10-K 1 cbna201510k.htm cbna201510k.htm

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

FORM 10-K
 
  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 2015
   
  o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from                     to                                       
  Commission file number 001-13695
 
 
 
(Exact name of registrant as specified in its charter)
 
                                       Delaware                                                              16-1213679                 
 (State or other jurisdiction of incorporation or organization)      (I.R.S. Employer Identification No.)
     
         5790 Widewaters Parkway, DeWitt, New York                                  13214-1883                  
 (Address of principal executive offices)    (Zip Code)
   (315) 445-2282  
(Registrant's telephone number, including area code)
 
Securities registered pursuant of Section 12(b) of the Act:
                                   Title of each class                                        Name of each exchange on which registered      
Common Stock, Par Value $1.00 per share   New York Stock Exchange
 
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  x    No  o.
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o    No  x .
 
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
 of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
 to such filing requirements for the past 90 days.   Yes   x    No  o.
 
 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data
 File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or
 for such shorter period that the registrant was required to submit and post such files).   Yes  x   No  o.
 
 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained
 herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by
 reference in Part III of this Form 10-K or any amendment of this Form 10-K.  o.
 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
 company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 Large accelerated filer   x  Accelerated filer  o  Non-accelerated filer  o  Smaller reporting company  o.
    (Do not check if a smaller reporting company)  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o  No  x  .
 
 The aggregate market value of the common stock, $1.00 par value per share, held by non-affiliates of the registrant computed by reference to the closing
 price as of the close of business on June 30, 2015 (the registrant’s most recently completed second fiscal quarter): $1,499,048,110.
 
The number of shares of the common stock, $1.00 par value per share, outstanding as of the close of business on January 31, 2016: 43,875,778
 
DOCUMENTS INCORPORATED BY REFERENCE.
 
 Portions of the Definitive Proxy Statement for the Annual Meeting of the Shareholders to be held on May 18, 2016 (the "Proxy Statement")
 is incorporated by reference in Part III of this Annual Report on Form 10-K.


 
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TABLE OF CONTENTS

PART I
 
Page
Item 1
Business____________________________________________________________________________________________________________
     3
Item 1A
Risk Factors _________________________________________________________________________________________________________  
13
Item 1B
Unresolved Staff Comments _____________________________________________________________________________________________
18
Item 2
Properties___________________________________________________________________________________________________________
18
Item 3
Legal Proceedings____________________________________________________________________________________________________
19
Item 4
Mine Safety Disclosures________________________________________________________________________________________________
19
Item 4A.
Executive Officers of the Registrant_______________________________________________________________________________________
19
     
PART II
   
Item 5
Market for Registrant's Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Securities_____________________________
20
Item 6
Selected Financial Data_________________________________________________________________________________________________
22
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Operations______________________________________________
24
Item 7A
Quantitative and Qualitative Disclosures about Market Risk_____________________________________________________________________
49
Item 8
Financial Statements and Supplementary Data:
 
 
     Consolidated Statements of Condition____________________________________________________________________________________
51
 
     Consolidated Statements of Income______________________________________________________________________________________
52
 
     Consolidated Statements of Comprehensive Income_________________________________________________________________________
53
 
     Consolidated Statements of Changes in Shareholders' Equity__________________________________________________________________
54
 
     Consolidated Statements of Cash Flows__________________________________________________________________________________
55
 
     Notes to Consolidated Financial Statements_______________________________________________________________________________
56
 
     Report on Internal Control over Financial Reporting_________________________________________________________________________
91
 
     Report of Independent Registered Public Accounting Firm____________________________________________________________________
92
 
Two Year Selected Quarterly Data_________________________________________________________________________________________
93
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure______________________________________________
93
Item 9A.
Controls and Procedures________________________________________________________________________________________________
93
Item 9B.
Other Information_____________________________________________________________________________________________________
94
     
PART III
   
Item 10
Directors, Executive Officers and Corporate Governance________________________________________________________________________
94
Item 11
Executive Compensation________________________________________________________________________________________________
94
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters______________________________________
94
Item 13
Certain Relationships and Related Transactions, and Director Independence_________________________________________________________
94
Item 14
Principal Accounting Fees and Services____________________________________________________________________________________
94
     
PART IV
   
Item 15
Exhibits, Financial Statement Schedules____________________________________________________________________________________
95
Signatures
__________________________________________________________________________________________________________________
99
     
     
     
     
     
     
     







 
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Part I

This Annual Report on Form 10-K contains certain forward-looking statements with respect to the financial condition, results of operations and business of Community Bank System, Inc.  These forward-looking statements by their nature address matters that involve certain risks and uncertainties.  Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set forth herein under the caption “Forward-Looking Statements.”

Item 1. Business

Community Bank System, Inc. (the “Company”) was incorporated on April 15, 1983, under the Delaware General Corporation Law.  Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214.  The Company is a registered financial holding company which wholly-owns two significant subsidiaries: Community Bank, N.A. (the “Bank” or “CBNA”), and Benefit Plans Administrative Services, Inc. (“BPAS”).  BPAS owns four subsidiaries: Benefit Plans Administrative Services, LLC (“BPA”), a provider of defined contribution plan administration services; BPAS Actuarial & Pension Services, LLC (“BPAS-APS”) (formally known as Harbridge Consulting Group, LLC), a provider of actuarial and benefit consulting services; BPAS Trust Company of Puerto Rico, a Puerto Rican trust company; and Hand Benefits & Trust Company (“HB&T”), a provider of collective investment fund administration and institutional trust services.  HB&T owns one subsidiary, Hand Securities, Inc. (“HSI”), an introducing broker dealer.  The Company also wholly-owns two unconsolidated subsidiary business trusts formed for the purpose of issuing mandatorily-redeemable preferred securities which are considered Tier I capital under regulatory capital adequacy guidelines. 

The Bank’s business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial, and municipal customers.  As of December 31, 2015, the Bank operates 194 full-service branches operating as Community Bank, N.A. throughout 36 counties of Upstate New York and six counties of Northeastern Pennsylvania, offering a range of commercial and retail banking services.  The Bank owns the following operating subsidiaries: The Carta Group, Inc. (“Carta Group”), CBNA Insurance Agency, Inc. (“CBNA Insurance”), CBNA Preferred Funding Corporation (“PFC”), CBNA Treasury Management Corporation (“TMC”), Community Investment Services, Inc. (“CISI”),  Nottingham Advisors, Inc. (“Nottingham”), OneGroup NY, Inc. (“OneGroup”), Oneida Wealth Management, Inc. (“OWM”) and Oneida Preferred Funding II LLC (“OPFCII”).  OneGroup and CBNA Insurance are full-service insurance agencies offering personal and commercial property insurance and other risk management products and services.  PFC and OPFCII primarily act as investors in residential real estate loans and properties.  TMC provides cash management, investment, and treasury services to the Bank.  CISI, the Carta Group, and OWM provide broker-dealer and investment advisory services.  Nottingham provides asset management services to individuals, corporations, corporate pension and profit sharing plans, and foundations.

The Company maintains a website at communitybankna.com.  Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, are available on the Company’s website free of charge as soon as reasonably practicable after such reports or amendments are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).  The information posted on the website is not incorporated into or a part of this filing.  Copies of all documents filed with the SEC can also be obtained by visiting the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC  20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SEC’s website at http://www.sec.gov.

Acquisition History (2011-2015)

Oneida Financial Corp.
On December 4, 2015, the Company completed its acquisition of Oneida Financial Corp. (“Oneida”), parent company of Oneida Savings Bank, headquartered in Oneida, New York for approximately $158 million in Company stock and cash, comprised of $56.3 million of cash and the issuance of 2.78 million common shares.  Upon the completion of the merger, the Bank added 12 branch locations in Oneida and Madison counties and approximately $769 million of assets, including approximately $399 million of loans and $226 million of investment securities, along with $699 million of deposits.  Through the acquisition of Oneida, the Company acquired OneGroup and OWM as wholly-owned subsidiaries primarily engaged in offering insurance and investment advisory services.  These subsidiaries complement the Company’s other non-banking financial services businesses.

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


 
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Bank of America Branches
On December 13, 2013,  the Bank completed its acquisition of eight retail branch-banking locations across its Northeast Pennsylvania markets from Bank of America, N.A. (“B of A”), acquiring approximately $1.1 million in loans and $303 million of deposits.  The assumed deposits consisted of $220 million of checking, savings and money market accounts (“core deposits”) and $83 million of time deposits.  Under the terms of the purchase agreement, the Bank paid B of A a blended deposit premium of 2.4%, or approximately $7.3 million.

HSBC and First Niagara Branches
On July 20, 2012,  the Bank completed its acquisition of 16 retail branches in central, northern and western New York from HSBC Bank USA, N.A. (“HSBC”), acquiring approximately $106 million in loans and approximately $697 million of deposits.  The assumed deposits consisted primarily of core deposits and the acquired loans consisted of in-market performing loans, primarily residential real estate loans.  Under the terms of the purchase agreement, the Bank paid First Niagara Bank, N.A. (“First Niagara”), who acquired HSBC’s Upstate New York banking business and assigned its right to purchase the 16 branches to the Bank, a blended deposit premium of 3.4%, or approximately $24 million.

On September 7, 2012, the Bank completed its acquisition of three branches in central New York from First Niagara, acquiring approximately $54 million of loans and $101 million of deposits.  The assumed deposits consisted primarily of core deposits and the acquired loans consist of in-market performing loans, primarily residential real estate loans. Under the terms of the purchase agreement, the Bank paid a blended deposit premium of 3.1%, or approximately $3 million.

In support of the HSBC and First Niagara branch acquisitions, the Company completed a public common stock offering in late January 2012, raising $57.5 million through the issuance of 2.13 million common shares.  The net proceeds of the offering were approximately $54.9 million.

CAI Benefits, Inc.
On November 30, 2011, the Company, through its BPAS subsidiary, acquired in an all-cash transaction, certain assets and liabilities of CAI Benefits, Inc. (“CAI”), a provider of actuarial, consulting and retirement plan administration services, with offices in New York City and Northern New Jersey.  The transaction added valuable service capacity and enhanced distribution prospects in support of the Company’s broader-based employee benefits business, including daily valuation plan and collective investment fund administration.

The Wilber Corporation
On April 8, 2011, the Company acquired The Wilber Corporation (“Wilber”), parent company of Wilber National Bank for $103 million of stock and cash, comprised of $20.4 million in cash and the issuance of 3.35 million additional shares of the Company’s common stock.  Based in Oneonta, New York, Wilber operated 22 branch-banking centers in the Central, Greater Capital District, and Catskill regions of Upstate New York.  The acquisition added approximately $462 million in loans, $297 million of investment securities, and $772 million in deposits.

Services

Banking
The Bank is a community bank committed to the philosophy of serving the financial needs of customers in local communities.  The Bank's branches are generally located in smaller towns and cities within its geograph­ic market areas of Upstate New York and Northeastern Pennsylvania. The Company believes that the local character of its business, knowledge of the customers and their needs, and its comprehensive retail and business products, together with responsive decision-making at the branch and regional levels, enable the Bank to compete effectively in its geographic market.   The Bank is a member of the Federal Reserve System (“FRB”) and the Federal Home Loan Bank of New York ("FHLB"), and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to applicable limits.

Employee Benefit Services
Through BPAS and its subsidiaries, the Company operates a national practice that provides employee benefit trust, collective investment fund, retirement plan administration, actuarial, VEBA/HRA and health and welfare consulting services to a diverse array of clients spanning the United States and Puerto Rico.

Wealth Management
Through the Bank, CISI, OWM, Carta Group, and Nottingham, the Company operates a wealth management, retirement planning, higher educational planning, fiduciary, risk management, and personal financial planning.  Through a third party broker-dealer relationship, the Company offers investment alternatives including stocks, bonds, mutual funds and advisory products.


 
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Insurance
Through OneGroup and CBNA Insurance, the Company offers personal and commercial property insurance and other risk management products and services. In addition, OneGroup offers employee benefit related services.  OneGroup and CBNA Insurance represent many leading insurance companies, including Travelers, CNA, Hartford, Progressive, Cincinnati and Utica National.

Segment Information
The Company has identified three reportable operating business segments:  Banking, Employee Benefit Services, and All Other.  Included in the All Other segment are the smaller Wealth Management and Insurance segments.  Information about the Company’s reportable business segments is included in Note U of the “Notes to Consolidated Financial Statements” filed herewith in Part II.

Competition
The banking and financial services industry is highly competitive in the New York and Pennsylvania markets.  The Company competes actively for loans, deposits and customers with other national and state banks, thrift institutions, credit unions, retail brokerage firms, mortgage bankers, finance companies, insurance companies, and other regulated and unregulated providers of financial services.  In order to compete with other financial service providers, the Company stresses the community nature of its operations and the development of profitable customer relationships across all lines of business.


 
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The table below summarizes the Bank’s deposits and market share by the forty-two counties of New York and Pennsylvania in which it has customer facilities.  Market share is based on deposits of all commercial banks, credit unions, savings and loan associations, and savings banks.

       
Number of
             
Towns Where
   
Deposits as of
       
Company
   
 6/30/2015(1)
Market
   
Towns/
Has 1st or 2nd
County
State
(000's omitted)
Share (1)
Branches
ATM's
Cities
Market Position
Lewis
NY
$177,913
74.82%
4
4
3
3
Franklin
NY
281,304
60.98%
6
6
5
5
Madison
NY
613,898
59.78%
8
8
5
5
Hamilton
NY
52,141
55.56%
2
2
2
2
Allegany
NY
236,056
47.11%
9
10
8
8
Cattaraugus
NY
402,793
43.95%
10
11
7
6
St. Lawrence
NY
424,885
37.91%
13
10
11
10
Otsego
NY
349,524
36.17%
10
9
6
5
Seneca
NY
141,246
28.95%
4
3
4
3
Jefferson
NY
407,326
27.83%
7
9
6
6
Schuyler
NY
50,541
27.63%
1
1
1
1
Clinton
NY
329,032
25.86%
4
7
2
2
Yates
NY
91,691
25.48%
3
2
2
1
Wyoming
PA
128,305
25.35%
3
4
3
3
Chautauqua
NY
327,776
22.36%
12
12
10
7
Livingston
NY
171,263
22.30%
5
6
5
4
Essex
NY
124,369
19.84%
5
5
4
4
Steuben
NY
184,281
19.01%
8
7
7
4
Wayne
NY
128,957
16.10%
3
3
2
2
Delaware
NY
151,914
15.89%
5
5
5
5
Ontario
NY
234,937
12.52%
8
13
5
3
Oswego
NY
168,214
9.79%
4
5
4
2
Tioga
NY
36,811
8.98%
2
2
2
1
Lackawanna
PA
403,255
7.94%
11
11
8
4
Luzerne
PA
442,484
7.78%
11
15
9
4
Chemung
NY
74,052
7.37%
2
2
1
0
Herkimer
NY
42,550
7.09%
1
1
1
1
Susquehanna
PA
52,604
7.00%
3
1
3
2
Oneida
NY
198,506
6.18%
7
7
6
5
Schoharie
NY
23,947
5.87%
1
1
1
0
Carbon
PA
40,824
4.30%
2
2
2
1
Bradford
PA
43,708
3.90%
2
2
2
1
Cayuga
NY
39,827
3.86%
2
2
2
1
Washington
NY
19,820
2.82%
1
0
1
1
Chenango
NY
25,561
2.68%
2
2
1
0
Warren
NY
31,615
2.03%
1
1
1
1
Onondaga
NY
140,435
1.53%
4
4
4
1
Broome
NY
31,781
1.22%
1
1
1
0
Ulster
NY
31,782
1.12%
1
1
1
1
Erie
NY
105,030
0.28%
4
4
3
2
Tompkins
NY
4,144
0.23%
1
0
1
0
Saratoga
NY
6,124
0.15%
1
1
1
0
   
$6,973,226
6.97%
194
202
158
117
               
(1) Deposits and Market Share data as of June 30, 2015, the most recent information available from SNL Financial LLC,
     adjusted for the Oneida acquisition occurring on December 4, 2015.
     Deposit amounts include $133.2 million of intercompany balances that are eliminated upon consolidation.
    

 

 
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Employees

As of December 31, 2015, the Company employed 2,207 full-time employees, 133 part-time employees and 150 temporary employees.  None of the Company’s employees are represented by a collective bargaining agreement.  The Company offers a variety of employment benefits and considers its relationship with its employees to be good.

Supervision and Regulation

General
The banking industry is highly regulated with numerous statutory and regulatory requirements that are designed primarily for the protection of depositors and the financial system, and not for the purpose of protecting shareholders.  Set forth below is a description of the material laws and regulations applicable to the Company and the Bank.  This summary is not complete and the reader should refer to these laws and regulations for more detailed information.  The Company’s and the Bank’s failure to comply with applicable laws and regulations could result in a range of sanctions and administrative actions imposed upon the Company and/or the Bank, including the imposition of civil money penalties, formal agreements and cease and desist orders.  Changes in applicable law or regulations, and in their interpretation and application by regulatory agencies, cannot be predicted, and may have a material effect on the Company’s business and results.

The Company and its subsidiaries are subject to the laws and regulations of the federal government and the states and jurisdictions in which they conduct business.  The Company, as a bank holding company, is subject to extensive regulation, supervision and examination by the Board of Governors of the FRB as its primary federal regulator.  The Bank is a nationally-chartered bank and is subject to extensive regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) as its primary federal regulator, and as to certain matters, the FRB, the Consumer Financial Protection Bureau (“CFPB”), and the Federal Deposit Insurance Corporation (“FDIC”).

The Company is also subject to the jurisdiction of the SEC and is subject to disclosure and regulatory requirement under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended.  The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) and it is subject to NYSE’s rules for listed companies.  Affiliated entities, including BPAS, HB&T, HSI, BPAS Trust Company of Puerto Rico, Nottingham, CISI, OneGroup, Carta Group, OWM and CBNA Insurance are subject to the jurisdiction of certain state and federal regulators and self-regulatory organizations including, but not limited to, the SEC, the Texas Department of Banking, the Financial Industry Regulatory Authority (“FINRA”), Puerto Rico Office of the Commissioner of Financial Institutions, and state securities and insurance regulators.

Federal Bank Holding Company Regulation
The Company is a bank holding company under the Bank Holding Company Act of 1956, (the “BHC Act”) that registered in 2015 with the FRB as a single bank financial holding company, as provided by the Financial Modernization Act of 1999 as amended (also known as the Gramm-Leach-Bliley Act (the “GLB Act”)).  The Company continues to maintain its status as a bank holding company for purposes of other FRB regulations.  The BHC Act generally restricts bank holding companies from engaging in business activities other than the business of banking and certain closely related activities.  As a bank holding company that has elected to become a financial holding company, the Company can affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature, as long as it continues to meet the eligibility requirements for financial holding companies (including requirements that the financial holding company and its depository institution subsidiary maintain their status as “well capitalized” and “well managed”).  Generally, FRB approval is not required for the Company to acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the FRB.

The FRB has the authority to limit a financial holding company’s ability to conduct activities that would otherwise be permissible if the financial holding company or any of its depositary institution subsidiaries ceases to meet the applicable eligibility requirements.  The FRB may also impose corrective capital and/or managerial requirements on the financial holding company and may require divestiture of the holding company’s depository institutions if the deficiencies persist.  Federal regulations also provide that if any depository institution controlled by a financial holding company fails to maintain a satisfactory rating under the Community Reinvestment Act, the FRB must prohibit the financial holding company and its subsidiaries from engaging in any activities other than those permissible for bank holding companies.


 
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Federal Reserve System Regulation
Because the Company is a bank holding company, it is subject to regulatory capital requirements and required by the FRB to, among other things, maintain cash reserves against its deposits.  The Bank is under similar capital requirements administered by the OCC as discussed below.  FRB policy has historically required a bank holding company to act as a source of financial and managerial strength to its subsidiary banks.  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) codifies this historical policy as a statutory requirement.  To the extent the Bank is in need of capital, the Company could be expected to provide additional capital, including borrowings from the FRB for such purpose.  Both the Company and the Bank are subject to extensive supervision and regulation, which focus on, among other things, the protection of depositors’ funds.

The FRB also regulates the national supply of bank credit in order to influence general economic conditions.  These policies have a significant influence on overall growth and distribution of loans, investments and deposits, and affect the interest rates charged on loans or paid for deposits.

