Edgar Filing: COMMUNITY BANK SYSTEM, INC.

COMMUNITY BANK SYSTEM, INC.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(In Thousands, Except Per-Share Data)

cbna201510q3rdqtr.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 September 30, 2015

	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.

41,099,876 shares of Common Stock, $1.00 par value, were outstanding on October 31, 2015.

TABLE OF CONTENTS

Part I.	Financial Information	Page

Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Condition
	September 30, 2015 and December 31, 2014	3

	Consolidated Statements of Income
	Three and nine months ended September 30, 2015 and 2014	4

	Consolidated Statements of Comprehensive Income/(Loss)
	Three and nine months ended September 30, 2015 and 2014	5

	Consolidated Statement of Changes in Shareholders’ Equity
	Nine months ended September 30, 2015	6

	Consolidated Statements of Cash Flows
	Nine months ended September 30, 2015 and 2014	7

	Notes to the Consolidated Financial Statements
	September 30, 2015	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41

Item 4.	Controls and Procedures	42

Part II.	Other Information

Item 1.	Legal Proceedings	43

Item 1A.	Risk Factors	43

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43

Item 3.	Defaults Upon Senior Securities	43

Item 4.	Mine Safety Disclosures	44

Item 5.	Other Information	44

Item 6.	Exhibits	44

Part I. Financial Information

Item 1. Financial Statements

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


	September 30,	December 31,
	2015	2014
Assets:
Cash and cash equivalents	$156,836	$138,396

Available-for-sale investment securities (cost of $2,766,581 and $2,397,886, respectively)	2,867,439	2,472,925

Other securities, at cost	49,824	40,049

Loans held for sale, at fair value	1,014	1,042

Loans	4,313,547	4,236,206
Allowance for loan losses	(45,588)	(45,341)
Net loans	4,267,959	4,190,865

Goodwill, net	375,174	375,174
Core deposit intangibles, net	7,894	10,023
Other intangibles, net	1,457	1,776
Intangible assets, net	384,525	386,973

Premises and equipment, net	92,491	93,633
Accrued interest and fees receivable	28,873	24,645
Other assets	148,205	140,912

Total assets	$7,997,166	$7,489,440

Liabilities:
Noninterest-bearing deposits	$1,357,554	$1,324,661
Interest-bearing deposits	4,790,556	4,610,603
Total deposits	6,148,110	5,935,264

Borrowings	558,100	338,000
Subordinated debt held by unconsolidated subsidiary trusts	102,140	102,122
Accrued interest and other liabilities	143,790	126,150
Total liabilities	6,952,140	6,501,536

Commitments and contingencies (See Note J)

Shareholders' equity:
Preferred stock, $1.00 par value, 500,000 shares authorized, 0 shares issued	0	0
Common stock, $1.00 par value, 75,000,000 shares authorized; 41,929,301 and 41,606,422 shares issued, respectively	41,929	41,606
Additional paid-in capital	421,213	409,984
Retained earnings	560,021	525,985
Accumulated other comprehensive income	45,907	30,720
Treasury stock, at cost (910,278 and 858,701 shares, respectively)	(24,044)	(20,391)
Total shareholders' equity	1,045,026	987,904

Total liabilities and shareholders' equity	$7,997,166	$7,489,440

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


		Three Months Ended		Nine Months Ended
		September 30,		September 30,
		2015	2014	2015	2014
Interest income:
	Interest and fees on loans	$47,040	$46,883	$138,422	$138,649
	Interest and dividends on taxable investments	13,454	12,239	38,802	37,481
	Interest and dividends on nontaxable investments	4,790	5,165	14,394	15,505
	Total interest income	65,284	64,287	191,618	191,635

Interest expense:
	Interest on deposits	1,694	1,962	5,225	6,265
	Interest on borrowings	587	308	1,081	846
	Interest on subordinated debt held by unconsolidated subsidiary trusts	640	623	1,881	1,852
	Total interest expense	2,921	2,893	8,187	8,963

Net interest income		62,363	61,394	183,431	182,672
Provision for loan losses		1,906	1,747	3,120	4,647
Net interest income after provision for loan losses		60,457	59,647	180,311	178,025

Noninterest revenues:
	Deposit service fees	13,459	13,833	39,142	39,260
	Other banking services	2,045	1,867	3,899	4,665
	Employee benefit services	11,330	10,755	33,727	31,638
	Wealth management services	4,552	4,617	13,383	13,529
Total noninterest revenues		31,386	31,072	90,151	89,092

Noninterest expenses:
	Salaries and employee benefits	31,179	30,941	93,218	92,090
	Occupancy and equipment	6,652	6,617	20,891	21,224
	Data processing and communications	7,643	7,475	22,106	21,529
	Amortization of intangible assets	843	1,051	2,642	3,293
	Legal and professional fees	1,564	1,973	4,952	5,427
	Office supplies and postage	1,636	1,466	4,733	4,664
	Business development and marketing	1,889	1,764	5,711	5,424
	FDIC insurance premiums	968	952	2,920	2,918
	Acquisition expenses and litigation settlement	562	2,800	1,318	2,923
	Other	3,143	3,772	9,584	10,404
	Total noninterest expenses	56,079	58,811	168,075	169,896

Income before income taxes		35,764	31,908	102,387	97,221
Income taxes		10,742	9,537	31,228	29,001
Net income		$25,022	$22,371	$71,159	$68,220

Basic earnings per share		$0.61	$0.55	$1.74	$1.67
Diluted earnings per share		$0.60	$0.54	$1.72	$1.65
Cash dividends declared per share		$0.31	$0.30	$0.91	$0.86

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		Nine Months Ended
	September 30,		September 30,
	2015	2014	2015	2014

Pension and other post retirement obligations:
Amortization of actuarial (gains)/losses included in net periodic pension cost, gross	$363	($79)	$1,090	($235)
Tax effect	(140)	31	(421)	92
Amortization of actuarial (gains)/losses included in net periodic pension cost, net	223	(48)	669	(143)

Amortization of prior service cost included in net periodic pension cost, gross	(43)	(43)	(127)	(130)
Tax effect	16	17	49	51
Amortization of prior service cost included in net periodic pension cost, net	(27)	(26)	(78)	(79)

Other comprehensive income/(loss) related to pension and other post retirement obligations, net of taxes	196	(74)	591	(222)

Unrealized gains/(losses) on available-for-sale securities:
Net unrealized holding gains/(losses) arising during period, gross	44,019	(1,808)	25,819	75,214
Tax effect	(16,979)	710	(11,223)	(27,776)
Net unrealized holding gains/(losses) arising during period, net	27,040	(1,098)	14,596	47,438

