Chemung Financial Corporation — Q2 2018 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and six months ended June 30, 2018. Chemung is a regional financial holding company whose principal business is community banking, alongside wealth management and investment services. Comparisons below are with the corresponding 2017 period unless otherwise noted.
Financial performance and condition
| Metric | Q2 2018 | Six months 2018 | Comparison |
|---|---|---|---|
| Net interest income | $15.0 million | $29.9 million | Up 7.6% and 9.0%, respectively |
| Non-interest income | $5.3 million | $10.8 million | Up 6.0% and 9.4% |
| Non-interest expense | $15.0 million | $29.1 million | Up 4.4% and 6.4% |
| Provision for loan losses | $2.4 million | $3.1 million | Up from $0.4 million and $1.5 million |
| Net income | $2.5 million | $7.0 million | Down 14.5% for Q2; up 17.4% year to date |
| Diluted EPS | $0.52 | $1.44 | Compared with $0.62 and $1.24 |
| Fully taxable-equivalent net interest margin | 3.73% | 3.74% | Compared with 3.47% and 3.46% |
Quarterly return on average assets was 0.59% and return on average equity was 6.70%; for the first half, the respective returns were 0.82% and 9.31%. The reported efficiency ratio was 67.47% for Q2 and 67.84% year to date; this is a non-GAAP measure.
At June 30, total assets were $1.710 billion, loans net of allowance were $1.315 billion, deposits were $1.479 billion, and shareholders’ equity was $151.8 million. Loans grew 1.7% from year-end 2017, while deposits grew 0.8%. The loan-to-deposit ratio was 90.23%. Cash and cash equivalents totaled $34.8 million. Borrowings were $63.4 million, down $10.9 million from year-end, primarily because a $10 million repurchase agreement matured. No repurchase-agreement or FHLBNY term advances remained outstanding at quarter-end; FHLBNY overnight advances were $59.0 million.
For the first half, operating cash flow was $10.6 million, investing cash flow was a $4.9 million outflow, and financing cash flow was a $1.5 million outflow; cash increased $4.1 million to $34.8 million. The Bank was categorized as well capitalized. Its total risk-based capital ratio was 11.45%, common equity Tier 1 ratio 10.19%, and Tier 1 leverage ratio 7.94%. Total equity was 8.88% of assets.
Material changes and drivers
- Q2 net interest income increased as loan interest income rose, particularly on commercial and indirect consumer loans. Higher deposit and borrowing costs partly offset the gains. Higher yields on interest-earning assets helped lift net interest margin.
- Credit costs rose sharply after multiple commercial loans to one borrower were charged off for $3.6 million in Q2. First-half net charge-offs were $4.6 million versus $0.6 million a year earlier. The allowance ended June at $19.6 million, or 1.47% of loans, versus $21.2 million and 1.61% at year-end.
- Non-interest income growth reflected wealth-management fees and other income. First-half “other” income included a $0.4 million New York State sales-tax refund. Wealth-management assets under management or administration were $1.894 billion at June 30, up 3.7% year over year but down 3.0% from year-end.
- Expenses increased with compensation, data processing, professional services, marketing, and real-estate-owned costs; the company also opened branches in Schenectady and Wilton, New York, during 2018.
- The federal corporate tax-rate reduction under the Tax Act contributed to lower tax expense. Effective tax rates were 16.1% in Q2 and 18.2% for the first half, versus 29.9% and 30.0%.
- Available-for-sale securities declined to $265.2 million from $293.1 million at year-end. First-half other comprehensive loss was $3.6 million, largely reflecting lower securities fair values; management attributed the unrealized losses mainly to interest rates, not credit quality, and said it did not expect to be required to sell the affected securities before recovery.
Outlook, risks, and unusual items
- Management expects future portfolio-loan growth primarily in commercial mortgages and commercial and industrial loans, particularly in the Capital Bank division. No formal earnings or financial guidance is provided in the filing.
- Management identifies interest-rate and credit risk as key exposures. A modeled immediate 200-basis-point rate decrease would reduce projected next-12-month net interest income by 9.61%; a 200-basis-point increase would raise it 2.59%. Both were within the company’s 15% policy limit.
- Commercial lending to real estate, real-estate rental, and lending businesses represented 45.4% of total loans. Management states that allowance estimates depend on judgments about borrower condition, collateral, historical losses, and economic conditions; deterioration could require additional provisions.
- On June 15, the Bank settled the Fane litigation for $3.3 million. It had reserved $2.3 million at March 31 and recorded an additional $1.0 million of legal expense in Q2. The action was agreed to be dismissed with prejudice. The company reported no other pending legal, arbitration, or regulatory matters it believed could materially harm results or liquidity.
- The company expects CECL adoption on January 1, 2020 and anticipates an increase in the allowance for loan losses; the amount is not stated. It planned parallel runs of the existing and CECL models before adoption. Lease accounting adoption was planned for January 1, 2019; management estimated a right-of-use asset and related obligation of less than $15 million.
- Liquidity sources included eligible FHLBNY borrowing capacity of $68.4 million and $38.0 million of available unsecured lines at June 30. Management said operating cash flow, cash balances, and borrowing capacity were sufficient for operating liquidity needs. Disclosure controls were judged effective, with no material change to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the $3.6 million single-borrower charge-off signals additional credit deterioration, and how subsequent charge-offs and provision levels evolve.
- Trends in criticized and classified commercial loans, non-performing loans, and the allowance: non-performing loans were $12.8 million (0.96% of loans), down from $17.3 million at year-end; non-performing assets were $13.7 million.
- Whether loan growth and deposit pricing sustain net interest margin as interest rates and funding costs change, including the effects of time-deposit promotions and CDARS/ICS balances of $219.4 million.
- The eventual CECL allowance increase and its implications for earnings and capital; the filing provides no quantified estimate.
- How securities valuation changes, the real-estate loan concentration, and branch-expansion costs affect capital, liquidity, and profitability in subsequent periods.