Fluctuations in interest rates, which may result from government fiscal policies and the monetary policies of the FRB, have a strong impact on the income derived from loans and securities, and interest paid on deposits and borrowings.  While the Company and the Bank strive to model various interest rate changes and adjust our strategies for such changes, the level of earnings can be materially affected by economic circumstances beyond their control.

The Office of Comptroller of the Currency Regulation
The Bank is supervised and regularly examined by the OCC.  The various laws and regulations administered by the OCC affect the Company’s practices such as payment of dividends, incurring debt, and acquisition of financial institutions and other companies.  It also affects the Bank’s business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and the location of its offices.  The OCC generally prohibits a depository institution from making any capital distributions, including the payment of a dividend, or paying any management fee to its parent holding company if the depository institution would become undercapitalized due to the payment.  Undercapitalized institutions are subject to growth limitations and are required to submit a capital restoration plan to the OCC.  The Bank is well capitalized under regulatory standards administered by the OCC.  For additional information on our capital requirements see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Shareholders’ Equity” and Note P to the Financial Statements.

Federal Home Loan Bank
The Bank is a member of the FHLB, which provides a central credit facility primarily for member institutions for home mortgage and neighborhood lending.  The Bank is subject to the rules and requirements of the FHLB, including the purchase of shares of FHLB activity-based stock in the amount of 4.5% of the dollar amount of outstanding advances and FHLB capital stock in an amount equal to the greater of $1,000 or the sum of 0.15% of the mortgage-related assets held by the Bank based upon the previous year-end financial information.  The Bank was in compliance with the rules and requirements of the FHLB at December 31, 2015.

Deposit Insurance
Deposits of the Bank are insured up to the applicable limits by the Deposit Insurance Fund (“DIF”) and are subject to deposit insurance assessments to maintain the DIF.  The Dodd-Frank Act permanently increased the maximum amount of deposit insurance to $250,000 per deposit category, per depositor, per institution.  A depository institution’s DIF assessment is calculated by multiplying its assessment rate by the assessment base, which is defined as the average consolidated total assets less the average tangible equity of the depository institution.  The initial base assessment rate is based on its capital level and supervisory ratings (its “CAMEL ratings”), certain financial measures to assess an institution’s ability to withstand asset related stress and funding related stress and, in some cases, additional discretionary adjustments by the FDIC to reflect additional risk factors.

In October 2010, the FDIC adopted a DIF restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act.  At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.  FDIC insurance expense totaled $4.0 million, $3.9 million and $3.8 million in 2015, 2014 and 2013, respectively.
 
Under the Federal Deposit Insurance Act, if the FDIC finds that an institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, the FDIC may determine that such violation or unsafe or unsound practice or condition require the termination of deposit insurance.


 
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Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
On July 21, 2010, the Dodd-Frank Act was signed into law, which resulted in significant changes to the banking industry.  The provisions that have received the most public attention have been those that apply to financial institutions larger than the Company; however, the Dodd-Frank Act does contain numerous other provisions that affect all banks and bank holding companies and impacts how the Company and the Bank handle their operations.  The Dodd-Frank Act requires various federal agencies, including those that regulate the Company and the Bank, to promulgate new rules and regulations and to conduct various studies and reports for Congress.  The federal agencies have either completed or are in the process of completing these rules and regulations and have been given significant discretion in drafting such rules and regulations.  Several of the provisions of the Dodd-Frank Act may have the consequence of increasing the Bank’s expenses, decreasing its revenues, and changing the activities in which it chooses to engage.  The specific impact of the Dodd-Frank Act on the Company’s current activities or new financial activities the Company may consider in the future, the Company’s financial performance, and the markets in which the Company operates depends on the manner in which the relevant agencies continue to develop and implement the required rules and regulations and the reaction of market participants to these regulatory developments.

Pursuant to FRB regulations mandated by the Dodd-Frank Act, effective October 1, 2011, interchange fees on debit card transactions are limited to a maximum of $.21 per transaction plus 5 basis points of the transaction amount.  A debit card issuer may recover an additional one cent per transaction for fraud prevention purposes if the issuer complies with certain fraud-related requirements prescribed by the FRB.  Issuers that, together with their affiliates, have less than $10 billion in assets, such as the Company, are exempt from the debit card interchange fee standards.  The FRB also adopted requirements in the final rule that issuers include two unaffiliated networks for routing debit transactions that are applicable to the Company and the Bank.

The final rules issued by the FRB, SEC, OCC, FDIC, and Commodity Futures Trading Commission implementing Section 619 of the Dodd-Frank Act (commonly known as the Volcker Rule) prohibit insured depository institutions and companies affiliated with insured depository institutions from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account.  The final rules also impose limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds.  Banking entities with less than $10 billion in total consolidated assets, which generally have very little or no involvement in prohibited proprietary trading or investment activities in covered funds, do not have any compliance obligations under the final rule if they do not engage in any covered activities other than trading in certain government, agency, State or municipal obligations.

The CFPB rules implementing Section 1073 of the Dodd-Frank Act create a comprehensive new system of consumer protections for remittance transfers sent by consumers in the United States to individuals and businesses in foreign countries.  The amendments provide new protections, including disclosure requirements, and error resolution and cancellation rights, to consumers who send remittance transfers to other consumers or businesses in a foreign country.  The Bank has adopted policies and procedures to comply with the final foreign remittance transfer rules.

The scope and impact of many of the Dodd-Frank Act’s provisions will continue to be determined over time, including as final regulations are issued and become effective.  As a result, the Company cannot predict the ultimate impact of the Dodd-Frank Act on the Company or the Bank at this time, including the extent to which it could increase costs or limit the Company’s ability to pursue business opportunities in an efficient manner, or otherwise adversely affect its business, financial condition and results of operations.  Nor can the Company predict the impact or substance of other future legislation or regulation.  However, it is expected that they at a minimum will increase the Company’s and the Bank’s operating and compliance costs.  As rules and regulations continue to be implemented or issued, the Company may need to dedicate additional resources to ensure compliance, which may increase its costs of operations and adversely impact its earnings.

Capital Requirements
The Company and the Bank are required to comply with applicable capital adequacy standards established by the federal banking agencies.  The risk-based capital standards that were applicable to the Company and the Bank through December 31, 2014 were based on the 1988 Capital Accord, known as Basel I (“Basel I”), of the Basel Committee on Banking Supervision (the “Basel Committee”).  However, in July 2013, the FRB, the OCC and the FDIC approved final rules (the “New Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations.  These rules went into effect for the Company and the Bank on January 1, 2015, subject to phase-in periods for certain components.

The New Capital Rules implement the Basel Committee’s December 2010 capital framework (known as “Basel III”) for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act.  The New Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the previous U. S. Basel I risk-based capital rules.  The New Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions regulatory capital ratios and replace the Basel I risk-weighting approach, with a more risk-sensitive one based, in part, on the standardized approach set forth in “Basel II”.  The New Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the Federal banking agencies’ rules.
 
 
 
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The New Capital Rules, among other things: (i) introduces as a new capital measure “Common Equity Tier 1,” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified revised requirements, (iii) defines CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expands the scope of the deductions from and adjustments to capital as compared to existing regulations.  Under the New Capital Rules, the most common form of Additional Tier 1 capital is non-cumulative perpetual preferred stock, and the most common form of Tier 2 capital is subordinated notes and a portion of the allowance for loan and lease losses, in each case, subject to the New Capital Rules specific requirements.
Under the New Capital Rules, the minimum capital rations as of January 1, 2015 are as follows:
  
4.5% CET1 to total risk-weighted assets;
●  
6.0% Tier 1 capital (CET1 plus Additional Tier 1 capital) to total risk-weighted assets;
●  
8.0% Total capital (Tier 1 Capital plus Tier 2 capital) to total risk-weighted assets;
●  
4.0% Tier 1 capital to total adjusted quarterly average assets (known as “leverage ratio”)
 
Beginning in 2016, the New Capital Rules will require the Company and the Bank to maintain a “capital conservation buffer” composed entirely of CET1. When it is fully phased-in by the beginning of 2019, banking organizations will be required to maintain a minimum capital conservation buffer of 2.5% (CET1 to Total risk-weighted assets), in addition to the minimum risk-based capital ratios. Therefore, to satisfy both the minimum risk-based capital ratios and the capital conservation buffer, a banking organization will be required to maintain the following: (i) CET1 to total risk-weighted assets of at least 7%, (ii) Tier 1 capital to total risk-weighted assets of at least 8.5%, and (iii) Total capital (Tier 1 capital plus Tier 2 capital) to total risk-weighted assets of at least 10.5% by January 1, 2019, upon full phase-in of the capital conservation buffer. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions that do not maintain a capital conservation buffer of 2.5% or more will face constraints on dividends, common share repurchases and incentive compensation based on the amount of the shortfall.

The New Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under the general Basel I risk based capital rules, the effects of accumulated other comprehensive income or loss items included in shareholders' equity (for example, marks-to-market of securities held in the available for sale portfolio) were reversed for the purposes of determining regulatory capital. Under the New Capital Rules, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banks, including the Company and the Bank, were permitted to, and in the case of the Company and the Bank they did, make a one-time permanent election to continue to exclude these items.

Consistent with the section 171 of the Dodd-Frank Act, the New Capital Rules allow certain bank holding companies to include certain hybrid securities, such as trust preferred securities, in Tier 1 capital if they had less than $15 billion in assets as of December 31, 2009 and the securities were issued before May 19, 2010.  Accordingly, the trust preferred securities classified as long-term debt on the Company’s balance sheet will be included as Tier 1 capital while they are outstanding, unless the Company completes an acquisition of a depository institution holding company that did not meet this criteria, or are acquired by such an organization, after January 1, 2014, at which time they would be subject to the stated phase-out requirements of the New Capital Rules and would be included as Tier 2 capital.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and will be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

With respect to the Bank, the New Capital Rules also revise the prompt corrective action (“PCA”) regulations established pursuant to Section 38 of the Federal Deposit Insurance Act, by (i) introducing a CET1 ratio requirement for each capital category other than critically undercapitalized, with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each capital category, with the minimum Tier 1 capital ratio for well-capitalized status being 8.0% (as compared to the current 6.0%); and (iii) eliminating the current provision that allows certain highly-rated banking organizations to maintain a 3.0% leverage ratio and still be adequately capitalized. The New Capital Rules do not change the Total risk-based PCA capital requirement for any capital category.


 
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The New Capital Rules prescribe a new standardized approach for risk weighted-assets that expands the risk-weight categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the asset. The new risk-weight categories generally range from 0% for U.S. government and agency securities, to 1250% for certain securitized exposures, and result in higher risk weights for a variety of asset categories. The standardized approach requires financial institutions to transition assets that are 90 days or more past due or on nonaccrual from their original risk weight to 150 percent.  Additionally, loans designated as high volatility commercial real estate (“HVCRE”) are assigned a risk-weighting of 140 percent.

Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company's net income and return on equity. The current requirements and the Company's actual capital levels are detailed in Note P of “Notes to Consolidated Financial Statements” filed in Part II, Item 8, “Financial Statements and Supplementary Data.”

Consumer Protection Laws
In connection with its banking activities, the Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy.  These laws include the Equal Credit Opportunity Act, GLB Act, the Fair Credit Reporting Act (“FCRA”), the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”), Electronic Funds Transfer Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Dodd-Frank Act, the Real Estate Settlement Procedures Act, the Secure and Fair Enforcement for Mortgage Licensing Act (“SAFE”), and various state law counterparts.

The Dodd-Frank Act created the CFPB with broad powers to supervise and enforce consumer protection laws, including laws that apply to banks in order to prohibit unfair, deceptive or abusive practices.  The CFPB has examination authority over all banks and savings institutions with more than $10 billion in assets.  Because the Company is below this threshold, the OCC continues to exercise primary examination authority over the Bank with regard to compliance with federal consumer protection laws and regulations.  The Dodd-Frank Act weakens the federal preemption rules that have been applicable to national banks and gives attorney generals for the states certain powers to enforce federal consumer protection laws.  Further, under the Dodd-Frank Act, it is unlawful for any provider of consumer financial products or services to engage in any unfair, deceptive, or abusive acts or practice (“UDAAP”).  A violation of the consumer protection and privacy laws, and in particular UDAAP, could have serious legal, financial, and reputational consequences.

In addition, the GLB Act requires all financial institutions to adopt privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties and establishes procedures and practices to protect customer data from unauthorized access.  In addition, the FCRA, as amended by the FACT Act, includes provisions affecting the Company, the Bank, and their affiliates, including provisions concerning obtaining consumer reports, furnishing information to consumer reporting agencies, maintaining a program to prevent identity theft, sharing of certain information among affiliated companies, and other provisions.  The FACT Act requires persons subject to FCRA to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available.  The FRB and the Federal Trade Commission have extensive rulemaking authority under the FACT Act, and the Company and the Bank are subject to the rules that have been created under the FACT Act, including rules regarding limitations on affiliate marketing and implementation of programs to identify, detect and mitigate certain identity theft red flags.  The Bank is also subject to data security standards and data breach notice requirements issued by the OCC and other regulatory agencies.  The Bank has created policies and procedures to comply with these consumer protection requirements.

The CFPB issued the final rules implementing the ability-to-repay and qualified mortgage (QM) provisions of the Truth in Lending Act, as amended by the Dodd-Frank Act (the “QM Rule”).  The ability-to-repay provision requires creditors to make reasonable, good faith determinations that borrowers are able to repay their mortgages before extending the credit based on a number of factors and consideration of financial information about the borrower derived from reasonably reliable third-party documents. Under the Dodd-Frank Act and the QM Rule, loans meeting the definition of “qualified mortgage” are entitled to a presumption that the lender satisfied the ability-to-repay requirements.  The presumption is a conclusive presumption/safe harbor for loans meeting the QM requirements, and a rebuttable presumption for higher-priced loans meeting the QM requirements.  The definition of a “qualified mortgage” incorporates the statutory requirements, such as not allowing negative amortization or terms longer than 30 years. The QM Rule also adds an explicit maximum 43% debt-to-income ratio for borrowers if the loan is to meet the QM definition, though some mortgages that meet government-sponsored enterprises, Federal Housing Administration, and Veterans Administration underwriting guidelines may, for a period not to exceed seven years, meet the QM definition without being subject to the 43% debt-to-income limits.  The Bank has created policies and procedures to comply with these consumer protection requirements.


 
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USA Patriot Act
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) imposes obligations on U.S. financial institutions, including banks and broker-dealer subsidiaries, to implement policies, procedures and controls which are reasonably designed to detect and report instances of money laundering and the financing of terrorism.  In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.  The USA Patriot Act also encourages information-sharing among financial institutions, regulators, and law enforcement authorities by providing an exemption from the privacy provisions of the GLB Act for financial institutions that comply with the provision of the Act.  Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences for the institution.  The Company has approved policies and procedures that are designed to comply with the USA Patriot Act and its regulations.

Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others administrated by the Treasury’s Office of Foreign Assets Control (“OFAC”).  The OFAC administered sanctions can take many different forms; however, they generally contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons).  Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC.  Failure to comply with these sanctions could have serious legal, financial, and reputational consequences.

Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) implemented a broad range of corporate governance, accounting and reporting reforms for companies that have securities registered under the Securities Exchange Act of 1934, as amended.  In particular, the Sarbanes-Oxley Act established, among other things: (i) new requirements for audit and other key Board of Directors committees involving independence, expertise levels, and specified responsibilities; (ii) additional responsibilities regarding the oversight of financial statements by the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) the creation of an independent accounting oversight board for the accounting industry; (iv) new standards for auditors and the regulation of audits, including independence provisions which restrict non-audit services that accountants may provide to their audit clients; (v) increased disclosure and reporting obligations for the reporting company and its directors and executive officers including accelerated reporting of company stock transactions; (vi) a prohibition of personal loans to directors and officers, except certain loans made by insured financial institutions on non-preferential terms and in compliance with other bank regulator requirements; and (vii) a range of new and increased civil and criminal penalties for fraud and other violations of the securities laws.

Electronic Fund Transfer Act
A federal banking rule under the Electronic Fund Transfer Act prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machines and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions.  The new rule does not govern overdraft fees on the payment of checks and certain other forms of bill payments.

Community Reinvestment Act of 1977
Under the Community Reinvestment Act of 1977 (“CRA”), the Bank is required to help meet the credit needs of its communities, including low- and moderate-income neighborhoods.  Although the Bank must follow the requirements of CRA, it does not limit the Bank’s discretion to develop products and services that are suitable for a particular community or establish lending requirements or programs.  In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibits discrimination in lending practices.  The Bank’s failure to comply with the provisions of the CRA could, at a minimum, result in regulatory restrictions on its activities and the activities of the Company.  The Bank’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions against it by its regulators as well as other federal regulatory agencies and the Department of Justice.  The Bank’s latest CRA rating was “Satisfactory”.

The Bank Secrecy Act
The Bank Secrecy Act (“BSA”) requires all financial institutions, including banks and securities broker-dealers, to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism.  The BSA includes a variety of recordkeeping and reporting requirements (such as cash and suspicious activity reporting), as well as due diligence/know-your-customer documentation requirements.  The Company has established an anti-money laundering program and taken other appropriate measures in order to comply with BSA requirements.
 
 
 
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Item 1A. Risk Factors

There are risks inherent in the Company’s business.  The material risks and uncertainties that management believes affect the Company are described below.  Adverse experience with these could have a material impact on the Company’s financial condition and results of operations.

Changes in interest rates affect our profitability, assets and liabilities.

The Company’s income and cash flow depends to a great extent on the difference between the interest earned on loans and investment securities, and the interest paid on deposits and borrowings.  Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB.  Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (1) our ability to originate loans and obtain deposits, which could reduce the amount of fee income generated, (2) the fair value of our financial assets and liabilities and (3) the average duration of the Company’s various categories of earning assets.  If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income could be adversely affected, which in turn could negatively affect our earnings.  Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.  Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on the results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the financial condition and results of operations.

The Company operates in a highly regulated environment and may be adversely affected by changes in laws and regulations.

The Company and its subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern nearly every aspect of its operations.  The Company, as a bank holding company, is subject to regulation by the FRB and its banking subsidiary is subject to regulation by the OCC.  These regulations affect deposit and lending practices, capital levels and structure, investment practices, dividend policy and growth.  In addition, the non-bank subsidiaries are engaged in providing retirement plan administration, investment management and insurance brokerage services, which industries are also heavily regulated at both a state and federal level.  Such regulators govern the activities in which the Company and its subsidiaries may engage.  These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a bank, the classification of assets by a bank and the adequacy of a bank’s allowance for loan losses.  Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on the Company and its operations.  Changes to the regulatory laws governing these businesses could affect the Company’s ability to deliver or expand its services and adversely impact its operating and financial condition.

For example, the Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes based upon the performance of, and ultimate government intervention in, the financial services sector.  To date, not all the rules required or expected to be implemented under the Dodd-Frank Act have been adopted and many of the rules that have been adopted are subject to interpretation or clarification.  The implications of the Dodd-Frank Act for the Company’s businesses continue to depend to a large extent on the implementation of the legislation by the FRB and other agencies as well as how market practices and structures change in response to the requirements of the Dodd-Frank Act.  All of these changes in regulations could subject the Company, among other things, to additional costs and limit the types of financial services and products it can offer and/or increase the ability of non-banks to offer competing financial services and products.

The Company’s failure to comply with laws, regulations or policies could result in civil or criminal sanctions and money penalties by state and federal agencies, and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations.  See “Supervision and Regulation” for more information about the regulations to which the Company is subject.


 
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If the Company’s total consolidated assets were to reach $10 billion, it would become subject to additional regulation and increased supervision.

The Dodd-Frank Act imposes additional regulatory requirement on institutions with $10 billion or more in assets.  The Company had $8.6 billion in assets as of December 31, 2015.  Additional growth that results in the Company having assets of $10 billion or more would subject the Company to the following; (1) supervision, examination and enforcement by the CFPB with respect to consumer financial protection laws, (2) regulatory stress testing requirements, whereby the Company would be required to conduct an annual stress test using assumptions for baseline, adverse and severely adverse scenarios, (3) a modified methodology for calculating FDIC insurance assessments and potentially higher assessment rates as a result of institutions with $10 billion or more in assets being required to bear a greater portion of the cost of raising the reserve ratio to 1.35% as required by the Dodd-Frank Act, (4) limitations on interchange fees for debit card transactions, (5) heightened compliance standards under the Volcker Rule, and (6) enhanced supervision as a larger financial institution.  The imposition of these regulatory requirements and increased supervision may require additional commitment of financial resources to regulatory compliance and may increase the Company’s cost of operations.  Further, the results of the stress testing process may lead the Company to retain additional capital or alter the mix of its capital components.

