Business context and reporting period
Chemung Financial Corporation, a New York-based bank holding company, filed this unaudited Form 10-Q for the quarter ended June 30, 2011. It provides banking and trust and investment advisory services. Comparisons below are with the second quarter or first half of 2010, or with December 31, 2010 for balance-sheet data.
On April 8, 2011, Chemung completed its acquisition of Fort Orange Financial Corp. (FOFC), parent of Capital Bank & Trust Company. The transaction was valued at approximately $31.9 million, including issuance of about 1.01 million Chemung shares. Capital Bank added approximately $254 million in assets at acquisition; its results are included from the acquisition date.
Financial and operating performance
- Second quarter: Net interest income was $11.45 million, up 30.4%; net interest margin was 4.08%, up 24 basis points. Net income was $2.62 million, up from $2.50 million, while diluted EPS fell to $0.57 from $0.69, reflecting merger-related costs and a larger share count.
- First half: Net interest income was $20.00 million, up 15.7%; net interest margin was 3.97%, up 13 basis points. Net income was $4.29 million versus $4.50 million, and diluted EPS was $1.04 versus $1.25. Non-interest income totaled $9.09 million, up 5.0%; operating expenses were $22.64 million, up 21.4%.
- Management reported direct FOFC transaction expenses of $1.19 million for the second quarter and $2.22 million for the first half. Excluding these expenses, management estimated net income of approximately $3.38 million ($0.73 per share) for the quarter and $5.72 million ($1.39 per share) for the first half; these are management estimates, not reported GAAP results.
- Credit costs: Provision for loan losses was $125,000 for the quarter and $250,000 for the first half, compared with $375,000 and $750,000, respectively, in 2010. First-half net recoveries were approximately $8,000, versus $270,000 of net charge-offs in 2010.
- Cash flow: For the first half, operating cash flow was $7.36 million, investing cash flow was $4.07 million, and financing cash flow was $11.90 million. Cash and cash equivalents increased $23.32 million to $83.94 million.
Financial position, liquidity, and asset quality
- At June 30, total assets were $1.237 billion, up 29.1% from year-end 2010; net loans were $778.96 million, deposits were $1.014 billion, and shareholders’ equity was $126.56 million. Growth largely reflects FOFC, alongside organic growth.
- Cash and cash equivalents were $83.94 million. Repurchase-agreement borrowings were $42.22 million and FHLB term advances were $44.10 million. The company reported $76.8 million of eligible FHLB borrowing capacity, based on available collateral and outstanding advances.
- The Bank reported a 7.59% leverage ratio, 10.91% Tier 1 risk-based capital ratio, and 12.40% total risk-based capital ratio; management stated these exceeded “well capitalized” requirements.
- Non-performing loans increased to $17.93 million from $11.25 million at year-end; non-performing assets were $18.36 million. The allowance for loan losses was $9.76 million, or 1.24% of total loans, and covered 54.4% of reported non-performing loans. Management cited higher commercial problem loans as the principal driver and said the allowance was adequate.
- Potential problem commercial relationships totaled $11.4 million, compared with $7.2 million at year-end. Some FOFC-acquired credit-impaired loans are accounted for separately and excluded from the reported non-performing-loan totals.
Material changes, outlook, and risks
- FOFC materially increased the scale of the company, adding loans, deposits, securities, borrowings, goodwill, and intangible assets. It generated $12.68 million of goodwill; purchase accounting remained subject to refinement. Integration and growth-management risks were identified by management.
- Management attributed improved net interest income and margin to larger earning assets and lower funding costs, partly offset by lower asset yields. No specific earnings or revenue guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- Two pooled trust-preferred securities remained exposed to deterioration among underlying financial institutions and illiquid markets. No additional OTTI was recorded in the first half. In early August, after quarter-end, one security defaulted and missed its scheduled interest payment; the company said this had no material impact on June 30 statements and that it would no longer accrue interest on that security.
- The Bank received settlement demands relating to alleged fiduciary-duty breaches in certain trusts. Beneficiaries seek aggregate damages of up to approximately $27 million. The claims had not been filed in court; management considered an adverse material effect reasonably possible but not probable and recorded no liability.
- Interest-rate sensitivity modeling estimated that an immediate 200-basis-point rate decrease would reduce next-12-month net interest income by 9.82%, while a 200-basis-point increase would reduce it by 1.46%; management said both were within its 15% policy limit. The filing also cites credit, economic, competitive, regulatory, and acquisition-integration risks. Disclosure controls were deemed effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Whether FOFC integration delivers the expected benefits and how merger costs, acquired goodwill, and purchase-accounting adjustments develop.
- Trends in non-performing and potential problem loans, particularly commercial credits, and the adequacy of the loan-loss allowance.
- Developments in the trust-preferred securities, including the consequences of the post-quarter-end default and any future impairment.
- Status and potential exposure of the trust-related claims, including whether demands become filed litigation.
- Reported GAAP earnings versus management’s estimates excluding merger expenses, and the effect of the increased share count on per-share results.
- Capital, liquidity, and net-interest-income sensitivity as acquired balances and interest rates change.