TOMPKINS FINANCIAL CORP quarterly report, Q2 FY2018

Tompkins Financial Corporation — Q2 2018 Form 10-Q

Business context and period. Tompkins is a New York-based financial holding company providing community banking, insurance, and wealth-management services. This unaudited filing covers the three and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. Dollar amounts below are in millions unless stated otherwise.

Financial performance and position

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net interest income	$52.7	$50.3	$105.4	$98.3
Net income attributable to Tompkins	$22.1	$16.9	$42.5	$32.6
Diluted EPS	$1.43	$1.11	$2.76	$2.13
Noninterest income	$21.2	$17.5	$39.0	$34.7
Noninterest expense	$45.0	$41.6	$88.7	$82.9

Q2 return on average assets was 1.32% (1.07% prior year) and return on average equity was 15.13% (11.85%). Six-month figures were 1.28% and 14.78%, respectively, versus 1.05% and 11.50%.
Net interest margin was 3.36% for Q2 and 3.39% year to date, compared with 3.45% and 3.42%. Rising funding costs weighed on margin.
At June 30, total assets were $6.75 billion, net loans and leases $4.75 billion, deposits $4.79 billion, total liabilities $6.16 billion, and equity $590.6 million.
Cash and cash equivalents were $82.7 million. First-half operating cash flow was $40.2 million, investing cash use $118.9 million, and financing cash flow $77.1 million; cash declined $1.6 million from year-end.
Other borrowings were $1.23 billion, up $158.2 million from year-end, while deposits declined $45.6 million. Borrowings included $731 million in FHLB overnight advances and $495 million in term advances. Unused FHLB borrowing capacity was $854 million.
Regulatory capital ratios exceeded stated minimum and well-capitalized requirements: total capital 12.68%, Tier 1 risk-based capital 11.80%, common equity Tier 1 11.46%, and Tier 1 leverage 8.71%.

Material changes versus comparable periods

Net income rose 30% in Q2 and 30% for the first half. Higher net interest income reflected loan growth and improved loan yields, partly offset by higher funding costs.
Noninterest income increased, including a $2.9 million gain from selling properties associated with completion of the new headquarters. Securities transaction gains were $150,000 in Q2 and $274,000 year to date.
Noninterest expense rose 8.2% in Q2 and 7.0% year to date. The periods included approximately $2.0 million of write-downs related to two leases on recently vacated space, as well as higher compensation, professional fees, and technology costs.
The effective tax rate fell to 21.0% in Q2 and 21.3% year to date from 32.7% and 32.4%, respectively, primarily reflecting the federal tax-rate reduction under the Tax Cuts and Jobs Act.
Originated loans grew $148.5 million, or 3.4%, from year-end; acquired loans declined $26.4 million. Commercial real estate loans rose 4.7%, while commercial and industrial loans declined 1.0%.
Accumulated other comprehensive loss widened to $69.4 million from $51.3 million at year-end, mainly due to unrealized losses on available-for-sale securities as market rates changed.

Outlook, risks, contingencies, and unusual items

Management provided no formal earnings guidance. Its base-case simulation indicated net interest margin stable to higher over the next 12–18 months. A May 31 rate simulation estimated net interest income would fall 3.2% under a 200-basis-point parallel increase and rise 0.1% under a 100-basis-point decline over one year; the model assumes no balance-sheet growth or management action.
Credit quality indicators warrant monitoring. Nonperforming loans and leases were $26.1 million, or 0.54% of loans, versus $23.0 million and 0.49% at year-end. Nonperforming assets were $28.3 million, or 0.42% of assets. Special Mention and Substandard loans increased $16.8 million, largely following downgrades of two credits totaling $16.7 million and agricultural downgrades associated with depressed milk prices. Management reported regular payments on approximately 94.8% of loans classified as nonperforming.
The allowance for loan and lease losses was $41.2 million, up 3.7% from year-end. Management identified allowance estimation and securities impairment assessment as critical accounting judgments. The expected-credit-loss standard, effective for Tompkins in 2020, is expected to likely increase the allowance; the amount was not quantifiable at filing.
Interest-rate exposure is a key market risk: the one-year static gap was negative $828.0 million, or 12.27% of assets, indicating greater near-term sensitivity to rising rates. Available-for-sale securities had $42.8 million of gross unrealized losses; management attributed these primarily to rates and liquidity, and reported no securities as other-than-temporarily impaired.
Liquidity sources include core deposits, cash, securities cash flows, and wholesale funding. Core deposits were 84.1% of deposits. Management reported no trends reasonably likely to cause material near-term liquidity changes.
Standby letters of credit represented a maximum potential obligation of $22.8 million; management did not anticipate significant losses. Management stated that ordinary-course litigation was not expected to have a material effect, and that there were no material changes to previously disclosed risk factors.
ASC 606 adoption increased beginning retained earnings by $1.8 million, primarily from insurance contingency income; management said adoption did not significantly affect first-half results. The filing reports no further subsequent-event disclosures were required.

Important facts for investors to verify

Whether the $16.7 million of downgraded credits, agricultural exposures, and rising nonperforming assets lead to additional provision expense or charge-offs.
Whether loan growth can be funded without continued reliance on higher-cost FHLB and other borrowings, and how deposit trends affect margins.
How the $2.9 million property-sale gain and $2.0 million lease write-down affect comparisons of recurring earnings; the company’s non-GAAP first-half adjusted diluted EPS was $2.72 versus GAAP EPS of $2.76.
How interest-rate movements affect net interest margin and the value of the securities portfolio, including the accumulated unrealized losses.
The eventual allowance impact and implementation readiness for the expected-credit-loss standard, and the balance-sheet effect of lease accounting adoption in 2019.