Q2 2020 Financial Institutions Inc Earnings Call
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Good morning, and welcome to the financial institutions Inc. second quarter earnings Conference call.
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I would now like turn the conference, though the Shelly Dory director of Investor Relations. Please go ahead.
Thank you for joining after today's call providing prepared comments will be president and CEO, Marty Birmingham and CFO just have become.
Director of financial planning of analysis might grow verbal participate in the Q and a portion of the cool.
Todays prepared comments and queuing. They will include forward looking statements.
Actual results may differ materially some forward looking statements due to a variety of risks uncertainties and other factors.
We refer you to yesterday's earnings release, and historical actually see filings available on our website for a safe Harbor description and the detailed discussion of risks factors relating to forward looking statements.
We will also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures.
Reconciliations of these measures to GAAP financial measures were provided in the earnings release, which was 12 as an exhibit to form 8-K.
Please note that this call includes information accurate only as of today's date July Thirtyth 2020, I'll now turn call over to Marty.
Thank you Shelly.
Good morning, everyone and welcome to our second quarter earnings call.
The past few months have been very challenging an eventful for our organization.
We responded swiftly to the cold pandemic in March taking action to protect our associates and our customers by creating less dense work environments.
Work from home and alternative work locations were implemented for his many associates as possible as well as non essential business travel and visitor restrictions.
Most brands lobbies were closed and by appointment only protocols were implemented for those transactions requiring face to face interaction.
And our new normal working together, yet apart, we implemented an array of actions to support consumers and businesses, including waiving certain fees not reporting payments referrals to credit bureaus, and the granting of up to 90 day, Grace periods, where consumer mortgage and auto loan payments.
4.3 million of consumer loan payments were extended on average for 60 days and forbearance was granted on approximately 633000 residential mortgages and monthly line payments on average for 90 days.
Credit was thoughtfully extended to small business and commercial customers for working capital and operating purposes, and loan relief, which provided to 135 small business customers, representing 19 million of loans and 227 commercial clients, representing 383 million in loans.
We were able to help approximately 1700 small businesses obtain 270 million of S.P.A. payroll protection program laws, helping to preserve the estimated 18000 jobs in our markets.
And we continue to work with customers on one to one to address unique needs. During this time.
We're staying in close contact with our commercial customers, making sure we understand their operating environments and business challenges.
And offering assistance or solutions, where possible we.
We completed a thorough credit analysis of our commercial loan portfolio designed to uncover potential portfolio risk and help us navigate the credit cycle.
We developed a watch list of higher risk industries to monitor monitor on a go forward basis.
We review key credit relationships every week up to the executive level. The bank tracking how businesses are performing this is a joint effort completed by our lending credit risk and finance teams.
All of these accomplishments were achieved with 65% of our associates working remotely.
Our organization transition very quickly from business as usual operations to a new standard of working together for multiple locations across our footprint.
So proud of the five star families collective resiliency and at that patient to so many changes.
To provide enhanced digital capabilities during a time when at home access was critical we move forward in the second quarter with the multiphase launch of our new online and mobile platform five Star Bank digital banking.
No more than ever consumers and businesses need the ability to do their banking anywhere and anytime and we leveraged the latest technology to provide new features and tools to improve the digital banking experience for our customers.
The five Star Bank digital banking platform provides a single dashboard to make payments of deposits transferred send money create budgets set financial goals and easily integrated external investment loan and other transactional accounts.
Customer response to the platform has been very favorable and we will continue to roll out enhancements overtime.
For example over the summer we will be launching a new digital account opening platform that will allow consumers and businesses to open most kinds of deposit accounts on any device.
During the quarter. We also developed our reentry plan, we will be working differently as we reopened and the approaches for re entry will vary by location.
We have completed significant preparation incorporating local directives with practical consideration for each location. So that went associates come back and customers come in they feel safe.
Our protocols have bad and we'll continue to be based on science and data.
We have the infrastructure and operations in place to be public health obligation and are putting in place additional layers of safeguards and all locations that can be monitored and revised as appropriate.
We have brought back a portion of associates into two of our administrative offices and so far it has gone very well.
We remain committed to maintaining a less dense workplace through the continued use of remote access and alternative work sites.
By keeping at least 50% of our workforce remote it will ensure resiliency and flexibility should there be an uptick in community spread.
Also critical to this next phase is maintaining our culture.
If we envision staying in this operating stayed or even a modified version for an extended period, we must ensure that our organizational and cultural values stay intact.
That means maintaining regular communication and making sure that our associates don't feel isolated silo.
We all benefit from being an impactful and collaborative organization, that's part of our success.
And we need to maintain and even strengthen that.
Despite all the headwinds we delivered strong results in the quarter.
Net income was just slightly lower than a year earlier period, and we generated the second highest quarterly pretax pre provision income in our history.
It was a good quarter for core fundamentals and the benefits of the diversified revenue stream were evident.
As I stated last quarter, we entered the crisis in a position of strength based on our diversified business model strong levels of capital and liquidity historically strong asset metrics.
In a disciplined risk management underwriting process.
We remain focused on taking good care of our customers, our associates and our capital and I believe we're well positioned to navigate the complexities of our current operating environment.
Now my pleasure to turn the call over to Justin for a discussion of results for the quarter Justin.
Thanks Marty.
Good morning, everyone.
Net income was $11.1 million for the quarter or 67 cents per diluted share as compared to $1.1 million or five cents per share in the first quarter of 2020.
You will recall that the first quarter results included a 13.9 million dollar provision.
For credit losses.
Reflecting deterioration in the economic environment due to cope with 19.
The adoption of Cecil and the impact of the partial charge off of a single thing and I loan.
The after tax impact of the higher first quarter provision was 59 cents per share.
Pretax pre provision income for the second quarter was 17.3 million a 2 million increase from the first quarter of 2020, and a 625000, an increase from the year earlier quarter.
Net interest income for the quarter was 34.2 million.
An increase of 1.1 million from the linked quarter.
The increase was driven by loan growth primarily from PPP loans.
Net interest margin was 3.23%.
Down eight basis points from the linked quarter.
The average yield on interest, earning assets was 3.76% a decrease of 39 basis points from the linked quarter.
Cost of funds was 53 basis points, a decrease of 31 basis points.
The decline in earning asset yield.
It's driven by the impact of lower yielding PPP loans originated during the second quarter and a full quarter impact of the lower interest rate environment.
Lower yields on PPP loans negatively impacted our earning asset yield by approximately six basis points.
The cost of funds decline was driven by lower deposit and wholesale borrowing costs driven by lower market interest rates and a favorable funding mix.
Provision expense for the quarter was 3.7 million.
And the allowance for credit losses on loans to total loans was 1.33% at quarter end as compared to 1.34% at March 31st.
If you exclude PPP loans.
The ratio increases to 1.44% and expansion of 10 basis points from the linked quarter.
The allowance for credit losses on loans increased to $46.3 million at June 32020.
From 43.4 million at March 31st 2020.
The higher allowance for credit losses considers the impact of Cobot 19.
And the economic environment on our primary loss driver, which is national unemployment.
We use the Bloomberg economist weighted average forecast.
Which forecasts Q3 national unemployment at 10.4%.
Lower than the peak level of unemployment that was forecasted last quarter.
However, we do forecast out six quarters and the overall unemployment forecasts for the next six quarters is higher for a longer now than it was last quarter.
In addition, our Cecil quantitative model estimates expected credit losses, using a reversion to the mean of the company's historic loss rates.
On a straight line basis over two years. Our model also includes qualitative adjustments, both favorable and unfavorable in nature.
Unfavorable adjustments broadly take into account incremental reserves attributable to cope with 19, partially offset by favorable adjustments attributable to massive U.S. government stimulus.
Support funding, including the FDA Paycheck protection program.
Credit losses were minimal during the quarter with net charge offs totaling $786000.
Yes, as we know the long term impact remains to be seen.
We don't expect a return to normalized levels of provision until the pandemic has worked its way through our economy.
From a credit perspective for both Cnine and theory.
We are cash flow lenders as a primary source of repayment.
As Marty addressed relationship managers are staying very close to our customers understanding and monitoring their operating environments on all exposures, especially those we have identified as higher risk due to the industry segment in which they operate.
A key strength of our community Bank model is the ability to develop deep ties to customers through good times and bad to understand their business needs risks facing their business and the impact of government release programs.
For the theory portfolio property is a secondary source of repayment.
Providing additional comfort that we will be repaid.
Our theory portfolio exposure carries a loan to value of approximately 60%.
For the see an eye portfolio, we take additional comfort in collateral as a secondary source of repayment.
Over 96% of RC and I portfolio exposure is secured by collateral. In addition, the vast majority of RC and I portfolio carry some level of recourse to the principles of the borrower.
Many of whom have long standing relationships with our organization.
Noninterest income was 130000 lower than the first quarter of 2020.
The key drivers were.
First service charges on deposits were 1.1 million lower driven by our covert relief accommodations of waving or eliminating feeds.
In place for the entire second quarter.
This initiative started on March 20, Threerd and ended on July nine.
Second insurance income was down 530000, primarily due to seasonality and contingent revenue received in the first quarter each year.
And third investments in limited partnerships generated a loss of 244000 in the quarter.
Resulting in a negative impact of 457000 as compared to the first quarter.
These factors were partially offset by a 1.2 million increase in the income.
From derivative instruments, and a 453000 increase in gains on investments securities.
Our interest rate swap program facilitates risk management strategies for our commercial banking customers. The program was initiated in the fall of 2017 and performance reflects the continued growth and maturity of our commercial business.
We sold some securities during the quarter that we believe have a higher propensity to prepay, resulting in the increase in game on investment Securities.
Despite severance related costs that netted to about 325000 noninterest expense was 26.7 million a decrease of 1 million from the linked quarter.
The largest contributors to the decrease were.
Professional services expense was 572000 lower.
Due to the timing of audit fees.
Typically highest in the first quarter of each year.
And the timing of fees for consulting and advisory projects.
Other expenses decreased 288000, as a result of lower education travel and business development expenses due to stay at home orders combined with lower indirect consumer lending related expenses.
Income tax expense was 2.4 million in the quarter, representing an effective tax rate of 18%.
Moving to the balance sheet growth in total loans was 249 million or nearly 8% from the end of the first quarter 2020.
Commercial business grew 39%.
Commercial mortgage grew 3%.
And residential loans grew 1%.
While consumer indirect decreased about 2%.
All PPP loans are reflected in commercial business driving this quarter's growth and in that category.
Excluding PPP loans commercial business decreased approximately 32 million largely due to the paydown of commercial lines of credit.
Broadly these lines increased at the end of March.
Into April paying down in May and June.
The line balances are down 27 million from 331.
And down 19 million from 12 31 2019.
Residential lending demonstrated improved performance during the second quarter, largely due to increased refinance volume driven by the low rate environment total originations for the quarter were 63 million as compared to 41 million in the first quarter of 2020, an increase of.
More than 50%.
Net gain on sale.
Of loans more than doubled increasing $427000 over the linked quarter.
Salable portion.
Of our portfolio continues to grow and represented 37% of the pipeline.
As of June 32020.
Total deposits at quarter end were 207 million higher than the end of the first quarter of 2020.
And 522 million higher than June thirtyth of last year.
The increase in deposits primarily in demand and savings accounts was largely the result of the impact of government stimulus programs, including the Paycheck protection program economic stimulus checks enhanced unemployment benefits.
And the deferral of tax payment deadlines, combined with pandemic related changes in customer habits.
Growth in the year over year period was also driven by our large municipal book.
Posits or at a seasonal low at the end of June and a seasonal high at the end of March. In addition, our broker deposit portfolio was 167 million higher than the year earlier period.
In February of 2020, we entered into a long term brokered sweep arrangement as a stable collateral free alternative funding source to reduce reliance on FHLB secured borrowings and improve our available committed liquidity.
Common equity tier one tier one and total risk based capital ratios increased in the quarter.
The leverage and TC he ratios decreased by 29 basis points, and 16 basis points, respectively, because of the PPP loans added during the quarter.
These ratio decline should be viewed as temporary as the PPP loans are 100% government guaranteed and are anticipated to have a short duration as the overwhelming majority will either be forgiven or paid off within two years.
The leverage ratio and TC ratios, excluding the PPP loans at June 32020, or 8.83% and 8.2%.
Increases of five and 30 basis points respectively.
During the second quarter of 2020, the company paid a common stock dividend of 26 cents per share returning 39% of second quarter net income to common shareholders. The company has no intention of reducing the dividend at this time.
Management and the board of Directors will continue to closely monitor the economic environment and business trends and will prudently manage capital levels going forward.
Consistent with the prior quarter, we will not be providing guidance at this time.
Uncertainties related to the coven 19 pandemic significantly widened the range of possible forecast outcomes, making a too difficult to project results with a reasonable level of accuracy.
With that said I'll now turn the call back to Marty for closing remarks.
Thank you Justin.
As we've discussed in previous quarters.
Our enterprise standardization program is focused on improving operational efficiency and future profitability, while enhancing the associate and customer experiences.
We have been assessing all lines of business and functional areas.
Opportunities identified by the program have resulted in the implementation of robotic automation and the streamlining of processes and operations throughout the organization.
Another outcome of the program was our July 17th announcement of changes in our retail branch network to better align us was shifting customer needs and preferences.
The announced transformation will result in six branch closures and a reduction in staffing.
Approximately 6% of the company's workforce was separated immediately in connection with the announcement.
Impacted branches will close this October.
These actions are expected to result in a charge in the third quarter of approximately 1.7 million.
Which is a combination of severance cost and real estate related charges.
Expected expense savings are anticipated at 2.6 billion on an annualized basis.
We plan to continue building market share beginning with two branch openings scheduled in the city of Buffalo next year.
We're also expanding the services, we offer across our operating footprint by offering in branch commercial lenders certified personal bankers.
In wealth management insurance professionals to provide customers with personalized timely solutions.
In summary, our company delivered solid net income in pretax pre provision income in the quarter. Despite the many disruptions associated with the cobot 19 pandemic in a lower interest rate environment.
We learned to work differently, you had efficiently while providing essential continued support to our customers.
Our company is sound and growing.
We have strong levels of capital liquidity thoughtfully develops strategy and effective risk management program and dedicated associates throughout the organization, we're well positioned to continue to deliver essential financial products and services to our communities.
Operator. This concludes our prepared comments, we are ready to open the call for questions.
Thank you.
We will now begin the question answer session.
To ask a question you May press Star then one on your telephone keypad, if you're using the speakerphone. Please pick up your handset before pressing the key.
To withdraw your question. Please press Star then too.
At this time, we will pause momentarily to assemble a roster.
[noise] and the first question will come from Alex Twerdahl with Piper Sandler. Please go ahead.
Good morning.
Morning, Alex.
First off on expenses I know, Justin you said, you weren't going to provide guidance, but I'm just a clarification.
Earlier this year when you when you rolled out the enterprise Standardization program, you had expected $5 million to $7 million of savings in in 2020 in 2021.
With the 2.6 million savings from the branch closures would that be included in that number that you disclosed earlier this year or is this additional to that.
That is included in that number Alex.
Okay. Thank you and then I was hoping you could give a little bit more color on slide 19, where you talk about the loan deferrals and to give the numbers through the end of June which is extremely helpful. But I'm sure a lot of these loans has come to the end of their initial three months.
In July and I was wondering if you can give a little bit more color on maybe what you're seeing as some of these loans rollover if you're seeing a good chunk of then returned to paying or a lot of them being extended for another three months or sort of what you're seeing.
Alex Let me start off by saying that you know in the finger Lakes region, which is greater Rochester in Western New York, which is greater Buffalo you know the underlying economic activity. You know was the first to open up relative to the way that New York State was managing the pandemic.
A few months ago. So we remain up with cautious optimism that we will continue to perform as well as we have in terms of Ah you know the covert 19 cases are infection rate was half of Metro New York anyway.
And today, if it was 14% at the height, we were at seven today, it's under 1%. So we.
We are seeing good economic.
Activity are starting to return subject to the continued performance of in this pandemic environment. So that has translated.
Well in terms of the performance of our customers and you know as you may be aware our official relief programs have concluded as of the end of June and you know we have seen very few requests for additional support and when we do.
We're dealing with those on a one on one basis, whether its consumer commercial as an example in our commercial business, we've really only had less than 10.
New request for a relief so we feel.
Good about where we stand today.
You know I would say across our residential portfolios or most of the borrowers have return excuse me a large a majority of the borrowers and reserve returned to a paying as agreed status and in our consumer loans two thirds of of my are returning to there.
Uh huh.
Contractual payment obligations and again in our commercial portfolio, we are watching that very closely particularly those impacted industries, but for the most part most of our deferrals and commercial work for three months and as I've said, the new requests have started to have been very minimal since the end of June Justin.
How would you.
Add to that.
Yeah, Alex I think Thats, a mart Marty spot on relative to the top right corner of slide 19, the commercial.
Box there as Marty referenced we've received less than 10 request so far.
To extend and other 90 days, which I think is pretty specifically what your question was.
That makes us cautiously optimistic.
Lastly, we can't predict the future there, but certainly that is you know if theres a good sign I guess that that is a good assign as we can have at this time.
I do think that you know it I think about three months ago, I Gotta, My car and drove around locally versus today.
It's it's so different.
The other thing that I think makes most of the upstate New York in Western New York Banks.
Cautiously optimistic as just what we're seeing around economic activity that's occurring in our local areas.
You know traffics getting back to normal stores have lines out the door, because they're not allowed to have more than a certain percentage of people in the store at any one time, but but people are out in about so.
Everybody's wearing masks and.
And so that makes us as I said and as Marty said cautiously optimistic.
Having said that you know, we don't know where this pandemics going and other flare up could certainly some things in a very different direction.
But I do think that broadly speaking.
As we said in our materials, we are seeing signs of stabilization and we are seeing decreasing deferral activity.
And as I said, we're hopeful that that will bode well for for the outlook that we have in Western New York.
That's great color. Thank you very much for that and then just a final question for me I'm just kind of taken at the next step and talking about the provision I think you said your prepared remarks that you kind of expect the provision to remain elevated.
Just given the uncertainty out there, but as we think about the reserves as it ties supervision do you feel like based on sort of the models out there and what you're seeing that the provision is really going to be more dependent on how.
Loans actually move and get downgraded and get charged off much more so than any of the modeling at this point and maybe the reserve is actually sort of reached its peak level.
That's a good question, Alex you know it it.
It's difficult for me.
To answer that question too specifically, because I don't as I said in my prepared remarks.
The current unemployment forecast is higher for longer.
So if you remember last quarter in the first quarter. It went it spiked up very very high and then it rapidly rapidly decline and I think that was really driven by just a misunderstanding of what that is pandemic was and maybe it's only going to be 90 days and we'll go right back to normal and obviously that hasn't happened a and so now its elevated for long.
Sure.
I can see a situation where that elevated for longer does get worse.
Even though the unemployment rate might come down it may not come down as quickly as we would like particularly given our models using national unemployment. A this is a unique pandemic, where it's very isolated to specific you know state by state, it's very different right. So it's hard for me to safe.
For sure. We also have qualitative factors that we're we're always evaluating and looking at saw I'm not I'm not going to say that we're not that we're thinking we're not going to need to build provision more I think it very very well may need to continue to build provision my comment about elevated levels I.
I mean, if you look back historically.
At what our provision build has been particularly the last prior to the pandemic, it's been very minimal.
So you know these elevated levels that we have right now the point that we were trying to make that we expect that to continue.
So I as I said I can't predict the future, but I'd be surprised if we don't continue to build provision going forward.
Alex I would just a supplement as Tom Justin's comments to say that you know we do have a a very disciplined model that supports our conversion to the Cecil a process and you know you know we completed that in the first quarter. So you know our reliance on the outlook for the economy ground.
The national unemployment.
As a major factor so for us it's going to be about the performance of our portfolios you're pointing out the mix of our business a unique to our company and our interpretation of the future and where it's coming from so you know since December I think we've increased our allowance by 50% in a very.
The responsible and prudent manner.
Which I personally feel good about relative to all the uncertainty that we're dealing with here today.
Thank you for taking my questions.
Thanks, Alex.
Once again, if you have a question. Please press Star then one.
Our next question comes through Marla backer with Sidoti. Please go ahead.
Thank you.
So I just want to follow up on one of the answers you just provided which is that this is a very.
Oh novel situation to say the lease and the impact is sort of on a state by state basis. So.
What extent is the region, where your operating footprint is to what extent is it some more reliant let's say on local tourism you know the finger lakes region, so that national numbers for unemployment might not tell the whole stores, what's going on in your particular market.
The finger Lakes region, certainly is one of the great recreational assets of our.
Geographic footprint, but it's not an overwhelming economic driver.
We've got a very strong manufacturing agricultural college, and University and technology High technology components of our economy, you know in terms of our exposure to a hospitality.
There we have very limited exposure in terms of.
Recreational facilities in in the finger lakes vacation type of concept that your your question implies ours are moderately priced a flag hotels that.
You know our dispersed through our geographic footprint that are part of those communities be at college communities, the Metro Rochester, Buffalo or the so no the cities in the southern tier.
Right.
Can I was thinking more in terms of local unemployment, perhaps not match state unemployment or not.
But.
From what you're saying that.
What's going on.
And in terms of the bank closures so.
And we.
Should we should we that this is where you stand right now with euro.
With your bank footprint or should we anticipate that there might be additional closures.
Well I think that this is a an issue that our management team will continue to face and you know again, it's driven by because we said consumer habits and their needs. So we'll continue to look at it but right now having just completed this part of our enterprise sterilization project.
I think we feel good about.
Our existing geographic footprint is we also indicated you know where we are not physically present, we do think it's important to to be there. For example, the branches that were building in Buffalo, but we're we're keenly focused on the fact that the traditional utilization of branches.
Of customer service and processing transactions is rapidly changing to multiple use offices, where we are prepared and can deliver financial education advice in the solutions. That's consistent with the business model, we've built a leveraging the core community bank for commercial and.
Consumer customers as well as a insurance risk management solutions in wealth management.
Okay. Then my last question is given your.
Sure.
Well, let you built.
Have you been seen with some of those adjacent silos to insurance.
The risk mat business.
Did you see.
The same kind of you know shifts towards.
Oh.
Basically taking up.
No.
The impact of.
Not being able to plan and see your risk advisor in person did see businesses sort of.
Well I understand kind of flexible.
The commercial bank was able to.
Yes, we have been a able to work with our those customers you know on a remote basis and.
Take care of their needs.
Okay. Thank you.
Thank you model.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to bodies, Birmingham for any closing remarks.
Thank you Chad very much and I want to thank God, those participating or call. This morning, we look forward to communicating with you again at the end of the third quarter.
Thank you Sir the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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Mhm.
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