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 March 31, 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 14,498,014 shares of Common Stock, $0.01 par value, outstanding as of April 29, 2016.


Table of Contents

FINANCIAL INSTITUTIONS, INC.

Form 10-Q

For the Quarterly Period Ended March 31, 2016

TABLE OF CONTENTS

 

         PAGE  

PART I.

 

FINANCIAL INFORMATION

     3   

ITEM 1.

 

Financial Statements

     3   
 

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

     3   
 

Consolidated Statements of Income (Unaudited) - Three months ended March 31, 2016 and 2015

     4   
  Consolidated Statements of Comprehensive Income (Unaudited) - Three months ended March 31, 2016 and 2015      5   
  Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) - Three months ended March 31, 2016 and 2015      6   
 

Consolidated Statements of Cash Flows (Unaudited) - Three months ended March 31, 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

     31   

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     48   

ITEM 4.

 

Controls and Procedures

     49   

PART II.

 

OTHER INFORMATION

     50   

ITEM 1.

 

Legal Proceedings

     50   

ITEM 1A.

 

Risk Factors

     50   

ITEM 6.

 

Exhibits

     51   
 

Signatures

     52   

 

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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)    March 31,     December 31,  
     2016     2015  
ASSETS     

Cash and due from banks

   $ 110,944      $ 60,121   

Securities available for sale, at fair value

     610,013        544,395   

Securities held to maturity, at amortized cost (fair value of $485,863 and $490,064, respectively)

     476,283        485,717   

Loans held for sale

     609        1,430   

Loans (net of allowance for loan losses of $27,568 and $27,085, respectively)

     2,087,466        2,056,677   

Company owned life insurance

     61,962        63,045   

Premises and equipment, net

     40,771        39,445   

Goodwill and other intangible assets, net

     76,567        66,946   

Other assets

     51,957        63,248   
  

 

 

   

 

 

 

Total assets

   $ 3,516,572      $ 3,381,024   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Deposits:

    

Noninterest-bearing demand

   $ 617,394      $ 641,972   

Interest-bearing demand

     622,443        523,366   

Savings and money market

     1,042,910        928,175   

Time deposits

     677,430        637,018   
  

 

 

   

 

 

 

Total deposits

     2,960,177        2,730,531   

Short-term borrowings

     179,200        293,100   

Long-term borrowings, net of issuance costs of $992 and $1,010, respectively

     39,008        38,990   

Other liabilities

     24,234        24,559   
  

 

 

   

 

 

 

Total liabilities

     3,202,619        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

     81,010        72,690   

Retained earnings

     223,290        218,920   

Accumulated other comprehensive loss

     (4,105     (11,327

Treasury stock, at cost – 197,131 and 207,317 shares, respectively

     (3,729     (3,923
  

 

 

   

 

 

 

Total shareholders’ equity

     313,953        293,844   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,516,572      $ 3,381,024   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

 

(In thousands, except per share amounts)    Three months ended
March 31,
 
     2016      2015  

Interest income:

     

Interest and fees on loans

   $ 22,057       $ 20,137   

Interest and dividends on investment securities

     5,578         4,860   
  

 

 

    

 

 

 

Total interest income

     27,635         24,997   
  

 

 

    

 

 

 

Interest expense:

     

Deposits

     1,959         1,620   

Short-term borrowings

     339         230   

Long-term borrowings

     618         —     
  

 

 

    

 

 

 

Total interest expense

     2,916         1,850   
  

 

 

    

 

 

 

Net interest income

     24,719         23,147   

Provision for loan losses

     2,368         2,741   
  

 

 

    

 

 

 

Net interest income after provision for loan losses

     22,351         20,406   
  

 

 

    

 

 

 

Noninterest income:

     

Service charges on deposits

     1,724         1,879   

Insurance income

     1,672         1,608   

ATM and debit card

     1,325         1,193   

Investment advisory

     1,243         487   

Company owned life insurance

     1,368         467   

Investments in limited partnerships

     56         474   

Loan servicing

     116         167   

Net gain on sale of loans held for sale

     78         69   

Net gain on disposal of investment securities

     613         1,062   

Net gain on disposal of other assets

     4         4   

Other

     1,018         887   
  

 

 

    

 

 

 

Total noninterest income

     9,217         8,297   
  

 

 

    

 

 

 

Noninterest expense:

     

Salaries and employee benefits

     11,614         10,223   

Occupancy and equipment

     3,625         3,699   

Professional services

     1,447         968   

Computer and data processing

     804         702   

Supplies and postage

     594         563   

FDIC assessments

     436         418   

Advertising and promotions

     377         239   

Other

     2,321         2,199   
  

 

 

    

 

 

 

Total noninterest expense

     21,218         19,011   
  

 

 

    

 

 

 

Income before income taxes

     10,350         9,692   

Income tax expense

     2,732         2,891   
  

 

 

    

 

 

 

Net income

   $ 7,618       $ 6,801   
  

 

 

    

 

 

 

Preferred stock dividends

     365         365   
  

 

 

    

 

 

 

Net income available to common shareholders

   $ 7,253       $ 6,436   
  

 

 

    

 

 

 

Earnings per common share (Note 3):

     

Basic

   $ 0.50       $ 0.46   

Diluted

   $ 0.50       $ 0.46   

Cash dividends declared per common share

   $ 0.20       $ 0.20   

Weighted average common shares outstanding:

     

Basic

     14,395         14,063   

Diluted

     14,465         14,113   

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

 

(Dollars in thousands)    Three months ended
March 31,
 
     2016      2015  

Net income

   $ 7,618       $ 6,801   

Other comprehensive income, net of tax:

     

Net unrealized gains on securities available for sale

     7,083         3,261   

Pension and post-retirement obligations

     139         135   
  

 

 

    

 

 

 

Total other comprehensive income, net of tax

     7,222         3,396   
  

 

 

    

 

 

 

Comprehensive income

   $ 14,840       $ 10,197   
  

 

 

    

 

 

 

See accompanying notes to the consolidated financial statements.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

Three months ended March 31, 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

     —           —           —          6,801        —          —          6,801   

Other comprehensive income, net of tax

     —           —           —          —          3,396        —          3,396   

Purchases of common stock for treasury

     —           —           —          —          —          (41     (41

Share-based compensation plans:

                

Share-based compensation

     —           —           103        —          —          —          103   

Stock options exercised

     —           —           3        —          —          69        72   

Restricted stock awards issued, net

     —           —           (874     —          —          874        —     

Excess tax benefit on share-based compensation

     —           —           4        —          —          —          4   

Cash dividends declared:

                

Series A 3% Preferred-$0.75 per share

     —           —           —          (1     —          —          (1

Series B-1 8.48% Preferred-$2.12 per share

     —           —           —          (364     —          —          (364

Common-$0.20 per share

     —           —           —          (2,813     —          —          (2,813
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2015

   $ 17,340       $ 144       $ 72,191      $ 206,935      $ (5,615   $ (4,306   $ 286,689   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at January 1, 2016

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

Comprehensive income:

                

Net income

     —           —           —          7,618        —          —          7,618   

Other comprehensive income, net of tax

     —           —           —          —          7,222        —          7,222   

Common stock issued

     —           3         8,097        —          —          —          8,100   

Share-based compensation plans:

                

Share-based compensation

     —           —           129        —          —          —          129   

Stock options exercised

     —           —           2        —          —          286        288   

Restricted stock awards forfeited

     —           —           92        —          —          (92     —     

Cash dividends declared:

                

Series A 3% Preferred-$0.75 per share

     —           —           —          (1     —          —          (1

Series B-1 8.48% Preferred-$2.12 per share

     —           —           —          (364     —          —          (364

Common-$0.20 per share

     —           —           —          (2,883     —          —          (2,883
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2016

