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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT
Pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934
For the three months ended March 31, 2003
Commission file number 0-11716
[GRAPHIC OMITTED]
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 Identification No.
of incorporation)
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)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, No par value - 13,034,474 shares outstanding as of May 14, 2003
TABLE OF CONTENTS
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Condition
March 31, 2003, December 31, 2002 and March 31, 2002 ................. 3
Consolidated Statements of Income
Three months ended March 31, 2003 and 2002 ........................... 4
Consolidated Statement of Shareholders' Equity
Three months ended March 31, 2003 .................................... 5
Consolidated Statements of Comprehensive Income
Three months ended March 31, 2003 and 2002 ........................... 6
Consolidated Statements of Cash Flows
Three months ended March 31, 2003 and 2002 ........................... 7
Notes to Consolidated Financial Statements
March 31, 2003 ....................................................... 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................... 12
Item 3. Quantitative and Qualitative Disclosure about Market Risk ........ 27
Item 4. Controls and Procedures .......................................... 28
Part II. Other Information
Item 1. Legal Proceedings ................................................ 29
Item 2. Changes in Securities ............................................ 29
Item 3. Defaults upon Senior Securities .................................. 29
Item 4. Submission of Matters to a Vote of Securities Holders ............ 29
Item 5. Other Information ................................................ 29
Item 6. Exhibits and Reports on Form 8-K ................................. 29
2
Part 1. Financial Information
Item 1. Financial Statements
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION (Unaudited)
(In Thousands, Except Share Data)
- -------------------------------------------------------------------------------------------------------
March 31, December 31, March 31,
2003 2002 2002
- -------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 104,325 $ 113,531 $ 92,115
Investment securities 1,225,081 1,283,565 1,297,471
Loans 1,820,686 1,806,905 1,724,400
Allowance for loan losses 27,350 26,331 24,010
- -------------------------------------------------------------------------------------------------------
Net loans 1,793,336 1,780,574 1,700,390
Premises and equipment, net 56,893 56,997 53,864
Accrued interest receivable 21,876 22,772 24,982
Core deposit intangibles, net 29,488 30,769 35,182
Goodwill, net 104,059 104,059 104,578
- -------------------------------------------------------------------------------------------------------
Intangible assets, net 133,547 134,828 139,760
Other assets 39,782 41,937 38,169
- -------------------------------------------------------------------------------------------------------
Total Assets $3,374,840 $3,434,204 $3,346,751
=======================================================================================================
Liabilities and Shareholders' Equity
Liabilities:
Deposits
Noninterest bearing $ 431,175 $ 439,075 $ 415,547
Interest bearing 2,104,785 2,066,281 2,121,435
- -------------------------------------------------------------------------------------------------------
Total deposits 2,535,960 2,505,356 2,536,982
Federal funds purchased 50,000 33,000 30,000
Borrowings 315,213 430,241 396,425
Company obligated mandatorily redeemable preferred securities
of subsidiaries, Community Capital/Statutory Trust I-III, holding
solely junior subordinated debentures of the Company 76,889 77,375 77,833
Accrued interest and other liabilities 59,794 63,194 33,421
- -------------------------------------------------------------------------------------------------------
Total liabilities 3,037,856 3,109,166 3,074,661
- -------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value for 2003 and 2002
20,000,000 share authorized; 13,017,178, 12,978,554 and 12,936,600
shares outstanding, respectively 13,017 12,979 12,937
Surplus 79,984 79,058 78,684
Undivided profits 200,657 194,483 175,541
Accumulated other comprehensive income 43,414 38,551 5,226
Employee stock plan - unearned (88) (33) (298)
- -------------------------------------------------------------------------------------------------------
Total shareholders' equity 336,984 325,038 272,090
- -------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $3,374,840 $3,434,204 $3,346,751
=======================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
3
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In Thousands, Except Per-Share Data)
- ------------------------------------------------------------------------------
Quarter Ended
March 31,
- ------------------------------------------------------------------------------
2003 2002
- ------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $31,215 $33,058
Interest and dividends on investments:
Taxable 12,315 14,120
Nontaxable 4,682 3,598
Interest on federal funds and deposits with other banks 0 1
- ------------------------------------------------------------------------------
Total interest income 48,212 50,777
- ------------------------------------------------------------------------------
Interest expense:
Interest on deposits 10,636 15,169
Interest on federal funds purchased 85 87
Interest on short-term borrowings 477 211
Interest on mandatorily redeemable preferred securities
of subsidiaries 1,365 1,473
Interest on long-term borrowings 3,165 3,669
- ------------------------------------------------------------------------------
Total interest expense 15,728 20,609
- ------------------------------------------------------------------------------
Net interest income 32,484 30,168
Less: provision for loan losses 3,400 1,518
- ------------------------------------------------------------------------------
Net interest income after provision for loan losses 29,084 28,650
- ------------------------------------------------------------------------------
Other income:
Fiduciary and investment services 871 878
Service charges on deposit accounts 4,375 2,921
Commissions and advisory fees on investment products 1,319 1,970
Other service charges, commissions and fees 2,192 1,960
Other operating income, net 285 6
Net investment security gain and loss on early
retirement of long-term borrowings (45) 0
- ------------------------------------------------------------------------------
Total other income 8,997 7,735
- ------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits 12,778 12,125
Occupancy expense, net 2,421 2,322
Equipment and furniture expense 1,904 1,871
Amortization of intangible assets 1,281 1,540
Legal and professional fees 736 854
Data processing expenses 1,604 1,679
Office supplies 586 687
Acquisition and unusual expenses 0 592
Other 3,327 2,979
- ------------------------------------------------------------------------------
Total other expenses 24,637 24,649
- ------------------------------------------------------------------------------
Income before income taxes 13,444 11,736
Income taxes 3,495 3,178
- ------------------------------------------------------------------------------
Net Income $9,949 $8,558
==============================================================================
Earnings per share - Basic $ 0.76 $ 0.66
==============================================================================
Earnings per share - Diluted $ 0.75 $ 0.65
==============================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
4
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Three Months Ended March 31, 2003
(In Thousands, Except Share Data)
- -----------------------------------------------------------------------------------------------------------------
Common Stock Accumulated Employee
------------------ Other Stock
Shares Undivided Comprehensive Plan
Outstanding Amount Surplus Profits Income -Unearned Total
- -----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 12,978,554 $12,979 $79,058 $194,483 $38,551 ($33) $325,038
Net income 9,949 9,949
Other comprehensive income, net of tax 4,863 4,863
Dividends declared:
Common, $.29 per share (3,775) (3,775)
Common stock issued under employee stock
plan 38,624 38 926 (55) 909
- -----------------------------------------------------------------------------------------------------------------
Balance at March 31, 2003 13,017,178 $13,017 $79,984 $200,657 $43,414 ($88) $336,984
=================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
5
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In Thousands)
- ------------------------------------------------------------------------------------------
Quarter Ended March 31,
- ------------------------------------------------------------------------------------------
2003 2002
- ------------------------------------------------------------------------------------------
Other comprehensive income (loss), before tax:
Change in minimum pension liability adjustment $ 97 $ 4,919
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) arising during period 6,532 (8,484)
Reclassification adjustment for gains included in net
income in net income 0 0
- ------------------------------------------------------------------------------------------
Other comprehensive income (loss), before tax 6,629 (3,565)
Income tax (expense) benefit related to other comprehensive (1,766) 1,510
income (loss)
- ------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 4,863 (2,055)
Net income 9,949 8,558
- ------------------------------------------------------------------------------------------
Comprehensive income $14,812 $ 6,503
==========================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
6
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
- ---------------------------------------------------------------------------------------------------
Quarter Ended
March 31,
- ---------------------------------------------------------------------------------------------------
2003 2002
- ---------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 9,949 $ 8,558
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation 1,697 1,453
Amortization of intangible assets 1,281 1,540
Net amortization of security premiums and discounts 627 1,181
Amortization of discount of loans (16) (35)
Amortization of unearned compensation and discount on junior
subordinated debentures 22 133
Provision for loan losses 3,400 1,518
Provision for deferred taxes 1,259 716
Loss on early retirement of long-term borrowings 45 0
Gain on sale of loans and other assets (233) (6)
Proceeds from the sale of loans held for sale 30,860 0
Change in interest receivable 896 (2,420)
Change in other assets and other liabilities (3,362) (10,213)
- ---------------------------------------------------------------------------------------------------
Net cash provided by operating activities 46,425 2,425
- ---------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities 6,960 8,350
Proceeds from maturities of held-to-maturity investment securities 1,095 1,239
Proceeds from maturities of available-for-sale investment securities 58,086 42,849
Purchases of held-to-maturity investment securities (1,191) (1,138)
Purchases of available-for-sale investment securities (1,242) (210,254)
Net change in loans outstanding (46,686) 7,095
Capital expenditures (1,680) (2,044)
- ---------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 15,342 (153,903)
- ---------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts 37,658 17,453
Net change in certificates of deposit (7,054) (26,441)
Net change in federal funds purchased 17,000 15,800
Net change in term borrowings (115,545) 133,000
Issuance of common stock 756 735
Cash dividends paid (3,760) (3,480)
Other financing activities (28) (28)
- ---------------------------------------------------------------------------------------------------
Net cash (used) provided by financing activities (70,973) 137,039
- ---------------------------------------------------------------------------------------------------
Change in cash and cash equivalents (9,206) (14,439)
Cash and cash equivalents at beginning of year 113,531 106,554
- ---------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $104,325 $ 92,115
===================================================================================================
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest $ 16,307 $ 21,443
Cash paid for income taxes $ 1,600 $ 607
===================================================================================================
Supplemental Disclosures of Noncash Financing and Investing Activities:
Dividends declared and unpaid $ 3,775 $ 3,491
Gross change in unrealized gains and (losses) on available-for-sale
securities $ 6,532 ($ 8,484)
Change in minimum pension liability adjustment ($97) ($ 4,919)
===================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
7
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Three Months Ended March 31, 2003
NOTE A: BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for fair presentation have been included. Operating results for the
three months ended March 31, 2003 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2003.
