COMMUNITY BANK SYSTEM, INC. - Annual Report: 2019 (Form 10-K)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

 Washington, D.C. 20549

For the fiscal year ended December 31, 2019

For the transition period from                       to                                           .

Commission file number 001-13695

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (315) 445-2282

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

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 ☒     No  ☐ .

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 ☐   No ☒ .

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

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

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

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

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

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, 2019 (the registrant’s most recently completed second fiscal quarter): $3,341,455,914.

The number of shares of the common stock, $1.00 par value per share, outstanding as of the close of business on January 31, 2020: 51,914,175

DOCUMENTS INCORPORATED BY REFERENCE.

Portions of the Definitive Proxy Statement for the Annual Meeting of the Shareholders to be held on May 15, 2020 (the “Proxy Statement”) is incorporated by reference in Part III of this Annual Report on Form 10-K. 

TABLE OF CONTENTS

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.”

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”).  As of December 31, 2019, BPAS owns five subsidiaries: Benefit Plans Administrative Services, LLC (“BPA”), a provider of defined contribution plan administration services; Northeast Retirement Services, LLC (“NRS”), a provider of institutional transfer agency, master recordkeeping services, fund administration, trust and retirement plan services; BPAS Actuarial & Pension Services, LLC (“BPAS-APS”), 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.  NRS owns one subsidiary, Global Trust Company, Inc. (“GTC”), a non-depository trust company which provides fiduciary services for collective investment trusts and other products.  HB&T owns one subsidiary, Hand Securities, Inc. (“HSI”), an introducing broker-dealer.  The Company also sponsors one unconsolidated subsidiary business trust 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 diversified financial services enterprise providing a broad array of banking and other financial services to retail, commercial and municipal customers.  As of December 31, 2019, the Bank operates 231 full-service branches operating as Community Bank, N.A. throughout 40 counties of Upstate New York, six counties of Northeastern Pennsylvania, 12 counties of Vermont and one county of Western Massachusetts, offering a range of commercial and retail banking services.  The Bank owns the following operating subsidiaries: The Carta Group, Inc. (“Carta Group”), CBNA Preferred Funding Corporation (“PFC”), CBNA Treasury Management Corporation (“TMC”), Community Investment Services, Inc. (“CISI”), NOTCH Investment Fund, LLC (“NOTCH”), Nottingham Advisors, Inc. (“Nottingham”), OneGroup NY, Inc. (“OneGroup”), and Oneida Preferred Funding II LLC (“OPFC II”).  OneGroup is a full-service insurance agency offering personal and commercial property insurance and other risk management products and services.  NOTCH, PFC and OPFC II primarily act as investors in residential and commercial real estate activities.  TMC provides cash management, investment, and treasury services to the Bank.  CISI and Carta Group 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 cbna.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 https://www.sec.gov.

Acquisition History (2015-2019)

On October 21, 2019, the Company announced that it had entered into a definitive agreement to acquire Steuben Trust Corporation (“Steuben”), parent company of Steuben Trust Company, a New York State chartered bank headquartered in Hornell, New York, for approximately $104.4 million in Company stock and cash.  Steuben currently operates 14 branch locations in Western New York. The acquisition will extend the Company’s footprint into two new counties in Western New York State and enhance the Company’s presence in four Western New York State counties in which it currently operates. The acquisition is expected to close during the second quarter of 2020, pending both customary regulatory and Steuben shareholder approval. The Company expects to incur certain one-time, transaction-related costs in 2020 in connection with the Steuben acquisition.

On September 18, 2019, the Company, through its subsidiary, CISI, completed its acquisition of certain assets of a practice engaged in the financial services business headquartered in Syracuse, New York. The Company paid $0.5 million in cash to acquire a customer list, and recorded a $0.5 million customer list intangible asset in conjunction with the acquisition.

On July 12, 2019, the Company completed its merger with Kinderhook Bank Corp. (“Kinderhook”), parent company of The National Union Bank of Kinderhook, headquartered in Kinderhook, New York, for $93.4 million in cash. The merger added 11 branch locations across a five county area in the Capital District of Upstate New York. The merger resulted in the acquisition of $642.8 million of assets, including $479.9 million of loans and $39.8 million of investment securities, as well as $568.2 million of deposits and $40.3 million in goodwill.

On January 2, 2019, the Company, through its subsidiary, CISI, completed its acquisition of certain assets of Wealth Resources Network, Inc. (“Wealth Resources”), a financial services business headquartered in Liverpool, New York. The Company paid $1.2 million in cash to acquire a customer list from Wealth Resources, and recorded a $1.2 million customer list intangible asset in conjunction with the acquisition.

On April 2, 2018, the Company, through its subsidiary, BPAS, acquired certain assets of HR Consultants (SA), LLC (“HR Consultants”), a provider of actuarial and benefit consulting services headquartered in Puerto Rico.  The Company paid $0.3 million in cash to acquire the assets of HR Consultants and recorded intangible assets of $0.3 million in conjunction with the acquisition.

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

On January 2, 2018, the Company, through its subsidiary, CISI, completed its acquisition of certain assets of Styles Bridges Associates (“Styles Bridges”), a financial services business headquartered in Canton, New York.  The Company paid $0.7 million in cash to acquire a customer list from Styles Bridges, and recorded a $0.7 million customer list intangible asset in conjunction with the acquisition.

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

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

On May 12, 2017, the Company completed its acquisition of Merchants Bancshares, Inc. (“Merchants”), parent company of Merchants Bank headquartered in South Burlington, Vermont, for $345.2 million in Company stock and cash, comprised of $82.9 million in cash and the issuance of 4.68 million shares of common stock.  The acquisition extended the Company’s footprint into the Vermont and Western Massachusetts markets with the addition of 31 branch locations in Vermont and one location in Massachusetts.  This transaction resulted in the acquisition of $2.0 billion of assets, including $1.49 billion of loans and $370.6 million of investment securities, as well as $1.45 billion of deposits and $189.0 million in goodwill.

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

On February 3, 2017, the Company completed its acquisition of NRS and its subsidiary GTC, headquartered in Woburn, Massachusetts, for $148.6 million in Company stock and cash.  NRS was a privately held corporation focused on providing institutional transfer agency, master recordkeeping services, custom target date fund administration, trust product administration and customized reporting services to institutional clients.  Its wholly-owned subsidiary, GTC, is chartered in the State of Maine as a non-depository trust company and provides fiduciary services for collective investment trusts and other products.  The acquisition of NRS and GTC, hereafter referred to collectively as NRS, strengthens and complements the Company’s existing employee benefit services businesses.  Upon the completion of the merger, NRS became a wholly-owned subsidiary of BPAS and operates as Northeast Retirement Services, LLC, a Delaware limited liability company.  This transaction resulted in the acquisition of $36.1 million in net tangible assets, principally cash and certificates of deposit, $60.2 million in customer list intangibles that will be amortized over 10 years, the creation of a $23.0 million deferred tax liability associated with the customer list intangible and $75.3 million in goodwill.

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

Services

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, Northeastern Pennsylvania, Vermont and Western Massachusetts.  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, the Federal Home Loan Bank of New York and the Federal Home Loan Bank of Boston (as a non-member bank) (collectively, referred to as “FHLB”), and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to applicable limits.

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

Through the Bank, its trust department, CISI, Carta Group, and Nottingham, the Company provides wealth management, retirement planning, higher educational planning, fiduciary, risk management, trust services and personal financial planning services.  The Company offers investment alternatives including stocks, bonds, mutual funds and advisory products.

Through OneGroup, the Company offers personal and commercial lines of insurance and other risk management products and services. In addition, OneGroup offers employee benefit related services.  OneGroup represents many leading insurance companies.

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 operations.  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, Pennsylvania, Vermont and Massachusetts markets.  The Company competes actively for loans, deposits, and financial services relationships with other national and state banks, thrift institutions, credit unions, retail brokerage firms, mortgage bankers, finance companies, insurance agencies, 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.

The Company’s employee benefit trust and plan administration business competes on a national scale and provides geographic diversification for the Company.  Certain lines of business are marketed primarily through unaffiliated financial advisors, while others are marketed directly to plan sponsors and fund companies.  In order to compete with large national firms, the Company stresses its consultative approach to complex engagements.

