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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1998
Commission file number 0-11716
[GRAPHIC OMITTED]
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1213679
(State or other jurisdiction of incorporation)(I.R.S.Employer Identification No)
5790 WIDEWATERS PARKWAY, DEWITT, NEW YORK 13214-1883
(Address of principal executive offices) (Zip Code)
(315) 445-2282
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Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Common Stock, No Par
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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 all the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X}
State the aggregate market value of the voting and non-voting
common equity stock held by non-affiliates of the registrant. The
aggregate market value shall be computed by reference to the price
at which the common equity was sold, or the average bid and asked
prices of such common equity, as of a specified date within 60 days
prior to the date of filing.
$186,109,993 based upon average selling price of $25.625 and 7,262,829
shares on March 3, 1999.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
7,262,829 Shares of common stock, no par value,
were issued and outstanding on March 3, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE.
List hereunder the following documents if incorporated by
reference and the Part of the Form 10-K into which the document is
incorporated: (1) any annual report to security holders; (2) any
proxy or information statement; and (3) any prospectus filed pursuant
to Rule 424(b) or (c) under the Securities Act of 1933.
Definitive Proxy Statement for Annual Meeting of Shareholders
to be held on May 12, 1999 (the "Proxy Statement") is incorporated
by reference in Part III of this Annual Report on Form 10-K.
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TABLE OF CONTENTS
PART I PAGE
Item 1. Business ............................................. 1
Item 2. Properties ........................................... 6
Item 3. Legal Proceedings .................................... 6
Item 4. Submission of Matters to a Vote of Security Holders .. 6
Item 4A. Executive Officers of the Registrant ................. 7
PART II
Item 5. Market for Registrant's Common Equity
and Related Shareholder Matters ...................... 8
Item 6. Selected Financial Data .............................. 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................. 10
Item 8. Financial Statements and Supplementary Data:
Community Bank System, Inc. and Subsidiaries:
Consolidated Statements of Financial Condition ..... 36
Consolidated Statements of Income .................. 37
Consolidated Statements of Changes in Shareholders'
Equity ............................................. 38
Consolidated Statements of Cash Flows .............. 39
Notes to Consolidated Financial Statements ......... 40
Independent Auditor's Report ....................... 56
Two Year Selected Quarterly Data, 1998 and 1997 ...... 57
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................ 58
PART III
Item 10. Directors and Executive Officers of the Registrant ... 58
Item 11. Executive Compensation ............................... 58
Item 12. Security Ownership of Certain Beneficial Owners
and Management ....................................... 58
Item 13. Certain Relationships and Related Transactions ....... 58
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K .............................. 58
Signatures .................................................... 60
PART I
This Annual Report on Form 10-K contains certain forward-looking statements with
respect to the financial condition, results of operations and business of the
Company. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by such forward-looking statements are set forth herein under
the caption "Forward-Looking Statements."
ITEM 1. BUSINESS
- ----------------
GENERAL
Community Bank System, Inc. ("Company") was incorporated on April 15, 1983,
under the Delaware General Corporation Law. Its principal office is located at
5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is
(315) 445-2282. The Company became a bank holding company in 1984 with the
acquisition of The St. Lawrence National Bank ("St. Lawrence Bank") on February
3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A or
"Horizon Bank") on March 2, 1984. Also in 1984 the Company obtained a national
bank charter for its third wholly-owned subsidiary bank, The Exchange National
Bank ("Exchange Bank"), and on July 1, 1984 Exchange Bank acquired the deposits
and certain of the assets of three branches of the Bank of New York located in
Southwestern New York. On September 30, 1987, the Company acquired The Nichols
National Bank ("Nichols Bank") located in Nichols, New York. On September 30,
1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located
in Addison, New York, the parent company to Community National Bank ("Community
Bank").
On March 26, 1990, Community Bank opened the Corning Market Street branch from
the Company's acquisition of deposits and certain assets from Key Bank of
Central New York. On January 1, 1992, the Company's five banking affiliates
consolidated into a single, wholly-owned national banking subsidiary, known as
Community Bank, N.A. ("Bank"). On March 31, 1993, the Bank's marketing
representative office in Ottawa, Canada was closed. On June 3, 1994, the Company
acquired three branch offices in Canandaigua, Corning and Wellsville, New York
from the Resolution Trust Corporation. At that time, the preexisting Canandaigua
branch office loans and deposits were transferred into the new facility. On
October 28, 1994, the Company acquired the Cato, New York branch of The Chase
Manhattan Bank, N.A. On July 14, 1995, the Company acquired 15 branch offices
from The Chase Manhattan Bank, N.A. located in Norwich, Watertown (two),
Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls,
Hammondsport, Canton, Newark (two), and Penn Yan, New York ("Chase Branches").
On December 15, 1995, the Company sold three of the former Chase Branches,
located in Norwich, New Hartford, and Utica, to NBT Bank, N.A. On June 16, 1997
the Company acquired eight branches from Key Bank of New York located in Alfred,
Cassadaga, Clymer, Cuba, Gowanda, Ripley, Sherman, and Wellsville in
Southwestern New York State. On July 18, 1997 the Company acquired 12 branches
from Fleet Bank located in Old Forge, Boonville, Ogdensburg, St. Regis Falls,
Gateway Plaza, Watertown (2), Clayton, Lowville, Massena (2), and Gouverneur in
Northern and Central New York State. Seven of the former Fleet offices or
existing Bank offices in Watertown (2), Boonville, Ogdensburg, Gouverneur, and
Massena (2) have since been or are scheduled to be combined.
The Company had a wholly-owned data processing subsidiary, Northeastern Computer
Services, Inc. ("Northeastern"). Northeastern was acquired by the Company from
The St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization.
Northeastern had previously been a wholly-owned subsidiary of The St. Lawrence
Bank and was the survivor of a merger with Lawban Computer Systems, Inc.,
another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office
was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the
Company entered into a five year agreement with Mellon Bank, N.A. ("Mellon") to
provide data processing services (the agreement has since been renewed with the
subsequent acquiror of Mellon's data services, Fiserv, Inc., for a term ending
December 31, 2002). On June 30, 1992, Northeastern ceased operations. On January
17, 1997 all the outstanding shares of common stock of Northeastern were
transferred from the Company to Community Bank, N.A. On that date, Northeastern
became a wholly-owned subsidiary of the Bank and changed its name to CBNA
Treasury Management Corporation ("TMC"). TMC is now utilized by the Bank to
manage its Treasury function, including asset/liability, investment portfolio,
and liquidity management.
The Company also had a wholly-owned mortgage banking subsidiary, Community
Financial Services, Inc. (CFSI), which was established in June 1986; it
commenced operation in January 1987. In July 1988, CFSI purchased Salt City
Mortgage Corp., a Syracuse-based mortgage broker. CFSI was dissolved in 1990.
In July 1996, the Company purchased Benefit Plans Administrators of Utica, New
York, a pension administration and consulting firm serving sponsors of defined
benefit and defined contribution plans.
On February 3, 1997, the Company formed a subsidiary business trust, Community
Capital Trust I, for the purpose of issuing preferred securities which qualify
as Tier 1 capital. Concurrent with its formation, the trust issued $30,000,000
of 9.75% preferred securities in an exempt offering maturing in year 2027 and
guaranteed by the Company. The entire net proceeds to the trust from the
offering were invested in junior subordinated obligations of the Company.
1
The Company provides banking services through its two regional offices at 45-49
Court Street, Canton, New York and 201 North Union Street, Olean, New York, as
well as through 68 customer facilities in the eighteen counties of St. Lawrence,
Jefferson, Lewis, Oneida, Cayuga, Seneca, Ontario, Oswego, Wayne, Yates,
Allegany, Cattaraugus, Tioga, Steuben, Chautauqua, Franklin, Herkimer, and
Onondaga. The administrative office is located at 5790 Widewaters Parkway,
DeWitt, New York, in Onondaga County.
The Bank is a community retail bank committed to the philosophy of serving the
financial needs of customers in local communities. The Bank's branches are
generally located in small towns and villages within its geographic market
areas. The Company believes that the local character of business, knowledge of
the customer and customer needs, and comprehensive retail and small business
products, together with rapid decision-making at the branch and regional level,
enable the Bank to compete effectively. The Bank is a member of the Federal
Reserve System and the Federal Home Loan Bank of New York ("FHLB"), and its
deposits are insured by the FDIC up to applicable limits.
Unless the context otherwise provides, all references in this Annual Report on
Form 10-K to the "Company" shall mean, collectively, Community Bank System,
Inc. and its subsidiaries.
BANKING SERVICES
- ----------------
The Bank offers a range of commercial and retail banking services in each of its
market areas to business, individual, agricultural and government customers.
ACCOUNT SERVICES. The Bank's account services include checking accounts,
negotiable orders of withdrawal ("NOW"), money market accounts, savings
accounts, time deposit accounts, and individual retirement accounts.
LENDING ACTIVITIES. The Bank's lending activities include the making of
residential and farm loans, business lines of credit, working capital
facilities, inventory and dealer floor plans, as well as installment,
commercial, term and student loans.
The Company's predominant focus on the retail borrower enables its loan
portfolio to be highly diversified. About 64% of loans outstanding are oriented
to consumers borrowing on an installment and residential mortgage loan basis. In
addition, the typical loan to the Company's commercial business borrowers is
under $70,000, with only 34% of the commercial portfolio being in loans in
excess of $500,000.
OTHER SERVICES. The Bank offers a range of trust services, including personal
trust, employee benefit trust, investment management, financial planning and
custodial services. In addition, through an affiliation with Prime Vest, Inc.,
the Bank offers nonbank financial products including fixed- and variable-rate
annuities, mutual funds, and stock investments. The Bank also offers safe
deposit boxes, travelers checks, money orders, wire transfers, collections,
foreign exchange, drive-in facilities, automatic teller machines (ATMs), and
twenty-four hour depositories. Through an accounts receivable management
program, the Bank provides a service to qualifying businesses by purchasing
accounts receivable on a discounted basis. Customers of the Bank also receive
pension administration and consulting service pertaining to their defined
benefit and defined contribution plans from CBSI's nonbank subsidiary, Benefit
Plans Administrative Services, Inc. (BPA); BPA also provides services to nonbank
customers.
COMPETITION
- -----------
The Company, through the Bank, competes in three distinct banking markets in the
Northern ("Northern Market"), Finger Lakes ("Finger Lakes Market"), and Southern
Tier ("Southern Tier Market") regions of New York State. The Bank considers its
market areas in these regions to be the counties in which it has banking
facilities. Major competitors in these markets primarily include local branches
of banks based in Boston, Massachusetts, Albany or Buffalo, New York, and
Cleveland, Ohio, as well as local independent banking and thrift institutions
and federal credit unions. Other competitors for deposits and loans within the
Bank's market areas include insurance companies, money market funds, consumer
finance companies and financing affiliates of consumer durable goods
manufacturers. Lastly, personal and corporate trust and investment counseling
services in competition with the Bank are offered by insurance companies,
investment counseling firms, other financial service firms, and individuals.
NORTHERN MARKET. Branches in the Northern Market compete for loans and deposits
in the six county market area of St. Lawrence, Jefferson, Lewis, Franklin,
Herkimer, and Oneida Counties in Northern New York State. Within this market
area, the Bank maintains a market share(1) of 10.4% including commercial banks,
credit unions, savings and loan associations and savings banks. However, in its
three county primary market area (St. Lawrence, Franklin, and Lewis), the Bank
has a 25.4% share. The Bank operates 28 customer facilities in this market and
is ranked either first or second in market share in 17 of the 20 towns where
these offices are located.
2
FINGER LAKES MARKET. In the Finger Lakes Market, the Bank operates 14 customer
facilities competing for loans and deposits in the six-county market area of
Seneca, Oswego, Ontario, Wayne, Onondaga, and Cayuga Counties. Within the Finger
Lakes Market area, the Bank maintains a market share(1) of approximately 2.9%
including commercial banks, credit unions, savings and loan associations and
savings banks. However, the Bank's primary market within this region is Seneca
County where the Bank has a 33.3% share. The Bank is ranked either first or
second in market share in six of the eleven Finger Lakes Market area towns where
its offices are located.
SOUTHERN TIER MARKET. The Bank's Southern Tier Market consists of two
sub-markets, the Olean submarket and the Corning submarket.
OLEAN SUBMARKET. The Olean Submarket competes for loans and deposits in the
primary market area of Cattaraugus, Chautaugua, and Allegany Counties in the
Southern Tier of New York State. Within this area, the Bank maintains a market
share(1) of approximately 13.6% including commercial banks, credit unions,
savings and loan associations and savings banks. The Olean Submarket operates 15
office locations, and the Bank is ranked either first or second in market share
in all 11 towns where these offices are located.
CORNING SUBMARKET. The Corning Submarket competes for loans and deposits in the
primary market area of Steuben, Yates and Tioga Counties in the Southern Tier of
New York State. Within this area, the Bank maintains a market share(1) of
approximately 9.8% including commercial banks, credit unions, savings and loan
associations and savings banks. The Corning Submarket operates eleven office
locations, and the Bank is ranked either first or second in market share in
seven of the eight towns where these offices are located. The Bank also competes
for loans where it has no banking facilities; this secondary market area
includes Chemung and Schuyler Counties in New York State, and Tioga County in
Pennsylvania.
(1) Deposit market share data as of June 30, 1997, the most recent information
available, calculated by Sheshunoff Information Services, Inc.
The table below summarizes the Bank's deposits and market share by the eighteen
counties in which it has customer facilities. Market share is based on deposits
of all commercial banks, credit unions, savings and loan associations, and
savings banks.
Number of
CBNA Towns Where
Deposits Number of CBNA Has
6/30/97 Market CBNA 1st or 2nd Banking
County (000's) Share Facilities* Market Position Market
----------- ----------- ----------- ----------- ----------- -----------
Lewis $ 78,175 40.0 % 4 3 Northern
Seneca 97,705 33.3 5 3 Finger Lakes
St.Lawrence 304,598 29.6 16 9 Northern
Allegany 90,047 26.2 5 3 Olean
Cattaraugus 173,485 25.2 5 4 Olean
Yates 49,978 24.4 1 1 Corning
Jefferson 183,195 18.2 5 2 Northern
Steuben 94,300 8.1 7 5 Corning
Ontario 64,461 6.9 3 0 Finger Lakes
Tioga 20,762 6.7 2 1 Corning
Wayne 49,497 6.5 2 0 Finger Lakes
Oswego 37,557 4.2 2 2 Finger Lakes
Chautauqua 47,713 3.8 5 4 Olean
Herkimer 19,914 3.4 1 1 Northern
Franklin 11,007 2.5 1 1 Northern
Oneida 60,743 2.0 2 1 Northern
Cayuga 14,167 1.9 1 1 Finger Lakes
Onondaga 8,577 0.1 1 0 Finger Lakes
----------- ----------- ----------- ----------- ----------- -----------
18 $1,405,881 7.1 % 68 41 CBNA
* Anticipates closure of 354 E. Orvis St., Massena NY office on or about March 19, 1999.
EMPLOYEES
- ---------
As of December 31, 1998, the Bank employed 718 full-time equivalent employees
versus 726 at year-end 1997. The Bank provides a variety of employment benefits
and considers its relationship with its employees to be good.
3
CERTAIN REGULATORY CONSIDERATIONS
Bank holding companies and national banks are regulated by state and federal
law. The following is a summary of certain laws and regulations that govern the
Company and the Bank. To the extent that the following information describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the actual statutes and regulations thereunder.
BANK HOLDING COMPANY SUPERVISION
- --------------------------------
The Company is registered as a bank holding company under the Bank Holding
Company Act of 1956, as amended (the "BHCA") and as such is subject to
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board"). As a bank holding company, the Company's activities and those
of its subsidiary are limited to the business of banking and activities closely
related or incidental to banking. Under Federal Reserve Board policy, a bank
holding company is expected to act as a source of financial strength to its
subsidiary banks and to make capital contributions to a troubled bank
subsidiary. The Federal Reserve Board may charge the bank holding company with
engaging in unsafe and unsound practices for failure to commit resources to a
subsidiary bank when required. A required capital injection may be called for at
a time when the Company does not have the resources to provide it. Any capital
loans by the Company to its subsidiary bank would be subordinate in right of
payment to depositors and to certain other indebtedness of such subsidiary
banks.
The BHCA requires the prior approval of the Federal Reserve Board in any case
where a bank holding company proposes to acquire direct or indirect ownership or
control of more than 5% of any class of the voting shares of, or substantially
all of the assets of, any bank (unless it owns a majority of such bank's voting
shares) or otherwise to control a bank or to merge or consolidate with any other
bank holding company. The BHCA also prohibits a bank holding company, with
certain exceptions, from acquiring more than 5% of the voting shares of any
company that is not a bank.
The Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on
September 29, 1994) provides that, among other things, substantially all state
law barriers to the acquisition of banks by out-of-state bank holding companies
are eliminated effective September 29, 1995. The law also permits interstate
branching by banks effective as of June 1, 1997, subject to the ability of
states to opt-out completely or to set an earlier effective date. The Company
believes that the effect of the new law has been to increase competition within
the markets where the Company operates, although the Company cannot quantify the
effect to which competition has increased in such markets or the timing of such
increases.
OCC SUPERVISION
- ---------------
The Bank is supervised and regularly examined by the Office of the Comptroller
of the Currency (OCC). The various laws and regulations administered by the OCC
affect corporate practices such as payment of dividends, incurring debt, and
acquisition of financial institutions and other companies, and affect business
practices, such as payment of interest on deposits, the charging of interest on
loans, types of business conducted and location of offices. There are no
regulatory orders or outstanding issues resulting from regulatory examinations
of the Bank.
LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES
- ---------------------------------------------
The Company's ability to pay dividends to its shareholders is largely dependent
on the Bank's ability to pay dividends to the Company. In addition to state law
requirements and the capital requirements discussed below, the circumstances
under which the Bank may pay dividends are limited by federal statutes,
regulations and policies. For example, as a national bank, the Bank must obtain
the approval of the OCC for the payment of dividends if the total of all
dividends declared in any calendar year would exceed the total of the Bank's net
profits, as defined by applicable regulations, for that year, combined with its
retained net profits for the preceding two years. Furthermore, the Bank may not
pay a dividend in an amount greater than its undivided profits then on hand
after deducting its losses and bad debts, as defined by applicable regulations.
At December 31, 1998, the Bank had $24.8 million in undivided profits legally
available for the payment of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The payment of
dividends that deplete a bank's capital base could be deemed to constitute such
an unsafe or an unsound practice. The Federal Reserve Board has indicated that
banking organizations should generally pay dividends only out of current
operating earnings.
4
There are also statutory limits on the transfer of funds to the Company by its
banking subsidiary whether in the form of loans or other extensions of credit,
investments or asset purchases. Such transfers by the Bank to the Company
generally are limited in amount to 10% of the Bank's capital and surplus, or 20%
in the aggregate. Furthermore, such loans and extensions of credit are required
to be collateralized in specified amounts.
CAPITAL REQUIREMENTS
- --------------------
The Federal Reserve Board has established risk-based capital guidelines which
are applicable to bank holding companies. The guidelines established a framework
intended to make regulatory capital requirements more sensitive to differences
in risk profiles among banking organizations and take off-balance sheet
exposures into explicit account in assessing capital adequacy. The Federal
Reserve Board guidelines define the components of capital, categorize assets
into different risk classes and include certain off-balance sheet items in the
calculation of risk-weighted assets. At least half of the total capital must be
comprised of common equity, retained earnings and a limited amount of perpetual
preferred stock, less goodwill ("Tier I capital"). Banking organizations that
are subject to the guidelines are required to maintain a ratio of Tier I capital
to risk-weighted assets of at least 4.00% and a ratio of total capital to
risk-weighted assets of at least 8.00%. The appropriate regulatory authority may
set higher capital requirements when an organization's particular circumstances
warrant. The remainder ("Tier 2 capital") may consist of a limited amount of
subordinated debt, limited-life preferred stock, certain other instruments and a
limited amount of loan and lease loss reserves. The sum of Tier I capital and
Tier 2 capital is "total risk-based capital." The Company's Tier I and total
risk-based capital ratios as of December 31, 1998 were 9.24% and 10.49%,
respectively.
In addition, the Federal Reserve Board has established a minimum leverage ratio
of Tier I capital to quarterly average assets less goodwill ("Tier I leverage
ratio") of 3.00% for bank holding companies that meet certain specified
criteria, including that they have the highest regulatory rating. All other bank
holding companies are required to maintain a Tier I leverage ratio of 3.00% plus
an additional cushion of at least 100 to 200 basis points. The Company's Tier I
leverage ratio as of December 31, 1998 was 5.71%, which exceeded its regulatory
requirement of 4.00%. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets. The Company is subject to the
same OCC capital requirements as those that apply to the Bank.
In February 1994, the federal banking agencies proposed amendments to their
respective risk-based capital requirements that would explicitly identify
concentration of credit risk and certain risks arising from nontraditional
activities, and the management of such risks, as important factors to consider
in assessing an institution's overall capital adequacy. The proposed amendments
do not, however, mandate any specific adjustments to the risk-based capital
calculations as a result of such factors. On August 24, 1994, the Federal
Reserve Board issued proposed amendments to its risk-based capital standards
that would increase the amount of capital required under such standards for
long-dated interest rate and exchange rate contracts and for derivative
contracts based on equity securities and indexes, precious metals (other than
gold) and other commodities. The proposed amendments would also permit banking
institutions to recognize the effect of bilateral netting arrangements in
calculating their exposure to derivative contracts for risk-based capital
purposes. The Company and the Bank do not believe that these proposals, which
have now been adopted, have had a material effect on its financial condition or
results of operations.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
- -------------------------------------------------------------
In December 1991, Congress enacted the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), which substantially revised the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and made
significant revisions to several other federal banking statutes. FDICIA provides
for, among other things, (i) a recapitalization of the Bank Insurance Fund (the
"BIF") of the FDIC by increasing the FDIC's borrowing authority and providing
for adjustments in its assessment rates; (ii) annual on-site examinations of
federally-insured depository institutions by banking regulators; (iii) publicly
available annual financial condition and management reports for financial
institutions, including audits by independent accountants; (iv) the
establishment of uniform accounting standards by federal banking agencies; (v)
the establishment of a "prompt corrective action" system of regulatory
supervision and intervention, based on capitalization levels, with more scrutiny
and restrictions placed on depository institutions with lower levels of capital;
(vi) additional grounds for the appointment of a conservator or receiver; (vii)
a requirement that the FDIC use the least-cost method of resolving cases of
troubled institutions in order to keep the costs to insurance funds at a
minimum; (viii) more comprehensive regulation and examination of foreign banks;
(ix) consumer protection provisions including a Truth-in-Savings Act; (x) a
requirement that the FDIC establish a risk-based deposit insurance assessment
system; (xi) restrictions or prohibitions on accepting brokered deposits, except
for institutions which significantly exceed minimum capital requirements; and
(xii) certain additional limits on deposit insurance coverage.
