-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, azY8Jj2qQbN4XF9vSlEViB9H2erBnFhZLqvpjkFU4R+J6jjVCYp2QeIrktIfTfi4 MQkVv1lD1G1se+j5CEz/nQ== 0000723188-95-000009.txt : 199506280000723188-95-000009.hdr.sgml : 19950628 ACCESSION NUMBER: 0000723188-95-000009 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19950331 FILED AS OF DATE: 19950627 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMUNITY BANK SYSTEM INC CENTRAL INDEX KEY: 0000723188 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 161213679 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-11716 FILM NUMBER: 95549379 BUSINESS ADDRESS: STREET 1: 5790 WIDEWATERS PKWY CITY: DEWITT STATE: NY ZIP: 13214 BUSINESS PHONE: 3154452282 MAIL ADDRESS: STREET 1: 5790 WIDEWATERS PARKWAY CITY: DEWITT STATE: NY ZIP: 13214 10-Q/A 1 FORM 10 - Q/A AMENDMENT NUMBER 2 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the three months ended March 31, 1995 Commission file number 0-11716 COMMUNITY BANK SYSTEM, INC. (Exact name of registrant as specified in its charter) DELAWARE 16-1213679 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5790 Widewaters Parkway, DeWitt, New York 13214 (Address of principal executive offices) (Zip Code) 315/445-2282 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No___ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $1.25 par value -- 2,789,750 shares as of May 3, 1995. INDEX COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated balance sheets -- March 31, 1995, December 31, 1994 and March 31, 1994. Consolidated statements of income -- Three months ended March 31, 1995 and 1994 Consolidated statements of cash flows -- Three months ended March 31, 1995 and 1994. Item 2. Management Discussion and Analysis of Financial Conditions and Results of Operations PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults upon Senior Securities Item 4. Submission of Matters to a Vote of Securities Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K SIGNATURES

Community Bank System, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) March 1995 Note A -- BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 1995 are not necessarily indicative of the results that may be expected for the year ended December 31, 1995. The Company adopted FAS 114, "Accounting by Creditors for Impairment of a Loan", on January 1, 1995. Under the new standard, 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 on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. No additional provision for credit losses needed to be recognized as a result of the adoption of FAS 114. The adequacy of the allowance for credit losses is peridically evaluated by the Company in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Management's evaluation of the adequacy of the allowance is based on a review of the Company's historical loss experience, known and inherent risks in the loan portfolio, including adverse circumstances that may affect the ability of the borrower to repay interest and/or principal, the estimated value of collateral, and an analysis of the levels and trends of delinquencies, charge-offs, and the risk ratings of the various loan catagories. Such factors as the level and trend of interest rates and condition of the national and local economies are also considered. The allowance for credit losses is established through charges to earnings in the form of a provision for credit loasses. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in the provision for credit loansses. Loans continue to be classified as impaired unless that are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. At March 31, 1995, the recorded investment in loans for which impairment has been recognized in accordance with FAS 114 totaled $4,203,000 with a corresponding valuation allowance of $1,519,000. Part 1. Financial Information Item 1. Financial Statements The information required by rule 10.01 of Regulation S-X is presented on the previous pages. Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations The purpose of the discussion is to present material changes in Community Bank System, Inc.'s financial condition and results of operations during the three months ended March 31, 1995 which are not otherwise apparent from the consolidated financial statements included in these reports. Certain information pertaining to the pending acquisition by Community Bank, N.A. of 15 branch locations from The Chase Manhattan Bank, N.A. (the "Acquisition") is set forth at the conclusion of the discussion. Earnings Performance Summary Three Months Ended Change 3/31/95 3/31/94 Amount Percent (000s) Net Income $2,752 $2,400 $352 14.6% Earnings per share $0.98 $0.85 $0.13 15.3% Weighted average shares outstanding 2,815 2,808 8 0.3% Return on average assets 1.20% 1.33% -0.13% N/A Average assets $929,778 $730,155 $199,623 27.3% Return on average shareholders' equity 16.62% 15.54% 1.08% N/A Average shareholders' equity $67,151 $62,636 $4,514 7.2% Percentage of average shareholders' equity to average assets 7.22% 8.58% -1.36% N/A Net income for first quarter 1995 reached a record high of $2.75 million, up 14.6% over the comparable 1994 period. Earnings per share rose 15.3% to $.98, also a record for the company. These records reflect continued excellent loan growth, an improved level of noninterest income, and enhanced utilization of shareholder capital. As a result, return on shareholder equity rose to 16.62%, up more than one percentage point from first quarter 1994. In addition, dividends to shareholders were 11.1% higher than one year earlier as a result of an increase approved last August to an annualized payment of $1.20 per share. Despite a narrower margin between earning asset yields and rates paid on deposits, as reflected by the bank's 63 basis point reduction in net interest margin from last year, CBSI's net interest income rose a very satisfactory 14.9% (nominal) for the quarter. This increase resulted from record loan growth of over 16% as well as 31% more in investment securities. In particular, net growth in automobile financing originated through dealers was very strong, up approximately $37 million or 48% from one year earlier. Overall business lending was nearly 14% higher while consumer mortgages increased almost 7%. More than 40% of the $161 million growth in earning assets this quarter was funded by the bank's four branch acquisitions in 1994, with the balance from greater deposits held by municipalities and borrowings from the Federal Home Loan Bank (FHLB). As discussed in its recently released annual report, the company intends to repay virtually all its FHLB borrowings with deposits to be assumed in connection with the Acquisition. A 13.7% improvement in noninterest income for the quarter reflected higher fees from the sale of annuities, mutual funds, and employee benefit trust products as well as greater service charges and commissions from an expanded customer base gained from 1994's acquisitions. Overhead was up 12.3% for the quarter, with more than half the increase reflecting personnel costs. Staff has been added because of the newly acquired branches as well as to support business development efforts. Other increases related to the new branches were reflected in greater occupancy, FDIC insurance, and deposit intangible amortization expense. Lastly, certain other costs were higher due to activities in preparation for the Acquisition and timing differences compared to first quarter 1994. Asset quality remained good at the company. Net charge-offs were very low at .09% of average loans, and nonperforming loans were down slightly from the year-end 1994 level to .64% of loans outstanding. These factors enabled loan loss provision expense to be nearly unchanged from first quarter 1994 and still maintain the ratio of loan loss reserves to loans outstanding at the year-end 1994 level of 1.30%. Though down from one year ago, the ratio of reserves to nonperformers is considered ample by management at 2.0 times. The following sections of this report more fully discusses the balance sheet and earnings trends summarized above. Net Interest Income Net interest income is the difference between interest earned on loans and other investments and interest paid on deposits and other sources of funds. On a tax-equivalent basis, net interest income for first quarter 1995 increased $1.3 million (14.2%) over the same period in 1994 to $10.6 million. Compared with fourth quarter 1994, there was a $120,000 decline. The change in net interest income reflects both the change in net interest margin (yield on earning assets less cost of funds as a percentage of earning assets) and the change in earning asset levels. The table below shows these underlying dynamics.

Note: (a) All net interest income, margin, and earning asset yield figures are full-tax equivalent. (b) Net interest income, margin, and earning asset yield figures exclude a premium on a called bonds of $297 on October 10, 1993. * May not foot due to rounding From fourth quarter 1992 through mid-1994, margins have narrowed because the yield on earning assets fell faster than the cost of funds rate. Since mid-1994 the margin has continued to narrow as the bank's cost of funds has increased at a faster pace than the earning asset yield. More specifically, from fourth quarter 1992 to second quarter 1994, the cost of funds rate (total interest expense divided by total deposits plus borrowings) was down only 28 basis points compared to a 110 basis point decline in earning asset yield. Since second quarter 1994, the cost of funds rate is up 108 BP largely due to an increasing volume of higher cost borrowings versus lower cost deposits (whose rate increases have lagged), while the yield on earning assets has grown only 59 BPs (as lower yielding loans gradually mature or reprice and are replaced with higher yields). Comparing the quarter just ended to one year earlier, the net interest margin narrowed by 63 basis points due to a 53 basis point increase in the yield on earning assets compared to the cost of funds rate increasing by 118 basis points (for the same reason outlined in the preceding paragraph). However, the $196.7 million increase in earning assets shown in the above table more than offsets the impact of this shrinkage. Had margins remained constant, net interest income would have increased by $2.6 million versus $1.3 million actually realized. Net interest income is also less than it would have been because since third quarter 1993, the mix of earning assets has moved toward a greater share in investments, which have a lower overall yield than loans. This change in mix as measured by the loans to earning asset ratio is the result of improved investment opportunities funded with short-term borrowings and the second quarter 1994 acquisition of four branches, about one-third of whose deposits was placed in the investment portfolio. Comparing first quarter 1995 to fourth quarter 1994 shows a 21 BP decline in the net interest margin. The yield on earning assets increased 30 basis points due to increased financial market rates and prime rate increases in November 1994 and February 1995, while the cost of funds rate rose 53 basis points because of a slight increase in deposit rates plus fed funds increases (corresponding to prime movements), which raised the rate on short-term borrowings. Despite $45.2 million in earning asset growth, net interest income fell $120,000 from the prior quarter due to the declining margin and two fewer days (had the number of days been equal, net interest income would have been over $100,000 higher than the prior quarter). Despite its recent decrease, net interest margin has long been a historical strength for CBSI, being in the top peer quartile based on comparative data as of December 31, 1994. This performance is largely the result of very high earning asset yields, being in the 80th to 90th percentile, versus cost of funds being slightly above norm in the 66th percentile. Non-Interest Income Non-interest income, including service charges, commissions, overdraft fees, trust income and fees from other sources, totaled approximately $1.4 million for the three months ended March 31, 1995, up $168,000 (13.7%) from the same period last year.

