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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
Commission file number 0-11716
[LOGO]
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
Delaware 16-1213679
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
5790 Widewaters Parkway, DeWitt, New York 13214-1883
(Address of principal executive offices) (Zip Code)
(315) 445-2282
Registrant's telephone number, including area code
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 of this Form 10-K. [X]
State the aggregate market value of the voting and non-voting common equity
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.
$380,071,184 based upon average selling price of $29.42 and 12,918,803
shares on March 8, 2002.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
12,918,803 shares of Common Stock, no par value, were
outstanding on March 8, 2002.
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 15, 2002 (the "Proxy Statement") is incorporated by reference in Part III of
this Annual Report on Form 10-K.
TABLE OF CONTENTS
PART I Page
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Item 4A. Executive Officers of the Registrant 11
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholders Matters 12
Item 6. Selected Financial Data 13
Item 7 and 7A. Management's Discussion and Analysis of Financial Condition and Results of
Operations and Quantitative and Qualitative Disclosures about Market Risk 15
Item 8. Financial Statements and Supplementary Data:
Community Bank System, Inc. and Subsidiaries:
Consolidated Statements of Financial Condition 41
Consolidated Statements of Income 42
Consolidated Statements of Changes in Shareholders' Equity 43
Consolidated Statements of Cash Flows 44
Notes to Consolidated Financial Statements 45
Report of Independent Accountants 64
Two Year Selected Quarterly Data, 2001 and 2000 65
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 65
PART III
Item 10. Directors and Executive Officers of the Registrant 66
Item 11. Executive Compensation 66
Item 12. Security Ownership of Certain Beneficial Owners and Management 66
Item 13. Certain Relationships and Related Transactions 66
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 67
Signatures 68
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 combined. On January 26, 2001, the Company purchased
the Citizens National Bank of Malone, with its offices in Brushton, Chateaugay,
Hermon, and Malone (2) now being administered from the Bank's Northern Market
operations and management center in Canton, NY. On May 11, 2001, the Company
purchased First Liberty Bank Corp. First Liberty had 13 branches based in the
Scranton/Wilkes Barre area of Northeastern Pennsylvania. These branches are now
identified in the marketplace as "First Liberty Bank & Trust, a division of
Community Bank, N.A." On November 16, 2001, the Company purchased 36 branches
located in the Finger Lakes and Western New York Regions from FleetBoston
Financial. These branches now operate as Community Bank, N.A. offices; five have
since been closed or combined with other bank branches.
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 twice been renewed with the
subsequent acquirer of Mellon's data services, Fiserv, Inc., for a term now
ending December 31, 2005. 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.
3
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 ceased operations in 1990
and was renamed CFSI Close-Out Corp. in 1997.
On July 8, 1996, the Company acquired Benefit Plans Administrators (BPA) of
Utica, NY. The subsidiary was renamed Benefit Plans Administrative Services,
Inc., continuing as 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.
On June 19, 1998, the Company formed a subsidiary, Community Financial Services,
Inc. (CFSI), to offer selected insurance products through its own agency.
On December 22, 1998, the Company formed a broker-dealer subsidiary, Community
Investment Services, Inc. (CISI). The subsidiary became fully operational in
March 1999, with a growing number of Financial Consultants available to provide
investment advice and products to customers.
On February 26, 1999, CBNA Preferred Funding Corp., a Real Estate Investment
Trust (REIT), was established as a subsidiary of the Bank to invest in real
estate mortgage assets originated by the Bank.
On April 3, 2000, the Company acquired Elias Asset Management, Inc., of
Williamsville, NY, a nationally recognized firm presently with $550 million in
assets under management for individuals, corporate pension and profit sharing
plans, and foundations.
On July 16, 2001, the Company formed a subsidiary business trust, Community
Capital Trust II, for the purpose of issuing preferred securities, which qualify
as Tier 1 capital. Concurrent with its formation, the trust issued $25,000,000
of pooled floating rate preferred securities (priced at 6 month LIBOR plus
3.75%) in an exempt offering maturing in year 2031 and guaranteed by the
Company. The entire net proceeds to the trust from the offering were invested in
junior subordinated obligations of the Company.
On July 31, 2001, the Company formed a subsidiary business trust, Community
Statutory Trust III, for the purpose of issuing preferred securities, which
qualify as Tier 1 capital. Concurrent with its formation, the trust issued
$24,450,000 of pooled floating rate preferred securities (priced at 3 month
LIBOR plus 3.58%) in an exempt offering maturing in year 2031 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 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 119 customer facilities in the twenty two counties of New York
State - Allegany, Lewis, Cattaraugus, Seneca, St. Lawrence, Yates, Franklin,
Steuben, Chemung, Schuyler, Jefferson, Chautauqua, Tioga, Livingston, Ontario,
Wayne, Herkimer, Oswego, Cayuga, Oneida, Erie and Onondoga and in two counties
in Northern Pennsylvannia - Lackawanna and Luzerne. 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 responsive 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.
4
Account Services. The Bank's account services include checking accounts,
interest-checking accounts, money market accounts, savings accounts, time
deposit accounts, and individual retirement accounts.
Lending Activities. The Bank's lending activities include the making of
residential, installment, student and farm loans, business lines of credit,
working capital facilities, special purpose term lending, equipment leasing
services (through a third party), and inventory and dealer floor plans.
The Company's predominant focus on the retail borrower results in a highly
diversified loan portfolio. About 63% of outstanding loans are provided 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 $100,000, representing 86% of our customers and 23% of our commercial
loans outstanding.
Other Services. The Bank offers a range of other financial services including
pension administration and consulting; asset management for individuals,
corporate pension and profit sharing plans, and foundations; personal trust
services including living, testamentary and charitable trusts, estate settlement
services, conservatorships and investment management services; and various
financial and insurance products including mutual funds, annuities, long-term
health care and other selected insurance products. 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.
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, as well as Northeastern
Pennsylvania. 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 four county primary market area (Franklin, Jefferson, Lewis, and St.
Lawrence), the Bank has a 21.4% share. The Bank operates 32 customer facilities
in this market and is ranked either first or second in market share in 21 of the
24 towns where these offices are located.
Finger Lakes Market. In the Finger Lakes Market, the Bank operates 20 customer
facilities competing for loans and deposits in the eight-county market area of
Seneca, Schuyler, Livingston, Oswego, Ontario, Wayne, Onondaga, and Cayuga
Counties. Within the Finger Lakes Market area, the Bank maintains a market share
(1) of approximately 3.3%, 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 eleven of the seventeen
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, Chautauqua, Chemung, Erie, and Allegany
Counties in the Southern Tier of New York State. Within this area, the Bank
maintains a market share (1) of approximately 3.6%, including commercial banks,
credit unions, savings and loan associations and savings banks. The Olean
Submarket operates 34 office locations and the Bank is ranked either first or
second in market share in 23 of the 28 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
5
approximately 15.9%, including commercial banks, credit unions, savings and loan
associations and savings banks. The Corning Submarket operates sixteen office
locations, and the Bank is ranked either first or second in market share in
eight of the twelve towns where these offices are located.
Northeastern Pennsylvania. In the Northeastern Pennsylvania Market, the Bank
operates 13 customer facilities competing for loans and deposits in the
two-county market area of Lackawanna and Luzerne Counties. Within the
Northeastern Pennsylvania Market area, the Bank maintains a market share (1) of
approximately 6.0%, including commercial banks, credit unions, savings and loan
associations and savings banks. The Bank is ranked either first or second in
market share in four of the ten towns where these offices are located.
The table below summarizes the Bank's deposits and market share by the
twenty-four 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 CBNA
6/30/00 Market Has 1st or 2nd Banking
County (000's)(1) Share Facilities ATM's Towns Market Position Market
- ---------------------------------------------------------------------------------------------
Allegany $ 180,249 52.2% 10 8 9 9 Olean
Lewis 79,077 40.1 4 1 3 3 Northern
Cattaraugus 286,288 35.5 10 7 8 7 Olean
Seneca 95,640 33.3 5 3 4 3 Finger Lakes
St. Lawrence 307,900 26.2 15 9 11 10 Northern
Yates 82,251 23.2 3 2 2 2 Corning
Franklin 103,403 21.3 5 3 4 4 Northern
Steuben 169,759 13.8 11 7 8 5 Corning
Lackawanna 488,504 13.4 11 13 8 4 PA
Chemung 14,883 13.2 1 1 1 0 Olean
Schuyler 14,397 12.8 1 1 1 1 Finger Lakes
Jefferson 133,439 12.7 5 5 4 2 Northern
Chautauqua 161,405 12.7 12 8 9 6 Olean
Tioga 32,118 9.6 2 2 2 1 Corning
Livingston 50,392 8.7 3 3 3 2 Finger Lakes
Ontario 72,372 6.8 4 4 3 1 Finger Lakes
Wayne 51,408 6.1 2 1 1 0 Finger Lakes
Herkimer 28,234 5.0 1 1 1 1 Northern
Oswego 42,755 4.3 2 2 2 2 Finger Lakes
Cayuga 25,148 3.2 2 1 2 2 Finger Lakes
Oneida 56,676 1.7 2 1 1 1 Northern
Luzerne 22,165 0.5 2 2 2 0 PA
Erie 18,534 0.1 1 0 1 1 Olean
Onondaga 7,908 0.1 1 1 1 0 Finger Lakes
- ---------------------------------------------------------------------------------------------
24 $2,524,905 5.4% 115 86 91 67 Total
=============================================================================================
(1) Deposit market share data as of June 30, 2000, the most recent information
available, calculated by Sheshunoff Information Services, Inc. Includes all
branches acquired from Citizens National Bank of Malone, First Liberty Bank
Corp. and FleetBoston during 2001.
Employees
As of December 31, 2001, the Company employed 1,115 full-time equivalent
employees, 1,016 providing banking services and 99 providing financial services.
At year-end 2000, there were 927 full-time equivalent employees, 847 providing
banking services and 80 providing financial services. The Company offers a
variety of employment benefits and considers its relationship with its employees
to be good.
6
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 have historically been limited to the business of banking and
activities closely related or incidental to banking. On March 12, 2000, however,
the Gramm-Leachy-Bliley Act took effect, relaxing the previous limitations and
permitting bank holding companies to engage in a broader range of financial
activities (see "Financial Services Modernization Act" in the final section of
this discussion for details).
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 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. It also affects
business practices, such as payment of interest on deposits, the charging of
interest on loans, types of business conducted and location of offices. There
are no regulatory orders or outstanding issues resulting from regulatory
examinations of the Bank.
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, 2001, the Bank had $26.6 million in undivided profits legally
available for the payment of dividends.
7
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 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 that 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, 2001 were 11.41% and 12.76%,
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, 2001 was 6.73%, 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.
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.
8
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, 2001, the
Bank's total risk-based capital ratio and Tier I risk - based capital ratio were
12.57% and 11.22%, respectively, and its Tier I leverage ratio as of such date
was 6.69%. 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 non-capital 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.
Financial Services Modernization Act
The Gramm-Leach-Bliley Act of 1999, effective March 11, 2000, repealed
provisions of the depression-era Glass-Steagall Act, which prohibited commercial
banks, securities firms, and insurance companies from affiliating with each
other and engaging in each other's businesses.
The Act creates a new type of financial services company called a "Financial
Holding Company" (an "FHC"), a bank holding company with dramatically expanded
powers. FHCs may offer virtually any type of financial service, including
banking, securities underwriting, insurance (both agency and underwriting) and
merchant banking. The Federal Reserve serves as the primary "umbrella" regulator
of FHCs. Balanced against the attractiveness of these expanded powers are higher
standards for capital adequacy and management, with heavy penalties for
noncompliance.
Bank holding companies that wish to engage in expanded activities but do not
wish to become financial holding companies may elect to establish "financial
subsidiaries," which are subsidiaries of national banks with expanded powers.
The Act permits financial subsidiaries to engage in the same types of activities
permissible for nonbank subsidiaries of financial holding companies, with the
exception of merchant banking, insurance underwriting and real estate investment
and development. CBSI expects to remain a bank holding company for the time
being and assess its options as circumstances change.
The Gramm-Leach Bliley Act also provides new privacy protections to consumers by
limiting the transfer and use by financial institutions of consumer's nonpublic,
personal information. The foregoing discussion is qualified in its entirety by
reference to the statutory provisions of the Gramm-Leach-Bliley Act and the
implementing regulations which have been or will be adopted by various
government agencies.
9
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 119 customer facilities, 86
are owned by the Bank, and 33 are located in long-term leased premises.
Real property and related banking facilities owned by the Company at December
31, 2001 had a net book value of $37.3 million and none of the properties was
subject to any encumbrances. For the year ended December 31, 2001, rental fees
of $1,319,000 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
10
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 Director, President and Chief Executive
Age 59 Officer of the Company and the Bank
David G. Wallace Treasurer of the Company and Executive
Age 57 Vice President and Chief Financial
Officer of the Bank
Michael A. Patton President, Financial Services
Age 56
James A. Wears President, Banking
Age 52
David J. Elias President, Chief Executive Officer, and
Age 56 Chief Investment Officer,
Elias Asset Management, Inc.
Steven R. Tokach President, First Liberty Bank & Trust
Age 55
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.
David G. Wallace (Treasurer of the Company; Executive 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
Senior Vice President and Chief Financial Officer of the Bank in August 1991. He
assumed his current position in February 2000. He was formerly Executive Vice
President, Cates Consulting Analysts, Inc. from 1987-1988, and previously held
senior financial planning and analysis positions at Syracuse Savings Bank and
Maryland National Bank.
Michael A. Patton (President, Financial Services). 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 Community Bank, N.A.,
he was named President, Southern Region. He assumed his current position in
February 2000.
James A. Wears (President, Banking). 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 President and Chief Executive Officer from January
1991 until January 1992. Following the January 1992 consolidation of the
Company's five subsidiary banks into Community Bank, N.A., Mr. Wears was named
President, Northern Region. He assumed his current position in February 2000.
David J. Elias (President, Chief Executive Officer, and Chief Investment
Officer, Elias Asset Management, Inc.). Mr. Elias assumed his present position
in April 2000, when his company, Elias Asset Management, Inc., was purchased by
Community Bank System, Inc.
Steven R. Tokach (President, First Liberty Bank & Trust). Mr. Tokach assumed his
position in May 2001, when First Liberty Bank Corp. was purchased by Community
Bank System, Inc. He was Executive Vice President of First Liberty Bank Corp.
and First Liberty Bank & Trust from 1994-2001, and from 1998-1993, served as
Vice President and Executive Vice President of Guaranty Bank, N.A. and First
Eastern Bank, respectively, both in Pennsylvania.
11
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 prices
for the common stock, and the cash dividends declared with respect thereto, for
the periods indicated. The prices do not include retail mark-ups, mark-downs or
commissions. There were 12,902,812 shares of common stock outstanding on
December 31, 2001, held by approximately 9,000 registered shareholders of record
and 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
Year/ High Low Closing Price Quarterly
Qtr Price Price Amount % Change Dividend
--- ----- ----- ------ -------- --------
2001
4th $ 27.80 $ 24.98 $ 26.20 $ -4.7% $ 0.27
3rd $ 29.85 $ 24.75 $ 27.50 $ -1.8% $ 0.27
2nd $ 28.94 $ 26.50 $ 28.00 $ -0.2% $ 0.27
1st $ 29.65 $ 25.15 $ 28.06 13.4% $ 0.27
2000
4th $ 25.94 $ 22.15 $ 24.75 $ -4.6% $ 0.27
3rd $ 26.03 $ 21.88 $ 25.94 $ 16.9% $ 0.27
2nd $ 24.13 $ 22.00 $ 22.19 $ -2.7% $ 0.25
1st $ 23.38 $ 20.25 $ 22.81 $ -1.4% $ 0.25
The Company has historically paid regular quarterly cash dividends on its common
stock, and declared a cash dividend of $0.27 per share for the first quarter of
2002. 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 "Certain Regulatory Considerations --
Limits On Dividends and Other Revenue Sources."
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, 2001. The historical "Income Statement Data" and historical
"Balance Sheet Data" are derived from the audited financial statements. The "Per
Share Data", "Common Outstanding Shares", "Selected Performance Ratios", "Asset
Quality Ratios" and "Capital Ratios" for all periods are unaudited. All
financial information in this table should be read in conjunction with the
information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations and Quantitative and Qualitative Disclosures
about Market Risk" and with the Consolidated Financial Statements and the
related notes thereto included elsewhere in this Annual Report on Form 10-K.
