Edgar Filing: COMMUNITY BANK SYSTEM, INC.

cbna201310q2ndqtr.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2013

	OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to .
	Commission File Number: 001-13695

(Exact name of registrant as specified in its charter)

Delaware		16-1213679
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5790 Widewaters Parkway, DeWitt, New York		13214-1883
(Address of principal executive offices)		(Zip Code)
	(315) 445-2282
(Registrant's telephone number, including area code)

	NONE
(Former name, former address and former fiscal year, if changed since last report)

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 o.

Indicate by check mark whether the registrant has submitted electronically and posted to its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o.

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o.
	(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o. No x.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

40,240,170 shares of Common Stock, $1.00 par value, were outstanding on July 31, 2013.

TABLE OF CONTENTS

Part I.	Financial Information	Page

Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Condition
	June 30, 2013 and December 31, 2012	3

	Consolidated Statements of Income
	Three and six months ended June 30, 2013 and 2012	4

	Consolidated Statements of Comprehensive Income/(Loss)
	Three and six months ended June 30, 2013 and 2012	5

	Consolidated Statement of Changes in Shareholders’ Equity
	Six months ended June 30, 2013	6

	Consolidated Statements of Cash Flows
	Six months ended June 30, 2013 and 2012	7

	Notes to the Consolidated Financial Statements
	June 30, 2013	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44

Item 4.	Controls and Procedures	45

Part II.	Other Information

Item 1.	Legal Proceedings	45

Item 1A.	Risk Factors	45

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Mine Safety Disclosures	46

Item 5.	Other Information	46

Item 6.	Exhibits	46

Part I. Financial Information

Item 1. Financial Statements

COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF CONDITION (Unaudited)
(In Thousands, Except Share Data)

	June 30,	December 31,
	2013	2012
Assets:
Cash and cash equivalents	$148,573	$228,558

Available-for-sale investment securities (cost of $1,708,296 and $1,989,938, respectively)	1,706,304	2,121,394
Held-to-maturity investment securities (fair value of $660,415 and $703,957, respectively)	619,207	637,894
Other securities, at cost	41,001	59,239

Loans held for sale, at fair value	1,153	0

Loans	3,935,998	3,865,576
Allowance for loan losses	(43,473)	(42,888)
Net loans	3,892,525	3,822,688

Goodwill, net	369,703	369,703
Core deposit intangibles, net	12,647	14,492
Other intangibles, net	2,465	2,939
Intangible assets, net	384,815	387,134

Premises and equipment, net	91,142	89,938
Accrued interest and fee receivable	28,492	32,305
Other assets	107,504	117,650

Total assets	$7,020,716	$7,496,800

Liabilities:
Noninterest-bearing deposits	$1,120,683	$1,110,994
Interest-bearing deposits	4,549,447	4,517,045
Total deposits	5,670,130	5,628,039

Borrowings	322,319	728,061
Subordinated debt held by unconsolidated subsidiary trusts	102,085	102,073
Accrued interest and other liabilities	76,151	135,849
Total liabilities	6,170,685	6,594,022

Commitments and contingencies (See Note J)

Shareholders' equity:
Preferred stock $1.00 par value, 500,000 shares authorized, 0 shares issued	-	-
Common stock, $1.00 par value, 75,000,000 shares authorized; 40,881,188 and
40,421,493 shares issued, respectively	40,881	40,421
Additional paid-in capital	387,133	378,413
Retained earnings	466,848	447,018
Accumulated other comprehensive income	(27,716)	54,334
Treasury stock, at cost (782,173 and 795,560 shares, respectively)	(17,115)	(17,408)
Total shareholders' equity	850,031	902,778

Total liabilities and shareholders' equity	$7,020,716	$7,496,800

The accompanying notes are an integral part of the consolidated financial statements.

COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In Thousands, Except Per-Share Data)


		Three Months Ended		Six Months Ended
		June 30,		June 30,
		2013	2012	2013	2012
Interest income:
	Interest and fees on loans	$46,412	$47,077	$93,530	$94,715
	Interest and dividends on taxable investments	12,566	17,450	27,782	31,725
	Interest and dividends on nontaxable investments	5,162	6,018	10,753	11,616
	Total interest income	64,140	70,545	132,065	138,056

Interest expense:
	Interest on deposits	2,703	4,380	5,845	9,889
	Interest on borrowings	2,375	7,713	8,105	15,113
	Interest on subordinated debt held by unconsolidated subsidiary trusts	630	681	1,258	1,374
	Total interest expense	5,708	12,774	15,208	26,376

Net interest income		58,432	57,771	116,857	111,680
Provision for loan losses		1,321	2,155	2,714	3,799
Net interest income after provision for loan losses		57,111	55,616	114,143	107,881

Noninterest income:
	Deposit service fees	12,345	11,035	23,940	21,404
	Other banking services	1,020	896	2,058	1,890
	Benefit trust, administration, consulting and actuarial fees	9,397	8,664	19,167	17,637
	Wealth management services	4,045	3,101	7,743	6,233
	Gain on sales of investment securities	16,008	0	63,799	0
	Loss on debt extinguishments	(15,717)	0	(63,500)	0
Total noninterest income		27,098	23,696	53,207	47,164

Noninterest expenses:
	Salaries and employee benefits	30,286	26,844	60,769	54,269
	Occupancy and equipment	6,750	6,130	13,815	12,593
	Data processing and communications	6,600	5,817	13,336	11,417
	Amortization of intangible assets	1,140	1,045	2,319	2,131
	Legal and professional fees	1,526	1,755	3,466	3,946
	Office supplies and postage	1,518	1,382	3,013	2,850
	Business development and marketing	1,804	1,876	3,283	3,048
	FDIC insurance premiums	945	903	2,000	1,809
	Acquisition expenses	0	164	0	424
	Other	3,807	3,454	6,927	6,286
	Total noninterest expenses	54,376	49,370	108,928	98,773

Income before income taxes		29,833	29,942	58,422	56,272
Income taxes		8,711	8,871	17,059	16,375
Net income		$21,122	$21,071	$41,363	$39,897

Basic earnings per share		$0.53	$0.53	$1.03	$1.02
Diluted earnings per share		$0.52	$0.53	$1.02	$1.01

The accompanying notes are an integral part of the consolidated financial statements.

COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS) (Unaudited)
(In Thousands)


	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2013	2012	2013	2012

Pension and other post retirement obligations:
Amortization of actuarial losses included in net periodic pension cost, gross	$1,012	$925	$2,021	$1,849
Tax effect	(394)	(359)	(784)	(717)
Amortization of actuarial losses included in net periodic pension cost, net	618	566	1,237	1,132

Amortization of prior service cost included in net periodic pension cost, gross	(30)	(243)	(61)	(485)
Tax effect	12	94	24	188
Amortization of prior service cost included in net periodic pension cost, net	(18)	(149)	(37)	(297)

Other comprehensive income related to pension and other post retirement obligations, net of taxes	600	417	1,200	835

Unrealized gains on securities:
Net unrealized holding (losses) gains arising during period, gross	(50,777)	51,397	(69,649)	44,388
Tax effect	19,081	(19,644)	26,179	(17,221)
Net unrealized holding (losses) gains arising during period, net	(31,696)	31,753	(43,470)	27,167

Reclassification adjustment for net gains included in net income, gross	(16,007)	0	(63,799)	0
Tax effect	6,175	0	24,019	0
Reclassification adjustment for gains, net included in net income, net	(9,832)	0	(39,780)	0

Other comprehensive loss related to unrealized gain on available-for-sale securities, net of taxes	(41,528)	31,753	(83,250)	27,167

Other comprehensive (loss)/income, net of tax	(40,928)	32,170	(82,050)	28,002
Net income	21,122	21,071	41,363	39,897
Comprehensive (loss)/income	($19,806)	$53,241	($40,687)	$67,899

	As of
	June 30,	December 31,
	2013	2012
Accumulated Other Comprehensive Income By Component:

Unrealized loss for pension and other postretirement obligations	($43,272)	($45,232)
Tax effect	16,687	17,447
Net unrealized loss for pension and other postretirement obligations	(26,585)	(27,785)

Unrealized (loss)/gain on available-for-sale securities	(1,992)	131,456
Tax effect	861	(49,337)
Net unrealized (loss)/gain on available-for-sale securities	(1,131)	82,119

Accumulated other comprehensive income	($27,716)	$54,334

The accompanying notes are an integral part of the consolidated financial statements.