   $ 17,340       $ 147       $ 81,010      $ 223,290      $ (4,105   $ (3,729   $ 313,953   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

 

(Dollars in thousands)    Three months ended
March 31,
 
     2016     2015  

Cash flows from operating activities:

    

Net income

   $ 7,618      $ 6,801   

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

    

Depreciation and amortization

     1,487        1,326   

Net amortization of premiums on securities

     714        743   

Provision for loan losses

     2,368        2,741   

Share-based compensation

     129        103   

Deferred income tax expense

     131        582   

Proceeds from sale of loans held for sale

     4,144        3,366   

Originations of loans held for sale

     (3,245     (3,198

Income on company owned life insurance

     (1,368     (467

Net gain on sale of loans held for sale

     (78     (69

Net gain on disposal of investment securities

     (613     (1,062

Net gain on sale and disposal of other assets

     (4     (4

Decrease in other assets

     5,804        7,702   

Decrease in other liabilities

     (127     (627
  

 

 

   

 

 

 

Net cash provided by operating activities

     16,960        17,937   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of available for sale securities

     (119,597     (78,405

Purchases of held to maturity securities

     (3,612     (11,024

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

     48,280        38,073   

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

     12,381        5,048   

Proceeds from sales of securities available for sale

     17,627        29,508   

Net loan originations

     (33,297     (14,190

Proceeds from company owned life insurance, net of purchases

     2,451        (7

Proceeds from sales of other assets

     109        109   

Purchases of premises and equipment

     (2,460     (1,024

Cash consideration paid for acquisition, net of cash acquired

     (868     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (78,986     (31,912
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in deposits

     229,646        254,168   

Net decrease in short-term borrowings

     (113,900     (159,231

Purchase of common stock for treasury

     —          (41

Proceeds from stock options exercised

     288        72   

Excess tax benefit on share-based compensation, net

     —          4   

Cash dividends paid to common and preferred shareholders

     (3,185     (3,176
  

 

 

   

 

 

 

Net cash provided by financing activities

     112,849        91,796   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     50,823        77,821   

Cash and cash equivalents, beginning of period

     60,121        58,151   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 110,944      $ 135,972   
  

 

 

   

 

 

 

Supplemental information:

    

Cash paid for interest

   $ 2,096      $ 1,473   

Cash paid for income taxes

     500        —     

Noncash investing and financing activities:

    

Real estate and other assets acquired in settlement of loans

     140        51   

Accrued and declared unpaid dividends

     3,248        3,178   

(Decrease) increase in net unsettled security purchases

     (170     6,222   

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.

 

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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 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.

 

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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.

 

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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 $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, 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      
  

 

 

    

(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
March 31,
 
     2016      2015  

Net income available to common shareholders

   $ 7,253       $ 6,436   

Weighted average common shares outstanding:

     

Total shares issued

     14,679         14,397   

Unvested restricted stock awards

     (79      (74

Treasury shares

     (205      (260
  

 

 

    

 

 

 

Total basic weighted average common shares outstanding

     14,395         14,063   

Incremental shares from assumed:

     

Exercise of stock options

     27         22   

Vesting of restricted stock awards

     43         28   
  

 

 

    

 

 

 

Total diluted weighted average common shares outstanding

     14,465         14,113   

Basic earnings per common share

   $ 0.50       $ 0.46   
  

 

 

    

 

 

 

Diluted earnings per common share

   $ 0.50       $ 0.46   
  

 

 

    

 

 

 

 

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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
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
 

March 31, 2016

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ 235,964       $ 5,506       $ 7       $ 241,463   

Mortgage-backed securities:

           

Federal National Mortgage Association

     293,220         4,312         53         297,479   

Federal Home Loan Mortgage Corporation

     28,019         535         28         28,526   

Government National Mortgage Association

     18,302         664         12         18,954   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     16,986         394         —           17,380   

Federal Home Loan Mortgage Corporation

     5,165         90         —           5,255   

Privately issued

     —           777         —           777   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     361,692         6,772         93         368,371   

Asset-backed securities

     —           179         —           179   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 597,656       $ 12,457       $ 100       $ 610,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

           

State and political subdivisions

     291,934         8,544         1         300,477   

Mortgage-backed securities:

           

Federal National Mortgage Association

     9,190         152         2         9,340   

Government National Mortgage Association

     26,365         204         41         26,528   

Collateralized mortgage obligations:

           

Federal National Mortgage Association

     54,281         227         15         54,493   

Federal Home Loan Mortgage Corporation

     77,407         467         5         77,869   

Government National Mortgage Association

     17,106         57         7         17,156   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     184,349         1,107         70         185,386   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

   $ 476,283       $ 9,651       $ 71       $ 485,863   
  

 

 

    

 

 

    

 

 

    

 

 

 

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   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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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 $908.8 million at March 31, 2016 were pledged 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
March 31,
 
     2016      2015  

Proceeds from sales

   $ 17,627       $ 29,508   

Gross realized gains

     613         1,073   

Gross realized losses

     —           11   

The scheduled maturities of securities available for sale and securities held to maturity at March 31, 2016 are shown below (in thousands). Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

 

     Amortized
Cost
     Fair
Value
 

Debt securities available for sale:

     

Due in one year or less

   $ 5,101       $ 5,137   

Due from one to five years

     179,535         182,050   

Due after five years through ten years

     300,883         308,638   

Due after ten years

     112,137         114,188   
  

 

 

    

 

 

 
   $ 597,656       $ 610,013   
  

 

 

    

 

 

 

Debt securities held to maturity:

     

Due in one year or less

   $ 20,934       $ 20,987   

Due from one to five years

     174,277         178,726   

Due after five years through ten years

     111,349         115,419   

Due after ten years

     169,723         170,731   
  

 

 

    

 

 

 
   $ 476,283       $ 485,863   
  

 

 

    

 

 

 

 

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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
 

March 31, 2016

                 

Securities available for sale:

                 

U.S. Government agencies and government sponsored enterprises

   $ 391       $ 1       $ 7,482       $ 6       $ 7,873       $ 7   

Mortgage-backed securities:

                 

Federal National Mortgage Association

     12,098         3         15,781         50         27,879         53   

Federal Home Loan Mortgage Corporation

     —           —           4,258         28         4,258         28   

Government National Mortgage Association

     1,332         12         —           —           1,332         12   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     13,430         15         20,039         78         33,469         93   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

     13,821         16         27,521         84         41,342         100   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Securities held to maturity:

                 

State and political subdivisions

     2,477         1         —           —           2,477         1   

Mortgage-backed securities:

                 

Federal National Mortgage Association

     1,362         2         —           —           1,362         2   

Government National Mortgage Association

     4,225         12         3,773         29         7,998         41   

Collateralized mortgage obligations:

                 

Federal National Mortgage Association

     6,895         15         —           —           6,895         15   

Federal Home Loan Mortgage Corporation

     5,100         5         —           —           5,100         5   

Government National Mortgage Association

     3,366         7         —           —           3,366         7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

     20,948         41         3,773         29         24,721         70   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

     23,425         42         3,773         29         27,198         71   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 37,246       $ 58       $ 31,294       $ 113       $ 68,540       $ 171   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(4.) INVESTMENT SECURITIES (Continued)

 

The total number of security positions in the investment portfolio in an unrealized loss position at March 31, 2016 was 45 compared to 152 at December 31, 2015. At March 31, 2016, the Company had positions in 13 investment securities with a fair value of $31.3 million and a total unrealized loss of $113 thousand that have been in a continuous unrealized loss position for more than 12 months. At March 31, 2016, there were a total of 32 securities positions in the Company’s investment portfolio with a fair value of $37.2 million and a total unrealized loss of $58 thousand that had been in a continuous unrealized loss position for less than 12 months. At December 31, 2015, the Company had positions in 10 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 142 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 three months ended March 31, 2016 and 2015.

