Financial Institutions, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Unaudited quarterly filing for the three and nine months ended September 30, 2018. The New York-based financial holding company provides banking services through Five Star Bank, insurance through SDN, and investment and wealth management services through Courier Capital and HNP Capital.
Financial performance and position
- Q3 earnings: Net income was $10.6 million, up 28% from $8.3 million a year earlier. Net income available to common shareholders was $10.2 million; diluted EPS was $0.64 versus $0.52. Return on average assets was 1.00% and return on average common equity was 10.82%.
- Nine-month earnings: Net income was $32.0 million versus $22.5 million; diluted EPS was $1.94 versus $1.44. The effective tax rate fell to 19.6% from 29.4%, primarily reflecting the lower federal tax rate under the Tax Cuts and Jobs Act.
- Interest income and margins: Q3 net interest income was $30.8 million, up from $28.4 million; on a taxable-equivalent basis it was $31.1 million versus $29.2 million. Taxable-equivalent net interest margin was 3.18% versus 3.17%. For the nine months, net interest income was $90.5 million versus $82.9 million; taxable-equivalent margin was 3.18% versus 3.19%. Loan growth and higher loan yields supported income, while funding costs rose.
- Other income and expenses: Q3 noninterest income rose to $9.9 million from $8.6 million, while noninterest expense increased to $25.5 million from $22.5 million. Nine-month totals were $27.4 million and $73.1 million, respectively. The nine-month efficiency ratio was 61.36%, compared with 61.01%.
- Balance sheet at September 30: Total assets were $4.26 billion, loans net of allowance were $2.95 billion, and deposits were $3.49 billion. Since December 31, 2017, assets increased $153.2 million, net loans increased $254.0 million, and deposits increased $275.6 million. Shareholders’ equity was $392.2 million.
- Credit quality: The allowance for loan losses was $34.0 million, or 1.14% of loans, versus $34.7 million and 1.27% at year-end 2017. Nine-month net charge-offs were $5.8 million versus $6.0 million; Q3 net charge-offs rose to $2.1 million from $1.6 million. Nonperforming assets declined to $8.1 million (0.19% of assets) from $12.7 million (0.31%).
- Cash flow and funding: For the first nine months, operating cash flow was $50.8 million, investing cash outflow was $158.2 million, and financing cash inflow was $125.5 million. Cash and cash equivalents ended at $117.3 million, up $18.1 million from year-end. Short-term borrowings were $308.2 million and long-term borrowings were $39.2 million, compared with $446.2 million and $39.1 million, respectively, at year-end.
- Capital: The company reported CET1 capital of 9.81%, Tier 1 capital of 10.34%, and total risk-based capital of 12.58%; management stated capital remained above well-capitalized thresholds.
Material changes versus comparable periods
- Average loans increased $374.3 million year over year in Q3; commercial loans grew notably. Higher balances and yields lifted interest income, but higher deposit and borrowing costs reduced the benefit to spread.
- Investment advisory income increased, reflecting the HNP Capital acquisition, the 2017 Robshaw & Julian acquisition, and growth at Courier Capital. HNP Capital was acquired June 1, 2018 for $5.1 million in cash and had approximately $344 million in assets under management at June 30.
- Operating expenses increased with staffing and growth initiatives, the wealth-management acquisitions, software and facilities investment, and the Five Star Bank brand campaign. A $1.6 million goodwill impairment recorded in 2017 did not recur.
- Accumulated other comprehensive loss increased to $21.8 million from $11.9 million, mainly due to lower fair values of securities as market interest rates changed. Management considered the losses temporary and reported no securities impairment.
Outlook, risks, contingencies and unusual items
- The filing gives no specific earnings or revenue guidance. Management describes continued organic loan and deposit growth and community banking focus, while noting that interim results are not necessarily indicative of full-year results.
- Key stated risks include credit losses, commercial and indirect lending exposure, interest-rate and liquidity risk, deposit withdrawals and funding costs, regional economic concentration, regulatory and tax changes, cybersecurity, competition, and successful integration of acquisitions.
- Management’s interest-rate simulation estimated 12-month net interest income changes of -3.30% under a 100-basis-point decline, +0.84% under a 100-basis-point rise, +1.69% under a 200-basis-point rise, and +2.57% under a 300-basis-point rise. These are model estimates, not forecasts. A +200-basis-point shock reduced estimated economic value of equity by 9.54%.
- Off-balance-sheet commitments included $664.1 million to extend credit and $12.7 million of standby letters of credit; amounts may not be drawn. The company also had $308.2 million of short-term FHLB borrowings and reported additional collateralized wholesale borrowing capacity of approximately $886.4 million.
- Management expected to reclassify approximately $2.8 million from accumulated other comprehensive loss to retained earnings upon adoption of the relevant accounting update. No material recognizable subsequent events were reported, and no material developments in legal proceedings were disclosed.
Most important facts for investors to verify
- Whether loan growth and higher yields can continue to offset rising deposit and wholesale funding costs, and how margins respond to rate changes.
- Credit trends behind the Q3 increase in net charge-offs, the adequacy of the allowance, and the composition and performance of commercial and indirect-auto loans.
- The sustainability of noninterest income growth and expense increases, including the contribution and integration costs of HNP Capital.
- The impact of unrealized securities losses, interest-rate sensitivity, deposit mix and wholesale funding on liquidity and regulatory capital.
- Actual utilization and credit quality of the $664.1 million in lending commitments, along with progress on the company’s stated growth strategy.