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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 March 31, 2019

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 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $1.00 par value per share

CBU

New York Stock Exchange


Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 51,529,044 shares of Common Stock, $1.00 par value per share, were outstanding on April 30, 2019.



TABLE OF CONTENTS

Part I.
Financial Information
Page
     
Item 1.
Financial Statements (Unaudited)
 
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8
     
Item 2.
27
     
Item 3.
42
     
Item 4.
43
     
Part II.
Other Information
 
     
Item 1.
44
     
Item 1A.
44
     
Item 2.
44
     
Item 3.
44
     
Item 4.
44
     
Item 5.
44
     
Item 6.
45

2

Part I.
Financial Information
Item 1.
Financial Statements

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

   
March 31,
2019
   
December 31,
2018
 
Assets:
           
Cash and cash equivalents
 
$
508,364
   
$
211,834
 
Available-for-sale investment securities (cost of $2,915,267 and $2,952,278, respectively)
   
2,922,943
     
2,936,049
 
Equity and other securities (cost of $42,241 and $44,678, respectively)
   
43,204
     
45,609
 
Loans held for sale, at fair value
   
212
     
83
 
                 
Loans
   
6,266,086
     
6,281,121
 
Allowance for loan losses
   
(49,107
)
   
(49,284
)
Net loans
   
6,216,979
     
6,231,837
 
                 
Goodwill, net
   
733,503
     
733,503
 
Core deposit intangibles, net
   
17,113
     
18,596
 
Other intangibles, net
   
53,803
     
55,250
 
Intangible assets, net
   
804,419
     
807,349
 
                 
Premises and equipment, net
   
151,976
     
119,988
 
Accrued interest and fees receivable
   
35,573
     
31,048
 
Other assets
   
232,797
     
223,498
 
                 
Total assets
 
$
10,916,467
   
$
10,607,295
 
                 
Liabilities:
               
Noninterest-bearing deposits
 
$
2,346,635
   
$
2,312,816
 
Interest-bearing deposits
   
6,273,027
     
6,009,555
 
Total deposits
   
8,619,662
     
8,322,371
 
                 
Short-term borrowings
   
0
     
54,400
 
Securities sold under agreement to repurchase, short-term
   
249,880
     
259,367
 
Other long-term debt
   
1,953
     
1,976
 
Subordinated debt held by unconsolidated subsidiary trusts
   
97,939
     
97,939
 
Accrued interest and other liabilities
   
189,905
     
157,459
 
Total liabilities
   
9,159,339
     
8,893,512
 
                 
Commitments and contingencies (See Note K)
               
                 
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; 51,727,758 and 51,576,839 shares issued, respectively
   
51,728
     
51,577
 
Additional paid-in capital
   
913,917
     
911,748
 
Retained earnings
   
817,933
     
795,563
 
Accumulated other comprehensive (loss)
   
(26,762
)
   
(45,305
)
Treasury stock, at cost (256,387 shares, including 176,252 shares held by deferred compensation arrangements at March 31, 2019 and 319,015 shares including 207,403 shares held by deferred compensation arrangements at December 31, 2018, respectively)
   
(9,601
)
   
(11,528
)
Deferred compensation arrangements (176,252 and 207,403 shares, respectively)
   
9,913
     
11,728
 
Total shareholders' equity
   
1,757,128
     
1,713,783
 
                 
Total liabilities and shareholders' equity
 
$
10,916,467
   
$
10,607,295
 

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

3

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

   
Three Months Ended
March 31,
 
   
2019
   
2018
 
Interest income:
           
Interest and fees on loans
 
$
73,703
   
$
69,441
 
Interest and dividends on taxable investments
   
16,087
     
15,525
 
Interest on nontaxable investments
   
2,891
     
3,438
 
Total interest income
   
92,681
     
88,404
 
                 
Interest expense:
               
Interest on deposits
   
4,107
     
2,132
 
Interest on borrowings
   
621
     
480
 
Interest on subordinated debt held by unconsolidated subsidiary trusts
   
1,094
     
1,168
 
Total interest expense
   
5,822
     
3,780
 
                 
Net interest income
   
86,859
     
84,624
 
Provision for loan losses
   
2,422
     
3,679
 
Net interest income after provision for loan losses
   
84,437
     
80,945
 
                 
Noninterest revenues:
               
