cbna10k2008.htm
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the
fiscal year ended December 31,
2008
oTRANSITION 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.)
|
|
|
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5790
Widewaters Parkway, DeWitt, New York
|
|
13214-1883
|
( Address of
principal executive offices)
|
|
(Zip
Code)
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(315)
445-2282
Registrant's
telephone number, including area code
Securities
registered pursuant of Section 12(b) of the Act:
Title of each
class
|
|
Name of each exchange on which
registered |
Common Stock,
Par Value $1.00 |
|
New York Stock
Exchange |
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes o No x .
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes o
No x
..
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 o.
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this
chapter) is not contained herein, and will not be contained, to the best of the
registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K. o.
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 definition of “accelerated filer”, “large accelerated
filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Large
accelerated filer o Accelerated
filer x Non-accelerated
filer o Smaller
reporting company o.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o . No x .
State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and ask price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter $599,542,522
.
Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date. 32,741,623 shares of Common
Stock, $1.00 par value, were outstanding on February 28,
2009.
DOCUMENTS
INCORPORATED BY REFERENCE.
Portions
of Definitive Proxy Statement for Annual Meeting of Shareholders to be held on
May 20, 2009 (the “Proxy Statement”) is incorporated by reference in Part III of
this Annual Report on Form 10-K.
Exhibit
Index is located on page 81 of 90
TABLE
OF CONTENTS
PART I |
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Page |
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Item |
1. |
Business |
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3 |
Item |
1A. |
Risk Factors
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8 |
Item |
1B. |
Unresolved
Staff Comments |
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10 |
Item |
2. |
Properties |
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11 |
Item |
3. |
Legal
Proceedings |
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11 |
Item |
4. |
Submission of
Matters to a Vote of Security Holders |
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11 |
Item |
4A. |
Executive
Officers of the Registrant |
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11 |
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PART II |
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Item |
5. |
Market for
Registrant's Common Stock, Related Shareholders Matters and Issuer Purchases
of Equity Securities |
|
12 |
Item |
6. |
Selected
Financial Data |
|
15 |
Item |
7. |
Management's
Discussion and Analysis of Financial Condition and Results ofOperations |
|
16 |
Item |
7A. |
Quantitative
and Qualitative Disclosures about Market Risk |
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41 |
Item |
8. |
Financial
Statements and Supplementary Data: |
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Consolidated
Statements of Condition
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44 |
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Consolidated
Statements of Income
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45 |
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Consolidated
Statements of Changes in Shareholders' Equity
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46 |
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Consolidated
Statements of Comprehensive Income
|
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47 |
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Consolidated
Statements of Cash Flows
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48 |
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Notes to
Consolidated Financial Statements
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49 |
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Report on
Internal Control over Financial Reporting
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77 |
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Report of
Independent Registered Public Accounting Firm
|
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78 |
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Two Year
Selected Quarterly Data |
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79 |
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Item |
9. |
Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure
|
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79 |
Item |
9A. |
Controls and
Procedures |
|
79 |
Item |
9B. |
Other
Information |
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79 |
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PART III |
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Item |
10. |
Directors, and
Executive Officers and Corporate Governance |
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80 |
Item |
11. |
Executive
Compensation |
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80 |
Item |
12. |
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters |
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80 |
Item |
13. |
Certain
Relationships and Related Transactions and Directors
Independence |
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80 |
Item |
14. |
Principal
Accounting Fees and Services |
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80 |
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PART IV |
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Item |
15. |
Exhibits,
Financial Statement Schedules |
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81 |
Signatures |
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84 |
Part
I
This
Annual Report on Form 10-K contains certain forward-looking statements with
respect to the financial condition, results of operations and business of
Community Bank System, Inc. These forward-looking statements by their
nature address matters that involve certain risks and
uncertainties. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements are set
forth herein under the caption “Forward-Looking Statements.” The
share and per-share information in this document has been adjusted to give
effect to a two-for-one stock split of the Company’s common stock effected as of
April 12, 2004.
Item 1.
Business
Community
Bank System, Inc. ("the Company") was incorporated on April 15, 1983, under
the Delaware General Corporation Law. Its principal office is located at
5790 Widewaters Parkway, DeWitt, New York 13214. The Company is a
single bank holding company which wholly-owns five subsidiaries: Community Bank,
N.A. (“the Bank”), Benefit Plans Administrative Services, Inc. (“BPAS”), CFSI
Closeout Corp. (“CFSICC”), First of Jermyn Realty Company, Inc. (“FJRC”) and
Town & Country Agency LLC (“T&C”). BPAS owns three
subsidiaries, Benefit Plans Administrative Services LLC (“BPA”), Harbridge
Consulting Group LLC (“Harbridge”) and Hand Benefit & Trust Company
(“HBT”). BPAS provides administration, consulting and actuarial
services to sponsors of employee benefit plans. CFSICC, FJRC and
T&C are inactive companies. The Company also wholly-owns two
unconsolidated subsidiary business trusts formed for the purpose of issuing
mandatorily redeemable preferred securities which are considered Tier I capital
under regulatory capital adequacy guidelines.
The
Company maintains a website at communitybankna.com and
firstlibertybank.com. Annual reports on Form 10-K, quarterly reports
on Form 10-Q and current reports on Form 8-K, and amendments to those reports,
are available on the Company’s website free of charge as soon as reasonably
practicable after such reports or amendments are electronically filed with or
furnished to the Securities and Exchange Commission (“SEC”). The
information on the website is not part of this filing. Copies of all
documents filed with the SEC can also be obtained by visiting the SEC’s Public
Reference Room at 100 F Street, NE, Washington, DC 20549, by calling
the SEC at 1-800-SEC-0330 or by accessing the SEC’s website at
http://www.sec.gov.
The
Bank’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 Bank operates 145 customer facilities throughout 28
counties of Upstate New York, where it operates as Community Bank, N.A. and five
counties of Northeastern Pennsylvania, where it is known as First Liberty Bank
& Trust, offering a range of commercial and retail banking
services. The Bank owns the following subsidiaries: Community
Investment Services, Inc. (“CISI”), CBNA Treasury Management Corporation
(“TMC”), CBNA Preferred Funding Corporation (“PFC”), Nottingham Advisors, Inc.
(“Nottingham”), First Liberty Service Corp. (“FLSC”), Brilie Corporation
(“Brilie”) and CBNA Insurance Agency, Inc (“CBNA Insurance”). CISI
provides broker-dealer and investment advisory services. TMC provides
cash management, investment, and treasury services to the Bank. PFC
primarily acts as an investor in residential real estate
loans. Nottingham provides asset management services to individuals,
corporate pension and profit sharing plans, and foundations. FLSC
provides banking-related services to the Pennsylvania branches of the Bank.
Brilie is an inactive company. CBNA Insurance is a full-service
property and casualty insurance agency.
Acquisition
History (2004-2008)
Citizens Branches
Acquisition
On
November 7, 2008, the Company acquired 18 branch-banking centers in northern New
York from Citizens Financial Group, Inc. (“Citizens”) in an all cash
transaction. The Company acquired approximately $109 million in loans
and $565 million in deposits at a blended deposit premium of 12%. In
support of the transaction, the Company issued approximately $50 million of
equity capital in the form of common stock in October 2008.
Alliance Benefit Group
MidAtlantic
On July
7, 2008, Benefit Plans Administrative Services, Inc. (“BPAS”), a wholly owned
subsidiary of the Company, acquired the Philadelphia division of Alliance
Benefit Group MidAtlantic (ABG) from BenefitStreet, Inc. in an all cash
transaction. ABG provides retirement plan consulting, daily valuation
administration, actuarial and ancillary support services.
Hand Benefits & Trust,
Inc.
On May
18, 2007, BPAS, a wholly owned subsidiary of the Company, acquired 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.
TLNB Financial
Corporation
On June
1, 2007, the Company acquired 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, NewYork, 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.
ONB
Corporation
On
December 1, 2006, the Company acquired ONB Corporation (“ONB”), the parent
company of Ontario National Bank, a federally-chartered national bank, in an
all-cash transaction valued at approximately $16 million. ONB
operated four branches in the villages of Clifton Springs, Phelps, and Palmyra,
New York.
ES&L Bancorp,
Inc.
On August
11, 2006, the Company acquired ES&L Bancorp, Inc. (“Elmira”), the parent
company of Elmira Savings and Loan, F.A., a federally-chartered thrift, in an
all-cash transaction valued at approximately $40 million. Elmira
operated two branches in the cities of Elmira and Ithaca, New York.
Dansville Branch
Acquisition
On
December 3, 2004, the Company acquired a branch office in Dansville, NewYork
(“Dansville”) from HSBC Bank USA, N.A. with deposits of $32.6 million and loans
of $5.6 million.
First Heritage
Bank
On May
14, 2004, the Company acquired First Heritage Bank (“First Heritage”), a closely
held bank headquartered in Wilkes-Barre, PA with three branches in Luzerne
County, Pennsylvania. First Heritage’s three branches operate as part
of First Liberty Bank & Trust, a division of Community Bank, N.A.
Consideration included 2,592,213 shares of common stock with a fair value of $52
million, employee stock options with a fair value of $3.0 million, and $7.0
million of cash (including capitalized acquisition costs of $1.0
million).
Services
The Bank
is a community bank committed to the philosophy of serving the financial needs
of customers in local communities. The Bank's branches are generally
located in smaller towns and cities within its geographic market areas of
Upstate New York and Northeastern Pennsylvania. The Company believes that the
local character of its business, knowledge of the customers and their needs, and
its comprehensive retail and business products, together with responsive
decision-making at the branch and regional levels, enable the Bank to compete
effectively in its geographic market. The Bank is a member of
the Federal Reserve System and the Federal Home Loan Bank of New York ("FHLB"),
and its deposits are insured by the Federal Deposit Insurance Corporation
(“FDIC”) up to applicable limits.
Competition
The
banking and financial services industry is highly competitive in the New York
and Pennsylvania markets. The Company competes actively for loans,
deposits and customers with other national and state banks, thrift institutions,
credit unions, retail brokerage firms, mortgage bankers, finance companies,
insurance companies, and other regulated and unregulated providers of financial
services. In order to compete with other financial service providers,
the Company stresses the community nature of its operations and the development
of profitable customer relationships across all lines of
business.
The table
below summarizes the Bank’s deposits and market share by the thirty-three
counties of New York and Pennsylvania in which it has customer
facilities. Market share is based on deposits of all commercial
banks, credit unions, savings and loan associations, and savings
banks.
|
|
|
|
Number
of
|
|
|
|
|
|
|
|
Towns
Where
|
|
|
Deposits
as of
|
|
|
|
|
Company
|
|
|
6/30/2008
|
Market
|
|
|
Towns/
|
Has
1st or 2nd
|
County
|
State
|
(000's
omitted) (1)
|
Share
|
Facilities
|
ATM's
|
Cities
|
Market
Position
|
Allegany
|
NY
|
$193,007
|
48.2%
|
9
|
8
|
8
|
8
|
Hamilton*
|
NY
|
$27,712
|
47.2%
|
2
|
0
|
2
|
2
|
Franklin*
|
NY
|
$235,664
|
45.8%
|
11
|
7
|
7
|
6
|
Lewis*
|
NY
|
$109,825
|
44.3%
|
5
|
3
|
4
|
4
|
Seneca
|
NY
|
$154,307
|
39.1%
|
4
|
3
|
4
|
3
|
Cattaraugus
|
NY
|
$283,212
|
28.9%
|
10
|
8
|
7
|
7
|
Yates
|
NY
|
$69,225
|
27.5%
|
2
|
2
|
1
|
1
|
St.
Lawrence
|
NY
|
$337,210
|
23.2%
|
12
|
7
|
11
|
10
|
Clinton*
|
NY
|
$275,417
|
21.5%
|
8
|
10
|
3
|
3
|
Wyoming
|
PA
|
$85,348
|
21.2%
|
4
|
3
|
4
|
3
|
Essex*
|
NY
|
$77,787
|
15.9%
|
4
|
4
|
4
|
3
|
Chautauqua
|
NY
|
$223,494
|
13.9%
|
12
|
11
|
10
|
7
|
Schuyler
|
NY
|
$18,392
|
12.1%
|
1
|
1
|
1
|
0
|
Livingston
|
NY
|
$81,625
|
11.9%
|
3
|
4
|
3
|
3
|
Steuben
|
NY
|
$176,768
|
10.7%
|
8
|
7
|
7
|
5
|
Ontario
|
NY
|
$152,849
|
9.9%
|
7
|
12
|
6
|
4
|
Lackawanna
|
PA
|
$448,417
|
9.5%
|
12
|
12
|
8
|
4
|
Jefferson
|
NY
|
$138,670
|
9.3%
|
5
|
5
|
4
|
2
|
Tioga
|
NY
|
$34,557
|
8.4%
|
2
|
2
|
2
|
1
|
Chemung
|
NY
|
$94,869
|
7.4%
|
2
|
2
|
1
|
0
|
Herkimer
|
NY
|
$35,082
|
5.9%
|
1
|
1
|
1
|
1
|
Wayne
|
NY
|
$55,679
|
5.7%
|
2
|
4
|
2
|
1
|
Susquehanna
|
PA
|
$24,060
|
4.1%
|
2
|
0
|
2
|
2
|
Oswego
|
NY
|
$43,952
|
4.1%
|
2
|
2
|
2
|
2
|
Luzerne
|
PA
|
$235,429
|
3.9%
|
6
|
7
|
6
|
2
|
Cayuga
|
NY
|
$34,969
|
3.9%
|
2
|
2
|
2
|
1
|
Washington*
|
NY
|
$20,888
|
3.4%
|
1
|
0
|
1
|
1
|
Warren*
|
NY
|
$38,297
|
2.9%
|
1
|
1
|
1
|
1
|
|
|
$3,706,711
|
11.5%
|
140
|
128
|
114
|
87
|
|
|
|
|
|
|
|
|
Bradford
|
PA
|
$22,450
|
2.5%
|
2
|
2
|
2
|
1
|
Oneida
|
NY
|
$53,988
|
1.3%
|
1
|
1
|
1
|
1
|
Tompkins
|
NY
|
$9,460
|
0.5%
|
1
|
0
|
1
|
0
|
Onondaga
|
NY
|
$12,603
|
0.1%
|
1
|
2
|
1
|
0
|
Erie
|
NY
|
$38,671
|
0.1%
|
2
|
2
|
2
|
1
|
|
|
$3,843,883
|
4.8%
|
147
|
135
|
121
|
90
|
(1)
Deposit market share data as of June 30, 2008 the most recent information
available. Source: SNL Financial LLC
* Includes
balances of Citizens’ branches acquired in November 2008.
Employees
As of
December 31, 2008, the Company employed 1,615 full-time equivalent
employees. The Company offers a variety of employment benefits and
considers its relationship with its employees to be good.
Supervision
and Regulation
Bank
holding companies and national banks are regulated by state and federal
law. The following is a summary of certain laws and regulations that
govern the Company and the Bank. To the extent that the following
information describes statutory or regulatory provisions, it is qualified in its
entirety by reference to the actual statutes and regulations
thereunder.
Federal Bank Holding Company
Regulation
The
Company is registered under, and is subject to, the Bank Holding Company Act of
1956, as amended. This Act limits the type of companies that
Community Bank System, Inc. may acquire or organize and the activities in which
it or they may engage. In general, the Company and the Bank are
prohibited from engaging in or acquiring direct or indirect control of any
corporation engaged in non-banking activities unless such activities are so
closely related to banking as to be a proper incident thereto. In
addition, the Company must obtain the prior approval of the Board of Governors
of the Federal Reserve System (the “FRB”) to acquire control of any bank; to
acquire, with certain exceptions, more than five percent of the outstanding
voting stock of any other corporation; or to merge or consolidate with another
bank holding company. As a result of such laws and regulation, the
Company is restricted as to the types of business activities it may conduct and
the Bank is subject to limitations on, among others, the types of loans and the
amounts of loans it may make to any one borrower. The Financial
Modernization Act of 1999 created, among other things, the "financial holding
company", a new entity which may engage in a broader range of activities that
are "financial in nature", including insurance underwriting, securities
underwriting and merchant banking. Bank holding companies which are
well capitalized and well managed under regulatory standards may convert to
financial holding companies relatively easily through a notice filing with the
FRB, which acts as the "umbrella regulator" for such entities. The
Company may seek to become a financial holding company in the
future.
Federal Reserve
System
The
Company is required by the Board of Governors of the Federal Reserve System to
maintain cash reserves against its deposits. After exhausting other
sources of funds, the Company may seek borrowings from the Federal Reserve for
such purposes. Bank holding companies registered with the FRB are,
among other things, restricted from making direct investments in real
estate. Both the Company and the Bank are subject to extensive
supervision and regulation, which focus on, among other things, the protection
of depositors' funds.
The
Federal Reserve System also regulates the national supply of bank credit in
order to influence general economic conditions. These policies have a
significant influence on overall growth and distribution of loans, investments
and deposits, and affect the interest rates charged on loans or paid for
deposits.
Fluctuations
in interest rates, which may result from government fiscal policies and the
monetary policies of the Federal Reserve System, have a strong impact on the
income derived from loans and securities, and interest paid on deposits and
borrowings. While the Company and the Bank strive to anticipate
changes and adjust their strategies for such changes, the level of earnings can
be materially affected by economic circumstances beyond their
control.
The
Company and the Bank are subject to minimum capital requirements established,
respectively, by the FRB, the OCC (as defined below) and the Federal Deposit
Insurance Corporation (“FDIC”). For information on these capital
requirements and the Company’s and the Bank's capital ratios see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Capital" and Note P to the Financial Statements.
Office of Comptroller of the
Currency
The Bank
is supervised and regularly examined by the Office of the Comptroller of the
Currency (the “OCC”). The various laws and regulations administered
by the OCC affect corporate practices such as payment of dividends, incurring
debt, and acquisition of financial institutions and other
companies. It also affects business practices, such as payment of
interest on deposits, the charging of interest on loans, types of business
conducted and location of offices. There are no regulatory orders or
outstanding issues resulting from regulatory examinations of the
Bank.
Insurance of Deposit
Accounts
The Bank
is a member of the Deposit Insurance Fund, which is administered by the
FDIC. Deposit accounts at the Bank are insured by the FDIC, generally
up to a maximum of $100,000 for each separately insured depositor and up to a
maximum of $250,000 for self-directed retirement accounts. However,
the FDIC increased the deposit insurance available on all deposit accounts to
$250,000, effective until December 31, 2009. In addition, certain
noninterest-bearing transaction accounts maintained with financial institutions
participating in the FDIC’s Transaction Account Guarantee Program are fully
insured regardless of the dollar amount until December 31, 2009. The
Bank has opted to participate in the FDIC’s Transaction Account Guarantee
Program.
The FDIC
imposes an assessment against all depository institutions for deposit
insurance. This assessment is based on the risk category of the
institution and, prior to 2009, ranged from five to 43 basis points of the
institution’s deposits. On October 7, 2008, as a result of decreases
in the reserve ratio of the DIF, the FDIC issued a proposed rule establishing a
Restoration Plan for the DIF. On December 22, 2008, the FDIC
published a final rule raising the current deposit insurance assessment rates
uniformly for all institutions by seven basis points for the first quarter of
2009. The FDIC expects to issue a second final rule in early 2009, to
be effective April 1, 2009, to change the way that the FDIC’s assessment system
differentiates for risk and to set new assessment rates beginning with the
second quarter of 2009.
Consumer Protection
Laws
In
connection with its lending activities, the Bank is subject to a number of
federal and state laws designed to protect borrowers and promote lending to
various sectors of the economy. These laws include the Equal Credit
Opportunity Act, the Fair Credit Reporting Act, the Fair and Accurate Credit
Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act,
and the Real Estate Settlement Procedures Act, and various state law
counterparts.
In
addition, federal law currently contains extensive customer privacy protection
provision. Under these provisions, a financial institution must
provide to its customers, at the inception of the customer relationship and
annually thereafter, the institution’s policies and procedures regarding the
handling of customers’ nonpublic personal financial
information. These provisions also provide that, except for certain
limited exceptions, a financial institution may not provide such personal
information to unaffiliated third parities unless the institution discloses to
the customer that such information may be provided and the customer is given the
opportunity to opt out of such disclosure.
USA Patriot
Act
The
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) imposes
obligations on U.S. financial institution, including banks and broker dealer
subsidiaries, to implement policies, procedures and controls which are
reasonably designed to detect and report instances of money laundering and the
financing of terrorism. In addition, provision of the USA Patriot Act
require the federal financial institution regulatory agencies to consider the
effectiveness of a financial institution’s anti-money laundering activities when
reviewing bank mergers and bank holding company acquisitions. The
Company has approved policies and procedures that are believed to be compliant
with the USA Patriot Act.
Sarbanes-Oxley Act of
2002
The
Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) implemented a broad range
of corporate governance, accounting and reporting reforms for companies that
have securities registered under the Securities Exchange Act of 1934. In
particular, the Sarbanes-Oxley Act established, among other things: (i) new
requirements for audit and other key Board of Directors committees involving
independence, expertise levels, and specified responsibilities; (ii) additional
responsibilities regarding the oversight of financial statements by the Chief
Executive Officer and Chief Financial Officer of the reporting company; (iii)
the creation of an independent accounting oversight board for the accounting
industry; (iv) new standards for auditors and the regulation of audits,
including independence provisions which restrict non-audit services that
accountants may provide to their audit clients; (v) increased disclosure and
reporting obligations for the reporting company and its directors and executive
officers including accelerated reporting of company stock transactions; (vi) a
prohibition of personal loans to directors and officers, except certain loans
made by insured financial institutions on nonpreferential terms and in
compliance with other bank regulator requirements; and (vii) a range of new
and increased civil and criminal penalties for fraud and other violation of the
securities laws.
The Emergency Economic
Stabilization Act of 2008
On
October 3, 2008, The Emergency Economic Stabilization Act of 2008 (“EESA”) was
enacted that provides the U.S. Secretary of the Treasury with broad authority to
implement certain actions to help restore stability and liquidity to U.S.
markets. The EESA authorizes the U.S. Treasury to, among other
things, purchase up to $700 billion of mortgages, mortgage-backed securities and
certain other financial instruments from financial institutions for the purpose
of stabilizing and providing liquidity to the U.S. financial
markets. The Company did not originate or invest in sub-prime assets
and, therefore, does not expect to participate in the sale of any of our assets
into these programs. One of the provisions resulting from the
legislation is the Troubled Asset Relief Program Capital Purchase Program (“TARP
Capital Purchase Program”), which provides direct equity investment in perpetual
preferred stock by the U.S. Treasury Department in qualified financial
institutions. The program is voluntary and requires an institution to
comply with a number of restrictions and provisions, including limits on
executive compensation, stock redemptions, and declaration of
dividends. The Company chose not to participate in the TARP Capital
Purchase Program.
Item 1A. Risk
Factors
Community
Bank System, Inc. and its subsidiaries could be adversely impacted by various
risks and uncertainties, which are difficult to predict. The material
risks and uncertainties that management believes affect the Company are
described below. Adverse experience with these or other risks could
have a material impact on the Company’s financial condition and results of
operations.
Changes
in interest rates affect our profitability and assets
The
Company’s income and cash flow depends to a great extent on the difference
between the interest earned on loans and investment securities, and the interest
paid on deposits and borrowings. Interest rates are highly sensitive
to many factors that are beyond the Company’s control, including general
economic conditions and polices of various governmental and regulatory agencies
and, in particular, the Federal Reserve. Changes in monetary policy,
including changes in interest rates, could influence not only the interest we
receive on loans and securities and the amount of interest we pay on deposits
and borrowings, but such changes could also affect (1) our ability to originate
loans and obtain deposits, which could reduce the amount of fee income
generated, (2) the fair value of our financial assets and liabilities and (3)
the average duration of our mortgage-backed securities portfolio. If
the interest rates paid on deposits and other borrowings increase at a faster
rate than the interest rates received on loans and other investments, our net
interest income could be adversely affected, which in turn could negatively
affect our earnings. Earnings could also be adversely affected if the
interest rates received on loans and other investments fall more quickly than
the interest rates paid on deposit and other borrowings. Although
management believes it has implemented effective asset and liability management
strategies to reduce the potential effects of changes in interest rates on the
result of operations, any substantial, unexpected, prolonged change in market
interest rates could have a material adverse effect on the financial condition
and results of operations.
Current
levels of market volatility are unprecedented
The
capital, credit and financial markets have experienced significant volatility
and disruption for more than a year. These conditions have had
significant adverse effects on our national and local economies, including
declining real estate values, a widespread tightening of the availability of
credit, illiquidity in certain securities markets, increasing loan
delinquencies, declining consumer confidence and spending, and a reduction of
manufacturing and service business activity. These conditions have
also adversely affected the stock market generally, and have contributed to
significant declines in the trading prices of stocks of financial
institutions. Management does not expect these difficult market
conditions to improve over the short term, and a continuation or worsening of
these conditions could exacerbate their adverse effects.
There
can be no assurance that the Emergency Economic Stabilization Act of 2008 and
the American Recovery and Reinvestment Act will stabilize the U.S. economy and
financial system
The U.S.
Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”) in
response to the impact of the volatility and disruption in the capital and
credit markets on the financial sector. The U.S. Department of the
Treasury and the federal banking regulators are implementing a number of
programs under this legislation that are intended to address these
conditions. In addition, the U.S. Congress recently enacted the
American Recovery and Reinvestment Act (“ARRA”) in an effort to save and create
jobs, stimulate the U.S. economy and promote long-term growth and
stability. There can be no assurance that EESA or ARRA will achieve
their intended purposes. The failure of EESA or ARRA to achieve their
intended purposes could result in a continuation or worsening of current
economic and market conditions, and this could adversely effect the Company’s
financial condition, results of operations and/or the trading price of Company
stock.
Regional
economic factors may have an adverse impact on the Company’s
business
The
Company’s main markets are located in the states of New York and
Pennsylvania. The local economic conditions in these areas have a
significant impact on the demand for the Company’s products and services as well
as the ability of the Company’s customers to repay loans, the value of the
collateral securing loans and the stability of the Company’s deposit funding
sources. A prolonged economic downturn in these markets could
negatively impact the Company.
The
allowance for loan loss may be insufficient
The
Company’s business depends on the creditworthiness of its
customers. The Company periodically reviews the allowance for loan
losses for adequacy considering economic conditions and trends, collateral
values and credit quality indicators, including past charge-off experience and
levels of past due loans and nonperforming assets. There is no
certainty that the allowance for loan losses will be adequate over time to cover
credit losses in the portfolio because of unanticipated adverse changes in the
economy, market conditions or events adversely affecting specific customers,
industries or markets.
The
Company may be adversely affected by changes in banking laws, regulations and
regulatory practices
The
Company and its subsidiaries are subject to extensive state and federal
regulation, supervision and legislation that govern nearly every aspect of its
operations. The bank holding company is subject to regulation by the
FRB and the bank subsidiary is subject to regulation by the
OCC. These regulations affect lending practices, capital structure,
investment practices, dividend policy and growth. In addition, the
non-bank subsidiaries are engaged in providing investment management and
insurance brokerage service, which industries are also heavily regulated on both
a state and federal level. Changes to the regulatory laws governing
these businesses could affect the Company’s ability to deliver or expand its
services and adversely impact its operations and financial
condition.
FDIC
deposit insurance premiums have increased and may increase further in the
future
The
FDIC’s reserve fund has declined over the past year due to costs associated with
bank failures and is expected to continue to decline in the
future. In addition, the FDIC basic insurance coverage limit was
temporarily increased to $250,000 through December 31, 2009. These
increases have increased the aggregate amount of deposits that the FDIC insures
and thus have exposed the FDIC deposit insurance fund to potentially greater
losses. The FDIC has adopted a plan to restore the reserve fund to
the required level by increasing the deposit insurance assessment rates that it
currently charges to insured depository institutions. Any increase
will have an adverse impact on the Company’s results of operations in 2009 and
in future years, and if the FDIC is required to increase its deposit insurance
assessment rate beyond the levels currently contemplated, the adverse impact
will be greater.
The
Company depends on dividends from its banking subsidiary for cash revenues, but
those dividends are subject to restrictions
The
ability of the company to satisfy its obligations and pay cash dividends to its
shareholders is primarily dependent on the earnings of and dividends from the
subsidiary bank. However, payment of dividends by the bank subsidiary
is limited by dividend restrictions and capital requirements imposed by bank
regulations. As of December 31, 2008, the Bank had the capacity
to pay up to $4.3 million in dividends to the Company without regulatory
approval. The ability to pay dividends is also subject to the
continued payment of interest that the Company owes on its subordinated junior
debentures. As of December 31, 2008 the Company had $102 million of
subordinated junior debentures outstanding. The Company has the right
to defer payment of interest on the subordinated junior debentures for a period
not exceeding 20 quarters although the Company has not done so to
date. If the Company defers interest payments on the subordinated
junior debentures, it will be prohibited, subject to certain exceptions, from
paying cash dividends on the common stock until all deferred interest has been
paid and interest payments on the subordinated junior debentures
resumes.
The
risks presented by acquisitions could adversely affect our financial condition
and result of operations
The
business strategy of the Company includes growth through
acquisition. Any future acquisitions will be accompanied by the risks
commonly encountered in acquisitions. These risks include among other
things: the difficulty of integrating operations and personnel, the potential
disruption of our ongoing business, the inability of our management to maximize
our financial and strategic position, the inability to maintain uniform
standards, controls, procedures and policies, and the impairment of
relationships with employees and customers as a result of changes in ownership
and management.
The
Company may be required to record impairment charges related to goodwill, other
intangible assets and the investment portfolio
The
Company may be required to record impairment charges in respect to goodwill,
other intangible assets and the investment portfolio. Numerous
factors, including lack of liquidity for resale of certain investment
securities, absence of reliable pricing information for investment securities,
adverse changes in the business climate, adverse actions by regulators,
unanticipated changes in the competitive environment or a decision to change the
operations or dispose of an operating unit could have a negative effect on the
investment portfolio, goodwill or other intangible assets in future
periods.
The
Company relies on third party service providers
The
Company relies on communication, information, operating and financial control
systems from third-party service providers. Any failure or
interruption or breach in security of these systems could result in failures or
interruptions in our customer relationship management, general ledger, deposit,
servicing and/or loan origination systems. While the Company has
policies and procedures designed to prevent or limit the effect of a failure,
interruption or security breach, there can be no assurance that any such
failures, interruptions or security breaches will not occur or, if they do
occur, that their impact can be adequately mitigated.
The
Company may be adversely affected by the soundness of other financial
institutions
The
Company owns common stock of Federal Home Loan Bank of New York (“FHLBNY”) in
order to qualify for membership in the FHLB system, which enables it to borrow
funds under the FHLBNY advance program. The carrying value of the
Company’s FHLBNY common stock was $38.0 million as of December 31,
2008. There are 12 branches of the FHLB, including New
York. Several members have warned that they have either breached
risk-based capital requirement or that they are close to breaching those
requirements. To conserve capital, some FHLB branches are suspending
dividends, cutting dividend payments, and not buying back excess FHLB stock that
members hold. FHLBNY has stated that they expect to be able to
continue to pay dividends, redeem excess capital stock, and provide
competitively priced advances in the future. The most severe problems
in FHLB have been at some of the other FHLB branches. Nonetheless,
the 12 FHLB branches are jointly liable for the consolidated obligations of the
FHLB system. To the extent that one FHLB branch cannot meet its
obligations to pay its share of the systems’ debt, other FHLB branches can be
called upon to make the payment.
The
Company continually encounters technological change and may have fewer resources
than many or its competitors to continue to invest in technological
improvements
The
financial services industry is continually undergoing rapid technological change
with frequent introductions of new technology-driven products and
services. The effective use of technology increases efficiency and
enables financial institutions to better serve customers and to reduce
costs. The Company’s future success depends, in part, upon its
ability to address the needs of its customers by using technology to provide
products and services that will satisfy customer demands as well as to create
additional efficiencies in the Company’s operations.
