SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K X FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2000 ----------------- Commission file number 0-11716COMMUNITY BANK SYSTEM, INC.(Exact name of registrant as specified in its charter) Delaware 16-1213679 - - ----------------- --------------------- (State or other jurisdiction of incorporation) (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 codeSecurities registered pursuant to Section 12(b) of the Act: Common Stock, No Par Securities registered pursuant to Section 12(g) of the Act: NoneIndicate 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 all the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X] State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of a specified date within 60 days prior to the date of filing.$217,810,853 based upon average selling price of $27.36 and 7,960,923shares on March 14, 2001.Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.7,960,923 shares of Common Stock, no par value, were and outstanding onMarch 14, 2001.DOCUMENTS INCORPORATED BY REFERENCE. List hereunder the following documents if incorporated by reference and the Part of the Form 10-K into which the document is incorporated: (1) any annual report to security holders; (2) any proxy or information statement; and (3) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. Definitive Proxy Statement for Annual Meeting of Shareholders to be held on May 2, 2001 (the "Proxy Statement") is incorporated by reference in Part III of this Annual Report on Form 10-K. TABLE OF CONTENTSPART I Page Item 1. Business 3 ---------------------------------------------------------------- Item 2. Properties 9 -------------------------------------------------------------- Item 3. Legal Proceedings 9 ------------------------------------------------------- Item 4. Submission of Matters to a Vote of Security Holders 9 --------------------- Item 4A. Executive Officers of the Registrant 10 ------------------------------------PART IIItem 5. Market for Registrant's Common Equity and Related Shareholder Matters 11 ----------------------------------------- Item 6. Selected Financial Data 11 ------------------------------------------------- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 ----------------------------------------------- Item 8. Financial Statements and Supplementary Data: Community Bank System, Inc. and Subsidiaries: Consolidated Statements of Financial Condition 40 --------------------- Consolidated Statements of Income 41 ---------------------------------- Consolidated Statements of Changes in Shareholders' Equity 42 --------- Consolidated Statements of Cash Flows 43 ------------------------------ Notes to Consolidated Financial Statements 44 ------------------------- Report of Independent Accountants 60 ---------------------------------- Two Year Selected Quarterly Data, 2000 and 1999 61 ------------------------- Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure---------------------------------------------- 61PART IIIItem 10. Directors and Executive Officers of the Registrant 62 ---------------------- Item 11. Executive Compensation 62 -------------------------------------------------- Item 12. Security Ownership of Certain Beneficial Owners and Management 62 ---------- Item 13. Certain Relationships and Related Transactions 62 --------------------------PART IVItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 63 -------- Signatures ------------------------------------------------------------------------- 64Part IThis Annual Report on Form 10-K 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 contemplated by such forward-looking statements are set forth herein under the caption "Forward-Looking Statements."Item 1. BusinessGENERALCommunity Bank System, Inc. ("Company") was incorporated on April 15, 1983, under the Delaware General Corporation Law. Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is (315) 445-2282. The Company became a bank holding company in 1984 with the acquisition of The St. Lawrence National Bank ("St. Lawrence Bank") on February 3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A or "Horizon Bank") on March 2, 1984. Also in 1984 the Company obtained a national bank charter for its third wholly-owned subsidiary bank, The Exchange National Bank ("Exchange Bank"), and on July 1, 1984 Exchange Bank acquired the deposits and certain of the assets of three branches of the Bank of New York located in Southwestern New York. On September 30, 1987, the Company acquired The Nichols National Bank ("Nichols Bank") located in Nichols, New York. On September 30, 1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located in Addison, New York, the parent company to Community National Bank ("Community Bank"). On March 26, 1990, Community Bank opened the Corning Market Street branch from the Company's acquisition of deposits and certain assets from Key Bank of Central New York. On January 1, 1992, the Company's five banking affiliates consolidated into a single, wholly-owned national banking subsidiary, known as Community Bank, N.A. ("Bank"). On March 31, 1993, the Bank's marketing representative office in Ottawa, Canada was closed. On June 3, 1994, the Company acquired three branch offices in Canandaigua, Corning and Wellsville, New York from the Resolution Trust Corporation. At that time, the preexisting Canandaigua branch office loans and deposits were transferred into the new facility. On October 28, 1994, the Company acquired the Cato, New York branch of The Chase Manhattan Bank, N.A. On July 14, 1995, the Company acquired 15 branch offices from The Chase Manhattan Bank, N.A. located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two), and Penn Yan, New York ("Chase Branches"). On December 15, 1995, the Company sold three of the former Chase Branches, located in Norwich, New Hartford, and Utica, to NBT Bank, N.A. On June 16, 1997 the Company acquired eight branches from Key Bank of New York located in Alfred, Cassadaga, Clymer, Cuba, Gowanda, Ripley, Sherman, and Wellsville in Southwestern New York State. On July 18, 1997 the Company acquired 12 branches from Fleet Bank located in Old Forge, Boonville, Ogdensburg, St. Regis Falls, Gateway Plaza, Watertown (2), Clayton, Lowville, Massena (2), and Gouverneur in Northern and Central New York State. Seven of the former Fleet offices or existing Bank offices in Watertown (2), Boonville, Ogdensburg, Gouverneur, and Massena (2) have since been or are scheduled to be combined. On January 26, 2001, the Company purchased the Citizens National Bank of Malone, with its offices in Brushton, Chateaugay, Hermon, and Malone (2) being administered from the Bank's Northern Market operations and management center in Canton, NY. The Company had a wholly-owned data processing subsidiary, Northeastern Computer Services, Inc. ("Northeastern"). Northeastern was acquired by the Company from The St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization. Northeastern had previously been a wholly-owned subsidiary of The St. Lawrence Bank and was the survivor of a merger with Lawban Computer Systems, Inc., another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the Company entered into a five year agreement with Mellon Bank, N.A. ("Mellon") to provide data processing services. The agreement has twice been renewed with the subsequent acquiror of Mellon's data services, Fiserv, Inc., for a term now ending December 31, 2005. On June 30, 1992, Northeastern ceased operations. On January 17, 1997 all the outstanding shares of common stock of Northeastern were transferred from the Company to Community Bank, N.A. On that date, Northeastern became a wholly-owned subsidiary of the Bank and changed its name to CBNA Treasury Management Corporation ("TMC"). TMC is now utilized by the Bank to manage its Treasury function, including asset/liability, investment portfolio, and liquidity management. The Company also had a wholly-owned mortgage banking subsidiary, Community Financial Services, Inc.(CFSI), which was established in June 1986; it commenced operation in January 1987. In July 1988, CFSI purchased Salt City Mortgage Corp., a Syracuse-based mortgage broker. CFSI ceased operations in 1990 and was renamed CFSI Close-Out Corp. in 1997. On July 8, 1996, the Company acquired Benefit Plans Administrators (BPA) of Utica, NY. The subsidiary was renamed Benefit Plans Administrative Services, Inc., continuing as a pension administration and consulting firm serving sponsors of defined benefit and defined contribution plans. On February 3, 1997, the Company formed a subsidiary business trust, Community Capital Trust I, for the purpose of issuing preferred securities, which qualify as Tier 1 capital. Concurrent with its formation, the trust issued $30,000,000 of 9.75% preferred securities in an exempt offering maturing in year 2027 and guaranteed by the Company. The entire net proceeds to the trust from the offering were invested in junior subordinated obligations of the Company. On June 19, 1998, the Company formed a subsidiary, Community Financial Services, Inc. (CFSI), to offer selected insurance products through its own agency. On December 22, 1998, the Company formed a broker-dealer subsidiary, Community Investment Services, Inc. (CISI). The subsidiary became fully operational in March 1999, with twelve Financial Consultants available to provide investment advice and products to customers. On February 26, 1999, CBNA Preferred Funding Corp., a Real Estate Investment Trust (REIT), was established as a subsidiary of the Bank to hold fixed rate real estate mortgages that are serviced by the Bank. On April 3, 2000, the Company acquired Elias Asset Management, Inc., of Williamsville, NY, a nationally recognized firm with $650 million in assets under management for individuals, corporate pension and profit sharing plans, and foundations. On January 26, 2001, the Company acquired the Citizens National Bank of Malone, an eighty-year-old commercial bank with $113 million in assets, $59 million in loans, $90 million in deposits, and offices in Brushton, Chateaugay, Hermon, and Malone, NY (2). Its five branches are now part of Community Bank, N.A., being administered from the Bank's Northern Market operations and management center in Canton, NY. The Company provides banking services through its two regional offices at 45-49 Court Street, Canton, New York and 201 North Union Street, Olean, New York, as well as through 72 customer facilities (including the five facilities acquired from the Citizens National Bank of Malone on January 26, 2001) in the eighteen counties of St. Lawrence, Jefferson, Lewis, Oneida, Cayuga, Seneca, Ontario, Oswego, Wayne, Yates, Allegany, Cattaraugus, Tioga, Steuben, Chautauqua, Franklin, Herkimer, and Onondaga. The administrative office is located at 5790 Widewaters Parkway, DeWitt, New York, in Onondaga County. The Bank is a community retail bank committed to the philosophy of serving the financial needs of customers in local communities. The Bank's branches are generally located in small towns and villages within its geographic market areas. The Company believes that the local character of business, knowledge of the customer and customer needs, and comprehensive retail and small business products, together with responsive decision-making at the branch and regional level, enable the Bank to compete effectively. The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank of New York ("FHLB"), and its deposits are insured by the FDIC up to applicable limits. Unless the context otherwise provides, all references in this Annual Report on Form 10-K to the "Company" shall mean, collectively, Community Bank System, Inc. and its subsidiaries.Banking ServicesThe Bank offers a range of commercial and retail banking services in each of its market areas to business, individual, agricultural and government customers.Account Services. The Bank's account services include checking accounts, interest-checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts.Lending Activities. The Bank's lending activities include the making of residential and farm loans, business lines of credit, working capital facilities, inventory and dealer floor plans, as well as installment, commercial, term and student loans. The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. About 64% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. In addition, the typical loan to the Company's commercial business borrowers is under $75,000, with approximately 83% of its customers representing about 28% of commercial loans outstanding.Other Services. The Bank offers a range of trust services, including personal trust, employee benefit trust, investment management, financial planning and custodial services. In addition, the Bank offers nonbank financial products including fixed- and variable-rate annuities, mutual funds, and stock investments. The Bank also offers safe deposit boxes, travelers checks, money orders, wire transfers, collections, foreign exchange, drive-in facilities, automatic teller machines (ATMs), and twenty-four hour depositories. Customers of the Bank also receive pension administration and consulting service pertaining to their defined benefit and defined contribution plans from CBSI's nonbank subsidiary, Benefit Plans Administrative Services, Inc. (BPA); BPA also provides services to nonbank customers.CompetitionThe Company, through the Bank, competes in three distinct banking markets in the Northern ("Northern Market"), Finger Lakes ("Finger Lakes Market"), and Southern Tier ("Southern Tier Market") regions of New York State. The Bank considers its market areas in these regions to be the counties in which it has banking facilities. Major competitors in these markets primarily include local branches of banks based in Boston, Massachusetts; Albany or Buffalo, New York; and Cleveland, Ohio, as well as local independent banking and thrift institutions and federal credit unions. Other competitors for deposits and loans within the Bank's market areas include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers. Lastly, personal and corporate trust and investment counseling services in competition with the Bank are offered by insurance companies, investment counseling firms, other financial service firms, and individuals.Northern Market. Branches in the Northern Market (including the five branches comprising the former Citizens National Bank of Malone) compete for loans and deposits in the six county market area of St. Lawrence, Jefferson, Lewis, Franklin, Herkimer, and Oneida Counties in Northern New York State. Within this market area, the Bank maintains a market share(1) of 10.7%, including commercial banks, credit unions, savings and loan associations and savings banks. However, in its four county primary market area (Franklin, Jefferson, Lewis, and St. Lawrence), the Bank has a 22.2% share. The Bank operates 32 customer facilities in this market and is ranked either first or second in market share in 21 of the 24 towns where these offices are located.Finger Lakes Market. In the Finger Lakes Market, the Bank operates 14 customer facilities competing for loans and deposits in the six-county market area of Seneca, Oswego, Ontario, Wayne, Onondaga, and Cayuga Counties. Within the Finger Lakes Market area, the Bank maintains a market share (1) of approximately 2.6%, including commercial banks, credit unions, savings and loan associations and savings banks. However, the Bank's primary market within this region is Seneca County, where the Bank has a 33.4% share. The Bank is ranked either first or second in market share in six of the eleven Finger Lakes Market area towns where its offices are located.Southern Tier Market. The Bank's Southern Tier Market consists of two sub-markets, the Olean submarket and the Corning submarket.Olean Submarket. The Olean Submarket competes for loans and deposits in the primary market area of Cattaraugus, Chautauqua, and Allegany Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share (1) of approximately 13.9%, including commercial banks, credit unions, savings and loan associations and savings banks. The Olean Submarket operates 16 office locations and the Bank is ranked either first or second in market share in 12 of the 14 towns where these offices are located.Corning Submarket. The Corning Submarket competes for loans and deposits in the primary market area of Steuben, Yates and Tioga Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share (1) of approximately 9.9%, including commercial banks, credit unions, savings and loan associations and savings banks. The Corning Submarket operates ten office locations, and the Bank is ranked either first or second in market share in seven of the eight towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chemung and Schuyler Counties in New York State, and Tioga County in Pennsylvania. (1) Deposit market share data as of June 30, 1999, the most recent information available, calculated by Sheshunoff Information Services, Inc. Includes all five branches of the former Citizens National Bank of Malone, acquired by the Company on January 26, 2001. The table below summarizes the Bank's deposits and market share by the eighteen counties in which it has customer facilities. Market share is based on deposits of all commercial banks, credit unions, savings and loan associations, and savings banks. Number of CBNA Towns Where Deposits Number of CBNA 6/30/99 Market CBNA Has 1st or 2nd Banking County (000's) Share Facilities Market Position Market - - ---------------- -------------- --------- ------------ ------------------------------------ Lewis $82,347 40.7 % 4 3 Northern Seneca 93,527 33.4 5 3 Finger Lakes Allegany 90,117 27.2 5 4 Olean St. Lawrence 305,064 27.1 15 10 Northern Cattaraugus 184,667 23.5 5 4 Olean Yates 49,232 22.4 1 1 Corning Franklin 103,261 22.0 5 4 Northern Jefferson 135,898 13.3 5 2 Northern Tioga 30,194 9.5 2 1 Corning Steuben 91,299 7.7 7 5 Corning Wayne 48,395 6.2 2 0 Finger Lakes Ontario 59,708 6.0 3 0 Finger Lakes Herkimer 26,846 4.9 1 1 Northern Chautauqua 50,279 4.1 6 4 Olean Oswego 40,106 4.1 2 2 Finger Lakes Oneida 56,587 1.7 2 1 Northern Cayuga 12,907 1.7 1 1 Finger Lakes Onondaga 8,498 0.1 1 0 Finger Lakes - - ---------------- -------------- --------- ------------ ------------------------------------ 18 $1,468,932 7.1 % 72 46 CBNAEmployeesAs of December 31, 2000, the Company employed 716 full-time equivalent employees, 642 providing banking services and 74 providing financial services. At year-end 1999, there were 711 full-time equivalent employees, 651 providing banking services and 60 providing financial services. The Company offers a variety of employment benefits and considers its relationship with its employees to be good.CERTAIN REGULATORY CONSIDERATIONSBank holding companies and national banks are regulated by state and federal law. The following is a summary of certain laws and regulations that govern the Company and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the actual statutes and regulations thereunder.Bank Holding Company SupervisionThe Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA") and as such is subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As a bank holding company, the Company's activities and those of its subsidiary have historically been limited to the business of banking and activities closely related or incidental to banking. On March 12, 2000, however, the Gramm-Leachy-Bliley Act took effect, relaxing the previous limitations and permitting bank holding companies to engage in a broader range of financial activities (see "Financial Services Modernization Act" in the final section of this discussion for details). Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital contributions to a troubled bank subsidiary. The Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the Company does not have the resources to provide it. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. The BHCA requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of, or substantially all of the assets of, any bank (unless it owns a majority of such bank's voting shares) or otherwise to control a bank or to merge or consolidate with any other bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank. The Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on September 29, 1994) provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of-state bank holding companies are eliminated effective September 29, 1995. The law also permits interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. The Company believes that the effect of the law has been to increase competition within the markets where the Company operates, although the Company cannot quantify the effect to which competition has increased in such markets or the timing of such increases.OCC SupervisionThe Bank is supervised and regularly examined by the Office of the Comptroller of the Currency (OCC). The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt, and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. There are no regulatory orders or outstanding issues resulting from regulatory examinations of the Bank.Limits on Dividends and Other Revenue SourcesThe Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the OCC for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 2000, the Bank had $17.8 million in undivided profits legally available for the payment of dividends. In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. There are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specified amounts.Capital RequirementsThe Federal Reserve Board has established risk-based capital guidelines which are applicable to bank holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes, and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill ("Tier I capital"). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier I capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization's particular circumstances warrant. The remainder ("Tier 2 capital") may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier I capital and Tier 2 capital is "total risk-based capital." The Company's Tier I and total risk-based capital ratios as of December 31, 2000 were 9.06% and 10.25%, respectively. In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier I capital to quarterly average assets less goodwill ("Tier I leverage ratio") of 3.00% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other bank holding companies are required to maintain a Tier I leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Company's Tier I leverage ratio as of December 31, 2000 was 5.79%, which exceeded its regulatory requirement of 4.00%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Company is subject to the same OCC capital requirements as those that apply to the Bank.Federal Deposit Insurance Corporation Improvement Act of 1991In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund (the "BIF") of the FDIC by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the FDIC use the least-cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions including a Truth-in-Savings Act; (x) a requirement that the FDIC establish a risk-based deposit insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage. FDICIA requires federal banking agencies to take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered "well capitalized" or "adequately capitalized" under Federal Reserve Board regulations:Well Capitalized Adequately CapitalizedTotal Risk-Based Capital Ratio 10% 8% Tier I Risk-Based Capital Ratio 6% 4% Tier I Leverage Ratio 5% 4% If a bank does not meet all of the minimum capital ratios necessary to be considered "adequately capitalized," it will be considered "undercapitalized," "significantly undercapitalized," or "critically undercapitalized," depending upon the amount of the shortfall in its capital. As of December 31, 2000, the Bank's total risk-based capital ratio and Tier I risk - based capital ratio were 10.63% and 9.41%, respectively, and its Tier I leverage ratio as of such date was 5.89%. Notwithstanding the foregoing, if its principal federal regulator determines that an "adequately capitalized" institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan; restrict its asset growth; and prohibit branching, new acquisitions, and new lines of business. Among other things, an institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings, or liquidity in its most recent examination. Possible sanctions for undercapitalized depository institutions include a prohibition on the payment of dividends and a requirement that an institution submit a capital restoration plan to its principal federal regulator. The capital restoration plan of an undercapitalized bank will not be approved unless the holding company that controls the bank guarantees the bank's performance. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lesser of five percent (5%) of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator. In addition, FDICIA requires regulators to impose new non-capital measures of bank safety, such as loan underwriting standards and minimum earnings levels. Regulators are also required to perform annual on-site bank examinations, place limits on real estate lending by banks and tighten auditing requirements.Financial Services Modernization ActOn November 12, 1999, the Gramm-Leach-Bliley Act was signed into law, repealing provisions of the depression-era Glass-Steagall Act, which prohibited commercial banks, securities firms, and insurance companies from affiliating with each other and engaging in each other's businesses. The major provisions of the Act took effect on March 12, 2000. The Act creates a new type of financial services company called a "Financial Holding Company" (an "FHC"), a bank holding company with dramatically expanded powers. FHCs may offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. The Federal Reserve serves as the primary "umbrella" regulator of FHCs. Balanced against the attractiveness of these expanded powers are higher standards for capital adequacy and management, with heavy penalties for noncompliance. Bank holding companies that wish to engage in expanded activities but do not wish to become financial holding companies may elect to establish "financial subsidiaries," which are subsidiaries of national banks with expanded powers. The Act permits financial subsidiaries to engage in the same types of activities permissible for nonbank subsidiaries of financial holding companies, with the exception of merchant banking, insurance underwriting and real estate investment and development. Merchant banking may be permitted after a five-year waiting period under certain regulatory circumstances. Implementing regulations under the Act have not yet been promulgated, and though the Company cannot predict the full impact of the new legislation, there is likely to be consolidation among financial services institutions and increased competition for the Company. CBSI expects to remain a bank holding company for the time being and access its options as circumstances change.Item 2. PropertiesThe Company leases its administrative offices at 5790 Widewaters Parkway, DeWitt, New York and the facility that houses Benefit Plans Administrative Services in Utica, New York. The Bank owns its regional offices in Olean, New York and Canton, New York. Of the Bank's remaining 72 customer facilities (including five branches added as a result of the Citizens National Bank of Malone acquisition on January 26, 2001), 49 are owned by the Bank, and 23 are located in long-term leased premises. Real property and related banking facilities owned by the Company at December 31, 2000 had a net book value of $16.7 million and none of the properties was subject to any encumbrances. For the year ended December 31, 2000, rental fees of $943,000 were paid on facilities leased by the Company for its operations.Item 3. Legal ProceedingsNot applicableItem 4. Submission of Matters to a Vote of Security HoldersNot applicableItem 4A. Executive Officers of the RegistrantThe following table sets forth certain information about the executive officers of the Company and the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors.Name and Age PositionSanford A. Belden Director, President and Chief Age 58 Executive Officer of the Company and the Bank David G. Wallace Treasurer of the Company and Age 56 Executive Vice President and Chief Financial Officer of the Bank Michael A. Patton President, Financial Services Age 55 James A. Wears President, Banking Age 51 David J. Elias President , Chief Executive Age 55 Officer, and Chief Investment Officer, Elias Asset Management, Inc.Sanford A. Belden (Director, President and Chief Executive Officer of the Company and the Bank). Mr. Belden has been President and Chief Executive Officer of the Company and the Bank since October 1, 1992. Mr. Belden was formerly Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to 1992 and prior thereto served as President, Community Banking, for First Bank System, Minneapolis, Minnesota, a multi-state bank holding company.David G. Wallace (Treasurer of the Company; Executive Vice President and Chief Financial Officer of the Bank). Mr. Wallace became Vice President and Chief Financial Officer of the Bank and Treasurer of the Company in November 1988 and Senior Vice President and Chief Financial Officer of the Bank in August 1991. He assumed his current position in February 2000.Michael A. Patton (President, Financial Services). Mr. Patton was the President and Chief Executive Officer of The Exchange National Bank, a former subsidiary of the Company, from 1984 until January 1992, when, in connection with the consolidation of the Company's five subsidiary banks into Community Bank, N.A., he was named President, Southern Region. He assumed his current position in February 2000.James A. Wears (President, Banking). Mr. Wears served as Senior Vice President of the St. Lawrence National Bank, a former subsidiary of the Company, from 1988 through January 1991 and as President and Chief Executive Officer from January 1991 until January 1992. Following the January 1992 consolidation of the Company's five subsidiary banks into Community Bank, N.A., Mr. Wears was named President, Northern Region. He assumed his current position in February 2000.David J. Elias (President, Chief Executive Officer, and Chief Investment Officer, Elias Asset Management, Inc.). Mr. Elias assumed his present position in April 2000 when his company, Elias Asset Management, Inc., was purchased by Community Bank System, Inc.Part IIItem 5. Market for the Registrant's Common Stock and Related Shareholder MattersThe common stock has been trading on the New York Stock Exchange under the symbol "CBU" since December 31, 1997. Prior to that, the common stock traded over-the-counter on the NASDAQ National Market under the symbol "CBSI" beginning on September 16, 1986. The following table sets forth the high and low prices for the common stock, and the cash dividends declared with respect thereto, for the periods indicated. ___ The prices do not include retail mark-ups, mark-downs or commissions. There were 6,993,459 shares of common stock outstanding on December 31, 2000 held by approximately 1,866 registered shareholders of record, and approximately 2,580 shareholders whose shares are held in nominee name at brokerage firms and other financial institutions. COMMON STOCK PERFORMANCE NYSE Symbol: CBU Newspaper Listing: CmntyBkSys Market (Bid) Price High Low Closing Price Quarterly ----------------------------- Year / Price Price Amount % Change Dividend Qtr 2000 4th $25.94 $22.15 $24.75 -4.6% $0.27 3rd $26.03 $21.88 $25.94 16.9% $0.27 2nd $24.13 $22.00 $22.19 -2.7% $0.25 1st $23.38 $20.25 $22.81 -1.4% $0.25 1999 4th $27.19 $22.81 $23.13 -15.5% $0.25 3rd $28.44 $24.38 $27.38 7.9% $0.25 2nd $28.00 $22.63 $25.38 6.6% $0.23 1st $32.63 $23.81 $23.81 -16.6% $0.23 The Company has historically paid regular quarterly cash dividends on its common stock, and declared a cash dividend of $0.27 per share for the first quarter of 2001. The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the common stock, as well as to make payment of regularly scheduled dividends on the trust preferred stock as and when due, subject to the Company's need for those funds. However, because substantially all of the funds available for the payment of dividends by the Company are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations. See "Supervision and Regulation -- Limits On Dividends and Other Payments."Item 6. Selected Financial DataThe following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five year period ended December 31, 2000. The historical "Income Statement Data" and historical "End of Period Balance Sheet Data" are derived from the audited financial statements. The "Per Share Data", "Selected Ratios" and "Other Data" for all periods are unaudited. All financial information in this table should be read in conjunction with the information contained in "Capitalization," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K.SELECTED CONSOLIDATED FINANCIAL INFORMATIONYears ended December 31, -------------------------------------------------------------- 2000 1999 1998 1997 1996 --------------------------------------------------------------Income Statement Data:Interest income $145,221 $123,888 $122,938 $117,628 $97,688 Interest expense 74,012 55,947 58,543 54,752 42,422 Net interest income (Excl. FTE) 71,209 67,941 64,395 62,876 55,266 Provision for possible loan losses 7,182 5,136 5,123 4,480 2,897 Net interest income after provision for for possible loan losses 64,027 62,805 59,272 58,396 52,369 Non-interest income 20,989 15,487 17,040 11,808 8,874 Non-interest expense 55,989 52,734 51,876 45,799 37,450 Cumululative effect of change in 0 0 328 0 0 accounting principle Income before income taxes 29,027 25,558 24,764 24,406 23,793 Provision for income taxes 8,708 7,923 9,036 8,844 9,660 Net income $20,319 $17,635 $15,728 $15,562 $14,133End of Period Balance Sheet Data:Total assets $2,022,635 $1,840,702 $1,680,689 $1,633,742 $1,343,865 Loans, net of unearned discount 1,098,726 1,009,223 917,220 843,212 652,474 Earning assets (Excl. MVA) 1,849,375 1,686,605 1,503,549 1,450,429 1,229,443 Total deposits 1,457,730 1,360,306 1,378,066 1,345,686 1,027,213 Long-term debt 180,000 70,000 70,000 25,000 100,000 Trust securities 29,824 29,817 29,810 29,804 0 Shareholders' equity 139,376 108,487 120,165 118,012 109,352Average Balance Sheet Data:Total assets $1,914,570 $1,723,242 $1,670,624 $1,491,920 $1,251,826 Loans, net of unearned discount 1,056,229 951,167 884,751 749,596 602,717 Earning assets (Excl. MVA) 1,779,473 1,572,356 1,512,175 1,363,703 1,147,455 Total deposits 1,424,238 1,369,270 1,396,700 1,213,793 1,032,169 Long-term debt 111,568 70,000 89,805 79,863 57,006 Trust securities 29,824 29,814 29,810 27,290 0 Shareholders' equity 115,731 115,876 120,936 110,689 103,398Common Per Share Data:Net income (diluted) $2.85 $2.42 $2.05 $2.02 $1.83 Cash dividend declared 1.04 0.96 0.86 0.76 0.69 Period-end book value - stated 19.93 15.30 16.47 15.56 14.03 Period-end book value - tangible 12.64 8.32 9.01 7.82 9.85 Common Outstanding Shares: Average during period (Incl. common 7,102,123 7,213,394 7,670,711 7,676,326 7,482,518 stock equivalents) End of period (Excl. common stock 6,993,459 7,092,259 7,296,453 7,586,512 7,474,406 equivalents) Selected Ratios: Return on average total assets 1.06% 1.02% 0.94% 1.04% 1.13% Return on average shareholders' 17.56% 15.22% 13.01% 14.09% 13.88% equity (Excl. preferred stock) Common dividend payout ratio 35.98% 39.05% 41.15% 37.30% 37.27% Net interest margin (taxable 4.29% 4.59% 4.31% 4.64% 4.86% equivalent basis) Noninterest income to average assets 1.10% 0.90% 1.02% 0.79% 0.71% Noninterest income to operating 21.70% 18.30% 19.00% 15.30% 13.60% income Efficiency ratio 52.60% 53.90% 58.50% 55.00% 53.40% Non-performing loans to period-end 0.55% 0.57% 0.43% 0.49% 0.44% total loans Non-performing assets to period-end total loans and other real estate owned 0.65% 0.67% 0.56% 0.60% 0.55% Allowance for loan losses to 1.33% 1.33% 1.36% 1.47% 1.25% period-end loans Allowance for loan losses to 240.40% 234.93% 312.12% 297.96% 285.58% period-end non-performing loans Allowance for loan losses to 205.80% 199.70% 234.60% 246.02% 224.33% period-end non-performing assets Net charge-offs (recoveries) to 0.57% 0.44% 0.58% 0.50% 0.29% average total loans Average net loans to average total 74.16% 69.47% 63.35% 61.76% 58.39% deposits Period-end total shareholders' 6.89% 5.89% 7.15% 7.22% 8.14% equity to period end assets Tier I capital to risk-adjusted 9.06% 9.28% 9.24% 9.28% 10.70% assets Total risk-based capital to 10.25% 10.50% 10.49% 10.53% 11.83% risk-adjusted assets Tier I leverage ratio 5.79% 5.80% 5.71% 5.67% 5.88%Item 7. Management's Discussion and Analysis of Financial Condition and Results ofOperationsThis Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements with respect to the financial condition, results of operations and business of Community Bank System, Inc. ("CBSI" or "the Company"). These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set herein under the caption "Forward-Looking Statements." The following discussion is intended to facilitate an understanding and assessment of significant changes in trends related to the financial condition of the Company and the results of its operations. The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Information and the Company's Consolidated Financial Statements and related notes thereto appearing elsewhere in this Form 10-K. All references in the discussion to financial condition and results of operations are to the consolidated position and results of the Company and its subsidiaries taken as a whole.Net Income and ProfitabilityNet income and diluted earnings per share reached record highs in 2000 of $20.3 million and $2.85, respectively. Compared to 1999, net income rose 15.2% while earnings per share were up 17.8%. The Company's share repurchase program continued to benefit earnings per share growth; since its inception in the fall of 1998, 648,100 shares or 8.5% of shares outstanding have been bought back, the most recent purchase having been made on June 19, 2000. Subsequent to year end, the repurchased shares were reissued in conjunction with the acquisition of the Citizens National Bank of Malone. Cash earnings per share (diluted) also reached record levels in 2000, up 16% to $3.23. Cash or tangible return on assets (ROA) for 2000 was 1.21% versus nominal ROA at 1.06%. Tangible return on equity (ROE) for the year climbed 2.37 percentage points over 1999's level to 19.94%, exceeding nominal ROE by 2.38 percentage points for the same period and placing the Company's performance in the top quartile of its regional peer banks. The difference between cash and nominal results reflects the contribution of the Company's acquisitions on an economic basis, which excludes the non-cash impact of amortizing the premiums paid for the acquisitions. Many analysts and investors consider cash results a better measure of core profitability and value created for shareholders than nominal results. 2000's recurring or core earnings were up 11.5% from last year to $20.4 million after removing the impact of one-time income and expense items. Items excluded relate to investment gains and losses and expense associated with branch properties no longer in use. The primary factors explaining 2000's improvement are explained in detail in the remaining sections of this document and are summarized as follows: o Net interest income (full tax-equivalent basis) increased 4.8% or $3.3 million due to a $207 million increase in average earning assets. Average loans grew $105 million (11.0%) while average investments also grew $102 million (16.4%). The growth in earning assets was funded by $142 million (64.4%) more in average borrowings and $54 million (4.0%) more in average deposits. However, the net interest margin decreased by a significant 30 basis points to 4.29% on average. o Total noninterest income increased by $5.5 million (35.5%) from 1999 to $21.0 million. Financial services accounted for $4.3 million of the improvement in noninterest income, with $3.1 million being attributable to the purchase of Elias Asset Management (EAM) on April 3, 2000. Revenues excluding net investment gains (losses) and the impact of branch properties no longer in use were up nicely for the sixth consecutive year to approximately $21.2 million in 2000, a $5.1 million (31.5%) improvement. o Noninterest expense or overhead rose $3.3 million or 6.2% in 2000 compared to $857,000 or 1.7% in 1999. Excluding the $2.1 million impact of the EAM purchase, noninterest expense was up $1.1 million or 2.1% in 2000. The primary sources of the increase were personnel expense, up $1.2 million or 4.6%, with the balance largely residing in higher data processing expense and greater depreciation and equipment expense. The bulk of these latter increases reflect additional expenditures related to conversion of the Company's check processing operations to image processing during the second and third quarter of the year. Professional fees were also lower. o Loan loss provision expense rose $2.0 million or 39.8% over 1999's level. The full year loan loss provision covered total actual net charge-offs by 1.20 times, this margin serving as a precaution in the event the Upstate New York economy weakens after its long sustained period of relative economic health. Net charge-offs as a percent of average loans increased 13 basis points in 2000 to .57%. The higher level of provision was in part due to what management believes to be two isolated and unusual commercial loan charge-offs in 2000. Nonperforming loans decreased during 2000 to .55% of loans outstanding at year end compared to .57% one year earlier. o The Company's combined effective federal and state tax rate decreased one percentage point this year to 30.0% as a result of an increased proportion of tax-exempt municipal investment holdings and continued effective tax planning strategies. The above combination of factors resulted in a level of profitability which may be compared to that of CBSI's peer bank holding companies; this group is comprised of 155 companies nationwide having $1 billion to $3 billion in assets based on data through September 30, 2000 (the most recently available disclosure) as provided by the Federal Reserve System. Through year-to-date September, the Company's return on average assets (ROA) was 1.08% compared to the peer norm of 1.11%. Shareholder return on equity (ROE) at 18.17% for the same period ranked higher than the peer norm of 13.85%, placing it in the 80th peer percentile. The Company's primary performance focus is on achieving returns to shareholders and is better measured by ROE than ROA. For the full year 2000, earnings per share (diluted) rose $.43 over 1999 to a record $2.85. The first three-quarters of 2000 at $.70, $.72 and $.72 per share exceeded the same 1999 quarters by $.20, $.17, and $.04, respectively. Fourth quarter earnings per share at $.70 exceeded the same 1999 period by $.01.Selected Profitability and Other MeasuresReturn on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows: At December 31, -------------------------------------------- 2000 1999 1998 -------------------------------------------- Percentage of net income to average total assets 1.06% 1.02% 0.94% Percentage of net income to average 17.56% 15.22% 13.01% shareholders equity Percentage of dividends declared per common share 35.98% 39.05% 41.95% to net income per common share Percentage of average shareholders' equity to 6.04% 6.72% 7.24% average total assetsNet Interest IncomeNet interest income is the amount that interest and fees on earning assets (loans and investments) exceeds the cost of funds, primarily interest paid to the Company's depositors, interest on capital market and bank borrowings, and dividends paid on the Company's $30 million in 9.75% trust preferred stock. 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. Net interest income (with non-taxable income converted to a full tax-equivalent basis) totaled $76.4 million in 2000; this represents a $4.1 million or 5.7% increase over the prior year. The increase was due both to higher earning asset volumes, which had a positive impact on net interest income of $9.1 million, while interest rate changes had an unfavorable impact of $5.0 million. With regard to the components of 2000's net interest income, greater average earning assets of $207.1 million helped contribute $17.4 million of the $22.2 million or 17.3% rise in interest income; higher yields explain the remainder of the increase. Average loans grew a total of $105.1 million in 2000, with the most significant portion occurring in the first half of the year. Overall interest and fees on loans climbed $11.8 million or 13.8% as a result of this growth and a 22 basis point (BP) increase in loan yields to 9.20%, which was caused by rising market rates during the latter part of 1999 and the first half of 2000. This rate environment also produced investment portfolio buying opportunities resulting in a $102.1 million increase in average investments. Investment interest income in 2000 was $10.4 million higher than the prior year as a result of the higher outstandings as well as an increase in the average investment yield from 6.88% to 7.35%. Rising market rates in the latter half of 1999 and first half of 2000 increased the yield on new investments and were the primary cause of the increase in average investment yield. Through September 30, 2000, the Company's loan yield was in the favorable 66th peer bank percentile while the investment yield was in the most favorable 96th percentile. The average earning asset yield rose 30 basis points to 8.45% in 2000 because of the aforementioned increase in investment and loan yields, partially offset by a reduced mix of loans to earning assets. The average ratio of loans to earning assets decreased from 60.5% in 1999 to 59.4% in 2000 as a consequence of increased investment opportunities and a slowing demand for new automobile purchases. Total average fundings (deposits and borrowings) grew by $196.5 million in 2000, largely attributable to a $141.5 million increase in borrowings (used to fund purchases of investment securities and approximately 1/3 of loan growth), and $55.0 million more in deposits. Approximately 60% of the latter reflects higher deposits from individuals, partnerships, and corporations, reflective of greater checking account balances and our successful CD promotions, with the balance from increased deposits of municipalities. Higher average interest-bearing funds contributed $8.2 million of the $18.1 million total rise in interest expense, with the balance caused by an increase in the average 2000 cost of funds, which as a percentage of earning assets rose by 60 basis points (BPs) to 4.16%. The rate on interest bearing deposits rose 50 BPs to 4.27%, due largely to across-the-board increases in deposit rates beginning in the middle of 1999 and continuing throughout most of 2000 and a 59 BP higher borrowing rate reflecting rising market rates. Overall, through September 30, 2000, the Company's average cost of funds rate was slightly above the peer norm in the 60th peer bank percentile, compared to being in the 45th percentile through September 30, 1999. The 50 BP increase in the rate on average interest bearing deposits from 1999 to 2000, in addition to the 59 BP increase in the average borrowed funds rate, caused CBSI's net interest margin to decrease by 30 basis points from 4.59% in 1999 to 4.29% this year. The Company's net interest margin ranked in the favorable 64th peer bank percentile through September 30, 2000, an improvement from the 61th peer bank percentile through September 30, 1999. The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon for the twelve month periods ended December 31, 2000 and 1999. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations.Year Ended December 31,--------------------------------------------------------------------------------------- 2000 1999 1998 ------------------------------------------------------------------------------------- (000's omitted except Avg. Amt.of Avg. Avg. Amt.of Avg. Avg of Amt. Avg. yields and rates) Balance Interest Yield/ Balance Interest Yield/ Balance Interest Yield/Rate Rate Rate Paid Paid Paid ------------------------------------------------------------------------------------- ASSETS: Interest-earning assets: Federal funds sold $9,982 $581 5.82% $666 $33 4.95% $5,428 $296 5.46% Time deposits in 462 27 5.81% 129 5 4.24% 35 2 5.51% other banks Taxable investment 586,254 42,935 7.32% 521,912 35,519 6.81% 592,559 38,290 6.46% securities Nontaxable 26,546 9,610 7.59% 98,482 7,210 7.32% 29,402 2,308 7.85% investment securities Loans (net of 1,056,229 97,216 9.20% 951,167 85,408 8.98% 884,751 82,778 9.36% unearned discount) ------------------- -------------------- -------------------- Total 1,779,473 150,369 8.45% 1,572,356 128,175 8.15% 1,512,175 123,674 8.18% interest-earning assets Noninterest earning assets Cash and due from banks 57,073 62,399 57,913 Premises and equipment 26,226 24,747 24,412 Other Assets 84,905 79,467 83,048 Less:allowance for loans (14,214) (12,693) (12,282) Net unrealizedgains/(losses) on available-for-sale(18,893) (3,034) 5,376 portfolio ---------- ----------- ----------- Total $1,914,570 $1,723,242 1,670,642 ========== =========== =========== LIABILITIES AND SHAREHOLDERS EQUITY: Interest-bearing liabailities Savings deposits $487,766 $11,061 2.27% $513,544 $11,108 2.16% 508,731 $12,155 2.39% Time deposits 688,547 39,144 5.69% 619,851 31,666 5.11% 672,972 37,515 5.57% Short-term 219,794 14,356 6.53% 119,830 6,278 5.24% 13,915 754 5.42% borrowings Long-term borrowings 141,392 9,452 6.68% 99,814 6,895 6.91% 119,615 8,120 6.79% ------------------- -------------------- -------------------- Total 1,537,499 74,013 4.81% 1,353,039 55,947 4.13% 1,315,233 58,544 4.45% interest-bearing liabilities Noninterest bearing liabilities Demand deposits 247,925 235,875 214,997 Other liabilities 13,415 18,452 19,476 Shareholders' equity 115,731 115,876 120,936 ----------- ---------- ----------- Total $1,914,570 $1,723,242 $1,670,642 ========== =========== =========== Net interest earnings $76,356 $72,228 $65,130 ========= ========= ========= Net yield on 4.29% 4.59% 4.31% interest-earning assets ======== ======== ======== Federal tax exemption on nontaxable investment securities and loans $5,147 $4,286 $736 included in interest income As discussed above, the change in 2000 net interest income (full tax-equivalent basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category. ----------------------------------- ----------------------------------- 2000 Compared to 1999 1999 Compared to 1998 ----------------------------------- ----------------------------------- Increase (Decrease) Due to Increase (Decrease) Due to Change In (1) Change In (1) Net Net Volume Rate Change Volume Rate Change ------ ---- ------ ------ ---- ------ Interest earned on: Federal funds sold and securities purchased under $541 $7 $548 ($238) ($25) ($263) agreements to resell Time deposits in other banks 19 3 21 4 (1) 3 Taxable investment securities 4,585 2,831 7,416 (4,733) 1,962 (2,771) Nontaxable investment securities 2,122 278 2,400 5,068 (166) 4,902 Loans(net of unearned discounts) 9,626 2,182 11,808 6,051 (3,421) 2,630 Total interest-earning assets (2) $17,367 $4,826 $22,193 $4,907 ($406) $4,501 Interest paid on: Savings deposits ($571) $524 ($47) $114 ($1,161) ($1,047) Time deposits 3,706 3,772 7,478 (2,841) (3,008) (5,849) Short-term borrowings 6,234 1,844 8,078 5,550 (26) 5,524 Long-term borrowings 2,786 (229) 2,557 (1,366) 141 (1,225) Total interest-bearing $8,195 $9,871 $18,066 $1,648 ($4,245) ($2,597) liabilities (2) Net interest earnings (2) $9,096 ($4,969) $4,127 $2,657 $4,441 $7,098 (1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each. (2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components. The following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon for the three month periods ended December 31, 2000 and 1999. Interest income and resultant yield information in the tables are on a fully tax-equivalent basis using a marginal federal income tax rate of 35%. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest earnings for purposes of these computations. ------------------------------------------------------------------------- Fourth Quarters Ended December 31, ------------------------------------------------------------------------- 2000 1999 (000's omitted except yields Avg. Amt.of Avg. Avg. Amt.of Avg. and rates) Balance Interest Yield/Rate Balance Interest Yield/Rate Paid Paid ------------------------------------------------------------------------- ASSETS: Interest-earning assets: Federal funds sold $241 $4 6.40% $2,331 $29 4.99% Time deposits in other banks 470 8 6.57% 333 4 4.68% Taxable investment 615,650 11,444 7.39% 530,336 9,620 7.20% securities Nontaxable investment 128,618 2,400 7.42% 114,100 2,088 7.26% securities Loans (net of unearned 1,090,961 25,630 9.35% 997,212 22,684 9.02% discount) ------------ --------- ------------ --------- Total 1,835,940 $39,486 8.56% 1,644,312 $34,425 8.31% interest-earning assets Noninterest earning assets Cash and due from banks 56,985 68,289 Premises and equipment 26,820 25,431 Other Assets 87,203 76,925 Less:allowance for loans (14,602) (12,870) Net unrealized gains/(losses) on available-for-sale (9,052) (16,235) portfolio ----------- ------------ Total $1,983,294 $1,785,852 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabailities Savings deposits $482,387 $2,871 2.37% $498,084 $2,715 2.16% Time deposits 719,399 10,991 6.08% 623,904 8,075 5.13% Short-term borrowings 169,526 2,944 6.91% 197,979 2,733 5.48% Long-term borrowings 215,747 3,510 6.47% 99,816 1,744 6.93% ------------ --------- ------------ -------- Total 1,587,059 20,316 5.09% 1,419,783 15,267 4.27% interest-bearing liabilities Noninterest bearing liabilities Demand deposits 253,199 239,619 Other liabilities 18,260 15,947 Shareholders' equity 124,776 110,503 ----------- ------------ Total $1,983,294 $1,785,852 ============ ============ Net interest earnings $19,170 $19,158 Net yield on 4.15% 4.62% interest-earning assets ========== ============ Federal tax exemption on nontaxable investment securities included in $1,282 $1,163 interest income The changes in net interest income (full tax-equivalent basis) by volume and rate component for fourth quarter 2000 versus fourth quarter 1999 are shown below for each major category of interest-earning assets and interest-bearing liabilities. --------------------------------------------- 4th Quarter 2000 versus 4th Quarter 1999 --------------------------------------------- Increase (Decrease) Due to Change In (1) Net Volume Rate Change Interest earned on: Federal funds sold and securities purchased under ($69) $44 ($25) agreements to resell Time deposits in other 2 2 4 banks Taxable investment 1,557 267 1,824 securities Nontaxable investment 265 47 312 securities Loans (net of unearned 2,137 809 2,946 discounts) Total interest-earning $4,022 $1,039 $5,060 assets (2) Interest paid on: Savings deposits ($471) $627 $156 Time deposits 1,325 1,591 2,916 Short-term borrowings (1,936) 2,147 211 Long-term borrowings 2,539 (773) 1,766 Total interest-bearing $1,909 $3,140 $5,049 liabilities (2) Net interest earnings (2) $4,590 ($4,579) $11 (1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each. (2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components.Noninterest IncomeThe Company's sources of noninterest income are of four primary types: financial services, comprised of personal trust, employee benefit trust, investment, and insurance products; specialty products, largely electronic, and mortgage banking activities; general banking services related to loans, deposits and other activities typically provided through the branch network; and periodic transactions, most often net gains (losses) from the sale of investments or other occasional events. Total noninterest income in 2000 increased by 35.5% to $21.0 million, largely due to the addition of Elias Asset Management (EAM) in April. Combined revenues, excluding investment gains and losses, were up strongly for the sixth consecutive year to approximately $21.1 million in 2000, a $5.0 million or 31.0% improvement over 1999. Fees from the financial services segment of noninterest income rose 72.6% in 2000 to $10.1 million compared to 11.7% growth in the prior year. Over the last five years, financial services revenues have climbed at a compound annual growth rate of nearly 37%, and for 2000 as a whole, comprise over 48% of total noninterest income, excluding net investment securities gains (losses). The increase in 2000's growth rate largely reflects the previously mentioned EAM acquisition, without which financial services revenues would have nonetheless climbed 20%. Overall, financial services contributed $3.0 million or 10.5% of the Company's pretax net income this year (before allocation of indirect corporate expense) reflecting nearly a 30% return on revenue. In 1999, the net income contribution was $1.8 million or 6.9%, with a return on revenue also of 30%. Assets under management from the Company's several financial services businesses reached $1.28 billion in 2000 compared to $583 million in the prior year, largely reflective of the addition of Elias Asset Management. Revenues and assets under management from these financial segments are as follows: o Fees from personal trust services were $1.4 million, up 9.9% in 2000 as compared to a 9.0% increase in 1999. Recurring trust fees (excluding periodic estate fees) related to individual investment management accounts and annual trust administration (together representing 89% of personal trust income) grew a combined 5.9%. Personal trust assets under management reached nearly $172 million by year end, up approximately .5% over the prior twelve months. Greater focus on business development, including pro-active integration of its major referral sources--the Company's twelve Financial Consultants; its Benefit Plans Administrative Services subsidiary; its newly acquired asset management subsidiary, Elias Asset Management, Inc. (see below); and the CBNA branch network--is expected to accelerate future fiduciary income growth. o Revenue from record keeping and consulting services provided by Benefits Plans Administrative Services, Inc. (acquired in July 1996), combined with investment management services through the Bank's employee benefits trust division (EBT), totaled $3.0 million in 2000 compared to $2.6 million in 1999, a 15.7% increase. Retirement plan assets reached nearly $267 million at year-end 2000, up 16.3% over 12 months earlier. During 2000, BPA formed marketing alliances with several mutual fund companies and third party brokers. These relationships contributed to a 700% increase in sales activity in the fourth quarter over the same period in 1999. The Company's market continues to grow from a local base to plan sponsors situated in the urban centers of New York State and beyond. Twenty-five percent of all new account activity in 2000 involved defined contribution administration and custodial services for companies in Puerto Rico. BPA/EBT supports defined benefit 401(k), 403(b)(7), 457, ESOP and other forms of daily valuation defined contribution plans, enhancing these products with voice response and transactional web services. o 2000 is the seventh year in which CBSI has offered mutual funds, annuities, and other investment products through Financial Consultants (FCs) situated in various locations throughout the Bank's branch network. Commission income from this source grew 41% in 2000 to $1.8 million, compared to nominal growth in 1999 of 6.5%. Theseproducts and services have been delivered since March of 1999 through the Company's own broker-dealer, Community Investment Services, Inc. (CISI), having been previously been provided in partnership with a third party which guided the Company in becoming established in the business beginning in mid-1994, PrimeVest Financial Services, Inc. of Saint Cloud, Minnesota. In late 1999 and in the fall of 2000, CISI established two stand-alone brokerage offices in Lockport and Jamestown, NY, respectively. These offices are staffed with professionals attracted from larger brokerage companies, who have brought much of their books of business to CISI. During the last five years, commission income from the sale of mutual funds and related products have grown at an annual compound growth rate of over 30%. Assets under management of CISI reached $220 million by year-end 2000, up $37 million or 20% over the prior twelve months. o Community Bank has long been in the business of selling creditor life and disability insurance to installment and mortgage loan customers through its branch system. Revenues from this activity, including the Bank's annual dividend from the New York State Bankers life insurance subsidiary through which the creditor life insurance is written, plus commissions generated by the sale of insurance products through the Company's Financial Consultants, amounted to $845,000 in 2000, up 16.1% over last year. The latter insurance products are distributed through Community Financial Services, Inc. (CFSI), established in mid-1998 with a focus on the sale of long-term health care and other selected insurance vehicles. o Lastly, revenues from Elias Asset Management (EAM), purchased on April 3, 2000, reached $3.09 million this year, up from $2.46 million or nearly 26% from the comparable nine month period in 1999 when EAM was an independently-owned company. Its customer base is approximately 52% individuals, followed by 22% corporations, and 26% largely for trusts, foundations, endowments, and estates. Despite unfavorable market conditions during the year, as reflected by a 9.1% decrease in the Standard & Poor's 500 index, total assets under management ended 2000 at $624 million, down 4.3%. This reflects net new business of $56 In addition to its financial services businesses, another segment of the Company's noninterest income is its specialty products, which largely include electronic products and mortgage banking and servicing activities. These activities in 2000 contributed 9.1% of noninterest income, excluding net investment securities gains (losses). Total revenues were $1.93 million, up 4.9% from $1.84 million in 1999, largely due to increased electronic product revenues as discussed below. Over the last five years, specialty product revenues have grown at an annual compound growth rate of nearly 36%. o Fees earned from electronic products reached $1.6 million this year, up 16% from 1999. This increase was primarily due to the Company's Visa(TM) affiliation, which rose to $1.1 million, reflecting continued growth of Visa Check Card revenues (climbing 29%) and ATM surcharge income, increasing 7% to $474,000. Visa merchant discount fees fell 3.3% in 2000. o Mortgage banking fees were $293,000 in 2000, down from $403,000 in the prior year. The primary reason for the decrease was the sharp reduction in loans sold to $9.2 million from $37.0 million in 1999, when the purchase money mortgage and refinancing market was much more favorable. This change is reflected in a reduction in the incremental increase in mortgage servicing rights from $239,000 in 1999 to $33,000 this year, partially offset by gains on loans sold of $39,000 this year versus a loss of $29,000 last year. Loan servicing fees were $221,000 in 2000, up 14.5% from the previous year on a serviced loan portfolio of approximately $90 million, consisting of about 1,521 loans. o Thirdly, the Company established a relationship in 1999 with a national, third-party leasing company, Synergy Resources of Bloomington, Minnesota, which pays referral commissions on leases booked for CBNA customers. Revenues, largely from small equipment leases, were $41,000 this year, down from 1999's level of $59,000. Customers may submit applications by telephone, fax, or the Internet. The second and previously largest segment of the Company's recurring noninterest income is the wide variety of fees earned from general banking services, which reached $9.0 million in 2000, up 7.9% from the prior year. This segment contributed 43% of noninterest income, excluding net investment securities gains (losses). The increase in these revenues is generally in the single digit range because they are largely dependent on deposit growth and expansion of services provided through CBNA's branch network. However, the Company's branch acquisitions beginning in 1994 have resulted in a five-year annual compound growth rate in these revenues of nearly 17%. o Service charges on deposit accounts and overdraft fees increased to $7.2 million in 2000, a 9.0% growth rate compared to a 5.6% growth rate in 1999. This year's improvement reflects a $630,000 increase in overdraft fees, reflective of the full-year impact of price increases which took place in the fourth quarter of 1999. o General commissions and miscellaneous income at $1.9 million were up 4.2% in 2000. This increase is attributable to approximately $71,000 more in Canadian exchange revenues and $45,000 additional earnings on a service in conjunction with SEI Investments, which "sweeps" the excess checking account deposits of commercial customers into an interest-bearing overnight investment instrument. Income from periodic transactions in 2000 largely includes $212,000 in losses taken on $11.6 million in investment sales, with the net proceeds reinvested at higher yields to achieve greater resulting cash flows than had the securities been held to maturity. This amount compares to losses of $638,000 million last year on a combined $14.6 million in investment sales. The investment gains and losses taken over the last two years are illustrative of the Company's active management of its investment portfolio to achieve a desirable total return and a targeted level of combined interest income and securities gains (losses) across financial market cycles. Other amounts of periodic income in 2000 were $111,000 compared to $47,000 in the prior year; this was largely due to gains on the sale of branch property and other miscellaneous assets in the normal course of business. Noninterest income, excluding transactions related to investment securities and disposal of branch properties, as a percent of operating income was 21.7% in 2000, an increase of 3.4 percentage points from the prior year. Since 1994, this ratio has risen 9.7 percentage points from 12.0%, resulting from a focused effort to raise product revenues less susceptible to interest rate fluctuation. Compared to peers as of September 30, 2000, this ratio increased to the 58th peer percentile, up from the 47th percentile in 1999. In light of management's ongoing objective to grow noninterest income, opportunities to develop new fee-based products are actively pursued, including newly permitted activities under the 1999 Financial Modernization Act; in addition, emphasis continues on the collection of fees (minimizing limitation on waived fees) for providing quality service. In an effort to focus on and accelerate growth of the Company's financial service businesses, Michael. A. Patton, who has headed for many years the Bank's trust department and Financial Consultant activities along with general banking activities in the Southern Region, was named President, Financial Services, in February 2000. The following table sets forth selected information by category of noninterest income for the Company for the years and quarters indicated. ------------------------------------------------- (000's omitted) Years ended December 31, Quarters ended December 31, ----------------------------- ----------------- 2000 1999 1998 2000 1999 ----- ----- ----- ----- ----- Personal trust $1,418 $1,290 $1,183 $410 $328 EBT/BPA 2,992 2,586 2,333 777 594 Elias Asset Management 3,091 0 0 1,052 0 Insurance 845 728 518 92 83 Other investment products 1,788 1,268 1,222 468 346 ------------------------------------------------- Total financial services 10,134 5,872 5,256 2,799 1,351 Electronic banking 1,595 1,379 1,140 386 407 Mortgage banking 293 403 737 58 36 Commercial leasing 41 59 0 9 14 ------------------------------------------------- Total specialty products 1,929 1,841 1,877 453 457 Deposit service charges 3,331 3,373 3,246 827 851 Overdraft fees 3,827 3,197 2,975 971 841 Commissions 1,869 1,795 1,473 469 408 ------------------------------------------------- General banking services 9,027 8,365 7,694 2,267 2,100 Miscellaneous revenue 30 47 473 3 (12) ------------------------------------------------- Total noninterest income excl. security gains/losses 21,120 16,125 15,300 5,522 3,896 Security gains/losses (a) (212) (638) 2,287 0 (416) Disposition of branch properties 81 0 (219) 81 0 ------------------------------------------------- Total noninterest income 20,989 15,487 17,368 5,603 3,480 Noninterest income as a percentage of operating income (excludes net securities gains (losses) and disposal of branch properties) 21.7% 18.3% 19.0% 22.4% 16.9% (a) includes $327,000 of investment gains on securities sold upon adoption of FAS 133 in third quarter 1998.Noninterest ExpenseNoninterest expense or overhead rose $3.3 million or 6.2% in 2000 compared to $857,000 or 1.7% in 1999. Excluding the $2.1 million impact of the April purchase of Elias Asset Management (EAM), noninterest expense was up $1.1 million or 2.1% in 2000. This year's overhead of $56.0 million as a percent of average assets was 2.92%, down from 3.06% in 1999; however, the ratio remains in the peer normal 50th percentile. Excluding amortization of intangible assets, which is a significant non-cash expense for the Company and virtually non-existent for its peer group, CBSI's noninterest expense ratio was 2.68% in 2000 compared to 2.95% for peers. For CBSI as a whole, higher personnel expense accounted for over 75% of 2000's increase in overhead, with personnel costs being up 9.3% as a result of the EAM acquisition versus rising 2.5% in 1999. The remainder of the increases in salary, benefit, and payroll tax expenses reflect modest annual merit awards for employees. Total full-time equivalent staff at year-end 2000 was 701 versus 711 at year-end 1999, down as the result of attrition and several cost saving initiatives during the year. These initiatives included consolidation of the Company's collection, indirect installment loan approval, mortgage servicing, and first-day deposit operations functions, all of which were previously performed in each of the Canton and Olean, NY operations or administrative centers. Nonpersonnel expense rose $809,000 or 3.1% this year as opposed to a $219,000 or 0.8% increase in 1999. This was largely caused by increases in data processing, up $495,000 or 12.5%; depreciation on equipment, up $170,000 or 5.8%; and office supplies, up $178,000 or 14.6%. These increases were partially offset by lower professional fees, down $41,000 or 2.1%. The bulk of the increase in data processing relates to an accounting classification change that now considers processing charges related to the Company's broker-dealer as a separate expense versus previously applying it against revenue. Depreciation on equipment rose due to the full year impact of purchases of new computers (replacements because of required Year 2000 upgrades), installation of check reader/sorters for the Olean and Canton, NY operations centers, and conversion to an image-based check processing system for the Northern Markets of the Company in mid-2000. Implementation of the image system for the Southern Markets followed later in the year, and depreciation on this phase will begin in 2001. Most of the remaining increases in these non-personnel areas reflects additional expenditures--some one-time--related to the conversion of the Company's check processing operations to image processing. The efficiency ratio is defined at two levels. The nominal ratio is total overhead expense divided by operating income (full tax-equivalent net interest income plus noninterest income, excluding net securities gains and losses). The adjusted or recurring efficiency ratio additionally excludes one-time expense and intangible amortization (a non-cash expense) as well as all one-time noninterest income; over the last five years, these one-time items have related to the disposal of branch properties. The lower the ratio, the more efficient a bank is considered to be. In 2000, the nominal efficiency ratio decreased 2.3 percentage points to 57.4% while the recurring ratio decreased 1.3 percentage points to 52.6%. Management believes it is more meaningful to use the recurring ratio to compare to national norms, because as mentioned above, most of the Company's peers do not have intangible expense to the significance that CBSI has. On that basis, CBSI's ratio is more favorable than the peer bank ratio of 60.6% based on data available as of September 30, 2000. The improvement in the 2000 efficiency ratio is a function of several factors: an increase in net interest income due to higher earning assets and reduced premium amortization on the Company's CMO securities, steady progress in developing more sources of noninterest income (cost recovery and penalty fees on the banking side of the business having the greatest impact on the ratio), and persistent control of overhead expense. Excluding the Company's financial services businesses, which by their nature carry a higher efficiency ratio (67.9% in 2000), the efficiency ratio was 50.8% for the year. While the Company's expense ratios have generally been favorable, management maintains a heightened focus on controlling costs and eliminating inefficiencies. Areas for improvement have been identified through detailed peer comparisons, a bank-wide program of employee involvement, targeted use of outside consultants, and review of productivity-enhancing technology. These combined efforts are intended to offset pressure from future price increases and higher transaction volumes and enable the Company to more fully benefit from economies of scale as it continues to grow. Specifically, the Bank benefited for the entirety of 2000 from the creation of its broker-dealer subsidiary during the first quarter of 1999, which brought down the expense of processing mutual funds and related products, and partially in 2000 from the overhead savings from the aforementioned conversion of the Company's check processing operations to image during the second and third quarter of this year. Also contributing to better productivity and control during 2000 were consolidation of the Company's collection, indirect installment loan approval, mortgage servicing, and first-day deposit operations functions, all of which were previously performed in each of the Canton and Olean, NY operations or administrative centers. The following table sets forth information by category of noninterest expense of the Company for the years and quarters indicated. -------------------------------- -------------------- (000's omitted) Years ended December 31, Quarters ended December 31, -------------------------------- -------------------- 2000 1999 1998 2000 1999 ----- ----- ----- ----- ----- Personnel expense $28,834 $26,388 $25,750 $7,456 $6,654 Net occupancy expense 3,959 3,919 4,056 1,006 936 Equipment expense 3,677 3,465 3,501 906 888 Professional fees 1,896 1,937 2,142 458 404 Data processing expense 4,450 3,955 3,928 1,089 1,078 Amortization of intangibles 4,670 4,615 4,640 1,187 1,149 Stationary and supplies 1,396 1,218 1,344 333 307 Deposit insurance premiums 278 183 189 69 46 Other 6,829 7,053 6,326 1,726 1,599 --------- --------- --------- --------- --------- Total noninterest expense $55,989 $52,733 $51,876 $14,230 $13,061 Total operating expenses 2.92% 3.06% 3.11% 2.85% 2.90% as a percentage of average assets Efficiency ratio (1) 52.6% 53.9% 58.5% 52.8% 51.7% (1) Noninterest expense excluding nonrecurring items and amortization of deposit intangibles divided by operating income excluding all nonrecurring items.Income and Income TaxesIncome