-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BcaKSHswcY3EBgZsh62k8So4ylXHWgH+7aPtReeZBYoFPSDk4485E1QJRkkc7GKM tuDAJeclTIiWK5CfrRUjbg== 0000950110-98-000362.txt : 19980401 0000950110-98-000362.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950110-98-000362 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMUNITY BANK SYSTEM INC CENTRAL INDEX KEY: 0000723188 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 161213679 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13695 FILM NUMBER: 98581508 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-K 1 FORM 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 Commission file number 0-11716 [GRAPHIC OMITTED] COMMUNITY BANK SYSTEM, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter)
DELAWARE 16-1213679 - ---------------------------------------------- ------------------------------------ (State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.) 5790 Widewaters Parkway, DeWitt, New York 13214-1883 - ------------------------------------------ ---------- (Address of principal executive offices) (Zip Code)
(315)445-2282 -------------------------------------------------- Registrant's telephone number, including area code SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, NO PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during all the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- State the aggregate market value of the voting stock held by nonaffiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. $260,321,578 based upon average selling price of $34.25 and 7,600,630 shares on March 2, 1998. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 7,600,630 shares Common Stock No Par Value at March 2, 1998. DOCUMENTS INCORPORATED BY REFERENCE. List hereunder the following documents if incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. 1. Definitive Proxy Statement for Annual Meeting of Shareholders to be held on May 13, 1998 . . . Part III Exhibit index on page 56 ================================================================================ TABLE OF CONTENTS PART I PAGE ---- Item 1. Business ...................................................... 1 Item 2. Properties .................................................... 6 Item 3. Legal Proceedings ............................................. 6 Item 4. Submission of Matters to a Vote of Security Holders ........... 6 Item 4A. Executive Officers of the Registrant .......................... 7 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters ............................. 8 Item 6. Selected Financial Data ....................................... 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................... 10 Item 8. Financial Statements and Supplementary Data: Community Bank System, Inc. and Subsidiaries: Consolidated Statements of Financial Condition ............ 34 Consolidated Statements of Income ......................... 35 Consolidated Statements of Changes in Shareholders' Equity .................................................. 36 Consolidated Statements of Cash Flows ..................... 37 Notes to Consolidated Financial Statements ................ 38 Independent Auditor's Report .............................. 54 Two Year Selected Quarterly Data, 1997 and 1996 ............... 55 Item 9. Changes in Disagreements and with Accounting and Financial Disclosure ........................................ 56 PART III Item 10. Directors and Executive Officers of the Registrant ............ 56 Item 11. Executive Compensation ........................................ 56 Item 12. Security Ownership of Certain Beneficial Owners and Management .............................................. 56 Item 13. Certain Relationships and Related Transactions ................ 56 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ..................................... 56 Signatures ................................................................ 58 Exhibit 11 Earnings per Share Computation ............................... A PART I ITEM 1. BUSINESS GENERAL Community Bank System, Inc. ("Company") was incorporated on April 15, 1983, under the Delaware General Corporation Law. Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is (315) 445-2282. The Company became a bank holding company in 1984 with the acquisition of The St. Lawrence National Bank ("St. Lawrence Bank") on February 3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A. or "Horizon Bank") on March 2, 1984. Also in 1984 the Company obtained a national bank charter for its third wholly-owned subsidiary bank, The Exchange National Bank ("Exchange Bank"), and on July 1, 1984 Exchange Bank acquired the deposits and certain of the assets of three branches of the Bank of New York located in Southwestern New York. On September 30, 1987, the Company acquired The Nichols National Bank ("Nichols Bank") located in Nichols, New York. On September 30, 1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located in Addison, New York, the parent company to Community National Bank ("Community Bank"). On March 26, 1990, Community Bank opened the Corning Market Street branch from the Company's acquisition of deposits and certain assets from Key Bank of Central New York. On January 1, 1992, the Company's five banking affiliates consolidated into a single, wholly-owned national banking subsidiary, known as Community Bank, N.A. ("Bank"). On March 31, 1993, the Bank's marketing representative office in Ottawa, Canada was closed. On June 3, 1994, the Company acquired three branch offices in Canandaigua, Corning and Wellsville, New York from the Resolution Trust Corporation. On October 28, 1994, the Company acquired the Cato, New York branch of The Chase Manhattan Bank, N.A. On July 14, 1995, the Company acquired 15 branch offices from The Chase Manhattan Bank, N.A. located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two), and Penn Yan, New York ("Chase Branches"). On December 15, 1995, the Company sold three of the former Chase Branches, located in Norwich, New Hartford, and Utica, to NBT Bank, N.A. On June 16, 1997 the Company acquired eight branches from Key Bank of New York located in Alfred, Cassadaga, Clymer, Cuba, Gowanda, Ripley, Sherman, and Wellsville in Southwestern New York State. On July 18, 1997 the Company acquired 12 branches from Fleet Bank located in Old Forge, Boonville, Ogdensburg, St. Regis Falls, Gateway Plaza, Watertown (2), Clayton, Lowville, Massena (2), and Gouverneur in Northern and Central New York State. Five of the former Fleet offices or existing Bank offices in Watertown (2), Ogdensburg, Gouverneur, and Massena have since been combined. The Company had a wholly-owned data processing subsidiary, Northeastern Computer Services, Inc. ("Northeastern"). Northeastern was acquired by the Company from The St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization. Northeastern had previously been a wholly-owned subsidiary of The St. Lawrence Bank and was the survivor of a merger with Lawban Computer Systems, Inc., another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the Company entered into a five year agreement with Mellon Bank, N.A. ("Mellon") to provide data processing services (the agreement has since been renewed with the subsequent acquiror of Mellon's data services, Fiserv, Inc., for a term ending December 31, 2002). On June 30, 1992, Northeastern ceased operations. On January 17, 1997 all the outstanding shares of common stock of Northeastern were transferred from the Company to Community Bank, N.A. On that date, Northeastern became a wholly-owned subsidiary of the Bank and changed its name to CBNA Treasury Management Corporation ("CBTM"). CBTM is now utilized by the Bank to manage its Treasury function, including asset/liability, investment portfolio, and liquidity management. The Company also had a wholly-owned mortgage banking subsidiary, Community Financial Services, Inc. (CFSI), which was established in June 1986; it commenced operation in January 1987. In July 1988, CFSI purchased Salt City Mortgage Corp., a Syracuse-based mortgage broker. CFSI was dissolved in 1990. In July 1996, the Company purchased Benefit Plans Administrators of Utica, New York, a pension administration and consulting firm serving sponsors of defined benefit and defined contribution plans. On February 3, 1997, the Company formed a subsidiary business trust, Community Capital Trust I, for the purpose of issuing preferred securities which qualify as Tier 1 capital. Concurrent with its formation, the trust issued $30,000,000 of 9.75% preferred securities in an exempt offering maturing in year 2027 and guaranteed by the Company. The entire net proceeds to the trust from the offering were invested in junior subordinated obligations of the Company. The Company provides banking services through its two regional offices at 45-49 Court Street, Canton, New York and 201 North Union Street, Olean, New York, as well as through 65 customer facilities in the eighteen counties of St. Lawrence, 1 Jefferson, Lewis, Oneida, Cayuga, Seneca, Ontario, Oswego, Wayne, Yates, Allegany, Cattaraugus, Tioga, Steuben, Chautauqua, Franklin, Herkimer, and Onondaga. The administrative office is located at 5790 Widewaters Parkway, DeWitt, New York, in Onondaga County. The Bank is a community retail bank committed to the philosophy of serving the financial needs of customers in local communities. The Bank's branches are generally located in small towns and villages within its geographic market areas. The Company believes that the local character of business, knowledge of the customer and customer needs, and comprehensive retail and small business products, together with rapid decision-making at the branch and regional level, enable the Bank to compete effectively. The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank of New York ("FHLB"), and its deposits are insured by the FDIC up to applicable limits. BANKING SERVICES The Bank offers a range of commercial and retail banking services in each of its market areas to business, individual, agricultural and government customers. ACCOUNT SERVICES. The Bank's account services include checking accounts, negotiable orders of withdrawal ("NOW"), money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. LENDING ACTIVITIES. The Bank's lending activities include the making of residential and farm loans, business lines of credit, working capital facilities, inventory and dealer floor plans, as well as installment, commercial, term and student loans. The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. About 66% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. In addition, the typical loan to the Company's commercial business borrowers is under $65,000, with only 30% of the commercial portfolio being in loans in excess of $500,000. OTHER SERVICES. The Bank offers a range of trust services, including personal trust, employee benefit trust, investment management, financial planning and custodial services. In addition, through an affiliation with Prime Vest, Inc., the Bank offers nonbank financial products including fixed- and variable-rate annuities, mutual funds, and stock investments. The Bank also offers safe deposit boxes, travelers checks, money orders, wire transfers, collections, foreign exchange, drive-in facilities, automatic teller machines (ATMs), and twenty-four hour depositories. Through an accounts receivable management program, the Bank provides a service to qualifying businesses by purchasing accounts receivable on a discounted basis. Customers of the Bank also receive pension administration and consulting service pertaining to their defined benefit and defined contribution plans from CBSI's nonbank subsidiary, Benefit Plans Administrative Services, Inc. (BPA); BPA also provides services to nonbank customers. COMPETITION The Company, through the Bank, competes in three distinct banking markets in the Northern ("Northern Market"), Finger Lakes ("Finger Lakes Market"), and Southern Tier ("Southern Tier Market") regions of New York State. The Bank considers its primary market areas in these regions to be the counties in which it has banking facilities. Major competitors in these markets primarily include local branches of banks based in Boston, Massachusetts, Albany or Buffalo, New York, and Cleveland, Ohio, as well as local independent banking and thrift institutions and federal credit unions. Other competitors for deposits and loans within the Bank's market areas include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers. Lastly, personal and corporate trust and investment counseling services in competition with the Bank are offered by insurance companies, investment counseling firms and other financial service firms, and individuals. NORTHERN MARKET. Branches in the Northern Market compete for loans and deposits in the six county primary market area of St. Lawrence, Jefferson, Lewis, Franklin, Herkimer, and Oneida Counties in Northern New York State. Within this market area, the Bank maintains a market share(1) of 29.0% including commercial banks, credit unions, savings and loan associations and savings banks. The Bank operates 29 customer facilities in this market and is ranked either first or second in market share in 17 of the 20 towns where these offices are located. FINGER LAKES MARKET. In the Finger Lakes Market, the Bank operates 14 customer facilities competing for loans and deposits in the six-county primary market area of Seneca, Oswego, Ontario, Wayne, Onondaga, and Cayuga Counties. Within the Finger Lakes Market area, the Bank maintains a market share(1) of approximately 2.6% including commercial 2 banks, credit unions, savings and loan associations and savings banks. The Bank is ranked either first or second in market share in seven of the eleven Finger Lakes Market area towns where its offices are located. SOUTHERN TIER MARKET. The Bank's Southern Tier Market consists of two sub-markets, the Olean submarket and the Corning submarket. OLEAN SUBMARKET. The Olean Submarket competes for loans and deposits in the primary market area of Cattaraugus, Chautaugua, and Allegany Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of approximately 13.7% including commercial banks, credit unions, savings and loan associations and savings banks. The Olean Submarket operates 14 office locations, and the Bank is ranked either first or second in market share in all 11 towns where these offices are located. CORNING SUBMARKET. The Corning Submarket competes for loans and deposits in the primary market area of Steuben, Yates and Tioga Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of approximately 10.1% including commercial banks, credit unions, savings and loan associations and savings banks. The Corning Submarket operates ten office locations, and the Bank is ranked either first or second in market share in eight of the nine towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chemung and Schuyler Counties in New York State, and Tioga County in Pennsylvania. (1) Deposit market share data as of June 30, 1997, as calculated by Sheshunoff Information Services, Inc. The number of facilities also includes two de novo offices opened in 1998 for which deposit market share is de minimus. EMPLOYEES As of December 31, 1997, the Bank employed 726 full-time equivalent employees versus 578 at year-end 1996. The Bank provides a variety of employment benefits and considers its relationship with its employees to be good. CERTAIN REGULATORY CONSIDERATIONS Bank holding companies and national banks are regulated by state and federal law. The following is a summary of certain laws and regulations that govern the Company and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the actual statutes and regulations thereunder. BANK HOLDING COMPANY SUPERVISION The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA") and as such is subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As a bank holding company, the Company's activities and those of its subsidiary are limited to the business of banking and activities closely related or incidental to banking. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital contributions to a troubled bank subsidiary. The Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the Company does not have the resources to provide it. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. The BHCA requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of, or substantially all of the assets of, any bank (unless it owns a majority of such bank's voting shares) or otherwise to control a bank or to merge or consolidate with any other bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank. The Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on September 29, 1994) provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies are eliminated effective September 29, 1995. The law also permits interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. The Company anticipates that the effect of the new law may be to increase competition within the markets where the Company operates, although the Company cannot predict the effect to which competition will increase in such markets or the timing of such increase. 3 OCC SUPERVISION The Bank is supervised and regularly examined by the OCC. The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt, and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. There are no regulatory orders or outstanding issues resulting from regulatory examinations of the Bank. LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the OCC for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1997, the Bank had $21.2 million in undivided profits legally available for the payment of dividends. In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. There are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specified amounts. CAPITAL REQUIREMENTS The Federal Reserve Board has established risk-based capital guidelines which are applicable to bank holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill ("Tier I capital"). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier I capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization's particular circumstances warrant. The remainder ("Tier 2 capital") may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier I capital and Tier 2 capital is "total risk-based capital." The Company's Tier I and total risk-based capital ratios as of December 31, 1997 were 9.30% and 10.55%, respectively. In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier I capital to quarterly average assets less goodwill ("Tier I leverage ratio") of 3.00% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other bank holding companies are required to maintain a Tier I leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Company's Tier I leverage ratio as of December 31, 1997 was 5.67%, which exceeded its regulatory requirement of 4.00%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Company is subject to the same OCC capital requirements as those that apply to the Bank. In February 1994, the federal banking agencies proposed amendments to their respective risk-based capital requirements that would explicitly identify concentration of credit risk and certain risks arising from nontraditional activities, and the management of such risks, as important factors to consider in assessing an institution's overall capital adequacy. The proposed amendments do not, however, mandate any specific adjustments to the risk-based capital calculations as a result 4 of such factors. On August 24, 1994, the Federal Reserve Board issued proposed amendments to its risk-based capital standards that would increase the amount of capital required under such standards for long-dated interest rate and exchange rate contracts and for derivative contracts based on equity securities and indexes, precious metals (other than gold) and other commodities. The proposed amendments would also permit banking institutions to recognize the effect of bilateral netting arrangements in calculating their exposure to derivative contracts for risk-based capital purposes. The Company and the Bank do not expect that these proposals, if adopted in their current form, would have a material effect on its financial condition or results of operations. FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991 In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund (the "BIF") of the FDIC by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the FDIC use the least-cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions including a Truth-in-Savings Act; (x) a requirement that the FDIC establish a risk-based deposit insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage. FDICIA requires federal banking agencies to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered "well capitalized" or "adequately capitalized" under Federal Reserve Board regulations: Well Capitalized Adequately Capitalized ---------------- ---------------------- Total Risk-Based Capital Ratio 10% 8% Tier I Risk-Based Capital Ratio 6% 4% Tier I Leverage Ratio 5% 4% 5 If a bank does not meet all of the minimum capital ratios necessary to be considered "adequately capitalized," it will be considered "undercapitalized," "significantly undercapitalized," or "critically undercapitalized," depending upon the amount of the shortfall in its capital. As of December 31, 1997, the Bank's total risk-based capital ratio and Tier I risk-based capital ratio were 10.55% and 9.30%, respectively, and its Tier I leverage ratio as of such date was 5.67%. Notwithstanding the foregoing, if its principal federal regulator determines that an "adequately capitalized" institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan; restrict its asset growth; and prohibit branching, new acquisitions, and new lines of business. Among other things, an institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings, or liquidity in its most recent examination. Possible sanctions for undercapitalized depository institutions include a prohibition on the payment of dividends and a requirement that an institution submit a capital restoration plan to its principal federal regulator. The capital restoration plan of an undercapitalized bank will not be approved unless the holding company that controls the bank guarantees the bank's performance. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lesser of five percent (5%) of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator. In addition, FDICIA requires regulators to impose new noncapital measures of bank safety, such as loan underwriting standards and minimum earnings levels. Regulators are also required to perform annual on-site bank examinations, place limits on real estate lending by banks and tighten auditing requirements. Many of the provisions of FDICIA will be implemented through the adoption of regulations by the various federal banking agencies. Although the precise effect of the legislation on the Company and the Bank therefore cannot be assessed at this time, the Company does not anticipate that such regulations will materially affect its operating results, financial condition, or liquidity. ITEM 2. PROPERTIES The Company leases its administrative offices at 5790 Widewaters Parkway, DeWitt, New York. The Bank owns its regional offices in Olean, New York and Canton, New York. Of the Bank's remaining 65 customer facilities, 42 are owned by the Bank, and 23 are located on long-term leased premises. Real property and related banking facilities owned by the Company at December 31, 1997 had a net book value of $15.6 million and none of the properties was subject to any encumbrances. For the year ended December 31, 1997, rental fees of $821,000 were paid on facilities leased by the Company for its operations. ITEM 3. LEGAL PROCEEDINGS Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable 6 ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information about the principal executive officers of the Company and the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors. NAME AND AGE POSITION ------------ -------- Sanford A. Belden President and Chief Executive Officer of Age 55 the Company and the Bank James A. Wears Regional President, Northern Region Age 48 of the Bank Michael A. Patton Regional President, Southern Region Age 52 of the Bank David G. Wallace Treasurer of the Company and Senior Vice Age 53 President and Chief Financial Officer of the Bank SANFORD A. BELDEN (Director; President and Chief Executive Officer of the Company and the Bank). Mr. Belden has been President and Chief Executive Officer of the Company and the Bank since October 1, 1992. Mr. Belden was formerly Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to 1992 and prior thereto served as President, Community Banking, for First Bank System, Minneapolis, Minnesota, a multi-state bank holding company. JAMES A. WEARS (Regional President, Northern Region of the Bank). Mr. Wears served as Senior Vice President of The St. Lawrence National Bank, a former subsidiary of the Company, from 1988 through January 1991, and as its President and Chief Executive Officer from January 1991 until January 1992. Following the January 1992 consolidation of the Company's five subsidiary banks into the Bank, Mr. Wears was named to his current position as Regional President for the Northern Region of the Bank. MICHAEL A. PATTON (Regional President, Southern Region of the Bank). Mr. Patton was the President and Chief Executive Officer of The Exchange National Bank, a former subsidiary of the Company, from 1984 until January 1992, when, in connection with the consolidation of the Company's five subsidiary banks into the Bank, he was named to his current position as Regional President for the Southern Region of the Bank. DAVID G. WALLACE (Treasurer of the Company; Senior Vice President and Chief Financial Officer of the Bank). Mr. Wallace became Vice President and Chief Financial Officer in November 1988, and has been Senior Vice President and Chief Financial Officer since August 1991. 7 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS The common stock has been trading on the New York Stock Exchange under the symbol "CBU" since December 31, 1997. Prior to that, the common stock traded over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning on September 16, 1986. The following table sets forth the high and low bid quotations for the common stock, and the cash dividends declared with respect thereto, for the periods indicated. The quotations represent bid prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. There were 7,586,512 shares of common stock outstanding on December 31, 1997 held by approximately 1,817 registered shareholders of record. COMMON STOCK PERFORMANCE NYSE Symbol: CBU Newspaper Listing: CmuntyBkSys Market (Bid) Price
