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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

Tompkins Financial Corporation (“Tompkins” or the “Company”) is headquartered in Ithaca, New York and is registered as a Financial Holding Company with the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. The Company is a locally oriented, community-based financial services organization that offers a full array of products and services, including commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, and insurance services.At December 31, 2020, the Company’s subsidiaries included: four wholly-owned banking subsidiaries, Tompkins Trust Company (the “Trust Company”), The Bank of Castile (DBA Tompkins Bank of Castile), Mahopac Bank (DBA Tompkins Mahopac Bank), VIST Bank (DBA Tompkins VIST Bank); and a wholly-owned insurance agency subsidiary, Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). The trust division of the Trust Company provides a full array of investment services, including investment management, trust and estate, financial and tax planning as well as life, disability and long-term care insurance services. The Company’s principal offices are located at 118 E. Seneca Street, P.O. Box 460, Ithaca, NY, 14850, and its telephone number is (888) 503-5753. The Company’s common stock is traded on the NYSE American under the Symbol “TMP.”

Forward-Looking Statements

This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The statements contained in this Report that are not statements of historical fact may include forward-looking statements that involve a number of risks and uncertainties. Forward-looking statements may be identified by use of such words as "may", "will", "estimate", "intend", "continue", "believe", "expect", "plan", or "anticipate", and other similar words. Examples of forward-looking statements may include statements regarding the asset quality of the Company's loan portfolios; the level of the Company's allowance for credit losses; whether, when and how borrowers will repay deferred amounts and resume scheduled payments; the sufficiency of liquidity sources; the Company's exposure to changes in interest rates, and to new, changed, or extended government/regulatory expectations; the impact of changes in accounting standards; and trends, plans, prospects, growth and strategies. Forward-looking statements are made based on management’s expectations and beliefs concerning future events impacting the Company and are subject to certain uncertainties and factors relating to the Company’s operations and economic environment, all of which are difficult to predict and many of which are beyond the control of the Company, that could cause actual results of the Company to differ materially from those expressed and/or implied by forward-looking statements. The following factors, in addition to those listed as Risk Factors in Item 1A are among those that could cause actual results to differ materially from the forward-looking statements: changes in general economic, market and regulatory conditions; the severity and duration of the COVID-19 outbreak and the impact of the outbreak (including the government’s response to the outbreak) on economic and financial markets, potential regulatory actions, and modifications to our operations, products, and services relating thereto; disruptions in our and our customers’ operations and loss of revenue due to pandemics, epidemics, widespread health emergencies, government-imposed travel/business restrictions, or outbreaks of infectious diseases such as the COVID-19, and the associated adverse impact on our financial position, liquidity, and our customers’ abilities or willingness to repay their obligations to us or willingness to obtain financial services products from the Company; a decision to amend or modify the terms under which our customers are obligated to repay amounts owed to us; the development of an interest rate environment that may adversely affect the Company’s interest rate spread, other income or cash flow anticipated from the Company’s operations, investment and/or lending activities; changes in laws and regulations affecting banks, bank holding companies and/or financial holding companies, such as the Dodd-Frank Act and Basel III and the Economic Growth, Regulatory Relief, and Consumer Protection Act; legislative and regulatory changes in response to COVID-19 with which we and our subsidiaries must comply, including the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") and the Consolidated Appropriations Act, 2021 and the rules and regulations promulgated thereunder, and federal, state and local government mandates; technological developments and changes; the ability to continue to introduce competitive new products and services on a timely, cost-effective basis; governmental and public policy changes, including environmental regulation; reliance on large customers; uncertainties arising from national and global events, including the potential impact of widespread protests, civil unrest, and political uncertainty on the economy and the financial services industry; and financial resources in the amounts, at the times and on the terms required to support the Company’s future businesses.

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Critical Accounting Policies

The accounting and reporting policies followed by the Company conform, in all material respects, to U.S. generally accepted accounting principles ("GAAP") and to general practices within the financial services industry. In the course of normal business activity, management must select and apply many accounting policies and methodologies and make estimates and assumptions that lead to the financial results presented in the Company’s consolidated financial statements and accompanying notes. There are uncertainties inherent in making these estimates and assumptions, which could materially affect the Company’s results of operations and financial position.

Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements. Management considers the accounting policies relating to the allowance for credit losses (“allowance”, or “ACL”), and the review of the securities portfolio for other-than-temporary impairment to be critical accounting policies because of the uncertainty and subjectivity involved in these policies and the material effect that estimates related to these areas can have on the Company’s results of operations. On January 1, 2020, the Company adopted ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which resulted in changes to the Company's existing critical accounting policy that existed at December 31, 2019.

The Company’s methodology for estimating the allowance considers available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. Refer to “Allowance for Credit Losses” below, "Note 4 - Allowance for Credit Losses", and "Note 1 – Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Form 10-K for the year ended December 31, 2020.

For information on the Company's significant accounting policies and to gain a greater understanding of how the Company’s financial performance is reported, refer to "Note 1 – Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Form 10-K for the year ended December 31, 2020.

COVID-19 Pandemic and Recent Events

The COVID-19 global pandemic presented health and economic challenges on an unprecedented scale in 2020. During the year, the Company focused on the health and well-being of its workforce, meeting its clients' needs, and supporting its communities. The Company has designated a Pandemic Planning Committee, which includes key individuals across the Company as well as members of Senior Management, to oversee the Company’s response to COVID-19, and has implemented a number of risk mitigation measures designed to protect our employees and customers while maintaining services for our customers and community. These measures included restrictions on business travel, establishment of a remote work environment for most non-customer facing employees, and social distancing restrictions for those employees working at our offices and branch locations. In July 2020, we began initiating the reopening of our offices and reinstatement of branch services, and the return of our workforce, but as of December 31, 2020, approximately 85% of our noncustomer facing employees continued to work remotely. To promote the health and well-being of the Company's workforce, customers, and visitors as we reopen, we implemented several new social distancing protocols and other protective measures, such as temperature screenings, distribution of personal protective equipment, and workforce self-certifications.

Tompkins continues to offer assistance to its customers affected by the COVID-19 pandemic by implementing a payment deferral program to assist both consumer and business borrowers that may be experiencing financial hardship due to COVID-19. Our standard program allows for the deferral of loan payments for up to 90 days. In certain cases, and where required by applicable law or regulations, we extend additional deferrals or other accommodations. Weekly deferral requests for the month of December 2020 were down 98.5% from peak levels the Company experienced in late March 2020. As of December 31, 2020, total loans impacted by COVID-19 that continued in a deferral status amounted to approximately $212.2 million, representing 4.0% of total loans. Loans to finance hotels and motels comprise approximately 53.0% of total loans that continue in deferral status. Of the loans that had come out of the deferral program as of December 31, 2020, about 94.4% had made at least one payment and 0.13% were more than 30 days delinquent. We expect that loans that are currently in deferral will continue to accrue interest during the deferral period unless otherwise classified as nonperforming. The provisions of the CARES Act and interagency guidance issued by Federal banking regulators provided clarification related to modifications and deferral programs to assist borrowers who are negatively impacted by the COVID-19 national emergency. Under the CARES Act, a modification deemed to be COVID-19 related is not considered to be a troubled debt restructuring ("TDR") if the loan was not more than 30 days past due as of December 31, 2019 and the deferral was executed between March 1, 2020 and the

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earlier of 60 days after the date of termination of the COVID-19 national emergency or December 31, 2020. The Consolidated Appropriations Act, 2021 extended the termination of these provisions to the earlier of 60 days after the COVID-19 national emergency date or January 1, 2022. The Federal banking regulators issued similar guidance. In accordance with the CARES Act, the Consolidated Appropriations Act, 2021, and the interagency guidance, the Company is not designating eligible loan modifications and deferrals resulting from the impacts of COVID-19 as TDRs.

Management continues to monitor credit conditions carefully at the individual borrower level, as well as by industry segment, in order to be responsive to changing credit conditions. The table below lists certain larger industry concentrations within our loan portfolio and the percentage of each segment that are currently in a deferral status.

Deferral Credit Concentrations

(In thousands) As of December 31, 2020

Lessors of Residential Buildings and Dwellings $ 520,793 16.1 % $ 490 0.1 %

Health Care and Social Assistance 156,693 4.8 % 0 0

The Company is also participating in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). Borrowers with loan balances which are not forgiven are obligated to repay such balances over a 2-year term at a rate of 1% interest, with principal and interest payments deferred for the first six months. The SBA has announced that, under limited circumstances described in the current SBA guidance, fees will not be paid, even if the participating lender has approved and processed the PPP loan. The Company began accepting applications for PPP loans on April 3, 2020, and approved and funded 2,998 loans totaling approximately $465.6 million during the second quarter of 2020. The Company received approximately $14.5 million of fees related to the PPP loans funded. The fees are amortized as interest income over the life of the loan and recognized net of origination costs. The Company recognized net loan fees of $9.2 million in 2020 related to the PPP loans. This program provides borrower guarantees for lenders, and envisions a certain amount of loan forgiveness for loan recipients who properly utilize funds, all in accordance with the rules and regulations established by the SBA for the PPP. At December 31, 2020, the Company had submitted 1,484 loans totaling $244.0 million to the SBA for forgiveness under the terms of the PPP program. Approximately 1,212 of those loans, totaling $171.1 million, had been forgiven by the SBA as of December 31, 2020. On January 11, 2021, the SBA reactivated the PPP. The Company's banking subsidiaries have originated additional PPP loans through the PPP, which is currently scheduled to extend through March 31, 2021. As of February 21, 2021 the Company had submitted 1,341 PPP loan applications totaling $171.0 million under the 2021 PPP authorization.

As of December 31, 2020, the Company's nonperforming assets represented 0.60% of total assets, up from 0.44% at September 30, 2020, and 0.47% at December 31, 2019. Special Mention loans totaled $121.3 million at the end of the fourth quarter of 2020, in line with the quarter ended September 30, 2020, and up compared to the $29.8 million reported for the fourth quarter of 2019. Total Substandard loans increased during the quarter to $68.6 million at December 31, 2020, compared to $45.4 million at September 30, 2020, and $60.5 million at December 31, 2019. The increases in nonperforming loans and leases and Substandard loans were mainly related to the downgrades of credit in the loan portfolio related to the hospitality industry. Included in the nonperforming and Substandard loans and leases are 17 loans totaling $17.8 million, that are currently in deferral status.

Results of Operations

(Comparison of December 31, 2020 and 2019 results)

General

The Company reported diluted earnings per share of $5.20 in 2020, compared to diluted earnings per share of $5.37 in 2019. Net income for the year ended December 31, 2020, was $77.6 million, a decrease of 5.1% compared to $81.7 million in 2019.

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In addition to earnings per share, key performance measurements for the Company include return on average shareholders’ equity (ROE) and return on average assets (ROA). ROE was 11.09% in 2020, compared to 12.55% in 2019, while ROA was 1.05% in 2020 and 1.22% in 2019. Tompkins’ 2020 ROE and ROA compared favorably with peer ratios of 8.40% for ROE and 0.88% for ROA, as of September 30, 2020. The peer group data is derived from the FRB's "Bank Holding Company Performance Report", which covers banks and bank holding companies with assets between $3.0 billion and $10.0 billion as of September 30, 2020 (the most recent report available). Although the peer group data is presented based upon financial information that is one fiscal quarter behind the financial information included in this report, the Company believes that it is relevant to include certain peer group information for comparison to current period numbers.

Segment Reporting

The Company operates in three business segments: banking, insurance and wealth management. Insurance is comprised of property and casualty insurance services and employee benefit consulting operated under the Tompkins Insurance Agencies, Inc. subsidiary. Wealth management activities include the results of the Company’s trust, financial planning, and wealth management services provided by Tompkins Financial Advisors, a division of the Trust Company. All other activities are considered banking. For additional financial information on the Company’s segments, refer to “Note 23 – Segment and Related Information” in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

Banking Segment

The banking segment reported net income of $69.3 million for the year ended December 31, 2020, representing a $5.2 million or 7.0%, decrease compared to 2019. Net interest income increased $14.7 million or 7.0% in 2020 compared to 2019. Contributing to the increase from 2019 were lower funding costs and an increase in average earning assets, which were partially offset by lower asset yield. Interest income decreased $7.0 million or 2.7% compared to 2019, while interest expense decreased $21.8 million or 42.9%.

The provision for credit loss expense was $16.2 million in 2020, compared to $1.4 million in the prior year. The first quarter of 2020 included provision expense of $16.3 million related to the impact of the economic conditions due to COVID-19 on economic forecasts and other model assumptions relied upon by management in determining the allowance, and reflects the calculation of the allowance for credit losses in accordance with ASU 2016-13. For additional information, see the section titled "The Allowance for Credit Losses" below.

Noninterest income in the banking segment of $26.0 million in 2020 decreased by $3.0 million or 10.5% when compared to 2019. The negative variance compared to the prior year was mainly in fee based services and was largely a result of a decrease in transactions attributable to the economic impact of pandemic-related travel and business restrictions, which reduced card services and the related service charge income. Card services fees and deposit fees in 2020 were down 12.0% and 24.1%, respectively, from prior year. This decrease was partially offset by gains on sales of residential loans, which were up $1.8 million over 2019, and the increase was mainly due to a higher volume of loans sold and higher premiums paid on sold loans.

