10-Q 1 d52591_10-q.txt QUARTERLY REPORT FORM 10 - Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the nine months ended September 30, 2002 Commission file number 0-11716 COMMUNITY BANK SYSTEM, INC. (Exact name of registrant as specified in its charter) DELAWARE 16-1213679 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5790 Widewaters Parkway, DeWitt, New York 13214 (Address of principal executive offices) (Zip Code) 315/445-2282 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, No par value - 12,966,591 shares outstanding as of November 8, 2002 INDEX COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Part I. Financial Information Item 1. Financial Statements (Unaudited) Consolidated Statements of Condition -- September 30, 2002, December 31, 2001 and September 30, 2001 Consolidated Statements of Income -- Three and nine months ended September 30, 2002 and 2001 Consolidated Statement of Shareholders' Equity -- Nine months ended September 30, 2002 Consolidated Statements of Comprehensive Income -- Nine months ended September 30, 2002 and 2001 Consolidated Statements of Cash Flows -- Nine months ended September 30, 2002, and 2001 Notes to Consolidated Financial Statements - September 30, 2002 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure about Market Risk Part II. Other Information Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults upon Senior Securities Item 4. Submission of Matters to a Vote of Securities Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K 2 CONSOLIDATED STATEMENTS OF CONDITION (Unaudited) COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES (In Thousands, Except Share Data)
September 30, December 31, September 30, 2002 2001 2001 ----------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 103,178 $ 106,554 $ 85,579 Federal funds sold 0 0 0 ----------------------------------------------------------------------------------------------------- Total cash and cash equivalents 103,178 106,554 85,579 Investment securities 1,356,863 1,148,182 1,050,856 Loans 1,779,440 1,732,870 1,564,806 Allowance for loan losses 24,080 23,901 21,083 ----------------------------------------------------------------------------------------------------- Net loans 1,755,360 1,708,969 1,543,723 Premises and equipment, net 56,907 53,266 44,170 Accrued interest receivable 23,149 22,562 21,723 Core deposit intangibles, net 32,081 36,722 9,039 Goodwill, net 103,628 19,814 21,285 Other intangibles, net (see Note A) 85,806 36,672 ----------------------------------------------------------------------------------------------------- Intangible assets, net 135,709 142,342 66,996 Other assets 37,426 28,958 31,303 ----------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 3,468,592 $ 3,210,833 $ 2,844,350 ===================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits Noninterest bearing $ 450,131 $ 447,544 $ 350,622 Interest bearing 2,101,604 2,098,426 1,737,484 ----------------------------------------------------------------------------------------------------- Total deposits 2,551,735 2,545,970 2,088,106 Federal funds purchased 11,500 14,200 41,100 Borrowings 439,100 263,100 338,100 Company obligated mandatorily redeemable preferred securities of subsidiaries, Community Capital/Statutory Trust I-III, holding solely junior subordinated debentures of the Company 77,361 77,819 77,805 Accrued interest and other liabilities 64,735 41,764 48,553 ----------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 3,144,431 2,942,853 2,593,664 ----------------------------------------------------------------------------------------------------- Shareholders' equity: Common stock no par $1.00 stated value 20,000,000 shares authorized; 12,962,549, 12,902,812 and 11,579,312 shares outstanding, respectively 12,963 12,903 11,579 Surplus 78,987 77,710 46,710 Undivided profits 188,604 170,472 169,127 Accumulated other comprehensive income 43,728 7,281 23,633 Shares issued under employee stock plan - unearned (121) (386) (363) ----------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 324,161 267,980 250,686 ----------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,468,592 $ 3,210,833 $ 2,844,350 =====================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF INCOME (Unaudited) COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES (In Thousands, Except Per-Share Data)
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------------------------------------------------------------------------------- 2002 2001 2002(1) 2001 ------------------------------------------------------------------------------------------------------- Interest income: Interest and fees on loans $ 32,816 $32,635 $ 97,952 $ 99,408 Interest and dividends on investments: Taxable 14,169 13,057 43,172 41,412 Nontaxable 4,530 2,726 12,389 7,302 Interest on federal funds and deposits with other banks 1 173 4 561 ------------------------------------------------------------------------------------------------------- Total interest income 51,516 48,591 153,517 148,683 ------------------------------------------------------------------------------------------------------- Interest expense: Interest on deposits 13,099 17,689 42,110 56,606 Interest on federal funds purchased 156 84 392 733 Interest on short-term borrowings 674 752 1,289 5,425 Interest on madatorily redeemable preferred securities of subsidiaries 1,439 1,452 4,336 2,918 Interest on long-term borrowings 3,751 4,805 11,387 12,973 ------------------------------------------------------------------------------------------------------- Total interest expense 19,119 24,782 59,514 78,655 ------------------------------------------------------------------------------------------------------- Net interest income 32,397 23,809 94,003 70,028 Less: provision for loan losses 2,278 1,579 7,180 4,320 ------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 30,119 22,230 86,823 65,708 ------------------------------------------------------------------------------------------------------- Other income: Fiduciary and investment services 707 801 2,484 2,327 Service charges on deposit accounts 3,343 2,530 9,384 7,271 Commissions on investment products 1,336 1,498 5,249 4,668 Other service charges, commissions and fees 2,490 2,050 6,065 5,217 Other operating income (4) 102 (8) 104 Investment security gain, net 216 2,688 1,359 2,559 ------------------------------------------------------------------------------------------------------- Total other income 8,088 9,669 24,533 22,146 ------------------------------------------------------------------------------------------------------- Other expenses: Salaries and employee benefits 12,020 9,879 36,411 30,321 Occupancy expense, net 1,781 1,464 6,179 4,554 Equipment and furniture expense 1,714 1,518 5,569 4,416 Amortization of intangible assets 1,597 1,541 4,641 4,542 Legal and professional fees 845 745 2,380 2,063 Data processing expenses 1,813 1,340 5,234 3,815 Acquisition and unusual expenses 0 631 700 6,117 Other 3,299 3,263 10,683 9,223 ------------------------------------------------------------------------------------------------------- Total other expenses 23,069 20,381 71,797 65,051 ------------------------------------------------------------------------------------------------------- Income before income taxes and extraordinary item 15,138 11,518 39,559 22,803 Income taxes 4,087 2,416 10,681 5,842 Income before extraordinary item 11,051 9,102 28,878 16,961 Extraordinary loss on early retirement of long term borrowings, net of tax benefit of $1,077 0 2,659 0 2,659 ------------------------------------------------------------------------------------------------------- NET INCOME $ 11,051 $ 6,443 $ 28,878 $ 14,302 ======================================================================================================= Earnings per share - Basic $ 0.85 $ 0.56 $ 2.23 $ 1.25 ======================================================================================================= Earnings per share - Diluted $ 0.84 $ 0.55 $ 2.19 $ 1.23 =======================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. (1) The consolidated statements of income for the three months ended March 31 and June 30, 2002 and the six months ended June 30, 2002 were restated for the adoption of SFAS 147. 4 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Nine Months Ended September 30, 2002 (In Thousands, Except Share Data)
Accumulated Shares Issued Common Stock Other Under Employee Shares Undivided Comprehensive Stock Plan Outstanding Amount Surplus Profits Income -Unearned Total -------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 12,902,812 $12,903 $77,710 $ 170,472 $ 7,281 ($386) $ 267,980 Net income 28,878 28,878 Other comprehensive income, net of tax 36,447 36,447 Dividends declared: Common, $.83 per share (10,746) (10,746) Common stock issued under employee stock plan 59,737 60 1,277 265 1,602 -------------------------------------------------------------------------------------------------------------------------------- Balance at September 30, 2002 12,962,549 $12,963 $78,987 $ 188,604 $43,728 ($121) $ 324,161 ================================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 5 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES (In Thousands)
Nine Months Ended September 30, 2002 2001 ----------------------------------------------------------------------------------- Other comprehensive income, before tax: Change in minimum pension liability adjustment $ 4,919 $ 0 Unrealized gain on securities: Unrealized holding gains arising during period 57,212 32,018 Reclassification adjustment for (gains) losses included in net income (1,359) (2,559) ----------------------------------------------------------------------------------- Other comprehensive income, before tax 60,772 29,459 Income tax expense related to other comprehensive income (24,325) (11,791) ----------------------------------------------------------------------------------- Other comprehensive income, net of tax 36,447 17,668 Net income 28,878 14,302 ----------------------------------------------------------------------------------- Comprehensive income $ 65,325 $ 31,970 ===================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 6 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES (In Thousands)
Nine Months Ended September 30, ------------------------------------------------------------------------------------ 2002 2001 ------------------------------------------------------------------------------------ Operating Activities: Net income $ 28,878 $ 14,302 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 4,868 3,661 Amortization of intangible assets 4,641 4,542 Net amortization of security premiums and discounts 3,081 1,528 Amortization of discount of loans (81) (160) Amortization of unearned compensation and discount on junior subordinated debentures 340 95 Provision for loan losses 7,180 4,320 Provision for deferred taxes 4,594 589 Gain on sale of investment securities (1,359) (2,559) Loss (gain) on sale of loans and other assets 7 (97) Change in interest receivable (587) 1,160 Change in other assets and other liabilities (9,416) 3,127 ------------------------------------------------------------------------------------ Net cash provided by operating activities 42,146 30,508 ------------------------------------------------------------------------------------ Investing Activities: Proceeds from sales of investment securities 75,782 139,414 Proceeds from maturities of held-to-maturity investment securities 3,862 4,978 Proceeds from maturities of available-for-sale investment securities 129,790 169,072 Purchases of held-to-maturity investment securities (3,498) (3,480) Purchases of available-for-sale investment securities (360,491) (354,823) Net change in loans outstanding (53,483) 6,040 Premium paid on acquisition of business 0 (2,993) Cash received in acquisition 0 3,777 Capital expenditures (6,560) (5,398) ------------------------------------------------------------------------------------ Net cash used by investing activities (214,598) (43,413) ------------------------------------------------------------------------------------ Financing Activities: Net change in demand deposits, NOW accounts, and savings accounts 49,952 46,456 Net change in certificates of deposit (44,187) 5,422 Net change in federal funds purchased (2,700) (7,630) Net change in borrowings 175,500 (62,950) Proceeds from issuance of redeemable preferred securities 0 47,967 Issuance of common stock 1,064 703 Cash dividends paid (10,469) (7,856) Other financing activities (84) (84) ------------------------------------------------------------------------------------ Net cash provided by financing activities 169,076 22,027 ------------------------------------------------------------------------------------ Change in cash