The Company may be subject to more stringent capital requirements.

As discussed above, Basel III and the Dodd-Frank Act require the federal banking agencies to establish stricter risk-based capital requirements and leverage limits for banks and bank holding companies.  Under the legislation, the federal banking agencies are required to develop capital requirements that address systemically-risky activities.  The capital rules must address, at a minimum, risks arising from significant volumes of activity in derivatives, securities products, financial guarantees, securities borrowing and lending and repurchase agreements; concentrations in assets for which reported values are based on models; and concentrations in market share for any activity that would substantially disrupt financial markets if the institutions were forced to unexpectedly cease the activity.  These requirements, and any other new regulations, could adversely affect the Company’s ability to pay dividends, or could require it to reduce business levels or to raise capital, including in ways that may adversely affect its results of operations or financial condition.

Regional economic factors may have an adverse impact on the Company’s business.

The Company’s main markets are located in the states of New York and Pennsylvania.  Most of the Company’s customers are individuals and small and medium-sized businesses which are dependent upon the regional economy.  Accordingly, the local economic conditions in these areas have a significant impact on the demand for the Company’s products and services as well as the ability of the Company’s customers to repay loans, the value of the collateral securing loans and the stability of the Company’s deposit funding sources.  A prolonged economic downturn in these markets could negatively impact the Company.

The Company is subject to a variety of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, which may adversely affect the Company’s business and results of operations.

The Company is exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees, or operational errors, including clerical or record keeping errors or those resulting from faulty or disabled computer or telecommunications systems or disclosure of confidential proprietary information of its customers.  Negative public opinion can result from actual or alleged conduct in any number of activities, including lending practices, sales practices, customer treatment, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Company’s ability to attract and keep customers and can expose the Company to litigation and regulatory action. Actual or alleged conduct by the Company can result in negative public opinion about its business.

If personal, nonpublic, confidential, or proprietary information of customers in the Company’s possession were to be mishandled or misused, the Company could suffer significant regulatory consequences, reputational damage, and financial loss. Such mishandling or misuse could include, for example, if such information were erroneously provided to parties who are not permitted to have the information, either by fault of its systems, employees, or counterparties, or where such information is intercepted or otherwise inappropriately taken by third parties.


 
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Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. The Company’s necessary dependence upon automated systems to record and process transactions and the large transaction volumes may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.  The Company also may be subject to disruptions of our operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability. The Company is further exposed to the risk that external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees) and to the risk that business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in a diminished ability to operate the Company’s business, potential liability to clients, reputational damage, and regulatory intervention, which could adversely affect our business, financial condition, and results of operations, perhaps materially.

The financial services industry is highly competitive and creates competitive pressures that could adversely affect the Company’s revenue and profitability.

The financial services industry in which the Company operates is highly competitive.  The Company competes not only with commercial and other banks and thrifts, but also with insurance companies, mutual funds, hedge funds, securities brokerage firms and other companies offering financial services in the U.S., globally and over the Internet.  The Company competes on the basis of several factors, including capital, access to capital, revenue generation, products, services, transaction execution, innovation, reputation and price.  Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a broad range of financial services have been acquired by or merged into other firms.  These developments could result in the Company’s competitors gaining greater capital and other resources, such as a broader range of products and services and geographic diversity.  The Company may experience pricing pressures as a result of these factors and as some of its competitors seek to increase market share by reducing prices or paying higher rates of interest on deposits.  Finally, technological change is influencing how individuals and firms conduct their financial affairs and changing the delivery channels for financial services, with the result that the Company may have to contend with a broader range of competitors including many that are not located within the geographic footprint of its banking office network.

Conditions in the insurance market could adversely affect the Company’s earnings.

Revenue from insurance fees and commissions could be negatively affected by fluctuating premiums in the insurance markets or other factors beyond the Company’s control.  Other factors that affect insurance revenue are the profitability and growth of the Company’s clients, the renewal rate of the current insurance policies, continued development of new product and services as well as access to new markets.  The Company’s insurance revenues and profitability may also be adversely affected by new laws and regulatory developments impacting the healthcare and insurance markets.

The allowance for loan losses may be insufficient.

The Company’s business depends on the creditworthiness of its customers.  The Company reviews the allowance for loan losses quarterly for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due loans and nonperforming assets.  If the Company’s assumptions prove to be incorrect, the Company’s allowance for loan losses may not be sufficient to cover losses inherent in the Company’s loan portfolio, resulting in additions to the allowance.  Material additions to the allowance would materially decrease its net income.  It is possible that over time the allowance for loan losses will be inadequate to cover credit losses in the portfolio because of unanticipated adverse changes in the economy, market conditions or events adversely affecting specific customers, industries or markets.

Changes in the equity markets could materially affect the level of assets under management and the demand for other fee-based services.

Economic downturns could affect the volume of income from and demand for fee-based services.  Revenue from the wealth management and benefit plan administration businesses depends in large part on the level of assets under management and administration.  Market volatility, that can lead customers to liquidate investments as well as lower asset values, can reduce the level of assets under management and administration and thereby decrease the Company’s investment management and administration revenues.


 
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Mortgage banking income may experience significant volatility.

Mortgage banking income is highly influenced by the level and direction of mortgage interest rates, and real estate and refinancing activity.  In lower interest rate environments, the demand for mortgage loans and refinancing activity will tend to increase.  This has the effect of increasing fee income, but could adversely impact the estimated fair value of the Company’s mortgage servicing rights as the rate of loan prepayments increase.  In higher interest rate environments, the demand for mortgage loans and refinancing activity will generally be lower.  This has the effect of decreasing fee income opportunities.

The Company depends on dividends from its banking subsidiary for cash revenues, but those dividends are subject to restrictions.

The ability of the Company to satisfy its obligations and pay cash dividends to its shareholders is primarily dependent on the earnings of and dividends from the subsidiary bank.  However, payment of dividends by the bank subsidiary is limited by dividend restrictions and capital requirements imposed by bank regulations.  The ability to pay dividends is also subject to the continued payment of interest that the Company owes on its subordinated junior debentures.  As of December 31, 2015, the Company had $102 million of subordinated junior debentures outstanding.  The Company has the right to defer payment of interest on the subordinated junior debentures for a period not exceeding 20 quarters, although the Company has not done so to date.  If the Company defers interest payments on the subordinated junior debentures, it will be prohibited, subject to certain exceptions, from paying cash dividends on the common stock until all deferred interest has been paid and interest payments on the subordinated junior debentures resumes.

The risks presented by acquisitions could adversely affect the Company’s financial condition and result of operations.

The business strategy of the Company includes growth through acquisition.  Any other future acquisitions will be accompanied by the risks commonly encountered in acquisitions.  These risks include among other things: obtaining timely regulatory approval, the difficulty of integrating operations and personnel, the potential disruption of our ongoing business, the inability of the Company’s management to maximize its financial and strategic position, the inability to maintain uniform standards, controls, procedures and policies, and the impairment of relationships with employees and customers as a result of changes in ownership and management.  Further, the asset quality or other financial characteristics of a company may deteriorate after the acquisition agreement is signed or after the acquisition closes.

A portion of the Company’s loan portfolio is acquired and was not underwritten by the Company at origination.

At December 31, 2015, 13% of the loan portfolio was acquired and was not underwritten by the Company at origination, and therefore is not necessarily reflective of the Company’s historical credit risk experience. The Company performed extensive credit due diligence prior to each acquisition and marked the loans to fair value upon acquisition, with such fair valuation considering expected credit losses that existed at the time of acquisition. Additionally, the Company evaluated the expected cash flows of these loans on a quarterly basis. However, there is a risk that credit losses could be larger than currently anticipated, thus adversely affecting earnings.

The Company may be required to record impairment charges related to goodwill, other intangible assets and the investment portfolio.

The Company may be required to record impairment charges in respect to goodwill, other intangible assets and the investment portfolio.  Numerous factors, including lack of liquidity for resale of certain investment securities, absence of reliable pricing information for investment securities, the economic condition of state and local municipalities, adverse changes in the business climate, adverse actions by regulators, unanticipated changes in the competitive environment or a decision to change the operations or dispose of an operating unit could have a negative effect on the investment portfolio, goodwill or other intangible assets in future periods.

The Company’s financial statements are based, in part, on assumptions and estimates, which, if conditions change, could cause unexpected losses in the future.

Pursuant to accounting principles generally accepted in the United States, the Company is required to use certain assumptions and estimates in preparing its financial statements, including in determining credit loss reserves, mortgage repurchase liability and reserves related to litigation, among other items.  Certain of the Company’s financial instruments, including available-for-sale securities and certain loans, among other items, require a determination of their fair value in order to prepare the Company’s financial statements.  Where quoted market prices are not available, the Company may make fair value determinations based on internally developed models or other means which ultimately rely to some degree on management judgment.  Some of these and other assets and liabilities may have no direct observable price levels, making their valuation particularly subjective, as they are based on significant estimation and judgment.  In addition, sudden illiquidity in markets or declines in prices of certain loans and securities may make it more difficult to value certain balance sheet items, which may lead to the possibility that such valuations will be subject to further change or adjustment.  If assumptions or estimates underlying the Company’s financial statements are incorrect, it may experience material losses.
 
 
 
16 of 105

 
 
Financial services companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, the Company may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. The Company may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on business and, in turn, the Company’s financial condition and results of operations.

The Company’s information systems may experience an interruption or security breach.

The Company relies heavily on communications and information systems to conduct its business.  The Company may be the subject of sophisticated and targeted attacks intended to obtain unauthorized access to assets or confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means.  Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s online banking system, its general ledger, and its deposit and loan servicing and origination systems.  Furthermore, if personal, confidential or proprietary information of customers or clients in the Company’s possession were to be mishandled or misused, the Company could suffer significant regulatory consequences, reputational damage and financial loss.  Such mishandling or misuse could include circumstances where, for example, such information was erroneously provided to parties who are not permitted to have the information, either by fault of the Company’s systems, employees, or counterparties, or where such information was intercepted or otherwise inappropriately taken by third parties.  The Company has policies and procedures designed to prevent or limit the effect of the possible failure, interruption or security breach of its information systems; however, any such failure, interruption or security breach could adversely affect the Company’s business and results of operations through loss of assets or by requiring it to expend significant resources to correct the defect, as well as exposing the Company to customer dissatisfaction and civil litigation, regulatory fines or penalties or losses not covered by insurance.

The Company is exposed to fraud in many aspects of the services and products that it provides.

The Company offers a wide variety of products and services.  When account credentials and other access tools are not adequately protected, risks and potential costs may increase.  As (a) sales of these services and products expand, (b) those who are committing fraud become more sophisticated and more determined, and (c) banking services and product offerings expand, the Company’s operational losses could increase.

The Company may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company has exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In addition, credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse effect on the Company’s financial condition and results of operations.
 
The Company is or may become involved in lawsuits, legal proceedings, information-gathering requests, investigations, and proceedings by governmental agencies or other parties that may lead to adverse consequences.

As a participant in the financial services industry, many aspects of the Company’s business involve substantial risk of legal liability. The Company and its subsidiaries have been named or threatened to be named as defendants in various lawsuits arising from its or its subsidiaries’ business activities (and in some cases from the activities of acquired companies). In addition, from time to time, the Company is, or may become, the subject of governmental and self-regulatory agency information-gathering requests, reviews, investigations and proceedings and other forms of regulatory inquiry, including by bank regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to delays in or prohibition to acquire other companies, significant penalties, including monetary penalties, damages, adverse judgments, settlements, fines, injunctions, restrictions on the way in which the Company conducts its business, or reputational harm.
 
Although the Company establishes accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, the Company does not have accruals for all legal proceedings where it faces a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, amounts accrued may not represent the ultimate loss to the Company from the legal proceedings in question. Thus, the Company’s ultimate losses may be higher than the amounts accrued for legal loss contingencies, which could adversely affect the Company’s financial condition and results of operations.
 
 
 
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The Company continually encounters technological change and the failure to understand and adapt to these changes could have a negative impact on the business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological changes affecting the financial services industry could have a material adverse impact on the Company’s financial condition and results of operations.

Trading activity in the Company’s common stock could result in material price fluctuations.

The market price of the Company’s common stock may fluctuate significantly in response to a number of other factors including, but not limited to:
●  
Changes in securities analysts’ expectations of financial performance;
●  
Volatility of stock market prices and volumes;
●  
Incorrect information or speculation;
●  
Changes in industry valuations;
●  
Variations in operating results from general expectations;
●  
Actions taken against the Company by various regulatory agencies;
●  
Changes in authoritative accounting guidance by the Financial Accounting Standards Board or other regulatory agencies;
●  
Changes in general domestic economic conditions such as inflation rates, tax rates, unemployment rates, oil prices, labor and healthcare cost trend rates, recessions, and changing government policies, laws and regulations; and
●  
Severe weather, natural disasters, acts of war or terrorism and other external events.

The Company’s ability to attract and retain qualified employees is critical to the success of its business, and failure to do so may have a materially adverse effect on the Company’s performance.

The Company’s employees are its most important resource, and in many areas of the financial services industry, competition for qualified personnel is intense.  The imposition on the Company or its employees of certain existing and proposed restrictions or taxes on executive compensation may adversely affect the Company’s ability to attract and retain qualified senior management and employees.  If the Company is unable to continue to retain and attract qualified employees, the Company’s performance, including its competitive position, could have a materially adverse effect.

Item 1B. Unresolved Staff Comments
None

Item 2.  Properties

The Company’s primary headquarters are located at 5790 Widewaters Parkway, Dewitt, New York, which is leased.  In addition, the Company has 225 properties located in the counties identified in the table on page 6, of which 148 are owned and 77 are under lease arrangements.  With respect to the Banking segment, the Company operates 194 full-service branches and six facilities for back office banking operations.  With respect to the Employee Benefit Services segment, the Company operates nine customer service facilities, all of which are leased.  With respect to the All Other segment, the Company operates 15 customer service facilities, 11 of which are leased and four are owned.  Some properties contain tenant leases or subleases.

Real property and related banking facilities owned by the Company at December 31, 2015 had a net book value of $80.8 million and none of the properties were subject to any material encumbrances.  For the year ended December 31, 2015, the Company paid $5.4 million of rental fees for facilities leased for its operations.  The Company believes that its facilities are suitable and adequate for the Company’s current operations.


 
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Item 3.  Legal Proceedings

The Company and its subsidiaries are subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. As of December 31, 2015, management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company or its subsidiaries will be material to the Company’s consolidated financial position. On at least a quarterly basis the Company assesses its liabilities and contingencies in connection with such legal proceedings. For those matters where it is probable that the Company will incur losses and the amounts of the losses can be reasonably estimated, the Company records an expense and corresponding liability in its consolidated financial statements. To the extent the pending or threatened litigation could result in exposure in excess of that liability, the amount of such excess is not currently estimable. The range of reasonably possible losses for matters where an exposure is not currently estimable or considered probable, beyond the existing recorded liabilities, is between $0 and $1 million in the aggregate. Although the Company does not believe that the outcome of pending litigation will be material to the Company’s consolidated financial position, it cannot rule out the possibility that such outcomes will be material to the consolidated results of operations for a particular reporting period in the future.

The United States District Court for the Middle District of Pennsylvania issued an order on July 14, 2015 preliminarily approving the settlement reached in the first of two related class actions, which were commenced on October 30, 2013 and May 23, 2014, respectively.  The two related cases allege, on behalf of similarly situated class members, that notices provided by the Bank in connection with the repossession of automobiles failed to comply with certain requirements of the Pennsylvania and New York Uniform Commercial Code and related statutes.  In accordance with mediation occurring in September 2014, the settlement provides for establishment of a settlement fund of $2.8 million in exchange for release of all claims of the class members covered by these actions. A litigation settlement charge of $2.8 million with respect to the settlement of the class actions was previously recorded in the third quarter of 2014.  The settlement is subject to the Court’s final approval which is expected to occur in the first quarter of 2016.   

Item 4.  Mine Safety Disclosures

Not Applicable

Item 4A. Executive Officers of the Registrant

The executive officers of the Company and the Bank who are elected by the Board of Directors are as follows:

Name
Age
Position
Mark E. Tryniski
 
55
Director, President and Chief Executive Officer.  Mr. Tryniski assumed his current position in August 2006. He served as Executive Vice President and Chief Operating Officer from March 2004 to July 2006 and as the Treasurer and Chief Financial Officer from June 2003 to March 2004. He previously served as a partner in the Syracuse office of PricewaterhouseCoopers LLP.
Scott Kingsley
 
51
Executive Vice President and Chief Financial Officer.  Mr. Kingsley joined the Company in August 2004 in his current position.  He served as Vice President and Chief Financial Officer of Carlisle Engineered Products, Inc., a subsidiary of the Carlisle Companies, Inc., from 1997 until joining the Company.
Brian D. Donahue
 
59
Executive Vice President and Chief Banking Officer.  Mr. Donahue assumed his current position in August 2004.  He served as the Bank’s Chief Credit Officer from February 2000 to July 2004 and as the Senior Lending Officer for the Southern Region of the Bank from 1992 until June 2004.
George J. Getman
59
Executive Vice President and General Counsel.  Mr. Getman assumed his current position in January 2008.  Prior to joining the Company, he was a partner with Bond, Schoeneck & King, PLLC and served as corporate counsel to the Company.


 
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Part II

Item 5.  Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock has been trading on the New York Stock Exchange under the symbol “CBU” since December 31, 1997.  Prior to that, the common stock traded over-the-counter on the NASDAQ National Market under the symbol “CBSI” beginning on September 16, 1986. There were 43,875,778 shares of common stock outstanding on January 31, 2016, held by approximately 3,785 registered shareholders of record. The following table sets forth the high and low closing prices for the common stock, and the cash dividends declared with respect thereto, for the periods indicated.  The prices do not include retail mark-ups, mark-downs or commissions.

 
High
Low
Quarterly
Year / Qtr
Price
Price
Dividend
2015
     
4th
$43.13
$36.70
$0.31
3rd
$39.80
$34.21
$0.31
2nd
$38.52
$34.58
$0.30
1st
$37.71
$33.60
$0.30
       
2014
     
4th
$38.99
$32.84
$0.30
3rd
$37.29
$33.59
$0.30
2nd
$39.91
$35.27
$0.28
1st
$39.43
$33.74
$0.28
       
 
The Company has historically paid regular quarterly cash dividends on its common stock, and declared a cash dividend of $0.31 per share for the first quarter of 2016.  The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the common stock, as well as to make payment of regularly scheduled dividends on the trust preferred stock when due, subject to the Company's need for those funds.  However, because substantially all of the funds available for the payment of dividends by the Company are derived from the subsidiary Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations.
 
 
 
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The following graph compares cumulative total shareholders returns on the Company’s common stock over the last eight fiscal years to the S&P 600 Commercial Banks Index, the NASDAQ Bank Index, the S&P 500 Index, and the KBW Regional Banking Index. Total return values were calculated as of December 31 of each indicated year assuming a $100 investment on December 31, 2010 and reinvestment of dividends.
 


 
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Equity Compensation Plan Information
The following table provides information as of December 31, 2015 with respect to shares of common stock that may be issued under the Company’s existing equity compensation plans.
 
     
Number of Securities
 
Number of
 
Remaining Available
 
Securities to be
 
For Future Issuance
 
Issued upon
Weighted-average
Under Equity
 
Exercise of
Exercise Price
Compensation Plans
 
Outstanding
of Outstanding
(excluding securities
 
Options, Warrants
Options, Warrants
reflected in the first
Plan Category
and Rights (1)
and Rights
column)
Equity compensation plans approved by security holders:
     
  1994 Long-term Incentive Plan
25,768
$17.41
5,701
  2004 Long-term Incentive Plan
1,838,147
24.80
708,168
  2014 Long-term Incentive Plan
351,697
29.38
647,472
Equity compensation plans not approved by security holders
0
0
0
     Total
2,215,612
$25.46
1,361,341
 
 (1) The number of securities includes 246,311 shares of unvested restricted stock.
 