Noninterest expense of $148.7 million for the year ended December 31, 2020, was up $3.6 million or 2.5% from 2019. The increases were mainly attributed to increases in salary and wages and employee benefits reflecting normal annual merit increases, premium pay for employees required to be on-site during pandemic-related business restrictions, and higher health insurance expense over the comparable periods in the prior year. Noninterest expenses for the year ended December 31, 2020, included $1.0 million in off-balance sheet exposures calculated due to changes in methodology in accordance with the adoption of ASU 2016-13.

Insurance Segment

The insurance segment reported net income of $4.4 million, up $198,000 or 4.7% when compared to 2019, as a $429,000 or 1.4% increase in noninterest revenue was only partially offset by a 0.1% increase in expenses. The increase in revenue included $384,000 or 1.9% of organic growth in property and casualty commissions and a $167,000 or 5.5% increase in contingency revenue over 2019. Health and voluntary benefits grew by $105,000 or 1.4%, while life, financial services and other revenue was $212,000 or 40.2% less than 2019; 2019 benefited from the new business of one large relationship in 2019.

Increases in expenses, mainly attributed to salaries, wages and employee benefits reflecting normal annual merit and incentive adjustments along with higher health insurance costs, were mainly offset by reductions in items such as auto, travel, entertainment and marketing that were affected by COVID-19 pandemic.

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Wealth Management Segment

The wealth management segment reported net income of $4.0 million for the year ended December 31, 2020, an increase of $0.9 million or 29.0% compared to 2019. Noninterest income of $18.1 million increased $1.1 million or 6.6% compared to 2019, mainly a result of estate and terminating trust fees, which were up $569,000 or 176.4% in 2020 over 2019, as a result of the settlement of a large estate in 2020, and an increase in assets under management. Noninterest expenses remained flat year over year, as increases in technology expenses were offset by decreases in travel and meetings expenses as a result of the COVID-19 pandemic. The market value of assets under management or in custody at December 31, 2020 totaled $4.4 billion, an increase of 9.5% compared to year-end 2019. This figure included $1.2 billion at year-end 2020, of Company-owned securities from which no income was recognized as the Trust Company was serving as custodian.

Net Interest Income

Net interest income is the Company’s largest source of revenue, representing 75.3% of total revenues for the year ended December 31, 2020, and 73.6% of total revenues for the year ended December 31, 2019. Net interest income is dependent on the volume and composition of interest earning assets and interest-bearing liabilities and the level of market interest rates. Table 1 – Average Statements of Condition and Net Interest Analysis shows average interest-earning assets and interest-bearing liabilities, and the corresponding yield or cost associated with each.

Tax-equivalent net interest income for 2020 increased by $15.2 million or 7.1% from 2019. The increase was mainly due to lower interest expense in 2020 compared to 2019, driven by lower market interest rates and by deposit growth, which contributed to a reduction in other borrowings. Average total deposits represented 91.7% of average total liabilities in 2020 compared to 84.4% in 2019, while total average borrowings represented 6.6% of average total liabilities in 2020 and 13.9% in 2019. Net interest income also benefited from the growth in average earning assets in 2020 over 2019; however, average asset yields for 2020 were down from 2019. The net interest margin for 2020 was 3.31% compared to 3.39% for 2019. The decline in net interest margin for 2020 when compared to 2019 was mainly due to a decrease in overall asset yields. The decrease in average asset yields was mainly due to lower securities yields and a slight shift in the composition of average earning assets, with a greater mix of lower yielding average interest bearing balances.

Tax-equivalent interest income decreased $6.6 million or 2.5% in 2020 from 2019. The decrease in taxable-equivalent interest income was mainly due to lower asset yields, partially offset by an increase in the volume of average earning assets. Average asset yields for 2020 were down 47 basis points compared to 2019, which reflects the impact of reductions in market interest rates during 2020, and the addition of lower yielding PPP loans. Average loans and leases increased $398.0 million or 8.2% in 2020 compared to 2019, and represented 76.1% of average earning assets in 2020 compared to 77.1% in 2019. The increase in average loans includes $465.6 million in PPP loans originated in the second quarter of 2020. As a result of its participation in the SBA's PPP, the Company recorded net deferred loan fees of $9.2 million, which are included in interest income. The average yield on loans was 4.38% in 2020, a decrease of 34 basis points compared to 4.72% in 2019. Average balances on securities increased $27.4 million or 2.0% in 2020 compared to 2019, while the average yield on the securities portfolio decreased 47 basis points or 20.4% compared to 2019 due to lower market interest rates in 2020.

Interest expense for 2020 decreased $21.8 million or 42.9% compared to 2019, driven mainly by decreases in rates paid on deposits and borrowings as a result of lower market interest rates. The average cost of interest bearing deposits was 0.46% in 2020, down 38 basis points from 0.84% in 2019, while the average cost of interest bearing liabilities decreased to 0.60% in 2020 from 1.12% in 2019. Average interest bearing deposits in 2020 increased $671.0 million or 18.2% compared to 2019. Average noninterest bearing deposit balances in 2020 increased $349.9 million or 24.9% over 2019 and represented 28.7% of average total deposits in 2020 compared to 27.6% in 2019. Average total deposits were up $1.0 billion or 20.1% in 2020 over 2019. Average deposit balances increased due to the $465.6 million of PPP loan originations during the second quarter of 2020, the majority of which were deposited into Tompkins checking accounts, as well as brokered funds obtained in the first half of 2020 to support PPP loans and overall liquidity during COVID-19. Average other borrowings decreased by $397.3 million or 52.1% in 2020 from 2019. The decrease in borrowings was due to the strong deposit growth during 2020.

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Table 1 - Average Statements of Condition and Net Interest Analysis

For the year ended December 31,

ASSETS

Interest-earning assets

Securities1

LIABILITIES & EQUITY

Deposits

Interest-bearing deposits

1 Average balances and yields on available-for-sale securities are based on historical amortized cost.

2 Interest income includes the tax effects of taxable-equivalent adjustments using the Federal income tax rate of 21.0% in 2020, 2019 and 2018 to increase tax exempt interest income to taxable-equivalent basis.

3 Nonaccrual loans are included in the average asset totals presented above. Payments received on nonaccrual loans have been recognized as disclosed in Note 1 of the Company’s consolidated financial statements included in Part 1 of this annual report on Form 10-K.

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Table 2 - Analysis of Changes in Net Interest Income

INTEREST INCOME:

Interest-bearing balances due from banks $ 229 $ (76) $ 153 $ (10) $ 20 $ 10

Investments1

INTEREST EXPENSE:

Interest-bearing deposits:

1 Interest income includes the tax effects of taxable-equivalent adjustments using the Federal income tax rate of 21.0% in 2020, 2019 and 2018 to increase tax exempt interest income to taxable-equivalent basis.

Changes in net interest income occur from a combination of changes in the volume of interest-earning assets and interest-bearing liabilities, and in the rate of interest earned or paid on them. The above table illustrates changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume), and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of the change. In 2020, net interest income increased by $15.2 million, resulting from a $21.8 million decrease in interest expense, partially offset by a $6.6 million decrease in interest income. Lower yields on average earning assets reduced interest income by $24.4 million, while the increase in average balances on interest-earning assets increased interest income by $17.8 million. The decrease in interest expense reflects lower rates paid on interest bearing liabilities, both deposits and other borrowings. Lower rates on deposits and borrowings reduced interest expense by $17.2 million, while lower average balances of interest bearing liabilities reduced interest expense by $4.6 million.

Provision for Credit Loss Expense

The provision for credit loss expense represents management’s estimate of the expense necessary to maintain the allowance for credit losses at an appropriate level. The provision for credit loss expense was $16.2 million in 2020, compared to $1.4 million in 2019. The ratio of total allowance to total loans and leases increased to 0.98% at December 31, 2020 from 0.81% at December 31, 2019. The first quarter of 2020 included a provision expense of $16.3 million driven by the impact of the economic restrictions/shutdowns related to COVID-19 on economic forecasts and other model assumptions relied upon by management in determining the allowance, as well as normal adjustments for loan growth and changing loan portfolio mix. See the section captioned “The Allowance for Credit Losses” included within “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Financial Condition” of this Report for further analysis of the Company’s allowance for credit losses.

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Noninterest Income

Year ended December 31,

Net gain (loss) on securities transactions 443 645 (466)

Noninterest income represented 24.7% of total revenues in 2020, and 26.4% in 2019.

Insurance commissions and fees increased 1.3% to $31.5 million in 2020, compared to $31.1 million in 2019. The increase in insurance commissions and fees in 2020 over 2019, was mainly in property and casualty commissions, personal line commissions, and contingency income, partially offset by an increase in reserves for cancellations and policy changes as a result of economic uncertainties related to COVID-19. New business volumes were also negatively impacted by COVID-19.

Investment services income of $17.5 million increased $1.1 million or 6.6% in 2020 compared to 2019, mainly due to an increase in advisory fee income resulting from the growth in assets under management, and higher estate and terminating trust fees earned in 2020. Investment services income includes trust services, financial planning, wealth management services, and brokerage related services. The fair value of assets managed by, or in custody of, Tompkins was $4.4 billion at December 31, 2020, up from $4.1 billion at December 31, 2019. The fair value of assets in custody at December 31, 2020 and 2019 includes $1.2 billion, and $1.0 billion, respectively, of Company-owned securities where Tompkins Trust Company is custodian.

Service charges on deposit accounts in 2020 were down $2.0 million or 24.1% compared to the prior year. Overdraft/insufficient funds charges, the largest component of service charges on deposit accounts, were down $1.7 million or 32.2% in 2020 compared to 2019. The decreases in overdraft/insufficient funds charges during 2020 were primarily related to a decrease in the volume of overdrafts relative to 2019.

Card services income decreased $1.3 million or 12.0% over 2019. The primary components of card services income are fees related to interchange income and transactions fees for debit card transactions, credit card transactions and ATM usage. The reduction in card services income in 2020, when compared to 2019, is largely related to the pandemic-related travel and business restrictions, which resulted in lower transaction volume. Additionally, card services income for 2019 included a one-time incentive payment of $500,000 related to the Company's merchant card business.

Other income of $8.8 million was up $401,000 or 4.8% compared to 2019. The increase was largely due to gains on sales of residential mortgage loans of $2.0 million in 2020, compared to gains of $227,000 in 2019, due to a higher volume of loans sold and higher premiums paid on loans sold in 2020.

Noninterest Expense

Year ended December 31,

Noninterest expense as a percentage of total revenue was 62.0% in 2020, compared to 63.6% in 2019. Expenses associated with salaries and wages and employee benefits are the largest component of total noninterest expense. In 2020, these expenses increased $4.4 million or 3.9% compared to 2019. Salaries and wages increased $3.1 million or 3.5% in 2020 over the prior

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year, mainly as a result of annual merit pay increases. Other employee benefits increased $1.3 million or 5.6% over 2019, mainly in health insurance, which was up $942,000 or 10.4% in 2020 over 2019. The $1.6 million increase in FDIC expense in 2020 over 2019 is due to the benefit of the FDIC insurance assessment small bank credits in 2019.

Other operating expenses of $43.4 million decreased by $2.1 million or 4.6% compared to 2019. The primary components of other operating expenses in 2020 were technology expense ($11.8 million), professional fees ($6.1 million), marketing expense ($4.8 million), and cardholder expense ($3.3 million) The decrease in other operating expenses in 2020 compared to 2019 was mainly in professional fees (down $2.9 million or 32.3%) and business related travel and entertainment expense (down $1.3 million or 67.3%). These decreases were partially offset by increases in technology related expenses in 2020 over 2019 (up $1.1 million or 10.5%), and expense related to our allowance for off-balance sheet exposures (up $1.0 million).

Noncontrolling Interests

Net income attributable to noncontrolling interests represents the portion of net income in consolidated majority-owned subsidiaries that is attributable to the minority owners of a subsidiary. The Company had net income attributable to noncontrolling interests of $154,000 in 2020, up $27,000 from 2019. The noncontrolling interests relate to three real estate investment trusts, which are substantially owned by the Company’s New York banking subsidiaries.

Income Tax Expense

The provision for income taxes provides for Federal, New York State, Pennsylvania and other miscellaneous state income taxes. The 2020 provision was $19.9 million, which decreased $1.1 million or 5.2% compared to the 2019 provision. The effective tax rate for the Company was 20.4% in 2020, down from 20.5% in 2019. The effective rates for 2020 and 2019 differed from the U.S. statutory rate of 21.0% during those periods due to the effect of tax-exempt income from loans, securities, and life insurance assets, investments in tax credits, and excess tax benefits of stock based compensation.

Results of Operations

(Comparison of December 31, 2019 and 2018 results)

General

The Company reported diluted earnings per share of $5.37 in 2019, compared to diluted earnings per share of $5.35 in 2018. Net income for the year ended December 31, 2019, was $81.7 million, a decrease of 0.7% compared to $82.3 million in 2018.

