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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, 2002
Commission file number 0-11716
[LOGO]
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
New York Stock Exchange
(Name of Each Exchange on Which Registered)
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. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on June 28, 2002, determined using the closing price per share on
that date of $32.25, as reported on the New York Stock Exchange was
$380,747,918.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
13,017,035 shares of Common Stock, no par value, were
outstanding on March 17, 2003.
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.
Portions of Definitive Proxy Statement for Annual Meeting of Shareholders
to be held on May 28, 2003 (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 Stock and Related Shareholders Matters ..................... 12
Item 6. Selected Financial Data ................................................................... 12
Item 7-7A. 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 Condition .................................................. 42
Consolidated Statements of Income ..................................................... 43
Consolidated Statements of Changes in Shareholders' Equity ............................ 44
Consolidated Statements of Cash Flows ................................................. 45
Notes to Consolidated Financial Statements ............................................ 46
Report of Independent Accountants ..................................................... 66
Two Year Selected Quarterly Data .......................................................... 67
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...... 67
PART III
Item 10. Directors and Executive Officers of the Registrant ........................................ 68
Item 11. Executive Compensation .................................................................... 68
Item 12. Security Ownership of Certain Beneficial Owners and Management ............................ 68
Item 13. Certain Relationships and Related Transactions ............................................ 68
Item 14. Controls and Procedures ................................................................... 68
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K .......................... 69
Signatures ............................................................................................. 71
Certifications ......................................................................................... 72
Part I
This Annual Report on Form 10-K contains certain forward-looking statements with
respect to the financial condition, results of operations and business of
Community Bank Services, Inc. and Subsidiaries. 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 maintains a website at communitybankna.com. Annual
reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form
8-K, and amendments to those reports, are available on the Company's website
free of charge as soon as reasonably practicable following the filing of those
reports with the Securities and Exchange Commission.
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. ("CBNA" or "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 pre-existing
Canandaigua branch office loans and deposits were transferred to 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").
As required under that agreement, the Company sold three of the former Chase
Branches, located in Norwich, New Hartford, and Utica, to NBT Bank, N.A. on
December 15, 1995. On June 16, 1997 the Company acquired from Key Bank of New
York eight branches located in Alfred, Cassadaga, Clymer, Cuba, Gowanda, Ripley,
Sherman, and Wellsville in Southwestern New York State. On July 18, 1997 the
Company acquired from Fleet Bank 12 branches 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. Eight of the
former Fleet offices or existing Bank offices in Watertown (2), Boonville,
Ogdensburg (2), 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. 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
3
name to CBNA Treasury Management Corporation ("TMC"). TMC is now utilized by the
Bank to manage its Treasury function, including asset/liability, investment
portfolio, and liquidity management.
The Company also had a wholly-owned mortgage banking subsidiary, Community
Financial Services, Inc. (CFSI), which was established in June 1986; it
commenced operation in January 1987. In July 1988, CFSI purchased Salt City
Mortgage Corp., a Syracuse-based mortgage broker. CFSI 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 located in 27 states
and the Commonwealth of Puerto Rico.
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. (EAM), of
Williamsville, NY, an asset management firm with clients located in New England,
New York, Ohio and Florida. As of December 31, 2002, EAM had $405 million in
assets under management for individuals, corporate pension and profit sharing
plans, and foundations.
On May 11, 2001, the Company formed First Liberty Service Corp. (FLSC). FLSC
provides banking-related services to the Pennsylvania branches of the Bank.
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 112 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. Financial services are provided through four other customer facilities.
The corporate 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.
4
Banking Services
The Bank offers a range of commercial and retail banking services in each of its
market areas to business, individual, agricultural and government customers.
Account Services. The Bank's account services include checking accounts,
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.
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, ACH (Automated Clearing House) direct deposit,
internet and telephone banking, money market investment sweep products, 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 New
York State: the Northern Market, East Market and West Market. The Bank also
competes in one distinct banking market in 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.
New York State Markets
o Northern Market. The Northern Market is located in Northern New York
State. The Bank operates 31 customer facilities competing for loans and
deposits in the six-county market area of Lewis, St. Lawrence, Franklin,
Jefferson, Herkimer, and Oneida Counties in Northern New York State.
Within this market area, the Bank maintains a market share (1) of 10%,
among commercial banks, credit unions, savings and loan associations and
savings banks. However, in its four-county primary market area (Lewis, St.
Lawrence, Franklin, and Jefferson), the Bank has a 21.2% share. The Bank
is ranked either first or second in market share in 21 of the 24 towns
where these offices are located.
o East Market. The East Market is located primarily in the Finger Lakes
Region and Corning area of New York State. The Bank operates 35 customer
facilities competing for loans and deposits in the twelve-county market
area of Yates, Seneca, Steuben, Tioga, Schuyler, Chemung, Livingston,
Ontario, Wayne, Oswego, Cayuga, and Onondaga Counties. Within this market
area, the Bank maintains a market share (1) of approximately 4.7%, among
commercial banks, credit unions, savings and loan associations and savings
banks. However, the Bank's primary market within this region is Yates
County, where the Bank has a 36.3% share. The Bank is ranked either first
or second in market share in 18 of the 30 towns where these offices are
located.
o West Market. The West Market is located primarily in the Southern Tier
Region of New York State. The Bank operates 33 customer facilities
competing for loans and deposits in the four-county market area of
Allegany, Cattaraugus, Chautauqua, and Erie Counties in the Southern Tier
of New York State. Within this area, the Bank maintains a market share (1)
of approximately 3.3%, among commercial banks, credit unions, savings and
loan associations and savings banks. However, in its primary market area,
which excludes Erie County, the Bank has a 24.0% share. The Bank is ranked
either first or second in market share in 23 of the 27 towns where these
offices are located.
5
Pennsylvania Market. The Pennsylvania Market is located in Northeastern
Pennsylvania. The Bank operates 13 customer facilities competing for loans and
deposits in the two-county market area of Lackawanna and Luzerne Counties.
Within this market area, the Bank maintains a market share (1) of approximately
5.7%, among commercial banks, credit unions, savings and loan associations and
savings banks. The Bank is ranked either first or second in market share in 4 of
the 10 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
-----------------------------------------------------
Towns Where
CBNA CBNA
Deposits Has 1st or
Banking 6/30/2001 Market 2nd Market
County Market (000's)(1) Share Facilities ATM's Towns Position
- -------------------------------- -------------------------- -----------------------------------------------------
Allegany West $174,732 51.1% 10 8 9 9
Lewis Northern 82,604 40.5 4 1 3 3
Cattaraugus West 271,915 36.6 10 7 8 7
Yates East 83,472 36.3 3 2 2 2
Seneca East 86,783 28.0 4 3 4 3
St. Lawrence Northern 309,907 25.8 14 8 11 10
Franklin Northern 87,506 18.7 5 3 4 4
Jefferson Northern 149,412 13.7 5 5 4 2
Lackawanna PA 473,858 13.1 11 13 8 4
Steuben East 165,572 12.7 10 6 8 5
Tioga East 41,929 12.2 2 2 2 1
Schuyler East 13,756 11.8 1 1 1 0
Chautauqua West 165,071 11.8 12 9 9 6
Chemung East 13,333 11.5 1 1 1 0
Livingston East 49,096 8.2 3 3 3 2
Ontario East 80,950 7.4 4 4 3 1
Wayne East 49,863 5.8 2 1 1 0
Herkimer Northern 27,599 5.1 1 1 1 1
Oswego East 46,445 4.1 2 2 2 2
Cayuga East 27,314 3.4 2 1 2 2
Oneida Northern 56,197 1.6 2 1 1 1
Luzerne PA 21,296 0.4 2 2 2 0
Erie West 28,815 0.2 1 0 1 1
Onondaga East 9,561 0.2 1 1 1 0
- -------------------------------- ------------------------- -----------------------------------------------------
24 Total $2,516,986 5.1% 112 85 91 66
=================================================================================================================
(1) Deposit market share data as of June 30, 2001, 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, 2002, the Company employed 1,120 full-time equivalent
employees, 1,019 providing banking services and 101 providing financial
services. At year-end 2001, there were 1,115 full-time equivalent employees,
1,016 providing banking services and 99 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" section 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 provides that,
among other things, substantially all state law barriers to the acquisition of
banks by out-of-state bank holding companies are eliminated. The law also
permits interstate branching by banks. 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, 2002, the Bank had $34.4 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, 2002 were 12.07% and 13.32%,
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, 2002 was 7.05%, 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 provided
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
established 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, 2002, the
Bank's total risk-based capital ratio and Tier I risk - based capital ratio were
12.54% and 11.29%, respectively, and its Tier I leverage ratio as of such date
was 6.59%. 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 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 created "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. The Company has remained a bank holding company for the time
being and will continue to assess its options as circumstances change. The
Gramm-Leach Bliley Act also provided privacy protections to consumers by
limiting the transfer and use by financial institutions of consumer's nonpublic,
personal information.
9
Sarbanes-Oxley Act of 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 was enacted. The various
provisions of the Act are effective upon many different dates and subject to
ongoing rule making by the Securities and Exchange Commission ("SEC"). The Act
generally addresses matters relating to corporate governance, auditing and
accounting, executive compensation matters, and enhanced and timely disclosure
of corporate information. The New York Stock Exchange has also proposed
amendments to its corporate governance rules that have been presented to the SEC
for review and approval. Among the objectives of the Act and related rules are
enhancing the accountability and timely reporting of financial information by
public companies.
Item 2. Properties
The Company has 120 properties, 83 are owned and 37 are located in long-term
leased premises. Of the 120 properties, 116 are considered customer facilities.
The remaining facilities include its administrative offices at 5790 Widewaters
Parkway, DeWitt, New York, its loan and deposit operation centers located in
Olean, and Canton, New York, respectively, and a training center located in
Ogdensburg, New York.
Real property and related banking facilities owned by the Company at December
31, 2002 had a net book value of $39.3 million and none of the properties was
subject to any encumbrances. For the year ended December 31, 2002, rental fees
of $1,896,000 were paid on facilities leased by the Company for its operations.
Item 3. Legal Proceedings
The Company and its subsidiaries are subject in the normal course of business to
various pending and threatened legal proceedings to various pending and
threatened legal proceedings in which claims for monetary damages are asserted.
Management, after consultation with legal counsel, does not anticipate that the
aggregate liability, if any, arising out of litigation pending against the
Company or its subsidiaries will have a material effect on the Company's
consolidated financial position.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of the shareholders during the quarter
ended December 31, 2002.
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 60 Officer of the Company and the Bank
David G. Wallace Treasurer of the Company and Executive
Age 58 Vice President and Chief Financial
Officer of the Bank
Michael A. Patton President, Financial Services
Age 57
James A. Wears President, Banking
Age 53
David J. Elias President, Chief Executive Officer, and
Age 57 Chief Investment Officer, Elias Asset
Management, Inc.
Steven R. Tokach President, First Liberty Bank & Trust
Age 56
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. Mr. Wallace has elected to take early retirement from
the Company. He will continue to serve as the Company's Chief Financial Officer
until mid-year 2003 as an appropriate transition plan is completed and will be
available under a consulting agreement throughout fiscal year 2004.
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 acquired 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 1993-1998, served as
Executive Vice President of Guaranty Bank, N.A. and Vice President of First
Eastern Bank, both in Pennsylvania.
11
Part II
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters
The Company's common stock has been trading on the New York Stock Exchange under
the symbol "CBU" since December 31, 1997. Prior to that, the common stock traded
over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning
on September 16, 1986. 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 12,978,554 shares of common stock outstanding on
December 31, 2002, 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
- --------------------------------------------------------------------------------
Closing Price
----------------
Year / High Low % Quarterly
Qtr Price Price Amount Change Dividend
- --------------------------------------------------------------------------------
2002
4th .................. $33.09 $27.20 $31.35 5.8% $0.29
3rd .................. $32.55 $26.50 $29.63 -8.1% $0.29
2nd .................. $34.21 $29.80 $32.25 7.0% $0.27
1st .................. $30.32 $25.93 $30.15 15.1% $0.27
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
The Company has historically paid regular quarterly cash dividends on its common
stock, and declared a cash dividend of $0.29 per share for the first quarter of
2003. The Board of Directors of the Company presently intends to continue the
payment of regular quarterly cash dividends on the common stock, as well as to
make payment of regularly scheduled dividends on the trust preferred stock when
due, subject to the Company's need for those funds. However, because
substantially all of the funds available for the payment of dividends by the
Company are derived from the Bank, future dividends will depend upon the
earnings of the Bank, its financial condition, its need for funds and applicable
governmental policies and regulations. 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, 2002. The historical "Income Statement Data" and historical
"Balance Sheet Data" are derived from the audited financial statements. The "
Common 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
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
In thousands except share and per share data 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Income Statement Data:
Interest income ........................................... $ 204,870 $ 197,850 $ 189,574 $ 166,490 $ 165,303
Interest expense .......................................... 77,020 101,195 99,141 78,490 81,216
Net interest income ....................................... 127,850 96,655 90,433 88,000 84,087
Provision for loan losses ................................. 12,222 7,097 7,722 5,856 5,663
Net interest income after provision for loan losses ....... 115,628 89,558 82,711 82,144 78,424
Noninterest income ........................................ 30,927 26,504 23,284 18,153 16,812
Net investment security gains (losses) & loss on
early retirement of long-term borrowings ................ 1,673 (113) (159) (413) 2,006
Noninterest expense ....................................... 89,171 74,163 65,643 62,055 61,389
Amortization of intangible assets ......................... 5,953 6,679 4,891 4,723 4,748
Acquisition and unusual expenses .......................... 700 8,164 400 0 1,098
Income before income taxes ................................ 52,404 26,943 34,902 33,106 30,007
Provision for income taxes ................................ 13,887 7,814 10,003 9,444 10,472
Net income before cumulative effect of change in
accounting principle .................................... 38,517 19,129 24,899 23,662 19,535
Cumulative effect of change in accounting principle ....... 0 0 0 0 194
Net income ........................................... $ 38,517 $ 19,129 $ 24,899 $ 23,662 $ 19,729
Net income - Operating (1) ........................... $ 38,942 $ 24,052 $ 25,136 $ 23,662 $ 20,378
Net income - Cash (2) ................................ $ 42,133 $ 23,474 $ 27,795 $ 26,480 $ 22,562
Net income - Cash Operating (3) ...................... $ 42,558 $ 28,397 $ 28,032 $ 26,480 $ 23,211
Balance Sheet Data:
Total assets .............................................. $ 3,434,204 $ 3,210,833 $ 2,650,673 $ 2,493,977 $ 2,296,059
Loans, net of unearned discount ........................... 1,806,905 1,732,870 1,515,877 1,425,773 1,293,135
Earning assets (Excl. MVA) (5) ............................ 3,026,159 2,863,944 2,435,604 2,295,871 2,079,876
Intangible assets ......................................... 134,828 142,342 55,234 54,150 54,438
Total deposits ............................................ 2,505,356 2,545,970 1,948,557 1,844,752 1,874,666
Long-term borrowings ...................................... 215,000 231,000 240,000 145,567 155,470
Trust preferred securities ................................ 77,375 77,819 29,824 29,817 29,810
Shareholders' equity ...................................... $ 325,038 $ 267,980 $ 201,791 $ 165,705 $ 179,073
Common Per Share Data:
Net income (diluted) ...................................... $ 2.93 $ 1.62 $ 2.32 $ 2.18 $ 1.75
Net income - operating (1) (diluted) ...................... $ 2.96 $ 2.03 $ 2.34 $ 2.18 $ 1.81
Net income - cash (2) (diluted) ........................... $ 3.20 $ 1.99 $ 2.59 $ 2.44 $ 2.00
Net income - cash operating (3) (diluted) ................. $ 3.23 $ 2.40 $ 2.61 $ 2.44 $ 2.06
Cash dividends declared ................................... $ 1.12 $ 1.08 $ 1.04 $ 0.96 $ 0.86
Book value - stated ....................................... $ 25.04 $ 20.77 $ 19.11 $ 15.55 $ 16.50
Book value - tangible ..................................... $ 14.66 $ 9.74 $ 13.88 $ 10.47 $ 11.02
Common Outstanding Shares:
Average during period (Incl. common stock
equivalents) ............................................ 13,166,954 11,824,589 10,737,000 10,861,000 11,260,000
End of period (Excl. common stock equivalents) ............ 12,978,554 12,902,812 10,559,897 10,657,770 10,855,964
Selected Performance Ratios:
Return on average total assets ............................ 1.14% 0.66% 0.97% 1.00% 0.87%
Return on average total assets - operating (1) ............ 1.15% 0.83% 0.98% 1.00% 0.90%
Return on average total assets - cash (2) ................. 1.24% 0.81% 1.09% 1.12% 0.99%
Return on average total assets - cash
operating (3) ........................................... 1.26% 0.98% 1.10% 1.12% 1.02%
Return on average common shareholders' equity ............. 13.06% 7.99% 14.27% 13.56% 11.11%
Return on average common shareholders' equity -
operating (1) ........................................... 13.21% 10.05% 14.40% 13.56% 11.47%
Return on average common shareholders' equity -
cash (2) ................................................ 14.29% 9.81% 15.93% 15.18% 12.70%
Return on average common shareholders' equity -
cash operating (3)....................................... 14.43% 11.86% 16.06% 15.18% 13.07%
Common dividend payout ratio .............................. 37.7% 65.7% 40.6% 40.4% 44.9%
Net interest margin (taxable equivalent basis) ............ 4.63% 3.97% 4.06% 4.32% 4.14%
Noninterest income to operating income (taxable
equivalent basis and excludes security
gains/losses and branch dispositions) ................... 17.9% 20.4% 19.3% 16.2% 16.3%
Efficiency ratio (4) ...................................... 52.5% 56.6% 54.6% 55.5% 59.7%
Loans, net of unearned discount, to deposits at
period end .............................................. 72.1% 68.1% 77.8% 77.3% 69.0%
Asset Quality Ratios:
Nonperforming loans to total loans ........................ 0.64% 0.53% 0.49% 0.51% 0.48%
Nonperforming assets to total loans and other real
estate owned ............................................ 0.69% 0.61% 0.58% 0.62% 0.62%
Nonperforming assets to total assets ...................... 0.36% 0.33% 0.33% 0.36% 0.35%
Allowance for loan losses to loans ........................ 1.46% 1.38% 1.32% 1.30% 1.32%
Allowance for loan losses to nonperforming loans .......... 226.1% 262.6% 270.6% 253.4% 276.4%
Net charge-offs to average total loans .................... 0.56% 0.42% 0.42% 0.33% 0.45%
Capital Ratios:
Total shareholders' equity to total assets ................ 9.46% 8.35% 7.61% 6.64% 7.80%
Tangible equity to tangible assets ....................... 5.77% 4.09% 5.65% 4.57% 5.56%
Tier I capital to risk-adjusted assets .................... 12.07% 10.53% 10.49% 10.87% 10.18%
Total risk-based capital to risk-adjusted assets .......... 13.32% 11.83% 11.70% 12.10% 11.43%
Tier I leverage ratio ..................................... 7.05% 6.73% 6.67% 6.76% 6.27%
(1) Operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings, and
accordingly, are not presented in accordance with Generally Accepted
Accounting Principles (GAAP).
(2) Cash adjusted amounts and ratios exclude the after-tax effect of
amortization of intangible assets and, accordingly, are not presented in
accordance with GAAP.
(3) Cash operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings and
amortization of intangible assets, and accordingly, are not presented in
accordance with GAAP.
(4) Efficiency ratio excludes acquisition and unusual expenses and
amortization of intangible assets.
(5) Market value adjustment
13
- ------------------------------------------------------------------------------------------------------------------------------------
TWO YEAR SELECTED QUARTERLY DATA
2002 RESULTS 1st 2nd 3rd 4th
(000's omitted, except per share data) Quarter(4) Quarter(4) Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income ............................................. $30,168 $ 31,438 $32,397 $ 33,847 $ 127,850
Provision for loan losses ....................................... 1,518 3,385 2,278 5,041 12,222
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ............. 28,650 28,053 30,119 28,806 115,628
Other income .................................................... 7,735 7,567 7,872 7,753 30,927
Net investment security gains and loss on early
retirement of long-term borrowings ............................ 0 1,144 216 313 1,673
Other expense ................................................... 22,517 22,467 21,472 22,715 89,171
Amortization of intangible assets ............................... 1,540 1,504 1,597 1,312 5,953
Acquisition and unusual expenses ................................ 592 108 0 0 700
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ...................................... 11,736 12,685 15,138 12,845 52,404
Provision for income taxes ...................................... 3,178 3,416 4,087 3,206 13,887
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ...................................................... $ 8,558 $ 9,269 $11,051 $ 9,639 $ 38,517
====================================================================================================================================
Net income - operating (1) ...................................... $ 8,918 $ 9,335 $11,051 $ 9,639 $ 38,942
Net income - cash (2) ........................................... $ 9,494 $ 10,182 $12,021 $ 10,436 $ 42,133
Net income - cash operating (3) ................................. $ 9,854 $ 10,248 $12,021 $ 10,436 $ 42,558
Basic net income per share ...................................... $ 0.67 $ 0.71 $ 0.85 $ 0.74 $ 2.97
Diluted income per share:
Net income .................................................... $ 0.65 $ 0.70 $ 0.84 $ 0.73 $ 2.93
Net income - operating (1) .................................... $ 0.68 $ 0.71 $ 0.84 $ 0.73 $ 2.96
Net income - cash (2) ......................................... $ 0.73 $ 0.77 $ 0.91 $ 0.79 $ 3.20
Net income - cash operating (3) ............................... $ 0.75 $ 0.78 $ 0.91 $ 0.79 $ 3.23
====================================================================================================================================
2001 RESULTS 1st 2nd 3rd 4th
(000's omitted, except per share data) Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income ............................................. $23,140 $ 23,080 $23,809 $ 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 ............. 21,814 21,665 22,230 23,849 89,558
Other income .................................................... 5,983 6,623 6,981 6,917 26,504
Net investment security gains (losses) and loss on
early retirement of long-term borrowings ...................... 9 (138) 29 (13) (113)
Other expense ................................................... 17,561 18,622 18,209 19,771 74,163
Amortization of intangible assets ............................... 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 ...................................... 7,934 3,351 8,859 6,799 26,943
Provision for income taxes ...................................... 2,185 1,241 2,416 1,972 7,814
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ...................................................... $ 5,749 $ 2,110 $ 6,443 $ 4,827 $ 19,129
====================================================================================================================================
Net income - operating (1) ...................................... $ 6,250 $ 4,950 $ 6,800 $ 6,052 $ 24,052
Net income - cash (2) ........................................... $ 6,681 $ 3,118 $ 7,450 $ 6,225 $ 23,474
Net income - cash operating (3) ................................. $ 7,182 $ 5,957 $ 7,808 $ 7,450 $ 28,397
Basic net 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 (1) .................................... $ 0.54 $ 0.42 $ 0.58 $ 0.49 $ 2.03
Net income - cash (2) ......................................... $ 0.58 $ 0.27 $ 0.63 $ 0.50 $ 1.99
Net income - cash operating (3) ............................... $ 0.63 $ 0.51 $ 0.67 $ 0.60 $ 2.40
====================================================================================================================================
(1) Operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings, and
accordingly, are not presented in accordance with Generally Accepted
Accounting Principles (GAAP).
