Item 1. Business - -----------------
GENERAL
Community Bank System, Inc.("Company") was incorporated on April 15, 1983, under the Delaware General Corporation Law. Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is (315) 445-2282. The Company became a bank holding company in 1984 with the acquisition of The St. Lawrence National Bank ("St. Lawrence Bank") on February 3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A or "Horizon Bank") on March 2, 1984. Also in 1984 the Company obtained a national bank charter for its third wholly-owned subsidiary bank, The Exchange National Bank ("Exchange Bank"), and on July 1, 1984 Exchange Bank acquired the deposits and certain of the assets of three branches of the Bank of New York located in Southwestern New York. On September 30, 1987, the Company acquired The Nichols National Bank ("Nichols Bank") located in Nichols, New York. On September 30, 1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located in Addison, New York, the parent company to Community National Bank ("Community Bank").
On March 26, 1990, Community Bank opened the Corning Market Street branch from the Company's acquisition of deposits and certain assets from Key Bank of Central New York. On January 1, 1992, the Company's five banking affiliates consolidated into a single, wholly-owned national banking subsidiary, known as Community Bank, N.A. ("Bank"). On March 31, 1993, the Bank's marketing representative office in Ottawa, Canada was closed. On June 3, 1994, the Company acquired three branch offices in Canandaigua, Corning and Wellsville, New York from the Resolution Trust Corporation. At that time, the preexisting Canandaigua branch office loans and deposits were transferred into the new facility. On October 28, 1994, the Company acquired the Cato, New York branch of The Chase Manhattan Bank, N.A. On July 14, 1995, the Company acquired 15 branch offices from The Chase Manhattan Bank, N.A. located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two), and Penn Yan, New York ("Chase Branches"). On December 15, 1995, the Company sold three of the former Chase Branches, located in Norwich, New Hartford, and Utica, to NBT Bank, N.A. On June 16, 1997 the Company acquired eight branches from Key Bank of New York located in Alfred, Cassadaga, Clymer, Cuba, Gowanda, Ripley, Sherman, and Wellsville in Southwestern New York State. On July 18, 1997 the Company acquired 12 branches from Fleet Bank located in Old Forge, Boonville, Ogdensburg, St. Regis Falls, Gateway Plaza, Watertown (2), Clayton, Lowville, Massena (2), and Gouverneur in Northern and Central New York State. Seven of the former Fleet offices or existing Bank offices in Watertown (2), Boonville, Ogdensburg, Gouverneur, and Massena (2) have since been or are scheduled to be combined.
The Company had a wholly-owned data processing subsidiary, Northeastern Computer Services, Inc. ("Northeastern"). Northeastern was acquired by the Company from The St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization. Northeastern had previously been a wholly-owned subsidiary of The St. Lawrence Bank and was the survivor of a merger with Lawban Computer Systems, Inc., another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the Company entered into a five year agreement with Mellon Bank, N.A. ("Mellon") to provide data processing services (the agreement has since been renewed with the subsequent acquiror of Mellon's data services, Fiserv, Inc., for a term ending December 31, 2002). On June 30, 1992, Northeastern ceased operations. On January 17, 1997 all the outstanding shares of common stock of Northeastern were transferred from the Company to Community Bank, N.A. On that date, Northeastern became a wholly-owned subsidiary of the Bank and changed its name to CBNA Treasury Management Corporation ("TMC"). TMC is now utilized by the Bank to manage its Treasury function, including asset/liability, investment portfolio, and liquidity management.
The Company also had a wholly-owned mortgage banking subsidiary, Community Financial Services, Inc. (CFSI), which was established in June 1986; it commenced operation in January 1987. In July 1988, CFSI purchased Salt City Mortgage Corp., a Syracuse-based mortgage broker. CFSI ceased operations in 1990 and was renamed CFSI Close-Out Corp. in 1997.
In July 1996, the Company purchased Benefit Plans Administrators of Utica, New York, a pension administration and consulting firm serving sponsors of defined benefit and defined contribution plans.
On February 3, 1997, the Company formed a subsidiary business trust, Community Capital Trust I, for the purpose of issuing preferred securities, which qualify as Tier 1 capital. Concurrent with its formation, the trust issued $30,000,000
of 9.75% preferred securities in an exempt offering maturing in year 2027 and guaranteed by the Company. The entire net proceeds to the trust from the offering were invested in junior subordinated obligations of the Company.
On June 19, 1998, the Company formed a subsidiary of the Bank, Community Financial Services, Inc., to offer selected insurance products through its own agency.
On December 22, 1998, the Company formed a broker/dealer subsidiary of the Bank, Community Investment Services Inc., which is fully implemented with ten Financial Consultants available to provide investment advice and products to customers.
On February 26, 1999, CBNA Preferred Funding Corp., a Real Estate Investment Trust (REIT), was established as a subsidiary of the Bank to hold fixed rate real estate mortgages that are serviced by the Bank.
On February 7, 2000, the Company announced its intention to acquire Elias Asset Management, a nationally recognized firm that currently manages $700 million in assets for individuals, corporate pension and profit sharing plans, and foundations.
The Company provides banking services through its two regional offices at 45-49 Court Street, Canton, New York and 201 North Union Street, Olean, New York, as well as through 67 customer facilities in the eighteen counties of St. Lawrence, Jefferson, Lewis, Oneida, Cayuga, Seneca, Ontario, Oswego, Wayne, Yates, Allegany, Cattaraugus, Tioga, Steuben, Chautauqua, Franklin, Herkimer, and Onondaga. The administrative office is located at 5790 Widewaters Parkway, DeWitt, New York, in Onondaga County.
The Bank is a community retail bank committed to the philosophy of serving the financial needs of customers in local communities. The Bank's branches are generally located in small towns and villages within its geographic market areas. The Company believes that the local character of business, knowledge of the customer and customer needs, and comprehensive retail and small business products, together with rapid decision-making at the branch and regional level, enable the Bank to compete effectively. The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank of New York ("FHLB"), and its deposits are insured by the FDIC up to applicable limits.
Unless the context otherwise provides, all references in this Annual Report on Form 10-K to the "Company" shall mean, collectively, Community Bank System, Inc. and its subsidiaries.
Banking Services - ----------------
The Bank offers a range of commercial and retail banking services in each of its market areas to business, individual, agricultural and government customers.
Account Services. The Bank's account services include checking accounts, negotiable orders of withdrawal ("NOW"), money market accounts, savings accounts, time deposit accounts, and individual retirement accounts.
Lending Activities. The Bank's lending activities include the making of residential and farm loans, business lines of credit, working capital facilities, inventory and dealer floor plans, as well as installment, commercial, term and student loans.
The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. About 63% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. In addition, the typical loan to the Company's commercial business borrowers is under $75,000, with nearly 80% of its customers representing about 25% of commercial loans outstanding.
Other Services. The Bank offers a range of trust services, including personal trust, employee benefit trust, investment management, financial planning and custodial services. In addition, the Bank offers nonbank financial products including fixed- and variable-rate annuities, mutual funds, and stock investments. The Bank also offers safe deposit boxes, travelers checks, money orders, wire transfers, collections, foreign exchange, drive-in facilities, automatic teller machines (ATMs), and twenty-four hour depositories. Through an accounts receivable management program, the Bank provides a service to qualifying businesses by purchasing accounts receivable on a discounted basis. Customers of the Bank also receive pension administration and consulting service pertaining to their defined benefit and defined contribution plans from CBSI's nonbank subsidiary, Benefit Plans Administrative Services, Inc. (BPA); BPA also provides services to nonbank customers.
Competition - -----------
The Company, through the Bank, competes in three distinct banking markets in the Northern ("Northern Market"), Finger Lakes ("Finger Lakes Market"), and Southern Tier ("Southern Tier Market") regions of New York State. The Bank considers its market areas in these regions to be the counties in which it has banking facilities. Major competitors in these markets primarily include local branches of banks based in Boston, Massachusetts, Albany or Buffalo, New York, and Cleveland, Ohio, as well as local independent banking and thrift institutions and federal credit unions. Other competitors for deposits and loans within the Bank's market areas include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers. Lastly, personal and corporate trust and investment counseling services in competition with the Bank are offered by insurance companies, investment counseling firms, other financial service firms, and individuals.
Northern Market. Branches in the Northern Market compete for loans and deposits in the six county market area of St. Lawrence, Jefferson, Lewis, Franklin, Herkimer, and Oneida Counties in Northern New York State. Within this market area, the Bank maintains a market share(1) of 10.1% including commercial banks, credit unions, savings and loan associations and savings banks. However, in its three county primary market area (St. Lawrence, Jefferson, and Lewis), the Bank has a 24.0% share. The Bank operates 27 customer facilities in this market and is ranked either first or second in market share in 17 of the 20 towns where these offices are located.
Finger Lakes Market. In the Finger Lakes Market, the Bank operates 14 customer facilities competing for loans and deposits in the six-county market area of Seneca, Oswego, Ontario, Wayne, Onondaga, and Cayuga Counties. Within the Finger Lakes Market area, the Bank maintains a market share (1) of approximately 2.8% including commercial banks, credit unions, savings and loan associations and savings banks. However, the Bank's primary market within this region is Seneca County, where the Bank has a 35.7% share. The Bank is ranked either first or second in market share in six of the eleven Finger Lakes Market area towns where its offices are located.
Southern Tier Market. The Bank's Southern Tier Market consists of two sub-markets, the Olean submarket and the Corning submarket.
Olean Submarket. The Olean Submarket competes for loans and deposits in the primary market area of Cattaraugus, Chautauqua, and Allegany Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share (1) of approximately 14.2% including commercial banks, credit unions, savings and loan associations and savings banks. The Olean Submarket operates 16 office locations (including the Falconer branch opened in February 2000), and the Bank is ranked either first or second in market share in 12 of the 14 towns where these offices are located.
Corning Submarket. The Corning Submarket competes for loans and deposits in the primary market area of Steuben, Yates and Tioga Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share (1) of approximately 9.7% including commercial banks, credit unions, savings and loan associations and savings banks. The Corning Submarket operates ten office locations, and the Bank is ranked either first or second in market share in seven of the eight towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chemung and Schuyler Counties in New York State, and Tioga County in Pennsylvania.
(1) Deposit market share data as of June 30, 1998, the most recent information available, calculated by Sheshunoff Information Services, Inc.
The table below summarizes the Bank's deposits and market share by the eighteen counties in which it has customer facilities. Market share is based on deposits of all commercial banks, credit unions, savings and loan associations, and savings banks. Number of CBNA Towns Where Deposits Number of CBNA Has 6/30/98 Market CBNA 1st or 2nd Banking County (000's) Share Facilities* Market Position Market - ------------- ---------- ----------- ---------- ------------- ----------- Lewis $102,460 46.5 % 4 3 Northern Seneca 98,771 35.7 5 3 Finger Lakes St.Lawrence 309,762 28.7 14 9 Northern Allegany 89,277 27.8 5 4 Olean Cattaraugus 192,470 24.8 5 4 Olean Yates 49,318 23.5 1 1 Corning Jefferson 145,509 14.2 5 2 Northern Steuben 88,650 7.7 7 5 Corning Tioga 25,211 8.1 2 1 Corning Ontario 63,350 6.9 3 0 Finger Lakes Wayne 47,251 6.0 2 0 Finger Lakes Herkimer 23,690 4.1 1 1 Northern Oswego 39,107 4.1 2 2 Finger Lakes Chautauqua 49,196 4.0 6 4 Olean Franklin 15,775 3.4 1 1 Northern Oneida 55,774 1.8 2 1 Northern Cayuga 13,457 1.8 1 1 Finger Lakes Onondaga 8,790 0.1 1 0 Finger Lakes - ------------- ---------- ----------- ---------- ------------- ----------- 18 $1,417,818 7.0 % 67 42 CBNA
Includes opening of 1982 E. Main St., Falconer, NY office and ATM in first quarter 2000.
Employees - ---------
As of December 31, 1999, the Bank employed 711 full-time equivalent employees versus 718 at year-end 1998. The Bank provides a variety of employment benefits and considers its relationship with its employees to be good.
CERTAIN REGULATORY CONSIDERATIONS
Bank holding companies and national banks are regulated by state and federal law. The following is a summary of certain laws and regulations that govern the Company and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the actual statutes and regulations thereunder.
Bank Holding Company Supervision - --------------------------------
The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA") and as such is subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As a bank holding company, the Company's activities and those of its subsidiary have historically been limited to the business of banking and activities closely related or incidental to banking. On November 12, 1999, however, the Gramm-Leachy-Bliley Act was signed into law which will, effective March 12, 2000, relax the previous limitations and permit bank holding companies to engage in a broader range of financial activities (see "Financial Services Modernization Act" in the final section of this discussion for details).
Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital contributions to a troubled bank subsidiary. The Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the Company does not have the resources to provide it. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks.
The BHCA requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of, or substantially all of the assets of, any bank (unless it owns a majority of such bank's voting shares) or otherwise to control a bank or to merge or consolidate with any other bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank.
The Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on September 29, 1994) provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies
are eliminated effective September 29, 1995. The law also permits interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. The Company believes that the effect of the law has been to increase competition within the markets where the Company operates, although the Company cannot quantify the effect to which competition has increased in such markets or the timing of such increases.
OCC Supervision - ---------------
The Bank is supervised and regularly examined by the Office of the Comptroller of the Currency (OCC). The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt, and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. There are no regulatory orders or outstanding issues resulting from regulatory examinations of the Bank.
Limits on Dividends and Other Revenue Sources - ---------------------------------------------
The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the OCC for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1999, the Bank had $15.9 million in undivided profits legally available for the payment of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings.
There are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specified amounts.
Capital Requirements - --------------------
The Federal Reserve Board has established risk-based capital guidelines which are applicable to bank holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill ("Tier I capital"). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier I capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization's particular circumstances warrant. The remainder ("Tier 2 capital") may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier I capital and Tier 2 capital is "total risk-based capital." The Company's Tier I and total risk-based capital ratios as of December 31, 1999 were 9.28% and 10.50%, respectively.
