Business Context and Reporting Period
Community Bank System, Inc. (the filing registrant; the request metadata identifies Community Financial System, Inc.) filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The company operates banking, employee benefit services, wealth management and insurance businesses across Upstate New York and other northeastern markets.
The June 12, 2020 merger with Steuben Trust Corporation expanded the branch network by 11 offices and added approximately $607.7 million of assets and $516.3 million of deposits. The transaction was funded with $21.6 million of cash and 1.36 million common shares, with $20.3 million of goodwill recognized.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 |
|---|---|---|---|---|
| Net interest income | $93.0 million | $91.3 million | $275.0 million | $266.4 million |
| Provision for credit losses | $1.9 million | $1.8 million | $17.3 million | $5.6 million |
| Noninterest revenue | $59.7 million | $57.1 million | $171.2 million | $173.5 million |
| Noninterest expense | $97.0 million | $96.9 million | $281.5 million | $276.8 million |
| Net income | $42.8 million | $39.2 million | $118.2 million | $126.2 million |
| Diluted EPS | $0.79 | $0.75 | $2.22 | $2.41 |
| Net interest margin | 3.12% | 3.73% | 3.36% | 3.78% |
- Third-quarter net income increased 9.2%, while year-to-date net income declined 6.3%. The year-to-date decline primarily reflected higher credit-loss provisions, COVID-19 effects, the litigation accrual and the absence of prior-year investment-security gains.
- Adjusted diluted EPS, excluding specified acquisition, litigation, intangible-amortization and other items, was $0.88 in both third-quarter 2020 and third-quarter 2019, and $2.48 versus $2.57 year-to-date.
- Adjusted pre-tax, pre-provision net revenue was $59.4 million in the quarter and $172.2 million year-to-date, compared with $57.5 million and $166.1 million, respectively, in the prior-year periods.
- Adjusted efficiency ratio was 58.9% for the quarter and 59.2% year-to-date, broadly consistent with the prior-year periods.
Financial Condition, Cash Flow, Debt and Liquidity
- Total assets were $13.85 billion at September 30, 2020, up from $11.41 billion at December 31, 2019. Loans were $7.46 billion, up 8.2% from year-end, and deposits were $11.12 billion, up 23.6% from year-end.
- Business lending increased to $3.43 billion, including $507.2 million of PPP loans. Consumer indirect and consumer direct loans declined year-to-date, while home equity loans increased.
- Cash and cash equivalents were $1.84 billion. The company reported approximately $1.7 billion of unused Federal Home Loan Bank capacity, $259.4 million of Federal Reserve discount-window availability, $1.3 billion of unencumbered securities and $25.0 million of unsecured correspondent-bank lines.
- Net cash provided by operating activities was $125.2 million for the first nine months, compared with $129.0 million in the prior-year period. Financing activities provided $1.58 billion, primarily from a $1.61 billion increase in deposits. Ending cash increased to $1.84 billion from $205.0 million at December 31, 2019.
- Borrowings were modest relative to deposits: securities sold under repurchase agreements were $280.8 million, other Federal Home Loan Bank borrowings were $7.7 million, subordinated notes were $13.7 million and subordinated debt held by subsidiary trusts was $77.3 million. Overnight Federal Home Loan Bank borrowings were zero.
- Shareholders’ equity was $2.10 billion. The Tier 1 leverage ratio was 10.21%, substantially above the 5.0% well-capitalized threshold; net tangible equity to assets was 9.92%.
Material Changes Versus Prior Comparable Period
- Net interest income rose 1.9% in the quarter and 3.2% year-to-date, but net interest margin contracted by 61 basis points and 42 basis points, respectively, because earning-asset yields declined faster than funding costs.
- Noninterest revenue increased 4.5% in the quarter but declined 1.3% year-to-date. Mortgage banking, employee benefit, wealth management and insurance revenue improved, while deposit service fees declined and the prior-year $4.9 million investment-security gain did not recur.
- The allowance for credit losses increased to $65.0 million, or 0.87% of loans, from $49.9 million at December 31, 2019 and $49.4 million at September 30, 2019. Year-to-date provision expense increased to $17.3 million from $5.6 million.
- Nonperforming loans were $32.2 million, or 0.43% of loans, compared with $28.7 million and 0.42% at December 31, 2019. Delinquent loans declined to 0.79% of loans from 0.85% at year-end.
- The company adopted CECL on January 1, 2020, increasing retained earnings by $1.1 million. The company recorded the full regulatory-capital impact rather than using the permitted phase-in.
- Year-to-date common dividends declared were $65.9 million, or $1.24 per share, and the quarterly dividend was increased to $0.42 per share. No shares were repurchased under the public repurchase program.
Guidance, Outlook, Commentary and Risks
- Management expects fourth-quarter net interest margin to remain depressed because of low short-term interest rates. PPP forgiveness and recognition of the remaining $11.3 million of deferred PPP fees may create timing-related earnings and asset-yield volatility.
- Management expects most PPP loans to be forgiven over the fourth quarter of 2020 and throughout 2021, which should reduce business-loan balances. The timing and eligibility of forgiveness and SBA reimbursement remain uncertain.
- The company processed more than 5,000 COVID-19 forbearance requests totaling approximately $950 million. At September 30, 216 borrowers representing approximately $193 million, or 2.6% of loans, remained in forbearance.
- Management expects forbearances to decline in the fourth quarter but warns that delinquencies, nonaccrual loans and credit-loss provisions may rise as deferrals expire. COVID-19 is expected to affect results through the remainder of 2020 and potentially a significant portion of 2021.
- Fourth-quarter deposit service fees and debit-card revenue were expected to improve modestly if economic reopening continued, while mortgage-banking revenue was expected to decline as secondary-market loan sales decreased. Operating expenses were expected to be similar to the third quarter.
- The company recorded a $3.0 million litigation accrual for an anticipated settlement of a class action concerning deposit-account terms, overdraft disclosures and overdraft fees. Settlement documentation and court approval were expected in the fourth quarter.
- Principal risks include COVID-19-related credit deterioration, interest-rate compression, changing PPP rules and forgiveness timing, uncertain deposit balances, market-related pressure on fee businesses, litigation, regulatory changes and acquisition-integration execution.
Investor Verification Items
- Verify the registrant’s legal name because the request metadata and filing text identify different company names.
- Track PPP forgiveness, deferred-fee recognition, the resulting reduction in business loans and the sustainability of stimulus-related deposits.
- Review subsequent-quarter delinquency, nonaccrual, charge-off and allowance trends after COVID-19 payment deferrals expire.
- Assess the sustainability of the 3.12% quarterly net interest margin under prolonged low rates and the stated rate-sensitivity scenarios.
- Confirm final terms, court approval and any additional cost from the overdraft-related litigation settlement.
- Evaluate Steuben integration results, acquired-loan credit performance, branch-network costs and realized synergies.