(2) Cash adjusted amounts and ratios exclude the after-tax effect of
amortization of intangible assets and, accordingly, are not presented in
accordance with GAAP.
(3) Cash operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings and
amortization of intangible assets, and accordingly, are not presented in
accordance with GAAP.
(4) The consolidated statements of income for the three months ended March 31
and June 30, 2002 were restated for the adoption of SFAS No. 147. The
effect of this restatement was to increase amounts previously reported for
net income by $1,122 and $1,090, basic income per share by $.09 and $.08,
and diluted income per share by $.08 and $.08, respectively.
14
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations and Quantitative and Qualitative Disclosures about Market Risk
Introduction
This Management's Discussion and Analysis ("MD&A") primarily reviews the
financial condition and results of operations of Community Bank System, Inc.,
and its subsidiaries for the past two years, although in some circumstances a
period longer than two years is covered in order to comply with Securities and
Exchange Commission disclosure requirements or to more fully explain long-term
trends. The following discussion and analysis should be read in conjunction with
the Selected Consolidated Financial Information on pages 13 and 14 and the
Company's Consolidated Financial Statements and related notes that appear on
pages 42 through 65. 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. Unless otherwise noted, all
earnings per share ("EPS") figures disclosed in the MD&A refer to diluted EPS.
All financial results reflect the 2001 acquisition of First Liberty Bank Corp.
("First Liberty") in accordance with pooling of interest accounting, unless
otherwise noted. All references to "peer banks", unless otherwise noted, pertain
to a group of 74 bank holding companies nationwide having $3 billion to $10
billion in assets and their associated composite financial results for the nine
months ending September 30, 2002 (the most recently available disclosure) as
provided by the Federal Reserve System. Lastly, unless otherwise noted, the term
"this year" refers to results in calendar year 2002.
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" on page 41.
Accounting Policies
As a result of the complex and dynamic nature of the Company's business,
management must exercise judgement in selecting and applying the most
appropriate accounting policies for its various areas of operations. The policy
decision process not only ensures compliance with the latest generally accepted
accounting principles, but also reflects on management's discretion with regard
to choosing the most suitable methodology for reporting the Company's financial
performance. It is management's opinion that the accounting estimates covering
certain aspects of the business have more significance than others due to the
relative importance of those areas to overall performance, or the level of
subjectivity in the selection process. Management believes that these areas
include the allowance for loan losses, fair value of investment securities, fair
value methodologies used to review the carrying value of goodwill, and actuarial
assumptions associated with the pension, post-retirement and other employee
benefit plans. The accounting policies for the first three items are disclosed
in Note A (Summary of Significant Accounting Policies) starting on page 46.
Pension, post-retirement and other benefits assumptions are reported in Note K
on pages 59 and 60. It is important to review all accounting policies in Note A
in order to better understand the performance of CBSI as reported in this
document.
Net Income and Profitability
Net income for the year ended December 31, 2002 was $38.5 million, up $19.4
million or 101% from the prior year. 2002 earnings per share of $2.93 were 81%
higher than the $1.62 earned in 2001. Results for both years include
nonrecurring costs associated with the Company's three 2001 acquisitions in
January, May, and November, which added $1.2 billion in assets and expanded its
branch network by 46. See Note B (pages 52-53) for a description of the
FleetBoston Financial ("FleetBoston"), Citizens National Bank of Malone
("Citizens"), and First Liberty Bank Corp. ("First Liberty" or "FLIB")
acquisitions. Acquisition and unusual expenses associated with these
transactions reduced earnings by $0.03 per share in 2002 and $0.41 in 2001. This
$0.38 difference explains 29% of the $1.31 improvement in EPS between the two
years.
The 2002 results include the benefit of adopting SFAS 147, an accounting
standard that eliminates the regular amortization of goodwill related to the
Company's branch acquisitions, and SFAS 142, which eliminates the requirement to
regularly amortize approximately $19.8 million in goodwill related to its
whole-company acquisitions. SFAS 142 and SFAS 147 were effective January 1, 2002
and increased current year earnings per share by $0.06 and $0.28, respectively.
Net income and earnings per share for the year ended December 31, 2001 were
$19.1 million and $1.62, down 23% and 30%, respectively, from 2000 results. The
net income decline was primarily driven by acquisition-related expenses. In
2001, non-recurring acquisition expenses rose $7.8 million to $8.2 million, and
intangible amortization expense was up
15
$1.8 million due to the significant goodwill and deposit intangibles added as a
result of the acquisitions that were recorded under the purchase method of
accounting (Citizens and FleetBoston). 2001 earnings per share declined by a
higher percentage than net income because of 10% higher weighted average diluted
shares outstanding. 952,000 common shares were issued in conjunction with the
Company's January whole bank purchase of Citizens National Bank of Malone, and
1.3 million shares were issued in the fourth quarter of 2001 to partially fund
the mid-November purchase of 36 branches from FleetBoston Financial.
Performance as measured by operating earnings, which exclude acquisition and
unusual expenses and various securities transactions related to acquisitions, is
considered by some securities analysts to be a more accurate reflection of the
underlying core earnings strength of a company. CBSI's operating earnings per
share for 2002 were $2.96, up 46% from the prior year's level of $2.03.
Excluding the aforementioned benefits from adopting SFAS 142 and 147 in 2002,
operating earnings per share of $2.62 this year were 29% higher than the
operating EPS generated in 2001. The resulting $0.59 improvement largely
reflects the full-year impact of the FleetBoston branch acquisition, improved
margins, a larger securities portfolio and a lower effective income tax rate.
CBSI has also historically reported its performance using another measure of
earnings power--cash earnings. Now that SFAS 142 and SFAS 147 have been adopted,
this metric has been redefined to exclude from earnings the expense of regularly
amortizing core deposit intangibles (CDI). CDI represents the premium the
Company has paid for deposits acquired in excess of the cost incurred had the
funds been purchased in the capital markets. Amortization of CDI is a non-cash
expense, and adding it back (tax-adjusted) to reported earnings creates the cash
earnings metric. Cash earnings are believed by some securities analysts to be a
better measure of a company's ability to build capital, fund expansion, and pay
shareholder dividends. CBSI's cash operating earnings per share for 2002 were
$3.23, up 35% from the prior year.
Table 1: Summary Income Statements
Years Ended Dec. 31, Change
000's omitted 2002 2001 $ %
- -----------------------------------------------------------------------------------------------
Net interest income (full tax-equiv.) ............ $139,921 $ 103,985 $ 35,936 34.6%
Loan loss provision .............................. 12,222 7,097 5,125 72.2%
Noninterest income ............................... 30,927 26,504 4,423 16.7%
Net investment security gain (loss)
& debt extinguishment .......................... 1,673 (113) 1,786 NM
Noninterest expense .............................. 95,124 80,842 14,282 17.7%
Acquisition and unusual expenses ................. 700 8,164 (7,464) -91.4%
- -----------------------------------------------------------------------------------------------
Income before taxes (full tax-equiv.) ............ 64,475 34,273 30,202 88.1%
- -----------------------------------------------------------------------------------------------
Full tax-equivalent adjustment ................... 12,071 7,330 4,741 64.7%
Income taxes ..................................... 13,887 7,814 6,073 77.7%
- -----------------------------------------------------------------------------------------------
Net income ....................................... $ 38,517 $ 19,129 $ 19,388 101.4%
===============================================================================================
Diluted earnings per share ....................... $ 2.93 $ 1.62 $ 1.31 80.9%
Diluted earnings per share-operating (1) ......... $ 2.96 $ 2.03 $ 0.93 45.8%
(1) Operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings, and
accordingly, are not presented in accordance with Generally Accepted
Accounting Principles (GAAP).
The primary factors explaining 2002 performance are discussed in detail in the
remaining sections of this document and are summarized as follows:
o As shown in Table 1 above, net interest income (full tax-equivalent basis)
increased 35% or $35.9 million due to a $401 million increase in average
earning assets and a 66 basis point improvement in the net interest
margin. The relative contribution of higher volumes and better margins was
about equal (48% versus 52%, respectively). The interest margin benefited
from the rates on deposits and borrowings declining more rapidly than the
yields earned on loans and investments in a falling rate environment.
Average loans grew $179 million (11.3%) while average investments rose
$222 million (21.3%). The growth in earning assets was funded by $416
million (19.5%) more average deposits and $24 million (5.0%) more average
borrowings. The growth in average loans and deposits was mostly
attributable to the acquisition of the 36 FleetBoston branches in November
2001 (31 branches after consolidation with existing CBSI branches).
16
o 2002 noninterest income (including net investment security gains and loss
on losses on debt extinguishment) increased by $6.2 million (23.5%) from
2001 to $32.6 million. General banking fees accounted for $3.4 million of
the improvement, as service income and the volume of overdrafts increased
due to the additional FleetBoston branches. Overdraft fee income also
benefited from a mid-year increase of the fee charged for overdrafts and
the implementation of the Overdraft FreedomTM program (described in
noninterest income section on pages 24-26). Financial services revenues
were $1.1 million higher due to strong growth at the Company's
broker-dealer business, Community Investment Services, Inc. (CISI), and at
the Company's pension administration and consulting subsidiary, Benefits
Plans Administrative Services (BPA). $2.6 million of gains on the sale of
debt instruments offset by a $925,000 prepayment penalty on the early
retirement of debt resulted in $1.8 million higher income from net
security transactions in 2002. Excluding net security transactions,
noninterest income increased for the eighth consecutive year to $30.9
million in 2002, a $4.4 million (16.7%) improvement over 2001.
o Noninterest expense or overhead (including acquisition and unusual
expenses) rose $6.8 million or 7.7% in 2002 to $95.8 million. Excluding
acquisition and unusual expenses in both years, 2002 operating expenses
rose $14.3 million or 17.7%. Ongoing overhead expense increased due to the
full-year impact of the Company's mid-November 2001 acquisition of the
FleetBoston branches. In addition, incremental costs were temporarily
incurred as a result of consolidating the Bank's regional loan and deposit
operations centers into two centralized locations. Efficiency steadily
improved in 2002 as integration of the acquisitions and the benefits of
streamlined operations were more fully realized in the second half of the
year.
o Loan loss provision increased $5.1 million or 72% from 2001's level. The
full year loan loss provision covered total actual net charge-offs by 1.25
times. Net charge-offs as a percent of average loans rose 14 basis points
in 2002 to 0.56%. The primary reason for the overall increase in
charge-offs is the impact of the softening economy in the markets we
serve, including partial charge-offs on two larger commercial customers in
the second quarter of 2002 and charge-off of the remaining balance of one
these customers in the fourth quarter. The increase in the loan loss
provision reflects the higher net charge-offs, a rise in specific
commercial allowance for loan loss allocations and the annual year-end
change in the historical periods used as a basis for general reserve
allocations. Nonperforming loans increased during 2002 to 0.64% of loans
outstanding at year end compared to 0.53% one year earlier, reflecting the
weak economy. Additional information on trends and policy related to asset
quality is provided in the asset quality section on pages 32-34.
o The Company's combined effective federal and state tax rate decreased 2.5
percentage points in 2002 to 26.5%, primarily as a result of an increased
proportion of tax-exempt municipal investment holdings and higher reported
pre-tax income due to the adoptions of SFAS 142 and SFAS 147.
Selected Profitability and Other Measures
Return on average assets, return on average equity, dividend payout and equity
to asset ratios for the years indicated are as follows:
Table 2: Selected Ratios
At December 31,
----------------------------------
2002 2001 2000
----------------------------------
Percentage of net income to average total assets ............................................ 1.14% 0.66% 0.97%
Percentage of net income-operating to average total assets (1) .............................. 1.15% 0.83% 0.98%
Percentage of net income to average shareholders' equity .................................... 13.06% 7.99% 14.27%
Percentage of net income-operating to average shareholders' equity (1) ..................... 13.21% 10.05% 14.40%
Percentage of dividends declared per common share to net income per share ................... 37.7% 65.7% 40.6%
Percentage of dividends declared per common share to net income-operating per share (1) .... 37.3% 52.3% 40.2%
Percentage of average shareholders' equity to average total assets .......................... 8.70% 8.29% 6.83%
(1) Operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and for 2001, net investment security
gains (losses) and loss on early retirement of long-term borrowings, and
accordingly, are not presented in accordance with Generally Accepted
Accounting Principles (GAAP).
As displayed in Table 2 above, return on average assets improved in 2002 in
comparison to both 2001 and 2000. This was primarily a result of substantially
higher net interest margins and improved operational efficiencies. Significantly
17
improved profitability resulted in a higher return on equity in 2002 versus
2001. However, the build-up of equity capital over the last two years from the
retention of net profits and common share offerings in conjunction with the
Company's 2001 acquisitions led to a lower return on equity in 2002 than 2000,
despite 55% higher net income. The strengthening of the Company's equity capital
position is also reflected in the 146 and 41 basis point increases in the
average equity to average total assets ratios in 2001 and 2002, respectively.
The dividend payout ratio spiked temporarily in 2001 due to lower earnings as a
result of acquisition-related expenses, an increased number of shares, and the
full year impact of a $0.02 per share increase in the dividend in the third
quarter of 2000. The dividend payout ratio for 2002 was below the 2000 level as
a result of net income growing at a higher compounded annual growth rate (24.4%)
than dividends (19.8%) during this period. This reflects management's emphasis
on enhancing the Company's capital position to support future internal and
external growth.
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 Bank'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.
As disclosed in Table 3, net interest income (with non-taxable income converted
to a full tax-equivalent basis) totaled $139.9 million in 2002; this represents
a $35.9 million or 35% increase over the prior year. The increase was due to
improved margins and net increase in interest-bearing balances, which had
positive impacts of $18.8 million and $17.2 million on net interest income,
respectively.
As shown in Tables 3 and 4, gross interest income on loans and investments grew
by $11.8 million or 5.7% in 2002 as a result of $400.9 million higher average
earning assets, which contributed $29.7 million, partially offset by $17.9
million related to lower rates. Average loans grew a total of $178.7 million in
2002, with the most significant portion occurring as a result of the November
2001 acquisition of $177 million of loans associated with the FleetBoston
branches. Interest and fees on loans decreased $905,000 or 0.7%. A 90 basis
point drop in yields due to falling capital market rates had more of an impact
(negative $15.1 million) than growth in average loans (positive $14.2 million).
Despite a falling rate environment, the steepening yield curve in the first half
of 2002 resulted in widening spreads for investments over cost of funds. This
situation created favorable opportunities to expand the Company's investment
portfolio, which was increased $132 million in the first quarter and $99 million
in the second quarter on an average balance basis. This expansion was primarily
funded through external borrowings. The investment portfolio was held relatively
flat in the third quarter, and in the fourth quarter of 2002 management decided
to allow the investment portfolio to run off, using the proceeds to pay down
borrowings due to the lack of investment opportunities offering acceptable
yields. As a result of the aforementioned portfolio activity as well as
increased investments in the fourth quarter of 2001, average balances for 2002
increased by $222 million over the year earlier period.
Investment interest income (full tax-equivalent basis) in 2002 was $12.7 million
or 17.5% higher than the prior year as a result of the larger portfolio
(positive $15.5 million impact), partially offset by a decrease in the average
investment yield from 6.96% to 6.74% (negative $2.8 million impact), which was
driven by declining yields on taxable investment securities. This decrease was
primarily due to purchases of taxable investments in a declining market rate
environment in late 2001 and early 2002 to replace run-off and increase the
overall size of the portfolio. The yields on tax-exempt securities increased by
19 basis points in 2002 despite falling interest rates as a result of the
purchase of intermediate-term municipal securities that offered attractive
yields and lengthened the average life of the portfolio. The drop in the average
yield on the total investment portfolio was mostly due to the decrease of
taxable investment yields, which more than offset the impact of the improved
yield and higher mix (28% in 2002 versus 21% in 2001) of non-taxable
investments.
The average earning asset yield fell 65 basis points to 7.18% in 2002 because of
the previously mentioned decrease in investment and loan yields and a reduced
proportion of loans to earning assets, which decreased on average from 60.3% in
2001 to 58.2% in 2002. This decline in loan mix is a consequence of the
favorable investment opportunities outlined above as well as tempered loan
growth due to continued weak economic conditions.
Total average fundings (deposits and borrowings) grew by $439.8 million in 2002,
with $415.6 million of the increase coming from deposits, mostly attributable to
acquisition of the FleetBoston branches, and $24.1 million from increased
capital market borrowings. The additional capital market borrowings primarily
came from the issuance of approximately $50 million in floating-rate trust
preferred securities in mid 2001 in anticipation of the FleetBoston branch
acquisition.
18
Total interest expense decreased by $24.2 million to $77.0 million in 2002.
Lower market rates resulted in $37.8 million less interest expense, with higher
average interest-bearing funds offsetting this by $13.7 million. Interest
expense as a percentage of earning assets, fell by 1.31 percentage points to
2.55%. The rate on interest bearing deposits fell 1.54 percentage points to
2.56%, due largely to steady declines in time deposit rates throughout 2002 and
periodic reduction of rates on other interest-bearing deposit products. The rate
on capital market borrowings declined 1.25 percentage points to 4.58% because of
substantially lower market rates, particularly on short-term and variable-rate
funding.
CBSI's net interest margin (full tax-equivalent basis) increased by 66 basis
points from 3.97% in 2001 to 4.63% this year. The 1.51 percentage point decrease
in the rate on average interest-bearing funds had a greater impact than the 65
basis point decline in the yield on interest-earning assets. The net interest
margin increased in every quarter of 2002, ending with a 4.83% margin for the
fourth quarter, as shown in Table 5. Downward repricing of the Company's
interest-bearing deposits and falling market rates on external borrowings
combined with a relatively stable yield on the investment portfolio led to the
improvement in the net interest margin over the course of the year. The
Company's net interest margin ranked in the favorable 68th peer bank percentile
for the nine months ending September 30, 2002.
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon for the years ended December 31, 2002, 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-earning assets for purposes of
these computations.
19
Table 3: Annual Average Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------- -------------------------------- ------------------------------
Avg. Avg. Avg.
Yield/ Yield/ Yield/
(000's omitted except Avg. Amt. Of Rate Avg. Amt. of Rate Avg. Amt. Of Rate
yields and rates) Balance Interest Paid Balance Interest Paid Balance Interest Paid
- -------------------------------------------------------------------- -------------------------------- ------------------------------
ASSETS:
Interest-earning assets:
Federal funds sold ............ $ 0 $ 0 0.00% $ 4,568 $ 171 3.74% $ 7,728 $ 452 5.85%
Time deposits in other banks .. 525 6 1.14% 306 379 N/A 3,147 183 5.82%
Taxable investment
securities .................. 904,160 58,235 6.44% 820,705 56,165 6.84% 732,490 52,026 7.10%
Nontaxable investment
securities .................. 358,643 26,899 7.50% 215,567 15,759 7.31% 156,885 11,957 7.62%
Loans (net of unearned
discount) (1) ............... 1,759,564 131,801 7.49% 1,580,870 132,706 8.39% 1,484,945 131,373 8.85%
--------------------- --------------------- ---------------------
Total interest-earning
assets ................... 3,022,892 216,941 7.18% 2,622,016 205,180 7.83% 2,385,195 195,991 8.22%
Noninterest earning assets ...... 367,519 264,496 171,443
---------- ---------- ----------
Total assets ............... $3,390,411 $2,886,512 $2,556,638
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings deposits .............. $ 969,664 11,416 1.18% $ 683,088 12,783 1.87% $ 622,164 13,784 2.22%
Time deposits ................. 1,131,296 42,462 3.75% 1,100,850 60,380 5.48% 991,754 56,137 5.66%
Short-term borrowings ......... 141,024 2,586 1.83% 141,772 6,738 4.75% 258,985 16,859 6.51%
Long-term borrowings .......... 364,073 20,556 5.65% 339,205 21,294 6.28% 188,120 12,361 6.57%
--------------------- --------------------- ---------------------
Total interest-bearing
liabilities .............. 2,606,057 77,020 2.96% 2,264,915 101,195 4.47% 2,061,023 99,141 4.81%
Noninterest bearing liabilities:
Demand deposits ............... 441,800 343,173 304,107
Other liabilities ............. 47,698 39,056 17,010
Shareholders' equity ............ 294,856 239,368 174,498
---------- ---------- ----------
Total liabilities and
shareholders' equity ..... $3,390,411 $2,886,512 $2,556,638
========== ========== ==========
Net interest earnings ........... $139,921 $103,985 $ 96,850
======== ======== ========
Net interest spread ............. 4.22% 3.36% 3.41%
Net interest margin on
interest-earning assets ....... 4.63% 3.97% 4.06%
Federal tax exemption on
nontaxable investment
securities and loans
included in interest income ... $ 12,071 0 $ 7,330 $ 6,417
(1) 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.
20
As discussed above, the change in 2002 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.
Table 4: Annual Rate/Volume
- ------------------------------------------------------------------------------------------------------------------------------------
2002 Compared to 2001 2001 Compared to 2000
- -------------------------------------------------------------------------------------------- ---------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
Change in (1) Change in (1)
- -------------------------------------------------------------------------------------------- ---------------------------------------
Net Net
(000's omitted) Volume Rate Change Volume Rate Change
- -------------------------------------------------------------------------------------------- ---------------------------------------
Interest earned on:
Federal funds sold ........................... $ (86) $ (85) $ (171) $ (149) $ (132) $ (281)
Time deposits in other banks ................. 159 (532) (373) (308) 504 196
Taxable investment securities ................ 5,498 (3,428) 2,070 6,090 (1,951) 4,139
Nontaxable investment securities ............. 10,721 419 11,140 4,308 (506) 3,802
Loans (net of unearned discount) ............. 14,173 (15,078) (905) 8,244 (6,911) 1,333
Total interest-earning assets (2) ............... $ 29,683 $(17,922) $ 11,761 $ 18,833 $(9,644) $ 9,189
Interest paid on:
Savings deposits ............................. $ 4,307 $ (5,674) $ (1,367) $ 1,269 $(2,270) $ (1,001)
Time deposits ................................ 1,627 (19,545) (17,918) 6,026 (1,783) 4,243
Short-term borrowings ........................ (35) (4,117) (4,152) (6,340) (3,781) (10,121)
Long-term borrowings ......................... 1,495 (2,233) (738) 9,508 (575) 8,933
Total interest-bearing liabilities (2) .......... $ 13,653 $(37,828) $(24,175) $ 9,402 $(7,348) $ 2,054
Net interest earnings (2) ....................... $ 17,168 $ 18,768 $ 35,936 $ 9,435 $(2,300) $ 7,135
(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.
