UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the
quarterly period ended March 31,
2008
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¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the
transition period from
to
.
Commission
file number 001-13695
 COMMUNITY BANK SYSTEM, INC.(Exact
name of registrant as specified in its
charter)
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Delaware
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16-1213679
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(State
or other jurisdiction of incorporation or organization)
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(I.R.S. Employer
Identification No.)
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5790 Widewaters Parkway, DeWitt, New
York
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13214-1883
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(Address
of principal executive offices)
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(Zip
Code)
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(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 period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No
¨.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of "large accelerated filer", "accelerated
filer", , and "smaller reporting company" in Rule 12b-2 of the Exchange
Act.
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Large
accelerated filer ¨
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Accelerated
filer x
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Non-accelerated
filer ¨
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Smaller
reporting company ¨.
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨. No x.
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date. 29,909,066 shares of Common
Stock, $1.00 par value, were outstanding on April 30, 2008.
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Page
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Part
I.
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Financial
Information
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Item
1.
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3
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4
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5
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6
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7
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8
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Item
2.
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14
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Item
3.
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28
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Item
4.
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29
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Part
II.
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Other
Information
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Item
1.
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29
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Item
1A.
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29
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Item
2.
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29
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Item
3.
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29
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Item
4.
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29
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Item
5.
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29
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Item
6.
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30
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Part
I. Financial Information
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Financial
Statements
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CONSOLIDATED
STATEMENTS OF CONDITION
(In
Thousands, Except Share Data)
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(Unaudited) March
31, |
December
31,
|
|||||||
|
2008
|
2007
|
|||||||
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Cash
and cash equivalents
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$ | 160,394 | $ | 130,823 | ||||
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Available-for-sale
investment securities, at fair value
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1,171,603 | 1,254,622 | ||||||
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Held-to-maturity
investment securities
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136,079 | 137,250 | ||||||
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Total
investment securities (fair value of $1,309,889 and $1,392,281,
respectively)
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1,307,682 | 1,391,872 | ||||||
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Loans
|
2,837,786 | 2,821,055 | ||||||
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Allowance
for loan losses
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(36,428 | ) | (36,427 | ) | ||||
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Net
loans
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2,801,358 | 2,784,628 | ||||||
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Core
deposit intangibles, net
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18,345 | 19,765 | ||||||
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Goodwill
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234,722 | 234,449 | ||||||
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Other
intangibles, net
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2,044 | 2,002 | ||||||
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Intangible
assets, net
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255,111 | 256,216 | ||||||
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Premises
and equipment, net
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70,109 | 69,685 | ||||||
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Accrued
interest receivable
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25,545 | 25,531 | ||||||
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Other
assets
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38,216 | 38,747 | ||||||
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Total
assets
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$ | 4,658,415 | $ | 4,697,502 | ||||
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Liabilities:
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||||||||
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Noninterest-bearing
deposits
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$ | 563,226 | $ | 584,921 | ||||
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Interest-bearing
deposits
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2,680,156 | 2,643,543 | ||||||
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Total
deposits
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3,243,382 | 3,228,464 | ||||||
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Borrowings
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766,153 | 801,604 | ||||||
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Subordinated
debt held by unconsolidated subsidiary trusts
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101,956 | 127,724 | ||||||
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Accrued
interest and other liabilities
|
58,256 | 60,926 | ||||||
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Total
liabilities
|
4,169,747 | 4,218,718 | ||||||
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Commitment
and contingencies (See Note H)
|
||||||||
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Shareholders'
equity:
|
||||||||
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Preferred
stock $1.00 par value, 500,000 shares authorized, 0 shares
issued
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0 | 0 | ||||||
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Common
stock, $1.00 par value, 50,000,000 shares
authorized; 33,256,871 and 32,999,544 shares issued in 2008 and
2007, respectively
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33,257 | 33,000 | ||||||
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Additional
paid-in capital
|
212,713 | 208,429 | ||||||
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Retained
earnings
|
314,927 | 310,281 | ||||||
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Accumulated
other comprehensive income
|
1,399 | 702 | ||||||
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Treasury
stock, at cost (3,364,811 and 3,364,811 shares,
respectively)
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(73,628 | ) | (73,628 | ) | ||||
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Total
shareholders' equity
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488,668 | 478,784 | ||||||
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Total
liabilities and shareholders' equity
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$ | 4,658,415 | $ | 4,697,502 | ||||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)
(In
Thousands, Except Per-Share Data)
|
Three
Months Ended
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||||||||
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March
31,
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||||||||
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2008
|
2007
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|||||||
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Interest
income:
|
||||||||
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Interest
and fees on loans
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$ | 46,515 | $ | 44,935 | ||||
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Interest
and dividends on taxable investments
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10,714 | 11,103 | ||||||
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Interest
and dividends on nontaxable investments
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5,922 | 5,520 | ||||||
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Total
interest income
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63,151 | 61,558 | ||||||
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Interest
expense:
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||||||||
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Interest
on deposits
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17,694 | 18,120 | ||||||
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Interest
on borrowings
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8,041 | 7,505 | ||||||
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Interest
on subordinated debt held by unconsolidated subsidiary
trusts
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1,818 | 2,566 | ||||||
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Total
interest expense
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27,553 | 28,191 | ||||||
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Net
interest income
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35,598 | 33,367 | ||||||
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Less: provision
for loan losses
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780 | 200 | ||||||
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Net
interest income after provision for loan losses
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34,818 | 33,167 | ||||||
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Noninterest
income:
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||||||||
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Deposit
service fees
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8,261 | 6,977 | ||||||
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Other
banking services
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595 | 670 | ||||||
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Benefit
plan administration, consulting and actuarial fees
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6,312 | 3,972 | ||||||
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Wealth
management services
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2,163 | 1,860 | ||||||
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Gain
on sales of investment securities
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287 | 0 | ||||||
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Total
noninterest income
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17,618 | 13,479 | ||||||
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Operating
expenses:
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||||||||
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Salaries
and employee benefits
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20,386 | 18,286 | ||||||
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Occupancy
and equipment
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5,573 | 4,666 | ||||||
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Data
processing and communications
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3,985 | 3,565 | ||||||
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Amortization
of intangible assets
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1,531 | 1,515 | ||||||
