FORM 10 - Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the six months ended June 30, 2002
Commission file number 0-11716
COMMUNITY BANK SYSTEM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 16-1213679
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5790 Widewaters Parkway, DeWitt, New York 13214
(Address of principal executive offices) (Zip Code)
315/445-2282
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, No par value - 12,959,869 shares outstanding as of August 8, 2002
INDEX
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Condition -- June 30, 2002,
December 31, 2001 and June 30, 2001
Consolidated Statements of Income -- Three and
six months ended June 30, 2002 and 2001
Consolidated Statement of Shareholders' Equity --
Six months ended June 30, 2002
Consolidated Statements of Comprehensive Income --
Six months ended June 30, 2002 and 2001
Consolidated Statements of Cash Flows --
Six months ended June 30, 2002, and 2001
Notes to Consolidated Financial Statements -
June 30, 2002
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Securities Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
CONSOLIDATED STATEMENTS OF CONDITION (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Share Data)
June 30, December 31, June 30,
2002 2001 2001
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $99,017 $106,554 $65,264
Investment securities 1,324,012 1,148,182 1,072,149
Loans 1,751,184 1,732,870 1,569,076
Allowance for loan losses 23,883 23,901 20,860
- ----------------------------------------------------------------------------------------------------------------
Net loans 1,727,301 1,708,969 1,548,216
Premises and equipment, net 56,376 53,266 43,020
Accrued interest receivable 26,354 22,562 22,533
Core deposit intangibles, net 33,678 36,722 9,485
Goodwill, net 19,814 19,814 21,624
Other intangibles, net 79,759 85,806 37,442
- ----------------------------------------------------------------------------------------------------------------
Intangible assets, net 133,251 142,342 68,551
Other assets 39,552 28,958 31,956
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $3,405,863 $3,210,833 $2,851,689
================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Noninterest bearing $434,400 $447,544 $322,056
Interest bearing 2,078,861 2,098,426 1,729,329
- ----------------------------------------------------------------------------------------------------------------
Total deposits 2,513,261 2,545,970 2,051,385
Federal funds purchased 41,100 14,200 25,500
Borrowings 431,100 263,100 473,100
Company obligated mandatorily redeemable preferred securities
of subsidiaries, Community Capital/Statutory Trust I-III, holding
solely junior subordinated debentures of the Company 77,347 77,819 29,827
Accrued interest and other liabilities 46,737 41,764 37,706
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 3,109,545 2,942,853 2,617,518
- ----------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock no par $1.00 stated value
20,000,000 share authorized; 12,958,915, 12,902,812 and 11,548,381
shares outstanding, respectively 12,959 12,903 11,548
Surplus 78,921 77,710 46,270
Undivided profits 179,102 170,472 165,807
Accumulated other comprehensive income 25,546 7,281 10,782
Shares issued under employee stock plan - unearned (210) (386) (236)
- ----------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 296,318 267,980 234,171
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHARHOLDERS' EQUITY $3,405,863 $3,210,833 $2,851,689
================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
3
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands, Except Per-Share Data)
Three Months Ended Six Months Ended
June 30, June 30,
- -------------------------------------------------------------------------------------------------------------------------------
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
Interest income:
Interest and fees on loans $32,078 $33,275 $65,136 $66,773
Interest and dividends on investments:
Taxable 14,883 14,165 29,003 28,355
Nontaxable 4,260 2,500 7,858 4,576
Interest on federal funds and deposits with other banks 2 196 3 387
- -------------------------------------------------------------------------------------------------------------------------------
Total interest income 51,223 50,136 102,000 100,091
- -------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 13,842 19,367 29,011 38,916
Interest on federal funds purchased 148 311 236 648
Interest on short-term borrowings 404 1,903 615 4,673
Interest on madatorily redeemable preferred securities of subsidiaries 1,423 733 2,896 1,466
Interest on long-term borrowings 3,968 4,742 7,637 8,168
- -------------------------------------------------------------------------------------------------------------------------------
Total interest expense 19,785 27,056 40,395 53,871
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income 31,438 23,080 61,605 46,220
Less: provision for loan losses 3,385 1,415 4,902 2,741
- -------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 28,053 21,665 56,703 43,479
- -------------------------------------------------------------------------------------------------------------------------------
Other income:
Fiduiciary and investment services 899 696 1,777 1,526
Service charges on deposit accounts 3,120 2,505 6,041 4,740
Commissions on investment products 1,943 1,646 3,913 3,170
Other service charges, commissions and fees 1,625 1,710 3,537 3,100
Other operating (loss) income, net (20) 66 34 69
Investment security gain (loss), net 1,144 (138) 1,144 (128)
- -------------------------------------------------------------------------------------------------------------------------------
Total other income 8,711 6,485 16,446 12,477
- -------------------------------------------------------------------------------------------------------------------------------
Other expenses:
Salaries and employee benefits 12,265 10,326 24,391 20,442
Occupancy expense, net 2,076 1,512 4,398 3,090
Equipment and furniture expense 1,984 1,543 3,854 2,898
Amortization of intangible assets 2,997 1,541 6,073 3,001
Legal and professional fees 681 691 1,535 1,318
Data processing expenses 1,743 1,267 3,421 2,475
Acquisition and unusual expenses 108 4,636 700 5,487
Other 3,718 3,283 7,384 5,960
- -------------------------------------------------------------------------------------------------------------------------------
Total other expenses 25,572 24,799 51,756 44,671
- -------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 11,192 3,351 21,393 11,285
Income taxes 3,013 1,241 5,776 3,426
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME $8,179 $2,110 $15,617 $7,859
===============================================================================================================================
Earnings per share - Basic $0.63 $0.18 $1.21 $0.69
===============================================================================================================================
Earnings per share - Diluted $0.62 $0.18 $1.19 $0.68
===============================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
Six Months Ended June 30, 2002
(In Thousands, Except Share Data)
Accumulated Shares Issued
Common Stock Other Under Employee
Shares Undivided Comprehensive Stock Plan
Outstanding Amount Surplus Profits Income -Unearned Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 12,902,812 $12,903 $77,710 $170,472 $7,281 ($386) $267,980
Net income 15,617 15,617
Other comprehensive income, net of tax 18,265 18,265
Dividends declared:
Common, $.54 per share (6,987) (6,987)
Common stock issued under employee stock plan 56,103 56 1,211 176 1,443
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 12,958,915 $12,959 $78,921 $179,102 $25,546 ($210) $296,318
===================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands)
Six Months Ended June 30,
- ----------------------------------------------------------------------------------------------
2002 2001
- ----------------------------------------------------------------------------------------------
Other comprehensive income, before tax:
Change in minimum pension liability adjustment $4,919 $0
Unrealized gain on securities:
Unrealized holding gains arising during period 26,591 7,720
Reclassification adjustment for (gains) losses included
in net income (1,144) 128
- ----------------------------------------------------------------------------------------------
Other comprehensive income, before tax 30,366 7,848
Income tax expense related to other comprehensive income (12,101) (3,032)
- ----------------------------------------------------------------------------------------------
Other comprehensive income, net of tax 18,265 4,816
Net income 15,617 7,859
- ----------------------------------------------------------------------------------------------
Comprehensive income $33,882 $12,675
==============================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
6
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES
(In Thousands)
Six Months Ended June 30,
- ------------------------------------------------------------------------------------------------------------------
2002 2001
- ------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $15,617 $7,859
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation 3,191 2,440
Amortization of intangible assets 6,073 3,001
Net amortization of security premiums and discounts 2,018 893
Amortization of discount of loans (49) (110)
Amortization of unearned compensation and discount on junior subordinated debentures 236 32
Provision for loan losses 4,902 2,741
Provision (benefit) for deferred taxes 1,082 (935)
(Gain) loss on sale of investment securities (1,144) 128
Loss (gain) on sale of loans and other assets 4 (6)
Change in interest receivable (3,792) 350
Change in other assets and other liabilities (12,545) 1,889
- ------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,593 18,282
- ------------------------------------------------------------------------------------------------------------------
Investing Activities:
Proceeds from sales of investment securities 63,513 58,255
Proceeds from maturities of held-to-maturity investment securities 3,231 2,415
Proceeds from maturities of available-for-sale investment securities 87,184 87,563
Purchases of held-to-maturity investment securities (2,075) (1,384)
Purchases of available-for-sale investment securities (303,115) (236,644)
Net change in loans outstanding (23,180) 2,999
Premium paid on acquisition of business 0 (3,007)
Cash received in acquisition 0 3,777
Capital expenditures (4,347) (3,041)
- ------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (178,789) (89,067)
- ------------------------------------------------------------------------------------------------------------------
Financing Activities:
Net change in demand deposits, NOW accounts, and savings accounts 24,841 (9,866)
Net change in certificates of deposit (57,550) 25,023
Net change in federal funds purchased 26,900 (23,230)
Net change in borrowings 167,500 72,050
Issuance of common stock 994 411
Cash dividends paid (6,970) (4,739)
Other financing activities (56) (56)
- ------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 155,659 59,593
- ------------------------------------------------------------------------------------------------------------------
Change in cash and cash equivalents (7,537) (11,192)
Cash and cash equivalents at beginning of year 106,554 76,456
- ------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $99,017 $65,264
==================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $39,728 $51,073
Cash paid for income taxes $5,224 $4,541
==================================================================================================================
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Dividends declared and unpaid $3,499 $3,118
Gross change in unrealized gains and (losses) on available-for-sale securities $25,447 ($7,848)
Change in minimum pension liability adjustment ($4,919) $0
Bank acquisition:
Fair value of assets acquired $0 $123,948
Liabilities assumed $0 $98,720
Common stock issued, including treasury stock of $0 and $17,006 $0 $25,228
==================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
7
Community Bank System, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
June 30, 2002
Note A -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for fair presentation have been included. Operating results for the
three-month period ended June 30, 2002 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2002.
On November 16, 2001, the Company acquired 36 branches from FleetBoston
Financial Corporation with $470 million in deposits and $177 million in loans.
The branches are located in Southwestern and Finger Lakes Regions of New York.
The results of the 36 branch operations have been included in the consolidated
financial statements since that date.
On May 11, 2001, the Company completed its acquisition of the $648-million-asset
First Liberty Bank Corp. ("First Liberty"). Pursuant to the terms of the merger,
each share of First Liberty stock was exchanged for .56 shares of the Company's
common stock, which amounted to approximately 3.6 million shares. The merger
constituted a tax-free reorganization and has been accounted for as a pooling of
interests under Accounting Principles Board Opinion No. 16. Accordingly, the
consolidated financial statements for the periods presented have been restated
to include the combined results of operations, financial position and cash flows
of the Company and First Liberty.
On January 26, 2001, the Company acquired the $111-million-asset Citizens
National Bank of Malone, an eighty-year old commercial bank with five branches
throughout Franklin and St. Lawrence counties in New York State. The Company
issued 952,000 shares of its common stock to the former shareholders at a cost
of $26.50 per share. All of the 648,100 shares held in the Company's treasury
were issued in this transaction. The results of operations from this transaction
have been included in the Company's consolidated financial statements since the
acquisition date.
