FINANCIAL INSTITUTIONS INC quarterly report, Q2 FY2017

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Financial Institutions, Inc. — Q2 2017 Form 10-Q

Business context and reporting period

Financial Institutions, Inc. is a New York financial holding company operating Five Star Bank, insurance agency Scott Danahy Naylon (SDN), and wealth manager Courier Capital. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are primarily with the corresponding 2016 periods. Balance-sheet comparisons are with December 31, 2016. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.

Financial and operating results

  • Q2 earnings: Net income was $6.25 million versus $7.15 million, down about 13%. Net income available to common shareholders was $5.88 million, or $0.40 diluted EPS, versus $6.79 million, or $0.47. Return on average assets was 0.65% and return on average equity was 7.44%, compared with 0.82% and 9.07%.
  • Net interest: Q2 net interest income was $27.42 million versus $25.20 million. On a fully taxable-equivalent basis it was $28.23 million, up from $25.98 million. Q2 net interest margin was 3.18%, down five basis points year over year. For the first half, taxable-equivalent net interest income was $56.04 million versus $51.50 million, while margin declined to 3.20% from 3.25%.
  • Other income and expenses: Q2 noninterest income was $9.33 million versus $8.92 million; noninterest expense was $23.94 million versus $22.12 million. The first-half figures were $17.17 million and $44.88 million, respectively. First-half efficiency ratio improved to 61.66% from 64.08%.
  • Balance sheet and lending: Total assets were $3.89 billion, up from $3.71 billion at year-end. Loans, net of allowance, were $2.48 billion versus $2.31 billion; total deposits were $3.13 billion versus $3.00 billion. Commercial loans grew, and indirect consumer loans were the largest loan category at $826.7 million.
  • Credit quality: Q2 provision for loan losses was $3.83 million versus $1.95 million; first-half provision was $6.61 million versus $4.32 million. Q2 net charge-offs were $1.75 million, or 0.29% of average loans annualized, versus $1.00 million, or 0.19%. Nonperforming assets increased to $12.78 million from $6.43 million at year-end; nonperforming loans were 0.50% of loans versus 0.27%. The allowance was $33.16 million, or 1.32% of total loans.
  • Cash flow and liquidity: First-half operating cash flow was $22.57 million versus $22.80 million; investing activities used $172.70 million, including $181.25 million of net loan originations; financing activities provided $163.39 million. Cash and cash equivalents ended at $84.54 million, up from $71.28 million at year-end. Management reported $347.5 million of short-term FHLB borrowings and additional borrowing capacity, including approximately $50 million of immediate FHLB capacity, $579 million of FRB discount-window capacity, and $140 million of unsecured federal funds lines.
  • Debt and capital: Total borrowings were $386.60 million, including $347.50 million short-term FHLB borrowings and $39.10 million of subordinated notes. The company reported that it and the Bank remained “well-capitalized.” Company CET1 and total risk-based capital ratios were 9.86% and 13.09%, respectively.
  • Shareholder returns and equity: Common dividends declared were $0.21 per share in Q2 and $0.42 for the first half, versus $0.20 and $0.40 in 2016. A new at-the-market offering raised $16.7 million net from 571,597 shares in Q2; the program permits up to $40 million in sales.

Material changes versus comparable periods

  • Despite higher net interest income and loan growth, Q2 earnings fell, reflecting higher loan-loss provision, higher operating expenses, and lower realized securities gains.
  • Q2 provision increased partly because of portfolio growth and a downgrade of one commercial credit relationship, which required an approximately $925,000 allowance increase. Nonperforming loans and net charge-offs also rose.
  • Q2 results included a $1.2 million noncash gain from an adjustment to the SDN contingent-consideration liability and a $1.575 million noncash goodwill impairment charge related to SDN. The impairment followed a valuation review; goodwill declined to $64.84 million from $66.42 million at year-end.
  • Q2 investment-security gains were $210,000, compared with $1.39 million in Q2 2016. First-half gains were $416,000 versus $2.00 million. First-half 2016 company-owned life-insurance income included $911,000 of death-benefit proceeds.
  • Loan growth was funded in part by increased deposits, short-term borrowings, and the Q2 equity offering. The company said higher funding costs contributed to margin pressure.

Outlook, commentary, risks, and unusual items

The filing provides no specific earnings, revenue, or margin guidance. Management describes a strategy focused on community banking, organic loan and deposit growth, and expanding mortgage-lending capabilities. It attributes the higher provision to loan growth and the downgrade of a commercial relationship, and states that the allowance was adequate at June 30, while noting that estimates and future adjustments remain uncertain.

Key disclosed risks include credit losses, concentration in Western and Central New York, indirect auto and commercial lending exposure, interest-rate and liquidity risk, deposit withdrawals and funding costs, regulatory and tax changes, cybersecurity and third-party systems, competition, and potential impairment of goodwill or other intangibles. Rate-sensitivity modeling estimated that a parallel +200-basis-point shock would increase 12-month net interest income by 1.49%, while economic value of equity would decline 7.38%; these are model estimates, not forecasts. Management reported no material subsequent events, no material legal-proceeding developments, effective disclosure controls, and no material quarter changes in internal control over financial reporting.

Important facts for investors to verify

  • Whether the rise in nonperforming loans, charge-offs, and provision reflects isolated credits or a broader deterioration, particularly in commercial and indirect consumer portfolios.
  • The composition, collateral, and subsequent performance of the downgraded commercial relationship that drove the approximately $925,000 allowance increase.
  • Whether loan growth and deposit mix can be sustained without further margin compression or greater reliance on higher-cost borrowings and time deposits.
  • The assumptions and valuation sensitivity behind the SDN goodwill impairment and contingent-consideration adjustment, and the remaining potential acquisition-related payments.
  • The effects of continued at-the-market share issuance on per-share earnings, capital, and shareholder dilution, and the use of proceeds.
  • The assumptions underlying liquidity and interest-rate sensitivity estimates, including seasonal municipal deposits and modeled deposit repricing behavior.