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Legal
and professional fees
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1,298 | 1,187 | ||||||
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Office
supplies and postage
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1,278 | 1,046 | ||||||
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Business
development and marketing
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1,322 | 950 | ||||||
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Other
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3,001 | 2,704 | ||||||
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Total
operating expenses
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38,374 | 33,919 | ||||||
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Income
before income taxes
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14,062 | 12,727 | ||||||
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Income
taxes
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3,164 | 3,071 | ||||||
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Net
income
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$ | 10,898 | $ | 9,656 | ||||
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Basic
earnings per share
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$ | 0.37 | $ | 0.32 | ||||
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Diluted
earnings per share
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$ | 0.36 | $ | 0.32 | ||||
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Dividends
declared per share
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$ | 0.21 | $ | 0.20 | ||||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Three
Months Ended March 31, 2008
(In
Thousands, Except Share Data)
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Accumulated
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||||||||||||||||||||||||||||
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Common
Stock
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Additional
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Other
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||||||||||||||||||||||||||
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Shares
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Amount
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Paid-In
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Retained
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Comprehensive
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Treasury
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|||||||||||||||||||||||
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Outstanding
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Issued
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Capital
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Earnings
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Income
|
Stock
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Total
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||||||||||||||||||||||
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Balance
at December 31, 2007
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29,634,733 | $ | 33,000 | $ | 208,429 | $ | 310,281 | $ | 702 | $ | (73,628 | ) | $ | 478,784 | ||||||||||||||
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Net
income
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10,898 | 10,898 | ||||||||||||||||||||||||||
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Other
comprehensive gain, net of tax
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697 | 697 | ||||||||||||||||||||||||||
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Dividends
declared:
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||||||||||||||||||||||||||||
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Common,
$0.21 per share
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(6,252 | ) | (6,252 | ) | ||||||||||||||||||||||||
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Common
stock issued under Stock plan, including tax benefits of
$294
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257,327 | 257 | 3,632 | 3,889 | ||||||||||||||||||||||||
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Stock
options earned
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652 | 652 | ||||||||||||||||||||||||||
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Balance
at March 31, 2008
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29,892,060 | $ | 33,257 | $ | 212,713 | $ | 314,927 | $ | 1,399 | $ | (73,628 | ) | $ | 488,668 | ||||||||||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In
Thousands)
|
Three
Months Ended
|
||||||||
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March
31,
|
||||||||
|
2008
|
2007
|
|||||||
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Other
comprehensive income (loss), before tax:
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||||||||
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Change
in pension liability
|
$ | (146 | ) | $ | (50 | ) | ||
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Change
in unrealized loss on derivative instruments used in cash flow hedging
relationship
|
(2,758 | ) | (423 | ) | ||||
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Unrealized
gain (loss) on securities:
|
||||||||
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Unrealized
holding gain arising during period
|
4,280 | 1,413 | ||||||
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Reclassification
adjustment for gains included in net income
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(287 | ) | 0 | |||||
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Other
comprehensive income (loss), before tax:
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1,089 | 940 | ||||||
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Income
tax expense related to other comprehensive income
|
(392 | ) | (237 | ) | ||||
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Other
comprehensive income, net of tax:
|
697 | 703 | ||||||
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Net
income
|
10,898 | 9,656 | ||||||
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Comprehensive
income
|
$ | 11,595 | $ | 10,359 | ||||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
(In
Thousands)
|
Three
Months Ended March 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
Operating
activities:
|
||||||||
|
Net
income
|
$ | 10,898 | $ | 9,656 | ||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
|
Depreciation
|
2,332 | 2,267 | ||||||
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Amortization
of intangible assets
|
1,531 | 1,515 | ||||||
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Net
(accretion) amortization of premiums and discounts on securities and
loans
|
(470 | ) | (405 | ) | ||||
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Amortization
of unearned compensation and discount on subordinated debt
|
128 | 100 | ||||||
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Provision
for loan losses
|
780 | 200 | ||||||
|
Gain
on investment securities and debt extinguishments
|
(287 | ) | 0 | |||||
|
Loss
(Gain) on sale of loans and other assets
|
39 | (34 | ) | |||||
|
Proceeds
from the sale of loans held for sale
|
438 | 3,889 | ||||||
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Origination
of loans held for sale
|
(440 | ) | (3,863 | ) | ||||
|
Excess
tax benefits from share-based payment arrangements
|
(287 | ) | (106 | ) | ||||
|
Change
in other operating assets and liabilities
|
(5,591 | ) | (3,691 | ) | ||||
|
Net
cash provided by operating activities
|
9,071 | 9,528 | ||||||
|
Investing
activities:
|
||||||||
|
Proceeds
from sales of available-for-sale investment securities
|
24,974 | 3,023 | ||||||
|
Proceeds
from maturities of held-to-maturity investment securities
|
1,645 | 8,095 | ||||||
|
Proceeds
from maturities of available-for-sale investment
securities
|
187,092 | 56,610 | ||||||
|
Purchases
of held-to-maturity investment securities
|
(510 | ) | (785 | ) | ||||
|
Purchases
of available-for-sale investment securities
|
(124,262 | ) | (153,413 | ) | ||||
|
Net
increase in loans outstanding
|
(17,509 | ) | 18,704 | |||||
|
Cash
paid for acquisition (net of cash acquired of $0)
|
(304 | ) | 0 | |||||
|
Capital
expenditures
|
(2,786 | ) | (2,271 | ) | ||||
|
Net
cash provided by (used in) investing activities
|
68,340 | (70,037 | ) | |||||
|
Financing
activities:
|
||||||||
|
Net
change in non-interest checking, interest checking and savings
accounts
|
27,531 | 42,636 | ||||||
|
Net
change in time deposits
|
(12,613 | ) | 67,533 | |||||
|
Net
change in short-term borrowings
|
(45,254 | ) | (20,394 | ) | ||||
|
Change
in long-term borrowings (net of payments of $197 and $322)
|
9,803 | (322 | ) | |||||
|
Payment
on subordinated debt held by unconsolidated subsidiary
trusts
|
(25,774 | ) | (30,928 | ) | ||||
|
Issuance
of common stock
|
4,419 | 2,004 | ||||||
|
Purchase
of treasury stock
|
0 | (1,252 | ) | |||||
|
Cash
dividends paid
|
(6,239 | ) | (5,989 | ) | ||||
|
Tax
benefits from share-based payment arrangements
|
287 | 106 | ||||||
|
Net
cash (used in) provided by financing activities
|
(47,840 | ) | 53,394 | |||||
|
Change
in cash and cash equivalents
|
29,571 | (7,115 | ) | |||||
|
Cash
and cash equivalents at beginning of period
|
130,823 | 232,032 | ||||||
|
Cash
and cash equivalents at end of period
|
$ | 160,394 | $ | 224,917 | ||||
|
Supplemental
disclosures of cash flow information:
|
||||||||
|
Cash
paid for interest
|
$ | 28,316 | $ | 29,475 | ||||
|
Cash
paid for income taxes
|
75 | 0 | ||||||
|
Supplemental
disclosures of noncash financing and investing activities:
|
||||||||
|
Dividends
declared and unpaid
|
6,252 | 6,027 | ||||||
|
Gross
change in unrealized gain on available-for-sale investment
securities
|
3,993 | 1,413 | ||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
COMMUNITY BANK SYSTEM, INC.
NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March
31, 2008
NOTE
A: BASIS OF PRESENTATION
The
interim financial data as of March 31, 2008 and for the three months ended March
31, 2008 and 2007 is unaudited; however, in the opinion of the Company, the
interim data includes all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the interim
periods. The results of operations for the interim periods are not
necessarily indicative of the results that may be expected for the full year or
any other interim period.
NOTE
B: ACQUISITION AND OTHER MATTERS
Hand
Benefits & Trust, Inc.
On May
18, 2007, Benefit Plans Administrative Services, Inc. (BPAS), a wholly owned
subsidiary of the Company, completed its acquisition of Hand Benefits &
Trust, Inc. (HBT) in an all cash transaction. HBT is a Houston, Texas
based provider of employee benefit plan administration and trust
services. The results of HBT's operations have been included in the
consolidated financial statements since that date.
TLNB
Financial Corporation
On June
1, 2007, the Company completed its acquisition of TLNB Financial Corporation,
parent company of Tupper Lake National Bank (TLNB), in an all-cash transaction
valued at approximately $17.8 million. Based in Tupper Lake, NY, TLNB
operated five branches in the northeastern New York State cities of Tupper Lake,
Plattsburgh and Saranac Lake, as well as an insurance subsidiary, TLNB Insurance
Agency, Inc. The results of TLNB's operations have been included in
the consolidated financial statements since that date.
The
estimated purchase price allocation of the assets acquired and liabilities
assumed in the purchase of HBT and TLNB, collectively, including capitalized
acquisition costs, is as follows:
|
(000's
omitted)
|
||||
|
Cash
and due from banks
|
$ | 9,374 | ||
|
Available-for-sale
investment securities
|
28,830 | |||
|
Loans
net of allowance for loan losses of $747
|
54,768 | |||
|
Premises
and equipment, net
|
3,034 | |||
|
Other
assets
|
1,286 | |||
|
Core
deposit & customer list intangibles
|
2,190 | |||
|
Goodwill
|
14,289 | |||
|
Total
assets acquired
|
113,771 | |||
|
Deposits
|
84,120 | |||
|
Borrowings
|
4,288 | |||
|
Other
liabilities
|
3,490 | |||
|
Total
liabilities assumed
|
91,898 | |||
|
Net
assets acquired
|
$ | 21,873 | ||
Stock
Repurchase Program
On April
20, 2005, the Company announced a twenty-month authorization to repurchase up to
1,500,000 of its outstanding shares. On December 20, 2006, the
Company extended the program through December 31, 2008 and announced an
additional two-year authorization to repurchase up to 900,000 of its shares in
open market or privately negotiated transactions. Through March 31,
2008, the Company has repurchased, pursuant to the program, 1,464,811 shares at
an aggregate cost of $31.5 million and an average price per share of
$21.51. The repurchased shares will be used for general corporate
purposes, including those related to stock plan activities.
NOTE
C: ACCOUNTING POLICIES
Critical
Accounting Policies
Allowance
for Loan Losses
Management
continually evaluates the credit quality of the Company's loan portfolio and
performs a formal review of the adequacy of the allowance for loan losses on a
quarterly basis. The allowance reflects management's best estimate of
probable losses inherent in the loan portfolio. Determination of the
allowance is subjective in nature and requires significant
estimates. The Company's allowance methodology consists of two
broad components, general and specific loan loss allocations.
