CHMG

Chemung Financial Corp. 2006 Annual Report Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2006. Chemung Financial Corporation is a financial holding company operating primarily in the southern tier of New York and the northern tier of Pennsylvania. Its principal subsidiary is Chemung Canal Trust Company, a full-service community bank, and CFS Group, Inc., which provides non-traditional financial services including brokerage and insurance. The company operates 16 full-service offices and one representative office.

Key Financial Metrics

Material Changes vs. Prior Period

• Loan Portfolio Growth: Total loans increased by $59.0 million (14.1%) to $477.7 million, driven primarily by a $36.5 million increase in residential mortgages and expansion into Tompkins County.
• Asset Quality Improvement: Non-performing loans decreased significantly from $9.14 million in 2005 to $3.61 million in 2006. This reduction was largely due to the sale of a commercial relationship and charge-offs, resulting in a lower provision for loan losses ($0.13 million vs. $1.30 million).
• Deposit Growth: Total deposits rose 11.5% to $585.1 million, with significant increases in time deposits and insured money market accounts.
• Securities Portfolio Reduction: The investment securities portfolio decreased by approximately $49.9 million, primarily due to maturities, calls, and a strategic reduction in mortgage-backed securities.
• Operating Expenses: Expenses increased 8.1% to $29.52 million, attributed to branch expansion, higher data processing costs, and expenses related to operating a golf course acquired through foreclosure (OREO).

Guidance, Outlook, and Risks

• Merger Activity: The Bank entered into an agreement to acquire the trust business of Partners Trust Financial Group, Inc., with a sale price of approximately $5.2 million. The transaction was expected to close in the second quarter of 2007 pending regulatory approval.
• Capital Position: The Corporation maintained a "well-capitalized" status. Total capital to risk-weighted assets was 17.11%, and the Tier 1 leverage ratio was 10.80%, both well above regulatory minimums.
• Share Repurchases: The Board authorized a new program to repurchase up to 180,000 shares. During 2006, the company repurchased 73,496 shares at an average price of $30.82.
• Interest Rate Risk: Management noted that a flat to inverted yield curve in 2006 compressed net interest margins. Stress testing indicated that a 200-basis point change in rates would impact net interest income by approximately 3.3% to 3.7%, within policy limits.
• Accounting Changes: The company adopted SFAS No. 158, requiring the recognition of overfunded/underfunded pension status on the balance sheet, and SAB 108 regarding prior year misstatements.

Investor Verification Checklist

• Asset Quality Trends: Verify the sustainability of the sharp decline in non-performing loans and the adequacy of the allowance for loan losses (1.67% of total loans) given the reduction in the provision.
• Merger Integration: Monitor the closing and integration of the Partners Trust Financial Group trust business acquisition.
• Expense Management: Assess whether operating expenses will stabilize following the one-time costs associated with branch expansion and the mainframe computer replacement.
• Interest Rate Sensitivity: Review future net interest margin performance in the context of the inverted yield curve and rising cost of funds.
• Pension Plan Status: Confirm the impact of the $10 million pension contribution made in Q4 2006 on future expense recognition.