The table below summarizes the Bank’s deposits and market share by the fifty-four counties of New York, Pennsylvania, Vermont, and Massachusetts in which it had customer facilities as of June 30, 2019.  Market share is based on deposits of all commercial banks, credit unions, savings and loan associations, and savings banks.

(1) Deposits and Market Share data as of June 30, 2019, the most recent information available from SNL Financial LLC.  Deposit amounts include $215.9 million of intercompany balances that are eliminated upon consolidation.

Employees

As of December 31, 2019, the Company employed 2,752 full-time employees and 286 part-time and 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

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 Federal Reserve System (“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 requirements 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, GTC, HB&T, HSI, BPAS Trust Company of Puerto Rico, Nottingham, CISI, OneGroup, and Carta Group 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 State of Maine Bureau of Financial Institutions, the Financial Industry Regulatory Authority (“FINRA”), Puerto Rico Office of the Commissioner of Financial Institutions, and state securities and insurance regulators.

The Company was a bank holding company under the Bank Holding Company Act of 1956, (the “BHC Act”), and became a financial holding company effective September 30, 2015.  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.  Prior notice to the FRB may be required, however, if the company to be acquired has total consolidated assets of $10 billion or more.  Prior FRB approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares or substantially all of the assets of a bank holding company, bank or savings association.

Because the Company is a financial holding company, if the Bank were to receive a rating under the Community Reinvestment Act of 1977, as amended (“CRA”), of less than Satisfactory, the Company will be prohibited, until the rating is raised to Satisfactory or better, from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations, except that the Company could engage in new activities, or acquire companies engaged in activities, that are considered “closely related to banking” under the BHC Act.  In addition, if the FRB determines that the Company or the Bank is not well capitalized or well managed, the Company would be required to enter into an agreement with the FRB to comply with all applicable capital and management requirements and may contain additional limitations or conditions.  Until corrected, the Company could be prohibited from engaging in any new activity or acquiring companies engaged in activities that are not closely related to banking, absent prior FRB approval.

Because the Company is a financial 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 financial 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 our control.

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.

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, 2019.

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 “CAMELS 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.  The Bank’s adjusted average consolidated total assets for 4 consecutive quarters exceeded $10.0 billion in 2018, which resulted in a deposit insurance assessment based on a large institution classification, rather than the small institution classification for years prior to 2018.

For large insured depository institutions, generally defined as those with at least $10 billion in total assets, the FDIC has eliminated risk categories when calculating the initial base assessment rates and now combine CAMELS ratings and financial measures into two scorecards to calculate assessment rates, one for most large insured depository institutions and another for highly complex insured depository institutions (which are generally those with more than $50 billion in total assets that are controlled by a parent company with more than $500 billion in total assets). Each scorecard has two components - a performance score and loss severity score, which are combined and converted to an initial assessment rate. The FDIC has the ability to adjust a large or highly complex insured depository institution’s total score by a maximum of 15 points, up or down, based upon significant risk factors that are not captured by the scorecard. Under the current assessment rate schedule, the initial base assessment rate for large and highly complex insured depository institutions ranges from three to 30 basis points, and the total base assessment rate, after applying the unsecured debt and brokered deposit adjustments, ranges from one and one-half to 40 basis points.  The Bank’s FDIC insurance for 2019 was based on an assessment rate of three basis points.

In October 2010, the FDIC adopted a DIF restoration plan to ensure that the fund reserve ratio reached 1.35% by September 30, 2020, as required by the Dodd-Frank Act.  In September 2018, the DIF reserve ratio reached 1.36%, exceeding the required reserve ratio of 1.35% ahead of the September 30, 2020 deadline.  Since the DIF reserve ratio remained above 1.35% in 2019, the Bank was permitted to offset its FDIC insurance assessments in 2019 with Small Bank Assessment Credits issued by the FDIC in January 2019.  The Bank offset $1.5 million of FDIC insurance assessments in 2019 with Small Bank Assessment Credits.  FDIC insurance expense net of Small Bank Assessment Credits in 2019 totaled $1.4 million, compared to $3.2 million in 2018 and $3.5 million in 2017.

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.

On July 21, 2010, the Dodd-Frank Act was signed into law, which resulted in significant changes to the banking industry.  As discussed further throughout this section, certain aspects of the Dodd-Frank Act are subject to implementing rules that have been taking effect over several years.

The Dodd-Frank Act contains numerous 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, interchange fees on debit card transactions are limited to a maximum of $0.21 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.  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 Company became subject to the interchange fee cap mandated by the Dodd-Frank Act beginning on July 1, 2018.  As such, the fees the Company received on and after July 1, 2018 for an electronic debit transaction were capped at the statutory limit.  Prior to July 1, 2018, the Company was exempt from the interchange fee cap under the "small issuer" exemption, which applies to any debit card issuer with total worldwide assets (including those of its affiliates) of less than $10 billion as of the end of the previous calendar year.

The Dodd-Frank Act established the CFPB and empowered it to exercise broad rulemaking, supervision, and enforcement authority for a wide range of consumer protection laws.  Since the Company’s total consolidated assets exceed $10 billion the Company is subject to the direct supervision of the CFPB.  The CFPB has issued numerous regulations and amendments under which the Company and the Bank may continue to incur additional expense in connection with its ongoing compliance obligations.  Significant recent CFPB developments that may affect operations and compliance costs include:

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.

As of October 2019, the five federal agencies identified above with rulemaking authority with respect to the Volcker Rule finalized amendments to the proprietary trading provisions of the Volcker Rule.  These amendments tailor the Volcker Rule’s compliance requirements to the amount of a firm’s trading activity, revise the definition of trading account, clarify certain key provisions in the Volcker Rule, and modify the information companies are required to provide the federal agencies.  These amendments to the Volcker Rule are not material to the Company’s investing and trading activities.

On January 30, 2020, the five federal agencies proposed additional amendments to the Volcker Rule related to the restrictions on ownership interests and relationships with covered funds.  The ultimate benefits or consequences of these amendments will depend on their final form, which the Company cannot predict.

In May of 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“Economic Growth Act”) was enacted to amend the Dodd-Frank Act and modify certain post-crisis regulatory requirements, including a variety of provisions intended to promote economic growth, provide tailored regulatory relief for smaller and less complex financial institutions, and enhance consumer protections.  Among other things, the law raised the asset size threshold for the filing of required company-run stress tests that the Dodd-Frank Act had applied to the Company and the Bank, from $10 billion to $250 billion in total assets.  As implemented by the federal banking agencies, these changes became effective in 2018 for banking organizations with total assets of less than $100 billion, such as the Bank.

The ongoing effects of the Dodd-Frank Act, as well as the recent and possible future changes to the regulatory framework as a result of the Economic Growth Act and future proposals make it difficult to assess the overall financial impact of the Dodd-Frank Act and related regulatory developments on the Company and the banking industry.  As a result, the Company cannot predict the ultimate impact of the Dodd-Frank Act on the Company or the Bank, 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 future legislation or regulation 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.

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 “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 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 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 Capital Rules define the components of capital and address other issues 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 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.

The Capital Rules, among other things: (i) introduces as a 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 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 Capital Rules specific requirements.

Under the Capital Rules, the minimum capital ratios as of January 1, 2016 are as follows:

Beginning in 2016, the Capital Rules required the Company and the Bank to maintain a “capital conservation buffer” composed entirely of CET1. When it was fully phased-in at the beginning of 2019, banking organizations were 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 is 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%. 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 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 Capital Rules, the effects of certain accumulated other comprehensive income or loss items are not excluded; however, banks not using the advanced approach, 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 Section 171 of the Dodd-Frank Act, the 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 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 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 were 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 began on January 1, 2016 at the 0.625% level and was phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019).

With respect to the Bank, the 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%; 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 Capital Rules do not change the Total risk-based PCA capital requirement for any capital category.

The Capital Rules prescribe a standardized approach for risk weighted-assets that expands the risk-weight categories from the 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 risk-weight categories generally range from 0% for U.S. government and agency securities, to 1,250% 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 150 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.”