In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier I capital to quarterly average assets less goodwill ("Tier I leverage ratio") of 3.00% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other bank holding companies are required to maintain a Tier I leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Company's Tier I leverage ratio as of December 31, 1999 was 5.80%, which exceeded its regulatory requirement of 4.00%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Company is subject to the same OCC capital requirements as those that apply to the Bank.
The four federal banking agencies - the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision - have recently issued an interagency proposal which revises the risk-based capital requirements for certain obligations related to securitized transactions. The changes are intended to produce more consistent capital treatment for credit risks associated with exposures arising from these types of transactions. The proposal would amend the risk based capital requirements for asset-backed securities as well as recourse obligations and direct credit substitutions. It incorporates many of the industry comments received in response to an earlier version published in November 1997. A consultative paper issued in June 1999 by the Basel Committee on Banking Supervision considers a similar approach to that contained in the current proposal. Public comment is requested by June 7, 2000. If the proposal is adopted, the Bank does not believe it will have a material effect on its financial condition or results of operations.
Federal Deposit Insurance Corporation Improvement Act of 1991 - -------------------------------------------------------------
In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund (the "BIF") of the FDIC by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the FDIC use the least-cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions including a Truth-in-Savings Act; (x) a requirement that the FDIC establish a risk-based deposit insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage.
FDICIA requires federal banking agencies to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered "well capitalized" or "adequately capitalized" under Federal Reserve Board regulations:
Well Capitalized Adequately Capitalized ---------------- ---------------------- Total Risk-Based Capital Ratio 10% 8% Tier I Risk-Based Capital Ratio 6% 4% Tier I Leverage Ratio 5% 4%
If a bank does not meet all of the minimum capital ratios necessary to be considered "adequately capitalized," it will be considered "undercapitalized," "significantly undercapitalized," or "critically undercapitalized," depending upon the amount of the shortfall in its capital. As of December 31, 1999, the Bank's total risk-based capital ratio and Tier I risk - based capital ratio were 10.61% and 9.39%, respectively, and its Tier I leverage ratio as of such date was 5.86%. Notwithstanding the foregoing, if its principal federal regulator determines that an "adequately capitalized" institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan; restrict its asset growth; and prohibit branching, new acquisitions, and new lines of business. Among other things, an institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings, or liquidity in its most recent examination.
Possible sanctions for undercapitalized depository institutions include a prohibition on the payment of dividends and a requirement that an institution submit a capital restoration plan to its principal federal regulator. The capital restoration plan of an undercapitalized bank will not be approved unless the holding company that controls the bank guarantees the bank's performance. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lesser of five percent (5%) of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.
In addition, FDICIA requires regulators to impose new noncapital measures of bank safety, such as loan underwriting standards and minimum earnings levels. Regulators are also required to perform annual on-site bank examinations, place limits on real estate lending by banks and tighten auditing requirements.
Financial Services Modernization Act - ------------------------------------
On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law, repealing provisions of the depression-era Glass-Steagall Act, which prohibited commercial banks, securities firms, and insurance companies from affiliating with each other and engaging in each other's businesses. The major provisions of the Act took effect on March 12, 2000.
The Act creates a new type of financial services company called a "Financial Holding Company:" (an "FHC"), a bank holding company with dramatically expanded powers. FHCs may offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. The Federal Reserve serves as the primary "umbrella" regulator of FHCs. Balanced against the attractiveness of these expanded powers are higher standards for capital adequacy and management, with heavy penalties for noncompliance.
Bank holding companies that wish to engage in expanded activities but do not wish to become financial holding companies may elect to establish "financial subsidiaries," which are subsidiaries of national banks with expanded powers. The Act permits financial subsidiaries to engage in the same types of activities permissible for nonbank subsidiaries of financial holding companies, with the exception of merchant banking, insurance underwriting and real estate investment and development. Merchant banking may be permitted after a five-year waiting period under certain regulatory circumstances.
Implementing regulations under the Act have not yet been promulgated, and though the Company cannot predict the full impact of the new legislation, there is likely to be consolidation among financial services institutions and increased competition for the Company. CBSI expects to remain a bank holding company for the time being and access its options as circumstances change.
Item 2.
Item 2. Properties - ------------------
The Company leases its administrative offices at 5790 Widewaters Parkway, DeWitt, New York and the facility that houses Benefit Plans Administrative Services in Utica, New York. The Bank owns its regional offices in Olean, New York and Canton, New York. Of the Bank's remaining 67 customer facilities, 47 are owned by the Bank, and 20 are located in long-term leased premises.
Real property and related banking facilities owned by the Company at December 31, 1999 had a net book value of $16.2 million and none of the properties was subject to any encumbrances. For the year ended December 31, 1999, rental fees of $889,000 were paid on facilities leased by the Company for its operations.
Item 3.
Item 3. Legal Proceedings - -------------------------
Not applicable
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders - -----------------------------------------------------------
Not applicable
Item 4A. Executive Officers of the Registrant - ---------------------------------------------
The following table sets forth certain information about the executive officers of the Company and the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors.
Name and Age Position ------------ -------- Sanford A. Belden Director, President and Chief Executive Age 57 Officer of the Company and the Bank
David G. Wallace Treasurer of the Company and Executive Age 55 Vice President and Chief Financial Officer of the Bank
Michael A. Patton President, Financial Services Age 54
James A. Wears President, Banking Age 50
Girard H. Mayer Chief Executive Officer, Age 61 Benefit Plans Administrative Services, Inc.
Sanford A. Belden (Director, President and Chief Executive Officer of the Company and the Bank). Mr. Belden has been President and Chief Executive Officer of the Company and the Bank since October 1, 1992. Mr. Belden was formerly Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to 1992 and prior thereto served as President, Community Banking, for First Bank System, Minneapolis, Minnesota, a multi-state bank holding company.
David G. Wallace (Treasurer of the Company; Executive Vice President and Chief Financial Officer of the Bank). Mr. Wallace became Vice President and Chief Financial Officer of the Bank and Treasurer of the Company in November 1988 and Senior Vice President and Chief Financial Officer of the Bank in August 1991. He assumed his current position in February 2000.
Michael A. Patton (President, Financial Services). Mr. Patton was the President and Chief Executive Officer of The Exchange National Bank, a former subsidiary of the Company, from 1984 until January 1992, when, in connection with the consolidation of the Company's five subsidiary banks into Community Bank, N.A., he was named President, Southern Region. He assumed his current position in February 2000.
James A. Wears (President, Banking). Mr. Wears served as Senior Vice President of the St. Lawrence National Bank, a former subsidiary of the Company, from 1988 through January 1991 and as President and Chief Executive Officer from January 1991 until January 1992. Following the January 1992 consolidation of the Company's five subsidiary banks into Community Bank, N.A., Mr. Wears was named President, Northern Region. He assumed his current position in February 2000.
Girard H. Mayer (Chief Executive Officer, Benefit Plans Administrative Services, Inc.). Mr. Mayer assumed his present position in July 1996 when his company (Benefit Plans Administrators) was purchased by Community Bank System, Inc.
Part II
Item 5.
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters - --------------------------------------------------------------------------------
The common stock has been trading on the New York Stock Exchange under the symbol "CBU" since December 31, 1997. Prior to that, the common stock traded over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning on September 16, 1986. The following table sets forth the high and low prices for the common stock, and the cash dividends declared with respect thereto, for the periods indicated. The prices do not include retail mark-ups, mark-downs or commissions. There were 7,092,259 shares of common stock outstanding on December 31, 1999 held by approximately 1,760 registered shareholders of record, and approximately 2,190 shareholders whose shares are held in nominee name at brokerage firms and other financial institutions.
COMMON STOCK PERFORMANCE NYSE Symbol: CBU Newspaper Listing: CmntyBkSys Market (Bid) Price
High Low Closing Price Quarterly Year/Qtr Price Price Amount %Change Dividend - -------- ----- ----- ------ ------- --------
4th $27.25 $22.81 $23.13 -15.5% $0.25 3rd $27.38 $24.63 $27.38 7.9% $0.25 2nd $26.00 $23.06 $25.38 6.6% $0.23 1st $27.81 $23.69 $23.81 -16.6% $0.23
4th $30.50 $27.13 $29.31 2.6% $0.23 3rd $33.94 $24.81 $28.56 -8.8% $0.23 2nd $38.25 $29.69 $31.31 -7.9% $0.20 1st $35.88 $30.56 $34.00 8.6% $0.20
The Company has historically paid regular quarterly cash dividends on its common stock, and declared a cash dividend of $0.25 per share for the first quarter of 2000. The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the common stock, as well as to make payment of regularly scheduled dividends on the trust preferred stock as and when due, subject to the Company's need for those funds. However, because substantially all of the funds available for the payment of dividends by the Company are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations. See "Supervision and Regulation -- Limits On Dividends and Other Payments."
Item 6.
Item 6. Selected Financial Data - -------------------------------
The following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five year period ended December 31, 1999. The historical "Income Statement Data" and historical "End of Period Balance Sheet Data" are derived from the audited financial statements. The "Per Share Data", "Selected Ratios" and "Other Data" for all periods are unaudited. All financial information in this table should be read in conjunction with the information contained in "Capitalization," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - -----------------------------------------------------------------------------
This Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements with respect to the financial condition, results of operations and business of Community Bank System, Inc. ("CBSI" or "the Company"). These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set herein under the caption "Forward-Looking Statements."
The following discussion is intended to facilitate an understanding and assessment of significant changes in trends related to the financial condition of the Company and the results of its operations. The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Information and the Company's Consolidated Financial Statements and related notes thereto appearing elsewhere in this Form 10-K. All references in the discussion to financial condition and results of operations are to the consolidated position and results of the Company and its subsidiaries taken as a whole.
Net Income and Profitability - ----------------------------
Net income and diluted earnings per share reached record highs in 1999 of $17.6 million and $2.42, respectively. Compared to 1998, net income rose 12.1% while earnings per share were up 18.0%. The Company's share repurchase program continued to benefit earnings per share growth; since its inception in the fall of 1998, 548,100 shares or 7.2% of shares outstanding have been bought back.
Cash earnings per share (diluted) also reached record levels in 1999, up 16% to $2.79. Cash or tangible return on assets (ROA) for 1999 was 1.18% versus nominal ROA at 1.02%. Tangible return on equity (ROE) for the year climbed 2.30 percentage points over 1998's level to 17.57%, exceeding nominal ROE by 2.35 percentage points for the same period and placing the Company's performance in the top quartile of its regional peer banks. The difference between cash and nominal results reflects the contribution of the Company's branch acquisitions on an economic basis, which excludes the non-cash impact of amortizing the premiums paid for the acquisitions. Many analysts and investors consider cash results a better measure of core profitability and value created for shareholders than nominal results.
1999's recurring or core earnings were up 24.5% from last year to $18.3 million after removing the impact of one-time income and expense items. Items excluded relate to investment gains and losses and expense associated with branch properties no longer in use.
The primary factors explaining 1999's improvement are explained in detail in the remaining sections of this document and are summarized as follows:
o Net interest income (full-tax equivalent basis) increased 5.5% or $3.5 million due to a $60 million increase in average earning assets. Average loans grew $66 million (7.5%) while average investments went down $6.2 million (-1.0%). The growth in earning assets was funded by $86 million (64.5%) more in average borrowings, offset by $27 million (2.0%) less in average deposits. The net interest margin improved by a meaningful 15 basis points to 4.46% on average.
o Total noninterest income decreased by 10.8% from 1998 to $15.5 million, largely due to the Company taking selected investment losses in 1999 (when there were economic opportunities to swap for higher yielding securities) instead of recognizing investment gains as it did in 1998 (to maintain a steady level of investment income based on a total return approach). Revenues excluding net investment gains (losses) and the impact of branch properties no longer in use were up nicely for the fifth consecutive year to approximately $16.1 million in 1999, a $823,000 (5.4%) improvement.
o Noninterest expense or overhead rose $857,000 or 1.7% in 1999 compared to $6.1 million or 13.3% in 1998. Unusual factors explaining 1999's small increase include losses on fraudulent customer transactions related to a floor plan dealer during the summer and approximately $506,000 in one-time expenses incurred to dispose of acquired branch properties no longer in use.
o Loan loss provision expense rose a minimal $13,000 or 0.3% over 1998's level. The full year loan loss provision covered total actual net charge-offs by 1.24 times, this margin serving as a precaution in the event the Upstate New York economy weakens after its long sustained period of relative economic health. Net charge-offs as a percent of average loans decreased 14 basis points in 1999 to .44%. The unchanged level of provision was in part made possible by significantly lower installment loan net charge-offs, indicative of more conservative underwriting practices and regular follow-up surveillance adopted during 1998. Nonperforming loans increased during 1999 to .57% of loans outstanding at year-end compared to .43 % one year earlier.
o The Company's combined effective federal and state tax rate decreased 550 basis points this year to 31.0%. The decrease resulted from improved tax planning and by an increased proportion of tax-exempt municipal investment holdings, which were an attractive value in 1999.
The above combination of factors resulted in a level of profitability which may be compared to that of CBSI's peer bank holding companies. This group is comprised of 155 companies nationwide having $1 billion to $3 billion in assets based on data through September 30, 1999 (the most recently available disclosure) as provided by the Federal Reserve System. Through year-to-date September, the Company's return on average assets (ROA) was .99% compared to the peer norm of 1.19%. Shareholder return on equity (ROE) at 14.32% for the same period ranked higher than the peer norm of 13.84%, placing it in the 54th peer percentile. The Company's primary performance focus is on achieving returns to shareholders and is better measured by ROE than ROA.
Underlying the 1999 growth in earnings per share was steady improvement on a quarterly basis. The first three quarters of 1999 at $.50, $.55 and $.68 per share exceeded the same 1998 quarters by $.02, $.05, and $.12, respectively. Fourth quarter earnings per share at $.69, a record high for the Company, exceeded the same 1998 period by $.18.