Stock Repurchase Program
At its December 2014 meeting, the Board approved a stock repurchase program authorizing the repurchase, at the discretion of senior management, of up to 2,000,000 shares of the Company’s common stock, in accordance with securities laws and regulations, during  a twelve-month period starting January 1, 2015.  There were 265,230 treasury stock purchases in 2015.  At its December 2015 meeting, the Board approved a new stock repurchase program authorizing the repurchase, at the discretion of senior management, of up to 2,200,000 shares of the Company’s common stock, in accordance with securities laws and regulations, during a twelve-month period starting January 1, 2016.  Any repurchased shares will be used for general corporate purposes, including those related to stock plan activities.  The timing and extent of repurchases will depend on market conditions and other corporate considerations as determined at the Company’s discretion.

The following table presents stock purchases made during the fourth quarter of 2015:

Issuer Purchases of Equity Securities
 
 
Total
 
Total Number of Shares
 
 
Number of
Average
Purchased as Part of
Maximum Number of Shares
Period
Shares
Purchased
Price Paid
Per share
Publicly Announced
Plans or Programs
That May Yet be Purchased
Under the Plans or Programs
October 1-31, 2015 (1)
50
$41.54
0
1,734,770
November 1-30, 2015
0
0
0
1,734,770
December 1-31, 2015
0
0
0
1,734,770
  Total
50
$41.54
   
         
(1) The common shares repurchased were acquired by the Company in connection with the satisfaction of tax withholding obligations
     on stock issued pursuant to the employee benefit plan.  These shares were not repurchased as part of the publicly announced
     repurchase plan described above.

Item 6.  Selected Financial Data

The following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five-year period ended December 31, 2015.  The historical information set forth under the captions “Income Statement Data” and “Balance Sheet Data” is derived from the audited financial statements while the information under the captions “Capital and Related Ratios”, “Selected Performance Ratios” and “Asset Quality Ratios” for all periods is unaudited.  All financial information in this table should be read in conjunction with the information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K.


 
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SELECTED CONSOLIDATED FINANCIAL INFORMATION

 
Years Ended December 31,
(In thousands except per share data and ratios)
2015
2014
2013
2012
2011
Income Statement Data:
         
Loan interest income
$187,743
$185,527
$188,197
$192,710
$192,981
Investment interest income
71,879
70,693
75,962
88,690
77,988
Interest expense
11,202
11,792
26,065
50,976
61,556
  Net interest income
248,420
244,428
238,094
230,424
209,413
Provision for loan losses
6,447
7,178
7,992
9,108
4,736
Noninterest income
123,303
119,020
108,748
98,955
89,283
Gain (loss) on investment securities & early retirement of long-term borrowings, net
(4)
0
(6,568)
291
(61)
Acquisition expenses, litigation settlement, and contract termination charges
7,037
2,923
2,181
8,247
4,831
Other noninterest expenses
226,018
223,657
219,074
203,510
185,541
Income before income taxes
132,217
129,690
111,027
108,805
103,527
     Net income
91,230
91,353
78,829
77,068
73,142
Diluted earnings per share
2.19
2.22
1.94
           1.93
2.01
           
Balance Sheet Data:
         
Cash equivalents
$21,931
$12,870
$11,288
$84,415
$203,082
Investment securities
2,847,940
2,512,974
2,218,725
2,818,527
2,151,370
Loans, net of unearned discount
4,801,375
4,236,206
4,109,083
3,865,576
3,471,025
Allowance for loan losses
(45,401)
(45,341)
(44,319)
(42,888)
(42,213)
Intangible assets
484,146
386,973
390,499
387,134
360,564
Total assets
8,552,669
7,489,440
7,095,864
7,496,800
6,488,275
Deposits
6,873,474
5,935,264
5,896,044
5,628,039
4,795,245
Borrowings
403,446
440,122
244,010
830,134
830,329
Shareholders’ equity
1,140,647
987,904
875,812
902,778
774,583
           
Capital and Related Ratios:
         
Cash dividends declared per share
$1.22
$1.16
$1.10
$1.06
$1.00
Book value per share
26.06
24.24
21.66
22.78
20.94
Tangible book value per share (1)
15.90
15.63
12.80
13.72
11.85
Market capitalization (in millions)
1,748
1,554
1,604
1,084
1,028
Tier 1 leverage ratio
10.32%
9.96%
9.29%
8.40%
8.38%
Total risk-based capital to risk-adjusted assets
18.08%
18.75%
17.57%
16.20%
15.51%
Tangible equity to tangible assets (1)
8.59%
8.92%
7.68%
7.62%
7.12%
Dividend payout ratio
55.5%
51.6%
56.0%
54.3%
49.3%
Period end common shares outstanding
43,775
40,748
40,431
39,626
36,986
Diluted weighted-average shares outstanding
41,605
41,232
40,726
39,927
36,454
           
Selected Performance Ratios:
         
Return on average assets
1.17%
1.23%
1.09%
1.08%
1.18%
Return on average equity
8.87%
9.65%
9.04%
8.82%
10.36%
Net interest margin
3.73%
3.91%
3.91%
3.88%
4.07%
Noninterest income/operating income (FTE)
32.1%
31.4%
30.0%
28.6%
28.4%
Efficiency ratio (2)
57.9%
57.9%
59.3%
57.4%
57.6%
           
Asset Quality Ratios:
         
Allowance for loan losses/total loans
0.95%
1.07%
1.08%
1.11%
1.22%
Nonperforming loans/total loans
0.50%
0.56%
0.54%
0.75%
0.85%
Allowance for loan losses/nonperforming loans
190%
190%
201%
147%
144%
Loan loss provision/net charge-offs
101%
117%
122%
108%
94%
Net charge-offs/average loans
0.15%
0.15%
0.17%
0.23%
0.15%
 
 
 (1) The tangible book value per share and the tangible equity to tangible asset ratio excludes goodwill and identifiable intangible assets, adjusted for deferred tax liabilities generated from tax deductible goodwill.  The ratio is not a financial measurement required by accounting principles generally accepted in the United States of America.  However, management believes such information is useful to analyze the relative strength of the Company’s capital position and is useful to investors in evaluating Company performance.
 
 
(2) Efficiency ratio provides a ratio of operating expenses to operating income.  It excludes intangible amortization, acquisition expenses, litigation settlement and contract termination charges from expenses and gains and losses on investment securities & early retirement of long-term borrowings from income while adding a fully-taxable equivalent adjustment. The efficiency ratio is not a financial measurement required by accounting principles generally accepted in the United States of America.  However, the efficiency ratio is used by management in its assessment of financial performance specifically as it relates to noninterest expense control.  Management also believes such information is useful to investors in evaluating Company performance.
 
 
 
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Item 7.                       Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) primarily reviews the financial condition and results of operations of the Company for the past two years, although in some circumstances a period longer than two years is covered in order to comply with SEC disclosure requirements or to more fully explain long-term trends.  The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Information beginning on page 22 and the Company’s Consolidated Financial Statements and related notes that appear on pages 51 through 90.  All references in the discussion to the financial condition and results of operations refer to the consolidated position and results of the Company and its subsidiaries taken as a whole.

Unless otherwise noted, all earnings per share (“EPS”) figures disclosed in the MD&A refer to diluted EPS; interest income, net interest income, and net interest margin are presented on a fully tax-equivalent (“FTE”) basis, which is a non-GAAP measure.  The term “this year” and equivalent terms refer to results in calendar year 2015, “last year” and equivalent terms refer to calendar year 2014, and all references to income statement results correspond to full-year activity unless otherwise noted.

This MD&A contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company.  These forward-looking statements involve certain risks and uncertainties.  Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set herein under the caption “Forward-Looking Statements” on page 49.

Critical Accounting Policies

As a result of the complex and dynamic nature of the Company’s business, management must exercise judgment in selecting and applying the most appropriate accounting policies for its various areas of operations.  The policy decision process not only ensures compliance with the latest generally accepted accounting principles (“GAAP”), but also reflects management’s discretion with regard to choosing the most suitable methodology for reporting the Company’s financial performance.  It is management’s opinion that the accounting estimates covering certain aspects of the business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity in the selection process.  These estimates affect the reported amounts of assets and liabilities and disclosures of revenues and expenses during the reporting period.  Actual results could differ from these estimates.  Management believes that the critical accounting estimates include:

●  
Acquired loans – Acquired loans are initially recorded at their acquisition date fair values based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

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

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

●  
Allowance for loan losses – The allowance for loan losses reflects management’s best estimate of probable loan losses in the Company’s loan portfolio. Determination of the allowance for loan losses is inherently subjective.  It requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, appraisal values of underlying collateral for collateralized loans, and the amount of estimated losses on pools of homogeneous loans which is based on historical loss experience and consideration of current economic trends, all of which may be susceptible to significant change.


 
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●  
Investment securities – Investment securities are classified as held-to-maturity, available-for-sale, or trading.  The appropriate classification is based partially on the Company’s ability to hold the securities to maturity and largely on management’s intentions with respect to either holding or selling the securities.  The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities.  Unrealized gains and losses on available-for-sale securities are recorded in accumulated other comprehensive income or loss, as a separate component of shareholders’ equity, and do not affect earnings until realized.  The fair values of investment securities are generally determined by reference to quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments, or a discounted cash flow model using market estimates of interest rates and volatility.  Investment securities with significant declines in fair value are evaluated to determine whether they should be considered other-than-temporarily impaired (“OTTI”).  An unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security.  The credit loss component of an other-than-temporary impairment write-down is recorded in earnings, while the remaining portion of the impairment loss is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying debt security, and it is not more likely than not that the Company will be required to sell the debt security prior to recovery of the full value of its amortized cost basis.  During 2013, the Company sold certain held-to-maturity securities and consequently did not use the held-to-maturity classification in 2014 or 2015.

●  
Retirement benefits - The Company provides defined benefit pension benefits to eligible employees and post-retirement health and life insurance benefits to certain eligible retirees.  The Company also provides deferred compensation and supplemental executive retirement plans for selected current and former employees.  Expense under these plans is charged to current operations and consists of several components of net periodic (benefit) cost based on various actuarial assumptions regarding future experience under the plans, including, but not limited to, discount rate, rate of future compensation increases, mortality rates, future health care costs and the expected return on plan assets.

●  
Provision for income taxes – The Company is subject to examinations from various taxing authorities.  Such examinations may result in challenges to the tax return treatment applied by the Company to specific transactions.  Management believes that the assumptions and judgments used to record tax-related assets or liabilities have been appropriate.  Should tax laws change or the taxing authorities determine that management’s assumptions were inappropriate, an adjustment may be required which could have a material effect on the Company’s results of operations.

●  
Intangible assets – As a result of acquisitions the Company carries goodwill and identifiable intangible assets.  Goodwill represents the cost of acquired companies in excess of the fair value of net assets at the acquisition date.  Goodwill is evaluated at least annually, or when business conditions suggest impairment may have occurred.  Should an impairment occur goodwill will be reduced to its carrying value through a charge to earnings.  Core deposits and other identifiable intangible assets are amortized to expense over their estimated useful lives.  The determination of whether or not impairment exists is based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows.  It also requires them to select a discount rate that reflects the current return requirements of the market in relation to present risk-free interest rates, required equity market premiums, and company-specific performance and risk metrics, all of which are susceptible to change based on changes in economic and market conditions and other factors.  Future events or changes in the estimates used to determine the carrying value of goodwill and identifiable intangible assets could have a material impact on the Company’s results of operations.

A summary of the accounting policies used by management is disclosed in Note A, “Summary of Significant Accounting Policies”, starting on page 56.

Executive Summary

The Company’s business philosophy is to operate as a community bank with local decision-making, principally in non-metropolitan markets, providing a broad array of banking and financial services to retail, commercial, and municipal customers.

The Company’s core operating objectives are: (i) grow the branch network, primarily through a disciplined acquisition strategy and certain selective de novo expansions, (ii) build profitable loan and deposit volume using both organic and acquisition strategies, (iii) increase the noninterest component of total revenue through development of banking-related fee income, growth in existing financial services business units, and the acquisition of additional financial services and banking businesses, and (iv) utilize technology to deliver customer-responsive products and services and to improve efficiencies.

Significant factors reviewed by management to evaluate achievement of the Company’s operating objectives and its operating results and financial condition include, but are not limited to:  net income and earnings per share; return on assets and equity; net interest margins; noninterest revenues; noninterest expenses; asset quality; loan and deposit growth; capital management; performance of individual banking and financial services units; performance of specific product lines and customers; liquidity and interest rate sensitivity; enhancements to customer products and services and their underlying performance characteristics; technology advancements; market share; peer comparisons; and the performance of acquisition and integration activities.
 
 
 
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The Company reported net income and earnings per share for the year ended December 31, 2015 that were 0.1% and 1.4%, respectively, below the prior year amounts.  The decrease in net income was due to increased operating expenses, higher acquisition expenses, as well as a higher effective tax rate.  Offsetting these items were the positive effects of an increase in net interest income, higher noninterest income, a lower provision for loan losses and the absence of the $2.8 million litigation settlement charge recorded in 2014.  The litigation settlement charge in 2014 pertained to the settlement of a class action lawsuit involving the sufficiency of consumer notice requirements for certain of the Company’s collateral recovery activities.  Also impacting the earnings per share were approximately 0.2 million more weighted-average diluted shares outstanding due to the stock consideration issued in the Oneida acquisition.
 
The Company experienced year-over-year growth in average interest-earning assets, reflective of the decision to pre-invest during the first half of 2015 the anticipated liquidity received from the Oneida transaction, as well as solid organic loan growth and the addition of loans from the Oneida transaction in December 2015.  Average deposits increased in 2015 as compared to 2014, reflective of organic growth in core deposits and the impact of the Oneida transaction, partially offset by a reduction in time deposit balances.  Average external borrowings in 2015 increased from 2014 reflective of the Company’s pre-investment strategy.

Asset quality in 2015 remained stable and favorable in comparison to averages for peer financial organizations.  As compared to the end of 2014, loan delinquency and nonperforming ratios at December 31, 2015 were improved while the total net loan charge-off ratio remained consistent year-over-year.

Net Income and Profitability

Net income for 2015 was $91.2 million, a decrease of $0.1 million, or 0.1%, from 2014’s earnings.  Earnings per share for 2015 were $2.19, down $0.03, or 1.4%, from 2014’s results.  The 2015 results included $7.0 million, or $0.11 per share, of acquisition expenses related to the Oneida acquisition that was completed in December of 2015.  The 2014 results included a $2.8 million ($0.05 per share) litigation settlement charge.
 
 
Net income for 2014 was $91.4 million, an increase of $12.5 million, or 15.9%, from 2013’s earnings, while earnings per share for 2014 were $2.22, up $0.28 from 2013’s results.  The 2014 results included the aforementioned litigation settlement charge.  The 2013 results included a $6.6 million, or $0.12 per share, net loss on the sale of certain investment securities and debt extinguishments, as well as $2.2 million, or $0.04 per share, of acquisition expenses related to the B of A branch acquisition in December of 2013.

Table 1: Condensed Income Statements

 
Years Ended December 31,
(000’s omitted, except per share data)
2015
2014
2013
2012
2011
Net interest income
$248,420
$244,428
$238,094
$230,424
$209,413
Provision for loan losses
6,447
7,178
7,992
9,108
4,736
(Loss)/Gain on sales of investment securities, net
(4)
0
80,768
291
30
Loss on debt extinguishments
0
0
87,336
0
91
Noninterest income
123,303
119,020
108,748
98,955
89,283
Acquisition expenses, litigation settlement, and contract termination charges
7,037
2,923
2,181
8,247
4,831
Other noninterest expenses
226,018
223,657
219,074
203,510
185,541
Income before taxes
132,217
129,690
111,027
108,805
103,527
Income taxes
40,987
38,337
32,198
31,737
30,385
Net income
$91,230
$91,353
$78,829
$77,068
$73,142
           
Diluted weighted average common shares outstanding
41,605
41,232
40,726
39,927
36,454
Diluted earnings per share
$2.19
$2.22
$1.94
$1.93
$2.01


 
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The Company operates in three business segments: Banking, Employee Benefit Services, and All Other.  The banking segment provides a wide array of lending and depository-related products and services to individuals, businesses, and municipal enterprises.  In addition to general liquidity and intermediation services, the Banking segment provides treasury management solutions, capital financing products, and payment processing services.  Employee Benefit Services, consisting of BPAS and its subsidiaries, provides on a national basis: employee benefit trust services; collective investment fund, retirement plan and VEBA & HRA/HSA plan administration services; actuarial services; and healthcare consulting services.  BPAS serves approximately 4,000 organizations and 400,000 plan participants, holds $19 billion in assets under custody, employs 270 professionals, and operates from 10 offices located in New York, New Jersey, Pennsylvania, Texas and Puerto Rico.  The All Other segment is comprised of wealth management services and insurance services.  Wealth management services activities include trust services provided by the personal trust unit of CBNA, investment products and services provided by CISI and OWM, and asset advisory services provided by Nottingham.  The insurance services activities include the offerings of personal and commercial property insurance and other risk management products and services provided by OneGroup and CBNA Insurance.  For additional financial information on the Company’s segments, refer to Note U – Segment Information in the Notes to Consolidated Financial Statements.

The primary factors explaining 2015 earnings performance are discussed in the remaining sections of this document and are summarized as follows:

BANKING
●  
Net interest income increased $3.9 million, or 1.6%.  This was the result of a $348.4 million increase in average earning assets, partially offset by a decrease in the net interest margin of 18 basis points.  Average loans grew $131.3 million due to growth in all portfolios.  Also contributing to the growth in interest-earning assets was a $217.2 million increase in the average book value of investments, including cash equivalents, due to the investment during the first two quarters of 2015 of the anticipated liquidity from the Oneida transaction.  Average interest-bearing deposits increased $78.6 million due to the Oneida acquisition and organic core deposit growth, partially offset by the continued trend of declining time deposit balances.  Average borrowings increased $108.4 million, or 26.7%, as compared to the prior year, primarily due to the additional leverage undertaken with regard to the early investing of Oneida liquidity.

●  
The loan loss provision of $6.4 million decreased $0.7 million, or 10.2%, from the prior year level.  Net charge-offs of $6.4 million were $0.2 million more than 2014.  This resulted in an annual net charge-off ratio (net charge-offs / total average loans) of 0.15%, which was consistent with the prior year.  Nonperforming loans as a percentage of total loans and nonperforming assets as a percentage of loans and other real estate owned, decreased six basis points and seven basis points, respectively, compared to December 31, 2014 levels, and remain well below averages for the Company’s peers.  Additional information on trends and policy related to asset quality is provided in the asset quality section on pages 40 through 44.

●  
Excluding net loss on sales of investment securities, banking noninterest income for 2015 of $57.7 million decreased by $0.9 million from 2014’s level primarily due to lower utilization of overdraft protection-related deposit services.  Fees from deposit services in 2015 were nearly identical to the prior year while other banking-related income was lower.  Additionally, 2015 mortgage banking revenue increased $0.2 million.
 
●  
Total banking noninterest expenses, including acquisition expenses, litigation settlement, and contract termination charges increased $2.8 million, or 1.5%, in 2015 to $184.7 million, primarily reflective of higher acquisition-related costs and continued investment in technology and data processing.  Excluding acquisition expenses and litigation settlement, banking noninterest expenses decreased $1.3 million, or 0.7%, due in part to the branch consolidations during the second half of 2014.

EMPLOYEE BENEFIT SERVICES
●  
Employee benefit services noninterest income for 2015 of $46.8 million was an increase of $3.1 million, or 7.1%, from the prior year level, benefiting from new and expanded customer relationships as well as additional service offerings.

●  
Employee benefit services noninterest expenses for 2015 totaled $35.7 million.  This represented an increase from 2014 of $2.2 million, or 6.7%, and was attributable to the additional resources needed to support a higher revenue base.

ALL OTHER (WEALTH MANAGEMENT AND INSURANCE SERVICES)
●  
Wealth management and insurance services noninterest income for 2015 was $21.0 million, an increase of $2.3 million, or 12.5%, from the prior year level.  The increase was primarily due to the addition of OneGroup from the Oneida acquisition.

●  
Wealth management and insurance services noninterest expenses of $14.8 million increased $1.8 million, or 13.4%, from 2014 primarily due to the addition of OneGroup and increased personnel costs associated with growth initiatives.