During the first quarter of 2002, the Company made a contribution of $5.0
million to its defined benefit pension plan. At March 31, 2002, an updated
actuarial valuation was performed which showed that plan assets exceeded the
accumulated benefit obligation. As a result, the additional minimum pension
liability of $4.919 million, which was recorded at December 31, 2001 as a charge
to shareholders' equity, net of tax, was reversed.
Note B -- Critical Accounting Policies
Allowance for Loan Losses
The allowance for loan losses reflects management's best estimate of probable
loan losses in the Company's loan portfolio, considering evaluations of
individual credits and concentrations of credit risk, changes in the quality of
the credit portfolio, levels of nonaccrual loans, current economic conditions,
changes in the size and character of the credit risks and other pertinent
factors. The allowance is increased by provisions charged to expense and reduced
by net charge-offs. A loan is considered impaired, based on current information
and events, if it is probable that the Bank will not be able to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. The measurement of impaired loans is
generally based on the present value of expected future cash flows discounted at
the historical effective interest rate, except that all collateral-dependent
loans are measured for impairment based on the fair value of the collateral.
8
New Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of, including long-term customer relationships of a financial
institution, such as core deposit intangibles. This Statement supersedes SFAS
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of;" however, this Statement retains the fundamental
provisions of Statement 121 for (a) recognition and measurement of the
impairment of long-lived assets to be held and used, and (b) measurement of
long-lived assets to be disposed of by sale. Effective January 1, 2002, the
Company adopted this pronouncement, which had no impact on the financial
condition or results of operations for the quarter and six months ended June 30,
2002.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. This Statement
supercedes Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit and Activity
(including Certain Costs Incurred in a Restructuring)." The provisions of this
Statement are effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The Company is not
anticipating that this pronouncement will have a significant impact on the
financial condition or results of its operations.
Note C -- Earnings Per Share
Basic earnings per share is computed based on the weighted average shares
outstanding. Diluted earnings per share is computed based on the weighted
average shares outstanding adjusted for the dilutive effect of the assumed
exercise of stock options during the year. The following is a reconciliation of
basic to diluted earnings per share for the three and six months ended June 30,
2002 and 2001.
Per Share
Income Shares Amount
- ------------------------------------------------------------------------------------------------------
Quarter ended June 30, 2002 Net income $8,179
Basic EPS 8,179 12,973 $0.63
Effect of dilutive
securities:
Stock options 221
---------------------
Diluted EPS $8,179 13,194 $0.62
======================================================================================================
Quarter ended June 30, 2001 Net income $2,110
Basic EPS 2,110 11,575 $0.18
Effect of dilutive
securities:
Stock options 158
---------------------
Diluted EPS $2,110 11,733 $0.18
======================================================================================================
Six months ended June 30, 2002 Net income $15,617
Basic EPS 15,617 12,957 $1.21
Effect of dilutive
securities:
Stock options 193
---------------------
Diluted EPS $15,617 13,150 $1.19
======================================================================================================
Six months ended June 30, 2001 Net income $7,859
Basic EPS 7,859 11,429 $0.69
Effect of dilutive
securities:
Stock options 158
---------------------
Diluted EPS $7,859 11,587 $0.68
======================================================================================================
9
Note D -- Intangible Assets
Effective January 1, 2002, the Company adopted Financial Accounting Standards
Board (FASB) SFAS No. 142, "Goodwill and Other Intangible Assets", which
addresses financial accounting and reporting for acquired goodwill and other
intangibles assets and supercedes APB Opinion No. 17, "Intangible Assets". The
statement requires that the Company subject goodwill and other intangible assets
to an annual impairment analysis to assess the need to write down the balances
and recognize an impairment loss. In addition, amortization of goodwill is no
longer being recorded in accordance with this statement. Core deposit
intangibles, net and other intangibles, net (primarily branch goodwill related
to branch acquisitions) will continue to be amortized. The adoption of this
pronouncement resulted in a reduction in amortization expense of $325,000 and
$650,000 for the quarter and six months ended June 30, 2002, respectively.
The proforma disclosures on net income and earnings per share of SFAS No. 142
for the quarter and six months ended June 30, 2001 are as follows:
($000s except for earnings-per-share amounts) Quarter Ended Six Months Ended
June 30, June 30,
--------------------------------------------------
2002 2001 2002 2001
--------------------------------------------------
Reported net income $8,179 $2,110 $15,617 $7,859
Add back: Goodwill amortization 202 354
--------------------------------------------------
Adjusted net income $8,179 $2,312 $15,617 $8,213
==================================================
Basic earnings per share:
Reported net income $0.63 $0.18 $1.21 $0.69
Goodwill amortization 0.02 0.03
--------------------------------------------------
Adjusted net income $0.63 $0.20 $1.21 $0.72
==================================================
Diluted earnings per share:
Reported net income $0.62 $0.18 $1.19 $0.68
Goodwill amortization 0.02 0.03
--------------------------------------------------
Adjusted net income $0.62 $0.20 $1.19 $0.71
==================================================
The gross carrying amount and accumulated amortization for each type of
intangible asset are as follows:
As of June 30, 2002 As of December 31, 2001
-----------------------------------------------------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
-----------------------------------------------------------------------------------
Amortized intangible assets:
Core deposit intangibles $47,218 ($13,540) $33,678 $47,218 ($10,496) $36,722
Other intangibles 99,700 (19,941) 79,759 102,718 (16,912) 85,806
-----------------------------------------------------------------------------------
Total amortized intangible 146,918 (33,481) 113,437 149,936 (27,408) 122,528
assets
Unamortized intangible assets:
Goodwill 21,275 (1,461) 19,814 21,275 (1,461) 19,814
-----------------------------------------------------------------------------------
Total intangible assets, net $168,193 ($34,942) $133,251 $171,211 ($28,869) $142,342
===================================================================================
There were no changes in the gross carrying value of goodwill for the quarter or
six months ended June 30, 2002. The decrease of $3,018 in the gross carrying
value of other intangibles pertains to "Statement 72 goodwill" associated with
the FleetBoston acquisition, specifically marking the bank premises and
equipment to fair market value and reflecting deferred taxes on the allowance
for loan losses and conversion costs. During the second quarter, the Company
completed its goodwill impairment analysis, and no adjustment was necessary.
10
The estimated aggregate amortization expense for each of the five succeeding
fiscal years ended December 31, is as follows:
2003 $11,229
2004 11,012
2005 10,339
2006 9,665
2007 9,665
The net carrying amount of core deposit intangibles, other intangibles and
goodwill as of June 30, 2002 by acquisition is as follows:
Next 12
Net Months'
Acquisition # of Carrying Amortization
Date Branches Amount Expense
--------------------------------------------------------
Core deposit intangibles:
FleetBoston Financial 11/16/01 36 $25,920 $3,667
Mellon Bank 06/07/00 2 3,553 271
First Liberty 01/01/97 2 162 108
ChaseManhattan Bank 07/14/95 15 4,043 1,348
----------------------
$33,678 $5,394
======================
Other intangible assets:
Fleet Boston Financial ** 11/16/01 36 $45,399 $3,034
Fleet Bank 07/18/97 12 11,735 1,174
Key Bank 06/16/97 8 8,992 907
ChaseManhattan Bank ** 07/14/95 15 10,850 601
ChaseManhattan Bank 10/28/94 1 257 35
Resolution Trust Corporation 06/03/94 3 2,526 365
----------------------
$79,759 $6,116
======================
Goodwill:
Citizens National Bank of Malone 01/26/01 $12,475 $0
Elias Asset Management 04/03/00 7,339 0
----------------------
$19,814 $0
======================
** During second quarter 2002 the FASB issued an exposure draft regarding the
reconsideration of certain provisions of SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions." Specifically, if
a Company separately identified a core deposit intangible asset from
"Statement 72 goodwill," the FASB may consider this goodwill under SFAS
No. 142. The comment period ended in late June. If this proposal is
implemented, it may be made retroactive to January 1, 2002. The Company
currently has $3.6 million in goodwill amortization that meets this
potential criterion, which would increase reported earnings per share by
approximately $0.04 per quarter.
11
Part 1. Financial Information
Item 1. Financial Statements
The information required by rule 10.01 of Regulation S-X is presented on the
previous pages.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The purpose of the discussion is to present material changes in Community Bank
System, Inc.'s financial condition and results of operations during the three
and six months ended June 30, 2002 which are not otherwise apparent from the
consolidated financial statements included in these reports. When used in this
report, the term "CBSI" or "CBU" means Community Bank System, Inc. and its
subsidiaries on a consolidated basis, unless indicated otherwise. Financial
performance comparisons to peer bank holding companies are based on data through
March 31, 2002 as provided by the Federal Reserve System; the peer group is
comprised of 70 bank holding companies having $3 to $10 billion in assets.
12
COMMUNITY BANK SYSTEM, INC.