Other comprehensive income/(loss) related to unrealized gains/(losses) on available-for-sale securities, net of taxes	27,040	(1,098)	14,596	47,438

Other comprehensive income/(loss), net of tax	27,236	(1,172)	15,187	47,216
Net income	25,022	22,371	71,159	68,220
Comprehensive income	$52,258	$21,199	$86,346	$115,436


	As of
	September 30, 2015	December 31, 2014
Accumulated Other Comprehensive Income By Component:

Unrealized loss for pension and other postretirement obligations	($25,979)	($26,941)
Tax effect	9,854	10,225
Net unrealized loss for pension and other postretirement obligations	(16,125)	(16,716)

Unrealized gain on available-for-sale securities	100,858	75,039
Tax effect	(38,826)	(27,603)
Net unrealized gain on available-for-sale securities	62,032	47,436

Accumulated other comprehensive income	$45,907	$30,720

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

COMMUNITY BANK SYSTEM, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)

Nine months ended September 30, 2015

(In Thousands, Except Share Data)

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

Balance at December 31, 2014	40,747,721	$41,606	$409,984	$525,985	$30,720	($20,391)	$987,904

Net income				71,159			71,159

Other comprehensive income, net of tax					15,187		15,187

Cash dividends declared:
Common, $0.91 per share				(37,123)			(37,123)

Common stock issued under
employee stock plan,
including tax benefits of $1,541	322,879	323	8,065				8,388

Stock-based compensation			3,164				3,164

Treasury stock purchased	(265,230)					(9,125)	(9,125)

Treasury stock issued to benefit plan	213,653					5,472	5,472

Balance at September 30, 2015	41,019,023	$41,929	$421,213	$560,021	$45,907	($24,044)	$1,045,026

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

COMMUNITY BANK SYSTEM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In Thousands)


	Nine Months Ended
	September 30,
	2015	2014
Operating activities:
Net income	$71,159	$68,220
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	9,820	9,801
Amortization of intangible assets	2,642	3,293
Net accretion of premiums and discounts on securities, loans, and borrowings	(2,100)	(2,894)
Stock-based compensation	3,164	3,073
Provision for loan losses	3,120	4,647
Amortization of mortgage servicing rights	307	337
Income from bank-owned life insurance policies	(775)	(760)
Net gain from sale of loans and other assets	(48)	(344)
Net change in loans originated for sale	582	258
Change in other assets and liabilities	(6,219)	5,448
Net cash provided by operating activities	81,652	91,079
Investing activities:
Proceeds from maturities of available-for-sale investment securities	131,709	101,228
Proceeds from maturities of other investment securities	172	12
Purchases of available-for-sale investment securities	(494,436)	(300,120)
Purchases of other securities	(9,947)	(7,761)
Net increase in loans	(84,064)	(114,603)
Cash paid for acquisition, net of cash acquired of $0	0	(924)
Expenditure for intangible asset	(100)	0
Purchases of premises and equipment, net	(9,184)	(7,839)
Net cash used in investing activities	(465,850)	(330,007)
Financing activities:
Net increase in deposits	212,846	71,287
Net change in borrowings, net of payments of $0 and $8	220,100	201,892
Issuance of common stock	8,388	6,115
Purchases of treasury stock	(9,125)	0
Issuances of treasury stock	5,472	0
Cash dividends paid	(36,584)	(33,989)
Tax benefits from share-based payment arrangements	1,541	1,476
Net cash provided by financing activities	402,638	246,781
Change in cash and cash equivalents	18,440	7,853
Cash and cash equivalents at beginning of period	138,396	149,647
Cash and cash equivalents at end of period	$156,836	$157,500

Supplemental disclosures of cash flow information:
Cash paid for interest	$8,249	$9,079
Cash paid for income taxes	21,334	19,527
Supplemental disclosures of noncash financing and investing activities:
Dividends declared and unpaid	12,793	12,255
Transfers from loans to other real estate	2,934	2,111
Purchase of intangible asset	93	0

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

COMMUNITY BANK SYSTEM, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

SEPTEMBER 30, 2015

NOTE A: BASIS OF PRESENTATION

The interim financial data as of and for the three and nine months ended September 30, 2015 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 January 1, 2014, the Company, through its subsidiary, Harbridge Consulting Group, LLC (“Harbridge”), completed its acquisition of a professional services practice from EBS-RMSCO, Inc., a subsidiary of The Lifetime Healthcare Companies (“EBS-RMSCO”). This professional services practice, which provides actuarial valuation and consulting services to clients who sponsor pension and post-retirement medical and welfare plans, enhances the Company’s participation in the Western New York market. 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 2014:

(000’s omitted)
Consideration paid:
Cash/Total net consideration paid	$924
Recognized amounts of identifiable assets acquired and liabilities assumed:
Other assets	163
Other intangibles	578
Total identifiable assets	741

Goodwill	$183

The other intangibles related to the EBS-RMSCO acquisition is being amortized using an accelerated method over their estimated useful life of eight years. The goodwill, which is not amortized for book purposes, was assigned to the Employee Benefit Services segment for the EBS-RMSCO acquisition and is deductible for tax purposes.

Supplemental pro forma financial information related to the EBS-RMSCO acquisition has not been provided as it would be impracticable to do so. Historical financial information regarding EBS-RMSCO is not accessible and, thus, the amounts would require estimates so significant as to render the disclosure irrelevant.

On February 24, 2015, the Company announced that it had entered into a definitive agreement to acquire Oneida Financial Corp. (“Oneida”), parent company of Oneida Savings Bank, headquartered in Oneida, NY, for approximately $142 million in Company stock and cash. The acquisition will extend the Company’s Central New York banking service area and complement and expand the Company’s existing service capacity in insurance, benefits administration and wealth management. Upon the completion of the merger, Community Bank N.A. (“the Bank”) will add 12 branch locations and approximately $813 million of assets, including approximately $397 million of loans and $708 million of deposits. The Oneida shareholders have approved the acquisition and the various required regulatory approvals for the transaction are expected in the fourth quarter. The Company expects to incur additional one-time, transaction-related costs during the remainder of 2015.

Direct costs related to acquisitions were expensed as incurred. Merger and acquisition integration-related expenses amount to $0.6 million and $1.3 million, respectively, in the three and nine months ended September 30, 2015 and $0.1 million in the nine months ended September 30, 2014.

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, 2014 filed with the Securities and Exchange Commission (“SEC”) on March 2, 2015.