COMMUNITY BANK SYSTEM, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)

Six months ended June 30, 2013

(In Thousands, Except Share Data)

					Accumulated
	Common Stock		Additional		Other
	Shares	Amount	Paid-In	Retained	Comprehensive	Treasury
	Outstanding	Issued	Capital	Earnings	Income (Loss)	Stock	Total

Balance at December 31, 2012	39,625,933	$40,421	$378,413	$447,018	$54,334	($17,408)	$902,778

Net income				41,363			41,363

Other comprehensive loss, net of tax					(82,050)		(82,050)

Cash dividends declared:
Common, $0.54 per share				(21,533)			(21,533)

Common stock issued under
employee stock plan,
including tax benefits of $666	473,082	460	6,613			293	7,366

Stock-based compensation			2,107				2,107

Balance at June 30, 2013	40,099,015	$40,881	$387,133	$466,848	($27,716)	($17,115)	$850,031

The accompanying notes are an integral part of the consolidated financial statements.

COMMUNITY BANK SYSTEM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In Thousands)


	Six Months Ended
	June 30,
	2013	2012
Operating activities:
Net income	$41,363	$39,897
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	5,947	5,551
Amortization of intangible assets	2,319	2,131
Net accretion of premiums and discounts on securities, loans and borrowings	(2,359)	(2,584)
Stock-based compensation	2,107	2,036
Provision for loan losses	2,714	3,799
Amortization of mortgage servicing rights	276	365
Income from bank-owned life insurance policies	(523)	(536)
Gain on sales of investment securities	(63,799)	0
Loss on debt extinguishments	63,500	0
Net loss/(gain) from sale of loans and other assets	187	(82)
Net change in loans held for sale	(1,136)	576
Change in other assets and liabilities	5,134	789
Net cash provided by operating activities	55,730	51,942
Investing activities:
Proceeds from sales of available-for-sale investment securities	672,750	0
Proceeds from maturities of available-for-sale investment securities	113,335	103,709
Proceeds from maturities of held-to-maturity investment securities	24,015	12,602
Proceeds from sale of other investment securities	18,240	1
Purchases of available-for-sale investment securities	(439,448)	(724,530)
Purchases of held-to-maturity investment securities	(4,153)	(106,226)
Purchases of other securities	(2)	(19,123)
Net increase in loans	(72,551)	(94,829)
Purchases of premises and equipment	(7,355)	(4,132)
Net cash provided by (used in) investing activities	304,831	(832,528)
Financing activities:
Net increase in deposits	42,091	115,107
Net change in borrowings, net of payments of $565,142 and $110	(469,242)	429,591
Issuance of common stock	7,366	61,017
Cash dividends paid	(21,427)	(19,825)
Tax benefits from share-based payment arrangements	666	720
Net cash (used in) provided by financing activities	(440,546)	586,610
Change in cash and cash equivalents	(79,985)	(193,976)
Cash and cash equivalents at beginning of period	228,558	324,878
Cash and cash equivalents at end of period	$148,573	$130,902

Supplemental disclosures of cash flow information:
Cash paid for interest	$18,358	$26,775
Cash paid for income taxes	11,768	9,655
Supplemental disclosures of noncash financing and investing activities:
Dividends declared and unpaid	10,805	10,260
Transfers from loans to other real estate	3,439	1,977

The accompanying notes are an integral part of the consolidated financial statements.

COMMUNITY BANK SYSTEM, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

June 30, 2013

NOTE A: BASIS OF PRESENTATION

The interim financial data as of and for the three and six months ended June 30, 2013 is unaudited; however, in the opinion of Community Bank System, Inc. (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 in conformity with generally accepted accounting principles (“GAAP”). 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: ACQUISITIONS

On September 7, 2012, Community Bank, N.A. (the “Bank”) completed its acquisition of three branches in Western New York from First Niagara Bank, N.A. (“First Niagara”), acquiring approximately $54 million of loans and $101 million of deposits. The assumed deposits consisted primarily of core deposits (checking, savings and money market accounts) and the purchased loans consisted of in-market performing loans, primarily residential real estate loans. Under the terms of the purchase agreement, the Bank paid a blended deposit premium of 3.1%, or approximately $3 million. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

On July 20, 2012, the Bank completed its acquisition of 16 retail branches in Central, Northern and Western New York from HSBC Bank USA, N.A. (“HSBC”), acquiring approximately $106 million in loans and $697 million of deposits. The assumed deposits consisted primarily of core deposits (checking, savings and money markets accounts) and the purchased loans consisted of in-market performing loans, primarily residential real estate loans. Under the terms of the purchase agreement, the Bank paid First Niagara (who acquired HSBC’s Upstate New York banking business and assigned its right to purchase the 16 branches to the Bank) a blended deposit premium of 3.4%, or approximately $24 million. The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

The assets and liabilities assumed in the acquisitions were recorded at their estimated fair values based on management's best estimates using information available at the dates of the acquisition, and are subject to adjustment based on updated information not available at the time of acquisition. The following table summarizes the estimated fair value of the assets acquired and liabilities assumed during 2012.

(000s omitted)
Consideration received:
Cash/Total net consideration received	($595,462)
Recognized amounts of identifiable assets acquired and liabilities assumed:
Cash and cash equivalents	5,510
Loans	160,116
Premises and equipment	4,941
Accrued interest receivable	588
Other assets and liabilities, net	171
Core deposit intangibles	6,521
Deposits	(797,962)
Total identifiable liabilities, net	(620,115)
Goodwill	$24,653

The following is a summary of the loans acquired from HSBC and First Niagara at the date of acquisition:

	Acquired	Acquired	Total
	Impaired	Non-Impaired	Acquired
(000’s omitted)	Loans	Loans	Loans
Contractually required principal and interest at acquisition	$0	$201,745	$201,745
Contractual cash flows not expected to be collected	0	(3,555)	(3,555)
Expected cash flows at acquisition	0	198,190	198,190
Interest component of expected cash flows	0	(38,074)	(38,074)
Fair value of acquired loans	$0	$160,116	$160,116

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

The core deposit intangible related to the HSBC acquisition is being amortized using an accelerated method over the estimated useful life of eight years. The goodwill associated with the First Niagara and HSBC acquisitions, which is not amortized for book purposes, was assigned to the Banking segment. The goodwill arising from the HSBC branch and First Niagara branch acquisitions is deductible for tax purposes.

Direct costs related to the acquisitions were expensed as incurred. Merger and acquisition integration-related expenses amount to $0.2 million and $0.4 million in the three and six months ended June 30, 2012, respectively, and have been separately stated in the Consolidated Statements of Income.

Supplemental pro forma financial information related to the HSBC and First Niagara acquisitions has not been provided as it would be impracticable to do so. Historical financial information regarding the acquired branches is not accessible and thus the amounts would require estimates so significant as to render the disclosure irrelevant.

NOTE C: ACCOUNTING POLICIES

The accounting policies of the Company, as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 55 through 60 of the Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission (“SEC”) on March 1, 2013.

Critical Accounting Policies

Acquired loans

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

For acquired loans that are not deemed impaired at acquisition, credit discounts representing principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods used to estimate the required allowance for loan losses for these loans is similar to originated loans. However, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discount. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loan.

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments are accounted for as impaired loans under ASC 310-30. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require the Company to evaluate the need for an allowance for loan losses on these loans. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which the Company then reclassifies as an accretable discount that is recognized into interest income over the remaining life of the loans using the interest method.