The
general loan loss allocation is composed of two calculations that are computed
on four main loan categories: commercial, consumer direct, consumer indirect and
residential real estate. The first calculation determines an
allowance level based on the latest three years of historical net charge-off
data for each loan category (commercial loans exclude balances with specific
loan loss allocations). The second calculation is qualitative and
takes into consideration five major factors affecting the level of loan loss
risk: portfolio risk migration patterns (internal credit quality trends); the
growth of the categories of the loan portfolio; economic and business
environment trends in the Company's markets (includes review of bankruptcy,
unemployment, population, consumer spending and regulatory trends); industry,
geographical and product concentrations in the portfolio; and the perceived
effectiveness of managerial resources and lending practices and policies. These
two calculations are added together to determine the general loan loss
allocation. The specific loan loss allocation relates to individual
commercial loans that are both greater than $0.5 million and in a nonaccruing
status with respect to interest. Specific losses are based on
discounted estimated cash flows, including any cash flows resulting from the
conversion of collateral.
Loan
losses are charged off against the allowance, while recoveries of amounts
previously charged off are credited to the allowance. A provision for
loan loss is charged to operations based on management's periodic evaluation of
the factors previously mentioned.
Income
Taxes
Provisions
for income taxes are based on taxes currently payable or refundable, and
deferred taxes which are based on temporary differences between the tax basis of
assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are reported in the
financial statements at currently enacted income tax rates applicable to the
period in which the deferred tax assets and liabilities are expected to be
realized or settled.
Intangible
Assets
Intangible
assets include core deposit intangibles, customer relationship intangibles and
goodwill arising from acquisitions. Core deposit intangibles and
customer relationship intangibles are amortized on either an accelerated or
straight-line basis over periods ranging from 7 to 20 years. Goodwill
is evaluated at least annually for impairment. The carrying value of
goodwill and other intangible assets is based upon discounted cash flow modeling
techniques that require management to make estimates regarding the amount and
timing of expected future cash flows. It also requires use of a
discount rate that reflects the current return requirements of the market in
relation to present risk-free interest rates, required equity market premiums,
and company-specific risk indicators.
Retirement
Benefits
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also
provides deferred compensation and supplemental executive retirement plans for
selected current and former employees and officers. Expense under
these plans is charged to current operations and consists of several components
of net periodic benefit cost based on various actuarial assumptions regarding
future experience under the plans, including discount rate, rate of future
compensation increases and expected return on plan assets.
New
Accounting Pronouncements
SFAS
No. 141(R)
In
December 2007, the FASB issued SFAS No. 141(R), Business
Combinations. This statement provides new accounting guidance
and disclosure requirements for business combinations. The Company
will be required to apply SFAS No. 141(R) to all business combinations completed
on or after January 1, 2009.
SFAS
No. 160
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No.
51. This statement provides new accounting guidance and
disclosure and presentation requirements for noncontrolling interests in a
subsidiary. SFAS No. 160 is effective for fiscal years beginning on
or after December 15, 2008. The Company is currently assessing the
effect of SFAS No. 160 on its financial statements.
SFAS
No. 161
In March
2008, the FASB issued SFAS No. 161, Disclosures About Derivative
Instruments and Hedging Activities – an amendment of FASB Statement No.
133. This statement expands quarterly disclosure requirements
in SFAS No. 133 about an entity's derivative instruments and hedging
activities. SFAS No. 161 is effective for fiscal years beginning on
or after November 15, 2008. The Company is currently assessing the
effect of SFAS No. 161 on its financial statements.
NOTE
D: EARNINGS PER SHARE
Basic
earnings per share are computed based on the weighted-average common shares
outstanding for the period. Diluted earnings per share are based on
the weighted-average shares outstanding adjusted for the dilutive effect of
restricted stock and the assumed exercise of stock options during the
year. The dilutive effect of options is calculated using the treasury
stock method of accounting. The treasury stock method determines the
number of common shares that would be outstanding if all the dilutive options
(those where the average market price is greater than the exercise price) were
exercised and the proceeds were used to repurchase common shares in the open
market at the average market price for the applicable time
period. There were approximately 1.6 million anti-dilutive stock
options outstanding at March 31, 2008 compared to approximately 1.7 million
weighted-average anti-dilutive stock options outstanding at March 31, 2007 that
were not included in the computation below. The following is a
reconciliation of basic to diluted earnings per share for the three months ended
March 31, 2008 and 2007.
|
Per
Share
|
||||||||||||
|
(000's
omitted, except per share data)
|
Income
|
Shares
|
Amount
|
|||||||||
|
Three
Months Ended March 31, 2008
|
||||||||||||
|
Basic
EPS
|
$ | 10,898 | 29,720 | $ | 0.37 | |||||||
|
Stock
options and restricted stock
|
316 | |||||||||||
|
Diluted
EPS
|
$ | 10,898 | 30,036 | $ | 0.36 | |||||||
|
Three
Months Ended March 31, 2007
|
||||||||||||
|
Basic
EPS
|
$ | 9,656 | 30,192 | $ | 0.32 | |||||||
|
Stock
options and restricted stock
|
355 | |||||||||||
|
Diluted
EPS
|
$ | 9,656 | 30,547 | $ | 0.32 | |||||||
NOTE
E: INTANGIBLE ASSETS
The gross
carrying amount and accumulated amortization for each type of intangible asset
are as follows:
|
As
of March 31, 2008
|
As
of December 31, 2007
|
|||||||||||||||||||||||
|
Gross
|
Net
|
Gross
|
Net
|
|||||||||||||||||||||
|
Carrying
|
Accumulated
|
Carrying
|
Carrying
|
Accumulated
|
Carrying
|
|||||||||||||||||||
|
(000's
omitted)
|
Amount
|
Amortization
|
Amount
|
Amount
|
Amortization
|
Amount
|
||||||||||||||||||
|
Amortizing
intangible assets:
|
||||||||||||||||||||||||
|
Core
deposit intangibles
|
$ | 66,368 | $ | (48,023 | ) | $ | 18,345 | $ | 66,368 | $ | (46,603 | ) | $ | 19,765 | ||||||||||
|
Other
intangibles
|
4,076 | (2,032 | ) | 2,044 | 3,923 | (1,921 | ) | 2,002 | ||||||||||||||||
|
Total
amortizing intangibles
|
70,444 | (50,055 | ) | 20,389 | 70,291 | (48,524 | ) | 21,767 | ||||||||||||||||
|
Non-amortizing
intangible assets:
|
||||||||||||||||||||||||
|
Goodwill
|
234,722 | 0 | 234,722 | 234,449 | 0 | 234,449 | ||||||||||||||||||
|
Total
intangible assets, net
|
$ | 305,166 | $ | (50,055 | ) | $ | 255,111 | $ | 304,740 | $ | (48,524 | ) | $ | 256,216 | ||||||||||
No
goodwill impairment adjustments were recognized in 2008 or 2007. The
estimated aggregate amortization expense for each of the succeeding fiscal years
ended December 31 is as follows:
|
(000's
omitted)
|
Amount
|
|||
|
Apr-Dec
2008
|
$ | 4,561 | ||
|
2009
|
5,499 | |||
|
2010
|
3,579 | |||
|
2011
|
1,481 | |||
|
2012
|
1,221 | |||
|
Thereafter
|
4,048 | |||
|
Total
|
$ | 20,389 | ||
NOTE
F: MANDATORILY REDEEMABLE PREFERRED SECURITIES
The
Company sponsors two business trusts, Community Statutory Trust III and
Community Capital Trust IV (Trust IV), of which 100% of the common stock is
owned by the Company. The trusts were formed for the purpose of
issuing company-obligated mandatorily redeemable preferred securities to
third-party investors and investing the proceeds from the sale of such preferred
securities solely in junior subordinated debt securities of the
Company. The debentures held by each trust are the sole assets of
that trust. Distributions on the preferred securities issued by each
trust are payable semi-annually or quarterly at a rate per annum equal to the
interest rate being earned by the trust on the debentures held by that trust and
are recorded as interest expense in the consolidated financial
statements. The preferred securities are subject to mandatory
redemption, in whole or in part, upon repayment of the
debentures. The Company has entered into agreements which, taken
collectively, fully and unconditionally guarantee the preferred securities
subject to the terms of each of the guarantees. The terms of the
preferred securities of each trust are as follows:
|
Issuance
|
Par
|
Maturity
|
||||
|
Date
|
Amount
|
Interest
Rate
|
Date
|
Call
Provision
|
Call
Price
|
|
|
III
|
7/31/2001
|
$24.5
million
|
3
month LIBOR plus 3.58% (6.82%)
|
7/31/2031
|
5
year beginning 2006
|
107.5000%
declining to par in 2011
|
|
IV
|
12/8/2006
|
$75
million
|
3
month LIBOR plus 1.65% (4.45%)
|
12/15/2036
|
5
year beginning 2012
|
Par
|
The
Company also entered into an interest rate swap agreement to convert Trust IV's
variable rate trust preferred securities into a fixed rate security for a term
of five years at a fixed rate of 6.43%. A net gain of $37,000 was
recognized for the interest rate swap agreement for the three months ended March
31, 2008 and was used to offset the interest expense for the trust preferred
securities.
