cbsi10q2009q1.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
|
For
the quarterly period ended March 31,
2009
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o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
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For
the transition period from
to
.
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Commission
File Number 001-13695
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COMMUNITY BANK SYSTEM, INC.
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(Exact
name of registrant as specified in its charter)
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Delaware
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16-1213679
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(State or
other jurisdiction of incorporation or organization)
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(I.R.S.
Employer Identification No.)
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5790
Widewaters Parkway, DeWitt, New York
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13214-1883
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(Address of
principal executive offices)
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(Zip
Code)
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(315)
445-2282
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Registrant's
telephone number, including area code
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NONE
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(Former name,
former address and former fiscal year, if changed since last
report)
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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 whether the registrant has submitted electronically and posted to
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
Yes o No
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 definitions of “large accelerated filer”, “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 |
(Do not
check if a smaller reporting company)
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o . No x .
Indicate
the number of shares outstanding of each of the issuer’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 April 30, 2009.
TABLE
OF CONTENTS
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Page |
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Part I. |
Financial Information |
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Item
1. |
Financial Statements
(Unaudited) |
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Consolidated
Statements of Condition
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March 31, 2009
and December 31, 2008
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3
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Consolidated
Statements of Income
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Three months
ended March 31, 2009 and 2008
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4
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Consolidated
Statement of Changes in Shareholders' Equity
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Three Months
ended March 31, 2009
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5
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Consolidated
Statements of Comprehensive Income
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Three Months
ended March 31, 2009 and 2008
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6
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Consolidated
Statements of Cash Flows
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Three months
ended March 31, 2009 and 2008
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7
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Notes to the
Consolidated Financial Statements
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March 31,
2009
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8
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Item
2. |
Management's
Discussion and Analysis of Financial Condition and Results of
Operations |
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18
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Item
3. |
Quantitative
and Qualitative Disclosures about Market Risk |
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33
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Item
4. |
Controls and
Procedures |
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34
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Part II. |
Other
Information |
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Item
1. |
Legal
Proceedings |
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34
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Item
1A |
Risk
Factors |
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34
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Item
2. |
Unregistered
Sales of Equity Securities and Use of Proceeds |
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34
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Item
3. |
Defaults Upon
Senior Securities |
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34
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Item
4. |
Submission of
Matters to a Vote of Securities Holders |
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34
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Item
5. |
Other
Information |
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34
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Item
6. |
Exhibits |
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35
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Part
I. Financial Information
Item
1. Financial Statements
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CONDITION
(In
Thousands, Except Share Data)
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(Unaudited)
|
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|
March
31,
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December
31,
|
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2009
|
2008
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Cash
and cash equivalents
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$350,670
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$213,753
|
|
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Available-for-sale
investment securities, at fair value
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1,299,965
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1,314,121
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Held-to-maturity
investment securities
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118,001
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80,890
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Total
investment securities (fair value of $1,420,736 and $1,397,589,
respectively)
|
1,417,966
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1,395,011
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Loans
held for sale
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16,429
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0
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Loans
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3,103,741
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3,136,140
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Allowance
for loan losses
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(40,053)
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(39,575)
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Net
loans
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3,063,688
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3,096,565
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Core
deposit intangibles, net
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20,519
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22,340
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Goodwill
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301,150
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301,149
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Other
intangibles, net
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4,850
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5,135
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Intangible
assets, net
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326,519
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328,624
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Premises
and equipment, net
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72,631
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73,294
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Accrued
interest receivable
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26,590
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26,077
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Other
assets
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50,240
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41,228
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Total
assets
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$5,324,733
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$5,174,552
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Liabilities:
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Noninterest-bearing
deposits
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$667,452
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$638,558
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Interest-bearing
deposits
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3,194,713
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3,062,254
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Total
deposits
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3,862,165
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3,700,812
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Borrowings
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756,854
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760,558
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Subordinated
debt held by unconsolidated subsidiary trusts
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101,981
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101,975
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Accrued
interest and other liabilities
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56,536
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66,556
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Total
liabilities
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4,777,536
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4,629,901
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Commitment
and contingencies (See Note H)
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Shareholders'
equity:
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Preferred
stock $1.00 par value, 500,000 shares authorized, 0 shares
issued
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-
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-
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Common
stock, $1.00 par value, 50,000,000 shares authorized;
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33,576
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33,468
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33,576,434
and 33,468,215 shares issued at March 31, 2009 and December 31, 2008,
respectively
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Additional
paid-in capital
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213,556
|
212,400
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Retained
earnings
|
333,176
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329,914
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Accumulated
other comprehensive income
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(14,844)
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(12,864)
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Treasury
stock, at cost (834,811 shares)
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(18,267)
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(18,267)
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Total
shareholders' equity
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547,197
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544,651
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Total
liabilities and shareholders' equity
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$5,324,733
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$5,174,552
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The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)
(In
Thousands, Except Per-Share Data)
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Three
Months Ended
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March
31,
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2009
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2008
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Interest
income:
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Interest
and fees on loans
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$46,791
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$46,515
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Interest
and dividends on taxable investments
|
10,307
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10,714
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Interest
and dividends on nontaxable investments
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6,001
|
5,922
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Total
interest income
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63,099
|
63,151
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Interest
expense:
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Interest
on deposits
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13,570
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17,694
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Interest
on borrowings
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7,757
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8,041
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Interest
on subordinated debt held by unconsolidated subsidiary
trusts
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1,586
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1,818
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Total
interest expense
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22,913
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27,553
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Net
interest income
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40,186
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35,598
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Less: provision
for loan losses
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2,810
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780
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Net
interest income after provision for loan losses
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37,376
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34,818
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Noninterest
income:
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Deposit
service fees
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9,018
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8,261
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Mortgage
banking and other services
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2,298
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595
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Benefit
plan administration, consulting and actuarial fees
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7,007
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6,312
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Wealth
management services
|
2,033
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2,163
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Gain
on sales of investment securities
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-
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287
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Total
noninterest income
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20,356
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17,618
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Operating
expenses:
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Salaries
and employee benefits
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22,962
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20,386
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Occupancy
and equipment
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6,211
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5,573
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Data
processing and communications
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4,850
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3,985
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Amortization
of intangible assets
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2,105
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1,531
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Legal
and professional fees
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1,284
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1,298
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Office
supplies and postage
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1,375
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1,278
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Business
development and marketing
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1,292
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1,322
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FDIC
premiums
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1,375
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109
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Other
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2,947
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2,892
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Total
operating expenses
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44,401
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38,374
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Income
before income taxes
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13,331
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14,062
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Income
taxes
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2,866
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3,164
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Net
income
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$10,465
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$10,898
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Basic
earnings per share
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$0.32
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$0.37
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Diluted
earnings per share
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$0.32
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$0.36
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Dividends
declared per share
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$0.22
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$0.21
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The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Three
Months Ended March 31, 2009
(In
Thousands, Except Share Data)
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Accumulated
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Common
Stock
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Additional
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Other
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Shares
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Amount
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Paid-In
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Retained
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Comprehensive
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Treasury
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Outstanding
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Issued
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Capital
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Earnings
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Loss
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Stock
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Total
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Balance
at December 31, 2008
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32,633,404
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$33,468
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$212,400
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$329,914
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($12,864)
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($18,267)
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$544,651
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Net
income
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10,465
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10,465
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Other
comprehensive loss, net of tax
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(1,980)
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(1,980)
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Dividends
declared:
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Common,
$0.22 per share
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(7,203)
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(7,203)
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Common
stock issued under
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Stock
plan, including
|
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tax
benefits of $86
|
108,219
|
108
|
513
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621
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Stock
options earned
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643
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643
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|
|
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Balance
at March 31, 2009
|
32,741,623
|
$33,576
|
$213,556
|
$333,176
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($14,844)
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($18,267)
|
$547,197
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In
Thousands)
|
|
Three
Months Ended
|
|
|
March
31,
|
|
|
2009
|
2008
|
Other
comprehensive (loss) income, before tax:
|
|
|
|
Change
in pension liability
|
|
$1,074
|
($146)
|
Change
in unrealized loss on derivative instruments used in cash flow hedging
relationship
|
|
187
|
(2,758)
|
Unrealized
(loss) gain on securities:
|
|
|
|
Unrealized
holding (loss) gain arising during period
|
|
(4,240)
|
4,280
|
Reclassification
adjustment for gains included in net income
|
|
0
|
(287)
|
Other
comprehensive (loss) income, before tax:
|
|
(2,979)
|
1,089
|
Income
tax benefit (expense) related to other comprehensive
income
|
|
999
|
(392)
|
Other
comprehensive (loss) income, net of tax:
|
|
(1,980)
|
697
|
Net
income
|
|
10,465
|
10,898
|
Comprehensive
income
|
|
$8,485
|
$11,595
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
(In
Thousands)
|
Three
Months Ended
March
31,
|
|
2009
|
2008
|
Operating
activities:
|
|
|
Net
income
|
$10,465
|
$10,898
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
Depreciation
|
2,522
|
2,332
|
Amortization
of intangible assets
|
2,105
|
1,531
|
Net
accretion of premiums and discounts on securities, loans and
borrowings
|
(24)
|
(464)
|
Stock-based
compensation
|
881
|
774
|
Provision
for loan losses
|
2,810
|
780
|
Gain
on investment securities and debt extinguishments
|
0
|
(287)
|
(Gain)
Loss on sale of loans and other assets
|
(235)
|
39
|
Net
change in loans originated for sale
|
(15,904)
|
(2)
|
Excess
tax benefits from share-based payment arrangements
|
(86)
|
(287)
|
Change
in other operating assets and liabilities
|
(17,582)
|
(5,591)
|
Net
cash (used in) provided by operating activities
|
(15,048)
|
9,723
|
Investing
activities:
|
|
|
Proceeds
from sales of available-for-sale investment securities
|
0
|
24,974
|
Proceeds
from maturities of held-to-maturity investment securities
|
16,666
|
1,645
|
Proceeds
from maturities of available-for-sale investment
securities
|
74,827
|
187,092
|
Purchases
of held-to-maturity investment securities
|
(53,849)
|
(510)
|
Purchases
of available-for-sale investment securities
|
(64,809)
|
(124,262)
|
Net
decrease (increase) in loans outstanding
|
30,067
|
(17,509)
|
Cash
paid for acquisition (net of cash acquired of $0)
|
0
|
(304)
|
Capital
expenditures
|
(1,876)
|
(2,786)
|
Net
cash provided by investing activities
|
1,026
|
68,340
|
Financing
activities:
|
|
|
Net
change in non-interest checking, interest checking and savings
accounts
|
167,452
|
27,531
|
Net
change in time deposits
|
(6,098)
|
(12,613)
|
Net
change in short-term borrowings
|
(3,574)
|
(45,254)
|
Change
in long-term borrowings (net of payments of $130 and $197)
|
(130)
|
9,803
|
Payment
on subordinated debt held by unconsolidated subsidiary
trusts
|
0
|
(25,774)
|
Issuance
of common stock
|
383
|
3,767
|
Cash
dividends paid
|
(7,180)
|
(6,239)
|
Tax
benefits from share-based payment arrangements
|
86
|
287
|
Net
cash provided by (used in) financing activities
|
150,939
|
(48,492)
|
Change
in cash and cash equivalents
|
136,917
|
29,571
|
Cash
and cash equivalents at beginning of period
|
213,753
|
130,823
|
Cash
and cash equivalents at end of period
|
$350,670
|
$160,394
|
Supplemental
disclosures of cash flow information:
|
|
|
Cash
paid for interest
|
$23,028
|
$28,316
|
Cash
paid for income taxes
|
0
|
75
|
Supplemental
disclosures of noncash financing and investing activities:
|
|
|
Dividends
declared and unpaid
|
7,203
|
6,252
|
Transfers
from loans to other real estate
|
601
|
168
|
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY
BANK SYSTEM, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March
31, 2009
NOTE
A: BASIS OF PRESENTATION
The
interim financial data as of March 31, 2009 and for the three months ended March
31, 2009 and 2008 is unaudited; however, in the opinion of the Company, the
interim data includes all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the interim
periods. The results of operations for the interim periods are not
necessarily indicative of the results that may be expected for the full year or
any other interim period.
