Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission file number 0-11716
[LOGO]
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
New York Stock Exchange
(Name of Each Exchange on Which Registered)
Delaware 16-1213679
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation)
5790 Widewaters Parkway, DeWitt, New York 13214-1883
(Address of principal executive offices) (Zip Code)
(315) 445-2282
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: Common Stock,
No Par Value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during all the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment of this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on June 30, 2003 determined using the closing price per share on that
date of $38.00, as reported on the New York Stock Exchange was approximately
$316,000,000.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
14,315,773 shares of Common Stock, no par value, were outstanding on
March 10, 2004.
DOCUMENTS INCORPORATED BY REFERENCE.
List hereunder the following documents if incorporated by reference and
the Part of the Form 10-K into which the document is incorporated: (1) any
annual report to security holders; (2) any proxy or information statement; and
(3) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act
of 1933.
Portions of Definitive Proxy Statement for Annual Meeting of Shareholders
to be held on May 19, 2004 (the "Proxy Statement") is incorporated by reference
in Part III of this Annual Report on Form 10-K.
Exhibit Index is located on page 71 of 74
TABLE OF CONTENTS
PART I Page
----
Item 1. Business ................................................................................ 3
Item 2. Properties .............................................................................. 7
Item 3. Legal Proceedings ....................................................................... 7
Item 4. Submission of Matters to a Vote of Security Holders ..................................... 7
Item 4a. Executive Officers of the Registrant .................................................... 8
PART II
Item 5. Market for Registrant's Common Stock, Related Shareholders Matters and Issuer
Purchases of Equity Securities ........................................................ 10
Item 6. Selected Financial Data ................................................................. 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations ............................................................................ 12
Item 7a. Quantitative and Qualitative Disclosures about Market Risk .............................. 38
Item 8. Financial Statements and Supplementary Data:
Consolidated Statements of Condition ............................................... 40
Consolidated Statements of Income .................................................. 41
Consolidated Statements of Changes in Shareholders' Equity ......................... 42
Consolidated Statements of Comprehensive Income .................................... 43
Consolidated Statements of Cash Flows .............................................. 44
Notes to Consolidated Financial Statements ......................................... 45
Report of Independent Auditors ..................................................... 68
Two Year Selected Quarterly Data ........................................................ 69
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .... 69
Item 9a. Controls and Procedures ................................................................. 69
PART III
Item 10. Directors and Executive Officers of the Registrant ...................................... 70
Item 11. Executive Compensation .................................................................. 70
Item 12. Security Ownership of Certain Beneficial Owners and Management .......................... 70
Item 13. Certain Relationships and Related Transactions .......................................... 70
Item 14. Principal Accountant Fees and Services .................................................. 70
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........................ 71
Signatures ......................................................................................... 74
2
Part I
This Annual Report on Form 10-K contains certain forward-looking statements with
respect to the financial condition, results of operations and business of
Community Bank System, Inc. These forward-looking statements involve certain
risks and uncertainties. Factors that may cause actual results to differ
materially from those contemplated by such forward-looking statements are set
forth herein under the caption "Forward-Looking Statements."
Item 1. Business
Community Bank System, Inc. ("the 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. The Company maintains a
web-site at communitybankna.com. Annual reports on Form 10-K, quarterly reports
on Form 10-Q and current reports on Form 8-K, and amendments to those reports,
are available on the Company's web-site free of charge as soon as reasonably
practicable after such reports or amendments are electronically filed with or
furnished to the Securities and Exchange Commission. The information on the
web-site is not part of this filing.
The Company's business philosophy is to operate as a community bank with local
decision-making, principally in non-metropolitan markets, providing a broad
array of banking and financial services to retail, commercial, and municipal
customers.
Community Bank System, Inc. is a single bank holding company which wholly-owns
four subsidiaries: Community Bank, N.A. ("the Bank"), Benefit Plans
Administrative Services, Inc. ("BPA"), CFSI Closeout Corp. ("CFSICC"), and First
of Jermyn Realty Co. ("FJRC"). BPA owns two subsidiaries, Benefit Plans
Administrative LLC and Harbridge Consulting Group LLC. BPA provides
administration, consulting and actuarial services to sponsors of employee
benefit plans. CFSICC and FJRC are inactive companies. The Company also
wholly-owns three unconsolidated subsidiary business trusts formed for the
purpose of issuing mandatorily redeemable preferred securities which are
considered Tier I capital under regulatory capital adequacy guidelines.
The Bank operates 126 customer facilities throughout twenty-two counties of
Upstate New York and five counties of Northeastern Pennsylvania offering a range
of commercial and retail banking services. The Bank owns the following
subsidiaries: Community Investment Services, Inc. ("CISI"), CBNA Treasury
Management Corporation ("TMC"), CBNA Preferred Funding Corporation ("PFC"),
Elias Asset Management, Inc. ("EAM") and First Liberty Service Corp. ("FLSC").
CISI provides broker-dealer and investment advisory services. TMC operates the
cash management, investment, and treasury functions of the Bank. PFC primarily
is an investor of residential real estate loans. EAM provides asset management
services to individuals, corporate pension and profit sharing plans, and
foundations. FLSC provides banking related services to the Pennsylvania branches
of the Bank.
Acquisition History (1999-2003)
First Heritage Bank
On January 6, 2004, the Company announced an agreement to acquire First Heritage
Bank in an all-stock transaction valued at approximately $74 million.
Headquartered in Wilkes-Barre, Pa., First Heritage is a closely held $275
million-asset bank with three branches in Luzerne County. First Heritage's three
branches will operate as part of First Liberty Bank & Trust, a division of
Community Bank, N.A. The acquisition is expected to close during the second
quarter of 2004, pending both customary regulatory and First Heritage
shareholder approval.
Grange National Banc Corp.
On November 24, 2003, the Company acquired Grange National Banc Corp.
("Grange"), a $280 million-asset bank holding company based in Tunkhannock, Pa.
Grange's 12 branches operate as part of First Liberty Bank & Trust, a division
of Community Bank, N.A. The Company issued approximately 1,147,000 shares of its
common stock to certain of the former shareholders at a cost of $47.94 per
share. The remaining shareholders received $42.50 in cash or approximately $20.9
million. In addition, Grange stock options representing $5.4 million of fair
value were exchanged for options of the Company.
Peoples Bankcorp Inc.
On September 5, 2003, the Company acquired Peoples Bankcorp, Inc. ("Peoples"), a
$29-million-asset savings and loan holding company based in Ogdensburg, New
York. Peoples' single branch is being operated as a branch of the Bank's network
of branches in Northern New York. The purchase price of the transaction
approximated $4.0 million in cash.
3
Harbridge Consulting Group
On July 31, 2003, the Company acquired PricewaterhouseCoopers' Upstate New York
Global Human Resource Solutions consulting group for a purchase price of
approximately $7.1 million in cash. This practice has been renamed Harbridge
Consulting Group ("Harbridge") and is a leading provider of retirement and
employee benefits consulting services throughout Upstate New York, and is
complementary to Benefit Plans Administrative Services, Inc., the Company's
defined contribution plan administration subsidiary.
FleetBoston Financial Corporation branches
On November 16, 2001, the Company acquired 36 branches from FleetBoston
Financial Corporation with $470 million in deposits and $177 million in loans.
The branches are located in the Southwestern and Finger Lakes Regions of New
York State.
First Liberty Bank Corp.
On May 11, 2001, the Company completed its acquisition of the $648-million-asset
First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger,
each share of First Liberty stock was exchanged for .56 shares of the Company's
common stock, which amounted to approximately 3.6 million shares. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under APB Opinion 16. Accordingly, the consolidated financial
statements for the periods presented have been restated to include the combined
results of operations, financial position and cash flows of the Company and
First Liberty. Certain reclassifications were made to First Liberty's prior year
financial statements to conform to the Company's presentation.
Citizens National Bank of Malone
On January 26, 2001, the Company acquired the $111-million-asset Citizens
National Bank of Malone, a commercial bank with five branches throughout
Franklin and St. Lawrence counties in New York State. The Company issued 952,000
shares of its common stock to the former shareholders at a cost of $26.50 per
share. All of the 648,100 shares held in the Company's treasury were issued in
this transaction.
Elias Asset Management, Inc.
On April 3, 2000, the Company acquired all the stock of Elias Asset Management,
Inc. (EAM) for cash of $6.5 million. Additional consideration of $3.0 million
was recognized in 2001 based upon performance targets set forth within the stock
purchase agreement. EAM, based in Williamsville, NY, is a nationally recognized
firm that manages assets for individuals, corporate pension and profit sharing
plans, and foundations.
Services
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
of Upstate New York and Northeastern Pennsylvania. The Company believes that the
local character of business, knowledge of the customer and customer needs, and
comprehensive retail and small business products, together with responsive
decision-making at the branch and regional level, enable the Bank to compete
effectively. The Bank is a member of the Federal Reserve System and the Federal
Home Loan Bank of New York ("FHLB"), and its deposits are insured by the FDIC up
to applicable limits.
Competition
The financial services business is highly competitive. The Company competes
actively with national and state banks, thrift institutions, credit unions,
securities dealers, mortgage bankers, finance companies, insurance companies,
and other regulated and unregulated providers of financial services.
4
The table below summarizes the Bank's deposits and market share by the
twenty-seven counties of New York and Pennsylvania in which it has customer
facilities. Market share is based on deposits of all commercial banks, credit
unions, savings and loan associations, and savings banks.
Number of
----------------------------------------------
Towns Where
Deposits Company
6/30/2003 Market Has 1st or 2nd
County State (000's) (1) Share Facilities ATM's Towns Market Position
- -----------------------------------------------------------------------------------------------------------
Allegany NY $ 197,975 48.9% 10 8 9 9
Lewis NY 78,786 37.9% 4 1 3 3
Seneca NY 127,261 34.5% 4 3 4 3
Susquehanna PA 170,994 33.7% 2 1 2 2
Yates NY 79,681 29.9% 3 2 2 2
Cattaraugus NY 258,049 28.6% 10 7 7 6
Wyoming PA 99,290 27.1% 4 2 4 3
St. Lawrence NY 341,240 26.2% 15 8 11 10
Franklin NY 82,954 16.5% 5 3 4 4
Chautauqua NY 195,875 14.2% 12 10 10 6
Schuyler NY 16,393 13.1% 1 1 1 0
Jefferson NY 141,765 12.3% 5 5 4 2
Steuben NY 168,020 11.3% 10 6 8 5
Lackawanna PA 440,663 11.0% 11 14 8 4
Tioga NY 36,670 9.8% 2 2 2 1
Livingston NY 48,366 8.2% 3 3 3 2
Ontario NY 82,080 6.2% 3 4 3 1
Wayne NY 51,586 5.9% 2 1 1 0
Herkimer NY 30,006 5.3% 1 1 1 1
Oswego NY 46,094 4.6% 2 2 2 2
Cayuga NY 29,728 3.6% 2 1 2 2
Luzerne PA 95,285 1.6% 8 7 5 2
Bradford PA 13,063 1.6% 2 2 1 0
Oneida NY 59,377 1.5% 2 1 1 1
Chemung NY 16,254 1.3% 1 1 1 0
Onondaga NY 9,690 0.1% 1 1 1 0
Erie NY 24,729 0.1% 1 0 1 1
- -----------------------------------------------------------------------------------------------------------
27 Total $2,941,874 5.1% 126 97 101 72
===========================================================================================================
(1) Deposit market share data as of June 30, 2003, the most recent information
available, calculated by Sheshunoff Information Services, Inc. Includes
all branches acquired from Peoples Bankcorp Inc. and Grange National Banc
Corp. during 2003.
Employees
As of December 31, 2003 and 2002 the Company employed 1,259 and 1,120 full-time
equivalent employees, respectively. The Company offers a variety of employment
benefits and considers its relationship with its employees to be good.
5
Supervision and Regulation
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.
Federal Bank Holding Company Regulation
The Company is registered under, and is subject to, the Bank Holding Company Act
of 1956, as amended. This Act limits the type of companies that Community Bank
System, Inc. may acquire or organize and the activities in which it or they may
engage. In general, the Company and the Bank are prohibited from engaging in or
acquiring direct or indirect control of any corporation engaged in non-banking
activities unless such activities are so closely related to banking as to be a
proper incident thereto. In addition, the Company must obtain the prior approval
of the Board of Governors of the Federal Reserve System ("the FRB") to acquire
control of any bank; to acquire, with certain exceptions, more than five percent
of the outstanding voting stock of any other corporation; or, to merge or
consolidate with another bank holding company. As a result of such laws and
regulation, the Company is restricted as to the types of business activities it
may conduct and the Bank is subject to limitations on, among others, the types
of loans and the amounts of loans it may make to any one borrower. The Financial
Modernization Act of 1999 created, among other things, a new entity, the
"financial holding company". Such entities can engage in a broader range of
activities that are "financial in nature", including insurance underwriting,
securities underwriting and merchant banking. Financial holding companies can be
established relatively easily through a notice filing with the FRB, which acts
as the "umbrella regulator" for such entities. The Company may determine to
become a financial holding company in the future.
Federal Reserve System
The Company is required by the Board of Governors of the Federal Reserve System
to maintain cash reserves against its deposits. After exhausting all other
sources of funds, the Company may request to borrow from the Federal Reserve.
Bank holding companies registered with the FRB are, among other things,
restricted from making direct investments in real estate. Both the Company and
the Bank are subject to extensive supervision and regulation, which focus on,
among other things, the protection of depositors' funds.
The Federal Reserve System also regulates the national supply of bank credit in
order to influence general economic conditions. These policies have a
significant influence on overall growth and distribution of loans, investments
and deposits, and affect the interest rates charged on loans or paid for
deposits.
Fluctuations in interest rates, which may result from government fiscal policies
and the monetary policies of the Federal Reserve System, have a strong impact on
the income derived from loans and securities, and interest paid on deposits.
While the Company and the Bank strive to anticipate changes and adjust their
strategies for such changes, the level of earnings can be materially affected by
economic circumstances beyond their control.
The Bank is subject to minimum capital requirements established, respectively,
by the FRB and the FDIC. For information on these capital requirements and the
Company's and the Bank's capital ratios see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Capital" and Note P
to the Financial Statements.
Office of Comptroller of the Currency
The Bank is supervised and regularly examined by the Office of the Comptroller
of the Currency ("the OCC"). The various laws and regulations administered by
the OCC affect corporate practices such as payment of dividends, incurring debt,
and acquisition of financial institutions and other companies. It also affects
business practices, such as payment of interest on deposits, the charging of
interest on loans, types of business conducted and location of offices. There
are no regulatory orders or outstanding issues resulting from regulatory
examinations of the Bank.
Sarbanes-Oxley Act of 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") was
signed into law. The Sarbanes-Oxley Act represents a comprehensive revision of
laws affecting corporate governance, accounting obligations and corporate
reporting. The Sarbanes-Oxley Act is applicable to all companies with equity or
debt securities registered under the Securities Exchange Act of 1934. In
particular, the Sarbanes-Oxley Act establishes: (i) new requirements for audit
committees, including independence, expertise, and responsibilities; (ii)
additional responsibilities regarding financial
6
statements for the Chief Executive Officer and Chief Financial Officer of the
reporting company; (iii) new standards for auditors and regulation of audits;
(iv) increased disclosure and reporting obligations for the reporting company
and their directors and executive officers; and (v) new and increased civil and
criminal penalties for violation of the securities laws. Sections 302(a) and 906
of Sarbanes-Oxley Act, require the Company's chief executive officer and chief
financial officer to certify that the Company's Quarterly and Annual Reports do
not contain any untrue statement of a material fact or omit to state a material
fact, that the Quarterly and Annual Reports comply with the Securities and
Exchange Act of 1934 and that the information in the Report fairly presents the
financial condition and results of operations of the Company. The rules have
several requirements, including having these officers certify that: they are
responsible for establishing, maintaining and regularly evaluating the
effectiveness of the Company's internal controls; they have made certain
disclosures to the Company's auditors and the audit committee of the Board of
Directors about the Company's internal controls; and they have included
information in the Company's Quarterly and Annual Reports about their evaluation
and whether there have been significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls
subsequent to the evaluation. The Company believes it is in compliance with all
effective sections of the Sarbanes-Oxley Act.
Item 2. Properties
The Company has 131 properties, 88 are owned and 43 are located in long-term
leased premises. Of the 131 properties, 126 are considered customer facilities.
The remaining facilities include its administrative offices at 5790 Widewaters
Parkway, DeWitt, New York, its loan and deposit operation centers located in
Olean and Canton, New York, respectively, its commercial lending center located
in Corning New York, and a training center located in Ogdensburg, New York.
Real property and related banking facilities owned by the Company at December
31, 2003 had a net book value of $44.0 million and none of the properties was
subject to any material encumbrances. For the year ended December 31, 2003,
rental fees of $1.9 million were paid on facilities leased by the Company for
its operations.
Item 3. Legal Proceedings
The Company and its subsidiaries are subject in the normal course of business to
various pending and threatened legal proceedings in which claims for monetary
damages are asserted. Management, after consultation with legal counsel, does
not anticipate that the aggregate liability, if any, arising out of litigation
pending against the Company or its subsidiaries will have a material effect on
the Company's consolidated financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of the shareholders during the quarter
ended December 31, 2003. In February 2004, the Company mailed a proxy statement
to shareholders related to the approval of an amendment to the Certificate of
Incorporation of the Company to increase its total authorized shares from 20
million to 50 million. The vote on this amendment will be held at a Special
Meeting of Shareholders on March 26, 2004.
7
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 61 Officer of the Company and the Bank
Mark E. Tryniski Treasurer of the Company, and Executive
Age 43 Vice President, Chief Operating Officer
and Chief Financial Officer of the Bank
Michael A. Patton President, Financial Services
Age 58
James A. Wears President, New York Banking
Age 54
Thomas A. McCullough President, Pennsylvania Banking
Age 57
Steven R. Tokach Senior Vice President and Chief Credit
Age 57 Administrator
Brian D. Donahue Senior Vice President and Chief Credit
Age 47 Officer
W. Valen McDaniel Senior Vice President and Chief Risk
Age 57 Officer
Timothy J. Baker Senior Vice President and Senior
Age 52 Operations Officer
Sanford A. Belden (Director, President and Chief Executive Officer of the
Company and the Bank). Mr. Belden has been Director, 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.
Mark E. Tryniski (Treasurer of the Company, Executive Vice President, Chief
Operating Officer and Chief Financial Officer of the Bank). Mr. Tryniski joined
the Company in June 2003. Prior to his position with the Company, Mr. Tryniski
was a partner in the Syracuse office of PricewaterhouseCoopers LLP, with
eighteen years of experience working with SEC registrants in banking and other
industries.
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, New York 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.
Thomas A. McCullough (President, Pennsylvania Banking). Mr. McCullough joined
the Company in November 2003 and serves as President of Banking of First Liberty
Bank & Trust, a division of Community Bank, N.A. He was previously employed by
Grange National Banc Corp., having joined that organization in 1977 as Vice
President and Commercial Loan Officer. He was promoted to President and Chief
Executive Officer in 1989 and served in that capacity until the merger of Grange
with the Company in November 2003.
Steven R. Tokach (Senior Vice President and Chief Credit Administrator). Mr.
Tokach assumed the Credit Administrator position in March 2003. Prior to this,
Mr. Tokach was President of First Liberty Bank & Trust since May
8
2001, when First Liberty Bank Corp. was acquired by the Company. He was
Executive Vice President of First Liberty Bank Corp. and First Liberty Bank &
Trust from 1998-2001, and from 1993-1998, served as Vice President of Guaranty
Bank, N.A. and Executive Vice President of First Eastern Bank, both in
Pennsylvania.
Brian D. Donahue (Senior Vice President and Chief Credit Officer). Mr. Donahue
began his career with Fleet Bank (via its merger with First Trust Union Bank) in
Western New York in early 1980. While there he held various positions which
included Team Leader in the Middle Market Commercial Lending unit as well as
heading up the Small Business Bank division until his departure in 1992 to join
the Company. Mr. Donahue has a diversified background with other areas of
expertise including human resources, branch management, and retail indirect and
mortgage lending.
W. Valen McDaniel (Senior Vice President and Chief Risk Officer). Mr. McDaniel
joined the Company in 1991 as Vice President and Corporate Auditor & Risk
Manager. He assumed his current position in January 2004. Mr. McDaniel was
formerly Vice President & Corporate Auditor for 1st Nationwide Bank, Westfield,
NJ.
Timothy J. Baker (Senior Vice President and Senior Operations Officer). Mr.
Baker joined the St. Lawrence County National Bank (predecessor to Community
Bank, N.A.) in October 1971. Mr. Baker's areas of responsibility have included
head of the Credit Department and Loan Processing from 1973 to 1977; Vice
President, Commercial and Consumer lending group, and Manager of Loan
Application conversions from 1977 to 1983; Merger and Acquisition team leader
for loans from 1983 to 1985; and Chief Financial Officer of the St. Lawrence
National Bank from 1985 to 1992. He assumed his current position in 1992.
9
Part II
Item 5. Market for the Registrant's Common Stock, Related Shareholder Matters
and Issuer Purchases of Equity Securities
The Company's common stock has been trading on the New York Stock Exchange under
the symbol "CBU" since December 31, 1997. Prior to that, the common stock traded
over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning
on September 16, 1986. There were 14,165,156 shares of common stock outstanding
on December 31, 2003, held by approximately 9,413 registered shareholders of
record and shareholders whose shares are held in nominee name at brokerage firms
and other financial institutions. 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.
Closing Price
High Low --------------------- Quarterly
Year / Qtr Price Price Amount % Change Dividend
- --------------------------------------------------------------------------------
2003
4th $50.95 $43.95 $49.00 11.6% $ 0.32
3rd $46.35 $37.33 $43.91 15.6% $ 0.32
2nd $38.76 $31.02 $38.00 20.9% $ 0.29
1st $34.23 $30.87 $31.43 0.3% $ 0.29
2002
4th $33.09 $27.20 $31.35 5.8% $ 0.29
3rd $32.55 $26.50 $29.63 -8.1% $ 0.29
2nd $34.21 $29.80 $32.25 7.0% $ 0.27
1st $30.32 $25.93 $30.15 15.1% $ 0.27
The Company has historically paid regular quarterly cash dividends on its common
stock, and declared a cash dividend of $0.32 per share for the first quarter of
2004. The Board of Directors of the Company presently intends to continue the
payment of regular quarterly cash dividends on the common stock, as well as to
make payment of regularly scheduled dividends on the trust preferred stock when
due, subject to the Company's need for those funds. However, because
substantially all of the funds available for the payment of dividends by the
Company are derived from the Bank, future dividends will depend upon the
earnings of the Bank, its financial condition, its need for funds and applicable
governmental policies and regulations.
The following table provides information as of December 31, 2003 with respect to
shares of common stock that may be issued under the Company's existing equity
compensation plans:
Number of Weighted
Securites to be Average Number of
Issued upon Exercise Price Securites Remaining
Exercise of on Shares Available for
Plan category Oustanding Options Outstanding Future Issuance
- ------------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by security holder:
1994 Long Term Incentive Plan 1,216,287 $ 25.56 755,079
Equity compensation plans not approved by security holder:
Citizens Advisory Council Plan 2,000 $ 32.05 3,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total 1,218,287 $ 25.57 758,079
====================================================================================================================================
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, 2003. The historical "Income Statement Data" and historical
"Balance Sheet Data" are derived from the audited financial statements. The
"Average Balance Sheet Data", "Capital and Related Ratios", "Selected
Performance Ratios" and "Asset Quality Ratios" for all periods are unaudited.
All financial information in this table should be read in conjunction with the
information contained in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and with the Consolidated Financial
Statements and the related notes thereto included elsewhere in this Annual
Report on Form 10-K.
10
SELECTED CONSOLIDATED FINANCIAL INFORMATION
Years Ended December 31,
---------------------------------------------------------------------------
In thousands, except per share data 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------------------
Income Statement Data:
Interest income $ 191,129 $ 205,093 $ 198,492 $ 189,665 $ 166,581
Interest expense 59,301 77,243 101,837 99,232 78,581
Net interest income 131,828 127,850 96,655 90,433 88,000
Provision for loan losses 11,195 12,222 7,097 7,722 5,856
Net interest income after provision for
loan losses 120,633 115,628 89,558 82,711 82,144
Non-interest income before security gains &
debt extinguishment 37,679 30,133 26,092 23,284 18,153
(Loss) gain on investment securities &
debt extinguishment (2,698) 1,673 (113) (159) (413)
Total non-interest income 34,981 31,806 25,979 23,125 17,740
Recurring operating expenses 101,963 94,330 80,430 70,534 66,778
Acquisition and unusual expenses 498 700 8,164 400 0
Total operating expense 102,461 95,030 88,594 70,934 66,778
Income before income taxes 53,153 52,404 26,943 34,902 33,106
Provision for income taxes 12,773 13,887 7,814 10,003 9,444
Net income $ 40,380 $ 38,517 $ 19,129 $ 24,899 $ 23,662
Net income - operating (1) $ 42,332 $ 37,926 $ 24,052 $ 25,230 $ 23,906
Diluted earnings per share $ 2.99 $ 2.93 $ 1.62 $ 2.32 $ 2.18
Diluted earnings per share - operating (1) $ 3.13 $ 2.88 $ 2.03 $ 2.35 $ 2.20
Balance Sheet Data:
Cash and cash equivalents $ 103,923 $ 113,531 $ 106,554 $ 76,456 $ 126,750
Investment securities 1,329,534 1,286,583 1,150,713 930,509 817,524
Loans, net of unearned discount 2,128,509 1,806,905 1,732,870 1,515,877 1,425,773
Allowance for loan losses (29,095) (26,331) (23,901) (20,035) (18,528)
Intangible assets 196,111 134,828 142,342 55,234 54,150
Other assets 126,415 121,731 104,787 93,598 89,274
Total assets $ 3,855,397 $ 3,437,247 $ 3,213,365 $ 2,651,639 $ 2,494,943
Deposits $ 2,725,488 $ 2,505,356 $ 2,545,970 $ 1,948,557 $ 1,844,752
Borrowings 667,786 543,575 357,931 471,053 462,762
Other liabilities 57,295 63,278 41,484 30,238 21,724
Shareholders' equity 404,828 325,038 267,980 201,791 165,705
Total liabilities and shareholders' equity $ 3,855,397 $ 3,437,247 $ 3,213,365 $ 2,651,639 $ 2,494,943
Average Balance Sheet Data:
Investment securities $ 1,185,487 $ 1,266,070 $ 1,042,726 $ 900,250 $ 826,708
Loans 1,885,604 1,759,564 1,580,870 1,484,945 1,343,652
Total interest-earning assets 3,071,091 3,025,634 2,623,596 2,385,195 2,170,360
Total assets 3,471,689 3,393,164 2,888,760 2,556,638 2,356,085
Interest-bearing deposits 2,090,749 2,100,960 1,783,938 1,613,918 1,588,481
Borrowings 508,392 507,893 482,583 447,105 280,806
Total interest-earning liabilities 2,599,141 2,608,853 2,266,521 2,061,023 1,869,287
Shareholders' equity $ 342,679 $ 294,856 $ 239,368 $ 174,498 $ 174,479
Capital and Related Ratios:
Tier I leverage ratio 7.26% 7.05% 6.73% 6.67% 6.76%
Total risk-based capital to risk-adjusted assets 13.01% 13.32% 11.83% 11.70% 12.10%
Tangible equity to tangible assets 5.70% 5.76% 4.09% 5.64% 4.57%
Cash dividends declared per share $ 1.22 $ 1.12 $ 1.08 $ 1.04 $ 0.96
Dividend payout ratio 40.2% 37.7% 65.7% 40.6% 40.4%
Book value per share $ 28.58 $ 25.04 $ 20.77 $ 19.11 $ 15.55
Tangible book value per share $ 14.73 $ 14.66 $ 9.74 $ 13.88 $ 10.47
Market capitalization (in millions) $ 694 $ 407 $ 338 $ 261 $ 247
Period end common shares outstanding 14,165 12,979 12,903 10,560 10,658
Diluted weighted average shares outstanding 13,517 13,167 11,825 10,737 10,861
Selected Performance Ratios:
Return on assets 1.16% 1.14% 0.66% 0.97% 1.00%
Return on assets - operating (1) 1.22% 1.12% 0.83% 0.99% 1.01%
Return on equity 11.78% 13.06% 7.99% 14.27% 13.56%
Return on equity - operating (1) 12.35% 12.86% 10.05% 14.46% 13.70%
Net interest margin 4.69% 4.62% 3.96% 4.06% 4.32%
Non-interest income/operating income 20.7% 17.7% 20.1% 19.4% 16.2%
Efficiency ratio 53.3% 52.0% 56.7% 54.6% 55.5%
Asset Quality Ratios:
Allowance for loan loss/loans outstanding 1.37% 1.46% 1.38% 1.32% 1.30%
Non-performing loans/loans outstanding 0.62% 0.64% 0.53% 0.49% 0.51%
Allowance for loan loss/non-performing loans 220% 226% 263% 271% 253%
Net charge-offs/average loans 0.54% 0.56% 0.42% 0.42% 0.33%
Loan loss provision/net charge-offs 109.1% 124.8% 107.8% 124.2% 133.5%
Non-performing assets/loans outstanding plus OREO 0.67% 0.69% 0.61% 0.58% 0.62%
1) Operating earnings excludes the effects of certain items the Company
considers to be non-operating, including acquisition expenses, the results
of securities transactions, and debt restructuring activities. See Table 1
in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a reconciliation of GAAP-based earnings results
to operating-based earnings results.