and cash equivalents (3,376) 9,122 Cash and cash equivalents at beginning of year 106,554 76,456 ------------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 103,178 $ 85,579 ==================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest $ 60,163 $ 77,345 Cash paid for income taxes $ 4,927 $ 6,142 ==================================================================================== SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING AND INVESTING ACTIVITIES: Dividends declared and unpaid $ 3,759 $ 3,124 Gross change in unrealized gains and (losses) on available-for-sale securities $ 55,853 ($ 29,459) Change in minimum pension liability adjustment ($ 4,919) $ 0 Bank acquisition: Fair value of assets acquired $ 0 $ 123,948 Liabilities assumed $ 0 $ 98,720 Common stock issued, including treasury stock of $0 and $17,006 $ 0 $ 25,228 ====================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 7 Community Bank System, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) September 30, 2002 Note A -- Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. On November 16, 2001, the Company acquired 36 branches from FleetBoston Financial Corporation with $470 million in deposits and $177 million in loans. The branches are located in Southwestern and Finger Lakes Regions of New York. The results of the 36 branch operations have been included in the consolidated financial statements since that date. On May 11, 2001, the Company completed its acquisition of the $648-million-asset First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger, each share of First Liberty stock was exchanged for .56 shares of the Company's common stock, which amounted to approximately 3.6 million shares. The merger constituted a tax-free reorganization and has been accounted for as a pooling of interests under Accounting Principles Board Opinion No. 16. Accordingly, the consolidated financial statements for the periods presented have been restated to include the combined results of operations, financial position and cash flows of the Company and First Liberty. On January 26, 2001, the Company acquired the $111-million-asset Citizens National Bank of Malone, an eighty-year old commercial bank with five branches throughout Franklin and St. Lawrence counties in New York State. The Company issued 952,000 shares of its common stock to the former shareholders at a cost of $26.50 per share. All of the 648,100 shares held in the Company's treasury were issued in this transaction. The results of operations from this transaction have been included in the Company's consolidated financial statements since the acquisition date. During the first quarter of 2002, the Company made a contribution of $5.0 million to its defined benefit pension plan. At March 31, 2002, an updated actuarial valuation was performed which showed that plan assets exceeded the accumulated benefit obligation. As a result, the additional minimum pension liability of $4.919 million, which was recorded at December 31, 2001 as a charge to shareholders' equity, net of tax, was reversed. On October 1, 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 147 (SFAS 147), "Accounting for Certain Acquisitions of Banking or Thrift Institutions." Under previous SFAS, goodwill arising from branch acquisitions was classified as an "unidentifiable intangible asset" and subject to regular amortization. SFAS 147 changes the accounting for goodwill arising from branch acquisitions and allows the Company to cease amortization on this goodwill and subject it to an annual impairment test. In accordance with the provisions of SFAS 147, the Company has adopted this Statement retroactive to January 1, 2002, with the impact of restatement on previously issued Form 10Q's as of March 31, 2002 and June 30, 2002 contained below. 8
Three Months Three Months Six Months Ended March Ended June Ended June ($000s except for earnings-per-share amounts) 31, 2002 30, 2002 30, 2002 ---------------------------------------- Net income as previously reported $ 7,438 $ 8,179 $ 15,617 Plus: branch goodwill amortization, net of tax 1,122 1,090 2,211 ---------------------------------------- Net income as restated $ 8,560 $ 9,269 $ 17,828 Basic EPS as previously reported $ 0.57 $ 0.63 $ 1.21 Diluted EPS as previously reported $ 0.57 $ 0.62 $ 1.19 Basic EPS as restated $ 0.66 $ 0.71 $ 1.38 Diluted EPS as restated $ 0.65 $ 0.70 $ 1.36
Note B -- Critical Accounting Policies Allowance for Loan Losses The allowance for loan losses reflects management's best estimate of probable loan losses in the Company's loan portfolio, considering evaluations of individual credits and concentrations of credit risk, changes in the quality of the credit portfolio, levels of nonaccrual loans, current economic conditions, changes in the size and character of the credit risks and other pertinent factors. The allowance is increased by provisions charged to expense and reduced by net charge-offs. A loan is considered impaired, based on 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. New Accounting Pronouncements In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of, including long-term customer relationships of a financial institution, such as core deposit intangibles. This Statement supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of;" however, this Statement retains the fundamental provisions of Statement 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used, and (b) measurement of long-lived assets to be disposed of by sale. Effective January 1, 2002, the Company adopted this pronouncement, which had no impact on the financial condition or results of operations for the quarter and nine months ended September 30, 2002. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses financial accounting and reporting for costs associated with exit or disposal activities. This Statement supersedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring)." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company is not anticipating that this pronouncement will have a significant impact on the financial condition or results of its operations. See Notes A and D for discussion of recent accounting pronouncements regarding goodwill and intangible assets. 9 Note C -- Earnings Per Share Basic earnings per share are 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 dilutive effect of options is calculated using the treasury stock method of accounting sanctioned by the FASB. This calculation determines approximately how many more common shares would be outstanding if all in-the-money (average market price is greater than the exercise price) vested and unvested options outstanding were exercised and the proceeds were used to repurchase common shares in the open market at the average price for the applicable time period. The following is a reconciliation of basic to diluted earnings per share for the three and nine months ended September 30, 2002 and 2001.
Per Share (In thousands except per share data) Income Shares Amount ---------------------------------------------------------------------------------------------------- Quarter ended September 30, 2002 Net income $11,051 Basic EPS 11,051 12,985 $0.85 Effect of dilutive securities: Stock options 187 -------------------- Diluted EPS $11,051 13,172 $0.84 ==================================================================================================== Quarter ended September 30, 2001 Net income $6,443 Basic EPS 6,443 11,591 $0.56 Effect of dilutive securities: Stock options 145 -------------------- Diluted EPS $6,443 11,736 $0.55 ==================================================================================================== Nine months ended September 30, 2002 Net income $28,878 Basic EPS 28,878 12,966 $2.23 Effect of dilutive securities: Stock options 191 -------------------- Diluted EPS $28,878 13,157 $2.19 ==================================================================================================== Nine months ended September 30, 2001 Net income $14,302 Basic EPS 14,302 11,483 $1.25 Effect of dilutive securities: Stock options 154 -------------------- Diluted EPS $14,302 11,637 $1.23 ====================================================================================================
10 Note D -- Intangible Assets Effective January 1, 2002, the Company adopted Financial Accounting Standards Board (FASB) SFAS No. 142, "Goodwill and Other Intangible Assets", which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". The statement requires that the Company subject goodwill and other intangible assets to an annual impairment analysis to assess the need to write down the balances and recognize an impairment loss. In addition, amortization of goodwill is no longer being recorded in accordance with this statement. Core deposit intangibles, net and other intangibles, net (primarily branch goodwill related to branch acquisitions) will continue to be amortized. The adoption of this pronouncement resulted in a reduction in amortization expense of $325,000 and $975,000 for the quarter and nine months ended September 30, 2002, respectively. In October 2002, the FASB issued SFAS No. 147, "Accounting for Certain Acquisitions of Banking and Thrift Institutions", which addresses financial accounting and reporting for certain intangibles associated with branch acquisitions. This statement removes acquisitions of financial institutions from the scope of SFAS No. 72 and FASB Interpretation No. 9. It reclassifies as goodwill certain "unidentified intangible assets" associated with the Company's branch acquisitions dating as far back as 1994. Financial statements are retroactively restated to January 1, 2002 to remove amortization recorded on Other Intangible Assets. Previously, these intangible assets were subject to being regularly amortized. As discussed above, under FASB 142, goodwill is not required to be amortized, but as an asset, is periodically reviewed for impairment. The adoption of this pronouncement resulted in a reduction in amortization expense of approximately $1.5 million and $4.5 million for the quarter and nine months ended September 30, 2002, respectively. The proforma disclosures on net income and earnings per share of SFAS No. 142 and SFAS No. 147 for the quarter and nine months ended September 30, 2002 and 2001 are as follows:
($000s except for earnings-per-share amounts) Quarter Ended Nine Months Ended September 30, September 30, ------------------------------------------------ 2002 2001 2002 2001 ------------------------------------------------ Reported net income $ 11,051 $ 6,443 $ 28,878 $ 14,302 Add back: Goodwill amortization 660 1,931 ------------------------------------------------ Adjusted net income $ 11,051 $ 7,103 $ 28,878 $ 16,233 ================================================ Basic earnings per share: Reported net income $ 0.85 $ 0.56 $ 2.23 $ 1.25 Add back: Goodwill amortization 0.05 0.16 ------------------------------------------------ Adjusted net income $ 0.85 $ 0.61 $ 2.23 $ 1.41 ================================================ Diluted earnings per share: Reported net income $ 0.84 $ 0.55 $ 2.19 $ 1.23 Add back: Goodwill amortization 0.06 0.16 ------------------------------------------------ Adjusted net income $ 0.84 $ 0.61 $ 2.19 $ 1.39 ================================================
11 The gross carrying amount and accumulated amortization for each type of intangible asset are as follows:
As of September 30, 2002 As of December 31, 2001 -------------------------------------------------------------------------------- Gross Net Gross Net ($000s) Carrying Accumulated Carrying Carrying Accumulated Carrying Amount Amortization Amount Amount Amortization Amount -------------------------------------------------------------------------------- Amortized intangible assets: Core deposit intangibles $47,218 ($15,137) $32,081 $47,218 ($10,496) $36,722 -------------------------------------------------------------------------------- Total amortized intangible assets 47,218 (15,137) 32,081 47,218 (10,496) 36,722 Unamortized intangible assets: Goodwill 122,001 (18,373) 103,628 123,993 (18,373) 105,620 -------------------------------------------------------------------------------- Total intangible assets, net $169,219 ($33,510) $135,709 $171,211 ($28,869) $142,342 ================================================================================