SUMMARY OF OPERATIONS
EARNINGS AND BALANCE SHEET RECAP
2ND QUARTER 2002 AND FULL YEAR COMPARISONS
------------------------------------------------
000's Omitted Three Months Ended
------------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
------------------------------------------------
Earnings
------------------------------------------------
1 Net interest income $31,438 $23,080 $8,358 36.2%
2 Loan loss provision 3,385 1,415 1,970 139.2%
3 Net interest income after provision for loan 28,053 21,665 6,388 29.5%
losses
4 Investment security gain (loss) 1,144 (138) 1,282 -929.0%
5a Other income-financial services 3,550 2,994 556 18.6%
5b Other income-banking services 4,017 3,629 388 10.7%
6a Other expense-financial services 2,645 2,462 183 7.4%
6b Other expense-banking services 19,822 16,160 3,662 22.7%
6c Acquisition and unusual expense 108 4,636 (4,528) -97.7%
7 Intangible amortization 2,997 1,541 1,456 94.5%
8 Inc before inc tax 11,192 3,351 7,841 234.0%
9 Income tax 3,013 1,241 1,772 142.8%
10a Net income $8,179 $2,110 $6,069 287.6%
10b Net income - Operating $8,245 $4,950 $3,295 66.6%
10c Net income - Cash $10,017 $3,118 $6,899 221.3%
10d Net income - Cash Operating $10,083 $5,957 $4,126 69.3%
Earnings per share
11a Basic $0.63 $0.18 $0.45 250.0%
11b Diluted $0.62 $0.18 $0.44 244.4%
11c Diluted - Operating $0.62 $0.42 $0.20 47.6%
11d Diluted - Cash $0.76 $0.27 $0.49 181.5%
11e Diluted - Cash Operating $0.76 $0.51 $0.25 49.0%
------------------------------------------------=================================================
Balances At Period End
------------------------------------------------
12 Loans 1,751,184 1,569,076 182,108 11.6%
13 Investments (excl. mkt val adj) 1,281,724 1,054,382 227,342 21.6%
14 Earning assets 3,032,908 2,623,458 409,450 15.6%
15 Allowance for loss 23,883 20,860 3,023 14.5%
16a Intangible assets - Core deposits 33,678 9,485 24,193 255.1%
16b Intangible assets - Goodwill & other 99,573 59,066 40,507 68.6%
intangibles
17 Total assets 3,405,863 2,851,689 554,174 19.4%
18 Deposits 2,513,261 2,051,385 461,876 22.5%
19a Borrowings - FHLB 472,200 498,600 (26,400) -5.3%
19b Borrowings - Trust Preferred 77,347 29,827 47,520 159.3%
20 Total equity $296,318 $234,171 $62,147 26.5%
21 Assets under management $1,370,346 $1,363,784 $6,562 0.5%
=================================================
13
----------------------------------------------
000's Omitted Six Months Ended
----------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
-------------------------------------------
Earnings
-------------------------------------------
1 Net interest income $61,605 $46,220 $15,385 33.3%
2 Loan loss provision 4,902 2,741 2,161 78.8%
3 Net interest income after provision for 56,703 43,479 13,224 30.4%
loan losses
4 Investment security gain (loss) 1,144 (128) 1,272 -993.8%
5a Other income-financial services 7,193 5,984 1,209 20.2%
5b Other income-banking services 8,109 6,621 1,488 22.5%
6a Other expense-financial services 5,370 4,714 656 13.9%
6b Other expense-banking services 39,613 31,469 8,144 25.9%
6c Acquisition and unusual expense 700 5,487 (4,787) -87.2%
7 Intangible amortization 6,073 3,001 3,072 102.4%
8 Inc before inc tax 21,393 11,285 10,108 89.6%
9 Income tax 5,776 3,426 2,350 68.6%
10a Net income $15,617 $7,859 $7,758 98.7%
10b Net income - Operating $16,042 $11,199 $4,843 43.2%
10c Net income - Cash $19,323 $9,798 $9,525 97.2%
10d Net income - Cash Operating $19,748 $13,137 $6,611 50.3%
Earnings per share
11a Basic $1.21 $0.69 $0.52 75.4%
11b Diluted $1.19 $0.68 $0.51 75.0%
11c Diluted - Operating $1.22 $0.97 $0.25 25.8%
11d Diluted - Cash $1.47 $0.85 $0.62 72.9%
11e Diluted - Cash Operating $1.50 $1.13 $0.37 32.7%
-------------------------------------------=================================================
Balances At Period End
-------------------------------------------
12 Loans 1,751,184 1,569,076 182,108 11.6%
13 Investments (excl. mkt val adj) 1,281,724 1,054,382 227,342 21.6%
14 Earning assets 3,032,908 2,623,458 409,450 15.6%
15 Allowance for loan loss 23,883 20,860 3,023 14.5%
16a Intangible assets - Core deposits 33,678 9,485 24,193 255.1%
16b Intangible assets - Goodwill & other 99,573 59,066 40,507 68.6%
intangibles
17 Total assets 3,405,863 2,851,689 554,174 19.4%
18 Deposits 2,513,261 2,051,385 461,876 22.5%
19a Borrowings - FHLB 472,200 498,600 (26,400) -5.3%
19b Borrowings - Trust Preferred 77,347 29,827 47,520 159.3%
20 Total equity $296,318 $234,171 $62,147 26.5%
21 Assets under management $1,370,346 $1,363,784 $6,562 0.5%
=================================================
14
----------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------
Line Jun 30, Mar 31, Change Change
No. 2002 2002 Amount Percent
-------------------------------------------
Earnings
-------------------------------------------
1 Net interest income $31,438 $30,168 $1,270 4.2%
2 Loan loss provision 3,385 1,518 1,867 123.0%
3 Net interest income after provision for 28,053 28,650 (597) -2.1%
loan losses
4 Investment security gain (loss) 1,144 0 1,144 0.0%
5a Other income-financial services 3,550 3,641 (91) -2.5%
5b Other income-banking services 4,017 4,094 (77) -1.9%
6a Other expense-financial services 2,645 2,725 (80) -2.9%
6b Other expense-banking services 19,822 19,791 31 0.2%
6c Acquisition and unusual expense 108 591 (483) -81.7%
7 Intangible amortization 2,997 3,076 (79) -2.6%
8 Inc before inc tax 11,192 10,202 990 9.7%
9 Income tax 3,013 2,764 249 9.0%
10a Net income $8,179 $7,438 $741 10.0%
10b Net income - Operating $8,245 $7,797 $448 5.7%
10c Net income - Cash $10,017 $9,306 $711 7.6%
10d Net income - Cash Operating $10,083 $9,665 $418 4.3%
Earnings per share
11a Basic $0.63 $0.57 $0.06 10.5%
11b Diluted $0.62 $0.57 $0.05 8.8%
11c Diluted - Operating $0.62 $0.60 $0.02 3.3%
11d Diluted - Cash $0.76 $0.71 $0.05 7.0%
11e Diluted - Cash Operating $0.76 $0.74 $0.02 2.7%
-------------------------------------------==============================================
Balances At Period End
-------------------------------------------
12 Loans 1,751,184 1,724,400 26,784 1.6%
13 Investments (excl. mkt val adj) 1,281,724 1,289,002 (7,278) -0.6%
14 Earning assets 3,032,908 3,013,402 19,506 0.6%
15 Allowance for loan loss 23,883 24,010 (127) -0.5%
16a Intangible assets - Core deposits 33,678 35,182 (1,504) -4.3%
16b Intangible assets - Goodwill & other 99,573 103,042 (3,469) -3.4%
intangibles
17 Total assets 3,405,863 3,345,214 60,649 1.8%
18 Deposits 2,513,261 2,536,982 (23,721) -0.9%
19a Borrowings - FHLB 472,200 426,100 46,100 10.8%
19b Borrowings - Trust Preferred 77,347 77,833 (486) -0.6%
20 Total equity $296,318 $270,968 $25,350 9.4%
21 Assets under management $1,370,346 $1,493,066 ($122,720) -8.2%
==============================================
15
----------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
-------------------------------------------
Profitability
-------------------------------------------
22 Return on assets 0.97% 0.29% 0.68 %pts.
23 Return on equity 11.73% 3.62% 8.11 %pts.
23a Return on equity - operating 11.82% 8.49% 3.33 %pts.
24 Tangible return on assets 1.19% 0.43% 0.76 %pts.
25 Tangible return on equity 14.36% 5.35% 9.01 %pts.
25a Tangible return on equity - operating 14.46% 10.21% 4.25 %pts.
26 Net interest margin (FTE) 4.54% 3.79% 0.75 %pts.
27 Non interest income/ 17.9% 21.1% (3.2) %pts.
operating income (FTE,
excl sec gains & branch disp)
28 Efficiency ratio 53.0% 59.1% (6.1) %pts.
(excl acquis. exp., 1-time items
& intangible amortization)
-------------------------------------------==============================================
Capital
-------------------------------------------
29 Tier I leverage ratio 6.69% 6.58% 0.11 %pts.
29b Tangible equity / assets 4.98% 5.95% (0.97) %pts.
30 Accum. other comp. Income $25,546 $10,782 $14,764 136.9%
Common shares outstanding
31a Weighted average 13,194 11,733 1,461 12.5%
31b Period end 12,959 11,548 1,411 12.2%
32 Cash dividends declared
per common share $0.27 $0.27 $0.00 0.0%
32a Common Stock Price $32.25 $28.00 $4.25 15.2%
32b Total Return - last 12 months 19.6% 31.5% (11.9) %pts.
33 Book value $22.87 $20.28 $2.59 12.8%
34 Tangible book value $12.58 $14.34 ($1.76) -12.3%
-------------------------------------------==============================================
Asset Quality Ratios
-------------------------------------------
35 Allowance for loan loss /
loans outstanding 1.36% 1.33% 0.03 %pts.
36 Nonperforming loans /
loans outstanding 0.64% 0.71% (0.07) %pts.
37 Allowance for loan loss /
nonperforming loans 214% 187% 27 %pts.
38 Net charge-offs / 0.81% 0.38% 0.43 %pts.
average loans
39 Loan loss provision / 96% 96% 0 %pts.
net charge-offs
40 Nonperforming assets / 0.74% 0.84% (0.10) %pts.
loans outstanding + OREO
==============================================
16
----------------------------------------------
000's Omitted Six Months Ended
----------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
-------------------------------------------
Profitability
-------------------------------------------
22 Return on assets 0.94% 0.56% 0.38 %pts.
23 Return on equity 11.36% 6.95% 4.41 %pts.
23a Return on equity - operating 11.67% 9.90% 1.77 %pts.
24 Tangible return on assets 1.17% 0.70% 0.47 %pts.
25 Tangible return on equity 14.05% 8.66% 5.39 %pts.
25a Tangible return on equity - operating 14.36% 11.61% 2.75 %pts.
26 Net interest margin (FTE) 4.53% 3.87% 0.66 %pts.
27 Non interest income/ 18.1% 20.3% (2.2) %pts.
operating income (FTE,
excl sec gains & branch disp)
28 Efficiency ratio 54.6% 58.2% (3.6) %pts.
(excl acquis. exp., 1-time items
& intangible amortization)
-------------------------------------------==============================================
Capital
-------------------------------------------
29 Tier I leverage ratio 6.69% 6.58% 0.11 %pts.
29b Tangible equity / assets 4.98% 5.95% (0.97) %pts.
30 Accum. other comp. Income $25,546 $10,782 $14,764 136.9%
Common shares outstanding
31a Weighted average 13,150 11,587 1,563 13.5%
31b Period end 12,959 11,548 1,411 12.2%
32 Cash dividends declared
per common share $0.54 $0.54 $0.00 0.0%
32a Common Stock Price $32.25 $28.00 $4.25 15.2%
32b Total Return - last 12 months 19.6% 31.5% (11.9) %pts.
33 Book value $22.87 $20.28 $2.59 12.8%
34 Tangible book value $12.58 $14.34 ($1.76) -12.3%
-------------------------------------------==============================================
Asset Quality Ratios
-------------------------------------------
35 Allowance for loan loss /
loans outstanding 1.36% 1.33% 0.03 %pts.
36 Nonperforming loans /
loans outstanding 0.64% 0.71% (0.07) %pts.
37 Allowance for loan loss /
nonperforming loans 214% 187% 27 %pts.
38 Net charge-offs / 0.57% 0.35% 0.22 %pts.
average loans
39 Loan loss provision / 100% 101% (1) %pts.
net charge-offs
40 Nonperforming assets / 0.74% 0.84% (0.10) %pts.
loans outstanding + OREO
==============================================
17
----------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------
Line Jun 30, Mar 31, Change Change
No. 2002 2002 Amount Percent
-------------------------------------------
Profitability
-------------------------------------------
22 Return on assets 0.97% 0.92% 0.05 %pts.
23 Return on equity 11.73% 10.97% 0.76 %pts.
23a Return on equity - operating 11.82% 11.50% 0.32 %pts.
24 Tangible return on assets 1.19% 1.15% 0.04 %pts.
25 Tangible return on equity 14.36% 13.73% 0.63 %pts.
25a Tangible return on equity - operating 14.46% 14.26% 0.20 %pts.
