Community Bank System, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2021, compared with the comparable 2020 periods. The company operates Banking, Employee Benefit Services, and All Other segments, including wealth management and insurance services. The filing identifies the registrant as Community Bank System, Inc., despite the request metadata referring to Community Financial System, Inc.
Key financial metrics
| Metric | Three months ended June 30, 2021 | Six months ended June 30, 2021 |
|---|---|---|
| Net interest income | $92.1 million | $186.1 million |
| Noninterest revenues | $59.5 million | $118.0 million |
| Net income | $47.9 million | $100.8 million |
| Diluted EPS | $0.88 | $1.85 |
| Net interest margin | 2.79% | 2.91% |
| Adjusted return on average assets | 1.35% | 1.46% |
| Adjusted return on average equity | 9.93% | 10.33% |
| Noninterest expenses | $93.5 million | $186.8 million |
- Net income increased 36.0% year over year in the second quarter and 33.7% year to date. Diluted EPS increased from $0.66 to $0.88 and from $1.43 to $1.85, respectively.
- Net interest income increased 0.2% in the quarter and 2.2% year to date, although net interest margin declined 58 basis points and 59 basis points, respectively, due primarily to lower earning-asset yields.
- The provision for credit losses was a $4.3 million benefit in the quarter and a $10.1 million benefit year to date, versus provisions of $9.8 million and $15.4 million in the prior-year periods.
- Noninterest revenues increased 12.3% in the quarter and 5.8% year to date, led by employee benefit services, wealth management, banking, and insurance activities.
- Total assets were $14.80 billion at June 30, 2021, up from $13.93 billion at December 31, 2020. Cash and cash equivalents were $2.21 billion and available-for-sale securities were $4.01 billion.
- Total loans were $7.24 billion, down 2.3% from year-end 2020 and 3.8% from June 30, 2020, primarily because PPP loans were forgiven. Total deposits were $12.34 billion, up 9.9% from year-end 2020.
- Shareholders’ equity was $2.06 billion, down $43.0 million from year-end, mainly because of a $110.5 million after-tax decline in accumulated other comprehensive income from available-for-sale securities.
- The allowance for credit losses was $51.8 million, or 0.71% of total loans, compared with 0.86% at June 30, 2020 and 0.82% at December 31, 2020. Net recoveries were $0.6 million in the quarter and $0.2 million year to date.
- Operating cash flow was $88.1 million for the first six months. Investing activities used $434.2 million, primarily for purchases of investment securities, while financing activities provided $906.3 million, primarily from deposit growth.
Material changes versus prior comparable periods
- Profitability improved substantially because of credit-loss provision reversals, higher noninterest revenues, lower acquisition expenses, and modestly higher net interest income.
- Interest-rate compression remained significant: the year-to-date yield on interest-earning assets decreased 72 basis points, while the cost of interest-bearing liabilities decreased 18 basis points.
- Noninterest expenses increased 2.9% in the quarter and 1.2% year to date. Excluding acquisition expenses, operating expenses increased 6.9% and 3.3%, respectively.
- Nonperforming loans were $70.2 million, or 0.97% of total loans, at June 30, 2021. This was lower than year-end 2020 but higher than the $26.8 million reported at June 30, 2020, largely because certain extended pandemic-related forbearances were reclassified to nonaccrual status.
- COVID-19-related loan forbearances declined materially to 12 borrowers with $2.4 million of balances from 74 borrowers with $66.5 million at December 31, 2020.
- The company redeemed $77.3 million of subordinated debt held by Community Capital Trust IV in March 2021. Subordinated debt held by unconsolidated subsidiary trusts was zero at June 30, 2021, compared with $77.3 million at year-end.
- The company completed the $2.9 million NuVantage Insurance acquisition on June 1, 2021, recording $1.4 million of customer-list intangible assets and $1.5 million of goodwill.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects third-quarter 2021 net interest margin, excluding PPP effects, to remain below the comparable 2020 quarter because of the sharp decline in short-term interest rates. Remaining deferred PPP fees were expected to contribute approximately $0.9 million of first-draw fee income in the third quarter and $9.2 million of second-draw fee income over subsequent quarters, subject to SBA forgiveness timing and eligibility.
- The company expects mortgage banking revenue to decline in 2021 because it is retaining most new consumer mortgage production rather than selling it in the secondary market.
- Business-loan balances are expected to be affected by continued forgiveness of first- and second-draw PPP loans. Longer-term loan demand after PPP repayment remains difficult to predict.
- Management cautions that COVID-19 variants, vaccination effectiveness, the pace of economic reopening, withdrawal of government assistance, unemployment, real estate and vehicle values, interest rates, deposit levels, liquidity, credit quality, technology execution, acquisitions, regulation, and litigation could materially affect future results.
- The investment portfolio had a $26.3 million net unrealized loss at June 30, 2021, primarily attributed to interest-rate changes. Management concluded that the losses did not represent credit losses.
- Liquidity was reported as strong: cash and cash equivalents were $2.21 billion, unused FHLB borrowing capacity was $1.64 billion, Federal Reserve discount-window availability was $249.5 million, unencumbered securities were $2.07 billion, and unsecured correspondent-bank lines were $25.0 million. The 30-day and 90-day basic surplus ratios were 24.9% and 25.2%, respectively, versus a 7.5% internal minimum.
- The Tier 1 leverage ratio was 9.36%, compared with a 5% well-capitalized requirement. The net tangible equity-to-assets ratio was 9.02%, down from 9.92% at year-end 2020.
- Pending litigation was not expected to be material to consolidated financial position. Reasonably possible losses beyond recorded liabilities were estimated at $0 to $1 million in aggregate. A $3.0 million litigation accrual was recorded in 2020, with final settlement approval scheduled for August 25, 2021.
- Subsequent events included the July 1, 2021 acquisition of Fringe Benefits Design of Minnesota for $15.3 million in cash plus contingent consideration of up to $2.7 million, and the August 2, 2021 acquisition of certain Thomas Gregory Associates assets for $11.6 million in cash plus contingent consideration of up to $3.4 million. One-time transaction costs were expected in the third quarter.
Most important facts for investors to verify
- Whether credit-loss reversals are sustainable as pandemic assistance and PPP benefits decline.
- The composition, aging, and resolution outlook of the $70.2 million nonperforming loan balance, especially commercial borrowers in hospitality, travel, and entertainment.
- The effect of continued low rates, excess cash balances, investment-portfolio duration, and deposit repricing on net interest margin.
- The timing and amount of SBA forgiveness and fee recognition for remaining PPP loans.
- Whether the planned acquisitions deliver expected revenue growth and synergies and how much additional acquisition-related expense is incurred.
- The sensitivity of tangible capital and accumulated other comprehensive income to further changes in long-term interest rates.
- Future trends in deposits, liquidity availability, capital ratios, loan demand, mortgage production, and noninterest expense growth.