Community Bank System, Inc. 10-Q Summary
Reporting period: Three months ended March 31, 2020; filed May 11, 2020. The request metadata names Community Financial System, Inc., but the filing identifies the registrant as Community Bank System, Inc. (NYSE: CBU). Results are unaudited and include the effects of the July 2019 Kinderhook acquisition.
Business Context and Financial Position
The company operates diversified banking, employee benefit services, wealth management, insurance and related financial services businesses across Upstate New York and surrounding markets. The filing was prepared during the early COVID-19 pandemic and includes significant discussion of related economic, credit and operational risks.
| Metric | March 31, 2020 | Comparable / Prior Period |
|---|---|---|
| Total assets | $11.81 billion | $11.41 billion at December 31, 2019; $10.92 billion at March 31, 2019 |
| Loans | $6.87 billion | Down 0.4% from December 31, 2019; up 9.6% year over year |
| Deposits | $9.30 billion | Up 3.4% from December 31, 2019 |
| Shareholders’ equity | $1.98 billion | $1.86 billion at December 31, 2019 |
| Cash and cash equivalents | $529.3 million | $205.0 million at December 31, 2019 |
Financial Results and Key Metrics
- Revenue and earnings: Net interest income was $90.1 million, up 3.7% year over year. Noninterest revenue was $58.6 million, up 5.3%.
- Profit: Net income was $40.1 million, down 4.3% from $41.9 million. Diluted EPS was $0.76 versus $0.80. Adjusted net income was $42.2 million versus $44.6 million, and adjusted diluted EPS was $0.80 versus $0.85.
- Credit costs: Provision for credit losses was $5.6 million, compared with $2.4 million. The allowance for credit losses was $55.7 million, or 0.81% of loans, versus 0.78% at March 31, 2019.
- Margins and expenses: Fully tax-equivalent net interest margin was 3.65%, down 15 basis points year over year. Noninterest expense increased 5.7% to $93.7 million. The adjusted efficiency ratio worsened to 60.4% from 59.1%.
- Cash flow: Operating activities generated $26.7 million; investing activities generated $49.4 million; financing activities generated $248.2 million. Cash increased $324.3 million during the quarter.
- Asset quality: Nonperforming loans were $31.8 million, or 0.46% of loans, versus 0.39% at December 31, 2019. Nonperforming assets were $33.3 million. Net charge-offs were $1.6 million, or 0.09% of average loans.
- Capital and liquidity: The Tier 1 leverage ratio was 11.10%, substantially above the 5.0% well-capitalized standard. Management reported $1.83 billion of unused FHLB borrowing capacity, $260.4 million of Federal Reserve discount-window availability and approximately $1.6 billion of unencumbered securities.
- Debt: Securities sold under repurchase agreements totaled $205.0 million. Other borrowings totaled approximately $94.8 million, excluding repurchase agreements, and subordinated debt included $77.3 million held by unconsolidated subsidiary trusts.
Material Changes Versus Prior Comparable Period
- Loan growth was primarily attributable to the Kinderhook acquisition and organic growth in business lending and consumer mortgages. Loans increased approximately $600.0 million year over year.
- Deposits increased approximately $651.5 million on an average basis, also substantially reflecting Kinderhook.
- Net interest income increased because of higher earning-asset balances, but lower market rates reduced asset yields and compressed net interest margin.
- COVID-19-related economic deterioration increased the credit-loss provision by $3.2 million year over year, despite lower net charge-offs.
- Noninterest expense increased $5.0 million, largely due to higher salaries and benefits, data processing, occupancy and professional fees associated with the expanded organization.
- The company adopted CECL on January 1, 2020. The adoption increased retained earnings by $0.5 million, including a $1.4 million increase in the loan allowance, a $3.1 million adjustment to loans and a $1.2 million increase in liabilities for off-balance-sheet exposures.
- Accumulated other comprehensive income increased to $83.4 million from a $10.2 million loss at year-end 2019, primarily because of higher unrealized gains on available-for-sale securities.
Guidance, Outlook, Risks and Unusual Items
- Management expects second-quarter net interest margin to decline, excluding the effect of PPP loans, because of the sharp reduction in Federal Funds and Prime rates. PPP fee recognition and forgiveness timing may create additional earning-asset yield volatility.
- Management expects noninterest revenue to decline in the second quarter and potentially thereafter because of lower commerce, reduced deposit and debit-card activity, and lower wealth-management asset values.
- Through April 30, 2020, the company had approved 3,314 PPP loans totaling $497.0 million. It anticipated approximately $366 million of PPP loan originations in the second quarter, with anticipated forgiveness and repayment during the third quarter; actual timing remains uncertain.
- Through April 30, 2020, payment deferrals had been granted to 4,376 consumer borrowers and 1,318 business borrowers representing $734.6 million of loans. Management expected deferral requests to increase significantly in the second quarter.
- The pending Steuben Trust Corporation acquisition was valued at approximately $106.7 million based on the April 30, 2020 stock price and was scheduled to close in the second quarter, although COVID-19 could delay closing. Additional transaction-related costs are expected.
- Management identified the COVID-19 pandemic as the principal near-term risk, with potential effects on credit losses, loan demand, interest income, fee revenue, capital, liquidity, operations, cybersecurity and regulatory compliance.
- A $9.9 million business line of credit that matured December 31, 2019 contributed materially to higher nonperforming loans. The company was seeking an extension, but stated that the borrower’s financial condition was uncertain and the loan could become nonaccrual in the second quarter.
- Pending litigation was not expected to materially affect financial position. The aggregate range of reasonably possible losses beyond recorded liabilities was estimated at $0 to $1 million, although effects on a particular future period could be material.
Most Important Facts to Verify
- Whether COVID-19 deferrals, PPP loan forgiveness and borrower deterioration result in materially higher charge-offs, nonaccrual loans and CECL provisions in subsequent quarters.
- The timing, final consideration, integration costs and expected benefits of the Steuben acquisition.
- Actual second-quarter net interest margin and fee-revenue performance following the Federal Reserve rate cuts and market volatility.
- Whether PPP loan volume, fees, forgiveness and SBA guarantee funding match management’s assumptions.
- Trends in deposits, liquidity utilization, borrowing capacity and regulatory capital ratios under stressed conditions.
- The resolution and credit impact of the $9.9 million matured business line of credit.
- The filing’s inconsistent presentation of certain diluted weighted-average share counts; investors should reconcile the detailed EPS note with the MD&A table.