-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AzkppXeWtet2xQ2IeM5rBSn7hGzXdZNqcyNEBsee4dmat1OXnBPQQ61uRJL6mYAv HL4pOMVwuGUjF7TWKfqTOA== 0001169232-05-002534.txt : 20050509 0001169232-05-002534.hdr.sgml : 20050509 20050509142329 ACCESSION NUMBER: 0001169232-05-002534 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050509 DATE AS OF CHANGE: 20050509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMUNITY BANK SYSTEM INC CENTRAL INDEX KEY: 0000723188 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 161213679 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13695 FILM NUMBER: 05811043 BUSINESS ADDRESS: STREET 1: 5790 WIDEWATERS PKWY CITY: DEWITT STATE: NY ZIP: 13214 BUSINESS PHONE: 8007242262 MAIL ADDRESS: STREET 1: 5790 WIDEWATERS PARKWAY CITY: DEWITT STATE: NY ZIP: 13214 10-Q 1 d63735_10-q.txt FORM 10-Q United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2005 Commission file number 001-13695 COMMUNITY BANK SYSTEM, INC. (Exact name of registrant as specified in its charter) New York Stock Exchange (Name of Each Exchange on Which Registered) Delaware 16-1213679 (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) 5790 Widewaters Parkway, DeWitt, New York 13214-1883 (Address of principal executive offices) (Zip Code) (315) 445-2282 (Registrant's telephone number, including area code) 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). |X| Yes |_| No Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practical date. Common Stock, $1.00 par value - 30,354,390 shares outstanding as of April 28, 2005 TABLE OF CONTENTS Page ---- Part I. Financial Information Item 1. Financial Statements (Unaudited) Consolidated Statements of Condition March 31, 2005 and December 31, 2004 ................................ 3 Consolidated Statements of Income Three months ended March 31, 2005 and 2004 .......................... 4 Consolidated Statement of Changes in Shareholders' Equity Three months ended March 31, 2005 ................................... 5 Consolidated Statements of Comprehensive Income Three months ended March 31, 2005 and 2004 .......................... 6 Consolidated Statements of Cash Flows Three months ended March 31, 2005 and 2004 .......................... 7 Notes to the Consolidated Financial Statements March 31, 2005 ...................................................... 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ......................................... 13 Item 3. Quantitative and Qualitative Disclosure about Market Risk ......... 25 Item 4. Controls and Procedures ........................................... 26 Part II. Other Information Item 1. Legal Proceedings ................................................. 27 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds ....... 27 Item 3. Defaults Upon Senior Securities ................................... 27 Item 4. Submission of Matters to a Vote of Securities Holders ............. 27 Item 5. Other Information ................................................. 27 Item 6. Exhibits and Reports on Form 8-K .................................. 27 2 Part 1. Financial Information Item 1. Financial Statements COMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENTS OF CONDITION (Unaudited) (In Thousands, Except Share Data)
March 31, December 31, 2005 2004 - ---------------------------------------------------------------------------------------------------------------- Cash and cash equivalents $ 135,040 $ 118,345 Available-for-sale investment securities 1,412,465 1,446,695 Held-to-maturity investment securities 142,364 137,644 - ---------------------------------------------------------------------------------------------------------------- Total investment securities (fair value of $1,551,997 and $1,582,873, 1,554,829 1,584,339 respectively) Loans 2,334,395 2,358,493 Allowance for loan losses 31,898 31,778 - ---------------------------------------------------------------------------------------------------------------- Net loans 2,302,497 2,326,715 Core deposit intangibles, net 33,482 35,351 Goodwill 195,168 195,163 Other intangibles, net 1,871 1,986 - ---------------------------------------------------------------------------------------------------------------- Intangible assets, net 230,521 232,500 Premises and equipment, net 63,403 63,510 Accrued interest receivable 28,534 27,947 Other assets 39,828 40,475 - ---------------------------------------------------------------------------------------------------------------- Total assets $ 4,354,652 $ 4,393,831 ================================================================================================================ Liabilities: Non-interest bearing deposits $ 577,738 $ 567,106 Interest bearing deposits 2,399,215 2,361,872 - ---------------------------------------------------------------------------------------------------------------- Total deposits 2,976,953 2,928,978 Federal funds purchased 12,700 13,200 Borrowings 761,776 826,865 Subordinated debt held by unconsolidated subsidiary trusts 80,460 80,446 Accrued interest and other liabilities 62,337 69,714 - ---------------------------------------------------------------------------------------------------------------- Total liabilities 3,894,226 3,919,203 - ---------------------------------------------------------------------------------------------------------------- Commitment and contingencies (See Note H) Shareholders' equity: Preferred stock $1.00 par value, 500,000 shares authorized, 0 shares issued Common stock, $1.00 par value, 50,000,000 shares authorized; 32,222,110 and 32,041,591 shares issued in 2005 and 2004, respectively 32,222 32,042 Additional paid-in capital 192,908 190,769 Retained earnings 256,173 248,295 Accumulated other comprehensive income 21,709 34,200 Treasury stock, at cost (1,900,000 and 1,400,000 shares, respectively) (42,114) (30,199) Employee stock plan - unearned (472) (479) - ---------------------------------------------------------------------------------------------------------------- Total shareholders' equity 460,426 474,628 - ---------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 4,354,652 $ 4,393,831 ================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 3 COMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In Thousands, Except Per-Share Data)
Three Months Ended March 31, ---------------------------- 2005 2004 - -------------------------------------------------------------------------- ---------------------------- Interest income: Interest and fees on loans $ 35,502 $ 32,517 Interest and dividends on taxable investments 13,570 12,222 Interest and dividends on non-taxable investments 6,151 5,182 - -------------------------------------------------------------------------- ---------------------------- Total interest income 55,223 49,921 - -------------------------------------------------------------------------- ---------------------------- Interest expense: Interest on deposits 9,179 8,634 Interest on short-term borrowings 2,926 1,121 Interest on subordinated debt held by unconsolidated subsidiary trusts 1,569 1,391 Interest on long-term borrowings 3,847 2,821 - -------------------------------------------------------------------------- ---------------------------- Total interest expense 17,521 13,967 - -------------------------------------------------------------------------- ---------------------------- Net interest income 37,702 35,954 Less: provision for loan losses 1,875 2,050 - -------------------------------------------------------------------------- ---------------------------- Net interest income after provision for loan losses 35,827 33,904 - -------------------------------------------------------------------------- ---------------------------- Non-interest income: Deposit service fees 6,077 5,776 Other banking services 525 658 Trust, investment and asset management fees 1,837 1,789 Benefit plan administration, consulting and actuarial fees 2,794 2,297 Gain on investment securities 1,726 10 - -------------------------------------------------------------------------- ---------------------------- Total non-interest income 12,959 10,530 - -------------------------------------------------------------------------- ---------------------------- Operating expenses: Salaries and employee benefits 16,166 15,167 Occupancy 3,032 2,630 Equipment and furniture 2,134 2,152 Amortization of intangible assets 1,984 1,639 Legal and professional fees 1,201 997 Data processing 1,710 1,880 Office supplies 585 521 Acquisition expenses 41 970 Other 4,178 3,800 - -------------------------------------------------------------------------- ---------------------------- Total operating expenses 31,031 29,756 - -------------------------------------------------------------------------- ---------------------------- Income before income taxes 17,755 14,678 Income taxes 4,421 3,523 - -------------------------------------------------------------------------- ---------------------------- Net income $ 13,334 $ 11,155 ========================================================================== ============================ Basic earnings per share $ 0.44 $ 0.39 Diluted earnings per share $ 0.43 $ 0.38 Dividends declared per share $ 0.18 $ 0.16
The accompanying notes are an integral part of the consolidated financial statements. 4 COMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) Three Months Ended March 31, 2005 (In Thousands, Except Share Data)
Common Stock Accumulated -------------------- Additional Other Employee Shares Amount Paid-In Retained Comprehensive Treasury Stock Plan Outstanding Issued Capital Earnings Income Stock -Unearned Total - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2004 30,641,591 $32,042 $190,769 $248,295 $ 34,200 ($30,199) ($479) $474,628 Net income 13,334 13,334 Other comprehensive loss, net of tax (12,491) (12,491) Dividends declared: Common, $0.18 per share (5,456) (5,456) Common stock issued under employee stock plan, including tax benefits of $625 180,519 180 2,139 7 2,326 Treasury stock purchased (500,000) (11,915) (11,915) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at March 31, 2005 30,322,110 $32,222 $192,908 $256,173 $ 21,709 ($42,114) ($472) $460,426 ====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 5 COMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (In Thousands)
Three Months Ended March 31, ---------------------------- 2005 2004 - --------------------------------------------------------------------------- ---------------------------- Other comprehensive (loss) income, before tax: Unrealized (losses) gains on securities: Unrealized holding (losses) gains arising during period (18,719) 19,057 Reclassification adjustment for gains included in net income (1,726) (10) - --------------------------------------------------------------------------- ---------------------------- Other comprehensive (loss) income, before tax (20,445) 19,047 Income tax benefit (expense) related to other comprehensive (loss) income 7,954 (7,421) - --------------------------------------------------------------------------- ---------------------------- Other comprehensive (loss) income, net of tax (12,491) 11,626 Net income 13,334 11,155 - --------------------------------------------------------------------------- ---------------------------- Comprehensive income $ 843 $ 22,781 =========================================================================== ============================