11
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 ("MD&A") primarily reviews the financial condition and results of
operations of Community Bank System, Inc., and its subsidiaries ("CBSI" or "the
Company") for the past two years, although in some circumstances a period longer
than two years is covered in order to comply with Securities and Exchange
Commission disclosure requirements or to more fully explain long-term trends.
The following discussion and analysis should be read in conjunction with the
Selected Consolidated Financial Information on page 11and the Company's
Consolidated Financial Statements and related notes that appear on pages 40
through 67. All references in the discussion to the financial condition and
results of operations are to the consolidated position and results of the
Company and its subsidiaries taken as a whole.
All financial results reflect the 2001 acquisition of First Liberty Bank Corp.
("First Liberty") in accordance with the pooling of interests method of
accounting. Unless otherwise noted, all earnings per share ("EPS") figures
disclosed in the MD&A refer to diluted EPS; interest income, net interest income
and net interest margin are presented on a fully tax-equivalent ("FTE") basis.
The term "this year" and equivalent terms refer to results in calendar year
2003, "last year" and equivalent terms refer to calendar year 2002, and all
references to income statement results correspond to full-year activity unless
otherwise noted. Lastly, all references to "peer banks" pertain to a group of 78
bank holding companies nationwide having $3 billion to $10 billion in assets and
their associated composite financial results for the nine months ending
September 30, 2003 (the most recently available disclosure), as provided by the
Federal Reserve Board's Division of Banking Supervision and Regulation in the
Bank Holding Company Performance Report.
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. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by such forward-looking statements are set herein under the
caption "Forward-Looking Statements" on page 37.
Critical Accounting Policies
As a result of the complex and dynamic nature of the Company's business,
management must exercise judgement in selecting and applying the most
appropriate accounting policies for its various areas of operations. The policy
decision process not only ensures compliance with the latest generally accepted
accounting principles, but also reflects on management's discretion with regard
to choosing the most suitable methodology for reporting the Company's financial
performance. It is management's opinion that the accounting estimates covering
certain aspects of the business have more significance than others due to the
relative importance of those areas to overall performance, or the level of
subjectivity in the selection process. These estimates affect the reported
amounts of assets and liabilities and disclosures of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Management believes that the critical accounting estimates include:
o Allowance for loan losses - The allowance for loan losses reflects
management's best estimate of probable loan losses in the Company's loan
portfolio. Determination of the allowance for loan losses is inherently
subjective. It requires significant estimates including the amounts and
timing of expected future cash flows on impaired loans and the amount of
estimated losses on pools of homogeneous loans which is based on
historical loss experience and consideration of current economic trends,
all of which may be susceptible to significant change.
o Actuarial assumptions associated with pension, post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of
future compensation increases and expected return on plan assets. Table 8
on page 23 shows the impact of a one percentage point increase and
decrease of each of these assumptions. Specific discussion of the
assumptions used by management is discussed in Note K on pages 60 through
62.
o Provision for income taxes- The Company is subject to examinations from
various taxing authorities. Such examinations may result in challenges to
the tax return treatment applied by the Company to specific transactions.
Management believes that the assumptions and judgements used to record tax
related assets or liabilities have been appropriate. Should tax laws
change or the taxing authorities determine that management's assumptions
were inappropriate, an adjustment may be required which could have a
material effect on the Company's results of operations.
o Fair value of certain investment securities- Fair values of 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.
12
o Carrying value of goodwill and other intangible assets - The carrying
value of goodwill and other intangible assets is based upon discounted
cash flow modeling techniques that require management to make estimates
regarding the amount and timing of expected future cash flows. It also
requires them to select a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest
rates, required equity market premiums and company-specific risk
indicators.
A summary of the accounting policies used by management is disclosed in Note A
(Summary of Significant Accounting Policies) starting on page 45.
Executive Summary
The Company's business philosophy is to operate as a community bank with local
decision-making, principally in non-metropolitan markets, providing a broad
array of banking and financial services to retail, commercial, and municipal
customers.
The Company's core operating objectives are: (i) grow the branch network,
primarily through a disciplined acquisition strategy, (ii) build high-quality,
profitable loan portfolios using both organic and acquisition strategies, (iii)
increase the non-interest income component of total revenues through development
of banking-related fee income, growth in existing financial services business
units, and the acquisition of additional financial services businesses, and (iv)
utilize technology to deliver customer-responsive products and services and to
reduce operating costs.
Significant factors management reviews to evaluate achievement of the Company's
operating objectives and its operating results and financial condition include,
but are not limited to: net income and earnings per share, return on assets and
equity, net interest margins, non-interest income, operating expenses, asset
quality, loan and deposit growth, capital management, performance of individual
banking and financial services business units, liquidity and interest rate
sensitivity, enhancements to customer products and services, technology
enhancements, market share, peer comparisons, and the performance of acquisition
and integration activities.
In 2003, the Company reported record earnings as a result of strong net interest
margins and significant increases in non-interest income. On an operating basis
(see Table 1 and related narrative), return on assets increased over 2002, while
return on equity declined slightly due to strengthened capital levels. Excluding
acquisition activity, revenues generated by the financial services businesses
declined slightly in 2003, principally as a result of the effects of a
challenging retail investment environment over the past three years. Operating
expenses and the efficiency ratio increased due to acquisition activity as well
as increased benefit costs.
Asset quality improved in 2003, with reductions in delinquency, charge-off and
non-performing loan ratios over 2002. Excluding acquisition activity, the
Company experienced strong loan growth in consumer mortgage and indirect
installment lending, with declines in the commercial and direct installment
portfolios. On a geographical basis, the New York markets reported growth in all
portfolios except consumer indirect. The Pennsylvania markets reported an
increase in consumer indirect, with declines in other portfolios. Excluding
acquisition activity, total deposits declined slightly from 2002.
The Company completed three acquisitions in 2003, including: (1) Harbridge
Consulting Group, an actuarial and benefits consulting firm based in Syracuse,
NY that was acquired from PricewaterhouseCoopers in July, (2) Peoples Bankcorp
Inc., a $29 million-asset single branch bank in Ogdensburg, NY acquired in
September, and (3) Grange National Banc Corp., a $280 million-asset bank with
twelve branches in five counties of Northeastern PA, acquired in November. In
January 2004, the Company announced an agreement to acquire First Heritage Bank,
a $275 million-asset commercial bank based in Wilkes-Barre PA that is expected
to close in May 2004.
Net Income and Profitability
Net income for 2003 was $40.4 million, up $1.9 million or 4.8% from the prior
year. Earnings per share of $2.99 in 2003 were 2.0% higher than 2002's results.
The growth rate of EPS was below that of net income due to higher weighted
average diluted shares outstanding. The increase in diluted shares was primarily
driven by the 1.1 million of common shares issued in conjunction with the
acquisition of Grange National Banc Corp. ("Grange") in November 2003, an
increased level of option grants and exercises, and a higher average common
share price (refer to the "Earnings per Share" section of Note A on page 48 for
information regarding the impact of share price on diluted shares). The 2003
results were impacted by $2.7 million of net losses from debt and security
transactions, including $2.6 million of debt restructuring charges associated
with the early retirement of higher-rate, medium-term borrowings. In contrast,
2002 earning per share benefited from net security and debt transaction gains of
$1.7 million.
13
Net income and earnings per share for 2002 were $38.5 million and $2.93, up 101%
and 81%, respectively, from 2001 results. The improvement in earnings in 2002
was primarily driven by a reduced level of acquisition expenses, which fell from
$8.2 million in 2001 to $0.7 million in 2002. This was due to the fact that two
of the Company's three acquisitions in 2001 were completed in the first half of
the year (see Note B - "Acquisitions"), and consequently the vast majority of
deal-related expenses were incurred during 2001. In addition, the 2002 results
include the benefit of adopting SFAS 147, an accounting standard that eliminates
the regular amortization of goodwill related to the Company's branch
acquisitions, and SFAS 142, which eliminates the requirement to regularly
amortize goodwill related to its whole-company acquisitions. SFAS 142 and SFAS
147 were effective January 1, 2002 and increased 2002 earnings per share by
$0.06 and $0.28, respectively, versus 2001 EPS. Earnings per share for 2002 rose
by a lesser percentage than net income versus 2001 because of 11% higher
weighted average diluted shares outstanding, principally due to 1.3 million
common shares issued in November 2001 to partially fund the acquisition of 36
branches from FleetBoston Financial.
In addition to the earnings results presented above in accordance with GAAP, the
Company provides earnings results on a non-GAAP, or operating basis. The
determination of operating earnings excludes the effects of certain items the
Company considers to be non-operating, including acquisition expenses, the
results of securities transactions, and debt restructuring activities.
Performance as measured by operating earnings is considered by management to be
a useful measure for gauging the underlying performance of the Company by
eliminating the volatility caused by voluntary, transaction-based items. Diluted
operating earnings per share for 2003 were $3.13, up 8.7% from the $2.88
reported in 2002. The growth in earnings in 2003 was principally due to
increased deposit service fee income, consumer mortgage growth, a higher net
interest margin and a lower effective income tax rate. These improvements to
earnings were partially offset by higher personnel, occupancy and volume-driven
expenses and a planned reduction of investment portfolio balances. A
reconciliation of GAAP-based earnings results to operating-based earnings
results is as follows:
Table 1: Reconciliation of GAAP EPS to Operating EPS
Years Ended December 31,
-----------------------------------------------------------
(000's omitted) 2003 2002 2001 2000 1999
-----------------------------------------------------------------------------------------------
Net income $40,380 $ 38,517 $ 19,129 $24,899 $23,662
Eliminate after-tax impact of:
Net securities losses/(gains) 33 (1,575) (1,514) 94 244
Loss on debt restructuring 1,615 559 1,581 0 0
Acquisition expenses 304 425 4,856 237 0
-----------------------------------------------------------------------------------------------
Net income - operating $42,332 $ 37,926 $ 24,052 $25,230 $23,906
===============================================================================================
Excluding the aforementioned benefits from adopting SFAS 142 and 147 in 2002,
operating earnings per share of $2.54 last year were 25% higher than the
operating EPS generated in 2001. The resulting $0.51 improvement largely
reflects the full-year impact of the FleetBoston branch acquisition, an improved
net interest margin, a larger securities portfolio and a lower effective income
tax rate.
Table 2: Summary Income Statements
Years Ended December 31,
-------------------------------------
(000's omitted, except per share data) 2003 2002 2001
----------------------------------------------------------------------------------------------------
Net interest income (FTE) $ 143,918 $139,921 $ 103,985
Provision for loan losses 11,195 12,222 7,097
Non-interest income 37,679 30,133 26,092
(Loss) gain on investment securities & debt extinguishment (2,698) 1,673 (113)
Operating expenses 101,963 94,330 80,430
Acquisition and unusual expenses 498 700 8,164
----------------------------------------------------------------------------------------------------
Income before taxes (FTE) 65,243 64,475 34,273
Fully tax-equivalent adjustment 12,090 12,071 7,330
Income taxes 12,773 13,887 7,814
----------------------------------------------------------------------------------------------------
Net income $ 40,380 $ 38,517 $ 19,129
====================================================================================================
Diluted earnings per share $ 2.99 $ 2.93 $ 1.62
Diluted earnings per share-operating $ 3.13 $ 2.88 $ 2.03
The primary factors explaining 2003 performance are discussed in detail in the
remaining sections of this document and are summarized as follows:
14
o As shown in Table 2 above, net interest income increased 2.9% or $4.0
million due to a $45 million increase in average earning assets and a
seven-basis point improvement in the net interest margin. The relative
contribution of changing balances and better margins were relatively
balanced at 53% and 47%, respectively (see Table 5 on page 19). The net
interest margin benefited from the rates on deposits and borrowings
declining more than the yields earned on investments in the low interest
rate environment. Average loans grew $126 million (7.2%), primarily due to
a record year for consumer mortgage volume as well as the impact of the
acquisitions of Grange and Peoples Bankcorp Inc. ("Peoples"). Average
investments declined $81 million (6.4%) in 2003 as a result of a
de-leveraging strategy undertaken in the first half of the year. The
growth in earning assets was funded by $22 million (0.8%) more average
deposits and slightly higher average borrowings (up $499,000 or 0.1%).
o The loan loss provision decreased $1.0 million or 8.4% from the prior year
level. Net charge-offs increased by $0.5 million primarily as a result of
a larger loan portfolio, as evidenced by a two-basis point decrease in the
net charge-off ratio (net charge-offs / total average loans) to 0.54%. The
loan loss provision decreased despite the higher net charge-offs because
the overall risk profile of the loan portfolio improved, in part due to a
higher proportion of relatively low-risk consumer mortgages being added
through organic growth and acquisitions. The improved asset quality
position in 2003 was evident in standard metrics such as non-performing
loans as a percentage of total loans (down two basis points),
non-performing assets as a percentage of loans and other real estate owned
(down two basis points) and delinquent loans (30+ days through
non-accruing) as a percentage of total loans (down 12 basis points).
Additional information on trends and policy related to asset quality is
provided in the asset quality section on pages 28 through 31.
o Non-interest income (excluding net gains and losses on investment security
transactions and debt prepayment) for 2003 of $37.7 million increased by
$7.5 million (25%) from 2002's level, the tenth consecutive year of
growth. Banking services accounted for $6.5 million of the improvement, as
overdraft volume increased significantly and income related to secondary
market mortgage activity rose. Overdraft fee income benefited from the
implementation of the Overdraft Freedom(TM) program (described in
non-interest income section on pages 20 through 22) in December 2002, an
increase of the fee charged for overdrafts in mid-2002 and a larger number
of customer accounts due primarily to the two bank acquisitions. Financial
services revenue was $1.0 million higher mostly as a result of the
acquisition of PricewaterhouseCoopers' Upstate New York Global Human
Resource Solutions consulting group (renamed Harbridge Consulting Group)
at the end of July 2003 and strong growth at the Company's retirement plan
administration business, Benefits Plans Administrative Services. As
previously noted, 2003 included $2.6 million of debt prepayment charges
and $0.1 million of net losses on investment security sales versus $2.6
million of gains on the sale of securities and a $925,000 charge for the
early retirement of debt in 2002. The $4.4 million negative variance from
security and debt transactions caused total non-interest income of $35.0
million in 2003 to rise by a lesser $3.2 million amount.
o Total operating expenses rose $7.4 million or 7.8% in 2003 to $102.5
million. Excluding acquisition expenses in both years, 2003 operating
expenses rose $7.6 million or 8.1%. A majority of the increase was due to
increased personnel expenses, as merit increases, new hires, higher
pension and medical expense rates and employees added through the three
acquisitions drove these expenses higher. In addition, volume-related
expenses such as checking charges (write-off of overdraft balances and
fees) and customer processing expenses for the consumer mortgage business
rose significantly in 2003 due to record levels of activity. Net occupancy
expenses also increased because of a larger number of facilities due to
acquisitions, current and prior year renovations, higher property tax and
utility rates and a rise in various weather-related costs.
o The Company's combined effective federal and state tax rate decreased 2.5
percentage points in 2003 to 24.0%, primarily as a result of an increased
proportion of pre-tax income from tax-exempt investments and loans.
Selected Profitability and Other Measures
Return on average assets, return on average equity, dividend payout and equity
to asset ratios for the years indicated are as follows:
Table 3: Selected Ratios
2003 2002 2001
-----------------------------------------------------------------------
Return on assets 1.16% 1.14% 0.66%
Return on assets - operating 1.22% 1.12% 0.83%
Return on equity 11.78% 13.06% 7.99%
Return on equity - operating 12.35% 12.86% 10.05%
Dividend payout ratio 40.2% 37.7% 65.7%
Average equity to average assets 9.87% 8.69% 8.29%
15
As displayed in Table 3 above, the return on average assets improved in 2003 in
comparison to both 2002 and 2001. This was primarily a result of higher net
interest margins, a greater proportion of earnings generated from non-interest
income and improved operational efficiencies. Based on operating earnings, the
return on assets was up 10 basis points in 2003. Reported return on equity in
2003 was down from 2002's level. This was mainly a result of the build-up of
equity capital this year from the retention of net profits and the common shares
issued in conjunction with the acquisition of Grange National Banc Corp., and
the $4.4 million swing in net gains and losses from security and debt
transactions. Consequently, average shareholders' equity increased 16.2% this
year, well above the 4.8% increase in reported (GAAP) net income. Based on
operating earnings, the return on equity in 2003 fell by a lesser 51 basis
points. The return on equity improved in 2002 versus 2001 despite significantly
higher equity levels (stock issuance and market value appreciation in the
investment portfolio) because of much higher profits. The strengthening of the
Company's equity capital position over the past two years is reflected in the 40
and 118 basis-point increases in the average equity to average total assets
ratios in 2002 and 2003, respectively.
The dividend payout ratio for 2003 was above 2002's level based on reported net
income mostly due to the security and debt transactions previously mentioned. On
an operating basis, the dividend payout ratio for 2003 was essentially equal to
the prior year (38.4% vs. 38.2%), as operating net income grew at approximately
the same rate (11.6%) as dividends declared (11.9%). The dividend payout ratio
spiked temporarily in 2001 due to a short-term drop in earnings as the Company
worked through the integration of three major acquisitions, and the related 2.3
million increase in the number of shares outstanding that caused the dollar
amount of declared dividends to rise significantly.
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 and interest on external borrowings. Net interest
margin is the difference between the gross yield on earning assets and the cost
of interest bearing funds as a percentage of earning assets.
As disclosed in Table 4, net interest income (with non-taxable income converted
to a fully tax-equivalent basis) totaled $143.9 million in 2003, up $4.0 million
or 2.9% over the prior year. The increase was due to a favorable shift in the
mix of interest-earning assets and interest-bearing balances and improved
margins, which had positive impacts of $2.1 million and $1.9 million on net
interest income, respectively (see Table 5 on page 19).
CBSI's net interest margin increased seven basis points from 4.62% in 2002 to
4.69% this year. The 68-basis point decrease in the rate on average
interest-bearing funds and a greater proportion of funding from
non-interest-bearing deposits had a greater impact than the 56-basis point
decline in the yield on interest-earning assets. Downward re-pricing of the
Company's interest-bearing deposits, a shift in deposit mix from higher-rate
accounts to low and non-interest bearing accounts and greater utilization of
low-rate, short-term borrowings, combined with a relatively stable yield on the
investment portfolio led to the improvement in the margin. The Company's net
interest margin ranked in the very favorable 86th peer bank percentile for the
nine months ending September 30, 2003.
The net interest margin declined in each of the quarters of 2003, ending with a
4.59% margin for the fourth quarter. This trend was mostly attributable to the
level and changes in market interest rates during 2003. Falling market rates
early in the year allowed the Company to reduce rates on non-time deposit
interest-bearing accounts in the first two quarters that were not reproduced in
the second half of 2003. The overall low level of interest rates resulted in
loan yields and time deposit rates declining throughout the year. However, due
to the larger size and substantial growth of the loan portfolio in 2003 (versus
a decline in average time deposit balances), the decline in loan yields had a
greater negative impact on the margin in 2003 ($15.0 million) than the benefit
derived from time deposit rate reductions ($9.5 million). Another reason the net
interest margin declined later in the year was that the de-leveraging of the
investment portfolio in the first half of 2003 allowed the Company to avoid
adding low-yielding securities during that time period. However, investment
purchases were made in the second half of 2003 that will provide incremental net
interest income in the coming years and help protect the Company from falling
interest rates, but also contributed somewhat to the contraction of the net
interest margin later in 2003.
As shown in Table 4, total interest income decreased by $13.9 million or 6.4% in
2003. Table 5 shows that lower rates contributed a negative variance of $17.2
million, partially offset by a positive impact of $3.2 million from $45.5
million higher average earning assets and changes in the mix of funding sources.
Average loans grew a total of $126.0 million in 2003, with the vast majority
coming from organic consumer mortgage and consumer indirect loan growth. The
addition of $15.1 million of loans through the acquisition of Peoples in early
September 2003 and $171.1 million from the late-November 2003 acquisition of
Grange had a positive, but less substantial impact on average loan growth due to
the timing of the transactions. Interest and fees on loans decreased $5.9
million or 4.5%. An 82-basis point drop in loan yields due to falling capital
market rates had more of an impact (negative $15.0 million) than growth in
average loans (positive $9.0 million).
16
In early fourth quarter 2002, management instituted an investment de-leveraging
strategy, allowing the portfolio to run down and using the proceeds to pay down
borrowings due to the lack of investment opportunities offering acceptable
yields. This approach was in effect through June 2003, when it was decided that
investment purchases should be reinitiated to take advantage of more attractive
medium and long-term rates and a steep yield curve, as well as protect the
Company from its interest rate exposure to falling rates. Due to the
de-leveraging strategy being in place for approximately half of 2003 versus less
than a quarter of 2002, average investment balances for 2003 were down $80.6
million versus the year-earlier period, primarily in the mortgage-backed
securities ("MBS") and collateralized mortgage obligations ("CMOs") segments of
the portfolio (refer to the "Investments" section of the MD&A on pages 34
through 36 for further information).
Investment interest income in 2003 of $77.4 million was $8.0 million or 9.4%
lower than the prior year as a result of the smaller portfolio (negative $4.5
million impact) and a decrease in the average investment yield from 6.74% to
6.53% (negative $3.5 million impact). The decrease in the yield was principally
driven by significant declines in market interest rates from early 2001 through
mid-2003. Consequently, the Company was unable to replace the run-off of
longer-held, higher-yielding securities with equivalent-rate investments, and
the purchase of securities in the relatively low-interest rate conditions in the
second half of 2003 led to yield declines. However, the net spread on these
medium-term investment purchases were comparable because they were funded by
very low-rate, short-term borrowings. In addition, the performance of the
investment portfolio in 2003 was strong given the interest rate environment. The
Company was able to maintain its yields to a great extent primarily because of
two important strategies: the addition of a substantial amount of call-protected
securities in 2001 and first half of 2002 when rates were higher, and foregoing
security purchases in the late-2002 to mid-2003 period as rates were falling
significantly. The success of these actions was evident in CBSI's exceptional
97th percentile ranking within its peer group for tax-equivalent investment
yield for the nine months ended September 2003.
The average earning asset yield fell 56 basis points to 6.62% in 2003 because of
the previously mentioned decrease in investment and loan yields and the fact
that the yields on the overall loan portfolio have converged with those of the
investment portfolio. In 2002 the yield on the loan portfolio was 75 basis
points higher than the yield on investments. Loan yields were only 14 basis
points above those produced by investments in 2003. Consequently, the shift in
the mix of average earning assets towards a higher proportion of loans in 2003
(61.4% vs. 58.2%) due to significant consumer mortgage growth, acquired loans
and the reduced size of the investment portfolio, did not provide the usual
yield advantage it would have under more normalized interest rate conditions.
Total average fundings (deposits and borrowings) grew by $22.1 million in 2003,
with $21.6 million of the increase coming from deposits, mostly attributable to
the acquisitions of Grange and Peoples, and $0.5 million from additional
external borrowings. All of the increase in external funding came from
short-term borrowings. Long-term debt was reduced through normal pay-downs and
the pre-payment of $25 million of medium-term FHLB borrowings in the fourth
quarter of 2003, which was replaced with much lower-rate, short-term funding
from the Federal Home Loan Bank.
Total interest expense decreased by $17.9 million to $59.3 million in 2003. As
shown in Table 5, lower rates on deposits and external borrowings accounted for
$17.7 million, or almost all of the decrease. Interest expense as a percentage
of earning assets fell by 62 basis points to 1.93%. The rate on interest bearing
deposits fell 73 basis points to 1.83%, due largely to steady declines in time
deposit rates throughout 2003 and periodic reduction of rates on other
interest-bearing deposit products. The rate on external borrowings declined 47
basis points to 4.13% because of substantially lower market rates and the
previously mentioned shift in funding mix towards short-term borrowings.
As shown in Table 4, net interest income for 2003 was $39.9 million higher than
2001's level due to a number of factors. Interest-earning assets have grown by
$447 million (17%) through a combination of acquired loans, organic loan growth
and effective management of a larger investment portfolio. The net interest
margin in 2003 was 73 basis points higher than two years ago in most part due to
earning-asset yields declining 123 basis points versus a 221 basis-point decline
in interest-bearing liabilities and an 197-basis point decrease in the cost of
funds (includes demand deposits). The yield on earning-assets benefited greatly
over the last two years by the relative stability of the investment portfolio
yield, which declined only 48 basis points over this period despite a
significant drop in market interest rates. The cost of funding was aided by the
change in the make-up of both the deposit base and external borrowings. The fall
of market interest rates over the last two years not only enabled a significant
reduction of interest-bearing deposit rates, but also caused many customers to
shift their funds from time deposits to less restrictive accounts such as
savings and demand deposits due to the greatly diminished rate spread between
the two groups of accounts. This is demonstrated by the percentage of average
deposits that were in time deposit accounts dropping from 52% in 2001 to 43% in
2003, accounting for a portion of the reduced funding costs beyond the absolute
drop in rates. The Company also changed the proportion of long-term funding in
average external borrowings from 71% in 2001 to 58% in 2003 to take advantage of
historically low short-term rates, providing further funding cost savings.
17
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon for the years ended December 31, 2003, 2002 and 2001. Interest
income and resultant yield information in the tables are on a fully
tax-equivalent basis using marginal income tax rates of 38.9% in 2003, 39.3% in
2002 and 40.5% in 2001. Averages are computed on daily average balances for each
month in the period divided by the number of days in the period. Yields and
amounts earned include loan fees. Nonaccrual loans have been included in
interest-earning assets for purposes of these computations.
Table 4: Average Balance Sheet
(000's omitted, except yields and rates) Year Ended December 31, 2003 Year Ended December 31, 2002
- ---------------------------------------- ------------------------------------------ ------------------------------------------
Avg. Avg.
Average Yield/Rate Average Yield/Rate
Balance Interest Paid Balance Interest Paid
- ---------------------------------------- ------------------------------------------ ------------------------------------------
Assets
Interest-earning assets:
Time deposits in other banks $ 346 $ 4 1.16% $ 525 $ 6 1.14%
Taxable investment securities (2) 779,107 48,212 6.19% 906,902 58,458 6.45%
Non-taxable investment securities (2) 406,034 29,148 7.18% 358,643 26,899 7.50%
Loans (net of unearned discount)(1) 1,885,604 125,855 6.67% 1,759,564 131,801 7.49%
-------------------------- --------------------------
Total interest-earning assets 3,071,091 203,219 6.62% 3,025,634 217,164 7.18%
Non-interest earning assets 400,598 367,530
---------- ----------
Total assets $3,471,689 $3,393,164
========== ==========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest checking, savings and
money market deposits $1,000,238 6,769 0.68% $ 969,664 11,416 1.18%
Time deposits 1,090,511 31,519 2.89% 1,131,296 42,462 3.75%
Short-term borrowings 212,512 2,685 1.26% 141,024 2,586 1.83%
Long-term borrowings 295,880 18,328 6.19% 366,869 20,779 5.66%
Total interest-bearing liabilities 2,599,141 59,301 2.28% 2,608,853 77,243 2.96%
Non-interest bearing liabilities:
Demand deposits 473,568 441,800
Other liabilities 56,301 47,655
Shareholders' equity 342,679 294,856
---------- ----------
Total liabilities and
shareholders' equity $3,471,689 $3,393,164
========== ==========
Net interest earnings $143,918 $139,921
======== ========
Net interest spread 4.34% 4.22%
Net interest margin on
interest-earnings assets 4.69% 4.62%
Fully tax-equivalent adjustment on $ 12,090 $ 12,071
Investments and loans
(000's omitted, except yields and rates) Year Ended December 31, 2001
- ---------------------------------------- ------------------------------------------
Avg.
