Peoples Financial Services Corp. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Unaudited consolidated results; dollar amounts are in thousands except per-share data. Peoples is a Pennsylvania-based bank holding company serving communities in Pennsylvania and New York.
Financial performance and position
- Second quarter: Net interest income was $16.1 million, up 5.5% year over year; net income was $5.7 million, up 16.6%; diluted EPS was $0.76 versus $0.66. Net interest margin on a tax-equivalent basis was 3.68%, down from 3.81% a year earlier. Return on average assets was 1.11% and return on average equity was 8.71%.
- First half: Net interest income was $32.0 million, up 5.7%; net income was $10.5 million, up 7.4%; diluted EPS was $1.41 versus $1.32. Tax-equivalent net interest margin was 3.71%, compared with 3.81% in the first half of 2016. Return on average assets was 1.04% and return on average equity was 8.13%.
- Income and expenses: First-half total interest income was $36.1 million and interest expense was $4.1 million. Noninterest income was $10.2 million, including a $2.278 million gain on sale of the merchant services business. Noninterest expense was $26.4 million, up 11.1%; salaries and benefits rose 18.4%, partly reflecting expansion-related staffing and resources. First-half income tax expense was $2.9 million, or 21.8% of pretax income.
- Balance sheet at June 30: Total assets were $2.065 billion, up 3.3% from year-end 2016. Gross loans were $1.597 billion, up $64.4 million; after the $17.8 million allowance, net loans were $1.580 billion. Deposits were $1.639 billion, up $50.7 million. Available-for-sale and held-to-maturity securities totaled $266.6 million.
- Funding and liquidity: Short-term borrowings were $91.5 million, up $8.8 million from year-end; long-term debt was $57.2 million, down $1.0 million. Cash and cash equivalents were $41.4 million. First-half operating cash flow was $11.5 million, investing cash outflow $64.0 million, and financing cash inflow $53.9 million; cash increased $1.46 million. Management said liquidity was adequate to meet obligations and commitments. Net noncore funding dependence was 14.6%, versus 14.4% at year-end.
- Capital and dividends: Stockholders’ equity was $263.5 million. The Bank reported a 9.85% Tier 1 leverage ratio, 11.90% Tier 1 risk-based and CET1 ratios, and a 12.99% total risk-based capital ratio; management said the Bank was well-capitalized and met fully phased-in Basel III requirements. Dividends declared were $0.31 per share in the quarter and $0.62 for the half-year.
Material changes and credit quality
- Loan growth was led by commercial loans, up $43.4 million, and commercial real estate loans, up $19.5 million. Residential real estate loans declined $3.5 million; management attributed this partly to selling most new mortgage originations rather than retaining them.
- The merchant business was sold in Q2 for $2.3 million, producing a $2.278 million gain. Peoples will no longer originate proprietary merchant relationships, but has a separate agreement to share in future revenue from the sold portfolio and new referrals.
- Tax-equivalent net interest margin declined year over year despite higher net interest income. Management cited lower loan yields, competitive loan pricing, and higher funding costs. First-half cost of interest-bearing liabilities increased to 0.59% from 0.55%.
- Nonperforming assets declined 18.0% from year-end to $11.6 million, or 0.73% of loans and foreclosed assets, from 0.93%. Nonaccrual loans fell to $8.3 million, primarily after workouts and collections on two large commercial real estate relationships. The allowance for loan losses rose to $17.8 million; first-half net charge-offs were $559, or 0.07% of average loans.
Outlook, risks, and contingencies
- No earnings or revenue guidance was provided. Management reported continued loan growth in its Lehigh Valley and King of Prussia expansion markets and expected to manage interest-rate exposure through loan and deposit pricing and reinvestment strategies.
- The company reported a positive one-year repricing gap; its model projected net interest income would increase 1.3% under an instantaneous 100-basis-point rate increase. Management cautioned that modeling and static gap analysis have limitations. It noted the Federal Reserve raised rates twice in the first half and projected another increase in 2017.
- Key disclosed risks include interest-rate and economic conditions, credit quality and collateral values, deposit flows, competition, regulation, business-combination execution, third-party service providers, and cybersecurity. Management anticipated that adoption of the expected-credit-loss standard (CECL) would increase the allowance and reduce regulatory capital ratios, but could not estimate the impact.
- Management reported no material legal proceedings, no material changes to previously disclosed risk factors, effective disclosure controls, and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of earnings growth remains after excluding the $2.278 million merchant-sale gain, and how the related referral/revenue-sharing agreement performs.
- Whether loan growth and deposit gathering continue at a pace that avoids greater reliance on short-term borrowings, and how funding costs affect net interest margin.
- Whether credit quality remains sound as the loan portfolio grows, including trends in nonaccrual loans, classified loans, charge-offs, and allowance coverage.
- The effect and timing of CECL adoption on the allowance, earnings, and regulatory capital; management expected an allowance increase but did not quantify it.
- Whether capital, liquidity, and the stated dividend remain supported by future results and applicable regulatory requirements.