UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
X
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
For the
quarterly period ended June 30,
2008
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|
For the
transition period from
to
.
|
Commission
file number 001-13695
|
COMMUNITY
BANK SYSTEM, INC. |
(Exact name of
registrant as specified in its
charter)
|
Delaware
|
|
16-1213679
|
(State or
other jurisdiction of incorporation or organization)
|
|
(I.R.S. Employer
Identification No.)
|
|
|
|
5790 Widewaters
Parkway, DeWitt, New York
|
|
13214-1883 |
(Address of
principal executive offices) |
|
(Zip
Code) |
(315)
445-2282
Registrant's
telephone number, including area code
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months
(or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.
|
Yes |
X |
No
|
|
|
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of “large accelerated filer”, “accelerated
filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer |
|
Accelerated
filer
|
X |
Non-accelerated
filer
|
|
Smaller reporting
company
|
|
. |
Indicate by
check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes |
|
. No |
X |
. |
Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable
date.
29,934,709 shares of Common
Stock, $1.00 par value, were outstanding on July 31, 2008.
TABLE
OF CONTENTS
|
|
Page |
Part
I. |
Financial
Information |
|
|
|
|
Item
1. |
Financial Statements
(Unaudited) |
|
|
|
|
|
Consolidated
Statements of Condition |
|
|
June 30, 2008
and December 31, 2007 |
3 |
|
|
|
|
Consolidated
Statements of Income |
|
|
Three and six
months ended June 30, 2008 and 2007 |
4 |
|
|
|
|
Consolidated
Statements of Changes in Shareholders' Equity |
|
|
Six months
ended June 30, 2008
|
5 |
|
|
|
|
Consolidated
Statements of Comprehensive Income |
|
|
Three and six
months ended June 30, 2008 and 2007 |
6 |
|
|
|
|
Consolidated
Statements of Cash Flows |
|
|
Six months
ended June 30, 2008 and 2007 |
7 |
|
|
|
|
Notes to the
Consolidated Financial Statements |
|
|
June 30,
2008 |
8 |
|
|
|
Item
2. |
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
15 |
|
|
|
Item
3. |
Quantitative
and Qualitative Disclosure about Market Risk
|
30 |
|
|
|
Item
4. |
Controls and
Procedures |
31 |
|
|
|
Part II. |
Other Information |
|
|
|
|
Item
1. |
Legal
Proceedings
|
31 |
|
|
|
Item
1A. |
Risk
Factors |
31 |
|
|
|
Item
2. |
Unregistered
Sales of Equity Securities and Use of Proceeds
|
31 |
|
|
|
Item
3. |
Defaults Upon
Senior Securities
|
31 |
|
|
|
Item
4. |
Submission of
Matters to a Vote of Securities Holders
|
32 |
|
|
|
Item
5. |
Other
Information
|
32 |
|
|
|
Item
6. |
Exhibits |
33 |
Part
I. Financial Information
Item
1. Financial Statements
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CONDITION
(In
Thousands, Except Share Data)
|
(Unaudited)
|
|
|
June
30,
|
December
31,
|
|
2008
|
2007
|
Cash
and cash equivalents
|
$123,233
|
$130,823
|
|
|
|
Available-for-sale
investment securities, at fair value
|
1,120,625
|
1,254,622
|
Held-to-maturity
investment securities
|
138,167
|
137,250
|
Total
investment securities (fair value of $1,258,673 and $1,392,281,
respectively)
|
1,258,792
|
1,391,872
|
|
|
|
Loans
|
2,922,243
|
2,821,055
|
Allowance
for loan losses
|
(37,128)
|
(36,427)
|
Net
loans
|
2,885,115
|
2,784,628
|
|
|
|
Core
deposit intangibles, net
|
16,926
|
19,765
|
Goodwill
|
234,686
|
234,449
|
Other
intangibles, net
|
2,140
|
2,002
|
Intangible
assets, net
|
253,752
|
256,216
|
|
|
|
Premises
and equipment, net
|
69,556
|
69,685
|
Accrued
interest receivable
|
23,654
|
25,531
|
Other
assets
|
43,681
|
38,747
|
Total
assets
|
$4,657,783
|
$4,697,502
|
|
|
|
Liabilities:
|
|
|
Noninterest-bearing
deposits
|
$584,752
|
$584,921
|
Interest-bearing
deposits
|
2,662,596
|
2,643,543
|
Total
deposits
|
3,247,348
|
3,228,464
|
|
|
|
Borrowings
|
772,646
|
801,604
|
Subordinated
debt held by unconsolidated subsidiary trusts
|
101,963
|
127,724
|
Accrued
interest and other liabilities
|
52,178
|
60,926
|
Total
liabilities
|
4,174,135
|
4,218,718
|
|
|
|
Commitment
and contingencies (See Note H)
|
|
|
|
|
|
Shareholders'
equity:
|
|
|
Preferred
stock $1.00 par value, 500,000 shares authorized, 0 shares
issued
|
-
|
-
|
Common
stock, $1.00 par value, 50,000,000 shares authorized;
|
33,300
|
33,000
|
33,299,520
and 32,999,544 shares issued in 2008 and 2007,
respectively
|
|
|
Additional
paid-in capital
|
213,970
|
208,429
|
Retained
earnings
|
319,927
|
310,281
|
Accumulated
other comprehensive (loss) income
|
(9,921)
|
702
|
Treasury
stock, at cost (3,364,811 and 3,364,811 shares,
respectively)
|
(73,628)
|
(73,628)
|
Total
shareholders' equity
|
483,648
|
478,784
|
|
|
|
Total
liabilities and shareholders' equity
|
$4,657,783
|
$4,697,502
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)
(In
Thousands, Except Per-Share Data)
|
|
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
June
30,
|
|
June
30,
|
|
2008
|
2007
|
|
2008
|
2007
|
Interest
income:
|
|
|
|
|
|
Interest
and fees on loans
|
$45,691
|
$46,090
|
|
$92,206
|
$91,025
|
Interest
and dividends on taxable investments
|
9,635
|
11,839
|
|
20,349
|
22,942
|
Interest
and dividends on nontaxable investments
|
5,744
|
5,327
|
|
11,666
|
10,847
|
Total
interest income
|
61,070
|
63,256
|
|
124,221
|
124,814
|
|
|
|
|
|
|
Interest
expense:
|
|
|
|
|
|
Interest
on deposits
|
16,039
|
20,092
|
|
33,733
|
38,212
|
Interest
on borrowings
|
7,882
|
7,388
|
|
15,923
|
14,893
|
Interest
on subordinated debt held by unconsolidated subsidiary
trusts
|
1,709
|
2,438
|
|
3,527
|
5,004
|
Total
interest expense
|
25,630
|
29,918
|
|
53,183
|
58,109
|
|
|
|
|
|
|
Net
interest income
|
35,440
|
33,338
|
|
71,038
|
66,705
|
Less: provision
for loan losses
|
1,570
|
414
|
|
2,350
|
614
|
Net
interest income after provision for loan losses
|
33,870
|
32,924
|
|
68,688
|
66,091
|
|
|
|
|
|
|
Noninterest
income:
|
|
|
|
|
|
Deposit
service fees
|
8,910
|
7,825
|
|
17,171
|
14,802
|
Other
banking services
|
539
|
425
|
|
1,134
|
1,095
|
Benefit
plan administration, consulting and actuarial fees
|
5,933
|
4,767
|
|
12,245
|
8,739
|
Wealth
management services
|
2,324
|
2,009
|
|
4,487
|
3,869
|
(Loss)/gain
on sales of investment securities
|
(57)
|
(8)
|
|
230
|
(8)
|
Total
noninterest income
|
17,649
|
15,018
|
|
35,267
|
28,497
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
Salaries
and employee benefits
|
19,772
|
18,386
|
|
40,158
|
36,672
|
Occupancy
and equipment
|
5,189
|
4,559
|
|
10,762
|
9,225
|
Data
processing and communications
|
4,100
|
3,808
|
|
8,085
|
7,373
|
Amortization
of intangible assets
|
1,645
|
1,581
|
|
3,176
|
3,096
|
Legal
and professional fees
|
902
|
1,054
|
|
2,200
|
2,241
|
Office
supplies and postage
|
1,237
|
1,008
|
|
2,515
|
2,054
|
Business
development and marketing
|
1,507
|
1,538
|
|
2,829
|
2,488
|
Other
|
2,603
|
2,198
|
|
5,604
|
4,902
|
Total
operating expenses
|
36,955
|
34,132
|
|
75,329
|
68,051
|
|
|
|
|
|
|
Income
before income taxes
|
14,564
|
13,810
|
|
28,626
|
26,537
|
Income
taxes
|
3,277
|
3,451
|
|
6,441
|
6,522
|
Net
income
|
$11,287
|
$10,359
|
|
$22,185
|
$20,015
|
|
|
|
|
|
|
Basic
earnings per share
|
$0.38
|
$0.34
|
|
$0.74
|
$0.66
|
Diluted
earnings per share
|
$0.37
|
$0.34
|
|
$0.74
|
$0.66
|
Dividends
declared per share
|
$0.21
|
$0.20
|
|
$0.42
|
$0.40
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Six
Months Ended June 30, 2008
(In
Thousands, Except Share Data)
|
|
|
|
|
Accumulated
|
|
|
|
Common
Stock
|
Additional
|
|
Other
|
|
|
|
Shares
|
Amount
|
Paid-in
|
Retained
|
Comprehensive
|
Treasury
|
|
|
Outstanding
|
Issued
|
Capital
|
Earnings
|
Income
(Loss)
|
Stock
|
Total
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2007
|
29,634,733
|
$33,000
|
$208,429
|
$310,281
|
$702
|
($73,628)
|
$478,784
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
22,185
|
|
|
22,185
|
|
|
|
|
|
|
|
|
Other
comprehensive loss, net of tax
|
|
|
|
|
(10,623)
|
|
(10,623)
|
|
|
|
|
|
|
|
|
Dividends
declared:
|
|
|
|
|
|
|
|
Common,
$0.42 per share
|
|
|
|
(12,539)
|
|
|
(12,539)
|
|
|
|
|
|
|
|
|
Common
stock issued under
|
|
|
|
|
|
|
|
Stock
plan, including
|
|
|
|
|
|
|
|
tax
benefits of $410
|
299,976
|
300
|
4,431
|
|
|
|
4,731
|
|
|
|
|
|
|
|
|
Stock
options earned
|
|
|
1,110
|
|
|
|
1,110
|
|
|
|
|
|
|
|
|
Balance
at June 30, 2008
|
29,934,709
|
$33,300
|
$213,970
|
$319,927
|
($9,921)
|
($73,628)
|
$483,648
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In
Thousands)
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
June
30,
|
|
June
30,
|
|
|
2008
|
2007
|
|
2008
|
2007
|
|
|
|
|
|
|
|
Change
in pension liability
|
|
$200
|
$0
|
|
$55
|
($50)
|
Change
in unrealized loss on derivative instruments used in cash flow hedging
relationship
|
|
2,832
|
1,414
|
|
73
|
991
|
Unrealized
gain (loss) on securities:
|
|
|
|
|
|
|
Unrealized
holding loss arising during period
|
|
(21,281)
|
(13,476)
|
|
(17,001)
|
(12,063)
|
Reclassification
adjustment for (gains) losses included in net income
|
|
57
|
8
|
|
(230)
|
8
|
Other
comprehensive loss, before tax
|
|
(18,192)
|
(12,054)
|
|
(17,103)
|
(11,114)
|
Income
tax benefit related to other comprehensive loss
|
|
6,873
|
4,438
|
|
6,480
|
4,201
|
Other
comprehensive loss, net of tax:
|
|
(11,319)
|
(7,616)
|
|
(10,623)
|
(6,913)
|
Net
income
|
|
11,287
|
10,359
|
|
22,185
|
20,015
|
Comprehensive
(loss) income
|
|
($32)
|
$2,743
|
|
$11,562
|
$13,102
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
(In
Thousands)
|
Six
Months Ended
June
30,
|
|
2008
|
2007
|
Operating
activities:
|
|
|
Net
income
|
$22,185
|
$20,015
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
Depreciation
|
4,698
|
4,601
|
Amortization
of intangible assets
|
3,176
|
3,096
|
Net
accretion of premiums and discounts on securities and
loans
|
(406)
|
(2,176)
|
Amortization
of unearned compensation and discount on subordinated debt
|
283
|
199
|
Provision
for loan losses
|
2,350
|
614
|
(Gain)
loss on investment securities and debt extinguishments
|
(230)
|
8
|
Loss
(Gain) on sale of loans and other assets
|
26
|
(64)
|
Proceeds
from the sale of loans held for sale
|
1,120
|
5,276
|
Origination
of loans held for sale
|
(1,115)
|
(5,238)
|
Excess
tax benefits from share-based payment arrangements
|
(379)
|
(129)
|
Change
in other operating assets and liabilities
|
(4,489)
|
(5,789)
|
Net
cash provided by operating activities
|
27,219
|
20,413
|
Investing
activities:
|
|
|
Proceeds
from sales of available-for-sale investment securities
|
31,344
|
5,478
|
Proceeds
from maturities of held-to-maturity investment securities
|
2,859
|
11,153
|
Proceeds
from maturities of available-for-sale investment
securities
|
219,644
|
269,235
|
Purchases
of held-to-maturity investment securities
|
(3,849)
|
(1,790)
|
Purchases
of available-for-sale investment securities
|
(133,515)
|
(258,056)
|
Net
increase in loans outstanding
|
(102,835)
|
(11,043)
|
Cash
paid for acquisition (net of cash acquired of $0 and
$9,181)
|
(479)
|
(11,613)
|
Expenditure
for intangibles
|
(322)
|
0
|
Capital
expenditures
|
(5,266)
|
(4,849)
|
Net
cash provided by (used in) investing activities
|
7,581
|
(1,485)
|
Financing
activities:
|
|
|
Net
change in non-interest checking, interest checking and savings
accounts
|
80,824
|
22,549
|
Net
change in time deposits
|
(61,940)
|
89,727
|
Net
change in short-term borrowings
|
(38,556)
|
(73,720)
|
Change
in long-term borrowings (net of payments of $402 and $866)
|
9,598
|
(915)
|
Payment
on subordinated debt held by unconsolidated subsidiary
trusts
|
(25,773)
|
(30,929)
|
Issuance
of common stock
|
5,570
|
2,685
|
Purchase
of treasury stock
|
0
|
(6,059)
|
Cash
dividends paid
|
(12,492)
|
(12,017)
|
Tax
benefits from share-based payment arrangements
|
379
|
129
|
Net
cash used in financing activities
|
(42,390)
|
(8,550)
|
Change
in cash and cash equivalents
|
(7,590)
|
10,378
|
Cash
and cash equivalents at beginning of period
|
130,823
|
232,032
|
Cash
and cash equivalents at end of period
|
$123,233
|
$242,410
|
Supplemental
disclosures of cash flow information:
|
|
|
Cash
paid for interest
|
$53,799
|
$57,666
|
Cash
paid for income taxes
|
6,316
|
3,575
|
Supplemental
disclosures of noncash financing and investing activities:
|
|
|
Dividends
declared and unpaid
|
6,286
|
5,976
|
Gross
change in unrealized gain on available-for-sale investment
securities
|
(17,231)
|
(12,055)
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June
30, 2008
The
interim financial data as of June 30, 2008 and for the three and six months
ended June 30, 2008 and 2007 is unaudited; however, in the opinion of the
Company, the interim data includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of the results for the
interim periods. The results of operations for the interim periods
are not necessarily indicative of the results that may be expected for the full
year or any other interim period.
