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Today is tomorrow in progress
Financial Institutions, Inc. 2017 Annual Report
Corporate
Profile
Financial Institutions, Inc. provides diversified financial services through its subsidiaries Five Star Bank, Scott Danahy
Naylon and Courier Capital.
Five Star Bank provides a wide range of consumer and commercial banking and lending services to individuals,
municipalities and businesses through a network of more than 50 offices throughout Western and Central New York State.
Scott Danahy Naylon provides a broad range of insurance services to personal and business clients across 45 states.
Courier Capital provides customized investment management, investment consulting and retirement plan services to
individuals, businesses, institutions, foundations and retirement plans.
Financial Institutions, Inc. and its subsidiaries employ approximately 650 individuals.
Financial Institutions, Inc. 2017 Annual Report
I am very proud of our many accomplishments
in 2017 and the team that made them happen.
We remained focused on the thoughtful
execution of our long-term strategic plan to
drive responsible and sustainable growth.
Investments were made in people, initiatives
and our communities that will help us achieve
our long-term goals. Importantly, we delivered
solid financial results in a
challenging interest rate
environment by focusing
on our customers and
managing risk effectively.
Martin K. Birmingham (President and Chief Executive
Officer) and Robert N. Latella (Chairman of the Board)
Financial Institutions, Inc. 2017 Annual Report
2017 Results
Strong loan growth
contributed to a 10%
increase in net interest
income.
This, combined with the positive impact
of deposit growth and continued expense
discipline, resulted in net income of
$33.5 million, $1.6 million higher than 2016.
Diluted earnings per share in 2017 was
$2.13, as compared to $2.10 in 2016.
Total loans at year-end
were $2.74 billion, 17%
higher than in 2016.
Commercial loans totaled $1.26 billion,
representing a 24% increase, and
consumer loans grew 12% to $1.48 billion.
This exceptionally strong loan growth
was driven by the addition of key
lenders, as well as our success in taking
advantage of banking disruption in the
marketplace. These outcomes confirm
the attractiveness and growing enthusiasm
for our community banking organization
in the markets we are serving.
Total deposits at year-
end were $3.21 billion,
7% higher than in
2016, while non-public
deposits increased 9%.
We remain focused on leveraging our
attractive deposit franchise and will
continue to deploy tactics to maximize
core deposit growth in 2018.
We remained focused on continued
expense management discipline. Our 2017
efficiency ratio of 60.65% ranked in the
top one-third of companies included in
the SNL U.S. Bank $1B to $5B Index.
02
Loans (Net)
[$ in Billions]
$2.50
$2.00
$1.50
$2.06
$1.88
$1.81
$2.70
$2.31
‘13 ‘14 ‘15 ‘16 ‘17
Deposits
[$ in Billions]
$3.00
$2.50
$2.00
$2.73
$2.45
$2.32
$3.21
$3.00
‘13 ‘14 ‘15 ‘16 ‘17
Key credit statistics in 2017 were in-line with
historical experience. Our net charge-offs
to average loans ratio of 38 basis points
was one basis point below our ten-year
average, and non-performing loans to
total loans ratio of 46 basis points was 10
basis points below our ten-year average.
We added credit professionals in 2017 to
further support our disciplined credit culture.
Positive measures of our 2017 actions and
efforts were increases in common book
value per share, from $20.82 at December 31,
2016, to $22.85 at December 31, 2017, and
tangible common book value per share*,
from $15.62 at December 31, 2016, to $18.16
at December 31, 2017.
Long-term growth
in progress
Capital to Support Growth
We took advantage of favorable capital
market conditions last year to complete
an equity offering. Between May and
November of 2017, we sold 1.4 million
shares of common stock at a weighted
average price of $29.33 through an
at-the-market offering. Gross proceeds
of $40.0 million were generated and net
proceeds of $38.3 million were realized.
This increase in capital supports our
growth strategies, enabling us to take
advantage of current opportunities in
our markets and strengthening our capital
ratios. Our common equity to assets
ratio grew to 8.86% at year-end from
8.16% in 2016, and our tangible common
equity to tangible assets ratio* grew to
7.17% at year-end from 6.25% in 2016.
While dilution to earnings per share and
the impact on stock price were negative
results in the short-term, we firmly believe
that this capital raise was the right
action to take for the long-term interests
of our Company and our shareholders.
Growing Wealth Management
In August 2017, our Courier Capital
subsidiary acquired the assets of
Robshaw & Julian Associates, Inc.,
a registered investment advisor based
in the Buffalo suburb of Williamsville,
New York. Steve Robshaw and Jim
Julian and their team are respected
investment professionals who built a
successful business characterized by
long and loyal client relationships
in greater Buffalo. At the time of closing,
Robshaw & Julian’s assets under
management were approximately
$175 million, increasing Courier Capital’s
total assets under management to
approximately $1.6 billion. This transaction
expands our wealth assets under
management and furthers our
strategy to increase fee-based
noninterest income.
Net Income &
Earnings per Share
[$ in Millions, except per share amounts]
. Net Income Available to Common Shareholders
. Diluted Earnings per Share
. Cash Dividends Declared per Share
$32.1
Common Book Value
& Tangible Common
Book Value*
. Common Book Value
. Tangible Common
Book Value
$22.85
$19.49
$18.57
$20.82
$20
$18.16
$30.5
$30
$17.17
$27.9
$26.9
$24.1
$2.00
$1.90
$1.75
$15.62
$14.77
$13.71
$2.13
$2.10
$20
$13.56
$15
$10
$0.80
$0.81
$0.85
$10
$0.77
$0.74
‘13 ‘14 ‘15 ‘16 ‘17
‘13 ‘14 ‘15 ‘16 ‘17
Dividends
In November 2017, the Company’s Board
of Directors increased the quarterly
dividend to common shareholders by
5%, to $0.22 per share per quarter.
In February 2018, the dividend was
increased by an additional 9%, to
$0.24 per share per quarter. We have a
demonstrated history of strong dividend
growth and a strong commitment to this
component of the shareholder experience.
Downtown Buffalo Financial
Solution Center
In February 2017, we opened a new
financial solution center at Fountain
Plaza in downtown Buffalo. This is our
first bank branch in the City of Buffalo
and our fourth in Erie County. It is an
ideal location for us to expand in the
Buffalo market and serve the needs of
downtown residents, businesses and
workers. This branch is an excellent
foundation for our continued growth
in Buffalo and Western New York. Both
the downtown Buffalo branch and the
financial solution center we opened in
downtown Rochester in December
2016 continue to grow and signal our
commitment to two key upstate New
York cities that represent significant
growth opportunities for the Company.
03
* Non-GAAP measure; refer to GAAP to Non-GAAP reconciliation on page 33
Financial Institutions, Inc. 2017 Annual Report
Expanding Residential Mortgage Loan Business
Residential mortgage lending is a fundamental line of business
for a high-performing community bank to appropriately serve
its customers and its communities. We made significant
progress on our priority to grow Five Star Bank’s residential
mortgage lending business in 2017. Eight mortgage loan
officers were hired, along with the back-office support
personnel necessary to underwrite and process their
production. We believe that this is the right time to expand
our residential mortgage lending capabilities, capitalizing
on market disruption and creating relationships with new
customers across all our lines of business–banking,
investment, and insurance.
With the addition of most of the aforementioned mortgage
loan officers occurring mid-year 2017, we saw our pipeline
and production increase as the year progressed. By year-
end, the pipeline was indicative of all our loan officers
producing at near capacity, which is expected to drive
increases in all aspects of our residential mortgage lending
program in 2018.
Omni-Channel Retail Delivery Platform
Our retail transformation journey continued in 2017, driven by
changing customer behaviors. Customer motivations for using
the branch have continued to shift away from transactions
toward a need for financial counseling and financial solutions.
This continued evolution prompted us to transform our branch
staff to serve as consultative solution providers, while offering
technologies that continue to support the migration of
transactions to alternative channels (web, mobile, ATM, phone).
These behavioral shifts have influenced our approach to our
branch model and our alternative channels, as we strive to
create an omni-channel distribution platform that meets our
customers’ needs and ensures that we are keeping their
financial well-being at the heart of everything we do.
In 2017, we made significant progress on the transition
of our staff from traditional teller and platform roles
to that of a universal banker, which we refer to as
our Certified Personal Banker. We improved staff
efficiencies and the customer experience by developing
colleagues who can individually address most of our
customers’ financial needs. We also augmented the
interiors of our traditional branches to provide new
technologies, simplify processes and remove barriers
to enhance the branch experience.
We continually seek convenient banking
solutions that meet our customers’ needs.
In the fall of 2017, we partnered with Allpoint
Network to offer our customers access to 55,000
surcharge-free ATMs worldwide. This partnership
serves as a valuable expansion of our ATM network,
making cash access quick, easy and surcharge-free.
Collectively, these efforts support our omni-channel
delivery platform, maximizing our branches’ ability to
offer financial solutions and enabling our customers
to have the same great experience, whether they are
seeking self-service, assisted service or a full-service
banking experience.
Launching a New Brand
In February 2018, we launched our new brand campaign.
This campaign is designed to increase awareness of
the depth of services we offer in community banking,
wealth management and insurance, and to increase
awareness of Five Star Bank in key urban growth
markets where our share of deposits is currently less
than 4%. Our campaign line of “Today is tomorrow in
progress” conveys our customer promise and reinforces
our goal of providing solutions today that lead to
financial well-being in the future.
04
Five Star brand
in progress
05
Financial Institutions, Inc. 2017 Annual Report
A Five Star Experience
Another major focus of the rebrand was overhauling
the Five Star Bank website, one of the pillars of a
successful omni-channel customer experience.
In addition to the visual transformation reflecting
the new brand’s look and feel, we’ve improved the
site’s functionality and navigation, making it easier
for our customers to use. Plus, we’ve updated
its content with more relevant and helpful
information. These enhancements reach across
all digital devices, promising a great user
experience whether on a computer, tablet, or
mobile phone. Early-mid Q1 2018 results show
these efforts have not been in vain, with terrific
growth in both customer awareness and satisfaction:
Total Users: Up 37% versus Feb/Mar 2017
New Users: Up 51% versus Feb/Mar 2017
Sessions: Up 20% versus Feb/Mar 2017
Mobile Users: More than double Feb/Mar 2017
06
Transformation
in progress
Employee and Customer Engagement
Investing in Our Communities
The most vital part of our past, current and future success
is the Five Star family–all of the employees of Five Star
Bank, Courier Capital and Scott Danahy Naylon. Their
diligence, dedication and commitment are critical to the
realization of our vision. Simultaneously with the brand
launch, we updated our internal Five Star Experience
cultural framework to ensure alignment with our new
brand promise and to power employee and customer
engagement.
Our Promise:
We put our customers’ financial well-being at the
heart of everything we do.
Our Promise Means:
• We work as a team in a welcoming environment
of trust, integrity and respect where success is
recognized and careers are encouraged.
• We know our customers and respond with solutions
that improve their financial well-being.
• We are committed to meeting the needs of
the communities we live and work in, and the
performance expectations of our shareholders.
As a community bank, we understand that our success is
directly linked to the success of our communities. We invest
in and support our communities in many ways, including
volunteer activities, charitable investments and product
offerings.
• We support our employees volunteering in the community
with paid time off. In addition to this program, employees
volunteer for events across our geographic footprint
and support more than 400 different community and
professional organizations as volunteers, trustees and
committee members.
• We are proud to support many organizations in the
markets we serve through donations and community
sponsorships.
• Our comprehensive product offerings include several
products tailored to meet the needs of the under-
banked or low-to-moderate income residents in the
communities we serve, including programs to assist
home buyers with grants and savings programs.
To further our commitment to support the communities
we serve, we added a Community Development Officer
and two Community Development Loan Officers in 2017.
Our Community Development Officer is responsible for
overseeing, coordinating and providing strategic direction
for Five Star Bank’s Community Reinvestment Act (“CRA”)
related programming and outreach programs throughout
the Bank’s footprint. Our Community Development
Loan Officers play important roles in the execution
of the Bank’s CRA program to increase access to
residential loans and low-cost deposit product opportunities
in low-to-moderate income neighborhoods, and promote
financial literacy workshops.
07
Financial Institutions, Inc. 2017 Annual Report
Impact of Tax Cuts and Jobs Act
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, reducing the
federal corporate tax rate. Tax reform will reduce our federal income tax rate in 2018
and provide opportunities to strengthen relationships with our employees, our customers
and the communities in which we operate.
In February 2018, a one-time award of $500 was paid to employees not covered by
certain incentive programs, or approximately 70% of our employees. These employees
are also eligible to receive additional compensation based on the Company’s 2018
performance, aligning them with corporate strategies.
We continue to evaluate the full impact of tax reform on our business and will be
thoughtful in determining how to maximize the benefits resulting from tax reform.
Conclusion
2017 was an eventful year for us as we made progress on our strategic goals and
invested in our organization for future growth. We also surpassed $4 billion in total
assets during the year, a significant milestone that was achieved through teamwork
and the successful execution of our long-term strategy.
I am encouraged about our Company’s prospects. There are many opportunities
available to us and we have a distinct competitive advantage as we are well-positioned
to deliver an energized and locally-focused community financial services platform.
I look forward with excitement to the possibilities that 2018 has in store.
Thank you for your support and investment in Financial Institutions, Inc. We look
forward to delivering another strong year for our Company.
Cordially,
Martin K. Birmingham
President & CEO
08
Five Star Leadership
Five Star Bank
Executive Management
Martin K. Birmingham 1
President and Chief Executive Officer
William L. Kreienberg 1
Executive Vice President, Chief Corporate
Development Executive and General Counsel
Kevin B. Klotzbach 1
Executive Vice President, Chief Financial
Officer and Treasurer
Michael D. Burneal 1
Senior Vice President, Chief Risk and
Enterprise Administration Officer
Paula D. Dolan 1
Senior Vice President, Director of Human
Resources and Enterprise Planning, Diversity
and Inclusion Officer
Joseph L. Dugan
Senior Vice President, Retail Growth and
Profitability Executive
Charles J. Guarino
Senior Vice President, Chief Retail Lending
Executive
Five Star Bank
Senior Management
Jeffrey P. Kenefick
Executive Vice President, Commercial
Market Executive and Southern Tier
Regional President
Thomas K. Arcuri
Senior Vice President, Senior Commercial
Banker
Scott D. Bader
Senior Vice President, Technology Services
Director
Shelly J. Doran
Senior Vice President, Director of
Investor and External Relations
Sonia M. Dumbleton 1
Senior Vice President, Controller
and Corporate Secretary
Jon M. Fogle
Senior Vice President, Commercial
Market Executive and Rochester
Regional President
Karla J.L. Gadley
Senior Vice President, Community
Development Officer
Michael D. Grover 1
Senior Vice President, Chief Accounting
Officer, Financial Reporting and Tax
Manager
Edward “Ted” S. Oexle
Senior Vice President,
C&I Lending Executive
and Buffalo Regional President
Randall R. Phillips
Senior Vice President, Loan Review
Administrator
Brenda B. Schell
Senior Vice President, Audit Manager
Sean M. Willett
Senior Vice President,
Director of Internal Audit
Steven L. Yantz
Senior Vice President, Commercial
Market Executive
David A. Young
Senior Vice President,
Senior Commercial Banker
Scott Danahy Naylon, LLC
Samuel J. Burruano, Jr.
Senior Vice President, Associate General
Counsel and Director of Regulatory Compliance
William E. Gallagher
Managing Director
Craig J. Burton
Senior Vice President, Commercial Real
Estate Executive
Vito Caraccio
Senior Vice President, Business Banking
Executive
David G. Case
Senior Vice President,
Chief Commercial Credit Officer
Courier Capital, LLC
Thomas J. Hanlon
Executive Vice President,
Chief Operating Officer
William H. Gurney
Executive Vice President
James P. Julian
Executive Vice President
Bruce Kaz
Executive Vice President
Randy M. Ordines
Executive Vice President
Stephen R. Robshaw
Executive Vice President
Board of Directors
Karl V. Anderson, Jr. 2 3 6
Of Counsel at Snavely, Plaskov and
Mullen, PLLC
Martin K. Birmingham
President and CEO of Financial
Institutions, Inc. and Five Star Bank
Donald K. Boswell 2 6
President and CEO of the Western New
York Public Broadcasting Association
(WNED-TV and WBFO-FM)
Dawn H. Burlew 6
Director of Business Development at
Corning Enterprises
Andrew W. Dorn, Jr. 3 4
Co-Managing Director and Director of
Government and Community Relations
of Energy Solutions Consortium, LLC
Robert M. Glaser 2 3
President of Glaser Consulting, LLC
Samuel M. Gullo 2 4
Owner and Operator of Family Furniture
Susan R. Holliday 3 5 6
CEO of Dumbwaiter Design, LLC
Erland E. Kailbourne 3 4 5
Chairman of Albany International
Corporation and Rand Capital Corporation
Robert N. Latella 3
Chairman of Financial Institutions, Inc.
and Five Star Bank; Of Counsel at
Barclay Damon, LLP; and COO of
Integrated Nano-Technologies, LLC
Kim E. VanGelder 5 6
Chief Information Officer and Senior
Vice President of Eastman Kodak
Company
James H. Wyckoff, PhD 4 5
University of Virginia Curry Memorial
Professor of Education and Policy and
Director of the Center for Education
Policy and Workforce Competitiveness
1 Also a Financial Institutions, Inc. officer
2 Audit Committee; Robert M. Glaser, Chair
3 Executive Committee; Erland E. Kailbourne, Chair
4 Management Development and Compensation Committee; Andrew W. Dorn, Jr., Chair
5 Nominating and Governance Committee; Susan R. Holliday, Chair
6 Risk Oversight Committee; Karl V. Anderson, Jr., Chair
Five Year
Financial Highlights
(Dollars in thousands, except per share data)
Selected financial condition data:
Total assets
Loans, net
Investment securities
Deposits
Borrowings
Shareholders’ equity
Common shareholders’ equity
Tangible common shareholders’ equity
(1)
Selected operations data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income a er provision for loan losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense
Net income
Preferred stock dividends
Net income available to common shareholders
Stock and related per share data:
Earnings per common share:
Basic
Diluted
Cash dividends declared per common share
Common book value per share
Tangible common book value per share
Market price (NASDAQ: FISI):
High
Low
Close
(1)
rmance and Capital ratios:
Pe
Net income, returns on:
Average assets
Average equity
Common dividend payout ratio
Net interest margin (fully
E ective tax rate
E ciency ratio (2)
Common equity to assets
Tangible common equity to tangible assets (1)
tax-equivalent)
Other data:
Number of branches
Full time equivalent employees
2017
At or for the year ended December 31,
2015
2014
2016
2013
$ 4,105,210
2,700,345
1, 041,439
3,210,174
485,331
381,177
363,848
289,145
$ 3,710,340
2,309,227
1,083,264
2,995,222
370,561
320,054
302,714
227,074
$ 3,381,024
2,056,677
1,030,112
2,730,531
332,090
293,844
276,504
209,558
$ 3,089,521
1,884,365
916,932
2,450,527
334,804
279,532
262,192
193,553
$ 2,928,636
1,806,883
859,185
2,320,056
337,042
254,839
237,497
187,495
$
$
$
$
$
$
$
$
$
$
$
130,110
17,495
112,615
13,361
99,254
34,730
90,513
43,471
9,945
33,526
1,462
32,064
$
$
$
115,231
12,541
102,690
9,638
93,052
35,760
84,671
44,141
12,210
31,931
1,462
30,469
$
$
$
105,450 $
10,137
95,313
7,381
87,932
30,337
79,393
38,876
10,539
28,337 $
1,462
26,875 $
101,055 $
7,281
93,774
7,789
85,985
25,350
72,355
38,980
9,625
29,355 $
1,462
27,893 $
98,931
7,337
91,594
9,079
82,515
24,833
69,441
37,907
12,377
25,530
1,466
24,064
2.13
2.13
0.85
22.85
18.16
$
$
$
$
$
35.40
25.65
31.10
$
$
$
2.11
2.10
0.81
20.82
15.62
$
$
$
$
$
34.55
25.98
34.20
$
$
$
1.91 $
1.90 $
0.80 $
19.49 $
14.77 $
29.04 $
21.67 $
28.00 $
2.01 $
2.00 $
0.77 $
18.57 $
13.71 $
27.02 $
19.72 $
25.15 $
1.75
1.75
0.74
17.17
13.56
26.59
17.92
24.71
0.86%
9.62%
39.91%
3.21 %
22.9%
60.65%
8.86%
7.17%
0.90%
10.01%
38.39%
3.24%
27.7%
60.95%
8.16%
6.25%
0.87%
9.78%
41.88%
3.28%
27.1%
62.44%
8.18%
6.32%
0.98%
10.80%
38.31%
3.50%
24.7%
59.18%
8.49%
6.41%
0.91%
10.10%
42.29%
3.64%
32.7%
58.92%
8.11%
6.51%
53
639
52
631
50
660
49
622
50
608
(1) This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the GAAP to Non-GAAP Reconciliation on page 33 for further information.
(2) Efficiency ratio provides a ratio of operating expenses to operating income. Efficiency ratio is calculated by dividing noninterest expense by net revenue, which is defined as the sum of
tax-equivalent net interest income and noninterest income before net gains on investment securities. The efficiency ratio is not a financial measurement required by GAAP. However, the
efficiency ratio is used by management in its assessment of financial performance specifically as it relates to noninterest expense control. Management also believes such information is
useful to investors in evaluating Company performance.
10
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
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
FINANCIAL INSTITUTIONS, INC.
(Exact name of registrant as specified in its charter)
NEW YORK
(State or other jurisdiction of incorporation or organization)
220 LIBERTY STREET, WARSAW, NEW YORK
(Address of principal executive offices)
Registrant’s telephone number, including area code:
(585) 786-1100
16-0816610
(I.R.S. Employer Identification No.)
14569
(ZIP Code)
Securities registered under Section 12(b) of the Exchange Act:
Title of each class
Common stock, par value $.01 per share
Name of exchange on which registered
NASDAQ Global Select Market
Securities registered under Section 12(g) of the Exchange Act:
NONE
Indicate by check mark if the regsitrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No
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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2)
Yes No
has been subject to such filing requirements for the past 90 days.
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 No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not
contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth
compant” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes No
The aggregate market value of the registrant’s common stock, par value $0.01 per share, held by non-affiliates of the registrant, as
computed by reference to the June 30, 2017 closing price reported by NASDAQ, was approximately $427,573,000.
As of February 23, 2018, there were outstanding, exclusive of treasury shares, 15,904,403 shares of the registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2018 Annual Meeting of Shareholders are incorporated by reference in Part III of this
Annual Report on Form 10-K.
TABLE OF CONTENTS
PART I
PAGE
Item 1.
Business.….……………………………………………………………………………………..…...............................
Item 1A.
Risk Factors………………………………………………………………………………….........................................
Item 1B.
Unresolved Staff Comments……………………………………………………………................................................
Item 2.
Properties…………………..………………………………………………………………….......................................
Item 3.
Legal Proceedings…………………………………………………………………………............................................
Item 4.
Mine Safety Disclosures..….……………………………………………………………………………………...........
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities......
Item 6.
Selected Financial Data…………………………………………………………………................................................
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations..........................................
Item 7A. Quantitative and Qualitative Disclosures About Market Risk…….................................................................................
Item 8.
Financial Statements and Supplementary Data………………………………................................................................
4
20
29
29
29
29
30
31
36
58
61
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure……….............................. 122
Item 9A. Controls and Procedures………………………………………………………………..................................................
122
Item 9B. Other Information…………………………………………………………………………............................................
122
PART III
Item 10.
Directors, Executive Officers and Corporate Governance......……….....……................................................................ 123
Item 11.
Executive Compensation………………………………………………………………….............................................
123
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters........................ 123
Item 13.
Certain Relationships and Related Transactions, and Director Independence………………………………………....
123
Item 14.
Principal Accounting Fees and Services.......................................................................................................................... 123
PART IV
Item 15.
Exhibits and Financial Statement Schedules.………………………………….............................................................. 124
Item 16.
Form 10-K Summary…………………........................................................................................................................... 126
Signatures........................................................................................................................................................................
127
FORWARD LOOKING INFORMATION
PART I
Statements and financial analysis contained in this Annual Report on Form 10-K that are based on other than historical data are forward-
looking 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” or “FII”) and its subsidiaries
(collectively, 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 Annual Report on 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 material 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 and liabilities 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, SDN, 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;
• We may be unable to successfully implement our growth strategies, including the integration and successful management of
newly-acquired businesses;
• We are subject to environmental liability risk associated with our lending activities;
• Our commercial business and mortgage 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 any adverse regulatory action may result in additional costs, loss of business opportunities, and
reputational damage;
• We make certain assumptions and estimates in preparing our financial statements that may prove to be incorrect, which could
significantly impact our results of operations, cash flows and financial condition, and we are subject to new or changing
accounting rules and interpretations, and the failure by us to correctly interpret or apply these evolving rules and interpretations
could have a material adverse effect;
• Legal and regulatory proceedings and related matters could adversely affect us;
• A breach in security of our or third party information systems, including the occurrence of a cyber incident or a deficiency in
cybersecurity, or a failure by us to comply with enhanced New York State cybersecurity regulations, 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 policies of the Federal Reserve 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;
• 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;
• 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;
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• 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, of this
Annual Report on 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.
ITEM 1. BUSINESS
GENERAL
The Parent is a financial holding company organized in 1931 under the laws of New York State (“New York” or “NYS”). The principal
office of the Parent is located at 220 Liberty Street, Warsaw, New York 14569 and its telephone number is (585) 786-1100. The Parent
was incorporated on September 15, 1931, but the continuity of the Company’s banking business is traced to the organization of the
National Bank of Geneva on March 28, 1817. Except as the context otherwise requires, the Parent and its direct and indirect
subsidiaries are collectively referred to in this report as the “Company.” Five Star Bank is referred to as “Five Star Bank,” “FSB” or
“the Bank,” Scott Danahy Naylon, LLC is referred to as “SDN” and Courier Capital, LLC is referred to as “Courier Capital.” The
consolidated financial statements include the accounts of the Parent, the Bank, SDN and Courier Capital. The Parent’s common stock is
traded on the NASDAQ Global Select Market under the ticker symbol “FISI.”
At December 31, 2017, the Company had consolidated total assets of $4.11 billion, deposits of $3.21 billion and shareholders’ equity of
$381.2 million.
The Parent’s primary business is the operation of its subsidiaries. It does not engage in any other substantial business activities. The
Parent’s three direct wholly-owned subsidiaries are: (1) the Bank, which provides a full range of banking services to consumer,
commercial and municipal customers in Western and Central New York; (2) SDN, which sells various premium-based insurance
policies on a commission basis to commercial and consumer customers; and (3) Courier Capital, which provides customized investment
management, investment consulting and retirement plan services to individuals, businesses, institutions, foundations and retirement
plans. At December 31, 2017, the Bank represented 99.1%, SDN represented 0.5% and Courier Capital represented 0.3% of the
consolidated assets of the Company. Further discussion of our segments is included in Note 21 to the Company’s Consolidated
Financial Statements included under Item 8 of this Annual Report on Form 10-K.