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 but are not limited to the Equal Credit Opportunity Act, the Gramm-Leach-Bliley 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”), the Servicemembers Civil Relief Act (“SCRA”), the Military Lending Act (“MLA”), 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 acts or practices.  The CFPB has examination authority over all banks and savings institutions with more than $10 billion in assets.  The Dodd-Frank Act also weakens the federal preemption rules that are 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 practices (“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 SCRA protects persons called to active military service and their dependents from undue hardship resulting from their military service, and the MLA extends specific protections if an accountholder, at the time of account opening, is a covered active duty member of the military or certain family members thereof.  The SCRA applies to all debts incurred prior to the commencement of active duty and limits the amount of interest, including service and renewal charges and any other fees or charges (other than bona fide insurance) that are related to the obligation or liability.  The MLA applies to certain consumer loans and extends specific protections if an accountholder, at the time of account opening, is a covered active duty member of the military or certain family members thereof.  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 (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 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.

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.

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, entity or individual, including prohibitions against direct or indirect imports and exports and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments, or providing investment related advice or assistance; and (ii) a blocking of assets in which the government or specially designated nationals 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.

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.

Among other provisions, the 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 rule does not govern overdraft fees on the payment of checks and certain other forms of bill payments.

Under the 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 (“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 currency transaction and suspicious activity reporting), as well as due diligence/know-your-customer documentation requirements.  The Company has established a bank secrecy act /anti-money laundering program and taken other appropriate measures in order to comply with BSA requirements.

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 the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (1) its ability to originate loans and obtain deposits, which could reduce the amount of fee income generated, (2) the fair value of its 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, the Company’s net interest income could be adversely affected, which in turn could negatively affect its 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.

Reforms to and uncertainty regarding the London Interbank Offered Rate (“LIBOR”) may adversely affect LIBOR-based financial arrangements of the Company.

In 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis will not be guaranteed after 2021. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is not currently possible to predict the effect of any such alternatives on the value of LIBOR-based financial arrangements. The Federal Reserve Board, in conjunction with the Alternative Reference Rates Committee, is considering replacing the U.S. dollar LIBOR with the Secured Overnight Financing Rate ("SOFR"), a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. Whether or not SOFR attains traction as a LIBOR replacement tool remains in question. Uncertainty as to the nature of alternative reference rates, and as to potential changes or other reforms to LIBOR, may adversely affect LIBOR rates and the value of LIBOR-based financial arrangements of the Company. The implementation of an alternative index or indices for the Company’s financial arrangements may result in the Company incurring expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices and may result in disputes or litigation with customers over the appropriateness or comparability of the alternative index to LIBOR, which could have an adverse effect on the Company’s results of operations.

The Company operates in a highly regulated environment and may be adversely affected by changes in laws and regulations or the interpretation and examination of existing 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 financial 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 services including, but not limited to, retirement plan administration, fiduciary services to collective investment funds, 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, legislation, interpretation or application, 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.

The Dodd-Frank Act, as amended by the Economic Growth Act, 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.  The ongoing effects of the Dodd-Frank Act, as well as continued rule-making and possible future changes to the regulatory requirements make it difficult to assess the overall impact of the Dodd-Frank Act and related regulatory developments on the Company and the Bank.  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 is also directly subject to the requirements of entities that set and interpret the accounting standards such as the Financial Accounting Standards Board, and indirectly subject to the actions and interpretations of the Public Company Accounting Oversight Board, which establishes auditing and related professional practice standards for registered public accounting firms and inspects registered firms to assess their compliance with certain laws, rules, and professional standards in public company audits.  These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies and interpretations, control the methods by which financial institutions and their holding companies conduct business, engage in strategic and tax planning, implement strategic initiatives, and govern financial reporting.

The Company’s failure to comply with laws, regulations or policies could result in civil or criminal sanctions, restrictions to its business model, 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.

The Company’s total consolidated assets exceeded $10 billion and is therefore subject to additional regulation and increased supervision including the CFPB.

The Dodd-Frank Act imposes additional regulatory requirements on institutions with $10 billion or more in assets.  The Company is now subject to the following: (1) supervision, examination and enforcement by the CFPB with respect to consumer financial protection laws, (2) a modified methodology for calculating FDIC insurance assessments and potentially higher assessment rates, (3) limitations on interchange fees for debit card transactions, (4) heightened compliance standards under the Volcker Rule, and (5) enhanced supervision as a larger financial institution.  The imposition of these regulatory requirements and increased supervision may continue to require additional commitment of financial resources to regulatory compliance and may increase the Company’s cost of operations.

Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could limit our ability to pay dividends, engage in share repurchases and pay discretionary bonuses.

The Federal Reserve, the FDIC and the OCC adopted final rules for the Basel III capital framework which substantially amended the regulatory risk-based capital rules applicable to the Company. The rules phased in over time and became fully effective in 2019.  A capital conservation buffer was phased in over three years, ultimately resulting in a requirement of 2.5% on top of the common Tier 1, Tier 1 and total capital requirements, resulting in a required common Tier 1 equity ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. Failure to satisfy any of these three capital requirements will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.

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, Pennsylvania, Vermont and Massachusetts.  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.

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 its 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 Company’s information systems may experience an interruption or security breach and expose the Company to additional operational compliance and legal risks.

The Company relies heavily on existing and emerging 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, ransomware, cyber-attacks and other means.  The methods used to obtain unauthorized access, disable or degrade service or sabotage systems are constantly evolving and may be difficult to anticipate or to detect for long periods of time.  The constantly changing nature of the threats means that the Company may not be able to prevent all data security breaches or misuse of data. 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 or other 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.

Evolving data security and privacy requirements could increase the Company’s costs and expose it to additional operational, compliance, and legal risks.

The Company’s business requires the secure processing and storage of sensitive information relating to its customers, employees, business partners, and others.  However, like any financial institution operating in today’s digital business environment, the Company is subject to threats to the security of its networks and data, as described above.  These threats continue to increase as the frequency, intensity and sophistication of attempted attacks and intrusions increase around the world.  In response to these threats there has been heightened legislative and regulatory focus on data privacy and cybersecurity in the U.S. and the European Union and as a result, the Company must comply with an evolving set of legal requirements in this area, including substantive cybersecurity standards as well as requirements for notifying regulators and affected individuals in the event of a data security incident.  This regulatory environment is increasingly challenging and may present material obligations and risks to the Company’s business, including significantly expanded compliance burdens, costs and enforcement risks.

The Company relies on third party vendors, which could expose the Company to additional cybersecurity risks.

 

Third party vendors provide key components of the Company’s business infrastructure, including certain data processing and information services. On behalf of the Company, third parties may transmit confidential, propriety information. Although the Company requires third party providers to maintain certain levels of information security, such providers may remain vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious attacks that could ultimately compromise sensitive information. While the Company may contractually limit liability in connection with attacks against third party providers, the Company remains exposed to the risk of loss associated with such vendors. In addition, a number of the Company’s vendors are large national entities with dominant market presence in their respective fields. Their services could prove difficult to replace in a timely manner if a failure or other service interruption were to occur. Failures of certain vendors to provide contracted services could adversely affect the Company’s ability to deliver products and services to customers and cause the Company to incur significant expense.

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, quality customer service, 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.  On January 1, 2020, the Company adopted ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), also referred to as CECL. Under this new standard, the Company’s required allowance for credit losses may fluctuate more significantly from period to period due to changes in economic conditions, changes in the composition of the Company’s loan portfolios, changes in historical loss rates and changes in other credit factors, including the level of delinquent loans.

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 employee benefit trust businesses depends in large part on the level of assets under management and administration.  Market volatility and the potential to 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 employee benefit trust revenues.

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 to support common dividend payments and other uses, 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 held with an unconsolidated subsidiary trust.  As of December 31, 2019, the Company had $77.3 million of subordinated junior debentures held with an unconsolidated subsidiary trust outstanding.  The Company has the right to defer payment of interest on the subordinated junior debentures held with an unconsolidated subsidiary trust 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 held with an unconsolidated subsidiary trust, 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.  Recently completed and 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 the Company’s 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 was acquired primarily through whole-bank acquisitions and was not underwritten by the Company at origination.

At December 31, 2019, 21% 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. 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.

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 information could have a material adverse impact on business and, in turn, the Company’s financial condition and results of operations.

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 by its customers, 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 executes 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.

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:

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 provides inadequate succession planning or is unable to continue to retain and attract qualified employees, the Company’s performance, including its competitive position, could have a materially adverse effect.