As shown by the table above, income from service charges on deposits is responsible for more than 58% of the total change from first quarter 1994 versus the quarter just ended and is the result of overdrafts and other fees associated with increased deposit accounts; this improvement reflects the four branches purchased during the last twelve months and efforts to reduce the number of waived charges. Increases also occurred in fiduciary services attributable to growth in employee benefit trust services. Personnel trust was essentially flat (due to declines in periodic, less predictable estate fees). Additionally, other service charges rose due to significant growth in the sale of annuities and mutual funds (a program launched through CBSI's branch network early in 1994) and the reinstatement of a holiday extension program for installment loans. Growth was partially offset by declining Visa merchant discount fees attributable to loss of a large vendor. Management recognizes that the company's level of non-interest income must be improved, its ratio to average assets being .61% for the quarter, or the first peer quartile (the 7 basis point decrease from one year earlier reflects CBSI's strong asset growth). Progress continues to be made to address this shortfall by maintaining competitive and value-based service charges; selling fixed rate annuities through our 36 customer facilities; offering full service brokerage/financial planning products through dedicated sales representatives in selected markets; and selling/servicing residential mortgages (which began in mid-1994). Non-Interest Expense Non-interest expense or overhead for the three months ended March 31, 1995 increased by $767,000 (12.3%) over the same period last year to $7.0 million. The table below summarizes the major components of change. Three Months Ended Change 3/31/95 3/31/94 Amount Percent (000's) Personnel Expense $3,711 $3,284 $427 13.0% Occupancy, furniture, $ 966 $ 948 $ 18 1.9% and equipment Administrative and business $1,175 $ 963 $212 22.0% development All other expense $1,171 $1,061 $110 10.4% ------- ------- ------- ------- Total noninterest expense - Amount $7,024 $6,256 $767 12.3% - % of Average assets 3.06% 3.47% -0.41% --- Efficiency ratio 58.7% 59.7% -1.0% --- Approximately 55% of the quarterly increase resides in personnel expense, the primary reasons being modest annual merit awards and 43 additional full-time equivalent (FTE) positions, resulting in a total of 440 employees as of March 31, 1995. These additions pertain to the Columbia Savings branch acquisition (21 FTE); the acquisition of the Chase Cato, New York branch in fourth quarter 1994; expanded business development efforts in the lending and fiduciary services functions; and the need to service the bank's increased transaction volumes over the last twelve months. The remainder of the quarter's overhead increase compared to the same quarter last year is spread over a number of expense categories. Higher occupancy expense resulted from the four new branches offset by a milder 1994-95 winter (as compared to the prior winter). Administrative expenses were up due to higher supplies and deposit insurance (both increases due to branch acquisitions). Computer services climbed due to an accounting change to reflect the external servicing costs of the EBT function. The amortization of intangibles rose $78,000 primarily due to the acquisition of the Columbia branches, whose $5.5 million premium (or 8.6% of the deposits assumed) added approximately $365,000 per annum over the prescribed 15 year amortization period. Finally, there were various other increases related to inflation, volume growth and acquisitions. The above increases were offset by lower advertising expense (caused by more in-house ad creation and reduced rate associated advertising) and reduced Visa processing expense, related to the loss of a large vendor. As a percentage of average assets, annualized overhead declined satisfactorily from 3.47% in first quarter 1994 to 3.06% in first quarter 1995; the latter level is now favorably below the peer norm and is attributable to persistent cost control efforts as well as asset growth (much of which was in the bank's investment portfolio, which requires minimal overhead). CBSI's efficiency ratio (operating expense divided by recurring operating income) decreased slightly in the first quarter from 59.7% last year to 58.7% this year, nicely below the peer bank average of 61.6% as of 12/31/94; the 1.0% improvement is caused by a greater percentage of earnings resulting from borrowing and investments rather than loans and deposits (which consume more overhead). Income and Income Taxes Income before tax was approximately $4.5 million for the quarter ended March 31, 1995, a $736,000 (19.3%) increase from the same period last year. As shown by the table below, the increases in overhead for the quarter are more than offset by greater net interest income and higher non-interest income. Three Months Ended Change 3/31/95 3/31/94 Amount Percent (000's) Net interest income $10,426 $9,074 $1,351 14.9% Loan loss provision $ 254 $ 239 $ 15 6.4% Net interest income $10,171 $8,835 $1,336 15.1% after provision for loan losses Other income $ 1,397 $1,229 $ 168 13.7% Other expense $ 7,024 $6,256 $ 767 12.3% Income before $ 4,545 $3,808 $ 736 19.3% income tax Income tax $ 1,793 $1,408 $ 385 27.3% Net income $ 2,752 $2,400 $ 351 14.6% As a result of higher pre-tax income, YTD income taxes increased by $385,000. CBSI's marginal tax rates are 35% federal and 9% state (plus a 4.0% surcharge scheduled to be phased out over time). First quarter 1995's effective tax rate of 39.5% is higher than first quarter 1994's rate due to the decreasing proportion of tax-exempt municipals. Compared to our peers, the company's effective tax rate is unfavorable because of New York State's very high tax level as well as tax exempt security holdings being slightly below the norm. Capital Three Months Ended Change 3/31/95 3/31/94 Amount Percent Tier 1 leverage ratio 6.70% 8.07% -1.37% N/A Tier 1 capital to 12.41 14.62 -2.21 N/A risk asset ratio Cash dividend declared $0.30 $0.27 $0.03 11.1% per common share Dividend payout 30.4% 30.9% -0.53% N/A Book value per share: Total $24.73 $22.81 $1.92 8.4% Tangible 22.59 22.66 (0.08) (0.3) As of March 31, 1995, the tier I leverage ratio of 6.70% was 137 basis points lower than one year earlier. The decrease in the ratio is the combined result of the $5.5 million intangible from the Columbia branch acquisition, which added approximately $58 million in deposits after run-off and $77 million in higher borrowings to help fund loan and investment growth. The $1.2 million negative after tax market value adjustment for the available-for-sale investment portfolio is excluded from the calculation per the OCC's definition. Though below the peer norm of 7.79% as of December 31, 1994, CBSI's tier I leverage ratio is well above the 5% minimum required to be a "well-capitalized" bank as defined by the FDIC. As noted more fully below, it is expected that the Acquisition will result in a decrease in tier I leverage ratio such that CBSI and the bank will be classified as "adequately capitalized" immediately following consummation of the Acquisition. As noted below, institutions are deemed by the FDIC to be "adequately capitalized" with respect to tier I leverage ratio if the ratio is between 4.0% and 5.0%. See "Pending Acquisition." As a result of the aforementioned reasons, the tier I risk-based capital ratio as of March 31, 1995 was 12.41% or 221 basis points lower than it was one year ago. This compares to a 6% "well-capitalized" regulatory minimum. To the degree that earning asset growth results from investment purchases, this risk-based ratio is more favorable than the nominal leverage ratio since investments have a lower risk component than most loans. Total capital reached $69.0 million as of March 31, 1995, $6.3 million (10.1%) higher than twelve months earlier. This increase is attributable to dividends declared on common stock of $3.2 million over the twelve months ended March 31, 1995 versus net income of $10.5 million during the same time frame. The remaining difference is due to additional shares issued in exercise of incentive stock options and changes in the market value adjustment. The higher YTD dividend shown above reflects a 3 cent per share increase (11.1%) in the quarterly dividend approved by the CBSI Board of Directors in August 1994, the fourth dividend hike within three years. The YTD 1994 dividend pay-out of 30.4% is at the low end of the company's targeted 30-40% guideline. The 8.4% increase in book value per share from March 31, 1994 approximates the increase in total capital discussed above, slightly offset by 1.4% more in shares outstanding largely because of the impact of a higher stock price on valuing unexercised options. Tangible book value per share declined slightly since first quarter 1994 due to the intangible resulting from the acquisition of the three Columbia Savings branches. The common shares of Community Bank System, Inc. are traded in the NASDAQ National Market System under the symbol CBSI. Stock price activity, numbers of shares outstanding, cash dividends declared and share volume traded are shown below.

Loans Loans outstanding, net of unearned discount, were $495.2 million as of March 31, 1995, a very favorable $68.8 million (16.1%) growth in the prior twelve months. As shown in the table below, CBSI is predominantly a retail bank, with over 70% of its outstandings spread across three basic consumer loan types. Strong growth in the last year has been experienced in consumer indirect and business lending. Additionally, reasonable growth has been felt in consumer direct and consumer mortgages. All four types are more fully defined in the company's 1994 annual report.

* May not foot due to rounding Greater than 50% of CBSI's loan growth in the last twelve months came from the indirect lending portfolio (applications taken at dealer locations), which grew 48%. This reflects both high automobile demand industry-wide, which began in the spring of 1993, as well as greater emphasis on this product line in CBSI's Southern Region. These factors produced a strong 11.1% increase in the quarter just ended. Approximately, 55% of the bank's indirect automobile loans are used versus 45% new. About 7% of the consumer indirect portfolio consists of mobile homes, and recreational and other vehicles. Almost 25% of CBSI's loan growth in the last twelve months came from the generally prime-based business lending portfolio, which grew nearly 14%. Though a relatively low prime lending rate has encouraged borrowing in the last year, small and medium sized companies have also been receptive to CBSI's responsive and personalized service. In addition, experienced lending officers who have joined the bank in the last two years have enhanced commercial loan growth. The recent increases in the prime rate may have dampened demand a bit, as evidenced by growth of 1.3% during the last three months (the lowest since third quarter 1993). The almost 7% increase in consumer mortgages since first quarter 1994 (or 13% of total loan growth) is attributable to the increasing mortgage rate environment, the continued wind-down of the fixed rate refinancing boom of the last two years, and a program to sell mortgages in the secondary market implemented by CBSI in third quarter 1994. Volume fell slightly in the first quarter with $800,000 in secondary market sales. Considering mortgage sales and normal portfolio amortization, management anticipates little future growth within this loan type, outside of that provided by the branches to be acquired in the Acquisition. Consumer direct loans have grown a favorable 6.2% since March 31, 1994. This category had been essentially flat since the end of 1992 after the accumulation and periodic sale of student loans is considered. The line of business started to show small increases in mid 1994 but has since leveled with a flat quarter for conventional installment and direct personal lending. Borrowing under home equity lines of credit has generally maintained steady growth, but fell slightly in the last three months due to decreased demand which had been absorbed with 1994's teaser rate promotion in conjunction with increasing first quarter 1995 rates. Loans at CBSI have now climbed for twelve consecutive quarters, which compares very favorably to the banking industry in general. The change in loan portfolio mix by type over the last year is shown at the bottom of the above table. While the mix of consumer mortgages fell in the last twelve months after a sharp increase in 1991-1993, the indirect loan share is rising after a slide which started before the 1990 recession and eased late in 1994. Although there has been favorable growth in consumer mortgages and consumer direct, the loan mix of each fell with stronger growth in other loan categories. As discussed in the net interest income section of this report, earning asset yields have grown 53 basis points over the last twelve months. Despite a 281 basis point increase in the average prime rate for the three months ending March 31, 1995 over the same period last year, the loan yield has grown only 51 basis points. This has resulted from the slow runoff of lower yielding loans and market pressure keeping rates on many loan types relatively low. Nonetheless, CBSI's predominantly retail loan mix and related pricing objectives have maintained a very favorable overall loan yield, being in the top peer quartile based on data as of December 31, 1994. Loan Loss Provision and Reserve for Loan Losses The provision for future loan losses was $254,000 for the three months ended March 31, 1995, up $15,000 (6.4%) versus the same period last year. Net charge-offs for the quarter were $112,000 (a very modest .09% of loans), down from $238,000 a year ago due a slight decline in gross charge offs and recoveries of two large commercial loans. CBSI's net charge offs are slightly above the peer norm, being in the 59th percentile as of December 31, 1994.

The lower provision along with strong loan growth discussed above caused the ratio of loan loss reserve to total loans to fall to 1.30%. Despite the ratio's decline, the reserve reached a new high at quarter end of $6.4 million. Management believes that having a loan loss reserve ratio in the neighborhood of 1.25% is consistent with CBSI's credit quality, which has enabled the reserve for loan losses to cover the level of non-performing loans by approximately two times or more since the company's restructuring as a single bank. Today's coverage of loan loss reserves over non-performers is favorable at 202%. Included in this coverage is an ample 12% in reserves to absorb general, unforeseen losses.

Non-performing loans increased 27% from twelve months earlier to $3.2 million as of the most recent quarter end attributable to one large commercial loan for which corrective action is being taken. Also up from the March 31, 1994 level was the ratio of non-performers to loans outstanding to .64%; the slightly higher level at December 31, 1994 was in the peer normal 45th percentile. The ratio of loan loss provision to net charge offs for the most recent quarter end was 227%, well above the 100% ratio twelve months earlier due the objective to maintain the ratio of loan loss allowance to total loans at 1.30%. The following table reflects the detail on non-performing and restructured loan levels. The ratio of non-performing assets to total assets was .36% as of March 31, 1995, down 5 basis points from a year ago. There is no troubled debt restructuring as of the most recent quarter end versus a year earlier at $228,000; the change reflects being paid out of previously restructured commercial loans. The ratio of nonperforming assets to loans plus OREO remains with the company's objective of .75%.

Total delinquencies at $6.1 million (loans greater than 30 days past due plus nonaccruals) declined slightly from one year earlier, and the ratio to total loans at 1.18% remained favorable to peer norms and improved from prior periods. The reason for the dollar decrease is improved installment loan collection efforts. Installment and real estate delinquencies decreased slightly.

Deposits Deposits are the primary source of funding for loans and investments as measured by the deposits to earning asset ratio. This ratio is down 8.4 percentage points from a year ago to 80.0%, reflecting borrowings as an increased source of funding in order to achieve management's balance sheet leverage objectives. Average earning assets have increased $196.7 million over the last twelve months, while average deposits have grown only $100.5 million. The table below displays the components of total deposits including volume and rate trends over the last six quarters.