NOTE
G: BENEFIT PLANS
The
Company provides defined benefit pension benefits and post-retirement health and
life insurance benefits to eligible employees. The Company also provides
supplemental pension retirement benefits for several current and former key
employees. No contributions in 2008 are required for regulatory
purposes. The Company accrues for the estimated cost of these
benefits through charges to expense during the years that employees earn these
benefits. The net periodic benefit cost for the three months ended
March 31 is as follows:
|
Pension
Benefits
|
Post-retirement
Benefits
|
|||||||||||||||
|
Three
Months Ended
|
Three
Months Ended
|
|||||||||||||||
|
March
31,
|
March
31,
|
|||||||||||||||
|
(000's
omitted)
|
2008
|
2007
|
2008
|
2007
|
||||||||||||
|
Service
cost
|
$ | 779 | $ | 763 | $ | 175 | $ | 148 | ||||||||
|
Interest
cost
|
819 | 678 | 150 | 131 | ||||||||||||
|
Expected
return on plan assets
|
(1,117 | ) | (1,024 | ) | 0 | 0 | ||||||||||
|
Net
amortization and deferral
|
165 | 247 | 25 | 29 | ||||||||||||
|
Amortization
of prior service cost
|
(28 | ) | (23 | ) | 27 | 28 | ||||||||||
|
Amortization
of transition obligation
|
0 | 0 | 10 | 10 | ||||||||||||
|
Net
periodic benefit cost
|
$ | 618 | $ | 641 | $ | 387 | $ | 346 | ||||||||
NOTE
H: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS
The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its
customers. These financial instruments consist primarily of
commitments to extend credit and standby letters of
credit. Commitments to extend credit are agreements to lend to
customers, generally having fixed expiration dates or other termination clauses
that may require payment of a fee. These commitments consist
principally of unused commercial and consumer credit lines. Standby
letters of credit generally are contingent upon the failure of the customer to
perform according to the terms of an underlying contract with a third
party. The credit risks associated with commitments to extend credit
and standby letters of credit are essentially the same as that involved with
extending loans to customers and are subject to normal credit
policies. Collateral may be obtained based on management's assessment
of the customer's creditworthiness.
The
contract amount of commitment and contingencies are as follows:
|
(000's
omitted)
|
March
31, 2008
|
December
31, 2007
|
||||||
|
Commitments
to extend credit
|
$ | 481,598 | $ | 482,517 | ||||
|
Standby
letters of credit
|
10,296 | 10,121 | ||||||
|
Total
|
$ | 491,894 | $ | 492,638 | ||||
NOTE
I: FAIR VALUE
Effective
January 1, 2008 the Company adopted SFAS No. 157, Fair Value Measurements (SFAS
157) and SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities (SFAS
159). SFAS 159 allows entities an irrevocable option to measure
certain financial assets and financial liabilities at fair
value. Unrealized gains and losses on items for which the fair value
option has been elected are reported in earnings. The implementation
of this standard did not have a material impact on the Company's consolidated
financial position or results of operations.
SFAS 157
establishes a common definition for fair value to be applied to generally
accepted accounting principals requiring the use of fair value, establishes a
framework for measuring fair value and expands disclosure about such fair value
instruments. It defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (exit
price). It also classifies the inputs used to measure fair value into
the following hierarchy:
|
|
·
|
Level
1 – Quoted prices in active markets for identical assets or
liabilities.
|
|
|
·
|
Level
2 – Quoted prices in active markets for similar assets or liabilities, or
quoted prices for identical or similar assets or liabilities in markets
that are not active, or inputs other than quoted prices that are
observable for the asset or
liability.
|
|
|
·
|
Level
3 – Significant valuation assumptions not readily observable in a
market.
|
A
financial instrument's categorization within the valuation hierarchy is based
upon the lowest level of input that is significant to the fair value
measurement. The following tables set forth the Company's
financial assets and liabilities that were accounted for at fair value on a
recurring basis as of March 31, 2008:
|
(000's
omitted)
|
Level
1
|
Level
2
|
Level
3
|
Total
Fair Value
|
||||||||||||
|
Available-for-sale
investment securities
|
$ | 1,062 | $ | 1,052,200 | $ | 69,584 | $ | 1,122,846 | ||||||||
|
Derivative
assets/(liabilities), net
|
0 | (5,003 | ) | 0 | (5,003 | ) | ||||||||||
|
Total
|
$ | 1,062 | $ | 1,047,197 | $ | 69,584 | $ | 1,117,843 | ||||||||
The
valuation techniques used to measure fair value for the items in the table above
are as follows:
|
|
·
|
Available
for sale investment securities – The fair value of available for sale
investment securities is based upon quoted prices, if
available. If quoted prices are not available, fair values are
measured using quoted market prices for similar securities or model-based
valuation techniques. Level 1 securities include U.S. Treasury
securities that are traded by dealers or brokers in active
over-the-counter markets. Level 2 securities include
mortgage-backed securities issued by government sponsored entities,
municipal securities and corporate debt securities. Securities
classified as Level 3 include asset-backed securities in less liquid
markets. The value of these instruments is determined using
pricing models or similar techniques as well as significant judgment or
estimation.
|
|
|
·
|
Derivative
assets and liabilities – The fair value of derivative instruments traded
in over-the-counter markets where quoted market prices are not readily
available, are measured using models that primarily use market observable
inputs, such as yield curves and option
volatilities.
|
Certain
other assets are measured at fair value on a nonrecurring
basis. These adjustments to fair value usually result from
application of lower or cost or fair value accounting or write-downs of
individual assets due to impairment. Examples of these nonrecurring
assets includes mortgage servicing rights and impaired loans for which the level
of impairment is determined based upon the fair value of the underlying
collateral of the loan. At March 31, 2008, the Company had no assets
measured at fair value on a nonrecurring basis.
The
changes in Level 3 assets measured at fair value on a recurring basis are
summarized in the following table:
|
(000's
omitted)
|
AFS
investments
|
|||
|
Balance
at December 31, 2007
|
$ | 73,442 | ||
|
Total
gains (losses) included in earnings (a)
|
6 | |||
|
Total
gains (losses) included in other comprehensive income
|
(3,796 | ) | ||
|
Purchases
|
0 | |||
|
Sales/calls
|
(68 | ) | ||
|
Transfers
|
0 | |||
|
Balance
at March 31, 2008
|
$ | 69,584 | ||
(a)
Included in Gain on sales of investment securities.
NOTE
J: SEGMENT INFORMATION
Statement
of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an
Enterprise and Related Information has established standards for public
companies relating to the reporting of financial and descriptive information
about their operating segments in financial statements. Operating
segments are components of an enterprise, which are evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and assess
performance. The Company's chief operating decision maker is the
President and Chief Executive Officer of the Company.
The
Company has identified "Banking" as its reportable operating business
segment. The Banking segment provides full-service banking to
consumers, businesses and governmental units in northern, central and western
New York as well as Northeastern Pennsylvania.
Immaterial
operating segments of the Company's operations, which do not have similar
characteristics to the banking segment and do not meet the quantitative
thresholds requiring disclosure, are included in the "Other"
category. Revenues derived from these segments includes
administration, consulting and actuarial services provided to sponsors of
employee benefit plans, broker-dealer and investment advisory services, asset
management services to individuals, corporate pension and profit sharing plans,
trust services and insurance commissions from various insurance related products
and services. The accounting policies used in the disclosure of
business segments are the same as those described in the summary of significant
accounting policies (See Note A, Summary of Significant Accounting
Policies of the most recent Form 10-K for the year ended December 31,
2007).