Trading
activity in the Company’s common stock could result in material price
fluctuations
The
market price of the Company’s common stock may fluctuate significantly in
response to a number of other factors including, but not limited
to:
·
|
Changes
in securities analysts’ expectations of financial
performance
|
·
|
Volatility
of stock market prices and volumes
|
·
|
Incorrect
information or speculation
|
·
|
Changes
in industry valuations
|
·
|
Variations
in operating results from general
expectations
|
·
|
Actions
taken against the Company by various regulatory
agencies
|
·
|
Changes
in authoritative accounting guidance by the Financial Accounting Standards
Board or other regulatory agencies
|
·
|
Changes
in general domestic economic conditions such as inflation rates, tax
rates, unemployment rates, labor and healthcare cost trend rates,
recessions, and changing government policies, laws and
regulations
|
·
|
Severe
weather, natural disasters, acts of war or terrorism and other external
events
|
Readers
are cautioned that it is not possible to predict or identify all of the risks,
uncertainties and other factors that may affect future results and that the
above list should not be considered to be a complete list.
Item 1B. Unresolved Staff
Comments
None
Item
2. Properties
The
Company’s primary headquarters is located at 5790 Widewaters Parkway, Dewitt,
New York, which is leased. In addition, the Company has 169
properties, of which 103 are owned and 66 are under long-term lease
arrangements. Real property and related banking facilities owned by
the Company at December 31, 2008 had a net book value of $52.6 million and
none of the properties was subject to any material encumbrances. For
the year ended December 31, 2008, rental fees of $3.6 million were paid on
facilities leased by the Company for its operations. The Company
believes that its facilities are suitable and adequate for the Company’s current
operations.
Item 3. 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 4. Submission of
Matters to a Vote of Security Holders
There
were no matters submitted to a vote of the shareholders during the quarter ended
December 31, 2008.
Item
4A. Executive
Officers of the Registrant
The
executive officers of the Company and the Bank who are elected by the Board of
Directors are as follows:
Name
|
Age
|
Position
|
Mark
E. Tryniski
|
48
|
Director,
President and Chief Executive Officer of the Company and the
Bank. Mr. Tryniski assumed his current position in August 2006.
He served as Executive Vice President and Chief Operating Officer from
March 2004 to July 2006 and as the Treasurer and Chief Financial Officer
from June 2003 to March 2004. He previously served as a partner in the
Syracuse office of PricewaterhouseCoopers LLP.
|
Scott
Kingsley
|
44
|
Treasurer
and Chief Financial Officer of the Company, and Executive Vice President
and Chief Financial Officer of the Bank. Mr. Kingsley joined
the Company in August 2004 in his current position. He served
as Vice President and Chief Financial Officer of Carlisle Engineered
Products, Inc., a subsidiary of the Carlisle Companies, Inc., from 1997
until joining the Company.
|
Brian
D. Donahue
|
52
|
Executive
Vice President and Chief Banking Officer. Mr. Donahue assumed
his current position in August 2004. He served as the Bank’s
Chief Credit Officer from February 2000 to July 2004 and as the Senior
Lending Officer for the Southern Region of the Bank from 1992 until June
2004.
|
George
J. Getman
|
52
|
Executive
Vice President and General Counsel. Mr. Getman assumed his
current position in January 2008. Prior to joining the Company,
he was a member with Bond, Schoeneck & King, PLLC and served as
corporate counsel to the Company.
|
Part
II
Item 5. Market for the
Registrant's Common Stock, Related Shareholder Matters and Issuer Purchases of
Equity Securities
The
Company’s common stock has been trading on the New York Stock Exchange under the
symbol “CBU” since December 31, 1997. Prior to that, the common stock
traded over-the-counter on the NASDAQ National Market under the symbol “CBSI”
beginning on September 16, 1986. There were 32,633,404 shares of common stock
outstanding on December 31, 2008, held by approximately 3,526 registered
shareholders of record. The following table sets forth the high and low prices
for the common stock, and the cash dividends declared with respect thereto, for
the periods indicated. The prices do not include retail mark-ups,
mark-downs or commissions.
|
High
|
Low
|
Quarterly
|
Year
/ Qtr
|
Price
|
Price
|
Dividend
|
2008
|
|
|
|
4th
|
$25.98
|
$19.00
|
$0.22
|
3rd
|
$33.00
|
$19.52
|
$0.22
|
2nd
|
$26.88
|
$20.50
|
$0.21
|
1st
|
$26.45
|
$17.91
|
$0.21
|
|
|
|
|
2007
|
|
|
|
4th
|
$21.85
|
$17.70
|
$0.21
|
3rd
|
$21.69
|
$16.61
|
$0.21
|
2nd
|
$21.38
|
$19.63
|
$0.20
|
1st
|
$23.63
|
$19.64
|
$0.20
|
|
|
|
|
The
Company has historically paid regular quarterly cash dividends on its common
stock, and declared a cash dividend of $0.22 per share for the first quarter of
2009. The Board of Directors of the Company presently intends to
continue the payment of regular quarterly cash dividends on the common stock, as
well as to make payment of regularly scheduled dividends on the trust preferred
stock when due, subject to the Company's need for those
funds. However, because substantially all of the funds available for
the payment of dividends by the Company are derived from the Bank, future
dividends will depend upon the earnings of the Bank, its financial condition,
its need for funds and applicable governmental policies and
regulations.
The
following graph compares cumulative total shareholders returns on the Company’s
common stock over the last five fiscal years to the S&P 600 Commercial Banks
Index, the NASDAQ Bank Index, the S&P 500 Index, and the KBW Regional
Banking Index. Total return values were calculated as of December 31 of each
indicated year assuming a $100 investment on December 31, 2003 and reinvestment
of dividends. The following table provides information as of December 31, 2008
with respect to shares of common stock that may be issued under the Company’s
existing equity compensation plans:
The
following table provides information as of December 31, 2008 with respect to
shares of common stock that may be issued under the Company’s existing equity
compensation plans.
|
Number
of
|
|
|
|
Securities
to be
|
Weighted-average
|
Number
of
|
|
Issued
upon
|
Exercise
Price
|
Securities
|
|
Exercise
of
|
on
Outstanding
|
Remaining
|
|
Outstanding
Options,
|
Options,
Warrants
|
Available
for
|
Plan
Category
|
Warrants
and Rights (1)
|
and
Rights
|
Future
Issuance
|
Equity
compensation plans approved by security holders:
|
|
|
|
1994
Long-term Incentive Plan
|
1,106,724
|
$17.50
|
0
|
2004
Long-term Incentive Plan
|
1,681,705
|
$20.79
|
2,192,250
|
Total
|
2,788,429
|
$19.48
|
2,192,250
|
(1) The
number of securities includes unvested restricted stock issued of
122,176.
The
following table shows treasury stock purchases during the fourth quarter 2008,
of which there were none.
|
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
|
October
1-31, 2008 (1)
|
0
|
$ 0.00
|
0
|
935,189
|
November
1-30, 2008 (1)
|
0
|
0.00
|
0
|
935,189
|
December
1-31, 2008 (1)
|
0
|
0.00
|
0
|
935,189
|
Total
|
0
|
$ 0.00
|
|
|
|
(1)
Repurchases were subject to the Company’s publicly announced share
repurchase program. 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. Also, on December 20,
2006, the Company announced an additional two-year authorization to
repurchase up to 900,000 of its outstanding shares in open market or
privately negotiated transactions. These repurchases were for
general corporate purposes, including those related to stock plan
activities.
|
Item 6. Selected
Financial Data
The
following table sets forth selected consolidated historical financial data of
the Company as of and for each of the years in the five-year period ended
December 31, 2008. The historical information set forth under the
captions “Income Statement Data” and “Balance Sheet Data” is derived from the
audited financial statements while the information under the captions “Capital
and Related Ratios”, “Selected Performance Ratios” and “Asset Quality Ratios”
for all periods is unaudited. All financial information in this table
should be read in conjunction with the information contained in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
with the Consolidated Financial Statements and the related notes thereto
included elsewhere in this Annual Report on Form 10-K.
SELECTED
CONSOLIDATED FINANCIAL INFORMATION
|
Years
Ended December 31,
|
(In
thousands except per share data and ratios)
|
2008
|
2007
|
2006
|
2005
|
2004
|
Income
Statement Data:
|
|
|
|
|
|
Loan
interest income
|
$186,833
|
$186,784
|
$167,113
|
$147,608
|
$137,077
|
Investment
interest income
|
64,026
|
69,453
|
64,788
|
71,836
|
75,770
|
Interest
expense
|
102,352
|
120,263
|
97,092
|
75,572
|
61,752
|
Net
interest income
|
148,507
|
135,974
|
134,809
|
143,872
|
151,095
|
Provision
for loan losses
|
6,730
|
2,004
|
6,585
|
8,534
|
8,750
|
Noninterest
income
|
73,244
|
63,260
|
51,679
|
48,401
|
44,321
|
Gain
(loss) on investment securities & early retirement of long-term
borrowings
|
230
|
(9,974)
|
(2,403)
|
12,195
|
72
|
Special
charges/acquisition expenses
|
1,399
|
382
|
647
|
2,943
|
1,704
|
Noninterest
expenses
|
157,163
|
141,692
|
126,556
|
124,446
|
118,195
|
Income
before income taxes
|
56,689
|
45,182
|
50,297
|
68,545
|
66,839
|
Net
income
|
45,940
|
42,891
|
38,377
|
50,805
|
50,196
|
Diluted
earnings per share (1)
|
1.49
|
1.42
|
1.26
|
1.65
|
1.64
|
Diluted
earnings per share – cash (1)
(3)
|
1.73
|
1.62
|
1.47
|
1.84
|
1.81
|
|
|
|
|
|
|
Balance
Sheet Data:
|
|
|
|
|
|
Investment
securities
|
1,395,011
|
1,391,872
|
1,229,271
|
1,303,117
|
1,584,633
|
Loans,
net of unearned discount
|
3,136,140
|
2,821,055
|
2,701,558
|
2,411,769
|
2,358,420
|
Allowance
for loan losses
|
(39,575)
|
(36,427)
|
(36,313)
|
(32,581)
|
(31,778)
|
Intangible
assets
|
328,624
|
256,216
|
246,136
|
224,878
|
232,500
|
Total
assets
|
5,174,552
|
4,697,502
|
4,497,797
|
4,152,529
|
4,393,295
|
Deposits
|
3,700,812
|
3,228,464
|
3,168,299
|
2,983,507
|
2,927,524
|
Borrowings
|
862,533
|
929,328
|
805,495
|
653,090
|
920,511
|
Shareholders’
equity
|
544,651
|
478,784
|
461,528
|
457,595
|
474,628
|
|
|
|
|
|
|
Capital
and Related Ratios:
|
|
|
|
|
|
Cash
dividend declared per share (1)
|
$0.86
|
$0.82
|
$0.78
|
$0.74
|
$0.68
|
Book
value per share (1)
|
16.69
|
16.16
|
15.37
|
15.28
|
15.49
|
Tangible
book value per share (1)
|
6.62
|
7.51
|
7.17
|
7.77
|
7.90
|
Market
capitalization (in millions)
|
796
|
589
|
690
|
676
|
866
|
Tier
1 leverage ratio
|
7.22%
|
7.77%
|
8.81%
|
7.57%
|
6.94%
|
Total
risk-based capital to risk-adjusted assets
|
12.53%
|
14.05%
|
15.47%
|
13.64%
|
13.18%
|
Tangible
equity to tangible assets
|
4.46%
|
5.01%
|
5.07%
|
5.93%
|
5.82%
|
Dividend
payout ratio
|
57.3%
|
57.1%
|
60.7%
|
43.9%
|
40.9%
|
Dividend
payout ratio – cash (3)
|
49.5%
|
50.1%
|
52.5%
|
39.3%
|
36.9%
|
Period
end common shares outstanding (1)
|
32,633
|
29,635
|
30,020
|
29,957
|
30,642
|
Diluted
weighted-average shares outstanding (1)
|
30,826
|
30,232
|
30,392
|
30,838
|
30,670
|
|
|
|
|
|
|
Selected
Performance Ratios:
|
|
|
|
|
|
Return
on average assets
|
0.97%
|
0.93%
|
0.90%
|
1.19%
|
1.20%
|
Return
on average equity
|
9.23%
|
9.20%
|
8.36%
|
10.89%
|
11.39%
|
Net
interest margin
|
3.82%
|
3.64%
|
3.91%
|
4.17%
|
4.45%
|
Noninterest
income/operating income (FTE)
|
31.0%
|
26.1%
|
24.8%
|
27.7%
|
21.1%
|
Efficiency
ratio(2)
|
62.7%
|
63.3%
|
59.9%
|
56.8%
|
52.8%
|
|
|
|
|
|
|
Asset
Quality Ratios:
|
|
|
|
|
|
Allowance
for loan loss/total loans
|
1.26%
|
1.29%
|
1.34%
|
1.35%
|
1.35%
|
Nonperforming
loans/total loans
|
0.40%
|
0.32%
|
0.47%
|
0.55%
|
0.55%
|
Allowance
for loan loss/nonperforming loans
|
312%
|
410%
|
288%
|
245%
|
245%
|
Net
charge-offs/average loans
|
0.20%
|
0.10%
|
0.24%
|
0.33%
|
0.37%
|
Loan
loss provision/net charge-offs
|
117%
|
76%
|
108%
|
110%
|
104%
|
(1) All
share and share-based amounts reflect the two-for-one stock split effected as a
100% stock dividend on April 12, 2004.
(2)
Efficiency ratio excludes intangible amortization, gain (loss) on investment
securities & debt extinguishments and special charges/acquisition
expenses.
(3) Cash
earnings are reconciled to GAAP net income in Table 2 on page 18.
Item
7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations
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”) for the past two
years, although in some circumstances a period longer than two years is covered
in order to comply with Securities and Exchange Commission disclosure
requirements or to more fully explain long-term trends. The following
discussion and analysis should be read in conjunction with the Selected
Consolidated Financial Information on page 15 and the Company’s Consolidated
Financial Statements and related notes that appear on pages 43 through
76. All references in the discussion to the financial condition and
results of operations are to the consolidated position and results of the
Company and its subsidiaries taken as a whole.
Unless
otherwise noted, all earnings per share (“EPS”) figures disclosed in the
MD&A refer to diluted EPS; interest income, net interest income and net
interest margin are presented on a fully tax-equivalent (“FTE”)
basis. The term “this year” and equivalent terms refer to results in
calendar year 2008, “last year” and equivalent terms refer to calendar year
2007, and all references to income statement results correspond to full-year
activity unless otherwise noted.
This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations contains certain forward-looking statements with respect to the
financial condition, results of operations and business of Community Bank
System, Inc. These forward-looking statements involve certain risks
and uncertainties. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements are set
herein under the caption “Forward-Looking Statements” on page 40.
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 (“GAAP”), 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 the critical accounting estimates
include:
·
|
Allowance
for loan losses – The allowance for loan losses reflects management’s best
estimate of probable loan losses in the Company’s loan portfolio.
Determination of the allowance for loan losses 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.
|
·
|
Investment
securities – Investment securities are classified as held-to-maturity,
available-for-sale, or trading. The appropriate classification
is based partially on the Company’s ability to hold the securities to
maturity and largely on management’s intentions with respect to either
holding or selling the securities. The classification of
investment securities is significant since it directly impacts the
accounting for unrealized gains and losses on
securities. Unrealized gains and losses on available-for-sale
securities are recorded in accumulated other comprehensive income or loss,
as a separate component of shareholders’ equity and do not affect earnings
until realized. The fair values of the investment securities
are generally determined by reference to quoted market prices, where
available. If quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments, or a
discounted cash flow model using market estimates of interest rates and
volatility. Marketable investment securities with significant
declines in fair value are evaluated to determine whether they should be
considered other-than –temporarily impaired. Impairment losses
must be recognized in current earnings rather than in other comprehensive
income or loss.
|
·
|
Actuarial
assumptions associated with pension, post-retirement and other employee
benefit plans – These assumptions include discount rate, rate of future
compensation increases and expected return on plan
assets. Specific discussion of the assumptions used by
management is discussed in Note K on pages 65 through
68.
|
·
|
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
judgments 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 them to select 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”, starting on page 49.
Executive
Summary
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 profitable loan and deposit volume using both organic and
acquisition strategies, (iii) increase the non-interest 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, performance of specific product lines, liquidity
and interest rate sensitivity, enhancements to customer products and services,
technology advancements, market share, peer comparisons, and the performance of
acquisition and integration activities.
The
Company’s reported net income for the year of $45.9 million, or $1.49 per share,
was 7.1% above 2007’s reported earnings of $42.9 million, or $1.42 per
share. The 2008 results were driven by strong organic loan and core
deposit growth, continued expansion of non-interest revenues, improved net
interest margin, and continued solid asset quality. The Company also
recorded a $1.7 million benefit related to a change in certain previously
unrecognized tax positions. These results were partially offset by a
$1.7 million non-cash charge for impairment of goodwill associated with one of
the Company’s wealth management businesses, as well as $1.4 million of
acquisition expenses related to the purchase of 18 branch-banking centers in
northern New York State from Citizens in November and the purchase of ABG in
July. Last year’s results included a $6.9 million benefit related to
the settlement and a related change in certain previously unrecognized tax
positions, and a $9.9 million pretax charge related to the early redemption of
$25 million of variable-rate, trust preferred obligations, and the refinancing
of $150 million of Federal Home Loan Bank advances into lower cost
instruments.
Asset
quality remained favorable in 2008, with increases in the loan charge-off,
delinquency and nonperforming loan ratios as well as a higher provision for loan
losses versus 2007, but still below long-term historical levels. The
Company experienced year-over-year loan growth in all portfolios: consumer
installment, consumer mortgage and business lending, due to both the Citizens
branch acquisition and strong organic loan growth. The investment
portfolio, including cash equivalents, increased from the prior year due to the
net liquidity created from the acquisition of Citizens’ branches in the fourth
quarter. Average deposits increased in 2008 as compared to 2007 as
the result of the acquisition of Citizens’ branches as well as organic growth in
core product relationships, offset by a reduction in time
deposits. External borrowings decreased from the end of December 2007
as a portion of the net liquidity from the branch acquisition was used to
eliminate short-term obligations.
While the
Company reported improved earnings for 2008, it anticipates that current global
economic conditions and challenges in the financial services industry may
negatively impact earnings in 2009. In particular, the Company
expects that in 2009: (1) premiums paid to the FDIC will increase significantly,
(2) pension and postretirement expenses will increase significantly, (3) revenue
from FHLB dividends may decrease, (4) payments representing interest and
principal on currently outstanding loans and investments will most likely be
reinvested at rates that are lower than the rates on currently outstanding loans
and investments and (5) the economy may have an adverse affect on asset quality
indicators and the provision for loan losses, and therefore credit costs, which
have trended higher in 2008, are not expected to decline until economic
indicators improve. Due to current uncertainty in economic conditions
and the financial services industry in general, it is particularly difficult to
estimate certain revenue, expenses, and other related matters. There
may be factors in addition to those identified above that impact 2009
results. For a discussion of risks and uncertainties that could
impact the Company’s future results, see Item 1A. Risk Factors.
Net Income and
Profitability
Net
income for 2008 was $45.9 million, up $3.0 million, or 7.1%, from 2007’s
earnings of $42.9 million. Earnings per share for 2008 was $1.49 per
share, up 4.9% from 2007’s earnings per share. The 2008 results
include a $1.7 million or $0.05 per share benefit related to a change in a
position taken on certain previously unrecognized tax positions. The
2008 results also include a $1.7 million or $0.04 per share non-cash charge for
impairment of goodwill associated with the Company’s wealth management business
and $1.4 million or $0.03 per share of acquisition expenses related to the
purchase of 18 branch-banking centers in northern New York Sate from Citizens in
November and the purchase of ABG in July.
In
addition to the earnings results presented above in accordance with GAAP, the
Company provides cash earnings per share which excludes the after-tax effect of
the amortization of intangible assets, the market value adjustments on net
assets acquired in mergers, and the noncash portion of debt extinguishments
costs. Management believes that this information helps investors
understand the effect of acquisition activity and certain noncash transactions
in reported results. Cash earnings per share for 2008 were $1.73, up
6.8% from $1.62 for the year ended December 31, 2007.
Net
income and earnings per share for 2007 were $42.9 million and $1.42, up 12% from
2006 results. The 2007 results include a $9.9 million, or $0.20 per
share, pre-tax charge related to the early redemption of $25 million of
variable-rate, trust preferred obligations, as well as the refinancing of $150
million of Federal Home Loan Bank advances into lower cost
instruments. The 2007 results also included a $6.9 million, or $0.23
per share, benefit related to the settlement and a related change in a position
taken on certain previously unrecognized tax positions. The 2006
earnings included a $2.4 million, or $0.06 per share, charge related to the
early redemption of fixed rate, trust-preferred obligations.
Table
1: Condensed Income Statements
|
Years
Ended December 31,
|
(000’s
omitted, except per share data)
|
2008
|
2007
|
2006
|
2005
|
2004
|
Net
interest income
|
$148,507
|
$135,974
|
$134,809
|
$143,872
|
$151,095
|
Loan
loss provision
|
6,730
|
2,004
|
6,585
|
8,534
|
8,750
|
Noninterest
income
|
73,474
|
53,286
|
49,276
|
60,596
|
44,393
|
Operating
expenses
|
158,562
|
142,074
|
127,203
|
127,389
|
119,899
|
Income
before taxes
|
56,689
|
45,182
|
50,297
|
68,545
|
66,839
|
Income
taxes
|
10,749
|
2,291
|
11,920
|
17,740
|
16,643
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
$50,805
|
$50,196
|
|
|
|
|
|
|
Diluted
earnings per share
|
$1.49
|
$1.42
|
$1.26
|
$1.65
|
$1.64
|
Diluted
earnings per share-cash(1)
|
$1.73
|
$1.62
|
$1.47
|
$1.84
|
$1.81
|
(1)
Cash earnings are reconciled to GAAP net income in Table 2.
Table
2: Reconciliation of GAAP Net Income To Non-GAAP Cash Net Income
|
Years
Ended December 31,
|
(000’s
omitted)
|
2008
|
2007
|
2006
|
2005
|
2004
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
$50,805
|
$50,196
|
After-tax
adjustments:
|
|
|
|
|
|
Net
amortization of market value adjustments on net assets acquired in
mergers
|
509
|
701
|
813
|
655
|
(126)
|
Amortization
of intangible assets
|
5,379
|
4,808
|
4,598
|
5,281
|
5,568
|
Noncash
portion of debt extinguishments charge
|
0
|
466
|
794
|
0
|
0
|
Impairment
of goodwill
|
1,360
|
0
|
0
|
0
|
0
|
Net
income – cash
|
$53,188
|
$48,866
|
$44,582
|
$56,741
|
$55,638
|
The
primary factors explaining 2008 performance are discussed in detail in the
remaining sections of this document and are summarized as follows:
·
|
As
shown in Table 1 above, net interest income increased $12.5 million, or
9.2%, due to a $144 million increase in average earning assets and an 18
basis point increase in the net interest margin. Average loans
grew $191 million or 7.0%, primarily due to strong business lending,
consumer installment and retail mortgage growth as well as the addition of
18 branch banking centers in November 2008, and TLNB in June
2007. Average investments decreased $6.8 million, or 0.5% in
2008. Short-term cash equivalents also decreased $40.4 million
as compared to 2007. Average borrowings increased $81.4 million
due to the need to supplement the funding of strong organic loan growth
and provide temporary financing for investment purchases made in advance
of the significant amount of liquidity that was provided by the Citizens
acquisition.
|
·
|
The
loan loss provision of $6.7 million increased $4.7 million, or 236%, from
the prior year level. Net charge-offs of $5.7 million increased
by $3.1 million from 2007, increasing the net charge-off ratio (net
charge-offs / total average loans) to 0.20% for the year. The
Company’s asset quality remained strong as key metrics such as
nonperforming loans as a percentage of total loans, nonperforming assets
as a percentage of loans and other real estate owned, and delinquent loans
(30+ days through nonaccruing) as a percentage of total loans increased
but remained below long-term historical levels. Additional information on
trends and policy related to asset quality is provided in the asset
quality section on pages 31 through
34.
|
·
|
Noninterest
income for 2008 of $73.5 million increased by $20.2 million, or 38%, from
2007’s level, due both to organic growth and the acquisitions of the
Citizens’ branches, ABG, HBT and TLNB. Noninterest income for
2007 included a $9.9 million debt refinancing charge, comprised
of the refinance of certain Federal Home Loan Bank advances and the early
redemption of $25 million of trust preferred securities. Fees
from banking services were up $3.5 million or 10%, primarily due to
several revenue enhancement initiatives implemented over the last two
years, as well as the acquisitions completed in 2008 and
2007. Financial services revenue was up $6.5 million, or 23%
higher, mostly from strong growth at the Company’s benefit plan
administration and consulting business and the acquisition of ABG and
HBT.
|
·
|
Total
operating expenses increased $16.5 million or 11.6% in 2008 to $158.6
million. A significant portion of the increase was primarily
attributable to incremental operating expenses related to the Citizens’
branches, ABG, TLNB and HBT acquisitions. Additionally,
expenses were up due to annual merit and other personnel costs, higher
FDIC insurance premiums, higher facility-based utility and maintenance
costs, higher volume based processing costs, and increased expenses
related to investments in the technology and facilities
infrastructure.
|
·
|
The
Company's combined effective federal and state income tax rate increased
13.9 percentage points in 2008 to 19.0% primarily as a result of a smaller
settlement of certain previously unrecognized tax positions as compared to
the previous year.
|
Selected Profitability and
Other Measures
Return on
average assets, return on average equity, dividend payout and equity to asset
ratios for the years indicated are as follows:
Table
3: Selected Ratios
|
2008
|
2007
|
2006
|
Return
on average assets
|
0.97%
|
0.93%
|
0.90%
|
Return
on average equity
|
9.23%
|
9.20%
|
8.36%
|
Dividend
payout ratio
|
57.3%
|
57.1%
|
60.7%
|
Average
equity to average assets
|
10.46%
|
10.14%
|
10.80%
|
As
displayed in Table 3 above, the return on average assets increased in 2008 as
compared to both 2007 and 2006. The increase in comparison to both
years was a result of higher net income primarily due to solid organic growth
and the 2008 and 2007 acquisitions. Reported return on equity in 2008
was also higher than 2007 and 2006’s levels for similar reasons.
The
dividend payout ratio for 2008 was above 2007’s level due to dividends declared
increasing 7.5%, versus the 7.1% growth in net income. The increase
in dividends declared was the result of a 4.9% increase in the dividend paid per
share as well as the additional 2.5 million shares issued during the common
equity offering in the fourth quarter. The dividend payout ratio
decreased in 2007 as compared to 2006 due to a larger increase in net income
than the 5.0% increase in dividends declared.
Net Interest
Income
Net
interest income is the amount that interest and fees on earning assets (loans
and investments) exceeds the cost of funds, which consists primarily of 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
disclosed in Table 4, net interest income (with nontaxable income converted to a
fully tax-equivalent basis) totaled $163.6 million in 2008, up $12.8 million, or
8.5%, from the prior year. A $144 million increase in average
interest-earning assets and an 18 basis point increase in net interest margin
more than offset a $120 million increase in average interest-bearing
liabilities. As reflected in Table 5, the higher net interest margin
had a $7.5 million favorable impact, and the volume changes mentioned above
increased net interest income by $5.3 million.
The net
interest margin increased 18 basis points from 3.64% in 2007 to 3.82% in
2008. This increase was primarily attributable to a 52 basis point
decrease in the cost of funds having a greater impact than the 34 basis point
decrease in earning-asset yields. The decreased cost of funds was
reflective of disciplined deposit pricing, in part due to the decreases in
short-term market rates in 2008, as well as planned reductions of time deposit
balances. Additionally, the rates on external borrowings decreased
throughout the year, as a result of the refinancing of $150 million of Federal
Home Loan Bank advances into lower cost instruments in the fourth quarter of
2007 and seven rate reductions by the Federal Reserve to the overnight federal
funds rates since the end of 2007. The yield on loans decreased 44
basis points in 2008, again due in part to the declining interest rates
throughout the market. The yield on investments decreased from 5.98%
in 2007 to 5.81% in 2008 as cash flows from the maturing of higher yielding
investments were used to fund loan growth rather than be reinvested at
unfavorable market rates in the first half of the year, as well as the steep
decline in yields earned on cash equivalents. In the second half of
the year, the Company purchased investments in advance of the liquidity provided
by the acquisition of the Citizens’ branches in November 2008.
The net
interest margin in 2007 was 3.64%, compared to 3.91% in 2006. This 27
basis point decline was primarily attributable to a 35 basis point increase in
the cost of funds having a greater impact than the nine basis point increase in
earning-asset yields. The increased cost of funds was due to rising
rates on deposit products, primarily time deposits in the first three quarters
of the year, as the rates on new volume were above those of maturing time
deposits, in part due to increases in short-term market rates in 2005 and
2006. The rates on external borrowings decreased throughout the year,
as a result of the early redemption of fixed rate trust preferred securities in
the first quarter of 2007 and four rate reductions by the Federal Reserve to the
overnight federal funds rates during the later half of 2007. The
yield on loans increased 16 basis points in 2007. The yield on
investments decreased from 6.04% in 2006 to 5.98% in 2007 due mostly to a
leveraging strategy undertaken in mid-2007, as well as declines in short and
medium term rates in the second half of the year.
As shown
in Table 4, total interest income decreased by $5.1 million, or 1.9%, in 2008.
Table 5 reveals that higher average earning assets contributed a positive $9.2
million variance offset by lower yields with a negative impact of $14.4
million. Average loans grew a total of $191.0 million in 2008, as a
result of $41.6 million from the acquisitions of 18 Citizens branches in
November 2008 and TLNB in June 2007 as well as $149.3 million of organic growth
in all portfolios: business lending, consumer mortgage and consumer
installment. Interest and fees were consistent with 2007,
attributable to higher average loan balances offset by a 44 basis point decrease
in loan yields. Total interest income increased by $24.5 million, or
9.9% in 2007 from 2006’s level. Table 5 indicates that higher average
earning assets contributed a positive $21.0 million variance and higher yields
contributed $3.5 million. Average loans grew $229.6 million in 2007
over 2006, as a result of $186.5 million from the acquisitions of TLNB in June
2007, ONB in December 2006 and Elmira in August 2006 and $43.1 million of
organic growth in the consumer mortgage and consumer installment
portfolios. Interest and fees on loans increased $19.8 million, or
11.8%, in 2007 as compared to 2006. The increase was attributable to
higher average loan balances, as well as a 16 basis point increase in loan
yields due to increases in short-term rates in the first half of the
year.
Investment
interest income in 2008 of $78.5 million was $5.1 million, or 6.1%, lower than
the prior year as a result of a smaller portfolio (negative $1.2 million
impact), and a 17 basis point decrease in the investment yield. The
decrease in balances was a result of cash flows from maturing investments being
used to fund loan growth rather than be reinvested at unfavorable market
rates. Investment purchases were initiated in the third and fourth
quarters of 2008 in anticipation of the net liquidity that would be supplied by
the Citizens’ branch acquisition. Investment interest income in 2007
of $83.6 million was $4.7 million, or 5.9%, higher than the prior year as a
result of a larger portfolio (positive $4.5 million impact). The
performance of the investment portfolio in 2008 and 2007 remained strong despite
the interest rate environment. During the third quarter of 2007, a
$200 million short-term investment leverage strategy was initiated, which
produced positive net interest income and served to demonstrate the company’s
ability to freely access liquidity sources despite tightened credit market
conditions.
The
average earning asset yield declined 34 basis points to 6.20% in 2008 because of
the previously mentioned decreases in loan and investment yields. In
2008, the gap between loan and investment yields decreased to 58 basis points as
the yield on the loan portfolio decreased 44 basis points while the yield on the
investment portfolio decreased a smaller 17 basis points reflective of the loan
portfolio having a significant proportion of variable and adjustable rate loans
which declined as the interest rates decreased throughout 2008, whereas the
investment portfolio was predominately comprised of fixed rate
instruments. The average earning asset yield grew nine basis points
to 6.54% in 2007 from 6.45% in 2006. During 2006, changes in market
interest rates combined with the strategic investment portfolio actions
previously discussed resulted in the yield on the loan portfolio being higher
than the investment portfolio by 63 basis points. This gap widened in
2007 as the yield on the loan portfolio expanded and the investment portfolio
yield stabilized resulting in loan yields being 85 basis points higher than the
yield on the investment portfolio.