Deposit service fees
   
15,864
     
19,177
 
Other banking revenues
   
1,536
     
1,243
 
Employee benefit services
   
24,054
     
23,006
 
Insurance services
   
7,862
     
7,359
 
Wealth management services
   
6,349
     
6,706
 
Unrealized gain on equity securities
   
31
     
0
 
Total noninterest revenues
   
55,696
     
57,491
 
                 
Noninterest expenses:
               
Salaries and employee benefits
   
53,379
     
51,859
 
Occupancy and equipment
   
10,288
     
10,531
 
Data processing and communications
   
9,399
     
8,742
 
Amortization of intangible assets
   
4,130
     
4,798
 
Legal and professional fees
   
2,720
     
2,781
 
Business development and marketing
   
2,788
     
2,059
 
Acquisition expenses
   
534
     
(8
)
Other expenses
   
5,414
     
5,569
 
Total noninterest expenses
   
88,652
     
86,331
 
                 
Income before income taxes
   
51,481
     
52,105
 
Income taxes
   
9,535
     
11,999
 
Net income
 
$
41,946
   
$
40,106
 
                 
Basic earnings per share
 
$
0.81
   
$
0.78
 
Diluted earnings per share
 
$
0.80
   
$
0.78
 

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

4

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

   
Three Months Ended
March 31,
 
   
2019
   
2018
 
             
Pension and other post-retirement obligations:
           
Amortization of actuarial losses included in net periodic pension cost, gross
 
$
651
   
$
303
 
Tax effect
   
(159
)
   
(74
)
Amortization of actuarial losses included in net periodic pension cost, net
   
492
     
229
 
                 
Amortization of prior service cost included in net periodic pension cost, gross
   
(29
)
   
(127
)
Tax effect
   
7
     
31
 
Amortization of prior service cost included in net periodic pension cost, net
   
(22
)
   
(96
)
                 
Other comprehensive income related to pension and other post-retirement
   obligations, net of taxes
   
470
     
133
 
                 
Unrealized gains (losses) on available-for-sale securities:
               
Net unrealized holding gains (losses) arising during period, gross
   
23,905
     
(41,815
)
Tax effect
   
(5,832
)
   
10,155
 
Net unrealized holding gains (losses) arising during period, net
   
18,073
     
(31,660
)
                 
Other comprehensive income/(loss) related to unrealized gains (losses) on
   available-for-sale securities, net of taxes
   
18,073
     
(31,660
)
                 
Other comprehensive income (loss), net of tax
   
18,543
     
(31,527
)
Net income
   
41,946
     
40,106
 
Comprehensive income
 
$
60,489
   
$
8,579
 

   
As of
 
   
March 31,
2019
   
December 31,
2018
 
Accumulated Other Comprehensive Income By Component:
           
             
Unrealized (loss) for pension and other post-retirement obligations
 
(42,875
)
 
(43,497
)
Tax effect
   
10,508
     
10,660
 
Net unrealized (loss) for pension and other post-retirement obligations
   
(32,367
)
   
(32,837
)
                 
Unrealized gain (loss) on available-for-sale securities
   
7,676
     
(16,229
)
Tax effect
   
(2,071
)
   
3,969
 
Reclassification of other comprehensive income due to change in accounting principle – equity securities
   
0
     
(208
)
Net unrealized gain (loss) on available-for-sale securities
   
5,605
     
(12,468
)
                 
Accumulated other comprehensive (loss)
 
(26,762
)
 
(45,305
)

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

5

COMMUNITY BANK SYSTEM, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)
Three months ended March 31, 2019 and 2018
(In Thousands, Except Share Data)


 
Common Stock
   
Additional
         
Accumulated
Other
         
Deferred
   
 
   
Shares
Outstanding
   
Amount
Issued
   
Paid-In
Capital
   
Retained
Earnings
   
Comprehensive
(Loss)
   
Treasury
Stock
   
Compensation
Arrangements
   
Total
 
                                                 
Balance at December 31, 2018
   
51,257,824
   
$
51,577
   
$
911,748
   
$
795,563
   
(45,305
)
 
(11,528
)
 
$
11,728
   
$
1,713,783
 
                                                                 
Net income
                           
41,946
                             
41,946
 
                                                                 
Other comprehensive income, net of tax
                                   
18,543
                     
18,543
 
                                                                 
Dividends declared:
                                                               
Common, $0.38 per share
                           
(19,576
)
                           
