Financial Institutions, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; balance-sheet comparisons are to December 31, 2010. The company provides banking and related financial services in Central and Western New York. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $20.3 | $19.7 | $40.1 | $38.9 |
| Net interest income, tax-equivalent | $20.8 | $20.1 | $41.1 | $39.9 |
| Provision for loan losses | $1.3 | $2.1 | $2.1 | $2.5 |
| Noninterest income | $5.0 | $5.0 | $10.1 | $9.0 |
| Noninterest expense | $15.2 | $14.9 | $30.5 | $29.6 |
| Net income | $5.7 | $5.2 | $11.5 | $10.5 |
| Net income available to common shareholders | $5.3 | $4.3 | $9.1 | $8.7 |
| Diluted EPS | $0.39 | $0.39 | $0.72 | $0.80 |
- Q2 net income rose 10%; management attributed the increase mainly to higher net interest income and lower loan-loss provision, partly offset by higher expenses and taxes. First-half net income also rose 10%.
- Tax-equivalent net interest margin was 4.00% in Q2 and 4.02% year to date, down 9 basis points in each comparison. Lower asset yields outweighed lower funding costs; loan and securities yields were pressured by the low-rate environment and competitive pricing.
- Q2 return on average assets/equity was 1.01%/10.03%; first-half return was 1.04%/10.43%. Efficiency ratio was 58.68% for Q2 and 59.32% for the first half.
- First-half diluted EPS declined despite higher net income, reflecting the additional shares issued in the March offering and a $1.2 million noncash preferred-stock discount accretion charge, which reduced year-to-date diluted EPS by $0.10.
Financial position, cash flow and asset quality
- At June 30, total assets were $2,282.9, up from $2,214.3 at year-end. Net loans were $1,347.4 (gross loans $1,368.1), up about 2% from year-end. Deposits were $1,872.2, down $10.7.
- Cash and cash equivalents were $46.1, compared with $39.1 at year-end. For the six months, operating cash flow was $24.0, investing cash flow was negative $61.5, and financing cash flow was positive $44.5; ending cash increased $7.0.
- Short-term borrowings rose to $132.4 from $77.1; long-term borrowings were $26.7. Separately, management’s borrowing composition shows total borrowings of $159.1, including customer repurchase agreements, federal funds, FHLB advances and $16.7 of junior subordinated debentures. Available funding included approximately $108 of immediate FHLB capacity, $359 of secured FRB capacity and $52 of unsecured federal funds lines.
- Shareholders’ equity increased to $233.7 from $212.1. Company regulatory capital ratios at June 30 were 9.30% Tier 1 leverage, 13.71% Tier 1 risk-based and 14.96% total risk-based.
- The allowance for loan losses was $20.6, or 1.51% of loans, versus $20.5 and 1.52% at year-end (the filing’s comparison table reports 1.51% for June and 1.69% for June 2010). First-half net charge-offs were $2.0, up from $1.4 a year earlier; the allowance covered nonperforming loans by 296%.
- Nonperforming loans were $7.0, down from $7.6 at year-end; nonperforming assets were $14.5, or 0.64% of assets, versus $8.9, or 0.40%. The increase largely reflected a $6.4 rise in fair value of nonperforming investment securities, not newly classified securities. Management said the loan allowance was adequate, while noting estimates are uncertain.
Material changes, outlook and risks
- The company issued 2,813,475 common shares in March at $16.35 per share, receiving $43.1 net proceeds. It redeemed all $37.5 of Treasury TARP Series A preferred stock and repurchased the Treasury warrant for $2.1, removing associated dividend, share-repurchase and certain executive-compensation restrictions.
- On July 1, the company gave notice that it would redeem $16.7 of 10.20% junior subordinated debentures on August 22, 2011, at 105.1% of principal plus accrued interest. Management expected a third-quarter pretax charge of about $1.1. The related $16.2 of trust preferred securities would also be redeemed. Upon notice, these securities ceased qualifying as company Tier 1 capital; management estimated the resulting ratios would be 8.57% leverage, 12.64% Tier 1 risk-based and 13.89% total risk-based. The bank’s capital was not expected to be significantly affected.
- The company sold one pooled trust preferred security in July and expected to record an approximately $1.0 gain in Q3. It also expected a $0.153 gain from the July sale of $13.6 of indirect auto loans held for sale.
- Investment securities available for sale had fair value of $707.0. Unrealized losses totaled $1.6, down from $6.2 at year-end; management judged the losses temporary and did not intend, nor expect to be required, to sell affected securities before recovery. The $7.0 fair value of nonperforming asset-backed securities included pooled trust preferred positions, most of which were not accruing interest and were rated below investment grade; the portfolio had incurred $32.9 of cumulative impairment charges through 2010.
- Off-balance-sheet commitments included $367.9 of credit commitments and $18.0 of standby letters of credit. Actual funding may be below stated commitment amounts, but the exposures carry credit risk.
- No numerical earnings or financial guidance was provided. Management discussed ongoing branch expansion and a July Rochester-area branch relocation. Principal disclosed risks include credit and collateral deterioration, interest-rate and securities valuation exposure, seasonal public deposits, and potential adverse effects from a U.S. government credit downgrade or selective debt-payment disruption. Management reported no material change in market risk since its 2010 Form 10-K.
- Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported. No material legal-proceeding developments were disclosed.
Important facts for investors to verify
- Whether the August 2011 debt and trust-preferred redemption occurred as planned, including the actual charge, funding impact and post-redemption capital ratios.
- Subsequent results for the July asset-backed security and indirect auto-loan sales, including realized gains and any further portfolio dispositions.
- Trends in net interest margin and funding costs, particularly given low asset yields, higher short-term borrowings and the company’s securities leverage strategy.
- Credit quality and reserve adequacy: first-half net charge-offs increased year over year, and reported nonperforming assets include securities whose fair value improved materially.
- Share dilution and capital deployment following the common-stock offering, preferred-stock redemption and ongoing dividends.