Acquired loans that met the criteria for non-accrual of interest prior to acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans. As such, the Company may no longer consider the loan to be non-accrual or non-performing and may accrue interest on these loans, including the impact of any accretable discount. For acquired loans that are not deemed impaired at acquisition, purchase discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance exceeds any remaining purchase discounts for loans evaluated collectively for impairment.

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 five main loan segments: business lending, consumer installment - direct, consumer installment - indirect, home equity and consumer mortgage. The first calculation is quantitative and determines an allowance level based on the latest 36 months of historical net charge-off data for each loan class (commercial loans exclude balances with specific loan loss allocations). The second calculation is qualitative and takes into consideration eight qualitative environmental factors: levels and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. A component of the qualitative calculation is the unallocated allowance for loan loss. The qualitative and quantitative 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 loan losses are based on discounted estimated cash flows, including any cash flows resulting from the conversion of collateral or collateral shortfalls. The allowance levels computed from the specific and general loan loss allocation methods are combined with unallocated allowances and allowances needed for acquired loans, if any, to derive the total required allowance for loan losses to be reflected on the Consolidated Statement of Condition.

Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of factors previously mentioned.

Investment Securities

The Company has classified its investments in debt and equity securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Company has the positive intent and ability to hold until maturity, and are reported at cost, which is adjusted for amortization of premiums and accretion of discounts. Securities not classified as held-to-maturity are classified as available-for-sale and are reported at fair value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes. None of the Company's investment securities have been classified as trading securities at June 30, 2013. Certain equity securities are stated at cost and include restricted stock of the Federal Reserve Bank of New York (“Federal Reserve”) and Federal Home Loan Bank of New York (“FHLB”).

Fair values for investment securities are based upon quoted market prices, where available. If quoted market prices are not available, fair values are based upon quoted market prices of comparable instruments, or a discounted cash flow model using market estimates of interest rates and volatility.

The Company conducts an assessment of all securities in an unrealized loss position to determine if other-than-temporary impairment (“OTTI”) exists on a quarterly basis. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. The OTTI assessment considers the security structure, recent security collateral performance metrics, if applicable, external credit ratings, failure of the issuer to make scheduled interest or principal payments, judgment about and expectations of future performance, and relevant independent industry research, analysis and forecasts. The severity of the impairment and the length of time the security has been impaired is also considered in the assessment. The assessment of whether an OTTI decline exists is performed on each security, regardless of the classification of the security as available-for-sale or held-to-maturity and involves a high degree of subjectivity and judgment that is based on the information available to management at a point in time.

An OTTI loss must be recognized for a debt security in an unrealized loss position if there is intent to sell the security or it is more likely than not the Company will be required to sell the security prior to recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between the fair value and the amortized cost basis of the security. Even if management does not have the intent, and it is not more likely than not that the Company will be required to sell the securities, an evaluation of the expected cash flows to be received is performed to determine if a credit loss has occurred. For debt securities, a critical component of the evaluation for OTTI is the identification of credit-impaired securities, where the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. In the event of a credit loss, only the amount of impairment associated with the credit loss would be recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in market interest rates, is recorded in accumulated other comprehensive loss.

Equity securities are also evaluated to determine whether the unrealized loss is expected to be recoverable based on whether evidence exists to support a realizable value equal to or greater than the amortized cost basis. If it is probable that the amortized cost basis will not be recovered, taking into consideration the estimated recovery period and the ability to hold the equity security until recovery, OTTI is recognized in earnings equal to the difference between the fair value and the amortized cost basis of the security.

The specific identification method is used in determining the realized gains and losses on sales of investment securities and OTTI charges. Premiums and discounts on securities are amortized and accreted, respectively, on the interest method basis over the period to maturity or estimated life of the related security. Purchases and sales of securities are recognized on a trade date basis.

Income Taxes

The Company and its subsidiaries file a consolidated federal income tax return. Provisions for income taxes are based on taxes currently payable or refundable as well as deferred taxes that 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.

Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority having full knowledge of all relevant information. A tax position meeting the more-likely-than-not recognition threshold should be measured at the largest amount of benefit for which the likelihood of realization upon ultimate settlement exceeds 50 percent.

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. The initial and ongoing 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, peer volatility indicators, and company-specific risk indicators.

The Company evaluates goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. The implied fair value of a reporting unit’s goodwill is compared to its carrying amount and the impairment loss is measured by the excess of the carrying value over fair value. The fair value of each reporting unit is compared to the carrying amount of that reporting unit in order to determine if impairment is indicated.

Retirement Benefits

The Company provides defined benefit pension benefits to eligible employees and post-retirement health and life insurance benefits to certain eligible retirees. The Company also provides deferred compensation and supplemental executive retirement plans for selected current and former employees, officers, and directors. 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.

NOTE D: INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities as of June 30, 2013 and December 31, 2012 are as follows:

	June 30, 2013				December 31, 2012
		Gross	Gross			Gross	Gross
	Amortized	Unrealized	Unrealized	Fair	Amortized	Unrealized	Unrealized	Fair
(000's omitted)	Cost	Gains	Losses	Value	Cost	Gains	Losses	Value
Held-to-Maturity Portfolio:
U.S. Treasury and agency securities	$539,979	$39,627	$1,786	$577,820	$548,634	$59,081	$0	$607,715
Obligations of state and political subdivisions	61,826	3,196	0	65,022	65,742	5,850	0	71,592
Government agency mortgage-backed securities	14,475	148	0	14,623	20,578	1,079	0	21,657
Corporate debt securities	2,914	23	0	2,937	2,924	53	0	2,977
Other securities	13	0	0	13	16	0	0	16
Total held-to-maturity portfolio	$619,207	$42,994	$1,786	$660,415	$637,894	$66,063	$0	$703,957

Available-for-Sale Portfolio:
U.S. Treasury and agency securities	$764,446	$2,553	$9,129	$757,870	$988,217	$91,040	$0	$1,079,257
Obligations of state and political subdivisions	604,692	16,634	10,483	610,843	629,883	33,070	61	662,892
Government agency mortgage-backed securities	232,707	8,697	2,717	238,687	253,013	16,989	51	269,951
Pooled trust preferred securities	56,796	0	9,506	47,290	61,979	0	12,379	49,600
Government agency collateralized mortgage obligations	25,222	1,116	0	26,338	32,359	1,579	3	33,935
Corporate debt securities	24,082	942	226	24,798	24,136	1,265	44	25,357
Marketable equity securities	351	142	15	478	351	94	43	402
Total available-for-sale portfolio	$1,708,296	$30,084	$32,076	$1,706,304	$1,989,938	$144,037	$12,581	$2,121,394

Other Securities:
Federal Home Loan Bank common stock	$20,171			$20,171	$38,111			$38,111
Federal Reserve Bank common stock	16,050			16,050	16,050			16,050
Other equity securities	4,780			4,780	5,078			5,078
Total other securities	$41,001			$41,001	$59,239			$59,239

A summary of investment securities that have been in a continuous unrealized loss position for less than, or greater, than twelve months is as follows:

As of June 30, 2013

	Less than 12 Months			12 Months or Longer			Total
			Gross			Gross			Gross
		Fair	Unrealized		Fair	Unrealized		Fair	Unrealized
(000's omitted)	#	Value	Losses	#	Value	Losses	#	Value	Losses
Held-to-Maturity Portfolio:
U.S. Treasury and agency securities/
Total held-to-maturity portfolio	5	$99,373	$1,786	0	$0	$0	5	$99,373	$1,786