High Low Closing Price Quarterly Year/Qtr Price Price Amount % Change Dividend -------- ----- ----- ------ -------- -------- 1997 4th $34.00 $27.00 $31.31 8.0% $0.20 3rd $29.75 $26.25 $29.00 2.7% $0.20 2nd $29.00 $20.00 $28.25 20.2% $0.18 1st $24.25 $19.25 $23.50 19.7% $0.18 1996 4th $20.13 $17.00 $19.63 14.6% $0.18 3rd $17.75 $15.38 $17.13 10.0% $0.18 2nd $16.63 $15.25 $15.57 0.4% $0.17 1st $16.38 $15.13 $15.50 -3.1% $0.17
The Company has historically paid regular quarterly cash dividends on its common stock, and declared a cash dividend of $0.20 per share for the first quarter of 1998. The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the common stock, as well as to make payment of regularly scheduled dividends on the trust preferred stock as and when due, subject to the Company's need for those funds. However, because substantially all of the funds available for the payment of dividends by the Company are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations. See "Supervision and Regulation -- Limits On Dividends and Other Payments." ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five year period ended December 31, 1997. The historical "Income Statement Data" and historical "Statement of Condition Data" are derived from financial statements which have been audited by Coopers & Lybrand L.L.P., independent public accountants. The "Per Share Data", "Selected Ratios" and "Other Data" for all periods are unaudited. All financial information in this table should be read in conjunction with the information contained in "Capitalization," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Form. 8 SELECTED CONSOLIDATED FINANCIAL INFORMATION
Years ended December 31, ------------------------------------------------------------------- (000's omitted except per share and ratios) 1997 1996 1995 1994 1993 ------------------------------------------------------------------- INCOME STATEMENT DATA: Interest income $117,628 $97,688 $83,387 $61,575 $54,642 Interest expense 54,752 42,422 36,307 22,130 17,733 ------------- -------------- ------------- ------------ --------- Net interest income (Excl. FTE) 62,876 55,266 47,080 39,445 36,909 Provision for possible loan losses 4,480 2,897 1,765 1,702 1,506 ------------- -------------- ------------- ------------ --------- Net interest income after provision for possible loan losses 58,396 52,369 45,315 37,743 35,403 Noninterest income 11,808 8,874 6,558 5,120 4,764 Noninterest expense 45,799 37,450 33,019 26,498 24,827 ------------- -------------- ------------- ------------ --------- Income before income taxes 24,406 23,793 18,854 16,365 15,340 Provision for income taxes 8,844 9,660 7,384 6,256 5,765 ------------- -------------- ------------- ------------ --------- Net income $ 15,562 $14,133 $11,470 $10,109 $ 9,575 ============= ============== ============= ============ ========= END OF PERIOD BALANCE SHEET DATA: Total Assets $1,633,742 $1,343,865 $1,152,045 $915,501 $713,053 Net Loans 843,212 652,474 560,151 483,079 417,871 Earning Assets 1,455,139 1,231,058 1,034,183 861,599 671,415 Total Deposits 1,345,686 1,027,213 1,016,946 679,638 588,315 Long-term debt 60,000 100,000 25,550 550 592 Trust Securities 30,000 0 0 0 0 Shareholders' equity 118,012 109,352 100,060 66,290 61,986 AVERAGE BALANCE SHEET DATA: Total Assets $1,491,920 $1,251,826 $1,054,610 $808,948 $684,863 Net Loans 749,596 602,717 519,762 446,135 382,680 Earning Assets (Excl. MVA) 1,363,703 1,147,455 975,257 756,871 640,070 Total Deposits 1,213,793 1,032,169 871,050 651,479 598,860 Long-term debt 79,863 57,006 3,399 557 256 Trust Securities 27,290 0 0 0 0 Shareholders' equity 110,689 103,398 84,231 64,033 57,298 COMMON PER SHARE DATA: Net Income $2.02 $1.83 $1.70 $1.80 $1.72 Cash dividend declared 0.76 0.69 0.62 0.57 0.52 Period-end book value - stated 15.56 14.03 12.99 11.89 11.28 Period-end book value - tangible 7.82 9.85 8.37 10.80 11.20 COMMON OUTSTANDING SHARES: Average during period (includes common stock equivalents) 7,676,326 7,482,518 6,522,410 5,629,420 5,576,660 End of period (excludes common stock equivalents) 7,586,512 7,474,406 7,358,450 5,576,300 5,496,636 SELECTED RATIOS: Return on average total assets 1.04% 1.13% 1.09% 1.25% 1.40% Return of average shareholders' equity (excludes preferred stock) 14.09% 13.88% 13.85% 15.79% 16.71% Common dividend payout ratio 37.30% 37.27% 34.79% 31.24% 29.67% Net interest margin (taxable equivalent basis) 4.64% 4.86% 4.88% 5.30% 5.90% Noninterest income to average assets 0.79% 0.71% 0.64% 0.69% 0.70% Efficiency ratio (taxable equivalent basis) 60.90% 58.00% 60.82% 57.94% 58.45% Nonperforming assets to period-end total loans and other real estate owned 0.60% 0.55% 0.47% 0.72% 0.73% Allowance for loan losses to period-end loans 1.47% 1.25% 1.25% 1.30% 1.37% Allowance for loan losses to period-end nonperforming loans 297.96% 285.58% 349.69% 192.79% 238.67% Allowance for loan losses to period-end nonperforming assets 246.02% 224.33% 267.40% 179.67% 186.06% Net charge offs (recoveries) to average total loans 0.50% 0.29% 0.21% 0.25% 0.20% Average net loans to average total deposits 61.76% 58.39% 59.67% 68.48% 63.90% Period-end total shareholders' equity to period end assets 7.22% 8.14% 8.69% 7.24% 8.69% Tier I capital to risk-adjusted assets 9.30% 10.70% 10.62% 12.43% 14.87% Total risk-based capital to risk-adjusted assets 10.55% 11.83% 11.76% 13.68% 16.12% Tier I leverage ratio 5.67% 5.88% 5.83% 6.80% 8.46%
9 ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS The following discussion is intended to facilitate an understanding and assessment of significant changes in trends related to the financial condition of the Company and the results of its operations. The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Data and the Company's Consolidated Financial Statements and related notes thereto appearing elsewhere in this Prospectus. All references in the discussion to financial condition and results of operations are to the consolidated position and results of the Company and its subsidiaries taken as a whole. NET INCOME AND PROFITABILITY Net income and diluted earnings per share reached record highs in 1997 at $15.6 million and $2.02, respectively. Compared to 1996, net income rose 10.1% while earnings per share were up 10.4%. The 1997 return on equity (ROE) increased 21 basis points to 14.09%. All per share results have been adjusted for the Company's 2 for 1 stock split effective March 12, 1997. Recurring or core earnings were up 10.2% from last year to $15.3 million after removing the impact of one-time income and expense items (including $990,000 in one-time acquisition expense) and net gains/losses on the sale of investment securities and other assets. 1996's net income climbed 23.2% over the prior year to $14.1 million while earnings per share were up 7.6% to $1.83; core earnings rose at a 17% pace. These results reflect the fourth consecutive year in which acquisitions had an important impact on the Company's results. Nineteen ninety-seven's earnings reflected the contributions of eight branches acquired in Southwestern New York in mid-June from KeyBank, N.A. and twelve branches acquired in Northern New York in mid July from Fleet Bank. Taken together, these branch locations (of which three have been consolidated to date) now account for approximately $301 million in deposits (or 22% of our year-end deposit base) and $95 million in loans (or 11% of our year-end loan base). 1997's improvement in net income over the prior year is explained by the following major factors: O Net interest income (full-tax equivalent basis) climbed 13.8% or $7.6 million due to significant increases in earning asset levels. Growth in loans and investments was $190.7 million (29.2%) and $33.3 million (5.8%), respectively. Loans grew $100.6 million or 15.4% excluding acquired Key and Fleet loans. This marks the fifth consecutive year in which loan growth has exceeded 15%. Earning asset growth was funded by $318 million (31%) in deposit growth resulting largely from the aforementioned acquisitions and was partially offset by reduced borrowings. The increase in net interest income comes despite the net interest margin, at 4.64%, averaging 22 basis points lower than the 1996 level. The margin decrease is due largely to the $30 million in 9.75% company-obligated Mandatorily Redeemable Preferred Securities issued to support the acquisitions. The Company's net interest margin declined by 25 basis points on average to 4.51% excluding favorable one-time items. O Recurring noninterest income was up 30.6% owing to the impact of continued strength in fiduciary and related services income; significant increases in BPA/EBT revenue; higher fees from the sale of mutual funds; expanded revenues from merchant credit and check card processing; the imposition of ATM surcharge fees; and greater overdraft fees, service charges, and commissions from an expanded customer base gained from the Key and Fleet branch purchase. O Overhead expense increased by 22.3%; excluding one-time costs of the Key and Fleet acquisitions, growth was $7.4 million or 19.8%. The bulk of the latter increase reflects costs related to branch expansion, including more personnel (both acquired branch staff and volume-sensitive positions in operations and other areas needed to support the expanded balance sheet), greater data processing requirements, expanded facilities costs, increased amortization of intangible assets, and other associated expenses. O For the year, one-time acquisition related expense totaled $990,000. These expenses were more than offset by one-time income totaling $1.4 million as a result of accretion adjustments on called bonds, an unexpected gain on life insurance, a gain on $8.2 million in loans sold in the secondary market in conjunction with a planned interest rate risk strategy, and a loan late fee recording adjustment. With the exception of two potential branch consolidations in 1998, the last major installment of Key- and Fleet-related acquisition expenses was absorbed during fourth quarter 1997. 10 O Loan loss provision expense rose 55% reflecting higher net charge offs and the Company's practice to cover them by 125%; charge offs related to acquired Key and Fleet loans were absorbed by the one-time valuation allowance established at acquisition date for that purpose. The ratio of net charge-offs to average loans outstanding rose to .50% versus .29% in 1996, largely due to consumer installment loans, which accounted for more than 90% of 1997's increase in net charge offs; over 60% of consumer charge offs was due to indirect automobile loans. Nonperforming loans increased to $4.2 million, a level $1.3 million or 47% higher than one year ago; about 55% of the increase pertains to consumer installment loans with the balance largely in commercial loans. As a result of tighter loan underwriting standards, changes in personnel, and strengthened monitoring and control, management anticipates improvement in the charge-off trend during 1998. O The Company's effective tax rate was significantly reduced in 1997 because of greater tax-exempt income. The above combination of factors resulted in a level of profitability which may be compared to that of CBSI's peer bank holding companies; this group is comprised of 126 companies nationwide having $1 billion to $3 billion in assets based on data through September 30, 1997 as provided by the Federal Reserve System. Through year-to-date September, net income per dollar employed, or return on average assets, was 1.06% in 1997, compared to the peer norm of 1.31%. Shareholder return on equity, or net income as a percent of average equity, was 14.22% for the same period versus the median for peers of 14.78%. Underlying these improved levels of profitability on an annual basis is a steady increase in quarterly performance measures for the four quarters of 1997. The two acquisitions were immediately accretive to earnings in the third quarter when earnings per share reached a record high of $.55. Fourth quarter earnings per share were off $.03 from that pace to $.52 largely due to increases in loan loss provision and selected overhead costs. SELECTED PROFITABILITY AND OTHER MEASURES Return on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows: 1997 1996 1995 ---- ---- ---- Percentage of net income to average total assets 1.04% 1.13% 1.09% Percentage of net income to average shareholders equity 14.09% 13.88% 13.85% Percentage of dividends declared per common share to net income per common share 37.30% 37.27% 34.79% Percentage of average shareholders' equity to average total assets 7.42% 7.90% 7.61% CASH-ADJUSTED EARNINGS AND PROFITABILITY Consistent earnings growth has been achieved despite the increasing noncash expense of amortizing deposit intangibles created by branch acquisitions. Many analysts consider that a better measure of the economic value of an acquisition is the cash earnings it generates, which is determined by adding back to reported earnings the after-tax expense of amortizing the acquisition premium. On that basis, CBSI's cash earnings increased 12.6% in 1997 to $17.8 million, reflecting the half-year impact of the summer's acquisitions, and climbed 27.3% in 1996 to $15.8 million, representing the full-year impact of the mid-1995 Chase branch purchases. Nineteen ninety-five's cash earnings were $12.4 million. Return on assets is also significantly higher on a cash basis, being 1.19%, 1.26%, and 1.18% in 1997, 1996, and 1995, respectively. In contrast to 1997's 10.4% increase in reported earnings per share (EPS) to $2.02, cash-basis EPS rose 12.2% to $2.30. Last year's reported EPS rose 7.6% compared to 10.8% on a cash basis of $2.05. As opposed to the $.09 decline in 11 1995's reported results, cash EPS rose $.01 to $1.85. Fourth quarter 1997 cash EPS is $.36 higher than reported EPS on an annualized basis. Performance measured by tangible or cash return on equity also showed better improvement than reported results, reaching 16.09% in 1997, almost regaining the pre-1995 level prior to the $27.5 million capital issuance which financed the Chase branch purchase. Tangible return on equity was 15.52% in 1996 and 15.0% in 1995. NET INTEREST INCOME Net interest income is the Company's principal source of core operating income for payment of overhead and possible loan losses. It is the amount that interest and fees on earning assets (loans and investments) exceeds the cost of funds, primarily interest paid to the Company's depositors as well as interest on borrowings from the Federal Home Loan Bank of New York. Net interest margin is the difference between the gross yield on earning assets and the cost of interest bearing funds as a percentage of earning assets. Net interest income (with nontaxable income converted to a full tax-equivalent basis) totaled $63.3 million in 1997; this represents a $7.6 million or 13.6% increase from the prior year. The increase was entirely due to higher earning asset volumes, which had a positive impact on net interest income of $9.9 million, while interest rate changes had a negative impact of $2.3 million. In contrast, interest rate changes in 1996 had a negative impact of only $196,000 versus higher earning asset volumes having a positive impact of $8.3 million. Combining these components, 1996's net interest income rose $8.2 million or 17.1% over the prior year to $55.7 million. With regard to the interest income component of 1997's net interest income, greater average earning assets of $216 million contributed all but 6% of the $19.9 million more in gross interest income (up 20.3%). Nearly 68% or $147 million in 1997's average earning asset growth resulted from increased lending activity in existing markets and the impact of loans initially acquired at the Key and Fleet branches. The average ratio of loans to earning assets increased 2.5 percentage points this year to 55.0% as a consequence of the aforementioned loan growth. Higher loan volume accounted for $14.0 million of the increase in gross interest income; higher average loan yields, which rose 10 basis points to 9.55% this year, added $615,000 to interest income. Through September 30, 1997, the Company's loan yield was in the favorable 70th peer bank percentile. The remaining $69 million of earning asset growth is explained by an increase in investment outstandings; this reflects both the strategic use of leveraging when favorable buying opportunities existed and the impact of investments purchased from funds provided by 1997's branch acquisitions. Higher investment volumes (including money market instruments) contributed $5.1 million of the increase in gross interest income, while higher investment yields (up 1 basis point to 7.58%) added only $238,000 in 1997. Through September 30, 1997, the Company's investment yield (excluding money market instruments) was in the very favorable 92nd peer bank percentile. The total of average deposits and borrowings grew by $230 million in 1997, primarily attributable to acquired deposits. Of the resulting $12.3 million increase in total interest expense, over 58% of this additional expense was due to interest paid on time deposits. During 1997, time deposit rates averaged 5.61%, or 12 basis points higher than in 1996. The mix of time deposits to average liabilities also increased slightly, reflecting the acquired deposits having a relatively higher proportion of time deposits. CBSI's $30 million in 9.75% trust preferred securities also caused interest expense to rise, contributing to the 86 basis point increase in the average borrowing rate. The cost of the Bank's interest-bearing account base not priced relative to the treasury yield curve remained stable. The average rate on savings (including interest checking) and money market accounts increased by only two basis points during 1997, rising from 2.45% in 1996 to 2.47% this year. The ratio of interest bearing funds to average earning assets rose slightly in 1997 to 87.6%. Overall, higher interest bearing outstandings contributed $9.1 million more in interest expense while higher rates added $3.2 million. Through September 30, 1997, the Company's average cost of funds rate rose to the less favorable 66th peer bank percentile, as compared to being in the 43rd percentile through September 30, 1996. In summary, CBSI's net interest margin declined by 22 basis points in 1997, from 4.86% in 1996 to 4.64% this year: O The average earning asset yield increased 11 basis points to 8.66% because of the aforementioned increase in average loan yield and an increased mix of loans to earning assets, as most types of loans have historically had higher yields than marketable securities. 12 O The increase in the average earning asset yield compares to an unfavorable 31 basis point increase in the average cost of funds (total interest expense divided by average earning assets) to 4.01% in 1997. This was due to the aforementioned increased time deposit rate and mix, and the growing proportion of longer term borrowings (including the trust preferred securities). Despite the decline in the Company's net interest margin, it ranks in the peer normal 51st percentile through September 30, 1997. While the Company's net interest margin has historically been well above the norm, the primary objective in recent years has been to maximize shareholder returns through active utilization of tangible capital. Thus, as management focuses on growing the earning asset base of the Company, there has been a downward change in margin resulting from leverage strategies to take advantage of favorable investment opportunities; this margin decrease is considered secondary to increasing the future stream of net interest income. The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rate thereon for the three-year period ended December 31, 1997. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations.
Years Ended December 31, ---------------------------------------------------------------------------------------------------- 1997 1996 1995 -------------------------------- -------------------------------- -------------------------------- (000'S omitted except yields and rates) Avg. Avg. Avg. Avg. Amt. of Yield/Rate Avg. Amt. of Yield/Rate Avg. Amt. of Yield/Rate Balance Interest Paid Balance Interest Paid Balance Interest Paid ---------- -------- ---------- ---------- -------- ---------- ---------- -------- ---------- ASSETS: Interest-earning assets: Federal Funds Sold $ 15,882 $ 865 5.45% $ 6,318 $ 336 5.32% $ 24,535 $ 1,422 5.80% Time deposits in other banks 33 2 6.06% -- -- -- -- Taxable investment securities 581,743 44,233 7.60% 521,668 39,410 7.55% 414,154 30,955 7.47% Non-taxable investment securities 16,449 1,420 8.63% 16,752 1,473 8.79% 16,806 1,580 9.40% Loans (net of unearned discount) 749,596 71,563 9.55% 602,717 56,932 9.45% 519,762 49,928 9.61% ---------- ---------- ---------- Total interest-earning assets 1,363,703 118,083 8.66% 1,147,455 98,151 8.55% 975,257 83,885 8.60% Noninterest earning assets: Cash and due from banks 46,750 43,251 39,118 Premises and equipment 19,422 16,848 13,840 Other assets 69,766 50,626 34,099 Less: allowance for loan losses (10,162) (7,418) (6,589) Net unrealized gains/(losses) on available-for-sale portfolio 2,442 1,063 (1,114) ---------- ---------- ---------- Total $1,491,921 $1,251,825 $1,054,611 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities Savings deposits $ 443,667 10,971 2.47% $ 406,925 9,953 2.45% $ 366,604 9,730 2.65% Time deposits 599,136 33,619 5.61% 481,250 26,430 5.49% 380,494 21,042 5.53% Short term borrowings 45,008 2,583 5.74% 46,535 2,620 5.63% 85,407 5,376 6.29% Long term borrowings 106,975 7,578 7.08% 57,006 3,419 6.00% 3,399 159 4.68% ---------- ------ ---------- ------ --------- ------ Total interest-bearing liabilities 1,194,786 54,751 4.58% 991,716 42,422 4.28% 835,904 36,307 4.34% Noninterest bearing liabilities: Demand deposits 170,989 143,995 123,952 Other liabilities 15,459 12,716 10,526 Shareholders' equity 110,687 103,398 84,229 ---------- ---------- ---------- Total $1,491,921 $1,251,825 $1,054,611 ========== ========== ========== Net interest earnings $ 63,332 $55,729 $47,578 ======== ======= ======= Net yield on interest-earning assets 4.64% 4.86% 4.88% ===== ===== =====
13 As discussed above, the change in 1997's net interest income may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.