* May not foot due to rounding Average total deposits for the quarter were 16.7% higher than the comparable 1994 period. As shown by the table, virtually all of the deposit growth was in time deposits (up $99.7 million), with the remainder split between $10.3 million in demand deposit growth and declines in savings and money markets. The major reasons for the total deposit increase are the $62.4 million Columbia Banking, FSA deposit acquisition late in the second quarter 1994, the Chase Cato branch acquisition in fourth quarter 1994, and an expanded business customer base consistent with increases in commercial loans. The deposit mix has changed slightly since first quarter 1994. Time deposits have increased with the recent upturn in financial market rates as funds shifted back from temporarily being parked in savings and money market accounts. Additionally, the time deposit mix expanded with the high proportion of time deposits in the acquired Columbia branches and CBNA bidding more aggressively early in first quarter 1995 on public fund CD's which had more favorable rates than short term borrowings. While borrowing costs have risen with the recent movement in the federal funds rate (see table in the following section), the above table shows that the average rates on interest bearing deposits have lagged this increase. As of December 31, 1994, CBSI's average rate on interest bearing deposits was in the 53rd peer percentile. After having steadily fallen for a number of quarters, the average rate on total deposits appears to have bottomed out in second quarter 1994 and has increased since then. The 37 basis point rise in average cost of deposits during the quarter is attributable to the increasing IPC deposit rates and more aggressive municipal time deposit bidding (which has since come down with New York State funds being paid out to many school districts). Liquidity and Borrowing Position Liquidity involves the ability to raise funds, to support asset growth, to meet requirements for deposit withdrawals, to maintain reserve requirements, and to otherwise sustain operations. This is accomplished through maturities of loans and investments, deposit growth, and access to sources of funds other than local deposits (such as borrowings from the Federal Home Loan Bank, selling securities under agreements to repurchase, and various other sources). All of these factors are considered by management in evaluating the bank's liquidity requirements and position assessment. The bank's liquidity level as of March 31, 1995 is considered by management to be adequate. In the event of a liquidity crisis, over $83 million (essentially short term assets minus short term liabilities) or 8.7% of assets could be converted into cash within a 30-day time period. This puts the liquidity position above the bank's 7.5% policy minimum. The same policy minimum applies to projections over a 90-day period for which the actual ratio was 7.1% as of this quarter end. This longer period encompasses continued service to loan customers and normal loan and deposit flows anticipating viability of the institution after coping with the initial crisis. The 90-day ratio is temporarily lower than the policy minimum because of anticipated outflows of public funds over the next 90 days and high levels of securities pledged to municipal deposit accounts (both related to the timing of state school district funding). While this liquidity approach and related measures have been practiced by leading banks for a number of years, they have recently been validated by the New England banking crises in the last decade. The following table shows the trend of loans, investments, large liability certificates of deposit and other borrowings over the last six quarters.

Note:(a) Net interest income, margin, and earning asset yield figures exclude a premium on a called bonds of $297 on October 10, 1993. (b) Defined as total deposits minus CD's > $100,000. Rate includes impact of non-interest bearing transaction accounts. * May not foot due to rounding Borrowings for first quarter 1995 averaged $153.6 million compared to $58.9 million a year earlier. This resulted from CBSI's strategy to increase net interest income by expanding earning assets as long as loan and investment opportunities are attractive and non-deposit funding sources are sufficient. As discussed in the capital section of this report, this strategy was executed within the guideline of maintaining the tier I leverage ratio in the 6.5-7% range. In addition, borrowings are constrained by an internal guideline not to exceed 50% of assets eligible to collateralize borrowings. This would provide for unused borrowing capacity of $40 million as of quarter end. CBNA's Federal Home Loan Bank borrowings are currently comprised of 90 day terms or less, with 27% at the currently manageable overnight rate. The bank's asset/liability management committee monitors the trade-off between raising funds through retail deposits versus large liability certificates of deposit and other borrowings. Management uses borrowings and certificates of deposit interchangeably according to the more cost effective option for the maturity of funds desired. On a short-term basis, borrowings also cushion fluctuations in deposits; the bank services a large municipal deposit base that varies with seasonal cash requirements and revenue flows. The company intends to repay virtually all of its FHLB borrowings with deposits to be assumed in the Acquisition. This is the main reason behind management's decision to maintain a short-term borrowing position. Investments and Asset/Liability Management The level and composition of Community Bank System, Inc.'s investment portfolio is designed to balance the constraints of liquidity, interest rate risk, capital and credit risk while providing an acceptable rate of return. In meeting that objective, the portfolio at quarter end comprised 43.9% of earning assets and contributes a substantial steady stream of interest income using high quality securities with relatively short maturities. As shown by the table below, the bank's investments consist primarily of U.S. treasury securities, mortgage-backed securities (including U.S. agencies and collateralized mortgage obligations), and tax-exempt obligations of state and political subdivisions. All investment strategies are developed in conjunction with the bank's asset/liability position, with particular attention given to managing interest rate risk.

Note: (a) Includes CMOs and pass-throughs (b) Includes Money Market Investments, Federal Home Loan Bank, and other * May not foot due to rounding Investments totaled $387 million for the quarter just ended, up $92 million (31.0%) from twelve months prior. This increase is attributable to (a) the previously mentioned strategy of increasing net interest income by growing earning asset levels when favorable investment opportunities are available and (b) deposits acquired via four new branches in the last twelve months. As rates were rising in the first and second quarters in 1994, cash flow producing investments (such as 15 year seasoned mortgage backed securities) were purchased to provide an expected flow of funds for reinvestment at higher rates later on. Thus, significant growth (34%) was seen from December 1993 to March 1994 in mortgage backed securities. In the middle of second quarter 1994, as rates began to level (and fall slightly in first quarter 1995), call protection investments were purchased. Thus, from March 1994 to March 1995 there is less growth in mortgage backed securities (12.4%) to $162.4 million than in call protection U.S. Governments (60.2%) to $192.5 million. Additional growth in investments resulted from significant increases in the bank's Federal Home Loan Bank stock level (reflected in other investments) as required by increased FHLB borrowing levels. Over the last twelve months, the investment portfolio mix has shifted such that there are increased proportions of U.S. Government securities (50% as of March 31, 1995) and other investments (Federal Home Loan Bank stock), while a decreasing proportion of tax exempt and mortgage backed securities. The average fully taxable equivalent yield in the last year has increased from 6.77% to 7.64% as the result of lower yielding investments running off and taking advantage of increased market rates. As of December 31, 1994, CBSI's overall investment yield is in the highly favorable 88th percentile. The average portfolio life based on earliest redemption date has increased from 3.3 years on March 31, 1994 to 3.9 years attributable to the increasing mix of investments with call protection features. Although interest rates have risen dramatically since March of 1994, little change in the market value of the bank's investment portfolio has occurred. Portfolio appreciaion dropped slightly from 101.7% of book value one year ago to 100.5% of book value as of March 31, 1995. Management, although keenly aware of how interest rate volatility may change the market value of its investments, continues to place an overriding emphasis on the future earnings stream of its portfolio; thus, its decision to classify the majority of new investment purchases as held-to-maturity. The held-to-maturity portfolio (78% of the total investments) amounted to $302 million as of March 31, 1994. Average time to maturity of these securities, based on the earliest redemption date, was 3.5 years, reflecting the increasing mix of call protection investments. The portfolio recorded a market value appreciation of $3.9 million or 1.3% above book value for the quarter just ended. As of the most recent quarter end, $72 million or 22% of the investment portfolio is classified as available-for-sale in accordance with SFAS No. 115, which was adopted as of year-end 1993. The most common criteria for placing securities in the AFS portfolio is the need to sell securities for liquidity needs and to manage interest rate risk. However, CBSI's liquidity position does not rely on security sales, and interest rate risk is managed at the time of investment purchase rather than after the fact. To be conservative, the bank chose to place in its AFS portfolio all collateralized mortgage obligations and most publicly traded securities with a stated final maturity or call date of two years or less. As of March 31, 1995, the AFS portfolio average maturity based on earliest redemption date was 5.5 years, and the pre-tax market value adjustment was a negative $2.0 million or (2.8%) of book value. The available for sale portfolio has been decreasing since the adoption of SFAS 115. Since that time, all new purchases have been classified as held to maturity. The following table displays several of the underlying investment portfolio statistical measures discussed above on a quarterly basis since December 31, 1992.

Note: (a) Net interest income, margin, and earning asset yield figures exclude a premium on a called bonds of $297 on October 10, 1993. (b) Based on earliest redemption date. * May not foot due to rounding PENDING ACQUISITION As noted in CBSI's 1994 10-K Annual Report, the bank and the company have entered into a Purchase and Assumption Agreement (the "Agreement") with The Chase Manhattan Bank, N.A. ("Chase"), which provides for the acquisition of certain assets and the assumption of certain liabilities by the bank relating to the 15 Chase branches located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two), and Penn Yan, New York (the "Chase Branches"). The purpose of this section is to set forth the status of the Acquisition as of March 31, 1995 and to update the discussion in the Annual Report through the use of March 31, 1995 information. The Acquisition is currently expected to close during the third quarter of 1995. At the closing, and subject to the terms of the Agreement, the bank will assume deposit liabilities booked at the Chase Branches (the "Chase Deposits") and pay Chase a premium of 8.25% on the Chase Deposits. As of March 31, 1995 the Chase Deposits totaled $450.9 million, which amount is subject to the change due to run-off or growth of deposits occurring prior to the closing date. In addition, the bank will acquire certain small business and consumer loans associated with the Chase Branches (the "Chase Loans"), as well as the real property owned or leased by Chase for operation of the Chase Branches and related furniture, equipment and other fixed operating assets (the "Chase Assets"). The Acquisition will be accounted for as a purchase; the excess of liabilities assumed over assets acquired (goodwill) approximates $19.0 million and will be amortized over a 25-year period on a straight-line basis. In addition, approximately $18.2 million of the premium will be attributed to the value of the Chase Deposits (the "Core Deposit Value"), which will be amortized over 10 years on an accelerated method. For tax purposes, both the excess of liabilities assumed over assets acquired and the core deposit value will be amortized over a 15-year period on a straight- line basis and is expected to be fully deductible under current law. The bank will acquire the Chase Loans at face value and the Chase Assets at fair market value with the exception of furniture, equipment and other fixed assets which will be acquired at book value. The face value of the Chase Loans as of March 31, 1995 was approximately $25.2 million, and the total purchase price of the Chase Assets is approximately $5.3 million. The deposit premium will be calculated on the basis of the average amount of Chase Deposits outstanding over specified time periods preceding the closing date, except that if the closing date occurs after June 30, 1995, the closing date for purposes of calculating the average amount of Chase Deposits outstanding will be June 30, 1995. Payment of the premium on the Chase Deposits, as well as the purchase price for the Chase Loans and Chase Assets, will be effectuated through an appropriate reduction of the cash received to fund deposits assumed by the bank. Accordingly, the bank expects to receive approximately $385.3 million in cash from Chase at the closing (the "Acquired Funds") in connection with its assumption of Chase Deposits of $450.9 million as of March 31, 1995, after deduction of (a) the deposit premium of approximately $37.2 million, (b) the purchase price of the Chase Loans of approximately $25.2 million, (c) the purchase price of the Chase Assets of approximately $5.3 million, and the addition of (d) other net liabilities of $2.1 million. The bank currently plans to use the approximately $385.3 million in cash expected to be received in the Acquisition to (i) fund investment security purchases and repay short-term borrowings and (ii) make loans in the market areas of the Chase Branches and thereby earn a return on the Acquired Funds. The company anticipates that it may take in excess of five years to invest the Acquired Funds in loans such that the resulting loan to deposit ratio approximates the loan to deposit ratio of the company prior to the Acquisition. In the interim, the bank will invest the Acquired Funds in seasoned 15-year fixed-rate mortgage-backed securities and repay short-term borrowings of the bank pursuant to an investment strategy adopted by the company. It is expected that such investment securities will earn interest at rates lower than the interest rates that would be earned on loans and, thus, the bank's net interest margin will