The accompanying notes are an integral part of the consolidated financial statements. 6 COMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands)
Three Months Ended March 31, -------------------------------- 2005 2004 - ------------------------------------------------------------------------------------------------------------------------ Operating activities: Net income $ 13,334 $ 11,155 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 2,063 1,983 Amortization of intangible assets 1,984 1,639 Net amortization of premiums and discounts on securities and loans 149 475 Amortization of unearned compensation and discount on subordinated debt 74 57 Provision for loan losses 1,875 2,050 Gain on investment securities (1,726) (10) (Gain) loss on loans and other assets (45) 7 Change in other operating assets and liabilities 1,312 2,827 - ------------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 19,020 20,183 - ------------------------------------------------------------------------------------------------------------------------ Investing activities: Proceeds from sales of available-for-sale investment securities 61,230 17,091 Proceeds from maturities of held-to-maturity investment securities 2,013 1,205 Proceeds from maturities of available-for-sale investment securities 44,330 50,193 Purchases of held-to-maturity investment securities (6,770) (417) Purchases of available-for-sale investment securities (90,166) (67,385) Net decrease in loans outstanding 22,352 20,781 Capital expenditures (1,915) (1,751) - ------------------------------------------------------------------------------------------------------------------------ Net cash provided by investing activities 31,074 19,717 - ------------------------------------------------------------------------------------------------------------------------ Financing activities: Net change in demand, checking, savings and money market deposits 38,233 5,857 Net change in time deposits 9,742 9,588 Net change in federal funds purchased (500) (29,300) Net change in short-term borrowings (65,000) (46,000) Payments on long-term borrowings (89) 0 Issuance of common stock 1,644 2,695 Purchase of treasury stock (11,915) (2,737) Cash dividends paid (5,514) (4,529) Other financing activities 0 (24) - ------------------------------------------------------------------------------------------------------------------------ Net cash used by financing activities (33,399) (64,450) - ------------------------------------------------------------------------------------------------------------------------ Change in cash and cash equivalents 16,695 (24,550) Cash and cash equivalents at beginning of year 118,345 103,923 - ------------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of period $ 135,040 $ 79,373 ======================================================================================================================= Supplemental disclosures of cash flow information: Cash paid for interest $ 17,519 $ 14,402 Cash paid for income taxes $ 0 $ 157 Supplemental disclosures of non-cash financing and investing activities: Dividends declared and unpaid $ 5,457 $ 4,584 Gross change in unrealized gains on available-for-sale investment securities ($20,445) $ 19,047
The accompanying notes are an integral part of the consolidated financial statements. 7 COMMUNITY BANK SYSTEM, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) March 31, 2005 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. These financial statements may not include all information and footnotes necessary to constitute a complete set of financial statements under generally accepted accounting principles applicable to annual periods and accordingly should be read in conjunction with the financial information contained in the Form 10-K. Management believes these unaudited consolidated financial statements reflect all adjustments of a normal recurring nature which are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period. NOTE B: OTHER MATTERS On December 15, 2004, the Board of Directors approved a twelve-month authorization to repurchase up to 500,000 of its outstanding shares in open market negotiated transactions. As of March 31, 2005, the Company has repurchased the 500,000 shares at an aggregate cost of $11.9 million and an average price per share of $23.83. On April 20, 2005, the Company announced a twenty-month authorization to repurchase up to 1,500,000 of its outstanding shares. The repurchases will be for general corporate purposes, including those related to stock plan activities. NOTE C: ACCOUNTING POLICIES Critical Accounting Policies Allowance for Loan Losses Management continually evaluates the credit quality of the Company's loan portfolio, and performs a formal review of the adequacy of the allowance for loan losses on a quarterly basis. The allowance reflects management's best estimate of probable losses inherent in the loan portfolio. Determination of the allowance is subjective in nature and requires significant estimates. The Company's allowance methodology consists of two broad components, general and specific loan loss allocations. The general loan loss allocation is composed of two calculations that are computed on four main loan segments: commercial, consumer direct, consumer indirect and residential real estate. The first calculation determines an allowance level based on the latest three years of historical net charge-off data for each loan category (commercial loans exclude balances with specific loan loss allocations). The second calculation is qualitative and takes into consideration five major factors affecting the level of loan loss risk: portfolio risk migration patterns (internal credit quality trends); the growth of the segments of the loan portfolio; economic and business environment trends in the Company's markets (includes review of bankruptcy, unemployment, population, consumer spending and regulatory trends); industry, geographical and product concentrations in the portfolio; and the perceived effectiveness of managerial resources and lending practices and policies. These two calculations are added together to determine the general loan loss allocation. The specific loan loss allocation relates to individual commercial loans that are both greater than $0.5 million and in a non-accruing status with respect to interest. Specific losses are based on discounted estimated cash flows, including any cash flows resulting from the conversion of collateral. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan loss is charged to operations based on management's periodic evaluation of factors previously mentioned. Income Taxes Provisions for income taxes are based on taxes currently payable or refundable, and deferred taxes which are based on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. 8 Intangible Assets Intangible assets include core deposit intangibles, customer relationship intangibles and goodwill arising from acquisitions. Core deposit intangibles and customer relationship intangibles are amortized on either an accelerated or straight-line basis over periods ranging from 7 to 20 years. Goodwill is evaluated at least annually for impairment. The carrying value of goodwill and other intangible assets is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires use of a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums, and company-specific risk indicators. Retirement Benefits The Company provides defined benefit pension benefits and post-retirement health and life insurance benefits to eligible employees. The Company also provides deferred compensation and supplemental executive retirement plans for selected current and former employees and officers. Expense under these plans is charged to current operations and consists of several components of net periodic benefit cost based on various actuarial assumptions regarding future experience under the plans, including discount rate, rate of future compensation increases and expected return on plan assets. Stock-Based Compensation The Company accounts for stock-based awards issued to directors, officers and key employees using the intrinsic value method. This method requires that compensation expense be recognized to the extent that the fair value of the underlying stock exceeds the exercise price of the stock award at the grant date. The Company generally does not recognize compensation expense related to stock awards because the stock awards generally have fixed terms and exercise prices that are equal to or greater than the fair value of the Company's common stock at the grant date. SFAS 123, "Accounting for Stock-Based Compensation," requires companies that use the "intrinsic value method" to account for stock compensation plans to provide pro forma disclosures of the net income and earnings per share effect of stock options using the "fair value method." Under this method, the fair value of the option on the date of grant is recognized ratably as compensation expense over the vesting period of the option. Management estimated the fair value of options granted using the Black-Scholes option-pricing model. This model was originally developed to estimate the fair value of exchange-traded equity options, which (unlike employee stock options) have no vesting period or transferability restrictions. As a result, the Black-Scholes model is not necessarily a precise indicator of the value of an option, but it is commonly used for this purpose. The Black-Scholes model requires several assumptions, which management developed based on historical trends and current market observations. These assumptions include: 2005 2004 - -------------------------------------------------------------------- Weighted-average expected life 7.76 7.79 Future dividend yield 3.00% 3.00% Share price volatility 26.78% 25.47%-25.59% Weighted average risk-free interest rate 4.17% 4.02%-4.05% ==================================================================== If these assumptions are not accurate, the estimated fair value used to derive the information presented in the following table also will be inaccurate. Moreover, the model assumes that the estimated fair value of an option is amortized over the option's vesting period and would be included in salaries and employee benefits on the income statement. 9 The pro forma impact of applying the fair value method of accounting for the periods shown below may not be indicative of the pro forma impact in future periods.
