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Section 1: 10-Q (10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                       to                                           .

Commission File Number: 001-13695



 (Exact name of registrant as specified in its charter)

Delaware
 
16‑1213679
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
5790 Widewaters Parkway, DeWitt, New York
 
13214-1883
(Address of principal executive offices)
 
(Zip Code)

 (315) 445‑2282
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes     No  .

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes     No   ☐.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
.
     
Emerging growth company
.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 51,186,421 shares of Common Stock, $1.00 par value per share, were outstanding on October 31, 2018.



TABLE OF CONTENTS

Part I.
Financial Information
Page
     
Item 1.
Financial Statements (Unaudited)
 
 

 
 
3
     
 
4
     
 
5
 

 
 
6
     
 
7
     
 
8
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
31
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
50
     
Item 4.
Controls and Procedures
52
     
Part II.
Other Information
 
     
Item 1.
Legal Proceedings
52
     
Item 1A.
Risk Factors
52
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
52
     
Item 3.
Defaults Upon Senior Securities
52
     
Item 4.
Mine Safety Disclosures
52
     
Item 5.
Other Information
52
     
Item 6.
Exhibits
53

2

Table of Contents
Part I.
Financial Information
Item 1.
Financial Statements

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

   
September 30,
2018
   
December 31,
2017
 
Assets:
           
Cash and cash equivalents
 
$
256,838
   
$
221,038
 
Available-for-sale investment securities (cost of $2,957,819 and $3,007,148, respectively)
   
2,904,779
     
3,031,088
 
Equity and other securities (cost of $42,281 and $50,291, respectively)
   
43,278
     
50,291
 
Loans held for sale, at fair value
   
0
     
461
 
                 
Loans
   
6,300,888
     
6,256,757
 
Allowance for loan losses
   
(50,133
)
   
(47,583
)
Net loans
   
6,250,755
     
6,209,174
 
                 
Goodwill, net
   
733,479
     
734,430
 
Core deposit intangibles, net
   
20,112
     
25,025
 
Other intangibles, net
   
58,109
     
65,633
 
Intangible assets, net
   
811,700
     
825,088
 
                 
Premises and equipment, net
   
120,273
     
123,393
 
Accrued interest and fees receivable
   
34,594
     
36,177
 
Other assets
   
237,350
     
249,488
 
                 
Total assets
 
$
10,659,567
   
$
10,746,198
 
                 
Liabilities:
               
Noninterest-bearing deposits
 
$
2,346,932
   
$
2,293,057
 
Interest-bearing deposits
   
6,116,889
     
6,151,363
 
Total deposits
   
8,463,821
     
8,444,420
 
                 
Short-term borrowings
   
0
     
24,000
 
Securities sold under agreement to repurchase, short-term
   
274,561
     
337,011
 
Other long-term debt
   
1,998
     
2,071
 
Subordinated debt held by unconsolidated subsidiary trusts
   
97,939
     
122,814
 
Accrued interest and other liabilities
   
152,903
     
180,567
 
Total liabilities
   
8,991,222
     
9,110,883
 
                 
Commitments and contingencies (See Note J)
               
                 
Shareholders' equity:
               
Preferred stock, $1.00 par value, 500,000 shares authorized, 0 shares issued
   
0
     
0
 
Common stock, $1.00 par value, 75,000,000 shares authorized; 51,547,253 and 51,263,841 shares issued, respectively
   
51,547
     
51,264
 
Additional paid-in capital
   
907,690
     
894,879
 
Retained earnings
   
774,403
     
700,557
 
Accumulated other comprehensive loss
   
(62,142
)
   
(3,699
)
Treasury stock, at cost (410,577 shares including 206,151 shares held by deferred compensation arrangements at September 30, 2018, and 567,764 shares including 237,494 shares held by deferred compensation arrangements at December 31, 2017, respectively)
   
(14,803
)
   
(21,014
)
Deferred compensation arrangements (206,151 and 237,494 shares, respectively)
   
11,650
     
13,328
 
Total shareholders' equity
   
1,668,345
     
1,635,315
 
                 
Total liabilities and shareholders' equity
 
$
10,659,567
   
$
10,746,198
 

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

3

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Interest income:
                       
Interest and fees on loans
 
$
72,256
   
$
69,498
   
$
212,849
   
$
184,233
 
Interest and dividends on taxable investments
   
15,421
     
15,228
     
47,462
     
43,969
 
Interest on nontaxable investments
   
3,226
     
3,761
     
10,001
     
11,665
 
Total interest income
   
90,903
     
88,487
     
270,312
     
239,867
 
                                 
Interest expense:
                               
Interest on deposits
   
2,764
     
2,123
     
7,277
     
5,918
 
Interest on borrowings
   
796
     
902
     
1,722
     
1,443
 
Interest on subordinated debt held by unconsolidated subsidiary trusts
   
1,145
     
1,067
     
3,645
     
2,808
 
Total interest expense
   
4,705
     
4,092
     
12,644
     
10,169
 
                                 
Net interest income
   
86,198
     
84,395
     
257,668
     
229,698
 
Provision for loan losses
   
2,215
     
2,314
     
8,342
     
5,603
 
Net interest income after provision for loan losses
   
83,983
     
82,081
     
249,326
     
224,095
 
                                 
Noninterest revenues:
                               
Deposit service fees
   
16,127
     
18,419
     
54,268
     
49,781
 
Other banking services
   
1,536
     
1,704
     
3,942
     
4,270
 
Employee benefit services
   
23,265
     
20,767
     
68,813
     
58,618
 
Insurance services
   
8,270
     
6,344
     
23,044
     
19,709
 
Wealth management services
   
6,168
     
5,707
     
19,370
     
16,105
 
Unrealized gain on equity securities
   
743
     
0
     
722
     
0
 
Loss on debt extinguishment
   
(318
)
   
0
     
(318
)
   
0
 
Gain on sales of investment securities
   
0
     
0
     
0
     
2
 
Total noninterest revenues
   
55,791
     
52,941
     
169,841
     
148,485
 
                                 
Noninterest expenses:
                               