 
 
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Selected Profitability and Other Measures

Return on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows:
 
Table 2: Selected Ratios

 
2015
2014
2013
Return on average assets
1.17%
1.23%
1.09%
Return on average equity
8.87%
9.65%
9.04%
Dividend payout ratio
55.5%
51.6%
56.0%
Average equity to average assets
13.16%
12.75%
12.11%

As displayed in Table 2, both the return on average assets and the return on average equity ratios decreased in 2015 as compared to 2014.  The decreases in return on average assets and return on average equity were the result of a decrease in net income, due primarily to acquisition charges related to the Oneida transaction, while both average assets and average equity increased.  Both return ratios increased in 2014 as compared to 2013.  The increase in return on average assets was the result of a significant increase in net income accomplished without a significant additional investment in assets.  The increase in return on average equity was the result of the increase in net income outpacing the increase in average shareholders’ equity.

The dividend payout ratio for 2015 increased 3.9 percentage points from 2014 as net income decreased slightly from 2014 while dividends declared increased 7.5%, as a result of a 5.2% increase in the dividends declared per share in addition to an increase in the shares outstanding due to the shares issued in conjunction with the employee stock plan during 2015 and 2014 and the Oneida transaction. The dividend payout ratio for 2014 decreased 4.4 percentage points from 2013 as net income increased at a 15.9% rate from 2013 while dividends declared increased at a slower 6.8% rate, resulting from a 5.5% increase in the dividends declared per share and additional shares issued in conjunction with the employee stock plan.

The average equity to average assets ratio continued to increase as the growth in common shareholders’ equity outpaced the growth in assets.  During 2015 average equity increased at a rate of 8.6% while average assets increased at a rate of 5.3%, while the year 2014 saw average equity rise 8.5% and average assets grew 3.1% in comparison to 2013.

Net Interest Income

Net interest income is the amount that interest and fees on earning assets (loans, investments and interest-bearing cash) exceeds the cost of funds, which consists primarily of interest paid to the Company's depositors and interest on external borrowings.  Net interest margin is the difference between the yield on earning assets and the cost of interest-bearing funds as a percentage of earning assets.

As disclosed in Table 3, net interest income (with nontaxable income converted to a fully tax-equivalent basis) totaled $260.8 million in 2015, up $0.9 million, or 0.3%, from the prior year.  This is a result of a $348.4 million, or 5.2%, increase in average interest-earning assets and a two basis point decrease in the average rate on interest-bearing liabilities, partially offset by a 20 basis point decline in the average yield on interest-earning assets and a $187.1 million increase in average interest-bearing liabilities.  As reflected in Table 4, the favorable impacts of the lower rate on interest-bearing liabilities ($1.0 million) and the increase in interest-earning assets ($13.9 million) were partially offset by a $13.6 million unfavorable impact from the decrease in the yield on interest-earning assets and the increase in interest-bearing liabilities ($0.4 million).

The 2015 net interest margin decreased 18 basis points to 3.73% from the 3.91% reported in 2014.  This result was attributable to the 20 basis point decrease in earning-asset yield, partially offset by the two basis point decrease in the cost of interest-bearing liabilities.  The yield on loans decreased seven basis points in 2015 to 4.42% from 4.49% in 2014, due to new loan volume carrying lower yields in the current low-rate environment than the loans maturing or being prepaid, a proportionally higher mix of shorter term adjustable rate business loans, as well as promotional rates and shorter blended maturity terms on new originations or fixed rate home equity loans.  The yield on investments, including cash equivalents, decreased from 3.42% in 2014 to 3.05% in 2015.  This is reflective of the purchase of lower-yielding Treasury securities at various times throughout the last 24 months, as well as the effect certain changes in state tax rates had on the fully tax-equivalent adjustment.  The cost of interest-bearing liabilities was 0.21% during 2015 as compared to 0.23% for 2014.  The decreased rate primarily reflects the larger proportion of funding being provided by lower-rate overnight borrowings.  Additionally, the proportion of customer deposits in higher cost time and money market deposits declined 2.5 percentage points in 2015, while the percentage of deposits in non-interest bearing and lower cost checking and savings accounts correspondingly increased.
 
 

 
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The net interest margin in 2014 was consistent with the 3.91% in 2013.  This was the result of a 23 basis point decrease in earning-asset yields, offset by a 28 basis point decrease in the cost of interest-bearing liabilities and a $173.0 million increase in average interest-earning assets.  The yield on loans decreased 29 basis points in 2014 to 4.49% from 4.78% in 2013, due to new loan volume carrying lower yields in the current low-rate environment than the loans maturing or being prepaid, as well as certain adjustable rate loans re-pricing downward.  The yield on investments, including cash equivalents, decreased from 3.58% in 2013 to 3.42% in 2014.  This is reflective of the balance sheet restructuring program completed in the first half of 2013 and the sale of the Company’s collateralized debt obligation (“CDO”) portfolio and certain Treasury securities at the end of 2013 and the purchase of lower-yielding Treasury securities at various times throughout the last 24 months.  The cost of interest-bearing liabilities decreased to 0.23% during 2014 as compared to 0.51% for 2013.  The decreased rate reflects the extinguishment of the higher rate FHLB borrowings in 2013 resulting in the use of lower rate overnight borrowings to cover current liquidity needs, as well as continued disciplined deposit pricing, whereby interest rates on essentially all deposit account categories were lowered throughout 2013 and 2014 in response to market conditions.  Additionally, the proportion of customer deposits in higher cost time deposits declined 2.4 percentage points in 2014, while the percentage of deposits in non-interest bearing and lower cost checking accounts correspondingly increased.

As shown in Table 3, total FTE-basis interest income increased by $0.3 million, or 0.1%, in 2015 in comparison to 2014. Table 4 indicates that a higher average earning-asset balance created $13.9 million of incremental interest income.  As mentioned previously, this was mostly offset by a lower average yield on earning assets that had a negative impact of $13.6 million.  Average loans increased a total of $131.3 million, or 3.2%, in 2015, a result of organic and acquired growth in all loan portfolios, with the Oneida acquisition accounting for $24.9 million of the total growth.  FTE-basis loan interest income and fees increased $2.8 million, or 1.5%, in 2015 as compared to 2014, attributable to the higher average balances, partially offset by a seven basis point decrease in loan yields.

Investment interest income (FTE basis) in 2015 was $2.5 million, or 2.9%, lower than the prior year as a result of a 37 basis point decrease in the average investment yield from 3.42% to 3.05% and changes in the state tax structures. These were partially offset by a $217.2 million, or 8.7%, higher average book basis balance (including cash equivalents) for 2015 versus the prior year that was driven by investment purchases made in the first half of the year in anticipation of liquidity to be received from the Oneida acquisition.  During 2015, market interest rates continued to be low, and as a result, cash flows from higher rate maturing investments were reinvested at lower interest rates.  The investments purchased during 2015 had a weighted average yield of 2.46%.

Total interest income decreased by $7.5 million, or 2.7%, in 2014 from 2013’s level.  Table 4 indicates that a lower average yield on earning assets had a negative impact of $14.8 million.  This was partially offset by a higher average earning-asset balance that created $7.3 million of incremental interest income.  Average loans increased a total of $202.3 million in 2014, the result of organic growth in the consumer indirect, business lending, consumer direct, and consumer mortgage portfolios, partially offset by a small decline in the home equity loan portfolio.  FTE-basis loan interest income and fees decreased $2.4 million, or 1.3%, in 2014 as compared to 2013, attributable to the 29 basis point decrease in loan yields, partially offset by higher average balances.  On an FTE basis, investment interest income, including interest on average cash equivalents, of $85.0 million in 2014, was $5.0 million, or 5.6%, lower than the prior year as a result of a 16 basis point decrease in the yield as well as a decline in the size of the portfolio.  Average investments for 2014, including cash equivalents, were $29.3 million lower than 2013, reflective of the balance sheet restructuring program completed in the first half of 2013 and the sale of the Company’s CDO portfolio and certain Treasury securities at the end of 2013, partially offset by the purchase of Treasury securities at various times throughout the last 24 months.

Total interest expense decreased by $0.6 million, or 5.0%, to $11.2 million in 2015.  As shown in Table 4, lower interest rates on interest-bearing liabilities resulted in decreasing interest expense by $1.0 million, while higher external borrowing balances accounted for $0.4 million more interest expense.  Interest expense as a percentage of average earning assets for 2015 decreased two basis points to 0.16%.  The rate on interest-bearing deposits decreased two basis points to 0.15% as rates have declined or held steady in all interest-bearing categories throughout 2015 and 2014, as well as the change in deposit mix to a lower proportion of time deposit products.  The rate on external borrowings decreased seven basis points to 0.82% in 2015 primarily due to lower-rate FHLB overnight borrowings being a larger proportion of the balance.  Total average funding (deposits and borrowings) in 2015 increased $289.9 million, or 4.6%.  Average deposits increased $181.5 million, of which approximately $53.1 million was attributable to the Oneida acquisition, with the remaining $128.4 million attributable to organic deposit growth.  Consistent with the Company’s funding mix objective and customers' unwillingness to commit to less liquid instruments in the low rate environment, average core deposit balances increased $288.8 million, while time deposits declined $107.3 million year-over-year.  Average external borrowings increased $108.4 million in 2015 as compared to the prior year, reflective of the funding of the pre-investment of expected liquidity from the Oneida acquisition.


 
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Total interest expense decreased by $14.3 million to $11.8 million in 2014 as compared to 2013.  Lower interest rates on deposits and external borrowing balances resulted in nearly all of this decrease, while lower external borrowing balances were offset by higher deposit balances.  Interest expense as a percentage of average earning assets decreased by 22 basis points to 0.18%.  The rate on interest-bearing deposits decreased seven basis points to 0.17% due to the reduction of rates in all interest-bearing categories throughout 2013 and 2014 and the change in deposit mix with a lower proportion of time deposits products.  The rate on external borrowings decreased 181 basis points to 0.89% in 2014 primarily due to the balance sheet restructuring undertaken in the first half of 2013 that retired $501.6 million of higher rate FHLB borrowings and by the initiative in the second and third quarter of 2013 to use lower rate short-term borrowings to pre-invest a portion of the liquidity expected from the branch acquisition in the fourth quarter of 2013, and to fund additional liquidity needs in 2014.  In 2014, total average funding increased $126.2 million or 2.0%.  Average deposits increased $287.9 million, of which approximately $240.9 million was attributable to the B of A branch acquisition while the remaining $47.0 million was attributable to organic deposit growth.  Average core deposit balances increased $383.0 million, while time deposits declined $95.1 million year-over-year.  Average external borrowings decreased $161.7 million in 2014 as compared to the prior year, reflective of a full year of the effects of the restructuring program undertaken during the first half of 2013, as well as borrowings being replaced by the net liquidity provided by the branch acquisition in December 2013.

The following table sets forth information related to average interest-earning assets and interest-bearing liabilities and their associated yields and rates for the years ended December 31, 2015, 2014 and 2013.  Interest income and yields are on a fully tax-equivalent basis using marginal income tax rates of 38.3% in 2015, 38.7% in 2014 and 39.1% in 2013.  Average balances are computed by totaling the daily ending balances in a period and dividing by the number of days in that period.  Loan interest income and yields include loan fees.  Average loan balances include nonaccrual loans and loans held for sale.

Table 3: Average Balance Sheet
 
 
Year Ended December 31, 2015
 
Year Ended December 31, 2014
 
Year Ended December 31, 2013
     
Avg.
     
Avg.
     
Avg.
 
Average
 
Yield/Rate
 
Average
 
Yield/Rate
 
Average
 
Yield/Rate
(000's omitted except yields and rates) 
Balance
Interest
Paid
 
Balance
Interest
Paid
 
Balance
Interest
Paid
                       
Interest-earning assets:
                     
   Cash equivalents
$13,543
$32
0.23%
 
$9,701
$21
0.21%
 
$62,584
$159
0.25%
   Taxable investment securities (1)
2,071,095
53,282
2.57%
 
1,834,430
52,268
2.85%
 
1,806,137
56,646
3.14%
   Nontaxable investment securities (1)
617,418
29,205
4.73%
 
640,737
32,737
5.11%
 
645,464
33,242
5.15%
   Loans (net of unearned discount)(2)
4,288,091
189,507
4.42%
 
4,156,840
186,727
4.49%
 
3,954,515
189,172
4.78%
       Total interest-earning assets
6,990,147
272,026
3.89%
 
6,641,708
271,753
4.09%
 
6,468,700
279,219
4.32%
Noninterest-earning assets
824,417
     
782,195
     
732,347
   
     Total assets
$7,814,564
     
$7,423,903
     
$7,201,047
   
                       
Interest-bearing liabilities:
                     
   Interest checking, savings and money market deposits
$4,053,761
3,598
0.09%
 
$3,867,818
3,614
0.09%
 
$3,614,722
3,773
0.10%
   Time deposits
737,734
3,373
0.46%
 
845,035
4,576
0.54%
 
940,095
6,959
0.74%
   Borrowings
513,827
4,231
0.82%
 
405,411
3,602
0.89%
 
567,079
15,333
2.70%
     Total interest-bearing liabilities
5,305,322
11,202
0.21%
 
5,118,264
11,792
0.23%
 
5,121,896
26,065
0.51%
Noninterest-bearing liabilities:
                     
   Noninterest checking deposits
1,352,683
     
1,249,807
     
1,119,935
   
   Other liabilities
128,521
     
109,206
     
86,920
   
Shareholders' equity
1,028,038
     
946,626
     
872,296
   
     Total liabilities and shareholders' equity
$7,814,564
     
$7,423,903
     
$7,201,047
   
                       
Net interest earnings
 
$260,824
     
$259,961
     
$253,154
 
                       
Net interest spread
   
3.68%
     
3.86%
     
3.81%
Net interest margin on interest-earning assets
   
3.73%
     
3.91%
     
3.91%
                       
Fully tax-equivalent adjustment
 
$12,404
     
$15,533
     
$15,060
 
 
 (1) Averages for investment securities are based on historical cost and the yields do not give effect to changes in fair value that is reflected as a component of shareholders’
     equity and deferred taxes.
 (2)  Includes nonaccrual loans.  The impact of interest and fees not recognized on nonaccrual loans was immaterial.

 
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As discussed above, the change in net interest income (fully tax-equivalent basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.

Table 4: Rate/Volume
 
 
2015 Compared to 2014
 
2014 Compared to 2013
 
Increase (Decrease) Due to Change in (1)
 
Increase (Decrease) Due to Change in (1)
     
Net
     
Net
(000's omitted)
Volume
Rate
Change
 
Volume
Rate
Change
Interest earned on:
             
  Cash equivalents
$9
$2
$11
 
($115)
($23)
($138)
  Taxable investment securities
6,369
(5,355)
1,014
 
875
(5,253)
(4,378)
  Nontaxable investment securities
(1,162)
(2,370)
(3,532)
 
(243)
(262)
(505)
  Loans (net of unearned discount)
5,833
(3,053)
2,780
 
9,410
(11,855)
(2,445)
Total interest-earning assets (2)
13,897
(13,624)
273
 
7,336
(14,802)
(7,466)
               
Interest paid on:
             
  Interest checking, savings and money market deposits
170
(186)
(16)
 
253
(412)
(159)
  Time deposits
(540)
(663)
(1,203)
 
(652)
(1,731)
(2,383)
  Borrowings
925
(296)
629
 
(3,496)
(8,235)
(11,731)
Total interest-bearing liabilities (2)
420
(1,010)
(590)
 
(18)
(14,255)
(14,273)
               
Net interest earnings (2)
$13,302
($12,439)
$863
 
$6,772
$35
$6,807

 
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts
     of change in each.
 
(2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes
     of the components.

Noninterest Income

The Company’s sources of noninterest income are of three primary types: 1) general banking services related to loans, deposits and other core customer activities typically provided through the branch network and electronic banking channels (performed by CBNA); 2) employee benefit services (performed by BPAS); and 3) wealth management and insurance services, comprised of trust services (performed by the personal trust unit within CBNA), broker-dealer investment services (performed by CISI, OWM, and Carta Group), insurance products (performed by OneGroup and CBNA Insurance), and investment advisory services (performed by Nottingham).  Additionally, the Company has periodic transactions, most often net gains (losses) from the sale of investment securities and prepayment of debt instruments.

Table 5: Noninterest Income

 
Years Ended December 31,
(000's omitted except ratios)
2015
2014
2013
Employee benefit services
$45,388
$42,580
$38,596
Deposit service charges and fees
28,087
29,379
28,595
Electronic banking
22,263
21,156
18,480
Wealth management and insurance services
20,208
17,870
15,550
Other banking revenues
5,656
6,576
5,854
Mortgage banking
1,701
1,459
1,673
  Subtotal
123,303
119,020
108,748
(Loss)/gain on sales of investment securities, net
(4)
0
80,768
Loss on debt extinguishments
0
0
(87,336)
    Total noninterest income
$123,299
$119,020
$102,180
       
Noninterest income/operating income (FTE basis) (1)
32.1%
31.4%
30.0%

 
(1) For purposes of this ratio noninterest income excludes (loss)/gain on sales of
     investment securities and loss on debt extinguishments. Operating income is
     defined as net interest income on a fully-tax equivalent basis, plus noninterest
     income, excluding gain on sales of investment securities and loss on debt
     extinguishments.
 
 
 
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As displayed in Table 5, total noninterest income, excluding security losses, increased by $4.3 million, or 3.6%, to $123.3 million in 2015 as compared to 2014, comprised of growth in revenue from the Company’s financial services businesses and increased debit card-related income, partially offset by lower banking fees due to the continuing trend of lower utilization of overdraft protection programs and a decline in certain other deposit-related services.  Noninterest income, excluding security gains and losses and debt extinguishments costs, of $119.0 million for 2014 increased $10.3 million, or 9.4%, from 2013.  The increase was a result of growth in revenue from the Company’s financial services businesses, increased debit card-related income, and higher banking fees due to the B of A branch acquisition.
 
Noninterest income as a percent of operating income (FTE basis) was 32.1% in 2015, up 0.7 percentage points from the prior year.  The current year increase was due to the 3.6% increase in noninterest income mentioned above, while net interest income (FTE basis) increased at a lower rate of 0.3%.  The increase in this ratio from 2013 to 2014 of 1.4 percentage points was driven by a 9.4% increase in noninterest income, primarily the result of solid organic growth in the financial services businesses and strong growth in debit card-related income, while net interest income increased at a smaller rate of 2.7%.

The largest portion of the Company’s recurring noninterest income is the wide variety of fees earned from general banking services generally provided through the branch network and electronic banking channels, which amounted to $56.0 million in 2015, down $1.1 million, or 1.9%, from the prior year.  The decrease was driven by the continuing trend of lower utilization of overdraft protection programs and other deposit-related services as well as smaller annual dividends from retail insurance programs that more than offset the addition of new deposit relationships from both acquired and organic sources, as well as solid growth in debit card-related revenue.  Electronic banking revenue grew $1.1 million due in large part to a continued concerted effort to increase the penetration and utilization of consumer debit and credit cards.  Fees from general banking services were $57.1 million in 2014, up $4.2 million, or 7.9%, from 2013.  The increase was due to the addition of new deposit relationships from both acquired and organic sources, as well as solid growth in debit card-related revenue and the annual dividend from retail insurance programs that more than offset the continuing trend of lower utilization of overdraft protection programs and other deposit-related services.   

Residential mortgage banking income consists of realized gains or losses from the sale of residential mortgage loans and the origination of mortgage loan servicing rights, unrealized gains and losses on residential mortgage loans held for sale and related commitments, mortgage loan servicing fees, and other mortgage loan-related fee income earned on sold consumer mortgages.  In 2015, mortgage banking revenue increased $0.2 million from the revenue generated in 2014, which was down $0.2 million from 2013.  Included in 2013’s mortgage banking revenue is a net impairment recovery of $0.4 million for the fair value of the mortgage servicing rights due primarily to a decrease in the expected prepayment speed of the Company’s sold loan portfolio with servicing retained.  Residential mortgage loans sold to investors, primarily the Federal National Mortgage Association (“Fannie Mae”), in 2015 totaled $35.5 million as compared to $25.7 million and $25.2 million during 2014 and 2013, respectively.  Residential mortgage loans held for sale and recorded at fair value at December 31, 2015 and 2014 totaled $0.9 million and $1.0 million, respectively.  Realization of the unrealized gains or losses on mortgage loans held for sale and the related commitments, as well as future revenue generation from mortgage banking activities, will be dependent on market conditions and long-term interest rate trends.