Selected Profitability and Other Measures - -----------------------------------------
Return on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows:
At December 31, 1999 1998 1997 ------------------------------------------
Percentage of net income to average total assets 1.02% 0.94% 1.04%
Percentage of net income to average shareholders' equity 15.22% 13.01% 14.09%
Percentage of dividends declared per common share to net income per common share 39.05% 41.95% 37.30%
Percentage of average shareholders' equity to average total assets 6.72% 7.24% 7.42%
Net Interest Income - -------------------
Net interest income is the amount that interest and fees on earning assets (loans and investments) exceeds the cost of funds, primarily interest paid to the Company's depositors as well as interest on borrowings from the Federal Home Loan Bank of New York, a $4 million M&T Bank line of credit, and dividends on the Company's $30 million in 9.75% trust preferred stock. Net interest margin is the difference between the gross yield on earning assets and the cost of interest bearing funds as a percentage of earning assets.
Net interest income (with non-taxable income converted to a full tax-equivalent basis) totaled $70.1 million in 1999; this represents a $5.0 million or 7.7% increase over the prior year. The increase was due both to higher earning asset volumes, which had a positive impact on net interest income of $2.6 million, and interest rate changes, which had a favorable impact of $2.4 million.
With regard to the components of 1999's net interest income, greater average earning assets of $60.2 million helped contribute to the $2.4 million or 2.0% rise in interest income. Average loans grew a total of $66.4 million in 1999, with the most significant portion occurring in the latter half of the year. Overall interest and fees on loans grew $2.1 million or 2.5% as a result of this growth and came despite a 44 basis point (BP) decrease in loan yields to 8.92%, which was caused by declining market rates during 1998 and the first part of 1999.
This rate environment also produced limited investment portfolio buying opportunities until mid-1999, resulting in a $6.2 million decrease in average investments. Despite the lower outstandings, 1999's investment interest income was slightly higher (.8% or $345,000) than the prior year due to an increase in the average investment yield from 6.52% to 6.64%. Rising market rates in the latter half of 1999, which both increased the yield on new investments and decreased the amount of premium amortization of the Company's existing premium collateralized mortgage obligations (CMOs), caused this increase in average investment yield.
Loans ended 1999 at $1.009 billion, up $92 million or 10.0%. The average ratio of loans to earning assets increased from 58.5% in 1998 to 60.5% in 1999 as a consequence of strong business development efforts in the lending function and the aforementioned decrease in average investments. Comparing year-end 1999 over year-end 1998, however, investments were $66.9 million higher, reflective of purchases during the more attractive rate environment beginning in mid-1999. Through September 30, 1999, the Company's loan yield was in the favorable 67th peer bank percentile while the investment yield was in the favorable 65th percentile. The average earning asset yield fell 16 basis points to 8.02% in 1999 because of the aforementioned declining loan yield, partially offset by the higher investment yield and the increased mix of loans to earning assets.
Total average fundings (deposits and borrowings) grew by $58.7 million in 1999, largely attributable to a $105.9 million increase in short-term borrowings (in part, related to cash raised for potential Year 2000 outflows), partially offset by lower municipal time deposit levels.
Despite higher average fundings, interest expense decreased by $2.6 million due to a drop in the average 1999 cost of funds, which as a percentage earning assets was reduced by 31 BPs to 3.56%. The rate on interest bearing deposits fell 43 BPs to 3.77%, due largely to across-the-board drops in deposit rates beginning in the fall of 1998 and continuing into early 1999 and a 65 BP lower borrowing rate reflecting declines in market rates. Overall, through September 30, 1999, the Company's average cost of funds rate fell favorably to the 45th peer bank percentile, compared to being in the 55th percentile through September 30, 1998.
The 32 BP decline in the average cost of funds from 1998 to 1999, in contrast to the 16 BP decline in the earning asset yield, caused CBSI's net interest margin to increase by 15 basis points from 4.31% in 1998 to 4.46% this year. The Company's net interest margin ranked in the 60th peer bank percentile through September 30, 1999, which favorably compares to the 40th peer bank percentile through September 30, 1998. For fourth quarter 1999, the net interest margin was 4.49% compared to 4.25% one year earlier. This can be attributed to a higher earning asset yield (up 28 BPs) at 8.18%, with only a slight increase (up 3 BP's) in the rate on interest-bearing liabilities at 4.27%.
The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon for the twelve month periods ended December 31, 1999 and 1998. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations.
As discussed above, the change in 1999's net interest income (full tax-equivalent basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.
(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.
The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon for the three month periods ended December 31, 1999 and 1998. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations.
The changes in net interest income (full tax-equivalent basis) by volume and rate component for fourth quarter 1999 versus fourth quarter 1998 are shown below for each major category of interest-earning assets and interest-bearing liabilities.
---------------------------------------- 4th Quarter 1999 versus 4th Quarter 1998 ----------------------------------------
Increase (Decrease) Due to Change In (1)
Net Volume Rate Change ------ ---- ------
Interest earned on: Federal funds sold and securities purchased under agreements to resell $7 $2 $9
Time deposits in other banks 3 (3) 0
Taxable investment securities (1,412) 2,911 1,499
Nontaxable investment securities 1,750 (447) 1,303
Loans (net of unearned discounts) 4,666 (3,348) 1,318
Total interest-earning assets (2) $3,040 $1,089 $4,129
Interest paid on: Savings deposits ($150) $87 ($63)
Time deposits (266) (488) (754)
Short-term borrowings 2,397 25 2,422
Long-term borrowings (361) 272 (89)
Total interest-bearing liabilities (2) $1,420 $96 $1,516
Net interest earnings (2) $1,652 $961 $2,613
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components.
Noninterest Income - ------------------
The Company's sources of noninterest income are of four primary types: financial services, comprised of personal trust, employee benefit trust, investment, and insurance products; specialty products, largely electronic products and mortgage banking and servicing activities; general banking services related to loans, deposits and other activities typically provided through the branch network; and periodic transactions, most often net gains/losses from the sale of investments or other occasional events.
Total noninterest income in 1999 decreased by 10.8% to $15.5 million, largely due to the lack of the prior year's $2.3 million in investment gains (including a pretax $328,000 realized upon adoption of FAS 133) compared to 1999's $638,000 in investment losses. Revenues excluding net investment gains (losses) and the impact of branch properties no longer in use were up nicely for the fifth consecutive year to approximately $16.1 million in 1999, a $823,000 (5.4%) improvement.
Fees from the financial services segment of noninterest income rose 11.7% in 1999 to $5.9 million compared to 20.0% growth in the prior year. Over the last five years, financial services revenues have climbed at a compound annual growth rate of nearly 28%, and now comprise over 36% on total noninterest income excluding net investment securities gains (losses). The reduction in 1999's growth rate largely reflects a slower rate of increase in the sale of mutual fund products due to several factors discussed below, which management believes to be temporary. The specific performance of the Company's several financial services businesses is as follows:
o Fees from personal trust services were $1.3 million, up 9.0% in 1999 as compared to a 2.9% increase in 1998. Recurring trust fees (which excludes periodic estate fees) related to individual investment management accounts and annual trust administration (together representing 81% of personal trust income) grew a combined 12.1%. Personal trust assets under management reached over $170 million by year end, up 1.7% over the prior twelve months. Greater focus on business development, including pro-active integration of its major referral sources--the Company's ten Financial Consultants, its Benefit Plans Administrative Services subsidiary, its newly acquired asset management subsidiary, Elias Asset Management, Inc. (see below), and the CBNA branch network--is expected to accelerate future fiduciary income growth.
o Revenue from record keeping and consulting services provided by Benefits Plans Administrative Services, Inc. (acquired in July 1996), combined with investment management services through the Bank's employee benefits trust division (EBT), totaled $2.6 million in 1999 compared to $2.3 million in 1998, an 11.0% increase. Retirement plan assets, reflecting more than 350 plan sponsors, reached nearly $230 million at year-end 1999, up almost 36% over 12 months earlier. BPA/EBT supports defined benefit, 403(b), 457, 401(k), ESOP and other forms of defined contribution plans, enhancing these products with voice response and transactional web services. BPA has been endorsed by several trade organizations and mutual fund companies; thus, its market continues to grow from a local base to plan sponsors located in the urban centers of New York State and beyond.
o 1999 is the sixth year in which CBSI has offered mutual funds, annuities, and other investment products through Financial Consultants (FCs) located in various locations throughout the Bank's branch network. Commission income from this source grew 3.8% in 1999 to $1.3 million, down from over 22% growth in 1998. Reasons for the reduced growth include greater attractiveness of the Bank's own fixed income products (C.D.s) due to 1999's rising interest rates beginning in the late spring of 1999 (upon which no commission income is earned); some lag in sales as the Bank implemented in the spring its own more cost-effective broker/dealer subsidiary, Community Investment Services, Inc. (CISI); and reluctance of some customers to invest toward the end of 1999 in light of Year 2000 concerns. A dedicated CISI office was established in the late fall in Lockport, New York, with its two new Financial Consultants bringing the bank-wide total to ten FCs. In addition, our newly established insurance agency, Community Financial Services, Inc. (CFSI), has expanded the product capabilities of the Financial Consultants by adding long-term health care and other selected insurance products to their offerings. Revenues from CFSI were nominal in 1999.
o Community Bank has long been in the business of selling creditor life and disability insurance to installment and mortgage loan customers through its branch system. Revenues from this activity, including the Bank's annual dividend from the New York State Bankers insurance subsidiary through which the insurance is written, plus commissions generated by the Company's Financial Consultants, amounted to $728,000 in 1999, up 40% over last year.
A very significant contribution to the Company's future growth in financial services income is the acquisition announced in February 2000 of Elias Asset Management (EAM), based in Williamsville, New York, a suburb of Buffalo. This transaction significantly expands our financial services capabilities and is expected to close during the second quarter of the year. Founded in 1981, EAM is a nationally recognized investment advisory firm with over $700 million in assets under management, comprised of more than 900 accounts with individuals, foundations, and corporate pension and profit-sharing plans.
By acquiring EAM, the Company is merging the strengths of two organizations that have successfully worked together since 1986 in various trust department and pension management capacities, satisfying customer preferences for an even greater range of services. The decision to acquire EAM is consistent with the direction of the financial services industry toward more diversified and broadly based companies - a trend that will accelerate as a result of Financial Modernization legislation (see brief discussion in the "Certain Regulatory Considerations" section of this Form 10-K in Item 1. "Business"). Operating as a separate, independent subsidiary, EAM and its existing clients will benefit from additional resources that will enable EAM to maintain its high quality reputation, while adding valuable personnel and enhanced services. As of year-end 1999, approximately 50% of EAM's $3.2 million in revenues was derived from individuals, with nearly 25% from corporate pension and thrift plans, and the remainder from foundations and charitable trusts.
In addition to its financial services businesses, another segment of the Company's noninterest income is its specialty products, which largely include electronic products and mortgage banking and servicing activities. These activities in 1999 contributed 12% of noninterest income excluding net investment securities gains (losses). Total revenues were $1.84 million, down slightly from $1.88 million in 1998, primarily due to reduced mortgage banking revenues as discussed below. Over the last five years, specialty product revenues have grown at an annual compound growth rate of nearly 18%.
o Fees earned from electronic products reached $1.38 million this year, up 21% from 1998. This increase was primarily due to income from the Company's Visa affiliation, which rose to $937,000, reflecting continued growth of Visa Check Card revenues (climbing 33%) and Visa merchant discount fees (up 25%). ATM surcharge income rose 8.1% to $442,000.
o Mortgage banking fees were $403,000 in 1999, down from $737,000 in the prior year. The primary reasons for the decrease were the disproportionate impact of recognizing the value of the Company's mortgage servicing rights in 1998 and the fact that secondary market mortgages were sold at a slight loss this year versus a $235,000 gain in 1998's more favorable financial market environment. Loan servicing fees more than doubled in 1999 to $195,000 on a serviced loan portfolio of $89 million, consisting of about 1,475 loans.
o Lastly, the Company established a relationship this year with a national, third-party leasing company, Synergy Resources of Bloomington, Minnesota, which pays referral commissions on leases booked for CBNA customers. Revenues were $59,000, largely from small equipment leases. Customers may submit applications by telephone, fax, or the Internet.
The third and largest segment of the Company's recurring noninterest income is the wide variety of fees earned from general banking services, which reached $8.4 million in 1999, up 8.7% from the prior year. This segment contributed 52% of noninterest income excluding net investment securities gains (losses). The increase in these revenues is generally in the single digit range because they are largely dependent on deposit growth and expansion of services provided through the branch network. However, CBSI's branch acquisitions beginning in 1994 have resulted in a five year annual compound growth rate in these revenues of nearly 22%.
o Service charges on deposit accounts and overdraft fees increased to $6.57 million in 1999, a 5.6% growth rate compared to a 27% growth rate in 1998. Last year's faster growth rate reflects the full-year impact of the Company's mid-1997 branch acquisitions.
o General commissions and miscellaneous income at $1.8 million were up 22% in 1999. This increase is attributable to approximately 13% more in miscellaneous service fees and a swing in Canadian exchange revenue from a loss in 1998 to a slightly positive level this year.
Income from periodic transactions in 1999 largely includes $638,000 in losses taken on $14.6 million in investment sales, with the net proceeds reinvested at higher yields to achieve greater resulting cash flows than had the securities been held to maturity. This amount compares to gains of $2.3 million last year on a combined $86 million in investment sales. The investment gains and losses taken over the last two years are illustrative of the Company's active management of its investment portfolio to achieve a desirable total return and a targeted level of combined interest income and securities gains/losses across financial market cycles.
Other amounts of periodic income in 1999 were a small $46,000 compared to $253,000 in the prior year; the latter was the combined result of a gain on life insurance and an asset sold, partially offset by losses on the sale of former acquired branch properties.
Noninterest income, excluding transactions related to investment securities and disposal of branch properties, as a percent of operating income was 18.7% in 1999, a decrease of .3 percentage points from the prior year. Excluding the impact of mortgage servicing rights and gains/losses on the sale of secondary product in both years, the ratio would have been up .1 percentage point, the increase being limited by the Company's record growth in net interest income. Since 1994, the percentage has risen 6.7 percentage points from 12.0%, resulting from a focused effort to raise product revenues less susceptible to interest rate fluctuation. Compared to peers as of September 30, 1999, this ratio remained in the 47th peer percentile.
