Financial Institutions, Inc. — 2013 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2013, with fourth-quarter comparisons where disclosed. Financial Institutions, Inc. is a New York bank holding company operating primarily through Five Star Bank in Western and Central New York, with indirect auto lending extending into other parts of New York and Northern Pennsylvania.
Financial performance and condition
Amounts are in U.S. dollars; financial statement figures below are shown in millions unless otherwise noted.
| Metric | 2013 | 2012 | Change / context |
|---|---|---|---|
| Total assets | $2,928.6 | $2,763.9 | Up 6% |
| Net loans | $1,806.9 | $1,681.0 | Up 8% |
| Deposits | $2,320.1 | $2,261.8 | Up 3% |
| Short-term borrowings | $337.0 | $179.8 | Up $157.2 million; no long-term borrowings at year-end |
| Net interest income | $91.6 | $88.5 | Up 3%; fully tax-equivalent NII was $94.2 million, up 4% |
| Net interest margin, tax-equivalent | 3.64% | 3.95% | Down 31 basis points |
| Provision for loan losses | $9.1 | $7.1 | Up 27% |
| Noninterest income | $24.8 | $24.8 | Essentially unchanged |
| Noninterest expense | $69.4 | $71.4 | Down 3%; 2012 included acquisition and CEO-retirement costs |
| Net income | $25.5 | $23.4 | Up 9%; diluted EPS was $1.75 versus $1.60 |
| Cash and cash equivalents | $59.7 | $60.4 | Down $0.7 million |
| Shareholders’ equity | $254.8 | $253.9 | Nearly flat; 2013 other comprehensive loss was $13.4 million |
- Margins and returns: Return on average assets was 0.91%, return on average equity 10.10%, and the efficiency ratio 58.48% (improved from 62.87%). The lower margin reflected declining asset yields in a low-rate environment, partly offset by lower funding costs and balance-sheet growth.
- Cash flow: Operating activities provided $37.2 million; investing activities used $242.2 million, including $131.9 million of net loan originations and $107.3 million of net securities transactions; financing activities provided $204.3 million, mainly from deposit growth and short-term borrowing. Common dividends declared were $0.74 per share, up from $0.57.
- Liquidity and funding: Deposits were the primary funding source. Year-end borrowing consisted of $298.0 million of short-term FHLB advances and $39.0 million of repurchase agreements. The company reported approximately $12 million of immediate FHLB capacity, $480 million of secured FRB discount-window capacity, and $120 million of unsecured federal funds lines.
- Capital: Company Tier 1 and total risk-based capital ratios were 10.82% and 12.08%, respectively; leverage ratio was 7.63%. The Bank met the applicable “well-capitalized” requirements. Tangible common equity to tangible assets was 6.72% in selected financial data; the MD&A separately cites 6.51% at year-end, so investors should verify the definition and calculation.
- Credit quality: Nonperforming loans rose to $16.6 million, or 0.91% of loans, from $9.1 million, or 0.53%; nonperforming assets reached $17.1 million, or 0.58% of assets. The allowance was $26.7 million, 1.46% of loans and 161% of nonperforming loans, versus 271% coverage a year earlier. Net charge-offs rose to $7.1 million, or 0.40% of average loans.
Material changes versus the prior comparable period
- Loans grew 8%, with commercial mortgage loans up 14%, home equity up 14%, and consumer indirect loans up 8%. Consumer loans represented 53.7% of total loans; indirect auto loans alone were 34.7%.
- Asset quality weakened, primarily because one $6.9 million commercial mortgage was restructured and placed on nonaccrual in the fourth quarter. Troubled debt restructurings totaled $8.9 million at year-end; the modified loan was current under its restructured terms at year-end.
- Borrowings increased substantially, principally to support a roughly $100 million securities leverage strategy launched in the first quarter. Management said the strategy added approximately $1.1 million to 2013 net interest income.
- The available-for-sale securities portfolio had $8.8 million of net unrealized losses at year-end, compared with $26.6 million of net unrealized gains in 2012, largely due to interest-rate changes. The company transferred $227.3 million of municipal securities from available-for-sale to held-to-maturity; it recorded no impairment charge in 2013.
- The 2012 comparison included approximately $3.0 million of branch-acquisition expenses and $2.6 million related to the former CEO’s retirement. Excluding those items, 2013 noninterest expense increased about 5%.
Fourth-quarter results
Fourth-quarter 2013 net income was $6.4 million versus $6.3 million in fourth-quarter 2012; diluted EPS was $0.43 in both periods. Net interest income increased 1% to $23.4 million, while the tax-equivalent net interest margin fell to 3.61% from 3.92%. Noninterest income declined 9% to $5.7 million; noninterest expense declined 1% to $17.4 million. Quarterly provision was $2.4 million, and net charge-offs were $2.4 million, or 0.52% annualized of average loans.
Outlook, commentary and risks
- 2014 outlook: Management expected moderate net interest income growth, partially offset by continued margin pressure; loan growth was expected to modestly outpace deposits. It anticipated noninterest income slightly above recent levels, expenses around current levels, no significant change in overall asset quality, and a lower effective tax rate, partly reflecting a newly formed REIT.
- Rate risk: Management described the balance sheet as generally asset-sensitive. Its 12-month simulation estimated net interest income changes of -1.88% under a 100-basis-point rate decline, +0.74% under a 100-basis-point increase, and +2.06% under a 200-basis-point increase. Separately, estimated economic value of equity declined 6.56% in the +200-basis-point scenario. These are model estimates, not forecasts.
- Key risks: Geographic concentration in Western and Central New York; credit deterioration, including commercial real estate and indirect auto exposures; continued low-rate margin pressure and interest-rate sensitivity; reliance on short-term wholesale funding; liquidity and capital needs; regulatory and compliance costs, including Basel III and consumer rules; cybersecurity and third-party service-provider risks; and competition.
- Other developments: The company closed two branches in October 2013 and one supermarket branch in January 2014. Its broker-dealer subsidiary ceased active operations and transferred accounts and advisers to an LPL Financial platform; FSB began offering those services through the partnership. In February 2014, the Bank formed Five Star REIT, Inc. to hold qualifying mortgage-related loans; management expected tax-rate benefits, subject to tax law changes.
- Contingencies and controls: Management said pending or threatened litigation was not expected to have a material adverse effect. The independent auditor issued unqualified opinions on the financial statements and internal control; management also concluded internal control was effective as of year-end.
Important facts for investors to verify
- Reconcile the reported year-end tangible common equity-to-tangible-assets figures of 6.72% and 6.51%, including their calculation bases.
- Track performance and collateral recovery of the $6.9 million restructured commercial mortgage, the broader $8.9 million TDR balance, and subsequent nonperforming-loan trends.
- Assess whether the increased short-term FHLB funding and securities leverage strategy remain profitable and sustainable as rates, liquidity needs, and asset yields change.
- Monitor the allowance relative to loan growth, charge-offs, and nonperforming loans, particularly the large indirect-auto and commercial real estate portfolios.
- Verify the extent of available liquidity and borrowing capacity after collateral requirements, and the effects of Basel III capital rules and the REIT structure on capital, taxes, and dividends.