Business context and reporting period
Financial Institutions, Inc. (Nasdaq: FISI) filed this unaudited Form 10-Q for the quarter ended September 30, 2020. The New York-based financial holding company operates Five Star Bank, an insurance agency, and investment and wealth-management businesses, primarily serving Western and Central New York.
Financial performance and condition
- Third quarter: Net income was $12.3 million, down 4% from $12.8 million a year earlier; diluted EPS was $0.74 versus $0.78. Return on average assets was 1.02% and return on average common equity was 10.72%, compared with 1.19% and 12.00%, respectively.
- First nine months: Net income was $24.5 million versus $35.8 million in 2019; diluted EPS was $1.46 versus $2.16. Pre-tax income was $30.2 million versus $46.0 million.
- Net interest income and margin: Third-quarter net interest income was $35.5 million, up from $32.5 million; taxable-equivalent net interest margin was 3.22%, down from 3.29%. For the first nine months, net interest income was $102.8 million versus $96.7 million, and taxable-equivalent margin was 3.25% versus 3.27%. Lower funding costs and loan growth supported net interest income, while lower asset yields pressured margin.
- Credit costs and asset quality: Provision for credit losses was $4.0 million in the quarter and $21.7 million year to date, compared with $1.8 million and $5.4 million in 2019. Third-quarter net charge-offs were $0.5 million (0.06% of average loans, annualized); nine-month net charge-offs were $11.4 million (0.45%), including an $8.2 million partial charge-off on a hospitality-related commercial loan. Nonperforming assets were $13.9 million, or 0.28% of assets, versus $9.1 million, or 0.21%, at year-end 2019. The loan allowance was $49.4 million at September 30.
- Noninterest income and expense: Quarterly noninterest income was essentially flat at $12.4 million; nine-month income rose to $32.2 million from $30.7 million. Quarterly noninterest expense increased to $28.7 million from $25.9 million, including branch-restructuring costs; nine-month expense was $83.1 million versus $76.1 million. The nine-month efficiency ratio increased to 61.89% from 60.09%.
- Balance sheet: Total assets were $4.96 billion, up from $4.38 billion at December 31, 2019. Loans, net of allowance, were $3.52 billion versus $3.19 billion. Deposits increased to $4.36 billion from $3.56 billion, with growth in demand and savings/money-market balances. Cash and due from banks rose to $282.1 million from $112.9 million.
- Debt, liquidity and capital: Borrowings totaled $44.6 million, down from $314.8 million at year-end, mainly reflecting lower short-term FHLB advances. The company reported $218.6 million of immediate FHLB capacity, $538.8 million of secured Federal Reserve borrowing capacity, and $145.0 million of unsecured federal funds lines. Regulatory capital ratios were 10.19% CET1 and 12.74% total risk-based capital; the company reported that it remained well-capitalized. Shareholders’ equity was $456.4 million versus $438.9 million.
- Cash flows, nine months: Operating activities provided $20.3 million, investing activities used $376.6 million, and financing activities provided $525.4 million. Financing included a $809.3 million increase in deposits, partly offset by a $270.2 million decrease in short-term borrowings and $13.4 million of dividends paid.
Material changes versus comparable periods
- Quarterly earnings declined modestly, while nine-month earnings fell substantially, primarily reflecting higher credit-loss provisions and increased expenses.
- Loans grew, with commercial lending growth substantially related to the Paycheck Protection Program (PPP). The filing reports $270.5 million of PPP loans in the loan note and $264.1 million net of deferred fees in MD&A; investors should note the differing presentations.
- Funding shifted toward deposits: total deposits rose $809.3 million from year-end, while short-term borrowings fell $270.2 million. Average loan yields and earning-asset yields declined year over year, while deposit and borrowing costs also decreased.
- Accumulated other comprehensive loss improved by $14.3 million during the first nine months, largely due to higher unrealized gains on available-for-sale securities.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no formal earnings or financial guidance. Management said the economic effects of COVID-19 and related credit outcomes remained uncertain. Interest-rate sensitivity modeling estimated 12-month net interest income increases of 1.28%, 2.92% and 4.84% under +100, +200 and +300 basis-point shocks, respectively; these are model scenarios, not forecasts.
- COVID-19 and CECL: Adoption of the current expected credit loss standard on January 1, 2020 reduced retained earnings by $8.7 million after tax and increased loan credit reserves by $9.6 million. The company cited pandemic-related uncertainty and unemployment forecasts as drivers of credit provisioning. At September 30, $526.7 million of loans had COVID-related modifications; as of October 23, about 3% of commercial and commercial-mortgage customers, 1% of residential real estate customers, and less than 1% of indirect-loan customers had active deferrals.
- Restructuring: Six branch closures and staffing reductions announced in July generated about $1.6 million of third-quarter charges. Management anticipates approximately $2.6 million in annualized savings. An additional branch closure planned for January 2021 was expected to cost about $130,000 in the fourth quarter and save approximately $340,000 annually.
- Subsequent financing and capital return: On October 7, the company issued $35.0 million of subordinated notes due 2030, initially bearing 4.375% interest, for general corporate purposes, growth and bank capital support. In November, it authorized repurchases of up to 801,879 shares, approximately 5% of outstanding common shares; the authorization does not require purchases.
- Other risks and contingencies: Risks include pandemic-driven borrower stress, commercial real estate and consumer credit exposure, PPP forgiveness and SBA-guarantee risks, low interest rates, deposit outflows, market volatility, cyber and operational risks, and potential goodwill impairment. A Pennsylvania vehicle-repossession notice class action remains pending; the company disputes the claims, but adverse outcomes or uninsured costs could materially affect results.
- Other unusual item: Management reported correcting an erroneously reported 2020 troubled-debt restructuring during the quarter, with no effect on other financial statement sections and no material impact to previously issued financial statements. The company reported no goodwill impairment after a third-quarter assessment.
Important facts for investors to verify
- How the allowance for credit losses and active loan modifications evolve as pandemic relief and deferrals end, particularly for commercial, hospitality and commercial real estate borrowers.
- The scale, forgiveness status, deferred fees and ultimate economics of PPP loans, including the differing gross and net balances disclosed in the filing.
- Whether deposit growth is durable and how reciprocal and brokered funding, liquidity capacity and borrowing needs change.
- Whether branch-consolidation savings are achieved and how technology, FDIC assessment and other operating costs affect the efficiency ratio.
- The capital and interest-expense effects of the October subordinated-note issuance and any share repurchases, alongside developments in the pending class action.