The decrease of $1,992 in the gross carrying value of goodwill pertains to the FleetBoston acquisition, specifically an adjustment to fair value of the Bank premises and equipment and reflecting deferred taxes on the allowance for loan losses and conversion costs. The Company completed its goodwill impairment analysis during 2002, and no adjustment was necessary. The estimated aggregate amortization expense for each of the five succeeding fiscal years ended December 31, is as follows: 2003 $4,970 2004 4,753 2005 4,079 2006 3,406 2007 3,406 12 Part 1. Financial Information Item 1. Financial Statements The information required by rule 10.01 of Regulation S-X is presented on the previous pages. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The purpose of the discussion is to present material changes in Community Bank System, Inc.'s financial condition and results of operations during the three and nine months ended September 30, 2002 which are not otherwise apparent from the consolidated financial statements included in these reports. When used in this report, the term "CBSI" or "CBU" means Community Bank System, Inc. and its subsidiaries on a consolidated basis, unless indicated otherwise. Financial performance comparisons to peer bank holding companies are based on data through June 30, 2002 as provided by the Federal Reserve System; the peer group is comprised of 73 bank holding companies having $3 to $10 billion in assets. 13 COMMUNITY BANK SYSTEM, INC. SUMMARY OF OPERATIONS EARNINGS AND BALANCE SHEET RECAP 3RD QUARTER 2002 AND FULL YEAR COMPARISONS
---------------------------------------------------------------- 000's Omitted Three Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Earnings ------------------------------------------------------ 1 Net interest income $32,397 $23,809 $8,588 36.1% 2 Loan loss provision 2,278 1,579 699 44.3% 3 Net interest income after provision for loan losses 30,119 22,230 7,889 35.5% 4a Financial services other income 3,689 3,688 1 0.0% 4b Banking services other income 4,183 3,293 890 27.0% 4c Investment security gain (loss) & debt extinguishment 216 29 187 644.8% 4d Total other income 8,088 7,010 1,078 15.4% 5a Financial services other expenses 2,500 2,560 (60) -2.3% 5b Banking services other expenses 18,972 15,649 3,323 21.2% 5c Intangible amortization 1,597 1,541 56 3.6% 5d Acquisition and unusual expense 0 631 (631) 0.0% 5e Total other expenses 23,069 20,381 2,688 13.2% 6 Income before taxes 15,138 8,859 6,279 70.9% 7 Income tax 4,087 2,416 1,671 69.2% 8a Net income $11,051 $6,443 $4,608 71.5% 8b Net income - Operating $11,051 $6,801 $4,250 62.5% 8c Net income - Cash $12,021 $7,451 $4,570 61.3% 8d Net income - Cash Operating $12,021 $7,809 $4,212 53.9% 9a Basic earnings per share $0.85 $0.56 $0.29 51.8% 9b Diluted earnings per share $0.84 $0.55 $0.29 52.7% 9c Diluted earnings per share-Operating $0.84 $0.58 $0.26 44.8% 9d Diluted earnings per share-Cash $0.91 $0.63 $0.28 44.4% 9e Diluted earnings per share-Cash Operating $0.91 $0.67 $0.24 35.8% ------------------------------------------------------================================================================ Balances At Period End ------------------------------------------------------ 10 Loans $1,779,440 $1,564,806 $214,634 13.7% 11 Investments & other interest bearing accounts 1,284,695 1,011,354 273,341 27.0% (excluding market value adjustment) 12 Earning assets 3,064,135 2,576,160 487,975 18.9% 13 Loan loss reserve 24,080 21,083 2,997 14.2% 14a Core deposit intangibles,net 32,081 9,039 23,042 254.9% 14b Goodwill & other intangibles, net 103,628 57,957 45,671 78.8% 14c Total intangible assets, net 135,709 66,996 68,713 102.6% 15 Total assets 3,468,592 2,844,350 624,242 21.9% 16 Deposits 2,551,735 2,088,106 463,629 22.2% 17a FHLB borrowings 450,600 379,200 71,400 18.8% 17b Trust preferred borrowings 77,361 77,805 (444) -0.6% 17c Total borrowings 527,961 457,005 70,956 15.5% 18 Total shareholders' equity 324,161 250,686 73,475 29.3% 19 Assets under management $1,267,289 $1,237,554 $29.735 2.4% ================================================================
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---------------------------------------------------------------- 000's Omitted Nine Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Earnings ------------------------------------------------------ 1 Net interest income $94,003 $70,028 $23,975 34.2% 2 Loan loss provision 7,180 4,320 2,860 66.2% 3 Net interest income after provision for loan losses 86,823 65,708 21,115 32.1% 4a Financial services other income 10,881 9,672 1,209 12.5% 4b Banking services other income 12,293 9,915 2,378 24.0% 4c Investment security gain (loss) & debt extinguishment 1,359 (100) 1,459 -1459.0% 4d Total other income 24,533 19,487 5,046 25.9% 5a Financial services other expenses 7,870 7,492 378 5.0% 5b Banking services other expenses 58,586 46,900 11,686 24.9% 5c Intangible amortization 4,641 4,542 99 2.2% 5d Acquisition and unusual expense 700 6,117 (5,417) -88.6% 5e Total other expenses 71,797 65,051 6,746 10.4% 6 Income before taxes 39,559 20,144 19,415 96.4% 7 Income tax 10,681 5,842 4,839 82.8% 8a Net income $28,878 $14,302 $14,576 101.9% 8b Net income - Operating $29,303 $18,000 $11,303 62.8% 8c Net income - Cash $31,697 $17,247 $14,450 83.8% 8d Net income - Cash Operating $32,122 $20,945 $11,177 53.4% 9a Basic earnings per share $2.23 $1.25 $0.98 78.4% 9b Diluted earnings per share $2.19 $1.23 $0.96 78.0% 9c Diluted earnings per share-Operating $2.23 $1.55 $0.68 43.9% 9d Diluted earnings per share-Cash $2.41 $1.48 $0.93 62.8% 9e Diluted earnings per share-Cash Operating $2.44 $1.80 $0.64 35.6% ------------------------------------------------------================================================================ Balances At Period End ------------------------------------------------------ 10 Loans $1,779,440 $1,564,806 $214,634 13.7% 11 Investments & other interest bearing accounts 1,284,695 1,011,354 273,341 27.0% (excluding market value adjustment) 12 Earning assets 3,064,135 2,576,160 487,975 18.9% 13 Loan loss reserve 24,080 21,083 2,997 14.2% 14a Core deposit intangibles,net 32,081 9,039 23,042 254.9% 14b Goodwill & other intangibles, net 103,628 57,957 45,671 78.8% 14c Total intangible assets, net 135,709 66,996 68,713 102.6% 15 Total assets 3,468,592 2,844,350 624,242 21.9% 16 Deposits 2,551,735 2,088,106 463,629 22.2% 17a FHLB borrowings 450,600 379,200 71,400 18.8% 17b Trust preferred borrowings 77,361 77,805 (444) -0.6% 17c Total borrowings 527,961 457,005 70,956 15.5% 18 Total shareholders' equity 324,161 250,686 73,475 29.3% 19 Assets under management $1,267,289 $1,237,554 $29.735 2.4% ================================================================
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---------------------------------------------------------------- 000's Omitted Three Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change No. ------------------------------------------------------ 2002 2002 Amount Percent -------------------------------------------------------------------------------------------------------------------------------- Earnings ------------------------------------------------------ 1 Net interest income $32,397 $31,438 $959 3.1% 2 Loan loss provision 2,278 3,385 (1,107) -32.7% 3 Net interest income after provision for loan losses 30,119 28,053 2,066 7.4% 4a Financial services other income 3,689 3,550 139 3.9% 4b Banking services other income 4,183 4,017 166 4.1% 4c Investment security gain (loss) & debt extinguishment 216 1,144 (928) -81.1% 4d Total other income 8,088 8,711 (623) -7.2% 5a Financial services other expenses 2,500 2,645 (145) -5.5% 5b Banking services other expenses 18,972 19,822 (850) -4.3% 5c Intangible amortization 1,597 1,504 93 6.2% 5d Acquisition and unusual expense 0 108 (108) 0.0% 5e Total other expenses 23,069 24,079 (1,010) -4.2% 6 Income before taxes 15,138 12,685 2,453 19.3% 7 Income tax 4,087 3,416 671 19.6% 8a Net income $11,051 $9,269 $1,782 19.2% 8b Net income - Operating $11,051 $9,335 $1,716 18.4% 8c Net income - Cash $12,021 $10,182 $1,839 18.1% 8d Net income - Cash Operating $12,021 $10,248 $1,773 17.3% 9a Basic earnings per share $0.85 $0.71 $0.14 19.7% 9b Diluted earnings per share $0.84 $0.70 $0.14 20.0% 9c Diluted earnings per share-Operating $0.84 $0.71 $0.13 18.3% 9d Diluted earnings per share-Cash $0.91 $0.77 $0.14 18.2% 9e Diluted earnings per share-Cash Operating $0.91 $0.78 $0.13 16.7% ------------------------------------------------------================================================================ Balances At Period End ------------------------------------------------------ 10 Loans $1,779,440 $1,751,184 $28,256 1.6% 11 Investments & other interest bearing accounts 1,284,695 1,281,724 2,971 0.2% (excluding market value adjustment) 12 Earning assets 3,064,135 3,032,908 31,227 1.0% 13 Loan loss reserve 24,080 23,883 197 0.8% 14a Core deposit intangibles,net 32,081 33,678 (1,597) -4.7% 14b Goodwill & other intangibles, net 103,628 102,602 1,026 1.0% 14c Total intangible assets, net 135,709 136,280 (571) -0.4% 15 Total assets 3,468,592 3,408,893 59,699 1.8% 16 Deposits 2,551,735 2,513,261 38,474 1.5% 17a FHLB borrowings 450,600 472,200 (21,600) -4.6% 17b Trust preferred borrowings 77,361 77,347 14 0.0% 17c Total borrowings 527,961 549,547 (21,586) -3.9% 18 Total shareholders' equity 324,161 298,529 25,632 8.6% 19 Assets under management $1,267,289 $1,370,346 ($103,057) -7.5% ================================================================
16
---------------------------------------------------------------- 000's Omitted Three Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Profitability ------------------------------------------------------ 20 Return on assets 1.28% 0.90% 0.38 %pts. 21a Return on equity 14.56% 10.73% 3.83 %pts. 21b Return on equity - operating 14.56% 11.33% 3.23 %pts. 22 Tangible return on assets 1.39% 1.04% 0.35 %pts. 23a Tangible return on equity 15.84% 12.41% 3.43 %pts. 23b Tangible return on equity - operating 15.84% 13.01% 2.83 %pts. 24 Net interest margin (FTE) 4.61% 3.94% 0.67 %pts. 25 Non interest income/operating income (FTE) 18.2% 21.3% (3.1) %pts. (excluding net security gains & branch disposition) 26 Efficiency ratio 49.7% 55.6% (5.9) %pts. (excluding acquisition & unusual expenses & intangible amortization) ------------------------------------------------------================================================================ Capital ------------------------------------------------------ 27 Tier I leverage ratio 6.87% 8.72% (1.85) %pts. 28 Tangible equity / assets 5.65% 6.61% (0.96) %pts. 29 Accumulated other comprehensive income $43,728 $23,633 $20,095 85.0% 30 Diluted weighted average common shares outstanding 13,172 11,736 1,436 12.2% 31 Period end common shares outstanding 12,963 11,579 1,384 12.0% 32 Cash dividends declared per common share $0.29 $0.27 $0.02 7.4% 33 Common stock price $29.63 $27.50 $2.13 7.7% 34 Total return - last 12 months 11.8% 10.3% 1.5 %pts. 35 Book value $25.01 $21.65 $3.36 15.5% 36 Tangible book value $14.54 $15.86 ($1.32) -8.3% ------------------------------------------------------================================================================ Asset Quality Ratios ------------------------------------------------------ 37 Loan loss reserve / 1.35% 1.35% 0.00 %pts. loans outstanding 38 Nonperforming loans / 0.69% 0.54% 0.15 %pts. loans outstanding 39 Loan loss reserve / 197% 247% (50) %pts. nonperforming loans 40 Net charge-offs / 0.47% 0.34% 0.13 %pts. average loans 41 Loan loss provision / 110% 116% (6) %pts. net charge-offs 42 Nonperforming assets / 0.75% 0.67% 0.08 %pts. loans outstanding + OREO ================================================================
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---------------------------------------------------------------- 000's Omitted Nine Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Profitability ------------------------------------------------------ 20 Return on assets 1.15% 0.67% 0.48 %pts. 21a Return on equity 13.50% 8.30% 5.20 %pts. 21b Return on equity - operating 13.70% 10.44% 3.26 %pts. 22 Tangible return on assets 1.26% 0.81% 0.45 %pts. 23a Tangible return on equity 14.82% 10.01% 4.81 %pts. 23b Tangible return on equity - operating 15.01% 12.15% 2.86 %pts. 24 Net interest margin (FTE) 4.56% 3.88% 0.68 %pts. 25 Non interest income/operating income (FTE) 18.1% 20.6% (2.5) %pts. (excluding net security gains & branch disposition) 26 Efficiency ratio 52.9% 57.3% (4.4) %pts. (excluding acquisition & unusual expenses & intangible amortization) ------------------------------------------------------================================================================ Capital ------------------------------------------------------ 27 Tier I leverage ratio 6.87% 8.72% (1.85) %pts. 28 Tangible equity / assets 5.65% 6.61% (0.96) %pts. 29 Accumulated other comprehensive income $43,728 $23,633 $20,095 85.0% 30 Diluted weighted average common shares outstanding 13,157 11,637 1,520 13.1% 31 Period end common shares outstanding 12,963 11,579 1,384 12.0% 32 Cash dividends declared per common share $0.83 $0.81 $0.02 2.5% 33 Common stock price $29.63 $27.50 $2.13 7.7% 34 Total return - last 12 months 11.8% 10.3% 1.5 %pts. 35 Book value $25.01 $21.65 $3.36 15.5% 36 Tangible book value $14.54 $15.86 ($1.32) -8.3% ------------------------------------------------------================================================================ Asset Quality Ratios ------------------------------------------------------ 37 Loan loss reserve / 1.35% 1.35% 0.00 %pts. loans outstanding 38 Nonperforming loans / 0.69% 0.54% 0.15 %pts. loans outstanding 39 Loan loss reserve / 197% 247% (50) %pts. nonperforming loans 40 Net charge-offs / 0.54% 0.35% 0.19 %pts. average loans 41 Loan loss provision / 103% 106% (3) %pts. net charge-offs 42 Nonperforming assets / 0.75% 0.67% 0.08 %pts. loans outstanding + OREO ================================================================
