Financial Institutions, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. The New York-based financial holding company operates Five Star Bank, insurance agency SDN, and wealth manager Courier Capital, with banking activity concentrated in Western and Central New York.
Key financial metrics
| Metric | Q1 2018 | Comparable / prior date |
|---|---|---|
| Net income | $9.3 million | $7.9 million, Q1 2017 |
| Net income available to common shareholders | $8.9 million; diluted EPS $0.56 | $7.6 million; diluted EPS $0.52, Q1 2017 |
| Net interest income | $29.6 million | $27.0 million, Q1 2017 |
| Tax-equivalent net interest margin | 3.19% | 3.23%, Q1 2017 |
| Noninterest income / expense | $9.0 million / $24.1 million | $7.8 million / $20.9 million, Q1 2017 |
| Return on average assets / common equity | 0.92% / 9.95% | 0.86% / 10.02%, Q1 2017 |
| Total assets | $4.15 billion | $4.11 billion, Dec. 31, 2017 |
| Net loans | $2.76 billion | $2.70 billion, Dec. 31, 2017 |
| Total deposits | $3.38 billion | $3.21 billion, Dec. 31, 2017 |
| Borrowings | $366.7 million | $485.3 million, Dec. 31, 2017 |
| Cash and cash equivalents | $122.9 million | $99.2 million, Dec. 31, 2017 |
Operating cash flow was $17.1 million, investing cash outflow was $40.7 million, and financing cash inflow was $47.3 million. Financing included a $169.8 million deposit increase, partly offset by a $118.6 million reduction in short-term borrowings and $3.9 million of dividends paid. The common dividend declared was $0.24 per share, up from $0.21 a year earlier.
The allowance for loan losses was $35.6 million, or 1.27% of loans. Q1 provision was $2.9 million; net charge-offs were $2.0 million, or 0.30% of average loans on an annualized basis. Nonperforming loans were $10.7 million (0.38% of loans), and nonperforming assets were $11.2 million (0.27% of assets) at quarter-end.
Regulatory capital ratios at March 31 were 10.09% CET1, 10.65% Tier 1 risk-based, 13.09% total risk-based, and 8.11% Tier 1 leverage for the company. Management said capital levels remained “well-capitalized.”
Material changes versus comparable periods
- Net income rose 17% year over year, supported by higher net interest income and lower income-tax expense. Net interest income grew as average interest-earning assets increased 9%, including average loans up $385.3 million.
- Net interest margin declined four basis points. Management attributed most of the decline to the lower tax-equivalent adjustment on tax-exempt securities following the federal corporate tax-rate reduction; funding costs also rose, with the cost of interest-bearing liabilities increasing from 0.52% to 0.78%.
- Noninterest income increased $1.1 million. Investment advisory income rose $347,000, partly reflecting the 2017 Robshaw & Julian acquisition; limited partnership income moved from a $30,000 loss to $568,000 of income. Q1 2017 included $206,000 in securities-sale gains; Q1 2018 had none.
- Noninterest expense increased $3.2 million. Salaries and benefits increased $2.1 million, including approximately $1.0 million of identified nonrecurring compensation costs. Advertising rose $515,000 with a new brand campaign. The efficiency ratio increased to 61.85% from 59.09%.
- Effective tax rate fell to 19.6% from 28.5%, primarily due to the Tax Cuts and Jobs Act. Net charge-offs and nonperforming assets were lower than the cited prior comparable or year-end levels, while the allowance increased from $34.7 million at year-end.
- Other comprehensive loss was $6.2 million, largely from increased unrealized losses on securities; shareholders’ equity consequently declined $0.9 million from year-end to $380.3 million.
Liquidity, outlook, risks and unusual items
Management reported $84.9 million of immediate FHLB capacity, approximately $637.5 million of secured FRB capacity, $165.0 million available on unsecured federal funds lines, and $89.9 million of unencumbered liquid securities. The parent’s $20 million revolver was undrawn and due to mature in May 2018. Public deposits rose seasonally to $989.5 million, or 29% of deposits; reciprocal CDARS and ICS deposits totaled approximately $348.5 million. The company had no traditional brokered deposits.
Management described interest-rate sensitivity as relatively neutral. Its 12-month net-interest-income simulation estimated changes of negative 0.25%, 0.19%, and 0.13% under +100, +200, and +300 basis-point shocks, respectively; a -100 basis-point shock estimated a 3.77% decrease. Economic value of equity declined 11.01% under the +200 basis-point scenario. These are model estimates, not forecasts, and depend on assumptions about rates, deposit behavior, repricing, and prepayments.
Investment securities had $22.9 million of aggregate unrealized losses at March 31, versus $11.0 million at year-end. Management attributed losses predominantly to interest-rate changes, considered them temporary, and reported no other-than-temporary impairment or intention to sell securities in loss positions. The company uses interest-rate caps to hedge short-term borrowing cash flows; $100 million was the reported notional amount, and $84,000 was expected to be reclassified to interest expense over the next 12 months.
Risks highlighted include credit losses, commercial and indirect lending exposure, geographic concentration, deposit withdrawals and funding costs, interest-rate and market risk, regulatory and cybersecurity matters, and execution/integration of acquisitions. Off-balance-sheet commitments included $701.1 million to extend credit and $12.4 million in standby letters of credit; amounts may not be drawn. The filing reported no material change in legal proceedings and no material recognizable subsequent events. Management provided no quantitative earnings or performance guidance in the supplied filing text.
Important facts for investors to verify
- Whether loan growth and asset yields can continue to offset rising deposit and borrowing costs, and whether margin pressure persists.
- Credit trends in commercial and consumer-indirect portfolios, including criticized loans, charge-offs, nonperforming assets, and the adequacy of the allowance.
- How much of the $1.0 million of nonrecurring compensation expense will recur, and whether expense growth and the higher efficiency ratio moderate.
- Liquidity and funding composition, including seasonal municipal deposits, reciprocal CDARS/ICS balances, borrowing capacity, and the parent revolver’s May 2018 maturity.
- Interest-rate exposure and the effect of securities’ unrealized losses on accumulated other comprehensive loss, equity, and regulatory capital.
- Exposure under undrawn credit commitments and the assumptions underlying management’s interest-rate and credit-loss estimates.