UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
Commission File Number 0-26481
FINANCIAL INSTITUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 16-0816610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
220 Liberty Street Warsaw, NY 14569
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number Including Area Code:
(585) 786-1100
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file reports) and (2) has been subject to such requirements for the
past 90 days. YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES |X| NO |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AT MAY 9, 2003
- ----------------------------- --------------------------
Common Stock, $0.01 par value 11,155,051 shares
FINANCIAL INSTITUTIONS, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Condition as of
March 31, 2003 and December 31, 2002 3
Consolidated Statements of Income for the three months
ended March 31, 2003 and 2002 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 2003 and 2002 5
Consolidated Statement of Changes in Shareholders' Equity
and Comprehensive Income for the three months ended
March 31, 2003 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES
EXHIBITS
2
Item 1. Financial Statements (Unaudited)
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)
March 31, December 31,
(Dollars in thousands, except per share amounts) 2003 2002
----------- -----------
Assets
Cash, due from banks and interest-bearing deposits $ 48,828 $ 48,429
Federal funds sold 59,693 --
Securities available for sale, at fair value 616,293 596,862
Securities held to maturity (fair value of $50,163 and $48,089
at March 31, 2003 and December 31, 2002, respectively) 48,729 47,125
Loans, net 1,315,688 1,300,232
Premises and equipment, net 31,518 27,254
Goodwill 40,621 40,593
Other assets 42,128 44,539
----------- -----------
Total assets $ 2,203,498 $ 2,105,034
=========== ===========
Liabilities And Shareholders' Equity
Liabilities:
Deposits:
Demand $ 233,170 $ 240,755
Savings, money market and interest-bearing checking 826,776 779,772
Certificates of deposit 760,662 687,996
----------- -----------
Total deposits 1,820,608 1,708,523
Short-term borrowings 63,230 87,189
Long-term borrowings 94,991 92,090
Guaranteed preferred beneficial interests in corporation's
junior subordinated debentures 16,200 16,200
Accrued expenses and other liabilities 26,898 22,738
----------- -----------
Total liabilities 2,021,927 1,926,740
Shareholders' equity:
3% cumulative preferred stock, $100 par value,
authorized 10,000 shares, issued and outstanding
1,666 shares at March 31, 2003 and December 31, 2002 167 167
8.48% cumulative preferred stock, $100 par value,
authorized 200,000 shares, issued and outstanding
175,755 shares at March 31, 2003 and December 31, 2002 17,575 17,575
Common stock, $ 0.01 par value, authorized 50,000,000 shares,
issued 11,303,533 shares at March 31, 2003 and December 31, 2002 113 113
Additional paid-in capital 19,761 19,728
Retained earnings 133,464 131,320
Accumulated other comprehensive income 11,421 10,368
Treasury stock, at cost - 276,369 shares at March 31, 2003
and 282,219 shares at December 31, 2002 (930) (977)
----------- -----------
Total shareholders' equity 181,571 178,294
----------- -----------
Total liabilities and shareholders' equity $ 2,203,498 $ 2,105,034
=========== ===========
See Accompanying Notes to Unaudited Consolidated Financial Statements.
3
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
----------------------
(Dollars in thousands, except per share amounts) 2003 2002
---------- ----------
Interest income:
Loans $ 21,752 $ 22,045
Securities 6,672 6,396
Other 103 119
---------- ----------
Total interest income 28,527 28,560
---------- ----------
Interest expense:
Deposits 7,916 8,658
Borrowings 1,351 1,406
Guaranteed preferred beneficial interests in
Company's junior subordinated debentures 419 419
---------- ----------
Total interest expense 9,686 10,483
---------- ----------
Net interest income 18,841 18,077
Provision for loan losses 3,298 1,007
---------- ----------
Net interest income after
provision for loan losses 15,543 17,070
---------- ----------
Noninterest income:
Service charges on deposits 2,655 2,327
Financial services group fees and commissions 1,374 1,305
Mortgage banking revenues 785 943
Gain (loss) on sale of available for sale securities 291 (196)
Other 997 558
---------- ----------
Total noninterest income 6,102 4,937
---------- ----------
Noninterest expense:
Salaries and employee benefits 8,881 6,921
Occupancy and equipment 1,988 1,830
Supplies and postage 662 548
Amortization of intangible assets 308 214
Computer and data processing expense 451 377
Professional fees 580 346
Other 2,706 1,864
---------- ----------
Total noninterest expense 15,576 12,100
---------- ----------
Income before income taxes 6,069 9,907
Income taxes 1,773 3,250
---------- ----------
Net income $ 4,296 $ 6,657
========== ==========
Earnings per common share:
Basic $ 0.35 $ 0.57
Diluted $ 0.35 $ 0.56
See Accompanying Notes to Unaudited Consolidated Financial Statements.
4
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
-------------------------
(Dollars in thousands) 2003 2002
---------- ----------
Cash flows from operating activities:
Net income $ 4,296 $ 6,657
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,942 1,284
Provision for loan losses 3,298 1,007
Deferred income tax benefit (728) (141)
Proceeds from sale of loans held for sale 44,551 39,108
Originations of loans held for sale (42,113) (40,508)
(Gain) loss on sale of available for sale securities (291) 196
Gain on sale of loans held for sale (578) (487)
Loss on sale of other assets 2 134
Minority interest in net income of subsidiaries 9 24
Decrease in other assets 2,197 81
Increase in accrued expenses and other liabilities 4,149 1,719
---------- ----------
Net cash provided by operating activities 16,734 9,074
Cash flows from investing activities:
Purchase of securities:
Available for sale (98,072) (233,227)
Held to maturity (4,961) (4,202)
Proceeds from maturity and call of securities:
Available for sale 54,100 135,795
Held to maturity 3,338 4,840
Proceeds from sale of available for sale securities 25,631 36,648
Loan originations less principal payments (20,614) (10,994)
Proceeds from sales of premises and equipment 33 5
Purchase of premises and equipment, net (5,055) (1,536)
Equity investment in Mercantile Adjustment Bureau, LLC -- (2,400)
---------- ----------
Net cash used in investing activities (45,600) (75,071)
Cash flows from financing activities:
Net increase in deposits 112,085 87,541
Net decrease in short-term borrowings (23,959) (7,867)
Proceeds from long-term borrowings 3,000 5,056
Repayment of long-term borrowings (98) (95)
Purchase of preferred and common shares -- (299)
Issuance of preferred and common shares 80 17
Dividends paid (2,150) (1,807)
---------- ----------
Net cash provided by financing activities 88,958 82,546
---------- ----------
Net increase in cash and cash equivalents 60,092 16,549
Cash and cash equivalents at the beginning of the period 48,429 53,171
---------- ----------
Cash and cash equivalents at the end of the period $ 108,521 $ 69,720
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest $ 10,664 $ 11,255
Income taxes 680 890
See Accompanying Notes to Unaudited Consolidated Financial Statements.