Average Yield/Rate
Balance Interest Paid
- ---------------------------------------- ------------------------------------------
Assets
Interest-earning assets:
Time deposits in other banks $ 4,874 $ 549 11.26%
Taxable investment securities (2) 822,285 56,808 6.91%
Non-taxable investment securities (2) 215,567 15,759 7.31%
Loans (net of unearned discount)(1) 1,580,870 132,706 8.39%
--------------------------
Total interest-earning assets 2,623,596 205,822 7.85%
Non-interest earning assets 265,164
----------
Total assets $2,888,760
==========
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest checking, savings and
money market deposits $ 683,088 12,783 1.87%
Time deposits 1,100,850 60,380 5.48%
Short-term borrowings 141,772 6,738 4.75%
Long-term borrowings 340,811 21,936 6.44%
---------- -------- -----
Total interest-bearing liabilities 2,266,521 101,837 4.49%
Non-interest bearing liabilities:
Demand deposits 343,173
Other liabilities 39,698
Shareholders' equity 239,368
----------
Total liabilities and
shareholders' equity $2,888,760
==========
Net interest earnings $103,985
========
Net interest spread 3.36%
Net interest margin on
interest-earnings assets 3.96%
Fully tax-equivalent adjustment on $ 7,330
Investments and loans
(1) The impact of interest not recognized on non-accrual loans and interest
income that would have been recorded if the restructured loans had been
current in accordance with their original terms was immaterial.
(2) Averages for investment securities are based on historical cost basis and
the yields do not give effect to changes in fair value that is reflected
as a component of shareholders' equity and deferred taxes.
18
As discussed above, the change in 2003 net interest income (fully tax-equivalent
basis) may be analyzed by segregating the volume and rate components of the
changes in interest income and interest expense for each underlying category.
Table 5: Rate/Volume
2003 Compared to 2002 2002 Compared to 2001
Increase (Decrease) Due to Change in (1) Increase (Decrease) Due to Change in (1)
---------------------------------------- ----------------------------------------
Net Net
(000's omitted) Volume Rate Change Volume Rate Change
- --------------------------------------- ---------------------------------------- ----------------------------------------
Interest earned on:
Time deposits in other banks ($2) $0 ($2) ($271) ($272) ($543)
Taxable investment securities (7,981) (2,265) (10,246) 5,609 (3,959) 1,650
Nontaxable investment securities 3,439 (1,190) 2,249 10,721 419 11,140
Loans (net of unearned discount) 9,033 (14,979) (5,946) 14,173 (15,078) (905)
Total interest-earning assets (2) $3,222 ($17,167) ($13,945) $29,814 ($18,472) $11,342
Interest paid on:
Interest checking, savings and $349 ($4,996) ($4,647) $4,307 ($5,674) ($1,367)
money market deposits
Time deposits (1,483) (9,460) (10,943) 1,627 (19,545) (17,918)
Short-term borrowings 1,058 (959) 99 (35) (4,117) (4,152)
Long-term borrowings (4,274) 1,823 (2,451) 1,599 (2,756) (1,157)
Total interest-bearing liabilities (2) ($286) ($17,656) ($17,942) $13,771 ($38,365) ($24,594)
Net interest earnings (2) $2,117 $1,880 $3,997 $17,207 $18,729 $35,936
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
19
Non-interest Income
The Company's sources of non-interest income are of three primary types: general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network; financial services, comprised of
retirement plan administration and employee benefit trusts (Benefit Plans
Administrative Services or BPA), employee benefit actuarial and consulting
services (Harbridge Consulting Group or Harbridge), personal trust, investment
and insurance products (Community Investment Services, Inc. or CISI) and
investment management (Elias Asset Management or EAM); and periodic
transactions, most often net gains (losses) from the sale of investments and
prepayment of term debt.
Table 6: Non-interest Income
Years Ended December 31,
------------------------------------
(000's omitted) 2003 2002 2001
---------------------------------------------------------------------------------------------------
Banking services:
Electronic banking $ 2,604 $ 2,375 $ 1,469
Mortgage banking 518 175 653
Deposit service charges 5,374 5,310 4,183
Overdraft fees 13,476 6,937 5,183
Credit life and disability insurance 856 1,082 835
Commissions and other fees 2,042 2,243 2,259
Miscellaneous (93) 163 89
---------------------------------------------------------------------------------------------------
Total banking services 24,777 18,285 14,671
Financial services:
Retirement plan administration and trust fees 4,668 3,845 3,585
Benefit plan actuarial and consulting fees 1,552 0 0
Asset advisory and management fees 1,890 2,606 3,643
Investment and insurance product commissions 3,339 3,715 2,372
Personal trust 1,453 1,682 1,821
---------------------------------------------------------------------------------------------------
Total financial services 12,902 11,848 11,421
---------------------------------------------------------------------------------------------------
Sub-total 37,679 30,133 26,092
(Loss) gain on investment securities & debt extinguishment (2,698) 1,673 (113)
---------------------------------------------------------------------------------------------------
Total non-interest income $ 34,981 $31,806 $ 25,979
===================================================================================================
Non-interest income/operating income (FTE) 20.7% 17.7% 20.1%
As displayed in Table 6, total non-interest income in 2003 increased by 10.0% to
$35.0 million, largely as a result of significantly higher overdraft volume, the
acquisition of Harbridge and growth at BPA. These improvements were offset by
substantially higher losses on the early retirement of long-term borrowings, the
absence of gains on the sale of securities and weakness in the other financial
services group businesses. Non-interest income, excluding transactions related
to investment securities and debt obligations, rose for the tenth consecutive
year to $37.7 million in 2003, a $7.5 million or 25% improvement over 2002.
Non-interest income, excluding net gains (losses) from the sale of securities
and early retirement of debt, as a percent of operating income (FTE basis) was
20.7% in 2003, up 3.0 percentage points from the prior year, and an all-time
high for the Company. This increase was primarily driven by the aforementioned
strong growth in overdraft fees and BPA revenue, as well as the acquisition of
Harbridge. This ratio is considered an important measure for determining the
progress the Company is making on one of its primary long-term strategies,
expansion of non-interest income in order to diversify its revenue sources and
reduce reliance on net interest margins that may be strongly impacted by general
interest rate and other market conditions.
The largest segment of the Company's recurring non-interest income is the wide
variety of fees earned from general banking services, which reached $24.8
million in 2003, up 36% from the prior year. This segment contributed 66% of
2003 non-interest income, excluding net gains and losses from security sales and
debt extinguishment. A large portion of the income growth was attributable to
overdraft fees, up $6.5 million (94%) over 2002's level, which benefited from
the implementation of the Company's Overdraft Freedom(TM) program in December
2002, additional accounts added through acquisitions and the full-year impact of
a fee increase implemented in June 2002. Overdraft Freedom(TM) is a program
currently offered to retail customers whereby the Company may pay overdrawn
amounts for qualified customers up to a
20
certain predetermined limit, for which they are charged a standard overdraft
fee. This program is a courtesy service to customers in good standing that may
allow them to avoid late and non-payment penalties from creditors and vendors
and help them in their effort to avoid the negative consequences of returned
checks. This type of deposit account service has become prevalent throughout
much of the banking industry.
Income derived from activity associated with the secondary market mortgage
portfolio rose to $518,000 in 2003, up $343,000 from the prior year. One of the
main reasons for the increase was that $67 million of consumer mortgages were
sold on the secondary market in 2003 versus $9 million in 2002. The selling of
secondary mortgages was resumed in October 2002 after a one-year suspension, and
continued through September 2003. The combination of increased sales and
fluctuations in interest rates was the primary driver of gains of $627,000 on
loans sold and $372,000 from the establishment of and valuation of mortgage
servicing rights. This compares to $64,000 of gains on loans sold and a $163,000
write-down of mortgage servicing rights in 2002. These income improvements were
offset by a $795,000 unrealized loss on mortgage loan commitments. Certain loan
commitments that had been categorized as held-for-sale were reclassified as
portfolio loans commitments after the decision was made to discontinue the sale
of twenty-year and longer mortgages. Market loss on these commitments was
recognized in earnings concurrent with the reclassification. Higher secondary
sales partially offset by increased levels of mortgage prepayments resulted in
the loan-servicing portfolio rising from $103.7 million at the end of 2002 to
$126.3 million at year-end 2003. This growth was the primary reason why a fourth
component of secondary market activity, loan-servicing fees, rose 14.5% to
$313,000 in 2003.
As disclosed in Table 6, non-interest income from the financial services segment
rose $1.0 million or 8.9% in 2003 to $12.9 million. Financial services revenue
now comprises 34% of total non-interest income, excluding net gains (losses) on
the sale of investment securities and retirement of debt. This compares to 39%
in 2002, with the decline primarily due to the tremendous success of the
Company's new overdraft program this year. The acquisition of Harbridge at the
end of July 2003 resulted in $1.6 million of incremental revenue for the
financial services group in the current year. Another impressive year of revenue
growth at BPA (up $823,000 or 21%) was driven by a significant number of new
plans and growth in the market value of client assets. These two businesses are
part of the Company's Benefits Plan Administrative Services, Inc. ("BPAS")
subsidiary, and operate collaboratively to offer clients a full array of
employee benefits, recordkeeping and consulting services throughout much of the
country. BPAS revenue of $6.2 million was $2.4 million higher than prior year
results.
The other financial services businesses, CISI, Elias Asset Management and
personal trust were all negatively impacted by the challenging retail investment
market conditions of the past few years. A significant drop in interest rates
this year resulted in much lower annuity volume and commission rates for CISI,
accounting for most of the $376,000 decline in their revenue to $3.3 million. An
extended period of weak performance by US equities from late-2000 through early
2003 had an adverse impact on EAM's assets under management, as lower valuations
and the loss of assets reduced their main driver of revenue generation.
Consequently, EAM's revenue was down $716,000 to $1.9 million in 2003. However,
significantly improved market conditions and investor confidence in the latter
part of 2003 directly benefited EAM's performance, as higher equity valuations
and new client acquisition resulted in 15% higher revenues in the second half of
the year versus the first half. Lastly, the personal trust business experienced
a $229,000 decline in revenue to $1.5 million, primarily due to the timing of
estate settlements.
Assets under management from the Company's financial services businesses rose
considerably to $1.807 billion at the end of 2003 compared to $1.364 billion at
year-end 2002. Market-driven gains in equity-based assets were augmented by
attraction of new client assets. BPA in particular was very successful at
growing its asset base, as demonstrated by the $312 million or 69% increase in
its assets under administration.
The total financial services group contributed $1.6 million (excluding
allocation of indirect corporate expense) or 2.9% of the Company's pretax income
this year, reflecting nearly a 12% margin. In 2002, financial services'
contribution was $2.2 million or 4.2% of total pretax income, with a margin of
18%. The lower earnings and margin were the result of up-front,
transaction-related expenses absorbed by Harbridge and cost-cutting efforts at
EAM and CISI not keeping pace with revenue shortfalls. In addition, most of the
expenses for the personal trust unit are fixed in nature and therefore its
margins and pre-tax contribution tend to fluctuate to a large degree with
variability of their traditionally uneven revenue stream. The decline in
percentage contribution was primarily due to the banking business's success at
growing net interest income, non-interest income and reducing the loan loss
provision in 2003. In addition, the near-term profitability challenges faced by
the financial services group due to market conditions, amortization of
intangible assets and unusual expenses are expected to diminish over time and be
more than offset by top-line growth.
There was a total net loss on security and debt transactions of $2.7 million
this year compared to $1.7 million of net gains in 2002. The loss in 2003 was
primarily composed of $2.6 million of charges associated with the early
retirement of $25 million of longer-term FHLB borrowings that were replaced with
lower rate, short-term borrowings, which is expected to provide a long-term
earnings benefit as well as reduce interest rate risk. Current year results also
included $0.1 million of
21
losses from a variety of smaller security and debt transactions. The net gain in
2002 included $2.6 million of gains on $80 million of investment sales, and a
$0.9 million prepayment penalty on the retirement of approximately $11 million
of intermediate-term FHLB borrowings in the fourth quarter. The security and
debt gains and losses taken over the last two years are illustrative of the
Company's active management of its investment portfolio and external borrowings
to achieve a desirable total return through the combination of net interest
income, transaction gains/losses and changes in market value across financial
market cycles.
Excluding gains and losses from security sales and debt retirement, non-interest
income for 2003 was up $11.6 million or 44% from 2001's level, driven by strong
growth of 15% and 25% in 2002 and 2003, respectively. The increase in 2002 came
from both the banking and financial services segments. The acquisition of 36
FleetBoston branches in November 2001 contributed a significant amount of
incremental banking fees in 2002. Prior year non-interest income also benefited
greatly from substantial business expansion at BPA, which has provided
consistent revenue growth since it was acquired in July 1996, and CISI which
successfully shifted it focus to annuity sales in 2002 to provide growth in a
very difficult year for equity-based products. As previously noted, the
impressive increase in recurring non-interest income in 2003 was driven by
deposit service fees, income related to the secondary mortgage market, the
acquisition of Harbridge and another year of robust growth at BPA. Total
non-interest income for 2003 was up a lesser $9.0 million from 2001's level, due
primarily to debt repayment penalties that will provide future benefits and very
limited security sales in comparison to the earlier periods.
Operating Expenses
As shown in Table 7, operating expenses rose $7.4 million or 7.8% in 2003 to
$102.5 million. Excluding acquisition expenses related to Harbridge, Peoples and
Grange in 2003 and the FleetBoston branches in 2002, operating expenses were up
$7.6 million or 8.1% in 2003, reflective mostly of incremental expenses from the
operations of the acquired businesses listed above, as well as increases in
pension, medical and volume-driven costs. This year's operating expenses as a
percent of average assets were 2.95%, up from 2.80% in 2002 and lower than the
3.07% in 2001. The increase in this ratio for 2003 was principally due to the
acquisition of a financial services unit whose revenue is not driven by earning
assets (Harbridge), and the charge-offs resulting from higher overdraft volume,
another significant revenue generating tool with a limited underlying asset
base. This ratio was elevated in 2001 primarily as a result of the high level of
acquisition expenses in that year. CBSI's operating expenses to average asset
ratio of 2.94% (annualized) for the nine months ended September 2003 was
slightly below the median of 2.95% for peer banks.
The efficiency ratio, a performance measurement tool widely used by banks, is
defined by the Company as operating expenses (excluding acquisition expenses and
intangible amortization) divided by operating income (fully tax-equivalent net
interest income plus non-interest income, excluding net securities and debt
gains and losses). Lower ratios correspond to higher efficiency. In 2003 the
efficiency ratio increased by 1.3 percentage points to 53.3%. This was primarily
a result of net interest income being tempered for much of the year due to the
investment de-leveraging strategy, rising pension and medical expenses and the
impact from reduced pre-tax margins in the financial services segment in 2003,
as discussed earlier. The efficiency ratio for 2003 was significantly lower than
the ratio of 56.7% for 2001, as initiatives undertaken in 2001, such as the
consolidation of the Company's loan and deposit operations centers and cost
take-outs at First Liberty, have provided ongoing efficiency improvements.
Table 7: Operating Expenses
Years Ended December,
----------------------------------
(000's omitted) 2003 2002 2001
------------------------------------------------------------------------
Salaries and employee benefits $ 53,164 $47,864 $40,930
Occupancy 9,297 8,154 6,122
Equipment and furniture 7,828 7,538 6,075
Legal and professional fees 3,183 3,272 2,789
Data processing 6,800 6,574 4,727
Amortization of intangible assets 5,093 5,953 6,679
Office supplies 1,996 2,321 1,995
Foreclosed property 561 902 1,059
Deposit insurance premiums 388 440 346
Other 13,653 11,312 9,708
------------------------------------------------------------------------
Total recurring expenses 101,963 94,330 80,430
Acquisition and unusual expenses 498 700 8,164
------------------------------------------------------------------------
Total operating expenses $102,461 $95,030 $88,594
========================================================================
Operating expenses/average assets 2.95% 2.80% 3.07%
Efficiency ratio 53.3% 52.0% 56.7%
22
Higher personnel expenses accounted for 69% of 2003's increase in operating
costs, excluding acquisition expenses, as they increased 11.1%, mostly as a
result of the three acquisitions. The remainder of the increases in personnel
expense reflect higher pension (discussed in further detail below) and medical
rates, merit increases and new hiring activity. Total full-time equivalent staff
at the end of 2003 was 1,259 compared to 1,120 at year-end 2002.
Medical expenses were up in 2003 due to a general rise in the cost of medical
care, administration and insurance, as well as a greater number of insured
employees. Qualified and non-qualified pension expenses increased significantly
in 2003 principally due to a reduction of the discount rate applied to future
payments to 6.10% from 6.75% (increases current expenses in present value terms)
and additional obligations for employees added through acquisition and organic
growth. In addition, a $1.2 million adjustment was recorded in the fourth
quarter of 2003 to reflect the proper actuarial impact of indexing salary levels
associated with certain benefits frozen in 1988. The three assumptions that have
the largest impact on the calculation of annual pension expense are the
aforementioned discount rate, the rate applied to future compensation increases
and the expected rate of return on plan assets. Table 8 contains the results of
a sensitivity analysis conducted to determine what the impact of a 1.0
percentage point increase and decrease in these three assumptions would have on
the annual pension expense for the two plans. Also, see Note K to the financial
statements for further information concerning the pension plan.
Table 8: Pension Plan Sensitivity Analysis
One Percentage Point
----------------------
(000's omitted) Increase Decrease
-----------------------------------------------------------
Discount rate ($834) $ 949
Rate of compensation increase $451 ($430)
Expected return on plan assets ($360) $ 360
Total non-personnel expenses increased $2.1 million or 4.5% in 2003. Excluding
acquisition-related expenses, non-personnel expenses were up $2.3 million or
5.0% from 2002's level. As displayed in Table 7, this was largely caused by
higher occupancy expense (up $1.1 million) and other expenses (up $2.3 million),
and partially offset by lower intangible amortization (down $0.9 million),
office supplies (down $0.3 million) and foreclosed property expenses (down $0.3
million). The increase in occupancy expense in 2003 was mainly due to
incremental costs from recently acquired facilities, expenses arising from
renovations and repairs, the effect of higher rates and severe weather on
maintenance and utilities expenses and the general increase in property taxes in
many of the municipalities we do business in. Other expenses include two
volume-driven expense items that were up considerably due to record levels of
business activity, mortgage processing expenses and checking charges related to
overdraft activity. In 2003 non-recurring expenses associated with the
retirement of a senior executive also impacted other expenses. Intangible
amortization in 2003 was down versus the prior year because the drop in
accelerated amortization of core deposit intangibles from the FleetBoston branch
acquisition had a greater impact than the amortization of intangibles added as a
result of the three acquisitions completed this year. Office supply expenses
declined primarily because of improved purchasing cost controls in 2003 and
escalated expense levels in early 2002 arising from the integration of the
acquired FleetBoston branches.
Acquisition and unusual expenses totaled $498,000 in 2003, down from $700,000 in
2002. These expenditures were primarily comprised of legal and consulting fees
of $213,000, $191,000 of system conversion costs and $94,000 of other general
administrative expenses. The majority of these expenses was incurred in
conjunction with the Company's largest acquisition of 2003, Grange National Banc
Corp., in November 2003.
As displayed in Table 7 above, recurring operating expenses in 2002 increased
$13.9 million or 17% in comparison to 2001. As was the case in 2003, the rise in
2002 was predominately caused by incremental expenses from acquired operations.
The increase in 2002 was substantially higher than the 8.1% rise this year
primarily due to 2002 including ten and a half months of additional expenses
from a large scale acquisition (FleetBoston branches), versus 2003 having only
one and half months of incremental expenses from a relatively large acquisition,
Grange. In addition, the two acquisitions made under the purchase method of
accounting in 2002 (Citizens and the FleetBoston branches) were larger than the
three acquisitions made this year ($949 million of assets and deposits vs. $600
million). The cumulative effect of these six acquisitions was the major
contributor to the $21.5 million of increased recurring operating expenses in
2003 in comparison to 2001, a modest increase in light of the $51.5 million
growth in recurring operating income over the same time period.
Income Taxes
The Company estimates its tax expense based on the amount it expects to owe the
respective tax authorities, plus the impact of deferred tax items. Taxes are
discussed in more detail in Note I of the Consolidated Financial Statements on
page 58. Accrued taxes represent the net estimated amount due or to be received
from taxing authorities. In estimating accrued taxes, management assesses the
relative merits and risks of the appropriate tax treatment of transactions
taking into account
23
statutory, judicial and regulatory guidance in the context of the Company's tax
position. If the final resolution of taxes payable differs from our estimates
due to regulatory determination or legislative or judicial actions, adjustments
to tax expense may be required.
The effective tax rate for 2003 declined by 2.5 percentage points to 24.0%. This
decline was primarily due to the benefits realized on a larger proportion of
income from tax-exempt investment securities. In addition, the amount of
nondeductible merger expenses declined in 2003.
The effective tax rate for 2002 of 26.5% was down from the 29.0% rate in 2001.
This decline was primarily due to the benefits realized on a larger proportion
of income from tax exempt investment securities, which mitigated the effect of
the near doubling of income before tax. In addition, the adoption of SFAS 142
and 147, the reduced level of nondeductible merger expenses in 2002 compared
with 2001, and a federal low-income housing tax credit claimed in 2002, all
contributed to the decline in the effective tax rate last year.
Capital
Shareholders' equity ended 2003 at $405 million, up $79.8 million or 25% from
one year earlier. This increase reflects $60.4 of common stock issued in
conjunction with the acquisition of Grange, net income of $40.4 and $6.4 million
from the issuance of shares through employee stock plans. These factors were
partially offset by common dividends declared of $16.2 million, treasury share
purchases of $8.5 million and a $2.6 million decline in the market value
adjustment ("MVA", represents the after-tax, unrealized change in value of
available-for-sale securities in the Company's investment portfolio). Excluding
the MVA in both 2003 and 2002, capital rose by $82 million or 29%. Shares
outstanding rose by 1,187,000 during the year, comprised of 1,147,000 issued to
Grange shareholders and 248,000 added through employee stock plans, offset by
the purchase of 208,000 treasury shares.
The Company's ratio of tier I capital to assets (or tier I leverage ratio), the
basic measure for which regulators have established a 5% minimum to be
considered "well-capitalized," increased 21 basis points in 2003 to 7.26%. This
was due to the net issuance of common stock and the capital-building
contribution from retained earnings (net income less dividends declared) more
than offsetting both the organic and acquired growth of the investment and loan
portfolios. The tangible equity/tangible assets ratio was 5.70% at the end of
2003 versus 5.76% one year earlier, with the decline in MVA having a negative
17-basis point impact on this ratio (MVA is excluded from tier I ratios). CBSI
manages organic and acquired growth in a manner that enables it to continue to
build upon its strong capital base, and maintain the company's ability to take
advantage of future strategic growth opportunities.
Cash dividends declared on common stock in 2003 of $16.2 million represented an
increase of 11.9% over the prior year. This growth was mostly a result of
dividends per share of $1.22 for 2003 increasing from $1.12 in 2002 due to
quarterly dividends per share being raised from $0.29 to $0.32 (+10.3%) in the
third quarter of 2003 and from $0.27 to $0.29 (+7.4%) in the third quarter of
2002. The increase in dollar amount of dividends declared also reflects an
increase in the number of shares outstanding at the end of this year, primarily
a result of the 1.1 million shares issued in November 2003 to Grange
shareholders.
The dividend payout ratio for this year was 40.2% compared to 37.7% in 2002 and
65.7% in 2001, and near the top of CBSI's targeted payout range for dividends on
common stock of 30-40%. The Company's payout ratio has historically been high
relative to peers, and for first nine months of 2003 the ratio of 36.9% was well
above the peer median of 31.4%. As previously noted, the primary reason for the
higher payout ratio in 2003 versus 2002 was the charges for early retirement of
debt in 2003 and the significant increases in the dividends per share in the
third quarters of both years. The payout ratio was substantially lower in 2002
than in 2001 despite higher dividends per share ($1.12 vs. $1.08). This was a
result of the 101% increase in net income in 2002, which was largely due to
higher interest earning assets, an improved net interest margin in 2002, and
considerably more acquisition-related expenses in 2001.
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.
The Bank's primary approach to measuring liquidity is known as the Basic
Surplus/Deficit model. It is used to calculate liquidity over two time periods:
first, the amount of cash that could be made available within 30 days
(calculated as liquid assets less short-term liabilities); and second, a
projection of subsequent cash availability over an additional 60 days. The
minimum policy level of liquidity under the Basic Surplus/Deficit approach is
7.5% of total assets for both the 30 and 90-day time horizons. As of December
31, 2003, this ratio was 15.1% and 14.9% for the respective time periods,
excluding the Company's capacity to borrow additional funds from the Federal
Home Loan Bank and other sources.
24
There is currently $194 million in additional Federal Home Loan Bank borrowing
capacity based on the Bank's year-end collateral levels. Additionally, the Bank
has $25 million in unused capacity at the Federal Reserve Bank and $10 million
in unused capacity from an unsecured line of credit with First Tennessee Bank,
N.A.
To measure longer-term liquidity, a baseline projection of loan and deposit
growth for five years is made to reflect how liquidity levels could change over
time. This five-year measure reflects ample liquidity for loan growth over the
next five years.
Intangible Assets
Intangible assets at the end of 2003 of $196 million were up $61 million from
the prior year-end due to the additional intangible assets arising from the
acquisitions from Peoples, Harbridge and Grange, offset by $5.1 million of
amortization during the year.
Intangible assets consist of goodwill, core deposit value and customer
relationships arising from acquisitions. Goodwill represents the excess cost of
an acquisition over the fair value of the net assets acquired. Goodwill at
December 31, 2003 equaled $160 million, comprised of $149 million related to
banking acquisitions and $11 million arising from the acquisition of financial
services businesses. Goodwill is subjected to an annual impairment analysis to
determine whether the carrying value of the acquired net assets exceeds their
fair value, which would necessitate a write-down of the goodwill. The Company
completed its goodwill impairment analyses during 2003 and 2002 and no
adjustments were necessary. The impairment analysis was based upon discounted
cash flow modeling techniques that require management to make estimates
regarding the amount and timing of expected future cash flows. It also requires
them to select a discount rate that reflects the current return requirements of
the market in relation to present risk-free interest rates, required equity
market premiums and company-specific risk indicators. Management believes that
there is very low probability of future impairment with regard to the goodwill
associated with whole-bank acquisitions. The performance of Elias Asset
Management weakened subsequent to its acquisition in 2000 as a result of adverse
market conditions in 2001 and 2002. Continued declines in EAM's operating
results may result in impairment to its recorded goodwill of $7.3 million.
Core deposit intangibles represent the premium the Company has paid for deposits
acquired in excess of the cost incurred had the funds been purchased in the
capital markets. Core deposit intangibles are amortized on either an accelerated
or straight-line basis over periods ranging from seven to nineteen years. The
recognition of a customer relationship intangible arose due to the acquisition
of Harbridge. This asset was determined based on a methodology that calculates
the present value of the projected future revenue derived from the acquired
customer base. This asset is being amortized over eleven years on an accelerated
basis.
Loans
The Company's loans outstanding, by type, as of December 31 are as follows:
Table 9: Loans Outstanding
(000's omitted) 2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------------
Consumer mortgage $ 739,593 $ 510,309 $ 443,767 $ 416,160 $ 380,886
Business lending 689,436 629,874 643,834 576,887 539,110
Consumer indirect 325,304 287,453 248,718 256,793 250,536
Consumer direct 374,258 379,385 396,769 267,039 256,660
- -------------------------------------------------------------------------------------------------------------------
Gross loans 2,128,591 1,807,021 1,733,088 1,516,879 1,427,192
Less: unearned discount 82 116 218 1,002 1,419
- -------------------------------------------------------------------------------------------------------------------
Net loans 2,128,509 1,806,905 1,732,870 1,515,877 1,425,773
Allowance for loan loss 29,095 26,331 23,901 20,035 18,528
- -------------------------------------------------------------------------------------------------------------------
Loans, net of allowance for loan losses $2,099,414 $1,780,574 $1,708,969 $1,495,842 $1,407,245
===================================================================================================================
As disclosed in Table 9 above, loans outstanding, net of unearned discount,
reached a record level of $2.129 billion as of year-end 2003, up $322 million or
18% compared to twelve months earlier. The acquisitions of Grange and Peoples
accounted for $186 million of that growth. Excluding the impact of these
acquisitions (at time of completion), total loans rose $136 million or 7.5%.