The outbreak of the novel coronavirus (“COVID-19”), or an outbreak of other highly infectious or contagious diseases, could adversely impact certain industries in which the Company’s customers operate and impair their ability to fulfill their obligations to the Company.  Further, the spread of the outbreak could cause severe disruptions in the U.S. economy and may disrupt banking and other financial activity in the areas in which the Company operates and could potentially create widespread business continuity issues for the Company.

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions.  The spread of highly infectious or contagious diseases could cause severe disruptions in the U.S. economy which could disrupt the Company’s operations and if the global response to contain COVID-19 escalates or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows.  For example, the Company has certain customers that are engaged in international trade, travel and tourism and their businesses may be adversely affected by quarantines and travel restrictions in countries affected by COVID-19.  The outbreak of COVID-19 or an outbreak of other highly infectious or contagious diseases may result in a decrease in business and cause such customers to be unable to fulfill their repayment obligations to the Company.  Furthermore, the outbreak could negatively impact the ability of the Company’s employees and customers to engage in banking and other financial transactions in the geographic areas in which the Company operates and could create widespread business continuity issues for the Company.

None

The Company’s primary headquarters are located at 5790 Widewaters Parkway, Dewitt, New York, which is leased.  In addition, the Company has 273 properties, of which 165 are owned and 108 are under lease arrangements.  With respect to the Banking segment, the Company operates 231 full-service branches and 11 facilities for back office banking operations.  With respect to the Employee Benefit Services segment, the Company operates 11 customer service facilities, all of which are leased.  With respect to the All Other segment, the Company operates 20 customer service facilities, all of which are leased.  Some properties contain tenant leases or subleases.

Real property and related banking facilities owned by the Company at December 31, 2019 had a net book value of $83.9 million and none of the properties were subject to any material encumbrances.  For the year ended December 31, 2019, the Company paid $8.8 million of rental fees for facilities leased for its operations.  Effective January 1, 2019, the Company adopted new lease accounting guidance in accordance with Accounting Standards Update 2016-02, Leases (Topic 842) that requires recognition of a liability associated with future payments under lease agreements and a right-of-use asset representing the right to use the underlying assets.  The adoption of this new guidance resulted in the recognition of a lease liability of $34.2 million and corresponding right-of-use asset of $34.2 million.  As of December 31, 2019, the lease liability and corresponding right-of-use asset were $40.9 million and $39.9 million, respectively.  See the “New Accounting Pronouncements” Section of Note A on page 74 of the Notes to the Consolidated Financial Statements for further information about this guidance.  The Company believes that its facilities are suitable and adequate for the Company’s current operations.

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, 2019, 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 believed to be 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.

Not Applicable

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

Part II

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 51,891,678 shares of common stock outstanding on January 31, 2020, held by approximately 3,766 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.

The Company has historically paid regular quarterly cash dividends on its common stock, and declared a cash dividend of $0.41 per share for the first quarter of 2020.  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 the substantial majority of the funds available for the payment of dividends by the Company are derived from the subsidiary Bank, future dividends will depend largely upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations.

The following graph compares cumulative total shareholders returns on the Company’s common stock over the last five 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, 2014 and reinvestment of dividends.

The following table provides information as of December 31, 2019 with respect to shares of common stock that may be issued under the Company’s existing equity compensation plans.

⁽¹⁾ The number of securities includes 196,788 shares of unvested restricted stock.

At its December 2018 meeting, the Board approved a stock repurchase program authorizing the repurchase, at the discretion of senior management, of up to 2,500,000 shares of the Company’s common stock, in accordance with securities laws and regulations, during a twelve-month period starting January 1, 2019.  There were no treasury stock purchases made under this authorization in 2019.  At its December 2019 meeting, the Board approved a new stock repurchase program authorizing the repurchase, at the discretion of senior management, of up to 2,600,000 shares of the Company’s common stock, in accordance with securities laws and regulations, during a twelve-month period starting January 1, 2020.  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 2019:

⁽¹⁾ Included in the common shares repurchased were 1,187 shares acquired by the Company in connection with administration of a deferred compensation plan.  These shares were not repurchased as part of the publicly announced repurchase plan described above.

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, 2019.  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.

SELECTED CONSOLIDATED FINANCIAL INFORMATION

 

⁽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 and other intangible assets.  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 (See Table 20 for Reconciliation of GAAP to Non-GAAP Measures).

 

 ⁽²⁾ For purposes of this ratio, noninterest revenues excludes unrealized gain on equity securities, loss on debt extinguishment and insurance-related recoveries. Operating revenues, a non-GAAP measure, is defined as net interest income on a fully-tax equivalent basis, plus noninterest revenues, excluding unrealized gain on equity securities, loss on debt extinguishment, insurance-related recoveries and acquired non-impaired loan accretion (See Table 20 for Reconciliation of GAAP to Non-GAAP measures).

 

 ⁽³⁾ Efficiency ratio provides a ratio of operating expenses to operating income.  It excludes intangible amortization, acquisition expenses, and litigation settlement from expenses and acquired non-impaired loan accretion, insurance-related recoveries, gains and losses on investment securities, and loss on debt extinguishment 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 (See Table 20 for Reconciliation of GAAP to Non-GAAP Measures).

 

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 26 and the Company’s Consolidated Financial Statements and related notes that appear on pages 60 through 111.  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 2019, “last year” and equivalent terms refer to calendar year 2018, 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 54.

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 current accounting principles generally accepted in the United States of America (“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 as well as disclosures of revenues and expenses during the reporting period.  Actual results could differ from these estimates.  Management believes that the critical accounting estimates include the allowance for loan losses, actuarial assumptions associated with the pension, post-retirement and other employee benefit plans, the provision for income taxes, investment valuation and other-than-temporary impairment, the carrying value of goodwill and other intangible assets, and acquired loan valuations.  A summary of the accounting policies used by management is disclosed in Note A, “Summary of Significant Accounting Policies”, starting on page 65.

The Company also provides supplemental reporting of its results on an “operating,” “adjusted net” or “tangible” basis, from which it excludes the after-tax effect of amortization of core deposit and other intangible assets (and the related goodwill, core deposit intangible and other intangible asset balances, net of applicable deferred tax amounts), accretion on non-impaired purchased loans, acquisition expenses, the unrealized gain (loss) on equity securities, loss on debt extinguishment and the one-time benefit from the revaluation of net deferred tax liabilities.  Although “adjusted net income” as defined by the Company is a non-GAAP measure, the Company’s management believes this information helps investors understand the effect of acquisitions and other non-recurring activity in its reported results.  Reconciliations of GAAP amounts with corresponding non-GAAP amounts are presented in Table 20.

The Company’s business philosophy is to operate as a diversified financial services enterprise providing a broad array of banking and other financial services to retail, commercial and municipal customers.  The Company’s banking subsidiary is Community Bank, N.A. (the “Bank” or “CBNA”).  The Company also provides employee benefit and trust related services via its Benefit Plans Administrative Services, Inc. (“BPAS”) subsidiary, and wealth management and insurance-related services.

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) manage an investment securities portfolio to complement the Company’s loan and deposit strategies and optimize interest rate risk, yield and liquidity, (iv) increase the noninterest component of total revenues through development of banking-related fee income, growth in existing financial services business units, and the acquisition of additional financial services and banking businesses, and (v) utilize technology to deliver customer-responsive products and services and 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; components of net interest margin; 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 recently acquired businesses.

On October 21, 2019, the Company announced that it had entered into a definitive agreement to acquire Steuben Trust Corporation (“Steuben”), parent company of Steuben Trust Company, a New York State chartered bank headquartered in Hornell, New York, for approximately $104.4 million in Company stock and cash.  Steuben currently operates 14 branch locations in Western New York.  The acquisition will extend the Company’s footprint into two new counties in Western New York State and enhance the Company’s presence in four Western New York State counties in which it currently operates. The acquisition is expected to close during the second quarter of 2020, pending both customary regulatory and Steuben shareholder approval. The Company expects to incur certain one-time, transaction-related costs in 2020 in connection with the Steuben acquisition.

On September 18, 2019, the Company, through its subsidiary, Community Investment Services, Inc. (“CISI”), completed its acquisition of certain assets of a practice engaged in the financial services business headquartered in Syracuse, New York. The Company paid $0.5 million in cash to acquire a customer list, and recorded a $0.5 million customer list intangible asset in conjunction with the acquisition.