NOTE
B: ACQUISITION AND OTHER MATTERS
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.
The
estimated purchase price allocation of the assets acquired and liabilities
assumed in the purchase of Citizens and ABG, collectively, including capitalized
acquisition costs, 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
|
NOTE
C: ACCOUNTING POLICIES
Critical
Accounting Policies
Allowance
for Loan Losses
Management
continually evaluates the credit quality of the Company’s loan portfolio and
performs a formal review of the adequacy of the allowance for loan losses on a
quarterly basis. The allowance reflects management’s best estimate of
probable losses inherent in the loan portfolio. Determination of the
allowance is subjective in nature and requires significant
estimates. The Company’s allowance methodology consists of two
broad components, general and specific loan loss allocations.
The
general loan loss allocation is composed of two calculations that are computed
on four main loan categories: commercial, consumer direct, consumer indirect and
residential real estate. The first calculation determines an
allowance level based on the latest seven 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 eight qualitative environmental
factors: levels and trends in delinquencies and impaired loans;
levels of and trends in charge-offs and recoveries; trends in volume and terms
of loans; effects of any changes in risk selection and underwriting standards,
and other changes in lending policies, procedure, and practices; experience,
ability, and depth of lending management and other relevant staff; national and
local economic trends and conditions; industry condition; and effects of changes
in credit concentrations. These two calculations are added together
to determine the general loan loss allocation. The specific loan loss
allocation relates to individual commercial loans that are both greater than
$0.5 million and in a nonaccruing status with respect to
interest. Specific losses are based on discounted estimated cash
flows, including any cash flows resulting from the conversion of
collateral.
Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for
loan loss is charged to operations based on management’s periodic evaluation of
the factors previously mentioned.
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 March 31, 2009. 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.
Income
Taxes
Provisions
for income taxes are based on taxes currently payable or refundable, and
deferred taxes which are based on temporary differences between the tax basis of
assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are reported in the
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled.
Intangible
Assets
Intangible
assets include core deposit intangibles, customer relationship intangibles and
goodwill arising from acquisitions. Core deposit intangibles and
customer relationship intangibles are amortized on either an accelerated or
straight-line basis over periods ranging from 7 to 20 years. The
carrying value of goodwill and other intangible assets is based upon discounted
cash flow modeling techniques that require management to make estimates
regarding the amount and timing of expected future cash flows. It
also requires use of a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest rates,
required equity market premiums, and company-specific risk
indicators.
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.
Retirement
Benefits
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also
provides deferred compensation and supplemental executive retirement plans for
selected current and former employees and officers. Expense under
these plans is charged to current operations and consists of several components
of net periodic benefit cost based on various actuarial assumptions regarding
future experience under the plans, including discount rate, rate of future
compensation increases and expected return on plan assets.
New
Accounting Pronouncements
SFAS
No. 141(R)
In
December 2007, the FASB issued SFAS No. 141(R), Business
Combinations. This statement provides new accounting guidance
and disclosure requirements for business combinations. The Company
will be required to apply SFAS No. 141(R) to all business combinations completed
on or after January 1, 2009.
FSP
FAS 132(R)-1
In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about
Postretirement Benefit Plan Assets.” This FSP amends SFAS No. 132 (revised
2003), “Employers’ Disclosures about Pensions and Other Postretirement
Benefits,” to provide guidance on an employer’s disclosures about plan assets of
a defined benefit pension or other postretirement plan on investment policies
and strategies, major categories of plan assets, inputs and valuation techniques
used to measure the fair value of plan assets and significant concentrations of
risk within plan assets. This FSP shall be effective for fiscal years ending
after December 15, 2009, with earlier application permitted. Upon initial
application, the provisions of this FSP are not required for earlier periods
that are presented for comparative purposes. The Company is currently evaluating
the disclosure requirements of this new FSP.
FASB
Staff Positions
In April
2009, the FASB issued three related Staff Positions to clarify the application
of SFAS 157 to fair value measurements in the current economic environment,
modify the recognition of other-than-temporary impairments of debt securities,
and require companies to disclose the fair values of financial instruments in
interim periods. The final Staff Positions are effective for interim and annual
periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009, if all three Staff Positions or both the
fair-value measurements and other-than-temporary impairment Staff Positions are
adopted simultaneously. The Company will adopt all three staff
positions in the second quarter of 2009.
FASB Staff Position (FSP) 157-4
provides additional guidance for estimating fair value in accordance with
SFAS 157 when the volume and level of activity for the asset or liability have
significantly decreased. It also provides guidance on identifying circumstances
that indicate a transaction is not orderly. It emphasizes that even if there has
been a significant decrease in the volume and level of activity for the asset or
liability and regardless of the valuation technique used, the objective of a
fair value measurement remains the same. Fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale), between
market participations at the measurement date under current market
conditions. This FSP is not expected to have a significant impact on
the Company’s financial statements.
FSP 115-2 and FSP 124-2
amends the other-than-temporary impairment guidance in U.S. GAAP for debt
securities to make the guidance more operational and to improve the presentation
and disclosure of other-than-temporary impairments on debt and equity securities
in the financial statements. It does not amend existing recognition and
measurement guidance related to other-than-temporary impairments of equity
securities. This FSP is not expected to have a significant impact on
the Company’s financial statements.
FSP FAS 107-1 and APB 28-1
amends SFAS 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. It also amends APB Opinion No. 28,
Interim Financial
Reporting, to require those disclosures in summarized information in
interim reporting periods. This FSP is not expected to have a
significant impact on the Company’s financial statements.
NOTE
D: EARNINGS PER SHARE
The
Company adopted FSP No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities
effective January 1, 2009. This FSP addresses whether
instruments granted in share-based payment transactions are participating
securities prior to vesting and, therefore, need to be included in the earnings
allocation in computing earnings per share under the two-class
method. The adoption of this FSP had a minimal effect on the EPS
calculation for the Company.
Basic
earnings per share are computed based on the weighted-average common shares
outstanding for the period. Diluted earnings per share are based on
the weighted-average shares outstanding adjusted for the dilutive effect of
restricted stock and the assumed exercise of stock options during the
year. The dilutive effect of options is calculated using the treasury
stock method of accounting. The treasury stock method determines the
number of common shares that would be outstanding if all the dilutive options
(those where the average market price is greater than the exercise price) were
exercised and the proceeds were used to repurchase common shares in the open
market at the average market price for the applicable time
period. There were approximately 2.1 million anti-dilutive stock
options outstanding at March 31, 2009 compared to approximately 1.6 million
weighted-average anti-dilutive stock options outstanding at March 31, 2008 that
were not included in the computation below. The following is a
reconciliation of basic to diluted earnings per share for the three months ended
March 31, 2009 and 2008.
|
Three
Months Ended March 31,
|
|
(000's
omitted, except per share data)
|
2009
|
2008
|
|
Net
income
|
$10,465
|
$10,898
|
|
Income
attributable to unvested stock-based compensation awards
|
(49)
|
(40)
|
|
Income
available to common shareholders –basic
|
10,416
|
10,858
|
|
Weighted
average common shares outstanding
|
32,651
|
29,720
|
|
Basic
earnings per share
|
$0.32
|
$0.37
|
|
|
|
|
|
Net
income
|
$10,465
|
$10,898
|
|
Income
attributable to unvested stock-based compensation awards
|
(49)
|
(40)
|
|
Income
available to common shareholders –basic
|
10,416
|
10,858
|
|
Weighted
average common shares outstanding
|
32,651
|
29,720
|
|
Assumed
exercise of stock options
|
167
|
315
|
|
Adjusted
weighted-average shares – diluted
|
32,818
|
30,035
|
|
Diluted
earnings per share
|
$0.32
|
$0.36
|
|
NOTE
E: INTANGIBLE ASSETS
The gross
carrying amount and accumulated amortization for each type of intangible asset
are as follows:
|
|
As
of March 31, 2009
|
|
As
of December 31, 2008
|
|
|
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
|
($39,414)
|
$20,519
|
|
$59,933
|
($37,593)
|
$22,340
|
Other
intangibles
|
|
7,882
|
(3,032)
|
4,850
|
|
7,882
|
(2,747)
|
5,135
|
Total
amortizing intangibles
|
|
67,815
|
(42,446)
|
25,369
|
|
67,815
|
(40,340)
|
27,475
|
Non-amortizing
intangible assets:
|
|
|
|
|
|
|
|
|
Goodwill
|
|
301,150
|
0
|
301,150
|
|
301,149
|
0
|
301,149
|
Total
intangible assets, net
|
|
$368,965
|
($42,446)
|
$326,519
|
|
$368,964
|
($40,340)
|
$328,624
|
No
goodwill impairment adjustment was recognized in the first quarter of 2009. The
estimated aggregate amortization expense for each of the succeeding fiscal years
ended December 31 is as follows:
(000's
omitted)
|
|
Amount
|
Apr-Dec
2009
|
|
$5,982
|
2010
|
|
5,801
|
2011
|
|
3,356
|
2012
|
|
2,793
|
2013
|
|
2,176
|
Thereafter
|
|
5,261
|
Total
|
|
$25,369
|
NOTE
F: MANDATORILY REDEEMABLE PREFERRED SECURITIES
The
Company sponsors two business trusts, Community Statutory Trust III and
Community Capital Trust IV (Trust IV), of which 100% of the common stock is
owned by the Company. The trusts were formed for the purpose of
issuing company-obligated mandatorily redeemable preferred securities to
third-party investors and investing the proceeds from the sale of such preferred
securities solely in junior subordinated debt securities of the
Company. The debentures held by each trust are the sole assets of
that trust. Distributions on the preferred securities issued by each
trust are payable semi-annually or quarterly at a rate per annum equal to the
interest rate being earned by the trust on the debentures held by that trust and
are recorded as interest expense in the consolidated financial
statements. The preferred securities are subject to mandatory
redemption, in whole or in part, upon repayment of the
debentures. The Company has entered into agreements which, taken
collectively, fully and unconditionally guarantee the preferred securities
subject to the terms of each of the guarantees. The terms of the
preferred securities of each trust are as follows:
|
Issuance
|
Par
|
|
Maturity
|
|
|
Trust
|
Date
|
Amount
|
Interest
Rate
|
Date
|
Call
Provision
|
Call
Price
|
III
|
7/31/2001
|
$24.5
million
|
3
month LIBOR plus 3.58% (4.75%)
|
7/31/2031
|
5
year beginning 2006
|
104.50%
declining to par in 2011
|
IV
|
12/8/2006
|
$75
million
|
3
month LIBOR plus 1.65% (2.97%)
|
12/15/2036
|
5
year beginning 2012
|
Par
|
Upon the
issuance of Trust IV, the Company entered into an interest rate swap agreement
to convert the variable rate trust preferred securities into a fixed rate
security for a term of five years at a fixed rate of
6.43%. Additional interest expense of $550,000 was recognized based
on the interest rate swap agreement for the three months ended March 31, 2009,
compared to the recognition of lower interest expense of $37,000 for the three
months ended March 31, 2008.
