UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
Commission File Number 0-26481
FINANCIAL INSTITUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
220 Liberty Street Warsaw, NY 14569
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days. YES |X| NO |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT AUGUST 1, 2002
Common Stock, $0.01 par value 11,091,581 shares
1
FINANCIAL INSTITUTIONS, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Condition as of
June 30, 2002 and December 31, 2001 3
Consolidated Statements of Income for the three months and six
months ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001 5
Consolidated Statements of Changes in Shareholders' Equity and
Comprehensive Income for the six months ended
June 30, 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES
EXHIBITS
2
Item 1. Financial Statements
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
(Dollars in thousands, except per share amounts) 2002 2001
----------- ------------
Assets
Cash, due from banks and interest-bearing deposits $ 44,052 $ 52,171
Federal funds sold 1,008 1,000
Securities available for sale, at fair value 553,319 428,423
Securities held to maturity (fair value of $54,638 and
$62,317 at June 30, 2002 and December 31, 2001, respectively) 53,774 61,281
Loans, net 1,221,819 1,146,976
Premises and equipment, net 25,621 24,467
Goodwill 37,310 37,308
Other assets 42,518 42,670
----------- -----------
Total assets $ 1,979,421 $ 1,794,296
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand $ 216,469 $ 224,628
Savings, money market and interest-bearing checking 730,690 572,563
Certificates of deposit 660,629 636,467
----------- -----------
Total deposits 1,607,788 1,433,658
Short-term borrowings 83,442 103,770
Long-term borrowings 87,284 70,419
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 16,200 16,200
Accrued expenses and other liabilities 20,272 21,062
----------- -----------
Total liabilities 1,814,986 1,645,109
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares at June 30, 2002 and December 31, 2001 167 167
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding
175,855 shares at June 30, 2002 and December 31, 2001 17,585 17,585
Common stock, $ 0.01 par value, authorized 50,000,000 shares,
issued 11,303,533 shares at June 30, 2002 and December 31, 2001 113 113
Additional paid-in capital 19,306 17,195
Retained earnings 122,354 112,786
Accumulated other comprehensive income 5,797 2,176
Treasury stock, at cost - 213,142 shares at June 30, 2002
and 282,219 shares at December 31, 2001 (887) (835)
----------- -----------
Total shareholders' equity 164,435 149,187
----------- -----------
Total liabilities and shareholders' equity $ 1,979,421 $ 1,794,296
=========== ===========
See accompanying notes to consolidated financial statements.
3
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
------------------- --------------------
(Dollars in thousands, except per share amounts) 2002 2001 2002 2001
-------- -------- -------- --------
Interest income:
Loans $ 22,490 $ 23,416 $ 44,535 $ 44,264
Securities 7,250 5,534 13,646 10,355
Other 187 202 306 287
-------- -------- -------- --------
Total interest income 29,927 29,152 58,487 54,906
-------- -------- -------- --------
Interest expense:
Deposits 9,039 11,659 17,697 22,855
Borrowings 1,483 1,089 2,889 1,877
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 419 419 838 600
-------- -------- -------- --------
Total interest expense 10,941 13,167 21,424 25,332
-------- -------- -------- --------
Net interest income 18,986 15,985 37,063 29,574
Provision for loan losses 1,181 1,026 2,188 1,837
-------- -------- -------- --------
Net interest income after
provision for loan losses 17,805 14,959 34,875 27,737
-------- -------- -------- --------
Noninterest income:
Service charges on deposits 2,607 1,724 4,934 3,043
Financial services group fees and commissions 1,325 440 2,630 826
Mortgage banking revenues 274 418 1,217 937
Gain (loss) on securities transactions 96 173 (100) 358
Other 855 697 1,413 1,073
-------- -------- -------- --------
Total noninterest income 5,157 3,452 10,094 6,237
-------- -------- -------- --------
Noninterest expense:
Salaries and employee benefits 7,507 5,509 14,428 10,266
Occupancy and equipment 1,711 1,459 3,541 2,747
Supplies and postage 611 493 1,190 909
Amortization of intangible assets 216 589 430 765
Professional fees 327 470 661 688
Other 2,721 1,889 4,943 3,278
-------- -------- -------- --------
Total noninterest expense 13,093 10,409 25,193 18,653
-------- -------- -------- --------
Income before income taxes 9,869 8,002 19,776 15,321
Income taxes 3,225 2,817 6,475 5,331
-------- -------- -------- --------
Net income $ 6,644 $ 5,185 $ 13,301 $ 9,990
======== ======== ======== ========
Earnings per common share:
Basic $ 0.57 $ 0.44 $ 1.14 $ 0.84
Diluted $ 0.56 $ 0.43 $ 1.12 $ 0.83
See accompanying notes to consolidated financial statements.
4
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
----------------------
(Dollars in thousands) 2002 2001
--------- ---------
Cash flows from operating activities:
Net income $ 13,301 $ 9,990
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,572 2,257
Provision for loan losses 2,188 1,837
Deferred income tax benefit (592) (730)
Loss (gain) on securities transactions 100 (358)
Gain on sale of loans (786) (517)
Loss (gain) on sale of other assets 134 (10)
Minority interest in net income of subsidiaries 47 48
Decrease (increase) in other assets 1,884 (125)
(Decrease) increase in accrued expenses and other liabilities (1,441) 3,537
--------- ---------
Net cash provided by operating activities 17,407 15,929
Cash flows from investing activities:
Purchase of securities:
Available for sale (357,583) (193,840)
Held to maturity (10,953) (10,153)
Proceeds from maturity and call of securities:
Available for sale 200,993 140,642
Held to maturity 18,372 19,021
Proceeds from sale of securities available for sale 39,633 7,508
Investment in Mercantile Adjustment Bureau, LLC (2,500) --
Increase in loans, net (66,011) (53,859)
Proceeds from sales of premises and equipment 5 39
Purchase of premises and equipment, net (2,594) (2,341)
Cash acquired in purchase of Bank of Avoca, net of cash paid 4,778 --
Purchase of Bath National Corporation, net of cash acquired -- (48,955)
--------- ---------
Net cash used in investing activities (175,860) (141,938)
Cash flows from financing activities:
Increase in deposits, net 157,360 72,027
(Decrease) increase in short-term borrowings, net (20,329) 42,349
Proceeds from long-term borrowings 17,056 12,579
Repayment of long-term borrowings (191) (120)
Proceeds from guaranteed preferred beneficial interests in
Company's junior subordinated debentures, net of costs -- 15,713
Purchase of preferred and common shares (384) (2)
Issuance of preferred and common shares 444 27
Dividends paid (3,614) (3,165)
--------- ---------
Net cash provided by financing activities 150,342 139,408
--------- ---------
Net (decrease) increase in cash and cash equivalents (8,111) 13,400
Cash and cash equivalents at the beginning of the period 53,171 30,152
--------- ---------
Cash and cash equivalents at the end of the period $ 45,060 $ 43,552
========= =========
Supplemental disclosure of cash flow information: Cash paid during period for:
Interest $ 23,122 $ 21,945
Income taxes 7,037 5,594
Noncash investing and financing activities:
Fair value of noncash assets acquired in acquisitions $ 14,043 $ 281,664
Fair value of liabilities assumed in acquisitions 17,322 269,897
Issuance of common stock in Bank of Avoca acquisition 1,499 --
Issuance of common stock for Burke Group, Inc. earnout 500 --
See accompanying notes to consolidated financial statements.