On July 12, 2019, the Company completed its merger with Kinderhook Bank Corp. (“Kinderhook”), parent company of The National Union Bank of Kinderhook, headquartered in Kinderhook, New York, for $93.4 million in cash. The merger added 11 branch locations across a five county area in the Capital District of Upstate New York. The merger resulted in the acquisition of $642.8 million of assets, including $479.9 million of loans and $39.8 million of investment securities, as well as $568.2 million of deposits and $40.3 million in goodwill.

On January 2, 2019, the Company, through its subsidiary, CISI, completed its acquisition of certain assets of Wealth Resources Network, Inc. (“Wealth Resources”), a financial services business headquartered in Liverpool, New York. The Company paid $1.2 million in cash to acquire a customer list from Wealth Resources, and recorded a $1.2 million customer list intangible asset in conjunction with the acquisition.

The Company reported net income of $169.1 million for the year ended December 31, 2019 that was 0.3% above the prior year, while earnings per share of $3.23 for the year was 0.3% below the prior year.  The increase in net income was due in part to the expanded business activities from the Kinderhook acquisition completed in the third quarter of 2019.  Contributing to the increase in net income was an increase in net interest income, a decrease in the provision for loan losses, an increase in gain on sales of investment securities, higher noninterest revenues and lower income taxes.  Partially offsetting these items were an increase in acquisition expenses, an increase in noninterest expenses and an increase in weighted average diluted shares outstanding attributable to shares issued in connection with the administration of the Company’s 401(k) plan and employee stock plan.  Net income adjusted to exclude acquisition expenses, gain on sales of investment securities, unrealized gain on equity securities, loss on debt extinguishment, amortization of intangibles, and acquired non-impaired loan accretion (“Adjusted Net Income”), increased $4.1 million, or 2.3%, compared to the prior year.  Earnings per share adjusted to exclude acquisition expenses, gain on sales of investment securities, unrealized gain on equity securities, loss on debt extinguishment, amortization of intangibles and acquired non-impaired loan accretion (“Adjusted Earnings Per Share”), of $3.44 increased $0.05, or 1.5%, compared to the prior year.  See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

The Company experienced year-over-year growth in average interest-earning assets, primarily reflective of the Kinderhook acquisition completed in July 2019.  Average deposits increased in 2019 as compared to 2018, reflective of organic growth and the impact of the Kinderhook acquisition.  Average external borrowings in 2019 decreased from 2018 reflective of a decrease in securities sold under an agreement to repurchase (“customer repurchase agreements”) as well as a decrease in overnight borrowings and a decrease in subordinated debt held by unconsolidated subsidiary trusts.  The decrease in average subordinated debt held by unconsolidated subsidiary trusts is due to the redemption of trust preferred debt held by MBVT Statutory Trust I (“MBVT I”) and the Kinderhook Capital Trust (“KCT”) during the third quarter of 2019, partially offset by subordinated debt acquired with the Kinderhook transaction.  Asset quality in 2019 remained stable and favorable in comparison to the end of 2018, with nonperforming loan ratios, the delinquency ratio and the full year net charge-off ratio at December 31, 2019 all improved from one year earlier.

Net income for 2019 was $169.1 million, an increase of $0.4 million, or 0.3%, from 2018’s earnings.  Earnings per share for 2019 was $3.23, down $0.01, or 0.3%, from 2018’s results.  Net income and earnings per share for 2019 were impacted by $8.6 million of acquisition expenses primarily related to the Kinderhook acquisition, while the Company recovered $0.8 million of vendor contract termination charges in 2018 that were initially recorded as an acquisition expense in the second quarter of 2017.  Adjusted Net Income increased $4.1 million, or 2.3%, compared to the prior year.  Adjusted Earnings per Share of $3.44 increased $0.05, or 1.5%, compared to the prior year.  See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

Net income for 2018 was $168.6 million, an increase of $17.9 million, or 11.9%, from 2017’s earnings, while earnings per share for 2018 was $3.24, up $0.21, or 6.9%. The 2018 results included the aforementioned $0.8 million recovery of vendor contract termination charges, while the 2017 results included $26.0 million, or $0.37 per share, of acquisition expenses primarily related to the Merchants and NRS acquisitions.  Adjusted Earnings per Share of $3.39 in 2018 increased $0.59, or 21.1%, compared to the prior year.  See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

Table 1: Condensed Income Statements

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 these general intermediation services, the Banking segment provides treasury management solutions and payment processing services.  Employee Benefit Services, consisting of BPAS and its subsidiaries, provides the following on a national basis: employee benefit trust services; collective investment fund; fund administration, transfer agency; retirement plan and VEBA/HRA and health savings account plan administration services; actuarial services; and healthcare consulting services.  BPAS services more than 3,800 benefit plans with approximately 450,000 plan participants and holds more than $89.3 billion in employee benefit trust assets.  In addition, BPAS employs 370 professionals located in 18 states, and occupies 11 offices located in Massachusetts, New York, New Jersey, Pennsylvania, Texas and Puerto Rico.  The All Other segment is comprised of wealth management and insurance services.  Wealth management activities include trust services provided by the personal trust unit of CBNA, investment products and services provided by CISI and The Carta Group, Inc. (“The Carta Group”), and asset advisory services provided by Nottingham Advisors, Inc. (“Nottingham”).  The insurance services activities include the offerings of personal and commercial property insurance and other risk management products and services provided by OneGroup NY, Inc. (“OneGroup”).  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 2019 earnings performance are discussed in the remaining sections of this document and are summarized by segment as follows:

BANKING

EMPLOYEE BENEFIT SERVICES

ALL OTHER (WEALTH MANAGEMENT AND INSURANCE SERVICES)

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

As displayed in Table 2, the 2019 return on average assets ratio decreased five basis points and the return on average equity ratio decreased 78 basis points as compared to 2018.  The decrease in return on average assets was primarily the result of an increase in average assets, primarily related to the Kinderhook acquisition, which outpaced the increase in net income that was impacted by $8.6 million in acquisition expenses incurred in 2019.  The return on average equity ratio decreased in 2019 as the increase in average equity outpaced net income that was impacted by the aforementioned acquisition expenses.  The return on average assets ratio in 2018 increased nine basis points, while the return on average equity ratio decreased one basis point as compared to 2017.  The increase in return on average assets was primarily the result of an increase in net income, reflective of a full year of activities from the Merchants and NRS transactions, which outpaced the increase in average assets.  The return on average equity ratio decreased slightly in 2018 as the increase in average equity due primarily to the impact of the shares issued for the Merchants and NRS acquisitions and earnings retention slightly outpaced the increase in net income.  The return on average assets adjusted to exclude acquisition expenses, gain on sales of investment securities, unrealized gain on equity securities, loss on debt extinguishment, amortization of intangibles, and acquired non-impaired loan accretion decreased two basis points to 1.63% in 2019, as compared to 1.65% in 2018.  The return on average equity adjusted to exclude acquisition expenses, gain on sales of investment securities, unrealized gain on equity securities, loss on debt extinguishment, amortization of intangibles, and acquired non-impaired loan accretion decreased 61 basis points to 10.03% in 2019, from 10.64% in 2018.  See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

The dividend payout ratio for 2019 increased 4.6% from 2018 as the 10.7% increase in dividends declared from 2018 was higher than the 0.3% increase in net income.  The increase in dividends declared in 2019 was a result of a 9.7% increase in the dividends declared per share and the issuance of shares in connection with the administration of the Company’s 401(k) plan and employee stock plan.  The dividend payout ratio for 2018 increased 0.3% from 2017 as the 12.7% increase in dividends declared from 2017 was modestly higher than the 11.9% increase in net income.  The increase in dividends declared in 2018 was a result of a 9.1% increase in the dividends declared per share and the issuance of shares in connection with the administration of the Company’s 401(k) plan and employee stock plan.

The average equity to average assets ratio continued to increase in 2019 as the growth in common shareholders’ equity outpaced the growth in assets.  During 2019, average equity increased 8.5% while average assets increased at a rate of 3.5%.  In 2018 average equity rose 12.0% and average assets grew 5.7% in comparison to 2017.

