Peoples Financial Services Corp. — Q2 2020 Form 10-Q
Quarter ended June 30, 2020; financial statements are unaudited. Unless stated otherwise, amounts below are in millions of dollars. The company is a Pennsylvania-based bank holding company operating through Peoples Security Bank and Trust Company.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $20.5 | $18.7 | $40.1 | $37.0 |
| Provision for loan losses | $1.8 | $0.4 | $5.3 | $1.4 |
| Noninterest income | $3.4 | $4.2 | $7.0 | $7.6 |
| Noninterest expense | $13.2 | $14.4 | $26.9 | $27.9 |
| Net income | $7.6 | $7.1 | $12.9 | $13.6 |
| Diluted earnings per share | $1.03 | $0.96 | $1.74 | $1.83 |
- Q2 net income rose 6.0% year over year; first-half net income fell 5.2%. First-half pre-provision net interest income increased, but the higher credit-loss provision and lower noninterest income more than offset that improvement.
- Tax-equivalent net interest margin was 3.36% in Q2 versus 3.62% a year earlier; for the first half it was 3.43% versus 3.60%. Q2 return on average assets was 1.13% and return on average equity 9.87%; first-half figures were 1.00% and 8.48%, respectively.
- First-half operating cash flow was $19.7 million, investing cash outflow $188.7 million, and financing cash inflow $189.8 million. Cash and cash equivalents increased $20.8 million to $51.9 million.
Balance sheet, debt and liquidity
- At June 30, total assets were $2.700 billion, loans $2.182 billion, deposits $2.210 billion and stockholders’ equity $312.0 million. Loans increased $243.7 million from year-end, primarily due to $201.3 million of PPP loans; deposits rose $238.6 million.
- The allowance for loan losses was $27.0 million, or 1.24% of loans (1.36% excluding PPP loans), up from $22.7 million at year-end. Net charge-offs for the first half were $1.0 million, versus $0.8 million in 2019.
- Short-term borrowings were $50.0 million and long-term debt $60.9 million; the company also had $33.0 million of subordinated notes. Short-term borrowings declined from $152.2 million at year-end. The notes issued June 1, 2020 mature in 2030, carry a 5.375% rate for five years and then float subject to a 4.75% floor.
- Management described liquidity as strong: cash was $51.9 million; unused FHLB borrowing capacity was $599.4 million; available Federal Reserve discount-window capacity was $158.1 million; and $233.3 million of available-for-sale securities were unencumbered. PPPLF borrowing capacity was $201.3 million, of which $40.2 million was outstanding.
- The Bank was reported well-capitalized at June 30. Tier 1 leverage was 10.47%, Tier 1 risk-based capital 13.33%, and total risk-based capital 14.58%. The subordinated debt proceeds supported a $30 million capital contribution to the Bank.
Material changes and management commentary
- COVID-19 drove a substantial increase in the loan-loss provision, mainly through revised economic and qualitative assumptions. Management said roughly $1.2 billion, or 73%, of commercial and commercial real estate loans were in sectors categorized as non-life-sustaining and subject to shutdowns.
- At June 30, payment deferrals covered 479 commercial loans totaling $306.8 million and 512 consumer loans totaling $23.3 million. As of July 30, the filing reported 481 commercial loans totaling $306.9 million and 505 consumer loans totaling $23.3 million. These short-term COVID-related deferrals were not treated as troubled debt restructurings or past due when eligible.
- Through July 30, the Bank had processed 1,417 PPP applications for more than $216.2 million in loans. PPP processing fees were estimated at about $6.9 million; recognition is deferred and amortized over the loan term or accelerated upon forgiveness. Management expected most PPP loans to be forgiven in the second half of 2020.
- Nonperforming assets increased to $13.5 million, or 0.62% of loans and foreclosed assets, from $10.5 million, or 0.54%, at year-end. Nonaccrual loans were $9.0 million. Special-mention loans increased, including credits affected by tenant losses and COVID-related cash-flow difficulties.
- Management expected loan activity outside PPP to decline amid economic uncertainty, and noted downward pressure on asset yields from the low-rate environment. It anticipated continued reductions in funding costs. The company notified customers and regulators of plans to close three branches in Q3 2020, with expected annual expense savings of $0.5 million.
- Q2 noninterest income declined, notably from lower service charges, wealth-management income and swap-related fees; higher mortgage banking income partly offset the decline. Management cautioned that COVID-related restrictions and market conditions could further reduce fee income and could increase operating, legal and professional costs.
Risks, contingencies and unusual items
- The filing states the pandemic’s duration and effects are uncertain and could impair borrower repayment, collateral values, loan demand, funding, operations and earnings. Elevated unemployment could increase future credit losses. Management cautioned that loan activity and customer ability to repay could be damaged temporarily or permanently.
- The Bank participates in PPP and identified potential litigation, compliance and SBA-guarantee risks, including possible denial or recovery of guarantees if loan origination, funding or servicing is found deficient.
- Goodwill was $63.4 million. A COVID- and share-price-related impairment assessment found fair value above carrying value and no impairment at June 30; further deterioration could prompt future testing and a possible charge.
- Interest-rate risk is significant in the current low-rate environment. The company reported that modeled net interest income remained within policy limits; a parallel 100-basis-point increase was projected to raise 12-month net interest income by 1.4%. The filing also notes LIBOR-linked contracts and the planned transition to SOFR.
- The Board declared a Q3 dividend of $0.36 per share on July 31, payable September 15, 2020. Future dividends remain subject to earnings, financial condition, legal restrictions and COVID-19 effects. No material legal proceedings were reported.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether payment-deferral borrowers resume scheduled payments, and how deferrals, delinquencies, nonaccruals and criticized loans evolve.
- Whether the allowance for loan losses adequately reflects COVID-19 exposures, particularly commercial real estate, hospitality, restaurants and other affected sectors.
- PPP forgiveness progress, fee recognition, and whether the SBA honors guarantees without material disputes or litigation.
- Whether deposit growth persists as PPP proceeds and stimulus balances run off, and how loan growth and funding needs affect liquidity and margins.
- Capital ratios, the cost and terms of subordinated debt, goodwill impairment assumptions, and the sustainability of the dividend amid the uncertain outlook.