before tax in 2000 was $29.0 million, up 13.6% over the prior year's amount. When income is recast as if all tax-exempt revenues were fully taxable on a federal basis, 2000's results rose by $4.3 million or 14.5% to $34.2 million before tax. The main reasons for improved pretax earnings were the favorable $4.1 million increase in net interest income (full tax-equivalent basis) related to strong earning asset growth (up 13.2% or $207.1 million on average), a $5.1 million or 31.5% climb in noninterest income, excluding net securities gains (losses), and a $426,000 reduction in securities losses compared to the prior year (see Investments section of this report). These factors were partially offset by a $3.3 million (6.2%) increase in overhead expense (largely relating to the Elias Asset Management acquisition), and a $2.0 million increase (39.8%) in loan loss provision expense as a result of two unusual and isolated commercial loans that were written down during the last half of 2000. The Company's combined effective federal and state tax rate decreased one percentage point this year to 30.0%. The decrease resulted from effective tax planning, principally because of increased purchases of tax-exempt municipal investments and other income during the year.CapitalShareholders' equity ended 2000 at $139.4 million, up 28% from one year earlier. This improvement reflects earnings for the year and the positive change in market value adjustment (MVA) of the Bank's available-for-sale investments, offset by dividends paid to shareholders and the cost of repurchasing 100,000 shares of CBU common stock during 2000. The Company's stock buy-back program, under which 648,100 shares have been acquired as Treasury stock, representing 8.5% of the shares outstanding prior to the inception of the program in late summer 1998, reflects the Company's belief that its common stock is an excellent investment and that the financial markets are not fully valuing its strong banking franchise. Excluding the MVA and purchase of Treasury stock in both 1999 and 2000, capital rose by $13.0 million or 9.6%. Shares outstanding fell by 99,000 during the year due to the aforementioned repurchase of stock offset by the exercise of stock options. Subsequent to year end, the repurchased shares were reissued in conjunction with the acquisition of the Citizens National Bank of Malone. Despite the repurchase of stock, the ratio of tier I capital to assets (or tier I leverage ratio), the basic measure for which regulators have established a 5% minimum to be considered "well-capitalized," remains sound at 5.79%, virtually unchanged from one year ago. The total capital to risk-weighted assets ratio decreased 33 basis points during 2000 to 10.25% as of year end compared to the 10% minimum requirement for "well-capitalized" banks. The Company is confident that capital levels are being prudently balanced between regulatory and investor perspectives. Cash dividends declared on common stock in 2000 of $7.3 million represented an increase of 6.2% over the prior year. This growth largely reflects a two cent per share increase in the quarterly common stock dividend beginning in the third quarter of 2000 from $.25 to $.27. This marks the ninth consecutive year of dividend increases, which have resulted in an 11.8% compound annual growth rate over that time period. Raising the Company's expected annualized dividend to $1.08 per common share reflects management's confidence that earnings strength is sustainable and that capital can be maintained at a satisfactory level. The dividend pay-out ratio for the year was 36.0% compared to 39.0% and 41.2% in 1999 and 1998, respectively, now at the mid-point of the Company's targeted pay-out range for dividends on common stock of 30-40%. Its pay-out ratio has historically been strong relative to peers. During the 1995-1998 period, the pay-out, including preferred dividends, ranged from the 66th to 74thpercentile. For 2000 and 1999, the ratio has been in the 58th and 61st peer percentile, respectively.LoansThe amounts of the Bank's loans outstanding (net of deferred loan fees or costs) at the dates indicated are shown in the following table according to type of loan: As of December 31, ----------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------------------------------------------------------------- Real estate mortgages: Residential $379,040 $334,104 $266,841 $278,912 $225,088 Commercial loans secured by 135,545 120,926 124,828 85,962 56,959 real estate Farm 19,850 17,652 12,486 10,434 8,296 ----------------------------------------------------------------- Total 534,435 472,682 404,155 375,308 290,343 Commercial, financial, and agricultural: Agricultural 26,489 27,722 22,691 23,894 21,689 Commercial and financial 181,877 171,660 168,984 138,067 99,445 ----------------------------------------------------------------- Total 208,366 199,382 191,675 161,961 121,134 Installment loans to individuals: Direct 113,353 112,698 105,480 89,138 62,176 Indirect 227,645 221,593 205,159 198,853 171,583 Student and other 1,131 1,545 6,477 10,880 9,635 ----------------------------------------------------------------- Total 342,129 335,836 317,116 298,871 243,394 Other Loans 14,205 2,043 5,581 8,887 3,496 ----------------------------------------------------------------- Gross Loans 1,099,135 1,009,943 918,527 845,027 658,367 Less: Unearned discounts 409 720 1,307 1,815 5,893 ----------------------------------------------------------------- Net loans 1,098,726 1,009,223 917,220 843,212 652,474 Reserve for possible 14,614 13,421 12,441 12,434 8,128 loan losses ----------------------------------------------------------------- Loans, net of loan loss reserve $1,084,112 $995,802 $904,779 $830,778 $644,346 Loans outstanding, net of unearned discount, reached a record $1,099 million as of year-end 2000, up over $89.5 million or 8.9% compared to twelve months earlier. About 27% of 2000's growth came from 20 branches acquired in mid-1997 from Key Bank, N.A. and Fleet Bank, with a like amount coming from the 12 branches (net of three subsequently sold) purchased from Chase Manhattan Bank in mid-1995. Thus, more than half of the Company's loan growth in 2000 reflected the markets opened by its strategic branch acquisitions over the last six years. Loan growth in 1999 was $92.0 million or 10.0% compared to $74.0 million or 8.8% in 1998. The Company's predominant focus on the retail borrower enables its loan portfolio to be highly diversified. Approximately 64% of loans outstanding are oriented to consumers borrowing on an installment and residential mortgage loan basis. Over the last several years, the growth rate of CBSI's commercial business loans has exceeded that of loans to individuals, and this sector exhibits a high degree of diversification as well. Loans are typically for amounts under $75,000, with approximately 83% of our customers representing about 28% of commercial loans outstanding. Slightly over thirty-five percent of our commercial portfolio is comprised of loans in excess of $500,000. The portfolio contains no credit card receivables. The overall yield on the portfolio is in the attractive 66th peer percentile. The "Nature of Lending" table below recasts the Company's loan portfolio into four major lines of business. As previously discussed, much of the 2000 loan growth relates to new business generated in markets where acquired branches are located. The increase in business lending accounted for 36% of the $90 million in total loan growth in 2000 versus 44% of 1999's $92 million increase. An increase in consumer direct loans contributed 14% toward total growth this year versus 16% in 1999. Consumer indirect loans accounted for 7% of this year's increase, down from 18% in the prior year. The decrease in direct and indirect consumer loans reflects softening demand in the automotive industry. Lastly, the share of this year's total loan increase for consumer mortgages was 43%, up from 1999's share of 22%, reflective of the even greater success of the Company's no-closing cost product. The following more fully discusses the underlying reasons for these changes by each of the Company's four major lending activities or lines of business.Nature of Lending Mix at Year End($ million and %) - - ----------------------- ------------------- --------------------- ------------------ -------------------- Total Loans Consumer Mortgage Business Lending Consumer Indirect Consumer DirectYear 000's Change% 000's TotalChange 000's Total Change 000's Total Change 000's Total Change $ $ % $ % % $ % % $ % % 2000 1,099 8.9% 258 23% 17.7% 398 36% 8.7% 228 21% 3.2% 215 20% 5.8% 1999 1,009 10.0% 219 22% 10.1% 366 36% 12.5% 221 22% 8.3% 203 20% 8.1% 1998 917 8.7% 199 22% 21.6% 326 36% 13.0% 204 22% 2.6% 188 20% -2.3% 1997 843 29.2% 164 19% 7.8% 288 34% 36.7% 199 24% 18.6% 192 23% 57.5% 1996 652 16.5% 152 23% 3.2% 211 32% 21.3% 168 26% 24.2% 122 19% 17.4% - - -------- ------ ------- ------ ---- ------- ------ ------ ------- ----- ----- ------ ------ ------ ------ The combined total of general purpose business lending, dealer floor plans, mortgages on commercial property, and farm loans is characterized as the Company's business lending activity. At $398 million, this segment represents 36% of loans outstanding at year-end, having steadily expanded its share by eight percentage points since year-end 1994. Outstandings climbed over $31 million or 9% in 2000 compared to a 13% growth rate for 1999 and 1998. Growth in the past three years has resulted from persistent business development efforts and the contributions of new lenders who joined the Bank often from larger banking institutions, frequently bringing their books of business with them over time. The portfolio is broadly diversified by industry type, reflective of the nature of the Company's markets. The largest share is service businesses (24%), followed by finance/insurance/real estate (14%), retail trade and agriculture/forestry/fishing (each at 13%), manufacturing and dealer floor plans (each at 9%), and miscellaneous industries (18%). Demand for installment debt indirectly originated through automobile, marine, and mobile home dealers increased modestly in 2000. Outstandings ended the year 3% or $6 million higher, primarily resulting from growth in the Bank's Southern Region. This compares to growth of 8% or $17 million in 1999. This portfolio segment, of which 90% relates to automobile lending (72% of the vehicles are used versus 28% new), constitutes 21% of total loans outstanding, down only slightly from 1999, but down from its peak of 26% in 1996. A slowdown in automobile sales during the latter half of 2000 primarily explains the reduction in growth versus 1999. The segment of the Company's loan portfolio committed to consumer mortgages is predominantly fixed (93%) versus adjustable rate (7%) residential lending. It accounts for $258 million or 23% of total loans outstanding. Growth during the last two years ($38.8 million or 17.7% in 2000 and $19.5 million or 9.8% in 1999) is attributable to the attractiveness of the Bank's no-closing cost mortgage product both for home purchase or refinancing as well as being a vehicle for consumers to term-out higher cost credit card debt. Portfolio growth is lower than it could have been due to a program which began in mid-1994 to sell selected fixed rate originations in the secondary market. The purpose of this program, with sales of $39.3 million in 1998, $37.0 million in 1999 and $9.5 million this year, is to develop a meaningful source of servicing income as well as to provide an additional tool to manage interest rate risk. The direct consumer lending activity increased 6.1% or $12 million in 2000. 1999's outstandings rose 8.0% or $15 million, in part reflective of an aggressive promotion largely in the Bank's Southern Region, versus a decrease of 2.5% or $5 million in 1998. This line of business is comprised of conventional installment loans (including some isolated installment lending to small businesses), personal loans, student loans (which are sold once principle repayment begins), and borrowing under variable and fixed rate home equity lines of credit. The consumer direct segment as a percent of total loans was 20%, equal to the 1999 portfolio share. The following table reconciles the differences between the line of business loan breakdown reflected above as compared to regulatory reporting definitions reflected on the Call Report and the table at the beginning of this section. Line of Business as of December 31, 2000 ------------------------------------------------------------------------- Consumer Consumer Consumer Business Total Direct Indirect Mortgages Lending Loans ---------- ----------- ------------ ----------- ----------- Regulatory Reporting Categories Loans secured by real estate Residential $91,205 $- $257,415 $30,420 $379,040 Commercial 28 $- 298 135,219 135,545 Farm 35 - 19,815 19,850 Agricultural loans 533 - 25,956 26,489 Commercial loans 12,299 - 169,578 181,877 Installment loans to 108,553 227,645 53 5,878 342,129 individuals Other loans 2,769 - 11,436 14,205 ---------- ----------- ------------ ----------- ----------- Total loans 215,422 227,645 257,766 398,302 1,099,135 Unearned Discounts (409) - - (409) ---------- ----------- ------------ ----------- ----------- Net Loans $215,013 $227,645 $257,766 $398,302 $1,098,726Maturities and Sensitivities of Loans to Changes in Interest RatesThe following table shows the amount of loans outstanding as of December 31, 2000, which, based on remaining scheduled payments of principal, are due in the periods indicated: --------------------------------------------------------- At December 31, 2000 --------------------------------------------------------- Maturing Maturing in After One But Maturing One Year or Within Five After Five Total Book Less Years Years Value (In thousands) Commercial, financial, and $72,942 $70,577 $64,847 $208,366 agricultural Real estate - construction 0 0 0 0 Real estate - mortgage 53,732 77,090 403,613 534,435 Installment 24,906 292,496 38,523 355,925 ------- -------- ------- ------- TOTAL $151,580 $440,163 $506,983 $1,098,726 ========= ========= ========= ========== The following table sets forth the sensitivity of the loan amounts due after one year to changes in interest rates. --------------------------------------- At December 31, 2000 --------------------------------------- Fixed Rate Variable Rate Due after one year but within five years $59,361 $380,802 Due after five years 357,490 149,493 -------- ------- TOTAL $416,851 $530,295 ========= ========Nonperforming Assets/Risk ElementsThe following table presents information concerning the aggregate amount of nonperforming assets: As of December 31, ---------------------------------------------------- (000's omitted) 2000 1999 1998 1997 1996 ---------------------------------------------------- Loans accounted for on a nonaccrual 4,423 4,666 2,473 1,385 2,023 basis Accruing loans which are contractually past due 90 days or more as to principal or interest payments 1,655 1,047 1,513 2,788 823 ------ ------ ------ ------ ----- Total nonperforming loans 6,078 5,713 3,986 4,173 2,846 Loans which are "troubled debt restructurings" as defined in Statement of Financial Accounting Standards No. 15 "Accounting by Debtors and Creditors for Troubled Debt 116 122 134 0 32 Restructurings" Other Real Estate 906 884 1,182 881 746 ---- ---- ------ ---- --- Total nonperforming assets 7,100 6,719 5,302 5,054 3,624 Ratio of allowance for loan losses to 1.33% 1.33% 1.36% 1.47% 1.25% period-end loans Ratio of allowance for loan losses to period-end nonperforming loans 240.4% 234.9% 312.0% 298.0% 285.6% Ratio of allowance for loan losses to period-end nonperforming assets 205.8% 199.7% 234.6% 246.0% 224.3% Ratio of nonperforming assets to period-end total loans and other real estate owned 0.65% 0.67% 0.56% 0.60% 0.55% The impact of interest not recognized on nonaccrual loans, and interest income that would have been recorded if the restructured loans had been current in accordance with their original terms, was immaterial. The Company's policy is to place a loan on nonaccrual status and recognize income on a cash basis when it is more than ninety days past due, except when in the opinion of management it is well secured and in the process of collection.Provision and Reserve for Loan LossesNonperforming loans, defined as nonaccruing loans plus accruing loans 90 days or more past due, ended 2000 at $6.1 million. This level is approximately $365,000 or 6% higher than one year earlier, primarily due to increases in residential mortgage and installment loan 90-day delinquencies, partially offset by an improvement in commercial and installment nonaccruals. The ratio of nonperforming loans to total loans fell 2 basis points from twelve months earlier to .55%. As of September 30, 2000, when the nonperforming loan ratio stood at .58%, the Company's asset quality was in the 50th percentile compared to peers. The ratio of nonperforming assets (which additionally include troubled debt restructuring and other real estate) to total loans plus OREO decreased to ..65%, down 2 basis points from one year earlier. Total delinquencies, defined as loans 30 days or more past due and nonaccruing, finished the year at 2.03% as a percent of total loans outstanding compared to 1.32% in 1999, with most of the increase taking place during the last three to six months. As of year-end 2000, total delinquencies for commercial loans, installment loans, and real estate mortgages were 2.75%, 2.11%, and 1.10%, respectively. These measures compare to delinquencies of peer bank holding companies as of September 30, 2000 of 2.08%, 1.70%, and 1.26%, respectively. As of September 30, 2000, the delinquency ratio was slightly higher than the norm at 1.65% versus 1.58%. The Company's collection function, which was centralized in mid-2000 to improve its productivity and effectiveness, is striving to reverse this trend and bring delinquencies back within the Company's internal guideline of less than 2.0%. Problem loans during the last nine months have been dominated by two commercial credits. The first loan has been written down by $1.47 million to the liquidation value of its assets; second and third quarter write-downs had been based on the sale value of the firm as a going concern. The other loan was secured by fraudulent receivables discovered in the third quarter, and after an initial write-down at that time, the lack of successful litigation since then has dictated that the entire $1.02 million balance be written off. These situations are considered by management to be unusual and isolated, and without them, commercial net charge-offs would have been limited to $635,000, a $214,000 improvement from 1999. The limited asset-based program through which this latter loan was administered is being terminated. Commercial loan net charge-offs as a whole were $3.1 million or .80% of average outstandings, or $635,000 and .16%, respectively, excluding the above two problem credits; these results compare to $849,000 and .24% in 1999. Consumer installment net charge-offs were down for the second consecutive year, ending 2000 at $2.85 million and .82% of average loans outstanding, down 13% and 21 basis points, respectively. Mortgage net charge-offs were de minimums. In total, net charge-offs for 2000 were higher by $1.8 million or 44%, finishing the year at $6.0 million or .57% of average loans compared to $4.2 million and ..44% last year. Gross charge-offs rose 33.6% to $7.1 million, or .67% of average loans outstanding versus .56% in 1999. This year's recoveries declined slightly to $1.1 million, but rose as a percentage of prior year gross charge-offs to 20.4% from 18.5% in 1999. As of September 30, 2000, the Bank's total net charge-off ratio was in the 90th peer percentile based on the peer norm of .17%. The full year loan loss provision covered total actual net charge-offs by 1.20 times, this margin serving as a precaution in the event the Upstate New York economy weakens after its long sustained period of relative economic health. Management continually evaluates loan loss reserve adequacy from a variety of perspectives, including projected overall economic conditions for the coming year, concentration of the loan portfolio by industry and loan type, and individual customer condition. The loan loss reserve was increased to $14.6 million versus $13.4 million in 1999; as a percent of total loans, the loss reserve ratio remained constant at 1.33% for year-end 2000. The reserve ratio is slightly above the peer median, being in the 54th peer percentile, and coverage of nonperforming loans as of September 30, 2000 was above the norm in the 53rd percentile; management believes the year-end coverage at 240% to be ample. As a percentage of average loans, the annual loan loss provision was well above the peer norm in the 91st percentile as of September 30, 2000. The loss provision ratio increased from .54% in 1999 to .68% this year. Due to higher net charge-offs in 2000 as discussed above, loan loss provision expense increased by $2.1 million in 2000. This compares to an increase of $13,000 and $643,000 in 1999 and 1998, respectively. Loan loss provision expense covered net charge-offs by 120% versus 124% in 1999.Summary of Loan Loss ExperienceThe following table summarizes loan balances at the end of each period indicated and the daily average amount of loans. Also summarized are changes in the allowance for possible loan losses arising from loans charged off, recoveries on loans previously charged off, and additions to the allowance which have been charged to expenses. As of Decebmer 31, ----------------------------------------------------------- (000's omitted) 2000 1999 1998 1997 1996 ----------------------------------------------------------- Amount of loans outstanding at end of period $1,099,135 $1,009,943 $918,527 $845,027 $658,367 ----------- ----------- --------- --------- -------- Daily average amount of loans (net of $1,056,229 $951,167 $884,751 $749,596 $602,717 unearned discounts) --------- --------- -------- --------- -------- Balance of allowance for possible loan losses at beginning of period $13,421 $12,441 $12,434 $8,128 $6,976 Loans charged off: Commercial, financial, and agricultural 3,224 980 698 418 324 Real estate construction 0 0 0 0 0 Real estate mortgage 16 52 24 25 26 Installment 3,825 4,256 5,375 4,006 2,108 ------ ------ ------ ------ ----- TOTAL LOANS CHARGED OFF 7,065 5,288 6,097 4,449 2,458 Recoveries of loans previously charged off: Commercial, financial, and agricultural 96 147 200 185 224 Real estate construction 0 0 0 0 0 Real estate mortgage 6 5 4 1 1 Installment 974 980 777 541 488 ---- ---- ---- ---- --- TOTAL RECOVERIES 1,076 1,132 981 727 713 Net loans charged off 5,989 4,156 5,116 3,722 1,745 ------ ------ ------ ------ ----- Additions to allowance charged to expense 7,182 5,136 5,123 4,480 2,897 (1) Reserves on acquired loans (2) 0 0 0 3,548 0 Balance at end of period $14,614 $13,421 $12,441 $ 12,434 $ 8,128 -------- -------- -------- ------- ----- Ratio of net charge-offs to average loans 0.57% 0.44% 0.58% 0.50% 0.29% outstanding (1) The additions to the allowance during 1996 through 2000 were determined using actual loan loss experience and future projected loan losses and other factors affecting the estimate of possible loan losses. (2) This reserve addition is attributable to loans purchased from Key Bank and Fleet Bank in association with the purchases of branch offices during 1997. The allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated. As of December 31, --------------------- ------------------- ------------------- ------------------ --------------------- 2000 1999 1998 1997 1996 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent of of of of of of of of of of Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans in in in in in Each Each Each Each Each Category Category Category Category Category to to to to to Total Total Total Total Total Loans Loans Loans Loans Loans ----------------------------------------------------------------------------------------------------- Commercial, financial, & agricultural $4,331 19.0% $3,786 19.8% $4,502 19.7% $4,136 19.2% $2,668 18.4% Real estate- 0 0.0% 0 0.0% 0 0.0% 0 0.0% 0 0.0% construction Real estate - mortgage 1,818 48.6% 1,285 46.8% 2,210 43.4% 2,026 44.4% 2,234 44.1% Installment 7,877 32.4% 7,285 33.4% 4,525 36.9% 4,461 36.4% 2,309 37.5% Unallocated 588 N/A 1,065 N/A 1,204 N/A 1,811 N/A 917 N/A --- --- ----- --- ----- --- ----- --- --- --- Total $14,614 100.0% $13,421 100.0% $12,441 100.0% $12,434 100.0% $8,128 100.0%Funding SourcesTypical of most commercial banking institutions today is the need to rely on a variety of funding sources to support the earning asset base as well as to achieve targeted growth objectives. There are three primary sources of funding that comprise CBSI's overall funding matrix, which considers maturity, stability, and price: deposits of individuals, partnerships and corporations (IPC deposits); collateralized municipal deposits; and capital market borrowings. - - --------------------------------------------------------------------------------------------------------- Sources of Funds Average 4th Quarter Balances ($ Million) - - --------------------------------------------------------------------------------------------------------- Year IPC Deposits Public Funds Capital Total