decrease in the short- to medium-term. The company believes that the net interest margin will increase over the long-term as the bank invests the Acquired Funds in loans at market rates. However, there can be no assurance that the Bank will be able to invest the Acquired Funds in loans at market rates or that the Bank will be able to earn a favorable net interest margin through investing the Acquired Funds in investment securities until loans can be made. Management currently intends to classify approximately one-third of these securities as available-for-sale investments with the remaining two-thirds classified as held-to-maturity. As with any fixed-rate investment, market value appreciation or depreciation of investment securities will occur depending upon the movement of interest rates. While the bank's intended purchases of seasoned 15-year fixed-rate mortgage-backed securities will not be immune from such forces, price volatility is expected to be less than that found in conventional 15-year or 30-year mortgage-backed securities. Given fluctuations in market conditions, there can be no assurance that management's current strategy for allocating the Acquired Funds to loans and investment securities will be the investment allocation ultimately pursued by the company. The bank has reviewed the Chase Loans and found them to be fully performing with acceptable risk ratings. The Agreement provides the bank the right to reject any loan failing to meet the bank's underwriting standards as provided in the Agreement, as well as loans which may be adversely affected by environmental conditions relating to real property securing such loans. In connection with its evaluation of the Acquisition, the bank examined the Chase Loans using substantially the same criteria, analyses and collateral evaluations that the Bank has traditionally used in the ordinary course of its business. The bank will retain approximately 103 full-time equivalent Chase employees currently associated with the Chase Branches. The Agreement requires the bank to recognize prior service with Chase for purposes of vesting and eligibility under the bank's benefit plans and to maintain base salary for all such transferred employees for a period of at least one year following the closing except in the case of discharge for cause, voluntary separation, death, or disability. All pension obligations earned by Chase employees prior to the Acquisition will be funded by Chase. The Agreement also requires Chase to pay the bank an amount, at closing, equal to the accounting benefit Chase would receive resulting from the reduction of the post retirement medical benefit liability under Statement of Financial Accounting Standards No. 106, "Accounting for Postretirement Benefits Other than Pensions." Pursuant to the Agreement, environmental inspection of the Chase Branches has been performed, and Chase is expected to remedy all material violations of environmental laws discovered during such inspections. The bank has the right to refuse specific properties in the event any noncompliance with environmental laws is not remedied. Effect Of Pending Acquisition On Capital In conjunction with the Acquisition, the company anticipates raising approximately $25.7 million (net of expenses) in additional capital through public offerings of common and preferred stock (the "Offerings") to offset the reduction in regulatory capital ratios associated with the Acquisition. The company will contribute the additional capital to the bank as capital surplus with the objective of maintaining the bank's Tier I leverage ratio following consummation of the Acquisition in the "adequately capitalized" range, which is defined by the FDIC as between 4.0% and 5.0%. The Company's sale of newly issued shares of Common Stock in the Common Stock Offering will represent approximately 21.2% of the shares of the Company's common stock outstanding following completion of the Common Stock Offering (23.6% if the over-allotment option granted to the underwriters is fully exercised). The Common Stock Offering will result in a 26.9% increase over the current number of shares outstanding (a 30.9% increase if the Underwriters' over-allotment option is fully exercised). Therefore, in the near term, the Company expects that the Offerings and the Acquisition will result in a dilution of the Company's return on equity, earnings per share, and tangible book value per share. However, the Company's long-term strategy, as evidenced by the Acquisition, is to enhance earnings per share, return on equity and tangible book value per share by deploying assets from investments into loans, continuing its asset growth and maintaining a favorable efficiency ratio. The Company believes that any initial dilution of earnings per share, return on equity, or tangible book value per share will be outweighed by the long-term benefits to the Company associated with the financial flexibility and opportunities which the Company expects to derive from the Acquisition. There can be no assurance, however, that the Company will be able to achieve these goals. In the event the bank is unable to close the Acquisition due to a lack of regulatory approval and the determining factor relates to the Community Reinvestment Act, Equal Credit Opportunity Act, the Fair Housing Act or possible anti-competitive effects, the bank is obligated to pay Chase a "break-up fee" of $1.0 million. In the event the Bank is unable to proceed to closing due to its inability to raise sufficient capital or due to a lack of regulatory approval for any other reason, the bank is obligated to pay Chase a "break-up fee" of $1.85 million. The Acquisition is expected to have a negative effect on the regulatory capital ratios of the company and the bank. Following the Acquisition and assuming net proceeds from the Offerings of $25.7 million, the company's Tier I leverage ratio will decrease from 6.70% (as of March 31, 1995) to 4.25%. The bank's Tier I leverage ratio will decrease from 6.59% (as March 31, 1995) to 4.15%. As a result of the expected decrease in the bank's Tier I leverage ratio, the bank will not qualify under regulatory guidelines as a "well capitalized" institution but rather as an "adequately capitalized" institution. As an "adequately capitalized" institution, the bank's cost of FDIC deposit insurance may increase. The following table sets forth the required regulatory ratios, the ratios of the company and the bank as of March 31, 1995, and the ratios expected to be achieved by the company and the bank; upon consummation of the Acquisition: March 31, 1995 Ratios After Regulatory Minimums Ratios Acquisition Well Adequately Under- Capitalized Capitalized Capitalized Company Bank Company Bank Total risk-based capital ratio ...10.00% 8.00% <8.00% 13.65% 13.46% 10.19% 9.93% Tier I risk-based capital ratio.... 6.00% 4.00% <4.00% 12.41% 12.21% 9.08% 8.82% Tier I leverage ratio....5.00% 4.00% <4.00% 6.70% 6.59% 4.25% 4.15% The bank's goal is to return to "well capitalized" status within approximately 12 months after consummation of the Acquisition. Until the company's Tier I leverage ratio returns to the "well capitalized" range, the additional leverage caused by the Acquisition will restrict the company's ability to consummate other possibly beneficial transactions which require further leverage or would result in the creation of additional intangibles. Acquisitions accounted for on a pooling of interests basis may not be precluded during this period if the transaction would facilitate returning to "well capitalized" status. Historically, the bank has targeted a Tier I leverage ratio well in excess of the regulatory minimum to allow for potential branch acquisitions and leverage strategies. The company believes that the Acquisition represents an opportunity which warrants foregoing such excess capacity in the near-term in order to maximize the potential long-term benefits of the Acquisition to the Company. While the bank expects to return to "well capitalized" status within approximately 12 months after consummation of the Acquisition and the Offerings, there can be no assurance that the bank will be able to do so. On March 6, 1995, Inner City Press/Community on the Move ("ICP") through its Executive Director, Matthew Lee, submitted to the OCC written comments in opposition to the bank's application for approval of the Acquisition and requested a public hearing on the application. ICP's objections to approval of the application included the bank's and Chase's Community Reinvestment Act and fair lending record and the potential anti-competitive effects of the Acquisition. ICP also incorporated written comments previously filed with the OCC in connection with an unrelated application filed by Chase, which application was approved by the OCC on February 10, 1995 notwithstanding ICP's comments. In addition to the ICP comments, the bank is aware that additional comments critical of the Acquisition have been submitted to the OCC by one of the company's institutional shareholders. The bank does not believe that these comments, or the ICP comments, raise any issues sufficient to warrant denial of the bank's application. Potential Disposition Subject to general market conditions and the company's ongoing assessment of business objectives, the bank anticipates that there will be a reduction in deposits of approximately $108 million consisting of approximately $26 million of Chase Deposits expected to run-off between March 31, 1995 and consummation of the Acquisition and approximately $82 million in deposits divested through a combination of selling certain branch locations and related deposits and reducing public funds from the bank's balance sheet. The company has had several substantive discussions with potential purchasers of deposits, although no binding commitments have been made. The purpose of any such divestitures would be to mitigate any potential adverse impact of the Acquisition on the company's earnings per share and tangible book value, reduce the company's exposure to interest rate risk, and strengthen the bank's capital ratios. Any such divestitures would occur subsequent to the consummation of the Acquisition, would be structured to maximize the bank's business objectives at that time, and would help facilitate the bank's return to a Tier I leverage ratio in the "well capitalized" range. There can be no assurance of the size or impact of any divestiture, or that a divestiture will actually occur. Reasons for the Acquisition The following summarizes the major objectives of the Acquisition and the benefits the company expects will accrue to the operations of the bank from the acquisition. * The Chase Branches consolidate and extend the bank's branch network into contiguous markets. Assuming the Acquisition and the Offerings were completed as of March 31, 1995, the company would have total assets in excess of $1.2 billion and 50 locations (net of the planned closing of one of the Canton facilities and prior to any potential dispositions). The Chase Branches will link the bank's existing Northern New York and Finger Lakes/Southern Tier distribution network. * The Chase Branches are located in markets with which the bank is already familiar, either because it is servicing them to some degree already without a branch facility, or because they are similar to the bank's existing markets, being comprised of small towns and villages outside of metropolitan trade centers. Of the 13 towns in which the Chase Branches are located, the Chase Branches are ranked either first, second or third in deposit market share as of June 30, 1994 in 10 of the towns, which, when coupled with the bank's present branches, will result in the bank being ranked either first, second or third in 36 of the 41 towns in which the bank will operate branches. * Although the Acquisition includes only a relatively small amount of loans outstanding, the depositor base of the Chase Branches includes approximately 300 small business customers and 30,000 customer households. Because of Chase's centralized style of underwriting and servicing, the company believes that these markets offer significant future growth opportunities. Based on the bank's locally responsive approach to loan decision-making, personalized service, and knowledge of these markets, the bank believes that, prior to any secondary market sales, the achievement of a 40.0% loan to deposit ratio in the Chase Branches (compared to a 5.6% level as of March 31, 1995) would be reasonable within five years. The bank's loan to deposit ratio for its present branch network is approximately 68.6% as of March 31, 1995. * The company believes that the Chase Deposits are largely stable, relatively low cost core deposit funds, similar to the bank's existing deposit base. The Chase Deposits will be used to replace the bank's presently higher cost FHLB borrowings, thus lowering overall funding costs and improving the bank's liquidity. After providing for purchased loans, branch facilities and equipment, and the deposit premium, approximately $218 million of cash received (net of repayment of short-term borrowings) will be temporarily placed in the bank's investment portfolio, increasing its size by nearly 58% (or approximately 65% including the impact of the Offerings). It is the company's intention to invest these funds in a mix of securities intended to produce a high, relatively stable level of interest income and provide on-going cash flow to help fund expected loan growth and/or be subsequently reinvested in other investment securities. * The Acquisition leverages the company's existing infrastructure. The Chase Branches will be administratively managed from either the bank's Northern or Southern Region by existing senior management personnel. The Northern and Southern regional service centers will process the added loan and deposit volumes, with incremental overhead limited to volume-sensitive staff and equipment. Similarly, a limited number of audit, loan review, and accounting personnel will be added. Up to a total of approximately 36 full- time employees may be added to the bank over a period of time following consummation of the Acquisition. The personnel acquired from Chase include only branch-related personnel, including approximately eight small-business lending and support staff and two residential mortgage origination personnel, for a total of approximately 103 full-time equivalent employees. To assist with the integration of the Chase Branches into its existing branch network, the bank has engaged and outside consultant to focus on customer sales and service training, operations center planning and upgrading; a full-time internal project coordinator has also been retained. * The company believes that the Acquisition provides it with the opportunity to increase non-interest income because annuities and mutual funds have been offered at the Chase Branches for several years. The bank only sold fixed-rate annuities at its branches during calendar year 1994 and was not fully staffed until late 1994 to sell variable-rate annuities and mutual funds. Consequently, the staff at the Chase Branches and the bank's new investment products should complement each other in increasing referrals for the sale of these products. It should be noted that the bank has not historically made acquisitions on the same scale as the Acquisition, and the future growth of the bank and the company will depend on the success