21
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, 2002 and 2001.
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- earning assets for purposes of
these computations.
Table 5: 4th Quarter Average Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------------------- --------------------------------------
Avg. Avg.
Yield/ Yield/
Avg. Amt. of Rate Avg. Amt. of Rate
(000's omitted except yields andrates) Balance Interest Paid Balance Interest Paid
- --------------------------------------------------------------------------------------------- --------------------------------------
ASSETS:
Interest-earning assets:
Time deposits in other banks ....................... $ 394 $ 2 2.01% $ 227 $ (10) -17.48%
Taxable investment securities ...................... 850,383 14,086 6.57% 820,771 13,880 6.71%
Nontaxable investment securities ................... 403,508 7,384 7.26% 245,359 4,584 7.41%
Loans (net of unearned discount) (1) ............... 1,797,678 33,207 7.33% 1,646,921 32,779 7.90%
---------------------- ------------------------
Total interest-earning assets ................... 3,051,963 54,679 7.11% 2,713,278 51,233 7.49%
Noninterest earning assets:
Cash and due from banks ............................ 103,169 99,394
Premises and equipment, net ........................ 56,657 47,827
Other assets ....................................... 194,762 154,603
Allowance for loan losses .......................... (24,338) (21,669)
Net unrealized gains on
available-for-sale portfolio ..................... 63,407 37,584
---------- ----------
Total assets .................................... $3,445,620 $3,031,017
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings deposits ................................... $ 972,360 2,216 0.90% $ 797,399 3,086 1.54%
Time deposits ...................................... 1,112,447 9,552 3.41% 1,113,653 13,472 4.80%
Short-term borrowings .............................. 217,122 905 1.65% 83,786 581 2.75%
Long-term borrowings ............................... 306,781 4,833 6.25% 335,174 5,403 6.40%
---------------------- ------------------------
Total interest-bearing liabilities .............. 2,608,710 17,506 2.66% 2,330,012 22,542 3.84%
Noninterest bearing liabilities:
Demand deposits .................................... 454,038 388,512
Other liabilities .................................. 61,893 46,706
Shareholders' equity ................................. 320,979 265,787
---------- ----------
Total liabilities and shareholders' equity ...... $3,445,620 $3,031,017
========== ==========
Net interest earnings ................................ $37,173 $ 28,691
======= ========
Net interest spread .................................. 4.45% 3.65%
Net interest margin on interest-earning assets ....... 4.83% 4.20%
Federal tax exemption on nontaxable investment
Securities and loans included in interest income ... $ 3,326 $ 2,065
(1) 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.
22
The changes in net interest income (full tax-equivalent basis) by volume and
rate component for fourth quarter 2002 versus fourth quarter 2001 are shown
below for each major category of interest-earning assets and interest-bearing
liabilities.
Table 6: 4th Quarter Rate/Volume
- --------------------------------------------------------------------------------
4th Quarter 2002 versus 4th Quarter 2001
- --------------------------------------------------------------------------------
Increase (Decrease) Due to Change in (1)
- --------------------------------------------------------------------------------
Net
(000's omitted) Volume Rate Change
- --------------------------------------------- ---------------------------------
Interest earned on:
Time deposits in other banks ............. $ (30) $ 42 $ 12
Taxable investment securities ............ 1,571 (1,365) 206
Nontaxable investment securities ......... 3,437 (637) 2,800
Loans (net of unearned discount) ......... 10,714 (10,286) 428
Total interest-earning assets (2) ........... $ 17,199 $(13,753) $ 3,446
Interest paid on:
Savings deposits ......................... $ 3,200 $ (4,070) $ (870)
Time deposits ............................ (15) (3,905) (3,920)
Short-term borrowings .................... 1,729 (1,405) 324
Long-term borrowings ..................... (449) (121) (570)
Total interest-bearing liabilities (2) ...... $ 13,973 $(19,009) $(5,036)
Net interest earnings (2) ................... $ 3,827 $ 4,655 $ 8,482
(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.
As previously mentioned, the fourth quarter 2002 net interest margin was the
highest of the year, 63 basis points greater than the margin for the
corresponding prior year period. This improvement was driven by the drop in the
cost of funds having a greater impact than falling yields on loans and
investments, and larger growth in average interest-earning assets than in
average interest-bearing liabilities, as demonstrated in Table 6 above. The
latter factor was primarily a result of the significant amount of
non-interest-bearing deposits acquired in the FleetBoston branch acquisition in
mid-November 2001. Economic and market conditions and the maturity and interest
rate sensitivity profile of the Company's balance sheet continuously change.
Therefore, fourth quarter 2002 results are not necessarily indicative of future
performance.
23
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.
Table 7: Noninterest Income
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, Twelve Months Ended December 31,
------------------------------------ -----------------------------------------------------------
Change from 4Q '01 Change from 2001 Change from 2000
(000's omitted) 2002 Amount Percent 2002 Amount Percent 2001 Amount Percent
- ------------------------------------------------------------------------ ---------------------------- ------------------------------
Personal trust ........................... $ 352 $ (61) -14.8% $ 1,682 $ (139) -7.6% $ 1,821 $ (299) -14.1%
EBT/BPA .................................. 1,249 119 10.5% 4,569 642 16.3% 3,927 935 31.3%
Elias Asset Management ................... 486 (329) -40.4% 2,676 (1,037) -27.9% 3,713 622 20.1%
CISI ..................................... 656 54 9.0% 3,715 1,343 56.6% 2,372 1,527 180.7%
Insurance - CBNA ......................... 100 64 177.8% 1,082 247 29.6% 835 (953) -53.3%
- ------------------------------------------------------------------------ ---------------------------- ------------------------------
Total financial services ............ 2,843 (153) -5.1% 13,724 1,056 8.3% 12,668 1,832 16.9%
Electronic banking ....................... 605 189 45.4% 2,375 906 61.7% 1,469 (388) -20.9%
Mortgage banking ......................... 37 (253) -87.2% 175 (478) -73.2% 653 313 92.1%
Commercial leasing ....................... 8 7 700.0% 17 (17) -50.0% 34 (7) -17.1%
Deposit service charges .................. 1,294 173 15.4% 5,311 970 22.3% 4,341 305 7.6%
Overdraft fees ........................... 2,188 646 41.9% 6,937 1,754 33.8% 5,183 1,356 35.4%
Commissions .............................. 601 133 28.4% 2,224 158 7.6% 2,066 (165) -7.4%
Miscellaneous revenue .................... 177 93 110.7% 164 76 86.4% 88 (28) -24.1%
- ------------------------------------------------------------------------ ---------------------------- ------------------------------
Total general banking services ......... 4,910 988 25.2% 17,203 3,369 24.4% 13,834 1,386 11.1%
Total noninterest income
excluding investment security
gain (loss), net and loss
early retirement of long-term
borrowings ............................... 7,753 835 12.1% 30,927 4,425 16.7% 26,502 3,218 13.8%
Investment security gain
(loss), net and loss early
retirement of long-term
borrowings ............................... 313 326 -2507.7% 1,673 1,786 -1580.5% (113) 46 -28.9%
- ------------------------------------------------------------------------ ---------------------------- ------------------------------
Total noninterest income ............ $8,066 $ 1,161 16.8% $32,600 $ 6,211 23.5% $ 26,389 $ 3,264 14.1%
======================================================================== ============================ ==============================
Noninterest income as a
percentage of operating income
(excludes investment security
gain (loss), net and other
timing adjustments) ...................... 17.2% -2.7% 17.9% -2.5% 20.4% 1.1%
As displayed in Table 7, total noninterest income in 2002 increased by 23.5% to
$32.6 million, largely as a result of reduced losses on the early retirement of
long-term borrowings, increased revenues from CISI and EBT/BPA (our pension
administration business working in concert with the Bank's employee benefit
trust service), and higher deposit service charges and overdraft fees.
Deposit-related fee income benefited significantly from the acquisition of the
FleetBoston branches. Combined revenues, excluding transactions related to
investment securities, debt and the disposal of branch properties, rose for the
eighth consecutive year to $30.9 million in 2002, a $4.4 million or 16.7%
improvement over 2001.
Noninterest income, excluding net gains (losses) from the sale of securities,
early retirement of debt and disposal of branch properties and other unusual
items, as a percent of operating income was 17.9% in 2002, a decrease of 2.5
percentage points from the prior year. This decline was primarily driven by the
aforementioned strong growth in net interest income and the adverse effect of
unfavorable equity market conditions on the financial service businesses,
particularly the Company's asset manager, Elias Asset Management, and the
personal trust unit.
The largest segment of the Company's recurring noninterest income is the wide
variety of fees earned from general banking services, which reached $17.2
million in 2002, up 24.4% from the prior year. This segment contributed 56% of
2002 noninterest income, excluding net securities gains and loss from debt
extinguishment. A large portion of the income growth was attributable to the
higher number of customer accounts due to the FleetBoston branch acquisition,
24
and is reflected in the significant increases in deposit service charges,
electronic banking fees and commissions, which combined grew by $2.0 million or
25.8%. 2002 overdraft fees, up $1.8 million (33.8%) over 2001's level, also
benefited from the additional accounts, but were additionally enhanced by a
mid-year fee increase and the implementation of the Company's Overdraft
FreedomTM program in December 2002. Overdraft FreedomTM is a program currently
offered to retail customers whereby the Bank may pay overdrawn amounts for
qualified customers up to a certain predetermined limit for which they are
charged the standard overdraft fee. This is a courtesy service to customers in
good standing that may allow them to avoid late and non-payment penalties from
creditors and vendors and help them in their effort to avoid the negative
consequences of returned checks. This form of service is becoming an industry
standard throughout much of the country.
Mortgage banking fees of $175,000 in 2002 were down $478,000 from the prior
year. The main reason for the decline was that $9.1 million of mortgages were
sold on the secondary market in 2002, versus $43.6 million in 2001. The
resulting lack of increase in servicing portfolio activity as well as mortgage
prepayments in 2002 resulted in $163,000 of mortgage servicing right write-downs
in 2002 compared to $139,000 of mortgage servicing right income in 2001.
Accordingly, the mortgage servicing rights asset decreased from $567,000 at
year-end 2001 to $283,000 at the end of this year. The reduced level of
secondary market activity also had an impact on the second mortgage banking fee
item, gains from the sale of mortgages, which dropped $138,000 in 2002 to
$64,000. Lower sales and mortgage prepayments were responsible for the
loan-servicing portfolio decreasing from $119.8 million at the end of 2001 to
$103.7 million at year-end 2002. Consequently, the third component of mortgage
banking income, loan-servicing fees, dropped $38,000 from 2001's level to
$274,000 in 2002.
As disclosed in Table 7, fees from the financial services segment of noninterest
income rose $1.1 million or 8.3% in 2002 to $13.7 million. Financial service
revenue now comprises 44% of total noninterest income, excluding net gains
(losses) on the sale of investment securities and debt extinguishment. Growth in
CISI revenues was driven by an expanded number of financial consultants,
penetration of new markets opened up by the three 2001 acquisitions, and strong
annuity sales in the first half of 2002. Another impressive year of revenue
growth for EBT/BPA was driven by the expanded servicing of a significant number
of new plans. Client companies of EBT/BPA are now located in 27 states and the
Commonwealth of Puerto Rico. Lower revenue for personal trust and Elias Asset
Management reflected equity market price declines in 2002 that drove down the
market value of their assets under management, which is the basis for a majority
of their income. Lastly, commissions from insurance products increased by 30%
due to increased sales of creditor life and disability products 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 $1.364 billion at the end of 2002 compared to $1.385 billion
in the prior year, with market-driven declines in equity-based assets being
offset somewhat by growth of new plan assets at BPA. Overall, financial services
contributed $3.2 million (before allocation of indirect corporate expense) or
6.2% of the Company's pretax income this year, reflecting nearly a 24% return on
revenue. In 2001, financial services' contribution was $2.7 million or 10.2% of
total pretax income, with a return on revenue of almost 22%. The improvement in
earnings and margin was the result of strong revenue growth at CISI and BPA and
the reduction of expense levels at EAM and personal trust. The decline in
percentage contribution was primarily due to large increases in net interest
income and banking fees in 2002 and the existence of substantial banking-related
acquisition costs in 2001.
Lastly, income from periodic transactions in 2002 was composed of $2.6 million
in gains taken on $80 million in investment sales, and a $925,000 prepayment
penalty on the retirement of approximately $11 million of intermediate-term FHLB
borrowings in the fourth quarter of 2002. These transactions compare to $2.5
million of net investment gains and $2.7 million of losses on debt
extinguishment in 2001. The total net gain on security and debt transactions of
$1.7 million in 2002 compares to a $113,000 net loss incurred in 2001. The
security gains and debt losses taken over the last two years are illustrative of
the Company's active management of its investment portfolio and capital market
borrowings to achieve a desirable total return through combined net interest
income and transaction gains (losses) across financial market cycles.
25
The following table reconciles differences between the line of business income
breakdown in Table 7 and regulatory reporting definitions as reflected on the
Call Report and the Consolidated Statements of Income.
Table 8: Noninterest Income
- ------------------------------------------------------------------------------------------------------------------------------------
Twelve Months Ended December 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Regulatory Reporting Categories
- ------------------------------------------------------------------------------------------------------------------------------------
Commissions Other
Fiduciary Service and Advisory Service
and Charges on Fees on Charges, Other Investment
Investment Deposit Investment Commissions Operating Security
(000's omitted) Services Accounts Products and Fees Income Gain, net Total
- ------------------------------------------------------------------------------------------------------------------------------------
Personal trust ................................. $ 1,682 $ 1,682
EBT/BPA ........................................ 1,587 $ 2,982 4,569
Elias Asset Management ......................... $ 2,676 2,676
CISI ........................................... 3,715 3,715
Insurance - CBNA ............................... 1,082 1,082
- ------------------------------------------------------------------------------------------------------------------------------------
Total financial services .................. 3,269 6,391 4,064 13,724
Electronic banking ............................. $ 811 1,564 2,375
Mortgage banking ............................... 111 $ 64 175
Commercial leasing ............................. 17 17
Deposit service charges ........................ 5,311 5,311
Overdraft fees ................................. 6,937 6,937
Commissions .................................... 2,224 2,224
Miscellaneous revenue .......................... 164 164
- ------------------------------------------------------------------------------------------------------------------------------------
Total general banking services ............ 13,059 3,916 228 17,203
Total ..................................... 3,269 13,059 6,391 7,980 228 30,927
Investment security gain, net and
loss on early retirement of
Long-term borrowings ......................... $ 1,673 1,673
- ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income ................... $ 3,269 $13,059 $ 6,391 $ 7,980 $ 228 $ 1,673 $32,600
====================================================================================================================================
Noninterest Expense
As shown in Table 9, noninterest expense or overhead rose $6.8 million or 7.7%
in 2002 to $95.8 million. Excluding acquisition and unusual expenses related to
Citizens National Bank of Malone (CNB), First Liberty (FLIB), and the
FleetBoston branches, noninterest expense was up $14.3 million or 17.7% in 2002,
reflective of a full year of operating expenses associated with the FleetBoston
branch acquisition versus less than two months in 2001. This year's overhead as
a percent of average assets was 2.83%, down from 3.08% in 2001. CBSI's
noninterest expense to average asset ratio was 2.85% (annualized) for the nine
months ended September 2002 compared to 2.98% for peers.
26
Table 9: Noninterest Expense
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, Twelve Months Ended December 31,
-------------------------------- ---------------------------------------------------------------
Change from 4Q '01 Change from 2001 Change from 2000
(000's omitted) 2002 Amount Percent 2002 Amount Percent 2001 Amount Percent
- -------------------------------------------------------------------- -------------------------------- ------------------------------
Personnel expense ................. $11,757 $ 1,033 9.6% $48,168 $ 7,123 17.4% $41,045 $ 4,302 11.7%
Net occupancy expense ............. 1,975 407 26.0% 8,155 2,033 33.2% 6,122 1,038 20.4%
Equipment expense ................. 1,970 311 18.7% 7,539 1,464 24.1% 6,075 851 16.3%
Legal and professional fees ....... 1,002 205 25.7% 3,342 483 16.9% 2,859 523 22.4%
Data processing expense ........... 1,953 647 49.5% 7,187 2,067 40.4% 5,120 594 13.1%
Amortization of intangibles ....... 1,312 (825) -38.6% 5,953 (726) -10.9% 6,679 1,788 36.6%
Stationery and supplies ........... 566 (25) -4.2% 2,321 326 16.3% 1,995 299 17.6%
Foreclosed property expense ....... 172 (136) -44.1% 902 (157) -14.8% 1,059 555 110.1%
Deposit insurance premiums ........ 104 12 13.0% 440 94 27.2% 346 68 24.5%
Other ............................. 3,216 490 18.0% 11,117 1,575 16.5% 9,542 290 3.1%
- -------------------------------------------------------------------- -------------------------------- ------------------------------
Total before one-time
expenses .......................... 24,027 2,119 9.7% 95,124 14,282 17.7% 80,842 10,308 14.6%
Acquisition and unusual
expenses ........................ 0 (2,046) -100.0% 700 (7,464) -91.4% 8,164 7,764 1941.0%
- -------------------------------------------------------------------- -------------------------------- ------------------------------
Total noninterest expense ..... $24,027 $ 73 0.3% $95,824 $ 6,818 7.7% $89,006 $18,072 25.5%
==================================================================== ================================ ==============================
Total operating expenses
as a percentage of
average assets .................. 2.77% -0.37% 2.83% -0.26% 3.08% 0.3%
Efficiency ratio-recurring ........ 51.2% -3.4% 52.5% -4.0% 56.6% 2.0%
Efficiency ratio-nominal .......... 53.5% -13.8% 56.1% -12.1% 68.2% 9.2%
For CBSI as a whole, higher personnel expense accounted for 50% of 2002's
increase in noninterest expense, excluding acquisition and unusual expenses,
with personnel costs up 17.4%, mostly as a result of the FleetBoston branch
acquisition. The remainder of the increases in salary, benefit, and payroll tax
expense reflect competitive annual merit awards for employees and higher pension
expense (discussed in further detail below). Total full-time equivalent staff at
year-end 2002 was 1,120 versus 1,115 at year-end 2001.
Qualified and non-qualified pension expense of $2.0 million in 2002 was up
$582,000 or 42% from 2001's level. This increase was primarily due to additional
pension obligations for the employees added through the FleetBoston branch
acquisition (pension plan assets were not included in the acquisition), a
reduction from 7.0% (7.5% for pre-acquisition FLIB portion) to 6.75% of the
discount rate applied to future payments and higher executive pension-eligible
earnings. The three assumptions that have the largest impact on the calculation
of annual pension expense are the aforementioned discount rate, the rate applied
to future compensation increases and the expected rate of return on plan assets
for the next fiscal year. Table 10 contains the results of a sensitivity
analysis conducted to determine what the impact of a 1.0 percentage point
increase and decrease in these three assumptions would have on the forthcoming
annual pension expense for the two plans.
Table 10: Pension Plan Sensitivity Analysis
(000's omitted) One Percentage Point
------------------------------------------- ---------------------------------
Pension expense increase (decrease) Increase Decrease
------------------------------------------- ---------------- ----------------
Discount rate ............................. $(474) $ 474
Rate of compensation increase ............. $ 287 $(287)
Expected return on plan assets ............ $(285) $ 285
Nonpersonnel expense declined $305,000 or 0.6% in 2002 due to significantly
lower acquisition and unusual expenses in 2002. Excluding acquisition-related
expenses, nonpersonnel expense rose $7.2 million or 18.0% in 2002. As displayed
in Table 9, this was largely caused by data processing, up $2.1 million or
40.4%; occupancy expense, up $2.0 million or 33.2%; and equipment expense, up
$1.5 million or 24.1%. The increases in net occupancy and equipment expenses in
2002 were mainly due to the full-year impact of having significantly more
branches, and the corresponding expenditures necessary to adequately manage the
resulting higher volume of business. Data processing expense primarily relates
to Fiserv processing fees, data line charges, check and ATM processing expenses
and financial market transaction expenses incurred by the Company's financial
service units. The 2002 processing expense increase was driven by the higher
number of banking customer accounts and strong growth at the Company's
broker-dealer and pension administration businesses. These higher expense items
were partially offset by a $726,000 decrease in intangible amortization expense
in 2002 as a result of the adoption of SFAS 142 and SFAS 147, accounting
statements that call for the discontinuation of the amortization of certain
goodwill associated with whole company and branch acquisitions, respectively.
Please refer to Note F on page 55-56 for further information on these accounting
statements.
The efficiency ratio, a performance measurement tool widely used by banks, 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 and debt gains and losses). The adjusted or
recurring efficiency ratio additionally excludes unusual expenses (a majority of
which are acquisition-related) and intangible amortization (a non-cash expense)
as well as all one-time noninterest income; these one-time income items mostly
relate the disposal of branch properties. Lower ratios correspond to higher
efficiency.
In 2002, the nominal efficiency ratio dropped by 12.1 percentage points to
56.1%, primarily as a result of much higher net interest income and
significantly lower acquisition-related expenses. The Company's nominal ratio of
57.0% was in line with the peer bank ratio of 56.7% for the nine months ended
September 2002. The 2002 recurring efficiency ratio decreased a favorable 4.0
percentage points from 2001's level to 52.5%. These results reflect the full
year impact of a combined $3.2 million in annual cost savings from actions taken
at First Liberty in mid-second quarter 2001 and the benefit of streamlining our
operations functions by eliminating duplicate loan and deposit processing units
in Canton and Olean, NY. The recurring ratio for the second half of 2002 was
50.5%, 4.2 percentage points below that of the first half, demonstrating
substantially improved efficiency arising from the full integration of the 2001
acquisitions and the consolidated operations units.
Due to the nature of the Company's financial services businesses, the efficiency
ratio of those activities is much higher than that generated by banking
operations (in most part due to the largest banking expense, interest, being
netted against gross interest income). The recurring efficiency ratio for
financial services was 76.9% for 2002, up from 75.3% in 2001, primarily as a
result of the adverse impact of unfavorable equity market conditions on Elias
Asset Management. The recurring efficiency ratio of the Company's banking
activities was 50.7% this year compared to 54.9% in 2001. The
27
efficiency improvements mentioned above had a proportionally greater benefit on
the banking portion of the business in 2002.
Acquisition and unusual expenses, which are excluded from recurring efficiency
ratio calculations, totaled $700,000 in 2002. These expenditures were primarily
comprised of legal and consulting fees of $455,000, $97,000 of severance expense
and general administrative expenses totaling $25,000. A vast majority of these
expenses was incurred in conjunction with the FleetBoston branch acquisition,
with the balance pertaining to the First Liberty acquisition (primarily
severance).