Alliance
Benefit Group MidAtantic
On July
7, 2008, Benefit Plans Administrative Services, Inc. (BPAS), a wholly owned
subsidiary of the Company, completed its acquisition of the Philadelphia
division of Alliance Benefit Group MidAtlantic (ABG) from BenefitStreet,
Inc. ABG provides retirement plan consulting, daily valuation
administration, actuarial and ancillary support services.
Citizens
Branch Acquisition
On June
25, 2008, the Company announced an agreement to acquire 18 branch-banking
centers in northern New York State from Citizens Financial Group, Inc.
(Citizens) in an all cash transaction. Under the terms of the
agreement, the company will acquire approximately $135 million in loans and $630
million in deposits at a blended deposit premium of 12%. The
acquisition is expected to close during the fourth quarter of 2008, pending
customary regulatory approvals. In support of the transaction, the
Company expects to issue approximately $30 million of equity capital prior to
its completion.
Hand
Benefits & Trust, Inc.
On May
18, 2007, BPAS completed its acquisition of Hand Benefits & Trust, Inc.
(HBT) in an all cash transaction. HBT is a Houston, Texas based
provider of employee benefit plan administration and trust
services. The results of HBT’s operations have been included in the
consolidated financial statements since that date.
TLNB
Financial Corporation
On June
1, 2007, the Company completed its acquisition of TLNB Financial Corporation,
parent company of Tupper Lake National Bank (TLNB), in an all-cash transaction
valued at approximately $17.8 million. Based in Tupper Lake, NY, TLNB
operated five branches in the northeastern New York State cities of Tupper Lake,
Plattsburgh and Saranac Lake, as well as an insurance subsidiary, TLNB Insurance
Agency, Inc. The results of TLNB’s operations have been included in
the consolidated financial statements since that date.
Stock
Repurchase Program
On April
20, 2005, the Company announced a twenty-month authorization to repurchase up to
1,500,000 of its outstanding shares. On December 20, 2006, the
Company extended the program through December 31, 2008 and announced an
additional two-year authorization to repurchase up to 900,000 of its shares in
open market or privately negotiated transactions. Through June 30,
2008, the Company has repurchased, pursuant to the program, 1,464,811 shares at
an aggregate cost of $31.5 million and an average price per share of
$21.51. The repurchased shares will be used for general corporate
purposes, including those related to stock plan activities.
Critical
Accounting Policies
Allowance
for Loan Losses
Management
continually evaluates the credit quality of the Company’s loan portfolio and
performs a formal review of the adequacy of the allowance for loan losses on a
quarterly basis. The allowance reflects management’s best estimate of
probable losses inherent in the loan portfolio. Determination of the
allowance is subjective in nature and requires significant
estimates. The Company’s allowance methodology consists of two
broad components, general and specific loan loss allocations.
The
general loan loss allocation is composed of two calculations that are computed
on four main loan categories: commercial, consumer direct, consumer indirect and
residential real estate. The first calculation determines an
allowance level based on the latest three years of historical net charge-off
data for each loan category (commercial loans exclude balances with specific
loan loss allocations). The second calculation is qualitative and
takes into consideration five major factors affecting the level of loan loss
risk: portfolio risk migration patterns (internal credit quality trends); the
growth of the categories of the loan portfolio; economic and business
environment trends in the Company’s markets (includes review of bankruptcy,
unemployment, population, consumer spending and regulatory trends); industry,
geographical and product concentrations in the portfolio; and the perceived
effectiveness of managerial resources and lending practices and policies. These
two calculations are added together to determine the general loan loss
allocation. The specific loan loss allocation relates to individual
commercial loans that are both greater than $0.5 million and in a nonaccruing
status with respect to interest. Specific losses are based on
discounted estimated cash flows, including any cash flows resulting from the
conversion of collateral.
Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for
loan loss is charged to operations based on management’s periodic evaluation of
the factors previously mentioned.
Income
Taxes
Provisions
for income taxes are based on taxes currently payable or refundable, and
deferred taxes which are based on temporary differences between the tax basis of
assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are reported in the
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled.
Intangible
Assets
Intangible
assets include core deposit intangibles, customer relationship intangibles and
goodwill arising from acquisitions. Core deposit intangibles and
customer relationship intangibles are amortized on either an accelerated or
straight-line basis over periods ranging from 7 to 20 years. Goodwill
is evaluated at least annually for impairment. The carrying value of
goodwill and other intangible assets is based upon discounted cash flow modeling
techniques that require management to make estimates regarding the amount and
timing of expected future cash flows. It also requires use of a
discount rate that reflects the current return requirements of the market in
relation to present risk-free interest rates, required equity market premiums,
and company-specific risk indicators.
Retirement
Benefits
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also
provides deferred compensation and supplemental executive retirement plans for
selected current and former employees and officers. Expense under
these plans is charged to current operations and consists of several components
of net periodic benefit cost based on various actuarial assumptions regarding
future experience under the plans, including discount rate, rate of future
compensation increases and expected return on plan assets.
New
Accounting Pronouncements
SFAS
No. 141(R)
In
December 2007, the FASB issued SFAS No. 141(R), Business
Combinations. This statement provides new accounting guidance
and disclosure requirements for business combinations. The Company
will be required to apply SFAS No. 141(R) to all business combinations completed
on or after January 1, 2009. The Company is currently assessing the
effect of SFAS No. 141(R) on its financial statements.
SFAS
No. 160
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No.
51. This statement provides new accounting guidance and
disclosure and presentation requirements for noncontrolling interests in a
subsidiary. SFAS No. 160 is effective for fiscal years beginning on
or after December 15, 2008. The Company is currently assessing the
effect of SFAS No. 160 on its financial statements.
SFAS
No. 161
In March
2008, the FASB issued SFAS No. 161, Disclosures About Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No.
133. This statement expands quarterly disclosure requirements
in SFAS No. 133 about an entity’s derivative instruments and hedging
activities. SFAS No. 161 is effective for fiscal years beginning on
or after November 15, 2008. The Company is currently assessing the
effect of SFAS No. 161 on its financial statements.
Basic
earnings per share are computed based on the weighted-average common shares
outstanding for the period. Diluted earnings per share are based on
the weighted-average shares outstanding adjusted for the dilutive effect of
restricted stock and the assumed exercise of stock options during the
year. The dilutive effect of options is calculated using the treasury
stock method of accounting. The treasury stock method determines the
number of common shares that would be outstanding if all the dilutive options
(those where the average market price is greater than the exercise price) were
exercised and the proceeds were used to repurchase common shares in the open
market at the average market price for the applicable time
period. There were approximately 1.1 million anti-dilutive stock
options outstanding at June 30, 2008 compared to approximately 1.7 million
weighted-average anti-dilutive stock options outstanding at June 30, 2007 that
were not included in the computation below. The following is a
reconciliation of basic to diluted earnings per share for the three and six
months ended June 30, 2008 and 2007.
|
|
|
Per
Share
|
(000's
omitted, except per share data)
|
Income
|
Shares
|
Amount
|
Three
Months Ended June 30, 2008
|
|
|
|
Basic
EPS
|
$11,287
|
29,885
|
$ 0.38
|
Stock
options and restricted stock
|
|
395
|
|
Diluted
EPS
|
$11,287
|
30,280
|
$ 0.37
|
|
|
|
|
Three
Months Ended June 30, 2007
|
|
|
|
Basic
EPS
|
$10,359
|
30,087
|
$ 0.34
|
Stock
options and restricted stock
|
|
309
|
|
Diluted
EPS
|
$10,359
|
30,396
|
$ 0.34
|
|
|
|
|
Six
Months Ended June 30, 2008
|
|
|
|
Basic
EPS
|
$22,185
|
29,802
|
$ 0.74
|
Stock
options and restricted stock
|
|
352
|
|
Diluted
EPS
|
$22,185
|
30,154
|
$ 0.74
|
|
|
|
|
Six
Months Ended June 30, 2007
|
|
|
|
Basic
EPS
|
$20,015
|
30,139
|
$ 0.66
|
Stock
options and restricted stock
|
|
332
|
|
Diluted
EPS
|
$20,015
|
30,471
|
$ 0.66
|
The gross
carrying amount and accumulated amortization for each type of intangible asset
are as follows:
|
|
As
of June 30, 2008
|
|
As
of December 31, 2007
|
|
|
Gross
|
|
Net
|
|
Gross
|
|
Net
|
|
|
Carrying
|
Accumulated
|
Carrying
|
|
Carrying
|
Accumulated
|
Carrying
|
(000's
omitted)
|
|
Amount
|
Amortization
|
Amount
|
|
Amount
|
Amortization
|
Amount
|
Amortizing
intangible assets:
|
|
|
|
|
|
|
|
|
Core
deposit intangibles
|
|
$66,368
|
$(49,442)
|
$16,926
|
|
$66,368
|
($46,603)
|
$19,765
|
Other
intangibles
|
|
4,290
|
(2,150)
|
2,140
|
|
3,923
|
(1,921)
|
2,002
|
Total
amortizing intangibles
|
|
70,658
|
(51,592)
|
19,066
|
|
70,291
|
(48,524)
|
21,767
|
Non-amortizing
intangible assets:
|
|
|
|
|
|
|
|
|
Goodwill
|
|
234,686
|
0
|
234,686
|
|
234,449
|
0
|
234,449
|
Total
intangible assets, net
|
|
$305,344
|
$(51,592)
|
$253,752
|
|
$304,740
|
($48,524)
|
$256,216
|
No
goodwill impairment adjustments were recognized in 2008 or 2007. The
estimated aggregate amortization expense for each of the succeeding fiscal years
ended December 31 is as follows:
(000's
omitted)
|
|
Amount
|
July-Dec
2008
|
|
$3,086
|
2009
|
|
5,607
|
2010
|
|
3,624
|
2011
|
|
1,481
|
2012
|
|
1,221
|
Thereafter
|
|
4,047
|
Total
|
|
$19,066
|
NOTE
F: MANDATORILY REDEEMABLE PREFERRED SECURITIES
The
Company sponsors two business trusts, Community Statutory Trust III and
Community Capital Trust IV (Trust IV), of which 100% of the common stock is
owned by the Company. The trusts were formed for the purpose of
issuing company-obligated mandatorily redeemable preferred securities to
third-party investors and investing the proceeds from the sale of such preferred
securities solely in junior subordinated debt securities of the
Company. The debentures held by each trust are the sole assets of
that trust. Distributions on the preferred securities issued by each
trust are payable semi-annually or quarterly at a rate per annum equal to the
interest rate being earned by the trust on the debentures held by that trust and
are recorded as interest expense in the consolidated financial
statements. The preferred securities are subject to mandatory
redemption, in whole or in part, upon repayment of the
debentures. The Company has entered into agreements which, taken
collectively, fully and unconditionally guarantee the preferred securities
subject to the terms of each of the guarantees. The terms of the
preferred securities of each trust are as follows:
|
Issuance
|
Par
|
|
Maturity
|
|
|
|
Date
|
Amount
|
Interest
Rate
|
Date
|
Call
Provision
|
Call
Price
|
III
|
7/31/2001
|
$24.5
million
|
3
month LIBOR plus 3.58% (6.48%)
|
7/31/2031
|
5
year beginning 2006
|
106.00%
declining to par in 2011
|
IV
|
12/8/2006
|
$75
million
|
3
month LIBOR plus 1.65% (4.43%)
|
12/15/2036
|
5
year beginning 2012
|
Par
|
The
Company also entered into an interest rate swap agreement on December 8, 2006 to
convert Trust IV’s variable rate trust preferred securities into a fixed rate
security for a term of five years at a fixed rate of
6.43%. Additional interest expense of $377,000 was recognized for the
interest rate swap agreement for the six months ended June 30,
2008.