Five Star Bank
The Bank is a New York chartered bank that has its headquarters at 55 North Main Street, Warsaw, NY, and a total of 53 full-service
banking offices in the New York State counties of Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston,
Monroe, Ontario, Orleans, Seneca, Steuben, Wyoming and Yates counties.
At December 31, 2017, the Bank had total assets of $4.07 billion, investment securities of $1.04 billion, net loans of $2.70 billion,
deposits of $3.22 billion and shareholders’ equity of $382.5 million, compared to total assets of $3.68 billion, investment securities of
$1.08 billion, net loans of $2.31 billion, deposits of $3.01 billion and shareholders’ equity of $318.5 million at December 31, 2016. The
Bank offers deposit products, which include checking and NOW accounts, savings accounts, and certificates of deposit, as its principal
source of funding. The Bank’s deposits are insured up to the maximum permitted by the Bank Insurance Fund (the “Insurance Fund”)
of the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers a variety of loan products to its customers, including
commercial and consumer loans and commercial and residential mortgage loans.
Scott Danahy Naylon, LLC
Acquired in August 2014, SDN is a full-service insurance agency founded in 1923 and headquartered in Amherst, NY. SDN offers
personal, commercial and financial services products and serves clients in 45 states. For the year ended December 31, 2017, SDN had
total revenue of $5.1 million, compared to total revenue of $5.2 million for the year ended December 31, 2016.
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SDN’s primary market area is Erie and Niagara counties in New York State. Most lines of personal insurance are provided, including
automobile, homeowners, boat, recreational vehicle, landlord, and umbrella coverage. Commercial insurance products are also
provided, consisting of property, liability, automobile, inland marine, workers compensation, bonds, crop and umbrella insurance. SDN
also provides the following financial services products: life and disability insurance, Medicare supplements, long-term care, annuities,
mutual funds, retirement programs and New York State disability.
Courier Capital, LLC
Acquired in January 2016, Courier Capital is an SEC-registered investment advisory and wealth management firm founded in 1967 and
based in Western New York, with offices in Buffalo, Amherst and Jamestown. With $1.69 billion in assets under management, Courier
Capital offers customized investment management, investment consulting and retirement plan services to individuals, businesses and
institutions across nine states. For the year ended December 31, 2017, Courier Capital had total revenue of $4.1 million, compared to
total revenue of $3.4 million for the period from date of acquisition through December 31, 2016.
In August 2017, Courier Capital acquired the assets of Robshaw & Julian Associates, Inc., a Buffalo-area registered investment adviser
with approximately $175 million assets under management, which increased Courier Capital’s total assets under management to
approximately $1.6 billion.
Other Subsidiaries
Five Star REIT, Inc. Five Star REIT, Inc. (“Five Star REIT”), a wholly-owned subsidiary of the Bank, operates as a real estate
investment trust that holds residential mortgages and commercial real estate loans. Five Star REIT provides additional flexibility and
planning opportunities for the business of the Bank.
Business Strategy
Our business strategy has been to maintain a community bank philosophy, which consists of focusing on and understanding the
individualized banking and other financial services needs of individuals, municipalities and businesses of the local communities
surrounding our primary service area. 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 who
prefer to build banking, insurance and wealth management relationships with a community bank that offers and 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 have evolved to meet changing customer needs by opening what we refer to as financial solution center branches.
These financial solution centers have a smaller footprint than our traditional branches, focus on technology to provide solutions that fit
our customer preferences for transacting business with us, and these branches are staffed by certified personal bankers who are trained
to meet a broad array of customer needs. In recent years, we have opened four financial solution centers in the Rochester and Buffalo
markets. 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.
Acquisition Strategy
We will continue to explore market expansion opportunities in or near our current market areas as opportunities arise. Our primary
focus will be on increasing market share within existing markets, while taking advantage of potential growth opportunities within our
insurance and wealth management lines of business by acquiring new businesses that can be added to existing operations. We believe
our capital position remains strong enough to support an active merger and acquisition strategy, and expansion of our core financial
service businesses of banking, insurance and wealth management. Consequently, we continue to explore acquisition opportunities in
these activities. In evaluating acquisition opportunities, we will balance the potential for earnings accretion with maintaining adequate
capital levels, which could result in our common stock being the predominate form of consideration and/or the need for us to raise
capital.
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Conversations with potential strategic partners occur on a regular basis. The evaluation of any potential opportunity will favor a
transaction that complements our core competencies and strategic intent, with a lesser emphasis being placed on geographic location or
size. Additionally, we remain committed to maintaining a diversified revenue stream. Our senior management team has had extensive
experience in acquisitions and post-acquisition integration of operations, and is prepared to act quickly should a potential opportunity
arise, but will remain disciplined with its approach. We believe this experience positions us to successfully acquire and integrate
additional financial services and banking businesses.
MARKET AREAS AND COMPETITION
We provide a wide range of banking and financial services to individuals, municipalities and businesses through a network of over 50
offices and an extensive ATM network throughout Western and Central New York. The region includes the counties of Allegany,
Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston, Monroe, Ontario, Orleans, Schuyler, Seneca, Steuben,
Wyoming and Yates counties. Our banking activities, though concentrated in the communities where we maintain branches, also extend
into neighboring counties. In addition, we have expanded our consumer indirect lending presence to the Capital District of New York
and Northern and Central Pennsylvania.
Our market area is economically diversified in that we serve both rural markets and the larger markets in and around Rochester and
Buffalo. Rochester and Buffalo are the two largest metropolitan areas in New York outside of New York City, with a combined
population of over two million people. We anticipate continuing to increase our presence in and around these metropolitan statistical
areas in the coming years.
We face significant competition in both making loans and attracting deposits, as Western and Central New York have a high density of
financial institutions. Our competition for loans comes principally from commercial banks, savings banks, savings and loan
associations, mortgage banking companies, credit unions, insurance companies and other financial services companies. Our most direct
competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional
competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms and
insurance companies. We generally compete with other financial service providers on factors such as level of customer service,
responsiveness to customer needs, availability and pricing of products, and geographic location. Our industry frequently experiences
merger activity, which affects competition by eliminating some institutions while potentially strengthening the franchises of others.
The following table presents the Bank’s market share percentage for total deposits as of June 30, 2017, in each county where we have
operations. The table also indicates the ranking by deposit size in each market. All information in the table was obtained from S&P
Global Market Intelligence, which compiles deposit data published by the FDIC as of June 30, 2017 and updates the information for any
bank mergers and acquisitions completed subsequent to the reporting date.
County
Allegany
Cattaraugus
Cayuga
Chautauqua
Chemung
Erie
Genesee
Livingston
Monroe
Ontario
Orleans
Seneca
Steuben
Wyoming
Yates
_____
Market
Share
8.9%
29.8%
3.5%
1.6%
14.5%
0.4%
21.8%
37.5%
1.7%
13.8%
23.8%
28.3%
31.8%
54.1%
42.3%
Market
Rank
3
2
10
8
3
10
2
1
8
2
2
1
1
1
1
Number of
Branches (1)
1
5
1
1
3
4
3
5
8
5
2
2
7
4
2
(1) Number of branches current as of December 31, 2017.
INVESTMENT ACTIVITIES
Our investment policy is contained within our overall Asset-Liability Management and Investment Policy. This policy dictates that
investment decisions will be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets,
need for collateral and desired risk parameters. In pursuing these objectives, we consider the ability of an investment to provide
earnings consistent with factors related to quality, maturity, marketability, pledgeable nature and risk diversification. Our Treasurer,
guided by our Asset-Liability Committee (“ALCO”), is responsible for investment portfolio decisions within the established policies.
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Our investment securities strategy is focused on providing liquidity to meet loan demand and redeeming liabilities, meeting pledging
requirements, managing credit risks, managing overall interest rate risks and maximizing portfolio yield. Our current policy generally
limits security purchases to the following:
• U.S. treasury securities;
• U.S. government agency securities, which are securities issued by official Federal government bodies (e.g., the Government
National Mortgage Association (“GNMA”) and the Small Business Administration (“SBA”)), and U.S. government-sponsored
enterprise securities, which are securities issued by independent organizations that are in part sponsored by the federal
government (e.g., the Federal Home Loan Bank (“FHLB”) system, the Federal National Mortgage Association (“FNMA”), the
Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal Farm Credit Bureau);
• Mortgage-backed securities (“MBS”), which include mortgage-backed pass-through securities, collateralized mortgage
•
obligations and multi-family MBS issued by GNMA, FNMA and FHLMC;
Investment grade municipal securities, including revenue, tax and bond anticipation notes, statutory installment notes and
general obligation bonds;
• Certain creditworthy unrated securities issued by municipalities;
• Certificates of deposit;
• Equity securities at the holding company level; and
• Limited partnership investments.
LENDING ACTIVITIES
General
We offer a broad range of loans including commercial business and revolving lines of credit, commercial mortgages, equipment loans,
residential mortgage loans and home equity loans and lines of credit, home improvement loans, automobile loans and personal loans.
Newly originated and refinanced fixed rate residential mortgage loans are either retained in our portfolio or sold to the secondary market
with servicing rights retained.
We continually evaluate and update our lending policy. The key elements of our lending philosophy include the following:
• To ensure consistent underwriting, employees must share a common view of the risks inherent in lending activities as well as
the standards to be applied in underwriting and managing credit risk;
Pricing of credit products should be risk-based;
•
• The loan portfolio must be diversified to limit the potential impact of negative events; and
• Careful, timely exposure monitoring through dynamic use of our risk rating system is required to provide early warning and
assure proactive management of potential problems.
Commercial Business and Commercial Mortgage Lending
We primarily originate commercial business loans in our market areas and underwrite them based on the borrower’s ability to service
the loan from operating income. We offer a broad range of commercial lending products, including term loans and lines of credit. Short
and medium-term commercial loans, primarily collateralized, are made available to businesses for working capital (including inventory
and receivables), business expansion (including acquisition of real estate, expansion and improvements) and the purchase of equipment.
We offer commercial business loans to customers in the agricultural industry for short-term crop production, farm equipment and
livestock financing. As a general practice, where possible, a first position collateral lien is placed on any available real estate,
equipment or other assets owned by the borrower and a personal guarantee of the owner is obtained. As of December 31, 2017, $122.4
million, or 27%, of our aggregate commercial business loan portfolio were at fixed rates, while $327.9 million, or 73%, were at variable
rates.
We also offer commercial mortgage loans to finance the purchase of real property, which generally consists of real estate with
completed structures and, to a smaller extent, agricultural real estate financing. Commercial mortgage loans are secured by first liens on
the real estate and are typically amortized over a 10 to 20 year period. The underwriting analysis includes credit verification, appraisals
and a review of the borrower’s financial condition and repayment capacity. As of December 31, 2017, $348.7 million, or 43%, of the
loans in our aggregate commercial mortgage portfolio were at fixed rates, while $460.2 million, or 57%, were at variable rates.
We utilize government loan guarantee programs where available and appropriate.
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Government Guarantee Programs
We participate in government loan guarantee programs offered by the SBA, U.S. Department of Agriculture, Rural Economic and
Community Development and Farm Service Agency, among others. As of December 31, 2017, we had loans with an aggregate
principal balance of $47.8 million that were covered by guarantees under these programs. The guarantees typically only cover a certain
percentage of these loans. By participating in these programs, we are able to broaden our base of borrowers while minimizing credit
risk.
Residential Real Estate Lending
We originate fixed and variable rate one-to-four family residential mortgages collateralized by owner-occupied properties located in our
market areas. We offer a variety of real estate loan products, including home improvement loans, closed-end home equity loans, and
home equity lines of credit, which are generally amortized over periods of up to 30 years. Loans collateralized by one-to-four family
residential real estate generally have been originated in amounts of no more than 80% of appraised value, or have mortgage insurance.
Mortgage title insurance and hazard insurance are normally required. We sell certain one-to-four family residential mortgages to the
secondary mortgage market and typically retain the right to service the mortgages. To assure maximum salability of the residential loan
products for possible resale, we typically follow the underwriting and appraisal guidelines of the secondary market, including the
FHLMC and the Federal Housing Administration, and service the loans in a manner that satisfies the secondary market agreements. As
of December 31, 2017, our residential mortgage servicing portfolio totaled $163.3 million, the majority of which has been sold to the
FHLMC. As of December 31, 2017, our residential real estate loan portfolio totaled $465.3 million, or 17% of our total loan portfolio.
As of December 31, 2017, our residential real estate lines portfolio totaled $116.3 million, or 4% of our total loan portfolio. As of
December 31, 2017, $417.4 million, or 90%, of the loans in our residential real estate loan portfolio were at fixed rates, while $47.9
million, or 10%, were at variable rates. The residential real estate lines portfolio primarily consists of variable rate lines.
Approximately 88% of the loans and lines in our residential real estate portfolios were in first lien positions at December 31, 2017. We
do not engage in sub-prime or other high-risk residential mortgage lending as a line-of-business.
Consumer Lending
We offer a variety of loan products to our consumer customers, including automobile loans, secured installment loans and other types of
secured and unsecured personal loans. At December 31, 2017, outstanding consumer loan balances were concentrated in indirect
automobile loans.
We originate indirect consumer loans for a mix of new and used vehicles through franchised new car dealers. The consumer indirect
loan portfolio is primarily comprised of loans with terms that typically range from 36 to 84 months. We have developed relationships
with franchised new car dealers in Western, Central and the Capital District of New York, and Northern and Central Pennsylvania. As
of December 31, 2017, our consumer indirect portfolio totaled $876.6 million, or 32% of our total loan portfolio. The consumer indirect
loan portfolio primarily consists of fixed rate loans with relatively short durations.
We also originate, independently of the indirect loans described above, consumer automobile loans, recreational vehicle loans, boat
loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically
range from 12 to 60 months and vary based upon the nature of the collateral and the size of loan. The majority of the consumer lending
program is underwritten on a secured basis using the customer’s financed automobile, mobile home, boat or recreational vehicle as
collateral. The other loans in our consumer portfolio totaled $17.6 million as of December 31, 2017, all but $753 thousand of which
were fixed rate loans.
Credit Administration
Our loan policy establishes standardized underwriting guidelines, as well as the loan approval process and the committee structures
necessary to facilitate and ensure the highest possible loan quality decision-making in a timely and businesslike manner. The policy
establishes requirements for extending credit based on the size, risk rating and type of credit involved. The policy also sets limits on
individual lending authority and various forms of joint lending authority, while designating which loans are required to be approved at
the committee level.
Our credit objectives are to:
• Compete effectively and service the legitimate credit needs of our target market;
• Enhance our reputation for superior quality and timely delivery of products and services;
Provide pricing that reflects the entire relationship and is commensurate with the risk profiles of our borrowers;
•
• Retain, develop and acquire profitable, multi-product, value added relationships with high quality borrowers;
Focus on government guaranteed lending to meet the needs of the small businesses in our communities; and
•
• Comply with all relevant laws and regulations.
- 8 -
Our policy includes loan reviews, under the supervision of our Audit and Risk Oversight committees of the Board of Directors and
directed by our Chief Risk Officer, in order to render an independent and objective evaluation of our asset quality and credit
administration process.
We assign risk ratings to loans in the commercial business and commercial mortgage portfolios. We use those risk ratings to:
Profile the risk and exposure in the loan portfolio and identify developing trends and relative levels of risk;
Identify deteriorating credits;
•
•
• Reflect the probability that a given customer may default on its obligations; and
• Assist with risk-based pricing.
Through the loan approval process, loan administration and loan review program, management seeks to continuously monitor our credit
risk profile and assess the overall quality of the loan portfolio and adequacy of the allowance for loan losses.
We have several procedures in place to assist in maintaining the overall quality of our loan portfolio. Delinquent loan reports are
monitored by credit administration to identify adverse levels and trends. Loans, including impaired loans, are generally classified as
non-accruing if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans
are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may
also be classified as non-accruing if repayment in full of principal and/or interest is uncertain.
Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance
reflects management’s estimate of the amount of probable loan losses in the portfolio, based on factors including, but not limited to:
Specific allocations for individually analyzed credits;
•
• Risk assessment process;
• Historical net charge-off experience;
• Evaluation of loss emergence and look-back periods;
• Evaluation of the loan portfolio with loan reviews;
• Levels and trends in delinquent and non-accruing loans;
• Trends in volume and terms of loans;
• Effects of changes in lending policy;
• Experience, ability and depth of management;
• National and local economic trends and conditions;
• Concentrations of credit;
Interest rate environment;
•
• Regulatory environment;
Information (availability of timely financial information); and
•
• Collateral values.
Our methodology for estimating the allowance for loan losses includes the following:
1.
Impaired commercial business and commercial mortgage loans are typically reviewed individually and assigned a specific loss
allowance, if considered necessary, in accordance with U.S. generally accepted accounting principles (“GAAP”).
2. The remaining portfolios of commercial business and commercial mortgage loans are segmented by risk rating into the following
loan classification categories: uncriticized or pass, special mention, substandard and doubtful. Uncriticized loans, special mention
loans, substandard loans and all doubtful loans not assigned a specific loss allowance are assigned allowance allocations based on
historical net loan charge-off experience for each of the respective loan categories, supplemented with loss emergence periods and
qualitative factors, if considered necessary. These qualitative factors include the levels and trends in delinquent and non-accruing
loans, trends in volume and terms of loans, effects of changes in lending policy, experience, ability, and depth of management,
national and local economic trends and conditions, concentrations of credit, interest rate environment, regulatory environment,
information (availability of timely financial information), and collateral values, among others.
3. The retail loan portfolio is segmented into the following types of loans: residential real estate loans, residential real estate lines,
consumer indirect and other consumer. Allowance allocations for the retail loan portfolio are based on the average loss experience
for the previous eight quarters, supplemented with loss emergence periods and qualitative factors similar to the elements described
above.
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Management presents a quarterly review of the adequacy of the allowance for loan losses to the Audit Committee of our Board of
Directors based on the methodology described above. See also the section titled “Allowance for Loan Losses” in Part II, Item 7,
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.
SOURCES OF FUNDS
Our primary sources of funds are deposits and borrowed funds.
Deposits
We maintain a full range of deposit products and accounts to meet the needs of the residents and businesses in our primary service area.
Products include an array of checking and savings account programs for individuals and businesses, including money market accounts,
certificates of deposit, sweep investment capabilities as well as Individual Retirement Accounts and other qualified plan accounts. We
rely primarily on competitive pricing of our deposit products, customer service and long-standing relationships with customers to attract
and retain these deposits and seek to make our services convenient to the community by offering a choice of several delivery systems
and channels, including telephone, mail, online, automated teller machines (ATMs), debit cards, point-of-sale transactions, automated
clearing house transactions (ACH), remote deposit, and mobile banking via telephone or wireless devices. We also take advantage of
the use of technology by offering business customers banking access via the Internet and various advanced cash management systems.
We had no traditional brokered deposits at December 31, 2017; however, we do participate in the Certificate of Deposit Account
Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) programs, which enable depositors to receive FDIC insurance coverage
for deposits otherwise exceeding the maximum insurable amount. 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
$159.2 million and $147.3 million, respectively, at December 31, 2017.
Borrowings
We have access to a variety of borrowing sources and use both short-term and long-term borrowings to support our asset base.
Borrowings from time-to-time include federal funds purchased, securities sold under agreements to repurchase, FHLB advances and
borrowings from the discount window of the FRB, as defined below.
Other sources of funds include scheduled amortization and prepayments of principal from loans and mortgage-backed securities,
maturities and calls of investment securities and funds provided by operations
OPERATING SEGMENTS
We have 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 SDN, 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.
For a discussion of the segments included in our principal activities and certain financial information for each segment, see Note 21,
Segment Reporting, of the notes to consolidated financial statements included in this Annual Report on Form 10-K.
OTHER INFORMATION
We also make available, free of charge, through our website, all reports filed with, or furnished to, the SEC, including our Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports,
as soon as reasonably practicable after those documents are filed with, or furnished to, the SEC. These filings may be viewed by
accessing the SEC Filings subsection of the Financials section of our website (www.fiiwarsaw.com). Information available on our
website is not a part of, and is not incorporated into, this Annual Report on Form 10-K.
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All of the reports we file with the SEC, including this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current
Reports on Form 8-K, as well as any amendments thereto may be accessed at www.sec.gov or at the public reference facility maintained
by the SEC at its public reference room at 100 F. Street, N.E., Room 1580, Washington, DC 20549 and copies of all or any part thereof
may be obtained from that office upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for further
information on the operation of the public reference room and you can request copies of the documents upon payment of a duplicating
fee, by writing to the SEC.
SUPERVISION AND REGULATION
We are subject to extensive regulation under federal and state laws. The regulatory framework is intended primarily for the protection of
depositors, federal deposit insurance funds and the banking system as a whole and not for the protection of shareholders and creditors.
We are also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities
Exchange Act of 1934, as amended, as administered by the Securities and Exchange Commission (“SEC”). Our common stock is listed
on the NASDAQ Global Select Market (“NASDAQ”) under the trading symbol “FISI” and is subject to NASDAQ rules for listed
companies.
Significant elements of the laws and regulations applicable to the Company are described below. The description is qualified in its
entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations and
policies are continually under review by Congress, state legislatures, and federal and state regulatory agencies. A change in statutes,
regulations or regulatory policies applicable to the Company could have a material effect on the business, financial condition and results
of operations of the Company.
Holding Company Regulation. We are subject to comprehensive regulation by the Board of Governors of the Federal Reserve
System, frequently referred to as the Federal Reserve Board (“FRB” or “Federal Reserve”), under the Bank Holding Company Act (the
“BHC Act”), as amended by, among other laws, the Gramm-Leach-Bliley Act of 1999 (the “Gramm-Leach-Bliley Act”), and by the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in 2010. We are registered with the
Federal Reserve as a bank holding company (“BHC”). We must file reports with the FRB and such additional information as the FRB
may require, and our holding company and non-banking affiliates are subject to examination by the FRB. Under FRB policy, a bank
holding company must serve as a source of strength for its subsidiary banks. Under this policy, the FRB may require, and has required
in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank. The BHC Act provides that a
bank holding company must obtain FRB approval before:
• Acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after
such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such
shares);
• Acquiring all or substantially all of the assets of another bank or bank holding company, or
• Merging or consolidating with another bank holding company.
The BHC Act generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other
than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these
prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities
closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among
other things: lending; operating a savings institution, mortgage company, finance company, credit card company or factoring company;
performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an
insurance agent for certain types of credit related insurance; leasing property on a full-payout, non-operating basis; selling money
orders, travelers’ checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities brokerage services for customers. These activities may also
be affected by federal legislation.
The Gramm-Leach-Bliley Act amended portions of the BHC Act to authorize bank holding companies, such as us, directly or through
non-bank subsidiaries to engage in securities, insurance and other activities that are financial in nature or incidental to a financial
activity. In order to undertake these activities, a bank holding company must become a "financial holding company" by submitting to
the appropriate Federal Reserve Bank a declaration that the company elects to be a financial holding company and a certification that all
of the depository institutions controlled by the company are well capitalized and well managed.
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The Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) significantly
changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting
large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and
small bank and thrift holding companies will be regulated in the future. Among other things, these provisions abolished the Office of
Thrift Supervision and transferred its functions to the other federal banking agencies, relaxed rules regarding interstate branching,
allowed financial institutions to pay interest on business checking accounts, and imposed new capital requirements on bank and thrift
holding companies. The Dodd-Frank Act also includes several corporate governance provisions that apply to all public companies, not
just financial institutions. These include provisions mandating certain disclosures regarding executive compensation and provisions
addressing proxy access by shareholders. We have elected to be treated as a financial holding company.
The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, including some that may affect our
business in substantial and unpredictable ways. We have incurred higher operating costs in complying with the Dodd-Frank Act, and we
expect that these higher costs will continue for the foreseeable future. Our management continues to monitor the ongoing
implementation of the Dodd-Frank Act and as new regulations are issued, will assess their effect on our business, financial condition
and results of operations.
On February 3, 2017, President Donald J. Trump issued an executive order directing the Secretary of the Treasury to report, within 120
days, on whether current governmental rules and policies either promote or inhibit the “Core Principles for Financial Regulation” as
defined in the executive order (the “Executive Order”). The Treasury Department has since issued multiple reports in response to the
Executive Order, the first of which, issued on June 12, 2017, analyzed and made recommendations with respect to the U.S. banking
system (the “Treasury Report”). In particular, the Treasury Report recommended several actions that would ease the requirements of
the Dodd-Frank Act on community banks such as us, as described in greater detail below. While some of these actions may be
implemented unilaterally by our regulators, others will require legislation in order to be put into effect.
On June 8, 2017, the U.S. House of Representatives passed the Financial CHOICE Act of 2017 (the “Financial CHOICE Act”), a bill
that, if enacted into law, would repeal or modify key provisions of the Dodd-Frank Act, including elimination of the Volcker Rule, as
defined below, and making the director of the CFPB, also defined below, subject to removal by the President. President Trump has
indicated that he would sign the Financial CHOICE Act but the U.S. Senate has yet to take up that bill. In early March 2018, the Senate
instead opened debate on the Economic Growth, Regulatory Relief, and Consumer Protection Act, a bill that would also impact several
of the provisions of the Dodd-Frank Act and that appears to enjoy significant bipartisan support.
We cannot predict how closely a final bill, if any, will resemble either the one passed by the House of Representatives last year or the
one currently under debate in the Senate. Similarly, it is too early for us to predict whether any other executive or congressional action
will attempt to implement the recommendations of the Treasury Report as they pertain to the Dodd-Frank Act.
See Item 1A, Risk Factors, for a more extensive discussion of this topic.
The Volcker Rule. The Dodd-Frank Act prohibits banks and their affiliates from engaging in proprietary trading and from investing
and sponsoring hedge funds and private equity funds. The statutory provision implementing these restrictions is commonly called the
“Volcker Rule.” To implement the Volcker Rule, federal regulators issued final rules in December 2013 that were to become effective
April 2014. The Federal Reserve subsequently issued an order extending the period that institutions have to conform their activities to
the requirements of the Volcker Rule to July 21, 2015, and extended the compliance date for banks to conform their investments in
certain “legacy covered funds” until July 21, 2016. These final rules exempt the Bank, as a bank with less than $10 billion in total
consolidated assets that does not engage in any covered activities other than trading in certain government, agency, state or municipal
obligations, from any significant compliance obligations under the Volcker Rule; therefore, the Volcker Rule will not have a material
effect on our business, financial condition and results of operations. We cannot predict whether the Volcker Rule will be repealed by
enactment of the Financial CHOICE Act, or modified by implementation of some or all of the relevant recommendations included in the
Treasury Report.