5
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
3% 8.48% Additional
(Dollars in thousands, Preferred Preferred Common Paid-in
except per share amounts) Stock Stock Stock Capital
--------- --------- ------ ----------
Balance - December 31, 2001 $ 167 $ 17,585 $ 113 $ 17,195
Purchase of 15,305 shares of common stock -- -- -- --
Issue 2,289 shares of common stock-directors plan -- -- -- 46
Issue 17,699 shares of common stock- employee
stock option plan -- -- -- 316
Issue 17,848 shares of common stock- Burke
Group, Inc. earnout -- -- -- 431
Issue 47,036 shares of common stock - acquisition
of Bank of Avoca -- -- -- 1,318
Comprehensive income:
Net income -- -- -- --
Unrealized gain on securities available
for sale (net of tax of $(2,474)) -- -- -- --
Reclassification adjustment for losses
included in net income (net of tax of $(40)) -- -- -- --
Net unrealized gain on securities available
for sale (net of tax of $(2,434)) -- -- -- --
Total comprehensive income -- -- -- --
Cash dividends declared:
3% Preferred - $1.50 per share -- -- -- --
8.48% Preferred - $2.24 per share -- -- -- --
Common - $0.27 per share -- -- -- --
--------- --------- ------ ----------
Balance - June 30, 2002 $ 167 $ 17,585 $ 113 $ 19,306
========= ========= ====== ==========
Accumulated
Other
Comprehensive Total
Retained Income Treasury Shareholders'
Earnings (Loss) Stock Equity
--------- ------------- -------- -------------
Balance - December 31, 2001 $ 112,786 $ 2,176 $ (835) $ 149,187
Purchase of 15,305 shares of common stock -- -- (384) (384)
Issue 2,289 shares of common stock-directors plan -- -- 9 55
Issue 17,699 shares of common stock- employee
stock option plan -- -- 73 389
Issue 17,848 shares of common stock- Burke
Group, Inc. earnout -- -- 69 500
Issue 47,036 shares of common stock - acquisition
of Bank of Avoca -- -- 181 1,499
Comprehensive income:
Net income 13,301 -- -- 13,301
Unrealized gain on securities available
for sale (net of tax of $(2,474)) -- 3,561 -- 3,561
Reclassification adjustment for losses
included in net income (net of tax of $(40)) -- 60 -- 60
-------------
Net unrealized gain on securities available
for sale (net of tax of $(2,434)) -- -- -- 3,621
-------------
Total comprehensive income -- -- -- 16,922
-------------
Cash dividends declared:
3% Preferred - $1.50 per share (2) -- -- (2)
8.48% Preferred - $2.24 per share (745) -- -- (745)
Common - $0.27 per share (2,986) -- -- (2,986)
--------- ------------- -------- -------------
Balance - June 30, 2002 $ 122,354 $ 5,797 $ (887) $ 164,435
========= ============= ======== =============
See accompanying notes to consolidated financial statements.
6
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Basis of Presentation
Financial Institutions, Inc. ("FII"), a financial holding company organized
under the laws of New York State, and subsidiaries (the "Company") provide
deposit, lending and other financial services to individuals and businesses in
Central and Western New York State. FII and subsidiaries are each subject to
regulation by certain federal and state agencies.
The consolidated financial statements include the accounts of FII, its five
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The National
Bank of Geneva (99.30% owned) ("NBG"), The Pavilion State Bank (100% owned)
("PSB"), First Tier Bank & Trust (100% owned) ("FTB") and Bath National Bank
(100% owned) ("BNB"), collectively referred to as the "Banks". During the third
quarter of 2002, the Company will strategically merge PSB operations with WCB
and NBG based on geography.
Also included are the accounts of the Burke Group, Inc. (100% owned) ("BGI"),
The FI Group, Inc. (100% owned) ("FIGI"), and FISI Statutory Trust I ("FISI")
(100% owned). BGI is an employee benefits and compensation consulting firm
acquired by the Company in October 2001. FIGI is a brokerage subsidiary. FISI is
a trust formed to accommodate the private placement of $16.2 million in capital
securities, the proceeds of which were utilized to partially fund the
acquisition of BNB. The capital securities are identified on the statement of
financial condition as guaranteed preferred beneficial interests in
Corporation's junior subordinated debentures.
The consolidated financial information included herein combines the results of
operations, the assets, liabilities and shareholders' equity of the Company and
its subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. In
preparing the consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of revenues,
expenses, assets and liabilities, and the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates. Amounts in the
prior period consolidated financial statements are reclassified when necessary
to conform with the current period presentation.
New Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
all business combinations be accounted for under the purchase method; use of the
pooling-of-interests method is no longer permitted for business combinations
initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including
goodwill reported in prior acquisitions) no longer be amortized to earnings, but
instead be reviewed for impairment annually, with any impairment losses charged
to earnings when they occur. As described in Note 4, the Company was required to
adopt SFAS No. 142 effective January 1, 2002 and, accordingly, ceased the
amortization of goodwill on that date. Intangible assets other than goodwill
continue to be amortized over their estimated useful lives.
In October 2001, FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The statement
supersedes SFAS No. 121 and is effective for fiscal years beginning after June
15, 2002 although early adoption is encouraged. SFAS No. 144 retains many of the
fundamental principles of SFAS No. 121, but differs from it in that it excludes
goodwill and intangible assets from its provisions and provides greater
direction relating to the implementation of its principles. Adoption is not
expected to have a material impact on the consolidated financial statements of
the Company.