Total
average funding (deposits and borrowings) in 2008 increased $134.4 million or
3.3%. Deposits increased $53.0 million, $102.8 million attributable
to the acquisitions of the 18 Citizens branches and TLNB offset by a $49.8
million decrease in organic deposits. Consistent with the Company’s
funding mix objective, average core deposit balances increased $150.5 million,
while time deposits were allowed to decline $97.5 million over the
year. Average external borrowings increased $81.4 million in 2008 as
compared to the prior year due primarily to the all-cash acquisitions of ABG,
TLNB and HBT. However, year-end borrowings declined $66.8 million
from the end of 2007 as a portion of the net liquidity from the branch
acquisition was used to eliminate short-term borrowings. In 2007,
total average funding increased $336.4 million or 9.0%. Deposits
increased $188.3 million, $170.8 million attributable to the acquisitions of
TLNB, ONB and Elmira and $17.5 million due to organic deposit
growth. Average external borrowings increased $148.1 million in 2007
as compared to the prior year due primarily to the incremental leverage strategy
implemented in the third quarter of 2007.
The cost
of funding decreased 52 basis points during 2008 impacted by the decreases to
short-term rates by the Federal Reserve throughout the latter part of 2007 and
all of 2008. Interest rates on deposit accounts were lowered
throughout 2008, with decreases in all product
offerings. Additionally, the Company’s focus on expanding core
account relationships while time deposit balances were allowed to
decline. This trend is demonstrated by the percentage of average
deposits that were in time deposit accounts decreasing from 44.8% in 2007 to
41.1% in 2008, while noninterest checking deposits, interest-bearing checking
deposits and money market accounts increased from 17.4%, 13.6% and 10.1%,
respectively, in 2007, to 17.6%, 15.4% and 12.1%, respectively, in
2008. The prepayment of trust preferred securities and Federal Home
Loan Bank advances from early 2007 through early 2008 contributed to the
decrease in the interest rate differential between short and long-term debt
instruments over the past two years.
Total
interest expense decreased by $17.9 million to $102.4 million in
2008. As shown in Table 5, lower interest rates on deposits and
external borrowings resulted in $21.9 million of this decrease, while the higher
deposit and borrowings balances accounted for an increase of $4.0 million in
interest expense. Interest expense as a percentage of earning assets
decreased by 51 basis points to 2.39%. The rate on interest-bearing
deposits decreased 58 basis points to 2.31%, due largely to decreases in time
deposits and money market rates throughout 2008 and the previously discussed run
off of higher rate deposit products. The rate on external borrowings
decreased 84 basis points to 4.35% because of the refinancing of $150 million of
Federal Home Loan Bank advances into lower cost instruments at the end of 2007
as well as the favorable rates on borrowings throughout 2008. Total
interest expense increased by $23.2 million to $120.3 million in 2007 as
compared to 2006. Higher interest rates accounted $12.3 million of
the increase, while the higher deposit and borrowing balances accounted for
$10.9 million of the increase in interest expense. The rate on
interest-bearing deposits increased 43 basis points to 2.89% and the rate on
external borrowings decreased 10 basis points to 5.19% in 2007.
The
following table sets forth information related to average interest-earning
assets and interest-bearing liabilities and their associated yields and rates
for the years ended December 31, 2008, 2007 and 2006. Interest income
and yields are on a fully tax-equivalent basis using marginal income tax rates
of 38.5% in 2008, 38.8% in 2007, and 38.4% in 2006. Average balances
are computed by totaling 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.
|
Year
Ended December 31, 2008
|
|
Year
Ended December 31, 2007
|
|
Year
Ended December 31, 2006
|
|
|
|
Avg.
|
|
|
|
Avg.
|
|
|
|
Avg.
|
|
Average
|
|
Yield/Rate
|
|
Average
|
|
Yield/Rate
|
|
Average
|
|
Yield/Rate
|
(000's
omitted except yields and rates)
|
Balance
|
Interest
|
Paid
|
|
Balance
|
Interest
|
Paid
|
|
Balance
|
Interest
|
Paid
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning
assets:
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
$39,452
|
$614
|
1.56%
|
|
$79,827
|
$4,019
|
5.03%
|
|
$36,458
|
$1,824
|
5.00%
|
Taxable
investment securities (1)
|
783,691
|
41,600
|
5.31%
|
|
830,315
|
46,048
|
5.55%
|
|
754,618
|
41,702
|
5.53%
|
Nontaxable
investment securities
(1)
|
527,993
|
36,327
|
6.88%
|
|
488,154
|
33,540
|
6.87%
|
|
515,459
|
35,418
|
6.87%
|
Loans
(net of unearned discount)(2)
|
2,934,790
|
187,399
|
6.39%
|
|
2,743,804
|
187,480
|
6.83%
|
|
2,514,173
|
167,676
|
6.67%
|
Total
interest-earning assets
|
4,285,926
|
265,940
|
6.20%
|
|
4,142,100
|
271,087
|
6.54%
|
|
3,820,708
|
246,620
|
6.45%
|
Noninterest-earning
assets
|
472,157
|
|
|
|
455,123
|
|
|
|
431,940
|
|
|
Total
assets
|
$4,758,083
|
|
|
|
$4,597,223
|
|
|
|
$4,252,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
$1,364,652
|
11,061
|
0.81%
|
|
$1,228,447
|
13,634
|
1.11%
|
|
$1,149,236
|
11,792
|
1.03%
|
Time
deposits
|
1,360,275
|
52,019
|
3.82%
|
|
1,457,768
|
64,048
|
4.39%
|
|
1,348,167
|
49,752
|
3.69%
|
Short-term
borrowings
|
450,780
|
17,816
|
3.95%
|
|
257,874
|
10,644
|
4.13%
|
|
144,043
|
5,513
|
3.83%
|
Long-term
borrowings
|
451,129
|
21,456
|
4.76%
|
|
562,672
|
31,937
|
5.68%
|
|
528,355
|
30,035
|
5.68%
|
Total
interest-bearing liabilities
|
3,626,836
|
102,352
|
2.82%
|
|
3,506,761
|
120,263
|
3.43%
|
|
3,169,801
|
97,092
|
3.06%
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest
checking deposits
|
581,271
|
|
|
|
566,981
|
|
|
|
567,500
|
|
|
Other
liabilities
|
52,145
|
|
|
|
57,283
|
|
|
|
56,149
|
|
|
Shareholders'
equity
|
497,831
|
|
|
|
466,198
|
|
|
|
459,198
|
|
|
Total
liabilities and shareholders' equity
|
$4,758,083
|
|
|
|
$4,597,223
|
|
|
|
$4,252,648
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest earnings
|
|
$163,588
|
|
|
|
$150,824
|
|
|
|
$149,528
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest spread
|
|
|
3.38%
|
|
|
|
3.11%
|
|
|
|
3.39%
|
Net
interest margin on interest-earning assets
|
|
|
3.82%
|
|
|
|
3.64%
|
|
|
|
3.91%
|
|
|
|
|
|
|
|
|
|
|
|
|
Fully
tax-equivalent adjustment
|
|
$15,081
|
|
|
|
$14,850
|
|
|
|
$14,719
|
|
(1)
Averages for investment securities are based on historical cost and the yields
do not give effect to changes in fair value that is reflected as a component
of shareholders’ equity and deferred taxes.
(2) The
impact of interest and fees not recognized on nonaccrual loans was
immaterial.
As
discussed above, the change in net interest income (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
5: Rate/Volume
|
2008
Compared to 2007
|
|
2007
Compared to 2006
|
|
Increase
(Decrease) Due to Change in (1)
|
|
Increase
(Decrease) Due to Change in (1)
|
|
|
|
Net
|
|
|
|
Net
|
(000's
omitted)
|
Volume
|
Rate
|
Change
|
|
Volume
|
Rate
|
Change
|
Interest
earned on:
|
|
|
|
|
|
|
|
Deposits
in other banks
|
($1,440)
|
($1,965)
|
($3,405)
|
|
$2,184
|
$11
|
$2,195
|
Taxable
investment securities
|
(2,523)
|
(1,925)
|
(4,448)
|
|
4,197
|
149
|
4,346
|
Nontaxable
investment securities
|
2,742
|
45
|
2,787
|
|
(1,876)
|
(2)
|
(1,878)
|
Loans
(net of unearned discount)
|
12,609
|
(12,690)
|
(81)
|
|
15,611
|
4,193
|
19,804
|
Total
interest-earning assets
(2)
|
9,217
|
(14,364)
|
(5,147)
|
|
20,994
|
3,473
|
24,467
|
|
|
|
|
|
|
|
|
Interest
paid on:
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
1,393
|
(3,966)
|
(2,573)
|
|
843
|
999
|
1,842
|
Time
deposits
|
(4,094)
|
(7,935)
|
(12,029)
|
|
4,276
|
10,020
|
14,296
|
Short-term
borrowings
|
7,642
|
(470)
|
7,172
|
|
4,667
|
464
|
5,131
|
Long-term
borrowings
|
(5,767)
|
(4,714)
|
(10,481)
|
|
1,947
|
(45)
|
1,902
|
Total
interest-bearing liabilities (2)
|
4,000
|
(21,911)
|
(17,911)
|
|
10,902
|
12,269
|
23,171
|
|
|
|
|
|
|
|
|
Net
interest earnings (2)
|
5,342
|
7,422
|
12,764
|
|
12,099
|
(10,803)
|
1,296
|
|
(1)
The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of change in
each.
|
|
(2)
Changes due to volume and rate are computed from the respective changes in
average balances and
rates of the totals; they are not a summation of the changes of
the components.
|
Noninterest
Income
The
Company’s sources of noninterest income are of three primary types: general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network; financial services, comprised of
employee benefit plan administration, actuarial and consulting services
(generated by BPAS which includes BPA, Harbridge and HBT), trust services,
investment and insurance products (generated by CISI and CBNA Insurance), asset
management (generated by Nottingham), and periodic transactions, most often net
gains (losses) from the sale of investments and prepayment of debt
instruments.
Table
6: Noninterest Income
|
Years
Ended December 31,
|
(000's
omitted except ratios)
|
2008
|
2007
|
2006
|
Deposit
service charges and fees
|
$27,167
|
$24,178
|
$22,183
|
Benefit
plan administration, consulting and actuarial fees
|
25,788
|
19,700
|
13,205
|
Wealth
management services
|
8,648
|
8,264
|
7,396
|
Other
fees
|
5,165
|
5,561
|
4,713
|
Electronic
banking
|
5,709
|
4,595
|
3,443
|
Mortgage
banking
|
767
|
962
|
739
|
Subtotal
|
73,244
|
63,260
|
51,679
|
Gain
(loss) on investment securities & debt extinguishments
|
230
|
(9,974)
|
(2,403)
|
Total
noninterest income
|
$73,474
|
$53,286
|
$49,276
|
|
|
|
|
Noninterest
income/operating income (FTE)
|
31.0%
|
26.1%
|
24.8%
|
As
displayed in Table 6, noninterest income, excluding security gains and debt
extinguishments costs, increased by 16% to $73.2 million largely as a result of
increased recurring bank fees and both organic and acquired growth in benefit
plan administration, consulting and actuarial fees. The loss on the
sale of investment securities and debt extinguishments decreased $10.2 million
in 2008 as 2007 included a one-time $9.9 million charge related to the early
redemption of $25 million of variable-rate trust preferred obligations, as well
as the refinance of $150 million of Federal Home Loan Bank advances into lower
cost instruments with no corresponding loss in 2008. Refer to the
“Investments” section of the MD&A on pages 37 through 39 for further
information. Total noninterest income, excluding security gains and
debt extinguishments costs, of $63.3 million for 2007 increased by 22% over
2006, largely as a result of higher utilization of bank services and growth at
BPAS both organically and from the acquisition of HBT in May
2007. The loss on the sale of investment securities and debt
extinguishments increased $7.6 million in 2007, which included the one time debt
refinancing discussed above, while 2006 included a $2.4 million charge related
to the early retirement of $30 million of fixed-rate trust preferred
securities.
Noninterest
income as a percent of operating income (FTE basis) was 31.0% in 2008, up 4.9
percentage points from the prior year. Excluding the gain (loss) on
investment securities and debt extinguishments, noninterest income as a percent
of operating income (FTE basis) was 30.9% in 2008, a 1.4 percentage point
increase from 29.5% for 2007. This increase was primarily driven by
the aforementioned strong growth in recurring bank fees and BPAS income,
partially offset by the favorable impact the 18 basis point increase in the net
interest margin had on net interest income. This ratio is considered
an important measure for determining the progress the Company is making on one
of its primary long-term strategies, which is the expansion of noninterest
income in order to diversify its revenue sources and reduce reliance on net
interest margins that may be strongly impacted by general interest rate and
other market conditions.
The
largest portion of the Company’s recurring noninterest income is the wide
variety of fees earned from general banking services, which reached $38.8
million in 2008, up 10.0% from the prior year. A large portion of the
income growth was attributable to electronic banking fees, up $1.1 million, or
24%, over 2007’s level, due in large part to a concerted effort to increase the
penetration and utilization of consumer debit cards. Overdraft fees
were also up $1.5 million, or 8.6%, over 2007’s level, driven by core deposit
account growth. Mortgage banking fees decreased $0.2 million, or 20%
in 2008. Fees from general banking services were $35.3 million in
2007, up $4.2 million or 13.6% from 2006, primarily driven by growth in
overdraft fees, commissions and electronic banking, generated from several
revenue enhancement initiatives and core deposit account growth.
As
disclosed in Table 6, noninterest income from financial services (including
revenues from benefit plan administration, consulting and actuarial fees and
wealth management services) rose $6.5 million, or 23%, in 2008 to $34.4
million. Financial services revenue now comprises 47% of total
noninterest income, excluding net gains (losses) on the sale of investment
securities and debt extinguishments. Strong performance at BPAS
generated revenue growth of $6.1 million, or 31%, for the 2008 year, achieved
primarily through the acquisition of ABG in July 2008 and HBT in May 2007, new
product offerings and expanded market coverage. BPAS offers their
clients daily valuation, actuarial and employee benefit consulting services on a
national basis from offices in Upstate New York, Texas, and
Pennsylvania. BPAS revenue of $19.7 million in 2007 was $6.5 million
higher than 2006’s results, driven by the acquisition of HBT and enhanced
service offerings to both new and existing clients.
CISI and
Nottingham revenue declined $0.2 million, or 5.4%, and $0.1 million or 6.4%,
respectively, in 2008 primarily due to the adverse conditions prevalent
throughout the financial markets. Revenue at personal trust increased
$0.1 million or 3.8%, during 2008. CBNA Insurance, acquired in June
of 2007, generated revenue growth of $0.6 million. In 2007, CISI
generated revenue growth of $0.7 million, or 17% primarily through the addition
of new financial consultants and improved sales
penetration. Nottingham generated revenue growth of 3.2% in 2007,
achieved primarily through the attraction of net new client assets and market
appreciation. Revenue at personal trust declined $0.2 million or,
8.5% during 2007. Excluding certain non-recurring estate fees
generated in 2006, trust services income increased slightly.
Assets
under management and administration at the Company’s financial services
businesses declined during 2008 to $3.7 billion from $4.7 billion at the end of
2007 due to the significant declines in asset valuations experienced in the
financial markets during 2008. This more than offset the new client
assets attracted during the year. Assets under management increased
$1.5 billion during 2007 from $3.2 billion at year-end
2006. Market-driven gains in equity-based assets were augmented by
attraction of new client assets and the acquisition of HBT. BPA, in
particular, was successful at growing its asset base, as demonstrated by the
approximately $500 million increase in its assets under administration during
2007, excluding assets added through the acquisition of HBT.
In the
fourth quarter of 2007, the Company incurred a $2.1 million charge related to
the early redemption of its $25 million, variable-rate trust preferred
obligations, which included a premium call provision at
6.15%. Additionally, the Company incurred a $7.8 million charge to
refinance $150 million of Federal Home Loan Bank advances into similar duration,
lower cost instruments. In 2006 the Company incurred a $2.4 million charge
related to the early redemption of its $30 million, 9.75% fixed-rate trust
preferred obligations, which included a premium call provision at
4.54%.
The
security and debt gains and losses taken over the last three years are
illustrative of the Company’s active management of its investment portfolio and
external borrowings to achieve a desirable total return through the combination
of net interest income, transaction gains/losses and changes in market value
across financial market cycles, as well as achieving an appropriate
interest-rate sensitivity profile in changing rate environments.
Operating
Expenses
As shown
in Table 7, operating expenses increased $16.5 million, or 11.6%, in 2008 to
$158.6 million primarily due to the four acquisitions completed in 2008 and
2007, as well as a goodwill impairment charge on the wealth management
businesses, and higher merit-based personnel expenses, FDIC insurance premiums,
and volume-based processing costs. Operating expenses in 2007
increased $14.9 million or 11.7% from 2006 primarily due to the four
acquisitions completed in 2007 and 2006, as well as higher merit-based personnel
expenses, business development and volume-based processing
costs. Operating expenses for 2008 as a percent of average assets
were 3.33%, up 24 basis points from 3.09% in 2007. Excluding the
goodwill impairment and acquisition expenses, operating expenses as a percent of
average assets would be 3.27%. This ratio is impacted by the
comparatively high growth rates of the financial service businesses, which are
less asset-intensive and consequently carry higher expense to asset
ratios.
The
efficiency ratio, a performance measurement tool widely used by banks, is
defined by the Company as operating expenses (excluding special
charges/acquisition expenses, goodwill impairment and intangible amortization)
divided by operating income (fully tax-equivalent net interest income plus
noninterest income, excluding net securities and debt gains and
losses). Lower ratios are often correlated to higher
efficiency. In 2008 the efficiency ratio improved 0.6 percentage
points to 62.7% due to an 8.5% increase in net interest income and a 16%
increase in noninterest income (excluding net securities gains and debt
extinguishments costs) having a greater impact than a 9.7% increase in operating
expenses. The efficiency ratio for 2007 was 3.4 percentage points
higher than the 59.9% ratio for 2006 due to a 12.4% increase in operating
expenses having a greater impact than a 0.9% increase in net interest income and
a 22% increase in noninterest income (excluding net securities gains and debt
extinguishments costs). In 2007, operating income growth was
inhibited by the contraction of the net interest margin. In addition,
the efficiency ratios for both periods were adversely affected by the growing
proportion of financial services activities, which due to the differing nature
of their business carry high efficiency ratios.
Table
7: Operating Expenses
|
Years
Ended December 31,
|
(000's
omitted)
|
2008
|
2007
|
2006
|
Salaries
and employee benefits
|
$82,962
|
$75,714
|
$67,103
|
Occupancy
and equipment
|
21,256
|
18,961
|
17,884
|
Customer
processing and communications
|
16,831
|
15,691
|
12,934
|
Amortization
of intangible assets
|
6,906
|
6,269
|
6,027
|
Legal
and professional fees
|
4,565
|
4,987
|
4,593
|
Office
supplies and postage
|
5,077
|
4,303
|
4,035
|
Business
development and marketing
|
5,288
|
5,420
|
4,251
|
Foreclosed
property
|
509
|
382
|
858
|
Goodwill
impairment
|
1,745
|
0
|
0
|
FDIC
insurance premiums
|
1,678
|
435
|
403
|
Special
charges/acquisition expenses
|
1,399
|
382
|
647
|
Other
|
10,346
|
9,530
|
8,468
|
Total
operating expenses
|
$158,562
|
$142,074
|
$127,203
|
|
|
|
|
Operating
expenses/average assets
|
3.33%
|
3.09%
|
2.99%
|
Efficiency
ratio
|
62.7%
|
63.3%
|
59.9%
|
Salaries
and benefits increased $7.2 million or 9.6% in 2008, of which approximately 40%
was the result of the four acquisitions in the last two
years. Additionally, approximately $2.3 million of the increase can
be attributed to annual merit increases, $0.7 million to higher medical costs
and the remaining growth to increased headcount, excluding the
acquisitions. Salaries and benefits increased $8.6 million or 13% in
2007 primarily due to costs associated with the acquisitions of TLNB, HBT,
Elmira and ONB, merit increases and higher medical costs. Total
full-time equivalent staff at the end of 2008 was 1,615 compared to 1,453 at
December 31, 2007 and 1,352 at the end of 2006.
Medical
expenses increased $0.7 million or 14% in 2008 primarily due to a greater number
of insured employees as well as increases in the cost of medical
care. Medical expenses increased $1.1 million in 2007, or 28%,
due to a general rise in the cost of medical care, administration and insurance,
as well as a greater number of insured employees. Additional vision
and dental coverage was added in 2007 at an incremental cost of $0.2 million to
bring the Company’s benefit offerings more closely in line with
peers. Qualified and nonqualified pension expense decreased $1.7
million in 2008 primarily due to an increase in the discount rate utilized to
calculate the pension expense as well as increased returns on assets contributed
to the plan in 2007 and 2008. Qualified and nonqualified pension
expenses decreased in 2007 principally due to the return on assets for
contributions made to the plan in 2007, partially offset by increases in retiree
medical expense due to the general rise in the cost of medical
care. The three assumptions that have the largest impact on the
calculation of annual pension expense are the discount rate utilized, the rate
applied to future compensation increases and the expected rate of return on plan
assets. See Note K to the financial statements for further
information concerning the pension plan. The Company’s contribution
to the 401(k) Employee Stock Ownership Plan increased $0.7 million in 2008
primarily due to a half percentage point increase in the Company’s matching
contribution, as well as an increase in employee participation.
Total
non-personnel operating expense, excluding one-time acquisition expenses and
goodwill impairment, increased $6.5 million or 9.8% in 2008. As
displayed in Table 7, this was largely caused by higher occupancy and equipment
expense (up $2.3 million), FDIC insurance premiums (up $1.2 million), customer
processing and communication expense (up $1.1 million), office supplies and
postage (up $0.8 million), other expenses (up $0.8 million), amortization of
intangible assets (up $0.6 million), and foreclosed property expenses (up $0.1
million), partially offset by decreases in legal and professional (down $0.4
million), and business development and marketing (down $0.1 million)
expenses. During 2007 and the first half of 2008, FDIC premiums were
met through the application of a credit balance created in prior
years. This credit balance was depleted in the second quarter and
resulted in higher FDIC premiums in the third and fourth quarters of
2008. Facility based utilities and maintenance costs increased due to
higher energy costs and inclement weather. A portion of the increase
in data processing and communications costs reflects the Company’s continued
investments in strategic technology initiatives and enhancement of its service
offerings. A majority of the remaining increase in nonpersonnel
operating costs is attributable to $3.4 million of expenses added as a result of
the four acquisitions in 2008 and 2007.
The
Company continually evaluates all aspects of its operating expense structure and
is diligent about identifying opportunities to improve operating
efficiencies. Over the last two years, the Company has consolidated
three of its branch offices. This realignment will reduce
market overlap and further strengthen its branch network, and reflects
management’s focus on achieving long-term performance improvements through
proactive strategic decision making.
Total
non-personnel operating expense increased $6.3 million or 10.4% in
2007. As displayed in Table 7, this was largely caused by higher
customer processing and communication expense (up $2.8 million), business
development and marketing (up $1.2 million), other expenses (up $1.1 million),
occupancy and equipment expense (up $1.1 million), legal and professional (up
$0.4 million), office supplies and postage (up $0.3 million), and, amortization
of intangible assets (up $0.2 million), partially offset by decreases in
foreclosed property expenses (down $0.5 million). The increase in
data processing and communications costs as well as the increase in business
development and marketing expenses reflects the Company’s continued investments
in strategic technology and business development initiatives to grow and enhance
its service offerings. A majority of the remaining increase in
nonpersonnel operating costs is attributable to $2.9 million of expenses added
as a result of the four acquisitions in 2007 and 2006.
Special
charges/acquisition expense totaled $1.4 million in 2008, an increase of $1.0
million from 2007 and relate solely to acquisitions. Special
charges/acquisition expenses totaled $0.4 million in 2007, down $0.3 million
from $0.6 million in 2006. The 2006 special charge related to early retirement
of certain long-service employees and acquisition expenses of $0.3
million. In 2008 the Company recorded a $1.7 million non-cash
goodwill impairment charge in the wealth management businesses, a direct result
of equity market valuation declines in 2008.
Income
Taxes
The
Company estimates its tax expense based on the amount it expects to owe the
respective tax authorities, plus the impact of deferred tax
items. Taxes are discussed in more detail in Note I of the
Consolidated Financial Statements beginning on page 63. Accrued taxes
represent the net estimated amount due or to be received from taxing
authorities. In estimating accrued taxes, management assesses the
relative merits and risks of the appropriate tax treatment of transactions
taking into account statutory, judicial and regulatory guidance in the context
of the Company’s tax position. If the final resolution of taxes
payable differs from its estimates due to regulatory determination or
legislative or judicial actions, adjustments to tax expense may be
required.
The
effective tax rate for 2008 increased 13.9 percentage points to
19.0%. There were two notable items during 2008, which impacted the
effective tax rate for the year. Upon settlement of open tax years
with certain taxing authorities, the Company recorded $1.7 million of previously
unrecognized tax benefits, as compared to a $6.9 million benefit recognized in
2007. Additionally, the Company recorded a non-cash goodwill
impairment charge related to its wealth management businesses, reducing pre-tax
net income. The effective tax rate for 2007 decreased by 18.6
percentage points to 5.1% as a result of the aforementioned $6.9
million benefit related to the settlement and a related change in a position
taken on certain previously unrecognized tax positions and a higher proportion
of tax exempt income, due in part to the higher debt restructuring charges in
2007.
Capital
Shareholders’
equity ended 2008 at $544.7 million, up $65.9 million, or 13.8%, from one year
earlier. This increase reflects net income of $45.9 million, $8.3
million from the issuance of shares through employee stock plans, $2.0 million
from stock based compensation and $49.5 million from a common stock
offering. These increases were partially offset by common stock
dividends declared of $26.3 million and a $13.6 million decrease in other
comprehensive income. The other comprehensive income is comprised of
a $2.4 million increase in the market value adjustment (“MVA”, represents the
after-tax, unrealized change in value of available-for-sale securities in the
Company’s investment portfolio), a $13.2 million charge based on the funded
status of the Company’s employee retirement plans, and a $2.8 million decrease
in the fair value of interest rate swaps designated as a cash flow
hedges. Excluding accumulated other comprehensive income in both 2008
and 2007, capital rose by $79.4 million, or 17%. Shares outstanding
increased by 2,999,000 during the year, comprised of 2,530,000 added through the
common stock offering in the fourth quarter and 469,000 added through employee
stock plans.
Shareholders’
equity ended 2007 at $478.8, up $17.3 million, or 3.7% from one year
earlier. This increase reflects net income of $42.9 million, $3.3
million from the issuance of shares through employee stock plans, $2.2 million
from stock based compensation and a $5.4 million increase in other comprehensive
income. These increases were partially offset by common stock
dividends declared of $24.5 million and treasury share purchases of $12.0
million. The other comprehensive income is comprised of a $6.0
million increase in the MVA, a $1.2 million benefit based on the funded status
of the Company’s employee retirement plans, partially offset by a $1.8 million
decrease in the fair value of interest rate swaps designated as a cash flow
hedges.
The
Company’s ratio of Tier 1 capital to assets (or tier 1 leverage ratio), the
basic measure for which regulators have established a 5% minimum for an
institution to be considered “well-capitalized,” decreased 55 basis points at
year-end 2008 to 7.22%. This was primarily the result of a 6.9% increase in
average assets due to the acquisitions of TLNB and the Citizens’ branches, as
well as organic loan growth, while tangible equity declined 0.7% due to the
intangible assets added in association with the two acquisitions made in 2008
(ABG and Citizens’ branches). The tangible equity/tangible
assets ratio was 4.46% at the end of 2008 versus 5.01% one year
earlier. The decline was due to intangible assets from the
acquisition of ABG and the Citizens’ branches, having a proportionally greater
impact on tangible equity than on tangible assets. The Company
manages organic and acquired growth in a manner that enables it to continue to
build upon its strong capital base, and maintain the Company’s ability to take
advantage of future strategic growth opportunities.
Cash
dividends declared on common stock in 2008 of $26.3 million represented an
increase of 7.5% over the prior year. This growth was mostly a result
of dividends per share of $0.86 for 2008 increasing from $0.82 in 2007, a result
of quarterly dividends per share being raised from $0.21 to $0.22 (+4.8%) in the
third quarter of 2008 and from $0.20 to $0.21 (+5.0%) in the third quarter of
2007. Contributing to the increase in the dividend was the 2.5
million shares issued in the common equity offering completed in the fourth
quarter of 2008. The dividend payout ratio for this year was 57.3%
compared to 57.1% in 2007, and 60.8% in 2006. In 2008 the increase in
dividends paid was slightly larger than the 7.1% increase in net
income. The change in 2007 is a result of the increase in dividends
declared being smaller than the 12% increase in net income.
Liquidity
Liquidity
risk is measured by the Company’s ability to raise cash when needed at a
reasonable cost and minimize any loss. The Company must be capable of meeting
all obligations to its customers at any time and, therefore, the active
management of its liquidity position is critical. Given the uncertain
nature of our customers' demands as well as the Company's desire to take
advantage of earnings enhancement opportunities, the Company must have available
adequate sources of on and off-balance sheet funds that can be acquired in time
of need. Accordingly, in addition to the liquidity provided by
balance sheet cash flows, liquidity must be supplemented with additional sources
such as credit lines from correspondent banks, the Federal Home Loan Bank, and
the Federal Reserve Bank. Other funding alternatives may also be
appropriate from time to time, including wholesale and retail repurchase
agreements, large certificates of deposit, and brokered CD
relationships.
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 as a percentage of
total assets); and second, a projection of subsequent cash availability over an
additional 60 days. As of December 31, 2008, this ratio was 14.5% and
14.2% for the respective time periods, excluding the Company's capacity to
borrow additional funds from the Federal Home Loan Bank and other sources, as
compared to the Bank policy that requires a minimum of 7.5%. At
December 31, 2008 there is $328 million in additional Federal Home Loan Bank
borrowing capacity based on the Company’s year-end collateral
levels. Additionally, the Company has $13 million in unused capacity
at the Federal Reserve Bank and $100 million in unused capacity from unsecured
lines of credit with other correspondent banks.
In
addition to the 30 and 90-day basic surplus/deficit model, longer-term liquidity
over a minimum of five years is measured and a liquidity analysis projecting
sources and uses of funds is prepared. To measure longer-term
liquidity, a baseline projection of loan and deposit growth for five years is
made to reflect how liquidity levels could change over time. This five-year
measure reflects ample liquidity for loan growth over the next five
years.
Though
remote, the possibility of a funding crisis exists at all financial
institutions. Accordingly, management has addressed this issue by
formulating a Liquidity Contingency Plan, which has been reviewed and approved
by both the Board of Directors and the Company’s Asset/Liability Management
Committee. The plan addresses those actions the Company would take in
response to both a short-term and long-term funding crisis.
A
short-term funding crisis would most likely result from a shock to the financial
system, either internal or external, which disrupts orderly short-term funding
operations. Such a crisis should be temporary in nature and would not
involve a change in credit ratings. A long-term funding crisis would
most likely be the result of drastic credit deterioration at the
Company. Management believes that both circumstances have been fully
addressed through detailed action plans and the establishment of trigger points
for monitoring such events.
Intangible
Assets
The
changes in intangible assets by reporting segment for the year ended December
31, 2008 are summarized as follows:
Table
7a: Intangible Assets
|
Balance
at
|
|
|
|
Balance
at
|
|
December
31, 2007
|
Additions
|
Amortization
|
Impairment
|
December
31, 2008
|
Banking
Segment
|
|
|
|
|
|
Goodwill
|
$221,224
|
$66,740
|
$0
|
$0
|
$287,964
|
Other
intangibles
|
0
|
322
|
(170)
|
0
|
152
|
Core
deposit intangibles
|
19,765
|
8,548
|
(5,973)
|
0
|
22,340
|
Total
|
$240,989
|
$75,610
|
$(6,143)
|
$0
|
$310,456
|
|
|
|
|
|
|
Other
Segment
|
|
|
|
|
|
Goodwill
|
$13,225
|
$1,705
|
$0
|
$(1,745)
|
$13,185
|
Other
intangibles
|
2,002
|
3,744
|
(763)
|
0
|
4,983
|
Total
|
$15,227
|
$5,449
|
$(763)
|
$(1,745)
|
$18,168
|
Intangible
assets at the end of 2008 totaled $328.6 million, an increase of $72.4 million
from the prior year-end due to $80.2 million of additional intangible assets
arising from the acquisitions of Citizens and ABG, and minor adjustments to the
intangible assets from prior acquisitions, offset by $6.8 million of
amortization during the year and the $1.7 million charge taken for impairment of
goodwill associated with the wealth management businesses.