Available-for-Sale Portfolio:
U.S. Treasury and agency securities	15	$352,566	$9,129	0	$0	$0	15	$352,566	$9,129
Obligations of state and political subdivisions	314	202,253	10,449	2	908	34	316	203,161	10,483
Government agency mortgage-backed securities	46	57,788	2,717	0	0	0	46	57,788	2,717
Pooled trust preferred securities	0	0	0	3	47,290	9,506	3	47,290	9,506
Corporate debt securities	1	3,012	54	1	2,747	172	2	5,759	226
Government agency collateralized mortgage obligations	4	335	0	1	8	0	5	343	0
Marketable equity securities	0	0	0	1	186	15	1	186	15
Total available-for-sale portfolio	380	615,954	22,349	8	51,139	9,727	388	667,093	32,076
Total investment portfolio	385	$715,327	$24,135	8	$51,139	$9,727	393	$766,466	$33,862

As of December 31, 2012

	Less than 12 Months			12 Months or Longer			Total
			Gross			Gross			Gross
		Fair	Unrealized		Fair	Unrealized		Fair	Unrealized
(000's omitted)	#	Value	Losses	#	Value	Losses	#	Value	Losses
Available-for-Sale Portfolio:
Obligations of state and political subdivisions	19	$11,503	$61	0	$0	$0	19	$11,503	$61
Pooled trust preferred securities	0	0	0	3	49,600	12,379	3	49,600	12,379
Government agency mortgage-backed securities	8	14,354	51	0	0	0	8	14,354	51
Corporate debt securities	1	2,905	44	0	0	0	1	2,905	44
Government agency collateralized mortgage obligations	4	426	2	2	1,041	1	6	1,467	3
Marketable equity securities	0	0	0	1	158	43	1	158	43
Total available-for-sale/investment portfolio	32	$29,188	$158	6	$50,799	$12,423	38	$79,987	$12,581

Included in the available-for-sale portfolio are pooled trust preferred, class A-1 securities with a current total par value of $58.0 million and unrealized losses of $9.5 million at June 30, 2013. The underlying collateral of these assets is principally trust preferred securities of smaller regional banks and insurance companies. The Company’s securities are in the super-senior cash flow tranche of the investment pools. All other tranches in these pools will incur losses before the super senior tranche is impacted. As of June 30, 2013, an additional 41% - 44% of the underlying collateral in these securities would have to be in deferral or default concurrently to result in an expectation of non-receipt of contractual cash flows.

A detailed review of the pooled trust preferred securities was completed as of June 30, 2013 and management concluded that it does not believe any individual unrealized loss represents an other-than-temporary impairment. This review included an analysis of collateral reports, a cash flow analysis, including varying degrees of projected deferral/default scenarios, and a review of various financial ratios of the underlying issuers. Based on the analysis performed, significant further deferral/defaults and further erosion in other underlying performance conditions would have to exist before the Company would incur a loss. To date, the Company has received all scheduled principal and interest payments and expects to fully collect all future contractual principal and interest payments. The Company does not intend to sell and it is not more likely than not that the Company will be required to sell the underlying securities. Subsequent changes in market or credit conditions could change those evaluations.

Management believes the unrealized losses in the portfolios are primarily attributable to changes in interest rates. The unrealized losses reported pertaining to government guaranteed mortgage-backed securities relate primarily to securities issued by GNMA, FNMA and FHLMC, which are currently rated AAA by Moody’s Investor Services, AA+ by Standard & Poor’s and are guaranteed by the U.S. government. The obligations of state and political subdivisions are typically general purpose debt obligations of various states and political subdivisions. The majority of the obligations of state and political subdivisions carry a credit rating of A or better, as well as a secondary level of credit enhancement. The Company does not intend to sell these securities, nor is it more likely than not that the Company will be required to sell these securities, prior to recovery of the amortized cost. Thus, management does not believe any individual unrealized loss as of June 30, 2013 represents OTTI.

The amortized cost and estimated fair value of debt securities at June 30, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.

	Held-to-Maturity		Available-for-Sale
	Amortized	Fair	Amortized	Fair
(000's omitted)	Cost	Value	Cost	Value
Due in one year or less	$8,786	$8,860	$35,212	$35,723
Due after one through five years	360,724	390,838	146,830	151,709
Due after five years through ten years	186,760	194,038	769,425	772,445
Due after ten years	48,462	52,056	498,549	480,924
Subtotal	604,732	645,792	1,450,016	1,440,801
Government agency collateralized mortgage obligations	0	0	25,222	26,338
Government agency mortgage-backed securities	14,475	14,623	232,707	238,687
Total	$619,207	$660,415	1,707,945	$1,705,826

During the first quarter of 2013 the Company initiated a balance sheet restructuring program through the sale of certain longer duration investment securities and retirement of a portion of the company’s existing FHLB borrowings. During the six month period ending June 30, 2013 the Company sold $648.8 million of U.S. Treasury and agency securities, realizing $63.8 million of gains. The proceeds from those sales were utilized to retire $501.6 million of FHLB borrowings with $63.5 million of associated early extinguishments costs.

NOTE E: LOANS

The segments of the Company’s loan portfolio are disaggregated into the following classes that allow management to monitor risk and performance:

·	Consumer mortgages - consist primarily of fixed rate residential instruments, typically 15 – 30 years in contractual term, secured by first liens on real property.

·	Business lending - is comprised of general purpose commercial and industrial loans including, but not limited to agricultural-related and dealer floor plans, as well as mortgages on commercial property.

·	Consumer indirect - consists primarily of installment loans originated through selected dealerships and are secured by automobiles, marine and other recreational vehicles.

·	Consumer direct - all other loans to consumers such as personal installment loans and lines of credit.

·	Home equity products - are consumer purpose installment loans or lines of credit most often secured by a first or second lien position on residential real estate with terms typically of 15 years or less.

The balance of these classes are summarized as follows:

	June 30,	December 31,
(000's omitted)	2013	2012
Consumer mortgage	$1,527,341	$1,448,415
Business lending	1,225,671	1,233,944
Consumer indirect	663,924	647,518
Consumer direct	171,727	171,474
Home equity	347,335	364,225
Gross loans, including deferred origination costs	3,935,998	3,865,576
Allowance for loan losses	(43,473)	(42,888)
Loans, net of allowance for loan losses	$3,892,525	$3,822,688

The outstanding balance related to credit impaired acquired loans was $20.2 million and $22.4 million at June 30, 2013 and December 31, 2012, respectively. The changes in the accretable discount related to the credit impaired acquired loans are as follows:

(000’s omitted)
Balance at December 31, 2012	$1,770
Accretion recognized, year-to-date	(538)
Net reclassification to accretable from nonaccretable	29
Balance at June 30, 2013	$1,261

Credit Quality

Management monitors the credit quality of its loan portfolio on an ongoing basis. Measurement of delinquency and past due status are based on the contractual terms of each loan. Past due loans are reviewed on a monthly basis to identify loans for non-accrual status. The following is an aged analysis of the Company’s past due loans, by class as of June 30, 2013:

Legacy Loans (excludes loans acquired after January 1, 2009)

	Past Due	90+ Days Past
	30 - 89	Due and		Total
(000’s omitted)	Days	Still Accruing	Nonaccrual	Past Due	Current	Total Loans
Consumer mortgage	$13,165	$940	$9,715	$23,820	$1,411,350	$1,435,170
Business lending	6,434	66	6,420	12,920	1,003,420	1,016,340
Consumer indirect	8,161	181	0	8,342	649,325	657,667
Consumer direct	1,622	78	5	1,705	158,937	160,642
Home equity	2,070	84	2,132	4,286	265,313	269,599
Total	$31,452	$1,349	$18,272	$51,073	$3,488,345	$3,539,418

Acquired Loans (includes loans acquired after January 1, 2009)

	Past Due	90+ Days Past
	30 - 89	Due and		Total	Acquired
(000’s omitted)	Days	Still Accruing	Nonaccrual	Past Due	Impaired(1)	Current	Total Loans
Consumer mortgage	$1,567	$54	$2,177	$3,798	$0	$88,373	$92,171
Business lending	978	0	2,130	3,108	12,108	194,115	209,331
Consumer indirect	232	0	0	232	0	6,025	6,257
Consumer direct	293	0	0	293	0	10,792	11,085
Home equity	206	36	418	660	0	77,076	77,736
Total	$3,276	$90	$4,725	$8,091	$12,108	$376,381	$396,580

(1)

Acquired impaired loans were not classified as nonperforming assets as the loans are considered to be performing under ASC 310-30. As a result interest income, through the accretion of the difference between the carrying amount of the loans and the expected cashflows, is being recognized on all acquired impaired loans.