-------------------------------------- -------------------------------------------- 1997 Compared to 1996 1996 Compared to 1995 -------------------------------------- -------------------------------------------- Increase (Decrease) Due Increase (Decrease) Due to Change in (1) to Change in (1) Net (000's omitted) Volume Rate Change Volume Rate Net Change ------ ---- ------ ------ ---- ---------- Interest earned on: Federal funds sold and securities purchased under agreements to resell 521 8 529 (979) (107) (1,086) Time deposits in other banks 2 -- 2 -- -- -- Taxable investment securities 4,566 257 4,823 8,120 335 8,455 Nontaxable investment securities (26) (27) (53) (5) (102) (107) Loans (net of unearned discounts) 14,016 615 14,631 7,849 (845) 7,004 Total interest-earning assets (2) 18,711 1,221 19,932 14,851 (585) 14,266 Interest paid on: Savings deposits 907 111 1,018 1,002 (779) 223 Time deposits 6,603 586 7,189 5,541 (153) 5,388 Short-term borrowings (90) 53 (37) (2,239) (517) (2,756) Long-term debt 3,447 712 4,159 3,202 58 3,260 Total interest-bearing liabilities 9,146 3,183 12,329 6,627 (512) 6,115 Net interest earnings (2) 9,904 (2,301) 7,603 8,347 (196) 8,151
- ---------- (1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each. (2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components. 14 The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon for the three month periods ended December 31, 1997 and 1996. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations.
Fourth Quarters Ended December 31, ----------------------------------------------------------------------------------- 1997 1996 ---------------------------------------- --------------------------------------- Avg. Avg. (000's omitted except yields and Avg. Amt. of Yield/Rate Avg. Amt. of Yield/Rate rates) Balance Interest Paid Balance Interest Paid ------------ -------- ------------ ----------- -------- ---------- ASSETS: Interest-earning assets: Federal Funds Sold $ 7,590 $ 104 5.44% $ 13 $ 1 16.23% Time deposits in other banks 35 1 5.70% -- -- -- Taxable investment securities 566,081 10,723 7.52% 556,542 10,496 7.48% Nontaxable investment securities 20,048 423 8.37% 18,389 379 8.18% Loans (net of unearned discount) 835,673 20,211 9.60% 639,764 15,220 9.44% ---------- ---------- Total interest-earning assets 1,429,427 31,462 8.73% 1,214,708 26,096 8.52% Noninterest earning assets: Cash and due from banks 52,891 40,410 Premises and equipment 22,813 16,777 Other assets 86,698 51,014 Less: allowance for loan losses (12,266) (7,842) Net unrealized gains/(losses) on available-for-sale portfolio 4,183 1,241 ---------- ---------- Total $1,583,746 $1,316,308 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities Savings deposits $ 497,257 3,097 2.47% $ 389,547 2,391 2.44% Time deposits 655,559 9,352 5.66% 491,323 6,847 5.53% Short-term borrowings 16,089 235 5.80% 68,011 971 5.66% Long-term borrowings 81,433 1,533 7.47% 100,000 1,536 6.09% ---------- ------- ---------- ------- Total interest-bearing liabilities 1,250,338 14,217 4.51% 1,048,881 11,745 4.44% Noninterest bearing liabilities: Demand deposits 199,373 146,338 Other liabilities 18,801 14,107 Shareholders' equity 115,234 106,983 ---------- ---------- Total $1,583,746 $1,316,308 ========== ========== Net interest earnings $17,244 $14,351 ======= ======= Net yield on interest-earning assets 4.79% 4.69% ===== =====
15 The changes in net interest income by volume and rate component for fourth quarter 1997 versus fourth quarter 1996 is shown below for each major category of interest-earning assets and interest-bearing liabilities.
------------------------------------------------------ 4th Quarter 1997 Compared to 4th Quarter 1996 ------------------------------------------------------ Increase (Decrease) Due to Change in (1) Volume Rate Net Change ------ ---- ---------- Interest earned on: Federal funds sold and securities purchased under agreements to resell 104 (0) 103 Time deposits in other banks 1 -- 1 Taxable investment securities 227 -- 227 Nontaxable investment securities 19 25 44 Loans (net of unearned discount) 4,734 257 4,991 Total interest-earning assets (2) 4,712 654 5,366 Interest paid on: Savings deposits 670 36 706 Time deposits 2,339 166 2,505 Short-term borrowings (760) 25 (736) Long-term debt 14 (17) (3) Total interest-bearing liabilities 2,288 184 2,472 Net interest earnings (2) 2,672 222 2,894
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each. (2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components. NONINTEREST INCOME The Company's sources of noninterest income are recurring fees from core banking operations (including personal trust income) and revenues from one-time events, defined as net gains/losses from the sale of investments, loans, and miscellaneous assets. Additional recurring income results from investment management, recordkeeping, and consulting services provided by Benefit Plans Administrative Services, Inc. (BPA) and the Bank's Employee Benefit Trust Function (EBT). Total noninterest income increased 33% to $11.8 million from 1996 to 1997. A quarter of the increase was attributable to the acquired branches, and another quarter attributable to the full year impact of BPA. Core banking fees (excluding BPA/EBT and nonrecurring income) were up strongly for the third consecutive year to approximately $9.6 million in 1997, a 26.2% improvement following a 25.6% increase in 1996. Included in this year's growth is approximately $785,000 more in fees due to the impact of the former Key and Fleet branches. Recurring noninterest income as a percent of total operating income (net interest income plus recurring noninterest income) reached 15.3% in 1997, up meaningfully from 13.6% and 12.1% in 1996 and 1995, respectively. While progress has been steady, this ratio remains below the norm of 21.0% or the 31st peer percentile. In light of management's objective to grow noninterest income toward the peer median, opportunities to develop new fee-based products are actively pursued, and the collection of fees for providing quality service is emphasized. In 1997, these efforts resulted in the institution of an ATM transaction surcharge for nonbank customers and the launching of cash management products for commercial businesses. The focus on growth has also continued to drive efforts to increase fiduciary income, control waived fees, and competitively price deposit service charges and commission-based services. As a result of these efforts, in addition to the benefits provided by the Key and Fleet acquisitions and a full year of BPA operations, fees from core banking operations improved in several key areas in 1997. 16 o Fees from personal trust services expanded to almost $1.2 million, up 7.7% in 1997 versus 13.1% in 1996, primarily reflecting a greater level of annual administrative fees on trust and individual investment management accounts, offset by a decline in estate fees. Continued focus on business development, including expanded referral programs, is expected to strengthen future fiduciary income growth. Total assets under management by CBNA's trust department (excluding BPA/EBT-related assets) were $149 million as of year-end 1997, up from $144 million and $138 million at year-end 1996 and 1995, respectively. o Service charges on deposit accounts and overdraft fees increased to $4.9 million in 1997, a 21.3% growth rate versus 21.4% in 1996. The 1997 increase reflects the impact of fees and commissions from an expanded customer base gained from the Key and Fleet acquisitions and an emphasis on ensuring competitive pricing and reducing waived fees. Note that 1996's increase reflected the full year impact of 1995's Chase branch acquisition. o Fees earned through the Company's Visa affiliation rose 23.4% in 1997 to $515,000, attributable mainly to continued growth of the Visa Check Card product (which more than doubled from 1996 to 1997), with Visa merchant discount fees remaining essentially flat. The direct margin on merchant discount fees (net of processing expense) dropped 2.3 percentage points to 29.5% in 1997. o 1997 is the fourth year in which CBSI has offered annuities, mutual funds, and other investment products through financial services representatives (FSR's) located in nine selected geographic markets within the Bank's branch network. These individuals are registered representatives working through PrimeVest Financial Services, Inc. of Saint Cloud, Minnesota. Commission income from this activity in 1997 reached $1.0 million on asset sales of $26.3 million, up over 28% from $782,000 in 1996 on sales of $24.8 million. A greater emphasis continues to be placed on growing this line of special investment products as evidenced by two additions to sales staff during the last half of 1997 and the hiring of a full-time program administrator in early 1998. General commissions and miscellaneous income at $1.8 million were up more than 44% in 1997. This increase is attributable to $182,000 more in dividends from the New York State Bankers Association's insurance subsidiary, an increased level of Canadian exchange revenue, and the impact of miscellaneous fees generated by the Key and Fleet branches. Nineteen ninety-seven's nonrecurring other income was $381,000. This includes a $236,000 gain on life insurance and gains on the sale of student loans and mortgages sold in the secondary market. Revenue from record keeping and consulting services provided by BPA (acquired in July 1996) and investment management services provided by the pre-existing EBT department totaled $1.8 million in 1997 compared to $1.1 million in 1996, a 60.8% increase as a result of the full year impact of BPA operations and strong business development efforts. Total assets under management by BPA/EBT more than doubled in 1997 to $125 million as of year end, up from $52 million and $47 million in 1996 and 1995, respectively. The following table sets forth selected information by category of noninterest income for the Company for the years and quarters indicated.
---------------------------------------------------------------------- (000's omitted) Years ended Quarters ended December 31, December 31, ---------------------------------------------------------------------- 1997 1996 1995 1997 1996 ----- ----- ---- ----- ---- Fiduciary and investment services $ 1,181 $1,097 $ 970 $ 363 $ 342 Service charges on deposits $ 2,709 2,259 1,959 797 528 Overdraft fees $ 2,186 1,778 1,367 658 474 Other service charges and fees $ 3,558 2,501 1,782 983 669 BPA/EBT income $ 1,793 1,115 477 446 403 Nonrecurring income $ 381 124 3 301 64 Total $11,808 $8,874 $6,558 $3,549 $2,481 Total noninterest income (excluding nonrecurring items) as a percentage of operating income 15.3% 13.6% 12.1% 15.9% 14.4%
17 NONINTEREST EXPENSE Noninterest expense or overhead rose $8.3 million or 22.3% in 1997 to $45.8 million compared to a 13.4% increase in 1996. The bulk of 1997's increase is due to branch expansion. The Key and Fleet acquisitions caused personnel additions (both acquired branch staff and volume-sensitive positions in operations and other areas needed to support the expanded balance sheet), greater data processing requirements, expanded facilities costs, and other expenses associated with servicing the expanded customer base. Overhead growth also reflects the impact of a full year of operating Benefit Plans Administrators acquired in July 1996. Total one-time Key and Fleet-related acquisition expenses were approximately $990,000 in 1997, including a loss of $47,000 on sale of a duplicate branch facility (accounted for as an offset to nonrecurring income). As a percent of average assets, overhead increased from 2.99% in 1996 to 3.07% in 1997, representing the peer normal 48th percentile. For CBSI as a whole, higher personnel expense accounted for over 44% of 1997's increase in overhead, with personnel costs being up 19.2% versus being 14.8% higher in 1996. Greater salary, benefit, and payroll tax expense primarily reflect staffing in the new branches, along with modest annual merit awards for existing personnel. Total full-time equivalent employees (FTE's) at December 31, 1997 were 726 versus 578 a year earlier. Nonpersonnel expense rose $4.7 million or 25.6% this year as opposed to a $1.9 million or an 11.9% increase in 1996. One-time Key and Fleet-related acquisition expenses accounted for $897,000 or 19% of the nonpersonnel increase. Higher occupancy expense, depreciation on equipment, office supplies, telephone, courier and armored car expense, postage, business development, and computer services resulted from the impact of the 20 new branches added in mid 1997. Total amortization of intangibles increased by $1,058,000 or 38.8% to $3.8 million in 1997 as a result of the branch acquisitions. Various other increases related to inflation, internal volume growth, the full year impact of BPA, expenses associated with repossessed assets, a change in reporting commission expense associated with annuity/mutual fund sales, and the valuation of CBSI director phantom stock were partially offset by lower FDIC insurance expense which resulted from the absence of a special one-time assessment in 1996 to rebuild the Savings Association Insurance Fund (SAIF). The efficiency ratio is defined as overhead expense divided by recurring operating income (full tax-equivalent net interest income plus noninterest income, excluding net securities gains and losses); the lower the ratio, the more efficient a bank is considered to be. In 1997, the efficiency ratio increased by 2.9 percentage points to 60.9%, which exceeds the national peer bank median of 57.3% based on data available as of September 30, 1997. The increase reflects the impact of one-time Key and Fleet acquisition related expenses incurred in 1997 combined with a disproportionately smaller increase in operating income, since most of the acquired deposits funded investments rather than higher yielding loans. However, this year's ratio is essentially equal to the 60.8% level of 1995, which was impacted by similar circumstances caused by the Chase branch acquisition. Excluding all nonrecurring income, one-time expenses, and the Company's relatively high level of intangible amortization, the efficiency ratio is 55.8% based on full year 1997 results. This calculation can be more logically compared to the 57.3% median for peer banks, which generally experience a much lower level of intangible amortization and which as a group are not heavily impacted by one-time acquisition expenses. Nonetheless the Company is striving to reduce its efficiency ratio by capturing opportunities for greater economies of scale at its enlarged size, including steady deployment of productivity-enhancing technology. Management has set an objective to bring this ratio (inclusive of intangible amortization) downward to 55% within the next three years. While the Company's expense ratios have generally been favorable, management maintains a heightened focus on controlling costs and eliminating inefficiencies. Areas for improvement have been identified through detailed peer comparisons, a bank-wide program of employee involvement in cost containment, and targeted use of outside consultants. These combined efforts are intended to offset pressure from price increases and higher transaction volumes and enable the Company to more fully benefit from economies of scale as it continues to grow. 18 The following table sets forth information by category of noninterest expenses of the Company for the years and quarters indicated.
-------------------------------------------------------------------------- (000's omitted) Years ended Quarters ended December 31, December 31, -------------------------------------------------------------------------- 1997 1996 1995 1997 1996 ----- ----- ---- ----- ---- Personnel expense $22,945 $19,247 $16,757 $6,311 $4,908 Net occupancy expense 3,426 3,073 2,608 952 782 Equipment expense 2,728 2,318 1,992 774 592 Professional fees 1,616 1,119 1,102 496 327 Data processing expense 3,584 2,975 2,449 909 729 Amortization 3,787 2,729 1,686 1,204 701 Stationary and supplies 1,749 951 1,231 658 260 Deposit insurance premiums 140 368 925 44 26 Other 5,823 4,670 4,269 1,559 1,155 ------------ ------------- -------------- --------------- ------------- Total $45,799 $37,451 $33,019 $12,906 $9,480 ============ ============= ============== =============== ============= Total operating expenses as a percentage of average assets 3.07% 2.99% 3.13% 3.26% 2.88% Efficiency ratio - nominal (1) 60.9% 58.0% 60.8% 62.0% 56.4% - adjusted (2) 55.8% 53.9% 56.7% 56.6% 53.0%
(1) Noninterest expense divided by operating income, excluding net securities gains/losses. (2) Noninterest expense excluding nonrecurring items and amortization of deposit intangibles divided by operating income excluding all nonrecurring items. INCOME AND INCOME TAXES Income before tax in 1997 was $24.4 million, up 2.6% over the prior year's amount. When pre-tax income is recast as if all tax-exempt revenues were fully taxable on a federal basis, 1997's results rose by $606,000 or 2.5%. Largely as a result of the acquisitions, pre-tax earnings were favorably impacted by $7.6 million greater net interest income (full tax-equivalent basis) and a $2.9 million climb in noninterest income. These factors were partially offset by $8.3 million more in overhead expense (also related to the acquisitions), and $1.6 million more in loan loss provision expense associated with an increased level of consumer loan charge-offs and the need to maintain adequate reserves in light of CBSI's strong loan growth. The Company's combined effective federal and state tax rate dropped a significant 440 basis points this year to 36.2%. The rate decreased because of an increasing proportion of tax-exempt investment income; a nonrecurring, nontaxable gain on life insurance; and the lack of 1996's additional taxes and interest resulting from an IRS tax audit of the years 1990 to 1993. CAPITAL Shareholders' equity ended 1997 at $118.0 million, up over 7.9% from one year earlier, primarily reflective of the contribution of strong earnings less dividends paid to shareholders. Excluding the $1.8 million after-tax change in this year's market value adjustment (MVA) on available-for-sale investment securities, capital rose 6.3%. Shares outstanding increased by nearly 112,000 during 1997 due to the exercise of stock options. On January 29, 1997, CBSI placed $30 million of fixed rate capital securities through Community Capital Trust I, a newly formed Delaware business trust, controlled by CBSI. The 9.75% Capital Securities, Series A of Community Capital Trust I were priced at 99.325% of par to yield 9.82%. Cash distributions are payable semi-annually on January 31 and July 31, and began on July 31, 1997. The 9.75% Capital Securities are rated Investment Grade ("BBB-") by Thomson BankWatch. The proceeds from the issuance were used to fund the Key and Fleet branch acquisitions, and to redeem the $4.5 million remaining half of CBSI's preferred stock issued in mid 1995. 19 The ratio of Tier I capital to assets (or Tier I leverage ratio), the basic measure for which regulators have established a 5% minimum to be considered "well capitalized," remains sound at 5.67%. This level compares to 5.88% a year ago. Despite higher capital produced by this year's strong earnings and the aforementioned Community Capital Trust I, the decrease in the 1997 Tier I ratio was a result of increased intangibles attributed to the Key and Fleet branch acquisitions. The total capital to risk-weighted assets ratio of 10.55% as of year-end 1997 was well above the 6% minimum requirement for "well capitalized" banks. The Company is confident that capital levels are being prudently balanced between regulatory and investor perspectives. Cash dividends declared on common stock in 1997 of $5.7 million represented an increase of 12.1% over the prior year. This growth reflects the exercise of stock options, and a two cent per share increase in the quarterly common stock dividend in the third quarter of 1997 from $.18 to $.20. Dividends declared on CBSI's preferred stock in 1997 were $180,000 compared to $405,000 in the prior year, reflecting the aforementioned redemption of preferred stock. Raising the Company's expected annualized dividend to $0.80 per common share represents management's confidence that earnings strength is sustainable and that capital can be maintained at a satisfactory level. The dividend payout ratio for the year was approximately 38%, or 37% excluding the preferred dividend, remaining relatively consistent with the 1996 levels of 39% and 36%, respectively. The Company's targeted payout range for dividends on common stock is 30-40%. Its payout ratio has historically been strong relative to peers, ranging from the 60th-77th percentile from 1993 through 1996. The 1997 peer payout ratio (including preferred dividend) remained high in the 75th peer percentile. LOANS The amounts of the Bank's loans outstanding (net of deferred loan fees or costs) at the dates indicated are shown in the following table according to type of loan:
-------------------------------------------------------------------------- Years ended December 31, -------------------------------------------------------------------------- (000's omitted) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Real Estate Mortgages: Residential $278,912 $225,088 $204,224 $196,548 $177,059 Commercial loans secured by real estate 85,962 56,959 46,971 35,604 32,914 Farm 10,434 8,296 8,224 7,625 7,421 Total 375,308 290,343 259,419 239,777 217,394 Commercial, Financial, and Agricultural: Agricultural 23,894 21,689 17,969 13,295 11,564 Commercial and financial 138,067 99,445 81,562 67,976 58,252 Total 161,961 121,134 99,531 81,271 69,816 Installment Loans to Individuals: Direct 89,138 62,176 57,646 58,371 58,963 Indirect 198,853 171,583 144,566 121,148 89,513 Student and other 10,880 9,635 10,268 8,690 6,337 Total 298,871 243,394 212,480 188,209 154,813 Other Loans 8,887 3,496 2,190 1,482 1,578 -------- -------- -------- -------- -------- Gross Loans 845,027 658,367 573,620 510,739 443,601 Less: Unearned Discounts 1,815 5,893 13,469 27,660 25,730 Reserve for Possible Loan Losses 12,434 8,128 6,976 6,281 5,706 -------- -------- -------- -------- -------- Net Loans $830,778 $644,346 $553,175 $476,798 $412,165
The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. About two-thirds of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. 20 Additionally, the typical size loan to the variety of commercial businesses in the Company's market areas is under $65,000, with only 30% of the commercial portfolio consisting of loans in excess of $500,000. The portfolio contains no credit card receivables. The overall yield on the portfolio is in the attractive 75th peer percentile. Loans outstanding, net of unearned discount, reached a record $843 million as of year-end 1997, up over $190 million or 29.2% compared to twelve months earlier. Nearly half of 1997's growth was due the contributions of eight branches acquired in Southwestern New York in mid June from KeyBank, N.A. and twelve branches acquired in Northern New York in mid July from Fleet Bank. Taken together, these branch locations now account for approximately $95 million in loans (or 11% of our year-end loan base). About 20% of 1997's growth took place in the markets served by the branches purchased from Chase at mid-year 1995; outstandings at these branches have risen from $12 million at the July 1995 acquisition date to $101 million at year-end 1997. This marks the fifth consecutive year in which total loan growth has exceeded 15%; loans in 1996 rose a strong $92 million or 16.5%. The "Nature of Lending" table below recasts the Company's loan portfolio into four major lines of business: consumer mortgages, business lending, consumer indirect, and consumer direct. Comparing the components of loan growth in 1997 versus 1996, the increase in business lending was slightly more this year at 41% of $191 million in total loan growth versus 40% of 1996's $92 million increase. About 37% of 1997's loan growth took place in the consumer direct area compared to the 19% share in 1996. Consumer indirect loans accounted for 16% of this year's increase, down from 36% in the prior year. Lastly, the share of this year's total loan increase from consumer mortgages increased slightly to 6% from 1996's level of 5%. The following discusses the underlying reasons for these changes by each of the Company's four major lending activities or lines of business.
