 30, 2000 to a net gain of $224,000 for the same period in 2001. The net loss on securities transactions for the three months ended June 30, 2000 was due primarily to a write-down of a corporate debt security amounting to $720,000 (pre-tax). Excluding the security write-down, non-interest income increased $169,000 for the three months ended June 30, 2001 when compared to the same period in 2000. Service charges on deposit accounts increased $115,000 (17.9%) for the three months ended June 30, 2001, totaling $759,000 as compared to $644,000 for the same period in 2000. The increase in service charges on deposit accounts is primarily a result of an increase in the number of transaction accounts serviced by the Company (due mainly to branch expansion activity) coupled with an increase in April 2001 in fees charged for certain services provided by the Company. Net gains on securities transactions (excluding a write-down of a corporate debt security) increased $149,000, from $75,000 for the three months ended June 30, 2000 to $224,000 for the same period in 2001. Included in net gain on securities transactions is $86,000 in unrealized gains on trading securities and $141,000 in unrealized losses on equity-linked indexed bonds and deposits for the three months ended June 30, 2001. Other income amounted to $472,000 for the three months ended June 30, 2001, down $95,000 from the $567,000 recognized in the same period of 2000. The primary reason for the decrease in other income is a result of the sale of the Company's merchant card processing business that resulted in a net gain of $82,000 during the three months ended June 30, 2000. Additionally, the Company recognized $76,000 in merchant card processing revenue during the three months ended June 30, 2000 compared to $0 for the same period in 2001. Offsetting these decreases were increases in mortgage banking activities of $37,000 and increases in title insurance commissions of $21,000. Total non-interest income increased $1.233 million, from $1.967 million for the six months ended June 30, 2000 to $3.200 million for the same period in 2001. Total non-interest income for the six months ended June 30, 2001 increased $513,000, excluding the security write-down mentioned above. Net gains on securities transactions were $864,000 for the six months ended June 30, 2001, up $470,000 from the $394,000 recognized during the same period in 2000 (excluding a write-down of a corporate debt security). Included in net gain on securities transactions for the six months ended June 30, 2001 is $327,000 in net unrealized gains on trading securities. 17 18 Service charges on deposit accounts increased 13.7%, from $1.224 million for the six months ended June 30, 2000 to $1.392 for the same period in 2001. The increase in service charges on deposit accounts is primarily a result of an increase in the number of transaction accounts serviced by the Company (due mainly to branch expansion activity) coupled with an increase in April 2001 in fees charged for certain services provided by the Company. Other income decreased $125,000, from $1.069 million for the six months ended June 30, 2000 to $944,000 for the same period in 2001. The decrease in other income resulted primarily from the sale of the Company's merchant card processing business, which resulted in a net gain of $82,000 during the quarter ended June 30, 2000. Merchant card processing revenues for the six months ended June 30, 2000 were $151,000. In addition, fiduciary and asset management revenues decreased $36,000 for the six months ended June 30, 2001 when compared to the same period in 2000. Offsetting these other income items were increases in title insurance commissions (the Company began offering this service to mortgage customers in the first quarter of 2000) of $45,000, and an increase in mortgage banking activities of $77,000. Non-interest expenses increased $99,000, from $6.282 million for the three months ended June 30, 2000 to $6.381 million for the same period in 2001. Salaries and employee benefits totaled $2.398 million for the three months ended June 30, 2001, up $93,000 from the same period in 2000. The increase in salaries and benefits can be primarily attributed to a $122,000 increase in salaries and a $70,000 increase in pension expense due primarily to the branch expansion activity in 2000 and the hiring of key officers in the fourth quarter of 2000 and first quarter of 2001. Partially offsetting this increase was a $115,000 decrease in incentive compensation. Occupancy and equipment increased from $700,000 for the three months ended June 30, 2000 to $798,000 for the same period in 2001. The increase in occupancy and equipment is primarily attributed to the opening of two new branches that occurred in February and August of 2000. Data processing increased from $610,000 for the three months ended June 30, 2000 to $678,000 for the same period in 2001. The increase in data processing can be attributed to increased core processing costs and maintenance expenses on systems and equipment. Professional fees amounted to $326,000 for the three months ended June 30, 2001, an increase of $148,000 when compared to the same period in 2000. The increase in professional fees is due primarily to legal costs related to non-accrual loans. Advertising and marketing decreased $118,000 during the three months ended June, 2001 when compared to the same period in 2000 due primarily to marketing campaigns the Company deployed in newly entered markets in the first half of 2000. Capital securities expense decreased $59,000 during the three months ended June, 2001 when compared to the same period in 2000 due to a decrease in the floating rate index (which resets quarterly) the capital securities are tied to. Other expenses decreased from $957,000 for the three months ended June 30, 2000 to $792,000 for the same period in 2001. The decrease in other expenses is due to several factors. Expenses related to the merchant card processing business, which was sold during the three months ended June 30, 2000, totaled $60,000 for the same period. Correspondent bank