On May 7, 2003, the Company announced that it has signed a definitive agreement
with Peoples Bankcorp, Inc. (PBI) to acquire all the stock of PBI and to merge
Peoples Bankcorp, Inc. into Community Bank System, Inc. The Company will pay $30
for each outstanding common share of PBI for a total purchase price of
approximately $4.2 million. PBI's single branch in Ogdensburg, New York, will be
operated as a branch of the Bank, as part of its network of branches in
Ogdensburg and Northern New York.
NOTE B: CRITICAL ACCOUNTING POLICIES
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-offs 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.
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.
8
The Black-Scholes model requires several assumptions, which management developed
based on historical trends and current market observations. These assumptions
include:
- --------------------------------------------------
2003 2002
- --------------------------------------------------
Weighted-average expected life 8.76 8.47
Future dividend yield 3.00% 3.00%
Share price volatility 27.58% 28.05%
Weighted average risk-free
interest rate 4.03% 5.16%
==================================================
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.
- ---------------------------------------------------------------------
Quarter Ended
March 31,
(000's omitted, except per share data) 2003 2002
- ---------------------------------------------------------------------
Net income:
As reported $9,949 $8,558
Pro forma $9,753 $8,386
Earnings per share:
As reported:
Basic $ 0.76 $ 0.66
Diluted $ 0.75 $ 0.65
Pro forma:
Basic $ 0.75 $ 0.65
Diluted $ 0.74 $ 0.64
=====================================================================
NOTE C: 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. The following is a reconciliation of basic to diluted earnings per
share for the three months ended March 31, 2003 and 2002.
- -----------------------------------------------------------------
Per
Share
(000's omitted except per share data) Income Shares Amount
- -----------------------------------------------------------------
March 31, 2003 Net income $9,949
Basic EPS 9,949 13,029 $0.76
Effect of dilutive
securities:
Stock options 215
-----------------
Diluted EPS $9,949 13,244 $0.75
=================================================================
March 31, 2002 Net income $8,558
Basic EPS 8,558 12,940 $0.66
Effect of dilutive
securities:
Stock options 153
-----------------
Diluted EPS $8,558 13,093 $0.65
=================================================================
9
NOTE D: 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." 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 were 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. In accordance with the provisions of SFAS 147, the Company adopted
this Statement retroactive to January 1, 2002, with the impact of restatement on
previously issued Form 10Q's as of March 31, 2002 contained below.
- -----------------------------------------------------------------
Three Months
Ended March 31,
(000's omitted except per share data) 2002
- -----------------------------------------------------------------
Net income as previously reported $7,438
Branch goodwill amortization, net
of tax 1,120
- -----------------------------------------------------------------
Net income as restated $8,558
=================================================================
Basic EPS as previously reported $ 0.57
Diluted EPS as previously reported $ 0.57
Basic EPS as restated $ 0.66
Diluted EPS as restated $ 0.65
- -----------------------------------------------------------------
The Company completed its goodwill impairment analysis during the first quarter
2003, and no adjustment was necessary. The gross carrying amount and accumulated
amortization for each type of intangible asset are as follows:
- ---------------------------------------------------------------------------------------------
As of March 31, 2003 As of December 31, 2002
- ---------------------------------------------------------------------------------------------
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 ($17,878) $29,488 $47,366 ($16,597) $30,769
Unamortized intangible assets:
Goodwill 122,432 (18,373) 104,059 122,432 (18,373) 104,059
- ---------------------------------------------------------------------------------------------
Total intangible
assets, net $169,798 ($36,251) $133,547 $169,798 ($34,970) $134,828
=============================================================================================
The estimated aggregate amortization expense for each of the succeeding fiscal
years ended December 31 is as follows:
2003 $3,689
2004 4,753
2005 4,079
2006 3,406
2007 3,406
2008 3,406
Thereafter 6,749
- ------------------
Total $29,488
==================
10
NOTE E: MANDATORILY REDEEMABLE PREFERRED SECURITIES
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 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.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 first quarters of 2003 and 2002, although in some
circumstances the fourth quarter of 2002 is also discussed in order to more
fully explain near-term trends. The following discussion and analysis should be
read in conjunction with the Company's Consolidated Financial Statements and
related notes that appear on pages 3 through 11. All references in the
discussion to financial condition and results of operations are to the
consolidated position and results of the Company and its subsidiaries taken as a
whole.
All references to "peer banks", unless otherwise noted, pertain to a group of 75
bank holding companies nationwide having $3 billion to $10 billion in assets and
their associated composite financial results for the 12 months ending December
31, 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 2003 and all earnings per share ("EPS") figures
disclosed in the MD&A refer to diluted EPS.
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 26.
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. Refer to Note A, "Summary of Significant Accounting Policies", on
pages 66 - 71 of the most recent Form 10K (fiscal year ended December 31, 2002)
for a complete review of the Company's most important accounting policies.
Net Income and Profitability
As shown in Table 1, earnings per share (diluted) for the first quarter were
$0.75, up 15.4% from the prior year's level of $0.65 and up 2.7% from fourth
quarter 2002's results of $0.73. On an operating basis, earnings per share
(diluted) rose 10.3% versus first quarter 2002. This measurement excludes
acquisition and unusual expenses in the first quarter of last year largely
related to the purchase of 36 branches from FleetBoston Financial in
mid-November 2001.
Net income for the quarter was $9.9 million, up $1.4 million or 16.3% over first
quarter 2002's level, and $310,000 or 3.2% higher than was generated during the
fourth quarter of 2002. Net interest income (full tax-equivalent) for first
quarter 2003 rose to $35.5 million, 8.5% over the same period last year.
Compared to fourth quarter 2002, net interest income (full tax-equivalent) was
down $1.7 million or 4.6% due to the previously announced strategy not to
reinvest securities run-off until longer-term market conditions are more
favorable. Noninterest income (excluding securities and debt transactions) of
$9.0 million in the first quarter was up $1.3 million (16.9%) from first quarter
2002, and was $1.3 million higher (16.6%) than fourth quarter 2002's level.
As revealed in Table 1, the primary reasons for improved first quarter earnings
compared to the same period last year were significantly higher net interest
income and noninterest income. The increase in net interest income was driven by
higher interest earning assets and improved net interest margins. The higher
noninterest income was mostly attributable to the incremental fees generated by
the Company's Overdraft FreedomTM program (described in the noninterest income
section on page 17) initiated in December 2002, and income associated with
secondary market mortgage portfolio activity. Increased operating income more
than offset a higher loan loss provision which resulted from increased net
charge-offs, a higher level of commercial loans identified as impaired, and the
revision of one of the qualitative risk factors used to calculate general
commercial loan allocations (refer to the asset quality discussion starting on
page 23 for further detail).