of the Acquisition. The success of the Acquisition will, in turn, depend on a number of factors, including, without limitation: the bank's ability to integrate the Chase Branches into the current operations of the bank; its ability to limit the outflow of deposits held by its new customers in the Chase Branches; its success in deploying the cash received in the Acquisition into assets bearing sufficiently high yields without incurring unacceptable credit or interest rate risk; its ability to control the incremental non-interest expense from the Chase Branches in a manner that enables the company to maintain its favorable overall efficiency ratio; its ability to retain and attract the appropriate personnel to staff the Chase Branches; and its ability to earn acceptable levels of non-interest income from the Chase Branches. No assurance can be given that the bank will be able to integrate the Chase Branches successfully; that the operation of the Chase Branches will not adversely affect the company's existing profitability; that the company will be able to achieve results in the future similar to those achieved by the bank's existing banking offices; or that the bank will be able to manage its growth resulting from the Acquisition effectively. Impact of the Acquisition on Operating Performance The following discussion represents the company's current assessment of the impact of the Acquisition on the operating performance of the company. Numerous factors, including factors outside the company's control (such as the general level of interest rates and both national and regional economic conditions), may significantly alter the effects described below. As such, there can be no assurance that the effects of the Acquisition will meet the company's expectations. Significant Assumptions. In addition to the assumptions stated below, the company made the following assumptions in arriving at the conclusions discussed in this section: (i) regional and national economic conditions will remain stable with no drastic improvement or slowdown in the economy; (ii) the Chase Branches are in markets similar to the bank's current markets and therefore the bank's experience in generating loans and fee income and in maintaining core deposits is a reasonable basis for making further assumptions about the impact of the Acquisition; and (iii) run-off of Chase Deposits, if any, will occur prior to consummation of the Acquisition. While the company believes that these assumptions and the other assumptions stated throughout this section were reasonable at the time they were made, there can be no assurance that actual results will be consistent with these assumptions. The basis for the company's conclusion that approximately $26 million of the Chase Deposits will run-off prior to the closing date of the Acquisition is that (i) certain customers will choose to remain with Chase because they bank near their place of work where Chase still operates; (ii) certain customers will elect to switch banks because they would rather bank with a larger, superregional institution; and (iii) certain municipalities that value selected cash management services offered by Chase (such as those which automatically invest idle cash balances into an interest-earning deposit or an overnight repurchase agreement) but not offered by the bank will stay with Chase. With the exception of these cash management services and personal computer banking, the company believes that the services offered by the bank will be virtually as broad as those offered by Chase and that its services for small businesses will be offered so as to provide greater service than that offered by Chase. Net Interest Income. When the Acquisition is consummated and prior to any expected deposit run-offs and divestitures, the bank is expected to assume deposit liabilities which totaled $450.9 million as of March 31, 1995 and receive approximately $25.2 million in loans and $385.3 million in cash. However, for purposes of its net interest income analysis, the company assumed that the Chase Deposits totaled $425.2 million, which was the balance of such deposits as of April 30, 1995 and approximates the company's estimate of $26 million in deposit run-off prior to the closing of the Acquisition. This would result in the bank receiving approximately $361.7 million in cash upon closing the Acquisition. An additional $25.7 million in cash is expected to be received from the net proceeds of the Offerings. The cash from the Acquisition and the Offerings will be used to fund investment security purchases, repay short-term borrowings of the bank, and fund additional growth. The impact of the Acquisition on interest income is expected, therefore, to include (i) interest income from investment securities purchased, (ii) interest income from the Chase Loans, and (iii) interest income from new loans originated through the Chase Branches. The impact of the Acquisition on interest expense is expected to include (i) interest expense of the Chase Deposits which had an average cost of approximately 3.70% as of March 31, 1995 and (ii) the benefit of the lower interest expense on the Chase Deposits which will replace the bank's higher costing short-term borrowings which had an average cost of approximately 6.40% as of March 31, 1995. The company believes that these rates do not differ significantly from those existing at mid May 1995, which was the basis for the company's analysis described below. The company currently estimates that, prior to any secondary market sales, the bank could make net new loans in an amount equal to at least 40.0% of the Chase Deposits outstanding within five years after consummation of the Acquisition, although there can be no assurance that the bank will be able to do so. These loans are estimated to grow at a steady rate for purposes of the company's analysis. Because the demographics of both consumers and businesses served by the Chase Branches are similar to those markets in which the bank currently operates, new loans are expected to be similar to the bank's current loan distribution with respect to types and pricing characteristics, subject to market conditions. Given the bank's current loan distribution and the Chase Loans to be acquired, the company estimates that such new loans could have an average yield of approximately 10% assuming a flat interest rate scenario. This estimate is dependent upon the bank's ability to generate new lending business and acquire market share from those financial institutions currently serving the small business loan customers in these markets. Since a large portion of the funds received in the Acquisition and the Offerings will initially be invested in securities, the company, assisted by an asset/liability consultant, has undertaken analyses to determine a strategy for the optimal deployment of these funds. In order to determine this investment strategy, the Company has conducted an analysis of the impact of the Acquisition on the bank's overall asset/liability risk position. A variety of interest rate simulations was considered, including, but not limited to, a flat rate environment, a rising rate environment with the Federal Funds rate increasing 200 basis points, and a falling rate environment with the Federal Funds rate decreasing 200 basis points. Each of these scenarios assumed interest rates existing at mid May 1995 and that any interest rate movements occurred at regular intervals during the first year of the Acquisition and remained constant thereafter. Additionally, the company, along with its asset/liability advisor, used historical experience to estimate the impact of Federal Funds rate changes on, among other things, deposit interest rates, the prime lending rate, Treasury rates and prepayment speeds for mortgage securities. The company continues to utilize and update its analysis as conditions warrant. The analysis combined the bank's March 31,1995 asset/liability profile with that of the Chase Branches. A number of investment strategies was then examined, focusing on the goal of enhancing the profitability of the Bank while limiting the volatility of earnings under a variety of interest rate environments. Such an investment strategy could be accomplished with a variety of approaches, including maturity laddering of bonds (with and without call features), purchasing mortgage-backed securities whose average life characteristics meet the investment objective, or a combination of these or similar securities. The company has determined that the strategy which it currently expects will best achieve its goals is investing the net funds received in the Acquisition and the Offerings in seasoned 15-year fixed-rate mortgage-backed securities with an average duration of two to four years. In its analysis, the company assumed that this type of security would have a yield of approximately 7.00% in the flat rate scenario. Management currently intends to classify approximately one-third of these securities as available-for sale investments with the remaining two-thirds classified as held-to-maturity. Consistent with the bank's long-standing practice, all of the assumed investment decisions were developed in conjunction wiht the bank's asset/ liability position, with particular attention given to the interest rate risk of the bank's entire balance sheet, not just that associated with incremental investment decisions. As with any fixed-rate investment, market value appreciation or depreciation will occur depending upon the movement of interest rates. While the bank's purchases of seasoned 15-year mortgage-backed securities will not be immune from such forces, price volatility is expected to be less than that found in conventional 15-year or 30-year mortgage-backed securities. In addition, falling interest rates may shorten and rising interest rates may extend the duration of these mortgage-backed securities. This means that in a falling interest rate environment, the bank would have additional proceeds from prepayments that would have to be reinvested at lower market rates. In a rising interest rate environment, the bank would have fewer proceeds to reinvest in securities or loans. The company included the anticipated impacts of interest rate movements on the durations of these securities in its analysis. Using the assumptions set forth above, the company estimates that, following closing of the Acquisition, it will have approximately $220.8 million to invest in these securities ($361.7 million in cash received from Chase at the closing of the Acquisition plus $25.7 million in net proceeds from the Offerings less $158.8 million used to repay the Bank's short-term borrowings and $7.8 million needed to provide for reserve requirements and vault cash) and that such investment will take place over a 12 month period with excess funds temporarily invested in short-term investments. The company anticipates using some of these funds to support loan growth during this period which will result in lower average investments. Since the interest rate environment could change substantially before all the funds from the Acquisition are invested, however, it is impossible to predict with certainty which investment combination will ultimately be pursued by the bank or the length of time it will take to make these investments. It is the bank's intention that the mix of securities selected will provide continuing cash flows to help fund expected loan growth and/or to subsequently invest in other securities. Given the company's current expectations for loan growth, the intended investment strategy, the repayment of the Bank's short-term borrowings and the acquired deposit liabilities, the company and its asset/liability consultant have analyzed potential results for the company under a variety of interest rate scenarios. The analysis showed that the Acquisition could add to net interest income in the first full year of operation approximately $8.1 million in the falling rate scenario, $10.7 million in the flat rate scenario and $13.0 million in the rising rate scenario. This is the result of increased interest income of $14.2 million, $16.5 million and $19.9 million and increased interest expense of $6.1 million, $5.8 million and $6.9 million, respectively, in a falling, flat and rising rate scenario. Changes in net interest income under differing interest rate environments result from contractual restrictions on and bank discretion as to the timing of asset and liability repricing, scheduled and prepaid cash flows in earning assets and interest bearing liabilities, and differences in how the yield curve is anticipated to react to the various movements in the Federal Funds rate. In conducting this analysis, the only variable factor utilized by the company was interest rates. That is, the company did not assume significant variations in its asset/liability mix. As the company is not in a position to predict future interest rates, it is unable to assign probabilities to the results of its analysis. Interest rate movements may occur at different times and in different amounts than those assumed by the company, and therefore no assurance can be made that these estimates will be indicative of actual results. While interest rates will continue to have a substantial impact on future earnings levels and no assurance can be given, anticipated loan growth could increase levels of net interest income in future years. Provision for Loan Losses. The Chase Loans and any new loans originated by the bank through the Chase Branches will meet the underwriting standards of the bank. As the loan portfolio grows, the bank expects to add annually to its allowance for loan losses by approximately 0.55% to 0.60% (after net charge-offs) of average new loans, building to a loan loss reserve of 1.30% of period-end loans within approximately four years. Assuming (i) new loans grow steadily over a five-year period, prior to any secondary market sales, to an amount equalling 40% of the Chase Deposits and (ii) the April 30, 1995 Chase Deposits balance of $425.2 million, the Acquisition could add between $0.2 million and $0.3 million to the bank's provision expense in the first full year. Actual loan loss reserves will be based on numerous factors, including the state of the national and regional economies and local real estate values, and may be higher or lower than the bank's current expectations. Non-Interest Income. The company expects to earn additional non- interest income through deposit service charges and by selling trust and investment products to the customers of the Chase Branches. The bank has historically earned approximately 70 basis points on average assets in non- interest income. While actual results will be based on numerous factors, many of which are not in the company's control, and, therefore, no assurance can be given, the company believes that a rate of 50 to 70 basis points of the Chase Deposits is a reasonable approximation of the level of non-interest income it could earn after the Acquisition. The company expects that most of this non-interest income will be derived from fees earned on deposit accounts through service charges and overdraft fees. Because of the similarities in the deposit bases and the fee structures of the Chase Branches and the bank, the company expects its historical rate of approximately 40 basis points of average deposits earned in such fees to be comparable at the Chase Branches. Other non-interest income is expected to be generated through annuity fees, trust income (both personal and employee benefit), merchant credit card income and mortgage servicing fees from loans sold into the secondary market. The combination of these sources could result in additional non-interest income of $2.3 million to $3.2 million on an annualized basis. For purposes of this non-interest income analysis, the company assumed the Chase Deposits as of March 31, 1995. The company does not believe that if it had assumed the Chase Deposits as of April 30, 1995 there would be a material impact on the company's estimates or on the estimated impact of the Acquisition on the operating performance of the company as a whole. Non-Interest Expense. The company has estimated the cost of operating the Chase Branches within the bank's existing infrastructure. The following is a breakdown of the additional annual expenses anticipated over the first full year of operations: Amount (In millions) Salary and employee benefits...............