The following is an aged analysis of the Company’s past due loans by class as of December 31, 2012:

Legacy Loans (excludes loans acquired after January 1, 2009)

	Past Due	90+ Days Past
	30 - 89	Due and		Total
(000’s omitted)	Days	Still Accruing	Nonaccrual	Past Due	Current	Total Loans
Consumer mortgage	$16,334	$1,553	$8,866	$26,753	$1,318,534	$1,345,287
Business lending	6,012	167	12,010	18,189	984,665	1,002,854
Consumer indirect	9,743	73	0	9,816	627,541	637,357
Consumer direct	1,725	71	8	1,804	154,462	156,266
Home equity	4,124	491	1,044	5,659	270,798	276,457
Total	$37,938	$2,355	$21,928	$62,221	$3,356,000	$3,418,221

Acquired Loans (includes loans acquired after January 1, 2009)

	Past Due	90+ Days Past
	30 - 89	Due and		Total	Acquired
(000’s omitted)	Days	Still Accruing	Nonaccrual	Past Due	Impaired(1)	Current	Total Loans
Consumer mortgage	$1,726	$265	$2,420	$4,411	$0	$98,717	$103,128
Business lending	3,665	80	1,681	5,426	13,761	211,903	231,090
Consumer indirect	434	0	0	434	0	9,727	10,161
Consumer direct	470	0	0	470	0	14,738	15,208
Home equity	959	48	331	1,338	0	86,430	87,768
Total	$7,254	$393	$4,432	$12,079	$13,761	$421,515	$447,355

(1)

The Company uses several credit quality indicators to assess credit risk in an ongoing manner. The Company’s primary credit quality indicator for its business lending portfolio is an internal credit risk rating system that categorizes loans as “pass”, “special mention”, or “classified”. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. In general, the following are the definitions of the Company’s credit quality indicators:

Pass	The condition of the borrower and the performance of the loans are satisfactory or better.

Special Mention	The condition of the borrower has deteriorated although the loan performs as agreed.

Classified	The condition of the borrower has significantly deteriorated and the performance of the loan could further deteriorate, if deficiencies are not corrected.

Doubtful	The condition of the borrower has deteriorated to the point that collection of the balance is improbable based on currently facts and conditions.

The following table shows the amount of business lending loans by credit quality category:

	June 30, 2013			December 31, 2012
(000’s omitted)	Legacy	Acquired	Total	Legacy	Acquired	Total
Pass	$825,147	$127,461	$952,608	$818,469	$144,869	$963,338
Special mention	108,281	31,246	139,527	92,739	32,328	125,067
Classified	81,625	38,516	120,141	90,035	40,132	130,167
Doubtful	1,287	0	1,287	1,611	0	1,611
Acquired impaired	0	12,108	12,108	0	13,761	13,761
Total	$1,016,340	$209,331	$1,225,671	$1,002,854	$231,090	$1,233,944

All other loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or nonperforming. Performing loans include current, 30 – 89 days past due and acquired impaired loans. Nonperforming loans include 90+ days past due and still accruing and nonaccrual loans.

The following table details the balances in all other loan categories at June 30, 2013:

Legacy loans (excludes loans acquired after January 1, 2009)

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$1,424,515	$657,486	$160,559	$267,383	$2,509,943
Nonperforming	10,655	181	83	2,216	13,135
Total	$1,435,170	$657,667	$160,642	$269,599	$2,523,078

Acquired loans (includes loans acquired after January 1, 2009)

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$89,940	$6,257	$11,085	$77,282	$184,564
Nonperforming	2,231	0	0	454	2,685
Total	$92,171	$6,257	$11,085	$77,736	$187,249

The following table details the balances in all other loan categories at December 31, 2012:

Legacy loans (excludes loans acquired after January 1, 2009)

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$1,334,868	$637,284	$156,187	$274,922	$2,403,261
Nonperforming	10,419	73	79	1,535	12,106
Total	$1,345,287	$637,357	$156,266	$276,457	$2,415,367

Acquired loans (includes loans acquired after January 1, 2009)

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$100,443	$10,161	$15,208	$87,389	$213,201
Nonperforming	2,685	0	0	379	3,064
Total	$103,128	$10,161	$15,208	$87,768	$216,265

All loan classes are collectively evaluated for impairment except business lending, as described in Note B. A summary of individually evaluated impaired loans as of June 30, 2013 and December 31, 2012 follows:

	June 30,	December 31,
(000’s omitted)	2013	2012
Loans with allowance allocation	$1,990	$1,611
Loans without allowance allocation	1,005	7,798
Carrying balance	2,995	9,409
Contractual balance	4,374	12,804
Specifically allocated allowance	980	800

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In this scenario, the Company attempts to work-out an alternative payment schedule with the borrower in order to optimize collectability of the loan. Any loans that are modified are reviewed by the Company to identify if a troubled debt restructuring (“TDR”) has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial standing and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two. With regard to determination of the amount of the allowance for loan losses, troubled debt restructured loans are considered to be impaired. As a result, the determination of the amount of allowance for loan losses related to impaired loans for each portfolio segment within troubled debt restructurings is the same as detailed previously.

Loans are considered modified in a TDR when, due to a borrower’s financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider. These modifications primarily include, among others, an extension of the term of the loan or granting a period with reduced or no principal and/or interest payments that can be caught up with payments made over the remaining term of the loan or at maturity. During 2012, clarified guidance was issued by the OCC addressing the accounting for certain loans that have been discharged in Chapter 7 bankruptcy. In accordance with this clarified guidance, loans that have been discharged in Chapter 7 bankruptcy, but not reaffirmed by the borrower, are classified as TDRs, irrespective of payment history or delinquency status, even if the repayment terms for the loan have not been otherwise modified. The Company’s lien position against the underlying collateral remains unchanged. Pursuant to that guidance, the Company records a charge-off equal to any portion of the carrying value that exceeds the net realizable value of the collateral. The amount of loss incurred in 2012 and 2013 was immaterial. In reporting periods prior to December 31, 2012, such loans were classified as TDRs only if there had been a change in contractual payment terms that represented a concession to the borrower. The impact on prior periods was determined to be immaterial and therefore, prior period disclosure has not been made.

Commercial loans greater than $0.5 million are individually evaluated for impairment, and if necessary, a specific allocation of the allowance for loan losses is provided. Included in the impaired loan balances above was one TDR totaling $1.6 million with a specific reserve of $0.4 million. TDRs less than $0.5 million are collectively included in the general loan loss allocation and the qualitative review if necessary.

Information regarding troubled debt restructurings as of June 30, 2013 and December 31, 2012 is as follows:

	June 30, 2013						December 31, 2012
(000’s omitted)	Nonaccrual		Accruing		Total		Nonaccrual		Accruing		Total
	#	Amount	#	Amount	#	Amount	#	Amount	#	Amount	#	Amount
Consumer mortgage	6	$336	53	$2,541	59	$2,877	3	$160	45	$2,074	48	$2,234
Business lending	10	2,687	1	50	11	2,737	10	3,046	0	0	10	3,046
Consumer indirect	2	10	114	740	116	750	0	0	106	718	106	718
Consumer direct	0	0	36	155	36	155	0	0	19	116	19	116
Home equity	5	39	22	322	27	361	5	70	19	266	24	336
Total	23	$3,072	226	$3,808	249	$6,880	18	$3,276	189	$3,174	207	$6,450

The following table presents information related to loans modified in a TDR during the three and six months ended June 30, 2013. Of the loans noted in the table below, all but two loans for the three months and six months ended June 30, 2013 were modified due to a Chapter 7 bankruptcy as described previously. The others were a business loan restructured via an extension of term and a consumer mortgage restructured via an extension of term and a rate concession. The financial effects of these restructurings were immaterial.