5
FDICIA requires federal banking agencies to take "prompt corrective action" with
respect to banks that do not meet minimum capital requirements. FDICIA
establishes five capital tiers: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized." The following table sets forth the minimum capital ratios
that a bank must satisfy in order to be considered "well capitalized" or
"adequately capitalized" under Federal Reserve Board regulations:
WELL CAPITALIZED ADEQUATELY CAPITALIZED
---------------- ----------------------
Total Risk-Based Capital Ratio 10% 8%
Tier I Risk-Based Capital Ratio 6% 4%
Tier I Leverage Ratio 5% 4%
If a bank does not meet all of the minimum capital ratios necessary to be
considered "adequately capitalized," it will be considered "undercapitalized,"
"significantly undercapitalized," or "critically undercapitalized," depending
upon the amount of the shortfall in its capital. As of December 31, 1998, the
Bank's total risk-based capital ratio and Tier I risk - based capital ratio were
10.74% and 9.49%, respectively, and its Tier I leverage ratio as of such date
was 5.92%. Notwithstanding the foregoing, if its principal federal regulator
determines that an "adequately capitalized" institution is in an unsafe or
unsound condition or is engaging in an unsafe or unsound practice, it may
require the institution to submit a corrective action plan; restrict its asset
growth; and prohibit branching, new acquisitions, and new lines of business.
Among other things, an institution's principal federal regulator may deem the
institution to be engaging in an unsafe or unsound practice if it receives a
less than satisfactory rating for asset quality, management, earnings, or
liquidity in its most recent examination.
Possible sanctions for undercapitalized depository institutions include a
prohibition on the payment of dividends and a requirement that an institution
submit a capital restoration plan to its principal federal regulator. The
capital restoration plan of an undercapitalized bank will not be approved unless
the holding company that controls the bank guarantees the bank's performance.
The obligation of a controlling bank holding company to fund a capital
restoration plan is limited to the lesser of five percent (5%) of an
undercapitalized subsidiary's assets or the amount required to meet regulatory
capital requirements. If an undercapitalized depository institution fails to
submit or implement an acceptable capital restoration plan, it can be subjected
to more severe sanctions, including an order to sell sufficient voting stock to
become adequately capitalized. Critically undercapitalized institutions are
subject to the appointment of a receiver or conservator.
In addition, FDICIA requires regulators to impose new noncapital measures of
bank safety, such as loan underwriting standards and minimum earnings levels.
Regulators are also required to perform annual on-site bank examinations, place
limits on real estate lending by banks and tighten auditing requirements.
Many of the provisions of FDICIA will be implemented through the adoption of
regulations by the various federal banking agencies. Although the precise effect
of the legislation on the Company and the Bank therefore cannot be assessed at
this time, the Company does not anticipate that such regulations will materially
affect its operating results, financial condition, or liquidity.
ITEM 2. PROPERTIES
- ------------------
The Company leases its administrative offices at 5790 Widewaters Parkway,
DeWitt, New York and the facility that houses Benefit Plans Administrative
Services in Utica, New York. The Bank owns its regional offices in Olean, New
York and Canton, New York. Of the Bank's remaining 68 customer facilities, 50
are owned by the Bank, and 18 are located on long-term leased premises.
Real property and related banking facilities owned by the Company at December
31, 1998 had a net book value of $16.8 million and none of the properties was
subject to any encumbrances. For the year ended December 31, 1998, rental fees
of $1 million were paid on facilities leased by the Company for its operations.
ITEM 3. LEGAL PROCEEDINGS
- -------------------------
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
Not applicable
6
Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
- --------------------------------------------
The following table sets forth certain information about the executive
officers of the Company and the Bank, each of whom is elected by the Board of
Directors and each of whom holds office at the discretion of the Board of
Directors.
NAME AND AGE POSITION
------------ --------
Sanford A. Belden President and Chief Executive Officer
Age 56 of the Company and the Bank
James A. Wears Regional President, Northern Region
Age 49 of the Bank
Michael A. Patton Regional President, Southern Region
Age 53 of the Bank
David G. Wallace Treasurer of the Company and Senior
Age 54 Vice President and Chief Financial
Officer of the Bank
Girard H. Mayer President and Chief Executive Officer,
Age 60 Benefit Plans Administrative
Services, Inc.
SANFORD A. BELDEN (Director; President and Chief Executive Officer of the
Company and the Bank). Mr. Belden has been President and Chief Executive Officer
of the Company and the Bank since October 1, 1992. Mr. Belden was formerly
Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to
1992 and prior thereto served as President, Community Banking, for First Bank
System, Minneapolis, Minnesota, a multi-state bank holding company.
JAMES A. WEARS (Regional President, Northern Region of the Bank). Mr. Wears
served as Senior Vice President of The St. Lawrence National Bank, a former
subsidiary of the Company, from 1988 through January 1991, and as its President
and Chief Executive Officer from January 1991 until January 1992. Following the
January 1992 consolidation of the Company's five subsidiary banks into the Bank,
Mr. Wears was named to his current position as Regional President for the
Northern Region of the Bank.
MICHAEL A. PATTON (Regional President, Southern Region of the Bank). Mr. Patton
was the President and Chief Executive Officer of The Exchange National Bank, a
former subsidiary of the Company, from 1984 until January 1992, when, in
connection with the consolidation of the Company's five subsidiary banks into
the Bank, he was named to his current position as Regional President for the
Southern Region of the Bank.
DAVID G. WALLACE (Treasurer of the Company; Senior Vice President and Chief
Financial Officer of the Bank). Mr. Wallace became Vice President and Chief
Financial Officer of the Bank and Treasurer of the Company in November 1988, and
has been Senior Vice President and Chief Financial Officer since August 1991.
GIRARD H MAYER (President and Chief Executive Officer, Benfit Plans
Administrative Services, Inc.). Mr Mayer assumed his position in July 1996 when
his company (Benefit Plans Administrators) was purchased by Community Bank
System, Inc.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
- --------------------------------------------------------------------------------
The common stock has been trading on the New York Stock Exchange under the
symbol "CBU" since December 31, 1997. Prior to that, the common stock traded
over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning
on September 16, 1986. The following table sets forth the high and low bid
quotations for the common stock, and the cash dividends declared with respect
thereto, for the periods indicated. The quotations represent bid prices between
dealers, do not include retail mark-ups, mark-downs or commissions, and do not
necessarily represent actual transactions. There were 7,296,453 shares of common
stock outstanding on December 31, 1998 held by approximately 1,844 registered
shareholders of record, and approximately 2,362 shareholders whose shares are
held in nominee name at brokerage firms and other financial institutions.
COMMON STOCK PERFORMANCE
NYSE Symbol: CBU
Newspaper Listing: CmntyBkSys
Market (Bid) Price
High Low Closing Price Quarterly
Year / Qtr Price Price Amount % Change Dividend
1998
4th $30.50 $27.13 $29.31 2.6% $0.23
3rd $33.94 $24.81 $28.56 -8.8% $0.23
2nd $38.25 $29.69 $31.31 -7.9% $0.20
1st $35.88 $30.56 $34.00 8.6% $0.20
1997
4th $34.00 $27.00 $31.31 8.0% $0.20
3rd $29.75 $26.25 $29.00 2.7% $0.20
2nd $29.00 $20.00 $28.25 20.2% $0.18
1st $24.25 $19.25 $23.50 19.7% $0.18
The Company has historically paid regular quarterly cash dividends on its common
stock, and declared a cash dividend of $0.23 per share for the first quarter of
1999. The Board of Directors of the Company presently intends to continue the
payment of regular quarterly cash dividends on the common stock, as well as to
make payment of regularly scheduled dividends on the trust preferred stock as
and when due, subject to the Company's need for those funds. However, because
substantially all of the funds available for the payment of dividends by the
Company are derived from the Bank, future dividends will depend upon the
earnings of the Bank, its financial condition, its need for funds and applicable
governmental policies and regulations. See "Supervision and Regulation -- Limits
On Dividends and Other Payments."
ITEM 6. SELECTED FINANCIAL DATA
- -------------------------------
The following table sets forth selected consolidated historical financial data
of the Company as of and for each of the years in the five year period ended
December 31, 1998. The historical "Income Statement Data" and historical
"Statement of Condition Data" are derived from the audited financial statements.
The "Per Share Data", "Selected Ratios" and "Other Data" for all periods are
unaudited. All financial information in this table should be read in conjunction
with the information contained in "Capitalization," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and with the
Consolidated Financial Statements and the related notes thereto included
elsewhere in this Annual Report on Form 10-K.
8
SELECTED CONSOLIDATED FINANCIAL INFORMATION
Years ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------
(000's omitted except per share and ratios)
Income Statement Data:
Interest income $ 122,938 $ 117,628 $ 97,688 $ 83,387 $ 61,575
Interest expense 58,543 54,752 42,422 36,307 22,130
---------- ---------- ---------- ---------- ----------
Net interest income (excludes FTE) 64,395 62,876 55,266 47,080 39,445
Provision for possible loan losses 5,123 4,480 2,897 1,765 1,702
---------- ---------- ---------- ---------- ----------
Net interest income after provision for
for possible loan losses 59,272 58,396 52,369 45,315 37,743
Non-interest income 17,040 11,808 8,874 6,558 5,120
Non-interest expense 51,876 45,799 37,450 33,019 26,498
---------- ---------- ---------- ---------- ----------
Income before income taxes 24,436 24,406 23,793 18,854 16,365
Provision for income taxes 8,902 8,844 9,660 7,384 6,256
Cumululative effect of change in accounting principle 194 0 0 0 0
---------- ---------- ---------- ---------- ----------
Net income $ 15,728 $ 15,562 $ 14,133 $ 11,470 $ 10,109
========== ========== ========== ========== ==========
End of Period Balance Sheet Data:
Total assets $1,680,689 $1,633,742 $1,343,865 $1,152,045 $ 915,501
Loans net of unearned discount 917,220 843,212 652,474 560,151 483,079
Earning assets (includes MVA) 1,510,760 1,455,139 1,231,058 1,034,183 861,599
Total deposits 1,378,066 1,345,686 1,027,213 1,016,946 679,638
Long-term debt 99,810 60,000 100,000 25,550 550
Trust securities 29,810 29,804 0 0 0
Shareholders' equity 120,165 118,012 109,352 100,060 66,290
Average Balance Sheet Data:
Total assets $1,670,624 $1,491,920 $1,251,826 $1,054,610 $ 808,948
Loans net of unearned discount 884,751 749,596 602,717 519,762 446,135
Earning assets (excludes MVA) 1,512,175 1,363,703 1,147,455 975,257 756,871
Total deposits 1,396,700 1,213,793 1,032,169 871,050 651,479
Long-term debt 119,615 79,863 57,006 3,399 557
Trust securities 30,000 27,290 0 0 0
Shareholders' equity 120,936 110,689 103,398 84,231 64,033
Common Per Share Data:
Net income $ 2.05 $ 2.02 $ 1.83 $ 1.70 $ 1.80
Cash dividend declared 0.86 0.76 0.69 0.62 0.57
Period-end book value - stated 16.47 15.56 14.03 12.99 11.89
Period-end book value - tangible 9.01 7.82 9.85 8.37 10.80
Common Outstanding Shares:
Average during period (Incl common stock equivalents) 7,670,711 7,676,326 7,482,518 6,522,410 5,629,420
End of period (Excl common stock equivalents) 7,296,453 7,586,512 7,474,406 7,358,450 5,576,300
Selected Ratios:
Return on average total assets 0.94% 1.04% 1.13% 1.09% 1.25%
Return on average shareholders' equity (excludes 13.01% 14.09% 13.88% 13.85% 15.79%
preferred stock)
Common dividend payout ratio 41.95% 37.30% 37.27% 34.79% 31.24%
Net interest margin (taxable equivalent basis) 4.31% 4.64% 4.86% 4.88% 5.30%
Noninterest income to average assets 1.02% 0.79% 0.71% 0.64% 0.69%
Noninterest income to operating income-(recurring) 17.90% 15.30% 13.60% 12.10% 12.00%
Efficiency ratio (taxable equivalent basis)-nominal 64.70% 60.90% 58.00% 60.80% 57.90%
Efficiency ratio (taxable equivalent basis)-recurring 59.10% 55.00% 53.40% 56.70% 56.10%
Non-performing loans to perion-end total loans 0.43% 0.49% 0.44% 0.36% 0.67%
Non-performing assets to period-end total loans and
other real estate owned 0.56% 0.60% 0.55% 0.47% 0.72%
Allowance for loan losses to period-end loans 1.36% 1.47% 1.25% 1.25% 1.30%
Allowance for loan losses to period-end non-performing loans 312.12% 297.96% 285.58% 349.69% 192.79%
Allowance for loan losses to period-end non-performing assets 240.74% 246.02% 224.33% 267.40% 179.67%
Net charge-offs (recoveries) to average total loans 0.58% 0.50% 0.29% 0.21% 0.25%
Average net loans to average total deposits 63.35% 61.76% 58.39% 59.67% 68.48%
Period-end total shareholders' equity to period end assets 7.15% 7.22% 8.14% 8.69% 7.24%
Tier I capital to risk-adjusted assets 9.24% 9.30% 10.70% 10.62% 12.43%
Total risk-based capital to risk-adjusted assets 10.49% 10.55% 11.83% 11.76% 13.68%
Tier I leverage ratio 5.71% 5.67% 5.88% 5.83% 6.80%
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- -----------------------------------------------------------------------------
This Management's Discussion and Analysis of Financial Condition and Results of
Operations 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 contemplated by such
forward-looking statements are set forth herein under the caption
"Forward-Looking Statements."
The following discussion is intended to facilitate an understanding and
assessment of significant changes in trends related to the financial condition
of the Company and the results of its operations. The following discussion and
analysis should be read in conjunction with the Selected Consolidated Financial
Data and the Company's Consolidated Financial Statements and related notes
thereto appearing elsewhere in this Form 10K. All references in the discussion
to financial condition and results of operations are to the consolidated
position and results of the Company and its subsidiaries taken as a whole.
NET INCOME AND PROFITABILITY
- ----------------------------
Net income and diluted earnings per share reached record highs in 1998 at $15.7
million and $2.05, respectively. Compared to 1997, net income rose 1.1% while
earnings per share were up 1.5%. The 1998 return on equity (ROE) decreased 1.08
percentage points from the prior year to 13.01%. Tangible or cash ROE was off a
lesser 82 basis points to 15.27%, placing the Company's performance nearly in
the top quartile of its regional peer banks.
Recurring or core earnings were up .9% from last year to $15.4 million after
removing the impact of one-time income and expense items. Net gains/losses on
the sale of investment securities are taken when economically justified by total
return analysis (as discussed in the "Investments" section of this document),
and as such are considered a component of core earnings. 1997's core net income
climbed 10% over the prior year to $15.3 million.
These results reflect the fifth consecutive year in which acquisitions had an
important impact on the Company's results. Their role is noted among the primary
factors explaining 1998's improvement in net income as follows:
o Net interest income (full-tax equivalent basis) increased 2.8% or $1.8
million due to a significant increase in earning asset levels. Average
loans grew $135 million (18.0%) while average investments grew $13.3
million (2.2%). During the last twelve months, loans increased by $74.0
million or 8.8%. Over 40% of this growth took place in the markets served
by the 12 branches (net of three divestitures) purchased from Chase
Manhattan Bank at mid-year 1995. About 38% of 1998's growth was due to the
contributions of 20 branches acquired in mid-1997 from Key Bank, N.A. (8)
and Fleet Bank (12). The growth in earning assets was funded by $183
million (15.1%) more in average deposits, resulting largely from the
aforementioned acquisitions offset by reduced borrowings. The increase in
net interest income came despite a net interest margin of 4.31%, 33 basis
points lower than the 1997 level due to the impact of a flat Treasury yield
curve on margins in general and a reduction in the investment portfolio
yield in particular. A key factor influencing the latter was an
acceleration in the amortization of premiums on certain of the Company's
collateralized mortgage obligations (CMOs) triggered by unusually high
mortgage refinancing activity nationwide.
o Total noninterest income (including $327,000 in investment gains on
securities sold upon adoption of Financial Accounting Standard 133)
increased by 47% over 1997 to $17.4 million. Half of the increase was
caused by higher non-recurring income and a quarter was attributable to
more service charges and overdraft fees generated from fee schedule
changes. The balance of the increase largely reflects the full-year impact
of the mid-1997 Key and Fleet acquisitions. Nearly three-quarters of the
1998 non-recurring income figure represented $2.3 million in gains taken on
$86 million in investment sales. Approximately $275,000 of these gains was
offset by losses on the sale of various acquired branch properties.
o Noninterest expense or overhead rose $6.1 million or 13.3% in 1998 compared
to $8.3 million or 22.3% in 1997. The bulk of the 1997 and 1998 increases
was caused by the impact of the mid-1997 Key and Fleet branch acquisitions.
This branch expansion caused personnel additions (due to both acquired
branch staff as well as operations positions to process higher transaction
volumes), greater other costs to service the expanded customer base, and
higher amortization of deposit intangibles. Besides the full year impact of
these expenses, approximately $302,000 in one-time expenses was incurred
this year to dispose of acquired branch properties.
o Loan loss provision expense rose $643,000 or 14.3% over 1997's level.
Because of lower than expected charge-offs on acquired Key and Fleet loans
and a sufficient loss reserve pertaining to all other loans, every dollar
of net-charge offs was covered by a single dollar of provision in 1998
versus the historical 1.2 times coverage. Net charge-offs as a percent of
average loans increased slightly over 1997 to a relatively high .58%, but
steady improvement during the year in installment loan charge-offs brought
this ratio down to .55% in the fourth quarter from a high of .76% one year
earlier. Nonperforming loans decreased during 1998 to a satisfactory .43%
of loans outstanding at year end.
10
The above combination of factors resulted in a level of profitability which may
be compared to that of CBSI's peer bank holding companies; this group is
comprised of 144 companies nationwide having $1 billion to $3 billion in assets
based on data through September 30, 1998 (the most recently available
disclosure) as provided by the Federal Reserve System. Through year-to-date
September, net income per dollar employed, or return on average assets, was
.98%, compared to the peer norm of 1.26%. Shareholder return on equity (ROE) at
13.20% for the same period ranked much closer to the peer norm of 13.97%,
placing it in the 45th peer percentile. The Company's primary performance focus
is on achieving returns to shareholders, which is best measured by ROE.
Underlying the 1998 growth in earnings per share was steady improvement on a
quarterly basis. The first three quarters of 1998 at $.48, $.50 and .$56 per
share exceeded the same 1997 quarters by $.01, $.02, and $.01, respectively.
Fourth quarter earnings per share were off $.01 from the same 1997 period in
part due to the previously mentioned write down of $302,000 on leases and fixed
assets of former acquired branch properties no longer in use.
SELECTED PROFITABILITY AND OTHER MEASURES
- -----------------------------------------
Return on average assets, return on average equity, dividend payout and equity
to asset ratios for the years indicated are as follows:
1998 1997 1996
---- ---- ----
Percentage of net income to
average total assets 0.94% 1.04% 1.13%
Percentage of net income to
average shareholders equity 13.01% 14.09% 13.88%
Percentage of dividends declared
per common share to net income
per common share 41.95% 37.30% 37.27%
Percentage of average shareholder's
equity to average total assets 7.24% 7.42% 7.90%
CASH-ADJUSTED EARNINGS AND PROFITABILITY
- ----------------------------------------
Many analysts consider that a better measure of the economic value of an
acquisition are the cash earnings that it generates, which is determined by
adding back to reported earnings the after-tax expense of amortizing the
acquisition premium. Over the last five years, growth has been consistently
greater in cash earnings than in reported earnings due to the Company's regular
program of branch acquisitions.
CBSI's cash earnings increased 4.5% in 1998 to $18.5 million compared to 12.6%
growth in 1997 and 27.2% in 1996. Cash-basis earnings per share rose 4.8% to
$2.41 in 1998 in contrast to a 1.5% increase in reported diluted EPS to $2.05.
Last year's cash EPS rose 12.2% compared to 10.4% on a reported basis, while
cash EPS was up 10.8% in 1996 versus 8.2% on a reported basis.
Return on assets is also significantly higher on a cash basis, being 1.11%,
1.19%, and 1.26% in 1998, 1997, and 1996, respectively. Moreover, performance
measured by tangible or cash return on equity was 15.27% in 1998 as compared to
16.09% in 1997 and 15.52% in 1996.
NET INTEREST INCOME
- -------------------
Net interest income is the Company's primary source of core operating income for
payment of overhead and possible loan losses. It is the amount that interest and
fees on earning assets (loans and investments) exceeds the cost of funds,
primarily interest paid to the Company's depositors as well as interest on
borrowings from the Federal Home Loan Bank of New York and dividends on the
Company's $30 million in 9.75% trust preferred stock. 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.
11
Net interest income (with non-taxable income converted to a full tax-equivalent
basis) totaled $65.1 million in 1998; this represents a $1.8 million or 2.8%
increase from the prior year. The increase was entirely due to higher earning
asset volumes, which had a positive impact on net interest income of $6.5
million, while interest rate changes had a negative impact of $4.7 million.
With regard to the components of 1998's net interest income, greater average
earning assets of $148 million helped contribute to the $5.6 million or 4.7%
rise in interest income. A total of $135 million in 1998's increased average
earning assets resulted from a greater level of lending activity in existing
markets and the impact of loans initially acquired with the Key and Fleet
branches. The average ratio of loans to earning assets increased from 55.0% in
1997 to 56.5% in 1998 as a consequence of the aforementioned acquisitions,
strong business development efforts and slower 1998 growth in investments.
Overall interest and fees on loans grew $11.2 million or 15.7% as a result of
loan growth and came despite a 19 basis point (BP) decrease in loan yields to
9.36% caused by declining market rates. Through September 30, 1998, the
Company's loan yield was in the favorable 61st peer bank percentile.