5
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(Unaudited)
Accumulated
Other
3% 8.48% Additional Comprehensive Total
(Dollars in thousands, Preferred Preferred Common Paid-in Retained Income Treasury Shareholders'
except per share amounts) Stock Stock Stock Capital Earnings (Loss) Stock Equity
-------- -------- -------- -------- -------- -------- -------- --------
Balance - December 31, 2002 $ 167 $ 17,575 $ 113 $ 19,728 $131,320 $ 10,368 $ (977) $178,294
Issue 266 shares of common stock-
directors plan -- -- -- 2 -- -- 2 4
Issue 5,584 shares of common stock -
exercised stock options -- -- -- 31 -- -- 45 76
Comprehensive income:
Net income -- -- -- -- 4,296 -- -- 4,296
Unrealized gain on securities
available for sale (net of tax
of $814) -- -- -- -- -- 1,228 -- 1,228
Reclassification adjustment for
gains included in net income
(net of tax of $(116)) -- -- -- -- -- (175) -- (175)
--------
Net unrealized gain on securities
available for sale (net of tax
of $698) -- -- -- -- -- -- -- 1,053
--------
Total comprehensive income -- -- -- -- -- -- -- 5,349
--------
Cash dividends declared:
3% Preferred - $0.75 per share -- -- -- -- (1) -- -- (1)
8.48% Preferred - $2.12 per share -- -- -- -- (373) -- -- (373)
Common - $0.16 per share -- -- -- -- (1,778) -- -- (1,778)
-------- -------- -------- -------- -------- -------- -------- --------
Balance - March 31, 2003 $ 167 $ 17,575 $ 113 $ 19,761 $133,464 $ 11,421 $ (930) $181,571
======== ======== ======== ======== ======== ======== ======== ========
See Accompanying Notes to Unaudited Consolidated Financial Statements.
6
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Basis of Presentation
Financial Institutions, Inc. ("FII"), a financial holding company organized
under the laws of New York State, and subsidiaries (the "Company") provide
deposit, lending and other financial services to individuals and businesses in
Central and Western New York State. FII and subsidiaries are each subject to
regulation by certain federal and state agencies.
The consolidated financial statements include the accounts of FII and its four
banking subsidiaries, Wyoming County Bank (99.65% owned) ("WCB"), The National
Bank of Geneva (100% owned) ("NBG"), First Tier Bank & Trust (100% owned)
("FTB") and Bath National Bank (100% owned) ("BNB"), collectively referred to as
the "Banks". During 2002, the Company completed a geographic realignment of the
subsidiary banks, which involved the merger of the subsidiary formerly known as
The Pavilion State Bank ("PSB") into NBG and transfer of other branch offices
between subsidiary banks. The merger and transfers were accounted for at
historical cost as a combination of entities under common control. Also included
are the accounts of the Burke Group, Inc. (100% owned) ("BGI") and The FI Group,
Inc. (100% owned) ("FIGI"), collectively referred to as the "Financial Services
Group". BGI is an employee benefits and compensation consulting firm acquired by
the Company in October 2001. FIGI is a brokerage subsidiary that commenced
operations in March 2000.
In February 2001, the Company formed FISI Statutory Trust I ("FISI") (100%
owned), to accommodate the private placement of $16.2 million in capital
securities, the proceeds of which were utilized to partially fund the
acquisition of BNB. The capital securities are identified on the consolidated
statements of financial condition as guaranteed preferred beneficial interests
in corporation's junior subordinated debentures.
The consolidated financial information included herein combines the results of
operations, the assets, liabilities and shareholders' equity of the Company and
its subsidiaries. All significant inter-company transactions and balances have
been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
prevailing practices in the banking industry. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities, and the reported revenues and expenses for the period.
All adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation of financial statements have been included. Actual
results could differ from those estimates. Amounts in the prior year's
consolidated financial statements are reclassified when necessary to conform
with the current year's presentation.
New Accounting Pronouncements
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others," was
issued in November 2002. FASB Interpretation No. 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of FASB Interpretation No. 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002. The Company adopted the recognition and
measurement provisions of FASB Interpretation No. 45 effective January 1, 2003.
Such adoption did not have a material impact on the Company's consolidated
financial statements.
7
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," was
issued in January 2003. FASB Interpretation No. 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FASB Interpretation No. 46 requires an enterprise to
consolidate a variable interest entity if that enterprise has a variable
interest (or combination of variable interests) that will absorb a majority of
the entity's expected losses if they occur, receive a majority of the entity's
expected returns if they occur, or both. It also requires that both the primary
beneficiary and all other enterprises with a significant variable interest in a
variable interest entity make certain disclosures. FASB Interpretation No. 46
applies immediately to variable interest entities created after January 31,
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. It applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
The adoption of the provisions of FASB Interpretation No. 46 is not expected to
have a material impact on the Company's consolidated financial statements.
(2) Stock Compensation Plans
The Company uses a fixed award stock option plan to compensate certain key
members of management of the Company and its subsidiaries. The Company accounts
for issuance of stock options under the intrinsic value-based method of
accounting prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, compensation
expense is recorded on the date the options are granted only if the current
market price of the underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair value-based method of accounting for stock-based
employee compensation plans. As allowed under SFAS No. 123, the Company has
elected to continue to apply the intrinsic value-based method of accounting
described above and has adopted only the disclosure requirements of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock - Based Compensation -
Transition and Disclosure."