Segment Reporting

Banking Segment

The banking segment reported net income of $74.5 million for the year ended December 31, 2019, representing a $424,000 or 0.6% decrease compared to 2018. Net interest income decreased $1.2 million or 0.6% in 2019 compared to 2018. Contributing to the decline from 2018, was a decline in average security balances, which was partially offset by an improved net interest margin in 2019. Interest income increased $9.8 million or 3.9% compared to 2018, while interest expense increased $11.0 million or 27.5%.

The provision for loan and lease losses was $1.4 million in 2019, compared to $3.9 million in the prior year. The reduction in provision was primarily due to a $3.0 million specific reserve on one commercial real estate property at December 31, 2018, which was subsequently charged off in the first quarter of 2019. The provision expense in 2019 also benefited from favorable trends in certain qualitative factors and lower average historical loan loss rates in all loan portfolios except commercial real estate at year-end 2019, compared to year-end 2018.

Noninterest income in the banking segment of $29.1 million in 2019 decreased by $2.7 million or 8.5% when compared to 2018. The negative variance to prior year was mainly due to the $2.9 million gain on the sale of two properties in 2018 related to the completion and move to the Company's new headquarters building and the collection of fees and nonaccrual interest of $2.5 million in 2018 on a loan that was charged off in 2010. This was partially offset by the $500,000 one-time incentive payment received by the Company in the first quarter of 2019 related to the Company's merchant card business, and gains of

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$645,000 on sales of available-for-sale securities in 2019 compared to net losses on sales of available-for-sale securities of $466,000 in 2018.

Noninterest expenses in 2019 were flat compared to 2018. Salary and wages and employee benefits were up in 2019 over 2018, mainly as a result of an increase in average FTEs, normal annual merit and incentive adjustments and higher health insurance costs. These increases were mainly offset by a decrease in other operating expenses. FDIC insurance expense was down in 2019 compared to 2018, mainly as a result of deposit insurance credits received from the FDIC, which included $1.5 million that were applied in 2019. 2018 operating expenses included write-downs of $2.3 million on leases on space vacated in 2018 following completion of the Company's new headquarters in 2018.

Insurance Segment

The insurance segment reported net income of $4.2 million, up $926,000 or 28.5% when compared to 2018, as a 5.9% increase in noninterest revenue was only partially offset by a 1.9% increase in expenses. This increase included $900,000 or 4.6% of organic growth in property and casualty commissions and a $738,000 or 32.0% increase in contingency revenue over 2018, while life, health and financial services commissions decreased slightly.

On May 1, 2019, Tompkins Insurance purchased the assets of Cali Agency, Inc. in Warsaw, NY, adding an additional $112,000 in non-interest income for 2019. The increase in expenses was mainly attributed to an increase in salary and wages and employee benefits reflecting normal annual merit and incentive adjustments and higher health insurance costs, respectively, over the prior year.

Wealth Management Segment

The wealth management segment reported net income of $3.1 million for the year ended December 31, 2019, a decrease of $1.1 million or 26.3% compared to 2018. Noninterest income of $17.0 million decreased $1.0 million or 5.5% compared to 2018, mainly a result of estate and terminating trust fees, which were down $1.0 million or 75.4% in 2019 over 2018, as a result of the settlement of a large estate in 2018. Noninterest expenses increased by $331,000 or 2.6% in 2019 compared to 2018, mainly due to changes in staffing and normal merit and incentive adjustments in 2019 compared to 2018. The market value of assets under management or in custody at December 31, 2019 totaled $4.1 billion, an increase of 6.7% compared to year-end 2018. This figure included $1.0 billion at year-end 2019 of Company-owned securities from which no income was recognized as the Trust Company was serving as custodian.

Net Interest Income

Net interest income is the Company’s largest source of revenue, representing 73.6% of total revenues for the year ended December 31, 2019, and 73.2% of total revenues for the year ended December 31, 2018. Net interest income is dependent on the volume and composition of interest earning assets and interest-bearing liabilities and the level of market interest rates.

Tax-equivalent net interest income for 2019 decreased by $1.3 million or 0.6% from 2018. The decrease was mainly due to the decline in average earning assets and higher funding costs in 2019 compared to 2018. Average total deposits represented 84.4% of average total liabilities in 2019 compared to 79.8% in 2018, while total average borrowings represented 13.9% of average total liabilities in 2019 and 19.1% in 2018.

Tax-equivalent interest income increased $9.7 million or 3.8% in 2019 over 2018. The increase in taxable-equivalent interest income was mainly the result of improved asset yields and an increase in average loan balances. Average loans and leases increased $72.5 million or 1.5% in 2019 compared to 2018. Average loan balances represented 77.1% of average earning assets in 2019 compared to 75.0% in 2018. The average yield on interest earning assets for 2019 was 4.2%, which increased by 20 basis points from 2018. The average yield on loans was 4.72% in 2019, an increase of 19 basis points compared to 4.53% in 2018. Average balances on securities decreased $132.1 million or 8.6% compared to 2018, while the average yield on the securities portfolio increased 5 basis points or 2.2% compared to 2018. The decrease in average securities was mainly due to the sale of approximately $152.1 million of available-for-sale securities in the second quarter of 2019. The proceeds from the sale were mainly used to reduce borrowings.

Interest expense for 2019 increased $11.0 million or 27.5% compared to 2018, reflecting higher rates as average interest bearing liabilities decreased $131.5 million or 2.8% from 2018. The increase in interest expense was the result of the increase in the average rates paid on deposits and interest bearing liabilities in 2019 compared to 2018. The average cost of interest bearing deposits was 0.84% in 2019, up 36 basis points from 0.48% in 2018, while the average costs of interest bearing liabilities increased to 1.12% in 2019 from 0.85% in 2018. Average total deposits were up $216.6 million or 4.4% in 2019 over 2018, with the majority of the growth in average interest bearing deposits. Average interest bearing deposits in 2019 increased $195.8

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million or 5.6% compared to 2018. Average noninterest bearing deposit balances in 2019 increased $20.8 million or 1.5% over 2018 and represented 27.6% of average total deposits in 2019 compared to 28.4% in 2018. Average other borrowings decreased by $323.9 million or 29.8% in 2019 from 2018. The decrease in borrowings was due to strong deposit growth during the third quarter of 2019 as well as pay downs resulting from proceeds from sales of $152.1 million of available-for-sale securities in the second quarter of 2019.

Provision for Loan and Lease Losses

The provision for loan and lease losses represents management’s estimate of the expense necessary to maintain the allowance for loan and lease losses at an appropriate level. The provision for loan and lease losses was $1.4 million in 2019, compared to $3.9 million in 2018. The ratio of total allowance to total loans and leases decreased to 0.81% at December 31, 2019 from 0.90% at December 31, 2018. Favorable trends in certain qualitative factors and lower average historical loan loss rates in all loan portfolios except commercial real estate at year-end 2019, compared to year-end 2018, and lower specific reserves for impaired loans, contributed to the lower allowance level at December 31, 2019. The allowance at December 31, 2018 included a specific reserve of $3.0 million related to one commercial real estate credit that was subsequently charged off in the first quarter of 2019. See the section captioned “The Allowance for Loan and Lease Losses” included within “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Financial Condition” of this Report for further analysis of the Company’s allowance for loan and lease losses.

Noninterest Income

Noninterest income represented 26.4% of total revenues in 2019, and 26.8% in 2018.

Insurance commissions and fees increased 5.9% to $31.1 million in 2019, compared to $29.4 million in 2018.This increase included $900,000 or 4.6% of organic growth in property and casualty commissions and a $738,000 or 32.0% increase in contingency revenue over 2018, while life, health and financial services commissions decreased slightly.

Investment services income of $16.4 million decreased $854,000 or 4.9% in 2019 compared to 2018. Investment services income includes trust services, financial planning, and wealth management services. The decrease in income was mainly a result of estate and terminating trust fees being down $1.0 million or 75.4% in 2019 over 2018, due to fees received in 2018 related to the settlement of a large estate.Fees are largely based on the market value and the mix of assets managed, and accordingly, the general direction of the stock market can have a considerable impact on fee income. The market value of assets managed by, or in custody of, the Trust Company was $4.1 billion at December 31, 2019, and $3.8 billion at December 31, 2018. These figures included $1.0 billion in 2019 and 2018 of Company-owned securities from which no income was recognized as the Trust Company was serving as custodian.

Service charges on deposit accounts in 2019 were down $114,000 or 1.4% compared to prior year. Overdraft/insufficient funds charges, the largest component of service charges on deposit accounts, were down $180,000 or 3.2% in 2019 compared to 2018, while service fees on personal and business accounts were up by $36,000 or 1.4% in 2019 compared to 2018.

Card services income increased $833,000 or 8.6% over 2018. The primary components of card services income are fees related to interchange income and transactions fees for debit card transactions, credit card transactions and ATM usage.Card services income for 2019 included a one-time incentive payment of $500,000 related to the Company's merchant card business.Increased revenue was also driven by increased transaction volume in both credit and debit cards.

The Company recognized $645,000 of gains on sales/calls of available-for-sale securities in 2019, compared to $466,000 of losses in 2018. The gains are primarily related to the sales of available-for-sale securities, which are generally the result of general portfolio maintenance and interest rate risk management.

Other income of $8.4 million was down $4.7 million or 35.9% compared to 2018. The primary contributors for the decrease in 2019 over 2018 were $2.9 million of gains on the sale of two properties we sold in 2018 upon completion of the Company's new headquarters building and $2.5 million related to the collection of fees and nonaccrual interest for a credit that was charged off in 2010.

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Noninterest Expense

Noninterest expense as a percentage of total revenue was 63.6% in 2019, compared to 62.6% in 2018.Expenses associated with salaries and wages and employee benefits are the largest component of total noninterest expense.In 2019, these expenses increased $5.2 million or 4.8% compared to 2018. Salaries and wages increased $3.8 million or 4.4% in 2019 over prior year, mainly as a result of annual merit pay increases. Other employee benefits increased $1.4 million or 6.3% over 2018, mainly in health insurance, which was up $736,000 or 8.9% in 2019 over 2018.

Other operating expenses of $45.5 million decreased by $2.8 million or 5.9% compared to 2018. The primary components of other operating expenses in 2019 were technology expense ($10.7 million), professional fees ($8.9 million), marketing expense ($4.9 million), cardholder expense ($3.2 million) and other miscellaneous expense ($18.3 million).Professional fees and technology related expenses in 2019 were up by $378,000 and $567,000, respectively, over 2018, mainly as a result of investments in strengthening the Company's compliance and information security infrastructure.Other operating expense in 2018 included $2.5 million of write-downs related to two leases on space vacated in 2018.

Noncontrolling Interests

Net income attributable to noncontrolling interests represents the portion of net income in consolidated majority-owned subsidiaries that is attributable to the minority owners of a subsidiary. The Company had net income attributable to noncontrolling interests of $127,000 in 2019 and 2018. The noncontrolling interests relate to three real estate investment trusts, which are substantially owned by the Company’s New York banking subsidiaries.

Income Tax Expense

The provision for income taxes provides for Federal, New York State, Pennsylvania and other miscellaneous state income taxes. The 2019 provision was $21.0 million, which decreased $789,000 or 3.6% compared to the 2018 provision. The effective tax rate for the Company was 20.5% in 2019, down from 20.9% in 2018. The effective rates for 2019 and 2018 differed from the U.S. statutory rate of 21.0% during those periods due to the effect of tax-exempt income from loans, securities, and life insurance assets, investments in tax credits, and excess tax benefits of stock based compensation.

Financial Condition

Total assets were $7.6 billion at December 31, 2020, increasing by 13.3% or $896.5 million from the previous year end. The increase in total assets was mainly due to increases in loans, securities, and cash and cash equivalent balances. Total cash and cash equivalents were up $250.5 million or 181.5% over December 31, 2019. The increase in cash and cash equivalents was mainly in balances held at the Federal Reserve and reflects the investment of excess liquidity in short term investments. Total deposits at year-end 2020 were up $1.2 billion or 23.5% over year-end 2019.

Loans and leases were 69.0% of total assets at December 31, 2020, compared to 73.1% of total assets at December 31, 2019. Total loan balances were $5.2 billion at December 31, 2020, up $342.8 million or 7.0% compared to the $4.9 billion reported at year-end 2019, mainly due to the addition of PPP loans originated and funded in the second quarter of 2020. PPP loan balances totaled $291.3 million at year-end 2020. A more detailed discussion of the loan portfolio is provided below in this section under the caption “Loans and Leases”.

As of December 31, 2020, total securities comprised 21.4% of total assets, compared to 19.3% of total assets at year-end 2019. Securities were up $328.6 million or 25.3% at December 31, 2020, compared to December 31, 2019. The increase in securities from year-end 2019 was largely due to the investment of excess liquidity into securities and interest bearing balances. The securities portfolio primarily contains mortgage-backed securities, obligations of U.S. Government sponsored entities, and obligations of states and political subdivisions. A more detailed discussion of the securities portfolio is provided below in this section under the caption “Securities”.