Depository Institution Regulation. The Bank is subject to regulation by the FDIC. This regulatory structure includes:
• Real estate lending standards, which provide guidelines concerning loan-to-value ratios for various types of real estate loans;
• Risk-based capital rules, including accounting for interest rate risk, concentration of credit risk and the risks posed by non-
traditional activities;
• Rules requiring depository institutions to develop and implement internal procedures to evaluate and control credit and
settlement exposure to their correspondent banks;
• Rules restricting types and amounts of equity investments; and
• Rules addressing various safety and soundness issues, including operations and managerial standards, standards for asset
quality, earnings and compensation standards.
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Capital Requirements. The Company and the Bank are each required to comply with applicable capital adequacy standards
established by the Federal Reserve. The current risk-based capital standards applicable to the Company and the Bank, parts of which
are currently in the process of being phased in, are based on the final capital framework for strengthening international capital standards,
known as Basel III, of the Basel Committee.
Prior to January 1, 2015, the risk-based capital standards applicable to the Company and the Bank (the “General Risk-based Capital
Rules”) were based on the 1988 Capital Accord, known as Basel I, of the Basel Committee. In July 2013, the federal bank regulators
approved the final Basel III Rules implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Basel
III Rules substantially revised the risk-based capital requirements applicable to BHCs and their depository institution subsidiaries,
including the Company and the Bank, as compared to the General Risk-based Capital Rules. The Basel III Rules became effective for
the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions).
The Basel III Rules, among other things, (i) introduce a new capital measure called CET1, which consists primarily of retained earnings
and common stock, (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments, such as preferred stock
and certain convertible securities, meeting certain revised requirements, (iii) define CET1 narrowly by requiring that most
deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expand the
scope of the deductions/adjustments to capital as compared to existing regulations.
Under the Basel III Rules, the minimum capital ratios effective as of January 1, 2015 are:
•
•
•
4.5% CET1 to risk-weighted assets;
6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and
8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.
The Basel III Rules also introduce a new capital conservation buffer designed to absorb losses during periods of economic stress. The
capital conservation buffer is an amount in addition to these minimum risk-based capital ratio requirements. The Basel III Rules also
provide for a countercyclical capital buffer applicable only to certain covered institutions. We do not expect the countercyclical capital
buffer to be applicable to the Company or the Bank. Banking institutions that do not hold capital above the required minimum levels,
including the capital conservation buffer, will face constraints on dividends and compensation based on the amount of the shortfall.
When fully phased in on January 1, 2019, the Basel III Rules will require the Company and the Bank to maintain an additional capital
conservation buffer of 2.5% of risk-weighted assets, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at
least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.
The Basel III Rules also provide for a number of deductions from and adjustments to CET1. These include, for example, the
requirement that MSRs, certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from
CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.
Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased in over a 4-year period
(beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer
began on January 1, 2016 at the 0.625% level and will be phased in over a 4-year period (increasing by that amount on each subsequent
January 1, until it reaches 2.5% on January 1, 2019).
The Basel III Rules prescribe a new standardized approach for risk weightings that expands the risk-weighting categories from the four
Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the
nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and
resulting in higher risk weights for a variety of asset classes.
The recommendations of the Treasury Report include making community banks such as us exempt from the risk-based capital standards
included under the Basel III Rules. As no meaningful action has yet been taken to implement these recommendations, we cannot predict
whether or to what extent we will continue to be subject to these standards in the future, including on the final phase-in date of January
1, 2019.
Leverage Requirements. BHCs and banks are also required to comply with minimum leverage ratio requirements. These requirements
provide for a minimum ratio of Tier 1 capital to total consolidated quarterly average assets (as defined for regulatory purposes), net of
the loan loss reserve, goodwill and certain other intangible assets (the “leverage ratio”), of 4.0%.
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Liquidity Regulation. During 2014, the U.S. banking agencies adopted final rules implementing one of the two new standards
provided for in the Basel III liquidity framework - its liquidity coverage ratio (“LCR”), which is designed to ensure that a bank
maintains an adequate level of unencumbered high quality liquid assets equal to the bank’s expected net cash outflows for a thirty-day
time horizon under an acute liquidity stress scenario. The rules as adopted apply in their most comprehensive form only to advanced
approaches bank holding companies and depository institution subsidiaries of such bank holding companies and, in a modified form, to
banking organizations having $50 billion or more in total consolidated assets. Accordingly, they do not apply to either the Company or
the Bank. As a result, we do not manage our balance sheet to be compliant with these rules.
The Basel III framework also included a second standard, referred to as the net stable funding ratio (“NSFR”), which is designed to
promote more medium-and long-term funding of the assets and activities of banks over a one-year time horizon. Although the Basel
Committee finalized its formulation of the NSFR in 2014, the U.S. banking agencies have not yet proposed an NSFR for application to
U.S. banking organizations or addressed the scope of banking organizations to which it will apply. The Basel Committee’s final NSFR
document states that the NSFR applies to internationally active banks, as did its final LCR document as to that ratio.
Prompt Corrective Action. The Federal Deposit Insurance Act, as amended (“FDIA”), requires among other things, the federal
banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements.
The FDIA establishes five capital categories for FDIC-insured banks: well capitalized, adequately capitalized, under-capitalized,
significantly under-capitalized and critically under-capitalized. Under rules in effect through December 31, 2014, a depository
institution is deemed to be “well-capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based
capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement,
capital directive or prompt corrective action directive to meet and maintain a specific level for any capital measure. As of January 1,
2015, the standards for “well-capitalized” status under prompt corrective action regulations changed by, among other things, introducing
a CET 1 ratio requirement of 6.5% and increasing the Tier 1 risk-based capital ratio requirement from 6.0% to 8.0%. The total risk-
based capital ratio and Tier 1 leverage ratio requirements remain at 10.0% and 5.0%, respectively.
The FDIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the
capital category in which an institution is classified. The current capital rule established by the federal bank regulators, discussed above
under “Capital Requirements,” amend the prompt corrective action requirements in certain respects, including adding a CET1 risk-based
capital ratio as one of the metrics (with a minimum 6.5% ratio for well-capitalized status) and increasing the Tier 1 risk-based capital
ratio required for each of the five capital categories, including an increase from 6.0% to 8.0% to be well-capitalized.
For further information regarding the capital ratios and leverage ratio of the Company and the Bank see the section titled “Capital
Resources” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in
this Annual Report on Form 10-K. The current requirements and the actual levels for the Company and the Bank are detailed in Note
11, Regulatory Matters, of the notes to consolidated financial statements, included in this Annual Report on Form 10-K.
Dividends. The FRB policy is that a bank holding company should pay cash dividends only to the extent that its net income for the past
year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company's capital
needs, asset quality and overall financial condition, and that it is inappropriate for a bank holding company experiencing serious
financial problems to borrow funds to pay dividends. Furthermore, a bank that is classified under the prompt corrective action
regulations as “undercapitalized” will be prohibited from paying any dividends.
The primary source of cash for dividends we pay is the dividends we receive from the Bank. The Bank is subject to various regulatory
policies and requirements relating to the payment of dividends, including requirements to maintain capital above regulatory minimums.
Approval of the New York State Department of Financial Services (the “NY DFS”) is required prior to paying a dividend if the dividend
declared by the Bank exceeds the sum of the Bank’s net profits for that year and its retained net profits for the preceding two calendar
years. At January 1, 2018, the Bank could declare dividends of $42.1 million from retained net profits of the preceding two years. The
Bank declared dividends of $12.0 million in 2017 and $16.0 million in 2016.
Federal Deposit Insurance Assessments. The Bank is a member of the FDIC and pays an insurance premium to the FDIC based upon
its assessable assets on a quarterly basis. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the
full faith and credit of the United States Government.
Under the Dodd-Frank Act, a permanent increase in deposit insurance was authorized to $250,000. The coverage limit is per depositor,
per insured depository institution for each account ownership category.
The Dodd-Frank Act also set a new minimum Deposit Insurance Fund (“DIF”) reserve ratio at 1.35% of estimated insured deposits.
The FDIC is required to attain this ratio by September 30, 2020. The Dodd-Frank Act also required the FDIC to define the deposit
insurance assessment base for an insured depository institution as an amount equal to the institution’s average consolidated total assets
during the assessment period minus average tangible equity. Premiums for the Bank are now calculated based upon the average balance
of total assets minus average tangible equity as of the close of business for each day during the calendar quarter.
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The FDIC has the flexibility to adopt actual rates that are higher or lower than the total base assessment rates adopted without notice and
comment, if certain conditions are met.
DIF-insured institutions pay a Financing Corporation (“FICO”) assessment in order to fund the interest on bonds issued in the 1980s in
connection with the failures in the thrift industry. For the fourth quarter of 2017, the FICO assessment was equal to 0.46 basis points
(annualized) computed on assets as required by the Dodd-Frank Act. These assessments will continue until the bonds mature in 2019.
The FDIC is authorized to conduct examinations of and require reporting by FDIC-insured institutions. It is also authorized to terminate
a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the
institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or
imposed by the bank’s regulatory agency. The termination of deposit insurance for the Bank would have a material adverse effect on our
earnings, operations and financial condition.
Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, the Bank is also subject to certain
consumer federal and state laws and regulations that are designed to protect consumers in transactions with banks. While the list set
forth herein is not exhaustive, these laws and regulations include, among others, the Fair Credit Reporting Act, the Truth in Lending
Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection
Practices Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state usury laws and
laws regarding unfair and deceptive acts and practices. These and other federal and state laws, among other things, require disclosures
of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions,
regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices,
restrict the Company’s ability to raise interest rates and subject the Company to substantial regulatory oversight. Violations of
applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual
damages, restitution and attorneys’ fees. Federal and state bank regulators, federal law enforcement agencies, state attorneys general
and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other
remedies, including regulatory sanctions, customer rescission rights, fines and civil money penalties. Failure to comply with consumer
protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition
transactions the Company may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.
The Dodd-Frank Act centralized responsibility for consumer financial protection by creating the Consumer Financial Protection Bureau
(“CFPB”), and giving it responsibility for implementing, examining and enforcing compliance with federal consumer protection laws.
The CFPB focuses on:
• Risks to consumers and compliance with the federal consumer financial laws, when it evaluates the policies and practices of a
financial institution;
• The markets in which firms operate and risks to consumers posed by activities in those markets;
• Depository institutions that offer a wide variety of consumer financial products and services; depository institutions with a
more specialized focus; and
• Non-depository companies that offer one or more consumer financial products or services.
The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other
things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that
materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take
unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer
financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB can issue
cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action
against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction. The CFPB has
examination and enforcement authority over all banks with more than $10 billion in assets, as well as their affiliates.
Neither the recommendations of the Treasury Report nor the Financial CHOICE Act provide for the abolishment of the CFPB; both,
however, call for the director of the CFPB to be subject to removal by the President and for repeal of the CFPB’s authority to perform
examinations. We cannot predict whether or how the CFPB will be impacted by either pending or future legislation or by possible future
executive action.
Banking regulators take into account compliance with consumer protection laws when considering approval of a proposed transaction.
Community Reinvestment Act. Pursuant to the Community Reinvestment Act (the “CRA”), under federal and New York State law,
the Bank is obligated, consistent with safe and sound banking practices, to help meet the credit needs of its entire community, including
low and moderate income neighborhoods. The FRB of New York and NY DFS periodically assess the Bank’s record of performance
under the CRA and issue one of the following ratings: “Outstanding,” “Satisfactory,” “Needs to Improve,” or “Substantial
Noncompliance.”
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The most recently completed evaluation of the Bank’s performance under the CRA was conducted by the FRB of New York for the
time period January 2011 through September 2013 and was disclosed to us in March 2018. This performance evaluation resulted in an
overall rating by the FRB of New York of “Needs to Improve.” In reaching this rating the FRB of New York considered several factors,
including the geographic distribution of loans we made from January 2011 through September 2013 in the Buffalo and Rochester
metropolitan areas, the accessibility of our retail delivery systems and our level of compliance during the time period with the Equal
Credit Opportunity Act and the Fair Housing Act. We believe the Bank has made significant improvements in these areas since
September 2013 and we are firmly committed to fair and responsible banking and helping to meet the credit needs of all segments of the
communities that we serve.
The FRB of New York’s evaluation of the Bank’s January 2011 through September 2013 CRA performance may subject the Bank to
enhanced scrutiny in any application it files with the FRB of New York or the NY DFS with respect to, among other things, the
establishment of new branches, the expansion or relocation of existing branches, or the acquisition by the Bank of another depository
institution. While the approval or denial of such an application is typically a facts and circumstances based determination, a less than
satisfactory CRA rating would be one of the factors our regulators will consider in their review.
We are in the process of preparing our response to the performance evaluation issued by the FRB of New York and we plan to file a
Current Report on Form 8-K when our response and the performance evaluation are publicly available.
In January 2015, we signed an Assurance of Discontinuance (“AOD”) with the NYS Attorney General’s office related to an
investigation into lending practices for minority residents within the City of Rochester from 2009 to June 2013. As part of the
agreement, we paid NYS $150 thousand to cover its costs. An additional $750 thousand in dedicated funds spread over three-years was
earmarked for ongoing business efforts consistent with the Bank’s growth initiatives in the Rochester market, and throughout Monroe
County, including efforts focused on marketing to minority communities, as well as lending discounts and/or subsidies. The Bank
successfully met all requirements of the AOD and in January 2018, the AOD expired by its terms.
The NY DFS is assessing our CRA performance since 2012 and has not yet completed its evaluation. The last CRA evaluation
completed by the NY DFS was in 2011 and resulted in the Bank being rated as “Outstanding.”
Privacy Rules. Federal banking regulators, as required under the Gramm-Leach-Bliley Act, have adopted rules limiting the ability of
banks and other financial institutions to disclose nonpublic information about consumers to non-affiliated third parties. The rules require
disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal
information to non-affiliated third parties. The privacy provisions of the Gramm-Leach-Bliley Act affect how consumer information is
transmitted through diversified financial services companies and conveyed to outside vendors.
In February 2017, the NY DFS issued a final rule, which became effective on March 1, 2017, requiring New York State-chartered or
licensed banks regulated by the NY DFS, such as us, to adopt broad cybersecurity protections. Specifically, we are now required to
establish a program designed to ensure the safety of our information systems, adopt a written cybersecurity policy, designate an
information security officer, and comply with NY DFS certification and reporting requirements. Compliance with this rule is subject to
four phase-in dates between September 2017 and March 2019.
Anti-Money Laundering and the USA Patriot Act. A major focus of governmental policy on financial institutions in recent years has
been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001, or the USA Patriot Act,
substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance
and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.
Financial institutions are also prohibited from entering into specified financial transactions and account relationships and must use
enhanced due diligence procedures in their dealings with certain types of high-risk customers and implement a written customer
identification program. Financial institutions must take certain steps to assist government agencies in detecting and preventing money
laundering and report certain types of suspicious transactions. Regulatory authorities routinely examine financial institutions for
compliance with these obligations, and for the failure of a financial institution to maintain and implement adequate programs to combat
money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and
reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or
acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these
obligations.
Interstate Branching. Pursuant to the Dodd-Frank Act, national and state-chartered banks may open an initial branch in a state other
than its home state (e.g., a host state) by establishing a de novo branch at any location in such host state at which a bank chartered in
such host state could establish a branch. Applications to establish such branches must still be filed with the appropriate primary federal
regulator. It is too early to predict whether President Trump’s Executive Order or any subsequent presidential or congressional action
will result in any change to a bank’s ability to establish a de novo branch in a host state.
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Transactions with Affiliates. FII, FSB, Five Star REIT, SDN and Courier Capital are affiliates within the meaning of the Federal
Reserve Act. The Federal Reserve Act imposes limitations on a bank with respect to extensions of credit to, investments in, and certain
other transactions with, its parent bank holding company and the holding company’s other subsidiaries. Furthermore, bank loans and
extensions of credit to affiliates also are subject to various collateral requirements.
Various governmental requirements, including Sections 23A and 23B of the Federal Reserve Act and the FRB's Regulation W, limit
borrowings by FII and its nonbank subsidiaries from FSB, and also limit various other transactions between FII and its nonbank
subsidiaries, on the one hand, and FSB, on the other. For example, Section 23A of the Federal Reserve Act limits the aggregate
outstanding amount of any insured depository institution's loans and other “covered transactions” with any particular nonbank affiliate
to no more than 10% of the institution's total capital and limits the aggregate outstanding amount of any insured depository institution's
covered transactions with all of its nonbank affiliates to no more than 20% of its total capital. “Covered transactions” are defined by
statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless
otherwise exempted by the FRB) from the affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the
issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. Section 23A of the Federal Reserve Act also generally
requires that an insured depository institution's loans to its nonbank affiliates be, at a minimum, 100% secured, and Section 23B of the
Federal Reserve Act generally requires that an insured depository institution's transactions with its nonbank affiliates be on terms and
under circumstances that are substantially the same or at least as favorable as those prevailing for comparable transactions with non-
affiliates. The Dodd-Frank Act significantly expanded the coverage and scope of the limitations on affiliate transactions within a
banking organization. For example, commencing in July 2012, the Dodd-Frank Act applies the 10% of capital limit on covered
transactions to financial subsidiaries and amends the definition of “covered transaction” to include (i) securities borrowing or lending
transactions with an affiliate, and (ii) all derivatives transactions with an affiliate, to the extent that either causes a bank or its affiliate to
have credit exposure to the securities borrowing/lending or derivative counterparty.
Office of Foreign Assets Control Regulation. The U.S. Treasury Department’s Office of Foreign Assets Control, or OFAC,
administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws,
including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. The
Company is responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting
unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with
these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to
approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not
required.
Insurance Regulation. SDN is required to be licensed or receive regulatory approval in nearly every state in which it does business. In
addition, most jurisdictions require individuals who engage in brokerage and certain other insurance service activities to be personally
licensed. These licensing laws and regulations vary from jurisdiction to jurisdiction. In most jurisdictions, licensing laws and regulations
generally grant broad discretion to supervisory authorities to adopt and amend regulations and to supervise regulated activities.
Investment Advisory Regulation. Courier Capital is a provider of investment consulting and financial planning services and, as such,
is considered an “investment adviser” under the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”). An
investment adviser is any person or entity that provides advice to others, or that issues reports or analyses, regarding securities for
compensation. While a BHC is generally excluded from regulation under the Advisers Act, the SEC has stated that this exclusion does
not apply to investment adviser subsidiaries of BHCs, such as Courier Capital. Since Courier Capital has over $100 million in assets
under management it is considered a “large adviser,” which requires registration with the SEC by filing Form ADV and updating it at
least once each year, and more frequently under certain specified circumstances. This registration covers Courier Capital and its
employees as well as other persons under its control and supervision, such as independent contractors, provided that their activities are
undertaken on behalf of Courier Capital.
In addition to these registration requirements, the Advisers Act contains numerous other provisions that impose obligations on
investment advisors. For example, Section 206 includes anti-fraud provisions that courts have interpreted as establishing fiduciary
duties extending to all services undertaken on behalf of the client. These duties include, but are not limited to, the disclosure of all
material facts to clients, providing only suitable investment advice, and seeking best price execution of trades. Section 206 also has
specific rules relating to, among other things, advertising, safeguarding client assets, the engagement of third-parties, the duty to
supervise persons acting on the investment adviser’s behalf, and the establishment of an effective internal compliance program and a
code of ethics.
Courier Capital is subject to each of these obligations and, as applicable, restrictions, and is also subject to examination by the SEC’s
Office of Compliance, Investigations, and Examinations to assess its overall compliance with the Advisers Act and the effectiveness of
its internal controls.
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Prior to our acquisition of Courier Capital in January 2016, the Bank had provided investment advisory and broker-dealer services to its
customers through its subsidiary Five Star Investment Services, Inc. Commencing in October 2013, the Bank entered into a partnership
with LPL Financial, one of the nation’s largest independent financial services companies (“LPL”), to provide investment advisory and
broker-dealer services to its customers through LPL. This partnership continues and the Bank employs wealth advisors, who are
licensed by LPL, to provide investment advisory and broker-dealer services to the Bank’s customers. LPL is an investment adviser
registered under the Advisers Act and is subject to its provisions.
Incentive Compensation. Our compensation practices are subject to oversight by the Federal Reserve. In June 2010, the Federal
banking agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive
compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging
excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an
organization, either individually or as part of a group, is based upon the key principles that a banking organization's incentive
compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization's ability to
effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by
strong corporate governance, including active and effective oversight by the organization's board of directors.
The Dodd-Frank Act requires the federal banking agencies to establish joint regulations or guidelines prohibiting incentive-based
payment arrangements at specified regulated entities having at least $1 billion in total consolidated assets (which would include the
Company and the Bank) that encourage inappropriate risks by providing an executive officer, employee, director or principal
shareholder with excessive compensation, fees or benefits or that could lead to material financial loss to the entity. In addition, the
agencies must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation
arrangements. In May 2016, six federal agencies, including the FRB, the FDIC and the SEC, invited public comments on a proposed
rule to accomplish this mandate; no final rule has since been issued, however, and it is uncertain at this time whether the agencies intend
to further pursue the rule for the foreseeable future.
The FRB will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking
organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each
organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation
arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated
into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions.
Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-
management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking
prompt and effective measures to correct the deficiencies.
Other Future Legislation and Changes in Regulations. In addition to the specific proposals described above, from time to time,
various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such
initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to
substantially change the financial institution regulatory system. Such legislation could change banking statutes and/or our operating
environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business,
limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other
financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any
implementing regulations, would have on our financial condition or results of operations. A change in statutes, regulations or regulatory
policies applicable to us or our subsidiaries could have a material effect on our business.
Impact of Inflation and Changing Prices
Our financial statements included herein have been prepared in accordance with GAAP, which requires us to measure financial position
and operating results principally using historic dollars. Changes in the relative value of money due to inflation or recession are
generally not considered. The primary effect of inflation on our operations is reflected in increased operating costs. We believe
changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate.
While interest rates are generally influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the
same magnitude. Interest rates are sensitive to many factors that are beyond our control, including changes in the expected rate of
inflation, general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and
various other governmental regulatory authorities.
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Regulatory and Economic Policies
Our business and earnings are affected by general and local economic conditions and by the monetary and fiscal policies of the U.S.
government, its agencies and various other governmental regulatory authorities. The FRB regulates the supply of money in order to
influence general economic conditions. Among the instruments of monetary policy available to the FRB are (i) conducting open market
operations in U.S. government obligations, (ii) changing the discount rate on financial institution borrowings, (iii) imposing or changing
reserve requirements against financial institution deposits, and (iv) restricting certain borrowings and imposing or changing reserve
requirements against certain borrowings by financial institutions and their affiliates. These methods are used in varying degrees and
combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on
deposits. For that reason, the policies of the FRB could have a material effect on our earnings.
On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJ Act”) was signed into law which, among other items, reduces the federal
statutory corporate tax rate from 35 percent to 21 percent, effective January 1, 2018.
EMPLOYEES
At December 31, 2017, we had 656 employees, none of whom are subject to a collective bargaining agreement. Management believes
our relations with employees are good.
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ITEM 1A. RISK FACTORS
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management
believes could affect us are described below. Before making an investment decision, you should carefully consider the risks and
uncertainties described below, together with all of the other information included or incorporated by reference herein. This Annual
Report on Form 10-K is qualified in its entirety by these risk factors. Further, to the extent that any of the information contained in this
Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements
identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking
statements made by or on behalf of us.
If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.
If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
If we experience greater credit losses than anticipated, earnings may be adversely impacted.
As a lender, we are exposed to the risk that customers will be unable to repay their loans according to their terms and that any collateral
securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making
loans and could have a material adverse impact on our results of operations.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our
borrowers and the value of the real estate and other assets serving as collateral, and we provide an allowance for estimated loan losses
based on a number of factors. We believe that the allowance for loan losses is adequate. However, if our assumptions or judgments are
wrong, the allowance for loan losses may not be sufficient to cover the actual credit losses. We may have to increase the allowance in
the future in response to the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a
result of any deterioration in the quality of our loan portfolio. The actual amount of future provisions for credit losses may vary from
the amount of past provisions.
Our tax strategies and the value of our deferred tax assets and liabilities could adversely affect our operating results and
regulatory capital ratios.
Our tax strategies are dependent upon our ability to generate taxable income in future periods. Our tax strategies will be less effective in
the event we fail to generate taxable income. Our deferred tax assets are subject to an evaluation of whether it is more likely than not
that they will be realized for financial statement purposes. In making this determination, we consider all positive and negative evidence
available including the impact of recent operating results as well as potential carryback of tax to prior years’ taxable income, reversals
of existing taxable temporary differences, tax planning strategies and projected earnings within the statutory tax loss carryover period.
If we were to conclude that a significant portion of our deferred tax assets were not more likely than not to be realized, the required
valuation allowance could adversely affect our financial position, results of operations and regulatory capital ratios. In addition, the
value of our deferred tax assets could be adversely affected by a change in statutory tax rates.
Geographic concentration may unfavorably impact our operations.
Substantially all of our business and operations are concentrated in the Western and Central New York region. As a result of this
geographic concentration, our results depend largely on economic conditions in these and surrounding areas. Deterioration in economic
conditions in our market could:
•
•
•
•
•
increase loan delinquencies;
increase problem assets and foreclosures;
increase claims and lawsuits;
decrease the demand for our products and services; and
decrease the value of collateral for loans, especially real estate, reducing customers’ borrowing power, the value of assets
associated with non-performing loans and collateral coverage.
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Generally, we make loans to small to mid-sized businesses whose success depends on the regional economy. These businesses
generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. Adverse economic and business
conditions in our market areas could reduce our growth rate, affect our borrowers’ ability to repay their loans and, consequently,
adversely affect our business, financial condition and performance. For example, we place substantial reliance on real estate as
collateral for our loan portfolio. A sharp downturn in real estate values in our market area could leave many of these loans inadequately
collateralized. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate
values, the impact on our results of operations could be materially adverse.
We depend on the accuracy and completeness of information about or from customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf o f customers
and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations
of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that
information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to
enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.
Our insurance brokerage subsidiary, SDN, is subject to risk related to the insurance industry.
SDN derives the bulk of its revenue from commissions and fees earned from brokerage services. SDN does not determine the insurance
premiums on which its commissions are based. Insurance premiums are cyclical in nature and may vary widely based on market
conditions. As a result, insurance brokerage revenues and profitability can be volatile. As insurance companies outsource the
production of premium revenue to non-affiliated brokers or agents such as SDN, those insurance companies may seek to further
minimize their expenses by reducing the commission rates payable to insurance agents or brokers, which could adversely affect SDN’s
revenues. In addition, there have been and may continue to be various trends in the insurance industry toward alternative insurance
markets including, among other things, increased use of self-insurance, captives, and risk retention groups. While SDN has been able to
participate in certain of these activities and earn fees for such services, there can be no assurance that we will realize revenues and
profitability as favorable as those realized from SDN’s traditional brokerage activities.
