Business Context and Reporting Period
The filing is a quarterly Form 10-Q for Community Bank System, Inc. (the source text does not identify Community Financial System, Inc.), covering the three and six months ended June 30, 2011. The company operated as a community bank serving consumers, businesses and governmental units in New York and Northern Pennsylvania, with additional employee-benefit, wealth-management and related financial services businesses.
On April 8, 2011, the company acquired The Wilber Corporation, parent of Wilber National Bank, for approximately $103.0 million in cash and stock. Wilber added 22 branches, approximately $464 million of loans, $297 million of investment securities and $772 million of deposits. Its results were included from the acquisition date.
Key Financial Metrics
| Metric | Three months ended June 30, 2011 | Six months ended June 30, 2011 |
|---|---|---|
| Net interest income | $54.2 million | $99.7 million |
| Provision for loan losses | $1.1 million | $2.1 million |
| Noninterest income | $22.8 million | $43.6 million |
| Operating expenses | $51.1 million | $94.4 million |
| Income before taxes | $24.8 million | $46.8 million |
| Net income | $18.0 million | $34.1 million |
| Diluted EPS | $0.49 | $0.96 |
| Dividends declared per share | $0.24 | $0.48 |
- Net income increased 11.3% year over year in the second quarter and 13.2% in the first six months. Diluted EPS increased from $0.48 to $0.49 and from $0.90 to $0.96, respectively.
- Net interest margin was 4.13% for the quarter and 4.10% year to date, up three and nine basis points, respectively. The fully tax-equivalent efficiency ratio was 57.2% for the quarter and 58.2% year to date.
- Operating expenses included $3.6 million of second-quarter and $4.3 million of year-to-date acquisition expenses. Excluding those costs, management reported diluted EPS of $0.56 for the quarter and $1.05 year to date.
- Cash provided by operating activities was $50.4 million for the first six months. Cash and cash equivalents increased from $211.8 million at December 31, 2010 to $273.7 million at June 30, 2011.
- Total assets were $6.39 billion, compared with $5.44 billion at year-end 2010. Loans were $3.48 billion, up 15%, and total deposits were $4.76 billion, up 21% from year-end, primarily because of the Wilber acquisition.
- Borrowings were $728.4 million and subordinated debt held by unconsolidated subsidiary trusts was $102.0 million at June 30, 2011.
- Shareholders’ equity was $730.1 million, compared with $607.3 million at December 31, 2010. The Tier 1 leverage ratio was 8.07%, above the 5% level cited by management for “well-capitalized” status; the tangible equity-to-assets ratio was 6.44%.
- Net charge-offs were $0.7 million in the second quarter and $2.1 million year to date. The allowance for loan losses was $42.5 million, or 1.22% of total loans, and covered 209% of nonperforming loans.
- Nonperforming loans were $20.3 million, or 0.58% of total loans. Nonperforming assets, including other real estate owned, were $23.6 million, or 0.67% of loans and other real estate.
Material Changes Versus Prior Comparable Period
- Second-quarter net interest income increased 18%, and year-to-date net interest income increased 12%, driven by higher earning assets from the Wilber acquisition and improved funding costs and net interest margin.
- Noninterest income rose 1.7% in the quarter but declined 1.1% year to date. Lower deposit service fees, regulatory changes affecting overdraft fees and softer utilization were partly offset by higher employee-benefit fees, mortgage banking revenue and acquisition-related contributions.
- Operating expenses increased 16% in the quarter and 6.8% year to date, primarily because of Wilber integration and operating costs. Lower intangible amortization and FDIC insurance premiums partly offset the increases.
- The allowance provision declined from $2.1 million to $1.1 million in the quarter and from $3.9 million to $2.1 million year to date. Net charge-offs also declined versus 2010.
- Available-for-sale securities increased to $1.44 billion from $1.09 billion at year-end 2010. The portfolio had a $38.2 million net unrealized gain at June 30, 2011.
- The company reported $19.8 million of unrealized losses on pooled trust-preferred securities. Management concluded that no other-than-temporary impairment existed, but noted that changes in market or credit conditions could alter that conclusion.
- Shares issued for the Wilber acquisition increased common shares issued by approximately 3.35 million. No shares had been repurchased under the outstanding 1.0 million-share authorization.
Outlook, Commentary, Risks and Unusual Items
Management emphasized continued growth through acquisitions, selective branch expansion, loan and deposit development, fee-income growth and technology investment. It described asset quality as stable and favorable relative to peer averages, while noting weak economic conditions, soft commercial demand, consumer deleveraging and elevated unemployment.
- No formal earnings or revenue guidance was provided in the filing.
- Management expected sufficient liquidity for the next year based on stress testing and reported a basic surplus ratio of 19.3% for both the 30-day and subsequent 60-day periods, compared with a 7.5% internal minimum.
- Liquidity sources included $273.7 million of cash and cash equivalents, $469 million of additional Federal Home Loan Bank borrowing capacity, approximately $1.1 billion of unencumbered securities and $65 million of unsecured correspondent-bank lines.
- Interest-rate modeling estimated annualized net interest income sensitivity of positive $2.5 million under a 200-basis-point increase and negative $0.9 million under the filing’s zero-basis-point scenario. Management stated that these scenarios were not forecasts.
- Principal risks included credit quality, interest-rate sensitivity, liquidity, economic conditions, regulatory and tax changes, technology implementation, acquisition integration, competition, employee costs, litigation and changes in consumer behavior.
- The filing identifies significant judgment in acquired-loan valuation, allowance adequacy, securities impairment, goodwill and intangible-asset valuation, retirement benefits and income taxes.
- Management stated that disclosure controls were effective as of June 30, 2011 and that no material change in internal control over financial reporting occurred during the quarter. Pending litigation was not expected to have a material effect.
- The company adopted no accounting change in the period that materially affected results. Newly issued comprehensive-income presentation guidance was expected to affect presentation only, while fair-value guidance effective January 1, 2012 was still being evaluated.
Investor Verification Checklist
- Verify the issuer identity: the provided filing is for Community Bank System, Inc., while the request metadata names Community Financial System, Inc.
- Assess whether Wilber’s acquired loans, deposits, branches and goodwill generate expected revenue and cost synergies after integration expenses end.
- Monitor asset quality of acquired and legacy portfolios, including the $24 million of fair-value loan marks on approximately $468 million of remaining Wilber-acquired loans.
- Reassess the $19.8 million unrealized loss on pooled trust-preferred securities and the assumptions supporting the conclusion that no impairment was other than temporary.
- Track the sustainability of the 4.10% year-to-date net interest margin as loan and investment yields decline and deposit pricing changes.
- Review the effects of Regulation E and economic conditions on deposit service fees and other recurring noninterest income.
- Confirm liquidity capacity, borrowing availability, capital ratios and exposure to interest-rate movements under changing market conditions.
- Consider the effect of acquisition expenses, stock issuance and the July 2011 dividend increase on future EPS, capital and payout ratios.