Financial Institutions, Inc. (Nasdaq: FISI) — Q3 2022 Form 10-Q
Business context and reporting period. Financial Institutions, Inc. is a New York financial holding company operating Five Star Bank, an insurance agency and wealth-management businesses. It filed an unaudited quarterly report for the three and nine months ended September 30, 2022; comparisons below are with the corresponding 2021 periods unless noted. Dollar amounts are in millions unless otherwise stated.
Key financial metrics
| Metric | Q3 2022 | Prior comparable period / balance-sheet comparison |
|---|---|---|
| Net interest income | $43.1 | $38.3 in Q3 2021; up 12.5% |
| Net interest margin, tax-equivalent | 3.28% | 3.07% in Q3 2021 |
| Noninterest income | $12.7 | $12.1 in Q3 2021 |
| Noninterest expense | $32.8 | $29.2 in Q3 2021 |
| Provision for credit losses | $4.3 | $0.5 benefit in Q3 2021 |
| Net income | $13.9 | $17.2 in Q3 2021 |
| Net income available to common shareholders; diluted EPS | $13.5; $0.88 | $16.8; $1.05 in Q3 2021 |
| Return on average assets; common equity | 0.98%; 12.72% | 1.27%; 13.94% in Q3 2021 |
| Total assets; net loans | $5,624.5; $3,822.7 | Assets $5,520.8; net loans $3,639.8 at Dec. 31, 2021 |
| Total deposits | $4,905.2 | $4,827.1 at Dec. 31, 2021 |
| Borrowings | $143.1 | $103.9 at Dec. 31, 2021; includes $69.0 short-term and $74.1 long-term |
| Shareholders’ equity | $394.0 | $505.1 at Dec. 31, 2021 |
| Cash and cash equivalents | $118.6 | $79.1 at Dec. 31, 2021 |
Nine-month results: Net interest income was $124.2 versus $113.9; noninterest income was $35.3 versus $35.2; noninterest expense was $95.8 versus $82.9; net income was $44.5 versus $58.1; and diluted EPS was $2.80 versus $3.58. The nine-month efficiency ratio rose to 59.91% from 55.41%.
Cash flow and capital: For the first nine months, operating activities provided $117.4, investing activities used $165.5, and financing activities provided $87.5. Financing included a $78.1 net deposit increase and $39.0 more short-term borrowings, offset in part by $15.3 of common-stock repurchases and $14.2 of dividends paid. At September 30, the company reported a 9.75% CET1 ratio and a 12.53% total risk-based capital ratio; management said capital remained above applicable well-capitalized thresholds.
Material changes and drivers
- Quarterly net interest income increased as loan and securities balances and yields rose amid 2022 rate increases. The benefit was partly offset by higher deposit costs: interest expense rose to $7.6 from $3.0.
- Profit declined despite higher net interest income, primarily because the credit-loss provision shifted from a benefit to an expense and noninterest expenses increased. Salaries and benefits rose 14% in Q3, which management attributed to staffing investment, labor-market wage pressure and higher medical claims. Technology spending and other expenses also increased.
- Loan balances grew $187.4 from year-end, led by commercial mortgage and consumer indirect lending. Total deposits increased $78.1; savings and money-market balances declined while demand and time deposits increased.
- Net charge-offs were $2.2 in Q3, or 0.22% of average loans on an annualized basis, compared with $0.6 and 0.06% a year earlier. Nonperforming loans were $8.5, or 0.22% of loans, versus $12.2, or 0.33%, at year-end 2021.
- Available-for-sale securities had a net unrealized loss of $183.9 at September 30, compared with $6.3 at year-end, largely attributed to rising interest rates. Accumulated other comprehensive loss increased to $141.2 from $13.2, contributing substantially to the decline in reported shareholders’ equity. Management said it did not intend, and was not more likely than not required, to sell the securities before recovery; it recorded no credit-loss allowance on these securities.
Outlook, risks and unusual items
- The filing provides no specific earnings or financial guidance. Management described the Q3 credit provision as a return toward more normalized levels, reflecting a higher national unemployment forecast and economic uncertainty from rising rates and geopolitical conditions.
- Management reported ample funding sources and compliance with structural liquidity measures. At September 30, the company had approximately $268.9 of immediate FHLB capacity, $587.3 of secured FRB discount-window capacity, $120.0 of unsecured federal-funds lines and $545.1 of unencumbered liquid securities. These are stated capacities, not cash on hand.
- Uninsured deposits totaled $1.35 billion. Management cited deposit flows, seasonal municipal deposits and customer line-of-credit utilization as items it monitors. Short-term borrowings rose to $69.0 from $30.0 at year-end.
- The securities valuation decline is a significant interest-rate and capital consideration. Management’s static 12-month simulation estimated net interest income increasing 0.18%, 0.36% and 0.54% under +100, +200 and +300 basis-point shocks, respectively, and decreasing 1.52% under a -100 basis-point shock. These are model estimates, not forecasts.
- A $2.0 increase in company-owned life-insurance income came from surrendering and redeploying $25.5 of cash surrender value; approximately $1.5 of incremental tax expense partly offset the benefit. The company also recorded $1.3 of restructuring charges in the first nine months for real-estate valuation adjustments.
- A putative consumer class action concerning notices sent after vehicle repossessions remains unresolved. The court certified classes, denied both sides’ partial-summary-judgment motions, and a Pennsylvania appellate court granted the company’s interlocutory appeal; the case was stayed pending appeal, with mediation being explored. No liability was accrued because the company could not conclude loss was probable or reasonably estimate it. The company warns that uninsured legal costs, settlement or judgment could materially affect results.
- Other stated risks include interest-rate sensitivity, credit losses, inflation and economic uncertainty, geographic and lending concentrations, deposit competition and withdrawals, regulatory and cybersecurity risks, and the possible effects of litigation. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether higher asset yields continue to exceed rising deposit and borrowing costs, and how that affects net interest margin and earnings.
- Whether credit quality, consumer indirect loan charge-offs, criticized commercial loans and provision levels worsen as economic conditions change.
- Whether the large unrealized securities losses remain unrealized or affect liquidity, capital or the ability to hold assets through recovery.
- Deposit composition and funding costs, including uninsured, brokered, reciprocal and seasonal public deposits, and actual use of available borrowing capacity.
- Developments in the repossession-notice class action, potential exposure and insurance coverage; also the effect of restructuring charges and the nonrecurring life-insurance transaction on comparisons.