Intangible
assets consist of goodwill, core deposit value and customer relationships
arising from acquisitions. Goodwill represents the excess cost of an
acquisition over the fair value of the net assets acquired. Goodwill
at December 31, 2008 amounted to $301 million, comprised of $288 million related
to banking acquisitions and $13 million arising from the acquisition of
financial services businesses. Goodwill is subjected to periodic
impairment analysis to determine whether the carrying value of the acquired net
assets exceeds their fair value, which would necessitate a write-down of the
goodwill. The Company completed its goodwill impairment analyses
during the first quarters of 2008 and 2007 and no adjustments were necessary on
the whole bank and branch acquisitions. The impairment analysis was
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 them to select 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. Management believes that there is a low probability of
future impairment with regard to the goodwill associated with whole-bank and
branch acquisitions.
The
performance of Nottingham (previously Elias Asset Management) weakened
subsequent to its acquisition in 2000 as a result of adverse market
conditions. Its operating performance stabilized in 2006 and improved
in 2007 and early 2008, however, significant declines in the equity markets
experienced in 2008 resulted in meaningful revenue declines. As a
result management determined that a triggering event had occurred and therefore
the Nottingham goodwill was tested for impairment during the fourth quarter of
2008. Based on the goodwill valuation performed in the fourth
quarter of 2008 the Company recognized an impairment charge and wrote down the
carrying value of the goodwill by $1.7 million to $5.6
million. Additional declines in Nottingham’s operating results
may cause future impairment to its remaining goodwill balance.
Core
deposit intangibles represent the value of non-time deposits acquired in excess
of funding that could have been purchased in the capital
markets. Core deposit intangibles are amortized on either an
accelerated or straight-line basis over periods ranging from seven to twenty
years. The recognition of customer relationship intangibles arose due
to the acquisitions of ABG, HBT and Harbridge. These assets were
determined based on a methodology that calculates the present value of the
projected future net income derived from the acquired customer
base. These assets are being amortized on an accelerated basis over
periods ranging from ten to twelve years.
Loans
The
Company’s loans outstanding, by type, as of December 31 are as
follows:
Table
8: Loans Outstanding
(000's
omitted)
|
2008
|
2007
|
2006
|
2005
|
2004
|
Consumer
mortgage
|
$1,062,943
|
$977,553
|
$912,505
|
$815,463
|
$801,069
|
Business
lending
|
1,058,846
|
984,780
|
960,034
|
819,605
|
831,244
|
Consumer
installment
|
1,014,351
|
858,722
|
829,019
|
776,701
|
726,107
|
Gross
loans
|
3,136,140
|
2,821,055
|
2,701,558
|
2,411,769
|
2,358,420
|
Allowance
for loans
|
39,575
|
36,427
|
36,313
|
32,581
|
31,778
|
Loans,
net of allowance for loan losses
|
$3,096,565
|
$2,784,628
|
$2,665,245
|
$2,379,188
|
$2,326,642
|
As
disclosed in Table 8 above, gross loans outstanding reached a record level of
$3.1 billion as of year-end 2008, up $315.1 million or 11.2% compared to twelve
months earlier. The acquisition of the Citizens branches accounted
for $110.8 million of the growth. Excluding the impact of the
Citizens branch and TLNB acquisitions, total loans rose $196.0 million or
7.1%. The organic loan growth was produced in the business lending,
consumer mortgage and consumer installment portfolios.
The
compounded annual growth rate (“CAGR”) for the Company’s total loan portfolio
between 2004 and 2008 was 7.4% comprised of approximately 4.4% organic growth,
with the remainder coming from acquisitions. The greatest overall
expansion occurred in the consumer installment segment, which grew at an 8.7%
CAGR (including the impact of acquisitions) over that time
frame. Consumer installment loans consist of home equity and personal
loans as well as borrowings originated in automobile, marine and recreational
vehicle dealerships. The consumer mortgage segment grew at a compounded annual
growth rate of 7.3% from 2004 to 2008. The consumer mortgage growth
was primarily driven by record mortgage refinancing volumes over the last five
years, as well as the acquisition of consumer-oriented banks and branches in
that time period. The business lending segment grew at a compounded
annual growth rate of 6.3% from 2004 to 2008.
The
weighting of the components of the Company’s loan portfolio enables it to be
highly diversified. Approximately 66% of loans outstanding at the end
of 2008 were made to consumers borrowing on an installment, line of credit or
residential mortgage loan basis. The business lending portfolio is
also broadly diversified by industry type as demonstrated by the following
distributions at year-end 2008: commercial real estate (26%), healthcare (10%),
general services (9%), retail trade (7%), construction (6%), agriculture (7%),
manufacturing (6%), motor vehicle and parts dealers (5%), restaurant &
lodging (6%), and wholesale trade (4%). A variety of other industries
with less than a 4% share of the total portfolio comprise the remaining
14%.
The
consumer mortgage portion of the Company’s loan portfolio is comprised of fixed
(95%) and adjustable rate (5%) residential lending. Consumer
mortgages increased $85.4 million or 8.7% in 2008. Excluding the
impact of the Citizens branch, and TLNB acquisitions, the consumer mortgage
portfolio was up $69.2 million or 7.2% in 2008. Consumer mortgage
growth increased over the last year in part due to heightened refinancing
activity due to a decline in long-term interest rates. 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 reflection of 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 of the Company’s markets. Interest rates
and expected duration continue to be the most significant factors in determining
whether the Company chooses to retain versus sell and service portions of its
new mortgage production.
The
combined total of general-purpose business lending, including
agricultural-related and dealer floor plans, as well as mortgages on commercial
property is characterized as the Company’s business lending
activity. The business-lending portfolio increased $74.1 million or
7.5% in 2008. Excluding the impact of the Citizens branch and TLNB
acquisitions, this segment increased $43.9 million or 4.6% as compared to the
prior year. The organic growth generated in 2008 was contributed by
every major product line within business lending. The intensity of
competition the Company faces in some of its markets has eased somewhat due to a
portion of the banks reducing their lending participation due to liquidity and
capital restraints they may be facing. The Company 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
installment loans, both those originated directly (such as personal loans and
home equity loans and lines of credit), and indirectly (originated predominantly
in automobile, marine and recreational vehicle dealerships), rose $155.6 million
or 18.1% from one year ago. Excluding the impact of the Citizens
branch and TLNB acquisitions, this segment increased $82.9 million or
9.7%. 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. Past business development
efforts have created opportunities to strategically expand the Company’s share
of the market, helping drive productive growth in this portfolio. The
Company will continue to focus more of its efforts on maintaining the solid
profitability produced by its in-market and contiguous indirect portfolio, while
striving to expand its dealer network modestly.
The
following table shows the maturities and type of interest rates for business and
construction loans as of December 31, 2008:
Table
9: Maturity Distribution of Business and Construction Loans (1)
(000's
omitted)
|
Maturing
in One Year or Less
|
Maturing
After One but Within Five Years
|
Maturing
After Five Years
|
Commercial,
financial and agricultural
|
$367,874
|
$518,325
|
$145,769
|
Real
estate – construction
|
26,878
|
0
|
0
|
Total
|
$394,752
|
$518,325
|
$145,769
|
|
|
|
|
Fixed
or predetermined interest rates
|
$173,240
|
$348,033
|
$49,734
|
Floating
or adjustable interest rates
|
221,512
|
170,292
|
96,035
|
Total
|
$394,752
|
$518,325
|
$145,769
|
(1) Scheduled
repayments are reported in the maturity category in which the payment is
due.
Asset
Quality
The
following table presents information concerning nonperforming assets as of
December 31:
Table
10: Nonperforming Assets
(000's
omitted)
|
2008
|
2007
|
2006
|
2005
|
2004
|
Nonaccrual
loans
|
$11,122
|
$7,140
|
$10,107
|
$10,857
|
$11,798
|
Accruing
loans 90+ days delinquent
|
553
|
622
|
1,207
|
1,075
|
1,158
|
Restructured
loans
|
1,004
|
1,126
|
1,275
|
1,375
|
0
|
Total
nonperforming loans
|
12,679
|
8,888
|
12,589
|
13,307
|
12,956
|
Other
real estate
|
1,059
|
1,007
|
1,838
|
1,048
|
1,645
|
Total
nonperforming assets
|
$13,738
|
$9,895
|
$14,427
|
$14,355
|
$14,601
|
|
|
|
|
|
|
Allowance
for loan losses / total loans
|
1.26%
|
1.29%
|
1.34%
|
1.35%
|
1.35%
|
Allowance
for loan losses / nonperforming loans
|
312%
|
410%
|
288%
|
245%
|
245%
|
Nonperforming
loans / total loans
|
0.40%
|
0.32%
|
0.47%
|
0.55%
|
0.55%
|
Nonperforming
assets / total loans and other real estate
|
0.44%
|
0.35%
|
0.53%
|
0.59%
|
0.62%
|
The
Company places a loan on nonaccrual status when the loan becomes ninety days
past due or sooner, if management concludes collection of interest is doubtful,
except when, in the opinion of management, it is well-collateralized and in the
process of collection. As shown in Table 10 above, nonperforming
loans, defined as nonaccruing loans, accruing loans 90 days or more past due and
restructured loans ended 2008 at $12.7 million, up approximately $3.8 million
from one year earlier and consistent with the 2006 level. The ratio of
nonperforming loans to total loans increased eight basis points from the prior
year to 0.40%. The ratio of nonperforming assets (which includes
other real estate owned, or “OREO”, in addition to nonperforming loans) to total
loans plus OREO increased to 0.44% at year-end 2008, up nine basis points from
one year earlier. The Company’s success at keeping these ratios at
favorable levels despite deteriorating economic conditions was the result of
continued focus on maintaining strict underwriting standards, and enhanced
collection and recovery efforts. Had nonaccrual loans for the year
ended December 31, 2008 been current in accordance with their original terms,
additional interest income of approximately $0.8 million would have been
recorded. At year-end 2008, the Company was managing 18 OREO
properties with a value of $1.1 million, as compared to 14 OREO properties with
a value of $1.0 million a year earlier. No single property has a
carrying value in excess of $225,000. This trend also reflects the
low level of foreclosure activity in the Company’s markets and its specific
portfolio in comparison to national markets.
Total
delinquencies, defined as loans 30 days or more past due or in nonaccrual
status, finished the current year at 1.43% of total loans outstanding versus
1.10% at the end of 2007. As of year-end 2008, total delinquency
ratios for commercial loans, consumer loans, and real estate mortgages were
1.73%, 1.27%, and 1.28%, respectively. These measures were 1.05%,
1.22% and 1.04%, respectively, as of December 31,
2007. Delinquency levels, particularly in the 30 to 89 days
category, tend to be somewhat volatile due to their measurement at a point in
time, and therefore management believes that it is useful to evaluate this ratio
over a longer period. The average quarter-end delinquency ratio for
total loans in 2008 was 1.20%, as compared to an average of 1.04% in 2007 and
1.24% in 2006.
The
changes in the allowance for loan losses for the last five years is as
follows:
Table
11: Allowance for Loan Loss Activity
|
Years
Ended December 31,
|
(000's
omitted except for ratios)
|
2008
|
2007
|
2006
|
2005
|
2004
|
|
|
|
|
|
|
Allowance
for loan losses at beginning of period
|
$36,427
|
$36,313
|
$32,581
|
$31,778
|
$29,095
|
Charge-offs:
|
|
|
|
|
|
Business
lending
|
2,516
|
1,088
|
3,787
|
2,639
|
3,621
|
Consumer
mortgage
|
235
|
387
|
344
|
522
|
535
|
Consumer
installment
|
6,325
|
4,965
|
5,902
|
8,071
|
7,624
|
Total
charge-offs
|
9,076
|
6,440
|
10,033
|
11,232
|
11,780
|
Recoveries:
|
|
|
|
|
|
Business
lending
|
478
|
844
|
930
|
730
|
871
|
Consumer
mortgage
|
184
|
86
|
107
|
142
|
48
|
Consumer
installment
|
2,675
|
2,873
|
2,925
|
2,629
|
2,437
|
Total
recoveries
|
3,337
|
3,803
|
3,962
|
3,501
|
3,356
|
|
|
|
|
|
|
Net
charge-offs
|
5,739
|
2,637
|
6,071
|
7,731
|
8,424
|
Provision
for loan losses
|
6,730
|
2,004
|
6,585
|
8,534
|
8,750
|
Allowance
on acquired loans (1)
|
2,157
|
747
|
3,218
|
0
|
2,357
|
Allowance
for loan losses at end of period
|
$39,575
|
$36,427
|
$36,313
|
$32,581
|
$31,778
|
|
|
|
|
|
|
Amount
of loans outstanding at end of period
|
$3,136,140
|
$2,821,055
|
$2,701,558
|
$2,411,769
|
$2,358,420
|
Daily
average amount of loans (net of unearned discount)
|
2,934,790
|
2,743,804
|
2,514,173
|
2,374,832
|
2,264,791
|
|
|
|
|
|
|
Net
charge-offs / average loans outstanding
|
0.20%
|
0.10%
|
0.24%
|
0.33%
|
0.37%
|
(1)
|
This
reserve addition is attributable to loans acquired from Citizens in 2008,
TLNB in 2007, Elmira and ONB in 2006, and First Heritage Bank in
2004.
|
As
displayed in Table 11 above, total net charge-offs in 2008 were $5.7 million, up
$3.1 million from the prior year, principally due to higher levels of
charge-offs in the business lending and consumer installment portfolios,
partially offset by a decrease in the consumer mortgage
portfolio. Net charge-offs in 2007 were $3.4 million below 2006’s
level, principally due to significantly improved results in the business-lending
and consumer installment portfolios, partially offset by a slight increase in
consumer mortgage net charge-offs.
Due to
the significant increases in average loan balances over time due to acquisition
and organic growth, management believes that net charge-offs as a percent of
average loans (“net charge-off ratio”) offers a more meaningful representation
of asset quality trends. The net charge-off ratio for 2008 was up ten
basis points from 2007’s historically low level of 0.10%. Recovery
performance remained strong in 2008. Gross charge-offs as a
percentage of average loans was 0.31% in 2008 as compared to 0.23 in 2007 and
0.40% in 2006. Continued strong recovery efforts were evidenced by
recoveries of $3.3 million in 2008, representing 43% of average gross
charge-offs for the latest two years, compared to 46% in 2007 and 37% in
2006.
Business
loan net charge-offs increased in 2008, totaling $2.0 million or 0.20% of
average business loans outstanding versus $0.2 million or 0.03% in
2007. The higher net charge-off ratio in 2008 was primarily
attributable to two specific commercial relationships. Consumer
installment loan net charge-offs increased to $3.7 million this year from $2.1
million in 2007, increasing the 2008 net charge-off ratio 15 basis points to
0.40%. Consumer mortgage net charge-offs decreased $0.2 million to
$0.1 million in 2008, and the net charge-off ratio declined two basis points to
0.01%.
Management
continually evaluates the credit quality of the Company’s loan portfolio and
conducts a formal review of the allowance for loan loss adequacy on a quarterly
basis. The two primary components of the loan review process that are
used to determine proper allowance levels are specific and general loan loss
allocations. Measurement of specific loan loss allocations is
typically based on expected future cash flows, collateral values and other
factors that may impact the borrower’s ability to pay. Impaired loans
greater than $0.5 million are evaluated for specific loan loss allocations, as
defined in SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, as amended. Consumer mortgages and
consumer installment loans are considered smaller balance homogeneous loans and
are evaluated collectively. The Company considers a loan to be
impaired when, based on current information and events, it is probable that the
Company will be unable to collect all amounts according to the contractual terms
of the loan agreement or the loan is delinquent 90 days or more.
The
second component of the allowance establishment process, general loan loss
allocations, is composed of two calculations that are computed on the four main
loan segments: business lending, 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 segments 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. The allowance levels
computed from the specific and general loan loss allocation methods are combined
with unallocated reserves, if any, to derive the required allowance for loan
loss to be reflected on the Consolidated Statement of Condition.
The loan
loss provision is calculated by subtracting the previous period allowance for
loan loss, net of the interim period net charge-offs, from the current required
allowance level. This provision is then recorded in the income
statement for that period. Members of senior management and the Loan/ALCO
Committee of the Board of Directors review the adequacy of the allowance for
loan loss quarterly. Management is committed to continually improving
the credit assessment and risk management capabilities of the Company and has
dedicated the resources necessary to ensure advancement in this critical area of
operations.
The
allowance for loan loss increased to $39.6 million at year-end 2008 from $36.4
million at the end of 2007. The $3.1 million increase was primarily
due to the $110 million additional loans from the Citizens branch acquisition as
well as $196 million of organic loan growth. The allowance level was
also 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. The ratio of the allowance for loan loss to total
loans decreased three basis points to 1.26% for year-end 2008 as compared to
1.29% for 2007 and 1.34% for 2006 primarily due to stable underlying credit
profile of our balanced portfolios. Management believes the year-end
2008 allowance for loan losses to be adequate in light of the probable losses
inherent in the Company’s loan portfolio.
The loan
loss provision of $6.7 million in 2008 increased by $4.7 million as a result of
the growth in the loan portfolio and management’s assessment of the probable
losses in the loan portfolio, as discussed above. The loan loss
provision as a percentage of average loans was 0.23% in 2008 as compared to
0.07% in 2007 and 0.26% in 2006. The loan loss provision was 117% of
net charge-offs this year versus 76% in 2007 and 108% in 2006, reflective of the
current economic conditions.
The
following table sets forth the allocation of the allowance for loan losses by
loan category as of the dates indicated, as well as the percentage of loans in
each category to total loans. This allocation is based on
management’s assessment, as of a given point in time, of the risk
characteristics of each of the component parts of the total loan portfolio and
is subject to changes when the risk factors of each component part
change. The allocation is not indicative of either the specific
amounts of the loan categories in which future charge-offs may be taken, nor
should it be taken as an indicator of future loss trends. The
allocation of the allowance to each category does not restrict the use of the
allowance to absorb losses in any category.
Table
12: Allowance for Loan Losses by Loan Type
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
|
|
Loan
|
|
|
Loan
|
|
|
Loan
|
|
|
Loan
|
|
|
Loan
|
(000's
omitted except for ratios)
|
|
Allowance
|
Mix
|
|
Allowance
|
Mix
|
|
Allowance
|
Mix
|
|
Allowance
|
Mix
|
|
Allowance
|
Mix
|
Consumer
mortgage
|
|
$3,298
|
33.9%
|
|
$3,843
|
34.7%
|
|
$3,519
|
33.8%
|
|
$2,991
|
33.8%
|
|
$1,810
|
34.0%
|
Business
lending
|
|
18,750
|
33.8%
|
|
17,284
|
34.9%
|
|
17,700
|
35.5%
|
|
15,917
|
34.0%
|
|
16,439
|
35.2%
|
Consumer
installment
|
|
12,226
|
32.3%
|
|
8,260
|
30.4%
|
|
10,258
|
30.7%
|
|
12,005
|
32.2%
|
|
11,487
|
30.8%
|
Unallocated
|
|
5,301
|
|
|
7,040
|
|
|
4,836
|
|
|
1,668
|
|
|
2,042
|
|
Total
|
|
$39,575
|
100.0%
|
|
$36,427
|
100.0%
|
|
$36,313
|
100.0%
|
|
$32,581
|
100.0%
|
|
$31,778
|
100.0%
|
As
demonstrated in Table 12 above and discussed previously, business lending by its
nature carries higher credit risk than consumer mortgage or consumer installment
loans, and as a result a disproportionate amount of the allowance for loan
losses is deemed necessary for this portfolio. As in prior years, the
unallocated allowance is maintained for inherent losses in the portfolio not
reflected in the historical loss ratios, model imprecision, and for the acquired
loan portfolios, including the 18 branch banking centers acquired from Citizens
(in 2008) and TLNB (in 2007). The unallocated allowance decreased
from $7.0 million in 2007 to $5.3 million in 2008.
Funding
Sources
The
Company utilizes a variety of funding sources to support the earning asset base
as well as to achieve targeted growth objectives. Overall funding is
comprised of three primary sources that possess a variety of maturity,
stability, and price characteristics: deposits of individuals, partnerships and
corporations (IPC deposits); collateralized municipal deposits (public funds);
and external borrowings.
The
average daily amount of deposits and the average rate paid on each of the
following deposit categories are summarized below for the years
indicated:
Table
13: Average Deposits
|
|
2008
|
|
2007
|
|
2006
|
|
|
Average
|
Average
|
|
Average
|
Average
|
|
Average
|
Average
|
(000's
omitted, except rates)
|
|
Balance
|
Rate
Paid
|
|
Balance
|
Rate
Paid
|
|
Balance
|
Rate
Paid
|
Noninterest
checking deposits
|
|
$581,271
|
0.00%
|
|
$566,981
|
0.00%
|
|
$567,500
|
0.00%
|
Interest
checking deposits
|
|
508,076
|
0.43%
|
|
440,855
|
0.58%
|
|
346,618
|
0.44%
|
Regular
savings deposits
|
|
458,270
|
0.44%
|
|
457,681
|
0.83%
|
|
465,058
|
0.76%
|
Money
market deposits
|
|
398,306
|
1.72%
|
|
329,911
|
2.20%
|
|
337,560
|
2.00%
|
Time
deposits
|
|
1,360,275
|
3.82%
|
|
1,457,768
|
4.39%
|
|
1,348,167
|
3.69%
|
Total
deposits
|
|
$3,306,198
|
1.91%
|
|
$3,253,196
|
2.39%
|
|
$3,064,903
|
2.01%
|
As
displayed in Table 13 above, total average deposits for 2008 equaled $3.31
billion, up $53.0 million or 1.6% from the prior year. Excluding the
average deposits acquired from the Citizens branch and TLNB acquisitions,
average deposits decreased $49.8 million or 1.6%. Consistent
with the Company’s focus on expanding core account relationships and reducing
higher cost time deposits, average core product relationships grew $150.5
million or 8.4% as compared to December 31, 2007 while time deposits were
allowed to decline $97.5 million or 6.7%. Average deposits in 2007
were up $188.3 million or 6.1% from 2006. Excluding the average
deposits acquired from TLNB, ONB and Elmira, average deposits increased $17.5
million or 0.6%.
The
Company’s funding composition continues to benefit from a high level of
non-public deposits, which reached an all-time high in 2008 with an average
balance of $3.08 billion, an increase of $43.8 million or 1.4% over the
comparable 2007 period. The Citizens branch and TLNB acquisitions
accounted for $94.5 million of additional non-public
deposits. Non-public deposits are frequently considered to be a
bank’s most attractive source of funding because they are generally stable, do
not need to be collateralized, have a relatively low cost, and provide a strong
customer base for which a variety of loan, deposit and other financial
service-related products can be sold.
Full-year
average deposits of local municipalities increased $9.2 million or 4.2% during
2008, with the Citizens branch and TLNB acquisitions accounting for $8.3 million
of the growth in municipal deposits and the remaining increase derived from
organic deposit growth. Municipal deposit balances tend to be more
volatile than non-public deposits because they are heavily impacted by the
seasonality of tax collection and fiscal spending patterns, as well as the
longer-term financial position of the government entities, which can change
significantly from year to year. The Company is required to
collateralize all local government deposits in excess of FDIC coverage with
marketable securities from its investment portfolio. Because of this
stipulation, as well as the competitive bidding nature of this product,
management considers municipal time deposit funding to be similar to external
borrowings and thus prices these products on a consistent basis.
The mix
of average deposits in 2008 changed slightly in comparison to
2007. The weighting of non-time (interest checking, noninterest
checking, savings and money market accounts) increased from their 2007 levels,
while, time deposits weighting decreased. This change in deposit mix
reflects the Company’s focus on expanding core account relationships and
reducing higher cost time deposits. The average balance for time
deposit accounts decreased from 44.8% of the total deposits in 2007 to 41.1% of
total deposits this year. Average core deposit balances increased
from 55.2% of the total deposits in 2007 to 58.9% of total deposits this
year. This shift in mix, combined with lower average interest rates
in all interest-bearing deposit product categories caused the cost of interest
bearing deposits to decline to 2.31% in 2008, as compared to 2.89% in 2007 and
2.46% in 2006.
The
remaining maturities of time deposits in amounts of $100,000 or more outstanding
as of December 31 are as follows:
Table
14: Time Deposit > $100,000 Maturities
(000's
omitted)
|
2008
|
2007
|
Less
than three months
|
$114,842
|
$84,586
|
Three
months to six months
|
82,037
|
53,741
|
Six
months to one year
|
67,924
|
73,534
|
Over
one year
|
64,516
|
69,155
|
Total
|
$329,319
|
$281,016
|
External
borrowings are defined as funding sources available on a national market basis,
generally requiring some form of collateralization. Borrowing sources
for the Company include the Federal Home Loan Bank of New York and Federal
Reserve Bank of New York, as well as access to the repurchase market through
established relationships with primary market security dealers. The
Company also had approximately $102 million in fixed and floating-rate
subordinated debt outstanding at the end of 2008 that is held by unconsolidated
subsidiary trusts. In the first quarter of 2008, the Company elected
to redeem early $25 million of variable-rate trust preferred
securities. The Company also elected to redeem early $30 million of
fixed-rate trust preferred securities in January 2007. In December
2006, the Company completed a sale of $75 million of trust preferred
securities. The securities mature on December 15, 2036 and carry an
annual rate equal to the three-month LIBOR rate plus 1.65%. The
Company used the net proceeds of the offering for general corporate purposes
including the early call of the $30 million of fixed-rate trust preferred
securities. At the time of the offering, the Company also entered
into an interest rate swap agreement to convert the variable rate trust
preferred securities into a fixed rate obligation for a term of five years at a
fixed rate of 6.43%.
External
borrowings averaged $902 million or 21% of total funding sources for all of 2008
as compared to $821 million or 20% of total funding sources for
2007. The increase in this ratio was primarily attributable to the
need to supplement the funding of strong organic loan growth and provide
temporary financing for investment purchases made in advance of the significant
amount of liquidity that was provided by the Citizens branch acquisition, as
well as the funding of acquisitions with cash over the past two years. As shown
in Table 15 on page 36, at year-end 2008, $415 million or 48% of external
borrowings had remaining terms of one year or less, down from $486 million or
52% at December 31, 2007 and up considerably from the $186 million or 23% at the
end of 2006. This change in external funding mix is primarily the
result of a $200 million short-term leverage strategy entered into in the third
quarter of 2007 funded with certain callable debt obligations classified as
short-term, reduced utilization of Fed Funds purchased and the early redemption
of trust preferred obligations.
As
displayed in Table 4 on page 22, the overall mix of funding has shifted in
2008. The percentage of funding derived from deposits decreased to
79% in 2008 from 80% in 2007 and 82% in 2006. Average FHLB borrowings
increased during 2008 in order to supplement the funding of strong organic loan
growth and provide temporary financing for investment purchases made in advance
of the significant amount of liquidity that was provided by the Citizens branch
acquisition. In addition, drastically lower short-term external
borrowing rates in the latter part of 2008 made this funding alternative more
attractive in comparison to other sources such as time deposits, a very
different environment than that experienced in 2006 and 2007. In
2007, the Company took advantage of improving spreads between short-term
convertible advances and certain short-term investment
opportunities. This strategy not only produced positive net interest
income, but it also served to demonstrate the Company’s ability to freely access
liquidity sources despite tightened credit market conditions. At
December 31, 2008 external borrowings declined $67 million from the end of the
prior year, as a portion of the new liquidity from the branch acquisition was
used to eliminate short-term obligations.
The
following table summarizes the outstanding balance of short-term borrowings of
the Company as of December 31:
Table
15: Short-term Borrowings
(000's
omitted, except rates)
|
2008
|
2007
|
2006
|
Federal
funds purchased
|
$ 0
|
$27,285
|
$ 0
|
Term
borrowings at banks
|
|
|
|
90
days or less
|
3,500
|
17,972
|
20,300
|
Over
90 days
|
411,476
|
415,000
|
135,000
|
Commercial
loans sold with recourse
|
6
|
8
|
143
|
Capital
lease obligation
|
40
|
37
|
0
|
Subordinated
debt held by unconsolidated subsidiary trusts
|
0
|
25,774
|
30,928
|
Balance
at end of period
|
$415,022
|
$486,076
|
$186,371
|
|
|
|
|
Daily
average during the year
|
$450,780
|
$257,874
|
$144,043
|
Maximum
month-end balance
|
$631,979
|
$486,076
|
$192,000
|
Weighted-average
rate during the year
|
3.95%
|
4.13%
|
3.83%
|
Weighted-average
year-end rate
|
4.05%
|
4.35%
|
4.90%
|
The
following table shows the maturities of various contractual obligations as of
December 31, 2008:
Table
16: Maturities of Contractual Obligations
|
|
Maturing
|
Maturing
|
|
|
|
Maturing
|
After
One
|
After
Three
|
|
|
|
Within
|
Year
but
|
Years
but
|
Maturing
|
|
|
One
Year
|
Within
|
Within
|
After
|
|
(000's
omitted)
|
Or
Less
|
Three
Years
|
Five
Years
|
Five
Years
|
Total
|
Federal
Home Loan Bank advances
|
$414,976
|
$26,703
|
$791
|
$318,000
|
$760,470
|
Subordinated
debt held by unconsolidated subsidiary trusts
|
0
|
0
|
0
|
101,975
|
101,975
|
Commercial
loans sold with recourse
|
6
|
18
|
12
|
0
|
36
|
Purchase
obligations, primarily premises and equipment
|
1,916
|
0
|
0
|
0
|
1,916
|
Capital
lease obligation
|
40
|
12
|
0
|
0
|
52
|
Operating
leases
|
3,851
|
6,355
|
4,508
|
6,112
|
$20,826
|
Total
|
$420,789
|
$33,088
|
$5,311
|
$426,087
|
$885,275
|
Financial Instruments with
Off-Balance Sheet Risk
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 fair value of these
commitments is immaterial for disclosure in accordance with FASB Interpretation
No. 45, “Guarantor’s
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others".
The
contract amount of these off-balance sheet financial instruments as of December
31 is as follows:
Table
17: Off-Balance Sheet Financial Instruments
(000's
omitted)
|
2008
|
2007
|
Commitments
to extend credit
|
$523,017
|
$482,517
|
Standby
letters of credit
|
13,209
|
10,121
|
Total
|
$536,226
|
$492,638
|
Investments
The
objective of the Company’s investment portfolio is to hold low-risk,
high-quality earning assets that provide favorable returns and provide another
effective tool to actively manage its asset/liability position in order to
maximize future net interest income opportunities. This must be
accomplished within the following constraints: (a) implementing certain interest
rate risk management strategies which achieve a relatively stable level of net
interest income; (b) providing both the regulatory and operational liquidity
necessary to conduct day-to-day business activities; (c) considering
investment risk-weights as determined by the regulatory risk-based capital
guidelines; and (d) generating a favorable return without undue compromise of
the other requirements.
As
displayed in Table 18 below, the book value of the Company’s investment
portfolio remained at $1.375 billion at year-end
2008. Average investment balances including cash equivalents (book
value basis) for 2008 decreased $47.2 million or 3.4% versus the prior
year. Investment interest income in 2008 was $5.1 million or 6.1%
lower than the prior year as a result of the lower average balances in the
portfolio and a 17 basis point decrease in the average investment yield from
5.98% to 5.81% primarily due to the reinvestment of cash flows of higher
yielding securities into similar products at lower yields based on current
market conditions.
During
2006, the investment portfolio continued to decline due to the contractual
runoff of securities. Cash flows from the maturing securities were
used to pay down short-term borrowings and the excess were invested in
short-term interest bearing cash equivalents, as the long-term investments
alternatives were not attractive in the then flat yield curve
environment. In the second half of 2007, the Company took advantage
of certain investment opportunities to increase the portfolio through a
short-term leverage strategy. This strategy produced positive net
interest income and served to demonstrate the Company’s ability to freely access
liquidity sources despite tightened credit market conditions. As of
December 31, 2007, the expected life-to-maturity of the portfolio was 4.9 years
versus 4.7 years as of December 31, 2006. In 2008 cash flows from
maturing investments were used to fund loan growth rather than be reinvested at
unfavorable market rates in the first half of the year. In the latter
half of the year, the Company took advantage of favorable market conditions to
purchase investments in advance of the liquidity provided by the Citizens branch
acquisition in November 2008.
