Mark Tryniski - President and Chief Executive Officer Scott Kingsley - Executive Vice President and Chief Financial Officer.

David Darst - Guggenheim Securities Collyn Gilbert - KBW Matt Schultheis - Boenning & Scattergood.

Good day everyone and welcome to the Community Bank System First Quarter 2014 Earnings Conference Call.

Please note that this presentation contains forward-looking statements within the provisions of the Private Securities 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 risks 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, Dana. Good morning and thanks all for joining our first quarter conference call. We have started out 2014 on a positive note and earnings were very good at $0.54 per share which is a first quarter record for us. The margin was actually up in the quarter which Scott will discuss further.

Growth in non-interest revenues continues to be very additive to the operating performance in both our wealth management, invested in some (administration) businesses are running at record levels of revenue, margin and earnings. Loans were down slightly for the quarter which is a seasonally expected and historically typical outcome for us.

Asset quality remains very strong particularly charge-off levels which contributed to the earnings performance. Heading into the second quarter our pipeline looks very good. Mortgage volumes are down 30% over last year but rates are higher and the mix of purchase versus refi has improved substantially.

Auto originations in Q1 were up 52% over last year and the business lending pipeline is up more than 20% over last year, so we think we’re in good shape heading into our peak Q2 and Q3 lending quarters. In addition deposit balances grew sequentially $140 million or 2.5% and it will provide lost cost funding support for expected loan growth.

The eight branches in Northeastern Pennsylvania we acquired from Bank of America this past December have been fully integrated and are performing very well.

Deposit retention has been nearly 100%, fee income is running at a level above that of our branches as a whole and we’ve begun to generate loans out of those branches, so we’re off to a productive start with this acquisition.

With respect to the remainder of the year we do expect core margin contraction and we’ll work hard to offset that impact by growing our business and effectively managing our expenses in our capital for the benefit of shareholders.

Scott?.

Thank you, Mark and good morning everyone. As Mark mentioned first quarter 2014 was a very sound start to the year for us. Also as a reminder for comparative purposes our acquisition of eight former Bank of America branches in Northeast Pennsylvania was completed in mid December of 2013. I’ll first take a shot at some of the balance sheet items.

Average earning assets of $6.58 billion for the first quarter were essentially even with the fourth quarter and first quarters of 2013, the net result of the productive balance sheet changes we initiated in 2013.

In addition the mix change of the earning asset base compared to the first quarter of last year was very positive in that loans grew organically $239 million or 6.2% with an almost offsetting reduction and investments in cash equivalents.

Average deposits were up 4.6% in the first quarter of last year principally from the branch acquisition completed in December which allows for a 40% reduction in Federal Home Loan Bank advances.

The multi-year trend away from time deposits and into core checking, savings and money market accounts continued in the first quarter resulting in a further decline in overall funding cost.

Outstandings in our business lending portfolio were down modestly from year end impacted by seasonal fluctuations and line utilization and were 2% higher than the end of the first quarter of last year and very consistent with our market demand characteristics.

Asset quality results in this portfolio continues to be stable and favorable to peers with an annual net charge-off of under 25 basis points over the last four, eight and 12 quarters.

Our total consumer real estate portfolios of $1.92 billion comprise of $1.58 billion of consumer mortgages and $341 million of home equity instruments were down $8 million from December but were $87 million higher than the end of last year’s first quarter or a 4.7% increase.

We continue to retain in portfolio most of our short and mid duration mortgage production while selling secondary eligible 30 year instruments. Asset quality results continue to be very favorable on these portfolios with a total annual net charge-offs over the last four, eight, and 12 quarters of under eight basis points.

Our consumer indirect portfolio of $756 million was up $16 million or 2.1% from the end of 2013 consistent with solid regional demand characteristics. Used car valuations were the largest majority of our lending in concentrated continued to be stable and favorable.

Annual net charge-offs for the last four, eight and 12 quarters were also under 25 basis points which we consider exceptional. With our continued bias toward A and B paper grades and the very competitive market conditions in this asset class, yields have continued to trend lower over the last several quarters.

We have continued to report very favorable net charge-off results with the first quarter 2014 results at just 0.11% of total loans being a stellar performance. Non-performing loans comprised of both legacy and acquired loans ended the first quarter at $23.6 million or 0.58% of total loans.