12
SELECTED CONSOLIDATED FINANCIAL INFORMATION
In Thousands except share and per share data Years Ended December 31,
- ----------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Income Statement Data:
Interest income $197,850 $189,574 $166,490 $165,303 $158,944
Interest expense 101,195 99,141 78,490 81,216 76,327
Net interest income 96,655 90,433 88,000 84,087 82,617
Provision for loan losses 7,097 7,722 5,856 5,663 5,080
Net interest income after provision for loan losses 89,558 82,711 82,144 78,424 77,537
Non-interest income 26,537 23,284 18,153 16,812 14,057
Security gains (losses) 2,546 (159) (413) 2,006 (205)
Non-interest expense 74,196 65,643 62,055 61,389 56,223
Amortization expense 6,679 4,891 4,723 4,748 3,903
Acquisition and unusual expenses 8,164 400 -- 1,098 --
Income before income taxes 29,602 34,902 33,106 30,007 31,263
Provision for income taxes 8,891 10,003 9,444 10,472 10,581
Net income before cumulative effect of change in
accounting principle and/or extraordinary
loss on early retirement of long term borrowings 20,711 24,899 23,662 19,535 20,682
Cumulative effect of change in accounting principle -- -- -- 194 --
Extraordinary loss on early retirement of long term
borrowings 1,582 -- -- -- --
Net income $19,129 $24,899 $23,662 $19,729 $20,682
Net income - Operating (1) $24,052 $25,136 $23,662 $20,378 $20,682
Net income - Cash (2) $23,474 $27,795 $26,480 $22,562 $23,015
Net income - Cash Operating (3) $28,397 $28,032 $26,480 $23,211 $23,015
Balance Sheet Data:
Total assets $3,210,833 $2,650,673 $2,493,977 $2,296,059 $2,218,793
Loans, net of unearned discount 1,732,870 1,515,877 1,425,773 1,293,135 1,203,806
Earning assets (Excl. MVA) 2,863,944 2,435,604 2,295,871 2,079,876 1,996,113
Intangible assets 142,342 55,234 54,150 54,438 58,672
Total deposits 2,545,970 1,948,557 1,844,752 1,874,666 1,830,488
Long term borrowings 231,000 240,000 145,567 155,470 100,744
Trust preferred securities 77,819 29,824 29,817 29,810 29,804
Shareholders' equity 267,980 201,791 165,705 179,073 173,596
Common Per Share Data:
Net income (diluted) $1.62 $2.32 $2.18 $1.75 $1.84
Net income - operating (1) (diluted) 2.03 2.34 2.18 1.81 1.84
Net income - cash (2) (diluted) 1.99 2.59 2.44 2.00 2.05
Net income - cash operating (3) (diluted) 2.40 2.61 2.44 2.06 2.05
Cash dividend declared 1.08 1.04 0.96 0.86 0.76
Book value - stated 20.77 19.11 15.55 16.50 15.62
Book value - tangible 9.74 13.88 10.47 11.02 9.85
Common Outstanding Shares:
Average during period (Incl. common stock equivalents) 11,824,589 10,737,000 10,861,000 11,260,000 11,238,714
End of period (Excl. common stock equivalents) 12,902,812 10,559,897 10,657,770 10,855,964 11,130.023
Selected Performance Ratios:
Return on average total assets 0.66% 0.97% 1.00% 0.87% 1.00%
Return on average total assets - operating (1) 0.83% 0.98% 1.00% 0.90% 1.00%
Return on average total assets - cash (2) 0.81% 1.09% 1.12% 0.99% 1.11%
Return on average total assets - cash operating (3) 0.98% 1.10% 1.12% 1.02% 1.11%
Return on average common shareholders' equity 7.99% 14.27% 13.56% 11.11% 12.61%
Return on average common shareholders' equity -
operating (1) 10.05% 14.40% 13.56% 11.47% 12.61%
Return on average common shareholders' equity - cash (2) 9.81% 15.93% 15.18% 12.70% 14.03%
Return on average common shareholders' equity - cash
operating (3) 11.86% 16.06% 15.18% 13.07% 14.03%
Common dividend payout ratio 65.7% 40.6% 40.4% 44.9% 38.0%
Net interest margin (taxable equivalent basis) 3.97% 4.06% 4.32% 4.14% 4.40%
Noninterest income to operating income (taxable equivalent basis
and excludes security gains/losses and branch
dispositions) 20.3% 19.3% 16.2% 16.3% 14.3%
Efficiency ratio (4) 57.0% 54.6% 55.5% 59.7% 57.2%
Loans, net of unearned discount, to deposits at period
end 68.1% 77.8% 77.3% 69.0% 65.8%
Asset Quality Ratios:
Non-performing loans to total loans 0.53% 0.49% 0.51% 0.48% 0.50%
Non-performing assets to total loans and other real
estate owned 0.61% 0.58% 0.62% 0.62% 0.66%
Non-performing assets to total assets 0.33% 0.33% 0.36% 0.35% 0.36%
Allowance for loan losses to loans 1.38% 1.32% 1.30% 1.32% 1.41%
Allowance for loan losses to non-performing loans 262.6% 270.6% 253.4% 276.4% 280.0%
Net charge-offs (recoveries) to average total loans 0.42% 0.42% 0.33% 0.45% 0.43%
Capital Ratios:
Total shareholders' equity to total assets 8.35% 7.61% 6.64% 7.80% 7.82%
Tangible equity to tangible assets 4.09% 5.65% 4.57% 5.56% 5.32%
Tier I capital to risk-adjusted assets 11.41% 10.49% 10.87% 10.18% 10.10%
Total risk-based capital to risk-adjusted assets 12.76% 11.70% 12.10% 11.43% 11.33%
Tier I leverage ratio 6.73% 6.67% 6.76% 6.27% 6.16%
(1) Operating adjusted amounts and ratios exclude the after tax effect of
acquisition expenses, net security gains / (losses) for 2001 only and
extraordinary loss, and, accordingly, are not presented in accordance with
Generally Accepted Accounting Principles (GAAP).
(2) Cash adjusted amounts and ratios exclude the after tax effects of
amortization expenses and, accordingly, are not presented in accordance
with GAAP.
(3) Cash operating adjusted amounts and ratios exclude the after tax effect of
acquisition expenses, net security gains / (losses) for 2001 only,
extraordinary loss, and amortization expenses and, accordingly, are not
presented in accordance with GAAP.
(4) Efficiency ratio excludes acquisition expenses and amortization expense.
13
TWO YEAR SELECTED QUARTER DATA
2001 RESULTS 1st 2nd 3rd 4th
(Dollars in Thousands) Quarter Quarter Quarter(1) Quarter Total
- -------------------------------------------------------------------------------------------------------------
Net interest income $ 23,141 $ 23,080 $ 23,808 $ 26,626 $ 96,655
Provision for loan losses 1,326 1,415 1,579 2,777 7,097
- -------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 21,815 21,665 22,229 23,849 89,558
Non-interest income 6,025 6,630 6,971 6,911 26,537
Security gains (losses) 9 (138) 2,688 (13) 2,546
Non-interest expense 17,604 18,629 18,198 19,765 74,196
Amortization expense 1,460 1,541 1,541 2,137 6,679
Acquisition and unusual expenses 851 4,636 631 2,046 8,164
- -------------------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary item 7,934 3,351 11,518 6,799 29,602
Provision for income taxes 2,185 1,241 3,493 1,972 8,891
- -------------------------------------------------------------------------------------------------------------
Income before extraordinary item 5,749 2,110 8,025 4,827 20,711
Extraordinary loss on early retirement of long term
borrowings, net of tax benefit of $1,077 0 0 1,582 0 1,582
- -------------------------------------------------------------------------------------------------------------
Net income $ 5,749 $ 2,110 $ 6,443 $ 4,827 $ 19,129
=============================================================================================================
Net income - operating $ 6,250 $ 4,950 $ 6,801 $ 6,052 $ 24,052
Net income - cash $ 6,681 $ 3,118 $ 7,450 $ 6,225 $ 23,474
Net income - cash operating $ 7,182 $ 5,957 $ 7,808 $ 7,450 $ 28,397
Basic income per share $ 0.51 $ 0.18 $ 0.56 $ 0.39 $ 1.64
Diluted income per share:
Net income $ 0.50 $ 0.18 $ 0.55 $ 0.39 $ 1.62
Net income - operating $ 0.54 $ 0.42 $ 0.58 $ 0.49 $ 2.03
Net income - cash $ 0.58 $ 0.27 $ 0.63 $ 0.50 $ 1.99
Net income - cash operating $ 0.63 $ 0.51 $ 0.67 $ 0.60 $ 2.40
=============================================================================================================
2000 RESULTS 1st 2nd 3rd 4th
(Dollars in Thousands) Quarter Quarter Quarter(1) Quarter Total
- -------------------------------------------------------------------------------------------------------------
Net interest income $ 22,769 $ 22,674 $ 22,338 $ 22,652 $ 90,433
Provision for loan losses 1,389 1,887 2,308 2,138 7,722
- -------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 21,380 20,787 20,030 20,514 82,711
Non-interest income 4,673 5,921 6,523 6,167 23,284
Security losses (159) 0 0 0 (159)
Non-interest expense 15,836 16,534 16,465 16,808 65,643
Amortization expense 1,137 1,214 1,259 1,281 4,891
Acquisition and unusual expenses 0 0 0 400 400
- -------------------------------------------------------------------------------------------------------------
Income before income taxes 8,921 8,960 8,829 8,192 34,902
Income taxes 2,535 2,564 2,529 2,375 10,003
- -------------------------------------------------------------------------------------------------------------
Net income $ 6,386 $ 6,396 $ 6,300 $ 5,817 $ 24,899
=============================================================================================================
Net income - operating $ 6,388 $ 6,396 $ 6,300 $ 6,052 $ 25,136
Net income - cash $ 7,058 $ 7,115 $ 7,046 $ 6,576 $ 27,795
Net income - cash operating $ 7,061 $ 7,115 $ 7,046 $ 6,811 $ 28,032
Basic income per share
Diluted income per share: $ 0.60 $ 0.60 $ 0.60 $ 0.55 $ 2.34
Net income $ 0.60 $ 0.59 $ 0.59 $ 0.54 $ 2.32
Net income - operating $ 0.59 $ 0.59 $ 0.59 $ 0.57 $ 2.34
Net income - cash $ 0.66 $ 0.66 $ 0.66 $ 0.62 $ 2.59
Net income - cash operating $ 0.66 $ 0.66 $ 0.66 $ 0.64 $ 2.61
=============================================================================================================
(1) The 3rd quarter 10Q previously netted reported prepayment penalties of
$2,659 incurred on the early retirement of long-term borrowings against
investment security gain (loss), net. The 3rd quarter information has been
restated to reflect these penalties as an extraordinary loss, net of tax benefit
in accordance with generally accepted accounting principles. The effect of this
restatement was to increase amounts previously reported for other income by
$2,659, decrease income before extraordinary item by $834 and increase basic and
diluted earnings per share before extraordinary item by $.13. There was no
impact on net income as previously reported, nor any effect on cash flows or
financial condition.
14
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations and Quantitative and Qualitative Disclosures about Market Risk
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains certain forward-looking statements with respect to the
financial condition, results of operations and business of Community Bank
System, Inc. ("CBSI" or "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
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
Information and the company's Consolidated Financial Statements and related
notes thereto appearing elsewhere in this Form 10-K. 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. All financial results reflect the 2001 acquisition of First Liberty Bank
Corp. ("First Liberty") in accordance with pooling of interest accounting,
unless otherwise noted. Lastly, all references to "peer banks", unless otherwise
noted, pertain to a group of 172 companies nationwide having $1 billion to $3
billion in assets based on data through September 30, 2001 (the most recently
available disclosure) as provided by the Federal Reserve System.
Net Income and Profitability
Net income and earnings per share (diluted) for the year ended December 31, 2001
were $19.1 million and $1.62, off 23% and 30%, respectively, from the prior
year. These results include $8.3 million in nonrecurring items associated with
the company's three 2001 acquisitions in January, May, and November, which added
$1.2 billion in assets and increased its branch network by 70% to 119 locations.
Included in these nonrecurring items are acquisition and other unusual costs as
well as net security gains and loss on early retirement of long-term debt.
2001's operating earnings, which exclude all nonrecurring items, were $24.1
million (down 4.3%), while operating earnings per share (diluted) were $2.03
(off 13.2% on 10.1% more average shares outstanding).
Cash operating earnings reached an all-time high in 2001 of $28.4 million, up
1.3% from 2000's level. In addition to deducting nonrecurring items, cash
operating earnings exclude the amortization of intangible assets, which
represent premiums paid on acquisitions.
Cash operating earnings per share (diluted) for all of 2001 were $2.40, a
decrease of 8.0% from 2000. These results reflect an additional 952,000 common
shares issued in connection with the company's January whole-bank purchase and
1.309 million issued in the fourth quarter to support the mid-November purchase
of 36 branches in Western New York from FleetBoston Financial (NYSE: FBF).
Cash operating return on assets (ROA) for 2001 was 0.98% versus nominal
operating ROA at 0.83%. Cash operating return on equity (ROE) for the year was
11.86% versus nominal operating ROE at 10.05%. The difference between cash and
nominal results reflects the contribution of the company's acquisitions on an
economic basis, which excludes the non-cash impact of amortizing the premiums
paid for the acquisitions. Many analysts and investors consider cash results a
better measure of core profitability and value created for shareholders than
nominal results.
The primary factors explaining 2001 are explained in detail in the remaining
sections of this document and are summarized as follows:
o Net interest income (full tax-equivalent basis) increased 7.4% or $7.1
million due to a $237 million increase in average earning assets. Average
loans grew $96 million (6.5%) while average investments rose $141 million
(15.7%). The growth in earning assets was funded by $209 million (10.9%)
more in average deposits and $34 million (7.6%) more in average borrowings.
Net interest margin decreased by 9 basis points to 3.97% on average,
largely reflective of the impact of rapidly falling financial market
interest rates during much of the year, which caused lower margins during
the first half of 2001.
o Total noninterest income increased by $3.3 million (14.3%) from 2000 to
$26.4 million. Financial services accounted for $1.8 million of the
improvement in noninterest income, with approximately $860,000 being
attributable to increased revenues from BPA (the company's pension
administration and consulting business) and nearly $660,000 attributable to
the full year impact of the purchase of Elias Asset Management (EAM) on
April 3, 2000. Revenues excluding net investment gains (losses) and the
impact of branch properties no longer in use were
15
up nicely for the seventh consecutive year to approximately $26.5 million
in 2001, a $3.3 million (14.0%) improvement.
o Noninterest expense or overhead rose $18.1 million or 25.5% in 2001 to
$89.0 million. Acquisition and other one-time expenses and intangible
amortization accounted for 54% of the increase, or $7.8 and $1.9 million,
respectively. While day-to-day overhead expense rose due to the company's
three 2001 acquisitions, more than $3.2 million in expense reductions was
realized on an annualized basis beginning in the third quarter of the year
as a result of aggressive cost cutting and efficiency improvement
strategies.
o Loan loss provision expense fell $625,000 or 8.1% from 2000's level. The
full year loan loss provision covered total actual net charge-offs by 1.08
times. Net charge-offs as a percent of average loans remained flat in 2001
at .42%. The lower level of provision was in part due to the 2000 level
being elevated by two isolated and unusual commercial loan charge-offs.
Nonperforming loans increased during 2001 to .53% of loans outstanding at
year end compared to .49% one year earlier, reflective of the weak economy.
o The company's combined effective federal and state tax rate decreased one
percentage point this year to 29.0% as a result of an increased proportion
of tax-exempt municipal investment holdings and continued effective tax
planning strategies.
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:
At December 31
------------------------
2001 2000 1999
------------------------
Percentage of net income to average total assets 0.66% 0.97% 1.00%
Percentage of net income-operating to average total assets 0.83% 0.98% 1.00%
Percentage of net income to average shareholders' equity 7.99% 14.27% 13.56%
Percentage of net income-operating to average shareholders' equity 10.05% 14.40% 13.56%
Percentage of dividends declared per common share to net income per share 65.7% 40.6% 40.4%
Percentage of dividends declared per common share to net income-operating per share 52.3% 40.2% 40.4%
Percentage of average shareholders' equity to average total assets 8.29% 6.83% 7.41%
Net Interest Income
Net interest income 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, interest on capital market borrowings, and dividends
paid on the company's 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.
Net interest income (with non-taxable income converted to a full tax-equivalent
basis) totaled $104.0 million in 2001; this represents a $7.1 million or 7.4%
increase over the prior year. The increase was due to higher earning asset
volumes, which had a positive impact on net interest income of $9.4 million,
while interest rate changes had an offsetting impact of $2.3 million.
Gross interest income on loans and investments grew by $9.2 million or 4.7% in
2001 as a result of greater average earning assets of $236.8 million, which
contributed $18.8 million, partially offset by $9.6 million related to lower
rates. Average loans grew a total of $95.9 million in 2001, with the most
significant portions occurring as a result of the January acquisition of $59
million in loans from Citizens National Bank of Malone and the November
acquisition of $177 million associated with the FleetBoston branches. Overall
interest and fees on loans climbed $1.3 million or 1.0% as a result of this
growth, partially offset by a 46 basis point (BP) decrease in loan yields to
8.39%, which was caused by falling capital market rates.
16
Despite a falling rate environment, the 2001 steepening yield curve allowed for
widening spreads over cost of funds on investment transactions. This situation
created favorable opportunities to expand the company's investment portfolio,
which increased $147 million on average (excluding Federal Funds sold) during
the year. Two primary components of this expansion were a $140 million
securities strategy made possible by First Liberty's ample capital position and
additional purchases of $120 million from the excess cash provided by
FleetBoston branch acquisition. Investment interest income in 2001 was $7.9
million or 12.4% higher than the prior year as a result of the higher
outstandings, partially offset by a decrease in the average investment yield
from 7.18% to 6.96%. The large volume of growth in 2001 being put on at
declining market rates was the primary cause of the change in average investment
yield.
The average earning asset yield fell 39 basis points to 7.83% in 2001 because of
the aforementioned decrease in investment and loan yields and a reduced mix of
loans to earning assets, which decreased on average from 62.3% in 2000 to 60.3%
in 2001. This decline in loan mix is a consequence of favorable investment
opportunities outlined above as well as a slight reduction in loans outstanding
excluding the Citizens and FleetBoston branch acquisitions.
Total average fundings (deposits and borrowings) grew by $243.0 million in 2001,
largely attributable to a $209 million increase in deposits related primarily to
acquisitions and $12.7 million more in capital market borrowings. In addition to
capital market borrowing largely from the Federal Home loan Bank of New York,
the bank has approximately $78 million in trust preferred borrowings
outstanding, $50 million of which are floating rate offerings completed in July
to help finance the FleetBoston branch purchase.
Total interest expense increased by $2.1 million in 2001. Higher average
interest-bearing funds contributed $9.4 million in additional interest expense,
with lower market rates offsetting this by $7.3 million. Interest expense as a
percentage of earning assets, fell by 30 basis points (BPs) to 3.86%. The rate
on interest bearing deposits fell 23 BPs to 4.10% due largely to steady declines
in deposit rates throughout 2001. The borrowing rate on capital market
borrowings declined 83 BPs because of lower market rates and a higher mix of
short-term funding taken on in advance of the FleetBoston branch acquisition.
CBSI's net interest margin decreased by 9 basis points from 4.06% in 2000 to
3.97% this year as the 23 BP decrease in the rate on average interest bearing
deposits from 2000 to 2001, in addition to the 83 BP decrease in the average
borrowed funds rate, were not enough to offset the 39 BP drop in the earning
asset yield. By the third quarter of the year, however, margins turned up after
steadily falling since third quarter 2000, as downward repricing of the
company's certificates of deposits continued while the decrease in earning asset
yield moderated. The company's net interest margin ranked in the favorable 53rd
peer bank percentile through September 30, 2001.
17
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon for the twelve month periods ended December 31, 2001, 2000 and
1999. 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.
Year Ended December 31,
-------------------------------------------------------------------------------------
2001 2000 1999
-------------------------------------------------------------------------------------
(000's omitted except yields Avg. Amt. of Avg. Avg. Amt. of Avg. Avg. Amt. of Avg.
and rates) Balance Interest Yield/ Balance Interest Yield/ Balance Interest Yield/
Rate Rate Rate
Paid Paid Paid
-------------------------------------------------------------------------------------
ASSETS:
Interest-earning assets:
Federal funds sold $4,568 $171 3.74% $7,728 $452 5.85% $2,198 $106 4.82%
Time deposits in other banks 306 379 N/A 3,147 183 5.82% 9,888 444 4.49%
Taxable investment securities 820,705 56,165 6.84% 732,490 52,026 7.10% 674,028 43,683 6.48%
Nontaxable investment 215,567 15,759 7.31% 156,885 11,957 7.62% 140,594 10,496 7.47%
securities
Loans (net of unearned 1,580,870 132,706 8.39% 1,484,945 131,373 8.85% 1,343,652 117,431 8.74%
discount) ------------------- ------------------- -------------------
Total interest-earning 2,622,016 205,180 7.83% 2,385,195 195,991 8.22% 2,170,360 172,160 7.93%
assets
Noninterest earning assets 264,496 171,443 185,725
---------- ---------- ----------
Total $2,886,512 $2,556,638 $2,356,085
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities
Savings deposits $683,088 $12,783 1.87% $622,164 $13,784 2.22% $654,794 $14,250 2.18%
Time deposits 1,100,850 60,380 5.48% 991,754 56,137 5.66% 933,687 47,652 5.10%
Short-term borrowings 141,772 6,738 4.75% 258,985 16,859 6.51% 125,433 6,584 5.25%
Long-term borrowings 339,205 21,294 6.28% 188,120 12,361 6.57% 155,373 10,004 6.44%
------------------- ------------------- -------------------
Total interest-bearing 2,264,915 101,195 4.47% 2,061,023 99,141 4.81% 1,869,287 78,490 4.20%
Liabilities
Noninterest-bearing liabilities
Demand deposits 343,173 304,107 289,749
Other liabilities 39,056 17,010 22,570
Shareholders' equity 239,368 174,498 174,479
---------- ---------- ----------
Total $2,886,512 $2,556,638 $2,356,085
========== ========== ==========
Net interest earnings $103,985 $96,850 $93,670
======== ======= =======
Net yield on interest-earning assets 3.97% 4.06% 4.32%
Federal tax exemption on nontaxable $7,330 $6,417 $5,670
investment securitie included in
interest income
18
As discussed above, the change in 2001 net interest income (full tax-equivalent
basis) may be analyzed by segregating the volume and rate components of the
changes in interest income and interest expense for each underlying category.