The
investment portfolio has limited credit risk due to the composition continuing
to heavily favor U.S. Agency debentures, U.S. Agency mortgage-backed
pass-throughs, U.S. Agency CMOs and municipal bonds. The U. S. Agency
debentures, U.S. Agency mortgage-backed pass-throughs and U.S. Agency CMOs are
all AAA-rated (highest possible rating). The majority of the
municipal bonds are AAA-rated. The portfolio does not include any
private label mortgage backed securities (MBSs) or private label collateralized
mortgage obligations (CMOs).
Included
in the available for sale portfolio are pooled trust preferred securities with a
current par value of $74.4 million and unrealized losses of $22.7 million at
December 31, 2008. The underlying collateral of these assets are
principally trust-preferred securities of smaller regional banks and insurance
companies. The Company’s securities are in the super senior, cash
flow tranche of the pools. All other tranches in these pools will
incur losses before this tranche is impacted. The market for these
securities at December 31, 2008 is not active and markets for similar securities
are also not active. The inactivity was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which
these securities trade and then by a significant decrease in the volume of
trades relative to historical levels. The fair value of these
securities was based on a discounted cash flow model using market estimates of
interest rates and volatility, as well as, observable quoted prices for similar
assets in markets that have not been active. These assumptions may
have a significant effect on the reported fair values. The use of
different assumptions, as well as, changes in market conditions, could result in
materially different fair values. The Company has the intent and
ability to hold these securities to recovery or maturity and does not consider
these investments to be other-than temporarily impaired as of December 31,
2008. In determining if unrealized losses are other-than-temporary,
management considers: the length of time and extent that fair value has been
less than cost, the financial condition and near term prospects of the issuer,
any external credit ratings and the Company’s ability and intent to hold the
security for a period sufficient to allow for any anticipated recovery in fair
value. Subsequent changes in market or credit conditions could change
those evaluations.
Ninety-four
percent of the investment portfolio was classified as available-for-sale at
year-end 2008 versus 90% at the end of 2007. The net pre-tax market
value gain over book value for the available-for-sale portfolio as of December
31, 2008 was $20.0 million, up $2.8 million from one year
earlier. This increase is indicative of the interest rate movements
during the respective time periods and the changes in the size and composition
of the portfolio.
The
following table sets forth the amortized cost and market value for the Company's
investment securities portfolio:
Table
18: Investment Securities
|
|
2008
|
|
2007
|
|
2006
|
|
|
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
|
|
$61,910
|
$64,268
|
|
$127,055
|
$127,382
|
|
$127,200
|
$124,020
|
Obligations
of state and political subdivisions
|
|
15,784
|
16,004
|
|
6,207
|
6,289
|
|
7,242
|
7,257
|
Other
securities
|
|
3,196
|
3,196
|
|
3,988
|
3,988
|
|
11,417
|
11,417
|
Total
held-to-maturity portfolio
|
|
80,890
|
83,468
|
|
137,250
|
137,659
|
|
145,859
|
142,694
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury and agency securities
|
|
382,301
|
411,783
|
|
432,832
|
438,526
|
|
372,706
|
370,787
|
Obligations
of state and political subdivisions
|
|
538,008
|
547,939
|
|
532,431
|
543,963
|
|
502,677
|
514,647
|
Corporate
debt securities
|
|
35,596
|
35,152
|
|
40,457
|
40,270
|
|
35,603
|
35,080
|
Collateralized
mortgage obligations
|
|
25,464
|
25,700
|
|
34,451
|
34,512
|
|
43,768
|
43,107
|
Pooled
trust preferred securities
|
|
72,535
|
49,865
|
|
73,089
|
72,300
|
|
0
|
0
|
Mortgage-backed
securities
|
|
188,560
|
192,054
|
|
72,655
|
73,525
|
|
76,266
|
75,181
|
Subtotal
|
|
1,242,464
|
1,262,493
|
|
1,185,915
|
1,203,096
|
|
1,031,020
|
1,038,802
|
Federal
Home Loan Bank common stock
|
|
38,056
|
38,056
|
|
39,770
|
39,770
|
|
32,717
|
32,717
|
Federal
Reserve Bank common stock
|
|
12,383
|
12,383
|
|
10,582
|
10,582
|
|
10,582
|
10,582
|
Other
equity securities
|
|
1,189
|
1,189
|
|
1,174
|
1,174
|
|
1,311
|
1,311
|
Total
available-for-sale portfolio
|
|
1,294,092
|
1,314,121
|
|
1,237,441
|
1,254,622
|
|
1,075,630
|
1,083,412
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized gain on available-for-sale portfolio
|
|
20,029
|
0
|
|
17,181
|
0
|
|
7,782
|
0
|
Total
|
|
$1,395,011
|
$1,397,589
|
|
$1,391,872
|
$1,392,281
|
|
$1,229,271
|
$1,226,106
|
The
following table sets forth as of December 31, 2008, the maturities of investment
securities and the weighted-average yields of such securities, which have been
calculated on the cost basis, weighted for scheduled maturity of each
security:
Table
19: Maturities of Investment Securities
|
|
Maturing
|
Maturing
|
|
|
|
Maturing
|
After
One
|
After
Five
|
|
Total
|
|
Within
|
Year
but
|
Years
but
|
Maturing
|
Amortized
|
|
One
Year
|
Within
|
Within
|
After
|
Cost/Book
|
(000's
omitted, except rates)
|
or
Less
|
Five
Years
|
Ten
Years
|
Ten
Years
|
Value
|
Held-to-Maturity
Portfolio:
|
|
|
|
|
|
U.S.
Treasury and agency securities
|
$0
|
$34,655
|
$27,255
|
$0
|
$61,910
|
Obligations
of state and political subdivisions
|
11,498
|
4,148
|
138
|
0
|
15,784
|
Other
securities
|
0
|
64
|
36
|
3,096
|
3,196
|
Held-to-maturity
portfolio
|
$11,498
|
$38,867
|
$27,429
|
$3,096
|
$80,890
|
|
|
|
|
|
|
Weighted-average
yield (1)
|
3.54%
|
4.47%
|
6.10%
|
4.49%
|
4.89%
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
U.S.
Treasury and agency securities
|
$11,005
|
$101,922
|
$192,554
|
$76,820
|
$382,301
|
Obligations
of state and political subdivisions
|
17,872
|
131,839
|
214,250
|
174,047
|
538,008
|
Corporate
debt securities
|
0
|
20,613
|
14,983
|
0
|
35,596
|
Collateralized
mortgage obligations (2)
|
8,538
|
14,564
|
2,362
|
0
|
25,464
|
Pooled
trust preferred securities
|
0
|
0
|
0
|
72,535
|
72,535
|
Mortgage-backed
securities (2)
|
8
|
289
|
5,715
|
182,548
|
188,560
|
Available-for-sale
portfolio
|
$37,423
|
$269,227
|
$429,864
|
$505,950
|
$1,242,464
|
|
|
|
|
|
|
Weighted-average
yield (1)
|
4.71%
|
4.56%
|
4.62%
|
4.84%
|
4.70%
|
|
(1)
Weighted-average yields are an arithmetic computation of income divided by
average balance; they may differ from the yield to maturity, which
considers the time value of money.
|
|
(2)
Mortgage-backed securities and collateralized mortgage obligations are
listed based on the contractual maturity. Actual maturities
will differ from contractual maturities because borrowers may have the
right to call or prepay certain obligations with or without
penalties.
|
Impact of Inflation and
Changing Prices
The
Company’s financial statements have been prepared in terms of historical
dollars, without considering changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies,
virtually all of the assets and liabilities of a financial institution are
monetary in nature. As a result, interest rates have a more
significant impact on a financial institution's performance than the effect of
general levels of inflation. Interest rates do not necessarily move
in the same direction or in the same magnitude as the prices of goods and
services. Notwithstanding this, inflation can directly affect the
value of loan collateral, in particular real estate.
New Accounting
Pronouncements
See “New Accounting
Pronouncements” Section of Note A of the notes to the consolidated
financial statements on page 54 for additional accounting
pronouncements.
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 exclusive. 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 will make additional updates or corrections with
respect thereto or with respect to other forward-looking
statements.
Item
7A. Quantitative and Qualitative Disclosures about Market
Risk
Market
Risk
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 starting on page 31. Although more than a third
of the securities portfolio at year-end 2008 was invested in municipal bonds,
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 also believes that it has an
insignificant amount of credit risk in its investment portfolio because
essentially all of the fixed-income securities in the portfolio are AAA-rated
(highest possible rating). The Company does not have any material
foreign currency exchange rate risk exposure. 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. The committee 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.
Asset/Liability
Management
The
primary objective of the Company’s asset/liability management process is to
maximize earnings and return on capital within acceptable levels of
risk. 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 that enable it to identify and quantify sources of
interest rate risk in varying rate environments. The primary tools
used by the Company in managing interest rate risk are the income simulation
model and economic value of equity modeling.
Interest
Rate Risk
Interest
rate risk (“IRR”) can result from: the timing differences in the
maturity/repricing of an institution's assets, liabilities, and off-balance
sheet contracts; the effect of embedded options, such as loan prepayments,
interest rate caps/floors, and deposit withdrawals; and differences in the
behavior of lending and funding rates, sometimes referred to as basis
risk. An example of basis risk would occur if floating rate assets
and liabilities, with otherwise identical repricing characteristics, were based
on market indexes that were imperfectly correlated.
Given the
potential types and differing related characteristics of IRR, it is important
that the Company maintain an appropriate process and set of measurement tools
that enable it to identify and quantify its primary sources of
IRR. The Company also recognizes that effective management of IRR
includes an understanding of when potential adverse changes in interest rates
will flow through the income statement. Accordingly, the Company will
manage its position so that it monitors its exposure to net interest income over
both a one year planning horizon and a longer-term strategic
horizon.
It is the
Company’s objective to manage its exposure to interest rate risk, bearing in
mind that it will always be in the business of taking on rate risk and that rate
risk immunization is not possible. Also, it is recognized that as
exposure to interest rate risk is reduced, so too may net interest margin be
reduced.
Income
Simulation
Income
simulation is tested on a wide variety of balance sheet and treasury yield curve
scenarios. The simulation projects changes in net interest income
caused by the effect of changes in interest rates. The model requires
management to make assumptions about how the balance sheet is likely to evolve
through time in different interest rate environments. Loan and
deposit growth rate assumptions are derived from management's outlook, as are
the assumptions used for new loan yields and deposit rates. Loan
prepayment speeds are based on a combination of current industry averages and
internal historical prepayments. Balance sheet and yield curve
assumptions are analyzed and reviewed by the ALCO Committee
regularly.
The
following table reflects the Company's one-year net interest income sensitivity,
using December 31, 2008 asset and liability levels as a starting
point.
The prime
rate and federal funds rate are assumed to move up 200 basis points and down 100
basis points over a 12-month period while the treasury curve shifts 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, generally reflecting 10%-65% of the movement of 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
|
Calculated
increase (decrease) in Projected
|
|
Net
Interest Income at December 31
|
Changes
in Interest Rates
|
2008
|
2007
|
+200
basis points
|
$2,261,000
|
$1,114,000
|
0
basis points (normal yield curve)
|
($2,735,000)
|
N/A
|
-100
basis points
|
N/A
|
($853,000)
|
In the
2008 and 2007 models, the rising rate environment reflects an increase in net
interest income (“NII”) from a flat rate environment while NII decreases if
rates were to fall. The change in NII in both environments is largely
due to assets repricing faster than corresponding liabilities. Over a
longer time period the growth in NII improves significantly in a rising rate
environment as lower yielding assets mature and are replaced at higher
rates.
For the
2008 model, the bank continues to show interest rate risk exposure to falling
rates despite Fed Funds trading at a range of 0 – 25 basis points. In
the 0 basis point model (normal yield curve), longer-term rates are lowered to
levels more consistent with historical norms. In this model, net
interest income declines during the first twelve months as cash flows from
assets reprice to lower rates and corresponding liabilities are assumed to
remain constant. Despite Fed Funds trading near 0%, the Company
believes long-term treasury rates could potentially fall further, and thus, the
(normal yield curve) model tests the impact of this lower treasury rate
scenario.
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 including: 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.
Management
uses a “value of equity” model to supplement the modeling technique described
above. Those supplemental analyses are based on discounted cash flows
associated with on and off-balance sheet financial instruments. Such
analyses are modeled to reflect changes in interest rates and shifts in the
maturity curve of interest rates and provide management with a long-term
interest rate risk metric.
Item 8. Financial
Statements and Supplementary Data
The
following consolidated financial statements and independent auditor’s reports of
Community Bank System, Inc. are contained on pages 44 through 76 of this
item.
·
|
Consolidated
Statements of Condition,
|
December
31, 2008 and 2007
·
|
Consolidated
Statements of Income,
|
Years
ended December 31, 2008, 2007, and 2006
·
|
Consolidated
Statements of Changes in Shareholders'
Equity,
|
Years
ended December 31, 2008, 2007, and 2006
·
|
Consolidated
Statements of Comprehensive Income,
|
Years
ended December 31, 2008, 2007, and 2006
·
|
Consolidated
Statements of Cash Flows,
|
Years
ended December 31, 2008, 2007, and 2006
·
|
Notes
to Consolidated Financial
Statements,
|
December
31, 2008
·
|
Management’s
Report on Internal Control over Financial
Reporting
|
·
|
Report
of Independent Registered Public Accounting
Firm
|
Quarterly
Selected Data (Unaudited) for 2008 and 2007 are contained on page
79.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CONDITION
(In
Thousands, Except Share Data)
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
213,753 |
|
|
$ |
130,823 |
|
|
|
|
|
|
|
|
|
|
Available-for-sale
investment securities
|
|
|
1,314,121 |
|
|
|
1,254,622 |
|
Held-to-maturity
investment securities
|
|
|
80,890 |
|
|
|
137,250 |
|
Total
investment securities (fair value of $1,397,589 and $1,392,281,
respectively)
|
|
|
1,395,011 |
|
|
|
1,391,872 |
|
|
|
|
|
|
|
|
|
|
Loans
|
|
|
3,136,140 |
|
|
|
2,821,055 |
|
Allowance
for loan losses
|
|
|
(39,575 |
) |
|
|
(36,427 |
) |
Net
loans
|
|
|
3,096,565 |
|
|
|
2,784,628 |
|
|
|
|
|
|
|
|
|
|
Core
deposit intangibles, net
|
|
|
22,340 |
|
|
|
19,765 |
|
Goodwill
|
|
|
301,149 |
|
|
|
234,449 |
|
Other
intangibles, net
|
|
|
5,135 |
|
|
|
2,002 |
|
Intangible
assets, net
|
|
|
328,624 |
|
|
|
256,216 |
|
|
|
|
|
|
|
|
|
|
Premises
and equipment, net
|
|
|
73,294 |
|
|
|
69,685 |
|
Accrued
interest receivable
|
|
|
26,077 |
|
|
|
25,531 |
|
Other
assets
|
|
|
41,228 |
|
|
|
38,747 |
|
Total
assets
|
|
$ |
5,174,552 |
|
|
$ |
4,697,502 |
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Noninterest
bearing deposits
|
|
$ |
638,558 |
|
|
$ |
584,921 |
|
Interest-bearing
deposits
|
|
|
3,062,254 |
|
|
|
2,643,543 |
|
Total
deposits
|
|
|
3,700,812 |
|
|
|
3,228,464 |
|
|
|
|
|
|
|
|
|
|
Borrowings
|
|
|
760,558 |
|
|
|
801,604 |
|
Subordinated
debt held by unconsolidated subsidiary trusts
|
|
|
101,975 |
|
|
|
127,724 |
|
Accrued
interest and other liabilities
|
|
|
66,556 |
|
|
|
60,926 |
|
Total
liabilities
|
|
|
4,629,901 |
|
|
|
4,218,718 |
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies (See Note N)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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; 33,468,215
and
|
|
|
|
|
|
|
|
|
32,999,544
shares issued at December 31, 2008 and 2007, respectively
|
|
|
33,468 |
|
|
|
33,000 |
|
Additional
paid-in capital
|
|
|
212,400 |
|
|
|
208,429 |
|
Retained
earnings
|
|
|
329,914 |
|
|
|
310,281 |
|
Accumulated
other comprehensive (loss)/income
|
|
|
(12,864 |
) |
|
|
702 |
|
Treasury
stock, at cost (834,811 and 3,364,811 shares,
respectively)
|
|
|
(18,267 |
) |
|
|
(73,628 |
) |
Total
shareholders' equity
|
|
|
544,651 |
|
|
|
478,784 |
|
Total
liabilities and shareholders' equity
|
|
$ |
5,174,552 |
|
|
$ |
4,697,502 |
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF INCOME
(In
Thousands, Except Per-Share Data)
|
Years
Ended December 31,
|
|
2008
|
2007
|
2006
|
Interest
income:
|
|
|
|
Interest
and fees on loans
|
$186,833
|
$186,784
|
$167,113
|
Interest
and dividends on taxable investments
|
41,022
|
48,032
|
41,869
|
Interest
and dividends on nontaxable investments
|
23,004
|
21,421
|
22,919
|
Total
interest income
|
250,859
|
256,237
|
231,901
|
|
|
|
|
Interest
expense:
|
|
|
|
Interest
on deposits
|
63,080
|
77,682
|
61,544
|
Interest
on short-term borrowings
|
17,816
|
10,644
|
5,513
|
Interest
on long-term borrowings
|
14,552
|
22,001
|
22,013
|
Interest
on subordinated debt held by unconsolidated subsidiary
trusts
|
6,904
|
9,936
|
8,022
|
Total
interest expense
|
102,352
|
120,263
|
97,092
|
|
|
|
|
Net
interest income
|
148,507
|
135,974
|
134,809
|
Less: provision
for loan losses
|
6,730
|
2,004
|
6,585
|
Net
interest income after provision for loan losses
|
141,777
|
133,970
|
128,224
|
|
|
|
|
Noninterest
income:
|
|
|
|
Deposit
service fees
|
35,624
|
32,012
|
28,348
|
Other
banking services
|
3,184
|
3,284
|
2,730
|
Trust,
investment and asset management fees
|
8,648
|
8,264
|
7,396
|
Benefit
plan administration, consulting and actuarial fees
|
25,788
|
19,700
|
13,205
|
Gain
(loss) on investment securities and debt extinguishments
|
230
|
(9,974)
|
(2,403)
|
Total
noninterest income
|
73,474
|
53,286
|
49,276
|
|
|
|
|
Operating
expenses:
|
|
|
|
Salaries
and employee benefits
|
82,962
|
75,714
|
67,103
|
Occupancy
and equipment
|
21,256
|
18,961
|
17,884
|
Customer
processing and communications
|
16,831
|
15,691
|
12,934
|
Amortization
of intangible assets
|
6,906
|
6,269
|
6,027
|
Legal
and professional fees
|
4,565
|
4,987
|
4,593
|
Office
supplies and postage
|
5,077
|
4,303
|
4,035
|
Business
development and marketing
|
5,288
|
5,420
|
4,251
|
Goodwill
impairment
|
1,745
|
0
|
0
|
FDIC
insurance premiums
|
1,678
|
435
|
403
|
Special
charges/acquisition expenses
|
1,399
|
382
|
647
|
Other
|
10,855
|
9,912
|
9,326
|
Total
operating expenses
|
158,562
|
142,074
|
127,203
|
|
|
|
|
Income
before income taxes
|
56,689
|
45,182
|
50,297
|
Income
taxes
|
10,749
|
2,291
|
11,920
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
|
|
|
|
Basic
earnings per share
|
$1.51
|
$1.43
|
$1.28
|
Diluted
earnings per share
|
$1.49
|
$1.42
|
$1.26
|
Cash
dividends declared per share
|
$0.86
|
$0.82
|
$0.78
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years
ended December 31, 2006, 2007 and 2008
(In
Thousands, Except Share Data)
|
|
|
|
|
Accumulated
|
|
|
|
|
Common
Stock
|
Additional
|
|
Other
|
|
Employee
|
|
|
Shares
|
Amount
|
Paid-In
|
Retained
|
Comprehensive
|
Treasury
|
Stock
Plan
|
|
|
Outstanding
|
Issued
|
Capital
|
Earnings
|
(Loss)/Income
|
Stock
|
-Unearned
|
Total
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2005
|
29,956,852
|
$32,451
|
$196,312
|
$276,809
|
$8,420
|
($56,074)
|
($323)
|
$457,595
|
Net
income
|
|
|
|
38,377
|
|
|
|
38,377
|
Other
comprehensive loss, net of tax
|
|
|
|
|
(3,226)
|
|
|
(3,226)
|
Adjustment
for initial adoption of SFAS 158
|
|
|
|
|
(9,891)
|
|
|
(9,891)
|
Dividends
declared:
|
|
|
|
|
|
|
|
|
Common,
$0.78 per share
|
|
|
|
(23,315)
|
|
|
|
(23,315)
|
Common
stock issued under employee stock plan, including
tax benefits of $936
|
322,757
|
322
|
5,024
|
|
|
|
161
|
5,507
|
Stock-based
compensation
|
|
|
2,023
|
|
|
|
|
2,023
|
Treasury
stock purchased
|
(259,450)
|
|
|
|
|
(5,542)
|
|
(5,542)
|
Reclassification
of unearned restricted stock awards to additional paid-in capital in
accordance with SFAS 123(R)
|
|
|
(162)
|
|
|
|
162
|
|
Balance
at December 31, 2006
|
30,020,159
|
32,773
|
203,197
|
291,871
|
(4,697)
|
(61,616)
|
0
|
461,528
|
Net
income
|
|
|
|
42,891
|
|
|
|
42,891
|
Other
comprehensive income, net of tax
|
|
|
|
|
5,399
|
|
|
5,399
|
Dividends
declared:
|
|
|
|
|
|
|
|
|
Common,
$0.82 per share
|
|
|
|
(24,481)
|
|
|
|
(24,481)
|
Common
stock issued under employee stock plan, including
tax benefits of $949
|
226,224
|
227
|
3,055
|
|
|
|
|
3,282
|
Stock-based
compensation
|
|
|
2,177
|
|
|
|
|
2,177
|
Treasury
stock purchased
|
(611,650)
|
|
|
|
|
(12,012)
|
|
(12,012)
|
Balance
at December 31, 2007
|
29,634,733
|
$33,000
|
$208,429
|
$310,281
|
$702
|
($73,628)
|
$0
|
$478,784
|
Net
income
|
|
|
|
45,940
|
|
|
|
45,940
|
Other
comprehensive income, net of tax
|
|
|
|
|
(13,566)
|
|
|
(13,566)
|
Dividends
declared:
|
|
|
|
|
|
|
|
|
Common,
$0.86 per share
|
|
|
|
(26,307)
|
|
|
|
(26,307)
|
Common
stock issued under employee stock plan, including
tax benefits of $927
|
468,671
|
468
|
7,845
|
|
|
|
|
8,313
|
Stock-based
compensation
|
|
|
2,036
|
|
|
|
|
2,036
|
Common
stock issuance
|
2,530,000
|
|
(5,910)
|
|
|
55,361
|
|
49,451
|
Balance
at December 31, 2008
|
32,633,404
|
$33,468
|
$212,400
|
$329,914
|
($12,864)
|
($18,267)
|
$0
|
$544,651
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
(In
Thousands)
|
Years
Ended December 31,
|
|
2008
|
2007
|
2006
|
Change
in accumulated unrealized (losses) gains for pension and
other postretirement obligations
|
($21,503)
|
$2,005
|
($118)
|
Change
in unrealized (losses) and gains on derivative instruments used in cash
flow hedging relationships
|
(4,476)
|
(2,994)
|
750
|
Unrealized
gains (losses) on securities:
|
|
|
|
Unrealized
holding gains (losses) arising during period
|
3,077
|
9,376
|
(5,928)
|
Reclassification
adjustment for (gains) losses included in net income
|
(230)
|
22
|
0
|
Other
comprehensive (loss) gain, before tax
|
(23,132)
|
8,409
|
(5,296)
|
Income
tax benefit (expense) related to other comprehensive loss
|
9,566
|
(3,010)
|
2,070
|
Other
comprehensive (loss) income, net of tax
|
(13,566)
|
5,399
|
(3,226)
|
Net
income
|
45,940
|
42,891
|
38,377
|
Comprehensive
income
|
$32,374
|
$48,290
|
$35,151
|
The accompanying notes are an integral
part of the consolidated financial statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(In
Thousands of Dollars, except Share Data)
|
Years
Ended December 31,
|
|
2008
|
2007
|
2006
|
Operating
activities:
|
|
|
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
Adjustments
to reconcile net income to net cash provided by operating
activities
|
|
|
|
Depreciation
|
9,463
|
9,323
|
8,613
|
Amortization
of intangible assets
|
6,906
|
6,269
|
6,027
|
Net
amortization of premiums and discounts on securities and
loans
|
(951)
|
(6,987)
|
1,094
|
Amortization
of unearned compensation and discount on subordinated debt
|
613
|
405
|
160
|
Provision
for loan losses
|
6,730
|
2,004
|
6,585
|
Impairment
of goodwill
|
1,745
|
0
|
0
|
Provision
for deferred taxes
|
3,999
|
742
|
(999)
|
(Gain)
loss on investment securities and debt extinguishments
|
(230)
|
9,955
|
2,403
|
Gain
on sale of loans and other assets
|
(75)
|
(118)
|
(116)
|
Proceeds
from the sale of loans held for sale
|
3,705
|
17,943
|
31,567
|
Origination
of loans held for sale
|
(3,654)
|
(17,823)
|
(31,446)
|
Excess
tax benefits from share-based payment arrangements
|
(926)
|
(409)
|
(420)
|
Change
in other operating assets and liabilities
|
(18,209)
|
(13,590)
|
11,256
|
Net
cash provided by operating activities
|
55,056
|
50,605
|
73,101
|
Investing
activities:
|
|
|
|
Proceeds
from sales of available-for-sale investment securities
|
60,096
|
15,900
|
37,866
|
Proceeds
from maturities of held-to-maturity investment securities
|
71,008
|
13,244
|
5,950
|
Proceeds
from maturities of available-for-sale investment
securities
|
324,888
|
564,351
|
121,949
|
Purchases
of held-to-maturity investment securities
|
(14,793)
|
(4,780)
|
(9,449)
|
Purchases
of available-for-sale investment securities
|
(440,313)
|
(706,130)
|
(78,776)
|
Net
increase in loans
|
(210,031)
|
(66,610)
|
(39,347)
|
Cash
received(paid) for acquisitions, net of cash acquired of $2,610, $21,873,
and $29,831
|
372,779
|
(12,499)
|
(26,989)
|
Capital
expenditures
|
(10,997)
|
(9,777)
|
(6,494)
|
Net
cash provided by (used in) by investing activities
|
152,637
|
(206,301)
|
4,710
|
Financing
activities:
|
|
|
|
Net
change in demand deposits, NOW accounts, and savings
accounts
|
66,090
|
10,379
|
(43,652)
|
Net
change in time deposits
|
(158,790)
|
(34,334)
|
7,203
|
Net
change in federal funds purchased
|
(27,285)
|
0
|
(36,300)
|
Net
change in short-term borrowings
|
(18,997)
|
312,767
|
(35,100)
|
Net
change in long-term borrowings (net of payments of $799, $150,845 and
$1,283)
|
(20,552)
|
(193,860)
|
171,037
|
Loss
on extinguishment of debt
|
0
|
(9,344)
|
0
|
Issuance
of common stock
|
59,212
|
4,713
|
4,571
|
Purchase
of treasury stock
|
0
|
(12,012)
|
(5,542)
|
Cash
dividends paid
|
(25,367)
|
(24,231)
|
(23,021)
|
Tax
benefits from share-based payment arrangements
|
926
|
409
|
420
|
Net
cash (used in) provided by financing activities
|
(124,763)
|
54,487
|
39,616
|
Change
in cash and cash equivalents
|
82,930
|
(101,209)
|
117,427
|
Cash
and cash equivalents at beginning of year
|
130,823
|
232,032
|
114,605
|
Cash
and cash equivalents at end of year
|
$213,753
|
$130,823
|
$232,032
|
Supplemental
disclosures of cash flow information:
|
|
|
|
Cash
paid for interest
|
$104,396
|
$122,071
|
$95,529
|
Cash
paid for income taxes
|
9,855
|
8,985
|
7,266
|
Supplemental
disclosures of noncash financing and investing activities:
|
|
|
|
Dividends
declared and unpaid
|
7,179
|
6,239
|
5,989
|
Acquisitions:
|
|
|
|
Fair
value of assets acquired, excluding acquired cash and
intangibles
|
111,836
|
87,910
|
273,588
|
Fair
value of liabilities assumed
|
565,674
|
91,665
|
273,884
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
Nature
of Operations
Community
Bank System, Inc. (the “Company”) is a single bank holding company which
wholly-owns five consolidated subsidiaries: Community Bank, N.A. (the “Bank”),
Benefit Plans Administrative Services, Inc. (“BPAS”), CFSI Closeout Corp.
(“CFSICC”), First of Jermyn Realty Co. (“FJRC”), and Town & Country Agency
LLC (“T&C”). BPAS owns three subsidiaries, Benefit Plans
Administrative Services LLC, Harbridge Consulting Group LLC, and Hand Benefits
& Trust, Inc. (“HBT”), which owns two subsidiaries Hand Securities Inc.
(“HSI”), and Flex Corporation (“Flex”). BPAS provides administration,
consulting and actuarial services to sponsors of employee benefit
plans. CFSICC, FJRC and T&C are inactive companies. The
Company also wholly-owns two unconsolidated subsidiary business trusts formed
for the purpose of issuing mandatorily redeemable preferred securities which are
considered Tier I capital under regulatory capital adequacy
guidelines (see Note H).
The Bank
operates 145 customer facilities throughout 28 counties of Upstate New York,
where it operates as Community Bank, N.A. and five counties of Northeastern
Pennsylvania, where it is known as First Liberty Bank & Trust, offering a
range of commercial and retail banking services. The Bank owns the
following subsidiaries: Community Investment Services, Inc. (“CISI”), CBNA
Treasury Management Corporation (“TMC”), CBNA Preferred Funding Corporation
(“PFC”), Nottingham Advisors, Inc. (“Nottingham”), First Liberty Service Corp.
(“FLSC”), Brilie Corporation (“Brilie”) and CBNA Insurance Agency (“CBNA
Insurance”). CISI provides broker-dealer and investment advisory
services. TMC provides cash management, investment, and treasury
services to the Bank. PFC primarily is an investor in residential
real estate loans. Nottingham provides asset management services to
individuals, corporate pension and profit sharing plans, and
foundations. FLSC provides banking-related services to the
Pennsylvania branches of the Bank. CBNA Insurance is a full
service property and casualty insurance agency.
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All inter-company accounts and
transactions have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform to the current period
presentation.
Financial
Accounting Standards Board Interpretation 46 Revised (“FIN 46R”), Consolidation of Variable Interest
Entities (VIE) provides guidance on when a company should
include in its financial statements the assets, liabilities, and activities of
another corporation, partnership, trust or any other legal structure used for
business purposes that either does not have equity investors with voting rights
or has equity investors that do not provide sufficient financial resources for
the entity to support its activities. FIN 46R requires a VIE to be
consolidated by a company if that company is subject to a majority of the risk
of loss or receives a majority of the entity’s residual returns or
both. The Company’s wholly owned subsidiaries Community Capital
Trusts III and IV are VIEs for which the Company is not the primary
beneficiary. Accordingly, the accounts of these entities are not
included in the Company’s consolidated financial statements.
Critical
Accounting Estimates in the Preparation of Financial Statements
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. Critical accounting estimates include the allowance for
loan losses, actuarial assumptions associated with the pension, post-retirement
and other employee benefit plans, the provision for income taxes, and the
carrying value of goodwill and other intangible assets.
Risk
and Uncertainties
In the
normal course of its business, the Company encounters economic and regulatory
risks. There are three main components of economic risk: interest
rate risk, credit risk and market risk. The Company is subject to
interest rate risk to the degree that its interest-bearing liabilities mature or
reprice at different speeds, or on different basis, from its interest-earning
assets. The Company’s primary credit risk is the risk of default on
the Company’s loan portfolio that results from the borrowers’ inability or
unwillingness to make contractually required payments. Market risk
reflects potential changes in the value of collateral underlying loans, the fair
value of investment securities, and loans held for sale.