NATURE OF LENDING Mix at Quarter End ($ million and %) Total Loans Consumer Mortgage Business Lending Consumer Indirect Consumer Direct - ----------------------- ----------------------- ----------------------- ------------------------ ------------------------- Year 000's % Change 000's % Total % Change 000's % Total % Change 000's % Total % Change 000's % Total % Change 1997 843 29.2% 164 19% 7.8% 288 34% 36.7% 199 24% 18.6% 192 23% 57.5% 1996 652 16.5% 152 23% 3.2% 211 32% 21.3% 168 26% 24.2% 122 19% 17.4% 1995 560 16.0% 147 26% 2.4% 174 31% 25.6% 135 24% 31.8% 104 19% 5.6% 1994 483 15.6% 143 30% 12.2% 139 29% 15.1% 102 21% 37.9% 99 20% 3.4% 1993 418 15.3% 128 30% 26.8% 120 29% 25.7% 74 18% 4.2% 96 23% 0.9%
The combined total of general purpose business lending, dealer floor plans, mortgages on commercial property, and farm loans is characterized as the Company's business lending activity. At $288 million, this segment represents 34% of loans outstanding at year end, having expanded its share by five percentage points since year-end 1993. This relatively high mix compared to the Bank's other loan types is largely attributable to borrowing by local commercial businesses. Outstandings climbed over $77 million or 37% in 1997. Comparative growth rates were 21% for 1996 and 26% in 1995. This year's growth resulted from strong business development efforts, the aforementioned contribution of acquired branches, and the addition of a number of experienced commercial lenders over the last few years. More than 86% of the Bank's total number of commercial loans have balances less than $100,000, which as a group constitutes approximately 34% of commercial loan outstandings. Commercial loans up to $250,000 comprise 23% of loans outstanding while loans in the size range of $250,000-$500,000 amount to 13%. Again, loans with balances greater than $500,000 represent 30% of the portfolio; about 9 percentage points of this segment represents floor plan loans to 25 automobile dealers. 21 Demand for installment debt indirectly originated through automobile, marine, and mobile home dealers continued to be very active in 1997 for the fourth consecutive year. Outstandings ended 1997 nearly 19% or $31 million higher compared to growth of 24% or $33 million in the prior year. Strength was evidenced in both CBSI's Northern Region, where this type of lending has been highly successful for a number of years, and in the Southern Region, where the commitment to indirect lending was re-energized during 1993 and has continued with success since then. This portfolio segment, of which 92% relates to automobile lending (71% used vehicles versus 29% new), constitutes 24% of total loans outstanding, up from its low of 18% at year-end 1993. No indirect loans were part of the mid-summer 1997 acquisitions. The segment of the Company's loan portfolio committed to consumer mortgages includes both fixed and adjustable rate residential lending. It accounts for $164 million or 19% of total loans outstanding. The growth during the last two years ($11.9 million or 7.8% in 1997, and $5.1 million or 3.2% in 1996) is lower than it would otherwise be due to a program which began in mid 1994 to sell selected fixed rate originations in the secondary market. The purpose of this program, which resulted in sales of $1.2 million in its first year, $4.3 million in 1995, $7.2 million in 1996 and $14.0 million this year, is to develop a meaningful source of servicing income as well as to provide an additional tool to manage interest rate risk. The direct consumer lending activity has increased modestly over the last five years. 1997 outstandings rose 57.5% or $70 million versus 17.0% or $18 million in 1996 largely due to loans obtained with the summer acquisitions. This line of business is comprised of conventional installment loans (including some isolated installment lending to small businesses), personal loans, student loans (which are sold once principle amortization begins), and borrowing under variable and fixed rate home equity lines of credit. The consumer direct segment as a percent of total loans trended downward from 1993 to 1995. However, it stabilized in 1996 at 19%, rising to 23% in 1997. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES The following table shows the amount of loans outstanding as of December 31, 1997, which, based on remaining scheduled payments of principal, are due in the periods indicated:
---------------------------------------------------------------------------- At December 31, 1997 ---------------------------------------------------------------------------- Maturing After One Maturing in but Maturing One Year or Within Five After Five Total Book (000's omitted) Less Years Years Value ------------------ ------------------ ----------------- ----------------- (In Thousands) Commercial, financial, and agricultural $ 69,056 $ 56,842 $ 36,063 $161,961 Real estate - construction 0 0 0 0 Real estate - mortgage 33,316 80,798 261,194 375,308 Installment, net of unearned discount 112,892 177,942 15,109 305,943 ------------------ ------------------ ----------------- ----------------- Total loans, net of unearned discount $215,264 $315,582 $312,366 $843,212 ================== ================== ================= =================
The following table sets forth the sensitivity of the loan amounts due after one year to changes in interest rates: ---------------------------------- (000's omitted) At December 31, 1997 ---------------------------------- Fixed Rate Variable Rate Due after one year but within five years $263,480 $52,102 Due after five years 270,122 42,244 ------------------ -------------- Total due after one year $533,602 $94,346 ================== ============== 22 NONPERFORMING ASSETS/RISK ELEMENTS The following table presents information concerning the aggregate amount of nonperforming assets:
------------------------------------------------------------------------------- Years ended December 31, ------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Dollars in thousands) Loans accounted for on a nonaccrual basis $ 1,385 $ 2,023 $ 1,328 $ 2,396 $ 1,738 Accruing loans which are contractually past due 90 days or more as to principal or interest payments 2,788 823 667 862 653 -------- -------- --------- --------- --------- Total nonperforming loans 4,173 2,846 1,995 3,258 2,391 Loans which are "troubled debt restructurings" as defined in Statement of Financial Accounting Standards No. 15 "Accounting by Debtors and Creditors for Troubled Debt Restructurings" 0 32 0 15 243 Other real estate 881 746 614 223 433 -------- -------- --------- --------- --------- Total nonperforming assets $ 5,054 $ 3,624 $ 2,609 $ 3,496 $ 3,067 ======== ======== ========= ========= ========= Ratio of allowance for loan losses to period-end loans 1.47% 1.25% 1.25% 1.30% 1.37% Ratio of allowance for loan losses to period-end nonperforming loans 297.96% 285.58% 349.69% 192.79% 238.67% Ratio of allowance for loan losses to period-end nonperforming assets 246.02% 224.27% 267.40% 179.67% 186.06% Ratio of nonperforming assets to period-end total loans and other real estate owned 0.60% 0.55% 0.47% 0.72% 0.73%
The impact of interest not recognized on nonaccrual loans, and interest income that would have been recorded if the restructured loans had been current in accordance with their original terms, was immaterial. The Company's policy is to place a loan on a nonaccrual status and recognize income on a cash basis when it is more than ninety days past due, except when in the opinion of management it is well secured and in the process of collection. PROVISION AND RESERVE FOR LOAN LOSSES Nonperforming loans, defined as nonaccruing loans plus accruing loans 90 days or more past due, ended 1997 at $4.2 million. This level is approximately $1.3 million or 47% higher than one year earlier; about 55% of the increase pertains to consumer installment loans with the balance largely in commercial loans. Because of strong loan growth, however, the ratio of nonperforming loans to total loans has risen a relatively small five basis points during the year to .49%. As of September 30, 1997, when the nonperforming loan ratio stood at .53%, the Company's asset quality was in the favorable 23rd percentile compared to peers. The ratio of nonperforming assets (which additionally include troubled debt restructuring and other real estate) to total loans plus OREO is also favorable at .60%. Total delinquencies, defined as loans 30 days or more past due and nonaccruing, have trended slightly higher as a percent of total loans over the last two years, generally fluctuating within a range of 1.2% to 1.4% in 1996 versus 1.3% to 1.7% in 1997; a brief seasonal or event-related spike outside these ranges occurred during both periods. Though commercial and real estate loan delinquencies have been relatively flat over the last 12 months, installment loan delinquencies exhibited an up-trend, averaging 2.29% for the last six months of 1997 versus 1.66% for the same prior year period. 23 As of year-end 1997, total delinquencies for commercial loans, installment loans, and real estate mortgages were 1.45%, 2.75%, and 1.00%, respectively. With the exception of installment loans, these measures compare favorably to delinquencies of peer bank holding companies as of September 30, 1997 of 2.49%, 2.42%, and 1.92%, respectively. Management views the higher installment loan delinquencies to be temporary and anticipates that the ratio will improve in 1998 with tighter loan underwriting standards, changes in personnel, and strengthened monitoring and control. The Bank strives to maintain its total and component category delinquencies below a 2% internal guideline, and is comfortable that this objective continues to be realistic. As of September 30, 1997, when overall delinquencies were at 1.72%, the Company ranked in the 46th peer percentile. Factors contributing to successful underwriting, collection, and credit monitoring include selective addition of experienced lenders over the last several years, loan servicing on a regionally-based level, collection departments focused on taking prompt corrective action, and a centralized loan review function which is given priority attention and has regular Board of Director accountability. Another measure of the Company's good asset quality is a reasonable net charge-offs record, which finished the year at $3.7 million or .50% of average loans. As a result of higher installment loan charge-offs, gross charge-offs rose 80.9% to $4.4 million, or .59% of average loans outstanding versus .41% in 1996. This year's recoveries rose to an all-time record in dollar amount of $727,000, while down from 1996 in percentage terms to 29.6% of prior year gross charge-offs. As of September 30, 1997, the Bank's net charge-off ratio was in the 70th peer percentile. It should be noted, as with the higher installment delinquencies, management views the growth in installment loan charge-offs to be temporary. A timely charge-off policy and relatively low nonperforming loans have enabled the Company to carry a reserve for loan losses below peers. As a percent of total loans, the loss reserve ratio has increased to a 1.47% level for the year ended 1997. Though the reserve ratio is presently in the 59th peer percentile, coverage over nonperforming loans as of September 30, 1997 was well above the norm in the 87th percentile; management believes the year-end level at 298% to be ample. The Company's small business loan orientation has historically reduced the likelihood of large, single borrower charge-offs. Another measure of comfort to management is that after conservative allocation by specific customer and loan type, over 14% of loan loss reserves remains available for absorbing general, unforeseen loan losses. The annual loan loss provision has characteristically been well in excess of net charge-offs, which have had coverage of over 1.2 times since 1990. This practice has enabled a steady increase in the loan loss reserve level, which rose by $4.3 million or 53.0% to an all-time high of $12.4 million at year-end 1997 (includes a $3.5 million valuation allowance to absorb acquired Key and Fleet loan charge-offs). As a percentage of average loans, the annual loan loss provision was well above the peer norm in the 77th percentile as of September 30, 1997. For full year 1997, the loss provision ratio was .60%, having remained in a .34% to .48% range during the prior three year period. This upward movement reflects the need to cover 1997's higher net charge-offs by 125% (excluding those pertaining to acquired Key and Fleet loans) so as to keep pace with record loan growth and maintain the loss reserve ratio at an adequate level. 24 SUMMARY OF LOAN LOSS EXPERIENCE The following table summarizes loan balances at the end of each period indicated and the daily average amount of loans. Also summarized are changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off and additions to the allowance which have been charged to expenses.
--------------------------------------------------------------------------- Years ended December 31, --------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (Dollars in thousands) Amount of loans outstanding at end of period $845,027 $658,367 $573,620 $510,739 $443,601 -------- -------- -------- -------- -------- Daily average amount of loans (net of unearned discounts) $749,596 $602,717 $519,762 $446,135 $382,680 -------- -------- -------- -------- -------- Balance of allowance for possible loan losses at beginning of period 8,128 6,976 6,281 5,706 4,982 Loans charged off: Commercial, financial, and agricultural 418 324 454 502 236 Real estate construction 0 0 0 0 0 Real estate mortgage 25 26 48 41 19 Installment 4,006 2,108 1,256 1,072 1,155 -------- -------- -------- -------- -------- Total loans charged off 4,449 2,458 1,758 1,615 1,410 Recoveries of loans previously charged off: Commercial, financial, and agricultural 185 224 213 38 85 Real estate construction 0 0 0 0 0 Real estate mortgage 1 1 27 1 1 Installment 541 488 448 449 542 -------- -------- -------- -------- -------- Total recoveries 727 713 688 488 628 Net loans charged off 3,722 1,745 1,070 1,127 782 -------- -------- -------- -------- -------- Additions to allowance charged to expense (1) 4,480 2,897 1,765 1,702 1,506 -------- -------- -------- -------- -------- Reserves on acquired loans (2) 3,548 0 0 0 0 -------- -------- -------- -------- -------- Balance at end of period $ 12,434 $ 8,128 $ 6,976 $ 6,281 $ 5,706 -------- -------- -------- -------- -------- Ratio of net chargeoffs to average loans outstanding 0.50% 0.29% 0.21% 0.25% 0.20%
(1) The additions to the allowance during 1993 through 1997 were determined using actual loan loss experience and future projected loan losses and other factors affecting the estimate of possible loan losses. (2) These reserve additions are attributable to loans purchased from Key Bank and Fleet Bank in association with the purchases of branch offices during 1997. 25 The allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated.
------------------------------------------------------------------------------------------------------------------- Years ended December 31, ------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 --------------------- -------------------- ---------------------- --------------------- ----------------------- Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in Each in Each in Each in Each in Each Amt. of Category Amt. of Category Amt. of Category Amt. of Category Amt. of Category Allow- to Total Allow- to Total Allow- to Total Allow- to Total Allow- to Total ance Loans ance Loans ance Loans ance Loans ance Loans -------- ---------- -------- --------- -------- ---------- -------- --------- ---------- --------- Commercial, financial, & agricultural $ 4,136 19.2% $2,668 18.4% $2,035 17.4% $1,832 15.9% $3,464 15.7% Real estate-- construction -- -- -- -- -- -- -- -- -- -- Real estate-- mortgage 2,026 44.4% 2,234 44.1% 2,255 45.2% 2,222 47.0 % 341 49.0% Installment 4,461 36.4% 2,309 37.5% 1,527 37.4% 1,422 37.1% 1,342 35.3% Unallocated 1,811 N/A 917 N/A 1,159 N/A 805 N/A 559 N/A Total $12,434 100.0% $8,128 100.0% $6,976 100.0% $6,281 100.0% $5,706 100.0%
FUNDING SOURCES Typical of most commercial banking institutions today is the need to rely on a variety of funding sources to support its earning asset base as well as to achieve targeted growth objectives. There are three primary sources of funding that comprise CBSI's overall funding matrix, which considers maturity, stability, and price: deposits of individuals, partnerships and corporations (IPC deposits); collateralized municipal deposits; and capital market borrowings.
