Community Bank System, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2019; unaudited. The filing identifies the registrant as Community Bank System, Inc. (NYSE: CBU), although the request metadata names Community Financial System, Inc.
Business Context and Financial Position
The company operates a diversified financial-services business comprising community banking, employee benefit services, wealth management, and insurance services across Upstate New York and adjacent markets. Its strategy emphasizes branch and financial-services acquisitions, organic loan and deposit growth, fee-income expansion, and operating efficiencies.
- Total assets were $11.60 billion, up 9.3% from December 31, 2018.
- Gross loans were $6.85 billion, up 9.1% from year-end and 8.8% from September 30, 2018.
- Total deposits were $9.17 billion, up 10.2% from year-end.
- Shareholders’ equity was $1.84 billion, up $126.6 million from year-end.
- Goodwill and other intangible assets totaled $840.7 million, including $773.6 million of goodwill.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net interest income | $91.3 million | $86.2 million | $266.4 million | $257.7 million |
| Noninterest revenues | $57.1 million | $55.8 million | $173.5 million | $169.8 million |
| Noninterest expenses | $96.9 million | $85.2 million | $276.8 million | $257.7 million |
| Net income | $39.2 million | $43.1 million | $126.2 million | $127.8 million |
| Diluted EPS | $0.75 | $0.83 | $2.41 | $2.46 |
| Net interest margin | 3.73% | 3.71% | 3.78% | 3.72% |
- Q3 net income declined 9.0%; nine-month net income declined 1.3%.
- Q3 operating net income, excluding specified acquisition and investment-related items, was $44.0 million, up 4.5%; diluted operating EPS was $0.84, up from $0.81.
- Adjusted diluted EPS, additionally excluding intangible amortization and acquired loan accretion, was $0.88 in Q3 and $2.57 for nine months.
- The efficiency ratio increased to 58.8% for Q3 and 59.2% year to date, versus 58.0% and 57.7%, respectively.
- Provision for loan losses was $1.8 million in Q3 and $5.6 million year to date, down from $2.2 million and $8.3 million.
- Allowance for loan losses was $49.4 million, or 0.72% of loans. Net charge-offs were $1.6 million in Q3 and $5.4 million year to date.
Cash Flow, Liquidity, Capital, and Debt
- Cash and cash equivalents increased to $1.01 billion from $211.8 million at year-end.
- Operating cash flow was $129.0 million; investing cash flow was $551.6 million, primarily reflecting $590.2 million of investment-security sales; financing cash flow was $121.7 million.
- The company reported $1.8 billion of unused Federal Home Loan Bank borrowing capacity, $939.3 million of unencumbered securities, and $25.0 million of unsecured correspondent-bank lines.
- The 30-day and 90-day basic surplus liquidity ratios were each 13.8%, above the company’s 7.5% internal requirement.
- Short-term borrowings were zero; securities sold under repurchase agreements were $233.3 million. Other reported debt included $13.8 million of subordinated notes, $77.3 million of subordinated trust debt, and $4.3 million of other long-term debt.
- The Tier 1 leverage ratio was 10.76%, above the 5% “well-capitalized” threshold. The net tangible equity-to-assets ratio was 9.68%.
- The quarterly common dividend increased to $0.41 per share; nine-month dividends declared were $60.5 million.
Material Changes Versus Comparable Periods
- The July 2019 Kinderhook Bank merger added 11 branches, approximately $642.9 million of assets, $479.9 million of loans, and $568.1 million of deposits. It contributed approximately $4.3 million of revenue and $1.8 million of direct expenses in the reported periods.
- Acquisition expenses were $6.1 million in Q3 and $7.8 million year to date, compared with acquisition-related recoveries in 2018. These expenses were the primary reason reported earnings fell despite higher net interest income and noninterest revenue.
- Loans and deposits grew substantially, primarily due to Kinderhook and secondarily to organic growth. Business lending increased 15.6% year over year.
- Investment securities declined, mainly because the company sold $590.2 million of Treasury and agency securities and held proceeds in interest-earning cash. The sale generated a $4.9 million year-to-date net gain.
- Recurring noninterest revenue was mixed: employee benefit and insurance services increased, while electronic banking revenue declined year to date because of Durbin Amendment debit-interchange restrictions.
- Nonperforming assets increased to $29.9 million from $26.3 million at year-end; nonperforming loans were 0.42% of total loans, compared with 0.40% at year-end.
Outlook, Risks, Contingencies, and Unusual Items
- On October 21, 2019, the company announced a proposed acquisition of Steuben Trust Corporation for approximately $106.8 million in cash and company stock. Closing was expected in Q2 2020, subject to regulatory and shareholder approvals, with transaction costs expected in 2019 and 2020.
- The company was developing its CECL model for adoption in 2020. Preliminary results indicated an allowance for credit losses of approximately $52 million to $60 million, versus the $49.4 million allowance under the existing model. Management characterized this estimate as preliminary.
- Management expects interest-rate changes, credit quality, local and national economic conditions, deposit costs, technology and cybersecurity, regulatory changes, acquisitions, litigation, and the ability to control expenses to affect future results.
- Modeled annualized net interest income sensitivity from the September 30 position ranged from an increase of $7.8 million under a 200-basis-point rise to a decrease of $7.5 million under a 175-basis-point decline. Management cautioned that these scenarios are not forecasts.
- Pending and threatened litigation was not expected to materially affect financial position. The estimated aggregate reasonably possible loss beyond recorded liabilities was stated as $0 to $1 million, although particular-period operating results could still be affected.
- The company adopted the new lease standard in 2019; total assets and liabilities increased by $34.2 million, with no material effect on earnings or cash flows.
Investor Verification Checklist
- Verify the final consideration, timing, approvals, integration costs, and realized synergies for the pending Steuben acquisition.
- Reconcile preliminary CECL estimates with the allowance and retained-earnings impact at adoption.
- Monitor nonperforming loans, criticized business loans, charge-offs, allowance coverage, and collateral values.
- Assess whether loan and deposit growth from Kinderhook is sustained organically and whether higher deposit costs pressure net interest margin.
- Separate recurring operating performance from acquisition expenses, investment-security gains, intangible amortization, and acquired-loan accretion.
- Review the effect of Durbin-related interchange reductions and the company’s plans to offset lost banking fee revenue.
- Confirm regulatory capital ratios, liquidity availability, and the effect of future acquisitions or securities repositioning on funding and capital.