CHMG

Business Context and Reporting Period

Company: Chemung Financial Corporation (Chemung Financial Corp)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Three months ended March 31, 2010

Business Overview: The Corporation operates through its wholly owned subsidiaries, Chemung Canal Trust Company and CFS Group, Inc., providing banking, financing, fiduciary, and investment services in its local market area. It is classified as a smaller reporting company.

Key Financial Metrics

Liquidity & Capital: The Corporation maintained a consolidated leverage ratio of 7.94%, with Tier I and Total Risk-Adjusted Capital ratios of 12.06% and 13.69%, respectively, exceeding "well capitalized" requirements. A $175.8 million line of credit was available with the Federal Home Loan Bank.

Material Changes vs. Prior Period

• Profitability: Net income increased by $266,000 (15.3%) compared to Q1 2009, driven primarily by higher net interest income and a reduced provision for loan losses.
• Net Interest Income: Increased by $820,000 (10.7%) due to a 13.5% increase in average earning assets and a 61 basis point decrease in the cost of interest-bearing liabilities. This was partially offset by a 55 basis point decrease in the yield on earning assets.
• Asset Quality: Non-performing loans decreased by $2.17 million to $11.63 million, largely due to a reclassification of a $2.01 million commercial loan to performing status. Net charge-offs decreased by $215,000.
• Loan Portfolio: Total loans decreased by $9.4 million (1.6%) from the prior quarter due to soft loan demand, with declines in consumer, residential, and commercial loan categories.
• Securities Portfolio: The available-for-sale portfolio increased by $36.3 million, driven by purchases of U.S. Treasury bonds and federal agency bonds.
• Operating Expenses: Increased by $260,000 (2.9%), primarily due to higher salaries, data processing costs, and FDIC insurance, partially offset by lower employee benefit costs and amortization of intangible assets.

Outlook, Risks, and Unusual Items

• Other-Than-Temporary Impairment (OTTI): The Corporation recognized $261,000 in OTTI losses on two pooled trust preferred securities (CDOs) due to credit deterioration and increased defaults/deferrals by underlying issuers. These securities are rated Caa3 by Moody's.
• Asset Quality Risks: Management identified $15.2 million in potential problem loans (performing but with known credit issues). There is no assurance these will not become non-performing if economic conditions worsen.
• Interest Rate Risk: Management models indicate that an immediate 200-basis point decrease in interest rates would negatively impact net interest income by 10.35% and the market value of capital by 9.84%. Both scenarios remain within the 15% tolerance limit set by the Asset/Liability Committee.
• Pension Plan Amendment: The Board approved an amendment to the Defined Benefit Pension Plan effective July 1, 2010, closing the plan to new hires. This is expected to decrease future benefit obligations and costs over time.
• Dividends: A cash dividend of $0.25 per share was declared, unchanged from the prior year.

Investor Verification Checklist

• OTTI Exposure: Verify the ongoing performance and cash flow projections of the two trust preferred securities pools ($856k book value) that incurred impairment charges.
• Non-Performing Assets: Monitor the $11.6 million in non-performing loans and the $15.2 million in potential problem loans for further deterioration.
• Loan Demand: Assess the impact of continued soft loan demand on future loan growth and net interest income.
• Capital Ratios: Confirm that capital ratios remain above regulatory thresholds for "well capitalized" status amidst potential future credit losses.
• Interest Rate Sensitivity: Review the Asset/Liability Committee's tolerance limits and hedging strategies given the low interest rate environment.