Had the Company determined compensation cost based on the fair value method
under SFAS No. 123, the Company's net income and earnings per share would have
been as follows:
Three Months Ended
March 31,
----------------------
(Dollars in thousands, except per share amounts) 2003 2002
--------- ---------
Reported net income $ 4,296 $ 6,657
Less: Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects 4 68
--------- ---------
Pro forma net income $ 4,292 $ 6,589
========= =========
Basic earnings per share:
Reported $ 0.35 $ 0.56
Pro forma 0.35 0.55
Diluted earnings per share:
Reported $ 0.35 $ 0.56
Pro forma 0.35 0.55
8
The weighted-average fair value of options granted during the quarters ended
March 31, 2003 and 2002 amounted to $10.38 and $11.16, respectively. The fair
value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model and the following weighted-average
assumptions:
Three Months Ended
March 31,
----------------------
2003 2002
--------- ---------
Dividend yield 2.84% 2.05%
Expected life (in years) 10.00 10.00
Expected volatility 51.89% 39.00%
Risk-free interest rate 3.95% 5.05%
(3) Mergers and Acquisitions
On December 13, 2002, BNB acquired the two Chemung County branch offices of BSB
Bank & Trust Company of Binghamton, New York. The two offices purchased, located
in Elmira and Elmira Heights, had deposit liabilities totaling $44.2 million at
the time of acquisition. The acquisition was accounted for as a business
combination using the purchase method of accounting, and accordingly, the excess
of the purchase price over the fair value of identifiable tangible and
intangible assets acquired, less liabilities assumed, of approximately $1.5
million has been recorded as goodwill. In accordance with SFAS No. 142, the
Company is not required to amortize goodwill recognized in this acquisition. The
Company also recorded a $2.0 million intangible asset attributable to core
deposits, which is being amortized using the straight-line method over seven
years.
On May 1, 2002, FII acquired all of the common stock of the Bank of Avoca
("BOA") in exchange for 47,036 shares of FII common stock. BOA was a community
bank with its main office located in Avoca, New York, as well as a branch office
in Cohocton, New York. Subsequent to the acquisition, BOA was merged with BNB.
The acquisition was accounted for as a business combination using the purchase
method of accounting, and accordingly, the excess of the purchase price ($1.5
million) over the fair value of identifiable tangible and intangible assets
acquired ($18.4 million), less liabilities assumed ($17.3 million), of
approximately $0.4 million has been recorded as goodwill. In accordance with
SFAS No. 142, the Company is not required to amortize goodwill recognized in
this acquisition. The Company recorded a $146,000 core deposit intangible asset,
which is being amortized using the straight-line method over seven years. The
2002 results of operations for BOA are included in the income statements from
the date of acquisition (May 1, 2002).
(4) Earnings Per Common Share
Basic earnings per share, after giving effect to preferred stock dividends, has
been computed using weighted average common shares outstanding. Diluted earnings
per share reflect the effects, if any, of incremental common shares issuable
upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following:
Three Months Ended
March 31,
----------------------
(Dollars and shares in thousands) 2003 2002
--------- ---------
Net income $ 4,296 $ 6,657
Less: Preferred stock dividends 374 374
--------- ---------
Net income available to common shareholders $ 3,922 $ 6,283
========= =========
Average number of common shares outstanding
used to calculate basic earnings per common share 11,107 11,014
Add: Effect of dilutive options 106 203
--------- ---------
Average number of common shares
used to calculate diluted earnings per common share 11,213 11,217
========= =========
9
(5) Segment Information
Reportable segments are comprised of WCB, NBG, BNB, FTB and the Financial
Services Group. As stated in Note 1, during 2002 the Company completed a
geographic realignment of the subsidiary banks, which involved the merger of the
subsidiary formerly known as PSB into NBG and subsequent transfer of branches
between NBG and WCB. Accordingly, the Company restated segment results to
reflect the merger and transfers for the three months ended March 31, 2002. All
of the revenue, expenses, assets and liabilities of PSB have been reallocated to
the WCB and NBG segments. The reportable segment information as of and for the
three months ended March 31, 2003 and 2002 follows:
(Dollars in thousands) 2003 2002
------------ ------------
Net interest income
WCB $ 7,027 $ 7,019
NBG 6,473 6,467
BNB 3,794 3,096
FTB 1,985 1,952
Financial Services Group -- --
------------ ------------
Total segment net interest income 19,279 18,534
Parent and eliminations, net (438) (457)
------------ ------------
Total net interest income $ 18,841 $ 18,077
============ ============
Net income
WCB $ 2,558 $ 2,643
NBG 192 2,653
BNB 1,330 1,021
FTB 663 670
Financial Services Group (105) 38
------------ ------------
Total segment net income 4,638 7,025
Parent and eliminations, net (342) (368)
------------ ------------
Total net income $ 4,296 $ 6,657
============ ============
Assets
WCB $ 710,717 $ 634,167
NBG 755,155 649,450
BNB 502,606 405,378
FTB 222,479 182,116
Financial Services Group 4,889 2,921
------------ ------------
Total segment assets 2,195,846 1,874,032
Parent and eliminations, net 7,652 10,194
------------ ------------
Total assets $ 2,203,498 $ 1,884,226
============ ============
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
INTRODUCTION
The principal objective of this discussion is to provide an overview of the
financial condition and results of operations of Financial Institutions, Inc.
and its subsidiaries for the periods covered in this quarterly report. This
discussion and tabular presentations should be read in conjunction with the
accompanying consolidated financial statements and accompanying notes.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States and are consistent
with predominant practices in the financial services industry. Application of
critical accounting policies, those policies that Management believes are the
most important to the Company's financial position and results, requires
Management to make estimates, assumptions, and judgments that affect the amounts
reported in the consolidated financial statements and accompanying notes and are
based on information available as of the date of the financial statements.
Future changes in information may affect these estimates, assumptions, and
judgments, which, in turn, may affect amounts reported in the financial
statements.
The Company has numerous accounting policies, of which the most significant are
presented in Note 1 of the Notes to Unaudited Consolidated Financial Statements.
These policies, along with the disclosures presented in the other financial
statement notes and in this discussion, provide information on how significant
assets and liabilities are reported in the financial statements and how those
reported amounts are determined. Based on the sensitivity of financial statement
amounts to the methods, assumptions, and estimates underlying those amounts,
Management has determined that the accounting policies with respect to the
allowance for loan losses and goodwill require subjective or complex judgments
important to the Company's financial position and results of operations, and, as
such, are considered to be critical accounting policies as discussed below.
Allowance for Loan Losses: Arriving at an appropriate level of allowance for
loan losses involves a high degree of judgment. The Company's allowance for loan
losses provides for probable losses based upon evaluations of known and inherent
risks in the loan portfolio. Management uses historical information to assess
the adequacy of the allowance for loan losses and considers the prevailing
business environment, as it is affected by changing economic conditions and
various external factors, which may impact the portfolio in ways currently
unforeseen. The allowance is increased by provisions for loan losses and by
recoveries of loans previously charged-off and reduced by loans charged-off.
Goodwill: In June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations and further clarifies the criteria for the
initial recognition and measurement of intangible assets separate from goodwill.
SFAS No. 142 prescribes the accounting for goodwill and intangible assets
subsequent to initial recognition. The provisions of SFAS No. 142 discontinue
the amortization of goodwill and intangible assets with indefinite lives.
