Welcome to the Community Bank System's Second Quarter 2015 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Security Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment in which the company operates. Such statements involve risk and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company's annual report and Form 10-K filed with the Securities and Exchange Commission. Today's call presenters are Mark Tryniski, President and Chief Executive Officer; and Scott Kingsley, Executive Vice President and Chief Financial Officer. Gentlemen, you may begin.

Thank you, Nicky. Good morning, everyone, and thank you all for joining our call this morning. Second quarter results were good and generally in line with our expectations. Last quarter's substantial underperformance in lending was this quarter's strength. Loans were up $100 million for the quarter led by Business Lending, with contribution from all markets. Auto Lending was strong as well, with mortgage, home equity and direct branch lending also up for the quarter and asset quality continues to be very good. Fee income results were mixed, wealth management and banking were flat but benefits administration revenues were up 8% over last year's quarter. Expense management was very good, with total operating expenses up less than 1% over 2014. Overall, it was a solid operating quarter. Last quarter, we discussed the pending Oneida Financial acquisition in detail, so I will just comment on current status. We initially expected this transaction to close this month, but as we announced in June, we've extended the closing pending completion of regulatory approvals. Oneida's shareholders overwhelmingly approved the transaction at their June 17th meeting. Integration efforts are underway and proceeding well, and we expect to close in the fourth quarter. We're excited about the prospects Oneida Financial brings to our combined organization, particularly around the opportunity related to their insurance, benefits administration and wealth management businesses. We continue to expect 2016 accretion to approximate $0.07 per share on a GAAP basis and $0.11 per share on a cash basis. Post Oneida, total assets will approximate $8.5 billion. Given the higher hurdles in many respects as being a $10 billion bank, we have begun to build the runway to prepare for that eventuality. We're making infrastructure investments in operations, capital planning, risk management and compliance in order to be fully prepared to meet higher organizational…

Thank you, Mark, and good morning, everyone. As Mark mentioned, the second quarter of 2015 was a very solid operating quarter for us, with modest yet still productive year-over-year operating improvement trends. I'll first discuss some balance sheet items. Average earning assets of $6.86 billion for the second quarter were up 3.5% from the second quarter of 2014. Average loans grew $90 million year-over-year or 2.2%. Ending loans were up $99.7 million in the end of the seasonally challenged first quarter of this year, with productive growth in all of our portfolios. Average investment securities were up 5.6% compared to the second quarter of 2014, principally a result of our decision to early invest the expected net liquidity of the pending Oneida Financial transaction. Since early March, we have purchased $400 million of treasury securities with blended yields just below 2% as a planned replacement for the $300 million of securities currently held in the Oneida portfolio as well as the redeployment of the remainder of our own expected invested cash flows for 2015. Average deposits were up 2.0% from the second quarter of last year and the multiyear trend away from time deposits and into core checking, savings and money market accounts continued in the first half of 2015, resulting in a further decline in overall funding costs. Quarter end loans in our Business Lending portfolio of $1.3 billion as of June 30 were $56.4 million or 4.5% above the end of the first quarter and are 2.6% above year-end 2014 levels. Asset quality results in this portfolio continue to be very favorable, with net charge-offs of under 11 basis points of average loans over the last 9 quarters. Our total consumer real estate portfolios of $1.95 billion comprised of $1.61 billion of consumer mortgages and $341 million of…

[Operator Instructions] And our first question will come from Alex Twerdahl with Sandler O'Neill.

First, Mark, you're talking in your prepared remarks about beginning to build up expenses in the expense base and building out some of the systems and adding into various departments as you approach the $10 billion mark. Is that something that's changed? I thought that's something that's been kind of going on for a couple of quarters already at this point. And based on what you're talking about a couple of minutes ago, is that going to -- should that change anyone's expense expectations for the coming quarters and into 2016?