	Three Months Ended		Six Months Ended
	June 30, 2013		June 30, 2013
(000’s omitted)	Number of loans modified	Outstanding Balance	Number of loans modified	Outstanding Balance
Consumer mortgage	3	$267	16	$1,269
Business lending	3	290	6	362
Consumer indirect	10	61	21	168
Consumer direct	5	41	14	72
Home equity	2	26	7	123
Total	23	$685	64	$1,994

Allowance for Loan Losses

The allowance for loan losses is general in nature and is available to absorb losses from any loan type despite the analysis below. The following presents by class the activity in the allowance for loan losses:

	Three Months Ended June 30, 2013
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$7,292	$17,557	$9,448	$3,084	$1,683	$2,927	$922	$42,913
Charge-offs	(229)	(280)	(997)	(407)	(135)	0	0	(2,048)
Recoveries	7	102	913	257	8	0	0	1,287
Provision	303	904	5	120	118	(182)	53	1,321
Ending balance	$7,373	$18,283	$9,369	$3,054	$1,674	$2,745	$975	$43,473

	Three Months Ended June 30, 2012
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$4,885	$21,413	$7,938	$3,066	$1,281	$2,770	$456	$41,809
Charge-offs	(150)	(1,662)	(1,134)	(273)	(65)	0	0	(3,284)
Recoveries	4	178	782	182	2	0	0	1,148
Provision	1,574	(1,458)	1,084	248	174	342	191	2,155
Ending balance	$6,313	$18,471	$8,670	$3,223	$1,392	$3,112	$647	$41,828

	Six Months Ended June 30, 2013
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$7,070	$18,013	$9,606	$3,303	$1,451	$2,666	$779	$42,888
Charge-offs	(600)	(1,064)	(1,888)	(952)	(320)	0	0	(4,824)
Recoveries	13	244	1,871	555	12	0	0	2,695
Provision	890	1,090	(220)	148	531	79	196	2,714
Ending balance	$7,373	$18,283	$9,369	$3,054	$1,674	$2,745	$975	$43,473

	Six Months Ended June 30, 2012
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$4,651	$20,574	$8,960	$3,290	$1,130	$3,222	$386	$42,213
Charge-offs	(419)	(3,227)	(2,173)	(730)	(181)	0	0	(6,730)
Recoveries	17	333	1,824	354	18	0	0	2,546
Provision	2,064	791	59	309	425	(110)	261	3,799
Ending balance	$6,313	$18,471	$8,670	$3,223	$1,392	$3,112	$647	$41,828

NOTE F: GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS

The gross carrying amount and accumulated amortization for each type of identifiable intangible asset are as follows:

	June 30, 2013			December 31, 2012
	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	$38,185	($25,538)	$12,647	$38,958	($24,466)	$14,492
Other intangibles	9,432	(6,967)	2,465	9,432	(6,493)	2,939
Total amortizing intangibles	$47,617	($32,505)	$15,112	$48,390	($30,959)	$17,431

The estimated aggregate amortization expense for each of the five succeeding fiscal years ended December 31 is as follows:

Jul - Dec 2013	$2,122
2014	3,597
2015	2,804
2016	2,094
2017	1,478
Thereafter	3,017
Total	$15,112

Shown below are the components of the Company’s goodwill at June 30, 2013:

(000’s omitted)	December 31, 2012	Activity	June 30, 2013
Goodwill	$374,527	$0	$374,527
Accumulated impairment	(4,824)	0	(4,824)
Goodwill, net	$369,703	$0	$369,703

NOTE G: MANDATORILY REDEEMABLE PREFERRED SECURITIES

The Company sponsors two business trusts, Community Statutory Trust III and Community Capital 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 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
Trust	Date	Amount	Interest Rate	Date	Call Price
III	7/31/2001	$24.5 million	3 month LIBOR plus 3.58% (3.86%)	7/31/2031	Par
IV	12/8/2006	$75 million	3 month LIBOR plus 1.65% (1.92%)	12/15/2036	Par

NOTE H: BENEFIT PLANS

The Company provides a qualified defined benefit pension to eligible employees and retirees, other post-retirement health and life insurance benefits to certain retirees, an unfunded supplemental pension plan for certain key executives, and an unfunded stock balance plan for certain of its nonemployee directors. 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 and six months ended June 30, 2013 and 2012 is as follows:

	Pension Benefits				Post-retirement Benefits
	Three Months Ended		Six Months Ended		Three Months Ended		Six Months Ended
	June 30,		June 30,		June 30,		June 30,
(000's omitted)	2013	2012	2013	2012	2013	2012	2013	2012
Service cost	$985	$848	$1,970	$1,696	$0	$0	$0	$0
Interest cost	1,028	1,098	2,057	2,197	22	29	44	57
Expected return on plan assets	(2,451)	(2,299)	(4,902)	(4,598)	0	0	0	0
Amortization of unrecognized net loss	1,008	922	2,015	1,844	3	3	6	6
Amortization of prior service cost	14	(37)	29	(74)	(45)	(206)	(90)	(411)
Net periodic benefit cost	$584	$532	$1,169	$1,065	($20)	($174)	($40)	($348)

During July 2013 the Company made a contribution to its defined benefit pension plan of $10.0 million. No other contributions are required in 2013.

NOTE I: EARNINGS PER SHARE

Basic earnings per share are computed based on the weighted-average of the common shares outstanding for the period. Diluted earnings per share are based on the weighted-average of the 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 0.7 million weighted-average anti-dilutive stock options outstanding for the three and six months ended June 30, 2013, compared to approximately 0.6 million weighted-average anti-dilutive stock options outstanding for the three months June 30, 2012 and approximately 0.4 million weighted-average anti-dilutive stock options outstanding for the six months June 30, 2012 that were not included in the computation below.

The following is a reconciliation of basic to diluted earnings per share for the three and six months ended June 30, 2013 and 2012.

	Three Months Ended		Six Months Ended
	June 30,		June 30,
(000's omitted, except per share data)	2013	2012	2013	2012
Net income	$21,122	$21,071	$41,363	$39,897
Income attributable to unvested stock-based compensation awards	(114)	(144)	(189)	(247)
Income available to common shareholders	$21,008	$20,927	$41,174	$39,650

Weighted-average common shares outstanding – basic	39,914	39,324	39,809	38,948
Basic earnings per share	$0.53	$0.53	$1.03	$1.02

Net income	$21,122	$21,071	$41,363	$39,897
Income attributable to unvested stock-based compensation awards	(114)	(144)	(189)	(247)
Income available to common shareholders	$21,008	$20,927	$41,174	$39,650

Weighted-average common shares outstanding – basic	39,914	39,324	39,809	38,948
Assumed exercise of stock options	427	463	445	501
Weighted-average common shares outstanding – diluted	40,341	39,787	40,254	39,449
Diluted earnings per share	$0.52	$0.53	$1.02	$1.01

Cash dividends declared per share	$0.27	$0.26	$0.54	$0.52

Stock Repurchase Program

At its December 2012 meeting, the Company’s Board of Directors approved a new repurchase program authorizing the repurchase of up to 2,000,000 of its outstanding shares in open market transactions or privately negotiated transactions in accordance with securities laws and regulations, through December 31, 2013. Any repurchased shares will be used for general corporate purposes, including those related to stock plan activities. The timing and extent of repurchases will depend on market conditions and other corporate considerations as determined at the Company’s discretion. There were no open market treasury stock purchases in 2012 or the first six months of 2013. There were approximately 22,000 common shares repurchased during the six months ended June 30, 2013 that were acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted stock.

NOTE J: 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 the Company’s normal credit policies. Collateral may be obtained based on management’s assessment of the customer’s creditworthiness. The fair value of the standby letters of credit is immaterial for disclosure.