Net interest income is the amount by which interest and fees on earning assets (loans, investments and cash equivalents) exceeds the cost of funds, which consists primarily of interest paid to the Company's depositors and interest on borrowings.  Net interest margin is the difference between the yield on interest earning assets and the cost of interest-bearing liabilities 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 $363.2 million in 2019, an increase of $13.8 million, or 3.9%, from the prior year.  The increase is a result of a $295.4 million, or 3.2%, increase in average interest-earning assets and an 11 basis point increase in the average yield on interest-earning assets, partially offset by a $97.5 million increase in average interest-bearing liabilities and a 13 basis point increase in the average rate on interest-bearing liabilities.  As reflected in Table 4, the favorable impact of the increase in interest-earning assets ($11.8 million) and increase in the yield ($10.9 million) was partially offset by the unfavorable impact of the increase in interest-bearing liabilities ($0.3 million) and the higher rate on interest-bearing liabilities ($8.6 million).

The 2019 net interest margin increased three basis points to 3.76% from 3.73% reported in 2018.  The increase was attributable to an 11 basis point increase in the earning-asset yield, offset by a 13 basis point increase in the cost of interest-bearing liabilities.  The 4.73% yield on loans increased 15 basis points in 2019 as compared to 4.58% in 2018, including the impact of acquired loan accretion associated with the Kinderhook acquisition.  The yield on investments, including cash equivalents, of 2.58% in 2019 was consistent with 2018.  The yield on investments included the impact of the sale of $590.2 million of available-for-sale Treasury securities in the second quarter of 2019 with subsequent reinvestment of the proceeds occurring primarily in the fourth quarter.  The proceeds from the sale of securities in the second quarter were held in interest-earning cash until more attractive reinvestment options became available in the fourth quarter.  The cost of interest-bearing liabilities was 0.40% during 2019 as compared to 0.27% for 2018.  The increased cost reflects the 10 basis point increase in the average rate paid on deposits and the 14 basis point higher average rate paid on borrowings in 2019.

The net interest margin in 2018 increased four basis points to 3.73% from 3.69% reported in 2017.  The increase was attributable to an eight basis point increase in the earning-asset yield, offset by a five basis point increase in the cost of interest-bearing liabilities.  The 4.58% yield on loans increased 19 basis points in 2018 as compared to 4.39% in 2017, including the impact of incremental acquired loan accretion on the Merchants portfolio.  The yield on investments, including cash equivalents, decreased from 2.79% in 2017 to 2.58% in 2018.  This lower yield on investments is reflective of maturing higher rate investments being replaced with lower-yielding securities and interest-earning cash, as well as the result of a lower fully tax-equivalent adjustment due to the lower federal tax rate associated with the Tax Cuts and Jobs Act.  The cost of interest-bearing liabilities was 0.27% during 2018 as compared to 0.22% for 2017.  The increased cost reflects the three basis point increase in the average rate paid on deposits and the 21 basis point higher average rate paid on borrowings in 2018.

As shown in Table 3, total FTE-basis interest income increased by $22.7 million, or 6.2%, in 2019 in comparison to 2018. Table 4 indicates that a higher average earning-asset balance created $11.8 million of incremental interest income and a higher yield on earning assets had a favorable impact of $10.9 million on interest income.  Average loans increased $278.9 million, or 4.5%, in 2019.  This increase was primarily due to acquired growth from the Kinderhook acquisition, which accounted for $217.6 million of the growth.  FTE-basis loan interest income and fees increased $22.1 million, or 7.7%, in 2019 as compared to 2018, attributable to the higher average balances and a 15 basis point increase in the loan yield.

Investment interest income (FTE basis) in 2019 was $0.6 million, or 0.7%, higher than the prior year as a result of a $16.6 million increase in the average book basis balance of investments (including cash equivalents) and an average investment yield of 2.58% that was consistent with the prior year.  The higher average investment book balance is inclusive of the $37.7 million of available-for-sale securities and $2.1 million of equity and other securities acquired with the Kinderhook transaction.

Total interest income in 2018 increased $28.2 million, or 8.3%, from 2017’s level.  As shown in table 4, the higher average earning-asset balance created $21.6 million of incremental interest income and a higher yield on earning assets had a favorable impact of $6.6 million on interest income.  Average loans increased $445.5 million, or 7.7%, in 2018.  This increase was primarily due to acquired growth from the Merchants acquisition, which accounted for $351.9 million of the growth.  FTE-basis loan interest income and fees increased $31.8 million, or 12.5%, in 2018 as compared to 2017, attributable to the higher average balances and a 19 basis point increase in the loan yield.  On a FTE basis, investment interest income, including interest on cash equivalents, totaled $80.0 million in 2018, $3.6 million, or 4.3%, lower than the prior year as a result of a 21 basis point decrease in the average investment yield from 2.79% in 2017 to 2.58% in 2018.  This decrease in yield was partially offset by a $108.2 million, or 3.6%, higher average book basis balance (including cash equivalents) for 2018 versus the prior year.  The lower average investment yield in 2018 was reflective of cash flows from higher rate maturing instruments in the investment portfolio being reinvested at lower interest rates or held in interest-earning cash.

Total interest expense increased by $8.9 million, or 50.2%, to $26.6 million in 2019.  As shown in Table 4, higher interest rates on interest-bearing liabilities resulted in an increase in interest expense of $8.6 million, while higher deposit balances resulted in a $0.3 million increase in interest expense.  Interest expense as a percentage of average earning assets for 2019 increased eight basis points to 0.27%.  The rate on interest-bearing deposits of 0.32% was 15 basis points higher than 2018, primarily due to an increase in certain product rates in response to changes in market interest rates during 2018 and 2019.  The rate on borrowings increased 14 basis points to 1.86% in 2019, primarily due to the increase in the average variable rate paid on subordinated debt held by unconsolidated subsidiary trusts and overnight borrowings.  Total average funding balances (deposits and borrowings) in 2019 increased $196.1 million, or 2.2%.  Average deposits increased $277.1 million, with $260.0 million of the increase from the Kinderhook acquisition.  Average non-time (“core”) deposit balances increased $184.9 million and accounted for 90.3% of total average deposits compared to 91.1% in 2018, due to the addition of $185.9 million in core deposit balances with the Kinderhook acquisition, partially offset by a $1.0 million decrease in legacy deposits.  Average time deposits increased by $92.2 million year-over-year, including $74.1 million in average time deposits from the Kinderhook acquisition.  Average time deposits represented 9.7% of total average deposits for 2019 compared to 8.9% in 2018.  Average external borrowings decreased $81.0 million in 2019 as compared to 2018, due to a decrease in average customer repurchase agreements of $42.6 million, a decrease in subordinated debt held by unconsolidated subsidiary trusts of $20.1 million and a decrease in FHLB borrowings, partially offset by an increase in average subordinated notes payable of $6.5 million associated with subordinated notes acquired in the Kinderhook transaction.  The decrease in average subordinated debt held by unconsolidated subsidiary trusts is due to the redemption of trust preferred debt held by MBVT I and the KCT during the third quarter of 2019 for a total of $22.7 million, offset by a partial year of subordinated debt acquired with the Kinderhook transaction.

Total interest expense increased by $3.9 million, or 28.3%, to $17.7 million in 2018.  As shown in Table 4, higher interest rates on interest-bearing liabilities resulted in an increase in interest expense of $3.5 million, while higher deposit balances resulted in a $0.4 million increase in interest expense.  Interest expense as a percentage of average earning assets for 2018 increased three basis points to 0.19%.  The rate on interest-bearing deposits of 0.17% was four basis points higher than 2017, primarily due to an increase in certain product rates in response to the increase in market interest rates during 2018.  The rate on borrowings increased 21 basis points to 1.72% in 2018, primarily due to the increase in the variable rate paid on subordinated debt held by unconsolidated subsidiary trusts and overnight borrowings.  Total average funding balances (deposits and borrowings) in 2018 increased $433.4 million, or 5.1%.  Average deposits increased $405.3 million, representing an increase of $428.6 million from the Merchants acquisition offset by a decrease of $23.3 million in legacy deposits.  Average non-time (“core”) deposit balances increased $420.1 million to 91.1% of total average deposits compared to 90.5% in 2017, while average time deposits decreased by $14.9 million year-over-year, representing 8.9% of total average deposits for 2018 compared to 9.5% in 2017.  Average external borrowings increased $28.1 million in 2018 as compared to 2017, as a year-over-year increase in average customer repurchase agreements of $88.9 million was partially offset by a decrease in average FHLB borrowings of $57.9 million and a decrease in average subordinated debt held by unconsolidated subsidiary trusts of $2.9 million.  The increase in average customer repurchase agreements is primarily related to a full year of customer activity from the Merchants acquisition, while the decrease in FHLB borrowings is due to cash flows from investment maturities being used to pay down overnight borrowings.  The decrease in average subordinated debt held by unconsolidated subsidiary trusts is due to the redemption of trust preferred debt held by Community Statutory Trust III during the third quarter of 2018 for a total of $25.2 million, offset by a full year of subordinated debt acquired with the Merchants transaction.