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.

Acquired Impaired Loans

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 Accounting Standards Codification (“ASC”) 310-30. The excess of undiscounted 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 using the interest method. The difference between contractually required payments at acquisition and the undiscounted 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 and other contractually required payments that the Company does not expect to collect. Subsequent decreases in expected cash flows are recognized as impairments through a charge to the provision for credit losses resulting in an increase in the allowance for loan losses. Subsequent improvements in expected cash flows result in a recovery of previously recorded allowance for loan losses or a 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.

Acquired Non-impaired Loans

Acquired loans that do not meet the requirements under ASC 310-30 are considered acquired non-impaired loans. The difference between the acquisition date fair value and the outstanding balance represents the fair value adjustment for a loan and includes both credit and interest rate considerations. Fair value adjustments may be discounts (or premiums) to a loan’s cost basis and are accreted (or amortized) to net interest income (or expense) over the loan’s remaining life in accordance with ASC 310-20. Fair value adjustments for revolving loans are accreted (or amortized) using a straight line method. Term loans are accreted (or amortized) using the constant effective yield method.

Subsequent to the purchase date, the methods used to estimate the allowance for loan losses for the acquired non-impaired loans are consistent with the policy described below. However, the Company compares the net realizable value of the loans to the carrying value, for loans collectively evaluated for impairment. The carrying value represents the net of the loan’s unpaid principal balance and the remaining purchase discount (or premium) that has yet to be accreted into interest income. When the carrying value exceeds the net realizable value, an allowance for loan losses is recognized.

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 direct; consumer 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 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 either 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 classified as available-for-sale 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 September 30, 2015. 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.

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 seven 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.

New Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This new guidance supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective prospectively for the Company for annual and interim periods beginning after December 15, 2017. The Company is currently evaluating the effect the guidance will have on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2015-16, Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments (Topic 805). The amendments clarify that an acquirer recognizes adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer needs to record, in the same period’s financial statements, the effect of changes in depreciation, amortization, or other income as a result of the change to the provisional amounts as if the accounting had been completed at the acquisition date. This amendment requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current period earnings by line item as if the provisional adjustments had been recognized as of the acquisition date. This guidance is effective for annual and interim periods beginning after December 15, 2015. These provisions are not anticipated to have a material impact on the Company’s financial statements.

NOTE D: INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities as of September 30, 2015 and December 31, 2014 are as follows:

	September 30, 2015				December 31, 2014
		Gross	Gross			Gross	Gross
	Amortized	Unrealized	Unrealized	Fair	Amortized	Unrealized	Unrealized	Fair
(000's omitted)	Cost	Gains	Losses	Value	Cost	Gains	Losses	Value
Available-for-Sale Portfolio:
U.S. Treasury and agency securities	$1,864,199	$69,071	$0	$1,933,270	$1,479,134	$39,509	$910	$1,517,733
Obligations of state and political subdivisions	662,774	24,374	521	686,627	645,398	26,749	244	671,903
Government agency mortgage-backed securities	208,817	8,087	968	215,936	228,971	9,782	1,025	237,728
Corporate debt securities	16,705	115	38	16,782	26,803	363	75	27,091
Government agency collateralized mortgage obligations	13,836	582	0	14,418	17,330	695	0	18,025
Marketable equity securities	250	167	11	406	250	195	0	445
Total available-for-sale portfolio	$2,766,581	$102,396	$1,538	$2,867,439	$2,397,886	$77,293	$2,254	$2,472,925

Other Securities:
Federal Home Loan Bank common stock	$29,500			$29,500	$19,553			$19,553
Federal Reserve Bank common stock	16,050			16,050	16,050			16,050
Other equity securities	4,274			4,274	4,446			4,446
Total other securities	$49,824			$49,824	$40,049			$40,049

A summary of investment securities that have been in a continuous unrealized loss position is as follows:

As of September 30, 2015

	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	70	$38,526	$473	3	$1,198	$48	73	$39,724	$521
Government agency mortgage-backed securities	5	7,342	37	19	31,333	931	24	38,675	968
Corporate debt securities	0	0	0	1	2,745	38	1	2,745	38
Government agency collateralized mortgage obligations	0	0	0	2	4	0	2	4	0
Marketable equity securities	1	90	11	0	0	0	1	90	11
Total available-for-sale/investment portfolio	76	$45,958	$521	25	$35,280	$1,017	101	$81,238	$1,538

As of December 31, 2014

	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:
U.S. Treasury and agency obligations	0	$0	$0	4	$102,363	$910	4	$102,363	$910
Obligations of state and political subdivisions	23	13,413	34	46	26,490	210	69	39,903	244
Government agency mortgage-backed securities	3	5	0	19	34,770	1,025	22	34,775	1,025
Corporate debt securities	1	3,040	1	1	2,755	74	2	5,795	75
Government agency collateralized mortgage obligations	1	0	0	1	5	0	2	5	0
Total available-for-sale/investment portfolio	28	$16,458	$35	71	$166,383	$2,219	99	$182,841	$2,254

The unrealized losses reported pertaining to securities issued by the U.S. government and its sponsored entities, include treasuries, agencies, and mortgage-backed securities issued by the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”), and the Federal Home Loan Corporation (“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 majority of the obligations of state and political subdivisions and corporations carry a credit rating of A or better. Additionally, a majority of the obligations of state and political subdivisions carry 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. The unrealized losses in the portfolios are primarily attributable to changes in interest rates. As such, management does not believe any individual unrealized loss as of September 30, 2015 represents OTTI.

The amortized cost and estimated fair value of debt securities at September 30, 2015, 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.

	Available-for-Sale
	Amortized	Fair
(000's omitted)	Cost	Value
Due in one year or less	$43,499	$43,925
Due after one through five years	157,648	161,758
Due after five years through ten years	2,094,774	2,173,882
Due after ten years	247,757	257,114
Subtotal	2,543,678	2,636,679
Government agency mortgage-backed securities	208,817	215,936
Government agency collateralized mortgage obligations	13,836	14,418
Total	$2,766,331	$2,867,033

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 10 – 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 properties.

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

●	Consumer direct consists of 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 up to 30 years.