Yes -- no Alex, I didn't intend to signal there was an increase in the expense base. I think we have begun during the first quarter, I would say, to invest in resources and software applications and processes and the consultants and the like to try to prepare the ground for the $10 billion mark. So it's just a reminder that, that effort will continue as we build out this runway so that we're fully prepared at the point we do our asset -- the threshold of $10 billion. So it's not intended to signal anything other than as a reminder that -- to our shareholders that we're continuing to invest and to think about it and to be prepared when that eventuality arises.

Okay, great. That's what I thought. And then maybe you can just give us a little more color on the commercial lending trends in the second quarter. I know you mentioned that the pipelines were very strong at the end of March. Maybe you can talk a little bit about whether or not the growth in the second quarter was really just a result of some closings being pushed into the second quarter, or if there was a change in addition of some initiatives? Or anything along those lines and then tell us where the pipeline were at the end of June.

Sure. To answer your question, I think that the performance in the second quarter was a result of both of these items and elements that you mentioned. One is there was certainly, if you look at the performance in the first quarter, a lot of things that didn't get done. There were a lot of -- there was deferral of projects, construction and otherwise from the first quarter into the second quarter. That was part of it. I think it was also organic activity in the second quarter. So I think the performance in the turnaround, plus $56 million in the second quarter was partially attributable to deferral and partially attributable to improved activity. I think also I would applaud our commercial Business Lending team. It was also a result of really very good execution on the ground in all of our markets. We saw very good activity and growth in our Northern New York markets, in our Northeast Pennsylvania markets, in our kind of Central New York markets and also in our Western markets. So it was just a really good, strong all-around performance across the company in the second quarter. And if you look at where it was, it was really -- it was also spread out across the board. It was CRE and it was also C&I. It was construction. It was some refis. It was some new CRE, some owner occupied, some not. It was also improved line utilization particularly by some of our larger commercial customers. So it was really an exceptionally good and strong performance by the commercial lending team. The pipeline is -- remains very strong. I think relative to where it was in March, it's at or above that level right now. So we are expecting another strong performance, let's call it, in the third and fourth quarters. So the trend line right now in momentum in commercial is very good, and we're hopeful that it continues through the remainder of the year.

And the next question will come from Joe Fenech with Hovde Group.

Guys, on the 1Q call, you indicated that you still considered yourself to be in a surplus capital position post the Oneida deal, which seem to imply that you'd consider additional acquisitions in the near term. If that assumption's correct, how does the delay impact your thinking on future deals, if at all? And how does that tie into your comments earlier about preparing for the approach to $10 billion?

Well, I think it's certainly true that we will have considerable excess capital after the Oneida transaction closes, possibly in the hundred million dollar range. So we will -- as we've suggested in the past, we need to continue to be disciplined to deploy that capital in a way that creates sustainable value for our shareholders, and we'll continue to do that. I don't know that the delay on the Oneida transaction is going to affect significantly how we think about other transactions other than thinking about the establishment of a closing time line and the impact of the current regulatory process for reviewing M&A. And I think historically, we'd like to sprint to the finish line and get an -- announce and close, execute and move forward. I think in the regulatory approval environment today, we're going to need to rethink the time line of that process, and we always use to like to sprint to the finish line. And now maybe it's a -- instead of 100-meter dash, maybe it's a quarter mile at this point. So I think that's probably the only takeaway, Joe. I think the other element is just, I think, the regulatory environment, also the expectations around things like risk management, and compliance, and CRA, and fair lending, and BSA AML, and all those things. I think the bar just continues to get raised on banks -- all banks, not just banks that are growing through M&A, but I would say particularly through banks that are going through M&A because of the opportunity that it creates for regulators to ask more questions. And I think we need to be mindful of the increased level of questions that might be asked and be prepared to efficiently answer those questions as we're going through presently with the Oneida transaction. So I don't expect a revolution in terms of how we think about integration and the time line related to that, but I do think it's an evolutionary process where we have to be mindful of what we expect are going to continue to be greater expectations on the part of regulators as it relates to the regulatory approval process.