Our reserves for loan losses represent 1.15% of our legacy loans and 1.08% of total outstanding and based on the trailing four quarter’s results represent over six years of annualized net charge-offs. As of March 31st our investment portfolio stood at $2.51 billion and was comprised of $306 million of U.S.

agency and agency-backed mortgage obligations or 13% of the total; $665 million of municipal bonds or 27% and $1.44 billion of U.S. treasury securities or 58% of the total. The remaining 2% was in corporate and debt securities. Our capital levels in the first quarter of 2014 continue to grow.

The Tier 1 leverage ratio rose to 9.48% at quarter end, a meaningful 70 basis point increase over the end of last year’s first quarter and tangible equity-to-net tangible assets ended 2014’s first quarter at 7.97%.

Shifting to the income statement, our reported net interest margin for the first quarter was 3.94% up six basis points from the fourth quarter of last year and eight basis points above the first quarter of 2013. Our net interest margin has been positively impacted by the 2013 balance sheet restructuring activities as previously described.

Proactive management of deposit funding costs continued to have a positive effect on margin results but have not being able to fully offset declining asset yields. First quarter non-interest income was up 8.6% from last year’s first quarter.

The company’s employee benefits, administration and consulting businesses posted a 6.8% increase in revenues from new customer additions, favorable equity market conditions, and additional service offerings.

Our wealth management group generated a 21% revenue improvement from last year and included solid organic growth and trust in asset advisory services while also benefiting from favorable market conditions.

Quarterly operating expenses of $55.9 million increased to $1.4 million or 2.5% over the first quarter of 2013 and included a full quarter of operating cost associated with the eight additional branches acquired in December. We did experience higher weather related maintenance and utilities cost in the first quarter of this year versus last year.

Merit-based personnel cost increases were partially offset by lower retirement plan cost related to the combination of strong plan asset performance and slightly higher pension discount rates. Our effective tax rate in the first quarter of 2014 was 29.7% versus 29.2% in last year’s first quarter.

As Mark pointed out we continue to expect net interest margin headwinds going forward as most of our existing assets are still being replaced by new assets with modestly lower yields. Our funding mix and costs are at very favorable levels today from which we do not expect significant improvement.

Our growth in all sources of non-interest revenues has been very positive and we believe we’re favorably positioned for the balance of 2014 to continue to expand in all areas. While operating expenses will continue to be managed in a very disciplined fashion we do expect to continue to consistently invest in all of our businesses.

Our asset quality has continued to remain the differentiating feature of our business model and we don’t expect that to change going forward. Tax rate management will continue to be subject to the successful reinvestment of cash flows into high quality municipal securities as it has been for the last several years.

We have faced similar market characteristics and dynamics over the last few years in this low interest rate environment and expect to execute on our business model in a consistent manner in order to create growing and sustainable value for shareholders. I’ll now turn it back over to Dana to open the line for any questions..

Thank you. (Operator Instructions) We’ll go first to David Darst with Guggenheim Securities..

Hey good morning..

Good morning, David..

Good morning, David..

Scott, did you comment on the $300 million or so of securities growth in the yields that you probably (own)?.

Yes. David, we did sort of consistent with the activities we had at the end of December.

We purchased about – just about $300 million of investment securities relatively early in January so early in the first quarter really comprised of about $240 million of treasury securities with the yields just about 2% maybe a little bit higher than that and duration between five and seven years.

And then we purchased some additional municipal securities in the first quarter again fairly early in the quarter to match up with our expected cash flows out of that portfolio over the next three to six months. So that was the add.

David really if you think about we got the earning asset base of the enterprise basically that’s even to where it was prior to those Boca related sales and some other activities that we had raised a bit end of the year last year..

Okay. And so I guess now your tangible common equity is right around 8% and you’re still able to do this kind of mid to high teen or (indiscernible) on that level. As to how are you thinking about deploying capital going forward I mean organic growth is still going to be accreting a lot of excess capital.

It looks like you’ve changed the language maybe around how you’re disclosing the buyback.

Is that something we should expect?.

No, I think we’ve had David the buyback has been in place for long time, I think we’ve had in that place just as a productive and effective capital management tool and we invested – it’s productive to (UI) that I mean you’re right our returns are – our earnings are generating returns on capital that are higher than we need to fund organic growth in our markets which runs let’s call it 3% or so.