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also provides
supplemental pension retirement benefits for several current and former key
employees. No contributions in 2008 are required for regulatory
purposes. The Company accrues for the estimated cost of these
benefits through charges to expense during the years that employees earn these
benefits. The net periodic benefit cost for the three and six months
ended June 30 is as follows:
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
|
Three
Months Ended
|
|
Six
months Ended
|
|
Three
Months Ended
|
|
Six
months Ended
|
|
June
30,
|
|
June
30,
|
|
June
30,
|
|
June
30,
|
(000's
omitted)
|
2008
|
2007
|
|
2008
|
2007
|
|
2008
|
2007
|
|
2008
|
2007
|
Service
cost
|
$780
|
$763
|
|
$1,559
|
$1,526
|
|
$175
|
$148
|
|
$350
|
$296
|
Interest
cost
|
819
|
678
|
|
1,638
|
1,357
|
|
150
|
131
|
|
300
|
261
|
Expected
return on plan assets
|
(1,118)
|
(1,007)
|
|
(2,235)
|
(2,014)
|
|
0
|
0
|
|
0
|
0
|
Net
amortization and deferral
|
165
|
248
|
|
330
|
494
|
|
25
|
29
|
|
50
|
59
|
Amortization
of prior service cost
|
(27)
|
(23)
|
|
(55)
|
(46)
|
|
28
|
28
|
|
55
|
55
|
Amortization
of transition obligation
|
0
|
0
|
|
0
|
0
|
|
10
|
10
|
|
20
|
21
|
Net
periodic benefit cost
|
$619
|
$659
|
|
$1,237
|
$1,317
|
|
$388
|
$346
|
|
$775
|
$692
|
During the third quarter, the
Company expects to make a contribution to its defined benefit pension plan of
$9.6 million. No additional contributions in 2008 are required for regulatory
purposes.
The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its
customers. These financial instruments consist primarily of
commitments to extend credit and standby letters of
credit. Commitments to extend credit are agreements to lend to
customers, generally having fixed expiration dates or other termination clauses
that may require payment of a fee. These commitments consist
principally of unused commercial and consumer credit lines. Standby
letters of credit generally are contingent upon the failure of the customer to
perform according to the terms of an underlying contract with a third
party. The credit risks associated with commitments to extend credit
and standby letters of credit are essentially the same as that involved with
extending loans to customers and are subject to normal credit
policies. Collateral may be obtained based on management’s assessment
of the customer’s creditworthiness.
The
contract amount of commitment and contingencies are as follows:
(000's
omitted)
|
June
30,
2008
|
December
31,
2007
|
Commitments
to extend credit
|
$503,230
|
$482,517
|
Standby
letters of credit
|
11,527
|
10,121
|
Total
|
$514,757
|
$492,638
|
Effective
January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS
157) and SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities (SFAS
159). SFAS 159 allows entities an irrevocable option to measure
certain financial assets and financial liabilities at fair
value. Unrealized gains and losses on items for which the fair value
option has been elected are reported in earnings. The implementation
of this standard did not have a material impact on the Company’s consolidated
financial position or results of operations.
SFAS 157
establishes a common definition for fair value to be applied to generally
accepted accounting principals requiring the use of fair value, establishes a
framework for measuring fair value and expands disclosure about such fair value
instruments. It defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (exit
price). It also classifies the inputs used to measure fair value into
the following hierarchy:
-
Level 1
– Quoted prices in active markets for identical assets or
liabilities.
-
Level 2 – Quoted prices
in active markets for similar assets or liabilities, or quoted prices for
identical or similar assets or liabilities in markets that are not active, or
inputs other than quoted prices that are observable for the asset or
liability.
-
Level 3
– Significant valuation assumptions not readily observable in a
market.
A
financial instrument’s categorization within the valuation hierarchy is based
upon the lowest level of input that is significant to the fair value
measurement. The following tables set forth the Company’s
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of June 30, 2008:
(000's
omitted)
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
Available-for-sale
investment securities
|
$1,049
|
$1,007,250
|
$63,144
|
$1,071,443
|
Derivative
assets/(liabilities), net
|
-
|
(2,171)
|
-
|
(2,171)
|
Total
|
$1,049
|
$1,005,079
|
$63,144
|
$1,069,272
|
The
valuation techniques used to measure fair value for the items in the table
above are as follows:
|
·
|
Available
for sale investment securities – The fair value of available for sale
investment securities is based upon quoted prices, if
available. If quoted prices are not available, fair values are
measured using quoted market prices for similar securities or model-based
valuation techniques. Level 1 securities include U.S. Treasury
securities that are traded by dealers or brokers in active
over-the-counter markets. Level 2 securities include
mortgage-backed securities issued by government sponsored entities,
municipal securities and corporate debt securities. Securities
classified as Level 3 include asset-backed securities in less liquid
markets. The value of these instruments is determined using
pricing models or similar techniques as well as significant judgment or
estimation.
|
·
|
Derivative
assets and liabilities – The fair value of derivative instruments traded
in over-the-counter markets where quoted market prices are not readily
available, are measured using models for which the significant assumptions
such as yield curves and option volatilities are market
observable.
|
The
changes in Level 3 assets measured at fair value on a recurring basis are
summarized in the following table:
(000's
omitted)
|
AFS
investments
|
Balance
at April 1, 2008
|
$69,584
|
Total
gains (losses) included in earnings (a)
|
18
|
Total
gains (losses) included in other comprehensive income
|
(6,353)
|
Purchases
|
34
|
Sales/calls
|
(139)
|
Transfers
|
0
|
Balance
at June 30, 2008
|
$63,144
|
(000's
omitted)
|
AFS
investments
|
Balance
at January 1, 2008
|
$73,442
|
Total
gains (losses) included in earnings (a)
|
24
|
Total
gains (losses) included in other comprehensive income
|
(10,149)
|
Purchases
|
34
|
Sales/calls
|
(207)
|
Transfers
|
0
|
Balance
at June 30, 2008
|
$63,144
|
(a)
Included in gain (loss) on sales of investment securities and relate to
securities still held at June 30, 2008.
Loans are
generally not recorded at fair value on a recurring basis. Periodically, the
Company records nonrecurring adjustments to the carrying value of loans based on
fair value measurements for partial charge-offs of the uncollectible portions of
those loans. Nonrecurring adjustments also include certain impairment amounts
for collateral-dependent loans calculated in accordance with SFAS No. 114,
“Accounting by Creditors for Impairment of a Loan,” when establishing the
allowance for credit losses. Such amounts are generally based on the fair value
of the underlying collateral supporting the loan and, as a result, the carrying
value of the loan less the calculated valuation amount does not necessarily
represent the fair value of the loan. Real estate collateral is typically valued
using independent appraisals or other indications of value based on recent
comparable sales of similar properties or assumptions generally observable in
the marketplace and the related nonrecurring fair value measurement adjustments
have generally been classified as Level 2. Estimates of fair value used for
other collateral supporting commercial loans generally are based on assumptions
not observable in the marketplace and therefore such valuations have been
classified as Level 3. Loans subject to nonrecurring fair value
measurement had a gross carrying amount of $1,994,000, with an associated
valuation allowance of $567,000 for a fair value of $1,427,000 at June 30,
2008. These loans were classified as a Level 3
valuation.
Statement
of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an
Enterprise and Related Information has established standards for public
companies relating to the reporting of financial and descriptive information
about their operating segments in financial statements. Operating
segments are components of an enterprise, which are evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and assess
performance. The Company’s chief operating decision maker is the
President and Chief Executive Officer of the Company.
The
Company has identified “Banking” as its reportable operating business
segment. The Banking segment provides full-service banking to
consumers, businesses and governmental units in northern, central and western
New York as well as Northeastern Pennsylvania.
Immaterial
operating segments of the Company’s operations, which do not have similar
characteristics to the banking segment and do not meet the quantitative
thresholds requiring disclosure, are included in the “Other”
category. Revenues derived from these segments includes
administration, consulting and actuarial services provided to sponsors of
employee benefit plans, broker-dealer and investment advisory services, asset
management services to individuals, corporate pension and profit sharing plans,
trust services and insurance commissions from various insurance related products
and services. The accounting policies used in the disclosure of
business segments are the same as those described in the summary of significant
accounting policies (See Note A, Summary of Significant Accounting
Policies of the most recent Form 10-K for the year ended December 31,
2007).
Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:
|
For
the Three Months Ended
|
|
June
30, 2008
|
|
June
30, 2007
|
(000's
omitted)
|
Banking
|
Other
|
Consolidated
Total
|
|
Banking
|
Other
|
Consolidated
Total
|
|
|
|
|
|
|
|
|
Net
interest income
|
$35,393
|
$47
|
$35,440
|
|
$33,208
|
$130
|
$33,338
|
Provision
for loan losses
|
1,570
|
0
|
1,570
|
|
414
|
0
|
414
|
Noninterest
income excluding loss on investment securities and debt
extinguishments
|
8,927
|
8,779
|
17,706
|
|
7,696
|
7,330
|
15,026
|
Loss
on investment securities
|
(57)
|
0
|
(57)
|
|
(8)
|
0
|
(8)
|
Amortization
of intangible assets
|
1,535
|
110
|
1,645
|
|
1,496
|
85
|
1,581
|
Other
operating expenses
|
28,586
|
6,724
|
35,310
|
|
27,173
|
5,378
|
32,551
|
Income
before income taxes
|
$12,572
|
$1,992
|
$14,564
|
|
$11,813
|
$1,997
|
$13,810
|
|
|
|
|
|
|
|
|
|
|
|
For
the Six Months Ended
|
|
June
30, 2008
|
|
June
30, 2007
|
|
Banking
|
Other
|
Consolidated
Total
|
|
Banking
|
Other
|
Consolidated
Total
|
Net
interest income
|
$70,908
|
$130
|
$71,038
|
|
$66,448
|
$257
|
$66,705
|
Provision
for loan losses
|
2,350
|
0
|
2,350
|
|
614
|
0
|
614
|
Noninterest
income excluding loss on investment securities and debt
extinguishments
|
17,393
|
17,644
|
35,037
|
|
14,864
|
13,641
|
28,505
|
Gain/(Loss)
on investment securities
|
230
|
0
|
230
|
|
(8)
|
0
|
(8)
|
Amortization
of intangible assets
|
2,956
|
220
|
3,176
|
|
2,941
|
155
|
3,096
|
Other
operating expenses
|
58,456
|
13,697
|
72,153
|
|
54,643
|
10,312
|
64,955
|
Income
before income taxes
|
$24,769
|
$3,857
|
$ 28,626
|
|
$23,106
|
$3,431
|
$26,537
|
|
|
|
|
|
|
|
|
Assets
|
$4,621,743
|
$36,040
|
$4,657,783
|
|
$4,548,958
|
$34,191
|
$4,583,149
|
Goodwill
|
$221,322
|
$13,364
|
$234,686
|
|
$220,770
|
$12,449
|
$233,219
|
|
|
|
|
|
|
|
|
Introduction
This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) primarily reviews the financial condition and results of
operations of Community Bank System, Inc. (the Company or CBSI) as of and for
the three and six months ended June 30, 2008 and 2007, although in some
circumstances the first quarter of 2008 is also discussed in order to more fully
explain recent trends. The following discussion and analysis should
be read in conjunction with the Company's Consolidated Financial Statements and
related notes that appear on pages 3 through 14. All references in
the discussion to the financial condition and results of operations are to those
of the Company and its subsidiaries taken as a whole.
Unless
otherwise noted, the term “this year” refers to results in calendar year 2008,
“second quarter” refers to the quarter ended June 30, 2008, earnings per share
(EPS) figures refer to diluted EPS, and net interest income and net interest
margin are presented on a fully tax-equivalent (FTE) basis.