Improvement in first quarter earnings in comparison to the fourth quarter of
2002 was primarily a result of a lower loan loss provision and higher
noninterest income, offset partially by lower net interest income and higher
noninterest expense. The lower loan loss provision was mostly due to a reduced
level of net charge-offs in the first quarter and the impact of the annual
update of the historical
12
period used for the general loan loss allowance calculation in the fourth
quarter. The increase in first quarter noninterest income was again driven by
higher overdraft fees and income derived from the secondary market mortgage
portfolio. As mentioned, the drop in net interest income was caused by the
decision to deleverage the balance sheet until market interest rates become more
attractive for investment purposes. Higher operating expenses were primarily a
result of increased personnel and net occupancy expenses, both of which were
impacted by normal seasonal fluctuations (front-loaded personnel taxes,
weather-related occupancy costs). Each of these items is discussed in further
detail in their respective sections of the MD&A (pages 14 through 20).
Table 1: Summary Income Statements
- ----------------------------------------------------------------------------------------------------------------
March 31, March 31, December 31, Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 2002 2002 Amount Percent Amount Percent
- ----------------------------------------------------------------------------------------------------------------
Net interest income (full tax-equiv.) $35,464 $32,697 $37,173 $2,767 8.5% ($1,709) - 4.6%
Loan loss provision 3,400 1,518 5,041 1,882 124.0% (1,641) -32.6%
Noninterest income 9,042 7,735 7,753 1,307 16.9% 1,289 16.6%
Net investment security gain and loss
on early retirement of long-term
borrowings (45) 0 313 (45) -100.0% (358) -114.4%
Noninterest expense 24,637 24,057 24,027 580 2.4% 610 2.5%
Acquisition and unusual expenses 0 592 0 (592) -100.0% 0 0.0%
- ----------------------------------------------------------------------------------------------------------------
Income before taxes (full tax-equiv.) 16,424 14,265 16,171 2,159 15.1% 253 1.6%
Full tax-equivalent adjustment 2,980 2,529 3,326 451 17.8% (346) -10.4%
Income taxes 3,495 3,178 3,206 317 10.0% 289 9.0%
- ----------------------------------------------------------------------------------------------------------------
Net income $ 9,949 $ 8,558 $ 9,639 $1,391 16.3% $ 310 3.2%
================================================================================================================
Diluted earnings per share $ 0.75 $ 0.65 $ 0.73 $ 0.10 15.4% $ 0.02 2.7%
Diluted earnings per share-operating (1) $ 0.75 $ 0.68 $ 0.73 $ 0.07 10.3% $ 0.02 2.7%
- ----------------------------------------------------------------------------------------------------------------
(1) Operating adjusted amounts and ratios exclude the after-tax effect of
acquisition and unusual expenses, and accordingly, are not presented in
accordance with Generally Accepted Accounting Principles (GAAP).
13
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 shown in Table 2, net interest income (with non-taxable income converted to a
full tax-equivalent basis) for first quarter 2003 rose to $35.5 million, 8.5%
over the same period last year. The primary reason for the growth was a
28-basis-point increase in the bank-wide net interest margin to 4.80%. As
reflected in Table 3, the higher margin accounted for nearly three-quarters
(73%) of the $2.8 million improvement (tax-equivalent basis) in net interest
income, with a $65 million increase in average earning assets (up 2.2%)
contributing the remainder. Compared to fourth quarter 2002, net interest income
on a tax equivalent basis was down $1.7 million or 4.6%. Approximately 72% of
the reduction reflects a planned $55 million decrease in average earning assets,
while the balance was caused by a three-basis-point decrease in the net interest
margin.
The trend in the margin over the last four quarters reflects a slower decrease
in earning asset yields than in the cost of funds, indicative of the interest
rate sensitivity of the Bank's balance sheet during this period, coupled with
loan and deposit repricing strategies. Approximately 37% of earning assets
reprice within one year. This is a function of the cash flow of the investment
portfolio, the mix of 62% fixed rate loans and 38% variable rate loans
(including loans that mature within 90 days) in the portfolio, and expected loan
amortization/pay-downs. Fifty-one percent of total interest-bearing liabilities
are regularly repriced (maturing CDs, money market accounts, and certain
borrowings) and another 26% are repriced periodically (interest-checking and
savings). Maturing CDs continued to reprice downward during the first quarter as
measured by the favorable 77-basis-point spread between the rate on CDs running
off and the lower rate at which they are being renewed. This favorable spread
has been fairly constant for the last three quarters. In addition, rates on
other non-CD deposits were lowered further in the first quarter, though the
overall cost of deposits benefited primarily from a full quarter's impact of the
reductions made in the fourth quarter of 2002 that were consistent with the
Federal Reserve's rate decrease. See pages 27-28 for an analysis of the
Company's net interest income sensitivity going forward under alternative
interest rate and balance sheet assumptions.
The slight narrowing in margin compared to fourth quarter 2002 reflects unusual
investment income items in each quarter. An additional $269,000 in interest
income was booked in the first quarter due to accretion of discounts on called
bonds, following $736,000 in the fourth quarter largely for the same reason. Had
these items not occurred, the first quarter net interest margin would have been
4.76% compared to 4.74% in the fourth quarter.
Earning assets at quarter-end were $39 million lower (down 1.3%) from one year
earlier, comprised of $96 million more loans (up 5.6%), offset by $135 million
less securities (down 11%). Investments have been allowed to run off during the
period, reflective of the Company's strategy to use cash flow to support loan
growth and repay borrowings until reinvestment and leverage opportunities become
attractive. Nearly half of the investment run-off ($65 million) occurred in
first quarter 2003, partially offset by $14 million in loan growth.
Approximately $62 million in borrowings has been paid down over the last twelve
months as a result of the above investment deleveraging strategy, causing the
borrowings-to-earning-asset ratio to drop 1.8 percentage-points to 14.9%. The
corresponding pay- down of lower rate, shorter maturity long-term borrowings,
caused the rate on total long-term borrowings (which also includes the Company's
trust preferred issuances) to increase 47 basis points in the first quarter
versus the year-earlier period despite lower market interest rates. However, a
strategic shift in the mix of borrowing activity towards short-term borrowings
enabled the Company to reduce the cost of funds on overall external borrowings
by 79 basis points over the same time frame.
14
Table 2 below sets forth certain information concerning average interest-earning
assets and interest-bearing liabilities and their associated yields and rates
for the quarters indicated below. 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 balances are computed using daily
balances. Yields and amounts earned include loan fees. Nonaccrual loans have
been included in interest-earning assets for purposes of these computations.
Table 2: Quarterly Average Balance Sheet
- ------------------------------------------------------------------------------------------------------------------------------------
First Quarter Ended Fourth Quarter Ended
March 31, December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
2003 2002 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Avg. Avg. Avg.
Amt. Yield/ Amt. Yield/ Amt. Yield/
(000's omitted except yields Avg. Of Rate Avg. Of Rate Avg. Of Rate
and rates) Balance Interest Paid Balance Interest Paid Balance Interest Paid
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Interest-earning assets:
Time deposits in other banks $ 223 $ 0 0.00% $ 357 $1 1.14% $ 394 $2 2.01%
Taxable investment securities 786,767 12,568 6.48% 898,231 14,428 6.51% 850,383 14,086 6.57%
Nontaxable investment securities 402,476 7,237 7.29% 299,673 5,687 7.70% 403,508 7,384 7.26%
Loans (net of unearned
discount)(1) 1,807,889 31,387 7.04% 1,733,863 33,190 7.76% 1,797,678 33,207 7.33%
------------------- -------------------- -------------------
Total interest-earning assets 2,997,355 51,192 6.93% 2,932,124 53,306 7.37% 3,051,963 54,679 7.11%
Noninterest earning assets:
Cash and due from banks 102,443 99,356 103,169
Premises and equipment, net 57,114 53,799 56,657
Other assets 192,916 196,881 194,762
Allowance for loan losses (26,327) (23,915) (24,338)
Net unrealized gains on
available-for-sale portfolio 64,934 26,748 63,407
---------- ---------- ----------
Total assets $3,388,435 $3,284,993 $3,445,620
========== ========== ==========
LIABILITIES AND SHAREHOLDERS'
EQUITY:
Interest-bearing liabilities:
Savings deposits $986,693 1,934 0.79% $959,169 3,195 1.35% $972,360 2,216 0.90%
Time deposits 1,101,091 8,702 3.21% 1,157,663 11,974 4.19% 1,112,447 9,552 3.41%
Short-term borrowings 171,339 562 1.33% 59,958 298 2.02% 217,122 905 1.65%
Long-term borrowings 294,637 4,530 6.24% 361,715 5,142 5.77% 306,781 4,833 6.25%
------------------- -------------------- -------------------
Total interest-bearing
liabilities 2,553,760 15,728 2.50% 2,538,505 20,609 3.29% 2,608,710 17,506 2.66%
Noninterest bearing liabilities:
Demand deposits 449,219 427,901 454,038
Other liabilities 55,953 43,296 61,893
Shareholders' equity 329,503 275,291 320,979
---------- ---------- ----------
Total liabilities and
shareholders' equity $3,388,435 $3,284,993 $3,445,620
========== ========== ==========
Net interest earnings $35,464 $32,697 $37,173
======= ======= =======
Net interest spread 4.43% 4.08% 4.45%
Net interest margin on
interest-earnings 4.80% 4.52% 4.83%
assets
Federal tax exemption on nontaxable
investment securities and loans
included in interest income $2,980 $2,529 $3,326
- ------------------------------------------------------------------------------------------------------------------------------------
(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.