As disclosed in Table 5, noninterest income from financial services (revenues from employee benefit services and wealth management and insurance services) increased $5.1 million, or 8.5%, in 2015 to $65.6 million.  In 2015, financial services revenue accounted for 53% of total noninterest income, excluding net losses on the sale of investment securities as compared to 51% in 2014.  Employee benefit services generated revenue of $45.4 million in 2015 that included growth of $2.8 million, or 6.6%, driven by a combination of new client generation and expanded service offerings.  Employee benefit services revenue in 2014 was $4.0 million higher than 2013’s results, primarily driven by a combination of new client generation, expanded service offerings, the EBS-RMSCO acquisition, and an increase in asset-based revenue.

Wealth management and insurance services revenue increased $2.3 million, or 13.1%, in 2015 primarily from the acquisition of OneGroup which increased insurance-related revenues by $1.9 million. CISI revenue increased $0.3 million with $0.6 million coming from the 2015 additions of OWM and Carta Group. Nottingham revenue increased $0.2 million, and personal trust revenue decreased $0.1 million. The improved revenue generation of the wealth management services was mostly reflective of additional resources and customers from both organic and acquired growth initiatives.  Wealth management services revenue in 2014 increased $2.3 million, or 14.9%, as compared to 2013.  Personal trust revenue increased $0.4 million, CISI revenue increased $1.6 million, Nottingham revenue increased $0.3 million, and CBNA Insurance revenue increased a nominal amount. The improved revenue generation of the wealth management services was driven by solid organic growth in trust, investment product sales and asset advisory services, as well as favorable market conditions.


 
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Assets under administration decreased $0.1 billion for the employee benefit services segment in 2015 as compared to 2014 due to lower equity market valuations.  Assets under management increased $0.9 billion for the wealth management businesses at year end 2015 as compared to one year earlier due to the addition of OWM and new client assets. Assets under administration within the Company’s employee benefit services segment increased $2.1 billion to $18.2 billion at the end of 2014 from $16.1 billion at year-end 2013, primarily as a result of additions to the collective investment fund administration business and higher equity market valuations.  Assets under management with the Company’s wealth management services segment increased $0.2 billion to $3.6 billion at the end of 2014 from $3.4 billion at year-end 2013 due to market-driven gains in equity-based assets and the addition of new client assets.

In December 2015, the Company sold $221.1 million of investment securities that were part of the Oneida acquisition, realizing a nominal amount of loss.  There were no sales of investments or debt extinguishments in 2014.  In the first half of 2013, the Company sold $648.7 million of investment securities, realizing $63.8 million of gains, and utilized the proceeds to retire FHLB borrowings of $501.6 million with $63.5 million of early extinguishment costs.  In late December 2013, in response to the uncertainties created by the announcement of the final regulations implementing the Volcker Rule, the Company sold its entire portfolio of bank CDOs, recognizing a $15.4 million loss on the sale.  In conjunction with the CDOs, the Company also extinguished $226 million of FHLB advances with $23.8 million of early extinguishment costs and sold $418 million of U.S. Treasury securities previously classified as held-to-maturity, realizing $32.4 million of gains.

Noninterest Expenses

As shown in Table 6, noninterest expenses of $233.1 million in 2015 were $6.5 million, or 2.9%, higher than 2014 and include non-recurring acquisition expenses as well as incremental operating expenses from the Oneida acquisition.  Noninterest expenses in 2014 increased $5.3 million, or 2.4%, from 2013 to $226.6 million and included a litigation settlement charge of $2.8 million and non-recurring acquisition expenses of $0.1 million, as well as incremental operating expenses from the B of A branch acquisition.

Operating expenses (excluding acquisition expenses, litigation settlement charge and amortization of intangible assets) as a percent of average assets for 2015 was 2.85%, down ten basis points from 2.95% in 2014 and 13 basis points lower than 2.98% in 2013.  The decrease in this ratio for 2015 was due to a 1.4% increase in operating expenses, primarily a result of expanded operations due to the Oneida acquisition, while average assets grew by 5.3% due to organic loan growth, investment purchases, and the Oneida acquisition.  The decrease in this ratio for 2014 was due to a 2.2% increase in operating expenses, primarily a result of expanded operations due to the B of A acquisition, while average assets grew by 3.1% due to organic loan growth.

The efficiency ratio, a performance measurement tool widely used by banks, is defined by the Company as operating expenses (excluding acquisition expenses, litigation settlement charge and intangible amortization) divided by operating income (fully tax-equivalent net interest income plus noninterest income, excluding net securities and debt gains and losses).  Lower ratios are correlated to higher operating efficiency.  In 2015, the efficiency ratio was equal to the 2014 ratio as the 1.4% increase in operating expenses, as defined above, was offset by a 1.4% increase in operating income, comprised of a 0.3% increase in net interest income and a 3.6% increase in noninterest income (excluding net securities losses).  The ratio for 2014 was 1.4 percentage points lower than the 59.3% ratio for 2013 due to a 2.2% increase in operating expenses, as defined above, being smaller than the 4.7% increase in operating income.  The increase in 2014 operating income was comprised of a 2.7% increase in net interest income and a 9.4% increase in noninterest income.

Table 6: Noninterest Expenses
 
 
Years Ended December 31,
(000's omitted)
2015
2014
2013
Salaries and employee benefits
$126,356
$123,077
$121,629
Occupancy and equipment
27,593
27,948
27,045
Data processing and communications
30,430
29,294
27,186
Amortization of intangible assets
3,663
4,287
4,469
Legal and professional fees
6,813
7,247
7,008
Office supplies and postage
6,476
6,270
6,122
Business development and marketing
7,204
7,125
6,815
FDIC insurance premiums
3,962
3,899
3,829
Acquisition expenses and litigation settlement
7,037
2,923
2,181
Other
13,521
14,510
14,971
   Total noninterest expenses
$233,055
$226,580
$221,255
       
Operating expenses(1) /average assets
2.85%
2.95%
2.98%
Efficiency ratio
57.9%
57.9%
59.3%
       
(1)  Operating expenses are total noninterest expenses excluding acquisition expenses, litigation
     settlement charges and amortization of intangible assets.
 
 
 
 
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Total salaries and employee benefits increased $3.3 million, or 2.7%, in 2015, due to the impact of annual merit increases as well as the addition of approximately 275 employees from the Oneida acquisition in December 2015 and higher pension costs, partially offset by lower incentive payments in 2015 based on the achievement of the Company’s annual business objectives.  Salaries and employee benefits increased $1.4 million, or 1.2%, in 2014 primarily due to the addition of approximately 40 employees as a result of the B of A acquisition in late 2013, as well as the impact of annual merit increases and higher incentive payments in 2014 based on the achievement of the Company’s annual business objectives, partially offset by lower pension-related costs.  Total full-time equivalent staff at the end of 2015 was 2,182 compared to 1,945 at December 31, 2014 and 1,987 at the end of 2013.

Retirement plan expense in 2015 increased $1.8 million due to higher levels of amortization of unrecognized losses, changes in actuarial assumptions, including a decrease in the discount rate from 5.0% to 4.5%, and increased participation in the Company’s 401(k) Plan.  Last year’s defined benefit retirement plan expense decreased $4.7 million from 2013 due to the strong asset performance and the increase in the actuarial assumption for liability discount rate from 3.4% to 5.0%.  The three assumptions that have the largest impact on the calculation of annual pension expense are the discount rate utilized, the rate applied to future compensation increases and the expected rate of return on plan assets.  See Note K to the financial statements for further information about the pension plan.

Total non-personnel noninterest expenses, excluding one-time acquisition expenses, and litigation settlement charges, decreased $0.9 million, or 0.9%, in 2015 as decreases in occupancy and equipment, amortization of intangible assets, legal and professional fees and other expenses were only partially offset by increases in data processing and communications and business development and marketing.  Excluding expenses related to the retail branches acquired from Oneida, non-personnel noninterest expenses as defined above declined $1.6 million as occupancy and equipment decreased $0.5 million, amortization of intangible assets decreased $0.9 million, legal and professional fees decreased $0.4 million and other expenses declined $0.8 million, partially offset by an increase in data processing and communications.  Total non-personnel noninterest expenses, excluding one-time acquisition expenses, and litigation settlement charges increased $3.1 million, or 3.2%, in 2014, and reflects the additional cost of operating an expanded franchise due to the B of A branch acquisition completed in December 2013.  Data processing and communication expenses increased $2.1 million, or 7.8%, over 2013 levels, due to the higher volume of electronic transaction processing, as well as continued investments in Company-wide technology enhancements.  Business development and marketing increased $0.3 million, or 4.6%, in 2014 and reflects the Company’s commitment to expanding its exposure and strengthening its market share.

Acquisition expenses for 2015 totaled $7.0 million and were associated with the Oneida acquisition.  Acquisition expenses and litigation settlement charges totaled $2.9 million in 2014 comprised of $0.1 million of acquisition expenses related to the EBS-RMSCO acquisition and a $2.8 million litigation settlement charge pertaining to class action lawsuits involving the sufficiency of consumer notice requirements for certain of the Company’s collateral recovery activities.  The Company contested the allegations and asserted affirmative defenses to the claims, however, the settlement the Company was able to achieve was, in its judgment, a superior outcome for the shareholders when measured against the risks and resources required for litigation.  Acquisition expenses for 2013 totaled $2.2 million and related primarily to the acquisition of the B of A branches.

The Company continually evaluates all aspects of its operating expense structure and is diligent about identifying opportunities to improve operating efficiencies.  The Company consolidated six of its branch offices during the second half of 2014 and four of its branch offices in 2013.  This realignment reduced market overlap, further strengthened its branch network, and reflects management’s focus on achieving long-term performance improvements through proactive, strategic decision making.

Income Taxes

The Company estimates its income tax expense based on the amount it expects to owe the respective taxing authorities, plus the impact of deferred tax items.  Taxes are discussed in more detail in Note I of the Consolidated Financial Statements beginning on page 73.  Accrued taxes represent the net estimated amount due or to be received from taxing authorities.  In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position.  If the final resolution of taxes payable differs from its estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

The effective tax rate for 2015 was 31.0%, compared to 29.6% in 2014, reflective of higher proportional levels of income being generated from fully taxable sources and certain legislated changes to state tax rates and structures.  The effective tax rate for 2014 was six basis points higher than the 29.0% rate reported in 2013, reflective of larger proportional levels of income from fully taxable sources.


 
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Shareholders’ Equity

Shareholders’ equity ended 2015 at $1.14 billion, up $152.7 million, or 15.5%, from one year earlier.  This increase reflects $102.2 million related to stock issued in connection with the Oneida acquisition, net income of $91.2 million, $9.8 million from the issuance of shares through employee stock plans, $16.6 million for treasury stock issued to the Company’s 401(k) benefit plan, and $4.2 million from stock-based compensation.  These increases were partially offset by common stock dividends declared of $50.6 million, an $11.5 million decrease in accumulated other comprehensive income, and treasury stock purchases of $9.1 million.  The change in other comprehensive income was comprised of a $6.9 million decrease due to changes in the unrealized gains and losses in the Company’s available-for-sale investment portfolio, due principally to the rise in long-term interest rates at the end of 2015, as well as a negative $4.6 million adjustment to the funded status of the Company’s employee retirement plans.  Excluding accumulated other comprehensive income in both 2015 and 2014, shareholders’ equity rose by $164.2 million, or 17.2%.  Shares outstanding increased by 3.0 million during the year as 2.4 million were issued in conjunction with the Oneida acquisition and 0.9 million were added through employee stock plans, partially offset by 0.3 million that were repurchased as treasury shares.

Shareholders’ equity ended 2014 at $987.9 million, up $112.1 million, or 12.8%, from one year earlier.  This increase reflects net income generation of $91.4 million, a $57.3 million increase in accumulated other comprehensive income, $9.4 million from the issuance of shares through employee stock plans, and $4.0 million from stock-based compensation.  These increases were partially offset by common stock dividends declared of $47.1 million and net treasury share purchases of $2.8 million.  The change in other comprehensive income was comprised of a $66.8 million increase in the market value adjustment (“MVA”, represents the after-tax, unrealized change in value of available-for-sale securities in the Company’s investment portfolio) due principally to a decrease in long-term interest rates, partially offset by a negative $9.6 million adjustment to the funded status of the Company’s employee retirement plans due primarily to a decrease in the discount rate used to calculated the Company’s liability related to its pension obligations at December 31, 2014 to 4.5%.  These changes in accumulated other comprehensive income contributed to net comprehensive income of $148.6 million in 2014 as compared to a net comprehensive loss of $2.1 million in 2013.  Excluding accumulated other comprehensive income in both 2014 and 2013, capital rose by $54.8 million, or 6.1%.  Shares outstanding increased by 0.3 million during the year as shares issued from employee stock plan activity exceeded share repurchase activity.

The Company’s ratio of ending Tier 1 capital to adjusted quarterly average assets (or Tier 1 leverage ratio), the basic measure for which regulators have established a 5% minimum for an institution to be considered “well-capitalized,” increased 36 basis points to end the year at 10.32%.  This was the result of an 11.8% increase in Tier 1 capital, due primarily to the shares issued for the Oneida transaction and retention of net income, while fourth quarter average net assets (excludes investment market value adjustment, and a portion of intangible assets net of related deferred tax liabilities) increased at a slower 7.9% rate.  The tangible equity-to-tangible assets ratio (a non-GAAP measure) was 8.59% at the end of 2015 versus 8.92% one year earlier.  The decrease was due to tangible assets increasing at a faster pace than tangible common shareholders’ equity, a result of acquired and organic asset growth, increasing faster than tangible capital, due in part to the intangible assets created as part of the Oneida transaction.  The Company manages organic and acquired growth in a manner that enables it to continue to maintain and grow its capital base and maintain its ability to take advantage of future strategic growth opportunities.

Cash dividends declared on common stock in 2015 of $50.6 million represented an increase of 7.5% over the prior year.  This growth was a result of the increase in outstanding shares as noted above and a $0.06 increase in dividends per share for the year. Dividends per share for 2015 of $1.22 represents a 5.2% increase from the $1.16 in 2014, a result of quarterly dividends per share being increased from $0.28 to $0.30 (a 7.1% increase) during the third quarter of 2014 and from $0.30 to $0.31 (a 3.3% increase) in the third quarter of 2015.  The 2015 increase in quarterly dividends marked the 23rd consecutive year of dividend increases for the Company.  The dividend payout ratio for this year was 55.5% compared to 51.6% in 2014, and 56.0% in 2013.  The dividend payout ratio increased during 2015 because dividends declared increased 7.5% while net income decreased at a 0.1% rate.  The payout ratio increased during 2014 because dividends declared increased 6.8% while net income increased 15.9%.

Liquidity

Liquidity risk is a measure of the Company’s ability to raise cash when needed at a reasonable cost and minimize any loss.  The Bank maintains appropriate liquidity levels in both normal operating environments as well as stressed environments.  The Company must be capable of meeting all obligations to its customers at any time and, therefore, the active management of its liquidity position remains an important management objective.  The Bank has appointed the Asset Liability Committee (“ALCO”) to manage liquidity risk using policy guidelines and limits on indicators of potential liquidity risk.  The indicators are monitored using a scorecard with three risk level limits.  These risk indicators measure core liquidity and funding needs, capital at risk and change in available funding sources.  The risk indicators are monitored using such statistics as the core basic surplus ratio, unencumbered securities to average assets, free loan collateral to average assets, loans to deposits, deposits to total funding and borrowings to total funding ratios.


 
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Given the uncertain nature of our customers' demands as well as the Company's desire to take advantage of earnings enhancement opportunities, the Company must have adequate sources of on- and off-balance sheet funds available that can be acquired in time of need.  Accordingly, in addition to the liquidity provided by balance sheet cash flows, liquidity must be supplemented with additional sources such as credit lines from correspondent banks and borrowings from the FHLB and the Federal Reserve Bank of New York (“Federal Reserve”).  Other funding alternatives may also be appropriate from time to time, including wholesale and retail repurchase agreements, large certificates of deposit and the brokered CD market.  The primary source of non-deposit funds is FHLB advances, of which $301 million was outstanding at December 31, 2015.

The Bank’s primary sources of liquidity are its liquid assets, as well as unencumbered securities that can be used to collateralize additional funding.  At December 31, 2015, the Bank had $153 million of cash and cash equivalents of which $22 million are interest-earning deposits held at the Federal Reserve, FHLB and other correspondent banks.  The Bank also had $984 million in unused FHLB borrowing capacity based on the Company’s quarter-end collateral levels.  Additionally, the Company has $1.6 billion of unencumbered securities that could be pledged at the FHLB or Federal Reserve to obtain additional funding.  There is $25 million available in unsecured lines of credit with other correspondent banks at year end.

The Company’s primary approach to measuring short-term liquidity is known as the Basic Surplus/Deficit model.  It is used to calculate liquidity over two time periods: first, the amount of cash that could be made available within 30 days (calculated as liquid assets less short-term liabilities as a percentage of average assets); and second, a projection of subsequent cash availability over an additional 60 days.  As of December 31, 2015, this ratio was 18.9% for 30-days and 18.8% for 90-days, excluding the Company's capacity to borrow additional funds from the FHLB and other sources.  There is a sufficient amount of liquidity given the Company’s internal policy requirement of 7.5%.

A sources and uses statement is used by the Company to measure intermediate liquidity risk over the next twelve months.  As of December 31, 2015, there is more than enough liquidity available during the next year to cover projected cash outflows.  In addition, stress tests on the cash flows are performed in various scenarios ranging from high probability events with a low impact on the liquidity position to low probability events with a high impact on the liquidity position.  The results of the stress tests as of December 31, 2015 indicate the Bank has sufficient sources of funds for the next year in all simulated stressed scenarios.

To measure longer-term liquidity, a baseline projection of loan and deposit growth for five years is made to reflect how liquidity levels could change over time.  This five-year measure reflects ample liquidity for loan and other asset growth over the next five years.

Though remote, the possibility of a funding crisis exists at all financial institutions.  Accordingly, management has addressed this issue by formulating a Liquidity Contingency Plan, which has been reviewed and approved by both the Company’s Board of Directors and the Company’s ALCO.  The plan addresses the actions that the Company would take in response to both a short-term and long-term funding crisis.

A short-term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly short-term funding operations.  Such a crisis should be temporary in nature and would not involve a change in credit ratings.  A long-term funding crisis would most likely be the result of drastic credit deterioration at the Company.  Management believes that both potential circumstances have been fully addressed through detailed action plans and the establishment of trigger points for monitoring such events.

 
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Intangible Assets

The changes in intangible assets by reporting segment for the year ended December 31, 2015 are summarized as follows:

Table 7: Intangible Assets

 
Balance at
     
Balance at
(000’s omitted)
December 31, 2014
Additions
Amortization
Impairment
December 31, 2015
Banking Segment
         
Goodwill
$364,495
$74,557
$0
$0
$439,052
Core deposit intangibles
10,023
2,570
2,804
0
9,789
Total Banking Segment
374,518
77,127
2,804
0
448,841
Employee Benefit Services Segment
         
Goodwill
8,019
0
0
0
8,019
Other intangibles
1,407
194
515
0
1,086
Total Employee Benefit Services Segment
9,426
194
515
0
9,105
All Other Segment
         
Goodwill
2,660
13,521
0
0
16,181
Other intangibles
369
9,994
344
0
10,019
Total All Other Segment
3,029
23,515
344
0
26,200
           
Total
$386,973
$100,836
$3,663
$0
$484,146

Intangible assets at the end of 2015 totaled $484.1 million, an increase of $97.2 million from the prior year-end due to an additional $100.6 million of intangible assets arising from the Oneida acquisition and the purchase of other intangibles amounting to $0.2 million, partially offset by $3.7 million of amortization during the year.  Intangible assets consist of goodwill and the calculated value of core deposits and customer relationships that arise from acquisitions.  Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired.  Goodwill at December 31, 2015 totaled $463.3 million, comprised of $439.1 million related to banking acquisitions and $24.2 million arising from the acquisition of financial services businesses.  Goodwill is subject to periodic impairment analysis to determine whether the carrying value of the identified businesses exceeds their fair value, which would necessitate a write-down of goodwill.  The Company completed its goodwill impairment analyses during the first quarters of 2015 and 2014 and no adjustments were necessary for the banking or financial services businesses.  The impairment analyses were based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows.  It also requires the selection of discount rates that reflect the current return characteristics of the market in relation to present risk-free interest rates, estimated equity market premiums and company-specific performance and risk indicators.  Management believes that there is a low probability of future impairment with regard to the goodwill associated with its whole-bank, branch and financial services business acquisitions.