NOTE
G: BENEFIT PLANS
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also provides
supplemental pension retirement benefits for several current and former key
employees. During the first quarter, the Company made a contribution
to its defined benefit pension plan of $15.0 million. No other
contributions are required for regulatory purposes in 2009. The
Company accrues for the estimated cost of these benefits through charges to
expense during the years that employees earn these benefits. The net
periodic benefit cost for the three months ended March 31 is as
follows:
|
Pension
Benefits
|
|
Post-retirement
Benefits
|
|
|
Three
Months Ended
|
|
Three
Months Ended
|
|
|
March
31,
|
|
March
31,
|
|
(000's
omitted)
|
2009
|
2008
|
|
2009
|
2008
|
|
Service
cost
|
$874
|
$779
|
|
$200
|
$175
|
|
Interest
cost
|
914
|
819
|
|
154
|
150
|
|
Expected
return on plan assets
|
(1,172)
|
(1,117)
|
|
0
|
0
|
|
Net
amortization and deferral
|
686
|
165
|
|
15
|
25
|
|
Amortization
of prior service cost
|
(29)
|
(28)
|
|
13
|
27
|
|
Amortization
of transition obligation
|
0
|
0
|
|
10
|
10
|
|
Net
periodic benefit cost
|
$1,273
|
$618
|
|
$392
|
$387
|
|
NOTE
H: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS
The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its
customers. These financial instruments consist primarily of
commitments to extend credit and standby letters of
credit. Commitments to extend credit are agreements to lend to
customers, generally having fixed expiration dates or other termination clauses
that may require payment of a fee. These commitments consist
principally of unused commercial and consumer credit lines. Standby
letters of credit generally are contingent upon the failure of the customer to
perform according to the terms of an underlying contract with a third
party. The credit risks associated with commitments to extend credit
and standby letters of credit are essentially the same as that involved with
extending loans to customers and are subject to normal credit
policies. Collateral may be obtained based on management’s assessment
of the customer’s creditworthiness.
The
contract amount of commitment and contingencies are as follows:
(000's
omitted)
|
March
31,
2009
|
December
31,
2008
|
Commitments
to extend credit
|
$498,355
|
$523,017
|
Standby
letters of credit
|
12,559
|
13,209
|
Total
|
$510,914
|
$536,226
|
NOTE
I: FAIR VALUE
SFAS No.
159, The Fair Value Option for
Financial Assets and Financial Liabilities (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
Company has elected to value loans held for sale at fair value in order to more
closely match the gains and losses associated with loans held for sale with the
gains and losses on forward sales contracts. Accordingly the impact
on the valuation will be recognized in the Company’s consolidated statement of
income. All mortgage loans held for sale are current and in
performing status.
SFAS No.
157, Fair Value
Measurements (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:
|
March
31, 2009
|
|
December
31. 2008
|
(000's
omitted)
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
Available-for-sale
investment securities
|
$1,026
|
$1,199,964
|
$48,703
|
$1,249,693
|
|
$1,035
|
$1,211,617
|
$51,030
|
$1,263,682
|
Forward
sales contracts
|
0
|
(102)
|
0
|
(102)
|
|
0
|
0
|
0
|
0
|
Commitments
to originate real estate loans for sale
|
0
|
0
|
271
|
271
|
|
0
|
0
|
0
|
0
|
Mortgage
loans held for sale
|
0
|
16,429
|
0
|
16,429
|
|
0
|
0
|
0
|
0
|
Interest
rate swap
|
0
|
(6,533)
|
0
|
(6,533)
|
|
0
|
(6,721)
|
0
|
(6,721)
|
Total
|
$1,026
|
$1,209,758
|
$48,974
|
$1,259,758
|
|
$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.
|
·
|
Mortgage
loans held for sale – Mortgage loans held for sale are carried at fair
value, which is determined using quoted secondary-market prices of loans
with similar characteristics and, as such, have been classified as a Level
2 valuation. The unpaid principal value of mortgage loans held
for sale at March 31, 2009 is $16.1 million. The unrealized
gain on mortgage loans held for sale of $0.3 million was recognized in
mortgage banking and other income in the consolidated statement of income
for the quarter ended March 31,
2009
|
·
|
Forward
sales contracts – The Company enters into forward sales contracts to sell
certain residential real estate loans. Such commitments are
considered to be derivative financial instruments and, therefore, are
carried at estimated fair value in the other asset or other liability
section of the consolidated balance sheet. The fair value of
these forward sales contracts is primarily measured by obtaining pricing
from certain government-sponsored entities. The pricing is
derived from market observable inputs that can generally be verified and
do not typically involve significant judgment by the Company and
therefore, are classified as Level 2 in the fair value
hierarchy.
|
·
|
Commitments
to originate real estate loans for sale – The Company enters into various
commitments to originate real estate loans for sale. Such
commitments are considered to be derivative financial instruments and,
therefore, are carried at estimated fair value in the other asset or other
liability section of the consolidated balance sheet. The
estimated fair value of these commitments is determined using quoted
secondary market prices obtained from certain government-sponsored
entities. Additionally, SAB No. 109 requires the expected net
future cash flows related to the associated servicing of the loan to be
included in the fair value measurement of the derivative. The
expected net future cash flows are based on a valuation model that
calculates the present value of estimated net servicing
income. The valuation model incorporates assumptions that
market participants would use in estimating future net servicing
income. Such assumptions include estimates of the cost of
servicing loans, appropriate discount rate and prepayment
speeds. The determination of expected net cash flows is
considered a significant unobservable input contributing to the Level 3
classification of commitments to originate real estate loans for
sale.
|
·
|
Interest
rate swap – The Company utilizes interest rate swap agreements to modify
the repricing characteristics of certain of its interest-bearing
liabilities. The fair value of these interest rate swaps 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 and
therefore, classified as Level 2 in the fair value
hierarchy.
|
The
changes in Level 3 assets measured at fair value on a recurring basis are
summarized in the following table:
|
|
Three
Months Ended March 31,
|
(000's
omitted)
|
|
2009
|
2008
|
Beginning
balance
|
|
$51,030
|
$73,442
|
Total
gains (losses) included in earnings
|
|
0
|
6
|
Total
gains (losses) included in other comprehensive income
|
|
(1,942)
|
(3,796)
|
Purchases
|
|
16
|
0
|
Sales/calls
|
|
(401)
|
(68)
|
Commitments
to originate real estate loans held for sale
|
|
271
|
0
|
Ending
balance
|
|
$48,974
|
$69,584
|
Assets
and liabilities measured on a non-recurring basis:
|
March
31, 2009
|
|
December
31, 2008
|
(000's
omitted)
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
Impaired
loans
|
$0
|
$364
|
$1,448
|
$1,812
|
|
$0
|
$0
|
$850
|
$850
|
Goodwill
|
n/a
|
n/a
|
n/a
|
n/a
|
|
0
|
0
|
5,579
|
5,579
|
Mortgage
servicing rights
|
0
|
0
|
2,387
|
2,387
|
|
|
|
|
|
Total
|
$0
|
$364
|
$3,835
|
$4,199
|
|
$0
|
$0
|
$6,429
|
$6,429
|
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. Due primarily to
an increase in the cost of servicing and an increase in the expected
prepayment speed of the Company’s sold loan portfolio with servicing
retained, the fair value of the Company’s mortgage servicing rights
declined during the first quarter of 2009. As a result of this
decline, the Company established a valuation allowance of $0.1 million at
March 31, 2009. The fair value of mortgage servicing rights is
based on a valuation model incorporating inputs that market participants
would use in estimating future net servicing income. Such
inputs include estimates of the cost of servicing loans, appropriate
discount rate and prepayment speeds. These inputs are
considered to be unobservable and contribute to the Level 3 classification
of mortgage servicing rights.
|
Loans are
generally not recorded at fair value on a recurring
basis. Periodically, the Company records nonrecurring adjustment 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. At March 31, 2009, all
impaired loans were classified as a Level 2 valuation.
The
initial carrying value of goodwill 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 requirement 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. As a result of significant declines the equity markets
experienced in 2008, management determined a triggering even had occurred and
the goodwill associated with Nottingham Advisors, one of the Company’s wealth
management businesses, was tested for impairment during the fourth quarter of
2008. Based on the goodwill valuation performed in the fourth quarter
of 2008 using Level 3 inputs, the Company recognized an impairment charge and
wrote down the carrying value of the goodwill by $1.7 million to $5.6
million.
NOTE
J: 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 Northeastern Pennsylvania.
Immaterial
operating segments of the Company’s operations, which do not have similar
characteristics to the banking segment and do not meet the quantitative
thresholds requiring disclosure, are included in the “Other”
category. Revenues derived from these segments includes
administration, consulting and actuarial services provided to sponsors of
employee benefit plans, broker-dealer and investment advisory services, asset
management services to individuals, corporate pension and profit sharing plans,
trust services and insurance commissions from various insurance related products
and services. The accounting policies used in the disclosure of
business segments are the same as those described in the summary of significant
accounting policies (See Note A, Summary of Significant Accounting
Policies of the most recent Form 10-K for the year ended December 31,
2008 filed with the SEC on March 13, 2009).
Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:
(000's
omitted)
|
Banking
|
Other
|
Consolidated
Total
|
For
the Three Months Ended March
31, 2009
|
|
|
|
Net
interest income
|
$40,172
|
$14
|
$40,186
|
Provision
for loan losses
|
2,810
|
0
|
2,810
|
Noninterest
income excluding gain (loss) on investment securities and debt
extinguishments
|
11,110
|
9,246
|
20,356
|
Gain
on investment securities
|
0
|
0
|
0
|
Amortization
of intangible assets
|
1,847
|
258
|
2,105
|
Other
operating expenses
|
34,152
|
8,144
|
42,296
|
Income
before income taxes
|
$12,473
|
$858
|
$13,331
|
Assets
|
$5,286,736
|
$37,997
|
$5,324,733
|
Goodwill
|
$287,965
|
$13,185
|
$301,150
|
|
|
|
|
For the Three Months
Ended March 31, 2008
|
|
|
|
Net
interest income
|
$35,515
|
$ 83
|
$35,598
|
Provision
for loan losses
|
780
|
0
|
780
|
Noninterest
income excluding gain (loss) on investment securities and debt
extinguishments
|
8,467
|
8,864
|
17,331
|
Gain
on investment securities
|
287
|
0
|
287
|
Amortization
of intangible assets
|
1,421
|
110
|
1,531
|
Other
operating expenses
|
29,870
|
6,973
|
36,843
|
Income
before income taxes
|
$ 12,198
|
$ 1,864
|
$ 14,062
|
Assets
|
$4,622,569
|
$35,846
|
$4,658,415
|
Goodwill
|
$221,315
|
$13,407
|
$234,722
|
NOTE
K: DERIVATIVE INSTRUMENTS
On
January 1, 2009, the Company adopted the provisions of SFAS No. 161,
“Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement
No. 133.” SFAS No. 161 amended the disclosure
requirements for derivative financial instruments and hedging
activities. As SFAS No. 161 amended only the disclosure
requirements for derivative financial instruments and hedged items, the adoption
had no impact on the Company’s statements of income and condition.