15
The changes in net interest income (full tax-equivalent basis) by volume and
rate component are shown below for each major category of interest-earning
assets and interest-bearing liabilities.
Table 3: Quarterly Rate/Volume
- ----------------------------------------------------------------------- ----------------------------------
1st Quarter 2003 versus 1st 1st Quarter 2003 versus 4th
Quarter 2002 Quarter 2002
- ----------------------------------------------------------------------- ----------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to Change
Change in (1) in (1)
- ----------------------------------------------------------------------- ----------------------------------
Net Net
(000's omitted) Volume Rate Change Volume Rate Change
- ----------------------------------------------------------------------- ----------------------------------
Interest earned on:
Time deposits in other banks ($0) ($1) ($1) ($1) ($1) ($2)
Taxable investment securities (1,781) (79) (1,860) (1,276) (242) (1,518)
Nontaxable investment
securities 3,444 (1,894) 1,550 (149) 2 (147)
Loans (net of unearned
discount) 7,311 (9,114) (1,803) 1,077 (2,897) (1,820)
Total interest-earning assets(2) $ 6,467 ($8,581) ($2,114) ($1,437) ($2,050) ($3,487)
Interest paid on:
Savings deposits $ 613 ($1,874) ($1,261) $ 200 ($ 482) ($ 282)
Time deposits (561) (2,711) (3,272) (125) (725) (850)
Short-term borrowings 918 (654) 264 (178) (165) (343)
Long-term borrowings (2,787) 2,175 (612) (286) (17) (303)
Total interest-bearing
liabilities(2) $ 862 ($5,743) ($4,881) ($452) ($1,326) ($1,778)
Net interest earnings (2) $ 739 $ 2,028 $ 2,767 ($1,228) ($481) ($1,709)
- ------------------------------------------------------------------------------------------------------------
(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.
16
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
retirement plan administration and consulting (BPA), personal trust, employee
benefit trust (EBT), investment and insurance products (CISI); and periodic
transactions, most often net gains (losses) from the sale of investments,
prepayment of term debt, or other occasional events.
Table 4: Noninterest Income
- --------------------------------------------------------------------------------------------
Three Months Ended March 31,
- --------------------------------------------------------------------------------------------
Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 Amount Percent Amount Percent
- --------------------------------------------------------------------------------------------
Personal trust $375 ($139) -27.0% $23 6.5%
EBT/BPA 1,335 233 21.1% 86 6.9%
Elias Asset Management 527 (250) -32.2% 41 8.4%
CISI 792 (401) -33.6% 136 20.7%
Insurance - CBNA 61 6 10.9% (39) -39.0%
- --------------------------------------------------------------------------------------------
Total financial services 3,090 (551) -15.1% 247 8.7%
Electronic banking 546 (60) -9.9% (59) -9.8%
Mortgage banking 689 569 474.2% 652 1762.2%
Deposit service charges 1,296 (17) -1.3% 2 0.2%
Overdraft fees 2,910 1,479 103.4% 722 33.0%
Commissions 546 (68) -11.1% (55) -9.2%
Miscellaneous income (loss) (35) (45) -450.0% (220) -118.9%
- --------------------------------------------------------------------------------------------
Total general banking services 5,952 1,858 45.4% 1,042 21.2%
- --------------------------------------------------------------------------------------------
Total noninterest income excluding
investment security gain, net and
loss on early retirement
of long-term borrowings 9,042 1,307 16.9% 1,289 16.6%
Investment security gain, net and loss on
early retirement of long-term borrowings (45) (45) 0.00% (358) -114.4%
- --------------------------------------------------------------------------------------------
Total noninterest income $8,997 $1,262 16.3% $931 11.5%
============================================================================================
Noninterest income as a percentage of
operating income (excludes investment
security gain, net and other timing
adjustments) 20.4% 2.1% 3.2%
- --------------------------------------------------------------------------------------------
As displayed in Table 4, noninterest income (excluding securities and debt
transactions) was $9.0 million in the first quarter, an increase of $1.3 million
or 16.9% from one year earlier. It rose by nearly the same amount or 16.6% from
the fourth quarter 2002 level.
The primary reason for the increase in both quarters was general banking
revenues, which climbed $1.9 million or 45% compared to first quarter 2002 and
$1.0 million or 21% versus fourth quarter 2002.
The greatest portion of the increase came from overdraft fees generated from the
Company's Overdraft Freedom(TM) program, introduced in early 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. Total first
quarter overdraft fees climbed by $1.5 million (103%) versus the same period
last year and by $722,000 versus the linked quarter. In the first quarter,
related net charges (write-off of uncollected overdrawn funds and fees, net of
recoveries, classified in other expense) represented approximately 11.4% of net
fee income (after 5.2% in refunds). This compares to net charges that equaled
11.0% and 6.7% of net fee income in the fourth and first quarters of 2002,
respectively. After net charges, total overdrafts produced $2.6 million of
income this quarter, an increase of $1.2 million from one year earlier, and
$619,000 more than collected in the linked quarter. Recurring Overdraft
Freedom(TM) overhead costs related to staffing and processing expense are less
than $350,000 per annum.
Mortgage banking fees accounted for the balance of the improvement in general
banking revenues. The Company resumed sale of secondary-market-eligible
mortgages in excess of 20-year maturities in late 2002, when rates fell below
the desirable holding yield
17
threshold. Since fourth quarter 2001, new production had been held in portfolio
because of its attractive yield and the ability to fund it through the (then)
newly-acquired FleetBoston branch core deposits. Total first quarter mortgage
banking fees of $689,000 (includes fees from servicing the portfolio, gains
(losses) on the sale of loans, and changes in the valuation of mortgage serving
rights) rose $569,000 versus first quarter 2002 and were $652,000 above the
linked quarter's level. The servicing portfolio as of March 31, 2003 was $123
million, with servicing rights representing 0.43% of the portfolio.
Financial services revenues of $3.1 million in the first quarter decreased
$551,000 or 15% from the same period last year, and rose $247,000 or 8.7%
compared to the prior quarter. The primary cause of the decrease over the last
four quarters is the weakened condition of the U.S. equity markets. Revenues
from Elias Asset Management (EAM), the Company's subsidiary which manages
investments for institutions and high net worth individuals, were negatively
impacted by the performance of equity markets and their impact on fees generated
from account balances and activity. Personal trust revenues were also reduced,
though to a lesser extent because of the higher portion of fixed income
investments held by its clients. The Company's broker-dealer, Community
Investment Services, Inc. (CISI), also had lower revenues, largely because of
unusually high annuity sales a year ago. As a whole, revenues for these three
businesses were off by $790,000 or 32% compared to first quarter 2002. Though
such revenues are impacted by investment mix, style, and a variety of
customer-specific factors, by way of comparison, the Standard & Poor's 500 index
(S&P) and the New York Stock Exchange index (NYSE) were each down approximately
26% over the same time period.
First quarter 2003 revenues from the above equity market-related businesses rose
$200,000 or 13% compared to fourth quarter 2002. Growth was positive for each of
them, in contrast to a 3.6% decline for the S&P and a 5.4% decline for the NYSE.
Reflective of continued strong new business generation, the Company's Benefit
Plans Administrative Services (BPA) subsidiary was largely unaffected by the
equity market weakness. First quarter revenues reached $1.3 million, up a strong
21% versus the comparable quarter last year, and were 6.9% higher than the prior
quarter. BPA provides actuarial, daily valuation recordkeeping, and custodial
services to organizations that offer retirement plans to their employees. It
markets these services to mutual fund companies, other banks and broker-dealers,
which in turn sell full-service retirement plans to their end-user customers.
Financial services' assets under management or administration were $1.439
billion as of quarter end, a 3.6% reduction from the year earlier level. Assets
fell at the three equity market-related businesses, ranging from -4% to -34%,
partially offset by BPA's growth in assets under administration of 50%. Over the
last 90 days, total financial services' assets under management or
administration have increased 5.5%, driven by growth at BPA.