This growth was attributable to the New York market, with the Pennsylvania
market experiencing a net decline in loans outstanding.
Based on overall asset/liability analysis, the decision was made to discontinue
selling secondary market-eligible mortgages with terms greater than 20 years in
the third quarter of 2003 (mortgages with shorter terms were already being held
in
25
portfolio). The secondary market activity in the first half of 2003 resulted in
$67 million of sales versus $9 million in the latter part of last year. Had
these loans not been sold in 2003, loan growth (excluding acquisitions) would
have been $203 million or 11.1%.
The compounded annual growth rate ("CAGR") for CBSI's total loan portfolio
between 1999 and 2003 was 10.5%, with approximately 6% of the growth coming from
whole bank and branch acquisitions and the balance from organic growth. The
greatest overall expansion occurred in the consumer mortgage segment, which grew
at an 18% CAGR (including the impact of acquisitions) over that time frame. The
consumer mortgage growth was primarily driven by record mortgage refinancing
volumes over the last two years, as well as the acquisition of consumer oriented
banks in the intervening period. The other loan categories grew at compounded
annual growth rates of between 6% and 10% from 1999 to 2003. As a consequence,
the consumer mortgages segment accounted for 35% of the total loan portfolio at
year-end 2003 versus 27% at the end of 1999.
The weighting of retail lending in the Company's loan portfolio enables it to be
highly diversified. Approximately 68% of loans outstanding at the end of 2003
were made to consumers borrowing on an installment and residential mortgage loan
basis. This proportion increased from 65% at year-end 2002 and 63% at the end of
2001. This was principally due to the strong growth of residential mortgages in
2002 and 2003, the addition of People's loan portfolio (100% consumer) and the
tempered organic growth in the business lending segment over the last few years
due to soft economic conditions in our primary markets.
There is also a high degree of diversification within the business lending
segment of the portfolio. The Company's business loans are typically for amounts
under $100,000, which account for about 81% of the number of business loans and
approximately 24% of business loan balances as of December 31, 2003.
Approximately 41% of the business portfolio is comprised of loans between
$100,000 and $750,000 (about 17% of the number of loans), while loans over
$750,000 account for the remaining 35% of ending balances (2% of the number of
loans). The commercial portfolio is also broadly diversified by industry type as
demonstrated by the following distributions at year-end 2003: real estate
development (16%), healthcare (11%), general services (10%), motor vehicle and
parts dealers (9%), agriculture (8%), restaurant & lodging (7%), retail trade
(7%), construction (6%), manufacturing (5%) and wholesale trade (4%). A variety
of other industries with less than a 3% share of the total portfolio comprise
the remaining 17%.
Table 9 breaks down the Company's loan portfolio into four major lines of
business. Including loans added through acquisitions, $322 million of loan
growth in 2003 was comprised of increases of $229 million in consumer mortgages,
$60 million in business loans and $38 million in consumer indirect loans, offset
by a $5 million decrease in consumer direct loans outstanding. Excluding the
impact of acquisitions, the increase in consumer mortgages contributed $128
million of the $136 million in total loan growth in 2003, and consumer indirect
loans accounted for $38 million. Conversely, consumer direct and business loan
balances were down $22 million and $8 million from year-end 2002 levels,
respectively.
The consumer mortgage segment of the Company's loan portfolio is comprised of
fixed (95%) and adjustable rate (5%) residential lending. Approximately $102
million of the $229 million growth in consumer mortgages was attributable to the
acquisition of Grange and Peoples. Excluding the impact of these acquisitions,
this segment was up $127 million or 25% in 2003 due to record mortgage volumes
driven by this year's historically low interest rate environment. All of the
organic growth was generated in the New York market, as Pennsylvania experienced
net run-off in 2003 despite a significant volume of new originations. Growth in
the consumer mortgage portfolio would have been 38% if the sale of longer-term,
fixed-rate mortgages in the secondary market had not been conducted in the first
three quarters of 2003. These mortgages were sold in the secondary market to
improve the Company's interest rate risk position.
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. Approximately $68 million in business loans
added through the Grange acquisition offset the $8 million (1.3%) decrease from
ongoing operations in 2003. All of this decrease was attributable to the
Pennsylvania market before the acquisition of Grange, with the New York market
generating marginal increases. Lending efforts in First Liberty's traditional
markets (excluding Grange's coverage) continue to be challenged by a slow
economic recovery, diminished capital spending levels in the commercial sector
and an extremely competitive pricing environment. Management has worked
aggressively to address the loan generation challenges in Pennsylvania by adding
lending talent, resources, and strong business relationships via completed
(Grange) and pending (First Heritage) acquisitions. The enhanced scale and
coverage of the Pennsylvania business combined with the new management team's
re-focused commitment to business development efforts, should position them to
fully take advantage of growth opportunities in this key market as economic
conditions improve and increased capital spending leads to expanded borrowing
activity in the commercial sector.
Installment loans indirectly originated through automobile and recreational
vehicle dealers increased by 13% or $38 million in 2003. All of the consumer
indirect loan growth was organic in nature (acquired banks did not provide these
loans),
26
primarily reflecting successful business development efforts that have increased
both the number and strength of the Company's dealer relationships and ability
to deliver attractive financing rates. Ninety-two percent of this loan segment
is comprised of automobile loans (75% of the vehicles are used and 25% are new).
Consumer indirect loan growth was generated in both the New York and
Pennsylvania markets.
Consumer direct loans are comprised of conventional installment loans, personal
loans, student loans (which are sold once principal repayment begins), and
variable and fixed-rate home equity loans and lines of credit. This loan segment
decreased 1.3% or $5 million in 2003. Excluding the addition of $17 million of
consumer direct loans through the acquisition of Grange and Peoples, this
segment was down 5.8% or $22 million. Loan balances fell in both the New York
and Pennsylvania markets, as installment loans were paid off during the year
through the use of funds made available through mortgage refinancing.
Competitive conditions are quite intense in this loan category, particularly
with regard to home equity lending. Management is dedicated to developing new
marketing and pricing strategies in order to generate significant new business
in this attractive segment of the market.
The following table shows the maturities of loans as of December 31, 2003:
Table 10: Loan Maturities
Maturing in Maturing After Maturing After Maturing
One Year or One But Within Five But Within After Total Book
(000's omitted) Less Five Years Fifteen Years Fifteen Years Value
-------------------------------------------------------------------------------------------------------------
Consumer mortgage $ 1,104 $ 22,966 $426,706 $288,817 $ 739,593
Business lending 185,469 246,184 221,537 36,246 689,436
Consumer indirect 5,555 279,232 39,542 912 325,241
Consumer direct 32,636 148,481 115,184 77,938 374,239
-------------------------------------------------------------------------------------------------------------
Total loans $224,764 $696,863 $802,969 $403,913 $2,128,509
=============================================================================================================
As displayed in Table 10 above, 11% of the loan portfolio at December 31, 2003
is scheduled to mature in one year or less, 33% of loans have maturities in the
one to five-year range, and approximately 56% mature after five years. This is
consistent with the 12%, 34% and 54% mix for the equivalent maturity categories
at year-end 2002, respectively. The proportional increase in loans maturing
after five years was due to the growth in the consumer mortgage segment of the
portfolio, which generally carry longer weighted average maturities.
The following table sets forth the profile of the loan portfolio with regard to
maturity and the type of interest rate:
Table 11: Loan Sensitivity
At December 31, 2003
------------------------------------------------
(000's omitted) Fixed Rate Variable Rate Total
-------------------------------------------------------------------------------------------------------
Due in one year or less $ 48,580 $176,184 $ 224,764
Due after one year but within five years 606,429 90,433 696,862
Due after five years but within fifteen years 590,548 114,744 705,292
Due after fifteen years 289,163 212,428 501,591
-------------------------------------------------------------------------------------------------------
Total loans $1,534,720 $593,789 $2,128,509
=======================================================================================================
Table 11 above reflects the nature of the Company's loan portfolio in relation
to the mix of maturities and interest rate characteristics. At year-end 2003 72%
of loans had fixed interest rates, and the 28% that have variable rates consist
primarily of home equity and commercial loans. This is very close to the 71% /
29% mix profile of the loan portfolio at the end of 2002. There was relatively
even distribution of the portfolio between loans with maturities below and above
5 years at 43% and 57% at December 31, 2003, respectively. Refer to the market
risk/interest rate risk section of the MD&A on page 38 for specific information
regarding the interest rate sensitivity of the Company's asset and liability
position at year-end 2003.
27
Asset Quality
The following table presents information concerning non-performing assets:
Table 12: Non-performing Assets
As of December 31,
---------------------------------------------------------
(000's omitted) 2003 2002 2001 2000 1999
------------------------------------------------------------------------------------------------------------------------
Non-accrual loans $11,940 $ 9,754 $ 7,186 $5,473 $6,112
Accruing loans 90+ days delinquent 1,307 1,890 1,914 1,930 1,201
------------------------------------------------------------------------------------------------------------------------
Total non-performing loans 13,247 11,644 9,100 7,403 7,313
Restructured loans 28 43 75 116 122
Other real estate 1,077 704 1,427 1,293 1,442
------------------------------------------------------------------------------------------------------------------------
Total non-performing assets $14,352 $12,391 $10,602 $8,812 $8,877
========================================================================================================================
Allowance for loan losses to total loans 1.37% 1.46% 1.38% 1.32% 1.30%
Allowance for loan losses to non-performing loans 220% 226% 263% 271% 253%
Non-performing loans to total loans 0.62% 0.64% 0.53% 0.49% 0.51%
Non-performing assets to total loans and other real estate 0.67% 0.69% 0.61% 0.58% 0.62%
The Company places a loan on nonaccrual status when the loan becomes 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. As shown in Table 12 above, non-performing
loans, defined as non-accruing loans plus accruing loans 90 days or more past
due, ended 2003 at $13.2 million, up approximately $1.6 million or 13.8% from
one year earlier. This was primarily due to the addition of acquired loans as
well as increases in existing commercial loan non-accruals. The ratio of
non-performing loans to total loans declined two basis points from twelve months
earlier to 0.62%. As of September 30, 2003, when the non-performing loan ratio
stood at 0.70%, the Company's position was favorable to the peer level of 0.87%.
The ratio of non-performing assets (which includes troubled debt restructuring
and other real estate, or OREO, in addition to non-performing loans) to total
loans plus OREO decreased to 0.67% at year-end 2003, down two basis points from
one-year earlier. The improvement in both ratios was driven by improvements in
the economy, enhanced collection and recovery efforts, the charge-off of problem
loans over the last two years, a reduced proportion of commercial loans, and the
acquisition of Grange, which had a lower level of non-performing assets than the
overall portfolio. Had nonaccrual loans as of December 31, 2003 been current in
accordance with their original terms, interest income of approximately $925,000
would have been recorded.
Total delinquencies, defined as loans 30 days or more past due or in nonaccrual
status, finished the current year at 1.76% of total loans outstanding versus
1.88% at the end of 2002. As of year-end 2003, total delinquency ratios for
commercial loans, installment loans, and real estate mortgages were 2.18%,
2.40%, and 1.10%, respectively. These measures were 2.31%, 1.80% and 0.98% as of
September 30, 2003, and compared to median peer levels of 2.30%, 1.79%, and
1.43%, respectively. The total delinquency ratio of 1.64% was slightly favorable
to the peer ratio of 1.69% at September 30, 2003. Delinquency levels,
particularly in the 30 to 89 days category tend to be somewhat volatile due to
them being measured at a point in time, and therefore it is useful to look at
this ratio over a longer period. The total average delinquency ratio for the
Company for the end of the last three months of 2003 was 1.72%, five basis
points below the previous three-month period, and the average ratio for the four
quarters of 2003 (end of period basis) was 1.76% versus 1.83% in the prior year.
28
The changes in the allowance for loan losses for the last five years is as
follows:
Table 13: Allowance for Loan Loss Activity
Years Ended December 31,
------------------------------------------------------------------
(000's omitted) 2003 2002 2001 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
Amount of loans outstanding at end of period $2,128,509 $1,806,905 $1,732,870 $1,515,877 $1,425,773
Daily average amount of loans (net of unearned discount) $1,885,604 $1,759,564 $1,580,870 $1,484,945 $1,343,652
Allowance for loan losses at beginning of year $ 26,331 $ 23,901 $ 20,035 $ 18,528 $ 17,059
Charge-offs:
Business lending 5,521 5,071 2,310 3,423 996
Consumer mortgage 239 221 282 93 23
Consumer direct 2,897 3,013 2,382 1,644 2,280
Consumer indirect 4,454 3,710 3,688 2,320 2,665
-----------------------------------------------------------------------------------------------------------------------------
Total charge-offs 13,111 12,015 8,662 7,480 5,964
Recoveries:
Business lending 417 281 313 181 146
Consumer mortgage 78 119 56 72 3
Consumer direct 773 603 614 379 764
Consumer indirect 1,580 1,220 1,095 633 664
-----------------------------------------------------------------------------------------------------------------------------
Total recoveries 2,848 2,223 2,078 1,265 1,577
-----------------------------------------------------------------------------------------------------------------------------
Net charge-offs 10,263 9,792 6,584 6,215 4,387
Provision for loan losses 11,195 12,222 7,097 7,722 5,856
Allowance on acquired loans (1) 1,832 0 3,353 0 0
-----------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of year $ 29,095 $ 26,331 $ 23,901 $ 20,035 $ 18,528
=============================================================================================================================
Net charge-offs to average loans outstanding 0.54% 0.56% 0.42% 0.42% 0.33%
(1) This reserve addition is attributable to loans purchased from Peoples
Bankcorp Inc. and Grange National Banc Corp in 2003 and Citizens National
Bank of Malone and FleetBoston Financial Corporation in 2001.
As displayed in Table 13 above, total net charge-offs in 2003 were $10.3
million, up $0.5 million from the prior year. This increase was primarily driven
by the significantly higher average loan balances resulting from both organic
and acquired loan growth in 2003, as well as business loans reserved for in
prior periods being charged-off during the year. Net charge-offs in 2002 were
$3.2 million above 2001's level, and were also impacted by the vastly increased
size of the average loan portfolio, due mostly to the acquisition of 36
FleetBoston branches in November 2001. In addition, a prolonged period of
economic weakness from late 2000 through early 2003 impacted the net charge-off
levels in both 2002 and 2003, with the greatest impact being realized in the
business loan segment.
Due to the significant increase in average loan balances in 2002 and 2003 as a
result of the factors mentioned above, net charge-offs as a percent of average
loans ("net charge-off ratio") offers a clearer representation of asset quality
trends. The net charge-off ratio for 2003 was down two basis points from last
year to 0.54%. This year's ratio benefited from improved recovery performance,
as evidenced by the $0.6 million increase in recoveries to $2.8 million,
representing 22.7% of average gross charge-offs for the latest two years,
compared to 21.5% in 2002. The net charge-off ratio for the current year was
also positively impacted by a higher proportion of low-risk consumer mortgages
in the portfolio, primarily due to the exceptionally strong growth of this
segment of the portfolio in 2003. Consumer mortgages accounted for 30% of total
average loans in 2003 versus 27% in 2002. For the nine months ended September
30, 2003, the Company's total net charge-off ratio of 0.55% was in the 78th
percentile of the distribution surrounding a peer median of 0.32%.
Business loan net charge-offs increased in 2003, totaling $5.1 million or 0.80%
of average business loans outstanding versus $4.8 million and 0.75% in 2002. The
primary reason for the increased net charge-off ratio for business loans was the
lagged effect of an extended period of soft economic conditions in the markets
served by the Company, and the charge-off of a number of large business loans
that had been identified as weak and had been specifically reserved for in
previous periods. Consumer direct loan net charge-offs declined to $2.1 million
this year from $2.4 million in 2002, resulting in a five-basis point drop in the
net charge-off ratio to 0.57%. Net charge-offs in the consumer indirect segment
were up $0.4 million to $2.9 million in 2003, but this was primarily due to loan
growth as supported by the net charge-off ratio rising only one basis point to
0.94%. The risk profile of new installment loans booked in 2003 was consistent
with 2002 in relation to the credit quality of the borrowers. Seventy-five
percent of new installment lending volume in 2003 was rated as A and B paper,
the two highest rankings in the standard A to D credit categories of FICO scores
considered by regulators to
29
be prime borrowers. This is comparable to the 77% of installment loan
originations rated as A and B in 2002, and well above the 63% of new loan volume
in 2001. Consumer mortgage net charge-offs rose $60,000 to $161,000 due to the
much larger size of the portfolio, and consequently the extremely low net
charge-off ratio of 0.03% was essentially flat with the prior year (0.02%).
All the primary asset quality metrics deteriorated in 2002 in comparison to the
1999 to 2001 period. This was principally due to the weakened economic
conditions in our markets, and was manifested most strongly in the business loan
portfolio. Based on almost all measurements, the asset quality profile of the
Company improved in 2003 in conjunction with gradually improving economic
conditions and strengthened credit administration and loan review resources.
Significant changes and enhancements were made to these functions and related
processes in 2003, and these improvements began to have a positive impact on
credit management performance over the course of the year.
Management continually evaluates the credit quality of the Company's loan
portfolio and conducts a formal review of the allowance for loan loss adequacy
on a quarterly basis. The two primary components of the loan review process that
are used to determine proper allowance levels are specific and general loan loss
allocations.
Measurement of specific loan loss allocations is typically based on expected
future cash flows, collateral values and other factors that may impact the
borrower's ability to pay. Impaired loans greater than $500,000 are evaluated
for specific loan loss allocations, as defined in SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan," as amended. Consumer mortgages and consumer
direct and indirect loans are considered smaller balance homogeneous loans and
are evaluated collectively. The Company considers a loan to be impaired when,
based on current information and events, it is probable that the Company will be
unable to collect all amounts according to the contractual terms of the loan
agreement or the loan is delinquent 90 days or more.
The second component of the allowance establishment process, general loan loss
allocations, is composed of two calculations that are computed on the four main
loan segments: commercial, consumer direct, consumer indirect and residential
real estate. The first calculation determines an allowance level based on the
latest three years of historical net charge-off data for each loan category. The
second calculation is qualitative and takes into consideration five major
factors affecting the level of loan loss risk: portfolio risk migration patterns
(internal credit quality trends); the growth of the segments of the loan
portfolio; economic and business environment trends in the Bank's markets
(includes review of bankruptcy, unemployment, population, consumer spending and
regulatory trends); industry, geographical and product concentrations in the
portfolio; and the perceived effectiveness of managerial resources and lending
practices and policies. These two allowance calculations are added together to
determine the general allocation ratio, which is applied to the four homogenous
loan pools (excluding commercial loan balances with specific loan loss
allocations). The allowance levels computed from the specific and general loan
loss allocation methods are combined to derive the necessary allowance for loan
loss to be reflected on the Consolidated Statement of Condition.
The loan loss provision is calculated by subtracting the previous period
allowance for loan loss, net of the interim period net charge-offs, from the
current required allowance level. This provision is then booked as an expense in
the income statement for that period.
The loan review department, senior credit officers, executive management and the
loan committee of the Board of Directors all examine the results of the
allowance for loan loss process in detail and determine if it is adequate each
quarter. Management is committed to continually improving the credit assessment
and risk management capabilities of the Bank and will dedicate the resources
necessary to ensure advancement in this critical area of operations.
The allowance for loan loss was increased to $29.1 million at year-end 2003 from
$26.3 million at the end of 2002. The $2.8 million increase was mostly due to
$322 million more loans outstanding, offset by less risk in the loan portfolio
due to a higher mix of consumer mortgages and an overall improvement in the
Company's asset quality position. This change in the risk profile is reflected
in the ratio of the allowance for loan loss to total loans, which decreased to
1.37% for year-end 2003 versus 1.46% at the end of last year. As of September
30, 2003, the Company's reserve ratio of 1.41% was 15 basis points below the
peer median, while the coverage of non-performing loans (allowance for loan loss
/ non-performing loans) at 200% was in the 53rd percentile. Management believes
the year-end 2003 allowance for loan losses to be adequate in light of the
probable losses inherent in the Company's loan portfolio.
The loan loss provision decreased by $1.0 million or 8.4% in 2003 as a result of
management's assessment of the probable losses in the loan portfolio as
discussed above. The loan loss provision as a percentage of average loans
decreased from 0.69% in 2002 to 0.59% this year in most part due to the
provision last year being elevated to cover higher risk levels in the business
loan segment of the portfolio. The loan loss provision covered net charge-offs
by 109% this year versus 125% in 2002, reflective of the shift in loan mix and
asset quality trends during the year.
30
The net charge-off ratios of the last two years were above the Company's
long-term historical levels, which were more consistent with the ratios of the
1999 to 2001 period, as shown in Table 13 above. As previously noted, there is a
strong correlation between the increased level of net charge-offs in 2002 and
2003 and the performance of the overall economy. The Company's net charge-off
ratio was also above 50 basis points during the 1990 to 1992 period, when the
ratio fluctuated between 51 and 59 basis points. Not surprisingly, similar to
the last three years, that time frame included a recession and the first stage
of an economic recovery. The net charge-off ratio dropped significantly in the
years immediately following that period. One of management's primary goals is to
steadily bring the net charge-off ratio back to a range that is consistent with
historical performance.
The following table shows management's allocation of the allowance for loan
losses by loan type as of December 31:
Table 14: Allowance for Loan Losses by Loan Type
2003 2002 2001
-------------------- -------------------- --------------------
Amount of Loan Amount of Loan Amount of Loan
(000's omitted) Allowance Mix Allowance Mix Allowance Mix
- ---------------------------- -------------------- -------------------- --------------------
Consumer mortgage $ 1,724 34.7% $ 479 28.2% $ 406 25.6%
Business lending 15,549 32.4% 16,765 34.9% 14,417 37.2%
Consumer direct and indirect 11,112 32.9% 8,978 36.9% 8,970 37.2%
Unallocated 710 109 108
- ---------------------------- -------------------- -------------------- --------------------
Total $29,095 100.0% $26,331 100.0% $23,901 100.0%
============================ ==================== ==================== ====================
2000 1999
-------------------- --------------------
Amount of Loan Amount of Loan
(000's omitted) Allowance Mix Allowance Mix
- ---------------------------- -------------------- --------------------
Consumer mortgage $ 1,483 27.5% $ 1,752 26.7%
Business lending 7,386 38.0% 5,850 37.8%
Consumer direct and indirect 8,314 34.5% 7,655 35.5%
Unallocated 2,852 3,271
- ---------------------------- -------------------- --------------------
Total $20,035 100.0% $18,528 100.0%
============================ ==================== ====================
As demonstrated in Table 14 above and discussed previously, the risk inherit in
the consumer mortgage portfolio is much lower than that of the other segments of
the loan portfolio. The risk differential is illustrated by the average net
charge-off ratio of 0.03% over the last three years for consumer mortgages
compared to the 0.67% average for the rest of the portfolio over the same time
frame. This is manifested in the comparatively small $1,724 allowance
attributable to consumer mortgages, representing only 0.2% of the their ending
balance versus 2.0% for the remaining portion of the loan portfolio. Table 14
also shows that the weighting of consumer mortgages has increased from an
average of 27% of total loans in 2001 and 2002 to 35% in 2003 (average balance
basis) due to strong organic growth in this segment in 2002 and 2003. As
demonstrated by the factors noted above, this shift in the mix of loans toward
low-risk mortgages has been beneficial to the Company's credit risk profile and
has helped offset some of the weakness that developed in the business portion of
the portfolio, primarily due to difficult economic conditions.
Funding Sources
The Company utilizes a variety of funding sources to support the earning asset
base as well as to achieve targeted growth objectives. CBSI's overall funding is
comprised of three primary sources that possess a variety of maturity,
stability, and price characteristics: deposits of individuals, partnerships and
corporations (IPC deposits); collateralized municipal deposits (public funds);
and external borrowings.
The average daily amount of deposits and the average rate paid on each of the
following deposit categories is summarized below for the years indicated:
Table 15: Average Deposits
2003 2002 2001
----------------------- ----------------------- -----------------------
Average Average Average Average Average Average
(000's omitted, except rates) Balance Rate Paid Balance Rate Paid Balance Rate Paid
- ------------------------------------ ----------------------- ----------------------- -----------------------
Non-interest-bearing demand deposits $ 473,568 0.00% $ 441,800 0.00% $ 343,173 0.00%
Interest-bearing demand deposits 274,689 0.24% 262,313 0.47% 186,032 0.71%
Regular savings deposits 430,264 0.80% 402,728 1.32% 344,906 2.11%
Money market deposits 295,287 0.89% 304,623 1.60% 152,150 2.76%
Time deposits 1,090,511 2.89% 1,131,296 3.75% 1,100,850 5.48%
- ------------------------------------ ---------- ---------- ----------
Total deposits $2,564,319 1.49% $2,542,760 2.12% $2,127,111 3.44%
==================================== ========== ========== ==========
As displayed in Table 15 above, total average deposits for 2003 equaled $2.564
billion, up $22 million or 0.8% from the prior year. The acquisitions of People
and Grange did not have a significant impact on full-year average deposit levels
because they were completed relatively late in the year. Average deposits in
2002 were up significantly versus 2001 ($416 million or 20%) primarily as a
result of the acquisition of 36 FleetBoston branches in November 2001 that added
$470 million of deposits.
31
The Company's funding composition continues to benefit from a high level of IPC
deposits, which reached an all-time high in 2003 with a fourth quarter average
of $2.485 billion, an increase of $107 million or 4.5% over the comparable 2002
period. This was largely due to the $242 million in IPC deposits added in
conjunction with the acquisitions of Peoples and Grange in September and
November 2003, respectively. 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 provide a strong
customer base for which a variety of loan, deposit and other financial
service-related products can be sold.
Full-year average deposits of local municipalities decreased $7 million or 3.8%
during 2003, despite the additional public funds acquired through the Grange
transaction. 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 external borrowings. As such, CBSI
endeavors to price these deposits at or below alternative external borrowing
rates. Municipal deposits decreased due to the favorability of the
aforementioned external borrowing rates in comparison to competitive pricing of
the public fund deposits. It should be noted that utilization of municipal
deposits has generally been flat to down over the last few years as a percent of
total funding sources.
The mix of CBSI's average deposits in 2003 changed slightly in comparison to
2002. The weightings of demand deposit, interest checking and savings account
balances all increased from their 2002 levels, while money market and time
deposit weightings decreased. This change in mix largely reflects less
willingness by certain customers to being locked into low CD rates and accounts
with higher minimum balance requirements (money market) given the market-driven
contraction of interest rate spreads between these accounts and less restrictive
ones, such as demand deposits and savings. This shift in the deposit mix
resulted in a greater drop in the overall cost of funds on deposits than would
have been achieved through the reduction of interest rates alone. As a result of
market interest rates remaining at historically low levels for an extended
period of time, spreads between these groups of accounts have stabilized and
customers appear to be more willing to hold term deposits given the lack of
viable alternatives with similar risk/return characteristics. This factor
combined with the Company's ongoing commitment to continually expand its
advantageous IPC deposit base to fund earning-asset growth, prompted the
development of a new CD product in September that has been an effective tool for
attracting new time deposits.
The remaining maturities of time deposits in amounts of $100,000 or more
outstanding as of December 31 are as follows:
Table 16: Time Deposit > $100,000 Maturities
(000's omitted) 2003 2002
--------------------------------------------------------
Less than three months $ 60,504 $ 63,891
Three months to six months 24,351 28,255
Six months to one year 48,306 29,646
Over one years 35,080 35,337
--------------------------------------------------------
Total $168,241 $157,129
========================================================
External 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 and
Federal Reserve Bank of New York, as well as access to the national repurchase
agreement market through established relationships with primary market security
dealers. The Company also had approximately $80 million in fixed and floating-
rate subordinated debt outstanding at the end of 2003 that is held by
unconsolidated subsidiary trusts. External borrowings averaged $508 million or
17% of total funding sources for all of 2003, essentially equivalent to 2002
levels. As shown in Table 17 below, at year-end 2003, $397 million or 59% of
external borrowings had remaining terms of one year or less, up considerably
from $248 million and 46% at the end of 2002. This change in external funding
mix was undertaken to take advantage of an extremely steep yield curve and
protect the Company from falling interest rates, its greatest interest rate risk
exposure.