The remaining $13 million of growth in earning assets is explained by an
increase in average investments outstanding; this primarily reflects the full
year impact of investments purchased in 1997 both for the strategic use of
leveraging when favorable buying opportunities existed and the impact of
investments purchased from funds provided by 1997's branch acquisitions. It
should be noted that from year end 1997 to year end 1998, investments were down
$20.9 million. The 1998 investment interest income was $5.6 million or 12.1%
lower than a year earlier due to the reduction in average investment yield from
7.58% to 6.52%; interest income from higher outstandings offset a portion of the
$7.3 million reduction due to lower rates. This reduction was caused by
declining market rates, including the negative impact of historically high
mortgage refinancing nationwide on the value of the Company's premium
collateralized mortgage obligations (CMOs). Despite this decline, the Company's
investment yield was in the favorable 65th peer bank percentile based on data
through September 30, 1998.
The average earning asset yield fell 48 basis points to 8.18% because of the
falling treasury yield curve directly affecting new investment rates and CMO
yields and creating downward pressure on new loan rates, partially offset by an
increased mix of loans to earning assets (most types of loans have historically
had higher yields than marketable securities).
Total average fundings (deposits and borrowings) grew by $164.5 million in 1998
attributable to the full year impact of 1997's acquired deposits, causing a $3.8
million increase in total interest expense. Virtually all of this additional
expense is due to interest paid on time deposits, which was particularly
influenced by the Key and Fleet acquisitions, both of which had relatively high
mixes of time deposits.
The impact of higher funding volumes more than offset the benefit of the rate on
interest bearing deposits falling 8 BPs to 4.20%, due largely to
across-the-board drops in deposit rates beginning in late summer 1998 and a 4 BP
lower borrowing rate reflecting declines in market rates. Overall, the average
1998 cost of funds as a percentage earning assets was reduced by 14 BPs to
3.87%. Through September 30, 1998, the Company's average cost of funds rate fell
favorably to the 55th peer bank percentile, as compared to being in the 68th
percentile through September 30, 1997.
While the Company's net interest margin has historically been very strong, the
primary objective in recent years has been to maximize shareholder returns
through active utilization of tangible capital. Thus, as management focuses on
growing the earning asset base of the Company, there has been a downward change
in margin resulting in part from leverage strategies to take advantage of
favorable investment opportunities and in part from a total return philosophy
that may sacrifice current yield for greater cash earnings over a specified
holding period. An example of the latter strategy is taking investment gains
though reinvestment yields are lower going forward. This investment approach, as
well as the reduction in value of premium CMOs in 1998, contributed to CBSI's
net interest margin declining by 33 basis points from 4.64% in 1997 to 4.31%
this year. Also contributing to the decline was a lag in lowering deposit
pricing compared to decreases in Treasury rates.
For fourth quarter 1998, the net interest margin was 4.25% compared to 4.79% one
year earlier. Again, this can be attributed to a lower earning asset yield (down
83 BPs) at 7.90%, partially offset by a 27 BP lower rate on interest-bearing
liabilities at 4.24%.
The Company's net interest margin ranked in the 40th peer bank percentile
through September 30, 1998, the first time it has not been well above the peer
median in many years. If securities gains are added to net interest income, the
adjusted net interest margin for 1998 is 4.46% versus the peer norm of 4.51%.
12
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yeilds and
rates theron for the twelve month periods ended December 31, 1998, 1997 and
1996. Interest income and resulant yeild information in the tables are on a
fully tax equivalant basis using margonal federal income tax rate of 35%.
Averages are computed on daily average balances for each month in the period
divded by the number of days in the period. Yeilds and amounts earned include
loan fees. Nonaccrual loans have been included in interest earnings for purposes
of these computations.
Average Balance and Yields
(000's omitted except yields and ratios)
Years Ended December 31,
1998 1997 1996
---------------------------------------------------------------------------------------------
Avg. Avg. Avg.
Avg. Amt. of Yield/Rate Avg. Amt. of Yield/Rate Avg. Amt. of Yield/Rate
Balance Interest Paid Balance Interest Paid Balance Interest Paid
ASSETS
Interest-earning assets:
Federal funds sold $5,428 $296 5.46% $15,882 $865 5.45% $6,318 $336 5.32%
Interest bearing cash equivalents 35 2 5.51 33 2 6.06 0 0 0.00
Taxable investment securities 592,559 38,290 6.46 581,743 44,233 7.60 521,668 39,410 7.55
Non-taxable investment securities 29,402 2,308 7.85 16,449 1,420 8.63 16,752 1,473 8.79
Loans (net of unearned discount) 884,751 82,778 9.36 749,596 71,563 9.55 602,717 56,932 9.45
------- ------ ---- ------- ------ ---- ------- ------ ----
Total Interest-earning assets 1,512,175 $123,674 8.18% 1,363,703 $118,083 8.66% 1,147,455 $98,151 8.55%
Non-Interest Earning Assets:
Cash and due from banks 57,913 46,750 43,251
Premises and equipment 24,412 19,422 16,848
Other assets 83,048 69,766 50,626
Less allowance for loan losses (12,282) (10,162) (7,418)
Net unrealized gains/(losses) on
available for sale portfolio 5,376 2,442 1,063
----- ----- -----
Total $1,670,642 $1,491,921 $1,251,825
========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities
Savings Deposits $508,731 $12,155 2.39% $443,667 $10,971 2.47% $406,925 $9,953 2.45%
Time Deposits 672,972 37,515 5.57 599,136 33,619 5.61 481,250 26,430 5.49
Short term borrowing 13,915 754 5.42 45,008 2,583 5.74 46,535 2,620 5.63
Long term borrowing 119,615 8,120 6.79 106,975 7,578 7.08 57,006 3,419 6.00
------- ----- ---- ------- ----- ---- ------ ----- ----
Total interest - bearing
liabilities 1,315,233 58,544 4.45% 1,194,786 54,751 4.58% 991,716 42,422 4.28%
Non-interest-bearing liabilities
Demand deposits 214,997 170,989 143,995
Other liabilities 19,476 15,459 12,716
Shareholders' equity 120,936 110,687 103,398
------- ------- -------
Total $1,670,642 $1,491,921 $1,251,825
========== ========== ==========
Net interest earnings $65,130 $63,332 $ 55,729
======= ======= =========
Net yield on interest-earning assets 4.31% 4.64% 4.86%
===== ===== =====
(1) Interest income on tax exempt securities is calculated on a tax-equivalent basis. Federal tax exemption expressed
as interest income amounted to $736 for 1998, $455 for 1997 and $462 for 1996.
13
As discussed above, the change in 1998's net interest income may be analyzed by
segregating the volume and rate components of the changes in interest income and
interest expense for each underlying category.
------------------------------- -------------------------------
1998 Compared to 1997 1997 Compared to 1996
------------------------------- -------------------------------
Increase (Decrease) Due Increase (Decrease) Due
to Change in (1) to Change in (1)
Net
(000's omitted) Volume Rate Change Volume Rate Net Change
------ ---- ------ ------ ---- ----------
Interest earned on:
Federal funds sold and securities
purchased under agreement to resell $ (694) $ 125 $ (569) $ 521 $ 8 $ 529
Time deposits in other banks - - - 2 - 2
Taxable investment securities 807 (6,750) (5,943) 4,566 257 4,823
Non-taxable investment securities 1,026 (138) 888 (26) (27) (53)
Loans (net of unearned discount) 12,666 (1,451) 11,215 14,016 615 14,631
Total interest-earning assets (2) $ 12,380 $(6,789) $ 5,591 $ 18,711 $ 1,221 $ 19,932
Interest paid on:
Savings deposits $ 1,551 $ (367) $ 1,184 $ 907 $ 111 $ 1,018
Time deposits 4,136 (240) 3,896 6,603 586 7,189
Short-term borrowings (1,692) (137) (1,829) (90) 53 (37)
Long-term debt 863 (321) 542 3,447 712 4,159
Total interest bearing liabilities (2) $ 5,383 $ (1,590) $ 3,793 $ 9,146 $ 3,183 $ 12,329
Net interest earnings (2) $ 6,532 $ (4,734) $ 1,798 $ 9,904 $(2,301) $ 7,603
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
14
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon for the three month periods ended December 31, 1998 and 1997.
Interest income and resultant yield information in the tables are on a fully
tax-equivalent basis using a marginal federal income tax rate of 35%. Averages
are computed on daily average balances for each month in the period divided by
the number of days in the period. Yields and amounts earned include loan fees.
Nonaccrual loans have been included in interest earnings for purposes of these
computations.
Fourth Quarters Ended December 31,
-------------------------------------------------------------------------------------
1998 1997
----------------------------------------- ------------------------------------------
(000's omitted except yields Avg. Amt. of Avg. Avg. Amt. of Avg.
and rates) Balance Interest Yield/Rate Balance Interest Yield/Rate
Paid Paid
ASSETS: ------- -------- ---------- ------- -------- ----------
Interest-earning assets:
Federal funds sold $ 1,533 $ 20 5.16% $ 7,590 $ 104 5.44%
Time deposits in other banks 35 0 5.27% 35 1 5.70%
Taxable investment securities 545,987 7,827 5.69% 566,081 10,723 7.52%
Nontaxable investment securities 35,601 688 7.66% 20,048 423 8.37%
Loans (net of ynearned discount) 912,334 21,227 9.23% 835,673 20,211 9.60%
----------- --------- --------- ----------- --------- --------
Total interest-earning assets 1,495,490 29,762 7.90% 1,429,427 31,462 8.73%
Noninterest earning assets
Cash and due from banks 60,148 52,891
Premises and equipment 25,028 22,813
Other Assets 80,722 86,698
Less:allowance for loans (12,293) (12,266)
Net unrealized gains/(losses) on
available-for-sale portfolio 9,815 4,183
-------------- --------------
Total $ 1,658,910 $ 1,583,746
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabailities
Savings deposits $ 512,308 2,778 2.15% $ 497,257 3,097 2.47%
Time deposits 643,305 8,829 5.44% 655,559 9,352 5.66%
Short-term borrowings 24,168 311 5.10% 16,089 235 5.80%
Long-term borrowings 107,853 1,833 6.74% 81,433 1,533 7.47%
----------- --------- --------- ----------- --------- --------
Total interest-bearing liabilities 1,287,634 13,751 4.24% 1,250,338 14,217 4.51%
Noninterest bearing liabilities
Demand deposits 226,924 199,373
Other liabilities 22,891 18,801
Shareholders' equity 121,461 115,234
-------------- --------------
Total $ 1,658,910 $ 1,583,746
============== ===============
Net interest earnings $ 16,011 $ 17,244
============ ============
Net yield on interest-earning assets 4.25% 4.79%
======= =======
15
The changes in net interest income by volume and rate component for fourth
quarter 1998 versus fourth quarter 1997 are shown below for each major category
of interest-earning assets and interest-bearing liabilities.
---------------------------------------------
4th Quarter 1998 Compared to 4th Quarter 1997
---------------------------------------------
Increase (Decrease) Due
to Change in (1)
VOLUME RATE NET CHANGE
Interest earned on:
Federal funds sold and securities
purchased under agreements to resell $ (83) $ (1) $ (84)
Time deposits in other banks - (1) (1)
Taxable investment securities (381) (2,515) (2,896)
Nontaxable investment securities 328 (63) 265
Loans (net of unearned discount) 1,855 (839) 1,016
Total interest-earning assets (2) $ 1,454 $(3,154) $(1,700)
Interest paid on:
Savings deposits $ 94 $ (413) $ (319)
Time deposits (175) (348) (523)
Short-term borrowings 118 (42) 76
Long-term debt 497 (197) 300
Total interest-bearing liabilities 424 (890) (466)
Net interest earnings (2) $ 798 $(2,031) $(1,233)
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
NONINTEREST INCOME
- ------------------
The Company's sources of noninterest income are recurring fees from core banking
and related operations and revenues from one-time events, defined as net
gains/losses from the sale of investments, loans, and miscellaneous assets. The
faster growing components of recurring revenue are commissions from the sale of
mutual fund and allied products, income from personal trust services, and
related revenues from investment management, recordkeeping, and consulting
services provided by Benefit Plans Administrative Services, Inc. (BPA) and the
Bank's Employee Benefit Trust function (EBT).
Total noninterest income (including $327,000 in investment gains on securities
sold upon adoption of FAS 133) increased by 47% to $17.4 million from 1997 to
1998, with half of the increase caused by higher non-recurring income and a
quarter of the increase attributable to more service charges and overdraft fees
generated from fee schedule changes. The balance of the increase reflects the
full-year impact of the mid-1997 Key and Fleet acquisitions. Core banking and
related fees were up strongly for the fourth consecutive year to approximately
$14.1 million in 1998, a $2.8 million (19.5%) improvement following a 30.6%
increase in 1997.
In addition to the full-year benefits of the Key and Fleet acquisitions, fees
from core banking and related operations improved in several key areas in 1998:
o Fees from personal trust services were $1.2 million, up 2.9% in 1998 as
compared to a 5.1% increase in 1997. The slower level of 1998 growth is
primarily reflective of fewer estate settlement fees and lower levels of
other less predictable fees. The more consistent and recurring trust fees
related to individual investment management accounts and annual trust
administration (together representing 81% of the Bank's personal trust
income) grew a combined 12.2%. Continued focus on business development,
including greater integration of Financial Service Representatives and BPA
as referral sources, is expected to strengthen future fiduciary income
growth.
o Service charges on deposit accounts and overdraft fees increased to $6.6
million in 1998, a 31.2% growth rate compared to a 25.2% growth rate in
1997. The 1998 and 1997 increases reflect the impact of fees and
commissions from an expanded customer base gained from the Key and Fleet
acquisitions and also significant changes in the Bank's fee schedule
effective in the spring of 1998.
16
o Fees earned through the Company's Visa affiliation rose 41.8% in 1998 to
$731,000, attributable to continued growth of the Visa Check Card product,
which almost doubled from 1997 to 1998, and with Visa merchant discount
fees increasing 17.6%. The direct margin on merchant discount fees (net of
processing expense) increased 2.2 percentage points to 31.7% in 1998.
o 1998 is the fifth year in which CBSI has offered annuities, mutual funds,
and other investment products through financial services representatives
(FSR's) located in ten selected geographic markets within the Bank's branch
network. Commission income grew 22.0% in 1998 to $1.2 million on asset
sales of $29.3 million. A greater emphasis continues to be placed on
growing this line of special investment products as evidenced by the hiring
of an experienced full time program manager early in 1998.
o Revenue from record keeping and consulting services provided by BPA
(acquired in July 1996) and investment management services provided by the
pre-existing EBT business totaled $2.3 million in 1998 compared to $1.8
million in 1997, a 27.9% increase resulting from continued business
development efforts and origination fees earned upon conversion to a new
mutual fund product offering.
o General commissions and miscellaneous income (excluding Visa related fees)
at $2.1 million were up 12.0% in 1998. This increase is attributable to
$81,000 more in dividends earned from the sale of creditor life insurance
products through a subsidiary of the New York State Bankers Association,
and from the full year impact of miscellaneous fees generated by the former
Key and Fleet branches, offset by a decrease in Canadian exchange revenue.
Non-recurring income was $3.2 million in 1998 (including FAS 133-related
securities gains) as compared to $381,000 in 1997. Approximately 72% of the 1998
figure represents $2.3 million in gains taken on $86 million in investment
sales, designed to both enhance portfolio total return as well as to improve the
Company's interest rate risk position through reinvestment of the proceeds or
paying down borrowings. Additional gains resulted from $235,000 in gains on
loans sold (student loans and mortgages sold in the secondary market), $406,000
in recognizing the value of the Company's $39 million mortgage servicing
portfolio, $167,000 in gain on life insurance and various other gains, offset by
$275,000 in losses on the sale of former acquired branch properties. The 1997
results included a $236,000 gain on life insurance and gains on secondary market
mortgage loans sold.
Recurring noninterest income as a percentage of total operating income increased
2.6 percentage points during 1998 to 17.9%. Since 1994, the percentage has risen
5.9 percentage points resulting from a focused effort to raise product revenues
less susceptible to interest rate fluctuation. Further growth was recognized
during fourth quarter 1998 as the ratio increased to 18.4% Compared to peers as
of September 30, 1998, this ratio was in the 47th peer percentile, a significant
improvement from the 31st percentile twelve months earlier.
In light of management's ongoing objective to grow noninterest income,
opportunities to develop new fee-based products are actively pursued and
emphasis continues on the collection of fees (including limitation on waived
fees) for providing quality service. In 1999, the Bank will strive for continued
growth in the sale of BPA/EBT, personal trust, mutual fund (further aided by the
creation of a broker/dealer subsidiary) and secondary market mortgage products.
The full benefit of the fee restructuring which took effect during 1998 is
expected to be realized as well as the opportunity beginning in first quarter
1999 to earn origination fees from the placement of commercial leases with a
third party provider.
The following table sets forth selected information by category of noninterest
income for the Company for the years and quarters indicated.
----------------------------------------------------------------
Years ended Quarters ended
(000's omitted) December 31, December 31,
----------------------------------------------------------------
1998 1997 1996 1998 1997
---- ---- ---- ---- ----
Personal trust income $1,183 $1,150 $1,094 $323 $355
Mutual fund and related investment 1,222 1,002 782 313 254
products
BPA/EBT income 2,333 1,824 1,117 572 454
Deposit service charges 3,655 2,868 2,259 931 883
Overdraft fees 2,975 2,186 1,778 824 658
Other service charges and fees 2,819 2,397 1,720 667 644
Non-recurring income (1) 3,181 381 124 846 301
Total $17,368 $11,808 $8,874 $4,476 $3,549
Total non-interest income (excluding
non-recurring income) as a percentage
of operating income 17.9% 15.3% 13.6% 18.4% 15.8%
(1) includes $327,000 of investment gains on securities sold upon adoption of FAS 133.
17
NONINTEREST EXPENSE
- -------------------
Noninterest expense or overhead rose $6.1 million or 13.3% in 1998 as compared
to $8.3 million or 22.3% in 1997. The bulk of the 1997 and 1998 increases was
caused by the impact of the mid-1997 Key and Fleet branch acquisitions. This
branch expansion caused personnel additions (both acquired branch staff and
volume-sensitive positions in operations and other areas needed to support the
expanded balance sheet), greater data processing requirements, higher facilities
costs, increased amortization of deposit intangibles, and other expenses
associated with servicing the expanded customer base. As a percent of average
assets, this year's overhead at 3.11% increased slightly from 3.07% in 1997;
however, the ratio remains in the peer normal 50th percentile.
For CBSI as a whole, higher personnel expense accounted for over 46% of 1998's
increase in overhead, with personnel costs being up 12.2% versus being 19.2%
higher in 1997. Salary, benefit, and payroll tax expense primarily increased
because of the full impact of staffing the new branches along with modest annual
merit awards for all employees. Total full-time equivalent staff at year-end
1998 were 718 versus 726 at year-end 1997, down as the result of reorganizing
job responsibilities so as to not replace turnover.
Nonpersonnel expense rose $3.3 million or 14.3% this year as opposed to a $4.7
million or 25.5% increase in 1997. Included in the 1998 increase was the
one-time write down of $302,000 in vacant former acquired properties not in use
(due to duplicate facilities within the same proximity), largely related to the
Key and Fleet acquisitions. In addition, higher expenses for occupancy,
depreciation on equipment, telephone, courier, armored car, postage, business
development, and computer services resulted from the full impact of the 20 new
branches added in mid 1997, of which seven have been or are soon to be
consolidated with other facilities. Total intangible amortization increased
$937,000 or 25.3% to $4.6 million in 1998 as a result of the full impact of the
branch acquisitions. Various other increases related to internal volume growth,
expenses associated with repossessed assets, and price increases from selected
vendors were partially offset by lower advertising and supplies caused by the
lack of 1997's acquired branch start-up costs.
The efficiency ratio is defined at two levels: the nominal ratio is total
overhead expense divided by operating income (full tax-equivalent net interest
income plus noninterest income, excluding net securities gains and losses). The
adjusted or recurring efficiency ratio excludes one-time expense and intangible
amortization as well as all one-time noninterest income. The lower the ratio,
the more efficient a bank is considered to be.
In 1998, the nominal efficiency ratio increased 3.8 percentage points to 64.7%;
the recurring ratio increased 4.1 percentage points to 59.1%. Management
believes it is more accurate to use the recurring ratio to compare to national
norms, because most of its peer do not have intangible expense to the
significance that CBSI has. On that basis, CBSI's ratio is more favorable than
the national peer bank holding company median of 60.9% based on data available
as of September 30, 1998. The primary reason for the softening in the 1998
efficiency ratios is the reduced increase in net interest income caused by a
reduction in margin, exacerbated by the historically unprecedented accelerated
amortization of premiums on certain of the Company's CMO securities. Consistent
with the Bank's initial strategy for buying the CMOs and corresponding with its
total return philosophy, investment gains were taken to mitigate the accelerated
amortization when the asset/liability position could be improved with
reinvestment of the cash flow or paydown of borrowings. Thus, if investment
gains are included, the recurring efficiency ratio increased 2.3 percentage
points from 55.1% in 1997 to 57.4% in 1998.
Recurring non-interest expense for fourth quarter 1998 was $13.0 million,
$361,000 or 2.9% higher than the same 1997 period. Both periods include the full
impact of the mid-1997 acquisitions.
While the Company's expense ratios have generally been favorable, management
maintains a heightened focus on controlling costs and eliminating
inefficiencies. Areas for improvement have been identified through detailed peer
comparisons, a bank-wide program of employee involvement, and targeted use of
outside consultants and review of productivity-enhancing technology. These
combined efforts are intended to offset pressure from future price increases and
higher transaction volumes and enable the Company to more fully benefit from
economies of scale as it continues to grow. Specifically, the Bank will benefit
more fully in 1999 from the spring 1998 installation of frame relay to lower the
cost of data communications, the creation of a broker/dealer subsidiary during
first quarter 1999 to bring down the expense of delivering mutual funds and
related products, the overhead savings following disposition of acquired branch
properties in 1998, and lower scheduled deposit intangible amortization.
18
The following table sets forth information by category of noninterest expenses
of the Company for the years and quarters indicated.
