Financial Institutions, Inc. — Q1 2019 Form 10-Q
Business context and reporting period. The company is a New York-based financial holding company operating Five Star Bank, an insurance agency and wealth-management businesses. This unaudited filing covers the three months ended March 31, 2019; income and cash-flow comparisons are against Q1 2018, while balance-sheet comparisons are generally against December 31, 2018. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2019 | Comparable / change |
|---|---|---|
| Net interest income | $31.8 million | $29.7 million in Q1 2018; up 7% |
| Net interest income, taxable-equivalent | $32.1 million | $30.1 million in Q1 2018 |
| Net interest margin, taxable-equivalent | 3.24% | 3.18% in Q1 2018 |
| Provision for loan losses | $1.2 million | $2.9 million in Q1 2018 |
| Noninterest income | $9.1 million | $8.9 million in Q1 2018 |
| Noninterest expense | $25.2 million | $24.1 million in Q1 2018 |
| Net income | $11.5 million | $9.3 million in Q1 2018; up 24% |
| Net income available to common shareholders | $11.2 million; $0.70 diluted EPS | $8.9 million; $0.56 diluted EPS in Q1 2018 |
| Return on average assets / common equity | 1.09% / 11.79% | 0.92% / 9.95% in Q1 2018 |
| Efficiency ratio | 60.99% | 61.85% in Q1 2018 |
Higher net interest income reflected growth in average earning assets, particularly loans. The improvement in net interest margin occurred despite a narrower interest-rate spread, as the contribution from noninterest-bearing funding increased. The effective tax rate was 20.8%, versus 19.6% in Q1 2018. The declared common dividend was $0.25 per share, compared with $0.24 a year earlier.
Balance sheet, liquidity and capital
- Assets and loans: Total assets were $4.30 billion at March 31, down slightly from $4.31 billion at year-end. Gross loans were $3.11 billion, up $22.6 million from year-end; commercial loans grew $30.9 million. Commercial loans were 49.8% of the portfolio, and consumer indirect loans were 29.0%.
- Deposits and borrowings: Deposits increased $141.9 million to $3.51 billion. Short-term borrowings fell $182.2 million to $287.3 million; long-term borrowings were $39.2 million, consisting primarily of subordinated notes. Total borrowings reported in MD&A were $326.5 million.
- Cash flow: Operating activities provided $15.4 million, investing activities provided $6.3 million, and financing activities used $44.7 million. Cash and cash equivalents declined $23.0 million to $79.8 million. Financing cash outflow chiefly reflected reduced short-term borrowings, partly offset by deposit growth.
- Liquidity access: Management reported approximately $859.5 million of additional collateralized wholesale borrowing capacity, $145.0 million of unsecured federal funds lines available, and $148.9 million of unencumbered liquid securities. The parent’s $20 million revolving line was undrawn and due to mature in May 2019.
- Capital: Shareholders’ equity was $408.3 million. Company regulatory ratios were 9.87% CET1, 10.37% Tier 1 capital, 12.50% total risk-based capital and 8.36% Tier 1 leverage. Management stated the company remained well-capitalized under applicable rules.
Material changes and credit quality
- Average loans rose $328.0 million year over year, while average securities fell $148.0 million. The average yield on earning assets rose to 4.23% from 3.79%; the cost of interest-bearing liabilities rose to 1.27% from 0.78%, including higher deposit and short-term borrowing costs.
- Investment advisory income increased $438,000, primarily reflecting the 2018 HNP Capital acquisition. Noninterest expense increased $1.1 million, with higher compensation, occupancy and professional-services costs partly offset by lower advertising expense.
- Net charge-offs were $1.8 million, or 0.23% of average loans annualized, versus $2.0 million, or 0.30%, in Q1 2018. Nonperforming assets declined to $5.8 million from $7.4 million at year-end; nonperforming loans were 0.19% of total loans.
- The allowance for loan losses was $33.3 million, or 1.07% of loans, versus $33.9 million and 1.10% at year-end. Management considered the allowance adequate, while noting estimates could require adjustment. Performing loans classified as substandard increased to $19.8 million from $11.9 million at year-end.
- Unrealized losses on securities in continuous loss positions totaled $8.2 million at quarter-end, down from $18.6 million at year-end; management attributed losses predominantly to interest-rate changes and recorded no impairment.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management describes organic loan and deposit growth and community banking as strategic priorities and cautions that interim results are not necessarily indicative of full-year results.
- Interest-rate sensitivity modeling estimated a 1.15% decline in 12-month net interest income under an immediate +100 basis-point shock and a 2.48% decline under +200 basis points. Estimated economic value of equity declined 6.31% and 13.31%, respectively. Management cautions that these are model estimates dependent on assumptions, not forecasts.
- Key disclosed risks include credit losses; geographic and commercial-real-estate concentration; consumer and indirect lending; deposit withdrawals and funding costs; interest-rate exposure; economic and market conditions; regulatory and legal matters; cybersecurity; and execution or integration of acquisitions. The company also disclosed $685.0 million of commitments to extend credit and $12.2 million of standby letters of credit; these may not be fully drawn.
- New lease accounting adopted January 1, 2019 added approximately $22.7 million of assets and $23.4 million of liabilities. Adoption of a tax-effects standard reclassified approximately $2.8 million from accumulated other comprehensive income to retained earnings; the filing also shows a $710,000 cumulative-effect adjustment to retained earnings. The expected credit-loss standard was still under evaluation, with its impact not yet reasonably estimable.
- No material recognizable subsequent events were reported through issuance. Management reported effective disclosure controls and no material change in internal control over financial reporting; no material developments in legal proceedings were reported.
Important facts for investors to verify
- Whether loan growth and deposit growth can continue without further pressure on funding costs and net interest margin.
- Trends in performing substandard loans and the allowance for loan losses, especially within commercial real estate and indirect consumer lending.
- Liquidity and funding after the reduction in short-term borrowings, including the renewal or replacement of the parent’s revolving credit line due in May 2019.
- Actual sensitivity of earnings and capital to changing interest rates compared with the filing’s model assumptions.
- The eventual effect of the expected-credit-loss accounting standard and whether acquisition-related revenue growth offsets ongoing operating expenses.