During fourth quarter 2003, $25 million in longer-term Federal Home Loan Bank
borrowings were retired early and replaced with significantly lower rate,
short-term debt, resulting in an earnings charge of $2.6 million. A similar
strategy was executed in fourth quarter 2002 when approximately $11 million of
intermediate-term FHLB borrowings were prepaid, resulting in a prepayment
penalty of $925,000. Both of these strategies were implemented because the
projected cost of the replacement debt, including prepayment charges, was
favorable on a long-term, economic basis in comparison to holding the existing
borrowings.
As displayed in Table 4 on page 18, the overall mix of funding has shifted
somewhat over the past two years as a result of two major factors. First, the
acquisitions completed during the 2001 to 2003 period supplied a substantial
amount of
32
deposits, but added insignificant levels of external borrowings, enabling the
Company to fund the majority of its earning-asset growth with this favorable
funding source. Consequently, the percentage of funding derived from deposits
was 83.5% in 2003 on a full-year average balance basis, 2.0 percentage points
higher than it was in 2001. This was despite the fact that the most recent
acquisition, Grange did not close until late November 2003, and therefore its
impact on the average funding mix was less pronounced in 2003 than it will be in
2004.
A second major development was that from January 2001 through mid-2003 market
interest rates declined significantly, largely influenced by the Federal Reserve
actions designed to stimulate a weakened US economy. In addition, short-term
interest rates declined by a much greater degree than long rates, resulting in a
much steeper yield curve. Management effectively responded to the changes in the
interest rate environment by reducing deposit rates in a timely manner and
greatly increasing the weighting of short-term borrowings in the external
funding portion of the balance sheet. These moves contributed significantly to
the 1.8 percentage-point drop in external borrowing costs and 2.2
percentage-point decline in the cost of total interest-bearing liabilities from
2001 to 2003.
The following table summarizes the outstanding balance of short-term borrowings
of the Company as of December 31:
Table 17: Short-term Borrowings
(000's omitted, except rates) 2003 2002 2001
---------------------------------------------------------------------------------
Federal funds purchased $ 36,300 $ 33,000 $ 14,200
Term borrowings at banks (original term)
90 days or less 361,000 215,000 31,100
Over 90 days 1,000
Capital lease obligations 96 241 354
---------------------------------------------------------------------------------
Balance at end of period $397,396 $248,241 $ 46,654
=================================================================================
Daily average during the year $212,512 $141,024 $141,772
Maximum month-end balance $397,396 $244,000 $268,600
Weighted average rate during the year 1.26% 1.83% 4.75%
Year-end average rate 1.28% 1.50% 4.16%
The following table shows the maturities of various contractual obligations as
of December 31, 2003:
Table 18: Maturities of Contractual Obligations
Amount
Amount Maturing
Maturing After
After Three
Amount One Years Amount
Maturing Year but but Maturing
Within Within Within After
One Year Three Five Five
(000's omitted) or Less Years Years Years Total
- --------------------------------------------------------------------------------------------------------------------------------
Time deposits $ 817,550 $271,582 $ 84,827 $ 393 $1,174,352
Federal funds purchased 36,300 36,300
Federal Home Loan Bank advances 361,000 15,000 175,000 551,000
Subordinated debt held by unconsolidated subsidiary trusts 80,390 80,390
Other borrowings 96 96
Operating leases 2,114 3,599 2,488 4,286 12,487
- --------------------------------------------------------------------------------------------------------------------------------
Total $1,217,060 $275,181 $102,315 $260,069 $1,854,625
================================================================================================================================
Financial Instruments with Off-Balance Sheet Risk
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
and standby letters of credit. Commitments to extend credit are agreements to
lend to customers, generally having fixed expiration dates or other termination
clauses that may require payment of a fee. These commitments consist principally
of unused commercial and consumer credit lines. Standby letters of credit
generally are contingent upon the failure of the customer to perform according
to the terms of the underlying contract with the third party. The credit risk
associated with commitments to extend credit and standby letters of credit is
essentially the same as that involved with the
33
extending loans to customers and is subject to normal credit policies.
Collateral may be obtained based on management's assessment of the customer's
creditworthiness.
The contract amount of these off-balance sheet financial instruments as of
December 31 is as follows:
Table 19: Off-Balance Sheet Financial Instruments
(000's omitted) 2003 2002
------------------------------------------------------
Standby letters of credit $ 19,163 $ 19,728
Commitments to extend credit 315,898 332,422
------------------------------------------------------
Total $335,061 $352,150
======================================================
Investments
The objective of CBSI's investment portfolio is to hold low-risk, high-quality
earning assets that provide favorable returns and another effective tool to
actively manage its asset/liability position to maximize future net interest
income production. This must be accomplished within the following constraints:
(a) implementing certain interest rate risk management strategies which achieve
a relatively stable level of net interest income; (b) providing both the
regulatory and operational liquidity necessary to conduct day-to-day business
activities; (c) considering investment risk-weights as determined by the
regulatory risk-based capital guidelines; and (d) generating a favorable return
without undue compromise of the other requirements.
As displayed in Table 20 below, the book value of CBSI's investment portfolio
increased $49 million or 4.0% during the year to $1.271 billion as a result of
$249 million of strategic capital market purchases made primarily in the second
half of 2003, offset by planned investment run-off and very limited sales.
Average investment balances (book value basis) for 2003 were down $81 million or
6.4% versus the prior year. This decline was primarily a result of the
de-leveraging policy that was in place in the first half of 2003, whereby
investments were allowed to run-off and the proceeds were used to pay down
external borrowing until investments opportunities became more attractive. This
approach enabled the Company to avoid adding investments at unfavorable spreads
while also building its capital position in order to improve its ability to make
future strategic investments.
Investment interest income in 2003 was $8.0 million or 9.4% lower than the prior
year as a result of the reduced average balances in the portfolio, and the drop
in the average investment yield from 6.74% to 6.53%. The decline in the yield
was primarily due to the general run-off of securities from the portfolio that
been issued in the higher interest rate environments of previous periods and
were partially replaced in the second half of the year with investments that
carry comparatively lower yields. This was inevitable given the fact that
longer-term market interest rates, despite modest increases in the third quarter
of 2003, were still at historically low levels. However, the impact of lower
investment yields was mostly offset by the funding of the purchases with very
low rate short-term borrowings, resulting in similar net spreads. In an annual
study conducted by Investment Performance Digest ("IPD") on banking results
nationwide, CBSI ranked in the 96th percentile for one-year total returns (yield
plus change in market value) on its investment portfolio.
In order to protect the Company against its exposure to falling interest rates,
the vast majority of the investment purchases in 2003 were in intermediate-term
US Agency securities with average call protection in excess of six years.
Investments sales in the current year totaled less than $27 million and were all
related to securities inherited from acquired companies, and resulted in an
immaterial amount of net losses. The sales were based on the Company's total
return strategy (see below) or to remove securities that no longer adhere to
investment policy guidelines. Those proceeds that were reinvested resulted in an
improved interest rate risk position. As of December 31, 2003 the investment
portfolio had a weighted average life of 6.6 years.
The investment portfolio has very limited credit risk due to the composition
continuing to heavily favor U.S. Agency debentures, U.S. Agency mortgage-backed
pass-throughs, U.S. Agency CMOs and municipal bonds insured by third parties. As
of year-end 2003, these four AAA-rated (highest possible rating) security types
accounted for 98% of the portfolio's total book value, excluding Federal Home
Loan Bank stock and Federal Reserve Bank stock, or 48%, 6%, 7% and 37%
respectively. These four security types also comprised 98% of total investments
as of December 31, 2002 at 32%, 11%, 20% and 35%, respectively. The change in
the investment mix reflects management's strategy over the last two years of
primarily purchasing medium-term, call-protected US Agency and municipal bonds
that offer both attractive yields and are free from short-term reinvestment
risk. MBS and CMO securities typically possess a high level of this latter risk,
particularly in periods with high levels of mortgage refinancing such as have
existed over the last few years in the extremely low interest rate environment.
As a consequence, the Company has avoided investing in these types of securities
during this period, and this fact combined with high run-off rates explains the
significant drop in their weighting in the total investment portfolio.
34
Since 1997, the Company has utilized total return as its primary methodology for
managing investment portfolio assets. Under this analytical method, shareholder
value is maximized through both interest income and market value appreciation.
The commitment to this approach is reflected in the fact that no security sales
were conducted in 2003 outside of minor transactions associated with the
investments of acquired banks, despite the significant level of market gains in
the portfolio (see MVA discussion in the following paragraph). Management chose
not to take gains in the current year to increase short-term earnings at the
expense of profitability in future periods. The effectiveness of the Company's
strategic long-term planning focus is evidenced by its total return of 7.81% for
the five-year period ending September 30, 2003, which placed it in the extremely
favorable 98th peer percentile of the IPD study referenced above.
In recent years nearly all of the Company's investments were classified as
available-for sale, but in 2003 a majority of the purchases made in the second
half of the year were categorized as held-to-maturity investments. Eighty-nine
percent of the investment portfolio was classified as available-for-sale at
year-end 2003 versus 99% at the end of the two previous years. The net pre-tax
market value gain over book value as of December 31, 2003 was $58.9 million,
$5.7 million lower than it was one year earlier, but $41.5 million higher than
the MVA at the end of 2001.
The following table sets forth the amortized cost and market value for the
Company's investment securities portfolio:
Table 20: Investment Securities
2003 2002
------------------------- -------------------------
Amortized Amortized
Cost/Book Market Cost/Book Market
(000's omitted) Value Value Value Value
- --------------------------------------------------- ------------------------- -------------------------
Held-to-Maturity Portfolio:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies $ 127,635 $ 125,003 $ 0 $ 0
Obligations of state and political subdivisions 7,459 7,677 7,412 7,666
Other securities 3,558 3,558 3,018 3,018
- --------------------------------------------------- ------------------------- -------------------------
Total held-to-maturity portfolio 138,652 136,238 10,430 10,684
- --------------------------------------------------- ------------------------- -------------------------
Available-for-Sale Portfolio:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies 456,913 479,454 380,243 411,278
Obligations of state and political subdivisions 443,930 470,210 404,864 420,605
Corporate securities 27,712 30,251 27,972 30,225
Collateralized mortgage obligations (CMO's) 89,566 93,552 235,286 245,368
Mortgage-backed securities 76,628 80,177 131,755 137,211
- --------------------------------------------------- ------------------------- -------------------------
Sub-total 1,094,749 1,153,644 1,180,120 1,244,687
Equity securities (1) 29,185 29,185 25,814 25,814
Federal Reserve Bank common stock 8,053 8,053 5,652 5,652
- --------------------------------------------------- ------------------------- -------------------------
Total available-for-sale portfolio 1,131,987 $1,190,882 1,211,586 $1,276,153
========== ==========
Net unrealized gain on available-for-sale portfolio 58,895 64,567
- --------------------------------------------------- ---------- ----------
Total carrying value $1,329,534 $1,286,583
========== ==========
2001
-------------------------
Amortized
Cost/Book Market
(000's omitted) Value Value
- --------------------------------------------------- -------------------------
Held-to-Maturity Portfolio:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies $ 0 $ 0
Obligations of state and political subdivisions 7,608 7,832
Other securities 2,532 2,532
- --------------------------------------------------- -------------------------
Total held-to-maturity portfolio 10,140 10,364
- --------------------------------------------------- -------------------------
Available-for-Sale Portfolio:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies 192,111 203,501
Obligations of state and political subdivisions 282,109 277,593
Corporate securities 43,392 44,399
Collateralized mortgage obligations (CMO's) 400,100 403,780
Mortgage-backed securities 173,978 179,786
- --------------------------------------------------- -------------------------
Sub-total 1,091,690 1,109,059
Equity securities (1) 25,863 25,863
Federal Reserve Bank common stock 5,652 5,652
- --------------------------------------------------- -------------------------
Total available-for-sale portfolio 1,123,205 $1,140,574
==========
Net unrealized gain on available-for-sale portfolio 17,369
- --------------------------------------------------- ----------
Total carrying value $1,150,714
==========
(1) Includes $28,365, $24,575, and $24,700 of FHLB common stock at December
31, 2003, 2002, and 2001, respectively.
35
The following table sets forth as of December 31, 2003, the maturities of
investment securities and the weighted-average yields of such securities, which
have been calculated on the cost basis, weighted for scheduled maturity of each
security, and adjusted to a fully tax-equivalent basis:
Table 21: Maturities of Investment Securities
Amount Amount
Amount Maturing Maturing
Maturing After One After Five Amount Total
Within Year but Years but Maturing Amortized
One Year Within Within After Cost/Book
(000's omitted, except rates) or Less Five Years Ten Years Ten Years Value
- ---------------------------------------------------------------------------------------------------------------------------------
Held-to-Maturity Portfolio:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies $ 0 $ 0 $ 99,267 $ 28,368 $ 127,635
Obligations of state and political subdivisions 4,582 2,390 487 0 7,459
Other securities 3,558 3,558
- ---------------------------------------------------------------------------------------------------------------------------------
Total held-to-maturity portfolio $4,582 $ 2,390 $ 99,754 $ 31,926 $ 138,652
=================================================================================================================================
Weighted Average Yield for Year(1) 4.20% 6.44% 4.72% 5.47% 4.91%
Available-for-Sale Portfolio:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies $2,000 $ 5,401 $297,334 $152,178 $ 456,913
Obligations of state and political subdivisions 2,283 23,013 172,959 245,675 443,930
Corporate securities 0 142 8,384 19,186 27,712
Collateralized mortgage obligations (CMO's) 0 1,478 29,892 58,196 89,566
Mortgage-backed securities 46 4,555 2,512 69,515 76,628
- ---------------------------------------------------------------------------------------------------------------------------------
Total available-for-sale portfolio $4,329 $34,589 $511,081 $544,750 $1,094,749
=================================================================================================================================
Weighted Average Yield for Year(1) 6.18% 6.75% 6.03% 6.71% 6.39%
(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
38.9%. 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.
Impact of Inflation and Changing Prices
The Company's financial statements have been prepared in terms of historical
dollars, without considering changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies, virtually all of
the assets and liabilities of a financial institution are monetary in nature. As
a result, interest rates have a more significant impact on a financial
institution's performance than the effect of general levels of inflation.
Interest rates do not necessarily move in the same direction or in the same
magnitude as the prices of goods and services. Notwithstanding this, inflation
can directly affect the value of loan collateral, in particular real estate.
New Accounting Pronouncements
In March 2003, the SEC issued Regulation G, Conditions for Use of Non-GAAP
Financial Measures. As defined in Regulation G, a non-GAAP financial measure is
a numerical measure of a company's historical or future performance, financial
position, or cash flow that excludes or includes amounts or adjustments that are
included or excluded in the most directly comparable measure calculated in
accordance with generally accepted accounting principles (GAAP). Companies that
present non-GAAP financial measures must disclose a numerical reconciliation to
the most directly comparable measurement using GAAP. This disclosure requirement
applies to earnings releases and similar announcements made after March 28,
2003. The Company adopted Regulation G in 2003.
See Accounting Pronouncement Section of Note A of the notes to the consolidated
financial statements on page 50 for additional accounting pronouncements.
36
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 or consumated by the Company and the costs and factors
associated therewith; (9) the ability to maintain and increase market share and
control expenses; (10) the effect of changes in laws and regulations (including
laws and regulations concerning taxes, banking, securities and insurance) and
accounting principles generally accepted in the United States; (11) changes in
the Company's organization, compensation and benefit plans and in the
availability of, and compensation levels for, employees in its geographic
markets; (12) the costs and effects of litigation and of any adverse outcome in
such litigation; (13) other risk factors outlined in the Company's filings with
the Securities and Exchange Commission from time to time; and (14) the success
of the Company at managing the risks of the foregoing.
The foregoing list of important factors is not exclusive. Such forward-looking
statements speak only as of the date on which they are made and the Company does
not undertake any obligation to update any forward-looking statement, whether
written or oral, to reflect events or circumstances after the date on which such
statement is made. If the Company does update or correct one or more
forward-looking statements, investors and others should not conclude that the
Company will make additional updates or corrections with respect thereto or with
respect to other forward-looking statements.
37
Item 7a. Quanitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates, prices or credit risk. Credit risk associated with the
Company's loan portfolio has been previously discussed in the asset quality
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations. Although more than a third of the securities portfolio at
year-end 2003 was invested in municipal bonds, management believes that the tax
risk of the Company's municipal investments associated with potential future
changes in statutory, judicial and regulatory actions is minimal. The Company
has an insignificant amount of credit risk in its investment portfolio because
essentially all of the fixed-income securities in the portfolio are AAA-rated
(highest possible rating). Therefore, almost all the market risk in the
investment portfolio is related to interest rates.
The ongoing monitoring and management of both interest rate risk and liquidity,
in the short and long term time horizons is an important component of the
Company's asset/liability management process, which is governed by limits
established in the policies reviewed and approved annually by the Board of
Directors. The Board of Directors delegates responsibility for carrying out the
policies to the Asset/Liability Committee (ALCO) which meets each month and is
made up of the Company's senior management as well as regional and
line-of-business managers who oversee specific earning asset classes and various
funding sources.
As the Company does not believe it is possible to reliably predict future
interest rate movements, it has maintained an appropriate process and set of
measurement tools which enable it to identify and quantify sources of interest
rate risk in varying rate environments. The primary tool used by the Company in
managing interest rate risk is income simulation.
While a wide variety of strategic balance sheet and treasury yield curve
scenarios are tested on an ongoing basis, the following reflects the Company's
one-year net interest income sensitivity based on:
o Asset and liability levels using December 31, 2003 as a starting point.
o There are assumed to be conservative levels of balance sheet growth-- low
to mid single digit growth in loans, investments and deposits, augmented
by necessary changes in borrowings and retained earnings, with no growth
in other major portions of the balance sheet.
o The prime rate and federal funds rates are assumed to move up 200 basis
points and down 100 basis points over a 12-month period while flattening
the long end of the treasury curve to spreads over federal funds that are
more consistent with historical norms. Deposit rates are assumed to move
in a manner that reflects the historical relationship between deposit rate
movement and changes in the federal funds rate, generally reflecting
10%-70% of the movement of the federal funds rate.
o Cash flows are based on contractual maturity, optionality and amortization
schedules along with applicable prepayments derived from internal
historical data and external sources.
Net Interest Income Sensitivity Model
Calculated increase (decrease) in Projected
Net Interest Income at December 31
Change in -------------------------------------------
Interest Rates 2003 2002
-----------------------------------------------------------------
+ 200 basis points ($3,900,000) $2,800,000
- 100 basis points ($2,100,000) ($3,000,000)
The change from 2002 largely reflects the increase in intermediate term US
Agency investments with an average call protection of greater than 6 years. The
addition of these investments which were funded relatively short reduced the net
interest income as rates rise but improves the net interest income if rates were
unchanged or decline.
In the 2003 model, both the rising and falling rate environments reflect a
reduction in net interest income (NII) from a flat rate environment due to the
assumed flattening of the yield curve. The modeled NII in a falling rate
environment is initially more favorable than if rates were to rise due to a
faster initial reaction from core deposit pricing and short-term capital market
borrowing rates. Over a longer time period, however, the growth in NII improves
significantly in a rising rate environment as a result of lower yielding earning
assets running off and being replaced at increased rates. The analysis does not
represent a Company forecast and should not be relied upon as being indicative
of expected operating results. These hypothetical estimates are based upon
numerous assumptions: the nature and timing of interest rate levels (including
yield curve shape), prepayments on loans and securities, deposit decay rates,
pricing decisions on loans and deposits, reinvestment/replacement of asset and
liability cash flows, and other factors. While the assumptions are developed
based upon current economic and local market conditions, the Company cannot make
any assurances as to the predictive
38
nature of these assumptions, including how customer preferences or competitor
influences might change. Furthermore, the sensitivity analysis does not reflect
actions that ALCO might take in responding to or anticipating changes in
interest rates.
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements and independent auditor's
reports of Community Bank System, Inc. and subsidiaries are contained on pages
40 through 68 of this item.
o Consolidated Statements of Condition,
December 31, 2003 and 2002
o Consolidated Statements of Income,
Years ended December 31, 2003, 2002, and 2001
o Consolidated Statements of Changes in Shareholders' Equity,
Years ended December 31, 2003, 2002, and 2001
o Consolidated Statements of Comprehensive Income,
Years ended December 31, 2003, 2002, and 2001
o Consolidated Statements of Cash Flows,
Years ended December 31, 2003, 2002, and 2001
o Notes to Consolidated Financial Statements,
December 31, 2003
o Report of Independent Auditor
Quarterly Selected Data (Unaudited) for 2003 and 2002 are contained on page 69.
39
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(In Thousands, Except Share Data)
December 31, December 31,
2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 103,923 $ 113,531
Held-to-maturity investment securities 138,652 10,430
Available-for-sale investment securities 1,190,882 1,276,153
- ----------------------------------------------------------------------------------------------------------------------
Total investment securities (fair value of $1,327,120 and $1,283,819) 1,329,534 1,286,583
Loans 2,128,509 1,806,905
Allowance for loan losses 29,095 26,331
- ----------------------------------------------------------------------------------------------------------------------
Net loans 2,099,414 1,780,574
Premises and equipment, net 61,705 56,997
Accrued interest receivable 25,851 22,793
Core deposit intangibles, net 33,998 30,769
Goodwill, net 159,596 104,059
Other intangibles, net 2,517 0
- ----------------------------------------------------------------------------------------------------------------------
Intangible assets, net 196,111 134,828
Other assets 38,859 41,941
- ----------------------------------------------------------------------------------------------------------------------
Total Assets $ 3,855,397 $ 3,437,247
======================================================================================================================
Liabilities and Shareholders' Equity
Liabilities:
Non-interest bearing deposits $ 498,195 $ 439,075
Interest bearing deposits 2,227,293 2,066,281
- ----------------------------------------------------------------------------------------------------------------------
Total deposits 2,725,488 2,505,356
Federal funds purchased 36,300 33,000
Borrowings 551,096 430,241
Subordinated debt held by unconsolidated subsidiary trusts 80,390 80,334
Accrued interest and other liabilities 57,295 63,278
- ----------------------------------------------------------------------------------------------------------------------
Total Liabilities 3,450,569 3,112,209
- ----------------------------------------------------------------------------------------------------------------------
Commitment and contingencies (see Note N)
Shareholders' equity:
Preferred stock $1.00 par value, $100.00 stated value; 500,000 shares
authorized, 0 shares issued
Common stock no par $1.00 stated value, 20,000,000 shares authorized;
14,373,306 and 12,978,554 shares issued for 2003 and 2002, respectively 14,373 12,979
Additional paid-in capital 144,440 79,058
Retained earnings 218,628 194,483
Accumulated other comprehensive income 35,958 38,551
Treasury stock, at cost (208,150 shares) (8,490) 0
Employee stock plan - unearned (81) (33)
- ----------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 404,828 325,038
- ----------------------------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 3,855,397 $ 3,437,247
======================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
40
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per-Share Data)
Years Ended December 31,
-------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $ 125,256 $130,860 $ 132,014
Interest and dividends on taxable investments 47,047 57,133 56,204
Interest and dividends on non-taxable investments 18,826 17,100 10,274
- ------------------------------------------------------------------------------------------------------------------
Total interest income 191,129 205,093 198,492
- ------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 38,288 53,878 73,163
Interest on federal funds purchased 298 511 883
Interest on short-term borrowings 2,387 2,075 5,855
Interest on subordinated debt held by unconsolidated subsidiary trusts 5,632 5,985 5,182
Interest on long-term borrowings 12,696 14,794 16,754
- ------------------------------------------------------------------------------------------------------------------
Total interest expense 59,301 77,243 101,837
- ------------------------------------------------------------------------------------------------------------------
Net interest income 131,828 127,850 96,655
Less: provision for loan losses 11,195 12,222 7,097
- ------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 120,633 115,628 89,558
- ------------------------------------------------------------------------------------------------------------------
Non-interest income:
Deposit service fees 23,124 16,480 12,737
Other banking services 1,653 1,805 1,934
Trust, investment and asset management fees 6,682 8,003 7,836
Benefit plan administration, consulting and actuarial fees 6,220 3,845 3,585
(Loss) gain on investment securities & debt extinguishment (2,698) 1,673 (113)
- ------------------------------------------------------------------------------------------------------------------
Total non-interest income 34,981 31,806 25,979
- ------------------------------------------------------------------------------------------------------------------
Operating expenses:
Salaries and employee benefits 53,164 47,864 40,930
Occupancy 9,297 8,154 6,122
Equipment and furniture 7,828 7,538 6,075
Amortization of intangible assets 5,093 5,953 6,679
Legal and professional fees 3,183 3,272 2,789
Data processing 6,800 6,574 4,727
Office supplies 1,996 2,321 1,995
Acquisition and unusual expenses 498 700 8,164
Other 14,602 12,654 11,113
- ------------------------------------------------------------------------------------------------------------------
Total operating expenses 102,461 95,030 88,594
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 53,153 52,404 26,943
Income taxes 12,773 13,887 7,814
- ------------------------------------------------------------------------------------------------------------------
Net Income $ 40,380 $ 38,517 $ 19,129
==================================================================================================================
Basic earnings per share $ 3.07 $ 2.97 $ 1.64
Diluted earnings per share $ 2.99 $ 2.93 $ 1.62
Dividends declared per share $ 1.22 $ 1.12 $ 1.08
The accompanying notes are an integral part of the consolidated financial
statements.
41
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2001, 2002 and 2003
(In Thousands, Except Share Data)
Common Stock
------------------------------
Additional
Shares Amount Paid-In Retained
Outstanding Issued Capital Earnings
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 10,559,897 $11,208 $37,711 $163,917
Net income 19,129
Other comprehensive income,
net of tax
Dividends declared:
Common, $1.08 per share (12,574)
Issuance of common stock 1,308,800 1,309 30,755
Common stock issued under
employee stock plan, including
tax benefits of $6 82,546 83 1,338
Fractional shares redeemed (431) (1) (12)
Stock issued for acquisition 952,000 304 7,918
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 12,902,812 $12,903 $77,710 $170,472
Net income 38,517
Other comprehensive income,
net of tax
Dividends declared:
Common, $1.12 per share (14,506)
Common stock issued under
employee stock plan, including
tax benefits of $219 75,742 76 1,348
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 12,978,554 $12,979 $79,058 $194,483
Net income 40,380
Other comprehensive loss,
net of tax
Dividends declared:
Common, $1.22 per share (16,235)
Common stock issued under
employee stock plan, including
tax benefits of $1,410 247,661 247 6,161
Stock and options issued for
acquisition 1,147,091 1,147 59,221
Treasury stock purchased (208,150)
- ------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 14,165,156 $14,373 $144,440 $218,628
============================================================================================================
Accumulated
Other Employee
Comprehensive Treasury Stock Plan
Income Stock -Unearned Total
- ----------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $5,966 ($17,006) ($5) $201,791
Net income 19,129
Other comprehensive income,
net of tax 1,315 1,315
Dividends declared:
Common, $1.08 per share (12,574)
Issuance of common stock 32,064
Common stock issued under
employee stock plan, including
tax benefits of $6 (381) 1,040
Fractional shares redeemed (13)
Stock issued for acquisition 17,006 25,228
- ----------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $7,281 $0 ($386) $267,980
Net income 38,517
Other comprehensive income,
net of tax 31,270 31,270
Dividends declared:
Common, $1.12 per share (14,506)
Common stock issued under
employee stock plan, including
tax benefits of $219 353 1,777
- ----------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $38,551 $0 ($33) $325,038
Net income 40,380
Other comprehensive loss,
net of tax (2,593) (2,593)
Dividends declared:
Common, $1.22 per share (16,235)
Common stock issued under
employee stock plan, including
tax benefits of $1,410 (48) 6,360
Stock and options issued for
acquisition 60,368
Treasury stock purchased (8,490) (8,490)
- ----------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $35,958 ($8,490) ($81) $404,828
==========================================================================================================
See Note A "Earnings Per Share" concerning an announced two-for-one stock split.
The accompanying notes are an integral part of the consolidated financial
statements.