26 Net interest margin (FTE) 4.54% 4.52% 0.02 %pts.
27 Non interest income/ 17.9% 18.3% (0.4) %pts.
operating income (FTE,
excl sec gains & branch disp)
28 Efficiency ratio 53.0% 56.3% (3.3) %pts.
(excl acquis. exp., 1-time items
& intangible amortization)
-------------------------------------------==============================================
Capital
-------------------------------------------
29 Tier I leverage ratio 6.69% 6.55% 0.14 %pts.
29b Tangible equity / assets 4.98% 4.14% 0.84 %pts.
30 Accum. other comp. Income $25,546 $5,226 $20,320 388.8%
Common shares outstanding
31a Weighted average 13,194 13,093 101 0.8%
31b Period end 12,959 12,937 22 0.2%
32 Cash dividends declared
per common share $0.27 $0.27 $0.00 0.0%
32a Common Stock Price $32.25 $30.15 $2.10 7.0%
32b Total Return - last 12 months 19.6% 11.7% 7.9 %pts.
33 Book value $22.87 $20.95 $1.92 9.2%
34 Tangible book value $12.58 $10.26 $2.32 22.6%
-------------------------------------------==============================================
Asset Quality Ratios
-------------------------------------------
35 Allowance for loan loss /
loans outstanding 1.36% 1.39% (0.03) %pts.
36 Nonperforming loans /
loans outstanding 0.64% 0.84% (0.20) %pts.
37 Allowance for loan loss /
nonperforming loans 214% 165% 49 %pts.
38 Net charge-offs / 0.81% 0.33% 0.48 %pts.
average loans
39 Loan loss provision / 96% 108% (12) %pts.
net charge-offs
40 Nonperforming assets / 0.74% 0.93% (0.19) %pts.
loans outstanding + OREO
==============================================
18
----------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
-------------------------------------------
99 Asset Quality Components *
-------------------------------------------
41 Nonaccruing loans $10,029 $5,291 $4,738 89.5%
42 90+ days delinquent $1,141 $5,856 ($4,715) -80.5%
------- ------- -------- ------
43 Tot nonperforming loans $11,170 $11,147 $23 0.2%
44 Troubled debt restructurings $59 $110 ($51) -46.4%
45 Other real estate $1,671 $1,938 ($267) -13.8%
------- ------- ------- ------
46 Tot nonperforming assets $12,900 $13,195 ($295) -2.2%
47 Net Charge-Offs $3,512 $1,472 $2,040 138.6%
-------------------------------------------=============================================
99 Components of Net Interest Margin (FTE)
-------------------------------------------
48 Loan yield 7.43% 8.57% (1.14) %pts.
49 Investment yield 6.78% 6.93% (0.15) %pts.
50 Earning asset yield 7.15% 7.91% (0.76) %pts.
51 Interest bearing deposits rate 2.63% 4.41% (1.78) %pts.
51a Borrowed funds rate - FHLB 4.03% 5.39% (1.36) %pts.
51b Borrowed funds rate - Trust Preferred & 7.37% 9.83% (2.46) %pts.
other
52 Cost of all interest bearing funds 3.01% 4.70% (1.69) %pts.
53 Cost of funds (includes DDA) 2.58% 4.13% (1.55) %pts.
54 Cost of funds / earning assets 2.61% 4.12% (1.51) %pts.
55 Net interest margin (FTE) 4.54% 3.79% 0.75 %pts.
56 Full tax equivalent adjustment $2,986 $1,806 $1,180 65.3%
-------------------------------------------=============================================
99 Average Balances for Period
-------------------------------------------
57 Loans $1,742,110 $1,572,265 $169,845 10.8%
58 Investments (excl. mkt val adj.) 1,296,787 1,061,428 235,359 22.2%
59 Earning assets 3,038,897 2,633,693 405,204 15.4%
60 Total assets 3,388,379 2,893,193 495,186 17.1%
61 Deposits 2,545,301 2,083,160 462,141 22.2%
62 Borrowings - FHLB 449,235 516,858 (67,623) -13.1%
62a Borrowings - Trust preferred & other 77,805 30,244 47,561 157.3%
63 Total equity $279,703 $233,959 $45,744 19.6%
==============================================
19
----------------------------------------------
000's Omitted Six Months Ended
----------------------------------------------
Line Jun 30, Jun 30, Change Change
No. 2002 2001 Amount Percent
-------------------------------------------
Asset Quality Components *
-------------------------------------------
41 Nonaccruing loans $10,029 $5,291 $4,738 89.5%
42 90+ days delinquent $1,141 $5,856 ($4,715) -80.5%
------- ------- ------- -----
43 Tot nonperforming loans $11,170 $11,147 $23 0.2%
44 Troubled debt restructurings $59 $110 ($51) -46.4%
45 Other real estate $1,671 $1,938 ($267) -13.8%
------- ------- ------- -----
46 Tot nonperforming assets $12,900 $13,195 ($295) -2.2%
------- ------- ------- -----
47 Net Charge-Offs $4,920 $2,703 $2,217 82.0%
-------------------------------------------==============================================
Components of Net Interest Margin (FTE)
-------------------------------------------
48 Loan yield 7.60% 8.69% (1.09) %pts.
49 Investment yield 6.80% 7.10% (0.30) %pts.
50 Earning asset yield 7.26% 8.06% (0.80) %pts.
51 Interest bearing deposits rate 2.77% 4.49% (1.72) %pts.
51a Borrowed funds rate - FHLB 4.30% 5.63% (1.33) %pts.
51b Borrowed funds rate - Trust Preferred & 7.48% 9.83% (2.35) %pts.
other
52 Cost of all interest bearing funds 3.15% 4.81% (1.66) %pts.
53 Cost of funds (includes DDA) 2.70% 4.21% (1.51) %pts.
54 Cost of funds / earning assets 2.73% 4.20% (1.47) %pts.
55 Net interest margin (FTE) 4.53% 3.87% 0.66 %pts.
56 Full tax equivalent adjustment $5,515 $3,432 $2,083 60.7%
-------------------------------------------==============================================
Average Balances for Period
-------------------------------------------
57 Loans $1,738,009 $1,563,362 $174,647 11.2%
58 Investments (excl. mkt val adj.) 1,247,796 1,026,078 221,718 21.6%
59 Earning assets 2,985,805 2,589,440 396,365 15.3%
60 Total assets 3,336,697 2,836,197 500,500 17.6%
61 Deposits 2,545,018 2,065,208 479,810 23.2%
62 Borrowings - FHLB 396,667 482,727 (86,060) -17.8%
62a Borrowings - Trust preferred & other 77,981 30,259 47,722 157.7%
63 Total equity $277,306 $228,114 $49,192 21.6%
==============================================
20
----------------------------------------------
000's Omitted Three Months Ended
----------------------------------------------
Line Jun 30, Mar 31, Change Change
No. 2002 2002 Amount Percent
-------------------------------------------
Asset Quality Components *
-------------------------------------------
41 Nonaccruing loans $10,029 $11,351 ($1,322) -11.6%
42 90+ days delinquent $1,141 $3,167 ($2,026) -64.0%
------- ------- -------- -----
43 Tot nonperforming loans $11,170 $14,518 ($3,348) -23.1%
44 Troubled debt restructurings $59 $76 ($17) -22.4%
45 Other real estate $1,671 $1,460 $211 14.5%
------- ------- ----- -----
46 Tot nonperforming assets $12,900 $16,054 ($3,154) -19.6%
47 Net Charge-Offs $3,512 $1,409 $2,103 149.3%
-------------------------------------------==============================================
Components of Net Interest Margin (FTE)
-------------------------------------------
48 Loan yield 7.43% 7.76% (0.33) %pts.
49 Investment yield 6.78% 6.81% (0.03) %pts.
50 Earning asset yield 7.15% 7.37% (0.22) %pts.
51 Interest bearing deposits rate 2.63% 2.91% (0.28) %pts.
51a Borrowed funds rate - FHLB 4.03% 4.67% (0.64) %pts.
51b Borrowed funds rate - Trust Preferred & 7.37% 7.59% (0.22) %pts.
other
52 Cost of all interest bearing funds 3.01% 3.29% (0.28) %pts.
53 Cost of funds (includes DDA) 2.58% 2.82% (0.24) %pts.
54 Cost of funds / earning assets 2.61% 2.85% (0.24) %pts.
55 Net interest margin (FTE) 4.54% 4.52% 0.02 %pts.
56 Full tax equivalent adjustment $2,986 $2,529 $457 18.1%
-------------------------------------------==============================================
Average Balances for Period
-------------------------------------------
57 Loans $1,742,110 $1,733,863 $8,247 0.5%
58 Investments (excl. mkt val adj.) 1,296,787 1,198,261 98,526 8.2%
59 Earning assets 3,038,897 2,932,124 106,773 3.6%
60 Total assets 3,388,379 3,284,441 103,938 3.2%
61 Deposits 2,545,301 2,544,733 568 0.0%
62 Borrowings - FHLB 449,235 343,513 105,722 30.8%
62a Borrowings - Trust preferred & other 77,805 78,160 (355) -0.5%
63 Total equity $279,703 $274,882 $4,821 1.8%
==============================================
* Certain items in first quarter 2002 have been reclassified to improve
comparability
21
Results of Operations
Overview:
Second quarter 2002 net income was $8.2 million. Due to substantial one-time
items for the comparable 2001 period, this quarter's net income rose $6.1
million or 288% from the same period last year. Non-recurring acquisition and
other costs (including net securities gains/losses in 2001) this quarter were
$108,000 versus $4.8 million one year earlier. For the first six months, net
income was $15.6 million, up 99% over last year. Earnings per share (diluted)
for the second quarter were $0.62, up 244% over the same 2001 period, while
earnings per share (diluted) for the first half were $1.19, up 75%.
Operating earnings, which exclude acquisition and unusual expenses and net
securities gains/losses related to the acquisitions, were $8.2 million for the
second quarter 2002, an increase of 67% from the same period last year and an
all-time high for the Company. For the first six months of the year, operating
earnings were $16.0 million, up 43% from the first half of last year. Operating
earnings per share (diluted) for the quarter were $0.62, up 48% from the prior
year's level of $0.42. For the six months, operating earnings per share
(diluted) were $1.22, up 26%. These results reflect increases of 13% and 14%,
respectively, in average shares outstanding as a result of financing the
Company's three 2001 acquisitions.
Cash operating earnings per share (diluted), which excludes intangible
amortization expense besides all one-time and unusual items related to
acquisitions, were $0.76 for the second quarter, up 49% over the prior year, and
$1.50 for the first half, up 33%.
Effective January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other
Intangible Assets," which eliminated the requirement to regularly amortize
approximately $21.3 million in goodwill related to certain of its acquisitions.
Annual amortization expense was thus reduced by approximately $1.3 million;
$.015 of the increase in earnings per share (diluted) this quarter and $0.03 for
the first half reflects the impact of this adoption. During the second quarter,
the Company completed its goodwill impairment analysis, and no adjustment was
necessary.