Based on management’s review and evaluation of the Company’s debt securities as of March 31, 2016, the debt securities with unrealized losses were not considered to be other-than-temporarily impaired. As of March 31, 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 March 31, 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.

 

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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  

March 31, 2016

        

Commercial business

   $ 317,420       $ 356       $ 317,776   

Commercial mortgage

     591,800         (1,484      590,316   

Residential real estate loans

     377,406         5,098         382,504   

Residential real estate lines

     123,894         2,632         126,526   

Consumer indirect

     655,348         24,498         679,846   

Other consumer

     17,889         177         18,066   
  

 

 

    

 

 

    

 

 

 

Total

   $ 2,083,757       $ 31,277         2,115,034   
  

 

 

    

 

 

    

Allowance for loan losses

           (27,568
        

 

 

 

Total loans, net

         $ 2,087,466   
        

 

 

 

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 $609 thousand and $1.4 million as of March 31, 2016 and December 31, 2015, respectively.

 

- 15 -


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  

March 31, 2016

                    

Commercial business

   $ 94       $ 2       $ —         $ 96       $ 4,056       $ 313,268       $ 317,420   

Commercial mortgage

     53         —           —           53         1,781         589,966         591,800   

Residential real estate loans

     515         22         —           537         1,601         375,268         377,406   

Residential real estate lines

     151         43         —           194         165         123,535         123,894   

Consumer indirect

     1,296         267         —           1,563         943         652,842         655,348   

Other consumer

     52         17         9         78         12         17,799         17,889   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, gross

   $ 2,161       $ 351       $ 9       $ 2,521       $ 8,558       $ 2,072,678       $ 2,083,757   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 March 31, 2016 and December 31, 2015. There were $9 thousand and $8 thousand in consumer overdrafts which were past due greater than 90 days as of March 31, 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, reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, collateral concessions, forgiveness of principal, forebearance 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).

 

     Number of
Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
 

March 31, 2016

        

Commercial business

     2       $ 312       $ 312   

Commercial mortgage

     1         550         550   
  

 

 

    

 

 

    

 

 

 

Total

     3       $ 862       $ 862   
  

 

 

    

 

 

    

 

 

 

March 31, 2015

        

Commercial business

     —         $ —         $ —     

Commercial mortgage

     1         682         330   
  

 

 

    

 

 

    

 

 

 

Total

     1       $ 682       $ 330   
  

 

 

    

 

 

    

 

 

 

 

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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 three month periods ended March 31, 2016 and 2015 were previously reported as an impaired loan prior to restructuring. Each of the loans restructured during the three months ended March 31, 2016 and 2015 were on nonaccrual status at the end of the respective period. The modifications related to collateral concessions. 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 three months ended March 31, 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 three 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
 

March 31, 2016

              

With no related allowance recorded:

              

Commercial business

   $ 2,130       $ 2,710       $ —         $ 1,516       $ —     

Commercial mortgage

     1,349         1,697         —           1,018         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     3,479         4,407         —           2,534         —     

With an allowance recorded:

           

Commercial business

     1,926         1,926         825         2,339         —     

Commercial mortgage

     432         432         127         114         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,358         2,358         952         2,453         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,837       $ 6,765       $ 952       $ 4,987       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

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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
 

March 31, 2016

     

Uncriticized

   $ 303,114       $ 576,742   

Special mention

     5,643         8,580   

Substandard

     8,663         6,478   

Doubtful

     —           —     
  

 

 

    

 

 

 

Total

   $ 317,420       $ 591,800   
  

 

 

    

 

 

 

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
 

March 31, 2016

           

Performing

   $ 375,805       $ 123,729       $ 654,405       $ 17,868   

Non-performing

     1,601         165         943         21   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 377,406       $ 123,894       $ 655,348       $ 17,889   
  

 

 

    

 

 

    

 

 

    

 

 

 

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   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

Allowance for Loan Losses

The following tables set forth the changes in the allowance for loan losses for the three month periods ended as of the dates indicated (in thousands):

 

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

March 31, 2016

                   

Allowance for loan losses:

                   

Beginning balance

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

Charge-offs

     602         4         46         4        2,498         157         3,311   

Recoveries

     100         5         25         4        1,170         122         1,426   

Provision

     398         687         58         —          1,167         58         2,368   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Ending balance

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

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                   

Individually

   $ 791       $ 120       $ —         $ —        $ —         $ —         $ 911   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Collectively

   $ 4,645       $ 9,595       $ 1,384       $ 345      $ 10,297       $ 391       $ 26,657   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Loans:

                   

Ending balance

   $ 317,420       $ 591,800       $ 377,406       $ 123,894      $ 655,348       $ 17,889       $ 2,083,757   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                   

Individually

   $ 3,924       $ 1,730       $ —         $ —        $ —         $ —         $ 5,654   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Collectively

   $ 313,496       $ 590,070       $ 377,406       $ 123,894      $ 655,348       $ 17,889       $ 2,078,103   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

March 31, 2015

                   

Allowance for loan losses:

                   

Beginning balance

   $ 5,621       $ 8,122       $ 1,620       $ 435      $ 11,383       $ 456       $ 27,637   

Charge-offs

     1,141         609         139         —          2,422         259         4,570   

Recoveries

     48         89         41         2        1,105         98         1,383   

Provision (credit)

     867         554         64         (35     1,139         152         2,741   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Ending balance

   $ 5,395       $ 8,156       $ 1,586       $ 402      $ 11,205       $ 447       $ 27,191   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                   

Individually

   $ 1,120       $ 817       $ —         $ —        $ —         $ —         $ 1,937   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Collectively

   $ 4,275       $ 7,339       $ 1,586       $ 402      $ 11,205       $ 447       $ 25,254   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Loans:

                   

Ending balance

   $ 277,427       $ 480,479       $ 351,088       $ 126,832      $ 637,380       $ 19,184       $ 1,892,390   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Evaluated for impairment:

                   

Individually

   $ 4,587       $ 3,411       $ —         $ —        $ —         $ —         $ 7,998   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Collectively

   $ 272,840       $ 477,068       $ 351,088       $ 126,832      $ 637,380       $ 19,184       $ 1,884,392   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

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.

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(5.) LOANS (Continued)

 

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.

(6.) GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying amount of goodwill totaled $66.4 and $60.4 million as of March 31, 2016 and December 31, 2015, respectively. The Company performs a goodwill impairment test on an annual basis 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, March 31, 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):

 

     March 31,      December 31,  
     2016      2015  

Other intangibles assets:

     

Gross carrying amount

   $ 12,610       $ 8,682   

Accumulated amortization

     (2,460      (2,138
  

 

 

    

 

 

 

Net book value

   $ 10,150       $ 6,544   
  

 

 

    

 

 

 

Amortization expense for total other intangible assets was $322 thousand and $243 thousand for the three months ended March 31, 2016 and 2015, respectively. As of March 31, 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)

   $ 927   

2017

     1,144   

2018

     1,035   

2019

     937   

2020

     840   

2021

     738   

 

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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 three month periods ended March 31, 2016 and 2015:

 

     Outstanding      Treasury      Issued  

March 31, 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 forfeited

     (4,914      4,914         —     

Stock options exercised

     15,100         (15,100      —     
  

 

 

    

 

 

    

 

 

 

Shares outstanding at March 31, 2016

     14,495,083         197,131         14,692,214   
  

 

 

    

 

 

    

 

 

 

March 31, 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         —     
  

 

 

    

 

 

    

 

 

 

Shares outstanding at March 31, 2015

     14,166,792         230,717         14,397,509   
  

 

 

    

 

 

    

 

 

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS

The following table presents the components of other comprehensive income for the three month periods ended March 31, 2016 and 2015 (in thousands):

 

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

March 31, 2016

        

Securities available for sale and transferred securities:

        