Okay. And would you say, guys, is there any hesitation on what I'll call tiptoeing up to the $10 billion threshold? In other words, are we more likely to see you try to vault past $10 billion in a significant way or would you be comfortable sitting right around $10 billion for a period of time, if that's how the situation turned out to be?

Well, I think if you look at post Oneida, we will be at somewhere in the $8.5 billion level of assets. Ideally, I think looking at another high-value acquisition opportunity, that would put us in the $9.5 billion range or maybe slightly larger and then prepare for a threshold transaction, which might be a little bit larger. And the closer you are to $10 billion, the smaller the acquisition would need to be in order to hurdle the -- what's -- for the most part, the Durbin impact. So from our perspective, strategically, and we've had a lot of dialogue with our board about this as well. The idea of getting to $9.5 billion or so and then thinking about that threshold transaction is probably the best risk reward strategy for us that we're thinking about presently. So that's the strategy. If we just did $9.5 billion, we can grow organically at 3%, 2% to 4% for a couple of years before we would be essentially, from a shareholder value perspective, be forced to think about a threshold transaction. We want to try to kind of strategically prepare how we're going to execute on that. And we've committed all along that we expect to do so without any impairment of shareholder value. Meaning, we expect the act of hurdling the $10 billion will create sufficient earnings capacity that it will, at least or more than offset the impact of Durbin. So that's our [indiscernible] right now, Joe.

And then appreciating that there might be sensitivities around what you can say. But can you talk in a little bit any more detail that you can give us on the reasons for the delay?

Well, it's right now with the D.C. Fed and they have asked some additional questions around lending and HMDA [ph] data and our specific kind of risk management/compliance processes. It was the -- the review was precipitated by a public comment, a letter written to the Fed during the public comment period who is a social activist from New York City and has a 20-year history of making the same allegations against other banks as part of the M&A process. So the Fed has asked us -- the D.C. Fed asked us some questions. We have responded with further information and we, at this juncture, expect the transaction to close in the fourth quarter.

And we will go next to William Wallace with Raymond James.

As I kind of look at your decision to go ahead and lever up a little bit ahead of the anticipation that you have some excess liquidity related to Oneida, was there anything that you saw in the markets that drove that decision or is it just really a matter of go ahead in taking that step you feel -- given some certain level of comfort that you have that the deal will definitely close?

Yes. I would say a little bit of both, Wally. I would say that we had -- after we announced the transaction, we had planned for sort of an orderly move to a group of assets that we were more comfortable in our portfolio with -- over a longer-term basis versus where they were positioned today, which is not necessarily a bad position but it didn't necessarily fit all of the criteria that we'd be looking for going forward. So we did start that initiative in March, continued that into the early parts of the second quarter, and in fairness, didn't really change our positioning on the expectations after we found out that transaction was going to need to be delayed a little bit. So we're still pretty comfortable that the -- when the transaction closes, there would be the disposition of the lion's share of their portfolio. We would just payout short-term borrowings that as you acknowledged or as you mentioned we created in the second quarter. I think there's a little bit of market timing with us relative to certain indicators that we saw in the markets that said this group of assets based on their duration and risk characteristics is essentially a productive time for us to be a buyer. So we exercised on those timings. But again, I would say, more than anything, we have sort of put on $300-plus million of the expected $850 million of assets we will get. So to Mark's point, you shouldn't expect to see the balance sheet grow $850 million by the time the end of October comes around, probably more like $550 million.

Okay, perfect. And then the borrowings that you guys put on to fund the strategy, will you keep your borrowings and get rid some of theirs or will you just use theirs and get rid of whatever you put on?

Yes, we might. They have very little borrowings themselves. As a matter-of-fact, they are actually in a net cash position as we speak. So the expectation, we would extinguish our short-term borrowings in the current mindset. Wally, that being said, we'll have plenty of capital to sort of stickhandle through that after the transaction. So if it does look like it's productive to carry a little bit of leverage into '16, we're certainly not afraid of that either.

