Fitch Affirms Community Bank System's IDR at 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Long-term and Short-term Issuer Default Ratings (IDRs) of Community Bank System, Inc. (CBU) and its subsidiary, Community Bank, N.A., at 'BBB' and 'F2', respectively. The Rating Outlook is Stable. A detailed list of rating actions follows at the end of this release.

KEY RATING DRIVERS - IDRs, VRs AND SENIOR DEBT

The rating affirmation and Stable Outlook reflect the company's consistent earnings performance and stable asset quality, regulatory capital and liquidity profile. CBU's earnings and asset quality continue to be a rating strength for the bank while its liquidity and funding profile also compare favorably to community banking peers. Ratings are constrained by CBU's limited operating environment and business model relative to higher rated peers.

Since last review, CBU's earnings profile continued its gradual improvement as one of the strongest and stable amongst banking peers. Return on average assets (ROAA) has exceeded 1% since 2010 and improved to 1.14% during the LTM ending 2Q'14.

Net interest margin (NIM) remains healthy, improving to 3.92% for the LTM, up from 3.88% at YE 2012. NIM continues to improve despite pressure on earning asset yields due the prolonged low interest rate environment. The bank has been actively reducing the overall cost of funds. Efforts include conservative deposit pricing and an increased emphasis on building core deposits.

While Fitch anticipates CBU's earnings to continue to be a relative strength for the bank in the near to intermediate term, Fitch expects net interest income to decline modestly in a more normalized rate environment given the bank's liability sensitive balance sheet. Primarily focused on residential real estate lending, CBU has a higher concentration of longer maturity assets than commercially focused lenders.

Credit quality also continues to be a rating strength for CBU. CBU's nonperforming assets (NPAs) totaled to just 0.39% of total assets at 2Q'14, significantly better than the community bank peer average of 1.25%. Fitch notes that CBU's asset quality performance has benefited from the stability of its local economies and the bank's conservative risk culture. While the local economy has traditionally possessed limited opportunities for growth, it has also experienced less housing volatility and fared better than other areas of the country in recent years. CBU has also proven to be conservative in avoiding growth in noncore, out of market assets, which has translated to a long track record of low credit losses.

CBU's liquidity and funding profile is strong relative to community banking peers as well. The bank's loan to deposit ratio is low at 70% relative to the community bank peer average of 79%, as of 2Q'14. Liquid assets exceed peers, totalling $1.5 billion or 24% of total liabilities. The bank's sizeable securities portfolio ($2.5 billion securities portfolio or 33% of total assets as of 2Q'14) provides an ample source of liquidity with only 44% pledged for borrowing purposes. The bank is also less reliant on wholesale with borrowings totalling just 6% of total assets.

Although CBU's regulatory and risk based capital ratios are strong, tangible common equity ratio is lower than the community bank peer group average at 8.00% for 2Q'14. Leverage ratio, tier 1 risked based, and total risk based capital exceed well capitalized standards at 9.64%, 17.07% and 18.21%, respectively, for 2Q'14. Fitch views CBU's current levels of capital as sufficient given the bank's relatively low risk profile, high reserves relative to impaired assets, and historic net charge off (NCO) experience.

RATING SENSITIVITIES - IDRS, VRs AND SENIOR DEBT

CBU's ratings are sensitive to its asset quality, earnings performance and liquidity profile. Although Fitch does not expect asset quality to deteriorate, earnings to weaken, or the bank's risk or liquidity profile to change materially, a worsening of these ratings factors could result in negative ratings pressure.

Fitch notes that CBU has a higher level of interest rate risk than peers given its balance sheet composition. While Fitch expects negative earnings pressure to be limited in a rising interest rate environment, a rapid increase in short and medium term rates resulting in a material impact to CBU's net interest income would be viewed negatively.

SUBSIDIARY AND AFFILIATED COMPANY KEY RATING DRIVERS

Community Bank, N.A. is a wholly owned subsidiary of CBU whose debt ratings are aligned with CBU's reflecting Fitch's view that the bank subsidiary is core to the franchise.