Three Months Ended March 31, ---------------------------- (000's omitted except per share amounts) 2005 2004 - -------------------------------------------------------------------------------------------- Net income, as reported $13,334 $11,155 Plus: stock-based compensation expense determined under intrinsic method, net of tax 35 25 Less: stock-based compensation expense determined under fair value method, net of tax (505) (433) - -------------------------------------------------------------------------------------------- Pro forma net income $12,864 $10,747 ============================================================================================ Earnings per share: As reported: Basic $ 0.44 $ 0.39 Diluted $ 0.43 $ 0.38 Pro forma: Basic $ 0.42 $ 0.38 Diluted $ 0.41 $ 0.36
As of March 31, 2005 there were 1,792,000 stock options outstanding. New Accounting Pronouncements In December 2004, the Financial Accounting Standards Board revised SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS 123R establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. SFAS 123R requires an entity to recognize compensation expense based on an estimate of the number of awards expected to actually vest, exclusive of awards expected to be forfeited. In April 2005, the Securities and Exchange Commission approved a new rule which delays the effective date of SFAS 123R. The provisions of this statement will become effective January 1, 2006 for all equity awards granted after the effective date. Management does not expect the impact of the adoption of this pronouncement to be materially different from the pro forma impacts disclosed under SFAS No. 123. NOTE D: EARNINGS PER SHARE Basic earnings per share are computed based on the weighted-average common shares outstanding for the period. Diluted earnings per share are 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. The treasury stock method determines the number of common shares that would be outstanding if all the dilutive options (average market price is greater than the exercise price) were exercised and the proceeds were used to repurchase common shares in the open market at the average market price for the applicable time period. There were 838,424 and 431,360 anti-dilutive stock options outstanding for the three months ended March 31, 2005 and 2004, respectively. The following is a reconciliation of basic to diluted earnings per share for the three months ended March 31, 2005 and 2004. Per Share (000's omitted, except per share data) Income Shares Amount - ------------------------------------------------------------------------------- Three Months Ended March 31, 2005 Basic EPS $13,334 30,580 $0.44 Stock options 612 - ------------------------------------------------------------------- Diluted EPS $13,334 31,192 $0.43 =================================================================== Three Months Ended March 31, 2004 Basic EPS $11,155 28,579 $0.39 Stock options 978 - ------------------------------------------------------------------- Diluted EPS $11,155 29,557 $0.38 =================================================================== 10 NOTE E: INTANGIBLE ASSETS The gross carrying amount and accumulated amortization for each type of intangible asset are as follows:
As of March 31, 2005 As of December 31, 2004 ------------------------------------- ------------------------------------- Gross Net Gross Net Carrying Accumulated Carrying Carrying Accumulated Carrying (000's omitted) Amount Amortization Amount Amount Amortization Amount - ---------------------------------- ------------------------------------- ------------------------------------- Amortizing intangible assets: Core deposit intangibles $ 63,691 ($30,209) $ 33,482 $ 63,691 ($28,340) $ 35,351 Other intangibles 2,750 (879) 1,871 2,750 (764) 1,986 - ---------------------------------- ------------------------------------- ------------------------------------- Total amortizing intangibles 66,441 (31,088) 35,353 66,441 (29,104) 37,337 Non-amortizing intangible assets: Goodwill 195,168 0 195,168 195,163 0 195,163 - ---------------------------------- ------------------------------------- ------------------------------------- Total intangible assets, net $261,609 ($31,088) $230,521 $261,604 ($29,104) $232,500 ================================== ===================================== =====================================
No goodwill impairment adjustments were recognized in 2005 or 2004. The estimated aggregate amortization expense for each of the succeeding fiscal years ended December 31 is as follows: (000's omitted) Amount - ---------------------------- April-Dec 2005 $ 5,259 2006 6,047 2007 5,657 2008 5,335 2009 4,836 Thereafter 8,219 - ----------------- --------- Total $ 35,353 ================= ========= NOTE F: MANDATORILY REDEEMABLE PREFERRED SECURITIES The Company sponsors three business trusts, Community Capital Trust I, Community Capital Trust II, and Community Statutory Trust III, of which 100% of the common stock is owned by the Company. The trusts were formed for the purpose of issuing company-obligated mandatorily redeemable preferred securities to third-party investors and investing the proceeds from the sale of such preferred securities solely in junior subordinated debt securities of the Company. The debentures held by each trust are the sole assets of that trust. Distributions on the preferred securities issued by each trust are payable semi-annually or quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by that trust. The preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. The Company has entered into agreements which, taken collectively, fully and unconditionally guarantee the preferred securities subject to the terms of each of the guarantees. The terms of the preferred securities of each trust are as follows:
Issuance Interest Maturity Call Call Date Amount Rate Date Provision Price - ----------------------------------------------------------------------------------------------------------------------------------- I 2/3/1997 $30 million 9.75% 2/03/2027 10 year beginning 2007 104.5400% declining to par in 2017 II 7/16/2001 $25 million 6 month LIBOR plus 3.75% (6.71%) 7/16/2031 5 year beginning 2006 107.6875% declining to par in 2011 III 7/31/2001 $24.5 million 3 month LIBOR plus 3.58% (6.31%) 7/31/2031 5 year beginning 2006 107.5000% declining to par in 2011 ===================================================================================================================================
11 NOTE G: BENEFIT PLANS The Company provides defined benefit pension benefits and post-retirement health and life insurance benefits to eligible employees. The Company also provides supplemental pension retirement benefits for several current and former key employees. The Company accrues for the estimated cost of these benefits through charges to expense during the years that employees earn these benefits. The net periodic benefit cost for the three months ended March 31 is as follows: Post-retirement Pension Benefits Benefits ---------------- -------------- (000's omitted) 2005 2004 2005 2004 - ------------------------------------------------------------- -------------- Service cost $ 652 $ 567 $ 110 $ 87 Interest cost 645 630 104 71 Expected return on plan assets (878) (790) 0 0 Net amortization and deferral 305 261 19 5 Amortization of prior service cost 29 73 28 14 Amortization of transition obligation 0 0 10 10 - ------------------------------------------------------------- -------------- Net periodic benefit cost $ 753 $ 741 $ 271 $ 187 ============================================================= ============== The Company is not required for regulatory purposes to make a contribution to its defined benefit pension plan. NOTE H: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee. These commitments consist principally of unused commercial and consumer credit lines. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party. The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as that involved with extending loans to customers and are subject to normal credit policies. Collateral may be obtained based on management's assessment of the customer's creditworthiness. The contract amount of commitment and contingencies are as follows: (000's omitted) March 31, December 31, 2005 2004 - ---------------------------------------------------------------- Commitments to extend credit $426,053 $429,751 Standby letters of credit 22,454 22,948 - ---------------------------------------------------------------- Total $448,507 $452,699 ================================================================ 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") primarily reviews the financial condition and results of operations of Community Bank System, Inc. ("the Company" or "CBSI") for the three months ended March 31, 2005 and 2004, although in some circumstances the fourth quarter of 2004 is also discussed in order to more fully explain recent trends. The following discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and related notes that appear on pages 3 through 12. All references in the discussion to the financial condition and results of operations are to those of the Company and its subsidiaries taken as a whole. Unless otherwise noted, the term "this year" refers to results in calendar year 2005, "first quarter" refers to the quarter ended March 31, 2005, earnings per share ("EPS") figures refer to diluted EPS, and net interest income and net interest margin are presented on a fully tax-equivalent ("FTE") basis. All share and share-based amounts reflect the two-for-one stock split effected as a 100% stock dividend on April 12, 2004. This MD&A contains certain forward-looking statements with respect to the financial condition, results of operations and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those proposed by such forward-looking statements are set herein under the caption, "Forward-Looking Statements," on page 25. Critical Accounting Policies As a result of the complex and dynamic nature of the Company's business, management must exercise judgement in selecting and applying the most appropriate accounting policies for its various areas of operations. The policy decision process not only ensures compliance with the latest generally accepted accounting principles, but also reflects on management's discretion with regard to choosing the most suitable methodology for reporting the Company's financial performance. It is management's opinion that the accounting estimates covering certain aspects of the business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity in the selection process. These estimates affect the reported amounts of assets and liabilities and disclosures of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that critical accounting estimates include: o Allowance for loan losses - The allowance for loan losses reflects management's best estimate of probable losses inherent in the loan portfolio. Determination of the allowance is subjective in nature and requires significant estimates. It requires significant estimates including the amounts and timing of expected future cash flows on impaired loans and the amount of estimated losses on pools of homogeneous loans which is based on historical loss experience and consideration of current economic trends, all of which may be susceptible to significant change. o Actuarial assumptions associated with pension, post-retirement and other employee benefit plans - These assumptions include discount rate, rate of future compensation increases and expected return on plan assets. o Provision for income taxes - The Company is subject to examinations from various taxing authorities. Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions. Management believes that the assumptions and judgements used to record tax related assets or liabilities have been appropriate. Should tax laws change or the taxing authorities determine that management's assumptions were inappropriate, an adjustment may be required which could have a material effect on the Company's results of operations. o Carrying value of goodwill and other intangible assets - The carrying value of goodwill and other intangible assets is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires use of a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums, and company-specific risk indicators. A summary of the accounting policies used by management is disclosed in Note A, "Summary of Significant Accounting Policies" on pages 43-48 of the most recent Form 10-K (fiscal year ended December 31, 2004). 13 Executive Summary The Company's business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial and municipal customers. The Company's core operating objectives are: (i) grow the branch network, primarily through a disciplined acquisition strategy, and certain selective de novo expansions, (ii) build high-quality, profitable loan portfolios using both organic and acquisition strategies, (iii) increase the non-interest income component of total revenues through development of banking-related fee income, growth in existing financial services business units, and the acquisition of additional financial services and banking businesses, and (iv) utilize technology to deliver customer-responsive products and services and to reduce operating costs. Significant factors management reviews to evaluate achievement of the Company's operating objectives and its operating results and financial condition include, but are not limited to: net income and earnings per share, return on assets and equity, net interest margins, non-interest income, operating expenses, asset quality, loan and deposit growth, capital management, performance of individual banking and financial services business units, liquidity and interest rate sensitivity, enhancements to customer products and services, technology enhancements, market share, peer comparisons, and the performance of acquisition and integration activities. In the first quarter of 2005 the Company generated a 19.5% increase in net income as compared to the first quarter of 2004, driven by higher earning asset levels, improved asset quality, higher non-interest income, including security gains, and lower acquisition expenses. These were partially offset by higher recurring operating expenses, a higher cost of funds, and a slightly higher effective tax rate. Diluted earnings per share for the first quarter of $0.43 were $0.05, or 13.2% above the first quarter of 2004. Cash earnings per share (which excludes the after-tax effect of the amortization of intangibles assets) were $0.47 versus $0.41 for the prior year's first quarter. Asset quality improved in the first quarter of 2005 in comparison to the same period last year, with reductions in delinquency, net charge-off and non-performing loan ratios. The Company experienced year-over-year loan growth in consumer mortgage and consumer installment lending on an organic basis, with declines in the commercial portfolio. On a geographical basis, growth in the New York markets mirrored the results for the Company, and the Pennsylvania markets reported an increase in consumer installment loans, with declines in other portfolios. Excluding acquisitions, total deposits declined slightly from March 31, 2004's level. The Company completed two acquisitions in 2004, including: (1) First Heritage Bank, a $275 million-asset three branch commercial bank based in Wilkes-Barre, PA acquired in May, and (2) a bank branch in Dansville, NY, from HSBC Bank USA, N.A., acquired in December with deposits of $32.6 million. Net Income and Profitability As shown in Table 1, earnings per share for the first quarter of $0.43 were $0.05 higher than the EPS generated in the same quarter last year. Net income for the quarter was $13.3 million, up 19.5% over the equivalent period of 2004. Net interest income for first quarter 2005 of $37.7 million was up $1.7 million or 4.9% from the prior year comparable period. First quarter non-interest income of $13.0 million was up $2.4 million (23%) from first quarter 2004. Operating expenses of $31.0 million for the quarter were up $1.3 million or 4.3% from the prior year comparable period. In addition to the earnings results presented above in accordance with generally accepted accounting principles ("GAAP"), the Company provides cash earnings per share, which excludes the after-tax effect of the amortization of intangible assets. Management believes that this information helps investors better understand the effect of acquisition activity in reported results. Cash earnings per share for the first quarter of 2005 were $0.47, up 14.6% from $0.41 for the first quarter of 2004. As reflected in Table 1, the primary reasons for improved first quarter earnings compared to the same quarter last year were higher net interest income and non-interest income and a lower loan loss provision, offset by higher operating expenses. Net interest income increased because of higher earning-asset levels derived primarily from the acquisitions of First Heritage and Dansville, growth in the investment portfolio, and organic consumer mortgage and consumer installment loan growth. The improvement in asset quality metrics and change in portfolio composition were the primary reasons for the decrease in loan loss provision, despite an increase in the overall loan portfolio. The increase in non-interest income was mostly attributable to a strong performance by the employee benefits consulting and plan administration business and additional banking fees generated by the First Heritage and Dansville branches. These performance improvements were partially offset by a growth in operating expenses resulting from the two acquisitions made in 2004, as well as higher compensation and benefit expenses. 14 Table 1: Summary Income Statements Three Months Ended March 31, ---------------------------- (000's omitted, except per share data) 2005 2004 ------------------------------------------ ---------------------------- Net interest income $37,702 $35,954 Provision for loan losses 1,875 2,050 Non-interest income 12,959 10,530 Operating expenses 31,031 29,756 ------------------------------------------ ---------------------------- Income before taxes 17,755 14,678 Income taxes 4,421 3,523 ------------------------------------------ ---------------------------- Net income $13,334 $11,155 =========================================== ============================= Diluted earnings per share $ 0.43 $ 0.38 Diluted earnings per share-cash (1) $ 0.47 $ 0.41 (1) Cash earnings exclude the after-tax effect of the amortization of intangible assets. Net Interest Income Net interest income is the amount that interest and fees on earning assets (loans and investments) exceeds the cost of funds, primarily interest paid to the Company's depositors and interest on external borrowings. Net interest margin is the difference between the gross yield on earning assets and the cost of interest-bearing funds as a percentage of earning assets. As shown in Table 2, net interest income (with non-taxable income converted to a fully tax-equivalent basis) for first quarter 2005 was $41.5 million, up $2.2 million or 5.6% from the same period last year. A $491 million increase in average earning-assets more than offset a $402 million higher interest-bearing liabilities and a 33-basis point decrease in the net interest margin. As reflected in Table 3, the volume changes mentioned above drove net interest income to rise $5.4 million, while the lower net interest margin negatively impacted net interest income by $3.2 million. Higher first quarter loan balances were attributable to $212 million of loans acquired in the First Heritage and Dansville transactions and $17 million of organic loan growth over the past 12 months, driven principally by consumer mortgage demand. Average investments for the first quarter rose $260 million (book value basis) in comparison to same period last year, as a result of the First Heritage acquisition and certain other investment purchases. Total average deposits of $3.0 billion in the first quarter were up $220 million or 8.0% from the same quarter of 2004, driven principally by deposits added in the First Heritage and Dansville acquisitions. Borrowings were increased to fund earning asset growth over the last three quarters of 2004, resulting in first quarter average borrowings that were up $249 million over the year-earlier period. The 4.34% net interest margin in the first quarter dropped 33 basis points in comparison to the prior year period. Excluding accretion on called securities of approximately $0.2 million in the first quarter 2005 and $0.7 million in first quarter 2004, the net interest margin of 4.32% was down 27 basis points. This decline was due to a 15-basis point decrease in the yield on earning assets, while the cost of funds increased 19 basis points, due principally to the effect of the seven rate hikes (25 basis points each) by the Federal Reserve since last June. The reduction of earning-asset yields was driven by a five basis point drop in loan yields, as originations over the majority of 2004 were