The
Company is party to derivative financial instruments in the normal course of its
business to meet the financing needs of its customers and to manage its own
exposure to fluctuations in interest rates. These financial
instruments have been limited to interest rate swap agreements, commitments to
originate real estate loans held for sale and forward sales
commitments. The Company does not hold or issue derivative financial
instruments for trading or other speculative purposes.
The
Company enters into forward sales commitments for the future delivery of
residential mortgage loans, and interest rate lock commitments to fund loans at
a specified interest rate. The forward sales commitments are utilized
to reduce interest rate risk associated with interest rate lock commitments and
loans held for sale. Changes in the estimated fair value of the
forward sales commitments and interest rate lock commitments subsequent to
inception are based on changes in the fair value of the underlying loan
resulting from the fulfillment of the commitment and changes in the probability
that the loan will fund within the terms of the commitment, which is affected
primarily by changes in interest rates and the passage of time. At
inception and during the life of the interest rate lock commitment, the Company
includes the expected net future cash flows related to the associated servicing
of the loan as part of the fair value measurement of the interest rate lock
commitments. These derivatives are recorded at fair value in
accordance with SFAS 133.
The
Company utilizes interest rate swap agreements as part of the management of
interest rate risk to modify the repricing characteristics of certain of its
borrowings. The interest rate swap has been designated as a
qualifying cash flow hedge in accordance with SFAS 133. See further
details of interest rate swap agreements in Note H to the consolidated financial
statements as of December 31, 2008.
The
following table presents the Company’s derivative financial instruments, their
estimated fair values, and balance sheet location as of March 31,
2009:
|
As
of March 31, 2009
|
|
Asset
Derivatives
|
|
Liability
Derivatives
|
(000's
omitted)
|
Location
|
Notional
|
Fair
Value
|
|
Location
|
Notional
|
Fair
Value
|
Derivatives
designated as hedging instruments under SFAS 133:
|
|
|
|
|
|
|
|
Interest
rate swap agreement
|
|
|
|
|
Other
liabilities
|
($75,000)
|
($6,533)
|
Derivatives
not designated as hedging instruments under SFAS 133:
|
|
|
|
|
|
|
|
Interest
rate lock commitments
|
Other
assets
|
$13,651
|
$271
|
|
|
|
|
Forward
sales commitments
|
|
|
|
|
Other
liabilities
|
(20,369)
|
(103)
|
Total
derivatives
|
|
|
$271
|
|
|
|
($6,636)
|
The
following table presents the Company’s derivative financial instruments and the
location of the net gain or loss recognized in the statement of income for the
three months ended March 31, 2009:
|
For
the Quarter Ending March 31, 2009
|
(000's
omitted)
|
Location
|
|
Gain/(loss)
recognized in the Statement of Income
|
Interest
rate swap agreement
|
Interest
on borrowings
|
|
$(550)
|
Interest
rate lock commitments
|
Other
banking services
|
|
271
|
Forward
sales commitments
|
Other
banking services
|
|
(103)
|
Total
|
|
|
$(382)
|
The
amount of gain recognized during the three months ended March 31, 2009 in other
comprehensive income related to the interest rate swap accounted for as a
hedging instrument was approximately $115,000. The amount of loss
reclassified from accumulated other comprehensive income into income (effective
portion) amounted to $550,000 and is located in interest expense on
borrowings.
Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations
Introduction
This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) primarily reviews the financial condition and results of
operations of Community Bank System, Inc. (the Company or CBSI) as of and for
the three months ended March 31, 2009 and 2008, although in some circumstances
the fourth quarter of 2008 is also discussed in order to more fully explain
recent trends. The following discussion and analysis should be read
in conjunction with the Company's Consolidated Financial Statements and related
notes that appear on pages 3 through 17. All references in the
discussion to the financial condition and results of operations are to those of
the Company and its subsidiaries taken as a whole.
Unless
otherwise noted, the term “this year” refers to results in calendar year 2009,
“first quarter” refers to the quarter ended March 31, 2009, earnings per share
(EPS) figures refer to diluted EPS, and net interest income and net interest
margin are presented on a fully tax-equivalent (FTE) basis.
This
MD&A contains certain forward-looking statements with respect to the
financial condition, results of operations and business of the
Company. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ
materially from those proposed by such forward-looking statements are set herein
under the caption, “Forward-Looking Statements,” on page 32.
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 management’s discretion with
regard to choosing the most suitable methodology for reporting the Company’s
financial performance. It is management’s opinion that the accounting
estimates covering certain aspects of the business have more significance than
others due to the relative importance of those areas to overall performance, or
the level of subjectivity in the selection process. These estimates
affect the reported amounts of assets and liabilities and disclosures of
revenues and expenses during the reporting period. Actual results
could differ from those estimates. Management believes that critical
accounting estimates include:
·
|
Allowance
for loan losses - The allowance for loan losses reflects management’s best
estimate of probable losses inherent in the loan
portfolio. Determination of the allowance is inherently
subjective. It requires significant estimates including the
amounts and timing of expected future cash flows on impaired loans and the
amount of estimated losses on pools of homogeneous loans which is based on
historical loss experience and consideration of current economic trends,
all of which may be susceptible to significant
change.
|
·
|
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.
|
·
|
Provision
for income taxes - The Company is subject to examinations from various
taxing authorities. Such examinations may result in challenges
to the tax return treatment applied by the Company to specific
transactions. Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate. Should tax laws change or the taxing authorities
determine that management’s assumptions were inappropriate, an adjustment
may be required which could have a material effect on the Company’s
results of operations.
|
·
|
Carrying
value of goodwill and other intangible assets - The carrying value of
goodwill and other intangible assets is based upon discounted cash flow
modeling techniques that require management to make estimates regarding
the amount and timing of expected future cash flows. It also
requires use of a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest
rates, required equity market premiums and company-specific risk
indicators.
|
A summary
of the accounting policies used by management is disclosed in Note A, “Summary
of Significant Accounting Policies”
on pages
49-54 of the most recent Form 10-K (fiscal year ended December 31, 2008) filed
with the Securities and Exchange Commission on March 13, 2009.
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 high-quality, profitable loan and deposit portfolios
using both organic and acquisition strategies, (iii) increase the noninterest
income component of total revenues through development of banking-related fee
income, growth in existing financial services business units, and the
acquisition of additional financial services and banking businesses, and (iv)
utilize technology to deliver customer-responsive products and services and
reduce operating costs.
Significant
factors management reviews to evaluate achievement of the Company’s operating
objectives and its operating results and financial condition include, but are
not limited to: net income and earnings per share, return on assets and equity,
net interest margins, noninterest income, operating expenses, asset quality,
loan and deposit growth, capital management, performance of individual banking
and financial services units, liquidity and interest rate sensitivity,
enhancements to customer products and services, technology advancements, market
share, peer comparisons, and the performance of acquisition and integration
activities.
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 raised approximately $50 million of
equity capital in the form of common stock in October 2008.
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.
First
quarter net income of $10.5 million, or $0.32 per share decreased 11% or $0.04
from the $0.36 per share reported in the first quarter of
2008. Increased operating expenses, principally acquisition related,
and significantly higher FDIC insurance assessments and a higher provision for
loan losses resulted in the decrease. These were partially offset by
higher net interest income generated through organic and acquired growth of both
loans and core deposits, continued expansion of non-interest income sources,
increased secondary market mortgage activity and a stable net interest
margin. Cash earnings per share (which excludes the after-tax effect
of the amortization of intangibles assets and acquisition-related market value
adjustments) were $0.37 versus $0.41 for the prior year’s first
quarter.
Asset
quality in the first quarter of 2009 remained stable and favorable, as compared
to peer financial organizations, with increases in loan charge-off, delinquency
and nonperforming loan ratios as well as a higher provision for loan losses
versus the first quarter of 2008, but they continued to be 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
organic growth and the acquisition of Citizens. The investment
portfolio, including cash equivalents, increased as compared to both the first
quarter of 2008 and December 31, 2008 due to the net liquidity created from the
acquisition of Citizens in the fourth quarter of 2008 and organic deposit
growth. Average deposits increased in the first quarter of 2009 as
compared to both the first and fourth quarters of 2008, reflective of the
Citizens acquisition and growth in core deposits. External borrowings
decreased from the end of December 2008 and the first quarter of
2008.
Net Income and
Profitability
As shown
in Table 1, net income for the quarter of $10.5 million declined 4.0% versus the
first quarter of 2008. Earnings per share for the first quarter of $0.32 was
$0.04 lower than the EPS generated in the same period of last
year. First quarter net interest income of $40.2 million was up $4.6
million or 12.9% from the comparable prior year period. The current
quarter’s provision for loan losses increased $2.0 million as compared to the
first quarter of 2008 and increased $0.4 million from the fourth quarter of
2008. First quarter noninterest income, excluding securities gains
and losses, was $20.4 million, up $3.0 million or 17% from the first quarter of
2008. Operating expenses of $44.4 million for the quarter were up
$6.0 million or 16% from the comparable prior year period, a significant portion
of the increase was attributable to the acquisitions of ABG and Citizens during
the second and fourth quarters of 2008, as well as higher FDIC insurance
assessments due to significant increases in premium rates and the incurrence of
higher pension costs.
In
addition to the earnings results presented above in accordance with generally
accepted accounting principles (GAAP), the Company provides
cash earnings per share, which excludes the after-tax effect of the amortization
of intangible assets and acquisition-related market value
adjustments. Management believes that this information helps
investors better understand the effect of acquisition activity in reported
results. Cash earnings per share for the first quarter of 2009 was
$0.37, down 9.8% from the $0.41 earned in the comparable period of
2008.
As
reflected in Table 1, the primary reasons for lower earnings were higher
operating expenses and loan loss provision, partially offset by higher
noninterest income and net interest income. Net interest income for
the first quarter of 2009 increased as compared to the first quarter of 2008 as
a result of a slightly higher net interest margin as well as acquired and
organic loan growth. Excluding security gains and losses, noninterest
income increased due to increased activity in the secondary mortgage banking
business, growth in the Company’s employee benefits consulting and plan
administration business, mostly as a result of the acquisition of ABG, as well
as higher banking service fees and debit card related revenues from the acquired
branches. Higher net charge-offs and an increase in total loans
outstanding were the primary reasons for the increase in loan loss
provision. Operating expenses increased for the quarter as compared
to the prior year, primarily due to costs associated with the two acquisitions
in the last year, as well as higher FDIC insurance assessments and higher
pension costs related to the underlying asset performance in 2008.