As displayed above in Table 9, recurring noninterest expenses for the fourth
quarter of 2002 were $2.1 million or 9.7% above the equivalent prior year
period. This change was primarily due to incurring a full quarter of expenses
associated with the branches acquired from FleetBoston versus approximately a
month and a half in 2001. Adoption of SFAS 142 and SFAS 147 in 2002 resulted in
significantly lower intangible amortization (prior year not restated as
prescribed by the accounting statements), offsetting a portion of the increases
in most of the other expense categories.
Income and Income Taxes
2002 income before taxes of $52.4 million was up $25.5 million or 95% from the
prior year's amount. Pre-tax income, adjusted to gross-up all tax-exempt
interest income to a full tax-equivalent basis, was $64.5 million, $30.2 million
or 88% above 2001's level.
The Company estimates its tax expense based on the amount it expects to owe the
respective tax authorities. Taxes are discussed in more detail in Note I of the
Consolidated Financial Statements on page 57. Accrued taxes represent the net
estimated amount due or to be received from taxing authorities. In estimating
accrued taxes, management assesses the relative merits and risks of the
appropriate tax treatment of transactions taking into account statutory,
judicial and regulatory guidance in the context of the Company's tax position.
If the final resolution of taxes payable differs from our estimates due to
regulatory determination or legislative or judicial actions, adjustments to tax
expense may be required.
The effective tax rate for 2002 declined by 2.5 percentage points to 26.5%. The
lower rate resulted in $0.10 higher earnings per share in 2002. This decline was
primarily due to the benefits realized on a larger proportion of income from tax
exempt investment securities, which mitigated the effect of the near doubling of
income before tax. In addition, the adoption of SFAS 142 and 147, the lack of
nondeductible merger expenses in 2002 compared with 2001, and a federal
low-income housing tax credit claimed in 2002, all contributed to the decline in
the effective tax rate.
Capital
Shareholders' equity ended 2002 at $325 million, up $57 million or 21.3% from
one year earlier. This improvement reflects earnings for the year and the
positive change in market value adjustment (MVA, represents the after-tax
unrealized appreciation of available-for-sale securities in the Company's
investment portfolio), offset by dividends declared to shareholders. Excluding
the MVA in both 2002 and 2001, capital rose by $28.8 million or 11.2%. Shares
outstanding grew by 76,000 during the year due to the exercise of stock options.
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 32 basis points in 2002 to 7.05%. This
reflects the capital-building contribution from retained earnings (net income
less dividends declared), which more than offset growth of the investment and
loan portfolios. The total capital to risk-weighted assets ratio increased 1.49
percentage points during 2002 to 13.32% as of year-end compared to the 10%
minimum requirement for "well-capitalized" banks. The tangible equity/tangible
assets ratio ended the year at 5.77% versus 4.09% at December 31, 2001;
approximately 76 basis points of this improvement reflect the increase in the
MVA. The Company's improved capital position strengthens its risk profile and
better enables it to take advantage of potential future strategic growth
opportunities.
Cash dividends declared on common stock in 2002 of $14.5 million represented an
increase of 15.4% over the prior year. This growth is partially a result of a
higher number of shares outstanding in the first three quarters of 2002 due to
the 1.3 million shares issued in the fourth quarter of 2001. The increase also
reflects the quarterly dividend per share being raised from $0.27 to $0.29 in
the third quarter of 2002.
CBSI's dividend payout ratio for the year was 37.7% compared to 65.7% in 2001
(52.3% as a percent of net income-operating), within the Company's targeted
payout range for dividends on common stock of 30-40%. Its payout ratio has
historically been high relative to peers, and for 2002, the ratio was in the
61st peer percentile. The large decrease in the payout ratio despite the higher
dividend reflects the 101% increase in net income from the prior year, which was
largely
28
due to higher interest earning assets, an improved net interest margin in 2002,
and considerably more acquisition-related expenses in 2001.
During the first quarter of 2002, the Company made a contribution of $5.0
million to its defined benefit pension plan. At March 31, 2002, an updated
actuarial valuation was performed which showed that plan assets exceeded the
accumulated benefit obligation (qualified pension obligations based on current
compensation levels). As a result, the additional minimum pension liability of
$5.016 million, which was recorded at December 31, 2001 as a charge to
shareholders' equity, net of tax, was reversed. During the last three quarters
of 2002 the Company contributed an additional $7.0 million to the plan to cover
the decline in plan assets partially caused by soft equity markets. At year-end
2002, an actuarial valuation was conducted. It was determined that plan assets
were greater than the accumulated benefit obligation, and therefore no minimum
pension liability adjustment was necessary. Refer to Note K on pages 59-60 of
the notes to the consolidated financial statements for further information
regarding the Company's benefit plans.
Intangible Assets
Intangible assets consist of core deposit intangibles and goodwill arising from
acquisitions. Core deposit intangibles represent the premium the Company has
paid for deposits acquired in excess of the cost incurred had the funds been
purchased in the capital markets. Core deposit intangibles are amortized on
either an accelerated or straight-line basis over periods ranging from seven to
fifteen years. Goodwill represents the excess cost of an acquisition over the
fair value of the net assets acquired. Goodwill is subjected to an annual
impairment analysis to determine whether the carrying value of the acquired net
assets exceeds their fair value, which would necessitate a write-down of the
goodwill. The Company completed its goodwill impairment analysis during 2002 and
no adjustment was necessary. The impairment analysis was based upon discounted
cash flow modeling techniques that require management to make estimates
regarding the amount and timing of expected future cash flows. It also requires
them to select a discount rate that reflects the current return requirements of
the market in relation to present risk-free interest rates, required equity
market premiums and company-specific risk indicators.
Loans
The Company's loans outstanding, by type, as of December 31 are as follows:
Table 11: Loans Outstanding
- ------------------------------------------------------------------------------------------------------------------------------------
As of December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Real estate mortgages:
Residential ...................................... $ 765,824 $ 712,550 $ 579,562 $ 543,195 $ 453,307
Commercial loans secured by real estate .......... 274,591 272,157 243,429 225,822 200,435
Farm ............................................. 21,761 20,851 20,472 18,324 13,205
- ------------------------------------------------------------------------------------------------------------------------------------
Total ......................................... 1,062,176 1,005,558 843,463 787,341 666,947
Commercial, financial, and agricultural:
Commercial and financial ......................... 257,403 274,734 237,462 219,600 227,932
Agricultural ..................................... 25,870 25,191 26,523 27,758 22,737
- ------------------------------------------------------------------------------------------------------------------------------------
Total ......................................... 283,273 299,925 263,985 247,358 250,669
Installment loans to individuals ................... 436,118 399,368 395,226 390,450 365,141
Other loans ........................................ 25,454 28,237 14,205 2,043 12,626
- ------------------------------------------------------------------------------------------------------------------------------------
Gross loans ........................................ 1,807,021 1,733,088 1,516,879 1,427,192 1,295,383
Less: unearned discount ............................ 116 218 1,002 1,419 2,248
- ------------------------------------------------------------------------------------------------------------------------------------
Net loans ..................................... 1,806,905 1,732,870 1,515,877 1,425,773 1,293,135
Allowance for loan losses ..................... 26,331 23,901 20,035 18,528 17,059
- ------------------------------------------------------------------------------------------------------------------------------------
Loans, net of allowance for loan losses ............ $1,780,574 $1,708,969 $1,495,842 $1,407,245 $1,276,076
====================================================================================================================================
As disclosed in Table 11 above, loans outstanding, net of unearned discount,
reached a record $1.807 billion as of year-end 2002, up $74 million or 4.3%
compared to twelve months earlier. CBNA's New York franchise grew $93 million or
6.9% during the year to $1.436 billion. In contrast, the Pennsylvania franchise
decreased by $19 million or 5.0% to $370 million at year-end 2002. A highly
competitive marketplace along with soft economic conditions contributed to the
decline at First
29
Liberty. Management is focused on enhancing lending efforts in the Pennsylvania
market and is committed to achieving solid loan growth in that region. Based on
overall asset/liability analysis, the decision was made not to sell secondary
market eligible mortgages for the first three quarters of 2002. Consequently,
only $9.1 million of the mortgages originated within our local markets were sold
in the secondary market in 2002 versus $43.6 million in 2001. Had these loans
not been sold in 2002, loan growth would have been $83 million or 4.8%.
The Company's predominant focus on the retail borrower enables its loan
portfolio to be highly diversified. As demonstrated in Table 12 below,
approximately 65% of loans outstanding are oriented to consumers borrowing on an
installment and residential mortgage loan basis. This proportion increased from
63% at year-end 2001 due to the decline in the business lending portfolio and
the strong growth of residential mortgages in 2002.
There is a high degree of diversification within the business lending sector.
The Bank's business loans are typically for amounts under $100,000, accounting
for about 82% of the number of business loans and approximately 23% of business
loan balances as of December 31, 2002. About 27% of the business portfolio is
comprised of loans between $250,000 and $1 million (about 6% of the number of
loans), while loans over $1 million comprise another 34% of the portfolio (1.6%
of the number of loans). The portfolio contains no credit card receivables.
Table 12 below recasts the Company's loan portfolio into four major lines of
business. The increase in consumer mortgages contributed $67 million of the $74
million in total loan growth in 2002, and consumer indirect loans accounted for
$39 million. Conversely, consumer direct and business lending portfolios were
down $18 million and $14 million from year-end 2001 levels, respectively. The
following section discusses the underlying reasons for changes in each of the
Company's four major lending activities or lines of business.
Table 12: Nature of Lending
($ million and %)
- --------------------------------------------------------------------------------
2002 Mix 2001 Mix 2000 Mix
- --------------------------------------------------------------------------------
Consumer mortgage ........ $ 511 28.3% $ 444 25.6% $ 417 27.5%
Business lending ......... 630 34.8% 644 37.2% 577 38.1%
Consumer indirect ........ 287 15.9% 248 14.3% 256 16.9%
Consumer direct .......... 379 21.0% 397 22.9% 266 17.5%
- --------------------------------------------------------------------------------
Total loans ............ $1,807 100.0% $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. The portfolio decreased by $14 million or
2.2% in 2002 and reflects declines of $3 million in New York and $11 million in
Pennsylvania as lending efforts were impeded by soft economic conditions and
diminished capital spending levels in the commercial sector. Management is
committed to growing the business lending portfolio through a strategy
predicated upon hiring talented professionals, intensifying calling efforts, and
expanding business relationships in order to be positioned to fully take
advantage of growth opportunities once economic conditions improve.
The Bank's total commercial portfolio is broadly diversified by industry type
with the largest shares being in commercial real estate (19%), services (14%),
and health care (10%); followed by auto dealers (9%), agriculture (8%),
hotel/eating/drinking (7%), and manufacturing, construction, retail trade and
transportation (6% each) as of year-end 2002. Miscellaneous industries make up
the balance at 9%.
Demand for installment debt indirectly originated through automobile, marine,
and mobile home dealers increased substantially in 2002. Indirect loans ended
the year 16% or $39 million higher, primarily reflecting successful business
development efforts that increased the number of dealer relationships and the
Bank's ability to deliver attractive financing rates. Ninety-one percent of this
portfolio segment relates to automobile lending (76% of the vehicles are used
versus 24% new). Indirect loans increased $7.9 million (22%) in the Company's
First Liberty franchise and were up $31 million (15%) in the New York markets.
The segment of the Company's loan portfolio consisting of consumer mortgages is
predominantly fixed (94%) versus adjustable rate (6%) residential lending.
Record volumes in this year's historically low interest rate environment drove
strong growth of $67 million or 15.1% in 2002. Nearly $76 million of the growth
was generated in the New York franchise, offset by $9 million of run-off in
Pennsylvania. Twenty-eight percent ($21 million) of the increase in the New York
market portfolio was contributed by new business generated out of the branches
acquired from FleetBoston Financial in 2001. Growth in the core mortgage
portfolio is lower than it could have been had it not been for the sale of
selected
30
fixed rate originations in the secondary market. This program gives the
Bank the capability to offer competitive mortgage pricing and provides an
additional tool to manage interest rate risk.
Direct consumer loans decreased 4.5% or $18 million in 2002 to $379 million.
Loan balances fell approximately $11 million ($2.8%) in the New York markets and
$7 million (20%) at First Liberty mostly due to the weak economy adversely
affecting demand for these type of loans and a certain amount of installment
loans being paid off through mortgage refinancing. Extremely competitive
conditions in this lending segment within the Company's Pennsylvania market has
led to some loan run-off, and management is focused on bolstering lending
business development efforts at the First Liberty branches to reverse this
trend. 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 principal repayment begins), and
borrowing under variable and fixed rate home equity lines of credit.
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, Table 11, and Note D (pages 54-55) of the
financial statements.
Table 13: Loans
- ----------------------------------------------------------------------------------------------------------------
Line of Business as of December 31, 2002
- ----------------------------------------------------------------------------------------------------------------
Consumer Consumer Consumer Business Total
(000's omitted) Direct Indirect Mortgages Lending Loans
- ----------------------------------------------------------------------------------------------------------------
Regulatory Reporting Categories:
Loans secured by real estate:
Residential ...................... $ 223,325 $ 0 $ 508,270 $ 34,229 $ 765,824
Commercial ....................... 44 -- 1,934 272,613 274,591
Farm ............................. 33 -- -- 21,728 21,761
Agricultural loans ................. 200 -- -- 25,670 25,870
Commercial loans ................... 14,015 -- -- 243,388 257,403
Installment loans to individuals ... 139,323 287,380 105 9,310 436,118
Other loans ........................ 2,489 -- -- 22,965 25,454
- ----------------------------------------------------------------------------------------------------------------
Total loans ................... 379,429 287,380 510,309 629,903 1,807,021
Unearned discount ............. (116) -- -- -- (116)
- ----------------------------------------------------------------------------------------------------------------
Net loans ..................... $ 379,313 $ 287,380 $ 510,309 $ 629,903 $ 1,806,905
================================================================================================================
The following table shows the maturities of loans as of December 31, 2002:
Table 14: Loan Maturities
- -------------------------------------------------------------------------------------------------------------
At December 31, 2002
- -------------------------------------------------------------------------------------------------------------
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 agricultural ..... $ 145,510 $ 89,418 $ 48,345 $ 283,273
Real estate mortgages ....................... 31,882 157,931 872,361 1,062,174
Installment and other ....................... 33,945 363,086 64,427 461,458
- -------------------------------------------------------------------------------------------------------------
Total loans ............................ $ 211,337 $ 610,435 $ 985,133 $1,806,905
=============================================================================================================
As displayed in Table 14 above, 12% of the loan portfolio at December 31, 2002
is scheduled to mature in one year or less, 34% of loans have maturities in the
one- to five-year range, and approximately 54% mature after five years. This
compares to 11%, 25% and 64% for the equivalent maturity categories at year-end
2001, respectively. The proportional increase in loans maturing in one to five
years reflects the growth of the indirect loan portfolio, a majority of which
relates to auto financing that predominately have terms that fall within this
range. The reduction of the percentage of loans that mature after five years was
due to a drop in time loan balances in the commercial portfolio that resulted in
a loan mix weighted more towards shorter-maturity loans.
31
The following table sets forth the profile of the loan portfolio with regard to
maturity and the type of interest rate.
Table 15: Loan Sensitivity
- --------------------------------------------------------------------------------
At December 31, 2002
- --------------------------------------------------------------------------------
(000's omitted) Fixed Rate Variable Rate Total
- --------------------------------------------------------------------------------
Due in one year or less ................. $ 60,589 $ 150,748 $ 211,337
Due after one year but within five years 531,569 78,866 610,435
Due after five years .................... 687,631 297,502 985,133
- --------------------------------------------------------------------------------
TOTAL ................................. $1,279,789 $ 527,116 $1,806,905
================================================================================
Table 15 above reflects the nature of the Company's loan portfolio in relation
to the mix of maturities and interest rate characteristics. At year-end 2002,
71% of loans have fixed interest rates, and the 29% that have variable rates
consist primarily of home equity and commercial loans. There is relatively even
distribution of the portfolio between loans with maturities below and above 5
years at 45% and 55% at December 31, 2002, respectively. Refer to the market
risk/interest rate risk section of the MD&A on pages 39 - 40 for specific
information regarding the interest rate sensitivity of the Company's asset and
liability position at year-end 2002.
Asset Quality
The following table presents information concerning nonperforming assets:
Table 16: Nonperforming Assets
- -----------------------------------------------------------------------------------------------------------------------------------
As of December 31,
- -----------------------------------------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Loans accounted for on a nonaccrual basis .................... $ 9,754 $ 7,186 $ 5,473 $ 6,112 $ 4,213
Accruing loans which are contractually past due 90
days or more as to principal or interest payments .......... 1,890 1,914 1,930 1,201 1,958
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans ............................... 11,644 9,100 7,403 7,313 6,171
Restructured loans ........................................... 43 75 116 122 134
Other real estate ............................................ 704 1,427 1,293 1,442 1,661
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets .............................. $12,391 $10,602 $ 8,812 $ 8,877 $ 7,966
===================================================================================================================================
Ratio of allowance for loan losses to period-end loans ....... 1.46% 1.38% 1.32% 1.30% 1.32%
Ratio of allowance for loan losses to period-end
nonperforming loans ........................................ 226.1% 262.6% 270.6% 253.4% 276.4%
Ratio of allowance for loan losses to period-end
nonperforming assets ....................................... 212.5% 225.4% 227.4% 208.7% 214.1%
Ratio of nonperforming loans to period-end loans ............. 0.64% 0.53% 0.49% 0.51% 0.48%
Ratio of nonperforming assets to period-end total
loans and other real estate ................................ 0.69% 0.61% 0.58% 0.62% 0.62%
As shown in Table 16 above, nonperforming loans, defined as nonaccruing loans
plus accruing loans 90 days or more past due, ended 2002 at $11.6 million, up
approximately $2.5 million or 28% from one year earlier. This was primarily due
to increases in commercial loan nonaccruals. The ratio of nonperforming loans to
total loans rose 11 basis points from twelve months earlier to 0.64%. As of
September 30, 2002, when the nonperforming loan ratio stood at 0.69%, the
Company's asset quality was favorable to the peer level of 1.04%. The ratio of
nonperforming assets (which includes troubled debt restructuring and other real
estate, or OREO, in addition to nonperforming loans) to total loans plus OREO
increased to 0.69% at year-end 2002, up 8 basis points from one year earlier.
Total delinquencies, defined as loans 30 days or more past due and nonaccruing,
finished the year at 1.88% of total loans outstanding versus 1.93% at the end of
2001. As of year-end 2002, total delinquencies for commercial loans, installment
loans, and real estate mortgages were 2.22%, 2.30%, and 1.23%, respectively.
These measures were 2.15%, 2.06% and 1.25% as of September 30, 2002 compared to
peer levels of 2.56%, 1.89%, and 1.76%, respectively. As of September 30, 2002,
the total delinquency ratio of 1.80% was lower than the peer ratio of 2.06%.
32
A portion of the increase in net charge-offs was due to the significantly higher
average loan portfolio in 2002 as a result of the $177 million of loans added as
part of the FleetBoston branch acquisition in mid-November 2001. Consequently,
net charge-offs as a percent of average loans offers a clearer representation of
asset quality trends. Total net charge-offs for 2002 were higher by $3.2 million
or 49%, finishing the year at $9.8 million versus $6.6 million in 2001. As a
percentage of average loans, net charge-offs were up 14 basis points from last
year to 0.56%. Gross charge-offs rose 39% to $12.0 million, or 0.68% of average
loans outstanding versus 0.55% in 2001. This year's recoveries increased
$145,000 to $2.2 million, representing 26% of prior year gross charge-offs
compared to 28% in 2001. For the nine months ended September 30, 2002, the
Bank's total net charge-off ratio of 0.54% was in the 78th peer percentile based
on the peer norm of 0.40%.
Commercial loan net charge-offs increased in 2002, totaling $4.8 million or
0.74% of average commercial outstandings versus $2.0 million and 0.33% in 2001.
The primary reason for the increased commercial net charge-off ratio was
weakened economic conditions in the markets served by the Bank and charge-offs
on two particular commercial credits. Consumer installment net charge-offs rose
to $4.9 million from $4.4 million in 2001, but the net charge-off ratio was
virtually flat at a 99 basis point level. The net charge-off dollar amount and
ratio were lower for the indirect installment portfolio (loans originated
largely through automobile dealerships) in 2002, while both these items
increased on the direct installment portfolio. A portion of this increase
reflects certain differences in underwriting criteria for acquired loans than
that practiced by the Bank. Mortgage net charge-offs were de minimus in both
years. The risk profile of new installment loans booked in 2002 improved versus
2001 in relation to the credit quality of the borrowers. Seventy-five percent of
new installment lending volume in 2002 was rated as A and B paper, the two
highest rankings in the standard A - D credit categories, compared to 62% in
2001.
Management continually evaluates the credit quality of the Company's loan
portfolio and conducts a formal review of the allowance for loan loss adequacy
on a quarterly basis. The two primary components of the loan review process that
are used to determine proper allowance levels are specific and general loan loss
allocations.
Specific loan loss allocations are established for loans within the commercial
loan portfolio that are determined to be temporarily impaired. The Bank's
commercial lenders identify such loans through regular credit analysis of their
customers' financial health and the collateral supporting their loans. If it is
determined that cash flow-generating ability of the commercial customer may not
be adequate to enable to them to make full payment of principal and interest as
scheduled, and the fair market value of the assets collateralizing the loans is
not sufficient to cover potential losses, the loans are categorized as
temporarily impaired. The impairment is deemed temporary if there is expectation
that the financial performance of the customer will improve or that the value of
the collateral will appreciate. If this is not the case, the impairment is
considered permanent, and the loan will be charged off. Specific loan loss
allocations are established for all large temporarily impaired commercial loans
based on their collateral shortfall.
The second component of the allowance establishment process, general loan loss
allocations, is composed of two calculations that are computed on the four main
loan segments: commercial, consumer direct, consumer indirect and residential
real estate. The first calculation determines an allowance level based on the
latest three years of historical net charge-off data for each loan category. The
second calculation is qualitative and takes into consideration five major
factors affecting the level of loan loss risk: portfolio risk migration patterns
(internal credit quality trends); the growth of the segments of the loan
portfolio; economic and business environment trends in the Bank's markets
(includes review of bankruptcy, unemployment, population, consumer spending and
regulatory trends); industry, geographical and product concentrations in the
portfolio; and the perceived effectiveness of managerial resources and lending
practices and policies. These two allowance calculations are added together to
determine the general allocation ratio, which is applied to the four homogenous
loan pools (excluding commercial loan balances with specific loan loss
allocations). The allowance levels computed from the specific and general loan
loss allocation methods are combined to derive the necessary allowance for loan
loss to be reflected on the Consolidated Statement of Condition.