--------------------------------------------------------------------------------
Years ended Quarters ended
(000's omitted) December 31, December 31,
--------------------------------------------------------------------------------
1998 1997 1996 1998 1997
---- ---- ---- ---- ----
Personnel expense $25,750 $22,945 $19,247 $6,407 $6,311
Net occupancy expense 4,056 3,426 3,073 940 952
Equipment expense 3,501 2,728 2,318 892 774
Professional fees 2,142 1,616 1,119 677 496
Data processing expense 3,928 3,584 2,975 940 909
Amortization of intangibles 4,640 3,787 2,729 873 1,204
Stationary and supplies 1,344 1,749 951 293 658
Deposit insurance premiums 189 140 368 46 44
Other 6,326 5,823 4,670 1,990 1,559
----- ----- ----- ----- -----
Total $51,876 $45,799 $37,451 $13,058 $12,906
======= ======= ======= ======= =======
Total operating expenses as
a percentage of average assets
3.11% 3.07% 2.99% 3.12% 3.26%
Efficiency ratio - nominal (1) 64.7% 60.9% 58.0% 65.5% 62.0%
- adjusted (2) 59.1% 55.8% 53.9% 59.8% 56.6%
(1) Noninterest expense divided by operating income, excluding net securities
gains/losses.
(2) Noninterest expense excluding nonrecurring items and amortization of deposit
intangibles divided by operating income excluding all nonrecurring items.
INCOME AND INCOME TAXES
- -----------------------
Income before tax in 1998, excluding the impact of FAS 133 accounting for
selected securities gains, was $24.4 million, up .1% over the prior year's
amount. When income is recast as if all tax-exempt revenues were fully taxable
on a federal basis, and all securities gains are stated on a pretax basis,
1998's results rose by $640,000 or 2.6% before tax.
Largely as a result of the full year impact of 1997's acquisitions, the main
reasons for improved pretax earnings were the favorable $1.8 million increase in
net interest income (full tax-equivalent basis) and a $2.8 million climb in
recurring noninterest income. Additionally, nonrecurring income rose $2.8
million primarily as a result of gains taken in the investment portfolio. These
factors were partially offset by $6.1 million more in overhead expense (also
related to the acquisitions), and $643,000 more in loan loss provision expense
associated with higher net charge-offs.
The Company's combined effective federal and state tax rate rose a slight 25
basis points this year to 36.5%. The increase resulted from certain adjustments
in calculating federal tax liability, partially offset by a greater proportion
of tax-exempt municipal investment holdings which became more attractive than
certain taxable securities in the present flat yield curve environment.
CAPITAL
- -------
Shareholders' equity ended 1998 at $120.2 million, up over 1.8% from one year
earlier, primarily reflective of the contribution of earnings and the after-tax
market value adjustment (MVA) of the Bank's available-for-sale investments.
These capital inflows were partially offset by dividends paid to shareholders
and $9.2 million in CBSI common stock repurchased during the fall of 1998 in the
open market, now held as treasury stock. Excluding the $1.5 million after-tax
change in this year's MVA, capital rose less than 1%. Shares outstanding fell by
over 290,000 during 1998 due to the repurchase of stock offset by the exercise
of stock options.
On September 17, 1998, the Company announced a stock repurchase program to
acquire up to 750,000 of its shares. The share repurchase program was intended
to be accompanied by a reduction in the investment security portfolio, largely
through run-off due to anticipated prepayments and bond calls. Management's
belief was that this was an opportune time to reduce the Bank's reliance on
earnings from the investment portfolio necessitated over the last several years
by significant deposit growth
19
via branch acquisitions; in addition, the share repurchase program had a more
positive impact on earnings per share than investment spreads could offer.
Through December 31, 1998, 326,600 shares have been repurchased representing the
aforementioned $9.2 million in treasury stock. Whether the remaining 423,400
shares of the original Board authorization is repurchased depends heavily on
whether the Company can maintain sufficient capital flexibility to move forward
with its strategic growth plans, including possible acquisitions. In addition,
continued repurchase is dependent on whether the Bank's volume of high cost
liabilities can be lowered, whether investment spreads improve to make
reinvestment of cash flows or leverage strategies more attractive, or whether
additional shares are needed to accommodate the exercise of stock options.
Despite the repurchase of stock, the ratio of tier I capital to assets (or tier
I leverage ratio), the basic measure for which regulators have established a 5%
minimum to be considered "well-capitalized," remains sound at 5.71%. This level
compares to 5.67% one year ago. The total capital to risk-weighted assets ratio
of 10.49% as of year-end 1998 was above the 10% minimum requirement for
"well-capitalized" banks. The Company is confident that capital levels are being
prudently balanced between regulatory and investor perspectives.
Cash dividends declared on common stock in 1998 of $6.5 million represented an
increase of 12.8% over the prior year. This growth largely reflects a three cent
per share increase in quarterly common stock dividend beginning in the third
quarter of 1998 from $.20 to $.23. There were no dividends declared on preferred
stock in 1998 as compared to $180,000 in the prior year, reflecting the
redemption of the remaining preferred stock in January of 1997.
Raising the Company's expected annualized dividend to $0.92 per common share
represents management's confidence that earnings strength is sustainable and
that capital can be maintained at a satisfactory level. The dividend payout
ratio for the year was approximately 41%, moving up from the 1997 levels of 38%
or 37% excluding preferred dividends. This is slightly higher than the Company's
targeted payout range for dividends on common stock of 30-40%. Its payout ratio
has historically been strong relative to peers, ranging from the 60th to 77th
percentile from 1993 through 1997, including preferred dividends. The 1998 peer
payout ratio remained high in the 65th peer percentile.
LOANS
- -----
The amounts of the Bank's loans outstanding (net of deferred loan fees or costs)
at the dates indicated are shown in the following table according to type of
loan:
----------------------------------------------------------------------------
Years ended December 31,
----------------------------------------------------------------------------
(000's omitted) 1998 1997 1996 1995 1994
- --------------- ---- ---- ---- ---- ----
Real estate mortgages
Residential $266,841 $278,912 $225,088 $204,224 $196,548
Commercial loans secured by real estate 124,828 85,962 56,959 46,971 35,604
Farm 12,486 10,434 8,296 8,224 7,625
------ ------ ----- ----- -----
Total 404,155 375,308 290,343 259,419 239,777
Commercial, financial, and agricultural
Agricultural loans 22,691 23,894 21,689 17,969 13,295
Commercial loans 168,984 138,067 99,445 81,562 67,976
------- ------- ------ ------ ------
Total 191,675 161,961 121,134 99,531 81,271
Installment loans to individuals
Direct 105,480 89,138 62,176 57,646 58,371
Indirect 205,159 198,853 171,583 144,566 121,148
Student & Other 6,477 10,880 9,635 10,268 8,690
----- ------ ----- ------ -----
Total 317,116 298,871 243,394 212,480 188,209
Other Loans 5,581 8,887 3,496 2,190 1,482
----- ----- ----- ----- -----
Gross loans 918,527 845,027 658,367 573,620 510,739
Less: Unearned discount 1,307 1,815 5,893 13,469 27,660
Reserve for possible loan losses 12,441 12,434 8,128 6,976 6,281
------ ------ ----- ----- -----
Net loans $904,779 $830,778 $644,346 $553,175 $476,798
20
The Company's predominant focus on the retail borrower enables its loan
portfolio to be highly diversified. Approximately 64% of loans outstanding are
oriented to consumers borrowing on an installment and residential mortgage loan
basis. Additionally, the typical size loan to the variety of commercial
businesses in the Company's market areas is under $70,000, with only 34% of the
commercial portfolio consisting of loans in excess of $500,000. The portfolio
contains no credit card receivables. The overall yield on the portfolio is in
the attractive 61st peer percentile.
Loans outstanding, net of unearned discount, reached a record $917 million as of
year-end 1998, up over $74 million or 8.8% compared to twelve months earlier.
Over 40% of 1998's growth took place in the markets served by the branches
purchased from Chase at mid-year 1995; outstandings at these branches have risen
from $12 million at the July 1995 acquisition date to $132 million at year-end
1998. About 38% of 1998's growth was due to the contributions of 20 branches
acquired in mid-1997 from Key Bank, N.A. and Fleet Bank, with combined year-end
1998 loans outstanding of $122 million. Taken together, all acquired branch
locations now account for approximately $254 million in loans (or 28% of the
Company's year-end loan base). If approximately $39.3 million in mortgages sold
on the secondary market in 1998 were considered, loan growth could have been
13.4%, marking the sixth consecutive year in which total loan growth (including
loans generated but not held in portfolio) has exceeded 13%.
The "Nature of Lending" table below recasts the Company's loan portfolio into
four major lines of business. As previously discussed, much of the 1997 and 1998
loan growth relates to acquired branch locations and resulting market
opportunities. The increase in business lending accounted for 51% of $74 million
in total loan growth in 1998 versus 41% of 1997's $191 million increase. On the
other hand, a reduction in consumer direct loans lowered total growth by 6% this
year versus contributing 37% of 1997s growth. Consumer indirect loans accounted
for 7% of this year's increase, down from 16% in the prior year. Lastly, the
share of this year's total loan increase for consumer mortgages rose
dramatically to 48% from 1997's level of 6%. The following more fully discusses
the underlying reasons for these changes by each of the Company's four major
lending activities or lines of business.
NATURE OF LENDING
Mix at Quarter End
($ million and %)
Total Loans Consumer Mortgage Business Lending Consumer Indirect Consumer Direct
---------------------- ------------------------ ------------------------ ----------------------- -------------------------
Year $Mil %Change $Mil %Total Change $Mil %Total %Change $Mil %Total %Change $Mil %Total %Change
1998 917 8.8% 199 22% 21.6% 326 36% 13.0% 204 22% 2.8% 188 20% -2.5%
1997 843 29.2% 164 19% 7.8% 288 34% 36.7% 199 24% 18.6% 192 23% 57.5%
1996 652 16.5% 152 23% 3.2% 211 32% 21.3% 168 26% 24.2% 122 19% 17.4%
1995 560 16.0% 147 26% 2.4% 174 31% 25.6% 135 24% 31.8% 104 19% 5.6%
1994 483 15.6% 143 30% 12.2% 139 29% 15.1% 102 21% 37.9% 99 20% 3.4%
The combined total of general purpose business lending, dealer floor plans,
mortgages on commercial property, and farm loans is characterized as the
Company's business lending activity. At $326 million, this segment represents
36% of loans outstanding at year end, having steadily expanded its share by
seven percentage points since year-end 1994. This relatively high mix compared
to the Bank's other loan types is largely attributable to borrowing by local
commercial businesses. Outstandings climbed over $37 million or 13% in 1998
compared to a 37% growth rate for 1997 and 21% in 1996. This year's growth
resulted from persistent business development efforts and the contributions of
new lenders who joined the Bank coincident with or as part of 1997's
acquisitions. Last year's increase was further aided by the acquired loans.
More than 85% of the Bank's total number of commercial loans have balances less
than $100,000, which as a group constitutes approximately 32% of commercial loan
outstandings. Commercial loans ranging from $100,000 to $250,000 comprise nearly
22% of loans outstanding while loans in the size range of $250,000-$500,000
amount to 13%. Loans with balances greater than $500,000, but less than $1
million represent 12% of the portfolio, while loans of $1 million or more
account for 22% of outstandings.
21
Demand for installment debt indirectly originated through automobile, marine,
and mobile home dealers slowed in 1998. Outstandings ended the year 3% or $5.5
million higher compared to growth of 19% or $31 million in 1997. Tighter
underwriting standards and increased competition from financing subsidiaries of
major automakers for new car purchases can be pointed to as causes of the
slowing level of growth. This portfolio segment, of which 92% relates to
automobile lending (72% of the vehicles are used versus 28% are new),
constitutes 22% of total loans outstanding, down from 24% in 1997 and its peak
of 26% in 1996.
The segment of the Company's loan portfolio committed to consumer mortgages
includes both fixed and adjustable rate residential lending. It accounts for
$199 million or 22% of total loans outstanding. The growth during the last two
years ($35.8 million or 21.9% in 1998 - attributable to the nationwide
refinancing boom - and $11.9 million or 7.8% in 1997) is lower than it would
otherwise be due to a program which began in mid-1994 to sell selected fixed
rate originations in the secondary market. The purpose of this program, with
sales of $7.2 million in 1996, $14.0 million in 1997 and $39.3 million this
year, is to develop a meaningful source of servicing income as well as to
provide an additional tool to manage interest rate risk.
The direct consumer lending activity decreased slightly this year. 1998's
outstandings fell 2.5% or $5 million versus a 57.5% increase or $70 million in
1997 due to acquisitions. This line of business is comprised of conventional
installment loans (including some isolated installment lending to small
businesses), personal loans, student loans (which are sold once principle
repayment begins), and borrowing under variable and fixed rate home equity lines
of credit. The consumer direct segment as a percent of total loans trended
upward in 1996 and 1997. However, 1998's portfolio share fell 3 percentage
points from the prior year, possibly representing consumer borrowing being
refinanced as mortgage debt in overall mortgage refinancing activity. The latter
represents a strategy that CBNA has been promoting in several of its major
markets, with special emphasis on paying down credit card debt held by other
lenders.
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
- ------------------------------------------------------------------
The following table shows the amount of loans outstanding as of December 31,
1998, which, based on remaining scheduled payments of principal, are due in the
periods indicated:
---------------------------------------------------------------
At December 31, 1998
---------------------------------------------------------------
Maturing
Maturing in After One But Maturing
One Year or Within Five After Five Total Book
(000's omitted) Less Years Years Value
----------- ------------- ------------ ------------
(In Thousands)
Commercial, financial, and agricultural $43,883 $84,071 $48,852 $176,806
Real estate - mortgage 22,886 104,607 303,522 431,015
Installment, net of unearned discount 90,876 200,448 18,075 309,399
-------- -------- -------- --------
Total loans, net of unearned discount $157,645 $389,126 $370,449 $917,220
======== ======== ======== ========
The following table sets forth the sensitivity of the loan amounts due after one
year to changes in interest rates:
-----------------------------
At December 31, 1998
-----------------------------
(000's omitted) Fixed Rate Variable Rate
Due after one year but within five years $ 313,155 $ 75,971
Due after five years 286,444 84,005
--------- ---------
Total due after one year $ 599,599 $ 159,976
========= =========
22
NONPERFORMING ASSETS/RISK ELEMENTS
- ----------------------------------
The following table presents information concerning the aggregate amount of
nonperforming assets:
-----------------------------------------------------------
Years ended December 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for on a non-accrual basis $2,473 $1,385 $2,023 $1,328 $2,396
Accruing loans which are contractually past
due 90 days or more as to principal or
interest payments 1,513 2,788 823 667 862
----- ----- --- --- ---
Total non-performing loans 3,986 4,173 2,846 1,995 3,258
Loans which are "troubled debt
restructurings" as defined in Statement of
Financial Accounting Standard No. 15,
"Accounting by Debtors and Creditors for
Troubled Debt Restructurings" 134 0 32 0 15
Other real estate (OREO) 1,182 881 746 614 223
----- --- --- --- ---
Total non-performing assets $5,302 $5,054 $3,624 $2,609 $3,496
====== ====== ====== ====== ======
Ratio of allowance for loan losses to
period-end loans 1.36% 1.47% 1.25% 1.25% 1.30%
Ratio of allowance for loan losses to
period-end non-performing loans 312.0% 298.0% 285.6% 349.7% 192.8%
Ratio of allowance for loan losses to
period-end non-performing assets 234.6% 246.0% 224.3% 267.4% 179.7%
Ratio of non-performing assets to period-
end total loans and other real estate owned 0.56% 0.60% 0.55% 0.47% 0.72%
The impact of interest not recognized on nonaccrual loans, and interest income
that would have been recorded if the restructured loans had been current in
accordance with their original terms, was immaterial. The Company's policy is to
place a loan on nonaccrual status and recognize income on a cash basis when it
is more than ninety days past due, except when in the opinion of management it
is well secured and in the process of collection.
PROVISION AND RESERVE FOR LOAN LOSSES
- -------------------------------------
Nonperforming loans, defined as nonaccruing loans plus accruing loans 90 days or
more past due, ended 1998 at $4.0 million. This level is approximately $200,000
or 4% lower than one year earlier, reflecting a decrease in 90 day delinquencies
being partially offset by higher nonaccruals. Accordingly, the ratio of
nonperforming loans to total loans has fallen 6 BPs during the year to .43%. As
of September 30, 1998, when the nonperforming loan ratio stood at .48%, the
Company's asset quality was in the favorable 28th percentile compared to peers.
The ratio of nonperforming assets (which additionally include troubled debt
restructuring and other real estate) to total loans plus OREO is also considered
favorable at .56%, down 4 basis points from one year earlier.
Total delinquencies, defined as loans 30 days or more past due and nonaccruing,
trended slightly lower as a percent of total loans in 1998, generally
fluctuating within a range of 1.3% to 1.5%, as compared to a range of 1.3% to
1.8% in 1997. The first six months of 1998 saw total delinquencies drop sharply
from 1.82% at year-end 1997 to 1.37% at June 30, 1998; total delinquencies
remained relatively stable for the last half of 1998, finishing at 1.40%.
As of year-end 1998, total delinquencies for commercial loans, installment
loans, and real estate mortgages were 1.22%, 2.09%, and 0.80% , respectively.
These measures compare favorably to delinquencies of peer bank holding companies
as of September 30, 1998 of 2.57%, 2.28%, and 1.72%, respectively. The Bank
strives to maintain its total and component category delinquencies below a 2%
internal guideline.
23
As of September 30, 1998, when overall delinquencies were at 1.39%, the Company
ranked in the favorable 37th peer percentile. Factors contributing to successful
underwriting, collection, and credit monitoring include selective addition of
experienced lenders over the last several years, loan servicing on a regional
level, collection departments focused on taking prompt corrective action, and a
centralized loan review function which is given priority attention and has
monthly Board of Director accountability.
As an indication of the Company's timely charge-off policy, which enables
delinquencies to be managed better than the norm, net charge-offs finished the
year at $5.1 million or a relatively high .58% of average loans. As a result of
unusually high installment loan charge-offs in the first quarter of 1998 (a
trend carried over from the fourth quarter of 1997), gross charge-offs rose
37.1% to $6.1 million, or .69% of average loans outstanding versus .59% in 1997.
This year's recoveries rose to an all-time record in dollar amount of $981,000,
while down from 1997 in percentage terms to 22.1% of prior year gross
charge-offs. As of September 30, 1998, the Bank's total net charge-off ratio was
in the 87th peer percentile based on the peer norm of .26%. Significant progress
in lowering net charge offs to more satisfactory levels is evidenced by a fourth
quarter 1998 ratio of .55% compared to a .76% one year earlier, which was the
high point for 1997.
A timely charge-off policy and relatively low nonperforming loans have enabled
the Company to carry a reserve for loan losses generally below peers. As a
percent of total loans, the loss reserve ratio has decreased to a 1.36% level at
year end 1998 from 1.47% as of year-end 1997 . Though the reserve ratio is
presently at the peer norm being in the 49th peer percentile, coverage of
nonperforming loans as of September 30, 1998 was well above the norm in the 69th
percentile; management believes the year-end coverage at 312% to be ample. The
Company's small business loan orientation has historically reduced the
likelihood of large, single borrower charge-offs. Another measure of comfort to
management is that after conservative allocation by specific customer and loan
type, over 8% of loan loss reserves remains available for absorbing general,
unforeseen loan losses.
The annual loan loss provision has historically been in excess of net
charge-offs by approximately 20%. However, because of lower than expected
charge-offs on acquired Key and Fleet loans and a sufficient loss reserve
pertaining to all other loans, every dollar of net-charge offs was covered by a
single dollar of provision in 1998. Consequently, the Bank felt comfortable
keeping the loan loss reserve flat at the year-end 1997 level of $12.4 million.
Management continually evaluates reserve adequacy from a variety of
perspectives, including projected overall economic conditions for the coming
year. The reserve for loan losses also encompasses risk associated with
potential Year 2000 business losses of its customers.
As a percentage of average loans, the annual loan loss provision was well above
the peer norm in the 79th percentile as of September 30, 1998. For full year
1998, the loss provision ratio was .58%, down from .60% in 1997, consistent with
the Company's decision to reduce net charge-off coverage from 1.2 times in 1997
to 1 times this year. Consequently, loan loss provision expense rose $643,000 or
14.4% in 1998 versus $1.6 million or nearly 55% in the prior year.
24
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------
The following table summarizes loan balances at the end of each period indicated
and the daily average amount of loans. Also summarized are changes in the
allowance for possible loan losses arising from loans charged off and recoveries
on loans previously charged off and additions to the allowance which have been
charged to expenses.
--------------------------------------------------------------------
Years ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in thousands)
Amount of loans outstanding at end of period $918,527 $845,027 $658,367 $573,620 $510,739
-------- -------- -------- -------- --------
Daily average amount of loans (net of unearned discounts) $884,751 $749,596 $602,717 $519,762 $446,135
-------- -------- -------- -------- --------
Balance of allowance for possible loan losses
at beginning of period $ 12,434 $ 8,128 $ 6,976 $ 6,281 $ 5,706
Loans charged off:
Commercial, financial, and agricultural 698 418 324 454 502
Real estate construction 0 0 0 0 0
Real estate mortgage 24 25 26 48 41
Installment 5,375 4,006 2,108 1,256 1,072
----- ----- ----- ----- -----
TOTAL LOANS CHARGED OFF 6,097 4,449 2,458 1,758 1,615
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 200 185 224 213 38
Real estate construction 0 0 0 0 0
Real estate mortgage 4 1 1 27 1
Installment 777 541 488 448 449
--- --- --- --- ---
TOTAL RECOVERIES 981 727 713 688 488
Net loans charged off 5,116 3,722 1,745 1,070 1,127
----- ----- ----- ----- -----
Additions to allowance charged to expense (1) 5,123 4,480 2,897 1,765 1,702
----- ----- ----- ----- -----
Reserves on acquired loans (2) 0 3,548 0 0 0
-------- -------- ------- ------- -------
Balance at end of period $ 12,441 $ 12,434 $ 8,128 $ 6,976 $ 6,281
-------- -------- ------- ------- -------
Ratio of net charge-offs to average loans outstanding 0.58% 0.50% 0.29% 0.21% 0.25%
(1) The additions to the allowance during 1994 through 1998 were determined
using actual loan loss experience and future projected loan losses and other
factors affecting the estimate of possible loan losses.
(2) This reserve addition is attributable to loans purchased from Key Bank and
Fleet Bank in association with the purchases of branch offices during 1997.
25
The allowance for possible loan losses has been allocated according to the
amount deemed to be reasonably necessary to provide for the possibility of
losses being incurred within the following categories of loans at the dates
indicated.