7
(2) Earnings Per Common Share
Basic earnings per share, after giving effect to preferred stock dividends, has
been computed using weighted average common shares outstanding. Diluted earnings
per share reflect the effects, if any, of incremental common shares issuable
upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
(Dollars and shares in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Net income $ 6,644 $ 5,185 $ 13,301 $ 9,990
Less: Preferred stock dividends 374 374 748 748
-------- -------- -------- --------
Net income available to common shareholders $ 6,270 $ 4,811 $ 12,553 $ 9,242
======== ======== ======== ========
Average number of common shares outstanding
used to calculate basic earnings per common share 11,067 10,987 11,041 10,987
Add: Effect of dilutive options 156 148 179 96
-------- -------- -------- --------
Average number of common shares
used to calculate diluted earnings per common share 11,223 11,135 11,220 11,083
======== ======== ======== ========
(3) Mergers and Acquisitions
On May 1, 2001, FII acquired all of the common stock of Bath National
Corporation ("BNC"), and its wholly-owned subsidiary bank, Bath National Bank.
BNB is a full service community bank headquartered in Bath, New York, which has
9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company
paid $48.00 per share in cash for each of the outstanding shares of BNC common
stock with an aggregate purchase price of approximately $62.6 million. The
acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired, less liabilities assumed,
was recorded as goodwill. Goodwill recognized with respect to the merger was
approximately $37.1 million. Goodwill amortization from the acquisition date
through December 31, 2001, using the straight-line method over 15 years, totaled
$1.7 million. However, in accordance with SFAS No. 142, the Company ceased
goodwill amortization on January 1, 2002. The results of operations for BNB are
included in the income statement from the date of acquisition.
On October 22, 2001, the Company acquired the Burke Group, Inc. ("BGI"), an
employee benefits administration and compensation consulting firm, with offices
in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and
consulting for retirement and employee welfare plans, administrative services
for defined contribution and benefit plans, actuarial services and post
employment benefits. The agreement provided for merger consideration of
$1,500,000 to BGI shareholders. Merger consideration payments of $200,000 in
cash and 34,452 shares of FII common stock was made on October 22, 2001 with the
balance of the merger consideration of $500,000 due October 22, 2002 to be paid
in shares of FII common stock based on the Company's average closing stock price
for the 30 day period preceding the payment date. In addition the agreement
provides for the payment of earned amount consideration of $500,000 and $750,000
in FII common stock based on achievement of financial performance targets for
the periods ending December 31, 2001 and 2002, respectively. The financial
performance target for the period ending December 31, 2001 was achieved and
17,848 shares were issued on April 1, 2002. Achievement of the financial
performance target for the period ending December 31, 2002 would be paid on
April 1, 2003 based on the Company's average closing stock price for the 30 day
period preceding the payment date. The agreement further provides for payment of
contingent consideration in the form of FII common stock based on other
financial performance targets for the periods ending December 31, 2002, 2003,
and 2004 with the maximum amount of payments being $1,000,000, $2,250,000, and
$2,500,000
8
respectively. The acquisition was accounted for under the purchase method of
accounting, and accordingly, the excess of the purchase price over the fair
value of identifiable assets acquired, less liabilities assumed, of
approximately $1,493,000 has been recorded as goodwill. In accordance with SFAS
No. 142 the Company is not required to amortize goodwill recognized in this
acquisition. The Company also recorded a $500,000 intangible asset attributable
to customer lists, which is being amortized using the straight-line method over
five years. The results of operations for BGI are included in the income
statement from the date of acquisition.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,055 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for under the purchase method of accounting, and
accordingly, the excess of the purchase price over the fair value of
identifiable tangible and intangible assets acquired, less liabilities assumed,
of approximately $0.4 million has been recorded as goodwill. In accordance with
SFAS No. 142, the Company is not required to amortize goodwill recognized in
this acquisition. The Company recorded a $146,000 intangible asset attributable
to core deposits, which is being amortized using the straight-line method over
seven years. The results of operations for BOA are included in the income
statement from the date of acquisition.
(4) Goodwill and Other Intangible Assets
The Company adopted the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002. Under SFAS No. 142, goodwill is no
longer amortized, but is reviewed for impairment at least annually. Identifiable
intangible assets acquired in a business combination are amortized over their
useful lives.
The following table presents the consolidated results of operations adjusted as
though the adoption of SFAS No. 142 occurred as of January 1, 2001.
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30, June 30,
(Dollars in thousands, except per share amounts) 2002 2001 2002 2001
---------- ---------- ---------- ----------
Reported net income $ 6,644 $ 5,185 $ 13,301 $ 9,990
Goodwill amortization add-back -- 413 -- 413
---------- ---------- ---------- ----------
Adjusted net income $ 6,644 $ 5,598 $ 13,301 $ 10,403
========== ========== ========== ==========
Basic earnings per share:
Reported $ 0.57 $ 0.44 $ 1.14 $ 0.84
Goodwill amortization add-back -- 0.04 -- 0.04
---------- ---------- ---------- ----------
Adjusted $ 0.57 $ 0.48 $ 1.14 $ 0.88
========== ========== ========== ==========
Diluted earnings per share:
Reported $ 0.56 $ 0.43 $ 1.12 $ 0.83
Goodwill amortization add-back -- 0.04 -- 0.04
---------- ---------- ---------- ----------
Adjusted $ 0.56 $ 0.47 $ 1.12 $ 0.87
========== ========== ========== ==========
9
Goodwill resulting from the previously disclosed mergers and acquisitions (see
Note 3) amounted to $37.3 million and $36.8 million at June 30, 2002 and
December 31, 2001, respectively. Goodwill amortization expense included in the
results of operations for the second quarter and first six months of 2001
amounted to $413,000. In accordance with SFAS No. 142, there is no goodwill
amortization included in the results of operations for the second quarter and
first six months of 2002.
The following table presents the change in the carrying amount of goodwill for
each of the reported business segments for the six months ended June 30, 2002:
Financial Services
BNB Group
(Dollars in thousands) Segment Segment Total
------- ------- -------
Balance as of December 31, 2001 $35,535 $ 1,294 $36,829
Goodwill adjustments (119) 199 80
Goodwill acquired during the period 401 - 401
------- ------- -------
Balance as of June 30, 2002 $35,817 $ 1,493 $37,310
======= ======= =======
Effective June 30, 2002 the BNB segment was tested for impairment and the
results indicated there was no impairment of goodwill.
The Company had other intangible assets of $2.2 million and $2.4 million at June
30, 2002 and December 31, 2001, respectively. The other intangible assets are
included in other assets on the Consolidated Statement of Financial Condition.
The following table details the major classes of amortizable intangible assets
as of June 30, 2002.
