NOTE B: ACQUISITIONS

On May 12, 2017, the Company completed its acquisition of Merchants Bancshares, Inc. (“Merchants”), parent company of Merchants Bank headquartered in South Burlington, Vermont, for $345.2 million in Company stock and cash, comprised of $82.9 million in cash and the issuance of 4.68 million shares of common stock. The acquisition extends the Company’s footprint into the Vermont and Western Massachusetts markets with the addition of 31 branch locations in Vermont and one location in Massachusetts. This transaction resulted in the acquisition of $1.99 billion of assets, including $1.49 billion of loans and $370.5 million of investment securities, as well as $1.45 billion of deposits and $190.3 million in goodwill. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date. Revenues of approximately $8.9 million and direct expenses, which may not include certain shared expenses, of approximately $4.0 million from Merchants were included in the consolidated income statement for the three months ended and six months ended June 30, 2017.

On March 1, 2017, the Company, through its subsidiary, OneGroup NY, Inc. (“OneGroup”), completed its acquisition of certain assets of Dryfoos Insurance Agency, Inc. (“Dryfoos”), an insurance agency headquartered in Hazleton, Pennsylvania. The Company paid $3.0 million in cash to acquire the assets of Dryfoos, and recorded goodwill in the amount of $1.7 million and other intangible assets of $1.7 million in conjunction with the acquisition. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

On February 3, 2017, the Company completed its acquisition of Northeast Retirement Services, Inc. (“NRS”) and its subsidiary Global Trust Company, Inc. (“GTC”), headquartered in Woburn, Massachusetts, for $148.6 million in Company stock and cash. NRS was a privately held corporation focused on providing institutional transfer agency, master recordkeeping services, custom target date fund administration, trust product administration and customized reporting services to institutional clients. Its wholly-owned subsidiary, GTC, is chartered in the State of Maine in 2008 as a non-depository trust company which provides fiduciary services for collective investment trusts and other products. The acquisition of NRS and GTC, hereafter referred to collectively as NRS, will strengthen and complement the Company’s existing employee benefit services businesses. Upon the completion of the merger, NRS became a wholly-owned subsidiary of Benefit Plans Administrative Services, Inc. (“BPAS”) and operates as Northeast Retirement Services, LLC, a Delaware limited liability company. This transaction resulted in the acquisition of $36.0 million in net tangible assets, principally cash and certificates of deposit, $60.2 million in customer list intangibles that will be amortized using the 150% declining balance method over 10 years, a $24.2 million deferred tax liability associated with the customer list intangible, and $76.5 million in goodwill. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date. Revenues of $8.4 million and expenses of $5.7 million from NRS were included in the consolidated income statement for the three months ended June 30, 2017. Revenues of $13.4 million and expenses of $9.3 million from NRS were included in the consolidated income statement for the six months ended June 30, 2017.

On January 1, 2017, the Company, through its subsidiary, OneGroup, acquired certain assets of Benefits Advisory Service, Inc. (“BAS”), a benefits consulting group headquartered in Forest Hills, New York. The Company paid $1.2 million in cash to acquire the assets of BAS and recorded intangible assets of $1.2 million in conjunction with the acquisition. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

On January 4, 2016, the Company, through its subsidiary, CBNA Insurance Agency, Inc. (“CBNA Insurance”), completed its acquisition of WJL Agencies Inc. doing business as The Clark Insurance Agencies (“WJL”), an insurance agency operating in Canton, New York. The Company paid $0.6 million in cash for the intangible assets of the company. Goodwill in the amount of $0.3 million and intangible assets in the amount of $0.3 million were recorded in conjunction with the acquisition. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date. On August 19, 2016, the Company merged together its insurance subsidiaries and as of that date, the activities of CBNA Insurance were merged into OneGroup.

The assets and liabilities assumed in the acquisitions were recorded at their estimated fair values based on management's best estimates using information available at the dates of the acquisition, and were subject to adjustment based on updated information not available at the time of acquisition. During the second quarter of 2017, the carrying amount of NRS’s other assets decreased by $2.7 million and other liabilities decreased by $2.4 million as a result of a reclassification of amounts from other assets into other liabilities, and an adjustment to other liabilities as a result of updated information not available at the time of acquisition. Goodwill associated with the NRS acquisition increased $0.3 million as a result of these changes in fair value estimates. During the second quarter of 2017, adjustments were made to the amount of cash consideration, assets acquired and liabilities assumed for the Dryfoos acquisition. The assets acquired and liabilities assumed were adjusted as a result of updated information not available at the time of acquisition. Goodwill associated with the Dryfoos acquisition was not impacted by the adjustments made in the second quarter of 2017. The accrued income taxes and deferred taxes associated with the Merchants acquisition were recorded on a provisional basis and could vary from the actual recorded balance once finalized.