Funds Sources Borrowings ---------------------- -------------------- -------------------- ------------------------ Amount % Total Amount %Total Amount % Total Amount %Change ------ ------- ------ ------- ------ ------- ------ ------- 2000 $1,274 69.2% $181 9.8% $385 21.0% $1,840 10.9% 1999 1,212 73.1 149 9.0 298 18.0 1,659 9.5 1998 1,194 78.8 189 12.5 132 8.7 1,515 4.4 1997 1,190 82.0 163 11.2 98 6.7 1,451 21.4 1996 903 75.6 124 10.4 168 14.1 1,195 13.4 The Company's funding matrix continues to benefit from a high level of IPC deposits, which reached an all-time record for a fourth quarter average of $1.274 billion, an increase of $62 million or 5.1% from the comparable 1999 period. This is the strongest dollar and percentage improvement in IPC deposits in the last five years, excluding the impact of branch acquisitions, reflective of excellent time deposit growth. IPC deposits are frequently considered to be a bank's most attractive source of funding because they are generally stable, do not need to be collateralized, have a relatively low cost, and because they represent a working customer base with the potential to be cross-sold a variety of loan, deposit and other financial service-related products. During the 1996-2000 period, overall consumer and business deposits have increased at a compound annual growth rate of 7.6% per annum. The mix of CBSI's IPC deposits has changed modestly over the last five years as measured by the trend of fourth quarter average balances. The time deposit share has fluctuated within the narrow range of 47% to 49%. Compared to the prior year, 2000's mix increased by 1% to 49% as a result of a $58 million or 10.3% increase, reflective of the Company's successful targeted C.D. programs. Since their inception in the spring of 1999, these promotions have attracted over $96 million in new money, or 28% of the promotions. Growth in time deposits also reflects consumer movement away from immediately available, lower earning savings accounts, which have declined steadily during the five year period from 24% of IPC deposits to the 17% level in 2000. A portion of these savings outflows may have been directed to higher yielding money market accounts, which have grown from 5% of IPC deposits in 1996 to 7% today. Lastly, while interest checking accounts have remained virtually constant at 9% over the last five years, the mix of regular checking accounts (demand deposits) has increased nicely from 14% in 1996 to 18% today. Excluding time accounts, IPC deposits were up by $3.4 million or .5% in 2000; a $13 million or 5.8% increase in demand deposits and a $13 million or 16.7% increase in money markets more than offset reductions in other IPC categories. Deposits of local municipalities increased $32 million or 22% during the past year, with balances for fourth quarter 2000 averaging $181 million versus $149 million for the same 1999 quarter. Under New York State Municipal Law, the Company is required to collateralize all local government deposits with marketable securities from its investment portfolio. Because of this stipulation, management considers this source of funding to be equivalent to capital market borrowings. As such, CBSI endeavors to price these deposits at or below alternative capital market borrowing rates. Consequently, levels of municipal deposits fluctuate throughout the year depending on how competitive pricing compares to the aforementioned borrowing rates. It should be noted that generally, utilization of municipal deposits has been flat to down over the last five years as a percent of total funding sources. Capital market borrowings are defined as funding sources available on a national market basis, generally requiring some form of collateralization. Borrowing sources for the Company include the Federal Home Loan Bank of New York, Federal Reserve Bank of New York, as well as access to the national repurchase agreement market through established relationships with primary market security dealers. Also considered as borrowings are the $30 million in 9.75% Company-Obligated Mandatorily Redeemable Preferred Securities issued to support 1997's acquisitions and advances under a $10 million line of credit tied to the 90 day libor rate with a large regional commercial bank. Capital market borrowings averaged $385 million or 21% of total funding sources for fourth quarter 2000 compared to $298 million or 18% of total funding sources for the same period in 1999. As of December 31, 2000, 50% or $183 million of capital market borrowings (excluding the aforementioned line of credit and Trust Preferred securities) had original terms of one year or less. The balance of long-term and short-term borrowings represents a move during the last half of the year to convert higher cost short-term funding to cheaper long-term funding, taking advantage of the inverted Treasury yield curve. The average daily amount of deposits and the average rate paid on each of the following deposit categories is summarized below for the years indicated. Years ended December 31, ---------------------------------------------------------------------- 2000 1999 1998 ---------------------------------------------------------------------- Average Average Average Average Average Average Balance Rate Paid Balance Rate Paid Balance Rate Paid Non-interest-bearing demand $247,925 0.00% $235,874 0.00% $214,997 0.00% deposits Interest-bearing demand 136,962 0.81% 148,489 0.89% 145,141 1.18% deposits Regular savings deposits 241,754 2.50% 255,947 2.50% 264,370 2.79% Money market deposits 109,050 3.59% 109,108 3.10% 99,219 3.08% Time deposits 688,547 5.69% 619,851 5.11% 672,972 5.57% -------- -------- Total average daily amount of domestic deposits $1,424,238 3.53% $1,369,269 3.12% $1,396,699 3.55% The remaining maturities of time deposits in amounts of $100,000 or more outstanding at December 31, 2000 and 1999 are summarized below: At December 31, --------------------------------------------- (000's omitted) 2000 1999 --------------------------------------------- Less than three months $73,157 $53,798 Three months to six months 40,117 28,644 Six months to one year 30,688 18,338 Over one years 12,210 11,618 ------- ------ $156,172 $112,398 ========= ======== The following table summarizes the outstanding balance of short-term borrowings of the Company for the years indicated. At December 31, ------------------------------------------- ------------------------------------------- (000's omitted) 2000 1999 1998 ------------------------------------------- Federal funds purchased $38,000 $0 $34,700 Term borrowings at banks (original term) 90 days or less 151,100 129,000 30,000 Over 90 days 0 125,000 0 ------------- ------------ ------------- Balance at end of period $189,100 $254,000 $64,700 ============= ============ ============= Daily average during the year $219,794 $119,830 $13,915 Maximum month-end balance $254,000 $64,700 261,100 Weighted average rate during the year 6.53% 5.24% 5.42% Year-end average rate 6.49% 5.60% 5.46%InvestmentsThe stated objective of CBSI's investment portfolio is to prudently provide a degree of low-risk, quality assets to the balance sheet. This must be accomplished within the constraints of: (a) absorbing funds when loan demand is low and infusing funds when demand is high; (b) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (c) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (d) considering investment risk-weights as determined by the regulatory risk-based capital guidelines; and (e) generating a favorable return without undue compromise of the other requirements. Since 1997, the Company has utilized total return as its primary methodology for managing investment portfolio assets. Under this analytical method, the Company seeks to maximize shareholder value through both interest income and market value appreciation. In the first quarter of 2000, the Bank's balance sheet simulation work pointed towards an exposure to falling interest rates. Growth in floating rate commercial loan assets as well as management's ability to hold rates low on core deposits in the face of rising interest rates contributed to this risk profile. To balance this exposure, management continued on its 1999 course of extending the maturity and call protection of new investments made throughout the year. Despite long-term interest rates falling by more than 100 basis points over the course of 2000, the weighted average life of the portfolio stood at 7.37 years on December 31, 2000 versus 8.51 years in the prior period. The average portfolio yield, calculated on a fully-tax equivalent basis and excluding money market investments, rose to 7.37% in 1999 from 6.89% in the prior year. In the fourth quarter of 2000, the portfolio yield averaged 7.40% versus 7.21% for the same period in 1999. Because nearly all of the Bank's investments are classified as available-for sale, any broad change in market value has a significant impact on book equity. As of year-end 2000, the net market value gain over book value was $11.9 million versus a loss of $22.1 million as of year-end 1999. This positive change of $34.0 million added $20.1 million to book equity, or $2.88 per share outstanding as of December 31, 2000. Beginning in late 1999 and continuing into 2000, the Bank sold low coupon municipal notes and purchased higher yielding long-term municipal bonds. This municipal tax loss strategy resulted in net investment losses for the year of $212,000 on sales of $11.6 million. In 1999, losses were $638,000 on sales of $15.3 million. The composition of the portfolio continues to heavily favor U.S. Agency Debentures, U.S. Agency mortgage-backed pass-throughs, U.S. Agency CMO's and AAA rated and insured municipal bonds. As of year-end 2000, these four security types (excluding Federal Home Loan Bank stock and Federal Reserve Bank stock) accounted for a combined 91% of total portfolio investments (33%, 6%, 33% and 19% respectively), down slightly from 94% in the prior year.Investment SecuritiesThe following table sets forth the amortized cost and market value for the Company's held-to-maturity investment securities portfolio: At December 31, ------------------------------------------------------------------- 2000 1999 1998 ------------------------------------------------------------------- Amortized Amortized Amortized Cost/Book Market Cost/Book Market Cost/Book Market Value Value Value Value Value Value ----- ----- ----- ----- ----- ----- U.S. Treasury securities and obligations of U.S. Government corporations and agencies $0 $0 $0 $0 $0 $0 Obligations of states and political subdivisions 5,351 5,451 5,042 5,084 4,038 4,107 Corporate securities 0 0 0 0 0 0 Mortgage-backed securities 0 0 0 0 0 0 -- -- -- -- -- -- Total $5,351 $5,451 $5,042 $5,084 $4,038 $4,107 ======= ======= ======= ======= ======= ====== The following table sets forth the amortized cost and market value for the Company's available-for-sale investment portfolio and grand total carrying value for both portfolios. At December 31, ------------------------------------------------------------------- 2000 1999 1998 ------------------------------------------------------------------- Amortized Amortized Amortized Cost/Book Market Cost/Book Market Cost/Book Market Value Value Value Value Value Value (In thousands) (In thousands) (In thousands) U.S. Treasury securities and obligations of U.S. Government corporations and $241,159 $252,381 $177,097 $171,793 $170,464 $175,866 agencies Obligations of states and political 134,653 136,181 118,223 110,125 40,591 41,329 subdivisions Corporate securities 44,612 44,652 35,914 33,099 9,153 9,382 Mortgage-backed securities 297,659 296,792 290,000 284,090 336,090 336,967 Equity securities (1) 24,497 24,497 24,364 24,364 23,784 23,784 Federal Reserve Bank common stock 2,294 2,294 2,174 2,174 2,174 2,174 ------ ------ ------ ------ ------ ----- Total $744,874 $756,797 $647,772 $625,645 $582,256 $589,502 ========= ========= ========= ========= ========= ======== Net unrealized gains/(losses) on available for 11,923 (22,127) 7,246 ------- -------- ----- sale portfolio Total Carrying Value $762,148 $630,687 $593,540 ========= ========= ======== (1) Includes $23,059 in FHLB common stock at December 31, 2000, 1999, and 1998, respectively. The following table sets forth as of December 31, 2000, the maturities of investment securities and the weighted-average yields of such securities, which have been calculated on the basis cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis: At December 31, 2000 ---------------------------------------------------------- Amount Amount Amount Maturing Maturing Maturing After One After Five Amount Total Within Year but Years but Maturing Cost One Year Within Within After Book Held-to-Maturity Portfolio or Less Five Years Ten Years Ten Years Value - - -------------------------- ----------- ----------------------- ----------- ---------- U.S. Treasury and other U.S. government agencies $0 $0 $0 $0 $0 Mortgage-backed securities 0 0 0 0 0 States and political 3,504 1,582 247 18 5,351 subdivisions Other 0 0 0 0 0 ----------- ----------- ----------- ----------- ---------- Total Held-to-Maturity $3,504 $1,582 $247 $18 $5,351 Portfolio Value =========== =========== =========== =========== ========== Weighted Average Yield for Year (1) 7.69% 7.85% 8.27% 8.96% 7.77% Available-for-Sale Portfolio U.S. Treasury and other U.S. government agencies $56,142 $479 $155,969 $28,568 $241,158 Mortgage-backed securities 41,083 130,213 75,236 51,127 297,659 States and political 514 7,766 29,959 96,414 134,653 subdivisions Other 3,023 545 2,000 39,044 44,612 ----------- ----------- ----------- ----------- ---------- Total Available-for-Sale $100,762 $139,003 $263,164 $215,153 $718,082 Portfolio Value =========== =========== =========== =========== ========== Weighted Average Yield for Year(1) 7.15% 7.60% 7.09% 7.34% 7.27% (1) Weighted average yields on the tax-exempt obligations have been computed on a fully tax equivalent basis assuming a marginal federal tax rate of 35%. These yields are an arithmetic computation of accrued income divided by average balance; they may differ from the yield to maturity, which considers the time value of money.Market Risk/Interest Rate RiskMarket risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Company's primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk, over both a short-term tactical and longer-term strategic time horizon, is an important component of the Company's asset/liability management process, which is governed by policies established by its Board of Directors and reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Management Committee (ALCO). In this capacity, ALCO develops guidelines and strategies impacting the Company's asset/liability management activities based upon estimated market risk sensitivity, policy limits, and overall market interest rate-related level and trends. As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools which enable it to identify and quantify sources of interest rate risk. The primary tool used by the Company in managing interest rate risk is income simulation. The analysis begins by measuring the impact of differences in maturity and repricing all balance sheet positions. Such work is further augmented by adjusting for prepayment and embedded option risk found naturally in certain asset and liability classes. Finally, balance sheet growth and funding expectations are added to the analysis in order to reflect the strategic initiatives set forth by the Company. Changes in net interest income are reviewed after subjecting the balance sheet to an array of Treasury yield curve possibilities, including an up or down 200 basis point (BP) movement in rates from current levels. While such an aggressive movement in rates provides management with good insight as to how the Company's net interest income may perform under extreme market conditions, results from a more modest shift in interest rates are used as a basis to conduct day-to-day business decisions. The following reflects the Company's one-year net interest income sensitivity based on asset and liability levels on December 31, 2000, assuming no growth in the balance sheet, and assuming a 200 basis point instantaneous rate shock in the prime rate, federal funds rate and the entire Treasury yield curve. REGULATORY MODEL - - -------------------------------------------------------------------------------------------------------- Rate Change Dollar Change Percent of Flat Rate In Basis Points (in 000's) Net Interest Income + 200 bp $(1,542) (2.2%) - 200 bp $ 646 0.9% A second simulation was performed based on what the Company believes to be conservative levels of balance sheet growth--high single digit growth in loans, low single digit growth in deposits, and necessary increases in borrowings, with no growth in investments or any other major portions of the balance sheet-- along with 200 BP movements over a twelve month period in the prime rate, federal funds rate, and a Treasury yield curve moving closer to historical spreads to fed funds. Under this set of assumptions, the Bank's net interest income is showing a mild level of sensitivity to rising interest rates. In a falling interest rate environment, net interest income is slightly better than if rates were unchanged as a result of balance sheet strategies implemented throughout 2000. MANAGEMENT MODEL - - -------------------------------------------------------------------------------------------------------- Rate Change Dollar Change Percent of Flat Rate In Basis Points (in 000's) Net Interest Income + 200 bp $(1,642) (2.3%) - 200 bp $1,549 2.2% The preceding interest rate risk analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. While the assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.LiquidityDue to the potential for unexpected fluctuations in deposits and loans, active management of the Company's liquidity is critical. In order to respond to these circumstances, adequate sources of both on- and off-balance sheet funding are in place. CBSI's primary approach to measuring liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short-term liabilities which are vulnerable to nonreplacement; and second, a projection of subsequent cash availability over an additional 60 days. The minimum policy level of liquidity under the Basic Surplus/Deficit approach is 7.5% of total assets for both the 30- and 90-day time horizons. As of year-end 2000, this ratio was 13.6% and 12.8%, respectively, excluding the Company's capacity to borrow additional funds from the Federal Home Loan Bank.GAP REPORTCOMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES as of December 31, 2000 Volumes 1-30 31-60 60-90 91-180 181-360 13-24 25-36 37-48 49-60 Over 60 ($000's) Days Days Days Days Days Months Months Months Months Months TOTAL - - --------------------------------------------------------------------------------------------------------------------------------ASSETS:Due from banks - - - - - - - - - 58,880 58,880 Money Market Inv 424 - - - - - - - - - 424 Fixed Rate Debentures - - - 6,822 49,551 - 10,479 23,346 43,575 107,386 241,159 Municipals 316 247 487 1,427 1,466 1,317 457 1,459 6,529 126,223 139,928 Fixed Rate Mortgage - - - - - - - - - - - Backed 2,185 1,920 2,395 10,162 20,684 31,658 33,340 26,418 18,141 125,992 272,895 Floating Rate Mortgage - - - - - - - - - - - Backed 24,844 - - - - - - - - - 24,844 Other Investments - - - - 3,023 545 - 3,721 - 64,115 71,404 - - --------------------------------------------------------------------------------------------------------------------------------TOTAL INVESTMENTS 27,769 2,167 2,882 18,411 74,724 33,520 44,276 54,944 68,245 482,596 809,534 - - -------------------------------------------------------------------------------------------------------------------------------- Mortgages: Adjustable Rate 204 221 2,206 3,923 10,009 1,978 - - - - 18,541 Fixed Rate 5,107 5,178 5,101 14,739 27,116 45,838 36,378 28,736 22,495 74,886 265,574 Variable Home Equity39,028 6,329 294 3,418 4,444 - - - - - 53,513 Commercial Variable 225,271 - - - - - - - - - 225,271 Other Commercial 41,638 5,093 5,131 15,618 32,280 62,422 16,360 - - (239) 178,303 Installment, Net 9,110 9,559 9,597 28,804 54,591 94,011 68,769 43,699 17,155 22,230 357,525 - - --------------------------------------------------------------------------------------------------------------------------------TOTAL LOANS 320,358 26,380 22,329 66,502 128,440 204,249 121,507 72,435 39,650 96,877 1,098,727 Loan Loss Reserve - - - - - - - - - (14,614) (14,614) Other Assets - - - - - - - - - 128,988 128,988 - - --------------------------------------------------------------------------------------------------------------------------------TOTAL ASSETS 348,127 28,547 25,211 84,913 203,164 237,769 165,783 127,379 107,895 693,847 2,022,635 AVERAGE YIELD 9.81% 9.14% 8.71% 8.68% 8.35% 8.72% 8.50% 8.10% 7.91% 4.66% 7.38% ================================================================================================================================LIABILITIES AND CAPTIAL:Demand Deposits - - - - - - - - - 258,004 258,004 Savings / NOW 1,354 1,354 1,354 4,063 18,542 16,253 - - - 314,234 357,154 Money Markets - - - 84,154 27,852 - - - - - 112,006 CD's / IRA / Other 73,903 54,490 41,660 149,099 276,635 106,178 15,463 6,430 5,364 1,344 730,566 - - --------------------------------------------------------------------------------------------------------------------------------TOTAL DEPOSITS 75,257 55,844 43,014 237,316 323,029 122,431 15,463 6,430 5,364 573,582 1,457,730 Short Term Borrowings 133,000 50,000 - - - - - - - - 183,000 Term Borrowing 6,100 - - - - 10,000 5,000 - - 165,000 186,100 Trust Securities - - - - - - - - - 29,824 29,824 Other Liabilities - - - - - - - - - 26,603 26,603 Capital - - - - - - - - - 139,378 139,378 - - --------------------------------------------------------------------------------------------------------------------------------TOTAL LIABILITIES AND CAPITAL 214,357 105,844 43,014 237,316 323,029 132,431 20,463 6,430 5,364 934,387 2,022,635 AVERAGE RATE 6.26% 5.81% 5.49% 5.15% 5.87% 5.84% 5.64% 5.28% 5.91% 1.95% 4.00% ================================================================================================================================ GAP 133,770 (77,297) (17,803) (152,403) (119,865) 105,338 145,320 120,949 102,531 (240,540) CUMULATIVE GAP 133,770 56,473 38,670 (113,733) (233,598) (128,260) 17,060 138,009 240,540 - CUMULATIVE GAP / TOTAL ASSETS 6.7% 2.8% 1.9% -5.7% -11.7% -6.4% 0.9% 6.9% 12.0% 0.0% Note: IPC=Accounts of individuals, partnerships, and corporations. Public=Accounts of U.S. government, state, and local municipalities. 85% of IPC savings are treated as core (>60 months). 100% of Public Fund Savings are treated as 181-360 days. 95% of IPC Money Markets are treated as core (91-180 days). 