SUBSIDIARY AND AFFILIATED COMPANY RATING SENSITIVITIES

Community Bank, N.A.'s ratings are sensitive to changes to CBU's VR or any changes to Fitch's view of structural subordination between bank subsidiary and holding company. Rating sensitivities for the VR are listed above.

Fitch has affirmed the following ratings with a Stable Outlook:

Community Bank System, Inc.

--Long-Term IDR at 'BBB';

--Short-Term IDR at 'F2';

--Viability Rating at 'bbb';

--Support at '5';

--Support Floor at 'NF'.

Community Bank, N.A.

--Long-Term IDR at 'BBB';

--Long-Term deposits at 'BBB+';

--Short-Term IDR at 'F2';

--Short-Term deposits at 'F2';

--Viability Rating at 'bbb';

--Support at '5';

--Support Floor at 'NF'

Additional information is available at 'www.fitchratings.com'.

The issuer did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure.

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria (Jan. 31, 2014');

--'Rating FI Subsidiaries and Holding Companies (Aug. 10, 2012)';

--'Assessing and Rating Bank Subordinated and Hybrid Securities Criteria (Jan. 31, 2014)';

--'U.S. Bank HoldCos & OpCos: Evolving Risk Profiles (March 27, 2014)';

--'U.S. Banking Quarterly Comment: 2Q14 (July 2014');

--'U.S. Banks: Liquidity and Deposit Funding (Diminishing QE Effectiveness and its Impact on Systemic Liquidity and Funding)' (Aug. 8, 2013);

--'U.S. Bank Mergers and Acquisitions' -- When Will The Catalysts Kick In? (July 11, 2013)

--'U.S. Banks: Interest Rate Risks (What Happens When Rates Rise)' (June 18, 2013)

--'U.S. Banks: Home Equity Reset Risk Hitting the Reset Button in 2014' (April 29, 2013)

--'U.S. Banks: Rationalizing the Branch Network (Witness the Incredible Shrinking Branch Network)' (Sept. 17, 2012);

--'Treatment of Unrealized Losses in U.S. Bank Capital Rule Proposal (Pro-Cyclical Capital Policy to Create Greater Capital Volatility for Banks)' (Aug. 7, 2012);

--'Risk Radar' (April 2014).

Applicable Criteria and Related Research:

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Rating FI Subsidiaries and Holding Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209

Assessing and Rating Bank Subordinated and Hybrid Securities Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732137

U.S. Bank HoldCos & OpCos: Evolving Risk Profiles

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=742096

U.S. Banking Quarterly Comment: 2Q14 (Environment Constraining Earnings)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=753107

U.S. Banks: Liquidity and Deposit Funding

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=714196

U.S. Bank Mergers and Acquisitions -- When Will The Catalysts Kick In?

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=712539

U.S. Banks: Interest Rate Risks (What Happens When Rates Rise)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710875

U.S. Banks -- Home Equity Reset Risk Hitting the Reset Button in 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706915

U.S. Banks: Rationalizing the Branch Network (Witness the Incredible Shrinking Branch Network)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688330

Treatment of Unrealized Losses in U.S. Bank Capital Rule Proposal (Pro-Cyclical Capital Policy to Create Greater Capital Volatility for Banks)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685638

Risk Radar Global 1Q14

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=742560

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=880174

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Contacts

Fitch Ratings
Primary Analyst
Ryan Doyle, +1-212-908-9162
Director
Fitch Ratings, Inc.
33 Whitehall St
New York, NY 10004
or
Secondary Analyst
Doriana Gamboa, +1-212-908-0865
Director
or
Committee Chairperson
Christopher Wolfe, +1-212-908-0771
Managing Director
or
Media Relations, New York
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Ryan Doyle, +1-212-908-9162
Director
Fitch Ratings, Inc.
33 Whitehall St
New York, NY 10004
or
Secondary Analyst
Doriana Gamboa, +1-212-908-0865
Director
or
Committee Chairperson
Christopher Wolfe, +1-212-908-0771
Managing Director
or
Media Relations, New York
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com