The contract amount of commitments and contingencies are as follows:

(000's omitted)	June 30, 2013	December 31, 2012
Commitments to extend credit	$638,774	$750,178
Standby letters of credit	23,314	24,168
Total	$662,088	$774,346

The Company and its subsidiaries are subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. As of June 30, 2013, management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company or its subsidiaries will be material to the Company’s consolidated financial position. On at least a quarterly basis the Company assesses its liabilities and contingencies in connection with such legal proceedings. For those matters where it is probable that the Company will incur losses and the amounts of the losses can be reasonably estimated, the Company records an expense and corresponding liability in its consolidated financial statements. To the extent the pending or threatened litigation could result in exposure in excess of that liability, the amount of such excess is not currently estimable. Although the Company does not believe that the outcome of pending litigation will be material to the Company’s consolidated financial position, it cannot rule out the possibility that such outcomes will be material to the consolidated results of operations for a particular reporting period in the future.

NOTE K: FAIR VALUE

Accounting standards allow 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 Company has elected to value loans held for sale at fair value in order to more closely match the gains and losses associated with loans held for sale with the gains and losses on forward sales contracts. Accordingly, the impact on the valuation will be recognized in the Company’s consolidated statement of income. All mortgage loans held for sale are current and in performing status.

Accounting standards establish a framework for measuring fair value and require certain disclosures 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 (i.e. exit price). Inputs used to measure fair value are classified 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. There were no transfers between any of the levels for the periods presented.

	June 30, 2013
(000's omitted)	Level 1	Level 2	Level 3	Total Fair Value
Available-for-sale investment securities:
U.S. Treasury and agency securities	$676,865	$81,005	$0	$757,870
Obligations of state and political subdivisions	0	610,843	0	610,843
Government agency mortgage-backed securities	0	238,687	0	238,687
Pooled trust preferred securities	0	0	47,290	47,290
Government agency collateralized mortgage obligations	0	26,338	0	26,338
Corporate debt securities	0	24,798	0	24,798
Marketable equity securities	478	0	0	478
Total available-for-sale investment securities	677,343	981,671	47,290	1,706,304
Forward sales commitments	0	141	0	141
Commitments to originate real estate loans for sale	0	0	(19)	(19)
Mortgage loans held for sale	0	1,153	0	1,153
Total	$677,343	$982,965	$47,271	$1,707,579

	December 31, 2012
(000's omitted)	Level 1	Level 2	Level 3	Total Fair Value
Available-for-sale investment securities:
U.S. Treasury and agency securities	$891,803	$187,454	$0	$1,079,257
Obligations of state and political subdivisions	0	662,892	0	662,892
Government agency mortgage-backed securities	0	269,951	0	269,951
Pooled trust preferred securities	0	0	49,600	49,600
Government agency collateralized mortgage obligations	0	33,935	0	33,935
Corporate debt securities	0	25,357	0	25,357
Marketable equity securities	402	0	0	402
Total available-for-sale investment securities/Total	$892,205	$1,179,589	$49,600	$2,121,394

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 obligations and marketable equity securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 securities include U.S. agency securities, mortgage-backed securities issued by government-sponsored entities, municipal securities and corporate debt securities that are valued by reference to prices for similar securities or through model-based techniques in which all significant inputs, such as reported trades, trade execution data, LIBOR swap yield curve, market prepayment speeds, credit information, market spreads, and security’s terms and conditions, are observable. Securities classified as Level 3 include pooled trust preferred securities in less liquid markets. The value of these instruments is determined using multiple pricing models or similar techniques from third party sources as well as significant unobservable inputs such as judgment or estimation by the Company in the weighting of the models. See Note D for further discussion of the fair value of investment securities.

Mortgage loans held for sale – Mortgage loans held for sale are carried at fair value, which is determined using quoted secondary-market prices of loans with similar characteristics and, as such, have been classified as a Level 2 valuation. The unpaid principal value of mortgage loans held for sale at June 30, 2013 is approximately $1,167,000. The unrealized loss on mortgage loans held for sale of approximately $14,000 was recognized in mortgage banking and other income in the consolidated statement of income for the three and six months ended June 30, 2013.

Forward sales contracts – The Company enters into forward sales contracts to sell certain residential real estate loans. Such commitments are considered to be derivative financial instruments and, therefore, are carried at estimated fair value in the other asset or other liability section of the consolidated balance sheet. The fair value of these forward sales contracts is primarily measured by obtaining pricing from certain government-sponsored entities and reflects the underlying price the entity would pay the Company for an immediate sale on these mortgages. These instruments are classified as Level 2 in the fair value hierarchy.

Commitments to originate real estate loans for sale – The Company enters into various commitments to originate residential real estate loans for sale. Such commitments are considered to be derivative financial instruments and, therefore, are carried at estimated fair value in the other asset or other liability section of the consolidated balance sheet. The estimated fair value of these commitments is determined using quoted secondary market prices obtained from certain government-sponsored entities. Additionally, accounting guidance requires the expected net future cash flows related to the associated servicing of the loan to be included in the fair value measurement of the derivative. The expected net future cash flows are based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Such assumptions include estimates of the cost of servicing loans, appropriate discount rate and prepayment speeds. The determination of expected net cash flows is considered a significant unobservable input contributing to the Level 3 classification of commitments to originate real estate loans for sale.

The changes in Level 3 assets measured at fair value on a recurring basis are summarized in the following tables:

	Three Months Ended June 30,
	2013			2012
(000's omitted)	Pooled Trust Preferred Securities	Commitments to Originate Real Estate Loans for Sale	Total	Pooled Trust Preferred Securities
Beginning balance	$47,486	$0	$47,486	$47,385
Total gains (losses) included in earnings (1)	47	0	47	96
Total gains included in other comprehensive income(2)	981	0	981	3,800
Principal reductions	(1,224)	0	(1,224)	(2,495)
Commitments to originate real estate loans held for sale, net	0	(19)	(19)	0
Ending balance	$47,290	($19)	$47,271	$48,786

(1)	Amounts included in earnings associated with the pooled trust preferred securities relate to accretion of related discount
	and are reported in interest and dividends on taxable investments.
(2)	Amounts included in other comprehensive income associated with the pooled trust preferred securities relate to changes
	in unrealized loss and are reported as a component of unrealized gains on securities in the Statement of Comprehensive Income.

	Six Months Ended June 30,
	2013			2012
(000's omitted)	Pooled Trust Preferred Securities	Commitments to Originate Real Estate Loans for Sale	Total	Pooled Trust Preferred Securities
Beginning balance	$49,600	$0	$49,600	$43,846
Total gains (losses) included in earnings (1)	150	0	150	144
Total gains included in other comprehensive income(2)	2,873	0	2,873	8,367
Principal reductions	(5,333)	0	(5,333)	(3,571)
Commitments to originate real estate loans held for sale, net	0	(19)	(19)	0
Ending balance	$47,290	($19)	$47,271	$48,786

(1)	Amounts included in earnings associated with the pooled trust preferred securities relate to accretion of related discount
	and are reported in interest and dividends on taxable investments.
(2)	Amounts included in other comprehensive income associated with the pooled trust preferred securities relate to changes
	in unrealized loss and are reported as a component of unrealized gains on securities in the Statement of Comprehensive Income.

Assets and liabilities measured on a non-recurring basis:

	June 30, 2013				December 31, 2012
(000's omitted)	Level 1	Level 2	Level 3	Total Fair Value	Level 1	Level 2	Level 3	Total Fair Value
Impaired loans	$0	$0	$1,990	$1,990	$0	$0	$1,186	$1,186
Other real estate owned	0	0	5,066	5,066	0	0	4,788	4,788
Mortgage servicing rights	0	0	858	858	0	0	1,028	1,028
Total	$0	$0	$7,914	$7,914	$0	$0	$7,002	$7,002

Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace, adjusted for non-observable inputs. Thus, the resulting nonrecurring fair value measurements are generally classified as Level 3. Estimates of fair value used for other collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and, therefore, such valuations classify as Level 3.