--------------------------------------------------------------------------------------------------------------------
Years ended December 31,
--------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------------------------------------
Amount of Percent of Amount of Percent of Amount of Percent of Amount of Percent of Amount of Percent of
Allowance Loans in Allowance Loans in Allowance Loans in Allowance Loans in Allowance Loans in
Each Each Each Each Each
Category to Category to Category to Category to Category to
Total Loans Total Loans Total Loans Total Loans Total Loans
--------------------------------------------------------------------------------------------------------------------
Commercial,
financial, &
agricultural $ 4,502 19.7% $ 4,136 19.2% $ 2,668 18.4% $ 2,035 17.4% $ 1,832 15.9%
Real estate -
construction - - - - - - - - - -
Real estate -
mortgage 2,210 43.4% 2,026 44.4% 2,234 44.1% 2,255 45.2% 2,222 47.0%
Installment 4,525 36.9% 4,461 36.4% 2,309 37.5% 1,527 37.4% 1,422 37.1%
Unallocated 1,096 N/A 1,811 N/A 917 N/A 1,159 N/A 805 N/A
Y2K credit risk
allocation 108 N/A N/A N/A N/A N/A N/A N/A N/A N/A
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total $12,441 100.00% $12,434 100.00% $ 8,128 100.00% $ 6,976 100.00% $ 6,281 100.00%
FUNDING SOURCES
- ---------------
Typical of most commercial banking institutions today is the need to rely on a
variety of funding sources to support its earning asset base as well as to
achieve targeted growth objectives. There are three primary sources of funding
that comprise CBSI's overall funding matrix, which considers maturity,
stability, and price: deposits of individuals, partnerships and corporations
(IPC deposits); collateralized municipal deposits; and capital market
borrowings.
--------------------------------------------------------------------------------------------------------------------------
Sources of Funds
Average 4th Quarter Balances
($ Million)
--------------------------------------------------------------------------------------------------------------------------
Total
Funds
Year IPC Deposits Public Funds Capital Borrowings Sources
---- ------------ ------------ ------------------ -------
Amount % Total Amount % Total Amount % Total Amount % Change
------ ------- ------ ------- ------ ------- ------ -------
1998 $1,194 78.8% $189 12.5% $132 8.7% $1,515 4.5%
1997 1,190 82.1 163 11.2 98 6.7 1,450 2.0%
1996 903 75.6 124 10.4 168 14.1 1,195 21.3%
1995 921 86.8 128 12.6 6 0.6 1,018 25.2%
1994 $583 71.7% $101 12.4% $129 15.9% $813 29.7%
The Company's funding matrix continues to benefit from a high level of IPC
deposits, which reached an all-time record for a fourth quarter average of
$1.194 billion, up slightly ($4 million or less than half of one percent) from
the comparable 1997 period. IPC deposits are frequently considered to be a
bank's most attractive source of funding because they are generally stable, are
uncollateralized, and have a relatively low cost, and because they represent a
working customer base with the potential to be cross-sold a variety of loan,
deposit and other financial service-related products.
26
The mix of CBSI's IPC deposits has changed over the last five years as measured
by the trend of fourth quarter average balances. The time deposit share grew
steadily, from 38% of deposits in 1994 to 49% in 1997, reflecting consumer
movement away from immediately available, lower earning savings and money market
accounts as well as the relatively high mix of time deposits in the branches
that have been acquired over the last few years. The time deposit mix was
reduced to 46% in 1998, corresponding to a $25 million reduction in
outstandings. Conversely, transaction accounts increased by an unusually strong
$31 million (no acquisitions having occurred during the period). The resulting
three percentage points higher deposit share of 27% reflects continued
commercial customer growth and, more importantly, a lower opportunity cost of
noninvested funds.
Deposits of local municipalities increased $27 million or 17% during the past
year, with balances for fourth quarter 1998 averaging $189 million versus $163
million for the same 1997 quarter. Under New York State Municipal Law, the
Company is required to collateralize all local government deposits with
marketable securities from its investment portfolio. Because of this
stipulation, management considers this source of funding to be equivalent to
capital market borrowings. As such, CBSI endeavors to price these deposits at or
below alternative capital market borrowing rates. Utilization of municipal
deposits has generally been decreasing since 1994 as a percent of total funding
sources; the uptick in 1998 reflects the strong cash flow of municipal
customers.
Capital market borrowings are defined as funding sources available on a national
market basis, generally requiring some form of collateralization. Borrowing
sources for the Company include the Federal Home Loan Bank of New York, as well
as access to the national repurchase agreement market through established
relationships with primary market security dealers. Also considered a borrowing
is the $30 million in 9.75% Company-Obligated Mandatorily Redeemable Preferred
Securities issued to support 1997's acquisitions. Capital market borrowings
averaged $132 million or 9% of total funding sources for fourth quarter 1998
compared to $98 million or 7% of total funding sources for the same period in
1997. As of December 31, 1998, more than half or $70 million of capital market
borrowings (excluding the aforementioned Trust Preferred securities) had
original terms of one year or more.
The average daily amount of deposits and the average rate paid on each of the
following deposit categories is summarized below for the years indicated.
1998 1997 1996
---------------------- ---------------------- ----------------------
(000's omitted) Average Average Average Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
------- --------- ------- --------- ------- ---------
Non-interest-bearing demand deposits $214,997 N/A $170,989 N/A $143,995 N/A
Interest-bearing demand deposits 145,141 1.18% 119,769 1.38% 100,278 1.40%
Regular savings deposits 264,370 2.79% 247,330 2.91% 241,199 2.87%
Money market deposits 99,219 3.08% 76,567 2.76% 65,448 2.48%
Time deposits 672,972 5.57% 599,136 5.61% 481,250 5.49%
------- ------- -------
Total average daily
amount of domestic deposits $1,396,699 3.55% $1,213,791 3.67% $1,032,170 3.52%
========== ========== ==========
The remaining maturities of time deposits in amounts of $100,000 or more
outstanding at December 31, 1998 and 1997 are summarized below:
---------------------------------
At December 31,
---------------------------------
(000's omitted) 1998 1997
---- ----
Less than three months $42,770 $33,240
Three months to six months 24,451 29,420
Six months to one year 15,508 19,340
Over one year 8,961 11,439
------- -------
Total $91,690 $93,439
======= =======
27
The following table summarizes the outstanding balance of short-term borrowings
of the Company for the years indicated.
------------------------------------------------
(000's omitted) At December 31,
------------------------------------------------
1998 1997 1996
---- ---- ----
Federal funds purchased $34,700 $45,000 $31,800
------- ------- -------
Term borrowings at banks (original term)
90 days or less 30,000 20,000 -
1 year - - 65,000
- ------- ------- -------
Balance at end of period $64,700 $65,000 $96,800
======= ======= =======
Daily Average during the year $13,915 $45,008 $46,535
Maximum month-end balance $64,700 $128,000 $96,800
Weighted average rate during the year 5.42% 5.74% 5.63%
Year-end average rate 5.46% 6.53% 6.07%
INVESTMENTS
- -----------
The stated objective of CBSI's investment portfolio is to prudently provide a
degree of low-risk, quality assets to the balance sheet. This must be
accomplished within the constraints of: (a) absorbing funds when loan demand is
low and infusing funds when demand is high; (b) implementing certain interest
rate risk management strategies which achieve a relatively stable level of net
interest income; (c) providing both the regulatory and operational liquidity
necessary to conduct day-to-day business activities; (d) considering investment
risk-weights as determined by regulatory risk-based capital guidelines; and (e)
generating a favorable return without undo compromise of other requirements.
Starting in the third quarter of 1997, the Company adopted the use of total
return as its primary methodology for managing investment portfolio assets.
Under this analytical method, the Company seeks to maximize shareholder value
through both interest income and market value appreciation.
Throughout 1998, falling interest rates accelerated the prepayments of many of
the Company's assets, including those in its residential mortgage,
mortgage-backed security and collateralized mortgage obligation (CMO) portfolio.
Such refinancings prompted management to consider asset/liability strategies
that would help reduce further balance sheet exposure to a low interest rate
environment. Four primary action steps were developed and implemented as a
result.
Early in the second quarter of 1998, management's first strategic initiative was
to sell $12.5 million in Libor-based CMO floaters and $10.5 million in callable
bonds with 18 months or less to first call date. This action resulted in a gain
to the Company of $571,000 over book. Including gains, the total holding period
return for these bonds averaged 8.30%. To hedge against further declines in the
yield curve, all proceeds were reinvested in long-lockout callable bonds and
discounted CMOs.
The second strategic decision made by management was to choose early adoption of
Statement of Financial Accounting Standard No. 133 during the third quarter.
This action made it possible to reclassify nearly all of the Company's $238
million held-to-maturity investments as available-for-sale. Greater flexibility
was thus achieved when managing the investment portfolio from a total return
perspective.
As the fall in interest rates further accelerated in the latter half of the
year, long-term investment opportunities became quite limited, leading to the
development of a third action plan. Rather than continue to leverage Bank
capital through the purchase of securities with increased future market value
risk, management embarked upon a strategy to deleverage portions of its
investment portfolio. This decision ultimately provided the opportunity for the
Company to begin its stock buy-back program announced in the third quarter of
1998, which resulted in 326,600 shares or $9.2 million in common stock being
repurchased during the late summer and early fall.
Approximately $57 million in investment securities was sold as a result of this
deleverage strategy. Gains recorded over book amounted to $1.58 million, while
the total holding period return on the assets sold averaged 8.90%. The majority
of investments sold were high coupon callable bonds with one year or less
remaining to first call date or mortgage-related securities (mortgage-backed and
CMO) with an average life of under two years. Interest rate sensitivity to a
potentially falling interest rate environment improved as a result of these
sales.
The fourth and final strategic action for the year came in mid November
following successive policy moves by the Federal Reserve Bank beginning on
September 30, 1998, which brought the targeted Federal Funds Rate down from
5.50% to 4.75%. With short-term capital market borrowing costs experiencing
similar declines, the Company chose to reinvest its portfolio cashflows back
into securities rather than repay short-term obligations or continue buying back
its common stock. The most attractive opportunity from both a total return and
interest rate risk perspective was a barbell purchase strategy coupling
long-term AAA rated and insured municipal bonds with uncapped Sallie Mae
floaters.
28
As mentioned previously, the downward pressure on interest rates during 1998 led
to historically high levels of mortgage refinancings in a variety of asset
sectors. Most notable were the prepayments experienced in the Company's premium
CMO portfolio. Premium CMOs, for purposes of this discussion, are defined as
those securities with an original purchase price of $102.5 or higher. Under
general accounting standards, any premium paid for mortgage-related bonds is
required to be amortized to par using a constant yield methodology. As mortgage
prepayments increased throughout the year, the monthly premium amortization
associated with these bonds increased accordingly. Because all such adjustments
are treated as reductions to investment income, the effects from high prepayment
levels serve to decrease the overall investment portfolio yield.
The average portfolio yield, including the effects from higher premium CMO
amortization, was 6.53%, or an earned spread to the average three year Treasury
rate of 137 basis points (BPs). This is down from 1997 levels, when the
portfolio returned 7.63% or a spread of 155 BPs to the same Treasury benchmark.
Higher premium amortization was largely responsible for this decline in spread,
the impact of which was estimated at 26 BPs or a $1.6 million accelerated charge
against interest income. However, when 1998 investment gains of $2.3 million on
$85 million in sales are included, the portfolio earned a cash return of 6.90%
or a spread of 174 BP's over the three year Treasury benchmark, an improvement
of 19 BPs from the prior year.
The composition of the portfolio continues to heavily favor U.S. Agency
Debentures, U.S. Agency mortgage-backed pass-throughs and U.S. Agency CMOs,
resulting in effective use of regulatory risk-based capital. As of year-end
1998, these three security types (excluding Federal Home Loan Bank stock and
Federal Reserve Bank stock) accounted for a combined 92% of total portfolio
investments (31%, 12% and 49%, respectively), down slightly from 96% in the
prior year. High balances of AAA rated and insured municipal bond balances at
year end accounted for this change. As of year end, the portfolio held $73
million of premium CMOs purchased before December 31, 1997 versus $113 million
one year earlier.
The average life of the portfolio, including the exercise of embedded call
options, decreased to 2.5 years as of December 31, 1998. At year end 1997, the
average life was 3.0 years. As a result of the above strategies, total
investments (excluding money market investments) ended 1998 at $594 million,
down $18 million or 3.0% from year-end 1997; the portfolio reached a high point
in April of approximately $671 million and a low point in November of
approximately $569 million.
29
INVESTMENT SECURITIES
- ---------------------
The following table sets forth the amortized cost and market value for the
Company's held-to-maturity investment securities portfolio:
Years ended December 31,
------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------
Amortized Amortized Amortized
(000's omitted) Cost/Book Market Cost/Book Market Cost/Book Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $0 $0 $164,199 $168,799 $248,264 $254,437
Obligations of states and
political subdivisions 4,038 4,107 10,221 10,575 17,796 18,292
Corporate securities 0 0 3,091 3,201 2 2
Mortgage-backed securities 0 0 86,148 88,838 103,795 105,765
------ ------ -------- -------- -------- --------
TOTAL $4,038 $4,107 $263,659 $271,413 $369,857 $378,496
====== ====== ======== ======== ======== ========
The following table sets forth the amortized cost and market value for the
Company's available-for-sale investment portfolio:
Years ended December 31,
------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------
Amortized Amortized Amortized
(000's omitted) Cost/Book Market Cost/Book Market Cost/Book Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $170,464 $175,866 $82,027 $84,730 $39,684 $40,005
Obligations of states and political
subdivisions 40,591 41,329 9,960 10,310 437 452
Corporate securities 9,153 9,382 0 0 0 0
Mortgage-backed securities 336,090 336,967 225,692 227,350 145,276 146,555
Equity securities (1) 23,784 23,784 23,669 23,669 20,282 20,282
Federal Reserve Bank common stock 2,174 2,174 2,174 2,174 1,403 1,403
-------- -------- -------- -------- -------- --------
TOTAL $582,256 $589,502 $343,523 $348,233 $207,082 $208,697
======== ======== ======== ======== ======== ========
Net unrealized gains/(losses)on
available for sale portfolio 7,246 4,710 1,614
-------- -------- --------
Total Carrying Value $593,540 $611,892 $578,553
======== ======== ========
(1) Includes $23,059; $19,709; and $19,678 in FHLB common stock at December 31,
1998, 1997, and 1996, respectively.
30
The following table sets forth as of December 31, 1998, the maturities of
investment securities and the weighted-average yields of such securities, which
have been calculated on the basis of the cost, weighted for scheduled maturity
of each security, and adjusted to a fully tax-equivalent basis:
At December 31, 1998
--------------------------------------------------------------------------------
Amount Amount
Amount Maturing Maturing
Maturing After One After Five Amount Total
Within Year but Years but Maturing Cost
One Year Within Within After Book
or Less Five Years Ten Years Ten Years Value
--------------------------------------------------------------------------------
Held-to-Maturity Portfolio
- --------------------------
U.S. Treasury and other
U.S. government agencies $0 $0 $0 $0 $0
Mortage-backed securities 0 0 0 0 0
States and political subdivisions 2,498 1,430 110 0 4,038
Other 0 0 0 0 0
------- -------- -------- -------- --------
Total Held-to-Maturity Portfolio Value $2,498 $1,430 $110 $0 $4,038
======= ======== ======== ======== ========
Weighted Average Yield at year end (1) 7.68% 11.00% 8.54% 0.00% 8.89%
Available-for-Sale Portfolio
- ----------------------------
U.S. Treasury and other
U.S. government agencies $6,002 $7,710 $115,209 $41,544 $170,465
Mortage-backed securities 57,632 204,178 50,765 23,515 336,090
States and political subdivisions 2,046 2,079 1,352 35,114 40,591
Other 2 50 2,492 6,609 9,153
------- -------- -------- -------- --------
Total Available-for-Sale Portfolio Value $65,682 $214,017 $169,818 $106,782 $556,299
Weighted average yield at year end (1) 6.19% 6.58% 7.41% 7.54% 6.97%
(1) Weighted average yields on the tax-exempt obligations have been computed on
a fully tax equivalent basis assuming a marginal federal tax rate of 35%. These
yields are an arithmetic computation of accrued income divided by average
balance; they may differ from the yield to maturity, which considers the time
value of money.
MARKET RISK
- -----------
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates/prices such as interest rates, foreign currency exchange
rates, commodity prices, and equity prices. The Company's primary market risk
exposure is interest rate risk. The ongoing monitoring and management of this
risk is an important component of the Company's asset/liability management
process, which is governed by policies established by its Board of Directors,
which reviews and approves them annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee (ALCO). In this capacity, ALCO develops guidelines and
strategies impacting the Company's asset/liability management related activities
based upon estimated market risk sensitivity, policy limits, and overall market
interest-related level and trends.
31
INTEREST RATE RISK
- ------------------
At Community Bank System, Inc, the fundamental purpose behind interest rate risk
management is to maximize net interest income over both a short-term tactical
and longer-term strategic time horizon. Because 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.
The primary tool used by the Company in managing interest rate risk is income
simulation. The analysis begins by measuring the impact of differences in
maturity and repricing of all balance sheet positions. Such work is further
augmented by adjusting for prepayment and embedded option risk found naturally
in certain asset and liability classes. Finally, balance sheet growth and
funding expectations are added to the analysis in order to reflect the strategic
initiatives set forth by the Company.
Changes in net interest income are reviewed after subjecting the balance sheet
to an array of Treasury yield curve possibilities including an up or down 200
basis point movement in rates from current levels. While such an aggressive
movement in rates provides management with good insight as to how the Company's
profit margins may perform under extreme market conditions, results from a more
modest shift in interest rates are used as a basis to conduct day-to-day
business decisions.
The following reflects the Company's one year net interest income sensitivity
analysis as of December 31, 1998. In addition to a 200 basis point
increase/decrease in rates, this analysis assumes a static, no growth balance
sheet:
Rate Change Estimated
BASIS POINTS NET INTEREST INCOME SENSITIVITY
+ 200 bp 1.74%
- 200 bp (0.81%)
The preceeding interest rate risk analysis does not represent a Company forecast
and should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cashflows,
and others. 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.
LIQUIDITY
- ---------
Due to the potential for unexpected fluctuations in deposits and loans, active
management of the Company's liquidity is critical. In order to respond to these
circumstances, adequate sources of both on- and off-balance sheet funding are in
place.
CBSI'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 relationship within 30 days between liquid assets and short-term
liabilities which are vulnerable to nonreplacement; and second, a projection of
subsequent cash flow funding needs 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 year-end 1998, this
ratio was 10.8% and 10.1%, respectively.
32
GAP REPORT
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
as of December 31, 1998
Volumes 1-30 31-60 60-90 91-180 181-360 13-24 25-36 37-48 49-60 Over 60
($000's) Days Days Days Days Days Months Months Months Months Months TOTAL
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Due from banks - - - - - - - - - 78,858 78,858
Fixed Rate Debentures 21 - 10,000 44,973 22,848 14,463 71,714 50 - 12,068 176,137
Floating Rate Debentures 6,466 6,466
Fixed Rate Mortgage
Backed 13,934 13,887 12,646 30,985 44,657 79,219 33,704 7,335 5,011 70,191 311,569
Floating Rate Mortgage
Backed 24,555 - - - - - - - - - 24,555
Other Investments 377 48 376 1,470 1,846 1,387 923 984 170 60,020 67,601
- ----------------------------------------------------------------------------------------------------------------------------------
Total Investments 45,353 13,935 23,022 77,428 69,351 95,069 106,341 8,369 5,181 221,137 665,186
- ----------------------------------------------------------------------------------------------------------------------------------
Mortgages:
Adjustable Rate 4,045 500 3,336 6,283 12,795 - - - - - 26,959
Fixed Rate 4,371 4,423 4,350 12,597 23,058 38,758 30,169 17,019 12,057 43,034 189,836
Variable Home Equity 31,719 9,813 273 3,290 5,517 - - - - - 50,612
Commercial Variable 214,155 - - - - - - - - - 214,155
Other Commercial 8,501 8,562 8,625 26,256 54,267 11,644 - - - (233) 117,622
Installment, Net 7,643 8,222 8,307 24,804 48,206 86,344 67,543 40,788 5,314 20,865 318,036
- ----------------------------------------------------------------------------------------------------------------------------------
Total Loans 270,434 31,520 24,891 73,230 143,843 136,746 97,712 57,807 17,371 63,666 917,220
Loan Loss Reserve - - - - - - - - - (12,441) (12,441)
Other Assets - - - - - - - - - 113,681 113,681
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS 315,787 45,455 47,913 150,658 213,194 231,815 204,053 66,176 22,552 383,087 1,680,689
==================================================================================================================================
Average Yield 8.34% 7.21% 7.07% 7.41% 7.77% 7.84% 8.31% 9.13% 8.53% 3.22% 6.90%
Liabilities and Captial:
Demand Deposits - - - - - - - - - 249,864 249,864
Savings / NOW 1,551 1,551 1,551 4,652 22,196 18,609 - - - 356,829 406,939
Money Markets - - - 72,535 26,945 - - - - - 99,480
CD's / IRA / Other 77,791 54,402 51,772 144,503 163,894 79,962 27,367 12,323 8,604 1,165 621,783
- ----------------------------------------------------------------------------------------------------------------------------------
Total Deposits 79,342 55,953 53,323 221,690 213,035 98,571 27,367 12,323 8,604 607,858 1,378,066
Short Term Borrowings 64,700 - - - - - - - - - 64,700
Term Borrowing - - - - - 15,000 - 10,000 5,000 40,000 70,000
Trust Securities - - - - - - - - - 29,810 29,810
Other Liabilities - - - - - - - - - 17,948 17,948
Capital - - - - - - - - - 120,165 120,165
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES
AND CAPITAL 144,042 55,953 53,323 221,690 213,035 113,571 27,367 22,323 13,604 815,781 1,680,689
AVERAGE RATE 4.97% 5.09% 5.21% 4.56% 4.61% 5.12% 5.45% 5.96% 5.65% 1.43% 3.20%
==================================================================================================================================
GAP 171,745 (10,498) (5,410) (71,032) 159 118,244 176,686 43,853 8,948 (432,695)
CUMULATIVE GAP 171,745 161,247 155,837 84,805 84,964 203,208 379,894 423,747 432,695 0
CUMULATIVE GAP /
TOTAL ASSETS 10.22% 9.89% 9.27% 5.05% 5.06% 12.09% 22.60% 25.21% 25.75% 0.00%
Note:
IPC=Accounts of individuals, partnerships, and corporations.