In light of management's ongoing objective to grow noninterest income, opportunities to develop new fee-based products are actively pursued, including newly permitted activities under the 1999 Financial Modernization Act, and emphasis continues on the collection of fees (minimizing limitation on waived fees) for providing quality service. In an effort to focus on and accelerate growth of the Company's financial service businesses, Michael A. Patton, who has headed for many years the Bank's trust department and Financial Consultant activities along with general banking activities in the Southern Region, was named President, Financial Services, in February 2000.
The following table sets forth selected information by category of noninterest income for the Company for the years and quarters indicated. --------------------------------------------- (000's omitted) Years ended December 31, Quarters ended December 31, --------------------------------------------- 1999 1998 1997 1999 1998 ---- ---- ---- ---- ----
Personal trust $1,290 $1,183 $1,150 $328 $323
EBT/BPA 2,586 2,333 1,824 595 572
Insurance 728 518 405 82 90
Other investment products 1,268 1,222 1,002 346 313 --------------------------------------------- Total financial services 5,872 5,257 4,380 1,351 1,298
Electronic banking 1,379 1,140 675 407 313
Mortgage banking 403 737 241 36 484
Commercial leasing 59 0 0 14 0 --------------------------------------------- Total specialty products 1,841 1,877 915 457 796
Deposit service charges 3,373 3,246 2,709 852 808
Overdraft fees 3,197 2,975 2,186 841 824
Commissions 1,795 1,473 1,440 408 327 ---------------------------------------------
General banking services 8,365 7,694 6,335 2,101 1,960
Miscellaneous revenue 46 473 191 (12) 11 ---------------------------------------------
Total noninterest income excl. security gains/losses 16,124 15,301 11,822 3,897 4,066
Security gains/losses (a) (638) 2,287 (14) (415) 562
Disposition of branch properties 0 (219) 0 0 (151) --------------------------------------------- Total noninterest income $15,487 $17,368 $11,808 $3,481 $4,476
Noninterest income as a percentage of operating income (excludes net securities gains/losses and disposal of branch properties) 18.7% 19.0% 15.3% 17.3% 20.3%
(a) includes $328,000 of investment gains on securities sold upon adoption of FAS 133 in third quarter 1998.
Noninterest Expense - -------------------
Noninterest expense or overhead rose $857,000 or 1.7% in 1999 compared to $6.1 million or 13.3% in 1998, which reflected the full-year impact of the Company's mid-1997 acquisitions of a combined 20 branches from Key Bank, N.A. and Fleet Bank. This year's overhead of $52.7 million as a percent of average assets was 3.06%, a slight decrease from 3.11% in 1998; however, the ratio remains in the peer normal 57th percentile. Excluding amortization of intangible assets, which is a significant non-cash expense for the Company and virtually non-existent for its peer group, CBSI's noninterest expense ratio was 2.79% in 1999 compared to 3.02% for peers. Non-interest expense for fourth quarter 1999 was $13.0 million, unchanged compared to the same 1998 period.
For CBSI as a whole, higher personnel expense accounted for over 74% of 1999's increase in overhead, with personnel costs being up 2.5% versus being 12.2% higher in 1998 as a result of acquisitions. Salary, benefit, and payroll tax expense increased primarily because of modest annual merit awards for employees. Total full-time equivalent staff at year-end 1999 was 711 versus 718 at year-end 1998, down as the result of attrition.
Nonpersonnel expense rose $219,000 or 0.8% this year as opposed to a $3.3 million or 14.3% increase in 1998. This was largely caused by losses on fraudulent customer transactions related to a floor plan dealer during the summer and write-downs of leases on former branch properties closed due to duplicate facilities within the same proximity. In addition, the increased expense can be explained by set up costs of the Company's newly formed Real Estate Investment Trust (REIT) and more aggressive 1999 advertising. These unfavorable items were partially offset by a reduction in delivery costs of mutual funds and other related products as a result of the creation of the Company's own broker/dealer subsidiary, lower supplies expense in part reflecting an improved system of control, and reduced occupancy expense due to the full year impact of the disposition of former branch properties in 1998.
The efficiency ratio is defined at two levels. The nominal ratio is total overhead expense divided by operating income (full tax-equivalent net interest income plus noninterest income, excluding net securities gains and losses). The adjusted or recurring efficiency ratio additionally excludes one-time expense and intangible amortization (a non-cash expense) as well as all one-time noninterest income; over the last five years, these one-time items have related to the disposal of branch properties. The lower the ratio, the more efficient a bank is considered to be.
In 1999, the nominal efficiency ratio decreased 3.5 percentage points to 61.1% while the recurring ratio decreased 3.3 percentage points to 55.2%. Management believes it is more meaningful to use the recurring ratio to compare to national norms, because as mentioned above, most of the Company's peers do not have intangible expense to the significance that CBSI has. On that basis, CBSI's ratio is more favorable than the national peer bank holding company median of 60.8% based on data available as of September 30, 1999. The improvement in the 1999 efficiency ratio is a function of several factors: an increase in net interest margin due to a lower cost of funds and reduced premium amortization on the Company's CMO securities, growth in earning assets, steady progress in developing more sources of noninterest income, and persistent control of overhead expense.
While the Company's expense ratios have generally been favorable, management maintains a heightened focus on controlling costs and eliminating inefficiencies. Areas for improvement have been identified through detailed peer comparisons, a bank-wide program of employee involvement, targeted use of outside consultants, and review of productivity-enhancing technology. These combined efforts are intended to offset pressure from future price increases and higher transaction volumes and enable the Company to more fully benefit from economies of scale as it continues to grow. Specifically, the Bank benefited more fully in 1999 from the spring 1998 installation of frame relay to lower the cost of data communications, the creation of a broker/dealer subsidiary during first quarter 1999 which brought down the expense of delivering mutual funds and related products, and the overhead savings following disposition of acquired branch properties in 1998.
The following table sets forth information by category of noninterest expense of the Company for the years and quarters indicated.
(000's omitted) Years ended Quarters ended December 31, December 31, ----------------------------------------------------------- 1999 1998 1997 1999 1998 ---- ---- ---- ---- ----
Personnel expense $26,388 $25,750 $22,945 $6,654 $6,407
Net occupancy expense 3,919 4,056 3,426 936 940
Equipment expense 3,465 3,501 2,728 888 892
Professional fees 1,937 2,142 1,616 404 677
Data processing expense 3,955 3,928 3,584 1,078 940
Amortization of intangibles 4,615 4,640 3,787 1,149 873
Stationary and supplies 1,218 1,344 1,749 307 293
Deposit insurance premiums 183 189 140 46 46
Other 7,053 6,326 5,823 1,599 1,990 ---------------------------------------------------- Total $52,733 $51,876 $45,799 $13,061 $13,058 ==================================================== Total operating expense as a percentage of average assets 3.06% 3.11% 3.07% 2.90% 3.12% Efficiency ratio (1) 55.2% 58.5% 55.0% 52.9% 58.3%
(1) Noninterest expense excluding nonrecurring items and amortization of deposit intangibles divided by operating income excluding all nonrecurring items.
Income and Income Taxes - -----------------------
Income before tax in 1999 was $25.6 million, up 4.6% over the prior year's amount, which excluded the impact of FAS 133 accounting for selected securities gains. When income is recast as if all tax-exempt revenues were fully taxable on a federal basis, and all securities gains are stated on a pretax basis, 1999's results rose by $2.3 million or 8.9% before tax.
The main reasons for improved pretax earnings were the favorable $5.0 million increase in net interest income (full tax-equivalent basis) related to strong earning asset growth (up 4.0% or $60.2 million on average) and a $823,000 climb in recurring noninterest income. These factors were partially offset by a modest $857,000 (1.5%) increase in overhead expense (largely relating to merit pay increases and selected vendor price adjustments) and the lack of the prior year's $2.3 million in investment gains as compared to 1999's $638,000 in investment losses (see "Investments" section of this Form 10-K). Loan loss provision expense was held virtually constant at the 1998 level.
The Company's combined effective federal and state tax rate decreased 550 basis points this year to 31.0%. The decrease resulted from effective tax planning, which was additionally benefited in 1999 by an organizational change in the first quarter, as well as increased purchases of tax-exempt municipal investments during the year.
Capital - -------
Shareholders' equity ended 1999 at $108.5 million, down 9.8% from one year earlier, primarily reflective of the after-tax market value adjustment (MVA) of the Bank's available-for-sale investments, dividends paid to shareholders, and 221,500 shares of CBSI common stock that was repurchased during 1999 (548,100 or 7.2% of shares outstanding since the fall of 1998). This stock repurchase program reflects the Company's belief that its common stock is an excellent investment and that the financial markets are not fully valuing its strong banking franchise. These capital outflows are partially offset by the contribution of earnings. Excluding the MVA in both 1998 and 1999, capital rose by $5.7 million or 4.9%. Shares outstanding fell by over 200,000 during 1999 due to the aforementioned repurchase of stock partially offset by the exercise of stock options.
Despite the repurchase of stock, the ratio of tier I capital to assets (or tier I leverage ratio), the basic measure for which regulators have established a 5% minimum to be considered "well-capitalized," remains sound at 5.80% and compares to 5.71% one year ago. The total capital to risk-weighted assets ratio of 10.50% as of year-end 1999 was above the 10% minimum requirement for "well-capitalized" banks. The Company is confident that capital levels are being prudently balanced between regulatory and investor perspectives.
Cash dividends declared on common stock in 1999 of $6.9 million represented an increase of 6.4% over the prior year. This growth largely reflects a two cent per share increase in the quarterly common stock dividend beginning in the third quarter of 1999 from $.23 to $.25. Nineteen ninety-nine is the eighth consecutive year of dividend increases, which have resulted in a 12.3% compound annual growth rate over that time period.
Raising the Company's expected annualized dividend to $1.00 per common share reflects management's confidence that earnings strength is sustainable and that capital can be maintained at a satisfactory level. The dividend pay out ratio for the year was approximately 39%, slightly lower than the 1998 level of 41%. However, this level is at the higher end of the Company's targeted pay out range for dividends on common stock of 30-40%. Its pay out ratio has historically been strong relative to peers, ranging from the 60th to 77th percentile from 1993 through 1998, including preferred dividends. The 1999 peer pay out ratio remained high in the 70th peer percentile.
Loans - -----
The amounts of the Bank's loans outstanding (net of deferred loan fees or costs) at the dates indicated are shown in the following table according to type of loan:
Loans outstanding, net of unearned discount, reached a record $1.009 million as of year-end 1999, up over $92 million or 10.0% compared to twelve months earlier. This marks the seventh consecutive year of double digit loan growth with the exception of 1998, when loan growth was held to 8.8% due to a minimal increase in installment lending, in part reflecting adoption of more conservative underwriting practices. About 34% of 1999's growth came from 20 branches acquired in mid-1997 from Key Bank, N.A. and Fleet Bank, with combined year-end 1999 loans outstanding of $154 million. Including approximately $37 million in mortgages sold on the secondary market, net loan generation in 1999 was nearly $129 million, 13.8% more than last year and the highest generation in the Company's history.
The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. Approximately 63% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. Over the last several years, the growth rate of CBSI's commercial business loans has exceeded that of loans to individuals, and this sector exhibits a high degree of diversification as well. Loans are typically for amounts under $75,000, with nearly 80% of our customers representing about 25% of commercial loans outstanding. Only thirty-three percent of our commercial portfolio--about 115 customers, including 25 automobile dealers is comprised of loans in excess of $500,000. The portfolio contains no credit card receivables. The overall yield on the portfolio is in the attractive 67th peer percentile.
The "Nature of Lending" table below recasts the Company's loan portfolio into four major lines of business. As previously discussed, much of the 1999 loan growth relates to acquired branch locations and resulting market opportunities. The increase in business lending accounted for 44% of the $92 million in total loan growth in 1999 versus 51% of 1998's $74 million increase. The increase in consumer direct loans contributed 16% toward total growth this year versus a reduction of 6% in 1998. Consumer indirect loans accounted for 18% of this year's increase, up from 8% in the prior year. Lastly, the share of this year's total loan increase for consumer mortgages was 21%, down from 1998's share of 48% reflective of that year's highly favorable interest rate environment for home mortgage refinancing. The following more fully discusses the underlying reasons for these changes by each of the Company's four major lending activities or lines of business.
The combined total of general purpose business lending, dealer floor plans, mortgages on commercial property, and farm loans is characterized as the Company's business lending activity. At $366 million, this segment represents 36% of loans outstanding at year end, having steadily expanded its share by eight percentage points since year-end 1994. Outstandings climbed over $40 million or 12.5% in 1999 compared to a 13% growth rate for 1998. Growth in the past two years has resulted from persistent business development efforts and the contributions of new lenders who joined the Bank coincident with or as part of 1997's acquisitions.
Demand for installment debt indirectly originated through automobile, marine, and mobile home dealers rose in 1998. Outstandings ended the year 8.3% or $17 million higher, primarily resulting from growth in the Bank's Southern Region. This compares to growth of 2.6% or $5.5 million in 1998. This portfolio segment, of which 91% relates to automobile lending (71% of the vehicles are used versus 29% are new), constitutes 22% of total loans outstanding, equal to 1998's share but down from its peak of 26% in 1996.
The segment of the Company's loan portfolio committed to consumer mortgages includes both fixed and adjustable rate residential lending. It accounts for $219 million or 22% of total loans outstanding. Growth during the last two years ($19.5 million or 10.1% in 1999 and $35.8 million or 21.6% in 1998) is attributable to the nationwide refinancing boom as well as promotion, especially in the Bank's Northern Region, of this vehicle as a way for consumers to term-out higher cost credit card debt. Portfolio growth is lower than it could have been due to a program which began in mid-1994 to sell selected fixed rate originations in the secondary market. The purpose of this program, with sales of $14.0 million in 1997, $39.3 million in 1998 and $37.0 million this year, is to develop a meaningful source of servicing income as well as to provide an additional tool to manage interest rate risk.
