Financial Institutions, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; fourth-quarter results are also summarized. Financial Institutions, Inc. (NASDAQ: FISI) is a New York-based financial holding company operating Five Star Bank, insurance agency SDN, and wealth manager Courier Capital, primarily in Western and Central New York.
Key financial metrics
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets, year-end | $4.11 billion | $3.71 billion |
| Total loans, year-end | $2.74 billion | $2.34 billion |
| Deposits, year-end | $3.21 billion | $3.00 billion |
| Borrowings, year-end | $485.3 million | $370.6 million |
| Net interest income | $112.6 million | $102.7 million |
| Net income | $33.5 million | $31.9 million |
| Diluted EPS | $2.13 | $2.10 |
| Net interest margin, tax-equivalent | 3.21% | 3.24% |
| Efficiency ratio | 60.65% | 60.95% |
| Return on average assets | 0.86% | 0.90% |
| Cash and cash equivalents, year-end | $99.2 million | $71.3 million |
Amounts are consolidated unless otherwise noted. Full-year net interest income on a fully taxable-equivalent basis was $115.8 million, up 9%. Average interest-earning assets grew 10%, while the margin declined three basis points. Net interest income after loan-loss provision was $99.3 million. Noninterest income was $34.7 million, down 3%; noninterest expense was $90.5 million, up 7%.
Operating cash flow was $46.3 million; investing activities used $372.6 million, chiefly reflecting $404.9 million of net loan originations; financing activities provided $354.3 million. The company reported $381.2 million in year-end shareholders’ equity. Regulatory capital ratios were 10.16% CET1, 10.74% Tier 1, 13.19% total risk-based capital, and 8.13% leverage at the holding company; the Bank’s leverage and total risk-based capital ratios were 8.75% and 12.73%. Both were reported as well-capitalized.
The company paid $0.85 per common share in declared dividends during 2017. Its $40 million at-the-market equity offering generated approximately $38.3 million net proceeds and issued about 1.36 million shares.
Material changes versus 2016
- Total loans increased 17%, led by commercial business loans (+29%), commercial mortgages (+21%), and consumer indirect loans (+16%). Deposits rose 7%; short-term borrowings increased $114.7 million.
- Net income rose 5%, while diluted EPS increased from $2.10 to $2.13. Growth in net interest income was partly offset by higher funding costs and a modest margin decline.
- Provision for loan losses rose 39% to $13.4 million. Net charge-offs increased to $9.6 million from $5.8 million, and nonperforming loans grew to $12.5 million, or 0.46% of loans, from $6.3 million, or 0.27%.
- Noninterest expense increased $5.8 million, including a $1.6 million SDN goodwill impairment charge, higher compensation, occupancy and technology costs. A decline in professional-services expense partly offset increases.
- Noninterest income fell $1.0 million, including lower securities gains and company-owned life insurance income; investment advisory income increased with market gains and the Robshaw & Julian acquisition.
Outlook, commentary, risks and unusual items
- Management described continued execution of its loan-growth and revenue-diversification strategy, including expansion of mortgage lending and wealth management. It intends to pursue disciplined acquisitions, but provided no quantified earnings or growth guidance.
- Fourth-quarter net income was $11.1 million versus $8.7 million a year earlier; diluted EPS was $0.68 versus $0.57. Fourth-quarter expense growth reflected staffing, healthcare, branch and technology costs. The 5.0% quarterly effective tax rate included an estimated $2.9 million tax benefit from the Tax Cuts and Jobs Act, chiefly from revaluing deferred tax liabilities. The law reduces the federal corporate tax rate to 21% effective in 2018.
- Full-year credit costs and problem loans increased. Consumer indirect auto lending represented 32% of loans, and commercial business and mortgage lending together represented 46%; management noted their sensitivity to borrower performance and economic conditions.
- Funding includes $446.2 million of short-term FHLB borrowings at year-end. The company reported approximately $32 million of immediate FHLB capacity, $622 million of secured FRB discount-window capacity, and $165 million in unsecured federal funds lines; availability depends on collateral and terms. Non-maturity deposits totaled $2.36 billion and may be withdrawn on demand.
- In March 2018, the Federal Reserve Bank of New York notified the Bank that its CRA evaluation for January 2011–September 2013 was “Needs to Improve.” The rating may increase scrutiny of expansion applications. The NY Attorney General assurance related to Rochester lending practices expired in January 2018 after the Bank met its requirements; a separate NY DFS CRA evaluation remained incomplete.
- The company recorded $1.6 million of SDN goodwill impairment in 2017; its 2017 annual impairment test found no additional charge. Management identified credit-loss estimates, goodwill, deferred taxes and pension assumptions as significant judgment areas. Interest-rate, regional concentration, liquidity, regulatory, cybersecurity and acquisition risks are also highlighted.
- The filing reports no pending or threatened legal proceeding believed likely to have a material adverse effect. KPMG issued unqualified opinions on the financial statements and internal control; management and the auditor reported effective internal control over financial reporting.
Most important facts for investors to verify
- Whether increased provisions, charge-offs and nonperforming loans persist, especially in commercial business and indirect auto portfolios.
- Whether loan growth can be funded without further reliance on more expensive borrowings, and how deposits and funding costs respond to rate changes.
- Progress addressing the “Needs to Improve” CRA rating and any effect on planned branches, acquisitions or market expansion.
- How much reported earnings benefited from the one-time tax-law revaluation, and the subsequent effective tax rate under the 21% federal rate.
- Integration and returns from Courier Capital and Robshaw & Julian, and whether SDN goodwill faces further impairment.
- Potential shareholder dilution and capital deployment following the 2017 equity offering, alongside dividend sustainability and regulatory capital headroom.