Financial Institutions, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. The New York-based financial holding company provides banking, insurance and wealth-management services, primarily through Five Star Bank. Amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net interest income | $42.3 | $41.6 | $84.2 | $81.2 |
| Provision for credit losses | $3.2 | $0.6 | $7.4 | $2.9 |
| Noninterest income | $11.5 | $11.4 | $22.4 | $22.7 |
| Noninterest expense | $33.8 | $32.9 | $67.4 | $63.0 |
| Net income | $14.4 | $15.6 | $26.5 | $30.6 |
| Diluted EPS | $0.91 | $0.99 | $1.67 | $1.93 |
- Q2 taxable-equivalent net interest margin was 2.99%, down from 3.19%; the six-month margin was 3.04%, down from 3.15%. Higher loan yields and loan growth were offset by sharply higher deposit and borrowing costs and a shift toward time deposits.
- Q2 return on average assets was 0.95% and return on average common equity was 13.64%, compared with 1.12% and 14.64%, respectively, a year earlier. The efficiency ratio rose to 62.66% from 61.91%.
- At June 30, total assets were $6.14 billion, net loans $4.35 billion, deposits $5.03 billion and shareholders’ equity $425.9 million. Loans grew $347.4 million from year-end 2022; commercial real estate loans were 44.6% of total loans.
- Cash and cash equivalents were $180.2 million, up $49.8 million from year-end. Six-month operating cash flow was $14.8 million versus $81.8 million in 2022; investing used $279.1 million, primarily reflecting $350.1 million of net loan originations. Financing provided $314.1 million, including increases in deposits and borrowings.
- Total borrowings rose to $498.4 million from $279.2 million at year-end, comprising $374.0 million short-term and $124.4 million long-term. Total deposits increased $105.4 million; time deposits rose to 30.7% of deposits. Uninsured deposits were $1.64 billion, of which about $926.1 million were collateralized by government-backed securities.
- The allowance for loan losses was $49.8 million, or 1.13% of loans. Nonperforming loans were $9.9 million (0.23% of loans), and nonperforming assets were $10.1 million. Q2 net charge-offs were $0.6 million, versus net recoveries of $1.0 million in Q2 2022.
- Available-for-sale securities had a $170.1 million net unrealized loss before tax at June 30, largely attributed to higher market interest rates; accumulated other comprehensive loss was $134.5 million. Management reported no intent or expected need to sell the securities before recovery and recorded no credit-loss allowance on them.
- Company regulatory capital ratios were 9.10% CET1, 9.43% Tier 1 and 11.77% total risk-based capital. The Bank’s corresponding ratios were 10.27%, 10.27% and 11.20%. Management said capital remained above well-capitalized thresholds.
Material changes and management commentary
- Net income declined year over year as the increase in credit-loss provision and operating costs outweighed higher net interest income. The prior-year comparison included a $2.0 million commercial-loan recovery in credit costs and a $586,000 gain from selling an indirect-loan portfolio.
- Q2 interest expense increased to $28.8 million from $3.7 million, mainly because deposit rates repriced and borrowings increased. Management cited loan growth and higher market rates as drivers of revenue, but noted that funding costs and deposit mix compressed margin.
- Commercial loans drove most loan growth. Management reported $169.0 million of indirect auto originations in the first half of 2023, down from $304.6 million in the comparable 2022 period.
- Operating expenses increased, including salaries, technology, FDIC assessments and other costs. Management attributed other-cost increases to derivative collateral interest charges, fraud charge-off timing, insurance and inflation. The 2022 period included $1.3 million of restructuring charges; Q2 2023 included a $19,000 recovery.
- Interest-rate sensitivity modeling estimates 12-month net interest income would decline 0.99% under an instantaneous +100-basis-point shock and 2.96% under +300 basis points, absent balance-sheet growth or mix changes. Management noted that the static model does not constitute a forecast.
- There is no specific earnings or financial guidance in the supplied filing text. Management said structural liquidity measures were in compliance and described available funding capacity, including approximately $949.6 million in additional collateralized wholesale borrowing capacity.
Risks, contingencies and notable items
- A consumer class action concerning notices sent after vehicle repossessions remains pending. Four classes were certified; the case is stayed pending a Pennsylvania Superior Court appeal. The company has not accrued a liability because it cannot conclude that a loss is probable or reasonably estimate one; an adverse outcome or insufficient insurance coverage could be material.
- The filing highlights risks from higher interest rates, deposit outflows and funding costs, credit deterioration, commercial real estate exposure, financial-industry instability, and the concentration of deposits above FDIC insurance limits.
- Newly emphasized risk disclosures include increased regulatory scrutiny of bank–FinTech/BaaS partnerships, federal-law and compliance risks from serving cannabis-related businesses, and the potential impact of losing key employees.
- The company completed the merger of HNP Capital into Courier Capital on May 1, 2023, and dissolved Corn Hill Innovations Lab, transferring its assets and liabilities to the Bank. A Q2 quantitative goodwill review found no impairment.
- Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether deposit pricing, time-deposit mix and borrowing needs continue to pressure net interest margin and liquidity; monitor uninsured and brokered/reciprocal deposit levels and maturities.
- Whether credit costs rise further, particularly in commercial real estate and indirect auto lending; track delinquency, net charge-offs, criticized loans and allowance coverage.
- How the sizable unrealized securities losses affect liquidity and capital if securities must be sold, despite management’s stated intention and ability to hold them.
- Developments, potential exposure and insurance coverage in the vehicle-repossession class action.
- Regulatory and compliance developments affecting BaaS/FinTech and cannabis banking, as well as any change in management’s interest-rate sensitivity assumptions.