Financial Institutions, Inc. — Q3 2017 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2017; comparisons are with Q3 and the first nine months of 2016, and balance-sheet comparisons are with December 31, 2016. The New York-based financial holding company operates Five Star Bank, insurance agency SDN, and investment advisory firm Courier Capital.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $28.4 million | $26.1 million | $82.9 million | $76.0 million |
| Net interest margin, tax-equivalent | 3.17% | 3.23% | 3.19% | 3.24% |
| Provision for loan losses | $2.8 million | $2.0 million | $9.4 million | $6.3 million |
| Noninterest income | $8.6 million | $8.5 million | $25.7 million | $26.7 million |
| Noninterest expense | $22.5 million | $20.6 million | $67.4 million | $64.0 million |
| Net income | $8.3 million | $8.5 million | $22.5 million | $23.2 million |
| Diluted EPS | $0.52 | $0.56 | $1.44 | $1.53 |
- At September 30, total assets were $4.02 billion; loans, net of allowance, were $2.58 billion; deposits were $3.28 billion; and shareholders’ equity was $366.0 million.
- Cash and cash equivalents were $97.8 million. Nine-month operating cash flow was $35.4 million; investing cash outflow was $294.0 million, primarily reflecting $282.5 million of net loan originations; financing cash inflow was $285.2 million.
- Borrowings totaled $349.9 million: $310.8 million short-term FHLB borrowings and $39.1 million subordinated notes. Total deposits grew $286.3 million from year-end 2016.
- Regulatory capital ratios at September 30 were 7.91% Tier 1 leverage, 10.09% common equity Tier 1, and 13.24% total risk-based capital; the company reported that it remained well-capitalized.
Material changes versus comparable periods
- Q3 net income declined about 2% year over year; nine-month net income declined about 3%. Higher net interest income was outweighed by increased credit provision and operating expenses.
- Loan growth supported net interest income: loans increased $276.1 million from year-end 2016. Management attributed year-over-year growth in average earning assets to loan growth, while the margin narrowed as funding costs rose.
- Q3 net charge-offs were $1.6 million, versus $1.1 million in Q3 2016; the annualized rate rose to 0.25% from 0.20%. Nonperforming assets increased to $12.9 million from $6.4 million at year-end, principally after commercial credit downgrades.
- Noninterest expense increased, including higher salaries and occupancy costs related to growth initiatives. Nine-month expense in 2016 had included about $2.1 million in professional services associated with an activist shareholder response.
Outlook, commentary, risks and unusual items
- No numerical earnings or balance-sheet guidance is provided in the supplied filing text. Management describes organic growth and diversified lending as strategic priorities.
- Management said the allowance for loan losses was adequate, while noting that estimates are uncertain and could require future adjustment. The allowance was $34.3 million; nonperforming loans were $12.6 million, or 0.48% of total loans. One commercial relationship downgrade required about $925,000 of additional provision.
- In August 2017, Courier Capital acquired Robshaw & Julian, an investment adviser with approximately $175 million in assets under management, for cash and contingent future bonuses. Courier Capital’s assets under management rose to approximately $1.6 billion.
- The company recorded a $1.6 million goodwill impairment in Q2 related to SDN and a separate $1.2 million noncash contingent-consideration liability adjustment. The Q2 items reduced reported earnings and affected year-to-date comparisons.
- Through September, the at-the-market offering issued 1,069,635 shares for approximately $29.7 million net proceeds; the program authorized up to $40 million in common-stock sales. Common dividends declared were $0.21 per share for Q3.
- Liquidity sources included approximately $204.8 million of immediate FHLB capacity, $606.4 million of secured Federal Reserve capacity, $140.0 million of unsecured federal funds lines, and $227.7 million of unencumbered liquid securities. These capacities are subject to availability and collateral requirements.
- Interest-rate simulations showed net interest income changes of -0.02% under a +100-basis-point shock and -1.33% under +300 basis points over 12 months. Estimated economic value of equity declined 10.56% in the +200-basis-point scenario. Management cautions that these model results rely on assumptions and are not forecasts.
- Other risks cited include credit losses, geographic and commercial/indirect-lending concentration, deposit withdrawals and funding costs, interest-rate and market conditions, regulatory and tax changes, cybersecurity, acquisition integration, and goodwill valuation. Commitments to extend credit were $644.9 million and standby letters of credit were $13.3 million; commitments may not be drawn. The filing reports no material developments in legal proceedings and no material subsequent events.
Important facts for investors to verify
- Whether rising nonperforming loans, charge-offs, and commercial-credit downgrades lead to further provisioning or weaker credit quality.
- Whether loan and deposit growth can sustain net interest income as deposit and borrowing costs rise and net interest margin remains under pressure.
- Capital, liquidity, and share-count effects of the at-the-market equity issuance, alongside dividend capacity and the Bank’s ability to upstream dividends.
- Performance and integration of the Robshaw & Julian acquisition, and subsequent goodwill testing and contingent consideration outcomes related to SDN.
- Management’s interest-rate sensitivity assumptions and the effect of changing rates on earnings, deposit pricing, and economic value.