Instead, these assets are subject to at least an annual impairment review, and
more frequently if certain impairment indicators are in evidence. SFAS No. 142
also requires that reporting units be identified for the purpose of assessing
impairment of goodwill.
11
FORWARD LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), that involve substantial risks and uncertainties. When used in this
report, or in the documents incorporated by reference herein, the words
"anticipate", "believe", "estimate", "expect", "intend", "may", and similar
expressions identify such forward-looking statements. Actual results,
performance or achievements could differ materially from those contemplated,
expressed or implied by the forward-looking statements contained herein. These
forward-looking statements are based on the current expectations of the Company
or the Company's management and are subject to a number of risks and
uncertainties, including but not limited to, economic, competitive, regulatory,
and other factors affecting the Company's operations, markets, products and
services, as well as expansion strategies and other factors discussed elsewhere
in this report filed by the Company with the Securities and Exchange Commission.
Many of these factors are beyond the Company's control.
The purpose of this discussion is to present material changes in the Company's
financial condition and results of operations during the three months ended
March 31, 2002 to supplement the information in the consolidated financial
statements included in this report.
SELECTED FINANCIAL DATA
The following table presents certain information and ratios that management of
the Company considers important in evaluating performance:
At or For the Three Months Ended March 31,
------------------------------------------
2003 2002 $ Change % Change
---- ---- -------- --------
Per common share data:
Net income - basic $ 0.35 $0.57 $(0.22) (39)%
Net income - diluted $ 0.35 $0.56 $(0.21) (38)%
Cash dividends declared $ 0.16 $0.13 $ 0.03 23%
Book value $14.75 $12.26 $ 2.49 20%
Common shares outstanding:
Weighted average shares - basic 11,107,014 11,013,548
Weighted average shares - diluted 11,212,507 11,217,430
Period end 11,109,664 11,009,761
Performance ratios, annualized:
Return on average assets 0.82% 1.47%
Return on average common equity 9.72% 18.83%
Common dividend payout ratio 45.71% 22.81%
Net interest margin (tax-equivalent) 4.01% 4.53%
Efficiency ratio * 58.95% 48.69%
Asset quality ratios:
Nonperforming loans to total loans 2.92% 0.89%
Nonperforming assets to total loans and other real estate 3.01% 0.99%
Net loan charge-offs to average loans 0.46% 0.20%
Allowance for loan losses to total loans 1.75% 1.65%
Allowance for loan losses to nonperforming loans 60% 186%
Capital ratios:
Average common equity to average total assets 7.67% 7.39%
Leverage ratio 6.83% 7.10%
Tier 1 risk based capital ratio 9.72% 10.02%
Risk-based capital ratio 10.98% 11.45%
* Efficiency ratio represents noninterest expense less other real estate expense
and amortization of intangibles divided by net interest income (tax equivalent)
plus other noninterest income less gain (loss) on sale of available for sale
securities.
12
OVERVIEW
First quarter 2003 net income was $4.3 million compared to $6.7 million for the
first three months of 2002. Diluted earnings per share were $0.35 for the first
quarter of 2003 compared to $0.56 for the 2002 period. Included in first quarter
2003 results was a provision for loan losses of $3.3 million, which represents
an increase of $2.3 million over the $1.0 million provision for loan losses for
the first quarter of 2002. The three month period ending March 31, 2003 also
included an impairment charge of $489,000 for a partnership investment carried
by NBG and expenses of $232,000 for professional services related to
organizational governance and credit administration issues at NBG. The first
quarter of 2003 also included a charge of $674,000 relating to incurred
separation costs of former management.
INVESTING ACTIVITIES
U.S. Treasury and Agency Securities
At March 31, 2003, the U.S. Treasury and Agency securities portfolio totaled
$139.2 million, all of which was classified as available for sale. The portfolio
was comprised entirely of U. S. federal agency securities, which were
predominately callable securities. These callable securities provide higher
yields than similar securities without call features. At December 31, 2002, the
U.S. Treasury and Agency securities portfolio totaled $120.6 million, all of
which was classified as available for sale. The portfolio consisted of $1.0
million in U. S. Treasury securities and $119.6 million in U. S. federal agency
securities.
State and Municipal Obligations
At March 31, 2003, the portfolio of state and municipal obligations totaled
$231.4 million, of which $182.7 million was classified as available for sale. At
that date, $48.7 million was classified as held to maturity, with a fair value
of $50.2 million. At December 31, 2002, the portfolio of state and municipal
obligations totaled $222.0 million, of which $174.9 million was classified as
available for sale. At that date, $47.1 million was classified as held to
maturity, with a fair value of $48.1 million. Over the past few years, more
favorable yields on new purchases of these securities, when compared to taxable
investment alternatives, has led to growth in this portfolio. In addition, the
Company has expanded its overall municipal banking relationship business which
includes both deposit activities and investing in obligations issued by those
municipalities.
Mortgage-Backed Securities
Mortgage-backed securities, all of which were classified as available for sale,
totaled $272.2 million and $283.5 million at March 31, 2003 and December 31,
2002, respectively. The portfolio was comprised of $174.1 million of
mortgage-backed pass-through securities and $98.1 million of collateralized
mortgage obligations (CMOs) at March 31, 2003. The mortgage backed pass-through
securities were predominantly agency issued debt (FNMA, FHLMC, or GNMA). Over
75% of the agency mortgage-backed pass-through securities were in fixed rate
securities that were predominately formed with mortgages having a balloon
payment of five or seven years. The adjustable rate agency mortgage-backed
securities portfolio is principally indexed to the one-year Treasury bill. The
CMO portfolio consists of government agency issues and privately issued AAA
rated securities. Also included in the CMO category are $11.8 million of Student
Loan Marketing Association (SLMA) floaters, which are securities backed by
student loans. At December 31, 2002 the portfolio consisted of $193.4 million of
mortgage-backed pass-through securities and $90.1 million of CMOs. The
mortgage-backed securities at December 31, 2002 were primarily agency issued
(FNMA, FHLMC, GNMA) obligations, but also included privately issued AAA rated
securities and SLMA floaters to further diversify the portfolio.
Corporate Bonds
The corporate bond portfolio, all of which was classified as available for sale,
totaled $13.4 million and $13.9 million at March 31, 2003 and December 31, 2002,
respectively. The portfolio was purchased to further diversify the investment
portfolio and increase investment yield. The Company's investment policy limits
investments in corporate bonds to no more than 10% of total investments and to
bonds rated as Baa or better by Moody's Investors Service, Inc. or BBB or better
by Standard & Poor's Ratings Services at the time of purchase.