The direct consumer lending activity increased this year after a slight decrease in 1998. 1999's outstandings rose 8.1% or $15 million, in part reflective of a promotion largely in the Bank's Southern Region, versus a decrease of 2.3% or $5 million in 1998. This line of business is comprised of conventional installment loans (including some isolated installment lending to small businesses), personal loans, student loans (which are sold once principle repayment begins), and borrowing under variable and fixed rate home equity lines of credit. The consumer direct segment as a percent of total loans remained essentially unchanged at 20% in 1999 after a decrease in the portfolio share in 1998. The portfolio share decrease in 1998 (2.3 percentage points) is partially explained by consumer borrowing being refinanced as mortgage debt in overall mortgage refinancing activity, as discussed above.
Maturities and Sensitivities of Loans to Changes in Interest Rates - ------------------------------------------------------------------
The following table shows the amount of loans outstanding as of December 31, 1999, which, based on remaining scheduled payments of principal, are due in the periods indicated:
The following table sets forth the sensitivity of the loan amounts due after one year to changes in interest rates:
--------------------------------- At December 31, 1999 ---------------------------------
Fixed Rate Variable Rate
Due after one year but within $ 264,362 $105,127 five years
Due after five years 347,840 41,950 ------- ------
TOTAL $ 612,202 $ 147,077 ========== =========
Nonperforming Assets/Risk Elements - ----------------------------------
The following table presents information concerning the aggregate amount of nonperforming assets:
The impact of interest not recognized on nonaccrual loans, and interest income that would have been recorded if the restructured loans had been current in accordance with their original terms, was immaterial. The Company's policy is to place a loan on nonaccrual status and recognize income on a cash basis when it is more than ninety days past due, except when in the opinion of management it is well secured and in the process of collection.
Provision and Reserve for Loan Losses - -------------------------------------
Nonperforming loans, defined as nonaccruing loans plus accruing loans 90 days or more past due, ended 1999 at $5.7 million. This level is approximately $1.7 million or 43% higher than one year earlier, solely attributable to the delinquency of a large commercial customer in the Bank's Northern Region in the fourth quarter. The customer experienced start-up problems with a new piece of equipment, thus causing a delay in projected higher cash flow. The equipment is now operative, and the associated $1.9 million loan is fully backed by collateral and a small specific assignment of loan loss reserve; nonetheless, management continues to monitor this situation carefully. Accordingly, the ratio of nonperforming loans to total loans has risen 14 basis points from twelve months earlier to .57%. Excluding the aforementioned delinquency, nonperforming loans would have decreased by $190,000 or 4.8% to $3.8 million. As of September 30, 1999, when the nonperforming loan ratio stood at .42%, the Company's asset quality was in the favorable 34th percentile compared to peers. The ratio of nonperforming assets (which additionally include troubled debt restructuring and other real estate) to total loans plus OREO increased to .67%, up 11 basis points from one year earlier.
Total delinquencies, defined as loans 30 days or more past due and nonaccruing, improved nicely in 1999 to finish the year at 1.32% as a percent of total loans outstanding compared to 1.40% in 1998. This ratio has remained in the 1.30% to 1.50% band for the last 21 months, well within the Company's internal guideline of 2.0%. As of year-end 1999, total delinquencies for commercial loans, installment loans, and real estate mortgages were 2.01%, 1.62%, and 0.68%, respectively. These measures compare favorably to median delinquencies of peer bank holding companies as of September 30, 1999 of 2.09%, 1.94%, and 1.40%, respectively.
As of September 30, 1999, when overall delinquencies were at 1.35%, the Company ranked better than the peer norm, being in the favorable 47th peer percentile. Factors contributing to successful underwriting, collection, and credit monitoring include selective addition of experienced lenders over the last several years, loan servicing placed at the regional level, collection departments focused on taking prompt corrective action, and a centralized loan review function which is given priority attention and has monthly Board of Director accountability.
Net charge-offs for 1999 were lower by $958,000 or 19%, finishing the year at an improved $4.2 million or .44% of average loans compared to $5.2 million and .58% last year. As a result of lower installment loan charge-offs in 1999, total gross charge-offs fell 13.3% to $5.3 million, or .56% of average loans outstanding versus .69% in 1998. This year's recoveries rose to an all-time record in dollar amount of $1,131,000, while down as a percentage of prior year gross charge-offs to 18.5% from 22.1% in 1998. As of September 30, 1999, the Bank's total net charge-off ratio was in the 87th peer percentile based on the peer norm of .21%. Significant progress in lowering net charge offs to more satisfactory levels is evidenced by a fourth quarter 1999 ratio of .38% compared to .55% one year earlier.
This year's reduction in installment loan net charge-offs of $1.2 million is indicative of more conservative underwriting practices and follow-up surveillance adopted during 1998; installment net charge-offs averaged 1.03% this year versus 1.45% last year. Commercial loan charge-offs were up by $352,000 in 1999 due to three specific commercial loans written down during the second and third quarters; the resulting net charge-off ratio rose from .16% to a still low .24% of commercial loans outstanding. The full year loan loss provision covered total actual net charge-offs by 1.24 times, this margin serving as a precaution in the event the Upstate New York economy weakens after its long sustained period of relative economic health.
Management continually evaluates loan loss reserve adequacy from a variety of perspectives, including projected overall economic conditions for the coming year, concentration of the loan portfolio by industry and loan type, and individual customer condition. The loan loss reserve was increased to $13.4 million versus $12.4 million in 1998; as a percent of total loans, the loss reserve ratio decreased to 1.33% at year-end 1999 from 1.36% at year-end 1998. The slight decrease in the ratio is consistent with the target established following assumption of $87 million in loans associated with 20 branches acquired from Key and Fleet Bank in mid 1997. The reserve ratio is presently at the peer median, being in the 50th peer percentile, and coverage of nonperforming loans as of September 30, 1999 was well above the norm in the 67th percentile; management believes the year-end coverage at 235% to be ample. It should be noted that the dollars in the reserve are more than the Bank's actual combined losses of the last three years. Another measure of comfort to management is that after conservative allocation by specific customer and loan type, almost 8% of loan loss reserve remains available for absorbing general, unforeseen loan losses.
As a percentage of average loans, the annual loan loss provision was well above the peer norm in the 87th percentile as of September 30, 1999. Despite a reduction in the loss provision ratio from .58% in 1998 to .54% this year, the Company increased coverage of the provision over net charge-offs from 1.0 times to 1.24 times. Due to lower net charge-offs in 1999 as discussed above, loan loss provision expense increased by only $13,000 in 1999. This compares to an increase of $643,000 and $1.6 million in 1998 and 1997, respectively.
Summary of Loan Loss Experience - -------------------------------
The following table summarizes loan balances at the end of each period indicated and the daily average amount of loans. Also summarized are changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off and additions to the allowance which have been charged to expenses.
(1) The additions to the allowance during 1995 through 1999 were determined using actual loan loss experience and future projected loan losses and other factors affecting the estimate of possible loan losses.
(2) This reserve addition is attributable to loans purchased from Key Bank and Fleet Bank in association with the purchases of branch offices during 1997.
The allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated.
Funding Sources - ---------------
Typical of most commercial banking institutions today is the need to rely on a variety of funding sources to support the earning asset base as well as to achieve targeted growth objectives. There are three primary sources of funding that comprise CBSI's overall funding matrix, which considers maturity, stability, and price: deposits of individuals, partnerships and corporations (IPC deposits); collateralized municipal deposits; and capital market borrowings.
The Company's funding matrix continues to benefit from a high level of IPC deposits, which reached an all-time record for a fourth quarter average of $1.212 billion, an increase of $18 million or 1.5% from the comparable 1998 period. IPC deposits are frequently considered to be a bank's most attractive source of funding because they are generally stable, do not need to be collateralized, have a relatively low cost, and because they represent a working customer base with the potential to be cross-sold a variety of loan, deposit and other financial service-related products.
The mix of CBSI's IPC deposits has changed over the last five years as measured by the trend of fourth quarter average balances. The time deposit share grew steadily, from 38% of deposits in 1994 to 49% in 1997, reflecting consumer movement away from immediately available, lower earning savings and money market accounts; in addition, there is a relatively high mix of time deposits in the branches that have been acquired over the last few years. After a slight reduction in time deposit mix in 1998 to 46%, 1999's mix increased slightly to 47% as a result of a $13 million or 2.4% increase in average fourth quarter outstandings. Excluding time accounts, fourth quarter IPC deposits were up by $5 million or .8% in 1999; a $15 million or 7.6% increase in demand deposits more than offset slight reductions in other IPC categories.
Deposits of local municipalities decreased $40 million or 21% during the past year, with balances for fourth quarter 1999 averaging $149 million versus $189 million for the same 1998 quarter. Under New York State Municipal Law, the Company is required to collateralize all local government deposits with marketable securities from its investment portfolio. Because of this stipulation, management considers this source of funding to be equivalent to capital market borrowings. As such, CBSI endeavors to price these deposits at or below alternative capital market borrowing rates. Consequently, levels of municipal deposits fluctuate throughout the year depending on how competitive pricing compares to the aforementioned borrowing rates. It should be noted that utilization of municipal deposits has generally been decreasing since 1994 as a percent of total funding sources.
Capital market borrowings are defined as funding sources available on a national market basis, generally requiring some form of collateralization. Borrowing sources for the Company include the Federal Home Loan Bank of New York, Federal Reserve Bank of New York, as well as access to the national repurchase agreement market through established relationships with primary market security dealers. Also considered as borrowings are the $30 million in 9.75% Company-Obligated Mandatorily Redeemable Preferred Securities issued to support 1997's acquisitions and a $4 million advance on a $10 million M&T Bank line of credit tied to the 90 day LIBOR rate (issued in late December 1999). Capital market borrowings averaged $298 million or 18% of total funding sources for fourth quarter 1999 compared to $132 million or 9% of total funding sources for the same period in 1998. As of December 31, 1999, more than 78% or $250 million of capital market borrowings (excluding the aforementioned line of credit and Trust Preferred securities) had original terms of one year or less. The short-term borrowings at year-end reflected the need for the Company to remain in a highly liquid position in preparation for potential Year 2000 (Y2K) cash outflows.
The average daily amount of deposits and the average rate paid on each of the following deposit categories is summarized below for the years indicated.
------------------------------------- At December 31, -------------------------------------
(000's omitted) 1999 1998
Less than three months 53,798 $42,770 Three months to six months 28,644 24,451 Six months to one year 18,338 15,508 Over one years 11,618 8,961 ------ ----- Total $112,398 $91,690 ======== =======
The following table summarizes the outstanding balance of short-term borrowings of the Company for the years indicated.
At December 31, ------------------------------------ (000's omitted) 1999 1998 1997 ------------------------------------ Federal funds purchased $0 $34,700 $45,000 Term borrowings at banks (original term) 90 days or less 129,000 30,000 20,000 Over 90 days 125,000 0 0 ----------- ----------- ----------- Balance at end of period $254,000 $64,700 $65,000 =========== =========== =========== Daily average during the year $119,830 $13,915 $45,008 Maximum month-end balance $254,000 $64,700 $128,000 Weighted average rate during the year 5.24% 5.42% 5.74% Year-end average rate 5.60% 5.46% 6.63%
Investments - -----------
The stated objective of CBSI's investment portfolio is to prudently provide a degree of low-risk, quality assets to the balance sheet. This must be accomplished within the constraints of: (a) absorbing funds when loan demand is low and infusing funds when demand is high; (b) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (c) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (d) considering investment risk-weights as determined by regulatory risk-based capital guidelines; and (e) generating a favorable return without undue compromise of other requirements.
Since 1997, the Company has utilized total return as its primary methodology for managing investment portfolio assets. Under this analytical method, the Company seeks to maximize shareholder value through both interest income and market value appreciation.
Based on balance sheet simulation work completed throughout 1999, the Bank's net interest margin exposure continued to point towards risk to falling interest rates. Much of this exposure could be explained by examining the strong growth in floating rate commercial loan assets and management's ability to the hold core IPC deposit rates low in the face of rising interest rates. While such strategies benefit the Bank's net interest margin nicely in a rising interest rate environment, they do begin to expose the Bank to some risk should rates begin to fall over the next few years.
The reversal of falling interest rates in mid 1999 provided the Bank with a strategic opportunity to not only increase net interest income but also address its falling interest rate risk concerns. This was accomplished by extending the maturity and call protection of new investment purchases made throughout the year. Such purchases were evenly balanced between long-term AAA rated municipal bonds and callable agency bonds with a minimum of four years of call protection. For the year, new purchases totaled $244 million with a weighted average life to first call date of 8.20 years and a weighted average life to maturity of 10.65 years. This compares to purchases of $219 million in 1998 with a weighted average life to first call date of 8.03 years and a weighted average life to maturity of 9.79 years.
The increase in interest rates also significantly reduced the prepayment exposure found in the Bank's premium collateralized mortgage obligation (CMO) portfolio. Premium CMOs, for purposes of this discussion, are defined as those securities with an original purchase price of $102.5 or higher. Under general accounting standards, any premium paid for mortgage-related bonds is required to be amortized to par using a constant yield methodology. As mortgage prepayments decreased throughout the second half of the year, the monthly premium amortization associated with these bonds also decreased, thus boosting the overall investment portfolio yield in 1999.
The average portfolio yield, excluding money market investments, rose to 6.64% in 1999 from 6.53% in the prior year. In the fourth quarter of 1999, the portfolio yield averaged 7.02% versus 5.86% for the same time period in 1998. The fourth quarter 1998 figure reflects the height of the premium CMO prepayments which the Bank experienced during that year.
In the third and fourth quarters of 1999, the Bank embarked upon a municipal tax loss strategy whereby low coupon municipal notes were swapped for higher yielding long-term municipal bonds. This strategy resulted in net investment losses for the year of $638,000 on sales of $14.6 million. In 1998, gains of $2.29 million (including $328,000 pretax realized upon adoption of FAS 133, reported as an after-tax change in accounting) were recognized on a combined $86 million in investment sales. Sales for the prior year were part of a deleverage strategy that helped provide the Bank with an opportunity to repurchase 326,600 shares of common stock in the late summer and early fall of that year.