Salaries and employee benefits
   
51,062
     
48,426
     
155,323
     
137,897
 
Occupancy and equipment
   
9,770
     
9,106
     
29,738
     
25,939
 
Data processing and communications
   
10,509
     
9,313
     
29,463
     
28,229
 
Amortization of intangible assets
   
4,427
     
4,949
     
13,780
     
11,980
 
Legal and professional fees
   
2,522
     
2,764
     
8,047
     
7,796
 
Business development and marketing
   
2,587
     
2,586
     
7,301
     
7,119
 
Acquisition expenses
   
(832
)
   
580
     
(769
)
   
25,192
 
Other expenses
   
5,188
     
6,052
     
14,793
     
16,078
 
Total noninterest expenses
   
85,233
     
83,776
     
257,676
     
260,230
 
                                 
Income before income taxes
   
54,541
     
51,246
     
161,491
     
112,350
 
Income taxes
   
11,435
     
16,003
     
33,673
     
33,659
 
Net income
 
$
43,106
   
$
35,243
   
$
127,818
   
$
78,691
 
                                 
Basic earnings per share
 
$
0.84
   
$
0.69
   
$
2.49
   
$
1.62
 
Diluted earnings per share
 
$
0.83
   
$
0.68
   
$
2.46
   
$
1.60
 
Cash dividends declared per share
 
$
0.38
   
$
0.34
   
$
1.06
   
$
0.98
 

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

4

Table of Contents
COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In Thousands)

   
Three Months
Ended
September 30,
   
Nine Months
Ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Pension and other post retirement obligations:
                       
Amortization of actuarial losses included in net periodic pension cost, gross
 
$
304
   
$
150
   
$
910
   
$
625
 
Tax effect
   
(74
)
   
(57
)
   
(221
)
   
(240
)
Amortization of actuarial losses included in net periodic pension cost, net
   
230
     
93
     
689
     
385
 
Amortization of prior service cost included in net periodic pension cost, gross
   
(105
)
   
(32
)
   
(359
)
   
(91
)
Tax effect
   
25
     
12
     
87
     
35
 
Amortization of prior service cost included in net periodic pension cost, net
   
(80
)
   
(20
)
   
(272
)
   
(56
)
Initial projected benefit obligation recognized upon plan adoption, gross (See Note H)
   
(775
)
   
0
     
(775
)
   
0
 
Tax effect
   
189
     
0
     
189
     
0
 
Initial projected benefit obligation recognized upon plan adoption, net
   
(586
)
   
0
     
(586
)
   
0
 
Unamortized actuarial gain due to plan merger, gross (See Note H)
   
0
     
0
     
0
     
1,858
 
Tax effect
   
0
     
0
     
0
     
(710
)
Unamortized actuarial gain due to plan merger, net
   
0
     
0
     
0
     
1,148
 
Other comprehensive (loss) income related to pension and other post retirement obligations, net of taxes
   
(436
)
   
73
     
(169
)
   
1,477
 
                                 
Unrealized (losses) gains on available-for-sale securities:
                               
Net unrealized holding (losses)/gains arising during period, gross
   
(20,094
)
   
(2,490
)
   
(76,705
)
   
11,163
 
Tax effect
   
4,879
     
952
     
18,639
     
(4,306
)
Net unrealized holding (losses)/gains arising during period, net
   
(15,215
)
   
(1,538
)
   
(58,066
)
   
6,857
 
Reclassification of other comprehensive income due to change in accounting principle – equity securities
   
0
     
0
     
(208
)
   
0
 
Other comprehensive (loss)/income related to unrealized (losses)/gains on available-for-sale securities, net of taxes
   
(15,215
)
   
(1,538
)
   
(58,274
)
   
6,857
 
Other comprehensive (loss)/income, net of tax
   
(15,651
)
   
(1,465
)
   
(58,443
)
   
8,334
 
Net income
   
43,106
     
35,243
     
127,818
     
78,691
 
Comprehensive income
 
$
27,455
   
$
33,778
   
$
69,375
   
$
87,025
 

   
As of
 
   
September 30,
2018
   
December 31,
2017
 
Accumulated Other Comprehensive Loss By Component:
           
Unrealized loss for pension and other post-retirement obligations
 
(28,901
)
 
(28,677
)
Tax effect
   
7,099
     
7,044
 
Net unrealized loss for pension and other post-retirement obligations
   
(21,802
)
   
(21,633
)
                 
Unrealized (loss) gain on available-for-sale securities
   
(53,040
)
   
23,940
 
Tax effect
   
12,908
     
(6,006
)
Reclassification of other comprehensive income due to change in accounting principle – equity securities
   
(208
)
   
0
 
Net unrealized (loss) gain on available-for-sale securities
   
(40,340
)
   
17,934
 
                 
Accumulated other comprehensive loss
 
(62,142
)
 
(3,699
)

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

5

Table of Contents
COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Nine months ended September 30, 2018
(In Thousands, Except Share Data)

   
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Loss
   
Treasury
Stock
   
Deferred
Compensation
Arrangements
   
Total
 
Common Stock
Shares
Outstanding
   
Amount
Issued
                                                 
Balance at December 31, 2017
   
50,696,077
   
$
51,264
   
$
894,879
   
$
700,557
   
(3,699
)
 
(21,014
)
 
$
13,328
   
$
1,635,315
 
                                                                 
Net income
                           
127,818
                             
127,818
 
                                                                 
Other comprehensive loss, net of tax
                                   
(58,235
)
                   
(58,235
)
                                                                 
Cumulative effect of change in accounting principle – equity securities
                           
208
     
(208
)
                   
0
 
                                                                 
Cash dividends declared: Common, $1.06 per share
                           
(54,180
)
                           
(54,180
)
                                                                 
Common stock issued under employee stock ownership plan
   
283,412
     
283
     
5,511
                                     
5,794
 
                                                                 
Stock-based compensation
                   
4,607
                                     
4,607
 
                                                                 
Distribution of stock under deferred compensation arrangements
   
35,233
                                     
1,898
     
(1,898
)
   
