Community Bank System, Inc. — Q1 2023 Form 10-Q Summary
Filing identification: The provided filing is for Community Bank System, Inc., not “Community Financial System, Inc.” It covers the unaudited three months ended March 31, 2023, compared with the three months ended March 31, 2022, and was filed May 10, 2023.
Business context and reporting period
The company operates diversified banking and financial-services businesses through Banking, Employee Benefit Services, and All Other segments, including insurance and wealth-management activities. Banking markets primarily cover Upstate New York, Northeastern Pennsylvania, Vermont, and Western Massachusetts. The company completed the Axiom Realty Group acquisition on March 1, 2023 and announced a subsequent $4.3 million acquisition of certain Hyde Park Insurance Services assets, completed May 1, 2023.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 / prior period |
|---|---|---|
| Net income | $5.8 million | $47.1 million |
| Diluted EPS | $0.11 | $0.86 |
| Net interest income | $111.0 million | $94.9 million |
| Provision for credit losses | $3.5 million | $0.9 million |
| Noninterest revenue | $13.5 million | $65.7 million |
| Noninterest expense | $114.1 million | $99.8 million |
| Net interest margin, fully tax-equivalent | 3.20% | 2.73% |
| GAAP efficiency ratio | 91.6% | 62.2% |
| Adjusted efficiency ratio | 62.5% | 59.6% |
| Total assets at quarter-end | $15.26 billion | $15.84 billion at Dec. 31, 2022 |
| Gross loans at quarter-end | $8.98 billion | $8.81 billion at Dec. 31, 2022 |
| Total deposits at quarter-end | $13.11 billion | $13.01 billion at Dec. 31, 2022 |
| Shareholders’ equity | $1.63 billion | $1.55 billion at Dec. 31, 2022 |
Operating net income, excluding specified acquisition, securities, debt-extinguishment, and equity-security items, was $46.8 million versus $47.3 million in the prior-year quarter. Diluted adjusted net earnings per share were $0.90 versus $0.91. Adjusted return on average assets was 1.29% in both periods.
Cash flow from operating activities was $77.4 million, compared with $51.9 million in Q1 2022. Investing activities provided $596.1 million, primarily from $733.8 million of proceeds from available-for-sale securities sales, partly offset by $179.3 million of net loan growth. Financing activities used $694.0 million, including a $710.0 million reduction in overnight borrowings and $23.7 million of dividends paid. Cash and cash equivalents ended the quarter at $189.3 million.
At March 31, 2023, the allowance for credit losses was $63.2 million, or 0.70% of total loans. Net charge-offs were $1.5 million, or 0.07% annualized of average loans. Nonaccrual loans were 0.33% of total loans, and delinquent loans were 0.73% of total loans.
Regulatory capital remained strong. The company reported a 9.06% Tier 1 leverage ratio, 15.20% common equity Tier 1 ratio, and 15.91% total risk-based capital ratio. The company and bank subsidiary met applicable requirements to be considered well capitalized.
Material changes versus comparable periods
- Net income fell 87.7%, primarily because the company recognized a $52.3 million pretax realized loss on the sale of available-for-sale investment securities.
- The company sold securities with a $786.1 million book value and used the $733.8 million proceeds to repay overnight borrowings. Management stated that the resulting earnings impact is expected to be recouped in approximately two years because the securities’ funding cost was about 320 basis points below the cost of the repaid borrowings.
- Net interest income increased 17.0%, while the fully tax-equivalent net interest margin expanded 47 basis points to 3.20%, reflecting higher asset yields and loan growth.
- Gross loans increased 2.0% from year-end 2022 and 21.0% from March 31, 2022, supported by organic growth and the Elmira Savings Bank acquisition completed in May 2022.
- Interest expense increased to $14.9 million from $2.8 million as deposit and borrowing costs rose. Average overnight borrowings were $362.5 million during the quarter, although quarter-end overnight borrowings declined to $58.4 million.
- Noninterest expenses increased 14.3%, led by a $9.8 million increase in salaries and employee benefits, along with higher legal, insurance, technology, and inflation-related costs.
- Available-for-sale securities declined to $3.49 billion from $4.15 billion at year-end 2022. Accumulated other comprehensive loss improved to $578.1 million from $686.4 million, primarily due to improved unrealized investment-security values.
- Total deposits increased 0.8% from year-end 2022 but average deposits declined 0.8% year over year. More than 30% of total deposits were noninterest-bearing, and 74% were in checking and savings accounts.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects deposit costs and the deposit beta to continue increasing as market rates change, with potential pressure from higher funding costs and greater reliance on wholesale borrowings.
- The company’s interest-rate sensitivity model estimates that a parallel 200-basis-point rate increase would reduce projected annualized net interest income by $14.5 million, while a 100-basis-point decrease would increase it by $16.9 million. Management stated these are hypothetical scenarios, not forecasts.
- Management cited a weaker economic forecast, including potential deterioration in residential and commercial real estate and used-vehicle prices, as a driver of the higher credit-loss provision. Asset quality nonetheless remained strong, with low charge-offs and declining delinquency and nonperforming-loan ratios.
- Immediately available liquidity was approximately $4.69 billion, compared with estimated uninsured deposits of approximately $2.2 billion. Liquidity sources included $1.84 billion of unused FHLB capacity, $1.54 billion of Federal Reserve discount-window availability, $1.21 billion of unencumbered securities, and $25 million of unsecured correspondent-bank lines.
- The company identified recent bank failures and potential customer-confidence effects as a new material risk. Potential consequences include deposit outflows, higher funding costs, reduced liquidity, regulatory scrutiny, and increased operating expenses.
- Commitments to extend credit totaled $1.46 billion and standby letters of credit totaled $56.8 million at March 31, 2023.
- Management did not expect pending or threatened legal matters to be material to consolidated financial position. The estimated range of reasonably possible losses beyond recorded liabilities was $0 to $1 million, although particular-period operating results could still be affected.
- The board authorized repurchases of up to 2.697 million shares during 2023; 200,000 shares were repurchased under the program during the first quarter for approximately $10.9 million.
- The company adopted ASU 2022-02 prospectively on January 1, 2023. The adoption expanded disclosures but did not materially affect the financial statements.
Investor verification checklist
- Confirm the issuer identity, because the request names Community Financial System, Inc. while the filing identifies Community Bank System, Inc.
- Assess whether the approximately $52.3 million securities-sale loss and the stated two-year payback from reduced borrowing costs are consistent with subsequent net interest income and funding trends.
- Monitor deposit balances, deposit beta, uninsured deposits, wholesale funding, and liquidity capacity amid continuing banking-sector confidence risks.
- Review whether loan growth, especially consumer indirect and commercial real estate lending, leads to higher delinquencies, charge-offs, or allowance requirements.
- Compare reported GAAP results with non-GAAP operating results and evaluate the recurring effect of rising compensation, technology, legal, FDIC insurance, and acquisition-related expenses.
- Verify the impact of the Hyde Park acquisition and other acquisitions beginning in the second quarter of 2023, including goodwill, intangibles, integration costs, and incremental revenue.
- Track accumulated other comprehensive loss, tangible equity, securities duration, and capital ratios under changing interest-rate conditions.