The primary reasons for improved second quarter earnings compared to the same
period last year are a 36% increase in net interest income and a 34% rise in
non-interest income. The resulting higher operating income more than offset a
higher loan loss provision (reflective of a $2.0 million or 139% increase in net
charge-offs) and increased overhead and intangible amortization resulting from
the acquisition of the former FleetBoston branches in mid-November 2001.
Year-to-date earnings were up versus the comparable period last year for
primarily the same reasons, though earnings growth lagged that of the second
quarter because operational efficiency improvements became more pronounced in
the second quarter of 2002.
Net Interest Income
Net interest income for second quarter 2002 rose to $31.4 million, 36% over the
same period last year. The improvement largely reflects improved margins and
higher earning asset levels. In particular, the former FleetBoston branches
contributed $168 million in commercial and consumer loans and $498 million in
low-cost core deposits as of June 30. While net run-off of loans in that new
market has approximated 5% since acquisition date, core deposits have risen over
4%. The net interest margin was 4.54%, virtually the same as in first quarter
2002 but up 75 basis points from the year-earlier level of 3.79%; that was its
low point in 2001, after which it widened for three consecutive quarters.
Lastly, the quarter benefited by the full impact of $199 million in securities
purchased in the first quarter of this year.
22
o The rise in margin reflects a slower decrease in earning asset yields than
in the cost of funds. Approximately 35% of earning assets reprice within
one year versus 64% of interest-bearing liabilities (excluding interest
checking). Maturing certificates of deposit continued to reprice downward
by 90 basis points on average during the quarter, slowing from the
212-basis-point pace of first quarter 2002, consistent with lower
financial market interest rates. The rate on total borrowings was reduced
by 71 basis points during the second quarter. The difference between the
spread of interest-bearing assets over liabilities and the net interest
margin narrowed primarily as a result of an increased proportion of
investment securities.
o $375,000 in loan interest income dating back to last year on two
commercial loans that have weakened was reversed in the second quarter and
applied to reduction of loan principal, bringing their combined balances
to approximately $4.0 million. Had this interest not been reversed, the
average yield on total loans for the second quarter would have been nine
basis points higher, and the net interest margin would have been 4.59%.
o Earning assets were 16% higher than one year earlier, comprised of $182
million more in loans and $227 million more in securities. Over the last
90 days, earning assets rose $20 million; loans increased by $27 million
while investments fell by $7 million, reflective of partial reinvestment
of proceeds from $52 million in securities sales during the quarter. This
is in contrast to first quarter 2002, when loans were off by $8.5 million
and investments rose by $158 million. The latter increase, which was
funded by short-term borrowings, reflected attractive buying opportunities
both as to gross yield and as a spread over borrowings, and represented an
earnings strategy intended to take advantage of the steep Treasury yield
curve, thereby offsetting the projected shortfall in loan growth compared
to the Company's initial 2002 goals.
o Growth in second quarter average earning assets of $405 million compared
to one year earlier was largely funded by an increase in average retail
and commercial deposits of $504 million, a planned decrease in more
volatile public funds deposits of $42 million, and a decrease in average
borrowings of $20 million. Compared to first quarter 2002, average earning
assets rose $107 million, virtually all funded with capital market
borrowings. Total borrowings as a percent of earning assets ended the
quarter at 18% versus 12% at year end, following the closing of the
FleetBoston transaction, and 20% as of June 30, 2001.
o Second quarter net interest income exceeded the first quarter 2002 level
by $1.3 million, primarily reflective of the full quarter's benefit of
securities added in the first quarter and a two-basis-point increase in
net interest margin.
23
The following table sets forth certain information concerning average
interest-earning assets and interest-bearing liabilities and the yields and
rates thereon. Interest income and resultant yield information in the tables are
on a fully tax-equivalent basis using a marginal federal income tax rate of 35%.
Averages are computed on daily average balances for each month in the period
divided by the number of days in the period. Yields and amounts earned include
loan fees. Nonaccrual loans have been included in interest earning assets for
purposes of these computations.
Three Months Ended June 30,
----------------------------------------------------------------------
(000's omitted except yields and rates) 2002 2001
----------------------------------------------------------------------
Average Average
Average Amount Yield/Rate Average Amount Yield/Rate
Balance of Interest Paid Balance of Interest Paid
------- ----------- ---- ------- ----------- ----
ASSETS
Interest-earning assets:
Federal funds sold $0 $0 0.00% $889 $9 4.06%
Time deposits in other banks 506 2 1.59% 338 187 221.91%
Taxable investment securities * 957,541 15,215 6.37% 850,221 14,165 6.68%
Nontaxable investment securities * 338,740 6,719 7.96% 209,980 3,970 7.58%
Loans (net of unearned discount) * 1,742,110 32,273 7.43% 1,572,265 33,611 8.57%
--------- ------ --------- ------
Total interest-earning assets 3,038,897 54,209 7.15% 2,633,693 51,942 7.91%
Noninterest earning assets:
Cash and due from banks 99,723 103,769
Premises and equipment 55,841 43,773
Other assets 196,313 116,275
Reserve for loan losses (23,835) (20,887)
Net unrealized gains on available-for-sale portfolio 21,440 16,570
--------- ---------
Total assets $3,388,379 $2,893,193
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Savings deposits $978,650 3,163 1.30% $643,536 3,315 2.07%
Time deposits 1,129,039 10,679 3.79% 1,116,305 16,052 5.77%
Short-term borrowings 110,971 552 2.00% 193,208 2,214 4.60%
Long-term borrowings 416,069 5,391 5.20% 353,894 5,475 6.21%
--------- ------ --------- ------
Total interest-bearing liabilities 2,634,729 19,785 3.01% 2,306,943 27,056 4.70%
Noninterest bearing liabilities:
Demand deposits 437,612 323,319
Other liabilities 36,335 28,972
Shareholders' equity 279,703 233,959
--------- ---------
Total liabilities and shareholders' equity $3,388,379 $2,893,193
========= =========
Net interest earnings $34,424 $24,886
====== =======
Net interest spread 4.14% 3.21%
Net yield on interest-earning assets 4.54% 3.79%
* Federal tax exemption on investment securities
and loans included in interest income $2,986 $1,806
24
The change in net interest income may be analyzed by segregating the volume and
rate components of the changes in interest income and interest expense for each
underlying category.
The volume and rate components of interest income and interest expense for each
underlying category are as follows:
- ---------------------------------------------------------------------------------------------
2nd Quarter 2002 versus 2nd Quarter 2001
Increase (Decrease) Due to Change in (1)
--------------------------------------------------------
Net
(000's omitted) Volume Rate Change
- ---------------------------------------------------------------------------------------------
Interest earned on:
Federal funds sold ($5) ($5) ($9)
Time deposits in other banks 435 (620) (185)
Taxable investment securities 4,615 (3,565) 1,050
Nontaxable investment securities 2,545 204 2,749
Loans (net of unearned discount) 15,496 (16,834) (1,338)
Total interest-earning assets(2) 25,953 (23,686) 2,267
Interest paid on:
Savings deposits 5,687 (5,839) (152)
Time deposits 1,248 (6,621) (5,373)
Short-term borrowings (713) (949) (1,662)
Long-term borrowings 3,664 (3,748) (84)
Total interest-bearing liabilities(2) 20,048 (27,319) (7,271)
Net interest earnings (2) $4,161 $5,377 $9,538
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of change in each.
(2) Changes due to volume and rate are computed from the respective changes in
average balances and rates of the totals; they are not a summation of the
changes of the components.
25
Noninterest Income
Noninterest income (excluding securities transactions) was $7.6 million in the
second quarter, an increase of $944,000 or 14% from one year earlier. It was
down slightly from the first quarter 2002 level.
The following table sets forth information for noninterest income by category
for the periods indicated:
Three Months Ended June 30, Six Months Ended June 30,
---------------------------------------------------------------------------------
Change Change Change Change
(000's omitted) 2002 2001 Amount Percent 2002 2001 Amount Percent
- ----------------------------------------------------------------------------------------------------------------------------------
Personal trust $440 $407 $33 8.1% $954 $936 $18 1.9%
EBT/BPA 1,095 878 217 24.7% 2,198 1,766 432 24.5%
Elias Asset Management 785 947 (162) -17.1% 1,563 1,994 (431) -21.6%
Insurance 252 109 143 131.2% 438 210 228 108.6%
Other investment products 978 653 325 49.8% 2,040 1,078 962 89.2%
- -----------------------------------------------------------------------------------------------------------------------------------
Total financial services 3,550 2,994 556 18.6% 7,193 5,984 1,209 20.2%
Electronic banking 546 395 151 38.2% 1,152 700 452 64.6%
Mortgage banking 66 198 (132) -66.7% 185 278 (93) -33.5%
Commercial leasing 5 16 (11) -68.8% 8 21 (13) -61.9%
Deposit service charges 1,332 1,062 270 25.4% 2,646 2,156 490 22.7%
Overdraft fees 1,582 1,291 291 22.5% 3,013 2,331 682 29.3%
Commissions 500 664 (164) -24.7% 1,114 1,149 (35) -3.0%
Miscellaneous revenue (14) 3 (17) -566.7% (9) (14) 5 -35.7%
- -----------------------------------------------------------------------------------------------------------------------------------
Total general banking services 4,017 3,629 388 10.7% 8,109 6,621 1,488 22.5%
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income excluding
investment security gain (loss), net 7,567 6,623 944 14.3% 15,302 12,605 2,697 21.4%
Investment security gain (loss), net 1,144 (138) 1,282 -929.0% 1,144 (128) 1,272 -993.8%
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $8,711 $6,485 $2,226 34.3% $16,446 $12,477 $3,969 31.8%
===================================================================================================================================
Noninterest income as a percentage of operating
income (excludes investment security gain/loss) 17.9% 21.1% -3.2% 18.1% 20.2% -2.1%
Second quarter financial services revenue at $3.6 million was $556,000 higher
(up nearly 19%) than the same quarter last year and was off 2.5% from first
quarter levels.
o The primary source of improvement over one year earlier was commissions
from the sale of investment and insurance products through the Company's
broker-dealer, Community Investment Services, Inc. (CISI), and the branch
network, where combined revenues rose 61%. Demand for fixed annuity
products has been strong in the face of declining equity markets. In
addition, pension administration and consulting fees from the Company's
Benefit Plans Administrative Services subsidiary (BPA) were 25% higher
than in second quarter 2001 because of growth in accounts serviced. These
improvements more that offset a 17% reduction at Elias Asset Management
(EAM) due to a decrease in the market value of client investments.
o Financial services revenue comprised 47% of total noninterest income
(excluding net securities gains/losses) for the quarter versus 45% one
year earlier.
o Assets under management were $1.370 billion as of quarter end, an 8.2%
reduction from the March 31, 2002 level. This decrease reflects a
double-digit reduction in assets under management at EAM, which
historically has invested in large capitalization growth stocks. This
reduction was tempered by single-digit decreases in the Bank's personal
trust department and broker-dealer, reflective of the more balanced nature
of their portfolios. In contrast, strong new business generation at BPA
increased assets by 2.7%. Compared to
26
June 30, 2001, total assets under management are higher by $7 million or
0.5% compared to a 18.1% decrease as measured by the Standard & Poor's 500
equity market index.