The balances of these classes are summarized as follows:

	September 30,	December 31,
(000's omitted)	2015	2014
Consumer mortgage	$1,621,862	$1,613,384
Business lending	1,288,772	1,262,484
Consumer indirect	872,988	833,968
Consumer direct	184,479	184,028
Home equity	345,446	342,342
Gross loans	4,313,547	4,236,206
Allowance for loan losses	(45,588)	(45,341)
Loans, net of allowance for loan losses	$4,267,959	$4,190,865

The outstanding balance related to credit impaired acquired loans was $5.2 million and $6.1 million at September 30, 2015 and December 31, 2014, respectively. The changes in the accretable discount related to the credit impaired acquired loans are as follows:

(000’s omitted)
Balance at December 31, 2014	$705
Accretion recognized, year-to-date	(437)
Net reclassification to accretable from non-accretable	329
Balance at September 30, 2015	$597

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 September 30, 2015:

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	$10,115	$1,351	$12,108	$23,574	$1,538,515	$1,562,089
Business lending	2,187	135	6,402	8,724	1,159,228	1,167,952
Consumer indirect	9,785	58	0	9,843	862,571	872,414
Consumer direct	1,148	41	1	1,190	179,428	180,618
Home equity	1,023	291	1,993	3,307	289,015	292,322
Total	$24,258	$1,876	$20,504	$46,638	$4,028,757	$4,075,395

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	$1,271	$130	$1,473	$2,874	$0	$56,899	$59,773
Business lending	192	0	710	902	4,675	115,243	120,820
Consumer indirect	25	0	0	25	0	549	574
Consumer direct	126	0	14	140	0	3,721	3,861
Home equity	446	69	432	947	0	52,177	53,124
Total	$2,060	$199	$2,629	$4,888	$4,675	$228,589	$238,152

(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, 2014:

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	$13,978	$2,165	$13,201	$29,344	$1,515,057	$1,544,401
Business lending	6,738	350	2,291	9,379	1,115,215	1,124,594
Consumer indirect	10,529	82	10	10,621	822,124	832,745
Consumer direct	1,389	36	2	1,427	177,158	178,585
Home equity	1,802	195	2,172	4,169	278,904	283,073
Total	$34,436	$2,828	$17,676	$54,940	$3,908,458	$3,963,398

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	$1,892	$232	$2,122	$4,246	$0	$64,737	$68,983
Business lending	608	0	489	1,097	5,312	131,481	137,890
Consumer indirect	40	0	0	40	0	1,183	1,223
Consumer direct	174	0	18	192	0	5,251	5,443
Home equity	674	46	426	1,146	0	58,123	59,269
Total	$3,388	$278	$3,055	$6,721	$5,312	$260,775	$272,808

(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 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 current facts and conditions.

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

	September 30, 2015			December 31, 2014
(000’s omitted)	Legacy	Acquired	Total	Legacy	Acquired	Total
Pass	$990,125	$84,944	$1,075,069	$949,960	$93,510	$1,043,470
Special mention	111,496	15,343	126,839	103,176	18,038	121,214
Classified	65,831	15,858	81,689	71,458	21,030	92,488
Doubtful	500	0	500	0	0	0
Acquired impaired	0	4,675	4,675	0	5,312	5,312
Total	$1,167,952	$120,820	$1,288,772	$1,124,594	$137,890	$1,262,484

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 loans classified as current as well as those classified as 30 - 89 days past due. 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 September 30, 2015:

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

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$1,548,630	$872,356	$180,576	$290,038	$2,891,600
Nonperforming	13,459	58	42	2,284	15,843
Total	$1,562,089	$872,414	$180,618	$292,322	$2,907,443

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

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$58,170	$574	$3,847	$52,623	$115,214
Nonperforming	1,603	0	14	501	2,118
Total	$59,773	$574	$3,861	$53,124	$117,332

The following table details the balances in all other loan categories at December 31, 2014:

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

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$1,529,035	$832,653	$178,547	$280,706	$2,820,941
Nonperforming	15,366	92	38	2,367	17,863
Total	$1,544,401	$832,745	$178,585	$283,073	$2,838,804

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

	Consumer	Consumer	Consumer	Home
(000’s omitted)	Mortgage	Indirect	Direct	Equity	Total
Performing	$66,629	$1,223	$5,425	$58,797	$132,074
Nonperforming	2,354	0	18	472	2,844
Total	$68,983	$1,223	$5,443	$59,269	$134,918

All loan classes are collectively evaluated for impairment except business lending, as described in Note C. A summary of individually evaluated impaired loans as of September 30, 2015 and December 31, 2014 follows:

	September 30,	December 31,
(000’s omitted)	2015	2014
Loans with allowance allocation	$2,800	$0
Loans without allowance allocation	1,086	0
Carrying balance	3,886	0
Contractual balance	3,986	0
Specifically allocated allowance	566	0

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.

In accordance with the clarified guidance issued by the Office of the Comptroller of the Currency (“OCC”), 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 2015 and 2014 was immaterial.

TDRs that are less than $0.5 million are collectively included in the general loan loss allocation and the qualitative review. TDRs that are commercial loans and greater than $0.5 million are individually evaluated for impairment, and if necessary, a specific allocation of the allowance for loan losses is provided. As a result, the determination of the amount of allowance for loan losses related to TDRs is the same as detailed in the critical accounting policies.

Information regarding TDRs as of September 30, 2015 and December 31, 2014 is as follows:

	September 30, 2015						December 31, 2014
(000’s omitted)	Nonaccrual		Accruing		Total		Nonaccrual		Accruing		Total
	#	Amount	#	Amount	#	Amount	#	Amount	#	Amount	#	Amount
Consumer mortgage	41	$1,500	38	$1,595	79	$3,095	49	$2,092	37	$1,770	86	$3,862
Business lending	3	117	4	567	7	684	6	442	3	468	9	910
Consumer indirect	0	0	74	700	74	700	0	0	79	615	79	615
Consumer direct	0	0	16	35	16	35	0	0	25	69	25	69
Home equity	7	101	12	258	19	359	13	218	13	278	26	496
Total	51	$1,718	144	$3,155	195	$4,873	68	$2,752	157	$3,200	225	$5,952

The following table presents information related to loans modified in a TDR during the three and nine months ended September 30, 2015 and 2014. Of the loans noted in the table below, all loans for the three and nine months ended September 30, 2015 and 2014 were modified due to a Chapter 7 bankruptcy as described previously. The financial effects of these restructurings were immaterial.

