Financial Institutions, Inc. — 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018; the filing also reports fourth-quarter results. Financial Institutions, Inc. (Nasdaq: FISI) is a New York-based financial holding company whose principal subsidiary, Five Star Bank, operates in Western and Central New York. The company also owns insurance agency SDN and wealth-management firms Courier Capital and HNP Capital; HNP Capital was acquired in June 2018.
Key financial results
| Metric | 2018 | 2017 | Change / context |
|---|---|---|---|
| Total assets, year-end | $4.312 billion | $4.105 billion | Up 5% |
| Gross loans, year-end | $3.087 billion | $2.735 billion | Up 13%; net loans were $3.053 billion |
| Deposits, year-end | $3.367 billion | $3.210 billion | Up 5% |
| Borrowings, year-end | $508.7 million | $485.3 million | Up $23.4 million |
| Net interest income (GAAP) | $122.9 million | $112.6 million | Up 9%; tax-equivalent NII was $124.2 million, up 7% |
| Net interest margin, tax-equivalent | 3.18% | 3.21% | Down 3 basis points |
| Provision for loan losses | $8.9 million | $13.4 million | Down 33% |
| Noninterest income | $36.5 million | $34.7 million | Up 5% |
| Noninterest expense | $100.9 million | $90.5 million | Up 11% |
| Net income | $39.5 million | $33.5 million | Up 18% |
| Diluted EPS | $2.39 | $2.13 | Up 12% |
- Returns and operating efficiency: Return on average assets was 0.95%; return on average equity was 10.18%. The efficiency ratio increased to 62.73% from 60.65%, reflecting higher expenses.
- Asset quality: Nonperforming loans fell to $7.1 million, or 0.23% of loans, from $12.5 million, or 0.46%. Net charge-offs were $9.7 million, 0.33% of average loans, versus $9.6 million and 0.38% in 2017. The allowance was $33.9 million, 1.10% of loans.
- Capital: Shareholders’ equity was $396.3 million, up from $381.2 million. FII’s year-end CET1, Tier 1, total risk-based capital and leverage ratios were 9.70%, 10.21%, 12.38% and 8.16%, respectively. The company and Bank exceeded applicable regulatory requirements and were considered well capitalized.
- Cash flows and liquidity: Operating activities provided $65.1 million; investing activities used $225.4 million, including $361.9 million of net loan originations; financing activities provided $163.8 million. Year-end cash and cash equivalents were $102.8 million. The Bank had $54.9 million of immediate FHLB credit capacity, $671.5 million of secured FRB discount-window capacity and $145 million of unsecured federal funds lines, of which $64 million was drawn.
- Dividends: Common dividends declared were $0.96 per share for 2018, up 13%; the common dividend payout ratio was 40.17%. The board intended to continue regular quarterly dividends, subject to results, capital and other needs.
Fourth-quarter results and material changes
- Fourth-quarter net income was $7.5 million, down from $11.1 million a year earlier; diluted EPS was $0.45 versus $0.68. Net income available to common shareholders was $7.1 million.
- Quarterly net interest income rose to $32.0 million from $29.8 million, while noninterest income was $9.3 million versus $9.0 million. Noninterest expense increased to $27.8 million from $23.2 million.
- Fourth-quarter 2018 results included a $2.4 million noncash goodwill impairment charge for SDN and $667,000 of nonrecurring employee retirement and severance expense. The impairment was not tax deductible and adversely affected the quarter’s effective tax rate.
- Fourth-quarter 2017 results benefited from a $2.9 million tax-expense reduction related to the Tax Cuts and Jobs Act, principally from revaluing the net deferred tax liability. This makes the reported quarterly profit comparison less representative of underlying operating performance.
- For the full year, income tax expense was $10.0 million and the effective tax rate was 20.2%, compared with 22.9% in 2017. The federal statutory rate fell to 21% effective in 2018.
Business, outlook and principal risks
- Management cited loan and deposit growth, expansion of fee-based businesses, HNP Capital’s acquisition and redeployment of securities into loans as strategic priorities. It provided no quantitative earnings or growth guidance in the supplied filing text.
- Loan growth was concentrated in commercial lending: commercial loans reached $1.516 billion, 49.1% of total loans. Consumer indirect auto loans were $919.9 million, 29.8% of loans. Management identified credit deterioration, regional economic concentration, real-estate collateral values and indirect auto credit losses as important risks.
- The Bank was liability-sensitive in its interest-rate modeling: a parallel 100-basis-point increase was estimated to reduce 12-month net interest income by 2.43%; a 200-basis-point increase by 5.04%. These are modeled estimates, not forecasts.
- Funding costs rose materially: average interest-bearing deposit cost increased to 0.73% from 0.45%, and average short-term borrowing cost to 2.11% from 1.16%. Management also flagged competition for deposits, callable deposits, liquidity and wholesale funding costs.
- At year-end, the AFS securities portfolio had a $9.9 million net unrealized loss, compared with $3.5 million a year earlier. Management attributed losses primarily to higher market rates and said it did not intend, and did not expect to be required, to sell securities before recovery; it recorded no impairment loss.
- The Federal Reserve’s most recent disclosed Community Reinvestment Act evaluation rated the Bank “Needs to Improve” for the 2011–September 2013 review period. The rating may bring heightened scrutiny to expansion applications; a New York State evaluation was still pending.
- Other notable risks include regulatory and cybersecurity compliance, acquisition integration, higher operating costs, goodwill impairment, pension assumptions, and the expected effect of adopting the current expected credit loss standard (CECL), which management said it could not yet reasonably estimate.
- Management reported no pending or threatened legal proceeding believed likely to have a material adverse effect. The external auditor gave an unqualified opinion on the 2018 financial statements and internal controls; management also concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Reconcile the annual and quarterly earnings trend after accounting for SDN impairment, severance costs and the prior-year tax benefit.
- Track whether rapid commercial and indirect-auto loan growth is accompanied by stable delinquency, charge-off and allowance trends.
- Assess deposit pricing, time-deposit growth, short-term borrowing reliance and the potential effect of rising rates on net interest margin and earnings.
- Monitor the SDN business and goodwill valuation after the additional $2.4 million impairment, and determine whether the HNP acquisition contributes sustained fee revenue.
- Follow the implications of the “Needs to Improve” CRA rating, the pending state review, CECL implementation and capital levels relative to fully phased-in requirements.