at rates that reflected the record-low rates prevalent in the market, particularly in the mortgage, home equity and auto financing businesses. The investment portfolio yield decreased 33 basis points principally driven by significant declines in market interest rates from early 2001 through mid-2003. Consequently, the purchase of shorter-term securities in the relatively low-interest rate environment in the second half of 2003 and 2004 also contributed to year over year yield declines. Loan yields for the first quarter of 2005 were seven basis points higher than those for the fourth quarter of 2004, while the investment yield was 20 basis points higher than last year's fourth quarter. The first quarter cost of funds increased versus the first quarter of the prior year due to a 44-basis point increase in the cost of borrowings, while deposit rates remained consistent. In the first quarter of 2005, short-term borrowing rates increased 145 basis points, while long-term rates decreased 126 basis points, as compared to the first quarter of 2004. The following table sets forth information related to average interest-earning assets and interest-bearing liabilities and their associated yields and rates for the three months ended March 31, 2005 and 2004. Interest income and yields are on a fully tax-equivalent basis using marginal income tax rates of 38.6% in 2005 and 38.7% in 2004. Average balances are computed by summing the daily ending balances in a period and dividing by the number of days in that period. Loan yields and amounts earned include loan fees. Average loan balances include non-accrual loans. 15 Table 2: Quarterly Average Balance Sheet
Three Months Ended Three Months Ended (000's omitted except yields and rates) March 31, 2005 March 31, 2004 - ------------------------------------------------------------------------------------------------- --------------------------------- Avg. Avg. Average Yield/Rate Average Yield/Rate Balance Interest Paid Balance Interest Paid - ------------------------------------------------------------------------------------------------- --------------------------------- Interest-earning assets: Time deposits in other banks $ 914 $ 4 1.77% $ 803 $ 1 0.50% Taxable investment securities (2) 972,048 13,913 5.80% 816,700 12,594 6.20% Non-taxable investment securities (2) 557,796 9,492 6.90% 452,935 8,039 7.14% Loans (net of unearned discount)(1) 2,342,467 35,591 6.16% 2,111,388 32,622 6.21% ----------------------- --------------------- Total interest-earning assets 3,873,225 59,000 6.18% 3,381,826 53,256 6.33% Non-interest earning assets 506,787 459,277 ---------- ---------- Total assets $4,380,012 $3,841,103 ========== ========== Interest-bearing liabilities: Interest checking, savings and money market deposits $1,182,257 1,952 0.67% $1,054,538 1,545 0.59% Time deposits 1,199,075 7,227 2.44% 1,173,440 7,089 2.43% Short-term borrowings 436,180 2,926 2.72% 356,163 1,121 1.27% Long-term borrowings 439,244 5,416 5.00% 270,479 4,212 6.26% ----------------------- --------------------- Total interest-bearing liabilities 3,256,756 17,521 2.18% 2,854,620 13,967 1.97% Non-interest bearing liabilities: Demand deposits 587,677 520,858 Other liabilities 64,003 54,809 Shareholders' equity 471,576 410,816 ---------- ---------- Total liabilities and shareholders' equity $4,380,012 $3,841,103 ========== ========== Net interest earnings $41,479 $39,289 ======= ======= Net interest spread 4.00% 4.36% Net interest margin on interest-earnings assets 4.34% 4.67% Fully tax-equivalent adjustment on investments and loans $ 3,777 $ 3,335
(1) The impact of interest not recognized on non-accrual loans was immaterial. (2) Averages for investment securities are based on historical cost basis and the yields do not give effect to changes in fair value that is reflected as a component of shareholders' equity and deferred taxes. 16 As discussed above, 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. Table 3: Rate/Volume
1st Quarter 2005 versus 1st Quarter 2004 Increase (Decrease) Due to Change in (1) ---------------------------------------- Net (000's omitted) Volume Rate Change ---------------------------------------- Interest earned on: Time deposits in other banks $ 0 $ 3 $ 3 Taxable investment securities 2,271 (952) 1,319 Non-taxable investment securities 1,796 (343) 1,453 Loans (net of unearned discount) 3,519 (550) 2,969 Total interest-earning assets (2) $ 7,532 ($1,788) $ 5,744 Interest paid on: Interest checking, savings and money market deposits $ 199 $ 208 $ 407 Time deposits 155 (17) 138 Short-term borrowings 299 1,506 1,805 Long-term borrowings 2,218 (1,014) 1,204 Total interest-bearing liabilities (2) $ 2,082 $ 1,472 $ 3,554 Net interest earnings (2) $ 5,419 ($3,229) $ 2,190
(1) The change in interest due to both rate and volume has been allocated 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 and are not a summation of the changes of the components. 17 Non-interest Income The Company's sources of non-interest income are as follows: general banking services related to loans, deposits and other core customer activities typically provided through the branch network; retirement plan administration and employee benefit, actuarial and consulting services (Benefit Plans Administrative Services, Inc. or BPAS), trust services, investment and insurance products (Community Investment Services, Inc. or CISI) and investment management (Elias Asset Management or EAM); and periodic transactions, most often net gains (losses) from the sale of investment securities and prepayment of term debt. Table 4: Non-interest Income
Three Months Ended March 31, ---------------------------- (000's omitted) 2005 2004 ---------------------------------------------------------- ---------------------------- Deposit service charges and overdraft fees $ 4,894 $ 4,789 Benefit plan administration, consulting and actuarial fees 2,794 2,297 Trust, investment and asset management fees 1,837 1,789 Commissions and other 918 859 Electronic banking 625 529 Mortgage banking 165 257 ---------------------------------------------------------- --------------------------- Sub-total 11,233 10,520 Gain on investment securities 1,726 10 ---------------------------------------------------------- --------------------------- Total non-interest income $12,959 $10,530 ========================================================== =========================== Non-interest income/operating income (FTE) 23.8% 21.1%
As displayed in Table 4, non-interest income (excluding securities gains) was $11.2 million in the first quarter, an increase of $713,000 or 6.8% from one year earlier. Most of the increase was contributed by the $545,000 or 13.3% growth in financial services revenue to $4.6 million. General banking fees of $6.6 million in the current quarter were up $168,000 or 2.6% compared to the first quarter of 2004. Gain on the sale of investment securities increased $1.7 million, as the Company took advantage of market conditions in the quarter to sell certain securities in order to maximize their expected total return attributes and to shorten the average length of the portfolio. A majority of the growth in banking non-interest income was derived from higher electronic banking and deposit service charges, which contributed a $201,000 year-over-year increase in the first quarter. This was due in large part to the incremental transaction volume generated from the accounts added through the First Heritage and Dansville acquisitions. These improvements were offset by a decline in mortgage banking income. A strong performance at BPAS generated revenue growth of $516,000 (22%) achieved primarily through obtaining new client relationships and additional projects with established clients. First quarter CISI revenue was up 17% due to additional client relationships developed in the established markets as a result of a more robust marketing effort. In comparison to the comparable period in the prior year, EAM and trust services were down principally due to pricing compression brought on by highly competitive market conditions. The ratio of non-interest income to operating income (FTE basis) was 23.8% for first quarter 2005, 2.7 percentage points higher than the same period last year. Excluding net security gains, the ratio of non-interest income to operating income (FTE basis) was 21.3% for the first quarter of 2005 as compared to 21.1% for the first quarter of 2004. 18 Operating Expenses Table 5 below sets forth the quarterly results of the major operating expense categories for the current and prior year, as well as efficiency ratios (defined below), a standard measure of overhead utilization used in the banking industry. Table 5: Operating Expenses Three Months Ended March 31, ---------------------------- (000's omitted) 2005 2004 ---------------------------------- ---------------------------- Salaries and employee benefits $16,166 $15,167 Occupancy 3,032 2,630 Equipment and furniture 2,134 2,152 Legal and professional fees 1,201 997 Data processing 1,710 1,880 Amortization of intangible assets 1,984 1,639 Office supplies 585 521 Foreclosed property 264 231 Acquisition expenses 41 970 Other 3,914 3,569 ---------------------------------- ---------------------------- Total operating expenses $31,031 $29,756 ================================== =========================== Operating expenses/average assets 2.82% 3.07% Efficiency ratio 55.0% 54.5% As shown in Table 5, first quarter 2005 operating expenses were $31.0 million, up $1.3 million or 4.3% from the prior year level. This increase was primarily attributable to higher personnel and occupancy costs, amortization of intangibles and business development expenses. Offsetting these increases is a $929,000 decrease in acquisition expenses. In the first quarter of 2004 expenses of $921,000 relating to an acquisition in a prior year were recorded. Recurring first quarter operating expenses (excluding acquisition expenses) were up 7.7% versus the equivalent prior year period. The first quarter increase in recurring operating expenses was mainly attributable to the acquisitions of First Heritage and Dansville in the second and fourth quarters of 2004, respectively, which affected virtually all expense categories. The $1.0 million rise in personnel expenses in comparison to the prior year was also impacted by merit increases. In addition, professional fess and business development expenses, which are included in other expenses, have increased due to a more robust marketing strategy. The Company's efficiency ratio (recurring operating expense excluding intangible amortization divided by the sum of net interest income (FTE) and recurring non-interest income) was 55.0% for the first quarter, 0.5 percentage points above the comparable quarter of 2004. This resulted from operating expenses (as defined above) increasing 6.8% primarily due to acquisitions and higher salary costs, while recurring operating income grew at a lesser, 5.8% pace. Income Taxes The first quarter effective income tax rate was 24.9%, a slight increase from the 24.0% rate used in the first quarter of 2004 principally as a result of the proportion of income being generated from tax-exempt securities and loans. 