13
Equity Securities
At March 31, 2003 and December 31, 2002, available for sale equity securities
totaled $8.8 million and $3.9 million, respectively. This portfolio is primarily
comprised of FHLMC preferred stock, but also includes some corporate equity
securities owned by the holding company.
LENDING ACTIVITIES
Set forth below is selected information concerning the composition of the
Company's loan portfolio at the dates indicated.
March 31, December 31, March 31,
(Dollars in thousands) 2003 2002 2002
--------------------- -------------------- --------------------
Commercial $ 260,109 19.4% $ 262,630 19.9% $ 241,864 20.5%
Commercial real estate 345,416 25.8 332,134 25.1 295,585 25.1
Agricultural 235,519 17.6 233,769 17.7 183,102 15.5
Residential real estate 255,604 19.1 251,898 19.1 229,687 19.5
Consumer and home equity 242,474 18.1 241,461 18.2 228,096 19.4
----------- ----- ----------- ----- ----------- -----
Total loans gross 1,339,122 100.0 1,321,892 100.0 1,178,334 100.0
Allowance for loan losses (23,434) (21,660) (19,483)
---------- ----------- ----------
Total loans, net $ 1,315,688 $ 1,300,232 $ 1,158,851
========== ========== ==========
Total gross loans increased $17 million to $1.339 billion at March 31, 2003 from
$1.322 billion at December 31, 2002. The growth in loans relates to commercial
mortagage originations, primarily at WCB and BNB, as the Company's commercial
mortgage portfolio increased $13 million to $345 million at March 31, 2003 from
$332 million at December 31, 2002. The table also indicates a relatively stable
loan mix between March 31, 2003 and December 31, 2002. The residential real
estate portfolio includes loans held for sale totaling $4,533,000, $6,971,000
and $8,371,000 at March 31, 2003, December 31, 2002 and March 31, 2002.
Nonaccruing Loans and Nonperforming Assets
Nonperforming assets at March 31, 2003 were $40.4 million compared to $38.4
million at December 31, 2002 and $11.6 million at March 31, 2002. The increase
in nonperforming assets in the first quarter of 2003 was related principally to
one commercial borrower at NBG, which was partially offset by charge-offs
recorded during the quarter. The extended soft economy has continued to
adversely affect the cash flows of some of the Company's borrowers. The dairy
industry continues to experience an extended period of low milk prices. Milk
prices however, have stabilized and the Company has restructured loans to a few
borrowers who have been experiencing the most difficulty. As previously
indicated, the Company has committed additional resources toward management of
the Company's nonperforming assets and strengthening the credit administration
function.
14
The following table sets forth information regarding nonaccruing loans and other
nonperforming assets at the dates indicated.
March 31, December 31, March 31,
(Dollars in thousands) 2003 2002 2002
------------- ------------- --------------
Nonaccruing loans(1)
Commercial $ 15,793 $ 12,760 $ 2,480
Commercial real estate 8,261 8,407 3,943
Agricultural 8,836 8,739 1,412
Residential real estate 1,028 1,065 1,173
Consumer and home equity 880 915 749
------------ ----------- -----------
Total nonaccruing loans 34,798 31,886 9,757
Restructured loans 2,940 4,129 -
Accruing loans 90 days or more delinquent 1,308 1,091 743
------------ ----------- -----------
Total nonperforming loans 39,046 37,106 10,500
Other real estate owned 1,316 1,251 1,125
------------ ----------- -----------
Total nonperforming assets $ 40,362 $ 38,357 $ 11,625
============ =========== ===========
Total nonperforming loans to total loans 2.92% 2.81% 0.89%
Total nonperforming assets to total loans and other
real estate 3.01% 2.90% 0.99%
(1) Loans are placed on nonaccrual status when they become 90 days or more
past due or if they have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
The recorded investment in loans that are considered to be impaired totaled
$24,838,000 and $8,672,000 at March 31, 2003 and 2002, respectively. The
allowance for loan losses related to impaired loans amounted to $5,081,000 and
$1,896,000 at March 31, 2003 and 2002, respectively. The average recorded
investment in impaired loans during the three months ended March 31, 2003 and
2002 was $24,802,000 and $8,723,000, respectively. Interest income recognized on
impaired loans, while such loans were impaired, during the three months ended
March 31, 2003 and 2002 was approximately $60,000 and $65,000, respectively.
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the amount of credit losses inherent in
the loan portfolio. Periodic, systematic reviews of each banks' portfolios are
performed to identify inherent losses. These reviews result in the
identification and quantification of loss factors, which are used in determining
the amount of the allowance for loan losses. In addition, the Company
periodically evaluates prevailing economic and business conditions, industry
concentrations, changes in the size and characteristics of the portfolio and
other pertinent factors. The allowance for loan losses is allocated to cover the
estimated losses inherent in each loan category based on the results of this
detailed review. The process used by the Company to determine the appropriate
overall allowance for loan losses is based on this analysis.
15
The following table sets forth the activity in the allowance for loan losses for
the periods indicated.
Three Months Ended
March 31,
(Dollars in thousands) 2003 2002
----------------------
Balance at beginning of period $ 21,660 $ 19,074
Charge-offs:
Commercial 1,252 227
Commercial real estate 24 144
Agricultural 13 29
Residential real estate 23 29
Consumer and home equity 337 304
--------- ---------
Total charge-offs 1,649 733
Recoveries:
Commercial 42 9
Commercial real estate 6 2
Agricultural 2 31
Residential real estate 7 --
Consumer and home equity 68 93
--------- ---------
Total recoveries 125 135
Net charge-offs 1,524 598
Provision for loan losses 3,298 1,007
--------- ---------
Balance at end of period $ 23,434 $ 19,483
========= =========
Ratio of net loan charge-offs to average loans (annualized) 0.46% 0.20%
Ratio of allowance for loan losses to total loans 1.75% 1.65%
Ratio of allowance for loan losses to nonperforming loans 60% 186%
Net loan charge-offs were $1.5 million for the first quarter of 2003 or 0.46% of
average loans compared to $0.6 million or 0.20% of average loans in the same
period last year. The increase in loan charge-offs relates primarily to NBG
where $1.3 million of commercial loans and commercial mortgages were charged-off
during the first quarter of 2003. Provision for loan losses was $3.3 million for
the first quarter of 2003 and reflects the increase in net loan charge-offs and
higher levels of specific allocations associated with impaired loans. The ratio
of the allowance for loan losses to nonperforming loans was 60% at March 31,
2003, compared to 58% at December 31, 2002 and 186% the previous year. The ratio
of the allowance for loan losses to total loans increased to 1.75% at March 31,
2003 compared to 1.64% at year end 2002 and 1.65% a year ago.