18
---------------------------------------------------------------- 000's Omitted Three Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change No. 2002 2002 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Profitability ------------------------------------------------------ 20 Return on assets 1.28% 1.10% 0.18 %pts. 21a Return on equity 14.56% 13.21% 1.35 %pts. 21b Return on equity - operating 14.56% 13.30% 1.26 %pts. 22 Tangible return on assets 1.39% 1.20% 0.19 %pts. 23a Tangible return on equity 15.84% 14.51% 1.33 %pts. 23b Tangible return on equity - operating 15.84% 14.61% 1.23 %pts. 24 Net interest margin (FTE) 4.61% 4.54% 0.07 %pts. 25 Non interest income/operating income (FTE) 18.2% 17.9% 0.3 %pts. (excluding net security gains & branch disposition) 26 Efficiency ratio 49.7% 53.0% (3.3) %pts. (excluding acquisition & unusual expenses & intangible amortization) ------------------------------------------------------================================================================ Capital ------------------------------------------------------ 27 Tier I leverage ratio 6.87% 6.66% 0.21 %pts. 28 Tangible equity / assets 5.65% 4.96% 0.69 %pts. 29 Accumulated other comprehensive income $43,728 $25,546 $18,182 71.2% 30 Diluted weighted average common shares outstanding 13,172 13,194 (22) -0.2% 31 Period end common shares outstanding 12,963 12,959 4 0.0% 32 Cash dividends declared per common share $0.29 $0.27 $0.02 7.4% 33 Common stock price $29.63 $32.25 ($2.62) -8.1% 34 Total return - last 12 months 11.8% 19.6% (7.8) %pts. 35 Book value $25.01 $23.04 $1.97 8.6% 36 Tangible book value $14.54 $12.52 $2.02 16.1% ------------------------------------------------------================================================================ Asset Quality Ratios ------------------------------------------------------ 37 Loan loss reserve / 1.35% 1.36% (0.01) %pts. loans outstanding 38 Nonperforming loans / 0.69% 0.64% 0.05 %pts. loans outstanding 39 Loan loss reserve / 197% 214% (17) %pts. nonperforming loans 40 Net charge-offs / 0.47% 0.81% (0.34) %pts. average loans 41 Loan loss provision / 110% 96% 14 %pts. net charge-offs 42 Nonperforming assets / 0.75% 0.74% 0.01 %pts. loans outstanding + OREO ==================================================================
19
---------------------------------------------------------------- 000's Omitted Three Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ------------------------------------------------------================================================================ Asset Quality Components ------------------------------------------------------ 43 Nonaccruing loans $10,928 $5,677 $5,251 92.5% 44 90+ days delinquent 1,289 2,842 (1,553) -54.6% 45 Total nonperforming loans 12,217 8,519 3,698 43.4% 46 Troubled debt restructurings 46 85 (39) -45.9% 47 Other real estate 1,033 1,835 (802) -43.7% 48 Total nonperforming assets 13,296 10,439 2,857 27.4% 49 Net charge-offs $2,080 $1,356 $724 53.4% ------------------------------------------------------================================================================ Components of Net Interest Margin (FTE) ------------------------------------------------------ 50 Loan yield 7.45% 8.30% (0.85) %pts. 51 Investment yield 6.58% 6.86% (0.28) %pts. 52 Earning asset yield 7.08% 7.73% (0.65) %pts. 53 Interest bearing deposits rate 2.48% 4.06% (1.58) %pts. 54 Borrowed funds rate - FHLB 3.87% 5.40% (1.53) %pts. 55 Borrowed funds rate - Trust preferred & other 7.47% 8.80% (1.33) %pts. 56 Cost of all interest bearing funds 2.87% 4.45% (1.58) %pts. 57 Cost of funds (includes DDA) 2.46% 3.85% (1.39) %pts. 58 Cost of funds / earning assets 2.47% 3.79% (1.32) %pts. 59 Net interest margin (FTE) 4.61% 3.94% 0.67 %pts. 60 Full tax equivalent adjustment $3,229 $1,935 $1,294 66.9% ------------------------------------------------------================================================================ Average Balances for Period ------------------------------------------------------ 61 Loans $1,763,855 $1,567,842 $196,013 12.5% 62 Investments & other interest bearing accounts 1,302,928 1,025,375 277,553 27.1% (excluding market value adjustment) 63 Earning assets 3,066,783 2,593,217 473,566 18.3% 64 Total assets 3,438,076 2,835,584 602,492 21.2% 65 Deposits 2,542,233 2,076,447 465,786 22.4% 66 FHLB borrowings 468,563 413,518 55,045 13.3% 67 Trust preferred & other borrowings 77,632 66,502 11,130 16.7% 68 Total borrowings 546,195 480,020 66,175 13.8% 69 Total shareholders' equity $301,148 $238,159 $62,989 26.4% ================================================================
20
---------------------------------------------------------------- 000's Omitted Nine Months Ended ---------------------------------------------------------------------------------------------------------------------- Line Six Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Sep 30, Change Change No. 2002 2001 Amount Percent ---------------------------------------------------------------------------------------------------------------------- Asset Quality Components ------------------------------------------------------ 43 Nonaccruing loans $10,928 $5,677 $5,251 92.5% 44 90+ days delinquent 1,289 2,842 (1,553) -54.6% 45 Total nonperforming loans 12,217 8,519 3,698 43.4% 46 Troubled debt restructurings 46 85 (39) -45.9% 47 Other real estate 1,033 1,835 (802) -43.7% 48 Total nonperforming assets 13,296 10,439 2,857 27.4% 49 Net charge-offs $7,001 $4,059 $2,942 72.5% ------------------------------------------------------================================================================ Components of Net Interest Margin (FTE) ------------------------------------------------------ 50 Loan yield 7.55% 8.57% (1.02) %pts. 51 Investment yield 6.72% 6.99% (0.27) %pts. 52 Earning asset yield 7.20% 7.94% (0.74) %pts. 53 Interest bearing deposits rate 2.67% 4.35% (1.68) %pts. 54 Borrowed funds rate - FHLB 4.14% 5.56% (1.42) %pts. 55 Borrowed funds rate - Trust preferred & other 7.48% 9.26% (1.78) %pts. 56 Cost of all interest bearing funds 3.05% 4.69% (1.64) %pts. 57 Cost of funds (includes DDA) 2.61% 4.09% (1.48) %pts. 58 Cost of funds / earning assets 2.64% 4.06% (1.42) %pts. 59 Net interest margin (FTE) 4.56% 3.88% 0.68 %pts. 60 Full tax equivalent adjustment $8,744 $5,265 $3,479 66.1% ------------------------------------------------------================================================================ Average Balances for Period ------------------------------------------------------ 61 Loans $1,746,719 $1,558,611 $188,108 12.1% 62 Investments & other interest bearing accounts 1,266,375 1,032,650 233,725 22.6% (excluding market value adjustment) 63 Earning assets 3,013,094 2,591,261 421,833 16.3% 64 Total assets 3,371,805 2,837,812 533,993 18.8% 65 Deposits 2,544,079 2,068,995 475,084 23.0% 66 FHLB borrowings 420,895 459,404 (38,509) -8.4% 67 Trust preferred & other borrowings 77,864 42,472 35,392 83.3% 68 Total borrowings 498,759 501,876 (3,117) -0.6% 69 Total shareholders' equity $286,053 $230,465 $55,588 24.1% ==================================================================
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---------------------------------------------------------------- 000's Omitted Three Months Ended -------------------------------------------------------------------------------------------------------------------------- Line Three Months Ended June 30, 2002 Restated for SFAS 147 Sep 30, Jun 30, Change Change No. 2002 2002 Amount Percent -------------------------------------------------------------------------------------------------------------------------- Asset Quality Components ---------------------------------------------------------- 43 Nonaccruing loans $10,928 $10,029 $899 9.0% 44 90+ days delinquent 1,289 1,141 148 13.0% 45 Total nonperforming loans 12,217 11,170 1,047 9.4% 46 Troubled debt restructurings 46 59 (13) -22.0% 47 Other real estate 1,033 1,671 (638) -38.2% 48 Total nonperforming assets 13,296 12,900 396 3.1% 49 Net charge-offs $2,080 $3,512 ($1,432) -40.8% ----------------------------------------------------------================================================================ Components of Net Interest Margin (FTE) ---------------------------------------------------------- 50 Loan yield 7.45% 7.43% 0.02 %pts. 51 Investment yield 6.58% 6.78% (0.20) %pts. 52 Earning asset yield 7.08% 7.15% (0.07) %pts. 53 Interest bearing deposits rate 2.48% 2.63% (0.15) %pts. 54 Borrowed funds rate - FHLB 3.87% 4.03% (0.16) %pts. 55 Borrowed funds rate - Trust preferred & other 7.47% 7.37% 0.10 %pts. 56 Cost of all interest bearing funds 2.87% 3.01% (0.14) %pts. 57 Cost of funds (includes DDA) 2.46% 2.58% (0.12) %pts. 58 Cost of funds / earning assets 2.47% 2.61% (0.14) %pts. 59 Net interest margin (FTE) 4.61% 4.54% 0.07 %pts. 60 Full tax equivalent adjustment $3,229 $2,986 $243 8.1% ----------------------------------------------------------================================================================ Average Balances for Period ---------------------------------------------------------- 61 Loans $1,763,855 $1,742,110 $21,745 1.2% 62 Investments & other interest bearing accounts 1,302,928 1,296,787 6,141 0.5% (excluding market value adjustment) 63 Earning assets 3,066,783 3,038,897 27,886 0.9% 64 Total assets 3,438,076 3,390,665 47,411 1.4% 65 Deposits 2,542,233 2,545,301 (3,068) -0.1% 66 FHLB borrowings 468,563 449,235 19,328 4.3% 67 Trust preferred & other borrowings 77,632 77,805 (173) -0.2% 68 Total borrowings 546,195 527,040 19,155 3.6% 69 Total shareholders' equity $301,148 $281,436 $19,712 7.0% ==================================================================
22 Results of Operations Overview: Third quarter 2002 net income was $11.1 million, up $4.6 million or 72% from the same period last year. There were no non-recurring acquisition and other costs this quarter versus $631,000 one year earlier. For the first nine months, net income was $28.9 million, up 101.9% over last year. Earnings per share (diluted) for the third quarter were $0.84, up 53% over the same 2001 period, while earnings per share (diluted) for the first nine months were $2.19, up 78%. These results include the benefit of adopting SFAS 147, an accounting standard that eliminates the regular amortization of goodwill related to the Company's branch acquisitions. This adoption increased third quarter and year-to-date earnings per share by $0.07 and $0.21, respectively. Without this benefit, third quarter earnings per share would have risen 40% and nine-month results would have been up by 61%. The primary reasons for these substantial increases are better earning asset margins over cost of funds and the improved contribution of the Company's three 2001 acquisitions. Together, these transactions added $1.2 billion in assets and expanded the Company's branch network by 70% as of year-end 2001. Effective January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other Intangible Assets," which eliminated the requirement to regularly amortize approximately $19.8 million in goodwill related to certain of its acquisitions. Annual amortization expense was thus reduced by approximately $1.3 million; $.015 of the increase in earnings per share (diluted) this quarter and $0.045 for the first nine months reflects the impact of this adoption. The Company completed its goodwill impairment analysis during 2002, and no adjustment was necessary. The primary reasons for improved third quarter earnings compared to the same period last year are a 36% increase in net interest income and a 15% rise in noninterest income. The resulting higher operating income more than offset a higher loan loss provision (reflective of a $724,000 or 53% increase in net charge-offs) and increased overhead resulting from the acquisition of the former FleetBoston branches in mid-November 2001. Year-to-date earnings were up versus the comparable period last year for primarily the same reasons. Proforma: Performance as measured by operating earnings, which exclude expenses and securities transactions related to acquisitions, is considered by some securities analysts to be a more accurate reflection of the underlying core earnings strength of a company. CBU's operating earnings per share (diluted) for the third quarter were $0.84, up 45% from the prior year's level of $0.58, while operating earnings per share (diluted) for the nine months were $2.23, up 44%. Excluding the benefit of adopting SFAS 147, third quarter operating earnings per share would have risen 33% to $0.77, and nine-month results would have been up by 30% to $2.02. CBU has also historically reported its performance using another measure of earnings power--cash earnings. Now that SFAS 147 has been adopted, this metric has been redefined to exclude from earnings the expense of regularly amortizing core deposit intangibles (CDI). CDI represents the premium the Company has paid for deposits acquired in excess of the cost incurred had the funds been purchased in the capital markets. Amortization of CDI is a non-cash expense, and adding it back (tax-adjusted) to reported earnings creates the cash earnings metric. Cash earnings are believed to be a better measure of a Company's ability to build capital, fund expansion, and pay shareholder dividends. CBU's cash operating earnings per share (diluted) for the third quarter were $0.91, up 36% from the prior year, while cash operating earnings per share (diluted) for the nine months were $2.44, also up 36%. 