19 Investments As reflected in Table 6 below, the carrying value of investments (including unrealized gains on available-for-sale securities) was $1.6 billion at the end of the first quarter, a decrease of $30 million from December 31, 2004 and an increase of $207 million from the end of first quarter 2004. The book value (excluding unrealized gains) of investments was down $9 million from year-end 2004 and up $250 million versus March 31, 2004. The year-over-year growth in the book value of the investment portfolio was driven by the First Heritage acquisition and the strategic security purchases made through the second quarter of 2004 to take advantage of improved investment market conditions. During the first quarter 2005, certain securities were sold in order to take advantage of market conditions and maximize their expected total return and shorten the average life of the portfolio. The overall mix of securities within the portfolio remained relatively consistent, with a slight increase towards U.S. treasury and agency securities. The change in the carrying value of investments is impacted by the amount of net unrealized gains in the portfolio at a point in time. Net unrealized gains decreased by $20 million and $43 million since December 31, 2004 and March 31, 2004, respectively. This fluctuation is indicative of the interest rate movements during the respective time periods and the changing composition of the portfolio. Table 6: Investments
March 31, 2005 December 31, 2004 March 31, 2004 ----------------------- ----------------------- ----------------------- Amortized Amortized Amortized Cost/Book Fair Cost/Book Fair Cost/Book Fair (000's omitted) Value Value Value Value Value Value - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Held-to-Maturity Portfolio: U.S. treasury and agency securities $ 127,454 $ 124,544 $ 127,490 $ 125,906 $ 127,599 $ 129,361 Obligations of state and political subdivisions 5,430 5,508 6,576 6,694 6,671 6,889 Other securities 9,480 9,480 3,578 3,578 3,557 3,557 - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Total held-to-maturity portfolio 142,364 139,532 137,644 136,178 137,827 139,807 - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Available-for-Sale Portfolio: U.S. treasury and agency securities 587,299 596,442 630,058 650,767 443,087 473,126 Obligations of state and political subdivisions 563,994 585,094 545,698 573,551 480,762 518,142 Corporate securities 40,375 43,236 40,443 43,898 23,783 26,815 Collateralized mortgage obligations 87,574 88,349 70,986 72,444 82,867 86,547 Mortgage-backed securities 47,327 48,795 50,347 52,664 66,518 70,328 - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Sub-total 1,326,569 1,361,916 1,337,532 1,393,324 1,097,017 1,174,958 Equity securities 50,549 50,549 53,371 53,371 34,805 34,805 - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Total available-for-sale portfolio 1,377,118 1,412,465 1,390,903 1,446,695 1,131,822 1,209,763 Net unrealized gain on available-for-sale portfolio 35,347 0 55,792 0 77,941 0 - -------------------------------------------------- ----------------------- ----------------------- ----------------------- Total $1,554,829 $1,551,997 $1,584,339 $1,582,873 $1,347,590 $1,349,570 ================================================== ======================= ======================= =======================
20 Loans As shown in Table 7, loans ended the first quarter at $2.3 billion, down $24 million (-1.0%) for the quarter and up $229 million (10.9%) versus one year earlier. Consistent with prior years, the Company experienced softness within our lending portfolio in the first quarter, due principally to seasonal (weather-related) trends and demands. The decline in loan balances in the first quarter 2005 was centered in the business and consumer installment lending categories. The acquisitions of First Heritage and Dansville in the second and fourth quarters of 2004 added approximately $212 million in loans. Excluding the impact of acquisitions, loans grew $16.8 million or 0.8% in the last 12 months primarily as a result of demand in the consumer mortgage segment, which produced a $38 million or 5.1% increase over the year-earlier period. The balance of the change reflects an increase in consumer installment loans of $6.3 million (+0.9%), and reductions in business loans of $27 million (-4.0%). The organic increase over the past four quarters in total loans outstanding was attributable to the New York markets. Table 7: Loans
(000's omitted) March 31, 2005 December 31, 2004 March 31, 2004 - ------------------------------------------------------ ----------------- ---------------- Consumer mortgage $ 801,923 34% $ 801,412 34% $ 743,699 35% Business lending 816,616 35% 831,244 35% 673,812 32% Consumer installment 715,856 31% 725,837 31% 687,904 33% - ------------------------------------------------------ ----------------- ---------------- Total loans $2,334,395 100% $2,358,493 100% $2,105,415 100% ====================================================== ================= ================
Total consumer mortgages increased $58 million year-over year and $511,000 during the first quarter. Excluding the impact of acquisitions, consumer mortgages were up $38 million (5.1%) over the last 12 months, as record levels of refinancing activity was driven by mortgage rates that were at 40-year lows. Consumer mortgages growth slowed in the first quarter of 2005 as the pace of refinancings slowed after an extended period of elevated demand in the low-rate environment. The growth for both the 12 and three-month time frames were derived from activity in the New York markets. Business loans rose $143 million over the latest 12 months and declined $14.6 million during the quarter. Excluding acquisitions, business loans fell $27 million or 4.0% since March 31, 2004. The decline in business loans was impacted by seasonal factors and challenging economic conditions in our primary markets as well as the payoff of an $8 million relationship in Pennsylvania during the first quarter of 2005. Consumer installment loans, largely borrowings originated in automobile, marine and recreational vehicle dealerships as well as branch originated home equity and installment loans, rose $28.0 million (4.1%) on a year-over-year basis and decreased $10.0 million (1.4%) in the last three months. Excluding acquisitions, consumer installment loans increased $6.3 million (0.9%) since March 31, 2004. Historically low interest rates, aggressive dealer and manufacturer incentives on new vehicles, and very competitive pricing on used vehicles have helped drive strong growth in auto, boat and recreational vehicle sales over the last two years. Consumer installment loans increased in both the New York and Pennsylvania markets during the 12 month time frame and decreased in both markets during the first quarter of 2005. 21 Asset Quality Table 8 below exhibits the major components of non-performing loans and assets and key asset quality metrics for the periods ending March 31, 2005 and 2004 and December 31, 2004. Table 8: Non-performing Assets
March 31, December 31, March 31, (000's omitted, except for ratios) 2005 2004 2004 - ------------------------------------------------------------- --------- ------------ --------- Non-accrual loans $ 13,433 $ 11,798 $ 12,499 Accruing loans 90+ days delinquent 1,255 1,158 1,462 Restructured loans 0 0 27 - ------------------------------------------------------------- --------- ------------ --------- Total non-performing loans 14,688 12,956 13,988 Other real estate 1,444 1,645 1,014 - ------------------------------------------------------------- --------- ------------ --------- Total non-performing assets $ 16,132 $ 14,601 $ 15,002 ============================================================= ========= =========== ========= Allowance for loan losses to total loans 1.37% 1.35% 1.37% Allowance for loan losses to non-performing loans 217% 245% 206% Non-performing loans to total loans 0.63% 0.55% 0.66% Non-performing assets to total loans and other real estate 0.69% 0.62% 0.71% Delinquent loans (30 days old to non-accruing) to total loans 1.35% 1.45% 1.65% Net charge-offs to average loans outstanding (quarterly) 0.30% 0.49% 0.44% Loan loss provision to net charge-offs (quarterly) 107% 72% 88%
As displayed in Table 8, non-performing assets at March 31, 2005 were $16.1 million, an increase of $1.5 million versus year-end 2004 and $1.1 million above the level at March 31, 2004. Most of the increase over the latest three months was due to three commercial loans moving to non-accrual-status. Total non-performing assets increased $1.1 million or 7.5% from one-year ago well below the 10.9% increase in the loan portfolio over the same period. Consequently, non-performing assets as a percentage of total loans plus other real estate declined 2 basis points versus March 31, 2004, reflecting stable asset quality results. Non-performing loans were 0.63% of total loans outstanding at the end of the first quarter versus the 0.55% reported at year-end 2004 and below the 0.66% at March 31, 2004. The change in the ratio in comparison to December 31, 2004 was mostly attributable to the commercial loans previously mentioned. The allowance for loan losses to non-performing loans ratio, a general measure of coverage adequacy, was 217% at the end of the first quarter. This was below the Company's coverage ratio of 245% at year-end 2004, but higher than the ratio of 206% at March 31, 2004 and the average coverage of 208% for the previous eight quarters. Delinquent loans (30 days through non-accruing) as a percent of total loans was 1.35% at the end of the first quarter, a 10 basis-point decrease from year-end 2004 and 30 basis points below the 1.65% delinquency ratio at March 31, 2004. Real estate and installment loan delinquency ratios at the end of the first quarter improved in comparison to both of the earlier periods. Commercial loan delinquency ratios improved from the first quarter of 2004, but declined from the fourth quarter of 2004. The current delinquency level was 29 basis points below the Company's average of 1.64% over the previous eight quarters. 22 Table 9: Allowance for Loan Losses Activity