FUNDING ACTIVITIES
Deposits
The banks offer a broad array of core deposit products including checking
accounts, interest-bearing transaction accounts, savings and money market
accounts and certificates of deposit under $100,000. These core deposits totaled
$1.564 billion or 85.9% of total deposits of $1.821 billion at March 31, 2003
compared to core deposits of $1.507 billion or 88.2% of total deposits of $1.709
billion at December 31, 2002. The core deposit base consists almost exclusively
of in-market accounts. The Company had total public deposits of $425.7 million
at March 31, 2003 compared to $361.2 million at December 31, 2002. The increase
is a result of the Company's continuing expansion in this line of business as
market opportunities have arisen from the exit of competitors. Core deposits are
supplemented with certificates of deposit over $100,000, which amounted to
$256.3 million and $201.8 million as of March 31, 2003 and December 31, 2002,
respectively, largely from in-market municipal, business and individual
customers.
16
As of March 31, 2003 and December 31, 2002, brokered certificates of deposit
included in certificates of deposit over $100,000 totaled $102.6 million and
$71.6 million, respectively.
Non-Deposit Sources of Funds
The Company's most significant source of non-deposit funds are FHLB borrowings.
FHLB advances outstanding amounted to $118.7 million and $112.8 million as of
March 31, 2003 and December 31, 2002, respectively. These FHLB borrowings
include both short and long-term advances maturing on various dates through
2009. The Company had approximately $6 million of immediate credit available
under lines of credit with the FHLB at March 31, 2003, which are collateralized
by FHLB stock and real estate mortgage loans. The Company also has lines of
credit with the Federal Agricultural Mortgage Corp. (Farmer Mac) permitting
borrowings to a maximum of $50.0 million. However, no advances were outstanding
against the Farmer Mac lines as of March 31, 2003. The Company also utilizes
securities sold under agreements to repurchase as a source of funds. The
short-term repurchase agreements amounted to $33.7 million and $60.7 million as
of March 31, 2003 and December 31, 2002, respectively.
During 2001 FISI Statutory Trust I (the "Trust") was established and issued 30
year guaranteed preferred beneficial interests in junior subordinated debentures
of the Company ("capital securities") in the aggregate amount of $16.2 million
at a fixed rate of 10.2%. The Company used the net proceeds from the sale of the
capital securities to partially fund the acquisition of BNB. As of March 31,
2003, all of the capital securities qualified as Tier I capital under regulatory
definitions. Since the capital securities are classified as debt for financial
statement purposes, the tax-deductible expense associated with the capital
securities is recorded as interest expense in the consolidated statements of
income.
NET INCOME ANALYSIS
Average Balance Sheet
The table on the following page sets forth certain information relating to the
Company's consolidated statements of financial condition and reflects the
average yields earned on interest-earning assets, as well as the average rates
paid on interest-bearing liabilities as of and for the three months ended March
31, 2003 and 2002. Such yields and rates were derived by dividing interest
income or expense by the average balances of interest-earning assets or
interest-bearing liabilities, respectively, for the periods shown. Tax
equivalent adjustments have been made. All average balances are average daily
balances. Nonaccruing loan balances are included in the yield calculations in
this table.
17
For The Three Months Ended March 31,
2003 2002
---- ----
Average Interest Annualized Average Interest Annualized
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(Dollars in thousands) Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Interest-earning assets:
Federal funds sold and interest-bearing
deposits $33,126 $103 1.26% $27,610 $119 1.75%
Investment securities(1):
Taxable 414,393 4,560 4.40% 302,633 4,258 5.63%
Non-taxable 225,781 3,249 5.76% 205,771 3,291 6.40%
---------- ------ ----- ---------- ------ ----
Total investment securities 640,174 7,809 4.88% 508,404 7,549 5.94%
Loans(2):
Commercial and agricultural 837,901 12,731 6.16% 707,750 12,457 7.14%
Residential real estate 252,404 4,613 7.31% 234,014 4,900 8.38%
Consumer and home equity 239,684 4,408 7.46% 229,885 4,688 8.27%
---------- ------ ----- ---------- ------ ----
Total loans 1,329,989 21,752 6.61% 1,171,649 22,045 7.61%
---------- ------ ----- ---------- ------ ----
Total interest-earning assets 2,003,289 29,664 5.97% 1,707,663 29,713 7.02%
---------- ------ ----- ---------- ------ ----
Allowance for loans losses (21,963) (19,286)
Other non-interest earning assets 153,539 143,221
---------- ----------
Total assets $2,134,865 $1,831,598
========== ==========
Interest-bearing liabilities:
Interest-bearing checking 388,824 1,058 1.10% 309,808 1,117 1.46%
Savings and money market 410,286 1,265 1.25% 332,300 1,327 1.62%
Certificates of deposit 724,365 5,593 3.13% 623,702 6,214 4.04%
Borrowed funds 162,751 1,351 3.37% 166,268 1,407 3.43%
Guaranteed preferred beneficial interests in
Corporation's junior subordinated
debentures 16,200 419 10.49% 16,200 419 10.49%
---------- ------ ----- ---------- ------ -----
Total interest-bearing liabilities 1,702,426 9,686 2.31% 1,448,278 10,484 2.94%
---------- ------ ----- ---------- ------ -----
Non-interest bearing demand deposits 228,493 208,533
Other non-interest-bearing liabilities 22,489 21,704
------ ------
Total liabilities 1,953,408 1,678,515
Shareholders' equity(3) 181,457 153,083
---------- ----------
Total liabilities and
shareholders' equity $2,134,865 $1,831,598
========== ==========
Net interest income - tax equivalent 19,978 19,229
Less: tax equivalent adjustment 1,137 1,152
----- -----
Net interest income $18,841 $18,077
======= =======
Net interest rate spread 3.66% 4.08%
===== ====
Net earning assets $300,863 $259,385
========== ==========
Net interest income as a percentage of
average interest-earning assets(4) 4.01% 4.53%
==== ====
Ratio of average interest-earning assets to
average interest-bearing liabilities 117.67% 117.91%
====== ======
(1) Amounts shown are amortized cost for held to maturity securities and fair
value for available for sale securities. In order for pre-tax income and
resultant yields on tax-exempt securities to be comparable to those on
taxable securities and loans, a tax-equivalent adjustment to interest
earned from tax-exempt securities has been computed using a federal rate
of 35%.
(2) Net of deferred loan fees and costs, and loan discounts and premiums.
(3) Includes gains (losses) on securities available for sale.