We have a very strong dividend policy as you know and distribute in the 50% to 60% range of earnings back to shareholders that still leaves us with excess capital that has accreted particularly over the last several years despite a number of acquisitions.

And I think we will continue to look for opportunities that are productive to deploy that capital through disciplined M&A opportunities. We will need some of that capital to fund organic growth. We expect as you know we’ve increased our dividend every year for the last maybe 21 years and don’t see any reason not to continue that trend into the future.

So right now we do have a bit of capital that probably is in excess of what we need certainly to capitalize our existing balance sheet and reasonable growth and need to be disciplined and active about how we deploy that capital for the benefit of shareholders going forward..

Okay.

And Scott I guess with bringing on the branches still and the weather it still looks like you’re able to take some incremental cost out of the company?.

Yes, David, again it’s a great point. I do think that it’s typical for us to run $4 to $600,000 of maintenance and utility cost. The first quarter above what the other quarters tend to look like and that was not inconsistent with this year’s first quarter.

I think the humidity of the weather in this year’s first quarter make utility cost significantly higher than what we had been planning for. And given the fact that it’s 37 degrees (indiscernible) we’re not quite through that yet. But at the same point in time I would expect we’ll see some improvement along that line.

We did get some cost savings that’s just one of my comment out of the fact that over the last two or three years we’ve had very good pension plan asset returns and you haven’t really seen those in our numbers because discount rates on the liabilities attached to our defined benefit plan have actually been going down.

So “in that pension expense is either been raising or flat”. This year with a little bit higher discount rates at the end of the year and great asset plan performance and we find ourselves in a meaningfully overfunded position in our core defined benefit plan and we’re getting a benefit of that through the actuarially determined pension cost.

So we had some good offsets of what would otherwise be an increase in personnel cost in the first quarter from that pension savings..

Is it $54 million to $55 million a good run rate for expenses?.

David, I think you’re just right, $56 million. I am pretty comfortable with that $56 million range. The first quarter had a little bit higher cost associated with payroll taxes and certain other benefits tend to be a little bit front-end loaded. The utility maintenance costs are a little bit higher.

That being said there is one or two more operating expense days in the balance of the year in the future quarters, the first quarter, the short quarter, but that also carries through to the earning asset side of the equation as well. So I think the net changes we’re pretty comfortable with that as a run rate David.

We’ve got some technology initiatives in front of us for the balance of the year that we do expect to continue forward on. We do expect those to be to a certain extent efficiency creating initiatives but that being said you don’t always get all of the efficiency out of those projects during the implementation.

So we could be a little bit more expensive on the technology side for the balance of the year..

Okay, got it, okay. Thank you..

Thank you..

Thanks, David..

We’ll take our next question from Collyn Gilbert with KBW..

Scott, just to drill down a little bit more on the comments about NIM headwinds and if we look at – so you had indicated that your securities purchases this quarter was 2%, your securities yield I guess was like 346.

Should we expect the continued securities purchases to be in that range so that, that gradual bleed will continue on the securities yield?.

No, I think Collyn what I would expect for the balance of the year this year instead it’s actually see that natural cap was off the portfolio which are in the $100 million to $125 million range would probably not be reinvested instead we would allow that modest amount of short term debt that we have on the books today actually get paid off with the cash flows from the investment securities portfolio.

And then as soon that our deposit growth characteristics can keep up with the loan demand or close to that so from a net standpoint I wouldn’t expect a lot of investment, capital reinvestment for the balance of 2014..

Okay, okay.

What is the split of your borrowings between the short-term and long-term?.

They’re all overnight. At the end of the quarter $270 million of all overnight; the other $100 million of borrowings you see is our trust preferred obligations that are...

Right..

Still through on capital for us, but I don’t see paying all that in my life then. So..

Okay, okay, alright.

And then just also tie into the NIM, what’s the differential that you’re seeing now between your loan origination yield and again your portfolio yield?.

It’s a good question. It’s a mix across the portfolio. We’ve almost gotten to a balance level on the mortgage side, on the residential asset side where new mortgage production and blended yield to portfolio are close together.

On the commercial side probably not quite at that crossover point yet so we’re still starting – we’re still seeing asset yields for new opportunities be slightly lower than our blend. That being said our blend is a little higher than everybody else’s.

From a comparative standpoint and clearly on the indirect side you’re getting erosion with lower yields to get that asset class.