This
MD&A contains certain forward-looking statements with respect to the
financial condition, results of operations and business of the
Company. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ
materially from those proposed by such forward-looking statements are set herein
under the caption, “Forward-Looking Statements,” on page 29.
Critical Accounting
Policies
As a
result of the complex and dynamic nature of the Company’s business, management
must exercise judgment in selecting and applying the most appropriate accounting
policies for its various areas of operations. The policy decision
process not only ensures compliance with the latest generally accepted
accounting principles, but also reflects on management’s discretion with regard
to choosing the most suitable methodology for reporting the Company’s financial
performance. It is management’s opinion that the accounting estimates
covering certain aspects of the business have more significance than others due
to the relative importance of those areas to overall performance, or the level
of subjectivity in the selection process. These estimates affect the
reported amounts of assets and liabilities and disclosures of revenues and
expenses during the reporting period. Actual results could
differ from those estimates. Management believes that critical
accounting estimates include:
·
|
Allowance
for loan losses - The allowance for loan losses reflects management’s best
estimate of probable losses inherent in the loan
portfolio. Determination of the allowance is inherently
subjective. It requires significant estimates including the
amounts and timing of expected future cash flows on impaired loans and the
amount of estimated losses on pools of homogeneous loans which is based on
historical loss experience and consideration of current economic trends,
all of which may be susceptible to significant
change.
|
·
|
Actuarial
assumptions associated with pension, post-retirement and other employee
benefit plans - These assumptions include, among other things, discount
rate, rate of future compensation increases and expected return on plan
assets.
|
·
|
Provision
for income taxes - The Company is subject to examinations from various
taxing authorities. Such examinations may result in challenges
to the tax return treatment applied by the Company to specific
transactions. Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate. Should tax laws change or the taxing authorities
determine that management’s assumptions were inappropriate an adjustment
may be required which could have a material effect on the Company’s
results of operations.
|
·
|
Carrying
value of goodwill and other intangible assets - The carrying value of
goodwill and other intangible assets is based upon discounted cash flow
modeling techniques that require management to make estimates regarding
the amount and timing of expected future cash flows. It also
requires use of a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest
rates, required equity market premiums, and company-specific risk
indicators.
|
A summary
of the accounting policies used by management is disclosed in Note A, “Summary
of Significant Accounting Policies” on pages
46-51 of the most recent Form 10-K (fiscal year ended December 31, 2007) filed
with the Securities and Exchange Commission on March 13, 2008.
The
Company’s business philosophy is to operate as a community bank with local
decision-making, principally in non-metropolitan markets, providing a broad
array of banking and financial services to retail, commercial and municipal
customers.
The
Company’s core operating objectives are: (i) grow the branch network, primarily
through a disciplined acquisition strategy, and certain selective de novo
expansions, (ii) build high-quality, profitable loan and deposit portfolios
using both organic and acquisition strategies, (iii) increase the noninterest
income component of total revenues through development of banking-related fee
income, growth in existing financial services business units, and the
acquisition of additional financial services and banking businesses, and (iv)
utilize technology to deliver customer-responsive products and services and to
reduce operating costs.
Significant
factors management reviews to evaluate achievement of the Company’s operating
objectives and its operating results and financial condition include, but are
not limited to: net income and earnings per share, return on assets and equity,
net interest margins, noninterest income, operating expenses, asset quality,
loan and deposit growth, capital management, performance of individual banking
and financial services units, liquidity and interest rate sensitivity,
enhancements to customer products and services, technology enhancements, market
share, peer comparisons, and the performance of acquisition and integration
activities.
On July
7, 2008, Benefit Plans Administrative Services, Inc. (BPAS) completed its
acquisition of the Philadelphia division of Alliance Benefit Group MidAtlantic
(ABG) from BenefitStreet, Inc. ABG provides retirement plan
consulting, daily valuation administration, actuarial and ancillary support
services. This transaction, which is expected to add approximately
$5.0 million in annual revenues, adds valuable capacity to support BPAS’s
growing customer base of more than 300 actuarial engagements, administration of
over 200,000 defined contribution and flexible spending participant accounts and
of nearly $4.0 billion in retirement plan assets.
On June
25, 2008, the Company announced an agreement to acquire 18 branch-banking
centers in northern New York State from Citizens Financial Group, Inc.
(Citizens) in an all cash transaction. Under the terms of the
agreement, the company will acquire approximately $135 million in loans and $630
million in deposits at a blended deposit premium of 12%. This
acquisition is expected to close during the fourth quarter of 2008, pending
customary regulatory approvals. In support of the transaction, the
Company expects to issue approximately $30 million of equity capital prior to
its completion. Excluding one-time expenses, the transaction is
expected to be immediately accretive to earnings per share, inclusive of the
impact of the additional equity issuance.
On June
1, 2007, the Company completed its acquisition of TLNB Financial Corporation,
parent company of Tupper Lake National Bank (TLNB), in an all-cash transaction
valued at approximately $17.8 million. Based in Tupper Lake, NY, TLNB
operated five branches in the northeastern New York State cities of Tupper Lake,
Plattsburgh and Saranac Lake, as well as an insurance subsidiary, TLNB Insurance
Agency, Inc. On a consolidated basis, TLNB had approximately $100
million in assets and $87 million of deposits.
On May
18, 2007, the Company’s subsidiary, Benefit Plans Administrative Services, Inc.
(BPAS), completed its acquisition of Hand Benefits & Trust, Inc. (HBT) in an
all cash transaction. HBT is a Houston, Texas based provider of
employee benefit plan administration and trust services.
Second
quarter and June year-to-date 2008 earnings per share were $0.37 and $0.74,
respectively, an increase of $0.03 and $0.08 as compared to the respective prior
year periods. The increase was driven by solid organic loan growth,
continued expansion of non-interest income sources, improved net interest margin
and favorable asset quality results. These were partially offset by a
higher provision for loan loss and increased operating expenses. Cash
earnings per share (which excludes the after-tax effect of the amortization of
intangibles assets and acquisition-related market value adjustments) were $0.42
versus $0.39 for the prior year’s second quarter and $0.83 versus $0.75 for the
prior year-to-date period.
Asset
quality in the second quarter of 2008 remained favorable in the first half of
the year and was relatively consistent with the same period last
year. Net charge-offs and nonperforming loan and total delinquent
loan ratios increased, but remained well below average historical quarterly
levels. The Company experienced solid year-over-year organic loan
growth in all portfolios: consumer installment, consumer mortgage and business
lending. The investment portfolio increased as compared to the second
quarter of 2007 and decreased as compared to December 31,
2007. Average deposits increased in the second quarter of 2008 as
compared to the first quarter of 2008 and declined from the second quarter of
2007. These changes supported the Company’s objective of lowering its
overall funding costs by reducing higher cost time deposits, and focusing on
expanding core account relationships. External borrowings decreased
from the end of December 2007 due to the redemption of $25 million of
variable-rate trust preferred securities in the beginning of the first quarter
of 2008 and lower funding needs due to the reduction of the investment portfolio
and cash equivalent balances. Additionally, in December 2007, the
Company refinanced $150 million of its fixed rate Federal Home Loan Bank (FHLB)
advances, replacing them with lower cost instruments with similar remaining
duration. These restructuring strategies had a positive impact on the
Company’s net interest margin in the first half of 2008.
As shown
in Table 1, earnings per share for the second quarter and June YTD of $0.37 and
$0.74, respectively, were $0.03 and $0.08 higher than the EPS generated in the
same periods of last year. Net income for the quarter of $11.3
million was up 9.0% over the second quarter of 2007 and net income of $22.2
million for the first six months of 2008 increased 10.8% from the amount earned
in the first half of 2007. As compared to the first quarter of 2008,
net income increased $0.4 million or 3.6% and earnings per share
increased $0.01 or 2.8%.
Second
quarter net interest income of $35.4 million was up $2.1 million or 6.3% from
the comparable prior year period, and net interest income for the first six
months of 2008 increased $4.3 million or 6.5% over the first half of
2007. The current quarter’s provision for loan losses increased $1.2
million as compared to the second quarter of 2007 and increased $1.7 million for
the first six months of 2008 as compared to the same period of 2007, reflective
of organic loan growth in the quarter. Second quarter noninterest
income, excluding securities gains and losses, was $17.7 million, up $2.7
million or 18% from the second quarter of 2007, while YTD noninterest income of
$35.0 million increased $6.5 million or 23% from the prior year
level. Operating expenses of $37.0 million for the quarter and $68.1
million for the first six months of 2008 were up $2.8 million or 8.3% and $7.3
million or 10.7% respectively, from the comparable prior year
periods. A significant portion of the increase was attributable to
the acquisitions of TLNB and HBT during the second quarter of 2007.
In
addition to the earnings results presented above in accordance with generally
accepted accounting principles (GAAP), the Company provides
cash earnings per share, which excludes the after-tax effect of the amortization
of intangible assets and acquisition-related market value
adjustments. Management believes that this information helps
investors better understand the impact of acquisition activity on reported
results. Cash earnings per share for the second quarter and the first
six months of 2008 were $0.42 and $0.83, respectively, up 7.7% and 10.7% from
the $0.39 and $0.75 earned in the comparable periods of 2007.
As
reflected in Table 1, the primary reasons for improved earnings over the prior
year were higher noninterest income and net interest income, partially offset by
higher operating expenses and loan loss provision. Net interest
income for the second quarter and year-to-date period increased as compared to
the comparable periods of 2007 as a result of higher net interest margins as
well as acquired and organic loan growth. Excluding security gains
and losses, noninterest income increased due to a strong performance by the
Company’s employee benefits consulting and plan administration business, as a
result of significant organic growth and the acquisition of HBT, as well as
higher banking service fees, including account fees and debit card related
revenues. An increase in total loans and higher net charge-offs were
the primary reasons for the increase in the loan loss
provision. Operating expenses increased for the quarter and
year-to-date periods, primarily due to costs associated with the two
acquisitions in the last year, as well as higher business development and
volume-based processing costs, increased facility-based utilities and
maintenance costs, and higher personnel expenses. As compared to the
first quarter of 2008, operating expenses decreased $1.4 million or 3.7%,
reflective of seasonally lower occupancy, professional and personnel-related
costs.
A
condensed income statement and a reconciliation of GAAP-based earnings results
to cash-based earnings results are as follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
June
30,
|
|
June
30,
|
(000's
omitted, except per share data)
|
|
2008
|
2007
|
|
2008
|
2007
|
Net
interest income
|
|
$35,440
|
$33,338
|
|
$71,038
|
$66,705
|
Provision
for loan losses
|
|
1,570
|
414
|
|
2,350
|
614
|
Noninterest
income excluding security losses
|
|
17,706
|
15,026
|
|
35,037
|
28,505
|
(Loss)
gain on sales of investment securities
|
|
(57)
|
(8)
|
|
230
|
(8)
|
Operating
expenses
|
|
36,955
|
34,132
|
|
75,329
|
68,051
|
Income
before taxes
|
|
14,564
|
13,810
|
|
28,626
|
26,537
|
Income
taxes
|
|
3,277
|
3,451
|
|
6,441
|
6,522
|
Net
income
|
|
$11,287
|
$10,359
|
|
$22,185
|
$20,015
|
|
|
|
|
|
|
|
Diluted
earnings per share
|
|
$0.37
|
$0.34
|
|
$0.74
|
$0.66
|
Table
2: Reconciliation of GAAP Net Income to Cash Net Income (Non-GAAP
measure)
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
June
30,
|
|
June
30,
|
(000’s
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Net
income
|
|
$11,287
|
$10,359
|
|
$22,185
|
$20,015
|
After-tax
cash adjustments:
|
|
|
|
|
|
|
Amortization
of market value adjustments
|
|
|
|
|
|
|
on
net assets acquired in mergers
|
|
149
|
175
|
|
305
|
354
|
Amortization
of intangible assets
|
|
1,274
|
1,185
|
|
2,461
|
2,335
|
Net
income – cash
|
|
$12,710
|
$11,719
|
|
$24,951
|
$22,704
|
|
|
|
|
|
|
|
Diluted
earnings per share – cash
|
|
$0.42
|
$0.39
|
|
$0.83
|
$0.75
|
Net
interest income is the amount by which interest and fees on earning assets
(loans, investments and cash) exceed the cost of funds, primarily interest paid
to the Company's depositors and interest on external borrowings. Net
interest margin is the difference between the gross yield on earning assets and
the cost of interest-bearing funds as a percentage of earning
assets.
As shown
in Table 3, net interest income (with nontaxable income converted to a fully
tax-equivalent basis) for the second quarter of 2008 was $39.2 million, a $2.1
million increase from the same period last year. A $90.4 million
increase in interest-earning assets and a 14 basis point increase in the net
interest margin versus the prior year offset a $73.7 million increase in average
interest-bearing liabilities. As reflected in Table 4, the rate
decreases from interest bearing liabilities and the volume increases in interest
earning assets had a $6.4 million favorable impact on net interest income, while
the decrease in rate on interest bearing assets and higher interest bearing
liability balances had a $4.3 million unfavorable impact on net interest
income. June 2008 YTD net interest income of $78.7 million increased
$4.4 million or 6.0% from the year earlier period. A $116.8 million
increase in interest bearing assets and a 10 basis point increase in the net
interest margin more than offset a $110.3 million increase in interest bearing
liabilities. The increase in interest earning assets and the lower
rate on interest bearing liabilities had a $10.5 million favorable impact that
was partially offset by a $6.1 million unfavorable impact from the decrease in
rate on interest bearing assets and the increase in interest bearing liability
balances.