General banking revenues were $4.0 million for the quarter, up 11% over the same
period last year and down slightly from first quarter 2002.
o A primary reason for the improvement over prior year was the contribution
of the acquired FleetBoston branches, largely in deposit service charges
and overdraft fees. These items rose a combined 24% compared to second
quarter 2001. While deposit service charges were unchanged over first
quarter 2002, overdraft fees increased 10.6% due to fewer waivers now that
initial problems with converted customer accounts have been resolved.
o The higher customer base due to 2001's acquisitions resulted in a strong
38% rise in electronic banking revenues over second quarter 2001. This
improvement more than offset reduced mortgage banking fees, which were off
because of prepayments and the decision to suspend sale of secondary
market-eligible production as of late fall last year.
o General commissions in the second quarter were below the one year ago
level largely because of a sizable earnings credit in 2001 that
accumulated on First Liberty Bank & Trust's books prior to its sale to the
company in May 2001. Commissions were up 16% from first quarter 2002 after
adjusting for unanticipated receipt of fourth quarter 2001 check sales
commissions.
The ratio of noninterest income to operating income (FTE) was 17.9% for second
quarter 2002, down 3.2 percentage points from the same period last year. In
part, the decreases reflect the unusually large 38% increase in net interest
income (FTE) caused by higher earning assets and improved margins. In addition,
the added revenues from cross selling financial services from the 2001
acquisitions have not yet been fully realized. The ratio was off a slight 0.4%
from first quarter 2002 for similar reasons. The Company remains committed to
its long-standing objective of increasing noninterest income and its
proportionate share of operating revenues.
Gains from the sale of investment securities were $1.1 million this quarter
compared to a $138,000 loss in second quarter last year related to acquisition
restructuring. Approximately $52 million in CMO securities was sold that in a
continued falling rate environment would likely have been prepaid, erasing
today's market value appreciation. By realizing the gain now on these
securities, the Company earned an 8.2% total return for the holding period. The
net proceeds were reinvested in municipal securities with increased call
protection in a falling rate environment and equivalent duration risk in the
event rates rise.
27
The following table reconciles differences between the line of business
noninterest income breakdown and regulatory reporting definitions as reflected
on the Call Report.
Six Months Ended June 30, 2002
---------------------------------------------------------------------------------------------
Regulatory Reporting Categories
---------------------------------------------------------------------------------------------
Other Service
iduciary and Service Charges Commissions Charges, Other Investment Total
Investment on Deposit on Investment Commissions Operating Security Gain Other
(000's omitted) Services Accounts Products and Fees Income (Loss), net Income
- ---------------------------------------------------------------------------------------------------------------------------------
Personal trust $954 $954
EBT/BPA 823 1,375 2,198
Elias Asset Management 1,563 1,563
Insurance 310 128 438
Other investment products 2,040 2,040
- ---------------------------------------------------------------------------------------------------------------------------------
Total financial services 1,777 0 3,913 1,503 0 0 7,193
Electronic banking 382 770 1,152
Mortgage banking 142 43 185
Commercial leasing 8 8
Deposit service charges 2,646 2,646
Overdraft fees 3,013 3,013
Commissions 1,114 1,114
Miscellaneous revenue (9) (9)
- ---------------------------------------------------------------------------------------------------------------------------------
Total general banking services 0 6,041 0 2,034 34 0 8,109
- ---------------------------------------------------------------------------------------------------------------------------------
Total noninterest income excluding
investment security gain (loss),
net 1,777 6,041 3,913 3,537 34 0 15,302
Investment security gain (loss), net 1,144 1,144
- ---------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $1,777 $6,041 $3,913 $3,537 $34 $1,144 $16,446
=================================================================================================================================
28
Noninterest Expense
Second quarter noninterest expense of $25.6 million was $0.8 million or 3.1%
higher than the equivalent 2001 period. Noninterest expense of $51.8 million for
the six months ending June 2002 was up $7.1 million or 15.9% compared to the
previous year. Excluding acquisition and unusual expenses, second quarter
non-interest expense was up $5.3 million or 26.3% versus the prior year. June
year-to-date noninterest expense excluding acquisition and unusual expenses was
$11.9 million or 30.3% higher than the same period of 2001. The quarterly and
year-to-date increases were primarily a result of the acquisition of the
FleetBoston branches in mid-November of 2001. These increases must be placed in
context with 16% growth in earning assets and 35% growth in operating income
over the last four quarters.
The following table sets forth information for noninterest expenses by category
for the periods indicated.
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------------------------------------------------------
Change Change Change Change
(000's omitted) 2002 2001 Amount Percent 2002 2001 Amount Percent
- ------------------------------------------------------------------------------------------------------------------------------
Personnel expense $12,265 $10,326 $1,939 18.8% $24,391 $20,442 $3,949 19.3%
Net occupancy expense 2,076 1,512 564 37.3% 4,398 3,090 1,308 42.3%
Equipment expense 1,984 1,543 441 28.6% 3,854 2,898 956 33.0%
Legal and professional fees 681 691 (10) -1.4% 1,535 1,318 217 16.5%
Data processing expense 1,743 1,267 476 37.6% 3,421 2,475 946 38.2%
Amortization of intangibles 2,997 1,541 1,456 94.5% 6,073 3,001 3,072 102.4%
Stationary and supplies 610 549 61 11.1% 1,297 903 394 43.6%
Foreclosed property expense 290 374 (84) -22.5% 618 535 83 15.5%
Deposit insurance premiums 109 86 23 26.7% 231 158 73 46.2%
Acquisition and unusual expenses 108 4,636 (4,528) -97.7% 700 5,487 (4,787) -87.2%
Other 2,709 2,274 435 19.1% 5,238 4,364 874 20.0%
- ------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $25,572 $24,799 $773 3.1% $51,756 $44,671 $7,085 15.9%
==============================================================================================================================
Total operating expenses as
a percentage of average assets 3.03% 3.44% -0.41% 3.13% 3.18% -0.05%
Efficiency ratio 53.0% 59.1% -6.1% 54.6% 58.2% -3.6%
Second quarter personnel expense was up $1.9 million or 18.8% from second
quarter 2001 levels, accounting for 37% of the increase in noninterest expense.
Total full-time equivalent staff at the end of June 2002 was 1,119, up 294 from
the end of June 2001 as a result of the branches acquired from FleetBoston and
the impact of the acquisition on selected back office and administrative
staffing requirements. These staffing increases also caused year-to-date
personnel expense to rise $3.9 million or 19.3% versus the prior year.
Second quarter non-personnel expense excluding acquisition and unusual expenses
was $3.4 million or 34.2% higher than the prior year period. Most of this
increase was a result of higher intangible amortization, up $1.5 million or
94.5%; occupancy expense, up $564,000 or 37.3%; data processing expenses, up
$476,000 or 37.6%; and equipment expense, up $441,000 or 28.6%. The increased
intangible amortization expense is mostly attributable to $1.7 million related
to the FleetBoston acquisition offset by a $325,000 reduction from the adoption
of SFAS 142 "Goodwill & Other Intangible Assets." Occupancy expenses were higher
primarily as a result of the impact of the FleetBoston branches acquired.
Increased data processing expenses were mainly due to higher Fiserv processing
fees, Federal Reserve Bank
29
check processing expenses and data line charges, all reflective of higher
processing volumes and communications costs of the acquired FleetBoston
branches. The rise in second quarter equipment expenses was largely a result of
higher depreciation due to the increased number of branches in 2002. Higher
intangible amortization, occupancy expense and data processing expenses were
also the primary causes for the year-to-date non-personnel expense increase of
$7.9 million or 42.3%, excluding acquisition and unusual expenses.
Administrative expenses such as office supplies, postage and telephone charges
also contributed to the higher expense level, again reflecting the additional
number of branches and employees arising from the FleetBoston transaction.
The Company's efficiency ratio, which excludes intangible amortization, net
securities gains/losses, acquisition costs, and unusual expenses, was 53.0% for
second quarter 2002, a 6.1-percentage-point improvement from the comparable 2001
quarter and a 3.3-percentage-point decrease from first quarter 2002.
o These results reflect the full impact of the combined $3.2 million in
First Liberty cost savings implemented in mid-second quarter 2001 and the
benefit of streamlining our operations functions by eliminating duplicate
loan and deposit processing units in Canton and Olean, N.Y. As a measure
of this latter success, the increase in outstandings being processed by
these units because of our 2001 acquisitions and internal growth may be
contrasted to the increase in staffing required to handle these volumes.
Loan operations staff increased by 23% compared to 60% higher loans
outstanding, deposit operations staff increased by 28% compared to 94%
higher non-CD deposits outstanding, and collections department staff
increased by 26% compared to 59% higher installment loans outstanding.
o Second quarter overhead for both the financial services segment of the
Company and the banking segment was virtually unchanged from first quarter
2002 levels. At the same time, operating revenues for both segments
expanded when adjusted for certain unanticipated timing differences,
resulting in improved productivity. Consequently, the efficiency ratio for
financial services improved to 74.5% in second quarter 2002 from 77.0% in
the first quarter and 82.2% in second quarter 2001. Moreover, the
efficiency ratio for the banking segment was reduced from 56.6% in second
quarter 2001 to 54.1% in first quarter 2002, dropping again to 50.6% for
the second quarter just ended.
o Improvement in the banking segment efficiency ratio over time reflects a
combination of increased noninterest income, rising margins, and higher
earning assets from internal growth, acquisitions and investment leverage
strategies. Together, these components drove operating income up by 36%
this quarter versus the second quarter of last year, which compares to a
23% increase in overhead over the same time period.
o Acquisition (including net securities gains/losses for 2001) and unusual
expenses, which are excluded from the efficiency ratio calculation, were
significantly reduced in the second quarter to $108,000, down from
$591,000 in first quarter 2002 and $4.8 million in second quarter 2001.
Income Taxes
The effective income tax rate was 26.9% for the second quarter and 27.0% for the
six months ending June 30, 2002, 10.1 and 3.4 percentage points below the prior
year periods, respectively. These reductions were due to a higher percentage of
income being derived from tax-exempt securities and other tax planning
strategies.
30
Financial Condition
Cash and Investments
Cash and investments were $1.423 billion at the end of the second quarter, an
increase of $168 million or 13.4% from the balances at December 31, 2001.
Average cash and investments of $1.418 billion for the second quarter were up
$215 million or 17.8% from the fourth quarter of 2001 and $229 million or 19.3%
from second quarter 2001 levels. The investment portfolio was increased in 2002
to take advantage of attractive buying opportunities in terms of gross yield and
spread over borrowings, and to offset some of the projected shortfall in loan
growth resulting from soft economic conditions in many of our primary markets.
