Business Context and Reporting Period
The filing is an unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The filing text identifies the registrant as Community Bank System, Inc., although the request metadata names Community Financial System, Inc.; investors should verify the issuer identity.
The company operates banking, employee benefit services, wealth management and insurance businesses across New York, Pennsylvania, Vermont and Western Massachusetts. Results include the Merchants Bancshares acquisition from May 12, 2017 and the NRS, Dryfoos and BAS acquisitions completed earlier in 2017.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net interest income | $84.4 million | $68.5 million | $229.7 million | $203.7 million |
| Noninterest revenue | $52.9 million | $40.0 million | $148.5 million | $117.0 million |
| Noninterest expense | $83.8 million | $66.2 million | $260.2 million | $200.3 million |
| Net income | $35.2 million | $27.2 million | $78.7 million | $77.4 million |
| Diluted EPS | $0.68 | $0.61 | $1.60 | $1.74 |
| Net interest margin | 3.64% | 3.67% | 3.67% | 3.69% |
| Efficiency ratio | 56.8% | 59.3% | 58.5% | 60.2% |
- Q3 net income rose 29.8%, while nine-month net income increased 1.6%. Nine-month diluted EPS declined because of acquisition expenses and the higher share count from acquisition-related stock issuance.
- Adjusted net income, excluding acquisition expenses, intangible amortization and acquired non-impaired loan accretion, was $37.8 million for Q3 and $101.7 million for nine months, compared with $27.7 million and $79.1 million, respectively, in the prior-year periods.
- Loans totaled $6.31 billion at September 30, up 27.5% from December 31, 2016. Deposits totaled $8.61 billion, up 21.6% from year-end.
- Total assets were $10.85 billion and shareholders’ equity was $1.59 billion at September 30, 2017. Goodwill and other intangible assets totaled $824.4 million, including $731.5 million of net goodwill.
- The allowance for loan losses was $48.0 million, or 0.76% of loans, compared with 0.95% at September 30, 2016. Nonperforming loans were $23.4 million, or 0.37% of loans, and nonperforming assets were $25.2 million, or 0.40% of loans and other real estate.
- Net charge-offs were $1.8 million in Q3 and $4.9 million for nine months. The allowance covered nonperforming loans by 205%.
- Cash and cash equivalents were $241.5 million at September 30. The company reported $1.7 billion of unused FHLB borrowing capacity, $1.3 billion of unencumbered securities and $25 million of unsecured correspondent-bank lines. Basic surplus liquidity was 11.4% over 30 days and 11.3% over 90 days, above the 7.5% internal requirement.
- External borrowings, including subordinated debt and other long-term debt, were $126.4 million at quarter-end. Securities sold under repurchase agreements totaled $310.7 million.
- Operating cash flow for the first nine months was $138.9 million. Investing activities provided $75.6 million, including a $120.0 million net reduction in loans and $105.4 million of cash paid for acquisitions. Financing activities used $146.8 million, principally from reduced borrowings and $45.1 million of dividends paid.
- The Tier 1 leverage ratio was 9.54%, versus a 5% regulatory threshold for well-capitalized status. Net tangible equity-to-assets was 8.36%, down from 9.24% at year-end 2016.
Material Changes Versus Prior Comparable Period
- Merchants added approximately $1.99 billion of assets, $1.49 billion of loans, $1.45 billion of deposits and $188.3 million of goodwill. The transaction added 31 Vermont branches and one Massachusetts branch.
- NRS contributed materially to employee benefit services revenue. Merchants and other acquisitions increased banking, insurance and employee benefit revenue but also expanded operating costs and amortization.
- Acquisition expenses were $25.2 million for the first nine months of 2017 versus $0.3 million in the prior-year period. Intangible amortization increased to $12.0 million from $4.2 million.
- Noninterest revenue increased 32.5% in Q3 and 26.9% year-to-date, led by employee benefit services and deposit service fees. Noninterest expense increased 26.5% in Q3 and 30.0% year-to-date.
- The net interest margin declined modestly, reflecting lower investment yields and higher funding costs, while loan and deposit volumes increased substantially.
- The quarterly dividend increased to $0.34 per share from $0.32. The company declared $0.98 per share for the first nine months, and the board’s 2.2 million-share repurchase authorization had no plan repurchases during the period; 773 shares were acquired for employee tax withholding.
Guidance, Outlook, Risks and Unusual Items
- No formal earnings or revenue guidance is provided. Management expects benefits from geographic diversification, acquired businesses and synergies, but pro forma information is not a forecast and does not include estimated cost savings or revenue enhancements.
- Management identifies credit quality, interest-rate sensitivity, liquidity, economic conditions, competition, technology and cybersecurity, acquisition integration, regulation, employee costs and litigation as key risks.
- The company’s interest-rate sensitivity model estimates first-year net interest income would decline by $3.5 million under a 200-basis-point increase, decline by $1.3 million under a 100-basis-point increase and decline by $4.2 million under a 100-basis-point decrease. These are hypothetical estimates, not forecasts.
- Management reported no material change in the risk factors from the 2016 Form 10-K. Pending litigation is not expected to be material to financial position; reasonably possible losses beyond recorded liabilities were estimated at $0 to $1 million in aggregate, although period-specific earnings effects cannot be ruled out.
- Future results remain sensitive to acquisition integration, purchase-accounting adjustments, amortization of acquired intangibles, loan-loss assumptions and potential goodwill impairment.
- The company adopted the stock-compensation accounting amendments in 2017, producing a $0.3 million Q3 and $2.9 million year-to-date benefit to net income. It expected to adopt the revenue-recognition standard on January 1, 2018 and was evaluating the future credit-loss and lease standards.
Important Facts for Investors to Verify
- Confirm the registrant’s legal name and ticker because the filing states Community Bank System, Inc., while the request metadata states Community Financial System, Inc.
- Separate acquisition-driven growth from organic growth, particularly in loans, deposits, employee benefit revenue and operating expenses.
- Assess the sustainability of earnings excluding $25.2 million of year-to-date acquisition expenses and elevated intangible amortization.
- Monitor net interest margin, deposit pricing, interest-rate sensitivity and the effect of rising funding costs.
- Review credit trends in business lending, consumer indirect lending and acquired loan portfolios, including the adequacy of purchase discounts and the allowance for loan losses.
- Evaluate capital dilution, tangible equity and goodwill concentration following the Merchants and NRS transactions.
- Review commitments to extend credit of $1.04 billion, standby letters of credit of $24.1 million and the potential effects of litigation, regulatory changes and pending accounting standards.