100% of Public Fund Money Markets are treated as 181-360 days. 15% of IPC Savings are spread over 24 months, and 5% of IPC Money Markets are in 181-360 days. Totals may not foot due to rounding.Effects of InflationThe financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Virtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rate changes have a more significant impact on the Company's performance than general levels of inflation.Forward-Looking StatementsThis document contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company's plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company's control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) risks related to credit quality, interest rate sensitivity and liquidity; (2) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (3) the effect of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (4) inflation, interest rate, market and monetary fluctuations; (5) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (6) changes in consumer spending, borrowing and savings habits; (7) technological changes; (8) any acquisitions or mergers that might be considered by the Company and the costs and factors associated therewith; (9) the ability to maintain and increase market share and control expenses; (10) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) and accounting principles generally accepted in the United States; (11) changes in the Company's organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (12) the costs and effects of litigation and of any adverse outcome in such litigation; and (13) the success of the Company at managing the risks of the foregoing. The foregoing list of important factors is not exclusive. Such forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.New Accounting PronouncementsIn 1998, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon adoption of the SFAS the Company transferred investment securities from held-to-maturity to available-for-sale (see Note C). As a result, securities previously classified as held-to-maturity were sold during the year and investment securities gains of approximately $194,000, net of tax, resulting from the sale have been reported as a cumulative effect of change in accounting principle. The Company has no outstanding derivative financial instruments and, accordingly, adoption of SFAS 133 had no other effect on the Company's financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a Replacement of SFAS No. 125". This statement revises the accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. Under the financial components approach, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001 and accordingly would apply to the Company for the quarter ended June 30, 2001. The provisions of this statement are not expected to have a significant change on the Company's current accounting for transfers and servicing of financial assets.Subsequent EventsACQUISITION OF THE CITIZENS NATIONAL BANK OF MALONE, BASED IN MALONE, NEW YORKOn January 26, 2001, the Company acquired the Citizens National Bank of Malone (CNB), an eighty-year-old commercial bank with $113 million in assets, $59 million in loans, and $90 million in deposits. Stockholders of Citizens Bank received 1.70 shares of registered common stock of Community Bank System, Inc. (NYSE: CBU), resulting in the issuance of 952,000 shares in the transaction, which was recorded using the purchase method of accounting. Paul M. Cantwell, Jr., former Chairman and President of Citizens, has become a member of the CBU Board of Directors. Mr. Cantwell will also remain actively involved in Citizens' market areas as a part-time consultant for a period of five years. CNB's four offices in Franklin County--Brushton, Chateaugay, and two in Malone--have the top deposit market share in their respective towns, resulting in the Bank now in a virtual tie for the number one market share in Franklin County at 22.0%. CNB's fifth office is in Hermon; it is the only banking facility in the town, further strengthening the Bank's long-standing number one market share in St. Lawrence County at 27.1%. These five branches are now being administered from the Bank's Northern Market operations and management center in Canton, NY.PROPOSED ACQUISITION OF FIRST LIBERTY BANK CORP., BASED IN JERMYN, PENNSYLVANIAOn November 29, 2000, the Company announced its first strategic partnership outside of New York State with the signing of a definitive agreement with First Liberty Bank Corp. (NASDAQ-OTC: FLIB), a $647 million asset commercial bank based in Jermyn, Pennsylvania, to acquire all the stock of FLIB. First Liberty Bank & Trust will be merged into Community Bank, N.A. (CBNA), operating under its present name in Pennsylvania as a division of CBNA. First Liberty has the second largest deposit market share, at 17%, in Lackawanna County, where 11 of its 13 branches are located; the remaining offices are located in Lucerne County. At CBU's closing price on November 28, 2000 of $24.30, the shares of CBU to be received by FLIB shareholders would have a value of $86.7 million, or $13.61 per share, representing a price to book value of 144% and a price/trailing earnings ratio of 17.7 times. Based on CBU's current annualized quarterly dividend, FLIB shareholders would realize a 37% increase in cash dividends per share. CBU will issue approximately 3,566,000 shares in the transaction, which will be recorded under the pooling method of accounting. Pending approval by shareholders of both FLIB and CBU, and after regulatory review and the satisfaction of other contingencies, the transaction is expected to close in second quarter 2001. At that time, Saul Kaplan, Peter A. Sabia and Harold S. Kaplan, FLIB's three largest shareholders, will become members of the CBU Board of Directors. William M. Davis will remain as CEO of the Pennsylvania division of Community Bank, N.A. FLIB has agreed not to solicit or pursue other transactions, and the parties have executed an agreement providing CBU with an option to acquire 19.9 percent of FLIB under certain conditions.Item 8, Financial Statements and Supplementary DataThe following consolidated financial statements and independent accountant's reports of Community Bank System, Inc. and subsidiaries are contained on pages 40 through 61 of this item. - - - Consolidated Statements of Condition-- December 31, 2000 and 1999 - - - Consolidated Statements of Income - Years ended December 31, 2000, 1999, and 1998 - - - Consolidated Statements of Changes in Shareholders' Equity - Years ended December 31, 2000, 1999, and 1998 - - - Consolidated Statements of Cash Flows - Years ended December 31, 2000, 1999, and 1998 - - - Notes to Consolidated Financial Statements - December 31, 2000 - - - Report of Independent Accountants Quarterly Selected Data (Unaudited) for 2000 and 1999 are contained on page 61. CONSOLIDATED STATEMENTS OF CONDITION COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES December 31, December 31, 2000 1999 - - -----------------------------------------------------------------------------------------------ASSETSCash and due from banks $59,304,276 $76,526,657 Federal funds sold 0 24,200,000 - - ----------------------------------------------------------------------------------------------- Total cash and cash equivalents 59,304,276 100,726,657 Investment securities (approximate fair value of $762,248,000 and 762,148,042 630,687,585 $630,729,252) Loans 1,098,726,348 1,009,222,515 Reserve for possible loan losses 14,613,877 13,420,610 - - ----------------------------------------------------------------------------------------------- Net loans 1,084,112,471 995,801,905 Premises and equipment, net 26,862,758 25,508,863 Accrued interest receivable 18,478,042 14,168,068 Intangible assets, net 50,949,252 49,484,949 Other assets 20,780,571 24,323,539 - - -----------------------------------------------------------------------------------------------TOTAL ASSETS $2,022,635,412 $1,840,701,566 ===============================================================================================LIABILITIES AND SHAREHOLDERS' EQUITYLiabilities: Deposits Noninterest bearing $258,004,313 $225,012,768 Interest bearing 1,199,725,229 1,135,293,216 - - ----------------------------------------------------------------------------------------------- Total deposits 1,457,729,542 1,360,305,984 Federal funds purchased 38,000,000 0 Borrowings 331,100,000 324,000,000 Company obligated mandatorily redeemable preferred securities of subsidiary Community Capital Trust 1 holding solely junior subordinated debentures of the company 29,823,938 29,817,188 Accrued interest and other liabilities 26,606,217 18,090,941 - - ----------------------------------------------------------------------------------------------- TOTAL LIABILITIES 1,883,259,697 1,732,214,113 - - ----------------------------------------------------------------------------------------------- Shareholders' equity: Common stock no par $1.00 stated value for 2000 and 1999; 20,000,000 shares authorized; 6,993,459 and 7,092,259 shares outstanding for 2000 and 1999, respectively 7,641,559 7,640,359 Surplus 33,343,519 33,327,586 Undivided profits 108,349,087 95,340,837 Accumulated other comprehensive income 7,052,563 (13,088,367) Treasury stock, at cost (648,100 and 548,100 shares for 2000 and 1999, respectively) (17,006,288) (14,718,787) Shares issued under employee stock plan - (4,725) (14,175) unearned - - ----------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 139,375,715 108,487,453TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,022,635,412 $1,840,701,566 =============================================================================================== The accompanying notes are an integral part of the consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Years Ended December 31, - - ----------------------------------------------------------------------------------------------------- 2000 1999 1998Interest income:Interest and fees on loans $96,524,921 $84,853,208 $82,778,201 $ Interest and dividends on investments: U.S. Treasury 99,229 270,681 269,408 U.S. Government agencies and corporations 15,887,808 12,287,617 16,340,308 States and political subdivisions 6,623,617 5,001,876 1,571,670 Mortgage-backed securities 21,182,642 17,925,398 19,588,820 Other securities 4,295,185 3,510,586 2,091,495 Interest on federal funds sold and deposits with 607,490 38,488 298,175 other banks - - ----------------------------------------------------------------------------------------------------- Total interest income 145,220,892 123,887,854 122,938,077Interest expense:Interest on deposits 50,204,754 42,773,861 49,668,906 Interest on federal funds purchased 907,519 1,330,890 597,355 Interest on short-term borrowings 13,448,491 4,946,617 156,607 Interest on mandatorily redeemable preferred 2,931,750 2,931,750 2,931,750 securities of subsidiary Interest on long-term borrowings 6,519,906 3,963,611 5,188,535 - - ----------------------------------------------------------------------------------------------------- Total interest expense 74,012,420 55,946,729 58,543,153 - - ----------------------------------------------------------------------------------------------------- Net interest income 71,208,472 67,941,125 64,394,924 Less: Provision for possible loan losses 7,181,700 5,136,068 5,122,596 - - ----------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 64,026,772 62,805,057 59,272,328 - - -----------------------------------------------------------------------------------------------------Other income:Fiduciary and investment services 2,548,805 2,344,496 1,921,766 Service charges on deposit accounts 7,631,065 7,012,704 6,630,004 Commissions on investment products 4,924,413 1,288,083 1,222,328 Other service charges, commissions and fees 5,913,866 5,223,396 4,412,523 Other operating income 183,067 255,639 893,924 Investment security gain (loss) (212,281) (637,654) 1,959,384 - - ----------------------------------------------------------------------------------------------------- Total other income 20,988,935 15,486,664 17,039,929 - - -----------------------------------------------------------------------------------------------------Other expenses:Salaries and employee benefits 28,834,429 26,387,554 25,749,840 Occupancy expense, net 3,958,678 3,919,378 4,085,818 Equipment and furniture expense 3,677,487 3,465,330 3,500,841 Amortization of intangible assets 4,670,046 4,614,514 4,639,536 Legal and professional fees 1,896,206 1,936,668 1,666,017 Computer services expenses 2,570,614 2,389,138 2,334,104 Other 10,381,568 10,020,488 9,899,793 - - ----------------------------------------------------------------------------------------------------- Total other expenses 55,989,028 52,733,070 51,875,949 - - ----------------------------------------------------------------------------------------------------- Income before income taxes 29,026,679 25,558,651 24,436,308 Income taxes 8,708,104 7,923,182 8,901,945 - - ----------------------------------------------------------------------------------------------------- Income before change in accounting 20,318,575 17,635,469 15,534,363 Cumulative effect of change in accounting principal, net of taxes of $133,883 in 1998 (note C) 0 0 193,860 - - -----------------------------------------------------------------------------------------------------NET INCOME $20,318,575 $17,635,469 $15,728,223 ===================================================================================================== Earnings per common share - basic $2.88 $2.45 $2.08 ===================================================================================================== Earnings per common share - diluted $2.85 $2.42 $2.05===================================================================================================== The accompanying notes are an integral part of the consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Years ended December 31, 1998, 1999 and 2000 Common Shares Issued Accumulated Under Common Stock Other Employee ----------------------------------- Shares Undivided Treasury Comprehensive Comprehensive Stock Plan Outstanding Amount Surplus Profits Stock Income Income - Unearned Total - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- - - ------------------- Balance at December 31, 1997 $7,586,512 $7,586,512 $32,401,331 $75,335,527 $2,778,913 ($90,300) $118,011,983 Net income - 1998 15,728,223 $15,728,223 15,728,223 ------------------ Other comprehensive income, before tax: Unrealized gains on securities: Unrealized holding gains arising during period 4,822,654 0 Reclassification adjustment for gains included in net income (2,287,127) ------------------ Other comprehensive income, before tax: 2,535,527 Income tax expense related to other comprehensive income (1,028,697) ------------------ Other comprehensive income, net of tax 1,506,830 1,506,830 1,506,830 ------------------ Comprehensive income $17,235,053 ================== Dividends declared: Common, $.86 per share (6,472,503) (6,472,503) Common stock issued under employee stock plan 36,541 36,541 441,441 64,909 542,891 Treasury stock purchased (326,600) (9,151,956) (9,151,956) - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- - - ------------------- Balance at December 31, 1998 7,296,453 $7,623,053 $32,842,772 $84,591,247 ($9,151,956) $4,285,743 ($25,391) $120,165,468 Net income - 1999 17,635,469 $17,635,469 17,635,469 ------------------ Other comprehensive loss, before tax: Unrealized losses on securities: Unrealized holding losses arising during period (30,010,621) 0 Reclassification adjustment for losses included in net income 637,654 ------------------ Other comprehensive loss, before tax: (29,372,967) Income tax benefit related to other comprehensive income 11,998,857 ------------------ Other comprehensive loss, net of tax (17,374,110) (17,374,110) (17,374,110) ------------------ Comprehensive income $261,359 ================== Dividends declared: Common, $.96 per share (6,885,879) (6,885,879) Common stock issued under employee stock plan 17,306 17,306 484,814 11,216 513,336 Treasury stock purchased (221,500) (5,566,831) (5,566,831) - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- - - ------------------- Balance at December 31, 1999 7,092,259 $7,640,359 $33,327,586 $95,340,837 ($14,718,787) ($13,088,367) ($14,175) 108,487,453 Net income - 2000 20,318,575 $20,318,575 20,318,575 ------------------ Other comprehensive income, before tax: Unrealized gains on securities: Unrealized holding gains arising during period 33,838,319 0 Reclassification adjustment for losses included in net income 212,281 ------------------ Other comprehensive income, before tax: 34,050,600 Income tax expense related to other comprehensive income (13,909,670) ------------------ Other comprehensive income, net of tax 20,140,930 20,140,930 20,140,930 ------------------ Comprehensive income $40,459,505 ================== Dividends declared: Common, $1.04 per share (7,310,325) (7,310,325) Common stock issued under employee stock plan 1,200 1,200 15,933 9,450 26,583 Treasury stock purchased (100,000) (2,287,501) (2,287,501) - - ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- - - ------------------- Balance at December 31, 2000 6,993,459 $7,641,559 $33,343,519 $108,349,087 ($17,006,288) $7,052,563 ($4,725) $139,375,715 =============================================================================================================================================================================================================================================== =================== The accompanying notes are an intergral part of the consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES For Twelve Months Ended December 31, 2000, 1999, and 1998 2000 1999 1998 - - ------------------------------------------------------------------------------------------------------------- Operating Activities: Net income $20,318,575 $17,635,469 $15,728,223 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 3,110,891 2,941,441 2,822,990 Amortization of intangible assets 4,670,046 4,614,513 4,639,536 Net amortization of security premiums and 438,604 3,719,956 6,922,686 discounts Amortization of discount on loans (311,491) (586,746) 1,443,122 Provision for loan losses 7,181,700 5,136,068 5,122,596 Provision (benefits) for deferred taxes 251,474 (730,136) 383,806 (Gain)/loss on sale of investment securities 212,281 637,654 (2,287,127) (Gain)/loss on sale of loans and other assets (176,069) (161,285) (102,847) Change in interest receivable (4,309,974) (1,792,734) 1,017,484 Change in other assets and other liabilities (2,201,951) 910,590 2,269,036 Change in unearned loan fees and costs (1,649,528) (1,328,952) (1,551,770) - - ------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 27,534,558 30,995,838 36,407,735 - - ------------------------------------------------------------------------------------------------------------- Investing Activities: Proceeds from sales of investment securities 11,519,958 13,915,420 87,188,668 Proceeds from maturities of held to maturity 3,726,679 2,771,314 55,077,029 investment securities Proceeds from maturities of available for sale 33,467,572 171,894,104 110,430,351 investment securities Purchases of held to maturity investment securities (4,035,076) (3,775,571) (7,943,215) Purchases of available for sale investment securities (142,739,875) (255,683,661) (228,500,654) Net change in loans outstanding (93,458,733) (94,033,913) (78,779,935) Premium paid on acquisition of business (6,134,349) 0 0 Capital expenditures (4,494,194) (3,753,697) (4,935,714) Proceeds from sales of property and equipment 132,963 132,963 752,235 Other investing activities 0 0 0 - - ------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (202,015,055) (168,533,041) (66,711,235) - - ------------------------------------------------------------------------------------------------------------- Financing Activities: Net change in demand deposits, NOW accounts, and (610,522) (28,505,058) 61,508,239 savings accounts Net change in certificates of deposit 98,034,080 10,745,464 (29,128,619) Net change in federal funds purchased 38,000,000 (34,700,000) (10,300,000) Net change in term borrowings 7,100,000 224,000,000 20,000,000 Issuance (retirement) of common and preferred stock 17,133 187,928 474,451 Treasury stock purchased (2,287,501) (5,566,831) (9,151,956) Cash dividends (7,195,074) (6,791,081) (6,311,580) - - ------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 133,058,116 159,370,422 27,090,535 - - ------------------------------------------------------------------------------------------------------------- Change in cash and cash equivalents (41,422,381) 21,833,219 (3,212,965) Cash and cash equivalents at beginning of year 100,726,657 78,893,438 82,106,403 - - ------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $59,304,276 100,726,657 78,893,438 ============================================================================================================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest $72,776,130 $56,577,891 $56,791,512 ============================================================================================================= Cash paid for income taxes $8,546,611 $7,681,112 $9,938,377 ============================================================================================================= SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES: Dividends declared and unpaid $1,888,234 $1,772,982 $1,678,184 Gross change in unrealized gains/losses on available-for-sale securities $34,050,600 ($29,372,967) $2,547,473 ============================================================================================================= The accompanying notes are an integral part of the consolidated financial statements.COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESNature of OperationsCommunity Bank System, Inc. (the Company) is a one bank holding company which wholly-owns three subsidiaries, Community Bank, N.A. (the Bank), Community Capital Trust I, a subsidiary business trust, and Benefit Plans Administrative Services, Inc. (BPA). Community Capital Trust I was formed for the purpose of issuing mandatorily redeemable convertible securities which are considered Tier I capital under regulatory capital adequacy requirements (see Note Q). BPA, located in Utica, New York, provides pension administration and consulting services to sponsors of defined benefit and defined contribution plans throughout New York State. The Bank operates 67 customer facilities throughout Northern New York, the Finger Lakes Region, the Southern Tier, and Southwestern New York and owns two banking related subsidiaries, Community Financial Services, Inc. (CFSI), and Community Investment Services, Inc. (CISI). CFSI offers insurance investment products and CISI provides broker-dealer and investment advisory services. In addition, the Bank owns three non-banking subsidiaries, CBNA Treasury Management Corporation (TMC), CBNA Preferred Funding Corporation (PFC), and Elias Asset Management, Inc. (EAM). TMC operates the cash management, investment, and treasury functions of the Bank and PFC primarily engages in investing of residential and commercial real estate loans. EAM, located in Williamsville, New York, provides asset management services to the general public (see Note B).Principles of ConsolidationThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.Use of Estimates in the Preparation of Financial StatementsThe preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.Cash and Cash EquivalentsFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.Investment SecuritiesThe Company has classified its investments in debt and equity securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Company has the positive intent and ability to hold to maturity, and are reported at cost, which is adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held to maturity are classified as available-for-sale and are reported at fair market 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. Equity securities are stated at cost and include stock of the Federal Reserve Bank of New York and Federal Home Loan Bank of New York. The average cost method is used in determining the realized gains and losses on sales of investment securities, which are reported under other income as investment security gains (losses). Premiums and discounts on securities are amortized and accreted, respectively, on a systematic basis over the period to maturity, estimated life, or earliest call date of the related security. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.LoansLoans are stated at unpaid principal balances. Fair values for variable rate loans that reprice frequently, with no significant credit risk, 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. Mortgage loans held for sale are carried at the lower of cost or market and are included in loans as the balance of such loans was not significant. The carrying amount of accrued interest approximates its fair value.Interest on Loans and Reserve for Possible Loan LossesInterest on commercial loans and mortgages is accrued and credited to operations based upon the principal amount outstanding. Unearned discount on installment loans is recognized as income over the term of the loan, principally by the actuarial method. Non-refundable loan fees and related direct costs are deferred and amortized over the life of the loan as an adjustment to loan yield using the effective interest method. The Bank places a loan on nonaccrual status and recognizes income on a cash basis when it is more than ninety days past due (or sooner, if management concludes collection of interest is doubtful), except when, in the opinion of management, it is well-collateralized and in the process of collection. The reserve for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The reserve is increased by provisions charged to expense and reduced by net charge-offs. The level of the reserve is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions. A loan is considered impaired, based current information and events, if it is probable that the Bank will not be able to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.Premises and EquipmentPremises and equipment are stated at cost less accumulated depreciation. The annual provision for depreciation is computed using the straight-line method in amounts sufficient to recognize the cost of depreciable assets over their estimated useful lives. Maintenance and repairs are charged to expense as incurred.Other Real EstateProperties acquired through foreclosure, or by deed in lieu of foreclosure, are carried at the lower of the unpaid loan balance plus settlement costs, or fair value less estimated costs of disposal. At December 31, 2000 and 1999, other real estate, included in other assets, amounted to $906,384 and $883,919, respectively.Intangible AssetsIntangible assets represent core deposit value and goodwill arising from acquisitions. The Company periodically reviews the carrying value of intangible assets using fair value methodologies. Core deposit intangibles are being amortized principally on an accelerated basis over ten years. Goodwill is being amortized on a straight-line basis over 15 to 25 years.Mortgage Servicing RightsOriginated mortgage servicing rights are recorded at their fair value at the time of transfer and are amortized in proportion to and over the period of estimated net servicing income or loss. The Bank uses a valuation model that calculates the present value of future cash flows to determine the fair value of servicing rights. In using this valuation method, the Bank incorporated assumptions that market participants would use in estimating future net servicing income, which included estimates of the cost of servicing per loan, the discount rate, and prepayment speeds. The carrying value of the originated mortgage servicing rights is periodically evaluated for impairment using these same market assumptions. At December 31, 2000 and 1999, mortgage servicing rights, included in other assets, amounted to approximately $526,201 and $577,457, respectively.DepositsThe fair values disclosed for demand and savings deposits are equal to the carrying amounts at the reporting date. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposit are estimated using discounted cash flows and interest rates currently being offered on similar certificates. The carrying value of accrued interest approximates fair value.BorrowingsThe carrying amounts of federal funds purchased and short-term borrowings approximate their fair values. Fair values for long-term borrowings are estimated using discounted cash flows and interest rates currently being offered on similar borrowings.Income TaxesProvisions for income taxes are based on taxes currently payable or refundable, and deferred taxes which are based on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.Trust Department AssetsAssets held in fiduciary or agency capacities for customers are not included in the accompanying consolidated statements of condition, since such items are not assets of the Company. Fees associated with providing trust management services are recorded on cash basis of income recognition and are included in other income.Earnings Per ShareBasic earnings per share is computed on the basis of actual weighted average common shares outstanding for the period. Diluted earnings per share reflects the dilutive effect of outstanding common stock equivalents.Treasury StockTreasury stock purchases are recorded at cost. During 2000 and 1999, the Company purchased 100,000 and 221,500 shares of treasury stock at an average cost of $22.88 and $25.13, respectively. The Company purchases treasury stock primarily in order to have shares available for issuance under the incentive stock option, restricted stock awards and non-qualified stock option plan and for other strategic purposes.Fair Values of Financial InstrumentsThe Company determines fair values based on quoted market values where available or on estimates using present values or other valuation techniques. Those techniques are significantly affected by the assumptions used, including 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, could not be realized in immediate settlement of the instrument. Statement Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments," excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The fair values of investment securities, loans, deposits, and borrowings have been disclosed in footnotes C, D, G, and H, respectively.Accounting PronouncementsIn 1998, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon adoption of the SFAS, the Company transferred investment securities from held-to-maturity to available-for-sale (see Note C). As a result, securities previously classified as held-to-maturity were sold during the year and investment securities gains of approximately $194,000, net of tax, resulting from the sale have been reported as a cumulative effect of a change in accounting principle. The Company has no outstanding derivative financial instruments and, accordingly, adoption of SFAS 133 had no other affect on the Company's financial statements.Subsequent EventsOn January 26, 2001, the Company acquired Citizens National Bank of Malone, an eighty-year-old commercial bank with five branches throughout Franklin and St. Lawrence counties in New York State. The Company issued 952,000 shares of its common stock to the former shareholders at a cost of $26.50 per share. All of the 648,100 shares held in the Company's treasury were issued in this transaction. The acquisition is being accounted for under the purchase method of accounting. The Company purchased assets with a fair value of $109,965,000, assumed liabilities with a fair value of $98,681,000 and recorded goodwill of $13,944,000. The Company announced its first strategic partnership outside New York State with the signing on November 29, 2000 of a definitive agreement with First Liberty Bank Corp. (NASDAQ-OTC:FLIB), a $647 million asset commercial bank based in Jermyn, Pennsylvania, to acquire all the stock of FLIB. First Liberty Bank and Trust will be merged into Community Bank, N.A. (CBNA), operating under its present name in Pennsylvania as a division of CBNA. Subject to shareholder and regulatory approvals, the transaction is expected to close in second quarter 2001.NOTE B: ACQUISITIONSElias Asset Management, Inc.On April 3, 2000, Community Bank System, Inc. acquired all the stock of Elias Asset Management, Inc. (EAM) for cash of $6.5 million. EAM, based in Williamsville, NY, is a nationally recognized firm with $650 million in assets under management for individuals, corporate pension and profit sharing plans, and foundations. In accordance with the stock purchase agreement, additional consideration will be paid if certain performance targets are met over a five year period. This transaction was accounted for under the purchase method, and the Company recognized $6.1 million of goodwill, which is being amortized over 20 years.NOTE C: INVESTMENT SECURITIESThe amortized cost and estimated fair values of investments in securities as of December 31 are as follows: 2000 1999 - - -------------------------------------------------------------------------------------------------------------------------------------- Gross Gross Estimated Gross Gross Estimated Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Held to Maturity Cost Gains Losses Value Cost Gains Losses Value - - -------------------------------------------------------------------------------------------------------------------------------------- Obligations of states and political subdivisions $5,350,574 $100,349 $139 $5,450,784 $5,042,178 $44,647 $2,978 $5,083,847 ----------- --------- ----- ----------- ----------- -------- ------- ---------- TOTALS 5,350,574 100,349 139 5,450,784 5,042,178 44,647 2,978 5,083,847 - - -------------------------------------------------------------------------------------------------------------------------------------- Available for Sale - - -------------------------------------------------------------------------------------------------------------------------------------- U.S. Treasury securities and obligations of U.S. government corporations and agencies 241,158,578 11,476,840 254,418 252,381,000 177,096,926 39,872 5,343,701 171,793,097 Obligations of states and political subdivisions 134,652,859 3,348,027 1,819,886 136,181,000 118,223,430 360,414 8,458,684 110,125,160 Corporate Securities 44,611,837 1,152,672 1,112,509 44,652,000 35,914,206 0 2,815,011 33,099,195 Mortgage-backed securities 297,659,183 3,612,686 4,480,229 296,791,640 290,000,398 1,805,835 7,716,143 284,090,090 ------------- --------- ---------- ------------ ------------ ---------- ---------- ----------- TOTALS 718,082,457 19,590,225 7,667,042 730,005,640 621,234,960 2,206,121 24,333,539 599,107,542 Equity securities 26,791,827 0 0 26,791,827 26,537,863 0 0 26,537,863 ----------- -- -- ----------- ----------- -- -- ---------- TOTALS 744,874,284 19,590,225 7,667,042 756,797,467 647,772,823 2,206,121 24,333,539 625,645,405 - - -------------------------------------------------------------------------------------------------------------------------------------- Net unrealized gain/(loss) on Available for Sale 11,923,184 (22,127,416) - - -------------------------------------------------------------------------------------------------------------------------------------- GRAND TOTAL CARRYING VALUE 762,148,042 630,687,585 ====================================================================================================================================== The amortized cost and estimated fair value of debt securities at December 31, 2000, 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. Held to Maturity Available for Sale Carrying Est. Market Carrying Est.Market Value Value Value Value - - --------------------------------------------------------------------------------- Due in one year or less $3,503,930 $3,518,200 $59,679,726 $60,531,542 Due after one through 1,581,421 1,636,720 8,789,622 8,854,670 five years Due after five years 247,129 275,030 187,928,283 196,052,022 through ten years Due after ten years 18,094 20,834 164,025,643 167,775,766 ---------------------------------------------------- TOTAL 5,350,574 5,450,784 420,423,274 433,214,000 Mortgage-backed 0 0 297,659,183 296,791,640 securities ---------------------------------------------------- TOTAL $5,350,574 $5,450,784 $718,082,457 $730,005,640 ================================================================================= Proceeds from sales of investments in debt securities during 2000, 1999, and 1998 were $11,520,000, $13,640,000, and $85,689,000, respectively. Gross gains of approximately $0, $276,642, and $2,287,000 for 2000, 1999, and 1998, respectively, and gross losses of $212,281, $914,000, and $0 in 2000, 1999, and 1998, respectively, were realized on those sales. Investment securities with a carrying value of $562, 952,000, $457,512,000 and $324,565,708 at December 31, 2000, 1999, and 1998, respectively, were pledged to collateralize deposits and borrowings. Pursuant to the adoption of Statement of Financial Accounting Standards No. 133, "Accounting for Derivatives Instruments and Hedging Activities," in 1998, the Company transferred investment securities having an amortized cost of $216,797,000 and net unrealized gains of $6,952,000 from held-to-maturity to available-for-sale. The Company subsequently sold a portion of those investments with an amortized cost of $17,424,000 within the same quarter; accordingly, the realized gain of $193,860, net of tax, has been reported as a cumulative effect of a change in accounting principle.NOTE D: LOANSMajor classifications of loans at December 31 are summarized as follows: 2000 1999 - - ----------------------------------------------------------------------------------------- Real estate mortgages: Residential 383,381,468 $336,466,553 Commercial 126,024,057 114,838,282 Farm 19,850,358 17,652,220 Agricultural loans 26,488,434 27,721,431 Commercial loans 181,974,604 171,787,084 Installment loans to individuals 341,910,320 329,275,510 Other loans 14,205,564 8,384,602 --------------------------------- 1,093,834,805 1,006,125,682 Less : Unearned interest, and deferred loan fees 4,891,543 3,096,833 and costs, net Reserve for possible loan losses (14,613,877) (13,420,610) --------------------------------- Net loans $1,084,112,471 $995,801,905 ========================================================================================= The estimated fair value of loans receivable at December 31, 2000 and 1999 was $1,078,000,000 and $991,000,000, respectively. Non-accrual loans of $4,423,000 and $4,666,000 at December 31, 2000 and 1999, respectively, are included in net loans. If non-accrual loans had been accruing interest at their originally contracted terms, interest income on these loans would have amounted to $271,488 and $189,346 in 2000 and 1999, respectively. Loans to directors and officers or other related parties were approximately $12,032,957 and $12,453,983 at December 31, 2000 and 1999, respectively. Mortgage loans serviced for others are not included in the accompanying consolidated statements of condition. The unpaid principal balances of mortgage loans serviced for others was $89,732,353 and $88,700,053 at December 31, 2000 and 1999, respectively. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $670,483 and $650,420 at December 31, 2000 and 1999, respectively. Changes in the reserve for possible loan losses for the years ended December 31 are summarized as follows: ---------------------------------------------- 2000 1999 1998 ---------------------------------------------- Balance at beginning of year $13,420,610 $12,441,255 $12,433,812 Reserves on acquired loans 0 0 0 Provision charged to expense 7,181,700 5,136,068 5,122,596 Loans charged off (7,065,735) (5,287,623) (6,096,561) Recoveries 1,077,302 1,130,910 981,408 ---------- ---------- ------- Balance at end of year $14,613,877 $13,420,610 $12,441,255 =========================================================================== As of December 31, 2000, 1999 and 1998, the Company's impaired loans for which specific valuation allowances were recorded were not significant.NOTE E: PREMISES AND EQUIPMENTPremises and equipment consist of the following at December 31: - - --------------------------------------------------------------------- 2000 1999 - - --------------------------------------------------------------------- Land and land improvements $3,161,163 $3,074,848 Bank premises owned 25,695,110 25,076,326 Equipment 22,153,588 19,529,121 ----------------------------- Premises and equipment gross $51,009,860 47,680,295 Less: Allowance for depreciation 24,147,103 22,171,432 ----------------------------- Premises and equipment, net $26,862,758 $25,508,863 =====================================================================NOTE F: INTANGIBLE ASSETSIntangible assets consist of the following at December 31: - - ----------------------------------------------------------------------------------------- 2000 1999 - - ----------------------------------------------------------------------------------------- - - ----------------------------------------------------------------------------------------- Core deposit intangible $14,434,507 $14,434,507 Goodwill and other intangibles 58,894,746 52,760,397 ---------------------- ----------------------- Intangible assets, gross 73,329,253 67,194,904 ---------------------- ----------------------- Less: Accumulated amortization (22,380,001) (17,709,955) ---------------------- ----------------------- Intangible assets, net $50,949,252 $49,484,949 =========================================================================================NOTE G: DEPOSITSDeposits by type at December 31 are as follows: - - ----------------------------------------------------------------------------------------- 2000 1999 - - ----------------------------------------------------------------------------------------- - - ----------------------------------------------------------------------------------------- Demand 258,004,313 225,012,767 Savings 469,162,934 502,765,002 Time 730,562,296 632,528,215 Total Deposits 1,457,729,542 1,360,305,984 ========================================================================================= The estimated fair values of deposits at December 31, 2000 and 1999 were approximately $1,455,000 and $1,357,000, respectively. At December 31, 2000 and 1999, time certificates of deposit in denominations of $100,000 and greater totaled $156,172,243 and $112,397,283, respectively. The approximate maturities of time deposits at December 31 are as follows: - - ----------------------------------------------------------------------------------------- Maturity 2000 1999 - - ----------------------------------------------------------------------------------------- One year or less 596,432,829 455,381,669 One to two years 106,177,653 132,756,822 Two to three years 15,463,112 25,793,504 Three to four years 6,429,817 12,287,767 Four to five years 5,363,512 5,393,330 Over five years 695,373 915,123 ---------------- --------------------- Total 730,562,296 632,528,215 =========================================================================================NOTE H: BORROWINGSAt December 31, 2000 and 1999, outstanding borrowings were as follows: - - ----------------------------------------------------------------------------------------- 2000 1999 - - ----------------------------------------------------------------------------------------- Short-term borrowings: Federal funds purchased 38,000,000 $0 Federal Home Loan Bank Advances 145,000,000 250,000,000 Other short-term borrowings 6,100,000 4,000,000 -------------- ------------------- 189,100,000 254,000,000 Long-term borrowings: Federal Home Loan Bank Advances 180,000,000 70,000,000 Company obligated mandatorily redeemable preferred securities of subsidiary trust holding solely junior subordinated debentures of the Company, net of discount of $176,063 29,823,938 29,817,187 and $182,813 ----------- ---------- $398,923,938 $353,817,187 ========================================================================================= Federal Home Loan Bank advances are secured by a blanket lien on the Company's residential real estate loan portfolio and mortgage-backed securities portfolio. Long-term borrowings at December 31, 2000 have maturity dates as follows: Weighted Average Rate Amount December 17, 2002 6.20% 10,000,000 February 10, 2003 5.52% 5,000,000 January 23, 2008 5.44% 10,000,000 January 28, 2008 5.48% 5,000,000 January 30, 2008 5.27% 20,000,000 February 4, 2008 5.45% 5,000,000 April 14, 2010 6.35% 25,000,000 September 27, 2010 5.88% 50,000,000 October 12, 2010 5.84% 50,000,000 January 30, 2027 9.75% 29,823,938 ----- ---------- 6.38% $209,823,938 ========================================================================== The estimated fair value of long term borrowings at December 31, 2000 and 1999 was $214,000,000 and $99,097,000, respectively.NOTE I: INCOME TAXESThe provision (benefit) for income taxes for the years ended December 31 is as follows: - - ---------------------------------------------------------------------------------------------------- 2000 1999 1998 - - ---------------------------------------------------------------------------------------------------- Current: Federal $7,914,753 $8,122,791 $7,889,187 State 541,877 530,527 762,835 Deferred: Federal 196,457 (569,274) 299,246 State 55,017 (160,862) 84,560 ---------- -------- ------ Total income taxes $8,708,104 $7,923,182 $9,035,828 ==================================================================================================== Components of the net deferred tax asset/liability, included in other assets/liabilities, as of December 31 are as follows: - - ----------------------------------------------------------------------------- 2000 1999 - - ----------------------------------------------------------------------------- Investment securities $0 $8,441,513 Allowance for loan losses 5,804,137 4,985,174 Postretirement and other reserves 955,792 975,669 Pension 512,195 444,811 Amortization of Intangibles 312,658 352,237 Other 1,339,496 1,328,233 ------------------------------ Total deferred tax asset 8,924,278 16,527,637 ------------------------------ Investment securities 5,853,237 0 Deferred loan fees 2,127,978 1,539,808 Depreciation 970,924 831,933 Mortgage Servcing Rights 213,269 235,883 ------------------------------ Total deferred tax liability 9,165,408 2,607,624 ------------------------------ Net deferred tax asset/liability $(241,130) $13,920,013 ============================================================================= The Company has determined that no valuation allowance is necessary as it is more likely than not that deferred tax assets will be realized through carryback of future deductions to taxable income in prior years, future reversals of existing temporary differences, and through future taxable income. A reconciliation of the differences between the federal statutory income tax rate and the effective tax rate for the years ended December 31 is shown in the following table: - - ------------------------------------------------------------------------------------------------ 2000 1999 1998 - - ------------------------------------------------------------------------------------------------ Federal statutory income tax rate 35.0% 35.0% 35.0% Increase (reduction) in taxes resulting from: Tax-exempt interest (6.8) (6.3) (1.9) State income taxes, net of federal benefit 1.1 0.6 1.9 Other 0.7 1.7 1.5 --- ---- --- Effective income tax rate (including tax effect of 30.0% 31.0% 36.5% accounting change) ================================================================================================NOTE J: LIMITS ON DIVIDENDS AND OTHER REVENUE SOURCESThe Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In additional to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations, and policies. For example, as a national bank, the Bank must obtain the approval of the Office of the Comptroller of the Currency (OCC) for payments of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 2000, the Bank had approximately $17,849,000 in undivided profits legally available for the payments of dividends. In addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. There are also statutory limits on the transfer of funds to the Company by its banking subsidiary, whether in the form of loans or other extensions of credit, investments or assets purchases. Such transfer by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specific amounts.NOTE K: BENEFIT PLANSThe Company has a noncontributory defined benefit pension plan covering the majority of its employees and retirees. The Company also provides health and life insurance benefits for eligible retired employees and dependents. The following table shows the funded status of the Company's Plans reconciled with amounts reported in the Company's consolidated balance sheets, and the assumptions used in determining the actuarial present value of the benefit obligations: Pension Benefits Postretirement Benefits ------------------------------------------------------------ 2000 1999 2000 1999 ------------------------------------------------------------ Change in benefit obligation Benefit obligation at the beginning of year $11,931,624 $12,482,616 $1,996,775 $2,693,122 Service cost 732,541 607,015 133,650 103,520 Interest cost 931,899 755,791 138,228 129,518 Deferred actuarial (gain) loss 1,636,216 (1,405,526) 7,819 (833,444) Benefits paid (605,792) (508,272) (127,973) (95,941) ------------------------------------------------------------ Benefit obligation at end of year 14,626,488 11,931,624 2,148,499 1,996,775 - - --------------------------------------------------------------------------------------------------------- Change in plan assets Fair value of plan assets at beginning of year 13,582,931 12,157,001 Actual return of plan assets (644,309) 1,637,354 Company contributions 489,549 296,848 Benefits paid (605,792) (508,272) ------------------------------------------------------------ Fair value of plan assets at end of year 12,822,379 13,582,931 - - - --------------------------------------------------------------------------------------------------------- Funded (unfunded) status (1,804,109) 1,651,307 (2,148,499) (1,996,775) Unrecognized actuarial (gain) loss 3,372,590 (117,742) (155,186) (163,005) Unrecognized prior service (benefit) cost (233,177) (248,367) - - Unrecognized transition asset (70,034) (92,282) Unrecognized portion of net obligation at transition 492,108 533,117 ------------------------------------------------------------ Prepaid (accrued) benefit cost $1,265,270 $1,192,916 $(1,811,577) $(1,626,663) ========================================================================================================= Weighted-average assumptions as of December 31 Discount rate 7.00% 7.00% 7.00% 7.00% Expected return on plan assets 9.00% 9.00% Rate of compensation increase 4.00% 4.00% ========================================================================================================= Pension Benefits Postretirement Benefits ---------------------------------------------------------------------- 2000 1999 1998 2000 1999 1998 - - --------------------------------------------------------------------------------------------------------- Components of net periodic benefit cost Service cost $732,541 $607,015 $462,548 $133,650 $103,520 $101,734 Interest cost 931,899 755,791 677,664 138,228 129,518 170,270 Actual return on plan assets 644,309 (1,637,354) (1,376,137) Net amortization and deferral (1,891,554) 518,453 454,474 Amortization of prior service cost - - 18,610 Amortization of unrecognized net loss - (4,325) (3,679) Amortization of transition obligation 41,009 41,009 61,200 ---------------------------------------------------------------------- Net periodic benefit cost $417,195 $243,905 $218,549 $312,877 $269,722 $348,135 ========================================================================================================= The defined benefit pension plan is authorized to invest up to 10% of the fair value of its total assets in common stock of Community Bank System, Inc. At December 31, 2000 and 1999, the plan holds 46,500 and 43,378 shares, respectively, of the sponsor company common stock. Health care cost assumptions have no effect on the amounts reported for the health care plans, since the plan changed to a fixed dollar employee contribution plan in 1999. The Company also has an Employee Savings and Retirement Plan, which is administered by the Trust Department of Community Bank, N. A. The Employee Savings and Retirement Plan includes Section 401(k) and Thrift provisions as defined under the Internal Revenue Code. Company contributions to the trust amounted to $838,000, $830,000, and $848,000 in 2000, 1999, and 1998, respectively. The Company has deferred compensation agreements with its President and Chief Executive Officer and several former executives and officers whereby monthly payments are to be provided upon retirement over periods ranging from ten to 25 years. Expense recognized during 2000, 1999, and 1998 related to these arrangements amounted to approximately $328,000, $367,000, and $258,000, respectively. The Company has recorded a liability of $1,985,000 and $1,713,000 at December 31, 2000 and 1999, respectively. The Company has a Stock Balance Plan for nonemployee directors who have completed six months of service. The Plan is a nonqualified, noncontributory defined benefit plan. The Plan provides benefits for periods of service prior to January 1, 1996 based on a predetermined formula. Amounts credited to participant accounts for all creditable service after January 1, 1996 are based on performance of the Company's stock. Participants become fully vested after six years of service. Benefits are payable in the form of stock of the Company on the first of the month following the later of a participant's disassociation from the Board or attainment of age 70. Unrecognized prior service cost of $435,425 at December 31, 2000 is being amortized over 8 years. Expense related to the Plan recognized in 2000, 1999, and 1998, approximated $9,000, $20,000, and $19,000, respectively. The accrued pension liability was approximately $349,000 and $367,000 at December 31, 2000 and 1999, respectively. The net periodic pension cost was calculated using discount rates of 7.0% in 2000 and 1999.NOTE L: STOCK-BASED COMPENSATION PLANSThe Company has long-term, stock-based incentive compensation programs for directors, officers, and key employees, including incentive stock options (ISO's), restricted stock awards (RSA's), nonqualified stock options (NQSO's), warrants, retroactive stock appreciation rights, and discounted options. The Company has authorized the grant of options for up to 985,000 shares of the Company's common stock. All options granted have ten year terms and vest and become fully exercisable at the end of five years of continued employment. Activity in these plans for 2000, 1999, and 1998 was as follows: - - ----------------------------------------------------------------------------------------------------- Options Range of Shares Weighted Outstanding Option Excersiable Average Price Exercise Price Per Share Shares Outstanding - - ----------------------------------------------------------------------------------------------------- Outstanding at December 293,030 5.87 - 19.13 129,765 14.54 31, 1997 Granted 231,311 31.31 - 35.31 Exercised / (Cancelled),net (45,573) 8.00 - 31.31 Forfeited 0 Outstanding at December 478,768 5.87 - 35.31 305,261 25.82 31, 1998 Granted 130,379 25.38 - 29.31 Exercised / (Cancelled),net (23,793) 12.13 - 19.13 Forfeited (1,085) Outstanding at December 584,269 5.87 - 35.31 380,031 25.86 31, 1999 Granted 150,491 23.13 Exercised / (Cancelled),net (1,850) 13.13 - 35.31 Forfeited (2,218) Outstanding at December 730,692 5.87 - 35.31 498,969 25.15 31, 2000 There were 254,308, 370,095 and 500,289 shares available for future grants or awards under the various programs described above at December 31, 2000, 1999, and 1998, respectively. Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," provides for a fair-value-based method of accounting for stock compensation plans with employees and others. Alternatively, the statement allows that entities may continue to account for stock-based compensation plans in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," with disclosure of pro forma amounts reflecting the difference between cost charged to operations pursuant to APB No. 25 and compensation cost that would have been charged to operations had SFAS No. 123 been applied. The Company has elected to continue following APB No. 25 in accounting for its stock-based compensation plans. Application of the fair-value based accounting provision of SFAS No. 123 results in the following pro forma amounts of net income and earnings per share: - - ------------------------------------- --------------- ------------------ --------------- ---------------- 2000 1999 1998 - - ------------------------------------- --------------- ------------------ ---------------- --------------- Net Income: As reported $20,318,576 $17,635,469 $15,728,222 Pro forma 19,660,475 17,084,216 14,005,208 Earnings per share: As reported: Basic $2.88 $2.45 $2.08 Diluted 2.85 2.42 2.05 Pro forma: Basic 2.78 2.38 1.86 Diluted 2.76 2.34 1.83 ========================================================================================================= The fair value of these options was estimated at the date of grant using a Black-Scholes options pricing model with the following weighted average assumptions for 2000, 1999 and 1998: risk-free interest rates by grant ranging from 4.65% to 6.93% during 2000, 4.65% to 5.78% during 1999, and 5.55% to 5.67% during 1998; dividend yields of 3.00% during 2000, 1999 and 1998; volatility factors of the expected market price of the Company's common stock of 29.15% for 2000, 30.78% for 1999 and 44.06% for 1998; and a weighted-average expected life of the option of 7.11 years in 2000, 6.70 for 1999, and 8.27 for 1998. For the purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Therefore, the preceding results are not likely to be representative of the effects on reported net income for future years due to additional years of vesting. At December 31, 2000 the weighted average information for outstanding and exercisable shares is as follows: - - ---------------------------------------------------------------------------------------------- Shares Outstanding Shares Exercisable Weighted Range of Shares Weighted Average Shares Average ----------------------------- Exercise Outstanding Exercise Remaining Outstanding Exercise Price Price Life Price (years) - - ---------------------------------------------------------------------------------------------- $5.87 - $7.06 2,000 $6.75 1.0 2,000 $6.75 $7.06 - $10.59 15,200 $7.50 1.9 15,200 $7.50 $10.59 - $14.13 42,838 $12.78 4.4 39,638 $12.83 $14.13 - $17.66 75,950 $15.63 4.6 64,393 $15.56 $17.66 - $21.19 88,563 $19.13 6.0 74,257 $19.13 $21.19 - $24.72 149,303 $23.13 9.0 48,564 $23.13 $24.72 - $28.25 3,102 $25.66 8.4 1,326 $25.51 $28.25 - $31.78 207,490 $30.11 7.6 107,345 $30.21 $31.78 - $35.31 146,246 $34.81 11.5 146,246 $34.81 - - ---------------------------------------------------------------------------------------------- Total / Average 730,692 $25.22 7.8 498,969 $25.15 ============================================================================================== Directors may elect to defer all or a portion of their director fees until a certain distribution date pursuant to a Deferred Compensation Plan. The administrator has established an account for each participating director and credits to such account the number of shares of Company common stock which would have been purchased with the director fees and shares equal to the amount of dividends which would have been received. On the distribution date, the director shall be entitled to receive either shares of the Company common stock equal to the number of shares accumulated or at the Company's election, cash equal to the fair value of the number of shares accumulated. There were 25,539 and 19,614 shares credited to participant accounts at December 31, 2000 and 1999, respectively, for which a liability of approximately $769,000 and $638,000 was accrued and approximately $130,000 and $146,000 was recognized as expense.NOTE M: EARNINGS PER SHAREBasic earnings per share is computed based on the weighted average shares outstanding. Diluted earnings per share is computed based on the weighted average shares outstanding adjusted for the dilutive effect of the assumed exercise of stock options during the year. The following is a reconciliation of basic to diluted earnings per share for the years ended December 31: - - ---------------------------------------------------------------------------------------------------- Income Shares Per Share Amount - - ---------------------------------------------------------------------------------------------------- 2000 Net Income $20,318,575 Basic EPS 20,318,575 7,063,051 $2.88 Effect of dilutive securities: Stock options 0 72,762 ------------------------------ Diluted EPS $20,318,575 7,135,813 $2.85 ==================================================================================================== 1999 Net Income $17,635,649 Basic EPS 17,635,649 7,188,626 $2.45 Effect of dilutive securities: Stock options 0 106,625 ------------------------------ Diluted EPS $17,635,649 7,295,251 $2.42 ==================================================================================================== 1998 Net Income $15,728,223 Basic EPS 15,728,223 7,544,938 $2.08 Effect of dilutive securities: Stock options 0 125,773 ------------------------------ Diluted EPS $15,728,223 7,670,711 $2.05 ====================================================================================================NOTE N: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONSThe 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, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement the Company has in this particular class of financial instrument. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. - - -------------------------------------------------------------------------------------------------------- 2000 1999 - - -------------------------------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk at December 31: Letters of Credit 16,513,902 17,498,107 Commitments to make or purchase loans or to extend credit on lines of credit 197,325,501 201,401,741 ------------------ ------------------ Total $213,839,403 $218,899,848 ======================================================================================================== The fair value of these financial instruments is not significant. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluated each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include residential real estate, income-producing commercial properties, and personal property. The Company has unused lines of credit totaling $3,900,000 and $6,000,000 at December 31, 2000 and 1999, respectively. The Company has additional unused borrowing capacity through collateralized transactions with the Federal Home Loan Bank. The Company is required to maintain a reserve balance, as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 2000 was $20,060,000, of which $2,000,000 was required to be on deposit with the Federal Reserve Bank of New York. The remaining $18,060,000 was represented by cash on hand.NOTE O: LEASESThe Company leases buildings and office space under agreements that expire in various years. Rental expense included in operating expenses amounted to $1,014,020, $991,103 and $1,132,000 in 2000, 1999 and 1998, respectively. The future minimum rental commitments as of December 31, 2000 for all noncancelleable operating leases are as follows: Year ending December 31: ================================ 2001 $883,910 2002 860,082 2003 661,941 2004 636,765 2005 495,163 Thereafter 1,832,702 --------------- $5,370,563 ================================NOTE P: REGULATORY MATTERSThe Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000 and December 31, 1999, that the Bank meets all capital adequacy requirements to which it is subject and is "well capitalized" under the regulatory framework of prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. - - --------------------------------------------------------------------------------------------------- To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions - - --------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio - - --------------------------------------------------------------------------------------------------- As of December 31, 2000: Total Core Capital (to Risk Weighted Assets) $125,812 10.63% $98,218 8.0% $122,772 10.0% Tier I Capital (to Risk Weighted Assets) $111,198 9.41% $49,109 4.0% $73,663 6.0% Tier I Capital (to Average Assets) $111,198 5.89% $76,817 4.0% $96,021 5.0% As of December 31, 1999: Total Core Capital (to Risk Weighted Assets) $116,257 10.61% $87,864 8.0% $109,836 10.0% Tier I Capital (to Risk Weighted Assets) $102,836 9.39% $43,932 4.0% $65,902 6.0% Tier I Capital (to Average Assets) $102,836 5.86% $70,340 4.0% $87,925 5.0% ===================================================================================================NOTE Q: PARENT COMPANY STATEMENTS- - -------------------------------------------------------------------------------- CONDENSED BALANCE SHEETS - - -------------------------------------------------------------------------------- December 31 December 31 2000 1999 - - -------------------------------------------------------------------------------- Assets: Cash and cash equivalents 307,791 519,259 Investment securities 894,675 820,211 Investment in and advances to subsidiaries 177,439,295 145,116,096 Other assets 1,138,332 129,489 -------------- ------------------ Total assets 179,780,093 146,585,055 ================================================================================ Liabilities: Due to subsidiary - - Accrued interest and other liabilities 3,552,440 3,352,414 Borrowings 36,851,938 34,745,188 Shareholders' equity 139,375,715 108,487,453 Total liabilities and shareholders' equity 179,780,093 146,585,055 ================================================================================ - - ------------------------------------------------------------------------------------------------------- CONDENSED STATEMENTS OF INCOME - - ------------------------------------------------------------------------------------------------------- Years Ended December 31 2000 1999 1998 - - ------------------------------------------------------------------------------------------------------- Dividends from subsidiaries 11,244,455 20,466,894 11,462,202 Interest on investments and deposits 40,000 40,000 40,000 Gain on sale of assets - - 150,000 --------------- ------------------ -------------------- Total revenues 11,284,455 20,506,894 11,652,202 --------------- ------------------ -------------------- Expenses: Interest on long term notes and debentures 3,449,732 3,024,977 3,022,485 Other Expenses 14,202 7,774 2,750 --------------- ------------------ -------------------- Total expenses 3,463,934 3,032,751 3,025,235 --------------- ------------------ -------------------- Income before tax benefit and equity in undistributed net income of subsidiaries 7,820,521 17,474,143 8,626,967 Income tax benefit 1,000,036 899,704 1,034,861 --------------- ------------------ -------------------- Income before equity in undistributed net income subsidiaries 8,820,557 18,373,847 9,661,828 Equity in undistributed net income: Subsidiary banks 11,498,018 (738,378) 6,066,395 Bank-related subsidiaries --------------- ------------------ -------------------- Net Income 20,318,575 17,635,469 15,728,223 ======================================================================================================= On February 3, 1997, the Company formed a subsidiary business trust, Community Capital Trust I (Trust), for the purpose of issuing preferred securities which qualify as Tier I capital (see Note P). Concurrent with its formation, the Trust issued $30,000,000 of 9.75% preferred securities in an exempt offering. The preferred securities are non-voting, mandatorily redeemable in 2027, and guaranteed by the Company. The entire net proceeds to the Trust from the offering were invested in junior subordinated obligations of the Company. The costs related to the issuance of these securities are capitalized and amortized over the life of the period to redemption on a straight-line basis.NOTE Q: PARENT COMPANY STATEMENTS (Continued)=================================================================================================== STATEMENTS OF CASH FLOWS - - --------------------------------------------------------------------------------------------------- Increase (Decrease) in Cash, Cash Equivalents, and Noncash Activities Years Ended December 31 2000 1999 1998 - - --------------------------------------------------------------------------------------------------- Operating Activities: Net income $20,318,575 $17,635,469 $15,728,223 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (11,498,018) 738,378 (6,066,395) Net change other assets and accrued liabilities (1,023,119) 694,498 (237,012) - - --------------------------------------------------------------------------------------------------- Net Cash Provided By Operating Activities 7,797,438 19,068,345 9,424,816 - - --------------------------------------------------------------------------------------------------- Investing Activities: Purchase of available for sale investment securities (74,464) (178,365) (114,617) Sale of available for sale investment securities Capital contributions to subsidiaries (569,000) (4,793,001) (602,264) - - --------------------------------------------------------------------------------------------------- Net Cash Used By Investing Activities (643,464) (4,971,366) (716,881) - - --------------------------------------------------------------------------------------------------- Financing Activities: Net change in loans to subsidiaries - (7,360,338) 7,360,338 Proceeds from issuance of short term debt 2,100,000 4,000,000 - Proceeds from issuance of junior subordinated debentures to subsidiary - - - Issuance (retirement) of common and preferred stock 17,133 187,928 474,450 Repurchase of treasury stock (2,287,501) (5,566,831) (9,151,956) Cash dividends (7,195,074) (6,791,082) (6,311,580) - - --------------------------------------------------------------------------------------------------- Net Cash Provided (Used) By Financing Activities (7,365,442) (15,530,323) (7,628,748) - - --------------------------------------------------------------------------------------------------- Change In Cash And Cash Equivalents: (211,468) (1,433,344) 1,079,187 Cash and cash equivalents at beginning of year 519,259 1,952,603 873,416 - - --------------------------------------------------------------------------------------------------- - - --------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR 307,791 519,259 1,952,603 =================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash Paid For Interest 3,439,398 3,022,231 3,022,485 =================================================================================================== SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: Dividends declared and unpaid $1,888,234 $1,772,982 $1,678,184 =================================================================================================== The accompanying notes are an integral part of the consolidated financial statements. On February 21, 1995, the Company adopted a Stockholder Protection Rights Agreement and declared a dividend of one right for each outstanding share of common stock. The rights can only be exercised when an individual or group has acquired or attempts to acquire 15% or more of the Company's common stock, if such action the Board of Directors believes is not in the best interest of the stockholders. Each right then entitles the holder to acquire common stock having a market value equivalent to two times the stated exercise price. The rights expire in February 2005 and may be redeemed by the Company in whole at a price of $.01 per right. Pricewaterhouse Coopers LLP a professional services firm Board of Directors and Shareholders Community Bank System, Inc. In our opinion, the accompanying consolidated statements of condition and the related consolidated statements of income, changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Community Bank System, Inc. and Subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principals generally accepted in the United State of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principals used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Pricewaterhouse Coopers LLP Syracuse, New York January 26, 2001 TWO YEAR SELECTED QUARTERLY DATA 2000 RESULTS 1st 2nd 3rd 4th (Dollars in Thousands) Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- Net interest income $17,820 $17,924 $17,578 $17,886 $71,208 Provision for loan 1,209 1,707 2,128 2,138 $7,182 losses --------------- -------------- -------------- --------------- -------------- Net interest income after provision for loan 16,611 16,217 15,450 15,748 64,026 losses Total other income 3,930 5,500 5,956 5,603 $20,989 Total other expense 13,363 14,315 14,081 14,230 $55,989 --------------- -------------- -------------- --------------- -------------- Income before income 7,178 7,402 7,121 29,026 taxes 7,325 Income taxes 2,154 2,220 2,198 2,136 $8,708 --------------- -------------- -------------- --------------- -------------- Net income $5,024 $5,182 $5,127 $4,985 $20,318 =============== ============== ============== =============== ============== Earnings per share - $0.71 $0.73 $0.73 $0.71 $2.88 Basic Earnings per share - $0.70 $0.72 $0.72 $0.70 $2.84 Diluted ======================================================================================================== 1999 RESULTS 1st 2nd 3rd 4th (Dollars in Thousands) Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- Net interest income $15,872 $16,519 $17,554 $17,996 $67,941 Provision for loan 1,169 1,421 1,099 1,447 $5,136 losses --------------- -------------- -------------- --------------- -------------- Net interest income after provision for loan 14,703 15,098 16,455 16,549 62,805 losses Total other income 4,103 3,880 4,022 3,482 15,487 Total other expense 13,219 13,188 13,266 13,061 52,734 --------------- -------------- -------------- --------------- -------------- Income before income 5,587 5,790 7,211 6,970 25,558 taxes Income taxes 1,899 1,742 2,309 1,973 $7,923 --------------- -------------- -------------- --------------- -------------- Net income $3,688 $4,048 $4,902 $4,997 $17,635 =============== ============== ============== =============== ============== Earnings per share - $0.51 $0.56 $0.69 $0.70 $2.45 Basic Earnings per share - $0.50 $0.55 $0.68 $0.69 $2.42 Diluted ========================================================================================================Item 9. Changes in and Disagreements with Accounting and Financial DisclosureNonePart IIIItem 10. Directors and Executive Officers of the RegistrantThe information concerning Directors of the Company required by this Item 10 is incorporated herein by reference to the section entitled "Nominees for Director and Directors Continuing in Office" in the Company's Proxy Statement. The Information concerning executive officers of the Company required by this Item 10 is incorporated by reference to Item 4A of this Annual Report on Form 10-K .Item 11. Executive CompensationThe information required by this Item 11 is incorporated herein by reference to the section entitled "Compensation of Executive Officers" in the Company's Proxy Statement.Item 12. Security Ownership of Certain Beneficial Owners and ManagementThe information required by this Item 12 is incorporated herein by reference to the sections entitled "Nominees for Director and Directors Continuing in Office" and "Security Ownership of Certain Beneficial Owners" in the Company's Proxy Statement to be filed with respect to its 2001 annual shareholders meeting.Item 13. Certain Relationships and Related TransactionsThe information required by this Item 13 is incorporated herein by reference to the section entitled "Transactions with Management" in the Company's Proxy Statement. Part IVItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-KA. Documents Filed 1. The following consolidated financial statements of Community Bank System, Inc. and subsidiaries are included in Item 8: - Consolidated Statements of Condition -- December 31, 2000 and 1999 - Consolidated Statements of Income -- Years ended December 31, 2000, 1999, and 1998 - Consolidated Statements of Changes in Shareholders' Equity -- Years ended December 31, 2000, 1999, and 1998 - Consolidated Statement of Cash Flows -- Years ended December 31, 2000, 1999, and 1998 - Notes to Consolidated Financial Statements -- December 31, 2000 - Independent Accountant's Report - Quarterly selected data -- Years ended December 31, 2000 and 1999 (unaudited) 2. Schedules are omitted since the required information is either not applicable or shown elsewhere in the financial statements. 3. Listing of Exhibits (21) List of the Company's Subsidiaries Subsidiaries of the CompanyName Jurisdiction of IncorporationCommunity Bank, N.A. New York Community Capital Trust I Delaware Community Financial Services, Inc. New York Benefit Plan Administrative Services, Inc. New York CBNA Treasury Management Corporation New York Community Investment Services, Inc. New York CBNA Preferred Funding Corp. Delaware CFSI Close-Out Corp. New York Elias Asset Management, Inc. Delaware (27)Financial Data Schedule B. Reports on Form 8-K None C. See Exhibit 14(a)(3) above. D. See Exhibit 14(a)(2) above SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMUNITY BANK SYSTEM, INC. By: /s/ Sanford A. Belden Sanford A. Belden President, Chief Executive Officer and Director March 21, 2001 Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 21st day of March 2001.Name/s/ James A. GabrielJames A. Gabriel, Director Chairman of the Board of Directors and Director/s/ David G. WallaceDavid G. Wallace Treasurer Directors:/s/ John M. BurgessJohn M. Burgess, Director/s/ Paul M. Cantwell, Jr.Paul M. Cantwell, Jr., Director/s/ William M. DempseyWilliam M. Dempsey, Director/s/ Nicholas A. DiCerboNicholas A. DiCerbo, Director/s/ Lee T. HirscheyLee T. Hirschey, Director/s/ David C. PattersonDavid C. Patterson, Director/s/ William N. SloanWilliam N. Sloan, Director