	Three Months Ended September 30, 2015		Three Months Ended September 30, 2014
(000’s omitted)	Number of loans modified	Outstanding Balance	Number of loans modified	Outstanding Balance
Consumer mortgage	4	$404	6	$283
Business lending	0	0	0	0
Consumer indirect	12	112	16	165
Consumer direct	1	0	5	7
Home equity	0	0	0	0
Total	17	$516	27	$455

	Nine Months Ended September 30, 2015		Nine Months Ended September 30, 2014
(000’s omitted)	Number of loans modified	Outstanding Balance	Number of loans modified	Outstanding Balance
Consumer mortgage	8	$585	22	$1,016
Business lending	0	0	7	556
Consumer indirect	23	263	29	334
Consumer direct	2	1	7	14
Home equity	1	13	5	173
Total	34	$862	70	$2,093

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 September 30, 2015
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$10,192	$15,353	$11,602	$2,991	$2,677	$2,374	$93	$45,282
Charge-offs	(276)	(234)	(1,597)	(427)	(66)	0	(59)	(2,659)
Recoveries	9	107	740	174	29	0	0	1,059
Provision	421	112	1,367	359	102	(461)	6	1,906
Ending balance	$10,346	$15,338	$12,112	$3,097	$2,742	$1,913	$40	$45,588

	Three Months Ended September 30, 2014
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$9,375	$16,553	$11,354	$3,298	$1,860	$2,012	$163	$44,615
Charge-offs	(203)	(435)	(1,711)	(307)	(74)	0	(10)	(2,740)
Recoveries	14	335	1,025	239	38	0	0	1,651
Provision	268	138	1,231	100	77	(65)	(2)	1,747
Ending balance	$9,454	$16,591	$11,899	$3,330	$1,901	$1,947	$151	$45,273

	Nine Months Ended September 30, 2015
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$10,286	$15,787	$11,544	$3,083	$2,701	$1,767	$173	$45,341
Charge-offs	(917)	(667)	(4,421)	(1,066)	(188)	0	(102)	(7,361)
Recoveries	75	715	3,077	566	55	0	0	4,488
Provision	902	(497)	1,912	514	174	146	(31)	3,120
Ending balance	$10,346	$15,338	$12,112	$3,097	$2,742	$1,913	$40	$45,588

	Nine Months Ended September 30, 2014
	Consumer	Business	Consumer	Consumer	Home		Acquired
(000’s omitted)	Mortgage	Lending	Indirect	Direct	Equity	Unallocated	Impaired	Total
Beginning balance	$8,994	$17,507	$10,248	$3,181	$1,830	$2,029	$530	$44,319
Charge-offs	(734)	(940)	(4,573)	(1,219)	(450)	0	(30)	(7,946)
Recoveries	67	607	2,826	677	76	0	0	4,253
Provision	1,127	(583)	3,398	691	445	(82)	(349)	4,647
Ending balance	$9,454	$16,591	$11,899	$3,330	$1,901	$1,947	$151	$45,273

NOTE F: GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS

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

	September 30, 2015			December 31, 2014
	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	$40,326	($32,432)	$7,894	$40,326	($30,303)	$10,023
Other intangibles	10,213	(8,756)	1,457	10,019	(8,243)	1,776
Total amortizing intangibles	$50,539	($41,188)	$9,351	$50,345	($38,546)	$11,799

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

(000's omitted)
Oct - Dec 2015	$788
2016	2,652
2017	1,943
2018	1,453
2019	1,026
Thereafter	1,489
Total	$9,351

Shown below are the components of the Company’s goodwill at December 31, 2014 and September 30, 2015:

(000’s omitted)	December 31, 2014	Activity	September 30, 2015
Goodwill	$379,998	$0	$379,998
Accumulated impairment	(4,824)	0	(4,824)
Goodwill, net	$375,174	$0	$375,174

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% (3.88%)	7/31/2031	Par
IV	12/8/2006	$75 million	3 month LIBOR plus 1.65% (1.99%)	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. No contributions to the defined benefit pension plan are required or planned for 2015.

The net periodic benefit cost for the three and nine months ended September 30, 2015 and 2014 is as follows:

	Pension Benefits				Post-retirement Benefits
	Three Months Ended		Nine Months Ended		Three Months Ended		Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
(000's omitted)	2015	2014	2015	2014	2015	2014	2015	2014
Service cost	$831	$882	$2,493	$2,647	$0	$0	$0	$0
Interest cost	1,375	1,318	4,124	3,953	22	26	65	76
Expected return on plan assets	(3,042)	(2,980)	(9,127)	(8,941)	0	0	0	0
Amortization of unrecognized net loss	366	(77)	1,099	(230)	(3)	(2)	(10)	(5)
Amortization of prior service cost	2	1	6	4	(45)	(45)	(134)	(134)
Net periodic benefit income	($468)	($856)	($1,405)	($2,567)	($26)	($21)	($79)	($63)

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 0.6 million weighted-average anti-dilutive stock options outstanding for the three months ended September 30, 2015, and approximately 0.5 million weighted-average anti-dilutive stock options outstanding for the nine months ended September 30, 2015, compared to approximately 0.3 million weighted-average anti-dilutive stock options outstanding for the three months ended September 30, 2014, and approximately 0.2 million weighted-average anti-dilutive stock options outstanding for the nine months ended September 30, 2014 that were not included in the computation below.

The following is a reconciliation of basic to diluted earnings per share for the three and nine months ended September 30, 2015 and 2014:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(000's omitted, except per share data)	2015	2014	2015	2014
Net income	$25,022	$22,371	$71,159	$68,220
Income attributable to unvested stock-based compensation awards	(129)	(115)	(352)	(337)
Income available to common shareholders	24,893	22,256	70,807	67,883

Weighted-average common shares outstanding – basic	40,873	40,596	40,741	40,543
Basic earnings per share	$0.61	$0.55	$1.74	$1.67

Net income	$25,022	$22,371	$71,159	$68,220
Income attributable to unvested stock-based compensation awards	(129)	(115)	(352)	(337)
Income available to common shareholders	24,893	22,256	70,807	67,883

Weighted-average common shares outstanding – basic	40,873	40,596	40,741	40,543
Assumed exercise of stock options	386	453	400	482
Weighted-average common shares outstanding – diluted	41,259	41,049	41,141	41,025
Diluted earnings per share	$0.60	$0.54	$1.72	$1.65

Stock Repurchase Program

At its December 2014 meeting, the Company’s Board of Directors (the “Board”) approved a new repurchase program authorizing the repurchase of up to 2,000,000 shares of the Company’s common stock, in accordance with securities laws and regulations, through December 31, 2015. 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. During the first nine months of 2015, the Company repurchased 265,230 shares of its common stock in open market transactions, compared to 123,000 shares repurchased during 2014.