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 change. The activities of our investment advisory and wealth
management operations are subject primarily to provisions of the Advisers Act 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.
We may be unable to successfully implement our growth strategies, including the integration and successful management of
newly-acquired businesses.
Our current growth strategy is multi-faceted. We seek to expand our branch network into nearby areas, make strategic acquisitions of
loans, portfolios, other regional banks and non-banking firms whose businesses we feel may be complementary with ours, and to
continue to organically grow our core deposits. Any failure by us to effectively implement any one or more of these growth strategies
could have several negative effects, including a possible decline in the size or the quality, or both, of our loan portfolio or a decrease in
profitability caused by an increase in operating expenses.
In particular, we hope to continue an active merger and acquisition strategy. However, even if we use our common stock as the
predominant form of consideration, we may need to raise capital in order to negotiate a transaction on terms acceptable to us and there
can be no assurance that we will be able to raise a sufficient amount of capital to enable us to complete an acquisition. It is also possible
that even with adequate capital we may still be unable to complete an acquisition on favorable terms, causing us to miss opportunities to
increase our earnings and expand or diversify our operations.
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Our growth strategy is also dependent upon the successful integration of new businesses, including SDN and Courier Capital, as well as
any future acquisitions, into our existing operations. While our senior management team has had extensive experience in acquisitions
and post-acquisition integration, there is no guarantee that our current or future integration efforts will be successful, and if our senior
management is forced to spend a disproportionate amount of time on integrating recently-acquired businesses, it may distract their
attention from other growth opportunities.
We are subject to environmental liability risk associated with our lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and
take title to properties securing certain loans. There is a risk that hazardous or toxic substances could be found on properties we have
foreclosed upon. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and
property damage regardless of whether we knew, had reason to know of, or caused the release of such substance. Environmental laws
may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the
affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may
increase our exposure to environmental liability. The remediation costs and any other financial liabilities associated with an
environmental hazard could have a material adverse effect on our financial condition and results of operations.
Our commercial business and mortgage loans increase our exposure to credit risks.
At December 31, 2017, our portfolio of commercial business and mortgage loans totaled $1,259.2 million, or 46.1% of total loans. We
plan to continue to emphasize the origination of these types of loans, which generally expose us to a greater risk of nonpayment and loss
than residential real estate or consumer loans because repayment of such loans often depends on the successful operations and income
stream of the borrowers. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related
borrowers compared to consumer loans or residential real estate loans. A sudden downturn in the economy could result in borrowers
being unable to repay their loans, thus exposing us to increased credit risk.
Our indirect lending involves risk elements in addition to normal credit risk.
A portion of our current lending involves the purchase of consumer automobile installment sales contracts from automobile dealers
located in Western, Central and the Capital District of New York, and Northern and Central Pennsylvania. These loans are for the
purchase of new or used automobiles. We serve customers that cover a range of creditworthiness, and the required terms and rates are
reflective of those risk profiles. While these loans have higher yields than many of our other loans, such loans involve risk elements in
addition to normal credit risk. Additional risk elements associated with indirect lending include the limited personal contact with the
borrower as a result of indirect lending through non-bank channels, namely automobile dealers. While indirect automobile loans are
secured, such loans are secured by depreciating assets and characterized by loan-to-value ratios that could result in us not recovering the
full value of an outstanding loan upon default by the borrower. If the losses from our indirect loan portfolio are higher than anticipated,
it could have a material adverse effect on our financial condition and results of operations.
We accept deposits that do not have a fixed term and which may be withdrawn by the customer at any time for any reason.
At December 31, 2017, we had $2.36 billion of deposit liabilities that have no maturity and, therefore, may be withdrawn by the
depositor at any time. These deposit liabilities include our checking, savings, and money market deposit accounts.
Market conditions may impact the competitive landscape for deposits in the banking industry. The unprecedented low rate environment
and future actions the Federal Reserve may take may impact pricing and demand for deposits in the banking industry. The withdrawal of
more deposits than we anticipate could have an adverse impact on our profitability as this source of funding, if not replaced by similar
deposit funding, would need to be replaced with wholesale funding, the sale of interest-earning assets, or a combination of these two
actions. The replacement of deposit funding with wholesale funding could cause our overall cost of funding to increase, which would
reduce our net interest income. A loss of interest-earning assets could also reduce our net interest income.
Any future FDIC insurance premium increases may adversely affect our earnings.
The amount that is assessed by the FDIC for deposit insurance is set by the FDIC based on a variety of factors. These include the
depositor insurance fund’s reserve ratio, the Bank’s assessment base, which is equal to average consolidated total assets minus average
tangible equity, and various inputs into the FDIC’s assessment rate calculation.
If there are financial institution failures, we may be required to pay higher FDIC premiums. Such increases of FDIC insurance
premiums may adversely impact our earnings. See Part I, Item 1 “Business, Supervision and Regulation-Federal Deposit Insurance
Assessments” for more information about FDIC insurance premiums.
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We are highly regulated and any adverse regulatory action may result in additional costs, loss of business opportunities, and
reputational damage.
As described in the section captioned “Supervision and Regulation” included in Part I, Item 1, “Business,” both our Banking and Non-
Banking segments are subject to extensive supervision, regulation and examination. The various regulatory authorities with jurisdiction
over us have significant latitude in addressing our compliance with applicable laws and regulations including, but not limited to, those
governing consumer credit, fair lending, anti-money laundering, anti-terrorism, capital adequacy, asset quality and risk, management
ability and performance, earnings, liquidity, and various other factors affecting us. As part of this regulatory structure, we are subject to
policies and other guidance developed by the regulatory agencies with respect to, among other things, capital levels, the timing and
amount of dividend payments, the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.
Our regulators have broad discretion to impose restrictions and limitations on our operations if they determine, for any reason, that our
operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the
supervisory policies of these agencies.
This supervisory framework could materially impact the conduct, growth and profitability of our operations. Any failure on our part to
comply with current laws, regulations, other regulatory requirements or safe and sound banking, insurance, or investment advisory
practices or concerns about our financial condition, or any related regulatory sanctions or adverse actions against us, could increase our
costs or restrict our ability to expand our business and result in damage to our reputation.
In March 2018, we were notified by the FRB of New York that its most recent evaluation of the Bank’s CRA performance for the time
period January 2011 through September 2013, resulted in an overall rating of “Needs to Improve.” This rating may subject the Bank to
enhanced scrutiny in any application for business expansion it files with the Federal Reserve or the NY DFS, which may result in a
delay in approving or the denial of such application. In addition, the publication of the “Needs to Improve” rating may damage our
reputation, making it more difficult for us to achieve our business goals and objectives, particularly in the Buffalo and Rochester
metropolitan areas.
We make certain assumptions and estimates in preparing our financial statements that may prove to be incorrect, which could
significantly impact our results of operations, cash flows and financial condition, and we are subject to new or changing
accounting rules and interpretations, and the failure by us to correctly interpret or apply these evolving rules and
interpretations could have a material adverse effect.
Accounting principles generally accepted in the United States require us to use certain assumptions and estimates in preparing our
financial statements, including in determining credit loss reserves and reserves related to litigation, among other items. Certain of our
financial instruments, including available-for-sale securities and certain loans, require a determination of their fair value in order to
prepare our financial statements. Where quoted market prices are not available, we may make fair value determinations based on
internally developed models or other means, which ultimately rely to some degree on management judgment. Some of these and other
assets and liabilities may have no direct observable price levels, making their valuation particularly subjective, as they are based on
significant estimation and judgment. In addition, sudden illiquidity in markets or declines in prices of certain loans and securities may
make it more difficult to value certain balance sheet items, which may lead to the possibility that such valuations will be subject to
further change or adjustment. If assumptions or estimates underlying our financial statements are incorrect, we may experience material
losses that would impact our results of operations, cash flows and financial condition.
As indicated in Note 1, Summary of Significant Accounting Policies - Recent Accounting Pronouncements, to the Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K, the regulations, rules, standards, policies, and
interpretations underlying GAAP are constantly evolving and may change significantly over time. If we fail to interpret any one or more
of these GAAP provisions correctly, or if our methodology in applying them to our financial reporting or disclosures is at all flawed, our
financial statements may contain inaccuracies that, if severe enough, could warrant a later restatement by us, which in turn could result
in a material adverse event.
Legal and regulatory proceedings and related matters could adversely affect us.
We have been, and may in the future be, subject to various legal and regulatory proceedings. It is inherently difficult to assess the
outcome of these matters, and there can be no assurance that we will prevail in any proceeding or litigation. Legal and regulatory
matters of any degree of significance could result in substantial cost and diversion of our efforts, which by itself could have a material
adverse effect on our financial condition and operating results. While, as disclosed in Part I, Item 3, “Legal Proceedings,” our
management does not believe that there are any pending or threatened proceedings against us, that, if determined adversely, would have
a material adverse effect on our business, results of operations or financial condition, there can be no guarantee that such a proceeding
will not arise in the near or long-term future. Further, adverse determinations in such matters could result in actions by our regulators
that could materially adversely affect our business, financial condition or results of operations.
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We establish reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably
estimated. We may still incur legal costs for a matter even if we have not established a reserve. In addition, due to the inherent
subjectivity of the assessments and unpredictability of the outcome of legal proceedings, the actual cost of resolving a legal claim may
be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending legal proceeding, depending on
the remedy sought and granted, could adversely affect our results of operations and financial condition.
A breach in security of our or third party information systems, including the occurrence of a cyber incident or a deficiency in
cybersecurity, or a failure by us to comply with enhanced New York State cybersecurity regulations, may subject us to liability,
result in a loss of customer business or damage our brand image.
We rely heavily on communications, information systems (both internal and provided by third parties) and the internet to conduct our
business. Our business depends on our ability to process and monitor a large volume of daily transactions in compliance with legal,
regulatory and internal standards and specifications. In addition, a significant portion of our operations relies heavily on the secure
processing, storage and transmission of personal and confidential information of our customers and clients. These risks may increase in
the future as our customers continue to adapt to mobile payment and other internet-based product offerings and we expand the
availability of web-based products and applications.
In addition, several U.S. financial institutions have experienced significant distributed denial-of-service attacks, some of which involved
sophisticated and targeted attacks intended to disable or degrade service, or sabotage systems. Other potential attacks have attempted to
obtain unauthorized access to confidential information or destroy data, often through the introduction of computer viruses or malware,
cyber-attacks and other means. To date, none of these types of attacks have had a material effect on our business or operations. Such
security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or who may be
linked to terrorist organizations or hostile foreign governments. Those same parties may also attempt to fraudulently induce employees,
customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or
clients. We are also subject to the risk that our employees may intercept and transmit unauthorized confidential or proprietary
information. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from
a customer or third party could result in legal liability, remediation costs, regulatory action and reputational harm, any of which could
adversely affect our results of operations and financial condition.
As of March 1, 2017, we are required to comply with new cybersecurity regulations promulgated by the NY DFS that will be phased in
between September 2017 and March 2019. Any failure by us to timely and successfully implement some or all of these regulations,
which mandate, among other things, the creation of a new cybersecurity program, a written policy, the appointment of an information
security officer and certification by the NY DFS, could also result in regulatory sanctions, public disclosure and reputational damage
even if we do not experience a significant cybersecurity breach.
We face competition in staying current with technological changes to compete and meet customer demands.
The financial services market, including banking services, faces rapid changes with frequent introductions of new technology-driven
products and services. In addition to better serving customers, the effective use of technology increases efficiency and may enable us to
reduce costs. Our future success may depend, in part, on our ability to use technology to provide products and services that provide
convenience to customers and to create additional efficiencies in our operations. Some of our competitors have substantially greater
resources to invest in technological improvements than we currently have. We may not be able to effectively implement new
technology-driven products and services or be successful in marketing these products and services to our customers. As a result, our
ability to effectively compete to retain or acquire new business may be impaired, and our business, financial condition or results of
operations, may be adversely affected.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core
application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems
caused by these third parties, including as a result of them not providing us their services for any reason or them performing their
services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business
efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.
- 24 -
Third parties perform significant operational services on our behalf. These third-party vendors are subject to similar risks as us relating
to cybersecurity, breakdowns or failures of their own systems or employees. One or more of our vendors may experience a
cybersecurity event or operational disruption and, if any such event does occur, it may not be adequately addressed, either operationally
or financially, by the third-party vendor. Certain of our vendors may have limited indemnification obligations or may not have the
financial capacity to satisfy their indemnification obligations. Financial or operational difficulties of a vendor could also impair our
operations if those difficulties interfere with the vendor’s ability to serve us. If a critical vendor is unable to meet our needs in a timely
manner or if the services or products provided by such a vendor are terminated or otherwise delayed and if we are not able to develop
alternative sources for these services and products quickly and cost-effectively, it could have a material adverse effect on our business.
Federal banking regulators recently issued regulatory guidance on how banks select, engage and manage their outside vendors. These
regulations may affect the circumstances and conditions under which we work with third parties and the cost of managing such
relationships.
We use financial models for business planning purposes that may not adequately predict future results.
We use financial models to aid in planning for various purposes including our capital and liquidity needs, interest rate risk, potential
charge-offs, reserves, and other purposes. The models used may not accurately account for all variables that could affect future results,
may fail to predict outcomes accurately and/or may overstate or understate certain effects. As a result of these potential failures, we may
not adequately prepare for future events and may suffer losses or other setbacks due to these failures.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain skilled people. Competition for highly talented people can be
intense, and we may not be able to hire sufficiently skilled people or retain them. Further, the rural location of our principal executive
offices and many of our bank branches make it challenging for us to attract skilled people to such locations. The unexpected loss of
services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of
our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.
Acquisitions may disrupt our business and dilute shareholder value.
We intend to continue to pursue a growth strategy for our business by expanding our branch network into communities within or
adjacent to markets where we currently conduct business. We may consider acquisitions of loans or securities portfolios, lending or
leasing firms, commercial and small business lenders, residential lenders, direct banks, banks or bank branches, wealth and investment
management firms, securities brokerage firms, specialty finance or other financial services-related companies. We also intend to expand
our SDN and Courier subsidiaries by acquiring smaller insurance agencies and wealth management firms in areas which complement
our current footprint. We may be unsuccessful in expanding our SDN and Courier subsidiaries through acquisition because of the
growing interest in acquiring insurance brokers and wealth management firms, which could make it more difficult for us to identify
appropriate targets and could make such acquisitions more expensive. Even if we are able to identify appropriate acquisition targets, we
may not have sufficient capital to fund acquisitions or be able to execute transactions on favorable terms. If we are unable to expand
our SDN and Courier operations through smaller acquisitions, we may not be able to achieve all of the expected benefits of the SDN and
Courier acquisitions, which could adversely affect our results of operations and financial condition.
Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks
commonly associated with acquisitions, including, among other things:
•
•
•
•
•
•
•
•
•
•
•
•
difficulty in estimating the value of the target company;
payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short
and long term;
potential exposure to unknown or contingent liabilities of the target company;
exposure to potential asset quality issues of the target company;
volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts;
challenge and expense of integrating the operations and personnel of the target company;
inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other
projected benefits;
potential disruption to our business;
potential diversion of our management’s time and attention;
the possible loss of key employees and customers of the target company;
potential changes in banking or tax laws or regulations that may affect the target company; and
additional regulatory burdens associated with new lines of business.
- 25 -
We are subject to interest rate risk.
Our earnings and cash flows depend largely upon our net interest income. Interest rates are highly sensitive to many factors that are
beyond our control, including general economic conditions and policies of governmental and regulatory agencies, particularly the
Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on
loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to
originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities; and (iii) the average duration of our
mortgage-backed securities portfolio and other interest-earning assets. If the interest rates paid on deposits and other borrowings
increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings,
could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall
more quickly than the interest rates paid on deposits and other borrowings.
Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition
and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the
impact of actual interest rate changes on our balance sheet.
Our business may be adversely affected by conditions in the financial markets and economic conditions generally.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding
loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly
dependent on the business environment in the markets where we operate, in the State of New York and in the United States as a whole.
A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low
inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic
and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations
on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural
disasters; or a combination of these or other factors.
The policies of the Federal Reserve have a significant impact on our earnings.
The policies of the Federal Reserve impact us significantly. The Federal Reserve regulates the supply of money and credit in the United
States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing
deposits and can also affect the value of financial instruments we hold. Those policies determine, to a significant extent, our cost of
funds for lending and investing and impact our net interest income, our primary source of revenue. Changes in those policies are
beyond our control and are difficult to predict. Federal Reserve policies can also affect our borrowers, potentially increasing the risk
that they may fail to repay their loans. For example, a tightening of the money supply by the Federal Reserve could reduce the demand
for a borrower’s products and services. This could adversely affect the borrower’s earnings and ability to repay its loan, which could
have a material adverse effect on our financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to
many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry,
including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us
to credit risk in the event of a default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral
held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due
us. Any such losses could have a material adverse effect on our financial condition and results of operations.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2017, we had $65.8 million of goodwill and $8.9 million of other intangible assets. Significant and sustained
declines in our stock price and market capitalization, significant declines in our expected future cash flows, significant adverse changes
in the business climate or slower growth rates, any or all of which could be materially impacted by many of the risk factors discussed
herein, may necessitate our taking charges in the future related to the impairment of our goodwill. Future regulatory actions could also
have a material impact on assessments of goodwill for impairment. If the fair value of our net assets improves at a faster rate than the
market value of our reporting units, or if we were to experience increases in book values of a reporting unit in excess of the increase in
fair value of equity, we may also have to take charges related to the impairment of our goodwill. If we were to conclude that a future
write-down of our goodwill is necessary, we would record the appropriate charge, which could have a material adverse effect on our
results of operations.
- 26 -
Identifiable intangible assets other than goodwill consist of core deposit intangibles and other intangible assets (primarily customer
relationships). Adverse events or circumstances could impact the recoverability of these intangible assets including loss of core
deposits, significant losses of customer accounts and/or balances, increased competition or adverse changes in the economy. To the
extent these intangible assets are deemed unrecoverable, a non-cash impairment charge would be recorded which could have a material
adverse effect on our results of operations.
During the fourth quarter of 2015, we determined that the carrying value of our SDN reporting unit exceeded its fair value and recorded
a $751 thousand impairment charge. During the second quarter of 2017, we again determined that the carrying value of our SDN
reporting unit exceeded its fair value and recorded an additional $1.6 million impairment charge. For further discussion, see Note 1,
Summary of Significant Accounting Policies, and Note 7, Goodwill and Other Intangible Assets, to the Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K.
We operate in a highly competitive industry and market area.
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may
have more financial resources. Such competitors primarily include national, regional and internet banks within the markets in which we
operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loan
associations, credit unions, finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial
services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued
consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which
can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting),
and merchant banking. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services
traditionally provided by banks, such as automatic transfer and automatic payment systems. More recently, peer to peer lending has
emerged as an alternative borrowing source for our customers and many other non-banks offer lending and payment services in
competition with banks. Many of these competitors have fewer regulatory constraints and may have lower cost structures. Additionally,
due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products
and services as well as better pricing for those products and services than we can.
Our ability to compete successfully depends on a number of factors, including, among other things:
the ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical
standards and safe, sound assets;
the ability to expand our market position;
the scope, relevance and pricing of products and services offered to meet customer needs and demands;
the rate at which we introduce new products and services relative to our competitors;
customer satisfaction with our level of service; and
industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth
and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.
Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business.
Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our
ability to conduct business. Such events could affect the operations of our bank branches, stability of our deposit base, impair the ability
of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss
of revenue, and/or cause us to incur additional expenses. The occurrence of any such event could have a material adverse effect on our
business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
Liquidity is essential to our businesses.
Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. Reduced liquidity may
arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects
third parties or us. Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or
unanticipated reductions in our liquidity. In such events, our cost of funds may increase, thereby reducing our net interest income, or we
may need to sell a portion of our investment and/or loan portfolio, which, depending upon market conditions, could result in us realizing
a loss.
- 27 -
We may need to raise additional capital in the future and such capital may not be available on acceptable terms or at all.
We may need to raise additional capital in the future to provide sufficient capital resources and liquidity to meet our commitments and
business needs. Our ability to raise additional capital, if needed, will depend on our financial performance and, among other things,
conditions in the capital markets at that time which is outside of our control.
In addition, we are highly regulated, and our regulators could require us to raise additional common equity in the future. We and our
regulators perform a variety of analyses of our assets, including the preparation of stress case scenarios, and as a result of those
assessments we could determine, or our regulators could require us, to raise additional capital.
We cannot assure that required capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the
capital markets, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the
capital markets, or a downgrade of our debt rating, may adversely affect our capital costs and ability to raise capital and, in turn, our
liquidity. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on our
business, financial condition, results of operations or liquidity.
We rely on dividends from our subsidiaries for most of our revenue.
We are a separate and distinct legal entity from our subsidiaries. A substantial portion of our revenue comes from dividends from our
Bank subsidiary. These dividends are the principal source of funds we use to pay dividends on our common and preferred stock, and to
pay interest and principal on our debt. Federal and/or state laws and regulations limit the amount of dividends that our Bank subsidiary
may pay to us. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the
prior claims of the subsidiary’s creditors. In the event our Bank subsidiary is unable to pay dividends to us, we may not be able to
service debt, pay obligations, or pay dividends on our common and preferred stock. The inability to receive dividends from our Bank
subsidiary could have a material adverse effect on our business, financial condition, and results of operations.
We may not pay or may reduce the dividends on our common stock.
Holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally
available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so
and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of 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.
In the future, we may attempt to increase our capital resources by entering into debt or debt-like financing that is unsecured or secured
by all or up to all of our assets, or by issuing additional debt or equity securities, which could include issuances of secured or unsecured
commercial paper, medium-term notes, senior notes, subordinated notes, preferred stock or securities convertible into or exchangeable
for equity securities. In the event of our liquidation, our lenders and holders of our debt and preferred securities would receive a
distribution of our available assets before distributions to the holders of our common stock. Because our decision to incur debt and
issue securities in our future offerings will depend on market conditions and other factors beyond our control, we cannot predict or
estimate the amount, timing or nature of our future offerings and debt financings. Further, market conditions could require us to accept
less favorable terms for the issuance of our securities in the future. We may also issue additional shares of our common stock or
securities convertible into or exchangeable for our common stock that could dilute our current shareholders and effect the value of our
common stock.
Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect.
Provisions of our certificate of incorporation, our bylaws, and federal and state banking laws, including regulatory approval
requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our
shareholders. The combination of these provisions may discourage others from initiating a potential merger, takeover or other change of
control transaction, which, in turn, could adversely affect the market price of our common stock.
- 28 -
The market price of our common stock may fluctuate significantly in response to a number of factors.
Our quarterly and annual operating results have varied in the past and could vary significantly in the future, which makes it difficult for
us to predict our future operating results. Our operating results may fluctuate due to a variety of factors, many of which are outside of
our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of
which may cause our stock price to fluctuate. If our operating results fall below the expectations of investors or securities analysts, the
price of our common stock could decline substantially. Our stock price can fluctuate significantly in response to a variety of factors
including, among other things:
volatility of stock market prices and volumes in general;
changes in market valuations of similar companies;
changes in conditions in credit markets;
changes in accounting policies or procedures as required by the Financial Accounting Standards Board, or FASB, or other
regulatory agencies;
legislative and regulatory actions (including the impact of the Dodd-Frank Act and related regulations) subjecting us to
additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies
and laws, including the interest rate policies of the Federal Reserve Board;
additions or departures of key members of management;
fluctuations in our quarterly or annual operating results; and
changes in analysts’ estimates of our financial performance.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We own a 27,400 square foot building in Warsaw, New York that serves as our headquarters, and principal executive and administrative
offices. We lease a 52,300 square foot regional administrative facility located in Rochester, New York. This lease expires in August
2027, with options for two additional ten-year extensions.
We are engaged in the banking business through 53 branch offices, of which 35 are owned and 18 are leased, in the following fifteen
contiguous counties of Western and Central New York: Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee,
Livingston, Monroe, Ontario, Orleans, Seneca, Steuben, Wyoming and Yates Counties. The operating leases for our branch offices
expire at various dates through the year 2047 and generally include options to renew. The Bank also has administrative operations at a
leased facility in Amherst, New York.
SDN operates from a leased 14,400 square foot office located in Williamsville, New York. The lease for such space, which is used by
SDN and several of our Bank’s commercial lenders, extends through September 2021. SDN also leases one retail location.
Courier Capital operates from an owned 11,000 square foot office, located in Buffalo, New York. Courier Capital also has operations at
a leased facility in Amherst, New York and an owned facility in Jamestown, New York.
We believe that our properties have been adequately maintained, are in good operating condition and are suitable for our business as
presently conducted, including meeting the prescribed security requirements. For additional information, see Note 6, Premises and
Equipment, Net, and Note 11, Commitments and Contingencies, in the accompanying financial statements included in Part II, Item 8, of
this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
From time to time we are a party to or otherwise involved in legal proceedings arising out of the normal course of business.
Management does not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have
a material adverse effect on our business, results of operations or financial condition.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
- 29 -
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “FISI.” At February 23, 2018, 15,904,403
shares of our common stock were outstanding and held by approximately 3,400 shareholders of record. During 2017, the high sales
price of our common stock was $35.40 and the low sales price was $25.65. The closing price per share of our common stock on
December 29, 2017, the last trading day of our fiscal year, was $31.10. We declared dividends of $0.85 per common share during the
year ended December 31, 2017. See additional information regarding the market price and dividends paid in Part II, Item 6, “Selected
Financial Data.”
We have paid regular quarterly cash dividends on our common stock and our Board of Directors presently intends to continue this
practice, subject to our results of operations and the need for those funds for debt service and other purposes. See the discussions in the
section captioned “Supervision and Regulation” included in Part I, Item 1, “Business,” in the section captioned “Liquidity and Capital
Resources” included in Part II, Item 7, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
and in Note 12, Regulatory Matters, in the accompanying financial statements included in Part II, Item 8, “Financial Statements and
Supplementary Data,” all of which are included elsewhere in this report and incorporated herein by reference thereto.
Stock Performance Graph
The stock performance graph below compares (a) the cumulative total return on our common stock for the period beginning December
31, 2012 as reported by the NASDAQ Global Select Market, through December 31, 2017, (b) the cumulative total return on stocks
included in the NASDAQ Composite Index over the same period, and (c) the cumulative total return, as compiled by S&P Global
Market Intelligence, formerly SNL Financial LC (“SNL”), of Major Exchange (NYSE, NYSE MKT and NASDAQ) Banks with $1
billion to $5 billion in assets over the same period. Cumulative return assumes the reinvestment of dividends. The graph was prepared
by S&P Global Market Intelligence and is expressed in dollars based on an assumed investment of $100.
Total Return Performance
Financial Institutions, Inc.
NASDAQ Composite Index
SNL Bank $1B-$5B Index
300
250
200
150
100
l
e
u
a
V
x
e
d
n
I
50
12/31/12
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
Index
Financial Institutions, Inc.