Higher
second quarter and June YTD average loan balances were attributable to $119.3
million of quarterly average organic loan growth since the second quarter of
2007, driven by growth in all portfolios: consumer installment, consumer
mortgage and business lending. The remaining contribution to the
increase in the average second quarter loan balance was the $38.0 million of
loan growth due to the TLNB acquisition. Average investments and cash
equivalents for the second quarter and YTD periods were $66.9 million and $30.6
million lower than the respective periods of 2007, primarily due to cash flows
from maturing investments being used to fund loan growth. In
comparison to the prior year, total average deposits declined $45.9 million or
1.4% and $2.7 million or 0.1% for the quarter and YTD periods,
respectively. Consistent with the Company’s objectives, core deposit
products increased $97 million or 5.5% since the second quarter of 2007, while
time deposits were allowed to decline $142 million during the same
timeframe. Quarterly average deposits from the TLNB acquisition
were $68 million, an increase of $41.9 million from the second quarter of
2007. Quarterly and YTD average borrowings increased $125.4 million
and $117.9 million as compared to the second quarter and first six months of
2007, respectively, primarily due to the all-cash acquisitions of TLNB and HBT,
partially offset by the redemption of $25 million of fixed rate trust preferred
securities in the first quarter of 2008.
The net
interest margin of 3.78% for the second quarter and 3.79% for the year to date
period increased 14 basis points and 10 basis points, respectively, versus the
same periods in the prior year. The improvement was primarily
attributable to a 48 basis point and a 33 basis point decrease in the cost of
funds for the quarter and year-to-date periods, respectively, as compared to the
prior year periods. The decrease in the cost of funds is due to a 54 basis point
and 34 basis point decrease in the rate paid on interest bearing deposits for
the second quarter and YTD periods, respectively, and the restructuring
of $175 million of external borrowings that were replaced with lower
cost instruments in late 2007 and early 2008. Partially offsetting
these improvements was a 33 basis point and 23 basis point decline in earning
assets yields for the quarter and YTD periods, respectively, as compared to the
comparable periods of 2007. The change in earning-asset yields was
driven by a 41 basis point and 29 basis point decrease in loan yields for the
quarter and YTD periods, respectively, and a 21 basis point and 12 basis point
decline in the investment yields for the quarter and YTD periods, respectively,
mostly as a result of variable and adjustable-rate assets repricing downward due
to the decline in short-term fed funds and other indexed rates.
The
second quarter cost of funds decreased 48 basis points versus the prior year’s
quarter due to an 86 basis point decrease in the average interest rate paid on
external borrowings and a 54 basis point decrease on interest-bearing deposits
rates. The decrease in the external borrowing rate is due to the
restructuring of $150 million of FHLB advances in December 2007 and the
redemption of $25 million of variable rate, trust-preferred securities in
January 2008. Additionally, the long-term rate was impacted by the
approximately 250 basis point decrease in the three month LIBOR (London
Interbank Offered Rates) over the last twelve months, from which the interest
rate on $25 million of the mandatorily redeemable preferred securities is
based. Interest rates on selected categories of deposit accounts were
lowered throughout the second half of 2007 and the first half of 2008 in
response to market conditions. Additionally, the proportion of
customer deposits in higher cost time deposits has declined 3.6 percentage
points over the last twelve months, while the percentage of deposits in lower
cost checking and savings accounts increased.
Tables 3a
and 3b below set forth information related to average interest-earning assets
and interest-bearing liabilities and their associated yields and rates for the
periods indicated. Interest income and yields are on a fully
tax-equivalent basis using marginal income tax rates of 38.49% in 2008 and
38.75% in 2007. Average balances are computed by accumulating the
daily ending balances in a period and dividing by the number of days in that
period. Loan yields and amounts earned include loan
fees. Average loan balances include nonaccrual loans and loans held
for sale.
Table
3a: Quarterly Average Balance Sheet
|
Three
Months Ended
|
|
Three
Months Ended
|
(000's
omitted except yields and rates)
|
June
30, 2008
|
|
June
30, 2007
|
|
|
|
Avg.
|
|
|
|
Avg.
|
|
Average
|
|
Yield/Rate
|
|
Average
|
|
Yield/Rate
|
|
Balance
|
Interest
|
Paid
|
|
Balance
|
Interest
|
Paid
|
Interest-earning
assets:
|
|
|
|
|
|
|
|
Cash
equivalents
|
$29,138
|
$140
|
1.93%
|
|
$87,554
|
$1,148
|
5.26%
|
Taxable
investment securities (1)
|
750,820
|
9,775
|
5.24%
|
|
797,807
|
11,214
|
5.64%
|
Nontaxable
investment securities
(1)
|
524,454
|
9,063
|
6.95%
|
|
485,922
|
8,355
|
6.90%
|
Loans
(net of unearned discount)
|
2,869,338
|
45,837
|
6.43%
|
|
2,712,021
|
46,262
|
6.84%
|
Total
interest-earning assets
|
4,173,750
|
64,815
|
6.25%
|
|
4,083,304
|
66,979
|
6.58%
|
Noninterest-earning
assets
|
466,196
|
|
|
|
453,044
|
|
|
Total
assets
|
$4,639,946
|
|
|
|
$4,536,348
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
$1,304,146
|
2,519
|
0.78%
|
|
$1,213,419
|
3,435
|
1.14%
|
Time
deposits
|
1,362,278
|
13,520
|
3.99%
|
|
1,504,716
|
16,657
|
4.44%
|
Short-term
borrowings
|
420,392
|
4,258
|
4.07%
|
|
154,799
|
1,622
|
4.20%
|
Long-term
borrowings
|
449,474
|
5,333
|
4.77%
|
|
589,686
|
8,204
|
5.58%
|
Total
interest-bearing liabilities
|
3,536,290
|
25,630
|
2.92%
|
|
3,462,620
|
29,918
|
3.47%
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
Demand
deposits
|
563,045
|
|
|
|
557,195
|
|
|
Other
liabilities
|
51,167
|
|
|
|
50,881
|
|
|
Shareholders'
equity
|
489,444
|
|
|
|
465,652
|
|
|
Total
liabilities and shareholders' equity
|
$4,639,946
|
|
|
|
$4,536,348
|
|
|
|
|
|
|
|
|
|
|
Net
interest earnings
|
|
$39,185
|
|
|
|
$37,061
|
|
Net
interest spread
|
|
|
3.33%
|
|
|
|
3.11%
|
Net
interest margin on interest-earnings assets
|
|
|
3.78%
|
|
|
|
3.64%
|
|
|
|
|
|
|
|
|
Fully
tax-equivalent adjustment
|
|
$3,745
|
|
|
|
$3,723
|
|
(1)
Averages for investment securities are based on historical cost basis and the
yields do not give effect to changes in fair value that is reflected as a
component of shareholders’
equity and deferred taxes.
Table
3b: Year-to-Date Average Balance Sheet
|
Six
Months Ended
|
|
Six
Months Ended
|
(000's
omitted except yields and rates)
|
June
30, 2008
|
|
June
30, 2007
|
|
|
|
Avg.
|
|
|
|
Avg.
|
|
Average
|
|
Yield/Rate
|
|
Average
|
|
Yield/Rate
|
|
Balance
|
Interest
|
Paid
|
|
Balance
|
Interest
|
Paid
|
Interest-earning
assets:
|
|
|
|
|
|
|
|
Cash
equivalents
|
$36,933
|
$458
|
2.49%
|
|
$95,012
|
$2,478
|
5.26%
|
Taxable
investment securities (1)
|
757,527
|
20,492
|
5.44%
|
|
769,712
|
21,493
|
5.63%
|
Nontaxable
investment securities
(1)
|
532,724
|
18,396
|
6.94%
|
|
493,058
|
16,994
|
6.95%
|
Loans
(net of unearned discount)
|
2,845,719
|
92,509
|
6.54%
|
|
2,698,369
|
91,367
|
6.83%
|
Total
interest-earning assets
|
4,172,903
|
131,855
|
6.35%
|
|
4,056,151
|
132,332
|
6.58%
|
Noninterest-earning
assets
|
468,079
|
|
|
|
446,830
|
|
|
Total
assets
|
$4,640,982
|
|
|
|
$4,502,981
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
$1,282,540
|
5,234
|
0.82%
|
|
$1,205,843
|
6,775
|
1.13%
|
Time
deposits
|
1,380,464
|
28,499
|
4.15%
|
|
1,464,725
|
31,437
|
4.33%
|
Short-term
borrowings
|
423,254
|
8,678
|
4.12%
|
|
157,108
|
3,259
|
4.18%
|
Long-term
borrowings
|
453,326
|
10,772
|
4.78%
|
|
601,589
|
16,638
|
5.58%
|
Total
interest-bearing liabilities
|
3,539,584
|
53,183
|
3.02%
|
|
3,429,265
|
58,109
|
3.42%
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
Demand
deposits
|
559,486
|
|
|
|
554,655
|
|
|
Other
liabilities
|
55,815
|
|
|
|
53,920
|
|
|
Shareholders'
equity
|
486,097
|
|
|
|
465,141
|
|
|
Total
liabilities and shareholders' equity
|
$4,640,982
|
|
|
|
$4,502,981
|
|
|
|
|
|
|
|
|
|
|
Net
interest earnings
|
|
$78,672
|
|
|
|
$74,223
|
|
Net
interest spread
|
|
|
3.33%
|
|
|
|
3.16%
|
Net
interest margin on interest-earnings assets
|
|
|
3.79%
|
|
|
|
3.69%
|
|
|
|
|
|
|
|
|
Fully
tax-equivalent adjustment
|
|
$7,634
|
|
|
|
$7,518
|
|
(1)
Averages for investment securities are based on historical cost basis and the
yields do not give effect to changes in fair value that is reflected as a
component of shareholders’
equity and deferred taxes.
As
discussed above and disclosed in Table 4 below, the quarterly change in net
interest income (on a fully tax-equivalent basis) may be analyzed by segregating
the volume and rate components of the changes in interest income and interest
expense for each underlying category.
Table
4: Rate/Volume
|
2nd
Quarter 2008 versus 2nd
Quarter 2007
|
|
Six
Months Ended June 30, 2008 versus June 30, 2007
|
|
|
Increase
(Decrease) Due to Change in (1)
|
|
Increase
(Decrease) Due to Change in (1)
|
|
|
Volume
|
Rate
|
Net
Change
|
|
Volume
|
Rate
|
Net
Change
|
|
(000's
omitted)
|
|
|
|
|
|
|
|
|
Interest
earned on:
|
|
|
|
|
|
|
|
|
Cash
equivalents
|
($517)
|
($491)
|
($1,008)
|
|
($1,088)
|
($932)
|
($2,020)
|
|
Taxable
investment securities
|
(639)
|
(800)
|
(1,439)
|
|
(336)
|
(665)
|
(1,001)
|
|
Nontaxable
investment securities
|
666
|
42
|
708
|
|
1,370
|
32
|
1,402
|
|
Loans
(net of unearned discount)
|
2,601
|
(3,026)
|
(425)
|
|
4,874
|
(3,732)
|
1,142
|
|
Total
interest-earning assets
(2)
|
1,461
|
(3,625)
|
(2,164)
|
|
3,752
|
(4,229)
|
(477)
|
|
|
|
|
|
|
|
|
|
|
Interest
paid on:
|
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
241
|
(1,157)
|
(916)
|
|
409
|
(1,950)
|
(1,541)
|
|
Time
deposits
|
(1,499)
|
(1,638)
|
(3,137)
|
|
(1,767)
|
(1,171)
|
(2,938)
|
|
Short-term
borrowings
|
2,692
|
(56)
|
2,636
|
|
5,457
|
(38)
|
5,419
|
|
Long-term
borrowings
|
(1,773)
|
(1,098)
|
(2,871)
|
|
(3,733)
|
(2,133)
|
(5,866)
|
|
Total
interest-bearing liabilities (2)
|
625
|
(4,913)
|
(4,288)
|
|
1,822
|
(6,748)
|
(4,926)
|
|
|
|
|
|
|
|
|
|
|
Net
interest earnings (2)
|
$832
|
$1,292
|
$2,124
|
|
$2,168
|
$2,281
|
$4,449
|
|
(1) The
change in interest due to both rate and volume has been allocated in proportion
to the relationship of the absolute dollar amounts of such change in each
component.
(2)
Changes due to volume and rate are computed from the respective changes in
average balances and
rates and are not a summation of the changes of the components.