Total deposits at year-end 2020 increased by $1.2 billion or 23.5% compared to December 31, 2019. All deposit categories at year-end 2020 were up over year-end 2019, with noninterest bearing deposits up by $472.4 million or 32.4%, time deposit balances up by $71.2 million or 10.6% and checking, savings and money market accounts up by $681.2 million or 22.1% at December 31, 2020 compared to December 31, 2019. Other borrowings, consisting mainly of short term advances with the FHLB, decreased $393.1 million from December 31, 2019, as deposit growth were used to reduce borrowings. A more detailed discussion of deposits and borrowings is provided below in this section under the caption “Deposits and Other Liabilities”.

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Shareholders’ Equity

The Consolidated Statements of Changes in Shareholders’ Equity included in the Consolidated Financial Statements of the Company contained in Part II, Item 8. of this Report, detail changes in equity capital over prior year end. Total shareholders’ equity was up $54.6 million or 8.2% to $717.7 million at December 31, 2020, from $663.1 million at December 31, 2019. Additional paid-in capital decreased by $4.5 million, from $338.5 million at December 31, 2019, to $334.0 million at December 31, 2020. The $4.5 million decrease included the following: a $9.4 million aggregate purchase price related to the Company's repurchase and retirement of 127,690 shares of its common stock in connection with the 2020 Repurchase Plan and $1.9 million related to the exercise of stock options and restricted stock activity. These were partially offset by $4.7 million attributed to stock based compensation expense, $1.8 million related to shares issued in connection with the Company's dividend reinvestment program and $255,000 related to shares issued for the Company's director deferred compensation plan. Retained earnings increased by $47.9 million, reflecting net income of $77.6 million, less dividends paid of $31.4 million and the net cumulative effect adjustment related to the adoption of ASU 2016-13 of $1.7 million.

Accumulated other comprehensive loss decreased from $43.6 million at December 31, 2019 to $32.1 million at December 31, 2020, reflecting a $16.6 million increase in unrealized gains on available-for-sale securities due to market interest rates, and a $5.1 million increase in actuarial loss associated with employee benefit plans. Under regulatory requirements, amounts reported as accumulated other comprehensive income/loss related to net unrealized gain or loss on available-for-sale securities and the funded status of the Company’s defined benefit post-retirement benefit plans do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage capital ratios.

Total shareholders’ equity was up $42.2 million or 6.8% to $663.1 million at December 31, 2019, from $620.9 million at December 31, 2018. Additional paid-in capital decreased by $28.1 million, from $366.6 million at December 31, 2018, to $338.5 million at December 31, 2019. The $28.1 million decrease included the following: $29.9 million aggregate purchase price related to the Company's repurchase and retirement of 376,021 shares of its common stock in connection with its stock repurchase plan and $2.9 million related to the exercise of stock options and restricted stock activity. These were partially offset by $4.2 million attributed to stock based compensation expense and $377,000 related to shares issued for the Company's director deferred compensation plan. Retained earnings increased by $51.1 million, reflecting net income of $81.7 million, less dividends paid of $30.6 million.

Accumulated other comprehensive loss decreased from $63.2 million at December 31, 2018 to $43.6 million at December 31, 2019; reflecting a $27.6 million increase in unrealized gains on available-for-sale securities due to market interest rates, and a $8.0 million decrease in actuarial loss associated with employee benefit plans.

The Company continued its long history of increasing cash dividends with a per share increase of 4.0% in 2020, which followed an increase of 4.1% in 2019. Dividends per share amounted to $2.10 in 2020, compared to $2.02 in 2019, and $1.94 in 2018. Cash dividends paid represented 40.4%, 37.5%, and 36.0% of after-tax net income in 2020, 2019, and 2018, respectively.

On July 19, 2018, the Company’s Board of Directors authorized a stock repurchase plan (the "2018 Repurchase Plan") for the Company to repurchase up to 400,000 shares of the Company’s common stock over the 24 months following adoption of the plan. Through December 31, 2019, the Company had repurchased 393,004 shares under the 2018 Repurchase Plan at an average price of $79.15.

On January 30, 2020, the Company’s Board of Directors authorized a stock repurchase plan (the "2020 Repurchase Plan") for the Company to repurchase up to 400,000 shares of the Company’s common stock over the 24 months following adoption of the plan. As with the 2018 Repurchase Plan, shares may be repurchased from time to time under the 2020 Repurchase Plan in open market transactions at prevailing market prices, in privately negotiated transactions, or by other means in accordance with federal securities laws, and the repurchase program may be suspended, modified or terminated by the Board of Directors at any time for any reason. Through December 31, 2020, the Company had repurchased 127,690 shares under the 2020 Repurchase Plan at an average price of $73.72.

The Company and its subsidiary banks are subject to various regulatory capital requirements administered by Federal bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s business, results of operation and financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (PCA), banks must meet specific guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and its subsidiary banks are also subject to qualitative judgments by regulators concerning components, risk

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weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios of common equity Tier 1 capital, Total capital and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. Management believes that the Company and its subsidiary banks meet all capital adequacy requirements to which they are subject.

In addition to setting higher minimum capital ratios, the Basel III Capital Rules introduced a capital conservation buffer, which must be added to each of the minimum capital ratios and is designed to absorb losses during periods of economic stress. The capital conservation buffer was phased-in over a three year period that began on January 1, 2016, and was fully phased-in on January 1, 2019 at 2.5%.

As of December 31, 2020, the capital ratios for the Company’s four subsidiary banks exceeded the minimum levels required to be considered well capitalized. Additional information on the Company’s capital ratios and regulatory requirements is provided in “Note 20 - Regulations and Supervision” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report on Form 10-K.

Securities

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

The Company classifies its securities at date of purchase as available-for-sale, held-to-maturity or trading. Securities, other than certain obligations of states and political subdivisions thereof, are generally classified as available-for-sale. Securities available-for-sale may be used to enhance total return, provide additional liquidity, or reduce interest rate risk. Securities in the held-to-maturity portfolio would consists of obligations of U.S. Government sponsored entities and obligations of state and political subdivisions. Securities in the trading portfolio would reflect those securities that the Company elects to account for at fair value, with the adoption of ASC Topic 825, Financial Instruments.

The Company’s total securities portfolio at December 31, 2020 totaled $1.63 billion compared to $1.30 billion at December 31, 2019. The table below shows the composition of the available-for-sale and held-to-maturity securities portfolio as of year-end 2020, 2019 and 2018. The increase in the available-for-sale portfolio at year-end 2020 over year-end 2019 reflects the reinvestment of excess liquidity. The Company purchased about $904.9 million of securities in 2020, which were partially offset by $545.6 million of payments, maturities and calls. In 2020, fair values were favorably impacted by changes in market interest rates.

For held-to-maturity securities, the Company early adopted ASU 2019-04 on November 30, 2019. Since the Company had already adopted ASUs 2016-01 and 2017-12, the related amendments were effective as of November 30, 2019. As part of the adoption of ASU 2019-04, the Company reclassified $138.2 million in aggregate amortized cost basis of debt securities from held-to-maturity to available-for-sale. Included in other comprehensive income at December 31, 2019 is an unrealized gain of approximately $3.8 million related to the fair market value versus the cost basis of the portfolio at the time of the transfer. The Company had not reclassified debt securities from held-to-maturity to available-for-sale upon adoption of the amendments in ASU 2017-12. Under ASU 2019-04, entities that did not reclassify debt securities from held-to-maturity to available-for-sale upon adoption of the amendments in ASU 2017-12 and elect to reclassify debt securities upon adoption of the amendments in ASU 2019-04 are required to reflect the reclassification as of the date of adoption of that Update.

Additional information on the securities portfolio is available in “Note 2 Securities” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report, which details the types of securities held, the carrying and fair values, and the contractual maturities as of December 31, 2020 and 2019.

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As of December 31,

Mortgage-backed securities-residential, issued by

Non-U.S. Government agencies or sponsored entities 0 0 0 0 31 31

Obligations of U.S. states and political subdivisions 0 0 0 0 9,273 9,269

Effective January 1, 2020, the Company adopted a new accounting standard (ASU 2016-13), "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" which amends the accounting guidance on the impairment of financial instruments.Management evaluates investment securities for expected credit losses (“ECL”) impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.Factors that may be indicative of ECL include, but are not limited to, the following:

•Extent to which the fair value is less than the amortized cost basis.

•Adverse conditions specifically related to the security, an industry, or geographic area (changes in technology, business practice).

•Payment structure of the debt security with respect to underlying issuer or obligor.

•Failure of the issuer to make scheduled payment of principal and/or interest.

•Changes to the rating of a security or issuer by a NRSRO.

•Changes in tax or regulatory guidelines that impact a security or underlying issuer.

For available for sale debt securities in an unrealized loss position, the Company evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (technical impairment) is the result of changes in interest rates or reflects a fundamental change in the credit worthiness of the underlying issuer.Any impairment that is not credit related is recognized in other comprehensive income, net of applicable taxes.Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings.Both the ACL and the adjustment to net income may be reversed if conditions change.

However, if the Company intends to sell an impaired available for sale debt security, or more likely than not be required to sell the debt security before the recovery of the amortized cost basis, the entire impairment amount, including any previously

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recognized ACL, must be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis.Because the security’s amortized cost basis is adjusted to fair value, there is no ACL.

The Company also holds non-marketable Federal Home Loan Bank New York (“FHLBNY”) stock, non-marketable Federal Home Loan Bank Pittsburgh (“FHLBPITT”) stock and non-marketable Atlantic Community Bankers Bank (“ACBB”) stock, all of which are required to be held for regulatory purposes and for borrowing availability. The required investment in FHLB stock is tied to the Company’s borrowing levels with the FHLB. Holdings of FHLBNY stock, FHLBPITT stock and ACBB stock totaled $11.0 million, $5.2 million and $95,000 at December 31, 2020, respectively. These securities are carried at par, which is also cost. The FHLBNY and FHLBPITT continue to pay dividends and repurchase stock. As such, the Company has not recognized any impairment on its holdings of FHLBNY and FHLBPITT stock. At December 31, 2019, the Company’s holdings of FHLBNY stock, FHLBPITT stock, and ACBB stock totaled $24.3 million, $9.3 million, and $95,000, respectively.

Management’s policy is to purchase investment grade securities that, on average, have relatively short expected durations. This policy helps mitigate interest rate risk and provides sources of liquidity without significant risk to capital. The contractual maturity distribution of debt securities and mortgage-backed securities as of December 31, 2020, along with the weighted average yield of each category, is presented in Table 3-Maturity Distribution below. Balances are shown at amortized cost and weighted average yields are calculated on a fully taxable-equivalent basis. Expected maturities will differ from contractual maturities presented in Table 3-Maturity Distribution below, because issuers may have the right to call or prepay obligations with or without penalty and mortgage-backed securities will pay throughout the periods prior to contractual maturity.

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Table 3 - Maturity Distribution

Securities Available-for-Sale1 Securities Held-to-Maturity

(dollar amounts in thousands) Amount Yield2 Amount Yield2

Obligations of U.S. Government sponsored entities

Obligations of U.S. state and political subdivisions

Mortgage-backed securities - residential

Other securities

Total securities

1 Balances of available-for-sale securities are shown at amortized cost.

2 Interest income includes the tax effects of taxable-equivalent adjustments using a combined New York State and Federal effective income tax rate of 24.5% to increase tax exempt interest income to taxable-equivalent basis.

The average taxable-equivalent yield on the securities portfolio was 1.83% in 2020, 2.30% in 2019 and 2.24% in 2018.

At December 31, 2020, there were no holdings of any one issuer, other than the U.S. Government sponsored entities, in an amount greater than 10% of the Company’s shareholders’ equity.

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Loans and Leases

Table 4 - Composition of Loan and Lease Portfolio

Loans and Leases As of December 31,

Commercial and industrial

Commercial real estate

Residential real estate

Consumer and other

Total loans and leases of $5.3 billion at December 31, 2020 were up $342.8 million or 7.0% from December 31, 2019. The growth was mainly in PPP loans, which totaled $291.3 million at year-end 2020. As of December 31, 2020, total loans and leases represented 69.0% of total assets compared to 73.1% of total assets at December 31, 2019.

Residential real estate loans, including home equity loans, of $1.4 billion at December 31, 2020, increased by $58.2 million or 4.2% from $1.4 billion at year-end 2019, and comprised 27.3% of total loans and leases at December 31, 2020. Growth in residential loan balances is impacted by the Company’s decision to retain these loans or sell them in the secondary market due to interest rate considerations. The Company’s Asset/Liability Committee meets regularly and establishes standards for selling and retaining residential real estate mortgage originations.

The Company may sell residential real estate loans in the secondary market based on interest rate considerations. These residential real estate loans are generally sold to Federal Home Loan Mortgage Corporation (“FHLMC”) or State of New York Mortgage Agency (“SONYMA”) without recourse in accordance with standard secondary market loan sale agreements. These residential real estate loans also are subject to customary representations and warranties made by the Company, including representations and warranties related to gross incompetence and fraud. The Company has not had to repurchase any loans as a result of these representations and warranties.