Change in unrealized gain/loss during the period

   $ 12,196       $ 4,706       $ 7,490   

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

     (662      (255      (407
  

 

 

    

 

 

    

 

 

 

Total securities available for sale and transferred securities

     11,534         4,451         7,083   

Amortization of pension and post-retirement items:

        

Prior service credit

     (12      (5      (7

Net actuarial losses

     239         93         146   
  

 

 

    

 

 

    

 

 

 

Total pension and post-retirement obligations

     227         88         139   
  

 

 

    

 

 

    

 

 

 

Other comprehensive income

   $ 11,761       $ 4,539       $ 7,222   
  

 

 

    

 

 

    

 

 

 

March 31, 2015

        

Securities available for sale and transferred securities:

        

Change in unrealized gain/loss during the period

   $ 6,396       $ 2,436       $ 3,960   

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

     (1,139      (440      (699
  

 

 

    

 

 

    

 

 

 

Total securities available for sale and transferred securities

     5,257         1,996         3,261   

Amortization of pension and post-retirement items:

        

Prior service credit

     (12      (5      (7

Net actuarial losses

     236         94         142   
  

 

 

    

 

 

    

 

 

 

Total pension and post-retirement obligations

     224         89         135   
  

 

 

    

 

 

    

 

 

 

Other comprehensive income

   $ 5,481       $ 2,085       $ 3,396   
  

 

 

    

 

 

    

 

 

 

 

(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.

 

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Table of Contents

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(8.) ACCUMULATED OTHER COMPREHENSIVE LOSS (Continued)

 

Activity in accumulated other comprehensive loss, net of tax, for the three month periods ended March 31, 2016 and 2015 was as follows (in thousands):

 

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

March 31, 2016

        

Balance at beginning of year

   $ (696    $ (10,631    $ (11,327

Other comprehensive income before reclassifications

     7,490         —           7,490   

Amounts reclassified from accumulated other comprehensive loss

     (407      139         (268
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income

     7,083         139         7,222   
  

 

 

    

 

 

    

 

 

 

Balance at end of period

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

 

 

    

 

 

    

 

 

 

March 31, 2015

        

Balance at beginning of year

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

Other comprehensive income before reclassifications

     3,960         —           3,960   

Amounts reclassified from accumulated other comprehensive loss

     (699      135         (564
  

 

 

    

 

 

    

 

 

 

Net current period other comprehensive income

     3,261         135         3,396   
  

 

 

    

 

 

    

 

 

 

Balance at end of period

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

 

 

    

 

 

    

 

 

 

The following table presents the amounts reclassified out of each component of accumulated other comprehensive loss for the three month periods ended March 31, 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
March 31,
      
     2016      2015       

Realized gain on sale of investment securities

   $ 613       $ 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

     49         77       Interest income
  

 

 

    

 

 

    
     662         1,139       Total before tax
     (255      (440    Income tax expense
  

 

 

    

 

 

    
     407         699       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      (236    Salaries and employee benefits
  

 

 

    

 

 

    
     (227      (224    Total before tax
     88         89       Income tax benefit
  

 

 

    

 

 

    
     (139      (135    Net of tax
  

 

 

    

 

 

    

Total reclassified for the period

   $ 268       $ 564      
  

 

 

    

 

 

    

 

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

 

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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 quarter 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 three month period ended March 31, 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 three month period ended March 31, 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 three month period ended March 31, 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%.

The Company previously granted restricted stock awards to certain members of management. There were no restricted stock awards granted during the quarter ended March 31, 2016. The following is a summary of restricted stock award activity for the three month period ended March 31, 2016:

 

            Weighted  
            Average  
            Market  
     Number of      Price at  
     Shares      Grant Date  

Outstanding at beginning of year

     82,908       $ 17.23   

Forfeited

     (4,914      22.69   
  

 

 

    

Outstanding at end of period

     77,994       $ 16.89   
  

 

 

    

At March 31, 2016, the total unrecognized compensation cost related to the nonvested awards granted and expected to vest was $1.5 million. This cost is expected to be recognized over a weighted-average period of 2.4 years.

 

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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 three months ended March 31, 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

     (15,100      19.03         

Expired

     —              
  

 

 

          

Outstanding and exercisable at end of period

     87,149       $ 19.24         1.2       $ 856   
  

 

 

          

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 three months ended March 31, 2016 and 2015 was $126 thousand and $13 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for the three months ended March 31, 2016 and 2015 was $288 thousand and $72 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  
     March 31,  
     2016      2015  

Salaries and employee benefits

   $ 98       $ 78   

Other noninterest expense

     31         25   
  

 

 

    

 

 

 

Total share-based compensation expense

   $ 129       $ 103   
  

 

 

    

 

 

 

(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  
     March 31,  
     2016      2015  

Service cost

   $ 721       $ 581   

Interest cost on projected benefit obligation

     601         583   

Expected return on plan assets

     (1,150      (1,205

Amortization of prior service credit

     (12      (12

Amortization of net actuarial losses

     239         236   
  

 

 

    

 

 

 

Net periodic benefit expense

   $ 399       $ 183   
  

 

 

    

 

 

 

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.

 

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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):

 

     March 31,
2016
     December 31,
2015
 

Commitments to extend credit

   $ 521,912       $ 514,818   

Standby letters of credit

     10,892         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 $826 thousand and $1.3 million at March 31, 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.

 

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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.

 

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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
     Significant
Other
Observable
Inputs
     Significant
Unobservable
Inputs
        
     (Level 1)      (Level 2)      (Level 3)      Total  

March 31, 2016

           

Measured on a recurring basis:

           

Securities available for sale:

           

U.S. Government agencies and government sponsored enterprises

   $ —         $ 241,463       $ —         $ 241,463   

Mortgage-backed securities

     —           368,371         —           368,371   

Asset-backed securities

     —           179         —           179   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 610,013       $ —         $ 610,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

Measured on a nonrecurring basis:

           

Loans:

           

Loans held for sale

   $ —         $ 609       $ —         $ 609   

Collateral dependent impaired loans

     —           —           1,263         1,263   

Other assets:

           

Loan servicing rights

     —           —           1,222         1,222   

Other real estate owned

     —           —           187         187   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 609       $ 2,672       $ 3,281   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 three months ended March 31, 2016 and 2015. There were no liabilities measured at fair value on a recurring or nonrecurring basis during the three month periods ended March 31, 2016 and 2015.

 

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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

   $ 1,263       Appraisal of collateral (1)    Appraisal adjustments (2)    0% - 50% discount

Loan servicing rights

     1,222       Discounted cash flow    Discount rate    4.7% (3)
         Constant prepayment rate    14.9% (3)

Other real estate owned

     187       Appraisal of collateral (1)    Appraisal adjustments (2)    39% - 48% 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 three months ended March 31, 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.

 

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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    March 31, 2016      December 31, 2015  
     Fair Value           Estimated             Estimated  
     Measurement    Carrying      Fair      Carrying      Fair  
     Hierarchy    Amount      Value      Amount      Value  

Financial assets:

              

Cash and cash equivalents

   Level 1    $ 110,944       $ 110,944       $ 60,121       $ 60,121   

Securities available for sale

   Level 2      610,013         610,013         544,395         544,395   

Securities held to maturity

   Level 2      476,283         485,863         485,717         490,064   

Loans held for sale

   Level 2      609         609         1,430         1,430   

Loans

   Level 2      2,086,203         2,092,237         2,055,192         2,046,235   

Loans (1)

   Level 3      1,263         1,263         1,485         1,485   

Accrued interest receivable

   Level 1      10,181         10,181         8,609         8,609   

FHLB and FRB stock

   Level 2      14,865         14,865         19,991         19,991   

Financial liabilities:

              

Non-maturity deposits

   Level 1      2,282,747         2,282,747         2,093,513         2,093,513   

Time deposits

   Level 2      677,430         674,410         637,018         636,159   

Short-term borrowings

   Level 1      179,200         179,200         293,100         293,100   

Long-term borrowings

   Level 2      39,008         37,566         38,990         40,313   

Accrued interest payable

   Level 1      5,495         5,495         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 non-banking to consider the inclusion of Courier Capital which has similar products, services and reporting, as noted above. Holding company amounts are the primary 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.