Information
about reportable segments and reconciliation of the information to the
consolidated financial statements follows:
|
(000's
omitted)
|
Banking
|
Other
|
Consolidated
Total
|
|||||||||
|
For
the Three Months Ended March
31, 2008
|
||||||||||||
|
Net
interest income
|
$ | 35,515 | $ | 83 | $ | 35,598 | ||||||
|
Provision
for loan losses
|
780 | 0 | 780 | |||||||||
|
Noninterest
income excluding gain (loss) on investment securities and debt
extinguishments
|
8,467 | 8,864 | 17,331 | |||||||||
|
Gain
on investment securities
|
287 | 0 | 287 | |||||||||
|
Amortization
of intangible assets
|
1,421 | 110 | 1,531 | |||||||||
|
Other
operating expenses
|
29,870 | 6,973 | 36,843 | |||||||||
|
Income
before income taxes
|
$ | 12,198 | $ | 1,864 | $ | 14,062 | ||||||
|
Assets
|
$ | 4,622,569 | $ | 35,846 | $ | 4,658,415 | ||||||
|
Goodwill
|
$ | 221,315 | $ | 13,407 | $ | 234,722 | ||||||
|
For the Three Months
Ended March 31, 2007
|
||||||||||||
|
Net
interest income
|
$ | 33,240 | $ | 127 | $ | 33,367 | ||||||
|
Provision
for loan losses
|
200 | 0 | 200 | |||||||||
|
Noninterest
income excluding gain (loss) on investment securities and debt
extinguishments
|
7,168 | 6,311 | 13,479 | |||||||||
|
Amortization
of intangible assets
|
1,445 | 70 | 1,515 | |||||||||
|
Other
operating expenses
|
27,470 | 4,934 | 32,404 | |||||||||
|
Income
before income taxes
|
$ | 11,293 | $ | 1,434 | $ | 12,727 | ||||||
|
Assets
|
$ | 4,528,735 | $ | 30,153 | $ | 4,558,888 | ||||||
|
Goodwill
|
$ | 208,932 | $ | 11,336 | $ | 220,268 | ||||||
|
Item 2.
|
Management's
Discussion and Analysis of Financial Condition and Results of
Operations
|
Introduction
This
Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) primarily reviews the financial condition and results of
operations of Community Bank System, Inc. (the Company or CBSI) as of and for
the three months ended March 31, 2008 and 2007, although in some circumstances
the fourth quarter of 2007 is also discussed in order to more fully explain
recent trends. The following discussion and analysis should be read
in conjunction with the Company's Consolidated Financial Statements and related
notes that appear on pages 3 through 13. All references in the
discussion to the financial condition and results of operations are to those of
the Company and its subsidiaries taken as a whole.
Unless
otherwise noted, the term "this year" refers to results in calendar year 2008,
"first quarter" refers to the quarter ended March 31, 2008, earnings per share
(EPS) figures refer to diluted EPS, and net interest income and net interest
margin are presented on a fully tax-equivalent (FTE) basis.
This
MD&A contains certain forward-looking statements with respect to the
financial condition, results of operations and business of the
Company. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ
materially from those proposed by such forward-looking statements are set herein
under the caption, "Forward-Looking Statements," on page 27.
Critical Accounting
Policies
As a
result of the complex and dynamic nature of the Company's business, management
must exercise judgment in selecting and applying the most appropriate accounting
policies for its various areas of operations. The policy decision
process not only ensures compliance with the latest generally accepted
accounting principles, but also reflects on management's discretion with regard
to choosing the most suitable methodology for reporting the Company's financial
performance. It is management's opinion that the accounting estimates
covering certain aspects of the business have more significance than others due
to the relative importance of those areas to overall performance, or the level
of subjectivity in the selection process. These estimates affect the
reported amounts of assets and liabilities and disclosures of revenues and
expenses during the reporting period. Actual results could
differ from those estimates. Management believes that critical
accounting estimates include:
|
·
|
Allowance
for loan losses - The allowance for loan losses reflects management's best
estimate of probable losses inherent in the loan
portfolio. Determination of the allowance is inherently
subjective. It requires significant estimates including the
amounts and timing of expected future cash flows on impaired loans and the
amount of estimated losses on pools of homogeneous loans which is based on
historical loss experience and consideration of current economic trends,
all of which may be susceptible to significant
change.
|
|
·
|
Actuarial
assumptions associated with pension, post-retirement and other employee
benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan
assets.
|
|
·
|
Provision
for income taxes - The Company is subject to examinations from various
taxing authorities. Such examinations may result in challenges
to the tax return treatment applied by the Company to specific
transactions. Management believes that the assumptions and
judgements used to record tax related assets or liabilities have been
appropriate. Should tax laws change or the taxing authorities
determine that management's assumptions were inappropriate an adjustment
may be required which could have a material effect on the Company's
results of operations.
|
|
·
|
Carrying
value of goodwill and other intangible assets - The carrying value of
goodwill and other intangible assets is based upon discounted cash flow
modeling techniques that require management to make estimates regarding
the amount and timing of expected future cash flows. It also
requires use of a discount rate that reflects the current return
requirements of the market in relation to present risk-free interest
rates, required equity market premiums, and company-specific risk
indicators.
|
A summary
of the accounting policies used by management is disclosed in Note A, "Summary
of Significant Accounting Policies" on pages
46-51 of the most recent Form 10-K (fiscal year ended December 31, 2007) filed
with the Securities and Exchange Commission on March 13, 2008.
Executive
Summary
The
Company's business philosophy is to operate as a community bank with local
decision-making, principally in non-metropolitan markets, providing a broad
array of banking and financial services to retail, commercial and municipal
customers.
The
Company's core operating objectives are: (i) grow the branch network, primarily
through a disciplined acquisition strategy, and certain selective de novo
expansions, (ii) build high-quality, profitable loan and deposit portfolios
using both organic and acquisition strategies, (iii) increase the noninterest
income component of total revenues through development of banking-related fee
income, growth in existing financial services business units, and the
acquisition of additional financial services and banking businesses, and (iv)
utilize technology to deliver customer-responsive products and services and to
reduce operating costs.
Significant
factors management reviews to evaluate achievement of the Company's operating
objectives and its operating results and financial condition include, but are
not limited to: net income and earnings per share, return on assets and equity,
net interest margins, noninterest income, operating expenses, asset quality,
loan and deposit growth, capital management, performance of individual banking
and financial services units, liquidity and interest rate sensitivity,
enhancements to customer products and services, technology enhancements, market
share, peer comparisons, and the performance of acquisition and integration
activities.
On June
1, 2007, the Company completed its acquisition of TLNB Financial Corporation,
parent company of Tupper Lake National Bank (TLNB), in an all-cash transaction
valued at approximately $17.8 million. Based in Tupper Lake, NY, TLNB
operated five branches in the northeastern New York State cities of Tupper Lake,
Plattsburgh and Saranac Lake, as well as an insurance subsidiary, TLNB Insurance
Agency, Inc. On a consolidated basis, TLNB had approximately $100
million in assets and $87 million of deposits.
On May
18, 2007, the Company's subsidiary, Benefit Plans Administrative Services, Inc.
(BPAS), completed its acquisition of Hand Benefits & Trust, Inc. (HBT) in an
all cash transaction. HBT is a Houston, Texas based provider of
employee benefit plan administration and trust services.
First
quarter net income of $10.9 million, or $0.36 per share was up 13% or $0.04 over
the $0.32 per share reported in the first quarter of 2007. The
increase was driven by higher interest income generated from solid loan growth,
continued expansion of non-interest income sources, improved net interest margin
and favorable asset quality results. These were partially offset by a
higher provision for loan loss and increased operating expenses. Cash
earnings per share (which excludes the after-tax effect of the amortization of
intangibles assets and acquisition-related market value adjustments) were $0.41
versus $0.36 for the prior year's first quarter.