23 Net Interest Income Net interest income for third quarter 2002 rose to $32.4 million, 36% over the same period last year. The improvement largely reflects improved margins and higher earning asset levels. In particular, the market served by the former FleetBoston branches contributed $172 million in commercial and consumer loans and $504 million in low-cost core deposits as of September 30. While net run-off of loans in that new market has approximated 3% since acquisition date, core deposits have risen over 5%. The quarter also benefited from a build-up of the investment portfolio earlier in the year and a $47 million increase in loans outstanding over the past nine months. The net interest margin was 4.61%, up 67 basis points from the year-earlier level of 3.94%. The margin's low point was in second quarter 2001 at 3.78%; it then widened for three consecutive quarters, and has essentially leveled off during the last two quarters. o The rise in margin reflects a slower decrease in earning asset yields than in the cost of funds. Approximately 34% of earning assets reprice within one year. Of total interest-bearing liabilities, 55% are regularly repriced (maturing C.D.s, money market accounts, and certain borrowings) and another 25% are repriced periodically (interest checking and savings). Maturing certificates of deposit continued to reprice downward by 68 basis points on average during the quarter, slowing from the 91- and 212-basis-point pace of the second and first quarter 2002, consistent with lower financial market interest rates. The rate on total capital market borrowings was reduced by 15 basis points during the third quarter. The difference between the net interest spread of earning assets over liabilities and the net interest margin has narrowed over the last four quarters, primarily as a result of an increased proportion of interest-bearing liabilities. o Earning assets were 19% higher than one year earlier, comprised of $215 million more in loans and $273 million more in securities. Over the last 90 days, earning assets rose $31 million; loans increased by $28 million while investments rose by $3 million. Growth in third quarter average assets of $602 million compared to one year earlier was largely funded by an increase in average retail and commercial deposits of $484 million, a planned decrease in more volatile public fund deposits of $18 million, and an increase in average borrowings of $66 million. Total borrowings as a percent of earning assets ended the quarter at 17% versus 12% at year-end, following the closing of the FleetBoston transaction, and 18% as of September 30, 2001. o The $3 million increase in investment securities this quarter reflects partial reinvestment of proceeds from $52 million in securities sales during the second quarter, which generated $1.1 million in gains. Approximately $216,000 in gains was recognized in the third quarter on the sale of $9.7 million in corporate bonds whose credit outlook had fallen to the low end of policy guidelines. Investment portfolio purchases for the third quarter were $57 million, down sharply from $86 million in the second quarter and $199 million in the first. The purchases in the first and second quarter, which were funded by short-term borrowings, reflected attractive buying opportunities at that time both as to gross yield and as a spread over borrowings, and represented an earnings strategy intended to supplement the projected shortfall in loan growth compared to the Company's initial 2002 goals. Since that purchase strategy was implemented, gross yields on securities with the combination of maturity, market value exposure, and interest rate characteristics that fit our investment criteria have been diminishing. o Third quarter net interest income exceeded the second quarter 2002 level by $959,000, primarily reflective of loans booked in the last 90 days and the investment securities adjustment noted above. An additional $336,000 in accrued income on a collateralized mortgage obligation was booked in the third quarter. Had this entry not occurred, the third quarter net interest margin would have been 4.57%, virtually the same as the 4.56% margin in the second quarter as adjusted for reversal of certain loan income and accretion of discount on a called investment security. 24 The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. 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 earning assets for purposes of these computations.
Three Months Ended September 30, --------------------------------------------------------------------- (000's omitted except yields and rates) 2002 2001 --------------------------------------------------------------------- Average Average Average Amount Yield/Rate Average Amount Yield/Rate Balance of Interest Paid Balance of Interest Paid --------------------------------------------------------------------- ASSETS Interest-earning assets: Federal funds sold $ 0 $ 0 0.00% $ 16,928 $ 171 4.01% Time deposits in other banks 839 1 0.47% 278 2 2.85% Taxable investment securities 910,937 14,506 6.32% 784,524 13,348 6.75% Nontaxable investment securities 391,152 7,108 7.21% 223,645 4,197 7.45% Loans (net of unearned discount) 1,763,855 33,131 7.45% 1,567,842 32,808 8.30% ---------------------- -------------------- Total interest-earning assets 3,066,783 54,746 7.08% 2,593,217 50,526 7.73% Noninterest earning assets: Cash and due from banks 99,251 70,246 Premises and equipment 57,036 43,714 Other assets 195,759 125,876 Reserve for loan losses (23,900) (20,831) Net unrealized gains on available-for-sale portfolio 43,147 23,362 ----------- ---------- Total assets $ 3,438,076 $2,835,584 =========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Savings deposits $ 968,345 2,843 1.16% $ 651,672 3,036 1.85% Time deposits 1,126,585 10,257 3.61% 1,078,799 14,653 5.39% Short-term borrowings 173,954 830 1.89% 83,203 836 3.99% Long-term borrowings 372,241 5,190 5.53% 396,817 6,257 6.26% ---------------------- -------------------- Total interest-bearing liabilities 2,641,125 19,120 2.87% 2,210,491 24,782 4.45% Noninterest bearing liabilities: Demand deposits 447,303 345,976 Other liabilities 48,500 40,958 Shareholders' equity 301,148 238,159 ----------- ---------- Total liabilities and shareholders' equity $ 3,438,076 $2,835,584 =========== ========== Net interest earnings $35,626 $25,744 ======= ======= Net interest spread 4.21% 3.28% Net interest margin on interest-earning assets 4.61% 3.94% Federal tax exemption on nontaxable investment Securities and loans included in interest income $ 3,229 $ 1,935
25 The change in net interest income (fully tax-equivalent basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category. The volume and rate components of interest income and interest expense for each underlying category are as follows: ------------------------------------------------------------------------------- 3rd Quarter 2002 versus 3rd Quarter 2001 Increase (Decrease) Due to Change in (1) --------------------------------------- Net (000's omitted) Volume Rate Change ------------------------------------------------------------------------------- Interest earned on: Federal funds sold ($86) ($86) ($171) Time deposits in other banks 2 (3) (1) Taxable investment securities 2,052 (894) 1,158 Nontaxable investment securities 3,048 (137) 2,911 Loans (net of unearned discount) 3,871 (3,548) 323 Total interest-earning assets (2) 8,697 (4,477) 4,220 Interest paid on: Savings deposits 1,166 (1,359) (193) Time deposits 624 (5,020) (4,396) Short-term borrowings 589 (595) (6) Long-term borrowings (372) (695) (1,067) Total interest-bearing liabilities (2) 4,221 (9,883) (5,662) Net interest earnings (2) $ 5,115 $ 4,767 $ 9,882 (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. 26 Noninterest Income The following table sets forth information for noninterest income by category for the periods indicated:
Three Months Ended September 30, Nine Months Ended Sept. 30, --------------------------------------------------------------------------------- Change from 3Q '01 Change from 2Q '02 ------------------ ------------------ Change Change (000's omitted) 2002 Amount Percent Amount Percent 2002 Amount Percent ----------------------------------------------------------------------------------------------------------------------------------- Personal trust $ 376 ($96) -20.3% ($64) -14.5% $1,330 ($78) -5.5% EBT/BPA 1,123 92 8.9% 28 2.6% 3,321 524 18.7% Elias Asset Management 627 (277) -30.6% (158) -20.1% 2,190 (708) -24.4% CISI 709 115 19.4% (449) -38.8% 3,059 1,289 72.8% Insurance - CBNA 854 167 24.3% 782 1086.1% 981 182 22.8% ----------------------------------------------------------------------------------------------------------------------------------- Total financial services 3,689 1 0.0% 139 3.9% 10,881 1,209 12.5% Electronic banking 618 265 75.1% 72 13.2% 1,770 717 68.1% Mortgage banking (47) (133) -154.7% (113) -171.2% 138 (226) -62.1% Commercial leasing 1 (12) -92.3% (4) -80.0% 9 (25) -73.5% Deposit service charges 1,371 307 28.9% 39 2.9% 4,017 797 24.8% Overdraft fees 1,736 426 32.5% 154 9.7% 4,750 1,109 30.5% Commissions 510 60 13.3% 10 2.0% 1,624 25 1.6% Miscellaneous revenue (6) (23) -135.3% 8 -57.1% (15) (19) -475.0% ----------------------------------------------------------------------------------------------------------------------------------- Total general banking services 4,183 890 27.0% 166 4.1% 12,293 2,378 24.0% ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest income excluding Investment security gain (loss), net and disposition of branch properties 7,872 891 12.8% 305 4.0% 23,174 3,587 18.3% Investment security gain (loss), net 216 (2,472) -92.0% (928) -81.1% 1,359 (1,200) -46.9% Disposition of branch properties 0 0 0.0% 0 0.0% 0 0 0.0% ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest income $ 8,088 ($1,581) -16.4% ($623) -7.2% $ 24,533 $ 2,387 10.8% =================================================================================================================================== Noninterest income as a percentage of operating income (excludes investment security gain (loss), net and other timing adjustments) 18.2% -3.1% 0.3% 18.1% -2.5%