The
Company’s sources of noninterest income are of three primary types: 1) general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network and electronic banking channels;
2) employee benefit plan administration, actuarial and consulting services
(performed by BPA-Harbridge and HBT); and 3) wealth management services,
comprised of trust services (performed by the trust unit within CBNA),
investment and insurance products (performed by Community Investment Services,
Inc. or CISI and CBNA Insurance Agency, Inc.) and asset management (performed by
Nottingham Advisors or Nottingham). Additionally, the Company has
periodic transactions, most often net gains (losses) from the sale of investment
securities and prepayment of debt instruments.
Table
5: Noninterest Income
|
|
Three
Months Ended
|
|
Six
months Ended
|
|
|
June
30,
|
|
June
30,
|
(000's
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Deposit
service fees
|
|
$8,910
|
$7,825
|
|
$17,171
|
$14,802
|
Benefit
plan administration, consulting and actuarial fees
|
|
5,933
|
4,767
|
|
12,245
|
8,739
|
Wealth
management services
|
|
2,324
|
2,009
|
|
4,487
|
3,869
|
Other
banking services
|
|
367
|
256
|
|
740
|
669
|
Mortgage
banking
|
|
172
|
169
|
|
394
|
426
|
Subtotal
|
|
17,706
|
15,026
|
|
35,037
|
28,505
|
(Loss)/gain
on sales of investment securities
|
|
(57)
|
(8)
|
|
230
|
(8)
|
Total
noninterest income
|
|
$17,649
|
$15,018
|
|
$35,267
|
$28,497
|
|
|
|
|
|
|
|
Noninterest
income/total income (FTE)
|
|
31.1%
|
28.9%
|
|
30.8%
|
27.7%
|
As
displayed in Table 5, noninterest income (excluding securities gains and losses)
was $17.7 million in the second quarter and $35.0 million for the first half of
2008. This represents an increase of $2.7 million or 18% for the
quarter, and $6.5 million or 23% for the YTD period in comparison to one year
earlier. A significant portion of the growth was attributable to
higher benefit plan administration, consulting and actuarial fees, primarily due
to the acquisition of HBT in mid May 2007. The remainder of the
increase was due to organic growth generated from new clients along with
enhanced product offerings to both new and existing customers. Second
quarter and YTD wealth management services revenue increased $0.3 million or 16%
and $0.6 million or 16%, respectively, a majority of which was attributable to
acquired insurance agency revenues.
General
recurring banking fees of $9.4 million and $18.3 million for the second quarter
and first six months of 2008 were up $1.2 million or 14.5% and $2.4 million or
15.1%, respectively, as compared to the prior year periods. The
increase was driven by organic core deposit account growth, higher
electronic-banking revenues, including card-related activity, and incremental
income generated from acquired branches.
The ratio
of noninterest income to total income (FTE basis) was 31.1% for the quarter and
30.8% for the year-to-date period versus 28.9% and 27.7% for the comparable
periods in 2007. This improvement is a function of increased
noninterest banking and financial services income (excluding net security
gains), combined with proportionally smaller increases in net interest
income.
Table 6
below sets forth the quarterly results of the major operating expense categories
for the current and prior year, as well as efficiency ratios (defined below), a
standard measure of expense utilization effectiveness used in the banking
industry.
Table
6: Operating Expenses
|
|
Three
Months Ended
|
|
Six
months Ended
|
|
|
June
30,
|
|
June
30,
|
(000's
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Salaries
and employee benefits
|
|
$19,772
|
$18,386
|
|
$40,158
|
$36,672
|
Occupancy
and equipment
|
|
5,189
|
4,559
|
|
10,762
|
9,225
|
Data
processing and communications
|
|
4,100
|
3,808
|
|
8,085
|
7,373
|
Amortization
of intangible assets
|
|
1,645
|
1,581
|
|
3,176
|
3,096
|
Legal
and professional fees
|
|
902
|
1,054
|
|
2,200
|
2,241
|
Office
supplies and postage
|
|
1,237
|
1,008
|
|
2,515
|
2,054
|
Business
development and marketing
|
|
1,507
|
1,538
|
|
2,829
|
2,488
|
Other
|
|
2,603
|
2,198
|
|
5,604
|
4,902
|
Total
operating expenses
|
|
$36,955
|
$34,132
|
|
$75,329
|
$68,051
|
|
|
|
|
|
|
|
Operating
expenses/average assets
|
|
3.20%
|
3.02%
|
|
3.26%
|
3.05%
|
Efficiency
ratio
|
|
62.1%
|
62.2%
|
|
63.4%
|
63.0%
|
As shown
in Table 6, second quarter 2008 operating expenses were $37.0 million, up $2.8
million or 8.3% from the prior year level. Year-to-date operating
expenses of $75.3 million rose $7.3 million or 10.7% compared to the same period
in 2007. A significant portion of the increase was attributable to
incremental operating expenses related to the TLNB and HBT
acquisitions. Additionally, the increase in operating expenses can be
attributed to annual merit and other personnel related costs ($0.7 million for
the quarter, $1.6 million for YTD), higher facility-based utility and
maintenance costs ($0.5 million for the quarter, $1.1 million YTD), higher
volume-based data processing and communication costs ($0.2 million for the
quarter, $0.4 million YTD), and an increased level of business development and
marketing expenses ($0.4 million for the YTD period). A portion of
the increase in data processing and communications costs, as well as the
increase in business development and marketing expenses, reflects the Company’s
continued investment in strategic technology and business development
initiatives to grow and enhance its service offerings.
The
Company’s efficiency ratio (recurring operating expenses excluding intangible
amortization and acquisition expenses divided by the sum of net interest income
(FTE) and recurring noninterest income) was 62.1% for the second quarter,
slightly below the comparable quarter of 2007. This resulted from
operating expenses (as described above) increasing 9.0% primarily due to the
acquisitions in the last year, while recurring operating income increased at a
slightly faster rate of 9.2%. The efficiency ratio of 63.4% for the
first half of 2008 was up 0.4 percentage points from a year earlier due to core
operating expenses increasing 11.5% while recurring operating income increased
at a slower rate of 10.8%. In both periods, the efficiency
ratios were adversely affected by the growing proportion of financial services
activities, which, due to the differing nature of their business carry high
efficiency ratios. Operating expenses as a percentage of average
assets increased 18 basis points and 21 basis points for the quarter and year to
date periods, respectively, as operating expenses increased 8.3% and 10.7%,
respectively, while average assets increased 2.3% and 3.1%, respectively, during
the same time periods. This ratio was impacted by the comparatively
higher growth rates of the financial services businesses, which are less
asset-intensive and have higher efficiency ratio attributes.
The
second quarter effective income tax rate was 22.5%, compared to the 25.0%
effective tax rate in the second quarter of 2007. The year to date
effective tax rate was 22.5% as compared to the 24.6% for the first half of
2007. The lower effective tax rate for 2008 was principally a
result of a higher proportion of income being generated from tax-exempt
securities and loans.
As
reflected in Table 7 below, the carrying value of investments (including
unrealized gains on available-for-sale securities) was $1.26 billion at the end
of the second quarter, a decrease of $133.1 million from December 31, 2007 and
an increase of $39.4 million from June 30, 2007. The book value
(excluding unrealized gains and losses) of investments decreased $115.8 million
from December 31, 2007 and increased $35.2 million from June 30,
2007. The short-term agency securities purchased during the third
quarter of 2007 matured during the fourth quarter of 2007 and the first quarter
of 2008. Cash flows from these securities provided an opportunity to
invest in municipal and certain mortgage-backed securities that improved the
Company’s interest rate sensitivity position. The overall mix of securities
within the portfolio over the last year has changed, with an increase in the
proportion of obligations of state and political subdivisions and
mortgage-backed securities, the addition of asset-backed securities and a
decrease in U.S. Treasury and Agency, collateralized mortgage obligations and
corporate securities. The change in the carrying value of investments
is impacted by the amount of net unrealized gains and losses in the available
for sale portfolio at a point in time. At June 30, 2008, the
portfolio had a $0.1 million net unrealized loss, a decrease of $17.2 million
from the unrealized gain at December 31, 2007 and an improvement of $4.2 million
from the unrealized loss at June 30, 2007. This fluctuation is
indicative of the interest rate movements during the respective time periods and
the changes in the size and composition of the portfolio.
Included
in the available for sale portfolio are asset-backed securities with a current
par value of $74.8 million and unrealized losses of $12.8 million at June 30,
2008. The underlying collateral of these assets are principally
trust-preferred securities of community banks. The Company has the
intent and ability to hold these securities to recovery and does not consider
these investments to be other-than temporarily impaired as of June 30, 2008.
Other than temporary impairment assessments are based on an evaluation of both
current and future market and credit conditions as of June 30,
2008. Subsequent changes in market or credit conditions could change
those evaluations.
Table
7: Investments
|
|
June
30, 2008
|
|
December
31, 2007
|
|
June
30, 2007
|
|
|
|
Amortized
|
|
|
Amortized
|
|
|
Amortized
|
|
|
|
|
Cost/Book
|
Fair
|
|
Cost/Book
|
Fair
|
|
Cost/Book
|
Fair
|
|
(000's
omitted)
|
|
Value
|
Value
|
|
Value
|
Value
|
|
Value
|
Value
|
|
Held-to-Maturity
Portfolio:
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury and Agency securities
|
|
$126,983
|
$126,800
|
|
$127,055
|
$127,382
|
|
$127,127
|
$122,376
|
|
Obligations
of state and political subdivisions
|
|
7,978
|
8,042
|
|
6,207
|
6,289
|
|
5,296
|
5,301
|
|
Other
securities
|
|
3,206
|
3,206
|
|
3,988
|
3,988
|
|
4,000
|
4,000
|
|
Total
held-to-maturity portfolio
|
|
138,167
|
138,048
|
|
137,250
|
137,659
|
|
136,423
|
131,677
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury and Agency securities
|
|
245,971
|
250,800
|
|
432,832
|
438,526
|
|
414,868
|
410,397
|
|
Obligations
of state and political subdivisions
|
|
515,893
|
523,835
|
|
532,431
|
543,963
|
|
479,600
|
482,719
|
|
Corporate
securities
|
|
35,613
|
35,349
|
|
40,457
|
40,270
|
|
40,527
|
39,533
|
|
Collateralized
mortgage obligations
|
|
29,978
|
30,243
|
|
34,451
|
34,512
|
|
38,483
|
37,934
|
|
Asset-backed
securities
|
|
72,920
|
61,981
|
|
73,089
|
72,300
|
|
0
|
0
|
|
Mortgage-backed
securities
|
|
169,923
|
168,040
|
|
72,655
|
73,525
|
|
72,076
|
70,698
|
|
Subtotal
|
|
1,070,298
|
1,070,248
|
|
1,185,915
|
1,203,096
|
|
1,045,554
|
1,041,281
|
|
Equity
securities
|
|
50,377
|
50,377
|
|
51,526
|
51,526
|
|
41,656
|
41,656
|
|
Total
available-for-sale portfolio
|
|
1,120,675
|
1,120,625
|
|
1,237,441
|
1,254,622
|
|
1,087,210
|
1,082,937
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized (loss) gain on available-for-sale portfolio
|
|
(50)
|
0
|
|
17,181
|
0
|
|
(4,273)
|
0
|
|
Total
|
|
$1,258,792
|
$1,258,673
|
|
$1,391,872
|
$1,392,281
|
|
$1,219,360
|
$1,214,614
|
|
As shown
in Table 8, loans ended the second quarter at $2.92 billion, up $101.2 million
or 3.6% from year-end 2007 and up $155.1 million or 5.6% versus one year
earlier. On an organic basis, average loans were up $119.3 million
versus one year earlier, with solid growth in all portfolios; consumer mortgage,
consumer installment and business lending. All three portfolios also
grew during the second quarter, with increases of $12.7 million in the business
lending portfolio, $27.3 million in the consumer mortgage portfolio, and $44.5
million in the consumer installment portfolio.
Table
8: Loans
(000's
omitted) |
|
June 30,
2008 |
|
December 31,
2007
|
|
June 30,
2007
|
Business
lending |
|
$1,011,137 |
34.6% |
|
$984,780 |
34.9%
|
|
$988,886
|
35.7%
|
Consumer
mortgage |
|
1,015,114 |
34.7% |
|
977,553 |
34.7%
|
|
948,430
|
34.3%
|
Consumer
installment |
|
895,992 |
30.7% |
|
858,722
|
30.4%
|
|
829,860
|
30.0%
|
Total loans |
|
$2,922,243 |
100.0% |
|
$2,821,055
|
100.0%
|
|
$2,767,176
|
100.0%
|
Business
lending increased $26.4 million in the first six months of 2008 and increased
$22.3 million versus one year ago. The Company continues to face
competitive conditions in most of its markets and it maintains its commitment to
generating growth in its business portfolio in a manner that adheres to its twin
goals of maintaining strong asset quality and producing profitable
margins. The Company has continued to invest in additional personnel,
technology and business development resources to further strengthen its
capabilities in this key business segment.