(19,576
)
                                                                 
Common stock activity under employee stock ownership plan
   
150,919
     
151
     
(995
)
                                   
(844
)
                                                                 
Stock-based compensation
                   
1,391
                                     
1,391
 
                                                                 
Distribution of stock under deferred compensation arrangements
   
32,431
             
1,064
                     
830
     
(1,894
)
   
0
 
                                                                 
Treasury stock issued to benefit plans, net
   
30,197
             
709
                     
1,097
     
79
     
1,885
 
                                                                 
Balance at March 31, 2019
   
51,471,371
   
$
51,728
   
$
913,917
   
$
817,933
   
(26,762
)
 
(9,601
)
 
$
9,913
   
$
1,757,128
 
                                                                 
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
                           
40,106
                             
40,106
 
                                                                 
Other comprehensive loss, net of tax
                                   
(31,527
)
                   
(31,527
)
                                                                 
Dividends declared:
                                                               
Common, $0.34 per share
                           
(17,259
)
                           
(17,259
)
                                                                 
Common stock activity under employee stock ownership plan
   
110,413
     
110
     
460
                                     
570
 
                                                                 
Stock-based compensation
                   
1,715
                                     
1,715
 
                                                                 
Distribution of stock under deferred compensation arrangements
   
35,233
                                     
1,898
     
(1,898
)
   
0
 
                                                                 
Treasury stock issued to benefit plans, net
   
41,880
             
982
                     
1,483
     
81
     
2,546
 
                                                                 
Balance at March 31, 2018
   
50,883,603
   
$
51,374
   
$
898,036
   
$
723,404
   
(35,226
)
 
(17,633
)
 
$
11,511
   
$
1,631,466
 

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

6

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

   
Three Months Ended
March 31,
 
   
2019
   
2018
 
Operating activities:
           
Net income
 
$
41,946
   
$
40,106
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
   
3,830
     
4,001
 
Amortization of intangible assets
   
4,130
     
4,798
 
Net accretion on securities, loans and borrowings
   
(1,944
)
   
(2,214
)
Stock-based compensation
   
1,391
     
1,715
 
Provision for loan losses
   
2,422
     
3,679
 
Amortization of mortgage servicing rights
   
98
     
117
 
Unrealized gain on equity securities
   
(31
)
   
0
 
Income from bank-owned life insurance policies
   
(391
)
   
(388
)
Net loss (gain) on sale of loans and other assets
   
22
     
(80
)
Change in other assets and other liabilities
   
(16,864
)
   
9,253
 
Net cash provided by operating activities
   
34,609
     
60,987
 
Investing activities:
               
Proceeds from maturities, calls, and paydowns of available-for-sale investment securities
   
52,520
     
27,363
 
Proceeds from maturities and redemptions of equity and other investment securities
   
2,460
     
4,960
 
Purchases of available-for-sale investment securities
   
(13,388
)
   
(23,434
)
Purchases of equity and other securities
   
(24
)
   
(21
)
Net decrease in loans
   
11,847
     
25,900
 
Cash paid for acquisitions, net of cash acquired of $0 and $16, respectively
   
(1,200
)
   
(1,464
)
Purchases of premises and equipment, net
   
(1,227
)
   
(1,556
)
Real estate limited partnership investments
   
(564
)
   
(79
)
Net cash provided by investing activities
   
50,424
     
31,669
 
Financing activities:
               
Net increase in deposits
   
297,291
     
326,672
 
Net decrease in borrowings
   
(63,910
)
   
(81,338
)
Issuance of common stock
   
(844
)
   
570
 
Purchases of treasury stock
   
(79
)
   
(81
)
Sales of treasury stock
   
1,885
     
2,546
 
Increase in deferred compensation arrangements
   
79
     
81
 
Cash dividends paid
   
(19,806
)
   
(17,281
)
Withholding taxes paid on share-based compensation
   
(3,119
)
   
(964
)
Net cash provided by financing activities
   
211,497
     
230,205
 
Change in cash and cash equivalents
   
296,530
     
322,861
 
Cash and cash equivalents at beginning of period
   
211,834
     
221,038
 
Cash and cash equivalents at end of period
 
$
508,364
   
$
543,899
 
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
 
$
5,684
   
$
3,757
 
Cash paid for income taxes
   
4,486
     
564
 
                 
Supplemental disclosures of noncash financing and investing activities:
               