------------------------------------------------------------------
2001 Compared to 2000 2000 Compared to 1999
------------------------------------------------------------------
Increase(Decrease) Due to Increase(Decrease) Due to
Change in (1) Change in (1)
Net Net
Volume Rate Change Volume Rate Change
------ ---- ------ ------ ---- ------
Interest earned on:
Federal funds sold ($149) ($132) ($281) $319 $27 $346
Time deposits in other banks (308) 504 196 (365) 104 (261)
Taxable investment securities 6,090 (1,951) 4,139 3,961 4,382 8,343
Nontaxable investment securities 4,308 (506) 3,802 1,238 223 1,461
Loans(net of unearned discounts) 8,244 (6,911) 1,333 9,293 4,649 13,942
Total interest-earning assets(2) $18,833 ($9,644) $9,189 $17,490 $6,341 $23,831
Interest paid on:
Savings deposits $1,269 ($2,270) ($1,001) ($720) $254 ($466)
Time deposits 6,026 (1,783) 4,243 3,081 5,404 8,485
Short-term borrowings (6,340) (3,781) (10,121) 8,384 1,891 10,275
Long-term borrowings 9,508 (575) 8,933 2,148 209 2,357
Total interest-bearing liabilities(2) $9,402 ($7,348) $2,054 $8,535 $12,116 $20,651
Net interest earnings(2) $9,435 ($2,300) $7,135 $8,929 ($5,749) $3,180
(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.
19
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, 2001 and 2000.
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 Quarter Ended December 31,
---------------------------------------------------------
2001 2000
---------------------------------------------------------
(000's omitted except yields Avg. Amt. of Avg. Avg. Amt. of Avg.
and rates) Balance Interest Yield/ Balance Interest Yield/
Rate Rate
Paid Paid
---------------------------------------------------------
ASSETS:
Interest-earning assets:
Federal funds sold $0 $0 0.00% $241 $4 6.60%
Time deposits in other banks 227 (10) -17.48% 470 14 11.85%
Taxable investment securities 820,771 13,880 6.71% 766,415 13,630 7.07%
Nontaxable investment securities 245,359 4,584 7.41% 162,609 2,970 7.27%
Loans (net of unearned discount) 1,646,921 32,779 7.90% 1,521,593 34,314 8.97%
------------------- -------------------
Total interest-earning 2,713,278 51,233 7.49% 2,451,328 50,932 8.27%
assets
Noninterest earning assets
Cash and due from banks 99,394 71,426
Premises and equipment 47,827 40,914
Other assets 154,603 91,987
Less: allowance for loans (21,669) (20,088)
Net unrealized gains (losses) on
available-for-sale portfolio 37,584 (13,016)
---------- ----------
Total $3,031,017 $2,622,551
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities
Savings deposits $797,399 $3,086 1.54% $617,555 $3,502 2.26%
Time deposits 1,113,653 13,472 4.80% 1,019,658 15,427 6.02%
Short-term borrowings 83,786 581 2.75% 250,395 4,227 6.72%
Long-term borrowings 335,174 5,403 6.40% 216,222 3,523 6.48%
------------------- -------------------
Total interest-bearing 2,330,012 22,542 3.84% 2,103,830 26,679 5.05%
Liabilities
Noninterest-bearing liabilities
Demand deposits 388,512 312,466
Other liabilities 76,706 20,336
Shareholders' equity 265,787 185,919
---------- ----------
Total $3,031,017 $2,622,551
========== ==========
Net interest earnings $28,691 $24,253
======= =======
Net yield on interest-earning assets 4.20% 3.94%
Federal tax exemption on nontaxable
investment securities included in
interest income $2,065 $1,601
20
The changes in net interest income (full tax-equivalent basis) by volume and
rate component for fourth quarter 2001 versus fourth quarter 2000 are shown
below for each major category of interest-earning assets and interest-bearing
liabilities.
---------------------------------------------
4th Quarter 2001 Compared to 4th Quarter 2000
---------------------------------------------
Increase(Decrease) Due to Change in (1)
Net
Volume Rate Change
------ ---- ------
Interest earned on:
Federal funds sold ($2) ($2) ($4)
Time deposits in other banks (4) (20) (24)
Taxable investment securities 3,387 (3,137) 250
Nontaxable investment securities 1,614 0 1,614
Loans (net of unearned discounts) 12,702 (14,237) (1,535)
Total interest-earning assets(2) $20,390 ($20,089) $301
Interest paid on:
Savings deposits (416) (0) (416)
Time deposits 7,166 (9,121) (1,955)
Short-term borrowings (1,932) (1,714) (3,646)
Long-term borrowings 2,201 (321) 1,880
Total interest-bearing liabilities(2) $14,529 ($18,666) ($4,137)
Net interest earnings(2) $2,746 $1,692 $4,438
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute dollar
amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
Noninterest Income
The company's sources of noninterest income are of three primary types: general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network; financial services, comprised of
personal trust, employee benefit trust, investment, and insurance products; and
periodic transactions, most often net gains (losses) from the sale of
investments or other occasional events.
Total noninterest income in 2001 increased by 25.8% to $29.1 million, largely
due to gains on the sale of investments, increased revenues from the company's
Benefits Plans Administrative Services subsidiary (BPA), and increased overdraft
fees. Combined revenues, excluding transactions related to investment securities
and disposal of branch properties, were up strongly for the seventh consecutive
year to approximately $26.5 million in 2001, a $3.3 million or 14.0% improvement
over 2000. Noninterest income, excluding transactions related to investment
securities and disposal of branch properties, as a percent of operating income
was 20.3% in 2001, an increase of one percentage point from the prior year.
The largest segment of the company's recurring noninterest income is the wide
variety of fees earned from general banking services, which reached $13.8
million in 2001, up 11.8% from the prior year. This segment contributed 52% of
noninterest income, excluding net investment securities gains (losses) and
disposal of branch properties. Highlighting this increase was a large rise in
service charges on deposit accounts and overdraft fees, which increased by $1.8
million, a 24% growth rate over $7.6 million in 2000. This reflects the
company's 2001 acquisitions, including a fee schedule
21
increase in the First Liberty market. Offsetting this increase was a decline of
$387,000 in revenue from electronic banking products due to a change in the
company's VISATM affiliation.
Mortgage banking fees were up strongly at $653,000 in 2001, an increase from
$340,000 in the prior year. The primary reason for the increase was the sharp
rise in loans sold on the secondary market to $43.6 million from $9.5 million in
2000, as driven by a decline in capital market rates. This change is reflected
in an increase in mortgage servicing rights from $526,201 in 2000 to $567,013
this year. Loan servicing fees (a component of mortgage banking income) were
$312,000 in 2001, up 30.5% from the previous year on a serviced loan portfolio
of approximately $120 million, consisting of 2,007 loans.
Fees from the financial services segment of noninterest income rose $1.8 million
or 16.9% in 2001 to $12.7 million. As a whole, financial services now comprise
48% of total noninterest income, excluding net investment securities gains
(losses). Strength in revenue from record keeping and consulting services
provided by EBT/BPA (our pension administration business working in concert with
the bank's employee benefit trust service), offset a reduction in personal trust
revenues, that was caused by lower estate fees (which periodically fluctuate)
and transfer of mutual fund sales commissions now being earned through the
company's broker-dealer, Community Investment Services, Inc. (CISI). Growth in
CISI revenues was consistent with an expanded force of financial consultants,
which numbered 20 at year end, including four in the recently acquired (and
formerly underserved) First Liberty franchise. The rise in revenues at
investment manager Elias Asset Management reflects the full year impact of the
firm, which was acquired in second quarter 2000. Lastly, commissions from
insurance products increased slightly due to greater sales by financial
consultants and a higher dividend from the underwriter of CBSI's creditor life
insurance products.
Assets under management from the company's several financial services businesses
dipped slightly to $1.39 billion in 2001 compared to $1.42 billion in the prior
year, largely reflective of reduced equity market levels. Overall, financial
services contributed $2.8 million or 9.3% of the company's pretax net income
this year (before allocation of indirect corporate expense), reflecting nearly a
22% return on revenue. In 2000, the net income contribution was $2.9 million or
8.3%, with a return on revenue of almost 27%. The decrease in earnings and
return on revenue was caused by front-end recruiting payments to new financial
consultants and reduced fees on products tied to equity assets under management.
Lastly, income from periodic transactions in 2001 largely includes $2.5 million
in gains taken on $118.7 million in investment sales, with the net proceeds used
to pre-pay $95.0 million in high-cost FHLB borrowings at a $2.7 million premium.
This amount compares to losses of $159,000 last year. The investment gains and
losses taken over the last two years are illustrative of the company's active
management of its investment portfolio to achieve a desirable total return and a
targeted level of combined interest income and securities gains (losses) across
financial market cycles.
22
The following table sets forth selected information by category of noninterest
income for the company for the years and quarters indicated.
- -----------------------------------------------------------------------------------------------------
(000's omitted) Years ended December 31, Quarters ended
December 31,
- -----------------------------------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Personal trust $ 1,821 $ 2,120 $ 1,956 $ 413 $ 591
EBT/BPA 3,927 2,992 2,586 1,130 777
Elias Asset Management 3,713 3,091 0 815 1,052
Insurance 1,043 845 730 115 92
Other investment products 2,164 1,788 1,268 523 468
- -----------------------------------------------------------------------------------------------------
Total financial services 12,668 10,836 6,540 2,996 2,980
Electronic banking 1,469 1,857 1,585 416 461
Mortgage banking 653 340 453 290 88
Commercial leasing 34 41 59 1 9
Deposit service charges 4,183 4,036 4,056 1,121 1,016
Overdraft fees 5,183 3,827 3,197 1,542 971
Commissions 2,259 2,231 2,206 461 557
- -----------------------------------------------------------------------------------------------------
General banking services 13,781 12,332 11,556 3,831 3,102
Miscellaneous revenue 13 35 57 9 4
- -----------------------------------------------------------------------------------------------------
Total noninterest income excluding
investment security gain (loss), net 26,462 23,203 18,153 6,836 6,086
Investment security gain (loss), net 2,546 (159) (413) (13) 0
Disposition of branch properties 75 81 0 75 81
- -----------------------------------------------------------------------------------------------------
Total noninterest income $ 29,083 $ 23,125 $ 17,740 $ 6,898 $ 6,167
=====================================================================================================
Non-interest income as a percentage of
operating Income (excludes investment
security gain (loss), net and disposal of
branch properties) 20.3% 19.3% 16.2% 19.2% 20.1%
Noninterest Expense
Noninterest expense or overhead rose $18.1 million or 25.5% in 2001. Excluding
acquisition expenses related to Citizens National Bank of Malone (CNB), First
Liberty (FLIB), and FleetBoston branches, noninterest expense was up $10.0
million or 14.1% in 2001. This year's overhead of $89.0 million as a percent of
average assets was 3.08%, up from 2.77% in 2000. Excluding amortization of
intangible assets, which is a significant non-cash expense for the company and
virtually non-existent for its peer group, CBSI's noninterest expense ratio was
2.85% in 2001 compared to 2.98% for peers.
For CBSI as a whole, higher personnel expense accounted for 32% of 2001's
increase in overhead, with personnel costs up 15.7% as a result of the three
acquisitions. The remainder of the increases in salary, benefit, and payroll tax
expense reflect modest annual merit awards for employees. Total full-time
equivalent staff at year-end 2001 was 1,115 versus 927 at year-end 2000, up as
the result of the 2001 acquisitions and their related impact on selected back
office and administrative staffing.
Nonpersonnel expense rose $12.3 million or 36.0% in 2001. Excluding
acquisition-related expenses, nonpersonnel expense rose $5.7 million or 16.6% in
2001. This was largely caused by increases in intangible amortization, up $1.8
million or 36.5%; occupancy expense, up $1.0 million or 20.4%; equipment
expense, up $851,000 or 16.3%; and data processing, up $729,000 or 13.7%. The
increase in intangible amortization was due to the Citizens and FleetBoston
acquisitions and a full year of the Elias Asset Management acquisition.
Occupancy expenses increased largely due to the impact of the Citizens branches
acquired in January and the Fleet branches acquired in November of 2001. Higher
equipment expenses were related to higher service contract costs and
depreciation expense due to the additional number of branches in 2001. Increases
in data processing relates to higher Fiserv processing fees, data line charges
and check processing expenses.
23
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 additionally excludes one-time expense
and intangible amortization (a non-cash expense) as well as all one-time
noninterest income; over the last five years, these one-time income items have
related to the disposal of branch properties. The lower the ratio, the more
efficient a bank is considered to be.
In 2001, the recurring efficiency ratio increased 2.3 percentage points to
56.9%. Management believes it is more meaningful to use the recurring ratio to
compare to national norms, because as mentioned above, most of the company's
peers do not have intangible expense to the significance that CBSI has. On that
basis, CBSI's ratio is more favorable than the peer bank ratio of 62.8% based on
data available as of September 30, 2001. These results only partially reflect
the full year impact of the $3.2 million in annual cost savings implemented in
mid second quarter 2001 in the First Liberty market, including the associated
benefit of streamlining our operations functions by eliminating duplicate loan
and deposit processing units in Canton and Olean, NY. However, because of the
surge in volumes being processed as a result of the former FleetBoston branches,
fourth quarter 2001 part-time and overtime costs were some $105,000 higher than
in the same period a year earlier, representing a .3% lag in lowering the
efficiency ratio. As experience in handling this additional work is gained,
improvement in the efficiency ratio is expected.
By the nature of the company's financial services businesses, the efficiency
ratio of those activities was 75.3% in 2001 compared to 71.4% in the prior year.
The efficiency ratio of the company's banking activities was 54.9% this year
compared to 52.9% in 2000. As discussed above, the efficiency ratio is expected
to improve for both businesses in 2002.
Acquisition and unusual expenses, which are excluded from the recurring
efficiency ratio calculation, totaled $8.2 million in 2001. The largest items
comprising the 2001 expenditures include $1.5 million in severance expense for
First Liberty; $3.2 million in professional and consulting fees; $1.3 million in
postage, printing, and check replacement costs; $1.3 million in data processing
conversion costs and obsolete software write-offs; and $.9 million in a wide
variety of other nonrecurring expenses.
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, 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.
24
The following table sets forth information by category of noninterest expense of
the company for the years and quarters indicated.
- ----------------------------------------------------------------------------------
(000's omitted) Years ended December 31, Quarters ended
December 31,
- ----------------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Personnel expense $41,045 $36,743 $33,693 $10,724 $ 9,394
Net occupancy expense 6,122 5,084 4,871 1,568 1,316
Equipment expense 6,075 5,224 4,932 1,659 1,326
Legal and professional fees 2,304 2,336 2,426 680 572
Data processing expense 4,436 4,526 4,125 1,161 1,109
Amortization of intangibles 6,679 4,891 4,723 2,137 1,281
Stationary and supplies 1,995 1,711 1,802 591 447
Deposit insurance premiums 346 278 183 92 69
Acquisition and unusual expenses 8,164 400 0 2,046 398
Other 11,873 9,741 10,023 3,290 2,577
- ----------------------------------------------------------------------------------
Total noninterest expense $89,039 $70,934 $66,778 $23,948 $18,489
==================================================================================
Total operating expenses as
a percentage of average assets 3.08% 2.77% 2.83% 3.13% 2.80%
Efficiency ratio (1) 56.9% 54.6% 55.5% 55.6% 55.4%
(1) Noninterest expense excluding nonrecurring items and amortization of deposit
intangibles divided by operating income excluding all nonrecurring items.
Income and Income Taxes
Income before taxes and extraordinary item in 2001 was $29.6 million, down 15.2%
over the prior year's amount. When income is recast as if all tax-exempt
revenues were fully taxable on a federal basis, 2001's results fell by $4.4
million or 10.6% to $36.9 million before tax.
The main reasons for the decline in pretax earnings were the $8.2 million in
acquisition and unusual expenses, partially offset by $2.5 million in net
investment security gains associated with the company's three 2001 acquisitions
in January, May, and November. Favorable increases in net interest income, up
$7.1 million or 7.4% (full tax-equivalent basis) related to strong earning asset
growth (up 9.9% or $236.8 million on average), and a $3.3 million or 14.0% climb
in noninterest income, excluding net securities gains (losses), helped partially
offset a portion of the acquisition related expenses.
The company's combined effective federal and state tax rate decreased one
percentage point this year to 29.0%. The decrease resulted from effective tax
planning, principally because of increased purchases of tax-exempt municipal
investments and other earning asset strategies during the year.
Capital
Shareholders' equity ended 2001 at $268 million, up 33% from one year earlier.
This improvement reflects earnings for the year, the positive change in market
value adjustment (MVA) of the bank's available-for-sale investments, an
additional 952,000 in common shares issued in conjunction with the company's
January whole bank purchase of Citizens National Bank of Malone, and 1.3 million
shares issued in the fourth quarter of 2001 to support the mid-November purchase
of 36 branches from FleetBoston Financial, offset by dividends paid to
shareholders. Excluding the MVA in both 2000 and 2001, capital rose by $61.8
million or 31.6%. Shares outstanding grew by 2.3 million during the year due to
the aforementioned issuance of stock and the exercise of stock options.
25
The company's 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," increased slightly from one year ago to 6.73%.
This reflects the combined impact of the additional shares of common stock and
approximately $50 million in floating rate trust preferred stock raised to
support the FleetBoston branch acquisition, which more than offset greater
intangibles resulting from acquisitions. The total capital to risk-weighted
assets ratio increased 106 BPs during 2001 to 12.76% as of year-end compared to
the 10% minimum requirement for "well-capitalized" banks. The tangible
equity/tangible assets ratio ended the year at 4.09% versus 5.65% at December
31, 2000. The company is confident that capital levels are being prudently
balanced between regulatory and investor perspectives.
Cash dividends declared on common stock in 2001 of $12.6 million represented an
increase of 24.3% over the prior year. This growth largely reflects the
aforementioned increase in the number of shares. The quarterly dividend per
share at $.27 remained unchanged from the level established in third quarter
2000.
CBSI's dividend payout ratio for the year was 65.7% compared to 40.6% in 2000,
temporarily 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, and for 2001, the ratio was in the 95th peer percentile. The large
increase in the payout ratio reflects maintenance of the dividend despite the
23.2% decrease in net income from the prior year, which was largely due to
one-time acquisition expense.