Financial services revenues contributed 34% of total recurring noninterest
income for the first quarter versus 47% one year earlier. The ratio declined
largely because of the softness in financial services revenues as discussed
above, coupled with the increase in banking fees provided by the Overdraft
Freedom(TM) program and restoration of secondary market mortgage sales. On a
pretax operating basis (excluding money market interest and nonrecurring items),
the combined contribution of the financial services businesses was $509,000 in
the first quarter compared to $916,000 one year earlier. These results
constitute 3.8% and 7.8% of company-wide pretax income, respectively.
The ratio of noninterest income to operating income was 20.4% for first quarter
2003, 2.1 percentage points higher than the same period last year. The
improvement reflects the unusually large increase in recurring noninterest
income (up 23%) compared to a 10.5% increase in net interest income (FTE,
adjusted for certain investment income items discussed above).
Securities transactions this quarter were limited to a $45,000 premium paid to
repurchase a second $500,000 block of the Company's 9.75% fixed-rate trust
preferred securities (the first block was acquired in second quarter 2002),
further lowering funding costs. There were no securities transactions in the
first quarter of last year. In the linked fourth quarter, $18 million of
securities were sold, generating $1.2 million in gains, partially offset by a
$925,000 penalty on the repurchase of approximately $11 million in
intermediate-term Federal Home Loan Bank (FHLB) debt. In accordance with
historic practice, all of these transactions benefited the Company on an
economic basis.
18
Table 5 below reconciles differences between the line of business income
breakdown in Table 4 and regulatory reporting definitions as reflected on the
Call Report and the Consolidated Statements of Income.
Table 5: Noninterest Income
- -----------------------------------------------------------------------------------------------------------
Quarter Ended March 31, 2003
- -----------------------------------------------------------------------------------------------------------
Regulatory Reporting Categories
----------------------------------------------------------------------
Commissions Loss on
Fiduciary Service and Other Early
(000's omitted) and Charges Advisory Service Other Retirement
Investment on Fees on Charges, Operating of
Services Deposit Investment Commissions Income Borrowings Total
Accounts Products And Fees
- -----------------------------------------------------------------------------------------------------------
Personal trust $375 $375
EBT/BPA 496 $839 1,335
Elias Asset Management $527 527
CISI 792 792
Insurance - CBNA 61 61
- -----------------------------------------------------------------------------------------------------------
Total financial services 871 1,319 900 3,090
Electronic banking $169 377 546
Mortgage banking 369 $320 689
Deposit service charges 1,296 1,296
Overdraft fees 2,910 2,910
Commissions 546 546
Miscellaneous income (loss) (35) (35)
- -----------------------------------------------------------------------------------------------------------
Total general banking services 4,375 1,292 285 5,952
- -----------------------------------------------------------------------------------------------------------
Total 871 4,375 1,319 2,192 285 9,042
Loss on early retirement of
borrowings ($45) (45)
- -----------------------------------------------------------------------------------------------------------
Total noninterest income $871 $4,375 $1,319 $2,192 $285 ($45) $8,997
===========================================================================================================
19
Noninterest Expense
As shown in Table 6, first quarter 2003 noninterest expense of $24.6 million was
essentially flat with the equivalent 2002 period, and $610,000 or 2.5% higher
than the fourth quarter of 2002.
Table 6: Noninterest Expense
- ---------------------------------------------------------------------------------
Three Months Ended March 31,
- ---------------------------------------------------------------------------------
Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 Amount Percent Amount Percent
- ---------------------------------------------------------------------------------
Personnel expense $12,778 $653 5.4% $1,021 8.7%
Net occupancy expense 2,421 99 4.3% 446 22.6%
Equipment expense 1,904 33 1.8% (66) -3.4%
Legal and professional fees 736 (118) -13.8% (266) -26.5%
Data processing expense 1,604 (75) -4.5% (349) -17.9%
Amortization of intangibles 1,281 (259) -16.8% (31) -2.4%
Stationery and supplies 586 (101) -14.7% 20 3.5%
Foreclosed property expense 167 (161) -49.1% (5) -2.9%
Deposit insurance premiums 104 (18) -14.8% 0 0.0%
Other 3,056 527 20.8% (160) -5.0%
- --------------------------------------------------------------------------------
Total before one-time expenses 24,637 580 2.4% 610 2.5%
Acquisition and unusual expenses 0 (592) -100.0% 0 0.0%
- --------------------------------------------------------------------------------
Total noninterest expense $24,637 ($12) 0.0% $610 2.5%
================================================================================
Financial services noninterest $2,581 ($144) -5.3% ($29) -1.1%
expense
Banking noninterest expense 22,056 132 0.6% 639 3.0%
- --------------------------------------------------------------------------------
Total noninterest expense $24,637 ($12) 0.0% $610 2.5%
================================================================================
Total noninterest expenses as
a percentage of average assets 2.95% -0.02% 0.18%
Efficiency ratio-recurring 53.3% -3.0% 2.1%
- --------------------------------------------------------------------------------
The Company's efficiency ratio, which excludes intangible amortization, net
securities gains/losses, acquisition costs, and unusual income and expense
items, was 53.3% for the first quarter, a 3.0-percentage-point improvement from
the comparable 2002 quarter. The ratio rose 2.1 percentage points versus fourth
quarter 2002, largely because of the planned $1.2 million-reduction in net
interest income (full-tax equivalent) as a result of the Company's investment
deleveraging strategy. Consequently, the increase in recurring operating income
was limited to growth in noninterest income, which rose $1.5 million or nearly
20%, for a net change of $244,000. By comparison, overhead rose $1.1 million or
4.7%.
There were no acquisition and unusual expenses in the current and linked
quarters. Such first quarter 2002 expenses were $592,000, primarily limited to
consulting fees related to restructuring the loan and deposit operations centers
to handle the higher volumes caused by 2001's acquisitions.
Amortization of deposit intangibles decreased $259,000 and $31,000 compared to
first quarter 2002 and fourth quarter 2002, respectively. These declines were
primarily due to the use of the accelerated method of amortization as prescribed
by GAAP.
Recurring overhead (excluding intangible amortization and 2002's acquisition and
unusual expenses) rose a modest $839,000 or 3.7% in the first quarter compared
to the same quarter last year. Compared to fourth quarter 2002, recurring
overhead rose $641,000 or 2.8%.
Recurring banking expense (excluding intangible amortization) rose $983,000 in
the first quarter compared to the same quarter last year. Eighty percent of the
increase is explained by higher personnel expense (up 7.7%) caused by expanded
benefit costs and annual merit increases. Staffing rose by six, with additions
limited to selected expertise in commercial lending, loan review, auditing,
finance, and technology. All other banking expense rose a net of $192,000, with
the largest single reason for increase being the $249,000 in additional charges
related to the Overdraft Freedom(TM) program. Compared to fourth quarter 2002,
recurring banking expense rose $670,000 or 3.3%. As previously mentioned, a
portion of the increases in personnel expense (up $978,000) and net occupancy
expense (up $452,000) was due to seasonal factors (taxes and weather), and a
good deal of their combined increase was offset by
20
reductions in almost all other major expense categories. The banking efficiency
ratio improved to 51.0% in the first quarter compared to 54.2% one year earlier
and 48.7% in the linked quarter.
Financial services recurring overhead decreased by $144,000 in the first quarter
compared to the same period last year (down 5.3%) and decreased $29,000 (down
1.1%) versus the linked quarter. These changes were primarily driven by
personnel expense. In certain components of the financial services business,
personnel costs are commission-based and directly track revenue changes. In
addition, non-commissioned staffing is being very carefully controlled in light
of continued soft equity market conditions and their impact on fees tied to
assets under management. The efficiency ratio for financial services was 83.5%
in the first quarter, up from 77.0% one year earlier but an improvement of 4.6
percentage points from the linked quarter.
Income and Income Taxes
First quarter 2003 income before taxes of $13.4 million was up $1.7 million or
15% from the prior year's amount. The effective income tax rate was 26.0% for
the first quarter of 2003 compared to 27.0% for the first quarter of 2002. This
reduction was mainly related to the benefits realized on a larger proportion of
income from tax-exempt securities.
Investments
As reflected in Table 7, investments were $1.225 billion at the end of the first
quarter, a decrease of $58 million or 4.6% from the balances at December 31,
2002. Average investments of $1.445 billion for the first quarter 2003 were down
$65 million or 5.2% from the fourth quarter 2002. As previously mentioned,
investments have been allowed to run off during the period, reflective of the
Company's strategy to use cash flow to support loan growth and repay borrowings
until reinvestment and leverage opportunities become more attractive.