0
 
                                                                 
Treasury stock issued to benefit plans, net
   
121,954
             
2,693
                     
4,313
     
220
     
7,226
 
                                                                 
Balance at September 30, 2018
   
51,136,676
   
$
51,547
   
$
907,690
   
$
774,403
   
(62,142
)
 
(14,803
)
 
$
11,650
   
$
1,668,345
 

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

6

Table of Contents
COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)

   
Nine Months Ended
September 30,
 
   
2018
   
2017
 
Operating activities:
           
Net income
 
$
127,818
   
$
78,691
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
   
11,854
     
12,026
 
Amortization of intangible assets
   
13,780
     
11,980
 
Net accretion on securities, loans and borrowings
   
(7,141
)
   
(4,412
)
Stock-based compensation
   
4,607
     
3,985
 
Provision for loan losses
   
8,342
     
5,603
 
Amortization of mortgage servicing rights
   
340
     
374
 
Unrealized gain on equity securities
   
(722
)
   
0
 
Loss on debt extinguishment
   
318
     
0
 
Income from bank-owned life insurance policies
   
(1,177
)
   
(1,170
)
Net (gain) loss on sale of loans and other assets
   
(207
)
   
155
 
Change in other assets and other liabilities
   
8,769
     
31,624
 
Net cash provided by operating activities
   
166,581
     
138,856
 
Investing activities:
               
Proceeds from maturities of available-for-sale investment securities
   
102,549
     
110,160
 
Proceeds from maturities of other investment securities
   
8,292
     
28,580
 
Purchases of available-for-sale investment securities
   
(47,495
)
   
(59,425
)
Purchases of other securities
   
(31
)
   
(12,434
)
Net (increase) decrease in loans
   
(51,170
)
   
120,029
 
Cash paid for acquisitions, net of cash acquired of $16 and $51,793, respectively
   
(1,737
)
   
(105,402
)
Settlement of bank-owned life insurance policies
   
0
     
1,779
 
Purchases of premises and equipment, net
   
(8,903
)
   
(7,701
)
Net cash provided by investing activities
   
1,505
     
75,586
 
Financing activities:
               
Net increase in deposits
   
19,401
     
81,630
 
Net decrease in borrowings
   
(86,523
)
   
(193,602
)
Payments on subordinated debt held by unconsolidated subsidiary trusts
   
(25,207
)
   
0
 
Issuance of common stock
   
5,794
     
3,740
 
Purchases of treasury stock
   
(220
)
   
(3,226
)
Sales of treasury stock
   
7,226
     
7,861
 
Increase in deferred compensation arrangements
   
220
     
3,226
 
Cash dividends paid
   
(52,006
)
   
(45,059
)
Withholding taxes paid on share-based compensation
   
(971
)
   
(1,389
)
Net cash used in financing activities
   
(132,286
)
   
(146,819
)
Change in cash and cash equivalents
   
35,800
     
67,623
 
Cash and cash equivalents at beginning of period
   
221,038
     
173,857
 
Cash and cash equivalents at end of period
 
$
256,838
   
$
241,480
 
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
 
$
12,870
   
$
10,092
 
Cash paid for income taxes
   
20,674
     
33,187
 
                 
Supplemental disclosures of noncash financing and investing activities:
               
Dividends declared and unpaid
   
19,634
     
17,412
 
Transfers from loans to other real estate
   
2,426
     
2,470
 
                 
Acquisitions:
               
Common stock issued
   
0
     
340,737
 
Fair value of assets acquired, excluding acquired cash and intangibles
   
115
     
1,960,922
 
Fair value of liabilities assumed
   
31
     
1,869,854
 

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

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COMMUNITY BANK SYSTEM, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 2018

NOTE A:
BASIS OF PRESENTATION

The interim financial data as of and for the three and nine months ended September 30, 2018 is unaudited; however, in the opinion of Community Bank System, Inc. (the “Company”), the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods in conformity with generally accepted accounting principles (“GAAP”).  The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.

NOTE B:
ACQUISITIONS

On April 2, 2018, the Company, through its subsidiary, Benefit Plans Administrative Services, Inc. (“BPAS”), acquired certain assets of HR Consultants (SA), LLC (“HR Consultants”), a benefits consulting group headquartered in Puerto Rico.  The Company paid $0.3 million in cash to acquire the assets of HR Consultants and recorded intangible assets of $0.3 million in conjunction with the acquisition.  The effects of the acquired assets have been included in the consolidated financial statements since that date.

On January 2, 2018, the Company, through its subsidiary, OneGroup NY, Inc. (“OneGroup”), completed its acquisition of certain assets of Penna & Associates Agency, Inc. (“Penna”), an insurance agency headquartered in Johnson City, New York.  The Company paid $0.8 million in cash to acquire the assets of Penna, and recorded goodwill in the amount of $0.3 million and a customer list intangible asset of $0.3 million in conjunction with the acquisition.  The effects of the acquired assets have been included in the consolidated financial statements since that date.

On January 2, 2018, the Company, through its subsidiary, Community Investment Services, Inc. (“CISI”), completed its acquisition of certain assets of Styles Bridges Associates (“Styles Bridges”), a financial services business headquartered in Canton, New York.  The Company paid $0.7 million in cash to acquire a customer list from Styles Bridges, and recorded a $0.7 million customer list intangible asset in conjunction with the acquisition.  The effects of the acquired assets have been included in the consolidated financial statements since that date.

On December 4, 2017, the Company, through its subsidiary, OneGroup, completed its acquisition of Gordon B. Roberts Agency, Inc. (“GBR”), an insurance agency headquartered in Oneonta, New York for $3.7 million in Company stock and cash, comprised of $1.35 million in cash and the issuance of 0.04 million shares of common stock.  The transaction resulted in the acquisition of $0.6 million of assets, $0.6 million of other liabilities, goodwill in the amount of $2.1 million and other intangible assets of $1.6 million.  The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

On November 17, 2017, the Company, through its subsidiary, CISI, completed its acquisition of certain assets of Northeast Capital Management, Inc. (“NECM”), a financial services business headquartered in Wilkes Barre, Pennsylvania.  The Company paid $1.2 million in cash to acquire a customer list from NECM, and recorded a $1.2 million customer list intangible asset in conjunction with the acquisition.  The effects of the acquired assets have been included in the consolidated financial statements since that date.