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:
- ---------------------------------------------------------------------------------------------------------
As of December 31,
(000's omitted) 2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------
Real estate mortgages:
Residential $ 712,550 $ 579,562 $ 543,195 $ 453,307 $ 451,633
Commercial loans secured by real
estate 272,157 243,429 225,822 200,435 165,813
Farm 20,851 20,472 18,324 13,205 11,195
- ---------------------------------------------------------------------------------------------------------
Total 1,005,558 843,463 787,341 666,947 628,641
Commercial, financial, and agricultural:
Agricultural 25,191 26,523 27,758 22,737 23,999
Commercial and financial 274,734 237,462 219,600 227,932 188,680
- ---------------------------------------------------------------------------------------------------------
Total 299,925 263,985 247,358 250,669 212,679
Installment loans to individuals 399,368 395,226 390,450 365,141 348,823
Other loans 28,237 14,205 2,043 12,626 16,608
- ---------------------------------------------------------------------------------------------------------
Gross loans 1,733,088 1,516,879 1,427,192 1,295,383 1,206,751
Less: Unearned discount 218 1,002 1,419 2,248 2,945
- ---------------------------------------------------------------------------------------------------------
Net loans 1,732,870 1,515,877 1,425,773 1,293,135 1,203,806
Reserve for loan losses 23,901 20,035 18,528 17,059 16,996
- ---------------------------------------------------------------------------------------------------------
Loans, net of reserve for loan losses $1,708,969 $1,495,842 $1,407,245 $1,276,076 $1,186,810
=========================================================================================================
Loans outstanding, net of unearned discount, reached a record $1.733 billion as
of year-end 2001, up over $217 million or 14.3% compared to twelve months
earlier. About $173 million or 80% of 2001's growth came from 36 branches
acquired in mid-November from FleetBoston Financial, while $53 million came from
the company's whole bank purchase of Citizens National Bank of Malone in January
(both loan figures reflecting slight run-off since acquisition date.)
Excluding the 2001 acquisitions, total loans declined by $9 million or .6 %.
CBNA's New York franchise grew $29 million or 2.6% during the year to $1.128
million. In contrast, the Pennsylvania franchise decreased by $19 million or
4.8% to $379 million at year end. None of these figures include $43.6 million in
mortgages originated within our local markets and sold in the secondary market
to FNMA. Had these loans not been sold, loan growth excluding acquisitions would
have been $35 million or 2.3%.
26
The company's predominant focus on the retail borrower enables its loan
portfolio to be highly diversified. Approximately 63% of loans outstanding are
oriented to consumers borrowing on an installment and residential mortgage loan
basis. Over the last several years, the growth rate of CBSI's commercial
business loans has exceeded that of loans to individuals, and even within this
sector there is a high degree of diversification. The bank's business loans are
typically for amounts under $100,000, accounting for 85% of our customers but
only 25% of our commercial loans outstanding. About 30% of our commercial
portfolio is comprised of loans between $250,000 and $1 million (about 5% of our
customers), while loans over $1 million comprise another 30% of the portfolio
(1.1% of our customers). The portfolio contains no credit card receivables.
The "Nature of Lending" table below recasts the company's loan portfolio into
four major lines of business. The increase in consumer direct loans contributed
60% of the $217 million in total loan growth in 2001 and business lending
accounted for 31%. A smaller 12% share of this year's total loan increase came
from consumer mortgages while consumer indirect loans declined slightly. The
following more fully discusses the underlying reasons for changes in each of the
company's four major lending activities or lines of business.
Nature of Lending
Mix at Year End
($ million and %)
-----------------------------------------------------
2001 Mix 2000 Mix
-----------------------------------------------------
Consumer Mortgage $ 444 25.6% $ 417 27.5%
Business Lending 644 37.2% 577 38.1%
Consumer Indirect 248 14.3% 256 16.9%
Consumer Direct 397 22.9% 266 17.5%
-----------------------------------------------------
Total Loans $1,733 100.0% $1,516 100.0%
=====================================================
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 $644 million, this segment represents
37% of loans outstanding at year-end. Outstandings climbed over $67 million or
12% in 2001 and largely resulted from $44 million in loans acquired from
FleetBoston Financial, $17 million in loans (reduced by run-off since
acquisition date) acquired from Citizens National Bank of Malone, and $28
million in growth from the New York market areas. Despite the softening economy,
the bank was able to slightly grow business lending excluding acquired loans due
to persistent business development efforts and the strength of its existing
customer base. Turnover in staff in the First Liberty market and run-off of
several large transactions due to refinancing with institutional lenders
resulted in a $23 million decrease in Pennsylvania-based loans.
CBNA's total commercial portfolio is broadly diversified by industry type with
the largest shares being in commercial real estate (16%), services (13%), and
health care (11%); followed by auto dealers and agriculture (8% each),
hotel/eating/drinking, manufacturing, and retail trade (7% each); and
construction and transportation (6% each). Miscellaneous industries make up the
balance at 11%.
Demand for installment debt indirectly originated through automobile, marine,
and mobile home dealers fell modestly in 2001. Outstandings ended the year 3% or
$8 million lower, primarily resulting from reduced demand in certain of our
market places and less new car financing due to significant discounting offered
by the major manufacturers. This portfolio segment, of which 91% relates to
automobile lending (75% of the vehicles are used versus 25% new), constitutes
14% of total loans outstanding. Indirect loans in the company's First Liberty
franchise increased $6.6 million (up 23%), in contrast to a $15.8 million
decrease (down 6.9%) in the New York markets excluding acquisitions. About $1.5
million in indirect loans was obtained via acquisition in 2001.
The segment of the company's loan portfolio committed to consumer mortgages is
predominantly fixed (95%) versus adjustable rate (5%) residential lending. It
accounts for $444 million or 26% of total loans outstanding. Growth during the
year of $27 million or 6.4% in 2001 resulted from $28 million in loans
(including subsequent growth) acquired from Citizens National Bank of Malone and
nearly $13 million generated in the New York franchise, less $14 million in
run-off in Pennsylvania. Growth in the core mortgage portfolio (prior to
acquisitions) is lower than it could have been had it not been for a program
that began in mid-1994 to sell selected fixed rate originations in the secondary
market. The purpose of this program, with sales of $43.6 million in 2001 and
$9.5 million in 2000, is to develop a meaningful source of mortgage banking
income (which reached $653,000 in 2001) as well as to provide an additional tool
to manage interest rate risk.
27
The direct consumer lending activity increased 49% or $131 million in 2001 to
$397 million. Acquired loans in this segment included $7 million from Citizens
National Bank of Malone and $133 million from Fleet Boston (nearly all of which
were home equity financing). The weak economy enabled a relatively small $6
million increase in the core New York markets, while the First Liberty market
was more adversely affected (down $15 million), which management considers a
consequence of the Pennsylvania bank going through its change of ownership
during 2001. 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 was 23%, compared to 18% in
2001.
The following table reconciles the differences between the line of business loan
breakdown reflected above as compared to regulatory reporting definitions
reflected on the Call Report and the table at the beginning of this section.
Line of Business as of December 31, 2001
- -----------------------------------------------------------------------------------------------------
(000's omitted) Consumer Consumer Consumer Business Total
Direct Indirect Mortgages Lending Loans
- -----------------------------------------------------------------------------------------------------
Regulatory Reporting
Categories
Loans secured by real estate
Residential $234,863 $440,826 $36,861 $712,550
Commercial 56 2,838 269,263 272,157
Farm 34 20,817 20,851
Agricultural loans 514 24,677 25,191
Commercial loans 10,002 264,732 274,734
Installment loans to
individuals 144,383 $248,592 103 6,290 399,368
Other loans 7,042 21,195 28,237
- -----------------------------------------------------------------------------------------------------
Total loans 396,894 248,592 443,767 643,835 1,733,088
Unearned discount (218) (218)
- -----------------------------------------------------------------------------------------------------
Net loans $396,676 $248,592 $443,767 $643,835 $1,732,870
=====================================================================================================
Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table shows the amount of loans outstanding as of December 31,
2001, which, based on remaining scheduled payments of principal, are due in the
periods indicated:
At December 31, 2001
- -------------------------------------------------------------------------------------------
Maturing in Maturing After Maturing
One Year or One But Within After Five Total Book
(000's omitted) Less Five Years Years Value
- -------------------------------------------------------------------------------------------
Commercial, financial, and agricultur $ 129,060 $ 77,427 $ 93,438 $ 299,925
Real estate - mortgage 25,529 113,439 866,590 1,005,558
Installment 28,370 243,936 155,081 427,387
- -------------------------------------------------------------------------------------------
TOTAL $ 182,959 $ 434,802 $1,115,109 $1,732,870
===========================================================================================
The following table sets forth the sensitivity of the loan amounts to changes in
interest rates.
At December 31, 2001
- ---------------------------------------------------------------------------
000's omitted) Fixed Rate Variable Rate Total
- ---------------------------------------------------------------------------
Due in one year or less $99,382 $83,577 $182,959
Due after one year but within five
years 74,222 360,580 434,802
Due after five years 614,997 500,112 1,115,109
- ---------------------------------------------------------------------------
TOTAL $788,601 $944,269 $1,732,870
===========================================================================
28
Nonperforming Assets/Risk Elements
The following table presents information concerning the aggregate amount of
nonperforming assets:
As of December 31,
- ----------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
(000's omitted)
Loans accounted for on a nonaccrual basis $ 7,186 $ 5,473 $ 6,112 $ 4,213 $ 2,992
Accruing loans which are contractually past due 90
days or more as to principal or interest
payments 1,914 1,930 1,201 1,958 3,078
- ----------------------------------------------------------------------------------------------------------
Total nonperforming loans 9,100 7,403 7,313 6,171 6,070
Loans which are "troubled debt restructurings" as
defined in FASB No. 15 "Accounting by Debtors
and Creditors for Troubled Debt Restructurings" 75 116 122 134 0
Other real estate 1,427 1,293 1,442 1,661 1,834
- ----------------------------------------------------------------------------------------------------------
Total nonperforming assets $10,602 $ 8,812 $ 8,877 $ 7,966 $ 7,904
==========================================================================================================
Ratio of allowance for loan losses to period-end
loans 1.38% 1.32% 1.30% 1.32% 1.41%
Ratio of allowance for loan losses to
period-end nonperforming loans 262.6% 270.6% 253.4% 276.4% 280.0%
Ratio of allowance for loan losses to
period-end nonperforming assets 225.4% 227.4% 208.7% 214.1% 215.0%
Ratio of nonperforming loans to period-end loans .53% .49% .51% .48% .50%
Ratio of nonperforming assets to period-end
total loans and other real estate 0.61% 0.58% 0.62% 0.62% 0.66%
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 2001 at $9.1 million. This level is approximately $1.7
million or 23% higher than one year earlier, primarily due to increases in
commercial and residential mortgage loan nonaccruals. The ratio of nonperforming
loans to total loans rose a modest 4 basis points from twelve months earlier to
.53%. As of September 30, 2001, when the nonperforming loan ratio stood at .54%,
the company's asset quality was better than the peer level of .79%. The ratio of
nonperforming assets (which additionally include troubled debt restructuring and
other real estate) to total loans plus OREO increased to .61%, up 3 basis points
from one year earlier.
Total delinquencies, defined as loans 30 days or more past due and nonaccruing,
finished the year at 1.93% as a percent of total loans outstanding compared to
1.84% in 2000. As of year-end 2001, total delinquencies for commercial loans,
installment loans, and real estate mortgages were 1.98%, 2.60%, and 1.32%,
respectively. These measures compare to delinquencies of peer bank holding
companies as of September 30, 2001 of 2.30%, 1.97%, and 1.43%, respectively. As
of September 30, 2001, the delinquency ratio was slightly higher than the norm
at 1.96% versus peers at 1.81%.
29
Commercial loan net charge-offs improved in 2001, totaling $2.0 million or .33%
of average commercial outstandings versus $3.1 million and .58% in 2000.
Consumer installment net charge-offs rose to $4.4 million and 1.03% of average
installment loans outstanding, up $1.4 million and 32 basis points,
respectively, from 2000's level. The increase by dollar amount was greater in
the indirect installment portfolio (loans originated largely through automobile
dealer show rooms) than the direct installment portfolio, though the increase in
the charge-off ratio for each component was approximately the same. Mortgage net
charge-offs were de minimus in both years. In total, net charge-offs for 2001
were higher by $369,000 or 6.0%, finishing the year at $6.6 million versus $6.2
million in 2000. As a percentage of average loans, net charge-offs were
unchanged from last year at .42%. Gross charge-offs rose 15.8% to $8.7 million,
or .55% of average loans outstanding versus .51% in 2000. This year's recoveries
increased sharply to $2.1 million, representing 28% of prior year gross
charge-offs compared to 21% in 2000. As of September 30, 2001, the bank's total
net charge-off ratio of .38% was in the 74th peer percentile based on the peer
norm of .26%.
Management continually evaluates loan loss reserve adequacy from a variety of
perspectives, including overall economic conditions, concentration of the loan
portfolio by industry and loan type, and individual customer condition. The loan
loss reserve was increased to $23.9 million versus $20.0 million in 2000,
including $3.4 million related to the $177 million in loans associated with the
acquired FleetBoston branches and the $59 million in loans associated with the
Citizens acquisition. Of this latter increment to the reserve, $787,000 related
to Citizens was offset by an increase to goodwill while the $2.565 million
related to FleetBoston was offset by an increase to other intangibles.
As a percent of total loans, the loss reserve ratio increased to 1.38% for
year-end 2001 versus 1.32% last year. As of September 30, 2001, the reserve
ratio at 1.35% was at the peer median and coverage of nonperforming loans at
247% was above the norm in the 62nd percentile. Management believes the year-end
coverage at 263% to be adequate in light of the probable losses in the company's
loan portfolio.
As a percentage of average loans, through September 30, 2001, the annualized
loan loss provision at .40% was slightly above the peer norm of .37%. The loss
provision ratio decreased from .52% in 2000 to .45% for all of this year. Due to
lower net charge-offs in 2001 and management's assessment of the probable losses
in the loan portfolio, loan loss provision expense decreased by $625,000 or 8.1%
in 2001. Loan loss provision expense covered net charge-offs by 108% this year
versus 124% in 2000.
30
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 loan losses arising from loans charged off, recoveries on loans
previously charged off, and additions to the allowance.
As of December 31,
- ---------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
(000's omitted)
Amount of loans outstanding at end of period $1,732,870 $1,515,877 $1,425,773 $1,293,135 $1,203,806
- ---------------------------------------------------------------------------------------------------------------
Daily average amount of loans (net of unearned
discount) $1,580,870 $1,484,945 $1,343,652 $1,257,059 $1,101,263
- ---------------------------------------------------------------------------------------------------------------
Balance of allowance for possible loan losses
at beginning of period $ 20,035 $ 18,528 $ 17,059 $ 16,996 $ 13,145
- ---------------------------------------------------------------------------------------------------------------
Loans charged off:
Commercial, financial, and agricultural 2,310 3,273 1,218 1,011 733
Real estate mortgage 290 246 272 280 846
Installment 6,062 3,961 4,474 5,583 4,177
- ---------------------------------------------------------------------------------------------------------------
TOTAL LOANS CHARGED OFF 8,662 7,480 5,964 6,874 5,756
Recoveries of loans previously charged off:
Commercial, financial, and agricultural 313 148 526 432 374
Real estate mortgage 56 103 30 32 36
Installment 1,709 1,014 1,021 810 569
- ---------------------------------------------------------------------------------------------------------------
TOTAL RECOVERIES 2,078 1,265 1,577 1,274 979
- ---------------------------------------------------------------------------------------------------------------
Net loans charged off 6,584 6,215 4,387 5,600 4,777
Additions to allowance charged to expense 7,097 7,722 5,856 5,663 5,080
Reserves on acquired loans (1) 3,353 0 0 0 3,548
- ---------------------------------------------------------------------------------------------------------------
Balance at end of period $ 23,901 $ 20,035 $ 18,528 $ 17,059 $ 16,996
===============================================================================================================
Ratio of net charge-offs to average loans
outstanding 0.42% 0.42% 0.33% 0.45% 0.43%
(1) This reserve addition is attributable to loans purchased from Key Bank and
Fleet Bank in 1997 and from Citizens National Bank of Malone and
FleetBoston Financial Corporation in 2001.
31
The allowance for loan losses has been allocated according to the amount deemed
to be reasonably necessary to provide for probable losses within the following
categories of loans as of December 31:
- ------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of of of of of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category Category Category Category Category
to to to to to
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
- ------------------------------------------------------------------------------------------------------------------------
(000's omitted, except percentages)
Commercial,
financial, and
agricultural $14,445 17.3% $ 7,386 17.4% $ 5,850 17.3% $ 7,441 19.3% $ 6,619 17.6%
Real estate -
mortgage 473 58.0% 1,635 55.6% 1,933 55.2% 1,751 51.5% 1,901 52.1%
Installment 8,912 24.7% 8,162 27.0% 7,474 27.5% 4,663 29.2% 4,703 30.3%
Unallocated 71 2,852 3,271 3,204 3,773
- ------------------------------------------------------------------------------------------------------------------------
Total $23,901 100.0% $20,035 100.0% $18,528 100.0% $17,059 100.0% $16,996 100.0%
========================================================================================================================
Funding Sources
Typical of most commercial banking institutions today is the need to rely on a
variety of funding sources to support the earning asset base as well as to
achieve targeted growth objectives. There are three primary sources of funding
that comprise CBSI's overall funding matrix, which considers maturity,
stability, and price: deposits of individuals, partnerships and corporations
(IPC deposits); collateralized municipal deposits; and capital market
borrowings.
Sources of Funds
Average 4th Quarter Balances
($ million and %)
2001 Mix 2000 Mix
---------------------------------------------------------
IPC deposits $2,130 78.3% $1,713 70.9%
Public funds 170 6.3% 236 9.8%
Capital borrowings 419 15.4% 467 19.3%
---------------------------------------------------------
Total funds sources $2,719 100.0% $2,416 100.0%
=========================================================
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
$2.130 billion, an increase of $417 million or 24.3% over the comparable 2000
period. This is largely due to the $88 million in deposits acquired from
Citizens National Bank of Malone in January 2001 and the $470 million in
deposits acquired from the 36 former FleetBoston branches in November 2001. IPC
deposits are frequently considered to be a bank's most attractive source of
funding because they are generally stable, do not need to be collateralized,
have a relatively low cost, and 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.
32
==============================================================================================================================
Deposit Mix
- ------------------------------------------------------------------------------------------------------------------------------
(000,000s omitted) 12/31/00 12/31/00 12/31/00 12/31/00 1/26/01 11/16/01 12/31/01 12/31/01
NYS PA CBSI Deposit Citizens FleetBoston CBSI Deposit
Franchise Franchise Consolidated Mix Acquisition Branch Acq. Consolidated Mix
- ------------------------------------------------------------------------------------------------------------------------------
Non-Interest Bearing Demand $ 258 $ 58 $ 316 16% $ 19 $ 76 $ 448 18%
Interest Bearing Demand 132 26 158 8% 10 82 259 10%
Savings 225 90 316 16% 23 32 378 15%
Money Market 112 18 130 7% 3 112 291 11%
Time Deposits 731 299 1,029 53% 33 169 1,170 46%
- ------------------------------------------------------------------------------------------------------------------------------
Total Deposits $1,458 $ 491 $1,949 100% $ 88 $ 470 $2,546 100%
==============================================================================================================================
Despite the 2001 acquisitions, the mix of CBSI's deposits changed only modestly.