Table 7: Investments
- ----------------------------------------------------------------------------------------------------------------
March 31, 2003 December 31, 2002
- ----------------------------------------------------------------------------------------------------------------
Amortized Market Amortized Market
(000's omitted) Cost/Book Value Value Cost/Book Value Value
- ---------------------------------------------------------------------------- -----------------------------------
Amount Mix % Amount Mix % Amount Mix % Amount Mix %
- ---------------------------------------------------------------------------- -----------------------------------
Held to Maturity Portfolio
Obligations of states and political $7,506 100% $7,766 100% $7,412 100% $7,666 100%
subdivisions
- ---------------------------------------------------------------------------- -----------------------------------
Total $7,506 100% $7,766 100% $7,412 100% $7,666 100%
============================================================================ ===================================
Available for Sale Portfolio
- ----------------------------
U.S. Treasury securities and obligations
of U.S. government corporations and
agencies $370,363 32% $399,832 33% $380,243 32% $411,278 32%
Obligations of state and political
subdivisions 401,773 35% 426,113 35% 404,864 34% 420,605 33%
Corporate securities 27,935 3% 30,685 2% 27,972 2% 30,225 3%
Collateralized mortgage obligations (CMO) 206,239 18% 215,220 18% 235,286 19% 245,368 19%
Mortgage-backed securities 115,702 10% 121,261 10% 131,755 11% 137,211 11%
- ---------------------------------------------------------------------------- -----------------------------------
Total 1,122,012 98% 1,193,111 98% 1,180,120 98% 1,244,687 98%
Equity securities 18,808 2% 18,808 2% 25,814 2% 25,814 2%
Federal Reserve Bank common stock 5,656 0% 5,656 0% 5,652 0% 5,652 0%
- ---------------------------------------------------------------------------- -----------------------------------
Total 1,146,476 100% $1,217,575 100% 1,211,586 100% $1,276,153 100%
======================= =========================
Net unrealized gain on available for sale
portfolio 71,099 64,567
---------- ----------
Total carrying value $1,225,081 $1,283,565
========== ==========
Loans
As shown in Table 8, loans ended the first quarter at $1.821 billion, up $14
million over the last 90 days, and $96 million or 5.6% higher than one year
earlier. Virtually all of the net growth during the last 12 months has been from
retail borrowers. While the prior three quarters have had increases in the
$27-$28 million range, the current quarter rose about half those amounts,
largely because of reduced mortgages originated for retention in portfolio. As
previously noted, sales of new secondary-market-eligible production resumed in
late 2002, amounting to placement of $9 million in the fourth quarter and $31
million in the first quarter. Had these mortgages been retained, loans would
have risen $136 million over the last twelve months or 7.9%. All loan growth has
occurred in the New York franchise (up 8.1%), offset by a slight reduction in
the Pennsylvania franchise (down 3.6%).
21
Table 8: Loans
- ---------------------------------------------------------------------------------------------------------------------------
March 31, December 31, March 31, Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 Mix 2002 Mix 2002 Mix Amount Percent Amount Percent
- ---------------------------------------------------------------------------------------------------------------------------
Consumer mortgage $ 520,480 28.6% $ 510,309 28.2% $455,522 26.4% $64,958 14.3% $10,171 2.0%
Business lending 639,176 35.1% 629,903 34.9% 638,024 37.0% 1,152 0.2% 9,273 1.5%
Consumer indirect 290,790 16.0% 287,380 15.9% 253,375 14.7% 37,415 14.8% 3,410 1.2%
Consumer direct 370,240 20.3% 379,313 21.0% 377,279 21.9% (7,039) -1.9% (9,073) -2.4%
- ---------------------------------------------------------------------------------------------------------------------------
Total loans $1,820,686 100.0% $1,806,905 100.0% $1,724,200 100.0% $96,486 5.6% $13,781 0.8%
===========================================================================================================================
Despite resumed secondary market sales, consumer mortgages extended their
two-year trend as the largest source of portfolio growth, up $10.2 million in
the first quarter due to the most favorable refinancing environment seen in
decades, along with the convenience and efficiency of our branch offices in
originating these loans. The new markets opened up by our 36-branch FleetBoston
purchase have generated $59 million in portfolio production since their
mid-November 2001 acquisition. Over the last twelve months, bank-wide consumer
mortgages have increased $65 million or 14% to $520 million (29% of total loans
outstanding). All the growth has been in the New York franchise.
Business lending, after being flat-to-down since the second quarter of 2001
(excluding loans acquired via FleetBoston), rose $9.3 million this quarter. This
was primarily due to the impact of seasonal floor plan borrowing by existing
automobile dealers and take-downs under lines of credit by several of our larger
commercial borrowers. This increase essentially offset the reduction in
outstandings that took place over the last nine months of 2002, resulting in
minimal 12-month loan growth of $1.2 million or 0.2%. Business loans ended the
quarter at $639 million or 35% of total loans outstanding. Both the New York and
Pennsylvania franchises have been flat.
Consumer indirect loans, largely borrowing originated in automobile dealer
showrooms, rose $3.4 million during the first quarter over the prior quarter,
reflecting seasonal softness that began in fourth quarter 2002 when loans
increased just $7.0 million. The traditionally strong third and second quarters
registered increases of $11 million and $15 million, respectively, in 2002.
Indirect loans at March 31, 2003 were $291 million (16% of total loans
outstanding), a rise of $37 million or 15% over the last 12 months. Both the New
York and Pennsylvania markets contributed growth, each of which added new
originating dealers in 2002. Overall, used vehicles constitute 76% of CBU's
indirect auto loans outstanding.
Consumer direct loans declined by $9.1 million in the first quarter, a portion
of which reflects reduced demand for this type of loan due to soft economic
conditions. In addition, a certain amount of installment and home equity loans
continues to be paid off through conventional mortgage refinancings. Consumer
direct loans at quarter end were $370 million (20% of total loans outstanding),
down $7.0 million or 1.9% over the last 12 months. Outstandings in the New York
franchise responded positively in the second and third quarters of last year to
the spring homeowner loan program, which included promotional rates on home
equity loans and direct installment loans. Loans then trailed off in the
following two quarters. Outstandings in the Pennsylvania franchise have been
decreasing steadily.
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 9: Loan Reconciliation to Call Report
- -------------------------------------------------------------------------------
Line of Business as of March 31, 2003
-------------------------------------------------
Consumer Consumer Consumer Business Total
(000's omitted) Direct Indirect Mortgages Lending Loans
- -------------------------------------------------------------------------------
Regulatory Reporting
Categories:
Loans secured by real estate:
Residential $217,360 $518,586 $33,254 $769,200
Commercial 42 1,800 272,214 274,056
Farm 32 22,935 22,967
Agricultural loans 156 25,025 25,181
Commercial loans 12,311 7 255,172 267,490
Installment loans to
individuals 137,314 $290,790 87 7,657 435,848
Other loans 3,125 22,919 26,044
- -------------------------------------------------------------------------------
Total loans 370,340 290,790 520,480 639,176 1,820,786
Unearned discount 100 100
- -------------------------------------------------------------------------------
Net loans $370,240 $290,790 $520,480 $639,176 $1,820,686
===============================================================================
22
Asset Quality
As displayed in Table 10, asset quality as of March 31, 2003 reflects a $4.2
million increase in nonperforming assets during the first quarter to $16.6
million (including 90-day delinquencies). The bulk of this change is
attributable to four commercial customers with balances over $400,000 previously
identified as weak (two of them in the building supply business), which together
total $2.9 million of the $3.8 million in additional nonaccruals. The
approximate $400,000 increase in loans delinquent 90 days or more represents the
net of three commercial loans totaling $535,000 moving to nonaccrual (including
one of the above two building supply borrowers), three loans with balances
totaling $513,000 becoming delinquent, and a number of new loans under $100,000
becoming delinquent. Compared to one year ago, nonperforming assets are higher
by $526,000 or 3.3%. However, as a percent of loans outstanding plus OREO (other
real estate owned), nonperforming assets were 0.91% at quarter end compared to
0.93% one year earlier and 0.69% at December 31, 2002.