- ------------------------------------------------------------------------------------------------------------------ Sources of Funds Average Fourth Quarter Balances ($ millions) - ------------------------------------------------------------------------------------------------------------------ Total Funds Year IPC Deposits Public Funds Capital Borrowings Sources -------------------------- -------------------------- -------------------------- ------------- Amount % Total Amount % Total Amount % Total Amount ------ ------- ------ ------- ------ ------- ------ 1997 $1,190 82.1% $163 11.2% $ 97 6.7% $1,450 1996 $ 903 75.6% $124 10.4% $168 14.1% $1,195 1995 $ 921 86.8% $128 12.6% $ 6 0.6% $1,018 1994 $ 583 71.7% $101 12.4% $129 15.9% $ 813
The Company's funding matrix continues to benefit from a high level of IPC deposits, which reached an all-time high for a fourth quarter average of $1,190 million, up $287 million or 32% from the comparable 1996 period. IPC deposits are generally considered to be a bank's most attractive source of funding because of their general stability and relatively low cost, and because they represent a working customer base with the potential to be cross-sold a variety of loan, deposit and other financial service-related products. Strongly impacting the Company's IPC funding source were the Key and Fleet branch acquisitions which took place in June and July of this year. These branches account for approximately $260 million or over 90% of the fourth quarter growth in IPC deposits. Following initial deposit attrition of a modest 3.3% through year-end 1997, steady acclimation of this new customer base within the Company will help reduce further erosion of this funding source during 1998. The mix of CBSI's IPC deposits has changed over the last four years. The steady growth in time deposit share, from 38% of deposits in 1994 to 49% this year, reflects consumer movement away from immediately available, lower earning savings and money market accounts. 26 Deposits of local municipalities increased $39 million or 31% during the past year, with balances for fourth quarter 1997 averaging $163 million versus $124 million for the same quarter in 1996. The Key and Fleet branch acquisitions contributed $22 and $27 million, respectively, towards the increase. Excluding the Key and Fleet branches, the Bank experienced a $10 million or 8% decrease in municipal deposits. Under New York State Municipal Law, the Company is required to collateralize all local government deposits with marketable securities from its investment portfolio. Because of this stipulation, management considers this source of funding to be equivalent to capital market borrowings. As such, CBSI endeavors to price these deposits at or below alternative capital market borrowing rates. Utilization of municipal deposits has gradually been decreasing over the last four years as a percent of total funding sources. Capital market borrowings are defined as funding sources available on a national market basis, generally requiring some form of collateralization. Borrowing sources for the Company include the Federal Home Loan Bank of New York, as well as access to the national repurchase agreement market through established relationships with primary market security dealers. Also considered borrowing (though it serves as Tier I capital) is the $30 million in 9.75% company-obligated mandatorily redeemable preferred securities issued to support 1997's acquisitions. Capital market borrowings averaged $98 million or 7% of total funding sources for fourth quarter 1997 compared to $168 million or 14% of total funding sources for the same period in 1996. The lower level of borrowings in 1997 is largely due to the net proceeds from the Key and Fleet transaction being utilized to repay borrowings. As of December 31, 1997, nearly half or $60 million of capital market borrowings (excluding the aforementioned trust preferred securities) had original terms of one year or more. The average daily amount of deposits and the average rate paid on each of the following deposit categories is summarized below for the years indicated.
1997 1996 1995 --------------------------- ---------------------------- ------------------------------ Avg. Avg. Avg. Avg. Avg. Avg. (000's omitted) Balance Rate Paid Balance Rate Paid Balance Rate Paid -------------- ------------ -------------- ------------ --------------- -------------- Noninterest-bearing demand deposits $ 170,989 N/A $ 143,995 N/A $ 123,952 N/A Interest-bearing demand deposit 119,769 1.38% 100,278 1.40% 83,812 1.66% Regular savings accounts 247,330 2.91% 241,199 2.87% 211,867 3.01% Money market savings 76,567 2.76% 65,448 2.48% 70,925 2.77% Time deposits 599,136 5.61% 481,250 5.49% 380,494 5.53% ---------- ---------- ---------- Total average daily amount of domestic deposits $1,213,791 3.67% $1,032,170 3.53% $ 871,050 3.53% ========== ========== ==========
The remaining maturities of time deposits in amounts of $100,000 or more outstanding at December 31, 1997 and 1996 are summarized below: ------------------------------ At December 31, ------------------------------ (000's omitted) 1997 1996 ---- ---- Less than three months $33,240 $47,556 Three months to six months 29,420 9,944 Six months to one year 19,340 7,856 Over one year 11,439 3,558 ------- ------- Total $93,439 $68,914 ======= ======= 27 The following table summarizes the outstanding balance of short-term borrowings of the Company for the years indicated.
At December 31, -------------------------------------------------------- (000's omitted) 1997 1996 1995 ----------------- ----------------- ----------------- Federal funds purchased $ 45,000 $31,800 $ -- -- Term borrowings at banks (original term) 90 days or less 20,000 -- -- 1 year -- 65,000 -- -------- ------- -------- Balance at end of period $ 65,000 $96,800 $ -- ======== ======= ======== Daily average during the year $ 45,008 $46,535 $ 85,407 Maximum month-end balance $128,000 $96,800 $188,200 Weighted average rate during the year 5.74% 5.63% 6.29% Year-end average rate 6.53% 6.07% 0.00%
INVESTMENTS The primary objective of CBSI's investment portfolio is to prudently provide a degree of low-risk, quality assets to the balance sheet. This must be accomplished within the constraints of: (a) absorbing funds when loan demand is low and infusing funds when demand is high; (b) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (c) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (d) considering investment risk-weights as determined by regulatory risk-based capital guidelines; and (e) generating a favorable return without undue compromise of other requirements. When choosing an appropriate investment for balance sheet management, the applied analytical method favored by the Company is total return. While the type of strategy considered ultimately determines the scope of analysis performed, management commonly tests the performance of its investment purchases over a one and three year forward time horizon, under conditions which include interest rate movements of up or down 300 basis points from current levels. It is through this methodology that prepayment risk, embedded option risk, and market value risk can be properly quantified by the Company. Throughout 1997, the balance sheet of the Company exhibited a structurally asset sensitive profile, in large part due to the influence of the Key and Fleet branch deposit acquisitions consummated in mid summer of this year. As a result, investment strategies pursued were primarily designed to manage this asset sensitive interest rate risk exposure, with a focus on improving the relative performance of net interest income in both rising and falling interest rate environments. Among the strategies employed by the Company during 1997 were the purchase of fixed rate U.S callable agency debentures with three to five years of initial call protection, as well as premium U.S. agency collateralized mortgage obligations (CMOs). In addition, a number of longer-dated insured municipal bonds were added to the portfolio because of their favorable risk/reward profile when compared to other investment alternatives. Total portfolio growth slowed to 5.8% during the past year as many of the Company's capital resources were redirected towards funding growth in the loan portfolio. As such, much of the 1997 portfolio activity was the result of a reinvestment of funds from mortgage backed security prepayments and callable bond proceeds. Total portfolio outstandings as of December 31, 1997 were $612 million as compared to $579 million as of year-end 1996. The composition of the portfolio continues to favor U.S. Governments and U.S. Agency mortgage-backed obligations, achieving effective use of regulatory risk-based capital. At December 31, 1997, these two security types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock) accounted for 96% of total portfolio investments versus 97% in the prior year. The average life of the portfolio, including the exercise of embedded call options, increased slightly to 3.6 years as of year end. The increase reflects $87 million in agency bonds called this year, which resulted in $696,000 of bond discount accretion being taken into income; $221,000 was earned in 1996 on a $2.8 million called bond. This source of nonrecurring income added 11 basis points in average yield to the portfolio (excluding money market instruments) to 7.63% compared to 7.57% in 1996, which was higher by 10 basis points due to bond discount accretion and another favorable nonrecurring item. Through September 30, 1997, the portfolio's reported average yield at 7.64% was in the 92nd percentile based on the peer median of 6.74%. Net losses on the sale of securities were $14,000 in 1997 versus gains of $32,000 in 1996. Gains and losses incurred by the portfolio are the result of normal investment management activity, which focuses on improving long-term portfolio earnings and market value performance. 28 INVESTMENT SECURITIES The following table sets forth the amortized cost and market value for the Company's held-to-maturity investment securities portfolio:
Years ended December 31, ------------------------------------------------------------------------------------ 1997 1996 1995 ------------------------------------------------------------------------------------ Amortized Amortized Amortized Cost/Book Market Cost/Book Market Cost/Book Market (000's omitted) Value Value Value Value Value Value ------------ ---------- ------------- ----------- ----------- ---------- U.S. Treasury securities and obligations of U.S. Government corporations and agencies $164,199 $168,799 $248,264 $254,437 $202,802 $212,415 Obligations of states and political subdivisions 10,221 10,575 17,796 18,292 15,409 16,077 Corporate securities 3,091 3,201 2 2 2 2 Mortgage-backed securities 86,148 88,838 103,795 105,765 97,593 99,848 -------- -------- -------- -------- -------- -------- TOTAL $263,659 $271,413 $369,857 $378,496 $315,806 $328,342 ======== ======== ======== ======== ======== ========
The following table sets forth the amortized cost and market value for the Company's available-for-sale investment portfolio.
Years ended December 31, ---------------------------------------------------------------------------------- 1997 1996 1995 -------------------------- ----------------------------- ------------------------- Amortized Amortized Amortized Cost/Book Market Cost/Book Market Cost/Book Market (000's omitted) Value Value Value Value Value Value ------------ ---------- ------------- ----------- ----------- ----------- U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 82,027 $ 84,730 $ 39,684 $ 40,005 $ 32,334 $ 32,695 Obligations of states and political subdivisions 9,960 10,310 437 452 435 459 Corporate securities 0 0 0 0 0 73 Mortgage-backed securities 225,693 227,350 145,276 146,555 96,326 97,595 Equity securities (1) 23,669 23,669 20,282 20,282 20,070 20,008 Federal Reserve Bank common stock 2,174 2,174 1,403 1,403 1,396 1,396 -------- -------- -------- -------- -------- -------- TOTAL $343,523 $348,233 $207,082 $208,697 $150,561 $152,226 ======== ======== ======== ======== ======== ======== Net unrealized gains/(losses) on available-for-sale portfolio 4,710 1,614 1,665 -------- -------- -------- Total Carrying Value $611,892 $578,553 $468,032 ======== ======== ========
(1) Includes $23,059; $19,709; and $19,678 in FHLB common stock at December 31, 1997, 1996, and 1995, respectively. 29 The following table sets forth as of December 31, 1997, the maturities of investment securities and the weighted-average yields of such securities, which have been calculated on the basis of the cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:
At December 31, 1997 ------------------------------------------------------------------------------- Amount Amount Amount Maturing Maturing Maturing After One After Five Amount Total Within Year but Years but Maturing Cost One Year Within Within After Book or Less Five Years Ten Years Ten Years Value ------------------------------------------------------------------------------- Held-to-Maturity Portfolio - -------------------------- U.S. Treasury and other U.S. government agencies $ 5 $ 9,874 $129,978 $ 24,341 $164,198 Mortgage-backed securities 0 3,293 41,863 40,993 86,149 States and political subdivisions 4,811 5,257 153 0 10,221 Other 0 52 2,492 547 3,091 ------ ------- -------- -------- -------- Total held-to-maturity portfolio value $4,816 $18,476 $174,486 $ 65,881 $263,659 ====== ======= ======== ======== ======== Weighted average yield at year end (1) 8.95% 8.81% 7.58% 8.02% 7.80% Available-for-Sale Portfolio: - ----------------------------- U.S. Treasury and other U.S. government agencies $ -- $ 6,007 $ 45,615 $ 30,406 $ 82,028 Mortgage-backed securities 1,953 1,414 18,093 204,232 225,692 States and political subdivisions 10 249 30 9,671 9,960 Other 0 0 0 0 -- ------ ------- -------- -------- -------- Total available-for-sale portfolio value $1,963 $ 7,670 $ 63,738 $244,309 $317,680 Weighted average yield at year end (1) 8.20% 5.91% 7.53% 7.30% 7.32%
(1) Weighted average yields on the tax-exempt obligations have been computed on a fully tax equivalent basis assuming a marginal federal tax rate of 35%. These yields are an arithmetic computation of accrued income divided by average balance; they may differ from the yield to maturity, which considers the time value of money. MARKET RISK Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company's primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company's asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Committee (ALCO) of the Company. In this capacity, ALCO develops guidelines and strategies impacting the Company's asset/liability management activities based upon estimated market risk sensitivity, policy limits, and the overall level and trend of market interest rates. 30 INTEREST RATE RISK At Community Bank, N.A., the fundamental purpose behind interest rate risk management is to maximize net interest income over both a short-term tactical and longer-term strategic time horizon. Because the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools which enable it to identify and quantify its sources of interest rate risk. The primary tool used by the Company in managing interest rate risk is income simulation. The analysis begins by measuring the impact of differences in maturity and repricing of all balance sheet positions. Such work is further augmented by adjusting for prepayment and embedded option risk found naturally in certain asset and liability classes. Finally, balance sheet growth and funding expectations are added to the analysis in order to reflect the strategic initiatives set forth by the Company. Changes in net interest income are reviewed after subjecting the balance sheet to an array of treasury yield curve possibilities including the traditional regulatory requirement of an immediate up or down shock of 200 basis points from current levels. While such an aggressive movement in rates provides management with good insight as to how its profit margins may perform under extreme market conditions, results from a more modest shift in interest rates are used as a basis to conduct day-to-day business decisions. The following reflects the Company's one year net interest income sensitivity analysis as of December 31, 1997 assuming a step up or down in rates over a twelve-month period (one of the simulation tests used for day-to-day decision making). In addition, this test assumes a static, no growth balance sheet: Rate Change Estimated Basis Points Net Interest Income Sensitivity ------------ ------------------------------- + 200 1.4% - 200 -5.0% The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cashflows, and others. While the assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps and floors of adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. LIQUIDITY Due to the potential for unexpected fluctuations in deposits and loans, active management of the Company's liquidity is critical. In order to respond to these circumstances, adequate sources of both on- and off-balance-sheet funding are in place. CBSI's primary approach to measuring liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short-term liabilities which are vulnerable to nonreplacement; and second, a projection of subsequent cash flow funding needs over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90 day time horizons. As of year-end 1997, this ratio was 13.9% and 12.6%, respectively. 31 GAP REPORT COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES as of December 31, 1997
Volumes 1-30 31-60 60-90 91-180 181-360 13-24 25-36 37-48 49-60 Over 60 ($000's) Days Days Days Days Days Months Months Months Months Months TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS: Due from banks - - - - - - - - - 82,106 82,106 Fixed Rate Debentures - - - 10,000 20,932 120,720 9,874 71,839 550 2,499 236,414 Floating Rate Debentures 6,006 6,006 Fixed Rate Mortgage Backed 3,109 3,871 3,214 9,887 20,405 44,044 41,538 29,230 25,406 100,361 281,065 Floating Rate Mortgage Backed 21,431 - - - - - - - - - 21,431 Other Investments 321 567 301 2,580 2,912 4,545 3,967 4,215 888 41,970 62,266 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS 30,867 4,438 3,515 22,467 44,249 169,309 55,379 105,284 26,844 226,936 689,288 - ------------------------------------------------------------------------------------------------------------------------------------ Mortgages: Adjustable Rate 1,724 2,014 3,815 5,775 17,489 - - - - - 30,817 Fixed Rate 2,728 2,708 2,758 7,890 15,010 27,184 23,914 21,204 18,693 28,217 150,306 Variable Home Equity 49,373 - - - - - - - - - 49,373 Commercial Variable 205,931 - - - - - - - - - 205,931 Other Commercial 5,014 5,054 5,094 15,527 32,177 27,726 - - - 64 90,656 Installment, Net 15,939 15,900 15,863 47,360 93,733 120,134 - - - 7,199 316,128 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LOANS 280,709 25,676 27,530 76,552 158,409 175,044 23,914 21,204 18,693 35,480 843,211 Loan Loss Reserve - - - - - - - - - (12,434) (12,434) Other Assets 397 397 397 1,191 2,382 4,764 4,764 1,588 1,390 96,406 113,676 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS 311,973 30,511 31,442 100,210 205,040 349,117 84,057 128,076 46,927 346,389 1,633,742 AVERAGE YIELD 9.76% 8.85% 8.82% 8.79% 8.71% 8.33% 7.22% 7.45% 7.52% 3.17% 7.39% ==================================================================================================================================== LIABILITIES AND CAPTIAL: Demand Deposits - - - - - - - - - 202,573 202,573 Savings / NOW 1,578 1,578 1,578 4,735 22,521 18,940 - - - 355,904 406,834 Money Markets - - - 63,207 22,160 - - - - - 85,367 CD's / IRA / Other 35,910 35,263 41,752 123,676 191,663 166,602 34,538 12,808 7,014 1,684 650,910 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL DEPOSITS 37,488 36,841 43,330 191,618 236,344 185,542 34,538 12,808 7,014 560,161 1,345,684 Short Term Borrowings 65,000 - - - - - - - - - 65,000 Term Borrowing - - - - 35,000 - 15,000 - 10,000 - 60,000 Trust Securities - - - - - - - - - 29,804 29,804 Other Liabilities - - - - - - - - - 15,241 15,241 Capital - - - - - - - - - 118,013 118,013 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND CAPITAL 102,488 36,841 43,330 191,618 271,344 185,542 49,538 12,808 17,014 723,219 1,633,742 AVERAGE RATE 5.60% 5.28% 5.38% 4.67% 5.15% 5.52% 6.06% 5.87% 6.13% 1.53% 3.61% ==================================================================================================================================== GAP 209,485 (6,330) (11,888) (91,408) (66,304) 163,575 34,519 115,268 29,913 (376,830) CUMULATIVE GAP 209,485 203,155 191,267 99,859 33,555 197,130 231,649 346,917 376,830 0 CUMULATIVE GAP / TOTAL ASSETS 12.82% 12.43% 11.71% 6.11% 2.05% 12.07% 14.18% 21.23% 23.07% 0.00%
Note: IPC=Accounts of individuals, partnerships, and corporations. Public=Accounts of U.S. government, state, and local municipalities. 85% of IPC savings are treated as core (>60 months). 100% of Public Fund Savings are treated as 181-360 days. 95% of IPC Money Markets are treated as core (91-180 days). 100% of Public Fund Money Markets are treated as 181-360 days. 15% of IPC Savings are spread over 24 months, and 5% of IPC Money Markets are in 181-360 days. Totals may not foot due to rounding. 32 EFFECTS OF INFLATION The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principals which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Virtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rate changes have a more significant impact on the Company's performance than the effects of general levels of inflation. YEAR 2000 Our Company is keenly aware of the challenges presented by Year 2000 Business Risk compliance. We have established a task force comprised of key personnel to define and coordinate the Year 2000 effort. CBSI has adopted the five elements outlined by its banking regulators: Awareness, Assessment, Renovation, Validation, and Implementation. It is anticipated that complete review and verification of our internal systems, as well as those of our major service providers, will be accomplished by December 31, 1998. NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This Statement will require the Company to report comprehensive income in its financial statements issued after December 31, 1997. For the Company, comprehensive income is determined by adding unrealized investment holding gains or losses during the period to net income. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This Statement requires companies to disclose financial and descriptive information about its reportable business segments. Management believes the Company only operates in one segment, which is the banking segment. Therefore, disclosures required under this pronouncement will not affect the financial statements of the Company. The following consolidated financial statements and auditor's reports of Community Bank System, Inc. and subsidiaries are contained on pages 34 through 54 of this item. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - Consolidated Statements of Condition-- December 31, 1997 and 1996 - - Consolidated Statements of Income - Years ended December 31, 1997, 1996, and 1995 - - Consolidated Statements of Changes in Shareholder's Equity - Years ended December 31, 1997, 1996, and 1995 - - Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996, and 1995 - - Notes to Consolidated Financial Statements - December 31, 1997 - - Auditor's Report Quarterly Selected Data (Unaudited) for 1997 and 1996 are contained on page 55 33