Third quarter financial services revenue at $3.7 million was unchanged compared to third quarter last year, but up $139,000 or 3.9% from the second quarter 2002 level. o The primary source of improvement over the linked quarter and maintenance of the year ago level was receipt of the Company's annual dividend on its creditor life insurance program managed by a subsidiary of the New York Bankers Association. The dividend reached an all-time high of $750,000 compared to $617,000 one year earlier. Compared to third quarter 2001, growth in the creditor life dividend and in revenues from the Company's Benefit Plans Administrative Services (BPA) subsidiary (up 9% due to a steady rise in plan sponsors) and broker-dealer, Community Investment Services, Inc. (CISI, up 19%) equally offset reductions of 20% from personal trust and 31% at Elias Asset Management. The success of CISI reflects an expanded number of financial consultants and a significant increase in branch referrals to the consultants. Third quarter 2002 financial services revenue was above second quarter 2002 due to the record dividend. Significant third quarter declines at CISI, personal trust and Elias were mostly a result of unfavorable equity market conditions. CISI was also adversely affected by substantial reductions in the interest rates being offered on annuity products for which they act as agent. o Financial services revenue comprised 47% of total recurring noninterest income for the quarter versus 53% one year earlier. The decrease was caused by increased overdraft and deposit service charge income from the former FleetBoston accounts acquired in mid- 27 November 2001; in contrast, the financial services accounts held by the FleetBoston customers were not offered as part of the acquisition package. o Assets under management were $1.267 billion as of quarter end, a 7.5% reduction from the June 30, 2002 level. This decrease reflects a double-digit reduction in assets under management at EAM, which historically has invested in large capitalization growth stocks, partially offset by lesser decreases in the Bank's personal trust department and broker-dealer, reflective of the more balanced nature of their portfolios. In contrast, strong new business generation at BPA resulted in an increase in assets under management of $11.7 million or 3.2%. Compared to September 30, 2001, assets under management are higher by $30 million or 2.4%, reflective of growth at BPA and personal trust, a very respectable figure when compared to many broad market indicators, including a 22% decline in the Standard & Poor's 500 equity market index. General banking revenues were $4.2 million for the quarter, up 27% or $890,000 over the same period last year and up 4.1% or $166,000 from second quarter 2002. o A primary reason for the improvement over prior year was the contribution of the acquired FleetBoston branches, largely in deposit service charges and overdraft fees. Bank-wide these items rose a combined 31% or $733,000 compared to third quarter 2001. While deposit service charges were up slightly over second quarter 2002, overdraft fees increased 9.7% or $154,000 due to an increase in the customer insufficient funds charge and higher volumes, which in part reflected a better collection rate. o Electronic banking revenues climbed 75% or $265,000 in the quarter compared to one year earlier, mirroring the higher customer base due to 2001's acquisitions and greater product usage, and increased 13% or $72,000 over the second quarter 2002 level. o Mortgage banking fees were slightly negative for the quarter because of a $115,000 write-down of mortgage servicing rights (approximately 21% of the value at June 30, 2002) due to accelerated mortgage prepayments caused by record refinancing. The rights are presently 0.39% of the $104 million serviced portfolio outstanding, which has been running down because of prepayments and the decision to suspend sale of secondary market-eligible production as of late fall last year. Fees from servicing mortgages previously sold on the secondary market are a relatively minor activity for the Company at this time. The ratio of noninterest income to operating income (FTE) was 18.2% for third quarter 2002, down 3.1 percentage points from the same period last year. In part, the decreases reflect the unusually large 38% increase in net interest income (FTE) caused by higher earning assets and improved margins. In addition, the added revenues from cross selling financial services from the 2001 acquisitions have not yet been fully realized. The ratio rose a slight 0.3% from second quarter 2002 because of the annual receipt of the Company's creditor life insurance dividend. The Company remains committed to its long-standing objective of increasing noninterest income and its proportionate share of operating revenues. 28 The following table reconciles differences between the line of business noninterest income breakdown and regulatory reporting definitions as reflected on the Call Report.
Nine Months Ended September 30, 2002 -------------------------------------------------------------------------------------------- Regulatory Reporting Categories -------------------------------------------------------------------------------------------- Other Service Fiduciary and Service Charges Commissions Charges, Other Investment Total Investment on Deposit on Investment Commissions Operating Security Gain Other (000's omitted) Services Accounts Products and Fees Income (Loss), net Income ---------------------------------------------------------------------------------------------------------------------------------- Personal trust $1,330 $1,330 EBT/BPA 1,154 2,167 3,321 Elias Asset Management 2,190 2,190 CISI 3,059 3,059 Insurance - CBNA 981 981 ---------------------------------------------------------------------------------------------------------------------------------- Total financial services 2,484 0 5,249 3,148 0 0 10,881 Electronic banking 617 1,152 1,769 Mortgage banking 132 6 138 Commercial leasing 9 9 Deposit service charges 4,017 4,017 Overdraft fees 4,750 4,750 Commissions 1,624 1,624 Miscellaneous revenue (14) (14) ---------------------------------------------------------------------------------------------------------------------------------- Total general banking services 0 9,384 0 2,917 (8) 0 12,293 Total noninterest income excluding Investment security gain (loss), net And disposition of branch properties 2,484 9,384 5,249 6,065 (8) 0 23,174 Investment security gain (loss), net 1,359 1,359 ---------------------------------------------------------------------------------------------------------------------------------- Total noninterest income $2,484 $9,384 $5,249 $6,065 ($8) $1,359 $24,533 ==================================================================================================================================
29 Noninterest Expense Third quarter noninterest expense of $23.1 million was $2.7 million or 13.2% higher than the equivalent 2001 period. Noninterest expense of $71.8 million for the nine months ending September 2002 was up $6.7 million or 10.4% compared to the previous year. Excluding acquisition and unusual expenses, third quarter noninterest expense was up $3.3 million or 16.8% versus the prior year. September year-to-date noninterest expense of $71.1 million excluding acquisition and unusual expenses was $12.2 million or 20.6% higher than the same period of 2001. The quarterly and year-to-date increases were primarily a result of the acquisition of the FleetBoston branches in mid-November of 2001. These increases must be placed in context with 19% growth in earning assets and 32% growth in operating income over the last four quarters. The following table sets forth information for noninterest expenses by category for the periods indicated.
Three Months Ended September 30, Nine Months Ended Sept. 30, ------------------------------------------------------------------------------------ Change from 3Q '01 Change from 2Q '02 ------------------ ------------------ Change Change (000's omitted) 2002 Amount Percent Amount Percent 2002 Amount Percent -------------------------------------------------------------------------------------------------------------------------- Personnel expense $12,020 $2,141 21.7% ($245) -2.0% $36,411 $6,090 20.1% Net occupancy expense 1,781 317 21.7% (295) -14.2% 6,179 1,625 35.7% Equipment expense 1,714 196 12.9% (270) -13.6% 5,569 1,153 26.1% Legal and professional fees 845 100 13.4% 164 24.1% 2,380 317 15.4% Data processing expense 1,813 473 35.3% 70 4.0% 5,234 1,419 37.2% Amortization of intangibles 1,597 56 3.6% 93 6.2% 4,641 99 2.2% Stationary and supplies 458 (43) -8.6% (152) -24.9% 1,756 352 25.1% Foreclosed property expense 111 (104) -48.4% (179) -61.7% 730 (21) -2.8% Deposit insurance premiums 106 9 9.3% (3) -2.8% 336 81 31.8% Other 2,624 174 7.1% (85) -3.1% 7,861 1,048 15.4% ------------------------------------------------------------------------------------------------------------------------- Total before one-time expenses 23,069 3,319 16.8% (902) -3.8% 71,097 12,163 20.6% Acquisition and unusual expenses 0 (631) -100.0% (108) -100.0% 700 (5,417) -88.6% ------------------------------------------------------------------------------------------------------------------------- Total noninterest expense $23,069 $2,688 13.2% ($1,010) -4.2% $71,797 $6,746 10.4% ========================================================================================================================= Total operating expenses as a percentage of average assets 2.66% -0.19% -0.16% 2.85% -0.22% Efficiency ratio 49.7% -5.9% -3.3% 52.9% -4.4%
Third quarter personnel expense was up $2.1 million or 21.7% from third quarter 2001 levels, accounting for 65% of the increase in noninterest expense excluding acquisition and unusual expenses. Total full-time equivalent staff at the end of September 2002 was 1,124, up 191 from the end of September 2001 as a result of the branches acquired from FleetBoston and the impact of the acquisition on selected back office and administrative staffing requirements. These staffing increases also caused year-to-date personnel expense to rise $6.1 million or 20.1% versus the prior year. 30 Third quarter non-personnel expense excluding acquisition and unusual expenses was $1.2 million or 11.9% higher than the prior year period. The increase was mostly attributable to data processing expenses, up $473,000 or 35.3%; occupancy expense, up $317,000 or 21.7%; and equipment expense, up $196,000 or 12.9%. Occupancy expenses were higher primarily as a result of the impact of the FleetBoston branches acquired. Increased data processing expenses were mainly due to higher Fiserv processing fees (the Company outsources its main-frame system), Federal Reserve Bank check processing expenses and data line charges, all reflective of greater processing volumes and communications costs of the acquired FleetBoston branches. The rise in third quarter equipment expenses was largely a result of higher depreciation due to the increased number of branches in 2002. Higher occupancy, data processing and equipment expenses were also the primary causes for the year-to-date non-personnel expense increase of $6.1 million or 21.2%, excluding acquisition and unusual expenses. Administrative expenses such as office supplies, postage and telephone charges also contributed to the higher expense level, again reflecting the additional number of branches and employees arising from the FleetBoston transaction. Third quarter operating expenses excluding acquisition and unusual expenses were $902,000 or 3.8% below the level of second quarter 2002. Overhead in the banking segment of the Company in third quarter 2002 was $850,000 lower than it was in the prior 90 days. This reduction reflects seasonality, lower write-down of repossessed property, and favorable expense variances. Financial services overhead decreased from the second quarter level due to lower commission expense on reduced sales. The Company's efficiency ratio, which excludes intangible amortization, net securities gains/losses, acquisition costs, and unusual income and expense items, was an historically low 49.7% for third quarter 2002, resulting in a 5.9-percentage-point improvement from the comparable 2001 quarter and a 3.3-percentage-point decrease from second quarter 2002. o The year-over-year change reflects the full impact of combined $3.2 million in First Liberty cost savings implemented in mid-second quarter 2001 and the benefit of streamlining our operations functions by eliminating duplicate loan and deposit processing units in Canton and Olean, N.Y. The improvement over second quarter 2002 resulted from the expense reductions discussed above as well as the record annual dividend in the third quarter on the Company's creditor life insurance program. o There were no acquisition and unusual expenses in the third quarter (by definition, they are excluded from the efficiency ratio calculation). For the first nine months, these one-time costs totaled $700,000 in contrast to $6.1 million for the same period last year. Income Taxes The effective income tax rate was 27.0% for the third quarter and 27.0% for the nine months ending September 30, 2002, 0.3 and 2.0 percentage points below the prior year periods, respectively. These reductions were due to a higher percentage of income being derived from tax-exempt securities and other tax planning strategies. 31 Financial Condition Cash and Investments Cash and investments were $1.460 billion at the end of the third quarter, an increase of $205 million or 16.4% from the balances at December 31, 2001. Average cash and investments of $1.445 billion for the third quarter were up $242 million or 20.1% from the fourth quarter of 2001 and $343 million or 31.1% from third quarter 2001 levels. The investment portfolio was increased in 2002, especially earlier in the year, to take advantage of attractive buying opportunities in terms of gross yield and spread over borrowings, and to offset some of the projected shortfall in loan growth resulting from soft economic conditions in many of our primary markets.