On May 12, 2017, the Company completed its acquisition of Merchants Bancshares, Inc. (“Merchants”), parent company of Merchants Bank, headquartered in South Burlington, Vermont, for $345.2 million in Company stock and cash, comprised of $82.9 million in cash and the issuance of 4.68 million shares of common stock.  The acquisition extends the Company’s footprint into the Vermont and Western Massachusetts markets with the addition of 31 branch locations in Vermont and one location in Massachusetts.  This transaction resulted in the acquisition of $2.0 billion of assets, including $1.49 billion of loans and $370.6 million of investment securities, as well as $1.45 billion of deposits and $189.0 million in goodwill.  The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.  Revenues of approximately $14.7 million and $46.8 million from Merchants were included in the consolidated income statement for the three and nine months ended September 30, 2018, respectively.  Direct expenses, which may not include certain shared expenses, of approximately $7.4 million and $22.7 million from Merchants were included in the consolidated income statement for the three and nine months ended September 30, 2018, respectively.  Revenues of approximately $16.8 million and $25.8 million from Merchants were included in the consolidated income statement for the three and nine months ended September 30, 2017, respectively.  Direct expenses, which may not include certain shared expenses, of approximately $7.5 million and $11.5 million from Merchants were included in the consolidated income statement for the three and nine months ended September 30, 2017, respectively.

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On March 1, 2017, the Company, through its subsidiary, OneGroup, completed its acquisition of certain assets of Dryfoos Insurance Agency, Inc. (“Dryfoos”), an insurance agency headquartered in Hazleton, Pennsylvania.  The Company paid $3.0 million in cash to acquire the assets of Dryfoos, and recorded goodwill in the amount of $1.7 million and other intangible assets of $1.7 million in conjunction with the acquisition.  The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date.

On February 3, 2017, the Company completed its acquisition of Northeast Retirement Services, Inc. (“NRS”) and its subsidiary Global Trust Company (“GTC”), headquartered in Woburn, Massachusetts, for $148.6 million in Company stock and cash.  NRS was a privately held corporation focused on providing institutional transfer agency, master recordkeeping services, custom target date fund administration, trust product administration and customized reporting services to institutional clients.  Its wholly-owned subsidiary, GTC, is chartered in the State of Maine as a non-depository trust company and provides fiduciary services for collective investment trusts and other products.  The acquisition of NRS and GTC, hereafter referred to collectively as NRS, strengthens and complements the Company’s existing employee benefit services businesses.  Upon the completion of the merger, NRS became a wholly-owned subsidiary of BPAS and operates as Northeast Retirement Services, LLC, a Delaware limited liability company.  This transaction resulted in the acquisition of $36.1 million in net tangible assets, principally cash and certificates of deposit, $60.2 million in customer list intangibles that will be amortized using the 150% declining balance method over 10 years, a $23.0 million deferred tax liability associated with the customer list intangible, and $75.3 million in goodwill.  The effects of the acquired assets and liabilities have been included in the consolidated financial statements since that date. Revenues of $10.3 million and $30.1 million from NRS were included in the consolidated statements of income for the three and nine months ended September 30, 2018, respectively.  Expenses of $6.1 million and $18.1 million from NRS were included in the consolidated statements of income for the three and nine months ended September 30, 2018, respectively.  Revenues of $8.7 million and $22.1 million from NRS were included in the consolidated income statement for the three and nine months ended September 30, 2017, respectively.  Expenses of $5.8 million and $15.1 million from NRS were included in the consolidated income statement for the three and nine months ended September 30, 2017, respectively.

On January 1, 2017, the Company, through its subsidiary, OneGroup, acquired certain assets of Benefits Advisory Service, Inc. (“BAS”), a benefits consulting group headquartered in Forest Hills, New York.  The Company paid $1.2 million in cash to acquire the assets of BAS and recorded intangible assets of $1.2 million in conjunction with the acquisition.  The effects of the acquired assets have been included in the consolidated financial statements since that date.

The assets and liabilities assumed in the acquisitions were recorded at their estimated fair values based on management's best estimates using information available at the dates of the acquisition, and were subject to adjustment based on updated information not available at the time of acquisition.  During the first quarter of 2018, the carrying amount of other liabilities associated with the NRS acquisition decreased by $1.2 million as a result of an adjustment to deferred taxes.  Goodwill associated with the NRS acquisition decreased $1.2 million as a result of this adjustment.  During the second quarter of 2018, the carrying amount of other liabilities associated with the GBR acquisition decreased by $0.09 million as a result of updated information not available at the time of acquisition.  Goodwill associated with the GBR acquisition decreased $0.09 million as a result of this adjustment.

The above referenced acquisitions expanded the Company’s geographical presence in New York, Pennsylvania, Vermont, and Western Massachusetts and management expects that the Company will benefit from greater geographic diversity and the advantages of other synergistic business development opportunities.