The time deposit mix dropped from 53% at the end of 2000 to 46% at the end of
2001, in part due to a lower relative mix in both the Citizens and FleetBoston
acquisitions and due to a certain amount of movement out of time deposits by
core customers who no longer wanted a maturity-based product. The money market
mix increased from 7% to 11% due to the higher mix of money market accounts in
the FleetBoston branches and due to time deposit runoff flowing into this
category. No other deposit category mix changed by more than two percentage
points.
Deposits of local municipalities decreased $66 million or 28% during the past
year, with balances for fourth quarter 2001 averaging $170 million versus $236
million for the same 2000 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. Consequently, levels of
municipal deposits fluctuate depending on how competitive pricing compares to
the aforementioned borrowing rates. It should be noted that utilization of
municipal deposits has generally been flat to down over the last five years as a
percent of total funding sources.
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, Federal
Reserve Bank of New York, as well as access to the national repurchase agreement
market through established relationships with primary market security dealers.
Also considered as borrowings are the $30 million in fixed rate 9.75%
Company-Obligated Mandatorily Redeemable Preferred Securities (trust preferred)
issued to support 1997's acquisitions, approximately $50 million in floating
rate trust preferred raised to support the FleetBoston branch acquisition, and
advances under a $10 million line of credit tied to the 90 day libor rate with a
large regional commercial bank. Capital market borrowings averaged $419 million
or 15% of total funding sources for fourth quarter 2001, a decline from the
fourth quarter 2000 level of $467 million or 19% of total funding due to
short-term borrowings being replaced with acquired deposits. As of December 31,
2001, only 15% or $40 million of capital market borrowings (excluding the
aforementioned line of credit and trust preferred securities) had remaining
terms of one year or less.
During third quarter 2001, approximately $36 million in investments was sold,
resulting in $2.6 million in gains used to offset $2.7 million in penalties on
prepaying $95 million in longer-term advances from the Federal Home Loan Bank.
These borrowings were replaced by core deposits from the FleetBoston
acquisition. The swap allowed the bank to reduce the overall cost of the $95
million in funds from 5.38% to 2.86%.
33
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.
Years ended December 31,
- -------------------------------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
- -------------------------------------------------------------------------------------------------
(000's omitted, except rates)
Noninterest-bearing demand deposits $ 343,173 0.00% $ 304,107 0.00% $ 289,749 0.00%
Interest-bearing demand deposits 186,032 0.71% 162,065 0.91% 170,528 0.96%
Regular savings deposits 344,906 2.11% 331,987 2.37% 347,870 2.40%
Money market deposits 152,150 2.76% 128,112 3.38% 136,396 2.91%
Time deposits 1,100,850 5.48% 991,754 5.66% 933,687 5.10%
- -------------------------------------------------------------------------------------------------
Total average daily
amount of domestic deposits $2,127,111 3.44% $1,918,025 3.65% $1,878,230 3.30%
=================================================================================================
The remaining maturities of time deposits in amounts of $100,000 or more
outstanding at December 31, 2001 and 2000 are summarized below:
At December 31,
- ------------------------------------------------
2001 2000
- ------------------------------------------------
(000's omitted)
Less than three months $ 78,601 $ 91,226
Three months to six months 37,193 52,618
Six months to one year 22,660 40,234
Over one year 38,548 26,585
- ------------------------------------------------
Totals $177,002 $210,663
================================================
The following table summarizes the outstanding balance of short-term borrowings
of the company for the years indicated.
At December 31,
- ------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------
(000's omitted)
Federal funds purchased $ 14,200 $ 48,730 $ 32,450
Term borrowings at banks (original
term)
90 days or less 31,100 151,100 129,000
Over 90 days 1,000 0 125,000
- ------------------------------------------------------------------------
Balance at end of period $ 46,300 $199,830 $286,450
========================================================================
Daily average during the year $141,772 $258,985 $125,433
Maximum month-end balance $268,600 $396,990 $361,450
Weighted average rate during the year 4.75% 6.51% 5.25%
Year-end average rate 4.16% 7.23% 5.55%
34
Investments
The objective of CBSI's investment portfolio is to provide low-risk, quality
assets to the balance sheet. This must be accomplished within the constraints
of: (a) absorbing funds when loan demand is low or when acquisitions provide
additional net funding sources, and infusing funds when loan 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 the
regulatory risk-based capital guidelines; and (e) generating a favorable return
without undue compromise of the other requirements.
From December 31, 2000 to December 31, 2001, the book value of CBSI's investment
portfolio increased $209 million or 22.9% to $1.1 billion, reflective of the
purchase strategies described below, partially offset by strategic investment
sales.
Early in 2001, prior to the First Liberty merger, the bank's balance sheet
simulation work pointed to an exposure to rising rates. The inverted treasury
yield curve was largely responsible for this profile. To minimize this exposure,
premium collateralized mortgage obligations (CMOs) and premium mortgage backed
pass throughs (MBSs) were purchased to improve the company's interest income as
rates rise.
Following the First Liberty merger in May 2001 and the FleetBoston branch
acquisition in November 2001, the asset/liability profile of the bank changed
significantly due to the infusion of the long-term core deposits. The new
liability structure shifted the bank's interest rate risk to one of greater
exposure to falling interest rates. To protect against such risk, the bank began
to purchase intermediate municipal bonds and agency securities with a minimum of
five years of call protection.
Despite a falling rate environment, the 2001 steepening yield curve allowed for
widening spreads over cost of funds on investment transactions. This situation
created favorable opportunities to expand the company's investment portfolio,
which increased $147 million on average (excluding Federal Funds sold) during
the year. Two primary components of this expansion were a $140 million
securities strategy made possible by First Liberty's ample capital position and
additional purchases of $120 million from the excess cash provided by
FleetBoston branch acquisition.
During 2001, approximately $119 million of investments was sold, resulting in
net investment gains of approximately $2.5 million. About $83 million of the
sales (resulting in a slight net loss) was related to repositioning of acquired
investments from Citizens National Bank of Malone and First Liberty Bank Corp.
The remaining $36 million in sales, which resulted in a $2.6 million gain, was
used to offset penalties to prepay $95 million in Federal Home Loan Bank
longer-term advances, which were replaced by core deposits from the FleetBoston
branch acquisition. The swap allowed the bank to reduce the overall cost of the
$95 million in funds from 5.38% to 2.86%.
Investment interest income in 2001 was $7.9 million or 12.4% higher than the
prior year as a result of the higher outstandings, partially offset by a
decrease in the average investment yield from 7.18% to 6.96%. The large volume
of growth in 2001 being put on at declining market rates was the primary cause
of the change in average investment yield. Through September 30, 2001, the tax
equivalent investment yield was in the 91st peer percentile.
The composition of the portfolio continues to heavily favor U.S. Agency
Debentures, U.S. Agency mortgage-backed pass-throughs, U.S. Agency CMOs and
AAA-rated insured municipal bonds. As of year-end 2001, these four security
types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock)
accounted for over 95% of total portfolio investments (17%, 16%, 36% and 26%
respectively). Excluding the First Liberty investment portfolio (much of which
was sold to reposition the combined balance sheet), these four security types
comprised 91% of total investments as of December 31, 2000 at 33%, 6%, 32% and
19%, respectively. At year-end 2001, the average life of the portfolio was 11
years (with callable agency and municipal securities considered to maturity) and
the effective duration, which measures price sensitivity, was 5.20 years.
Since 1997, the company has utilized total return as its primary methodology for
managing investment portfolio assets. Under this analytical method, shareholder
value is maximized through both interest income and market value appreciation.
For the third quarter of 2001 (prior to the FleetBoston branch acquisition), the
bank's five-year total return at 8.00% was in the excellent 98th peer percentile
per the Investment Performance Digest.
35
Because nearly all of the bank's investments are classified as available-for
sale, any broad change in market value has a significant impact on book equity.
As of year-end 2001, the pre-tax net market value gain over book value was $17.4
million (101.6 dollar price) versus a gain of $10.3 million as of year-end 2000.
This positive change of $7.1 million added $4.3 million to book equity, or $0.33
per share outstanding as of December 31, 2001.
The following table sets forth the amortized cost and market value for the
company's investment securities portfolio:
At December 31,
- -------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------------
(000's omitted) Amortized Amortized Amortized
Cost/Book Market Cost/Book Market Cost/Book Market
Value Value Value Value Value Value
- -------------------------------------------------------------------------------------------------------------------------------
Held to Maturity Portfolio
Obligations of states and political
subdivisions $ 7,608 $ 7,832 $ 5,351 $ 5,451 $ 5,042 $ 5,084
- -------------------------------------------------------------------------------------------------------------------------------
Total $ 7,608 $ 7,832 $ 5,351 $ 5,451 $ 5,042 $ 5,084
===============================================================================================================================
Available for Sale Portfolio
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 192,111 $ 203,501 $ 300,714 $ 311,348 $ 237,640 $ 230,306
Obligations of states and political
subdivisions 282,109 277,593 164,110 165,609 154,129 144,342
Corporate securities 43,392 44,399 44,862 44,902 36,164 33,349
Collateralized mortgage obligations (CMO's) 400,100 403,780 273,382 271,825 266,042 258,847
Mortgage-backed securities 173,978 179,786 98,363 98,024 114,251 112,445
- -------------------------------------------------------------------------------------------------------------------------------
Total 1,091,690 1,109,059 881,431 891,708 808,226 779,289
Equity securities (1) 25,863 25,863 29,986 29,986 29,851 29,851
Federal Reserve Bank common stock 5,652 5,652 2,536 2,536 2,414 2,414
- -------------------------------------------------------------------------------------------------------------------------------
Total 1,123,205 $1,140,574 913,953 $ 924,230 840,491 $ 811,554
========== ========== ==========
Net unrealized gain/(loss) on available for sale 17,369 10,277 (28,937)
---------- ---------- ----------
GRAND TOTAL CARRYING VALUE $1,148,182 $ 929,581 $ 816,596
========== ========== ==========
(1) Includes $24,700, $28,546 and $28,546 of FHLB common stock at December 31,
2001, 2000 and 1999, respectively.
36
The following table sets forth as of December 31, 2001, the maturities of
investment securities and the weighted-average yields of such securities, which
have been calculated on the cost basis, weighted for scheduled maturity of each
security, and adjusted to a fully tax-equivalent basis:
(000's omitted) At December 31, 2001
- ----------------------------------------------------------------------------------------------------------------
Amount Amount
Maturing Maturing
After After
Amount One Five
Maturing Year Years Amount
Within but but Maturing Total
One Within Within After Amortized
Year of Five Ten Ten Cost/Book
Less Years Years Years Value
- ----------------------------------------------------------------------------------------------------------------
Held to Maturity Portfolio
Obligations of states and political
subdivisions $ 3,385 $ 2,481 $ 727 $ 1,015 $ 7,608
- ----------------------------------------------------------------------------------------------------------------
Total $ 3,385 $ 2,481 $ 727 $ 1,015 $ 7,608
================================================================================================================
Weighted average yield (1) 7.12% 7.65% 7.79% 12.30% 8.18%
Available for Sale Portfolio
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 101 $ 10,005 $ 150,932 $ 31,073 $ 192,111
Obligations of states and political
subdivisions 2,823 15,594 85,940 177,752 282,109
Corporate securities 49 746 10,070 32,527 43,392
Mortgage-backed securities and CMO's 88,372 285,925 107,808 91,973 574,078
- ----------------------------------------------------------------------------------------------------------------
Total $ 91,345 $ 312,270 $ 354,750 $ 333,325 $1,091,690
================================================================================================================
Weighted average yield (1) 5.81% 6.58% 6.77% 7.17% 6.76%
(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/Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates or prices. The company's primary market risk exposure is
interest rate risk. The ongoing monitoring and management of this risk, over
both a short-term tactical and longer-term strategic time horizon, is an
important component of the company's asset/liability management process, which
is governed by policies established by its Board of Directors and reviewed and
approved annually. The Board of Directors delegates responsibility for carrying
out the asset/liability management policies to the Asset/Liability Management
Committee (ALCO). In this capacity, ALCO develops guidelines and strategies
impacting the company's asset/liability management activities based upon
estimated market risk sensitivity, policy limits, and overall market interest
rate level and trends.
As the company does not believe it is possible to reliably predict future
interest rate movements, it has maintained an appropriate process and set of
measurement tools which enable it to identify and quantify sources of interest
rate risk in varying rate environments. The primary tool used by the company in
managing interest rate risk is income simulation. The analysis begins by
measuring the impact of differences in maturity and repricing 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.
37
Changes in net interest income are reviewed after subjecting the balance sheet
to an array of treasury yield curve possibilities. The following reflects the
company's one-year net interest income sensitivity based on asset and liability
levels on December 31, 2001, assuming no growth in the balance sheet, and
assuming an instantaneous 200 basis point increase and 150 basis point decrease
in the prime rate, federal funds rate and the entire treasury yield curve.
REGULATORY MODEL
- -------------------------------------------------------------------------------------
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
+ 200 bp $2.1 million 1.7%
- 150 bp ($4.3 million) (3.6%)
The rising rate environment performs better than the falling rate environment
due in large part to the increased 2001 level of core deposits, which are not as
volatile in terms of rate movement as are other funding sources.
Given the steepness in slope of the treasury yield curve as of year-end 2001, a
second group of simulations was performed based on what the company believes to
be conservative levels of balance sheet growth--high single digit growth in
loans and investments, and low single digit growth in deposits, augmented by any
necessary increases in borrowings, with no growth in other major portions of the
balance sheet. On that basis, a variety of scenarios was tested, including: A)
raising short term rates (fed funds and prime) by 200 BP over a one year period
while holding the long end of the treasury yield curve constant, and B) holding
short term rates (fed funds and prime) constant, while flattening the long end
of the treasury curve. Under these sets of assumptions, the bank's net interest
income shows a mild level of sensitivity to the flattening of the yield curve.
MANAGEMENT MODEL
- ----------------------------------------------------------------------------------------------------
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
A) Increasing Short Term Rates ($3.7 million) (2.8%)
B) Reducing Longer Term Rates ($794,000) (.6%)
The preceding 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: the nature and
timing of interest rate levels (including yield curve shape), prepayments on
loans and securities, deposit decay rates, pricing decisions on loans and
deposits, reinvestment/replacement of asset and liability cash flows, and
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 amount of cash that could be made available within 30 days
(calculated as liquid assets less short-term liabilities); and second, a
projection of subsequent cash availability over an additional 60 days. The
minimum policy level of liquidity under the Basic Surplus/Deficit approach is
7.5% of total assets for both the 30- and 90-day time horizons. As of year-end
2001, this ratio was 18.3% and 17.8%, respectively, excluding the company's
capacity to borrow additional funds from the Federal Home Loan Bank.
38
GAP REPORT
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
as of December 31, 2001
Volumes 1-30 31-60 60-90 91-180 181-360 13-24
($000's) Days Days Days Days Days Months
- --------------------------------------------------------------------------------------------------------------
ASSETS:
Fixed Rate Debentures -- -- 5,000 -- -- 28,457
Municipals 321 133 457 2,645 2,989 2,769
Fixed Rate Mortgage -- -- -- -- -- --
Backed 8,752 8,224 8,848 31,129 51,334 90,515
Other Investments 864 -- -- -- 746 --
- --------------------------------------------------------------------------------------------------------------
Total Investments 9,937 8,357 14,305 33,774 55,069 121,741
- --------------------------------------------------------------------------------------------------------------
Mortgages:
Adjustable Rate 281 315 1,800 4,684 10,786 5,180
Fixed Rate 12,360 12,463 12,194 34,882 62,257 99,646
Variable Home Equity 49,699 24,484 352 39,003 660 --
Commercial Variable 260,021 1,049 1,049 3,147 6,294 12,588
Other Commercial 48,488 10,159 10,226 31,080 64,014 115,093
Installment, Net 10,343 11,047 11,087 32,918 62,264 105,792
- --------------------------------------------------------------------------------------------------------------
Total Loans 381,192 59,517 36,708 145,714 206,275 338,299
Loan Loss Reserve -- -- -- -- -- --
Other Assets -- -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------
TOTAL ASSETS 391,129 67,874 51,013 179,488 261,344 460,040
Average Yield 6.04% 7.29% 7.91% 7.99% 8.02% 8.02%
==============================================================================================================
LIABILITY AND CAPITAL
Demand Deposits -- -- -- -- -- --
Savings / NOW/MM 2,312 2,312 2,312 278,134 66,804 27,599
CD's / IRA / Other 132,669 111,706 86,619 246,767 349,541 148,874
- --------------------------------------------------------------------------------------------------------------
Total Deposits 134,981 114,018 88,931 524,901 416,345 176,473
Short Term Borrowings 14,200 -- -- -- -- --
Term Borrowing 31,100 -- -- -- 1,000 6,000
Trust Securities 49,450 -- -- -- -- --
Other Liabilities -- -- -- -- -- --
Capital -- -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES
AND CAPITAL 229,731 114,018 88,931 524,901 417,345 182,473
AVERAGE RATE 4.98% 4.97% 4.78% 3.27% 3.63% 4.21%
==============================================================================================================
GAP 161,398 (46,144) (37,918) (345,413) (156,001) 277,567
CUMULATIVE GAP 161,398 115,254 77,336 (268,077) (424,078) (146,511)
CUMULATIVE GAP /
TOTAL ASSETS 5.1% 3.6% 2.4% -8.4% -13.4% -4.7%
Volumes 25-36 37-60 Over 60
($000's) Months Months Months TOTAL
- -------------------------------------------------------------------------------
ASSETS:
Fixed Rate Debentures 64,951 83,006 10,688 192,102
Municipals 2,649 12,344 266,308 290,615
Fixed Rate Mortgage
Backed 74,819 104,609 196,684 574,914
Other Investments 3,725 -- 67,848 73,183
- -------------------------------------------------------------------------------
Total Investments 146,144 199,959 541,528 1,130,814
- -------------------------------------------------------------------------------
Mortgages:
Adjustable Rate -- -- -- 23,046
Fixed Rate 73,571 100,253 125,677 533,303
Variable Home Equity -- -- -- 114,198
Commercial Variable 12,588 25,156 17 321,909
Other Commercial 50,749 -- 2,860 332,669
Installment, Net 77,586 62,590 34,118 407,745
- -------------------------------------------------------------------------------
Total Loans 214,494 187,999 162,672 1,732,870
Loan Loss Reserve -- -- (23,900) (23,900)
Other Assets -- -- 371,049 371,049
- -------------------------------------------------------------------------------
TOTAL ASSETS 360,638 387,958 1,051,349 3,210,833
Average Yield 7.75% 7.59% 3.82% 6.30%
===============================================================================
LIABILITY AND CAPITAL
Demand Deposits -- -- 447,544 447,544
Savings / NOW/MM -- -- 549,107 928,580
CD's / IRA / Other 42,353 48,665 2,652 1,169,846
- -------------------------------------------------------------------------------
Total Deposits 42,353 48,665 999,303 2,545,970
Short Term Borrowings -- -- -- 14,200
Term Borrowing -- 63,750 161,603 263,453
Trust Securities -- -- 28,819 78,269
Other Liabilities -- -- 40,961 40,961
Capital -- -- 267,980 267,980
- -------------------------------------------------------------------------------
TOTAL LIABILITIES
AND CAPITAL 42,353 112,415 1,498,666 3,210,833
AVERAGE RATE 5.05% 5.82% 1.20% 2.74%
===============================================================================
GAP 318,285 275,543 (447,317)
CUMULATIVE GAP 171,774 447,317 --
CUMULATIVE GAP /
TOTAL ASSETS 5.4% 14.0% 0.0%
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.
