Financial Institutions, Inc. — Q3 2019 Form 10-Q
Business context and period. This unaudited filing covers the quarter and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Financial Institutions, Inc. operates Five Star Bank, an insurance agency, and investment advisory and wealth management businesses, primarily serving Western and Central New York.
Financial performance and condition
Amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $32.5 | $30.9 | $96.7 | $90.8 |
| Noninterest income | $12.4 | $9.8 | $30.7 | $27.1 |
| Provision for loan losses | $1.8 | $2.1 | $5.4 | $5.1 |
| Noninterest expense | $25.9 | $25.5 | $76.1 | $73.1 |
| Net income | $12.8 | $10.6 | $35.8 | $32.0 |
| Diluted earnings per common share | $0.78 | $0.64 | $2.16 | $1.94 |
| Tax-equivalent net interest margin | 3.29% | 3.17% | 3.27% | 3.17% |
| Efficiency ratio | 59.52% | 62.04% | 60.09% | 61.36% |
- Management reported Q3 return on average common equity of 12.00% and return on average assets of 1.19%, versus 10.82% and 1.00%, respectively, a year earlier.
- At September 30, 2019, total assets were $4.33 billion, net loans were $3.12 billion, deposits were $3.59 billion, and shareholders’ equity was $432.6 million. Since December 31, 2018, loans rose by $69.8 million and deposits by $219.3 million.
- Cash and cash equivalents were $136.8 million, up $34.1 million from year-end 2018. For the first nine months, operating cash flow was $41.2 million, investing cash flow was $44.8 million, and financing cash flow was negative $51.9 million.
- Borrowings totaled $250.7 million at September 30, down from $508.7 million at year-end, principally reflecting a $258.1 million net reduction in short-term borrowings. Long-term subordinated notes, net, were $39.3 million.
- Regulatory capital ratios at September 30 included a 10.06% Common Equity Tier 1 ratio, 10.55% Tier 1 capital ratio, and 12.57% total risk-based capital ratio. The company reported that it remained well-capitalized.
Material changes and management commentary
- Q3 net income increased 21% year over year. Higher loan balances and yields supported net interest income: average loans rose $207.4 million year over year for the quarter. The increase was partly offset by higher funding costs; the average cost of interest-bearing liabilities rose to 1.30% from 1.07%.
- Noninterest income rose in Q3, reflecting higher debit-card activity and derivative income, as well as a $1.6 million gain on securities sales. The company sold $65.4 million of securities and reinvested the proceeds in intermediate-duration securities.
- Noninterest expenses increased modestly. Management cited personnel benefits, software and facilities investment, and consulting fees; lower FDIC assessments and advertising costs partly offset these increases.
- Credit costs warrant attention. Q3 net charge-offs were $4.6 million, or 0.58% of average loans annualized, versus $2.1 million and 0.28% a year earlier. Management attributed the increase primarily to a $3.0 million partial charge-off on a $5.6 million nonperforming loan. Nonperforming assets rose to $9.9 million from $7.4 million at year-end; nonperforming loans were 0.31% of total loans versus 0.23%.
- The allowance for loan losses was $31.7 million, or 1.00% of total loans, at September 30. The filing states management considered the allowance adequate, while noting that estimates are subject to uncertainty and regulatory review.
- A $0.6 million expense adjustment related to the Tax Cuts and Jobs Act provisional estimate contributed to higher Q3 and year-to-date effective tax rates: 25.0% and 22.3%, respectively, versus 19.5% and 19.6% in 2018.
Outlook, risks, and contingencies
- The filing provides no specific earnings or growth guidance. Management describes ongoing organic loan and deposit growth initiatives and a strategy to redeploy securities into loans, while noting interest-rate, credit, liquidity, and economic risks.
- Interest-rate simulations estimate 12-month net interest income declines of 0.86% under a +100 basis-point shock and 1.60% under +200 basis points; declines are also estimated under falling-rate scenarios. These are model-based scenarios, not forecasts, and depend on assumptions about asset and deposit repricing.
- The company had approximately $835.7 million of additional collateralized wholesale borrowing capacity and $145.0 million of available unsecured federal-funds lines; it also reported $121.9 million of unencumbered liquid securities. Capacity is subject to collateral and facility terms.
- The expected-credit-loss standard (CECL) was scheduled for adoption January 1, 2020. Management was preparing models, processes, controls, and disclosures and expected an impact on financial condition and income, but the filing does not provide a clear estimate of the impact.
- Off-balance-sheet commitments to extend credit were $820.6 million and standby letters of credit were $11.9 million. Management said the commitments may not be fully drawn. The company also reported ordinary-course legal proceedings and did not expect aggregate liability to have a material adverse effect.
- Other disclosed risks include regional economic and borrower concentration, consumer and commercial credit exposure, deposit withdrawals, interest-rate movements, cybersecurity, regulation, competition, and execution of growth or acquisitions. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether elevated Q3 charge-offs and increased nonperforming assets persist, and how the identified commercial real-estate credit is resolved.
- Whether loan growth and net interest margin can be sustained as deposit and borrowing costs change, particularly after rate cuts or further market shifts.
- The composition, pricing, and stability of deposit growth, including public, time, brokered, CDARS, and ICS deposits.
- The eventual CECL transition adjustment and its effect on the allowance, earnings, and regulatory capital.
- How much of Q3 earnings growth depended on securities-sale gains and derivative activity, and whether recurring fee income and expense trends support continued profitability.