Consumer
mortgages increased $66.7 million year-over-year and $37.6 million in the first
six months of 2008. Consumer mortgage growth has been strong over the
last few quarters despite softening demand in the overall market. The
consumer real estate portfolio does not include exposure to subprime, Alt-A, or
other higher-risk mortgage products. The Company’s solid performance
during a tumultuous period in the overall industry is a testament to the stable,
low-risk profile of its portfolio, and its ability to successfully meet customer
needs at a time when some national mortgage lenders are restricting their
lending activities in many markets.
Consumer
installment loans, including borrowings originated in automobile, marine and
recreational vehicle dealerships, as well as branch originated home equity and
installment loans, increased $37.3 million in the first six months of 2008 and
increased $66.1 million on a year-over-year basis. Declines in
manufacturer production and industry sale projections indicate continued
weakness in the new vehicle market which has created demand in late model used
and program car inventories, segments in which the Company is an active
participant. Aggressive business development efforts have created
opportunities to strategically expand the Company’s share of the market, helping
drive productive growth in this portfolio.
Table 9
below exhibits the major components of nonperforming loans and assets and key
asset quality metrics for the periods ending June 30, 2008 and 2007 and December
31, 2007.
Table
9: Nonperforming Assets
|
|
June
30,
|
|
December
31,
|
|
June
30,
|
(000's
omitted)
|
|
2008
|
|
2007
|
|
2007
|
Nonaccrual
loans
|
|
$10,016
|
|
$7,140
|
|
$8,003
|
Accruing
loans 90+ days delinquent
|
|
370
|
|
622
|
|
778
|
Restructured
loans
|
|
1,064
|
|
1,126
|
|
1,189
|
Total
nonperforming loans
|
|
11,450
|
|
8,888
|
|
9,970
|
Other
real estate owned (OREO)
|
|
637
|
|
1,007
|
|
1,411
|
Total
nonperforming assets
|
|
$12,087
|
|
$9,895
|
|
$11,381
|
|
|
|
|
|
|
|
Allowance
for loan losses to total loans
|
|
1.27%
|
|
1.29%
|
|
1.33%
|
Allowance
for loan losses to nonperforming loans
|
|
324%
|
|
410%
|
|
368%
|
Nonperforming
loans to total loans
|
|
0.39%
|
|
0.32%
|
|
0.36%
|
Nonperforming
assets to total loans and other real estate
|
|
0.41%
|
|
0.35%
|
|
0.41%
|
Delinquent
loans (30 days past due to nonaccruing) to total loans
|
|
1.13%
|
|
1.10%
|
|
0.95%
|
Net
charge-offs to average loans outstanding (quarterly)
|
|
0.12%
|
|
0.13%
|
|
0.05%
|
Loan
loss provision to net charge-offs (quarterly)
|
|
180%
|
|
98%
|
|
114%
|
As
displayed in Table 9, nonperforming assets at June 30, 2008 were $12.1 million,
an increase of $0.7 million versus one year earlier and a $2.2 million increase
as compared to the level at the end of 2007. Nonperforming loan
ratios increased slightly during the second quarter of 2008, but remain at or
near historically low levels, reflective of disciplined credit management and
relatively stable economic conditions in our markets over the past few
years. Other real estate owned (OREO) decreased $0.4 million and $0.8
million from year-end 2007 and one-year ago, respectively, a result
of the Company managing 14 OREO properties at June 30, 2008 as compared to 20
OREO properties at June 30, 2007. No single property has a carrying
value in excess of $200,000.
Nonperforming
loans were 0.39% of total loans outstanding at the end of the second quarter,
seven basis points higher than the level at December 31, 2007 and three basis
points higher than the 0.36% at June 30, 2007. The allowance for loan
losses to nonperforming loans ratio, a general measure of coverage adequacy, was
324% at the end of the second quarter compared to 410% at year-end 2007 and 368%
at June 30, 2007, reflective of a favorable and stable overall asset quality
profile, combined with slightly higher nonaccrual loan levels.
Delinquent
loans (30 days through nonaccruing) as a percent of total loans was 1.13% at the
end of the second quarter, slightly higher than the 1.10% at year-end 2007 and
the 0.95% at June 30, 2007. The commercial loan delinquency ratio at
the end of the second quarter increased in comparison to December 31, 2007 and
June 30, 2007. The delinquency rate for real estate loans decreased
as compared to the December 31, 2007 and increased as compared to June 30,
2007. The consumer installment loan delinquency rate decreased as
compared to both December 31, 2007 and June 30, 2007. The delinquency
levels at the end of the current quarter remain favorable and are only
slightly above the Company’s average of 1.11% over the previous eight
quarters.
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
June
30,
|
|
June
30,
|
(000's
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Allowance
for loan losses at beginning of period
|
|
$36,428
|
$35,891
|
|
$36,427
|
$36,313
|
Charge-offs:
|
|
|
|
|
|
|
Business
lending
|
|
406
|
295
|
|
684
|
535
|
Consumer
mortgage
|
|
62
|
45
|
|
114
|
280
|
Consumer
installment
|
|
1,305
|
1,251
|
|
2,653
|
2,412
|
Total
charge-offs
|
|
1,773
|
1,591
|
|
3,451
|
3,227
|
Recoveries:
|
|
|
|
|
|
|
Business
lending
|
|
168
|
389
|
|
341
|
646
|
Consumer
mortgage
|
|
9
|
20
|
|
55
|
21
|
Consumer
installment
|
|
726
|
820
|
|
1,405
|
1,576
|
Total
recoveries
|
|
903
|
1,229
|
|
1,801
|
2,243
|
|
|
|
|
|
|
|
Net
charge-offs
|
|
870
|
362
|
|
1,650
|
984
|
Provision
for loans losses
|
|
1,570
|
414
|
|
2,350
|
614
|
Allowance
for acquired loans
|
|
0
|
747
|
|
0
|
747
|
Allowance
for loan losses at end of period
|
|
$37,128
|
$36,690
|
|
$37,128
|
$36,690
|
|
|
|
|
|
|
|
Net
charge-offs to average loans outstanding:
|
|
|
|
|
|
|
Business
lending
|
|
0.10%
|
-0.04%
|
|
0.07%
|
-0.02%
|
Consumer
mortgage
|
|
0.02%
|
0.01%
|
|
0.01%
|
0.06%
|
Consumer
installment
|
|
0.27%
|
0.21%
|
|
0.29%
|
0.21%
|
Total
loans
|
|
0.12%
|
0.05%
|
|
0.12%
|
0.07%
|
As
displayed in Table 10, net charge-offs during the second quarter were $0.9
million, $0.5 million higher than the equivalent 2007 period. All
portfolios, consumer installment, business lending, and consumer mortgage
experienced small increases in the level of charge-offs as compared to the
historical low levels experienced in the second quarter of 2007. The
net charge-off ratio (net charge-offs as a percentage of average loans
outstanding) for the second quarter was 0.12%, seven basis points higher than
the comparable quarter of 2007 and two basis points below the average charge-off
ratio for the previous eight quarters. Net charge-offs and the
corresponding net charge-off ratios continue to be below the average net
charge-off levels of the past several years.
All
portfolios experienced slightly higher net charge off ratios for the second
quarter of 2008 as compared to the second quarter of 2007. For
the six months ended June 30, 2008 the net charge off ratio improved five basis
points for the consumer mortgage portfolio, while the business lending and
consumer installment charge off ratios were higher by nine and eight basis
points, respectively. The average net charge-off ratio for each
of the portfolios is lower in the current quarter than their average net
charge-off ratios for the previous eight quarters.
A loan
loss allowance of $37.1 million was determined as of June 30, 2008,
necessitating a $1.6 million loan loss provision for the quarter, compared to
$0.4 million one year earlier, driven by the growth in the loan portfolio during
the second quarter. The allowance for loan losses rose $0.4 million
or 1.2% over the last 12 months, less than the 5.6% growth in the loan portfolio
over the same period. Contributing to the changes were the favorable
charge-off, nonperforming and delinquency trends experienced over the last
twelve months. This contributed to the ratio of allowance for loan
loss to loans outstanding declining to 1.27% at the end of the second quarter,
six basis points below its level at June 30, 2007 and two basis points lower
than the level at December 31, 2007. The decrease was also slightly
impacted by the increased proportion of low-risk consumer mortgage and home
equity loans in the overall loan portfolio, as a result of both organic and
acquired growth.
As shown
in Table 11, average deposits of $3.2 billion in the second quarter were down
$45.9 million or 1.4% compared to the second quarter of 2007 and decreased $12.7
million or 0.4% versus the fourth quarter of last year. Excluding the
impact of the TLNB acquisition, average deposits decreased $87.7 million or 2.7%
as compared to the second quarter of 2007. Consistent with the
Company’s focus on expanding core account relationships and reducing higher cost
time deposits, core product relationships grew $96.6 million or 5.5% as compared
to the second quarter of 2007 while time deposits were allowed to decline $142.4
million or 9.5%. Interest checking account balances are
above the prior year levels primarily as a result of the continued success of
new product initiatives that commenced in the second quarter of
2006. This shift in mix, combined with the Company’s ability to
reduce rates due to market conditions, resulted in the quarterly cost of
interest-bearing deposits declining from 3.0% in the second quarter of 2007 to
2.4% in the most recent quarter.
Average
second quarter non-public fund deposits were down $18.9 million or 0.6% compared
to the year earlier period and decreased $22.6 million or 0.7% versus the fourth
quarter of 2007. Excluding time deposits, non-public deposits for the
second quarter were up $98.3 million or 6.1% as compared to the second quarter
of 2007. Average public funds have increased $9.9 million or 5.1%
from the fourth quarter of 2007 and decreased $26.9 million or 11.6%
from the second quarter of 2007. The Company continues to focus
heavily on growing its core deposits through enhanced marketing and training
programs and new product offerings introduced during the past two
years. The success of these efforts is demonstrated by the solid
organic core deposit growth generated over the past year, with second quarter
average balances increasing $68.4 million or 3.9% versus one year
earlier.
Table
11: Quarterly Average Deposits
|
|
June
30,
|
|
December
31,
|
|
June
30,
|
(000's
omitted)
|
|
2008
|
|
2007
|
|
2007
|
Demand
deposits
|
|
$563,045
|
|
$574,266
|
|
$557,195
|
Interest
checking deposits
|
|
485,113
|
|
464,996
|
|
430,038
|
Savings
deposits
|
|
458,556
|
|
451,148
|
|
459,514
|
Money
market deposits
|
|
360,477
|
|
329,566
|
|
323,867
|
Time
deposits
|
|
1,362,278
|
|
1,422,159
|
|
1,504,716
|
Total
deposits
|
|
$3,229,469
|
|
$3,242,135
|
|
$3,275,330
|
|
|
|
|
|
|
|
Non-public
fund deposits
|
|
$3,023,407
|
|
$3,046,018
|
|
$3,042,325
|
Public
fund deposits
|
|
206,062
|
|
196,117
|
|
233,005
|
Total
deposits
|
|
$3,229,469
|
|
$3,242,135
|
|
$3,275,330
|
Borrowings
of $874.6 million at the end of the second quarter, decreased $54.7 million from
December 31, 2007 and were up $170.4 million versus the end of the second
quarter of 2007. Borrowings were up from one year ago primarily due
to the need to supplement the funding of strong loan growth and selected
investment purchases. The decline in borrowings during the first six
months of 2008 was mostly attributable to a planned reduction of short-term
investments and substantial core deposit balance growth. In December
2007, the Company refinanced $150 million of its fixed rate FHLB advances,
replacing them with lower cost instruments with similar remaining duration and
conducted an early redemption of $25 million of its variable rate,
trust-preferred securities in January 2008. These restructuring
strategies helped reduce the Company’s interest expense on external borrowings
and consequently improved its net interest margin in the first six months of
2008.
On April
20, 2005, the Company announced a twenty-month authorization to repurchase up to
1.5 million of its outstanding shares in open market or privately negotiated
transactions. On December 20, 2006, the Company extended the program
through December 31, 2008 and announced an additional two-year authorization to
repurchase up to 900,000 of its outstanding shares in open market or privately
negotiated transactions. All reacquired shares will become treasury
shares and will be used for general corporate purposes, including those related
to employee and director stock plan activities. Through June 30,
2008, the Company had repurchased 1,464,811 shares at an aggregate cost of $31.5
million under this program.
Total
shareholders’ equity of $483.6 million at the end of the second quarter
increased $4.9 million from the balance at December 31, 2007. This
change consisted of net income of $22.2 million, $4.7 million from shares issued
under the employee stock plan, and $1.1 million from employee stock
options earned, partially offset by dividends declared of $12.5 million and a
$10.6 million decrease in other comprehensive income. The other
comprehensive loss is comprised of a $10.7 million decrease in the after-tax
market value adjustment on the available-for-sale investment portfolio,
partially offset by a $45,000 increase in the after-tax market value adjustment
on the interest rate swap and a $33,000 adjustment to the funded status of the
Company’s retirement plans. Over the past 12 months total
shareholders’ equity increased by $24.0 million, as net income, positive
contributions from shares issued under the employee stock plan, and a higher
market value adjustment more than offset dividends declared, treasury stock
purchases, and the funded status of the Company’s defined benefit pension
and other postretirement plans.
