Chemung Financial Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Amounts below are in U.S. dollars; financial-statement amounts are generally shown in millions unless stated otherwise. Chemung Financial, through Chemung Canal Trust Company and CFS Group, provides banking, lending, fiduciary and other financial services, primarily in its local markets.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $12.1m | $11.3m | $24.1m | $23.0m |
| Other operating income | $5.4m | $4.5m | $10.4m | $8.5m |
| Provision for loan losses | $1.1m | $0.5m | $1.7m | $0.9m |
| Operating expenses | $13.6m | $11.4m | $26.9m | $23.1m |
| Net income | $1.9m | $2.7m | $4.0m | $5.1m |
| Diluted EPS | $0.41 | $0.57 | $0.85 | $1.09 |
| Fully taxable-equivalent net interest margin | 3.51% | 3.93% | 3.55% | 4.04% |
Second-quarter net income fell 27.3%; first-half net income fell 21.2%. Higher operating costs and loan-loss provisions more than offset growth in net interest income and fee income. Return on average assets and equity for the first half were 0.54% and 5.68%, respectively, versus 0.81% and 7.65% a year earlier.
Balance sheet, cash flow and liquidity
- Total assets were $1.516bn at June 30, up $39.7m, or 2.7%, from year-end 2013. Net loans increased $88.5m (8.9%) to $1.084bn, led by commercial mortgages and indirect consumer loans. Available-for-sale securities declined $59.6m to $286.4m, primarily as securities were sold, called or matured to help fund lending growth.
- Deposits rose $42.2m (3.3%) to $1.308bn. Growth in demand, savings and money-market balances exceeded a $19.0m decline in time deposits. The company reported increased use of CDARS/ICS deposits; brokered deposits were $3.6m.
- Cash and cash equivalents were $66.3m, up $14.7m from year-end. First-half operating cash flow was $7.5m, investing cash flow was negative $30.0m, and financing cash flow was positive $37.1m. Net loan growth was a major investing use; deposit growth was a key financing source.
- Repurchase-agreement funding was $30.7m and FHLB term advances were $24.1m at June 30; a $0.4m long-term branch lease obligation was also recorded. FHLB borrowing capacity was reported at $104.7m, with $28.0m of unsecured credit lines available.
- Shareholders’ equity was $141.8m; equity-to-assets was 9.35% and tangible equity-to-tangible assets was 7.68%. Management reported that both the Corporation and Bank exceeded regulatory capital requirements for “well-capitalized” status.
Material changes and credit quality
- Net interest income increased, but margin compressed as asset yields—especially loan yields—fell amid continued repricing at historically low market rates. Average interest-earning assets increased substantially, partly reflecting the late-2013 branch acquisition.
- Operating expenses rose 16.5% for the first half, with acquired-branch costs contributing to increases in staffing, occupancy and data processing. The company also recorded $0.5m of merger-related expenses in the first half.
- The allowance for loan losses was $13.6m (1.26% of loans), up from $12.8m at year-end. First-half net charge-offs were $0.9m, compared with net recoveries of less than $0.1m in the prior-year period. Management cited portfolio growth and additional specific reserves on five acquired commercial loans.
- Non-performing assets were $8.3m, or 0.55% of assets, down from $9.1m and 0.61% at year-end. Troubled debt restructurings totaled $7.1m; $0.7m were on non-accrual. Acquired credit-impaired loans of $8.9m are reported separately from non-performing assets.
- Book value per share was $30.28; tangible book value per share was $24.40. The quarterly dividend was $0.26 per share, unchanged from the prior-year quarter.
Outlook, risks, contingencies and unusual items
- Management said it anticipates future portfolio growth primarily in commercial mortgages, commercial and industrial loans, and indirect consumer loans. It was evaluating alternative uses of cash cautiously in the low-interest-rate environment. No formal earnings or financial-target guidance was provided.
- Interest-rate sensitivity estimates showed a 200-basis-point rate decrease could reduce next-12-month net interest income by 10.63%, while a 200-basis-point increase could reduce it by 8.25%; both were within the company’s 15% policy limit. Management also modeled adverse impacts of 4.72% for a 100-basis-point decline and 12.31% for a 300-basis-point increase.
- Two pending trust-account proceedings involve beneficiary claims of $9.6m and $24.1m, plus unspecified legal fees. The Bank disputes the claims and is defending them; no loss was accrued because management did not consider a loss probable or reasonably estimable.
- Disclosure controls were deemed ineffective because of an outstanding material weakness in identifying and evaluating troubled debt restructurings. Remediation and testing were ongoing, with management expecting remediation by year-end 2014.
- A trust-preferred CDO liquidation generated $0.5m of other operating income in Q1; first-half securities transactions also produced a $0.522m net gain. Management stated that unrealized securities losses were primarily interest-rate-related and did not consider the affected securities other-than-temporarily impaired.
- Key stated risks include economic and interest-rate changes, credit quality, growth management, competition and legal or regulatory changes. The filing reported no material change to the risk factors in the 2013 Form 10-K.
Important facts for investors to verify
- Whether loan growth can continue without further deterioration in credit performance, higher charge-offs or additional reserves.
- Whether margin pressure persists as loans reprice and how rate movements affect earnings and capital value.
- The sustainability of deposit growth and the composition and cost of funding, including CDARS/ICS and other non-core sources.
- Whether acquired-branch expenses and other operating costs moderate, and how much reported income depends on securities or liquidation gains.
- Progress in remediating the TDR-related material weakness and any developments in the pending trust litigation.