The
Company is subject to regulations of various governmental
agencies. These regulations can and do change significantly from
period to period. The Company also undergoes periodic examinations by
the regulatory agencies which may subject it to further changes with respect to
asset valuations, amounts of required loan loss allowances, and operating
restrictions resulting from the regulators’ judgments based on information
available to them at the time of their examinations.
Revenue
Recognition
The
Company recognizes income on an accrual basis. CISI recognizes fee income when
investment and insurance products are sold to customers. Nottingham
provides asset management services to brokerage firms and clients and recognizes
income ratably over the contract period during which service is
performed. Revenue from BPA’s administration and recordkeeping
services is recognized ratably over the service contract
period. Revenue from consulting and actuarial services is recognized
when services are rendered. CBNA Insurance recognizes commission
revenue at the later of the effective date of the insurance policy, or the date
on which the policy premium is billed to the customer. At that date,
the earnings process has been completed and the impact of refunds for policy
cancellations can be reasonably estimated to establish reserves. The reserve for
policy cancellations is based upon historical cancellation experience adjusted
by known circumstances. All inter-company revenue and expense among related
entities are eliminated in consolidation.
Cash
and Cash Equivalents
For
purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks and highly liquid investments with original
maturities of less than ninety days. The carrying amounts reported in
the balance sheet for cash and cash equivalents approximate those assets' fair
values.
Investment
Securities
The
Company has classified its investments in debt and equity securities as
held-to-maturity or available-for-sale. Held-to-maturity securities
are those for which the Company has the positive intent and ability to hold to
maturity, and are reported at cost, which is adjusted for amortization of
premiums and accretion of discounts. Securities not classified as
held-to-maturity are classified as available-for-sale and are reported at fair
market value with net unrealized gains and losses reflected as a separate
component of shareholders' equity, net of applicable income
taxes. None of the Company's investment securities have been
classified as trading securities at December 31, 2008. Equity
securities are stated at cost and include restricted stock of the Federal
Reserve Bank of New York and Federal Home Loan Bank of New
York. Investment securities are reviewed regularly for other than
temporary impairment. Where there is other than temporary impairment,
the carrying value of the investment security is reduced to the estimated fair
value, with the impairment loss recognized in the consolidated statements of
income as other expense. In determining if losses are
other-than-temporary, management considers: the length of time and extent that
fair value has been less than cost, the financial condition and near term
prospects of the issuer, any external credit ratings and the Company’s ability
and intent to hold the security for a period sufficient to allow for any
anticipated recovery in fair value.
The
specific identification method is used in determining the realized gains and
losses on sales of investment securities and other than temporary impairment
charges. Premiums and discounts on securities are amortized and
accreted, respectively, on a systematic basis over the period to maturity,
estimated life, or earliest call date of the related
security. Purchases and sales of securities are recognized on a trade
date basis.
Fair
values for investment securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments, or a discounted cash
flow model using market estimates of interest rates and volatility.
Derivative
Financial Instruments
The
Company utilizes interest rate swap agreements, considered to be cash flow
hedges, as part of the management of interest rate risk to modify the repricing
characteristics of certain portions of its portfolios of interest-bearing
liabilities. Under the guidelines of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, (“SFAS 133”), as amended, all
derivative instruments are required to be carried at fair value on the balance
sheet.
Cash flow
hedges are accounted for by recording the fair value of the derivative
instrument on the balance sheet as either a freestanding asset or liability,
with a corresponding offset recorded in other comprehensive income within
stockholders’ equity, net of tax. Amounts are reclassified from other
comprehensive income to the income statement in the period or periods the hedged
forecasted transaction affects earnings. Derivative gains and losses
not effective in hedging the expected cash flows of the hedged item are
recognized immediately in the income statement. At the hedge’s
inception and at least quarterly thereafter, a formal assessment is performed to
determine the effectiveness of the cash flow hedge. If it is
determined that a derivative instrument has not been or will not continue to be
highly effective as a hedge, hedge accounting is discontinued.
Loans
Loans are
stated at unpaid principal balances, net of unearned income. Mortgage
loans held for sale are carried at the lower of cost or fair value and are
included in loans as the balance of such loans was not
significant. Fair values for variable rate loans that reprice
frequently are based on carrying values. Fair values for fixed rate
loans are estimated using discounted cash flows and interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality. The carrying amount of accrued interest approximates its
fair value.
Interest
on loans is accrued and credited to operations based upon the principal amount
outstanding. Nonrefundable loan fees and related direct costs are
included in the loan balances and are deferred and amortized over the life of
the loan as an adjustment to loan yield using the effective yield
method. Premiums and discounts on purchased loans are amortized using
the effective yield method over the life of the loans.
Impaired
and Other Nonaccrual Loans
The
Company places a loan on nonaccrual status when the loan becomes ninety days
past due (or sooner, if management concludes collection is doubtful), except
when, in the opinion of management, it is well-collateralized and in the process
of collection. A loan may be placed on nonaccrual status earlier than
ninety days past due if there is deterioration in the financial position of the
borrower or if other conditions of the loan so warrant. When a loan is placed on
nonaccrual status, uncollected accrued interest is reversed against interest
income and the deferral and amortization of nonrefundable loan fees and related
direct costs is discontinued. Interest income during the period the loan is on
nonaccrual status is recorded on a cash basis after recovery of principal is
reasonably assured. Nonaccrual loans are returned to accrual status when
management determines that the borrower’s performance has improved and that both
principal and interest are collectible. This generally requires a
sustained period of timely principal and interest payments.
Commercial
loans greater than $0.5 million are evaluated individually for impairment in
accordance with FASB No. 114, “Accounting by Creditors for Impairment of a
Loan.” A loan is considered impaired, based on current information
and events, if it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. The measurement of impaired
loans is generally based upon the present value of expected future cash flows or
the fair value of the collateral, if the loan is
collateral-dependent.
The
Company’s charge-off policy by loan type is as follows:
·
|
Commercial
loans are generally charged-off to the extent outstanding principal
exceeds the fair value of estimated proceeds from collection efforts,
including liquidation of collateral. The charge-off is
recognized when the loss becomes reasonably
quantifiable.
|
·
|
Consumer
installment loans are generally charged-off to the extent outstanding
principal balance exceeds the fair value of collateral, and are recognized
by the end of the month in which the loan becomes 120 days past
due.
|
·
|
Loans
secured by 1-4 family residential real estate are generally charged-off to
the extent outstanding principal exceeds the fair value of the property,
and are recognized when the loan becomes 180 days past
due.
|
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 segments: 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 segments 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
factors previously mentioned.
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. The initial 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.
The
Company evaluates goodwill for impairment on an annual basis, or more often if
events or circumstances indicate there may be impairment. The fair
value of each reporting unit is compared to the carrying amount of that
reporting unit in order to determine if impairment is indicated. If
so, the implied fair value of the reporting units’ goodwill is compared to its
carrying amount and the impairment loss is measured by the excess of the
carrying value over fair value.
Premises
and Equipment
Premises
and equipment are stated at cost less accumulated
depreciation. Computer software costs that are capitalized only
include external direct costs of obtaining and installing the
software. The Company has not developed any internal use
software. Depreciation is calculated using the straight-line method
over the estimated useful lives of the assets. Useful lives range
from five to ten years for equipment; three to five years for software and
hardware; and 10 to 40 years for building and building
improvements. Land improvements are depreciated over 15 years and
leasehold improvements are amortized over the term of the respective lease plus
any optional renewal periods that are reasonably assured or life of the asset if
shorter. Maintenance and repairs are charged to expense as
incurred.
Long-lived
depreciable assets are evaluated periodically for impairment when events or
changes in circumstances indicate the carrying amount may not be
recoverable. Impairment exists when the expected undiscounted future
cash flows of a long-lived asset are less than its carrying value. In
that event, the Company recognizes a loss for the difference between the
carrying amount and the estimated fair value of the asset based on a quoted
market price, if applicable, or a discounted cash flow
analysis. Impairment losses are recorded in other expenses on the
income statement.
Other
Real Estate
Properties
acquired through foreclosure, or by deed in lieu of foreclosure, are carried at
the lower of the unpaid loan balance or fair value less estimated costs of
disposal. Subsequent changes in value are reported as adjustments to
the carrying amount, not to exceed the initial carrying value of the asset at
the time of transfer. Changes in value subsequent to transfer are
recorded in operating expenses on the income statement. Gains or
losses not previously recognized resulting from the sale of other real estate
are recognized as an expense on the date of sale. At December 31,
2008 and 2007, other real estate, included in other assets, amounted to $1.1
million and $1.0 million, respectively.
Mortgage
Servicing Rights
Originated
mortgage servicing rights are recorded at their fair value at the time of sale
of the underlying loan, and are amortized in proportion to and over the period
of estimated net servicing income or loss. The Company uses a
valuation model that calculates the present value of future cash flows to
determine the fair value of servicing rights. In using this valuation
method, the Company incorporates assumptions that market participants would use
in estimating future net servicing income, which includes estimates of the
servicing cost per loan, the discount rate, and prepayment
speeds. The carrying value of the originated mortgage servicing
rights is evaluated quarterly for impairment using these same market
assumptions.
Deposits
The fair
value of deposit obligations are based on current market rates for alternative
funding sources, principally the Federal Home Loan Bank of New York. The
carrying value of accrued interest approximates fair value.
Borrowings
The
carrying amounts of federal funds purchased and short-term borrowings
approximate their fair values. Fair values for long-term borrowings
are estimated using discounted cash flows and interest rates currently being
offered on similar borrowings. Since the Company considers debt
extinguishments to be a component of its interest rate risk management, any
related gains or losses are not deemed extraordinary and are presented in the
noninterest income section of the consolidated statements of
income.
Treasury
Stock
Repurchases
of shares of the Company’s common stock are recorded at cost as a reduction of
stockholders’ equity. Reissuance of shares of treasury stock is
recorded at average cost.
On April
20, 2005 the Board of Directors authorized a twenty-month program to repurchase
up to 1,500,000 shares of its outstanding shares. On December 20,
2006 the Company extended the program through December 31,
2008. As of December 31, 2008, the Company has repurchased
1,464,811 shares at an aggregate cost of $31.5 million, or $21.51 per
share. The repurchases were for general corporate purposes, including
those related to stock plan activities. On December 20,
2006 the Company announced an additional two-year authorization, through
December 31, 2008, to repurchase up to 900,000 of its outstanding shares in open
market or privately negotiated transactions.
Income
Taxes
The
Company and its subsidiaries file a consolidated federal income tax
return. Provisions for income taxes are based on taxes currently
payable or refundable as well as deferred taxes that 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.
In June
2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109. This interpretation
specifies that benefits from tax positions should be recognized in the financial
statements only when it is more likely than not that the tax position will be
sustained upon examination by the appropriate taxing authority having full
knowledge of all relevant information. A tax position meeting the
more-likely-than-not recognition threshold should be measured at the largest
amount of benefit for which the likelihood of realization upon ultimate
settlement exceeds 50 percent. The adoption of FIN 48 did not result in any
change to the Company’s liability for uncertain tax positions as of January 1,
2007 (See Note I).
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.
Assets
Under Management or Administration
Assets
held in fiduciary or agency capacities for customers are not included in the
accompanying consolidated statements of condition as they are not assets of the
Company. Substantially all fees associated with providing asset
management services are recorded on an accrual basis of accounting and are
included in noninterest income. Assets under management or
administration at December 31, 2008 and 2007 were $3.703 billion and $4.695
billion, respectively.
Advertising
Advertising
costs amounting to approximately $2.2 million, $2.4 million and $2.1 million for
the years ending December 31, 2008, 2007 and 2006, respectively, are nondirect
response in nature and expensed as incurred.
Earnings
Per Share
Basic
earnings per share is computed by dividing net income by the weighted-average
common shares outstanding for the period. Diluted earnings per share
is computed by dividing net income by the weighted-average common shares plus
common stock equivalents computed using the Treasury Share method (See Note
M). All earnings per share disclosures appearing in these financial
statements, related notes and management’s discussion and analysis, are computed
using dilution unless otherwise indicated.
Stock-Based
Compensation
On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123(R), Share-Based
Payment ("SFAS 123(R)"), which replaced the existing SFAS 123 and
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, (“APB 25”). SFAS 123(R) requires companies to
measure and record compensation expense for stock options and other share-based
payments based on the instruments’ fair value on the date of
grant. The Company adopted this standard using the modified
prospective method. Under this method, expense is recognized for
awards that are granted, modified, or settled after December 31, 2005, as well
as for unvested awards that were granted prior to January 1,
2006. Stock based compensation expense is recognized ratably over the
requisite service period for all awards (see Note L).
Fair
Values of Financial Instruments
The
Company determines fair values based on quoted market values where available or
on estimates using present values or other valuation
techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument. SFAS 107,
Disclosures about Fair Value
of Financial Instruments, excludes certain financial instruments and all
nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented
do not represent the underlying value of the Company. The fair values
of investment securities, loans, deposits, and borrowings have been disclosed in
footnotes C, D, G, and H, respectively.
New
Accounting Pronouncements
SFAS
No. 141(R)
In
December 2007, the Financial Accounting Standards Board (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.
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 does not expect the adoption
of this standard to have a significant impact 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 does not expect the adoption
of this standard to have a significant impact on its financial
statements.
FSP
142-3
In April
2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, Determination of the Useful Life of
Intangible Assets. FSP 142-3 amends the
factors to be considered in developing renewal or extension assumptions used to
determine the useful life of intangible assets under SFAS No. 142, Goodwill and Other Intangible
Assets. Its intent is to improve the consistency between the
useful life of intangible assets acquired or renewed after January 1,
2009. The Company does not expect the adoption of this standard to
have a significant impact on its financial statements.
FSP
03-6-1
In June
2008 the FASB issued FSP Emerging Issues Task Force (“EITF”) 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating
Securities. FSP 03-6-1 clarifies that unvested share-based
payment awards that contain nonforfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities as defined in
EITF 03-6 and, therefore, should be included in the computation of earnings per
share using the two-class method described in SFAS No. 128, Earnings Per
Share. This staff position will be effective for fiscal years
beginning after December 15, 2008 and interim periods within those years and
requires all presented prior-period earnings per share data to be adjusted
retrospectively. The Company is evaluating the impact that this staff
position will have on the presentation of its basic and diluted earning per
share.
FSP
132(R)-1
In
December 2008, the FASB issued FSP No. 132(R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (“FSP 132(R)-1”). This FSP amends FASB
Statement No. 132(R), “Employer’s Disclosures about
Pensions and Other Postretirement Benefits” (“FAS 132(R)”), to require
additional disclosures about assets held in an employer’s defined benefit
pension or other postretirement plan. This FSP is applicable to an employer that
is subject to the disclosure requirements of FAS 132(R) and is generally
effective for fiscal years ending after December 15, 2009. The Company is
evaluating the impact FSP 132(R)-1 will have to the financial
statements.
Citizens
Branches Acquisition
On
November 7, 2008, the Company acquired 18 branch-banking centers in northern New
York from Citizens Financial Group, Inc. (“Citizens”) in an all cash
transaction. The Company acquired approximately $109 million in loans
and $565 million in deposits at a blended deposit premium of 12%. The
results of operations for the 18 branches acquired from Citizens have been
included in the consolidated financial statements since that date. In
support of the transaction, the Company issued approximately $50 million of
equity capital in the form of common stock in October 2008.
Alliance
Benefit Group MidAtlantic
On July
7, 2008, Benefit Plans Administrative Services, Inc. (“BPAS”), a wholly owned
subsidiary of the Company, acquired the Philadelphia division of Alliance
Benefit Group MidAtlantic (ABG) from BenefitStreet, Inc. in an all cash
transaction. ABG provides retirement plan consulting, daily valuation
administration, actuarial and ancillary support services. The results
of ABG’s operations have been included in the consolidated financial statements
since that date.
Hand
Benefits & Trust, Inc.
On May
18, 2007, BPAS acquired Hand Benefits & Trust, Inc. (HBT), a Houston, Texas
based provider of employee benefit plan administration and trust services, in an
all cash transaction. 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 acquired TLNB Financial Corporation, parent company of
Tupper Lake National Bank (TLNB), in an all-cash transaction valued at
approximately $17.6 million. Based in Tupper Lake, NewYork, 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.
ONB
Corporation
On
December 1, 2006, the Company acquired ONB Corporation (ONB) in an all-cash
transaction valued at approximately $16 million. ONB, the parent
company of Ontario National Bank, a federally chartered national bank operated
four branches in the villages of Clifton Springs, Phelps and Palmyra, New
York. The results of ONB’s operations have been included in the
consolidated financial statements since that date.
ES&L
Bancorp
On August
11, 2006, the Company acquired ES&L Bancorp (Elmira), the parent company of
Elmira Savings and Loan, F.A., a federally chartered thrift in an all-cash
transaction valued at approximately $40 million. Elmira operated two
branches in the cities of Elmira and Ithaca, New York. The results of
Elmira’s operations have been included in the consolidated financial statements
since that date.
2008
Acquisition Summary
The
purchase price allocation of the assets acquired and liabilities assumed,
including capitalized acquisition costs, for the acquisitions of Citizens and
ABG, and minor adjustments to the intangible assets from prior acquisitions is
as follows:
(000’s
omitted)
|
|
Cash
and due from banks
|
$ 2,610
|
Loans,
net of allowance for loan losses
|
108,633
|
Premises
and equipment, net
|
2,051
|
Other
assets
|
1,152
|
Core
deposit intangibles
|
8,547
|
Customer
list intangible
|
4,067
|
Goodwill
|
68,445
|
Total
assets acquired
|
195,505
|
Deposits
|
565,048
|
Borrowings
|
14
|
Other
liabilities
|
612
|
Total
liabilities assumed
|
565,674
|
Net
liabilities assumed
|
$ 370,169
|
The
amortized cost and estimated fair value of investment securities as of December
31 are as follows:
|
2008
|
|
2007
|
|
|
Gross
|
Gross
|
Estimated
|
|
|
Gross
|
Gross
|
Estimated
|
|
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
|
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
(000's
omitted)
|
Cost
|
Gains
|
Losses
|
Value
|
|
Cost
|
Gains
|
Losses
|
Value
|
Held-to-Maturity
Portfolio:
|
|
|
|
|
|
|
|
|
|
U.S.
treasury and agency securities
|
$61,910
|
$2,358
|
$0
|
64,268
|
|
$127,055
|
$881
|
$554
|
$127,382
|
Obligations
of state and political subdivisions
|
15,784
|
220
|
0
|
16,004
|
|
6,207
|
82
|
0
|
6,289
|
Other
securities
|
3,196
|
0
|
0
|
3,196
|
|
3,988
|
0
|
0
|
3,988
|
Total
held-to-maturity portfolio
|
80,890
|
2,578
|
0
|
83,468
|
|
137,250
|
$963
|
$554
|
137,659
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
|
|
U.S.
treasury and agency securities
|
382,301
|
29,482
|
0
|
411,783
|
|
432,832
|
5,747
|
53
|
438,526
|
Obligations
of state and political subdivisions
|
538,008
|
13,537
|
3,606
|
547,939
|
|
532,431
|
11,976
|
444
|
543,963
|
Corporate
debt securities
|
35,596
|
333
|
777
|
35,152
|
|
40,457
|
212
|
399
|
40,270
|
Collateralized
mortgage obligations
|
25,464
|
236
|
0
|
25,700
|
|
34,451
|
180
|
119
|
34,512
|
Pooled
trust preferred securities
|
72,535
|
0
|
22,670
|
49,865
|
|
73,089
|
0
|
789
|
72,300
|
Mortgage-backed
securities
|
188,560
|
4,234
|
740
|
192,054
|
|
72,655
|
1,070
|
200
|
73,525
|
Subtotal
|
1,242,464
|
47,822
|
27,793
|
1,262,493
|
|
1,185,915
|
19,185
|
2,004
|
1,203,096
|
Federal
Home Loan Bank
|
38,056
|
0
|
0
|
38,056
|
|
39,770
|
0
|
0
|
39,770
|
Federal
Reserve Bank
|
12,383
|
0
|
0
|
12,383
|
|
10,582
|
0
|
0
|
10,582
|
Other
equity securities
|
1,189
|
0
|
0
|
1,189
|
|
1,174
|
0
|
0
|
1,174
|
Total
available-for-sale portfolio
|
1,294,092
|
$47,822
|
$27,793
|
1,314,121
|
|
1,237,441
|
$19,185
|
$2,004
|
1,254,622
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized gain on
available-for-sale
portfolio
|
20,029
|
|
|
0
|
|
17,181
|
|
|
0
|
Total
|
$1,395,011
|
|
|
$1,397,589
|
|
$1,391,872
|
|
|
$1,392,281
|
A summary
of investment securities that have been in a continuous unrealized loss position
for less than or greater than twelve months is as follows:
As of December 31,
2008
|
|
Less
than 12 Months
|
|
12
Months or Longer
|
|
Total
|
|
|
|
Gross
|
|
|
Gross
|
|
|
Gross
|
|
|
Fair
|
Unrealized
|
|
Fair
|
Unrealized
|
|
Fair
|
Unrealized
|
(000's
omitted)
|
|
Value
|
Losses
|
|
Value
|
Losses
|
|
Value
|
Losses
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
|
|
Obligations
of state and political subdivisions
|
|
$61,879
|
$3,126
|
|
$7,419
|
$479
|
|
$69,298
|
$3,605
|
Corporate
debt securities
|
|
10,897
|
681
|
|
1,903
|
97
|
|
12,800
|
778
|
Pooled
trust preferred securities
|
|
0
|
0
|
|
49,865
|
22,670
|
|
49,865
|
22,670
|
Mortgage-backed
securities
|
|
24,897
|
738
|
|
338
|
2
|
|
25,235
|
740
|
Total
available-for-sale portfolio
|
|
$97,673
|
$4,545
|
|
$59,525
|
$23,248
|
|
$157,198
|
$27,793
|
As of December 31,
2007
|
|
Less
than 12 Months
|
12
Months or Longer
|
Total
|
|
|
|
Gross
|
|
Gross
|
|
Gross
|
|
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
(000's
omitted)
|
|
Value
|
Losses
|
Value
|
Losses
|
Value
|
Losses
|
Held-to-Maturity
Portfolio:
|
|
|
|
|
|
|
|
U.S.
treasury and agency securities / total held-to-maturity
portfolio
|
|
$0
|
$0
|
$74,446
|
($554)
|
$74,446
|
($554)
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
U.S.
treasury and agency securities
|
|
$ 0
|
$ 0
|
$15,436
|
($ 53)
|
$
15,436
|
($ 53)
|
Obligations
of state and political subdivisions
|
|
54,201
|
(357)
|
23,716
|
(87)
|
77,917
|
(444)
|
Corporate
debt securities
|
|
0
|
0
|
21,565
|
(399)
|
21,565
|
(399)
|
Collateralized
mortgage obligations
|
|
0
|
0
|
19,934
|
(119)
|
19,934
|
(119)
|
Pooled
trust preferred securities
|
|
72,300
|
(789)
|
0
|
0
|
72,300
|
(789)
|
Mortgage-backed
securities
|
|
12,901
|
(11)
|
10,473
|
(189)
|
23,374
|
(200)
|
Total
available-for-sale portfolio
|
|
$139,402
|
($1,157)
|
$91,124
|
($847)
|
$230,526
|
($2,004)
|
Included
in the available for sale portfolio are pooled trust preferred securities with a
current par value of $74.4 million and unrealized losses of $22.7 million at
December 31, 2008. The underlying collateral of these assets are
principally trust-preferred securities of smaller regional banks and insurance
companies. The Company’s securities are in the super senior, cash
flow, tranche of the pools. All other tranches in these pools will
incur losses before this tranche is impacted. The market for these
securities at December 31, 2008 is not active and markets for similar securities
are also not active. The inactivity was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which
these securities trade and then by a significant decrease in the volume of
trades relative to historical levels. The fair value of these
securities was based on a discounted cash flow model using market estimates of
interest rates and volatility, as well as, observable quoted prices for similar
assets in markets that have not been active. These assumptions have a
significant effect on the reported fair values. The use of different
assumptions, as well as, changes in market conditions, could result in
materially different fair values. The Company has the intent and
ability to hold these securities to recovery or maturity and does not consider
these investments to be other-than temporarily impaired as of December 31,
2008. In determining if unrealized losses are other-than-temporary,
management considers: the length of time and extent that fair value has been
less than cost, the financial condition and near term prospects of the issuer,
any external credit ratings and the Company’s ability and intent to hold the
security for a period sufficient to allow for any anticipated recovery in fair
value. Subsequent changes in market or credit conditions could change
those evaluations.
Management
does not believe any individual unrealized loss as of December 31, 2008 or 2007
represents an other than temporary impairment. The unrealized losses
reported for the agency and mortgage-backed securities relate primarily to
securities issued by FHLB, FNMA and FHLMC and are currently rated AAA by Moody’s
Investor Services and Standard & Poor’s. The unrealized losses in
the portfolios are primarily attributable to changes in interest
rates. The Company has both the intent and ability to hold these
securities for the time necessary to recover the amortized cost.
The
amortized cost and estimated fair value of debt securities at December 31, 2008,
by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
|
|
Held-to-Maturity
|
|
Available-for-Sale
|
|
|
Carrying
|
Fair
|
|
Carrying
|
Fair
|
(000's
omitted)
|
|
Value
|
Value
|
|
Value
|
Value
|
Due
in one year or less
|
|
$11,498
|
$11,595
|
|
$28,877
|
$29,266
|
Due
after one through five years
|
|
38,866
|
39,968
|
|
254,374
|
264,652
|
Due
after five years through ten years
|
|
27,430
|
28,809
|
|
421,786
|
445,144
|
Due
after ten years
|
|
3,096
|
3,096
|
|
323,403
|
305,677
|
Subtotal
|
|
80,890
|
83,468
|
|
1,028,440
|
1,044,739
|
Collateralized
mortgage obligations
|
|
0
|
0
|
|
25,464
|
25,700
|
Mortgage-backed
securities
|
|
0
|
0
|
|
188,560
|
192,054
|
Total
|
|
$80,890
|
$83,468
|
|
$1,242,464
|
$1,262,493
|
Cash flow
information on investment securities for the years ended December 31 is as
follows:
(000's
omitted)
|
2008
|
2007
|
2006
|
Proceeds
from the sales of investment securities
|
$21,667
|
$15,900
|
$0
|
Gross
gains on sales of investment securities
|
559
|
22
|
0
|
Gross
losses on sales of investment securities
|
329
|
0
|
0
|
Proceeds
from the maturities of mortgage-backed securities and
CMO's
|
25,742
|
23,198
|
51,588
|
Purchases
of mortgage-backed securities and CMO's
|
132,505
|
10,923
|
40,712
|
Investment
securities with a carrying value of $719.8 million and $693.6 million at
December 31, 2008 and 2007, respectively, were pledged to collateralize certain
deposits and borrowings.
Major
classifications of loans at December 31 are summarized as follows:
(000's
omitted)
|
2008
|
2007
|
Consumer
mortgage
|
$1,062,943
|
$977,553
|
Business
lending
|
1,058,846
|
984,780
|
Consumer
installment
|
1,014,351
|
858,722
|
Gross
loans
|
3,136,140
|
2,821,055
|
Allowance
for loan losses
|
39,575
|
36,427
|
Loans,
net of allowance for loan losses
|
$3,096,565
|
$2,784,628
|
The
estimated fair value of loans at December 31, 2008 and 2007 was $3.2 billion and
$2.9 billion, respectively. Nonaccrual loans of $12.1 million and
$8.3 million and accruing loans ninety days past due of $0.6 million and $0.6
million at December 31, 2008 and 2007, respectively, are included in net
loans.
Changes
in loans to directors and officers and other related parties for the years ended
December 31 are summarized as follows:
(000's
omitted)
|
2008
|
2007
|
Balance
at beginning of year
|
$24,419
|
$21,788
|
New
loans
|
42
|
7,387
|
Payments
|
(1,292)
|
(4,756)
|
Balance
at end of year
|
$23,169
|
$24,419
|
The
Company sells consumer mortgage loans in the secondary market and typically
retains the right to service the loans sold. Upon sale, a mortgage
servicing right (MSR) is established, which represents the then current fair
value of future net cash flows expected to be realized for performing the
servicing activities. The Company stratifies these assets based on
predominant risk characteristics, namely expected term of the underlying
financial instruments, and uses a valuation model that calculates the present
value of future cash flows to determine the fair value of servicing rights. MSRs are
carried at the lower of the initial capitalized amount, net of accumulated
amortization or fair value. Mortgage loans serviced for others are
not included in the accompanying consolidated statements of
condition.
The
following table summarizes the changes in carrying value of MSRs and the
associated valuation allowance:
(000’s
omitted)
|
2008
|
2007
|
Balance
at beginning of period
|
$2,045
|
$2,638
|
Additions
|
2
|
108
|
Sales
|
(42)
|
0
|
Amortization
|
(659)
|
(803)
|
Obtained
via acquisition
|
0
|
102
|
Carrying
value before valuation allowance at end of period
|
1,346
|
2,045
|
Valuation
allowance balance at beginning of period
|
0
|
0
|
Impairment
charges
|
0
|
0
|
Impairment
recoveries
|
0
|
0
|
Valuation
allowance balance at end of period
|
0
|
0
|
Net
carrying value at end of period
|
$1,346
|
$2,045
|
Fair
value of MSRs at end of period
|
$2,817
|
$3,091
|
Unpaid
principal balance of loans serviced for others
|
$354,016
|
$329,476
|
The
following table summarizes the key economic assumptions used to estimate the
value of the MSRs at December 31:
|
2008
|
2007
|
Weighted-average
life (in years)
|
19.5
|
20.3
|
Weighted-average
constant prepayment rate (CPR)
|
6.86%
|
8.4%
|
Weighted-average
discount rate
|
3.34%
|
5.26%
|
|
|
|
The
following table summarizes the key economic assumptions used to estimate the
fair value of MSRs capitalized during the year:
|
2008
|
2007
|
Weighted-average
life (in years)
|
29.75
|
29.81
|
Weighted-average
constant prepayment rate (CPR)
|
10.60%
|
8.98%
|
Weighted-average
discount rate
|
5.12%
|
5.40%
|
|
|
|
Custodial
escrow balances maintained in connection with the foregoing loan servicing, and
included in noninterest deposits, were approximately $5.5 million and $6.0
million at December 31, 2008 and 2007, respectively.
Changes
in the allowance for loan losses for the years ended December 31 are summarized
as follows:
(000's
omitted)
|
2008
|
2007
|
2006
|
Balance
at beginning of year
|
$36,427
|
$36,313
|
$32,581
|
Provision
for loan losses
|
6,730
|
2,004
|
6,585
|
Reserve
on acquired loans
|
2,157
|
747
|
3,218
|
Charge-offs
|
(9,076)
|
(6,440)
|
(10,033)
|
Recoveries
|
3,337
|
3,803
|
3,962
|
Balance
at end of year
|
$39,575
|
$36,427
|
$36,313
|
As of
December 31, 2008 and 2007, the Company had impaired loans of $3,608,000 and
$1,126,000, respectively. The specifically allocated allowance for
loan loss recognized on these impaired loans was $470,000 and $423,000 at
December 31, 2008 and 2007, respectively. For the years ended
December 31, 2008 and 2007 the Company had average impaired loans of $2,701,000
and $1,190,000. Interest income recognized on these loans in 2008 and
2007 was $0 and $49,000, respectively. Included in total impaired
loans at December 31, 2008 and 2007 were $1.0 million and $1.1 million of
restructured loans.