Core deposit intangibles represent the value of acquired non-time deposits in excess of funding that could have been obtained in the capital markets.  Core deposit intangibles are amortized on either an accelerated or straight-line basis over periods ranging from eight to twenty years.  The recognition of customer relationship intangibles was determined based on a methodology that calculates the present value of the projected future net income derived from the acquired customer base.  These assets are being amortized on an accelerated basis over periods ranging from seven to twelve years.


 
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Loans

The Company’s loans outstanding, by type, as of December 31 are as follows:

Table 8: Loans Outstanding

(000's omitted)
2015
2014
2013
2012
2011
Consumer mortgage
$1,769,754
$1,613,384
$1,582,058
$1,448,415
$1,214,621
Business lending
1,497,271
1,262,484
1,260,364
1,233,944
1,226,439
Consumer indirect
935,760
833,968
740,002
647,518
556,955
Consumer direct
195,076
184,028
180,139
171,474
149,170
Home equity
403,514
342,342
346,520
364,225
323,840
Gross loans
4,801,375
4,236,206
4,109,083
3,865,576
3,471,025
Allowance for loan losses
(45,401)
(45,341)
(44,319)
(42,888)
 (42,213)
Loans, net of allowance for loan losses
$4,755,974
$4,190,865
$4,064,764
$3,822,688
$3,428,812
Daily average of total gross loans
$4,288,091
$4,156,840
$3,954,515
$3,628,006
$3,355,286

As disclosed in Table 8 above, gross loans outstanding of $4.8 billion as of December 31, 2015 increased $565.2 million, or 13.3%, compared to December 31, 2014 as a result of organic and acquired growth in the all lending portfolios.  Excluding loans acquired from Oneida, loans increased $172.5 million, or 4.1% driven by improvement in customer demand, the continued low interest rate environment and proactive business development efforts.  Gross loans outstanding at December 31, 2014 of $4.2 billion increased $127.1 million, or 3.1%, compared to December 31, 2013 as a result of organic growth in the consumer mortgage, consumer indirect and direct, and business lending portfolios and was attributable to the low interest rate environment and continued business development efforts, partially offset by the continued soft demand for home equity loans.

The compounded annual growth rate (“CAGR”) for the Company’s total loan portfolio between 2010 and 2015 was 9.7%, comprised of approximately 4.5% of organic growth, with the remainder coming from acquisitions.  The greatest overall expansion occurred in the consumer indirect and direct segment, which grew at a 12.0% CAGR.  The consumer mortgage portfolio grew at a compounded annual growth rate of 10.9% from 2010 to 2015.  The business lending segment grew at a CAGR of 7.9% driven in most part by acquisitions during the five year period.  The home equity lending segment grew at a compounded annual growth rate of 5.8% from 2010 to 2015, including the impact from acquisitions.
 
The weighting of the components of the Company’s loan portfolio enables it to be highly diversified.  Approximately 69% of loans outstanding at the end of 2015 were made to consumers borrowing on an installment, line of credit or residential mortgage loan basis.  The business lending portfolio is also broadly diversified by industry type as demonstrated by the following distributions at year-end 2015: commercial real estate (24%), restaurant & lodging (12%), healthcare (11%), general services (9%), retail trade (8%), agriculture (7%), manufacturing (6%), construction (5%), wholesale trade (5%) and motor vehicle and parts dealers (4%).  A variety of other industries with less than a 3% share of the total portfolio comprise the remaining 9%.

The consumer mortgage loans include no exposure to Alt-A or other higher-risk mortgage products and are comprised of fixed (96%) and adjustable rate (4%) residential lending.  Volume in this portion of the Company’s loan portfolio has been strong over the last few years due to historically low long-term interest rates and comparatively stable real estate valuations in the Company’s primary markets.  Consumer mortgages increased $156.4 million, or 9.7%, in 2015 and does not include $35.5 million of longer-term, fixed-rate residential mortgages that Company originated and sold, principally to Fannie Mae.  Excluding loans acquired in the Oneida transaction, the consumer mortgage portfolio grew $25.8 million, or 1.6%.  The portfolio grew $31.3 million, or 2.0% in 2014, which does not include $25.7 million of longer-term, fixed-rate residential mortgages that Company originated and sold, principally to Fannie Mae last year.  The Company’s solid performance is a reflection of the high quality profile of its portfolio and its ability to successfully meet customer needs at a time when some national mortgage lenders have restricted their lending activities in many of the Company’s markets.  Market interest rates, expected duration, and the Company’s overall interest rate sensitivity profile continue to be the most significant factors in determining whether the Company chooses to retain versus sell and service portions of its new mortgage generation.


 
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The combined total of general-purpose business lending, including agricultural-related and dealer floor plans, as well as mortgages on commercial property, is characterized as the Company’s business lending activity.  The business lending portfolio increased $234.8 million, or 18.6%, in 2015.  Excluding loans from the Oneida acquisition, the portfolio grew $83.7 million, or 6.6% in 2015.  The Company is committed to generating growth in its business portfolio in a manner that adheres to its linked goals of maintaining strong asset quality and producing profitable margins.  The Company continued to invest in additional personnel, technology, and business development resources to further enhance its capabilities in this important product category which translated into the strong growth realized during the year.  The portfolio ended 2014 $2.1 million, or 0.2%, larger than it ended 2013, as generating organic growth in this segment proved challenging as tepid customer demand and highly competitive market conditions have resulted in aggressive underwriting and, at times, undisciplined pricing by competition.  Competition in the mid-market segment is being driven by increased activity by money center bank and non-bank lenders.  Continued expansion of business service offerings by credit unions and niche non-bank lenders is driving less stringent underwriting in the small market segment.  Further, the Company productively managed payout of certain loan relationships that did not provide an appropriate risk adjusted return.

The following table shows the maturities and type of interest rates for business and construction loans as of December 31, 2015:

Table 9:  Maturity Distribution of Business and Construction Loans (1)
 
(000's omitted)
Maturing in
One Year or
Less
Maturing After
One but Within
Five Years
Maturing
After Five
Years
Total
Commercial, financial and agricultural
$177,923
$489,081
$787,717
$1,454,721
Real estate – construction
48,253
0
0
48,253
     Total
$226,176
$489,081
$787,717
$1,502,974
         
Fixed interest rates
$31,347
$252,149
$145,524
$429,020
Floating or adjustable interest rates
194,829
236,932
642,193
1,073,954
     Total
$226,176
$489,081
$787,717
$1,502,974
 
(1) Scheduled repayments are reported in the maturity category in which the payment is due.
 
Consumer installment loans, both those originated directly (such as personal installment loans and lines of credit), and indirectly (originated predominantly in automobile, marine and recreational vehicle dealerships), increased $112.8 million, or 11.1%, from one year ago.  Excluding loans from the Oneida acquisition, the portfolio increased $54.3 million, or 5.3%.  In 2014 the portfolio increased $97.9 million, or 10.6%, from the year earlier period.  The volume of new and used vehicle sales to upper-tier credit profile customers in the Company’s primary markets has improved in recent years.  The Company is focused on maintaining the solid profitability produced by its in-market and contiguous market indirect portfolio, while continuing to pursue its disciplined, long-term approach to expanding its dealer network.  However, the increasingly competitive nature of this market has resulted in aggressive pricing and incentives that have caused declining indirect loan yields, particularly in the automobile segment.  Market predictions are for flat or slightly reduced volume levels but the Company will continue to seek opportunities for growth in our markets.

Home equity loans increased $61.2 million, or 17.9%, from the end of 2014, due primarily to the $52.5 million of loans acquired from Oneida.  Excluding those loans, the portfolio increased $8.7 million, or 2.5%, as mortgage refinance activity slowed and historically low rate offerings stimulated demand for the home equity product.  Home equity loans decreased $4.2 million, or 1.2%, during 2014, due primarily to home equity loans being paid off or down as part of the above average level of mortgage refinancing activity that occurred over the prior 12 months in the low rate environment.


 
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Asset Quality

The following table presents information regarding nonperforming assets as of December 31:

Table 10: Nonperforming Assets

(000's omitted)
2015
2014
2013
2012
2011
Nonaccrual loans
         
   Consumer mortgage
$12,790
$15,323
$12,560
$11,286
$6,520
   Business lending
6,567
2,780
4,555
13,691
18,535
   Consumer indirect
0
10
14
0
2
   Consumer direct
15
20
4
8
0
   Home equity
2,356
2,598
2,340
1,375
1,205
     Total nonaccrual loans
21,728
20,731
19,473
26,360
26,262
Accruing loans 90+ days delinquent
         
   Consumer mortgage
1,805
2,397
1,338
1,818
2,171
   Business lending
126
350
164
247
399
   Consumer indirect
102
82
755
73
32
   Consumer direct
51
36
117
71
95
   Home equity
111
241
181
539
393
     Total accruing loans 90+ days delinquent
2,195
3,106
2,555
2,748
3,090
Nonperforming loans
         
   Consumer mortgage
14,595
17,720
13,898
13,104
8,691
   Business lending
6,693
3,130
4,719
13,938
18,934
   Consumer indirect
102
92
769
73
34
   Consumer direct
66
56
121
79
95
   Home equity
2,467
2,839
2,521
1,914
1,598
     Total nonperforming loans
23,923
23,837
22,028
29,108
29,352
           
Other real estate (OREO)
2,088
1,855
5,060
4,788
2,682
     Total nonperforming assets
$26,011
$25,692
$27,088
$33,896
$32,034
           
Nonperforming loans / total loans
0.50%
0.56%
0.54%
0.75%
0.85%
Legacy nonperforming loans / legacy total loans
0.49%
0.52%
0.49%
0.71%
0.69%
Nonperforming assets / total loans and other real estate
0.54%
0.61%
0.66%
0.88%
0.92%
Delinquent loans (30 days old to nonaccruing) to total loans
1.16%
1.46%
1.49%
1.92%
1.99%
Loan loss provision to net charge-offs
101%
117%
122%
108%
94%
Legacy loan loss provision to net charge-offs (1)
86%
125%
134%
116%
86%
 
(1)Legacy loans exclude loans acquired after January 1, 2009.

The Company places a loan on nonaccrual status when the loan becomes 90 days past due, or sooner if management concludes collection of interest is doubtful, except when, in the opinion of management, it is well-collateralized and in the process of collection.  As shown in Table 10 above, nonperforming loans, defined as nonaccruing loans, accruing loans 90 days or more past due, and restructured loans, ended 2015 at $23.9 million, an increase of approximately $0.1 million from one year earlier.  The ratio of nonperforming loans to total loans at December 31, 2015 decreased six basis points from the prior year to 0.50%.  Excluding nonperforming acquired loans, the ratio of nonperforming loans to total loans at the end of 2015 was 0.49%, a decrease of three basis points from the prior year.  The ratio of nonperforming assets (which includes other real estate owned, or “OREO”, in addition to nonperforming loans) to total loans plus OREO decreased to 0.54% at year-end 2015, down seven basis points from one year earlier.  The Company’s success at keeping these ratios at favorable levels throughout varying economic conditions was the result of continued focus on maintaining strict underwriting standards, early problem recognition, and effective collection and recovery efforts.  At December 31, 2015 OREO was comprised of four commercial real estate properties with a total value of $0.6 million and 27 residential properties with a total value of $1.5 million. This compares to four commercial real estate properties with a total value of $0.5 million and 29 residential properties with a total value of $1.4 million at December 31, 2014. 


 
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Approximately 61% of nonperforming loans at December 31, 2015 are related to the consumer mortgage portfolio.  Collateral values of residential properties within the Company’s market area have generally stabilized over the past few years.  However, the improved process efficiency and economic conditions as well as lower unemployment levels have positively impacted consumers, and have resulted in lower mortgage nonperforming levels in 2015.  Additionally, contributing to the higher level of nonperforming consumer mortgages in 2014 was the greater amount of time required to complete the consumer foreclosure process which was due to new regulatory requirements.  Approximately 28% of the nonperforming loans at December 31, 2015 are related to the business lending portfolio, which is comprised of business loans broadly diversified by industry type.  The level of nonperforming business loans has increased primarily as a result of one large relationship.  Even with this increase, the level of nonperforming business loans is below the Company’s longer-term average results as a proportion of  total business loans and is due to general economic improvements, effective problem loan management, and maintenance of strict underwriting standards.  The remaining 11% percent of nonperforming loans relate to consumer installment and home equity loans.  The allowance for loan losses to nonperforming loans ratio, a general measure of coverage adequacy, was 190% at the end of 2015 compared to 190% at year-end 2014 and 201% at December 31, 2013, reflective of a slightly larger proportional increase in the level of nonperforming loans than in the allowance for loan losses.  Excluding acquired loans, the ratio of allowance for legacy loans to nonperforming legacy loans was 212% at the end of 2015, compared to 221% at year-end 2014 and 234% at December 31, 2013.

Members of senior management, special asset officers, and commercial bankers review all delinquent and nonaccrual loans and OREO regularly, in order to identify deteriorating situations, monitor known problem credits and discuss any needed changes to collection efforts, if warranted.  Based on the group’s consensus, a relationship may be assigned a special assets officer or other senior lending officer to review the loan, meet with the borrowers, assess the collateral and recommend an action plan.  This plan could include foreclosure, restructuring the loans, issuing demand letters or other actions.  The Company’s larger criticized credits are also reviewed on at least a quarterly basis by senior credit administration, special assets and commercial lending management to monitor their status and discuss relationship management plans.  Commercial lending management reviews the entire criticized business loan portfolio on a monthly basis.

Total delinquencies, defined as loans 30 days or more past due or in nonaccrual status, finished the current year at 1.16% of total loans outstanding, versus 1.46% at the end of 2014.  As of year-end 2015, delinquency ratios for commercial loans, consumer installment loans, real estate mortgages and home equity loans were 0.78%, 1.20%, 1.49%, and 1.04%, respectively, and reflected improvement over prior year levels.  These measures were 0.83%, 1.21%, 2.08%, and 1.55%, respectively, as of December 31, 2014.  Delinquency levels, particularly in the 30 to 89 days category, tend to be somewhat volatile due to their measurement at a point in time, and therefore management believes that it is useful to evaluate this ratio over a longer time period.  The average quarter-end delinquency ratio for total loans in 2015 was 1.16%, as compared to an average of 1.32% in 2014, and 1.50% in 2013, reflective of management’s continued focus on maintaining strict underwriting standards, as well as the effective utilization of its collection and recovery capabilities.

Loans are considered modified in a troubled debt restructuring (“TDR”) when, due to a borrower’s financial difficulties, the Company makes one or more concessions to the borrower that it would not otherwise consider.  These modifications primarily include, among others, an extension of the term of the loan or granting a period with reduced or no principal and/or interest payments, which can be recaptured through payments made over the remaining term of the loan or at maturity.  Historically, the Company has created very few TDRs.   Regulatory guidance by the OCC requires certain loans that have been discharged in Chapter 7 bankruptcy to be reported as TDRs.  In accordance with this guidance, loans that have been discharged in Chapter 7 bankruptcy but not reaffirmed by the borrower are classified as TDRs, irrespective of payment history or delinquency status, even if the repayment terms for the loan have not been otherwise modified and the Company’s lien position against the underlying collateral remains unchanged.  Pursuant to that guidance, the Company records a charge-off equal to any portion of the carrying value that exceeds the net realizable value of the collateral.  As of December 31, 2015, the Company had 55 loans totaling $1.9 million considered to be nonaccruing TDRs and 183 loans totaling $4.3 million considered to be accruing TDRs.  This compares to 68 loans totaling $2.8 million considered to be nonaccruing TDRs and 157 loans totaling $3.2 million considered to be accruing TDRs at December 31, 2014.


 
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The changes in the allowance for loan losses for the last five years are as follows:

Table 11: Allowance for Loan Losses Activity

 
Years Ended December 31,
(000's omitted except for ratios)
2015
2014
2013
2012
2011
           
Allowance for loan losses at beginning of period
$45,341
$44,319
$42,888
$42,213
$42,510
Charge-offs:
         
  Consumer mortgage
1,374
1,075
1,012
1,004
748
  Business lending
2,249
1,596
3,671
5,654
2,964
  Consumer indirect
6,714
6,784
4,544
5,407
4,464
  Consumer direct
1,490
1,595
1,954
1,694
1,273
  Home equity
244
765
650
423
265
     Total charge-offs
12,071
11,815
11,831
14,182
9,714
Recoveries:
         
  Consumer mortgage
80
205
36
59
30
  Business lending
877
750
692
1,295
692
  Consumer indirect
3,943
3,773
3,488
3,551
3,200
  Consumer direct
722
846
1,034
821
674
  Home equity
62
85
20
23
85
     Total recoveries
5,684
5,659
5,270
5,749
4,681
           
Net charge-offs
6,387
6,156
6,561
8,433
5,033
Provision for loan losses
6,349
7,497
7,358
8,715
4,350
Provision for acquired impaired loans
98
(319)
634
393
386
           
Allowance for loan losses at end of period
$45,401
$45,341
$44,319
$42,888
$42,213
           
Allowance for loan losses / total loans
0.95%
1.07%
1.08%
1.11%
1.22%
Allowance for legacy loan losses / total legacy loans (1)
1.05%
1.14%
1.15%
1.21%
1.36%
Allowance for loan losses / nonperforming loans
190%
190%
201%
147%
144%
Allowance for legacy loans  / nonperforming legacy loans (1)
212%
221%
234%
171%
197%
Net charge-offs to average loans outstanding:
         
  Consumer mortgage
0.08%
0.05%
0.06%
0.07%
0.06%
  Business lending
0.11%
0.07%
0.24%
0.36%
0.19%
  Consumer indirect
0.33%
0.38%
0.16%
0.31%
0.24%
  Consumer direct
0.41%
0.40%
0.52%
0.54%
0.39%
  Home equity
0.05%
0.20%
0.18%
0.12%
0.06%
  Total loans
0.15%
0.15%
0.17%
0.23%
0.15%
           
(1)Legacy loans exclude loans acquired after January 1, 2009.

As displayed in Table 11 above, total net charge-offs in 2015 were $6.4 million, $0.2 million more than the prior year due to higher net charge-offs in the business lending, consumer mortgage, and consumer direct portfolios, partially offset by lower levels of net charge-offs in the consumer indirect and home equity portfolios.  Net charge-offs in 2014 were $0.4 million lower than 2013’s level, due to lower net charge-offs in the business lending, consumer mortgage, and consumer direct portfolios, partially offset by higher levels of net charge-offs in the consumer indirect and home equity portfolios.

Due to the significant increases in average loan balances over time as a result of acquisition and organic growth, management believes that net charge-offs as a percent of average loans (“net charge-off ratio”) offers the most meaningful representation of charge-off trends.  The total net charge-off ratio of 0.15% for 2015 held steady from 2014 and was two basis points lower than 2013.  Gross charge-offs as a percentage of average loans was 0.28% in 2015, as compared to 0.28% in 2014, and 0.30% in 2013, evidence management’s continued focus on maintaining strict underwriting standards.  Continued strong recovery efforts were demonstrated by recoveries of $5.7 million in 2015, representing 48% of average gross charge-offs for the latest two years, compared to 48% in 2014 and 41% in 2013.


 
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Business loan net charge-offs increased in 2015, totaling $1.4 million, or 0.11% of average business loans outstanding versus $0.8 million, or 0.07% of the average outstanding balance in 2014, primarily due to the partial charge-off of one large commercial relationship in the fourth quarter of 2015.  Consumer installment loan net charge-offs decreased to $3.5 million this year from $3.8 million in 2014, with a net charge-off ratio of 0.34% in 2015 and 0.38% in 2014.  This is reflective of the nearly 23% growth in balances since the end of 2013 as well as lower levels of gross charge-offs of consumer installment loans in 2015 as compared to 2014 partially offset by lower market resale valuations that hindered consumer installment recovery efforts.  The dollar amount of consumer mortgage net charge-offs increased $0.4 million in 2015, with the net charge-off ratio increasing three basis points to 0.08%.  Home equity net charge-offs decreased $0.5 million to $0.2 million in 2015 while the net charge-off ratio decreased 15 basis points to 0.05%.