A
condensed income statement and a reconciliation of GAAP-based earnings results
to cash-based earnings results are as follows:
Table
1: Summary Income Statements
|
|
Three
Months Ended
|
|
|
March
31,
|
(000's
omitted, except per share data)
|
|
2009
|
2008
|
Net
interest income
|
|
$40,186
|
$35,598
|
Provision
for loan losses
|
|
2,810
|
780
|
Noninterest
income, excluding security losses
|
|
20,356
|
17,331
|
Gain
on sales of investment securities
|
|
0
|
287
|
Operating
expenses
|
|
44,401
|
38,374
|
Income
before taxes
|
|
13,331
|
14,062
|
Income
taxes
|
|
2,866
|
3,164
|
Net
income
|
|
$10,465
|
$10,898
|
|
|
|
|
Diluted
earnings per share
|
|
$0.32
|
$0.36
|
Table
2: Reconciliation of GAAP Net Income to Cash Net Income (Non-GAAP
measure)
|
|
Three
Months Ended
|
|
|
March
31,
|
(000’s
omitted)
|
|
2009
|
2008
|
Net
income
|
|
$10,465
|
$10,898
|
After-tax
cash adjustments:
|
|
|
|
Amortization
of market value adjustments
|
|
|
|
on
net assets acquired in mergers
|
|
53
|
156
|
Amortization
of intangible assets
|
|
1,653
|
1,187
|
Net
income – cash
|
|
$12,171
|
$12,241
|
|
|
|
|
Diluted
earnings per share – cash
|
|
$0.37
|
$0.41
|
Net Interest
Income
Net
interest income is the amount by which interest and fees on earning assets
(loans, investments and cash) exceed the cost of funds, primarily interest paid
to the Company's depositors and interest on external borrowings. Net
interest margin is the difference between the gross yield on earning assets and
the cost of interest-bearing funds as a percentage of earning
assets.
As shown
in Table 3, net interest income (with nontaxable income converted to a fully
tax-equivalent basis) for the first quarter of 2009 was $44.2 million, a $4.7
million increase from the same period last year and was consistent with the
fourth quarter of 2008. A $526 million increase in first quarter
interest-earning assets and a one basis point increase in the net interest
margin versus the prior year had a greater impact than the $442 million increase
in average interest-bearing liabilities. As reflected in Table 4, the
volume increase from interest bearing assets and the rate decrease on interest
bearing liabilities had a $15.7 million favorable impact on net interest income,
while the volume increase from interest bearing liabilities and rate decrease on
interest bearing assets had a $11.0 million unfavorable impact on net interest
income. The decrease in the cost of funding had a slightly
greater favorable impact on net interest margin than the lower yields on
interest bearing assets.
Higher
first quarter average loan balances were attributable to $201 million of organic
loan growth since the first quarter of 2008, driven by growth in all portfolios:
consumer installment, consumer mortgage and business lending. The
remaining contribution to the increase in the average first quarter loan balance
was the $117 million of loans acquired in the Citizens
acquisition. Average investments and cash equivalents for the first
quarter period were $207 million higher than the respective period of 2008,
reflective of the net liquidity generated from the Citizens acquisition and
organic deposit growth. In comparison to the prior year, total
average deposits were up $559 million or 17% for the quarter as a result of the
November 2008 acquisition of Citizens. First quarter average deposits
from the Citizens acquisition were $565 million. On an organic basis,
average deposits for the first quarter decreased $5.7 million from the first
quarter of 2008, as a result of the Company’s objective of lowering its overall
funding costs by reducing higher cost time deposits. Quarterly
average borrowings decreased $21 million as compared to the first quarter of
2008 as a portion of the net liquidity from the branch acquisition was used to
eliminate short-term borrowings.
The net
interest margin of 3.82% for the first quarter increased one basis point versus
the same period in the prior year. The improvement was primarily
attributable to a 70-basis point decrease in the cost of funds, driven by a
75-basis point drop in the cost of deposit funding and a nine-basis point
decline in the cost of external borrowings. Partially offsetting
these improvements was a 67-basis point decline in the earning asset yield for
the quarter as compared to the first quarter of 2008. The change in
the earning-asset yield was driven by a 59-basis point decrease in loan yields
for the quarter and an 80-basis point decline in the investment yields for the
quarter, mostly as a result of variable and adjustable-rate loans repricing
downward due to the decline in interest rates, as well as the Company’s
increased holdings of lower yielding cash instruments as it maintains a liquid
position in anticipation of improved investment opportunities in future
periods.
The first
quarter cost of funds decreased 70 basis points versus the prior year quarter
due to a 75-basis point decrease on interest-bearing deposits rates and a
nine-basis point decrease in the average interest rate paid on external
borrowings. The decreased cost of funds was reflective of disciplined
deposit pricing, whereby interest rates on selected categories of deposit
accounts were lowered throughout 2008 and the first quarter of 2009 in response
to market conditions. Additionally, the proportion of customer
deposits in higher cost time deposits has declined 6.0 percentage points over
the last twelve months, while the percentage of deposits in lower cost checking
and savings accounts has increased. The rate paid on long-term
borrowings was impacted by the approximately 200 basis point decrease in the
three-month LIBOR (London Interbank Offered Rates) over the last twelve months,
from which the interest rate on $25 million of the mandatorily redeemable
preferred securities is based.
Table 3
below sets forth information related to average interest-earning assets and
interest-bearing liabilities and their associated yields and rates for the
periods indicated. Interest income and yields are on a fully
tax-equivalent basis using marginal income tax rates of 38.46% in 2009 and
38.49% in 2008. Average balances are computed by accumulating the
daily ending balances in a period and dividing by the number of days in that
period. Loan yields and amounts earned include loan
fees. Average loan balances include nonaccrual loans and loans held
for sale.
Table
3: Quarterly Average Balance Sheet
|
Three
Months Ended
|
|
Three
Months Ended
|
(000's
omitted except yields and rates)
|
March
31, 2009
|
|
March
31, 2008
|
|
|
|
Avg.
|
|
|
|
Avg.
|
|
Average
|
|
Yield/Rate
|
|
Average
|
|
Yield/Rate
|
|
Balance
|
Interest
|
Paid
|
|
Balance
|
Interest
|
Paid
|
Interest-earning
assets:
|
|
|
|
|
|
|
|
Cash
equivalents
|
$155,306
|
$96
|
0.25%
|
|
$44,728
|
$318
|
2.86%
|
Taxable
investment securities (1)
|
842,496
|
10,541
|
5.07%
|
|
764,234
|
10,717
|
5.64%
|
Nontaxable
investment securities
(1)
|
559,344
|
9,579
|
6.95%
|
|
540,993
|
9,334
|
6.94%
|
Loans
(net of unearned discount)
|
3,140,524
|
46,908
|
6.06%
|
|
2,822,100
|
46,672
|
6.65%
|
Total
interest-earning assets
|
4,697,670
|
67,124
|
5.79%
|
|
4,172,055
|
67,041
|
6.46%
|
Noninterest-earning
assets
|
537,582
|
|
|
|
469,964
|
|
|
Total
assets
|
$5,235,252
|
|
|
|
$4,642,019
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
liabilities:
|
|
|
|
|
|
|
|
Interest
checking, savings and money market deposits
|
$1,691,147
|
3,051
|
0.73%
|
|
$1,260,934
|
2,714
|
0.87%
|
Time
deposits
|
1,432,149
|
10,519
|
2.98%
|
|
1,398,650
|
14,980
|
4.31%
|
Short-term
borrowings
|
477,184
|
4,928
|
4.19%
|
|
426,116
|
4,419
|
4.17%
|
Long-term
borrowings
|
384,852
|
4,415
|
4.65%
|
|
457,177
|
5,440
|
4.79%
|
Total
interest-bearing liabilities
|
3,985,332
|
22,913
|
2.33%
|
|
3,542,877
|
27,553
|
3.13%
|
Noninterest-bearing
liabilities:
|
|
|
|
|
|
|
|
Demand
deposits
|
651,298
|
|
|
|
555,927
|
|
|
Other
liabilities
|
52,490
|
|
|
|
60,465
|
|
|
Shareholders'
equity
|
546,132
|
|
|
|
482,750
|
|
|
Total
liabilities and shareholders' equity
|
$5,235,252
|
|
|
|
$4,642,019
|
|
|
|
|
|
|
|
|
|
|
Net
interest earnings
|
|
$44,211
|
|
|
|
$39,488
|
|
Net
interest spread
|
|
|
3.46%
|
|
|
|
3.33%
|
Net
interest margin on interest-earnings assets
|
|
|
3.82%
|
|
|
|
3.81%
|
|
|
|
|
|
|
|
|
Fully
tax-equivalent adjustment
|
|
$4,025
|
|
|
|
$3,890
|
|
(1)
Averages for investment securities are based on historical cost basis and the
yields do not give effect to changes in fair value that is reflected as a
component of
shareholders’
equity and deferred taxes.
As
discussed above and disclosed in Table 4 below, the quarterly change in net
interest income (fully tax-equivalent basis) may be analyzed by segregating the
volume and rate components of the changes in interest income and interest
expense for each underlying category.
Table
4: Rate/Volume
|
1st
Quarter 2009 versus 1st Quarter 2008
|
|
Increase
(Decrease) Due to Change in (1)
|
|
Volume
|
Rate
|
Net
Change
|
(000's
omitted)
|
|
|
|
Interest
earned on:
|
|
|
|
Cash
equivalents
|
$262
|
($484)
|
($222)
|
Taxable
investment securities
|
1,040
|
(1,216)
|
(176)
|
Nontaxable
investment securities
|
314
|
(69)
|
245
|
Loans
(net of unearned discount)
|
4,992
|
(4,756)
|
236
|
Total
interest-earning assets
(2)
|
7,948
|
(7,865)
|
83
|
|
|
|
|
Interest
paid on:
|
|
|
|
Interest
checking, savings and money market deposits
|
825
|
(488)
|
337
|
Time
deposits
|
351
|
(4,812)
|
(4,461)
|
Short-term
borrowings
|
528
|
(19)
|
509
|
Long-term
borrowings
|
(836)
|
(189)
|
(1,025)
|
Total
interest-bearing liabilities (2)
|
3,150
|
(7,790)
|
(4,640)
|
|
|
|
|
Net
interest earnings (2)
|
$4,947
|
$(224)
|
$4,723
|
(1) The
change in interest due to both rate and volume has been allocated in proportion
to the relationship of the absolute dollar amounts of such change in each
component.
(2)
Changes due to volume and rate are computed from the respective changes in
average balances and
rates and are not a summation of the changes of the components.
Noninterest
Income
The
Company’s sources of noninterest income are of three primary types: 1) general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network and electronic banking channels
(performed by Community Bank, N.A. and First Liberty Bank and Trust); 2)
employee benefit plan administration, actuarial and consulting services
(performed by BPAS); and 3) wealth management services, comprised of trust
services (performed by the trust unit within CBNA), investment and insurance
products (performed by Community Investment Services, Inc. or CISI and CBNA
Insurance Agency, Inc.) and asset management (performed by Nottingham Advisors
or Nottingham). Additionally, the Company has periodic transactions,
most often net gains (losses) from the sale of investment securities and
prepayment of debt instruments.