But that being said we’re okay with them because we really like the duration of that asset class as we start to step towards this perceived rate increase going forward, again getting to this belief that rates are going up here over the next three, six, nine, 12, 15 months but that being said that’s an asset class in terms of cash flow so fast that we don’t mind having a little more than that class because we’ll get the chance to reinvest those into new loans the way out..

Okay, okay. That makes sense.

So just given some of the dynamics that you’ve talked about on the balance sheet and then the NIM outlook, do you think you can still grow NII or is that going to sort of flat line in here for a little bit?.

Looking at the next three quarters I would say the opportunity is around us making sure that the balance sheet grows.

So it’s incumbent upon us as to Mark pointed out to get that second quarter and third quarter loan growth that we seem to get every year and we need to perform in the second and third quarter to get that because I don’t think naturally we’re going to get rate bump that’s going to impact and improve net interest income generation in 2014 and even skeptical of the year you’ll see in the first couple of quarters in 2015..

Sure, okay, okay. And then shifting gears to fee income I mean you guys have great momentum there. What is your outlook I mean do you think it seems like kind of the fee income growth is sort of stayed and kind of a tight end of that 8% to 10%.

I mean are you guys now at a point where you think that the momentum can increase from here or is that just sort of the nature of the beast in terms of what we can expect going forward?.

I think with respect to those businesses Collyn we’ve invested a fair bit in those businesses over the last several years in terms of both internal and organic resource growth as well as some very productive smaller acquisitions.

I think people continue to invest in those businesses they have – as we’ve invested in them one of the things we focused on is maintaining margin so it’s not about – we’re not just managing the top-line or managing the bottom line I mean this is about earnings results.

And right now as I said they’re running at record levels of revenue margin and earnings in terms of dollars and margin.

We’re getting some benefit on both the wealth management and the benefits administration business and we get the strength of the market conditions over the past several years have been helpful, but even apps and pads have been very strong growth in those businesses in terms of organic relationships and also operating leverage as we’ve done a very good job in managing the operating expenses and actually improving the margins by simply focusing on rolling the revenues at a faster pace and we’re growing expenses which is pretty simple but that is – it’s been a fact to sell.

To get back to your question in terms of the kind of 8ish and 10ish percent growth we love to continue to see that – we think that’s a great performance, I don’t know if that will continue forever but I think over time we would expect to see growth in those businesses in terms of revenue and earnings performance that is greater than that of the bank..

Okay, okay. That’s all I had for now. Great. Thanks guys..

Thank you..

Thanks, Collyn..

We’ll go next to Matt Schultheis with Boenning [Boenning & Scattergood]..

Good morning..

Good morning, Matt..

Hi, Matt..

Couple of quick questions.

Do you have any estimates for the impact of the change on the New York State tax code for tax forward?.

We do Matt. And for us going into (indiscernible) 2014 but starting in 2015 it’s a net negative for us.

And in fairness we’ve been a very efficient New York State tax payer over the last 10 or 15 years and some of the structural changes that came through the new budget for April 1 takeaway some of the latitude that we might have had relative to planning and certain classes that we were focused on. So it’s a “net expectation we’ll see an increase”.

The other thing is we’re at that unique asset side where the New York State we’re not getting a lot of the benefits of “the Community Banking Provisions anymore because we’re over a certain threshold”. So Matt I would say that if everything being equal we will have our time sustaining an effective tax rate below 30% in 2015..

(Operator Instructions) We’ll go next to Matthew (Reece) with Sterne Agee..

Good morning everybody..

Good morning, Matt..

Just getting back to the margin discussion, with the buildup of securities this quarter and your expected loan growth outlook I mean in the near term what kind of margin compression should we be expecting?.

I think it’s consistent Matt and I’ll come back to your question in two ways. I think it’s consistent what we said in the fourth quarter, it’s three to five basis points a quarter again assuming the components of the balance sheet remain relatively consistent.

That being said I don’t think we buildup securities in the first quarter, I think we ended from an average securities standpoint in the first quarter exactly where we were in the fourth quarter. It was that gap in the middle at the end of the year where we had lower ending balances.

And in fairness I think we saw given our current capital we needed to deploy at an earning asset level that was consistent of what we were in the fourth quarter of last year. So that copes with our plan for a while.

I think back to your question relative to where that margin erosion is coming from again it’s in that asset classes where you’re seeing lower rates of new assets than our blended average which again I think our blended average is higher than most of our peers today.