Okay. And then just switching gears a little bit, the decline on a sequential basis in your mortgage banking fee income line was a little bit surprising just given the seasonality that we typically see in the second and third quarter and what we're seeing in other banks. Is there anything going on there that would've driven your production lower, did you balance sheet more or?

Let me run through that a little bit because I think that's probably the fourth question this morning I've gotten on that. So if I start with the mortgage banking in the second quarter of 2014, essentially from mortgage-banking-related activities in the second quarter of '14, we were about $350,000 of revenues compared to $200,000 in the second quarter of 2015. Essentially, we took $130,000 mortgage service impairment charge in the second quarter of this year. It doesn't sound like the accounting in the rate environment would ever lead you to that outcome, but as you know, that's a very mechanical calculated outcome. So essentially, some of the production we sold in the last 2 years reached its seasoned capability, reached its seasoned destination. And rates are modestly higher today, so there is a sense that there's still some modest prepayment risk attached to that. We carry a very, very small asset associated to mortgage servicing rates, so that's a piece of that. To your question relative to the third and fourth quarter of last year that had higher activity there, a couple of other things to point out. We typically are a larger seller of mortgage transactions in the second half of the year, every year, just based on activity. In other words, fourth quarter pipeline isn't terribly robust for first quarter activity. We talked about first quarter activity being very slow this year, so second quarter sales were pretty small. We would expect a higher number. The other piece that ends up on that line for presentation standpoint is we end up with sort of other banking services revenues, which for us tend to BOLE [ph] -related income, small miscellaneous stuff that can't find a home elsewhere. But last year in the second quarter, we had about $450,000 of nonrecurring life insurance gains coming out of some of our BOLE [ph] assets and certainly don't or project those to continue. But on a going-forward basis, I think if you use the number that we have in the second quarter, put back some mortgage servicing impairment charge that we wouldn't expect to be recurring, you're kind of running in a level that's in that $900,000 to $1 million per quarter. And as a reminder for everybody, we do expect a dividend from one of the retail insurance programs we participate in on a pooled basis that always comes in the third quarter. We always say it's in and around $0.01 per share. That number could move up or down $100,000 and $200,000 in any given year, but that should be an expectation people's modeling for the third quarter.

Okay. And Scott, just one kind of housekeeping question. In your prepared remarks, you mentioned as it relates to margin that this quarter had a 3-basis-point benefit related to something that was not expected [ph]. What was that? I missed it.

Yes. So the Federal Reserve, well, it pays you your semiannual dividend on your holdings of Federal Reserve stack June 30 and December 30 each year. So that $500,000 for us or $480,000 for us. It shows up in the second quarter and the fourth quarter. So you tend to get a "tick down" in the third quarter on yield just because that's not there.

And we'll go next to David Darst with Guggenheim Securities.

Just, Mark, just help on the liability duration and deposit pricing details you gave us. But maybe how are you thinking about the asset side, your AOCI rose -- kind of rising rate environment, and were there other alternatives relative to the treasuries you bought that would have a maybe a better profile for rising rates?