service charges decreased $37,000 during the three months ended June 30, 2001 when compared to the same period in 2000, due to measures taken to reduce check clearing expenses. Lastly, there was a decrease in residual losses on the sale of terminated leased vehicles amounting to $40,000. A charge of $595,000 was taken to increase the reserve for residual losses on auto leases in the fourth quarter of 2000. The 18 19 provision for residual losses on auto leases in the fourth quarter reflected weak business conditions in the used automobile market which management believes has resulted in a decline in residual values that is other-than-temporary. Management concluded as of June 30, 2001, that the reserve for residual losses on auto leases is adequate, and the estimated other-than-temporary impairment of lease residual values has been appropriately recorded. While management uses available information with respect to estimating the necessary level of reserve, changes in economic and market conditions and other factors may occur that would result in additional estimated other-than-temporary impairment on lease residual values. Non-interest expenses increased $20,000 from $12.823 million for the six months ended June 30, 2000 to $12.843 million for the same period in 2001. Salaries and employee benefits totaled $5.064 million for the three months ended June 30, 2001, up $82,000 from the same period in 2000. The increase in salaries and benefits can be primarily attributed to a $239,000 increase in salaries and a $145,000 increase in pension expense due primarily to the branch expansion activity in 2000 and the hiring of key officers in the fourth quarter of 2000 and first quarter of 2001. Partially offsetting this increase was a $135,000 decrease in incentive compensation and an increase in loan origination activity, as salaries and benefits deferrals associated with loan origination activity increased $168,000 for the six months ended June 30, 2001 when compared to the same period in 2000. Occupancy and equipment increased from $1.427 million for the six months ended June 30, 2000 to $1.609 million for the same period in 2001. The increase in occupancy and equipment is primarily attributed to the opening of two new branches that occurred in February and August of 2000 and an increase in property tax expense related to the Company's corporate headquarters. Data processing increased from $1.231 million for the six months ended June 30, 2000 to $1.392 million for the same period in 2001. The increase in data processing can be attributed to increased core processing costs and maintenance expenses on systems and equipment. Professional fees amounted to $515,000 for the six months ended June 30, 2001, an increase of $125,000 when compared to the same period in 2000. The increase in professional fees is due primarily to legal costs related to non-accrual loans. Advertising and marketing decreased $177,000 during the six months ended June, 2001 when compared to the same period in 2000 due primarily to marketing campaigns the Company deployed in newly entered markets in the first half of 2000. Other real estate owned and repossessed assets expense decreased $133,000 for the six months ended June 30, 2001 when compared to the same period in 2000, due primarily to a $42,000 decrease in net losses on sales and write-downs of other real estate owned and repossessed assets and a $54,000 decrease in repossession expenses for manufactured homes. Other expenses decreased from $1.805 million for the six months ended June 30, 2000 to $1.570 million for the same period in 2001. The decrease in other expenses is due to several factors. Expenses related to the merchant card processing business, which was sold during the six months ended June 30, 2000, totaled $62,000 for the same period. Correspondent bank service charges decreased $52,000 during the six months ended June 30, 2001 when compared to the same period in 2000, due to measures taken to reduce check clearing expenses. Lastly, there was a decrease in residual losses on the sale of terminated leased vehicles amounting to $87,000. 19 20 Income tax expense was $824,000 for the three months ended June 30, 2001, up $141,000 from the $683,000 recognized in the same period in 2000. The effective tax rate for the three months ended June 30, 2001 and 2000 was 30.6% and 26.3%, respectively. Income tax expense was $1.672 million for the six months ended June 30, 2001, up $206,000 from the $1.466 million recognized for the same period in 2000. The effective tax rate for the six months ended June 30, 2001 and 2000 was 29.6% and 26.4%, respectively. The increase in the Company's effective tax rate for the three and six months ended June 30, 2001 resulted from the decrease in tax-exempt securities the Company maintained in its securities available for sale portfolio. NET INTEREST INCOME (The accompanying schedule entitled "Average Balances/Net Interest Margin - Fully Taxable Equivalent Basis (FTE)" is the basis of and should be read in conjunction with this discussion). Net Interest Income FTE Basis Earning Assets Total average earning assets increased $28.576 million, from $900.636 million for the three months ended June 30, 2000 to $929.212 million for the same period in 2001. Average loan and leases receivable increased $50.469 million (10.4%), from $486.963 million for the three months ended June 30, 2000 to $537.432 million for the same period in 2001. Offsetting this increase in average loan and leases receivable were decreases in average taxable securities of $12.945 million and average tax-exempt securities of $10.049 million during the three months ended June 30, 2001 when compared to the same period in 2000. The yield on average earning assets decreased 53 and 41 basis points (bp), from 7.91% for the three months ended June 30, 2000 and from 7.79% for the three months ended March 31, 2001, respectively, to 7.38% for the three months ended June 30, 2001. The decrease in yield on average earning assets resulted primarily from a decrease in yield on average taxable securities of 70 and 40 bp and average