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 amounts of commitments and contingencies are as follows:

(000's omitted)	September 30, 2015	December 31, 2014
Commitments to extend credit	$730,652	$733,827
Standby letters of credit	18,280	23,916
Total	$748,932	$757,743

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 September 30, 2015, 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. The range of reasonably possible losses for matters where an exposure is not currently estimable or considered probable, beyond the existing recorded liabilities, is between $0 and $1 million in the aggregate. 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.

On July 14, 2015, the Court issued an order preliminarily approving the settlement reached in the first of two related class actions pending in the United States District Court for the Middle District of Pennsylvania, which cases were commenced on October 30, 2013 and May 23, 2014, respectively. The two related cases allege, on behalf of similarly situated class members, that notices provided by the Bank in connection with the repossession of automobiles failed to comply with certain requirements of the Pennsylvania and New York Uniform Commercial Code and related statutes. In accordance with mediation which occurred in September 2014, the settlement provides for establishment of a settlement fund of $2.8 million in exchange for release of all claims of the class members covered by these actions. A litigation settlement charge of $2.8 million with respect to the settlement of the class actions was previously recorded in the third quarter of 2014. The settlement is subject to the Court’s final approval following notice to the class members, including the ability of class members to oppose or opt-out of the settlement.

NOTE K: FAIR VALUE

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.

	September 30, 2015
(000's omitted)	Level 1	Level 2	Level 3	Total Fair Value
Available-for-sale investment securities:
U.S. Treasury and agency securities	$1,933,270	$0	$0	$1,933,270
Obligations of state and political subdivisions	0	686,627	0	686,627
Government agency mortgage-backed securities	0	215,936	0	215,936
Corporate debt securities	0	16,782	0	16,782
Government agency collateralized mortgage obligations	0	14,418	0	14,418
Marketable equity securities	406	0	0	406
Total available-for-sale investment securities	1,933,676	933,763	0	2,867,439
Mortgage loans held for sale	0	1,014	0	1,014
Commitments to originate real estate loans for sale	0	0	276	276
Forward sales commitments	0	(94)	0	(94)
Total	$1,933,676	$934,683	$276	$2,868,635

	December 31, 2014
(000's omitted)	Level 1	Level 2	Level 3	Total Fair Value
Available-for-sale investment securities:
U.S. Treasury and agency securities	$1,496,667	$21,066	$0	$1,517,733
Obligations of state and political subdivisions	0	671,903	0	671,903
Government agency mortgage-backed securities	0	237,728	0	237,728
Corporate debt securities	0	27,091	0	27,091
Government agency collateralized mortgage obligations	0	18,025	0	18,025
Marketable equity securities	445	0	0	445
Total available-for-sale investment securities	1,497,112	975,813	0	2,472,925
Mortgage loans held for sale	0	1,042	0	1,042
Commitments to originate real estate loans for sale	0	0	185	185
Forward sales commitments	0	(43)	0	(43)
Total	$1,497,112	$976,812	$185	$2,474,109

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 values of available-for-sale investment securities are 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. See Note D for further disclosure of the fair value of investment securities.

●

Mortgage loans held for sale –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. The fair value of mortgage loans held for sale 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 September 30, 2015 is approximately $1.0 million. The unrealized gain on mortgage loans held for sale was recognized in mortgage banking and other income in the consolidated statement and is immaterial.

●

Forward sales commitments – The Company enters into forward sales commitments 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 commitments 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. As such, 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		Nine Months Ended
	September 30,		September 30,
	2015	2014	2015	2014
(000's omitted)	Commitments to Originate Real Estate Loans for Sale	Commitments to Originate Real Estate Loans for Sale	Commitments to Originate Real Estate Loans for Sale	Commitments to Originate Real Estate Loans for Sale
Beginning balance	$195	$142	$185	$44
Total losses included in earnings (1)	(195)	(142)	(532)	(253)
Commitments to originate real estate loans held for sale, net	276	170	623	379
Ending balance	$276	$170	$276	$170
(1) Amounts included in earnings associated with the commitments to originate real estate loans for sale are reported as a component of other banking services in the Consolidated Statement of Income.

Assets and liabilities measured on a non-recurring basis:

	September 30, 2015				December 31, 2014
(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	$2,708	$2,708	$0	$0	$0	$0
Other real estate owned	0	0	2,531	2,531	0	0	1,855	1,855
Mortgage servicing rights	0	0	553	553	0	0	0	0
Total	$0	$0	$5,792	$5,792	$0	$0	$1,855	$1,855

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 (“OREO”) is valued at the time the loan is foreclosed upon and the asset is transferred to OREO. 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 5% to 65% at September 30, 2015 and result in a Level 3 classification of the inputs for determining fair value. OREO is reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The Company recovers the carrying value of OREO through the sale of the property. The ability to affect future sales prices is subject to market conditions and factors beyond the Company’s 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. 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. 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. Impairment is recognized through a valuation allowance. There is an immaterial valuation allowance at September 30, 2015.

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

(000's omitted)	Fair Value at September 30, 2015	Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Range (Weighted Average)
Impaired loans	$2,708	Fair Value of Collateral	Estimated cost of disposal/market adjustment	10.0% - 65.6% (61.5%)
Other real estate owned	2,531	Fair Value of Collateral	Estimated cost of disposal/market adjustment	5.4% - 64.7% (23.9%)
Commitments to originate real estate loans for sale	276	Discounted cash flow	Embedded servicing value	1%
Mortgage servicing rights	553	Discounted cash flow	Weighted average constant prepayment rate	11.4%
			Weighted average discount rate	3.62%
			Adequate compensation	$7/loan

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, 2014 are as follows:

(000's omitted)	Fair Value at December 31, 2014	Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Range (Weighted Average)
Other real estate owned	$1,855	Fair value of collateral	Estimated cost of disposal/market adjustment	10.0% - 77.5% (30.6%)
Commitments to originate real estate loans for sale	185	Discounted cash flow	Embedded servicing value	1%

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 September 30, 2015 and December 31, 2014 are as follows:

	September 30, 2015		December 31, 2014
	Carrying	Fair	Carrying	Fair
(000's omitted)	Value	Value	Value	Value
Financial assets:
Net loans	$4,267,959	$4,317,941	$4,190,865	$4,251,565
Financial liabilities:
Deposits	6,148,110	6,147,341	5,935,264	5,935,690
Borrowings	558,100	558,100	338,000	338,000
Subordinated debt held by unconsolidated subsidiary trusts	102,140	87,170	102,122	85,189

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. The fair value of FHLB overnight advances is the amount payable on demand at the reporting date. Fair values for long-term borrowings are estimated using discounted cash flows and interest rates currently being offered on similar borrowings, and are immaterial as of the reporting dates.