39
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 accounting
principles generally accepted in the United States; (11) changes in the
company's organization, compensation and benefit plans and in the availability
of, and compensation levels for, employees in its geographic markets; (12) the
costs and effects of litigation and of any adverse outcome in such litigation;
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.
New Accounting Pronouncements
See Accounting Pronouncement Section of Note A of the notes to the Consolidated
Financial Statements on page 48.
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and independent accountant's
reports of Community Bank System, Inc. and subsidiaries are contained on pages
41 through 64 of this item.
- - Consolidated Statements of Condition--
December 31, 2001 and 2000
- - Consolidated Statements of Income - Years ended December 31, 2001, 2000, and
1999
- - Consolidated Statements of Changes in Shareholders' Equity - Years ended
December 31, 2001, 2000, and 1999
- - Consolidated Statements of Cash Flows - Years ended December 31, 2001, 2000,
and 1999
- - Notes to Consolidated Financial Statements -
December 31, 2001
- - Report of Independent Accountants
Quarterly Selected Data (Unaudited) for 2001 and 2000 are contained on page 65.
40
CONSOLIDATED STATEMENTS OF CONDITION
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Share Data)
December 31, December 31,
2001 2000
- ----------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 106,554 $ 76,456
Federal funds sold -- --
- ----------------------------------------------------------------------------------------------------
Total cash and cash equivalents 106,554 76,456
Investment securities
(approximate fair value of $1,148,406 and $929,681) 1,148,182 929,581
Loans 1,732,870 1,515,877
Reserve for loan losses 23,901 20,035
- ----------------------------------------------------------------------------------------------------
Net loans 1,708,969 1,495,842
Premises and equipment, net 53,266 40,941
Accrued interest receivable 22,562 21,873
Core deposit intangibles, net 36,722 10,349
Goodwill, net 19,814 5,902
Other intangibles, net 85,806 38,983
- ----------------------------------------------------------------------------------------------------
Intangible assets, net 142,342 55,234
Other assets 28,958 30,746
- ----------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 3,210,833 $ 2,650,673
====================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Noninterest bearing $ 447,544 $ 316,162
Interest bearing 2,098,426 1,632,395
- ----------------------------------------------------------------------------------------------------
Total deposits 2,545,970 1,948,557
Federal funds purchased 14,200 48,730
Borrowings 263,100 391,100
Company obligated mandatorily redeemable
preferred securities of subsidiaries,
Community Capital/ Statutory
Trust I-III, holding solely junior
subordinated debentures of the Company 77,819 29,824
Accrued interest and other liabilities 41,764 30,671
- ----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 2,942,853 2,448,882
- ----------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value for 2001
and 2000; 20,000,000 shares authorized; 12,902,812
and 10,559,897 shares outstanding for 2001 and
2000, respectively 12,903 11,208
Surplus 77,710 37,711
Undivided profits 170,472 163,917
Accumulated other comprehensive income 7,281 5,966
Treasury stock, at cost (0 and 648,100
shares for 2001 and 2000, respectively) -- (17,006)
Shares issued under employee stock plan - unearned (386) (5)
- ----------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY
267,980 201,791
- ----------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,210,833 $ 2,650,673
====================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
41
CONSOLIDATED STATEMENTS OF INCOME
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Per-Share Data)
Years Ended December 31
- ------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $ 132,014 $ 130,207 $ 115,603
Interest and dividends on investments:
Taxable 55,012 50,885 43,422
Nontaxable 10,274 7,847 6,915
Interest on federal funds sold and deposits with other banks 550 635 550
- ------------------------------------------------------------------------------------------------------------------------
Total interest income 197,850 189,574 166,490
- ------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 73,163 69,921 61,902
Interest on federal funds purchased 883 3,411 1,637
Interest on short-term borrowings 5,855 16,304 7,993
Interest on mandatorily redeemable preferred securities of subsidiaries 4,540 2,932 2,932
Interest on long-term borrowings 16,754 6,573 4,026
- ------------------------------------------------------------------------------------------------------------------------
Total interest expense 101,195 99,141 78,490
- ------------------------------------------------------------------------------------------------------------------------
Net interest income 96,655 90,433 88,000
Less: Provision for loan losses 7,097 7,722 5,856
- ------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 89,558 82,711 82,144
- ------------------------------------------------------------------------------------------------------------------------
Other income:
Fiduciary and investment services 3,080 3,251 3,010
Service charges on deposit accounts 9,999 8,385 7,746
Commissions on investment products 6,085 4,924 1,288
Other service charges, commissions and fees 6,944 6,507 5,814
Other operating income 429 217 295
Investment security gain (loss), net 2,546 (159) (413)
- ------------------------------------------------------------------------------------------------------------------------
Total other income 29,083 23,125 17,740
- ------------------------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits 41,045 36,743 33,693
Occupancy expense, net 6,122 5,084 4,871
Equipment and furniture expense 6,075 5,224 4,932
Amortization of intangible assets 6,679 4,891 4,723
Legal and professional fees 2,304 2,336 2,426
Data processing expenses 4,436 4,526 4,125
Acquisition and unusual expenses 8,164 400 --
Other 14,214 11,730 12,008
- ------------------------------------------------------------------------------------------------------------------------
Total other expenses 89,039 70,934 66,778
- ------------------------------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary item 29,602 34,902 33,106
Income taxes 8,891 10,003 9,444
- ------------------------------------------------------------------------------------------------------------------------
Income before extraordinary item 20,711 24,899 23,662
Extraordinary loss on early retirement of long term borrowings,
net of tax benefit of $1,077 1,582 -- --
- ------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 19,129 $ 24,899 $ 23,662
========================================================================================================================
Earnings per share - Basic $ 1.64 $ 2.34 $ 2.20
========================================================================================================================
Earnings per share - Diluted $ 1.62 $ 2.32 $ 2.18
========================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
44
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Years ended December 31, 2001, 2000 and 1999
(In Thousands, Except Share Data)
Common Stock
----------------------
Shares Undivided Treasury
Outstanding Amount Surplus Profits Stock
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 10,855,964 $ 11,183 $ 36,995 $ 135,026 $ (9,152)
Net income - 1999 23,662
Other comprehensive loss, before tax:
Unrealized losses on securities:
Unrealized holding losses arising during period
Reclassification adjustment for losses 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
Dividends declared:
Common, $.96 per share (9,557)
Common stock issued under employee stock plan 23,306 23 687
Treasury stock purchased (221,500) (5,567)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 10,657,770 $ 11,206 $ 37,682 $ 149,131 $ (14,719)
Net income - 2000 24,899
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains arising during period
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
Dividends declared:
Common, $1.04 per share (10,113)
Common stock issued under employee stock plan 2,127 2 29
Treasury stock purchased (100,000) (2,287)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 10,559,897 $ 11,208 $ 37,711 $ 163,917 $ (17,006)
Net income - 2001 19,129
Other comprehensive income, before tax:
Minimum pension liability adjustment
Unrealized gains on securities:
Unrealized holding gains arising during period
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
Dividends declared:
Common, $1.08 per share (12,574)
Issuance of common stock 1,308,800 1,309 30,755
Common stock issued under employee stock plan 82,546 83 1,338
Fractional shares redeemed (431) (1) (12)
Stock issued for acquisition 952,000 304 7,918 17,006
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 12,902,812 $ 12,903 $ 77,710 $ 170,472 $ 0
==============================================================================================================================
Other Employee
Comprehensive Comprehensive Stock Plan
Income Income - Unearned Total
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $ 5,047 $ (26) $ 179,073
Net income - 1999 $ 23,662 23,662
--------
Other comprehensive loss, before tax:
Unrealized losses on securities:
Unrealized holding losses arising during period (37,745)
Reclassification adjustment for losses included
in net income 413
--------
Other comprehensive loss, before tax: (37,332)
Income tax benefit related to other comprehensive loss 14,704
--------
Other comprehensive loss, net of tax (22,628) (22,628) (22,628)
--------
Comprehensive income $ 1,034
========
Dividends declared:
Common, $.96 per share (9,557)
Common stock issued under employee stock plan 12 722
Treasury stock purchased (5,567)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 $ (17,581) $ (14) $ 165,705
Net income - 2000 $ 24,899 24,899
--------
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 39,053
Reclassification adjustment for gains included
in net income 159
--------
Other comprehensive income, before tax: 39,212
Income tax expense related to other comprehensive income (15,665)
--------
Other comprehensive income, net of tax 23,547 23,547 23,547
--------
Comprehensive income $ 48,446
========
Dividends declared:
Common, $1.04 per share (10,113)
Common stock issued under employee stock plan 9 40
Treasury stock purchased (2,287)
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $ 5,966 $ (5) $ 201,791
Net income - 2001 $ 19,129 19,129
--------
Other comprehensive income, before tax:
Minimum pension liability adjustment (5,016)
Unrealized gains on securities:
Unrealized holding gains arising during period 9,638
Reclassification adjustment for gains included
in net income (2,546)
--------
Other comprehensive income, before tax: 2,076
Income tax expense related to other comprehensive income (761)
--------
Other comprehensive income, net of tax 1,315 1,315 1,315
--------
Comprehensive income $ 20,444
========
Dividends declared:
Common, $1.08 per share (12,574)
Issuance of common stock 32,064
Common stock issued under employee stock plan (381) 1,040
Fractional shares redeemed (13)
Stock issued for acquisition 25,228
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 7,281 $ (386) $ 267,980
=======================================================================================================================
43
CONSOLIDATED STATEMENTS OF CASH FLOWS
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands) Years Ended December 31
- -----------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 19,129 $ 24,899 $ 23,662
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 5,049 4,072 3,784
Amortization of intangible assets 6,679 5,050 4,995
Net amortization of security premiums and discounts 2,229 439 3,720
Amortization of discount on loans (199) (311) (587)
Amortization of unearned compensation and discount on junior subordinated
debentures 276 16 18
Provision for loan losses 7,097 7,722 5,856
(Benefit) provision for deferred taxes (835) 412 (586)
Extraordinary loss on early retirement of long-term borrowings 1,582 -- --
(Gain) loss on sale of investment securities (2,546) 159 413
Gain on sale of loans and other assets (283) (236) (202)
Change in interest receivable 1,276 (4,308) (2,903)
Change in other assets and other liabilities 5,349 (6,009) 932
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 44,803 31,905 39,102
- -----------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities 141,959 16,811 34,433
Proceeds from maturities of held-to-maturity investment securities 6,172 3,727 2,771
Proceeds from maturities of available-for-sale investment securities 205,135 51,799 227,072
Purchases of held-to-maturity investment securities (4,380) (4,035) (3,775)
Purchases of available-for-sale investment securities (514,132) (142,671) (328,223)
Net change in loans outstanding 12,607 (96,220) (137,390)
Premium paid on acquisition of business (1,830) (6,134) --
Cash received in acquisitions 212,353 -- --
Capital expenditures (7,730) (5,304) (8,870)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 50,154 (182,027) (213,982)
- -----------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts 206,490 9,236 (46,092)
Net change in certificates of deposit (166,998) 94,569 16,178
Net change in federal funds purchased (34,530) 16,280 (7,250)
Net change in term borrowings (139,532) (7,900) 249,000
Proceeds from issuance of redeemable preferred securities 47,967 -- --
Issuance of common stock, net of issuance costs 32,837 29 396
Treasury stock purchased -- (2,287) (5,567)
Cash dividends paid (10,980) (9,998) (9,463)
Other financing activities (113) (101) (93)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by financing activities (64,859) 99,828 197,109
- -----------------------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents 30,098 (50,294) 22,229
Cash and cash equivalents at beginning of year 76,456 126,750 104,521
- -----------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 106,554 $ 76,456 $ 126,750
===================================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 103,664 $ 97,326 $ 75,884
Cash paid for income taxes $ 8,082 $ 9,876 $ 8,983
===================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Dividends declared and unpaid $ 3,482 $ 1,888 $ 1,773
Gross change in unrealized gains and (losses) on available-for-sale securities $ 7,092 $ 39,212 $ (37,332)
Minimum pension liability adjustment $ 5,016 $ -- $ --
Bank and branch acquisitions:
Fair value of assets acquired $ 382,560 $ -- $ --
Liabilities assumed $ 569,685 $ -- $ --
Common stock issued, including treasury stock of $17,006 $ 25,228 $ -- $ --
===================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
44
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Community Bank System, Inc. is a one bank holding company which wholly-owns six
subsidiaries: Community Bank, N.A. (the Bank), Community Capital Trust I, II,
Community Statutory Trust III subsidiary business trusts, Benefit Plans
Administrative Services, Inc. (BPA), and Community Financial Services, Inc.
Closeout Corp. (CFSICC). Community Capital Trust I was formed in February 1997
for the purpose of issuing mandatorily redeemable convertible securities which
are considered Tier I capital under regulatory capital adequacy requirements
(see Note P). In July 2001, Community Capital Trust II and Community Statutory
Trust III were formed to issue Company obligated pooled capital securities which
are considered Tier I capital under regulatory capital adequacy requirements.
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. CFSICC is an inactive company. The Bank operates 119
customer facilities throughout Northern New York, the Finger Lakes Region, the
Southern Tier, Southwestern New York and Northern Pennsylvania, and owns the
following subsidiaries: Community Financial Services, Inc. (CFSI), Community
Investment Services, Inc. (CISI), CBNA Treasury Management Corporation (TMC),
CBNA Preferred Funding Corporation (PFC), Elias Asset Management, Inc. (EAM) and
First Liberty Service Corp. (FLSC). CFSI offers insurance investment products
and CISI provides broker-dealer and investment advisory services. CFSI is
expected to be consolidated into CISI in 2002. TMC operates the cash management,
investment, and treasury functions of the Bank, and PFC primarily engages in
investing of residential and commercial real estate loans. EAM, located in
Williamsville, New York, provides asset management services to the general
public. FLSC provides banking related services to the Pennsylvania branches of
the Bank.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All inter-company accounts and transactions have
been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Risk and Uncertainties
In the normal course of its business, the Company encounters economic and
regulatory risks. There are three main components of economic risk: interest
rate risk, credit risk and market risk. The Company is subject to interest rate
risk to the degree that its interest-bearing liabilities mature or reprice at
different speeds, or on different bases from its interest-earning assets. The
Company's primary credit risk is the risk of default on the Company's loan
portfolio that results from the borrowers' inability or unwillingness to make
contractually required payments. Market risk reflects potential changes in the
value of collateral underlying loans, the fair value of investment securities
and loans held for sale.
The Company is subject to the regulations of various governmental agencies.
These regulations can and do change significantly from period to period. The
Company also undergoes periodic examinations by the regulatory agencies which
may subject it to further changes with respect to asset valuations, amounts of
required loss allowances, and operating restrictions resulting from the
regulators' judgements based on information available to them at the time of
their examinations.
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.
45
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 has been classified as trading securities. Equity securities are
stated at cost and include stock of the Federal Reserve Bank of New York and
Federal Home Loan Bank of New York.
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 gain (loss), net. 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 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.
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 loan losses reflects management's best estimate of probable loan
losses in the Company's loan portfolio, considering evaluations of individual
credits and concentrations of credit risk, changes in the quality of the credit
portfolio, levels of nonaccrual loans, current economic conditions, changes in
the size and character of the credit risks and other pertinent factors. The
reserve is increased by provisions charged to expense and reduced by net
charge-offs. A loan is considered impaired, based on 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, 2001 and 2000, other
real estate, included in other assets, amounted to $1,427 and $1,293,
respectively.
46
Intangible Assets
Intangible assets represent principally core deposit value, goodwill and other
intangibles arising from acquisitions. 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 and goodwill is being amortized on a straight-line basis over 15 to 25
years.
Mortgage Servicing Rights
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 incorporates
assumptions that market participants would use in estimating future net
servicing income, which includes 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. At December 31, 2001 and 2000, mortgage servicing
rights, included in other assets, amounted to approximately $567 and $526,
respectively.
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 short-term borrowings
approximate their fair values. Fair values for long-term borrowings are
estimated using discounted cash flows and interest rates currently being offered
on similar borrowings.
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.
Trust Department Assets
Assets held in fiduciary or agency capacities for customers are not included in
the accompanying consolidated statements of condition, since such items are not
assets of the Company. Fees associated with providing trust management services
are recorded on cash basis of income recognition and are included in other
income. Assets under management at December 31, 2001 and 2000 were $1,385 and
$1,417, respectively.
Earnings Per Share
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.
Treasury Stock
Treasury stock purchases are recorded at cost. During 2001, the Company issued
648,100 shares of treasury stock in connection with the acquisition of Citizens
National Bank of Malone. During 2000, the Company purchased 100,000 shares of
treasury stock at an average cost of $22.88. The Company purchases treasury
stock primarily in order to have shares available for issuance under its
incentive stock option, restricted stock award, and non-qualified stock option
plans and for other strategic purposes.
47
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 Financial Accounting Standard No. 107, "Disclosures about
Fair Value of Financial Instruments," excludes certain financial instruments and
all non-financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
The fair values of investment securities, loans, deposits, and borrowings have
been disclosed in footnotes C, D, G, and H, respectively.
Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
142, "Goodwill and Other Intangible Assets", which addresses financial
accounting and reporting for acquired goodwill and other intangibles assets and
supercedes APB Opinion No. 17, "Intangible Assets". The statement requires,
beginning January 1, 2002, that the Company subject goodwill and other
intangible assets to an annual impairment analysis to assess the need to write
down the balances and recognize an impairment loss. In addition, amortization of
goodwill will no longer be recorded upon adoption of this statement. Core
deposit intangibles, net and other intangibles, net related to branch
acquisitions totaling $122,528 at December 31, 2001 will continue to be
amortized. The Company expects that the adoption of this pronouncement will
reduce annual amortization expense by approximately $1,300.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of, including long-term customer relationships of a financial
institution, such as core deposit intangibles. This Statement supersedes SFAS
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," however, this Statement retains the fundamental
provisions of Statement 121 for (a) recognition and measurement of the
impairment of long-lived assets to be held and used and (b) measurement of
long-lived assets to be disposed of by sale. The provisions of this Statement
are effective for financial statements issued for fiscal year beginning after
December 15, 2001, and interim periods within those fiscal years. The Company
has not yet determined what the impact of adopting SFAS No. 144 will have on the
financial statements.
48
NOTE B: ACQUISITIONS
FleetBoston Financial Corporation
On November 16, 2001, the Company acquired 36 branches from FleetBoston
Financial Corporation with $470 million in deposits and $177 million in loans.
The branches are located in the Southwestern and Finger Lakes Regions of New
York. The results of the 36 branch operations have been included in the
consolidated financial statements since that date. As a result of the
acquisition, the Company's core deposit funding increased, and the addition of
new markets with expanded lending and financial service opportunities will
enable the Company to grow in an increasingly competitive banking environment.