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The following table summarizes the estimated fair value of the assets acquired and liabilities assumed after considering the measurement period adjustments described above:

   
2018
   
2017
 
(000s omitted)
 
Other (1)
   
NRS
   
Merchants
   
Other (2)
   
Total
 
Consideration paid :
                             
Cash
 
$
1,753
   
$
70,073
   
$
82,898
   
$
6,775
   
$
159,746
 
Community Bank System, Inc. common stock
   
0
     
78,483
     
262,254
     
2,395
     
343,132
 
Total net consideration paid
   
1,753
     
148,556
     
345,152
     
9,170
     
502,878
 
Recognized amounts of identifiable assets acquired and liabilities assumed:
                                       
Cash and cash equivalents
   
16
     
11,063
     
40,730
     
339
     
52,132
 
Investment securities
   
0
     
20,294
     
370,648
     
0
     
390,942
 
Loans
   
0
     
0
     
1,488,157
     
0
     
1,488,157
 
Premises and equipment
   
10
     
411
     
16,608
     
27
     
17,046
 
Accrued interest receivable
   
0
     
72
     
4,773
     
0
     
4,845
 
Other assets
   
105
     
8,088
     
51,585
     
583
     
60,256
 
Core deposit intangibles
   
0
     
0
     
23,214
     
0
     
23,214
 
Other intangibles
   
1,343
     
60,200
     
2,857
     
5,626
     
68,683
 
Deposits
   
0
     
0
     
(1,448,406
)
   
0
     
(1,448,406
)
Other liabilities
   
(31
)
   
(26,828
)
   
(11,750
)
   
(1,131
)
   
(39,709
)
Short-term advances
   
0
     
0
     
(80,000
)
   
0
     
(80,000
)
Securities sold under agreement to repurchase, short-term
   
0
     
0
     
(278,076
)
   
0
     
(278,076
)
Long-term debt
   
0
     
0
     
(3,615
)
   
0
     
(3,615
)
Subordinated debt held by unconsolidated subsidiary trusts
   
0
     
0
     
(20,619
)
   
0
     
(20,619
)
Total identifiable assets, net
   
1,443
     
73,300
     
156,106
     
5,444
     
234,850
 
Goodwill
 
$
310
   
$
75,256
   
$
189,046
   
$
3,726
   
$
268,028
 

(1) Includes amounts related to the Penna, Styles Bridges and HR Consultants acquisitions.
(2) Includes amounts related to the BAS, Dryfoos, NECM and GBR acquisitions.

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments were aggregated by comparable characteristics and  recorded at fair value without a carryover of the related allowance for loan losses.  Cash flows for each loan were determined using an estimate of credit losses and rate of prepayments.  Projected monthly cash flows were then discounted to present value using a market-based discount rate.  The excess of the undiscounted expected cash flows over the estimated fair value is referred to as the “accretable yield” and is recognized into interest income over the remaining lives of the acquired loans.

The following is a summary of the loans acquired from Merchants at the date of acquisition:

(000s omitted)
 
Acquired
Impaired
Loans
   
Acquired
Non-impaired
Loans
   
Total
Acquired
Loans
 
Contractually required principal and interest at acquisition
 
$
15,454
   
$
1,872,574
   
$
1,888,028
 
Contractual cash flows not expected to be collected
   
(5,385
)
   
(14,753
)
   
(20,138
)
Expected cash flows at acquisition
   
10,069
     
1,857,821
     
1,867,890
 
Interest component of expected cash flows
   
(793
)
   
(378,940
)
   
(379,733
)
Fair value of acquired loans
 
$
9,276
   
$
1,478,881
   
$
1,488,157
 

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

The core deposit intangibles and other intangibles related to the HR Consultants, Penna, Styles Bridges, GBR, NECM, Merchants, Dryfoos, and BAS acquisitions are being amortized using an accelerated method over their estimated useful life of eight years.  The goodwill, which is not amortized for book purposes, was assigned to the Banking segment for the Merchants acquisition, the Employee Benefit Services segment for NRS, and All Other segments for the Penna, GBR, and Dryfoos acquisitions.  Goodwill arising from the Merchants, NRS and GBR acquisitions is not deductible for tax purposes.  Goodwill arising from the Penna and Dryfoos acquisitions is deductible for tax purposes.

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Direct costs related to the acquisitions were expensed as incurred.  During the three and nine months ended September 30, 2018, the Company recognized merger and acquisition integration-related recoveries in the amount of $0.8 million due to an adjustment of contract termination expenses related to the Merchants acquisition that have been separately stated in the Consolidated Statements of Income.  Merger and acquisition integration-related expenses amount to $0.6 million and $25.2 million during the three and nine months ended September 30, 2017 and have been separately stated in the Consolidated Statements of Income.

NOTE C:
ACCOUNTING POLICIES

The accounting policies of the Company, as applied in the consolidated interim financial statements presented herein, are substantially the same as those followed on an annual basis as presented on pages 63 through 71 of the Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission (“SEC”) on March 1, 2018.

Investment Securities
The Company can classify its investments in debt securities as held-to-maturity, available-for-sale, or trading.  Held-to-maturity securities are those for which the Company has the positive intent and ability to hold until maturity, and are reported at cost, which is adjusted for amortization of premiums and accretion of discounts.  Available-for-sale debt securities are reported at fair value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes.  Equity securities with a readily determinable fair value are reported at fair value with net unrealized gains and losses recognized in the consolidated statements of income.  None of the Company's investment securities have been classified as trading securities at September 30, 2018.  Certain equity securities that do not have a readily determinable fair value are stated at cost, less impairment, adjusted for observable price changes in orderly transactions for identical or similar investments of the same issuer.  These securities include restricted stock of the Federal Reserve Bank of New York (“Federal Reserve”), the Federal Home Loan Bank of New York and the Federal Home Loan Bank of Boston (collectively referred to as “FHLB”), as well as other equity securities.  During the third quarter of 2018, the Company adjusted the carrying value of an equity security without a readily determinable fair value based on observable price changes for identical investments of the same issuer.  This adjustment resulted in a $0.8 million unrealized gain on equity securities.

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

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

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

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

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Revenue Recognition
On January 1, 2018, the Company adopted ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the newly adopted guidance. Topic 606 is applicable to the Company’s noninterest revenue streams including its deposit related fees, electronic payment interchange fees, merchant income, trust, asset management and other wealth management revenues, insurance commissions and benefit plan services income. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606.  Noninterest revenue streams in-scope of Topic 606 are discussed below.

Deposit Service Fees
Deposit service fees consist of account activity fees, monthly service fees, check orders, debit and credit card income, ATM fees, Merchant services income and other revenues from processing wire transfers, bill pay service, cashier’s checks and foreign exchange.  Debit and credit card income is primarily comprised of interchange fees earned at the time the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM.   Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for deposit service fees is generally satisfied, and the related revenue recognized, when the services are rendered or the transaction has been completed.  Payment for deposit service fees is typically received at the time it is assessed through a direct charge to customers’ accounts or on a monthly basis.  Deposit service fees revenue primarily relates to the Company’s Banking operating segment.