Three Months Ended March 31, ---------------------------- (000's omitted) 2005 2004 ---------------------------------------------------------------------------------- Allowance for loan losses at beginning of period $31,778 $29,095 Charge-offs: Business lending 707 1,119 Consumer mortgage 23 96 Consumer installment 1,715 1,809 ---------------------------------------------------------------------------------- Total charge-offs 2,445 3,024 Recoveries: Business lending 41 142 Consumer mortgage 7 12 Consumer installment 642 546 ---------------------------------------------------------------------------------- Total recoveries 690 700 ---------------------------------------------------------------------------------- Net charge-offs 1,755 2,324 Provision for loan losses 1,875 2,050 ---------------------------------------------------------------------------------- Allowance for loan losses at end of period $31,898 $28,821 ================================================================================== Net charge-offs to average loans outstanding: Business lending 0.33% 0.58% Consumer mortgage 0.01% 0.05% Consumer installment 0.61% 0.73% Total loans 0.30% 0.44%
As displayed in Table 9, net charge-offs during the first quarter were $1.8 million, $569,000 less than the equivalent 2004 period, as all loan classifications, business, consumer mortgage and consumer installment experienced declines. This decrease occurred despite a $231 million increase in average loan balances, and resulted in a 14 basis point drop in the net charge-off ratio (net charge-offs as a percentage of average loans outstanding) to 0.30%. This improvement was primarily reflective of the effectiveness of credit risk management resources and strengthening economic conditions. The business lending net charge-off ratio declined 25 basis points to 0.33%, the consumer mortgage net charge-off ratio improved by four basis points to 0.01% and the consumer installment net charge-off ratio decreased 12 basis points versus the equivalent prior year period. A required loan loss allowance of $31.9 million was determined as of March 31, 2005, necessitating a $1.9 million loan loss provision for the quarter compared to $2.1 million one year earlier. The first quarter 2005 loan loss provision was $0.1 million higher than net charge-offs mainly due to the downgrade of risk ratings on certain business loans and a slight increase in the historical loss factors for consumer direct and consumer mortgage loans. The allowance for loan losses rose $3.1 million or 10.7% over the last 12 months, versus a 10.9% increase in loans outstanding. Consequently, the ratio of allowance for loan loss to loans outstanding remained consistent at 1.37%. Deposits As shown in Table 10, average deposits of $3.0 billion in the first quarter were up 1.0% compared to fourth quarter 2004 and increased 8.0% versus the same quarter of last year. Deposits totaling $245 million were added as a result of the acquisitions of First Heritage and Dansville in May and December 2004, respectively. In 2004, the deposit mix shifted towards demand deposits and more liquid interest-bearing deposits (interest checking and savings accounts). This shift in deposit mix may have reflected customers' rising rate expectations and consequently their unwillingness to be locked into rates and products for extended periods of time. Increased yields on money market accounts in the first quarter from 0.78% to 1.09% resulted in the average balances for money market accounts increasing from 10.6% of the total deposits to 11.4% of total deposits. The reduced opportunity cost of holding money in non-interest and low-interest bearing accounts contributed to the average balances for demand deposit, interest checking and savings accounts increasing to 49% of total deposits at December 31, 2004 and decreasing to 48% in first quarter 2005 versus 47% in first quarter 2004. This shift in mix drove up the cost of deposits by 7 basis points in the first quarter of 2005, equivalent to the cost of deposits in the first quarter of 2004. Excluding the impact of acquisitions, average IPC (individuals and businesses) deposits have decreased $17.5 million or 0.6% since December 31, 2004 and $33.9 million or 1.3% over the latest 12 months, mostly reflecting the competitive conditions in our 23 primary markets and the relative attractiveness of alternative funding sources. Average public funds, excluding acquisitions, have increased $23.8 million or 13.3% and $9.4 million or 4.9% over the same periods. A decrease in IPC deposits and an inflow of public funds deposits in the first quarter is a common seasonal fluctuation in our markets as payment of local property taxes shifts funds from one category to the other. Table 10: Average Deposits March 31, December 31, March 31, (000's omitted) 2005 2004 2004 --------------------------- ---------- ----------- ---------- Demand deposits $ 587,677 $ 584,223 $ 520,858 Interest checking deposits 310,546 309,817 287,295 Savings deposits 532,806 542,954 471,249 Money market deposits 338,905 312,317 295,994 Time deposits 1,199,075 1,189,729 1,173,440 --------------------------- ---------- ----------- ---------- Total deposits $2,969,009 $2,939,040 $2,748,836 =========================== ========== =========== ========== IPC deposits $2,764,691 $2,759,633 $2,557,112 Public funds deposits 204,318 179,407 191,724 --------------------------- ---------- ----------- ---------- Total deposits $2,969,009 $2,939,040 $2,748,836 =========================== ========== =========== ========== Borrowings At the end of the first quarter, borrowings of $855 million were down $66 million from December 31, 2004 and were up $262 million from the first quarter 2004 level. The decline over the last three months was dictated by the sale of certain investments, a drop in outstanding loan balances and an increase in deposits. The funding needed for consumer mortgage and indirect loan growth and investment purchases drove the year-over-year increase in borrowings. Borrowings decreased in the first quarter and have increased since the first quarter of 2004. Long-term borrowings are essentially flat over both periods. A higher proportion of short-term borrowings have been utilized in recent periods in order to take advantage of an unusually steep yield curve and help reduce the Company's risk with regard to falling interest rates in certain timeframes. Shareholders' Equity On April 20, 2005 the Company announced that its Board of Directors had authorized a stock repurchase program to acquire up to 1,500,000 of its shares, or approximately 5%, of its outstanding common stock. The shares may be repurchased from time to time, in open market or privately negotiated transactions over the course of the subsequent 20 months. All reacquired shares will become treasury shares and will be used for general corporate purposes. Total shareholders' equity equaled $460 million at the end of the first quarter, a decrease of $14.2 million from the balance at December 31, 2004. This decrease consisted of net income of $13.3 million, $2.3 million from shares issued under the employee stock plan, offset by a change in the after-tax market value adjustment of $12.5 million, dividends declared of $5.5 million and treasury stock purchases of $11.9 million. Over the past 12 months total shareholders' equity increased by $37 million, as net income, and a significant increase in paid-in capital from shares issued in the First Heritage acquisition and the employee stock plan more than offset dividends declared, treasury stock purchases, and a lower market value adjustment. The Company's Tier I leverage ratio, a primary measure of regulatory capital for which 5% is the requirement to be "well-capitalized," was 6.83% at the end of the first quarter, down eleven basis points from year-end 2004 and 36 basis points lower than its level one year ago. These declines were primarily caused by the treasury share purchases made over the last 12 months. The tangible equity-to-assets ratio of 5.57% declined 25 basis points in the quarter and 72 basis points versus March 31, 2004. A lower market value adjustment (unrealized gains in the investment portfolio) was the primary driver of the additional decrease in this ratio. The changes in the market value adjustment did not have the equivalent impact on the Tier I leverage ratio because that component of equity is excluded from this ratio. The dividend payout ratio (dividends declared divided by net income) for first quarter 2005 was 40.9%, down 2.6 percentage points from the fourth quarter of 2004 and 0.2 percentage points lower than one year ago. The ratio decreased from first quarter 2004 because dividends declared increased 19.2%, a lower percentage increase than the 19.5% growth in net income. The expansion of dividends declared was caused by shares outstanding increasing 6.2% and dividends per share being raised 12.5% in August 2004, from $0.16 to $0.18. The decline in the payout ratio in comparison to the linked quarter was due to a reduced level of dividends declared in the fourth quarter 2004, caused by 1% decrease in the shares outstanding, while net income for the quarter increased 5.3%. 