The loan loss provision is calculated by subtracting the previous period
allowance for loan loss, net of the interim period net charge-offs, from the
current required allowance level. This provision is then booked as an expense in
the income statement for that period.
The loan review department, senior credit officers, executive management and the
loan committee of the Board of Directors all examine the results of the
allowance for loan loss process in detail and determine if it is adequate each
quarter. Management is committed to continually improving the credit assessment
and risk management capabilities of the Bank and will dedicate the resources
necessary to ensure advancement in this critical area of operations.
The allowance for loan loss was increased to $26.3 million at year-end 2002
versus $23.9 million at the end of 2001. The $2.4 million increase was due to
$74 million more loans outstanding, a year-end update of the historical
component of the general allocation calculation (2002's high commercial
charge-off ratio replaced 1999's comparatively low ratio),
33
and higher commercial loan specific allocations ($5.1 or 0.79% of the commercial
portfolio at December 31, 2002 versus $4.3 million or 0.65% at year-end 2001).
As a percent of total loans, the allowance for loan loss ratio increased to
1.46% for year-end 2002 versus 1.38% last year. As of September 30, 2002, the
Company's reserve ratio of 1.35% was 20 basis points below the peer median,
while the coverage of nonperforming loans at 197% was above the norm of 188%
(61st percentile). Management believes year-end 2002 coverage at 226% to be
adequate in light of the probable losses in the Company's loan portfolio.
The loan loss provision as percentage of average loans increased from 0.45% in
2001 to 0.69% for all of this year. The annualized provision ratio for the nine
months ended September 30, 2002 of 0.55% was slightly above the peer norm of
0.53%. Due to higher net charge-offs in 2002 and management's assessment of the
probable losses in the loan portfolio as discussed above, loan loss provision
increased by $5.1million or 72% in 2002. Loan loss provision covered net
charge-offs by 125% this year versus 108% in 2001.
Changes in the allowance for loan losses for the last five years is as follows:
Table 17: Allowance for Loan Loss Activity
- ------------------------------------------------------------------------------------------------------------------------------------
As of December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Amount of loans outstanding at end of period ................. $1,806,905 $1,732,870 $1,515,877 $1,425,773 $1,293,135
- ------------------------------------------------------------------------------------------------------------------------------------
Daily average amount of loans (net of unearned discount) ..... $1,759,564 $1,580,870 $1,484,945 $1,343,652 $1,257,059
- ------------------------------------------------------------------------------------------------------------------------------------
Balance of allowance for loan losses at beginning of period .. $ 23,901 $ 20,035 $ 18,528 $ 17,059 $ 16,996
Loans charged off:
Commercial, financial, and agricultural .................... 5,071 2,310 3,273 1,218 1,011
Real estate ................................................ 249 290 250 272 280
Installment and check credit ............................... 6,695 6,062 3,957 4,474 5,583
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans charged off ................................. 12,015 8,662 7,480 5,964 6,874
Recoveries of loan previously charged off:
Commercial, financial and agricultural ..................... 281 313 148 526 432
Real estate ................................................ 119 56 103 30 32
Installment and check dredit ............................... 1,823 1,709 1,014 1,021 810
- ------------------------------------------------------------------------------------------------------------------------------------
Total recoveries ........................................ 2,223 2,078 1,265 1,577 1,274
- ------------------------------------------------------------------------------------------------------------------------------------
Net loans charged off ........................................ 9,792 6,584 6,215 4,387 5,600
Provision for loan losses .................................... 12,222 7,097 7,722 5,856 5,663
Reserve on acquired loans (1) ................................ 0 3,353 0 0 0
- ------------------------------------------------------------------------------------------------------------------------------------
Balance of allowance for loan losses at end of period ........ $ 26,331 $ 23,901 $ 20,035 $ 18,528 $ 17,059
====================================================================================================================================
Ratio of net charge-offs to average loans outstanding ........ 0.56% 0.42% 0.42% 0.33% 0.45%
(1) This reserve addition is attributable to loans purchased from Citizens
National Bank of Malone and FleetBoston Financial Corporation in 2001.
The following table shows management's allocation of the allowance for loan
losses by loan type as of December 31:
Table 18: Allowance for Loan Losses by Loan Type
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
- ------------------------------------------------- -------------------- -------------------- -------------------- -------------------
Amount Amount Amount Amount Amount
of Loan Of Loan Of Loan of Loan of Loan
(000's omitted) Allowance Mix Allowance Mix Allowance Mix Allowance Mix Allowance Mix
- ------------------------------------------------- -------------------- -------------------- -------------------- -------------------
Commercial, financial and
agricultural ............. $16,765 15.7% $14,417 17.3% $ 7,386 17.4% $ 5,850 17.3% $ 7,441 19.3%
Real
estate ..................... 563 58.8% 473 58.0% 1,635 55.6% 1,933 55.2% 1,751 51.5%
mortgages
Installment ................ 8,894 25.5% 8,903 24.7% 8,162 27.0% 7,474 27.5% 4,663 29.2%
Unallocated ................ 109 108 2,852 3,271 3,204
- ------------------------------------------------- -------------------- -------------------- -------------------- -------------------
Total ...................... $26,331 100.0% $23,901 100.0% $20,035 100.0% $18,528 100.0% $17,059 100.0%
====================================================================================================================================
34
Funding Sources
Typical of most commercial banking institutions today is the need to rely on a
variety of funding sources to support the earning asset base as well as to
achieve targeted growth objectives. There are three primary sources of funding
that comprise CBSI's overall funding matrix, which considers maturity,
stability, and price: deposits of individuals, partnerships and corporations
(IPC deposits); collateralized municipal deposits (public funds); and capital
market borrowings.
Table 19: Source of Funds
Average 4th Quarter Balances
($ million and %)
- --------------------------------------------------------------------------------
2002 Mix 2001 Mix 2000 Mix
- --------------------------------------------- ---------------- ----------------
IPC deposits ............. $2,378 77.6% $2,130 78.3% $1,713 70.9%
Public funds ............. 161 5.3% 170 6.3% 236 9.8%
Capital borrowings ....... 524 17.1% 419 15.4% 467 19.3%
- --------------------------------------------- ---------------- ----------------
Total fund sources ..... $3,063 100.0% $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 with a fourth quarter average of
$2.378 billion, an increase of $248 million or 11.6% over the comparable 2001
period. This is largely due to the $470 million in deposits acquired from the 36
former FleetBoston branches in November 2001. From the acquisition date through
year-end 2002, IPC deposits in the acquired branches have increased 4.1%. 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 represent a strong customer base for which a
variety of loan, deposit and other financial service-related products can be
cross-sold.
The mix of CBSI's deposits changed only modestly, with the average fourth
quarter time deposit mix dropping from 49% of IPC deposits in 2001 to 45% in
2002. This decrease largely reflects certain customer preferences not to renew
at current rates, often placing the funds in non-CD accounts at the Bank for the
time being. A higher mix of money market and checking deposits in the fourth
quarter of 2002 versus the year-earlier period was not unexpected given the
interest rate environment. Historically low market rates resulted in reduced
spreads between CDs and other interest-bearing deposits and lessened the
opportunity costs associated with holding demand deposits.
Deposits of local municipalities decreased $9 million or 5.3% during the past
year, with balances for fourth quarter 2002 averaging $161 million versus $170
million for the same 2001 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. Municipal deposits decreased
due to the favorability of the aforementioned borrowing rates in comparison to
competitive pricing of the public fund deposits. It should be noted that
utilization of municipal deposits has generally been flat to down over the last
few 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 and approximately $50 million in
floating-rate trust preferred raised to support the FleetBoston branch
acquisition. Capital market borrowings averaged $524 million or 17% of total
funding sources for fourth quarter 2002, an increase from the fourth quarter
2001 level of $419 million or 15% of total funding. These additional borrowings
were used to fund investment purchases made during the first half of 2002. As of
December 31, 2002, 54% or $248 million of capital market borrowings (excluding
the aforementioned line of credit and trust preferred securities) had remaining
terms of one year or less.
During fourth quarter 2002, approximately $11 million in term advances from the
Federal Home Loan Bank were prepaid, resulting in a prepayment penalty of
$925,000. This strategy was implemented because the cost of replacement debt,
including prepayment penalty, was economically justified versus continuing to
hold the existing instruments. A similar strategy was executed in third quarter
2001 when $95 million of debt was prepaid, resulting in a penalty of $2.7
million.
35
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.
Table 20: Average Deposits
- ------------------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------- ---------------------------- -------------------------
Average Average Average
Average Rate Average Rate Average Rate
(000's omitted, except rates) Balance Paid Balance Paid Balance Paid
- ----------------------------------------------------------------------------- ---------------------------- -------------------------
Noninterest-bearing demand deposits ......... $ 441,800 0.00% $ 343,173 0.00% $ 304,107 0.00%
Interest-bearing demand deposits ............ 262,313 0.47% 186,032 0.71% 162,065 0.91%
Regular savings deposits .................... 402,728 1.32% 344,906 2.11% 331,987 2.37%
Money market deposits ....................... 304,623 1.60% 152,150 2.76% 128,112 3.38%
Time deposits ............................... 1,131,296 3.75% 1,100,850 5.48% 991,754 5.66%
- ----------------------------------------------------------------------------- ---------------------------- -------------------------
Total average daily
amount of domestic deposits ............... $2,542,760 2.12% $2,127,111 3.44% $1,918,025 3.65%
====================================================================================================================================
The remaining maturities of time deposits in amounts of $100,000 or more
outstanding are summarized below:
Table 21 Time Deposit > $100,000 Maturities
- --------------------------------------------------------------------------------
At December 31,
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Less than three months ................... $ 63,891 $ 78,601
Three months to six months ............... 28,255 37,193
Six months to one year ................... 29,646 22,660
Over one year ............................ 35,337 38,548
- --------------------------------------------------------------------------------
Total .................................. $157,129 $177,002
================================================================================
The following table summarizes the outstanding balance of short-term borrowings
of the Company for the years indicated:
Table 22: Short-term Borrowings
- -------------------------------------------------------------------------------
At December 31,
- -------------------------------------------------------------------------------
(000's omitted, except rates) 2002 2001 2000
- -------------------------------------------------------------------------------
Federal funds purchased .............. $ 33,000 $ 14,200 $ 48,730
Term borrowings at banks
90 days or less ................. 215,000 31,100 151,100
Over 90 days .................... 0 1,000 0
- -------------------------------------------------------------------------------
Balance at end of period ... $248,000 $ 46,300 $199,830
================================================================================
Daily average during the year ........ $141,024 $141,772 $258,985
Maximum month-end balance ............ $244,000 $268,600 $396,990
Weighted average rate during the year 1.83% 4.75% 6.51%
Year-end average rate ................ 1.50% 4.16% 7.23%
Investments
The objective of CBSI's investment portfolio is to provide low-risk, quality
assets to the statement of condition. This must be accomplished within the
following constraints: (a) implementing certain interest rate risk management
strategies which achieve a relatively stable level of net interest income; (b)
providing both the regulatory and operational liquidity necessary to conduct
day-to-day business activities; (c) considering investment risk-weights as
determined by the regulatory risk-based capital guidelines; and (d) generating a
favorable return without undue compromise of the other requirements.
From December 31, 2001 to December 31, 2002, the book value of CBSI's investment
portfolio increased $88 million or 7.8% to $1.2 billion, reflective of purchase
strategies largely in the first half of 2002, offset by planned investment
runoff and strategic investment sales.
36
Investment interest income in 2002 was $13.2 million or 18.4% higher than the
prior year as a result of $227 million or 22% higher average outstandings,
partially offset by a decrease in the average investment yield from 6.96% to
6.74%. This drop occurred because the decrease in taxable yields caused by the
overall decrease in market rates more than offset the increased yield and
greater mix of tax-exempt holdings, whose maturities were lengthened. Through
September 30, 2002, the tax equivalent investment yield was in the exceptional
98th percentile compared to national peer banks in the $3 to $10 billion asset
range.
To protect the Bank against exposure to falling interest rates, the bulk of the
Bank's 2002 purchases were in intermediate-term municipal bonds and agency
securities with a minimum of five years of call protection. Despite a continued
falling rate environment, the steepness of the yield curve in 2002 combined with
the call-protected yields on this year's investment purchases, allowed for
widening spreads over cost of funds on investment transactions.
During 2002, approximately $80 million of investments were sold, resulting in
net investment gains of approximately $2.6 million. The sales were based on the
Company's total return strategy (see below) or to maintain holdings within
investment policy guidelines. Those proceeds that were reinvested resulted in an
improved interest rate risk position.
The investment portfolio has essentially no credit risk due to the composition
continuing to heavily favor U.S. Agency Debentures, U.S. Agency mortgage-backed
pass-throughs, U.S. Agency CMOs and municipal bonds insured by third parties. As
of year-end 2002, these four AAA-rated (highest possible rating) security types
accounted for 98% of the total portfolio excluding Federal Home Loan Bank stock
and Federal Reserve Bank stock, or 32%, 11%, 20% and 35% respectively. These
four security types comprised 95% of total investments as of December 31, 2001
at 17%, 16%, 36% and 26%, respectively. While a little more than a third of the
investment portfolio at year-end 2002 is in municipal bonds, management believes
that the tax risk in the Company's municipal investments arising from potential
future changes in statutory, judicial and regulatory actions is minimal. The
investment portfolio's December 31, 2002 effective duration, which measures
price sensitivity, was 3.94 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 2002, the Company's five-year total return at 8.25% was
in the extremely favorable 98th peer percentile per the Investment Performance
Digest.
Because nearly all of the Company'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 2002, the pre-tax net market value gain over book value was $64.6
million versus a gain of $17.4 million as of year-end 2001.
37
The following table sets forth the amortized cost and market value for the
Company's investment securities portfolio:
Table 23: Investment Securities
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------- ------------------------- ------------------------
Amortized Amortized Amortized
Cost/Book Market Cost/Book Market Cost/Book Market
(000's omitted) Value Value Value Value Value Value
- --------------------------------------------------------------------------------- ------------------------- ------------------------
Held to Maturity Portfolio:
Obligations of state and politicalsubdivisions ....... $ 7,412 $ 7,666 $ 7,608 $ 7,832 $ 5,351 $ 5,451
- --------------------------------------------------------------------------------- ------------------------- ------------------------
Total .............................................. 7,412 7,666 7,608 7,832 5,351 5,451
================================================================================= ========================= ========================
Available for Sale Portfolio:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ............... 380,243 411,278 192,111 203,501 300,714 311,348
Obligations of state and political subdivisions ...... 404,864 420,605 282,109 277,593 164,110 165,609
Corporate securities ................................. 27,972 30,225 43,392 44,399 44,862 44,902
Collateralized mortgage obligations (CMO's) .......... 235,286 245,368 400,100 403,780 273,382 271,825
Mortgage-backed securities ........................... 131,755 137,211 173,978 179,786 98,363 98,024
- --------------------------------------------------------------------------------- ------------------------- ------------------------
Total .............................................. 1,180,120 1,244,687 1,091,690 1,109,059 881,431 891,708
Equity securities (1) ................................ 25,814 25,814 25,863 25,863 29,986 29,986
Federal Reserve Bank common stock .................... 5,652 5,652 5,652 5,652 2,536 2,536
- --------------------------------------------------------------------------------- ------------------------- ------------------------
Total .............................................. 1,211,586 $1,276,153 1,123,205 $1,140,574 913,953 $ 924,230
========== ========== ==========
Net unrealized gain on available for sale
portfolio .......................................... 64,567 17,369 10,277
---------- ---------- ----------
Total carrying value ............................ $1,283,565 $1,148,182 $ 929,581
========== ========== ==========
(1) Includes $24,575, $24,700, and $28,546 of FHLB common stock at December
31, 2002, 2001, and 2000, respectively.
The following table sets forth as of December 31, 2002, 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:
Table 24: Maturities of Investment Securites
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Amount Amount
Amount Maturing Maturing
Maturing After One After Five Amount Total
Within Year but Years but Maturing Amortized
One Year Within Within After Cost/Book
(000's omitted, except rates) or Less Five Years Ten Years Ten Years Value
- ------------------------------------------------------------------------------------------------------------------------------------
Held to Maturity Portfolio:
Obligations of state and political subdivisions ......... $ 4,307 $ 2,373 $ 732 $ 0 $ 7,412
- ------------------------------------------------------------------------------------------------------------------------------------
Total .............................................. $ 4,307 $ 2,373 $ 732 $ 0 $ 7,412
====================================================================================================================================
Weighted Average Yield for Year(1) ...................... 5.10% 6.87% 7.09% 0.00% 5.86%
Available for Sale Portfolio:
U.S. Treasury securities and obligations ................ $ 501 $ 7,000 $ 244,397 $ 128,345 $ 380,243
of U.S. government corporations and agencies
Obligations of state and political subdivisions ......... 1,400 9,624 133,332 260,508 404,864
Corporate securities .................................... 250 0 8,507 19,215 27,972
Collateralized mortgage obligations (CMO's) ............. 0 4,000 48,794 182,492 235,286
Mortgage-backed securities .............................. 49 5,695 6,425 119,586 131,755
- ------------------------------------------------------------------------------------------------------------------------------------
Total .............................................. $ 2,200 $ 26,319 $ 441,455 $ 710,146 $1,180,120
====================================================================================================================================
Weighted Average Yield for Year(1) ...................... 6.61% 6.73% 6.37% 6.19% 6.27%
(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.
38
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
to 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 levels 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 of all balance
sheet positions. Such work is further augmented by adjusting for prepayment and
embedded option risk found naturally in certain asset and liability classes.
Finally, balance sheet growth and funding expectations are added to the analysis
in order to reflect the strategic initiatives set forth by the Company.
Changes in net interest income are reviewed after subjecting the balance sheet
to an array of treasury yield curve possibilities. The following reflects the
Company's one-year net interest income sensitivity based on asset and liability
levels on December 31, 2002, assuming no growth in the balance sheet, and
assuming an instantaneous 200 basis point increase and 100 basis point decrease
in the prime rate, federal funds rate and the entire treasury yield curve. This
test is one that is suggested by the Company's regulators (the Office of the
Comptroller of the Currency), and represents conditions that are largely
theoretical as compared to the "management model" discussed below.
Table 25: Regulatory Model
Net Interest Income
Rate Change Dollar Change During First 12 Months
In Basis Points Versus No Change In Rates Percent Change
- -----------------------------------------------------------------------------
+ 200 bp $2.2 million 1.7%
- 100 bp -$2.0 million -1.6%
When compared to no change in interest rates during the first 12 months, net
interest income performs better in the rising rate environment than in the
falling rate environment due in large part to significant levels of core
deposits, which are not as volatile in terms of rate movement as are other
funding sources.
Additionally, to consider balance sheet growth and the steepness in slope of the
treasury yield curve as of year-end 2002, a second group of simulations was
performed based on what the Company believes to be conservative levels of
balance sheet growth-- low single digit growth in loans and deposits along with
natural run-off of investments, augmented by any necessary changes in
borrowings, with no growth in other major portions of the balance sheet. On that
basis, a variety of scenarios was tested, including moving Prime and Fed Funds
up 200 basis points and down 100 basis points over a 12 month period while
flattening the long end of the treasury curve to spreads over fed funds that are
more consistent with historical norms.
Table 26: Management Model
Net Interest Income
Rate Change Dollar Change During First 12 Months
In Basis Points Versus No Change In Rates Percent Change
- -----------------------------------------------------------------------------
+ 200 bp $2.8 million 2.2%
- 100 bp -$3.0 million -2.4%
This test is considered by Company management to be a more realistic measure of
interest rate risk when compared to no change in rates over the first 12 months.
Nonetheless, the analysis does not represent a Company forecast and should not
be relied upon as being indicative of expected operating results. These
hypothetical estimates are based upon numerous assumptions: the nature and
timing of interest rate levels (including yield curve shape), prepayments on
loans and securities, deposit decay rates, pricing decisions on loans and
deposits, reinvestment/replacement of asset and liability cash flows, and other
factors. While the assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions, including
39
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
2002, this ratio was 16.2% and 16.1%, respectively, excluding the Company's
capacity to borrow additional funds from the Federal Home Loan Bank.
To measure longer-term liquidity, a baseline projection of loan and deposit
growth for five years is made to reflect how current liquidity levels could
change over time. This five-year measure reflects ample liquidity for loan
growth over the next five years.
40
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;
(13) other risk factors outlined in the Company's filings with the Securities
and Exchange Commission from time to time; and (14) the success of the Company
at managing the risks of the foregoing.
The foregoing list of important factors is not exclusive. Such forward-looking
statements speak only as of the date on which they are made and the Company does
not undertake any obligation to update any forward-looking statement, whether
written or oral, to reflect events or circumstances after the date on which such
statement is made. If the Company does update or correct one or more
forward-looking statements, investors and others should not conclude that the
Company will make additional updates or corrections with respect thereto or with
respect to other forward-looking statements.
New Accounting Pronouncements
See Accounting Pronouncement Section of Note A of the notes to the consolidated
financial statements on page 44.
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
42 through 66 of this item.
- - Consolidated Statements of Condition--
December 31, 2002 and 2001
- - Consolidated Statements of Income -
Years ended December 31, 2002, 2001, and 2000
- - Consolidated Statements of Changes in Shareholders' Equity -
Years ended December 31, 2002, 2001, and 2000
- - Consolidated Statements of Cash Flows -
Years ended December 31, 2002, 2001, and 2000
- - Notes to Consolidated Financial Statements -
December 31, 2002
- - Report of Independent Accountants
Quarterly Selected Data (Unaudited) for 2002 and 2001 are contained on page 67.