 

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

(13.) SEGMENT REPORTING (Continued)

 

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
 

March 31, 2016

           

Goodwill

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

Other intangible assets, net

     762         9,388         —           10,150   

Total assets

     3,484,886         31,545         141         3,516,572   

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

Three months ended March 31, 2016

           

Net interest income (expense)

   $ 25,337       $ —         $ (618    $ 24,719   

Provision for loan losses

     (2,368      —           —           (2,368

Noninterest income

     6,863         2,484         (130      9,217   

Noninterest expense

     (18,345      (1,806      (1,067      (21,218
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     11,487         678         (1,815      10,350   

Income tax (expense) benefit

     (3,101      (264      633         (2,732
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 8,386       $ 414       $ (1,182    $ 7,618   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended March 31, 2015

           

Net interest income

   $ 23,147       $ —         $ —         $ 23,147   

Provision for loan losses

     (2,741      —           —           (2,741

Noninterest income

     6,831         1,593         (127      8,297   

Noninterest expense

     (17,279      (1,187      (545      (19,011
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     9,958         406         (672      9,692   

Income tax (expense) benefit

     (2,949      (159      217         (2,891
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 7,009       $ 247       $ (455    $ 6,801   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

 

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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;

 

    The current proxy contest for the election of directors at our annual meeting could cause us to incur costs in excess of our current estimates and 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;

 

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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 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 – the growth of a diversified and high-quality loan portfolio.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

EXECUTIVE OVERVIEW

Summary of 2016 First Quarter Results

Net income increased $817 thousand or 12% to $7.6 million for the first quarter of 2016 compared to $6.8 million for the first quarter of 2015. Net income available to common shareholders for the first quarter of 2016 was $7.3 million, or $0.50 per diluted share, compared with $6.4 million, or $0.46 per diluted share, for the first quarter of last year. Return on average equity was 9.91% and return on average assets was 0.90% for the first quarter of 2016 compared to 9.68% and 0.89%, respectively, for the first quarter of 2015.

Net interest income totaled $24.7 million in the first quarter 2016, up from $23.1 million in the first quarter 2015. Average earning assets were up $313.1 million, led by a $193.4 million increase in average loans in the first quarter of 2016 compared to the same quarter in 2015. The growth in earning assets was offset by a lower net interest margin. First quarter 2016 net interest margin was 3.27%, a decrease of 16 basis points from 3.43% reported in the first quarter of 2015.

The provision for loans losses was $2.4 million in the first quarter of 2016 compared to $2.7 million in the first quarter of 2015. Net charge-offs during the recent quarter were $1.9 million, down from $3.2 million in the first quarter of 2015. Net charge-offs expressed as an annualized percentage of average loans outstanding were 0.36% during the first three months of 2016 compared with 0.68% in the first 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 $9.2 million in the first quarter of 2016, compared to $8.3 million in the first quarter of 2015. Included in these totals are net gains realized from the sale of investment securities totaling $613 thousand for the first quarter of 2016 and $1.1 million for the first quarter of 2015. Also, included in company owned life insurance for the first quarter of 2016 is $911 thousand of death benefit proceeds. Exclusive of those items, noninterest income was $7.7 million in the first quarter of 2016 and $7.2 million in the first quarter of 2015. The higher noninterest income in the first quarter 2016 compared to the first quarter 2015 is primarily a result of the investment advisory income from Courier Capital.

Noninterest expense in the first quarter of 2016 totaled $21.2 million compared with $19.0 million in the first quarter of 2015. The increase in noninterest expense was largely due to higher salaries and employee benefits reflecting the addition of Courier Capital and an increase in professional services associated with responding to the demands of an activist shareholder.

The regulatory Common equity Tier 1 ratio and Total risk-based capital ratio were 9.83%, and 13.39%, respectively, for the first 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

 

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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 consistent with our strategic initiatives and continued support of middle market small business lending. Automobile loan originations remained strong through the first quarter of 2016, reflecting the positive impact from our investment in 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 with the addition of Courier Capital, coupled with higher salaries and benefits costs associated with our expansion initiatives, including the opening of our second financial solution center in Rochester, New York. We also expect to incur approximately $1.8 million of additional out-of-pocket expenses associated with the current proxy contest, of which approximately $360 thousand was incurred in the first quarter of 2016. Otherwise, we remain committed to diligent expense control and have implemented several initiatives designed to reduce operating expenses late in the first quarter of 2016. We expect those savings to be reflected beginning in the second quarter.

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.

 

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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
March 31,
 
     2016      2015  

Interest income per consolidated statements of income

   $ 27,635       $ 24,997   

Adjustment to fully taxable equivalent basis

     793         752   
  

 

 

    

 

 

 

Interest income adjusted to a fully taxable equivalent basis

     28,428         25,749   

Interest expense per consolidated statements of income

     2,916         1,850   
  

 

 

    

 

 

 

Net interest income on a taxable equivalent basis

   $ 25,512       $ 23,899   
  

 

 

    

 

 

 

Analysis of Net Interest Income for the Three Month Periods ended March 31, 2016 and 2015

Net interest income on a taxable equivalent basis for the three months ended March 31, 2016, was $25.5 million, an increase of $1.6 million versus the comparable quarter last year. The increase in net interest income was due to an increase in average earning assets of $313.1 million or 11% compared to the first quarter of 2015.

The net interest margin for the first quarter of 2016 was 3.27%, 16 basis points lower than 3.43% for the same period in 2015. This comparable period decrease was a function of a 20 basis point decrease in interest rate spread, partially offset by a higher contribution from net free funds of 4 basis points (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 decrease in the yield on earning assets and a 15 increase in the cost of average interest-bearing liabilities.

For the first quarter of 2016, the yield on average earning assets of 3.64% was 5 basis points lower than the first quarter of 2015. Loan yields decreased 6 basis points during the first quarter of 2016 to 4.21%. The yield on investment securities increased 1 basis point during the first quarter of 2016 to 2.48%. Overall, the earning asset rate changes reduced interest income by $98 thousand during the first quarter of 2016, but that was more than offset by a favorable volume variance that increased interest income by $2.8 million, which collectively drove a $2.7 million increase in interest income.

Average interest-earning assets were $3.13 billion for the first quarter 2016, an increase of $313.1 million or 11% from the comparable quarter last year, with average loans up $193.4 million and average securities up $119.7 million. The growth in average loans reflected increases in most loan categories. Commercial loans, in particular, were up $154.8 million or 21% from the first quarter of 2015. Loans represented 67.2% of average interest-earning assets during first quarter of 2016 compared to 67.8% during the first quarter of 2015. The increase in the volume of average loans resulted in a $2.1 million increase in interest income, partially offset by a $154 thousand decrease due to the unfavorable rate variance. Securities represented 32.8% of average interest-earning assets during first quarter of 2016 compared to 32.2% during the first quarter of 2015. The increase in the volume of average securities resulted in a $703 thousand increase in interest income, coupled with a $56 thousand increase due to the favorable rate variance.

