Community Bank System, Inc. — FY2020 Form 10-K Summary
Filing identity: The supplied filing is for Community Bank System, Inc. (NYSE: CBU), although the request metadata names Community Financial System, Inc. The report covers the fiscal year ended December 31, 2020, with comparisons primarily to 2019.
Business context and reporting period
Community Bank System is a diversified financial holding company operating through Community Bank, N.A. and Benefit Plans Administrative Services, Inc. Its reportable segments are Banking, Employee Benefit Services, and All Other, which includes wealth management and insurance operations. The Bank operated 232 branches across Upstate New York, Northeastern Pennsylvania, Vermont, and Western Massachusetts and had 3,047 employees at year-end.
The Company completed its merger with Steuben Trust Corporation on June 12, 2020 for $98.6 million in cash and stock. The transaction added approximately $607.8 million of assets, $516.3 million of deposits, 11 branches, and $20.2 million of goodwill.
Financial performance and key metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Net interest income | $368.4 million | $359.2 million | +2.6% |
| Provision for credit losses | $14.2 million | $8.4 million | +68.6% |
| Noninterest revenue | $228.4 million | $230.6 million | -1.0% |
| Noninterest expenses | $376.5 million | $372.0 million | +1.2% |
| Income before taxes | $206.1 million | $209.3 million | -1.6% |
| Net income | $164.7 million | $169.1 million | -2.6% |
| Diluted EPS | $3.08 | $3.23 | -4.6% |
| Return on average assets | 1.28% | 1.53% | -25 bps |
| Return on average equity | 8.13% | 9.42% | -129 bps |
| Net interest margin | 3.28% | 3.76% | -48 bps |
| Efficiency ratio | 59.6% | 59.6% | Flat |
Adjusted net income was $180.1 million versus $180.0 million in 2019, while diluted adjusted EPS declined 2.0% to $3.37. Results were affected by COVID-19, higher credit-loss provisions, lower investment-security gains, increased expenses, a $3.0 million litigation accrual, and additional shares issued for the Steuben acquisition.
At December 31, 2020, total assets were $13.93 billion, up 22.1%; loans were $7.42 billion, up 7.6%; deposits were $11.22 billion, up 24.8%; and shareholders’ equity was $2.10 billion, up 13.4%. Cash and cash equivalents were $1.65 billion and investment securities were $3.60 billion.
Operating cash flow was $179.5 million, compared with $202.5 million in 2019. Investing activities used $398.7 million, primarily reflecting purchases of investment securities and loan growth. Financing activities provided $1.66 billion, driven primarily by a $1.71 billion increase in deposits. Cash and cash equivalents increased $1.44 billion during the year.
Year-end borrowings totaled $371.3 million, including $284.0 million of short-term repurchase agreements, $77.3 million of subordinated debt held by an unconsolidated subsidiary trust, and $6.7 million of other FHLB borrowings. The Company reported a 10.16% Tier 1 leverage ratio and 19.87% total risk-based capital ratio; the Company and Bank were categorized as well capitalized.
Material changes versus the prior comparable period
- Average interest-earning assets increased 17.5%, but lower market rates reduced earning-asset yields and drove the net interest margin down 48 basis points.
- Average deposits increased 18.3%, reflecting government stimulus inflows, PPP activity, and the Steuben acquisition. The cost of total deposits declined to 0.16% from 0.23%.
- Gross loans increased $525.4 million, primarily from $470.7 million of PPP loans and the Steuben acquisition. Business lending increased 23.9%, while consumer installment balances declined.
- Nonperforming loans increased to $76.9 million from $24.3 million, and nonperforming loans as a percentage of total loans rose to 1.04% from 0.35%, primarily due to pandemic-related borrower stress and acquired Steuben loans.
- The allowance for credit losses increased to $60.9 million from $49.9 million, and allowance coverage of nonperforming loans declined to 79% from 206%.
- Employee Benefit Services revenue increased 4.0% to $103.5 million, while All Other revenue increased 4.3% to $61.6 million. Banking noninterest revenue declined excluding certain nonrecurring items.
- The Company adopted CECL on January 1, 2020, recording a $1.1 million increase to retained earnings. No material allowance was recorded for available-for-sale securities.
- Common dividends declared increased to $1.66 per share from $1.58. No shares were repurchased under the 2020 public repurchase authorization; a new authorization for up to 2.68 million shares began January 1, 2021.
Guidance, outlook, risks, contingencies, and unusual items
Management expects 2021 net interest margin to remain below historical levels, excluding PPP effects, because the Federal Funds rate and Prime rate fell sharply in 2020 and are expected to remain low. The timing of forgiveness of the remaining $9.0 million of deferred PPP fees is uncertain. Management expects deposit service fees and debit interchange revenue to increase slightly as economies reopen, but expects mortgage banking revenue to decline because the Company reduced secondary-market mortgage sales late in 2020. Operating expenses are expected to increase modestly due to technology investments, resumed marketing and employee-development activities, and a full year of Steuben-related branch expenses.
At year-end, 74 borrowers representing $66.5 million of loans remained in COVID-19 forbearance. Management expects forbearances to decline during 2021 but warns that delinquent and nonperforming loans, provisions, and charge-offs may increase as deferrals expire. The Company had 3,417 PPP loans totaling $470.7 million and participated in the 2021 Second Draw program, although future origination volume was uncertain.
Liquidity was strong: cash and cash equivalents, net of float, were approximately $1.57 billion; available-for-sale securities totaled $3.55 billion, including $1.78 billion unpledged; unused FHLB capacity was approximately $1.66 billion; Federal Reserve discount-window availability was $256.2 million; and unsecured correspondent lines totaled $25.0 million. The 30-day and 90-day basic surplus ratios were 20.6% and 21.6%, respectively, versus an internal minimum of 7.5%.
Material risks include COVID-19-related credit deterioration, interest-rate and liquidity risk, deposit outflows, PPP forgiveness and SBA-guarantee risks, regulatory and compliance costs, cybersecurity and vendor risks, acquisition integration, goodwill and intangible-asset impairment, regional economic weakness, and competition. The Company recorded a $3.0 million accrual for an anticipated settlement of an overdraft-related class action; the settlement remained subject to documentation and court approval. Management estimated reasonably possible litigation losses beyond recorded liabilities at $0 to $1 million in aggregate.
On January 20, 2021, the Board approved redemption of the $77.3 million CCT IV subordinated debentures and associated preferred securities. Redemption was expected to occur on March 15, 2021 at par.
PricewaterhouseCoopers LLP issued an unqualified opinion on the financial statements and internal control over financial reporting. Management and the auditor concluded that internal control over financial reporting was effective as of December 31, 2020.
Most important facts for investors to verify
- Confirm the issuer identity: the filing is for Community Bank System, Inc., not Community Financial System, Inc.
- Assess whether the increase in nonperforming loans and the decline in allowance coverage reflect temporary pandemic effects or a more persistent deterioration in commercial credit quality.
- Track PPP loan forgiveness, recognition of the remaining $9.0 million of deferred fees, and the effect of Second Draw originations on loan balances and net interest income.
- Evaluate the sustainability of the 3.28% net interest margin under prolonged low rates and changing deposit balances.
- Review the effect of the Steuben integration, branch expenses, acquisition-related goodwill, and the Company’s substantial intangible-asset balance.
- Verify the completion and final cost of the overdraft litigation settlement and the March 2021 redemption of the $77.3 million subordinated debt.
- Consider dividend capacity and capital requirements, including the Bank’s legally available dividend capacity of approximately $110.7 million and the proposed 2021 share-repurchase authorization.