Table
5: Noninterest Income
|
|
Three
Months Ended
|
|
|
March
31,
|
(000's
omitted)
|
|
2009
|
2008
|
Deposit
service charges and fees
|
|
$9,018
|
$8,261
|
Benefit
plan administration, consulting
|
|
|
|
and
actuarial fees
|
|
7,007
|
6,312
|
Wealth
management services
|
|
2,033
|
2,163
|
Other
banking services
|
|
280
|
373
|
Mortgage
banking
|
|
2,018
|
222
|
Subtotal
|
|
20,356
|
17,331
|
Gain
on sales of investment securities
|
|
0
|
287
|
Total
noninterest income
|
|
$20,356
|
$17,618
|
|
|
|
|
Noninterest
income/total income (FTE)
|
|
31.5%
|
30.5%
|
As
displayed in Table 5, noninterest income (excluding securities gains) was $20.4
million in the first quarter, an increase of $3.0 million or 17% from the prior
year level. A significant portion of the growth was attributable to
higher residential mortgage banking revenues, which grew to $2.0 million in the
first quarter of 2009 from $0.2 million in the year earlier
period. Residential mortgage banking income consists of realized
gains or losses from the sale of residential mortgage loans and the origination
of mortgage loan servicing rights, unrealized gains and losses on residential
mortgage loans held for sale and related commitments, mortgage loans servicing
fees and other mortgage loan-related fees and income. Residential
mortgage loans sold to investors, primarily Fannie Mae, totaled $91.8 million in
the first quarter of 2009 as compared to $0.4 million in the first quarter of
2008. Residential mortgage banking income totaled $2.0 million in the
first quarter of 2009. Residential mortgage loans held for sale
recorded at fair value at March 31, 2009 totaled $16.4 million. The
continuation of the level of revenue experienced in the first quarter from
mortgage banking will be dependent on market conditions and the trend in
long-term interest rates.
General
recurring banking fees of $9.0 million for the first quarter were up $0.8
million or 9.2%, as compared to the prior year period, driven by organic core
deposit account growth, higher electronic banking related revenues, and
incremental income generated from the acquired Citizens
branches. Benefit plan administration, consulting and actuarial fees,
increased $0.7 million due to the acquisition of ABG in mid July 2008 which
generated approximately $1.1 million of revenue growth in the
quarter. Asset-based benefit plan administration fees declined as
compared to the first quarter of 2008 due to the overall decline in the
financial market valuations over the last year. First quarter wealth
management services revenue decreased $0.1 million or 6.0%, primarily
attributable to the adverse conditions prevalent throughout the financial
markets.
The ratio
of noninterest income to total income (FTE basis) was 31.5% for the quarter
versus 30.5% for the comparable period in 2008. This improvement is a
function of increased noninterest income, primarily mortgage banking and
acquisition related, combined with proportionally smaller increases in net
interest income.
Operating
Expenses
Table 6
below sets forth the quarterly results of the major operating expense categories
for the current and prior year, as well as efficiency ratios (defined below), a
standard measure of expense utilization effectiveness used in the banking
industry.
Table
6: Operating Expenses
|
|
Three
Months Ended
|
|
|
March
31,
|
(000's
omitted)
|
|
2009
|
2008
|
Salaries
and employee benefits
|
|
$22,962
|
$20,386
|
Occupancy
and equipment
|
|
6,211
|
5,573
|
Data
processing and communications
|
|
4,850
|
3,985
|
Amortization
of intangible assets
|
|
2,105
|
1,531
|
Legal
and professional fees
|
|
1,284
|
1,298
|
Office
supplies and postage
|
|
1,375
|
1,278
|
Business
development and marketing
|
|
1,292
|
1,322
|
FDIC
premiums
|
|
1,375
|
109
|
Other
|
|
2,947
|
2,892
|
Total
operating expenses
|
|
$44,401
|
$38,374
|
|
|
|
|
Operating
expenses/average assets
|
|
3.43%
|
3.32%
|
Efficiency
ratio
|
|
65.3%
|
64.8%
|
As shown
in Table 6, first quarter 2009 operating expenses were $44.4 million, up $6.0
million or 15.7% from the prior year level. The significant portion
of the increase was attributable to incremental operating expenses related to
the ABG and Citizens acquisitions. Additionally, the increase in
operating expenses can be attributable to an increased level of FDIC-insurance
assessments ($1.3 million), higher pension costs related to the
underlying asset performance in 2008 ($0.9 million), higher volume-based data
processing and communication costs ($0.6 million), and increased amortization of
intangibles related to the two acquisitions completed in the last
year ($0.4 million). During 2007 and the first half of
2008, FDIC premiums were principally met through the application of a credit
balance created in prior years. This credit balance was depleted in
the second quarter of 2008 and resulted in higher FDIC premiums in subsequent
quarters. Additionally, the FDIC’s reserve fund has declined over the
past year due to costs associated with recent bank failures and is expected to
continue to decline in the future. Also in late 2008, the FDIC basic
insurance coverage limit was temporarily increased to $250,000 through December
31, 2009. These actions have resulted in significant increases in the
FDIC assessment charge rates (240% above the first quarter of 2008) and are
expected to continue throughout the remainder of 2009. The Company is
also participating in the FDIC’s Temporary Liquidity Guarantee Program (TLGP)
that provides unlimited coverage for transaction deposit accounts and for which
a supplemental 10-basis point premium is assessed. Several expense
category increases continue to be impacted by the Company’s investment in
strategic technology and business development initiatives to grow and enhance
its service offerings.
The
Company’s efficiency ratio (recurring operating expenses excluding intangible
amortization and acquisition expenses divided by the sum of net interest income
(FTE) and recurring noninterest income) was 65.3% for the first quarter, 0.5
percentage point above the comparable quarter of 2008. This resulted
from operating expenses (as described above) increasing 14.5% primarily due to
the acquisitions in the last year and the increased levels of FDIC premium and
pension related expense, while recurring operating income increased at a slower
rate of 13.6% due to a $2.7 million or 15.5% increase in noninterest income
excluding security gains and a $4.7 million or 12.0% increase in net interest
income year over year. Operating expenses as a percentage of average
assets increased 12 basis points for the quarter as operating expenses increased
15.7%, while average assets increased 12.8% during the same time
period. The increased level of FDIC premiums and pension related
costs, which do not enhance revenue growth, impacted both ratios.
Income
Taxes
The first
quarter effective income tax rate was 21.5%, compared to the 22.5% effective tax
rate in the first quarter of 2008. The lower effective tax rate
for 2009 was principally a result of a higher proportion of income being
generated from tax-exempt securities and loans.
Investments
As
reflected in Table 7 below, the carrying value of investments (including
unrealized gains on available-for-sale securities) was $1.42 billion at the end
of the first quarter, an increase of $22.9 million and $110.3 million from
December 31, 2008 and March 31, 2008, respectively. The book value
(excluding unrealized gains) of investments increased $27.2 million and $115.7
million from December 31, 2008 and March 31, 2008,
respectively. During the fourth quarter of 2008 and continuing in the
first quarter of 2009, the Company invested a portion of the net liquidity
received in the Citizens acquisition into mortgage-backed securities and
obligations of state and political subdivisions. The overall mix of
securities within the portfolio over the last year has changed, with an increase
in the proportion of mortgage-backed securities and small decreases in all other
security categories. The change in the carrying value of investments
is impacted by the amount of net unrealized gains in the available for sale
portfolio at a point in time. At March 31, 2009, the portfolio had a
$15.8 million net unrealized gain, a decrease of $4.2 million from the
unrealized gain at December 31, 2008 and a decrease of $5.4 million from the
unrealized gain at March 31, 2008. This fluctuation is indicative of
the liquidity risk associated with the pooled trust preferred securities,
interest rate movements during the respective time periods and the changes in
the size and composition of the portfolio.
Included
in the available for sale portfolio are pooled trust preferred securities with a
current par value of $74.0 million and unrealized losses of $24.6 million at
March 31, 2009. The underlying collateral of these assets is
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 March 31, 2009 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 March 31,
2009. 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.
Table
7: Investments
|
|
March
31, 2009
|
|
December
31, 2008
|
|
March
31, 2008
|
|
|
|
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
|
|
$46,874
|
$49,025
|
|
$61,910
|
$64,268
|
|
$127,019
|
$129,117
|
|
Government
guaranteed mortgage-backed securities
|
|
50,603
|
50,900
|
|
0
|
0
|
|
0
|
0
|
|
Obligations
of state and political subdivisions
|
|
17,333
|
17,655
|
|
15,784
|
16,004
|
|
5,850
|
5,959
|
|
Other
securities
|
|
3,191
|
3,191
|
|
3,196
|
3,196
|
|
3,210
|
3,210
|
|
Total
held-to-maturity portfolio
|
|
118,001
|
120,771
|
|
80,890
|
83,468
|
|
136,079
|
138,286
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-Sale
Portfolio:
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury and Agency securities
|
|
352,307
|
378,018
|
|
382,301
|
411,783
|
|
251,006
|
260,473
|
|
Obligations
of state and political subdivisions
|
|
554,793
|
563,639
|
|
538,008
|
547,939
|
|
534,985
|
547,991
|
|
Corporate
securities
|
|
35,588
|
35,356
|
|
35,596
|
35,152
|
|
37,259
|
37,626
|
|
Collateralized
mortgage obligations
|
|
20,811
|
21,292
|
|
25,464
|
25,700
|
|
32,340
|
32,722
|
|
Pooled
trust preferred securities
|
|
72,206
|
47,567
|
|
72,535
|
49,865
|
|
73,038
|
68,454
|
|
Government
guaranteed mortgage-backed securities
|
|
197,042
|
202,673
|
|
188,560
|
192,054
|
|
171,882
|
174,418
|
|
Subtotal
|
|
1,232,747
|
1,248,545
|
|
1,242,464
|
1,262,493
|
|
1,100,510
|
1,121,684
|
|
Equity
securities
|
|
51,429
|
51,420
|
|
51,628
|
51,628
|
|
49,919
|
49,919
|
|
Total
available-for-sale portfolio
|
|
1,284,176
|
1,299,965
|
|
1,294,092
|
1,314,121
|
|
1,150,429
|
1,171,603
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized gain on available-for-sale portfolio
|
|
15,789
|
0
|
|
20,029
|
0
|
|
21,174
|
0
|
|
Total
|
|
$1,417,966
|
$1,420,736
|
|
$1,395,011
|
$1,397,589
|
|
$1,307,682
|
$1,309,889
|
|
Loans
As shown
in Table 8, loans ended the first quarter at $3.10 billion, down $32.4 million
(1.0%) from year-end 2008 and up $266.0 million (9.4%) versus one year
earlier. The Citizens acquisition added approximately $118 million of
loans to the loan portfolio as of March 31, 2009. Excluding the
impact of the Citizens acquisition, loans increased $147.7 million or 5.2% from
the first quarter of 2008 with organic growth in all portfolios; consumer
mortgage, consumer installment and business lending. During the first
quarter of 2009 loans declined in the consumer mortgage portfolio ($36.0
million) due to the sale of loans and the consumer installment portfolio ($16.1
million), partially offset by an increase in the business lending portfolio
($19.7 million).
Table
8: Loans
(000's
omitted) |
|
March
31, 2009
|
|
December
31, 2008
|
|
March
31, 2008
|
|
Business
lending
|
|
$1,078,593
|
34.7%
|
|
$1,058,846
|
33.8%
|
|
$998,443
|
35.2%
|
|
Consumer
mortgage
|
|
1,026,934
|
33.1%
|
|
1,062,943
|
33.9%
|
|
987,807
|
34.8%
|
|
Consumer
installment
|
|
998,214
|
32.2%
|
|
1,014,351
|
32.3%
|
|
851,536
|
30.0%
|
|
Total
loans
|
|
$3,103,741
|
100.0%
|
|
$3,136,140
|
100.0%
|
|
$2,837,786
|
100.0%
|
|
Business
lending increased $19.7 million in the first three months of 2009 and increased
$80.2 million versus one year ago. Excluding the impact of the
Citizens acquisition, business lending increased $14.1 million over the last
three months and $45.1 million over the last year. 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 the 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
mortgages increased $39.1 million, year-over-year, and declined $36.0 million in
the first three months of 2009. Excluding the impact of the Citizens
acquisition, consumer mortgages decreased $36.3 million for the first quarter of
2009 and increased $25.5 million over the past twelve
months. During the first quarter of 2009, the Company originated
$107.9 million of residential mortgages for sale to others, principally Fannie
Mae. Longer-term fixed rate residential mortgages sold to investors
totaled $91.8 million in the first quarter of 2009. Consumer mortgage
growth has been strong over the last few quarters 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 testament to the stable, low-risk profile of its
portfolio and its ability to successfully meet customer needs at a time when
some national mortgage lenders are restricting their lending activities in many
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.