Dividends declared and unpaid
   
19,578
     
17,438
 
Transfers from loans to other real estate
   
412
     
942
 
                 
Acquisitions:
               
Common stock issued
   
0
     
0
 
Fair value of assets acquired, excluding acquired cash and intangibles
   
0
     
27
 
Fair value of liabilities assumed
   
0
     
31
 

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

7

COMMUNITY BANK SYSTEM, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
MARCH 31, 2019

NOTE A:  BASIS OF PRESENTATION

The interim financial data as of and for the three months ended March 31, 2019 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 in the United States of America (“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

Pending Acquisition – Kinderhook Bank Corp.
On January 22, 2019, the Company announced that it had entered into a definitive agreement to acquire Kinderhook Bank Corp. (“Kinderhook”), parent company of The National Union Bank of Kinderhook headquartered in Kinderhook, New York, for approximately $93.4 million in cash. The acquisition will extend the Company’s footprint into the Capital District of Upstate New York. Upon completion of the merger, the Bank will add 11 branch locations across a five county area in the Capital District of Upstate New York. The parties have received the shareholder and regulatory approvals necessary to complete the merger, including approval from the Office of the Comptroller of the Currency and a waiver from filing an application with the Federal Reserve Bank of New York. The Company expects the merger to close on July 12, 2019, subject to customary closing conditions. The Company expects to incur certain one-time, transaction-related costs in 2019.

On January 2, 2019, the Company, through its subsidiary, Community Investment Services, Inc. (“CISI”), completed its acquisition of certain assets of Wealth Resources Network, Inc. (“Wealth Resources”), a financial services business headquartered in Liverpool, New York. The Company paid $1.2 million in cash to acquire a customer list from Wealth Resources, 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 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 provider of actuarial and benefit consulting services 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 and liabilities have been included in the consolidated financial statements since that date.

On January 2, 2018, the Company, through its subsidiary, 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.

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 acquisitions, and were subject to adjustment based on updated information not available at the time of the acquisitions.

8

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

   
2019
   
2018
 
(000s omitted)
 
Wealth Resources
   
Other (1)
 
Consideration paid :
           
Cash
 
$
1,200
   
$
1,753
 
Total net consideration paid
 
$
1,200
   
$
1,753
 
Recognized amounts of identifiable assets acquired and liabilities assumed:
               
Cash and cash equivalents
   
0
     
16
 
Premises and equipment
   
0
     
10
 
Other assets
   
0
     
105
 
Other intangibles
   
1,200
     
1,343
 
Other liabilities
   
0
     
(31
)
Total identifiable assets, net
   
1,200
     
1,443
 
Goodwill
 
$
0
   
$
310
 

 (1) Includes amounts related to the Styles Bridges, Penna, and HR Consultants acquisitions.

The other intangibles related to the Wealth Resources, Styles Bridges, Penna, and HR Consultants 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 All Other segment for the Penna acquisition.  Goodwill arising from the Penna acquisition is deductible for tax purposes.

Direct costs related to the acquisitions were expensed as incurred.  Merger and acquisition integration-related expenses amount to $0.5 million during the three months ended March 31, 2019 and have been separately stated in the consolidated statements of income.  Merger and acquisition integration-related expenses for the three months ended March 31, 2018 were immaterial.

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 65 through 75 of the Annual Report on Form 10-K for the year ended December 31, 2018 filed with the Securities and Exchange Commission (“SEC”) on March 1, 2019 except as noted below.

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 March 31, 2019, $29.4 million of accounts receivable, including $9.5 million of unbilled fee revenue, and $3.5 million of unearned revenue was recorded in the consolidated statements of condition. As of December 31, 2018, $26.4 million of accounts receivable, including $7.8 million of unbilled fee revenue, and $2.2 million of unearned revenue was recorded in the consolidated statements of condition.

Leases
The Company occupies certain offices and uses certain equipment under non-cancelable operating lease agreements. The Company determines if an arrangement is a lease at inception. The right-of-use assets associated with operating leases are recorded in premises and equipment in the Company’s consolidated statements of condition. The lease liabilities associated with operating leases are included in accrued interest and other liabilities in the Company’s consolidated statements of condition.

