Business context and reporting period
Financial Institutions, Inc. (Nasdaq: FISI) filed this Form 10-K for the fiscal year ended December 31, 2020. The New York-based financial holding company is primarily a community bank operating Five Star Bank, with additional insurance and wealth-management businesses. The Bank operates across Western and Central New York; the company reported $4.91 billion in consolidated assets.
Financial performance and position
| Metric | 2020 | 2019 |
|---|---|---|
| Net interest income | $139.0 million | $129.9 million |
| Noninterest income | $43.2 million | $40.4 million |
| Provision for credit losses | $27.2 million | $8.0 million |
| Net income | $38.3 million | $48.9 million |
| Net income available to common shareholders | $36.9 million; $2.30 diluted EPS | $47.4 million; $2.96 diluted EPS |
| Net interest margin, tax-equivalent | 3.22% | 3.28% |
| Return on average assets / equity | 0.82% / 8.49% | 1.14% / 11.61% |
For fourth-quarter 2020, net income was $13.8 million and diluted EPS was $0.84, versus $13.1 million and $0.79 a year earlier. Quarterly net interest income rose to $36.2 million from $33.2 million; provision expense increased to $5.5 million from $2.7 million.
- Balance sheet: Total assets rose 12% to $4.91 billion. Gross loans grew 12% to $3.60 billion, including $248.0 million of PPP loans net of deferred fees; deposits increased 20% to $4.28 billion. Investment securities were $900.0 million and shareholders’ equity was $468.4 million.
- Credit quality: The allowance for loan losses was $52.4 million, or 1.46% of loans, versus $30.5 million, or 0.95%, in 2019. Net charge-offs were $13.8 million, or 0.40% of average loans. Nonperforming assets rose to $12.5 million from $9.1 million; nonperforming loans were $9.5 million, or 0.26% of total loans.
- Cash flow: Operating activities provided $43.5 million; investing activities used $531.1 million; financing activities provided $468.5 million. Cash and cash equivalents ended the year at $93.9 million, down from $112.9 million.
- Debt and liquidity: Total borrowings were $78.9 million, down from $314.8 million, reflecting lower FHLB advances and issuance of $35 million of subordinated notes. The notes carry a 4.375% fixed rate through October 2025, then reset to three-month SOFR plus 4.265%, and mature in 2030. The company reported a 10.18% CET1 ratio, 10.63% Tier 1 ratio, 13.61% total risk-based capital ratio and 8.25% leverage ratio; the company and Bank exceeded regulatory minimums and were considered well-capitalized.
- Shareholder returns and efficiency: Common dividends declared were $1.04 per share, up from $1.00; the common dividend payout ratio was 45.22%. The efficiency ratio was 60.22%, compared with 60.59%.
Material changes versus the prior comparable period
- Net income declined 22%, primarily as the credit-loss provision increased amid CECL adoption and uncertainty about COVID-19’s economic effects. The provision included a significant charge related to a hospitality borrower; $8.2 million was charged off on that credit.
- Net interest income increased as average earning assets grew 9% and funding costs fell, but the margin narrowed six basis points. Lower asset yields, PPP lending and excess liquidity invested at lower yields pressured margin.
- Noninterest income rose 7%, supported by derivative income and residential mortgage loan sales. Deposit service charges fell 34%, partly due to temporary COVID-related fee relief and lower insufficient-funds fees.
- Noninterest expense increased 6% to $109.3 million. Higher compensation, technology and FDIC assessment costs included $1.7 million of branch-related restructuring charges.
- CECL adoption on January 1, 2020 reduced retained earnings by $8.7 million after tax and increased the loan allowance by $9.6 million; it also established a reserve for unfunded commitments.
Outlook, commentary, risks and unusual items
Management did not provide specific earnings or revenue guidance. It expects approximately $2.7 million of annualized expense savings from its branch-consolidation and efficiency program, which was still underway. Seven branch closures were announced in 2020; two additional Buffalo financial solution centers were planned to open in 2021. SDN acquired Landmark Group’s assets on February 1, 2021. A repurchase authorization covers up to 801,879 shares; none were repurchased in 2020, while 238,439 shares were repurchased through February 28, 2021.
- COVID-19, low interest rates, borrower stress, regional economic concentration and commercial real estate exposure are key risks. Commercial and mortgage loans totaled $2.05 billion, 57% of loans. About 5% of commercial loan and mortgage customers had active payment deferrals at year-end; the filing reports $113.0 million of loans still on deferral.
- PPP loans are SBA-guaranteed, but the company warns that eligibility or servicing deficiencies could affect guarantee recovery. The filing reports $253.1 million of PPP principal outstanding in one disclosure and $248.0 million net of deferred fees in another.
- A putative consumer class action alleges that repossession notices for vehicle loans did not comply with New York and Pennsylvania law. Class certification remained pending; the court rejected the company’s time-bar defense as to one named plaintiff. The company disputes the claims.
- Management identified allowance estimation as a critical accounting matter. The allowance depends on forecasts and subjective assumptions; actual credit losses could exceed estimates. The auditor issued an unqualified opinion on the financial statements and internal controls.
- Other risks include cyber and third-party technology exposure, interest-rate sensitivity, deposit withdrawals, LIBOR transition, regulatory constraints and possible goodwill impairment. No goodwill impairment was recorded in 2020.
Most important facts for investors to verify
- Whether credit quality and deferrals deteriorate as pandemic relief ends, and whether the $52.4 million loan allowance adequately reflects expected losses.
- PPP forgiveness, fee recognition and SBA guarantee performance, including the differing reported year-end balances.
- Whether deposit growth is durable and how excess liquidity can be reinvested without further margin pressure.
- Delivery of the stated $2.7 million annualized savings, restructuring cash costs and the financial effects of the Landmark acquisition and share repurchases.
- Progress and potential exposure in the repossession-notice litigation, and any subsequent regulatory or legal developments.