41
CONSOLIDATED STATEMENTS OF CONDITION
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Share Data)
- ------------------------------------------------------------------------------------------------
December 31, December 31,
2002 2001
- ------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents ..................................... $ 113,531 $ 106,554
Investment securities ......................................... 1,283,565 1,148,182
(approximate fair value of $1,283,819 and $1,148,406)
Loans ......................................................... 1,806,905 1,732,870
Allowance for loan losses ..................................... 26,331 23,901
- -------------------------------------------------------------------------------------------------
Net loans ..................................................... 1,780,574 1,708,969
Premises and equipment, net ................................... 56,997 53,266
Accrued interest receivable ................................... 22,772 22,562
Core deposit intangibles, net ................................. 30,769 36,722
Goodwill, net ................................................. 104,059 19,814
Other intangibles, net (See note A ) .......................... 0 85,806
- -------------------------------------------------------------------------------------------------
Intangible assets, net ........................................ 134,828 142,342
Other assets .................................................. 41,937 28,958
- -------------------------------------------------------------------------------------------------
TOTAL ASSETS .................................................. $ 3,434,204 $ 3,210,833
=================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Noninterest bearing ......................................... $ 439,075 $ 447,544
Interest bearing ............................................ 2,066,281 2,098,426
- -------------------------------------------------------------------------------------------------
Total deposits ................................................ 2,505,356 2,545,970
Federal funds purchased ....................................... 33,000 14,200
Borrowings .................................................... 430,000 263,100
Company obligated mandatorily redeemable preferred
securities of subsidiaries, Community Capital
Trust I-III, holding solely junior subordinated
debentures of the Company ................................... 77,375 77,819
Accrued interest and other liabilities ........................ 63,435 41,764
- -------------------------------------------------------------------------------------------------
TOTAL LIABILITIES ............................................. 3,109,166 2,942,853
- -------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value for 2002 and 2001;
20,000,000 share authorized; 12,978,554 and
12,902,812 shares outstanding for 2002 and
2001, respectively .......................................... 12,979 12,903
Surplus ....................................................... 79,058 77,710
Undivided profits ............................................. 194,483 170,472
Accumulated other comprehensive income ........................ 38,551 7,281
Employee stock plan - unearned ................................ (33) (386)
- -------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY .................................... 325,038 267,980
- -------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .................... $ 3,434,204 $ 3,210,833
=================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
42
CONSOLIDATED STATEMENTS OF INCOME
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Per-Share Data)
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans ..................................................... $ 130,860 $ 132,014 $ 130,207
Interest and dividends on investments:
Taxable ...................................................................... 56,904 55,012 50,885
Nontaxable ................................................................... 17,100 10,274 7,847
Interest on federal funds sold and deposits with other banks ................... 6 550 635
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income ............................................................ 204,870 197,850 189,574
- ------------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits ........................................................... 53,878 73,163 69,921
Interest on federal funds purchased ............................................ 511 883 3,411
Interest on short-term borrowings .............................................. 2,075 5,855 16,304
Interest on mandatorily redeemable preferred securities of subsidiaries ........ 5,762 4,540 2,932
Interest on long-term borrowings ............................................... 14,794 16,754 6,573
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense ........................................................... 77,020 101,195 99,141
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income .............................................................. 127,850 96,655 90,433
Less: Provision for loan losses ................................................. 12,222 7,097 7,722
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses .............................. 115,628 89,558 82,711
- ------------------------------------------------------------------------------------------------------------------------------------
Other income:
Fiduciary and investment services .............................................. 3,269 3,080 3,251
Service charges on deposit accounts ............................................ 13,059 9,999 8,385
Commissions and advisory fees on investment products ........................... 6,391 6,085 4,924
Other service charges, commissions and fees .................................... 7,980 7,050 6,541
Other operating income, net .................................................... 228 290 183
Net investment security gain (loss) and loss on early
retirement of long-term borrowings ........................................... 1,673 (113) (159)
- ------------------------------------------------------------------------------------------------------------------------------------
Total other income ............................................................... 32,600 26,391 23,125
- ------------------------------------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits ................................................. 48,168 41,045 36,743
Occupancy expense, net ......................................................... 8,155 6,122 5,084
Equipment and furniture expense, net ........................................... 7,539 6,075 5,224
Amortization of intangible assets .............................................. 5,953 6,679 4,891
Legal and professional fees .................................................... 3,342 2,859 2,336
Data processing expenses ....................................................... 7,187 5,120 4,526
Office supplies ................................................................ 2,321 1,995 1,696
Acquisition and unusual expenses ............................................... 700 8,164 400
Other .......................................................................... 12,459 10,947 10,034
- ------------------------------------------------------------------------------------------------------------------------------------
Total other expenses ............................................................. 95,824 89,006 70,934
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ....................................................... 52,404 26,943 34,902
Income taxes ..................................................................... 13,887 7,814 10,003
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME ....................................................................... $ 38,517 $ 19,129 $ 24,899
====================================================================================================================================
Earnings per share - Basic ....................................................... $ 2.97 $ 1.64 $ 2.34
====================================================================================================================================
Earnings per share - Diluted ..................................................... $ 2.93 $ 1.62 $ 2.32
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
43
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Years ended December 31, 2000, 2001 and 2002
(In Thousands, Except Share Data)
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common Stock Other Employee
---------------------- Compre- Compre- Stock
Shares Undivided Treasury hensive hensive Plan -
Outstanding Amount Surplus Profits Stock Income Income Unearned Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 ...... 10,657,770 $11,206 $37,682 $149,131 $(14,719) $(17,581) $ (14) $ 165,705
Net income - 2000 ............... 24,899 $24,899 24,899
-------
Other comprehensive income,
before tax:
Unrealized gains on
securities:
Unrealized holding gains
arising during period .... 39,053
Reclassification
adjustment for losses
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) (10,113)
Common stock issued under
employee stock plan ........... 2,127 2 29 9 40
Treasury stock purchased ........ (100,000) (2,287) (2,287)
- ------------------------------------------------------------------------------------------- ------------------------------
Balance at December 31, 2000 ...... 10,559,897 $11,208 $37,711 $163,917 $(17,006) $ 5,966 $ (5) $ 201,791
Net income - 2001 ............... 19,129 $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) (12,574)
Issuance of common stock ........ 1,308,800 1,309 30,755 32,064
Common stock issued under
employee stock plan ........... 82,546 83 1,338 (381) 1,040
Fractional shares redeemed ...... (431) (1) (12) (13)
Stock issued for acquisition .... 952,000 304 7,918 17,006 25,228
- ------------------------------------------------------------------------------------------- ------------------------------
Balance at December 31, 2001 ...... 12,902,812 $12,903 $77,710 $170,472 $ 0 $ 7,281 $(386) $ 267,980
Net income - 2002 ............... 38,517 $38,517 38,517
-------
Other comprehensive income,
before tax:
Minimum pension liability
adjustment ................ 4,919
Unrealized gains on securities:
Unrealized holding gains
arising during period ..... 49,796
Reclassification adjustment
for gains included
in net income ............. (2,598)
-------
Other comprehensive income,
before tax .................... 52,117
Income tax expense related
to other comprehensive
income ........................ (20,847)
-------
Other comprehensive income,
net of tax .................... 31,270 31,270 31,270
-------
Comprehensive income ............ $69,787
=======
Dividends declared:
Common, $1.12 per share ....... (14,506) (14,506)
Common stock issued under
employee stock plan ........... 75,742 76 1,348 353 1,777
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 ...... 12,978,554 $12,979 $79,058 $194,483 $ 0 $ 38,551 $ (33) $ 325,038
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
44
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars, except Share Data)
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income ............................................................................. $ 38,517 $ 19,129 $ 24,899
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation ....................................................................... 6,596 5,049 4,072
Amortization of intangible assets .................................................. 5,953 6,679 4,891
Net amortization of security premiums and discounts ................................ 3,358 2,229 439
Amortization of discount on loans .................................................. (102) (199) (311)
Amortization of unearned compensation and discount on junior subordinated debentures 443 276 16
Provision for loan losses .......................................................... 12,222 7,097 7,722
Provision (benefit) for deferred taxes ............................................. 4,458 (835) 412
Loss on early retirement of long-term borrowings ................................... 925 2,659 0
(Gain) loss on sale of investment securities ....................................... (2,598) (2,546) 159
Loss (gain) on sale of loans and other assets ...................................... 100 (283) (236)
Change in interest receivable ...................................................... (210) 1,276 (4,308)
Change in other assets and other liabilities ....................................... (11,586) 5,349 (5,850)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities ........................................ 58,076 45,880 31,905
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities ........................................... 96,294 141,959 16,811
Proceeds from maturities of held-to-maturity investment securities ..................... 4,521 6,172 3,727
Proceeds from maturities of available-for-sale investment securities ................... 197,928 205,135 51,799
Purchases of held-to-maturity investment securities .................................... (4,095) (4,380) (4,035)
Purchases of available-for-sale investment securities .................................. (383,598) (514,132) (142,671)
Net change in loans outstanding ........................................................ (83,789) 12,607 (96,220)
Premium paid on acquisition of business ................................................ 0 (1,830) (6,134)
Cash received in acquisitions .......................................................... 0 212,353 0
Capital expenditures, net .............................................................. (8,831) (7,730) (5,304)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities .................................... (181,570) 50,154 (182,027)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts ...................... 25,005 206,490 9,236
Net change in certificates of deposit .................................................. (65,619) (166,998) 94,569
Net change in federal funds purchased .................................................. 18,800 (34,530) 16,280
Net change in term borrowings .......................................................... 165,475 (140,609) (7,900)
Proceeds from issuance of redeemable preferred securities .............................. 0 47,967 0
Issuance of common stock, net of issuance costs ........................................ 1,151 32,837 29
Treasury stock purchased ............................................................... 0 0 (2,287)
Cash dividends paid .................................................................... (14,228) (10,980) (9,998)
Other financing activities ............................................................. (113) (113) (101)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities ................................... 130,471 (65,936) 99,828
- ------------------------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents ...................................................... 6,977 30,098 (50,294)
Cash and cash equivalents at beginning of year ........................................... 106,554 76,456 126,750
- ------------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR ................................................. $ 113,531 $ 106,554 $ 76,456
====================================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest ................................................................... $ 79,038 $ 103,664 $ 97,326
Cash paid for income taxes ............................................................... $ 6,429 $ 8,082 $ 9,876
====================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Dividends declared and unpaid ............................................................ $ 3,760 $ 3,482 $ 1,888
Gross change in unrealized gains on available-for-sale securities ........................ $ 47,198 $ 7,092 $ 39,212
Minimum pension liability adjustment ..................................................... $ (4,919) $ 5,016 $ 0
Bank and branch acquisitions:
Fair value of assets acquired .......................................................... $ 0 $ 382,560 $ 0
Liabilities assumed .................................................................... $ 0 $ 569,685 $ 0
Common stock issued, including treasury stock of $17,006 ............................... $ 0 $ 25,228 $ 0
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
45
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
seven subsidiaries: Community Bank, N.A. (the Bank), Community Capital Trust I,
II, and Community Statutory Trust III subsidiary business trusts, Benefit Plans
Administrative Services, Inc. (BPA), CFSI Closeout Corp. (CFSICC), and First of
Jermyn Realty Co. (FJRC). 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 provides pension administration and consulting services to sponsors of
defined benefit and defined contribution plans. CFSICC and FJRC are inactive
companies. The Bank operates 112 customer facilities throughout the Northern,
the Finger Lakes, and the Southern Tier regions of New York State, as well as
Northeastern 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 and investment products. CISI provides
broker-dealer and investment advisory services. TMC operates the cash
management, investment, and treasury functions of the Bank. PFC primarily
engages in investing of residential real estate loans. EAM provides asset
management services to individuals, corporate pension and profit sharing plans,
and foundations. FLSC provides banking related services to the Pennsylvania
branches of the Bank.
Basis of Presentation
All amounts except share, per-share and rates are presented in thousands.
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.
Critical Accounting Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Critical accounting estimates include the allowance for loan losses, actuarial
assumptions associated with the pension, post-retirement and other employee
benefit plans, fair value of investment securities, and fair value methodologies
used to review the carrying value of goodwill.
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 regulations of various governmental agencies. These
regulations can and do change significantly from period to period. The Company
also undergoes periodic examinations by the regulatory agencies which may
subject it to further changes with respect to asset valuations, amounts of
required loan loss allowances, and operating restrictions resulting from the
regulators' judgements based on information available to them at the time of
their examinations.
46
Business Combinations
Since the Financial Accounting Standards Board (FASB) issued SFAS 141, "Business
Combinations," business combinations initiated after June 30, 2001, are required
to be accounted for under the purchase method. Under the purchase method, net
assets of the business acquired are recorded at their estimated fair value as of
the date of acquisition with any excess of the cost of the acquisition over the
fair value of the net tangible and intangible assets acquired recorded as
goodwill. Results of operations of the acquired business are included in the
income statement from the date of acquisition. Prior to SFAS 141, certain
business combinations were accounted for under the pooling-of-interests method,
which required the retroactive combining of the assets, liabilities,
shareholders' equity, and results of operations of the merged entity with the
Company's respective accounts at historical amounts. Prior period financial
statements were restated to give effect to business combinations accounted for
under this method.
Revenue Recognition
The Company recognizes income on an accrual basis. TMC recognizes interest
income on its investment assets using the interest method and recognizes
management fee income for its treasury and investment management services
rendered to the Bank and PFC. CISI and CFSI both recognize fee income when
insurance and investment products are sold to the public. EAM provides asset
management services to brokerage firms and clients and recognizes income ratably
over the contract period during which service is performed. PFC recognizes
interest income on real estate mortgages using the interest method and a
management fee for services it provides to the Bank. FLSC earns a fee from the
Bank for the personnel and management services it provides to the Pennsylvania
division of the Bank. BPA performs actuarial and recordkeeping services and
earns its income over the portion of the contract period during which service is
performed. Community Capital Trust I and II and Community Statutory Trust III
earn interest income on their investment in Junior Subordinated Debentures of
the Parent Company using the interest method. All intercompany fees and interest
income and expense among related entities eliminate in consolidation.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, amounts due from banks and federal funds sold. Generally, federal funds
are sold for one-day periods. The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate those assets' fair values.
Investment Securities
The Company has classified its investments in debt and equity securities as
held-to-maturity or available-for-sale. Held-to-maturity securities are those
for which the Company has the positive intent and ability to hold to maturity,
and are reported at cost, which is adjusted for amortization of premiums and
accretion of discounts. Debt securities not classified as held-to-maturity are
classified as available-for-sale and are reported at fair market value with net
unrealized gains and losses reflected as a separate component of shareholders'
equity, net of applicable income taxes. None of the Company's investment
securities 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. Investment securities are reviewed regularly
for other than temporary impairment. Where there is other than temporary
impairment, the carrying value of the investment security is reduced to the
estimated fair value, with the impairment loss recognized in the consolidated
statements of income as other operating income, net.
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.
47
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 included
in the loan balances and are deferred and amortized over the life of the loan as
an adjustment to loan yield using the effective interest method.
Impaired and Other Nonaccrual Loans
The Company places a loan on nonaccrual status when the loan 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. A loan may be placed on nonaccrual status
earlier than ninety days past due if there is deterioration in the financial
position of the borrower or if other conditions of the loan so warrant. When a
loan is placed on nonaccrual status, uncollected accrued interest is charged
against interest income. Interest income during the period the loan is on
nonaccrual status is recorded on a cash basis. Nonaccrual loans are returned to
accrual status when management determines that the borrower's performance has
improved and that both principal and interest are collectible. This generally
requires a sustained period of timely principal and interest payments.
A loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. The measurement of impaired loans is generally based upon the present
value of expected future cash flows, except that all collateral-dependent loans
are measured for impairment based on fair value of the collateral.
Allowance for Loan Losses
When appropriate, an impaired loan is assigned a specific allowance. Specific
loan loss allocations for certain identified commercial customers are considered
and revised as necessary. Charge-off of these commercial customers are taken
against the specific allocations before being applied against the general
reserve. General allocations on the commercial, residential and consumer loan
portfolios are reviewed and recalculated quarterly based on historical loss
experience and various qualitative judgement factors. These qualitative factors
include changes in national and local economic and business conditions, changes
in experience, ability and depth of lending management, changes in the portfolio
mix and risk profile, and changes in the growth of the loan portfolios. Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance.
The allowance for loan losses reflects management's best estimate of probable
loan losses in the Company's loan portfolio. Determination of the allowance for
loan losses is inherently subjective. It requires significant estimates
including the amounts and timing of expected future cash flows on impaired loans
and the amount of estimated losses on pools of homogeneous loans which is based
on historical loss experience and consideration of current economic trends, all
of which may be susceptible to significant change.
Intangible Assets
Intangible assets represent core deposit intangibles and goodwill arising from
acquisitions. On January 1, 2002, the Company adopted SFAS 142, "Goodwill and
Other Intangible Assets," and SFAS 147, "Accounting for Certain Acquisitions of
Banking and Thrift Institutions." Under the provisions of SFAS 142 and SFAS 147,
goodwill is no longer ratably amortized into the income statement over an
estimated life, but rather is tested at least annually for impairment. Core
deposit intangibles continue to be amortized on either an accelerated or
straight-line basis over periods ranging from 7 to 15 years. Prior to the
adoption of SFAS 142 and SFAS 147, the Company's goodwill was amortized on a
straight-line basis over varying periods not exceeding 25 years. Note F includes
a summary of the Company's core deposit intangibles and goodwill as well as
further detail about the impact of the adoption of SFAS 142 and SFAS 147.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Computer software costs that are capitalized only include external direct costs
of obtaining and installing the software. The annual provision for depreciation
is computed using the straight-line method over the assets' 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, 2002 and 2001, other
real estate, included in other assets, amounted to $704 and $1,427,
respectively.
48
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 Company uses a valuation model that
calculates the present value of future cash flows to determine the fair value of
servicing rights. In using this valuation method, the Company incorporates
assumptions that market participants would use in estimating future net
servicing income, which includes estimates of the servicing cost per loan, the
discount rate, and prepayment speeds. The carrying value of the originated
mortgage servicing rights is periodically evaluated for impairment using these
same market assumptions. At December 31, 2002 and 2001, mortgage servicing
rights, included in other assets, amounted to $283 and $567, respectively.
Deposits
The fair values of demand and savings deposits are based on carrying values. The
carrying amounts for variable rate money market accounts and certificates of
deposit approximate their fair values. 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.
Since the Company considers debt extinguishments in its interest rate risk
strategy, any prepayment penalties incurred on long-term borrowings are
presented in the other income section of the consolidated statements of income.
Treasury Stock
Treasury stock purchases are recorded at cost. The Company purchases treasury
stock primarily for strategic purposes. During 2001, the Company issued 648,100
shares of treasury stock in connection with the acquisition of Citizens National
Bank of Malone.
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.
Retirement Benefits
The Company has established tax-qualified retirement plans covering
substantially all full-time employees and certain part-time employees. The
Company also provides post-retirement benefits for eligible retired employees
and dependents. Expense under these plans is charged to current operations and
consists of several components of net periodic benefit cost based on various
actuarial assumptions regarding future experience under the plans. In addition,
the Company has unfunded deferred compensation and supplemental executive
retirement plans for selected current and former employees and officers that
provide benefits that cannot be paid from a qualified retirement plan due to
Internal Revenue Code restrictions. These plans are nonqualified under the
Internal Revenue Code, and assets used to fund benefit payments are not
segregated from other assets of the Company; therefore, in general, a
participant's or beneficiary's claim to benefits under these plans is as a
general creditor.
Assets Under Management
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. Substantially all fees associated with providing
management services are recorded on an accrual basis of income and are included
in other income. Assets under management at December 31, 2002 and 2001 were
$1,364,000 and $1,385,000, respectively.
49
Earnings Per Share
Basic-earnings per share are computed based on the weighted-average common
shares outstanding for the period. Diluted-earnings per share are based on the
weighted-average shares outstanding adjusted for the dilutive effect of the
assumed exercise of stock options during the year. The dilutive effect of
options is calculated using the treasury stock method of accounting. The
treasury stock method determines the number of common shares which would be
outstanding if all the in-the-money options (average market price is greater
than the exercise price) were exercised and the proceeds were used to repurchase
common shares in the open market at the average market price for the applicable
time period.
Stock-Based Compensation
The Company accounts for stock awards issued to directors, officers and key
employees using the intrinsic value method. This method requires that
compensation expense be recognized to the extent that the fair value of the
stock exceeds the exercise price of the stock award at the grant date. The
Company generally does not recognize compensation expense related to stock
awards because the stock awards generally have fixed terms and exercise prices
that are equal to or greater than the fair value of the Company's common stock
at the grant date.
SFAS 123, "Accounting for Stock-Based Compensation," requires companies that use
the "intrinsic value method" to account for stock compensation plans to provide
pro forma disclosures of the net income and earnings per share effect of stock
options using the "fair value method." Under the intrinsic value method, the
excess of the fair value of the stock over the exercise price is recorded as
expense on the date at which both the number of shares the recipient is entitled
to receive and the exercise price are known.
Management estimated the fair value of options granted using the Black-Scholes
option-pricing model. This model was originally developed to estimate the fair
value of exchange-traded equity options, which (unlike employee stock options)
have no vesting period or transferability restrictions. As a result, the
Black-Scholes model is not a perfect indicator of the value of an option, but it
is commonly used for this purpose.
The Black-Scholes model requires several assumptions, which management developed
based on historical trends and current market observations. These assumptions
include:
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Weighted-average expected life .... 6.74 7.02 7.11
Future dividend yield ............. 3.00% 3.00% 3.00%
Share price volatility ............ 27.82% 28.14% 29.15%
Weighted average risk-free
interest rate ................... 3.814%-5.157% 5.11% 4.65%-6.93%
================================================================================
If these assumptions are not accurate, the estimated fair value used to derive
the information presented in the following table also will be inaccurate.
Moreover, the model assumes that the estimated fair value of an option is
amortized over the option's vesting period and would be included in personnel
expense on the income statement. The pro forma impact of applying the fair value
method of accounting for the years shown below may not be indicative of the pro
forma impact in future years.
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Net Income:
As reported ........... $ 38,517 $ 19,129 $ 24,899
Pro forma
$ 37,825 $ 18,333 $ 24,282
Earnings per share:
As reported:
Basic .............. $ 2.97 $ 1.64 $ 2.34
Diluted ............ $ 2.93 $ 1.62 $ 2.32
Pro forma:
Basic .............. $ 2.92 $ 1.57 $ 2.28
Diluted ............ $ 2.87 $ 1.55 $ 2.27
================================================================================
50
Fair Values of Financial Instruments
The Company determines fair values based on quoted market values where available
or on estimates using present values or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. SFAS 107, "Disclosures about Fair Value of Financial Instruments,"
excludes certain financial instruments and all 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 August 2001, the FASB issued SFAS 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." SFAS 144 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. Effective January 1, 2002, the Company adopted this
pronouncement, which had no impact on the financial condition or results of
operations for the year ended December 31, 2002.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,"
which updates, clarifies, and simplifies certain existing accounting
pronouncements beginning at various dates in 2002 and 2003. This Statement
rescinds SFAS 4 and SFAS 64, which required net gains or losses from the
extinguishment of debt to be classified as an extraordinary item in the income
statement. These gains and losses will now be classified as extraordinary only
if they meet the criteria for such classification as outlined in APB Opinion 30,
which allows for extraordinary treatment if the item is material and both
unusual and infrequent in nature. The Statement also rescinds SFAS 44 related to
the accounting for intangible assets for motor carriers and amends SFAS 13 to
require certain lease modifications that have economic effects similar to
sale-leaseback transactions to be accounted for as such. The Company adopted
this pronouncement as of July 1, 2002. As a result, gains and losses from debt
extinguishments have been presented in the other income section of the
consolidated statements of income and all prior periods have been restated.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. This Statement
supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit and Activity
(including Certain Costs Incurred in a Restructuring)." The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. This pronouncement does
not have a significant impact on the Company's financial condition or results of
operations for the year ended December 31, 2002.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS 123, "Accounting for Stock-Based Compensation,"
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company will continue to
account for stock-based compensation using the intrinsic value method but will
provide pro forma disclosures of the net income and earnings per share effect of
stock options using the "fair value method" in its annual and interim financial
statements.