September 30, 2002 December 31, 2001 Amortized Estimated Fair Amortized Estimated Fair (000's omitted) Cost Value Cost Value ----------------------------------------------------------------------------------------------------------------------------------- Amount Mix % Amount Mix % Amount Mix % Amount Mix % ------ ----- ------ ----- ------ ----- ------ ----- Held to Maturity Portfolio Obligations of states and political subdivisions $ 7,476 100% $ 7,869 100% $ 7,608 100% $ 7,832 100% Available for Sale Portfolio U.S. treasury securities and agency obligations 382,953 30% 412,067 31% 192,111 17% 203,501 18% Obligations of states and political subdivisions 405,522 32% 429,409 32% 282,110 25% 277,593 24% Corporate securities 33,092 3% 36,619 3% 43,392 4% 44,399 4% Collateralized mortgage obligations 273,628 21% 284,837 21% 400,100 36% 403,780 35% Mortgage-backed securities 149,497 12% 154,983 11% 173,978 15% 179,786 16% FHLB stock and other equity securities 25,821 2% 25,821 2% 25,863 2% 25,863 2% Federal Reserve Bank common stock 5,652 0% 5,652 0% 5,652 1% 5,652 1% ---------------------------------------------------------------------------------------------------------------------------------- Total available for sale investments 1,276,165 100% $1,349,388 100% 1,123,206 100% $1,140,574 100% Net unrealized gain on available for sale investments 73,222 17,368 ---------- ---------- GRAND TOTAL CARRYING VALUE $1,356,863 $1,148,182 ========== ==========
The mix of securities in the investment portfolio was altered during the first nine months of 2002 as part of an overall investment strategy to further protect net interest income in a falling rate environment. CMOs and corporate bonds were sold, and U.S. agency and municipal securities were purchased. The net unrealized gain on the investment portfolio has grown by $55.9 million through September 30, 2002 due to market price appreciation caused by declining interest rates. See further discussion of the investment purchases in the "Net Interest Income" section above. Loans Loans ended the third quarter at $1.779 billion, up $215 million or 13.7% from September 30, 2001. The improvement reflects the contribution of the acquired FleetBoston branch loans as well as consumer loan growth largely in the Company's long-standing markets. Compared to December 31, 2001, total loans have increased by $47 million, reflecting an $8 million contraction in the first quarter followed by growth in the second and third quarters of $27 million and $28 million, respectively, or a combined 3.2% over the last six months. Excluding the impact of acquisitions, this quarter's increase was the largest since second quarter 2000. o Business lending decreased $2 million during the last 90 days following a $7 million drop in the second quarter and a $6 million drop in the first. With the exception of acquisitions, commercial loan growth has been relatively flat for the last two years, reflective of reduced business activity in our markets due to economic softness, the desire to maintain credit quality, and use of commercial lenders in evaluating and integrating acquisitions versus developing new business. Though commercial loan production in the overall New York 32 franchise remains off, outstandings have been climbing slightly in the Northeastern Pennsylvania market (the Bank's First Liberty subsidiary) over the last six months. Business loan outstandings at quarter end were $629 million (35% of total loans outstanding). o Consumer direct loans increased slightly over $1 million in the third quarter following an over $9 million climb during the second quarter. This growth, compared to a $19 million decrease in first quarter 2002, reflects the impact of the Company's spring marketing program to homeowners, which included promotional rates on home equity loans and direct installment loans. Run-off in the portfolio due to regular repayments was stemmed in the New York markets but was relatively unchanged in the First Liberty market. Consumer direct loans ended the quarter at $388 million (22% of total loans outstanding). o Consumer indirect loans, largely borrowing originated in automobile dealer showrooms, rose $11 million during the third quarter following increases of $15 million and $5 million in the second and first quarters, respectively. Both the New York and Pennsylvania markets contributed growth, and new originating dealers have also been added. Overall, used vehicles constitute 75% of CBU's indirect automobile loans outstanding. Indirect loans at quarter end were $280 million (16% of total loans outstanding). o Consumer mortgages rose $17 million over the last 90 days, the greatest increase this year after rising $9 million in the second quarter and $12 million in the first. This rise reflects the Company's spring homeowner marketing campaign, the most favorable refinancing environment seen in decades, and the Company's strategy for the last nine months to book secondary-market-eligible loans in portfolio, made possible because of the increase in core deposit funding from the FleetBoston branch acquisition. Over the last twelve months, consumer mortgages have increased $39 million or 9% to $482 million (27% of total loans outstanding). 33 The amounts of the Company'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:
--------------------------------------------------------------------------------------- As of September 30, ------------------------------------------ Change Change (000's omitted) 2002 2001 Amount Percent --------------------------------------------------------------------------------------- Real estate mortgages: Residential $ 737,858 $ 599,079 $ 138,779 23.2% Commercial loans secured by real estate 271,354 263,130 8,224 3.1% Farm 22,034 21,507 527 2.5% --------------------------------------------------------------------------------------- Total 1,031,246 883,716 147,530 16.7% Commercial, financial, and agricultural: Commercial and financial 255,859 236,205 19,654 8.3% Agricultural 26,650 25,829 821 3.2% --------------------------------------------------------------------------------------- Total 282,509 262,034 20,475 7.8% Installment loans to individuals 434,683 386,863 47,820 12.4% Other loans 31,139 32,442 (1,303) -4.0% --------------------------------------------------------------------------------------- Gross loans 1,779,577 1,565,055 214,522 13.7% Less: unearned discount 137 249 (112) -45.0% --------------------------------------------------------------------------------------- Net loans 1,779,440 1,564,806 214,634 13.7% Allowance for loan losses 24,080 21,083 2,997 14.2% --------------------------------------------------------------------------------------- Loans, net of allowance for loan losses $1,755,360 $1,543,723 $ 211,637 13.7% =======================================================================================
The following table reconciles the differences between the line of business loan breakdown reflected in the narrative of this report as compared to regulatory reporting definitions reflected on the Call Report.
----------------------------------------------------------------------------------------- Line of Business as of September 30, 2002 ------------------------------------------------------- Consumer Consumer Consumer Business Total (000's omitted) Direct Indirect Mortgages Lending Loans ----------------------------------------------------------------------------------------- Regulatory Reporting Categories: Loans secured by real estate: Residential $225,414 $ 0 $479,979 $ 32,465 $ 737,858 Commercial 46 0 2,032 269,276 271,354 Farm 33 0 22,001 22,034 Agricultural loans 356 0 26,294 26,650 Commercial loans 14,041 0 241,818 255,859 Installment loans to individuals 145,861 280,345 105 8,372 434,683 Other loans 2,258 0 28,881 31,139 ----------------------------------------------------------------------------------------- Total loans 388,009 280,345 482,116 629,107 1,779,577 Unearned discount 137 0 0 0 137 ----------------------------------------------------------------------------------------- Net loans $387,872 $280,345 $482,116 $629,107 $1,779,440 =========================================================================================
Asset Quality Asset quality as of September 30, 2002 reflects increased nonaccruing loans from one year ago, largely isolated to three commercial loans added during first and second quarter 2002, and a higher number of real estate mortgages added gradually throughout the period. Overall, nonperforming loans (including 90-day delinquencies) have risen $3.7 million or 43% over the last 12 months, and $1.0 million or 9% in the last 90 days. As a percent of loans outstanding, nonperforming loans were 0.69% at quarter end compared to 0.54% one year earlier and 0.64% at June 30, 2002. 34 Net charge-offs for the third quarter were $2.1 million compared to $1.4 million one year ago; they were down significantly from $3.5 million in second quarter 2002. For the last 12 months, quarterly net charge-offs have averaged $2.4 million compared to $1.6 million for the preceding 12-month period. o The primary reason for the overall increase in charge-offs is the impact of the softening economy on certain of our commercial borrowers, including two aforementioned larger customers in the second quarter of this year. Until the economy begins to strengthen, it is difficult to estimate whether the current 12-month run-rate for commercial net charge-offs of $1.3 million per quarter will move closer to its average of the prior 12-month period of about $500,000 per quarter. o Consumer installment net charge-offs have averaged $1.0 million per quarter since September 30, 2001, virtually unchanged from the preceding 12-month period. Consumer mortgage charge-offs continue to be historically de minimus. The upturn in real estate nonperformers noted above may be a reflection of overall weaker economic conditions. o Total net charge-offs for the first nine months of the year were $7.0 million, up $2.9 million or 73%, reflecting higher commercial loan write-offs as discussed above. o All net charge-off ratios stated below are on annualized basis. As a percent of average loans outstanding, net charge-offs for the third quarter were 0.47%, well within the range of the trailing four quarters of 0.33% - 0.81%. Consistent with the recently higher level of net charge-offs, the average quarterly rate for the last 12 months at 0.56% exceeded that for the preceding 12-month period of 0.41%. Year-to-date, net charge-offs have averaged 0.54% of outstandings versus 0.35% in 2001. The sole cause of the increase was commercial net charge-offs; as a percent of related outstandings for the first nine months of this year, they averaged 0.78% versus 0.17% for the comparable 2001 period. In contrast, consumer installment loans have averaged 0.89% this year, an improvement over 1.00% for full year 2001. Mortgage and home equity net charge-offs have been negligible. Regular bottom-up review of the asset quality of the portfolio is completed each quarter. Specific loan loss allocations for certain identified commercial customers are considered and revised as necessary, and charge-offs are taken against these reserves before being applied against the general reserve. General allocations against non-criticized commercial loans and the consumer product lines are reviewed and recalculated quarterly based on historical loss experience, performance trends, and various quantifiable judgement factors. As a result of this process, a required loan loss reserve of $24.1 million was determined as of September 30, 2002, resulting in a $2.3 million loan loss provision compared to $1.6 million in third quarter 2001 and $3.4 million in second quarter 2002. This provision represented 110% of net charge-offs, bringing year-to-date coverage to 103%, down slightly from 106% last year at this time. As noted above, nonperforming loans (loans 90 days past due and non-accruing) were 0.69% as a percent of loans outstanding at quarter end versus 0.54% one year earlier. Though higher than a year ago, the level of this ratio compared favorably with the peer bank median at June 30, 2002, which was 0.95% versus the Company's ratio of 0.64% at that time. Peer bank coverage of the reserve over nonperformers, a general comparative measure of reserve adequacy, was 202% as of the same date, less than the Company's coverage ratio of 214%. The Company's coverage ratio decreased slightly during the third quarter to 197%, for which no comparable peer data is yet available. Delinquent loans (30 days through nonaccruing) as a percent of total outstandings increased a slight three basis points during the last 90 days to 1.80%. This compares to 1.96% one year ago, after which the ratio steadily fell for three consecutive quarters. 35 The following table presents information concerning the aggregate amount of nonperforming assets:
------------------------------------------------------------------------------------------------ As of September 30, --------------------------------------- Change Change (000's omitted) 2002 2001 Amount Percent ------------------------------------------------------------------------------------------------ Loans accounted for on a nonaccrual basis $10,928 $ 5,677 $ 5,251 92.5% Accruing loans which are contractually past due 90 days or more as to principal or interest payments 1,289 2,842 (1,553) -54.6% ------------------------------------------------------------------------------------------------ Total nonperforming loans 12,217 8,519 3,698 43.4% Restructured loans 46 85 (39) -45.9% Other real estate 1,033 1,835 (802) -43.7% ------------------------------------------------------------------------------------------------ Total non performing assets $13,296 $10,439 $ 2,857 27.4% ================================================================================================ Ratio of allowance for loan losses to period-end loans 1.35% 1.35% 0.00% Ratio of allowance for loan losses to period-end nonperforming loans 197.1% 247.5% -50.4% Ratio of allowance for loan losses to period-end nonperforming assets 181.1% 202.0% -20.9% Ratio of nonperforming loans to period-end loans 0.69% 0.54% 0.15% Ratio of nonperforming assets to period-end total loans and other real estate 0.75% 0.67% 0.08%
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. 36 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 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.