During 2020, 2019, and 2018, the Company sold residential mortgage loans totaling $51.7 million, $16.9 million, and $27.7 million, respectively, and realized net gains on these sales of $2.1 million, $227,000, and $458,000, respectively. The increase in sold residential mortgage loans was mainly due to a higher volume of originated loans in 2020 compared to 2019. The higher volume sold coupled with higher premiums paid on sold loans resulted in higher net gains on the sales of residential mortgage loans. When residential mortgage loans are sold to FHLMC or SONYMA, the Company typically retains all servicing rights, which provides the Company with a source of fee income. In connection with the sales in 2020, 2019, and 2018, the Company recorded mortgage-servicing assets of $388,000, $127,000, and $207,000, respectively.

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The Company originates fixed rate and adjustable rate residential mortgage loans, including loans that have characteristics of both, such as a 7/1 adjustable rate mortgage, which has a fixed rate for the first seven years and then adjusts annually thereafter. The majority of residential mortgage loans originated over the last several years have been fixed rate given the low interest rate environment. Adjustable rate residential real estate loans may be underwritten based upon an initial rate which is below the fully indexed rate; however, the initial rate is generally less than 100 basis points below the fully indexed rate. As such, the Company does not believe that this practice creates any significant credit risk.

Commercial real estate loans totaled $2.6 billion at December 31, 2020, an increase of $125.6 million or 5.1% compared to December 31, 2019, and represented 48.8% of total loans and leases at December 31, 2020, compared to 49.7% at December 31, 2019.

Commercial and industrial loans totaled $1.2 billion at December 31, 2020, which is an increase of $170.7 million or 16.9% from December 31, 2019. Commercial and industrial loans represented 22.4% of total loans at December 31, 2020 compared to 20.5% at December 31, 2019. The increase at year-end 2020 over year-end 2019 was mainly due to PPP loan originations. In the second quarter of 2020, the Company funded $465.6 million of PPP loans. At December 31, 2020, PPP loans totaled $291.3 million, with the decrease reflecting loans forgiven by the SBA. The PPP provides borrower guarantees for lenders, as well as loan forgiveness incentives for borrowers that utilize the loan proceeds to cover employee compensation-related expenses and certain other eligible business operating costs, all in accordance with the rules and regulations established by the SBA. On January 11, 2021, the SBA reactivated the PPP. The Company's banking subsidiaries have originated additional PPP loans through the PPP, which is currently scheduled to extend through March 31, 2021. As of February 21, 2021, the Company had submitted 1,341 PPP loan applications totaling $171.0 million under the 2021 PPP authorization.

As of December 31, 2020, agriculturally-related loans totaled $296.4 million or 5.6% of total loans and leases compared to $290.7 million or 5.9% of total loans and leases at December 31, 2019. Agriculturally-related loans include loans to dairy farms and cash and vegetable crop farms. Agriculturally related loans are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral, personal guarantees, and government related guarantees. Agriculturally-related loans are generally secured by the assets or property being financed or other business assets such as accounts receivable, livestock, equipment or commodities/crops.

The consumer loan portfolio includes personal installment loans, indirect automobile financing, and overdraft lines of credit. Consumer and other loans were $69.8 million at December 31, 2020, compared to $74.4 million at December 31, 2019.

The lease portfolio decreased by 18.0% to $14.2 million at December 31, 2020 from $17.3 million at December 31, 2019. As of December 31, 2020, commercial leases and municipal leases represented 100.0% of total leases.

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures. There were no significant changes to the Company’s existing policies, underwriting standards and loan review during 2020. The Company’s Board of Directors approves the lending policies at least annually. The Company recognizes that exceptions to policy guidelines may occasionally occur and has established procedures for approving exceptions to these policy guidelines. Management has also implemented reporting systems to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans.

The Company’s loan and lease customers are located primarily in the New York and Pennsylvania communities served by its four subsidiary banks. Although operating in numerous communities in New York State and Pennsylvania, the Company is still dependent on the general economic conditions of these states. The suspension of business activities in our market area has led to a significant increase in unemployment rates and has had a negative effect on our customers. There continues to be a great deal of uncertainty regarding how long those conditions will continue to exist. As a result, the economic consequences of the pandemic on our market area generally and on the Company in particular continue to be difficult to quantify. Other than geographic and general economic risks, management is not aware of any material concentrations of credit risk to any industry or individual borrower.

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Analysis of Past Due and Nonperforming Loans

As of December 31,

Loans 90 days past due and accruing1

Consumer and other $ 0 $ 0 $ 0 $ 44 $ 0

Total loans 90 days past due and accruing 0 0 0 44 0

Nonaccrual loans

1 The 2019, 2018, 2017 and 2016 columns in the above table exclude $794,000, $1.3 million, $1.1 million, and $2.6 million, respectively, of acquired loans that are 90 days past due and accruing interest. These loans were originally recorded at fair value on the acquisition date of August 1, 2012. These loans are considered to be accruing as the Company can reasonably estimate future cash flows on these acquired loans and the Company expects to fully collect the carrying value of these loans. Therefore, the Company is accreting the difference between the carrying value of these loans and their expected cash flows into interest income.

The level of nonperforming assets at the past five year-ends is illustrated in the table above. The Company’s total nonperforming assets as a percentage of total assets was 0.60% at December 31, 2020, up from 0.47% at December 31, 2019, and compares to its peer group's most recent ratio of 0.51% at September 30, 2020. The peer data is from the Federal Reserve Board and represents banks or bank holding companies with assets between $3.0 billion and $10.0 billion. A breakdown of nonperforming loans by portfolio segment is shown above. Nonperforming loans totaled $45.8 million at December 31, 2020 and were up 45.6% from December 31, 2019. Nonperforming loans represented 0.87% of total loans at December 31, 2020, compared to 0.64% of total loans at December 31, 2019, and 0.55% of total loans at December 31, 2018. The increase in nonperforming loans was mainly in the commercial real estate and residential real estate portfolios, and a result of unfavorable economic conditions related to the COVID-19 pandemic. Nonperforming loans in the commercial real estate portfolio at year-end 2020 increased by $12.8 million compared to 2019; the increase was mainly due to one credit totaling $11.8 million in the hospitality industry that was downgraded to Substandard and placed on nonaccrual status in the fourth quarter of 2020. The loan is also currently in the Company's deferral payment program. At December 31, 2020, other real estate owned was down $340,000 from prior year-end and represented 0.2% of total nonperforming assets, down from 1.3% at December 31, 2019. The decrease in other real estate owned was mainly a result of sales during 2020.

The Company implemented a payment deferral program to assist both consumer and business borrowers that may be experiencing financial hardship due to COVID-19. Weekly deferral requests for the month of December were down 98.5% from peak levels the Company experienced in late March. As of December 31, 2020, total loans, impacted by COVID-19 and that continued in a deferral status amounted to approximately $212.2 million, representing 4.0% of total loans. Loans to finance hotels and motels comprise approximately 53.0% of total loans that continue in deferral status. Of loans that had come out of the deferral program as of December 31, 2020, about 94.4% had made at least one payment and only 0.13% were more than 30 days delinquent.

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Loans are considered modified in a troubled debt restructuring (“TDR”) when, due to a borrower’s financial difficulties, the Company makes a concession(s) to the borrower that the Company would not otherwise consider. When modifications are provided for reasons other than as a result of the financial distress of the borrower, these loans are not classified as TDRs or impaired. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity. TDRs are included in the above table within the following categories: “loans 90 days past due and accruing”, “nonaccrual loans”, or “troubled debt restructurings not included above”. Loans in the latter category include loans that meet the definition of a TDR but are performing in accordance with the modified terms and have shown a satisfactory period of repayment (generally six consecutive months) and where full collection of all is reasonably assured. At December 31, 2020, the Company had $8.5 million in TDR balances, which are included in the above table, of which $6.8 million are included in the line captioned “Troubled debt restructurings not included above” and the remainder are included within nonaccrual loans.

In general, the Company places a loan on nonaccrual status if principal or interest payments become 90 days or more past due and/or management deems the collectability of the principal and/or interest to be in question, as well as when called for by regulatory requirements. Although in nonaccrual status, the Company may continue to receive payments on these loans. These payments are generally recorded as a reduction to principal and interest income is recorded only after principal recovery is reasonably assured. For additional financial information on the difference between the interest income that would have been recorded if these loans and leases had been paid in accordance with their original terms and the interest income that was recorded, refer to “Note 3 – Loans and Leases” in the Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

The Company’s recorded investment in loans and leases that are individually evaluated totaled $32.18 million at December 31, 2020, and $19.4 million at December 31, 2019. A loan is individually evaluated when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Individually evaluated loans consist of our non-homogenous nonaccrual loans and loans that are 90 days or more past due. Specific reserves on individually evaluated loans that are not collateral dependent are measured based on the present value of expected future cash flows discounted at the original effective interest rate of each loan. For loans that are collateral dependent, impairment is measured based on the fair value of the collateral less estimated selling costs, and such impaired amounts are generally charged off.

At December 31, 2020, there were specific reserves of $308,000 on four commercial real estate loans and five commercial loans, compared to $907,000 of specific reserves on seven commercial real estate loans at December 31, 2019. The majority of the individually evaluated loans are collateral dependent loans that have limited exposure or require limited specific reserves because of the amount of collateral support with respect to these loans or the loans have been written down to fair value. Interest payments on individually evaluated loans are typically applied to principal unless collectability of the principal amount is reasonably assured. In these cases, interest is recognized on a cash basis. There was no interest income recognized on individually evaluated loans and leases for 2020, 2019 and 2018.

The ratio of the allowance to nonperforming loans (loans past due 90 days and accruing, nonaccrual loans and restructured troubled debt) was 112.87% at December 31, 2020, compared to 126.90% at December 31, 2019. The Company’s nonperforming loans are mostly made up of collateral dependent loans requiring little to no specific allowance due to the level of collateral available with respect to these loans and/or previous charge-offs.

Management reviews the loan portfolio for evidence of potential problem loans and leases. Potential problem loans and leases are loans and leases that are currently performing in accordance with contractual terms, but where known information about possible credit problems of the related borrowers causes management to have doubt as to the ability of such borrowers to comply with the present loan payment terms and may result in such loans and leases becoming nonperforming at some time in the future. Management considers loans and leases classified as Substandard, which continue to accrue interest, to be potential problem loans and leases. The Company, through its credit administration function, identified 35 commercial relationships totaling $40.8 million at December 31, 2020 that were potential problem loans. At December 31, 2019, there were 41 relationships totaling $44.0 million in the loan portfolio that were considered potential problem loans. Of the 35 commercial relationships from the portfolio that were classified as potential problem loans at December 31, 2020, there were 12 relationships that equaled or exceeded $1.0 million, which in aggregate totaled $36.1 million. The potential problem loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and personal or government guarantees. These factors, when considered in the aggregate, give management reason to believe that the current risk exposure on these loans does not warrant accounting for these loans as nonperforming. However, these loans do exhibit certain risk factors, which have the potential to cause them to become nonperforming. Accordingly, management’s attention is focused on these credits, which are reviewed on at least a quarterly basis.

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The Allowance for Credit Losses

Management reviews the appropriateness of the ACL on a regular basis. Management considers the accounting policy relating to the allowance to be a critical accounting policy, given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that assumptions could have on the Company’s results of operations. The Company has developed a methodology to measure the amount of estimated credit loss exposure inherent in the loan portfolio to assure that an appropriate allowance is maintained. The Company’s methodology is based upon guidance provided in SEC Staff Accounting Bulletin No. 119, Measurement of Credit Losses on Financial Instruments ("CECL"), and Financial Instruments - Credit Losses and ASC Topic 326, Financial Instruments - Credit Losses.

The Company uses a discounted cash flow ("DCF") method to estimate expected credit losses for all loan segments excluding the leasing segment. For each of these loan segments, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, curtailments, recovery lag probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery are based on internal historical data.

The Company uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. For all loans utilizing the DCF method, management utilizes and forecasts national unemployment and a one year percentage change in national gross domestic product as loss drivers in the model.

For all DCF models, management has determined that four quarters represents a reasonable and supportable forecast period and reverts back to a historical loss rate over eight quarters on a straight-line basis. Management leverages economic projections from a reputable and independent third party to inform its loss driver forecasts over the four-quarter forecast period. Other internal and external indicators of economic forecasts, and scenario weightings, are also considered by management when developing the forecast metrics.

Due to the size and characteristics of the leasing portfolio, the Company uses the remaining life method, using the historical loss rate of the commercial and industrial segment, to determine the allowance for credit losses.

The combination of adjustments for credit expectations and timing expectations produces an expected cash flow stream at the instrument level. Instrument effective yield is calculated, net of the impacts of prepayment assumptions, and the instrument expected cash flows are then discounted at that effective yield to produce a net present value of expected cash flows ("NPV"). An ACL is established for the difference between the NPV and amortized cost basis.

The Company adopted ASU 2016-13 using the prospective transition approach for financial assets purchased with credit deterioration ("PCD") that were previously classified as purchased credit impaired ("PCI") and accounted for under ASC 310-30. In accordance with the standard, the Company did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. The remaining discount on the PCD assets will be accreted into interest income on a level-yield method over the life of the loans.