Public=Accounts of U.S. government, state, and local municipalities.
85% of IPC savings are treated as core (>60 months). 100% of Public Fund Savings are treated as 181-360 days.
95% of IPC Money Markets are treated as core (91-180 days). 100% of Public Fund Money Markets are treated as 181-360 days.
15% of IPC Savings are spread over 24 months, and 5% of IPC Money Markets are in 181-360 days.
Totals may not foot due to rounding.
33
EFFECTS OF INFLATION
- --------------------
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles which require the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation.
Virtually all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rate changes have a more significant impact on the
Company's performance than the effects of general levels of inflation.
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 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 generally
accepted accounting principles; (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; and (13) the success
of the Company at managing the risks of the foregoing.
The foregoing list of important factors is not exclusive. Such forward-looking
statements speak only as of the date on which they are made and the Company does
not undertake any obligation to update any forward-looking statement, whether
written or oral, to reflect events or circumstances after the date on which such
statement is made. If the Company does update or correct one or more
forward-looking statements, investors and others should not conclude that the
Company will make additional updates or corrections with respect thereto or with
respect to other forward-looking statements..
YEAR 2000
- ---------
The Year 2000 issue is the result of computer programs being written using two
digits rather the four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions or engage in normal
business activities.
Based on its assessment, the Company determined that the majority of its
processing systems are outsourced to industry standard vendors. The Company,
through its Year 2000 Committee, has identified critical vendors and processes
and have put in place monitoring and measuring techniques to assure its critical
vendors are complying with the Federal Financial Institutions Examining Council
guidelines for Year 2000 compliance. In brief, the Company's loan, deposit, and
general ledger systems are outsourced to Fiserv, Inc.; the investment accounting
system is outsourced to First Tennessee Bank; ATM processing is outsourced to
Mellon Network Services, Inc.; and the trust accounting system employs Sungard
software. The Company is subject to quarterly reviews by the Office of the
Comptroller of the Currency (OCC), including Year 2000 compliance. The Company
presently believes that with modifications to existing software and conversions
to new software, the Year 2000 Issue can be mitigated without impact on the
Company's operations.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the status of Year 2000 compliance
and if appropriate contingency plans and business resumption plans are in place
in the event the vendor or customer should experience a Year 2000 compliant
failure. To date, 65% of our vendors have responded that they are Year 2000
compliant, 31% have reported that they are working diligently and will be
compliant before January 1, 2000, and 4% have not yet stated their position. The
Company is closely following the progress of those vendors who are working on
the project and will seek alternate vendors for all suppliers that cannot become
Year 2000 compliant or those vendors who have failed to respond to the Company's
inquiries.
34
The Company is utilizing both internal and external resources to reprogram or
replace, test and validate the software for Year 2000 modifications. The Company
has estimated that the overall Year 2000 dollar expense for upgrades and
equipment will total between $500,000 and $1,000,000. This budget estimate
includes (but is not limited to) expenditures for upgrades to Item Processing
software and hardware, NCR ATM's, third party reviews of outsourcing vendors,
proxy testing, PC software and hardware, the cost of service vendor mailings,
follow-up testing, customer awareness efforts and commercial customer risk
assessments. The Company plans to complete all renovations on critical systems
before March 31, 1999. To date the Company has incurred approximately $410,000
of expenses funded through general operations, related to the assessment of and
renovation/replacement efforts in connection with its Year 2000 project plan. No
major information technology projects have been significantly delayed as a
result of Year 2000 compliance efforts.
The cost of the project and the date on which the Company plans to complete the
Year 2000 modifications are based on management's best estimates and efforts,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modifications plans and
other factors. The Company does not anticipate any material disruption of
service; however, there can be no guarantee that these estimates will be
achieved.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
Effective January 1, 1998 the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 130, "Reporting Comprehensive Income." This statement
established standards for reporting and display of comprehensive income and its
components in the financial statements. The Company has reported other
comprehensive income within the statements of changes in shareholders' equity.
In 1998, the Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement requires an entity to
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. Upon adoption of the SFAS the
Company transferred investment securities from held-to-maturity to
available-for-sale (see Note C). As a result, securities previously classified
as held-to-maturity were sold during the year and investment securities gains of
approximately $194,000, net of tax, resulting from the sale have been reported
as a cumulative effect of change in accounting principal. The Company has no
outstanding derivative financial instruments and, accordingly, adoption of SFAS
133 had no other affect on the Company's financial statements.
In October 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise." This statement requires that
after the securitization of a mortgage loan held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments. SFAS No. 134 is effective for the first fiscal quarter beginning
after December 15, 1998 and accordingly, would apply to the Company for the
quarter ending March 31, 1999. The Company has not engaged in the securitization
of its mortgage loans held for sale and does not expect to do so in the
foreseeable future. Therefore, this pronouncement is not expected to have a
material impact on the financial statements of the Company.
The following consolidated financial statements and auditor's reports of
Community Bank System, Inc. and subsidiaries are contained on pages 36 through
56 of this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
- - Consolidated Statements of Condition--
December 31, 1998 and 1997
- - Consolidated Statements of Income -
Years ended December 31, 1998, 1997, and 1996
- - Consolidated Statements of Changes in Shareholders' Equity -
Years ended December 31, 1998, 1997, and 1996
- - Consolidated Statements of Cash Flows -
Years ended December 31, 1998, 1997, and 1996
- - Notes to Consolidated Financial Statements -
December 31, 1998
- - Auditor's Report
Quarterly Selected Data (Unaudited) for 1998 and 1997 are contained on page 57
35
CONSOLIDATED STATEMENTS OF CONDITION
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
December 31, December 31,
1998 1997
- --------------------------------------------------------------------------------------------------------------
ASSETS
Total cash and cash equivalents $ 78,893,438 $ 82,106,403
Investment securities
(approximate fair value of $593,605,000 and $619,646,000) 593,539,767 611,891,978
Loans 917,220,120 843,211,857
Reserve for possible loan losses 12,441,255 12,433,812
- --------------------------------------------------------------------------------------------------------------
Net loans 904,778,865 830,778,045
Premises and equipment, net 24,877,782 23,649,279
Accrued interest receivable 12,375,334 13,392,818
Intangible assets, net 54,438,219 58,671,755
Other assets 11,785,296 13,251,973
- --------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,680,688,701 $ 1,633,742,251
==============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Noninterest bearing $ 249,863,649 $ 202,573,162
Interest bearing 1,128,201,929 1,143,112,796
- --------------------------------------------------------------------------------------------------------------
Total deposits 1,378,065,578 1,345,685,958
Federal funds purchased 34,700,000 45,000,000
Borrowings 100,000,000 80,000,000
Company obligated mandatorily redeemable preferred securities
of subsidiary Community Capital Trust 1 holding solely junior
subordinated debentures of the company 29,810,438 29,803,688
Accrued interest and other liabilities 17,947,217 15,240,622
- --------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 1,560,523,233 1,515,730,268
- --------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value for 1998 and 1997;
20,000,000 shares authorized ; 7,623,053 and 7,586,512 shares
issued for 1998 and 1997, respectively 7,623,053 7,586,512
Surplus 32,842,772 32,401,331
Undivided profits 84,591,247 75,335,527
Accumulated other comprehensive income 4,285,743 2,778,913
Treasury stock, at cost (326,600 shares) (9,151,956)
Shares issued under employee stock plan - unearned (25,391) (90,300)
- --------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 120,165,468 118,011,983
- --------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,680,688,701 $ 1,633,742,251
==============================================================================================================
The accompanying notes are an intergral part of the consolidated financial statements.
36
CONSOLIDATED STATEMENTS OF INCOME
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Years Ended December 31,
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $ 82,778,201 $ 71,562,755 $ 56,931,658
Interest and dividends on investments:
U.S. Treasury 269,408 269,240 493,117
U.S. Government agencies and corporations 16,340,308 23,767,244 21,169,844
States and political subdivisions 1,571,670 964,917 1,010,860
Mortgage-backed securities 19,588,820 18,317,165 16,074,631
Other securities 2,091,495 1,879,799 1,672,300
Interest on federal funds sold and deposits with other bank 298,175 867,046 336,002
- ----------------------------------------------------------------------------------------------------------------------
Total interest income 122,938,077 117,628,166 97,688,412
- ----------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 49,668,906 44,590,208 36,383,486
Interest on federal funds purchased 597,355 698,859 1,152,922
Interest on short-term borrowings 156,607 1,884,314 1,465,894
Interest on long-term borrowings 8,120,285 7,578,370 3,420,155
- ----------------------------------------------------------------------------------------------------------------------
Total interest expense 58,543,153 54,751,751 42,422,457
- ----------------------------------------------------------------------------------------------------------------------
Net interest income 64,394,924 62,876,415 55,265,955
Less: Provision for possible loan losses 5,122,596 4,480,000 2,897,068
- ----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 59,272,328 58,396,415 52,368,887
- ----------------------------------------------------------------------------------------------------------------------
Other income:
Fiduciary and investment services 1,921,766 1,725,084 1,522,653
Service charges on deposit accounts 6,630,004 5,054,542 4,037,150
Commissions on investment products 1,222,328 1,001,588 782,178
Other service charges, commissions and fees 4,412,523 2,397,375 1,719,251
Other operating income 893,924 1,643,151 780,834
Investment security gain (loss) 1,959,384 (13,881) 32,394
- ----------------------------------------------------------------------------------------------------------------------
Total other income 17,039,929 11,807,859 8,874,460
- ----------------------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits 25,749,840 22,944,801 19,247,336
Occupancy expense, net 4,085,818 3,426,189 3,073,107
Equipment and furniture expense 3,500,841 2,727,739 2,318,489
Amortization of intangible assets 4,639,536 3,702,850 2,728,886
Legal and professional fees 1,666,017 1,616,227 1,119,466
Computer services expenses 2,334,104 2,095,395 1,921,859
Other 9,899,793 12,997,062 10,082,166
- ----------------------------------------------------------------------------------------------------------------------
Total other expenses 51,875,949 45,798,641 37,449,984
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes 24,436,308 24,405,633 23,793,363
Income taxes 8,901,945 8,844,127 9,660,319
- ----------------------------------------------------------------------------------------------------------------------
Income before change in accounting 15,534,363 15,561,506 14,133,044
Cumulative effect of change in accounting principle,
net of taxes of $133,883(note C) 193,860 0 0
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME $ 15,728,223 $ 15,561,506 $ 14,133,044
======================================================================================================================
Earnings per common share - basic $2.08 $2.05 $1.85
======================================================================================================================
Earnings per common share - diluted $2.05 $2.02 $1.83
======================================================================================================================
The accompanying notes are an intergral part of the consolidated financial statements.
37
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Years ended December 31, 1996, 1997 and 1998
Preferred Common Stock Undivided
------------
Stock Shares Amount Surplus Profits
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 1996 $4,500,000 7,359,250 $4,599,531 $32,955,273 $57,079,501
Comprehensive Income:
Net income - 1996 14,133,044
Other comprehensive income, before tax
Net unrealized losses on securities:
Net unrealized holding losses arising during the period
Less: reclassification adjustment for gains included
in net income
Other comprehensive loss, before tax
Income tax benefit related to other comprehensive loss
Other comprehensive loss, net of tax
Comprehensive Income
Cash dividends:
Preferred, $9.00 per share (405,000)
Common, $0.69 per share (5,116,520)
Common stock issued under
employee stock plan 33,906 21,192 554,817
Common stock issued
in acquisition 81,250 50,781 74,683
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 $4,500,000 7,474,406 $4,671,504 $33,584,773 $65,691,025
Comprehensive Income:
Net income - 1997 15,561,506
Other comprehensive income, before tax
Net unrealized losses on securities:
Net unrealized holding losses arising during the period
Less: reclassification adjustment for gains included
in net income
Other comprehensive loss, before tax
Income tax benefit related to other comprehensive loss
Other comprehensive loss, net of tax
Comprehensive Income
Cash dividends:
Preferred, $9.00 per share (180,000)
Common, $0.76 per share (5,737,004)
Preferred stock redeemed (4,500,000) (180,000)
Common stock issued under
employee stock plan 112,106 95,660 1,815,906
Change in par value 0 2,819,348 (2,819,348)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $0 $7,586,512 $7,586,512 $32,401,331 $75,335,527
Net income - 1998 15,728,223
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains arising during period
Less: reclassification adjustment for gains included
in net income
Other comprehensive income, before tax:
Income tax expense related to other comprehensive income
Other comprehensive income, net of tax
Comprehensive Income
Cash dividends:
Common, $.86 per share (6,472,503)
Common stock issued under
employee stock plan 36,541 36,541 441,441
Treasury stock purchased (326,600)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $0 7,296,453 $7,623,053 $32,842,772 $84,591,247
====================================================================================================================================
Common
Shares
Issued
Accumulated Under
Other Employee
Treasury Comprehensive Comprehensive Stock Plan
Stock Income Income - Unearned Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 1996 $977,457 ($51,513) $100,060,249
Comprehensive Income:
Net income - 1996 14,133,044 14,133,044
----------
Other comprehensive income, before tax
Net unrealized losses on securities:
Net unrealized holding losses arising during the period (18,030)
Less: reclassification adjustment for gains included
in net income (32,394)
-------
Other comprehensive loss, before tax (50,424)
Income tax benefit related to other comprehensive loss 20,820
------
Other comprehensive loss, net of tax (29,604) (29,604) (29,604)
-------
Comprehensive Income 14,103,440
----------
Cash dividends:
Preferred, $9.00 per share (405,000)
Common, $0.69 per share (5,116,520)
Common stock issued under
employee stock plan 8,585 584,594
Common stock issued
in acquisition 125,464
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 $947,853 ($42,928) $109,352,227
Comprehensive Income:
Net income - 1997 15,561,506 15,561,506
----------
Other comprehensive income, before tax
Net unrealized losses on securities:
Net unrealized holding losses arising during the period 3,081,709
Less: reclassification adjustment for gains included
in net income 13,881
------
Other comprehensive loss, before tax 3,095,590
Income tax benefit related to other comprehensive loss (1,264,530)
----------
Other comprehensive loss, net of tax 1,831,060 1,831,060 1,831,060
---------
Comprehensive Income 17,392,566
----------
Cash dividends:
Preferred, $9.00 per share (180,000)
Common, $0.76 per share (5,737,004)
Preferred stock redeemed (4,680,000)
Common stock issued under
employee stock plan (47,372) 1,864,194
Change in par value 0
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $2,778,913 ($90,300) $118,011,983
Net income - 1998 $15,728,223 15,728,223
-----------
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 4,822,654 0
Less: reclassification adjustment for gains included
in net income (2,287,127)
----------
Other comprehensive income, before tax: 2,535,527
Income tax expense related to other comprehensive income (1,028,697)
----------
Other comprehensive income, net of tax 1,506,830 1,506,830 1,506,830
---------
Comprehensive Income $17,235,052
===========
Cash dividends:
Common, $.86 per share (6,472,503)
Common stock issued under
employee stock plan 64,909 542,891
Treasury stock purchased (9,151,956) (9,151,956)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 ($9,151,956) $4,285,743 ($25,391) $120,165,468
====================================================================================================================================
The accompanying notes are an intergral part of the consolidated financial statements.
38
CONSOLIDATED STATEMENT OF CASH FLOWS
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
For Twelve Months Ended December 31, 1998 and 1997
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 15,728,223 $ 15,561,506 $ 14,133,044
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 2,822,990 2,130,434 1,948,619
Amortization of intangible assets 4,639,536 3,702,850 2,728,886
Net amortization of security premiums and discounts 6,922,686 8,005 (1,690,528)
Amortization of discount on loans 1,443,122 3,142,460 7,576,343
Provision for loan losses 5,122,596 4,480,000 2,897,068
Provision for deferred taxes 383,806 (223,394) (1,840,573)
(Gain)\Loss on sale of investment securities (2,287,127) 13,881 (32,394)
(Gain)\Loss on sale of loans and other assets (102,847) (158,033) (91,780)
Change in interest receivable 1,017,484 (2,602,746) (1,639,568)
Change in other assets and other liabilities 2,269,036 1,750,674 1,254,964
Change in unearned loan fees and costs (1,551,770) (883,108) (659,412)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 36,407,735 23,780,069 17,008,326
- ---------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities 87,188,668 51,916,026 15,803,016
Proceeds from maturities of held to maturity investment securities 55,077,029 114,946,856 77,849,167
Proceeds from maturities of available for sale investment securities 110,430,351 13,507,367 27,014,893
Purchases of held to maturity investment securities (7,943,215) (7,989,300) (130,151,635)
Purchases of available for sale investment securities (228,500,654) (202,645,932) (99,364,521)
Net change in loans outstanding (78,779,935) (103,025,001) (93,336,338)
Loans purchased in branch acquisition (86,800,537) 0
Capital expenditures (4,935,714) (9,042,922) (1,775,188)
Proceeds from sales of property and equipment 752,235 0 0
Premium paid for branch acquisitions 0 (31,133,116) 0
- ---------------------------------------------------------------------------------------------------------------------------------
Net Cash Used By Investing Activities (66,711,235) (260,266,559) (203,960,606)
- ---------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts 61,508,239 (6,835,157) (22,671,180)
Net change in certificates of deposit (29,128,619) 15,967,588 32,938,212
Deposits assumed in branch acquisition 0 309,340,271 0
Net change in Federal Funds purchased (10,300,000) 13,200,000 171,800,000
Net change in term borrowings 20,000,000 (85,000,000) (550,000)
Issuance of mandatorily redeemable capital securities of subsidiary 0 29,803,688 0
Debt issuance costs 0 (1,222,041) 0
Issuance (retirement) of common and preferred stock 474,451 (3,451,047) 457,142
Treasury stock purchased (9,151,956) 0 0
Cash dividends (6,311,580) (5,745,135) (5,390,271)
- ---------------------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Financing Activities 27,090,535 266,058,167 176,583,903
- ---------------------------------------------------------------------------------------------------------------------------------
Change In Cash And Cash Equivalents (3,212,965) 29,571,677 (10,368,377)
Cash and cash equivalents at beginning of year 82,106,403 52,534,726 62,903,103
- ---------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD 78,893,438 82,106,403 52,534,726
=================================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash Paid For Interest $56,791,512 $52,235,280 $42,090,983
=================================================================================================================================
Cash Paid For Income Taxes $9,938,377 $9,716,995 $10,654,673
=================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING
AND INVESTING ACTIVITIES:
Dividends declared and unpaid $1,678,184 $1,517,262 $1,345,393
Gross change in unrealized gains and (losses) on
available-for-sale securities $2,535,527 $3,095,590 ($50,424)
=================================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
39
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Community Bank System, Inc. (the Company) is a one-bank holding company which
wholly owns three subsidiaries, Community Bank, N.A. (the Bank), Community
Capital Trust I, a subsidiary business trust, and Benefit Plans Administrative
Services, Inc. (BPA). BPA, located in Utica, New York, provides pension
administration and consulting services to sponsors of defined benefit and
defined contribution plans throughout New York State. The Bank operates 68
customer facilities throughout Northern New York, the Finger Lakes Region, and
Southern Tier, and Southwestern New York and owns two banking related
subsidiaries, Community Financial Services, Inc. (CFSI), and Community
Investment Services, Inc. (CISI). CFSI offers insurance investment products and
CISI provides broker/dealer and investment advisory services. In addition, the
Bank wholly owns one nonbanking subsidiary, CBNA Treasury Management Corporation
(TMC). TMC operates the cash management, investment, and treasury functions of
the Bank. In early 1997, Community Capital Trust I was formed for the purpose of
issuing mandatorily redeemable capital securities which are considered Tier I
capital under regulatory capital adequacy requirements (see Note Q).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All intercompany accounts and transactions have
been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks and federal funds sold. Generally, federal funds
are sold for one-day periods. The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate those assets' fair values.
INVESTMENT SECURITIES
The Company has classified its investments in debt and equity securities as
held-to-maturity or available-for-sale. Held-to-maturity securities are those
for which the Company has the positive intent and ability to hold to maturity,
and are reported at cost, which is adjusted for amortization of premiums and
accretion of discounts. Debt 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.
The average cost method is used in determining the realized gains and losses on
sales of investment securities, which are reported under other income as
investment security gains (losses). 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.
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.
LOANS
Loans are stated at unpaid principal balances. Fair values for variable rate
loans that reprice frequently, with no significant credit risk, are based on
carrying values. Fair values for fixed rate loans are estimated using discounted
cash flows and interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. Mortgage loans held for sale are
carried at the lower of cost or market and are included in loans as the balance
of such loans was not significant. The carrying amount of accrued interest
approximates its fair value.
INTEREST ON LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES
Interest on commercial loans and mortgages is accrued and credited to operations
based upon the principal amount outstanding. Unearned discount on installment
loans is recognized as income over the term of the loan, principally by the
actuarial method. Non-refundable loan fees and related direct costs are deferred
and amortized over the life of the loan as an adjustment to loan yield using the
effective interest method.
40
The Bank places a loan on nonaccrual status and recognizes income on a cash
basis when it is more than ninety days past due (or sooner, if management
concludes collection of interest is doubtful), except when, in the opinion of
management, it is well-collateralized and in the process of collection.
The reserve for possible loan losses is maintained at a level considered
adequate to provide for potential loan losses. The reserve is increased by
provisions charged to expense and reduced by net charge-offs. The level of the
reserve is based on management's evaluation of potential losses in the loan
portfolio, as well as prevailing economic conditions. A loan is considered
impaired, based current information and events, if it is probable that the Bank
will not be able to collect the scheduled payments of principal or interest when
due according to the contractual terms of the loan agreement. The measurement of
impaired loans is generally based on the present value of expected future cash
flows discounted at the historical effective interest rate, except that all
collateral-dependent loans are measured for impairment based on the fair value
of the collateral.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation. The
annual provision for depreciation is computed using the straight-line method in
amounts sufficient to recognize the cost of depreciable assets over their
estimated useful lives. Maintenance and repairs are charged to expense as
incurred.
OTHER REAL ESTATE
Properties acquired through foreclosure, or by deed in lieu of foreclosure, are
carried at the lower of the unpaid loan balance plus settlement costs, or fair
value less estimated costs of disposal. At December 31, 1998 and 1997, other
real estate, included in other assets, amounted to $1,181,926 and $881,456,
respectively.
