Financial Institutions, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet comparisons are to December 31, 2022. Financial Institutions is a New York financial holding company whose principal subsidiary is Five Star Bank, with insurance and wealth-management businesses. Figures are in U.S. dollars; financial-statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q1 2023 | Comparison |
|---|---|---|
| Net interest income | $41.8 million GAAP; $41.9 million tax-equivalent | Up from $39.6 million GAAP; $39.7 million tax-equivalent in Q1 2022 |
| Net interest margin | 3.09% | 3.11% in Q1 2022 |
| Provision for credit losses | $4.2 million | $2.3 million in Q1 2022 |
| Noninterest income / expense | $10.9 million / $33.7 million | $11.3 million / $30.1 million in Q1 2022 |
| Net income | $12.1 million; $0.76 diluted EPS | $15.0 million; $0.93 diluted EPS in Q1 2022 |
| Return on average assets / common equity | 0.84% / 11.87% | 1.09% / 12.49% in Q1 2022 |
| Efficiency ratio | 63.68% | 59.06% in Q1 2022 |
Higher loan yields and loan growth lifted interest income, but sharply higher deposit costs largely offset that benefit. Management attributed lower earnings primarily to increased credit-loss provision and higher operating expenses. Expenses rose with personnel and wage costs, technology investment, FDIC assessments, derivative-collateral interest charges, fraud-related charge-offs, insurance costs and inflation. Noninterest income declined, mainly on lower deposit service charges and limited-partnership income.
Financial condition, funding and capital
- Assets and loans: Total assets were $5.97 billion, up from $5.80 billion at year-end. Gross loans were $4.24 billion, up $192.9 million; commercial loans were 59.8% of the portfolio. The loan allowance was $47.5 million, or 1.12% of loans.
- Deposits and borrowings: Deposits rose $211.9 million to $5.14 billion. Time deposits increased to 28.6% of deposits from 26.0%. Total borrowings were $240.3 million, including $116.0 million short-term and $124.3 million long-term.
- Liquidity: Cash and due from banks totaled $140.0 million. Management reported compliance with liquidity indicators and approximately $990.5 million of additional collateralized wholesale borrowing capacity, plus $145.0 million of available unsecured federal funds lines. Uninsured deposits were approximately $2.17 billion.
- Cash flow: Operating activities provided $6.6 million; investing activities used $164.6 million, largely reflecting $195.0 million in net loan originations; financing activities provided $167.5 million, including deposit growth and $50.0 million of long-term borrowing proceeds. Cash increased $9.5 million during the quarter.
- Capital: Shareholders’ equity was $422.8 million. At the Company, CET1, Tier 1 risk-based and total risk-based capital ratios were 9.21%, 9.55% and 11.93%, respectively; management reported the Company and Bank as well-capitalized. The Bank’s corresponding ratios were 10.48%, 10.48% and 11.38%.
- Securities and accumulated losses: Available-for-sale securities had a fair value of $945.4 million and an unrealized loss of approximately $158.4 million. Management attributed the losses mainly to higher market interest rates and said it did not intend, and did not expect to be required, to sell the securities before recovery. Accumulated other comprehensive loss improved by $10.1 million during the quarter.
Material changes, outlook and risks
- Net charge-offs were $2.1 million, or 0.21% of average loans on an annualized basis, versus $0.8 million and 0.09% a year earlier. Nonperforming assets declined to $8.9 million from $10.2 million at year-end; performing substandard loans increased to $25.8 million from $22.7 million.
- Management increased the loan-loss provision partly for loan growth, higher net charge-offs, a higher national unemployment forecast and uncertainty associated with higher interest rates. It provided no specific earnings or financial guidance in the supplied filing text.
- Interest-rate exposure remains important. The filing’s 12-month net-interest-income sensitivity table shows estimated declines of 0.50% for both a 100-basis-point decrease and increase, 1.00% for a 200-basis-point increase and 1.49% for a 300-basis-point increase. However, accompanying narrative says rising-rate scenarios indicate net interest income would increase; this conflicts with the table and merits verification.
- Banking-sector stress, deposit competition and withdrawals, interest-rate and securities valuation risk, potential recession and credit deterioration, uninsured and seasonal public deposits, and higher funding costs are identified risks. The filing also notes a class action concerning notices sent after vehicle repossessions. The company disputes the claims, has not accrued a liability because loss probability and amount cannot presently be estimated, and warns that an unfavorable outcome or insufficient insurance coverage could materially affect results.
- Other developments: the company dissolved its BaaS/FinTech oversight subsidiary in March, transferring its assets and liabilities to the Bank. HNP Capital merged into Courier Capital on May 1, 2023. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the interest-rate sensitivity table with management’s narrative about rising-rate effects on net interest income.
- Track deposit mix, deposit pricing, uninsured-deposit levels, reciprocal and brokered funding, and liquidity capacity as funding costs evolve.
- Monitor commercial real estate and consumer-indirect credit quality, charge-offs, nonperforming loans and allowance adequacy.
- Assess the impact of the securities portfolio’s unrealized losses, including whether liquidity needs could require sales before recovery.
- Follow developments in the vehicle-repossession class action and confirm the potential financial exposure and insurance coverage.
- Compare subsequent earnings and expense trends with Q1’s lower profitability, rising efficiency ratio and lack of specific company guidance.