Citizens National Bank of Malone
On January 26, 2001, the Company acquired the $111-million-asset Citizens
National Bank of Malone, an eighty-year-old commercial bank with five branches
throughout Franklin and St. Lawrence counties in New York State. The Company
issued 952,000 shares of its common stock to the former shareholders at a cost
of $26.50 per share. All of the 648,100 shares held in the Company's treasury
were issued in this transaction. The acquisition is being accounted for under
the purchase method of accounting.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed as of the date FleetBoston Financial Corporation and
Citizens National Bank of Malone were acquired. The Company is in the process of
finalizing third-party valuations of the fair value of loans and premises and
equipment for the FleetBoston Financial Corporation acquisition; thus, the
allocation of the purchase price may be subject to refinement.
FleetBoston
Financial Citizens National
Corporation Bank of Malone Total
------------------------------------------
Cash $208,576 $ 3,777 $212,353
Investments 0 46,029 46,029
Loans 177,014 58,768 235,782
Reserve for loan losses 2,565 787 3,352
------------------------------------------
Net loan 174,449 57,981 232,430
Bank premises and equipment 8,068 1,495 9,563
Other assets 1,226 1,355 2,581
Intangible assets 78,646 13,311 91,957
------------------------------------------
Total assets $470,965 $123,948 $594,913
==========================================
Deposits $470,250 $ 87,671 $557,921
Borrowings 0 9,950 9,950
Other liabilities 715 1,099 1,814
------------------------------------------
Total liabilities $470,965 $ 98,720 $569,685
==========================================
Of the $91,957 of intangible assets, $28,100 represents core deposit intangibles
and is being amortized over a weighted-average useful life of 7 years; $13,311
is considered goodwill and will be evaluated annually for impairment; and the
remaining $50,546 is considered other intangibles and is being amortized over 15
years. The other intangibles are expected to be deductible for tax purposes.
First Liberty Bank Corp.
On May 11, 2001, Company completed its acquisition of the $648-million-asset
First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger,
each share of First Liberty stock was exchanged for .56 shares of the Company's
common stock, which amounted to approximately 3.6 million shares. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under Accounting Principles Board Opinion No. 16. Accordingly, the
consolidated financial statements for the periods presented have been restated
to include the combined results of operations, financial position and cash flows
of the Company and First Liberty. Certain reclassifications were made to First
Liberty's prior year financial statements to conform to the Company's
presentation.
49
Results of operations for the separate companies and the combined amounts
presented in the consolidated financial statements follow:
For the Four Months For the Twelve Months Ended
Ended April 30, December 31,
- ------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------
NET INTEREST INCOME:
Community Bank System, Inc. $24,742 $71,209 $67,941
First Liberty Bank Corp. 6,112 19,224 20,059
- ------------------------------------------------------------------------------
Combined $30,854 $90,433 $88,000
==============================================================================
NET INCOME:
Community Bank System, Inc. $ 5,874 $20,319 $17,635
First Liberty Bank Corp. 1,765 4,580 6,027
- ------------------------------------------------------------------------------
Combined $ 7,639 $24,899 $23,662
==============================================================================
Elias Asset Management, Inc.
On April 3, 2000, Community Bank System, Inc. acquired all the stock of Elias
Asset Management, Inc. (EAM) for cash of $6.1 million. Additional consideration
of $1.9 million was recognized in 2001 based upon performance targets set forth
within the stock purchase agreement. EAM, based in Williamsville, NY, is a
nationally recognized firm with approximately $550 million in assets under
management for individuals, corporate pension and profit sharing plans, and
foundations as of December 31, 2001. This transaction was accounted for under
the purchase method, and the Company recognized $8.0 million of goodwill.
Acquisition and Unusual Expenses
The Company incurred one-time expenses in connection with the above
acquisitions. The following table shows the components of acquisition and
unusual expenses which are presented in the consolidated statements of income
for the years ended December 31:
2001 2000
- ----------------------------------------------------------------------
Acquisition expenses:
Legal and professional fees $2,742 $ 371
Severance and employee benefits 1,462 --
Equipment write-downs 934 --
Customer check repurchase 811 --
Other 1,381 29
- ----------------------------------------------------------------------
Total acquisition expenses 7,330 400
- ----------------------------------------------------------------------
Unusual expenses:
Legal and professional fees 395 --
Other 439 --
- ----------------------------------------------------------------------
Total unusual expenses 834 --
- ----------------------------------------------------------------------
Total acquisition and unusual expense $8,164 $ 400
======================================================================
50
NOTE C: INVESTMENT SECURITIES
The amortized cost and estimated fair values of investments in securities as of
December 31 are as follows:
2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity
Obligations of states and $ 7,608 $ 224 $ 7,832 $ 5,351 $ 100 $ -- $ 5,451
political subdivisions
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 7,608 $ 224 $ -- $ 7,832 $ 5,351 $ 100 $ -- $ 5,451
- ------------------------------------------------------------------------------------------------------------------------------------
Available for Sale
U.S. Treasury securities
and obligations of
U.S. government corporations 192,111 11,390 -- 203,501 300,714 11,477 843 311,348
and agencies
Obligations of states and 282,109 2,024 6,540 277,593 164,110 3,348 1,849 165,609
political subdivisions
Corporate securities 43,392 1,336 329 44,399 44,862 1,153 1,113 44,902
Mortgage-backed securities 574,078 12,596 3,108 583,566 371,745 3,612 5,508 369,849
- ------------------------------------------------------------------------------------------------------------------------------------
Total 1,091,690 27,346 9,977 1,109,059 881,431 19,590 9,313 891,708
Equity securities 31,515 -- -- 31,515 32,522 -- -- 32,522
Total 1,123,205 $ 27,346 $ 9,977 $1,140,574 913,953 $ 19,590 $ 9,313 $ 924,230
- --------------------------------------------====================================----------------====================================
Net unrealized gain/(loss)
on available for sale 17,369 10,277
---------- ----------
GRAND TOTAL CARRYING VALUE $1,148,182 $ 929,581
========== ==========
The amortized cost and estimated fair value of debt securities at December 31,
2001, 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 $ 3,385 $ 2,976 $ 2,973 $ 2,984
Due after one through five
years 2,481 2,602 26,345 27,295
Due after five years through
ten years 727 783 246,942 255,488
Due after ten years 1,015 1,471 241,352 239,726
- --------------------------------------------------------------------------------
TOTAL 7,608 7,832 517,612 525,493
Mortgage-backed securities -- -- 574,078 583,566
- --------------------------------------------------------------------------------
TOTAL $ 7,608 $ 7,832 $1,091,690 $1,109,059
================================================================================
Proceeds from sales of investment securities during 2001, 2000, and 1999 were
$141,959, $16,864, and $34,158, respectively. Gross gains of approximately
$2,964, $53, and $562 for 2001, 2000, and 1999, respectively, and gross losses
of $418, $212, and $974 in 2001, 2000, and 1999, respectively, were realized on
those sales.
Investment securities with a carrying value of $596,200 and $609,330 at December
31, 2001 and 2000, respectively, were pledged to collateralize deposits and
borrowings.
51
NOTE D: LOANS
Major classifications of loans at December 31 are summarized as follows:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Real estate mortgages $1,005,558 $ 843,463
Commercial, financial and agricultural loans 299,925 263,985
Installment loans to individuals 399,368 395,226
Other loans 28,237 14,205
- --------------------------------------------------------------------------------
Gross loans 1,733,088 1,516,879
Unearned discount 218 1,002
- --------------------------------------------------------------------------------
Net loans 1,732,870 1,515,877
Reserve for loan losses 23,901 20,035
- --------------------------------------------------------------------------------
Loans, net of loan loss reserve $1,708,969 $1,495,842
================================================================================
The estimated fair value of loans receivable at December 31, 2001 and 2000 was
$1,702,617 and $1,483,487, respectively. Non-accrual loans of $7,186 and $5,473
at December 31, 2001 and 2000, respectively, are included in net loans.
Changes in loans to directors and officers or other related parties for the year
ended December 31 are summarized as follows:
Balance at beginning of year $19,017
New loans 1,993
Payments 5,336
- ------------------------------------------
Balance at end of year $15,674
==========================================
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 were $119,838, $101,254, and $95,099 at December 31,
2001, 2000, and 1999, respectively. Custodial escrow balances maintained in
connection with the foregoing loan servicing, and included in demand deposits,
were approximately $883 and $670 at December 31, 2001 and 2000, respectively.
Changes in the reserve for probable loan losses for the years ended December 31
are summarized as follows:
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Balance at beginning of year $ 20,035 $ 18,528 $ 17,059
Provision charged to expense 7,097 7,722 5,856
Reserve on acquired loans 3,352 0 0
Loans charged off (8,662) (7,481) (5,963)
Recoveries 2,079 1,266 1,576
- --------------------------------------------------------------------------------
Balance at end of year $ 23,901 $ 20,035 $ 18,528
================================================================================
As of December 31, 2001, 2000 and 1999, 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:
- -----------------------------------------------------------------
2001 2000
- -----------------------------------------------------------------
Land and land improvements $ 7,665 $ 3,780
Bank premises owned 44,486 40,295
Equipment 33,595 29,550
- -----------------------------------------------------------------
Premises and equipment, gross 85,746 73,445
Less: Allowance for depreciation 32,480 32,504
- -----------------------------------------------------------------
Premises and equipment, net $53,266 $40,941
=================================================================
52
NOTE F: INTANGIBLE ASSETS
Intangible assets consist of the following at December 31:
- --------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------
Core deposit intangible $ 46,819 $ 18,719
Goodwill 21,275 6,134
Other intangibles 103,307 52,761
- --------------------------------------------------------------------
Intangible assets, gross 171,401 77,614
Less: Accumulated amortization (29,059) (22,380)
- --------------------------------------------------------------------
Intangible assets, net $ 142,342 $ 55,234
====================================================================
NOTE G: DEPOSITS
Deposits by type consist of the following at December 31:
- -------------------------------------------------------
2001 2000
- -------------------------------------------------------
Demand $ 447,544 $ 316,162
Savings 928,582 603,293
Time 1,169,844 1,029,102
- -------------------------------------------------------
Total deposits $2,545,970 $1,948,557
=======================================================
The estimated fair values of deposits at December 31, 2001 and 2000 were
approximately $1,171,465 and $1,944,871, respectively.
At December 31, 2001 and 2000, time certificates of deposit in denominations of
$100 and greater totaled $177,002 and $210,663, respectively.
The approximate maturities of time deposits at December 31 are as follows:
- -----------------------------------------------------------------------
Maturity 2001 2000
- -----------------------------------------------------------------------
Three months or less $ 333,002 $ 83,651
Over three months through twelve months 596,308 719,730
Over one year through three years 191,228 190,689
Over three years 49,306 35,032
- -----------------------------------------------------------------------
Total $1,169,844 $1,029,102
=======================================================================
NOTE H: BORROWINGS
Outstanding borrowings at December 31 are as follows:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased $ 14,200 $ 48,730
Federal Home Loan Bank Advances 26,000 145,000
Other short-term borrowings 6,100 6,100
- --------------------------------------------------------------------------------
46,300 199,830
Long-term borrowings:
Federal Home Loan Bank Advances 231,000 240,000
Company obligated mandatorily redeemable
preferred securities of subsidiary
trusts holding solely junior subordinated
debentures of the Company, net of
discount of $1,631 and $176 77,819 29,824
- --------------------------------------------------------------------------------
$355,119 $469,654
================================================================================
53
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, 2001 have maturity dates as follows:
Weighted
Average
Rate Amount
- --------------------------------------------------
February 10, 2003 5.52% $ 5,000
December 2, 2003 6.24% 1,000
December 3, 2004 6.16% 10,000
January 23, 2008 5.44% 10,000
January 28, 2008 5.48% 5,000
January 30, 2008 5.27% 20,000
February 4, 2008 5.45% 5,000
April 14, 2010 6.35% 25,000
September 27, 2010 5.88% 50,000
October 12, 2010 5.84% 50,000
November 1, 2010 5.77% 50,000
February 3, 2027 9.75% 29,831
July 16, 2031 6.73% 24,261
July 31, 2031 7.27% 23,727
- --------------------------------------------------
6.38% $308,819
==================================================
The estimated fair value of long term borrowings at December 31, 2001 and 2000
were $338,801 and $271,894, respectively.
On September 10, 2001 the Company prepaid $95,000 of Federal Home Loan Bank
advances with maturity dates ranging from December 17, 2002 to February 23, 2004
and a weighted average rate of 5.38%. These long-term borrowings were paid with
gains resulting from investment sales of $36 million. As a result of the
prepayment, the Company incurred penalties of $2,659 that has been reflected in
the consolidated statements of income as an extraordinary loss, net of tax
benefit of $1,077.
On July 16, 2001, the Company formed a wholly owned subsidiary, Community
Capital Trust II, a Delaware business trust. The trust issued $25,000 of 30 year
floating rate Company-obligated pooled Capital Securities of Community Capital
Trust II Holding Solely Parent Debentures. On July 31, 2001, the Company formed
a wholly owned subsidiary, Community Statutory Trust III, a Connecticut business
trust. The trust issued $24,450 of 30 year floating rate Company-obligated
pooled Capital Securities of Community Statutory Trust III Holding Solely Parent
Debentures. The Company borrowed the proceeds of the Capital Securities from its
Subsidiaries by issuing Deeply Subordinated Junior Debentures having
substantially similar terms. The Capital Securities mature in 2031 and are
treated as Tier I capital by the Federal Reserve Bank of New York. Trust II
Capital Securities are a pooled trust preferred fund of MM Community Funding I,
Ltd, and are tied to the six month LIBOR plus 3.75%, with a five year call
provision. Trust III Capital Securities are a pooled trust preferred fund of
First Tennessee/KBW Pooled Trust Preferred Deal III and are tied to the three
month LIBOR plus 3.58%, with a five year call provision. All of these securities
are guaranteed by the Company.
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 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.
54
NOTE I: INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31 is as
follows:
- --------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------
Current:
Federal $ 8,301 $ 9,049 $ 9,499
State 348 542 531
Deferred:
Federal (691) 357 (425)
State (144) 55 (161)
- --------------------------------------------------------------
Total income taxes $ 7,814 $10,003 $ 9,444
==============================================================
Components of the net deferred tax asset/liability, included in other
assets/liabilities, as of December 31 are as follows:
- --------------------------------------------------------------
2001 2000
- --------------------------------------------------------------
Allowance for loan losses $ 8,956 $ 7,237
Employee benefits 4,226 1,873
Amortization of
intangibles 326 465
Goodwill 1,408 --
Other 1,716 1,521
- --------------------------------------------------------------
Total deferred tax asset 16,632 11,096
- --------------------------------------------------------------
Investment securities 8,142 5,293
Loan origination costs 2,117 1,913
Depreciation 1,532 1,317
Mortgage servicing rights 222 213
- --------------------------------------------------------------
Total deferred tax liability 12,013 8,736
- --------------------------------------------------------------
Net deferred tax asset $ 4,619 $ 2,360
==============================================================
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:
- --------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
Increase (reduction) in taxes resulting from:
Tax-exempt interest -11.1% -9.5% -8.4%
State income taxes, net of federal benefit 0.7% 1.1% 0.6%
Other 4.5% 2.1% 1.3%
- --------------------------------------------------------------------------
Effective income tax rate 29.1% 28.7% 28.5%
==========================================================================
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 payments
of dividends if the total of all dividends declared in any calendar year would
exceed the total of the Bank's net profits, as defined by applicable
regulations, for that year, combined with its retained net profits for the
preceding two years. Furthermore, the Bank may not pay a dividend in an amount
greater than its undivided profits then on hand after deducting its losses and
bad debts, as defined by applicable regulations. At December 31, 2001, the Bank
had approximately $26,586 in undivided profits legally available for the
payments of dividends.
55
In addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The Federal Reserve
Board has indicated that banking organizations should generally pay dividends
only out of current operating earnings.
There are also statutory limits on the transfer of funds to the Company by its
banking subsidiary, whether in the form of loans or other extensions of credit,
investments or assets purchases. Such transfer by the Bank to the Company
generally is limited in amount to 10% of the Bank's capital and surplus, or 20%
in the aggregate. Furthermore, such loans and extensions of credit are required
to be collateralized in specific amounts.
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 funded status of the Company's Plans reconciled with
amounts reported in the Company's consolidated statements of condition, and the
assumptions used in determining the actuarial present value of the benefit
obligations:
Pension Benefits Postretirement Benefits
- -----------------------------------------------------------------------------------------------
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation at the beginning of year $ 23,459 $ 20,613 $ 2,148 $ 1,997
Service cost 1,121 1,125 165 134
Interest cost 1,650 1,530 210 138
Deferred actuarial loss 4,665 1,069 980 7
Benefits paid (1,005) (878) (125) (128)
- -----------------------------------------------------------------------------------------------
Benefit obligation at end of year 29,890 23,459 3,378 2,148
- -----------------------------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets at beginning of year 22,034 22,605 -- --
Actual return of plan assets (1,384) (516) -- --
Company contributions 1,439 823 -- --
Benefits paid (1,005) (878) -- --
- -----------------------------------------------------------------------------------------------
Fair value of plan assets at end of year 21,084 22,034 -- --
- -----------------------------------------------------------------------------------------------
Unfunded status (8,806) (1,425) (3,378) (2,148)
Unrecognized actuarial loss (gain) 10,626 2,875 66 (155)
Unrecognized prior service (benefit) cost (430) (545) 421 --
Unrecognized transition (asset ) liability (23) (42) 451 492
- -----------------------------------------------------------------------------------------------
Prepaid (accrued) benefit cost
1,367 863 (2,440) (1,811)
Additional minimum liability (5,016) -- -- --
- -----------------------------------------------------------------------------------------------
Total (accrued) prepaid benefit cost $ (3,649) $ 863 $ (2,440) $ (1,811)
===============================================================================================
Weighted-average assumptions as of
December 31
Discount rate 6.75% 7.0%-7.5% 6.75% 7.0%
Expected return on plan assets 9.00% 8.5%-9.0% 0.00% 0.00%
Rate of compensation increase 4.00% 3.0%-4.0% 0.00% 0.00%
===============================================================================================
Pension Benefits Postretirement Benefits
- ----------------------------------------------------------------------------------------------------
2001 2000 1999 2001 2000 1999
- ----------------------------------------------------------------------------------------------------
Net periodic benefit cost
Service cost $ 1,121 $ 1,125 $ 1,184 $ 165 $ 134 $ 104
Interest cost 1,650 1,530 1,326 210 138 129
Expected return on plan assets (1,921) (306) (2,361) -- -- --
Net amortization and deferral 218 (1,920) 518 -- -- (4)
Amortization of prior service cost (114) (24) (24) 30 -- --
Amortization of transition obligation (19) 3 3 41 41 41
- ----------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 935 $ 408 $ 646 $ 446 $ 313 $ 270
====================================================================================================
56
Financial Accounting Standards Board Statement No. 87 ("SFAS 87"), "Employers'
Accounting for Pensions" requires recognition in the balance sheet of an
additional minimum liability for pension plans with accumulated benefits in
excess of plan assets. At December 31, 2001, the accumulated benefit obligation
exceeded the plan assets resulting in the recognition of an additional minimum
pension liability of $5,016, which was recorded as a charge to shareholders'
equity, net of tax benefit of $1,966.