Other Banking Services
Other banking services consists of other recurring revenue streams such as commissions from sales of credit life insurance, safe deposit box rental fees, mortgage banking income, bank owned life insurance income and other miscellaneous revenue streams. Commissions from the sale of credit life insurance are recognized at the time of sale of the policies.  Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.  Mortgage banking income and bank owned life insurance income are not within the scope of Topic 606.  Other banking services revenue primarily relates to the Company’s Banking operating segment.

Employee Benefit Services
Employee benefit services income consists of revenue received from retirement plan services, collective investment fund services, fund administration, transfer agency, consulting and actuarial services.  The Company’s performance obligation that relates to plan services are satisfied over time and the resulting fees are recognized monthly or quarterly, based upon the market value of the assets under management and the applicable fee rate or on a time expended basis. Payment is generally received a few days after month end or quarter end. The Company does not earn performance-based incentives. Transactional services such as consulting services, mailings, or other ad hoc services are provided to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.  Employee benefit services revenue primarily relates to the Company’s Employee Benefit Services operating segment.

Insurance Services
Insurance services primarily consists of commissions received on insurance product sales and consulting services. The Company acts in the capacity of a broker or agent between the Company’s customer and the insurance carrier. The Company’s performance obligation related to insurance sales for both property and casualty insurance and employee benefit plans is generally satisfied upon the later of the issuance or effective date of the policy. The Company’s performance obligation related to consulting services is considered transactional in nature and is generally satisfied when the services have been completed and related revenue recognized at a point in time.  Payment is received at the time services are rendered.  The Company earns performance based incentives, commonly known as contingency payments, which usually are based on certain criteria established by the insurance carrier such as premium volume, growth and insured loss ratios.  Contingent payments are accrued for based upon management’s expectations for the year.  Commission expense associated with sales of insurance products is expensed as incurred.  Insurance services revenue primarily relates to the Company’s All Other operating segment.

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Wealth Management Services
Wealth management services income is primarily comprised of fees earned from the management and administration of trusts and other customer assets.   The Company generally has two types of performance obligations related to these services.  The Company’s performance obligation that relates to advisory and administration services are satisfied over time and the resulting fees are recognized monthly, based upon the market value of the assets under management and the applicable fee rate. Payment is generally received soon after month end or quarter end through a direct charge to customers’ accounts. The Company does not earn performance-based incentives. Transactional services such as tax return preparation services, purchases and sales of investments and insurance products are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e. as incurred). Payment is generally received on a monthly basis.  Wealth management services revenue primarily relates to the Company’s All Other operating segment.

Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2018, $26.9 million of accounts receivable, including $7.9 million of unbilled fee revenue, and $2.9 million of unearned revenue was recorded in the Consolidated Statements of Condition.  As of December 31, 2017, $29.8 million of accounts receivable, including $6.5 million of unbilled fee revenue, and $3.9 million of unearned revenue was recorded in the Consolidated Statements of Condition.

Contract Acquisition Costs
In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient method which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition costs.

Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).  This new guidance supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. In doing so, companies generally will be required to use more judgment and make more estimates than under prior guidance.   These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.   Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income, interest expense and mortgage banking income.  The Company completed a comprehensive assessment of the revenue streams and reviewed related contracts potentially affected by the ASU for all segments of its business.  Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the manner in which the Company recognized revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e. gross versus net) and timing of compensatory payments to producers.  Based on the Company’s evaluation, it was determined that changes in the presentation of expenses and timing of the recognition of compensation expense did not materially affect noninterest income or expense.   The Company adopted this guidance on January 1, 2018 utilizing the modified retrospective approach.   Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The primary focus of this guidance is to supersede the guidance to classify equity securities with readily determinable fair values into different categories (trading or available-for-sale) and requires equity securities to be measured at fair value with changes in the fair value recognized through net income. This guidance requires adoption through a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.  This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Company adopted this guidance on January 1, 2018.  The impact of the adoption of this guidance resulted in the reclassification of $0.2 million of other comprehensive income to retained earnings.  See the Consolidated Statements of Comprehensive Income and Consolidated Statement of Changes in Shareholders’ Equity.

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In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The amendments provide guidance on the following eight specific cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. This ASU is effective for fiscal years beginning after December 31, 2017, including interim periods within those fiscal years.  The Company adopted this guidance on January 1, 2018 on a retrospective basis.  The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.  This guidance requires the service cost component of net periodic pension and postretirement benefit costs to be presented separately from other components of net benefit cost in the statement of income.  This ASU is effective for the Company for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The Company adopted this guidance on January 1, 2018 and applied the guidance on a modified retrospective basis for the presentation of other components of net periodic benefit cost in the Consolidated Statements of Income.  The impact of the adoption of this guidance resulted in the reclassification of net periodic benefit income of $1.9 million and $5.1 million from salaries and employee benefits to other expenses in the Consolidated Statements of Income for the three and nine months ended September 30, 2017, respectively.

New Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This new guidance supersedes the lease requirements in Topic 840, Leases and is based on the principle that a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  The accounting applied by a lessor is largely unchanged from that applied under the previous guidance.  In addition, the guidance requires an entity to separate the lease components from the nonlease components in a contract.  The ASU requires disclosures about the amount, timing, and judgments related to a reporting entity’s accounting for leases and related cash flows.  The standard is required to be applied to all leases in existence as of the date of adoption using a modified retrospective transition approach.  This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all companies in any interim or annual period.  The Company occupies certain offices and uses certain equipment under non-cancelable operating lease agreements, which currently are not reflected in its consolidated statement of condition.  The Company expects to recognize lease liabilities and right of use assets associated with these lease agreements; however, the extent of the impact on the Company’s consolidated financial statements is currently under evaluation.  The Company is in the process of a system implementation to facilitate the change in accounting.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326).  This new guidance significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.  This ASU will replace the “incurred loss” model under existing guidance with an “expected loss” model for instruments measured at amortized cost, and require entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model.  This ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans.  This guidance requires adoption through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted for all companies as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  The Company is currently evaluating the impact the guidance will have on the Company’s consolidated financial statements, and expects a change in the allowance for loan losses resulting from the change to expected losses for the estimated life of the financial asset. The amount of the change in the allowance for loan losses resulting from the new guidance will be impacted by the portfolio composition and asset quality at the adoption date, as well as economic conditions and forecasts at the time of adoption.  Implementation efforts include evaluation of data requirements, segmentation of the Company’s loan portfolio, guidance interpretation and consideration of relevant internal processes and controls.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350). The amendments simplify how an entity is required to test goodwill for impairment by eliminating the requirement to measure a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill.  Instead, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount of the reporting unit exceeds its fair value.  Impairment loss recognized under this new guidance will be limited to the goodwill allocated to the reporting unit.  This ASU is effective prospectively for the Company for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  This ASU is not expected to have a material impact on the Company’s consolidated financial statements.

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In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.  This new guidance amends current guidance to better align hedge accounting with risk management activities and reduce the complexity involved in applying hedge accounting.  Under this new guidance, the concept of hedge ineffectiveness will be eliminated.  Ineffective income generated by cash flow and net investment hedges will be recognized in the same financial reporting period and income statement line item as effective income, so as to reflect the full cost of hedging at one time and in one place. Ineffective income generated by fair value hedges will continue to be reflected in current period earnings; however, it will be recognized in the same income statement line item as effective income. The guidance will also allow any contractually specified variable rate to be designated as the hedged risk in a cash flow hedge.  With respect to fair value hedges of interest rate risk, the guidance will allow changes in the fair value of the hedged item to be calculated solely using changes in the benchmark interest rate component of the instrument’s total contractual coupon cash flows. This ASU is effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  Early adoption is permitted, including adoption in an interim period.  This ASU is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE D:
INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities as of September 30, 2018 and December 31, 2017 are as follows:

   
September 30, 2018
   
December 31, 2017
 
(000's omitted)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
Available-for-Sale Portfolio:
                                               
U.S. Treasury and agency securities

$
2,039,086
   
$
0
   
$
40,991
   
$
1,998,095
   
$
2,043,023
   
$
15,886
   
$
4,838
   
$
2,054,071
 
Obligations of state and political subdivisions
   
473,048
     
5,250
     
2,933
     
475,365
     
514,949
     
14,064
     
57
     
528,956
 
Government agency mortgage-backed securities
   
369,970
     
1,297
     
13,204
     
358,063
     
358,180
     
3,121
     
3,763
     
357,538
 
Corporate debt securities
   
2,603
     
0
     
53
     
2,550
     
2,648
     
0
     
25
     
2,623
 
Government agency collateralized mortgage obligations
   
73,112
     
25
     
2,431
     
70,706
     
88,097
     
155
     
878
     
87,374
 
Marketable equity securities
   
0
     
0
     
0
     
0
     
251
     
275
     
0
     
526
 
Total available-for-sale portfolio
 
$
2,957,819
   
$
6,572
   
$
59,612
   
$
2,904,779
   
$
3,007,148
   
$
33,501
   
$
9,561
   
$
3,031,088
 
                                                                 
Equity and other Securities:
                                                               
Equity securities, at fair value
 
$
251
   
$
247
   
$
0
   
$
498
   
$
0
   
$
0
   
$
0
   
$
0
 
Federal Home Loan Bank common stock
   
6,343
     
0
     
0
     
6,343
     
9,896
     
0
     
0
     
9,896
 
Federal Reserve Bank common stock
   
30,690
     
0
     
0
     
30,690
     
30,690
     
0
     
0
     
30,690
 
Certificates of deposit
   
0
     
0
     
0
     
0
     
3,865
     
0
     
0
     
3,865
 
Other equity securities, at cost
   
4,997
     
750
     
0
     
5,747
     
5,840
     
0
     
0
     
5,840
 
Total equity and other securities
 
$
42,281
   
$
997
   
$
0
   
$
43,278
   
$
50,291
   
$
0
   
$
0
   
$
50,291
 

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

As of September 30, 2018
   
Less than 12 Months
   
12 Months or Longer
   
Total
 
(000's omitted)
   
#
   
Fair
Value
   
Gross
Unrealized
Losses
     
#
   
Fair
Value
   
Gross
Unrealized
Losses
     
#
   
Fair
Value
   
Gross
Unrealized
Losses
 
                                                         
   
Available-for-Sale Portfolio:
                                                             
U.S. Treasury and agency securities
   
50
   
$
1,633,859
   
$
30,625
     
32
   
$
364,236
   
$
10,366
     
82
   
$
1,998,095
   
$
40,991
 
Obligations of state and political subdivisions
   
333
     
171,781
     
2,619
     
9
     
5,913
     
314
     
342
     
177,694
     
2,933
 
Government agency mortgage-backed securities
   
89
     
128,752
     
3,783
     
136
     
178,871
     
9,421
     
225
     
307,623
     
13,204
 
Corporate debt securities
   
0
     
0
     
0
     
1
     
2,550
     
53
     
1
     
2,550
     
53
 
Government agency collateralized mortgage obligations
   
12
     
8,371
     
199
     
36
     
59,825
     
2,232
     
48
     
68,196
     
2,431
 
Total available-for-sale investment portfolio
   
484
   
$
1,942,763
   
$
37,226
     
214
   
$
611,395
   
$
22,386
     
698
   
$
2,554,158
   
$
59,612
 

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Table of Contents
As of December 31, 2017

   
Less than 12 Months
   
12 Months or Longer
   
Total
 
(000's omitted)
   
#
   
Fair
Value
   
Gross
Unrealized
Losses
     
#
   
Fair
Value
   
Gross
Unrealized
Losses
     
#
   
Fair
Value
   
Gross
Unrealized
Losses
 
                                                         
   
Available-for-Sale Portfolio:
                                                             