Consumer
installment loans, including borrowings originated in automobile, marine and
recreational vehicle dealerships, as well as branch originated home equity and
installment loans, decreased $16.1 million in the first three months of 2009 and
increased $146.7 million on a year-over-year basis. Excluding the
impact of the Citizens acquisition, consumer installment lending decreased $13.3
million for the first three months of 2009 and increased $77.1 million for the
year-over-year period. The origination of consumer installment loans
demonstrates definite seasonal patterns and is traditionally slower in the first
quarter. Declines in manufacturer production and industry sale
projections indicate continued weakness in the new vehicle market which has
created a 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 is focused on maintaining the solid profitability produced by its
in-market and contiguous indirect portfolio, while continuing to pursue its
long-term steady approach to expanding its dealer network.
Asset
Quality
Table 9
below exhibits the major components of nonperforming loans and assets and key
asset quality metrics for the periods ending March 31, 2009 and 2008 and
December 31, 2008.
Table
9: Nonperforming Assets
|
|
March
31,
|
|
December
31,
|
|
March
31,
|
(000's
omitted)
|
|
2009
|
|
2008
|
|
2008
|
Nonaccrual
loans
|
|
$13,361
|
|
$11,122
|
|
$7,662
|
Accruing
loans 90+ days delinquent
|
|
947
|
|
553
|
|
392
|
Restructured
loans
|
|
977
|
|
1,004
|
|
1,095
|
Total
nonperforming loans
|
|
15,285
|
|
12,679
|
|
9,149
|
Other
real estate (OREO)
|
|
1,383
|
|
1,059
|
|
1,027
|
Total
nonperforming assets
|
|
$16,668
|
|
$13,738
|
|
$10,176
|
|
|
|
|
|
|
|
Allowance
for loan losses to total loans
|
|
1.29%
|
|
1.26%
|
|
1.28%
|
Allowance
for loan losses to nonperforming loans
|
|
262%
|
|
312%
|
|
398%
|
Nonperforming
loans to total loans
|
|
0.49%
|
|
0.40%
|
|
0.32%
|
Nonperforming
assets to total loans and other real estate
|
|
0.54%
|
|
0.44%
|
|
0.36%
|
Delinquent
loans (30 days old to nonaccruing) to total loans
|
|
1.33%
|
|
1.43%
|
|
0.99%
|
Net
charge-offs (annualized) to quarterly average loans
outstanding
|
|
0.30%
|
|
0.30%
|
|
0.11%
|
Loan
loss provision to net charge-offs (quarterly)
|
|
120%
|
|
100%
|
|
100%
|
As
displayed in Table 9, nonperforming assets at March 31, 2009 were $16.7 million,
a $2.9 million increase versus the level at the end of 2008 and an increase of
$6.5 million as compared to the very favorable level one year
earlier. Other real estate (OREO) increased $0.4 million from
one-year ago and increased $0.3 million from year-end 2008, a result of the
Company managing 20 OREO properties at March 31, 2009 as compared to 12 OREO
properties at March 31, 2008. No single property has a carrying value
in excess of $325,000. Nonperforming loans were 0.49% of total loans
outstanding at the end of the first quarter, nine and 17 basis points higher
than the levels at December 31, 2008 and March 31, 2008,
respectively. The allowance for loan losses to nonperforming loans
ratio, a general measure of coverage adequacy, was 262% at the end of the first
quarter compared, to 312% at year-end 2008 and 398% at March 31, 2008,
reflective of the rising level of nonperforming loans.
Delinquent
loans (30 days through nonaccruing) as a percent of total loans was 1.33% at the
end of the first quarter, ten basis points below the 1.43% at year-end 2008 and
34 basis points higher than the 0.99% at March 31, 2008. The
commercial loan delinquency ratio at the end of the first quarter increased in
comparison to both December 31, 2008 and March 31, 2008. The
delinquency rate for installment loans and real estate loans decreased as
compared to the December 31, 2008 and increased as compared to March 31,
2008. The Company’s success at keeping the non-performing and
delinquency ratios at favorable levels despite deteriorating economic conditions
was the result of its continued focus on maintaining strict underwriting
standards, as well as effective utilization of its collection and recovery
capabilities.
Table
10: Allowance for Loan Losses Activity
|
|
Three
Months Ended
|
|
|
March
31,
|
(000's
omitted)
|
|
2009
|
2008
|
Allowance
for loan losses at beginning of period
|
|
$39,575
|
$36,427
|
Charge-offs:
|
|
|
|
Business
lending
|
|
1,144
|
277
|
Consumer
mortgage
|
|
75
|
52
|
Consumer
installment
|
|
2,027
|
1,348
|
Total
charge-offs
|
|
3,246
|
1,677
|
Recoveries:
|
|
|
|
Business
lending
|
|
109
|
173
|
Consumer
mortgage
|
|
6
|
46
|
Consumer
installment
|
|
799
|
679
|
Total
recoveries
|
|
914
|
898
|
|
|
|
|
Net
charge-offs
|
|
2,332
|
779
|
Provision
for loans losses
|
|
2,810
|
780
|
Allowance
for loan losses at end of period
|
|
$40,053
|
$36,428
|
|
|
|
|
Net
charge-offs (annualized) to quarterly average loans
outstanding:
|
|
|
|
Business
lending
|
|
0.39%
|
0.04%
|
Consumer
mortgage
|
|
0.03%
|
0.00%
|
Consumer
installment
|
|
0.49%
|
0.31%
|
Total
loans
|
|
0.30%
|
0.11%
|
As
displayed in Table 10, net charge-offs during the first quarter were $2.3
million, $1.6 million higher than the equivalent 2008 period. The
business lending, consumer mortgage and consumer installment portfolios
experienced increases in the level of charge-offs as compared to the first
quarter of 2008. The business lending portfolio included on $0.5
million charge-off on a single commercial relationship. The net
charge-off ratio (net charge-offs as a percentage of average loans outstanding)
for the first quarter was 0.30%, 19 basis points higher than the comparable
quarter of 2008. Net charge-offs and the corresponding net charge-off
ratios continue to be below average long-term historical levels.
The
consumer mortgage portfolio experienced a net charge-off ratio of 0.03% for the
quarter, versus a neutral result in the previous year. The consumer
installment and business lending net charge-off ratios for the first quarter of
0.49% and 0.39%, respectively, increased 18 basis points and 35 basis points
versus prior year levels. As compared to the fourth quarter of 2008,
the consumer installment charge-off ratio improved by three basis points while
the business lending portfolio and consumer mortgage portfolio charge-off ratios
were higher by one basis point each.
A loan
loss allowance of $40.1 million was determined as of March 31, 2009,
necessitating a $2.8 million loan loss provision for the quarter, compared to
$0.8 million one year earlier. The first quarter 2009 loan loss
provision was $0.5 million higher than the level of net charge-offs, due mostly
to higher levels of nonperforming loans and greater qualitative risk factors
attributable to the portfolio due to deteriorating economic
conditions. The allowance for loan losses rose $3.6 million or 10.0%
over the last 12 months, slightly higher than the 9.4% growth in the loan
portfolio. Contributing to the changes was the deteriorating
charge-off, nonperforming and delinquency trends experienced over the last
twelve months. This contributed to the ratio of allowance for loan
loss to loans outstanding increasing three basis points to 1.29% for the first
quarter, as compared to the level at December 31, 2008 and increasing one basis
point from the level at March 31, 2008. The increase was also
slightly impacted by the decreased proportion of low-risk consumer mortgage
loans in the overall loan portfolio, a result of the recent selling of mortgages
and organic and acquired growth in the other loan portfolios.
Deposits
As shown
in Table 11, average deposits of $3.8 billion in the first quarter were up
$559.1 million compared to first quarter 2008 and $245.4 million versus the
fourth quarter of last year. Excluding the impact of the Citizens
acquisition, average deposits increased $5.1 million as compared to the fourth
quarter of 2008 and decreased $5.7 million as compared to the first quarter of
the prior year. The mix of average deposits changed since the first
quarter of 2008. The weightings of non-time (interest checking,
non-interest checking, savings and money markets accounts) have increased from
their year-ago levels, while the proportion of time deposits
decreased. This change in deposit mix reflects the Company’s focus on
expanding core account relationships and reducing higher cost time deposit
balances, as well as the deposit profile of the acquired Citizens
branches. This shift in mix, combined with the Company’s ability to
reduce rates due to market conditions, resulted in the quarterly cost of
interest-bearing deposits declining from 2.68% in the first quarter of 2008 to
1.76% in the most recent quarter.
Average
first quarter non-public fund deposits were up $444.5 million or 14.8% compared
to the year earlier period and $178.6 million or 5.5% versus the fourth quarter
of 2008. Average public funds have increased $66.8 million or 25%
from the fourth quarter of 2008 and $114.6 million or 52% from the first quarter
of 2008. The Company continues to focus heavily on growing its
core deposits through enhanced marketing and training programs and new product
offerings introduced over the last few years.
Table
11: Quarterly Average Deposits
|
|
March
31,
|
|
December
31,
|
|
March
31,
|
(000's
omitted)
|
|
2009
|
|
2008
|
|
2008
|
Demand
deposits
|
|
$651,298
|
|
$615,540
|
|
$555,927
|
Interest
checking deposits
|
|
609,750
|
|
571,540
|
|
473,805
|
Savings
deposits
|
|
470,417
|
|
463,797
|
|
452,929
|
Money
market deposits
|
|
610,980
|
|
508,119
|
|
334,200
|
Time
deposits
|
|
1,432,149
|
|
1,370,215
|
|
1,398,650
|
Total
deposits
|
|
$3,774,594
|
|
$3,529,211
|
|
$3,215,511
|
|
|
|
|
|
|
|
Non-public
fund deposits
|
|
$3,439,732
|
|
$3,261,115
|
|
$2,995,201
|
Public
fund deposits
|
|
334,862
|
|
268,096
|
|
220,310
|
Total
deposits
|
|
$3,774,594
|
|
$3,529,211
|
|
$3,215,511
|
Borrowings
At the
end of the first quarter, borrowings of $858.8 million decreased $3.7 million
from December 31, 2008 and $9.3 million versus the end of the first quarter of
2008 as a portion of the new liquidity from the Citizens acquisition was used to
eliminate short-term obligations.
Shareholders’
Equity
Total
shareholders’ equity of $547.2 million at the end of the first quarter increased
$2.5 million from the balance at December 31, 2008. This change
consisted of net income of $10.5 million, $0.6 million from shares issued under
the employee stock plan and $0.6 million from employee stock options earned,
partially offset by dividends declared of $7.2 million and a $2.0 million
decrease in other comprehensive income. The other comprehensive loss
is comprised of a $2.8 million decrease in the after-tax market value adjustment
on the available for sale investment portfolio, partially offset by a $0.1
million increase in the after-tax market value adjustment on the interest rate
swap and a positive $0.7 million adjustment to the funded status of the
Company’s retirement plans. Over the past 12 months, total shareholders’ equity
increased by $58.5 million, as net income and positive contributions from a
common stock offering and shares issued under the employee stock plan more than
offset dividends declared, a lower market value adjustment on investments, and
the funded status of the Company’s defined benefit pension and other
postretirement plans.