Asset
quality in the first quarter of 2008 remained strong in comparison to the same
period last year, with reductions in nonperforming loan and total delinquent
loan ratios. Net charge-offs increased, but remained well below
average quarterly charge-offs in the last few years. The Company
experienced year-over-year loan growth in all portfolios: consumer installment,
consumer mortgage and business lending, due to organic growth and the
acquisition of TLNB. The investment portfolio decreased as compared
to both the first quarter of 2007 and December 31, 2007. Average
deposits increased in the first quarter of 2008 as compared to the first quarter
of 2007 and declined slightly from the fourth quarter of
2007. External borrowings decreased from the end of December 2007 due
to the redemption of $25 million of variable-rate trust preferred securities in
the beginning of the first quarter of 2008. Additionally, in December
2007, the Company restructured $150 million of its fixed rate Federal Home Loan
Bank (FHLB) advances, replacing them with lower cost instruments with similar
remaining duration. These restructuring strategies had a positive
impact on the Company's net interest margin in the first quarter of
2008.
Net Income and
Profitability
As shown
in Table 1, net income for the quarter of $10.9 million was up 12.9% over the
first quarter of 2007. Earnings per share for the first quarter of $0.36 was
$0.04 higher than the EPS generated in the same period of last
year. First quarter net interest income of $35.6 million was up $2.2
million or 6.7% from the comparable prior year period. The current
quarter's provision for loan losses increased $0.6 million as compared to the
first quarter of 2007 and decreased $0.1 million from the fourth quarter of
2007. First quarter noninterest income, excluding securities gains
and losses, was $17.3 million, up $3.9 million or 29% from the first quarter of
2007. Operating expenses of $38.4 million for the quarter were up
$4.5 million or 13% from the comparable prior year period, a significant portion
of the increase was attributable to the acquisitions of TLNB and HBT during the
second quarter of 2007.
In
addition to the earnings results presented above in accordance with generally
accepted accounting principles (GAAP), the Company provides
cash earnings per share, which excludes the after-tax effect of the amortization
of intangible assets and acquisition-related market value
adjustments. Management believes that this information helps
investors better understand the effect of acquisition activity in reported
results. Cash earnings per share for the first quarter of 2008 was
$0.41, up 14% from the $0.36 earned in the comparable period of
2007.
As
reflected in Table 1, the primary reasons for higher earnings were higher
noninterest income and net interest income, partially offset by higher operating
expenses and loan loss provision. Net interest income for the first
quarter of 2008 increased as compared to both the first and the fourth quarters
of 2007 as a result of higher net interest margins as well as acquired and
organic loan growth. Excluding security gains and losses, noninterest
income increased due to a strong performance by the Company's employee benefits
consulting and plan administration business, as a result of significant organic
growth and the acquisition of HBT, as well as higher banking service fees,
including higher account fees and debit card related revenues. Higher
net charge-offs and an increase in total loans were the primary reasons for the
increase in loan loss provision, which remained below the average provision for
the prior eight quarters. Operating expenses increased for the
quarter as compared to the prior year, primarily due to costs associated with
the two acquisitions in the last year, as well as higher business development
and volume-based processing costs, increased facility-based utilities and
maintenance costs, and higher personnel expenses.
A
condensed income statement and a reconciliation of GAAP-based earnings results
to cash-based earnings results are as follows:
Table
1: Summary Income Statements
|
Three
Months Ended
|
||||||||
|
March
31,
|
||||||||
|
(000's
omitted, except per share data)
|
2008
|
2007
|
||||||
|
Net
interest income
|
$ | 35,598 | $ | 33,367 | ||||
|
Provision
for loan losses
|
780 | 200 | ||||||
|
Noninterest
income excluding security losses
|
17,331 | 13,479 | ||||||
|
Gain
on sales of investment securities
|
287 | 0 | ||||||
|
Operating
expenses
|
38,374 | 33,919 | ||||||
|
Income
before taxes
|
14,062 | 12,727 | ||||||
|
Income
taxes
|
3,164 | 3,071 | ||||||
|
Net
income
|
$ | 10,898 | $ | 9,656 | ||||
|
Diluted
earnings per share
|
$ | 0.36 | $ | 0.32 | ||||
Table
2: Reconciliation of GAAP Net Income to Cash Net Income (Non-GAAP
measure)
|
Three
Months Ended
|
||||||||
|
March
31,
|
||||||||
|
(000's
omitted)
|
2008
|
2007
|
||||||
|
Net
income
|
$ | 10,898 | $ | 9,656 | ||||
|
After-tax
cash adjustments:
|
||||||||
|
Amortization
of market value adjustments on net assets acquired in
mergers
|
156 | 179 | ||||||
|
Amortization
of intangible assets
|
1,187 | 1,150 | ||||||
|
Net
income – cash
|
$ | 12,241 | $ | 10,985 | ||||
|
Diluted
earnings per share – cash
|
$ | 0.41 | $ | 0.36 | ||||
Net Interest
Income
Net
interest income is the amount by which interest and fees on earning assets
(loans, investments and cash) exceed the cost of funds, primarily interest paid
to the Company's depositors and interest on external borrowings. Net
interest margin is the difference between the gross yield on earning assets and
the cost of interest-bearing funds as a percentage of earning
assets.
As shown
in Table 3, net interest income (with nontaxable income converted to a fully
tax-equivalent basis) for the first quarter of 2008 was $39.5 million, a $2.3
million increase from the same period last year and a $0.8 million increase from
the fourth quarter of 2008. A $143 million increase in first quarter
interest-earning assets and a seven basis point increase in the net interest
margin versus the prior year offset a $147 million increase in average
interest-bearing liabilities. As reflected in Table 4, the volume and
rate increases from interest bearing assets had a $1.7 million favorable impact
on net interest income, while the volume and rate increases from interest
bearing liabilities had a $0.6 million favorable impact on net interest
income. The increase in interest bearing assets and the
decrease in the cost of funding had a favorable impact on net interest margin,
which was partially offset by the increase in the interest bearing liabilities
and the lower yields on interest bearing assets.
Higher
first quarter average loan balances were attributable to $82 million of organic
loan growth since the first quarter of 2007, driven by growth in the consumer
mortgage and consumer installment portfolios. The remaining
contribution to the increase in the average first quarter loan balance was the
$56 million of loans acquired in the TLNB acquisitions. Average
investments and cash equivalents for the first quarter period were $5.8 million
higher than the respective period of 2007. In comparison to the prior
year, total average deposits were up $41 million or 1.3% for the quarter as a
result of the acquisition of TLNB. Quarterly average deposits from
acquisitions were $70 million. On an organic basis, average deposits
for the first quarter decreased $29 million from the first quarter of 2007, as a
result of the Company's objective of lowering its overall funding costs by
reducing higher cost time deposits. Quarterly average borrowings
increased $110 million as compared to the first quarter of 2007 due to the
all-cash acquisitions of TLNB and HBT, partially offset by the redemption of $25
million of fixed rate trust preferred securities in the first quarter of
2008.
The net
interest margin of 3.81% for the first quarter increased seven basis points
versus the same period in the prior year. The improvement was
primarily attributable to a 20 basis point decrease in the cost of funds, due
primarily to a 10 basis point drop in the cost of deposit funding and the
restructuring of $175 million of external borrowings that were
replaced with lower cost instruments in late 2007 and early
2008. Partially offsetting these improvements was a 12 basis point
decline in earning assets yields for the quarter as compared to the first
quarter of 2007. The change in the earning-asset yield was driven by
a 16 basis point decrease in loan yields for the quarter and a four basis point
decline in the investment yields for the quarter, mostly as a result of variable
and adjustable-rate assets repricing downward due to the decline in short-term
fed funds rates.
The first
quarter cost of funds decreased 20 basis points versus the prior year quarter
due to a 79 basis point decrease in the average interest rate paid on external
borrowings and a 12 basis point decrease on interest-bearing deposits
rates. The decrease in the external borrowing rate is due to the
restructuring of $150 million of FHLB advances in December 2007 and the
redemption of $25 million of variable rate, trust-preferred securities in
January 2008. Additionally, the long-term rate was impacted by the
approximately 200 basis point decrease in the three month LIBOR (London
Interbank Offered Rates) over the last twelve months, from which the interest
rate on $25 million of the mandatorily redeemable preferred securities is
based. Interest rates on selected categories of deposit accounts were
lowered throughout the second half of 2007 and the first quarter of 2008 in
response to market conditions. Additionally, the proportion of
customer deposits in higher cost time deposits has declined 1.4 percentage
points over the last twelve months, while the percentage of deposits in lower
cost checking and savings accounts has increased.