The above referenced insurance-related acquisitions expanded the Company’s geographical presence in New York, Pennsylvania, Vermont, and Western Massachusetts and management expects that the Company will benefit from greater geographic diversity and the advantages of other synergistic business development opportunities.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed after considering the measurement period adjustments described above:

	2017														2016
(000s omitted)	BAS		NRS			Dryfoos			Merchants			Total			WJL
Consideration paid :
Cash	$	1,200	$	70,073		$	3,024		$	82,898		$	157,195		$	575
Community Bank System, Inc. common stock		0		78,483			0			262,254			340,737			0
Total net consideration paid		1,200		148,556			3,024			345,152			497,932			575
Recognized amounts of identifiable assets acquired and liabilities assumed:
Cash and cash equivalents		0		11,063			0			40,730			51,793			0
Investment securities		0		20,294			0			370,480			390,774			0
Loans		0		0			0			1,489,273			1,489,273			0
Premises and equipment		0		411			27			12,973			13,411			0
Accrued interest receivable		0		72			0			4,773			4,845			0
Other assets		0		8,088			272			46,363			54,723			0
Core deposit intangibles		0		0			0			23,214			23,214			0
Other intangibles		1,200		60,200			1,657			2,857			65,914			288
Deposits		0		0			0			(1,448,408	)		(1,448,408	)		0
Other liabilities		0		(28,106	)		(582	)		(5,071	)		(33,759	)		0
Short-term advances		0		0			0			(80,000	)		(80,000	)		0
Securities sold under agreement to repurchase, short-term		0		0			0			(278,076	)		(278,076	)		0
Long-term debt		0		0			0			(3,615	)		(3,615	)		0
Subordinated debt held by unconsolidated subsidiary trusts		0		0			0			(20,619	)		(20,619	)		0
Total identifiable assets, net		1,200		72,022			1,374			154,874			229,470			288
Goodwill	$	0	$	76,534		$	1,650		$	190,278		$	268,462		$	287

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments were aggregated by comparable characteristics and recorded at fair value without a carryover of the related allowance for loan losses. Cash flows for each loan were determined using an estimate of credit losses and an estimated rate of prepayments. Projected monthly cash flows were then discounted to present value using a market-based discount rate. The excess of the undiscounted expected cash flows over the estimated fair value is referred to as the “accretable yield” and is recognized into interest income over the remaining lives of the acquired loans.

The following is a summary of the loans acquired from Merchants at the date of acquisition:

(000s omitted)	Acquired Impaired Loans			Acquired Non-impaired Loans			Total Acquired Loans
Contractually required principal and interest at acquisition	$	16,351		$	1,872,574		$	1,888,925
Contractual cash flows not expected to be collected		(5,190	)		(14,753	)		(19,943	)
Expected cash flows at acquisition		11,161			1,857,821			1,868,982
Interest component of expected cash flows		(769	)		(378,940	)		(379,709	)
Fair value of acquired loans	$	10,392		$	1,478,881		$	1,489,273

The fair value of checking, savings and money market deposit accounts acquired were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificate of deposit accounts were valued at the present value of the certificates’ expected contractual payments discounted at market rates for similar certificates.

The core deposit intangibles and other intangibles related to the Merchants, Dryfoos, BAS and WJL acquisitions are being amortized using an accelerated method over their estimated useful life of eight years. The goodwill, which is not amortized for book purposes, was assigned to the Banking segment for the Merchants acquisition, the Employee Benefit Services segment for NRS, and All Other segments for the Dryfoos, BAS, and WJL acquisitions. Goodwill arising from the Merchants and NRS acquisitions is not deductible for tax purposes. Goodwill arising from the Dryfoos, BAS and WJL acquisitions is deductible for tax purposes.

Direct costs related to the acquisitions were expensed as incurred. Merger and acquisition integration-related expenses amount to $22.9 million and $0.3 million during the three months ended June 30, 2017 and 2016, respectively, and $24.6 million and $0.3 million for the six months ended June 30, 2017 and 2016, respectively, and have been separately stated in the Consolidated Statements of Income.

Supplemental Pro Forma Financial Information

The following unaudited condensed pro forma information assumes the Merchants and NRS acquisitions had been completed as of January 1, 2016 for the three and six months ended June 30, 2016 and June 30, 2017. The pro forma information does not include amounts related to BAS and Dryfoos as the amounts were immaterial. The table below has been prepared for comparative purposes only and is not necessarily indicative of the actual results that would have been attained had the acquisitions occurred as of the beginning of the year presented, nor is it indicative of the Company’s future results. Furthermore, the unaudited pro forma information does not reflect management’s estimate of any revenue-enhancing opportunities nor anticipated cost savings that may have occurred as a result of the integration and consolidation of the acquisitions.

The pro forma information set forth below reflects the historical results of Merchants and NRS combined with the Company’s consolidated statement of income with adjustments related to (a) certain purchase accounting fair value adjustments and (b) amortization of customer lists and core deposit intangibles. Acquisition-related expenses totaling $22.8 million and $24.4 million for the three and six months ended June 30, 2017 were included in the pro forma information as if they were incurred in the first quarter of 2016.

	Pro Forma (Unaudited) Three Months Ended				Pro Forma (Unaudited) Six Months Ended
(000’s omitted)	June 30, 2017		June 30, 2016		June 30, 2017		June 30, 2016
Total revenue, net of interest expense	$	129,599	$	133,813	$	242,690	$	265,315
Net income		33,051		31,862		60,757		46,274