Gross Carrying Accumulated Net Carrying
(Dollars in thousands) Amount Amortization Amount
-------------- ------------- --------------
Other intangible assets
Core deposits $ 9,079 $ (7,266) $ 1,813
Customer list 500 (75) 425
------------- ------------- --------------
Total other intangible assets $ 9,395 $ (7,157) $ 2,238
============= ============= ==============
Intangible amortization was $216,000 and $430,000 for the quarter and six months
ended June 30, 2002, compared to $176,000 and $352,000 for the same periods last
year. Amortization of other intangible assets was computed using the
straight-line method over the estimated lives of the respective assets, which
range from 5 to 20 years. Estimated amortization expense in future years for
intangible assets is as follows:
Year ending December 31,
(Dollars in thousands)
2002 $ 882
2003 894
2004 477
2005 199
2006 163
Thereafter 53
-------
$ 2,668
=======
10
(5) Segment Information
Reportable segments are comprised of WCB, NBG, BNB, PSB, FTB and the Financial
Services Group.
The Financial Service Group is a new reportable segment, identified to include
the activities of BGI, FIGI and the trust activities of the Banks. The
reportable segment information as of and for the six months ended June 30, 2002
and 2001 follows:
(Dollars in thousands) 2002 2001
----------- -----------
Net interest income
WCB $ 12,226 $ 11,305
NBG 10,837 9,653
BNB 6,529 2,165
PSB 4,293 3,974
FTB 4,096 2,776
Financial Services Group -- --
----------- -----------
Total segment net interest income 37,981 29,873
Parent and eliminations, net (918) (299)
----------- -----------
Total net interest income $ 37,063 $ 29,574
=========== ===========
Revenue *
WCB $ 14,630 $ 13,193
NBG 13,338 11,597
BNB 7,793 2,630
PSB 5,158 5,034
FTB 4,873 3,359
Financial Services Group 2,630 826
----------- -----------
Total segment revenue 48,422 36,639
Parent and eliminations, net (1,265) (828)
----------- -----------
Total revenue $ 47,157 $ 35,811
=========== ===========
Net income
WCB $ 4,684 $ 4,011
NBG 4,485 3,822
BNB 2,246 404
PSB 1,254 1,317
FTB 1,405 823
Financial Services Group 59 26
----------- -----------
Total segment net income 14,133 10,403
Parent and eliminations, net (832) (413)
----------- -----------
Total net income $ 13,301 $ 9,990
=========== ===========
Assets
WCB $ 578,815 $ 535,945
NBG 585,521 521,597
BNB 446,748 346,904
PSB 184,474 181,007
FTB 187,327 132,946
Financial Services Group 3,113 348
----------- -----------
Total segment assets 1,985,998 1,718,747
Parent and eliminations, net (6,577) (3,551)
----------- -----------
Total assets $ 1,979,421 $ 1,715,196
=========== ===========
* Revenue is comprised of net interest income and noninterest income.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), that involve substantial risks and uncertainties. When used in
this report, or in the documents incorporated by reference herein, the words
"anticipate", "believe", "estimate", "expect", "intend", "may", and similar
expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. These
forward-looking statements are based on the current expectations of the Company
or the Company's management and are subject to a number of risks and
uncertainties, including but not limited to, economic, competitive, regulatory,
and other factors affecting the Company's operations, markets, products and
services, as well as expansion strategies and other factors discussed elsewhere
in this report filed by the Company with the Securities and Exchange Commission.
Many of these factors are beyond the Company's control.
The purpose of this discussion is to present material changes in the Company's
financial condition and results of operations during the three months and six
months ended June 30, 2002 to supplement the information in the consolidated
financial statements included in this report.
Overview
The following table and discussion present certain information that the Company
considers important in evaluating performance:
At or For the Three Months Ended June 30,
-----------------------------------------
2002 2001 $ Change % Change
---- ---- -------- --------
Per common share data:
Net income - basic $ 0.57 $ 0.44 $ 0.13 30%
Net income - diluted $ 0.56 $ 0.43 $ 0.13 30%
Adjusted net income - basic (excluding goodwill
amortization) $ 0.57 $ 0.48 $ 0.09 19%
Adjusted net income - diluted (excluding goodwill
amortization) $ 0.56 $ 0.47 $ 0.09 19%
Cash dividends declared $ 0.14 $ 0.12 $ 0.02 17%
Book value $ 13.23 $ 11.20 $ 2.03 18%
Common shares outstanding:
Weighted average shares - basic 11,067,393 10,987,210
Weighted average shares - diluted 11,223,097 11,135,205
Period end 11,090,881 10,987,862
Performance ratios, annualized:
Return on average assets 1.36% 1.33%
Return on average common equity 17.83% 15.92%
Common dividend payout ratio 24.56% 27.27%
Net interest margin (tax-equivalent) 4.39% 4.62%
Efficiency ratio 51.05% 48.47%
Asset quality ratios:
Nonperforming loans to total loans 0.87% 0.95%
Nonperforming assets to total loans and other real estate 0.99% 1.05%
Net loan charge-offs to average loans 0.24% 0.14%
Allowance for loan losses to total loans 1.62% 1.58%
Allowance for loan losses to nonperforming loans 187% 166%
Capital ratios:
Average common equity to average total assets 7.18% 7.72%
Leverage ratio 7.05% 7.60%
Tier 1 risk based capital ratio 10.16% 9.85%
Risk-based capital ratio 11.42% 11.11%
12
Second quarter net income increased 28% to $6,644,000 for 2002 compared to
$5,185,000 for the second quarter of 2001. Diluted earnings per common share
increased to $0.56 for the second quarter of 2002 compared to $0.43 in the 2001
period. Net income for the first six months of 2002 increased 33% to $13,301,000
compared to $9,990,000 for the same period in 2001. Diluted earnings per share
increased to $1.12 for the first six months of 2002, compared to $0.83 for the
same period in 2001. Return on average common equity was 18.32% for the six
months ended June 30, 2002. In accordance with a new accounting standard,
goodwill is no longer amortized effective January 1, 2002. In the second quarter
of 2001 and for the first six months of 2001, goodwill amortization, none of
which was tax deductible, was $413,000. Accordingly, net income for the second
quarter of 2001 and for the six months ended June 30, 2001 would have been
$5,598,000 (or $0.47 per diluted common share) and $10,403,000 (or $0.87 per
diluted common share), respectively, excluding the effect of goodwill
amortization. This would equate to a $1,046,000 or 19% increase in second
quarter 2002 net income compared to the same period in 2001 and a $2,808,000 or
27% increase in net income for the first six months of 2002 compared to 2001.
Lending Activities
Set forth below is selected information concerning the composition of the
Company's loan portfolio at the dates indicated.
