Fitch Affirms Community Bank System at 'BBB+' on Merger with Merchants Bank

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Community Bank System Inc. (CBU) at 'BBB+' following the announcement that it will acquire Merchants Bancshares Inc. (MBVT). CBU's Rating Outlook remains Stable. A complete list of rating actions follows at the end of this release. Fitch affirmed CBU's IDRs and Stable Outlook on Sept. 16, 2016.

The transaction is valued at $304 million financed by 70% stock and 30% cash. The deal represents a price-to-tangible book value of 2.0x for MBVT. The deal will be accretive to CBU's earnings in 2018 and synergies from the transaction are expected to fully absorb the costs CBU will incur by crossing over $10 billion in assets. The transaction is expected to close in the second quarter of 2017 (2Q17), subject to regulatory approvals.

KEY RATING DRIVERS

IDRS AND VR

The affirmation and Stable Outlook reflects Fitch's view that the MBVT transaction represents limited credit risk, manageable integration, a logical strategic fit, and reasonable cost savings estimates. Execution risks are viewed as modest given CBU's successful track record of integrating transactions and MBVT's history of strong asset quality performance. CBU's capital position will decline, though Fitch views this in the context of the additional geographic and loan portfolio diversification the transaction brings. CBU's estimated pro-forma Tier 1 Leverage Ratio will decline to 9.2% from 10.4% at 3Q16. Its pro-forma estimated Tier 1 Capital Ratio of 15.6% and loan-to-deposit ratio of 74.9% will remain ahead of its peer group average.

In Fitch's view, the transaction presents a good opportunity for CBU to expand its business into a similar, contiguous market to its existing footprint while obtaining a solid #3 market share of 11% in Vermont. MBVT's loan portfolio is more commercially oriented than CBU's portfolio, and the combination will increase CBU's commercial loan mix to 37% from 29%. Fitch views the added geographic and loan portfolio diversification positively.

Previously, Fitch had stated that 150 basis points (bps) of tangible capital reduction could lead to negative ratings momentum, which is close to the pro-forma estimates in this transaction. Fitch believes the benefits from prudent diversification in the geographic footprint and loan portfolio by acquiring a bank with a solid asset quality track record help offset the capital reduction from a ratings perspective.

Fitch believes the projected cost saves of 23% are reasonable given back-office and technological overlap between the entities. Fitch expects these costs saves will offset the limits on interchange revenue and costs associated with Dodd-Frank annual stress testing that come with crossing $10 billion in assets. The pricing of the transaction is relatively in-line with other recently announced bank deals of similar size.

Fitch expects the combined entity's risk appetite and asset quality performance will remain in line with CBU's current rating. Similar to CBU, MBVT's net charge-offs (NCOs) were quite stable through the previous credit cycle, with NCOs peaking in 2009 at 19bps of average loans. CBU will be a taking a $13 million (or 1%) credit mark on MBVT's book, which appears appropriate based on the portfolio's historical performance. MBVT also has an attractive deposit base, with a 20bps deposit cost and 42% of deposits in non-interest bearing. Given the sizable non-interest bearing component and rational deposit competition in the Vermont market, Fitch believes MBVT's deposits are poised to perform well under a rising rate environment, similar to CBU's existing deposit base. Pro-forma estimated loan-to-deposits is 74.9% which remains conservative and supports CBU's rating.

SUPPORT RATING AND SUPPORT RATING FLOOR

CBU has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, CBU is not systemically important and therefore, the probability of support is unlikely. The IDRs do not incorporate any support.

LONG- AND SHORT-TERM DEPOSIT RATINGS

CBU's uninsured deposit ratings at the subsidiary banks are rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.

HOLDING COMPANY

The IDR and VR of CBU is equalized with its operating company Community Bank, N.A., reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries.

RATING SENSITIVITIES

IDRS AND VR

Fitch believes CBU's ratings are well anchored at their current level. The capital reduction and execution risks associated with this transaction limit upside over the Outlook horizon. Over the longer term, upward rating momentum could occur should the bank continue to prudently expand its geographic footprint and/or product mix while maintaining capital at or above the estimated pro-forma levels.

CBU's ratings are sensitive to its ability to successfully integrate MBVT's franchise and achieve cost saves targeted in this transaction to offset the costs associated with crossing $10 billion in assets. CBU's ratings could be pressured if it fails to maintain earnings at above peer levels following the integration of MBVT. Additionally, should unexpected operational and integration risks arise that are material to CBU's financial performance or if credit quality deteriorates beyond peer averages, the rating would likely be reviewed for negative action.

Negative ratings pressure could develop should management pursue another bank acquisition before MBVT is fully integrated into CBU's franchise or should Tier 1 Leverage fall by more than 100bps below the estimated pro-forma level.

SUPPORT RATING AND SUPPORT RATING FLOOR

CBU's Support Rating and Support Rating Floor are sensitive to Fitch's assumption around capacity to procure extraordinary support in case of need.

SHORT- AND LONG-TERM DEPOSIT RATINGS

The ratings of long- and short-term deposits issued by CBU and its subsidiaries are primarily sensitive to any change in the company's IDR. This means that should a long-term IDR be downgraded, deposit ratings could be similarly impacted.

HOLDING COMPANY

If CBU became undercapitalized or increased double leverage significantly there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.

Fitch has affirmed the following ratings with a Stable Outlook:

Community Bank System, Inc.

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

--Viability Rating at 'bbb+';

--Short-Term IDR at 'F2';

--Support at '5';

--Support Rating Floor at 'NF'.

Community Bank, NA

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

--Viability Rating at 'bbb+';

--Long-Term Deposits at 'A-';

--Short-Term Deposits at 'F1';

--Short-Term IDR at 'F2';

--Support at '5';

--Support Rating Floor at 'NF'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 15 Jul 2016)https://www.fitchratings.com/site/re/884135

Additional Disclosures

Dodd-Frank Rating Information Disclosure Formhttps://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013716

Solicitation Statushttps://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013716

Endorsement Policyhttps://www.fitchratings.com/regulatory

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Source: Fitch Ratings

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