FINANCIAL INSTITUTIONS INC quarterly report, Q2 FY2012

Abrir documento

Business context and reporting period

Financial Institutions, Inc. is a New York financial holding company operating Five Star Bank and a financial-services subsidiary, serving individuals and businesses mainly in Central and Western New York. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012; income and cash-flow comparisons are against the corresponding 2011 periods, while balance-sheet comparisons are against December 31, 2011. Amounts below are in U.S. dollars.

Financial performance and position

  • Quarterly earnings: Net income was $6.7 million, up 16% from $5.7 million. Net income available to common shareholders was $6.3 million, or $0.46 per diluted share, versus $5.3 million, or $0.39. Return on average assets was 1.08% and return on average equity was 10.94%.
  • Six-month earnings: Net income was $12.9 million versus $11.5 million. Net income available to common shareholders was $12.1 million, or $0.88 per diluted share, versus $9.1 million, or $0.72. Return on average assets was 1.07% and return on average equity was 10.65%.
  • Interest income and margins: Q2 net interest income was $21.4 million, compared with $20.3 million; on a taxable-equivalent basis it was $22.0 million, up 6%. Q2 net interest margin was 3.89%, down 11 basis points year over year. For the first half, taxable-equivalent net interest income was $43.4 million, up 6%, while net interest margin was 3.97%, down 5 basis points.
  • Other income and expenses: Noninterest income was $6.7 million in Q2 and $12.1 million in the first half, versus $5.0 million and $10.1 million, respectively. Noninterest expense was $16.6 million and $32.2 million, respectively, up from $15.2 million and $30.5 million. The reported non-GAAP efficiency ratio was 60.41% for Q2 and 59.52% for the first half, compared with 58.68% and 59.32%.
  • Credit costs and asset quality: Provision for loan losses was $1.5 million in Q2 and $2.8 million in the first half, versus $1.3 million and $2.1 million. First-half net charge-offs were $2.0 million, approximately unchanged from 2011; the annualized Q2 net charge-off ratio was 0.29%, versus 0.24%. Nonperforming loans rose to $11.3 million, or 0.70% of loans, from $7.1 million, or 0.48%, at year-end. The allowance was $24.1 million, 1.49% of total loans.
  • Balance sheet and funding: Total assets were $2.623 billion, up from $2.336 billion at year-end. Net loans were $1.600 billion, up from $1.462 billion; deposits were $2.135 billion, up from $1.932 billion. Available-for-sale securities were $765.2 million, versus $627.5 million. Cash and cash equivalents were $61.8 million, versus $57.6 million.
  • Borrowings and capital: Short-term borrowings were $200.8 million, up from $150.7 million; there were no long-term borrowings outstanding. Shareholders’ equity was $246.9 million, up from $237.2 million. At June 30, the Company’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 8.27%, 11.39% and 12.64%, respectively; all exceeded the then-applicable well-capitalized thresholds.
  • Cash flow: For the first half, operating activities provided $28.2 million, investing activities used $143.5 million and financing activities provided $119.6 million. Cash increased $4.2 million to $61.8 million. Investing outflows included $83.3 million of net loan originations and substantial securities purchases; financing inflows included $74.1 million of deposit growth and $50.1 million of additional short-term borrowings.

Material changes versus comparable periods

  • Q2 and first-half net income rose year over year, supported by higher net interest income and noninterest income. Lower funding costs helped, while lower asset yields and a reduced net interest margin partially offset the benefit of loan growth.
  • Average loans increased year over year, particularly consumer indirect and commercial loans. At period-end, total loans also grew from year-end, reflecting organic growth and the First Niagara branch purchase.
  • Q2 noninterest income included a $1.2 million securities-sale gain; first-half gains on securities were $1.6 million. Excluding securities gains and impairment under the company’s non-GAAP presentation, adjusted total revenue was $27.4 million for Q2 and $54.1 million for the first half.
  • Nonperforming loans and the allowance both increased from year-end. Management attributed much of the increase in commercial nonperforming loans to two borrowers.
  • Regulatory capital ratios declined from year-end, which the company attributed primarily to the completed and expected branch acquisitions and related balance-sheet funding.

Outlook, commentary, risks and unusual items

  • Acquisitions: The Bank completed its purchase of four First Niagara branches on June 22, assuming $129.5 million of deposits and acquiring $58.2 million of loans, as well as other assets and liabilities. Preliminary goodwill was $5.1 million and a core deposit intangible of $1.4 million was recorded. The company expected to close the separate HSBC branch acquisition on August 17, 2012; based on May estimates, it would assume approximately $192.2 million of deposits and acquire approximately $17.4 million of loans, at a 4.0% deposit premium.
  • Acquisition and other unusual costs: Pre-tax expenses related to the First Niagara transaction were approximately $1.0 million in Q2 and $1.1 million for the first half. Other expense increases included workforce realignment severance and costs associated with an executive officer’s retirement. A $91,000 securities impairment charge was recognized in Q1 for a privately issued whole-loan CMO.
  • Funding strategy: Management said short-term FHLB advances were used to pre-acquire securities ahead of the branch transactions and anticipated using cash received from the HSBC transaction to repay those advances. At June 30, the Bank reported approximately $42.3 million of immediate FHLB capacity, $401.5 million of secured FRB discount-window capacity and $114 million available on unsecured federal funds lines.
  • Guidance and risks: The filing provides no specific earnings or financial guidance. Management cited the sensitivity of earnings to interest rates, competitive pricing, economic conditions, credit quality and customer deposit behavior. It reported that proposed Basel III-related capital rules were under consideration and believed the company would comply with the proposed requirements based on its June 30 capital position. The filing cautions that actual results may differ from forward-looking statements.
  • Other disclosures: Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter. It reported no material changes to previously disclosed legal proceedings or risk factors.

Important facts for investors to verify

  1. Track nonperforming commercial loans, charge-offs, allowance adequacy and the performance of the two borrowers cited as driving commercial problem-loan growth.
  2. Assess whether loan growth and deposit funding can sustain net interest income as asset yields and net interest margin remain under pressure.
  3. Verify completion and integration of the HSBC branch acquisition, including actual acquired balances, deposit pricing, transaction costs and repayment of short-term FHLB advances.
  4. Evaluate the repeatability of earnings excluding the $1.6 million first-half securities gains, alongside acquisition, severance and executive-retirement costs.
  5. Monitor short-term borrowing reliance, liquidity capacity, capital ratios and the eventual regulatory capital requirements; the stated credit facilities are subject to collateral and other conditions.