loans and leases receivable of 42 and 36 bp, which represent 38% and 58% of average earning assets for the three months ended June 30, 2001, respectively, when compared to the yield of these earning assets for three months ended June 30, 2000 and March 31, 2001, respectively. Loans and leases receivable Average loans and leases receivable increased $50.469 million (10.4%), from $486.963 million for the three months ended June 30, 2000 to $537.432 million for the same period in 2001. The yield earned on average loans and lease decreased 42 bp, from 8.28% for the three months ended June 30, 2000 to 7.86% for the same period in 2001. Average loans secured by real estate increased $42.783 million (14.7%), from $220.336 million for the three months ended June 30, 2000 to $263.119 million for the same period in 2001. The yield on average loans secured by real estate decreased 33 bp, from 8.41% for the three months ended June 30, 2000 to 8.08% for the same period in 2001. Average loans secured by one-to-four family real 20 21 estate increased $20.014 million (22.2%), from $90.084 million for the three months ended June 30, 2000 to $110.098 million for the same period in 2001. The decrease in yield on loans secured by one-to-four family real estate can be attributed to the rapid decrease in interest rates, which occurred during the first six months of 2001. The decrease in interest rates resulted in adjustable rate loans secured by one-to-four family real estate, which comprises 30.6% of total loans secured by one-to-four family real estate, re-pricing at lower rates and an increase in higher yielding fixed rate loans secured by one-to-four family real estate re-financing at lower rates. The increase in average one-to-four family real estate loans can be primarily attributed to the Company's market expansion and efforts to grow the product through an increase in mortgage originators. An additional factor contributing to the increase in average one-to-four family real estate loans was a new adjustable rate mortgage product the Company offered in 2000 which is competitive in a rising interest rate environment. The Company maintains adjustable rate mortgage products in its loan portfolio. The Company anticipates an increase in its one-to-four family real estate loan origination volume in the near term. However, due to the current low interest rate environment, the Company anticipates a majority of the volume will be fixed rate mortgage products that will be sold on the secondary market limiting growth in average one-to-four family real estate loans. Average commercial real estate loans increased $16.712 million, from $85.249 million for the three months ended June 30, 2000 to $101.961 million for the same period in 2001. The yield on commercial real estate loans decreased 22 bp, from 8.76% for the three months ended June 30, 2000 to 8.54% for the same period in 2001. Other loans increased $7.686 million, from $266.627 million for the three months ended June 30, 2000 to $274.313 million for the same period in 2001. The yield on other loans decreased 57 bp, from 8.22% for the three months ended June 30, 2000 to 7.65% for the same period in 2001. Average consumer loans, which are comprised mainly of new and used automobiles, increased $8.523 million, from $69.550 million for the three months ended June 30, 2000 to $78.073 million for the same period in 2001. The yield on consumer loans decreased 29 basis points, from 8.28% for the three months ended June 30, 2000 to 7.99% for the same period in 2001. Average lease receivables, which are comprised of automobile leases, increased $2.774 million, from $76.371 million for the three months ended June 30, 2000 to $79.145 million for the same period in 2001. The yield on lease receivables decreased 25 basis points, from 6.86% for the three months ended June 30, 2000 to 6.61% for the same period in 2001. The decrease in yield on consumer loans and lease receivables is due primarily to a combination of the Company's focus on limiting its credit risk and originating consumer loans with higher credit quality, which results in lower rates and a rapid decrease in interest rates during the first six months of 2001. Commercial loans increased $5.407 million, from $40.827 million for the three months ended June 30, 2000 to $46.234 million for the same period in 2001. The yield on commercial loans decreased 239 bp, from 9.80% for the three months ended June 30, 2000 to 7.41% for the same period in 2001. The decrease in yield on commercial loans is due primarily to 72.9% of the commercial loan portfolio comprised of variable rate loans that have re-pricing frequencies tied to the Prime rate which generally moves with changes in Federal Reserve Bank discount rate which has decreased 275 basis points since January 1, 2001. 21 22 Securities Average taxable securities decreased $12.945 million, from $367.381 million for the three months ended June 30, 2000 to $354.436 million for the same period in 2001. The decrease in average taxable securities resulted primarily from US agency securities, decreasing $33.987 million, from $78.782 million for the three months ended June 30, 2000 to $44.795 million for the same period in 2001. The decrease in US agency securities resulted from callable US agency securities that were called during the first six months of 2001. Offsetting the decrease in US agency securities was an increase in collateralized mortgage obligations (CMOs) and asset-backed securities (ABS) of $21.120 million. CMOs and ABS averaged $176.067 million during the three months ended June 30, 2001. The yield on taxable securities decreased from 7.53% for the three months ended June 30, 2000 to 6.83% for the same period in 2001. The decrease in yield during the periods resulted primarily from US agency securities and collateralized mortgage obligations (CMOs). The yield on US agency securities and CMOs decreased from 7.77% and 7.61% for the three months ended June 30, 2000 to 6.89% and 7.01%, respectively, for the same period in 2001. The decrease in yield on US agency securities resulted primarily from callable