June 30, December 31, June 30,
(Dollars in thousands) 2002 2001 2001
------------------- ------------------- ------------------
Commercial $ 248,427 20.0% $ 232,379 19.9% $ 224,650 19.9%
Commercial real estate 318,283 25.6 274,702 23.6 248,577 22.0
Agricultural 209,689 16.9 186,623 16.0 179,467 15.9
Residential real estate 232,954 18.8 240,141 20.6 247,300 21.9
Consumer and home equity 232,587 18.7 232,205 19.9 230,421 20.3
---------- ---- ---------- ---- ---------- ----
Total loans gross 1,241,940 100.0 1,166,050 100.0 1,130,415 100.0
Allowance for loan losses (20,121) (19,074) (17,815)
---------- ---------- ----------
Total loans, net $ 1,221,819 $ 1,146,976 $ 1,112,600
========== ========== ==========
The loan growth relates primarily to the expansion of the commercial, commercial
real estate and agricultural loan portfolios as the Company targets the suburban
markets of Erie and Monroe County. Commercial loans increased $16.0 million and
$23.8 million over December 31, 2001 and June 30, 2001, respectively. Commercial
real estate loans increased $43.6 million and $69.7 million over December 31,
2001 and June 30, 2001, respectively. Agricultural loans increased $23.0 million
and $30.2 million over December 31, 2001 and June 30, 2001, respectively.
Conversely, the table indicates the declining percentage of residential real
estate loans to total loans, which is a direct result of the Company's decision
to sell most newly originated residential mortgages. Residential mortgage loans
sold with servicing retained amounted to $280.3 million, $245.4 million and
$202.3 million at June 30, 2002, December 31, 2001 and June 30, 2001,
respectively. Loans held for sale amounted to $5.6 million, $10.6 million and
$3.8 million at June 30, 2002, December 31, 2001 and June 30, 2001,
respectively.
13
Nonaccruing Loans and Nonperforming Assets
Nonperforming assets increased to $12.3 million at June 30, 2002. The Company's
ratio of nonperforming loans to total loans of 0.87% at June 30, 2002, increased
slightly from the ratio of 0.86% at December 31, 2001. The overall level of
nonperforming assets as a percentage of total loans and other real estate was
0.99% at June 30, 2002, comparable to 0.94% at December 31, 2001.
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets at the dates indicated.
June 30, December 31, June 30,
(Dollars in thousands) 2002 2001 2001
-------- -------------- --------
Nonaccruing loans (1)
Commercial $ 2,156 $ 2,623 $ 3,075
Commercial real estate 4,252 3,344 2,406
Agricultural 1,385 1,529 2,787
Residential real estate 1,447 921 1,111
Consumer and home equity 590 541 676
-------- -------------- --------
Total nonaccruing loans 9,830 8,958 10,055
Accruing loans 90 days or more delinquent 943 1,064 650
-------- -------------- --------
Total nonperforming loans 10,773 10,022 10,705
Other real estate owned 1,539 947 1,212
-------- -------------- --------
Total nonperforming assets $ 12,312 $ 10,969 $ 11,917
======== ============== ========
Total nonperforming loans to total loans 0.87% 0.86% 0.95%
Total nonperforming assets to total loans and other real estate 0.99% 0.94% 1.05%
(1) Loans are placed on nonaccrual status when they become 90 days or more
past due or if they have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
14
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the estimated amount of credit losses
inherent in the loan portfolio. Periodic, systematic reviews of each banks'
portfolios are performed to identify inherent losses. These reviews result in
the identification and quantification of loss factors, which are used in
determining the amount of the allowance for loan losses. In addition, the
Company periodically evaluates prevailing economic and business conditions,
industry concentrations, changes in the size and characteristics of the
portfolio and other pertinent factors. The allowance for loan losses is
allocated to cover the estimated losses inherent in each loan category based on
the results of this detailed review. The process used by the Company to
determine the appropriate overall allowance for loan losses is based on this
analysis.
The following table sets forth the activity in the allowance for loan losses for
the periods indicated.
Three Months Ended Six Months Ended
-------------------- --------------------
June 30, June 30,
(Dollars in thousands) 2002 2001 2002 2001
-------- -------- -------- --------
Balance at beginning of period $ 19,483 $ 14,466 $ 19,074 $ 13,883
Addition as a result of acquisition 174 2,686 174 2,686
Chargeoffs:
Commercial 528 60 755 114
Commercial real estate 47 7 191 66
Agricultural -- -- 29 --
Residential real estate 6 103 35 103
Consumer and home equity 371 348 675 348
-------- -------- -------- --------
Total charge-offs 952 518 1,685 824
Recoveries:
Commercial 10 7 19 14
Commercial real estate 68 -- 71 10
Agricultural 5 -- 36 --
Residential real estate 54 -- 54 --
Consumer and home equity 98 148 190 209
-------- -------- -------- --------
Total recoveries 235 155 370 233
-------- -------- -------- --------
Net charge-offs 717 363 1,315 591
Provision for loan losses 1,181 1,026 2,188 1,837
-------- -------- -------- --------
Balance at end of period $20,121 $ 17,815 $ 20,121 $ 17,815
======== ======== ======== ========
Ratio of net loan charge-offs to average loans (annualized) 0.24% 0.14% 0.22% 0.12%
Ratio of allowance for loan losses to total loans 1.62% 1.58% 1.62% 1.58%
Ratio of allowance for loan losses to nonperforming loans 187% 166% 187% 166%
The higher level of charge-offs during the second quarter and first six months
of 2002 reflects an overall softening of economic conditions in the Company's
markets.
15
Investing Activities
U.S. Treasury and Agency Securities: At June 30, 2002, the U.S. Treasury and
Agency securities portfolio totaled $126.1 million, of which $124.1 million was
classified as available for sale. The portfolio consisted of $3.1 million in U.
S. Treasury securities and $123.0 million in U. S. federal agency securities.
The U. S. federal agency security portfolio consists almost exclusively of
callable securities. At December 31, 2001, the U.S. Treasury and Agency
securities portfolio totaled $185.4 million, of which $183.5 million was
classified as available for sale. The decline in U.S. Agency securities is
attributed to a re-positioning of the portfolio in an effort to lessen the
exposure to callable securities.
State and Municipal Obligations: At June 30, 2002, the portfolio of state and
municipal obligations totaled $209.2 million, of which $157.4 million was
classified as available for sale and $51.8 million was classified as held to
maturity. At December 31, 2001, the portfolio of state and municipal obligations
totaled $202.6 million, of which $143.2 million was classified as available for
sale.
Mortgage-Backed Securities: At June 30, 2002, the Company had $259.8 million in
mortgage-backed securities, all classified as available for sale. At December
31, 2001, the Company had $90.0 million in mortgage-backed securities, all
classified as available for sale. The significant increase in mortgage-backed
securities relates to providing for the collateral needs of the Company's
expanding municipal banking business, as well as the investment of funds made
available from the aforementioned re-positioning of callable Agency securities.