Since the methodology is based upon historical experience and trends, current conditions, and reasonable and supportable forecasts, as well as management’s judgment, factors may arise that result in different estimates. While management’s evaluation of the allowance as of December 31, 2020, considers the allowance to be appropriate, under adversely different conditions or assumptions, the Company would need to increase or decrease the allowance. In addition, various federal and State regulatory agencies, as part of their examination process, review the Company's allowance and may require the Company to recognize additions to the allowance bases on their judgements and information available to them at the time of their examinations.

Loan Commitments and Allowance for Credit Losses on Off-Balance Sheet Credit Exposures

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans, and commercial letters of credit. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to credit loss expense for off-balance sheet credit exposures included in other noninterest expense in the Company's consolidated statements of income.

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As of December 31, 2020, the Company's reserve for off-balance sheet credit exposures was $1.9 million, compared to $477,000 at December 31, 2019. As a result of the adoption of ASC 326, the Company recorded a net cumulative-effect adjustment increasing the allowance for credit losses on off-balance sheet credit exposures by $381,000 from $477,000 at December 31, 2019, to $858,000 at January 1, 2020.

The allocation of the Company’s allowance as of December 31, 2020, and each of the previous four years is illustrated in Table 5- Allocation of the Allowance for Credit Losses, below. The table represents the allowance for credit losses calculated under the new accounting guidance as of December 31, 2020, and the prior period show amounts calculated under the incurred loss methodology calculation used prior to adoption. The table provides an allocation of the allowance for credit losses for inherent loan losses by type. The allocation is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of future loss trends. The allocation of the allowance for credit losses to each category does not restrict the use of the allowance to absorb losses in any category.

Table 5 - Allocation of the Allowance for Credit Losses

As of December 31,

Allocation of the ACL by loan type:

Allocation of the ACL as a percentage of total allowance:

Consumer and other 3 % 3 % 3 % 3 % 3 %

Leases 0 % 0 % 0 % 0 % 0 %

Loan and lease types as a percentage of total loans and leases:

Consumer and other 1 % 1 % 1 % 1 % 1 %

Leases 0 % 0 % 0 % 0 % 0 %

The five year trend in the allowance is shown above. Over the three year period between 2016 through 2018, the allowance steadily increased driven in large part by growth in loans. The increase in 2018 was also a result of specific reserve allocations for one commercial real estate relationship. This credit was charged off during 2019, which contributed to the decrease in the allowance from year-end 2018 to year-end 2019.

As a result of the adoption of ASU 2016-13, the Company recorded a net cumulative-effect adjustment reducing the allowance for credit losses by $2.5 million from $39.9 million at December 31, 2019 to $37.4 million at January 1, 2020. As of December 31, 2020, the total allowance for credit losses was $51.7 million, which was up $11.8 million or 29.5% from year-end 2019. The $14.3 million increase in the allowance at December 31, 2020, compared to January 1, 2020 was mainly due to a $14.9 million increase in the provision expense driven by changes in economic conditions and forecasts related to the impact of COVID-19, including forecasts of significantly slower economic growth and higher unemployment. The majority of the increase in the allowance and provision expense in 2020 was in the first quarter of 2020. The allowance was relatively flat

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between June 30, 2020 and December 31, 2020, as lower estimated reserves driven by improvements in forecasts for unemployment and the gross domestic product used in our model were offset by increases in qualitative reserves for loans within the hospitality and certain other industries that may have an elevated level of risk due to the adverse economic impact of the COVID-19 pandemic, as well as loans that remain in the Company's payment deferral program implemented in response to the COVID-19 pandemic. The qualitative reserves were added to all portfolio segments with the majority in commercial real estate and then residential real estate.

Total loans were $5.3 billion at December 31, 2020, up $342.8 million or 7.0% from December 31, 2019. The increase from year-end 2019 included $465.6 million of PPP loans originated in the second quarter of 2020. Since the PPP loans are guaranteed by the SBA, there are no reserves allocated to these loans. Credit quality metrics at December 31, 2020, were mixed compared to year-end 2019. Nonperforming assets represented 0.60% of total assets at December 31, 2020, compared to 0.47% at December 31, 2019. Nonperforming loans and leases were up $14.3 million or 45.6% from year end 2019 and represented 0.87% of total loans at December 31, 2020 compared to 0.64% at December 31, 2019. Loans internally-classified Special Mention or Substandard were up $99.6 million or 110.3% compared to December 31, 2019. The increase over December 31, 2019, was mainly a result of the downgrade of loans in the hospitality industry, reflecting cash flow stress related to the pandemic-related business and travel restrictions and social distancing guidelines. Many of these hospitality loans are in the Company's payment deferral program and are included in the estimate of qualitative reserves.

Table 6 - Analysis of the Allowance for Credit Losses

December 31,

Loans charged-off:

Recoveries of loans previously charged-off:

The above table shows a fairly stable level of gross loan charge-offs over the period, with the increase in 2019 mainly related to a $3.3 million charge-off related to one commercial real estate loan. The higher level of loan recoveries in 2016 to 2018 was mainly a result of recoveries on two large commercial/commercial real estate relationships that were charged off in 2011 and 2012. Provision expense was stable between 2016 and 2018. For 2019, favorable trends in certain qualitative factors, lower

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historical loss rates in all loan portfolios except for commercial real estate at year-end 2019 compared to year-end 2018, and lower specific reserves for impaired loans contributed to the lower allowance level at December 31, 2019 compared to December 31, 2018 and a decrease in provision expense in 2019 compared to 2018. As mentioned above, the $16.2 million provision expense in 2020 was driven by changes in economic conditions and forecasts related to the impact of COVID-19, including forecasts of significantly slower economic growth and higher unemployment. The majority of the increase in the allowance and provision expense in 2020 was in the first quarter of 2020.

The ratio of the allowance for credit losses as a percentage of total loans was 0.98% at year-end 2020 compared to 0.81% at year-end 2019. The allowance coverage to nonperforming loans and leases was 112.87% at December 31, 2020 compared to 126.90% at December 31, 2019. Management believes that, based upon its evaluation as of December 31, 2020, the allowance is appropriate.

Deposits and Other Liabilities

Total deposits were $6.4 billion at December 31, 2020, up $1.2 billion or 23.5% compared to year-end 2019. The increase from year-end 2019 consisted of savings and money market balances, noninterest bearing deposits, and time deposits up $681.2 million, $472.4 million, and $71.2 million, respectively. Deposit balances during 2020 benefited from the $465.6 million of PPP loan originations during the second quarter of 2020, the majority of which were deposited in Tompkins checking accounts. The growth also included short-term brokered deposits. In April 2020, the Company obtained $295.0 million of short-term brokered deposits and actively increased liquid assets to further strengthen the Company's liquidity position in response to the economic uncertainty related to the COVID-19 pandemic. Of the $295.0 million of brokered deposits, $95.0 million matured and were paid in the fourth quarter of 2020; the remaining $200.0 million mature in April 2021.

The most significant source of funding for the Company is core deposits. The Company defines core deposits as total deposits less time deposits of $250,000 or more, brokered deposits, municipal money market deposits and reciprocal deposit relationships with municipalities. Core deposits increased by $863.8 million or 20.1% to $5.2 billion at year-end 2020 from $4.3 billion at year-end 2019. Core deposits represented 80.1% of total deposits at December 31, 2020, compared to 82.3% of total deposits at December 31, 2019.

Municipal money market accounts and reciprocal deposit relationships with municipalities totaled $685.6 million at year-end 2020, which increased 11.3% over year-end 2019. In general, there is a seasonal pattern to municipal deposits starting with a low point during July and August. Account balances tend to increase throughout the fall and into the winter months from tax deposits and receive an additional inflow at the end of March from the electronic deposit of state funds.

Table 1-Average Statements of Condition and Net Interest Analysis, shows the average balance and average rate paid on the Company’s primary deposit categories for the years ended December 31, 2020, 2019, and 2018. Average interest-bearing deposits in 2020 increased $671.0 million or 18.2% when compared to 2019. The average cost of interest-bearing deposits was 0.46% for 2020 and 0.84% for 2019. Average noninterest bearing deposits for 2020 were up $349.9 million or 24.9% over 2019. A maturity schedule of time deposits outstanding at December 31, 2020 is included in “Note 7 Deposits” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

The Company uses both retail and wholesale repurchase agreements. Retail repurchase agreements are arrangements with local customers of the Company, in which the Company agrees to sell securities to the customer with an agreement to repurchase those securities at a specified later date. Retail repurchase agreements totaled $65.8 million at December 31, 2020, and $60.3 million at December 31, 2019. Management generally views local repurchase agreements as an alternative to large time deposits. Refer to “Note 8 Federal Funds Purchased and Securities Sold Under Agreements to Repurchase” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report for further details on the Company’s repurchase agreements.

The Company’s other borrowings totaled $265.0 million at year-end 2020, which was $393.1 million below prior year end. The decrease in borrowings was due to core deposit growth, municipal deposit growth, and an increase in brokered deposits from year-end 2019. The $265.0 million in borrowings at December 31, 2020, represented term advances from the FHLB. Borrowings of $658.1 million at year-end 2019 included $239.1 million in overnight advances from the FHLB, $415.0 million of FHLB term advances, and a $4.0 million advance from a bank. Of the $265.0 million in FHLB term advances at year-end 2020, $235.0 million are due in over one year. Refer to “Note 9 - Other Borrowings” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report for further details on the Company’s term borrowings with the FHLB.

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Liquidity Management

As of December 31, 2020, the Company had not experienced any significant impact on our liquidity or funding capabilities as a result of the COVID-19 pandemic. As previously noted, the Company participated in the SBA's PPP. The Company began accepting applications for PPP loans on April 3, 2020, and funded 2,998 PPP loans during the second quarter of 2020. Outstanding PPP loans totaled $291.3 million as of December 31, 2020. The majority of the PPP loan proceeds were deposited into accounts at Tompkins, which contributed to the deposit growth in the second quarter of 2020. In April 2020, the Company obtained $295.0 million of short-term brokered deposits and actively increased liquid assets to further strengthen the Company's position with the goal of guarding against economic uncertainty related to the COVID-19 pandemic. The Company has a long-standing liquidity plan in place that is designed to ensure that appropriate liquidity resources are available to fund the balance sheet. Additionally, given the uncertainties related to the impact of the COVID-19 crisis on liquidity, the Company has confirmed the availability of funds at the FHLB of NY and FHLB of Pittsburgh, completed actions required to activate participation in the Federal Reserve Bank PPP lending facility, and confirmed availability of Federal Fund lines with correspondent bank partners.

The objective of liquidity management is to ensure the availability of adequate funding sources to satisfy the demand for credit, deposit withdrawals, operating expenses, and business investment opportunities. The Company’s large, stable core deposit base and strong capital position are the foundation for the Company’s liquidity position. The Company uses a variety of resources to meet its liquidity needs, which include deposits, cash and cash equivalents, short-term investments, cash flow from lending and investing activities, repurchase agreements, and borrowings. The Company may also use borrowings as part of a growth strategy. Asset and liability positions are monitored primarily through the Asset/Liability Management Committee of the Company’s subsidiary banks. This Committee reviews periodic reports on the liquidity and interest rate sensitivity positions. Comparisons with industry and peer groups are also monitored. The Company’s strong reputation in the communities it serves, along with its strong financial condition, provides access to numerous sources of liquidity as described below. Management believes these diverse liquidity sources provide sufficient means to meet all demands on the Company’s liquidity that are reasonably likely to occur.

Core deposits, discussed above under “Deposits and Other Liabilities”, are a primary and low cost funding source obtained primarily through the Company’s branch network. In addition to core deposits, the Company uses non-core funding sources to support asset growth. These non-core funding sources include time deposits of $250,000 or more, brokered time deposits, municipal money market deposits, reciprocal deposits, bank borrowings, securities sold under agreements to repurchase, overnight borrowings and term advances from the FHLB and other funding sources. Rates and terms are the primary determinants of the mix of these funding sources.

Non-core funding sources totaled $1.6 billion at December 31, 2020, a decrease of $26.6 million or 1.6% from $1.6 billion at December 31, 2019. The decrease reflects the pay down of FHLB borrowings, partially offset by the increase in brokered deposits mentioned above under "Deposits and Other Liabilities". Non-core funding sources decreased year-over-year as the Company experienced sufficient growth in core deposits to fund earning asset growth. Non-core funding sources as a percentage of total liabilities decreased from 27.1% at year-end 2019 to 23.4% at year-end 2020.

Non-core funding sources may require securities to be pledged against the underlying liability. Securities carried at $1.2 billion at December 31, 2020 and 2019, were either pledged or sold under agreements to repurchase. Pledged securities or securities sold under agreements to repurchase represented 75.3% of total securities at December 31, 2020, compared to 89.7% of total securities at December 31, 2019.

Cash and cash equivalents totaled $388.5 million as of December 31, 2020, up from $138.0 million at December 31, 2019. Short-term investments, consisting of securities due in one year or less, decreased from $108.1 million at December 31, 2019, to $55.0 million at December 31, 2020.

