Business Context and Reporting Period
Registrant: Community Bank System, Inc. (the request metadata identifies Community Financial System, Inc.; the filing itself identifies Community Bank System, Inc.). This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
The company operates banking, employee benefit services, wealth management, and insurance businesses across New York, Pennsylvania, Vermont, and Western Massachusetts.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net interest income | $78.0 million, up 14.2% | $145.3 million, up 7.5% |
| Noninterest revenue | $51.2 million, up 32.1% | $95.5 million, up 24.0% |
| Provision for loan losses | $1.5 million, down from $2.3 million | $3.3 million, down from $3.6 million |
| Noninterest expense | $102.9 million, up 55.0% | $176.5 million, up 31.7% |
| Net income | $17.2 million, down 33.5% | $43.4 million, down 13.6% |
| Diluted EPS | $0.35, versus $0.58 | $0.91, versus $1.13 |
| Cash dividends declared per share | $0.32, versus $0.31 | $0.64, versus $0.62 |
Second-quarter net interest margin was 3.72% on a fully tax-equivalent basis, compared with 3.73% in the prior-year quarter. Year-to-date margin was 3.69%, compared with 3.70%. The noninterest revenue ratio increased to 38.9% of operating revenue from 35.3% in the quarter and 35.4% year to date.
Excluding acquisition expenses and intangible amortization, adjusted net income was $35.9 million for the quarter and $65.4 million year to date, compared with $27.0 million and $52.4 million, respectively, in 2016. Adjusted diluted EPS was $0.73 for the quarter and $1.37 year to date.
Financial Position, Cash Flow, Debt, and Liquidity
- Total assets were $10.88 billion at June 30, 2017, compared with $8.67 billion at December 31, 2016.
- Total loans were $6.36 billion, up 28.5% from year-end 2016, primarily due to the Merchants acquisition and organic growth.
- Total deposits were $8.63 billion, up from $7.08 billion at year-end 2016.
- Cash and cash equivalents were $219.7 million. Six-month operating cash flow was $92.1 million; investing cash flow was $8.6 million; financing cash flow was negative $54.8 million.
- External borrowings and subordinated debt totaled approximately $495.9 million, including $179.0 million of short-term borrowings, $190.4 million of repurchase agreements, $3.6 million of other long-term debt, and $122.8 million of subordinated debt.
- Shareholders’ equity was $1.57 billion, compared with $1.20 billion at year-end 2016. The increase primarily reflected stock issued for acquisitions, earnings, and other comprehensive income, partly offset by dividends.
- The Tier 1 leverage ratio was 10.19%, above the 5% regulatory well-capitalized threshold. Net tangible equity-to-assets was 8.08%, compared with 9.24% at year-end 2016.
- Management reported $1.4 billion of unused FHLB borrowing capacity, $1.2 billion of unencumbered securities, and $25 million of unsecured correspondent-bank lines. The 30-day and 90-day basic surplus ratios were 10.8% and 10.7%, respectively, above the company’s 7.5% internal requirement.
Material Changes Versus Prior Comparable Period
- The May 12, 2017 acquisition of Merchants Bancshares added approximately $1.99 billion of assets, including $1.49 billion of loans, $370.5 million of investment securities, $1.45 billion of deposits, 32 branches, and $190.3 million of goodwill. Consideration was $345.2 million in cash and company stock.
- The February 2017 acquisition of Northeast Retirement Services and Global Trust Company added employee benefit capabilities and generated $13.4 million of revenue and $9.3 million of expenses in the first six months.
- Other 2017 acquisitions included Benefits Advisory Service and certain assets of Dryfoos Insurance Agency.
- Acquisition expenses rose to $22.9 million in the second quarter and $24.6 million year to date, versus $0.3 million and $0.3 million, respectively, in the 2016 periods. Intangible amortization increased to $4.3 million quarterly and $7.0 million year to date.
- Loan growth and deposit growth materially increased interest income and fee revenue, but the acquisitions also increased employee, technology, occupancy, amortization, and integration costs.
- Asset quality improved modestly: nonperforming loans were $22.9 million, or 0.36% of loans, versus 0.49% at June 30, 2016; nonperforming assets were $25.4 million, or 0.40% of loans and OREO. The allowance for loan losses was $47.5 million, or 0.75% of loans.
Outlook, Risks, Contingencies, and Unusual Items
Management did not provide formal earnings guidance in the filing. Management expects the acquisitions to expand geographic diversity, strengthen employee benefit and insurance businesses, and provide potential business-development synergies, but the filing cautions that pro forma information is not indicative of future results and does not include anticipated cost savings or revenue enhancements.
- Interest-rate sensitivity modeling indicated projected annualized net interest income declines of approximately $2.0 million under a 100-basis-point increase, $4.9 million under a 200-basis-point increase, and $3.1 million under a 75-basis-point decrease. These are hypothetical scenarios, not forecasts.
- Key risks include credit quality, interest-rate and liquidity exposure, acquisition integration, competition, economic conditions, technology and cybersecurity, regulatory changes, employee costs, litigation, and the ability to realize expected acquisition benefits.
- Pending litigation is not expected to be material to consolidated financial position. Additional reasonably possible losses beyond recorded liabilities were estimated at $0 to $1 million in aggregate, although period-specific earnings impacts cannot be ruled out.
- The Merchants acquisition accounting remained provisional for certain tax balances. Goodwill increased to $733.6 million and amortizing intangible assets totaled $97.8 million at June 30, 2017.
- The company adopted stock-compensation accounting changes that reduced income tax expense by $0.3 million in the quarter and $2.5 million year to date.
- The board authorized repurchases of up to 2.2 million shares through December 31, 2017, but no shares were repurchased under that program during the first six months. Shares acquired during the quarter related to tax withholding and deferred compensation arrangements.
Important Facts for Investors to Verify
- Reconcile reported GAAP earnings with adjusted earnings, particularly the recurring impact of acquisition expenses and intangible amortization.
- Assess whether the large loan and deposit increases from Merchants can produce sustainable organic growth after integration costs normalize.
- Monitor net interest margin, deposit pricing, borrowing costs, and the company’s modeled sensitivity to changing interest rates.
- Review credit quality, charge-offs, acquired-loan marks, allowance coverage, and the potential effect of adopting the expected-credit-loss standard.
- Evaluate tangible capital ratios and goodwill and intangible balances following the 2017 acquisitions.
- Confirm liquidity capacity, collateral availability, and the continued reliance on FHLB funding and repurchase agreements.
- Track integration execution, provisional purchase accounting adjustments, and whether anticipated acquisition synergies are realized.