42
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
Years Ended December 31,
-------------------------------------
2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, before tax:
Change in minimum pension liability adjustment $ 92 $ 4,919 ($5,016)
Unrealized (loss) gain on securities:
Unrealized holding (losses) gains arising during period (5,727) 49,796 9,638
Reclassification adjustment for losses (gains) included in net income 54 (2,598) (2,546)
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, before tax (5,581) 52,117 2,076
Income tax benefit (expense) related to other comprehensive (loss) income 2,988 (20,847) (761)
- --------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax (2,593) 31,270 1,315
Net income 40,380 38,517 19,129
- --------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 37,787 $ 69,787 $ 20,444
====================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
43
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars, except Share Data)
Years Ended December 31,
------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 40,380 $ 38,517 $ 19,129
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation 7,139 6,596 5,049
Amortization of intangible assets 5,093 5,953 6,679
Net amortization of premiums and discounts on securities and loans 2,303 3,256 2,030
Amortization of unearned compensation and discount on subordinated debt 172 443 276
Provision for loan losses 11,195 12,222 7,097
Provision for deferred taxes 835 4,458 (835)
Loss (gain) on sale of investment securities and early retirement of long-term borrowings 2,698 (1,673) 113
Loss (gain) on loans and other assets 350 (28) (283)
Proceeds from the sale of loans held for sale 67,482 9,103 43,802
Origination of loans held for sale (61,036) (14,858) (43,350)
Change in other operating assets and liabilities (3,541) (11,815) 8,191
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 73,070 52,174 47,898
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of available-for-sale investment securities 41,227 96,294 141,959
Proceeds from maturities of held-to-maturity investment securities 5,229 4,521 6,172
Proceeds from maturities of available-for-sale investment securities 242,614 197,928 205,135
Purchases of held-to-maturity investment securities (133,517) (4,577) (5,946)
Purchases of available-for-sale investment securities (141,658) (383,598) (514,132)
Net (increase) decrease in loans outstanding (151,520) (77,906) 12,155
Cash paid for acquisitions (net of cash acquired of $23,986, $0, $212,353) (9,630) 0 210,523
Capital expenditures (8,322) (8,831) (7,730)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash (used) provided by investing activities (155,577) (176,169) 48,136
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts 39,745 25,005 206,490
Net change in time deposits (68,220) (65,619) (166,998)
Net change in federal funds purchased 3,300 18,800 (34,530)
Net change in borrowings 117,356 165,976 (92,642)
Issuance of common stock 4,819 1,151 32,837
Purchase of treasury stock (8,490) 0 0
Cash dividends paid (15,466) (14,228) (10,980)
Other financing activities (145) (113) (113)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 72,899 130,972 (65,936)
- ------------------------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents (9,608) 6,977 30,098
Cash and cash equivalents at beginning of year 113,531 106,554 76,456
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 103,923 $ 113,531 $ 106,554
====================================================================================================================================
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest $ 60,062 $ 79,250 $ 104,306
Cash paid for income taxes $ 13,095 $ 6,429 $ 8,082
Supplemental Disclosures of Non-cash Financing and Investing Activities:
Dividends declared and unpaid $ 4,529 $ 3,760 $ 3,482
Gross change in unrealized gains on available-for-sale investment securities ($5,673) $ 47,198 $ 7,092
Change in minimum pension liability adjustment ($92) ($4,919) $ 5,016
Acquisitions:
Fair value of assets acquired, excluding acquired cash $ 327,530 $ 0 $ 382,560
Fair value of liabilities assumed $ 257,532 $ 0 $ 569,685
Common stock and options issued, including treasury stock of $17,006 in 2001 $ 60,376 $ 0 $ 25,228
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
44
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Community Bank System, Inc. is a single bank holding company which wholly-owns
four consolidated subsidiaries: Community Bank, N.A. (the Bank), Benefit Plans
Administrative Services, Inc. (BPA), CFSI Closeout Corp. (CFSICC), and First of
Jermyn Realty Co. (FJRC). BPA owns two subsidiaries, Benefit Plans
Administrative LLC and Harbridge Consulting Group LLC. BPA provides
administration, consulting and actuarial services to sponsors of employee
benefit plans. CFSICC and FJRC are inactive companies.
The Bank operates 126 customer facilities throughout twenty-two counties of
Upstate New York and five counties of Northeastern Pennsylvania. The Bank owns
the following subsidiaries: Community Investment Services, Inc. (CISI), CBNA
Treasury Management Corporation (TMC), CBNA Preferred Funding Corporation (PFC),
Elias Asset Management, Inc. (EAM) and First Liberty Service Corp. (FLSC). CISI
provides broker-dealer and investment advisory services. TMC operates the cash
management, investment, and treasury functions of the Bank. PFC primarily is an
investor inresidential real estate loans. EAM provides asset management services
to individuals, corporate pension and profit sharing plans, and foundations.
FLSC provides banking related services to the Pennsylvania branches of the Bank.
The Company wholly-owns three unconsolidated subsidiary business trusts formed
for the purpose of issuing mandatorily redeemable preferred securities which are
considered Tier I capital under regulatory capital adequacy guidelines (see Note
A - Accounting Pronouncements and Notes H and P).
Basis of Presentation
All amounts except share, per-share and rates are presented in thousands.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All inter-company accounts and transactions have
been eliminated in consolidation. Certain prior period amounts have been
reclassified to conform with the current period presentation.
Critical Accounting Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Critical accounting estimates include the allowance for loan losses, actuarial
assumptions associated with the pension, post-retirement and other employee
benefit plans, the provision for income taxes, the fair value of certain
investment securities, and the carrying value of goodwill and other intangible
assets.
Risk and Uncertainties
In the normal course of its business, the Company encounters economic and
regulatory risks. There are three main components of economic risk: interest
rate risk, credit risk and market risk. The Company is subject to interest rate
risk to the degree that its interest-bearing liabilities mature or reprice at
different speeds, or on different bases, from its interest-earning assets. The
Company's primary credit risk is the risk of default on the Company's loan
portfolio that results from the borrowers' inability or unwillingness to make
contractually required payments. Market risk reflects potential changes in the
value of collateral underlying loans, the fair value of investment securities,
and loans held for sale.
The Company is subject to regulations of various governmental agencies. These
regulations can and do change significantly from period to period. The Company
also undergoes periodic examinations by the regulatory agencies which may
subject it to further changes with respect to asset valuations, amounts of
required loan loss allowances, and operating restrictions resulting from the
regulators' judgements based on information available to them at the time of
their examinations.
45
Business Combinations
Since the Financial Accounting Standards Board (FASB) issued SFAS 141, "Business
Combinations," business combinations initiated after June 30, 2001 are required
to be accounted for under the purchase method. Under the purchase method, net
assets of the business acquired are recorded at their estimated fair value as of
the date of acquisition with any excess of the cost of the acquisition over the
fair value of the net tangible and intangible assets acquired recorded as
goodwill. Results of operations of the acquired business are included in the
income statement from the date of acquisition. Prior to SFAS 141, certain
business combinations were accounted for under the pooling-of-interests method,
which required the retroactive combining of the assets, liabilities,
shareholders' equity, and results of operations of the merged entity with the
Company's respective accounts at historical amounts. Prior period financial
statements were restated to give effect to business combinations accounted for
under this method.
Revenue Recognition
The Company recognizes income on an accrual basis. CISI recognizes fee income
when investment and insurance products are sold to customers. EAM provides asset
management services to brokerage firms and clients and recognizes income ratably
over the contract period during which service is performed. Revenue from BPA's
administration and recordkeeping services is recognized ratably over the service
contract period. Revenue from consulting and actuarial services in recognized
when services are rendered. All inter-company revenue and expense among related
entities are eliminated in consolidation.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand and amounts due from banks. The carrying amounts reported in the balance
sheet for cash and cash equivalents approximate those assets' fair values.
Investment Securities
The Company has classified its investments in debt and equity securities as
held-to-maturity or available-for-sale. Held-to-maturity securities are those
for which the Company has the positive intent and ability to hold to maturity,
and are reported at cost, which is adjusted for amortization of premiums and
accretion of discounts. Debt securities not classified as held-to-maturity are
classified as available-for-sale and are reported at fair market value with net
unrealized gains and losses reflected as a separate component of shareholders'
equity, net of applicable income taxes. None of the Company's investment
securities has been classified as trading securities. Equity securities are
stated at cost and include stock of the Federal Reserve Bank of New York and
Federal Home Loan Bank of New York. Investment securities are reviewed regularly
for other than temporary impairment. Where there is other than temporary
impairment, the carrying value of the investment security is reduced to the
estimated fair value, with the impairment loss recognized in the consolidated
statements of income as non-interest income.
The average cost method is used in determining the realized gains and losses on
sales of investment securities. 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, net of unearned income. Mortgage
loans held for sale are carried at the lower of cost or fair value and are
included in loans as the balance of such loans was not significant. Fair values
for variable rate loans that reprice frequently 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. The carrying amount of accrued interest approximates
its fair value.
Interest on loans 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 interest method.
Non-refundable loan fees and related direct costs are included in the loan
balances and are deferred and amortized over the life of the loan as an
adjustment to loan yield using the effective interest method. Premiums and
discounts on purchased loans are amortized on an accelerated method over the
life of the loans.
46
Impaired and Other Nonaccrual Loans
The Company places a loan on nonaccrual status when the loan becomes ninety
days past due (or sooner, if management concludes collection of interest is
doubtful), except when, in the opinion of management, it is well-collateralized
and in the process of collection. A loan may be placed on nonaccrual status
earlier than ninety days past due if there is deterioration in the financial
position of the borrower or if other conditions of the loan so warrant. When a
loan is placed on nonaccrual status, uncollected accrued interest is reversed
against interest income. Interest income during the period the loan is on
nonaccrual status is recorded on a cash basis. Nonaccrual loans are returned to
accrual status when management determines that the borrower's performance has
improved and that both principal and interest are collectible. This generally
requires a sustained period of timely principal and interest payments.
Commercial loans greater than $500,000 are evaluated individually for impairment
in accordance with FASB No. 114, "Accounting by Creditors for Impairment of a
Loan." A loan is considered impaired, based on current information and events,
if it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. The measurement of impaired loans is generally based upon
the present value of expected future cash flows, except that all
collateral-dependent loans are measured for impairment based on fair value of
the collateral.
The Company's charge-off policy by loan type is as follows:
o Commercial loans and commercial loans secured by real estate are generally
charged-off to the extent outstanding principal exceeds the fair value of
estimated proceeds from collection efforts, including liquidation of
collateral. The charge-off is recognized when the loss becomes reasonably
quantifiable, but no later than 120 days after an uncured delinquency.
o Consumer installment loans are generally charged-off to the extent
outstanding principal balance exceeds the fair value of collateral, and
are recognized by the end of the month in which the loan becomes 120 days
past due.
o Loans secured by 1-4 family residential real estate are generally
charged-off to the extent outstanding principal exceeds the fair value of
the property, and are recognized when the loan becomes 180 days past due.
Allowance for Loan Losses
The allowance for loan losses reflects management's best estimate of probable
loan losses in the Company's loan portfolio. Determination of the allowance for
loan losses is inherently subjective. It requires significant estimates
including the amounts and timing of expected future cash flows on impaired loans
and the amount of estimated losses on pools of homogeneous loans which is based
on historical loss experience and consideration of current economic trends, all
of which may be susceptible to significant change.
When appropriate, an impaired loan is assigned a specific allowance. Specific
loan loss allocations for certain commercial loans are considered and revised as
necessary. Charge-off of these commercial loans are taken against the specific
allocations before being applied against the general reserve. General
allocations on the commercial, residential and consumer loan portfolios are
reviewed and recalculated quarterly based on historical loss experience and
various qualitative judgement factors. Loan losses are charged off against the
allowance, while recoveries of amounts previously charged off are credited to
the allowance.
Intangible Assets
Intangible assets include core deposit intangibles, customer relationship
intangibles and goodwill arising from acquisitions. Goodwill is evaluated at
least annually for impairment. Core deposit intangibles and customer
relationship intangibles are amortized on either an accelerated or straight-line
basis over periods ranging from 7 to 19 years.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation.
Computer software costs that are capitalized only include external direct costs
of obtaining and installing the software. The annual provision for depreciation
is computed using the straight-line method over the assets' estimated useful
lives. Maintenance and repairs are charged to expense as incurred.
Other Real Estate
Properties acquired through foreclosure, or by deed in lieu of foreclosure, are
carried at the lower of the unpaid loan balance or fair value less estimated
costs of disposal. At December 31, 2003 and 2002, other real estate, included in
other assets, amounted to $1,077 and $704, respectively.
47
Mortgage Servicing Rights
Originated mortgage servicing rights are recorded at their allocated fair value
at the time of sale of the underlying loan, and are amortized in proportion to
and over the period of estimated net servicing income or loss. The Company uses
a valuation model that calculates the present value of future cash flows to
determine the fair value of servicing rights. In using this valuation method,
the Company incorporates assumptions that market participants would use in
estimating future net servicing income, which includes estimates of the
servicing cost per loan, the discount rate, and prepayment speeds. The carrying
value of the originated mortgage servicing rights is periodically evaluated for
impairment using these same market assumptions.
Deposits
The fair value of deposit obligations are based on current market rates for
alternative funding sources, principally the Federal Home Loan Bank of New York.
The carrying value of accrued interest approximates fair value.
Borrowings
The carrying amounts of federal funds purchased and short-term borrowings
approximate their fair values. Fair values for long-term borrowings are
estimated using discounted cash flows and interest rates currently being offered
on similar borrowings.
Since the Company considers debt extinguishments to be a component of its
interest rate risk management, any related gains or losses are not deemed
extraordinary and are presented in the non-interest income section of the
consolidated statements of income.
Treasury Stock
On June 9, 2003, the Company announced a twelve-month authorization to
repurchase up to 700,000 of its outstanding shares in open market or privately
negotiated transactions. The repurchases will be for general corporate purposes,
including those related to acquisition and stock plan activities. As of December
31, 2003, the Company has repurchased 208,150 shares at an aggregate cost of
$8,490 or $40.79 per share.
Income Taxes
Provisions for income taxes are based on taxes currently payable or refundable,
and deferred taxes which are based on temporary differences between the tax
basis of assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are reported in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled.
Retirement Benefits
The Company has established tax-qualified retirement plans covering
substantially all full-time employees and certain part-time employees. The
Company also provides post-retirement benefits for eligible retired employees
and dependents. Expense under these plans is charged to current operations and
consists of several components of net periodic benefit cost based on various
actuarial assumptions regarding future experience under the plans. In addition,
the Company has unfunded deferred compensation and supplemental executive
retirement plans for selected current and former employees and officers that
provide benefits that cannot be paid from a qualified retirement plan due to
Internal Revenue Code restrictions. These plans are nonqualified under the
Internal Revenue Code, and assets used to fund benefit payments are not
segregated from other assets of the Company.
Assets Under Management or Administration
Assets held in fiduciary or agency capacities for customers are not included in
the accompanying consolidated statements of condition as they are not assets of
the Company. Substantially all fees associated with providing asset management
services are recorded on an accrual basis of accounting and are included in
non-interest income. Assets under management or administration at December 31,
2003 and 2002 were $1,807,000 and $1,364,000, respectively.
Earnings Per Share
Basic earnings per share is computed based on the weighted-average common shares
outstanding for the period. Diluted earnings per share is based on the
weighted-average shares outstanding adjusted for the dilutive effect of the
assumed exercise of stock options during the year. The dilutive effect of
options is calculated using the treasury stock method.
48
The treasury stock method determines the number of common shares that would be
outstanding if all in-the-money options (average market price is greater than
the exercise price) were exercised and the proceeds were used to repurchase
common shares in the open market at the average market price for the applicable
time period. There were no anti-dilutive stock options for the year ended
December 31, 2003.
On January 21, 2004, the Company announced a two-for-one stock split, subject to
shareholder approval of an increase in its authorized shares. The split will be
effected in the form of a 100% stock dividend, which the Company expects to be
payable on or about April 12, 2004, to shareholders of record on or about March
17, 2004. The Company will seek approval of an amendment to increase its total
authorized shares from 20 million to 50 million shares at a special Meeting of
Shareholders to be held on March 26, 2004.
Accumulated Other Comprehensive Income
Accumulated other comprehensive income includes unrealized holding gains on
investment securities of $35,961, $38,610 and $10,330 and a minimum pension
liability adjustment of ($3), ($59) and ($3,049) as of December 31, 2003, 2002
and 2001, respectively.
Stock-Based Compensation
The Company accounts for stock awards issued to directors, officers and key
employees using the intrinsic value method. This method requires that
compensation expense be recognized to the extent that the fair value of the
stock exceeds the exercise price of the stock award at the grant date. The
Company generally does not recognize compensation expense related to stock
awards because the stock awards generally have fixed terms and exercise prices
that are equal to or greater than the fair value of the Company's common stock
at the grant date.
SFAS 123, "Accounting for Stock-Based Compensation," requires companies that use
the "intrinsic value method" to account for stock compensation plans to provide
pro forma disclosures of the net income and earnings per share effect of stock
options using the "fair value method." Under this method, the fair value of the
option on the date of grant is recognized ratably as compensation expense over
the vesting period of the option.
Management estimated the fair value of options granted using the Black-Scholes
option-pricing model. This model was originally developed to estimate the fair
value of exchange-traded equity options, which (unlike employee stock options)
have no vesting period or transferability restrictions. As a result, the
Black-Scholes model is not necessarily a precise indicator of the value of an
option, but it is commonly used for this purpose. The Black-Scholes model
requires several assumptions, which management developed based on historical
trends and current market observations. These assumptions include:
2003 2002 2001
- -------------------------------------------------------------------------------
Weighted-average expected life 7.55-8.76 6.74 7.02
Future dividend yield 3.00% 3.00% 3.00%
Share price volatility 25.59%-27.58% 27.82% 28.14%
Weighted average risk-free interest rate 3.82%-4.03% 3.81%-5.16% 5.11%
===============================================================================
If these assumptions are not accurate, the estimated fair value used to derive
the information presented in the following table also will be inaccurate.
Moreover, the model assumes that the estimated fair value of an option is
amortized over the option's vesting period and would be included in salaries and
employee benefits on the income statement. The pro forma impact of applying the
fair value method of accounting for the years shown below may not be indicative
of the pro forma impact in future years.
2003 2002 2001
- -------------------------------------------------------------------------------------------
Net income, as reported $40,380 $38,517 $19,129
Less: stock-based compensation expense determined under
fair value method, net of tax 779 692 796
- -------------------------------------------------------------------------------------------
Pro forma net income $39,601 $37,825 $18,333
===========================================================================================
Earnings per share as reported:
Basic $ 3.07 $ 2.97 $ 1.64
Diluted $ 2.99 $ 2.93 $ 1.62
Pro forma earnings per share:
Basic $ 3.01 $ 2.92 $ 1.57
Diluted $ 2.93 $ 2.87 $ 1.55
===========================================================================================
49
Fair Values of Financial Instruments
The Company determines fair values based on quoted market values where available
or on estimates using present values or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. SFAS 107, "Disclosures about Fair Value of Financial Instruments,"
excludes certain financial instruments and all non-financial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company. The fair values
of investment securities, loans, deposits, and borrowings have been disclosed in
footnotes C, D, G, and H, respectively.
Accounting Pronouncements
In December 2003, the SEC staff announced its intention to release a Staff
Accounting Bulletin that would require all registrants to account for mortgage
loan interest rate lock commitments related to loans held for sale as written
options, effective no later than for commitments entered into after March 31,
2004. The Company periodically enters into such commitments with customers in
connection with residential mortgage loan applications. At December 31, 2003
there were no loans held for sale.
In December 2003, the FASB revised SFAS No. 132, "Employer Disclosures about
Pensions and Other Post-retirement Benefits". This statement retains the
disclosures required by the original SFAS No. 132 and requires additional
disclosures about the assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension and post-retirement plans. In addition, this
statement requires interim period disclosure of the components of net periodic
benefit cost and contributions if significantly different from previously
reported amounts. The Company adopted the provisions of this statement as of
December 31, 2003 (see Note K).
In October 2003, the FASB preliminarily concluded that companies will be
required to charge stock-option costs against earnings beginning in 2005. The
new standard is to be exposed for public comment in early 2004, with a final
rule expected to be issued in the second half of 2004.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability, including certain preferred securities. Effective July 1, 2003,
the Company adopted this pronouncement, which had no impact on the historical
measurement or classification of financial instruments, or on the financial
condition or results of operations of the Company.
In April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS No. 133. SFAS No. 149 is generally effective for
contracts entered into or modified after June 30, 2003 and is effective for
hedging relationships designated after June 30, 2003. Provisions of SFAS No. 149
that relate to SFAS No. 133 implementation issues that had been effective for
fiscal quarters that began prior to June 15, 2003 should continue to be applied
in accordance with their respective dates. All provisions of SFAS No. 149 should
be applied prospectively, except for paragraphs 7(a) and 23(a), which relate to
forward purchases or sales of "when-issued" securities or other securities that
do not yet exist, which should be applied to both existing contracts and new
contracts entered into after June 30, 2003. The provisions of SFAS No. 149 did
not have a material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN"), "Consolidation
of Variable Interest Entities, an interpretation of Accounting Research Bulletin
No. 51", which establishes accounting guidance for consolidation of variable
interest entities (VIE) that function to support the activities of the primary
beneficiary. The primary beneficiary of a VIE entity is the entity that absorbs
the majority of the VIE's expected losses, receives a majority of the VIE's
expected residual returns, or both, as a result of ownership, controlling
interest, contractual relationship or other business relationship with a VIE.
Prior to the implementation of FIN No. 46, VIE were generally consolidated by an
enterprise when the enterprise had a controlling financial interest through
ownership of a majority of voting interest in the entity. The provisions of FIN
46 were effective immediately for all arrangements entered into after January
31, 2003, and are otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. In December 2003, the FASB issued FIN 46R
"Consolidation of Variable Interest Entities - an interpretation of ARB No. 51,"
which modifies and clarifies FIN 46. Application of this guidance was effective
for interests in certain VIE's commonly referred to as special-purpose entities
(SPEs) as of December 31, 2003. Application for all other types of entities is
required for periods ending after March 15, 2004, unless previously applied.
50
During the fourth quarter 2003, the Company retroactively applied the provisions
of FIN 46 to three wholly-owned subsidiary trusts that issued preferred
securities to third-party investors. The application of FIN 46 resulted in the
de-consolidation of the three wholly-owned subsidiary trusts. The assets and
liabilities of the subsidiary trusts that were de-consolidated totalled $82,410
and $79,891 at December 31, 2003, and $82,461 and $79,938 at December 31, 2002.
See Note H for further information on the adoption of FIN No. 46 and its impact
on the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which provides guidance on how to
transition from the intrinsic value method of accounting for stock-based
employee compensation under APB 25 to the fair value method under SFAS No. 123,
if a company so elects. SFAS No.148 also amends the disclosure provisions of
SFAS No. 123 to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to
stock-based employee compensation and amends APB Opinion No. 28, "Interim
Financial Reporting," to require disclosure about those effects in interim
financial information. Since the Company did not adopt the fair value method of
accounting under SFAS No. 123, this pronouncement has had no impact on its
consolidated financial statements.
In November 2002, FIN No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" was issued. This Interpretation elaborates on the disclosures to be made
by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that is has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and measurement provisions are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements are effective for financial statements of interim or
annual periods ending after December 15, 2002. The Company has complied with the
disclosure requirements. The recognition and measurement provisions were adopted
effective January 1, 2003, and had no material impact on the Company's financial
condition or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Among other things, SFAS No. 145 rescinds FASB Statement No. 4, "Reporting Gains
and Losses From Extinguishment of Debt", which required all gains and losses
from extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. The provisions of SFAS No.
145 related to the rescission of FASB Statement No. 4 are effective for fiscal
years beginning after May 15, 2002, with early application encouraged. The
Company adopted this pronouncement as of July 1, 2002. As a result, gains and
losses from debt extinguishments have been presented in the non-interest income
section of the consolidated statements of income and all prior periods have been
reclassified.
See Note F for discussion of recent accounting pronouncements related to
goodwill and intangible assets.
NOTE B: ACQUISITIONS
First Heritage Bank
On January 6, 2004, the Company announced an agreement to acquire First Heritage
Bank in an all-stock transaction valued at approximately $74 million.
Headquartered in Wilkes-Barre, Pa., First Heritage is a closely held $275
million-asset bank with three branches in Luzerne County. First Heritage's three
branches will operate as part of First Liberty Bank & Trust, a division of
Community Bank, N.A. The acquisition is expected to close during the second
quarter of 2004, pending both customary regulatory and First Heritage
shareholder approval.
Grange National Banc Corp.
On November 24, 2003, the Company acquired Grange National Banc Corp.
("Grange"), a $280 million-asset bank holding company based in Tunkhannock, Pa.
Grange's 12 branches operate as part of First Liberty Bank & Trust, a division
of Community Bank, N.A. The Company issued approximately 1,147,000 shares of its
common stock to certain of the former shareholders at a cost of $47.94 per
share. The remaining shareholders received $42.50 in cash or approximately $20.9
million. In addition, Grange stock options representing $5.4 million of fair
value were exchanged for options of the Company. The results of Grange's
operations have been included in the consolidated financial statements since
that date.
Peoples Bankcorp Inc.
On September 5, 2003, the Company acquired Peoples Bankcorp, Inc. ("Peoples"), a
$29-million-asset savings and loan holding company based in Ogdensburg, New
York. Peoples' single branch is being operated as a branch of the Bank's network
of branches in Northern New York. The purchase price of the transaction
approximated $4.0 million in cash. The results of Peoples' operations have been
included in the consolidated financial statements since that date.
51
Harbridge Consulting Group
On July 31, 2003, the Company acquired PricewaterhouseCoopers' Upstate New York
Global Human Resource Solutions consulting group for a purchase price of
approximately $7.1 million in cash. This practice has been renamed Harbridge
Consulting Group ("Harbridge") and is a leading provider of retirement and
employee benefits consulting services throughout Upstate New York, and is
complementary to Benefit Plans Administrative Services, Inc., the Company's
defined contribution plan administration subsidiary. The results of Harbridge's
operations have been included in the consolidated financial statements since
that date.
FleetBoston Financial Corporation branches
On November 16, 2001, the Company acquired 36 branches from FleetBoston
Financial Corporation with $470 million in deposits and $177 million in loans.
The branches are located in the Southwestern and Finger Lakes Regions of New
York State. The acquisition has been accounted for under the purchase method of
accounting.
Citizens National Bank of Malone
On January 26, 2001, the Company acquired the $111-million-asset Citizens
National Bank of Malone, a commercial bank with five branches throughout
Franklin and St. Lawrence counties in New York State. The Company issued 952,000
shares of its common stock to the former shareholders at a cost of $26.50 per
share. All of the 648,100 shares held in the Company's treasury were issued in
this transaction. The acquisition has been accounted for under the purchase
method of accounting.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed, including capitalized acquisition costs, as of the
dates the acquisitions were consumated:
Grange Peoples Harbridge FleetBoston Citizens
National Bankcorp Consulting Financial National Bank
Banc Corp. Inc. Group Corporation of Malone
- --------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 14,558 $ 9,428 $ 0 $ 5,028 $ 3,777
Available-for-sale investment securities 62,941 2,650 0 0 46,029
Loans, net of allowance for loan losses 170,224 14,871 0 174,449 57,981
Premises and equipment, net 3,306 400 0 9,600 1,495
Other assets 5,808 84 618 1,255 1,355
Goodwill 49,366 2,192 3,980 48,985 13,311
Other intangible assets 7,942 397 2,750 28,100 0
- --------------------------------------------------------------------------------------------------------------------------------
Total assets acquired 314,145 30,022 7,348 267,417 123,948
Deposits 225,175 23,682 0 470,250 87,671
Borrowings 0 1,000 0 0 9,950
Other liabilities 6,517 1,158 0 715 1,099
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities assumed 231,692 25,840 0 470,965 98,720
- --------------------------------------------------------------------------------------------------------------------------------
Net assets acquired/(liabilities assumed) $ 82,453 $ 4,182 $7,348 ($203,548) $ 25,228
================================================================================================================================
First Liberty Bank Corp.