Three Months Ended September 30, Nine Months Ended September 30, ----------------------------------------------------------------------------------------- Change Change Change Change (000's omitted) 2002 2001 Amount Percent 2002 2001 Amount Percent ----------------------------------------------------------------------------------------------------------------------------------- Amount of loans outstanding at end of period $1,779,440 $1,564,806 $214,634 13.7% $1,779,440 $1,564,806 $214,634 13.7% ---------------------------------------------------------------------------------------------------------------------------------- Daily average amount of loans (net of unearned discount) 1,763,855 1,567,842 196,013 12.5% 1,746,719 1,558,611 188,108 12.1% ---------------------------------------------------------------------------------------------------------------------------------- Balance of allowance for loan losses at beginning of period 23,883 20,860 3,023 14.5% 23,901 20,035 3,866 19.3% Loans charged off: Commercial, financial, and agricultural 864 128 736 575.0% 4,021 1,015 3,006 296.2% Real estate 84 21 63 300.0% 84 117 (33) -28.2% Installment 1,642 1,612 31 1.9% 4,654 4,443 211 4.7% ---------------------------------------------------------------------------------------------------------------------------------- Total loans charged off 2,590 1,761 830 47.1% 8,759 5,575 3,184 57.1% Recoveries of loan previously charged off: Commercial, financial and agricultural 53 27 26 96.3% 248 259 (11) -4.2% Real estate 11 4 7 175.0% 117 55 62 112.7% Installment 446 374 72 19.3% 1,393 1,202 191 15.9% ---------------------------------------------------------------------------------------------------------------------------------- Total recoveries 510 405 105 25.9% 1,758 1,516 242 16.0% ---------------------------------------------------------------------------------------------------------------------------------- Net loans charged off 2,080 1,356 725 53.5% 7,001 4,059 2,942 72.5% Provision for loan losses 2,278 1,579 699 44.3% 7,180 4,320 2,860 66.2% Reserve on acquired loans (1) 0 0 0 0.0% 0 787 (787) -100.0% ---------------------------------------------------------------------------------------------------------------------------------- Balance of allowance for loan losses at end of period $ 24,080 $ 21,083 $ 2,997 14.2% $ 24,080 $ 21,083 $ 2,997 14.2% ================================================================================================================================== Ratio of net charge-offs to average loans outstanding 0.47% 0.34% 0.13% 0.54% 0.35% 0.19%
(1) This reserve addition is attributable to loans purchased from Citizens National Bank of Malone. Deposits Total deposits at September 30, 2002 were $2.552 billion, $6 million or 0.2% above the balance at year-end 2001. Third quarter average total deposits of $2.542 billion remained essentially flat with the average for the second quarter of 2002.
September December Change Change (000's omitted) 30, 2002 31, 2001 Amount Percent ------------------------------------------------------------------------------- Noninterest-bearing demand deposits $ 450,131 $ 447,544 $2,587 0.6% Interest-bearing demand deposits 256,976 259,141 (2,165) -0.8% Regular savings deposits 412,070 378,065 34,005 9.0% Money market deposits 306,901 291,375 15,526 5.3% Time deposits 1,125,657 1,169,845 (44,188) -3.8% ------------------------------------------------------------------------------- Total deposits $2,551,735 $2,545,970 $5,765 0.2% =============================================================================== IPC deposits $2,390,578 $2,394,395 ($3,817) -0.2% Public fund deposits 161,157 151,575 9,582 6.3% ------------------------------------------------------------------------------- Total deposits $2,551,735 $2,545,970 $5,765 0.2% ===============================================================================
Increases in checking, savings and money market account balances over the past nine months have neutralized run-off of time deposit balances. This shift in customer account balances may be reflective of lower yield spreads between CD and other interest bearing accounts, 37 less willingness of consumers to be locked into rates for longer terms given the low interest rate environment and its expected duration, and less attention to managing down checking account balances due to low opportunity cost. Borrowings At the end of the third quarter, borrowings and federal funds purchased of $451 million were $173 million or 62% higher than they were at the end of 2001. Short-term borrowings increased by $201 million, long-term borrowings decreased by $25 million and federal funds purchased were reduced by $3 million. The additional borrowing was primarily used to fund the growth of the investment portfolio in order to take advantage of favorable interest rate spreads caused by the steep Treasury yield curve. Other Assets and Liabilities Other assets and liabilities had a net liability balance of $27.309 million at the end of the second quarter versus a net liability position of $12.806 million at December 31, 2001. The change was mainly attributable to an increase in deferred taxes related to the market value adjustment and assorted timing differences. Shareholders' Equity Total shareholders' equity equaled $324.2 million at the end of the third quarter, $56.2 million higher than the balance at December 31, 2001. This increase consisted of $1.6 million from shares issued under the employee stock plan, an after-tax market value adjustment of $33.4 million, an after-tax minimum pension liability adjustment of $3.0 million and net income of $28.9 million, offset by dividends declared of $10.7 million. 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 additional deposits, borrowings and available lines of credit are in place. CBU's primary approach to measuring liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short-term liabilities which are vulnerable to nonreplacement; and second, a projection of subsequent cash availability over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90-day time horizons. As of September 30, 2002, this ratio was 17.2% and 17.7%, respectively, excluding the Company's capacity to borrow additional funds from the Federal Home Loan Bank. Including this latter capacity, the 30 and 90-day ratios are 24.9% and 25.4%, respectively. The Company considers liquidity adequate to meet its operating needs for the foreseeable future. 38 Forward-Looking Statements This document contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company's plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company's control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) risks related to credit quality, interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (3) the effect of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (4) inflation, interest rate, market and monetary fluctuations; (5) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (6) changes in consumer spending, borrowing and savings habits; (7) technological changes; (8) any acquisitions or mergers that might be considered by the Company and the costs and factors associated therewith; (9) the ability to maintain and increase market share and control expenses; (10) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and accounting principles generally accepted in the United States; (11) changes in the Company's organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (12) the costs and effects of litigation and of any adverse outcome in such litigation; and (13) the success of the Company at managing the risks of the foregoing. The foregoing list of important factors is not all-inclusive. Such forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements. 39 Item 3. Quantitative and Qualitative Disclosure about Market Risk Interest Rate Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates, price, or credit risk. The Company has a de minimus amount of credit risk in its portfolio because of its long-standing policy of purchasing low credit risk investments. Consequently, the primary market risk exposure of the organization is interest rate risk. The composition of the portfolio continues to heavily favor U.S. agency debentures, U.S agency mortgage-backed pass throughs, U.S agency CMO's, and AAA rated insured municipal bonds. As of September 30, 2002, these four security types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock) accounted for over 95% of total portfolio investments. The ongoing monitoring and management of this risk, over both a short-term tactical and longer-term strategic time horizon, is an important component of the Company's asset/liability management process, which is governed by policies established by its Board of Directors and reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Management Committee (ALCO). 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 overall market interest rate-related level and trends. As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools which enable it to identify and quantify sources of interest rate risk in varying environments. 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 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. The following reflects the Company's one-year net interest income sensitivity based on approximate asset and liability levels on September 30, 2002, assuming no growth in the balance sheet, and assuming a 200 basis point instantaneous upward rate shock in the prime rate, federal funds rate and the entire Treasury yield curve and a similar 100 basis point instantaneous downward rate shock.
Regulatory Model Rate Change Net Interest Income Net Interest Income In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates ------------------------------------------------------------------------------------------ +200 bp $979,000 0.8% -100 bp ($1.8 million) (1.4%)
Given the steepness in slope of the Treasury yield curve as of September 30, 2002, a second group of simulations was performed based on what the Company believes to be conservative levels of balance sheet growth. These levels include no growth in the Company's securities portfolio and low single digit loan growth. Under this set of assumptions, were the slope of the yield curve to change, holding short rates constant while flattening long-term rates over the next 12 months, the net interest margin is projected to narrow modestly (simulation B). If short term rates were to increase 200 basis points over the next 12 months (holding long-term rates constant), margins are also projected to narrow (simulation A). 40 Management Model
Rate Change Net Interest Income Net Interest Income In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates ---------------------------------------------------------------------------------------------------------- A) Increasing Short Term Rates ($3.1 million) (2.4%) B) Reducing Longer Term Rates ($2.2 million) (1.7%)
The preceding interest rate risk 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 cash flows, and others. While the assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. Item 4. Controls and Procedures Under the supervision and with the participation of our management, including the President and Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing date of this quarterly report, and, based on their evaluation, our President and Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company is accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. 41 Part II. Other Information Item 1. Legal Proceedings. Not Applicable Item 2. Changes in Securities. Not Applicable Item 3. Defaults Upon Senior Securities. Not Applicable. Item 4. Submission of Matters to a Vote of Securities Holders. Not Applicable. Item 5. Other Information. Not Applicable. Item 6. Exhibits and Reports on Form 8-K a) Exhibits required by Item 601 of Regulation S-K: (21) Subsidiaries of the registrant - Community Bank, N.A., State of New York - Community Financial Services, Inc., State of New York - Community Capital Trust I, State of Delaware - Community Capital Trust II, State of Delaware - Community Statutory Trust III, State of Connecticut - Benefit Plans Administrative Services, Inc., State of New York - CBNA Treasury Management Corporation, State of New York - Community Investment Services, Inc., State of New York - CBNA Preferred Funding Corporation, State of Delaware - Elias Asset Management, Inc., State of Delaware - CFSI Close-Out Corp., State of New York - First Liberty Service Corporation, State of Delaware b) Exhibits required by the Sarbanes-Oxley Act of 2002 (99.1) Certification of Sanford A. Belden, President and Chief Executive Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of the Sarbanes-Oxley Act of 2002. (99.2) Certification of David G. Wallace, Treasurer and Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to the Sarbanes-Oxley Act of 2002. c) Reports on Form 8-K: Not Applicable. 42 SIGNATURES Pursuant to the requirements of The Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Community Bank System, Inc. Date: November 14, 2002 /s/ Sanford A. Belden ----------------------------------- Sanford A. Belden, President and Chief Executive Officer Date: November 14, 2002 /s/ David G. Wallace ----------------------------------- David G. Wallace, Treasurer and Chief Financial Officer 43 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATIONS I, Sanford A. Belden, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Bank System, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Sanford A. Belden ------------------------------------- Sanford A. Belden, President and Chief Executive Officer November 14, 2002 44 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATIONS I, David G. Wallace, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Bank System, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ David G. Wallace -------------------------------------- David G. Wallace, Treasurer and Chief Financial Officer November 14, 2002 45