The composition of the portfolio continues to heavily favor U.S. Agency Debentures, U.S. Agency mortgage-backed pass-throughs, U.S. Agency CMOs, and AAA rated and insured municipal bonds. As of year-end 1999, these four security types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock) accounted for a combined 94% of total portfolio investments (28%, 8%, 38% and 20%, respectively), down slightly from 98% in the prior year.
As stated previously, the Bank's interest rate simulation work pointed towards the need to increase call protection within the overall balance sheet structure of the organization. This was most readily accomplished by extending the average life of the portfolio through purchases made throughout the year as discussed above. Aiding in this task, though to a much lesser extent, was the slowdown experienced from prepayments within the fixed rate portion of the CMO portfolio. As a result, the average life of the portfolio stood at 8.51 years as of year-end 1999, up from 2.68 years as of the prior year-end.
Investment Securities - ---------------------
The following table sets forth the amortized cost and market value for the Company's held-to-maturity investment securities portfolio:
The following table sets forth the amortized cost and market value for the Company's available-for-sale investment portfolio and grand total carrying value for both portfolios.
The following table sets forth as of December 31, 1999, the maturities of investment securities and the weighted-average yields of such securities, which have been calculated on the basis cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:
(1) Weighted average yields on the tax-exempt obligations have been computed on a fully tax equivalent basis assuming a marginal federal tax rate of 35%. These yields are an arithmetic computation of accrued income divided by average balance; they may differ from the yield to maturity, which considers the time value of money.
Interest Rate Risk - ------------------
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company's primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk, 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, which reviews and approves them annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Committee (ALCO). In this capacity, ALCO develops guidelines and strategies impacting the Company's asset/liability management related activities based upon estimated market risk sensitivity, policy limits, and overall market interest-related level and trends.
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. The primary tool used by the Company in managing interest rate risk is income simulation. The analysis begins by measuring the impact of differences in maturity and repricing of all balance sheet positions. Such work is further augmented by adjusting for prepayment and embedded option risk found naturally in certain asset and liability classes. Finally, balance sheet growth and funding expectations are added to the analysis in order to reflect the strategic initiatives set forth by the Company.
Changes in net interest income are reviewed after subjecting the balance sheet to an array of Treasury yield curve possibilities, including an up or down 200 basis point movement (BP) in rates from current levels. While such an aggressive movement in rates provides management with good insight as to how the Company's profit margins may perform under extreme market conditions, results from a more modest 100 BP shift in interest rates are used as a basis to conduct day-to-day business decisions.
Historically with increases in the yield curve, income simulations have shown that the Bank's net interest income tended to be higher than in flat rate environments. This was caused by the Bank's structural asset sensitivity (which by definition indicates that earning assets would mature or reprice sooner than a corresponding liability) and because loan and investment rates tended to closely track prime or movement in various Treasurys while funding costs (largely deposits) generally moved upward at a much slower pace.
Conversely, the same factors that widened simulated margins in a rising rate environment created risk in a falling rate environment.
The mid-1999 reversal of falling interest rates provided the Bank with a strategic opportunity to not only increase net interest income but also address its falling interest rate risk concerns. This was accomplished by extending the maturity and call protection of new investment purchases made throughout the year (as further explained in the "Investments" section of this document) and by making the strategic decision to keep the bulk of the Bank's borrowing position short (terms of 180 days or less as opposed to longer term borrowings).
As a result, if there were no growth in the balance sheet, simulation results now show the Bank to be better off as rates fall. The following reflects the Company's one-year net interest income sensitivity based on asset and liability levels on December 31, 1999, assuming no growth in the balance sheet, and assuming 200 BP movements over a twelve month period in the prime rate, federal funds rate and the entire Treasury yield curve:
REGULATORY MODEL ------------------------------------------------------------------------ Rate Change Dollar Change Percent of Flat Rate In Basis Points (in 000s) Net Interest Income --------------- --------- -------------------
+ 200 bp $(1,663) (2.3%) - 200 bp $ 436 .1%
A second simulation was performed based on what the Company believes to be conservative levels of balance sheet growth (8% for loans, 2% for deposits and necessary increases in borrowings, with no growth in investment or any other major portions of the balance sheet), along with 100 BP movements over a twelve month period in the prime rate and federal funds rate, and a yield curve moving closer to historical spreads to fed funds. Under this set of assumptions, the Bank is able to better take advantage of rising rates as earning assets mature or reprice and are replaced at higher yields (with the opposite occurring as rates fall). Thus, given the second set of assumptions, the risk of rate changes of the magnitude tested appears to be somewhat negated.
The following reflects the Company's one-year net interest income sensitivity analysis based on asset and liability levels on December 31, 1999 assuming the aforementioned balance sheet growth and yield curve changes:
MANAGEMENT MODEL ------------------------------------------------------------------------ Rate Change Dollar Change Percent of Flat Rate In Basis Points (in 000s) Net Interest Income --------------- ------------- -------------------
+ 100 bp $ 13 .02% - 100 bp $ (365) (.49%)
The preceding interest rate risk analyses do not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cashflows, and others. While the assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. Furthermore, the sensitivity analyses do not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.
Liquidity - ---------
Due to the potential for unexpected fluctuations in deposits and loans, active management of the Company's liquidity is critical. In order to respond to these circumstances, adequate sources of both on- and off-balance sheet funding are in place.
CBSI's primary approach to measuring liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short-term liabilities which are vulnerable to nonreplacement; and second, a projection of subsequent cash availability over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90-day time horizons. As of year-end 1999, this ratio was 17.3% and 20.6%, respectively, excluding the Company's capacity to borrow additional funds from the Federal Home Loan Bank.
Effects of Inflation - --------------------
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.
Virtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rate changes have a more significant impact on the Company's performance than general levels of inflation.
Forward-Looking Statements - --------------------------
This document contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company's plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company's control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) risks related to credit quality, interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (3) the effect of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (4) inflation, interest rate, market and monetary fluctuations; (5) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (6) changes in consumer spending, borrowing and savings habits; (7) technological changes; (8) any acquisitions or mergers that might be considered by the Company and the costs and factors associated therewith; (9) the ability to maintain and increase market share and control expenses; (10) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and accounting principles generally accepted in the United States; (11) changes in the Company's organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (12) the costs and effects of litigation and of any adverse outcome in such litigation; and (13) the success of the Company at managing the risks of the foregoing.
The foregoing list of important factors is not exclusive. Such forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.
Year 2000 - ---------
The Year 2000 issue is the result of computer programs being written using two digits rather the four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities.
Based on its assessment, the Company determined that the majority of its processing systems are outsourced to industry standard vendors. The Company, through its Year 2000 Committee, has identified critical vendors and processes and have put in place monitoring and measuring techniques to assure its critical vendors are complying with the Federal Financial Institutions Examining Council guidelines for Year 2000 compliance. In brief, the Company's loan, deposit and general ledger systems are outsourced to Fiserv, Inc.; the investment accounting is outsourced to First Tennessee Bank; ATM processing is outsourced to U. S. Bank Network Services; and the trust account system employs Sungard software. The Company is subject to quarterly reviews by the Office of the Comptroller of the Currency (OCC), including Year 2000 compliance.
The Company completed formal communications with all of its significant suppliers and large customers to determine the status of Year 2000 compliance and if appropriate contingency plans and business resumption plans were in place in the unlikely event the vendor or customer should experience a Year 2000 compliant failure.
The Company has utilized both internal and external resources to reprogram or replace, test and validate the software for Year 2000 modifications. The Company has spent $686,888 for overall Year 2000 upgrades and equipment along with an additional estimated labor cost of $400,000. The expenditures included but were not limited to: upgrades to Item Processing software and hardware, PC software and hardware, NCR ATM's, third party reviews of outsourcing vendors, proxy testing, the cost of service vendor mailings, follow-up testing, customer awareness efforts and commercial customer risk assessments.
The Company completed all renovations on critical systems prior to the roll-over to Year 2000, including modifications to existing software and conversions to new software. As a result, the Year 2000 issue had no impact on the Company's operation. As a further precaution, cash reserves in the branches were maintained well above normal year end levels, but there was no activity that was out of the ordinary. Large cash reserves were then shipped out of the branches during the week of January 3rd, and cash levels are now back to normal operating levels.
As a result of a supportive Senior Management Team, an energetic Y2K Committee and a cooperative staff company-wide, CBSI's Y2K transition was smooth and uneventful. Roll-over weekend went very well with only a couple of minor issues, which were resolved on January 1 or January 3rd. All subsidiaries, departments and branches of the Company participated in Event Weekend testing, and all was in order for reopening on January 3rd.
As of the date of this filing, the Company has not incurred any significant business interruption as a result of the Year 2000 issue. The Company will continue to monitor the issue throughout 2000 and expeditiously remediate any issues that may arise. Based on the Company's readiness efforts, the Company does not reasonably foresee any material Year 2000 issues, and therefore, costs associated with any potential issues are not expected to have a material adverse effect on either the financial condition or operating capacity of the Company.
New Accounting Pronouncements - -----------------------------
In 1998, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon adoption of the SFAS the Company transferred investment securities from held-to-maturity to available-for-sale (see Note C). As a result, securities previously classified as held-to-maturity were sold during the year and investment securities gains of approximately $194,000, net of tax, resulting from the sale have been reported as a cumulative effect of change in accounting principle. The Company has no outstanding derivative financial instruments and, accordingly, adoption of SFAS 133 had no other effect on the Company's financial statements.
In October 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This statement requires that after the securitization of a mortgage loan held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. SFAS No. 134 is effective for the first fiscal quarter beginning after December 15, 1998 and accordingly, would apply to the Company for the quarter ending March 31, 1999. The Company has not engaged in the securitization of its mortgage loans held for sale and does not expect to do so in the foreseeable future. Therefore, this pronouncement is not expected to have a material impact on the financial statements of the Company.
The following consolidated financial statements and auditor's reports of Community Bank System, Inc. and subsidiaries are contained on pages 42 through 63 of this item.
Item 8.
Item 8. Financial Statements and Supplementary Data - --------------------------------------------------- - - Consolidated Statements of Condition- December 31, 1999 and 1998
- - Consolidated Statements of Income - Years ended December 31, 1999, 1998, and 1997
- - Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 1999, 1998, and 1997
- - Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998, and 1997
- - Notes to Consolidated Financial Statements - December 31, 1999
- - Auditor's Report Quarterly Selected Data (Unaudited) for 1999 and 1998 are contained on page 62.
44 B
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Community Bank System, Inc. (the Company) is a one bank holding company which wholly-owns three subsidiaries, Community Bank, N.A. (the Bank), Community Capital Trust I, a subsidiary business trust, and Benefit Plans Administrative Services, Inc. (BPA). BPA, located in Utica, New York, provides pension administration and consulting services to sponsors of defined benefit and defined contribution plans throughout New York State. The Bank operates 67 customer facilities throughout Northern New York, the Finger Lakes Region, the Southern Tier, and Southwestern New York and owns two banking related subsidiaries, Community Financial Services, Inc. (CFSI), and Community Investment Services, Inc. (CISI). CFSI offers insurance investment products and CISI provides broker/dealer and investment advisory services. In addition, the Bank owns two nonbanking subsidiaries, CBNA Treasury Management Corporation (TMC) and CBNA Preferred Funding Corporation (PFC). TMC operates the cash management, investment, and treasury functions of the Bank, and PFC invests in residential real estate loans as a real estate investment trust. In early 1997, Community Capital Trust I was formed for the purpose of issuing mandatorily redeemable convertible securities, which are considered Tier I capital under regulatory capital adequacy requirements (see Note Q).
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.
The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.
Investment Securities
The Company has classified its investments in debt and equity securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Company has the positive intent and ability to hold to maturity, and are reported at cost, which is adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held to maturity are classified as available-for-sale and are reported at fair market value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes. None of the Company's investment securities have been classified as trading securities. Equity securities are stated at cost and include stock of the Federal Reserve Bank of New York and Federal Home Loan Bank of New York.
The average cost method is used in determining the realized gains and losses on sales of investment securities, which are reported under other income as investment security gains (losses). Premiums and discounts on securities are amortized and accreted, respectively, on a systematic basis over the period to maturity, estimated life, or earliest call date of the related security.
Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Loans
Loans are stated at unpaid principal balances. Fair values for variable rate loans that reprice frequently, with no significant credit risk, are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flows and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Mortgage loans held for sale are carried at the lower of cost or market and are included in loans as the balance of such loans was not significant. The carrying amount of accrued interest approximates its fair value.
Interest on Loans and Reserve for Possible Loan Losses
Interest on commercial loans and mortgages is accrued and credited to operations based upon the principal amount outstanding. Unearned discount on installment loans is recognized as income over the term of the loan, principally by the actuarial method. Non-refundable loan fees and related direct costs are deferred and amortized over the life of the loan as an adjustment to loan yield using the effective interest method.
The Bank places a loan on nonaccrual status and recognizes income on a cash basis when it is more than ninety days past due (or sooner, if management concludes collection of interest is doubtful), except when, in the opinion of management, it is well-collateralized and in the process of collection.
The reserve for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The reserve is increased by provisions charged to expense and reduced by net charge-offs. The level of the reserve is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions. A loan is considered impaired, based current information and events, if it is probable that the Bank will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. The annual provision for depreciation is computed using the straight-line method in amounts sufficient to recognize the cost of depreciable assets over their estimated useful lives. Maintenance and repairs are charged to expense as incurred.
Other Real Estate
Properties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at the lower of the unpaid loan balance plus settlement costs, or fair value less estimated costs of disposal. At December 31, 1999 and 1998, other real estate, included in other assets, amounted to $883,919 and $1,181,926, respectively.
Intangible Assets
Intangible assets represent core deposit value and goodwill arising from acquisitions. The Company periodically reviews the carrying value of intangible assets using fair value methodologies.