US agency securities that were called during the first six months of 2001 due to falling interest rates. The decrease in yield from CMOs resulted primarily from $51.176 million in adjustable rate CMOs tied to short-term interest rate indexes, which decreased during the first six months of 2001 due to falling interest rates. Funding Sources The Company utilizes deposit products such as time, savings, N.O.W. and money market deposits as its primary source for funding. Other sources such as short-term and long-term borrowings are utilized as necessary to support the Company's growth in assets and to achieve interest rate sensitivity objectives. The average balance of interest-bearing liabilities increased to $815.861 million for the three months ended June 30, 2001 from $793.771 million for the same period in 2000. The average rate paid on interest-bearing liabilities decreased 10 bp, from 4.52% for the three months ended June 30, 2000 to 4.42% for the same period in 2001. The slight decrease in the rate paid for interest-bearing liabilities can be attributed to an increase in short-term interest rates in 2000. Due to the Federal Reserve Board's recent action decreasing short-term interest rates, the Company anticipates a decrease in its cost of funds in the near-term. This can be seen in the decrease in the average rate paid on interest-bearing liabilities, from 4.77% for the three months ended March 31, 2001 to 4.42% for the three months ended June 30, 2001. Deposits The average balance of time deposits less than $100,000 increased to $280.561 million for the three months ended June 30, 2001 from $275.593 million for the same period in 2000. The rate paid on time deposits less than $100,000 increased 78 bp, to 5.79% for the three months ended June 30, 2001 from 5.01% for the same period in 2000. The increase in the rate paid on time deposits less than $100,000 resulted from time deposits, which typically have terms of 6 months to 2 years, originating or renewing in a rising rate 22 23 environment in 2000. Asset/liability analysis performed by the Company indicates segments of the time deposit portfolio will mature in future periods at lower rates, resulting in a lower cost of funds. This is evidenced by the decrease in the rate paid on time deposits less than $100,000, from 5.94% for the three months ended March 31, 2001 to 5.79% for the three months ended June 30, 2001. Time deposits greater than $100,000, which are primarily comprised of deposits from municipalities and school districts, increased $10.293 million, from $170.309 million for the three months ended June 30, 2000, to $180.602 million for the same period in 2001. The rate paid on time deposits greater than $100,000 decreased 76 bp, from 6.18% for the three months ended June 30, 2000 to 5.42% for the same period in 2001. Time deposits greater than $100,000 are very sensitive to changes in short-term interest rates as the terms on these deposits are generally less than six months. The decrease in its rate paid on these deposits is due to the decrease in short-term interest rates during the first six months of 2001. Short-Term Borrowings The average balance of short-term borrowings was $35.512 million for the three months ended June 30, 2001, up from $31.847 million for the same period in 2000. The rate paid on short-term borrowings decreased 184 basis points during the three months ended June 30, 2001 when compared to the same period in 2000. The decrease in the rate paid on short-term borrowings is due to the decrease in short-term interest rates during the first six months of 2001. AVERAGE BALANCES/NET INTEREST MARGIN - FULLY TAXABLE EQUIVALENT (FTE) BASIS The following table sets forth average balance and interest rate information. The average balances used for these tables and other statistical disclosures were calculated using daily averages. Tax exempt income has been adjusted to a tax equivalent basis by tax effecting such income at the Federal tax rate. Non-accruing loans have been included in loans with interest earned recognized on a cash basis only. Securities include securities available for sale, investment securities held to maturity, and trading securities, if any, all at amortized cost. 23 24

24 25

25 26 FINANCIAL CONDITION AND LIQUIDITY The Company's total assets at June 30, 2001 were $992.601 million, an increase of $41.261 million (8.7% annual rate of increase) when compared to December 31, 2000. The increase was primarily in securities available for sale of $22.657 million, net loans and leases receivable of $13.493 million, and trading securities of $9.550 million. Total deposits increased $39.671 million and short-term borrowings decreased $1.734 million. Stockholders' equity increased $2.648 million, due to earnings retention of $2.540 million, and an increase in accumulated other comprehensive income of $817,000, offset by treasury stock purchases of $709,000. SECURITIES The Company's investment policy focuses investment decisions on maintaining a balance of high quality, diversified investments. In making its investment decisions, the Company also considers liquidity, collateral to be used for pledging purposes, tax position, and maximum overall returns. Under the Company's investment policy, securities eligible for the Company to purchase include: U.S. Government securities, U.S. Agency securities, mortgaged-backed securities, collateralized mortgage obligations (CMO), municipal securities, corporate debt obligations (including equity-linked securities), bankers acceptances, certificates of deposit, commercial paper, and asset-backed securities. The following table represents the composition of the Company's securities available for sale portfolio in dollar amounts and percentages at the dates indicated:

26 27