INTANGIBLE ASSETS
Intangible assets represent core deposit value, goodwill arising from
acquisitions, and mortgage servicing rights. The Company periodically reviews
the carrying value of intangible assets using fair value methodologies.
Core deposit intangibles are being amortized principally on an accelerated basis
over ten years. Goodwill is being amortized on a straight-line basis over 15 to
25 years.
Originated mortgage servicing rights are recorded at their fair value at the
time of transfer and are amortized in proportion to and over the period of
estimated net servicing income or loss. The Bank uses a valuation model that
calculates the present value of future cash flows to determine the fair value of
servicing rights. In using this valuation method, the Bank incorporated
assumptions that market participants would use in estimating future net
servicing income, which included estimates of the cost of servicing per loan,
the discount rate, and prepayment speeds. The carrying value of the originated
mortgage servicing rights is periodically evaluated for impairment using these
same market assumptions.
DEPOSITS
The fair values disclosed for demand and savings deposits are equal to the
carrying amounts at the reporting date. The carrying amounts for variable rate
money market accounts and certificates of deposit approximate their fair values
at the reporting date. Fair values for fixed rate certificates of deposit are
estimated using discounted cash flows and interest rates currently being offered
on similar certificates. The carrying value of accrued interest approximates
fair value.
BORROWINGS
The carrying amounts of federal funds purchased and borrowings approximate their
fair values.
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.
EARNINGS PER SHARE AND STOCK SPLIT
Basic earnings per share is computed on the basis of actual weighted average
common shares outstanding for the period. Diluted earnings per share reflects
the dilutive effect of outstanding common stock equivalents.
On March 12, 1997, a two-for-one split of the Company's common stock was
effected in the form of a stock dividend of one share of common stock for each
share of common stock outstanding at the close of business on February 10, 1997.
The number of authorized shares of common stock was increased from 5,000,000 to
20,000,000 pursuant to shareholder approval. All share and per share data of
prior periods has been restated, where required, to retroactively reflect the
stock split.
41
During 1997, the par value of the Company's common stock was changed from $1.25
par to no par $1.00 stated value per share.
TREASURY STOCK
Treasury stock purchases are recorded at cost. During 1998, the Company
purchased 326,600 shares of treasury stock at an average cost of $28.02. The
Company purchases treasury stock primarily in order to have shares available for
issuance under the incentive stock option, restricted stock awards and
non-qualified stock option plans.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company determines fair values based on quoted market values where available
or on estimates using present values or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. Statement of Financial Accounting Standard (SFAS) No. 107,
"Disclosures about Fair Value of Financial Instruments," excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Company.
The fair values of investment securities, loans and deposits have been disclosed
in footnotes C, D, and G, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998 the Company adopted Statement of Financial Accounting
Standard (SFAS) No. 130, "Reporting Comprehensive Income." This statement
establishes standards for reporting and display of comprehensive income and its
components in the financial statements. The Company has reported other
comprehensive income within the statements of changes in shareholder's equity.
In 1998 the Company adopted Statement of Financial Accounting Standard (SFAS)
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
statement requires an entity to recognize all derivatives as either assets or
liabilities in the balance sheet and measure those instruments at fair value.
Upon adoption of this SFAS, the Company transferred investment securities from
held-to-maturity to available-for-sale (see Note C). As a result, securities
previously classified as held-to-maturity were sold during the year and
investment securities gains of approximately $194,000, net of tax, resulting
from the sale have been reported as a cumulative effect of a change in
accounting principal. The Company has no outstanding derivative financial
instruments, and accordingly, adoption of SFAS 133 had no other affect on the
Company's financial statements.
42
NOTE B: BRANCH ACQUISITIONS
During 1997, the Company acquired certain assets and assumed certain liabilities
relating to eight branch offices of Key Bank, N.A. located in Southwestern New
York State and 12 branch offices of Fleet Bank located in Northern and Central
New York State.
A summary of these acquisitions and the divestiture activity is as follows:
ACQUISITIONS
-----------------------------------------
KEY BANK FLEET BANK
(6/16/97) (7/18/97)
-----------------------------------------
CASH RECEIVED (PAID) $ 110,752,957 $ 76,516,971
LOANS ACQUIRED (DIVESTED) 24,093,903 62,706,634
PROPERTY AND EQUIPMENT ACQUIRED (DIVESTED) 1,836,405 2,438,645
OTHER ASSETS AND (LIABILITIES) ACQUIRED 34,323 (172,683)
(DIVESTED), NET
PURCHASE PRICE ALLOCATED TO GOODWILL 13,563,861 17,569,255
------------- -------------
DEPOSIT LIABILITIES ASSUMED (DIVESTED) $ 150,281,449 $ 159,058,822
================================================================================
Goodwill arising from these transactions is being amortized over a period of 15
years on a straight-line basis.
The transactions above have been recorded under the purchase method of
accounting and, accordingly, the operating results of the branches acquired have
been included in the Company's consolidated financial statements from the date
of acquisition. Results of operations on a proforma basis are not presented
since historical financial information for the branches acquired is not
available.
In July of 1996, the Company acquired all of the outstanding shares of common
stock of Benefit Plan Administrators, Inc., a pension administration and
actuarial firm, in exchange for 81,250 shares of Company's common stock. The
transaction was accounted for as a pooling of interests, and, accordingly, the
consolidated financial statements for 1996 include the accounts of Benefit Plan
Administrators. Consolidated financial statements for the prior periods
presented were not restated as the effect on those periods is not significant.
43
NOTE C: INVESTMENT SECURITIES
The amortized cost and estimated fair values of investments in securities as of
December 31 are as follows:
1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars) Gross Gross Estimated Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Held-to-Maturity Cost Gains Losses Value Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies 164,198,645 4,607,000 7,000 168,799,000
Obligations of
states and political
subdivisions 4,037,920 65,448 $ 0 4,103,368 10,221,035 355,000 1,000 10,575,000
Corporate securities 0 0 0 0 3,090,597 111,000 1,000 3,201,000
Mortgage-backed securities 0 0 0 0 86,148,702 2,702,000 13,000 88,838,000
- - - - ---------- --------- ------ ----------
TOTALS 4,037,920 65,448 0 4,103,368 263,658,979 7,775,000 22,000 271,413,000
- ------------------------------------------------------------------------------------------------------------------------------------
Available-for-Sale
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies 170,464,535 5,417,176 15,398 175,866,313 82,027,316 2,742,939 40,046 84,730,209
Obligations of
states and political
subdivisions 40,590,647 937,758 199,217 41,329,188 9,960,459 349,594 0 10,310,053
Corporate Securities 9,152,685 232,308 3,228 9,381,765
Mortgage-backed securities 336,090,433 3,360,728 2,484,578 336,966,583 225,691,821 3,103,934 1,446,399 227,349,356
----------- --------- --------- ----------- ----------- --------- --------- -----------
TOTALS 556,298,300 9,947,970 2,702,421 563,543,849 317,679,596 6,196,467 1,486,445 322,389,618
Equity securities 25,957,998 0 0 25,957,998 25,843,381 0 0 25,843,381
---------- - - ---------- ---------- - - ----------
TOTALS 582,256,298 9,947,970 2,702,421 589,501,847 343,522,977 6,196,467 1,486,445 348,232,999
- ------------------------------------------------------------------------------------------------------------------------------------
Net unrealized gain/(loss) on
Available for Sale 7,245,549 4,710,022
- ------------------------------------------------------------------------------------------------------------------------------------
GRAND TOTAL CARRYING VALUE 593,539,767 611,891,978
====================================================================================================================================
The amortized cost and estimated fair value of debt securities at December 31,
1998, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Held-to-Maturity Available-for-Sale
Carrying Est. Market Carrying Est. Market
Value Value Value Value
Due in one year or less $2,497,911 $2,507,314 $7,644,123 $7,657,876
Due after one through five years 1,430,406 1,477,716 9,839,514 10,526,680
Due after five years through ten years 109,603 118,338 117,716,139 120,696,537
Due after ten years 0 0 85,008,091 87,696,173
------------------------------------------------------------
TOTAL 4,037,920 4,103,368 220,207,867 226,577,266
Mortgage-backed securities 0 0 336,090,433 336,966,583
------------------------------------------------------------
TOTAL $4,037,920 $4,103,368 $556,298,300 $563,543,849
Proceeds from sales of investments in debt securities during 1998, 1997, and
1996 were $85,689,000, $51,916,000 and $12,940,000, respectively. Gross gains of
approximately $2,287,000, $283,000 and $32,000 for 1998, 1997 and 1996,
respectively, and gross losses of $297,000 in 1997 and were realized on those
sales.
Investment securities with a carrying value of $324,565,708 and $320,953,967 at
December 31, 1998 and 1997, respectively, were pledged to collateralize deposits
and borrowings.
Pursuant to adoption of Statement of Financial Accounting Standard No. 133,
"Accounting for Derivatives Instruments and Hedging Activities," in 1998, the
Company transferred investment securities having an amortized cost of
$216,797,000 and net unrealized gains of $6,952,000 from held-to-maturity to
available-for-sale. The Company subsequently sold a portion of those with an
amortized cost of $17,424,400, within the same quarter; accordingly, the
realized gain of $193,860, net of tax, has been reported as a cumulative effect
of a change in accounting principle.
44
NOTE D: LOANS
Major classifications of loans at December 31 are summarized as follows:
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
Real estate mortgages:
Residential $ 314,782,271 $ 278,912,124
Commercial 101,286,004 85,962,156
Farm 12,491,763 10,433,795
Agricultural loans 24,143,691 23,894,346
Commercial loans 152,822,499 138,066,982
Installment loans to individuals 301,803,189 298,871,021
Other loans 8,705,823 8,886,538
---------------------------------
916,035,240 845,026,962
Less: Unearned interest,and deferred
loan fee and costs, net 1,184,880 (1,815,105)
Reserve for possible loan losses (12,441,255) (12,433,812)
---------------------------------
Net loans $904,778,865 $ 830,778,045
================================================================================
The estimated fair value of loans receivable at December 31, 1998 and 1997 was
$919,000,000 and $848,000,000, respectively.
Loans to directors and officers or other related parties were approximately
$7,336,000 and $5,231,000 at December 31, 1998 and 1997, respectively. During
1998, new loans to such parties amounted to $2,126,000, and repayments amounted
to $21,000.
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of condition. The unpaid principal balances of mortgage
loans serviced for others was $58,825,355, $24,965,011, $12,467,000 at December
31, 1998, 1997, and 1996, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing and included in demand deposits were approximately $427,349, $183,585,
and $79,965 at December 31, 1998, 1997 and 1996 respectively.
Changes in the reserve for possible loan losses for the years ended December 31
are summarized below:
- ----------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------
Balance at the beginning of year $ 12,433,812 $ 8,127,752 $ 6,976,385
Reserves on acquired loans 0 3,547,641 0
Provision charged to expense 5,122,596 4,480,000 2,897,068
Loans charged off (6,096,561) (4,448,281) (2,458,651)
Recoveries 981,408 726,700 712,950
-----------------------------------------------------
Balance at end of year $ 12,441,255 $ 12,433,812 $ 8,127,752
=====================================================
As of December 31, 1998 and 1997, the Company's impaired loans for which
specific valuation allowances were recorded were not significant.
NOTE E: PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
Land and land improvements $ 3,056,589 $ 3,066,610
Bank premises owned 22,851,189 21,331,006
Equipment 18,706,427 16,578,656
----------- -----------
Premises and equipment, gross 44,614,205 40,976,272
Less: Allowance for depreciation 19,736,423 17,326,993
----------- -----------
Premises and equipment,net $24,877,782 $23,649,279
=========== ===========
45
NOTE F: INTANGIBLE ASSETS
Intangible assets consist of the following at December 31:
- ----------------------------------------------------------------------------------------
1998 1997
- ----------------------------------------------------------------------------------------
Core deposit intangible $14,434,507 $ 14,434,507
Goodwill and other intangibles 52,760,397 52,760,397
Mortgage servicing rights 406,000 0
----------- ------------
Intangible assets, gross 67,600,904 67,194,904
Less: Accumulated amortization (13,162,685) (8,523,149)
----------- ------------
Intangible assets, net $54,438,219 $ 58,671,755
========================================================================================
NOTE G: DEPOSITS
Deposits by type at December 31 are as follows:
- ----------------------------------------------------------------------------------------
1998 1997
- ----------------------------------------------------------------------------------------
Demand $249,863,649 $ 202,573,162
Savings 506,419,177 492,201,426
Time 621,782,752 650,911,370
------------- --------------
Total Deposits $1,378,065,578 $1,345,685,958
========================================================================================
The estimated fair values of deposits at December 31, 1998 and 1997 were
approximately $1,387,000 and $1,348,000, respectively.
At December 31, 1998 and 1997, time certificates of deposit in denominations of
$100,000 and greater totaled $91,689,939 and $93,439,246, respectively.
The approximate maturities of time deposits at December 31 are as follows:
- ----------------------------------------------------------------------------------------
MATURITY 1998 1997
- ----------------------------------------------------------------------------------------
One year or less $497,600,234 $472,000,905
One to two years 76,588,398 130,873,353
Two to three years 26,443,032 29,519,578
Three to four years 11,840,172 11,468,042
Four to five years 8,395,567 6,031,819
Over five years 915,549 1,017,673
------------ ------------
$621,782,752 $650,911,370
========================================================================================
NOTE H: BORROWINGS
At December 31, 1998 and 1997, outstanding borrowings were as follows:
- ----------------------------------------------------------------------------------------
1998 1997
- ----------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased $34,700,000 $45,000,000
Federal Home Loan Bank advances 30,000,000 80,000,000
Long-term borrowings:
Federal Home Loan Bank Advances (Current
portion of $0 and $35,000,000 in 1998 and
1997, respectively) 70,000,000 60,000,000
Company obligated mandatorily redeemable
preferred securities of subsidiary trust holding
solely junior subordinated debentures of the
Company, net of unamortized discount of
$189,562 and $196,312, respectively $164,510,438 $154,803,688
========================================================================================
46
Federal Home Loan Bank advances are secured by a blanket lien on the Company's
residential real estate loan portfolio and mortgage-backed securities portfolio.
Long-Term borrowings at December 31, 1998 have maturity dates as follows:
WEIGHTED
AVERAGE RATE AMOUNT
------------ -------------
December 13, 2000 5.86% $15,000,000
December 17, 2002 6.20% 10,000,000
February 10, 2003 5.52% 5,000,000
January 23, 2008 5.44% 10,000,000
January 28, 2008 5.48% 5,000,000
January 30, 2008 5.27% 20,000,000
February 4, 2008 5.45% 5,000,000
January 30, 2027 9.75% 29,810,438
------------ -------------
6.84% $99,810,438
========================================================================================
NOTE I: INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31 is as
follows:
- ----------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------
Current:
Federal $ 7,889,187 $ 8,071,488 $ 8,909,495
State 762,835 996,033 2,591,397
Deferred:
Federal 299,246 (174,176) (1,426,394)
State 84,560 (49,218) (414,179)
----------- ----------- -----------
Total income taxes $ 9,035,828 $ 8,844,127 $ 9,660,319
========================================================================================
Components of the net deferred tax asset, included in other assets, as of
December 31 are as follows:
- ----------------------------------------------------------------------------------------
1998 1997
- ----------------------------------------------------------------------------------------
Allowance for loan losses $3,950,235 $3,630,000
Postretirement and other reserves 758,068 607,577
Pension 309,462 373,735
Amortization of Intangibles 334,550 279,172
Other 641,287 515,036
-----------------------------------------
Total deferred tax asset $5,993,602 $5,405,520
-----------------------------------------
Investment securities 3,248,258 2,186,796
Deferred loan fees 996,932 363,034
Depreciation 557,393 252,167
---------- ----------
Total deferred tax liability $4,802,583 $2,801,997
---------- ----------
Net deferred tax asset $1,191,019 $2,603,523
========================================================================================
The Company has determined that no valuation allowance is necessary as it is
more likely than not that deferred tax assets will be realized through carryback
of future deductions to taxable income in prior years, future reversals of
existing temporary differences and through future taxable income.
A reconciliation of the differences between the federal statutory income tax
rate and the effective tax rate for the years ended December 31 is shown in the
following table:
- ----------------------------------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
Increase (reduction) in taxes resulting from:
Tax-exempt interest (1.9) (1.2) (1.3)
State income taxes, net of federal benefit 1.9 2.4 5.8
Other 1.5 0.0 1.1
---- ---- ----
Effective income tax rate (including tax
effect of accounting change) 36.5% 36.2% 40.6%
========================================================================================
47
NOTE J: LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES
The Company's ability to pay dividends to its shareholders is largely dependent
on the Bank's ability to pay dividends to the Company. In addition to state law
requirements and the capital requirements discussed below, the circumstances
under which the Bank may pay dividends are limited by federal statutes,
regulations, and policies. For example, as a national bank, the Bank must obtain
the approval of the Office of the Comptroller of the Currency (OCC) for payment
of dividends if the total of all dividends declared in any calendar year would
exceed the total of the Bank's net profits, as defined by applicable
regulations, for that year, combined with its retained net profits for the
preceding two years. Furthermore, the Bank may not pay a dividend in an amount
greater than its undivided profits then on hand after deducting its losses and
bad debts, as defined by applicable regulations. At December 31, 1998, the Bank
had approximately $24,773,000 in undivided profits legally available for the
payment of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The payment of
dividends that deplete a bank's capital base could be deemed to constitute such
an unsafe or an unsound practice. The Federal Reserve Board has indicated that
banking organizations should generally pay dividends only out of current
operating earnings.
There are also statutory limits on the transfer of funds to the Company by its
banking subsidiary whether in the form of loans or other extensions of credit,
investments or asset purchases. Such transfers by the Bank to the Company
generally are limited in amount to 10% of the Bank's capital and suplus, or 20%
in the aggregate. Furthermore, such loans and extensions of credit are required
to be collateralized in specific amounts.
48
NOTE K: BENEFIT PLANS
The Company has a noncontributory defined benefit pension plan covering the
majority of its employees and retirees. The Company also provides health and
life insurance benefits for eligible retired employees and dependents.
The following table shows the Company's Plans' funded status reconciled with
amounts reported in the Company's consolidated balance sheets, and the
assumptions used in determining the actuarial present value of the benefit
obligations:
PENSION BENEFITS POSTRETIREMENT BENEFITS
-------------------- ----------------------------
1998 1997 1998 1997
---- ---- ---- ----
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at thebeginning of year $ 9,775,164 $ 8,893,253 $ 2,963,555 $ 2,411,418
Service cost 462,548 353,762 101,734 125,779
Interest cost 677,664 631,010 170,270 195,508
Deferred actuarial loss(gain) 2,060,111 356,848 (452,500) 366,942
Benefits paid (492,871) (459,709) (89,937) (136,092)
-------------------------------------------------------------------------
Benefit obligation at end of year 12,482,616 9,775,164 2,693,122 2,963,555
- -----------------------------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year 10,689,215 9,095,755 -- --
Actual return of plan assets 1,376,137 1,688,816
Company contributions 584,520 364,353
Benefits paid (492,871) (459,709)
-------------------------------------------------------------------------
Fair value of plan assets at end of year 12,157,001 10,689,215 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Funded (unfunded) status (325,615) 914,051 (2,693,122) (2,963,555)
Unrecognized actuarial loss 1,843,675 275,476 116,495 565,264
Unrecognized prior service (benefit) cost (263,557) (278,747) 260,445 279,055
Unrecognized net asset at date of adoption (114,530) (136,778)
Unrecognized portion of net obligation
at transition 863,300 924,500
-------------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 1,139,973 $ 774,002 ($1,452,882) ($1,194,736)
====================================================================================================================================
The decrease in the discount rate from 7.0% to 6.5% increased the projected
benefit obligation of the pension plan at December 31, 1998 by $1,039,000. The
change from the 1984 Unisex Pensioners mortality table to the 1983 Group Annuity
Mortality Table increases to projected benefit obligation of the pension plan by
$1,021,000.
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate 6.50% 7.00% 6.50% 7.25%
Expected return on plan assets 9.00% 9.00%
Rate of compensation increase 4.00% 4.00%
===================================================================================================================================
For measurement purposes, an 8.0% annual rate of increase in the per capita cost
of covered health care benefits was assumed for 1998. The rate was assumed to
decrease gradually to 4.0% until 2017 and remained at that level thereafter.
PENSION BENEFITS POSTRETIREMENT
BENEFITS
---------------------- ----------------------
1998 1997 1996 1998 1997 1996
----------------------------------------------------------------------------------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 462,548 $ 353,762 $ 281,318 $ 101,734 $ 125,779 $ 111,252
Interest cost 677,664 631,010 596,266 170,270 195,508 164,656
Actual return on plan assets (1,376,137) (1,688,816) (1,134,302)
Net amortization and deferral 454,474 916,794 507,801
Amortization of prior service cost 18,610 18,610 10,200
Amortization of unrecognized net loss (3,679) 14,948 16,985
Amortization of transition obligation 61,200 61,200 61,200
=========== =========== =========== =========== =========== ===========
Net periodic benefit cost $ 218,549 $ 212,750 $ 251,083 $ 348,135 $ 416,045 $ 364,293
====================================================================================================================================
The defined benefit pension plan is authorized to invest up to 10% of the fair
value of its total assets in common stock of Community Bank System, Inc. At
December 31, 1998 and 1997, the plan holds 35,828 and 41,128 shares,
respectively, of the sponsor company common stock.
49
Assumed heath care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage-point change in the assumed
health care cost trend rates would have the following effects:
- ----------------------------------------------------------------------------
1% POINT 1% POINT
INCREASE DECREASE
- ----------------------------------------------------------------------------
Effect on total of service and interest $ 58,088 $ 48,525
cost components
Effect on postretirement benefit obligation $ 451,340 $ 383,466
============================================================================
The Company also has an Employee Savings and Retirement Plan, which is
administered by the Trust Department of Community Bank, N. A. The Employee
Savings and Retirement Plan included Section 401(k) and Thrift provisions as
defined under the Internal Revenue Code. Company contributions to the trust
amounted to $425,000, $757,000, and $599,000 in 1998, 1997, and 1996,
respectively.
The Company has deferred compensation agreements with its President and Chief
Executive Officer and several former executives and officers whereby monthly
payments are to be provided upon retirement over periods ranging from ten to 25
years. Expense recognized during 1998, 1997, and 1996 related to these
arrangements amounted to approximately $258,000, $257,000, and $377,000,
respectively.