Table 10: Nonperforming Assets
- ---------------------------------------------------------------------------------------------------------------
March March December Change from 1Q Change from 4Q
31, 31, 31, '02 '02
(000's omitted) 2003 2002 2002 Amount Percent Amount Percent
- ---------------------------------------------------------------------------------------------------------------
Nonaccrual loans $13,577 $11,351 $9,754 $2,226 19.6% $3,823 39.2%
Accruing loans 90+ days delinquent 2,264 3,167 1,890 (903) -28.5% 374 19.8%
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming loans 15,841 14,518 11,644 1,323 9.1% 4,197 36.0%
Restructured loans 39 76 43 (37) -48.7% (4) -9.3%
Other real estate 700 1,460 704 (760) -52.1% (4) -0.6%
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming assets $16,580 $16,054 $12,391 $ 526 3.3% $4,189 33.8%
===============================================================================================================
Allowance for loan losses to total loans 1.50% 1.39% 1.46% 0.11% 0.04%
Allowance for loan losses to nonperforming
loans 172.7% 165.4% 226.1% 7.3% -53.4%
Allowance for loan losses to nonperforming
assets 165.0% 149.6% 212.5% 15.4% -47.5%
Nonperforming loans to total loans 0.87% 0.84% 0.64% 0.03% 0.23%
Nonperforming assets to total loans and other
real estate 0.91% 0.93% 0.69% -0.02% 0.22%
- ---------------------------------------------------------------------------------------------------------------
As displayed in Table 11, net charge-offs during the last 90 days were $2.4
million. This compares to $2.8 million in the fourth quarter of 2002 and $1.4
million in first quarter 2002. For the last 12 months, quarterly net charge-offs
have averaged $2.7 million compared to the preceding 12-month period average of
$1.7 million.
Table 11: Allowance for Loan Loss Activity
- -----------------------------------------------------------------------------------------------------------------------
March 31, March 31, December 31, Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 2002 2002 Amount Percent Amount Percent
- -----------------------------------------------------------------------------------------------------------------------
Loans outstanding at end of period $1,820,686 $1,724,400 $1,806,905 $ 96,286 5.6% $13,781 0.8%
- -----------------------------------------------------------------------------------------------------------------------
Average loans (net of unearned discount) 1,807,889 1,733,863 1,797,678 74,026 4.3% 10,211 0.6%
- -----------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning
of period 26,331 23,901 24,080 2,430 10.2% 2,251 9.3%
Loans charged off:
Commercial, financial, and
agricultural 1,180 582 1,050 598 102.7% 130 12.4%
Real estate 75 0 164 75 100.0% (89) -54.3%
Installment and check credit 1,727 1,486 2,040 241 16.2% (313) -15.3%
- -----------------------------------------------------------------------------------------------------------------------
Total loans charged off 2,982 2,068 3,254 914 44.2% (272) -8.4%
Recoveries of loan previously charged off:
Commercial, financial and agricultural 66 62 33 4 6.5% 33 100.0%
Real estate 4 103 2 (99) -96.1% 2 100.0%
Installment and check credit 531 494 429 37 7.5% 102 23.8%
- -----------------------------------------------------------------------------------------------------------------------
Total recoveries 601 659 464 (58) -8.8% 137 29.5%
- -----------------------------------------------------------------------------------------------------------------------
Net loans charged off 2,381 1,409 2,790 972 69.0% (409) -14.7%
Provision for loan losses 3,400 1,518 5,041 1,882 124.0% (1,641) -32.6%
- -----------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of
period $ 27,350 $ 24,010 $ 26,331 $ 3,340 13.9% $ 1,019 3.9%
=======================================================================================================================
Net charge-offs to average loans
outstanding 0.53% 0.33% 0.62% 0.20% -0.09%
- -----------------------------------------------------------------------------------------------------------------------
23
The primary reason for the overall increase in charge-offs over the last four
quarters is the impact of the softening economy, largely on the Company's
business borrowers, including partial or full charge-offs of loans made to three
large commercial customers. Until the economy begins to strengthen, it is
difficult to estimate whether the current 12-month run-rate for commercial net
charge-offs of $1.3 million per quarter will be reduced. The prior 12-month
run-rate was $538,000. Commercial net charge-offs for the first quarter were
$1.1 million, $805,000 of which pertained to loans that were classified as
nonperforming. In accordance with industry accounting standards for the
Company's loan loss allowance, specific allocations recognizing probable losses
in the commercial portfolio were increased during the quarter by approximately
$580,000 to $5.7 million or 0.87% of that portfolio; this compares to $5.1
million or 0.79% of the portfolio as of year-end 2002 and $4.4 million or 0.68%
one year earlier. Before the impact of charge-offs or elimination of specific
allocations no longer justified, new specific allocations in the first quarter
on loans over $50,000 were $1.8 million compared to $1.0 million in fourth
quarter 2002.
Consumer installment net charge-offs for the first quarter were $1.2 million,
which was in line with the average for the prior four quarters and approximately
14% higher than 2001's run rate. The higher net charge-offs in part reflect
differences in underwriting criteria on acquired loans associated with the
Company's 2001 branch acquisition. Consumer mortgage charge-offs continue to be
historically de minimus.
As a percent of average loans outstanding, net charge-offs for the first quarter
were 0.53%, 0.09% less than in fourth quarter 2002 and below the 0.56% average
for all of 2002. Commercial net charge-offs were 0.70% of average outstandings
compared to 0.63% in the linked quarter and 0.74% for 2002 as a whole. Consumer
installment loan net charge-offs equaled 0.98% of average loans for the quarter
just ended, well under 1.27% for fourth quarter 2002 and a virtual match to the
0.99% reported for all of 2002. Mortgage and home equity net charge-offs
continue to have a negligible impact.
Regular bottom-up review of the asset quality of the portfolio is completed each
quarter. As noted above, specific loan loss allocations for certain commercial
customers identified as weak are considered and revised as necessary. General
allocations against all other commercial loans and the consumer product lines
are reviewed and recalculated quarterly based on historical loss experience,
performance trends, and various quantifiable judgement factors. In accordance
with this review, one of the qualitative risk factors related to commercial
loans was increased this quarter, causing an additional $414,000 to be added to
the allowance. As a result of this process, a required loan loss allowance of
$27.4 million was determined as of March 31, 2003, necessitating a $3.4 million
loan loss provision for the quarter compared to $1.5 million one year earlier
and $5.0 million in fourth quarter 2002. The total loan loss provision for the
first quarter represented 143% of net charge-offs, 18 percentage points above
the 125% average for 2002 as a whole.
The allowance for loan losses has risen 14% over the last 12 months compared to
a 5.6% increase in loans outstanding. Consequently, the ratio to loans
outstanding has climbed 11 basis points to 1.50%, the highest in the Company's
history and commensurate with the probable risk in the portfolio at this time.
Nonperforming loans (90 days past due and non-accruing) were 0.87% of loans
outstanding at quarter end versus 0.64% as of December 31, 2002. This latter
ratio compared very favorably with the peer bank median of 0.94% for year-end
2002. Peer bank allowance coverage of nonperforming loans, a general comparative
measure of adequacy, was 207% at year end 2002, less favorable than the
Company's coverage ratio of 226% at that time. The Company's coverage ratio
decreased during the quarter just ended to 173%, still eight percentage points
higher than one year earlier. While present coverage is below the Company's
longer-term historic norm, the dollar amount of the allowance nonetheless
represents 121% of cumulative three-year net charge-offs (2000-2002) and is 2.8
times 2002's full-year net charge-offs.
Delinquent loans (30 days through nonaccruing) as a percent of total
outstandings decreased three basis points from year end to 1.85%, which compares
to 1.89% at March 31, 2002. The current delinquency level is well within the
range of 1.77%-1.96% experienced over the last eight quarters. As of December
31, 2002, the median peer bank delinquency ratio was 1.97%.
During the first quarter, the Company appointed Steven R. Tokach, previously
President of Pennsylvania Banking, to a newly-designated Chief Credit
Administrator position. In addition, a consultant with deep credit
administration experience in Upstate New York has been retained to further
strengthen credit administration practices.
24
Deposits
Total deposits at March 31, 2003 were $2.536 billion, $30.6 million or 1.2%
above the balance at year-end 2002 and virtually unchanged from one year
earlier. First quarter average total deposits of $2.537 billion remained
essentially flat with the averages for the fourth and first quarters of 2002
(down 0.1% and 0.3%, respectively).
First quarter 2003 public fund deposits increased on a period-end and average
basis versus fourth quarter 2002, reflective of the timing of the receipt of
property taxes by municipalities; they were essentially flat with the prior year
first quarter balances.