(4) The net interest margin is equal to net interest income divided by average
interest-earning assets and is presented on an annualized basis.
18
Net Interest Income
Net interest income, the principal source of the Company's earnings, increased
4.0% to $18.8 million compared to $18.1 million in the first quarter of 2002.
Net interest margin was 4.01% for the first quarter of 2003, a drop of 52 basis
points from the 4.53% level for the same period last year. Growth in average
earning assets of $295.6 million, or 17%, offset the fall in net interest margin
and produced the increased revenue. The growth in average earning assets
reflects increases of $131.8 million in the Company's investment portfolio and
$158.3 million in loans. The decline in net interest margin reflects the effects
of the increase in nonaccrual loans combined with overall spread compression
associated with yields generated on incremental asset growth relative to related
funding costs in a period of historically low market interest rates.
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest-bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (1) changes attributable to changes in volume (changes in volume
multiplied by the current year rate); (2) changes attributable to changes in
rate (changes in rate multiplied by the prior year volume); and (3) the net
change. The changes attributable to the combined impact of volume and rate have
been allocated proportionately to the changes due to volume and changes due to
rate.
1st Quarter 2003 Compared to 1st Quarter 2002
---------------------------------------------
Increase (Decrease) Due to Total Increase/
(Dollars in thousands) Volume Rate (Decrease)
------ ---- ----------
Interest-earning assets:
Federal funds sold and interest-bearing deposits $ 17 $ (33) $ (16)
Investment securities:
Taxable 1,241 (939) 302
Non-taxable 291 (333) (42)
------- ------- -----
Total investment securities 1,532 (1,272) 260
------- ------- -----
Loans:
Commercial and agricultural 2,028 (1,754) 274
Residential real estate 332 (619) (287)
Consumer and home equity 181 (461) (280)
------- ------- -----
Total loans 2,541 (2,834) (293)
------- ------- -----
Total interest-earning assets 4,090 (4,139) (49)
Interest-bearing liabilities:
Interest-bearing checking 207 (266) (59)
Savings and money market 236 (298) (62)
Certificates of deposit 776 (1,397) (621)
Borrowed funds (30) (26) (56)
Guaranteed preferred beneficial interests in
Corporation's junior subordinated debentures -- -- --
------- ------- -----
Total interest-bearing liabilities 1,189 (1,987) (798)
------- ------- -----
Net interest income $ 2,901 $(2,152) $ 749
19
Provision for Loan Losses
The provision for loan losses for the first quarter of 2003 totaled $3.3
million, which represents an increase of $2.3 million over the $1.0 million
provision for loan losses for the first quarter of 2002. First quarter 2003
provision for loan losses reflects the increase in net charge-offs and increases
in specific allocations associated with impaired loans. See discussion of the
Analysis of the Allowance for Loan Losses.
Noninterest Income
Noninterest income increased 24% in the first quarter of 2003 to $6.1 million
from $4.9 million for the first quarter of 2002. Security gains in the first
quarter of 2003 were $291,000 compared to a loss of $196,000 in the first
quarter of 2002 and account for $487,000 of the increase. Growth in deposits and
related activity resulted in service charges on deposits increasing $328,000 to
$2.7 million for the three months ending March 31, 2003 compared to $2.3 million
for the same period a year ago.
Noninterest Expense
Noninterest expense for the first quarter of 2003 totaled $15.6 million compared
with $12.1 million for the first quarter of 2002. As previously discussed $1.4
million of the increase related to three specific matters: $232,000 of the
increase was from professional fees related to NBG organizational governance and
credit administration issues, $489,000 from an impairment charge on a
partnership investment, and $674,000 from separation costs. The remaining
increase is principally from compensation cost for additional staffing of the
credit administration function and costs associated with the Company's expansion
and growth of its products and delivery channels. These additional costs are the
principal factor in an increase in the Company's efficiency ratio to 58.95%,
compared to 48.69% for the same period a year ago. The Company's strategic plan
has identified opportunities for expansion into markets where we believe our
brand of banking will allow us to achieve significant market share. During 2002
six offices were opened in new locations and the Company expects to add three
more new locations in 2003. The costs associated with expansion and related
support structure have contributed to an increase in the efficiency ratio. The
Company expects the efficiency ratio to improve as the new offices come on line
and our credit costs decline as we work through our problem loans
Income Tax Expense
The provision for income taxes, which provides for Federal and New York State
income taxes, amounted to $1.8 million and $3.3 million for the three months
ended March 31, 2003 and 2002, respectively. While the decrease corresponds
generally to the decreased levels of taxable income, the effective tax rate for
first quarter 2003 decreased to 29.2%, compared to 32.8% for first quarter
primarily 2002 as a result of an increase in holdings of tax-exempt securities.
Liquidity and Capital Resources
Liquidity
The objective of maintaining adequate liquidity is to assure the ability of the
Company and its subsidiaries to meet their financial obligations. These
obligations include the withdrawal of deposits on demand or at their contractual
maturity, the repayment of borrowings as they mature, the ability to fund new
and existing loan commitments and the ability to take advantage of new business
opportunities. The Company and its subsidiaries achieve liquidity by maintaining
a strong base of core customer funds, maturing short-term assets, the ability to
sell securities, lines of credit, and access to capital markets.
Liquidity at the subsidiary bank level is managed through the monitoring of
anticipated changes in loans, core deposits, and wholesale funds. The strength
of the subsidiary bank's liquidity position is a result of its base of core
customer deposits. These core deposits are supplemented by wholesale funding
sources which include credit lines with the other banking institutions, the
FHLB, Farmer Mac, and the Federal Reserve Bank.
The primary source of liquidity for the parent company is dividends from
subsidiaries, lines of credit, and access to capital markets. Dividends from
subsidiaries are limited by various regulatory requirements related to capital
adequacy and earnings trends. The Company's subsidiaries rely on cash flows from
20
operations, core deposits, borrowings, short-term liquid assets, and, in the
case of non-banking subsidiaries, funds from the parent company.
In the normal course of business, the Company has outstanding commitments to
extend credit which are not reflected in the Company's consolidated financial
statements. The commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. At March 31, 2003 letters
of credit totaling $12.9 million and unused loan commitments of $330.7 million
were contractually available. Comparable amounts for these commitments at
December 31, 2002 were $13.4 million and $316.6 million, respectively. The total
commitment amounts do not necessarily represent future cash requirements as
certain of the commitments are expected to expire without funding.
The Company's cash and cash equivalents were $108.5 million at March 31, 2003,
an increase of $60.1 million from the balance of $48.4 million at December 31,
2002. The primary factor leading to the increase in cash was the net increase in
deposits during the quarter.