David, I think you sort of have to process that by saying we are certainly not managing the institution with fluctuations in AOCI. And as you know, from a regulatory standpoint, any bank under $250 billion in size, opted out of including changes in AOCI as part of their regulatory capital as it was. So not really something we're thinking about from a day-to-day operations standpoint. So the only time you get any kind of discussion around AOCI changes in a rising rate environment would be similar to what you talk about in interest rate sensitivity. So in other words, this is something that could happen -- you're going to put yourself into an unrealized gain position or go from an unrealized gain position to an unrealized loss position with a rate change. And we understand, given the size of our portfolio, we are certainly susceptible to some movements there. But since that's tangible equity that you really can't use from an operating standpoint, it is not something we spend a lot of incremental time thinking about. It's out there for purposes of enterprise value calculations for the EVA side of stuff from a regulatory standpoint, but really, we don't get a lot of questions on it, David. I think what you're kind of back to in your discussion or your question so it would be saying, "Did you have a choice of another asset class that has different duration characteristics than the treasuries you pooled?" We picked treasuries that were a little bit above sort of a 5-year duration, and we thought that those fit into our longer-term composite balance sheet type of a planning attribute. Not lost on us was that they are qualitatively superior to most every other choice we had out there other on the market today. And similar to Mark's comment, I think we looked at what we thought would be a slow gradual pace of interest rate changes underway up and we look at our historical and expected performance on deposit retention and deposit pricing characteristics and thought these don't run afoul of any of those kinds of expectations. So on a composite basis, David, that's just kind of the justification.

Okay. So should this change our kind of -- you said obviously, the EPS accretion doesn't change, but should this change our kind of margin expectation on a pro forma basis for the [indiscernible]?

Yes. I'm looking at this way, David. Decent question. I would say that we did bring forward a small portion of the earnings accretion from the transaction. Anytime you can put incremental $300 million of assets on the balance sheet with yield differential between your 200 basis points of yield on the instrument and 45 basis points of borrowing cost, you picked up some income at an early basis. On the margin side, I would say we had been already signaling that Oneida carried a lower net interest margin base than we did pro forma, so there would be some dilution to net interest margin in the combination anyway. Kind of thinking of it this way now. Bring on now $550 million of a balance sheet from Oneida, that essentially does not have investment securities on it today. So that's where I would kind of go with my pro forma side if that's -- essentially, we're bringing over a loan portfolio that has similar characteristics to our kind of yield on the loan side. Their deposit pricing is a little bit higher than ours today because in fairness on their side, they don't enjoy some of the interest rate sensitivity flexibility that we do in their primary markets. But you're going to get a mark-to-market of all that stuff as of the closing date anyway. So I would essentially say, yes, think about getting up a $500 million balance sheet that's probably got net interest margin characteristics in the $335 million to $350 million level, mix that with what you just saw from us at the current $376 million, you'll probably still get a little bit of margin dilution.

Okay, got it. And just on credit and you're provision outlook. I mean, should we be -- should we really kind of think about you being kind of sub 10 basis points for the next couple of quarters?

I think we would love to book it for the rest of our careers, David. But from a category [ph] standpoint, I kind of look at it this way, that we essentially have been providing for a provision above net charge-off levels very historically. And we've enjoyed, usually, certainly most second, third and fourth quarters enough organic growth to validate why you continue to book above net charge-off levels. All the indicators are very, very positive today. So if you ask me if I thought I needed to retain at a 106% going forward, that number could be 105%, could be 104%, but again, it will depend on the underlying performance of the actual portfolio. In our second quarter, we enjoyed some pretty good rating changes on the commercial side, which, again, led to a conclusion that you just didn't need as much as you did before from an overall proportional outcome. But boy, if we could sign up for 3 or 6 or 9 basis points of charge-offs and validate that for the next 3 to 6 quarters, we would love to do that. Given the mix of our portfolio, it would be hard to project that, but at the same point in time, nothing on the horizon that we see that's leading us to believe we should hunker down for anything significantly higher.

And we will go next to Collyn Gilbert with KBW.

Mark, just back to your commentary on the crossing of the $10 billion. As you guys kind of look at your budget process, is there a time line that you think you would achieve this $10 billion crossover? I know you'd said deal $9.5 billion, grow organically 2% to 4%, and then maybe something more meaningful post that. But just trying to get an overall time frame as to how you're thinking about this.

