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, 2003
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 7, 2003
----- -------------------------------
Common Stock, $0.01 par value 11,166,517 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
September 30, 2003 and December 31, 2002 3
Consolidated Statements of Income for the three months and
nine months ended September 30, 2003 and 2002 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 5
Consolidated Statement of Changes in Shareholders' Equity and
Comprehensive Income for the nine months ended
September 30, 2003 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES
EXHIBITS
2
Item 1. Financial Statements (Unaudited)
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
September 30, December 31,
(Dollars in thousands, except per share amounts) 2003 2002
------------- -------------
Assets
Cash, due from banks and interest-bearing deposits $ 66,653 $ 48,429
Federal funds sold 53,228 --
Securities available for sale, at fair value 558,371 596,862
Securities held to maturity (fair value of $46,531 and $48,089 at
September 30, 2003 and December 31, 2002, respectively) 45,424 47,125
Loans, net 1,344,403 1,300,232
Premises and equipment, net 33,152 27,254
Goodwill 40,621 40,593
Other assets 44,498 44,539
------------- -------------
Total assets $ 2,186,350 $ 2,105,034
============= =============
Liabilities And Shareholders' Equity
Liabilities:
Deposits:
Demand $ 263,433 $ 240,755
Savings, money market and interest-bearing checking 826,114 779,772
Certificates of deposit 738,379 687,996
------------- -------------
Total deposits 1,827,926 1,708,523
Short-term borrowings 70,392 87,189
Long-term borrowings 68,606 92,090
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 16,200 16,200
Accrued expenses and other liabilities 20,489 22,738
------------- -------------
Total liabilities 2,003,613 1,926,740
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding - 1,666 shares
at September 30, 2003 and December 31, 2002 167 167
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding - 175,683 shares
at September 30, 2003 and 175,755 shares at December 31, 2002 17,568 17,575
Common stock, $ 0.01 par value, authorized 50,000,000 shares, issued
11,303,533 shares at September 30, 2003 and December 31, 2002 113 113
Additional paid-in capital 20,916 19,728
Retained earnings 136,852 131,320
Accumulated other comprehensive income 8,098 10,368
Treasury stock, at cost - 141,324 shares at September 30, 2003 and
199,719 shares at December 31, 2002 (977) (977)
------------- -------------
Total shareholders' equity 182,737 178,294
------------- -------------
Total liabilities and shareholders' equity $ 2,186,350 $ 2,105,034
============= =============
See Accompanying Notes to Unaudited Consolidated Financial Statements.
3
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
(Dollars in thousands, except per share amounts) 2003 2002 2003 2002
-------- -------- -------- --------
Interest income:
Loans $ 21,628 $ 23,078 $ 65,556 $ 67,613
Securities 5,511 7,194 18,648 20,840
Other 171 71 397 377
-------- -------- -------- --------
Total interest income 27,310 30,343 84,601 88,830
-------- -------- -------- --------
Interest expense:
Deposits 7,144 8,932 22,943 26,629
Borrowings 1,205 1,457 3,826 4,347
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 421 421 1,258 1,258
-------- -------- -------- --------
Total interest expense 8,770 10,810 28,027 32,234
-------- -------- -------- --------
Net interest income 18,540 19,533 56,574 56,596
Provision for loan losses 5,590 1,452 14,199 3,640
-------- -------- -------- --------
Net interest income after
provision for loan losses 12,950 18,081 42,375 52,956
-------- -------- -------- --------
Noninterest income:
Service charges on deposits 2,973 2,803 8,399 7,737
Financial services group fees and commissions 1,408 1,453 4,110 4,083
Mortgage banking revenues 1,113 439 2,849 1,656
Net gain on securities transactions 581 139 1,023 39
Other 984 853 2,940 2,266
-------- -------- -------- --------
Total noninterest income 7,059 5,687 19,321 15,781
-------- -------- -------- --------
Noninterest expense:
Salaries and employee benefits 8,491 7,401 25,408 21,829
Occupancy and equipment 2,138 1,840 6,210 5,381
Supplies and postage 578 569 1,838 1,704
Amortization of intangible assets 309 226 926 656
Computer and data processing expense 440 579 1,386 1,359
Professional fees 398 459 1,458 1,157
Other 2,542 2,344 8,193 6,525
-------- -------- -------- --------
Total noninterest expense 14,896 13,418 45,419 38,611
-------- -------- -------- --------
Income before income taxes 5,113 10,350 16,277 30,126
Income taxes 1,058 3,466 4,276 9,941
-------- -------- -------- --------
Net income $ 4,055 $ 6,884 $ 12,001 $ 20,185
======== ======== ======== ========
Earnings per common share (note 4):
Basic $ 0.33 $ 0.59 $ 0.98 $ 1.72
Diluted $ 0.33 $ 0.58 $ 0.97 $ 1.70
See Accompanying Notes to Unaudited Consolidated Financial Statements.
4
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
------------------------
(Dollars in thousands) 2003 2002
---------- ----------
Cash flows from operating activities:
Net income $ 12,001 $ 20,185
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,950 4,005
Provision for loan losses 14,199 3,640
Deferred income tax benefit (2,286) (564)
Proceeds from sale of loans held for sale 161,394 87,168
Originations of loans held for sale (164,111) (87,275)
Net gain on securities transactions (1,023) (39)
Gain on sale of loans held for sale (2,228) (1,028)
(Gain) loss on sale of other assets (34) 133
Minority interest in net income of subsidiaries 26 166
Decrease (increase) in other assets 2,961 (92)
Decrease in accrued expenses and other liabilities (943) (893)
---------- ----------
Net cash provided by operating activities 25,906 25,406
Cash flows from investing activities:
Purchase of securities:
Available for sale (290,936) (410,778)
Held to maturity (22,133) (25,984)
Proceeds from maturity and call of securities:
Available for sale 234,080 261,988
Held to maturity 23,778 36,689
Proceeds from sale of available for sale securities 90,099 44,802
Loan originations less principal payments (53,425) (103,846)
Proceeds from sales of premises and equipment 76 5
Purchase of premises and equipment (8,496) (3,197)
Cash acquired in purchase of Bank of Avoca, net of cash paid -- 4,778
Equity investment in Mercantile Adjustment Bureau, LLC -- (2,500)
---------- ----------
Net cash used in investing activities (26,957) (198,043)
Cash flows from financing activities:
Net increase in deposits 119,403 199,560
Net decrease in short-term borrowings (16,797) (36,096)
Proceeds from long-term borrowings 5,000 35,059
Repayment of long-term borrowings (28,484) (291)
Purchase of preferred and common shares (425) (384)
Issuance of preferred and common shares 266 459
Dividends paid (6,460) (5,541)
---------- ----------
Net cash provided by financing activities 72,503 192,766
---------- ----------
Net increase in cash and cash equivalents 71,452 20,129
Cash and cash equivalents at the beginning of the period 48,429 53,171
---------- ----------
Cash and cash equivalents at the end of the period $ 119,881 $ 73,300
========== ==========
Supplemental information:
Cash paid during period for:
Interest $ 27,711 $ 34,493
Income taxes 6,267 11,226
Noncash investing and financing activities:
Fair value of noncash assets acquired in acquisitions $ -- $ 14,043
Fair value of liabilities assumed in acquisitions -- 17,322
Issuance of common stock in Bank of Avoca acquisition -- 1,499
Issuance of common stock for Burke Group, Inc. earnout 1,340 500
See Accompanying Notes to Unaudited Consolidated Financial Statements.
5
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(Unaudited)
Accumulated
Other
3% 8.48% Additional Comprehensive
(Dollars in thousands, Preferred Preferred Common Paid-in Retained Income
except per share amounts) Stock Stock Stock Capital Earnings (Loss)
----- ----- ----- ------- -------- ------
Balance - December 31, 2002 $ 167 $ 17,575 $ 113 $ 19,728 $ 131,320 $ 10,368
Purchase 72 shares of preferred stock -- (7) -- (1) -- --
Purchase 22,000 shares of common stock -- -- -- -- -- --
Issue 2,440 shares of common stock-
Director's retainer -- -- -- 34 -- --
Issue 15,568 shares of common stock -
exercised stock options -- -- -- 120 -- --
Issue 62,387 shares of common stock -
Burke Group, Inc. contingent earnout -- -- -- 1,035 -- --
Comprehensive income:
Net income -- -- -- -- 12,001 --
Unrealized loss on securities available
for sale (net of tax of $(1,913)) -- -- -- -- -- (2,885)
Reclassification adjustment for net gains
included in net income (net of tax of $408) -- -- -- -- -- 615
Net unrealized loss on securities available
for sale (net of tax of $(1,505)) -- -- -- -- -- --
Total comprehensive income -- -- -- -- -- --
Cash dividends declared:
3% Preferred - $2.25 per share -- -- -- -- (4) --
8.48% Preferred - $6.36 per share -- -- -- -- (1,118) --
Common - $0.48 per share -- -- -- -- (5,347) --
--------- --------- --------- --------- --------- ---------
Balance - September 30, 2003 $ 167 $ 17,568 $ 113 $ 20,916 $ 136,852 $ 8,098
========= ========= ========= ========= ========= =========
Total
(Dollars in thousands, Treasury Shareholders'
except per share amounts) Stock Equity
----- ------
Balance - December 31, 2002 $ (977) $ 178,294
Purchase 72 shares of preferred stock -- (8)
Purchase 22,000 shares of common stock (417) (417)
Issue 2,440 shares of common stock-
Director's retainer 16 50
Issue 15,568 shares of common stock -
exercised stock options 96 216
Issue 62,387 shares of common stock -
Burke Group, Inc. contingent earnout 305 1,340
Comprehensive income:
Net income -- 12,001
Unrealized loss on securities available
for sale (net of tax of $(1,913)) -- (2,885)
Reclassification adjustment for net gains
included in net income (net of tax of $408) -- 615
---------
Net unrealized loss on securities available
for sale (net of tax of $(1,505)) -- (2,270)
---------
Total comprehensive income -- 9,731
---------
Cash dividends declared:
3% Preferred - $2.25 per share -- (4)
8.48% Preferred - $6.36 per share -- (1,118)
Common - $0.48 per share -- (5,347)
--------- ---------
Balance - September 30, 2003 $ (977) $ 182,737
========= =========
See Accompanying Notes to Unaudited Consolidated Financial Statements.
6
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Basis of Presentation
Financial Institutions, Inc. ("FII"), a bank 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 and its four
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The National
Bank of Geneva (100% owned) ("NBG"), First Tier Bank & Trust (100% owned)
("FTB") and Bath National Bank (100% owned) ("BNB"), collectively referred to as
the "Banks". During 2002, the Company completed a geographic realignment of the
subsidiary Banks, which involved the merger of the subsidiary formerly known as
The Pavilion State Bank ("PSB") into NBG and transfer of other branch offices
between subsidiary Banks. The merger and transfers were accounted for at
historical cost as a combination of entities under common control. Also included
are the accounts of the Burke Group, Inc. (100% owned) ("BGI") and The FI Group,
Inc. (100% owned) ("FIGI"), collectively referred to as the "Financial Services
Group". BGI is an employee benefits and compensation consulting firm acquired in
October 2001. FIGI is a brokerage subsidiary that commenced operations in March
2000.
In February 2001, the Company formed FISI Statutory Trust I ("FISI") (100%
owned), 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 consolidated
statements 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 and
prevailing practices in the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities, and the reported revenues and expenses for the period.
All adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation of financial statements have been included. Actual
results could differ from those estimates. Amounts in the prior year's
consolidated financial statements are reclassified when necessary to conform to
the current year's presentation.
7
New Accounting Pronouncements
Financial Accounting Standards Board (FASB) Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," was issued in November 2002. FASB
Interpretation No. 45 elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition and
initial measurement provisions of FASB Interpretation No. 45 are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements of interim or
annual periods ending after December 15, 2002. The Company adopted the
recognition and measurement provisions of FASB Interpretation No. 45 effective
January 1, 2003. Such adoption did not have a material impact on the Company's
consolidated financial statements.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," was
issued in January 2003. FASB Interpretation No. 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FASB Interpretation No. 46 requires an enterprise to
consolidate a variable interest entity if that enterprise has a variable
interest (or combination of variable interests) that will absorb a majority of
the entity's expected losses if they occur, receive a majority of the entity's
expected returns if they occur, or both. It also requires that both the primary
beneficiary and all other enterprises with a significant variable interest in a
variable interest entity make certain disclosures. FASB Interpretation No. 46
applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first fiscal period ending after
December 15, 2003, to variable interest entities in which an enterprise holds a
variable interest that it acquired before February 1, 2003. The adoption of the
provisions of FASB Interpretation No. 46 is not expected to have a material
impact on the Company's consolidated financial statements.
Statement of Financial Accounting Standard (SFAS) No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," was issued by
FASB in April 2003. SFAS No. 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified and hedging
relationships designated after June 30, 2003. The adoption of the provisions of
SFAS No. 149 did not have a material impact on the Company's consolidated
financial statements.
SFAS No. 150, "Accounting for Certain Financial Instruments With Characteristics
of Both Liabilities and Equity," was issued by FASB in May 2003. SFAS No. 150
changes the classification in the statement of financial condition of certain
common financial instruments from either equity or mezzanine presentation to
liabilities and requires an issuer of those financial statements to recognize
changes in fair value or redemption amount, as applicable, in earnings. SFAS No.
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise shall be effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of the provisions of SFAS No.
150 is not expected to have a material impact on the Company's consolidated
financial statements.
8
(2) Stock Compensation Plans
The Company uses a fixed award stock option plan to compensate certain key
members of management of the Company and its subsidiaries. The Company accounts
for issuance of stock options under the intrinsic value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense is recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed under SFAS No. 123, the Company has
elected to continue to apply the intrinsic value-based method of accounting
described above and has adopted only the disclosure requirements of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock - Based Compensation -
Transition and Disclosure."
Had the Company determined compensation cost based on the fair value method
under SFAS No. 123, the Company's net income and earnings per share would have
been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
(Dollars in thousands, except per share amounts) 2003 2002 2003 2002
-------- -------- -------- --------
Reported net income $ 4,055 $ 6,884 $ 12,001 $ 20,185
Less: Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects 112 77 223 266
-------- -------- -------- --------
Pro forma net income $ 3,943 $ 6,807 $ 11,778 $ 19,919
======== ======== ======== ========
Basic earnings per share:
Reported $ 0.33 $ 0.59 $ 0.98 $ 1.72
Pro forma 0.32 0.58 0.96 1.70
Diluted earnings per share:
Reported $ 0.33 $ 0.58 $ 0.97 $ 1.70
Pro forma 0.32 0.57 0.95 1.68
The weighted-average fair value of options granted during the nine months ended
September 30, 2003 and 2002 amounted to $10.00 and $12.02, respectively. The
fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model and the following weighted-average
assumptions:
September 30,
-----------------
2003 2002
----- -----
Dividend yield 2.89% 1.94%
Expected life (in years) 10.00 10.00
Expected volatility 51.06% 38.14%
Risk-free interest rate 3.96% 4.98%
9
(3) Mergers and Acquisitions
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased are
located in Elmira and Elmira Heights, and had deposit liabilities totaling $44.2
million at the time of acquisition. The acquisition was accounted for as a
business combination using 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 $1.5
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 also recorded a $2.0 million intangible asset attributable to core
deposits, which is being amortized using the straight-line method over seven
years.
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 as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value of identifiable tangible and intangible assets
acquired ($18.4 million), less liabilities assumed ($17.3 million), 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 core deposit intangible asset,
which is being amortized using the straight-line method over seven years. The
2002 results of operations for BOA are included in the income statements from
the date of acquisition (May 1, 2002).
(4) 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) 2003 2002 2003 2002
-------- -------- -------- --------
Net income $ 4,055 $ 6,884 $ 12,001 $ 20,185
Less: Preferred stock dividends 374 374 1,122 1,122
-------- -------- -------- --------
Net income available to common shareholders $ 3,681 $ 6,510 $ 10,879 $ 19,063
======== ======== ======== ========
Average number of common shares outstanding
used to calculate basic earnings per common share 11,159 11,091 11,142 11,058
Add: Effect of dilutive options 107 127 103 162
-------- -------- -------- --------
Average number of common shares
used to calculate diluted earnings per common share 11,266 11,218 11,245 11,220
======== ======== ======== ========
Earnings per common share:
Basic $ 0.33 $ 0.59 $ 0.98 $ 1.72
Diluted $ 0.33 $ 0.58 $ 0.97 $ 1.70
10
(5) Segment Information
Reportable segments are comprised of WCB, NBG, BNB, FTB and the Financial
Services Group. As stated in Note 1, during 2002 the Company completed a
geographic realignment of the subsidiary Banks, which involved the merger of the
subsidiary formerly known as PSB into NBG and subsequent transfer of branches
between NBG and WCB. Accordingly, the Company restated segment results to
reflect the merger and transfers for the 2002 periods presented. All of the
revenue, expenses, assets and liabilities of PSB have been reallocated to the
WCB and NBG segments. The reportable segment information is as follows:
September 30, December 31,
(Dollars in thousands) 2003 2002
------------- -------------
Assets
WCB $ 717,609 $ 674,755
NBG 756,910 721,090
BNB 473,328 495,055
FTB 226,384 203,382
Financial Services Group 4,956 5,052
------------- -------------
Total segment assets 2,179,187 2,099,334
Parent and eliminations, net 7,163 5,700
------------- -------------
Total assets $ 2,186,350 $ 2,105,034
============= =============
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
(Dollars in thousands) 2003 2002 2003 2002
-------- -------- -------- --------
Net interest income
WCB $ 6,998 $ 7,282 $ 21,094 $ 21,466
NBG 6,315 6,896 19,300 20,068
BNB 3,645 3,717 11,343 10,246
FTB 2,008 2,082 6,131 6,178
Financial Services Group -- -- -- --
-------- -------- -------- --------
Total segment net interest
income 18,966 19,977 57,868 57,958
Parent and eliminations, net (426) (444) (1,294) (1,362)
-------- -------- -------- --------
Total net interest income $ 18,540 $ 19,533 $ 56,574 $ 56,596
======== ======== ======== ========
Net income (loss)
WCB $ 2,650 $ 2,647 $ 7,572 $ 7,903
NBG (364) 2,575 160 7,742
BNB 1,495 1,418 3,127 3,664
FTB 593 752 1,970 2,157
Financial Services Group 61 103 (135) 162
-------- -------- -------- --------
Total segment net income 4,435 7,495 12,694 21,628
Parent and eliminations, net (380) (611) (693) (1,443)
-------- -------- -------- --------
Total net income $ 4,055 $ 6,884 $ 12,001 $ 20,185
======== ======== ======== ========
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
INTRODUCTION
The principal objective of this discussion is to provide an overview of the
financial condition and results of operations of Financial Institutions, Inc.
and its subsidiaries for the periods covered in this quarterly report. This
discussion and tabular presentations should be read in conjunction with the
accompanying consolidated financial statements and accompanying notes.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and are consistent
with predominant practices in the financial services industry. Application of
critical accounting policies, those policies that Management believes are the
most important to the Company's financial position and results, requires
Management to make estimates, assumptions, and judgments that affect the amounts
reported in the consolidated financial statements and accompanying notes and are
based on information available as of the date of the financial statements.
Future changes in information may affect these estimates, assumptions, and
judgments, which, in turn, may affect amounts reported in the financial
statements.
The Company has numerous accounting policies, of which the most significant are
presented in Note 1 of the Notes to Consolidated Financial Statements included
in the Company's Annual Report on Form 10-K as of December 31, 2002, dated March
14, 2003, as filed with the Securities and Exchange Commission. These policies,
along with the disclosures presented in the other financial statement notes and
in this discussion, provide information on how significant assets and
liabilities are reported in the financial statements and how those reported
amounts are determined. Based on the sensitivity of financial statement amounts
to the methods, assumptions, and estimates underlying those amounts, Management
has determined that the accounting policies with respect to the allowance for
loan losses and goodwill require subjective or complex judgments important to
the Company's financial position and results of operations, and, as such, are
considered to be critical accounting policies as discussed below.
Allowance for Loan Losses: Arriving at an appropriate level of allowance for
loan losses involves a high degree of judgment. The Company's allowance for loan
losses provides for probable losses based upon evaluations of known and inherent
risks in the loan portfolio. Management uses historical information to assess
the adequacy of the allowance for loan losses and considers the prevailing
business environment, as it is affected by changing economic conditions and
various external factors, which may impact the portfolio in ways currently
unforeseen. The allowance is increased by provisions for loan losses and by
recoveries of loans previously charged-off and reduced by loans charged-off.
Goodwill: SFAS No. 141 requires that the purchase method of accounting be used
for all business combinations and further clarifies the criteria for the initial
recognition and measurement of intangible assets separate from goodwill. SFAS
No. 142 prescribes the accounting for goodwill and intangible assets subsequent
to initial recognition. The provisions of SFAS No. 142 discontinue the
amortization of goodwill and intangible assets with indefinite lives. Instead,
these assets are subject to at least an annual impairment review, and more
frequently if certain impairment indicators are in evidence. SFAS No. 142 also
requires that reporting units be identified for the purpose of assessing
impairment of goodwill.
12
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.
SELECTED FINANCIAL DATA
The following table presents certain information and ratios that management of
the Company considers important in evaluating performance:
At or For the Nine Months Ended September 30,
---------------------------------------------
2003 2002 $ Change % Change
---- ---- -------- --------
Per common share data:
Net income - basic $0.98 $1.72 $(0.74) (43)%
Net income - diluted $0.97 $1.70 $(0.73) (43)%
Cash dividends declared $0.48 $0.42 $0.06 14%
Book value $14.78 $14.03 $0.75 5%
Common shares outstanding:
Weighted average shares - basic 11,142,055 11,057,731
Weighted average shares - diluted 11,244,866 11,219,501
Period end 11,162,209 11,091,581
Performance ratios, annualized:
Return on average assets 0.74% 1.40%
Return on average common equity 8.73% 17.87%
Common dividend payout ratio 48.98% 24.42%
Net interest margin (tax-equivalent) 3.95% 4.43%
Efficiency ratio * 55.87% 49.68%
Asset quality ratios:
Nonperforming loans to total loans 3.73% 1.13%
Nonperforming assets to total loans and other real estate 3.78% 1.24%
Net loan charge-offs to average loans 0.67% 0.26%
Allowance for loan losses to total loans 2.12% 1.60%
Allowance for loan losses to nonperforming loans 57% 142%
Capital ratios:
Average common equity to average total assets 7.78% 7.57%
Leverage ratio 7.00% 7.19%
Tier 1 risk based capital ratio 9.99% 10.32%
Risk-based capital ratio 11.25% 11.57%
* Efficiency ratio represents noninterest expense less other real estate
expense and amortization of intangibles divided by net interest income
(tax equivalent) plus other noninterest income less gain (loss) on sale of
available for sale securities.
13
ANALYSIS OF FINANCIAL CONDITION
Lending Activities
Loan Portfolio Composition
The following table provides selected information regarding the composition of
the Company's loan portfolio at the dates indicated.
September 30, December 31,
(Dollars in thousands) 2003 2002
------------------- -------------------
Commercial $ 260,033 18.9% $ 262,630 19.9%
Commercial real estate 366,250 26.7 332,134 25.1
Agricultural 247,272 18.0 233,769 17.7
Residential real estate 250,983 18.3 251,898 19.1
Consumer and home equity 248,917 18.1 241,461 18.2
----------- ----- ----------- -----
Total loans gross 1,373,455 100.0 1,321,892 100.0
Allowance for loan losses (29,052) (21,660)
----------- -----------
Total loans, net $ 1,344,403 $ 1,300,232
=========== ===========
Total gross loans increased $52 million to $1.373 billion at September 30, 2003
from $1.322 billion at December 31, 2002. Commercial real estate loans increased
$34 million to $366 million or 26.7% of the portfolio at September 30, 2003 from
$332 million or 25.1% at December 31, 2002. Agricultural loans increased $13
million, to $247 million at September 30, 2003 from $234 million at December 31,
2002. Included in agricultural loans were $123 million in loans to dairy
farmers, or 9.0% of the total loan portfolio at September 30, 2003 comparable to
$119 million or 9.0% of the total loan portfolio at December 31, 2002. The
residential real estate portfolio includes loans held for sale totaling
$9,688,000 and $6,971,000 at September 30, 2003 and December 31, 2002,
respectively.
Nonaccruing Loans and Nonperforming Assets
Nonperforming assets at September 30, 2003 were $51.9 million compared to $38.4
million at December 31, 2002. The increase in nonperforming loans includes an
increase of $5.7 million in commercial loans, $1.6 million in commercial
mortgage loans and $6.0 million in agricultural loans. The increase in
commercial and commercial mortgage nonaccrual loans relates to general continued
weak economic conditions and the overextended positions of the borrowers. The
increase in nonaccrual agricultural loans relates to an extended period of low
milk prices in the dairy industry that has adversely affected the borrowers'
cash flow. More recently there has been favorable upward movement in milk
prices. Over the past few quarters the Company has committed additional
resources toward management of the Company's nonperforming assets and
strengthening the credit administration function.
14
The following table provides information regarding nonaccruing loans and other
nonperforming assets at the dates indicated.
September 30, December 31,
(Dollars in thousands) 2003 2002
------------- -------------
Nonaccruing loans (1)
Commercial $ 18,910 $ 12,760
Commercial real estate 10,387 8,407
Agricultural 14,550 8,739
Residential real estate 2,005 1,065
Consumer and home equity 500 915
------------- -------------
Total nonaccruing loans 46,352 31,886
Restructured loans 3,098 4,129
Accruing loans 90 days or more delinquent 1,723 1,091
------------- -------------
Total nonperforming loans 51,173 37,106
Other real estate owned 756 1,251
------------- -------------
Total nonperforming assets $ 51,929 $ 38,357
============= =============
Total nonperforming loans to total loans 3.73% 2.81%
Total nonperforming assets to total loans and other real estate 3.78% 2.90%
(1) Loans are placed on nonaccrual status when they have been identified by
the Company as presenting uncertainty with respect to the collectibility
of interest or principal.
The recorded investment in loans considered impaired totaled $30,127,000 and
$24,626,000 at September 30, 2003 and December 31, 2002, respectively. The
allowance for loan losses related to impaired loans amounted to $7,597,000 and
$4,462,000 at September 30, 2003 and December 31, 2002, respectively. Interest
income recognized on impaired loans, while such loans were impaired, during the
nine months ended September 30, 2003 and 2002 was approximately $148,000 and
$349,000, respectively.
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the estimated amount of probable credit
losses inherent in the Company's loan portfolio. Periodic, systematic reviews of
the loan portfolio are performed to identify 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 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, taking into consideration
management's judgment. Allowance methodology is reviewed on a periodic basis and
modified as appropriate. Based on this analysis the Company believes the
allowance for loan losses is fairly stated at September 30, 2003.
15
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) 2003 2002 2003 2002
-------- -------- -------- --------
Balance at beginning of period $ 26,518 $ 20,121 $ 21,660 $ 19,074
Addition as a result of acquisition -- -- -- 174
Charge-offs:
Commercial 1,600 679 4,099 1,234
Commercial real estate 687 77 1,594 467
Agricultural -- -- 27 29
Residential real estate 26 19 97 54
Consumer and home equity 897 412 1,652 1,087
-------- -------- -------- --------
Total charge-offs 3,210 1,187 7,469 2,871
Recoveries:
Commercial 63 9 419 28
Commercial real estate 6 14 18 84
Agricultural 1 -- 3 35
Residential real estate 1 -- 10 54
Consumer and home equity 83 65 212 256
-------- -------- -------- --------
Total recoveries 154 88 662 457
-------- -------- -------- --------
Net charge-offs 3,056 1,099 6,807 2,414
Provision for loan losses 5,590 1,452 14,199 3,640
-------- -------- -------- --------
Balance at end of period $ 29,052 $ 20,474 $ 29,052 $ 20,474
======== ======== ======== ========
Ratio of net loan charge-offs to average loans (annualized) 0.89% 0.35% 0.67% 0.26%
Ratio of allowance for loan losses to total loans 2.12% 1.60% 2.12% 1.60%
Ratio of allowance for loan losses to nonperforming loans 57% 142% 57% 142%
Net loan charge-offs were $6.8 million for the first nine months of 2003 or
0.67% (annualized) of average loans compared to $2.4 million or 0.26% of average
loans in the same period last year. Provision for loan losses amounted to $14.2
million for the first nine months of 2003 and reflects the increased amount of
net loan charge-offs, higher levels of specific allocations associated with
impaired loans, and overall higher allowances on pools of homogeneous loans. The
ratio of the allowance for loan losses to nonperforming loans was 57% at
September 30, 2003, compared to 58% at December 31, 2002. The ratio of the
allowance for loan losses to total loans increased to 2.12% at September 30,
2003, compared to 1.64% at December 31, 2002.
16
Investing Activities
U.S. Treasury and Agency Securities
At September 30, 2003, the U.S. Treasury and Agency securities portfolio totaled
$171.4 million, all of which was classified as available for sale. The portfolio
was comprised entirely of U. S. federal agency securities, which were
predominately callable securities. These callable securities provide higher
yields than similar securities without call features. At December 31, 2002, the
U.S. Treasury and Agency securities portfolio totaled $120.6 million, all of
which was classified as available for sale.
State and Municipal Obligations
At September 30, 2003, the portfolio of state and municipal obligations totaled
$232.2 million, of which $186.8 million was classified as available for sale. At
that date, $45.4 million was classified as held to maturity, with a fair value
of $46.5 million. At December 31, 2002, the portfolio of state and municipal
obligations totaled $222.0 million, of which $174.9 million was classified as
available for sale. At that date, $47.1 million was classified as held to
maturity, with a fair value of $48.1 million. The growth in this portfolio can
be attributed to the Company's efforts to expand municipal banking
relationships, which includes both deposit activities and investing in
obligations issued by those municipalities.
Mortgage-Backed Securities
Mortgage-backed securities, all of which were classified as available for sale,
totaled $190.3 million and $283.5 million at September 30, 2003 and December 31,
2002, respectively. The portfolio was comprised of $131.2 million of
mortgage-backed pass-through securities, $48.7 million of collateralized
mortgage obligations (CMOs) and $10.4 million of other asset-backed securities
at September 30, 2003. The mortgage backed pass-through securities were
predominantly agency issued debt (FNMA, FHLMC, or GNMA). Over 75% of the agency
mortgage-backed pass-through securities were in fixed rate securities that were
most frequently formed with mortgages having an original balloon payment of five
or seven years. The adjustable rate agency mortgage-backed securities portfolio
is principally indexed to the one-year Treasury bill. The CMO portfolio consists
of government agency issues and privately issued AAA rated securities. The other
asset-backed securities are primarily Student Loan Marketing Association (SLMA)
floaters, which are securities backed by student loans. At December 31, 2002 the
portfolio consisted of $193.4 million of mortgage-backed pass-through securities
and $90.1 million of CMOs. The mortgage-backed portfolio at December 31, 2002
was primarily agency issued (FNMA, FHLMC, GNMA) obligations, but also included
privately issued AAA rated securities and SLMA floaters to further diversify the
portfolio. During the first nine months of 2003, the low interest rate
environment has led to significant refinance activity and high prepayments of
mortgage-backed securities. These increased prepayments have led to a decline in
the Company's mortgage-backed security portfolio.
Corporate Bonds
The corporate bond portfolio, all of which was classified as available for sale,
totaled $4.1 million and $13.9 million at September 30, 2003 and December 31,
2002, respectively. 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 as Baa or better by Moody's Investors Service,
Inc. or BBB or better by Standard & Poor's Ratings Services at the time of
purchase.
Equity Securities
At September 30, 2003 and December 31, 2002, available for sale equity
securities totaled $5.8 million and $3.9 million, respectively. This portfolio
is primarily comprised of FHLMC preferred stock, but also includes corporate
equity securities owned by the holding company.
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
$1.6 billion or 87.5% of total deposits of $1.828 billion at September 30, 2003
compared to core deposits of $1.507 billion or 88.2% of total deposits of $1.709
billion at December 31, 2002. The core deposit base consists almost exclusively
of in-market accounts. The Company had total public deposits of $398.3 million
at September 30, 2003 compared to $361.2 million at December 31, 2002. The
increase is a reflection of the seasonality of the municipal banking business.
Included in total deposits are certificates of deposit over $100,000, which
amounted to $227.7 million and $201.8 million as of September 30, 2003 and
December 31, 2002, respectively. As of September 30, 2003 and December 31, 2002,
brokered certificates of deposit included in certificates of deposit over
$100,000 totaled $83.7 million and $71.6 million, respectively.
Non-Deposit Sources of Funds
The Company's most significant source of non-deposit funds is FHLB borrowings.
FHLB advances outstanding amounted to $102.0 million and $112.8 million as of
September 30, 2003 and December 31, 2002, respectively. These FHLB borrowings
include both short and long-term advances maturing on various dates through
2009. The Company had approximately $21.0 million of immediate credit available
under lines of credit with the FHLB at September 30, 2003, collateralized by
FHLB stock and real estate mortgage loans. The Company also has lines of credit
with the Federal Agricultural Mortgage Corp. (Farmer Mac) permitting borrowings
to a maximum of $50.0 million. However, no advances were outstanding against the
Farmer Mac lines as of September 30, 2003. The Company also utilizes securities
sold under agreements to repurchase as a source of funds. These short-term
repurchase agreements amounted to $31.4 million and $60.7 million as of
September 30, 2003 and December 31, 2002, respectively.
During 2001 FISI Statutory Trust I (the "Trust") was established and 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,
2003, 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.
Equity Activities
Total shareholders' equity totaled $182.7 million at September 30, 2003, an
increase of $4.4 million from $178.3 million at December 31, 2002. Retained
earnings increased to $136.9 million at September 30, 2003, a $5.5 million
increase over retained earnings at year-end. The increase in retained earnings
was offset by a $2.3 million decrease in accumulated other comprehensive income
attributed to a decline in unrealized gain on available for sale securities.
RESULTS OF OPERATIONS
Average Balance Sheets
The tables on the following pages set forth certain information relating to the
Company's consolidated statements of financial condition and reflect the average
yields earned on interest-earning assets, as well as the average rates paid on
interest-bearing liabilities for the periods presented. Dividing interest income
or interest expense by the average balances of interest-earning assets or
interest-bearing liabilities, respectively, derived the yields and rates. Tax
equivalent adjustments have been made. All average balances are average daily
balances. Nonaccruing loan balances are included in the yield calculations in
these tables.
18
For The Three Months Ended September 30,
----------------------------------------
2003 2002
---- ----
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 $ 65,723 $ 171 1.03% $ 15,280 $ 71 1.84%
Investment securities (1):
Taxable 348,650 3,477 3.99% 389,146 5,074 5.21%
Non-taxable 230,435 3,130 5.43% 212,812 3,262 6.13%
----------- ----------- ------ ----------- ----------- -------
Total investment securities 579,085 6,607 4.56% 601,958 8,336 5.54%
Loans (2):
Commercial and agricultural 874,278 12,747 5.78% 791,515 13,477 6.76%
Residential real estate 259,537 4,638 7.15% 233,321 4,796 8.22%
Consumer and home equity 244,898 4,243 6.87% 234,522 4,805 8.13%
----------- ----------- ------ ----------- ----------- -------
Total loans 1,378,713 21,628 6.23% 1,259,358 23,708 7.29%
----------- ----------- ------ ----------- ----------- -------
Total interest-earning assets 2,023,521 28,406 5.58% 1,876,596 31,485 6.68%
----------- ----------- ------ ----------- ----------- -------
Allowance for loans losses (26,375) (20,331)
Other non-interest earning assets 160,262 145,012
----------- -----------
Total assets $ 2,157,408 $ 2,001,277
=========== ===========
Interest-bearing liabilities:
Interest-bearing checking 387,250 794 0.81% 372,025 1,346 1.44%
Savings and money market 401,828 833 0.82% 355,600 1,404 1.57%
Certificates of deposit 753,866 5,517 2.90% 675,435 6,182 3.63%
Borrowed funds 136,487 1,205 3.51% 170,723 1,457 3.37%
Guaranteed preferred beneficial interests in
Corporation's junior subordinated
debentures 16,200 421 10.31% 16,200 421 10.31%
----------- ----------- ------ ----------- ----------- -------
Total interest-bearing liabilities 1,695,631 8,770 2.05% 1,589,983 10,810 2.70%
----------- ----------- ------ ----------- ----------- -------
Non-interest bearing demand deposits 254,528 222,854
Other non-interest-bearing liabilities 21,677 19,233
----------- -----------
Total liabilities 1,971,836 1,832,070
Shareholders' equity (3) 185,572 169,207
----------- -----------
Total liabilities and shareholders'
equity $ 2,157,408 $ 2,001,277
=========== ===========
Net interest income - tax equivalent 19,636 20,675
Less: tax equivalent adjustment 1,096 1,142
----------- -----------
Net interest income $ 18,540 $ 19,533
=========== ===========
Net interest rate spread 3.53% 3.98%
====== =======
Net earning assets $ 327,890 $ 286,613
=========== ===========
Net interest margin (4) 3.86% 4.39%
====== =======
Ratio of average interest-earning assets to
average interest-bearing liabilities 119.34% 118.03%
====== =======
(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 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
For The Nine Months Ended September 30,
---------------------------------------
2003 2002
---- ----
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 $ 46,598 $ 397 1.14% $ 28,469 $ 377 1.77%
Investment securities (1):
Taxable 391,979 12,385 4.22% 355,605 14,441 5.41%
Non-taxable 230,011 9,635 5.59% 208,954 9,845 6.28%
----------- ----------- -------- ----------- ----------- --------
Total investment securities 621,990 22,020 4.72% 564,559 24,286 5.73%
Loans (2):
Commercial and agricultural 857,233 38,554 6.01% 750,806 39,118 6.97%
Residential real estate 257,267 14,053 7.28% 232,257 14,393 8.26%
Consumer and home equity 241,683 12,949 7.16% 231,421 14,102 8.15%
----------- ----------- -------- ----------- ----------- --------
Total loans 1,356,183 65,556 6.46% 1,214,484 67,613 7.44%
----------- ----------- -------- ----------- ----------- --------
Total interest-earning assets 2,024,771 87,973 5.80% 1,807,512 92,276 6.82%
----------- ----------- -------- ----------- ----------- --------
Allowance for loans losses (24,068) (19,836)
Other non-interest earning assets 156,474 145,197
----------- -----------
Total assets $ 2,157,177 $ 1,932,873
=========== ===========
Interest-bearing liabilities
Interest-bearing checking 386,805 2,805 0.97% 348,957 3,844 1.47%
Savings and money market 410,619 3,224 1.05% 351,553 4,246 1.61%
Certificates of deposit 748,428 16,913 3.02% 649,023 18,539 3.82%
Borrowed funds 148,654 3,827 3.44% 172,271 4,347 3.37%
Guaranteed preferred beneficial interests in
Corporation's junior subordinated
debentures 16,200 1,258 10.38% 16,200 1,258 10.38%
----------- ----------- -------- ----------- ----------- --------
Total interest-bearing liabilities 1,710,706 28,027 2.19% 1,538,004 32,234 2.80%
----------- ----------- -------- ----------- ----------- --------
Non-interest bearing demand deposits 239,843 214,761
Other non-interest-bearing liabilities 22,365 19,694
----------- -----------
Total liabilities 1,972,914 1,772,459
Shareholders' equity (3) 184,263 160,414
----------- -----------
Total liabilities and shareholders'
equity $ 2,157,177 $ 1,932,873
=========== ===========
Net interest income - tax equivalent 59,946 60,042
Less: tax equivalent adjustment 3,372 3,446
----------- -----------
Net interest income $ 56,574 $ 56,596
=========== ===========
Net interest rate spread 3.61% 4.02%
======== ========
Net earning assets $ 314,065 $ 269,508
=========== ===========
Net interest margin (4) 3.95% 4.43%
======== ========
Ratio of average interest-earning assets to
average interest-bearing liabilities 118.36% 117.52%
======== ========
(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 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.
20
Net Interest Income
Net interest income, the principal source of the Company's earnings, decreased
5.0% to $18.5 million compared to $19.5 million in the third quarter of 2002.
Net interest margin was 3.86% for the third quarter of 2003, a drop of 53 basis
points from 4.39% for the same period last year.
For the nine months ended September 30, 2003 and 2002, net interest income
totaled $56.6 million. In the 2003 period net interest margin decreased to 3.95%
from 4.43%.
Net interest margin has declined over the past year, as market interest rates
have fallen to historically low levels. The trend of compression in net interest
margin has developed as a result of yields on incremental asset growth declining
more rapidly than funding costs in this period of low interest rates. The loss
of interest income on nonaccrual loans has also contributed to the declines in
net interest margin in recent quarters.
Provision for Loan Losses
The provision for loan losses for the third quarter of 2003 totaled $5.6
million, an increase of $4.1 million over the $1.5 million provision for loan
losses for the third quarter of 2002. For the first nine months of 2003, the
provision for loan losses totaled $14.2 million compared to $3.6 million for the
same period last year.
The increased provision for loan losses in 2003 is a reflection of higher loan
charge-offs, increased specific reserve allocations on impaired loans, a decline
in asset quality and the extended soft economy with resulting effects on the
Company's assessment of the allowance for loan losses. See the discussion under
"Analysis of the Allowance for Loan Losses."
Noninterest Income
Noninterest income increased 24% in the third quarter of 2003 to $7.1 million
from $5.7 million for the third quarter of 2002. For the first nine months of
2003, noninterest income totaled $19.3 million, an increase of 22% over the same
period last year.
Growth in deposits and related activity resulted in service charges on deposits
increasing $662,000 to $8.4 million for the nine months ending September 30,
2003 compared to $7.7 million for the same period a year ago. Mortgage banking
revenues, which include gains and losses from the sale of residential mortgage
loans, mortgage servicing income and the amortization of mortgage servicing
rights, increased $1.2 million to $2.8 million for the nine months ended
September 30, 2003 from $1.6 million for the same period last year. The increase
in mortgage banking revenues corresponds with the increase in residential
mortgage refinancing activity resulting from the historically low interest rate
environment. The Company sells most fixed rate newly originated and refinanced
mortgage loans in the secondary market. Net gains on sale of securities
increased to $581,000 for the three months ending September 30, 2003 compared to
$139,000 for the same period a year ago.
Noninterest Expense
Noninterest expense for the third quarter of 2003 totaled $14.9 million compared
with $13.4 million for the third quarter of 2002. For the nine months ended
September 30, 2003, noninterest expense was $45.4 million, an increase of $6.8
million over $38.6 million for the prior year.
Salaries and benefits have increased $3.6 million for year-to-date 2003,
primarily as a result of additional staffing associated with the Company's new
branch offices and the expansion of its credit administration department. The
first quarter of 2003 also included $674,000 of former management separation
costs. Occupancy and equipment costs have increased $829,000 during the nine
months ended September 30, 2003 due to the additional branches and expansion of
the Company's technology platform.
Additional items at the Company's NBG subsidiary affecting noninterest expense
during the nine months ended September 30, 2003 include an impairment charge of
$489,000 for a partnership investment, professional services amounting to
$232,000 related to organizational governance and credit administration issues,
and a $538,000 write-down of a parcel of other real estate owned.
21
These additional expenses, coupled with a slowing of net interest income growth,
are the principal factors increasing the Company's year-to-date efficiency ratio
for 2003 to 55.87%, compared to 49.68% for the same period a year ago.
Income Tax Expense
The provision for income taxes, which provides for Federal and New York State
income taxes, amounted to $1.1 million and $3.5 million for the third quarter of
2003 and 2002, respectively. For the nine months ended September 30, 2003 and
2002, the provision for income taxes totaled $4.3 million and $9.9 million,
respectively. While the decrease generally corresponds to the decreased levels
of taxable income, the effective tax rate for year-to-date 2003 decreased to
26.3%, compared to 33.0% for year-to-date 2002, primarily as a result of an
increase in holdings of tax-exempt securities.
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, including credit lines with the 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.
In the normal course of business, the Company has outstanding commitments to
extend credit 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, 2003 letters of
credit totaling $11.6 million and unused loan commitments of $315.5 million were
contractually available. Comparable amounts for these commitments at December
31, 2002 were $13.4 million and $316.6 million, respectively. The total
commitment amounts do not necessarily represent future cash requirements as
certain of the commitments are expected to expire without funding.
The Company's cash and cash equivalents were $119.9 million at September 30,
2003, an increase of $71.5 million from the balance of $48.4 million at December
31, 2002. The primary factors leading to the increase in cash during the first
nine months of 2003 were the increase in deposits and decrease in securities,
offset by an increase in net loans and decrease in borrowings.
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%. 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 7.00% and 6.96% at September 30, 2003
and December 31, 2002, respectively, well-above minimum regulatory capital
requirements. Total Tier 1 capital of $147.2
22
million at September 30, 2002 increased $7.6 million from $139.6 million at
December 31, 2002. The increase in Tier 1 capital relates primarily to the
increase of $5.5 million in retained earnings resulting from the Company's 2003
nine month earnings net of dividend payouts.
The Company's total risk-weighted capital ratio was 11.25% at September 30,
2003, comparable to 11.08% at and December 31, 2002, both well-above minimum
regulatory capital requirements. Total risk-based capital was $165.7 million at
September 30, 2003, an increase of $8.3 million from $157.4 million at December
31, 2002.
The Company has previously disclosed its intent to secure financing that will
enable the Company to make capital contributions to its NBG and BNB subsidiary
banks to achieve capital ratios at those banks specified in agreements entered
into by the banks with the Office of the Comptroller of the Currency. The
Company is negotiating with a major financial institution to provide medium term
debt financing in an amount that will enable the Company to make those capital
contributions. Finalization of terms and receipt of funds is anticipated by
December 31, 2003 at which time the Company expects to make contributions to the
banks in amounts sufficient to achieve the level of capital ratios required by
March 31, 2004 in the agreements.
Other Matters
The Company disclosed in its 2003 Annual Report on Form 10-K that the OCC began
Safety & Soundness Examinations at NBG and BNB in early January 2003 and that
management was undertaking significant remedial measures in credit
administration, compliance and organizational structure to address the issues
identified in those examinations.
On April 30, 2003, at examination exit meetings with the senior managements of
NBG and BNB, the OCC outlined proposed findings and provided a written summary
of issues requiring attention in the areas of regulatory compliance, credit risk
management and internal controls.
On August 13, 2003 the OCC delivered its Report of Examination with respect to
each of NBG and BNB for the period ended September 30, 2002 (each an "ROE" and
collectively the "ROEs") to the Boards of Directors of NBG and BNB. The NBG ROE
was based on financial information as of September 30, 2002, updated to December
31, 2002, where possible, and the BNB ROE was based on financial information as
of September 30, 2002, updated to March 31, 2003, where possible.
As described in the "Other Matters" section of the Management's Discussion and
Analysis of Financial Condition and Results of Operations at pages 23 through 25
of the Company's second quarter Form 10-Q filed on August 14, 2003 (which
section is referred to herein as the "Second Quarter 10-Q MD&A") the ROEs
concluded that both NBG and Bath required improvement in board and management
supervision and had less than satisfactory asset quality, although, in the case
of both banks, the ROEs concluded that the allowance for loan and lease losses
was adequate. The ROEs also found that in both banks, capital was strained,
although earnings were satisfactory and liquidity was adequate. Various
regulatory violations were identified at both banks, all of which have either
already been corrected or are in the process of being corrected by management of
the banks. As a consequence of these findings, both ROEs stated the banks would
lose their "well managed" status and "satisfactory" composite ratings, and would
be the subject of enforcement actions. In the case of NBG, the OCC indicated
that it was considering whether to impose civil money penalties.
Also on August 13, and as described in the Second Quarter 10-Q MD&A, the OCC
initiated enforcement actions against both banks by delivering drafts of
proposed formal agreements to the Boards of NBG and BNB (each an "Agreement" and
collectively the "Agreements"). On September 4, the boards of the two banks
entered into the Agreements, under the terms of which the boards, without
admitting any violations, agreed to take actions designed to assure that their
operations are in accordance with applicable laws and regulations. The actions
required by the Agreements with respect to management and credit policy at both
banks are summarized in the Second Quarter 10-Q MD&A. The Agreements also
require NBG and BNB to adopt dividend policies that would permit them to declare
dividends only when they are in
23
compliance with their approved capital plan and the provisions of 12 U.S.C.
Section 56 and 60, and upon prior written notice to (but not consent of) the
Assistant Deputy Comptroller. The banks are important sources of funds to the
Company and, if they are unable, or limited in their ability, to pay dividends
to the Company, that will affect the Company's ability to pay dividends to its
shareholders.
In addition, the Agreements require both banks to develop capital plans that
will enable them to achieve, by March 31, 2004, a tier 1 leverage capital ratio
equal to 8%, a tier 1 risk-based capital ratio equal to 10%, and a total
risk-based capital ratio of 12%. Interim levels, to be achieved by December 31,
2003, were also established, at 6.25%, 9.0% and 11.0%, respectively, for BNB,
and 7.0%, 9.0% and 10.5%, respectively, for NBG.
The NBG Agreement, as more fully described in the Second Quarter 10-Q MD&A,
requires the Board to adopt a written policy on extensions of overdraft credit
and limit the circumstances under which NBG would be permitted to directly or
indirectly extend credit to its affiliates, and requires the bank to engage an
independent appraiser to provide written or updated real property collateral
appraisals where required. The BNB Agreement, as previously described, requires
its Board of Directors to adopt a written action plan outlining proposed
corrective action addressing the pre-existing Matters Requiring Attention (MRA)
pertaining to Interest Rate Risk Measurement and Monitoring Systems.
As described in the "Liquidity and Capital Resources" section of the Management
Discussion and Analysis, the Company is negotiating with a major financial
institution to provide financing in an amount that will enable the Company to
make capital contributions to NBG and BNB to satisfy the requirements of their
respective capital plans.
The findings in the ROEs are consistent with discussions the Company has had
with the OCC and the disclosures in its 2002 Annual Report on Form 10K,
Quarterly Report March 31, 2003 on Form 10Q, and Quarterly Report June 30, 2003
on Form 10Q. The ROEs did not identify any nonperforming assets that were not
disclosed in the Company's Quarterly Reports March 31, 2003 or June 30, 2003 on
Form 10Q. To address the issues noted the Company and the banks have taken the
following actions to date:
o The Board of NBG has appointed a new President and new Senior Lender.
o The Board of BNB has created and filled a new Senior Lender position.
o The Company has engaged a new external loan review firm and revised the
scope of the engagement.
o In September 2002 the Company created and filled a new Senior Credit
Administrator position at the holding company level.
o In the first quarter of 2003 the Company created and filled a new Senior
Credit Risk Management position and credit analysis function at the
holding company level that supports the loan underwriting process.
o In the first half of 2003 the Company created and filled positions of a
new loan workout department at the holding company level to manage all
classified credits.
o The Company has revised its lending policy in the areas of approval
authorities, insider lending, transactions with affiliates, real estate
appraisals, review of the allowance for loan losses, and terms and
collateral on selected classes of credit.
o To enhance capital levels NBG has not paid a dividend in 2003 and the
Company contributed an additional $1,000,000 in capital. At September 30,
2003 NBG had a tier 1 leverage capital ratio of 6.64%, a tier 1 risk-based
capital ratio of 9.03% and a total risk based capital ratio of 10.30%.
24
o To enhance capital levels BNB has not paid a dividend since its first
quarter 2003 dividend. At September 30, 2003 BNB had a tier 1 leverage
capital ratio of 6.27%, a tier 1 risk-based capital ratio of 10.43%, and a
total risk based capital ratio of 11.68%.
o BNB has instituted new procedures to test the validity of assumptions made
in its interest rate risk measuring and monitoring systems.
The OCC Agreements are included as exhibits to the Current Report filed on Form
8-K September 5, 2003. The OCC Agreements are also available on the OCC's
website and, together with any CMPs that may be assessed, could have adverse
effects on NBG and Bath, including without limitation making it more difficult
for them to attract and retain qualified directors, making them ineligible to
accept brokered deposits without FDIC approval, increasing their expenses
associated with complying with the ROEs' recommendations and damaging their
reputations. These actions also could have adverse effects on the Company,
including without limitation reducing its access to capital, reducing its
liquidity and damaging its reputation. Because the OCC reports concluded that
NBG and Bath were not entitled to "well-managed" and "well-capitalized" status,
the Company on September 4 voluntarily terminated its financial holding company
(FHC) status under the Bank Holding Company Act, and will operate instead as a
bank holding company. The change in status will not affect any non-financial
subsidiaries or activities currently being conducted by FII, although it will
mean that future acquisitions or expansions of non-financial activities may
require prior Federal Reserve Board approval and will be limited to those that
are permissible for bank holding companies.
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's Annual Report on Form 10-K as of December 31, 2002,
dated March 14, 2003, as filed with the Securities and Exchange Commission.
25
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
Under the supervision and with the participation of the Company's management,
including the Chief Executive Officer and Chief Financial Officer, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Exchange Act) as of the end of the period covered by this quarterly report.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that, as of the end of the period covered by this quarterly
report, the Company's disclosure controls and procedures are effective to ensure
that information required to be disclosed in the reports that the Company files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission's rules and forms. There has been no change in the Company's
internal control over financial reporting during the most recent fiscal quarter
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit 11.1 Computation of Per Share Earnings*
Exhibit 31.1 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit 32.2 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 4 to the consolidated financial statements
in this report.
(b) Reports on Form 8-K.
Pursuant to Regulation FD under item 9, the Company filed a Form 8-K on
July 22, 2003.
Pursuant to Regulation FD under item 5, the Company filed a Form 8-K on
September 5, 2003.
26
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 13, 2003 FINANCIAL INSTITUTIONS, INC.
Date Signatures
November 13, 2003 /s/ Peter G. Humphrey
-----------------------------
Peter G. Humphrey
President, Chief Executive Officer
(Principal Executive Officer),
Chairman of the Board and Director
November 13, 2003 /s/ Ronald A. Miller
-------------------------------
Ronald A. Miller
Senior Vice President
and Chief Financial Officer
(Principal Accounting Officer)
27