Premises
and equipment consist of the following at December 31:
(000's
omitted)
|
2008
|
2007
|
Land
and land improvements
|
$12,044
|
$10,755
|
Bank
premises owned
|
70,998
|
69,155
|
Equipment
and construction in progress
|
63,080
|
56,036
|
Premises
and equipment, gross
|
146,122
|
135,946
|
Less: Accumulated
depreciation
|
(72,828)
|
(66,261)
|
Premises
and equipment, net
|
$73,294
|
$69,685
|
The gross
carrying amount and accumulated amortization for each type of intangible asset
are as follows:
|
|
As
of December 31, 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
|
|
$59,933
|
($37,593)
|
$22,340
|
|
$66,368
|
($46,603)
|
$19,765
|
Other
intangibles
|
|
7,882
|
(2,747)
|
5,135
|
|
3,923
|
(1,921)
|
2,002
|
Total
amortizing intangibles
|
|
67,815
|
(40,340)
|
27,475
|
|
70,291
|
(48,524)
|
21,767
|
Nonamortizing
intangible assets:
|
|
|
|
|
|
|
|
|
Goodwill
|
|
301,149
|
0
|
301,149
|
|
234,449
|
0
|
234,449
|
Total
intangible assets, net
|
|
$368,964
|
($40,340)
|
$328,624
|
|
$304,740
|
($48,524)
|
$256,216
|
The
performance of Nottingham (previously Elias Asset Management) weakened
subsequent to its acquisition in 2000 as a result of adverse market
conditions. Its operating performance stabilized in 2006 and improved
in 2007 and early 2008, however, significant declines in the equity markets
experienced in 2008 resulted in meaningful revenue declines. As a
result management determined that a triggering event had occurred and the
Nottingham goodwill was tested for impairment during the fourth quarter of
2008. Based on the goodwill valuation performed in the fourth
quarter of 2008 the Company recognized an impairment charge and wrote down the
carrying value of the goodwill by $1.7 million to $5.6
million. Additional declines in Nottingham’s operating results
may cause future impairment to its remaining goodwill balance. The
remaining changes in the gross carrying amount of core deposit and goodwill
relate to the 2008 acquisitions of Citizens and ABG, as well as minor
adjustments to the intangible assets from prior acquisitions. No
goodwill impairment adjustment was recognized in 2007. The estimated aggregate
amortization expense for each of the five succeeding fiscal years ended December
31 is as follows:
2009
|
$8,087
|
2010
|
5,801
|
2011
|
3,356
|
2012
|
2,792
|
2013
|
2,176
|
Thereafter
|
5,263
|
Total
|
$27,475
|
Deposits
consist of the following at December 31:
(000's
omitted)
|
2008
|
2007
|
Noninterest
checking
|
$638,558
|
$584,921
|
Interest
checking
|
597,445
|
467,450
|
Savings
|
464,626
|
453,274
|
Money
market
|
574,278
|
324,975
|
Time
|
1,425,905
|
1,397,844
|
Total
deposits
|
$3,700,812
|
$3,228,464
|
The
estimated fair value of deposits at December 31, 2008 and 2007 was approximately
$3.6 billion and $3.1 billion, respectively. At December 31, 2008 and
2007, time certificates of deposit in denominations of $100,000 and greater
totaled $329.3 million and $281.0 million
respectively. The approximate maturities of time deposits at December
31, 2008 are as follows:
(000's
omitted)
|
Amount
|
2009
|
$1,088,812
|
2010
|
177,440
|
2011
|
41,924
|
2012
|
83,665
|
2013
|
33,558
|
Thereafter
|
506
|
Total
|
$1,425,905
|
Outstanding
borrowings at December 31 are as follows:
(000's
omitted)
|
2008
|
2007
|
Short-term
borrowings:
|
|
|
Federal
funds purchased
|
$0
|
$27,285
|
Federal
Home Loan Bank advances
|
414,976
|
432,972
|
Commercial
loans sold with recourse
|
6
|
8
|
Capital
lease obligation
|
40
|
37
|
Subordinated
debt held by unconsolidated subsidiary trusts
|
0
|
25,774
|
Total
short-term borrowings
|
415,022
|
486,076
|
|
|
|
Long-term
borrowings:
|
|
|
Federal
Home Loan Bank advances
|
345,495
|
341,221
|
Commercial
loans sold with recourse
|
30
|
44
|
Capital
lease obligation
|
11
|
37
|
Subordinated
debt held by unconsolidated subsidiary trusts,
|
|
|
net
of discount of $552 and $577
|
101,975
|
101,950
|
Total
long-term borrowings
|
447,511
|
443,252
|
Total
borrowings
|
$862,533
|
$929,328
|
The
weighted-average interest rates on short-term borrowings for the years ended
December 31, 2008 and 2007 were 4.05% and 4.35%,
respectively. Federal Home Loan Bank advances are collateralized by a
blanket lien on the Company's residential real estate loan portfolio and various
investment securities.
Long-term
borrowings at December 31, 2008 have maturity dates as follows:
(000's
omitted, except rate)
|
Notional
Amount
|
Weighted
-average Rate
|
January
19, 2010
|
312
|
3.35%
|
February
18, 2010
|
391
|
3.26%
|
April
14, 2010 (Callable)
|
25,000
|
6.35%
|
November
18, 2010
|
1,000
|
5.09%
|
February
15, 2011
|
2
|
6.25%
|
July
15, 2012
|
9
|
4.30%
|
January
17, 2013 (Callable)
|
792
|
4.00%
|
November
23, 2014
|
30
|
2.75%
|
May
19, 2016 (Callable)
|
100,000
|
4.72%
|
October
11, 2016 (Callable)
|
25,000
|
4.62%
|
October
11, 2016 (Callable)
|
25,000
|
4.35%
|
December
21, 2017 (Callable)
|
31,600
|
3.16%
|
December
21, 2017 (Callable)
|
126,400
|
3.40%
|
January
25, 2018 (Callable)
|
10,000
|
2.73%
|
July
31, 2031
|
24,655
|
7.00%
|
December
15, 2036
|
77,320
|
3.64%
|
Total
|
$447,511
|
4.12%
|
Instruments
noted above as callable are Federal Home Loan Bank advances. These
advances have characteristics that include an initial lockout period, followed
by a quarterly call option at the discretion of the Federal Home Loan
Bank. The estimated fair value of long-term borrowings at December
31, 2008 and 2007 was approximately $456.3 million and $442.1 million,
respectively.
The
Company sponsors two business trusts, , Community Statutory Trust III, and
Community Capital 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 at a
rate per annum equal to the interest rate being earned by the trust on the
debentures held by that trust. 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
|
|
Interest
|
Maturity
|
Call
|
Call
|
|
Date
|
Amount
|
Rate
|
Date
|
Provision
|
Price
|
III
|
7/31/2001
|
24,450
|
3
month LIBOR plus 3.58% (7.00%)
|
7/31/2031
|
5
year beginning 2006
|
104.50%
declining to par in 2011
|
IV
|
12/8/2006
|
75,000
|
3
month LIBOR plus 1.65% (3.64%)
|
12/15/2036
|
5
year beginning 2012
|
Par
|
On
December 8, 2006, the Company established Community Capital Trust IV, which
completed the sale of $75 million of trust preferred securities. At
the time of the offering, the Company also entered into an interest rate swap
agreement to convert the variable rate trust preferred securities into fixed
rate securities for a term of five years at a fixed rate of
6.43%. Additional interest expense of $1.2 million and lower interest
expense of $0.5 million was recognized due to the interest rate swap
agreement as of December 31, 2008 and 2007, respectively.
The
provision for income taxes includes a $1.7 million benefit in 2008 and a $6.9
million benefit in 2007, related to the settlement and a related change in a
position taken on certain previously unrecognized tax positions. The
provision for income taxes for the years ended December 31 is as
follows:
(000's
omitted)
|
2008
|
2007
|
2006
|
Current:
|
|
|
|
Federal
|
$9,382
|
$9,257
|
$11,563
|
State
and other
|
(2,632)
|
(7,708)
|
1,356
|
Deferred:
|
|
|
|
Federal
|
3,438
|
152
|
(1,198)
|
State
and other
|
561
|
590
|
199
|
Provision
for income taxes
|
$10,749
|
$2,291
|
$11,920
|
Components
of the net deferred tax asset (liability), included in other liabilities, as of
December 31 are as follows:
(000's
omitted)
|
2008
|
2007
|
Allowance
for loan losses
|
$15,221
|
$14,022
|
Employee
benefits
|
6,463
|
3,053
|
Pension
|
7,239
|
5,996
|
Interest
rate swap
|
2,585
|
864
|
Debt
extinguishment
|
2,709
|
3,604
|
Other
|
294
|
875
|
Deferred
tax asset
|
34,511
|
28,414
|
|
|
|
Investment
securities
|
10,119
|
9,715
|
Intangible
assets
|
12,899
|
11,766
|
Loan
origination costs
|
5,190
|
5,697
|
Depreciation
|
4,336
|
4,195
|
Mortgage
servicing rights
|
518
|
788
|
Deferred
tax liability
|
33,062
|
32,161
|
Net
deferred tax asset (liability)
|
$1,449
|
($3,747)
|
The
Company has determined that no valuation allowance is necessary as it is more
likely than not that the gross deferred tax assets will be realized through
carryback of future deductions to taxable income in prior years, future
reversals of existing temporary differences, and through future taxable
income.
A
reconciliation of the differences between the federal statutory income tax rate
and the effective tax rate for the years ended December 31 is shown in the
following table:
|
2008
|
2007
|
2006
|
Federal
statutory income tax rate
|
35.0%
|
35.0%
|
35.0%
|
Increase
(reduction) in taxes resulting from:
|
|
|
|
Tax-exempt
interest
|
(12.7)
|
(14.6)
|
(14.0)
|
State
income taxes, net of federal benefit
|
(2.3)
|
(15.7)
|
0.1
|
Other
|
(1.0)
|
0.4
|
2.6
|
Effective
income tax rate
|
19.0%
|
5.1%
|
23.7%
|
The
adoption of FIN 48 as of January 1, 2007 did not result in any change to the
Company’s liability for uncertain tax positions as of that date. A
reconciliation of the unrecognized tax benefits for the years ended December 31
is shown in the following table:
(000’s
omitted)
|
2008
|
2007
|
Unrecognized
tax benefits at beginning of year
|
$2,701
|
$9,235
|
Changes
related to:
|
|
|
Positions
taken during the current year
|
77
|
288
|
Positions
taken during a prior period
|
(1,400)
)
|
(5,141)
)
|
Settlements
with taxing authorities
|
(225)
)
|
(1,366)
)
|
Lapse
of statutes of limitation
|
(297)
)
|
(315)
)
|
Unrecognized
tax benefits at end of year
|
$ 856
|
$2,701
|
|
|
|
As of
December 31, 2008, the total amount of unrecognized tax benefits that would
impact the Company’s effective tax rate if recognized is $0.9
million.
The
Company’s policy is to recognize interest and penalties related to unrecognized
tax benefits in income taxes in the consolidated statement of
income. The accrued interest related to tax positions was
approximately $0.2 million and $0.9 million at December 31, 2008 and 2007,
respectively.
The
Company’s federal and state income tax returns are routinely subject to
examination from various governmental 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 judgment used to record tax-related assets or liabilities have
been appropriate. Future examinations by taxing authorities of the
Company’s federal or state tax returns could have a material impact on the
Company’s results of operations. The Company’s federal income tax
returns for years after 2004 may still be examined by the Internal Revenue
Service. New York State income tax examinations are underway for
years 2005 through 2007. It is not possible to estimate when those
examinations may be completed.
It is
reasonably possible that the amount of unrecognized tax benefits could change in
the next twelve months as a result of the New York State examination and
expiration of statutes of limitations on prior tax returns. The
estimated range of change in unrecognized tax benefits is estimated to be
between $0.2 million and $0.3 million.
The
Company’s ability to pay dividends to its shareholders is largely dependent on
the Bank’s ability to pay dividends to the Company. In addition to
state law requirements and the capital requirements discussed below, the
circumstances under which the Bank may pay dividends are limited by federal
statutes, regulations, and policies. For example, as a national bank,
the Bank must obtain the approval of the Office of the Comptroller of the
Currency (OCC) for payments of dividends if the total of all dividends declared
in any calendar year would exceed the total of the Bank’s net profits, as
defined by applicable regulations, for that year, combined with its retained net
profits for the preceding two years. Furthermore, the Bank may not
pay a dividend in an amount greater than its undivided profits then on hand
after deducting its losses and bad debts, as defined by applicable
regulations. At December 31, 2008, the Bank had approximately
$4,243,000 in undivided profits legally available for the payments of
dividends.
In
addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The
Federal Reserve Board has indicated that banking organizations should generally
pay dividends only out of current operating earnings.
There are
also statutory limits on the transfer of funds to the Company by its banking
subsidiary, whether in the form of loans or other extensions of credit,
investments or assets purchases. Such transfer by the Bank to the
Company generally is limited in amount to 10% of the Bank’s capital and surplus,
or 20% in the aggregate. Furthermore, such loans and extensions of
credit are required to be collateralized in specific amounts.
Pension
and post-retirement plans
The
Company provides a qualified defined benefit pension and other post-retirement
health and life insurance benefits to qualified employees and
retirees. As of December 31, 2007 the Ontario National Bank
Retirement Plan and the Hand Benefits & Trust, Inc. Retirement Plan were
merged into the Company’s plan. Using a measurement date of December
31, the following table shows the funded status of the Company's plans
reconciled with amounts reported in the Company's consolidated statements of
condition:
|
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
(000's
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Change
in benefit obligation:
|
|
|
|
|
|
|
Benefit
obligation at the beginning of year
|
|
$56,026
|
$51,390
|
|
$9,827
|
$9,298
|
Service
cost
|
|
3,274
|
3,186
|
|
691
|
593
|
Interest
cost
|
|
3,272
|
2,720
|
|
600
|
522
|
Participant
contributions
|
|
0
|
0
|
|
572
|
481
|
Plan
amendment/merger
|
|
25
|
3,977
|
|
(354)
|
0
|
Deferred
actuarial (gain) loss
|
|
1,422
|
(1,733)
|
|
(6)
|
(212)
|
Benefits
paid
|
|
(4,062)
|
(3,514)
|
|
(866)
|
(855)
|
Benefit
obligation at end of year
|
|
59,957
|
56,026
|
|
10,464
|
9,827
|
Change
in plan assets:
|
|
|
|
|
|
|
Fair
value of plan assets at beginning of year
|
|
59,000
|
47,213
|
|
0
|
0
|
Actual
return of plan assets
|
|
(15,715)
|
3,084
|
|
0
|
0
|
Participant
contributions
|
|
0
|
0
|
|
572
|
481
|
Employer
contributions
|
|
9,654
|
9,200
|
|
294
|
374
|
Plan
merger
|
|
0
|
2,552
|
|
0
|
0
|
Transfer
of deferred compensation balances
|
|
0
|
62
|
|
0
|
0
|
Benefits
paid
|
|
(3,734)
|
(3,111)
|
|
(866)
|
(855)
|
Fair
value of plan assets at end of year
|
|
49,205
|
59,000
|
|
0
|
0
|
Funded
status at year end
|
|
($10,752)
|
$2,974
|
|
($10,464)
|
($9,827)
|
|
|
|
|
|
|
|
Assets
and liabilities recognized in the consolidated balance sheet
were:
|
|
|
|
|
|
|
Other
assets
|
|
$0
|
$7,617
|
|
$0
|
$0
|
Other
liabilities
|
|
(10,752)
|
(4,643)
|
|
(10,464)
|
(9,827)
|
|
|
|
|
|
|
|
Amounts
recognized in accumulated other comprehensive income (“AOCI”)
were:
|
|
|
|
|
|
|
Net
loss
|
|
$33,335
|
$11,815
|
|
$1,875
|
$2,007
|
Net
prior service cost
|
|
(488)
|
(784)
|
|
302
|
761
|
Net
transition obligation
|
|
0
|
0
|
|
164
|
205
|
Pre-tax
adjustment to AOCI
|
|
32,847
|
11,031
|
|
2,341
|
2,973
|
Taxes
|
|
(12,651)
|
(4,260)
|
|
(906)
|
(1,149)
|
Net
adjustment to AOCI
|
|
$20,196
|
$6,771
|
|
$1,435
|
$1,824
|
The
Company has unfunded supplemental pension plans for certain key
executives. The projected benefit obligation and accrued benefit cost
included in the preceding table related to these plans was $4.8 million for 2008
and $4.6 million for 2007, respectively. The benefit
obligation for the defined benefit pension plan was $55.2 million
and $51.4 million as of December 31, 2008 and 2007
respectively.
Amounts
recognized in accumulated other comprehensive income, net of tax, for the year
ended December 31, are as follows:
|
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
(000's
omitted)
|
|
2008
|
2007
|
|
2008
|
2007
|
Prior
service cost
|
|
$182
|
$126
|
|
($283)
|
($69)
|
Transition
obligation
|
|
0
|
0
|
|
(25)
|
(26)
|
Net
(gain) or loss
|
|
13,243
|
(1,119)
|
|
(81)
|
(209)
|
Total
|
|
$13,425
|
($993)
|
|
($389)
|
($304)
|
The
estimated costs, net of tax, that will be amortized from accumulated other
comprehensive (income) loss into net periodic (income) cost over the next fiscal
year are as follows:
|
|
Pension
|
Post-retirement
|
(000's
omitted)
|
|
Benefits
|
Benefits
|
Prior
service cost
|
|
($118)
|
$53
|
Transition
obligation
|
|
0
|
41
|
Net
(gain) or loss
|
|
2,633
|
71
|
Total
|
|
$2,515
|
$165
|
The
weighted-average assumptions used to determine the benefit obligations as of
December 31 are as follows:
|
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
|
|
2008
|
2007
|
|
2008
|
2007
|
Discount
rate
|
|
6.10%
|
6.10%
|
|
6.10%
|
6.10%
|
Expected
return on plan assets
|
|
8.00%
|
8.00%
|
|
N/A
|
N/A
|
Rate
of compensation increase
|
|
4.00%
|
4.00%
|
|
N/A
|
N/A
|
The net
periodic benefit cost as of December 31 is as follows:
|
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
(000's
omitted)
|
|
2008
|
2007
|
2006
|
|
2008
|
2007
|
2006
|
Service
cost
|
|
$3,114
|
$3,186
|
$2,920
|
|
$691
|
$593
|
$521
|
Interest
cost
|
|
3,272
|
3,014
|
2,537
|
|
600
|
523
|
474
|
Expected
return on plan assets
|
|
(4,817)
|
(4,340)
|
(3,309)
|
|
0
|
0
|
0
|
Amortization
of unrecognized net loss
|
|
533
|
1,101
|
1,163
|
|
93
|
118
|
107
|
Amortization
of prior service cost
|
|
(110)
|
(69)
|
(31)
|
|
105
|
110
|
110
|
Amortization
of transition (asset) obligation
|
|
0
|
0
|
0
|
|
41
|
41
|
41
|
Net
periodic benefit cost
|
|
$1,992
|
$2,892
|
$3,280
|
|
$1,530
|
$1,385
|
$1,253
|
Prior
service costs in which all or almost all of the plan’s participants are fully
eligible for benefits under the plan are amortized on a straight-line basis over
the expected future working years of all active plan
participants. Prior service costs associated with transferring
individual nonqualified plans are amortized on a straight-line basis over a
three-year period. Unrecognized gains or losses are amortized using
the “corridor approach”, which is the minimum amortization required by Statement
of Financial Accounting Standards No. 87. Under the corridor approach, the
net gain or loss in excess of 10 percent of the greater of the projected
benefit obligation or the market-related value of the assets is amortized on a
straight-line basis over the expected future working years of all active plan
participants.
The
weighted-average assumptions used to determine the net periodic pension cost for
the years ended December 31 are as follows:
|
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
|
|
2008
|
2007
|
2006
|
|
2008
|
2007
|
2006
|
Discount
rate
|
|
6.10%
|
5.60%
|
5.60%
|
|
6.10%
|
5.60%
|
5.60%
|
Expected
return on plan assets
|
|
8.00%
|
8.00%
|
8.00%
|
|
N/A
|
N/A
|
N/A
|
Rate
of compensation increase
|
|
4.00%
|
4.00%
|
4.00%
|
|
N/A
|
N/A
|
N/A
|
The
amount of benefit payments that are expected to be paid over the next ten years
are as follows:
|
Pension
|
Post-retirement
|
(000's
omitted)
|
Benefits
|
Benefits
|
2009
|
$4,544
|
$536
|
2010
|
4,620
|
620
|
2011
|
5,681
|
695
|
2012
|
5,591
|
745
|
2013
|
5,851
|
789
|
2014-2018
|
30,478
|
4,772
|
The
payments reflect future service and are based on various assumptions including
retirement age and form of payment (lump-sum versus annuity). Actual results may
differ from these estimates.
The
assumed discount rate is used to reflect the time value of future benefit
obligations. The discount rate was determined based upon the yield on
high-quality fixed income investments expected to be available during the period
to maturity of the pension benefits. This rate is sensitive to
changes in interest rates. A decrease in the discount rate would
increase the Company’s obligation and future expense while an increase would
have the opposite effect. The expected long-term rate of return
was estimated by taking into consideration asset allocation, reviewing
historical returns on the type of assets held and current economic
factors. The appropriateness of the assumptions is reviewed
annually.
The asset
allocation for the defined benefit pension plan as of December 31, by asset
category, is as follows:
|
2008
|
2007
|
Equity
securities
|
63%
|
70%
|
Debt
securities
|
17%
|
25%
|
Alternative
investments
|
5%
|
0%
|
Cash
|
15%
|
5%
|
Total
|
100%
|
100%
|
Plan
assets included $2,561,000 (5%) and $3,533,000 (6%) of Community Bank System,
Inc. stock at December 31, 2008 and 2007, respectively.
The
investment objective for the defined benefit pension plan is to achieve an
average annual total return over a five-year period equal to the assumed rate of
return used in the actuarial calculations. At a minimum performance
level, the portfolio should earn the return obtainable on high quality
intermediate-term bonds. The Company’s perspective regarding
portfolio assets combines both preservation of capital and moderate
risk-taking. Asset allocation favors equities, with a target
allocation of approximately 60% equity securities and 40% fixed income
securities. In order to diversify the risk within the pension
portfolio, the pension committee authorized the purchase of up to 15% of the
assets may be in alternative investments, which are primarily hedge
funds. No more than 10% of the portfolio can be in stock of the
Company. Due to the volatility in the market, the target allocation
is not always desirable and asset allocations will fluctuate between acceptable
ranges. Prohibited transactions include purchase of securities on
margin, uncovered call options, and short sale transactions.
The
Company makes contributions to its funded qualified pension plan as required by
government regulation or as deemed appropriate by management after considering
the fair value of plan assets, expected return on such assets, and the value of
the accumulated benefit obligation. The Company expects to make a
contribution of $15 million to its defined benefit pension plan during
2009. The Company funds the payment of benefit obligations for the
supplemental pension and post-retirement plans because such plans do not hold
assets for investment.
TLNB
participated in a multi-employer tax qualified defined benefit pension
plan. All employees of TLNB who met minimum service requirements
participated in the plan. Contributions for 2008 and 2007 were
$35,000 and $57,000, respectively.
The
assumed health care cost trend rate used in the post-retirement health plan at
December 31, 2008 was 8.25% for the pre-65 participants and 7.00% for the
post-65 participants for medical costs and 10.00% for prescription
drugs. The rate to which the cost trend rate is assumed to decline
(the ultimate trend rate) and the year that the rate reaches the ultimate trend
rate is 5.0% and 2015, respectively.
Assumed
health care cost trend rates have a significant effect on the amounts reported
for the health care plan. A one-percentage-point increase in the
trend rate would increase the service and interest cost components by $69,000
and increase the benefit obligation by $405,000. A
one-percentage-point decrease in the trend rate would decrease the service and
interest cost components by $63,000 and decrease the benefit obligation by
$370,000.
401(k)
Employee Stock Ownership Plan
The
Company has a 401(k) Employee Stock Ownership Plan in which employees can
contribute from 1% to 90% of eligible compensation, with the first 1% being
eligible for a 100% matching contribution in the form of Company common stock
and the next 5% being eligible for a 50% matching contributions in the form of
Company common stock. The Plan also permits the Company to distribute a
discretionary profit-sharing component in the form of Company common stock to
all participants except certain executive employees. The expense
recognized under this plan for the years ended December 31, 2008, 2007 and 2006
was $2,395,000, $1,821,000 and $1,750,000, respectively.
Deferred
Compensation Plan for Certain Executive Employees
The
Company has a Deferred Compensation Plan for Certain Executive Employees in
which participants may contribute up to 15% of their eligible compensation less
any amounts contributed to the 401(k) Employee Stock Ownership
Plan. Any discretionary profit-sharing amounts that the executive
receives from the Company must be contributed to the Deferred Compensation
Plan. The expense recognized under this plan for the years ended
December 31, 2008, 2007 and 2006 was $59,000, $58,000 and $71,000,
respectively.
Other
Deferred Compensation Arrangements
In
addition to the supplemental pension plans for certain executives, the Company
has nonqualified deferred compensation arrangements for several former
directors, officers and key employees. All benefits provided under
these plans are unfunded and payments to plan participants are made by the
Company. At December 31, 2008 and 2007, the Company has recorded a
liability of $6,103,000 and $6,823,000, respectively. The expense
recognized under these plans for the years ended December 31, 2008, 2007, and
2006 was $6,000, $673,000 and $934,000, respectively.
Deferred
Compensation Plan for Directors
Directors
may defer all or a portion of their director fees under the Deferred
Compensation Plan for Directors. Under this plan, there is a separate
account for each participating director which is credited with the amount of
shares which could have been purchased with the director’s fees as well as any
dividends on such shares. On the distribution date, the director will
receive common stock equal to the accumulated share balance in his
account. As of December 31, 2008 and 2007, there were 98,957 and
90,359 shares credited to the participants’ accounts, for which a liability of
$1,914,000 and $1,702,000 was accrued, respectively. The expense
recognized under the plan for the years ended December 31, 2008, 2007 and 2006,
was $404,000, $256,000, and $251,000, respectively.
Director
Stock Balance Plan
The
Company has a Stock Balance Plan for nonemployee directors who have completed
six months of service. The Plan is a nonqualified, noncontributory
defined benefit plan. The Plan provides benefits for service prior to
January 1, 1996 based on a predetermined formula and benefits for service after
January 1, 1996 based on the performance of the Company’s common
stock. Participants become fully vested after six years of
service. The directors can elect to receive offset stock options that
may reduce the Company’s liability under the Plan. These options vest
immediately and expire one year after the date the director retires or two years
in the event of death. Benefits are payable in the form of cash
and/or Company stock (as elected by the director) on January 1st of the
year after the director retires from the Board. As of December 31,
2008 and 2007, the accrued liability was $776,000 and $439,000, respectively.
The expense recognized under this plan for the years ended December 31, 2008,
2007 and 2006, was $71,000, $17,000 and $50,000, respectively. The
expense and related liability were calculated using a dividend rate of 3.00%,
stock price appreciation of 6.00%, and a discount rate of 6.1% for 2008, and
6.1% for 2007, and 5.6% for 2006.
The
Company has a long-term incentive program for directors, officers and
employees. Under this program, the Company authorized 4,000,000
shares of Company common stock for the grant of incentive stock options,
nonqualified stock options, restricted stock awards, retroactive stock
appreciation rights. As of December 31, 2008, the Company has
authorization to grant up to 2,192,250 additional shares of Company common stock
for these instruments. The nonqualified (offset) stock options in its
Director’s Stock Balance Plan vest and become exercisable immediately and expire
one year after the date the director retires or two years in the event of
death. The remaining options have a ten-year term, and vest and
become exercisable on a grant-by-grant basis, ranging from immediate vesting to
ratably over a five-year period.
Activity
in this long-term incentive program is as follows:
|
Stock
Options
|
|
|
Weighted-average
|
|
|
Exercise
Price of
|
|
Outstanding
|
Shares
|
Outstanding
at December 31, 2006
|
2,574,963
|
$19.54
|
Granted
|
349,927
|
22.83
|
Exercised
|
(176,935)
|
15.01
|
Forfeited
|
(26,676)
|
23.44
|
Outstanding
at December 31, 2007
|
2,721,279
|
20.22
|
Granted
|
363,991
|
18.19
|
Exercised
|
(388,491)
|
17.50
|
Forfeited
|
(30,526)
|
16.93
|
Outstanding
at December 31, 2008
|
2,666,253
|
$20.38
|
Exercisable
at December 31, 2008
|
1,764,679
|
$19.73
|
The
following table summarizes the information about stock options outstanding under
the Company’s stock option plan at December 31, 2008:
|
Options
outstanding
|
|
Options
exercisable
|
Range
of Exercise Price
|
Shares
|
Weighted
-average
Exercise
Price
|
Weighted- average
Remaining
Life (years)
|
|
Shares
|
Weighted
-average
Exercise
Price
|
$0.00
– $10.328
|
17,139
|
$9.20
|
1.3
|
|
17,139
|
$9.20
|
$10.328
– $12.910
|
203,656
|
12.19
|
1.8
|
|
203,656
|
12.19
|
$12.910
– $15.492
|
161,306
|
13.14
|
3.0
|
|
161,306
|
13.14
|
$15.492
– $18.074
|
358,979
|
16.37
|
5.6
|
|
358,979
|
16.37
|
$18.074
– $20.656
|
386,869
|
18.19
|
8.8
|
|
63,734
|
18.38
|
$20.656
– $23.238
|
488,494
|
22.95
|
8.4
|
|
226,238
|
22.97
|
$23.238
– $25.820
|
1,049,810
|
24.24
|
6.1
|
|
733,627
|
24.29
|
TOTAL
|
2,666,253
|
$20.38
|
6.3
|
|
1,764,679
|
$19.73
|
The
weighted-average remaining contractual term of outstanding and exercisable stock
options at December 31, 2008 is 6.3 years and 5.5 years,
respectively. The aggregate intrinsic value of outstanding and
exercisable stock options at December 31, 2008 is $10.9 million and $8.3
million, respectively.
The
Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS
123(R)”), on January 1, 2006 using the modified prospective
method. Under this method, awards that are granted, modified, or
settled after December 31, 2005, are measured and accounted for in accordance
with SFAS 123(R). Also under this method, expense is recognized for
unvested awards that were granted prior to January 1, 2006, based upon the fair
value determined at the grant date under SFAS 123(R). Stock based compensation
expense is recognized ratably over the requisite service period for all
awards. Prior to the adoption of SFAS 123(R), the Company accounted
for stock compensation under the intrinsic value method permitted by Accounting
Principles Board Opinion No 25, Accounting for Stock Issued to
Employees (“APB No. 25”) and related
interpretations. Accordingly, the Company previously recognized no
compensation cost for employee stock options that were granted with an exercise
price equal to the market value of the underlying common stock on the date of
grant.
As a
result of applying the provisions of SFAS 123(R), the Company recognized
stock-based compensation expense related to incentive and non-qualified stock
options of $2.0 million and $2.2 million for the years ended December 31, 2008
and 2007, respectively. A related income tax benefit was recognized
of $525,000 and $472,000 for the 2008 and 2007 years,
respectively. Compensation expense related to restricted stock
vesting recognized in the income statement for 2008 and 2007 was $585,000 and
$300,000, respectively.
Management
estimated the fair value of options granted using the Black-Scholes
option-pricing model. This model was originally developed to estimate
the fair value of exchange-traded equity options, which (unlike employee stock
options) have no vesting period or transferability restrictions. As a
result, the Black-Scholes model is not necessarily a precise indicator of the
value of an option, but it is commonly used for this purpose. The
Black-Scholes model requires several assumptions, which management developed
based on historical trends and current market observations.
|
2008
|
2007
|
2006
|
Weighted-average
Fair Value of Options Granted
|
$4.48
|
$6.14
|
$6.10
|
Assumptions:
|
|
|
|
Weighted-average
expected life (in years)
|
7.74
|
7.89
|
7.78
|
Future
dividend yield
|
3.00%
|
3.00%
|
3.00%
|
Share
price volatility
|
26.85%
|
26.15%
|
26.46%
|
Weighted-average
risk-free interest rate
|
3.70%
|
4.87%
|
4.37%
|
Unrecognized
stock based compensation expense related to non-vested stock options totaled
$3.3 million at December 31, 2008, which will be recognized as expense over the
next five years. The weighted-average period over which this
unrecognized expense would be recognized is 2.8 years. The total fair
value of shares vested during 2008, 2007, and 2006 were $1.6 million, $1.9
million and $1.7 million, respectively.
During
the twelve months ended December 31, 2008 and 2007, proceeds from stock option
exercises totaled $6.8 million and $2.7 million, respectively, and the related
windfall tax benefits from exercise were approximately $927,000 and $410,000,
respectively. During the twelve months ended December 31, 2008
and 2007, 388,491 and 176,935 shares, respectively, were issued in connection
with stock option exercise. All shares issued were new shares issued
from available authorized shares. The total intrinsic value of
options exercised during 2008, 2007 and 2006 were $3.0 million, $1.2 million and
$2.8 million, respectively.