(1) Includes the fair value of the embedded derivatives. See Note 3 to the Unaudited Consolidated Interim Financial Statements. CMOs and asset-backed securities increased $25.744 million from December 31, 2000, and represent 45.2% of the securities available for sale ("SAFS") portfolio at June 30, 2001. The weighted-average life and weighted-average rate of CMOs and asset-backed securities was 3.1 years and 6.12%, respectively, at June 30, 2001. Mortgage-backed securities ("MBS") decreased $1.020 million from December 31, 2000, and represent 9.5% of the SAFS portfolio at June 30, 2001. The weighted-average life and weighted-average rate of the MBS was 5.1 years and 6.97%, respectively, at June 30, 2001. If interest rates continue to decrease, the Company anticipates that the weighted-average lives of CMOs and MBS will decrease and the fair value of the securities will increase. Alternatively, if interest rates rise, the Company anticipates that the weighted-average lives of CMOs and MBS will increase and the fair value of the securities will decrease. Corporate and taxable municipal debt securities remained relatively unchanged from December 31, 2000, and represent 17.6% of SAFS at June 30, 2001. The weighted-average life and weighted-average rate of the corporate and taxable municipal debt portfolio was 6.7 years and 7.29%, respectively, at June 30, 2001. Included in corporate debt securities are two corporate obligations that management believes are other-than-temporarily impaired. For the years ended December 31, 2000 and 1999, the Company wrote-down these corporate debt securities a total of $2.056 million and $1.392 million, respectively. No such write-downs were taken during the six months ended June 30, 2001. The remaining carrying value of the two corporate obligations is $1.354 million at June 30, 2001, which management will continue to monitor for additional other-than-temporary impairment. 27 28 U.S. government agency securities decreased $23.558 million from December 31, 2000, and represents 12.0% of SAFS at June 30, 2001. The weighted-average life and weighted-average rate of U.S. agency securities was 9.3 years and 6.82%, respectively, at June 30, 2001. The decrease in U.S. agency securities resulted primarily from a substantial number of these securities having call features, and in a decreasing interest rate environment, these securities were called. State and municipal obligations increased $25.402 million from December 31, 2000, and represents 10.9% of SAFS at June 30, 2001. The weighted-average life and weighted-average tax-equivalent rate of state and municipal obligations was 10.1 years and 5.85%, respectively, at June 30, 2001. LOANS AND LEASES Net loans and leases receivable increased $13.493 million from $524.967 million at December 31, 2000 to $538.460 million at June 30, 2001. The following schedule details the Company's loan and lease portfolio:

Loans secured by residential real estate increased $10.373 million, from $104.430 million at December 31, 2000 to $114.803 million at June 30, 2001. The Company anticipates that its residential real estate activity will continue to increase. In light of this anticipated increase in residential real estate activity and as part of its asset/liability management strategy, the Company sells most of its fixed rate residential real estate loans on the secondary market, and retains servicing rights on the majority of the loans it sells. The Company's residential real estate servicing portfolio increased $6.803 million, from $15.371 million at December 31, 2000 to $22.174 million at June 30, 2001. Commercial real estate loans increased $3.210 million, from $100.769 million at December 31, 2000 to $103.979 million at June 30, 2001. 28 29 Lease receivables decreased $1.738 million, from $88.874 million at December 31, 2000 to $87.136 million at June 30, 2001. Lease receivables are secured by automobiles and sport utility vehicles and generally have terms ranging from three to five years. Consumer loans remained relatively unchanged, totaling $76.219 million at December 31, 2000, as compared to $76.475 million at June 30, 2001. Consumer loans are primarily comprised of automobile loans. The decrease in lease receivables and the stagnant growth in consumer loans is primarily due to the slow down in economy resulting in a decrease in demand for automobiles. The Company anticipates maintaining the level consumer loans and lease receivables it has outstanding for the remainder of the year. If economic conditions improve and demand increases for automobiles, consumer loans and lease receivables may experience growth. The Company will continue to focus its efforts in growth related to residential real estate, and the commercial real estate/commercial loan portfolios. DEPOSITS Total deposits increased $39.671 million, from $799.938 million at December 31, 2000 to $839.609 million at June 30, 2001. The following schedule details the Company's deposit liabilities:

The Company's primary source of funds is deposits. The Company offers deposit accounts having a range of interest rates and terms. The Company offers transaction accounts, savings accounts, money market accounts, N.O.W. accounts, and certificate of deposit accounts with various terms. The Company only solicits deposits from its primary market area and depositors include individuals, local governments and businesses. The flow of deposits is influenced significantly by general economic conditions, changes in prevailing interest rates, and competition. The variety of deposit accounts offered by the Company has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. The Company manages the pricing of its deposits in keeping with its asset/liability management, liquidity and profitability objectives. Based on experience, the Company believes that its transaction accounts, savings accounts and money market accounts are relatively stable sources of deposits. However, the ability of the Company to attract and maintain certificates of deposits, as well as the rates paid on those deposits, has been and will continue to be significantly affected by market conditions. 