U.S. Treasury and agency securities
   
44
   
$
699,709
   
$
4,838
     
0
   
$
0
   
$
0
     
44
   
$
699,709
   
$
4,838
 
Obligations of state and political subdivisions
   
45
     
23,432
     
57
     
0
     
0
     
0
     
45
     
23,432
     
57
 
Government agency mortgage-backed securities
   
120
     
185,716
     
1,433
     
55
     
75,712
     
2,330
     
175
     
261,428
     
3,763
 
Corporate debt securities
   
1
     
2,623
     
25
     
0
     
0
     
0
     
1
     
2,623
     
25
 
Government agency collateralized mortgage obligations
   
39
     
80,041
     
878
     
1
     
1
     
0
     
40
     
80,042
     
878
 
Total available-for-sale investment portfolio
   
249
   
$
991,521
   
$
7,231
     
56
   
$
75,713
   
$
2,330
     
305
   
$
1,067,234
   
$
9,561
 

The unrealized losses reported pertaining to securities issued by the U.S. government and its sponsored entities, include treasuries, agencies, and mortgage-backed securities issued by Ginnie Mae, Fannie Mae, and Freddie Mac, which are currently rated AAA by Moody’s Investor Services, AA+ by Standard & Poor’s and are guaranteed by the U.S. government. The majority of the obligations of state and political subdivisions and corporations carry a credit rating of A or better.  Additionally, a majority of the obligations of state and political subdivisions carry a secondary level of credit enhancement. The Company does not intend to sell these securities, nor is it more likely than not that the Company will be required to sell these securities prior to recovery of the amortized cost. The unrealized losses in the portfolios are primarily attributable to changes in interest rates.  As such, management does not believe any individual unrealized loss as of September 30, 2018 represents OTTI.

The amortized cost and estimated fair value of debt securities at September 30, 2018, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity date are shown separately.

   
Available-for-Sale
 
(000's omitted)
 
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
61,112
   
$
60,985
 
Due after one through five years
   
2,020,525
     
1,985,501
 
Due after five years through ten years
   
274,222
     
270,449
 
Due after ten years
   
158,878
     
159,075
 
Subtotal
   
2,514,737
     
2,476,010
 
Government agency mortgage-backed securities
   
369,970
     
358,063
 
Government agency collateralized mortgage obligations
   
73,112
     
70,706
 
Total
 
$
2,957,819
   
$
2,904,779
 

As of September 30, 2018, $289.0 million of U.S. Treasury securities were pledged as collateral for securities sold under agreement to repurchase.  All securities sold under agreement to repurchase as of September 30, 2018 have an overnight and continuous maturity.

NOTE E:
LOANS

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

·
Consumer mortgages consist primarily of fixed rate residential instruments, typically 10 – 30 years in contractual term, secured by first liens on real property.

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

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

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

·
Home equity products are consumer purpose installment loans or lines of credit most often secured by a first or second lien position on residential real estate with terms up to 30 years.

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Table of Contents
The balances of these classes are summarized as follows:

(000's omitted)
 
September 30,
2018
   
December 31,
2017
 
Business lending
 
$
2,403,624
   
$
2,424,223
 
Consumer mortgage
   
2,220,022
     
2,220,298
 
Consumer indirect
   
1,098,943
     
1,011,978
 
Consumer direct
   
184,349
     
179,929
 
Home equity
   
393,950
     
420,329
 
Gross loans, including deferred origination costs
   
6,300,888
     
6,256,757
 
Allowance for loan losses
   
(50,133
)
   
(47,583
)
Loans, net of allowance for loan losses
 
$
6,250,755
   
$
6,209,174
 

The outstanding balance related to credit impaired acquired loans was $7.8 million and $13.4 million at September 30, 2018 and December 31, 2017, respectively.  The changes in the accretable discount related to the credit impaired acquired loans are as follows:

(000’s omitted)
     
Balance at December 31, 2017
 
$
976
 
Accretion recognized, year-to-date
   
(722
)
Net reclassification between accretable and non-accretable
   
239
 
Balance at September 30, 2018
 
$
493
 

Credit Quality
Management monitors the credit quality of its loan portfolio on an ongoing basis.  Measurement of delinquency and past due status are based on the contractual terms of each loan.  Past due loans are reviewed on a monthly basis to identify loans for non-accrual status.  The following is an aged analysis of the Company’s past due loans, by class as of September 30, 2018:

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

(000’s omitted)
 
Past Due
30 – 89
Days
   
90+ Days Past
Due and
Still Accruing
   
Nonaccrual
   
Total
Past Due
   
Current
   
Total Loans
 
Business lending
 
$
5,751
   
$
355
   
$
3,335
   
$
9,441
   
$
1,573,366
   
$
1,582,807
 
Consumer mortgage
   
10,189
     
1,767
     
9,915
     
21,871
     
1,793,227
     
1,815,098
 
Consumer indirect
   
12,408
     
175
     
0
     
12,583
     
1,073,607
     
1,086,190
 
Consumer direct
   
1,510
     
20
     
0
     
1,530
     
179,399
     
180,929
 
Home equity
   
1,191
     
371
     
1,433
     
2,995
     
311,817
     
314,812
 
Total
 
$
31,049
   
$
2,688
   
$
14,683
   
$
48,420
   
$
4,931,416
   
$
4,979,836
 

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

(000’s omitted)
 
Past Due
30 – 89
Days
   
90+ Days Past
Due and
Still Accruing
   
Nonaccrual
   
Total
Past Due
   
Acquired
Impaired(1)
   
Current
   
Total Loans
 
Business lending
 
$
1,134
   
$
0
   
$
3,711
   
$
4,845
   
$
5,851
   
$
810,121
   
$
820,817
 
Consumer mortgage
   
977
     
215
     
2,438
     
3,630
     
0
     
401,294
     
404,924
 
Consumer indirect
   
100
     
34
     
0
     
134
     
0
     
12,619
     
12,753
 
Consumer direct
   
74
     
0
     
0
     
74
     
0
     
3,346
     
3,420
 
Home equity
   
618
     
14
     
1,150
     
1,782
     
0