Table 3
below sets forth information related to average interest-earning assets and
interest-bearing liabilities and their associated yields and rates for the
periods indicated. Interest income and yields are on a fully
tax-equivalent basis using marginal income tax rates of 38.49% in 2008 and
38.75% in 2007. Average balances are computed by accumulating the
daily ending balances in a period and dividing by the number of days in that
period. Loan yields and amounts earned include loan
fees. Average loan balances include nonaccrual loans and loans held
for sale.
Table
3: Quarterly Average Balance Sheet
|
Three
Months Ended
|
Three
Months Ended
|
|||||||||||||||||||||||
|
(000's
omitted except yields and rates)
|
March
31, 2008
|
March
31, 2007
|
||||||||||||||||||||||
|
Avg.
|
Avg.
|
|||||||||||||||||||||||
|
Average
|
Yield/Rate
|
Average
|
Yield/Rate
|
|||||||||||||||||||||
|
Balance
|
Interest
|
Paid
|
Balance
|
Interest
|
Paid
|
|||||||||||||||||||
|
Interest-earning
assets:
|
||||||||||||||||||||||||
|
Cash
equivalents
|
$ | 44,728 | $ | 318 | 2.86 | % | $ | 102,553 | $ | 1,329 | 5.26 | % | ||||||||||||
|
Taxable
investment securities (1)
|
764,234 | 10,717 | 5.64 | % | 741,304 | 10,280 | 5.62 | % | ||||||||||||||||
|
Nontaxable
investment securities
(1)
|
540,993 | 9,334 | 6.94 | % | 500,273 | 8,639 | 7.00 | % | ||||||||||||||||
|
Loans
(net of unearned discount)
|
2,822,100 | 46,672 | 6.65 | % | 2,684,566 | 45,106 | 6.81 | % | ||||||||||||||||
|
Total
interest-earning assets
|
4,172,055 | 67,041 | 6.46 | % | 4,028,696 | 65,354 | 6.58 | % | ||||||||||||||||
|
Noninterest-earning
assets
|
469,964 | 440,548 | ||||||||||||||||||||||
|
Total
assets
|
$ | 4,642,019 | $ | 4,469,244 | ||||||||||||||||||||
|
Interest-bearing
liabilities:
|
||||||||||||||||||||||||
|
Interest
checking, savings and money market deposits
|
$ | 1,260,934 | 2,714 | 0.87 | % | $ | 1,198,183 | 3,340 | 1.13 | % | ||||||||||||||
|
Time
deposits
|
1,398,650 | 14,980 | 4.31 | % | 1,424,289 | 14,780 | 4.21 | % | ||||||||||||||||
|
Short-term
borrowings
|
426,116 | 4,419 | 4.17 | % | 159,444 | 1,637 | 4.16 | % | ||||||||||||||||
|
Long-term
borrowings
|
457,177 | 5,440 | 4.79 | % | 613,624 | 8,434 | 5.57 | % | ||||||||||||||||
|
Total
interest-bearing liabilities
|
3,542,877 | 27,553 | 3.13 | % | 3,395,540 | 28,191 | 3.37 | % | ||||||||||||||||
|
Noninterest-bearing
liabilities:
|
||||||||||||||||||||||||
|
Demand
deposits
|
555,927 | 552,087 | ||||||||||||||||||||||
|
Other
liabilities
|
60,465 | 56,994 | ||||||||||||||||||||||
|
Shareholders'
equity
|
482,750 | 464,623 | ||||||||||||||||||||||
|
Total
liabilities and shareholders' equity
|
$ | 4,642,019 | $ | 4,469,244 | ||||||||||||||||||||
|
Net
interest earnings
|
$ | 39,488 | $ | 37,163 | ||||||||||||||||||||
|
Net
interest spread
|
3.33 | % | 3.21 | % | ||||||||||||||||||||
|
Net
interest margin on interest-earnings assets
|
3.81 | % | 3.74 | % | ||||||||||||||||||||
|
Fully
tax-equivalent adjustment
|
$ | 3,890 | $ | 3,796 | ||||||||||||||||||||
|
(1)
|
Averages
for investment securities are based on historical cost basis and the
yields do not give effect to changes in fair value that is reflected as a
component of shareholders' equity and deferred
taxes.
|
As
discussed above and disclosed in Table 4 below, the quarterly change in net
interest income (fully tax-equivalent basis) may be analyzed by segregating the
volume and rate components of the changes in interest income and interest
expense for each underlying category.
Table
4: Rate/Volume
|
1st
Quarter 2008 versus 1st Quarter 2007
|
||||||||||||
|
Increase
(Decrease) Due to Change in (1)
|
||||||||||||
|
Volume
|
Rate
|
Net
Change
|
||||||||||
|
(000's
omitted)
|
||||||||||||
|
Interest
earned on:
|
||||||||||||
|
Cash
equivalents
|
$ | (562 | ) | $ | (449 | ) | $ | (1,011 | ) | |||
|
Taxable
investment securities
|
321 | 116 | 437 | |||||||||
|
Nontaxable
investment securities
|
703 | (8 | ) | 695 | ||||||||
|
Loans
(net of unearned discount)
|
2,283 | (717 | ) | 1,566 | ||||||||
|
Total
interest-earning assets
(2)
|
2,309 | (622 | ) | 1,687 | ||||||||
|
Interest
paid on:
|
||||||||||||
|
Interest
checking, savings and money market deposits
|
168 | (794 | ) | (626 | ) | |||||||
|
Time
deposits
|
(269 | ) | 469 | 200 | ||||||||
|
Short-term
borrowings
|
2,766 | 16 | 2,782 | |||||||||
|
Long-term
borrowings
|
(1,961 | ) | (1,033 | ) | (2,994 | ) | ||||||
|
Total
interest-bearing liabilities (2)
|
1,192 | (1,830 | ) | (638 | ) | |||||||
|
Net
interest earnings (2)
|
$ | 1,343 | $ | 982 | $ | 2,325 | ||||||
|
(1)
|
The
change in interest due to both rate and volume has been allocated in
proportion to the relationship of the absolute dollar amounts of such
change in each component.
|
|
(2)
|
Changes
due to volume and rate are computed from the respective changes in average
balances and
rates and are not a summation of the changes of the
components.
|
Noninterest
Income
The
Company's sources of noninterest income are of three primary types: 1) general
banking services related to loans, deposits and other core customer activities
typically provided through the branch network and electronic banking channels;
2) employee benefit plan administration, actuarial and consulting services
(performed by BPA-Harbridge and HBT); and 3) wealth management services,
comprised of trust services (performed by the trust unit within CBNA),
investment and insurance products (performed by Community Investment Services,
Inc. or CISI and CBNA Insurance Agency, Inc.) and asset management (performed by
Nottingham Advisors or Nottingham). Additionally, the Company has
periodic transactions, most often net gains (losses) from the sale of investment
securities and prepayment of debt instruments.
Table
5: Noninterest Income
|
Three
Months Ended
|
||||||||
|
March
31,
|
||||||||
|
(000's
omitted)
|
2008
|
2007
|
||||||
|
Deposit
service charges and fees
|
$ | 8,261 | $ | 6,977 | ||||
|
Benefit
plan administration, consulting and actuarial fees
|
6,312 | 3,972 | ||||||
|
Wealth
management services
|
2,163 | 1,860 | ||||||
|
Other
banking services
|
373 | 413 | ||||||
|
Mortgage
banking
|
222 | 257 | ||||||
|
Subtotal
|
17,331 | 13,479 | ||||||
|
Gain
on sales of investment securities
|
287 | 0 | ||||||
|
Total
noninterest income
|
$ | 17,618 | $ | 13,479 | ||||
|
Noninterest
income/total income (FTE)
|
30.5 | % | 26.6 | % | ||||
As
displayed in Table 5, noninterest income (excluding securities gains) was $17.3
million in the first quarter, an increase of $3.8 million or 29% from the prior
year level. A significant portion of the growth was attributable to
growth in benefit plan administration, consulting and actuarial fees, primarily
due to the acquisition of HBT in mid May 2007 which generated approximately $1.7
million of revenue growth in the quarter. The remainder of the
increase was due to organic growth generated from new clients along with
enhanced product offerings to both new and existing customers and a strong
quarter from the unit's actuarial consulting practice. First quarter
wealth management services revenue increased $0.3 million or 16%, primarily
attributable to the acquisition of TLNB's Insurance Agency
business. General recurring banking fees of $8.9 million for the
first quarter were up $1.2 million or 15.8%, as compared to the prior year
period, driven by organic core deposit account growth, higher electronic banking
related revenues, and incremental income generated from the acquired TLNB
branches.