29 30 BORROWINGS Although deposits are the Company's primary source of funds, the Company utilizes security repurchase agreements and other borrowings as a funding source. The Company regularly has security repurchase agreements with several customers in the ordinary course of business. For liquidity management, lines of credit have also been established with correspondent banks to meet short-term funding needs. At June 30, 2001, the Company had short-term borrowings with the Federal Home Loan Bank of New York (FHLB) amounting to $30.970 million and short-term repurchase agreements totaling $19.349 million. The Company has $961,000 in long-term borrowings with the FHLB at June 30, 2001. This FHLB borrowing bears interest at 5.45%, amortizes monthly and matures in 2003. In 1995 and 1996, the Company issued Industrial Revenue Bonds to fund the construction of its administrative and operations complex. As of June 30, 2001, the remaining balance on the bonds was $4.424 million and bears interest at a variable interest rate, which adjusts weekly, based on a commercial paper rate index. The bonds have annual principal payments due through 2025. NON-PERFORMING ASSETS Non-performing assets are summarized in the following table:

Non-accrual loans at June 30, 2001 were comprised of $1.472 million of commercial/commercial real estate loans, $2.083 million of agricultural loans, $475,000 of residential real estate, and $318,000 of manufactured housing loans, and $84,000 of home equity and other loans. Loans past due 90 days or more and still accruing were comprised mainly of manufactured housing loans at June 30, 2001. 30 31 The remaining carrying value of the two impaired corporate debt obligations is $1.354 million at June 30, 2001. These debt securities, which are not actively traded, are monitored closely by management and at this time, management does not believe any additional write-down is required. However, if adverse conditions continue or worsen, additional write-downs may be necessary. Subsequent to June 30, 2001, a corporate debt security with a carrying amount of $955,000 the Company held was downgraded by Moody's from Caa to Ca, and the issuer of the corporate debt security announced the suspension of interest payments on their debt and their intention to pursue a consensual restructuring of its unsecured debt with its bondholders. Based on the information noted above, the Company placed the corporate debt security on non-accrual status. The actions taken by the issuer of the corporate debt security are monitored closely by management. If adverse conditions continue or worsen, the corporate debt security may be determined to be other-than-temporarily impaired and subject to a write-down. Gross charge-offs for six months ended June 30, 2001 amounted to $500,000. Charge-offs were mainly comprised of consumer/manufactured housing loans amounting to $339,000 and lease receivables of $100,000. Recoveries for the six months ended June 30, 2001 amounted to $170,000. Provisions for loan and lease losses amounted to $620,000 for the six months ended June 30, 2001. The allowance for loan and lease losses increased $290,000 from $8.145 million at December 31, 2000 to $8.435 million at June 30, 2001. The allowance for loan and lease losses represents management's estimate of an amount adequate to provide for probable losses inherent in the loan and lease portfolio. In its continuing evaluation of the allowance and its adequacy, management considers the Company's loan and lease loss experience, the amount of past-due and non-performing loans, current economic conditions, underlying collateral values securing loans and other factors which affect the allowance for loan and lease losses. LIQUIDITY AND CAPITAL RESOURCES Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the ability to meet the day-to-day cash flow requirements of our customers, whether they be depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Asset and liability management functions not only to assure adequate liquidity in order to meet the needs of our customers, but also to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities in order to generate an appropriate return to stockholders. In the banking environment, both assets and liabilities are considered sources of liquidity funding and both are monitored on a daily basis. The asset portion of the balance sheet provides liquidity primarily through loans, mortgage-backed security and collateralized mortgage obligation principal repayments, maturities and calls of securities and sales from the available for sale and trading portfolios. Management closely monitors the timing of cash inflows and outflows although changes in interest rates, economic conditions and competitive forces strongly impact the predictability of these cash flows. The Company attempts to provide stable and flexible sources of funding through its branch network as well as with limited use of borrowings. Management believes that the level of the Company's liquid assets combined with daily 31 32 monitoring of cash inflows and outflows provide adequate liquidity to fund outstanding loan commitments, meet daily withdrawal requirements of depositors, and meet all other daily obligations of the Company. The Company and its bank subsidiary are currently subject to two sets of regulatory capital measures, a leverage ratio test and risk-based capital guidelines. The risk-based guidelines assign weightings to all assets and certain off-balance sheet items and establish an 8% minimum ratio of qualified total capital to risk-weighted assets. At least half of total capital must consist of "Tier 1" capital, which comprises common equity, retained earnings and a limited amount of minority interest in consolidated subsidiaries (subordinated debt), less goodwill. Up to half of total capital may consist of so-called "Tier 2" capital, comprising a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of the allowance for loan and lease losses. The leverage ratio test establishes minimum limits on the ratio of Tier 1 capital to total tangible assets, without risk weighting. For top-rated companies, the minimum leverage ratio is 4%, but lower-rated or rapidly expanding companies may be required to meet substantially higher minimum leverage ratios. The FDIC Improvement Act of 1991 ("FDICIA") mandated actions to be taken by banking regulators for financial institutions that are undercapitalized as measured by these ratios. FDICIA established five levels of capitalization for financial institutions ranging from "critically undercapitalized" to "well-capitalized." As of June 30, 2001, the Tier 1 leverage and risk-based capital ratios for the Company and its bank subsidiary were as follows: Summary of Capital Ratios