Capital Resources
The Federal Reserve Board has adopted a system using risk-based capital
guidelines to evaluate the capital adequacy of bank holding companies. The
guidelines require a minimum total risk-based capital ratio of 8.0%. Leverage
ratio is also utilized in assessing capital adequacy with a minimum requirement
that can range from 3.0% to 5.0%.
The Company's Tier 1 leverage ratio was 6.83% and 6.96% at March 31, 2003 and
December 31, 2002, respectively, well-above minimum regulatory capital
requirements. Total Tier 1 capital of $142.1 million at March 31, 2002 increased
$2.5 million from $139.6 million at December 31, 2002. The increase in Tier 1
capital relates primarily to the increase of $2.1 million in retained earnings
resulting from the Company's first quarter 2003 earnings net of dividend
payouts.
The Company's total risk-weighted capital ratio was 10.98% at March 31, 2003,
comparable to 11.08% at and December 31, 2002, both well-above minimum
regulatory capital requirements. Total risk-based capital was $160.5 million at
March 31, 2003, an increase of $3.1 million from $157.4 million at December 31,
2002.
Other Matters
The Company disclosed in its 2003 Annual Report on Form 10-K that the OCC began
Safety & Soundness Examinations at NBG and BNB in early January 2003 and that
management was undertaking significant remedial measures in credit
administration, compliance and organizational structure to address the issues
identified in those examinations.
On April 30, 2003, at examination exit meetings with the senior managements of
Bath National Bank and National Bank of Geneva, the OCC outlined proposed
findings and provided a written summary of issues requiring attention in the
areas of regulatory compliance, credit risk management and internal controls.
Management was directed to develop responses promptly, and the OCC indicated
that it intends to issue final reports of examination around the end of June.
The OCC indicated that enforcement action is under consideration with respect to
NBG, the form and substance of which is under review and will be determined
after consideration of the responses being prepared by bank management and the
Company. In the event one or both banks lose their "well-managed" ratings, the
Company's status as a financial holding company could be jeopardized, which
could limit its ability to make acquisitions and expand into new business areas
without Federal Reserve approval.
During the first quarter, the Company continued to execute the initiatives
described in its 2003 Form 10-K, which management believes addresses many of the
OCC's preliminary findings. As of March 31, 2003, the Company has a leverage
ratio of 6.83% and a total risk based capital ratio of 10.98%. That capital
level is $43.5 million in excess of minimum regulatory capital requirements and
$14.4 million in excess of minimum regulatory capital requirements to meet
"well-capitalized" guidelines. This excess capital represents an additional
source of strength available to the Company's subsidiary banks. During the first
21
quarter of 2003, the Company made a capital contribution of $1 million to NBG
and NBG did not declare its regular quarterly dividend.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The principal objective of the Company's interest rate risk management is to
evaluate the interest rate risk inherent in certain assets and liabilities,
determine the appropriate level of risk to the Company given its business
strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines
approved by the Company's Board of Directors. The Company's senior management is
responsible for reviewing with the Board its activities and strategies, the
effect of those strategies on the net interest margin, the fair value of the
portfolio and the effect that changes in interest rates will have on the
portfolio and exposure limits. Senior Management develops an Asset-Liability
Policy that meets strategic objectives and regularly reviews the activities of
the subsidiary banks. Each subsidiary bank board adopts an Asset-Liability
Policy within the parameters of the overall FII Asset-Liability Policy and
utilizes an asset/liability committee comprised of senior management of the bank
under the direction of the bank's board.
Management of the Company's interest rate risk requires the selection of
appropriate techniques and instruments to be utilized after considering the
benefits, costs and risks associated with available alternatives. Since the
Company does not utilize derivative instruments, management's techniques usually
consider one or more of the following: (1) interest rates offered on products,
(2) maturity terms offered on products, (3) types of products offered, and (4)
products available to the Company in the wholesale market such as advances from
the FHLB.
The Company uses a net interest income and economic value of equity model as one
method to identify and manage its interest rate risk profile. The model is based
on expected cash flows and repricing characteristics for all financial
instruments and incorporates market-based assumptions regarding the impact of
changing interest rates on these financial instruments. Assumptions based on the
historical behavior of deposit rates and balances in relation to changes in
interest rates are also incorporated into the model. These assumptions are
inherently uncertain and, as a result, the model cannot precisely measure net
interest income or precisely predict the impact of fluctuations in interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude, and frequency of interest rate changes as well as
changes in market conditions and management strategies. The Company has
experienced no significant changes in market risk due to changes in interest
rates since the Company's Annual Report on Form 10-K as of December 31, 2002,
dated March 14, 2003, as filed with the Securities and Exchange Commission.
Management also uses a static gap analysis to identify and manage the Company's
interest rate risk profile. Interest sensitivity gap ("gap") analysis measures
the difference between the assets and liabilities repricing or maturing within
specific time periods.
Item 4. Controls and Procedures
Within 90 days of the date of this report, the Company, under the supervision of
its Chief Executive Officer and Chief Financial Officer, conducted an evaluation
of the effectiveness of disclosure controls and procedures pursuant to Exchange
Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that all material information required to
be filed in the Company's periodic SEC reports is made known to them in a timely
fashion. There have been no significant changes in the Company's internal
controls, or in factors that could significantly affect the Company's internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.
22
PART II -- OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit 10.1 Separation Agreement for Thomas L. Kime
Exhibit 11.1 Computation of Per Share Earnings*
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
* Data required by Statement of Financial Accounting
Standards No. 128, Earnings per Share, is provided
in note 4 to the consolidated financial statements
in this report.
(b) Reports on Form 8-K.
Pursuant to Regulation FD under item 9, the Company filed a Form 8-K on
February 13, 2003 and March 14, 2003.
23
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.
May 14, 2003 FINANCIAL INSTITUTIONS, INC.
Date Signatures
May 14, 2003 /s/ Peter G. Humphrey
----------------------------------
Peter G. Humphrey
President, Chief Executive Officer
(Principal Executive Officer),
Chairman of the Board and Director
May 14, 2003 /s/ Ronald A. Miller
----------------------------------
Ronald A. Miller
Senior Vice President
and Chief Financial Officer
(Principal Accounting Officer)
24
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
CERTIFICATION
I, Peter G. Humphrey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Financial Institutions,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Peter G. Humphrey
-----------------------
Peter G. Humphrey
Chief Executive Officer
25
CERTIFICATION
I, Ronald A. Miller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Financial Institutions,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Ronald A. Miller
-----------------------
Ronald A. Miller
Chief Financial Officer
26