NASDAQ Composite
SNL Bank $1B-$5B Index
Period Ending
12/31/12
100.00
100.00
100.00
12/31/13
137.52
140.12
145.41
12/31/14
144.64
160.78
152.04
12/31/15 12/31/16 12/31/17
208.99
166.38
195.36
187.22
171.97
242.71
244.85
170.20
261.04
- 30 -
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
Selected financial condition data:
Total assets
Loans, net
Investment securities
Deposits
Borrowings
Shareholders’ equity
Common shareholders’ equity
Tangible common shareholders’ equity (1)
Selected operations data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense
Net income
Preferred stock dividends
Net income available to common shareholders
Stock and related per share data:
Earnings per common share:
Basic
Diluted
Cash dividends declared per common share
Common book value per share
Tangible common book value per share (1)
Market price (NASDAQ: FISI):
High
Low
Close
_____
2017
At or for the year ended December 31,
2015
2014
2016
2013
$ 4,105,210
2,700,345
1,041,439
3,210,174
485,331
381,177
363,848
289,145
$ 3,710,340
2,309,227
1,083,264
2,995,222
370,561
320,054
302,714
227,074
$ 3,381,024 $ 3,089,521 $ 2,928,636
1,806,883
859,185
2,320,056
337,042
254,839
237,497
187,495
1,884,365
916,932
2,450,527
334,804
279,532
262,192
193,553
2,056,677
1,030,112
2,730,531
332,090
293,844
276,504
209,558
$ 130,110
17,495
112,615
13,361
99,254
34,730
90,513
43,471
9,945
33,526
1,462
32,064
$
$
$
$
$
$
$
$
$
$
2.13
2.13
0.85
22.85
18.16
35.40
25.65
31.10
$ 115,231 $ 105,450 $ 101,055 $
12,541
102,690
9,638
93,052
35,760
84,671
44,141
12,210
31,931 $
1,462
30,469 $
10,137
95,313
7,381
87,932
30,337
79,393
38,876
10,539
28,337 $
1,462
26,875 $
7,281
93,774
7,789
85,985
25,350
72,355
38,980
9,625
29,355 $
1,462
27,893 $
2.11 $
2.10 $
0.81 $
20.82 $
15.62 $
34.55 $
25.98 $
34.20 $
1.91 $
1.90 $
0.80 $
19.49 $
14.77 $
29.04 $
21.67 $
28.00 $
2.01 $
2.00 $
0.77 $
18.57 $
13.71 $
27.02 $
19.72 $
25.15 $
$
$
$
$
$
$
$
$
$
$
98,931
7,337
91,594
9,079
82,515
24,833
69,441
37,907
12,377
25,530
1,466
24,064
1.75
1.75
0.74
17.17
13.56
26.59
17.92
24.71
(1) This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the
GAAP to Non-GAAP Reconciliation for further information.
- 31 -
(Dollars in thousands)
Performance ratios:
Net income, returns on:
Average assets
Average equity
Average common equity
Average tangible common equity (1)
Average tangible assets (1)
Common dividend payout ratio
Net interest margin (fully tax-equivalent)
Effective tax rate
Efficiency ratio (2)
Capital ratios:
Leverage ratio (3)
Common equity Tier 1 capital ratio (3)
Tier 1 capital ratio (3)
Total risk-based capital ratio (3)
Average equity to average assets
Common equity to assets
Tangible common equity to tangible assets (1)
Asset quality:
Non-performing loans
Non-performing assets
Allowance for loan losses
Net loan charge-offs
Non-performing loans to total loans
Non-performing assets to total assets
Net charge-offs to average loans
Allowance for loan losses to total loans
Allowance for loan losses to non-performing loans
Other data:
Number of branches
Full time equivalent employees
_____
2017
0.86%
9.62%
9.68%
12.51%
0.84%
39.91%
3.21%
22.9%
60.65%
At or for the year ended December 31,
2015
2014
2016
0.90%
10.01%
10.10%
13.51%
0.88%
38.39%
3.24%
27.7%
60.95%
0.87%
9.78%
9.87%
13.16%
0.84%
41.88%
3.28%
27.1%
62.44%
0.98%
10.80%
10.96%
14.12%
0.95%
38.31%
3.50%
24.7%
59.18%
2013
0.91%
10.10%
10.23%
13.00%
0.87%
42.29%
3.64%
32.7%
58.92%
8.13%
10.16%
10.74%
13.19%
8.95%
8.86%
7.17%
7.36%
9.59%
10.26%
12.97%
8.99%
8.16%
6.25%
7.41%
9.77%
10.50%
13.35%
8.86%
8.18%
6.32%
7.35%
n/a
10.47%
11.72%
9.08%
8.49%
6.41%
7.63%
n/a
10.82%
12.08%
9.01%
8.11%
6.51%
8,440
$
6,326
$
$ 12,531
$
$
$ 12,679
8,603
6,433
$ 27,085
$ 30,934
$ 34,672
7,933
5,789
9,623
$
$
$
0.41%
0.27%
0.46%
0.25%
0.17%
0.31%
0.40%
0.26%
0.38%
1.30%
1.32%
1.27%
321%
489%
277%
$ 10,153
$ 10,347
$ 27,637
$
6,888
0.53%
0.33%
0.37%
1.45%
272%
16,622
$
$ 17,083
$ 26,736
7,057
$
0.91%
0.58%
0.40%
1.46%
161%
53
639
52
631
50
660
49
622
50
608
(1) This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the
GAAP to Non-GAAP Reconciliation for further information.
(2) Efficiency ratio provides a ratio of operating expenses to operating income. Efficiency ratio is calculated by dividing noninterest
expense by net revenue, which is defined as the sum of tax-equivalent net interest income and noninterest income before net gains
on investment securities. The efficiency ratio is not a financial measurement required by GAAP. However, the efficiency ratio is
used by management in its assessment of financial performance specifically as it relates to noninterest expense control.
Management also believes such information is useful to investors in evaluating Company performance.
(3) 2017, 2016 and 2015 ratios calculated under Basel III rules, which became effective January 1, 2015.
- 32 -
GAAP to Non-GAAP Reconciliation
(In thousands, except per share data)
Computation of ending tangible common equity:
Common shareholders’ equity
Less: goodwill and other intangible assets, net
Tangible common equity
Computation of ending tangible assets:
Total assets
Less: goodwill and other intangible assets, net
Tangible assets
2017
At or for the year ended December 31,
2015
2014
2016
2013
$
$
363,848 $
74,703
289,145 $
302,714 $
75,640
227,074 $
276,504 $
66,946
209,558 $
262,192 $
68,639
193,553 $
237,497
50,002
187,495
$ 4,105,210 $ 3,710,340 $ 3,381,024 $ 3,089,521 $ 2,928,636
50,002
$ 4,030,507 $ 3,634,700 $ 3,314,078 $ 3,020,882 $ 2,878,634
75,640
74,703
66,946
68,639
Tangible common equity to tangible assets (1)
7.17%
6.25%
6.32%
6.41%
6.51%
Common shares outstanding
Tangible common book value per share (2)
Computation of average tangible common equity:
Average common equity
Average goodwill and other intangible assets, net
Average tangible common equity
$
$
$
15,925
$
18.16
14,538
$
15.62
14,191
$
14.77
14,118
13.71 $
13,829
13.56
331,184 $
74,818
256,366 $
301,666 $
76,170
225,496 $
272,367 $
68,138
204,229 $
254,533 $
57,039
197,494 $
235,290
50,201
185,089
Computation of average tangible assets:
Average assets
Average goodwill and other intangible assets, net
Average tangible assets
$ 3,896,071 $ 3,547,105 $ 3,269,890 $ 2,994,604 $ 2,803,825
50,201
$ 3,821,253 $ 3,470,935 $ 3,210,752 $ 2,937,565 $ 2,753,624
68,138
76,170
74,818
57,039
$
Net income available to common shareholders
Return on average tangible common equity (3)
Return on average tangible assets (4)
_____
(1) Tangible common equity divided by tangible assets.
(2) Tangible common equity divided by common shares outstanding.
(3) Net income available to common shareholders divided by average tangible common equity.
(4) Net income available to common shareholders divided by average tangible assets.
30,469 $
13.51%
0.88%
32,064 $
12.51%
0.84%
26,875 $
13.16%
0.84%
27,893 $
14.12%
0.95%
24,064
13.00%
0.87%
This table contains disclosure that includes calculations for tangible common equity, tangible assets, tangible common equity to tangible
assets, tangible common book value per share, average tangible common equity, average tangible assets, return on average tangible
common equity and return on average tangible assets, which are determined by methods other than in accordance with GAAP. We
believe that these non-GAAP measures are useful to our investors as measures of the strength of our capital and ability to generate
earnings on tangible common equity invested by our shareholders. These non-GAAP measures provide supplemental information that
may help investors to analyze our capital position without regard to the effects of intangible assets. Non-GAAP financial measures have
inherent limitations and are not uniformly utilized by issuers. Therefore, these non-GAAP financial measures should not be considered
in isolation, or as a substitute for comparable measures prepared in accordance with GAAP.
- 33 -
SELECTED QUARTERLY DATA
(Dollars in thousands, except per share data)
2017
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense
Net income
Preferred stock dividends
Net income applicable to common shareholders
Earnings per common share (1):
Basic
Diluted
Market price (NASDAQ: FISI):
High
Low
Close
Cash dividends declared per common share
2016
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense
Net income
Preferred stock dividends
Net income applicable to common shareholders
Earnings per common share (1):
Basic
Diluted
Market price (NASDAQ: FISI):
High
Low
Close
Cash dividends declared per common share
_____
$
$
$
$
$
$
$
$
$
$
$
$
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
34,767
5,007
29,760
3,946
25,814
8,987
23,163
11,638
580
11,058
365
10,693
$ 33,396
4,958
28,438
2,802
25,636
8,574
22,467
11,743
3,464
8,279
366
7,913
$
$
$ 31,409
3,987
27,422
3,832
23,590
9,333
23,941
8,982
2,736
6,246
366
5,880
$
$
$ 30,538
3,543
26,995
2,781
24,214
7,836
20,942
11,108
3,165
7,943
365
7,578
$
$
$
0.68
0.68
$
0.52
0.52
$
0.40
0.40
0.52
0.52
34.10
28.70
31.10
0.22
$
$
31.15
25.65
28.80
0.21
$
$
35.35
29.09
29.80
0.21
$
35.40
30.50
32.95
$
0.21
29,990
3,268
26,722
3,357
23,365
9,088
20,715
11,738
3,045
8,693
365
8,328
$ 29,360
3,310
26,050
1,961
24,089
8,539
20,618
12,010
3,541
8,469
366
8,103
$
$
$ 28,246
3,047
25,199
1,952
23,247
8,916
22,120
10,043
2,892
7,151
366
6,785
$
$
$ 27,635
2,916
24,719
2,368
22,351
9,217
21,218
10,350
2,732
7,618
365
7,253
$
$
$
0.58
0.57
$
0.56
0.56
$
0.47
0.47
0.50
0.50
34.55
25.98
34.20
0.21
$
$
27.63
25.16
27.11
0.20
$
$
29.49
24.56
26.07
0.20
$
29.53
25.38
29.07
$
0.20
(1) Earnings per share data is computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings
per common share amounts may not equal the total for the year.
- 34 -
2017 FOURTH QUARTER RESULTS
Net income was $11.1 million for the fourth quarter of 2017 compared with $8.7 million for the fourth quarter of 2016. After preferred
dividends, net income available to common shareholders for the fourth quarter of 2017 was $10.7 million or $0.68 per diluted share,
compared to $8.3 million or $0.57 per share in the fourth quarter of 2016.
Net interest income was $29.8 million for the fourth quarter of 2017 compared with $26.7 million for the fourth quarter of 2016. The
increase was primarily related to an increase in average interest-earning assets of $331.6 million, led by a $349.6 million increase in
loans.
The provision for loan losses was $3.9 million for the fourth quarter of 2017 compared with $3.4 million for the fourth quarter of 2016.
Net charge-offs for the fourth quarter of 2017 were $3.6 million, or 0.54% annualized, of average loans, compared to $1.8 million, or
0.30% annualized, of average loans in the fourth quarter of 2016.
Noninterest income was $9.0 million for the fourth quarter of 2017 compared to $9.1 million in the fourth quarter of 2016.
Noninterest expense was $23.2 million for the fourth quarter of 2017 compared to $20.7 million in the fourth quarter of 2016. The
increase was the result of higher salaries and employee benefits related to organic growth initiatives, higher healthcare costs largely
attributable to the high cost of specialty pharmaceuticals; higher occupancy and equipment expense related to 2016 and 2017 branch
openings and relocation of the Rochester regional administration center; higher computer and data processing expense in connection
with technology upgrades; and an increase in advertising and promotions expense related to development of a rebranding initiative
launched in the first quarter of 2018.
Income tax expense was $580 thousand in the fourth quarter of 2017, representing an effective tax rate of 5.0%, compared to $3.0
million in the fourth quarter of 2016, representing an effective tax rate of 25.9%. The decrease in income tax expense and lower
effective tax rate was the result of an estimated $2.9 million reduction in income tax expense due to the TCJ Act, primarily driven by a
revaluation adjustment to our net deferred tax liability. Effective tax rates are impacted by items of income and expense that are not
subject to federal or state taxation. Our effective tax rates differ from the statutory rates primarily due to the effect of interest income
from tax-exempt securities, earnings on company owned life insurance, the non-cash fair value adjustment of the contingent
consideration liability associated with the SDN acquisition, the 2017 non-cash goodwill impairment charge related to SDN and, in 2017,
the net impact of the TCJ Act, as described above.
- 35 -
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following is a discussion and analysis of our financial position and results of operations and should be read in conjunction with the
information set forth under Part I, Item 1A, “Risks Factors,” and our consolidated financial statements and notes thereto appearing
under Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
INTRODUCTION
Financial Institutions, Inc. (the “Parent” and together with all its subsidiaries, “we,” “our,” or “us”), is a financial holding company
headquartered in New York State. We offer a broad array of deposit, lending, and other financial services to individuals, municipalities
and businesses in Western and Central New York through our wholly-owned New York chartered banking subsidiary, Five Star Bank
(the “Bank”). Our indirect lending network includes relationships with franchised automobile dealers in Western and Central New
York, the Capital District of New York and Northern and Central Pennsylvania. We offer insurance services through our wholly-owned
subsidiary, Scott Danahy Naylon, LLC (“SDN”), a full service insurance agency. In addition, we offer customized investment
management, investment consulting and retirement plan services through our wholly-owned subsidiary Courier Capital, LLC (“Courier
Capital”), an SEC-registered investment advisory and wealth management firm.
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, investment advisory 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.
EXECUTIVE OVERVIEW
2017 Financial Performance Review
During 2017 we continued to execute on our growth and diversification strategy and we progressed in growing our core banking
franchise. We delivered year-over-year increases in both total loans and total deposits of 17% and 7%, respectively, which drove our
revenue higher. We completed an at-the-market equity offering (“ATM Offering”) that generated $38.3 million in net proceeds,
positioning us for future growth; added eight mortgage loan officers plus underwriting and servicing support staff, significantly
expanding our residential mortgage lending capacity; and acquired a Buffalo-area wealth management firm, furthering our strategy to
increase fee-based noninterest income. We also surpassed $4 billion in total assets during the year, a significant milestone for us.
Net income for 2017 was $33.5 million, compared to $31.9 million for 2016. This resulted in a 0.86% return on average assets and a
9.62% return on average equity. Net income available to common shareholders was $32.1 million or $2.13 per diluted share for 2017,
compared to $30.5 million or $2.10 per diluted share for 2016. We declared cash dividends of $0.85 during 2017, an increase of $0.04
per common share or 5% compared to the prior year.
Fully-taxable equivalent net interest income was $115.8 million in 2017, an increase of $9.9 million, or 9%, compared with 2016. This
reflected the impact of 10% growth in average interest-earning assets, partially offset by a three basis point decline in the net interest
margin to 3.21%.
The provision for loan losses increased $3.7 million, or 39%, from 2016 as our allowance for loan losses reflects growth in our loan
portfolio. Net charge-offs increased $3.8 million from the prior year to $9.6 million in 2017. Net charge-offs were an annualized
0.38% of average loans in the current year compared to 0.26% in 2016. In addition, non-performing loans increased $6.2 million
compared to a year ago to $12.5 million, or 0.46% of total loans.
Noninterest income totaled $34.7 million for the full year 2017, a decrease of $1.0 million or 3% when compared to the prior year.
Investment advisory income increased by $896 thousand to $6.1 million during the current year reflecting higher assets under
management driven by the acquisition of the assets of Robshaw & Julian and favorable market conditions. Income from company
owned life insurance decreased to $1.8 million in 2017 from $2.8 million in the prior year, as the first quarter of 2016 included $911
thousand of death benefit proceeds. In addition, the net gain on investment securities decreased by $1.4 million. During both 2017 and
2016, we recognized non-cash fair value adjustments of the contingent consideration liability related to the SDN acquisition that
resulted in noninterest income of $1.2 million. The fair value of the contingent consideration liability was recorded at the time of the
SDN acquisition as a component of the purchase price.
- 36 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Noninterest expense for the full year 2017 totaled $90.5 million, a $5.8 million increase compared to $84.7 million in the prior year.
Salaries and benefits expense increased $3.5 million year-over-year, due to our organic growth initiatives and higher healthcare costs
largely attributable to the high cost of specialty pharmaceuticals. Also contributing to the increase were higher occupancy and
equipment expense, computer and data processing expense, advertising and promotions expense and a $1.6 million goodwill impairment
charge related to the SDN acquisition. Partially offsetting, professional services decreased $1.7 million year-over-year, primarily in
connection with the Company’s 2016 proxy contest.
Income tax expense for the year was $9.9 million, representing an effective tax rate of 22.9% compared with an effective tax rate of
27.7% in 2016. The decrease in income tax expense and lower effective tax rate was the result of an estimated $2.9 million reduction in
income tax expense due to the TCJ Act, primarily driven by a revaluation adjustment to the net deferred tax liability.
Total assets were $4.11 billion at December 31, 2017, up $394.9 million from $3.71 billion at December 31, 2016. The increase was
largely the result of loan growth funded by deposit growth, short-term borrowings and proceeds from the ATM Offering. Total loans
were $2.74 billion at December 31, 2017, up $394.9 million, or 17%, from December 31, 2016.
• Commercial mortgage loans totaled $808.9 million, up $138.9 million, or 21%, from December 31, 2016.
• Commercial business loans totaled $450.3 million, up $100.8 million, or 29%, from December 31, 2016.
• Residential real estate loans totaled $465.3 million, up $37.3 million, or 9%, from December 31, 2016.
• Consumer indirect loans totaled $876.6 million, up $124.1 million, or 16%, from December 31, 2016.
Total deposits were $3.21 billion at December 31, 2017, an increase of $215.0 million from December 31, 2016, which was primarily
the result of successful business development efforts in both municipal and retail banking. Short-term borrowings were $446.2 million
at December 31, 2017, up $114.7 million from December 31, 2016.
Shareholders’ equity was $381.2 million at December 31, 2017, compared to $320.1 million at December 31, 2016. Common book
value per share was $22.85 at December 31, 2017, an increase of $2.03 or 10% from $20.82 at December 31, 2016. The increase in
shareholders’ equity as compared to December 31, 2016, is attributable to common stock issued through the ATM Offering plus net
income less dividends paid, net of the change in pension and post-retirement obligations, a component of accumulated other
comprehensive loss.
The Company’s leverage ratio was 8.13% at December 31, 2017 compared to 7.36% at December 31, 2016. The increase in the
leverage ratio was due to capital raised in the 2017 ATM Offering. The Bank’s leverage ratio and total risk-based capital ratio were
8.75% and 12.73%, respectively, at December 31, 2017.
RESULTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 2017 AND DECEMBER 31, 2016
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.
We use interest rate spread and net interest margin 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
shareholders’ 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.
- 37 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
The Federal Reserve influences the general market rates of interest, which impacts the deposit and loan rates offered by many financial
institutions. The intended federal funds rate, which is the cost of immediately available overnight funds, was increased by 25 basis
points in each of March, June and December 2017, resulting in a range of 1.25% to 1.50% at year-end 2017. The Federal Reserve had
previously increased the intended federal funds rate by 25 basis points to a range of 0.50% to 0.75% in December 2016 and by 25 basis
points to a range of 0.25% to 0.50% in December 2015. Prior to that, the intended federal funds rate had remained at a range of zero to
0.25% since 2008. Our loan portfolio is significantly affected by changes in the prime interest rate and changes in the prime interest
rate generally follow changes in the federal funds rate. The prime interest rate, which is the rate offered on loans to borrowers with
strong credit, increased to 4.50% in December 2017, reflecting the three 25 basis point increases in 2017, after the previous 25 basis
point increase to 3.75% in December 2016 and 25 basis point increase to 3.50% in December 2015. Prior to that, the prime interest rate
had remained at 3.25% since 2008.
Net Interest Income and Net Interest Margin
The following table reconciles interest income per the consolidated statements of income to interest income adjusted to a fully taxable
equivalent basis for the years ended December 31 (in thousands):
Interest income per consolidated statements of income
Adjustment to fully taxable equivalent basis
Interest income adjusted to a fully taxable equivalent basis
Interest expense per consolidated statements of income
Net interest income on a taxable equivalent basis
2017
2016
130,110
3,160
133,270
17,495
115,775
$
$
115,231
3,172
118,403
12,541
105,862
$
$
2015
105,450
3,097
108,547
10,137
98,410
$
$
Net interest income on a taxable equivalent basis for 2017 increased $9.9 million or 9%, compared to 2016. The increase was due to an
increase in average interest-earning assets of $339.5 million or 10% compared to 2016. The net interest margin of 3.21% for 2017
declined three basis points compared to 3.24% in 2016. This decrease was a function of a five basis point decrease in interest rate
spread to 3.08% during 2017, partially offset by a two basis point higher contribution from net free funds. The lower interest rate spread
was a net result of a seven basis point increase in the yield on earning assets and a 12 basis point increase in the cost of interest-bearing
liabilities.
For the year ended December 31, 2017, the yield on average earning assets of 3.69% was seven basis points higher than 2016. Loan
yields increased four basis points during 2017 to 4.22%. The yield on investment securities increased three basis points during 2017 to
2.48%. Overall, the earning asset rate changes increased interest income by $1.2 million during 2017 and a favorable volume variance
increased interest income by $13.7 million, which collectively drove a $14.9 million increase in interest income.
Average interest-earning assets were $3.61 billion for 2017, an increase of $339.5 million or 10% from the prior year, with average
loans up $312.5 million, average securities up $23.1 million and average federal funds sold and other interest-earning deposits up $3.9
million. Average loans were $2.52 billion for 2017, an increase of $312.5 million or 14% from the prior year. The growth in average
loans reflected increases in most loan categories, which in turn reflects the impact of our growth strategy, with commercial loans up
$169.1 million, residential real estate loans up $34.1 million, and consumer loans up $115.1 million, partially offset by a $5.8 million
decrease in residential real estate lines. Loans made up 69.7% of average interest-earning assets during 2017 compared to 67.4% during
2016. Loans generally have significantly higher yields compared to securities and federal funds sold and interest-bearing deposits and,
as such, have a more positive effect on the net interest margin. The yield on average loans was 4.22% for 2017, an increase of four
basis points compared to 4.18% for 2016. The increase in the volume of average loans resulted in a $13.2 million increase in interest
income, in addition to a $830 thousand increase due to the favorable rate variance. Average securities were $1.09 billion for 2017, an
increase of $23.1 million or 2% from the prior year. Securities made up 30.1% of average interest-earning assets in 2017 compared to
32.5% in 2016. The taxable equivalent yield on average securities was 2.48% in 2017 compared to 2.45% in 2016. The increase in the
volume of average securities resulted in a $531 thousand increase in interest income, in addition to a $295 thousand increase due to the
favorable rate variance.
For the year ended December 31, 2017, the cost of average interest-bearing liabilities of 0.61% was 12 basis points higher than 2016.
The cost of average interest-bearing deposits increased eight basis points to 0.45%, the cost of short-term borrowings increased 51 basis
points to 1.16% in 2017 compared to 2016 and the cost of long-term borrowings decreased one basis point to 6.32%. Overall, interest-
bearing liability rate and volume increases resulted in $5.0 million of higher interest expense.
Average interest-bearing liabilities of $2.85 billion in 2017 were $278.8 million or 11% higher than 2016. On average, interest-bearing
deposits grew $189.3 million, while noninterest-bearing demand deposits (a principal component of net free funds) were up $41.5
million. The increase in average deposits was due to successful business development efforts. Overall, interest-bearing deposit rate and
volume changes resulted in $2.6 million of higher interest expense during 2017. Average short-term and long-term borrowings were
$377.5 million in 2017, $89.5 million higher than in 2016. Overall, short and long-term borrowing rate and volume changes resulted in
$2.3 million of higher interest expense during 2017.
- 38 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
The following tables present, for the periods indicated, information regarding: (i) the average balance sheet; (ii) the amount of interest
income from interest-earning assets and the resulting annualized yields (tax-exempt yields have been adjusted to a tax-equivalent basis
using the applicable Federal tax rate in each year); (iii) the amount of interest expense on interest-bearing liabilities and the resulting
annualized rates; (iv) net interest income; (v) net interest rate spread; (vi) net interest income as a percentage of average interest-earning
assets (“net interest margin”); and (vii) the ratio of average interest-earning assets to average interest-bearing liabilities. Investment
securities are at amortized cost for both held to maturity and available for sale securities. Loans include net unearned income, net
deferred loan fees and costs and non-accruing loans. Dollar amounts are shown in thousands.