The cost of average interest-bearing liabilities of 0.48% in the first quarter of 2016 was 15 basis points higher than the first quarter of 2015. The cost of average interest-bearing deposits increased 3 basis points to 0.36% and the cost of short-term borrowings increased 25 basis points to 0.62% in the first quarter of 2016 compared to the same quarter of 2015. The cost of long-term borrowings for the first quarter of 2016 was 6.34% due to the issuance of $40 million of subordinated notes during the second quarter of 2015. Overall, interest-bearing liability rate and volume increases resulted in $1.1 million of higher interest expense.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Average interest-bearing liabilities of $2.46 billion in the first quarter of 2016 were $212.3 million or 10% higher than the first quarter of 2015. On average, interest-bearing deposits grew $203.8 million, while noninterest-bearing demand deposits (a principal component of net free funds) were up $53.1 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 $339 thousand of higher interest expense during the first quarter of 2016. Average borrowings increased $8.6 million compared to the first quarter of 2016. Overall, short and long-term borrowing rate and volume changes resulted in $727 thousand of higher interest expense during the first quarter of 2016, with the majority of the increase related to the issuance of the subordinate notes in the second quarter of 2015.

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 March 31,  
     2016     2015  
     Average
Balance
    Interest      Average
Rate
    Average
Balance
    Interest      Average
Rate
 

Interest-earning assets:

              

Federal funds sold and interest-earning deposits

   $ 70        —           —     $ 124      $ —           0.19

Investment securities (1):

              

Taxable

     734,084        4,105         2.24        630,633        3,463         2.20   

Tax-exempt (2)

     293,518        2,266         3.09        277,238        2,149         3.10   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total investment securities

     1,027,602        6,371         2.48        907,871        5,612         2.47   

Loans:

              

Commercial business

     316,143        3,248         4.13        264,814        2,724         4.17   

Commercial mortgage

     582,142        6,713         4.64        478,705        5,551         4.70   

Residential real estate loans

     382,077        3,832         4.01        355,866        3,720         4.18   

Residential real estate lines

     127,317        1,208         3.82        129,444        1,166         3.65   

Consumer indirect

     678,133        6,531         3.87        661,727        6,426         3.94   

Other consumer

     17,926        525         11.78        19,736        550         11.30   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans

     2,103,738        22,057         4.21        1,910,292        20,137         4.27   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-earning assets

     3,131,410        28,428         3.64        2,818,287        25,749         3.69   
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (27,638          (27,884     

Other noninterest-earning assets

     301,679             325,113        
  

 

 

        

 

 

      

Total assets

   $ 3,405,451           $ 3,115,516        
  

 

 

        

 

 

      

Interest-bearing liabilities:

              

Deposits:

              

Interest-bearing demand

   $ 572,424        202         0.14   $ 551,503      $ 156         0.11

Savings and money market

     965,629        324         0.13        839,218        217         0.10   

Certificates of deposit

     658,537        1,433         0.88        602,115        1,247         0.84   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing deposits

     2,196,590        1,959         0.36        1,992,836        1,620         0.33   

Short-term borrowings

     221,326        339         0.62        251,768        230         0.37   

Long-term borrowings

     38,997        618         6.34        —          —           —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total borrowings

     260,323        957         1.47        251,768        230         0.37   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     2,456,913        2,916         0.48        2,244,604        1,850         0.33   
    

 

 

    

 

 

     

 

 

    

 

 

 

Noninterest-bearing demand deposits

     617,590             564,500        

Other noninterest-bearing liabilities

     21,760             21,453        

Shareholders’ equity

     309,188             284,959        
  

 

 

        

 

 

      

Total liabilities and shareholders’ equity

   $ 3,405,451           $ 3,115,516        
  

 

 

        

 

 

      

Net interest income (tax-equivalent)

       25,512           $ 23,899      
    

 

 

        

 

 

    

Interest rate spread

          3.16          3.36
       

 

 

        

 

 

 

Net earning assets

   $ 674,497           $ 573,683        
  

 

 

        

 

 

      

Net interest margin (tax-equivalent)

          3.27          3.43
       

 

 

        

 

 

 

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

          127.45          125.56
       

 

 

        

 

 

 

 

(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%.

 

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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
March 31, 2016 vs. 2015
 
     Volume      Rate      Total  

Increase (decrease) in:

        

Interest income:

        

Federal funds sold and interest-earning deposits

   $ —         $ —         $ —     

Investment securities:

        

Taxable

     577         65         642   

Tax-exempt

     126         (9      117   
  

 

 

    

 

 

    

 

 

 

Total investment securities

     703         56         759   

Loans:

        

Commercial business

     527         (3      524   

Commercial mortgage

     1,193         (31      1,162   

Residential real estate loans

     267         (155      112   

Residential real estate lines

     (19      61         42   

Consumer indirect

     158         (53      105   

Other consumer

     (52      27         (25
  

 

 

    

 

 

    

 

 

 

Total loans

     2,074         (154      1,920   
  

 

 

    

 

 

    

 

 

 

Total interest income

     2,777         (98      2,679   
  

 

 

    

 

 

    

 

 

 

Interest expense:

        

Deposits:

        

Interest-bearing demand

     6         40         46   

Savings and money market

     36         71         107   

Certificates of deposit

     121         65         186   
  

 

 

    

 

 

    

 

 

 

Total interest-bearing deposits

     163         176         339   

Short-term borrowings

     (31      140         109   

Long-term borrowings

     309         309         618   
  

 

 

    

 

 

    

 

 

 

Total borrowings

     278         449         727   
  

 

 

    

 

 

    

 

 

 

Total interest expense

     441         625         1,066   
  

 

 

    

 

 

    

 

 

 

Net interest income

   $ 2,336       $ (723    $ 1,613   
  

 

 

    

 

 

    

 

 

 

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 first quarter of 2016 was $2.4 million, compared to $2.7 million for the same period 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.

 

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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
March 31,
 
         2016              2015      

Service charges on deposits

   $ 1,724       $ 1,879   

Insurance income

     1,672         1,608   

ATM and debit card

     1,325         1,193   

Investment advisory

     1,243         487   

Company owned life insurance

     1,368         467   

Investments in limited partnerships

     56         474   

Loan servicing

     116         167   

Net gain on sale of loans held for sale

     78         69   

Net gain on disposal of investment securities

     613         1,062   

Net gain on disposal of other assets

     4         4   

Other

     1,018         887   
  

 

 

    

 

 

 

Total noninterest income

   $ 9,217       $ 8,297   
  

 

 

    

 

 

 

Service charges on deposit accounts for the three months ended March 31, 2016 decreased $155 thousand compared to the same period in 2015. The decrease was primarily due to a decrease in the amount of checking account overdraft activity.

Investment advisory income increased to $1.2 million in the first quarter of 2016 compared to $487 thousand in the first quarter of 2015, reflecting the contribution from Courier Capital which was acquired during the first quarter 2016 as part of our strategy to diversify our business lines and increase noninterest income through additional fee-based services.

Company owned life insurance increased to $1.4 million in the first quarter of 2016 compared to $467 thousand in the same period in 2015, as the current quarter includes $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 $56 thousand and $474 thousand for the three months ended March 31, 2016 and 2015, respectively. The income from these equity method investments fluctuates based on the performance of the underlying investments.

During the first quarter of 2016, we recognized net gains on investment securities totaling $613 thousand from the sale of one agency security and six 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 investments securities is dependent on a number of factors, including our prudent efforts to realize gains while managing duration, premium and credit risk.

 

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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
March 31,
 
     2016      2015  

Salaries and employee benefits

   $ 11,614       $ 10,223   

Occupancy and equipment

     3,625         3,699   

Professional services

     1,447         968   

Computer and data processing

     804         702   

Supplies and postage

     594         563   

FDIC assessments

     436         418   

Advertising and promotions

     377         239   

Other

     2,321         2,199   
  

 

 

    

 

 

 

Total noninterest expense

   $ 21,218       $ 19,011   
  

 

 

    

 

 

 

Salaries and employee benefits expense increased by $1.4 million or 14% in the first quarter of 2016 compared to the same period in 2015, reflecting the addition of Courier Capital and a combination of additional personnel to support organic growth as part of the Company’s expansion initiatives and higher medical expense as the level of medical claims in the first quarter of 2015 were unusually low.