This class of securities provides the most attractive yields consistent with the
liquidity and re-pricing characteristics of municipal deposits.
Corporate Bonds: The corporate bond portfolio at June 30, 2002 totaled $8.1
million, all of which was classified as available for sale. The portfolio was
purchased to further diversify the investment portfolio and increase investment
yield. The Company's investment policy limits investments in corporate bonds to
no more than 10% of total investments and to bonds rated at inception as Baa or
better by Moody's Investors Service, Inc. or BBB or better by Standard & Poor's
Ratings Services. The corporate bond portfolio at December 31, 2001 totaled $7.9
million, all of which was classified as available for sale.
Equity Securities: At June 30, 2002, equity securities totaled $3.9 million, all
of which was classified as available for sale. Included in the portfolio is $3.0
million of FHLMC preferred stock. At December 31, 2001, equity securities
totaled $3.8 million, all of which was classified as available for sale.
Equity Method Investments: On February 28, 2002, the Company invested $2.5
million in Mercantile Adjustment Bureau, LLC (MAB), a full-service accounts
receivable management firm located in Rochester, New York. The CompanyI has a
50% equity interest in MAB that is accounted for under the equity method of
accounting.
16
Funding Activities
Deposits: The banks offer a broad array of core deposit products including
checking accounts, interest-bearing transaction accounts, savings and money
market accounts and certificates of deposit under $100,000. These core deposits
totaled $1.4 billion or 86.8% of total deposits of $1.6 billion at June 30,
2002. The core deposit base consists almost exclusively of in-market accounts.
The Company had total public deposits of $374.1 million at June 30, 2002
compared to $292.6 million at December 31, 2001. The increase is a result of the
Company's continuing expansion in this line of business as market opportunities
have arisen from the exit of competitors. Core deposits are supplemented with
certificates of deposit over $100,000, which amounted to $211.7 million as of
June 30, 2002, largely from in-market municipal, business and individual
customers. As of June 30, 2002, brokered certificates of deposit included in
certificates of deposit over $100,000 totaled $59.8 million.
Total deposits at December 31, 2001 amounted to $1.4 billion. Core deposit
products were $1.2 million or 83.6% of total deposits at December 31, 2001.
Certificates of deposit over $100,000 totaled $234.5 million at December 31,
2001, which included $45.0 million in brokered certificates of deposit.
Non-Deposit Sources of Funds: The Company's most significant source of
non-deposit funds are FHLB borrowings. FHLB advances outstanding as of June 30,
2002 amounted to $115.0 million and include both short and long-term advances,
which mature on various dates through 2011. The Company had $3.3 million of
remaining credit available under lines of credit with the FHLB at June 30, 2002,
which are collateralized by FHLB stock and real estate mortgage loans. As of
December 31, 2001, FHLB advances outstanding amounted to $107.3 million. The
Company also utilizes securities sold under agreements to repurchase as a source
of funds. The short-term repurchase agreements amounted to $43.0 million and
$44.0 million as of June 30, 2002 and December 31, 2001, respectively.
In 2001, the Company established FISI Statutory Trust I (the "Trust") . The
Trust issued 30 year guaranteed preferred beneficial interests in junior
subordinated debentures of the Company ("capital securities") in the aggregate
amount of $16.2 million at a fixed rate of 10.2%. The Company used the net
proceeds from the sale of the capital securities to partially fund the
acquisition of BNB. As of June 30, 2002, virtually all of the capital securities
qualified as Tier I capital under regulatory definitions. Since the capital
securities are classified as debt for financial statement purposes, the
tax-deductible expense associated with the capital securities is recorded as
interest expense in the consolidated statements of income. Also, in 2001, the
Company obtained lines of credit with the Federal Agricultural Mortgage Corp.
(Farmer Mac) permitting borrowings to a maximum of $50.0 million. As of June 30,
2002, there were no advances outstanding against the Farmer Mac lines.
Net Income Analysis
Average Balance Sheet
The table on the following page sets forth certain information relating to the
Company's consolidated statements of financial condition and reflects the
average yields earned on interest-earning assets, as well as the average rates
paid on interest-bearing liabilities as of and for the three months ended June
30, 2002 and 2001. Such yields and rates were derived by dividing interest
income or expense by the average balances of interest-earning assets or
interest-bearing liabilities, respectively, for the periods shown. Tax
equivalent adjustments have been made. All average balances are average daily
balances. Nonaccruing loans are included in the yield calculations in this
table.
17
For The Three Months Ended June 30,
2002 2001
---- ----
Average Interest Annualized Average Interest Annualized
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(Dollars in thousands) Balance Paid Rate Balance Paid Rate
----------- --------- ----------- ----------- ----------- -----------
Interest-earning assets:
Federal funds sold and interest-bearing
deposits $ 42,653 $ 187 1.76% $ 17,594 $ 200 4.56%
Investment securities (1):
Taxable 374,085 5,109 5.46% 243,271 3,760 6.18%
Non-taxable 208,202 3,292 6.32% 162,946 2,734 6.71%
----------- --------- ----------- ----------- ----------- -----------
Total investment securities 582,287 8,401 5.77% 406,215 6,494 6.40%
Loans (2):
Commercial and agricultural 752,234 13,184 7.03% 603,022 13,152 8.75%
Residential real estate 229,443 4,697 8.19% 227,889 5,170 9.07%
Consumer and home equity 229,805 4,609 8.04% 215,438 5,095 9.49%
----------- --------- ----------- ----------- ----------- -----------
Total loans 1,211,482 22,490 7.44% 1,046,349 23,417 8.97%
----------- --------- ----------- ----------- ----------- -----------
Total interest-earning assets 1,836,422 31,078 6.78% 1,470,158 30,111 8.21%
----------- --------- ----------- ----------- ----------- -----------
Allowance for loan losses (19,879) (16,496)
Other non-interest earning assets 147,338 115,534
----------- -----------
Total assets $ 1,963,881 $ 1,569,196
=========== ===========
Interest-bearing liabilities:
Interest-bearing checking 364,355 1,381 1.52% 157,470 463 1.18%
Savings and money market 366,501 1,515 1.66% 245,749 1,332 2.17%
Certificates of deposit 647,363 6,143 3.81% 724,242 9,864 5.46%
Borrowed funds 179,773 1,482 3.31% 89,634 1,089 4.87%
Guaranteed preferred beneficial interests in
Corporation's junior subordinated
debentures 16,200 419 10.37% 16,200 419 10.37%
----------- --------- ----------- ----------- ----------- -----------
Total interest-bearing liabilities 1,574,192 10,940 2.79% 1,233,295 13,167 4.28%
----------- --------- ----------- ----------- ----------- -----------
Non-interest bearing demand deposits 212,738 176,794
Other non-interest-bearing liabilities 18,179 20,164
----------- -----------
Total liabilities 1,805,109 1,430,253
Shareholders' equity (3) 158,772 138,943
----------- -----------
Total liabilities and
shareholders' equity $ 1,963,881 $ 1,569,196
=========== ===========
Net interest income $ 20,138 $ 16,944
========= ===========
Net interest rate spread 3.99% 3.93%
=========== ===========
Net earning assets $ 262,230 $ 236,863
=========== ===========
Net interest income as a percentage of
average interest-earning assets (4) 4.39% 4.62%
=========== ===========
Ratio of average interest-earning assets to
average interest-bearing liabilities 116.66% 119.21%
=========== ===========
(1) Amounts shown are amortized cost for held to maturity securities and fair
value for available for sale securities. In order for pre-tax income and
resultant yields on tax-exempt securities to be comparable to those on
taxable securities and loans, a tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal rate
of 35%.
(2) Net of deferred loan fees and costs, and loan discounts and premiums.
(3) Includes after-tax net unrealized gains (losses) on securities available
for sale.
(4) The net interest margin is equal to net interest income divided by average
interest-earning assets and is presented on an annualized basis.
18
Net Interest Income
Net interest income, the principal source of the Company's earnings, increased
19% to $18,986,000 compared to $15,985,000 in the second quarter of 2001. Second
quarter 2002 average earning asset growth of 25% over second quarter 2001,
primarily drove the increase in net interest income, as net interest margin
decreased to 4.39% from 4.62% for those periods. The growth in average earning
assets is the result of the continuing expansion of the commercial loan and
investment security portfolios. The increase in investment securities relates to
the placement of funds generated from growth in municipal deposits. The net
interest rate spread on incremental loan and investment assets has declined,
creating a drop in the overall net interest margin.
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's tax equivalent interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to: (1) changes attributable to changes in volume (changes
in volume multiplied by the current year rate); (2) changes attributable to
changes in rate (changes in rate multiplied by the prior year volume); and (3)
the net change. The changes attributable to the combined impact of volume and
rate have been allocated proportionately to the changes due to volume and
changes due to rate.
2nd Quarter 2002 Compared to 2nd Quarter 2001
---------------------------------------------
Increase (Decrease) Due to Total Increase/
(Dollars in thousands) Volume Rate (Decrease)
------- ------- ---------------
Interest-earning assets:
Federal funds sold and interest-bearing deposits $ 110 $ (123) (13)
Investment securities:
Taxable 1,798 (440) 1,358
Non-taxable 709 (160) 549
------- ------- ---------------
Total investment securities 2,507 (600) 1,907
------- ------- ---------------
Loans:
Commercial and agricultural 2,694 (2,662) 32
Residential real estate 32 (505) (473)
Consumer and home equity 285 (771) (486)
------- ------- ---------------
Total loans 3,011 (3,938) (927)
------- ------- ---------------
Total interest-earning assets 5,628 (4,661) 967
Interest-bearing liabilities:
Interest-bearing checking 785 133 918
Savings and money market 486 (303) 183
Certificates of deposit (732) (2,989) (3,721)
Borrowed funds 740 (347) 393
Guaranteed preferred beneficial interests in
Corporation's junior subordinated debentures _ _ _
------- ------- ---------------
Total interest-bearing liabilities 1,279 (3,506) (2,227)
------- ------- ---------------
Net interest income $ 4,349 $(1,155) 3,194
======= ======= ===============
19
Provision for Loan Losses
The provision for loan losses for the second quarter of 2002 was $1.2 million,
compared to $1.0 million for the 2002 quarter. For the first six months of 2002
the provision was $2.2 million, compared to $1.8 million for the same period in
2001. Net loan charge-offs were $717,000 for the first quarter of 2002 or 0.24%
of average loans compared to $363,000 or 0.14% of average loans in the same
period last year. The higher loan charge-offs reflect the effects of the
expansion of the loan portfolio. Nonetheless, the ratio of nonperforming assets
to total loans and other real estate of 0.99% at June 30, 2002, has improved
slightly from 1.05% a year ago. Similarly, the ratio of the allowance for loan
losses to nonperforming loans improved to 187% at June 30, 2002, from 166% a
year earlier. The ratio of the allowance for loan losses to total loans also
shows slight improvement to 1.62% at June 30, 2002 versus 1.58% a year earlier.
Noninterest Income
Noninterest income increased 49% in the second quarter of 2002 to $5.2 million
from $3.5 million for the second quarter of 2001. This increase can be
attributed to a combination of fees and commissions generated by BGI, our newly
acquired employee benefits administration and compensation consulting firm, as
well as the growth in deposits and the related service fees. Financial Services
Group fees and commissions, which include BGI revenue, were $2.6 million for the
first six months of 2002, an increase of $1.8 million from the same period last
year. BGI accounts for $1.6 million of this increase, with the remainder
relating to the ongoing expansion of the Company's investment brokerage and
trust businesses. Mortgage banking revenues totaled $1.2 million during the
first six months of 2002, up from $0.9 million for the same period last year.
The increase can be attributed to the growth in the sold and serviced
residential mortgage loan portfolio, which totaled $280 million as of June 30,
2002, a 39% increase from $202 million as of June 30, 2001.
Noninterest Expense
Noninterest expense for the second quarter of 2002 totaled $13.1 million
compared with $10.4 million for the second quarter of 2001. The increase relates
to the ongoing additions of staff and other resources necessary to support our
continuing expansion of lending activities, product lines and delivery channels
as well as the addition of BGI, BNB and BOA. While these additions have better
positioned the Company for future asset and earnings growth, they contributed to
an increase in our efficiency ratio for the second quarter of 2002 to 51.1%,
compared to 48.5% for the same period a year ago. The efficiency ratio for the
first six months of 2001 was 49.9% compared to 47.9% for the same period last
year.
Income Tax Expense
The provision for income taxes provides for Federal and New York State income
taxes, which amounted to $6.5 million and $5.3 million for the six months ended
June 30, 2002 and 2001, respectively. While the increase corresponds to
increased levels of taxable income, the effective tax rate for the first six
months of 2002 decreased to 32.7%, compared to 34.8% for the first six months of
2001 as a result of an increase in holdings of tax-exempt securities.
20
Liquidity and Capital Resources
Liquidity
The objective of maintaining adequate liquidity is to assure the ability of the
Company and its subsidiaries to meet their financial obligations. These
obligations include the withdrawal of deposits on demand or at their contractual
maturity, the repayment of borrowings as they mature, the ability to fund new
and existing loan commitments and the ability to take advantage of new business
opportunities. The Company and its subsidiaries achieve liquidity by maintaining
a strong base of core customer funds, maturing short-term assets, the ability to
sell securities, lines of credit, and access to capital markets.