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, which were immaterial at September 30, 2015. The effect of the changes to these derivatives for the three and nine months then ended was also immaterial.

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, Employee Benefit Services and Wealth Management as its reportable operating business segments. The Bank 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. The employee benefit services segment, which includes Benefit Plans Administrative Services, Inc. (“BPAS”) and its subsidiaries, with offices throughout the U.S. and Puerto Rico, provides employee benefit trust, collective investment fund, retirement plan administration, actuarial, VEBA/HRA and health and welfare consulting services. The wealth management services segment includes trust services provided by the personal trust unit within the Bank, investment and insurance products and services provided by the Bank’s subsidiaries Community Investment Services, Inc. (“CISI”) and CBNA Insurance Agency, Inc., and asset management services provided by the Bank’s Nottingham Advisors, Inc. subsidiary. 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, 2014 filed with the SEC on March 2, 2015).

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

(000's omitted)	Banking	Employee Benefit Services	Wealth Management	Eliminations	Consolidated Total
Three Months Ended September 30, 2015
Net interest income	$62,295	$37	$31	$0	$62,363
Provision for loan losses	1,906	0	0	0	1,906
Noninterest revenues	15,503	11,674	4,735	(526)	31,386
Amortization of intangible assets	680	125	38	0	843
Other operating expenses	43,790	8,644	3,328	(526)	55,236
Income before income taxes	$31,422	$2,942	$1,400	$0	$35,764
Assets	$7,970,345	$30,958	$18,921	($23,058)	$7,997,166
Goodwill	$364,495	$8,019	$2,660	$0	$375,174

Three Months Ended September 30, 2014
Net interest income	$61,350	$21	$23	$0	$61,394
Provision for loan losses	1,747	0	0	0	1,747
Noninterest revenues	15,700	11,049	4,809	(486)	31,072
Amortization of intangible assets	850	153	48	0	1,051
Other operating expenses	46,837	8,140	3,269	(486)	57,760
Income before income taxes	$27,616	$2,777	$1,515	$0	$31,908
Assets	$7,476,030	$29,605	$14,965	($17,957)	$7,502,643
Goodwill	$364,495	$8,019	$2,660	$0	$375,174

Nine Months Ended September 30, 2015
Net interest income	$183,243	$102	$86	$0	$183,431
Provision for loan losses	3,120	0	0	0	3,120
Noninterest revenues	43,037	34,633	13,943	(1,462)	90,151
Amortization of intangible assets	2,129	391	122	0	2,642
Other operating expenses	131,002	26,052	9,841	(1,462)	165,433
Income before income taxes	$90,029	$8,292	$4,066	$0	$102,387

Nine Months Ended September 30, 2014
Net interest income	$182,537	$67	$68	$0	$182,672
Provision for loan losses	4,647	0	0	0	4,647
Noninterest revenues	43,922	32,434	14,101	(1,365)	89,092
Amortization of intangible assets	2,644	496	153	0	3,293
Other operating expenses	133,680	24,622	9,666	(1,365)	166,603
Income before income taxes	$85,488	$7,383	$4,350	$0	$97,221

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

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 and nine months ended September 30, 2015 and 2014, although in some circumstances the second quarter of 2015 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 25. 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 2015, “third quarter” refers to the three months ended September 30, 2015, “year-to-date”, or “YTD”, refers to the nine months ended September 30, 2015, and earnings per share (“EPS”) figures refer to diluted EPS.

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 41.

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 (“GAAP”), but also reflects 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, liabilities and shareholders’ equity and disclosures of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that critical accounting estimates include:

●

Acquired loans – Acquired loans are initially recorded at their acquisition date fair values 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.

Acquired loans deemed impaired at acquisition are recorded in accordance with ASC 310-30. The excess of undiscounted cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount. The difference between contractually required payments at acquisition and the undiscounted cash flows expected to be collected at acquisition is referred to as the non-accretable discount, which represents estimated future credit losses and other contractually required payments that the Company does not expect to collect. Subsequent decreases in expected cash flows are recognized as impairments through a charge to the provision for loan credit losses resulting in an increase in the allowance for loan losses. Subsequent improvements in expected cash flows result in a recovery of previously recorded allowance for loan losses or a 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.

For acquired loans that are not deemed impaired at acquisition, the difference between the acquisition date fair value and the outstanding balance represents the fair value adjustment for a loan and includes both credit and interest rate considerations. Subsequent to the purchase date, the methods used to estimate the allowance for loan losses for the acquired non-impaired loans is consistent with the policy described below. However, the Company compares the net realizable value of the loans to the carrying value for loans collectively evaluated for impairment. The carrying value represents the net of the loan’s unpaid principal balance and the remaining purchase discount (or premium) that has yet to be accreted into interest income. When the carrying value exceeds the net realizable value an allowance for loan losses is recognized. For loans individually evaluated for impairment, a provision is recorded when the required allowance exceeds the remaining discount on the loan.

●

Allowance for loan losses – The allowance for loan losses reflects management’s best estimate of probable loan losses in the Company’s loan portfolio. Determination of the allowance for loan losses is inherently subjective. It requires significant estimates including the amounts and timing of expected future cash flows and evaluation of collateral values 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.

●

Investment securities – Investment securities can be classified as held-to-maturity, available-for-sale, or trading. The appropriate classification is based on management’s intentions with respect to either holding or selling the securities as well as on the Company’s ability to hold the securities to maturity. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized gains and losses on available-for-sale securities are recorded in accumulated other comprehensive income or loss, as a separate component of shareholders’ equity, and do not affect earnings until realized. The fair values of investment securities are generally determined by reference to quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments, or a discounted cash flow model using market estimates of the amount and timing of future cash flows, prepayment speed assumptions, expected interest rate curve attributes, and the selection of discount rates that appropriately reflect market and credit risks. Investment securities with significant declines in fair value are evaluated to determine whether they should be considered other-than-temporarily impaired (“OTTI”). An unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. The credit loss component of an OTTI write-down is recorded in earnings, while the remaining portion of the impairment loss is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying security, and it is not more likely than not that the Company will be required to sell the debt security prior to recovery of the full value of its amortized cost basis.

●

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 and officers. Expenses under these plans are charged to current operations and consist of several components of net periodic benefit cost based on various actuarial assumptions regarding future experience under the plans, including, but not limited to, discount rate, rate of future compensation increases, mortality rates, future health care costs, and expected return on plan assets.