Loans
Loans ended the second quarter at $1.751 billion, up $182 million or 11.6% from
June 30, 2001. The improvement reflects the contribution of the acquired
FleetBoston branch loans as well as consumer loan growth in the Company's core
markets. Compared to December 31, 2001, total loans have increased by $18
million, reflecting second quarter growth of nearly $27 million following an
$8.5 million contraction in the first quarter. Excluding the impact of
acquisitions, this quarter's increase was the largest since second quarter 2000.
o Commercial loans decreased $7 million during the last 90 days following a
$6 million decrease in the first quarter. With the exception of
acquisitions, commercial loan growth has been relatively flat for the last
two years reflective of reduced business activity in our markets due to
economic softness, the desire to maintain credit quality, and the
Company's focus on acquisitions. Now that the FleetBoston acquisition
conversion is complete and added personnel are in place in the First
Liberty and former FleetBoston branch markets, new business calling
efforts have been accelerated. Commercial loan outstandings at quarter end
were $631 million (36% of total loans outstanding) compared to $605
million twelve months earlier, an increase of $26 million or 4%.
o Consumer direct loans increased approximately $9 million during the second
quarter following a $19 million decrease in first quarter 2002. This
growth reflects the impact of the company's spring marketing program to
homeowners, which included promotional rates on home equity loans and
direct installment loans. Approximately 120,000 mailers were sent to bank
customers, effectively countering the run-off in the portfolio due to
regular repayments that has been experienced for the last year. Consumer
direct loans ended the quarter at $386 million (22% of total loans
outstanding), up $121 million or 46% since June 30, 2001.
o Consumer indirect loans, largely borrowing originated in automobile dealer
showrooms, rose $15 million during the second quarter following an
increase of $5 million in the first quarter. Prior to that point, the
portfolio had been flat to down since fourth quarter 2000. Volume has been
improving with the addition of new originating dealers. Overall, used
vehicles constitute 75% of CBU's indirect loans outstanding. Indirect
loans at quarter end were $269 million (15% of total loans outstanding),
an increase of $19 million or 8% from twelve months earlier.
o Consumer mortgages rose $9 million over the last 90 days, following an
unusually large $12 million increase in the first quarter. This rise
reflects the Company's spring homeowner marketing campaign as well as the
strategy for the last six months to book secondary-market-eligible loans
in portfolio, made possible because of the increase in core deposit
funding from the FleetBoston branch acquisition. This growth was moderated
somewhat by competitors' actions beginning earlier this year to
aggressively undercut the pricing on our no-closing-cost mortgage product.
Over the last twelve months, consumer mortgages have increased $16 million
or 4% to $465 million (27% of total loans outstanding).
31
The amounts of the Company's loans outstanding (net of deferred loan fees or
costs) at the dates indicated are shown in the following table according to type
of loan:
As of June 30,
-------------------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- -----------------------------------------------------------------------------------------
Real estate mortgages:
Residential $720,559 $607,180 $113,379 18.7%
Commercial loans secured by real estate 269,208 264,519 4,689 1.8%
Farm 21,431 20,755 676 3.3%
- ---------------------------------------------------------------------------------------
Total 1,011,198 892,454 118,744 13.3%
Commercial, financial, and agricultural:
Commercial and financial 261,762 236,897 24,865 10.5%
Agricultural 25,134 26,738 (1,604) -6.0%
- ---------------------------------------------------------------------------------------
Total 286,896 263,635 23,261 8.8%
Installment loans to individuals 423,035 383,604 39,431 10.3%
Other loans 30,224 29,682 542 1.8%
- ---------------------------------------------------------------------------------------
Gross loans 1,751,353 1,569,375 181,978 11.6%
Less: unearned discount 169 299 (130) -43.5%
- ---------------------------------------------------------------------------------------
Net loans 1,751,184 1,569,076 182,108 11.6%
Allowance for loan losses 23,883 20,860 3,023 14.5%
- ---------------------------------------------------------------------------------------
Loans, net of allowance for loan losses $1,727,301 $1,548,216 $179,085 11.6%
=======================================================================================
The following table reconciles the differences between the line of business loan
breakdown reflected in the narrative of this report as compared to regulatory
reporting definitions reflected on the Call Report.
Line of Business as of June 30, 2002
--------------------------------------------------------------
Consumer Consumer Consumer Business Total
(000's omitted) Direct Indirect Mortgages Lending Loans
- ---------------------------------------------------------------------------------------------------
Regulatory Reporting Categories:
- --------------------------------
Loans secured by real estate:
Residential $224,611 $462,432 $33,516 $720,559
Commercial 49 2,203 266,956 269,208
Farm 34 21,397 21,431
Agricultural loans 389 24,745 25,134
Commercial loans 12,856 248,906 261,762
Installment loans to individuals 146,046 268,889 102 7,998 423,035
Other loans 2,617 27,607 30,224
- ---------------------------------------------------------------------------------------------------
Total loans 386,602 268,889 464,737 631,125 1,751,353
Unearned discount 169 169
- ---------------------------------------------------------------------------------------------------
Net loans $386,433 $268,889 $464,737 $631,125 $1,751,184
===================================================================================================
Asset Quality
Asset quality as of June 30, 2002 was comparable to one year ago as measured by
the Company's balance sheet ratios. During the second quarter, it was determined
that a certain $2.8 million commercial loan, which had been making payments for
the last 12 months but in an irregular pattern, should be reclassified as
nonaccruing. Even with this change, most of the Company's balance sheet asset
quality ratios have improved during the last 90 days.
o As noted earlier in this document, net charge-offs for the second quarter
rose $2.0 million from one year ago to $3.5 million; this compares to $2.5
million in fourth quarter 2001 and $1.2-$1.5 million for all other
quarters since fourth quarter 2000. The primary
32
reason for the resulting $2.1 million increase over the first quarter 2002
level are partial write-downs on two commercial customers: a $3.2 million
relationship which had been placed on non-accrual as of March 31, 2002 and
a $675,000 loan which became 90 days delinquent as of the same date.
Specific loss reserve allocations of $100,000 each remain on these two
customers.
o As a percent of average loans outstanding, annualized net charge-offs for
the second quarter were 0.81%, well beyond the 0.20%-0.61% range of the
prior nine quarters. The sole cause was commercial net charge-offs; as a
percent of related outstandings, they were 1.51% compared to their average
for the preceding nine quarters of 0.43%. Installment loan net charge-offs
were 0.90% of related average outstandings, only slightly above their
0.84% nine-quarter norm. Mortgage and home equity net charge-offs, which
are historically de minimus, have reflected zero or a net recovery for the
past two quarters.
o Regular bottom-up review of the portfolio this quarter necessitated the
addition of approximately $1.4 million in specific commercial loan
allocations to the Company's allowance for loan loss; however, this
increase was more than offset by charge-offs recognized during the quarter
against specific allocations previously established. General allocations
against each loan product line continue to be reviewed and recalculated
quarterly. Consequently, a required allowance for loan loss of $23.9
million was determined, resulting in a $3.4 million loan loss provision
compared to $1.4 million in second quarter 2001 and $1.5 million in first
quarter 2002. This provision represented 96% of net charge-offs, the same
multiple as one year ago and down from 108% for quarter ended March 31,
2002.
o As a percent of loans outstanding, nonperforming loans (loans 90 days past
due and non-accruing) were 0.64% at quarter end versus 0.71% one year
earlier and 0.84% as of March 31, 2002. These levels compare very
favorably to the peer bank median of 1.04% at the end of first quarter
2002. Coverage of the reserve over nonperformers, a general comparative
measure of reserve adequacy, also improved in the second quarter at 214%
compared to 165% ninety days earlier and 187% at June 30, 2001.
o Delinquent loans (30 days through nonaccruing) as a percent of total
outstandings decreased 12 basis points during the last 90 days to 1.77%.
This compares to 1.83% one year ago, after which the ratio increased to
1.96% as of September 30, 2001 before it began to steadily fall to its
current level.
33
The following table presents information concerning the aggregate amount of
nonperforming assets:
As of June 30,
--------------------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- -------------------------------------------------------------------------------------------------------------------------
Loans accounted for on a nonaccrual basis $10,029 $5,291 $4,738 89.5%
Accruing loans which are contractually past due 90 days or more as to
principal or interest payments 1,141 5,856 (4,715) -80.5%
- -------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 11,170 11,147 23 0.2%
Loans which are "troubled debt restructurings" as defined in FASB No. 15
"Accounting by Debtors and Creditors for Troubled Debt Restructurings" 59 110 (51) -46.4%
Other real estate 1,671 1,938 (267) -13.8%
- -------------------------------------------------------------------------------------------------------------------------
Total non performing assets $12,900 $13,195 ($295) -2.2%
=========================================================================================================================
Ratio of allowance for loan losses to period-end loans 1.36% 1.33% 0.03%
Ratio of allowance for loan losses to period-end nonperforming loans 213.8% 187.1% 26.7%
Ratio of allowance for loan losses to period-end nonperforming assets 185.1% 158.1% 27.0%
Ratio of nonperforming loans to period-end loans 0.64% 0.71% -0.07%
Ratio of nonperforming assets to period-end total loans and other real
estate 0.74% 0.84% -0.10%
The impact of interest not recognized on nonaccrual loans, and interest income
that would have been recorded if the restructured loans had been current in
accordance with their original terms, was immaterial. The Company's policy is to
place a loan on a nonaccrual status and recognize income on a cash basis when it
is more than ninety days past due, except when in the opinion of management it
is well secured and in the process of collection.
34
The following table summarizes loan balances at the end of each period indicated
and the daily average amount of loans. Also summarized are changes in the
allowance for loan losses arising from loans charged off and recoveries on loans
previously charged off and additions to the allowance, which have been charged
to expenses.