Right-of-use assets represent the Company’s right to use the underlying assets for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the associated leases. Operating lease right-of-use assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. The Company uses interest rates on advances from the Federal Home Loan Bank of New York available at the time of commencement to determine the present value of lease payments. The operating lease right-of-use assets include any lease payments made at the time of commencement and exclude lease incentives. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the option will be exercised. Lease expense is recognized on a straight-line basis over the lease term and is included in occupancy and equipment expense in the Company’s consolidated statements of income.

9

The Company elected to account for lease and non-lease components separately, applies a portfolio approach to account for the lease right-of-use assets and liabilities for certain equipment leases and elected to exclude leases with a term of 12 months or less from the recognition and measurement policies described above.

Derivative Financial Instruments and Hedging Activities
The Company accounts for derivative financial instruments at fair value.  If certain conditions are met, a derivative may be specifically designated as (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”), (2) a hedge of the exposure to variable cash flows of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”).  For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change.  For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings.  Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest revenues.

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged.  Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest revenues.  Cash flows on hedges are classified in the consolidated statement of cash flow statement the same as the cash flows of the items being hedged.

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and strategy for undertaking hedge transactions at the inception of the hedging relationship.  This documentation includes linking the fair value or cash flow hedges to specific assets and liabilities on the statement of condition or to specific commitments or forecasted transactions.  The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded in noninterest revenues.  When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.  When a cash flow hedge is discontinued, but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

Recently Adopted 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, with certain practical expedients available. The Company adopted this guidance on January 1, 2019 using the cumulative-effect adjustment method. The cumulative-effect adjustment was not material. The Company elected several practical expedients available under the standard. The Company elected to not reassess whether any expired or existing contracts are or contain leases, to not reassess the classification (operating or capital) of any expired or existing contracts, to not reassess initial direct costs for existing leases, and to use hindsight in determining the lease term. The Company has implemented processes and a lease accounting system to ensure adequate internal controls were in place to assess our contracts and enable proper accounting and reporting of financial information upon adoption. The increase in total assets and total liabilities was $34.2 million. The impact on the Company’s results of operations and cash flows was not material.

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. The Company adopted this guidance on January 1, 2019 on a modified retrospective basis. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

10

New Accounting Pronouncements
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 was 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.

NOTE D:  INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities as of March 31, 2019 and December 31, 2018 are as follows:


 
March 31, 2019
   
December 31, 2018
 
(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
 
$
2,033,399
   
$
6,841
   
$
5,268
   
$
2,034,972
   
$
2,036,474
   
$
2,190
   
$
14,911
   
$
2,023,753
 
Obligations of state and political subdivisions
   
423,916
     
9,319
     
76
     
433,159
     
453,640
     
6,563
     
1,049
     
459,154
 
Government agency mortgage-backed securities
   
389,154
     
2,587
     
5,198
     
386,543
     
390,234
     
1,526
     
9,283
     
382,477
 
Corporate debt securities
   
2,572
     
0
     
19
     
2,553
     
2,588
     
0
     
42
     
2,546
 
Government agency collateralized mortgage obligations
   
66,226
     
88
     
598
     
65,716
     
69,342
     
60
     
1,283
     
68,119
 
Total available-for-sale portfolio
 
$
2,915,267
   
$
18,835
   
$
11,159
   
$
2,922,943
   
$
2,952,278
   
$
10,339
   
$
26,568
   
$
2,936,049
 
                                                                 
Equity and other Securities:
                                                               