Cash flow from the loan and investment portfolios provides a significant source of liquidity. These assets may have stated maturities in excess of one year, but they have monthly principal reductions. Total mortgage-backed securities, at fair value, were $887.6 million at December 31, 2020 compared with $824.0 million at December 31, 2019. Outstanding principal balances of residential mortgage loans, consumer loans, and leases totaled approximately $1.5 billion at December 31, 2020 compared to $1.5 billion at December 31, 2019. Aggregate amortization from monthly payments on these assets provides significant additional cash flow to the Company.

Liquidity is enhanced by ready access to national and regional wholesale funding sources including Federal funds purchased, repurchase agreements, brokered certificates of deposit, and FHLB advances. Through its subsidiary banks, the Company has

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borrowing relationships with the FHLB and correspondent banks, which provide secured and unsecured borrowing capacity. At December 31, 2020, the unused borrowing capacity on established lines with the FHLB was $2.1 billion.

As members of the FHLB, the Company’s subsidiary banks can use certain unencumbered mortgage-related assets and securities to secure additional borrowings from the FHLB. At December 31, 2020, total unencumbered mortgage loans and securities of the Company were $1.6 billion. Additional assets may also qualify as collateral for FHLB advances upon approval of the FHLB.

The Company has not identified any trends or circumstances that are reasonably likely to result in material increases or decreases in liquidity in the near term.

Table 7 - Loan Maturity

Remaining maturity of loans December 31, 2020

(In thousands) Total Less than 1 year After 1 year to 5 years After 5 years

Of the loan amounts shown above in Table 7 - Loan Maturity, maturing over 1 year, $2.3 billion have fixed rates and $2.5 billion have adjustable rates.

Off-Balance Sheet Arrangements

In the normal course of business, the Company is party to certain financial instruments, which in accordance with accounting principles generally accepted in the United States, are not included in its Consolidated Statements of Condition. These transactions include commitments under standby letters of credit, unused portions of lines of credit, and commitments to fund new loans and are undertaken to accommodate the financing needs of the Company’s customers. Loan commitments are agreements by the Company to lend monies at a future date. These loan and letter of credit commitments are subject to the same credit policies and reviews as the Company’s loans. Because most of these loan commitments expire within one year from the date of issue, the total amount of these loan commitments as of December 31, 2020, are not necessarily indicative of future cash requirements. Further information on these commitments and contingent liabilities is provided in “Note 17 Commitments and Contingent Liabilities” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report.

Contractual Obligations

The Company leases land, buildings, and equipment under operating lease arrangements extending to the year 2090. Most leases include options to renew for periods ranging from 5 to 20 years. In addition, the Company has a software contract for its core banking application through June 30, 2024 along with contracts for more specialized software programs through 2021. Further information on the Company’s lease arrangements is provided in “Note 6 Premises and Equipment” in Notes to Consolidated Financial Statements in Part II, Item 8. of this Report. The Company’s contractual obligations as of December 31, 2020, are shown in Table 8-Contractual Obligations and Commitments below.

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Table 8 - Contractual Obligations and Commitments

Contractual cash obligations At December 31, 2020Payments due within

(In thousands) Total 1 year 1-3 years 3-5 years After 5 years

1 Dollar amounts include interest payments and contractual payments due until maturity without conversion to stock or early redemption for the remainder of the Company's Trust Preferred Debentures.

2 Operating leases include renewals the Company considers reasonably certain to exercise.

Non-GAAP Disclosure

The following table summarizes the Company’s results of operations on a GAAP basis and on an operating (non-GAAP) basis for the periods indicated. The non-GAAP financial measures adjust GAAP measures to exclude the effects of non-operating items, such as acquisition related intangible amortization expense, and significant nonrecurring income or expense on earnings, equity, and capital. The Company believes the non-GAAP measures provide meaningful comparisons of our underlying operational performance and facilitate management's and investors' assessments of business and performance trends in comparison to others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a measure of the Company's profitability or liquidity; they are in addition to, and are not a substitute for, financial measures under GAAP. The non-GAAP financial measures presented herein may be different from non-GAAP financial measures used by other companies, and may not be comparable to similarly titled measures reported by other companies. In the future, the Company may utilize other measures to illustrate performance. Non-GAAP financial measures have limitations since they do not reflect all of the amounts associated with the Company's results of operations as determined in accordance with GAAP.

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For the year ended December 31,

Adjustments for non-operating income and expense:

Gain on sale of real estate 0 0 (2,950) 0 0

Write-down of impaired leases 0 0 2,536 0 0

Remeasurement of deferred taxes 0 0 0 14,944 0

Write-down of real estate pending sale 673 0 0 0 0

Newly Adopted Accounting Standards

ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 was effective for the Company on January 1, 2020. Upon adoption, a cumulative effect adjustment for the change in the allowance for credit losses was recognized in

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retained earnings. The cumulative-effect adjustment to retained earnings, net of taxes, is comprised of the impact on the allowance for credit losses on outstanding loans and leases and the impact on the liability for off-balance sheet commitments. The Company adopted ASU 2016-13 on January 1, 2020 using the modified retrospective approach. Results for the periods beginning after January 1, 2020 are presented under Accounting Standards Codification (“ASC”) 326, while prior period amounts continue to be reported in accordance with previously applicable US GAAP. The Company recorded a net increase to retained earnings of $1.7 million, upon adoption. The transition adjustment includes a decrease in the allowance for credit losses on loans of $2.5 million, and an increase in the allowance for credit losses on off-balance sheet credit exposures of $0.4 million, net of the corresponding decrease in deferred tax assets of $0.4 million.

The Company adopted ASU 2016-13 using the prospective transition approach for financial assets purchased with credit deterioration (“PCD”) that were previously classified as purchased credit impaired (“PCI”) and accounted for under ASC 310-30. In accordance with the standard, the Company did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. The remaining discount on the PCD assets was determined to be related to noncredit factors and will be accreted into interest income on a level-yield method over the life of the loans.

ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compute the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 was effective for the Company on January 1, 2020 and did not have a material impact on our consolidated financial statements.

ASU 2018-13, “Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 was effective for the Company on January 1, 2020, and did not have a significant impact on our consolidated financial statements.

ASU 2018-14, “Compensation - Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20).” ASU 2018-14 amends and modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans. The amendments in this update remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU 2018-14 became effective for us on December 31, 2020, and did not have a significant impact on our consolidated financial statements. The Company updated its disclosures at December 31, 2020, to comply with the amended guidance.

ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 clarifies certain aspects of ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 does not affect the accounting for the service element of a hosting arrangement that is a service contract. ASU 2018-15 was effective for the Company on January 1, 2020, and did not have a significant impact on our consolidated financial statements.

ASU 2020-03 "Codification Improvements to Financial Instruments." ASU 2020-03 revised a wide variety of topics in the Codification with the intent to make the Codification easier to understand and apply by eliminating inconsistencies and providing clarifications. ASU 2020-03 was effective immediately upon its release in March 2020 and did not have a significant impact on our consolidated financial statements.

Accounting Standards Pending Adoption

ASU No 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU 2019-12 removes certain exceptions to the general principles in Topic 740 in Generally Accepted Accounting Principles. ASU 2019-12 is effective for public entities for fiscal years beginning after December 15, 2020, with early adoption permitted. Tompkins is currently evaluating the potential impact of ASU 2019-12 on our consolidated financial statements.

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ASU No. 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." The amendments in this update provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. Tompkins is currently evaluating the potential impact of ASU 2020-04 on our consolidated financial statements.

Fourth Quarter Summary

Net income was $24.0 million for the fourth quarter of 2020 , compared to $21.1 million reported for the same period in 2019. Diluted earnings per share of $1.61 for the fourth quarter of 2020 were up 15.0% from $1.40 in the fourth quarter of 2019.

Net interest income was $57.8 million for the fourth quarter of 2020, compared to $53.2 million reported for the same period in 2019. The net interest margin for the fourth quarter of 2020 was 3.12%, down from the 3.44% reported for the quarter ended December 31, 2019, and 3.26% for the third quarter of 2020.

Net interest income benefited from lower funding costs and growth in average earning assets and average deposits. The cost of interest bearing liabilities for the fourth quarter of 2020 was 0.45% compared to 1.03% for the fourth quarter of 2019. The decrease reflects lower market interest rates as well as an improved funding mix as a result of deposit growth and the pay down of borrowings. Average earnings assets for the fourth quarter of 2020 were up $1.2 billion, or 19.7% compared to the fourth quarter of 2019. Average loans, average securities, and average interest bearing balances due from banks for the fourth quarter of 2020 increased by $447.1 million or 9.2%, $344.5 million or 26.7%, and $437.0 million, respectively, over the same quarter in the prior year. The growth in average earning assets was offset by a decrease in the average yield on earning assets from 4.17% for the fourth quarter of 2019 to 3.43% for the fourth quarter of 2020. The decrease in the yield on average assets for the fourth quarter of 2020 compared to the fourth quarter of 2019 reflects lower market interest rates and an increase in the mix of lower yielding securities and cash balances as a percentage of average earning assets for 2020 compared to 2019.

Average deposits for the fourth quarter of 2020 increased $1.3 billion, or 24.0% compared to the same period in 2019. Included in the growth of average deposits for the fourth quarter of 2020 was a $442.4 million or 30.1% increase in average noninterest bearing deposits over the fourth quarter of 2019.

Provision for credit losses for the fourth quarter of 2020 was $6,000 compared to a negative $1.0 million for the same period in 2019. Net charge-offs for the fourth quarter of 2020 were $630,000 compared to net charge-offs of $479,000 reported in the fourth quarter of 2019.

Noninterest income of $18.8 million for the fourth quarter of 2020 was up 4.8% compared to the same period in 2019. The increase was mainly in insurance commissions and fees, investment services income and gains on sales of residential real estate loans. Investment services income in the fourth quarter of 2020 benefited from fees related to the settlement of a large estate. These increases were partially offset by lower service charges on deposit accounts, mainly due to a decrease in overdraft fees, resulting from a decline in the volume of overdrafts related to the COVID-19 pandemic.

Noninterest expense was $46.4 million for the fourth quarter of 2020, up $505,000, or 1.1%, over the fourth quarter of 2019.

Income tax expense for the fourth quarter of 2020 was $6.1 million compared to $5.2 million for the fourth quarter of 2019. The Company's effective tax rate was 20.4% for the fourth quarter of 2020, compared to 19.8% for the same period in 2019.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market Risk

Interest rate risk is the primary market risk category associated with the Company’s operations. Interest rate risk refers to the volatility of earnings caused by changes in interest rates. The Company manages interest rate risk using income simulation to measure interest rate risk inherent in its on-balance sheet and off-balance sheet financial instruments at a given point in time. The simulation models are used to estimate the potential effect of interest rate shifts on net interest income for future periods. Each quarter the Company’s Asset/Liability Management Committee reviews the simulation results to determine whether the exposure of net interest income to changes in interest rates remains within Board-approved levels. The Committee also discusses strategies to manage this exposure and incorporates these strategies into the investment and funding decisions of the

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Company. The Company does not currently use derivatives, such as interest rate swaps, to manage its interest rate risk exposure, but may consider such instruments in the future.

The Company’s Board of Directors has set a policy that interest rate risk exposure will remain within a range whereby net interest income will not decline by more than 10% in one year as a result of a 100 basis point parallel change in rates. Based upon the simulation analysis performed as of November 30, 2020, a 200 basis point parallel upward change in interest rates over a one-year time frame would result in a one-year decrease in net interest income of approximately 2.0% from the base case, while a 100 basis point parallel decline in interest rates over a one-year period would result in a one-year decrease in net interest income of approximately 0.7% from the base case. The simulation assumes no balance sheet growth and no management action to address balance sheet mismatches.

The decrease in net interest income in the rising rate scenario is a result of the balance sheet showing a more liability sensitive position over a one year time horizon. As such, in the short-term net interest income is expected to trend slightly below the base assumption, as upward adjustments to rate sensitive deposits and short-term funding outpace increases to asset yields which are concentrated in intermediate to longer-term products. As intermediate and longer-term assets continue to reprice/adjust into higher rate environment and funding costs stabilize, net interest income is expected to trend upwards.

The down 100 basis point scenario decreases net income slightly in the first year as a result of the Company's assets repricing downward to a greater degree than the rates on the Company's interest-bearing liabilities, mainly deposits and overnight borrowings. Rates on savings and money market accounts have moved down in the last 3 months, approaching historically low levels, allowing for minimal interest expense relief in the first year of a declining rate scenario. In addition, the model assumes that prepayments accelerate in the lower interest rate environment resulting in additional pressure on asset yields as proceeds are reinvested at lower rates.

The most recent simulation of a base case scenario, which assumes interest rates remain unchanged from the date of the simulation, reflects a net interest margin that is declining slightly over the next 12 to 18 months.

Although the simulation model is useful in identifying potential exposure to interest rate movements, actual results may differ from those modeled as the repricing, maturity, and prepayment characteristics of financial instruments may change to a different degree than modeled. In addition, the model does not reflect actions that management may employ to manage its interest rate risk exposure. The Company’s current liquidity profile, capital position, and growth prospects, offer a level of flexibility for management to take actions that could offset some of the negative effects of unfavorable movements in interest rates. Management believes the current exposure to changes in interest rates is not significant in relation to the earnings and capital strength of the Company.