24 Liquidity Management of the Company's liquidity is critical due to the potential for unexpected fluctuations in deposits and loans. Adequate sources of both on and off-balance sheet funding are in place to effectively respond to such unexpected fluctuations. The Bank's primary approach to measuring liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the amount of cash that could be made available within 30 days (calculated as liquid assets less short-term liabilities); and second, a projection of subsequent cash availability over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total assets for both the 30 and 90-day time horizons. As of March 31, 2005, this ratio for the 30 and 90-day time period was 15.8% and 17.9%, respectively, excluding the Company's capacity to borrow additional funds from the Federal Home Loan Bank. To measure longer-term liquidity, a baseline projection of loan and deposit growth for five years is made to reflect how current liquidity levels could change over time. This five-year measure reflects adequate liquidity to fund loan and other asset growth over the next five years. New Accounting Pronouncements See New Accounting Pronouncement section of Note C to the consolidated financial statements. Forward-Looking Statements This document contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company's plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company's control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) risks related to credit quality, interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (3) the effect of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (4) inflation, interest rate, market and monetary fluctuations; (5) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (6) changes in consumer spending, borrowing and savings habits; (7) technological changes; (8) any acquisitions or mergers that might be considered or consummated by the Company and the costs and factors associated therewith; (9) the ability to maintain and increase market share and control expenses; (10) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and accounting principles generally accepted in the United States; (11) changes in the Company's organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (12) the costs and effects of litigation and of any adverse outcome in such litigation; (13) other risk factors outlined in the Company's filings with the Securities and Exchange Commission from time to time; and (14) the success of the Company at managing the risks of the foregoing. The foregoing list of important factors is not exclusive. Such forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company would make additional updates or corrections with respect thereto or with respect to other forward-looking statements. Item 3. Quantitative and Qualitative Disclosure about Market Risk Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates, prices or credit risk. Credit risk associated with the Company's loan portfolio has been previously discussed in the asset quality section of Management's Discussion and Analysis of Financial Condition and Results of Operations. Management believes that the tax risk of the Company's municipal investments associated with potential future changes in statutory, judicial and regulatory actions is minimal. The Company has an insignificant amount of credit risk in its investment portfolio because essentially all of the fixed-income securities in the portfolio are AAA-rated (highest possible rating). Therefore, almost all the market risk in the investment portfolio is related to interest rates. The ongoing monitoring and management of both interest rate risk and liquidity, in the short and long term time horizons is an important component of the Company's asset/liability management process, which is governed by limits established in the policies reviewed and approved annually by the Board of Directors. The Board of Directors delegates responsibility for carrying out the policies to the Asset/Liability Committee (ALCO) which meets each month and is made up of the Company's senior management as well as regional and line-of-business managers who oversee specific earning asset classes and various funding sources. 25 As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools, which enable it to identify and quantify sources of interest rate risk in varying rate environments. The primary tool used by the Company in managing interest rate risk is income simulation. While a wide variety of strategic balance sheet and treasury yield curve scenarios are tested on an ongoing basis, the following reflects the Company's one-year net interest income sensitivity based on: o Asset and liability levels using March 31, 2005 as a starting point. o There are assumed to be conservative levels of balance sheet growth--low to mid single digit growth in loans and deposits, while using the cashflows from investment contractual maturities and prepayments to repay short-term capital market borrowings. o The prime rate and federal funds rates are assumed to move up 200 basis points and down 100 basis points over a 12-month period while flattening the long end of the treasury curve to spreads over federal funds that are more consistent with historical norms. Deposit rates are assumed to move in a manner that reflects the historical relationship between deposit rate movement and changes in the federal funds rate, generally reflecting 10%-65% of the movement of the federal funds rate. o Cash flows are based on contractual maturity, optionality and amortization schedules along with applicable prepayments derived from internal historical data and external sources. Net Interest Income Sensitivity Model Calculated annualized increase (decrease) in Change in interest projected net interest rates income at March 31, 2005 ------------------------------------------------- + 200 basis points (2.4%) - 100 basis points 0.2% The modeled NII in a falling rate environment is initially more favorable than if rates were to rise due to a faster initial reaction from core deposit pricing and short-term capital market borrowing rates. Over a longer time period, however, the growth in NII improves in a rising rate environment as a result of lower yielding earning assets running off and being replaced at increased rates. The analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions: the nature and timing of interest rate levels (including yield curve shape), prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and other factors. While the assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive 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 We maintain disclosure controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the Securities and Exchange Commission, or SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on their evaluation of our disclosure controls and procedures, our management, with the participation of the Chief Executive and the Chief Financial Officer, has concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, these disclosure controls and procedures were effective to ensure that we are able to record, process, summarize and report the information we are required to disclose in the reports we file with the SEC within the required time periods. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in the paragraph above. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 26 Part II. Other Information Item 1. Legal Proceedings. The Company and its subsidiaries are subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate liability, if any, arising out of litigation pending against the Company or its subsidiaries will have a material effect on the Company's consolidated financial position or results of operations. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. On April 20, 2005, the Company announced a twenty-month authorization to repurchase up to 1,500,000 of its outstanding shares in open market or privately negotiated transactions. On December 15, 2004, the Board of Directors approved a twelve-month authorization to repurchase up to 500,000 of its outstanding shares in open market transactions. These repurchases will be for general corporate purposes, including those related to stock plan activities. The following table shows treasury stock purchases under the December authorization during the first quarter 2005. Total Number Number of Shares Number of Average Price of Shares Remaining to be Shares Purchased Per share Purchased Purchased - -------------------------------------------------------------------------------- January 2005 0 $ 0.00 0 500,000 February 2005 500,000 23.83 500,000 0 March 2005 0 0.00 0 0 - -------------------------------------------------------------------------------- Total 500,000 $23.83 500,000 0 ================================================================================ Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Securities Holders. There were no matters submitted to a vote of the shareholders during the quarter ending March 31, 2005. Item 5. Other Information. Not applicable Item 6. Exhibits and Reports on Form 8-K Exhibit No. Description - ----------- ----------- 31.1 Certification of Sanford A. Belden, President and Chief Executive Officer of the Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Scott A. Kingsley, Treasurer and Chief Financial Officer of the Registrant, pursuant to Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Sanford A. Belden, President and Chief Executive Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Scott A. Kingsley, Treasurer and Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Reports on Form 8-K: o Form 8-K related to quarterly earnings press release was filed on April 21, 2005. 27 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: May 6, 2005 /s/ Sanford A. Belden -------------------------------------- Sanford A. Belden, President, Chief Executive Officer and Director Date: May 6, 2005 /s/ Scott A. Kingsley -------------------------------------- Scott A. Kingsley, Treasurer and Chief Financial Officer 28 EX-31.1 2 d63735_ex31-1.txt SECTION 302 CERTIFICATION OF SANFORD A. BELDEN Exhibit 31.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 6, 2005 /s/ Sanford A. Belden - --------------------- Sanford A. Belden, President, Chief Executive Officer and Director 29 EX-31.2 3 d63735_ex31-2.txt SECTION 302 CERTIFICATION OF SCOTT A. KINGSLEY Exhibit 31.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Scott A. Kingsley, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Bank System, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: May 6, 2005 /s/ Scott A. Kingsley - --------------------- Scott A. Kingsley, Treasurer and Chief Financial Officer 30 EX-32.1 4 d63735_ex32-1.txt SECTION 906 CERTIFICATION OF SANFORD A. BELDEN Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Community Bank System, Inc. (the "Company") on Form 10-Q for the quarter ended March 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Sanford A. Belden, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Sanford A. Belden - --------------------- Sanford A. Belden President, Chief Executive Officer and Director May 6, 2005 31 EX-32.2 5 d63735_ex32-2.txt SECTION 906 CERTIFICATION OF SCOTT A. KINGSLEY Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Community Bank System, Inc. (the "Company") on Form 10-Q for the quarter ended March 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Scott A. Kingsley, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Scott A. Kingsley - --------------------- Scott A. Kingsley, Treasurer and Chief Financial Officer May 6, 2005 32 -----END PRIVACY-ENHANCED MESSAGE-----