So I wouldn’t think it’s a big surprise that our peers may say they reach over characteristics before we get there..

Right.

And then with the pipelines you referenced in your commentary to what extent do you think you can grow loans in 2014?.

Well I think as you know if you look historically for us we’re usually if things go well we’re flat in the first quarter we’re usually down historically in the first quarter.

There is a little bit of net run-off I think we lost $12 million I think it was in the first quarter this year which is three tenth of a percent or something pretty seasonally typical.

I think where we if you look again historically where we grow our loans is in the second and third quarter and the fourth quarter usually again is somewhat flattish but usually hope to be up in the fourth quarter but again you get more seasonality it starts to kick in the second half of the fourth quarter.

So we really need to get it done in the second and third quarter. I think the last two years we’ve grown loans organically couple of $150 million a big part of that has been the mortgage growth which we think is not going to recur so I don’t expect that this year’s growth in loans is going to be $250 million.

I think there is a chance we can still grow the mortgage portfolio as well, but it won’t be the same kind of double-digit growth level that we had last year, on the other hand the other lending business is very strong as I said the originations are running about 30% they had in last year. So I think we can continue to perform well there.

The commercial loan pipeline as I said is up over 20% where it was over last year and we actually had a good fourth quarter last year in business lending. So I don’t think we’re going to be at I think Scott said fourth quarter, first quarter of last year and the first quarter of this year in the kind of trailing 12 month period we were up about 6%.

I don’t think we’re going to see that again, I would expect will be closer to the 3% maybe half of that which is consistent generally with the kind of the growth in our markets overall..

Right, okay. And then I think getting back to your excess capital commentary and maybe the pent-up to use some of that in acquisition.

Could you remind us of your parameters around the acquisition, touch on geography, site limitation, the type of bank that would be a good fit, just a color around that?.

Sure. I think first we look at really the qualitative implications of the opportunity, it’s not all about the bottles. It’s got to be something that makes sense for us in terms of geography, in terms of integration, synergy, culture, balance sheet profile, all those kinds of things which were much more qualitative.

We’ve never done geographically, we’ve never done anything that a big jump for us in terms of – we’ve always – we’ve grown substantially over time what we’ve done in the geographically contiguous fashion.

We would certainly look for and have looked and then look at opportunities that are in adjacent state that are close to our existing book trend like Vermont and New Jersey and other parts of Pennsylvania and Eastern Ohio which are despite in fact those are different states there.

And generally, geographically contiguous reasonably in some of our existing book trend, so we are not going to buy a bank in Florida, we’re not going to buy a bank in Texas, we’re not going to buy a bank in (indiscernible). So in terms of opportunities for us it will be generally contiguous geographic expansion.

And that includes banks as well as non bank opportunities. So we continue to look at opportunities in the wealth management and business or benefits administration stays and the growth there has been very productive.

And just to remind everyone the benefits administration business as we do business then I think 48 states and of the largest 401(k) provider of the Commonwealth in Puerto Rico. So that’s a national business. It’s really entirely unconstrained by the bank’s footprint.

And so we continue to look through opportunities in that space as well which has been very productive for us. I mean at the end of the day what we’re looking for is opportunities to acquire franchises at appropriate levels that we believe can help support our principal objective which is to grow earnings in a sustainable fashion over time..

That’s great color.

What kind of size parameters would you be comfortable acquiring if you were to be just a traditional whole-bank acquisition?.

Typically what we’ve done our entity is that in between $100 million and ($1 billion), maybe we’ve gotten a little bit larger. We certainly have I believe the capacity and the internal capabilities to do something larger, that doesn’t mean we’re looking to do that.

We don’t I mean we don’t look at size as an objective, I mean frankly I mean our objective is to create growing a sustainable earnings for shareholders.

I would rather shrink to do that because it’s easier to manage a smaller institution, but when you have regulated capital levels over time you can’t shrink you have to grow, but you need to do that in disciplined, in a disciplined fashion.

So we’ll continue to look for those opportunities but at the end of the day it’s about growing sustainable earnings for the benefit of our shareholders..

Understood. Thank you very much..

Thanks for the questions..

And there are no further questions in the queue at this time..

Excellent. Thank you all for participating. We’ll talk to you again next quarter. Thank you..

Thank you..

Again that does conclude today’s presentation. We thank you for your participation..