Interest-earning assets:
Federal funds sold and other
interest-earning deposits
Investment securities:
Taxable
Tax-exempt
Total investment securities
Loans:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans
Total interest-earning assets
Less: Allowance for loan losses
Other noninterest-earning assets
Total assets
Interest-bearing liabilities:
Deposits:
Interest-bearing demand
Savings and money market
Time deposits
Total interest-bearing deposits
Short-term borrowings
Long-term borrowings
Total borrowings
Total interest-bearing liabilities
Noninterest-bearing deposits
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’
equity
Net interest income (tax-equivalent)
Interest rate spread
Net earning assets
Net interest margin (tax-equivalent)
Ratio of average interest-earning
assets to average interest-bearing
liabilities
2017
Years ended December 31,
2016
2015
Average
Balance
Interest
Average Average
Balance
Rate
Interest
Average Average
Balance
Rate
Average
Interest Rate
$
7,060 $
73 1.04% $
3,116 $
18 0.56% $
37 $
- 0.40%
788,923
297,377
1,086,300
17,886 2.27
9,029 3.04
26,915 2.48
767,371
295,850
1,063,221
17,025 2.22
9,064 3.06
26,089 2.45
727,564 16,123 2.22
8,849 3.09
286,607
1,014,171 24,972 2.46
396,319
727,849
438,586
118,797
819,598
17,111
17,400 4.39
34,019 4.67
16,409 3.74
4,838 4.07
31,551 3.85
2,065 12.07
2,518,260 106,282 4.22
3,611,620 133,270 3.69
14,091 4.19
336,633
28,465 4.60
618,436
15,722 3.89
404,456
4,734 3.80
124,635
27,190 3.86
703,975
2,094 11.89
17,620
2,205,755
92,296 4.18
3,272,092 118,403 3.62
286,019 11,774 4.12
522,328 24,136 4.62
366,032 15,053 4.11
4,669 3.63
128,525
665,454 25,746 3.87
2,197 11.58
1,987,327 83,575 4.21
3,001,535 108,547 3.62
18,969
(32,821)
317,272
$ 3,896,071
$ 638,295
1,033,836
801,394
2,473,525
338,392
39,094
377,486
2,851,011
674,884
21,656
348,520
(28,791)
303,804
$ 3,547,105
$ 576,046
1,010,510
697,654
2,284,210
248,938
39,023
287,961
2,572,171
633,416
22,512
319,006
897 0.14
1,487 0.14
8,709 1.09
11,093 0.45
3,931 1.16
2,471 6.32
6,402 1.70
17,495 0.61
(27,599)
295,954
$ 3,269,890
833 0.14
1,339 0.13
6,286 0.90
8,458 0.37
1,612 0.65
2,471 6.33
4,083 1.42
12,541 0.49
$ 543,690
908,614
616,747
2,069,051
262,494
27,886
290,380
754 0.14
1,166 0.13
5,386 0.87
7,306 0.35
1,081 0.41
1,750 6.28
2,831 0.98
2,359,431 10,137 0.43
599,334
21,418
289,707
$ 3,896,071
$ 3,547,105
$ 3,269,890
$115,775
$105,862
$ 98,410
3.08%
3.13%
$ 760,609
$ 699,921
$ 642,104
3.21%
3.24%
3.19%
3.28%
126.68%
127.21%
127.21%
The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate
levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest
income is set forth in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” included elsewhere in this report.
- 39 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Rate /Volume 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 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):
Increase (decrease) in:
Interest income:
Federal funds sold and interest-earning
deposits
Investment securities:
Taxable
Tax-exempt
Total investment securities
Loans:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans
Total interest income
Interest expense:
Deposits:
Interest-bearing demand
Savings and money market
Time deposits
Total interest-bearing deposits
Short-term borrowings
Long-term borrowings
Total borrowings
Total interest expense
Net interest income
Provision for Loan Losses
Change from 2016 to 2017
Rate
Total
Volume
Change from 2015 to 2016
Volume
Rate
Total
$ 34
$ 21
$ 55
$ 18 $ -
$ 18
484
47
531
377
(82)
295
861
(35)
826
883
283
1,166
19
(68)
(49)
902
215
1,117
2,594
5,108
1,292
(228)
4,451
(61)
13,156
13,721
715
446
(605)
332
(90)
32
830
1,146
88
32
1,015
1,135
722
4
726
1,861
11,860 $
(24)
116
1,408
1,500
1,597
(4)
1,593
3,093
(1,947) $
$
3,309
5,554
687
104
4,361
(29)
13,986
14,867
64
148
2,423
2,635
2,319
-
2,319
4,954
9,913
2,116
4,424
1,524
(144)
1,488
(159)
9,249
10,433
201
(95)
(855)
209
(44)
56
(528)
(577)
2,317
4,329
669
65
1,444
(103)
8,721
9,856
46
134
725
905
(59)
705
646
1,551
8,882 $
33
39
175
247
590
16
606
853
79
173
900
1,152
531
721
1,252
2,404
(1,430) $ 7,452
$
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 was $13.4 million for the year ended
December 31, 2017 compared with $9.6 million for 2016. See the “Allowance for Loan Losses” section of this Management’s
Discussion and Analysis for further discussion.
- 40 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Noninterest Income
The following table summarizes our noninterest income for the years ended December 31 (in thousands):
Service charges on deposits
Insurance income
ATM and debit card
Investment advisory
Company owned life insurance
Investments in limited partnerships
Loan servicing
Net gain on sale of loans held for sale
Net gain on investment securities
Net gain on other assets
Amortization of tax credit investment
Contingent consideration liability adjustment
Other
Total noninterest income
2017
2016
2015
7,391
5,266
5,721
6,104
1,781
110
439
376
1,260
37
-
1,200
5,045
34,730
$
$
7,280
5,396
5,687
5,208
2,808
300
436
240
2,695
313
-
1,170
4,227
35,760
$
$
7,742
5,166
5,084
2,193
1,962
895
503
249
1,988
27
(390)
1,093
3,825
30,337
$
$
Insurance income decreased by $130 thousand, or 2%, to $5.3 million during 2017. The decrease was primarily the result of non-
renewal by a few large commercial accounts due to: one customer being acquired, one customer going out of business and one customer
selecting another agency as a result of a competitive bidding process. These non-renewals have been partially replaced with several
new, but smaller, commercial and personal accounts.
Investment advisory income increased to $6.1 million in 2017, compared to $5.2 million in 2016, reflecting higher assets under
management driven by the acquisition of the assets of Robshaw & Julian and favorable market conditions.
Company owned life insurance decreased by $1.0 million or 37% in 2017. The decrease was primarily due to $911 thousand of non-
recurring death benefit proceeds received by the Company in the first quarter of 2016.
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 $110 thousand and $300 thousand for the years ended
December 31, 2017 and 2016, respectively. The income from these equity method investments fluctuates based on the maturity and
performance of the underlying investments.
During the year ended December 31, 2017, we recognized net gains of $1.3 million from the sale of available for sale (“AFS”) securities
with an amortized cost totaling $48.8 million. The securities sold were comprised of 11 agency securities, six mortgage backed
securities and one asset backed security. During the year ended December 31, 2016, we recognized gains of $2.7 million from the sale
of AFS securities with an amortized cost totaling $92.6 million. The securities sold were comprised of 25 agency securities and 22
mortgage backed securities. The amount and timing of net gains on investment securities is dependent on a number of factors, including
our prudent efforts to realize gains while managing duration, premium and credit risk.
For each of the years ended December 31, 2017 and 2016, we recognized a $1.2 million non-cash fair value adjustment of the
contingent consideration liability related to the SDN acquisition. For additional discussion related to the 2017 fair value adjustment of
the contingent consideration liability see Note 7, Goodwill and Other Intangible Assets, of the notes to consolidated financial
statements.
- 41 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Noninterest Expense
The following table summarizes our noninterest expense for the years ended December 31 (in thousands):
Salaries and employee benefits
Occupancy and equipment
Professional services
Computer and data processing
Supplies and postage
FDIC assessments
Advertising and promotions
Amortization of intangibles
Goodwill impairment
Other
Total noninterest expense
2017
2016
2015
$
$
48,675
16,293
4,083
4,935
2,003
1,817
2,171
1,170
1,575
7,791
90,513
$
$
45,215
14,529
5,782
4,451
2,047
1,735
2,097
1,249
-
7,566
84,671
$
$
42,439
13,856
3,681
4,267
2,155
1,719
1,986
942
751
7,597
79,393
Salaries and employee benefits increased by $3.5 million or 8% when comparing 2017 to 2016. The increase was primarily due to our
organic growth initiatives and higher healthcare costs largely attributable to the high cost of specialty pharmaceuticals.
Occupancy and equipment increased by $1.8 million or 12% when comparing 2017 to 2016. The incremental expenses reflect the 2016
and 2017 financial solution center openings and the relocation of our Rochester regional administration center.
Professional services expense of $4.1 million in 2017 decreased $1.7 million or 29% from 2016. The decrease was primarily due to the
Company’s 2016 proxy contest, which increased our need for professional services during that year.
Computer and data processing increased by $484 thousand or 11% when comparing 2017 to 2016. We continue to invest in information
technology to both maintain and improve our infrastructure.
We recognized $1.6 million of goodwill impairment in the second quarter of 2017 related to the SDN acquisition. For additional
discussion related to the goodwill impairment see Note 7, Goodwill and Other Intangible Assets, of the notes to consolidated financial
statements.
The efficiency ratio for the year ended December 31, 2017 was 60.65% compared with 60.95% for 2016. The improved efficiency ratio
is a result of the higher net interest income associated with our organic growth initiatives. The efficiency ratio provides a ratio of
operating expenses to operating income. The efficiency ratio is calculated by dividing total noninterest expense by net revenue, defined
as the sum of tax-equivalent net interest income and noninterest income before net gains on investment securities. 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. The efficiency ratio, a banking industry financial measure, is not required by GAAP. However,
the efficiency ratio is used by management in its assessment of financial performance specifically as it relates to noninterest expense
control. Management also believes such information is useful to investors in evaluating Company performance.
Income Taxes
We recorded income tax expense of $9.9 million for 2017, compared to $12.2 million for 2016. Our effective tax rate was 22.9% for
2017 compared to 27.7% for 2016. The decrease in income tax expense and lower effective tax rate was the result of an estimated $2.9
million reduction in income tax expense due to the TCJ Act, primarily driven by a revaluation adjustment to our net deferred tax
liability. Effective tax rates are impacted by items of income and expense that are not subject to federal or state taxation. Our effective
tax rates differ from the statutory rates primarily due to the effect of interest income from tax-exempt securities, earnings on company
owned life insurance, the non-cash fair value adjustment of the contingent consideration liability associated with the SDN acquisition,
the 2017 non-cash goodwill impairment charge related to SDN and, in 2017, the net impact of the TCJ Act.
On December 22, 2017, the TCJ Act was signed into law which, among other items, reduces the federal statutory corporate tax rate from
35 percent to 21 percent, effective January 1, 2018.
- 42 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 2016 AND DECEMBER 31, 2015
Net Interest Income and Net Interest Margin
Net interest income was $102.7 million in 2016, compared to $95.3 million in 2015. The taxable equivalent adjustments of $3.2 million
and $3.1 million for 2016 and 2015, respectively, resulted in fully taxable equivalent net interest income of $105.9 million in 2016 and
$98.4 million in 2015.
Net interest income on a taxable equivalent basis for 2016 increased $7.5 million or 8%, compared to 2015. The increase was due to an
increase in average interest-earning assets of $270.6 million or 9% compared to 2015. The net interest margin of 3.24% for 2016
declined compared to 3.28% in 2015. This decrease was a function of a six basis point decrease in interest rate spread to 3.13% during
2016, partially offset by a two basis point higher contribution from net free funds. The lower interest rate spread was a net result of no
change in the yield on earning assets and a six basis point increase in the cost of interest-bearing liabilities.
For the year ended December 31, 2016, the yield on average earning assets of 3.62% was unchanged from 2015. Loan yields decreased
3 basis points during 2016 to 4.18%. The yield on investment securities decreased 1 basis point during 2016 to 2.45%. Overall, the
earning asset rate changes reduced interest income by $577 thousand during 2016, but that was more than offset by a favorable volume
variance that increased interest income by $10.4 million, which collectively drove a $9.8 million increase in interest income.
Average interest-earning assets were $3.27 billion for 2016, an increase of $270.6 million or 9% from the prior year, with average loans
up $218.4 million, average securities up $49.1 million and average federal funds sold and other interest-earning deposits up $3.1
million. Average loans were $2.21 billion for 2016, an increase of $218.4 million or 11% from the prior year. The growth in average
loans reflected increases in most loan categories reflecting the impact of our growth strategy, with commercial loans up $146.7 million,
residential real estate loans up $38.4 million, and consumer loans up $37.2 million, partially offset by a $3.9 million decrease in
residential real estate lines. Loans made up 67.4% of average interest-earning assets during 2016 compared to 66.2% during 2015.
Loans generally have significantly higher yields compared to securities and federal funds sold and interest-bearing deposits and, as such,
have a more positive effect on the net interest margin. The yield on average loans was 4.18% for 2016, a decrease of 3 basis points
compared to 4.21% for 2015. The yield on average loans was negatively impacted by lower average spreads due to increased
competition in loan pricing during 2016 compared to 2015. The increase in the volume of average loans resulted in a $9.2 million
increase in interest income, partially offset by a $528 thousand decrease due to the unfavorable rate variance. Average securities were
$1.06 billion for 2016, an increase of $49.1 million or 5% from the prior year. Securities made up 32.5% of average interest-earning
assets in 2016 compared to 33.8% in 2015. The taxable equivalent yield on average securities was 2.45% in 2016 compared to 2.46% in
2015. The increase in the volume of average securities resulted in a $1.2 million increase in interest income, partially offset by a $49
thousand decrease due to the unfavorable rate variance.
For the year ended December 31, 2016, the cost of average interest-bearing liabilities of 0.49% was 6 basis points higher than 2015.
The cost of average interest-bearing deposits increased two basis points to 0.37%, the cost of short-term borrowings increased 24 basis
points to 0.65% in 2016 compared to 2015 and the cost of long-term borrowings increased five basis points to 6.33%. Overall, interest-
bearing liability rate and volume increases resulted in $2.4 million of higher interest expense.
Average interest-bearing liabilities of $2.57 billion in 2016 were $212.7 million or 9% higher than 2015. On average, interest-bearing
deposits grew $215.2 million, while noninterest-bearing demand deposits (a principal component of net free funds) were up $34.1
million. The increase in average deposits was due to successful business development efforts. Overall, interest-bearing deposit rate and
volume changes resulted in $1.2 million of higher interest expense during 2016. Average short-term and long-term borrowings were
$288.0 million in 2016, $2.4 million lower than in 2015. Overall, short and long-term borrowing rate and volume changes resulted in
$1.2 million of higher interest expense during 2016.
Provision for Loan Losses
The provision for loan losses was $9.6 million for the year ended December 31, 2016 compared with $7.4 million for 2015.
Noninterest Income
Service charges on deposits were $7.3 million for 2016, a decrease of $462 thousand or 6%, compared to 2015. The decrease was
primarily due to a decrease in the amount of checking account overdraft activity, primarily due to changes in customer behavior.
Insurance income increased by $230 thousand, or 4%, to $5.4 million during 2016, reflecting successful business development efforts,
including cross-selling of SDN products and services to the Bank’s customers.
ATM and debit card income was $5.7 million for 2016, an increase of $603 thousand or 12%, compared to 2015. The increase was
primarily attributable to more favorable contract terms with a new card vendor and higher transaction volumes.
- 43 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Investment advisory income increased to $5.2 million in 2016, compared to $2.2 million in 2015, reflecting the contribution from
Courier Capital which was acquired in January 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 by $846 thousand or 43% in 2016. The increase was primarily due to $911 thousand of death
benefit proceeds received by the Company in first quarter of 2016.
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 $300 thousand and $895 thousand for the years ended
December 31, 2016 and 2015, respectively. The income from these equity method investments fluctuates based on the maturity and
performance of the underlying investments.
During the year ended December 31, 2016 we recognized net gains of $2.7 million from the sale of available for sale (“AFS”) securities
with an amortized cost totaling $92.6 million. The securities sold were comprised of 25 agency securities and 22 mortgage backed
securities. During the year ended December 31, 2015 we recognized gains of $2.0 million from the sale of AFS securities with an
amortized cost totaling $52.3 million. The securities sold were comprised of five agency securities and 13 mortgage backed securities.
The amount and timing of net gains on investment securities is dependent on a number of factors, including our prudent efforts to
realize gains while managing duration, premium and credit risk.
We recognized $390 thousand for the year ended December 31, 2015, of amortization of a historic tax investment in a community-based
project. The amortization was included in noninterest income, recorded as contra-income, with an offsetting tax benefit that reduced
income tax expense. These types of investments are, for the most part, fully amortized in the first year the project is placed in service.
For the years ended December 31, 2016 and 2015, we recognized a $1.2 million and $1.1 million, respectively, non-cash fair value
adjustment of the contingent consideration liability related to the SDN acquisition. For additional discussion related to the fair value
adjustment of the contingent consideration liability see Note 2, Business Combinations, of the notes to consolidated financial
statements.
Noninterest Expense
Salaries and employee benefits increased by $2.8 million or 7% when comparing 2016 to 2015. The increase was primarily due to the
addition of Courier Capital as well as additional personnel to support organic growth as part of our expansion initiatives.
Occupancy and equipment increased by $673 thousand or 5% when comparing 2016 to 2015. The incremental expenses reflect the
addition of Courier Capital and our expansion initiatives, including the opening of financial solution centers in the Rochester market.
Professional services expense of $5.8 million in 2016 increased $2.2 million or 60% from 2015. The increase was primarily due to the
Company’s 2016 proxy contest.
Computer and data processing increased by $184 thousand or 4% when comparing 2016 to 2015. We continue to invest in information
technology to both maintain and improve our infrastructure.
Amortization of intangibles increased by $307 thousand or 33% when comparing 2016 to 2015. The increase was primarily due to
higher intangible asset amortization associated with the Courier Capital acquisition.
We recognized $751 thousand of goodwill impairment in the fourth quarter of 2015 related to the SDN acquisition.
The efficiency ratio for the year ended December 31, 2016 was 60.95% compared with 62.44% for 2015.
Income Taxes
We recorded income tax expense of $12.2 million for 2016, compared to $10.5 million for 2015. Our effective tax rate was 27.7% for
2016 compared to 27.1% for 2015. Effective tax rates are impacted by items of income and expense that are not subject to federal or
state taxation. Our effective tax rates differ from the statutory rates primarily due to the effect of interest income from tax-exempt
securities, earnings on company owned life insurance and the non-cash fair value adjustment of the contingent consideration liability
associated with the SDN acquisition.
In March 2014, the New York legislature approved changes in the state tax law to be phased-in over two years, beginning in 2015. The
primary changes that impact us included 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 from 7.1% to 6.5% for 2016. The repeal of Article 32 and
the expanded nexus standards lowered our taxable income apportioned to New York in 2016 and 2015 compared to 2014.
- 44 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
ANALYSIS OF FINANCIAL CONDITION
OVERVIEW
At December 31, 2017, we had total assets of $4.11 billion, an increase of 11% from $3.71 billion as of December 31, 2016, largely
attributable to our continued loan growth. Net loans were $2.70 billion as of December 31, 2017, up $391.1 million or 17%, when
compared to $2.31 billion as of December 31, 2016. The increase in net loans was primarily attributable to organic growth in the
commercial, residential real estate loans and consumer indirect portfolios. Non-performing assets totaled $12.7 million as of December
31, 2017, up $6.2 million from a year ago. Total deposits amounted to $3.21 billion as of December 31, 2017, up $215.0 million or 7%,
compared to December 31, 2016. As of December 31, 2017, borrowed funds totaled $485.3 million, compared to $370.6 million as of
December 31, 2016. Common book value per common share was $22.85 and $20.82 as of December 31, 2017 and 2016, respectively.
As of December 31, 2017, our total shareholders’ equity was $381.2 million compared to $320.1 million a year earlier.
INVESTING ACTIVITIES
The following table summarizes the composition of our available for sale and held to maturity securities portfolios (in thousands).
Securities available for sale:
U.S. Government agency and
government-sponsored enterprise securities
Mortgage-backed securities:
Agency mortgage-backed securities
Non-Agency mortgage-backed securities
Asset-backed securities
Total available for sale securities
Securities held to maturity:
State and political subdivisions
Mortgage-backed securities
Total held to maturity securities
Total investment securities
Investment Securities Portfolio Composition
At December 31,
2016
2015
2017
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
$
163,025 $ 161,889
$
187,325 $ 186,268
$
260,748 $ 260,863
365,433
-
-
528,458
362,108
976
-
524,973
356,667
-
-
543,992
352,643
824
191
539,926
282,873
-
-
543,621
282,505
809
218
544,395
283,557
232,909
516,466
285,212
227,771
512,983
$ 1,044,924 $ 1,037,956
305,248
238,090
543,338
305,759
234,232
539,991
$ 1,087,330 $ 1,079,917
294,423
191,294
485,717
300,981
189,083
490,064
$ 1,029,338 $ 1,034,459
Our investment policy is contained within our overall Asset-Liability Management and Investment Policy. This policy dictates that
investment decisions will be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets,
need for collateral and desired risk parameters. In pursuing these objectives, we consider the ability of an investment to provide
earnings consistent with factors of quality, maturity, marketability, pledgeable nature and risk diversification. Our Treasurer, guided by
ALCO, is responsible for investment portfolio decisions within the established policies.
Our AFS investment securities portfolio decreased $14.9 million to $525.0 million at December 31, 2017 from $539.9 million at
December 31, 2016. Our AFS portfolio had a net unrealized loss totaling $3.5 million at December 31, 2017 compared to a net
unrealized loss of $4.1 million at December 31, 2016. The fair value of most of the investment securities in the AFS portfolio fluctuates
as market interest rates change.
During the year ended December 31, 2015, we transferred $165.2 million of AFS mortgage backed securities to the held to maturity
(“HTM”) category, reflecting our intent to hold those securities to maturity. Transfers of investment securities into the HTM category
from the AFS category are made at fair value at the date of transfer. The related $1.1 million of unrealized holding losses that were
included in the transfer during the year ended December 31, 2015 are retained in accumulated other comprehensive income and in the
carrying value of the HTM securities. These amounts will be amortized as an adjustment to interest income over the remaining life of
the securities. This will offset the impact of amortization of the net premium created in the transfer. There were no gains or losses
recognized as a result of this transfer. The transfers of securities from AFS to HTM are expected to reduce the fair value fluctuations in
the available for sale portfolio.
- 45 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
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 i.) the intent to sell the debt security or ii.) 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: a.) the length of time and the extent to which the fair
value has been less than the amortized cost basis, b.) adverse conditions specifically related to the security, an industry, or a geographic
area, c.) the historical and implied volatility of the fair value of the security, d.) the payment structure of the debt security and the
likelihood of the issuer being able to make payments that increase in the future, e.) failure of the issuer of the security to make scheduled
interest or principal payments, f.) any changes to the rating of the security by a rating agency, and g.) recoveries or additional declines in
fair value subsequent to the balance sheet date.
As of December 31, 2017, we do not have the intent to sell any of our securities in a loss position and we believe that it is not likely that
we will be required to sell any such securities before the anticipated recovery of amortized cost. The unrealized losses are largely due to
increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is
expected to recover as the bonds approach their maturity date, repricing date or if market yields for such investments decline. We do
not believe any of the securities in a loss position are impaired due to reasons of credit quality. Accordingly, as of December 31, 2017,
we concluded that unrealized losses on our investment securities are temporary and no further impairment loss has been realized in our
consolidated statements of income. The following discussion provides further details of our assessment of the securities portfolio by
investment category.
U.S. Government Agencies and Government Sponsored Enterprises (“GSE”). As of December 31, 2017, there were 37 securities
in an unrealized loss position in the U.S. Government agencies and GSE portfolio with unrealized losses totaling $1.3 million. Of these,
10 were in an unrealized loss position for 12 months or longer and had an aggregate fair value of $31.6 million and unrealized losses of
$687 thousand. The decline in fair value is attributable to changes in interest rates, and not credit quality, and because we do not have
the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, we do
not consider these securities to be other-than-temporarily impaired at December 31, 2017.
State and Political Subdivisions. As of December 31, 2017, the state and political subdivisions, i.e. municipal securities, portfolio
totaled $283.6 million, all of which was classified as HTM. As of that date, there were 156 securities in an unrealized loss position in
the municipal securities portfolio with unrealized losses totaling $662 thousand. Of these, 46 were in an unrealized loss position for 12
months or longer and had an aggregate fair value of $14.5 million and unrealized losses of $367 thousand.
The decline in fair value is attributable to changes in interest rates, and not credit quality, and because we do not have the intent to sell
these securities and it is not likely that we will be required to sell the securities before their anticipated recovery, we do not consider
these securities to be other-than-temporarily impaired at December 31, 2017.
Agency Mortgage-backed Securities. With the exception of the non-Agency mortgage-backed securities (“non-Agency MBS”)
discussed below, all of the mortgage-backed securities held by us as of December 31, 2017, were issued by U.S. Government sponsored
entities and agencies (“Agency MBS”), primarily FNMA and FHLMC. The contractual cash flows of our Agency MBS are guaranteed
by FNMA, FHLMC or GNMA. The GNMA mortgage-backed securities are backed by the full faith and credit of the U.S. Government.
As of December 31, 2017, there were 99 securities in the AFS Agency MBS portfolio that were in an unrealized loss position with
unrealized losses totaling $3.9 million. Of these, 35 were in an unrealized loss position for 12 months or longer and had an aggregate
fair value of $84.0 million and unrealized losses of $1.9 million. As of December 31, 2017, there were 119 securities in the HTM
Agency MBS portfolio that were in an unrealized loss position totaling $5.2 million. Of these, 81 were in an unrealized loss position for
12 months or longer and had an aggregate fair value of $144.7 million and unrealized losses of $4.1 million.
Given the high credit quality inherent in Agency MBS, we do not consider any of the unrealized losses as of December 31, 2017 on
such Agency MBS to be credit related or other-than-temporary. As of December 31, 2017, we did not intend to sell any Agency MBS
that were in an unrealized loss position, all of which were performing in accordance with their terms.
Non-Agency Mortgage-backed Securities. Our non-Agency MBS portfolio consists of positions in one privately issued whole loan
collateralized mortgage obligations with a fair value and net unrealized gain of $976 thousand as of December 31, 2017. As of that
date, the one non-Agency MBS was rated below investment grade. This security was not in an unrealized loss position.
- 46 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Other Investments. As a member of the FHLB, the Bank is required to hold FHLB stock. The amount of required FHLB stock is
based on the Bank’s asset size and the amount of borrowings from the FHLB. We have assessed the ultimate recoverability of our
FHLB stock and believe that no impairment currently exists. As a member of the FRB system, we are required to maintain a specified
investment in FRB stock based on a ratio relative to our capital. At December 31, 2017, our ownership of FHLB and FRB stock totaled
$21.9 million and $5.8 million, respectively, and is included in other assets and recorded at cost, which approximates fair value.
LENDING ACTIVITIES
Total loans were $2.74 billion at December 31, 2017, an increase of $394.9 million or 17% from December 31, 2016. Commercial
loans increased $239.6 million and represented 46.1% of total loans at the end of 2017. Consumer loans increased $155.2 million to
represent 53.9% of total loans at December 31, 2017. The composition of our loan portfolio, excluding loans held for sale and including
net unearned income and net deferred fees and costs, is summarized as follows (in thousands):
2017
2016
Loan Portfolio Composition
At December 31,
2015
2014
2013
Amount
Percent Amount
Percent Amount
ITEM 9. $
670,058 28.6
1,259,234 46.1 1,019,605 43.5
ITEM 8. $ 349,547 14.9 %
Percent Amount
ITEM 10. $ 267,409 14.0 %
475,092 24.8
742,501 38.8
Percent Amount
Percent
ITEM 11. $ 265,766 14.5 %
469,284 25.6
735,050 40.1
313,758 15.0 %
566,101 27.2
879,859 42.2
808,908 29.6
465,283 17.0
427,937 18.3
381,074 18.3
357,187 18.7
310,394 16.9
116,309 4.3
876,570 32.0
17,621 0.6
6.8
129,529
661,673 34.6
1.1
1,475,783 53.9 1,320,556 56.5 1,203,903 57.8 1,169,501 61.2
ITEM 17. 1,912,002 100.0 %
ITEM 16.
