Financial Institutions, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Financial Institutions, Inc. is a New York financial holding company operating Five Star Bank, an insurance agency, and wealth-management businesses. It serves Western and Central New York and has indirect auto-lending relationships in nearby markets. This unaudited filing covers the quarter and six months ended June 30, 2020; comparisons are with the same 2019 periods unless stated otherwise. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2020 | Prior-year comparison |
|---|---|---|
| Net interest income | $34.2 million | $32.5 million; up 5.3% |
| Provision for credit losses | $3.7 million | $2.4 million |
| Noninterest income | $9.8 million | $9.2 million |
| Noninterest expense | $26.7 million | $25.0 million |
| Net income | $11.1 million | $11.4 million; down 2.4% |
| Net income available to common shareholders; diluted EPS | $10.8 million; $0.67 | $11.0 million; $0.69 |
| Return on average assets; return on average common equity | 0.97%; 10.05% | 1.06%; 11.12% |
| Tax-equivalent net interest margin | 3.23% | 3.28% |
For the six months, net income was $12.3 million versus $22.9 million, and diluted EPS was $0.72 versus $1.39. Net interest income rose to $67.3 million from $64.3 million, while the provision for credit losses increased to $17.7 million from $3.5 million. Tax-equivalent net interest margin was 3.27%, compared with 3.26%.
- Balance sheet at June 30: assets were $4.68 billion, up from $4.38 billion at year-end 2019; loans, net of allowance, were $3.44 billion versus $3.19 billion; and total deposits were $3.99 billion versus $3.56 billion.
- Credit reserves and asset quality: allowance for loan credit losses was $46.3 million, or 1.33% of total loans, versus $30.5 million at year-end. Nonperforming loans were $13.2 million (0.38% of loans), and nonperforming assets were $13.9 million (0.30% of assets), both higher than year-end. Six-month net charge-offs were $10.9 million, including an $8.2 million partial charge-off on a commercial hospitality loan.
- Liquidity, funding and debt: cash and due from banks were $119.6 million. Short-term borrowings were $105.3 million and long-term borrowings, net, were $39.3 million. Management reported $901.8 million of additional collateralized wholesale borrowing capacity, $145.0 million available under unsecured federal funds lines, and $176.3 million of unencumbered liquid securities. The company said its structural liquidity measures remained compliant and funding sources were ample.
- Capital: company CET1 and total risk-based capital ratios were 10.27% and 12.83%, respectively; management said the company remained well-capitalized. Shareholders’ equity was $448.0 million, compared with $438.9 million at year-end.
- Cash flow, six months: operating activities provided $10.2 million; investing activities used $262.6 million, including $276.4 million of net loan originations; and financing activities provided $259.0 million, primarily reflecting deposit growth partly offset by lower short-term borrowings and dividends. Cash increased $6.7 million to $119.6 million.
Material changes and drivers
- Q2 loan growth supported net interest income, but lower market rates reduced asset yields: loan yield fell to 4.14% from 4.82%. Lower funding costs partly offset this; the cost of interest-bearing liabilities declined to 0.71% from 1.31%.
- Commercial business loans rose substantially, in part because the company had $268.5 million of Paycheck Protection Program loans at June 30. Total loans increased $264.8 million from year-end, with commercial loans representing 56.2% of the portfolio, versus 52.1%.
- Deposits increased $438.3 million from year-end, with higher noninterest-bearing, demand, and savings balances and lower time deposits. Management attributed growth partly to PPP proceeds, business development, and reciprocal deposits.
- Q2 service-charge income fell to $0.5 million from $1.8 million, largely because of COVID-19 customer fee relief. Derivative income rose to $1.9 million from a $45,000 loss, while securities-sale gains were $674,000 versus $166,000.
- Q2 noninterest expense increased, particularly salaries and benefits and professional services. The six-month efficiency ratio rose to 62.78% from 60.39%.
Outlook, risks and unusual items
- COVID-19 and credit risk: The company cited the pandemic’s effects on the economy, customers, unemployment forecasts, commercial property tenants, consumer employment, and its regional markets. It had $522.2 million of loans with COVID-related modifications at June 30. As of July 20, it reported helping more than 1,700 customers obtain over $270 million in PPP loans. Consumer and commercial payment deferrals, fee waivers, and other relief may affect future income and credit quality. Management warned that actual credit losses may exceed estimates.
- CECL adoption: The company adopted the current expected credit loss standard on January 1, 2020. Adoption reduced retained earnings by $8.7 million after tax and increased credit-related reserves; estimates depend on forecasts and could be revised as economic conditions change.
- Subsequent branch restructuring: Announced July 17, the plan calls for six branch closures—about 10% of the network—and staffing reductions affecting approximately 6% of the workforce. The company expects about $1.7 million in pretax costs, mostly in Q3 2020, and approximately $2.6 million in annual expense savings. It expects $0.8 million of the costs to require future cash expenditures.
- Other risks and contingencies: The filing highlights interest-rate and market risk, potential loan and municipal-bond losses, PPP forgiveness and SBA-guaranty risks, cybersecurity and remote-work risks, and potential goodwill impairment. A Q2 qualitative assessment found no goodwill impairment. Management said pending litigation was not expected to have a material adverse effect. No formal earnings guidance is provided in the supplied filing text.
Important facts for investors to verify
- Whether COVID-related loan modifications, deferrals, and PPP exposures lead to deterioration in delinquencies, nonperforming assets, provisions, or charge-offs.
- The allowance adequacy and outlook, including the assumptions behind CECL forecasts and the effect of the large hospitality-loan charge-off.
- Whether deposit growth and liquidity remain durable as PPP funds and other pandemic-related balances change, and how funding costs respond to rates.
- Whether the announced branch closures deliver the expected $2.6 million annual savings and stay within the estimated $1.7 million cost.
- How reduced interest rates, market volatility, and changes in asset yields affect net interest margin, investment-advisory revenue, and capital.