Financial Institutions, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; balance-sheet comparisons are to December 31, 2012. The company operates Five Star Bank and Five Star Investment Services, principally in Central and Western New York, with indirect auto lending extending into other areas.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $22.8 million | $23.1 million | $68.2 million | $65.4 million |
| Net interest margin, taxable-equivalent | 3.62% | 3.96% | 3.66% | 3.97% |
| Provision for loan losses | $2.8 million | $1.8 million | $6.7 million | $4.6 million |
| Noninterest income | $6.2 million | $6.4 million | $19.1 million | $18.5 million |
| Noninterest expense | $17.0 million | $21.6 million | $52.1 million | $53.9 million |
| Net income | $6.2 million | $4.3 million | $19.2 million | $17.1 million |
| Diluted EPS | $0.42 | $0.28 | $1.31 | $1.16 |
Q3 net income rose 45%; nine-month net income rose 12%. Q3 return on average assets and equity were 0.88% and 9.93%, respectively; nine-month figures were 0.92% and 10.13%. Common dividends declared were $0.19 per share for Q3 and $0.55 year to date.
Financial position, cash flow and liquidity
- At September 30, assets were $2.87 billion, loans net of allowance were $1.75 billion, deposits were $2.41 billion, short-term borrowings were $188.1 million, and shareholders’ equity was $247.8 million.
- Since year-end 2012, total loans increased $73.9 million and deposits increased $152.4 million. Cash and cash equivalents rose to $99.4 million from $60.4 million.
- For the first nine months, operating cash flow was $34.8 million, investing cash outflow was $148.0 million, and financing cash inflow was $152.1 million. Financing inflows chiefly reflected deposit growth and increased short-term borrowings; dividends paid were $8.2 million.
- There were no long-term borrowings. The company reported $52 million of immediate FHLB capacity, $463 million of secured Federal Reserve discount-window capacity, $120 million of unsecured federal funds lines, and $101 million of unencumbered liquid securities available for pledging.
- Company regulatory capital ratios were 7.68% Tier 1 leverage, 10.94% Tier 1 risk-based, and 12.19% total risk-based. The company stated it believed it would meet the new Basel III rules if then in effect.
Material changes and unusual items
- Net interest margin compressed year over year as earning-asset yields fell faster than funding costs. Q3 taxable-equivalent net interest income declined 1%, while nine-month net interest income rose 5%, supported by asset growth and lower interest expense.
- Management attributed much of the year-over-year earnings improvement to the absence of 2012 costs: approximately $1.9 million of Q3 and $3.0 million of nine-month branch-acquisition expenses, plus approximately $2.6 million of CEO-retirement-related costs in both 2012 comparison periods.
- In Q3, $227.3 million of available-for-sale municipal securities were transferred to held-to-maturity. The transfer recognized no gain or loss; it was intended to reduce reported equity volatility from fair-value changes. Accumulated other comprehensive income fell $16.6 million over the first nine months, mainly from unrealized securities losses.
- The company used short-term FHLB advances to fund an approximately $100 million securities leverage strategy. Management said it added about $280,000 to Q3 and $830,000 to year-to-date net interest income, while reducing net interest margin.
- Two branches were consolidated effective October 31, 2013; related expenses were not expected to be material. The final purchase-price allocation for the 2012 branch acquisitions was completed in Q3 2013.
Credit quality, outlook and risks
- Nonperforming assets were $10.9 million, or 0.38% of assets, versus $10.1 million, or 0.36%, at year-end. Nonperforming loans were $10.3 million, or 0.58% of loans. The allowance was $26.7 million, 1.50% of total loans; nine-month net charge-offs were $4.7 million, or 0.36% of average loans.
- Provision expense increased year over year. A commercial mortgage with an $8.4 million unpaid balance was downgraded to substandard in Q3, requiring approximately $960,000 of additional provision; it became 60 days past due as of October 31, 2013. Management said it continued to monitor the credit and evaluate options.
- Management cited low interest rates and competitive pricing as pressures on asset yields and margin. The bank was generally asset-sensitive in its rate simulation: a +100 basis-point shock was estimated to increase 12-month net interest income by 2.64%, while a -100 basis-point shock was estimated to reduce it by 1.72%. These are model estimates, not forecasts.
- Management expected deposit-service-charge income to stabilize over the longer term following product and fee changes. The filing provides no earnings or revenue guidance. Risks include credit losses, interest-rate changes, deposit seasonality, and reliance on assumptions used in loan-loss and securities valuations.
- Off-balance-sheet commitments included $444.8 million to extend credit and $9.8 million of standby letters of credit; amounts drawn may differ. Management reported no material change in legal proceedings or risk factors and no material weakness in disclosure controls.
Important facts for investors to verify
- Whether the $8.4 million commercial mortgage credit’s delinquency and repayment prospects worsen, and whether further provisioning is needed.
- Whether loan growth and fee income can offset continued asset-yield and margin pressure, and how sustainable earnings are after excluding 2012 one-time costs.
- The effects of the securities transfer and interest-rate movements on fair value, accumulated other comprehensive income, and regulatory capital.
- Deposit mix and seasonality, use of short-term FHLB funding, and the ongoing returns and risks of the securities leverage strategy.
- Future credit performance, particularly consumer indirect loans, and whether realized charge-offs remain consistent with the allowance for loan losses.