The defined benefit pension plan maintained by the Bank 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, 2001 and 2000, the plan holds 45,500 and
46,500 shares, respectively, of the sponsor Company common stock.
Health care cost assumptions have no effect on the amounts reported for the
health care plans, since the plan changed to a fixed dollar employee
contribution plan in 1999.
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 includes Section 401(k) and Thrift provisions as
defined under the Internal Revenue Code. Company contributions to the trust
amounted to $979, $838, and $830 in 2001, 2000, and 1999, respectively.
The Company has deferred compensation agreements with several current and former
executives and officers whereby monthly payments are to be provided upon
retirement over periods ranging from ten to twenty-five years. Additionally, in
connection with the acquisition of First Liberty, the Company maintains a
Supplemental Retirement Plan (the Plan) for certain of the First Liberty
executive officers and directors which provides that the participants share in
the rights to the death benefits of a split-dollar life insurance policy and
provides for additional compensation to the participants, equal to any income
tax consequences related to the Plan until retirement. Additional benefits for
certain participants in the Plan are calculated as (1) the amount of the benefit
obligation increased or decreased each year by an amount equal to the annual
BOLI policy earnings less the Company's cost of funds or (2) the amount of the
benefit obligation increased by interest rates of between 11%-12%. To fund the
annual premium on the split-dollar policy and mitigate the obligations under
this Plan, the Company has purchased a bank owned life insurance (BOLI) policy
on the participants' lives.
Expense recognized during 2001, 2000, and 1999 related to the deferred
compensation and supplemental retirement plans amounted to approximately $469,
$328, and $367, respectively. The Company has recorded a liability of $2,796 and
$1,985 at December 31, 2001 and 2000, respectively. At December 31, 2001 and
2000, the Company had $3,670 and $3,509, respectively, in cash surrender value
of BOLI.
The Company has a Stock Balance Plan for non-employee directors who have
completed six months of service. The Plan is a nonqualified, noncontributory
defined benefit 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. Unrecognized prior service cost of $381
at December 31, 2001 is being amortized over 8 years. Expense related to the
Plan recognized in 2001, 2000, and 1999, approximated $4, $9, and $20,
respectively. The accrued pension liability was approximately $283 and $349 at
December 31, 2001 and 2000, respectively. The net periodic pension cost was
calculated using discount rates of 6.75% and 7.00% and stock price appreciation
of 10.00% and 6.00% in 2001 and 2000, respectively.
57
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 2,537,000 shares of the
Company's common stock. All options granted under these programs have ten-year
terms and vest and become fully exercisable at the end of five years of
continued employment. In addition, The Company grants options as an offset to
its Stock Balance Plan for non-employee directors (See Note K). The options vest
immediately and expire at the date the director retires. Activity in these plans
for 2001, 2000, and 1999 was as follows:
Weighted
Average
Exercise
Price
Options Range of Option Shares Shares
Outstanding Price Per Share Exercisable Outstanding
- ------------------------------------------------------------------------------------------------
Outstanding at December 31, 1998 533,753 $ 6.75 - $35.31 360,246 $24.70
Granted 130,379 $25.38 - $29.31
Exercised / (cancelled), net (34,117) $12.13 - $19.13
Forfeited (1,085)
- ------------------------------------------------------------------------------------------------
Outstanding at December 31, 1999 628,930 $ 6.75 - $35.31 424,692 $25.08
Granted 150,491 $23.13
Exercised / (cancelled), net (2,777) $13.13 - $35.31
Forfeited (2,218)
- ------------------------------------------------------------------------------------------------
Outstanding at December 31, 2000 774,426 $ 6.75 - $34.81 542,703 $24.57
Granted 272,979 $24.90
Exercised / (cancelled), net (65,851) $ 7.50 - $26.50
Forfeited (5,488)
- ------------------------------------------------------------------------------------------------
Outstanding at December 31, 2001 976,066 $ 6.75 - $34.81 652,114 $25.37
================================================================================================
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 based accounting provision of SFAS No. 123 results in the following
pro forma amounts of net income and earnings per share:
- ------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------
Net Income:
As reported $ 19,129 $ 24,899 $ 23,662
Pro forma 18,307 24,240 23,111
Earnings per share:
As reported:
Basic $ 1.64 $ 2.34 $ 2.20
Diluted $ 1.62 $ 2.32 $ 2.18
Pro forma:
Basic $ 1.57 $ 2.28 $ 2.15
Diluted $ 1.55 $ 2.26 $ 2.13
============================================================
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 2001, 2000 and 1999: risk-free interest rates by grant of 5.11%
during 2001, 4.65% to 6.93% during 2000, and 4.65% to 5.78% during 1999;
dividend yields of 3.00% during 2001, 2000 and 1999; volatility factors of the
expected market price of the Company's common stock of 28.14% for 2001, 29.15%
for 2000 and 30.78% for 1999; and a weighted-average expected life of the option
of 7.02 years in 2001, 7.11 in 2000 and 6.70 for 1999.
58
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,
2001 the weighted average information for outstanding and exercisable shares is
as follows:
Options Outstanding
- ----------------------------------------------------------------------------
Weighted Average Options Exercisable
- ----------------------------------------------------------------------------
Weighted
Average
Range of Exercise Remaining Exercise
Exercise Price Shares Price Life (years) Shares Price
- ----------------------------------------------------------------------------
$ 6.75 - $ 7.06 2,000 $ 6.75 0.0 2,000 $ 6.75
$10.59 - $14.13 33,870 $ 12.78 3.4 33,870 $ 12.78
$14.13 - $17.66 97,039 $ 15.37 3.5 97,039 $ 15.37
$17.66 - $21.19 75,570 $ 19.13 5.0 75,570 $ 19.13
$21.19 - $24.72 142,306 $ 23.13 8.0 68,673 $ 23.13
$24.72 - $28.25 274,022 $ 24.91 8.9 90,017 $ 24.77
$28.25 - $31.78 205,013 $ 30.11 6.6 138,699 $ 30.19
$31.78 - $34.81 146,246 $ 34.81 10.5 146,246 $ 34.81
- ----------------------------------------------------------------------------
Total / Average 976,066 $ 25.37 7.5 652,114 $ 25.27
============================================================================
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. As of December 31, 2001 and 2000
there were 31,473 and 25,239 shares credited to participant accounts, for which
a liability of $933 and $769 was accrued, respectively. The expense recognized
under this plan for the years ended December 31, 2001, 2000 and 1999 was $164,
$130, and $146, respectively.
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:
Per share
Income Shares amount
- --------------------------------------------------------------------------
2001 Net Income $ 19,129
Basic EPS 19,129 11,681 $ 1.64
Effect of dilutive
securities:
Stock options 144
------------------
Diluted EPS $ 19,129 11,825 $ 1.62
==========================================================================
2000 Net Income $ 24,899
Basic EPS 24,899 10,629 $ 2.34
Effect of dilutive
securities:
Stock options 108
------------------
Diluted EPS $ 24,899 10,737 $ 2.32
==========================================================================
1999 Net Income $ 23,662
Basic EPS 23,662 10,755 $ 2.20
Effect of dilutive
securities:
Stock options 106
------------------
Diluted EPS $ 23,662 10,861 $ 2.18
==========================================================================
For the year ended December 31, 2001 basic and diluted earnings per share before
extraordinary item was $1.77 and $1.75, respectively.
59
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.
Financial instruments whose contract amounts represent credit risk are as
follows at December 31:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Financial instruments whose contract
amounts represent credit risk at December 31:
Letters of credit $ 18,059 $ 18,682
Commitments to make or purchase loans
or to extend credit on lines of credit 336,218 226,285
- --------------------------------------------------------------------------------
Total $354,277 $244,967
================================================================================
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 evaluated each customer's credit
worthiness 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 $3,900 at December 31,
2001 and 2000. The Company has additional unused borrowing capacity of
approximately $260,000 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, 2001 was $34,063, of which $2,000
was required to be on deposit with the Federal Reserve Bank of New York. The
remaining $32,063 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 $1,620,
$1,014 and $991 in 2001, 2000 and 1999, respectively. The future minimum rental
commitments as of December 31, 2001 for all noncancelleable operating leases are
as follows:
2002 $ 1,483
2003 1,341
2004 1,127
2005 750
2006 627
Thereafter 2,555
- ------------------------
$ 7,883
========================
60
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, 2001 and December
31, 2000, 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, 2001:
Total Core Capital
(to Risk Weighted Assets) $212,391 12.57% $135,154 8.00% $168,943 10.00%
Tier I Capital
(to Risk Weighted Assets) $189,493 11.22% $ 67,577 4.00% $101,366 6.00%
Tier I Capital
(to Average Assets) $189,493 6.69% $113,268 4.00% $141,585 5.00%
As of December 31, 2000:
Total Core Capital
(to Risk Weighted Assets) $189,903 12.08% $125,790 8.00% $157,237 10.00%
Tier I Capital
(to Risk Weighted Assets) $170,415 10.84% $ 62,867 4.00% $ 94,300 6.00%
Tier I Capital
(to Average Assets) $170,415 6.75% $100,963 4.00% $126,204 5.00%
=================================================================================================================
61
NOTE Q: PARENT COMPANY STATEMENTS
Condensed financial statement information of the parent company is as follows:
CONDENSED BALANCE SHEETS
December 31 December 31
2001 2000
- --------------------------------------------------------------------------------
Assets:
Cash and cash equivalents $ 12,921 $ 323
Investment securities 605 895
Investment in and advances to
subsidiaries 346,980 239,683
Other assets 311 1,295
- --------------------------------------------------------------------------------
Total assets $360,735 $242,196
================================================================================
Liabilities:
Accrued interest and other liabilities $ 6,377 $ 3,553
Borrowings 86,378 36,852
Shareholders' equity 267,980 201,791
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $360,735 $242,196
================================================================================
CONDENSED STATEMENTS OF INCOME
Years Ended December 31
- ------------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------------
Revenues:
Dividends from subsidiaries $18,373 $14,046 $23,139
Interest on investments and deposits 57 40 40
- ------------------------------------------------------------------------------------
Total revenues 18,430 14,086 23,179
- ------------------------------------------------------------------------------------
Expenses:
Interest on long term notes and debentures 5,041 3,450 3,025
Other expenses 48 25 19
- ------------------------------------------------------------------------------------
Total expenses 5,089 3,475 3,044
- ------------------------------------------------------------------------------------
Income before tax benefit and equity in undistributed
net income of subsidiaries 13,341 10,611 20,135
Income tax benefit 1,419 1,000 900
- ------------------------------------------------------------------------------------
Income before equity in undistributed net income
of subsidiaries 14,760 11,611 21,035
Equity in undistributed net income of subsidiary banks 4,369 13,288 2,627
- ------------------------------------------------------------------------------------
Net income $19,129 $24,899 $23,662
====================================================================================
62
STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash, Cash Equivalents, and Noncash Activities
Years Ended December 31
- -----------------------------------------------------------------------------------------------
2001 2000 1999
- -----------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 19,129 $ 24,899 $ 23,662
Adjustments to reconcile net income to net cash provided
by operating activities
Equity in undistributed net income of subsidiaries (4,369) (13,288) (2,627)
Net change in other assets and accrued liabilities 5,109 (1,162) 702
- -----------------------------------------------------------------------------------------------
Net cash provided by operating activities 19,869 10,449 21,737
- -----------------------------------------------------------------------------------------------
Investing Activities:
Purchase of available-for-sale investment securities (210) (74) (178)
Sale of available-for-sale investment securities 500 -- --
Capital contributions of subsidiaries (80,399) (569) (4,847)
- -----------------------------------------------------------------------------------------------
Net cash used in investing activities (80,109) (643) (5,025)
- -----------------------------------------------------------------------------------------------
Financing Activities:
Net change in loans to subsidiaries -- -- (7,360)
Net change in short term borrowings -- 2,100 4,000
Proceeds from junior subordinated debentures 50,981 -- --
Issuance of common stock, net of issuance costs 32,837 29 396
Repurchase of treasury stock -- (2,287) (5,567)
Cash dividends (10,980) (9,998) (9,463)
- -----------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 72,838 (10,156) (17,994)
- -----------------------------------------------------------------------------------------------
Change in cash and cash equivalents 12,598 (350) (1,282)
Cash and cash equivalents at beginning of year 323 673 1,955
- -----------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 12,921 $ 323 $ 673
===============================================================================================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 3,883 $ 3,439 $ 3,022
===============================================================================================
Supplemental disclosures of noncash financing
activities
Dividends declared and unpaid $ 3,482 $ 1,888 $ 1,773
===============================================================================================
On November 16, 2001 and December 12, 2001 the Company issued 1,200,000 and
108,800 shares of common stock at a price of $26.35. Proceeds from the issuance
of common stock, net of issuance costs were $32,064.
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 stated exercise price. The rights
expire in February 2005 and may be redeemed by the Company in whole at a price
of $.01 per right.
63
Report of Independent Accountants
Board of Directors and Shareholders
Community Bank System, Inc.
In our opinion, the accompanying consolidated statements of condition and the
related consolidated statements of income, changes in shareholders' equity and
of cash flows present fairly, in all material respects, the financial position
of Community Bank System, Inc. and Subsidiaries at December 31, 2001 and 2000,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. 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
auditing standards generally accepted in the United States of America, 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 principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Syracuse, New York
January 28, 2002
64
TWO YEAR SELECTED QUARTERLY DATA
2001 RESULTS 1st 2nd 3rd 4th
(Dollars in Thousands) Quarter Quarter Quarter(1) Quarter Total
------- ------- ------- ------- -----
Net interest income $23,141 $23,080 $23,808 $26,626 $96,655
Provision for loan losses 1,326 1,415 1,579 2,777 7,097
Net interest income after
Provision for loan losses 21,815 21,665 22,229 23,849 89,558
Total other income 6,034 6,492 9,659 6,898 29,083
Total other expense 19,915 24,806 20,370 23,948 89,039
-------------------------------------------------
Income before income taxes and extraordinary item 7,934 3,351 11,518 6,799 29,602
Income taxes 2,185 1,241 3,493 1,972 8,891
-------------------------------------------------
Income before extraordinary item 5,749 2,110 8,025 4,827 20,711
Extraordinary loss on early retirement of long term
borrowings, net of tax benefit of $1,077 -- -- 1,582 -- 1,582
-------------------------------------------------
Net income $ 5,749 $ 2,110 $ 6,443 $ 4,827 $19,129
=================================================
Basic income per share:
Income before extraordinary item $ 0.51 $ 0.18 $ 0.69 $ 0.39 $ 1.77
Net income $ 0.51 $ 0.18 $ 0.56 $ 0.39 $ 1.64
Diluted income per share:
Income before extraordinary item $ 0.50 $ 0.18 $ 0.68 $ 0.39 $ 1.75
Net income $ 0.50 $ 0.18 $ 0.55 $ 0.39 $ 1.62
=======================================================================================================
2000 RESULTS 1st 2nd 3rd 4th
(Dollars in Thousands) Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
Net interest income $22,769 $22,674 $22,338 $22,652 $90,433
Provision for loan losses 1,389 1,887 2,308 2,138 7,722
-------------------------------------------------
Net interest income after
Provision for loan losses 21,380 20,787 20,030 20,514 82,711
Total other income 4,515 5,920 6,523 6,167 23,125
Total other expense 16,974 17,747 17,724 18,489 70,934
-------------------------------------------------
Income before income taxes
8,921 8,960 8,829 8,192 34,902
Income taxes 2,535 2,564 2,529 2,375 10,003
-------------------------------------------------
Net income $ 6,386 $ 6,396 $ 6,300 $ 5,817 $24,899
=================================================
Earnings per share - Basic $ 0.60 $ 0.60 $ 0.60 $ 0.55 $ 2.34
Earnings per share - Diluted $ 0.60 $ 0.59 $ 0.59 $ 0.54 $ 2.32
=======================================================================================================
(1) The 3rd quarter 10Q previously netted reported prepayment penalties of
$2,659 incurred on the early retirement of long-term borrowings against
investment security gain (loss), net. The 3rd quarter information has been
restated to reflect these penalties as an extraordinary loss, net of tax benefit
in accordance with generally accepted accounting principles. The effect of this
restatement was to increase amounts previously reported for other income by
$2,659, decrease income before extraordinary item by $834 and increase basic and
diluted earnings per share before extraordinary item by $.13. There was no
impact on net income as previously reported, nor any effect on cash flows or
financial condition.
Item 9. Changes in and Disagreements with Accounting and Financial Disclosure
None
65
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 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 sections entitled "Nominees for Director and Directors Continuing in Office"
and "Security Ownership of Certain Beneficial Owners" in the Company's Proxy
Statement to be filed with respect to its 2002 annual shareholders meeting.
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.
66
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, 2001 and 2000
- Consolidated Statements of Income --
Years ended December 31, 2001, 2000, and 1999
- Consolidated Statements of Changes in Shareholders' Equity --
Years ended December 31, 2001, 2000, and 1999
- Consolidated Statement of Cash Flows --
Years ended December 31, 2001, 2000, and 1999
- Notes to Consolidated Financial Statements --
December 31, 2001
- Independent Accountant's Report
- Quarterly selected data --
Years ended December 31, 2001 and 2000 (unaudited)
2. Schedules are omitted since the required information is either not
applicable or shown elsewhere in the financial statements.
3. Listing of Exhibits
(21) List of the Company's Subsidiaries
Subsidiaries of the Company
Name Jurisdiction of Incorporation
---- -----------------------------
Community Bank, N.A. New York
Community Capital Trust I Delaware
Community Capital Trust II Delaware
Community Statutory Trust III Connecticut
Community Financial Services, Inc. New York
Benefit Plans Administrative Services, Inc. New York
CBNA Treasury Management Corporation New York
Community Investment Services, Inc. New York
CBNA Preferred Funding Corp. Delaware
CFSI Close-Out Corp. New York
Elias Asset Management, Inc. Delaware
First Liberty Service Corporation Delaware
(23) Consent of PricewaterhouseCoopers LLP
B. Reports on Form 8-K
Report on 8-K/A was filed on October 24, 2001. It amends Exhibits 99.1 and
99.2 of the Form 8-K dated August 31, 2001.
C. See Exhibit 14(a)(3) above.
D. See Exhibit 14(a)(2) above
67
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 20, 2002
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 20th day of March 2002.
Name
/s/ James A. Gabriel
- ----------------------------------
James A. Gabriel, Director and
Chairman of the Board of Directors
/s/ David G. Wallace
- ----------------------------------
David G. Wallace
Treasurer
Directors:
/s/ John M. Burgess
- ----------------------------------
John M. Burgess, Director
/s/ Paul M. Cantwell, Jr.
- ----------------------------------
Paul M. Cantwell, Jr., 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/ Harold S. Kaplan
- ----------------------------------
Harold S. Kaplan, Director
/s/ Saul Kaplan
- ----------------------------------
Saul Kaplan, Director
/s/ David C. Patterson
- ----------------------------------
David C. Patterson, Director
/s/ Peter A. Sabia
- ----------------------------------
Peter A. Sabia, Director
/s/ William N. Sloan
- ----------------------------------
William N. Sloan, Director
68