Core deposit intangibles are being amortized principally on an accelerated basis over ten years. Goodwill is being amortized on a straight-line basis over 15 to 25 years.
Mortgage Servicing Rights
Originated mortgage servicing rights are recorded at their fair value at the time of transfer and are amortized in proportion to and over the period of estimated net servicing income or loss. The Bank uses a valuation model that calculates the present value of future cash flows to determine the fair value of servicing rights. In using this valuation method, the Bank incorporated assumptions that market participants would use in estimating future net servicing income, which included estimates of the cost of servicing per loan, the discount rate, and prepayment speeds. The carrying value of the originated mortgage servicing rights is periodically evaluated for impairment using these same market assumptions. At December 31, 1999 and 1998, mortgage servicing rights, included in other assets, amounted to approximately $577,457 and $406,000, respectively.
Deposits
The fair values disclosed for demand and savings deposits are equal to the carrying amounts at the reporting date. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using discounted cash flows and interest rates currently being offered on similar certificates. The carrying value of accrued interest approximates fair value.
Borrowings
The carrying amounts of federal funds purchased and borrowings approximate their fair values.
Income Taxes
Provisions for income taxes are based on taxes currently payable or refundable, and deferred taxes which are based on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.
Earnings Per Share and Stock Split
Basic earnings per share is computed on the basis of actual weighted average common shares outstanding for the period. Diluted earnings per share reflects the dilutive effect of outstanding common stock equivalents.
On March 12, 1997, a two-for-one split of the Company's common stock was effected in the form of a stock dividend of one share of common stock for each share of common stock outstanding at the close of business on February 10, 1997. The number of authorized shares of common stock was increased from 5,000,000 to 20,000,000 pursuant to shareholder approval. All share and per share data of prior periods has been restated, where required, to retroactively reflect the stock split.
During 1997, the par value of the Company's common stock was changed from $1.25 par to no par $1.00 stated value per share.
Treasury Stock
Treasury stock purchases are recorded at cost. During 1999 and 1998, the Company purchased 221,500 and 326,600 shares of treasury stock at an average cost of $25.13 and $28.02, respectively. This stock repurchase program reflects the Company's belief that its common stock is an investment and that the financial markets are not fully valuing its strong banking franchise.
Fair Values of Financial Instruments
The Company determines fair values based on quoted market values where available or on estimates using present values or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments," excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The fair values of investment securities, loans and deposits have been disclosed in footnotes C, D, and G, respectively.
In 1998, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon adoption of the SFAS the Company transferred investment securities from held-to-maturity to available-for-sale (see Note C). As a result, securities previously classified as held-to-maturity were sold during the year and investment securities gains of approximately $194,000, net of tax, resulting from the sale have been reported as a cumulative effect of a change in accounting principal. The Company has no outstanding derivative financial instruments and, accordingly, adoption of SFAS 133 had no other affect on the Company's financial statements.
NOTE B: BRANCH ACQUISITIONS
During 1997, the Company acquired certain assets and assumed certain liabilities relating to eight branch offices of Key Bank, N.A. located in Southwestern New York State and 12 branch offices of Fleet Bank located in Northern and Central New York State.
A summary of these acquisitions and the divestiture activity is as follows:
Acquisitions --------------------------------- Key Bank Fleet Bank (6/16/97) (7/18/97) ---------------------------------
Cash received (paid) $110,752,957 $76,516,971
Loans acquired (divested) 24,093,903 62,706,634
Property and equipment acquired (divested) 1,836,405 2,438,645
Other assets and (liabilities) 34,323 (172,683) acquired (divested), net
Purchase price allocated to goodwill 13,563,861 17,569,255
--------------------------------- Deposit liabilities assumed (divested) $150,281,449 $159,058,822
===========================================================================
Goodwill arising from these transactions is being amortized over a period of 15 years on a straight-line basis.
The transactions above have been recorded under the purchase method of accounting and, accordingly, the operating results of the branches acquired have been included in the Company's consolidated financial statements from the date of acquisition. Results of operations on a proforma basis are not presented since historical financial information for the branches acquired is not available.
Proceeds from sales of investments in debt securities during 1999, 1998, and 1997 were $13,915,000, $87,189,000, and $51,916,000, respectively. Gross gains of approximately $7,000, $2,287,000, and $283,000 for 1999, 1998, and 1997, respectively, and gross losses of $914,000, $0, and $297,000 in 1999, 1998, and 1997, respectively, were realized on those sales.
Investment securities with a carrying value of $457,512,000, $324,565,708 and $320,953,967 at December 31, 1999, 1998, and 1997, respectively, were pledged to collateralze deposits and borrowings.
Pursuant to the adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives Instruments and Hedging Activities," in 1998, the Company transferred investment securities having an amortized cost of $216,797,000 and net unrealized gains of $6,952,000 from held-to-maturity to available-for-sale. The Company subsequently sold a portion of those investments with an amortized cost of $17,424,400, within the same quarter. Accordingly, the realized gain of $193,860, net of tax, has been reported as a cumulative effect of a change in accounting principle.
The estimated fair value of loans receivable at December 31, 1999 and 1998 was $991,000,000 and $848,000,000, respectively.
Non-accrual loans of $4,589,000 and $2,473,000 at December 31, 1999 and 1998, respectively, are included in net loans. If non-accrual loans had been accruing interest at their originally contracted terms, interest income on these loans would have amounted to $189,346 and $174,405 in 1999 and 1998, respectively.
Loans to directors and officers or other related parties were approximately $2,330,000 and $2,336,000 at December 31, 1999 and 1998, respectively. During 1999, new loans to such parties amounted to $980,000 and repayments amounted to $986,000.
Mortgage loans serviced for others are not included in the accompanying consolidated statements of condition. The unpaid principal balances of mortgage loans serviced for others was $88,700,053 and $58,825,355 at December 31, 1999 and 1998, respectively.
Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $650,420 and $427,349 at December 31, 1999 and 1998, respectively.
Changes in the reserve for possible loan losses for the years ended December 31 are summarized as follows:
NOTE E: PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31: - ------------------------------------------------------------ 1999 1998 - ------------------------------------------------------------
Land and land improvements $ 3,074,848 3,056,589
Bank premises owned 25,076,326 22,851,189
Equipment 19,529,121 18,706,427 ------------------------ Premises and equipment,gross 47,680,295 44,614,205 Less: Allowance fo depreciation 22,171,432 19,736,423 ------------------------ Premises and equipment, net $25,508,863 24,877,782
NOTE F: INTANGIBLE ASSETS
Intangible assets consist of the following at December 31: - --------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------
Core deposit intangible $ 14,434,507 $ 14,434,507 Goodwill and other intangibles 52,760,397 52,760,397 ------------------- ------------------- Intangible assets,gross 67,194,904 67,194,904 ------------------- ------------------- Less: Accumulated amortization (17,709,955) (13,162,685) ------------------- ------------------- Intangible assets, net $ 49,484,949 $ 54,032,219 ===========================================================================
NOTE G: DEPOSITS
Deposits by type at December 31 are as follows: - --------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------
Demand $225,012,767 $249,863,649 Savings 502,765,002 506,419,177 Time 632,528,215 621,782,752 ----------- ----------- Total Deposits $1,360,305,984 $1,378,065,578
The estimated fair values of deposits at December 31, 1999 and 1998 were approximately $1,357,000 and $1,387,000, respectively.
At December 31, 1999 and 1998, time certificates of deposit in denominations of $100,000 and greater totaled $112,397,283 and $91,689,939, respectively.
The approximate maturities of time deposits at December 31 are as follows:
- --------------------------------------------------------------------------- Maturity 1999 1998 - --------------------------------------------------------------------------- One year or less $455,381,669 497,600,234
One to two years 132,756,822 76,588,398 Two to three years 25,793,504 26,443,032 Three to four years 12,287,767 11,840,172 Four to five years 5,393,330 8,395,567 Over five years 915,123 915,549 ------------ ----------- $632,528,215 $621,782,952 ===========================================================================
NOTE H: BORROWINGS
At December 31, 1999 and 1998, outstanding borrowings were as follows: - --------------------------------------------------------------------------- 1999 1998 - ---------------------------------------------------------------------------
Short-term borrowings: Federal funds purchased $34,700,000 Federal Home Loan Bank Advances $250,000,000 30,000,000 Other short-term borrowings 4,000,000 0 ------------- --------------- 254,000,000 64,700,000 Long term borrowings: Federal Home Loan Bank Advances 70,000,000 70,000,000 Company obligated mandatory redeemable preferred securities of subsidiary trust holding solely junior subordinated debentures of the Company, net of discount of$182,813 and $189,562 29,817,188 29,810,438 ------------- --------------- $353,817,188 $164,510,438 ===========================================================================
Federal Home Loan Bank advances are secured by a blanket lien on the Company's residential real estate loan portfolio and mortgage-backed securities portfolio.
Long-term borrowings at December 31, 1999 have maturity dates as follows: Weighted Average Rate Amount ------------ ------
February 13, 2000 5.86% $ 15,000,000 December 17, 2002 6.20% 10,000,000 February 10, 2003 5.52% 5,000,000 January 23, 2008 5.44% 10,000,000 January 28, 2008 5.48% 5,000,000 January 30, 2008 5.27% 20,000,000 February 4, 2008 5.45% 5,000,000 January 30, 2027 9.75% 29,817,188 ---- ----------
6.84% $ 99,817,188 ==============================================================
NOTE I: INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31 is as follows: - ------------------------------------------------------------------------------- 1999 1998 1997 - ------------------------------------------------------------------------------- Current: Federal $8,122,791 $7,889,187 $8,071,488 State 530,527 762,835 996,033 Deferred: Federal (569,274) 299,246 (174,176) State (160,862) 84,560 (49,218) -------- ------ ------- Total income taxes $7,923,182 $9,035,828 $8,844,127 ===============================================================================
Components of the net deferred tax asset, included in other assets, as of December 31 are as follows: - ----------------------------------------------------------------- 1999 1998 - ----------------------------------------------------------------- Investment securities $8,441,513 - Allowance for loan losses 4,985,174 $3,950,235 Postretirement and other reserves 975,669 758,068 Pension 444,811 309,462 Amortization of intangibles 352,237 334,550 Other 1,328,233 641,287 -------------------------- Total deferred tax asset 16,527,637 5,993,602 --------------------------
Investment securities - 3,248,258 Deferred loan fees 1,539,808 996,932 Depreciation 831,933 557,393 Mortgage servicing rights 235,883 - -------------------------- Total deferred tax liability 2,607,624 4,802,583 -------------------------- Net deferred tax asset $13,920,013 $1,191,019
The Company has determined that no valuation allowance is necessary as it is more likely than not that deferred tax assets will be realized through carryback of future deductions to taxable income in prior years, future reversals of existing temporary differences, and through future taxable income.
A reconciliation of the differences between the federal statutory income tax rate and the effective tax rate for the years ended December 31 is shown in the following table:
- -------------------------------------------------------------------------------- 1999 1998 1997 - --------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0% Increase (reduction) in taxes resulting from: Tax-exempt interest (6.3) (1.9) (1.2) State income taxes, net of federal benefit 0.6 1.9 2.4 Other 1.7 1.5 0.0 --- --- --- Effective income tax rate (inlcuding tax 31.0% 36.5% 36.2% effect of accounting change) ================================================================================
NOTE J: LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES
The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In additional to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations, and policies. For example, as a national bank, the Bank must obtain the approval of the Office of the Comptroller of the Currency (OCC) for payments of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1999, the Bank had approximately $15,887,000 in undivided profits legally available for the payments of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings.
There are also statutory limits on the transfer of funds to the Company by its banking subsidiary, whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specific amounts.
NOTE K: BENEFIT PLANS
The Company has a noncontributory defined benefit pension plan covering the majority of its employees and retirees. The Company also provides health and life insurance benefits for eligible retired employees and dependents.
The following table shows the Company's Plans' funded status reconciled with amounts reported in the Company's consolidated balance sheets, and the assumptions used in determining the actuarial present value of the benefit obligations:
- ---------------------------------------------------------------------- 1% Point 1% Point Increase Decrease - ---------------------------------------------------------------------- Effect on total of service and interest $58,088 $48,525 cost components Effect on postretirement benefit obligation $451,340 $383,466 ======================================================================
The Company also has an Employee Savings and Retirement Plan, which is administered by the Trust Department of Community Bank, N. A. The Employee Savings and Retirement Plan included Section 401(k) and Thrift provisions as defined under the Internal Revenue Code. Company contributions to the trust amounted to $440,000, $647,000, and $791,000 in 1999, 1998, and 1997, respectively.
The Company has deferred compensation agreements with its President and Chief Executive Officer and several former executives and officers whereby monthly payments are to be provided upon retirement over periods ranging from ten to 25 years. Expense recognized during 1999, 1998, and 1997 related to these arrangements amounted to approximately $367,000, $258,000, and $257,000, respectively.
The Company has a Stock Balance Plan for nonemployee directors who have completed six months of service. The Plan is a nonqualified, noncontributory defined benefit plan. The Plan provides benefits for periods of service prior to January 1, 1996 based on a predetermined formula. Amounts credited to participant accounts for all creditable service after January 1, 1996 are based on performance of the Company's stock. Participants become fully vested after six years of service. Benefits are payable in the form of stock of the Company on the first of the month following the later of a participant's disassociation from the Board or attainment of age 70. In the event of a change in control or other occurrences, as defined, participants have the right to receive a distribution of common stock equal to the number of shares credited to the participant. Unrecognized prior service cost of $549,633 is being amortized over 10 years. Expense related to the Plan recognized in 1999, 1998, and 1997 approximated $220,000, $190,000, and $203,000, respectively. The accrued pension liability was approximately $367,000 and $455,000 at December 31, 1999 and 1998, respectively. The net periodic pension cost was calculated using discount rates of 7.0% and 6.5% for 1999 and 1998, respectively.