CONSOLIDATED STATEMENTS OF CONDITION COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES December 31, December 31, 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 82,106,403 $ 52,534,726 Federal funds sold 0 0 - --------------------------------------------------------------------------------------------------------------------------- Total cash and cash equivalents 82,106,403 52,534,726 Investment securities (approximate fair value of $619,646,000 and $587,193,000) $ 611,891,978 578,553,291 Loans 843,211,857 652,473,875 Reserve for possible loan losses 12,433,812 8,127,752 - --------------------------------------------------------------------------------------------------------------------------- Net loans 830,778,045 644,346,123 Premises and equipment, net 23,649,279 16,782,034 Accrued interest receivable 13,392,818 10,790,071 Intangible assets, net 58,671,755 31,241,489 Other assets 13,251,973 9,616,928 - --------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $1,633,742,251 $1,343,864,662 =========================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits Noninterest bearing $ 202,573,162 $ 144,351,214 Interest bearing 1,143,112,796 882,862,042 - --------------------------------------------------------------------------------------------------------------------------- Total deposits 1,345,685,958 1,027,213,256 Federal funds purchased 45,000,000 31,800,000 Borrowings 80,000,000 165,000,000 Mandatorily redeemable capital securities of subsidiary 29,803,688 Accrued interest and other liabilities 15,240,622 10,499,179 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,515,730,268 1,234,512,435 - --------------------------------------------------------------------------------------------------------------------------- Shareholders' equity: Preferred stock $1 par, $100 stated value 500,000 shares authorized 45,000 shares issued and 0 and 45,000 outstanding 0 4,500,000 Common stock no par $1.00 stated value for 1997; $1.25 par for 1996; 20,000,000 and 5,000,000 shares authorized for 1997 and 1996, respectively; 7,586,512 and 7,474,406 (adjusted for stock split and change in par value) shares issued and outstanding for 1997 and 1996, respectively. 7,586,512 4,671,504 Surplus 32,401,331 33,584,773 Undivided profits 75,335,527 65,691,025 Unrealized gains on available for sale securities, net 2,778,913 947,853 Shares issued under employee stock plan - unearned (90,300) (42,928) - --------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 118,011,983 109,352,227 - --------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,633,742,251 $1,343,864,662 ===========================================================================================================================
The accompany notes are an integral part of the consolidated financial statements. 34
CONSOLIDATED STATEMENTS OF INCOME COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Years Ended December 31, 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME: Interest and fees on loans $71,562,755 $56,931,658 $49,927,725 Interest and dividends on investments: U.S. Treasury 269,240 493,117 993,238 U.S. Government agencies and corporations 23,767,244 21,169,844 15,699,390 States and political subdivisions 964,917 1,010,860 1,082,381 Mortgage-backed securities 18,317,165 16,074,631 13,081,731 Other securities 1,879,799 1,672,300 1,180,775 Interest on federal funds sold and deposits with other banks 867,046 336,002 1,421,785 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest income 117,628,166 97,688,412 83,387,025 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest on deposits 44,590,208 36,383,486 30,772,056 Interest on federal funds purchased 698,859 1,152,922 1,118,220 Interest on short-term borrowings 1,884,314 1,465,894 4,257,866 Interest on long-term borrowings 7,578,370 3,420,155 158,756 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest expense 54,751,751 42,422,457 36,306,898 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income 62,876,415 55,265,955 47,080,127 Less: Provision for possible loan losses 4,480,000 2,897,068 1,765,148 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 58,396,415 52,368,887 45,314,979 - ---------------------------------------------------------------------------------------------------------------------------------- OTHER INCOME: Fiduciary and investment services 1,725,084 1,522,653 1,446,898 Service charges on deposit accounts 5,054,542 4,037,150 3,326,274 Commissions on investment products 1,001,588 782,178 473,101 Other service charges, commissions and fees 2,397,375 1,719,251 1,323,026 Other operating income 1,643,151 780,834 140,720 Investment security gain (loss) (13,881) 32,394 (152,375) - ---------------------------------------------------------------------------------------------------------------------------------- Total other income 11,807,859 8,874,460 6,557,644 - ---------------------------------------------------------------------------------------------------------------------------------- OTHER EXPENSES: Salaries and employee benefits 22,944,801 19,247,336 16,756,706 Occupancy expense, net 3,426,189 3,073,107 2,608,104 Equipment and furniture expense 2,727,739 2,318,489 1,991,541 Amortization of intangible assets 3,702,850 2,728,886 1,569,478 Other 12,997,062 10,082,166 10,092,890 - ---------------------------------------------------------------------------------------------------------------------------------- Total other expenses 45,798,641 37,449,984 33,018,719 - ---------------------------------------------------------------------------------------------------------------------------------- Income before income taxes 24,405,633 23,793,363 18,853,904 Income taxes 8,844,127 9,660,319 7,384,000 - ---------------------------------------------------------------------------------------------------------------------------------- NET INCOME $15,561,506 $14,133,044 $11,469,904 ================================================================================================================================== EARNINGS PER COMMON SHARE - BASIC $2.05 $1.85 $1.72 ================================================================================================================================== EARNINGS PER COMMON SHARE - DILUTED $2.02 $1.83 $1.70 ==================================================================================================================================
The accompany notes are an integral part of the consolidated financial statements. 35 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
COMMON SHARES UNREALIZED ISSUED NET GAINS UNDER (LOSSES) ON PREFERRED COMMON STOCK EMPLOYEE AVAILABLE- ---------------------- UNDIVIDED STOCK PLAN FOR-SALE STOCK SHARES AMOUNT SURPLUS PROFITS -UNEARNED SECURITIES TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 1995 5,576,300 $3,485,187 $14,885,096 $49,853,313 ($3,667) ($1,930,414) $66,289,515 Net income - 1995 11,469,904 11,469,904 Cash dividends: Preferred, $9.00 per share (253,125) (253,125) Common, $0.62 per share (3,990,591) (3,990,591) Issuance of preferred stock $9,000,000 9,000,000 Repurchase of preferred stock (4,500,000) (4,500,000) Issuance of common stock 1,725,000 1,078,125 17,364,533 18,442,658 Common stock issued under employee stock plan 57,950 36,219 705,644 (47,846) 694,017 Market value adjustment on available-for-sale investments 2,907,871 2,907,871 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1995 4,500,000 7,359,250 4,599,531 32,955,273 57,079,501 (51,513) 977,457 100,060,249 Net income - 1996 14,133,044 14,133,044 Cash dividends: Preferred, $9.00 per share (405,000) (405,000) Common, $0.69 per share (5,116,520) (5,116,520) Common stock issued under employee stock plan 33,906 21,192 554,817 8,585 584,594 Common stock issued in acquisition 81,250 50,781 74,683 125,464 Market value adjustment on available-for-sale investments (29,604) (29,604) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1996 4,500,000 7,474,406 4,671,504 33,584,773 65,691,025 (42,928) 947,853 109,352,227 Net income - 1997 15,561,506 15,561,506 Cash dividends: Preferred, $9.00 per share (180,000) (180,000) Common, $0.76 per share (5,737,004) (5,737,004) Preferred stock redeemed (4,500,000) (180,000) (4,680,000) Common stock issued under employee stock plan 112,106 95,660 1,815,906 (47,372) 1,864,194 Change in par value 0 2,819,348 (2,819,348) 0 Market value adjustment on available-for-sale investments 1,831,060 1,831,060 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1997 $ 0 7,586,512 $7,586,512 $32,401,331 $75,335,527 (90,300) $2,778,913 118,011,983 ====================================================================================================================================
36 CONSOLIDATED STATEMENTS OF CASH FLOWS COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES FOR TWELVE MONTHS ENDED DECEMBER 31, 1997, 1996, AND 1995
1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 15,561,506 $ 14,133,044 $ 11,469,904 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 2,130,434 1,948,619 1,618,205 Net amortization of intangible assets 3,702,850 2,728,886 1,569,477 Net accretion of security premiums and discounts 8,005 (1,690,528) (1,422,859) Provision for loan losses 4,480,000 2,897,068 1,765,148 Provision for deferred taxes (223,394) (1,840,573) (99,586) (Gain)\Loss on sale of investment securities 13,881 (32,394) 152,375 (Gain)\Loss on sale of loans and other assets (158,033) (91,780) (140,720) Change in interest receivable (2,602,746) (1,639,568) (2,493,177) Change in other assets and other liabilities 1,750,674 1,254,964 (679,527) Change in unearned loan fees and costs (883,108) (659,412) (225,949) - ----------------------------------------------------------------------------------------------------------------------- Net cash Provided by operating activities 23,780,069 17,008,326 11,513,291 - ----------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Proceeds from sales of investment securities 51,916,026 15,803,016 4,125,000 Proceeds from maturities of held to maturity investment securities 114,946,856 77,849,167 35,575,390 Proceeds from maturities of available for sale investment 13,507,367 27,014,893 28,579,113 securities Purchases of held to maturity investment securities (7,989,300) (130,151,635) (97,175,179) Purchases of available for sale investment securities (202,645,932) (99,364,521) (54,418,605) Net change in loans outstanding (103,025,001) (93,336,338) (64,934,240) Loans purchased in branch acquisition (86,800,537) 0 (12,835,406) Capital expenditures (9,042,922) (1,775,188) (8,831,705) Proceeds from sales of capital assets 0 0 939,922 Premium paid for branch acquisitions (31,133,116) 0 (29,621,013) - ----------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (260,266,559) (203,960,606) (198,596,723) - ----------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in demand deposits, NOW accounts, and savings accounts (6,835,157) (22,671,180) (58,313,216) Net change in certificates of deposit 15,967,588 32,938,212 13,045,466 Deposits assumed in branch acquisition 309,340,271 0 382,576,350 Net change in Federal Funds purchased 13,200,000 171,800,000 25,000,000 Net change in term borrowings (85,000,000) (550,000) (162,300,000) Issuance of mandatorily redeemable capital securities of subsidiary 29,803,688 0 0 Debt issuance costs (1,222,041) 0 0 Issuance (retirement) of common and preferred stock (3,451,047) 457,142 23,321,763 Cash dividends (5,745,135) (5,390,271) (3,866,017) - ----------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 266,058,167 176,583,903 219,464,346 - ----------------------------------------------------------------------------------------------------------------------- CHANGE IN CASH AND CASH EQUIVALENTS 29,571,677 (10,368,377) 32,380,914 Cash and cash equivalents at beginning of year 52,534,726 62,903,103 30,522,189 - ----------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 82,106,403 $ 52,534,726 $ 62,903,103 ======================================================================================================================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $ 52,235,280 $ 42,090,983 $ 35,002,244 ======================================================================================================================= Cash paid for income taxes $ 9,716,995 $ 10,654,673 $ 7,635,999 ======================================================================================================================= SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES: Dividends declared and unpaid $ 1,517,262 $ 1,345,393 $ 1,214,144 =======================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 37 COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Community Bank System, Inc. (the Company) is a one bank holding company which wholly owns two active operating subsidiaries, Community Bank, N.A. (the Bank) and Benefit Plans Administrative Services, Inc. (BPA). In addition, the Company wholly owns a subsidiary trust and one inactive subsidiary. The Bank operates 67 customer facilities throughout Northern New York, the Finger Lakes Region, the Southern Tier, and Southwestern New York. It provides individual, business, agricultural, and government customers with a complete range of banking services, including qualified retirement plan administration, investment management, and personal trust services; retail and commercial loan and deposit products, and nondeposit annuities and investment products. BPA, located in Utica, New York, provides pension administration and actuarial services to various customers throughout New York State. The Bank wholly owns one nonbanking subsidiary, CBNA Treasury Management Corporation (TMC). TMC operates the cash management, investment, and treasury functions of the Bank. During 1997, the Company formed a subsidiary business trust, Community Capital Trust I, for the purpose of issuing manditorily redeemable convertible securities, which are considered Tier I capital under regulatory capital adequacy requirements. (see Note Q). PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: the Bank and its subsidiary TMC; BPA, and a currently inactive nonbanking subsidiary. All intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. INVESTMENT SECURITIES The Company has classified its investments in debt and equity securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Company has the positive intent and ability to hold to maturity, and are reported at cost, which is adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held-to-maturity are classified as available-for-sale and are reported at fair market value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes. None of the Company's investment securities has been classified as trading securities. The average cost method is used in determining the realized gains and losses on sales of investment securities, which are reported under other income as investment security gains (losses). Premiums and discounts on securities are amortized and accreted, respectively, on a systematic basis over the period to maturity, estimated life, or earliest call date of the related security. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. LOANS Loans are stated at unpaid principal balances. Fair values for variable rate loans that reprice frequently, with no significant credit risk, are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flows and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value. INTEREST ON LOANS AND RESERVE FOR POSSIBLE LOAN LOSSES Interest on commercial loans and mortgages is accrued and credited to operations based upon the principal amount outstanding. Unearned discount on installment loans is recognized as income over the term of the loan, principally by the 38 actuarial method. Nonrefundable loan fees and related direct costs are deferred and amortized over the life of the loan as an adjustment to loan yield using the effective interest method. The Bank places a loan on nonaccrual status and recognizes income on a cash basis when it is more than ninety days past due (or sooner, if management concludes collection of interest is doubtful), except when, in the opinion of management, it is well-collateralized and in the process of collection. The reserve for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The reserve is increased by provisions charged to expense and reduced by net charge-offs. The level of the reserve is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions. A loan is considered impaired, based current information and events, if it is probable that the Bank will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. The annual provision for depreciation is computed using the straight-line method in amounts sufficient to recognize the cost of depreciable assets over their estimated useful lives. Maintenance and repairs are charged to expense as incurred. OTHER REAL ESTATE Properties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at the lower of the unpaid loan balance plus settlement costs, or fair value less estimated costs of disposal, At December 31, 1997 and 1996, other real estate, included in other assets, amounted to $881,456 and $745,504, respectively. INTANGIBLE ASSETS Intangible assets represent core deposit value and goodwill arising from acquisitions. The Company periodically reviews the carrying value of intangible assets using fair value methodologies. Core deposit intangibles are being amortized principally on an accelerated basis over ten years. Goodwill is being amortized on a straight-line basis over 15 to 25 years. DEPOSITS The fair values disclosed for demand and savings deposits are equal to the carrying amounts at the reporting date. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using discounted cash flows and interest rates currently being offered on similar certificates. The carrying value of accrued interest approximates fair value. BORROWINGS The carrying amounts of federal funds purchased and borrowings approximate their fair values. INCOME TAXES Provisions for income taxes are based on taxes currently payable or refundable, and deferred taxes are based on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. EARNINGS PER SHARE AND STOCK SPLIT As of December 31, 1997 the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share." Under this new standard, both basic and diluted earnings per share are presented for each period for which an income statement is presented. Basic earnings per share is computed on the basis of actual weighted average common shares outstanding for the period. Diluted earnings per share reflects the dilutive effect of outstanding common stock equivalents. On March 12, 1997, a two-for-one split of the Company's common stock was effected in the form of a stock dividend of one share of common stock for each share of common stock outstanding at the close of business on February 10, 1997. The number of authorized shares of common stock was increased from 5,000,000 to 20,000,000 pursuant to shareholder approval. All share and per share data of prior periods has been restated, where required, to retroactively reflect the stock split. 39 During 1997, the par value of the Company's common stock was changed from $1.25 par to no par $1.00 stated value per share. FAIR VALUES OF FINANCIAL INSTRUMENTS The Company determines fair values based on quoted market values where available or on estimates using present values or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments," excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The fair values of investment securities, loans, and deposits have been disclosed in footnotes C, D, and G, respectively. NOTE B: BRANCH ACQUISITIONS During 1997, the Company acquired certain assets and assumed certain liabilities relating to eight branch offices of Key Bank, N.A. located in Southwestern New York State and 12 branch offices of Fleet Bank located in Northern and Central New York State. In July 1995, the Company acquired certain assets and assumed certain liabilities relating to fifteen branch offices of The Chase Manhattan Bank, N.A. located in the Northern, Central, and Finger Lakes Regions of New York State. In December 1995, the Company sold the assets and liabilities of three of these branches to another banking entity. A summary of these acquisitions and the divestiture activity is as follows:
ACQUISITIONS -------------------------------------------------------- KEY BANK FLEET BANK CHASE MANHATTAN DIVESTITURE (6/16/97) (7/18/97) BANK (7/14/95) (12/15/95) -------------------------------------------------------- ------------- CASH RECEIVED (PAID) $110,752,957 $76,516,971 $330,229,952 ($37,707,788) LOANS ACQUIRED (DIVESTED) 24,093,903 62,706,634 13,954,164 (1,118,758) PROPERTY AND EQUIPMENT ACQUIRED (DIVESTED) 1,836,405 2,438,645 5,133,354 (741,500) OTHER ASSETS AND (LIABILITIES) ACQUIRED 34,323 (172,683) 1,247,553 (124,406) (DIVESTED), NET PURCHASE (DIVESTED) PRICE ALLOCATED TO: CORE DEPOSIT VALUE 16,375,717 (1,941,210) GOODWILL 13,563,861 17,569,255 15,635,610 (917,463) ------------ ------------ ------------ ------------- DEPOSIT LIABILITIES ASSUMED (DIVESTED) $150,281,449 $159,058,822 $382,576,350 ($42,551,125) =============================================================================================================================
Net core deposit value and goodwill arising from these transactions is being amortized over ten years on an accelerated basis, and over a range of 15 to 25 years on a straight-line basis, respectively. The transactions above have been recorded under the purchase method of accounting and, accordingly, the operating results of the branches acquired have been included in the Company's consolidated financial statements from the date of acquisition. Results of operations on a pro forma basis are not presented since historical financial information for the branches acquired is not available. In July 1996, the Company acquired all of the outstanding shares of common stock of Benefit Plan Administrators, Inc., a pension administration and actuarial firm, in exchange for 81,250 shares of the Company's common stock. The transaction was accounted for as a pooling of interests, and, accordingly, the consolidated financial statements for 1996 include the accounts of Benefit Plan Administrators. Consolidated financial statements for the prior periods presented were not restated as the effect on those periods is not significant. 40
