Chemung Financial Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited consolidated results. Chemung Financial is a New York bank holding company operating through Chemung Canal Trust Company and CFS Group, Inc., with core banking and wealth-management businesses.
Financial performance and position
| Metric | Q3 2013 | Nine months 2013 | Comparable 2012 |
|---|---|---|---|
| Net interest income | $11.52 million | $34.56 million | $11.79 million Q3; $35.20 million nine months |
| Net interest margin | 3.84% | 3.93% | 4.04% Q3; 4.10% nine months |
| Provision for loan losses | $0.87 million | $1.76 million | $0.23 million Q3; $0.75 million nine months |
| Other operating income | $4.35 million | $12.85 million | $3.99 million Q3; $13.00 million nine months |
| Other operating expenses | $11.81 million | $34.93 million | $11.34 million Q3; $34.15 million nine months |
| Net income / diluted EPS | $2.18 million / $0.47 | $7.25 million / $1.56 | $2.83 million / $0.61 Q3; $8.89 million / $1.92 nine months |
For the nine months, net income declined 18.5%; Q3 net income declined 23.1%. The filing attributes the nine-month earnings decrease mainly to lower net interest income, higher loan-loss provision and expenses, and lower securities gains and casualty-insurance gains. Lower income taxes partly offset these pressures. Nine-month return on average assets and equity was 0.76% and 7.25%, respectively; Q3 figures were 0.67% and 6.45%.
- Balance sheet at September 30: Assets were $1.341 billion, up 7.4% from year-end 2012; net loans were $955.8 million, up 8.2%; deposits were $1.088 billion, up 4.2%; shareholders’ equity was $134.8 million.
- Funding and debt: FHLB advances totaled $75.1 million, including $49.1 million of overnight advances, and repurchase-agreement funding was $30.5 million. The overnight advances were part of acquisition pre-funding and management expected repayment after the branch transaction closed.
- Liquidity and capital: Cash and cash equivalents were $39.9 million. The Bank reported Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios of 8.57%, 10.71%, and 12.19%; each exceeded the regulatory well-capitalized threshold. Equity/assets was 10.05% and tangible equity/tangible assets was 8.25%.
- Cash flow, nine months: Operating activities provided $14.9 million; investing activities used $102.2 million; financing activities provided $87.0 million. Cash and equivalents decreased $0.3 million to $39.9 million.
- Credit quality: Allowance for loan losses was $11.9 million, 1.23% of loans, versus $10.4 million and 1.17% at year-end. Net charge-offs were $0.3 million, versus net recoveries of $0.3 million in 2012. Non-performing assets were $8.2 million, or 0.61% of assets, versus $6.6 million and 0.53% at year-end.
Material changes versus comparable periods
- Nine-month net interest income fell 1.8%, and net interest margin contracted 17 basis points. Management cited falling yields on earning assets, especially loans repricing at low market rates; lower funding costs and higher average earning assets partly mitigated the decline.
- Q3 net interest income fell 2.3%, and the margin narrowed 20 basis points year over year. The Q3 loan-loss provision rose to $0.87 million from $0.23 million, primarily reflecting one commercial and industrial loan, portfolio growth, and higher net charge-offs.
- Nine-month other income fell 1.1%, largely because 2012 included casualty gains and securities transaction gains. Wealth-management fees and deposit service charges increased. Nine-month operating expenses rose 2.3%, including higher salaries, data-processing costs, and acquisition-related expenses.
- Loan growth was concentrated in commercial mortgages and indirect consumer loans. Commercial mortgages increased to $361.1 million from $320.2 million at year-end, while consumer loans increased to $272.6 million from $239.0 million.
Outlook, risks, contingencies, and unusual items
- Pending branch acquisition: The Bank agreed to acquire six Bank of America branches in Auburn, Cortland, Ithaca, and Seneca Falls, expected to close in Q4 2013. The transaction was expected to add about $261 million in deposits and $1.6 million in loans; the deposit premium is 1.5% of specified average deposits, plus the net book value of assets and accrued loan interest. Regulatory approval had been received. Management planned to deploy deposits first into securities and then into new commercial and consumer loans.
- Interest-rate risk: Management identified interest-rate risk as its most significant market risk. Modeled immediate changes of plus or minus 200 basis points would reduce next-12-month net interest income by 9.36% or 10.33%, respectively, within the stated 15% policy limit. A 300-basis-point increase was modeled to reduce net interest income by 15.44%, exceeding that limit. Management said derivatives were not used during the nine months.
- Credit and valuation risks: Management considered the loan-loss allowance adequate but warned that weaker economic conditions, loan performance, or collateral values could require additional provision. A trust-preferred CDO with $629,025 amortized cost was rated Caa3; the filing reported no additional OTTI in the quarter, but noted sensitivity to defaults, deferrals, recoveries, liquidity, and valuation assumptions.
- Legal proceedings: Two trust-account proceedings include claims of $9.6 million and $24.1 million, 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.
- Management gave no numerical earnings guidance. It cautioned that interim results are not necessarily indicative of full-year or future results. Forward-looking risks include economic and real-estate conditions, employment, interest rates, credit quality, growth execution, competition, and regulatory changes.
Important facts for investors to verify
- Whether the six-branch acquisition closed on the expected terms and schedule, and how acquired deposits were funded and deployed.
- Whether loan growth, non-performing assets, troubled debt restructurings, and the allowance for loan losses continue to develop as described.
- Whether margin pressure from asset-yield declines persists and whether the modeled interest-rate exposure changes.
- How the Caa3 trust-preferred CDO and its Level 3 valuation assumptions evolve, and whether any further impairment is recognized.
- Developments in the two trust litigation matters and any change in the assessment of potential loss.