Chemung Financial Corporation — Q2 2016 Form 10-Q
Business context and reporting period. The company is a New York financial holding company operating through Chemung Canal Trust Company, CFS Group and, from May 31, 2016, a Nevada captive insurer. Its principal activities are community banking, lending, deposits and wealth management. This unaudited report covers the quarter and six months ended June 30, 2016; comparisons are with the prior-year periods unless otherwise stated. Financial amounts below are in millions of dollars unless indicated.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $12.97 | $12.65 | $25.99 | $24.99 |
| Non-interest income | $5.22 | $5.33 | $10.82 | $10.51 |
| Non-interest expense | $15.57 | $13.82 | $29.58 | $27.56 |
| Provision for loan losses | $0.39 | $0.26 | $0.98 | $0.65 |
| Net income | $1.62 | $2.58 | $4.33 | $4.85 |
| Basic and diluted EPS | $0.34 | $0.55 | $0.91 | $1.03 |
| Fully taxable-equivalent net interest margin | 3.36% | 3.50% | 3.41% | 3.50% |
| Return on average assets / equity | 0.39% / 4.57% | 0.66% / 7.52% | 0.53% / 6.14% | 0.63% / 7.16% |
Balance sheet at June 30, 2016: Total assets were $1.684 billion, up 3.9% from year-end 2015. Loans, net of deferred fees, were $1.201 billion, up 2.8%; deposits were $1.468 billion, up 4.8%; and shareholders’ equity was $143.4 million. Loans-to-deposits were 81.83%. Total equity-to-assets was 8.52%, and tangible equity-to-tangible assets was 7.12%.
Cash flow and liquidity: For the first half, operating activities provided $11.4 million, investing activities provided $18.0 million and financing activities provided $51.7 million. Cash and cash equivalents rose $81.2 million to $107.4 million, primarily reflecting deposit inflows and securities proceeds. The company had no FHLBNY overnight advances at quarter-end; term advances were $19.1 million, repurchase-agreement liabilities $28.8 million and long-term capital lease obligations $4.8 million. Available FHLBNY borrowing capacity was $118.2 million, and $28.0 million in unsecured credit lines was available. The Bank exceeded regulatory well-capitalized thresholds; its total capital, Tier 1 and common equity Tier 1 ratios were 11.42%, 10.19% and 10.19%, respectively.
Material changes versus comparable periods
- Q2 net income fell 37.1% and EPS declined from $0.55 to $0.34. For the first half, net income fell 10.8% and EPS declined from $1.03 to $0.91.
- Net interest income rose 2.5% in Q2 and 4.0% in the first half, supported by growth in commercial loans and taxable securities. However, the fully taxable-equivalent margin narrowed 14 basis points in Q2 and 9 basis points for the half, as loan yields declined amid low rates.
- Non-interest expense rose 12.6% in Q2 and 7.3% for the half. The Q2 increase included a $1.2 million legal reserve, branch-closure depreciation and captive-insurer start-up costs. The company’s reported Q2 non-GAAP reconciliation excludes the legal reserve and intangible amortization.
- Loan-loss provision increased 49.8% in Q2 and 51.5% for the half; first-half net charge-offs were $0.58 million versus $0.31 million a year earlier.
- Commercial mortgages increased $45.3 million from year-end, while indirect consumer loans declined $7.3 million. Municipal-client deposits contributed to deposit growth and repayment of $13.9 million in overnight advances.
- Six-month non-interest income included $0.91 million of securities gains, versus $0.30 million in the prior-year period. Q2 had no securities gains, compared with $0.25 million in Q2 2015.
Outlook, commentary, risks and contingencies
- No specific earnings or financial guidance was provided. Management anticipated future loan growth primarily in commercial mortgages and commercial and industrial loans, particularly in the Capital Bank division.
- Management identified interest-rate risk as its most significant market risk. Its modeled immediate 200-basis-point rate decrease and increase would reduce next-12-month net interest income by an estimated 11.81% and 8.29%, respectively; both were within the company’s 15% policy limit. These are scenarios, not forecasts.
- Commercial real estate-related lending was 43.0% of total loans, up from 40.6% at year-end 2015. Non-performing loans were $12.4 million, or 1.03% of loans; non-performing assets were $12.8 million, or 0.76% of assets. The allowance was $14.7 million, or 1.22% of loans.
- Accruing loans past due 90 days or more totaled $2.3 million, primarily one well-collateralized commercial mortgage. The filing reports that subsequent payments brought that loan current. Troubled debt restructurings totaled $11.3 million; $5.0 million were non-accrual and $6.3 million accruing.
- Lease litigation: A New York court’s July 25, 2016 order granted partial summary judgment to the landlord on liability for anticipatory breach and breach of contract, dismissed fraud claims and left trespass claims unresolved. The landlord sought $4.0 million in damages; damages remained to be determined. The company recorded a $1.2 million reserve as of June 30 and stated counsel was assessing an appeal.
- Assets under WMG management or administration were $1.689 billion, down 9.0% from year-end, reflecting the loss of a large nonprofit customer and lower market values.
- Management cited risks including economic and interest-rate changes, credit quality, growth execution, competition and regulatory changes. It considered the loan-loss allowance adequate but noted that deterioration in economic conditions, loan losses or collateral values could require further provision. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- The eventual damages determination, any appeal and whether the $1.2 million lease-dispute reserve is sufficient.
- Whether elevated operating costs and the higher loan-loss provision persist after the legal reserve and start-up or closure-related items.
- Commercial real estate concentration, delinquency trends, TDR performance and adequacy of the allowance as the loan portfolio grows.
- Durability and cost of municipal-related deposit growth, including CDARS/ICS balances, and the company’s liquidity if those balances reverse.
- Net interest margin sensitivity to rate changes and the trajectory of WMG assets and fees following the large-client departure.