As shown in Table 12, average balances for IPC (individual and business)
deposits in the first quarter were down slightly compared to fourth quarter 2002
and first quarter 2002 (-1.0% and -0.2%, respectively). Both reductions reflect
the recent trend of time deposit run-off and lower money market account balances
more than offsetting increases in liquid interest-bearing deposits such as
interest checking and savings accounts. This shift in deposit mix may reflect
customers' unwillingness to be locked into CD rates for extended periods of time
given low market-driven rates and the diminished interest rate spread between
CDs and shorter-term interest-bearing accounts. Despite the impact of lower time
and money market deposits, total IPC deposits in the first quarter were down
very slightly from a year ago because of 4.8% growth in demand deposits; in
contrast, IPC demand deposits were off 3.1% compared to fourth quarter 2002,
largely due to seasonal factors. As of March 31, 2003, IPC deposits were down
minimally compared to year-end 2002 (-0.2%) and virtually equaled the balances
at the year-earlier date. IPC deposits in the 36 former FleetBoston branches
purchased in mid-November 2001 have risen 4% since that time.
Table 12: Average Deposits
- -----------------------------------------------------------------------------------------------------------
March 31, December 31, March 31, Change from 1Q '02 Change from 4Q '02
(000's omitted) 2003 2002 2002 Amount Percent Amount Percent
- -----------------------------------------------------------------------------------------------------------
Noninterest-bearing demand
deposits $ 449,219 $ 454,038 $ 427,901 $21,318 5.0% ($4,819) -1.1%
Interest-bearing demand deposits 270,947 263,490 260,146 10,801 4.2% 7,457 2.8%
Regular savings deposits 415,628 407,701 390,005 25,623 6.6% 7,927 1.9%
Money market deposits 300,118 301,169 309,018 (8,900) -2.9% (1,051) -0.3%
Time deposits 1,101,091 1,112,447 1,157,663 (56,572) -4.9% (11,356) -1.0%
- ------------------------------------------------------------------------------------------------------------
Total deposits $2,537,003 $2,538,845 $2,544,733 ($7,730) -0.3% ($1,842) -0.1%
============================================================================================================
IPC deposits $2,352,885 $2,377,777 $2,357,754 ($4,869) -0.2% ($24,892) -1.0%
Public fund deposits 184,118 161,068 186,979 (2,861) -1.5% 23,050 14.3%
- ------------------------------------------------------------------------------------------------------------
Total deposits $2,537,003 $2,538,845 $2,544,733 ($7,730) -0.3% ($1,842) -0.1%
============================================================================================================
Borrowings
At the end of the first quarter 2003, borrowings and federal funds purchased of
$365 million were $98 million or 21% lower than they were at the end of 2002.
Short-term borrowings decreased by $110 million, long-term borrowings decreased
by $5 million and federal funds purchased increased by $17 million. The decrease
in combined borrowings is the result of the investment deleveraging strategy
previously discussed. Refer to the net interest income section on page 14 for
further review of borrowing activity over the past 12 months.
Other Assets and Liabilities
Other assets and liabilities had a net liability balance of $20.0 million at
March 31, 2003 versus a net liability position of $21.3 million at December 31,
2002. The change was mainly attributable to an increase in deferred taxes
related to the market value adjustment and assorted timing differences.
Shareholders' Equity
Total shareholders' equity equaled $337 million at the end of the first quarter,
$11.9 million higher than the balance at December 31, 2002. This increase
consisted of $909,000 from shares issued under the employee stock plan, an
after-tax market value adjustment of $4.9 million and net income of $9.9
million, offset by dividends declared of $3.8 million. Over the past 12 months
total shareholders' equity increased by $64.9 million, a majority of which came
from $41.0 million of net income and a $38.1 million increase in the after-tax
market value adjustment, reduced by dividends declared of $14.8 million.
25
The Company's Tier I leverage ratio, a primary measure of regulatory capital for
which 5% is the requirement to be `well-capitalized,' reached 7.44% at the end
of the first quarter, its strongest level in a decade. The tangible
equity-to-assets ratio has risen 215 basis points over the last 12 months from
4.13% to 6.28%. Excluding the impact of the change in the market value
adjustment (which impacts both asset and equity levels), the
tangible-equity-to-assets ratio at March 31, 2003 would have risen by 108 basis
points versus one year earlier.
The dividend payout ratio (dividends declared divided by net income) for first
quarter 2003 was 37.9%, compared to 39.0% and 40.8% for the fourth and first
quarters of 2002, respectively. First quarter 2003's ratio was lower than the
prior year period, despite a $0.02 higher dividend declared per share ($0.29 vs.
$0.27), because of the $1.4 million (16.3%) increase in net income. The first
quarter 2003 dividend payout ratio fell from fourth quarter 2002's level due to
net income rising $310,000 or 3.2%, while dividends declared per share were
constant.
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 March 31,
2003, this ratio was 14.5% for both time periods, 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.
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 all-inclusive. Such
forward-looking statements speak only as of the date on which they are made and
the Company does not undertake any obligation to update any forward-looking
statement, whether written or oral, to reflect events or circumstances after the
date on which such statement is made. If the Company does update or correct one
or more forward-looking statements, investors and others should not conclude
that the Company will make additional updates or corrections with respect
thereto or with respect to other forward-looking statements.
26
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates, prices or credit risk. The Company has an immaterial
amount of credit risk because essentially all of the fixed-income securities in
the investment portfolio are AAA-rated (highest possible rating). In addition,
equity investments make up less than 3% of the overall investment portfolio, and
therefore, almost all the price risk is related to interest rates, the primary
market risk exposure of the Bank. 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 March 31, 2003, assuming 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 the prime and federal funds rates 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 federal funds that are more
consistent with historical norms.
Table 13: Management Model
Net Interest Income
Dollar Change During First 12
Rate Change Months
In Basis Points Versus No Change In Rates Percent Change
--------------------------------------------------------------------------------------
+ 200 bp $1.7 million 1.3%
- 100 bp -$3.7 million -3.0%
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.
The analysis does not represent a Company forecast and should not be relied upon
as being indicative of expected operating results. These hypothetical estimates
are based upon numerous assumptions: the nature and timing of interest rate
levels (including yield curve shape), prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of asset and liability cash flows, and other factors.
While the assumptions are developed based upon current economic and local market
conditions, the Company cannot make any assurances as to the predictive nature
of these assumptions, including how customer preferences or competitor
influences might change. Furthermore, the sensitivity analysis does not reflect
actions that ALCO might take in responding to or anticipating changes in
interest rates.
27
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including
the President and Chief Executive Officer and Chief Financial Officer, the
Company has evaluated the effectiveness of the design and operation of our
disclosure controls and procedures within 90 days of the filing date of this
quarterly report, and, based on their evaluation, our President and Chief
Executive Officer and Chief Financial Officer have concluded that these controls
and procedures are effective. There were no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed in the reports
that the Company files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by the Company is accumulated and
communicated to our management, including our President and Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.
28
Part II. Other Information
Item 1. Legal Proceedings.
The Company and its subsidiaries are subject in the normal course of business to
various pending and threatened legal proceedings 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 2. Changes in Securities.
There have been no changes in securities during the quarter ended March 31,
2003.
Item 3. Defaults Upon Senior Securities.
There were no defaults upon senior securities during the quarter ended March 31,
2003.
Item 4. Submission of Matters to a Vote of Securities Holders.
There were no matters submitted to a vote of the shareholders during the quarter
ended March 31, 2003.
Item 5. Other Information.
Not applicable
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits required by Item 601 of Regulation S-K:
(21) Subsidiaries of the registrant
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 Corporation Delaware
CFSI Close-Out Corp. New York
Elias Asset Management, Inc. Delaware
First Liberty Service Corporation Delaware
First of Jermyn Realty Co. Delaware
b) Exhibits required by the Sarbanes-Oxley Act of 2002 (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 the Sarbanes-Oxley Act of 2002.
c) Reports on Form 8-K: Form 8-K related to quarterly press release was
filed on April 25, 2003 Form 8-K announcing the Agreement and Plan
of Merger with Peoples Bankcorp, Inc. on May 8, 2003
29
SIGNATURES
Pursuant to the requirements of The Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Community Bank System, Inc.
Date: May 15, 2003
/s/ Sanford A. Belden
------------------------------------
Sanford A. Belden,
President, Chief
Executive Officer and
Director
Date: May 15, 2003
/s/ David G. Wallace
------------------------------------
David G. Wallace, Treasurer and
Chief Financial Officer
30
I, Sanford A. Belden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bank System,
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers 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 officers and I have indicated in this
quarterly 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.
Date: May 15, 2003
/s/ Sanford A. Belden
- -----------------------------------------------
Sanford A. Belden,
President, Chief Executive Officer and Director
31
I, David G. Wallace, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bank System,
Inc.;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 officers 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 officers and I have indicated in this
quarterly 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: May 15, 2003
/s/ David G. Wallace
- -------------------------------------
David G. Wallace,
Treasurer and Chief Financial Officer
32