Chemung Financial Corporation — FY 2011 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2011. Chemung Financial is a New York-based financial holding company operating Chemung Canal Trust Company, a community bank, and CFS Group, which provides brokerage, insurance, investment and tax services. On April 8, 2011, the company acquired Fort Orange Financial Corp. (FOFC) and merged its Capital Bank subsidiary into the Bank, expanding its Albany-area footprint. Comparisons with 2010 are therefore affected by the acquisition.
Financial performance and condition
| Metric | FY 2011 / year-end | Comparison / context |
|---|---|---|
| Net income | $10.54 million | Up 4.3% from $10.10 million in 2010 |
| Diluted EPS | $2.40 | Down from $2.80, principally reflecting 776,302 additional average shares after the acquisition |
| Net interest income / margin | $43.85 million / 4.07% | Up 27.0% and 26 basis points, respectively; acquisition growth and lower funding costs contributed |
| Non-interest income | $17.46 million | Down 11.1%, mainly because 2010 included unusually high trust fees from an estate settlement |
| Operating expenses | $44.78 million | Up 18.3%; includes $2.26 million of 2011 merger-related expense |
| Return on average assets / equity | 0.90% / 8.77% | ROAA was 1.02% and ROE 10.64% in 2010 |
| Efficiency ratio | 71.18% | Compared with 68.35% in 2010 |
| Assets / loans / deposits | $1.216 billion / $796.9 million / $998.5 million | Assets rose 26.9%, loans 29.9% and deposits 27.0%, substantially reflecting FOFC |
| Cash and cash equivalents | $52.9 million | Down $7.7 million year over year |
| Operating cash flow | $9.14 million | Down from $17.85 million in 2010; investing and financing activities brought cash down by $7.72 million overall |
| Borrowings at year-end | $37.1 million repos / $43.3 million FHLB advances | FHLB advances increased from $20.0 million, principally as debt was assumed in the FOFC acquisition |
| Capital ratios | Consolidated leverage 8.27%; Tier 1 risk-based 11.84%; total risk-based 13.28% | Bank ratios were 7.92%, 11.36% and 12.80%; Bank reported as well capitalized |
| Dividend | $1.00 per share | Unchanged from 2010; 41.0% payout ratio versus 34.9% |
Management’s non-GAAP comparison, excluding 2011 FOFC transaction costs and the unusually large 2010 estate-settlement revenue (and associated disclosed transaction costs), gives net income of $11.99 million, or $2.74 per share, in 2011 versus $8.14 million, or $2.26 per share, in 2010. Management attributed the improvement in part to Capital Bank, which contributed an estimated $3.3 million to 2011 net income excluding direct transaction costs.
Asset quality and material changes
- Non-performing loans rose to $20.9 million from $11.3 million; non-performing assets were $21.8 million. The reported non-performing loan ratio increased to 2.62% from 1.83%.
- The increase included $7.3 million of acquired construction loans more than 90 days past stated maturity but still accruing interest. Management cited third-party credit enhancements and expected no losses on these loans. Separately, $14.8 million of acquired purchased-credit-impaired loans is accounted for outside reported non-performing totals.
- Allowance for loan losses was $9.66 million, or 1.21% of total loans, versus $9.50 million and 1.55% in 2010. Provision expense declined to $958,000 from $1.13 million; net charge-offs fell to $797,000 from $1.59 million. Management retained a $443,000 unallocated reserve, citing a fragile recovery.
- Commercial real estate and business loans were 51.0% of total loans. Commercial real estate loans to borrowers in the real estate, rental or leasing sector represented 22.5% of loans, versus 10.4% in 2010, partly reflecting the acquired portfolio.
- The available-for-sale securities portfolio increased to $280.9 million from $223.5 million; net unrealized appreciation rose to $12.9 million from $9.2 million. The company recorded $67,000 of other-than-temporary impairment charges on trust-preferred securities in 2011.
- Fourth-quarter 2011 net income was $2.96 million and EPS was $0.64, versus $3.05 million and $0.84 in fourth-quarter 2010. Quarterly net interest income rose to $12.01 million from $8.56 million, while other operating income declined to $4.04 million from $6.74 million.
Outlook, risks and contingencies
The filing provides no quantified earnings or growth guidance. Management described local economic improvement as preliminary and the recovery as fragile; it considered continued reserve coverage prudent. The company cited sensitivity to interest rates, credit conditions, commercial real estate and business lending, competition, acquisition execution, regulatory change and technology/security risks. A modeled immediate 200-basis-point rate decrease would reduce projected next-12-month net interest income by 9.86%; a 200-basis-point increase would reduce it by 2.76%, within the company’s stated 15% policy limit.
- Trust litigation: Beneficiaries alleged breach of fiduciary duties, including inadequate portfolio diversification, and sought up to approximately $27 million. The matter remained pending. Management assessed an unfavorable material effect as reasonably possible but not probable; it could not reasonably estimate a loss range and intends to defend the claims.
- ATM patent claim: On March 19, 2012, the company received a letter asserting patent infringement and proposing a complaint seeking injunctive relief and damages. The company was reviewing the allegations and planned to engage counsel.
- Off-balance-sheet commitments: At year-end, disclosed standby letters of credit, unused lines of credit and commitments to fund new loans totaled $152.1 million, excluding specified consumer and home-equity lines without contractual maturities. Commitments may not be drawn; the filing says material losses are not anticipated.
- Regulation and capital: Management warned that Dodd-Frank implementation and future Basel III rules could raise compliance costs or affect capital requirements; the ultimate impact was uncertain.
- Controls: Management and the auditor concluded internal control over financial reporting was effective at year-end. A branch-level control deficiency had permitted an alleged misappropriation to go undetected; management said it was not material and reported remediation steps.
Important facts for investors to verify
- Whether FOFC/Capital Bank integration delivers the expected earnings contribution and whether acquisition-related costs and expense growth moderate.
- Trends in non-performing loans, acquired construction loans and purchased-credit-impaired loans, and the adequacy of the allowance relative to the acquired and legacy portfolios.
- The status, insurance coverage and potential financial exposure from the trust-beneficiary claims and the ATM patent allegations.
- Deposit retention and funding costs, including upcoming time-deposit maturities, FHLB borrowing and repurchase-agreement obligations.
- Whether the $1.00 annual dividend remains supportable given earnings, capital needs and regulatory limits on Bank dividends to the parent.
- Valuation and cash-flow assumptions for lower-rated pooled trust-preferred securities, and the effect of interest-rate changes on earnings and securities values.