The Company has a Stock Balance Plan for nonemployee directors who have
completed six months of service. The Plan is a nonqualified, noncontributory
deferred compensation plan. The Plan provides benefits for periods of service
prior to January 1, 1996 based on a predetermined formula. Amounts credited to
participant accounts for all creditable service after January 1, 1996 are based
on performance of the Company's stock. Participants become fully vested after
six years of service. Benefits are payable in the form of stock of the Company
on the first of the month following the later of a participant's disassociation
from the Board or attainment of age 70. In the event of a change in control or
other occurrences, as defined, participants have the right to receive a
distribution of common stock equal to the number of shares credited to the
participant plus the projected number of shares that would have been credited at
normal retirement age (70) had the event not occurred. Unrecognized prior
service cost of $628,206 is being being amortized over 20 years. Expense related
to the Plan recognized in 1998, 1997, and 1996 approximated $190,000, $203,000,
and $150,000, respectively. The accrued pension liability was approximately
$455,000 and $319,000 at December 31, 1998 and 1997, respectively. The net
periodic pension cost was calculated using discount rates of 7.0% and 7.25% for
1998 and 1997, respectively.
NOTE L: STOCK-BASED COMPENSATION PLANS
The Company has long-term, stock-based incentive compensation programs for
directors, officers, and key employees including incentive stock options
(ISO's), restricted stock awards (RSA's), nonqualified stock options (NQSO's),
warrants, retroactive stock appreciation rights, and discounted options. The
Company has authorized the grant of options for up to 605,000 shares of the
Company's common stock. All options granted have ten year terms and vest and
become fully exercisable at the end of five years of continued employment.
Activity in these plans for 1998, 1997, and 1996 was as follows:
- -------------------------------------------------------------------------------------------------
Options Range of Shares Weighted
Outstanding Option Excersiable Average
Price Exercise Price
Per Share of Shares
Outstanding
- -------------------------------------------------------------------------------------------------
OUTSTANDING AT DECEMBER 31, 1995 248,480 $6.75 - 19.13 123,500 $11.01
Granted 177,300 16.00 - 19.13 17.80
Granted at a discount 16,000 12.13 12.13
Exercised/cancelled (40,850) 7.75 - 13.13 11.55
Forfeited (3,300) 7.75 7.75
OUTSTANDING AT DECEMBER 31, 1996 397,630 6.75 - 19.13 168,460 14.20
Granted 5,700 27.25
Exercised/cancelled (110,300) 7.50 - 16.125 11.56
Forfeited 0
OUTSTANDING AT DECEMBER 31, 1997 293,030 5.87 - 19.13 129,765 14.54
Granted 231,311 31.31 - 34.81
Exercised/cancelled (45,573) 8.00 - 33.31 15.18
Forfeited
OUTSTANDING AT DECEMBER 31, 1998 478,768 $6.75 - 34.8125 305,261 $25.82
=================================================================================================
50
The Company granted 8,000 discounted options in 1996 and recognized compensation
expense of approximately $13,000. Restricted stock awarded in 1998 and 1997
amounted to 100 and 5,700 shares, respectively. Total expense is based on the
market value of the stock at the date of grant and is being accrued over the
period the restrictions lapse. Expense in 1998, 1997, and 1996 was $81,241,
$145,753, and $92,047,respectively. There were 125,289, 356,000 and 362,300
shares available for future grants or awards under the various programs
described above at December 31, 1998, 1997, and 1996, respectively. Directors
may elect to defer all or a portion of their director fees until a certain
distribution date pursuant to a Deferred Compensation Plan. The administrator
has established an account for each participating director and credits to such
account the number of shares of Company common stock which would have been
purchased with the director fees and shares equal to the amount of dividends
which would have been received. On the distribution date, the director shall be
entitled to receive either shares of the Company common stock equal to the
number of shares accumulated or at the Company's election, cash equal to the
fair value of the number of shares accumulated. There were 12,636 shares
credited to participant accounts at December 31, 1998 for which a liability of
approximately $492,000 was accrued and approximately $122,000 was recognized as
expense.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," provides for a fair-value-based method of accounting
for stock compensation plans with employees and others. Alternatively, the
statement allows that entities may continue to account for stock-based
compensation plans in accordance with Accounting Principles Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees," with disclosure of pro forma
amounts reflecting the difference between cost charged to operations pursuant to
APB No.25 and compensation cost that would have been charged to operations had
SFAS No. 123 been applied. The Company has elected to continue following APB No.
25 in accounting for its stock-based compensation plans. Application of the
fair-value base accounting provision of SFAS No. 123 results in the following
pro forma amounts of net income and earnings per share:
- ------------------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------
Net Income:
As reported $15,728,222 $15,561,506 $14,133,044
Pro forma 14,005,208 15,372,474 13,699,412
Earnings per share:
As reported $2.08 $2.05 $1.85
Pro forma basic earnings per share 1.83 2.03 1.79
The fair value of these options was estimated at the date of grant using a
Black-Scholes options pricing model with the following weighted average
assumptions for 1998, 1997 and 1996: risk-free interest rates by grant ranging
from 5.55% to 5.67% during 1998, 5.48% to 7.83% during 1997, and 5.75% during
1996; dividend yields of 3.00% during 1998 and 1997 and 3.95% during 1996;
volatility factors of the expected market price of the Company's common stock of
44.06% for 1998, 45.93% for 1997 and 48.21% for 1996; and a weighted-average
expected life of the option of 8.27 years for 1998, and 7.18 years for 1997, and
7.13 years for 1996.
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Therefore, the
preceding results are not likely to be representative of the effects on reported
net income for future years due to additional years of vesting. At December 31,
1998 the weighted average information for outstanding and exercisable shares is
as follows:
- ----------------------------------------------------------------------------------------------------
Shares Outstanding Shares Exercisable
Range of Shares WEIGHTED AVERAGE Weighted Average
Exercise Outstanding Exercise Remaining Shares Exercise
Price Price Life(years) Outstanding Price
- ----------------------------------------------------------------------------------------------------
$3.5314 - $7.0625 2,000 $6.7500 3.0 2,000 $6.7500
$7.0626 - $10.5938 19,200 $7.4700 3.1 19,200 $7.4740
$10.5939 - $14.1250 48,248 $12.8017 6.3 20,328 $12.8298
$14.1251 - $17.6563 85,670 $15.6030 6.3 45,141 $15.4753
$17.6564 - $21.1875 92,876 $19.1250 8.0 48,613 $19.1250
$24.7189 - $28.2500 2,100 $27.2500 8.5 0 $0.0000
$28.2501 - $31.7813 82,328 $31.3125 9.0 23,733 $31.3125
$31.7814 - $35.3125 146,346 $34.8128 13.5 146,246 $34.8125
-------------------------------------------------------------------------------
Total/Average 478,768 $24.2653 9.2 305,261 $25.8154
====================================================================================================
51
NOTE M: EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average shares
outstanding. Diluted earnings per share is computed based on the weighted
average shares outstanding adjusted for the dilutive effect of the assumed
exercise of stock options during the year. The following is a reconciliation of
basic to diluted earnings per share for the years ended December 31:
- -------------------------------------------------------------------------------------------
INCOME SHARES PER SHARE
AMOUNT
- -------------------------------------------------------------------------------------------
1998 NET INCOME $ 15,728,223
BASIC EPS 15,728,223 7,544,938 $ 2.08
EFFECT OF DILUTIVE SECURITIES:
STOCK OPTIONS 0 125,773
- -------
DILUTED EPS $ 15,728,223 7,670,711 $ 2.05
===========================================================================================
1997 Net Income $ 15,561,506
Less: Preferred stock dividends (78,750)
-------
Basic EPS 15,482,756 7,537,043 $ 2.05
Effect of diluitve securities:
Stock options 0 139,283
- -------
Diluted EPS $ 15,482,756 7,676,326 $ 2.02
===========================================================================================
1996 Net Income $ 14,133,044
Less: Preferred stock dividends (405,000)
--------
Basic EPS 13,728,044 7,407,212 $ 1.85
Effect of diluitve securities:
Stock options 0 75,306
- ------
Diluted EPS $ 13,728,044 7,482,518 $ 1.83
===========================================================================================
NOTE N: 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,
which involve, to varying degrees, elements of credit risk in excess of the
amount recognized in the statement of condition. The contract amount of those
commitments to extend credit reflects the extent of involvement the Company has
in this particular class of financial instrument. The Company's exposure to
credit loss in the event of nonperformance by the other party to the financial
instrument for commitments to extend credit is represented by the contractual
amount of the instrument. The Company uses the same credit policies in making
commitments as it does for on-balance-sheet instruments.
- ------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------
Financial instruments whose
contract amounts represent
credit risk at December 31:
Letters of Credit $3,745,000 $2,427,000
Commitments to make or
purchase loans or to extend
credit on lines of credit 176,857,000 157,931,000
-------------- ----------------
Total $180,602,000 $160,358,000
==================================================================
The fair value of these financial instruments is not significant.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the customer. Collateral held varies but may
include residential real estate, income-producing commercial properties, and
personal property. The Company has unused lines of credit totaling $73,859,534
and $43,486,000 at December 31, 1998 and 1997, respectively. The Company has
additional unused borrowing capacity through collateralized transactions with
the Federal Home Loan Bank.
The Company is required to maintain a reserve balance, as established by the
Federal Reserve Bank of New York. The required average total reserve for the
14-day maintenance period ended December 31, 1998 was $19,717,000 of which
52
$2,000,000 was required to be on deposit with the Federal Reserve Bank of New
York. The remaining $17,717,000 was represented by cash on hand.
NOTE O: LEASES
The Company leases buildings and office space under agreements that expire in
various years. Rental expense included in operating expenses amounted to
$1,132,000, $913,306 and $740,398 in 1998, 1997 and 1996, respectively. The
future minimum rental commitments as of December 31, 1998 for all
noncancelleable operating leases are as follows:
Years ending
December 31:
====================================
1999 $822,974
2000 744,945
2001 648,894
2002 492,721
2003 490,721
Thereafter $2,195,264
====================================
NOTE P: REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1998 and 1997, that
the Bank meets all capital adequacy requirements to which it is subject and is
"well capitalized" under the regulatory framework of prompt corrective action.
To be categorized as "well capitalized," the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
following table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
- --------------------------------------------------------------------------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- --------------------------------------------------------------------------------------------
As of December 31,1998:
Total Core Capital
(to Risk Weighted Assets) $103,693 10.49% $80,321 8% $100,402 10%
Tier I Capital
(to Risk Weighted Assets) $91,252 9.24% $40,161 4% $60,241 6%
Tier I Capital
(to Average Assets) $91,252 5.71% $63,889 4% $79,861 5%
As of December 31,1997:
Total Core Capital
(to Risk Weighted Assets) $98,001 10.55% $74,469 8% $93,087 10%
Tier I Capital
(to Risk Weighted Assets) $86,365 9.30% $37,235 4% $55,852 6%
Tier I Capital
(to Average Assets) $86,365 5.67% $60,892 4% $76,115 5%
53
NOTE Q: PARENT COMPANY STATEMENTS
- --------------------------------------------------------------------------------
CONDENSED BALANCE SHEETS
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1998 1997
- --------------------------------------------------------------------------------
Assets:
Cash and cash equivalents $ 1,952,603 $ 873,416
Investment securities 641,846 527,229
Investment in and advances
to subsidiaries 158,467,480 148,623,329
Other assets 278,795 1,514,286
----------- -----------
Total assets $161,340,724 $151,538,260
================================================================================
Liabilities:
Due to subsidiary $ 7,360,338
Accrued interest and other liabilities 3,076,480 $ 2,800,853
Borrowings 30,738,438 30,725,424
Shareholders' equity 120,165,468 118,011,983
------------ ------------
Total liabilities and
shareholders' equity $161,340,724 $151,538,260
================================================================================
CONDENSED STATEMENTS OF INCOME
- ---------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------------
Dividends from subsidiaries $11,462,202 $ 7,646,993 $ 5,521,520
Interest on investments and deposits 40,000 50,368 20,006
Gain on sale of assets 150,000 0 0
----------- ----------- -----------
Total revenues 11,652,202 7,697,361 5,541,526
----------- ----------- -----------
Expenses:
Interest on long term notes and debentures 3,022,485 2,753,370 0
Other Expenses 2,750 2,250 2,005
----------- ----------- -----------
Total expenses 3,025,235 2,755,620 2,005
----------- ----------- -----------
Income before tax benefit
and equity in undistributed net
income of subsidiaries 8,626,967 4,941,741 5,539,521
Income tax benefit 1,034,861 980,331 0
----------- ----------- -----------
Income before equity in
undistributed net income
subsidiaries 9,661,828 5,922,072 5,539,521
Equity in undistributed net income:
Subsidiary banks 6,066,395 9,639,434 8,593,523
----------- ----------- -----------
Net Income $15,728,223 $15,561,506 $14,133,044
=============================================================================================
On February 3, 1997, the Company formed a subsidiary business trust, Community
Capital Trust I (Trust), for the purpose of issuing preferred securities which
qualify as Tier I capital (see Note P). Concurrent with its formation, the Trust
issued $30,000,000 of 9.75% preferred securities in an exempt offering. The
preferred securities are non-voting, mandatorily redeemable in 2027, and
guaranteed by the Company. The entire net proceeds to the Trust from the
offering were invested in junior subordinated obligations of the Company. The
costs related to the issuance of these securities are capitalized and amortized
over the life of the period to redemption on a straight-line basis. Net proceeds
were used to repurchase the 45,000 shares of preferred stock outstanding from a
1995 offering and for other corporate purposes. The preferred stock was
repurchased at a value of $104 per share plus accrued dividends on the date the
Trust was formed.
54
NOTE Q: PARENT COMPANY STATEMENTS (CONTINUED)
- -------------------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash, Cash Equivalents, and Noncash Activities
YEARS ENDED DECEMBER 31,
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 15,728,223 $ 15,561,506 $ 14,133,044
Adjustments toreconcile
net income to net cash
provided by operating activities:
Equity in undistributed
net income
of subsidiaries (6,066,395) (9,639,435) (8,593,523)
Net change other assets
and accrued liabilities (237,012) 240,777 14,840
- -------------------------------------------------------------------------------------------------------------
Net Cash Provided By
Operating Activities 9,424,816 6,162,848 5,554,361
- -------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Purchase of available for
sale investment securities (114,617) (27,229) (502,812)
Sale of available for sale
investment securities 322,154
Capital contributions
to subsidiaries (602,264) (27,374,880) (378,334)
- -------------------------------------------------------------------------------------------------------------
Net Cash Used By
Investing Activities (716,881) (27,402,109) (558,992)
- -------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net change in loans
to subsidiaries 7,360,338 (500,000) 500,000
Proceeds from issuance of junior
subordinated debentures to subsidiary 30,719,236
Issuance (retirement)of common
and preferred stock 474,450 (3,451,047) 457,143
Repurchase of treasury stock (9,151,956)
Cash dividends (6,311,580) (5,745,135) (5,390,271)
- -------------------------------------------------------------------------------------------------------------
Net Cash Provided (Used)
By Financing Activities (7,628,748) 21,023,054 (4,433,128)
- -------------------------------------------------------------------------------------------------------------
CHANGE IN CASH
AND CASH EQUIVALENTS: 1,079,187 (216,207) 562,241
Cash and cash equivalents at beginning of
year 873,416 1,089,623 527,382
- -------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END
OF YEAR $ 1,952,603 $ 873,416 $ 1,089,623
- -------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash Paid For Interest $ 3,022,485 $ 1,497,175 $ 0
- -------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF
NONCASH FINANCING ACTIVITIES:
Dividends declared and unpaid $ 1,678,184 $ 1,517,262 $ 1,345,393
=============================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
On February 21, 1995, the Company adopted a Stockholder Protection Rights
Agreement and declared a dividend of one right for each outstanding share of
common stock. The rights can only be exercised when an individual or group has
acquired or attempts to acquire 15% or more of the Company's common stock, if
such action the Board of Directors believes is not in the best interest of the
stockholders. Each right then entitles the holder to acquire common stock having
a market value equivalent to two times the state exercise price. The rights
expire in February 2005 and may be redeemed by the Company in whole at a price
of $.01 per right.
55
PRICEWATERHOUSE COOPERS LLP
One Lincoln Center
Syracuse, NY 13202-9972
Telephone (315) 474 8541
Facsimile (315) 473 1385
Report of Independent Accountants
To the Board of Directors and Shareholders
Community Bank System, Inc.
Dewitt, New York
In our opinion, the accompanying consolidated statements of condition and the
related consolidated statements of income, changes in stockholders' equity and
of cash flows present fairly, in all material respects, the financial position
of Community Bank System, Inc. and Subsidiaries at December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principals. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principals used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ Pricewaterhouse Coopers LLP
Syracuse, New York
January 30, 1999
56
TWO YEAR SELECTED QUARTERLY DATA
1998 RESULTS 1ST 2ND 3RD 4TH
(Dollars in QUARTER QUARTER QUARTER QUARTER TOTAL
Thousands)
Net interest income $16,169 $15,922 $16,513 $15,791 $64,395
Provision for loan
losses 1,371 1,303 1,177 1,272 5,123
--------- --------- --------- --------- ---------
Net interest income
after provision for
loan losses 14,798 14,619 15,336 14,519 59,272
Total other income 3,681 4,683 4,392 4,476 17,232
Total other expense 12,662 13,166 12,988 13,058 51,874
--------- --------- --------- --------- ---------
Income before
income taxes 5,817 6,136 6,740 5,937 24,630
Income taxes 2,129 2,234 2,374 2,165 8,902
--------- --------- -------- --------- ---------
Net income $3,688 $3,902 $4,366 $3,772 $15,728
========= ========= ========= ========= =========
Earnings per share
- - Basic $0.49 $0.51 $0.57 $0.53 $2.08
Earnings per share
- - Diluted $0.48 $0.50 $0.56 $0.51 $2.05
=========================================================================
1997 RESULTS 1st 2nd 3rd 4th
(Dollars in QUARTER QUARTER QUARTER QUARTER TOTAL
Thousands)
Net interest income $14,370 $14,585 $16,813 $17,108 $62,876
Provision for loan
losses 730 850 1,235 1,665 4,480
--------- --------- --------- --------- ---------
Net interest income
after provision for
loan losses 13,640 13,735 15,578 15,443 58,396
Total other income 2,326 2,530 3,403 3,549 11,808
Total other expense 10,179 10,426 12,287 12,906 45,798
--------- --------- -------- --------- ---------
Income before
income taxes 5,787 5,839 6,694 6,086 24,406
Income taxes 2,122 2,171 2,459 2,092 8,844
--------- --------- -------- --------- ---------
Net income $3,665 $3,668 $4,235 $3,994 $15,562
========= ========= ========= ========= =========
Earnings per share
- - Basic $0.48 $0.49 $0.56 $0.53 $2.05
Earnings per share
- - Diluted $0.47 $0.48 $0.55 $0.52 2.02
=========================================================================
57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- ------------------------------------------------------------------------------
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
The information concerning directors of the Company required by this Item 10 is
incorporated herein by reference to the section entitled "Nominees for Director
and Directors Continuing in Office" in the Company's Proxy Statement. The
information concerning executive officers of the Company required by this Item
10 is incorporated herein by reference to Item 4A of this Annual Report on Form
10-K.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this Item 11 is incorporated herein by reference to
the section entitled "Compensation of Executive Officers" in the Company's Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information required by this Item 12 is incorporated herein by reference to
the section entitled "Nominees for Director and Directors Continuing in Office"
in the Company's Proxy Statement. The Company is not aware of any persons who
benefically own 5% or more of the issued and outstanding shares of common stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this Item 13 is incorporated herein by reference to
the section entitled "Transactions with Management" in the Company's Proxy
Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
A. Documents Filed
1. The following consolidated financial statements of Community Bank
System, Inc. and subsidiaries are included in Item 8:
- Consolidated Statements of Condition --
December 31, 1998 and 1997
- Consolidated Statements of Income --
Years ended December 31, 1998, 1997, and 1996
- Consolidated Statements of Changes in Shareholders' Equity --
Years ended December 31, 1998, 1997, and 1996
- Consolidated Statement of Cash Flows --
Years ended December 31, 1998, 1997, and 1996
- Notes to Consolidated Financial Statements --
December 31, 1998
- Auditor's report
- Quarterly selected data --
Years ended December 31, 1998 and 1997 (unaudited)
2. Schedules are omitted since the required information is either
not applicable or shown elsewhere in the financial statements.
58
3. Listing of Exhibits
Exhibit No. Exhibit
----------- -------
21 List of the Company's subsidiaries
27 Financial Date Schedule
B. Reports on Form 8-K
The Company filed with the Securities and Exchange Commission on October 1, 1998
a Current Report on Form 8-K to report the announcement of its stock repurchase
program.
C. See Exhibit 14(a)(3) above.
D. See Exhibit 14(a)(2) above
59
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
COMMUNITY BANK SYSTEM, INC.
By: /S/ SANFORD A. BELDEN
-------------------------
Sanford A. Belden
President, Chief Executive Officer and Director
March 17, 1999
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 17th day of March 1999.
NAME
/S/ JAMES A. GABRIEL
- --------------------
James A. Gabriel, Director
Chairman of the Board of Directors
and Director
/S/ DAVID G. WALLACE
- --------------------
David G. Wallace
Treasurer
Directors:
/S/ JOHN M. BURGESS
- -------------------
John M. Burgess, Director
/S/ RICHARD C. CUMMINGS
- -----------------------
Richard C. Cummings, Director
/S/ WILLIAM M. DEMPSEY
- ----------------------
William M. Dempsey, Director
/S/ NICHOLAS A. DICERBO
- -----------------------
Nicholas A. DiCerbo, Director
/S/ LEE T. HIRSCHEY
- -------------------
Lee T. Hirschey, Director
/S/ DAVID C. PATTERSON
- ----------------------
David C. Patterson, Director
/S/ WILLIAM N. SLOAN
- --------------------
William N. Sloan, Director
60
Exhibit 21
-----------
Subsidiaries of the Company
Name Jurisdiction of Incorporation
Community Bank N.A. New York
Community Capital Trust I Delware
Community Financial Services, Inc. New York
Benefit Plans Administrative Services, Inc. New York
CBNA Treasury Management Corporation Delaware
61