The
Company’s Tier I leverage ratio, a primary measure of regulatory capital for
which 5% is the requirement to be “well-capitalized,” was 7.16% at the end of
the first quarter, down six basis points from year-end 2008 and 43 basis points
lower than its level one year ago. The decrease in the Tier I
leverage ratio compared to December 31, 2008 is primarily the result of the
Citizens acquisition and organic loan growth increasing average assets
proportionally more than the common stock offering increased stockholders
equity. Tier I decreased as compared to the prior’s year first
quarter for similar reasons as average assets excluding intangibles and the
market value adjustment increased 12.5% while shareholders’ equity, excluding
intangibles and the market value adjustment, increased at a lesser 6.1%
rate. The tangible equity-to-assets ratio of 4.42% decreased four
basis points from December 31, 2008 and decreased 88 basis points versus March
31, 2008. The decline from the year earlier period was primarily due
to the intangible and total assets added as a result of the acquisition of ABG
and Citizens, having a proportionally greater impact on the ratio than the
common equity offering and other capital generating factors discussed
above.
The
dividend payout ratio (dividends declared divided by net income) for the first
three months of 2009 was 68.8%, up from 57.4% for the first three months of
2008. The ratio increased because net income declined 4.0% while
dividends declared increased 15.2%. The Company’s quarterly dividend
increased because there were 2.9 million more shares outstanding primarily due
to the common stock offering in the fourth quarter of
2008. Additionally, the quarterly dividend was raised 4.8% in August
2008, from $0.21 to $0.22. On a cash earnings basis, the dividend
payout ratio was 59.2% for the first three months of 2009 as compared to 51.1%
for the first three months of 2008.
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); and second, a
projection of subsequent cash availability over an additional 60
days. The minimum policy level of liquidity under the Basic
Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90-day time
horizons. As of March 31, 2009, this ratio was 14.4% for 30 days and
14.3% for 90 days, excluding the Company's capacity to borrow additional funds
from the FHLB.
To
measure longer-term liquidity, a baseline projection of loan and deposit growth
for five years is made to reflect how current liquidity levels could change over
time. This five-year measure reflects adequate liquidity to fund loan and other
asset growth over the next five years.
Forward-Looking
Statements
This
document contains comments or information that constitute forward-looking
statements (within the meaning of the Private Securities Litigation Reform Act
of 1995), which involve significant risks and uncertainties. Actual
results may differ materially from the results discussed in the forward-looking
statements. Moreover, the Company’s plans, objectives and intentions
are subject to change based on various factors (some of which are beyond the
Company’s control). Factors that could cause actual results to differ
from those discussed in the forward-looking statements include: (1)
risks related to credit quality, interest rate sensitivity and
liquidity; (2) the strength of the U.S. economy in general and the
strength of the local economies where the Company conducts its
business; (3) the effect of, and changes in, monetary and fiscal
policies and laws, including interest rate policies of the Board of Governors of
the Federal Reserve System; (4) inflation, interest rate, market and
monetary fluctuations; (5) the timely development of new products and
services and customer perception of the overall value thereof (including
features, pricing and quality) compared to competing products and
services; (6) changes in consumer spending, borrowing and savings
habits; (7) technological changes; (8) any acquisitions or
mergers that might be considered or consummated by the Company and the costs and
factors associated therewith; (9) the ability to maintain and
increase market share and control expenses; (10) the effect of
changes in laws and regulations (including laws and regulations concerning
taxes, banking, securities and insurance) and accounting principles generally
accepted in the United States; (11) changes in the Company’s
organization, compensation and benefit plans and in the availability of, and
compensation levels for, employees in its geographic markets; (12)
the costs and effects of litigation and of any adverse outcome in such
litigation; (13) other risk factors outlined in the Company’s filings with the
Securities and Exchange Commission from time to time; and (14) the success of
the Company at managing the risks of the foregoing.
The
foregoing list of important factors is not all-inclusive. Such
forward-looking statements speak only as of the date on which they are made and
the Company does not undertake any obligation to update any forward-looking
statement, whether written or oral, to reflect events or circumstances after the
date on which such statement is made. If the Company does update or
correct one or more forward-looking statements, investors and others should not
conclude that the Company would make additional updates or corrections with
respect thereto or with respect to other forward-looking
statements.
Item
3. Quantitative and Qualitative Disclosures about 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. Management believes that the tax risk of the
Company's municipal investments associated with potential future changes in
statutory, judicial and regulatory actions is minimal. The Company
has an minimal amount of credit risk in its investment portfolio because
essentially all of the fixed-income securities in the portfolio are AA or higher
rated. Therefore, almost all the market risk in the investment
portfolio is related to interest rates.
The
ongoing monitoring and management of both interest rate risk and liquidity, in
the short and long term time horizons is an important component of the Company's
asset/liability management process, which is governed by limits established in
the policies reviewed and approved annually by the Board of
Directors. The Board of Directors delegates responsibility for
carrying out the policies to the Asset/Liability Committee (ALCO) which meets
each month and is made up of the Company's senior management as well as regional
and line-of-business managers who oversee specific earning asset classes and
various funding sources. As the Company does not believe it is
possible to reliably predict future interest rate movements, it has maintained
an appropriate process and set of measurement tools, which enable it to identify
and quantify sources of interest rate risk in varying rate
environments. The primary tool used by the Company in managing
interest rate risk is income simulation.
While a
wide variety of strategic balance sheet and treasury yield curve scenarios are
tested on an ongoing basis, the following reflects the Company's projected net
interest income sensitivity over the subsequent twelve months based
on:
·
|
Asset
and liability levels using March 31, 2009 as a starting
point.
|
·
|
There
are assumed to be conservative levels of balance sheet growth—low to mid
single digit growth in loans and deposits, while using the cashflows from
investment contractual maturities and prepayments to repay short-term
capital market borrowings or reinvested in securities or cash
equivalents.
|
·
|
The
prime rate and federal funds rates are assumed to move up 200 basis points
over a 12-month period while moving the long end of the treasury curve to
spreads over federal funds that are more consistent with historical
norms. Deposit rates are assumed to move in a manner that
reflects the historical relationship between deposit rate movement and
changes in the federal funds rate.
|
·
|
Cash
flows are based on contractual maturity, optionality, and amortization
schedules along with applicable prepayments derived from internal
historical data and external
sources.
|
Net
Interest Income Sensitivity Model
Change
in interest rates
|
Calculated
annualized increase (decrease) in projected net interest income at March
31, 2009
|
+200
basis points
|
$6,844,000
|
|
0
basis points (normalized yield curve)
|
($3,539,000)
|
|
The
modeled net interest income (NII) reflects an increase in a rising rate
environment from a flat rate scenario as well as interest rate risk exposure to
falling rates despite the Federal Funds trading at a range of 0 – 25 basis
points. The increase in a rising rate environment is largely due to
slower investment cash flows, a higher reinvestment rate, the repricing of
assets to higher rates offset by the increase of liability
rates. 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.
In the 0
basis point model, the current yield curve shifts to a normalized level based on
historical spreads to the federal funds rate. The decrease in NII is
largely due to faster investment cash flows and assets repricing to lower rates
as corresponding liabilities and held at current levels. Despite Fed
Funds trading near 0%, the Company believes 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: the nature and timing of interest
rate levels (including yield curve shape), prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of asset and liability cash flows, and other
factors. While the assumptions are developed based upon current
economic and local market conditions, the Company cannot make any assurances as
to the predictive nature of these assumptions, including how customer
preferences or competitor influences might change. Furthermore, the
sensitivity analysis does not reflect actions that ALCO might take in responding
to or anticipating changes in interest rates.
Item
4. Controls and Procedures
The
Company maintains disclosure controls and procedures, as defined in Rule 13a –
15(e) under the Securities Exchange Act of 1934, designed to: (i) record,
process, summarize, and report within the time periods specified in the
Securities and Exchange Commission’s (SEC) rules and forms, and (ii) accumulate
and communicate to management, including the principal executive and principal
financial officers, as appropriate, to allow timely decisions regarding
disclosure. Based on management’s evaluation of the Company’s
disclosure controls and procedures, with the participation of the Chief
Executive Officer and the Chief Financial Officer, it has concluded that, as of
the end of the period covered by this Quarterly Report on Form 10-Q, these
disclosure controls and procedures were effective as of March 31,
2009.
There
have been no changes in the Company’s internal controls over financial reporting
in connection with the evaluation referenced in the paragraph above that
occurred during the Company’s last fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company’s internal control
over financial reporting.
Part
II. Other
Information
Item
1. Legal
Proceedings
The
Company and its subsidiaries are subject in the normal course of business to
various pending and threatened legal proceedings in which claims for monetary
damages are asserted. Management, after consultation with legal
counsel, does not anticipate that the aggregate liability, if any, arising out
of litigation pending against the Company or its subsidiaries will have a
material effect on the Company’s consolidated financial position or results of
operations.
Item
1A. Risk Factors
There has
not been any material change in the risk factors disclosure from that contained
in the Company’s 2008 Form 10-K for the fiscal year ended December 31, 2008
(filed with the SEC on March 13, 2009).
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds
None
Item
3. Defaults
Upon Senior Securities
Not
applicable.
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
ending March 31, 2009.
Item
5. Other
Information
Not
applicable.
Item
6. Exhibits
Exhibit
No. Description
10.1
|
Supplemental
Retirement Plan Agreement dated April 9, 2009, by and among Community Bank
System, Inc., Community Bank, N.A. and George J.
Getman. Incorporated by reference to Exhibit 10.1 to the Form
8-K filed on April 9, 2009 (Registration No.
001-13695.
|
10.2
|
Employment
Agreement dated March 18, 2009 by and among Community Bank System, Inc.,
Community Bank, N.A. and Mark E. Tryniski. Incorporated by
reference to Exhibit 10.1 to the Form 8-K filed on March 18, 2009
(Registration No. 001-13695).
|
10.3
|
Supplemental
Retirement Plan Agreement dated March 18, 2009 by and among Community Bank
System, Inc., Community Bank, N.A. and Mark E.
Tryniski. Incorporated by reference to Exhibit 10.2 to the Form
8-K filed on March 18, 2009 (Registration No.
001-13695).
|
31.1
|
Certification
of Mark E. Tryniski, President and Chief Executive Officer of the
Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
31.2
|
Certification
of Scott Kingsley, Treasurer and Chief Financial Officer of the
Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
32.1
|
Certification
of Mark E. Tryniski, President and Chief Executive Officer of the
Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2
|
Certification
of Scott Kingsley, Treasurer and Chief Financial Officer of the
Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
|
Signatures
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Community
Bank System, Inc.
Date: May 7,
2009 |
|
/s/
Mark E. Tryniski |
|
|
Mark E.
Tryniski, President and Chief |
|
|
Executive
Officer |
|
|
|
|
|
|
Date: May 7,
2009 |
|
/s/
Scott Kingsley |
|
|
Scott
Kingsley, Treasurer and Chief |
|
|
Financial
Officer |