A summary
of the status of the Company’s unvested stock awards as of December 31,
2008, and changes during the twelve months ended December 31, 2008, is
presented below:
|
Restricted
Shares
|
Weighted-average
grant
date fair value
|
Unvested
at January 1, 2007
|
9,443
|
$23.56
|
Awards
|
54,238
|
22.60
|
Cancellations
|
(1,624)
|
22.97
|
Vestings
|
(4,817)
|
22.77
|
Unvested
at December 31, 2007
|
57,240
|
$22.73
|
Awards
|
83,914
|
18.31
|
Cancellations
|
(2,555)
|
19.14
|
Vestings
|
(16,423)
|
22.96
|
Unvested
at December 31, 2008
|
122,176
|
$19.74
|
The
following is a reconciliation of basic to diluted earnings per share for the
years ended December 31:
|
|
|
Per
Share
|
(000's
omitted, except per share data)
|
Income
|
Shares
|
Amount
|
Year
Ended December 31, 2008
|
|
|
|
Basic
EPS
|
$45,940
|
30,496
|
$1.51
|
Common
stock equivalents
|
|
330
|
|
Diluted
EPS
|
$45,940
|
30,826
|
$1.49
|
|
|
|
|
Year
Ended December 31, 2007
|
|
|
|
Basic
EPS
|
$42,891
|
29,918
|
$1.43
|
Common
stock equivalents
|
|
314
|
|
Diluted
EPS
|
$42,891
|
30,232
|
$1.42
|
|
|
|
|
Year
Ended December 31, 2006
|
|
|
|
Basic
EPS
|
$38,377
|
29,976
|
$1.28
|
Common
stock equivalents
|
|
416
|
|
Diluted
EPS
|
$38,377
|
30,392
|
$1.26
|
There
were approximately 1.5 million, 1.7 million, and 1.4 million anti-dilutive stock
options outstanding for the years ended December 31, 2008, 2007 and 2006,
respectively.
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 fair value of the standby
letters of credit is immaterial for disclosure in accordance with FASB
Interpretation No. 45, Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. The contract amount of commitment and
contingencies is as follows:
(000's
omitted)
|
2008
|
2007
|
Commitments
to extend credit
|
$523,017
|
$482,517
|
Standby
letters of credit
|
13,209
|
10,121
|
Total
|
$536,226
|
$492,638
|
The
Company has unused lines of credit of $100.0 million at December 31,
2008. The Company has unused borrowing capacity of approximately
$327.7 million through collateralized transactions with the Federal Home Loan
Bank and $12.5 million through collateralized transactions with the Federal
Reserve Bank.
The
Company is required to maintain a reserve balance, as established by the Federal
Reserve Bank of New York. The required average total reserve for the
14-day maintenance period of December 18, 2008 through December 31, 2008 was
$59.7 million of which $2.0 million was required to be on deposit with the
Federal Reserve Bank of New York. The remaining, $57.7 million, was
represented by cash on hand.
The
Company leases buildings and office space under agreements that expire in
various years. Rental expense included in operating expenses amounted
to $3.6 million, $3.0 million and $2.7 million in 2008, 2007 and 2006,
respectively. The future minimum rental commitments as of December
31, 2008 for all noncancelable operating leases are as follows:
2009
|
$3,851
|
2010
|
3,423
|
2011
|
2,932
|
2012
|
2,477
|
2013
|
2.031
|
Thereafter
|
6,112
|
Total
|
$20,826
|
The
Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company’s and the Bank’s assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company’s and the Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative
measures established by regulation to ensure capital adequacy require the
Company and Bank to maintain minimum total core capital to risk-weighted assets
of 8%, and Tier I capital to risk-weighted assets and Tier I capital to average
assets of 4%. Management believes, as of December 31, 2008, that the
Company and Bank meet all capital adequacy requirements to which they are
subject.
As of
December 31, 2008 and 2007, the most recent notification from the Office of the
Comptroller of the Currency categorized the Company and Bank as “well
capitalized” under the regulatory framework for prompt corrective
action. To be categorized as “well capitalized,” the Company and Bank
must maintain minimum total core capital to risk-weighted assets of 10%, Tier I
capital to risk-weighted assets of 6% and Tier I capital to average assets of
5%. There are no conditions or events since that notification that
management believes have changed the institution’s category. In
addition, there were no significant capital requirements imposed or agreed to
during the regulatory approval process of any of our acquisitions.
The
capital ratios and amounts of the Company and the Bank as of December 31 are
presented below:
|
|
2008
|
|
2007
|
(000's
omitted)
|
|
Company
|
Bank
|
|
Company
|
Bank
|
Tier
1 capital to average assets
|
|
|
|
|
|
|
Amount
|
|
$342,071
|
$288,612
|
|
$344,436
|
$281,354
|
Ratio
|
|
7.22%
|
6.11%
|
|
7.77%
|
6.37%
|
Minimum
required amount
|
|
$189,452
|
$188,917
|
|
$177,297
|
$176,811
|
Tier
1 capital to risk-weighted assets
|
|
|
|
|
|
|
Amount
|
|
$342,071
|
$288,612
|
|
$344,436
|
$281,354
|
Ratio
|
|
11.28%
|
9.55%
|
|
12.80%
|
10.48%
|
Minimum
required amount
|
|
$121,304
|
$120,830
|
|
$107,637
|
$107,417
|
|
|
|
|
|
|
|
Total
core capital to risk-weighted assets
|
|
|
|
|
|
|
Amount
|
|
$380,003
|
$326,397
|
|
$378,107
|
$314,957
|
Ratio
|
|
12.53%
|
10.81%
|
|
14.05%
|
11.73%
|
Minimum
required amount
|
|
$242,609
|
$241,660
|
|
$215,275
|
$214,835
|
NOTE
Q: PARENT COMPANY STATEMENTS
The
condensed balance sheets of the parent company at December 31 is as
follows:
(000's
omitted)
|
2008
|
2007
|
Assets:
|
|
|
Cash
and cash equivalents
|
$46,704
|
$51,228
|
Investment
securities
|
3,489
|
4,317
|
Investment
in and advances to subsidiaries
|
603,751
|
548,094
|
Other
assets
|
8,298
|
16,293
|
Total
assets
|
$662,242
|
$619,932
|
|
|
|
Liabilities
and shareholders' equity:
|
|
|
Accrued
interest and other liabilities
|
$15,616
|
$13,424
|
Borrowings
|
101,975
|
127,724
|
Shareholders'
equity
|
544,651
|
478,784
|
Total
liabilities and shareholders' equity
|
$662,242
|
$619,932
|
The
condensed statements of income of the parent company for the years ended
December 31 is as follows:
(000's
omitted)
|
2008
|
2007
|
2006
|
Revenues:
|
|
|
|
Dividends
from subsidiaries
|
$44,000
|
$43,000
|
$39,750
|
Interest
and dividends on investments
|
246
|
385
|
236
|
Gain
on sale of fixed asset
|
0
|
26
|
204
|
Other
income
|
26
|
11
|
24
|
Total
revenues
|
44,272
|
43,422
|
40,214
|
|
|
|
|
Expenses:
|
|
|
|
Interest
on long-term notes and debentures
|
6,904
|
9,973
|
8,441
|
Loss
on early debt extinguishments
|
0
|
2,128
|
1,498
|
Other
expenses
|
106
|
100
|
124
|
Total
expenses
|
7,010
|
12,201
|
10,063
|
|
|
|
|
Income
before tax benefit and equity in undistributed
|
|
|
|
net
income of subsidiaries
|
37,262
|
31,221
|
30,151
|
Income
tax benefit
|
3,874
|
12,629
|
2,299
|
Income
before equity in undistributed net income (loss)
|
|
|
|
of
subsidiaries
|
41,136
|
43,850
|
32,450
|
Equity
in undistributed net income (loss) of subsidiaries
|
4,804
|
(959)
|
5,927
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
The
statements of cash flows of the parent company for the years ended December 31
is as follows:
(000's
omitted)
|
2008
|
2007
|
2006
|
Operating
activities:
|
|
|
|
Net
income
|
$45,940
|
$42,891
|
$38,377
|
Gain
on sale of fixed assets/investment securities
|
(558)
|
(24)
|
(204)
|
Adjustments
to reconcile net income to net cash provided by operating
activities
|
|
|
|
Equity
in undistributed net (income) loss of subsidiaries
|
(4,804)
|
959
|
(5,927)
|
Net
change in other assets and other liabilities
|
7,670
|
(10,483)
|
4,096
|
Net
cash provided by operating activities
|
48,248
|
33,343
|
36,342
|
Investing
activities:
|
|
|
|
Purchase
of investment securities
|
0
|
0
|
(2,423)
|
Proceeds
from sale of investment securities
|
816
|
1,009
|
0
|
Proceeds
from sale of fixed assets
|
0
|
180
|
260
|
Advances
to subsidiaries
|
(1,820)
|
(1,600)
|
0
|
Capital
contributions to subsidiaries
|
(59,839)
|
0
|
(24,000)
|
Net
cash used in investing activities
|
(60,843)
|
(411)
|
(26,163)
|
Financing
activities:
|
|
|
|
Net
change in long-term borrowings
|
(25,774)
|
(30,928)
|
77,320
|
Issuance
of common stock
|
59,212
|
4,713
|
4,571
|
Purchase
of treasury stock
|
0
|
(12,012)
|
(5,542)
|
Cash
dividends paid
|
(25,367)
|
(24,231)
|
(23,021)
|
Net
cash (used) provided by financing activities
|
8,071
|
(62,458)
|
53,328
|
Change
in cash and cash equivalents
|
(4,524)
|
(29,526)
|
63,507
|
Cash
and cash equivalents at beginning of year
|
51,228
|
80,754
|
17,247
|
Cash
and cash equivalents at end of year
|
$46,704
|
$51,228
|
$80,754
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
Cash
paid for interest
|
$8,019
|
$11,903
|
$7,814
|
Supplemental
disclosures of noncash financing activities
|
|
|
|
Dividends
declared and unpaid
|
$7,179
|
$6,239
|
$5,989
|
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 December 31, 2008:
(000's
omitted)
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
Available-for-sale
investment securities
|
$1,035
|
$1,211,617
|
$51,030
|
$1,263,682
|
Derivative
assets/(liabilities), net
|
-
|
(6,721)
|
-
|
(6,721)
|
Total
|
$1,035
|
$1,204,896
|
$51,030
|
$1,256,961
|
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 September 30, 2008
|
$51,485
|
Total
gains included in earnings (a)
|
23
|
Total
losses included in other comprehensive income
|
(229)
|
Purchases
|
6
|
Payments
received
|
(255)
|
Balance
at December 31, 2008
|
$51,030
|
(000's
omitted)
|
AFS
investments
|
Balance
at January 1, 2008
|
$73,442
|
Total
gains included in earnings (a)
|
67
|
Total
losses included in other comprehensive income
|
(21,881)
|
Purchases
|
40
|
Payments
received
|
(638)
|
Balance
at December 31, 2008
|
$51,030
|
(a) Included
in gain (loss) on sales of investment securities and relate to securities
still held at December 31, 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 $1,029,000, with an associated
valuation allowance of $179,000 for a fair value of $850,000 at
December 31, 2008. These loans were classified as a Level 3
valuation. The Company recorded goodwill impairment charges of
$1.7 million as of December 31, 2008, as determined based on Level 3
inputs. See Note F, “Intangible Assets,” for additional information
on goodwill impairment.
NOTE
S: SEGMENT INFORMATION
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 Northern 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 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).
Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:
(000's
omitted)
|
Banking
|
Other
|
Consolidated
Total
|
2008
|
|
|
|
Net
interest income
|
$148,348
|
$ 159
|
$148,507
|
Provision
for loan losses
|
6,730
|
0
|
6,730
|
Noninterest
income excluding loss on investment securities and debt
extinguishments
|
37,625
|
35,619
|
73,244
|
Loss
on investment securities and debt extinguishments
|
230
|
0
|
230
|
Amortization
of intangible assets
|
6,143
|
763
|
6,906
|
Goodwill
impairment
|
0
|
1,745
|
1,745
|
Other
operating expenses
|
121,954
|
27,957
|
149,911
|
Income
before income taxes
|
$
51,376
|
$ 5,313
|
$
56,689
|
Assets
|
$5,148,939
|
$25,613
|
$5,174,552
|
Goodwill
|
$287,964
|
$13,185
|
$301,149
|
|
|
|
|
2007
|
|
|
|
Net
interest income
|
$135,530
|
$ 444
|
$135,974
|
Provision
for loan losses
|
2,004
|
0
|
2,004
|
Noninterest
income excluding loss on investment securities and debt
extinguishments
|
34,952
|
28,308
|
63,260
|
Loss
on investment securities and debt extinguishments
|
(9,972)
|
(2)
|
(9,974)
|
Amortization
of intangible assets
|
5,917
|
352
|
6,269
|
Other
operating expenses
|
113,379
|
22,426
|
135,805
|
Income
before income taxes
|
$ 39,210
|
$ 5,972
|
$ 45,182
|
Assets
|
$4,676,129
|
$21,373
|
$4,697,502
|
Goodwill
|
$221,224
|
$13,225
|
$234,449
|
|
|
|
|
2006
|
|
|
|
Net
interest income
|
$134,385
|
$ 424
|
$134,809
|
Provision
for loan losses
|
6,585
|
0
|
6,585
|
Noninterest
income excluding gain on investment securities and debt
extinguishments
|
30,786
|
20,893
|
51,679
|
Gain
on investment securities and debt extinguishments
|
(2,403)
|
0
|
(2,403)
|
Amortization
of intangible assets
|
5,672
|
355
|
6,027
|
Other
operating expenses
|
104,591
|
16,585
|
121,176
|
Income
before income taxes
|
$ 45,920
|
$ 4,377
|
$ 50,297
|
Assets
|
$4,482,030
|
$15,767
|
$4,497,797
|
Goodwill
|
$208,954
|
$11,336
|
$220,290
|
Report
on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a – 15(f). Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation management concluded that our
internal control over financial reporting was effective as of December 31,
2008. Additionally, there were no changes in internal control during
the quarter ended December 31, 2008 that have materially affected, or are
reasonably likely to materially affect, internal control over financial
reporting.
The
consolidated financial statements of the Company have been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm
that was engaged to express an opinion as to the fairness of presentation of
such financial statements. PricewaterhouseCoopers LLP was also
engaged to assess the effectiveness of the Company’s internal control over
financial reporting. The report of PricewaterhouseCoopers LLP follows
this report.
Community
Bank System, Inc.
By: /s/ Mark E.
Tryniski
Mark E.
Tryniski,
President,
Chief Executive Officer and Director
By: /s/
Scott Kingsley
Scott
Kingsley,
Treasurer
and Chief Financial Officer
Report
of Independent Registered Public Accounting Firm
To the
Board of Directors and Stockholders of
Community
Bank System, Inc.
In our
opinion, the consolidated financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Community
Bank System, Inc. and its subsidiaries (the "Company") at December 31, 2008 and
2007, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2008 in conformity with accounting
principles generally accepted in the United States of America. Also
in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company's management is responsible
for these financial statements, for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Report on
Internal Control Over Financial Reporting. Our responsibility is to
express opinions on these financial statements and on the Company's internal
control over financial reporting based on our integrated audits. We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other
procedures as we considered necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
/s/PricewaterhouseCoopers
LLP
Buffalo,
New York
March 13,
2009
TWO
YEAR SELECTED QUARTERLY DATA (Unaudited)
2008
Results
|
4th
|
3rd
|
2nd
|
1st
|
|
(000's
omitted, except per share data)
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Total
|
Net
interest income
|
$40,396
|
$37,073
|
$35,440
|
$35,598
|
$148,507
|
Provision
for loan losses
|
2,395
|
1,985
|
1,570
|
780
|
6,730
|
Net
interest income after provision for loan losses
|
38,001
|
35,088
|
33,870
|
34,818
|
141,777
|
Noninterest
income
|
18,824
|
19,383
|
17,649
|
17,618
|
73,474
|
Operating
expenses
|
43,977
|
39,256
|
36,955
|
38,374
|
158,562
|
Income
before income taxes
|
12,848
|
15,215
|
14,564
|
14,062
|
56,689
|
Income
taxes
|
879
|
3,429
|
3,277
|
3,164
|
10,749
|
Net
income
|
$11,969
|
$11,786
|
$11,287
|
$10,898
|
$45,940
|
|
|
|
|
|
|
Basic
earnings per share
|
$0.37
|
$0.39
|
$0.38
|
$0.37
|
$1.51
|
Diluted
earnings per share
|
$0.37
|
$0.39
|
$0.37
|
$0.36
|
$1.49
|
|
|
|
|
|
|
2007
Results
|
4th
|
3rd
|
2nd
|
1st
|
|
(000's
omitted, except per share data)
|
Quarter
|
Quarter
|
Quarter
|
Quarter
|
Total
|
Net
interest income
|
$34,989
|
$34,280
|
$33,338
|
$33,367
|
$135,974
|
Provision
for loan losses
|
880
|
510
|
414
|
200
|
2,004
|
Net
interest income after provision for loan losses
|
34,109
|
33,770
|
32,924
|
33,167
|
133,970
|
Noninterest
income
|
7,217
|
17,572
|
15,018
|
13,479
|
53,286
|
Operating
expenses
|
37,258
|
36,765
|
34,132
|
33,919
|
142,074
|
Income
before income taxes
|
4,068
|
14,577
|
13,810
|
12,727
|
45,182
|
Income
taxes
|
(7,779)
|
3,548
|
3,451
|
3,071
|
2,291
|
Net
income
|
$11,847
|
$11,029
|
$10,359
|
$9,656
|
$42,891
|
|
|
|
|
|
|
Basic
earnings per share
|
$0.40
|
$0.37
|
$0.34
|
$0.32
|
$
1.43
|
Diluted
earnings per share
|
$0.39
|
$0.37
|
$0.34
|
$0.32
|
$
1.42
|
Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure
None
Item 9A. Controls and
Procedures
Under the
supervision and with the participation of our management, including our chief
executive officer and chief financial officer, we conducted an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 13a -
15(e) under the Securities Exchange Act of 1934. Based upon this
evaluation, our chief executive officer and our chief financial officer
concluded that our disclosure controls and procedures were effective as of the
end of the period covered by this annual report. Management’s annual
report on internal control over financial reporting is included under the
heading “Report on Internal Control Over Financial Reporting” at Item 8 of this
Annual Report on Form 10-K. The attestation report of the registered
public accounting firm is included under the heading “Report of the Independent
Registered Public Accounting Firm” at Item 8 of this Annual Report on Form
10-K.
The
Company continually assesses the adequacy of its internal control over financial
reporting and enhances its controls in response to internal control assessments,
and internal and external audit and regulatory recommendations. No
change in internal control over financial reporting during the quarter ended
December 31, 2008 or through the date of this Annual Report on Form 10-K have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate due to changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Item 9B. Other
Information
None
Part
III
Item 10.
Directors, Executive Officers and Corporate
Governance
The
information concerning Directors of the Company required by this Item 10 is
incorporated herein by reference to the sections entitled “Nominees for Director
and Directors Continuing in Office” and “Section 16(a) Beneficial Ownership
Reporting Compliance” in the Company’s Proxy Statement. The
information concerning executive officers of the Company required by this Item
10 is incorporated by reference to Item 4A of this Annual Report on Form
10-K. The Company has adopted a code of ethics that applies to its
principal executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions. The
text of the code of ethics is posted on the Company’s website at www.communitybankna.com,
and is available free of charge in print to any person who requests it. The
Company intends to satisfy the requirements under Item 5.05 of Form 8-K
regarding an amendment to, or a waiver from, the code of ethics that relates to
certain elements thereof, by posting such information on its website referenced
above. In addition, information concerning Audit Committee and Audit
Committee Financial Expert is included in the Proxy Statement under the caption
“Audit Committee Report” and is incorporated herein by reference.
Item 11. Executive
Compensation
The
information required by this Item 11 is incorporated herein by reference to the
section entitled “Compensation of Executive Officers” in the Company’s Proxy
Statement.
Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The
information required by this Item 12 is incorporated herein by reference to the
section entitled “Nominees for Director and Directors Continuing in Office” in
the Company’s Proxy Statement.
Item 13. Certain
Relationships and Related Transactions and Director
Independence
The
information required by this Item 13 is incorporated herein by reference to the
sections entitled “Corporate Governance” and “Transactions with Related Parties”
in the Company’s Proxy Statement.
Item
14. Principal Accounting Fees and Services
The
information required by this Item 14 is incorporated herein by reference to the
section entitled “Audit Fees” in the Company’s Proxy Statement.
Part
IV
Item 15. Exhibits,
Financial Statement Schedules
A. Documents
Filed
|
1.
|
The
following consolidated financial statements of Community Bank System,
Inc. and subsidiaries are included in Item
8:
|
-Consolidated
Statements of Condition,
December
31, 2008 and 2007
-Consolidated
Statements of Income,
Years
ended December 31, 2008, 2007, and 2006
-Consolidated
Statements of Changes in Shareholders' Equity,
Years
ended December 31, 2008, 2007, and 2006
-Consolidated
Statements of Comprehensive Income,
Years
ended December 31, 2008, 2007, and 2006
-Consolidated
Statement of Cash Flows,
Years
ended December 31, 2008, 2007, and 2006
-Notes to
Consolidated Financial Statements,
December
31, 2008
-Report of
Independent Registered Public Accounting Firm
-Quarterly selected
data,
Years
ended December 31, 2008 and 2007 (unaudited)
2.
|
Schedules
are omitted since the required information is either not applicable or
shown elsewhere in the
|
financial
statements.
3.
|
The
exhibits filed as part of this report and exhibits incorporated herein by
reference to other documents are listed
below:
|
2.1 Agreement
and Plan of Merger, dated August 2, 2006, by and among Community Bank
System, Inc., Seneca Acquisition Corp. and ONB
Corporation. Incorporated by reference to Exhibit 2.2 to the
Quarterly Report on Form 10-Q filed on November 8, 2006 (Registration No.
001-13695).
2.2 Agreement
and Plan of Merger dated April 20, 2006, by and among Community Bank
System, Inc., ESL Acquisition Corp., and ES&L Bancorp,
Inc. Incorporated by reference to Exhibit 2.1 to the Form 8-K
filed on April 25, 2006 (Registration No. 001-13695).
|
3.1
Certificate of Incorporation of Community Bank System, Inc., as
amended. Incorporated by reference to Exhibit No. 3.1 to the
Registration Statement on Form S-4 filed on October 20, 2000 (Registration
No. 333-48374).
|
3.2
Certificate of Amendment of Certificate of Incorporation of Community Bank
System, Inc. Incorporated by reference to Exhibit No. 3.1 to the Quarterly
Report on Form 10-Q filed on May 5, 2004 (Registration No.
001-13695).
|
3.3 Bylaws
of Community Bank System, Inc., amended July 18,
2007. Incorporated by reference to Exhibit 3.2 to the Form 8-K
filed on July 24, 2007. (Registration No. 001-13695)
|
4.1
Form of Common Stock Certificate. Incorporated by reference to
Exhibit No. 4.1 to the Amendment No. 1 to the Registration Statement on
Form S-3 filed on September 29, 2008 (Registration No.
333-153403).
|
10.1
Supplemental Retirement Plan Agreement, by and between Community Bank
System, Inc. and Mark E. Tryniski. Incorporated by reference to
Exhibit No. 10.1 to the Quarterly Report on Form 10-Q filed on May 8, 2007
(Registration No. 001-13695).**
10.2
Indenture dated as of December 8, 2006, between Community Bank System,
Inc. and Wilmington Trust Company, as trustee. Incorporated by
reference to Exhibit No. 4.1 to the Form 8-K filed on December 12, 2006
(Registration No. 001-13695).
10.3 Amended
and Restated Declaration of Trust dated as of December 8, 2006, among
Community Bank System, Inc., as sponsor, Wilmington Trust Company, as
Delaware trustee, Wilmington Trust Company, as institutional trustee, and
Mark E. Tryniski, Scott A. Kingsley, and Joseph J. Lemchak as
administrators. Incorporated by reference to Exhibit 10.1 to
the Form 8-K filed on December 12, 2006 (Registration No.
001-13695).
10.4 Guarantee
Agreement dated as of December 8, 2006, between Community Bank System,
Inc., as guarantor, and Wilmington Trust Company, as guarantee
trustee. Incorporated by reference to Exhibit 10.1 to the Form
8-K filed on December 12, 2006 (Registration No. 001-13695).
10.5
Employment Agreement, dated December 1, 2005, by and between Community
Bank System, Inc., Community Bank, N.A. and Mark E. Tryniski. Incorporated
by reference to Exhibit No. 10.29 to the Current Report on Form 8-K of the
Registrant filed on January 6, 2006 (Registration No. 001-13695).
**
|
10.6
Post-2004 Supplemental Retirement Agreement, effective January 1, 2005, by
and between Community Bank System, Inc., Community Bank, N.A. and Sanford
Belden. Incorporated by reference to Exhibit No. 10.2 to the
Annual Report on Form 10-K filed on March 15, 2005 (Registration No.
001-13695). **
|
|
10.7 Pre-2005
Supplemental Retirement Agreement, effective December 31, 2004, by and
between Community Bank System, Inc., Community Bank, N.A. and Sanford
Belden. Incorporated by reference to Exhibit No. 10.3 to the
Annual Report on Form 10-K filed on March 15, 2005 (Registration No.
001-13695).**
|
|
10.8
Supplemental Retirement Plan Agreement, effective August 2, 2004, by and
between Community Bank System Inc. and Scott A.
Kingsley. Incorporated by reference to Exhibit No. 10.4
to the Quarterly Report on Form 10-Q filed on August 4, 2004 (Registration
No. 001-13695). **
|
|
10.9
Employment Agreement, effective August 1, 2004, by and between Community
Bank System, Inc., Community Bank N.A. and Brian D. Donahue, as amended
December 31, 2008. * **
|
|
10.10
Supplemental Retirement Plan Agreement, effective March 26, 2003, by and
between Community Bank System Inc. and Thomas
McCullough. Incorporated by reference to Exhibit No.
10.11 to the Annual Report on Form 10-K filed on March 12, 2004
(Registration No. 001-13695). **
|
|
10.11
2004 Long-Term Incentive Compensation Program. Incorporated by
reference to Appendix A to the Definitive Proxy Statement on Schedule 14A
filed on April 15, 2004 (Registration No. 001-13695).
**
|
|
10.12
Stock Balance Plan for Directors, as amended. Incorporated by
reference to Annex I to the Definitive Proxy Statement on Schedule 14A
filed on March 31, 1998 (Registration No. 001-13695).
**
|
|
10.13
Deferred Compensation Plan for Directors, as
amended. Incorporated by reference to Annex I to the Definitive
Proxy Statement on Schedule 14A filed on March 31, 1998 (Registration No.
001-13695). **
|
|
10.14
Community Bank System, Inc. Pension Plan Amended and Restated as of
January 1, 2004. Incorporated by reference to
Exhibit No. 10.27 to the Annual Report on Form 10-K filed on March 15,
2005 (Registration No. 001-13695). **
|
|
10.15
Amendment #1 to the Community Bank System, Inc. Pension Plan, as amended
and restated as of January 1, 2004 (“Plan”). Incorporated by
reference to Exhibit No. 10.27 to the Annual Report on Form 10-K filed on
March 15, 2005 (Registration No.
001-13695). **
|
|
10.16
Amendment #1 to the Deferred Compensation Plan For Certain Executive
Employees of Community Bank System, Inc., as amended and restated as of
January 1, 2002. Incorporated by reference to Exhibit No. 10.33
to the Annual Report on Form 10-K filed on March 15, 2005 (Registration
No. 001-13695). **
|
|
10.17
Employment Agreement, dated January 1, 2008, by and among Community Bank
System, Inc., Community Bank N.A. and George J.
Getman. Incorporated by reference to Exhibit No. 10.1 to
the Quarterly Report on Form 10-Q filed on May 8, 2008 (Registration No.
001-13695). **
|
|
10.18
Employment Agreement, dated April 4, 2008, by and among Community Bank
System, Inc., Community Bank N.A. and Scott
Kingsley. Incorporated by reference to Exhibit No. 10.1
to the Form 8-K filed on April 9, 2008 (Registration No. 001-13695).
**
|
|
14.1
Community Bank System, Inc., Code of Ethics. Incorporated by
reference to Exhibit No. 1 to the Annual Report on Form 10-K filed on
March 15, 2005 (Registration No.
001-13695).
|
|
|
21.1 Subsidiaries
of Community Bank System, Inc.
|
|
Name
|
Jurisdiction of
Incorporation |
Community
Bank, N.A.
|
New
York |
Community
Statutory Trust III
|
Connecticut |
Community
Capital Trust IV
|
Delaware |
Benefit
Plans Administrative Services, Inc.
|
New
York |
Benefit
Plans Administrative Services LLC
|
New
York |
Harbridge
Consulting Group LLC
|
New
York |
CBNA
Treasury Management Corporation
|
New
York |
Community
Investment Services, Inc.
|
New
York
|
CBNA
Preferred Funding Corp.
|
Delaware |
CFSI
Close-Out Corp.
|
New
York |
Nottingham
Advisors, Inc.
|
Delaware |
First
Liberty Service Corporation
|
Delaware |
First
of Jermyn Realty Company, Inc.
|
Delaware |
Brilie
Corporation
|
New
York |
Town
& Country Agency LLC
|
New
York |
CBNA
Insurance Agency, Inc.
|
New
York |
Hand
Benefits & Trust Company
|
Texas |
Hand
Securities, Inc.
|
Texas |
Flex
Corporation
|
Texas |
|
23.1
Consent of PricewaterhouseCoopers LLP. *
|
|
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.
*
|
* Filed
herewith
**Denotes
management contract or compensatory plan or arrangement
B. Not
applicable
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) 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.
By: /s/ Mark E.
Tryniski
Mark
E. Tryniski
President
and Chief Executive Officer
March
13, 2009
Pursuant
to the requirements of the Securities and Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities indicated on the 13th day of
March 2009.
/s/ Mark E.
Tryniski
Mark E.
Tryniski
President,
Chief Executive Officer and Director
(Principal
Executive Officer)
/s/ Scott
Kingsley
Scott
Kingsley
Treasurer
and Chief Financial Officer
(Principal
Financial Officer and
Principal
Accounting Officer)
Directors:
/s/ Brian R.
Ace
Brian R.
Ace, Director
/s/ Paul M. Cantwell,
Jr.
Paul M.
Cantwell, Jr., Director and
Chairman
of the Board of Directors
/s/ Nicholas A.
DiCerbo
Nicholas
A. DiCerbo, Director
/s/ James A.
Gabriel
James A.
Gabriel, Director
/s/ James W. Gibson,
Jr.
James W.
Gibson, Jr., Director
/s/ Charles E.
Parente
Charles
E. Parente, Director
/s/ David C.
Patterson
David C.
Patterson, Director
/s/ Sally A.
Steele
Sally A.
Steele, Director
/s/ James A.
Wilson
James A.
Wilson, Director
NEW YORK
STOCK EXCHANGE
The
undersigned Chief Executive Officer of Community Bank System, Inc. (the
“Company”) certifies to the New York Stock Exchange (“NYSE”) that, as of the
date of this certification, he is unaware of any violation by Community Bank
System, Inc. of the NYSE’s corporate governance listing standards in effect as
of the date of this certification.
The Chief
Executive Officer of the Company submitted the required certification to the
NYSE (as required pursuant to Section 303A.12 of the NYSE Listed Company Manual)
without qualification to the NYSE for the year ended December 31,
2008. In addition, the certifications of the Chief Executive Officer
and the Chief Financial Officer required by Section 302 of the Sarbanes-Oxley
Act of 2002 (the “SOX 302 certifications”) with respect to the Company’s
disclosures in its Annual Report on Form 10-K for the year ended December 31,
2008 were filed as Exhibits 31.1 and 31.2 to such Annual Report on Form
10-K. The SOX 302 Certifications with respect to the Company’s
disclosures in its Form 10-K for the year ended December 31, 2008 are being
filed as Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K.
Date: March
13, 2009
/s/ Mark E.
Tryniski
Mark E.
Tryniski,
President,
Chief Executive Officer and Director