The
Company’s Tier I leverage ratio, a primary measure of regulatory capital for
which 5% is the requirement to be “well-capitalized,” was 7.75% at the end of
the second quarter, down five basis points from year-end 2007 and 12 basis
points lower than its level one year ago. The decrease in the Tier I
leverage ratio compared to December 31, 2007 is primarily the result of the
early call of $25 million of variable-rate trust preferred securities in the
first quarter. The decrease in the Tier I ratio, as compared to the
prior year second quarter, is the result of a 0.8% increase in Tier I capital
(includes shareholders equity and trust preferred securities and excludes
intangibles and the market value adjustment), combined with a larger 2.3%
increase in average assets excluding intangibles and the market value
adjustment. The primary drivers of the year-over-year changes were
treasury share purchases, the redemption of trust-preferred securities and two
acquisitions that increased both asset and intangible levels. The
tangible equity-to-assets ratio of 5.22% increased 21 basis points versus
December 31, 2007 and increased 56 basis points versus June 30, 2007, due to
shareholders equity excluding intangible assets growing at a faster pace than
assets excluding intangibles.
The
dividend payout ratio (dividends declared divided by net income) for the first
six months of 2008 was 56.5%, down from 60.0% for the first six months of
2007. The ratio decreased because net income increased 10.8% while
dividends declared increased at a lesser 4.5%. The expansion of
dividends declared was caused by the dividend per share being raised 5.0% in
August 2007, from $0.20 to $0.21, and a slight increase in the number of shares
outstanding. On a cash earnings basis, the dividend payout ratio was
50.3% for the first six months of 2008 as compared to 52.9% for the first six
months of 2007.
Management
of the Company's liquidity is critical due to the potential for unexpected
fluctuations in deposits and loans. Adequate sources of both on and
off-balance sheet funding are in place to effectively respond to such unexpected
fluctuations.
The
Company's primary approach to measuring liquidity is known as the Basic
Surplus/Deficit model. It is used to calculate liquidity over two
time periods: first, the amount of cash that could be made available within 30
days (calculated as liquid assets less short-term liabilities); and second, a
projection of subsequent cash availability over an additional 60
days. The minimum policy level of liquidity under the Basic
Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90-day time
horizons. As of June 30, 2008, this ratio was 10.8% for 30 days and
10.8% for 90 days, excluding the Company's capacity to borrow additional funds
from the FHLB.
To
measure longer-term liquidity, a baseline projection of loan and deposit growth
for five years is made to reflect how current liquidity levels could change over
time. This five-year measure reflects adequate liquidity to fund loan and other
asset growth over the next five years.
Forward-Looking
Statements
This
document contains comments or information that constitute forward-looking
statements (within the meaning of the Private Securities Litigation Reform Act
of 1995), which involve significant risks and uncertainties. Actual
results may differ materially from the results discussed in the forward-looking
statements. Moreover, the Company’s plans, objectives and intentions
are subject to change based on various factors (some of which are beyond the
Company’s control). Factors that could cause actual results to differ
from those discussed in the forward-looking statements include: (1)
risks related to credit quality, interest rate sensitivity and
liquidity; (2) the strength of the U.S. economy in general and the
strength of the local economies where the Company conducts its
business; (3) the effect of, and changes in, monetary and fiscal
policies and laws, including interest rate policies of the Board of Governors of
the Federal Reserve System; (4) inflation, interest rate, market and
monetary fluctuations; (5) the timely development of new products and
services and customer perception of the overall value thereof (including
features, pricing and quality) compared to competing products and
services; (6) changes in consumer spending, borrowing and savings
habits; (7) technological changes; (8) any acquisitions or
mergers that might be considered or consummated by the Company and the costs and
factors associated therewith; (9) the ability to maintain and
increase market share and control expenses; (10) the effect of
changes in laws and regulations (including laws and regulations concerning
taxes, banking, securities and insurance) and accounting principles generally
accepted in the United States; (11) changes in the Company’s
organization, compensation and benefit plans and in the availability of, and
compensation levels for, employees in its geographic markets; (12)
the costs and effects of litigation and of any adverse outcome in such
litigation; (13) other risk factors outlined in the Company’s filings with the
Securities and Exchange Commission from time to time; and (14) the success of
the Company at managing the risks of the foregoing.
The
foregoing list of important factors is not all-inclusive. Such
forward-looking statements speak only as of the date on which they are made and
the Company does not undertake any obligation to update any forward-looking
statement, whether written or oral, to reflect events or circumstances after the
date on which such statement is made. If the Company does update or
correct one or more forward-looking statements, investors and others should not
conclude that the Company would make additional updates or corrections with
respect thereto or with respect to other forward-looking
statements.
Market
risk is the risk of loss in a financial instrument arising from adverse changes
in market rates, prices or credit risk. Credit risk associated with
the Company's loan portfolio has been previously discussed in the asset quality
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations. Management believes that the tax risk of the
Company's municipal investments associated with potential future changes in
statutory, judicial and regulatory actions is minimal. The Company
has a minimal amount of credit risk in its investment portfolio because the
majority of the fixed-income securities in the portfolio are AAA-rated (highest
possible rating). Therefore, almost all the market risk in the
investment portfolio is related to interest rates.
The
ongoing monitoring and management of both interest rate risk and liquidity, in
the short and long term time horizons is an important component of the Company's
asset/liability management process, which is governed by limits established in
the policies reviewed and approved annually by the Board of
Directors. The Board of Directors delegates responsibility for
carrying out the policies to the Asset/Liability Committee (ALCO) which meets
each month and is made up of the Company's senior management as well as regional
and line-of-business managers who oversee specific earning asset classes and
various funding sources. As the Company does not believe it is
possible to reliably predict future interest rate movements, it has maintained
an appropriate process and set of measurement tools, which enable it to identify
and quantify sources of interest rate risk in varying rate
environments. The primary tool used by the Company in managing
interest rate risk is income simulation.
While a
wide variety of strategic balance sheet and treasury yield curve scenarios are
tested on an ongoing basis, the following reflects the Company's projected net
interest income sensitivity over the subsequent twelve months based
on:
·
|
Asset
and liability levels using June 30, 2008 as a starting
point.
|
·
|
There
are assumed to be conservative levels of balance sheet growth—low to mid
single digit growth in loans and deposits, while using the cashflows from
investment contractual maturities and prepayments to repay short-term
capital market borrowings.
|
·
|
The
prime rate and federal funds rates are assumed to move up 200 basis points
and down 100 basis points over a 12-month period while moving the long end
of the treasury curve to spreads over federal funds that are more
consistent with historical norms. Deposit rates are assumed to
move in a manner that reflects the historical relationship between deposit
rate movement and changes in the federal funds
rate.
|
·
|
Cash
flows are based on contractual maturity, optionality and amortization
schedules along with applicable prepayments derived from internal
historical data and external
sources.
|
Net
Interest Income Sensitivity Model
Change
in interest rates
|
Calculated
annualized increase (decrease) in projected net interest income at June
30, 2008
|
+
200 basis points
|
(0.7%)
|
-
100 basis points
|
(3.4%)
|
The
modeled net interest income (NII) reflects a decrease in a rising and falling
rate environment from a flat rate scenario. The decrease in a rising
rate environment is largely a result of the repricing of liabilities to higher
rates, while assets reprice to higher rates at a slower pace. The decrease in a
falling rate environment is largely a result of lower rates on assets offset by
lower liability rates and the rate decrease of total investments. In the long
term the growth in NII improves in a rising rate environment as lower yielding
assets mature and are replaced at higher rates.
The
analysis does not represent a Company forecast and should not be relied upon as
being indicative of expected operating results. These hypothetical
estimates are based upon numerous assumptions: the nature and timing of interest
rate levels (including yield curve shape), prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of asset and liability cash flows, and other
factors. While the assumptions are developed based upon current
economic and local market conditions, the Company cannot make any assurances as
to the predictive nature of these assumptions, including how customer
preferences or competitor influences might change. Furthermore, the
sensitivity analysis does not reflect actions that ALCO might take in responding
to or anticipating changes in interest rates.
Item
4. Controls and Procedures
The
Company maintains disclosure controls and procedures, as defined in Rule 13a –
15(e) under the Securities Exchange Act of 1934, designed to: (i) record,
process, summarize, and report within the time periods specified in the
Securities and Exchange Commission’s (SEC) rules and forms, and (ii) accumulate
and communicate to management, including the principal executive and principal
financial officers, as appropriate, to allow timely decisions regarding
disclosure. Based on management’s evaluation of the Company’s
disclosure controls and procedures, with the participation of the Chief
Executive Officer and the Chief Financial Officer, it has concluded that, as of
the end of the period covered by this Quarterly Report on Form 10-Q, these
disclosure controls and procedures were effective as of June 30,
2008.
There
have been no changes in the Company’s internal controls over financial reporting
in connection with the evaluation referenced in the paragraph above that
occurred during the Company’s last fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company’s internal control
over financial reporting.
Part
II. Other
Information
Item
1. Legal
Proceedings
The
Company and its subsidiaries are subject in the normal course of business to
various pending and threatened legal proceedings in which claims for monetary
damages are asserted. Management, after consultation with legal
counsel, does not anticipate that the aggregate liability, if any, arising out
of litigation pending against the Company or its subsidiaries will have a
material effect on the Company’s consolidated financial position or results of
operations.
Item
1A. Risk Factors
There has
not been any material change in the risk factors disclosure from that contained
in the Company’s 2007 Form 10-K for the fiscal year ended December 31, 2007
(filed with the SEC on March 13, 2008).
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds
On April
20, 2005, the Company announced a twenty-month authorization to repurchase up to
1,500,000 of its outstanding shares in open market or privately negotiated
transactions. On December 20, 2006, the Company extended the program
through December 31, 2008 and announced an additional two-year authorization to
repurchase up to 900,000 of its shares in open market or privately negotiated
transactions. These repurchases will be for general corporate
purposes, including those related to stock plan activities. The
following table shows treasury stock purchases during the second quarter of
2008.
|
Number
of
|
Average
Price
|
Total
Number of Shares
|
Maximum
Number of Shares
|
|
Shares
|
Paid
|
Purchased
as Part of Publicly
|
That
May Yet Be Purchased
|
|
Purchased
|
Per
share
|
Announced
Plans or Programs
|
Under
the Plans or Programs
|
April
2008
|
0
|
$0
|
1,464,811
|
935,189
|
May
2008
|
0
|
0
|
1,464,811
|
935,189
|
June
2008
|
0
|
0
|
1,464,811
|
935,189
|
Total
|
0
|
$0
|
|
|
Item
3. Defaults
Upon Senior Securities
Not
applicable.
Item
4. Submission
of Matters to a Vote of Security Holders
At the
2008 Annual Meeting of Shareholders of the Company held on May 21, 2008, the
shareholders elected three directors to serve for three-year terms expiring in
2011, ratified the appoint of PricewaterhouseCoopers LLP as independent auditors
for the year ending December 31, 2008, and voted on a shareholder proposal
regarding the annual election of all Directors. Directors whose terms
in office continued after the Annual Meeting were David C. Patterson, Sally A.
Steele, Mark E. Tryniski, Nicholas A. DiCerbo, James A. Gabriel and Charles E.
Parente.
The vote
on each issue was as follows:
|
For
|
Against
|
Abstain
|
|
Election
of Directors:
|
|
|
|
|
Brian
R. Ace
|
17,025,974
|
*
|
8,782,286
|
|
Paul
M. Cantwell, Jr.
|
18,548,578
|
*
|
7,259,682
|
|
William
M. Dempsey
|
23,777,894
|
*
|
2,030,366
|
|
|
|
|
|
|
Ratification
of the appointment of PricewaterhouseCoopers LLP as Independent
Auditors
|
25,090,395
|
625,760
|
92,107
|
|
|
|
|
|
|
Shareholder
proposal regarding annual election of all Directors
|
11,863,989
|
9,370,981
|
575,097
|
**
|
* Proxies
provide that shareholders may either cast a vote for, or abstain from voting
for, directors
** In
addition, there were 3,998,184 broker nonvotes on this matter.
Item
5. Other
Information
Not
applicable.
Item
6. Exhibits
31.1
|
Certification
of Mark E. Tryniski, President and Chief Executive Officer of the
Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
31.2
|
Certification
of Scott Kingsley, Treasurer and Chief Financial Officer of the
Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
32.1
|
Certification
of Mark E. Tryniski, President and Chief Executive Officer of the
Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2
|
Certification
of Scott Kingsley, Treasurer and Chief Financial Officer of the
Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
|
Signatures
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Community
Bank System, Inc.
Date: August
7,2008 |
/s/ Mark E.
Tryniski |
|
Mark E.
Tryniski, President and Chief |
|
Executive
Officer |
|
|
|
|
Date: August
7, 2008 |
/s/
Scott Kingsley |
|
Scott
Kingsley, Treasurer and Chief |
|
Financial
Officer |