See Note F for discussion of recent accounting pronouncements regarding goodwill
and intangible assets.
51
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 State. The acquisition has been accounted for under the purchase method of
accounting. 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 has been 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 dates FleetBoston Financial Corporation and
Citizens National Bank of Malone were acquired.
- --------------------------------------------------------------------------------
FleetBoston Citizens
Financial National Bank
(000's omitted) Corporation of Malone Total
- --------------------------------------------------------------------------------
Cash ....................................... $208,576 $ 3,777 $212,353
Investments ................................ 0 46,029 46,029
Loans, net of allowance for loan losses .... 174,449 57,981 232,430
Premises and equipment, net ................ 9,600 1,495 11,095
Other assets ............................... 1,255 1,355 2,610
Core deposit intangibles ................... 28,100 0 28,100
Goodwill ................................... 48,985 13,311 62,296
- --------------------------------------------------------------------------------
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
================================================================================
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 APB Opinion 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.
Results of operations for the separate companies and the combined amounts
presented in the consolidated financial statements follow:
- --------------------------------------------------------------------------------
For the
For the Four Twelve
Months Ended Months Ended
April 30, December 31,
- --------------------------------------------------------------------------------
(000's omitted) 2001 2000
- --------------------------------------------------------------------------------
NET INTEREST INCOME:
Community Bank System, Inc. ................ $24,742 $71,209
First Liberty Bank Corp .................... 6,112 19,224
- --------------------------------------------------------------------------------
Combined ................................... $30,854 $90,433
================================================================================
NET INCOME:
Community Bank System, Inc. ................ $ 5,874 $20,319
First Liberty Bank Corp .................... 1,765 4,580
- --------------------------------------------------------------------------------
Combined ................................... $ 7,639 $24,899
================================================================================
52
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 $6.5 million. Additional consideration
of $3.0 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 $405 million in assets under
management for individuals, corporate pension and profit sharing plans, and
foundations as of December 31, 2002. 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:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000
- --------------------------------------------------------------------------------
Acquisition expenses:
Legal and professional fees ................ $ 455 $2,742 $ 371
Severance and employee benefits ............ 97 1,462 0
Equipment write-downs ...................... 0 934 0
Customer check repurchase .................. 61 811 0
Other ...................................... 87 1,381 29
- --------------------------------------------------------------------------------
Total acquisition expenses .............. 700 7,330 400
- --------------------------------------------------------------------------------
Unusual expenses:
Legal and professional fees ................ 0 395 0
Other ...................................... 0 439 0
- --------------------------------------------------------------------------------
Total unusual expenses .................. 0 834 0
- --------------------------------------------------------------------------------
Total acquisition and unusual expenses .. $ 700 $8,164 $ 400
================================================================================
NOTE C: INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities as of
December 31 are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
- --------------------------------------------------------------------------------- --------------------------------------------------
Gross Gross Estimated Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
(000's omitted) Cost Gains Gains Value Cost Gains Losses Value
- --------------------------------------------------------------------------------- --------------------------------------------------
Held to Maturity Portfolio:
Obligations of state and
political subdivisions ..... $ 7,412 $ 254 $ 0 $ 7,666 $ 7,608 $ 224 $ 0 $ 7,832
- --------------------------------------------------------------------------------- --------------------------------------------------
Total ................. 7,412 254 0 7,666 7,608 224 0 7,832
- --------------------------------------------------------------------------------- --------------------------------------------------
Available for Sale
Portfolio:
U.S. Treasury securities
and obligations
of U.S. government
corporations and
agencies ................. 380,243 31,035 0 411,278 192,111 11,390 0 203,501
Obligations of state and
political subdivisions ... 404,864 15,781 40 420,605 282,109 2,024 6,540 277,593
Corporate securities ....... 27,972 2,253 0 30,225 43,392 1,336 329 44,399
Collateralized mortgage
obligations (CMO's) ...... 235,286 10,082 0 245,368 400,100 6,753 3,073 403,780
Mortgage-backed securities . 131,755 5,457 1 137,211 173,978 5,843 35 179,786
- --------------------------------------------------------------------------------- --------------------------------------------------
Total .................. 1,180,120 64,608 41 1,244,687 1,091,690 27,346 9,977 1,109,059
Equity securities .......... 31,466 0 0 31,466 31,515 0 0 31,515
- --------------------------------------------------------------------------------- --------------------------------------------------
Total .................. 1,211,586 $ 64,608 $ 41 $1,276,153 1,123,205 $ 27,346 $ 9,977 $1,140,574
===================================== ====================================
Net unrealized gain on
available for sale
portfolio ................ 64,567 17,369
---------- -----------
Total carrying value .. $1,283,565 $1,148,182
========== ===========
53
The amortized cost and estimated fair value of debt securities at December 31,
2002, 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
- --------------------------------------------------------------------------------------------------- --------------------------------
Est. Est.
Carrying Market Carrying Market
(000's omitted) Value Value Value Value
- ---------------------------------------------------------------------------------------------------- -------------------------------
Due in one year or less .................................... $ 4,307 $ 4,346 $ 2,151 $ 2,172
Due after one through five years ........................... 2,373 2,520 16,624 17,775
Due after five years through ten years ..................... 732 800 386,236 409,157
Due after ten years ........................................ 0 0 408,068 433,004
- --------------------------------------------------------------------------------------------------- --------------------------------
Total ................................................. 7,412 7,666 813,079 862,108
Collateralized mortgage obligations (CMO's) ................ 0 0 235,286 245,368
Mortgage-backed securities ................................. 0 0 131,755 137,211
- --------------------------------------------------------------------------------------------------- --------------------------------
Total ................................................. $ 7,412 $ 7,666 $1,180,120 $1,244,687
====================================================================================================================================
Proceeds from sales of investment securities during 2002, 2001, and 2000 were
$81,264, $137,162, and $16,864, respectively. Gross gains of approximately
$2,593, $2,964, and $53 for 2002, 2001, and 2000, respectively, and gross losses
of $0, $418, and $212 in 2002, 2001, and 2000, respectively, were realized on
those sales.
Investment securities with a carrying value of $685,102 and $596,200 at December
31, 2002 and 2001, respectively, were pledged to collateralize deposits and
borrowings.
NOTE D: LOANS
Major classifications of loans at December 31 are summarized as follows:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Real estate mortgages ............................ $1,062,176 $1,005,558
Commercial, financial and agricultural loans ..... 283,273 299,925
Installment loans to individuals ................. 436,118 399,368
Other loans ...................................... 25,454 28,237
- --------------------------------------------------------------------------------
Gross loans .................................... 1,807,021 1,733,088
Unearned discount ................................ 116 218
- --------------------------------------------------------------------------------
Net loans ...................................... 1,806,905 1,732,870
Allowance for loan losses ........................ 26,331 23,901
- --------------------------------------------------------------------------------
Loans, net of allowance for loan losses .......... $1,780,574 $1,708,969
================================================================================
The estimated fair value of loans at December 31, 2002 and 2001 was $1,841,000
and $1,703,000, respectively. Non-accrual loans of $9,754 and $7,186 at December
31, 2002 and 2001, respectively, are included in net loans.
Changes in loans to directors and officers and other related parties for the
years ended December 31 are summarized as follows:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Balance at beginning of year ............... $ 15,674 $ 19,017
New loans .................................. 287 1,993
Payments ................................... (226) (5,336)
- --------------------------------------------------------------------------------
Balance at end of year ..................... $ 15,735 $ 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 $103,663, $119,838, and $101,254 at December 31,
2002, 2001, and 2000, respectively. Custodial escrow balances maintained in
connection with the foregoing loan servicing, and included in demand deposits,
were approximately $717 and $883 at December 31, 2002 and 2001, respectively.
54
Changes in the allowance for loan losses for the years ended December 31 are
summarized as follows:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000
- --------------------------------------------------------------------------------
Balance at beginning of .............. $23,901 $20,035 $18,528
year
Provision charged to ................. 12,222 7,097 7,722
expense
Reserve on acquired loans ............ 0 3,353 0
Loans charged off .................... 12,015 8,662 7,480
Recoveries ........................... 2,223 2,078 1,265
- --------------------------------------------------------------------------------
Balance at end of year ............... $26,331 $23,901 $20,035
================================================================================
As of December 31, 2002, the Company had $17,256 in impaired loans. This amount
includes $12,608 of impaired loans with a specifically allocated allowance for
loan loss of $5,078, and $4,648 of impaired loans with no specifically allocated
allowance. As of December 31, 2001, the Company had $21,636 in impaired loans,
including $16,032 with a specifically allocated allowance of $4,262, and $5,604
with no specifically allocated allowance.
NOTE E: PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Land and land improvements ..................... $ 8,270 $ 7,665
Bank premises owned ............................ 47,129 44,486
Equipment ...................................... 39,577 33,595
- --------------------------------------------------------------------------------
Premises and equipment, gross ................ 94,976 85,746
Less: Allowance for depreciation .............. 37,979 32,480
- --------------------------------------------------------------------------------
Premises and equipment, net .................. $56,997 $53,266
================================================================================
NOTE F: INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other
Intangible Assets," which addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supercedes APB Opinion 17,
"Intangible Assets". The statement requires 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 is no longer being recorded in accordance with this
statement. Core deposit intangibles will continue to be amortized.
In October 2002, the FASB issued SFAS 147, "Accounting for Certain Acquisitions
of Banking and Thrift Institutions," which addresses financial accounting and
reporting for certain intangibles associated with branch acquisitions. This
statement removes acquisitions of financial institutions from the scope of SFAS
72 and FASB Interpretation 9. It reclassifies as goodwill certain "unidentified
intangible assets" associated with the Company's branch acquisitions dating as
far back as 1994. Financial statements are retroactively restated to January 1,
2002 to remove amortization recorded on Other Intangible Assets. Previously,
these intangible assets were being regularly amortized. As discussed above,
under FASB 142, goodwill is not required to be amortized, but as an asset, is
periodically reviewed for impairment.
The pro forma disclosures on net income and earnings per share of SFAS 142 and
SFAS 147 for the twelve months ended December 31, 2002, 2001 and 2000 are as
follows:
Twelve Months Ended December 31,
- --------------------------------------------------------------------------------
($000's omitted except per share amounts) 2002 2001 2000
- --------------------------------------------------------------------------------
Reported net income ..................... $ 38,517 $ 19,129 $ 24,899
Goodwill amortization, net of taxes ..... 2,945 1,964
- --------------------------------------------------------------------------------
Adjusted net income ..................... $ 38,517 $ 22,074 $ 26,863
================================================================================
Basic earnings per share:
Reported net income ..................... $ 2.97 $ 1.64 $ 2.34
Goodwill amortization, net of taxes ..... 0.25 0.18
- --------------------------------------------------------------------------------
Adjusted net income ..................... $ 2.97 $ 1.89 $ 2.52
================================================================================
Diluted earnings per share:
Reported net income ..................... $ 2.93 $ 1.62 $ 2.32
Goodwill amortization, net of taxes ..... 0.25 0.18
- --------------------------------------------------------------------------------
Adjusted net income ..................... $ 2.93 $ 1.87 $ 2.50
================================================================================
55
The gross carrying amount and accumulated amortization for each type of
intangible asset are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
As of December 31, 2002 As of December 31, 2001
- -------------------------------------------------------------------------------------------- ---------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
(000's omitted) Amount Amortization Amount Amount Amortization Amount
- -------------------------------------------------------------------------------------------- ---------------------------------------
Amortized intangible assets:
Core deposit intangibles ................... $ 47,366 $(16,597) $ 30,769 $ 47,366 $(10,644) $ 36,722
- -------------------------------------------------------------------------------------------- ---------------------------------------
Total amortized intangible assets ....... 47,366 (16,597) 30,769 47,366 (10,644) 36,722
Unamortized intangible assets:
Goodwill ................................... 122,432 (18,373) 104,059 123,993 (18,373) 105,620
- -------------------------------------------------------------------------------------------- ---------------------------------------
Total intangible assets, net ............ $169,798 $(34,970) $134,828 $171,359 $(29,017) $142,342
====================================================================================================================================
The decrease of $1,561 in the gross carrying value of goodwill pertains to the
FleetBoston acquisition, specifically an adjustment to fair value of the Bank
premises and equipment following receipt of an external appraisal and reflecting
deferred taxes. The Company completed its goodwill impairment analysis during
2002, and no adjustment was necessary.
The estimated aggregate amortization expense for each of the five succeeding
fiscal years ended December 31 is as follows:
2003 ........... $4,970
2004 ........... 4,753
2005 ........... 4,079
2006 ........... 3,406
2007 ........... 3,406
Thereafter ..... 10,155
- ---------------------------
Total .......... $30,769
===========================
NOTE G: DEPOSITS
Deposits consist of the following at December 31:
- ---------------------------------------------------
(000's omitted) 2002 2001
- ---------------------------------------------------
Demand ................ $ 439,075 $ 447,544
Savings ............... 962,056 928,582
Time .................. 1,104,225 1,169,844
- ---------------------------------------------------
Total deposits ...... $2,505,356 $2,545,970
===================================================
The estimated fair value of deposits at December 31, 2002 and 2001 was
approximately $2,523,000 and $2,548,000, respectively.
At December 31, 2002 and 2001, time certificates of deposit in denominations of
$100 and greater totaled $157,129 and $177,002, respectively.
The approximate maturities of time deposits at December 31 are as follows:
- --------------------------------------------------------------------------------
(000's omitted) .............................. 2002 2001
- --------------------------------------------------------------------------------
Three months or less ......................... $ 276,298 $ 333,002
Over three months through twelve months ...... 538,850 596,308
Over one year through three years ............ 250,667 191,228
Over three years ............................. 38,410 49,306
- --------------------------------------------------------------------------------
Total ...................................... $1,104,225 $1,169,844
================================================================================
56
NOTE H: BORROWINGS
Outstanding borrowings at December 31 are as follows:
- ----------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001
- ----------------------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased .................................................. $ 33,000 $ 14,200
Federal Home Loan Bank advances .......................................... 215,000 26,000
Other short-term borrowings .............................................. 0 6,100
- ----------------------------------------------------------------------------------------------------
Total short-term borrowings ........................................... 248,000 46,300
Long-term borrowings:
Federal Home Loan Bank advances .......................................... 215,000 231,000
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts holding solely junior subordinated debentures
of the Company, net of discount of $1,575 and $1,631 .................. 77,375 77,819
- ----------------------------------------------------------------------------------------------------
Total long-term borrowings .......................................... 292,375 308,819
- ----------------------------------------------------------------------------------------------------
Total borrowings .................................................. $540,375 $355,119
====================================================================================================
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, 2002 have maturity dates as follows:
- -----------------------------------------------------------
Weighted
Average
(000's omitted, except rates) Amount Rate
- -----------------------------------------------------------
January 23, 2008 ............ $ 10,000 5.44%
January 28, 2008 ............ 5,000 5.48%
January 30, 2008 ............ 20,000 5.27%
February 4, 2008 ............ 5,000 5.45%
April 14, 2010 .............. 25,000 6.35%
September 27, 2010 .......... 50,000 5.88%
October 12, 2010 ............ 50,000 5.84%
November 1, 2010 ............ 50,000 5.77%
February 3, 2027 ............ 29,338 9.75%
July 16, 2031 ............... 24,286 6.13%
July 31, 2031 ............... 23,751 5.49%
- -----------------------------------------------------------
Total ..................... $292,375 6.20%
===========================================================
The estimated fair value of long-term borrowings at December 31, 2002 and 2001
was approximately $345,000 and $339,000 respectively.
In December 2002, the Company prepaid $11,000 of Federal Home Loan Bank advances
with maturity dates ranging from December 15, 2003 to December 31, 2004 and a
weighted average rate of 6.17%. In September 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%. As a result of
these prepayments, the Company incurred penalties of $925 and $2,659 in 2002 and
2001, respectively. These penalties have been reflected in the consolidated
statements of income as net investment security gains and loss on early
retirement of long-term borrowings.
On February 3, 1997, the Company formed a wholly-owned subsidiary business
trust, Community Capital Trust I (Trust), for the purpose of issuing
Company-Obligated Mandatorily Redeemable Preferred Securities representing
undivided beneficial interests in the assets of the Trust. The Trust issued
$30,000 of 9.75% preferred securities that are non-voting and mandatorily
redeemable in 2027 with a ten-year call provision beginning in 2007 at a premium
of 104.54% declining to par in 2017. The Company borrowed the proceeds of the
preferred securities from the Trust by issuing Junior Subordinated Debentures
having substantially similar terms as the preferred securities. The assets of
the Trust include the principal amount of the Company's Junior Subordinated
Debentures and related accrued interest and were $32,022 at December 31, 2002.
The preferred securities mature in 2027 and are treated as Tier 1 capital. The
guarantees issued by the Company for the Trust, together with the Company's
obligations under the trust agreement, the Junior Subordinated Debentures, and
the
57
Indenture under which the Junior Subordinated Debentures were issued, constitute
a full and unconditional guarantee by the Company of the preferred securities
issued by the Trust. 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.
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 beginning in 2006 at a premium of 107.6875% declining to par in 2011.
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 beginning in 2006 at a premium
of 107.5% declining to par in 2011. All of these securities are guaranteed by
the Company.
NOTE I: INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31 is as
follows:
- --------------------------------------------------------
(000's omitted) 2002 2001 2000
- --------------------------------------------------------
Current:
Federal ........ $ 9,268 $8,301 $ 9,049
State .......... 161 348 542
Deferred:
Federal ........ 3,764 (691) 357
State .......... 694 (144) 55
- ---------------------------------------------------------
Total income taxes .. $13,887 $7,814 $10,003
=========================================================
Components of the net deferred tax asset/liability, included in other
assets/liabilities, as of December 31 are as follows:
- ---------------------------------------------------------------------------
(000's omitted) 2002 2001
- ---------------------------------------------------------------------------
Allowance for loan losses ..................... $ 10,112 $8,956
Employee benefits ............................. 1,430 4,226
Goodwill and amortization of intangibles ...... 978 1,734
Other ......................................... 1,935 1,716
- ---------------------------------------------------------------------------
Total deferred tax asset ...................... 14,455 16,632
- ---------------------------------------------------------------------------
Investment securities ......................... 27,089 8,142
Loan origination costs ........................ 2,462 2,117
Depreciation and loss on disposal ............. 2,809 1,532
Pension ....................................... 3,111 0
Mortgage servicing rights ..................... 110 222
- ---------------------------------------------------------------------------
Total deferred tax liability .................. 35,581 12,013
- ---------------------------------------------------------------------------
Net deferred tax (liability) asset ............ $ (21,126) $4,619
===========================================================================
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:
- -------------------------------------------------------------------------------
2002 2001 2000
- -------------------------------------------------------------------------------
Federal statutory income tax rate ................... 35.0% 35.0% 35.0%
Increase (reduction) in taxes resulting from:
Tax-exempt interest ............................ (9.9%) (11.1%) (9.5%)
State income taxes, net of federal benefit ..... 0.6% 0.7% 1.1%
Other .......................................... 0.8% 4.5% 2.1%
- -------------------------------------------------------------------------------
Effective income tax rate ........................... 26.5% 29.1% 28.7%
===============================================================================
58
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, 2002, the Bank
had approximately $34,368 in undivided profits legally available for the
payments of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The Federal Reserve
Board has indicated that banking organizations should generally pay dividends
only out of current operating earnings.
There are also statutory limits on the transfer of funds to the Company by its
banking subsidiary, whether in the form of loans or other extensions of credit,
investments or assets purchases. Such transfer by the Bank to the Company
generally is limited in amount to 10% of the Bank's capital and surplus, or 20%
in the aggregate. Furthermore, such loans and extensions of credit are required
to be collateralized in specific amounts.
NOTE K: BENEFIT PLANS
The Company has a noncontributory defined benefit pension plan covering the
majority of its employees and retirees. The benefits are based on years of
service and the participant's average compensation, as defined in the Plan. The
Company also provides health and life insurance benefits for eligible retired
employees and dependents. The Company does not fund this plan. The Company
accrues for the estimated cost of these benefits through charges to expense
during the years that the employees earn these benefits. 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 as of
December 31:
Pension Benefits Post-retirement Benefits
- ---------------------------------------------------------------------------------------------------- -------------------------------
(000's omitted) 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------- -------------------------------
Change in benefit obligation
Benefit obligation at the beginning of year .................... $ 29,890 $ 23,459 $ 3,378 $ 2,148
Service cost ................................................... 1,173 1,121 159 165
Interest cost .................................................. 1,779 1,650 241 210
Deferred actuarial (gain) loss ................................. (152) 4,665 491 980
Benefits paid .................................................. (1,170) (1,005) (110) (125)
- ---------------------------------------------------------------------------------------------------- -------------------------------
Benefit obligation at end of year .............................. 31,520 29,890 4,159 3,378
- ---------------------------------------------------------------------------------------------------- -------------------------------
Change in plan assets
Fair value of plan assets at beginning of year ................. 21,084 22,034 0 0
Actual return of plan assets ................................... (2,781) (1,384) 0 0
Company contributions .......................................... 12,000 1,439 0 0
Benefits paid .................................................. (1,170) (1,005) 0 0
- ---------------------------------------------------------------------------------------------------- -------------------------------
Fair value of plan assets at end of year ....................... 29,133 21,084 0 0
- ---------------------------------------------------------------------------------------------------- -------------------------------
Unfunded status ................................................ (2,387) (8,806) (4,159) (3,378)
Unrecognized actuarial loss .................................... 15,122 10,626 232 66
Unrecognized prior service (benefit) cost ...................... (397) (430) 391 421
Unrecognized transition (asset ) liability ..................... (4) (23) 410 451
- ---------------------------------------------------------------------------------------------------- -------------------------------
Prepaid (accrued) benefit cost ................................. 12,334 1,367 (3,126) (2,440)
Additional minimum liability ................................... 0 (5,016) 0 0
- ---------------------------------------------------------------------------------------------------- -------------------------------
Total prepaid (accrued) benefit cost ........................... $ 12,334 $ (3,649) $ (3,126) $ (2,440)
==================================================================================================== ===============================
Weighted-average assumptions as of
Discount rate .................................................. 6.10% 6.75% 6.10% 6.75%
Expected return on plan assets ................................. 9.00% 9.00% 0.00% 0.00%
Rate of compensation increase .................................. 4.00% 4.00% 0.00% 0.00%
====================================================================================================================================
59
The net periodic benefit cost as of December 31 is as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Pension Benefits Post-retirement Benefits
- ----------------------------------------------------------------------------------------------- ------------------------------------
(000's omitted) ................................... 2002 2001 2000 2002 2001 2000
- ----------------------------------------------------------------------------------------------- ------------------------------------
Components of net periodic benefit cost
Service cost ...................................... $ 1,173 $ 1,121 $ 1,125 $ 159 $ 165 $ 134
Interest cost ..................................... 1,779 1,650 1,530 241 210 138
Expected return on plan assets .................... (1,898) (1,983) (2,034) 0 0 0
Net amortization and deferral ..................... 32 280 (192) 0 0 0
Amortization of prior service cost ................ (33) (114) (24) 30 30 0
Amortization of transition obligation ............. (19) (19) 3 41 41 41
- ----------------------------------------------------------------------------------------------- ------------------------------------
Net periodic benefit cost ......................... $ 1,034 $ 935 $ 408 $ 471 $ 446 $ 313
====================================================================================================================================
FASB 87, "Employers' Accounting for Pensions," requires recognition in the
balance sheet of an additional minimum liability for pension plans with
accumulated benefit obligation 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. For
the year ended December 31, 2002, the plan assets exceeded the accumulated
benefit obligation. As a result, the additional minimum liability was reversed.