$ 3.3 to 3.6 Occupancy expense.......................... 1.1 Amortization of intangible assets.......... 3.0 Other expense.............................. 3.4 to 3.6 ------------ Total incremental non-interest expense....$10.8 to 11.3 ============= Salary and employee benefits include approximately 103 full-time equivalent employees currently at the Chase Branches. Up to approximately 36 full-time equivalent employees may be added over a period of time following the Acquisition, primarily in the bank's operations centers to service the Chase Deposits, Chase Loans, and expected loan growth. Occupancy expense includes estimated costs of refurbishment and other capital expenditures that the bank is expected to incur after completion of the Acquisition. For income tax purposes, the intangible assets created from the 8.25% deposit premium paid in the Acquisition are fully tax-deductible and amortizable on a straight-line basis over a 15 year period under current law. For financial statement proposes, generally accepted accounting principles as currently in effect require that a portion of the premium be attributed to the Core Deposit Value and amortized over the expected life of the Chase Deposits in a manner approximating their decay rate. The balance of the premium is attributable to the cost of entering the new banking markets represented by the Chase Branches, and is amortizable on a straight-line basis over a 25-year period. Assuming the Chase Deposits as of March 31, 1995, the Core Deposit Value is expected to be $18.2 million, amortizable over a 10-year period. For the first full year, amortization of the Core Deposit Value and other intangibles is expected to be approximately $3.0 million, declining to $2.8 million and $2.5 million in the second and third years, respectively. The company does not believe that assuming the Chase Deposits as of April 30, 1995 would have a material impact on the Core Deposit Value and other intangibles or the amortization thereof. Other expenses include conversion costs and data processing expenses estimated for the Acquisition as well as the other support costs needed to operate the Chase Branches, including the impact of increased FDIC deposit insurance premiums to the bank of approximately $210,000 (assuming that the bank remains in the "adequately capitalized" designation for one year following the Acquisition). $275,000 of other expenses are one-time charges (mostly anticipated to be incurred in 1995) necessary in order to effect the Acquisition. In addition, the company expects to incur $1.9 million in related incremental capital expenditures. For purposes of this non-interest expense analysis, the company assumed the Chase Deposits as of March 31, 1995. The company does not believe that if it had assumed the Chase Deposits as of April 30, 1995, there would be a material impact on the company's estimates or on the estimated impact of the Acquisition on the operating performance of the company as a whole. Depending on the actual number of employees to be added to service the incremental business from the Chase Branches and discretion in incurring other incremental expenses, total incremental expense may range from $10.8 million to $11.3 million in the first full year of operating the Chase Branches. Impact of the Acquisition on Operating Performance Assuming Intended Potential Disposition As noted above, the Bank anticipates that there will be a reduction in deposits of approximately $108 million consisting of approximately $26 million in Chase Deposits expected to run-off between March 31, 1995 and consummation of the Acquisition and approximately $82 million in deposits divested through a combination of selling certain branch locations and related deposits and reducing public funds from the Bank's balance sheet. The company estimates that any branch sales would not be completed until at least three months after consummation of the Acquisition. These divestitures, if and when completed, should have the effect of returning the Bank's Tier I leverage ratio to the "well capitalized" level more quickly and should reduce potential variances in earnings levels. If the Bank were to divest $82 million in deposits and if $26 million in run-off of Chase Deposits occurred prior to the Acquisition, the following are the company's estimates of the impact to its operations: Net Interest Income. Using the same analysis described above, the company estimates that the intended disposition could result in additional net interest income of $8.1 million, $9.8 million and $11.6 million compared to $8.1 million, $10.7 million and $13.0 million, respectively, in the falling, flat and rising rate environments without the intended disposition. This is the result of increased interest income of $13.5 million, $15.4 million and $18.7 million and interest expense of $5.4 million, $5.6 million and $7.1 million, respectively, in the falling, flat, and rising rate scenarios. The differences in the company's estimate of interest expense assuming the disposition versus the company's estimate without the intended disposition is the result of reduced deposit levels for part of the year offset by increased borrowings during the second half of the year. The company assumed for purposes of this analysis that such borrowings would total approximately $150 million by the end of the first year following the Acquisition. As discussed above, the company expects loan generation to reach 40% of the reduced deposit total by the fifth year of operation. The company expects a similar mix of investment securities to be purchased. Because it is estimated that only $149.1 million will be available for purchasing investment securities and funding additional growth given the deposit reduction, the company believes it could have these funds fully invested within 8 to 12 months, subject to market conditions. However, as discussed above, the company expects to utilize the increased borrowings in the second half of the year to fund an increase in investments. Therefore, the average level of investments is expected to be only slightly lower than without the intended disposition. Provision for Loan Losses. The only direct effect of divestitures on the bank's provision level would be due to lower loan volumes as a result of fewer branch locations to originate new loans. Assuming net new loans grow steadily over a five-year period prior to any secondary market sales, to an amount equalling 40% of the reducted deposit total, the Acquisition could add approximately $0.2 million to the bank's provision expense in the first full year. Non-Interest Income. The reduction in deposits could reduce the expected additional income by $0.4 million to $0.7 million which could result in additional non-interest income to the bank of $1.9 million to $2.5 million, rather than $2.3 million to $3.2 million. The decline is due only to the assumption that there are fewer deposits and accounts as a result of the divestitures from which to generate fees and service charges, as well as to cross-sell other investment products. The company still expects to earn from 50 to 70 basis points on the deposit total for the same reasons discussed above. Non-Interest Expense. A $108 million reduction in deposits as described above would result in reduced expenses. The extent of such reductions would be largely dependent upon the number and identity of branches sold. The company estimates the savings to be approximately $1.3 million in the first full year of operations. This could cause the net impact from the Acquisition on non-interest expense to be reduced from $10.8 million to $11.3 million to approximately $9.5 million to $10.0 million. Part II. Other Information Item 1. Legal Proceedings. Not Applicable. Item 2. Changes in Securities. Not Applicable. Item 3. Defaults Upon Senior Securities. Not Applicable. Item 4. Submission of Matters to a Vote of Securities Holders. Not Applicable. Item 5. Other Information. Not Applicable. Item 6. Exhibits and Reports on Form 8-K a) Exhibits required by Item 601 of Regulation S-K: (2.1) Purchase and Assumption Agreement dated December 6, 1994 among the Registrant, Community Bank, N.A. and The Chase Manhattan Bank, N.A., previously filed with the Commission on April 11, 1995 as Exhibit 10.01 to the Registrant's Registration Statement on Form S-2 (No. 33-58539) and incorporated herein by reference. (2.2) First Amendment dated April 4, 1995 to Purchase and Assumption Agreement dated December 6, 1994 among the Registrant, Community Bank, N.A. and The Chase Manhattan Bank, N.A., previously filed with the Commission on April 11, 1995 as Exhibit 10.02 to the Registrant's Registration Statement on Form S-2 (No. 33-58539) and incorporated herein by reference. (3.1) Certificate of Incorporation of the Registrant, as amended, previously filed with the Commission on May 30, 1995 as Exhibit 3.1 to the Registrant's Registration Statement on Form S-2 (No. 33-58539) and incorporated herein by reference. (3.2) Bylaws of the Registrant, as amended, previously filed with the Commission on May 30, 1995 as Exhibit 3.2 to the Registrant's Registration Statement on Form S-2 (No. 33-58539) and incorporated herein by reference. (10) Employment Agreement dated January 1, 1995 between the Registrant, Community Bank, N.A. and Sanford A. Belden. (11) Statement re Computation of earnings per share b) Reports on Form 8-K: Filed on 2/27/95. Item 5. Other Information. News release: Stockholder Protection Rights Plan adopted by CBSI Board of Directors Signatures Pursuant to the requirements of The Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Community Bank System, Inc. Date: June 5, 1995 /s/ Sanford A. Belden -------------------------------- Sanford A. Belden, President and Chief Executive Officer Date: June 5, 1995 /s/ David G. Wallace -------------------------------- David G. Wallace, Senior Vice President Chief Financial Officer EXHIBIT 10 EMPLOYMENT AGREEMENT This sets forth the Employment Agreement made effective as of January 1, 1995 between (i) COMMUNITY BANK SYSTEM, INC., a Delaware corporation and registered bank holding company, and COMMUNITY BANK, N.A., a national banking association, both having offices located in Dewitt, New York (collectively, the "Employer"), and (ii) SANFORD A. BELDEN, an individual currently residing at 9 Lynacres Boulevard, Fayetteville, New York ("Employee"). This agreement supersedes the employment agreement between the parties, effective as of October 1, 1992, which provided for employment for a term ending on September 30, 1995. WITNESSETH IN CONSIDERATION of the premises and mutual agreements and covenants contained herein, and other good and valuable consideration, the parties agree as follows: 1. Employment. (a) Term. Employer shall continue to employ Employee, and Employee shall continue to serve, as Director, President and Chief Executive Officer of Employer for a three year term commencing on January 1, 1995 and ending on December 31, 1997 ("Period of Employment"), subject to termination as provided in paragraph 3 hereof. (b) Employer. Whenever in this Agreement Employee is entitled to compensation, benefits or other remuneration from Employer, the term Employer shall mean only Community Bank, N.A. Employee shall not be entitled to any compensation, benefits or other remuneration from Community Bank System, Inc. (c) Salary. During the period of January 1, 1995 through December 31, 1995, Employer shall pay Employee base salary at an annual rate of $240,000 ("Base Salary"). Employee's Base Salary for the period January 1, 1996 through December 31, 1996 shall be $275,000. Employee's Base Salary for the period January 1, 1997 through December 31, 1997 shall be $300,000. Employee's Base Salary is payable in accordance with Employer's regular payroll practices for executive employees. (d) Incentive Bonuses. Employee shall be entitled to annual incentive bonuses pursuant to the terms of the executive incentive compensation plan which has been approved by the Board of Directors of Employer to cover key personnel of Employer. Upon termination of Employee's employment pursuant to subparagraph 3(a), 3(b) 3(c) or 7, Employee shall be entitled to a pro rata portion (based on Employee's complete months of active employment in the applicable year) of the annual incentive bonus that is payable with respect to the year during which the termination occurs or, in the case of a termination upon Employee's disability pursuant to subparagraph 3(c), the date the Disability Period began. (e) Renegotiations. Beginning January 1, 1997 (12 months before the end of the Period of Employment), Employee and Employer shall commence good faith negotiations, to be completed by June 30, 1997, for Employee's continued employment by Employer after the end of the Period of Employment. If Employee and Employer cannot agree on the terms of Employee's continued employment by December 31, 1997, and Employee ceases to be employed by Employer, Employee shall be entitled to be paid (i) as severance compensation, one year of Base Salary, payable in equal installments in accordance with Employer's regular payroll practice from January 1, 1998 through December 31, 1998, and (ii) an amount equal to the sum of Employee's non-vested accrued benefit (determined as of Employee's employment termination date using, as applicable, the mortality table and discount rate used by Employer's actuary to determine funding requirements for Employer's qualified defined benefit plan) under paragraph 6 of this Agreement and under all tax-qualified retirement plans (within the meaning of Section 401(a) of the Internal Revenue Code and including any plan of Employer that is subject to Section 401(k) of the Internal Revenue Code) maintained by Employer and in which Employee is a covered participant, with the total to be paid in 12 equal monthly installments commencing 30 days after Employee's termination of employment. If Employee's employment by Employer is not continued after December 31, 1997 as a result of Employee's decision not to continue such employment, then Employer shall not be obligated to continue to pay Employee's Base Salary as severance compensation, or to pay Employee an amount equal to Employee's non-vested accrued benefits under Employer's tax- qualified retirement plans, in accordance with this paragraph 1(e). Payments of Base Salary as severance compensation pursuant to this paragraph 1(e) shall be reduced to the extent Employee receives severance or similar compensation pursuant to any severance pay plan or similar plan, program or arrangement maintained by Employer. If Employee obtains any employment or becomes self-employed following the termination of Employee's employment by Employer (including self-employment pursuant to paragraph 7(a)(i)), payment of Employee's Base Salary as severance compensation shall cease. For any period during which Employee's Base Salary is continued as severance compensation, Employee shall be eligible to continue to participate in Employer's group-term life insurance plan and group health benefit plan as if Employee were an active, full-time employee of Employer. Employee's right to "COBRA" continuation coverage under Employer's group health benefit plan shall commence as of the end of the period during which Base Salary is continued as severance compensation. (f) In the event Employer's average assets during any monthly reporting period during the Employment Period reach $1.75 billion, Employer agrees to review Employee's Base Salary as provided for under paragraph 1(c) above. 2. Duties during the Period of Employment. Employee shall have full responsibility, subject to the control of Employer's Board of Directors, for the supervision of all aspects of Employer's business and operations, and the discharge of such other duties and responsibilities to Employer as may from time to time be reasonably assigned to Employee by Employer's Board of Directors. Employee shall report to the Board of Directors of Employer. Employee shall devote Employee's best efforts to the affairs of Employer, serve faithfully and to the best of Employee's ability and devote all of Employee's working time and attention, knowledge, experience, energy and skill to the business of Employer, except that Employee may affiliate with professional associations, business and civic organizations. Employee shall serve on the Board of Directors of, or as an officer of Employer's affiliates, without additional compensation if requested to do so by the Board of Directors of Employer. Employee shall receive only the compensation and other benefits described in this Agreement for Employee's duties as a Director of Employer. 3. Termination. Employee's employment by Employer shall be subject to termination as follows: (a) Expiration of the Term. This Agreement shall terminate automatically at the expiration of the Period of Employment unless the parties enter into a written agreement extending Employee's employment. (b) Termination Upon Death. This Agreement shall terminate upon Employee's death. In the event this Agreement is terminated as a result of Employee's death, Employer shall continue payments of Employee's Base Salary for a period of 60 days following Employee's death to the beneficiary designated by Employee on the "Beneficiary Designation Form" attached to this Agreement as Appendix A. (c) Termination Upon Disability. Employer may terminate this Agreement upon Employee's disability. For the purpose of this Agreement, Employee's inability to perform Employee's duties hereunder by reason of physical or mental illness or injury for a period of 26 successive weeks (the "Disability Period") shall constitute disability. The determination of disability shall be made by a physician selected by Employer and a physician selected by Employee; provided, however, that if the two physicians so selected shall disagree, or if Employer shall disagree with the findings of the physicians, the determination of disability shall be submitted to arbitration in accordance with the rules of the American Arbitration Association and the decision of the arbitrator shall be binding and conclusive on Employee and Employer. During the Disability Period, Employee shall be entitled to 100% of Employee's Base Salary otherwise payable during that period, reduced by any other benefits to which Employee may be entitled for the Disability Period on account of such disability (including, but not limited to, benefits provided under any disability insurance policy or program, worker's compensation law, or any other benefit program or arrangement). (d) Termination for Cause. Employer may terminate Employee's employment immediately for "cause" by written notice to Employee. For purposes of this Agreement, a termination shall be for "cause" if the termination results from any of the following events: (i) Material breach of this Agreement; (ii) Misconduct as an executive or director of Employer, or any subsidiary or affiliate of Employer for which Employee is performing services hereunder including, but not limited to, misappropriating any funds or property of any such company, or attempting to obtain any personal profit (x) from any transaction to which such company is a party or (y) from any transaction with any third party in which Employee has an interest which is adverse to the interest of any such company, unless, in either case, Employee shall have first obtained the written consent of the Board of Directors of Employer; (iii) unreasonable neglect or refusal to perform the duties assigned to Employee under or pursuant to this Agreement; (iv) Conviction of a crime involving moral turpitude; (v) Adjudication as a bankrupt, which adjudication has not been contested in good faith, unless bankruptcy is caused directly by Employer's unexcused failure to perform its obligations under this Agreement; (vi) Failure to follow the reasonable instructions of the Board of Directors of Employer, provided that the instructions do not require Employee to engage in unlawful conduct; or (vii) Any violation of the rules or regulations of the Office of the Comptroller of the Currency or of any other regulatory agency. Notwithstanding any other term or provision of this Agreement to the contrary, if Employee's employment is terminated for cause, Employee shall forfeit all rights to payments and benefits otherwise provided pursuant to this Agreement; provided, however, that Base Salary shall be paid through the date of termination. 4. Fringe Benefits. (a) Benefit Plans. During the Period of Employment, Employee shall be eligible to participate in any employee pension benefit plans (as that term is defined under Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended), Employer-paid group life insurance plans, medical plans, dental plans, long-term disability plans, business travel insurance programs and other fringe benefit programs maintained by Employer for the benefit of its executive employees. Participation in any of Employer's benefit plans and programs shall be based on, and subject to satisfaction of, the eligibility requirements and other conditions of such plans and programs. (b) Expenses. Upon submission to Employer of vouchers or other required documentation, Employee shall be reimbursed for Employee's actual out-of-pocket travel and other expenses reasonably incurred and paid by Employee in connection with Employee's duties hereunder, not to include country club dues or membership fees. Reimbursable expenses must be submitted to the Personnel Committee of Employer's Board of Directors for review on a quarterly basis. (c) Other Benefits. During the Period of Employment, Employee also shall be entitled to receive the following benefits: (i) Paid vacation of 4 weeks during each calendar year (with no carry over of unused vacation to a subsequent year) and any holidays that may be provided to all employees of Employer in accordance with Employer's holiday policy; (ii) Reasonable sick leave; (iii) Reimbursement of membership fees incurred by Employee at a health club of Employee's choice; (iv) The use of an Employer-owned automobile of Employee's choice, the purchase and replacement of which shall be subject to the approval of the Personnel Committee of the Board of Directors of Employer; and (v) Reimbursement of the purchase price of a car telephone and all Employer-related business charges incurred in connection with the use of such telephone. 5. Stock Options. (a) 1992 Stock Option Grant. Pursuant to a 1992 Non- Statutory Stock Option Agreement made effective as of October 1, 1992 ("Option Agreement"), which Option Agreement implemented the grant of options provided for in the 1992 Employment Agreement between Employee and Employer ("Employment Agreement"), Employee was granted options to purchase 48,000 shares of common stock of Community Bank System, Inc. The Option Agreement provides that Employee's right to exercise options upon a termination of employment shall be governed by the terms of the Employment Agreement. The parties hereby agree that the Option Agreement shall be amended to incorporate into the Option Agreement specific terms regarding the exercise of options following Employee's termination of employment and to make such other changes as the parties shall agree to make. (b) Future Grants. Employer shall cause the Personnel Committee of the Board of Directors of Employer to review whether Employee should be granted additional options to purchase shares of common stock of Community Bank System, Inc. Such review may be conducted pursuant to the terms of the Community Bank System, Inc. 1994 Long-Term Incentive Compensation Program or independently, as the Personnel Committee shall determine. Reviews shall be conducted no less frequently than annually. 6. Supplemental Retirement Benefit. (a) Employer shall pay Employee an annual supplemental retirement benefit equal to the product of (i) 4%, times (ii) Employee's number of years of service, times (iii) Employee's final average compensation, with the product of (i) times (ii) times (iii) reduced by Employee's other retirement benefits. The foregoing benefit shall only be paid if Employee is credited with a minimum of five years of service. (b) For purposes of this paragraph 6, "years of service" shall be credited to Employee in the same manner as years of service are credited to Employee under the Community Bank System, Inc. Pension Plan, as amended through December 31, 1994 ("Pension Plan"); provided that, for purposes of this paragraph 6, (i) Employee's service to Employer as a consultant pursuant to paragraph 7(a) (i) shall be included in Employee's years of service, and (ii) Employee shall be credited with additional years of service to the extent provided pursuant to paragraph 7 (a) (iii); and provided further that no more than 15 years of service will be taken into account under this paragraph 6. (c) For purposes of this paragraph 6, Employee's "final average compensation" shall be the annual average of Employee's Base Salary and cash bonus received during the five consecutive calendar years preceding Employee's termination or retirement that produces the highest average; provided that, for purposes of this paragraph 6(i) if Employee shall be employed by Employer for less than five consecutive calendar years, Employee's final average compensation shall be the annual average of Employee's Base Salary and cash bonus received during Employee's actual period of employment with Employer, and (ii) the cash bonus received by Employee in 1993 shall be deemed to have been received by Employee in 1994. (d) For purposes of this paragraph 6, Employee's "other retirement benefits" shall mean the sum of (i) the annual benefit payable to Employee from the Pension Plan, plus (ii) the estimated annual benefit payable to Employee pursuant to the Federal Social Security Act, plus (iii) the annual benefit payable to Employee under the defined benefit pension plan maintained by Farm Credit (in which Employee was a participant prior to his employment with Employer), plus (iv) the annual benefit that could be provided by (A) Employer contributions (other than elective deferrals) made on Employee's behalf under the Community Bank System, Inc. Employee Savings and Retirement Plan, (B) First Bank System contributions (other than elective deferrals) made on Employee's behalf under the defined contribution plan maintained by First Bank System (in which Employee was a participant prior to his employment with Employer), and (C) actual earnings on contributions under (A) and (B), if such contributions and earnings were converted to a benefit payable at the same time and in the same form as the benefit paid under this paragraph 6, using the factors applied to determine actuarial equivalents under the Pension Plan at the time payments begin under this paragraph 6. The amount of "other retirement benefits," determined as of the date of this Agreement, is reflected on Appendix B attached to this Agreement. To the extent Employee receives a payment of "other retirement benefits" prior to the date supplemental retirement benefits are paid pursuant to this paragraph 6, and such amounts are not rolled over or transferred to an individual retirement account or tax-qualified retirement plan, the total of "other retirement benefits" shall be determined by including amounts received and not rolled over or transferred and assuming such amounts earned interest at an annual rate of 6% from the date received to the date "other retirement benefits" are calculated. Employee shall provide such financial and other information as Employer may reasonably require to determine "other retirement benefits." (e) For purposes of paragraph 6, Employee's Social Security Benefit ("Benefit") will be valued by the actual Benefit Employee receives or is qualified to receive at the time Employee elects to receive the supplemental retirement benefit, or if Employee has not yet qualified for the Benefit, the Benefit will be valued by the maximum benefit available to a then 62 year old individual. (f) For the purposes of paragraph 6, Employer's Pension Plan Benefit will be Employee's accrued benefit under the Plan, determined as of the date Employee elects to receive the supplemental retirement plan benefit, adjusted for the timing and form of benefit. (g) The supplemental retirement benefit described in paragraph six shall be payable commencing on the first day of the month following the later of (i) Employee's receipt of all payment due under the terms of this Agreement (other than this paragraph 6) (ii) termination of employment with Employer, or (iii) Employee's attainment of age 58. (h) The supplemental retirement benefit described in this paragraph 6 shall be paid in the form of an actuarially reduced Joint and 50% Survivor benefit with Employee's spouse as survivor annuitant; provided however, that if Employee's simultaneously commences receipt of Employer's Pension Plan benefit, then the benefit under this paragraph 6 shall be paid in the same form as Employee's Pension Plan Benefit. If Employee or his beneficiaries shall receive payment of Employee's benefit under the Pension Plan in a form other than a single life annuity for Employee's life and/or prior to Employee's attainment of age 65, the supplement retirement benefit under this paragraph 6 shall be converted to the same form of payment and/or subject to the same early retirement reduction, using the factors applied to determine actuarial equivalents and early retirement benefits under the Pension Plan at the time payments begin. (i) Employer shall establish a "grantor trust" (as that term is defined in Internal Revenue Code Section 671) to aid it in the accumulation and payment of the supplement retirement benefit described in this paragraph 6; provided that the trust shall be established with the intention that the creation and funding of the trust shall not result in the recognition of gross income by Employee of any amount credited under the trust prior to the date the amount is paid or made available. Assets of the trust, and any other assets set aside by Employer to satisfy its obligations under this Agreement, shall remain at all times subject to the claims of Employer's general creditors. Employee and his beneficiaries shall not have any rights under this paragraph 6 that are senior to the claims of general unsecured creditors of Employer. (j) The right to receive the supplemental retirement benefit described in this paragraph 6 shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge or encumbrance, nor subject to attachment, garnishment, levy, execution or other legal or equitable process for the debts, contracts or liabilities of Employee or his beneficiaries. 