All capital ratios for the Company and its subsidiary bank at June 30, 2001 were above minimum capital standards for financial institutions. Additionally, the Company and its subsidiary bank capital ratios at that date were above FDICIA's "well-capitalized" standard. Total stockholders' equity amounted to $65.794 million at June 30, 2001, which is a $2.648 million increase from the $63.146 million at December 31, 2000. The increase resulted primarily from earnings retention of $2.540 million, an increase in accumulated other comprehensive income of $817,000, offset by treasury stock repurchases of $709,000. 32 33 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity risk, do not arise in the normal course of the Company's business activities. Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company's net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or re-price on a different basis than earning assets. When interest-bearing liabilities mature or re-price more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income. An important element of both earnings performance and liquidity is management of interest rate sensitivity. Interest rate sensitivity management involves comparison between the maturity and re-pricing dates of earning assets and interest-bearing liabilities, with the goal being to minimize the impact on net interest income in periods of extreme fluctuations in interest rates. Quarterly, the change in net interest income, as well as several other strategic measurement ratios, are presented to the Company's Asset/Liability Committee (ALCO) and Board of Directors and compared to Company-established guidelines. The Company consistently maintains the ratios within the acceptable ranges of the guidelines established. On a weekly basis, the ALCO, which is comprised of Senior Management, meets to monitor the interest rate sensitivity and liquidity position. The ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a one-year period, it also utilizes additional tools to monitor longer-term interest rate risk. The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all earning assets and interest-bearing liabilities reflected on the Company's balance sheet. This sensitivity analysis is compared to ALCO policy limits which specify a maximum tolerance level for net interest income exposure over a one year horizon, assuming no balance sheet growth, a 200 basis point upward and downward shift in interest rates, and the use of convexity factors which estimate the change in interest rate risk caused by changes in the Company's structure in response to the rate change. As of June 30, 2001, under this analysis, a 200 basis point increase in interest rates would result in a $2.008 million decrease (6.2%) in annual net interest income and a 200 basis point decrease in interest rates would result in a $986,000 increase (3.1%) in annual net interest income. These amounts were within the Company's ALCO policy limits. 33 34 Interest rate risk analyses performed by the Company indicate that the Company is liability sensitive, or its interest-bearing liabilities re-price more quickly than its earning assets. As a result, rising interest rates could result in a decrease in net interest income. The Company has taken steps to manage its interest rate risk by attempting to match the re-pricing periods of earning assets to its interest-bearing liabilities. The Company's current emphasis in growing loans with terms less than five years and selling long-term fixed rate loans are methods the Company has utilized to manage interest rate risk. Additionally, the Company will focus on growing its core deposit base which should be less volatile when rates change when compared to time deposits greater than $100,000 and short-term borrowings, which are more volatile when rates change due to their short-terms which typically range from 1 day to six months. Under a declining rate scenario, the analysis indicates that the Company's benefit from its miss-match in interest-bearing liabilities re-pricing more quickly than earning assets is mitigated due to the optionality of earning assets. The Company is asset sensitive in a rapidly declining rate environment, as earning assets would re-price faster than interest-bearing liabilities would re-price. Management makes certain assumptions in relation to prepayment speeds for loans, CMOs and mortgaged-backed securities, which would prepay much faster in a falling rate scenario. These assumptions are based on historical analyses and industry standards for prepayments. Management continuously evaluates various alternatives to address interest rate risk. The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps and floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. 34 35 CNB FINANCIAL CORP. PART II - OTHER INFORMATION Item 1 - Legal Proceedings No material changes since filing of the Registrant's Form 10-K for the year end December 31, 2000. Item 2 - Changes in Securities and Use of Proceeds None Item 3 - Defaults upon Senior Securities None Item 4 - Submission of Matters to a Vote of Security Holders On May 3, 2001, the Company held its annual meeting of shareholders. A vote was held pertaining to the re-election of continuing directors J. Carl Barbic and Donald L. Brass. The re-election of J. Carl Barbic who received 5,603,997 votes for re-election, with 40,630 votes withheld, and Donald L. Brass who received 5,590,049 votes for re-election, with 59,110 votes withheld, to serve on the board of directors of CNB Financia Corp. for terms expiring in 2004 was approved by the shareholders on May 3, 2001. Item 5 - Other Information None Item 6 - Exhibits and reports on Form 8-K (A) Exhibits

