PEOPLES FINANCIAL SERVICES CORP. quarterly report, Q3 FY2019

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Peoples Financial Services Corp. — Q3 2019 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2019. The company is a Pennsylvania bank holding company operating through Peoples Security Bank and Trust Company. Unless otherwise noted, financial amounts below are in millions of dollars; the statements are unaudited.

Financial performance

  • Third-quarter net income: $7.15 million, versus $6.72 million a year earlier; diluted EPS was $0.97 versus $0.91.
  • Nine-month net income: $20.70 million, versus $18.53 million; diluted EPS was $2.80 versus $2.50.
  • Net interest income: $19.24 million for Q3, up from $17.95 million; $56.26 million for nine months, up from $52.79 million. Tax-equivalent net interest margin was 3.61% for Q3 and 3.60% year to date, compared with 3.57% for each prior-year period. The nine-month net interest spread declined to 3.31% from 3.38%.
  • Noninterest income and expense: Q3 noninterest income was $3.68 million, up from $3.25 million; nine-month income was $11.25 million, up from $10.49 million. Noninterest expense rose to $14.08 million for Q3 from $12.54 million and to $42.00 million year to date from $39.11 million, led by personnel and occupancy costs.
  • Credit provision: $0.70 million for Q3 and $2.10 million for nine months, both below the corresponding 2018 periods ($1.05 million and $3.15 million). The company attributed the year-to-date decrease to lower-than-projected loan growth.
  • Returns and dividends: Q3 ROA was 1.21% and ROE 9.65%; nine-month ROA was 1.19% and ROE 9.63%. Dividends declared were $0.34 per share in Q3 and $1.02 year to date.

Financial position, cash flow and liquidity

  • Assets and loans: Total assets were $2,372.70 million at September 30, up from $2,288.99 million at year-end 2018. Loans before allowance rose to $1,881.09 million from $1,823.27 million, with commercial real estate lending the main growth driver.
  • Deposits and borrowings: Deposits increased to $2,001.29 million from $1,875.02 million. Short-term borrowings declined from $86.50 million at year-end to zero; long-term debt increased to $52.51 million from $37.91 million. The company said deposit inflows, particularly in Q3, enabled repayment of short-term advances. It also entered into $16 million of longer-term FHLB advances during Q2.
  • Cash flow: Nine-month operating cash flow was $27.28 million, investing cash flow was negative $54.82 million, and financing cash flow was $46.20 million. Cash and cash equivalents increased $18.67 million to $51.28 million.
  • Capital: Stockholders’ equity was $296.17 million, up from $278.61 million at year-end. The Bank reported September 30 Tier 1 leverage of 10.05%, common equity Tier 1 and Tier 1 risk-based capital ratios of 11.85%, and total risk-based capital of 13.00%; it said the Bank was well-capitalized.

Material changes and credit quality

  • Growth in average earning assets supported higher interest income, but higher deposit and borrowing costs increased nine-month interest expense by $4.12 million. Management noted that the Federal Reserve’s 2019 rate cuts could put downward pressure on loan yields, while lower funding costs may take time to flow through.
  • Nonperforming loans increased to $11.04 million from $9.59 million at year-end; nonperforming assets rose to $11.53 million from $9.97 million. Nonperforming loans were 0.59% of loans, versus 0.53%. The allowance for loan losses was $22.39 million, or 1.19% of loans, compared with $21.38 million, or 1.17%, at year-end.
  • Substandard loans increased materially, primarily after several larger commercial credits were downgraded. Management described two prominent relationships—$10.4 million and $5.3 million—as well-secured and current at September 30. Nonaccrual loans increased, including a $4.7 million commercial relationship placed on nonaccrual during Q1.
  • Net charge-offs for the first nine months were $1.09 million, down from $1.70 million a year earlier. The filing reported no material legal proceedings and no material changes to previously disclosed risk factors.

Outlook, risks and notable items

  • The filing provides no specific earnings or financial guidance. Management said it believes liquidity is adequate to meet obligations and commitments and intends to continue cash dividends, subject to results, capital needs, restrictions and other factors.
  • Interest-rate risk is a key exposure. The company’s modeling showed net interest income broadly unchanged under an instantaneous +100-basis-point shock for the 12 months ending September 30, 2020; a -100-basis-point scenario projected a 1.8% decline in net interest income. Management said modeled exposures were within policy limits. Its static-gap discussion also indicates that falling rates could reduce net interest income.
  • The company has material contracts indexed to USD-LIBOR and is monitoring the proposed transition to SOFR, then expected by the end of 2021. Other stated risks include credit quality, local economic conditions, competition, deposit flows, regulation, cybersecurity and third-party service providers.
  • Adoption of the lease standard resulted in $6.52 million of right-of-use assets and lease liabilities, with no material income-statement impact. The company said the expected-credit-loss standard was deferred for smaller reporting companies to 2023 and was still evaluating its impact.
  • Noninterest income included a $0.22 million recovery on a previously charged-off purchased impaired commercial credit. Prior-year comparisons included a $0.29 million gain on sale of the credit-card portfolio and $0.37 million of bank-owned life insurance death-benefit proceeds; these did not recur in the current period. Q3 fee income also benefited from commercial loan interest-rate swap activity.

Important facts for investors to verify

  • Whether growth in commercial real estate and commercial lending is accompanied by stabilization in criticized, nonaccrual and past-due loans.
  • The performance and collateral coverage of the larger downgraded and nonaccrual commercial credit relationships, and any resulting provision or charge-off needs.
  • Whether deposit growth is sustainable beyond seasonal public-deposit inflows, and how deposit pricing affects net interest margin after rate cuts.
  • The drivers and durability of higher operating expenses, particularly staffing, expansion and technology costs, relative to income growth.
  • The company’s future allowance methodology and capital impact as it prepares to adopt the expected-credit-loss standard, and its progress managing LIBOR transition exposure.