Management continually evaluates the credit quality of the Company’s loan portfolio and conducts a formal review of the allowance for loan losses adequacy on a quarterly basis.  The two primary components of the loan review process that are used to determine proper allowance levels are specific and general loan loss allocations.  Measurement of specific loan loss allocations is typically based on expected future cash flows, collateral values and other factors that may impact the borrower’s ability to repay.  Impaired loans greater than $0.5 million are evaluated for specific loan loss allocations.  Consumer mortgages, consumer installment and home equity loans are considered smaller balance homogeneous loans and are evaluated collectively.  The Company considers a loan to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all principal and interest according to the contractual terms of the loan agreement or the loan is delinquent 90 days or more.

The second component of the allowance establishment process, general loan loss allocations, is composed of two calculations that are computed on the five main loan segments: consumer mortgage, business lending, consumer indirect, consumer direct, and home equity.  The first calculation determines an allowance level based on the latest 36 months of historical net charge-off data for each loan category (business loans exclude balances with specific loan loss allocations).  The second calculation is qualitative and takes into consideration eight qualitative environmental factors: levels and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedure, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.  The allowance levels computed from the specific and general loan loss allocation methods are combined with unallocated allowances, if any, to derive the required allowance for loan losses to be reflected on the Consolidated Statement of Condition.  As it has in prior periods, the Company strives to refine and enhance its loss evaluation and estimation processes continually.

The loan loss provision is calculated by subtracting the previous period allowance for loan losses, net of the interim period net charge-offs, from the current required allowance level.  This provision is then recorded in the income statement for that period. Members of senior management and the Audit/Compliance/Risk Management Committee of the Board of Directors review the adequacy of the allowance for loan losses quarterly.  Management is committed to continually improving the credit assessment and risk management capabilities of the Company and has dedicated the resources necessary to ensure advancement in this critical area of operations.

Acquired loans are recorded at their acquisition date fair values and, therefore, are excluded from the calculation of loan loss reserves as of the acquisition date.  To the extent there is a decrease in the present value of cashflows from the acquired impaired loans after the date of acquisition, the Company records a provision for potential losses. During the year ended December 31, 2015, the allowance for loan losses related to the acquired impaired portfolio remained consistent with the prior year-end.  During the year ended December 31, 2014, the Company reversed $0.3 million of its provision for loan losses related to acquired impaired loans as the value received at closure for certain loans was greater than the value they were being carried on the books.  In 2013, an additional $0.6 million of provision for loan losses related to the acquired impaired loans was recorded.

For acquired loans that are not deemed impaired at acquisition, a fair value adjustment is recorded that includes both credit and interest rate considerations.  Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance exceeds any remaining purchased discounts.  For the 2015, year the Company recorded a provision for loan losses on acquired non-impaired loans of $1.0 million, primarily for the Oneida commercial portfolio where the net fair value of the pool was deemed greater than its par value at acquisition.  During 2014 and 2013, the Company recorded a provision for loan losses on acquired non-impaired loans of $0.6 million and $0.3 million, respectively.


 
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The allowance for loan losses increased to $45.4 million at the end 2015 from $45.3 million as of year-end of 2014.  The $0.1 million increase was primarily due to both organic and acquired loan growth, partially offset by improved credit quality within the legacy portfolios.  The allowance for legacy loan losses decreased $1.5 million as growth in the loan portfolio was more than offset by the improved credit quality of the portfolio.  The ratio of the allowance for loan losses to total loans decreased 12 basis point to 0.95% for year-end 2015 as compared to 1.07% for 2014 and 1.08% for 2013, primarily due to improved credit quality and the Oneida acquisition.  The ratio of allowance for legacy loan losses to total legacy loans decreased nine basis points to 1.05% for 2015 as compared 2014.  Management believes the year-end 2015 allowance for loan losses to be adequate in light of the probable losses inherent in the Company’s loan portfolio.

The loan loss provision for legacy loans of $5.3 million in 2015, was $1.5 million less than the prior year, and reflects management’s assessment of the probable losses in the loan portfolio, as discussed above.  The loan loss provision as a percentage of average loans was 0.15% in 2015 as compared to 0.17% in 2014 and 0.20% in 2013.  The loan loss provision was 101% of net charge-offs this year versus 117% in 2014 and 122% in 2013, reflective of the assessed risk in the overall portfolio.

The following table sets forth the allocation of the allowance for loan losses by loan category as of the end of the years indicated, as well as the proportional share each category is to total loans.  This allocation is based on management’s assessment, as of a given point in time, of the risk characteristics of each of the component parts of the total loan portfolio and is subject to changes when the risk factors of each component part change.  The allocation is not indicative of either the specific amounts of the loan categories in which future charge-offs may be taken, nor should it be taken as an indicator of future loss trends.  The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category.

Table 12: Allowance for Loan Losses by Loan Type

   
2015
 
2014
 
2013
 
2012
 
2011
     
Loan
   
Loan
   
Loan
   
Loan
   
Loan
(000's omitted except for ratios)
 
Allowance
Mix
 
Allowance
Mix
 
Allowance
Mix
 
Allowance
Mix
 
Allowance
Mix
Consumer mortgage
 
$10,198
36.8%
 
$10,286
38.1%
 
$8,994
38.5%
 
$7,070
37.5%
 
$4,651
35.0%
Business lending
 
15,749
31.0%
 
15,787
29.7%
 
17,507
30.5%
 
18,013
31.6%
 
20,574
34.8%
Consumer indirect
 
12,422
19.5%
 
11,544
19.7%
 
10,248
18.0%
 
9,606
16.7%
 
8,960
16.1%
Consumer direct
 
2,997
4.1%
 
3,083
4.3%
 
3,181
4.4%
 
3,303
4.4%
 
3,290
4.3%
Home equity
 
2,666
8.4%
 
2,701
8.1%
 
1,830
8.4%
 
1,451
9.4%
 
1,130
9.3%
Acquired impaired loans
 
168
0.2%
 
173
0.1%
 
530
0.2%
 
779
0.4%
 
386
0.5%
Unallocated
 
1,201
   
1,767
   
2,029
   
2,666
   
3,222
 
Total
 
$45,401
100.0%
 
$45,341
100.0%
 
$44,319
100.0%
 
$42,888
100.0%
 
$42,213
100.0%

As demonstrated in Table 12 above and discussed previously, business lending and consumer installment by their nature carries higher credit risk than residential real estate, and as a result these loans carry allowance for loan losses that cover a higher percentage of their total portfolio balances.  As in prior years, the unallocated allowance is maintained for inherent losses in the portfolio that is not reflected in the historical loss ratios, model imprecision, and for acquired loan portfolios in the process of being fully integrated at year-end.  The unallocated allowance decreased from $2.0 million at year-end 2013 to $1.8 million at year-end 2014 to $1.2 million at December 31, 2015.  The general declines in the unallocated portion of the allowance, as well as changes in year-over-year allowance allocations reflect management’s continued refinement of its loss estimation techniques.  However, given the inherent imprecision in the many estimates used in the determination of the allocated portion of the allowance, management deliberately remained cautious and conservative in establishing the overall allowance for loan losses.  Management considers the allocated and unallocated portions of the allowance for loan losses to be prudent and reasonable.  Furthermore, the Company’s allowance for loan loss is general in nature and is available to absorb losses from any loan category.


 
44 of 105

 


Funding Sources

The Company utilizes a variety of funding sources to support the earning-asset base as well as to achieve targeted growth objectives.  Overall funding is comprised of three primary sources that possess a variety of maturity, stability, and price characteristics; deposits of individuals, partnerships and corporations (nonpublic deposits), municipal deposits that are collateralized for amounts not covered by FDIC insurance (public funds), and external borrowings.  The average daily amount of deposits and the average rate paid on each of the following deposit categories are summarized below for the years indicated:

Table 13: Average Deposits

   
2015
 
2014
 
2013
   
Average
Average
 
Average
Average
 
Average
Average
(000's omitted, except rates)
 
Balance
Rate Paid
 
Balance
Rate Paid
 
Balance
Rate Paid
Noninterest checking deposits
 
$1,352,683
0.00%
 
$1,249,807
0.00%
 
$1,119,935
0.00%
Interest checking deposits
 
1,429,450
0.03%
 
1,334,745
0.03%
 
1,206,242
0.03%
Regular savings deposits
 
1,106,127
0.08%
 
1,039,173
0.08%
 
982,519
0.10%
Money market deposits
 
1,518,184
0.15%
 
1,493,900
0.16%
 
1,425,961
0.17%
Time deposits
 
737,734
0.46%
 
845,035
0.54%
 
940,095
0.74%
  Total deposits
 
$6,144,178
0.11%
 
$5,962,660
0.14%
 
$5,674,752
0.19%
                   
 
As displayed in Table 13, average total deposits in 2015 increased $181.5 million, or 3.0%, from the prior year comprised of a $288.8 million, or 5.6%, increase in core deposits, and a $107.3 million, or 12.7%, decrease in time deposits.  Excluding the impact of the Oneida acquisition, average deposits increased $128.4 million, or 2.2%, as compared to 2014.  Consistent with the Company’s focus on expanding core account relationships and reduced customer demand for time deposits, average non-acquired, non-time (“core”) deposit balances grew $244.9 million, or 4.8%, as compared to 2014 while non-acquired time deposits balances declined $116.6 million, or 13.8%.  This shift in mix also reflects the diminished rate differential between core and time deposits in the low interest rate environment and helped lower the cost of deposits, including the impact of non-interest checking deposits, to 0.11% in 2015 as compared to 0.14% for 2014.

Total average deposits for 2014 equaled $5.96 billion, up $287.9 million, or 5.1%, from 2013.  Excluding the impact of the 2013 branch acquisition, average deposits increased $47.0 million, or 0.8%, as compared to 2013.  Core deposit balances grew $200.7 million, or 4.2%, as compared to 2013 while non-acquired time deposit balances declined $153.7 million, or 16.4%.  The cost of deposits, including the impact of non-interest checking deposits, decreased to 0.14% in 2014 as compared to 0.19% for 2013.

Nonpublic, core deposits are frequently considered to be a bank’s most attractive source of funding because they are generally stable, do not need to be collateralized, have a relatively low cost, generate solid fee income, and provide a strong customer base for which a variety of loan, deposit and other financial service-related products can be cross-sold. The Company’s funding composition continues to benefit from a high level of nonpublic deposits, which reached an all-time high in 2015 with an average balance of $5.45 billion, an increase of $72.6 million, or 1.4%, over the comparable 2014 period.  Excluding the impact of the 2015 Oneida acquisition, average nonpublic deposits increased $33.1 million during 2015.

Full-year average public fund deposits increased $108.9 million, or 18.6%, during 2015 to $695.8 million.  Excluding the impact of the Oneida acquisition, average public fund deposits increased $95.3 million, or 16.2%, during 2015.  Public fund deposit balances tend to be more volatile than nonpublic deposits because they are heavily impacted by the seasonality of tax collection and fiscal spending patterns, as well as the longer-term financial position of the local government entities, which can change from year to year.  However, the Company has many strong, long-standing relationships with municipal entities throughout its markets and the diversified core deposits held by these customers have provided an attractive and comparatively stable funding source over an extended time period.  The Company is required to collateralize all local government deposits in excess of FDIC coverage with marketable securities from its investment portfolio.  Because of this stipulation, as well as the competitive bidding nature of municipal time deposits, management considers this funding source to share some of the attributes of external borrowings and thus prices these products based on external borrowing rates.

The mix of average deposits has been changing throughout the last several years.  The weighting of core (noninterest checking, interest checking, savings, and money market accounts) has increased, while time deposits’ weighting has decreased.  This change in deposit mix reflects the Company’s focus on expanding core account relationships and customers’ preference for unrestricted accounts in the current low rate environment.  The average balance for time deposit accounts decreased from 14.2% of total average deposits in 2014 to 12.0% of total average deposits for 2015.  Correspondingly, average core deposit balances have increased from 85.8% in 2014 to 88.0% in 2015.  This shift in mix, combined with lower average offered interest rates caused the cost of interest-bearing deposits to decline to 0.15% in 2015, as compared to 0.17% in 2014 and 0.24% in 2013.  The total cost of deposit funding, which includes noninterest-bearing deposits, also declined in 2015 to 0.11%, versus 0.14% in 2014, benefiting from the 8.2% increase in non-interest bearing checking average balances.
 
 
 
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The remaining maturities of time deposits in amounts of $250,000 or more outstanding as of December 31 are as follows:

Table 14: Maturity of Time Deposits $250,000 or More

(000's omitted)
2015
2014
Less than three months
$18,970
$9,395
Three months to six months
11,147
6,534
Six months to one year
17,212
7,358
Over one year
8,101
8,717
  Total
$55,430
$32,004

Borrowing sources for the Company include the FHLB and Federal Reserve, as well as access to the brokered CD and repurchase markets through established relationships with primary market security dealers.  The Company also had $102.1 million in floating-rate subordinated debt outstanding at the end of 2015 that is held by unconsolidated subsidiary trusts.

As shown in Table 15, year-end 2015 external borrowings totaled $403.4 million, a decrease of $36.7 million from the $440.1 million outstanding at the end of 2014.  Overnight advances from the FHLB were used to fund the purchase of investment securities and cover other liquidity needs during 2015 and 2014.  External borrowings averaged $513.8 million, or 7.7% of total funding sources for 2015, as compared to $405.4 million, or 6.4% of total funding sources for 2014.  This ratio increased as the Company utilized FHLB overnight advances during 2015 to fund the pre-investment during the first half of 2015 of the liquidity expected to be received from the Oneida acquisition.  As shown in Table 15 at the end of 2015, the Company had $301.3 million, or 75% of external borrowings, with remaining terms of one year or less as compared to 77% of external borrowings maturing within one year at December 31, 2014.

As displayed in Table 3 on page 30, after years of proportionally more funding from deposits, the percentage of funding from deposits declined in 2015 due to borrowings used to fund pre-investment activity conducted early in the year, most of which was paid down after the acquisition was completed.  The percentage of average funding derived from deposits was 92.3% in 2015 as compared to 93.6% in 2014 and 90.9% in 2013.  During 2015, average borrowings increased 26.7% while average deposits increased 3.0%.

The following table summarizes the outstanding balance of borrowings of the Company as of December 31:

Table 15: Borrowings

(000's omitted, except rates)
2015
2014
2013
FHLB overnight advance
$301,300
$338,000
$141,900
Capital lease obligation
0
0
13
Subordinated debt held by unconsolidated subsidiary trusts
102,146
102,122
102,097
      Balance at end of period
$403,446
$440,122
$244,010
       
Daily average during the year
$513,827
$405,411
$567,079
Maximum month-end balance
$701,338
$521,211
$830,099
Weighted-average rate during the year
0.82%
0.89%
2.70%
Weighted-average year-end rate
1.05%
0.79%
1.22%

The following table shows the contractual maturities of various obligations as of December 31, 2015:

Table 16: Maturities of Contractual Obligations

   
Maturing
Maturing
   
 
Maturing
After One
After Three
   
 
Within
Year but
Years but
Maturing
 
 
One Year
Within
Within
After
 
(000's omitted)
Or Less
Three Years
Five Years
Five Years
Total
FHLB overnight advance
$301,300
$0
$0
$0
$301,300
Subordinated debt held by unconsolidated subsidiary trusts
0
0
0
102,527
102,527
Interest on borrowings
2,674
5,314
5,314
39,757
53,059
Operating leases
6,323
10,390
5,799
7,200
29,712
     Total
$310,297
$15,704
$11,113
$149,484
$486,598
 
 
 
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Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments consist primarily of commitments to extend credit and standby letters of credit.  Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee.  These commitments consist principally of unused commercial and consumer credit lines.  Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party.  The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as that involved with extending loans to customers and are subject to normal credit policies.  Collateral may be required based on management’s assessment of the customer’s creditworthiness.  The fair value of these commitments is immaterial for disclosure.

The contractual amounts of these off-balance sheet financial instruments as of December 31 were as follows:

Table 17: Off-Balance Sheet Financial Instruments

(000's omitted)
2015
2014
Commitments to extend credit
$811,442
$733,827
Standby letters of credit
19,053
23,916
     Total
$830,495
$757,743

Investments

The objective of the Company’s investment portfolio is to hold low-risk, high-quality earning assets that provide favorable returns and provide another effective tool to actively manage its asset/liability position in order to maximize future net interest income opportunities.  This must be accomplished within the following constraints: (a) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (b) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (c) considering investment risk-weights as determined by the regulatory risk-based capital guidelines; and (d) generating a favorable return without undue compromise of the other requirements.

The carrying value of the Company’s investment portfolio ended 2015 at $2.85 billion, an increase of $335.0 million, or 13.3%, from the end of 2014.  The book value (excluding unrealized gains and losses) of the portfolio increased $344.4 million from December 31, 2014 while the unrealized holding gain on the available-for-sale securities decreased $9.2 million.  During 2015, the Company purchased $398.2 million of U.S. Treasury and agency securities at an average yield of 1.96%, as well as $86.3 million of obligations of state and political subdivisions at an average yield of 4.00%, and $18.5 million of government agency mortgage-backed securities at an average rate of 2.47%.  Offsetting these purchases were $169.5 million of maturities, calls and collections.  Additionally, $225.7 million of investment securities were acquired as part of the Oneida transaction, of which $221.1 million were subsequently sold.
 
The carrying value of the Company’s investment portfolio increased $294.2 million during 2014 to end the year at $2.51 billion.  The book value of available-for-sale investments increased $180.7 million from December 31, 2013.  During 2014, the Company purchased $224.6 million of U.S. Treasury securities at an average yield of 2.40% along with $63.7 million of obligations of state and political subdivisions at an average yield of 5.15% and $22.2 million of government agency mortgage-backed securities at an average rate of 2.83%.  Offsetting these purchases were $137.1 million of maturities, calls and collections.

The investment portfolio has limited credit risk due to the composition continuing to heavily favor U.S. Treasury debentures, U.S. Agency mortgage-backed pass-throughs, U.S. Agency CMOs and municipal bonds.  The U.S. Treasury debentures, U.S. Agency mortgage-backed pass-throughs and U.S. Agency CMOs are all AAA-rated (highest possible rating) by Moody’s and AA+ by Standard and Poor’s.  The majority of the municipal bonds are A-rated or higher.  The portfolio does not include any private label mortgage-backed securities (MBSs) or private label collateralized mortgage obligations.  The overall mix of securities within the portfolio over the last year has changed, with an increase in the proportion of U.S. Treasury and Agency securities and a decrease in the proportion of obligations of state and political subdivisions, government agency mortgage-backed securities and other securities.

The net pre-tax unrealized market value gain on the available-for-sale investment portfolio as of December 31, 2015 was $65.8 million, as compared to $75.0 million one year earlier.  This decrease is indicative of the interest rate movements during the respective time periods and the changes in the size and composition of the portfolio.

 
 
47 of 105

 
 
The following table sets forth the amortized cost and market value for the Company's investment securities portfolio:

Table 18: Investment Securities

   
2015
 
2014
   2013
   
Amortized
   
Amortized
   
Amortized
 
   
Cost/Book
Fair
 
Cost/Book
Fair
 
Cost/Book
Fair
(000's omitted)
 
Value
Value
 
Value
Value
 
Value
Value
Available-for-Sale Portfolio:
                 
  U.S. Treasury and agency securities
 
$1,866,819
$1,899,978
 
$1,479,134
$1,517,733
 
$1,252,332
$1,212,147
  Obligations of state and political subdivisions
 
640,455
666,883
 
645,398
671,903
 
665,441
668,982
  Government agency mortgage-backed securities
 
205,220
210,865
 
228,971
237,728
 
250,431
254,978
  Corporate debt securities
 
16,672
16,680
 
26,803
27,091
 
26,932
27,587
  Government agency collateralized mortgage obligations
 
12,862
13,308
 
17,330
18,025
 
21,779
22,048
  Marketable equity securities
 
250
399
 
250
445
 
250
421
     Total available-for-sale portfolio
 
2,742,278
2,808,113
 
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