Well, I think at this juncture, I think it's several years out but we think we need to prepare for that because it's going to take a little bit of time to put in place the improvements or enhancements to some of the some of the risk management processes to get our capital planning in DFAST disciplines up to speed. So we're not in a hurry to do it. We would prefer not to have to do it, but you have to grow if you want to continue to create above-average returns for your shareholders, which means we need to exceed the $10 billion threshold at some point. And we're also faced with dealing with the realities of what that means, so we're trying to do that in advance. So we're not going to hurry to get there. I don't think that we care if it takes 5 years. I don't know that we care if it happens over the course of the next 3 years or 2 years if the right opportunity arises. But the one thing that I will say is that we will be disciplined about how we go about that and expect again to execute on our commitment to shareholders that we do it in a way that does not dilute shareholder value.

Okay. Okay, that's helpful. And then Scott, just back to the comment you made on mortgage. You had said that you're retaining mostly the short and mid duration but then selling 30 year. How is that breaking out? Number one, what is the short and mid-duration that you're retaining? And then number two, just what's the split that you're seeing between what you're selling versus what you're retaining?

Today, Collyn, we're probably retaining 75% of our originations. Remember, the little bit of a different perspective in our marketplace, 15-year fixed is the product of choice and has arguably been the product of choice in our marketplace for probably the last 9 quarters. So I think we've done a lot of work around expected duration of our mortgage instruments. And interestingly enough, in our marketplace, whether you wrote the mortgage at 15, 20, 25 or 30 and you portfolio-ed it, its expected life is in and around 9.5 years. So what is that actually telling you about the consumer? The 15 year -- the people who select 15-year product are probably trying to get to the finish line in terms of not having a mortgage obligation. It probably tells you that the people who originally selected 30 are certainly moving either in your market or out of your market in a shorter period of time. In other words, none of these instruments are making it to that duration. So I think it leads us to be comfortable that we're not putting on, by portfolio-ing 15 and sometimes 20-year instruments, we're not putting on above-average interest rate risk, because again, the consumer has historically portrayed to us that, that indeed they're not going to go the duration of the instrument. And Collyn, we didn't just use the last sort of 4, 5 or 6 years out of the cycle outcome. We actually went back 30. And the shockingly we actually found the data, shockingly for me, but at the same point in time, that's something that's multiple cycles. The indicator was 9.5 years should be what you expect out of the duration of the portfolio. I also think too, we have a smaller average mortgage size than almost every bank in the country, certainly at our size. So when we start to prepare ourselves for what does it take to build up a group of assets that we're actually going to sell in the secondary market, it usually takes us 2x or 3x the amount of loans. So from a processing and a preparation to closing standpoint, we do have to acknowledge that we'd better be really efficient at it because they're small-valued outcomes. So I think you've seen with the refinancing side of the world sort of complete, maybe complete in the last year. New purchase money is certainly the majority of the new instruments that we're seeing. I will say we're not still seeing a little bit of refi activity out there. But generally, we're starting to see people who if they're in the refi they are trying to shorten the duration of their remaining instrument with the finish line in sight.

[Operator Instructions] We'll go next to Matt Schultheis with Boenning.

Really quickly, most of my questions have been answered, but really quickly, could you remind us of the anticipated merger-related costs in the third and fourth quarter?

Matt, I think we're using a number in the neighborhood of $12 million, some of which will be borne by Oneida and some of which will be borne by us in terms of the combination of severance activities, and termination of IT-related outcomes, changing-control type agreements. So I -- we haven't really changed from that. Some of the delay in the timing of the transaction may actually result in some of those costs being sort of pushed down to the Oneida Financial's as opposed to ours, but we really haven't changed our thoughts on that.

Okay, so you're not willing to share with us what the impact on your income statement would be for the next 2 quarters until [indiscernible]...

We haven't changed our estimate. That's -- use 12, if you want to. It's a nonrecurring expense, I'm fine with that.

And there are no further questions at this time. Gentlemen, I will turn the conference back over to you for any additional or closing remarks.

Great, thank you, Nicky. I appreciate everyone joining in on the call this morning, and we hope to see you again on our third quarter call. Thank you.

Thank you. And that does conclude today's conference. Thank you for you participation.