Liquidity at the subsidiary bank level is managed through the monitoring of
anticipated changes in loans, core deposits, and wholesale funds. The strength
of the subsidiary bank's liquidity position is a result of its base of core
customer deposits. These core deposits are supplemented by wholesale funding
sources which include credit lines with other banking institutions, the FHLB,
Farmer Mac, and the Federal Reserve Bank.
The primary source of liquidity for the parent company is dividends from
subsidiaries, lines of credit, and access to capital markets. Dividends from
subsidiaries are limited by various regulatory requirements related to capital
adequacy and earnings trends. The Company's subsidiaries rely on cash flows from
operations, core deposits, borrowings, short-term liquid assets, and, in the
case of non-banking subsidiaries, funds from the parent company.
The Company's cash and cash equivalents were $45.1 million at June 30, 2002, a
decrease of $8.1 million from the balance of $53.2 million at December 31, 2001.
The decrease results primarily from a decrease in cash on hand and cash items in
process as of the current quarter-end.
In the normal course of business the Company has outstanding commitments to
extend credit which are not reflected in the Company's consolidated financial
statements. The commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. At June 30, 2002 letters
of credit totaling $9 million and unused loan commitments and lines of credit of
$279 million were contractually available. Comparable amounts for these
commitments at December 31, 2001 were $9 million and $266 million, respectively.
The total commitment amounts do not necessarily represent future cash
requirements as many of the commitments are expected to expire without funding.
Capital Resources
The Federal Reserve Board has adopted a system using risk-based capital
guidelines to evaluate the capital adequacy of bank holding companies. The
guidelines require a minimum total risk-based capital ratio of 8.0%. A leverage
ratio is also utilized in assessing capital adequacy, with a minimum requirement
that can range from 3.0% to 5.0%.
The Company's Tier 1 leverage ratio was 7.05% and 7.02% at June 30, 2002 and
December 31, 2001, respectively, well-above minimum regulatory capital
requirements. Total Tier 1 capital of $135.5 million at June 30, 2002 increased
$14.9 million from $120.6 million at December 31, 2001. The increase in Tier 1
capital relates primarily to the $9.6 million increase in retained earnings
resulting from the Company's first six months 2002 earnings net of dividend
payouts, and a $3.6 million increase in accumulated other comprehensive income
resulting from the increase in the net unrealized gain on securities available
for sale during the first six months of 2002.
The Company's total risk-weighted capital ratio was 11.42% at June 30, 2002,
comparable to 11.37% at December 31, 2001, both well-above minimum regulatory
capital requirements. Total risk-based capital was $152.3 million at June 30,
2002, an increase of $12.4 million from $139.9 million at December 31, 2001.
21
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk to the Company given its business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Company's Board of Directors. The Company's senior management is
responsible for reviewing with the Board its activities and strategies, the
effect of those strategies on the net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the
portfolio and exposure limits. Senior management develops an Asset-Liability
Policy that meets strategic objectives and regularly reviews the activities of
the subsidiary banks. Each subsidiary bank board adopts an Asset-Liability
Policy within the parameters of the overall FII Asset-Liability Policy and
utilizes an asset/liability committee comprised of senior management of the bank
under the direction of the bank's board.
Management of the Company's interest rate risk requires the selection of
appropriate techniques and instruments to be utilized after considering the
benefits, costs and risks associated with available alternatives. Since the
Company does not utilize derivative instruments, management's techniques usually
consider one or more of the following: (1) interest rates offered on products,
(2) maturity terms offered on products, (3) types of products offered, and (4)
products available to the Company in the wholesale market such as advances from
the FHLB.
The Company uses a net interest income and economic value of equity model as one
method to identify and manage its interest rate risk profile. The model is based
on expected cash flows and repricing characteristics for all financial
instruments and incorporates market-based assumptions regarding the impact of
changing interest rates on these financial instruments. Assumptions based on the
historical behavior of deposit rates and balances in relation to changes in
interest rates are also incorporated into the model. These assumptions are
inherently uncertain and, as a result, the model cannot precisely measure net
interest income or precisely predict the impact of fluctuations in interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude, and frequency of interest rate changes as well as
changes in market conditions and management strategies. The Company has
experienced no significant changes in market risk due to changes in interest
rates since the Company filed its 2001 Annual Report on Form 10-K, dated March
11, 2002, with the Securities and Exchange Commission.
Management also uses a static gap analysis to identify and manage the Company's
interest rate risk profile. Interest sensitivity gap ("gap") analysis measures
the difference between the assets and liabilities repricing or maturing within
specific time periods.
22
PART II -- OTHER INFORMATION
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Item 1. Legal Proceedings
The Company is not involved in any material pending legal proceedings,
other than the ordinary routine litigation occurring in the normal course
of its business.
Item 2. Changes in Securities
(c) On October 22, 2001 the Company acquired the Burke Group, Inc.
("BGI"). BGI's shareholders received cash and shares of the Company's Common
Stock which were not registered under the Securities Act of 1933 in reliance
upon the exemption provided in Section 4(2) of the Act. On April 1, 2002 the
Company issued an additional 17,848 shares of its Common Stock to BGI's former
shareholders based on BGI's achievement of performance criteria for the period
ending December 31, 2001 also in reliance upon the exemption provided in Section
4(2) of the Securities Act.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Shareholders held May 8, 2002,
shareholders elected the directors listed below for a term of three years. The
voting results were as follows:
Number of Votes
---------------
Broker
Nominee For Withheld Abstain Non-Votes
- ------- ----------- -------- ------- -------------
Peter G. Humphrey 10,179,776 177,016 -- --
Barton P. Dambra 10,342,879 13,913 -- --
John E. "Jack" Benjamin 10,334,085 22,497 -- --
Pamela Davis Heilman 10.334.295 22,707 -- --
Susan R. Holliday 10,343,079 13,713 -- --
Item 5. Other Information
None.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits. None.
(b) Reports on Form 8-K. The Company filed no Current Reports on Form 8-K
during the quarter ended June 30, 2002.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
FINANCIAL INSTITUTIONS, INC.
Signatures Title Date
/s/ Peter G. Humphrey President, Chief Executive Officer August 12, 2002
- ---------------------
Peter G. Humphrey (Principal ExecutiveOfficer),
Chairman of the Board and Director
/s/ Ronald A. Miller Senior Vice President and August 12, 2002
- ---------------------
Ronald A. Miller Chief Financial Officer
(Principal Accounting Officer)
24