On May 11, 2001, the Company completed its acquisition of the $648-million-asset
First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger,
each share of First Liberty stock was exchanged for .56 shares of the Company's
common stock, which amounted to approximately 3.6 million shares. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under APB Opinion 16. Accordingly, the consolidated financial
statements for the periods presented have been restated to include the combined
results of operations, financial position and cash flows of the Company and
First Liberty. Certain reclassifications were made to First Liberty's prior year
financial statements to conform to the Company's presentation.
Results of operations for the separate companies and the combined amounts
presented in the consolidated financial statements for the four months ended
April 30, 2001 are as follows:
Net Interest Net
Income Income
- ---------------------------------------------------------------------------
Community Bank System, Inc. $24,742 $5,874
First Liberty Bank Corp 6,112 1,765
- ---------------------------------------------------------------------------
Combined $30,854 $7,639
===========================================================================
52
Acquisition and Unusual Expenses
The Company incurred certain expenses in connection with the above acquisitions.
The following table shows the components of acquisition and unusual expenses
which are presented in the consolidated statements of income for the years ended
December 31:
2003 2002 2001
- --------------------------------------------------------------------------------
Acquisition expenses:
Legal and professional fees $213 $455 $2,742
Severance and employee benefits 0 97 1,462
Equipment write-downs 0 0 934
Data processing 191 16 330
Customer check repurchase 10 61 811
Other 84 71 1,051
- --------------------------------------------------------------------------------
Total acquisition expenses 498 700 7,330
Unusual expenses:
Legal and professional fees 0 0 395
Other 0 0 439
- --------------------------------------------------------------------------------
Total unusual expenses 0 0 834
- --------------------------------------------------------------------------------
Total acquisition and unusual expenses $498 $700 $8,164
================================================================================
NOTE C: INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities as of
December 31 are as follows:
2003
--------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------- --------------------------------------------------------
Held-to-Maturity Portfolio:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 127,635 $ 235 $ 2,867 $ 125,003
Obligations of state and
political subdivisions 7,459 218 0 7,677
Other securities 3,558 0 0 3,558
- ---------------------------------- --------------------------------------------------------
Total held-to-maturity portfolio 138,652 453 2,867 136,238
- ---------------------------------- --------------------------------------------------------
Available-for-Sale Portfolio:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies 456,913 22,638 97 479,454
Obligations of state and
political subdivisions 443,930 26,291 11 470,210
Corporate securities 27,712 2,539 30,251
Collateralized mortgage
obligations (CMO's) 89,566 3,987 1 93,552
Mortgage-backed securities 76,628 3,668 119 80,177
- ---------------------------------- --------------------------------------------------------
Sub-total 1,094,749 59,123 228 1,153,644
Equity securities 37,238 37,238
- ---------------------------------- --------------------------------------------------------
Total available-for-sale portfolio 1,131,987 $59,123 $ 228 $1,190,882
======================================
Net unrealized gain on available
for-sale portfolio 58,895
- ---------------------------------- ----------
Total carrying value $1,329,534
================================== ==========
2002
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ---------------------------------- -------------------------------------------------------
Held-to-Maturity Portfolio:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 0 $ 0 $ 0 $ 0
Obligations of state and
political subdivisions 7,412 254 0 7,666
Other securities 3,018 0 0 3,018
- ---------------------------------- -------------------------------------------------------
Total held-to-maturity portfolio 10,430 254 0 10,684
- ---------------------------------- -------------------------------------------------------
Available-for-Sale Portfolio:
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies 380,243 31,035 0 411,278
Obligations of state and
political subdivisions 404,864 15,781 40 420,605
Corporate securities 27,972 2,253 0 30,225
Collateralized mortgage
obligations (CMO's) 235,286 10,082 0 245,368
Mortgage-backed securities 131,755 5,457 1 137,211
- ---------------------------------- -------------------------------------------------------
Sub-total 1,180,120 64,608 41 1,244,687
Equity securities 31,466 0 0 31,466
- ---------------------------------- -------------------------------------------------------
Total available-for-sale portfolio 1,211,586 $64,608 $ 41 $1,276,153
======================================
Net unrealized gain on available
for-sale portfolio 64,567
- ---------------------------------- ----------
Total carrying value $1,286,583
================================== ==========
All of the gross unrealized losses have been outstanding for less than twelve
months. Management does not believe any individual unrealized loss as of
December 31, 2003 represents an other than temporary impairment. The unrealized
losses reported for the agency and mortgage-backed securities relate primarily
to securities issued by FHLB, FNMA and FHLMC and are currently rated AAA by
Moody's and S&P. These unrealized losses are primarily attributable to changes
in interest rates. The Company has both the intent and ability to hold these
securities for the time necessary to recover the amortized cost.
53
The amortized cost and estimated fair value of debt securities at December 31,
2003, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Held-to-Maturity Available-for-Sale
----------------------- ---------------------------
Carrying Market Carrying Market
Value Value Value Value
- -------------------------------------------------------------- ----------------------- ---------------------------
Due in one year or less $ 4,580 $ 4,609 $ 4,283 $ 4,367
Due after one through five years 2,390 2,524 28,557 29,684
Due after five years through ten years 99,756 98,224 478,677 501,519
Due after ten years 31,926 30,881 417,038 444,345
- -------------------------------------------------------------- ----------------------- ---------------------------
Total 138,652 136,238 928,555 979,915
Collateralized mortgage obligations (CMO's) 0 0 89,566 93,552
Mortgage-backed securities 0 0 76,628 80,177
- -------------------------------------------------------------- ----------------------- ---------------------------
Total $138,652 $136,238 $1,094,749 $1,153,644
============================================================== ======================= ===========================
Proceeds from sales of investment securities during 2003, 2002, and 2001 were
$41,227, $197,928 and $141,959, respectively. Gross gains of approximately $11,
$2,593, and $2,964 for 2003, 2002, and 2001, respectively, and gross losses of
$65, $0, and $418, in 2003, 2002, and 2001, respectively, were realized on those
sales.
Investment securities with a carrying value of $563,341 and $685,102 at December
31, 2003 and 2002, respectively, were pledged to collateralize certain deposits
and borrowings.
NOTE D: LOANS
Major classifications of loans at December 31 are summarized as follows:
2003 2002
- --------------------------------------------------------------------------------
Consumer mortgage $ 739,593 $ 510,309
Business lending 689,436 629,874
Consumer indirect 325,304 287,453
Consumer direct 374,258 379,385
- --------------------------------------------------------------------------------
Gross loans 2,128,591 1,807,021
Unearned discount 82 116
- --------------------------------------------------------------------------------
Net loans 2,128,509 1,806,905
Allowance for loan losses 29,095 26,331
- --------------------------------------------------------------------------------
Loans, net of allowance for loan losses $2,099,414 $1,780,574
================================================================================
The estimated fair value of loans at December 31, 2003 and 2002 was $2,140,000
and $1,841,000, respectively. Non-accrual loans of $11,940 and $9,754 and
accruing loans ninety days past due of $1,307 and $1,890 at December 31, 2003
and 2002, respectively, are included in net loans.
Changes in loans to directors and officers and other related parties for the
years ended December 31 are summarized as follows:
- --------------------------------------------------------------------------------
2003 2002
- --------------------------------------------------------------------------------
Balance at beginning of year $ 15,735 $ 15,674
New loans 3,313 287
Payments (4,210) (226)
- --------------------------------------------------------------------------------
Balance at end of year $ 14,838 $ 15,735
================================================================================
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of condition. The unpaid principal balances of mortgage
loans serviced for others were $126,324, $103,663, and $119,838 at December 31,
2003, 2002, and 2001, respectively. Custodial escrow balances maintained in
connection with the foregoing loan servicing, and included in demand deposits,
were approximately and $773 and $717 at December 31, 2003 and 2002,
respectively. At December 31, 2003 and 2002, mortgage servicing rights, included
in other assets, amounted to $456 and $283, respectively.
54
Changes in the allowance for loan losses for the years ended December 31 are
summarized as follows:
2003 2002 2001
- --------------------------------------------------------------------------------
Balance at beginning of year $ 26,331 $ 23,901 $ 20,035
Provision for loan losses 11,195 12,222 7,097
Reserve on acquired loans 1,832 0 3,353
Charge-offs (13,110) (12,015) (8,662)
Recoveries 2,847 2,223 2,078
- --------------------------------------------------------------------------------
Balance at end of year $ 29,095 $ 26,331 $ 23,901
================================================================================
As of December 31, 2003 and 2002, the Company had impaired loans of $5,682 and
$8,703, respectively. The specifically allocated allowance for loan loss
recognized on these impaired loans was $1,825 and $3,200 at December 31, 2003
and 2002, respectively. For the year ended December 31, 2003 the Company had
average impaired loans of $7,100 for which $46 of interest income recognized.
NOTE E: PREMISES AND EQUIPMENT
Premises and equipment consist of the following at December 31:
2003 2002
- --------------------------------------------------------------------------------
Land and land improvements $ 8,616 $ 8,270
Bank premises owned 53,560 47,129
Equipment 42,146 39,577
- --------------------------------------------------------------------------------
Premises and equipment, gross 104,322 94,976
Allowance for depreciation (42,617) (37,979)
- --------------------------------------------------------------------------------
Premises and equipment, net $ 61,705 $ 56,997
================================================================================
NOTE F: INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other
Intangible Assets," which addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supercedes APB Opinion 17,
"Intangible Assets". The statement requires that the Company subject goodwill
and other intangible assets to an annual impairment analysis to assess the need
to write down the balances and recognize an impairment loss. In addition,
amortization of goodwill is no longer being recorded in accordance with this
statement. Core deposit intangibles will continue to be amortized.
In October 2002, the FASB issued SFAS 147, "Accounting for Certain Acquisitions
of Banking and Thrift Institutions," which addresses financial accounting and
reporting for certain intangibles associated with branch acquisitions. This
statement removes acquisitions of financial institutions from the scope of SFAS
72 and FASB Interpretation 9. It reclassifies as goodwill certain "unidentified
intangible assets" associated with the Company's branch acquisitions dating as
far back as 1994. Financial statements are retroactively restated to January 1,
2002 to remove amortization recorded on other intangible assets. Previously,
these intangible assets were being regularly amortized. As discussed above,
under FASB 142, goodwill is not required to be amortized, but as an asset, is
periodically reviewed for impairment.
55
The pro forma disclosures on net income and earnings per share of SFAS 142 and
SFAS 147 for the twelve months ended December 31, 2003, 2002 and 2001 are as
follows:
Twelve Months Ended December 31,
- --------------------------------------------------------------------------------
2003 2002 2001
- --------------------------------------------------------------------------------
Reported net income $40,380 $38,517 $19,129
Plus: Goodwill amortization 2,945
- --------------------------------------------------------------------------------
Adjusted net income $40,380 $38,517 $22,074
================================================================================
Basic earnings per share:
Reported net income $ 3.07 $ 2.97 $ 1.64
Plus: Goodwill amortization 0.25
- --------------------------------------------------------------------------------
Adjusted net income $ 3.07 $ 2.97 $ 1.89
================================================================================
Diluted earnings per share:
Reported net income $ 2.99 $ 2.93 $ 1.62
Plus: Goodwill amortization 0.25
- --------------------------------------------------------------------------------
Adjusted net income $ 2.99 $ 2.93 $ 1.87
================================================================================
The gross carrying amount and accumulated amortization for each type of
intangible asset are as follows:
As of December 31, 2003 As of December 31, 2002
--------------------------------------- ---------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
- --------------------------------- --------------------------------------- ---------------------------------------
Amortizing intangible assets:
Core deposit intangibles $ 55,455 ($21,457) $ 33,998 $ 47,366 ($16,597) $ 30,769
Other intangibles 2,750 (233) 2,517 0 0 0
- --------------------------------- --------------------------------------- ---------------------------------------
Total amortized intangibles 58,205 (21,690) 36,515 47,366 (16,597) 30,769
Non-amortizing intangible assets:
Goodwill 177,969 (18,373) 159,596 122,432 (18,373) 104,059
- --------------------------------- --------------------------------------- ---------------------------------------
Total intangible assets, net $236,174 ($40,063) $196,111 $169,798 ($34,970) $134,828
================================= ======================================= =======================================
As shown in Note B the increases in the gross carrying amount of core deposit
intangibles, other intangibles and goodwill relate to the 2003 acquisition of
Grange National Banc Corp. ($49,366 in goodwill), Peoples Bankcorp Inc. ($2,192
in goodwill) and Harbridge Consulting Group ($3,980 in goodwill). No goodwill
impairment adjustments were recognized in 2003 and 2002.
The estimated aggregate amortization expense for each of the five succeeding
fiscal years ended December 31 is as follows:
2004 $ 6,571
2005 5,754
2006 4,862
2007 4,700
2008 4,535
Thereafter 10,093
- -----------------------------
Total $36,515
=============================
NOTE G: DEPOSITS
Deposits consist of the following at December 31:
2003 2002
- --------------------------------------------------------------------------------
Demand $ 498,195 $ 439,075
Savings 1,052,941 962,056
Time 1,174,352 1,104,225
- --------------------------------------------------------------------------------
Total deposits $2,725,488 $2,505,356
================================================================================
56
The estimated fair value of deposits at December 31, 2003 and 2002 was
approximately $2,536,000 and $2,523,000, respectively.
At December 31, 2003 and 2002, time certificates of deposit in denominations of
$100 and greater totaled $168,241 and $157,129, respectively.
The approximate maturities of time deposits at December 31, 2003 are as follows:
2004 $ 894,215
2005 145,307
2006 49,609
2007 59,232
2008 25,595
Thereafter 394
- ------------------------------------
Total $1,174,352
====================================
NOTE H: BORROWINGS
Outstanding borrowings at December 31 are as follows:
2003 2002
- --------------------------------------------------------------------------------------
Short-term borrowings:
Federal funds purchased $ 36,300 $ 33,000
Federal Home Loan Bank advances 361,000 215,000
Other borrowings 96 241
- --------------------------------------------------------------------------------------
Total short-term borrowings 397,396 248,241
Long-term borrowings:
Federal Home Loan Bank advances 190,000 215,000
Subordinated debt held by unconsolidated subsidiary trusts,
net of discount of $1,519 and $1,575 80,390 80,334
- --------------------------------------------------------------------------------------
Total long-term borrowings 270,390 295,334
- --------------------------------------------------------------------------------------
Total borrowings $667,786 $543,575
======================================================================================
The weighted-average interest rates on short-term borrowings for the years ended
December 31, 2003 and 2002 were 1.26% and 1.83%, respectively. Federal Home Loan
Bank advances are collateralized by a blanket lien on the Company's residential
real estate loan portfolio and mortgage-backed securities portfolio.
Long-term borrowings at December 31, 2003 have maturity dates as follows:
Weighted
Amount Average Rate
- --------------------------------------------------------------------------------
January 23, 2008 $ 10,000 5.44%
January 28, 2008 5,000 5.48%
April 14, 2010 25,000 6.35%
September 27, 2010 50,000 5.88%
October 12, 2010 50,000 5.84%
November 1, 2010 50,000 5.77%
February 3, 2027 30,772 9.75%
July 16, 2031 25,085 5.12%
July 31, 2031 24,533 4.92%
- --------------------------------------------------------------------------------
Total $270,390 6.15%
================================================================================
The estimated fair value of long-term borrowings at December 31, 2003 and 2002
was approximately $314,000 and $345,000 respectively.
In December 2003, the Company prepaid $25,000 of Federal Home Loan Bank ("FHLB")
advances with maturity dates ranging from January 30, 2008 to February 4, 2008
and a weighted-average rate of 5.31%. In December 2002, the Company prepaid
$11,000 of FHLB advances with maturity dates ranging from December 15, 2003 to
December 31, 2004
57
and a weighted-average rate of 6.17%. In September 2001, the Company prepaid
$95,000 of FHLB advances with maturity dates ranging from December 17, 2002 to
February 23, 2004 and a weighted-average rate of 5.38%. As a result of these
prepayments, the Company incurred penalties of $2,600, $925 and $2,659 in 2003,
2002 and 2001, respectively. These penalties have been reflected in the
consolidated statements of income as gain (loss) on investment securities and
early retirement of long-term borrowings.
The Company sponsors three business trusts, Community Capital Trust I, Community
Capital Trust II, and Community Statutory Trust III, of which 100% of the common
stock is owned by the Company. The trusts were formed for the purpose of issuing
company-obligated mandatorily redeemable preferred securities to third-party
investors and investing the proceeds from the sale of such preferred securities
solely in junior subordinated debt securities of the Company. The debentures
held by each trust are the sole assets of that trust. Distributions on the
preferred securities issued by each trust are payable semi-annually at a rate
per annum equal to the interest rate being earned by the trust on the debentures
held by that trust. The preferred securities are subject to mandatory
redemption, in whole or in part, upon repayment of the debentures. The Company
has entered into agreements which, taken collectively, fully and unconditionally
guarantee the preferred securities subject to the terms of each of the
guarantees. The terms of the preferred securities of each trust are as follows:
Issuance Preferred Interest Maturity Call Call
Trust Date Securities Rate Date Provision Price
- ------------------------------------------------------------------------------------------------------------------------------------
I 2/3/1997 30,000 9.75% 2/03/2027 10 year beginning 2007 104.5400% declining to par in 2017
II 7/16/2001 25,000 six-month LIBOR plus 3.75% 7/16/2031 5 year beginning 2006 107.6875% declining to par in 2011
III 7/31/2001 24,450 three-month LIBOR plus 3.58% 7/31/2031 5 year beginning 2006 107.5000% declining to par in 2011
====================================================================================================================================
In the fourth quarter 2003, as a result of applying the provisions of FIN 46, as
discussed in Note A, the Company was required to de-consolidate these subsidiary
trusts from its financial statements. The de-consolidation of the net assets and
results of operations of the trusts had an immaterial impact on the Company's
financial statements. The Company continues to be obligated to repay the
debentures held by the trusts and guarantees repayment of the preferred
securities issued by the trusts. The reported consolidated debt obligation
related to the trusts increased from $77,931 to $80,390 at December 31, 2003 and
$77,375 to $80,334 at December 31, 2002, as a result of de-consolidation, with
the difference representing the Company's common ownership interest in the
trusts that is now reported as an investment.
The preferred securities held by the trusts qualify as Tier 1 capital for the
Company under Federal Reserve Board guidelines. As a result of the issuance of
FIN 46, the Federal Reserve Board is currently evaluating whether
de-consolidation of the trusts will affect the qualification of the preferred
securities as Tier 1 capital. If it is determined that the preferred securities
no longer qualify as Tier 1 capital, the Company would still exceed the
regulatory required minimum for capital adequacy purposes.
NOTE I: INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31 is as
follows:
2003 2002 2001
- --------------------------------------------------------------------------------
Current:
Federal $11,534 $ 9,268 $ 8,301
State 341 161 348
Deferred:
Federal 758 3,764 (691)
State 140 694 (144)
- --------------------------------------------------------------------------------
Total income taxes $12,773 $13,887 $ 7,814
================================================================================
58
Components of the net deferred tax liability, included in other
assets/liabilities, as of December 31 are as follows:
2003 2002
- --------------------------------------------------------------------------------
Allowance for loan losses $ 10,537 $ 10,112
Employee benefits 1,610 1,430
Goodwill 0 978
Other 2,009 1,935
- --------------------------------------------------------------------------------
Total deferred tax asset 14,156 14,455
- --------------------------------------------------------------------------------
Investment securities 24,216 27,089
Goodwill 4,910 0
Loan origination costs 3,324 2,462
Depreciation 3,526 2,809
Pension 1,586 3,111
Mortgage servicing rights 178 110
- --------------------------------------------------------------------------------
Total deferred tax liability 37,740 35,581
- --------------------------------------------------------------------------------
Net deferred tax liability ($23,584) ($21,126)
================================================================================
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:
2003 2002 2001
- --------------------------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
Increase (reduction) in taxes resulting from:
Tax-exempt interest (11.2%) (9.9%) (11.1%)
State income taxes, net of federal benefit 0.1% 0.6% 0.7%
Other 0.1% 0.8% 4.5%
- --------------------------------------------------------------------------------
Effective income tax rate 24.0% 26.5% 29.1%
================================================================================
NOTE J: LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES
The Company's ability to pay dividends to its shareholders is largely dependent
on the Bank's ability to pay dividends to the Company. In addition to state law
requirements and the capital requirements discussed below, the circumstances
under which the Bank may pay dividends are limited by federal statutes,
regulations, and policies. For example, as a national bank, the Bank must obtain
the approval of the Office of the Comptroller of the Currency (OCC) for payments
of dividends if the total of all dividends declared in any calendar year would
exceed the total of the Bank's net profits, as defined by applicable
regulations, for that year, combined with its retained net profits for the
preceding two years. Furthermore, the Bank may not pay a dividend in an amount
greater than its undivided profits then on hand after deducting its losses and
bad debts, as defined by applicable regulations. At December 31, 2003, the Bank
had approximately $19,531 in undivided profits legally available for the
payments of dividends.
In addition, the Federal Reserve Board and the OCC are authorized to determine
under certain circumstances that the payment of dividends would be an unsafe or
unsound practice and to prohibit payment of such dividends. The Federal Reserve
Board has indicated that banking organizations should generally pay dividends
only out of current operating earnings.
There are also statutory limits on the transfer of funds to the Company by its
banking subsidiary, whether in the form of loans or other extensions of credit,
investments or assets purchases. Such transfer by the Bank to the Company
generally is limited in amount to 10% of the Bank's capital and surplus, or 20%
in the aggregate. Furthermore, such loans and extensions of credit are required
to be collateralized in specific amounts.
59
NOTE K: BENEFIT PLANS
The Company has a noncontributory defined benefit pension plan covering the
majority of its employees and retirees. The benefits are based on years of
service and the participant's average compensation, as defined in the Plan. The
Company also provides health and life insurance benefits for eligible retired
employees and dependents. The Company funds this plan as costs are incurred. The
Company accrues for the estimated cost of these benefits through charges to
expense during the years that the employees earn these benefits. Using a
measurement date of December 31, the following table shows the funded status of
the Company's plans reconciled with amounts reported in the Company's
consolidated statements of condition:
Pension Benefits Post-retirement Benefits
----------------------- ------------------------
2003 2002 2003 2002
- ---------------------------------------------- ----------------------- ---------------------
Change in benefit obligation
Benefit obligation at the beginning of year $ 31,520 $ 29,039 $ 4,159 $ 3,378
Service cost 1,674 1,173 275 159
Interest cost 1,953 1,779 260 241
Participant contributions 0 0 186 161
Plan amendment/acquisition 1,726 0 220 0
Other loss 1,218 0 0 0
Deferred actuarial loss 3,387 699 391 491
Benefits paid (1,345) (1,170) (408) (271)
- ---------------------------------------------- ----------------------- ---------------------
Benefit obligation at end of year 40,133 31,520 5,083 4,159
- ---------------------------------------------- ----------------------- ---------------------
Change in plan assets
Fair value of plan assets at beginning of year 29,133 21,084 0 0
Actual return of plan assets 6,815 (2,781) 0 0
Participant contributions 0 0 186 161
Employer contributions 2,181 12,000 222 110
Benefits paid (1,345) (1,170) (408) (271)
- ---------------------------------------------- ----------------------- ---------------------
Fair value of plan assets at end of year 36,784 29,133 0 0
- ---------------------------------------------- ----------------------- ---------------------
Unfunded status (3,349) (2,387) (5,083) (4,159)
Unrecognized actuarial loss 13,234 15,122 615 232
Unrecognized prior service cost (benefit) 1,361 (397) 361 391
Unrecognized transition (asset) liability 0 (4) 369 410
- ---------------------------------------------- ----------------------- ---------------------
Prepaid (accrued) benefit cost $ 11,246 $ 12,334 ($3,738) ($3,126)
============================================== ======================= =====================
In 2003, the Company amended its defined benefit pension plan to provide certain
benefits that were previously accrued under supplemental retirement plans.
The accumulated benefit obligation for the pension plan was $35,025 and $26,845
as of December 31, 2003 and 2002, respectively. The Company does not anticipate
making a contribution to its defined benefit pension plan in 2004.
The weighted-average assumptions used to determine the benefit obligations as of
December 31 are as follows:
Pension Benefits Post-retirement Benefits
------------------ ------------------------
2003 2002 2003 2002
- ------------------------------ ------------------ ------------------------
Discount rate 5.90% 6.10% 5.90% 6.10%
Expected return on plan assets 9.00% 9.00% 0.00% 0.00%
Rate of compensation increase 4.00% 4.00% 0.00% 0.00%
============================== ================== ========================
60
The net periodic benefit cost as of December 31 is as follows:
Pension Benefits Post-retirement Benefits
-------------------------------- ------------------------
2003 2002 2001 2003 2002 2001
- -------------------------------------- -------------------------------- ------------------------
Service cost $ 1,674 $ 1,173 $ 1,121 $275 $159 $165
Interest cost 1,953 1,779 1,650 260 241 210
Expected return on plan assets (2,567) (2,268) (1,921) 0 0 0
Net amortization and deferral 1,027 402 218 8 0 0
Amortization of prior service cost (33) (33) (114) 31 30 30
Amortization of transition obligation (4) (19) (19) 41 41 41
Other expense 1,218 0 0 0 0 0
- -------------------------------------- -------------------------------- ------------------------
Net periodic benefit cost $ 3,268 $ 1,034 $ 935 $615 $471 $446
====================================== ================================ ========================
Other expense represents a $1.2 million adjustment recorded in the fourth
quarter of 2003 to reflect the proper actuarial impact of indexing salary levels
associated with certain benefits frozen in 1988.
The weighted-average assumptions used to determine the net periodic pension cost
for the years ended December 31 are as follows:
Pension Benefits Post-retirement Benefits
----------------------------- -----------------------------
2003 2002 2001 2003 2002 2001
- ------------------------------ ----------------------------- -----------------------------
Discount rate 6.10% 6.75% 7.00% 6.10% 6.75% 7.00%
Expected return on plan assets 9.00% 9.00% 9.00% 0.00% 0.00% 0.00%
Rate of compensation increase 4.00% 4.00% 4.00% 0.00% 0.00% 0.00%
============================== ============================= =============================
The expected long-term rate of return was estimated by reviewing historical
returns on the pension investment portfolio, considering the current target
asset allocations. The asset allocation for the defined benefit pension plan as
of December 31, by asset category, is as follows:
% of Plan Assets
-----------------------
2003 2002
- --------------------------------------------------------------------------------
Mutual funds 42% 20%
Equity securities 28% 39%
Debt securities 20% 21%
Cash 10% 20%
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Equity securities include $2,230 and $1,426 of Community Bank System, Inc. stock
at December 31, 2003 and 2002, respectively.
The investment objective for the defined benefit pension plan is to achieve an
average annual total return over a five-year period equal to the assumed rate of
return used in the actuarial calculations. At a minimum performance level, the
portfolio should earn the return obtainable on high quality intermediate-term
bonds. The Company's perspective regarding portfolio assets combines both
preservation of capital and moderate risk-taking. Asset allocation favors
equities, with a target allocation of approximately 75% equity securities, 20%
fixed income securities and 5% cash. Due to the volatility in the market, the
target allocation is not always desirable and asset allocations will fluctuate
between acceptable ranges. Prohibited transactions include purchase of
securities on margin, uncovered call options, short sale transactions, and use
of real estate, unlisted limited partnerships, derivative products or venture
capital loans as fixed income investment vehicles.
The assumed health care cost trend rate used in the post-retirement health plan
at December 31 is as follows:
2003
- --------------------------------------------------------------------------------
Health care cost trend rate for next year 9.50%
Rate to which the cost trend rate is assumed to
decline (ultimate trend rate) 5.00%
Year the rate reaches the ultimate trend rate 2013
================================================================================
61
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plan. A one-percentage-point change in the assumed
health care cost trend rate would have the following effect:
1% Point 1% Point
Increase Decrease
- --------------------------------------------------------------------------------
Effect on total of service and interest cost components 29 (22)
Effect on post-retirement benefit obligation 188 (166)
================================================================================
In December 2003, a bill was signed into law that expands Medicare benefits,
primarily adding a prescription drug benefit for Medicare-eligible retirees
beginning in 2006. The law also provides a federal subsidy to companies which
sponsor post-retirement benefit plans that provide prescription drug coverage.
FASB Staff Position 106-1, "Accounting and Disclosure Requirements Related to
the Medicare Prescription Drug, Improvement and Modernization Act of 2003"
permits deferring the recognition of the new Medicare provisions' impact due to
lack of specific authoritative guidance on accounting for the federal subsidy.