NOTE C: INVESTMENT SECURITIES The amortized cost and estimated fair values of investments in securities as of December 31 are as follows: 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- GROSS GROSS ESTIMATED GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR HELD-TO-MATURITY COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government corporations and agencies $164,198,645 $4,607,000 $ 7,000 $168,799,000 $248,264,441 $6,210,000 $ 37,000 $254,437,000 Obligations of states and political subdivisions 10,221,035 355,000 1,000 10,575,000 17,795,714 499,000 3,000 18,292,000 Corporate Securities 3,090,597 111,000 1,000 3,201,000 1,500 500 0 2,000 Mortgage-backed securities 86,148,702 2,702,000 13,000 88,838,000 103,794,817 2,184,000 214,000 105,765,000 ------------ ---------- ---------- ------------ ------------ ---------- -------- ------------ TOTALS 263,658,979 7,775,000 22,000 271,413,000 369,856,472 8,893,500 254,000 378,496,000 - ------------------------------------------------------------------------------------------------------------------------------------ AVAILABLE-FOR-SALE - ------------------------------------------------------------------------------------------------------------------------------------ U.S. Treasury securities and obligations of U.S. government corporations and agencies 82,027,316 2,742,939 40,046 84,730,209 39,684,493 527,326 207,137 40,004,682 Obligations of states and political subdivisions 9,960,459 349,594 0 10,310,053 436,856 15,574 0 452,430 Mortgage-backed securities 225,691,821 3,103,934 1,446,399 227,349,356 145,276,186 1,853,074 574,405 146,554,855 ------------ ---------- ---------- ------------ ------------ ---------- -------- ------------ TOTALS 317,679,596 6,196,467 1,486,445 322,389,618 185,397,535 2,395,974 781,542 187,011,967 Federal Home Loan Bank & other equity securities 23,669,431 0 0 23,669,431 20,282,002 0 0 20,282,002 Federal Reserve Bank common stock 2,173,950 0 0 2,173,950 1,402,850 0 0 1,402,850 ------------ ---------- ---------- ------------ ------------ ---------- -------- ------------ TOTALS 343,522,977 6,196,467 1,486,445 348,232,999 207,082,387 2,395,974 781,542 208,696,819 - ------------------------------------------------------------------------------------------------------------------------------------ Net unrealized gain/(loss) on Available-for-Sale 4,710,022 1,614,432 - ------------------------------------------------------------------------------------------------------------------------------------ GRAND TOTAL CARRYING VALUE $611,891,978 $578,553,291 ====================================================================================================================================
The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturies will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
HELD-TO-MATURITY AVAILABLE-FOR-SALE CARRYING EST. MARKET EST. MARKET VALUE VALUE VALUE VALUE - ---------------------------------------------------------------------------------------------------------- Due in one year or less $4,815,772 $4,869,000 $10,000 $10,067 Due after one through five years 15,182,745 16,323,000 6,256,359 6,245,108 Due after five years through ten years 132,623,337 135,777,000 45,644,652 47,276,747 Due after ten years 24,888,416 25,606,000 40,076,764 41,508,340 ------------------------------------------------------------------- TOTAL 177,510,270 182,575,000 91,987,775 95,040,262 Mortgage-backed securities 86,148,709 88,838,000 225,691,821 227,349,356 ------------------------------------------------------------------- TOTAL $263,658,979 $271,413,000 $317,679,596 $322,389,618 ==========================================================================================================
Proceeds from sales of investments in debt securities during 1997, 1996, and 1995 were $51,916,000, $12,940,000 and $3,950,000, respectively. Gross gains of approximately $283,000 and $32,000 for 1997 and 1996 respectively, and gross losses of $297,000 and $150,000 in 1997 and 1995, respectively, were realized on those sales. Investment securities with a carrying value of $320,953,967 and $304,022,444 at December 31, 1997 and 1996, repectively, were pledged to collateralize deposits and securities sold under agreements to repurchase and for other purposes required by law. 41 NOTE D: LOANS Major classifications of loans at December 31 are summarized as follows:
- --------------------------------------------------------------------------------------------------- 1997 1996 - --------------------------------------------------------------------------------------------------- Real estate mortgages: Residential $278,912,124 $224,998,461 Commercial 85,962,156 56,958,511 Farm 10,433,795 8,295,934 Agricultural loans 23,894,346 21,688,695 Commercial loans 138,066,982 99,682,495 Installment loans to individuals 298,871,021 243,246,292 Other loans 8,886,538 3,496,175 ------------ ------------ 845,026,962 658,366,563 Less: Unearned interest, and deferred loan fees and costs, net (1,815,105) (5,892,688) Reserve for possible loan losses (12,433,812) (8,127,752) ------------ ------------ Net loans $830,778,045 $644,346,123 ==================================================================================================================
The estimated fair value of loans receivable at December 31, 1997 and 1996 was $848,000,000 and $662,000,000, respectively. Changes in the reserve for possible loan losses for the years ended December 31 are summarized below:
- ------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------ Balance at the beginning of year $ 8,127,752 $6,976,385 $6,281,109 Reserves on acquired loans 3,547,641 Provision charged to expense 4,480,000 2,897,068 1,765,148 Loans charged off (4,448,281) (2,458,651) (1,757,584) Recoveries 726,700 712,950 687,712 ----------- ---------- ----------- Balance at end of year $12,433,812 $8,127,752 $6,976,385 =========== ========== ===========
As of December 31, 1997 and 1996, the Company's impaired loans for which specific valuation allowances were recorded were not significant. NOTE E: PREMISES AND EQUIPMENT Premises and equipment consist of the following at December 31:
- ------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------- Land and land improvements $ 4,417,606 $ 3,715,154 Bank premises owned 19,980,010 16,026,615 Equipment 16,578,656 12,378,636 ----------- ------------ Premises and equipment gross 40,976,272 32,120,405 Less: Allowance for depreciation 17,326,993 15,338,371 ----------- ------------ Premises and equipment net $23,649,279 $16,782,034 ===========================================================================================
NOTE F: INTANGIBLE ASSETS Intangible assets consist of the following at December 31:
- ------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------ Core deposit intangible $14,434,507 $15,007,907 Goodwill and other intangibles 52,760,397 21,591,942 ----------- ----------- Intangible assets, gross 67,194,904 36,599,849 Less: Accumulated amortization (8,523,149) (5,358,360) ----------- ----------- Intangible assets, net $58,671,755 $31,241,489 ==========================================================================================
42 NOTE G: DEPOSITS Deposits by type at December 31 are as follows: - ------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------ Demand $ 202,573,162 $ 144,351,214 Savings 492,201,426 387,545,640 Time 650,911,370 495,316,402 Total Deposits $1,345,685,958 $1,027,213,256 ============================================================================== The estimated fair values of deposits at December 31, 1997 and 1996 were approximately $1,348,000,000 and $1,027,000,000 respectively. At December 31, 1997 and 1996, time certificates of deposit in denominations of $100,000 and greater totaled $93,439,246 and $68,914,112, respectively. NOTE H: BORROWINGS At December 31, 1997 and 1996, outstanding borrowings were as follows: - ------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------ Federal funds purchased $ 45,000,000 $ 31,800,000 Federal Home Loan Bank advances 80,000,000 165,000,000 Mandatorily redeemable capital securities of subsidiary, net of discount of $196,312 29,803,688 0 ------------ ------------ $154,803,688 $196,800,000 ============================================================================== Federal Home Loan Bank advances are secured by a blanket lien on the Company's residential real estate loan portfolio and mortgage-backed securities portfolio. Borrowings at December 31, 1997 have maturity dates as follows: WEIGHTED AVERAGE RATE AMOUNT -------------- ------------ January 2, 1998 6.38% $ 45,000,000 February 2, 1998 6.88% 20,000,000 July 22, 1998 6.50% 25,000,000 December 14, 1998 5.69% 10,000,000 December 13, 2000 5.86% 15,000,000 December 17, 2002 6.20% 10,000,000 January 30, 2027 9.75% 29,803,688 ------------ 7.01% $154,803,688 ============================================================================== 43 NOTE I: INCOME TAXES The provision (benefit) for income taxes for the years ended December 31 is as follows:
- ----------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------- Current: Federal $8,071,488 $ 8,909,495 $5,658,251 State 996,033 2,591,397 1,825,335 Deferred: Federal (174,176) (1,426,394) (76,248) State (49,218) (414,179) (23,338) ---------- ------------ ---------- Total income taxes $8,844,127 $ 9,660,319 $7,384,000 ===============================================================================================
Components of the net deferred tax asset, included in other assets, as of December 31 are as follows:
- ----------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------- Allowance for loan losses $3,630,000 $3,331,971 Postretirement and other reserves 607,577 606,481 Pension 373,735 348,537 Intangible assets 279,172 184,239 Other 515,036 166,950 Total deferred tax asset $5,405,520 $4,638,178 ---------- ---------- Investment securities 2,186,796 901,553 Deferred loan fees 363,034 Depreciation 252,167 91,965 ---------- ---------- Total deferred tax liability $2,801,997 $993,518 ---------- ---------- Net deferred tax asset $2,603,523 $3,644,660 ===============================================================================================
The Company has determined that no valuation allowance is necessary as it is more likely than not that deferred tax assets will be realized through future reversals of existing temporary differences and through future taxable income. A reconciliation of the differences between the federal statutory income tax rate and the effective tax rate for the years ended December 31 is shown in the following table:
- ----------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------- Federal statutory income tax rate 35.0% 35.0% 35.0% Increase (reduction) in taxes resulting from: Tax-exempt interest (1.2) (1.3) (1.8) State income taxes, net of federal benefit 2.4 5.8 6.2 Other 0.0 1.1 (0.2) ---- ---- ---- Effective income tax rate 36.2% 40.6% 39.2% =================================================================================================================
NOTE J: LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCES The Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations, and policies. For example, as a national bank, the Bank must obtain the approval of the Office of the Comptroller of the Currency (OCC) for payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1997, the Bank had approximately $21,186,000 in undivided profits legally available for the payment of dividends. In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations could generally pay dividends only out of current operating earnings. There are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments, or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specific amounts. 44 NOTE K: BENEFIT PLANS The Company has a noncontributory pension plan for all eligible employees which is administered by the Trust Department of Community Bank, N.A. under the direction of an appointed retirement board. The policy of the Company is to fund the plan to the extent of its maximum tax deductibility. The net periodic pension cost and actuarial assumptions for the years ended December 31 were as follows:
- ----------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------- Service cost-benefits earned during the year $353,762 $281,318 $197,695 Interest cost on projected benefit obligation 631,010 596,266 551,207 Actual return on plan assets (1,819,260) (1,257,927) (1,424,112) Administrative expenses 130,444 123,625 73,162 Net amortization and deferral 916,794 507,801 837,321 ----------- ----------- ----------- Net periodic pension cost $212,750 $251,083 $235,273 ======================================================================================================================= Discount rate 7.00% 7.25% 7.0% Expected long term rate of return on assets 9.0% 9.0% 9.0% Rate of increase in compensation levels 4.0% 4.0% 4.0% =======================================================================================================================
The following table presents a reconciliation of the plan's funded status at December 31:
- ------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------ Actuarial present value of benefit obligations: Vested $8,339,305 $7,386,006 Nonvested 123,386 105,342 ---------- ---------- Accumulated benefit obligation $8,462,691 $7,491,348 The entire amount of unrecognized gains and losses is amortized over the average remaining service lives of the participants on a straight-line basis. - ------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------ Projected benefit obligation ($9,775,164) ($8,893,253) Plan assets at fair value 10,689,215 9,095,755 ----------- ----------- Plan assets in excess of projected benefit 914,051 202,502 obligation Unrecognized net loss/(gain) from past experience different from that assumed and effects of changes in assumptions 275,476 872,861 Unrecognized prior service cost, being recognized over 17 years (278,747) (293,937) Unrecognized net asset at date of adoption, being recognized over 17 years (136,778) (159,026) ---------- ---------- Prepaid pension cost included in other assets $ 774,002 $ 622,400 ================================================================================================
The decrease in the discount rate from 7.25% to 7% increased the projected benefit obligation at December 31, 1997 by $306,534. Plan assets consist primarily of listed stocks, governmental securities, and cash equivalents. The plan is authorized to invest up to 10% of the fair value of its total assets in common stock of Community Bank System, Inc. At December 31, 1997 and 1996, the plan holds 41,128 and 52,128 shares, respectively, of the sponsor company common stock. The Company also has an Employee Savings and Retirement Plan, which is administered by the Trust Department of Community Bank, N.A. The Employee Savings and Retirement Plan includes Section 401(k) and Thrift provisions as defined under the Internal Revenue Code. The provisions permit employees to contribute up to 15% of their total compensation on a pre-tax or post-tax basis. The Company matches 50% of the first 6% of employee contributions. Company contributions to the trust amounted to $757,444, $598,998, and $522,680 in 1997, 1996, and 1995, respectively. 45 The Company has deferred compensation agreements with its President and Chief Executive Officer and several former executives and officers whereby monthly payments are to be provided upon retirement over periods ranging from ten to 25 years. Expense recognized during 1997, 1996 and 1995 related to these agreements amounted to approximately $257,000, $377,000, and $369,000, respectively. Effective January 1, 1996, the Board approved a Stock Balance Plan for nonemployee directors who have completed six months of service. The Plan is a nonqualified, noncontributory deferred compensation plan. The Plan provides benefits for periods of service prior to January 1, 1996 based on a predetermined formula. Amounts credited to participant accounts for all creditable service after January 1, 1996 are based on performance of the Company's stock. Participants become fully vested after six years of service. Benefits are payable in the form of an annuity on the first of the month following the later of a participant's disassociation from the Board or attainment of age 70. Unrecognized prior service cost of $628,206 is being amortized over 20 years. Expense related to the Plan recognized in 1997 and 1996 approximated $203,000, and $150,000, respectively. NOTE L: POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company provides health and life insurance benefits for eligible retired employees and their dependents. An employee becomes eligible for these benefits by satisfying plan provisions which include certain age and/or service requirements. Medical benefits are based on years of service at retirement, with forty years of service being required in order to be fully eligible for benefits. The medical plans pay a stated percentage of medical expenses reduced by deductibles and other coverages. The Medicare supplement policy provides for a $100,000 maximum lifetime benefit. Generally, life insurance benefits are equal to $5,000. The cost of postretirement benefits is recognized over the active service lives of employees. The Company is amortizing the transition obligation over a 20-year period. Net periodic postretirement benefit cost for the years ended December 31 include the following components: 1997 1996 1995 - -------------------------------------------------------------------------------- Service Cost $125,779 $111,252 $80,600 Amortization of transition 61,200 obligation over 20.1 years 61,200 61,200 Amortization of prior service cost 18,610 10,200 5,100 Amortization of unrecognized net 13,400 loss over 19.3 years 14,948 16,985 Interest on APBO less interest on expected benefit payments 195,508 164,656 163,800 -------- -------- -------- Net periodic postretirement benefit $416,045 $364,293 $324,100 cost ================================================================================ 46 A 9.5% annual rate of increase in the per capita costs of covered health care benefits was assumed for 1997, gradually decreasing to 5.5 percent by the year 2017. Increasing the assumed health care cost trend rates by one percentage point each year would increase the accumulated postretirement benefit obligation as of January 1, 1997 by $172,500 and increase the aggregate service cost and interest components of net periodic postretirement benefit cost for 1997 by $12,000. Discount rates of 7.25% for 1997 and 1996 were used to determine the accumulated postretirement benefit obligation. The following sets forth the funded status of the plan as of December 31:
- ----------------------------------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- Accumulated Postretirement Benefit Obligation (APBO): Retirees 974,066 $ 837,825 Fully eligible active plan participants 273,103 153,558 Other active plan participants 1,716,386 1,420,035 ---------- ---------- Total APBO 2,963,555 2,411,418 Plan assets at fair value 0 0 ---------- ---------- Accumulated postretirement benefits obligation in excess of plan (2,963,555) (2,411,418) assets Unrecognized prior service cost 279,055 126,100 Unrecognized portion of net obligation at transition 924,500 985,700 Unrecognized net loss 565,264 466,523 ---------- ---------- Accrued postretirement benefit cost ($1,194,736) ($ 833,095) =======================================================================================================================
NOTE M: STOCK-BASED COMPENSATION PLANS The Company has long-term stock-based incentive compensation programs for directors, officers, and key employees including incentive stock options (ISO's), restricted stock awards (RSA's), nonqualified stock options (NQSO's), warrants, retroactive stock appreciation rights, and discounted options. The Company has authorized the grant of options for up to 605,000 shares of the Company's common stock. All options granted have ten year terms and vest and become fully exercisable at the end of five years of continued employment. Activity in these plans for 1997, 1996, and 1995 was as follows:
- ---------------------------------------------------------------------------------------------------------- Options Range of Shares Weighted Outstanding Option Exercisable Average Price Exercise Price Per Share Shares Outstanding - ---------------------------------------------------------------------------------------------------------- Outstanding at December 31, 1994 250,580 $7.75 - 15.13 149,680 Granted 54,500 13.13 - 16.13 Exercised (51,800) 7.75 - 14.50 Forfeited (4,800) 5.87 Outstanding at December 31, 1995 248,480 6.75 - 19.13 123,500 $11.01 Granted 177,300 16.00 - 19.13 17.80 Granted at a discount 16,000 12.13 12.13 Exercised (40,850) 7.75 - 13.13 11.55 Forfeited (3,300) 7.75 - 15.875 7.75 Outstanding at December 31, 1996 397,630 6.75 - 19.13 168,460 14.20 Granted 5700 27.25 Exercised/cancelled (100,300) 7.50 - 16.125 11.56 Forfeited 0 Outstanding at December 31, 1997 293,030 $5.87 - 19.13 129,765 $14.53 ==========================================================================================================
47 The Company granted 8,000 discounted options in 1996 and recognized compensation expense of approximately $13,000. Restricted stock awarded in 1997 and 1996 amounted to 5,700 and 1,500 shares, respectively. Total expense is based on the market value of the stock at the date of grant and is being accrued over the period the restrictions lapse. Expense in 1997, 1996, and 1995 was $145,753, $92,047, and $77,618, respectively. There were 356,600, 362,300; and 205,500 shares available for future grants or awards under the various programs described above at December 31, 1997, 1996, and 1995, respectively. Directors may elect to defer all or a portion of their director fees until a certain distribution date pursuant to a Deferred Compensation Plan. The administrator has established an account for each participating director and credits to such account the number of shares of Company common stock which would have been purchased with the director fees and shares equal to the amount of dividends which would have been received. On the distribution date, the director shall be entitled to receive either shares of the Company common stock equal to the number of shares accumulated or at the Company's election, cash equal to the fair value of the number of shares accumulated. There were 11,920 shares credited to participant accounts at December 31, 1997 for which a liability of approximately $373,000 was accrued and approximately $194,000 was recognized as expense in 1997. The FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," effective for 1996, which establishes a fair-value-based method of accounting for stock compensation plans with employees and others. Alternatively, the statement allows that entities may continue to account for stock-based compensation plans in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," with disclosure of pro forma amounts reflecting the difference between cost charged to operations pursuant to APB No. 25 and compensation cost that would have been charged to operations had Statement No. 123 been applied. The Company has elected to continue following APB No. 25 in accounting for its stock-based compensation plans. Application of the fair-value-based accounting provision of Statement No. 123 results in the following pro forma amounts of net income and earnings per share: - -------------------------------------------------------------------------------- 1997 1996 - -------------------------------------------------------------------------------- Net Income: As reported $15,561,506 $14,133,044 Pro forma 15,372,474 13,699,412 Earnings per share: As reported $2.05 $1.85 Pro forma basic earnings per share 2.03 1.79 The fair value for these options was estimated at the date of grant using a Black-Scholes options pricing model with the following weighted average assumptions for 1997 and 1996: risk-free interest rates by grant ranging from 5.48% to 7.83% during 1997 and 5.75% during 1996; dividend yields of 3.00% during 1997 and 3.95% during 1996; volatility factors of the expected market price of the Company's common stock of 45.93% for 1997 and 48.21% for 1996; and a weighted-average expected life of the option of 7.18 years for 1997 and 7.13 years for 1996. For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Therefore, these results are not likely to be representative of the effects on reported net income for future years due to additional years of vesting. At December 31, 1997 the weighted average information for outstanding and exersisable shares is as follows:
- ------------------------------------------------------------------------------------------------------------------------------ Shares Outstanding Shares Exercisable Weighted Average Range of Shares ------------------------- Shares Weighted Average Exercise Outstanding Exercise Remaining Outstanding Exercise Price Price Life (years) Price - ------------------------------------------------------------------------------------------------------------------------------ $ 0.0000 - $ 3.1313 0 $0.0000 0.0 0 $0.0000 $ 3.1314 - $ 6.2625 0 $0.0000 0.0 0 $0.0000 $ 6.2626 - $ 9.3938 29,430 $7.5719 3.0 29,430 $7.5719 $ 9.3939 - $12.5250 15,600 $12.1250 8.0 2,800 $12.1250 $12.5251 - $15.6563 65,100 $13.5622 6.6 26,300 $13.7230 $15.6563 - $18.7875 77,000 $15.9937 8.0 30,276 $16.0017 $18.7876 - $21.9187 100,200 $19.1250 9.0 40,959 $19.1250 $21.9188 - $25.0500 0 $0.0000 0.0 0 $0.0000 $25.0501 - $28.1813 5,700 $27.2500 9.5 0 $0.0000 $28.1814 - $31.3125 0 $0.0000 0.0 0 $0.0000 -------------------------------------------------------------------------------------- 293,030 $15.6914 7.6 129,765 $14.5302 ==============================================================================================================================
48 NOTE N: EARNINGS PER SHARE Basic earnings per share is computed based on the weighted average shares outstanding. Diluted earnings per share is computed based on the weighted average shares outstanding adjusted for the dilutive effect of the assumed exercise of stock options during the year. The following is a reconciliation of basic to diluted earnings per share for the years ended December 31:
- --------------------------------------------------------------------------------------------------- INCOME SHARES PER SHARE AMOUNT - --------------------------------------------------------------------------------------------------- 1997 NET INCOME $15,561,506 LESS: PREFERRED STOCK DIVIDENDS (78,750) ----------- BASIC EPS 15,482,756 7,537,043 $2.05 ===== EFFECT OF DILUTIVE SECURITIES: STOCK OPTIONS 0 139,283 -------------------------- DILUTED EPS $15,482,756 7,676,326 $2.02 =================================================================================================== - --------------------------------------------------------------------------------------------------- 1996 Net Income $14,133,044 Less: Preferred stock dividends (405,000) ----------- Basic EPS 13,728,044 7,407,212 $1.85 ===== Effect of dilutive securities: Stock options 0 75,306 -------------------------- Diluted EPS $13,728,044 7,482,518 $1.83 =================================================================================================== - --------------------------------------------------------------------------------------------------- 1995 Net Income $11,469,904 Less: Preferred stock dividends (354,375) ----------- Basic EPS 11,115,529 6,457,288 $1.72 ===== Effect of dilutive securities Stock options 0 65,122 -------------------------- Diluted EPS $11,115,529 6,522,410 $1.70 ===================================================================================================
NOTE O: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement the Company has in this particular class of financial instrument. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
- ---------------------------------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk at December 31: Letters of Credit $2,427,000 $843,000 Commitments to make or purchase loans or to extend credit on lines of credit 157,931,000 94,730,000 Total $160,358,000 $95,573,000 ====================================================================================================
The fair value of these financial instruments is not significant. 49 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include residential real estate, income-producing commercial properties, and personal property. The Company has unused lines of credit totaling $43,486,000 and $0 at December 31, 1997 and 1996, respectively. The Company has additional unused borrowing capacity through collateralized transactions with the Federal Home Loan Bank. The Company is required to maintain a reserve balance, as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 1997 was $20,688,000 of which $2,000,000 was required to be on deposit with the Federal Reserve Bank of New York. The remaining $18,688,000 was represented by cash on hand. NOTE P: LEASES Rental expense included in operating expenses amounted to $913,306, $740,398, and $630,459 in 1997, 1996, and 1995, respectively. The future minimum rental commitments as of December 31, 1997 for all noncancelable operating leases are as follows: =============================================================================== Years ending December 31: Building Equipment Total =============================================================================== 1998 $867,814 $18,447 $886,261 1999 649,067 649,067 2000 575,328 0 575,328 2001 525,477 0 525,477 2002 444,695 0 444,695 Thereafter 3,656,305 0 3,656,305 =============================================================================== NOTE Q: REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guideline and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997 and 1996, that the Bank meets all capital adequacy requirements to which it is subject and is "well capitalized" under the regulatory framework of prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. 50
- -------------------------------------------------------------------------------------------------------------------------------- To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions - -------------------------------------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1997: Total Core Capital (to Risk Weighted Assets) $98,001 10.5% $74,469 8.0% $93,087 10.0% Tier I Capital (to Risk Weighted Assets) $86,365 9.3% $37,235 4.0% $55,852 6.0% Tier I Capital (to Average Assets) $86,365 5.7% $60,892 4.0% $76,115 5.0% As of December 31, 1996: Total Core Capital (to Risk Weighted Assets) $85,291 11.8% $57,675 8.0% $72,094 10.0% Tier I Capital (to Risk Weighted Assets) $77,163 10.7% $28,838 4.0% $43,256 6.0% Tier I Capital (to Average Assets) $77,163 6.2% $49,918 4.0% $62,398 5.0% ================================================================================================================================
NOTE R: PARENT COMPANY STATEMENTS
- --------------------------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS - --------------------------------------------------------------------------------------------------- DECEMBER 31 1997 1996 - --------------------------------------------------------------------------------------------------- Assets: Cash and cash equivalents $ 873,416 $ 1,089,623 Investment securities 527,229 500,000 Investment in and advances to subsidiaries 148,623,329 109,613,349 Other assets 1,514,286 2,111 ------------ ------------ Total assets $151,538,260 $111,205,083 =================================================================================================== Liabilities: Accrued interest and other liabilities $ 2,800,853 $ 1,852,856 Borrowings 30,725,424 Shareholders' equity 118,011,983 109,352,227 ------------ ------------ Total liabilities and shareholders' equity $151,538,260 $111,205,083 ===================================================================================================
51 CONDENSED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------- Dividends from subsidiaries $ 7,646,993 $ 5,521,520 $ 8,743,717 Interest on investments and deposits 50,368 20,006 6,376 ----------- ----------- ----------- Total revenues 7,697,361 5,541,526 8,750,093 ----------- ----------- ----------- Expenses: Interest on long term notes and debentures 2,753,370 0 0 Other Expenses 2,250 2,005 1,700 ----------- ----------- ----------- Total expenses 2,755,620 2,005 1,700 ----------- ----------- ----------- Income before tax benefit and equity in undistributed net income of subsidiaries 4,941,741 5,539,521 8,748,393 Income tax benefit 980,331 0 0 ----------- ----------- ----------- Income before equity in undistributed net income subsidiaries 5,922,072 5,539,521 8,748,393 Equity in undistributed net income: Subsidiary banks 9,639,434 8,593,523 2,721,511 Bank-related subsidiaries 0 0 0 ----------- ----------- ----------- Net Income $15,561,506 $14,133,044 $11,469,904 =============================================================================================================
52 NOTE R: PARENT COMPANY STATEMENTS (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS - ----------------------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash, Cash Equivalents, and Noncash Activities YEARS ENDED DECEMBER 31 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $15,561,506 $14,133,044 $11,469,904 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (9,639,435) (8,593,523) (2,721,511) Net change other assets and accrued liabilities 240,777 14,840 98,029 - ----------------------------------------------------------------------------------------------------------------- Net Cash Provided By Operating Activities 6,162,848 5,554,361 8,846,422 - ----------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Purchase of available for sale investment securities (27,229) (502,812) (6,218) Sale of available for sale investment securities 322,154 25,000 Capital contributions to subsidiaries (27,374,880) (378,334) (28,516,591) - ----------------------------------------------------------------------------------------------------------------- Net Cash Used By Investing Activities (27,402,109) (558,992) (28,497,809) - ----------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net change in loans to subsidiaries (500,000) 500,000 Proceeds from issuance of junior subordinated debentures to subsidiary 30,719,236 Issuance (retirement) of common and preferred stock (3,451,047) 457,143 23,321,762 Cash dividends (5,745,135) (5,390,271) (3,866,017) - ----------------------------------------------------------------------------------------------------------------- Net Cash Provided (Used) By Financing Activities 21,023,054 (4,433,128) 19,455,745 - ----------------------------------------------------------------------------------------------------------------- CHANGE IN CASH AND CASH EQUIVALENTS: (216,207) 562,241 (195,642) Cash and cash equivalents at beginning of year 1,089,623 527,382 723,024 - ----------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 873,416 $ 1,089,623 $ 527,382 ================================================================================================================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash Paid For Interest $ 1,497,175 $ 0 $ 0 ================================================================================================================= SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Dividends declared and unpaid $ 1,517,262 $ 1,345,393 $ 1,214,144 ================================================================================================================= The accompanying notes are an integral part of the consolidated financial statements.
53 COOPERS & LYBRAND L.L.P a professional services firm Board of Directors and Shareholders Community Bank System, Inc. We have audited the accompanying consolidated statements of condition of Community Bank System, Inc. and Subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial condition of Community Bank System, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. Syracuse, New York January 30, 1998 54 TWO YEAR SELECTED QUARTERLY DATA
1997 RESULTS 1ST 2ND 3RD 4TH (Dollars in Thousands) QUARTER QUARTER QUARTER QUARTER TOTAL ------- ------- ------- ------- ----- Net interest income $14,370 $14,585 $16,813 $17,108 $62,876 Provision for loan losses 730 850 1,235 1,665 4,480 ------- ------- ------- ------- ------- Net interest income after provision for loan losses 13,640 13,735 15,578 15,443 58,396 Total other income 2,326 2,530 3,403 3,549 11,808 Total other expense 10,179 10,426 12,287 12,906 45,798 ------- ------- ------- ------- ------- Income before income taxes 5,787 5,839 6,694 6,086 24,406 Income taxes 2,122 2,171 2,459 2,092 8,844 ------- ------- ------- ------- ------- Net income $ 3,665 $ 3,668 $ 4,235 $ 3,994 $15,562 ======= ======= ======= ======= ======= Earnings per share - Basic $ 0.48 $ 0.49 $ 0.56 $ 0.53 $ 2.05 Earnings per share - Diluted $ 0.47 $ 0.48 $ 0.55 $ 0.52 $ 2.02 ======================================================================================================================== 1996 RESULTS 1st 2nd 3rd 4th (Dollars in Thousands) Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- Net interest income $13,205 $13,590 $14,238 $14,233 $55,266 Provision for loan losses 588 609 630 1,070 2,897 ------- ------- ------- ------- ------- Net interest income after provision for loan losses 12,617 12,981 13,608 13,163 52,369 Total other income 1,953 2,001 2,440 2,480 8,874 Total other expense 9,252 9,059 9,660 9,479 37,450 ------- ------- ------- ------- ------- Income before income taxes 5,318 5,923 6,388 6,164 23,793 Income taxes 2,180 2,398 2,596 2,486 9,660 ------- ------- ------- ------- ------- Net income $ 3,138 $ 3,525 $ 3,792 $ 3,678 $14,133 ======= ======= ======= ======= ======= Earnings per share - Basic $ 0.41 $ 0.46 $ 0.50 $ 0.48 $ 1.85 Earnings per share - Diluted $ 0.41 $ 0.46 $ 0.50 $ 0.47 $ 1.83 ========================================================================================================================
55 ITEM 9. CHANGES IN DISAGREEMENTS AND WITH ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------------------------------ None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------------------------------ This item is incorporated by reference from the registrant's definitive Proxy Statement. Information concerning executive officers is included in Part I after Item 4 of this Form 10-K Annual Report. ITEM 11. EXECUTIVE COMPENSATION - -------------------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------ This item is incorporated by reference from the registrant's definitive Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------------------------------------------------------- This item is incorporated by reference from the registrant's definitive Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------------------------------------------------------------------------- A. Documents Filed 1. The following consolidated financial statements of Community Bank System, Inc. and subsidiaries are included in Item 8: - Consolidated Statements of Condition -- December, 31, 1997 and 1996 - Consolidated Statements of Income -- Years ended December 31, 1997, 1996, and 1995 - Consolidated Statements of Changes in Stockholders' Equity -- Years ended December 31, 1997, 1996, and 19945 - Consolidated Statement of Cash Flows -- Years ended December 31, 1997, 1996, and 1995 - Notes to Consolidated Financial Statements -- December 31, 1997 - Auditor's report - Quarterly selected data -- Years ended December 31, 1997 and 1996 (unaudited) 2. Schedules are omitted since the required information is either not applicable or shown elsewhere in the financial statements. 56 3. Listing of Exhibits (11) Statement re: Computation of earnings per share (21) Subsidiaries of the registrant - Community Bank, National Association, State of New York - Community Capital Trust I, State of Delaware - Community Financial Services, Inc., State of New York - Benefit Plan Administrative Services, Inc., State of New York B. Reports on Form 8-K Report on Form 8-K was filed on December 10, 1997. Item number 5-other events: News release announcing CBSI filed application to list its common stock on the New York Stock Exchange. C. See Exhibit 14(a)(3) above. D. See Exhibit 14(a)(2) above 57 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMUNITY BANK SYSTEM, INC. By: /s/ SANFORD A. BELDEN ----------------------------------------------- Sanford A. Belden President, Chief Executive Officer and Director March 18, 1998 Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 18th day of March 1998. Name ---- /s/ DR. EARL W. MACARTHUR - -------------------------------------------------- Dr. Earl W. MacArthur Chairman of the Board of Directors and Director /s/ DAVID G. WALLACE - -------------------------------------------------- David G. Wallace Treasurer Directors: /s/ JOHN M. BURGESS - ------------------------------------------------- John M. Burgess, Director /s/ RICHARD C. CUMMINGS - ------------------------------------------------- Richard C. Cummings, Director /s/ WILLIAM M. DEMPSEY - ------------------------------------------------- William M. Dempsey, Director /s/ NICHOLAS A. DICERBO - ------------------------------------------------- Nicholas A. DiCerbo, Director /s/ JAMES A. GABRIEL - ------------------------------------------------- James A. Gabriel, Director /s/ LEE T. HIRSCHEY - ------------------------------------------------- Hirschey, Director /s/ DAVID C. PATTERSON - ------------------------------------------------- David C. Patterson, Director /s/ WILLIAM N. SLOAN - ------------------------------------------------- William N. Sloan, Director 58 EX-11 2 STATEMENT RE: EARNINGS PER SHARE COMPUTATION COMMUNITY BANK SYSTEM, INC. STATEMENT RE: EARNINGS PER SHARE COMPUTATION EXHIBIT 11
Three Months Ended Twelve Months Ended December 31, December 31, ---------------------------------------- -------------------------------------------- 1997 1996 1997 1996 Basic Earnings Per Share: Net Income $3,994,283 $3,677,991 $15,561,507 $14,133,044 Less: Accrued Dividends on Preferred Stock 0 (101,250) (78,750) (405,000) ---------------------------------------- -------------------------------------------- Income applicable to common stock $3,994,283 $3,576,741 $15,482,757 $13,728,044 ---------------------------------------- -------------------------------------------- Weighted average number of common shares 7,572,876 7,457,578 7,537,043 7,407,212 ---------------------------------------- -------------------------------------------- BASIC EARNINGS PER SHARE $ 0.53 $ 0.48 $ 2.05 $ 1.85 ======================================== ============================================ Diluted Earnings Per Share: Net Income $3,994,283 $3,677,991 $15,561,507 $14,133,044 Less: Accrued Dividends on Preferred Stock 0 (101,250) (78,750) (405,000) Income applicable ---------------------------------------- -------------------------------------------- to common stock $3,994,283 $3,576,741 $15,482,757 $13,728,044 ---------------------------------------- -------------------------------------------- Weighted average number of common shares 7,572,876 7,457,578 7,537,043 7,407,212 Add: Shares issuable from assumed exercise of incentive stock options 144,617 100,176 139,283 75,306 Weighted average number of ---------------------------------------- -------------------------------------------- common shares - adjusted 7,717,493 7,557,754 7,676,326 7,482,518 ---------------------------------------- -------------------------------------------- DILUTED EARNINGS PER SHARE $0.52 $0.47 $2.02 $1.83 ======================================== ============================================
EX-27.1 3 FDS-YEAR END 1997
9 1,000 YEAR DEC-31-1997 DEC-31-1997 82,106 0 0 0 348,233 263,659 271,413 843,212 12,434 1,633,742 1,345,686 45,000 15,240 80,000 29,804 0 7,587 110,425 1,633,742 71,563 45,198 867 117,628 44,590 54,752 62,876 4,480 (14) 45,798 24,406 24,406 0 0 15,562 2.05 2.02 4.64 1,385 2,788 0 0 8,128 4,449 727 12,434 12,434 0 1,811
EX-27.2 4 FDS-RESTATED YEAR END 1996/1995
9 1,000 YEAR YEAR DEC-31-1996 DEC-31-1995 DEC-31-1996 DEC-31-1995 52,535 56,903 0 0 0 6,000 0 0 208,697 152,226 369,856 315,806 378,496 328,343 652,474 560,152 8,128 6,976 1,343,865 1,152,045 1,027,214 1,016,946 96,800 0 10,499 9,489 100,000 25,550 0 0 4,500 4,500 4,672 4,600 100,180 90,960 1,343,865 1,152,045 56,932 49,928 40,420 32,037 336 1,422 97,688 83,387 36,383 30,772 42,422 36,307 55,266 47,080 2,897 1,765 32 (152) 37,450 33,019 23,793 18,854 23,793 18,854 0 0 0 0 14,133 11,470 1.85 1.72 1.83 1.70 4.86 4.88 2,023 1,328 823 667 32 0 0 0 6,976 6,281 2,458 1,758 713 688 8,128 6,976 8,128 6,976 0 0 917 1,159
EX-27.3 5 FDS-RESTATED QUARTER ENDS 1997
9 1,000 3-MOS 6-MOS 9-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 MAR-31-1997 JUN-30-1997 SEP-30-1997 46,467 67,023 72,106 0 0 0 0 0 3,000 0 0 0 243,735 262,593 285,559 365,397 346,992 309,568 369,231 353,735 317,663 674,178 735,877 826,905 8,400 9,599 12,369 1,395,284 1,486,509 1,594,256 1,061,061 1,232,555 1,384,893 34,800 24,000 0 13,381 14,463 15,099 150,000 75,000 50,000 29,799 29,800 29,802 0 0 0 7,518 7,536 7,549 98,726 103,155 106,913 1,395,284 1,486,509 1,594,256 15,774 32,131 51,352 11,146 22,829 34,187 128 144 763 27,048 55,104 86,302 9,365 19,617 32,141 12,678 26,150 40,535 14,370 28,955 45,767 730 1,580 2,815 0 0 5 10,179 20,606 32,892 5,787 11,626 18,319 5,787 11,626 18,319 0 0 0 0 0 0 3,665 7,333 11,567 .48 .97 1.53 .47 .95 1.50 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
EX-27.4 6 FDS-RESTATED QUARTER ENDS 1996
9 1,000 3-MOS 6-MOS 9-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996 69,022 49,431 52,589 0 0 0 0 0 0 0 0 0 159,706 172,790 201,177 342,542 401,778 394,379 351,244 403,538 397,671 576,495 599,538 626,693 7,186 7,469 7,805 1,208,127 1,283,201 1,337,422 1,059,508 1,022,408 1,038,227 10,000 45,800 40,850 11,581 11,098 12,480 25,550 100,550 140,000 0 0 0 4,500 4,500 4,500 4,603 4,603 4,657 92,385 94,243 96,708 1,208,127 1,002,444 1,337,422 13,480 27,315 41,711 8,873 18,690 29,664 323 335 335 22,676 46,340 71,710 9,097 18,138 27,145 9,471 19,545 30,677 13,205 26,795 41,033 588 1,197 1,827 0 0 0 9,252 18,311 27,970 5,318 11,242 17,630 5,318 11,242 17,630 0 0 0 0 0 0 3,138 6,663 10,455 .41 .88 1.37 .41 .87 1.36 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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