The ratio
of noninterest income to total income (FTE basis) was 30.5% for the quarter
versus 26.6% for the comparable period in 2007. This improvement is a
function of increased noninterest banking and financial services income
(excluding net security gains), combined with proportionally smaller increases
in net interest income.
Operating
Expenses
Table 6
below sets forth the quarterly results of the major operating expense categories
for the current and prior year, as well as efficiency ratios (defined below), a
standard measure of expense utilization effectiveness used in the banking
industry.
Table
6: Operating Expenses
|
Three
Months Ended
|
||||||||
|
March
31,
|
||||||||
|
(000's
omitted)
|
2008
|
2007
|
||||||
|
Salaries
and employee benefits
|
$ | 20,386 | $ | 18,286 | ||||
|
Occupancy
and equipment
|
5,573 | 4,666 | ||||||
|
Data
processing and communications
|
3,985 | 3,565 | ||||||
|
Amortization
of intangible assets
|
1,531 | 1,515 | ||||||
|
Legal
and professional fees
|
1,298 | 1,187 | ||||||
|
Office
supplies and postage
|
1,278 | 1,046 | ||||||
|
Business
development and marketing
|
1,322 | 950 | ||||||
|
Other
|
3,001 | 2,704 | ||||||
|
Total
operating expenses
|
$ | 38,374 | $ | 33,919 | ||||
|
Operating
expenses/average assets
|
3.32 | % | 3.08 | % | ||||
|
Efficiency
ratio
|
64.8 | % | 63.8 | % | ||||
As shown
in Table 6, first quarter 2008 operating expenses were $38.4 million, up $4.5
million or 13.1% from the prior year level. The majority of the
increase was attributable to incremental operating expenses related to the TLNB
and HBT acquisitions. Additionally, the increase in operating
expenses can be attributable to annual merit and other personnel related costs
($0.9 million), higher facility-based utility and maintenance costs ($0.7
million), higher volume-based data processing and communication costs ($0.3
million), and an increased level of business development and marketing expense
($0.4 million). A portion of the increase in data processing and
communications costs, as well as the increase in business development and
marketing expenses, reflects the Company's continued investments in strategic
technology and business development initiatives to grow and enhance our service
offerings.
The
Company's efficiency ratio (recurring operating expenses excluding intangible
amortization and acquisition expenses divided by the sum of net interest income
(FTE) and recurring noninterest income) was 64.8% for the first quarter, 1.0
percentage point above the comparable quarter of 2007. This resulted
from operating expenses (as described above) increasing 14% primarily due to the
acquisitions in the last year, while recurring operating income increased at a
slower rate of 12.3% due to a $3.9 million or 29% increase in noninterest income
excluding security gains and a $2.4 million or 6.4% increase in net interest
income quarter over quarter. In both periods, the efficiency ratios
were adversely affected by the growing proportion of financial services
activities which, due to the differing nature of their business, carry high
efficiency ratios. Operating expenses as a percentage of average
assets increased 24 basis points for the quarter as operating expenses increased
13.1%, while average assets increased 3.9% during the same time
period. This ratio was impacted by the comparatively higher growth
rates of the financial services businesses, which are less asset-intensive and
have higher efficiency ratio attributes.
Income
Taxes
The first
quarter effective income tax rate was 22.5%, compared to the 24.1% effective tax
rate in the first quarter of 2007. The lower effective tax rate
for 2008 was principally a result of a higher proportion of income being
generated from tax-exempt securities and loans.
Investments
As
reflected in Table 7 below, the carrying value of investments (including
unrealized gains on available-for-sale securities) was $1.31 billion at the end
of the first quarter, a decrease of $84.2 million and $9.9 million from December
31, 2007 and March 31, 2007, respectively. The book value (excluding
unrealized gains) of investments decreased $88.2 million and $21.9 million from
December 31, 2007 and March 31, 2007, respectively. The short-term
agency securities purchased during the third quarter of 2007 matured during the
fourth quarter of 2007 and the first quarter of 2008. Cash flows from
these securities provided an opportunity to invest in municipal and certain
mortgage-backed securities that improved the Company's interest rate sensitivity
position. The overall mix of securities within the portfolio over the last
year has changed, with an increase in the proportion of obligations of state and
political subdivisions and mortgage-backed securities, the addition of
asset-backed securities and a decrease in U.S. Treasury and Agency
securities. The change in the carrying value of investments is
impacted by the amount of net unrealized gains in the available for sale
portfolio at a point in time. At March 31, 2008, the portfolio had a
$21.2 million net unrealized gain, an increase of $4.0 million from the
unrealized gain at December 31, 2007 and an improvement of $12.0 million from
the unrealized gain at March 31, 2007. This fluctuation is indicative
of the interest rate movements during the respective time periods and the
changes in the size and composition of the portfolio.
Included
in the available for sale portfolio are asset-backed securities with a book
value of $73.0 million and unrealized losses of $4.6 million at March 31,
2008. The underlying collateral of these assets are trust-preferred
securities of community banks. The Company has the intent and ability
to hold these securities to recovery and does not consider these investments to
be other-than temporarily impaired as of March 31, 2008.
Table
7: Investments
|
March
31, 2008
|
December
31, 2007
|
March
31, 2007
|
||||||||||||||||||||||
|
Amortized
|
Amortized
|
Amortized
|
||||||||||||||||||||||
|
Cost/Book
|
Fair
|
Cost/Book
|
Fair
|
Cost/Book
|
Fair
|
|||||||||||||||||||
|
(000's
omitted)
|
Value
|
Value
|
Value
|
Value
|
Value
|
Value
|
||||||||||||||||||
|
Held-to-Maturity
Portfolio:
|
||||||||||||||||||||||||
|
U.S.
Treasury and Agency securities
|
$ | 127,019 | $ | 129,117 | $ | 127,055 | $ | 127,382 | $ | 127,164 | $ | 124,538 | ||||||||||||
|
Obligations
of state and political subdivisions
|
5,850 | 5,959 | 6,207 | 6,289 | 7,345 | 7,373 | ||||||||||||||||||
|
Other
securities
|
3,210 | 3,210 | 3,988 | 3,988 | 4,004 | 4,004 | ||||||||||||||||||
|
Total
held-to-maturity portfolio
|
136,079 | 138,286 | 137,250 | 137,659 | 138,513 | 135,915 | ||||||||||||||||||
|
Available-for-Sale
Portfolio:
|
||||||||||||||||||||||||
|
U.S.
Treasury and Agency securities
|
251,006 | 260,473 | 432,832 | 438,526 | 484,354 | 483,805 | ||||||||||||||||||
|
Obligations
of state and political subdivisions
|
534,985 | 547,991 | 532,431 | 543,963 | 491,172 | 502,447 | ||||||||||||||||||
|
Corporate
securities
|
37,259 | 37,626 | 40,457 | 40,270 | 35,568 | 35,209 | ||||||||||||||||||
|
Collateralized
mortgage obligations
|
32,340 | 32,722 | 34,451 | 34,512 | 41,005 | 40,592 | ||||||||||||||||||
|
Asset-backed
securities
|
73,038 | 68,454 | 73,089 | 72,300 | 0 | 0 | ||||||||||||||||||
|
Mortgage-backed
securities
|
171,882 | 174,418 | 72,655 | 73,525 | 74,067 | 73,308 | ||||||||||||||||||
|
Subtotal
|
1,100,510 | 1,121,684 | 1,185,915 | 1,203,096 | 1,126,166 | 1,135,361 | ||||||||||||||||||
|
Equity
securities
|
49,919 | 49,919 | 51,526 | 51,526 | 43,680 | 43,680 | ||||||||||||||||||
|
Total
available-for-sale portfolio
|
1,150,429 | 1,171,603 | 1,237,441 | 1,254,622 | 1,169,846 | 1,179,041 | ||||||||||||||||||
|
Net
unrealized gain on available-for-sale portfolio
|
21,174 | 0 | 17,181 | 0 | 9,195 | 0 | ||||||||||||||||||
|
Total
|
$ | 1,307,682 | $ | 1,309,889 | $ | 1,391,872 | $ | 1,392,281 | $ | 1,317,554 | $ | |||||||||||||