The Company has elected to defer accounting for the effects of this new
legislation until the specific authoritative guidance is issued. Accordingly,
the post-retirement benefit obligations and net periodic costs reported in the
accompanying financial statements and notes do not reflect the impact of this
legislation. The accounting guidance, when issued, could require changes to
previously reported financial information. The Company anticipates its benefit
costs after 2006 will be somewhat lower as a result of the new Medicare
provisions, however, the adoption of this standard is not expected to have a
material impact on results of operations, financial position, or liquidity of
the Company.
The Company has a 401(k) Employee Stock Ownership Plan that is qualified under
Section 401(k) of the Internal Revenue Code. Employees can contribute from 1% to
90% of eligible compensation, with up to 6% being eligible for matching
contributions in the form of Company common stock. The Plan also permits the
Company to distribute a discretionary profit-sharing component in the form of
Company common stock to all participants except certain executive employees. The
expense recognized under this plan for the years ended December 31, 2003, 2002
and 2001, was $733, $666, and $528, respectively. The Company also has a
Deferred Compensation Plan for Certain Executive Employees that is unqualified
under Section 401(k) of the Internal Revenue Code. Under this Plan, participants
may contribute 15% of their eligible compensation less any amounts contributed
to the 401(k) Employee Stock Ownership Plan. Any discretionary profit-sharing
amounts that the executive receives from the Company must be contributed to the
Deferred Compensation Plan in the form of Company common stock. The Company
incurs no expense related to this plan.
The Company has nonqualified deferred compensation and supplemental retirement
plans for several current and former directors, officers, and key employees. The
liability arising from these plans is being accrued over the participant's
remaining period of service so that at the expected retirement date, the then
present value of the annual payments will have been expensed. All benefits
provided under these plans are unfunded and payments to plan participants are
made by the Company. At December 31, 2003 and 2002, the Company has recorded a
liability of $6,020 and $3,690, respectively. The expense recognized under these
plans for the years ended December 31, 2003, 2002, and 2001 was $1,585, $952,
and $469, respectively.
Directors may defer all or a portion of their director fees under the Deferred
Compensation Plan for Directors. Under this plan, there is a separate account
for each participating director which is credited with the amount of shares
which could have been purchased with the director's fees as well as any
dividends on such shares. On the distribution date, the director will receive
common stock equal to the accumulated share balance in his account. As of
December 31, 2003 and 2002, there were 28,451 and 25,510 shares credited to the
participants' accounts, for which a liability of $894 and $781 was accrued,
respectively. The expense recognized under the plan for the years ended December
31, 2003, 2002 and 2001, was $113, $126, and $164, respectively.
The Company has a Stock Balance Plan for non-employee directors who have
completed six months of service. The Plan is a nonqualified, noncontributory
defined benefit plan. The Plan provides benefits for service prior to January 1,
1996 based on a predetermined formula and benefits for service after January 1,
1996 based on the performance of the Company's common stock. Participants become
fully vested after six years of service. The directors can elect to receive
offset stock options that may reduce the Company's liability under the Plan.
These options vest immediately and expire one year after the date the director
retires or two years in the event of death. Benefits are payable in the form of
cash and/or Company stock (as elected by the director) on January 1st of the
year after the director retires from the Board. As of December 31, 2003 and
2002, the accrued pension liability was $251 and $379, respectively. The expense
recognized under this plan for the years ended December 31, 2003, 2002 and 2001,
was $38, $69, and $4, respectively. The expense and related liability were
calculated using a dividend rate of 3.00%, stock price appreciation of 6.00%,
and a discount rate of 5.9% for 2003, 6.10% for 2002, and 6.75% for 2001.
62
NOTE L: STOCK-BASED COMPENSATION PLANS
The Company has a long-term incentive program for directors, officers, and key
employees. Under this program the Company authorized 2,537,000 shares of Company
common stock for the grant of incentive stock options, restricted stock awards,
nonqualified stock options, retroactive stock appreciation rights, and offset
options to its Stock Balance Plan (see Note K). The offset options vest and
become exercisable immediately and expire one year after the date the director
retires or two years in the event of death. The remaining options have a
ten-year term. They vest and become exercisable on a grant by grant basis,
ranging from immediate vesting to ratably over a five-year period. Activity in
these plans is as follows:
Weighted
Average
Exercise
Price
Options Range of Option Shares of Options
Outstanding Price Per Share Exercisable Outstanding
- ----------------------------------------------------------------------------------------------------
December 31, 2000 774,426 $6.75 - $34.81 542,703 $24.57
Granted 272,979 24.90
Exercised (65,851) 7.50 - 26.50
Forfeited (5,488) 19.13 - 31.31
- ----------------------------------------------------------------------------------------------------
December 31, 2001 976,066 $6.75 - $34.81 652,114 $25.37
Granted 206,702 26.20 - 31.35
Exercised (96,018) 6.75 - 29.31
Forfeited (1,988) 24.75 - 26.20
- ----------------------------------------------------------------------------------------------------
December 31, 2002 1,084,762 $12.13 - $34.81 707,405 $26.16
Granted 423,565 5.34 - 47.85
Exercised (284,104) 7.29 - 31.35
Forfeited (5,936) 23.13 - 31.31
- ----------------------------------------------------------------------------------------------------
December 31, 2003 1,218,287 $5.34 - $47.85 757,901 $25.57
====================================================================================================
Options granted in 2003 include approximately 193,000 options exchanged in
connection with the Grange acquisition.
At December 31, 2003 the range of exercise prices and other information relating
to the Company's stock options is as follows:
Options Outstanding Options Exercisable
----------------------------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Range of Exercise Remaining Exercise
Exercise Price Shares Price Life (years) Shares Price
- --------------- ----------------------------------------- ----------------------
$5.34 - $9.74 126,579 $ 7.66 2.2 126,579 $ 7.66
$9.74 - $14.61 18,609 11.91 2.7 18,609 11.91
$14.61 - $19.48 76,348 17.90 3.7 76,348 17.90
$19.48 - $24.35 103,282 23.09 6.0 69,846 23.08
$24.35 - $29.22 376,088 25.47 7.5 163,106 25.30
$29.22 - $34.09 361,635 30.87 7.3 157,167 30.41
$34.09 - $38.96 153,746 34.96 8.6 146,246 34.81
$38.96 - $43.83 1,000 41.02 9.6 0 0.00
$43.83 - $47.85 1,000 47.85 10.0 0 0.00
- --------------- ----------------------------------------- ----------------------
Total 1,218,287 $25.57 6.6 757,901 $23.97
=============== ========================================= ======================
On February 21, 1995, the Company adopted a Stockholder Protection Rights
Agreement. Under the Plan, each stockholder received one right, representing the
right to purchase one share of common stock for $42.50 for each share of stock
owned. All of the rights expire on February 21, 2005, but the Company may redeem
the rights earlier for $.005 per right, subject to certain limitations. Rights
will become exercisable if a person or group acquires 15% or more of the
Company's outstanding shares. Until that time, the rights will trade with the
common stock; any transfer of common stock will also constitute a transfer of
the associated right. If the rights become exercisable, they will begin to trade
apart from the common stock. If one of a number of "flip-in events" occurs, each
right will entitle the holder to purchase common stock having a market value
equivalent of two times the exercise price.
63
NOTE M: EARNINGS PER SHARE
The following is a reconciliation of basic to diluted earnings per share for the
years ended December 31:
Per Share
Income Shares Amount
- --------------------------------------------------------------------------------
Year Ended December 31, 2003
Basic EPS $40,380 13,149 $3.07
Stock options 368
- ----------------------------------------------------------------
Diluted EPS $40,380 13,517 $2.99
================================================================
Year Ended December 31, 2002
Basic EPS $38,517 12,973 $2.97
Stock options 194
- ----------------------------------------------------------------
Diluted EPS $38,517 13,167 $2.93
================================================================
Year Ended December 31, 2001
Basic EPS $19,129 11,681 $1.64
Stock options 144
- ----------------------------------------------------------------
Diluted EPS $19,129 11,825 $1.62
================================================================
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
and standby letters of credit. Commitments to extend credit are agreements to
lend to customers, generally having fixed expiration dates or other termination
clauses that may require payment of a fee. These commitments consist principally
of unused commercial and consumer credit lines. Standby letters of credit
generally are contingent upon the failure of the customer to perform according
to the terms of the underlying contract with the third party. The credit risk
associated with commitments to extend credit and standby letters of credit is
essentially the same as that involved with the extending loans to customers and
is subject to normal credit policies. Collateral may be obtained based on
management's assessment of the customer's creditworthiness.
The contract amount of commitment and contingencies as of December 31 is as
follows:
2003 2002
- --------------------------------------------------------------------------------
Standby letters of credit $ 19,163 $ 19,728
Commitments to extend credit 315,898 332,422
- --------------------------------------------------------------------------------
Total $335,061 $352,150
================================================================================
The fair value of these financial instruments approximates carrying value.
The Company has an unused line of credit of $10,000 at December 31, 2003. The
Company has unused borrowing capacity of approximately $194,000 through
collateralized transactions with the Federal Home Loan Bank and $24,590 through
collateralized transactions with the Federal Reserve Bank. As of December 31,
2003, the Company has a letter of credit of approximately $12,669 that expires
on June 16, 2004.
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, 2003 was $52,336, of which $2,000
was required to be on deposit with the Federal Reserve Bank of New York. The
remaining $50,336 was represented by cash on hand.
64
NOTE O: LEASES
The Company leases buildings and office space under agreements that expire in
various years. Rental expense included in operating expenses amounted to $1,940,
$1,896, and $1,414 in 2003, 2002 and 2001, respectively. The future minimum
rental commitments as of December 31, 2003 for all non-cancelable operating
leases are as follows:
2004 $ 2,114
2005 1,878
2006 1,721
2007 1,498
2008 990
Thereafter 4,286
- ---------------------------------
Total $12,487
=================================
NOTE P: REGULATORY MATTERS
The Company and the Bank are 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 Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company's and the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company's and the Bank's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Under capital adequacy guidelines the Company must maintain minimum total core
capital to risk weighted assets of 8%, and tier I capital to risk weighted
assets and tier I capital to average assets of 4%. Management believes, as of
December 31, 2003 and December 31, 2002, that the Company and 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 core capital to risk
weighted assets of 10%, tier I capital to risk weighted assets of 6% and tier I
capital to average assets of 5%.
The capital ratios and amounts of the Company and the Bank as of December 31 are
presented below:
2003 2002
------------------------ ------------------------
Company Bank Company Bank
- ------------------------------------------------------------------------ ------------------------
Tier 1 capital to average assets
Amount $249,641 $245,809 $228,947 $213,786
Ratio 7.26% 7.28% 7.05% 6.59%
Minimum required amount $137,607 $134,977 $129,848 $129,777
Tier 1 capital to risk weighted assets
Amount $249,641 $245,809 $228,947 $213,786
Ratio 11.76% 11.63% 12.07% 11.29%
Minimum required amount $ 84,916 $ 84,576 $ 75,863 $ 76,772
Total core capital to risk weighted assets
Amount $276,177 $272,339 $252,654 $237,465
Ratio 13.01% 12.88% 13.32% 12.54%
Minimum required amount $169,831 $169,151 $151,725 $151,545
65
NOTE Q: PARENT COMPANY STATEMENTS
The condensed balance sheet of the parent company at December 31 is as follows:
2003 2002
- --------------------------------------------------------------------------------
Assets:
Cash $ 24,429 $ 16,999
Investment securities 2,747 2,523
Investment in and advances to subsidiaries 482,407 389,945
Other assets 3,161 2,336
- --------------------------------------------------------------------------------
Total assets $512,744 $411,803
================================================================================
Liabilities and shareholders' equity:
Accrued interest and other liabilities $ 7,526 $ 6,431
Borrowings 100,390 80,334
Shareholders' equity 404,828 325,038
- --------------------------------------------------------------------------------
Total liabilities and shareholders' equity $512,744 $411,803
================================================================================
The condensed statement of income of the parent company for the years ended
December 31 is as follows:
2003 2002 2001
- -----------------------------------------------------------------------------------------
Revenues:
Dividends from subsidiaries $42,771 $29,587 $18,373
Interest on investments 6 10 57
- -----------------------------------------------------------------------------------------
Total revenues 42,777 29,597 18,430
- -----------------------------------------------------------------------------------------
Expenses:
Interest on long term notes and debentures 5,765 6,112 5,041
Other expenses 84 9 48
- -----------------------------------------------------------------------------------------
Total expenses 5,849 6,121 5,089
- -----------------------------------------------------------------------------------------
Income before tax benefit and equity in undistributed
net income of subsidiaries 36,928 23,476 13,341
Income tax benefit 1,364 1,572 1,419
- -----------------------------------------------------------------------------------------
Income before equity in undistributed net income
of subsidiaries 38,292 25,048 14,760
Equity in undistributed net income of subsidiaries 2,088 13,469 4,369
- -----------------------------------------------------------------------------------------
Net income $40,380 $38,517 $19,129
=========================================================================================
66
The statements of cash flows of the parent company for the years ended December
31 is as follows:
2003 2002 2001
- -----------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 40,380 $ 38,517 $ 19,129
Adjustments to reconcile net income to net cash provided
by operating activities
Equity in undistributed net income of subsidiaries (2,088) (13,469) (4,369)
Net change in other assets and other liabilities 1,633 (886) 5,109
- -----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 39,925 24,162 19,869
- -----------------------------------------------------------------------------------------------------
Investing Activities:
Purchase of investment securities (227) (76) (210)
Sale of investment securities 0 0 500
Capital contributions to subsidiaries (33,131) (831) (80,399)
- -----------------------------------------------------------------------------------------------------
Net cash used in investing activities (33,358) (907) (80,109)
- -----------------------------------------------------------------------------------------------------
Financing Activities:
Net change in borrowings 20,000 (6,100) 0
Proceeds from junior subordinated debentures 0 0 50,981
Issuance of common stock, net of issuance costs 4,819 1,151 32,837
Purchase of treasury stock (8,490) 0 0
Cash dividends paid (15,466) (14,228) (10,980)
- -----------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 863 (19,177) 72,838
- -----------------------------------------------------------------------------------------------------
Change in cash and cash equivalents 7,430 4,078 12,598
Cash and cash equivalents at beginning of year 16,999 12,921 323
- -----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 24,429 $ 16,999 $ 12,921
=====================================================================================================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 5,841 $ 6,412 $ 3,883
Supplemental disclosures of non-cash financing activities
Dividends declared and unpaid $ 4,529 $ 3,760 $ 3,482
=====================================================================================================
On November 16, 2001 and December 12, 2001, the Company issued 1,200,000 and
108,800 shares of common stock at a price of $26.35. Proceeds from the issuance
of common stock, net of issuance costs, were $32,064.
67
Report of Independent Auditors
Board of Directors and Shareholders
Community Bank System, Inc.
In our opinion, the accompanying consolidated statements of condition and the
related consolidated statements of income, shareholders' equity, comprehensive
income and cash flows present fairly, in all material respects, the financial
position of Community Bank System, Inc. and its subsidiaries at December 31,
2003 and 2002, and the results of their operations and their cash flows for each
of the three years then ended in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note F to the consolidated financial statements, effective
January 1, 2002, the Company adopted Statement of Financial Accounting Standards
Nos. 142 "Goodwill and Other Intangible Assets" and 147 "Accounting for Certain
Acquisitions of Banking and Thrift Institutions."
/s/ Pricewaterhousecoopers LLP
Syracuse, New York
January 26, 2004
68
TWO YEAR SELECTED QUARTERLY DATA
2003 RESULTS 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Total
- -----------------------------------------------------------------------------------------------------------------------
Net interest income $34,703 $32,539 $32,102 $32,484 $131,828
Provision for loan losses 3,093 2,029 2,673 3,400 11,195
- -----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 31,610 30,510 29,429 29,084 120,633
Non-interest income 7,618 9,725 8,891 8,747 34,981
Operating expenses 27,799 25,152 25,123 24,387 102,461
- -----------------------------------------------------------------------------------------------------------------------
Income before income taxes 11,429 15,083 13,197 13,444 53,153
Income taxes 2,759 3,354 3,165 3,495 12,773
- -----------------------------------------------------------------------------------------------------------------------
Net income $ 8,670 $11,729 $10,032 $ 9,949 $ 40,380
=======================================================================================================================
Basic earnings per share $ 0.64 $ 0.90 $ 0.77 $ 0.76 $ 3.07
Diluted earnings per share $ 0.62 $ 0.87 $ 0.75 $ 0.75 $ 2.99
=======================================================================================================================
2002 RESULTS 4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter Total
- -----------------------------------------------------------------------------------------------------------------------
Net interest income $33,848 $32,397 $31,437 $30,168 $127,850
Provision for loan losses 5,042 2,278 3,384 1,518 12,222
- -----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 28,806 30,119 28,053 28,650 115,628
Non-interest income 7,846 7,882 8,516 7,562 31,806
Operating expenses 23,807 22,864 23,883 24,476 95,030
- -----------------------------------------------------------------------------------------------------------------------
Income before income taxes 12,845 15,137 12,686 11,736 52,404
Income taxes 3,206 4,087 3,416 3,178 13,887
- -----------------------------------------------------------------------------------------------------------------------
Net income $ 9,639 $11,050 $ 9,270 $ 8,558 $ 38,517
=======================================================================================================================
Basic earnings per share $ 0.74 $ 0.85 $ 0.71 $ 0.66 $ 2.97
Diluted earnings per share $ 0.73 $ 0.84 $ 0.70 $ 0.65 $ 2.93
=======================================================================================================================
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9a. Controls and Procedures
As of December 31, 2003, the Chief Executive Officer and Chief Financial Officer
of the Company evaluated the Company's disclosure controls and procedures
related to the recording, processing, summarization and reporting of information
in the Company's reports that it files with the Securities and Exchange
Commission (SEC). These disclosure controls and procedures have been designed to
ensure that (a) material information relating to the Company, including its
consolidated subsidiaries, is made known to the Company's management, including
their officers, by other employees of the Company and its subsidiaries, and (b)
this information is recorded, processed, summarized, evaluated and reported, as
applicable, within the time periods specified in the SEC's rules and forms.
Based upon this evaluation, these officers concluded that the design and
effectiveness of the disclosure controls and procedures is sufficient to
accomplish their purpose.
There have been no significant changes in the Company's internal controls or
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
69
Part III
Item 10. Directors and Executive Officers of the Registrant
The information concerning Directors of the Company required by this Item 10 is
incorporated herein by reference to the sections entitled "Nominees for Director
and Directors Continuing in Office" and "Section 16(a) Beneficial Ownership
Reporting Compliance" 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. The
Company has adopted a code of ethics that applies to its principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. The text of the code of
ethics is posted on the Company's web-site at www.communitybankna.com. The
Company intends to satisfy the requirements under Item 10 of Form 8-K regarding
an amendment to, or a waiver from, the code of ethics that relates to certain
elements thereof, by posting such information on its web-site referenced above.
In addition, information concerning Audit Committee Financial Expert is included
in the Proxy Statement under the caption "Audit Committee Report" and is
incorporated herein by reference.
Item 11. Executive Compensation
The information required by this Item 11 is incorporated herein by reference to
the section entitled "Compensation of Executive Officers" in the Company's Proxy
Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item 12 is incorporated herein by reference to
the section entitled "Nominees for Director and Directors Continuing in Office"
in the Company's Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information required by this Item 13 is incorporated herein by reference to
the section entitled "Transactions with Management" in the Company's Proxy
Statement.
Item 14. Principal Accountant Fees and Services
The information required by this Item 14 is incorporated herein by reference to
the section entitled "Audit Fees" in the Company's Proxy Statement.
70
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
A. Documents Filed
1. The following consolidated financial statements of Community Bank
System, Inc. and subsidiaries are included in Item 8:
- Consolidated Statements of Condition,
December 31, 2003 and 2002
- Consolidated Statements of Income,
Years ended December 31, 2003, 2002, and 2001
- Consolidated Statements of Changes in Shareholders' Equity,
Years ended December 31, 2003, 2002, and 2001
- Consolidated Statements of Comprehensive Income,
Years ended December 31, 2003, 2002, and 2001
- Consolidated Statement of Cash Flows,
Years ended December 31, 2003, 2002, and 2001
- Notes to Consolidated Financial Statements,
December 31, 2003
- Independent Auditor's Report
- Quarterly selected data,
Years ended December 31, 2003 and 2002 (unaudited)
2. Schedules are omitted since the required information is either not
applicable or shown elsewhere in the financial statements.
3. The exhibits filed as part of this report and exhibits incorporated
herein by reference to other documents are listed below:
2.1 Amended and Restated Agreement and Plan of Merger, dated June 7,
2003, by and between Community Bank System, Inc. and Grange National
Banc Corp. Incorporated by reference to Annex A to the proxy
statement/prospectus included in the Registration Statement on Form
S-4 (Reg. No. 333-107949) filed on August 20, 2003, as amended.
2.2 Agreement and Plan of Merger, dated May 6, 2003, by and among
the Registrant, PB Acquisition Corp. and Peoples Bankcorp, Inc.
Incorporated by reference to Exhibit 2.1 to the Current Report on
Form 8-K of the Registrant filed on May 8, 2003).
2.3 Agreement and Plan of Merger, dated November 29, 2000, by and
between Community Bank System, Inc. and First Liberty Bank Corp.
Incorporated by reference to Exhibit No. 2.1 to the Current Report
on Form 8-K filed on December 20, 2000 (File No. 001-13695).
2.4 Agreement regarding the Agreement and Plan of Merger, dated
September 26, 2000, by and between Community Bank, N.A. and The
Citizens National Bank of Malone. Incorporated by reference to
Exhibit No. 10.1 to the Registration Statement on Form S-4 filed on
October 20, 2000 (Registration No. 333-48374).
2.5 Purchase and Assumption Agreement, dated December 6, 1994, by
and between Community Bank System, Inc. and The Chase Manhattan
Bank, N.A. Incorporated by reference to Exhibit No. 10.01 to the
Registration Statement on Form S-2 filed on April 11, 1995
(Registration No. 033-58539).
71
3.1 Certificate of Incorporation of Community Bank System, Inc., as
amended. Incorporated by reference to Exhibit No. 3.1 to the
Registration Statement on Form S-4 filed on October 20, 2000
(Registration No. 333-48374).
3.2 Bylaws of Community Bank System, Inc., as amended. Incorporated
by reference to Exhibit No. 3.2 to the Registration Statement on
Form S-4 filed on October 20, 2000 (Registration No. 333-48374).
4.1 Junior Subordinated Deferrable Interest Debentures, dated as
February 3, 1997, by and between Community Bank System, Inc. and The
Chase Manhattan Bank. Incorporated by reference to Exhibit No. 4.1
to the Registration Statement on Form S-4 filed on June 25, 1997
(Registration No. 333-30045).
4.2 Amended and Restated Declaration of Trust of Community Capital
Trust I, dated as February 3, 1997, by and between Community Bank
System, Inc. and The Chase Manhattan Bank. Incorporated by reference
to Exhibit No. 4.5 to the Registration Statement on Form S-4 filed
on June 25, 1997 (Registration No. 333-30045).
4.3 Form of Common Stock Certificate. Incorporated by reference to
Exhibit No. 4.1 to the Amendment No. 1 to the Registration Statement
on Form S-3 filed on October 24, 2001 (Registration No. 333-68866).
10.1 Employment Agreement, effective March 1, 2004, by and between
Community Bank System, Inc. and Sanford A. Belden.* **
10.2 Supplemental Retirement Plan Agreement, effective March 1,
2004, by and between Community Bank System Inc. and Sanford A.
Belden. * **
10.3 Agreement dated December 23, 2002, by and between Community
Bank System, Inc., Community Bank N.A. and David G. Wallace.
Incorporated by reference to Exhibit 10.2 to the Annual Report on
10-K for the year ended December 31, 2002. **
10.4 Employment Agreement, effective March 8, 2004, by and between
Community Bank System, Inc. and Mark E. Tryniski. * **
10.5 Supplemental Retirement Plan Agreement, effective July 1, 2003,
by and between Community Bank System Inc. and Mark E. Tryniski. * **
10.6 Employment Agreement, effective March 20, 2003, by and between
Community Bank System, Inc. and James A. Wears. * **
10.7 Supplemental Retirement Plan Agreement, effective February 1,
2004, by and between Community Bank System Inc. and James A. Wears.
* **
10.8 Employment Agreement, effective March 20, 2003, by and between
Community Bank System, Inc. and Michael A. Patton. * **
10.9 Supplemental Retirement Plan Agreement, effective February 1,
2004, by and between Community Bank System Inc. and Michael A.
Patton. * **
10.10 Employment Agreement, effective November 21, 2003, by and
between Community Bank System, Inc. and Thomas A. McCullough. * **
10.11 Supplemental Retirement Plan Agreement, effective March 26,
2003, by and between Community Bank System Inc. and Thomas
McCullough. * **
10.12 Employment Agreement, effective April 3, 2000, by and between
Community Bank System, Inc. and David J. Elias. * **
72
10.13 1994 Long-Term Incentive Compensation Program, as amended.
Incorporated by reference to Appendix B to the Definitive Proxy
Statement on Schedule 14A filed on April 3, 2001 (File No.
001-13695). **
10.14 Stock Balance Plan for Directors, as amended. Incorporated by
reference to Annex I to the Definitive Proxy Statement on Schedule
14A filed on March 31, 1998 (File No. 001-13695).
10.15 Deferred Compensation Plan for Directors, as amended.
Incorporated by reference to Annex I to the Definitive Proxy
Statement on Schedule 14A filed on March 31, 1998 (File No.
001-13695).
21.1 Subsidiaries of Community Bank System, Inc.
Jurisdiction
Name of Incorporation
---- ----------------
Community Bank, N.A New York
Community Capital Trust I Delaware
Community Capital Trust II Delaware
Community Statutory Trust III Connecticut
Community Financial Services, Inc. New York
Benefit Plans Administrative Services, Inc. New York
Benefit Plans Administrative Services LLP New York
Harbridge Consulting Group LLP New York
CBNA Treasury Management Corporation New York
Community Investment Services, Inc. New York
CBNA Preferred Funding Corp. Delaware
CFSI Close-Out Corp. New York
Elias Asset Management, Inc. Delaware
First Liberty Service Corporation Delaware
First of Jermyn Realty Co. Delaware
23.1 Consent of PricewaterhouseCoopers LLP. *
31.1 Certification of Sanford A. Belden, President and Chief
Executive Officer of the Registrant, pursuant to Rule 13a-15(e) or
Rule 15d-15(e) under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2 Certification of Mark E. Tryniski, Treasurer, Chief Operating
Officer and Chief Financial Officer of the Registrant, pursuant to
Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act
of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. *
32.1 Certification of Sanford A. Belden, President and Chief
Executive Officer of the Registrant, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. *
32.2 Certification of Mark E. Tryniski, Treasurer, Chief Operating
Officer and Chief Financial Officer of the Registrant, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. *
* Filed herewith
**Denotes management contract or compensatory plan or arrangement
B. Reports on Form 8-K
Form 8-K related to quarterly earnings press release was filed on October
21, 2003.
C. Not applicable
73
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 12, 2004
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 15th day of March 2004.
/s/ James A. Gabriel
- -------------------------------
James A. Gabriel, Director and
Chairman of the Board of Directors
/s/ Mark E. Tryniski
- -------------------------------
Mark E. Tryniski
Treasurer, Chief Operating Officer and Chief Financial Officer
Directors:
/s/ Brian R. Ace
- -------------------------------
Brian R. Ace, Director
/s/ John M. Burgess
- -------------------------------
John M. Burgess, Director
/s/ Paul M. Cantwell, Jr.
- -------------------------------
Paul M. Cantwell, Jr., Director
/s/ William M. Dempsey
- -------------------------------
William M. Dempsey, Director
/s/ Nicholas A. DiCerbo
- -------------------------------
Nicholas A. DiCerbo, Director
/s/ Lee T. Hirschey
- -------------------------------
Lee T. Hirschey, Director
/s/ Harold S. Kaplan
- -------------------------------
Harold S. Kaplan, Director
/s/ Saul Kaplan
- -------------------------------
Saul Kaplan, Director
/s/ David C. Patterson
- -------------------------------
David C. Patterson, Director
/s/ Peter A. Sabia
- -------------------------------
Peter A. Sabia, Director
/s/ William N. Sloan
- -------------------------------
William N. Sloan, Director
/s/ Sally A. Steele
- -------------------------------
Sally A. Steele, Director
74