Community Bank System, Inc. 10-Q Summary
Reporting period: Three and six months ended June 30, 2019. The filing identifies the registrant as Community Bank System, Inc., although the request metadata names Community Financial System, Inc. Financial statements are unaudited and presented in thousands, except per-share data.
Business Context
The company operates a diversified financial services business through Banking, Employee Benefit Services, and All Other segments, including wealth management and insurance services. Banking serves customers primarily in Upstate New York, Northeastern Pennsylvania, Vermont, and Western Massachusetts.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Net interest income | $88.3 million | $86.8 million | $175.2 million | $171.5 million |
| Noninterest revenues | $60.7 million | $56.6 million | $116.4 million | $114.1 million |
| Noninterest expenses | $91.2 million | $86.1 million | $179.8 million | $172.4 million |
| Net income | $45.0 million | $44.6 million | $87.0 million | $84.7 million |
| Diluted EPS | $0.86 | $0.86 | $1.66 | $1.63 |
| Net interest margin | 3.80% | 3.73% | 3.80% | 3.72% |
- Q2 net income increased 0.9%; year-to-date net income increased 2.7%. Diluted EPS was flat in Q2 and increased $0.03 year to date.
- Adjusted diluted EPS, excluding specified acquisition, investment-security, intangible-amortization, and acquired-loan-accretion items, was $0.84 in Q2 and $1.69 year to date, versus $0.90 and $1.71, respectively.
- Adjusted return on average assets was 1.64% in Q2 and 1.67% year to date; adjusted return on average equity was 9.98% and 10.23%, respectively.
- Total assets were $10.75 billion at June 30, up from $10.61 billion at December 31, 2018. Loans were $6.28 billion, essentially unchanged from year-end and up 0.7% from June 2018.
- Total deposits were $8.49 billion, up $165.8 million from year-end. Core deposits represented approximately 91% of average deposits, while average deposit costs increased to 0.22% from 0.11% in the prior-year quarter.
- Shareholders’ equity was $1.81 billion, up $95.7 million from year-end. The Tier 1 leverage ratio was 11.54%, and the net tangible equity-to-assets ratio was 10.56%.
- Cash and cash equivalents totaled $874.8 million. Six-month operating cash flow was $89.9 million, compared with $112.8 million in the prior-year period. Investing cash flow was $616.7 million, principally reflecting $590.2 million of investment-security sales.
- Debt and funding included $97.9 million of subordinated debt, $1.9 million of other long-term debt, and $142.4 million of short-term customer repurchase agreements. There were no short-term borrowings at June 30, 2019.
Material Changes Versus Prior Comparable Period
- Net interest income benefited from higher earning-asset yields and a higher net interest margin, partially offset by increased deposit and borrowing costs.
- Recurring noninterest revenue declined because the Durbin Amendment reduced debit-interchange revenue by approximately $3.5 million in Q2 and $6.7 million year to date.
- Total noninterest revenue nevertheless increased due primarily to a $4.9 million net gain on available-for-sale investment securities and growth in employee benefit and insurance services.
- Noninterest expense increased 5.9% in Q2 and 4.3% year to date. The increases reflected salaries and benefits, technology, marketing, other expenses, and $1.2 million of Q2 acquisition expenses related to Kinderhook.
- The efficiency ratio worsened to 59.8% in Q2 and 59.5% year to date, from 57.2% and 57.5%, respectively.
- The provision for loan losses declined to $1.4 million in Q2 and $3.8 million year to date, versus $2.4 million and $6.1 million in the prior-year periods.
- Nonperforming loans were $24.5 million, or 0.39% of total loans, compared with $29.3 million, or 0.47%, at June 30, 2018. The allowance for loan losses was $49.3 million, or 0.78% of loans, providing 202% coverage of nonperforming loans.
- The available-for-sale securities portfolio declined to $2.36 billion from $2.94 billion at year-end, while its net unrealized position improved to a $37.3 million gain from a $16.2 million loss.
Guidance, Outlook, Risks, and Unusual Items
- On July 12, 2019, after quarter-end, the company completed the approximately $93.4 million cash acquisition of Kinderhook Bank Corp., adding 11 branches in five Capital District counties. Management expects one-time transaction costs in 2019 and estimated first-full-year accretion of approximately $0.07 to $0.08 per share, excluding acquisition-related expenses.
- The company sold $590.2 million of Treasury and agency securities in Q2, recognizing a $4.9 million net gain; proceeds were held primarily in higher-yielding cash equivalents.
- Management expects the allowance for loan losses to change when CECL, the expected-credit-loss standard, is adopted for fiscal years beginning after December 15, 2019. The amount was not yet determinable.
- Liquidity appeared strong: $1.7 billion of unused FHLB borrowing capacity, $1.1 billion of unencumbered securities, and $25 million of unsecured correspondent-bank lines were available. The 30-day and 90-day basic surplus ratios were 15.7% and 15.1%, above the company’s 7.5% internal requirement.
- Modeled 12-month net-interest-income sensitivity ranged from a $7.4 million decline under a 200-basis-point rate decrease to a $1.5 million increase under a 100-basis-point increase. Management cautioned that these scenarios are not forecasts.
- Risks include credit quality, interest-rate and liquidity exposure, deposit-cost pressure, competition, regulatory changes, technology and cybersecurity, acquisition integration, litigation, and economic conditions. Management reported no material change to the risk factors disclosed in the 2018 Form 10-K.
- Pending litigation was not expected to materially affect financial position; reasonably possible losses beyond recorded liabilities were estimated at $0 to $1 million in aggregate, although a material effect on a particular future period cannot be excluded.
Investor Verification Items
- Verify the registrant identity and ticker: the filing is for Community Bank System, Inc., ticker CBU.
- Assess the sustainability of earnings excluding the $4.9 million securities-sale gain and the effect of Durbin-related interchange revenue reductions.
- Review Kinderhook’s post-closing purchase accounting, integration costs, branch performance, and realization of the stated $0.07-$0.08 per-share accretion expectation.
- Monitor deposit pricing, funding costs, net interest margin, and sensitivity to changing interest rates.
- Evaluate CECL implementation and its effect on the allowance, retained earnings, and regulatory capital.
- Track credit quality, charge-offs, nonperforming loans, OREO, and allowance coverage, particularly in consumer mortgage and business lending portfolios.
- Confirm liquidity capacity and capital ratios after funding the Kinderhook acquisition and paying regular dividends.