Occupancy and equipment expense was relatively flat at $3.6 million, as the incremental expenses associated with Courier Capital’s operations were offset by the favorable impact of a mild winter compared to a year ago.

Professional services increased $479 thousand when comparing the first quarter of 2016 to the same period in 2015. The first quarter of 2016 includes approximately $360 thousand of professional services associated with the current proxy contest.

Other noninterest expense was $2.3 million in the first quarter of 2016 compared to $2.2 million in the first quarter of 2015. Other noninterest expense for the first quarter 2016 included an increase of $79 thousand in intangible asset amortization attributable to the Courier Capital acquisition.

Our efficiency ratio for the first quarter of 2016 was 62.90% compared with 60.27% for the first quarter of 2015. The higher efficiency ratio is a result of the higher noninterest expenses associated with our expansion initiatives and current 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 three months ended March 31, 2016, we recorded income tax expense of $2.7 million, versus $2.9 million a year ago. The effective tax rates for the first quarters of 2016 and 2015 were 26.4% and 29.8%, respectively. The decrease in income tax expense and 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 for 2016 and 2015 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.

 

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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  
     March 31, 2016      December 31, 2015  
     Amortized      Fair      Amortized      Fair  
     Cost      Value      Cost      Value  

Securities available for sale:

           

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

   $ 235,964       $ 241,463       $ 260,748       $ 260,863   

Mortgage-backed securities:

           

Agency mortgage-backed securities

     361,692         367,594         282,873         282,505   

Non-Agency mortgage-backed securities

     —           777         —           809   

Asset-backed securities

     —           179         —           218   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

     597,656         610,013         543,621         544,395   

Securities held to maturity:

           

State and political subdivisions

     291,934         300,477         294,423         300,981   

Mortgage-backed securities

     184,349         185,386         191,294         189,083   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity securities

     476,283         485,863         485,717         490,064   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 1,073,939       $ 1,095,876       $ 1,029,338       $ 1,034,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

The available for sale (“AFS”) investment securities portfolio increased $65.6 million or 12%, from $544.4 million at December 31, 2015 to $610.0 million at March 31, 2016. The AFS portfolio had net unrealized gains totaling $12.4 million and $774 thousand at March 31, 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”) with formal reviews performed quarterly. Declines in the fair value of held to maturity and available for sale securities 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 three month periods ended March 31, 2016 and 2015.

 

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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  
     March 31, 2016     December 31, 2015  
     Amount      % of
Total
    Amount      % of
Total
 

Commercial business

   $ 317,776         15.0   $ 313,758         15.0

Commercial mortgage

     590,316         27.9        566,101         27.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial

     908,092         42.9        879,859         42.2   

Residential real estate loans

     382,504         18.1        381,074         18.3   

Residential real estate lines

     126,526         6.0        127,347         6.1   

Consumer indirect

     679,846         32.1        676,940         32.5   

Other consumer

     18,066         0.9        18,542         0.9   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer

     1,206,942         57.1        1,105,594         57.8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

     2,115,034         100.0     2,083,762         100.0
     

 

 

      

 

 

 

Less: Allowance for loan losses

     27,568           27,085      
  

 

 

      

 

 

    

Total loans, net

   $ 2,087,466         $ 2,056,677      
  

 

 

      

 

 

    

Total loans increased $31.3 million to $2.12 billion at March 31, 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 $28.2 million and represented 42.9% of total loans as of March 31, 2016, a result of our continued commercial business development efforts.

The consumer indirect portfolio totaled $679.8 million and represented 32.1% of total loans as of March 31, 2016. During the first quarter of 2016, we originated $75.9 million in indirect auto loans with a mix of approximately 41% new auto and 59% used auto. During the first quarter of 2015, we originated $69.3 million in indirect auto loans with a mix of approximately 39% new auto and 61% 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 $609 thousand and $1.4 million as of March 31, 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 $192.6 million and $196.0 million as of March 31, 2016 and December 31, 2015, respectively.

 

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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 March 31,  
     2016     2015  

Balance as of beginning of period

   $ 27,085      $ 27,637   

Charge-offs:

    

Commercial business

     602        1,141   

Commercial mortgage

     4        609   

Residential real estate loans

     46        139   

Residential real estate lines

     4        —     

Consumer indirect

     2,498        2,422   

Other consumer

     157        259   
  

 

 

   

 

 

 

Total charge-offs

     3,311        4,570   

Recoveries:

    

Commercial business

     100        48   

Commercial mortgage

     5        89   

Residential real estate loans

     25        41   

Residential real estate lines

     4        2   

Consumer indirect

     1,170        1,105   

Other consumer

     122        98   
  

 

 

   

 

 

 

Total recoveries

     1,426        1,383   
  

 

 

   

 

 

 

Net charge-offs

     1,885        3,187   

Provision for loan losses

     2,368        2,741   
  

 

 

   

 

 

 

Balance at end of period

   $ 27,568      $ 27,191   
  

 

 

   

 

 

 

Net loan charge-offs to average loans (annualized)

     0.36     0.68

Allowance for loan losses to total loans

     1.30     1.41

Allowance for loan losses to non-performing loans

     322     246

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 March 31, 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 $1.9 million in the first quarter of 2016 represented 0.36% of average loans on an annualized basis compared to $3.2 million or 0.68% in the first quarter of 2015. The first quarter of 2015 included charge-offs for two commercial loan relationships totaling $1.7 million. The allowance for loan losses was $27.6 million at March 31, 2016, compared with $27.1 million at December 31, 2015. The ratio of the allowance for loan losses to total loans was 1.30% at March 31, 2016 and December 31, 2015. The ratio of allowance for loan losses to non-performing loans was 322% at March 31, 2016, compared with 321% at December 31, 2015.

 

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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  
     March 31,     December 31,  
     2016     2015  

Nonaccrual loans:

    

Commercial business

   $ 4,056      $ 3,922   

Commercial mortgage

     1,781        947   

Residential real estate loans

     1,601        1,848   

Residential real estate lines

     165        235   

Consumer indirect

     943        1,467   

Other consumer

     12        13   
  

 

 

   

 

 

 

Total nonaccrual loans

     8,558        8,432   

Accruing loans 90 days or more delinquent

     9        8   
  

 

 

   

 

 

 

Total non-performing loans

     8,567        8,440   

Foreclosed assets

     187        163   
  

 

 

   

 

 

 

Total non-performing assets

   $ 8,754      $ 8,603   
  

 

 

   

 

 

 

Non-performing loans to total loans

     0.41     0.41

Non-performing assets to total assets

     0.25     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 months ended March 31, 2016 was as follows (in thousands):

 

Nonaccrual loans at December 31, 2015

   $ 8,432   

Additions

     6,005   

Payments

     (1,962

Charge-offs

     (3,234

Returned to accruing status

     (543

Transferred to other real estate or repossessed assets

     (140
  

 

 

 

Nonaccrual loans at March 31, 2016

   $ 8,558   
  

 

 

 

Non-performing assets include non-performing loans and foreclosed assets. Non-performing assets at March 31, 2016 were $8.8 million, an increase of $151 thousand from the $8.6 million balance at December 31, 2015. The primary component of non-performing assets is non-performing loans, which were $8.6 million or 0.41% of total loans at March 31, 2016, compared with $8.4 million or 0.41% of total loans at December 31, 2015.

Approximately $1.8 million, or 21%, of the $8.6 million in non-performing loans as of March 31, 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 $2.8 million and $2.4 million at March 31, 2016 and December 31, 2015, respectively. We had no TDRs that were accruing interest as of March 31, 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 two properties totaling $187 thousand at March 31, 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 $9.3 million and $12.1 million in loans that continued to accrue interest which were classified as substandard as of March 31, 2016 and December 31, 2015, respectively.

