Community Bank System, Inc. — FY2013 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013, with comparisons to 2012 and 2011. The source filing identifies the registrant as Community Bank System, Inc.; this differs from the request metadata naming Community Financial System, Inc. The company operates community banking, employee benefit services, and wealth management businesses in Upstate New York, Northeastern Pennsylvania, and other U.S. markets.
Business context
- Community Bank, N.A. operated 183 full-service branches across 35 New York counties and six Northeastern Pennsylvania counties.
- Employee benefit services served approximately 3,600 plan sponsors and 350,000 participants, with $16.1 billion of assets under custody or administration at year-end.
- Wealth management assets under management increased to approximately $3.4 billion.
- On December 13, 2013, the company acquired eight Bank of America branches in Northeastern Pennsylvania, adding approximately $303 million of deposits and $1 million of loans for a $7.3 million deposit premium.
FY2013 financial performance
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net income | $78.8 million | $77.1 million | Up 2.3% |
| Diluted EPS | $1.94 | $1.93 | Up $0.01 |
| Net interest income | $238.1 million | $230.4 million | Up 3.3% |
| Provision for loan losses | $8.0 million | $9.1 million | Down 12% |
| Recurring noninterest income, excluding securities and debt items | $108.7 million | $99.0 million | Up 9.9% |
| Noninterest expense | $221.3 million | $211.8 million | Up 4.5% |
| Return on average assets | 1.09% | 1.08% | Improved |
| Return on average equity | 9.04% | 8.82% | Improved |
| Net interest margin | 3.91% | 3.88% | Up 3 basis points |
| Efficiency ratio | 59.3% | 57.4% | Worsened 1.9 points |
Fourth quarter: Net income was $15.5 million, or $0.38 diluted EPS, compared with $18.8 million, or $0.47 diluted EPS, in fourth quarter 2012. The filing does not provide a clear adjusted fourth-quarter earnings figure excluding unusual securities and debt transactions.
Balance sheet, credit quality, debt and liquidity
- Total assets declined to $7.10 billion from $7.50 billion, primarily following balance-sheet restructuring and investment-security sales.
- Gross loans increased 6.3% to $4.11 billion. Consumer mortgages rose 9.2%, consumer indirect loans rose 14%, and business lending rose 2.1%; home equity loans declined 4.9%.
- Deposits increased 4.8% to $5.90 billion, with noninterest-bearing deposits rising to $1.20 billion. Average deposits increased 8.7%, while time deposits declined.
- Nonperforming loans declined to $22.0 million, or 0.54% of total loans, from $29.1 million, or 0.75%. Nonperforming assets declined to 0.66% of loans and other real estate owned.
- Net charge-offs declined to $6.6 million, or 0.17% of average loans, from $8.4 million, or 0.23%. The allowance for loan losses was $44.3 million, equal to 1.08% of loans and 201% of nonperforming loans.
- Borrowings fell to $244.0 million from $830.1 million. This included $141.9 million of FHLB overnight advances and $102.1 million of subordinated debt held by unconsolidated trusts.
- Capital remained strong: the company reported a 9.29% Tier 1 leverage ratio, 16.42% Tier 1 risk-based capital ratio, and 17.57% total risk-based capital ratio. The company and bank were categorized as well capitalized.
- Liquidity included approximately $150 million of cash and cash equivalents, $1.1 billion of unused FHLB borrowing capacity, $1.3 billion of unencumbered securities, and $65 million of unsecured correspondent-bank lines. The 30-day basic surplus ratio was 16.4%, above the company’s 7.5% internal requirement.
- Operating cash flow was $103.2 million. Investing activities provided $553.3 million, primarily from investment-security sales and acquisition-related cash receipts, while financing activities used $735.4 million, mainly from debt repayments and dividends. Cash and cash equivalents ended at $149.6 million.
Material changes and unusual items
- The company sold $648.7 million of U.S. Treasury and agency securities in the first half of 2013, realizing $63.8 million of gains, and used proceeds to retire $501.6 million of FHLB borrowings, incurring $63.5 million of early-extinguishment costs.
- In December 2013, the company sold its $56.2 million portfolio of pooled trust-preferred CDO securities in response to Volcker Rule uncertainty, recognizing an approximately $15.5 million loss.
- The company also sold $417.6 million of securities previously classified as held-to-maturity, realizing $32.4 million of gains, and retired an additional $226.4 million of FHLB term advances at a cost of $23.8 million.
- Because held-to-maturity securities were sold, the remaining $198.9 million of that portfolio was transferred to available-for-sale classification, and the company stated it would not use held-to-maturity classification for the foreseeable future.
- Acquisition expenses declined to $2.2 million from $5.7 million, while 2012 included a $2.5 million litigation settlement charge related to debit-card overdraft processing.
- Shareholders’ equity declined 3.0% to $875.8 million, primarily because accumulated other comprehensive income fell $80.9 million as interest rates rose and securities were sold. Comprehensive income was a loss of $2.1 million.
- The company declared $1.10 per share of dividends in 2013 and announced a $0.28 per-share dividend for the first quarter of 2014. A new authorization allowed repurchases of up to 2 million shares, although no shares were repurchased under the public program during 2013.
Outlook, risks and contingencies
- Management expected the company to comply with Basel III capital standards as they become effective beginning in 2015, but noted that regulatory changes may increase compliance costs and constrain activities, dividends, or growth.
- Management announced the acquisition of an actuarial and consulting practice by Harbridge, completed January 1, 2014, and expected to add approximately $1.2 million of annual revenue.
- The principal risks are interest-rate and margin compression, regional economic weakness in New York and Pennsylvania, credit losses, competitive pressure, regulatory and consumer-protection requirements, acquisition integration, market volatility affecting fee-based assets, cybersecurity, and potential impairment of goodwill or securities.
- The company modeled a $4.5 million annualized decrease in projected net interest income under a 200-basis-point rate increase and a $0.9 million decrease under its zero-rate scenario. Management cautioned that these are hypothetical sensitivities, not forecasts.
- Off-balance-sheet commitments totaled $729.4 million, including $704.9 million of commitments to extend credit and $24.4 million of standby letters of credit.
- Pending and threatened litigation was not expected to be material to consolidated financial position. The disclosed reasonably possible loss range beyond recorded liabilities was $0 to $5 million, and a Pennsylvania automobile-repossession matter could proceed as a class action.
- Management and PricewaterhouseCoopers LLP concluded that internal control over financial reporting was effective as of December 31, 2013. The audit report expressed an unqualified opinion.
Important facts for investors to verify
- Confirm the registrant name and ticker because the supplied metadata says Community Financial System, while the filing identifies Community Bank System, Inc. and ticker CBU.
- Assess how much 2013 earnings depended on nonrecurring securities gains, debt-extinguishment costs, and the Volcker Rule-related CDO liquidation.
- Review the sustainability of loan and deposit growth following the Bank of America branch acquisition and the integration costs associated with recent acquisitions.
- Monitor net interest margin sensitivity, deposit repricing, FHLB borrowing maturities, and the effect of rising or falling interest rates on securities valuations and accumulated other comprehensive income.
- Validate credit quality trends, particularly business lending classifications, consumer mortgage nonperforming loans, other real estate owned, and allowance coverage.
- Review the potential exposure from regulatory changes, the Pennsylvania repossession litigation, credit commitments, and the company’s reliance on subsidiary-bank dividends to fund holding-company obligations and shareholder dividends.