2,735,017 100.0 %
5.2
122,555
752,421 32.2
0.8
6.1
127,347
676,940 32.5
0.9
7.0
128,737
636,368 34.7
1.3
23,070
1,098,569 59.9
ITEM 19. 1,833,619 100.0 %
ITEM 18.
ITEM 15. 2,083,762 100.0 %
ITEM 14.
ITEM 13. 2,340,161 100.0 %
ITEM 12.
17,643
18,542
21,112
Commercial business $ 450,326 16.5 %
Commercial mortgage
Total commercial
Residential real estate
loans
Residential real estate
lines
Consumer indirect
Other consumer
Total consumer
Total loans
Allowance for
loan losses
Total loans, net
34,672
$ 2,700,345
30,934
$ 2,309,227
27,085
$ 2,056,677
27,637
$ 1,884,365
26,736
$ 1,806,883
Commercial loans increased during 2017 as we continued our successful commercial business development efforts. 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.
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of
existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an appropriate
allowance for loan losses, and sound nonaccrual and charge off policies.
An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are
made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of
borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed and graded on an ongoing basis for early
identification of potential problems. Further analyses by customer, industry, and geographic location are performed to monitor trends,
financial performance, and concentrations.
We participate in various lending programs in which guarantees are supplied by U.S. government agencies, such as the SBA, U.S.
Department of Agriculture, Rural Economic and Community Development and Farm Service Agency, among others. As of December
31, 2017, the principal balance of such loans (included in commercial loans) was $47.8 million and the guaranteed portion amounted to
$30.0 million. Most of these loans were guaranteed by the SBA.
Commercial business loans were $450.3 million at the end of 2017, up $100.8 million or 29% since the end of 2016, and comprised
16.5% of total loans outstanding at December 31, 2017, compared to 14.9% at December 31, 2016. We typically originate business
loans of up to $15.0 million for small to mid-sized businesses in our market area for working capital, equipment financing, inventory
financing, accounts receivable financing, or other general business purposes. Loans of this type are in a diverse range of industries. As
of December 31, 2017, commercial business SBA loans accounted for a total of $34.0 million or 8% of our commercial business loan
portfolio.
- 47 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Commercial mortgage loans totaled $808.9 million at December 31, 2017, up $138.9 million or 21% from December 31, 2016, and
comprised 29.6% of total loans, compared to 28.6% at December 31, 2016. Commercial mortgage loans include both owner occupied
and non-owner occupied commercial real estate loans. Approximately 35% and 39% of our commercial mortgage portfolio at
December 31, 2017 and 2016, respectively, was owner occupied commercial real estate. The majority of our commercial real estate
loans are secured by office buildings, manufacturing facilities, distribution/warehouse facilities, and retail centers, which are generally
located in our local market area. As of December 31, 2017, commercial mortgage SBA loans accounted for a total of $9.6 million or
1% of our commercial mortgage loan portfolio.
We determine our current lending standards for commercial real estate and real estate construction lending by property type and
specifically address many criteria, including: maximum loan amounts, maximum loan-to-value (“LTV”), requirements for pre-leasing or
pre-sales, minimum debt-service coverage ratios, minimum borrower equity, and maximum loan to cost. Currently, the maximum
standard for LTV is 85%, with lower limits established for certain higher risk types, such as raw land which has a 65% LTV maximum.
Consumer loans totaled $1.48 billion at December 31, 2017, up $155.2 million or 12% compared to 2016, and represented 53.9% of the
2017 year-end loan portfolio versus 56.5% at year-end 2016. Loans in this classification include residential real estate loans, residential
real estate lines, indirect consumer and other consumer installment loans. 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. Risks of loss are
generally on smaller average balances per loan spread over many borrowers. Once charged off, there is usually less opportunity for
recovery on these smaller retail loans. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring
payment histories, and taking appropriate collateral and guaranty positions.
Residential real estate portfolios include conventional first lien mortgages and home equity loans and lines of credit. For conventional
first lien mortgages, we generally limit the maximum loan to 85% of collateral value without credit enhancement (e.g. personal
mortgage insurance). The majority of our fixed-rate conventional mortgage loans are sold in the secondary market with servicing rights
retained. Our conventional mortgage products continue to be underwritten using FHLMC secondary marketing guidelines. Our
underwriting guidelines for home equity products include a combination of borrower FICO (credit score), the LTV of the property
securing the loan and evidence of the borrower having sufficient income to repay the loan. Currently, for home equity products, the
maximum acceptable LTV is 90%. The average FICO score for new home equity production was 763 during the years ended December
31, 2017 and 2016.
Residential real estate loans totaled $465.3 million at the end of 2017, up $37.3 million or 9% from the end of the prior year and
comprised 17.0% of total loans outstanding at December 31, 2017 compared to 18.3% at year-end 2016. As of December 31, 2017 and
2016, our residential real estate loan portfolio included $8.6 million and $11.3 million, respectively, of loans acquired during the 2012
branch acquisitions. The residential real estate line portfolio amounted to $116.3 million at December 31, 2017 down $6.2 million or 5%
compared to 2016, and represented 4.3% of the 2017 year-end loan portfolio versus 5.2% at year-end 2016. As of December 31, 2017
and 2016, our residential real estate line portfolio included $9.5 million and $11.5 million, respectively, of loans acquired during the
2012 branch acquisitions.
The residential real estate loans and lines portfolios had a weighted average LTV at origination of approximately 64% and 63% at
December 31, 2017 and 2016, respectively. Approximately 88% and 87% of the loans and lines were first lien positions at December
31, 2017 and 2016, respectively. We continue to grow our home equity portfolio as the lower origination cost and convenience to
customers has made these products an attractive alternative to conventional residential mortgage loans.
Consumer indirect loans amounted to $876.6 million at December 31, 2017 up $124.1 million or 16% compared to 2016, and
represented 32.0% of the 2017 year-end loan portfolio versus 32.2% at year-end 2016. The loans are primarily for the purchase of
automobiles (both new and used) and light duty trucks primarily by individuals, but also by corporations and other organizations. The
loans are originated through dealerships and assigned to us with terms that typically range from 36 to 84 months. During the year ended
December 31, 2017, we originated $433.1 million in indirect loans with a mix of approximately 42% new vehicles and 58% used
vehicles. This compares with $356.4 million in indirect loans with a mix of approximately 43% new vehicles and 57% used vehicles for
the same period in 2016. We do business with over 450 franchised auto dealers located in Western, Central, and the Capital District of
New York, and Northern and Central Pennsylvania. The average FICO score for indirect loan production was 734 and 731 during the
years ended December 31, 2017 and 2016, respectively. Other consumer loans totaled $17.6 million at December 31, 2017, down $22
thousand or less than 1% compared to 2016, and represented less than one percent of the 2017 and 2016 year-end loan portfolio. Other
consumer loans consist of personal loans (collateralized and uncollateralized) and deposit account collateralized loans.
Our loan portfolio is widely diversified by types of borrowers, industry groups, and market areas within our core footprint. Significant
loan concentrations are considered to exist for a financial institution when there are amounts loaned to numerous borrowers engaged in
similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2017, no significant
concentrations, as defined above, existed in our portfolio in excess of 10% of total loans.
- 48 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
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 loans and totaled $2.7 million and $1.1 million as of December 31, 2017 and 2016,
respectively.
We sell certain qualifying newly originated or refinanced residential real estate loans on the secondary market. Residential real estate
loans serviced for others, which are not included in the consolidated statements of financial condition, amounted to $163.3 million and
$173.7 million as of December 31, 2017 and 2016, respectively.
Allowance for Loan Losses
The following table summarizes the activity in the allowance for loan losses (in thousands).
Allowance for loan losses, beginning of year
Charge-offs:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total charge-offs
Recoveries:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total recoveries
Net charge-offs
Provision for loan losses
Allowance for loan losses, end of year
2017
30,934
$
$
3,614
10
431
106
10,164
926
15,251
416
262
130
60
4,444
316
5,628
9,623
13,361
34,672
$
$
Loan Loss Analysis
Year Ended December 31,
2015
27,637
$
$
2016
27,085
943
385
289
104
8,748
607
11,076
447
45
174
15
4,259
347
5,287
5,789
9,638
30,934
$
1,433
895
397
199
9,156
878
12,958
212
146
114
31
4,200
322
5,025
7,933
7,381
27,085
$
2014
26,736
2013
24,714
$
204
304
382
148
10,004
972
12,014
201
143
76
19
4,321
366
5,126
6,888
7,789
27,637
1,070
553
748
54
8,125
928
11,478
349
319
169
42
3,161
381
4,421
7,057
9,079
26,736
$
Net charge-offs to average loans
Allowance to end of period loans
Allowance to end of period non-performing loans
0.38%
1.27%
277%
0.26%
1.32%
489%
0.40%
1.30%
321%
0.37%
1.45%
272%
0.40%
1.46%
161%
- 49 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
The following table sets forth the allocation of the allowance for loan losses by loan category as of the dates indicated. The allocation is
made for analytical purposes and is not necessarily indicative of the categories in which actual losses may occur. The total allowance is
available to absorb losses from any segment of the loan portfolio (in thousands).
2017
Allowance for Loan Losses by Loan Category
At December 31,
2015
2014
2016
2013
Loan
Loss
Percentage
of loans by
category to
Percentage
of loans by
category to
Allowance total loans Allowance total loans Allowance total loans Allowance total loans Allowance total loans
14.5%
$ 15,668
25.6
3,696
Percentage
of loans by
category to
Percentage
of loans by
category to
Percentage
of loans by
category to
16.5% $ 7,225
10,315
29.6
15.0% $ 5,621
8,122
27.2
14.0% $
24.8
14.9% $
28.6
5,540
9,027
4,273
7,743
Loan
Loss
Loan
Loss
Loan
Loss
Loan
Loss
1,322
17.0
1,478
18.3
1,347
18.3
1,620
18.7
1,607
16.9
180
13,415
391
4.3
32.0
0.6
303
11,311
302
5.2
32.2
0.8
345
10,458
368
6.1
32.5
0.9
435
11,383
456
6.8
34.6
1.1
436
12,230
447
7.0
34.7
1.3
$ 34,672 100.0% $ 30,934 100.0% $ 27,085 100.0% $ 27,637 100.0% $ 26,736 100.0%
Commercial business
Commercial mortgage
Residential real estate
loans
Residential real estate
lines
Consumer indirect
Other consumer
Total
Management believes that the allowance for loan losses at December 31, 2017 is adequate to cover probable losses in the loan portfolio
at that date. Factors beyond our control, however, such as general national and local economic conditions, can adversely impact the
adequacy of the allowance for loan losses. As a result, no assurance can be given that adverse economic conditions or other
circumstances will not result in increased losses in the portfolio or that the allowance for loan losses will be sufficient to meet actual
loan losses. See Part I, Item 1A “Risk Factors” for the risks impacting this estimate. Management presents a quarterly review of the
adequacy of the allowance for loan losses to the Audit Committee of our Board of Directors based on the methodology that is described
in further detail in Part I, Item I “Business” under the section titled “Lending Activities.” See also “Critical Accounting Estimates” for
additional information on the allowance for loan losses.
Non-performing Assets and Potential Problem Loans
The following table sets forth information regarding non-performing assets (in thousands):
Non-accruing loans:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total non-accruing loans
Restructured accruing loans
Accruing loans contractually past due over 90 days
Total non-performing loans
Foreclosed assets
Non-performing investment securities
Total non-performing assets
2017
5,344
2,623
2,252
404
1,895
2
12,520
-
11
12,531
148
-
12,679
$
$
Non-performing Assets
At December 31,
2015
2016
2014
$
$
2,151
1,025
1,236
372
1,526
7
6,317
-
9
6,326
107
-
6,433
$
$
3,922
947
1,848
235
1,467
13
8,432
-
8
8,440
163
-
8,603
$
4,288
3,020
1,451
206
1,169
11
10,145
-
8
10,153
194
-
$ 10,347
2013
$
3,474
9,663
1,723
280
1,471
5
16,616
-
6
16,622
333
128
$ 17,083
Non-performing loans to total loans
Non-performing assets to total assets
0.46%
0.31%
0.27%
0.17%
0.41%
0.25%
0.53%
0.33%
0.91%
0.58%
- 50 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Non-performing assets include non-performing loans, foreclosed assets and non-performing investment securities. Non-performing
assets at December 31, 2017 were $12.7 million, an increase of $6.3 million from the $6.4 million balance at December 31, 2016. The
primary component of non-performing assets is non-performing loans, which were $12.5 million or 0.46% of total loans at December
31, 2017, an increase of $6.2 million from $6.3 million or 0.27% of total loans at December 31, 2016.
Approximately $870 thousand, or 7%, of the $12.5 million in non-performing loans as of December 31, 2017 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. The amount of interest income forgone totaled $481 thousand and $234 thousand for non-accruing loans outstanding as of
December 31, 2017 and 2016, respectively. Included in nonaccrual loans are troubled debt restructurings (“TDRs”) of $1.3 million and
$1.4 million at December 31, 2017 and 2016, respectively. We had one TDR of $633 thousand that was accruing interest as of
December 31, 2017, and we had no TDRs that were accruing interest as of December 31, 2016.
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 four properties totaling $148 thousand
at December 31, 2017 and four properties totaling $107 thousand at December 31, 2016.
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 $12.5 million and $15.6
million in loans that continued to accrue interest which were classified as substandard as of December 31, 2017 and 2016, respectively.
FUNDING ACTIVITIES
Deposits
The following table summarizes the composition of our deposits (dollars in thousands).
Noninterest-bearing demand
Interest-bearing demand
Savings and money market
Time deposits < $250,000
Time deposits of $250,000 or more
Total deposits
2017
At December 31,
2016
2015
Amount
$
718,498
634,203
1,005,317
698,179
153,977
$ 3,210,174
Percent
22.4 %
19.8
31.3
21.7
4.8
100.0 %
Amount
$
677,076
581,436
1,034,194
602,715
99,801
$ 2,995,222
Percent
22.6 %
19.4
34.5
20.2
3.3
100.0 %
Amount
$ 641,972
523,366
928,175
545,044
91,974
$ 2,730,531
Percent
23.5 %
19.2
34.0
19.9
3.4
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 December 31, 2017, total deposits were $3.21 billion, representing an increase of $215.0 million for the year.
Nonpublic deposits, the largest component of our funding sources, totaled $2.07 billion and $1.90 billion at December 31, 2017 and
2016, respectively, and represented 65% and 63% 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 $829.5 million and $803.6 million at December 31, 2017 and December 31, 2016, respectively, and represented
26% and 27% of total deposits as of the end of each period, respectively. The increase in public deposits during 2017 was due largely to
higher balances with existing customers.
We had no traditional brokered deposits at December 31, 2017 or December 31, 2016; 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 $159.2 million and $147.3 million, respectively, at December 31, 2017, compared to $143.2 million
and $152.9 million, respectively, at December 31, 2016, and collectively represented 9% and 10% of total deposits as of the end of each
period, respectively.
- 51 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Borrowings
The Company classifies borrowings as short-term or long-term in accordance with the original terms of the agreement. Outstanding
borrowings are summarized as follows as of December 31 (in thousands):
Short-term borrowings:
Short-term FHLB borrowings
Long-term borrowings:
Subordinated notes, net
Total borrowings
Short-term borrowings
2017
2016
$
446,200
$
331,500
39,131
485,331
$
39,061
370,561
$
Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings which we typically utilize
to address short term funding needs as they arise. Short-term FHLB borrowings at December 31, 2017 consisted of $304.7 million in
overnight borrowings and $141.5 million in short-term advances. Short-term FHLB borrowings at December 31, 2016 consisted of
$171.5 million in overnight borrowings and $160.0 million in short-term advances. The FHLB borrowings are collateralized by
securities from the Company’s investment portfolio and certain qualifying loans. At December 31, 2017 and 2016, the Company’s
borrowings had a weighted average rate of 1.50% and 0.76%, respectively.
We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase
agreements. We had approximately $32 million of immediate credit capacity with the FHLB as of December 31, 2017. We had
approximately $622 million in secured borrowing capacity at the Federal Reserve Bank (“FRB”) discount window, none of which was
outstanding at December 31, 2017. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio
and certain qualifying loans. We had $165 million of credit available under unsecured federal funds purchased lines with various banks
as of December 31, 2017. Additionally, we had approximately $184 million of unencumbered liquid securities available for pledging.
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 December 31, 2017, no amounts have been drawn on the line of credit.
The following table summarizes information relating to our short-term borrowings (dollars in thousands).
Year-end balance
Year-end weighted average interest rate
Maximum outstanding at any month-end
Average balance during the year
Average interest rate for the year
Long-term borrowings
At or for the Year Ended December 31,
2017
$ 446,200
2016
$ 331,500
2015
$ 293,100
1.50 %
0.76 %
0.53 %
$ 446,900
$ 338,392
$ 358,700
$ 248,938
$ 351,600
$ 262,494
1.16 %
0.65 %
0.41 %
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 net proceeds from this offering were used for general corporate purposes, including but not limited to,
contribution of capital to the Bank to support both organic growth and opportunistic acquisitions. The Subordinated Notes qualify as
Tier 2 capital for regulatory purposes.
Shareholders’ Equity
Total shareholders’ equity was $381.2 million at December 31, 2017, an increase of $61.1 million from $320.1 million at December 31,
2016. Net income for the year and stock issued from the “at-the-market” common stock offering increased shareholders’ equity by
$33.5 million and $38.3 million, respectively, which were partially offset by common and preferred stock dividends declared of $14.4
million. Accumulated other comprehensive loss included in shareholders’ equity decreased $2.0 million during the year due primarily
to the change in pension and post-retirement obligations. For detailed information on shareholders’ equity, see Note 13, Shareholders’
Equity, of the notes to consolidated financial statements. FII and the Bank are subject to various regulatory capital requirements. At
December 31, 2017 both FII and the Bank exceeded all regulatory requirements. For detailed information on regulatory capital
requirements, see Note 12, Regulatory Matters, of the notes to consolidated financial statements.
- 52 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES
The objective of maintaining adequate liquidity is to ensure 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 sources of liquidity for FII are dividends from the Bank and access to financial and capital markets. Dividends from the
Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows
from operations, core deposits, borrowings and short-term liquid assets.
Cash and cash equivalents were $99.2 million as of December 31, 2017, an increase of $27.9 million from $71.3 million as of December
31, 2016. Net cash provided by operating activities totaled $46.3 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 $372.6 million, which included
outflows of $404.9 million for net loan originations and partially offset by inflows of $40.5 million from net investment securities
transactions. Net cash provided by financing activities of $354.3 million was attributed to a $215.0 million increase in deposits, a
$114.7 million increase in short-term borrowings and $38.3 million from the “at-the-market” common stock offering, partly offset by
$14.0 million in dividend payments.
Contractual Obligations and Other Commitments
The following table summarizes the maturities of various contractual obligations and other commitments (in thousands):
Within 1
year
Over 1 to 3
years
At December 31, 2017
Over 3 to 5
Years
Over 5
years
Total
On-Balance sheet:
Time deposits (1)
Supplemental executive retirement plans
Earn-out liabilities
Subordinated notes
Off-Balance sheet:
Purchase commitments
Limited partnership investments (2)
Commitments to extend credit (3)
Standby letters of credit (3)
Operating leases
_____
$
$
$
$
678,352
390
-
-
-
646
661,021
10,424
2,459
$
$
138,647
687
1,990
-
359
1,293
-
1,579
4,587
$
$
35,157
466
-
-
-
646
-
178
3,814
-
604
-
40,000
$ 852,156
2,147
1,990
40,000
-
-
-
-
30,815
$
359
2,585
661,021
12,181
41,675
(1)
Includes the maturity of time deposits amounting to $100 thousand or more as follows: $265.4 million in three months or less; $85.1 million
between three months and six months; $79.4 million between six months and one year; and $61.5 million over one year.
(2) We have committed to capital investments in several limited partnerships of up to $9.0 million, of which we have contributed $6.4 million as of
December 31, 2017, including $583 thousand during 2017.
(3) We do not expect all of the commitments to extend credit and standby letters of credit to be funded. Thus, the total commitment amounts do not
necessarily represent our future cash requirements.
Off-Balance Sheet Arrangements
With the exception of obligations in connection with our irrevocable loan commitments, operating leases and limited partnership
investments as of December 31, 2017, we had no other off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors. For additional information on off-balance sheet arrangements, see
Note 1, Summary of Significant Accounting Policies and Note 11, Commitments and Contingencies, in the notes to the accompanying
consolidated financial statements.
- 53 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Security Yields and Maturities Schedule
The following table sets forth certain information regarding the amortized cost (“Cost”), weighted average yields (“Yield”) and
contractual maturities of our debt securities portfolio as of December 31, 2017. Mortgage-backed securities are included in maturity
categories based on their stated maturity date. Actual maturities may differ from the contractual maturities presented because borrowers
may have the right to call or prepay certain investments. No tax-equivalent adjustments were made to the weighted average yields
(dollars in thousands).
Due in less than
one year
Due from one to
five years
Due after five
years through
ten years
Due after ten
years
Total
Cost
Yield Cost
Yield Cost
Yield Cost
Yield Cost
Yield
Available for sale debt securities:
U.S. Government agencies and
government-sponsored enterprises $
Mortgage-backed securities
-
2 4.05
2 4.05
- % $ 26,215 1.96% $ 132,984 2.34% $ 3,826 2.08% $ 163,025 2.27%
96,795 1.89
123,010 1.91
161,828 2.52
294,812 2.44
106,808 2.34
110,634 2.33
365,433 2.30
528,458 2.29
Held to maturity debt securities:
State and political subdivisions
Mortgage-backed securities
Total investment securities
57,692 1.89
-
-
57,692 1.89
$ 57,694 1.89% $ 282,768 2.06% $ 398,405 2.27% $ 306,057 2.28% $ 1,044,924 2.19%
283,557 2.04
232,909 2.16
516,466 2.09
-
-
195,423 2.25
195,423 2.25
159,758 2.17
-
159,758 2.17
66,107 1.84
37,486 1.68
103,593 1.78
-
Contractual Loan Maturity Schedule
The following table summarizes the contractual maturities of our loan portfolio at December 31, 2017. Loans, net of deferred loan
origination costs, include principal amortization and non-accruing loans. Demand loans having no stated schedule of repayment or
maturity and overdrafts are reported as due in one year or less (in thousands).
$
Due from one
to five years
220,836
370,727
182,361
39,346
546,327
8,878
1,368,475
Due after five
years
$
$
74,931
224,269
220,099
61,149
19,896
1,094
601,438
Total
$
450,326
808,908
465,283
116,309
876,570
17,621
$ 2,735,017
$
$
$
977,794
390,681
1,368,475
$
$
311,034
290,404
601,438
$ 1,288,828
681,085
$ 1,969,913
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans
Loans maturing after one year:
With a predetermined interest rate
With a floating or adjustable rate
Total loans maturing after one year
Due in less
than one year
154,559
$
213,912
62,823
15,814
310,347
7,649
765,104
$
- 54 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Capital Resources
The FRB has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies on a
consolidated basis. 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 December 31, 2017, the Company's capital levels remained
characterized as "well-capitalized" under the new rules. We continue to evaluate the potential impact that regulatory rules may have on
our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. See Note 12,
Regulatory Matters of the notes to consolidated financial statements and the “Basel III Capital Rules" section below for further
discussion. The following table reflects the Company’s ratios and their components as of December 31 (in thousands):
Common shareholders’ equity
Less: Goodwill and other intangible assets
Net unrealized (loss) gain on investment securities (1)
Net periodic pension & postretirement benefits plan adjustments
Other
Common equity Tier 1 (“CET1”) capital
Plus: Preferred stock
Less: Other
Tier 1 Capital
Plus: Qualifying allowance for loan losses
Subordinated Notes
Total regulatory capital
Adjusted average total assets (for leverage capital purposes)
Total risk-weighted assets
Regulatory Capital Ratios
Tier 1 leverage (Tier 1 capital to adjusted average assets)
CET1 capital (CET1 capital to total risk-weighted assets)
Tier 1 capital (Tier 1 capital to total risk-weighted assets)
Total risk-based capital (Total regulatory capital to total risk-weighted assets)
_____
2017
363,848
70,413
(3,275)
(8,641)
-
305,351
17,329
-
322,680
34,672
39,131
396,483
3,967,749
3,005,655
$
2016
302,714
68,759
(3,729)
(10,222)
-
247,906
17,340
-
265,246
30,934
39,061
$
335,241
$ 3,602,377
$ 2,584,161
$
$
$
$
8.13%
10.16
10.74
13.19
7.36%
9.59
10.26
12.97
(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
In July 2013, the FRB and the FDIC approved the final rules implementing the BCBS’s capital guidelines for U.S. banks. Under the
final rules, minimum requirements will increase for both the quantity and quality of capital held by the Company. The rules include a
new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-
weighted assets from 4.0% to 6.0%, require a minimum ratio of total capital to risk-weighted assets 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.
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. Strict eligibility criteria for
regulatory capital instruments were also implemented under the final rules. The final rules also revise the definition and calculation of
Tier 1 capital, total capital, and risk-weighted assets.
The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final
rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of December 31, 2017, the
Company's capital levels remained characterized as "well-capitalized" under the new rules.
- 55 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with GAAP and are consistent with predominant practices in the
financial services industry. Application of critical accounting policies, which are those policies that management believes are the most
important to our financial position and results, requires management to make estimates, assumptions, and judgments that affect the
amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date
of the financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may
affect amounts reported in the financial statements.
We have numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting
Policies, of the notes to consolidated financial statements. These policies, along with the disclosures presented in the other financial
statement notes and in this discussion, provide information on how significant assets, liabilities, revenues and expenses are reported in
the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement
amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies
with respect to the allowance for loan losses, valuation of goodwill and deferred tax assets, and accounting for defined benefit plans
require particularly subjective or complex judgments important to our financial position and results of operations, and, as such, are
considered to be critical accounting policies as discussed below. These estimates and assumptions are based on management’s best
estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current
economic environment. We adjust these estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and
volatile equity have combined with declines in consumer spending to increase the uncertainty inherent in these estimates and
assumptions. As future events cannot be determined with precision, actual results could differ significantly from our estimates.