35 36 -------------------------------------------------------------------------------- S-4 (File No. 33-45522), filed on March 4, 1992, and subsequent amendments, Exhibits 4.2, 4.3 and 4.4 to Registrant's Form S-8, filed on November 3, 1998 (File No. 333-66721). -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 3.2 The Bylaws of Registrant filed herewith. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.1 Agreement of Merger by and between NBT Bank, National Association and Central National Bank, Canajoharie, dated as of June 29, 2001, incorporated by reference to Exhibit 10.1 to NBT's Registration Statement on Form S-4 (File No. 333-66472), filed on August 1, 2001. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.2 Stock Option Agreement, dated as of June 19, 2001, by and between NBT Bancorp Inc. and Registrant, incorporated by reference to Exhibit III to Exhibit 2.1 to NBT's Form 8-K (File No. 000-14703), filed on June 22, 2001. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.3 Senior Executive Severance Agreement between Registrant and Donald L. Brass, dated as of January 1, 2001, incorporated by reference to Exhibit 10.4 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.4 Senior Executive Severance Agreement between Registrant and Peter J. Corso, dated as of January 1, 2001, incorporated by reference to Exhibit 10.5 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.5 Senior Executive Severance Agreement between Registrant and Michael Hewitt, dated as of January 1, 2001, incorporated by reference to Exhibit 10.6 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.6 Service and Non-Competition Agreement between NBT, Registrant, and Donald L. Brass, dated as of June 19, 2001, incorporated by reference to Exhibit 10.7 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.7 Supplemental Retirement Annuity Agreement between Registrant and Donald L. Brass, dated as of May 15, 2000, incorporated by reference to Exhibit 10.1 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.8 Supplemental Retirement Annuity Agreement between Registrant and Peter J. Corso, dated as of May 15, 2000, incorporated by reference to Exhibit 10.2 to Registrant's --------------------------------------------------------------------------------

36 37 -------------------------------------------------------------------------------- Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.9 Automatic Dividend Reinvestment and Stock Purchase Plan of Registrant, incorporated by reference to Registrant's Registration Statement on Form S-3 (File No. 33-63176), filed on May 21, 1993. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.10 Trust for Deferred Compensation Plan for Certain Executive Employees and Directors of Central National Bank, Canajoharie, dated as of March 21, 1997, filed herewith.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 99.1 Form of Voting Agreement dated as of June 19, 2001, by and between NBT Bancorp Inc. and certain directors and executive officers of Registrant, incorporated by reference to Exhibit IV of Exhibit 2.1 to NBT's Form 8-K (File No. 000-14703), filed on June 22, 2001. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 99.2 CNB Financial Corp. 401(K) Plan, incorporated by reference to Exhibit 99.1 to the Company's Form S-8 (File No. 333-54844), filed on February 2, 2001. -------------------------------------------------------------------------------- * Compensatory plan or arrangement. (B) Current Reports filed on Form 8-K - June 19, 2001, related to the announcement of entering into a definitive Agreement and Plan of Merger with NBT Bancorp, Inc. 37 38 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CNB FINANCIAL CORP. Registrant Date: August 14, 2001 By: /s/DONALD L. BRASS ----------------------- -------------------- Donald L. Brass President Date: August 14, 2001 By: /s/ PETER J. CORSO ----------------------- -------------------- Peter J. Corso Executive Vice President 38 39 INDEX TO EXHIBITS The following documents are attached as Exhibits to this Form 10-Q or are incorporated by reference as Exhibits as indicated by the exhibit cross-reference to the prior filings of the Registrant with the Commission.

39 40 -------------------------------------------------------------------------------- incorporated by reference to Exhibit 10.6 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.6 Service and Non-Competition Agreement between NBT, Registrant, and Donald L. Brass, dated as of June 19, 2001, incorporated by reference to Exhibit 10.7 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.7 Supplemental Retirement Annuity Agreement between Registrant and Donald L. Brass, dated as of May 15, 2000, incorporated by reference to Exhibit 10.1 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.8 Supplemental Retirement Annuity Agreement between Registrant and Peter J. Corso, dated as of May 15, 2000, incorporated by reference to Exhibit 10.2 to Registrant's Form 10-K/A (File No. 000-23730), filed on August 1, 2001.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.9 Automatic Dividend Reinvestment and Stock Purchase Plan of Registrant, incorporated by reference to Registrant's Registration Statement on Form S-3 (File No. 33-63176), filed on May 21, 1993. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 10.10 Trust for Deferred Compensation Plan for Certain Executive Employees and Directors of Central National Bank, Canajoharie, dated as of March 21, 1997, filed herewith.* -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 99.1 Form of Voting Agreement dated as of June 19, 2001, by and between NBT Bancorp Inc. and certain directors and executive officers of Registrant, incorporated by reference to Exhibit IV to Exhibit 2.1 to NBT's Form 8-K (File No. 000-14703), filed on June 22, 2001. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 99.2 CNB Financial Corp. 401(K) Plan, incorporated by reference to Exhibit 99.1 to the Company's Form S-8 (File No. 333-54844), filed on February 2, 2001. -------------------------------------------------------------------------------- * Compensatory plan or arrangement. 40

CNB FINANCIAL CORP /NY/ 10-Q