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, 2019, 2018 and 2017.  Interest income and yields are on a fully tax-equivalent basis using marginal income tax rates of 24.0% in 2019, 24.4% in 2018 and 37.7% in 2017.  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 and acquired loan accretion.  Average loan balances include acquired loan purchase discounts and premiums, nonaccrual loans and loans held for sale.

Table 3: Average Balance Sheet

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

The Company’s sources of noninterest revenues are of four 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 trust and benefit plan administration services (performed by BPAS and its subsidiaries); 3) wealth management services, comprised of personal trust services (performed by the trust unit within CBNA), investment products and services (performed by CISI and The Carta Group) and asset management services (performed by Nottingham); and 4) insurance products and services (performed by OneGroup).  Additionally, the Company has other transactions, including unrealized gains or losses on equity securities, realized gains or losses from the sale of investment securities and loss on debt extinguishment.

Table 5: Noninterest Revenues

As displayed in Table 5, total noninterest revenues, excluding unrealized gain on equity securities, gain on the sale of investment securities and loss on debt extinguishment, increased $2.0 million, or 0.9%, to $225.7 million in 2019 as compared to 2018.  The increase was comprised of growth in revenue from the Company’s employee benefit services businesses, an increase in wealth management and insurance services revenue and an increase in other banking revenues, partially offset by a decrease in debit card-related revenue related to Durbin amendment mandated debit interchange price restrictions.  Noninterest revenues, excluding unrealized gain on equity securities, loss on debt extinguishment and gain on the sale of investment securities, increased by $21.3 million, or 10.5%, to $223.7 million in 2018 as compared to 2017.  The increase was comprised of growth in revenue from the Company’s employee benefit services businesses, primarily from a full year of activity associated with the NRS acquisition and organic growth, an increase in wealth management and insurance services revenue and an increase in other banking revenues, partially offset by a decrease in debit card-related revenue related to Durbin amendment mandated debit interchange price restrictions.

Noninterest revenues as a percent of operating revenues (FTE basis) were 38.7% in 2019, down 0.9% from the prior year.  The current year decrease was due to the 4.6% increase in adjusted net interest income (FTE basis), while noninterest revenues increased by the 0.9% mentioned above.  The 0.8% increase in this ratio from 2017 to 2018 was driven by a 10.5% increase in noninterest revenues mentioned above, while net interest income increased 7.0%.

A significant portion of the Company’s recurring noninterest revenue is comprised of the wide variety of fees earned from general banking services provided through the branch network, electronic banking channels and other banking revenues, which totaled $70.5 million in 2019, a decrease of $4.9 million, or 6.4%, from the prior year.  The decrease was primarily driven by a decrease in debit card-related revenue due to the impact of Durbin amendment mandated debit interchange price restrictions that were effective beginning in the third quarter of 2018, partially offset by the addition of new deposit relationships from the Kinderhook acquisition.  Fees from general banking services were $75.4 million in 2018, an increase of $2.0 million, or 2.7%, from 2017.  The increase was primarily driven by the addition of new deposit relationships from the Merchants acquisition, offset by a decrease of approximately $7.1 million in debit card-related revenue due to the impact of Durbin amendment mandated debit interchange price restrictions that were effective beginning in the third quarter of 2018.

As disclosed in Table 5, noninterest revenue from financial services (revenues from employee benefit services, wealth management services and insurance services) increased $6.9 million, or 4.6%, in 2019 to $155.2 million.  In 2019, financial services revenue accounted for 67% of total noninterest revenues, as compared to 66% in 2018.  Employee benefit services generated revenue of $97.2 million in 2019 that reflected growth of $4.9 million, or 5.3%, primarily due to organic increases in the number of supported plans and related participant levels.  Employee benefit services revenue in 2018 of $92.3 million reflected growth of $11.4 million, or 14.2%, driven primarily by a full year of activity from NRS.

Wealth management and insurance services revenues increased $2.0 million, or 3.3%, in 2019 due primarily to an increase in OneGroup revenue.  Wealth management and insurance services revenue increased $7.9 million, or 16.3%, in 2018 due to revenue growth from OneGroup, which represented $4.2 million of the increase, an increase in revenue from CISI of $2.2 million and an increase in personal trust revenue of $1.5 million.

Employee benefit trust assets increased $14.9 billion to $89.3 billion for the employee benefit services segment in 2019 as compared to 2018 due primarily to organic growth in the collective investment trust business.  Assets under management increased $793.8 million to $6.6 billion for the wealth management businesses at year end 2019 as compared to one year earlier due to organic growth.  Trust assets within the Company’s employee benefit services segment increased $11.5 billion to $74.4 billion at the end of 2018 as compared to 2017 due primarily to organic growth in the collective investment trust business.  Assets under management with the Company’s wealth management services segment decreased $667.9 million to $5.8 billion at the end of 2018 as compared to year-end 2017 due in part to a general decline in overall market valuations late in 2018.

As shown in Table 6, noninterest expenses of $372.0 million in 2019 were $26.7 million, or 7.7%, higher than 2018, primarily reflective of the $8.6 million in one-time expenses incurred in 2019 related to the Kinderhook acquisition and the additional expenses associated with operating an expanded branch network subsequent to the Kinderhook transaction.  Noninterest expenses in 2018 decreased $1.9 million, or 0.5%, from 2017 to $345.3 million, primarily reflective of the $26.0 million in one-time expenses incurred in 2017 related to the Merchants and NRS acquisitions, offset by the expenses associated with operating an expanded branch network and other business activities acquired with the Merchants and NRS transactions for a full year.

Operating expenses (excluding acquisition expenses and amortization of intangible assets) as a percent of average assets for 2019 was 3.15%, an increase of eight basis points from 3.07% in 2018 and 13 basis points higher than the 3.02% in 2017.  The increase in this ratio for 2019 was due to a 6.0% increase in operating expenses, primarily a result of expanded operations from the Kinderhook acquisition, while average assets grew by 3.5% due primarily to net assets and intangibles from the Kinderhook acquisition and organic growth.  The increase in this ratio for 2018 was due to a 7.8% increase in operating expenses, primarily a result of a full year of expanded operations from the Merchants and NRS acquisitions, while average assets grew by 5.7% due primarily to a full year of acquired net assets and intangibles from the Merchants and NRS transactions. 

The efficiency ratio, a performance measurement tool widely used by banks, is defined by the Company as operating expenses (excluding acquisition expenses and intangible amortization) divided by operating revenue (fully tax-equivalent net interest income plus noninterest revenue, excluding acquired non-impaired loan accretion, unrealized gain on equity securities, and insurance-related recoveries).  Lower ratios are correlate to higher operating efficiency.  In 2019, the efficiency ratio was 1.6% higher than 2018 as the 6.0% increase in operating expenses grew at a faster pace than the 3.1% increase in operating revenue, comprised of a 4.6% increase in adjusted net interest income and a 0.9% increase in adjusted noninterest revenue, as defined above.  The ratio for 2018 was 0.3% below 2017 as the 8.4% increase in operating revenue, comprised of a 7.0% increase in adjusted net interest income and a 10.5% increase in noninterest revenue, as defined above, grew at a faster pace than the 7.8% increase in operating expenses.  See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

Table 6: Noninterest Expenses

Total salaries and employee benefits increased $12.6 million, or 6.1%, in 2019, due to the impact of annual merit increases, a partial year expanded operations associated with the Kinderhook acquisition, higher incentive compensation, and an increase in medical expenses.  Salaries and employee benefits increased $20.5 million, or 10.9%, in 2018, due to the impact of annual merit increases, a full year of expenses related to the employees from the Merchants acquisition in May 2017, a full year of expenses related to the employees from the NRS acquisition in February 2017, higher incentive compensation, an increase in retirement plan costs and higher severance expense.  Total full-time equivalent staff at the end of 2019 was 2,763 compared to 2,675 at December 31, 2018 and 2,617 at the end of 2017.  The increase in retirement plan expense in 2019 and 2018 is primarily due to the increase in service cost associated with an increase in the number of employees participating in the plan combined with an increase in eligible compensation associated with merit increases and increases in incentive compensation.  See Note K to the financial statements for further information about the pension plan.