 

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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  
     March 31, 2016     December 31, 2015  
     Amount      % of
Total
    Amount      % of
Total
 

Noninterest-bearing demand

   $ 617,394         20.9   $ 641,972         23.5

Interest-bearing demand

     622,443         21.0        523,366         19.2   

Savings and money market

     1,042,910         35.2        928,175         34.0   

Certificates of deposit < $250,000

     575,621         19.5        545,044         19.9   

Certificates of deposit of $250,000 or more

     101,809         3.4        91,974         3.4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total deposits

   $ 2,960,177         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 March 31, 2016, total deposits were $2.96 billion, representing an increase of $229.6 million for the year. Time deposits were approximately 23% of total deposits at March 31, 2016 and December 31, 2015. Depositors remain hesitant to invest in time deposits, such as certificates of deposit, for long periods due to the low interest rate environment. This has resulted in lower amounts being placed in time deposits for generally shorter terms.

Nonpublic deposits, the largest component of our funding sources, totaled $2.07 billion and $2.05 billion at March 31, 2016 and December 31, 2015, respectively, and represented 70% and 75% 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 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 $888.0 million and $675.7 million at March 31, 2016 and December 31, 2015, respectively, and represented 30% 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 March 31, 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 $120.9 million and $153.7 million, respectively, at March 31, 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):

 

     March 31,      December 31,  
     2016      2015  

Short-term borrowings - Short-term FHLB borrowings

   $ 179,200       $ 293,100   

Long-term borrowings - Subordinated notes

     39,008         38,990   
  

 

 

    

 

 

 

Total borrowings

   $ 218,208       $ 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 $193 million of immediate credit capacity with the FHLB as of March 31, 2016. We had approximately $500 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) discount window, none of which was outstanding at March 31, 2016. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had approximately $120 million of credit available under unsecured federal funds purchased lines with various banks as of March 31, 2016. Additionally, we had approximately $180 million of unencumbered liquid securities available for pledging.

 

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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 March 31, 2016 consisted of $8.5 million in overnight borrowings and $170.7 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 March 31, 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.

Liquidity for the Bank is managed through 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 $179.2 million outstanding at March 31, 2016. In addition to this amount, we have additional collateralized wholesale borrowing capacity of approximately $800 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 March 31, 2016. The line of credit has a one year term and matures in May 2016. Funds drawn would be used for general corporate purposes and backup liquidity.

Cash and cash equivalents were $110.9 million as of March 31, 2016, up $50.8 million from $60.1 million as of December 31, 2015. Net cash provided by operating activities totaled $17.0 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 $79.0 million, which included outflows of $33.3 million for net loan originations and $44.9 million from net investment securities transactions. Net cash provided by financing activities of $112.8 million was attributed to a $229.6 million increase in deposits, partly offset by a $113.9 million decrease in short-term borrowings and $3.2 million in dividend payments. The higher cash and cash equivalents balance resulted from strong public deposit inflows at the end of the first quarter of 2016.

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 the Bank 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.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Shareholders’ equity was $314.0 million at March 31, 2016, an increase of $20.1 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 $7.6 million and $8.1 million, respectively, which were partially offset by common and preferred stock dividends declared of $3.2 million. Accumulated other comprehensive income included in shareholders’ equity increased $7.2 million during the first three 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 March 31, 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):

 

     March 31,     December 31,  
     2016     2015  

Common shareholders’ equity

   $ 296,613      $ 276,504   

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

     69,349        61,217   

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

     6,387        (696

Net periodic pension & postretirement benefits plan adjustments

     (10,492     (10,631

Other

     246        201   
  

 

 

   

 

 

 

Common equity Tier 1 (“CET1”) capital

     231,123        226,413   

Plus: Preferred stock

     17,340        17,340   

Less: Other

     164        301   
  

 

 

   

 

 

 

Tier 1 Capital

     248,299        243,452   

Plus: Qualifying allowance for loan losses

     27,568        27,085   

Subordinated Notes

     39,008        38,990   
  

 

 

   

 

 

 

Total regulatory capital

   $ 314,875      $ 309,527   
  

 

 

   

 

 

 

Adjusted average total assets (for leverage capital purposes)

   $ 3,330,552      $ 3,287,646   
  

 

 

   

 

 

 

Total risk-weighted assets

   $ 2,351,522      $ 2,318,536   
  

 

 

   

 

 

 

Regulatory Capital Ratios

    

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

     7.46     7.41

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

     9.83        9.77   

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

     10.56        10.50   

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

     13.39        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 will be phased-in beginning 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.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

 

The following table presents actual and required capital ratios as of March 31, 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  

March 31, 2016

                    

Tier 1 leverage:

                    

Company

   $ 248,299         7.46   $ 133,222         4.00   $ 133,222         4.00   $ 166,528         5.00

Bank

     269,909         8.13        132,840         4.00        132,840         4.00        166,050         5.00   

CET1 capital:

                    

Company

     231,123         9.83        120,518         5.13        164,607         7.00        152,849         6.50   

Bank

     269,909         11.53        119,991         5.13        163,890         7.00        152,183         6.50   

Tier 1 capital:

                    

Company

     248,299         10.56        155,788         6.63        199,879         8.50        188,122         8.00   

Bank

     269,909         11.53        155,110         6.63        199,009         8.50        187,303         8.00   

Total capital:

                    

Company

     314,875         13.39        202,819         8.63        246,910         10.50        235,152         10.00   

Bank

     297,477         12.71        201,936         8.63        245,835         10.50        234,128         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.

 

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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 March 31, 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 March 31, 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 March 31, 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

   $ (1,436   $ 1,889      $ 4,366      $ 3,847   

% Change

     (1.40 )%      1.85     4.27     3.76

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 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).

 

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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 March 31, 2016 and December 31, 2015. The analysis additionally presents a measurement of the interest rate sensitivity at March 31, 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.

 

     March 31, 2016     December 31, 2015  
     EVE      Change     Percentage
Change
    EVE      Change     Percentage
Change
 

Rate Shock Scenario:

              

Pre-Shock Scenario

   $ 505,174           $ 497,349        

- 100 Basis Points

     537,090       $ 31,916        6.32     508,973       $ 11,624        2.34

+ 100 Basis Points

     487,993         (17,181     (3.40     480,888         (16,461     (3.31

+ 200 Basis Points

     468,578         (36,596     (7.24     460,567         (36,782     (7.40

+ 300 Basis Points

     435,502         (69,672     (13.79     429,381         (67,968     (13.67

The Pre-Shock Scenario EVE was $505.2 million at March 31, 2016, compared to $497.3 million at December 31, 2015. The increase in the Pre-Shock Scenario EVE at March 31, 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 $468.6 million at March 31, 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 (7.24)% at March 31, 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 March 31, 2016, compared to December 31, 2015.

 

ITEM 4. Controls and Procedures

Evaluation of disclosure controls and procedures

As of March 31, 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 March 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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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 the percentage of 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.

 

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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

  10.1    Form of Restricted Stock Unit Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan    Filed Herewith
  10.2    Form of Performance Stock Unit Award Agreement Pursuant to the Financial Institutions, Inc. 2015 Long-Term Incentive Plan    Filed Herewith
  10.3    Consulting Agreement, dated April 1, 2016, by and between the Company and Richard J. Harrison.    Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated March 31, 2016
  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   

 

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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

       , May 6, 2016
Martin K. Birmingham   
President and Chief Executive Officer   
(Principal Executive Officer)   

/s/ Kevin B. Klotzbach

       , May 6, 2016
Kevin B. Klotzbach   
Executive Vice President, Chief Financial Officer and Treasurer   
(Principal Financial Officer)   

/s/ Michael D. Grover

       , May 6, 2016
Michael D. Grover   
Senior Vice President and Chief Accounting Officer   
(Principal Accounting Officer)   

 

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