7. Change of Control. (a) If Employee's employment by Employer (as an employee) shall cease for reasons other than "cause" (as described in paragraph 3(d)) within 2 years following a "Change of Control" that occurs during the Period of Employment, Employer shall: (i) Retain the services of Employee, on an independent contractor basis, as a consultant to Employer for a period of no less than 24 months at an annual consulting fee rate equal to Employee's Base Salary in effect at the time of Employee' s termination; (ii) Provide Employee with fringe benefits, or the cash equivalent of such benefits, identical to those described in paragraph 4(a) for the period during which Employee is retained as a consultant pursuant to (i) above; (iii) Credit Employee with three additional years of service for purposes of determining Employee's supplemental retirement benefit described in paragraph 6. (iv) Treat as immediately exercisable all unexpired stock options described in paragraph 5 that are not otherwise exercisable or that have not been exercised; and (v) Pay to Employee the difference between the total purchase price paid by Employee for the home owned by him in the Syracuse area and the proceeds of the sale of such home by Employee following the termination of his employment not later than December 31, 1997 if he elects to move outside of the metropolitan Syracuse area to take other employment and he establishes to the satisfaction of the Board of Directors of Employer that he is unable despite reasonable efforts to sell the home within one year from the termination of his employment for a sum equal to the purchase price, or, in lieu thereof, Employer may purchase the home for a sum equal to the price Employee paid for it. (vi) If any portion of the amounts paid to, or value received by, Employee following a "Change of Control" (whether paid or received pursuant to this paragraph 7 or otherwise) constitutes an "excess parachute payment" within the meaning of Internal Revenue Code Section 280G, then the parties shall negotiate a restructuring of payment dates and/or methods (but not payment amounts) to minimize or eliminate the application of Internal Revenue Code Section 280G. If an agreement to restructure payments cannot be reached within 60 days of the date the first payment is due under this paragraph 7, then payments shall be made without restructuring. Employee shall be responsible for all taxes and penalties payable by Employee as a result of Employee's receipt of an "excess parachute payment." (b) For purposes of paragraph 7(a), a "Change of Control" shall be deemed to have occurred if: (i) any "person," including a "group" as determined in accordance with the Section 13(d) (3) of the Securities Exchange Act of 1934 ("Exchange Act"), is or becomes the beneficial owner, directly or indirectly, of securities of Employer representing 30% or more of the combined voting power of Employer's then outstanding securities; (ii) as a result of, or in connection with, any tender offer or exchange offer, merger or other business combination (a "Transaction"), the persons who were directors of Employer before the Transaction shall cease to constitute a majority of the Board of Directors of Employer or any successor to Employer; (iii) Employer is merged or consolidated with another corporation and as a result of the merger or consolidation less than 70% of the outstanding voting securities of the surviving or resulting corporation shall then be owned in the aggregate by the former stockholders of Employer, other than (A) affiliates within the meaning of the Exchange Act, or (B) any party to the merger or consolidation; (iv) a tender offer or exchange offer is made and consummated for the ownership of securities of Employer representing 30% or more of the combined voting power of Employer's then outstanding voting securities; or (v) Employer transfers substantially all of its assets to another corporation which is not controlled by Employer. 8. Withholding. Employer shall deduct and withhold from compensation and benefits provided under this Agreement all necessary income and employment taxes and any other similar sums required by law to be withheld. 9. Covenants. (a) Confidentiality. Employee shall not, without the prior written consent of Employer, disclose or use in any way, either during his employment by Employer or thereafter, except as required in the course of his employment by Employer, any confidential business or technical information or trade secret acquired in the course of Employee's employment by Employer. Employee acknowledges and agrees that it would be difficult to fully compensate Employer for damages resulting from the breach or threatened breach of the foregoing provision and, accordingly, that Employer shall be entitled to temporary preliminary injunctions and permanent injunctions to enforce such provision. This provision with respect to injunctive relief shall not, however, diminish Employer's right to claim and recover damages. Employee covenants to use his best efforts to prevent the publication or disclosure of any trade secret or any confidential information concerning the business or finances of Employer or Employer's affiliates, or any of its or their dealings, transactions or affairs which may come to Employee's knowledge in the pursuance of his duties or employment. (b) No Competition. Employee's employment is subject to the condition that during the term of his employment hereunder and for a period of 12 months following the date of termination of his employment (the "Date of Termination"), Employee shall not, directly or indirectly, own, manage, operate, control or participate in the ownership, management, operation or control of, or be connected as an officer, employee, partner, director, individual proprietor, lender, consultant or otherwise with, or have any financial interest in, or aid or assist anyone else in the conduct of, any entity or business (a "Competitive Operation") which competes in the banking industry or with any other business conducted by Employer or by any group, affiliate, division or subsidiary of Employer, in any area or market where such business is being conducted at the Date of Termination. Employee shall keep Employer fully advised as to any activity, interest, or investment Employee may have in any way related to the banking industry. It is understood and agreed that, for the purposes of the foregoing provisions of this paragraph, (i) no business shall be deemed to be a business conducted by Employer or any group, division, affiliate or subsidiary of Employer unless 5% or more of Employer's consolidated gross sales or operating revenues is derived from, or 5% or more of Employer's consolidated assets are devoted to, such business; (ii) no business conducted by any entity by which Employee is employed or in which he is interested or with which he is connected or associated shall be deemed competitive with any business conducted by Employer or any group, division or subsidiary of Employer unless it is one from which 2% or more of its consolidated gross sales or operating revenues is derived, or to which 2% or more of its consolidated assets are devoted; and (iii) no business which is conducted by Employer at the Date of Termination and which subsequently is sold by Employer shall, after such sale, be deemed to be a Competitive Operation within the meaning of this paragraph. Ownership of not more than 5% of the voting stock of any publicly held corporation shall not constitute a violation of this paragraph. (c) Certain Affiliates of Employer. It is understood that Employee may have access to technical knowledge, trade secrets and customer lists of affiliates of Employer or companies which Employer's parent may acquire in the future and may serve as a member of the board of directors or as an officer or employee of an affiliate of Employer. Employee covenants that he shall not, during the term of his employment by Employer or for a period of 12 months thereafter, in any way, directly or indirectly, own, manage, operate, control or participate in the ownership, management, operation or control of, or be connected as an officer, employee, partner, director, individual proprietor, lender, consultant or otherwise aid or assist anyone else in any business or operation which competes with or engages in the business of such an affiliate. (d) Termination of Payments. Upon the breach by Employee of any covenant under this paragraph 9, Employer may offset and/or recover from Employee immediately any and all severance benefits paid to Employee under paragraph 1(e) hereof in addition to any and all other remedies available to Employer under the law or in equity. (e) The non-competition provisions of paragraphs 9(b) and 9(c) shall not apply if Employee's employment ceases within the two-year period following a change of control within the meaning of paragraph 7. 10. Notices. Any notice which may be given hereunder shall be sufficient if in writing and mailed by certified mail, return receipt requested, to Employee at his Residence and to Employer at 5790 Widewaters Parkway, Dewitt, New York 13214 or at such other addresses as either Employee or Employer may, by similar notice, designate. 11. Rules, Regulations and Policies. Employee shall abide by and comply with all of the rules, regulations, and policies of Employer, including without limitation Employer's policy of strict adherence to, and compliance with, any and all requirements of the banking, securities, and antitrust laws and regulations. 12. No Prior Restrictions. Employee affirms and represents that Employee is under no obligations to any former employer or other third party which is in any way inconsistent with, or which imposes any restriction upon, the employment of Employee by Employer, or Employee's undertakings under this Agreement. 13. Return of Employer's Property. After Employee has received notice of termination or at the end of the term hereof, whichever first occurs, Employee shall forthwith return to Employer all documents and other property in his possession belonging to Employer. 14. Construction and Severability. The invalidity of any one or more provisions of this Agreement or any part thereof, all of which are inserted conditionally upon their being valid in law, shall not affect the validity of any other provisions to this Agreement; and in the event that one or more provisions contained herein shall be invalid, as determined by a court of competent jurisdiction, this instrument shall be construed as if such invalid provisions had not been inserted. 15. Governing Law. This Agreement was executed and delivered in New York and shall be construed and governed in accordance with the laws of the State of New York. 16. Assignability and Successors. This Agreement may not be assigned by Employee or Employer, except that this Agreement shall be binding upon and shall inure to the benefit of the successor of Employer through merger or corporate reorganization. 17. Miscellaneous. This Agreement constitutes the entire understanding and agreement between the parties with respect to the subject matter hereof and shall supersede all prior understandings and agreements, including a letter agreement between Employer and Employee dated September 16, 1992 and an employment agreement made effective as of October 1, 1992. This Agreement cannot be amended, modified, or supplemented in any respect, except by a subsequent written agreement entered into by the parties hereto. The services to be performed by Employee are special and unique; it is agreed that any breach of this Agreement by Employee shall entitle Employer (or any successor or assigns of Employer), in addition to any other legal remedies available to it, to apply to any court of competent jurisdiction to enjoin such breach. The provisions of paragraphs 1(e), 7 and 9 hereof shall survive the termination of this Agreement. 18. Counterparts. This Agreement may be executed in counterparts (each of which need not be executed by each of the parties), which together shall constitute one and the same instrument. 19. Jurisdiction and Venue. The jurisdiction of any proceeding between the parties arising out of, or with respect to, this Agreement shall be in a court of competent jurisdiction in New York State, and venue shall be in Onondaga County. Each party shall be subject to the personal jurisdiction of the courts of New York State. The foregoing is established by the following signatures of the parties. COMMUNITY BANK SYSTEM, INC. By: /s/ Earl W. MacArthur Its: Chairman of the Board COMMUNITY BANK, N.A. By: /s/ Earl W. MacArthur Its: Chairman of the Board /s/ Sanford A. Belden SANFORD A. BELDEN APPENDIX B LISTING OF QUALIFIED RETIREMENT BENEFITS REFERRED TO IN PARAGRAPH 6 APPENDIX A BENEFICIARY DESIGNATION FORM Pursuant to the Employment Agreement between (i) Community Bank System, Inc. and Community Bank, N.A., and (ii) Sanford A. Belden, dated as of October 1, 1994 ("Agreement"), I, Sanford A. Belden, hereby designate Elizabeth G. Belden, my wife, as the beneficiary of amounts payable upon my death in accordance with paragraph 3(b) of the Agreement. My beneficiary's current address is 9 Lynacres Boulevard, Fayetteville, New York. Dated: 12/22/94 /s/ Sanford A. Belden Sanford A. Belden /s/ Barry S. Kublin Witness Community Bank System, Inc. Statement re Earnings Per Share Computation Exhibit 11 Three Months Ended March 31, March 31, 1995 1994 Primary Earnings Per Share Net Income 2,751,518 2,400,231 ---------- - --------- Income applicable to common stock 2,751,518 2,400,231 ========== ========= Weighted average number of common shares 2,788,150 2,748,905 Add: Shares issuable from assumed exercise of incentive stock options 27,227 58,746 --------- - --------- Weighted average number of common shares - adjusted 2,815,377 2,807,651 ========= ========= Primary earnings per share $0.98 $0.85 ========= ========= Fully Diluted Earnings Per Share Net Income 2,751,518 2,400,231 ========= ========= Weighted average number of common shares - adjusted 2,818,963 2,807,651 Add: Equivalent number of common shares assuming conversion of preferred --------- - --------- Weighted average number of common shares - adjusted 2,818,963 2,807,651 ========= ========= Fully diluted earnings per share $0.98 $0.85 ========= ========= EX-27 2
9 1000 3-MOS DEC-31-1995 MAR-31-1995 50,721 0 0 0 302,586 302,586 306,592 495,381 6,424 960,280 722,380 158,765 9,621 550 3,485 0 0 65,478 960,280 11,471 7,185 0 18,656 5,891 8,230 10,426 254 0 7,024 4,545 4,545 0 0 2,752 0.98 0.98 0 0 0 0 0 0 0 0 0 0 0 0

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