NOTE L: STOCK-BASED COMPENSATION PLANS
The Company has long-term, stock-based incentive compensation programs for directors, officers, and key employees including incentive stock options (ISO's), restricted stock awards (RSA's), nonqualified stock options (NQSO's), warrants, retroactive stock appreciation rights, and discounted options. The Company has authorized the grant of options for up to 605,000 shares of the Company's common stock. All options granted have ten year terms and vest and become fully exercisable at the end of five years of continued employment. Activity in these plans for 1999, 1998, and 1997 was as follows:
The Company granted 8,000 discounted options in 1996 and recognized compensation expense of approximately $13,000. Restricted stock awarded in 1998 and 1997 amounted to 100 and 5,700 shares, respectively. Total expense is based on the market value of the stock at the date of grant and is being accrued over the period the restrictions lapse. Expense in 1999, 1998, and 1997 was $24,015, $81,241, and $145,753, respectively. There were 370,995, 500,289 and 356,600 shares available for future grants or awards under the various programs described above at December 31, 1999, 1998, and 1997, respectively. Directors may elect to defer all or a portion of their director fees until a certain distribution date pursuant to a Deferred Compensation Plan. The administrator has established an account for each participating director and credits to such account the number of shares of Company common stock which would have been purchased with the director fees and shares equal to the amount of dividends which would have been received. On the distribution date, the director shall be entitled to receive either shares of the Company common stock equal to the number of shares accumulated or at the Company's election, cash equal to the fair value of the number of shares accumulated. There were 4,960 and 2,636 shares credited to participant accounts at December 31, 1999 and 1998, respectively, for which a liability of approximately $638,000 and $492,000 was accrued and approximately $146,000 and $122,045 was recognized as expense.
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," provides for a fair-value-based method of accounting for stock compensation plans with employees and others. Alternatively, the statement allows that entities may continue to account for stock-based compensation plans in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," with disclosure of pro forma amounts reflecting the difference between cost charged to operations pursuant to APB No. 25 and compensation cost that would have been charged to operations had SFAS No. 123 been applied. The Company has elected to continue following APB No. 25 in accounting for its stock-based compensation plans. Application of the fair-value based accounting provision of SFAS No. 123 results in the following pro forma amounts of net income and earnings per share:
- ----------------------------------------------------------------------- 1999 1998 - ----------------------------------------------------------------------- Net income: As reported $17,635,469 $15,728,222 Pro forma 17,084,216 14,005,208 Earnings per share: As reported $2.42 $2.08 Pro forma basic earnings per share 2.34 1.83
=======================================================================
The fair value of these options was estimated at the date of grant using a Black-Scholes options pricing model with the following weighted average assumptions for 1999, 1998 and 1997: risk-free interest rates by grant ranging from 4.65% to 5.78% during 1999, 5.55% to 5.67% during 1998, and 5.48% to 7.83% during 1997; dividend yields of 3.00% during 1999, 1998 and 1997; volatility factors of the expected market price of the Company's common stock of 30.78% for 1999, 44.06% for 1998 and 45.93% for 1997; and a weighted-average expected life of the option of 6.70 years in 1999, 8.27 for 1998, and 7.18 for 1997.
For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Therefore, the preceding results are not likely to be representative of the effects on reported net income for future years due to additional years of vesting. At December 31, 1999 the weighted average information for outstanding and exercisable shares is as follows:
NOTE M: EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average shares outstanding. Diluted earnings per share is computed based on the weighted average shares outstanding adjusted for the dilutive effect of the assumed exercise of stock options during the year. The following is a reconciliation of basic to diluted earnings per share for the years ended December 31: - -------------------------------------------------------------------------------- Income Shares Per Share Amount - -------------------------------------------------------------------------------- 1999 Net Income $17,635,649
Basic EPS 17,635,649 7,188,626 $2.45
Effect of dilutive securities: Stock options 0 106,625 - -------
Diluted EPS $17,635,649 7,295,251 $2.42 ================================================================================
1998 Net Income $15,728,223
Basic EPS 15,728,223 7,544,938 $2.08
Effect of dilutive securities: Stock options 0 125,773 - -------
Diluted EPS $15,728,223 7,670,711 $2.05 ================================================================================
1997 Net Income $15,561,506 Less: Preferred stock dividends (78,750) -------
Basic EPS 15,482,756 7,537,043 $2.05
Effect of dilutive securities: Stock options 0 139,283 - -------
Diluted EPS $15,482,756 7,676,326 $2.02 ================================================================================
NOTE N: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement the Company has in this particular class of financial instrument. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
- -------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk at December 31: 17,498,107 3,745,000 Letters of credit Commitments to make or purchase loans or to extend credit on lines of credit 201,401,741 176,857,000 ---------------- ------------- Total $218,899,848 $180,602,000
================================================================================ The fair value of these financial instruments is not significant.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include residential real estate, income-producing commercial properties, and personal property. The Company has unused lines of credit totaling $6,000,000 and $73,859,534 at December 31, 1999 and 1998, respectively. The Company has additional unused borrowing capacity through collateralized transactions with the Federal Home Loan Bank.
The Company is required to maintain a reserve balance, as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 1999 was $21,211,000, of which $2,000,000 was required to be on deposit with the Federal Reserve Bank of New York. The remaining $19,211,000 was represented by cash on hand.
NOTE O: LEASES
The Company leases buildings and office space under agreements that expire in various years. Rental expense included in operating expenses amounted to $991,103, $1,132,000 and $913,306 in 1999, 1998 and 1997, respectively. The future minimum rental commitments as of December 31, 1999 for all noncancelleable operating leases are as follows:
Years ending December 31: ===================================================
2000 $757,278 2001 666,896 2002 510,357 2003 502,370 2004 362,857 Thereafter 1,835,457 ===================================================
NOTE P: REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1998 and 1997, that the Bank meets all capital adequacy requirements to which it is subject and is "well capitalized" under the regulatory framework of prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table.
NOTE Q: PARENT COMPANY STATEMENTS
- ------------------------------------------------------------------------------ CONDENSED BALANCE SHEETS - ------------------------------------------------------------------------------ December 31 December 31 1999 1998 - ------------------------------------------------------------------------------
Assets: Cash and cash equivalents 519,259 1,952,603 Investment securities 820,211 641,846 Investment in and advances to subsidiaries 145,116,096 158,467,480 Other assets 129,489 278,795 ------------ -------------- Total assets 146,585,055 161,340,724 ==============================================================================
Liabilities: Due to subsidiary - 7,360,338 Accrued interest and other liabilities 3,352,414 3,076,480 Borrowings 34,745,188 30,738,438 Shareholders' equity 108,487,453 120,165,468 ------------ ------------- Total liabilities and shareholders' equity 146,585,055 161,340,724 ==============================================================================
On February 3, 1997, the Company formed a subsidiary business trust, Community Capital Trust I (Trust), for the purpose of issuing preferred securities which qualify as Tier I capital (see Note P). Concurrent with its formation, the Trust issued $30,000,000 of 9.75% preferred securities in an exempt offering. The preferred securities are non-voting, mandatorily redeemable in 2027, and guaranteed by the Company. The entire net proceeds to the Trust from the offering were invested in junior subordinated obligations of the Company. The costs related to the issuance of these securities are capitalized and amortized over the life of the period to redemption on a straight-line basis. Net proceeds were used to repurchase the 45,000 shares of preferred stock outstanding from a 1995 offering and for other corporate purposes. The preferred stock was repurchased at a value of $104 per share plus accrued dividends on the date the Trust was formed.
NOTE Q: PARENT COMPANY STATEMENTS (Continued) ================================================================================ STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- Increase (Decrease) in Cash, Cash Equivalents, and Noncash Activities Years Ended December 31 1999 1998 1997 - -------------------------------------------------------------------------------- Operating Activities: Net income 17,635,469 15,728,223 15,561,506 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries 738,378 (6,066,395) (9,639,435) Net change other assets and accrued liabilities 694,498 (237,012) 240,777 - -------------------------------------------------------------------------------- Net Cash Provided By Operating Activities 19,068,345 9,424,816 6,162,848 - -------------------------------------------------------------------------------- Investing Activities: Purchase of available for sale investment securities (178,365) (114,617) (27,229) Sale of available for sale investment securities Capital contributions to subsidiaries (4,793,001) (602,264) (27,374,880) - -------------------------------------------------------------------------------- Net Cash Used By Investing Activities (4,971,366) (716,881) (27,402,109) - -------------------------------------------------------------------------------- Financing Activities: Net change in loans to subsidiaries (7,360,338) 7,360,338 (500,000) Proceeds from issuance of short term debt 4,000,000 Proceeds from issuance of junior subordinated debentures to subsidiary 30,719,236 Issuance (retirement) of common and preferred stock 187,928 474,450 (3,451,047) Repurchase of treasury stock (5,566,831) (9,151,956) Cash dividends (6,791,082) (6,311,580) (5,745,135) - -------------------------------------------------------------------------------- Net Cash Provided (Used) By Financing Activities (15,530,323) (7,628,748) 21,023,054 - -------------------------------------------------------------------------------- Change In Cash And Cash Equivalents: (1,433,344) 1,079,187 (216,207) Cash and cash equivalents at beginning of year 1,952,603 873,416 562,241 ================================================================================ CASH AND CASH EQUIVALENTS AT END OF YEAR 519,259 1,952,603 346,034 ================================================================================ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash Paid For Interest 3,022,231 3,022,485 1,497,175 ================================================================================ SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Dividends declared and unpaid 1,772,982 1,678,184 1,517,262 ================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
On February 21, 1995, the Company adopted a Stockholder Protection Rights Agreement and declared a dividend of one right for each outstanding share of common stock. The rights can only be exercised when an individual or group has acquired or attempts to acquire 15% or more of the Company's common stock, if such action the Board of Directors believes is not in the best interest of the stockholders. Each right then entitles the holder to acquire common stock having a market value equivalent to two times the stated exercise price. The rights expire in February 2005 and may be redeemed by the Company in whole at a price of $.01 per right.
PricewaterhouseCoopers LLP One Lincoln Center Syracuse NY 13202-9972 Telephone (315) 474 8541 Facsimile (315) 473 1385
Report of Independent Accountants
To the Board of Directors and Shareholders Community Bank System, Inc. DeWitt, New York
In our opinion, the accompanying consolidated statements of condition and the related consolidated statements of income, changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Community Bank System, Inc. and Subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Syracuse, New York January 30, 2000
Item 9.
Item 9. Changes in and Disagreements with Accounting and Financial Disclosure - -----------------------------------------------------------------------------
None
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------
The information concerning Directors of the Company required by this Item 10 is incorporated herein by reference to the section entitled "Nominees for Director and Directors Continuing in Office" in the Company's Proxy Statement. The Information concerning executive officers of the Company required by this Item 10 is incorporated by reference to Item 4A of this Annual Report on Form 10-K .
Item 11.
Item 11. Executive Compensation - -------------------------------
The information required by this Item 11 is incorporated herein by reference to the section entitled "Compensation of Executive Officers" in the Company's Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------
The information required by this Item 12 is incorporated herein by reference to the section entitled "Nominees for Director and Directors Continuing in Office" in the Company's Proxy Statement.
The following table sets forth information with respect to persons known to the Company to own beneficially more than 5% of the outstanding shares of the Company's common stock as of March 27, 2000.
Number of Shares Name & Address of Beneficial Owner Beneficially Owned Percent of Class - ---------------------------------- ------------------- ---------------- Perkins, Wolf, McDonnell & Company 473,600 * 6.7% 53 West Jackson Boulevard Suite 722 Chicago, Illinois 60604
* Based solely on information contained in Schedule 13G filed with the Securities and Exchange Commission on February 11, 2000, Perkins, Wolf, McDonnell & Company has indicated that it is an investment advisory firm having shared voting and dispositive power (but not sole voting or dispositive power) with respect to all shares listed.
Item 13.
Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------
The information required by this Item 13 is incorporated herein by reference to the section entitled "Transactions with Management" in the Company's Proxy Statement.
Part IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------
A. Documents Filed
1. The following consolidated financial statements of Community Bank System, Inc. and subsidiaries are included in Item 8:
- Consolidated Statements of Condition -- December 31, 1999 and 1998
- Consolidated Statements of Income -- Years ended December 31, 1999, 1998, and 1997
- Consolidated Statements of Changes in Shareholders' Equity -- Years ended December 31, 1999, 1998, and 1997
- Consolidated Statement of Cash Flows -- Years ended December 31, 1999, 1998, and 1997
- Notes to Consolidated Financial Statements -- December 31, 1999
- Auditor's report
- Quarterly selected data -- Years ended December 31, 1999 and 1998 (unaudited)
2. Schedules are omitted since the required information is either not applicable or shown elsewhere in the financial statements.
3. Listing of Exhibits
(10) Material Contracts: Employment agreement dated January 1, 1997 between Company and Mr. Belden, as amended and restated October 31, 1999. Supplemental Retirement Plan Aggreement dated April 1, 1997 between Company and Mr. Belden, as amended and restated October 31, 1999.
(21) List of the Company's Subsidiaries
(27) Financial Data Schedule
B. Reports on Form 8-K None
C. See Exhibit 14(a)(3) above.
D. See Exhibit 14(a)(2) above
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
COMMUNITY BANK SYSTEM, INC.
By: /s/ Sanford A. Belden ----------------------- Sanford A. Belden President, Chief Executive Officer and Director March 17, 2000
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 17th day of March 2000.
Name
/s/ James A. Gabriel - -------------------- James A. Gabriel, Director Chairman of the Board of Directors and Director
/s/ David G. Wallace - -------------------- David G. Wallace Treasurer
Directors:
/s/ John M. Burgess - ------------------- John M. Burgess, Director
/s/ Richard C. Cummings - ----------------------- Richard C. Cummings, Director
/s/ William M. Dempsey - ---------------------- William M. Dempsey, Director
/s/ Nicholas A. DiCerbo - ----------------------- Nicholas A. DiCerbo, Director
/s/ Lee T. Hirschey - ------------------- Lee T. Hirschey, Director
/s/ David C. Patterson - ---------------------- David C. Patterson, Director
/s/ William N. Sloan - -------------------- William N. Sloan, Director