Community Bank System, Inc. – Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2018. The filing identifies the registrant as Community Bank System, Inc., despite the request metadata naming Community Financial System, Inc. Interim financial statements are unaudited. The company operates Banking, Employee Benefit Services, wealth management, and insurance businesses.
Financial performance and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $86.8 million | $78.0 million | $171.5 million | $145.3 million |
| Provision for loan losses | $2.4 million | $1.5 million | $6.1 million | $3.3 million |
| Noninterest revenue | $56.6 million | $51.2 million | $114.1 million | $95.5 million |
| Noninterest expense | $86.1 million | $102.9 million | $172.4 million | $176.5 million |
| Net income | $44.6 million | $17.2 million | $84.7 million | $43.4 million |
| Diluted EPS | $0.86 | $0.35 | $1.63 | $0.91 |
| Cash dividends per share | $0.34 | $0.32 | $0.68 | $0.64 |
- Net interest margin: 3.73% in Q2, compared with 3.72% in Q2 2017; 3.72% year to date, compared with 3.69% in the prior-year period.
- Adjusted profitability: Adjusted net income was $46.7 million in Q2 and $88.9 million year to date, producing adjusted diluted EPS of $0.90 and $1.71, respectively. These non-GAAP figures exclude acquisition expenses, intangible amortization, and acquired non-impaired loan accretion.
- Efficiency: The adjusted efficiency ratio improved to 57.2% in Q2 and 57.5% year to date, from 58.3% and 59.5%, respectively.
- Assets and equity: Total assets were $10.63 billion and shareholders’ equity was $1.66 billion at June 30, 2018. The Tier 1 leverage ratio was 10.53%; net tangible equity-to-assets was 9.00%.
- Loans and deposits: Loans were $6.24 billion and deposits were $8.51 billion at quarter-end. Loans declined 0.3% from December 31, 2017 and 1.9% from June 30, 2017, while deposits increased 0.8% from year-end.
- Debt and liquidity: External borrowings totaled approximately $124.8 million, excluding securities sold under repurchase agreements of $181.8 million. Cash and cash equivalents were $250.2 million. Available liquidity included approximately $1.7 billion of unused FHLB borrowing capacity, $1.7 billion of unencumbered securities, and $25 million of unsecured correspondent-bank lines.
- Cash flow: Year-to-date operating cash flow was $111.6 million; investing activities provided $52.0 million; financing activities used $134.5 million. Ending cash and cash equivalents were $250.2 million.
Material changes versus prior comparable periods
- Q2 net income increased 159.5%, and year-to-date net income increased 95.0%, primarily because of higher net interest income and noninterest revenue, substantially lower acquisition expenses, and a lower effective tax rate.
- Net interest income increased 11.3% in Q2 and 18.0% year to date, driven mainly by the Merchants Bancshares acquisition, higher average earning assets, and higher loan yields.
- Noninterest revenue increased 10.4% in Q2 and 19.4% year to date, led by deposit service fees, employee benefit services, insurance, and wealth management.
- Noninterest expense declined because 2017 included $22.9 million of Q2 and $24.6 million of year-to-date acquisition-related expenses. Excluding acquisition expenses and intangible amortization, operating expenses increased 7.6% in Q2 and 12.6% year to date as the company operated a larger franchise.
- Effective tax rates declined to 18.7% in Q2 and 20.8% year to date, from 31.0% and 28.9%, respectively, primarily due to the Tax Cuts and Jobs Act and share-based compensation tax benefits.
- Accumulated other comprehensive loss increased to $46.5 million from $3.7 million at year-end 2017, primarily due to after-tax unrealized losses on available-for-sale securities caused by higher interest rates.
- Nonperforming loans increased to $29.3 million, or 0.47% of total loans, from $27.5 million at year-end and $22.9 million a year earlier. The increase was driven substantially by two commercial relationships.
Outlook, risks, contingencies, and unusual items
- No formal earnings or revenue guidance is provided in the filing.
- Beginning in the third quarter of 2018, the company expected the Durbin Amendment interchange-fee limitation to reduce deposit service fees by approximately $2.5 million to $3.5 million during that quarter.
- Management described competitive conditions in commercial lending and consumer indirect lending, including pressure on loan spreads. Higher mortgage rates were reducing refinance activity, and market conditions affected mortgage banking revenue.
- Interest-rate sensitivity modeling indicated projected first-year net interest income declines of approximately $2.4 million under a 200-basis-point increase, $0.8 million under a 100-basis-point increase, and $6.2 million under a 100-basis-point decline. These scenarios are not forecasts and exclude potential management responses.
- The company completed small acquisitions of Penna & Associates, Styles Bridges Associates, and HR Consultants during 2018. The Merchants and NRS acquisitions continued to materially affect year-over-year comparisons.
- On July 31, 2018, after quarter-end, the company redeemed the Community Statutory Trust III debentures and related preferred securities for $25.2 million.
- Commitments to extend credit were $1.07 billion and standby letters of credit were $33.6 million at June 30, 2018. Management did not expect pending litigation to be material to consolidated financial position; reasonably possible losses beyond recorded liabilities were estimated at $0 to $1 million in aggregate, although a material effect on a particular future period could not be ruled out.
- The company adopted revenue-recognition, equity-security, cash-flow, and pension-presentation standards during 2018. Adoption did not materially affect net income, except for a $0.2 million reclassification from accumulated other comprehensive income to retained earnings related to equity securities.
- Future adoption of the credit-loss standard is expected to change the allowance for loan losses, but the amount was not yet estimable. Lease accounting implementation was also in progress.
Investor verification points
- Verify the registrant identity, since the filing states Community Bank System, Inc. rather than Community Financial System, Inc.
- Assess the sustainability of earnings growth after excluding 2017 acquisition costs, intangible amortization, acquired-loan accretion, tax-rate benefits, and other nonrecurring effects.
- Monitor the effect of Durbin interchange limits on deposit service revenue beginning in Q3 2018.
- Review commercial credit deterioration, nonperforming-loan trends, allowance coverage, and the impact of the two relationships added to nonperforming loans.
- Evaluate exposure to rising or falling interest rates, deposit repricing, loan growth, and unrealized securities losses.
- Confirm the financial and capital effects of the July 31, 2018 redemption and future acquisitions.
- Review the eventual impact of the expected-loss credit standard and the new lease standard on capital, earnings, and reported assets and liabilities.