Three Months Ended June 30,
---------------------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- ------------------------------------------------------------------------------------------------
Amount of loans outstanding at end of period $1,751,184 $1,569,076 $182,108 11.6%
- ------------------------------------------------------------------------------------------------
Daily average amount of loans (net of unearned
discount) 1,742,110 1,572,265 169,845 10.8%
- ------------------------------------------------------------------------------------------------
Balance of allowance for loan losses at beginning
of period 24,010 20,917 3,093 14.8%
Loans charged off:
Commercial, financial, and agricultural 2,576 468 2,108 450.4%
Real estate 0 34 (34) -100.0%
Installment 1,526 1,582 (56) -3.5%
- ------------------------------------------------------------------------------------------------
Total loans charged off 4,102 2,084 2,018 96.8%
Recoveries of loan previously charged off:
Commercial, financial and agricultural 134 177 (43) -24.3%
Real estate 3 38 (35) -92.1%
Installment 453 397 56 14.1%
- ------------------------------------------------------------------------------------------------
Total recoveries 590 612 (22) -3.6%
- ------------------------------------------------------------------------------------------------
Net loans charged off 3,512 1,472 2,040 138.6%
Provision for loan losses 3,385 1,415 1,970 139.2%
Reserve on acquired loans (1) 0 0 0 0
- ------------------------------------------------------------------------------------------------
Balance of allowance for loan losses at end of
period $23,883 $20,860 $3,023 14.5%
================================================================================================
Ratio of net charge-offs to average loans
outstanding 0.81% 0.38% 0.43% 0.43%
Six Months Ended June 30,
---------------------------------
Change Change
(000's omitted) 2002 2001 Amount Percent
- -----------------------------------------------------------------------------------------------
Amount of loans outstanding at end of period $1,751,184 1,569,076 $182,108 11.6%
- -----------------------------------------------------------------------------------------------
Daily average amount of loans (net of unearned
discount) 1,738,009 1,563,362 174,647 11.2%
- -----------------------------------------------------------------------------------------------
Balance of allowance for loan losses at beginning
of period 23,901 20,035 3,866 19.3%
Loans charged off:
Commercial, financial, and agricultural 3,157 887 2,270 255.9%
Real estate 0 96 (96) -100.0%
Installment 3,012 2,831 181 6.4%
- -----------------------------------------------------------------------------------------------
Total loans charged off 6,169 3,814 2,355 61.7%
Recoveries of loan previously charged off:
Commercial, financial and agricultural 196 232 (36) -15.5%
Real estate 106 51 55 107.8%
Installment 947 828 119 14.4%
- -----------------------------------------------------------------------------------------------
Total recoveries 1,249 1,111 138 12.4%
- -----------------------------------------------------------------------------------------------
Net loans charged off 4,920 2,703 2,217 82.0%
Provision for loan losses 4,902 2,741 2,161 78.8%
Reserve on acquired loans (1) 0 787 (787) -100.0%
- -----------------------------------------------------------------------------------------------
Balance of allowance for loan losses at end of
period $23,883 $20,860 $3,023 14.5%
=============================================================================================
Ratio of net charge-offs to average loans
outstanding 0.57% 0.35% 0.22%
(1) This reserve addition is attributable to loans purchased from Citizens
National Bank of Malone.
Deposits
Total deposits at June 30, 2002 were $2.513 billion, $33 million or 1.3% below
the balance at year-end 2001. This year-to-date decline was mostly attributable
to some minor deposit runoff in certain of our marketplaces. Second quarter
average total deposits of $2.545 billion remained essentially flat with the
average for the first quarter of 2002.
Borrowings
At the end of the second quarter, borrowings and federal funds purchased of $472
million were $195 million or 70% higher than they were at the end of 2001. 49%
of this increase came from long-term borrowings, 38% from short-term borrowings
and 14% from federal funds purchased. The additional borrowing was primarily
used to fund the growth of the investment portfolio in order to take advantage
of favorable interest rate spreads caused by the steep Treasury yield curve.
35
Other Assets and Liabilities
Other assets and liabilities had a net liability balance of $7.186 million at
the end of the second quarter versus a net liability position of $12.807 million
at December 31, 2001. The change was mainly attributable to an increase in
deferred taxes related to the market value adjustment, funding of the pension
plan and assorted timing differences.
Shareholders' Equity
Total shareholders' equity equaled $296.3 million at the end of the second
quarter, $28.3 million higher than the balance at December 31, 2001. This
increase consisted of $1.4 million from shares issued under the employee stock
plan, an after-tax market value adjustment of $15.5 million, an after-tax
minimum pension liability adjustment of $2.8 million and net income of $15.6
million, offset by dividends declared of $7.0 million.
Liquidity
Due to the potential for unexpected fluctuations in deposits and loans, active
management of the Company's liquidity is critical. In order to respond to these
circumstances, adequate sources of additional deposits, borrowings and available
lines of credit are in place.
CBSI's primary approach to measuring liquidity is known as the Basic
Surplus/Deficit model. It is used to calculate liquidity over two time periods:
first, the relationship within 30 days between liquid assets and short-term
liabilities which are vulnerable to nonreplacement; and second, a projection of
subsequent cash 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 June 30, 2002, this ratio
was 16.6% and 16.3%, respectively, excluding the Company's capacity to borrow
additional funds from the Federal Home Loan Bank. Including this latter
capacity, the 30 and 90-day ratios are 22.5% and 22.1%, respectively. The
Company considers liquidity adequate to meet its operating needs for the
foreseeable future.
36
Forward-Looking Statements
This document contains comments or information that constitute forward-looking
statements (within the meaning of the Private Securities Litigation Reform Act
of 1995), which involve significant risks and uncertainties. Actual results may
differ materially from the results discussed in the forward-looking statements.
Moreover, the Company's plans, objectives and intentions are subject to change
based on various factors (some of which are beyond the Company's control).
Factors that could cause actual results to differ from those discussed in the
forward-looking statements include: (1) risks related to credit quality,
interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in
general and the strength of the local economies where the Company conducts its
business; (3) the effect of, and changes in, monetary and fiscal policies and
laws, including interest rate policies of the Board of Governors of the Federal
Reserve System; (4) inflation, interest rate, market and monetary fluctuations;
(5) the timely development of new products and services and customer perception
of the overall value thereof (including features, pricing and quality) compared
to competing products and services; (6) changes in consumer spending, borrowing
and savings habits; (7) technological changes; (8) any acquisitions or mergers
that might be considered by the Company and the costs and factors associated
therewith; (9) the ability to maintain and increase market share and control
expenses; (10) the effect of changes in laws and regulations (including laws and
regulations concerning taxes, banking, securities and insurance) and accounting
principles generally accepted in the United States; (11) changes in the
Company's organization, compensation and benefit plans and in the availability
of, and compensation levels for, employees in its geographic markets; (12) the
costs and effects of litigation and of any adverse outcome in such litigation;
and (13) the success of the Company at managing the risks of the foregoing.
The foregoing list of important factors is all inclusive. Such forward-looking
statements speak only as of the date on which they are made and the Company does
not undertake any obligation to update any forward-looking statement, whether
written or oral, to reflect events or circumstances after the date on which such
statement is made. If the Company does update or correct one or more
forward-looking statements, investors and others should not conclude that the
Company will make additional updates or corrections with respect thereto or with
respect to other forward-looking statements.
37
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Interest Rate Risk
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates, price, or credit risk. Because of the Company's
long-standing policy of purchasing low credit risk investments, the primary
market risk exposure of the organization is interest rate risk. The composition
of the portfolio continues to heavily favor U.S. agency debentures, U.S agency
mortgage-backed pass throughs, U.S agency CMO's, and AAA rated insured municipal
bonds. As of June 30, 2002, these four security types (excluding Federal Home
Loan Bank stock and Federal Reserve Bank stock) accounted for over 95% of total
portfolio investments.
The ongoing monitoring and management of this risk, over both a short-term
tactical and longer-term strategic time horizon, is an important component of
the Company's asset/liability management process, which is governed by policies
established by its Board of Directors and reviewed and approved annually. The
Board of Directors delegates responsibility for carrying out the asset/liability
management policies to the Asset/Liability Management Committee (ALCO). In this
capacity, ALCO develops guidelines and strategies impacting the Company's
asset/liability management activities based upon estimated market risk
sensitivity, policy limits, and overall market interest rate-related level and
trends.
As the Company does not believe it is possible to reliably predict future
interest rate movements, it has maintained an appropriate process and set of
measurement tools which enable it to identify and quantify sources of interest
rate risk in varying environments. The primary tool used by the Company in
managing interest rate risk is income simulation. The analysis begins by
measuring the impact of differences in maturity and repricing all balance sheet
positions. Such work is further augmented by adjusting for prepayment and
embedded option risk found naturally in certain asset and liability classes.
Finally, balance sheet growth and funding expectations are added to the analysis
in order to reflect the strategic initiatives set forth by the Company.
Changes in net interest income are reviewed after subjecting the balance sheet
to an array of Treasury yield curve possibilities.
The following reflects the Company's one-year net interest income sensitivity
based on approximate asset and liability levels on June 30, 2002, assuming no
growth in the balance sheet, and assuming a 200 basis point instantaneous upward
rate shock in the prime rate, federal funds rate and the entire Treasury yield
curve and a similar 150 basis point instantaneous downward rate shock.
Regulatory Model
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
- -------------------- ---------------------------------------- --------------------------------
+200 bp (891,000) (.7%)
-150 bp ($2.3 million) (1.9%)
Given the steepness in slope of the Treasury yield curve as of June 30, 2002, a
second group of simulations was performed based on what the Company believes to
be conservative levels of balance sheet growth. These levels include no growth
in the Company's securities portfolio, flat loan levels until mid-year, and low
single digit loan growth thereafter. Under this set of assumptions, were the
slope of the yield curve to change, holding short rates constant while
flattening long-term rates over the next 12 months, the net interest margin is
projected to narrow modestly (simulation B). If short term rates were to
increase 200 basis points over the next 12 months (holding long-term rates
constant), margins are projected to narrow to a similar degree (simulation A).
38
Management Model
Rate Change Net Interest Income Net Interest Income
In Basis Points Dollar Change During First 12 Months Percent Change from Flat Rates
- ----------------------------------- --------------------------------------- ---------------------------------
A) Increasing Short Term Rates ($2.5 million) (1.9%)
B) Reducing Longer Term Rates ($2.0 million) (1.6%)
The preceding interest rate risk analysis does not represent a Company forecast
and should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including: the
nature and timing of interest rate levels (including yield curve shape),
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of asset and liability cash flows,
and others. While the assumptions are developed based upon current economic and
local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumptions, including how customer preferences or
competitor influences might change. Furthermore, the sensitivity analysis does
not reflect actions that ALCO might take in responding to or anticipating
changes in interest rates.
39
Part II. Other Information
Item 1. Legal Proceedings.
Not Applicable
Item 2. Changes in Securities.
Not Applicable
Item 3. Defaults Upon Senior Securities.
Not Applicable.
Item 4. Submission of Matters to a Vote of Securities Holders.
Not Applicable.
Item 5. Other Information.
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits required by Item 601 of Regulation S-K:
(21) Subsidiaries of the registrant
- Community Bank, N.A., State of New York
- Community Financial Services, Inc., State of New York
- Community Capital Trust I, State of Delaware
- Community Capital Trust II, State of Delaware
- Community Statutory Trust III, State of Connecticut
- Benefit Plans Administrative Services, Inc., State of New York
- CBNA Treasury Management Corporation, State of New York
- Community Investment Services, Inc., State of New York
- CBNA Preferred Funding Corporation, State of Delaware
- Elias Asset Management, Inc., State of Delaware
- CFSI Close-Out Corp., State of New York
- First Liberty Service Corporation, State of Delaware
b) Exhibits required by Section 906 of the Sarbanes-Oxley Act (99.1)
Certification of Sanford A. Belden, President and Chief Executive
Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of the
Sarbanes-Oxley Act of 2002.
(99.2) Certification of David G. Wallace, Treasurer and Chief
Financial Officer of the Registrant, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
c) Reports on Form 8-K: Not Applicable.
40
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: August 14, 2002
/s/ Sanford A. Belden
--------------------------------
Sanford A. Belden, President and
Chief Executive Officer
Date: August 14, 2002 /s/ David G. Wallace
--------------------------------
David G. Wallace, Treasurer and
Chief Financial Officer
41