Other real estate owned is valued at the time the loan is foreclosed upon and the asset is transferred to other real estate owned. The value is based primarily on third party appraisals, less costs to sell. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the customer and customer’s business. Such discounts are significant, ranging from 4% to 53% at June 30, 2013 and result in a Level 3 classification of the inputs for determining fair value. Other real estate owned is reviewed and evaluated on at least an annual basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company recovers the carrying value of other real estate owned through the sale of the property. The ability to affect future sales prices is subject to market conditions and factors beyond our control and may impact the estimated fair value of a property.

Originated mortgage servicing rights are recorded at their fair value at the time of sale of the underlying loan, and are amortized in proportion to and over the estimated period of net servicing income. In accordance with GAAP, the Company must record impairment charges, on a nonrecurring basis, when the carrying value of a stratum exceeds its estimated fair value. The fair value of mortgage servicing rights is based on a valuation model incorporating inputs that market participants would use in estimating future net servicing income. Such inputs include estimates of the cost of servicing loans, appropriate discount rate and prepayment speeds and are considered to be unobservable and contribute to the Level 3 classification of mortgage servicing rights. The amount of impairment recognized is the amount by which the carrying value of the capitalized servicing rights for a stratum exceeds estimated fair value. Impairment is recognized through a valuation allowance. There is a valuation allowance of approximately $0.4 million at June 30, 2013 and December 31, 2012.

The Company evaluates goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. The fair value of each reporting unit is compared to the carrying amount of that reporting unit in order to determine if impairment is indicated. If so, the implied fair value of the reporting unit’s goodwill is compared to its carrying amount and the impairment loss is measured by the excess of the carrying value of the goodwill over fair value of the goodwill. In such situations, the Company performs a discounted cash flow modeling technique that requires management to make estimates regarding the amount and timing of expected future cash flows of the assets and liabilities of the reporting unit that enable the Company to calculate the implied fair value of the goodwill. It also requires use of a discount rate that reflects the current return expectation of the market in relation to present risk-free interest rates, expected equity market premiums, peer volatility indicators and company-specific risk indicators. The Company did not recognize an impairment charge during 2012 or the six months ended June 30, 2013.

The significant unobservable inputs used in the determination of fair value of assets classified as Level 3 on a recurring or non-recurring basis as of June 30, 2013 are as follows:

(000's omitted)	Fair Value at June 30, 2013	Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Range (Weighted Average)

Pooled trust preferred securities	$47,290	Consensus pricing	Weighting of offered quotes	74.8% - 85.5% (81.6%)

Impaired loans	1,990	Fair Value of Collateral	Estimated cost of disposal/market adjustment	11.0% -50.0% (39.0%)

Other real estate owned	5,066	Fair Value of Collateral	Estimated cost of disposal/market adjustment	4.0% - 53.0% (29.7%)

Mortgage servicing rights	858	Discounted cash flow	Weighted average constant prepayment rate	13.6% - 41.4% (37.2%)
			Discount rate	3.27% - 3.97% (3.80%)
			Adequate compensation	$7/loan

Commitments to originate real estate loans for sale	(19)	Discounted cash flow	Embedded servicing value	1%

The significant unobservable inputs used in the determination of fair value of assets classified as Level 3 on a recurring or non-recurring basis as of December 31, 2012 are as follows:

(000's omitted)	Fair Value at December 31, 2012	Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Range (Weighted Average)

Pooled trust preferred securities	$49,600	Consensus pricing	Weighting of offered quotes	65.3% - 85.1% (78.4%)

Impaired loans	1,186	Fair value of collateral	Estimated cost of disposal/market adjustment	25.0% - 50.0% (27.5%)

Other real estate owned	4,788	Fair value of collateral	Estimated cost of disposal/market adjustment	11.0% - 60.2% (19.9%)

Mortgage servicing rights	1,028	Discounted cash flow	Weighted average constant prepayment rate	1.1% - 39.6% (34.4%)
			Discount rate	2.5% - 3.3% (3.1%)
			Adequate compensation	$7/loan

The Company determines fair values based on quoted market values, where available, estimates of present values, or other valuation techniques. Those techniques are significantly affected by the assumptions used, including, but not limited to, the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, may not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from fair value disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts and estimated fair values of the Company’s other financial instruments that are not accounted for at fair value at June 30, 2013 and December 31, 2012 are as follows:

	June 30, 2013		December 31, 2012
	Carrying	Fair	Carrying	Fair
(000's omitted)	Value	Value	Value	Value
Financial assets:
Net loans	$3,935,998	$3,875,023	$3,865,576	$3,881,354
Financial liabilities:
Deposits	5,670,130	5,674,653	5,628,039	5,635,320
Borrowings	322,319	345,766	728,061	820,377
Subordinated debt held by unconsolidated subsidiary trusts	102,085	102,337	102,073	97,899

The following is a further description of the principal valuation methods used by the Company to estimate the fair values of its financial instruments.

Loans have been classified as a Level 3 valuation. Fair values for variable rate loans that reprice frequently are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flows and interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Deposits have been classified as a Level 2 valuation. The fair value of demand deposits, interest-bearing checking deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair value of time deposit obligations are based on current market rates for similar products.

Borrowings have been classified as a Level 2 valuation. Fair values for long-term borrowings are estimated using discounted cash flows and interest rates currently being offered on similar borrowings.

Subordinated debt held by unconsolidated subsidiary trusts have been classified as a Level 2 valuation. The fair value of subordinated debt held by unconsolidated subsidiary trusts are estimated using discounted cash flows and interest rates currently being offered on similar securities.

Other financial assets and liabilities – Cash and cash equivalents have been classified as a Level 1 valuation, while accrued interest receivable and accrued interest payable have been classified as a Level 2 valuation. The fair values of each approximate the respective carrying values because the instruments are payable on demand or have short-term maturities and present relatively low credit risk and interest rate risk.

NOTE L: DERIVATIVE INSTRUMENTS

The Company is party to derivative financial instruments in the normal course of its business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments have been limited to commitments to originate real estate loans held for sale and forward sales commitments. The Company does not hold or issue derivative financial instruments for trading or other speculative purposes.

The Company enters into forward sales commitments for the future delivery of residential mortgage loans, and interest rate lock commitments to fund loans at a specified interest rate. The forward sales commitments are utilized to reduce interest rate risk associated with interest rate lock commitments and loans held for sale. Changes in the estimated fair value of the forward sales commitments and interest rate lock commitments subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time. At inception and during the life of the interest rate lock commitment, the Company includes the expected net future cash flows related to the associated servicing of the loan as part of the fair value measurement of the interest rate lock commitments. These derivatives are recorded at fair value.

The following table presents the Company’s derivative financial instruments, their estimated fair values, and balance sheet location as of June 30, 2013:

	Asset Derivatives
(000's omitted)	Location	Notional	Fair Value
Derivatives not designated as hedging instruments:
Forward sales commitments	Other assets	$7,874	$141
Commitments to originate real estate loans for sale	Other assets	$10,481	(19)
Total derivatives			$122

The following table presents the Company’s derivative financial instruments and the location of the net gain or loss recognized in the statement of income for the three and six months ended June 30, 2013:

		Gain (Loss) recognized in the Statement of Income
(000's omitted)	Location	Three Months Ending June 30, 2013	Six Months Ending June 30, 2013
Forward sales commitments	Mortgage banking and other services	$141	$141
Commitments to originate real estate loans for sale	Mortgage banking and other services	(19)	(19)
Total		$122	$122

NOTE M: SEGMENT INFORMATION

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. Community Bank, N.A. operates the banking segment that provides full-service banking to consumers, businesses and governmental units in northern, central and western New York as well as Northern Pennsylvania.

Other 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 include administration, consulting and actuarial services to sponsors of employee benefit plans, 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, 2012 filed with the SEC on March 1, 2013).

Information about reportable segments and reconciliation of the information to the consolidated financial statements follows: