Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-26481

 

 

 

LOGO

(Exact name of registrant as specified in its charter)

 

 

 

NEW YORK   16-0816610

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

220 LIBERTY STREET, WARSAW, NEW YORK   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 12 months (or for such shorter period that the registrant was required to file such reports),

and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every

Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the regsitrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The registrant had 14,528,319 shares of Common Stock, $0.01 par value, outstanding as of July 28, 2016.


Table of Contents

FINANCIAL INSTITUTIONS, INC.

Form 10-Q

For the Quarterly Period Ended June 30, 2016

TABLE OF CONTENTS

 

         PAGE  

PART I.

 

FINANCIAL INFORMATION

     3   

ITEM 1.

 

Financial Statements

     3   
 

Consolidated Statements of Financial Condition - at June 30, 2016 (Unaudited) and December 31, 2015

     3   
 

Consolidated Statements of Income (Unaudited) - Three and six months ended June 30, 2016 and 2015

     4   
  Consolidated Statements of Comprehensive Income (Unaudited) - Three and six months ended June 30, 2016 and 2015      5   
  Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) - Six months ended June 30, 2016 and 2015      6   
 

Consolidated Statements of Cash Flows (Unaudited) - Six months ended June 30, 2016 and 2015

     7   
 

Notes to Consolidated Financial Statements (Unaudited)

     8   

ITEM 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     54   

ITEM 4.

 

Controls and Procedures

     55   

PART II.

 

OTHER INFORMATION

     56   

ITEM 1.

 

Legal Proceedings

     56   

ITEM 1A.

 

Risk Factors

     56   

ITEM 6.

 

Exhibits

     57   
 

Signatures

     58   

 

- 2 -


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition (Unaudited)

 

(Dollars in thousands, except share and per share data)    June 30,
2016
    December 31,
2015
 
ASSETS     

Cash and due from banks

   $ 67,624      $ 60,121   

Securities available for sale, at fair value

     619,719        544,395   

Securities held to maturity, at amortized cost (fair value of $490,833 and $490,064, respectively)

     478,549        485,717   

Loans held for sale

     209        1,430   

Loans (net of allowance for loan losses of $28,525 and $27,085, respectively)

     2,183,306        2,056,677   

Company owned life insurance

     62,456        63,045   

Premises and equipment, net

     40,562        39,445   

Goodwill and other intangible assets, net

     76,252        66,946   

Other assets

     56,912        63,248   
  

 

 

   

 

 

 

Total assets

   $ 3,585,589      $ 3,381,024   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Deposits:

    

Noninterest-bearing demand

   $ 626,240      $ 641,972   

Interest-bearing demand

     560,284        523,366   

Savings and money market

     960,325        928,175   

Time deposits

     711,156        637,018   
  

 

 

   

 

 

 

Total deposits

     2,858,005        2,730,531   

Short-term borrowings

     338,300        293,100   

Long-term borrowings, net of issuance costs of $975 and $1,010, respectively

     39,025        38,990   

Other liabilities

     28,083        24,559   
  

 

 

   

 

 

 

Total liabilities

     3,263,413        3,087,180   
  

 

 

   

 

 

 

Shareholders’ equity:

    

Series A 3% preferred stock, $100 par value; 1,533 shares authorized; 1,492 shares issued

     149        149   

Series B-1 8.48% preferred stock, $100 par value; 200,000 shares authorized; 171,906 shares issued

     17,191        17,191   
  

 

 

   

 

 

 

Total preferred equity

     17,340        17,340   

Common stock, $0.01 par value; 50,000,000 shares authorized; 14,692,214 and 14,397,509 shares issued, respectively

     147        144   

Additional paid-in capital

     81,255        72,690   

Retained earnings

     227,184        218,920   

Accumulated other comprehensive loss

     (654     (11,327

Treasury stock, at cost – 163,695 and 207,317 shares, respectively

     (3,096     (3,923
  

 

 

   

 

 

 

Total shareholders’ equity

     322,176        293,844   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,585,589      $ 3,381,024   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 3 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

 

(In thousands, except per share amounts)    Three months ended      Six months ended  
     June 30,      June 30,  
     2016      2015      2016      2015  

Interest income:

           

Interest and fees on loans

   $ 22,368       $ 20,446       $ 44,425       $ 40,583   

Interest and dividends on investment securities

     5,877         5,513         11,455         10,373   

Other interest income

     1         —           1         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     28,246         25,959         55,881         50,956   

Interest expense:

           

Deposits

     2,086         1,827         4,045         3,447   

Short-term borrowings

     344         213         683         443   

Long-term borrowings

     617         515         1,235         515   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     3,047         2,555         5,963         4,405   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     25,199         23,404         49,918         46,551   

Provision for loan losses

     1,952         1,288         4,320         4,029   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     23,247         22,116         45,598         42,522   

Noninterest income:

           

Service charges on deposits

     1,755         1,964         3,479         3,843   

Insurance income

     1,183         1,057         2,855         2,665   

ATM and debit card

     1,421         1,283         2,746         2,476   

Investment advisory

     1,365         541         2,608         1,028   

Company owned life insurance

     486         493         1,854         960   

Investments in limited partnerships

     36         55         92         529   

Loan servicing

     112         96         228         263   

Net gain on sale of loans held for sale

     78         39         156         108   

Net gain on disposal of investment securities

     1,387         —           2,000         1,062   

Net gain on disposal of other assets

     82         16         86         20   

Other

     1,011         911         2,029         1,798   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

     8,916         6,455         18,133         14,752   

Noninterest expense:

           

Salaries and employee benefits

     10,818         10,606         22,432         20,829   

Occupancy and equipment

     3,664         3,375         7,289         7,074   

Professional services

     2,833         866         4,280         1,834   

Computer and data processing

     913         810         1,717         1,512   

Supplies and postage

     464         508         1,058         1,071   

FDIC assessments

     441         415         877         833   

Advertising and promotions

     347         238         724         477   

Other

     2,640         2,418         4,961         4,617   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

     22,120         19,236         43,338         38,247   

Income before income taxes

     10,043         9,335         20,393         19,027   

Income tax expense

     2,892         2,750         5,624         5,641   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 7,151       $ 6,585       $ 14,769       $ 13,386   

Preferred stock dividends

     366         366         731         731   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income available to common shareholders

   $ 6,785       $ 6,219       $ 14,038       $ 12,655   

Earnings per common share (Note 3):

           

Basic

   $ 0.47       $ 0.44       $ 0.97       $ 0.90   

Diluted

   $ 0.47       $ 0.44       $ 0.97       $ 0.90   

Cash dividends declared per common share

   $ 0.20       $ 0.20       $ 0.40       $ 0.40   

Weighted average common shares outstanding:

           

Basic

     14,434         14,078         14,415         14,071   

Diluted

     14,489         14,121         14,477         14,118   

See accompanying notes to the consolidated financial statements.

 

- 4 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

 

(Dollars in thousands)    Three months ended     Six months ended  
     June 30,     June 30,  
     2016      2015     2016      2015  

Net income

   $ 7,151       $ 6,585      $ 14,769       $ 13,386   

Other comprehensive income (loss), net of tax:

          

Net unrealized (losses) gains on securities available for sale

     3,311         (6,207     10,394         (2,946

Pension and post-retirement obligations

     140         140        279         275   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other comprehensive income (loss), net of tax

     3,451         (6,067     10,673         (2,671
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 10,602       $ 518      $ 25,442       $ 10,715   
  

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 5 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

Six months ended June 30, 2016 and 2015

 

(Dollars in thousands,

except per share data)

   Preferred
Equity
     Common
Stock
     Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Loss
    Treasury
Stock
    Total
Shareholders’
Equity
 

Balance at January 1, 2015

   $ 17,340       $ 144       $ 72,955      $ 203,312      $ (9,011   $ (5,208   $ 279,532   

Comprehensive income:

                

Net income

     —           —           —          13,386        —          —          13,386   

Other comprehensive income, net of tax

     —           —           —          —          (2,671     —          (2,671

Purchases of common stock for treasury

     —           —           —          —          —          (41     (41

Share-based compensation plans:

                

Share-based compensation

     —           —           370        —          —          —          370   

Stock options exercised

     —           —           2        —          —          163        165   

Restricted stock awards issued, net

     —           —           (1,060     —          —          1,060        —     

Excess tax benefit on share-based compensation

     —           —           1        —          —          —          1   

Stock awards

     —           —           11        —          —          43        54   

Cash dividends declared:

                

Series A 3% Preferred-$1.50 per share

     —           —           —          (2     —          —          (2

Series B-1 8.48% Preferred-$4.24 per share

     —           —           —          (729     —          —          (729

Common-$0.40 per share

     —           —           —          (5,630     —          —          (5,630
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2015

   $ 17,340       $ 144       $ 72,279      $ 210,337      $ (11,682   $ (3,983   $ 284,435   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2016

   $ 17,340       $ 144       $ 72,690      $ 218,920      $ (11,327   $ (3,923   $ 293,844   

Comprehensive income:

                

Net income

     —           —           —          14,769        —          —          14,769   

Other comprehensive income, net of tax

     —           —           —          —          10,673        —          10,673   

Common stock issued

     —           3         8,097        —          —          —          8,100   

Share-based compensation plans:

                

Share-based compensation

     —           —           432        —          —          —          432   

Stock options exercised

     —           —           19        —          —          767        786   

Restricted stock awards issued, net

     —           —           (17     —          —          17        —     

Excess tax benefit on share-based compensation

     —           —           13        —          —          —          13   

Stock awards

     —           —           21        —          —          43        64   

Cash dividends declared:

                

Series A 3% Preferred-$1.50 per share

     —           —           —          (2     —          —          (2

Series B-1 8.48% Preferred-$4.24 per share

     —           —           —          (729     —          —          (729

Common-$0.40 per share

     —           —           —          (5,774     —          —          (5,774
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2016

   $ 17,340       $ 147       $ 81,255      $ 227,184      $ (654   $ (3,096   $ 322,176   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

- 6 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in thousands)    Six months ended  
     June 30,  
     2016     2015  

Cash flows from operating activities:

    

Net income

   $ 14,769      $ 13,386   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     2,990        2,671   

Net amortization of premiums on securities

     1,503        1,547   

Provision for loan losses

     4,320        4,029   

Share-based compensation

     432        370   

Deferred income tax expense

     (150     202   

Proceeds from sale of loans held for sale

     7,671        7,321   

Originations of loans held for sale

     (6,294     (6,906

Income on company owned life insurance

     (1,854     (960

Net gain on sale of loans held for sale

     (156     (108

Net gain on disposal of investment securities

     (2,000     (1,062

Net gain on sale and disposal of other assets

     (86     (20

(Increase) decrease in other assets

     (780     1,009   

Increase in other liabilities

     2,434        820   
  

 

 

   

 

 

 

Net cash provided by operating activities

     22,799        22,299   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of available for sale securities

     (176,913     (241,906

Purchases of held to maturity securities

     (23,699     (39,570

Proceeds from principal payments, maturities and calls on available for sale securities

     57,707        57,787   

Proceeds from principal payments, maturities and calls on held to maturity securities

     31,147        16,394   

Proceeds from sales of securities available for sale

     62,275        29,508   

Net loan originations

     (131,323     (101,567

Proceeds from company owned life insurance, net of purchases

     2,443        (34

Proceeds from sales of other assets

     318        167   

Purchases of premises and equipment

     (3,422     (2,891

Cash consideration paid for acquisition, net of cash acquired

     (868     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (182,335     (282,112
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in deposits

     127,474        205,711   

Net increase in short-term borrowings

     45,200        15,796   

Issuance of long-term debt

     —          40,000   

Debt issuance costs

     —          (1,060

Purchase of common stock for treasury

     —          (41

Proceeds from stock options exercised

     786        165   

Excess tax benefit on share-based compensation, net

     13        1   

Cash dividends paid to common and preferred shareholders

     (6,434     (6,356
  

 

 

   

 

 

 

Net cash provided by financing activities

     167,039        254,216   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     7,503        (5,597

Cash and cash equivalents, beginning of period

     60,121        58,151   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 67,624      $ 52,554   
  

 

 

   

 

 

 

Supplemental information:

    

Cash paid for interest

   $ 5,492      $ 3,166   

Cash paid for income taxes

     3,224        1,539   

Noncash investing and financing activities:

    

Real estate and other assets acquired in settlement of loans

     374        130   

Accrued and declared unpaid dividends

     3,256        3,182   

Increase in net unsettled security purchases

     1,250        4,023   

Common stock issued for acquisition

     8,100        —     

Assets acquired and liabilities assumed in business combinations:

    

Fair value of assets acquired

     4,848        —     

Fair value of liabilities assumed

     1,845        —     

See accompanying notes to the consolidated financial statements.

 

- 7 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1.) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Financial Institutions, Inc., (the “Company”) is a financial holding company organized in 1931 under the laws of New York State. The Company provides diversified financial services through its subsidiaries, Five Star Bank, Scott Danahy Naylon, LLC (“Scott Danahy Naylon”) and Courier Capital, LLC (“Courier Capital”). The Company offers a broad array of deposit, lending and other financial services to individuals, municipalities and businesses in Western and Central New York through its wholly-owned New York chartered banking subsidiary, Five Star Bank (the “Bank”). The Bank has also expanded its indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern and Central Pennsylvania. Scott Danahy Naylon provides a broad range of insurance services to personal and business clients across 44 states. Acquired on January 5, 2016, Courier Capital provides customized investment management, investment consulting and retirement plan services to individuals, businesses, institutions, foundations and retirement plans across nine states.

Basis of Presentation

The consolidated financial statements include the accounts of Financial Institutions, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accounting and reporting policies conform to U.S. generally accepted accounting principles (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in conformity with GAAP have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary for a fair presentation of the consolidated statements of financial condition, income, comprehensive income, changes in shareholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. Prior years’ consolidated financial statements are re-classified whenever necessary to conform to the current year’s presentation. These consolidated financial statements should be read in conjunction with the Company’s 2015 Annual Report on Form 10-K for the year ended December 31, 2015. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

Reclassifications

Certain reclassifications of previously reported amounts have been made to conform to the current year presentation. Such reclassifications did not impact net income or shareholders’ equity as previously reported.

Subsequent Events

The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued and determined there were no material recognizable subsequent events.

Use of Estimates

The preparation of these financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates relate to the determination of the allowance for loan losses, the carrying value of goodwill and deferred tax assets, and assumptions used in the defined benefit pension plan accounting.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The effective date was recently deferred for one year to the interim and annual periods beginning on or after December 15, 2017. Early adoption is permitted as of the original effective date – interim and annual periods beginning on or after December 15, 2016. The Company continues to assess the potential impact of ASU 2014-09 on its accounting and disclosures.

 

- 8 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(1.) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 is intended to improve the recognition and measurement of financial instruments by requiring equity investments to be measured at fair value with changes in fair value recognized in net income; requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured and amortized at cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU 2016-01 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2017. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company is assessing the impact of ASU 2016-01 on its accounting and disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). ASU 2016-02 establishes a right of use model that requires a lessee to record a right of use asset and a lease liability for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. A lease will be treated as sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years for public business entities. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with certain practical expedients available. Early adoption is permitted. The Company is assessing the impact of ASU 2016-02 on its accounting and disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718) – Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee’s shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election for forfeitures as they occur. The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those years. Early adoption is permitted. The Company is assessing the impact of ASU 2016-09 on its accounting and disclosures.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments. ASU 2016-13 amends guidance on reporting credit losses for financial assets held at amortized cost basis and available for sale debt securities. Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses based on historical experience, current conditions and reasonable and supportable forecasts. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. The guidance is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those years. Early adoption is permitted beginning after December 15, 2018. The Company is assessing the impact of ASU 2016-13 on its accounting and disclosures.

 

- 9 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(2.) BUSINESS COMBINATIONS

Courier Capital Acquisition

On January 5, 2016, the Company completed the acquisition of Courier Capital Corporation, a registered investment advisory and wealth management firm with approximately $1.2 billion in assets under management. Consideration for the acquisition totaled $9.0 million and included stock of $8.1 million and $918 thousand of cash. The acquisition also included up to $2.8 million of potential future payments of stock and up to $2.2 million of potential future cash bonuses contingent upon Courier Capital meeting certain EBITDA performance targets through 2018. In addition, the Company purchased two pieces of real property in Buffalo and Jamestown, New York used by Courier Capital for total cash considerations of $1.3 million. As a result of the acquisition, the Company recorded goodwill of $6.0 million and other intangible assets of $3.9 million. The goodwill is not expected to be deductible for income tax purposes. Pro forma results of operations for this acquisition have not been presented because the effect of this acquisition was not material to the Company’s consolidated financial statements.

This acquisition was accounted for under the acquisition method in accordance with FASB ASC Topic 805. Accordingly, the assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition date. Due to the timing of the closing of the acquisition, the fair values of other intangibles recorded are subject to adjustment as additional information becomes available to indicate a more accurate or appropriate fair value for the intangibles during the measurement period, which is not to exceed one year from the acquisition date. The following table presents the allocation of acquisition cost to the assets acquired and liabilities assumed, based on their estimated fair values.

 

Cash

   $ 50   

Identified intangible assets

     3,928   

Premises and equipment, accounts receivable and other assets

     870   

Deferred tax liability

     (1,797

Other liabilities

     (48
  

 

 

 

Net assets acquired

   $ 3,003   
  

 

 

 

The amounts assigned to goodwill and other intangible assets for the Courier Capital acquisition are as follows:

 

     Amount
allocated
     Useful life
(in years)
 

Goodwill

   $ 6,015         n/a   

Other intangible assets – customer relationships

     3,900         20   

Other intangible assets – other

     28         5   
  

 

 

    
   $ 9,943      
  

 

 

    

 

- 10 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(3.) EARNINGS PER COMMON SHARE (“EPS”)

The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS (in thousands, except per share amounts).

 

     Three months ended      Six months ended  
     June 30,      June 30,  
     2016      2015      2016      2015  

Net income available to common shareholders

   $ 6,785       $ 6,219       $ 14,038       $ 12,655   

Weighted average common shares outstanding:

           

Total shares issued

     14,692         14,398         14,686         14,398   

Unvested restricted stock awards

     (75      (100      (77      (87

Treasury shares

     (183      (220      (194      (240
  

 

 

    

 

 

    

 

 

    

 

 

 

Total basic weighted average common shares outstanding

     14,434         14,078         14,415         14,071   

Incremental shares from assumed:

           

Exercise of stock options

     21         22         24         22   

Vesting of restricted stock awards

     34         21         38         25   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total diluted weighted average common shares outstanding

     14,489         14,121         14,477         14,118   

Basic earnings per common share

   $ 0.47       $ 0.44       $ 0.97       $ 0.90   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share

   $ 0.47       $ 0.44       $ 0.97       $ 0.90   
  

 

 

    

 

 

    

 

 

    

 

 

 
For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted EPS because the effect would be antidilutive:    

Stock options

     —           —           —           —     

Restricted stock awards

     8         3         4         2   
  

 

 

    

 

 

    

 

 

    

 

 

 
     8         3         4         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 11 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES

The amortized cost and fair value of investment securities are summarized below (in thousands):

 

     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  

June 30, 2016

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ 241,583       $ 6,550       $ 7       $ 248,126   

Mortgage-backed securities:

           

Federal National Mortgage Association

     311,783         8,776         —           320,559   

Federal Home Loan Mortgage Corporation

     30,743         772         —           31,515   

Government National Mortgage Association

     17,390         737         14         18,113   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     363         —           1         362   

Federal Home Loan Mortgage Corporation

     77         —           1         76   

Privately issued

     —           784         —           784   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     360,356         11,069         16         371,409   

Asset-backed securities

     —           184         —           184   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 601,939       $ 17,803       $ 23       $ 619,719   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

State and political subdivisions

     294,507         10,061         1         304,567   

Mortgage-backed securities:

           

Federal National Mortgage Association

     12,047         290         —           12,337   

Government National Mortgage Association

     25,978         307         4         26,281   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     54,246         525         11         54,760   

Federal Home Loan Mortgage Corporation

     76,655         1,038         2         77,691   

Government National Mortgage Association

     15,116         85         4         15,197   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     184,042         2,245         21         186,266   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

   $ 478,549       $ 12,306       $ 22       $ 490,833   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ 260,748       $ 1,164       $ 1,049       $ 260,863   

Mortgage-backed securities:

           

Federal National Mortgage Association

     209,671         1,092         2,333         208,430   

Federal Home Loan Mortgage Corporation

     24,564         282         194         24,652   

Government National Mortgage Association

     26,465         943         4         27,404   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     16,998         90         154         16,934   

Federal Home Loan Mortgage Corporation

     5,175         1         91         5,085   

Privately issued

     —           809         —           809   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     282,873         3,217         2,776         283,314   

Asset-backed securities

     —           218         —           218   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 543,621       $ 4,599       $ 3,825       $ 544,395   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

State and political subdivisions

     294,423         6,562         4         300,981   

Mortgage-backed securities:

           

Federal National Mortgage Association

     9,242         14         79         9,177   

Government National Mortgage Association

     25,607         33         159         25,481   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     56,791         —           818         55,973   

Federal Home Loan Mortgage Corporation

     80,570         —           1,120         79,450   

Government National Mortgage Association

     19,084         19         101         19,002   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     191,294         66         2,277         189,083   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

   $ 485,717       $ 6,628       $ 2,281       $ 490,064   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 12 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

Investment securities with a total fair value of $856.5 million at June 30, 2016 were pledged and encumbered as collateral to secure public deposits and for other purposes required or permitted by law.

Sales and calls of securities available for sale were as follows (in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2016      2015      2016      2015  

Proceeds from sales

   $ 44,648       $ —         $ 62,275       $ 29,508   

Gross realized gains

     1,387         —           2,000         1,073   

Gross realized losses

     —           —           —           11   

The scheduled maturities of securities available for sale and securities held to maturity at June 30, 2016 are shown below (in thousands). Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

 

     Amortized      Fair  
     Cost      Value  

Debt securities available for sale:

     

Due in one year or less

   $ 5,042       $ 5,047   

Due from one to five years

     175,737         179,161   

Due after five years through ten years

     306,996         317,590   

Due after ten years

     114,164         117,921   
  

 

 

    

 

 

 
   $ 601,939       $ 619,719   
  

 

 

    

 

 

 

Debt securities held to maturity:

     

Due in one year or less

   $ 38,909       $ 39,051   

Due from one to five years

     176,378         182,498   

Due after five years through ten years

     92,311         96,184   

Due after ten years

     170,951         173,100   
  

 

 

    

 

 

 
   $ 478,549       $ 490,833   
  

 

 

    

 

 

 

 

- 13 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

Unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (in thousands):

 

     Less than 12 months      12 months or longer      Total  
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

June 30, 2016

                 

Securities available for sale:

                 

U.S. Government agencies and government sponsored enterprises

   $ 9,997       $ 3       $ 1,637       $ 4       $ 11,634       $ 7   

Mortgage-backed securities:

                 

Government National Mortgage Association

     1,258         14         —           —           1,258         14   

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     362         1         —           —           362         1   

Federal Home Loan Mortgage Corporation

     64         1         —           —           64         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     1,684         16         —           —           1,684         16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

     11,681         19         1,637         4         13,318         23   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

                 

State and political subdivisions

     832         1         —           —           832         1   

Mortgage-backed securities:

                 

Government National Mortgage Association

     —           —           1,635         4         1,635         4   

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     4,119         11         —           —           4,119         11   

Federal Home Loan Mortgage Corporation

     1,196         2         —           —           1,196         2   

Government National Mortgage Association

     3,695         4         —           —           3,695         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     9,010         17         1,635         4         10,645         21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

     9,842         18         1,635         4         11,477         22   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 21,523       $ 37       $ 3,272       $ 8       $ 24,795       $ 45   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

                 

Securities available for sale:

                 

U.S. Government agencies and government sponsored enterprises

   $ 82,298       $ 735       $ 26,302       $ 314       $ 108,600       $ 1,049   

Mortgage-backed securities:

                 

Federal National Mortgage Association

     123,774         2,134         9,562         199         133,336         2,333   

Federal Home Loan Mortgage Corporation

     12,660         194         —           —           12,660         194   

Government National Mortgage Association

     1,405         4         —           —           1,405         4   

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     7,778         154         —           —           7,778         154   

Federal Home Loan Mortgage Corporation

     4,998         91         —           —           4,998         91   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     150,615         2,577         9,562         199         160,177         2,776   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

     232,913         3,312         35,864         513         268,777         3,825   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

                 

State and political subdivisions

     3,075         4         —           —           3,075         4   

Mortgage-backed securities:

                 

Federal National Mortgage Association

     5,666         79         —           —           5,666         79   

Government National Mortgage Association

     8,790         159         —           —           8,790         159   

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     55,973         818         —           —           55,973         818   

Federal Home Loan Mortgage Corporation

     79,323         1,120         —           —           79,323         1,120   

Government National Mortgage Association

     14,559         101         —           —           14,559         101   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     164,311         2,277         —           —           164,311         2,277   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

     167,386         2,281         —           —           167,386         2,281   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 400,299       $ 5,593       $ 35,864       $ 513       $ 436,163       $ 6,106   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

- 14 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

The Company had 29 security positions in the investment portfolio in an unrealized loss position at June 30, 2016 compared to 174 at December 31, 2015. At June 30, 2016, the Company had positions in 6 investment securities with a fair value of $3.3 million and a total unrealized loss of $8 thousand that have been in a continuous unrealized loss position for more than 12 months. At June 30, 2016, there were a total of 23 securities positions in the Company’s investment portfolio with a fair value of $21.5 million and a total unrealized loss of $37 thousand that had been in a continuous unrealized loss position for less than 12 months. At December 31, 2015, the Company had positions in 14 investment securities with a fair value of $35.9 million and a total unrealized loss of $513 thousand that had been in a continuous unrealized loss position for more than 12 months. At December 31, 2015, there were a total of 160 securities positions in the Company’s investment portfolio with a fair value of $400.3 million and a total unrealized loss of $5.6 million that had been in a continuous unrealized loss position for less than 12 months. The unrealized loss on investment securities was predominantly caused by changes in market interest rates subsequent to purchase. The fair value of most of the investment securities in the Company’s portfolio fluctuates as market interest rates change.

The Company reviews investment securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”) with formal reviews performed quarterly. When evaluating debt securities for OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the debt security or whether it is more likely than not that it will be required to sell the debt security before its anticipated recovery. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information then available to management. There was no impairment recorded during the six months ended June 30, 2016 and 2015.

Based on management’s review and evaluation of the Company’s debt securities as of June 30, 2016, the debt securities with unrealized losses were not considered to be other-than-temporarily impaired. As of June 30, 2016, the Company did not intend to sell any of the securities in a loss position and believes that it is not likely that it will be required to sell any such securities before the anticipated recovery of amortized cost. Accordingly, as of June 30, 2016, management has concluded that unrealized losses on its investment securities are temporary and no further impairment loss has been realized in the Company’s consolidated statements of income.

 

- 15 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS

The Company’s loan portfolio consisted of the following as of the dates indicated (in thousands):

 

     Principal
Amount
Outstanding
     Net Deferred
Loan (Fees)
Costs
     Loans, Net  

June 30, 2016

        

Commercial business

   $ 349,076       $ 356       $ 349,432   

Commercial mortgage

     615,547         (1,406      614,141   

Residential real estate loans

     402,538         5,829         408,367   

Residential real estate lines

     122,360         2,694         125,054   

Consumer indirect

     672,018         24,890         696,908   

Other consumer

     17,752         177         17,929   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,179,291       $ 32,540         2,211,831   
  

 

 

    

 

 

    

Allowance for loan losses

           (28,525
        

 

 

 

Total loans, net

         $ 2,183,306   
        

 

 

 

December 31, 2015

        

Commercial business

   $ 313,475       $ 283       $ 313,758   

Commercial mortgage

     567,481         (1,380      566,101   

Residential real estate loans

     376,023         5,051         381,074   

Residential real estate lines

     124,766         2,581         127,347   

Consumer indirect

     652,494         24,446         676,940   

Other consumer

     18,361         181         18,542   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,052,600       $ 31,162         2,083,762   
  

 

 

    

 

 

    

Allowance for loan losses

           (27,085
        

 

 

 

Total loans, net

         $ 2,056,677   
        

 

 

 

Loans held for sale (not included above) were comprised entirely of residential real estate mortgages and totaled $209 thousand and $1.4 million as of June 30, 2016 and December 31, 2015, respectively.

 

- 16 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Past Due Loans Aging

The Company’s recorded investment, by loan class, in current and nonaccrual loans, as well as an analysis of accruing delinquent loans is set forth as of the dates indicated (in thousands):

 

     30-59 Days
Past Due
     60-89 Days
Past Due
     Greater
Than 90
Days
     Total
Past Due
     Nonaccrual      Current      Total Loans  

June 30, 2016

                    

Commercial business

   $ 46       $ —         $ —         $ 46       $ 2,312       $ 346,718       $ 349,076   

Commercial mortgage

     —           —           —           —           1,547         614,000         615,547   

Residential real estate loans

     562         52         —           614         1,485         400,439         402,538   

Residential real estate lines

     315         —           —           315         182         121,863         122,360   

Consumer indirect

     1,221         233         —           1,454         1,015         669,549         672,018   

Other consumer

     99         25         11         135         4         17,613         17,752   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, gross

   $ 2,243       $ 310       $ 11       $ 2,564       $ 6,545       $ 2,170,182       $ 2,179,291   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

                    

Commercial business

   $ 321       $ 612       $ —         $ 933       $ 3,922       $ 308,620       $ 313,475   

Commercial mortgage

     68         146         —           214         947         566,320         567,481   

Residential real estate loans

     723         395         —           1,118         1,848         373,057         376,023   

Residential real estate lines

     199         34         —           233         235         124,298         124,766   

Consumer indirect

     1,975         286         —           2,261         1,467         648,766         652,494   

Other consumer

     98         13         8         119         13         18,229         18,361   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, gross

   $ 3,384       $ 1,486       $ 8       $ 4,878       $ 8,432       $ 2,039,290       $ 2,052,600   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

There were no loans past due greater than 90 days and still accruing interest as of June 30, 2016 and December 31, 2015. There were $11 thousand and $8 thousand in consumer overdrafts which were past due greater than 90 days as of June 30, 2016 and December 31, 2015, respectively. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not accrue interest.

Troubled Debt Restructurings

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession. Commercial loans modified in a TDR may involve temporary interest-only payments, term extensions, reductions in the interest rate for the remaining term of the loan, extensions of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, collateral concessions, forgiveness of principal, forbearance agreements, or substituting or adding a new borrower or guarantor.

The following table presents information related to loans modified in a TDR during the quarterly periods indicated (dollars in thousands).

 

     Quarter-to-Date      Year-to-Date  
     Number of
Contracts
     Pre-
Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
     Number of
Contracts
     Pre-
Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
 

June 30, 2016

                 

Commercial business

     1       $ 214       $ 214         3       $ 526       $ 526   

Commercial mortgage

     —           —           —           1         550         550   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1       $ 214       $ 214         4       $ 1,076       $ 1,076   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2015

                 

Commercial business

     2       $ 1,342       $ 1,342         2       $ 1,342       $ 1,342   

Commercial mortgage

     —           —           —           1         682         330   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2       $ 1,342       $ 1,342         3       $ 2,024       $ 1,672   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

- 17 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

The loans identified as a TDR by the Company during the six month periods ended June 30, 2016 and 2015 were previously reported as impaired loans prior to restructuring. Each of the loans restructured during the six months ended June 30, 2016 and 2015 were on nonaccrual status at the end of the respective period. The modifications related to collateral concessions and forbearance agreements. Nonaccrual loans that are restructured remain on nonaccrual status, but may move to accrual status after they have performed according to the restructured terms for a period of time. The TDR classifications did not have a material impact on the Company’s determination of the allowance for loan losses because the modified loans were impaired and evaluated for a specific reserve both before and after restructuring.

There were no loans modified as a TDR within the previous 12 months that defaulted during the six months ended June 30, 2016 or 2015. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower becomes 90 days past due.

Impaired Loans

Management has determined that specific commercial loans on nonaccrual status and all loans that have had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents the recorded investment, unpaid principal balance and related allowance of impaired loans as of the dates indicated and average recorded investment and interest income recognized on impaired loans for the six month periods ended as of the dates indicated (in thousands):

 

     Recorded
Investment(1)
     Unpaid
Principal
Balance(1)
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

June 30, 2016

              

With no related allowance recorded:

              

Commercial business

   $ 1,209       $ 1,752       $ —         $ 1,678       $ —     

Commercial mortgage

     777         986         —           1,114         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,986         2,738         —           2,792         —     

With an allowance recorded:

              

Commercial business

     1,103         1,103         476         1,323         —     

Commercial mortgage

     770         900         131         510         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,873         2,003         607         1,833         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,859       $ 4,741       $ 607       $ 4,625       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

              

With no related allowance recorded:

              

Commercial business

   $ 1,441       $ 1,810       $ —         $ 1,352       $ —     

Commercial mortgage

     937         1,285         —           1,013         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,378         3,095         —           2,365         —     

With an allowance recorded:

              

Commercial business

     2,481         2,481         996         1,946         —     

Commercial mortgage

     10         10         10         449         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,491         2,491         1,006         2,395         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 4,869       $ 5,586       $ 1,006       $ 4,760       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Difference between recorded investment and unpaid principal balance represents partial charge-offs.

 

- 18 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors such as the fair value of collateral. The Company analyzes commercial business and commercial mortgage loans individually by classifying the loans as to credit risk. Risk ratings are updated any time the situation warrants. The Company uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans that do not meet the criteria above that are analyzed individually as part of the process described above are considered “Uncriticized” or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.

The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of the dates indicated (in thousands):

 

     Commercial
Business
     Commercial
Mortgage
 

June 30, 2016

     

Uncriticized

   $ 333,564       $ 594,576   

Special mention

     8,796         15,098   

Substandard

     6,716         5,873   

Doubtful

     —           —     
  

 

 

    

 

 

 

Total

   $ 349,076       $ 615,547   
  

 

 

    

 

 

 

December 31, 2015

     

Uncriticized

   $ 298,413       $ 551,603   

Special mention

     4,916         9,015   

Substandard

     10,146         6,863   

Doubtful

     —           —     
  

 

 

    

 

 

 

Total

   $ 313,475       $ 567,481   
  

 

 

    

 

 

 

The Company utilizes payment status as a means of identifying and reporting problem and potential problem retail loans. The Company considers nonaccrual loans and loans past due greater than 90 days and still accruing interest to be non-performing. The following table sets forth the Company’s retail loan portfolio, categorized by payment status, as of the dates indicated (in thousands):

 

     Residential
Real Estate
Loans
     Residential
Real Estate
Lines
     Consumer
Indirect
     Other
Consumer
 

June 30, 2016

           

Performing

   $ 401,053       $ 122,178       $ 671,003       $ 17,737   

Non-performing

     1,485         182         1,015         15   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 402,538       $ 122,360       $ 672,018       $ 17,752   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

           

Performing

   $ 374,175       $ 124,531       $ 651,027       $ 18,340   

Non-performing

     1,848         235         1,467         21   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 376,023       $ 124,766       $ 652,494       $ 18,361   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 19 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Allowance for Loan Losses

Loans and the related allowance for loan losses are presented below as of the dates indicated (in thousands):

 

                   Residential      Residential                       
     Commercial
Business
     Commercial
Mortgage
     Real Estate
Loans
     Real Estate
Lines
     Consumer
Indirect
     Other
Consumer
     Total  

June 30, 2016

                    

Loans:

                    

Ending balance

   $ 349,076       $ 615,547       $ 402,538       $ 122,360       $ 672,018       $ 17,752       $ 2,179,291   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                    

Individually

   $ 2,281       $ 1,532       $ —         $ —         $ —         $ —         $ 3,813   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 346,795       $ 614,015       $ 402,538       $ 122,360       $ 672,018       $ 17,752       $ 2,175,478   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for loan losses:

                    

Ending balance

   $ 6,197       $ 9,496       $ 1,444       $ 318       $ 10,696       $ 374       $ 28,525   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                    

Individually

   $ 466       $ 129       $ —         $ —         $ —         $ —         $ 595   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 5,731       $ 9,367       $ 1,444       $ 318       $ 10,696       $ 374       $ 27,930   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

June 30, 2015

                    

Loans:

                    

Ending balance

   $ 292,674       $ 538,034       $ 95,259       $ 391,645       $ 641,871       $ 19,141       $ 1,978,624   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                    

Individually

   $ 4,643       $ 3,070       $ —         $ —         $ —         $ —         $ 7,713   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 288,031       $ 534,964       $ 95,259       $ 391,645       $ 641,871       $ 19,141       $ 1,970,911   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for loan losses:

                    

Ending balance

   $ 5,334       $ 9,358       $ 465       $ 1,198       $ 10,676       $ 469       $ 27,500   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                    

Individually

   $ 1,247       $ 707       $ —         $ —         $ —         $ —         $ 1,954   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively

   $ 4,087       $ 8,651       $ 465       $ 1,198       $ 10,676       $ 469       $ 25,546   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the changes in the allowance for loan losses for the three and six month periods ended June 30, 2016 (in thousands):

 

                 Residential     Residential                    
     Commercial
Business
    Commercial
Mortgage
    Real Estate
Loans
    Real Estate
Lines
    Consumer
Indirect
    Other
Consumer
    Total  

Three months ended June 30, 2016

  

Beginning balance

   $ 5,436      $ 9,715      $ 1,384      $ 345      $ 10,297      $ 391      $ 27,568   

Charge-offs

     (42     (8     (134     (47     (1,898     (119     (2,248

Recoveries

     69        6        100        3        994        81        1,253   

Provision (credit)

     734        (217     94        17        1,303        21        1,952   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,197      $ 9,496      $ 1,444      $ 318      $ 10,696      $ 374      $ 28,525   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2016

              

Beginning balance

   $ 5,540      $ 9,027      $ 1,347      $ 345      $ 10,458      $ 368      $ 27,085   

Charge-offs

     (644     (12     (180     (51     (4,396     (276     (5,559

Recoveries

     169        11        125        7        2,164        203        2,679   

Provision

     1,132        470        152        17        2,470        79        4,320   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,197      $ 9,496      $ 1,444      $ 318      $ 10,696      $ 374      $ 28,525   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

- 20 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

The following table sets forth the changes in the allowance for loan losses for the three and six month periods ended June 30, 2015 (in thousands):

 

     Commercial
Business
    Commercial
Mortgage
    Residential
Real Estate
Loans
    Residential
Real Estate
Lines
    Consumer
Indirect
    Other
Consumer
    Total  

Three months ended June 30, 2015

              

Beginning balance

   $ 5,395      $ 8,156      $ 558      $ 1,430      $ 11,205      $ 447      $ 27,191   

Charge-offs

     (13     (201     (22     (154     (1,841     (154     (2,385

Recoveries

     86        7        13        9        1,196        95        1,406   

Provision (credit)

     (134     1,396        (84     (87     116        81        1,288   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 5,334      $ 9,358      $ 465      $ 1,198      $ 10,676      $ 469      $ 27,500   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2015

              

Beginning balance

   $ 5,621      $ 8,122      $ 570      $ 1,485      $ 11,383      $ 456      $ 27,637   

Charge-offs

     (1,154     (810     (77     (238     (4,263     (413     (6,955

Recoveries

     134        96        46        19        2,301        193        2,789   

Provision

     733        1,950        (74     (68     1,255        233        4,029   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 5,334      $ 9,358      $ 465      $ 1,198      $ 10,676      $ 469      $ 27,500   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Risk Characteristics

Commercial business loans primarily consist of loans to small to midsize businesses in our market area in a diverse range of industries. These loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than residential mortgage loans, potentially resulting in higher losses on an individual customer basis. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real estate market could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential real estate loans (comprised of conventional mortgages and home equity loans) and residential real estate lines (comprised of home equity lines) are generally made on the basis of the borrower’s ability to make repayment from his or her employment and other income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.

Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities, particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances such as job loss, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

- 21 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(6.) GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying amount of goodwill totaled $66.4 and $60.4 million as of June 30, 2016 and December 31, 2015, respectively. The Company performs a goodwill impairment test on an annual basis as of September 30 or more frequently if events and circumstances warrant.

 

    Banking     Non-Banking     Total  

Balance, December 31, 2015

  $ 48,536      $ 11,866      $ 60,402   

Acquisition

    —          6,015        6,015   
 

 

 

   

 

 

   

 

 

 

Balance, June 30, 2016

  $ 48,536      $ 17,881      $ 66,417   
 

 

 

   

 

 

   

 

 

 

Goodwill and other intangible assets added during the period relates to the Courier Capital acquisition, which was completed on January 5, 2016. See Note 2 – Business Combinations for additional information.

The Company has other intangible assets that are amortized, consisting of core deposit intangibles and other intangibles (primarily related to customer relationships). Changes in the gross carrying amount, accumulated amortization and net book value, were as follows (in thousands):

 

     June 30,      December 31,  
     2016      2015  

Other intangibles assets:

     

Gross carrying amount

   $ 12,610       $ 8,682   

Accumulated amortization

     (2,775      (2,138
  

 

 

    

 

 

 

Net book value

   $ 9,835       $ 6,544   
  

 

 

    

 

 

 

Amortization expense for total other intangible assets was $315 thousand and $637 thousand for the three and six months ended June 30, 2016, $238 thousand and $481 thousand for the three and six months ended June 30, 2015, respectively. As of June 30, 2016, the estimated amortization expense of other intangible assets for the remainder of 2016 and each of the next five years is as follows (in thousands):

 

2016 (remainder of year)

   $ 612   

2017

     1,144   

2018

     1,035   

2019

     937   

2020

     840   

2021

     738   

 

- 22 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(7.) SHAREHOLDERS’ EQUITY

Common Stock

The changes in shares of common stock were as follows for the six month periods ended June 30, 2016 and 2015:

 

     Outstanding      Treasury      Issued  

June 30, 2016

        

Shares outstanding at December 31, 2015

     14,190,192         207,317         14,397,509   

Common stock issued for acquisition

     294,705         —           294,705   

Restricted stock awards issued

     8,800         (8,800      —     

Restricted stock awards forfeited

     (7,983      7,983         —     

Stock options exercised

     40,561         (40,561      —     

Stock awards

     2,244         (2,244      —     
  

 

 

    

 

 

    

 

 

 

Shares outstanding at June 30, 2016

     14,528,519         163,695         14,692,214   
  

 

 

    

 

 

    

 

 

 

June 30, 2015

        

Shares outstanding at December 31, 2014

     14,118,048         279,461         14,397,509   

Restricted stock awards issued

     49,084         (49,084      —     

Restricted stock awards forfeited

     (2,271      2,271         —     

Stock options exercised

     3,722         (3,722      —     

Treasury stock purchases

     (1,791      1,791         —     

Stock awards

     2,363         (2,363      —     
  

 

 

    

 

 

    

 

 

 

Shares outstanding at June 30, 2015

     14,184,135         213,374         14,397,509   
  

 

 

    

 

 

    

 

 

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS

The following tables present the components of other comprehensive income (loss) for the three and six month periods ended June 30, 2016 and 2015 (in thousands):

 

    Pre-tax
Amount
    Tax Effect     Net-of-tax
Amount
 

Three months ended June 30, 2016

     

Securities available for sale and transferred securities:

     

Change in unrealized gain/loss during the period

  $ 6,810      $ 2,629      $ 4,181   

Reclassification adjustment for net gains included in net income (1)

    (1,417     (547     (870
 

 

 

   

 

 

   

 

 

 

Total securities available for sale and transferred securities

    5,393        2,082        3,311   

Amortization of pension and post-retirement items:

     

Prior service credit

    (12     (4     (8

Net actuarial losses

    239        91        148   
 

 

 

   

 

 

   

 

 

 

Total pension and post-retirement obligations

    227        87        140   
 

 

 

   

 

 

   

 

 

 

Other comprehensive income

  $ 5,620      $ 2,169      $ 3,451   
 

 

 

   

 

 

   

 

 

 

Three months ended June 30, 2015

     

Securities available for sale and transferred securities:

     

Change in unrealized gain/loss during the period

  $ (9,986   $ (3,822   $ (6,164

Reclassification adjustment for net gains included in net income (1)

    (69     (26     (43
 

 

 

   

 

 

   

 

 

 

Total securities available for sale and transferred securities

    (10,055     (3,848     (6,207

Amortization of pension and post-retirement items:

     

Prior service credit

    (12     (4     (8

Net actuarial losses

    235        87        148   
 

 

 

   

 

 

   

 

 

 

Total pension and post-retirement obligations

    223        83        140   
 

 

 

   

 

 

   

 

 

 

Other comprehensive loss

  $ (9,832   $ (3,765   $ (6,067
 

 

 

   

 

 

   

 

 

 

 

(1)  Includes amounts related to the amortization/accretion of unrealized net gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category. The unrealized net gains/losses will be amortized/accreted over the remaining life of the investment securities as an adjustment of yield.

 

- 23 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS (Continued)

 

    Pre-tax
Amount
    Tax Effect     Net-of-tax
Amount
 

Six months ended June 30, 2016

     

Securities available for sale and transferred securities:

     

Change in unrealized gain/loss during the period

  $ 19,006      $ 7,335      $ 11,671   

Reclassification adjustment for net gains included in net income (1)

    (2,079     (802     (1,277
 

 

 

   

 

 

   

 

 

 

Total securities available for sale and transferred securities

    16,927        6,533        10,394   

Amortization of pension and post-retirement items:

     

Prior service credit

    (24     (9     (15

Net actuarial losses

    478        184        294   
 

 

 

   

 

 

   

 

 

 

Total pension and post-retirement obligations

    454        175        279   
 

 

 

   

 

 

   

 

 

 

Other comprehensive income

  $ 17,381      $ 6,708      $ 10,673   
 

 

 

   

 

 

   

 

 

 

Six months ended June 30, 2015

     

Securities available for sale and transferred securities:

     

Change in unrealized gain/loss during the period

  $ (3,590   $ (1,386   $ (2,204

Reclassification adjustment for net gains included in net income (1)

    (1,208     (466     (742
 

 

 

   

 

 

   

 

 

 

Total securities available for sale and transferred securities

    (4,798     (1,852     (2,946

Amortization of pension and post-retirement items:

     

Prior service credit

    (24     (9     (15

Net actuarial losses

    471        181        290   
 

 

 

   

 

 

   

 

 

 

Total pension and post-retirement obligations

    447        172        275   
 

 

 

   

 

 

   

 

 

 

Other comprehensive loss

  $ (4,351   $ (1,680   $ (2,671
 

 

 

   

 

 

   

 

 

 

 

(1)  Includes amounts related to the amortization/accretion of unrealized net gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category. The unrealized net gains/losses will be amortized/accreted over the remaining life of the investment securities as an adjustment of yield.

Activity in accumulated other comprehensive loss, net of tax, for the three and six month periods ended June 30, 2016 and 2015 was as follows (in thousands):

 

     Securities
Available for
Sale and
Transferred
Securities
     Pension and
Post-
retirement
Obligations
     Accumulated
Other
Comprehensive
Loss
 

Three months ended June 30, 2016

        

Balance at beginning of period

   $ 6,387       $ (10,492    $ (4,105

Other comprehensive income before reclassifications

     4,181         —           4,181   

Amounts reclassified from accumulated other comprehensive loss

     (870      140         (730
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income

     3,311         140         3,451   
  

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 9,698       $ (10,352    $ (654
  

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2015

        

Balance at beginning of period

   $ 4,886       $ (10,501    $ (5,615

Other comprehensive loss before reclassifications

     (6,164      —           (6,164

Amounts reclassified from accumulated other comprehensive loss

     (43      140         97   
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income (loss)

     (6,207      140         (6,067
  

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ (1,321    $ (10,361    $ (11,682
  

 

 

    

 

 

    

 

 

 

 

- 24 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS (Continued)

 

     Securities
Available for
Sale and
Transferred
Securities
     Pension and
Post-
retirement
Obligations
     Accumulated
Other
Comprehensive
Loss
 

Six months ended June 30, 2016

        

Balance at beginning of period

   $ (696    $ (10,631    $ (11,327

Other comprehensive income before reclassifications

     11,671         —           11,671   

Amounts reclassified from accumulated other comprehensive loss

     (1,277      279         (998
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income

     10,394         279         10,673   
  

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 9,698       $ (10,352    $ (654
  

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2015

        

Balance at beginning of period

   $ 1,625       $ (10,636    $ (9,011

Other comprehensive loss before reclassifications

     (2,204      —           (2,204

Amounts reclassified from accumulated other comprehensive loss

     (742      275         (467
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income (loss)

     (2,946      275         (2,671
  

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ (1,321    $ (10,361    $ (11,682
  

 

 

    

 

 

    

 

 

 

The following tables present the amounts reclassified out of each component of accumulated other comprehensive loss for the three and six month periods ended June 30, 2016 and 2015 (in thousands):

 

Details About Accumulated Other

Comprehensive Loss Components

   Amount Reclassified from
Accumulated Other
Comprehensive Loss
    

Affected Line Item in the

Consolidated Statement of Income

     Three months ended
June 30,
      
     2016      2015       

Realized gain on sale of investment securities

   $ 1,387       $ —         Net gain on disposal of investment securities

Amortization of unrealized holding gains (losses) on investment securities transferred from available for sale to held to maturity

     30         69       Interest income
  

 

 

    

 

 

    
     1,417         69       Total before tax
     (547      (26    Income tax expense
  

 

 

    

 

 

    
     870         43       Net of tax

Amortization of pension and post-retirement items:

        

Prior service credit (1)

     12         12       Salaries and employee benefits

Net actuarial losses (1)

     (239      (235    Salaries and employee benefits
  

 

 

    

 

 

    
     (227      (223    Total before tax
     87         83       Income tax benefit
  

 

 

    

 

 

    
     (140      (140    Net of tax
  

 

 

    

 

 

    

Total reclassified for the period

   $ 730       $ (97   
  

 

 

    

 

 

    

 

(1)  These items are included in the computation of net periodic pension expense. See Note 10 – Employee Benefit Plans for additional information.

 

- 25 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS (Continued)

 

Details About Accumulated Other

Comprehensive Loss Components

   Amount Reclassified from
Accumulated Other
Comprehensive Loss
    

Affected Line Item in the

Consolidated Statement of Income

     Six months ended
June 30,
      
     2016      2015       

Realized gain on sale of investment securities

   $ 2,000       $ 1,062       Net gain on disposal of investment securities

Amortization of unrealized holding gains (losses) on investment securities transferred from available for sale to held to maturity

     79         146       Interest income
  

 

 

    

 

 

    
     2,079         1,208       Total before tax
     (802      (466    Income tax expense
  

 

 

    

 

 

    
     1,277         742       Net of tax

Amortization of pension and post-retirement items:

        

Prior service credit (1)

     24         24       Salaries and employee benefits

Net actuarial losses (1)

     (478      (471    Salaries and employee benefits
  

 

 

    

 

 

    
     (454      (447    Total before tax
     175         172       Income tax benefit
  

 

 

    

 

 

    
     (279      (275    Net of tax
  

 

 

    

 

 

    

Total reclassified for the period

   $ 998       $ 467      
  

 

 

    

 

 

    

 

(1)  These items are included in the computation of net periodic pension expense. See Note 10 – Employee Benefit Plans for additional information.

 

- 26 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) SHARE-BASED COMPENSATION PLANS

The Company maintains certain stock-based compensation plans that were approved by the Company’s shareholders and are administered by the Company’s Board of Directors, or the Management Development and Compensation Committee (the “MD&C Committee”) of the Board. The share-based compensation plans were established to allow for the grant of compensation awards to attract, motivate and retain employees, executive officers and non-employee directors who contribute to the success and profitability of the Company and to give such persons a proprietary interest in the Company, thereby enhancing their personal interest in the Company’s success.

The MD&C Committee approved the grant of restricted stock units (“RSUs”) and performance share units (“PSUs”) shown in the table below to certain members of management during the first six months of 2016.

 

            Weighted  
            Average  
     Number of      Per Share  
     Underlying      Grant Date  
     Shares      Fair Value  

RSUs

     14,500       $ 24.21   

PSUs

     24,084         22.94   

The grant-date fair value for the RSUs granted during the six month period ended June 30, 2016 is equal to the closing market price of our common stock on the date of grant reduced by the present value of the dividends expected to be paid on the underlying shares.

The number of PSUs that ultimately vest is contingent on achieving specified EPS targets and specified total shareholder return (“TSR”) targets relative to the SNL Small Cap Bank & Thrifts Index. Thirty percent of the shares subject to each grant will be earned based upon achievement of an EPS performance requirement for the Company’s fiscal year ended December 31, 2016. The remaining seventy percent of the shares will be earned based on the Company’s achievement of a relative TSR performance requirement, on a percentile basis, compared to the SNL Small Cap Bank & Thrifts Index over a three-year performance period ended December 31, 2018. The shares earned based on the achievement of the EPS and TSR performance requirements, if any, will vest on February 24, 2019 assuming the recipient’s continuous service to the Company.

The grant-date fair value for the EPS portion of the PSUs granted during the six month period ended June 30, 2016 is equal to the closing market price of our common stock on the date of grant reduced by the present value of the dividends expected to be paid on the underlying shares. The grant-date fair value of the TSR portion of the PSUs granted during the six month period ended June 30, 2016 was determined using the Monte Carlo simulation model on the date of grant, assuming the following (i) expected term of 2.85 years, (ii) risk free interest rate of 0.88%, (iii) expected dividend yield of 2.99% and (iv) expected stock price volatility over the expected term of the TSR award of 24.3%.

During the six months ended June 30, 2016, the Company issued a total of 2,244 shares of common stock in-lieu of cash for the annual retainer of four non-employee directors and granted a total of 8,800 restricted shares of common stock to non-employee directors, of which 4,400 shares vested immediately and 4,400 shares will vest after completion of a one-year service requirement. The market price of the stock and restricted stock on the date of grant was $28.38.

The following is a summary of restricted stock award activity for the six month period ended June 30, 2016:

 

            Weighted  
            Average  
            Market  
     Number of      Price at  
     Shares      Grant Date  

Outstanding at beginning of year

     82,908       $ 17.23   

Granted

     8,800         28.38   

Vested

     (9,770      25.56   

Forfeited

     (7,983      19.47   
  

 

 

    

Outstanding at end of period

     73,955       $ 17.22   
  

 

 

    

At June 30, 2016, the total unrecognized compensation cost related to the nonvested awards granted and expected to vest was $1.3 million. This cost is expected to be recognized over a weighted-average period of 2.1 years.

 

- 27 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(9.) SHARE-BASED COMPENSATION PLANS (Continued)

 

The Company uses the Black-Scholes valuation method to estimate the fair value of its stock option awards. There were no stock options awarded during 2016 or 2015. The following is a summary of stock option activity for the six months ended June 30, 2016 (dollars in thousands, except per share amounts):

 

                   Weighted         
            Weighted      Average         
            Average      Remaining      Aggregate  
     Number of      Exercise      Contractual      Intrinsic  
     Options      Price      Term      Value  

Outstanding at beginning of year

     102,249       $ 19.21         

Exercised

     (40,561      19.39         

Expired

     (2,000      19.70         
  

 

 

          

Outstanding and exercisable at end of period

     59,688       $ 19.07         1.3       $ 418   
  

 

 

          

The aggregate intrinsic value (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) of option exercises for the six months ended June 30, 2016 and 2015 was $334 thousand and $39 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for the six months ended June 30, 2016 and 2015 was $787 thousand and $165 thousand, respectively.

The Company amortizes the expense related to stock-based compensation awards over the vesting period. Share-based compensation expense is recorded as a component of salaries and employee benefits in the consolidated statements of income for awards granted to management and as a component of other noninterest expense for awards granted to directors. The share-based compensation expense included in the consolidated statements of income is as follows (in thousands):

 

     Three months ended      Six months ended  
     June 30,      June 30,  
     2016      2015      2016      2015  

Salaries and employee benefits

   $ 157       $ 113       $ 255       $ 191   

Other noninterest expense

     146         154         177         179   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation expense

   $ 303       $ 267       $ 432       $ 370   
  

 

 

    

 

 

    

 

 

    

 

 

 

(10.) EMPLOYEE BENEFIT PLANS

The components of the Company’s net periodic benefit expense for its pension and post-retirement obligations were as follows (in thousands):

 

     Three months ended      Six months ended  
     June 30,      June 30,  
     2016      2015      2016      2015  

Service cost

   $ 721       $ 581       $ 1,442       $ 1,162   

Interest cost on projected benefit obligation

     602         583         1,203         1,166   

Expected return on plan assets

     (1,150      (1,205      (2,300      (2,410

Amortization of prior service credit

     (12      (12      (24      (24

Amortization of net actuarial losses

     239         235         478         471   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic pension expense

   $ 400       $ 182       $ 799       $ 365   
  

 

 

    

 

 

    

 

 

    

 

 

 

The net periodic benefit expense is recorded as a component of salaries and employee benefits in the consolidated statements of income. The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of the Internal Revenue Code. The Company has no minimum required contribution for the 2016 fiscal year.

 

- 28 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(11.) COMMITMENTS AND CONTINGENCIES

The Company has financial instruments with off-balance sheet risk established in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk extending beyond amounts recognized in the Company’s financial statements.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved with extending loans to customers. The Company uses the same credit underwriting policies in making commitments and conditional obligations as for on-balance sheet instruments.

Off-balance sheet commitments consist of the following (in thousands):

 

     June 30,
2016
     December 31,
2015
 

Commitments to extend credit

   $ 518,186       $ 514,818   

Standby letters of credit

     11,750         11,746   

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses which may require payment by the customer of a termination fee. Commitments may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.

The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements, the Company may enter into forward commitments to sell individual residential mortgages. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value. Forward sales commitments totaled $617 thousand and $1.3 million at June 30, 2016 and December 31, 2015, respectively. In addition, the net change in the fair values of these derivatives was recognized as other noninterest income or other noninterest expense in the consolidated statements of income.

(12.) FAIR VALUE MEASUREMENTS

Determination of Fair Value – Assets Measured at Fair Value on a Recurring and Nonrecurring Basis

Valuation Hierarchy

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. There have been no changes in the valuation techniques used during the current period. The fair value hierarchy is as follows:

 

    Level 1 – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

    Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

    Level 3 – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

Transfers between levels of the fair value hierarchy are recorded as of the end of the reporting period.

 

- 29 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(12.) FAIR VALUE MEASUREMENTS (Continued)

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities available for sale: Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans held for sale: The fair value of loans held for sale is determined using quoted secondary market prices and investor commitments. Loans held for sale are classified as Level 2 in the fair value hierarchy.

Collateral dependent impaired loans: Fair value of impaired loans with specific allocations of the allowance for loan losses is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable and collateral value is determined based on appraisals performed by qualified licensed appraisers hired by the Company. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and the client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

Loan servicing rights: Loan servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of loan servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs, ancillary income, impound account balances, and discount rates. The significant unobservable inputs used in the fair value measurement of the Company’s loan servicing rights are the constant prepayment rates and weighted average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they will generally move in opposite directions. Loan servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other real estate owned (Foreclosed assets): Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. The appraisals are sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and result in a Level 3 classification of the inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Commitments to extend credit and letters of credit: Commitments to extend credit and fund letters of credit are principally at current interest rates, and, therefore, the carrying amount approximates fair value. The fair value of commitments is not material.

 

- 30 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(12.) FAIR VALUE MEASUREMENTS (Continued)

 

Assets Measured at Fair Value

The following tables present for each of the fair-value hierarchy levels the Company’s assets that are measured at fair value on a recurring and non-recurring basis as of the dates indicated (in thousands).

 

     Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Total  

June 30, 2016

           

Measured on a recurring basis:

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ —         $ 248,126       $ —         $ 248,126   

Mortgage-backed securities

     —           371,409         —           371,409   

Asset-backed securities

     —           184         —           184   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 619,719       $ —         $ 619,719   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured on a nonrecurring basis:

           

Loans:

           

Loans held for sale

   $ —         $ 209       $ —         $ 209   

Collateral dependent impaired loans

     —           —           1,232         1,232   

Other assets:

           

Loan servicing rights

     —           —           1,183         1,183   

Other real estate owned

     —           —           281         281   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 209       $ 2,696       $ 2,905   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

           

Measured on a recurring basis:

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ —         $ 260,863       $ —         $ 260,863   

Mortgage-backed securities

     —           283,314         —           283,314   

Asset-backed securities

     —           218         —           218   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 544,395       $ —         $ 544,395   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured on a nonrecurring basis:

           

Loans:

           

Loans held for sale

   $ —         $ 1,430       $ —         $ 1,430   

Collateral dependent impaired loans

     —           —           1,485         1,485   

Other assets:

           

Loan servicing rights

     —           —           1,241         1,241   

Other real estate owned

     —           —           163         163   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 1,430       $ 2,889       $ 4,319   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between Levels 1 and 2 during the six months ended June 30, 2016 and 2015. There were no liabilities measured at fair value on a recurring or nonrecurring basis during the six month periods ended June 30, 2016 and 2015.

 

- 31 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(12.) FAIR VALUE MEASUREMENTS (Continued)

 

The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis for which the Company has utilized Level 3 inputs to determine fair value (dollars in thousands).

 

Asset

   Fair
Value
    

Valuation Technique

  

Unobservable Input

   Unobservable Input
Value or Range

Collateral dependent impaired loans

   $ 1,232       Appraisal of collateral (1)    Appraisal adjustments (2)    35% - 50% discount

Loan servicing rights

     1,183       Discounted cash flow    Discount rate    4.4% (3)
         Constant prepayment rate    15.4% (3)

Other real estate owned

     281       Appraisal of collateral (1)    Appraisal adjustments (2)    13% - 72% discount

 

(1)  Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.
(2)  Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
(3)  Weighted averages.

Changes in Level 3 Fair Value Measurements

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of or during the six months ended June 30, 2016.

Disclosures about Fair Value of Financial Instruments

The assumptions used below are expected to approximate those that market participants would use in valuing these financial instruments.

Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, including estimates of timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument. Care should be exercised in deriving conclusions about our business, its value or financial position based on the fair value information of financial instruments presented below.

The estimated fair value approximates carrying value for cash and cash equivalents, Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock, accrued interest receivable, non-maturity deposits, short-term borrowings and accrued interest payable. Fair value estimates for other financial instruments not included elsewhere in this disclosure are discussed below.

Securities held to maturity: The fair value of the Company’s investment securities held to maturity is primarily measured using information from a third-party pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Loans: The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made for the same remaining maturities. Loans were first segregated by type such as commercial, residential mortgage, and consumer, and were then further segmented into fixed and variable rate and loan quality categories. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time deposits: The fair value of time deposits was estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments. The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Long-term borrowings: Long-term borrowings consist of $40 million of subordinated notes issued during the second quarter of 2015. The subordinated notes are publicly traded and are valued based on market prices, which are characterized as Level 2 liabilities in the fair value hierarchy.

 

- 32 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(12.) FAIR VALUE MEASUREMENTS (Continued)

 

The following presents (in thousands) the carrying amount, estimated fair value, and placement in the fair value measurement hierarchy of the Company’s financial instruments as of the dates indicated.

 

     Level in      June 30, 2016      December 31, 2015  
     Fair Value
Measurement
Hierarchy
     Carrying
Amount
     Estimated
Fair

Value
     Carrying
Amount
     Estimated
Fair

Value
 

Financial assets:

              

Cash and cash equivalents

     Level 1       $ 67,624       $ 67,624       $ 60,121       $ 60,121   

Securities available for sale

     Level 2         619,719         619,719         544,395         544,395   

Securities held to maturity

     Level 2         478,549         490,833         485,717         490,064   

Loans held for sale

     Level 2         209         215         1,430         1,430   

Loans

     Level 2         2,182,074         2,202,286         2,055,192         2,046,235   

Loans (1)

     Level 3         1,232         1,232         1,485         1,485   

Accrued interest receivable

     Level 1         8,919         8,919         8,609         8,609   

FHLB and FRB stock

     Level 2         22,086         22,086         19,991         19,991   

Financial liabilities:

              

Non-maturity deposits

     Level 1         2,146,849         2,146,849         2,093,513         2,093,513   

Time deposits

     Level 2         711,156         712,905         637,018         636,159   

Short-term borrowings

     Level 1         338,300         338,300         293,100         293,100   

Long-term borrowings

     Level 2         39,025         37,566         38,990         40,313   

Accrued interest payable

     Level 1         5,147         5,147         4,676         4,676   

 

(1)  Comprised of collateral dependent impaired loans.

(13.) SEGMENT REPORTING

The Company has two reportable segments: Banking and Non-Banking. These reportable segments have been identified and organized based on the nature of the underlying products and services applicable to each segment, the type of customers to whom those products and services are offered and the distribution channel through which those products and services are made available.

The banking segment includes all of the Company’s retail and commercial banking operations. The non-banking segment includes the activities of Scott Danahy Naylon, a full service insurance agency that provides a broad range of insurance services to both personal and business clients, and Courier Capital, an investment advisor and wealth management firm that provides customized investment management, investment consulting and retirement plan services to individuals, businesses, institutions, foundations and retirement plans. The Company operated as two business segments (banking and insurance) until the acquisition of Courier Capital on January 5, 2016, at which time the insurance segment was re-named as the non-banking segment to reflect the inclusion of Courier Capital which has similar products, services and reporting, as noted above. Holding company amounts primarily reflect the differences between segment amounts and consolidated totals, and are reflected in the Holding Company and Other column below, along with amounts to eliminate balances and transactions between segments.

The following tables present information regarding our business segments as of and for the periods indicated (in thousands).

 

     Banking      Non-Banking      Holding
Company and
Other
     Consolidated
Totals
 

June 30, 2016

           

Goodwill

   $ 48,536       $ 17,881       $ —         $ 66,417   

Other intangible assets, net

     3,733         6,102         —           9,835   

Total assets

     3,553,354         30,315         1,920         3,585,589   

December 31, 2015

           

Goodwill

   $ 48,536       $ 11,866       $ —         $ 60,402   

Other intangible assets, net

     829         5,715         —           6,544   

Total assets

     3,356,987         20,315         3,722         3,381,024   

 

- 33 -


Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(13.) SEGMENT REPORTING (Continued)

 

     Banking      Non-Banking (1)      Holding
Company and
Other
     Consolidated
Totals
 

Three months ended June 30, 2016

        

Net interest income (expense)

   $ 25,816       $ —         $ (617    $ 25,199   

Provision for loan losses

     (1,952      —           —           (1,952

Noninterest income

     6,944         2,050         (78      8,916   

Noninterest expense

     (18,054      (1,764      (2,302      (22,120
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     12,754         286         (2,997      10,043   

Income tax (expense) benefit

     (3,889      (112      1,109         (2,892
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 8,865       $ 174       $ (1,888    $ 7,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2016

        

Net interest income

   $ 51,153       $ —         $ (1,235    $ 49,918   

Provision for loan losses

     (4,320      —           —           (4,320

Noninterest income

     13,807         4,534         (208      18,133   

Noninterest expense

     (36,399      (3,570      (3,369      (43,338
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     24,241         964         (4,812      20,393   

Income tax (expense) benefit

     (6,990      (376      1,742         (5,624
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 17,251       $ 588       $ (3,070    $ 14,769   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Banking      Non-Banking      Holding
Company and
Other
     Consolidated
Totals
 

Three months ended June 30, 2015

           

Net interest income

   $ 23,919       $ —         $ (515    $ 23,404   

Provision for loan losses

     (1,288      —           —           (1,288

Noninterest income

     5,522         1,033         (100      6,455   

Noninterest expense

     (17,668      (1,050      (518      (19,236
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     10,485         (17      (1,133      9,335   

Income tax (expense) benefit

     (3,107      5         352         (2,750
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 7,378       $ (12    $ (781    $ 6,585   
  

 

 

    

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2015

           

Net interest income

   $ 47,066       $ —         $ (515    $ 46,551   

Provision for loan losses

     (4,029      —           —           (4,029

Noninterest income

     12,353         2,626         (227      14,752   

Noninterest expense

     (34,947      (2,237      (1,063      (38,247
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     20,443         389         (1,805      19,027   

Income tax (expense) benefit

     (6,056      (154      569         (5,641
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 14,387       $ 235       $ (1,236    $ 13,386   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Includes activity from Courier Capital since January 5, 2016 (the date of acquisition).

 

- 34 -


Table of Contents
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q should be read in conjunction with the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2015. In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.

FORWARD LOOKING INFORMATION

Statements and financial analysis contained in this document that are based on other than historical data are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:

 

    statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Financial Institutions, Inc. (the “Parent”) and our subsidiaries (together, the “Company,” “we,” “our” or “us”); and

 

    statements preceded by, followed by or that include the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “projects,” or similar expressions.

These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this document and our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, which we refer to as the Form 10-K, including, but not limited to, those presented in the Management’s Discussion and Analysis of Financial Condition and Results of Operations. Factors that might cause such differences include, but are not limited to:

 

    If we experience greater credit losses than anticipated, earnings may be adversely impacted;

 

    Our tax strategies and the value of our deferred tax assets could adversely affect our operating results and regulatory capital ratios;

 

    Geographic concentration may unfavorably impact our operations;

 

    We depend on the accuracy and completeness of information about or from customers and counterparties;

 

    Our insurance brokerage subsidiary is subject to risk related to the insurance industry;

 

    Our investment advisory and wealth management operations are subject to risk related to the financial services industry;

 

    Our inability to successfully implement our growth strategies;

 

    We are subject to environmental liability risk associated with our lending activities;

 

    Commercial real estate and business loans increase our exposure to credit risks;

 

    Our indirect lending involves risk elements in addition to normal credit risk;

 

    We accept deposits that do not have a fixed term and which may be withdrawn by the customer at any time for any reason;

 

    Any future FDIC insurance premium increases may adversely affect our earnings;

 

    We are highly regulated and may be adversely affected by changes in banking laws, regulations and regulatory practices;

 

    New or changing tax and accounting rules and interpretations could significantly impact our strategic initiatives, results of operations, cash flows, and financial condition;

 

    Legal and regulatory proceedings and related matters could adversely affect us and banking industry in general;

 

    A breach in security of our or third party information systems, including the occurrence of a cyber incident or a deficiency in cyber security, may subject us to liability, result in a loss of customer business or damage our brand image;

 

    We face competition in staying current with technological changes to compete and meet customer demands;

 

    We rely on other companies to provide key components of our business infrastructure;

 

    We use financial models for business planning purposes that may not adequately predict future results;

 

    We may not be able to attract and retain skilled people;

 

    Acquisitions may disrupt our business and dilute shareholder value;

 

    We are subject to interest rate risk;

 

    Our business may be adversely affected by conditions in the financial markets and economic conditions generally;

 

    The fiscal and monetary policies of the federal government and its agencies have a significant impact on our earnings;

 

    The soundness of other financial institutions could adversely affect us;

 

    The value of our goodwill and other intangible assets may decline in the future;

 

    A future proxy contest for the election of directors at our annual meeting or proposals arising out of shareholder initiatives could cause us to incur additional substantial costs and could negatively affect our business;

 

    We operate in a highly competitive industry and market area;

 

    Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business;

 

- 35 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

    Liquidity is essential to our businesses;

 

    We may need to raise additional capital in the future and such capital may not be available on acceptable terms or at all;

 

    We rely on dividends from our subsidiaries for most of our revenue;

 

    We may not pay or may reduce the dividends on our common stock;

 

    We may issue debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in liquidation, which could dilute our current shareholders or negatively affect the value of our common stock;

 

    Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect; and

 

    The market price of our common stock may fluctuate significantly in response to a number of factors.

We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advise readers that various factors, including those described above, could affect our financial performance and could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected. See also Item 1A, Risk Factors in the Form 10-K for further information. Except as required by law, we do not undertake, and specifically disclaim any obligation to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

GENERAL

Financial Institutions, Inc. (the “Parent”) is a financial holding company headquartered in New York State, providing banking and nonbanking financial services to individuals, municipalities and businesses primarily in our Western and Central New York footprint. The Company provides diversified financial services through its subsidiaries, Five Star Bank, Scott Danahy Naylon, LLC (“Scott Danahy Naylon”) and Courier Capital, LLC (“Courier Capital”). The Company offers a broad array of deposit, lending and other financial services to individuals, municipalities and businesses in Western and Central New York through its wholly-owned New York chartered banking subsidiary, Five Star Bank (the “Bank”). The Bank has also expanded its indirect lending network to include relationships with franchised automobile dealers in the Capital District of New York and Northern and Central Pennsylvania. Scott Danahy Naylon provides a broad range of insurance services to personal and business clients across 44 states. Courier Capital, which we acquired on January 5, 2016, provides customized investment management, investment consulting and retirement plan services to individuals, businesses, institutions, foundations and retirement plans across nine states.

Our primary sources of revenue are net interest income (interest earned on our loans and securities, net of interest paid on deposits and other funding sources) and noninterest income, particularly fees and other revenue from insurance and financial services provided to customers or ancillary services tied to loans and deposits. Business volumes and pricing drive revenue potential, and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth, and competitive conditions within the marketplace. We are not able to predict market interest rate fluctuations with certainty and our asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on our results of operations and financial condition.

Our business strategy has been to maintain a community bank philosophy, which consists of focusing on and understanding the individualized banking needs of individuals, municipalities and businesses of the local communities surrounding our primary service areas. We believe this focus allows us to be more responsive to our customers’ needs and provide a high level of personal service that differentiates us from larger competitors, resulting in long-standing and broad based banking relationships. Our core customers are primarily small to medium-sized businesses, individuals and community organizations, which prefer to build banking, insurance and wealth management relationships with a community bank that combines high quality, competitively-priced products and services with personalized service. Because of our identity and origin as a locally operated bank, we believe that our level of personal service provides a competitive advantage over larger banks, which tend to consolidate decision-making authority outside local communities.

A key aspect of our current business strategy is to foster a community-oriented culture where our customers and employees establish long-standing and mutually beneficial relationships. We believe that we are well-positioned to be a strong competitor within our market area because of our focus on community banking needs and customer service, our comprehensive suite of deposit, loan, insurance and wealth management products typically found at larger banks, our highly experienced management team and our strategically located banking centers. We believe that the foregoing factors all help to grow our core deposits, which supports a central element of our business strategy, namely the growth of a diversified and high-quality loan portfolio.

 

- 36 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

EXECUTIVE OVERVIEW

Summary of 2016 Second Quarter Results

Net income increased $566 thousand or 9% to $7.2 million for the second quarter of 2016 compared to $6.6 million for the second quarter of 2015. Net income available to common shareholders for the second quarter of 2016 was $6.8 million, or $0.47 per diluted share, compared with $6.2 million, or $0.44 per diluted share, for the second quarter of last year. Return on average equity was 9.07% and return on average assets was 0.80% for the second quarter of 2016 compared to 9.19% and 0.78%, respectively, for the second quarter of 2015.

Net interest income totaled $25.2 million in the second quarter 2016, up from $23.4 million in the second quarter 2015. Average earning assets were up $236.9 million, led by a $191.1 million increase in average loans in the second quarter of 2016 compared to the same quarter in 2015. The increase in average loans was primarily attributable to organic commercial loan growth. Second quarter 2016 net interest margin was 3.23%, a slight decrease from 3.24% reported in the second quarter of 2015.

The provision for loans losses was $2.0 million in the second quarter of 2016 compared to $1.3 million in the second quarter of 2015. Net charge-offs during the recent quarter were $1.0 million, unchanged from the second quarter of 2015. Net charge-offs expressed as an annualized percentage of average loans outstanding were 0.19% during the second quarter of 2016 compared with 0.20% in the second quarter of 2015. See the “Allowance for Loan Losses” and “Non-Performing Assets and Potential Problem Loans” sections of this Management’s Discussion and Analysis for further discussion regarding the decreases in the provision for loan losses and net-charge-offs.

Noninterest income totaled $8.9 million in the second quarter of 2016, compared to $6.5 million in the second quarter of 2015. Included in the second quarter of 2016 are net gains realized from the sale of investment securities totaling $1.4 million. The higher noninterest income in the second quarter 2016 compared to the same quarter last year is also a result of the investment advisory income from Courier Capital. The increases in insurance income and ATM and debit income were partially offset by a decrease in service charges on deposits when comparing the second quarter periods.

Noninterest expense in the second quarter of 2016 totaled $22.1 million compared with $19.2 million in the second quarter of 2015. The increase in noninterest expense reflected higher professional services associated with responding to the proxy contest with Clover Partners, L.P., which amounted to $1.7 million in the second quarter of 2016. The second quarter of 2016 also included increases in salaries and employee benefits and occupancy and equipment costs reflecting the addition of Courier Capital.

The regulatory Common equity Tier 1 ratio and Total risk-based capital ratio were 9.63%, and 13.08%, respectively, for the second quarter of 2016. See the “Liquidity and Capital Management” section of this Management’s Discussion and Analysis for further discussion regarding regulatory capital and the Basel III capital rules.

Courier Capital Acquisition

On January 5, 2016, we completed the acquisition of Courier Capital Corporation, a registered investment advisory and wealth management firm with approximately $1.2 billion in assets under management. Consideration for the acquisition totaled $9.0 million and included stock of $8.1 million and $918 thousand of cash. The acquisition also included $2.8 million of potential future payments of stock and $2.2 million of potential future cash bonuses contingent upon Courier Capital meeting certain EBITDA performance targets through 2018. In addition, the Company purchased two pieces of real property in Buffalo and Jamestown, New York used by Courier Capital for total cash considerations of $1.3 million. As a result of the acquisition, we recorded goodwill of $6.0 million and other intangible assets of $3.9 million. The goodwill is not expected to be deductible for income tax purposes. Courier Capital now operates as a subsidiary of Financial Institutions, Inc. and an affiliate of Five Star Bank and Scott Danahy Naylon.

We expect to realize the following benefits from this acquisition:

 

    Grow and diversify our noninterest income by offering investment advisory services

 

    Further increase revenue by cross-selling between our banking, insurance and wealth management lines of business

 

    Retain capable management with extensive experience in the investment advisory and wealth management industry

 

    Improve our presence and brand recognition in the Buffalo marketplace

 

    Provide access to a new customer base in our target expansion markets of Rochester and Buffalo

 

- 37 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

2016 Outlook

We began 2016 in a strong financial condition and with positive momentum. We expect net interest income to increase in 2016. We anticipate an increase in earning assets as we remain focused on loan growth, which will be primarily funded through deposit gathering. However, the benefit to net interest income from increased earning assets is expected to be partially offset by slight downward pressure on net interest margin. We plan to maintain a disciplined approach to loan pricing, but asset yields remain under pressure due to the low interest rate environment and flattening of the yield curve, while the opportunity for deposit repricing remains limited.

We expect our commercial loan portfolio to grow in a manner that is consistent with our strategic initiatives and continued support of middle market small business lending. Automobile loan originations remained strong through the first half of 2016, reflecting the positive impact from our investment in building automotive dealer relationships. The residential real estate portfolio, which includes both first and junior lien residential real estate related products, is expected to increase as we remain focused on the customer experience and our convenient application process.

We anticipate the increase in total loans will modestly outpace growth in total deposits. This anticipated outcome reflects our continued focus on targeting loyal relationship-based deposit customers rather than those that are more price sensitive. We expect to continue managing our overall cost of funds using short-term borrowings, as well as our continued shift in mix of deposits towards low- and no-cost demand deposits and money market deposit accounts.

Noninterest income during 2016 is expected to be higher than 2015, reflecting our continued efforts to increase both account and transaction-based fee income, coupled with the benefit of revenue from our fee-based subsidiaries, Scott Danahy Naylon and Courier Capital. We anticipate that the results of these efforts will further reduce our reliance on traditional spread-based net interest income, as fee-based activities are a relatively stable revenue source during periods of changing interest rates.

Noninterest expense is expected to increase in 2016 with the addition of Courier Capital, coupled with higher salaries and benefits costs associated with our expansion initiatives, including the opening of additional financial solution centers. We remain committed to diligent expense control and implemented several initiatives designed to reduce operating expenses late in the first quarter of 2016. We expect those specific savings to be reflected throughout the remainder of the year, however we do plan to continue to invest in our business with a focus on revenue enhancing initiatives to further accelerate our growth in the communities we serve.

We do not expect significant changes in overall asset quality and allowance measurements.

The effective tax rate for 2016 is expected to be slightly higher than it was in 2015, as the lower effective tax rate in 2015 was partly driven by historic tax credits claimed in 2015. However, our 2016 effective tax rate will continue to reflect the positive impacts of tax-exempt income (including the $911 thousand of non-taxable company owned life death benefit proceeds received in the first quarter of 2016), tax advantaged investments, the formation of our real estate investment trust in early 2014 and benefits from New York State tax law changes that began going into effect during 2015.

 

- 38 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

RESULTS OF OPERATIONS

Net Interest Income and Net Interest Margin

Net interest income is our primary source of revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities and repricing frequencies.

Interest rate spread and net interest margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and stockholders’ equity, also support earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt investment securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

The following table reconciles interest income per the consolidated statements of income to interest income adjusted to a fully taxable equivalent basis (dollars in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2016      2015      2016      2015  

Interest income per consolidated statements of income

   $ 28,246       $ 25,959       $ 55,881       $ 50,956   

Adjustment to fully taxable equivalent basis

     785         777         1,578         1,529   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest income adjusted to a fully taxable equivalent basis

     29,031         26,736         57,459         52,485   

Interest expense per consolidated statements of income

     3,047         2,555         5,963         4,405   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income on a taxable equivalent basis

   $ 25,984       $ 24,181       $ 51,496       $ 48,080   
  

 

 

    

 

 

    

 

 

    

 

 

 

Analysis of Net Interest Income for the Three Month Periods ended June 30, 2016 and 2015

Net interest income on a taxable equivalent basis for the three months ended June 30, 2016, was $26.0 million, an increase of $1.8 million versus the comparable quarter last year. The increase in net interest income was due to an increase in average earning assets of $236.9 million or 8% compared to the second quarter of 2015.

The net interest margin for the second quarter of 2016 was 3.23%, 1 basis point lower than 3.24% for the same period in 2015. This comparable period decrease was a function of a 2 basis point decrease in interest rate spread, partially offset by a higher contribution from net free funds of 1 basis point (due principally to increases in average noninterest-bearing deposits and other net free funds). The lower interest rate spread was a result of a 5 basis point increase in the cost of average interest-bearing liabilities partly offset by a 3 basis point increase in the yield on earning assets.

For the second quarter of 2016, the yield on average earning assets of 3.61% was 3 basis points higher than the second quarter of 2015. Loan yields decreased 1 basis point to 4.17% when comparing the second quarter of 2016 to the same period in 2015. The yield on investment securities increased 4 basis points during the second quarter of 2016 to 2.48%. Overall, the earning asset rate changes increased interest income by $5 thousand during the second quarter of 2016.

Average interest-earning assets were $3.23 billion for the second quarter 2016, an increase of $236.9 million or 8% from the comparable quarter last year, with average loans up $191.1 million and average securities up $45.6 million. The growth in average loans reflected increases in most loan categories. Commercial loans, in particular, were up $142.4 million or 18% from the second quarter of 2015. Loans represented 66.7% of average interest-earning assets during second quarter of 2016 compared to 65.6% during the second quarter of 2015. The increase in the volume of average loans resulted in a $2.0 million increase in interest income, partially offset by a $107 thousand decrease due to the unfavorable rate variance. Securities represented 33.3% of average interest-earning assets during the second quarter of 2016 compared to 34.4% during the second quarter of 2015. The increase in the volume of average securities resulted in a $260 thousand increase in interest income, coupled with a $112 thousand increase due to the favorable rate variance.

The cost of average interest-bearing liabilities of 0.48% in the second quarter of 2016 was 5 basis points higher than the second quarter of 2015. The cost of average interest-bearing deposits increased 2 basis points to 0.37% and the cost of short-term borrowings increased 27 basis points to 0.65% in the second quarter of 2016 compared to the same quarter of 2015. The cost of long-term borrowings for the second quarter of 2016 was 6.33% compared to 6.23% for the same quarter of 2015, reflecting the issuance of $40 million of subordinated notes during the second quarter of 2015. Overall, interest-bearing liability rate and volume increases resulted in $492 thousand of higher interest expense.

 

- 39 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Average interest-bearing liabilities of $2.55 billion in the second quarter of 2016 were $181.7 million or 8% higher than the second quarter of 2015. On average, interest-bearing deposits grew $188.5 million, while noninterest-bearing demand deposits (a principal component of net free funds) were up $34.5 million. The increase in average deposits was due in part to seasonal inflows of municipal deposits, successful business development efforts in retail banking, and an increase in deposits from our Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) programs. For further discussion of the CDARS and ICS programs, refer to the “Funding Activities - Deposits” section of this Management’s Discussion and Analysis. Overall, interest-bearing deposit rate and volume changes resulted in $258 thousand of higher interest expense during the second quarter of 2016. Average borrowings decreased $6.8 million compared to the second quarter of 2015. Overall, short and long-term borrowing rate and volume changes resulted in $234 thousand of higher interest expense during the second quarter of 2016.

Analysis of Net Interest Income for the Six Months ended June 30, 2016 and June 30, 2015

Net interest income on a taxable equivalent basis for the first six months of 2016 was $51.5 million compared to $48.1 million for the same period last year. The increase in net interest income was due to an increase in average earning assets of $274.5 million or 9% compared to the first six months of 2015.

The net interest margin for the first six months of 2016 was 3.25%, 8 basis points lower than 3.33% for the same period last year. This comparable period decrease was a function of a 10 basis point decrease in interest rate spread to 3.15% during the first six months of 2016, partially offset by a 2 basis point higher contribution from net free funds. The lower interest rate spread was a net result of a 10 basis point increase in the cost of interest-bearing liabilities.

The yield on earning assets was 3.63% for the first six months of 2016 and 2015. A decrease in the yield on the loan portfolio during the period (down 3 basis points to 4.19%), was offset by an increase in the yield on the investment securities portfolio (up 2 basis points, to 2.48%). Overall, earning asset rate changes reduced interest income by $87 thousand during the first half of 2016, but that was more than offset by a favorable volume variance that increased interest income by $5.1 million, which collectively drove a $5.0 million increase in interest income.

The cost of interest-bearing liabilities of 0.48% for the first six months of 2016 was 10 basis points higher than the same period in 2015. Rates on interest-bearing deposits were up 2 basis points to 0.36% for the first six months of 2016 versus the same period in 2015. The cost of short-term borrowings for the first six months of 2016 was 0.63% or 26 basis points higher that 0.37% for the same period last year. The cost of long-term borrowings for the first half of 2016 was 6.33% compared to 6.20% for the first half of 2015 due to the issuance of the Subordinated Notes in April 2015. Overall, interest-bearing liability rate and volume increases resulted in $513 thousand and $1.0 million of higher interest expense, respectively.

Average interest-earning assets were $3.18 billion for the first six months of 2016, an increase of $274.5 million or 9% from the comparable period last year, with average loans up $192.1 million and average securities up $82.3 million. The growth in average loans was comprised of increases in most loan categories. Commercial loans, in particular, were up $148.4 million or 19% from the first half of 2015. Residential real estate loans increased $30.3 million or 12% and consumer indirect loans increased $17.9 million or 3% when comparing the first six months of 2016 with the same period in 2015.

Average interest-bearing liabilities of $2.50 billion in the first six months of 2016 were $196.7 million or 9% higher than the first six months of 2015. On average, interest-bearing deposits grew $195.8 million, while noninterest-bearing demand deposits were up $43.7 million and average short-term borrowings decreased $21.5 million. Average long-term borrowings increased $22.4 million during the first half of 2016 due to the issuance of the subordinated notes in April 2015.

 

- 40 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table sets forth certain information relating to the consolidated balance sheets and reflects the average yields earned on interest-earning assets, as well as the average rates paid on interest-bearing liabilities for the periods indicated (in thousands).

 

    Three months ended June 30,  
    2016     2015  
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
 

Interest-earning assets:

           

Federal funds sold and interest-earning deposits

  $ 316      $ —          0.49   $ 26      $ —          0.39

Investment securities (1):

           

Taxable

    784,166        4,419        2.25        741,355        4,069        2.20   

Tax-exempt (2)

    291,054        2,243        3.08        288,285        2,221        3.08   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

    1,075,220        6,662        2.48        1,029,640        6,290        2.44   

Loans:

           

Commercial business

    329,901        3,458        4.22        284,535        2,922        4.12   

Commercial mortgage

    606,360        6,872        4.56        509,317        5,823        4.59   

Residential real estate loans

    391,826        3,850        3.93        357,442        3,699        4.14   

Residential real estate lines

    125,212        1,182        3.80        129,167        1,168        3.63   

Consumer indirect

    683,722        6,491        3.82        664,222        6,281        3.79   

Other consumer

    17,562        516        11.81        18,848        553        11.76   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    2,154,583        22,369        4.17        1,963,531        20,446        4.18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    3,230,119        29,031        3.61        2,993,197        26,736        3.58   
   

 

 

   

 

 

     

 

 

   

 

 

 

Allowance for loan losses

    (28,307         (27,924    

Other noninterest-earning assets

    305,948            297,838       
 

 

 

       

 

 

     

Total assets

  $ 3,507,760          $ 3,263,111       
 

 

 

       

 

 

     

Interest-bearing liabilities:

           

Deposits:

           

Interest-bearing demand

  $ 579,497      $ 208        0.14   $ 561,570      $ 197        0.14

Savings and money market

    1,017,911        330        0.13        929,701        289        0.12   

Time deposits

    698,505        1,547        0.89        616,145        1,341        0.87   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    2,295,913        2,085        0.37        2,107,416        1,827        0.35   

Short-term borrowings

    213,826        344        0.65        226,577        213        0.38   

Long-term borrowings

    39,015        618        6.33        33,053        515        6.23   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total borrowings

    252,841        962        1.52        259,630        728        1.12   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    2,548,754        3,047        0.48        2,367,046        2,555        0.43   
   

 

 

   

 

 

     

 

 

   

 

 

 

Noninterest-bearing demand deposits

    621,912            587,396       

Other noninterest-bearing liabilities

    19,923            21,320       

Shareholders’ equity

    317,171            287,349       
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 3,507,760          $ 3,263,111       
 

 

 

       

 

 

     

Net interest income (tax-equivalent)

    $ 25,984          $ 24,181     
   

 

 

       

 

 

   

Interest rate spread

        3.13         3.15
     

 

 

       

 

 

 

Net earning assets

  $ 681,365          $ 626,151       
 

 

 

       

 

 

     

Net interest margin (tax-equivalent)

        3.23         3.24
     

 

 

       

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

        126.73         126.45
     

 

 

       

 

 

 

 

(1)  Investment securities are shown at amortized cost.
(2)  The interest on tax-exempt securities is calculated on a tax equivalent basis assuming a Federal tax rate of 35%.

 

- 41 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

    Six months ended June 30,  
    2016     2015  
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
 

Interest-earning assets:

           

Federal funds sold and interest-earning deposits

  $ 193      $ 1        0.53   $ 75      $ —          0.23

Investment securities (1):

           

Taxable

    759,125        8,524        2.25        686,299        7,532        2.20   

Tax-exempt (2)

    292,286        4,510        3.09        282,792        4,370        3.09   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

    1,051,411        13,034        2.48        969,091        11,902        2.46   

Loans:

           

Commercial business

    323,022        6,705        4.17        274,729        5,646        4.14   

Commercial mortgage

    594,251        13,585        4.60        494,095        11,374        4.64   

Residential real estate loans

    386,952        7,682        3.91        356,658        7,419        4.16   

Residential real estate lines

    126,264        2,390        3.81        129,305        2,334        3.64   

Consumer indirect

    680,927        13,022        3.85        662,982        12,707        3.86   

Other consumer

    17,744        1,041        11.80        19,290        1,103        11.53   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    2,129,160        44,425        4.19        1,937,059        40,583        4.22   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

    3,180,764        57,460        3.63        2,906,225        52,485        3.63   
   

 

 

   

 

 

     

 

 

   

 

 

 

Allowance for loan losses

    (27,973         (27,904    

Other noninterest-earning assets

    303,814            311,400       
 

 

 

       

 

 

     

Total assets

  $ 3,456,605          $ 3,189,721       
 

 

 

       

 

 

     

Interest-bearing liabilities:

           

Deposits:

           

Interest-bearing demand

  $ 575,960      $ 411        0.14   $ 556,564      $ 353        0.13

Savings and money market

    991,770        654        0.13        884,709        506        0.12   

Time deposits

    678,521        2,981        0.88        609,169        2,588        0.86   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

    2,246,251        4,046        0.36        2,050,442        3,447        0.34   

Short-term borrowings

    217,576        683        0.63        239,103        443        0.37   

Long-term borrowings

    39,006        1,235        6.33        16,618        515        6.20   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total borrowings

    256,582        1,918        1.50        255,721        958        0.75   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

    2,502,833        5,964        0.48        2,306,163        4,405        0.38   
   

 

 

   

 

 

     

 

 

   

 

 

 

Noninterest-bearing demand deposits

    619,751            576,011       

Other noninterest-bearing liabilities

    20,842            21,386       

Shareholders’ equity

    313,179            286,161       
 

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 3,456,605          $ 3,189,721       
 

 

 

       

 

 

     

Net interest income (tax-equivalent)

    $ 51,496          $ 48,080     
   

 

 

       

 

 

   

Interest rate spread

        3.15         3.25
     

 

 

       

 

 

 

Net earning assets

  $ 677,931          $ 600,062       
 

 

 

       

 

 

     

Net interest margin (tax-equivalent)

        3.25         3.33
     

 

 

       

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

        127.09         126.02
     

 

 

       

 

 

 

 

(1)  Investment securities are shown at amortized cost.
(2)  The interest on tax-exempt securities is calculated on a tax equivalent basis assuming a Federal tax rate of 35%.

 

- 42 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table presents, on a tax equivalent basis, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest income not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

 

     Three months ended     Six months ended  
     June 30, 2016 vs. 2015     June 30, 2016 vs. 2015  
     Volume     Rate     Total     Volume     Rate     Total  

Increase (decrease) in:

            

Interest income:

            

Federal funds sold and interest-earning deposits

   $ —        $ —        $ —        $ 1      $ —        $ 1   

Investment securities:

            

Taxable

     239        111        350        815        177        992   

Tax-exempt

     21        1        22        146        (6     140   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

     260        112        372        961        171        1,132   

Loans:

            

Commercial business

     475        61        536        1,001        58        1,059   

Commercial mortgage

     1,100        (51     1,049        2,291        (80     2,211   

Residential mortgage

     344        (193     151        611        (348     263   

Home equity

     (36     50        14        (56     112        56   

Consumer indirect

     185        25        210        343        (28     315   

Other consumer

     (38     1        (37     (90     28        (62
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

     2,030        (107     1,923        4,100        (258     3,842   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     2,290        5        2,295        5,062        (87     4,975   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

            

Deposits:

            

Interest-bearing demand

     6        5        11        12        46        58   

Savings and money market

     28        13        41        65        83        148   

Time deposits

     182        24        206        303        90        393   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     216        42        258        380        219        599   

Short-term borrowings

     (13     144        131        (43     283        240   

Long-term borrowings

     94        9        103        709        11        720   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total borrowings

     81        153        234        666        294        960   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     297        195        492        1,046        513        1,559   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 1,993      $ (190   $ 1,803      $ 4,016      $ (600   $ 3,416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for loan losses for the three and six month periods ended June 30, 2016 were $2.0 million and $4.3 million, respectively, compared to $1.3 million and $4.0 million for the corresponding periods in 2015.

See the “Allowance for Loan Losses” and “Non-Performing Assets and Potential Problem Loans” sections of this Management’s Discussion and Analysis for further discussion.

 

- 43 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Noninterest Income

The following table details the major categories of noninterest income for the periods presented (in thousands):

 

     Three months ended      Six months ended  
     June 30,      June 30,  
     2016      2015      2016      2015  

Service charges on deposits

   $ 1,755       $ 1,964       $ 3,479       $ 3,843   

Insurance income

     1,183         1,057         2,855         2,665   

ATM and debit card

     1,421         1,283         2,746         2,476   

Investment advisory

     1,365         541         2,608         1,028   

Company owned life insurance

     486         493         1,854         960   

Investments in limited partnerships

     36         55         92         529   

Loan servicing

     112         96         228         263   

Net gain on sale of loans held for sale

     78         39         156         108   

Net gain on disposal of investment securities

     1,387         —           2,000         1,062   

Net gain (loss) on disposal of other assets

     82         16         86         20   

Other

     1,011         911         2,029         1,798   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

   $ 8,916       $ 6,455       $ 18,133       $ 14,752   
  

 

 

    

 

 

    

 

 

    

 

 

 

Service charges on deposit accounts for the six months ended June 30, 2016 decreased $364 thousand, or 9%, compared to the same period in 2015. The decrease was primarily due to a decrease in the amount of checking account overdraft activity.

Insurance income increased $190 thousand, or 7%, to $2.9 million for the first six months of 2016 compared to $2.7 million for the first half of 2015 reflecting successful business development efforts to drive increases in our fee-based revenue.

Investment advisory income increased to $2.6 million in the first half of 2016 compared to $1.0 million in the first half of 2015, reflecting the contribution from Courier Capital which was acquired early in the first quarter 2016 as part of our strategy to diversify our business lines and increase noninterest income through additional fee-based services.

Income from company owned life insurance increased to $1.9 million in the first six months of 2016 compared to $960 thousand in the same period in 2015, as the first quarter of 2016 included $911 thousand of death benefit proceeds.

We have investments in limited partnerships, primarily small business investment companies, and account for these investments under the equity method. Income from investments in limited partnerships was $92 thousand and $529 thousand for the six months ended June 30, 2016 and 2015, respectively. The income from these equity method investments fluctuates based on the performance of the underlying investments.

During the first half of 2016, we recognized net gains on investment securities totaling $2.0 million from the sale of 17 agency securities and nine mortgage backed securities. The $1.1 million in gains realized during the first quarter of 2015 resulted from the sale of six agency securities and nine mortgage backed securities. The amount and timing of our sale of investment securities is dependent on a number of factors, including our prudent efforts to realize gains while managing duration, premium and credit risk.

 

- 44 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Noninterest Expense

The following table details the major categories of noninterest expense for the periods presented (in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2016      2015      2016      2015  

Salaries and employee benefits

   $ 10,818       $ 10,606       $ 22,432       $ 20,829   

Occupancy and equipment

     3,664         3,375         7,289         7,074   

Professional services

     2,833         866         4,280         1,834   

Computer and data processing

     913         810         1,717         1,512   

Supplies and postage

     464         508         1,058         1,071   

FDIC assessments

     441         415         877         833   

Advertising and promotions

     347         238         724         477   

Other

     2,640         2,418         4,961         4,617   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 22,120       $ 19,236       $ 43,338       $ 38,247   
  

 

 

    

 

 

    

 

 

    

 

 

 

Salaries and employee benefits expense increased by $1.6 million or 8% in the first half of 2016 compared to the same period in 2015, reflecting the addition of Courier Capital as well as additional personnel to support organic growth as part of the Company’s expansion initiatives.

Occupancy and equipment expense was relatively flat at $7.3 million, as the incremental expenses associated with Courier Capital’s operations were offset by the favorable impact of lower snow plowing and lawn maintenance costs compared to a year ago.

Professional services increased $2.4 million when comparing the first six months of 2016 to the same period in 2015. The current year includes approximately $2.1 million of professional services associated with the proxy contest.

Computer and data processing expense increased $205 thousand, or 14%, when comparing the first half of 2016 to the first half of 2015 primarily due to information technology projects to maintain and improve our infrastructure.

Advertising and promotions expense was $724 thousand for the six month period ended June 30, 2016 compared to $477 thousand for the same time period in 2015. The increase was due to advertising campaigns implemented during the current year to build recognition of our brand in the Rochester and Buffalo markets.

Other noninterest expense was $5.0 million in the first six months of 2016 compared to $4.6 million in the first six months of 2015. Other noninterest expense for the first six months ended June 30, 2016 included an increase of $195 thousand in intangible asset amortization attributable to the Courier Capital acquisition.

Our efficiency ratio for the six months ended June 30, 2016 was 63.97% compared with 61.13% for the first half of 2015. The increase in the efficiency ratio is a result of noninterest expenses increasing at a higher rate than noninterest income during the comparable periods. The higher level of noninterest expense is associated with the aforementioned proxy contest. The efficiency ratio is calculated by dividing total noninterest expense, excluding other real estate expense and amortization of intangible assets, by net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains on investment securities and proceeds from company owned life insurance. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease indicates a more efficient allocation of resources.

Income Taxes

For the six months ended June 30, 2016 and 2015, we recorded income tax expense of $5.6 million. The effective tax rates for the year-to-date periods in 2016 and 2015 were 27.6% and 29.6%, respectively. The decrease in the effective tax rate was primarily due to the non-taxable death benefits proceeds on company owned life insurance received in the first quarter of 2016. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt securities and earnings on company owned life insurance. In addition, our effective tax rate reflects the New York State tax savings generated by our real estate investment trust.

In March 2014, the New York legislature approved changes in the state tax law that will be phased-in over two years, beginning in 2015. The primary changes that impact us include the repeal of the Article 32 franchise tax on banking corporations (“Article 32”) for 2015, expanded nexus standards for 2015 and a reduction in the corporate tax rate for 2016. The repeal of Article 32 and the expanded nexus standards lowered our taxable income apportioned to New York to approximately 85% in both 2016 and 2015. In addition, our New York state income tax rate was reduced from 7.1% to 6.5% in 2016.

 

- 45 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

ANALYSIS OF FINANCIAL CONDITION

INVESTING ACTIVITIES

Investment Securities

The following table sets forth selected information regarding the composition of our investment securities portfolio as of the dates indicated (in thousands):

 

     Investment Securities Portfolio Composition  
     June 30, 2016      December 31, 2015  
     Amortized      Fair      Amortized      Fair  
     Cost      Value      Cost      Value  

Securities available for sale (“AFS”):

           

U.S. Government agencies and government-sponsored enterprise securities

   $ 241,583       $ 248,126       $ 260,748       $ 260,863   

Mortgage-backed securities:

           

Agency mortgage-backed securities

     360,356         370,625         282,873         282,505   

Non-Agency mortgage-backed securities

     —           784         —           809   

Asset-backed securities

     —           184         —           218   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total AFS securities

     601,939         619,719         543,621         544,395   

Securities held to maturity (“HTM”):

           

State and political subdivisions

     294,507         304,567         294,423         300,981   

Mortgage-backed securities

     184,042         186,266         191,294         189,083   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total HTM securities

     478,549         490,833         485,717         490,064   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 1,080,488       $ 1,110,552       $ 1,029,338       $ 1,034,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

The AFS investment securities portfolio increased $75.3 million or 14%, from $544.4 million at December 31, 2015 to $619.7 million at June 30, 2016. The AFS portfolio had net unrealized gains totaling $17.8 million and $774 thousand at June 30, 2016 and December 31, 2015, respectively. The unrealized gains in the AFS portfolio were predominantly caused by changes in market interest rates. The fair value of most of the investment securities in the AFS portfolio fluctuates as market interest rates change.

Impairment Assessment

We review investment securities on an ongoing basis for the presence of other than temporary impairment (“OTTI”) and perform formal reviews quarterly. Declines in the fair value of HTM and AFS below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses or the security is intended to be sold or will be required to be sold. The amount of the impairment related to non-credit related factors is recognized in other comprehensive income. Evaluating whether the impairment of a debt security is other than temporary involves assessing the intent to sell the debt security or the likelihood of being required to sell the security before the recovery of its amortized cost basis. In determining whether the OTTI includes a credit loss, we use our best estimate of the present value of cash flows expected to be collected from the debt security considering factors such as: the length of time and the extent to which the fair value has been less than the amortized cost basis, adverse conditions specifically related to the security, an industry, or a geographic area, the historical and implied volatility of the fair value of the security, the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of the security by a rating agency, and recoveries or additional declines in fair value subsequent to the balance sheet date. The assessment of whether OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. There were no securities deemed to be other-than-temporarily impaired during the six month periods ended June 30, 2016 and 2015.

 

- 46 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

LENDING ACTIVITIES

The following table sets forth selected information regarding the composition of our loan portfolio as of the dates indicated (in thousands).

 

     Loan Portfolio Composition  
     June 30, 2016     December 31, 2015  
     Amount      % of
Total
    Amount      % of
Total
 

Commercial business

   $ 349,432         15.8   $ 313,758         15.0

Commercial mortgage

     614,141         27.8        566,101         27.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial

     963,573         43.6        879,859         42.2   

Residential real estate loans

     408,367         18.5        381,074         18.3   

Residential real estate lines

     125,054         5.6        127,347         6.1   

Consumer indirect

     696,908         31.5        676,940         32.5   

Other consumer

     17,929         0.8        18,542         0.9   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer

     1,248,258         56.4        1,203,903         57.8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

     2,211,831         100.0     2,083,762         100.0
     

 

 

      

 

 

 

Less: Allowance for loan losses

     28,525           27,085      
  

 

 

      

 

 

    

Total loans, net

   $ 2,183,306         $ 2,056,677      
  

 

 

      

 

 

    

Total loans increased $128.1 million to $2.21 billion at June 30, 2016 from $2.08 billion at December 31, 2015. The increase in loans was attributable to organic growth, primarily in the commercial loan portfolios.

Commercial loans increased $83.7 million and represented 43.6% of total loans as of June 30, 2016, a result of our continued commercial business development efforts.

The consumer indirect portfolio totaled $696.9 million and represented 31.5% of total loans as of June 30, 2016. During the first half of 2016, we originated $157.8 million in indirect auto loans with a mix of approximately 41% new auto and 59% used auto. During the first half of 2015, we originated $149.3 million in indirect auto loans with a mix of approximately 41% new auto and 59% used auto. Our origination volumes and mix of new and used vehicles financed fluctuate depending on general market conditions.

Loans Held for Sale and Loan Servicing Rights

Loans held for sale (not included in the loan portfolio composition table) were entirely comprised of residential real estate mortgages and totaled $209 thousand and $1.4 million as of June 30, 2016 and December 31, 2015, respectively.

We sell certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, which are not included in the consolidated statements of financial condition, amounted to $186.5 million and $196.0 million as of June 30, 2016 and December 31, 2015, respectively.

 

- 47 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Allowance for Loan Losses

The following table sets forth an analysis of the activity in the allowance for loan losses for the periods indicated (in thousands).

 

     Loan Loss Analysis  
     Three months ended June 30,     Six months ended June 30,  
     2016     2015     2016     2015  

Balance as of beginning of period

   $ 27,568      $ 27,191      $ 27,085      $ 27,637   

Charge-offs:

        

Commercial business

     42        13        644        1,154   

Commercial mortgage

     8        201        12        810   

Residential real estate loans

     134        58        180        197   

Residential real estate lines

     47        118        51        118   

Consumer indirect

     1,898        1,841        4,396        4,263   

Other consumer

     119        154        276        413   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     2,248        2,385        5,559        6,955   

Recoveries:

        

Commercial business

     69        86        169        134   

Commercial mortgage

     6        7        11        96   

Residential real estate loans

     100        20        125        61   

Residential real estate lines

     3        2        7        4   

Consumer indirect

     994        1,196        2,164        2,301   

Other consumer

     81        95        203        193   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     1,253        1,406        2,679        2,789   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     995        979        2,880        4,166   

Provision for loan losses

     1,952        1,288        4,320        4,029   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 28,525      $ 27,500      $ 28,525      $ 27,500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loan charge-offs to average loans (annualized)

     0.19     0.20     0.27     0.43

Allowance for loan losses to total loans

     1.29     1.37     1.29     1.37

Allowance for loan losses to non-performing loans

     435     257     435     257

The allowance for loan losses represents the estimated amount of probable credit losses inherent in our loan portfolio. We perform periodic, systematic reviews of the loan portfolio to estimate probable losses in the respective loan portfolios. In addition, we regularly evaluate prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. The process we use to determine the overall allowance for loan losses is based on this analysis. Based on this analysis, we believe the allowance for loan losses is adequate as of June 30, 2016.

Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing a variety of factors, including the risk-profile of our loan products and customers.

The adequacy of the allowance for loan losses is subject to ongoing management review. While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to increase the allowance based on their judgments about information available to them at the time of their examination.

Net charge-offs of $995 thousand in the second quarter of 2016 represented 0.19% of average loans on an annualized basis compared to $979 thousand or 0.20% in the second quarter of 2015. For the six months ended June 30, 2016, net charge-offs of $2.9 million represented 0.27% of average loans, compared to $4.2 million or 0.43% of average loans for the same period in 2015. The first quarter of 2015 included charge-offs for two commercial loan relationships totaling $1.7 million. The allowance for loan losses was $28.5 million at June 30, 2016, compared with $27.1 million at December 31, 2015. The ratio of the allowance for loan losses to total loans was 1.29% at June 30, 2016 and 1.30% at December 31, 2015. The ratio of allowance for loan losses to non-performing loans was 435% at June 30, 2016, compared with 321% at December 31, 2015.

 

- 48 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Non-Performing Assets and Potential Problem Loans

The table below sets forth the amounts and categories of our non-performing assets at the dates indicated (in thousands).

 

     Non-Performing Assets  
     June 30,
2016
    December 31,
2015
 

Nonaccrual loans:

    

Commercial business

   $ 2,312      $ 3,922   

Commercial mortgage

     1,547        947   

Residential real estate loans

     1,485        1,848   

Residential real estate lines

     182        235   

Consumer indirect

     1,015        1,467   

Other consumer

     4        13   
  

 

 

   

 

 

 

Total nonaccrual loans

     6,545        8,432   

Accruing loans or consumer overdrafts 90 days or more delinquent

     11        8   
  

 

 

   

 

 

 

Total non-performing loans

     6,556        8,440   

Foreclosed assets

     281        163   
  

 

 

   

 

 

 

Total non-performing assets

   $ 6,837      $ 8,603   
  

 

 

   

 

 

 

Non-performing loans to total loans

     0.30     0.41

Non-performing assets to total assets

     0.19     0.25

Changes in the level of nonaccrual loans typically represent increases for loans that reach a specified past due status, offset by reductions for loans that are charged-off, paid down, sold, transferred to foreclosed real estate, or are no longer classified as nonaccrual because they have returned to accrual status. Activity in nonaccrual loans for the three and six months ended June 30, 2016 was as follows (in thousands):

 

     Three months      Six months  
     ended      ended  
     June 30, 2016      June 30, 2016  

Nonaccrual loans, beginning of period

   $ 8,558       $ 8,432   

Additions

     3,351         9,356   

Payments

     (2,822      (4,784

Charge-offs

     (2,189      (5,423

Returned to accruing status

     (119      (662

Transferred to other real estate or repossessed assets

     (234      (374
  

 

 

    

 

 

 

Nonaccrual loans, end of period

   $ 6,545       $ 6,545   
  

 

 

    

 

 

 

Non-performing assets include non-performing loans and foreclosed assets. Non-performing assets at June 30, 2016 were $6.8 million, a decrease of $1.8 million from $8.6 million at December 31, 2015. The primary component of non-performing assets is non-performing loans, which were $6.6 million or 0.30% of total loans at June 30, 2016, compared with $8.4 million or 0.41% of total loans at December 31, 2015.

Approximately $2.8 million, or 42%, of the $6.6 million in non-performing loans as of June 30, 2016 were current with respect to payment of principal and interest, but were classified as non-accruing because repayment in full of principal and/or interest was uncertain. Included in nonaccrual loans are troubled debt restructurings (“TDRs”) of $2.0 million and $2.4 million at June 30, 2016 and December 31, 2015, respectively. We had no TDRs that were accruing interest as of June 30, 2016 or December 31, 2015.

Foreclosed assets consist of real property formerly pledged as collateral for loans, which we have acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Foreclosed asset holdings represented five properties totaling $281 thousand at June 30, 2016 and four properties totaling $163 thousand at December 31, 2015.

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes us to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. We consider loans classified as substandard, which continue to accrue interest, to be potential problem loans. We identified $8.7 million and $12.1 million in loans that continued to accrue interest which were classified as substandard as of June 30, 2016 and December 31, 2015, respectively.

 

- 49 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

FUNDING ACTIVITIES

Deposits

The following table summarizes the composition of our deposits at the dates indicated (dollars in thousands):

 

     Deposit Composition  
     June 30, 2016     December 31, 2015  
     Amount      % of
Total
    Amount      % of
Total
 

Noninterest-bearing demand

   $ 626,240         21.9   $ 641,972         23.5

Interest-bearing demand

     560,284         19.6        523,366         19.2   

Savings and money market

     960,325         33.6        928,175         34.0   

Certificates of deposit < $250,000

     590,524         20.7        545,044         19.9   

Certificates of deposit of $250,000 or more

     120,632         4.2        91,974         3.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 2,858,005         100.0   $ 2,730,531         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

We offer a variety of deposit products designed to attract and retain customers, with the primary focus on building and expanding long-term relationships. At June 30, 2016, total deposits were $2.86 billion, representing an increase of $127.5 million for the year. Time deposits were approximately 25% of total deposits at June 30, 2016 and 23% at December 31, 2015.

Nonpublic deposits, the largest component of our funding sources, totaled $1.82 billion at June 30, 2016 and December 31, 2015, and represented 64% and 66% of total deposits as of the end of each period, respectively. We have managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high cost deposit account.

As an additional source of funding, we offer a variety of public (municipal) deposit products to various public entities, including the towns, villages, counties and school districts within our market. Public deposits generally range from 20% to 30% of our total deposits. There is a high degree of seasonality in this component of funding, because the level of deposits varies with the seasonal cash flows for these public customers. We maintain the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. Total public deposits were $757.9 million and $675.7 million at June 30, 2016 and December 31, 2015, respectively, and represented 27% and 25% of total deposits as of the end of each period, respectively. The increase in public deposits during 2016 was due largely to successful business development efforts.

We had no traditional brokered deposits at June 30, 2016 or December 31, 2015; however, we do participate in the CDARS and ICS programs, which enable depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. CDARS and ICS deposits are considered brokered deposits for regulatory reporting purposes. Through these programs, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. Reciprocal CDARS deposits and ICS deposits totaled $131.7 million and $148.4 million, respectively, at June 30, 2016, compared to $92.9 million and $146.6, respectively, at December 31, 2015.

Borrowings

The Company classifies borrowings as short-term or long-term in accordance with the original terms of the applicable agreement. Outstanding borrowings consisted of the following as of the dates indicated (in thousands):

 

     June 30,      December 31,  
     2016      2015  

Short-term borrowings - Short-term FHLB borrowings

   $ 338,300       $ 293,100   

Long-term borrowings - Subordinated notes

     39,025         38,990   
  

 

 

    

 

 

 

Total borrowings

   $ 377,325       $ 332,090   
  

 

 

    

 

 

 

Short-term Borrowings

We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $13 million of immediate credit capacity with the FHLB as of June 30, 2016. We had approximately $500 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) discount window, none of which was outstanding at June 30, 2016. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had approximately $140 million of credit available under unsecured federal funds purchased lines with various banks as of June 30, 2016. Additionally, we had approximately $235 million of unencumbered liquid securities available for pledging.

 

- 50 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Federal funds purchased are short-term borrowings that typically mature within one to ninety days. Short-term repurchase agreements are secured overnight borrowings with customers. Short-term FHLB borrowings have original maturities of up to one year and include overnight borrowings which we typically utilize to address short term funding needs as they arise. Short-term FHLB borrowings at June 30, 2016 consisted of $176.8 million in overnight borrowings and $161.5 million in short-term advances. Short-term FHLB borrowings at December 31, 2015 consisted of $116.8 million in overnight borrowings and $176.3 million in short-term advances.

The Parent has a revolving line of credit with a commercial bank allowing borrowings up to $20.0 million in total as an additional source of working capital. At June 30, 2016, no amounts have been drawn on the line of credit.

Long-term Borrowings

On April 15, 2015, we issued $40.0 million of Subordinated Notes in a registered public offering. The Subordinated Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to the April 15, 2030 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month London Interbank Offered Rate (LIBOR) plus 3.944%, payable quarterly. The Subordinated Notes are redeemable by us at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. Proceeds, net of debt issuance costs of $1.1 million, were $38.9 million. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.

LIQUIDITY AND CAPITAL MANAGEMENT

Liquidity

The objective of maintaining adequate liquidity is to assure that we meet our financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. We achieve liquidity by maintaining a strong base of core customer funds, maturing short-term assets, our ability to sell or pledge securities, lines-of-credit, and access to the financial and capital markets.

We manage liquidity for the Bank by the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions, the FHLB and the FRB. The primary source of our non-deposit borrowings is FHLB advances, of which we had $338.3 million outstanding at June 30, 2016. In addition to this amount, we have additional collateralized wholesale borrowing capacity of approximately $650 million from various funding sources which include the FHLB, Federal Reserve Bank, and commercial banks that we can use to fund lending activities, liquidity needs, and/or to adjust and manage our asset and liability position.

The Parent’s funding requirements consist primarily of dividends to shareholders, debt service, income taxes, operating expenses, funding of nonbank subsidiaries, repurchases of our stock, and acquisitions. The Parent obtains funding to meet obligations from dividends received from the Bank, net taxes collected from subsidiaries included in the federal consolidated tax return, and the issuance of debt and equity securities. In addition, the Parent maintains a revolving line of credit with a commercial bank for an aggregate amount of up to $20.0 million, all of which was available at June 30, 2016. The line of credit has a one year term and matures in May 2017. Funds drawn would be used for general corporate purposes and backup liquidity.

Cash and cash equivalents were $67.6 million as of June 30, 2016, up $7.5 million from $60.1 million as of December 31, 2015. Net cash provided by operating activities totaled $22.8 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items. Net cash used in investing activities totaled $182.3 million, which included outflows of $131.3 million for net loan originations and $49.5 million from net investment securities transactions. Net cash provided by financing activities of $167.0 million was attributed to a $127.5 million increase in deposits and a $45.2 million increase in short-term borrowings, partly offset by $6.4 million in dividend payments.

Capital Management

We actively manage capital, commensurate with our risk profile, to enhance shareholder value. We also seek to maintain capital levels for the Company, and/or the Bank specifically, at amounts in excess of the regulatory “well-capitalized” thresholds. Periodically, we may respond to market conditions by implementing changes to our overall balance sheet positioning to manage our capital position.

Banks and financial holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material impact on our consolidated financial statements. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

 

- 51 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Shareholders’ equity was $322.2 million at June 30, 2016, an increase of $28.3 million from $293.8 million at December 31, 2015. Net income for the year and stock issued for the acquisition of Courier Capital increased shareholders’ equity by $14.8 million and $8.1 million, respectively, which were partially offset by common and preferred stock dividends declared of $6.5 million. Accumulated other comprehensive income included in shareholders’ equity increased $10.7 million during the first six months of 2016 due primarily to higher net unrealized gains on securities available for sale.

The FRB and FDIC have adopted a system using risk-based capital guidelines to evaluate the capital adequacy of banks and bank holding companies. The final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks became effective for the Company on January 1, 2015, with full compliance with all of the final requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of June 30, 2016, the Company’s capital levels remained characterized as “well-capitalized” under the new rules.

The following table reflects the ratios and their components (dollars in thousands):

 

     June 30,     December 31,  
     2016     2015  

Common shareholders’ equity

   $ 304,836      $ 276,504   

Less: Goodwill and other intangible assets, net of deferred tax liabilities

     69,151        61,217   

Net unrealized (loss) gain on investment securities (1)

     9,698        (696

Net periodic pension & postretirement benefits plan adjustments

     (10,352     (10,631

Other

     179        201   
  

 

 

   

 

 

 

Common equity Tier 1 (“CET1”) capital

     236,160        226,413   

Plus: Preferred stock

     17,340        17,340   

Less: Other

     120        301   
  

 

 

   

 

 

 

Tier 1 Capital

     253,380        243,452   

Plus: Qualifying allowance for loan losses

     28,525        27,085   

Subordinated Notes

     39,025        38,990   
  

 

 

   

 

 

 

Total regulatory capital

   $ 320,930      $ 309,527   
  

 

 

   

 

 

 

Adjusted average total assets (for leverage capital purposes)

   $ 3,429,128      $ 3,287,646   
  

 

 

   

 

 

 

Total risk-weighted assets

   $ 2,452,780      $ 2,318,536   
  

 

 

   

 

 

 

Regulatory Capital Ratios

    

Tier 1 leverage (Tier 1 capital to adjusted average assets)

     7.39     7.41

CET1 capital (CET1 capital to total risk-weighted assets)

     9.63        9.77   

Tier 1 capital (Tier 1 capital to total risk-weighted assets)

     10.33        10.50   

Total risk-based capital (Total regulatory capital to total risk-weighted assets)

     13.08        13.35   

 

(1)  Includes unrealized gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category.

Basel III Capital Rules

The BCBS rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, increase the minimum Tier 1 capital to risk-weighted assets ratio from 4.0% to 6.0%, require a minimum total capital to risk-weighted assets ratio of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer is also established above the regulatory minimum capital requirements, effectively increasing the minimum required risk-weighted asset ratios. This capital conservation buffer is being phased-in beginning on January 1, 2016 at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Banking institutions with a capital conservation buffer below the minimum level will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Company or the Bank. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revised the definition and calculation of Tier 1 capital, total capital, and risk-weighted assets.

 

- 52 -


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table presents actual and required capital ratios as of June 30, 2016 and December 31, 2015 for the Company and the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of those dates based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules have been fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules (in thousands):

 

                  Minimum Capital     Minimum Capital     Required to be  
                  Required – Basel III     Required – Basel III     Considered Well  
     Actual     Phase-in Schedule     Fully Phased-in     Capitalized  
     Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  

June 30, 2016

                    

Tier 1 leverage:

                    

Company

   $ 253,380         7.39   $ 137,165         4.00   $ 137,165         4.00   $ 171,456         5.00

Bank

     274,992         8.04        136,838         4.00        136,838         4.00        171,047         5.00   

CET1 capital:

                    

Company

     236,160         9.63        125,705         5.13        171,695         7.00        159,431         6.50   

Bank

     274,992         11.26        125,144         5.13        170,928         7.00        158,719         6.50   

Tier 1 capital:

                    

Company

     253,380         10.33        162,497         6.63        208,486         8.50        196,222         8.00   

Bank

     274,992         11.26        161,771         6.63        207,556         8.50        195,346         8.00   

Total capital:

                    

Company

     320,930         13.08        211,552         8.63        257,542         10.50        245,278         10.00   

Bank

     303,517         12.43        210,608         8.63        256,392         10.50        244,183         10.00   

December 31, 2015

                    

Tier 1 leverage:

                    

Company

   $ 243,452         7.41   $ 131,506         4.00   $ 131,506         4.00   $ 164,382         5.00

Bank

     265,487         8.09        131,188         4.00        131,188         4.00        163,985         5.00   

CET1 capital:

                    

Company

     226,413         9.77        104,334         4.50        162,297         7.00        150,705         6.50   

Bank

     265,487         11.49        103,971         4.50        161,733         7.00        150,180         6.50   

Tier 1 capital:

                    

Company

     243,452         10.50        139,112         6.00        197,076         8.50        185,483         8.00   

Bank

     265,487         11.49        138,628         6.00        196,389         8.50        184,837         8.00   

Total capital:

                    

Company

     309,527         13.35        185,483         8.00        243,446         10.50        231,854         10.00   

Bank

     292,572         12.66        184,837         8.00        242,599         10.50        231,046         10.00   

Dividend Restrictions

In the ordinary course of business we are dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years.

 

- 53 -


Table of Contents
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosures about market risk were presented at December 31, 2015 in Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission on March 8, 2016. The following is an update of the discussion provided therein.

Portfolio Composition

There was no material change in the composition of assets, deposit liabilities or borrowings from December 31, 2015 to June 30, 2016. See the section titled “Analysis of Financial Condition” in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of asset, deposit and borrowing activity during the period.

Net Interest Income at Risk

A primary tool used to manage interest rate risk is “rate shock” simulation to measure the rate sensitivity. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income as well as economic value of equity. At June 30, 2016, the Company was slightly asset sensitive, meaning that net interest income increases in rising rate conditions.

Net interest income at risk is measured by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of 12 months. The following table sets forth the estimated changes to net interest income over the 12-month period ending June 30, 2017 assuming instantaneous changes in interest rates for the given rate shock scenarios (dollars in thousands):

 

     Changes in Interest Rate  
     -100 bp     +100 bp     +200 bp     +300 bp  

Change in net interest income

   $ (822   $ 570      $ 1,592      $ (5

% Change

     (0.80 )%      0.55     1.55     0.00

In addition to the changes in interest rate scenarios listed above, other scenarios are typically modeled to measure interest rate risk. These scenarios vary depending on the economic and interest rate environment.

The simulations referenced above are based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates. Further, it assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of future results, does not measure the effect of changing interest rates on noninterest income and is based on many assumptions that, if changed, could cause a different outcome.

Economic Value of Equity At Risk

The economic (or “fair”) value of financial instruments on our balance sheet will also vary under the interest rate scenarios previously discussed. This variance is measured by simulating changes in our economic value of equity (“EVE”), which is calculated by subtracting the estimated fair value of liabilities from the estimated fair value of assets. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while fair values of non-financial assets and liabilities are assumed to equal book value and do not vary with interest rate fluctuations. An economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change substantially over time as the characteristics of our balance sheet evolve and as interest rate and yield curve assumptions are updated.

The amount of change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including the stated interest rate or spread relative to current market rates or spreads, the likelihood of prepayment, whether the rate is fixed or floating, and the maturity date of the instrument. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical data (back-testing).

 

- 54 -


Table of Contents

The analysis that follows presents the estimated EVE resulting from market interest rates prevailing at a given quarter-end (“Pre-Shock Scenario”), and under other interest rate scenarios (each a “Rate Shock Scenario”) represented by immediate, permanent, parallel shifts in interest rates from those observed at June 30, 2016 and December 31, 2015. The analysis additionally presents a measurement of the interest rate sensitivity at June 30, 2016 and December 31, 2015. EVE amounts are computed under each respective Pre- Shock Scenario and Rate Shock Scenario. An increase in the EVE amount is considered favorable, while a decline is considered unfavorable.

 

     June 30, 2016     December 31, 2015  
     EVE      Change     Percentage
Change
    EVE      Change     Percentage
Change
 

Rate Shock Scenario:

              

Pre-Shock Scenario

   $ 505,639           $ 497,349        

- 100 Basis Points

     538,742       $ 33,103        6.55     508,973       $ 11,624        2.34

+ 100 Basis Points

     492,771         (12,868     (2.54     480,888         (16,461     (3.31

+ 200 Basis Points

     472,886         (32,753     (6.48     460,567         (36,782     (7.40

+ 300 Basis Points

     440,533         (65,106     (12.88     429,381         (67,968     (13.67

The Pre-Shock Scenario EVE was $505.6 million at June 30, 2016, compared to $497.3 million at December 31, 2015. The increase in the Pre-Shock Scenario EVE at June 30, 2016, compared to December 31, resulted primarily from a more favorable valuation of non-maturity deposits that reflected alternative funding rate changes used for discounting future cash flows.

The +200 basis point Rate Shock Scenario EVE increased from $460.6 million at December 31, 2015 to $472.9 million at June 30, 2016, reflecting the more favorable valuation of non-maturity deposits. The percentage change in the EVE amount from the Pre-Shock Scenario to the +200 basis point Rate Shock Scenario decreased from to (7.40)% at December 31, 2015 to (6.48)% at June 30, 2016. The decrease in sensitivity resulted from an increased benefit in the valuation of non-maturity deposits in the +200 basis point Rate Shock Scenario EVE as of June 30, 2016, compared to December 31, 2015.

 

ITEM 4. Controls and Procedures

Evaluation of disclosure controls and procedures

As of June 30, 2016, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting

The acquisition of Courier Capital Corporation was consummated on January 5, 2016, at which time Courier Capital, LLC (“Courier Capital”) became a consolidated subsidiary of the Company. The Company is in the process of reviewing the internal control structure of Courier Capital and, if necessary, will make appropriate changes as it integrates Courier Capital into the Company’s overall internal control over financial reporting process. In connection with the foregoing evaluation by the Company’s Chief Executive Officer and its Chief Financial Officer, other than as noted above, no changes in the Company’s internal control over financial reporting have occurred during the quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

- 55 -


Table of Contents

PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings

The Company has experienced no material developments in its legal proceedings from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, dated March 8, 2016, as filed with the Securities and Exchange Commission (“SEC”).

 

ITEM 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed under Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, dated March 8, 2016, as filed with the SEC, as updated by the factor below. These factors could materially adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.

Our investment advisory and wealth management operations are subject to risk related to the financial services industry.

The financial services industry is subject to extensive regulation at the federal and state levels. It is very difficult to predict the future impact of the legislative and regulatory requirements affecting our business. The securities laws and other laws that govern the activities of our registered investment advisor are complex and subject to rapid change. The activities of our investment advisory and wealth management operations are subject primarily to provisions of the Investment Advisers Act of 1940, as amended and the Employee Retirement Income Act of 1940, as amended (“ERISA”). We are a fiduciary under ERISA. Our investment advisory services are also subject to state laws including anti-fraud laws and regulations. Any claim of noncompliance, regardless of merit or ultimate outcome, could subject us to investigation by the SEC or other regulatory authorities. Our compliance processes may not be sufficient to prevent assertions that we failed to comply with any applicable law, rule or regulation. If our investment advisory and wealth management operations are subject to investigation by the SEC or other regulatory authorities or if litigation is brought by clients based on our failure to comply with applicable regulations, our results of operations could be materially adversely effected.

In addition, the majority of our investment advisory revenue is from fees based on assets under management. The value of the assets under management is determined, in part by market conditions that can be volatile. As a result, investment advisory revenues and profitability can fluctuate with market conditions.

 

- 56 -


Table of Contents
ITEM 6. Exhibits

 

  (a) The following is a list of all exhibits filed or incorporated by reference as part of this Report:

 

Exhibit
Number

  

Description

  

Location

  31.1    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – Principal Executive Officer    Filed Herewith
  31.2    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – Principal Financial Officer    Filed Herewith
  32    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    Filed Herewith
101.INS    XBRL Instance Document   
101.SCH    XBRL Taxonomy Extension Schema Document   
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document   
101.LAB    XBRL Taxonomy Extension Label Linkbase Document   
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document   
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document   

 

- 57 -


Table of Contents

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.

 

FINANCIAL INSTITUTIONS, INC.   

/s/ Martin K. Birmingham

       , August 5, 2016
Martin K. Birmingham   
President and Chief Executive Officer   
(Principal Executive Officer)   

/s/ Kevin B. Klotzbach

       , August 5, 2016
Kevin B. Klotzbach   
Executive Vice President, Chief Financial Officer and Treasurer   
(Principal Financial Officer)   

/s/ Michael D. Grover

       , August 5, 2016
Michael D. Grover   
Senior Vice President and Chief Accounting Officer   
(Principal Accounting Officer)   

 

- 58 -