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Intangible assets – As a result of acquisitions, the Company has acquired goodwill and identifiable intangible assets. Goodwill represents the value paid for acquired companies in excess of the fair value of net assets at the acquisition date. Goodwill is evaluated at least annually, or when business conditions suggest impairment may have occurred, and will be reduced to its carrying value through a charge to earnings if impairment exists. Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives. The determination of whether or not impairment exists 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 them to select a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, expected equity market premiums, peer volatility indicators and company-specific market and performance metrics, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company’s results of operations.

A summary of the accounting policies used by management is disclosed in Note A, “Summary of Significant Accounting Policies” on pages 55-60 of the most recent Form 10-K (fiscal year ended December 31, 2014) filed with the Securities and Exchange Commission (“SEC”) on March 2, 2015.

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 banking subsidiary is Community Bank, N.A. (the “Bank” or “CBNA”).

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 profitable loan and deposit volume using both organic and acquisition strategies, (iii) increase the noninterest revenues 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 improve efficiencies.

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 revenues; noninterest 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 and their underlying performance characteristics; technology advancements; market share; peer comparisons; and the performance of acquisition activities.

On January 1, 2014, Harbridge Consulting Group, LLC completed its acquisition of a professional services practice from EBS-RMSCO, Inc., a subsidiary of The Lifetime Healthcare Companies. This professional services practice, which provides actuarial valuation and consulting services to clients who sponsor pension and post-retirement medical and welfare plans, enhances the Company’s participation in the Western New York marketplace.

Third quarter and year-to-date net income and earnings per share increased approximately 11% and 4%, respectively, compared to the comparable 2014 timeframes. For the quarter, the higher net income was due to lower noninterest expenses, primarily due to a $2.8 million litigation settlement recorded in the third quarter of 2014 that was partially offset by $0.6 million, or one cent per share, of acquisition expenses in 2015, higher net interest income, and increased noninterest revenues. These were partially offset by a higher provision for loan losses. For the year-to-date timeframe, the higher net income was due to lower operating expenses, primarily due to the aforementioned litigation settlement charge, a lower provision for loan losses, higher noninterest revenues, and higher net interest income, which were partially offset by a higher effective income tax rate.

The growth in loans and deposits was evident as loan and deposit balances showed increases on both an average and ending basis as compared to the corresponding prior year period and the fourth quarter of 2014. The increases were a result of organic growth. Additionally, the trend of larger proportions of deposits coming from lower rate and noninterest-bearing accounts continued and, as a result, assisted in the continued decline in the cost of funds.

The current quarter provision for loan losses was higher than that recorded in the second quarter of 2015 and third quarter of 2014, reflective of higher levels of net charge-offs and a larger loan portfolio. Asset quality in the third quarter of 2015 remained stable and favorable in comparison to averages for peer financial organizations. Third quarter net charge-off, nonperforming loan, and delinquent loan ratios were comparable to those experienced in the third quarter of 2014 and better than long-term historical averages.

On February 24, 2015, the Company announced that it had entered into a definitive agreement to acquire Oneida Financial Corp., the parent company of Oneida Savings Bank and headquartered in Oneida, NY, for approximately $142 million in Company stock and cash. The acquisition will extend CBNA’s Central New York banking service area and complement and expand the Company’s existing service capacity in insurance, benefits administration, and wealth management. Upon the completion of the merger, the Bank will add 12 branch locations and approximately $813 million of assets, including approximately $397 million of loans and $708 million of deposits. The Oneida shareholders have approved the acquisition and the various required regulatory approvals for the transaction are expected in the fourth quarter. The Company expects to incur additional one-time, transaction-related costs during the remainder of 2015.

Net Income and Profitability

As shown in Table 1, net income for the third quarter and September year-to-date of $25.0 million and $71.2 million, respectively, was up $2.7 million, or 11.9%, as compared to the third quarter of 2014 and up $2.9 million, or 4.3%, compared to September year-to-date 2014. Earnings per share of $0.60 for the third quarter was six cents greater than was generated in the third quarter of 2014, while earnings per share for the first nine months of 2015 of $1.72 was seven cents more than the first nine months of 2014. The increases are due primarily to the recording of a litigation settlement charge of $2.8 million, or five cents per share, in the third quarter of 2014, as well as increased net interest income and noninterest revenues.

As reflected in Table 1, third quarter net interest income of $62.4 million was up $1.0 million, or 1.6%, from the comparable prior year period while net interest income for the first nine months of 2015 increased $0.8 million, or 0.4%, versus the first nine months of 2014. The quarterly and year-to-date improvement resulted from an increase in interest-earning assets, primarily due to organic loan growth and investment purchases made during 2015 which more than offset the decrease in net interest margin.

The provision for loan losses for the third quarter and September year-to-date increased $0.2 million and decreased $1.5 million, respectively, as compared to the third quarter and first nine months of 2014, reflective of the corresponding net charge-offs levels.

Third quarter and year-to-date noninterest revenues were $31.4 million and $90.2 million, respectively, up $0.3 million, or 1.0%, from the third quarter of 2014 and up $1.1 million, or 1.2%, from the first nine months of 2014. The increases were a result of revenue growth generated by the Company’s financial services subsidiaries, partially offset by a decrease in revenues from banking sources.

Operating expenses of $56.1 million and $168.1 million for the third quarter and year-to-date periods resulted in a decrease of $2.7 million, or 4.6%, from the prior year third quarter and $1.8 million, or 1.1%, less than the comparable 2014 year-to-date period. Excluding acquisition-related expenses and the 2014 litigation settlement, 2015 operating expenses were $0.5 million, or 0.9%, lower for the third quarter and $0.2 million, or 0.1%, higher for the year-to-date timeframe.

A condensed income statement is as follows:

Table 1: Condensed Income Statements

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(000's omitted, except per share data)	2015	2014	2015	2014
Net interest income	$62,363	$61,394	$183,431	$182,672
Provision for loan losses	1,906	1,747	3,120	4,647
Noninterest revenues	31,386	31,072	90,151	89,092
Noninterest expenses	56,079	58,811	168,075	169,896
Income before income taxes	35,764	31,908	102,387	97,221
Income taxes	10,742	9,537	31,228	29,001
Net income	$25,022	$22,371	$71,159	$68,220

Diluted weighted average common shares outstanding	41,470	41,260	41,343	41,227
Diluted earnings per share	$0.60	$0.54	$1.72	$1.65

Net Interest Income

Net interest income is the amount by which interest and fees on earning assets (loans, investments and cash equivalents) 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.