The Company has a 401(k) Employee Stock Ownership Plan that is qualified under
Section 401(k) of the Internal Revenue Code. Employees can contribute from 1% to
90% of eligible compensation, with up to 6% being eligible for matching
contributions in the form of Company common stock. The Plan also permits the
Company to distribute a discretionary profit-sharing component in the form of
Company common stock to all participants except certain executive employees. The
expense recognized under this plan for the years ended December 31, 2002, 2001
and 2000 was $666, $528 and $450, respectively. The Company also has a Deferred
Compensation Plan for Certain Executive Employees that is unqualified under
Section 401(k) of the Internal Revenue Code. Under this Plan, the participants
can contribute 15% of their eligible compensation less any amounts contributed
to the 401(k) Employee Stock Ownership Plan. Any discretionary profit-sharing
amounts that the executive receives from the Company must be contributed to the
Deferred Compensation Plan in the form of Company common stock.
The Company has nonqualified deferred compensation and supplemental retirement
plans for several current and former directors, officers, and key employees. The
liability arising from these plans is being accrued over the participant's
remaining period of service so that at the expected retirement date, the then
present value of the annual payments will have been expensed. All benefits
provided under these plans are unfunded and payments to plan participants are
made by the Company. At December 31, 2002 and 2001, the Company has recorded a
liability of $3,690 and $2,796, respectively. The expense recognized under these
plans for the years ended December 31, 2002, 2001, and 2000 was $952, $469, and
$371, respectively.
Directors may defer all or a portion of their director fees under the Deferred
Compensation Plan for Directors. Under this plan, there is a separate account
for each participating director which is credited with the amount of shares
which could have been purchased with the director's fees as well as any
dividends on such shares. On the distribution date, the director will receive
common stock equal to the accumulated share balance in his account. As of
December 31, 2002 and 2001, there were 25,510 and 31,473 shares credited to the
participants' accounts, for which a liability of $781 and $933 was accrued,
respectively. The expense recognized under the plan for the years ended December
31, 2002, 2001 and 2000 was $126, $164, and $130, respectively.
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 service prior to January 1,
1996 based on a predetermined formula and benefits for service after January 1,
1996 based on the performance of the Company's common stock. Participants become
fully vested after six years of service. The directors can elect to receive
offset stock options that will reduce the Company's liability under the Plan.
These options vest immediately and expire one year after the date the director
retires or two years in the event of death. Benefits are payable in the form of
cash and/or Company stock on January 1st of the year after the director retires
from the Board. As of December 31, 2002 and 2001, the accrued pension liability
was $379 and $283, respectively. The expense recognized under this plan for the
years ended December 31, 2002, 2001 and 2000 was $69, $4 and $9, respectively.
The expense and related liability were calculated using a dividend rate of
3.00%, stock price appreciation of 6.00% for 2002 and 2001 and 10.00% for 2000,
and a discount rate of 6.10% for 2002, 6.75% for 2001, and 7.00% for 2000.
60
NOTE L: STOCK-BASED COMPENSATION PLANS
The Company has a long-term incentive program for directors, officers, and key
employees. Under this program, the Company authorized up to 2,537,000 shares of
Company common stock to be used for the grant of incentive stock options,
restricted stock awards, nonqualified stock options, retroactive stock
appreciation rights and offset options to its Stock Balance Plan (see Note K).
The offset options vest and become exercisable immediately and expire one year
after the date the director retires or two years in the event of death. The
remaining options have a ten-year term. They vest and become exercisable on a
grant by grant basis, ranging from immediate vesting to ratably over a five-year
period. Activity in these plans is as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted
Average
Exercise
Range of Price
Options Option Price Shares on Shares
Outstanding Per Share Exercisable Outstanding
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 1999 ............................. 628,930 $6.75 - $35.31 424,692 $ 25.08
Granted ...................................................... 150,491 23.13
Exercised / cancelled ........................................ (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 ........................................ (65,851) 7.50 - 26.50
Forfeited .................................................... (5,488)
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2001 ............................. 976,066 $6.75 - $34.81 652,114 $ 25.37
Granted ...................................................... 206,702 26.20 - 31.35
Exercised / cancelled ........................................ (96,018) 6.75 - 29.31
Forfeited .................................................... (1,988)
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding at December 31, 2002 ............................. 1,084,762 $12.13 - $34.81 707,405 $ 26.40
====================================================================================================================================
At December 31, 2002 the range of exercise prices and other related information
pertaining to the Company's stock options is as follows:
- --------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Range of Exercise Remaining Exercise
Exercise Price Shares Price Life (years) Shares Price
- --------------------------------------------------------------------------------------------
$12.13 - $14.13 ..... 21,120 $12.56 2.6 21,120 $12.56
$14.13 - $17.66 ..... 66,640 $15.41 2.8 66,640 $15.41
$17.66 - $21.19 ..... 57,052 $19.13 4.0 57,052 $19.13
$21.19 - $24.72 ..... 128,696 $23.13 7.0 77,820 $23.13
$24.72 - $28.25 ..... 453,240 $25.45 8.4 163,859 $25.16
$28.25 - $31.78 ..... 211,768 $30.16 5.7 174,668 $30.23
$31.78 - $34.81 ..... 146,246 $34.81 9.5 146,246 $34.81
- --------------------------------------------------------------------------------------------
Total / Average ..... 1,084,762 $26.16 7.2 707,405 $26.40
============================================================================================
On February 21, 1995, the Company adopted a Stockholder Protection Rights
Agreement. Under the Plan, each stockholder received one right, representing the
right to purchase one share of common stock for $42.50 for each share of stock
owned. All of the rights expire on February 21, 2005, but the Company may redeem
the rights earlier for $.005 per right, subject to certain limitations. Rights
will become exercisable if a person or group acquires 15% or more of the
Company's outstanding shares. Until that time, the rights will trade with the
common stock; any transfer of common stock will also constitute a transfer of
the associated right. If the rights become exercisable, they will begin to trade
apart from the common stock. If one of a number of "flip-in events" occurs, each
right will entitle the holder to purchase common stock having a market value
equivalent of two times the exercise price.
61
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
(000's omitted, except per share data) Income Shares amount
- -----------------------------------------------------------------------------------------------
2002 Net income .............................. $38,517
Basic EPS ............................... 38,517 12,973 $2.97
Effect of dilutive securities:
Stock options ........................... 194
------------------------
Diluted EPS ............................. $38,517 13,167 $2.93
===============================================================================================
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
===============================================================================================
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:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Letters of credit ................................ $ 19,728 $ 18,059
Commitments to make or purchase loans
or to extend credit on lines of credit ......... 332,422 336,218
- --------------------------------------------------------------------------------
Total ....................................... $352,150 $354,277
================================================================================
The fair value of these financial instruments is not significant.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's 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 $10,000 at December 31, 2002.
The Company has additional unused borrowing capacity of approximately $235,000
through collateralized transactions with the Federal Home Loan Bank and $25,000
through collateralized transactions with the Federal Reserve Bank. As of
December 31, 2002, the Company has a letter of credit of approximately $12,600
that expires on June 16, 2004.
62
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, 2002 was $44,283, of which $2,000
was required to be on deposit with the Federal Reserve Bank of New York. The
remaining $42,283 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 $1,896,
$1,414 and $1,014 in 2002, 2001 and 2000, respectively. The future minimum
rental commitments as of December 31, 2002 for all noncancelleable operating
leases are as follows:
2003 .............. $1,675
2004 .............. 1,586
2005 .............. 1,266
2006 .............. 917
2007 .............. 768
Thereafter ........ 2,538
- ------------------------------
Total ........... $8,750
==============================
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, 2002 and December
31, 2001, 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
- ----------------------------------------------------------------------------------- ------------------------- ---------------------
(000's omitted, except ratios) ........................ Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------- ------------------------- ---------------------
As of December 31, 2002:
Total Core Capital to Risk Weighted Assets ............ $237,465 12.54% $151,545 8.00% $189,431 10.00%
Tier I Capital to Risk Weighted Assets ................ $213,786 11.29% $ 76,772 4.00% $113,659 6.00%
Tier I Capital to Average Assets ...................... $213,786 6.59% $129,777 4.00% $162,222 5.00%
- ----------------------------------------------------------------------------------- ------------------------- ---------------------
As of December 31, 2001:
Total Core Capital to Risk Weighted Assets ............ $213,449 11.65% $135,154 8.00% $168,943 10.00%
Tier I Capital to Risk Weighted Assets ................ $189,549 10.35% $ 67,577 4.00% $101,366 6.00%
Tier I Capital to Average Assets ...................... $189,549 6.69% $113,268 4.00% $141,585 5.00%
63
NOTE Q: PARENT COMPANY STATEMENTS
The condensed balance sheet of the parent company at December 31 is as follows:
- --------------------------------------------------------------------------------
(000's omitted) 2002 2001
- --------------------------------------------------------------------------------
Assets:
Cash and cash equivalents .......................... $ 16,999 $ 12,921
Investment securities .............................. 681 605
Investment in and advances to subsidiaries ......... 392,468 346,898
Other assets ....................................... 1,655 311
- --------------------------------------------------------------------------------
Total assets .................................... $411,803 $360,735
================================================================================
Liabilities and Shareholders' Equity:
Accrued interest and other liabilities ............. $ 6,431 $ 6,377
Borrowings ......................................... 80,334 86,378
Shareholders' equity ............................... 325,038 267,980
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity ...... $411,803 $360,735
================================================================================
The condensed statement of income of the parent company for the years ended
December 31 is as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Dividends from subsidiaries ............................................. $29,587 $18,373 $14,046
Interest on investments and deposits .................................... 10 57 40
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues .................................................... 29,597 18,430 14,086
- ------------------------------------------------------------------------------------------------------------------------------------
Expenses:
Interest on long term notes and debentures .............................. 6,112 5,041 3,450
Other expenses .......................................................... 9 48 25
- ------------------------------------------------------------------------------------------------------------------------------------
Total expenses .................................................... 6,121 5,089 3,475
- ------------------------------------------------------------------------------------------------------------------------------------
Income before tax benefit and equity in undistributed
net income of subsidiaries .............................................. 23,476 13,341 10,611
Income tax benefit ........................................................ 1,572 1,419 1,000
- ------------------------------------------------------------------------------------------------------------------------------------
Income before equity in undistributed net income
of subsidiaries ......................................................... 25,048 14,760 11,611
Equity in undistributed net income of subsidiaries ........................ 13,469 4,369 13,288
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ........................................................... $38,517 $19,129 $24,899
====================================================================================================================================
64
The statements of cash flows of the parent company for the years ended December
31 is as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
(000's omitted) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income ................................................................. $ 38,517 $ 19,129 $ 24,899
Adjustments to reconcile net income to net cash provided
by operating activities
Equity in undistributed net income of subsidiaries ................. (13,469) (4,369) (13,288)
Net change in other assets and other liabilities ................... (886) 5,109 (1,162)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities .................................... 24,162 19,869 10,449
- -----------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Purchase of available-for-sale investment securities ....................... (76) (210) (74)
Sale of available-for-sale investment securities ........................... 0 500 0
Capital contributions of subsidiaries ...................................... (831) (80,399) (569)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities ........................................ (907) (80,109) (643)
- -----------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in short-term borrowings ........................................ (6,100) 0 2,100
Proceeds from junior subordinated debentures ............................... 0 50,981 0
Issuance of common stock, net of issuance costs ............................ 1,151 32,837 29
Repurchase of treasury stock ............................................... 0 0 (2,287)
Cash dividends paid ........................................................ (14,228) (10,980) (9,998)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by financing activities ............................. (19,177) 72,838 (10,156)
- -----------------------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents .......................................... 4,078 12,598 (350)
Cash and cash equivalents at beginning of year ............................... 12,921 323 673
- -----------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR ..................................... $ 16,999 $ 12,921 $ 323
===================================================================================================================================
Supplemental disclosures of cash flow information:
Cash paid for interest ..................................................... $ 6,412 $ 3,883 $ 3,439
===================================================================================================================================
Supplemental discosures of noncash financing activities
Dividends declared and unpaid .............................................. $ 3,760 $ 3,482 $ 1,888
===================================================================================================================================
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.
65
Report of Independent Accountants
Board of Directors and Shareholders
Community Bank System, Inc.
In our opinion, based on our audits and the report of other auditors, the
accompanying consolidated statements of condition and the related consolidated
statements of income, changes in shareholders' equity and cash flows present
fairly, in all material respects, the financial position of Community Bank
System, Inc. and Subsidiaries at December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002 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. The consolidated
financial statements give retroactive effect to the merger of First Liberty Bank
Corp., on May 11, 2001, in a transaction accounted for as pooling of interests,
as described in note B to the consolidated financial statements. We did not
audit the financial statements of First Liberty Bank Corp., which statements
reflect net interest income of $19,087,000 for the year ended December 31, 2000.
These statements were audited by other auditors whose report thereon has been
furnished to us, our opinion expressed herein, insofar as it relates to the
amounts included for First Liberty Bank Corp., is based solely on the report of
other auditors. 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.
As discussed in Note F to the consolidated financial statements, effective
January 1, 2002, the Company adopted Statement of Financial Accounting Standards
Nos. 142 "Goodwill and Other Intangible Assets" and 147 "Accounting for Certain
Acquisitions of Banking and Thrift Institutions."
/s/ PricewaterhouseCoopers LLP
Syracuse, New York
January 23, 2003
66
TWO YEAR SELECTED QUARTERLY DATA
- ------------------------------------------------------------------------------------------------------------------------------------
2002 RESULTS 1st 2nd 3rd 4th
(000's omitted, except per share data) ....................... Quarter(1) Quarter(1) Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income .......................................... $ 30,168 $ 31,438 $ 32,397 $ 33,847 $127,850
Provision for loan losses .................................... 1,518 3,385 2,278 5,041 12,222
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses .......... 28,650 28,053 30,119 28,806 115,628
Other income ................................................. 7,735 8,711 8,088 8,066 32,600
Other expense ................................................ 24,649 24,079 23,069 24,027 95,824
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ................................... 11,736 12,685 15,138 12,845 52,404
Income taxes ................................................. 3,178 3,416 4,087 3,206 13,887
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ................................................... $ 8,558 $ 9,269 $ 11,051 $ 9,639 $ 38,517
====================================================================================================================================
Basic income per share ....................................... $ 0.67 $ 0.71 $ 0.85 $ 0.74 $ 2.97
Diluted income per share ..................................... $ 0.65 $ 0.70 $ 0.84 $ 0.73 $ 2.93
====================================================================================================================================
2001 RESULTS 1st 2nd 3rd 4th
(000's omitted, except per share data) ....................... Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income .......................................... $ 23,140 $ 23,080 $ 23,809 $ 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 .......... 21,814 21,665 22,230 23,849 89,558
Other income ................................................. 5,992 6,485 7,010 6,904 26,391
Other expense ................................................ 19,872 24,799 20,381 23,954 89,006
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ................................... 7,934 3,351 8,859 6,799 26,943
Income taxes ................................................. 2,185 1,241 2,416 1,972 7,814
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ................................................... $ 5,749 $ 2,110 $ 6,443 $ 4,827 $ 19,129
====================================================================================================================================
Basic income per share ....................................... $ 0.51 $ 0.18 $ 0.56 $ 0.39 $ 1.64
Diluted income per share ..................................... $ 0.50 $ 0.18 $ 0.55 $ 0.39 $ 1.62
(1) The consolidated statements of income for the three months ended March 31
and June 30, 2002 were restated for the adoption of SFAS 147. The effect
of this restatement was to increase amounts previously reported for net
income by $1,122 and $1,090, basic income per share by $.09 and $.08, and
diluted income per share by $.08 and $.08, respectively.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
67
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.
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.
Item 14. Controls and Procedures
Within the 90-day period prior to the filing date of this report, the Chief
Executive Officer and Chief Financial Officer of the Company evaluated the
Company's disclosure controls and procedures related to the recording,
processing, summarization and reporting of information in the Company's reports
that it files with the Securities and Exchange Commission (SEC). These
disclosure controls and procedures have been designed to ensure that (a)
material information relating to the Company, including its consolidated
subsidiaries, is made known to the Company's management, including their
officers, by other employees of the Company and its subsidiaries, and (b) this
information is recorded, processed, summarized, evaluated and reported, as
applicable, within the time periods specified in the SEC's rules and forms.
Based upon this evaluation, these officers concluded that the design of the
disclosure controls and procedures is sufficient to accomplish their purpose.
There have been no significant changes in the Company's internal controls or
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
68
Part IV
Item 15. 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, 2002 and 2001
- Consolidated Statements of Income --
Years ended December 31, 2002, 2001, and 2000
- Consolidated Statements of Changes in Shareholders' Equity --
Years ended December 31, 2002, 2001, and 2000
- Consolidated Statement of Cash Flows --
Years ended December 31, 2002, 2001, and 2000
- Notes to Consolidated Financial Statements --
December 31, 2002
- Independent Accountant's Report
- Quarterly selected data --
Years ended December 31, 2002 and 2001 (unaudited)
2. Schedules are omitted since the required information is either not
applicable or shown elsewhere in the financial statements.
3. The exhibits filed as part of this report and exhibits incorporated
herein by reference to other documents are listed below:
2.1 Agreement and Plan of Merger, dated November 29, 2000, by and
between Community Bank System, Inc. and First Liberty Bank Corp.
Incorporated by reference to Exhibit No. 2.1 to the Current Report
on Form 8-K filed on December 20, 2000 (File No. 001-13695).
2.2 Agreement regarding the Agreement and Plan of Merger, dated
September 26, 2000, by and between Community Bank, N.A. and The
Citizens National Bank of Malone. Incorporated by reference to
Exhibit No. 10.1 to the Registration Statement on Form S-4 filed on
October 20, 2000 (Registration No. 333-48374).
2.3 Purchase and Assumption Agreement, dated December 6, 1994, by
and between Community Bank System, Inc. and The Chase Manhattan
Bank, N.A. Incorporated by reference to Exhibit No. 10.01 to the
Registration Statement on Form S-2 filed on April 11, 1995
(Registration No. 033-58539).
3.1 Certificate of Incorporation of Community Bank System, Inc., as
amended. Incorporated by reference to Exhibit No. 3.1 to the
Registration Statement on Form S-4 filed on October 20, 2000
(Registration No. 333-48374).
3.2 Bylaws of Community Bank System, Inc. as amended. Incorporated
by reference to Exhibit No. 3.2 to the Registration Statement on
Form S-4 filed on October 20, 2000 (Registration No. 333-48374).
4.1 Junior Subordinated Deferrable Interest Debentures, dated as
February 3, 1997, by and between Community Bank System, Inc. and The
Chase Manhattan Bank. Incorporated by reference to Exhibit No. 4.1
to the Registration Statement on Form S-4 filed on June 25, 1997
(Registration No. 333-30045)
69
4.2 Amended and Restated Declaration of Trust of Community Capital
Trust I, dated as February 3, 1997, by and between Community Bank
System, Inc. and The Chase Manhattan Bank. Incorporated by reference
to Exhibit No. 4.5 to the Registration Statement on Form S-4 filed
on June 25, 1997 (Registration No. 333-30045).
4.3 Common Stock Certificate. Incorporated by reference to Exhibit
No. 4.1 to the Amendment No. 1 to the Registration Statement on Form
S-3 filed on October 24, 2001 (Registration No. 333-68866).
10.1 Employment Agreement, effective April 1, 2002, by and between
Community Bank System, Inc. and Sanford A. Belden.*
10.2 Agreement dated December 23, 2002 by and between Community Bank
System, Inc., Community Bank N.A. and David G. Wallace.*
10.3 1994 Long-Term Incentive Compensation Program, as amended.
Incorporated by reference to Appendix B to the Definitive Proxy
Statement on Schedule 14A filed on April 3, 2001 (File No.
001-13695).
10.4 Stock Balance Plan for Directors, as amended. Incorporated by
reference to Annex I to the Definitive Proxy Statement on Schedule
14A filed on March 31, 1998 (File No. 001-13695).
10.5 Deferred Compensation Plan for Directors, as amended.
Incorporated by reference to Annex I to the Definitive Proxy
Statement on Schedule 14A filed on March 31, 1998 (File No.
001-13695).
21.1 Subsidiaries of Community Bank System, Inc.
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
First of Jermyn Realty Co. Delaware
23.1 Consent of PricewaterhouseCoopers LLP
99.1 Certification of Sanford A. Belden, President and Chief Executive
Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of the
Sarbanes-Oxley Act of 2002. *
99.2 Certification of David G. Wallace, Treasurer and Chief Financial
Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Filed herewith.
B. Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
2002.
C. See Exhibit 15(a)(3) above.
D. See Exhibit 15(a)(2) above
70
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 19, 2003
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 19th day of March 2003.
Name
/s/ James A. Gabriel
- --------------------------
James A. Gabriel, Director and
Chairman of the Board of Directors
/s/ David G. Wallace
- --------------------------
David G. Wallace
Treasurer and Chief Financial Officer
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
71
I, Sanford A. Belden, certify that:
1. I have reviewed this annual report on Form 10-K of Community Bank System,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: March 19, 2003
/s/ Sanford A. Belden
- --------------------------
Sanford A. Belden, President, Chief Executive Officer and Director
72
I, David G. Wallace, certify that:
1. I have reviewed this annual report on Form 10-K of Community Bank System,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Dated: March 19, 2003
/s/ David G. Wallace
- --------------------
David G. Wallace, Treasurer and Chief Financial Officer
73