Total non-personnel, noninterest expenses, excluding one-time acquisition expenses, increased $4.8 million, or 3.5%, in 2019, mostly reflective of a partial year of the additional costs associated with the acquired Kinderhook business activities.  Increases in data processing and communications, legal and professional fees, business development and marketing and other expenses were partially offset by a decrease in occupancy and equipment and amortization of intangible assets.  Total non-personnel noninterest expenses, excluding one-time acquisition expenses, increased $4.4 million, or 3.3%, in 2018, mostly reflective of a full year of the additional costs associated with the acquired Merchants and NRS business activities.  Increases in occupancy and equipment, data processing and communications, and amortization of intangible assets, all primarily a result of the additional costs associated with a full year of expanded business activities from the Merchants and NRS acquisitions, were partially offset by a decrease in legal and professional fees, business development and marketing and other expenses.

Acquisition expenses for 2019 totaled $8.6 million, including $8.0 million associated with the Kinderhook acquisition and $0.6 million associated with the Steuben acquisition.  During 2018, the Company recovered $0.8 million of vendor contract termination charges associated with the Merchants acquisition, which were recorded as an acquisition expense during the second quarter of 2017.  Acquisition expenses for 2017 totaled $26.0 million, including $24.6 million associated with the Merchants acquisition, $1.2 million associated with the NRS acquisition and $0.2 related to all other acquisitions.

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 90.  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.

On December 22, 2017, H.R.1, referred to as the “Tax Cuts and Jobs Act,” was signed into law.  Among other things, the Tax Cuts and Jobs Act permanently lowered the corporate tax rate to 21% from a maximum rate of 35%, effective for tax years including or commencing January 1, 2018.  ASC 740, Income Taxes, requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to be applied when the temporary differences are to be realized or settled. Thus, as of the December 22, 2017 date of enactment, deferred taxes were re-measured based upon the new 21% tax rate.  Prior to the change in tax rate in 2017, the Company had recorded net deferred tax liabilities based on a marginal tax rate of 37.70%.  The change in tax rate resulted in a decrease in the marginal tax rate to 24.29% and a deferred tax benefit of $38.0 million from the write-down of the net deferred tax liabilities in the fourth quarter of 2017. The effect of this change in tax law was recorded as a component of the income tax provision including those deferred assets and liabilities that were established through a financial statement component other than continuing operations.

The effective tax rate for 2019 was 19.2%, compared to 20.8% in 2018 and 5.8% in 2017.  The effective tax rate of 5.8% for 2017 included the impact of the $38.0 million one-time gain from the revaluation of net deferred tax liabilities related to the enactment of the Tax Cuts and Jobs Act passed in the fourth quarter of 2017.  The adjusted effective tax rate for 2017, excluding the one-time gain from revaluation of net deferred tax liabilities, was 29.5%.  The decline in the effective rate for 2019, compared to the effective tax rate for 2018, is primarily attributable to an increase in windfall tax benefit associated with stock-based compensation activity and a reduction in certain activity-based state income tax expenses.

Shareholders’ equity ended 2019 at $1.86 billion, up $141.5 million, or 8.3%, from the end of 2018.  This increase reflects net income of $169.1 million, $6.9 million from the issuance of shares through the employee stock plans, $6.9 million for treasury stock issued to the Company’s 401(k) plan, $5.3 million from stock-based compensation and a $35.1 million increase in accumulated other comprehensive income.  These increases were partially offset by common stock dividends declared of $81.8 million.  The change in accumulated other comprehensive income was comprised of a $37.1 million increase due to changes in the unrealized gains and losses in the Company’s available-for-sale investment portfolio, partially offset by a $2.0 million adjustment in the overfunded status of the Company’s employee retirement plans.  Excluding accumulated other comprehensive income in both 2019 and 2018, shareholders’ equity increased by $106.4 million, or 6.0%.  Shares outstanding increased by 0.5 million during the year due to share issuances under the employee stock plan, deferred compensation arrangements and to the Company’s 401(k) plan.

Shareholders’ equity ended 2018 at $1.71 billion, up $78.5 million, or 4.8%, from the end of 2017.  This increase reflects net income of $168.6 million, $6.4 million from the issuance of shares through the employee stock plan, $12.6 million for treasury stock issued to the Company’s 401(k) plan and $6.1 million from stock-based compensation.  These increases were partially offset by common stock dividends declared of $73.8 million and a $41.4 million decrease in accumulated other comprehensive income.  The change in accumulated other comprehensive income was comprised of a $30.2 million decrease due to changes in the unrealized gains and losses in the Company’s available-for-sale investment portfolio and an $11.2 million net decline in the overfunded status of the Company’s employee retirement plans.  Excluding accumulated other comprehensive income in both 2018 and 2017, shareholders’ equity rose by $120.1 million, or 7.3%.  Shares outstanding increased by 0.6 million during the year due to share issuances under the employee stock plan, deferred compensation arrangements and to the Company’s 401(k) plan.

The Company’s ratio of ending tier 1 capital to adjusted quarterly average assets (or tier 1 leverage ratio), the primary measure for which regulators have established a 5% minimum for an institution to be considered “well-capitalized,” decreased 0.28% from the prior year to end the year at 10.80%.  This was the result of an increase of 7.8% in average adjusted net assets (excludes investment market value adjustment, and a portion of intangible assets net of related deferred tax liabilities), while tier 1 capital increased by 5.0% from the prior year.  For additional financial information on the Company’s regulatory capital, refer to Note P – Regulatory Matters in the Notes to Consolidated Financial Statements.  The tangible equity-to-tangible assets ratio (a non-GAAP measure) was 10.01% at the end of 2019 versus 9.68% one year earlier (See Table 20 for Reconciliation of GAAP to Non-GAAP Measures).  The increase was due to tangible common shareholders’ equity increasing by 11.6% from the prior year, while tangible assets increased at a lesser 7.8% from the prior year.  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 2019 of $81.8 million represented an increase of 10.7% over the prior year.  This growth was a result of the increase in outstanding shares as noted above and a $0.14 increase in dividends per share for the year.  Dividends per share for 2019 of $1.58 represents a 9.7% increase from $1.44 in 2018, a result of quarterly dividends per share increasing from $0.34 to $0.38, or 11.8%, during the third quarter of 2018 and from $0.38 to $0.41, or 7.9%, in the third quarter of 2019.  The 2019 increase in quarterly dividends marked the 27^th consecutive year of dividend increases for the Company.  The dividend payout ratio for this year was 48.4% compared to 43.8% in 2018, and 43.5% in 2017.  The dividend payout ratio increased during 2019 because dividends declared increased 10.7% while net income increased 0.3% from 2018.  The payout ratio increased during 2018 because dividends declared increased 12.7% while net income increased 11.9% from 2017.

Liquidity risk is a measure of the Company’s ability to raise cash when needed at a reasonable cost and minimize any loss.  The Company 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.

Given the uncertain nature of the Company’s 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 utilized 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 overnight advances, of which there were $8.3 million at December 31, 2019.

The Company’s primary sources of liquidity are its liquid assets, as well as unencumbered loans and securities that can be used to collateralize additional funding.  At December 31, 2019, the Bank had $205.0 million of cash and cash equivalents of which $43.2 million are interest-earning deposits held at the Federal Reserve, FHLB and other correspondent banks.  The Company also had $1.8 billion in unused FHLB borrowing capacity based on the Company’s quarter-end collateral levels.  Additionally, the Company has $1.7 billion of unencumbered securities that could be pledged at the FHLB or Federal Reserve to obtain additional funding.  There is $25.0 million available in unsecured lines of credit with other correspondent banks.

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, 2019, this ratio was 13.9% for 30-days and 13.9% for 90-days, excluding the Company's capacity to borrow additional funds from the Federal Home Loan Bank of New York (“FHLB”) and other sources.  This is considered to be a sufficient amount of liquidity based on 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, 2019, 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, 2019 indicate the Company 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 (the “Board”) 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 would likely 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.

The changes in intangible assets by reporting segment for the year ended December 31, 2019 are summarized as follows:

Table 7: Intangible Assets