Community Bank System, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three months ended March 31, 2019. The company operates banking, employee benefit services, wealth management and insurance businesses across Upstate New York, Northeastern Pennsylvania, Vermont and Western Massachusetts. The filing identifies the registrant as Community Bank System, Inc.; this differs from the request metadata naming Community Financial System, Inc.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 / Prior period |
|---|---|---|
| Net income | $41.9 million | $40.1 million; up 4.6% |
| Diluted EPS | $0.80 | $0.78 |
| Net interest income | $86.9 million | $84.6 million; up 2.6% |
| Net interest margin | 3.80% | 3.71%; up 9 basis points |
| Noninterest revenue | $55.7 million | $57.5 million; down 3.1% |
| Noninterest expense | $88.7 million | $86.3 million; up 2.7% |
| Effective tax rate | 18.5% | 23.0% |
| Adjusted diluted EPS | $0.85 | $0.82; up 3.7% |
| Operating efficiency ratio | 59.1% | 57.8% |
| Cash flow from operations | $34.6 million | $61.0 million |
At March 31, 2019, total assets were $10.92 billion, loans were $6.27 billion, deposits were $8.62 billion, shareholders’ equity was $1.76 billion, and cash and cash equivalents were $508.4 million. Available-for-sale securities totaled $2.92 billion. Borrowings excluding securities sold under repurchase agreements were $99.9 million, while short-term repurchase agreements totaled $249.9 million.
The allowance for loan losses was $49.1 million, or 0.78% of total loans. Net charge-offs were $2.6 million, compared with $3.2 million in the prior-year quarter, and the provision for loan losses declined to $2.4 million from $3.7 million. Nonperforming loans were $24.3 million, or 0.39% of total loans, and total nonperforming assets were $25.8 million.
Liquidity remained strong. Management reported $1.7 billion of unused Federal Home Loan Bank borrowing capacity, $1.4 billion of unencumbered securities, and $25.0 million of unsecured correspondent-bank lines. The 30-day and 90-day basic surplus ratios were 15.1% and 14.9%, respectively, compared with an internal minimum of 7.5%. The Tier 1 leverage ratio was 11.27%, and the net tangible equity-to-assets ratio was 9.83%.
Material changes versus comparable periods
- Net income increased $1.8 million, primarily due to higher net interest income, lower credit-loss provisioning and a lower effective tax rate.
- Net interest income benefited from higher asset yields and lower average interest-bearing liabilities, although funding costs increased. The average loan yield rose 25 basis points, while the average rate paid on interest-bearing liabilities rose 13 basis points.
- Noninterest revenue declined $1.8 million. Debit-card revenue fell approximately $3.2 million following Durbin Amendment interchange-fee restrictions effective in the third quarter of 2018.
- Noninterest expense rose $2.3 million, driven primarily by salaries and benefits, data processing and communications, business development and marketing, and $0.5 million of acquisition-related expenses.
- Average deposits declined 1.0% year over year to $8.41 billion, while ending deposits increased from December 31, 2018. Loan balances increased 0.6% from March 31, 2018 but declined 0.2% from year-end.
- Asset quality improved: nonperforming loans declined from $29.7 million at March 31, 2018 and $25.0 million at December 31, 2018, while delinquent loans declined to 0.88% of total loans.
- Accumulated other comprehensive loss improved to $26.8 million from $45.3 million at December 31, 2018, mainly due to higher available-for-sale securities valuations.
Guidance, outlook, risks and unusual items
The company did not provide formal full-year earnings guidance in the filing. Management expects the Kinderhook Bank Corp. merger to close on July 12, 2019, subject to customary closing conditions. The approximately $93.4 million cash acquisition is expected to add 11 branches in five Capital District counties and generate one-time transaction-related costs during 2019. Required shareholder and regulatory approvals had been received as of the filing date.
On January 2, 2019, the company acquired certain Wealth Resources Network assets for $1.2 million in cash and recorded a $1.2 million customer-list intangible asset. Acquisition expenses were $0.5 million in the quarter.
The company adopted the new lease standard on January 1, 2019. The adoption increased assets and liabilities by $34.2 million, with no material effect on earnings or cash flows. The company is evaluating the expected-credit-loss standard, effective for fiscal years beginning after December 15, 2019, and expects it to change the allowance for loan losses; the amount was not yet determinable.
Key risks include credit quality, interest-rate sensitivity, liquidity, economic conditions, competition, technology and cybersecurity, regulatory and tax changes, acquisition execution and integration, litigation, and the adequacy of credit-loss and valuation estimates. The filing’s interest-rate sensitivity analysis estimated annualized changes in projected net interest income of negative $1.3 million under a 200-basis-point increase, positive $0.7 million under a 100-basis-point increase, negative $1.5 million under a 100-basis-point decrease and negative $7.7 million under a 200-basis-point decrease. These are hypothetical sensitivities, not forecasts.
Pending and threatened litigation was not expected to be material to consolidated financial position. The filing states that reasonably possible losses beyond recorded liabilities were between $0 and $1 million in aggregate, although a material effect on a particular future reporting period cannot be ruled out.
Important facts for investors to verify
- Confirm the registrant identity and ticker: the filing is for Community Bank System, Inc. and NYSE: CBU.
- Track completion, purchase accounting, financing and integration costs associated with the Kinderhook acquisition.
- Assess the durability of net interest margin expansion as deposit and borrowing costs rise.
- Monitor the continuing impact of Durbin Amendment limits on debit-card revenue and the company’s ability to offset that decline with fee-based businesses.
- Evaluate implementation impacts of the expected-credit-loss standard on the allowance, capital and earnings.
- Review loan growth, nonperforming assets, charge-offs and allowance coverage, particularly in consumer indirect and business lending portfolios.
- Reconcile GAAP results with management’s non-GAAP adjusted EPS and operating measures.