Chemung Financial Corporation — 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; it is not a quarterly filing, though it includes fourth-quarter results. Chemung Financial is a New York bank holding company operating through Chemung Canal Trust Company and related subsidiaries. Its community banking business is concentrated in New York and Pennsylvania, with 34 branches, and includes commercial, residential and consumer lending, deposits, and wealth management.
Financial performance and condition
| Metric | 2018 | 2017 |
|---|---|---|
| Total assets at year-end | $1.755 billion | $1.708 billion |
| Loans, net of deferred fees | $1.312 billion | $1.312 billion |
| Deposits | $1.569 billion | $1.467 billion |
| Net interest income | $60.5 million | $57.0 million |
| Provision for loan losses | $3.2 million | $9.0 million |
| Non-interest income | $23.1 million | $20.5 million |
| Non-interest expense | $56.8 million | $53.8 million |
| Net income | $19.6 million | $7.4 million |
| Basic and diluted EPS | $4.06 | $1.55 |
- Net income increased 164.1%. Return on average assets rose to 1.14% from 0.43%, and return on average equity to 12.76% from 4.91%.
- Fully taxable-equivalent net interest margin, a non-GAAP measure, increased to 3.72% from 3.56%. Net interest income grew 6.1%, reflecting higher average earning assets and yields; interest expense also rose 32.8% as deposit costs increased.
- Non-interest income grew 12.6%, led by wealth-management fees, debit-card interchange, and a $2.0 million increase in the fair value of equity investments associated primarily with Visa Class B shares. The shares were sold in the third quarter.
- Non-interest expense increased 5.6%, including higher salaries, occupancy, data processing, professional services, marketing, and other-real-estate-owned costs. The adjusted efficiency ratio was 67.22% versus 66.60%; this is a non-GAAP measure.
- Cash and cash equivalents were $130.0 million at year-end, up $99.2 million. Operating cash flow was $27.8 million; investing activities provided $43.9 million and financing activities provided $27.6 million.
- Year-end shareholders’ equity was $165.0 million, or 9.40% of assets; tangible equity to tangible assets was 8.19%. The Bank was reported as well-capitalized, with total risk-based capital of 12.62% and Tier 1 leverage of 8.41%.
- There were no FHLBNY advances or repurchase-agreement borrowings at year-end; the balance sheet included a $4.3 million long-term capital lease obligation. Loans-to-deposits were 83.60%, down from 89.40%.
Material changes and unusual items
- Credit quality measures improved year over year: non-performing loans fell to $12.3 million, or 0.93% of loans, from $17.3 million, or 1.32%; non-performing assets declined to $12.8 million, or 0.73% of assets, from $19.3 million, or 1.13%.
- Despite lower non-performing balances, net charge-offs increased to $5.4 million from $2.1 million. A $3.6 million charge-off of multiple commercial loans to one borrower was a principal factor. The allowance for loan losses ended at $18.9 million, or 1.44% of loans, versus $21.2 million, or 1.61%.
- Commercial and agricultural loans plus commercial mortgages totaled $864.0 million, 65.9% of loans. Real estate and real-estate-rental borrowers represented 47.2% of total loans.
- The effective tax rate fell to 17.0% from 49.4%. The 2017 rate included a $2.9 million one-time deferred-tax remeasurement following the Tax Act; 2018 included a $0.4 million tax benefit. Management’s stated adjusted effective rates, excluding those items, were 18.8% and 29.5%, respectively.
- The Bank settled the Fane lease litigation for $3.3 million in June 2018 and recorded an additional $1.0 million legal expense against its existing reserve. The filing says other pending proceedings were not expected to materially affect results or liquidity.
- For the fourth quarter, net income was $5.7 million, or $1.18 per share, compared with a $2.2 million net loss, or $0.45 per share, in fourth-quarter 2017. The 2018 quarter included a $0.2 million provision credit; the 2017 quarter included $4.9 million of specific commercial-loan reserves and a $2.9 million tax remeasurement.
Outlook, risks, and contingencies
- The filing provides no numerical earnings or growth guidance. Management’s strategy emphasizes relationship banking, stable low-cost deposits, high-quality lending, branch and digital network expansion, and growth in commercial lending, particularly in the Capital Bank division.
- Management anticipates continued commercial-loan growth. Key exposures include commercial real estate and business-credit concentrations, indirect auto lending, economic conditions in the company’s markets, and the adequacy of the loan-loss allowance.
- Interest-rate risk is material. The company estimated that an immediate 200-basis-point rate decrease would reduce next-12-month net interest income by 12.38%, while a 200-basis-point increase would raise it by 7.71%; both were within its 15% policy limit.
- Liquidity resources included $129.972 million of cash and cash equivalents, FHLBNY borrowing capacity of up to $112.6 million based on available collateral, and $28.0 million in available unsecured lines of credit. Management stated that operating cash flows, cash balances, and borrowing access were sufficient for liquidity needs.
- Off-balance-sheet commitments totaled $186.0 million, including $142.7 million of unused lines of credit, $27.2 million of commitments to fund new loans, and $16.2 million of standby letters of credit. The company did not anticipate material losses from these commitments.
- The company expects CECL adoption on January 1, 2020 to increase its allowance for credit losses; it was evaluating the effect and planned to run the existing and CECL models concurrently for 12 months. Adoption of the new lease standard in January 2019 was expected to create right-of-use assets and lease liabilities of less than $8.5 million each.
- Other stated risks include deposit competition and funding costs, cybersecurity and operational disruption, regulatory and compliance changes, environmental liabilities on foreclosed property, and possible fiduciary claims. Elmira’s long-term bond rating was lowered to junk status in 2018 amid local revenue challenges and a weak economy.
Important facts for investors to verify
- Whether the commercial credit charge-off and related portfolio trends remain contained, and how the allowance responds to future losses and CECL implementation.
- Whether loan and deposit growth can sustain margins as deposit pricing costs rise; review the mix and retention of deposits, including time deposits and reciprocal CDARS/ICS balances.
- How repeatable 2018 earnings are after separating the Visa-related fair-value gain, unusual legal costs, and tax items; reconcile GAAP and management’s non-GAAP results.
- Whether real-estate concentrations, rate sensitivity, liquidity access, and capital remain within management’s stated risk limits as conditions change.
- The status and financial effect of any contingencies or related-party exposures. The filing reports related-party loans of $62.7 million at year-end, up from $39.2 million, partly reflecting changes in the composition of related parties.
The auditor, Crowe LLP, issued an unqualified opinion on the consolidated financial statements and concluded that internal control over financial reporting was effective as of December 31, 2018.