Financial Institutions, Inc. (Nasdaq: FISI) — 2019 Form 10-K
Reporting period: Year ended December 31, 2019; includes fourth-quarter results. The company is a New York financial holding company whose businesses include Five Star Bank, insurance brokerage, and wealth and investment management, primarily serving Western and Central New York. The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting.
Key financial results
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net interest income, GAAP | $129.9 million | $122.9 million | +6% |
| Net interest income, fully taxable equivalent | $131.0 million | $124.2 million | +6% |
| Net interest margin, fully taxable equivalent | 3.28% | 3.18% | +10 basis points |
| Provision for loan losses | $8.0 million | $8.9 million | −10% |
| Noninterest income | $40.4 million | $36.5 million | +11% |
| Noninterest expense | $102.8 million | $100.9 million | +2% |
| Net income | $48.9 million | $39.5 million | +24% |
| Diluted EPS | $2.96 | $2.39 | +24% |
| Return on average assets / equity | 1.14% / 11.61% | 0.95% / 10.18% | Higher |
| Cash dividends per common share | $1.00 | $0.96 | +4% |
Net interest income growth reflected higher average loans and a shift from securities into loans, which generally yield more. Interest income rose, but interest expense also increased as deposit costs rose. Noninterest income benefited from a $1.7 million net securities gain, higher interest-rate swap income, and increased investment advisory and debit-card income. The efficiency ratio improved to 60.59% from 62.73%.
Fourth quarter: Net income was $13.1 million, or $0.79 diluted EPS, versus $7.5 million, or $0.45, in the 2018 quarter. The 2019 quarter included an approximately $2.7 million income-tax benefit from tax-credit investments placed in service; the 2018 quarter included a $2.4 million SDN goodwill impairment and $667,000 of retirement and severance costs. The 2019 effective tax rate was 2.3% for the quarter and 17.8% for the full year.
Financial position, cash flow and asset quality
- Balance sheet: Total assets were $4.38 billion, up 2% year over year. Net loans were $3.19 billion, up 5%; deposits were $3.56 billion, up 6%; and shareholders’ equity was $438.9 million, up from $396.3 million.
- Loan mix: Commercial business and commercial mortgage loans totaled $1.68 billion, or 52.1% of total loans. Commercial mortgage loans grew 16% to $1.11 billion. Indirect consumer loans declined 8% to $850.1 million.
- Funding and debt: Borrowings fell to $314.8 million from $508.7 million, largely reflecting a $194.0 million reduction in short-term borrowings. The balance included $275.5 million of short-term FHLB borrowings and $39.3 million of subordinated notes. Time deposits rose to $1.18 billion; brokered deposits, including non-reciprocal CDARS deposits, increased to $208.8 million from $87.8 million.
- Cash flow: Operating activities provided $57.7 million; investing activities used $24.7 million; and financing activities used $22.8 million. Cash and cash equivalents ended the year at $112.9 million, up $10.2 million.
- Capital and liquidity: Company regulatory ratios were 9.00% leverage, 10.31% CET1, 10.80% Tier 1, and 12.77% total risk-based capital; the company and bank were reported as well-capitalized. The bank reported $43.5 million of immediate FHLB capacity, $643.8 million of secured FRB discount-window capacity, and $145.0 million available on unsecured federal-funds lines, of which $52.5 million was outstanding.
- Credit quality: Nonperforming loans rose to $8.6 million, or 0.27% of loans, from $7.1 million, or 0.23%. Nonperforming assets were $9.1 million, or 0.21% of assets. Net charge-offs increased to $11.5 million, or 0.37% of average loans, from $9.7 million, or 0.33%. The allowance declined to $30.5 million, or 0.95% of loans, from $33.9 million, or 1.10%; management said it was adequate.
Material changes, outlook and risks
- Management said 2019 loan growth and an improved earning-asset mix supported higher net interest income. It sold $65.4 million of securities in the third quarter, generating a $1.6 million gain, and reinvested proceeds in securities with intermediate durations.
- Management said it would pursue organic growth and disciplined acquisitions, with emphasis on existing markets and complementary insurance and wealth businesses. In February 2020, regulators approved applications for two additional Buffalo financial solution centers. The filing provides no specific earnings or revenue guidance.
- Interest-rate exposure remains important: the bank described itself as liability-sensitive. Its 12-month simulation estimated net interest income declines of 0.80%, 1.42%, and 2.14% under immediate, sustained rate increases of 100, 200, and 300 basis points, respectively. These are model estimates, not forecasts.
- The company expected adoption of the current expected credit loss standard (CECL) on January 1, 2020 to increase credit-loss reserves by an estimated 15% to 30%; actual impact would depend on portfolio characteristics and economic forecasts.
- Key disclosed risks include regional economic and real-estate concentration, commercial credit exposure, indirect auto lending and seasoning, competition and deposit withdrawals, interest-rate and LIBOR transition risk, cybersecurity and third-party service-provider risk, regulation, and acquisition integration.
- A putative consumer class action alleges that vehicle-repossession notices did not comply with New York and Pennsylvania law. The company disputed the claims and planned to defend itself; it agreed to mediation in February 2020. Management said the outcome and potential costs were uncertain.
- The Bank’s NY DFS CRA evaluation disclosed in November 2019 rated performance “Satisfactory”; a separate prior Federal Reserve evaluation for 2011–2013 had rated it “Needs to Improve.” The company said the latter could bring added scrutiny to expansion applications. The Federal Reserve’s later evaluation was not complete in the filing.
Most important facts for investors to verify
- Whether loan-loss experience, nonperforming loans, and the allowance remain consistent with management’s credit assumptions, especially in commercial real estate and indirect auto.
- The realized CECL reserve increase and its effects on capital, earnings, and credit-loss volatility after adoption.
- Whether deposit growth is sustainable and how deposit pricing, brokered funding, and short-term borrowings affect funding costs and net interest margin.
- How much 2019 earnings growth depended on tax-credit benefits, securities gains, and other variable or nonrecurring items.
- The resolution, potential exposure, and insurance coverage for the repossession-notice litigation, and any effects of CRA evaluations on planned expansion.