CHMG

Business Context and Reporting Period

Company: Chemung Financial Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: A financial holding company providing banking, financing, fiduciary, and investment services through its subsidiaries, Chemung Canal Trust Company and CFS Group, Inc. The company operates primarily in New York's Broome, Tioga, and Chemung counties.

Key Financial Metrics

Capital Ratios (as of Sept 30, 2008): Leverage Ratio: 8.57%; Tier 1 Capital: 11.90%; Total Risk-Based Capital: 13.57% (All exceed "well capitalized" requirements).

Material Changes vs. Prior Period

• Acquisitions: Significant growth driven by the March 2008 acquisition of three branches from Manufacturers and Traders Trust Company (M&T), adding $64.6 million in deposits and $12.6 million in loans. Also acquired Cascio Financial Strategies in May 2008.
• Profitability: Net income increased 11.7% in Q3 2008 and 20.3% YTD 2008 compared to prior year periods, driven by higher net interest income and non-interest income.
• Interest Rates: Net interest margin expanded 37 basis points in Q3 and 33 basis points YTD due to a significant decrease in the cost of interest-bearing liabilities (down 104 bps in Q3), partially offset by lower yields on earning assets.
• Asset Quality: Non-performing loans increased slightly to $3.77 million (from $3.57 million at year-end 2007), primarily due to an increase in accruing loans past due 90 days or more. The allowance for loan losses coverage ratio to non-performing loans was 231.6%.
• Securities Portfolio: Available-for-sale securities increased to $196.0 million, largely due to a leveraged purchase of mortgage-backed securities. Unrealized losses on the portfolio increased due to market credit spreads and illiquidity, though management deemed impairments temporary.

Guidance, Outlook, and Risks

• Strategic Decisions: Management decided to discontinue originating new student loans due to lower interest rates and higher costs. The company elected not to participate in the Treasury's TARP Capital Purchase Program, citing a strong capital position sufficient for strategic initiatives.
• Subsequent Events: Entered an agreement to sell merchant card processing assets to Elavon, Inc., expecting a pre-tax gain of approximately $460,000 in Q4 2008. This will reduce future non-interest income by ~$1.4 million but offset by similar expense reductions.
• Risk Factors:
  • Economic Conditions: High volatility in national and global credit markets poses risks to asset quality and market value of financial institutions.
  • Interest Rate Risk: A 200-basis point decrease in rates is estimated to negatively impact net interest income by 5.18% and market value of capital by 5.87% over the next 12 months.
  • Asset Quality: Management identified $10.8 million in potential problem loans (performing but with credit concerns). Deterioration in real estate values or economic conditions could require increased loan loss provisions.

Investor Verification Checklist

• Acquisition Integration: Verify the realization of synergies and deposit retention from the M&T branch acquisition.
• Loan Portfolio Quality: Monitor the $10.8 million in "potential problem loans" and the trend in accruing loans past due 90 days.
• Securities Valuation: Review the status of the $2.8 million in trust preferred securities with fair value below cost to ensure impairments remain temporary.
• Student Loan Strategy: Assess the impact of discontinuing student loan origination on future fee income and portfolio diversification.
• Merchant Card Sale: Confirm the timing and magnitude of the $460,000 gain and the net impact on operating expenses from the Elavon transaction.