Equity securities, at fair value
 
$
251
   
$
215
   
$
2
   
$
464
   
$
251
   
$
200
   
$
19
   
$
432
 
Federal Home Loan Bank common stock
   
6,308
     
0
     
0
     
6,308
     
8,768
     
0
     
0
     
8,768
 
Federal Reserve Bank common stock
   
30,690
     
0
     
0
     
30,690
     
30,690
     
0
     
0
     
30,690
 
Other equity securities, at adjusted cost
   
4,992
     
750
     
0
     
5,742
     
4,969
     
750
     
0
     
5,719
 
Total equity and other securities
 
$
42,241
   
$
965
   
$
2
   
$
43,204
   
$
44,678
   
$
950
   
$
19
   
$
45,609
 

11

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

As of March 31, 2019


 
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
   
0
   
$
0
   
$
0
     
48
   
$
862,482
   
$
5,268
     
48
   
$
862,482
   
$
5,268
 
Obligations of state and political subdivisions
   
3
     
869
     
2
     
20
     
11,854
     
74
     
23
     
12,723
     
76
 
Government agency mortgage-backed securities
   
9
     
5,241
     
6
     
181
     
242,566
     
5,192
     
190
     
247,807
     
5,198
 
Corporate debt securities
   
0
     
0
     
0
     
1
     
2,553
     
19
     
1
     
2,553
     
19
 
Government agency collateralized mortgage obligations
   
1
     
1
     
0
     
39
     
56,690
     
598
     
40
     
56,691
     
598
 
Total available-for-sale investment portfolio
   
13
   
$
6,111
   
$
8
     
289
   
$
1,176,145
   
$
11,151
     
302
   
$
1,182,256
   
$
11,159
 
                                                                         
Equity and other Securities:
                                                                       
Equity securities, at fair value
   
1
   
$
98
   
$
2
     
0
   
$
0
   
$
0
     
1
   
$
98
   
$
2
 
Total equity and other securities
   
1
   
$
98
   
$
2
     
0
   
$
0
   
$
0
     
1
   
$
98
   
$
2
 

As of December 31, 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
   
7
   
$
473,082
   
$
682
     
64
   
$
1,213,276
   
$
14,229
     
71
   
$
1,686,358
   
$
14,911
 
Obligations of state and political subdivisions
   
118
     
55,671
     
216
     
97
     
51,753
     
833
     
215
     
107,424
     
1,049
 
Government agency mortgage-backed securities
   
43
     
47,708
     
258
     
181
     
253,931
     
9,025
     
224
     
301,639
     
9,283
 
Corporate debt securities
   
0
     
0
     
0
     
1
     
2,546
     
42
     
1
     
2,546
     
42
 
Government agency collateralized mortgage obligations
   
1
     
66
     
0
     
41
     
63,112
     
1,283
     
42
     
63,178
     
1,283
 
Total available-for-sale investment portfolio
   
169
   
$
576,527
   
$
1,156
     
384
   
$
1,584,618
   
$
25,412
     
553
   
$
2,161,145
   
$
26,568
 
                                                                         
Equity and other Securities:
                                                                       
Equity securities, at fair value
   
1
   
$
82
   
$
19
     
0
   
$
0
   
$
0
     
1
   
$
82
   
$
19
 
Total equity and other securities
   
1
   
$
82
   
$
19
     
0
   
$
0
   
$
0
     
1
   
$
82
   
$
19
 

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 March 31, 2019 represents other-than-temporary impairment.

12

The amortized cost and estimated fair value of debt securities at March 31, 2019, 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
 
$
76,873
   
$
76,767
 
Due after one through five years
   
2,093,361
     
2,096,910
 
Due after five years through ten years
   
152,168
     
156,042
 
Due after ten years
   
137,485
     
140,965
 
Subtotal
   
2,459,887
     
2,470,684
 
Government agency mortgage-backed securities
   
389,154
     
386,543
 
Government agency collateralized mortgage obligations
   
66,226
     
65,716
 
Total
 
$
2,915,267
   
$
2,922,943
 

As of March 31, 2019, $263.0 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 March 31, 2019 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.

The balances of these classes are summarized as follows:

(000's omitted)
 
March 31,
2019
   
December 31,
2018
 
Business lending
 
$
2,410,477
   
$
2,396,977
 
Consumer mortgage
   
2,237,430
     
2,235,408
 
Consumer indirect
   
1,070,840
     
1,083,207
 
Consumer direct
   
173,042
     
178,820
 
Home equity
   
374,297
     
386,709
 
Gross loans, including deferred origination costs
   
6,266,086
     
6,281,121
 
Allowance for loan losses
   
(49,107
)
   
(49,284
)
Loans, net of allowance for loan losses
 
$
6,216,979
   
$
6,231,837
 

The outstanding balance related to credit impaired acquired loans was $7.3 million and $7.4 million at March 31, 2019 and December 31, 2018, respectively.  The changes in the accretable discount related to the credit impaired acquired loans are as follows:

(000’s omitted)
     
Balance at December 31, 2018
 
$
437
 
Accretion recognized, year-to-date
   
(74
)
Balance at March 31, 2019
 
$
363
 

13

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 March 31, 2019:

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
 
$
6,042
   
$
68
   
$
4,147
   
$
10,257
   
$
1,652,950
   
$
1,663,207
 
Consumer mortgage
   
8,937
     
1,960
     
9,794
     
20,691
     
1,843,754
     
1,864,445
 
Consumer indirect
   
9,824
     
201
     
0
     
10,025
     
1,051,493
     
1,061,518
 
Consumer direct
   
985
     
41
     
0
     
1,026
     
169,334
     
170,360
 
Home equity
   
1,005
     
323
     
1,583
     
2,911
     
301,113
     
304,024
 
Total
 
$
26,793
   
$
2,593
   
$
15,524
   
$
44,910
   
$
5,018,644
   
$
5,063,554
 

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
 
$
2,526
   
$
66
   
$
3,254
   
$
5,846
   
$
5,342
   
$
736,082
   
$
747,270
 
Consumer mortgage
   
883
     
287
     
1,954
     
3,124
     
0
     
369,861
     
372,985
 
Consumer indirect
   
32
     
33
     
0
     
65
     
0
     
9,257
     
9,322
 
Consumer direct
   
33
     
25
     
0
     
58
     
0
     
2,624
     
2,682
 
Home equity
   
558
     
15
     
520
     
1,093
     
0
     
69,180
     
70,273
 
Total
 
$
4,032
   
$
426
   
$
5,728
   
$
10,186
   
$
5,342
   
$
1,187,004
   
$
1,202,532
 

(1)
Acquired impaired loans were not classified as nonperforming assets as the loans are considered to be performing under ASC 310-30.  As a result interest income, through the accretion of the difference between the carrying amount of the loans and the expected cashflows, is being recognized on all acquired impaired loans.

The following is an aged analysis of the Company’s past due loans by class as of December 31, 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
 
$
5,261
   
$
179
   
$
4,872
   
$
10,312
   
$
1,608,515
   
$
1,618,827
 
Consumer mortgage
   
12,468
     
1,393
     
9,872
     
23,733
     
1,824,717
     
1,848,450
 
Consumer indirect
   
14,609
     
258
     
0
     
14,867
     
1,057,525
     
1,072,392
 
Consumer direct
   
1,778
     
48
     
0
     
1,826
     
173,948
     
175,774
 
Home equity
   
983
     
228
     
1,438
     
2,649
     
309,892
     
312,541
 
Total
 
$
35,099
   
$
2,106
   
$
16,182
   
$
53,387
   
$
4,974,597
   
$
5,027,984
 

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
 
$
974
   
$
0
   
$
3,498
   
$
4,472
   
$
5,446
   
$
768,232
   
$
778,150
 
Consumer mortgage
   
841
     
232
     
2,390
     
3,463
     
0
     
383,495
     
386,958
 
Consumer indirect
   
78
     
34
     
0
     
112
     
0
     
10,703
     
10,815
 
Consumer direct
   
115
     
4
     
0
     
119
     
0
     
2,927
     
3,046
 
Home equity
   
613
     
79
     
474
     
1,166
     
0
     
73,002
     
74,168
 
Total
 
$
2,621
   
$
349
   
$
6,362
   
$
9,332
   
$
5,446
   
$
1,238,359
   
$
1,253,137
 

(1)
Acquired impaired loans were not classified as nonperforming assets as the loans are considered to be performing under ASC 310-30.  As a result interest income, through the accretion of the difference between the carrying amount of the loans and the expected cashflows, is being recognized on all acquired impaired loans.

14

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

Pass
The condition of the borrower and the performance of the loans are satisfactory or better.
Special Mention
The condition of the borrower has deteriorated although the loan performs as agreed.
Classified
The condition of the borrower has significantly deteriorated and the performance of the loan could further deteriorate, if deficiencies are not corrected.
Doubtful
The condition of the borrower has deteriorated to the point that collection of the balance is improbable based on current facts and conditions.

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

   
March 31, 2019
   
December 31, 2018
 
(000’s omitted)
 
Legacy
   
Acquired
   
Total
   
Legacy
   
Acquired
   
Total
 
Pass
 
$
1,475,145
   
$
659,645
   
$
2,134,790
   
$
1,439,337
   
$
702,493
   
$
2,141,830
 
Special mention
   
108,129
     
53,562
     
161,691
     
105,065
     
40,107
     
145,172
 
Classified
   
79,933
     
28,721
     
108,654
     
74,425
     
28,525
     
102,950
 
Doubtful
   
0
     
0
     
0
     
0
     
1,579
     
1,579
 
Acquired impaired
   
0
     
5,342
     
5,342
     
0
     
5,446