In addition to the simulation analysis, management uses an interest rate gap measure. Table 9-Interest Rate Risk Analysis below is a Condensed Static Gap Report, which illustrates the anticipated repricing intervals of assets and liabilities as of December 31, 2020. The Company’s one-year interest rate gap was a positive $58.9 million or 0.77% of total assets at December 31, 2020, compared with a negative $173.6 million or 2.58% of total assets at December 31, 2019. The change from year-end 2019 to year-end 2020 is mainly due to deposit growth, which resulted in a decrease in overnight borrowings with the FHLB as well as an increase some shorter term assets, including interest bearing balances. A positive gap position exists when the amount of interest-bearing assets maturing or repricing exceeds the amount of interest-earning liabilities maturing or repricing within a particular time period. This analysis suggests that the Company’s net interest income is equally at risk in both an increasing and decreasing rate environment over the next 12 months. An interest rate gap measure could be significantly affected by external factors such as a rise or decline in interest rates, loan or securities prepayments, and deposit withdrawals.

Table 9 - Interest Rate Risk Analysis

Condensed Static Gap - December 31, 2020

(In thousands) Total 0-3 months 3-6 months 6-12 months 12 months

Net gap position as a percentage of total assets (6.62) % 1.05 % 6.34 % 0.77 %

1Balances of available-for-sale securities are shown at amortized cost.

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Item 8. Financial Statements and Supplementary Data

Financial Statements and Supplementary Data consist of the consolidated financial statements and the unaudited quarterly financial data as indexed and presented below.

Index to Financial Statements Page

Management’s Statement of Responsibility 65

Consolidated Statements of Condition – December 31, 2020 and 2019 70

Notes to Consolidated Financial Statements 77

Unaudited Quarterly Financial Data 135

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Management’s Statement of Responsibility

Management is responsible for the preparation of the consolidated financial statements and related financial information contained in all sections of this annual report, including the determination of amounts that must necessarily be based on judgments and estimates. It is the belief of management that the consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles.

Management establishes and monitors the Company’s system of internal accounting controls to meet its responsibility for reliable financial statements. The system is designed to provide reasonable assurance that assets are safeguarded, and that transactions are executed in accordance with management’s authorization and are properly recorded.

The Audit/Examining Committee of the board of directors, composed solely of outside directors, meets periodically and privately with management, internal auditors, and the independent registered public accounting firm, KPMG LLP, to review matters relating to the quality of financial reporting, internal accounting control, and the nature, extent, and results of audit efforts. The independent registered public accounting firm and internal auditors have unlimited access to the Audit/Examining Committee to discuss all such matters. The consolidated financial statements have been audited by KPMG LLP for the purpose of expressing an opinion on the consolidated financial statements. In addition, KPMG LLP has audited the Company's internal control over financial reporting, as of December 31, 2020.

/s/ Stephen S. Romaine /s/ Francis M. Fetsko Date: March 1, 2021

Stephen S. Romaine Francis M. Fetsko

Chief Executive Officer Chief Financial Officer

Chief Operating Officer

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Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors

Tompkins Financial Corporation:

Opinion on Internal Control Over Financial Reporting

We have audited Tompkins Financial Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated statements of condition of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and changes in shareholders’ equity for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated March 1, 2021 expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP

Rochester, New York

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Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors

Tompkins Financial Corporation:

Opinion on the ConsolidatedFinancial Statements

We have audited the accompanying consolidated statements of condition of Tompkins Financial Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and changes in shareholders’ equity for each of the years in the three‐year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three‐year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2020 due to the adoption of ASC Topic 326, Financial Instruments – Credit Losses.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Credit Losses – Loans evaluated on a Collective Basis

As discussed in Note 1 to the consolidated financial statements, the Company adopted ASU No. 2016-13, Financial Instruments — Credit Losses (ASC Topic 326), as of January 1, 2020. As discussed in Notes 1 and 4 to the consolidated financial statements, the Company’s allowance for credit losses on loans was $51.7 million as of December 31, 2020, a portion of which related to the allowance for credit losses on loans evaluated on a collective bases (the collective ACL on loans). The collective ACL on loans includes the measure of expected credit losses on a

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collective basis for those loans that share similar risk characteristics. The methodologies apply historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual lives of the financial assets that are reasonable and supportable. The Company uses a discounted cash flow methodology (DCF methodology) where the respective cash flows for each segment are developed using the assumptions of probability of default (PD), loss given default (LGD), and exposure at default using estimated prepayment speeds. The DCF methodology is calculated at the loan level and aggregated at the segment level, and expected credit losses are estimated over the effective life of the loans by measuring the difference between the net present value of modeled cash flows and the amortized cost basis. The Company uses models to develop the PD and LGD, which are derived from internal and selected peer groups’ historical default and loss experience, that incorporate probability weighted economic scenarios and macroeconomic assumptions over a reasonable and supportable forecast period. In order to capture the unique risks of the loan segments within the PD and LGD models, the Company measures expected credit losses at the loan level by segment, by pooling loans when the financial assets share similar risk characteristics. After the reasonable and supportable forecast period, the Company reverts back to a historical loss rate over eight quarters on a straight-line basis. A portion of the collective ACL on loans is comprised of adjustments to historical loss information. These adjustments are based on qualitative factors not reflected in the quantitative model but are likely to impact the measurement of estimated credit losses.

We identified the assessment of the collective ACL on loans as a critical audit matter. A high degree of audit effort, including specialized skills and knowledge, and subjective and complex auditor judgment was involved in the assessment of the collective ACL on loans due to significant measurement uncertainty. Specifically, the assessment encompassed the evaluation of the collective ACL on loans methodology, including the methods and models used to estimate the PD, LGD and their significant assumptions, including portfolio segmentation, estimated prepayment speeds, the economic forecast scenarios and scenario weightings, macroeconomic assumptions, the reasonable and supportable forecast period, the composition of the peer group data, and the historical observation period. The assessment also included the evaluation of the qualitative factors and their significant assumptions, including the effects of limitations inherent in the quantitative model and an evaluation of the conceptual soundness and performance of the PD and LGD models. In addition, auditor judgment was required to evaluate the sufficiency of audit evidence obtained.

The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the measurement of the collective ACL on loans, including controls over the:

–development of the collective ACL on loans methodology

–development of the PD and LGD models

–performance monitoring of the PD and LGD models

–identification and determination and measurement of the significant assumptions used in the PD and LGD models, including prepayment assumptions

–development of the qualitative adjustments, including the significant assumptions

–analysis of the collective ACL on loans results, trends, and ratios.

We evaluated the Company’s process to develop the collective ACL on loans estimate by testing certain sources of data, factors, and assumptions that the Company used, and considered the relevance and reliability of such data, factors, and assumptions. In addition, we involved credit risk professionals with specialized skills and knowledge, who assisted in:

–evaluating the Company’s collective ACL on loans methodology for compliance with U.S. generally accepted accounting principles

–evaluating judgments made by the Company relative to the development and performance testing of the PD and LGD models, and other significant assumptions such as prepayment speeds by comparing them to relevant Company-specific metrics and trends and the applicable industry and regulatory practices

–assessing the conceptual soundness and performance testing of the PD and LGD models, by inspecting the model documentation to determine whether the models are suitable for their intended use

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–evaluating the economic forecast, including selection of the economic forecast scenarios and weightings, by comparing them to the Company's business environment and relevant industry practices

–evaluating the length of the historical observation period and reasonable and supportable forecast period evaluating to relevant trends

–assessing the composition of the peer group by comparing to specific portfolio characteristics

–evaluating the methodology used to develop the qualitative factors and the effect of those factors on the collective ACL on loans compared with relevant credit risk factors and consistency with credit trends and identified limitations of the underlying quantitative model.

We also assessed the sufficiency of the audit evidence obtained related to the collective ACL on loans by evaluating the:

–cumulative results of the audit procedures

–qualitative aspects of the Company’s accounting practices

–potential bias in the accounting estimate.

/s/ KPMG LLP

We have served as the Company's auditor since 1995.

Rochester, New York

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CONDITION

(In thousands, except share and per share data) As of As of

Cash and noninterest bearing balances due from banks $ 21,245 $ 136,010

Interest bearing balances due from banks 367,217 1,972

Federal Home Loan Bank and other stock 16,382 33,695

LIABILITIES

Deposits:

Interest bearing:

EQUITY

Tompkins Financial Corporation shareholders' equity:

Accumulated other comprehensive loss (32,074) (43,564)

Total Tompkins Financial Corporation Shareholders’ Equity 716,277 661,642

See notes to consolidated financial statements.

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Year ended December 31,

INTEREST AND DIVIDEND INCOME

Federal Home Loan Bank stock and Federal Reserve Bank stock 1,373 3,003 3,377

INTEREST EXPENSE

NONINTEREST INCOME

Net gain (loss) on securities transactions 443 645 (466)

NONINTEREST EXPENSES

Less: Net income attributable to noncontrolling interests 154 127 127

Diluted Earnings Per Share $ 5.20 $ 5.37 $ 5.35

See notes to consolidated financial statements.

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Year ended December 31,

Other comprehensive income (loss), net of tax:

Available-for-sale securities:

Change in net unrealized gain (loss) during the period 16,894 25,241 (10,981)

Unrealized gains on HTM securities transferred to AFS securities 0 2,852 0

Employee benefit plans:

Net actuarial gain due to curtailment 0 (302) 0

Net retirement plan prior service (credit) cost 0 (1,373) 0

Amortization of net retirement plan actuarial gain 1,786 1,266 1,298

Amortization of net retirement plan prior service cost 162 24 11

See notes to consolidated financial statements.

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year ended December 31,

OPERATING ACTIVITIES

Accretion related to purchase accounting (1,066) (1,448) (1,948)

Earnings from corporate owned life insurance, net (2,188) (2,164) (1,818)

Net (gain) loss on sale of securities transactions (443) (645) 466

Loss on redemption of trust preferred debentures 139 0 0

Net gain on sale of bank premises and equipment (3) (98) (2,946)

Net excess tax benefit from stock based compensation 118 944 680

(Increase) decrease in accrued interest receivable (12,732) 1,629 (800)

(Decrease) increase in accrued interest payable (759) 78 355

INVESTING ACTIVITIES

Purchases of held-to-maturity securities 0 (7,589) (8,492)

Proceeds from sale of bank premises and equipment 22 448 3,317

Purchases of bank premises, equipment and software (4,551) (6,014) (18,084)

Redemption of corporate owned life insurance 446 1,370 0

Net cash used in acquisitions 0 (436) 0

FINANCING ACTIVITIES

Redemption of trust preferred debentures (4,124) 0 0

Net shares issued related to restricted stock awards (1,682) (1,875) (1,403)

Shares issued for dividend reinvestment plan 1,825 0 0

Shares issued for employee stock ownership plan 0 0 3,073

Net proceeds from exercise of stock options (253) (992) (540)

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Supplemental Cash Flow Information

Year ended December 31,

Non-cash investing and financing activities:

Transfer of loans to other real estate owned 192 803 518

Transfer of securities from held-to-maturity to available-for-sale 0 138,206 0

Initial recognition of operating lease right-of-use assets 0 35,783 0

Initial recognition of operating lease liabilities 0 38,119 0

Right-of-use assets obtained in exchange for new lease liabilities 1,256 585 0

See notes to consolidated financial statements.

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Total Comprehensive Income 70,501

Stock-based compensation expense 3,477 3,477

Shares issued for employee stock ownership plan (38,883 shares) 4 3,069 3,073

Directors deferred compensation plan (1,422 shares) 410 (410) 0

Partial repurchase of noncontrolling interest (10) (10)

Dividend to noncontrolling interests (127) (127)

Total Comprehensive Income 101,446

Stock-based compensation expense 4,235 4,235

Directors deferred compensation plan (1,729 shares) 377 (377) 0

Dividend to noncontrolling interests (127) (127)

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TOMPKINS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (continued)

Total Comprehensive Income 89,232

Net exercise of stock options (3,775 shares) 1 (254) (253)

Stock-based compensation expense 4,733 4,733

Shares issued for dividend reinvestment plan (29,842 shares) 3 1,822 1,825

Directors deferred compensation plan (893 shares) 255 (255) 0

Partial repurchase of noncontrolling interest (6) (6)

Dividend to noncontrolling interests (148) (148)

See notes to consolidated financial statements.

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Note 1 Summary of Significant Accounting Policies

Basis Of Presentation

Tompkins Financial Corporation (“Tompkins” or “the Company”) is a registered Financial Holding Company with the Federal Reserve Board pursuant to the Bank Holding Company Act of 1956, as amended, organized under the laws of New York State, and is the parent company of Tompkins Trust Company (the “Trust Company”), The Bank of Castile, Mahopac Bank, VIST Bank, and Tompkins Insurance Agencies, Inc. (“Tompkins Insurance”). The Trust Company provides a full array of trust and investment services under the Tompkins Financial Advisors brand. Unless the context otherwise requires, the term “Company” refers to Tompkins Financial Corporation and its subsidiaries.

TMP US Equity

TMP · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data

TMP US Equity☆

TMP · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data

TMP US Equity