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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 SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________to _________________
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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 NOVEMBER 1, 2002
----- -------------------------------
Common Stock, $0.01 par value 11,103,498 shares
FINANCIAL INSTITUTIONS, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Condition as of
September 30, 2002 and December 31, 2001 3
Consolidated Statements of Income for the three months and
nine months ended September 30, 2002 and 2001 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and 2001 5
Consolidated Statement of Changes in Shareholders' Equity and
Comprehensive Income for the nine months ended
September 30, 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 23
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 26
2
Item 1. Financial Statements
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
(Dollars in thousands, except per share amounts) 2002 2001
------------ -------------
Assets
Cash, due from banks and interest-bearing deposits $ 46,423 $ 52,171
Federal funds sold 26,877 1,000
Securities available for sale, at fair value 546,772 428,423
Securities held to maturity (fair value of $51,102 and $62,317
at September 30, 2002 and December 31, 2001, respectively) 50,461 61,281
Loans, net 1,258,551 1,146,976
Premises and equipment, net 25,504 24,467
Goodwill 37,293 36,829
Other assets 41,774 43,149
----------- -----------
Total assets $ 2,033,655 $ 1,794,296
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand $ 229,331 $ 224,628
Savings, money market and interest-bearing checking 748,424 572,563
Certificates of deposit 672,233 636,467
----------- -----------
Total deposits 1,649,988 1,433,658
Short-term borrowings 67,674 103,770
Long-term borrowings 105,187 70,419
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 16,200 16,200
Accrued expenses and other liabilities 21,272 21,062
----------- -----------
Total liabilities 1,860,321 1,645,109
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares at September 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 September 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 September 30, 2002 and December 31, 2001 113 113
Additional paid-in capital 19,318 17,195
Retained earnings 127,200 112,786
Accumulated other comprehensive income 9,835 2,176
Treasury stock, at cost - 211,952 shares at September 30, 2002
and 282,219 shares at December 31, 2001 (884) (835)
----------- -----------
Total shareholders' equity 173,334 149,187
----------- -----------
Total liabilities and shareholders' equity $ 2,033,655 $ 1,794,296
=========== ===========
See accompanying notes to consolidated financial statements.
3
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
(Dollars in thousands, except per share amounts) 2002 2001 2002 2001
-------- ------- ------- --------
Interest income:
Loans $23,078 $24,090 $67,613 $68,354
Securities 7,194 6,096 20,840 16,451
Other 71 45 377 332
------- ------- ------- -------
Total interest income 30,343 30,231 88,830 85,137
------- ------- ------- -------
Interest expense:
Deposits 8,932 11,163 26,629 34,018
Borrowings 1,457 1,509 4,347 3,386
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 421 421 1,258 1,021
------- ------- ------- -------
Total interest expense 10,810 13,093 32,234 38,425
------- ------- ------- -------
Net interest income 19,533 17,138 56,596 46,712
Provision for loan losses 1,452 1,563 3,640 3,400
------- ------- ------- -------
Net interest income after
provision for loan losses 18,081 15,575 52,956 43,312
------- ------- ------- -------
Noninterest income:
Service charges on deposits 2,803 2,177 7,737 5,220
Financial services group fees and commissions 1,453 433 4,083 1,259
Mortgage banking revenues 439 507 1,656 1,444
Gain on securities transactions 139 84 39 442
Other 853 801 2,266 1,874
------- ------- ------- -------
Total noninterest income 5,687 4,002 15,781 10,239
------- ------- ------- -------
Noninterest expense:
Salaries and employee benefits 7,401 5,856 21,829 16,122
Occupancy and equipment 1,840 1,566 5,381 4,313
Supplies and postage 606 556 1,796 1,465
Amortization of intangible assets 226 796 656 1,561
Professional fees 438 229 1,099 917
Other 2,907 2,306 7,850 5,584
------- ------- ------- -------
Total noninterest expense 13,418 11,309 38,611 29,962
------- ------- ------- -------
Income before income taxes 10,350 8,268 30,126 23,589
Income taxes 3,466 2,908 9,941 8,239
------- ------- ------- -------
Net income $ 6,884 $ 5,360 $20,185 $15,350
======= ======= ======= =======
Earnings per common share:
Basic $ 0.59 $ 0.45 $ 1.72 $ 1.29
Diluted $ 0.58 $ 0.45 $ 1.70 $ 1.28
See accompanying notes to consolidated financial statements.
4
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months Ended
September 30,
-------------
(Dollars in thousands) 2002 2001
---------- ----------
Cash flows from operating activities:
Net income $ 20,185 $ 15,350
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,005 4,043
Provision for loan losses 3,640 3,400
Deferred income tax benefit (564) (1,006)
Gain on securities transactions (39) (442)
Gain on sale of loans (1,028) (850)
Loss on sale of other assets 133 29
Minority interest in net income of subsidiaries 166 74
Increase in other assets (92) (2,668)
(Decrease) increase in accrued expenses and other liabilities (893) 6,425
--------- ---------
Net cash provided by operating activities 25,513 24,355
Cash flows from investing activities:
Purchase of securities:
Available for sale (410,778) (268,850)
Held to maturity (25,984) (16,580)
Proceeds from maturity and call of securities:
Available for sale 261,988 206,227
Held to maturity 36,689 26,908
Proceeds from sale of securities available for sale 44,802 9,538
Investment in Mercantile Adjustment Bureau, LLC (2,500) --
Increase in loans, net (103,953) (63,722)
Proceeds from sales of premises and equipment 5 29
Purchase of premises and equipment (3,197) (3,664)
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 (198,150) (159,069)
Cash flows from financing activities:
Increase in deposits, net 199,560 121,592
(Decrease) increase in short-term borrowings, net (36,096) 15,502
Proceeds from long-term borrowings 35,059 14,501
Repayment of long-term borrowings (291) (131)
Proceeds from guaranteed preferred beneficial interests in
Company's junior subordinated debentures, net of costs -- 15,713
Purchase of preferred and common shares (384) (14)
Issuance of preferred and common shares 459 27
Dividends paid (5,541) (4,858)
--------- ---------
Net cash provided by financing activities 192,766 162,332
--------- ---------
Net increase in cash and cash equivalents 20,129 27,618
Cash and cash equivalents at the beginning of the period 53,171 30,152
--------- ---------
Cash and cash equivalents at the end of the period $ 73,300 $ 57,770
========= =========
Supplemental cash flow information: Cash paid during period for:
Interest $ 34,493 $ 36,199
Income taxes 11,226 9,210
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 STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Accumulated
Other
3% 8.48% Additional Comprehensive Total
(Dollars in thousands, Preferred Preferred Common Paid-in Retained Income Treasury Shareholders'
except per share amounts) Stock Stock Stock Capital Earnings (Loss) Stock Equity
----- ----- ----- ------- -------- ------- ----- ------
Balance - December 31, 2001 $167 $17,585 $113 $17,195 $ 112,786 $ 2,176 $(835) $ 149,187
Purchase of 15,305 shares of common stock -- -- -- -- -- -- (384) (384)
Issue 2,989 shares of common stock-directors plan -- -- -- 58 -- -- 12 70
Issue 17,699 shares of common stock- employee
stock option plan -- -- -- 316 -- -- 73 389
Issue 17,848 shares of common stock- Burke
Group, Inc. contingent earnout -- -- -- 431 -- -- 69 500
Issue 47,036 shares of common stock - acquisition
of Bank of Avoca -- -- -- 1,318 -- -- 181 1,499
Comprehensive income:
Net income -- -- -- -- 20,185 -- -- 20,185
Unrealized gain on securities available
for sale (net of tax of $5,235) -- -- -- -- -- 7,682 -- 7,682
Reclassification adjustment for gains
included in net income (net of tax of $(16)) -- -- -- -- -- (23) -- (23)
---------
Net unrealized gain on securities available
for sale (net of tax of $5,219) -- -- -- -- -- -- -- 7,659
---------
Total comprehensive income -- -- -- -- -- -- -- 27,844
---------
Cash dividends declared:
3% Preferred - $2.75 per share -- -- -- -- (4) -- -- (4)
8.48% Preferred - $6.36 per share -- -- -- -- (1,118) -- -- (1,118)
Common - $0.42 per share -- -- -- -- (4,649) -- -- (4,649)
---- ------- ---- ------- --------- ------- ----- ---------
Balance - September 30, 2002 $167 $17,585 $113 $19,318 $ 127,200 $ 9,835 $(884) $ 173,334
==== ======= ==== ======= ========= ======= ===== =========
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 unaudited financial statements include the accounts of FII, its
four banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The
National Bank of Geneva (99.30% owned) ("NBG"), 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
strategically merged The Pavilion State Bank ("PSB") operations with WCB and NBG
based on geography. This combination of entities under common control was
accounted for on a historical cost basis.
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 unaudited 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 accompanying unaudited
consolidated financial statements are unaudited
The consolidated unaudited 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.
The accompanying consolidated financial statements are unaudited and include the
accounts of FII and its subsidiaries. In the opinion of management, all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation have been reflected. The accompanying unaudited consolidated
financial statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's Annual Report
on Form 10-K.
7
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.
In October 2002, FASB issued SFAS No. 147, "Acquisitions of Certain Financial
Institutions", an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9 (SFAS 147). This statement removes acquisitions of
financial institutions from the scope of both Statement No.72 and Interpretation
No. 9 and requires that those transactions, which constitute a business, be
accounted for in accordance with SFAS No. 141 and SFAS No. 142. Thus, the
requirement in paragraph 5 of Statement No. 72 to recognize (and subsequently
amortize) any excess of the fair value of liabilities assumed over the fair
value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset no longer applies to acquisitions within the
scope of SFAS 147. SFAS 147 also clarifies that an acquisition that does not
meet the definition of a business combination because the transferred net assets
and activities do not constitute a business is an acquisition of net assets.
Those acquisitions should be accounted for in the same manner as any other net
asset acquisition and do not give rise to goodwill. SFAS 147 is effective for
acquisitions on or after October 1, 2002 with mandatory implementation effective
January 1, 2001 for existing intangibles.
8
(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 Nine Months Ended
September 30, September 30,
------------- -------------
(Dollars and shares in thousands) 2002 2001 2002 2001
------- ------- ------- -------
Net income $ 6,884 $ 5,360 $20,185 $15,350
Less: Preferred stock dividends 374 374 1,122 1,122
------- ------- ------- -------
Net income available to common shareholders $ 6,510 $ 4,986 $19,063 $14,228
======= ======= ======= =======
Average number of common shares outstanding
used to calculate basic earnings per common share 11,091 10,988 11,058 10,987
Add: Effect of dilutive options 127 172 162 124
------- ------- ------- -------
Average number of common shares
used to calculate diluted earnings per common share 11,218 11,160 11,220 11,111
======= ======= ======= =======
(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 were 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 earnout 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
9
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 47,036 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.
On October 3, 2002, BNB announced that it has entered into a definitive
agreement to purchase the two Chemung County branch offices of BSB Bank & Trust
Company of Binghamton, New York. The two offices to be acquired are located in
Elmira and Elmira Heights. As of June 30, 2002, the offices had total deposits
of approximately $50 million. The purchase, which is subject to regulatory
approval and will result in the recognition of additional intangible assets, is
expected to close by the end of the fourth quarter of 2002. At that time, the
offices will begin operating as full-service branch offices of Bath National
Bank.
(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 Nine Months Ended
September 30, September 30,
------------- -------------
(Dollars in thousands, except per share amounts) 2002 2001 2002 2001
--------- --------- --------- ---------
Reported net income $ 6,884 $ 5,360 $ 20,185 $ 15,350
Goodwill amortization add-back -- 620 -- 1,033
---------- ---------- ---------- ----------
Adjusted net income $ 6,884 $ 5,980 $ 20,185 $ 16,383
========== ========== ========== ==========
Basic earnings per share:
Reported $ 0.59 $ 0.45 $ 1.72 $ 1.29
Goodwill amortization add-back -- 0.06 -- 0.10
---------- ---------- ---------- ----------
Adjusted $ 0.59 $ 0.51 $ 1.72 $ 1.39
========== ========== ========== ==========
Diluted earnings per share:
Reported $ 0.58 $ 0.45 $ 1.70 $ 1.28
Goodwill amortization add-back -- 0.05 -- 0.09
---------- ---------- ---------- ----------
Adjusted $ 0.58 $ 0.50 $ 1.70 $ 1.37
========== ========== ========== ==========
10
Goodwill resulting from the previously disclosed mergers and acquisitions (see
Note 3) amounted to $37.3 million and $36.8 million at September 30, 2002 and
December 31, 2001, respectively. Goodwill amortization expense included in the
results of operations for the third quarter and first nine months of 2001
amounted to $620,000 and $1,033,000, respectively. In accordance with SFAS No.
142, there is no goodwill amortization included in the results of operations for
the third quarter and first nine months of 2002.
The following table presents the change in the carrying amount of goodwill
allocated by business segment for the nine months ended September 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) 118 (1)
Goodwill acquired during the period 465 -- 465
-------- ------ --------
Balance as of September 30, 2002 $ 35,881 $1,412 $ 37,293
======== ====== ========
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 $2.0 million and $2.4 million at
September 30, 2002 and December 31, 2001, respectively. These other intangible
assets are amortizable and are included in other assets in the Consolidated
Statements of Financial Condition. The following table details the major classes
of amortizable intangible assets as of September 30, 2002.
Gross Carrying Accumulated Net Carrying
(Dollars in thousands) Amount Amortization Amount
-------------- ------------ ------------
Other intangible assets
Core deposits $8,895 $(7,284) $1,611
Customer list 500 (100) 400
------ ------- ------
Total other intangible assets $9,395 $(7,384) $2,011
====== ======= ======
Intangible amortization of these other intangible assets was $226,000 and
$656,000 for the quarter and nine months ended September 30, 2002, compared to
$176,000 and $528,000 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. Based on the
current level of intangible assets, estimated amortization expense for other
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
======
11
(5) Segment Information
Reportable segments are comprised of WCB, NBG, BNB, 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. Also, during
the third quarter of 2002, the Company strategically merged PSB operations with
WCB and NBG based on geography. Accordingly, the Company restated segment
results to reflect the merger for the first nine months of 2002 and for all of
2001. All of the revenue, expenses, assets and liabilities of PSB have been
reallocated to the WCB and NBG segments. The reportable segment information as
of and for the nine months ended September 30, 2002 and 2001 follows:
(Dollars in thousands) 2002 2001
---- ----
Net interest income
WCB $ 21,466 $ 19,917
NBG 20,068 18,152
BNB 10,246 5,132
FTB 6,178 4,276
Financial Services Group -- --
----------- -----------
Total segment net interest income 57,958 47,477
Parent and eliminations, net (1,362) (765)
----------- -----------
Total net interest income $ 56,596 $ 46,712
=========== ===========
Revenue *
WCB $ 25,770 $ 23,706
NBG 23,685 22,145
BNB 12,332 6,279
FTB 7,427 5,185
Financial Services Group 4,083 1,260
----------- -----------
Total segment revenue 73,297 58,575
Parent and eliminations, net (920) (1,624)
----------- -----------
Total revenue $ 72,377 $ 56,951
=========== ===========
Net income
WCB $ 7,903 $ 7,140
NBG 7,742 6,936
BNB 3,664 1,721
FTB 2,157 1,281
Financial Services Group 162 30
----------- -----------
Total segment net income 21,628 17,108
Parent and eliminations, net (1,443) (1,758)
----------- -----------
Total net income $ 20,185 $ 15,350
=========== ===========
Assets
WCB $ 665,491 $ 627,220
NBG 716,950 628,869
BNB 445,538 357,004
FTB 198,650 143,980
Financial Services Group 3,096 317
----------- -----------
Total segment assets 2,029,725 1,757,390
Parent and eliminations, net 3,930 (7,740)
----------- -----------
Total assets $ 2,033,655 $ 1,749,650
=========== ===========
* Revenue is comprised of net interest income and noninterest income.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding 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.
Overview
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 nine
months ended September 30, 2002 to supplement the information in the
consolidated financial statements included in this report.
The following table and discussion present certain information that the Company
considers important in evaluating performance:
At or For the Three Months Ended September 30,
----------------------------------------------
2002 2001 $ Change % Change
---- ---- -------- --------
Per common share data:
Net income - basic $0.59 $0.45 $0.14 31%
Net income - diluted $0.58 $0.45 $0.13 29%
Adjusted net income - basic (excluding goodwill
amortization) $0.59 $0.51 $0.08 15%
Adjusted net income - diluted (excluding goodwill
amortization) $0.58 $0.50 $0.08 16%
Cash dividends declared $0.15 $0.12 $0.03 25%
Book value $14.03 $11.85 $2.18 18%
Common shares outstanding:
Weighted average shares - basic 11,091,398 10,987,742
Weighted average shares - diluted 11,217,971 11,159,772
Period end 11,091,581 10,986,862
Performance ratios, annualized:
Return on average assets 1.36% 1.24%
Return on average common equity 17.05% 15.68%
Common dividend payout ratio 25.42% 26.67%
Net interest margin (tax-equivalent) 4.39% 4.57%
Efficiency ratio 49.30% 47.40%
Asset quality ratios:
Nonperforming loans to total loans 1.13% 0.93%
Nonperforming assets to total loans and other real estate 1.24% 1.03%
Net loan charge-offs to average loans 0.35% 0.31%
Allowance for loan losses to total loans 1.60% 1.62%
Allowance for loan losses to nonperforming loans 142% 175%
Capital ratios:
Average common equity to average total assets 7.57% 7.37%
Leverage ratio 7.19% 7.22%
Tier 1 risk based capital ratio 10.32% 10.05%
Risk-based capital ratio 11.57% 11.31%
13
Third quarter net income increased 28% to $6,884,000 for 2002 compared to
$5,360,000 for the third quarter of 2001. Diluted earnings per common share
increased to $0.58 for the third quarter of 2002 compared to $0.45 in the 2001
period. Net income for the first nine months of 2002 increased 31% to
$20,185,000 compared to $15,350,000 for the same period in 2001. Diluted
earnings per share increased to $1.70 for the first nine months of 2002,
compared to $1.28 for the same period in 2001. Return on average common equity
was 17.87% and 15.67% for the nine months ended September 30, 2002 and 2001,
respectively. In accordance with SFAS No. 142, goodwill is no longer amortized
effective January 1, 2002. In the third quarter of 2001 and in the first nine
months of 2001, goodwill amortization, none of which was tax deductible, was
$620,000 and $1,033,000, respectively. Accordingly, excluding the effect of
goodwill amortization, net income for the third quarter of 2001 and for the nine
months ended September 30, 2001 would have been $5,980,000 (or $0.50 per diluted
common share) and $16,383,000 (or $1.37 per diluted common share), respectively.
This equates to a $904,000 or 15% increase in third quarter 2002 net income
compared to the same period in 2001 and a $3,802,000 or 23% increase in net
income for the first nine 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.
September 30, December 31, September 30,
(Dollars in thousands) 2002 2001 2001
-------------------- -------------------- --------------------
Commercial $ 256,116 20.0% $ 232,379 19.9% $ 217,798 19.1%
Commercial real estate 324,748 25.4 274,702 23.6 265,539 23.3
Agricultural 222,440 17.4 186,623 16.0 178,167 15.6
Residential real estate 238,344 18.6 240,141 20.6 244,254 21.4
Consumer and home equity 237,377 18.6 232,205 19.9 233,972 20.6
----------- ----- ----------- ------ ----------- -----
Total loans gross 1,279,025 100.0 1,166,050 100.0 1,139,730 100.0
Allowance for loan losses (20,474) (19,074) (18,497)
----------- ----------- -----------
Total loans, net $ 1,258,551 $ 1,146,976 $ 1,121,233
=========== =========== ===========
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 $23.7 million and
$38.3 million over December 31, 2001 and September 30, 2001, respectively.
Commercial real estate loans increased $50.0 million and $59.2 million over
December 31, 2001 and September 30, 2001, respectively. Agricultural loans
increased $35.8 million and $44.3 million over December 31, 2001 and September
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 fixed rate residential
mortgages. Residential mortgage loans serviced for others amounted to $333.5
million, $245.4 million and $220.0 million at September 30, 2002, December 31,
2001 and September 30, 2001, respectively. Loans held for sale amounted to $5.9
million, $10.6 million and $10.1 million at September 30, 2002, December 31,
2001 and September 30, 2001, respectively.
14
Nonaccruing Loans and Nonperforming Assets
Nonperforming assets increased to $15.9 million at September 30, 2002. The
overall weakness in economic conditions has contributed to the higher than
normal levels of nonperforming assets. The Company's ratio of nonperforming
loans to total loans of 1.13% at September 30, 2002, increased 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 1.24% at September 30, 2002,
also up from 0.94% at December 31, 2001.
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets at the dates indicated.
September 30, December 31, September 30,
(Dollars in thousands) 2002 2001 2001
------------- ------------ -------------
Nonaccruing loans (1)
Commercial $ 3,029 $ 2,623 $ 2,918
Commercial real estate 5,632 3,344 2,915
Agricultural 1,422 1,529 1,764
Residential real estate 1,205 921 890
Consumer and home equity 595 541 616
------- ------- -------
Total nonaccruing loans 11,883 8,958 9,103
Accruing loans 90 days or more delinquent 2,512 1,064 1,451
------- ------- -------
Total nonperforming loans 14,395 10,022 10,554
Other real estate owned 1,532 947 1,193
------- ------- -------
Total nonperforming assets $15,927 $10,969 $11,747
======= ======= =======
Total nonperforming loans to total loans 1.13% 0.86% 0.93%
Total nonperforming assets to total loans and other real estate 1.24% 0.94% 1.03%
(1) Loans are generally 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.
The increase in nonaccrual loans can be attributed to a few non-owner occupied
commercial real estate loans that are experiencing cash flow shortfalls from
lower occupancy rates. The increase in accruing loans 90 days or more delinquent
relates to dairy industry loans. Milk prices are at historical cyclical lows and
have stayed at that price for an extended period of time placing stress on the
cash flow of dairy farmers.
15
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 Nine Months Ended
------------------ -----------------
September 30, September 30,
(Dollars in thousands) 2002 2001 2002 2001
--------- --------- --------- ---------
Balance at beginning of period $20,121 $17,815 $19,074 $13,883
Addition as a result of acquisitions -- -- 174 2,686
Chargeoffs:
Commercial 679 452 1,234 566
Commercial real estate 77 184 467 250
Agricultural -- 4 29 4
Residential real estate 19 14 54 159
Consumer and home equity 412 385 1,087 884
------- ------- ------- -------
Total charge-offs 1,187 1,039 2,871 1,863
Recoveries:
Commercial 9 40 28 54
Commercial real estate 14 8 84 19
Agricultural -- -- 35 --
Residential real estate -- 5 54 5
Consumer and home equity 65 105 256 313
------- ------- ------- -------
Total recoveries 88 158 457 391
------- ------- ------- -------
Net charge-offs 1,099 881 2,414 1,472
Provision for loan losses 1,452 1,563 3,640 3,400
------- ------- ------- -------
Balance at end of period $20,474 $18,497 $20,474 $18,497
======= ======= ======= =======
Ratio of net loan charge-offs to average loans (annualized) 0.35% 0.31% 0.26% 0.19%
Ratio of allowance for loan losses to total loans 1.60% 1.62% 1.60% 1.62%
Ratio of allowance for loan losses to nonperforming loans 142% 175% 142% 175%
Overall weakness in economic conditions has contributed to the higher level of
charge-offs in 2002. The conditions have affected both consumer and commercial
loans with liquidation of some commercial sector loans generating losses from
collateral shortfalls.
16
Investing Activities
U.S. Treasury and Agency Securities: At September 30, 2002, the U.S. Treasury
and Agency securities portfolio totaled $115.8 million, of which $113.8 million
was classified as available for sale. The portfolio consisted of $1.0 million in
U. S. Treasury securities and $114.8 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 September 30, 2002, the portfolio of state
and municipal obligations totaled $214.3 million, of which $165.8 million was
classified as available for sale and $48.5 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 September 30, 2002, the Company had $251.6
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 reflects the need for additional collateral to secure
deposits accepted in 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 September 30, 2002 totaled
$11.5 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 September 30, 2002, equity securities totaled $4.0
million, all of which was classified as available for sale. Included in the
portfolio is $3.0 million of Freddie Mac 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 Company has a 50%
equity interest in MAB that is accounted for under the equity method of
accounting.
17
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 $1.43 billion or 86.6% of total deposits of $1.65 billion at September
30, 2002. The core deposit base consists almost exclusively of in-market
accounts. . Core deposits are supplemented with certificates of deposit over
$100,000, which amounted to $221.7 million as of September 30, 2002, largely
from in-market municipal, business and individual customers. As of September 30,
2002, brokered certificates of deposit included in certificates of deposit over
$100,000 totaled $71.6 million. The Company had total public (municipal)
deposits of $380.4 million at September 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
Total deposits at December 31, 2001 amounted to $1.43 billion. Core deposit
products were $1.20 billion 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 September
30, 2002 amounted to $119.9 million and include both short and long-term
advances, which mature on various dates through 2011. The FHLB advances are
collateralized by FHLB stock and real estate mortgage loans. As of September 30,
2002, the Company had $8.4 million in pledged collateral available for the
purpose of extending FHLB credit lines. 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 $47.1 million and $44.0 million as of
September 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 September 30, 2002, 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 September 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
September 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.
18
For The Three Months Ended September 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 $ 15,280 $ 71 1.84% $ 5,923 $ 47 3.15%
Investment securities (1):
Taxable 389,146 5,074 5.21% 264,946 4,060 6.12%
Non-taxable 212,812 3,262 6.13% 188,768 3,117 6.60%
----------- ------- ------ ----------- ------- ------
Total investment securities 601,958 8,336 5.54% 453,714 7,177 6.32%
Loans (2):
Commercial and agricultural 791,515 13,477 6.76% 656,518 13,515 8.17%
Residential real estate 233,321 4,796 8.22% 242,955 5,286 8.70%
Consumer and home equity 234,522 4,805 8.13% 232,788 5,289 9.01%
----------- ------- ------ ----------- ------- ------
Total loans 1,259,358 23,078 7.29% 1,132,261 24,090 8.46%
----------- ------- ------ ----------- ------- ------
Total interest-earning assets 1,876,596 31,485 6.68% 1,591,898 31,314 7.83%
----------- ------- ------ ----------- ------- ------
Allowance for loan losses (20,331) (17,953)
Other non-interest earning assets 145,012 137,547
----------- -----------
Total assets $ 2,001,277 $ 1,711,492
=========== ===========
Interest-bearing liabilities:
Interest-bearing checking 372,025 1,346 1.44% 183,691 600 1.30%
Savings and money market 355,600 1,404 1.57% 269,597 1,396 2.05%
Certificates of deposit 675,435 6,182 3.63% 743,235 9,168 4.89%
Borrowed funds 170,723 1,457 3.37% 129,206 1,509 4.63%
Guaranteed preferred beneficial interests in
Corporation's junior subordinated
debentures 16,200 421 10.31% 16,200 421 10.31%
----------- ------- ------ ----------- ------- ------
Total interest-bearing liabilities 1,589,983 10,810 2.70% 1,341,929 13,094 3.87%
----------- ------- ------ ----------- ------- ------
Non-interest bearing demand deposits 222,854 201,052
Other non-interest-bearing liabilities 19,233 24,622
----------- -----------
Total liabilities 1,832,070 1,567,603
Shareholders' equity (3) 169,207 143,889
----------- -----------
Total liabilities and
shareholders' equity $ 2,001,277 $ 1,711,492
=========== ===========
Net interest income $20,675 $18,220
======= =======
Net interest rate spread 3.98% 3.96%
====== ======
Net earning assets $ 286,613 $ 249,969
=========== ===========
Net interest income as a percentage of
average interest-earning assets (4) 4.39% 4.57%
====== ======
Ratio of average interest-earning assets to
average interest-bearing liabilities 118.03% 118.63%
====== ======
(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.
19
Net Interest Income
In the third quarter of 2002, net interest income, the principal source of
earnings, increased 14% to $19.5 million compared to $17.1 million in the third
quarter of 2001. The increase in net interest income was primarily the result of
the growth in average earning assets which increased $285 million or 18% in the
third quarter of 2002 compared to the third quarter of 2001. Loans accounted for
$127 million and total investment assets for $158 million of that growth in
average earning assets. Loan growth was concentrated in the commercial sector
with average loans in that sector growing $135 million while the consumer sector
dropped $8 million attributed to selling nearly all newly originated fixed rate
residential mortgage loans. The principal funding source for the average earning
asset growth was deposits, which for the third quarter of 2002 increased $228
million or 15% over the average for the same period in 2001. Net interest margin
for the third quarter of 2002 was 4.39% compared to 4.57% in the same period
last year. The net interest margin has remained at relatively high levels, but
the current low level of market interest rates has created some pressure on
placing new funds in earning assets at the Company's historically higher
spreads.
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.
3rd Quarter 2002 Compared to 3rd Quarter 2001
---------------------------------------------
Increase (Decrease) Due to Total Increase/
(Dollars in thousands) Volume Rate (Decrease)
------ ---- ----------
Interest-earning assets:
Federal funds sold and interest-bearing deposits $ 45 $ (21) $ 24
Investment securities:
Taxable 1,617 (603) 1,014
Non-taxable 364 (219) 145
------- ------- -------
Total investment securities 1,981 (822) 1,159
------- ------- -------
Loans:
Commercial and agricultural 2,603 (2,641) (38)
Residential real estate (198) (292) (490)
Consumer and home equity 36 (520) (484)
------- ------- -------
Total loans 2,441 (3,453) (1,012)
------- ------- -------
Total interest-earning assets 4,467 (4,296) 171
Interest-bearing liabilities:
Interest-bearing checking 681 65 746
Savings and money market 85 (77) 8
Certificates of deposit (621) (2,365) (2,986)
Borrowed funds 319 (371) (52)
Guaranteed preferred beneficial interests in
Corporation's junior subordinated debentures - - -
------- ------- -------
Total interest-bearing liabilities 464 (2,748) (2,284)
------- ------- -------
Net interest income $ 4,003 $(1,548) $ 2,455
======= ======= =======
20
Provision for Loan Losses
The provision for loan losses for the third quarter of 2002 was $1.5 million,
compared to $1.6 million for the 2001 quarter. For the first nine months of 2002
the provision was $3.6 million compared to $3.4 million for the same period in
2001. Nonperforming assets totaled $15.9 million at September 30, 2002 compared
to $11.7 million a year earlier. Net loan charge-offs were $1.1 million for the
third quarter of 2002 or 0.35% of average loans compared to $0.9 million or
0.31% of average loans in the same period last year. The ratio of nonperforming
assets to total loans and other real estate of 1.24% at September 30, 2002
compared to 1.03% a year ago. The ratio of the allowance for loan losses to
total loans was 1.60% at September 30, 2002, compared to 1.62% a year ago.
Noninterest Income
Noninterest income increased 42% in the third quarter of 2002 to $5.7 million
from $4.0 million for the third quarter of 2001. This increase can be attributed
to a combination of fees and commissions generated by our employee benefits
administration and compensation consulting firm, BGI, which was acquired in the
fourth quarter of 2001, as well as the growth in deposits and the related
service fees. Financial Services Group fees and commissions, which include BGI
revenue, were $1.5 million for the third quarter of 2002, an increase of $1.0
million from the same period last year. BGI accounts for $0.9 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
$1.7 million during the first nine months of 2002, up from $1.4 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 $333.5 million
as of September 30, 2002, a 51% increase from $220.0 million as of September 30,
2001.
Noninterest Expense
Noninterest expense for the third quarter of 2002 totaled $13.4 million compared
with $11.3 million for the third quarter of 2001. For the nine months ending
September 30, 2002, noninterest expense was $38.6 million compared to $30.0
million for the same period last year. The increase relates to the ongoing
additions of staff and other resources necessary to support our continuing
expansion of lending activities, product lines and new branch offices as well as
the addition of BGI, BNB and BOA. While the aforementioned additions have
positioned the Company for future growth, they have also contributed to an
increase in the efficiency ratio for the third quarter of 2002 to 49.3%,
compared to 47.4% for the same period a year ago and for the first nine months
of 2002 to 49.7% compared to 47.7% for the first nine months of 2001.
Income Tax Expense
The provision for income taxes provides for Federal and New York State income
taxes, which amounted to $9.9 million and $8.2 million for the nine months ended
September 30, 2002 and 2001, respectively. While the increase corresponds to
increased levels of taxable income, the effective tax rate for the first nine
months of 2002 decreased to 33.0%, compared to 34.9% for the first nine months
of 2001 as a result of an increase in holdings of tax-exempt securities.
21
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 $73.3 million at September 30,
2002, an increase of $20.1 million from the balance of $53.2 million at December
31, 2001. The increase results primarily from an increase in Federal funds sold
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 September 30, 2002,
letters of credit totaling $10.0 million and unused loan commitments and lines
of credit of $299.8 million were contractually available to customers.
Comparable amounts for these commitments at December 31, 2001 were $8.6 million
and $265.9 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 7.19% and 7.02% at September 30, 2002
and December 31, 2001, respectively, well-above minimum regulatory capital
requirements. Total Tier 1 capital of $140.4 million at September 30, 2002
increased $19.8 million from $120.6 million at December 31, 2001. The increase
in Tier 1 capital relates primarily to the $14.4 million increase in retained
earnings resulting from the Company's net income for the first nine months of
2002 net of dividend payouts, and a $7.7 million increase in accumulated other
comprehensive income resulting from the increase in the net unrealized gain on
securities available for sale during the first nine months of 2002.
The Company's total risk-based capital ratio was 11.57% at September 30, 2002,
comparable to 11.37% at December 31, 2001, both well-above minimum regulatory
capital requirements. Total risk-based capital was $157.5 million at September
30, 2002, an increase of $17.6 million from $139.9 million at December 31, 2001.
22
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 or periodic interest rate adjustment 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 or brokered certificates of
deposit.
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's overall
interest rate risk position is slightly asset sensitive which will provide
modest opportunities for expansion of net interest income in an upward rate
environment and modest declines in a downward rate environment. 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.
Item 4. Controls and Procedures
Within 90 days of the date of this report, the Company, under the supervision of
its Chief Executive Officer and Chief Financial Officer, conducted an evaluation
of the effectiveness of disclosure controls and procedures pursuant to Exchange
Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that all material information required to
be filed in the Company's periodic SEC reports is made known to them in a timely
fashion. There have been no significant changes in the Company's internal
controls, or in factors that could significantly affect the Company's internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.
23
PART II -- OTHER INFORMATION
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits.
Exhibit10.1 Separation Agreement for John R. Koelmel
Exhibit11.1 Computation of Per Share Earnings*
Exhibit99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
* Data required by Statement of Financial Accounting
Standards No. 128, Earnings per Share, is provided
in note 2 to the consolidated financial statements
in this report.
(b) Reports on Form 8-K.
A Form 8-K was filed on August 12, 2002.
24
Signatures
Pursuant to the requirements 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.
November 12, 2002 FINANCIAL INSTITUTIONS, INC.
Date Signatures
November 12, 2002 /s/ Peter G. Humphrey
---------------------
Peter G. Humphrey
President, Chief Executive Officer
(Principal Executive Officer),
Chairman of the Board and Director
November 12, 2002 /s/ Ronald A. Miller
--------------------
Ronald A. Miller
Senior Vice President
and Chief Financial Officer
(Principal Accounting Officer)
25
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CERTIFICATION
I, Peter G. Humphrey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Financial Institutions,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Peter G. Humphrey
-----------------------
Peter G. Humphrey
Chief Executive Officer
26
CERTIFICATION
I, Ronald A. Miller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Financial Institutions,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Ronald A. Miller
-----------------------
Ronald A. Miller
Chief Financial Officer
27