Adequacy of the Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining
the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the
use of subjective measurements including management’s assessment of the internal risk classifications of loans, changes in the nature of
the loan portfolio, industry concentrations, existing economic conditions, the fair value of underlying collateral, and other qualitative
and quantitative factors which could affect probable credit losses. Because current economic conditions and borrower strength can
change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the
appropriateness of the allowance for loan losses, could change significantly. As an integral part of their examination process, various
regulatory agencies also review the allowance for loan losses. Such agencies may require additions to the allowance for loan losses or
may require that certain loan balances be charged off or downgraded into criticized loan categories when their credit evaluations differ
from those of management, based on their judgments about information available to them at the time of their examination. We believe
the level of the allowance for loan losses is appropriate as recorded in the consolidated financial statements.
For additional discussion related to our accounting policies for the allowance for loan losses, see the sections titled “Allowance for Loan
Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 1,
Summary of Significant Accounting Policies, of the notes to consolidated financial statements.
Valuation of Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in accordance with the purchase method
of accounting for business combinations. Goodwill has an indefinite useful life and is not amortized, but is tested for impairment.
GAAP requires goodwill to be tested for impairment at our reporting unit level on an annual basis and more frequently if events or
circumstances indicate that there may be impairment. We test goodwill for impairment as of October 1st of each year.
Impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value. In testing goodwill for impairment,
GAAP permits us to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is
less than its carrying value (Step 0). If, after assessing the totality of events and circumstances, we determine it is not more likely than
not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test would be
unnecessary. However, if we conclude otherwise, we would then be required to perform the goodwill impairment test (Step 1). Step 1
compares the fair value of a reporting unit with its carrying value, including goodwill. If the carrying value of the reporting unit
exceeds its fair value, a goodwill impairment charge is recognized.
- 56 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Valuation of Deferred Tax Assets and Liabilities
The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate
temporary differences. The carrying value of our net deferred tax assets or liabilities assumes that we will be able to generate sufficient
future taxable income based on estimates and assumptions (after consideration of historical taxable income as well as tax planning
strategies). If these estimates and related assumptions change, we may be required to record valuation allowances against our deferred
tax assets and liabilities resulting in additional income tax expense or benefit in the consolidated statements of income. We evaluate
deferred tax assets and liabilities on a quarterly basis and assess the need for a valuation allowance, if any. A valuation allowance is
established when management believes that it is more likely than not that some portion of its deferred tax assets and liabilities will not
be realized. Changes in valuation allowance from period to period are included in our tax provision in the period of change. For
additional discussion related to our accounting policy for income taxes see Note 16, Income Taxes, of the notes to consolidated financial
statements.
Defined Benefit Pension Plan
We have a defined benefit pension plan covering substantially all employees. For employees hired prior to December 31, 2006, who
met participation requirements on or before January 1, 2008 (“Tier 1 Participant”), the benefits are generally based on years of service
and the employee's highest average compensation during five consecutive years of employment. For eligible employees who were hired
on and after January 1, 2007 (“Tier 2 Participant”), the benefits are generally based on a cash balance benefit formula. Assumptions are
made concerning future events that will determine the amount and timing of required benefit payments, funding requirements and
defined benefit pension expense. The major assumptions are the weighted average discount rate used in determining the current benefit
obligation, the weighted average expected long-term rate of return on plan assets, the rate of compensation increase and the estimated
mortality rate. The weighted average discount rate was based upon the projected benefit cash flows and the market yields of high grade
corporate bonds that are available to pay such cash flows as of the measurement date, December 31. The weighted average expected
long‐term rate of return is estimated based on current trends experienced by the assets in the plan as well as projected future rates of
return on those assets and reasonable actuarial assumptions for long term inflation, and the real and nominal rate of investment return
for a specific mix of asset classes. The current target asset allocation model for the plans is detailed in Note 18 to the consolidated
financial statements. The expected returns on these various asset categories are blended to derive one long-term return assumption. The
assets are invested in certain collective investment and mutual funds, common stocks, U.S. Treasury and other U.S. government agency
securities, and corporate and municipal bonds and notes. The rate of compensation increase is based on reviewing the compensation
increase practices of other plan sponsors in similar industries and geographic areas as well as the expectation of future increases.
Mortality rate assumptions are based on mortality tables published by third-parties such as the Society of Actuaries (“SOA”),
considering other available information including historical data as well as studies and publications from reputable sources. We review
the pension plan assumptions on an annual basis with our actuarial consultants to determine if the assumptions are reasonable and adjust
the assumptions to reflect changes in future expectations.
The assumptions used to calculate 2017 expense for the defined benefit pension plan were a weighted average discount rate of 4.00%, a
weighted average long-term rate of return on plan assets of 6.50% and a rate of compensation increase of 3.00%. Defined benefit
pension expense in 2018 is expected to decrease to $1.2 million from the $2.0 million recorded in 2017, primarily driven by an increase
in the expected return on assets, driven by overall higher plan asset values, and a decrease in the amount of accumulated actuarial losses
to be amortized.
Due to the long-term nature of pension plan assumptions, actual results may differ significantly from the actuarial-based estimates.
Differences resulting in actuarial gains or losses are required to be recorded in shareholders' equity as part of accumulated other
comprehensive loss and amortized to defined benefit pension expense in future years. For 2017, the actual return on plan assets in the
qualified defined benefit pension plan was a gain of $11.3 million, compared to an expected return on plan assets of $5.0 million. Total
pretax losses recognized in accumulated other comprehensive loss at December 31, 2017 were $14.3 million for the defined benefit
pension plan. Actuarial pretax net gains recognized in other comprehensive income for the year ended December 31, 2017 were $1.5
million for the defined benefit pension plan.
Defined benefit pension expense is recorded in “Salaries and employee benefits” expense on the consolidated statements of income.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1, Summary of Significant Accounting Policies - Recent Accounting Pronouncements, in the notes to consolidated financial
statements for a discussion of recent accounting pronouncements.
- 57 -
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset-Liability Management
The principal objective of our interest rate risk management is to evaluate the interest rate risk inherent in assets and liabilities,
determine the appropriate level of risk to us given our business strategy, operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with the guidelines approved by our Board of Directors. Management is
responsible for reviewing with the Board of Directors our activities and strategies, the effect of those strategies on net interest income,
the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Management
has developed an Asset-Liability Management and Investment Policy that meets the strategic objectives and regularly reviews the
activities of the Bank.
Portfolio Composition
Our balance sheet assets are a mix of fixed and variable rate assets with consumer indirect loans, commercial loans, and MBSs
comprising a significant portion of our assets. Our consumer indirect loan portfolio comprised 21% of assets and is primarily fixed rate
loans with relatively short durations. Our commercial loan portfolio totaled 31% of assets and is a combination of fixed and variable
rate loans, lines and mortgages. The MBS portfolio, including collateralized mortgages obligations, totaled 15% of assets with
durations averaging three to five years.
Our liabilities are made up primarily of deposits, which account for 86% of total liabilities. Of these deposits, the majority, or 51%, is
in nonpublic variable rate and noninterest bearing products including demand (both noninterest and interest- bearing), savings and
money market accounts. In addition, fixed rate nonpublic certificate of deposit products make up 23% of total deposits. The Bank also
has a significant amount of public deposits, which represented 26% of total deposits as of December 31, 2017.
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
December 31, 2017, the Bank’s sensitivity was relatively neutral, meaning that net interest income is modestly impacted as interest rates
change.
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 December 31, 2018 assuming instantaneous changes in interest rates for the
given rate shock scenarios (dollars in thousands):
Estimated change in net interest income
% Change
-100 bp
(1,834)
$
Changes in Interest Rate
+200 bp
$ (3,968)
+100 bp
$ (1,890)
+300 bp
$ (6,132)
(1.46)%
(1.50)%
(3.16)%
(4.88)%
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 simulation referenced above is based on our 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 the future results, does not measure the effect of changing interest rates on noninterest
income and is based on many assumptions that, if changed, could cause a different outcome.
Economic Value of Equity At Risk
The economic (or “fair”) value of financial instruments on our balance sheet will also vary under the interest rate scenarios previously
discussed. This variance is measured by simulating changes in our economic value of equity (“EVE”), which is calculated by
subtracting the estimated fair value of liabilities from the estimated fair value of assets. Fair values for financial instruments are
estimated by discounting projected cash flows (principal and interest) at current replacement rates for each account type, while fair
values of non-financial assets and liabilities are assumed to equal book value and do not vary with interest rate fluctuations. An
economic value simulation is a static measure for balance sheet accounts at a given point in time, but this measurement can change
substantially over time as the characteristics of our balance sheet evolve and as interest rate and yield curve assumptions are updated.
- 58 -
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).
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 December 31, 2017 and 2016. The analysis additionally presents a measurement of the interest
rate sensitivity at December 31, 2017 and 2016. 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.
December 31, 2017
December 31, 2016
Rate Shock Scenario:
Pre-Shock Scenario
- 100 Basis Points
+ 100 Basis Points
+ 200 Basis Points
+ 300 Basis Points
$
EVE
578,550
592,527 $
544,507
507,137
468,787
13,977
(34,043)
(71,413)
(109,763)
2.42%
(5.88)
(12.34)
(18.97)
EVE
$ 532,744
543,506 $
507,924
481,692
445,207
10,762
(24,820)
(51,052)
(87,537)
2.02%
(4.66)
(9.58)
(16.43)
Change
Percentage
Change
Change
Percentage
Change
The Pre-Shock Scenario EVE was $578.6 million at December 31, 2017, compared to $532.7 million at December 31, 2016. The
increase in the Pre-Shock Scenario EVE at December 31, 2017, compared to December 31, 2016 resulted primarily from a more
favorable valuation of non-maturity deposits and certain fixed rate assets that reflected alternative funding rate changes used for
discounting future cash flows.
The +200 basis point Rate Shock Scenario EVE increased from $481.7 million at December 31, 2016 to $507.1 million at December 31,
2017. The percentage change in the EVE amount from the Pre-Shock Scenario to the +200 basis point Rate Shock Scenario changed
from (9.58)% at December 31, 2016 to (12.34)% at December 31, 2017. The increase in sensitivity resulted from a decreased benefit in
the valuation of certain fixed rate assets in the +200 basis point Rate Shock Scenario EVE as of December 31, 2017, compared to
December 31, 2016.
- 59 -
Interest Rate Sensitivity Gap
The following table presents an analysis of our interest rate sensitivity gap position at December 31, 2017. All interest-earning assets
and interest-bearing liabilities are shown based on the earlier of their contractual maturity or re-pricing date. The expected maturities
are presented on a contractual basis or, if more relevant, based on projected call dates. Investment securities are at amortized cost for
both securities available for sale and securities held to maturity. Loans, net of deferred loan origination costs, include principal
amortization adjusted for estimated prepayments (principal payments in excess of contractual amounts) and non-accruing loans.
Because the interest rate sensitivity levels shown in the table could be changed by external factors such as loan prepayments and
liability decay rates or by factors controllable by us, such as asset sales, it is not an absolute reflection of our potential interest rate risk
profile (in thousands).
INTEREST-EARNING ASSETS:
Investment securities
Loans
Total interest-earning assets
Cash and due from banks
Other assets (1)
Total assets
INTEREST-BEARING LIABILITIES:
Interest-bearing demand, savings and
money market
Time deposits
Borrowings
Total interest-bearing liabilities
Noninterest-bearing deposits
Other liabilities
Total liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
Interest sensitivity gap
Cumulative gap
Cumulative gap ratio (2)
Cumulative gap as a percentage of total assets
_____
$
$
$
$
$
$
At December 31, 2017
Three
Months
or Less
Over Three
Months
Through
One Year
Over
One Year
Through
Five Years
Over
Five Years
Total
56,012 $
810,119
866,131 $
140,089 $
406,864
546,953 $
474,956 $
1,178,077
1,653,033 $
1,639,520 $
352,352
414,400
2,406,272 $
$
-
326,001
31,800
357,801 $
-
$
173,803
-
173,803 $
(1,540,141) $
(1,540,141) $
36.0 %
(37.5) %
189,152 $
(1,350,989) $
51.1 %
(32.9) %
1,479,230 $
128,241 $
104.4 %
3.1 %
373,867 $ 1,044,924
342,675 2,737,735
716,542 3,782,659
99,195
223,356
$ 4,105,210
$ 1,639,520
-
852,156
-
39,131
485,331
39,131 2,977,007
718,498
28,528
3,724,033
381,177
$ 4,105,210
805,652
677,411 $
805,652
127.1 %
19.6 %
(1)
Includes net unrealized loss on securities available for sale and allowance for loan losses.
(2) Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.
For purposes of interest rate risk management, we direct more attention on simulation modeling, such as “net interest income at risk” as
previously discussed, rather than gap analysis. We consider the net interest income at risk simulation modeling to be more informative
in forecasting future income at risk.
- 60 -
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
Management’s Report on Internal Control over Financial Reporting…………..............................................................................
Page
62
Report of Independent Registered Public Accounting Firm (on the Consolidated Financial Statements)…..…….........................
63
Report of Independent Registered Public Accounting Firm (on Internal Control over Financial Reporting)..…….......................
64
Consolidated Statements of Financial Condition at December 31, 2017 and 2016……………………………….........................
65
Consolidated Statements of Income for the years ended December 31, 2017, 2016 and 2015…………………............................
66
Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015..............................
67
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2017, 2016 and 2015...............
68
Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015………………….....................
70
Notes to Consolidated Financial Statements…………………………………………………………………………....................
71
- 61 -
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for Financial Institutions,
Inc. and its subsidiaries (the “Company”), as such term is defined in Exchange Act Rule 13a-15(f). The Company’s system of internal
control over financial reporting has been designed to provide reasonable assurance to the Company’s management and board of
directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external
purposes in accordance with U.S. generally accepted accounting principles.
Any system of internal control over financial reporting, no matter how well designed, has inherent limitations, including the possibility
that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because
of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control
will provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company’s management has, including the Company’s principal executive officer and principal financial officer as identified
below, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. To make this
assessment, we used the criteria for effective internal control over financial reporting described in Internal Control – Integrated
Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment and
based on such criteria, we believe that, as of December 31, 2017, the Company’s internal control over financial reporting was effective.
KPMG LLP, the Company’s independent registered public accounting firm that audited the Company’s consolidated financial
statements has issued an attestation report on internal control over financial reporting as of December 31, 2017. That report appears
herein.
/s/ Martin K. Birmingham
President and Chief Executive Officer
March 14, 2018
/s/ Kevin B. Klotzbach
Executive Vice President and Chief Financial Officer
March 14, 2018
- 62 -
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Financial Institutions, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial condition of Financial Institutions, Inc. and subsidiaries (the
Company) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in
shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes
(collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting
principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB),
the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control –
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated
March 14, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and
are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules
and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error
or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining,
on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation
of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 1995.
Rochester, New York
March 14, 2018
- 63 -
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Financial Institutions, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Financial Institutions, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of
December 31, 2017, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated
Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB),
the consolidated statements of financial condition of the Company as of December 31, 2017 and 2016, the related consolidated
statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year
period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated March
14, 2018 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based
on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances.
We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect
on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Rochester, New York
March 14, 2018
- 64 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(in thousands, except share and per share data)
ASSETS
Cash and due from banks
Securities available for sale, at fair value
Securities held to maturity, at amortized cost (fair value of $512,983 and $539,991, respectively)
Loans held for sale
Loans (net of allowance for loan losses of $34,672 and $30,934, respectively)
Company owned life insurance
Premises and equipment, net
Goodwill and other intangible assets, net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
December 31,
2017
2016
$
99,195
524,973
516,466
2,718
2,700,345
65,288
45,189
74,703
76,333
$ 4,105,210
$
71,277
539,926
543,338
1,050
2,309,227
63,455
42,398
75,640
64,029
$ 3,710,340
$
Deposits:
Noninterest-bearing demand
Interest-bearing demand
Savings and money market
Time deposits
Total deposits
Short-term borrowings
Long-term borrowings, net of issuance costs of $869 and $939, respectively
Other liabilities
Total liabilities
Commitments and contingencies (Note 11)
Shareholders’ equity:
Series A 3% preferred stock, $100 par value; 1,533 shares authorized; 1,439 and 1,492 shares issued
Series B-1 8.48% preferred stock, $100 par value; 200,000 shares authorized; 171,847 and 171,906
shares issued
Total preferred equity
Common stock, $0.01 par value; 50,000,000 shares authorized; 16,056,178 and 14,692,214
shares issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock, at cost – 131,240 and 154,617 shares, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
718,498
634,203
1,005,317
852,156
3,210,174
446,200
39,131
28,528
3,724,033
$
677,076
581,436
1,034,194
702,516
2,995,222
331,500
39,061
24,503
3,390,286
144
149
17,185
17,329
17,191
17,340
161
121,058
257,078
(11,916)
(2,533)
381,177
$ 4,105,210
147
81,755
237,687
(13,951)
(2,924)
320,054
$ 3,710,340
See accompanying notes to the consolidated financial statements.
- 65 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share data)
Interest income:
Interest and fees on loans
Interest and dividends on investment securities
Other interest income
Total interest income
Interest expense:
Deposits
Short-term borrowings
Long-term borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income:
Service charges on deposits
Insurance income
ATM and debit card
Investment advisory
Company owned life insurance
Investments in limited partnerships
Loan servicing
Net gain on sale of loans held for sale
Net gain on investment securities
Net gain on other assets
Amortization of tax credit investment
Contingent consideration liability adjustment
Other
Total noninterest income
Noninterest expense:
Salaries and employee benefits
Occupancy and equipment
Professional services
Computer and data processing
Supplies and postage
FDIC assessments
Advertising and promotions
Amortization of intangibles
Goodwill impairment
Other
Total noninterest expense
Income before income taxes
Income tax expense
Net income
Preferred stock dividends
Net income available to common shareholders
Earnings per common share (Note 17):
Basic
Diluted
Cash dividends declared per common share
Weighted average common shares outstanding:
Basic
Diluted
See accompanying notes to the consolidated financial statements.
- 66 -
Years ended December 31,
2016
2017
2015
$
$
$
$
$
$
106,282
23,755
73
130,110
11,093
3,931
2,471
17,495
112,615
13,361
99,254
7,391
5,266
5,721
6,104
1,781
110
439
376
1,260
37
-
1,200
5,045
34,730
48,675
16,293
4,083
4,935
2,003
1,817
2,171
1,170
1,575
7,791
90,513
43,471
9,945
33,526
1,462
32,064
2.13
2.13
0.85
$
$
$
$
$
$
92,296
22,917
18
115,231
8,458
1,612
2,471
12,541
102,690
9,638
93,052
7,280
5,396
5,687
5,208
2,808
300
436
240
2,695
313
-
1,170
4,227
35,760
45,215
14,529
5,782
4,451
2,047
1,735
2,097
1,249
-
7,566
84,671
44,141
12,210
31,931
1,462
30,469
2.11
2.10
0.81
$
83,575
21,875
-
105,450
7,306
1,081
1,750
10,137
95,313
7,381
87,932
7,742
5,166
5,084
2,193
1,962
895
503
249
1,988
27
(390)
1,093
3,825
30,337
42,439
13,856
3,681
4,267
2,155
1,719
1,986
942
751
7,597
79,393
38,876
10,539
28,337
1,462
26,875
1.91
1.90
0.80
$
$
$
$
$
15,044
15,085
14,436
14,491
14,081
14,135
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
Net income
Other comprehensive income (loss), net of tax:
Net unrealized gains (losses) on securities available for sale
Pension and post-retirement obligations
Total other comprehensive income (loss), net of tax
Comprehensive income
Years ended December 31,
2016
2017
2015
$
33,526
$
31,931
$
28,337
454
1,581
2,035
35,561
$
(3,033)
409
(2,624)
29,307
$
(2,321)
5
(2,316)
26,021
$
See accompanying notes to the consolidated financial statements.
- 67 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
Years ended December 31, 2017, 2016 and 2015
(in thousands,
except per share data)
Balance at January 1, 2015
Comprehensive income:
Net income
Other comprehensive loss, net of tax
Purchases of common stock for treasury
Share-based compensation plans:
Share-based compensation
Stock options exercised
Restricted stock awards issued, net
Excess tax benefit
Stock awards
Cash dividends declared:
Series A 3% Preferred-$3.00 per share
Series B-1 8.48% Preferred-$8.48 per share
Common-$0.80 per share
Balance at December 31, 2015
Comprehensive income:
Net income
Other comprehensive loss, net of tax
Common stock issued
Share-based compensation plans:
Share-based compensation
Stock options exercised
Restricted stock awards issued, net
Excess tax benefit
Stock awards
Cash dividends declared:
Series A 3% Preferred-$3.00 per share
Series B-1 8.48% Preferred-$8.48 per share
Common-$0.81 per share
Balance at December 31, 2016
Continued on next page
Preferred
Equity
Common
Stock
$ 17,340 $ 144 $ 72,955
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Treasury
Stock
Total
Shareholders’
Equity
$ 203,312 $ (9,011) $ (5,208) $ 279,532
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
28,337
-
-
-
(2,316)
-
-
-
(202)
28,337
(2,316)
(202)
674
6
(1,052)
79
28
-
-
-
-
-
-
-
-
-
-
-
353
1,052
-
82
674
359
-
79
110
-
-
-
-
-
-
$ 17,340 $ 144 $ 72,690
-
-
-
(4)
(1,458)
(11,267)
-
-
-
$ 218,920 $ (11,327) $ (3,923) $ 293,844
(4)
(1,458)
(11,267)
-
-
-
-
-
-
-
-
-
-
-
-
-
3
-
-
8,097
31,931
-
-
-
(2,624)
-
-
-
-
31,931
(2,624)
8,100
-
-
-
-
-
845
23
24
30
46
-
-
-
-
-
-
-
-
-
-
-
941
(24)
-
82
845
964
-
30
128
-
-
-
(4)
(1,458)
(11,702)
$ 17,340 $ 147 $ 81,755 $ 237,687 $ (13,951) $ (2,924) $ 320,054
(4)
(1,458)
(11,702)
-
-
-
-
-
-
-
-
-
-
-
-
See accompanying notes to the consolidated financial statements.
- 68 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity (Continued)
Years ended December 31, 2017, 2016 and 2015
(in thousands,
except per share data)
Balance at December 31, 2016
Balance carried forward
Cumulative-effect adjustment
Balance at January 1, 2017
Comprehensive income:
Net income
Other comprehensive income, net of tax
Common stock issued
Purchase of common stock for treasury
Repurchase of Series A 3% preferred stock
Repurchase of Series B-1 8.48% preferred stock
Share-based compensation plans:
Share-based compensation
Stock options exercised
Restricted stock awards issued, net
Stock awards
Cash dividends declared:
Series A 3% Preferred-$3.00 per share
Series B-1 8.48% Preferred-$8.48 per share
Common-$0.85 per share
Balance at December 31, 2017
Preferred
Equity
$ 17,340
-
$ 17,340
-
-
-
-
(5)
(6)
-
-
-
-
-
-
-
$ 17,329
Common
Stock
$ 147 $ 81,755 $237,687 $ (13,951) $ (2,924) $ 320,054
Treasury
Stock
Retained
Earnings
Total
Shareholders’
Equity
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income (Loss)
-
-
$ 147 $ 81,476 $237,966 $ (13,951) $ (2,924) $ 320,054
(279)
279
-
-
-
-
14
-
-
-
-
-
-
-
-
-
38,289
-
2
-
1,174
5
21
91
33,526
-
-
-
-
-
-
-
-
-
-
2,035
-
-
-
-
-
-
-
-
-
-
-
(148)
-
-
-
408
(21)
152
33,526
2,035
38,303
(148)
(3)
(6)
1,174
413
-
243
-
-
-
(4)
(1,458)
(12,952)
$ 161 $121,058 $257,078 $ (11,916) $ (2,533) $ 381,177
(4)
(1,458)
(12,952)
-
-
-
-
-
-
-
-
-
See accompanying notes to the consolidated financial statements.
- 69 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Net amortization of premiums on securities
Provision for loan losses
Share-based compensation
Deferred income tax expense (benefit)
Proceeds from sale of loans held for sale
Originations of loans held for sale
Increase in company owned life insurance
Net gain on sale of loans held for sale
Net gain on investment securities
Amortization of tax credit investment
Goodwill impairment
Net gain on other assets
(Increase) decrease in other assets
Increase (decrease) in other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of investment securities:
Available for sale
Held to maturity
Proceeds from principal payments, maturities and calls on investment securities:
Available for sale
Held to maturity
Proceeds from sales of securities available for sale
Net loan originations
Proceeds from company owned life insurance, net of purchases
Proceeds from sales of other assets
Purchases of premises and equipment
Cash consideration paid for acquisition, net of cash acquired
Net cash used in investing activities
Cash flows from financing activities:
Net increase in deposits
Net increase (decrease) in short-term borrowings
Issuance of long-term debt
Debt issuance costs
Repurchase of preferred stock
Proceeds from issuance of common stock
Purchases of common stock for treasury
Proceeds from stock options exercised
Excess tax benefit on share-based compensation
Cash dividends paid to preferred shareholders
Cash dividends paid to common shareholders
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Years ended December 31,
2016
2015
2017
$
33,526
$
31,931
$
28,337
6,177
3,298
13,361
1,174
12,403
14,555
(15,847)
(1,781)
(376)
(1,260)
-
1,575
(37)
(24,505)
4,016
46,279
(86,434)
(71,479)
51,978
96,376
50,084
(404,905)
(52)
234
(7,740)
(676)
(372,614)
214,952
114,700
-
-
(9)
38,303
(148)
413
-
(1,462)
(12,496)
354,253
27,918
71,277
99,195
$
5,958
3,192
9,638
845
(1,718)
11,655
(11,035)
(2,808)
(240)
(2,695)
-
-
(313)
2,027
257
46,694
5,429
3,150
7,381
674
1,798
16,195
(16,621)
(1,962)
(249)
(1,988)
390
751
(27)
(545)
376
43,089
(213,413)
(126,375)
(271,899)
(64,397)
119,190
66,579
95,261
(262,684)
2,398
854
(7,619)
(868)
(326,677)
264,691
38,400
-
-
-
-
-
964
30
(1,462)
(11,484)
291,139
11,156
60,121
71,277
$
127,257
36,162
54,277
(180,067)
(79)
365
(7,493)
-
(305,874)
280,004
(41,704)
40,000
(1,060)
-
-
(202)
359
79
(1,462)
(11,259)
264,755
1,970
58,151
60,121
$
See accompanying notes to the consolidated financial statements.
- 70 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Institutions, Inc. (individually referred to herein as the “Parent Company” and together with all of its subsidiaries, collectively
referred to herein as the “Company”) is a financial holding company organized in 1931 under the laws of New York State (“New
York”). At December 31, 2017, the Company conducted its business through its three subsidiaries: Five Star Bank (the “Bank”), a New
York chartered bank; Scott Danahy Naylon, LLC (“SDN”), a full service insurance agency; and Courier Capital, LLC (“Courier
Capital”), an SEC-registered investment advisory and wealth management firm. The Company provides a full range of banking and
related financial services to consumer, commercial and municipal customers through its bank and nonbank subsidiaries.
The accounting and reporting policies conform to general practices within the banking industry and to U.S. generally accepted
accounting principles (“GAAP”).
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.
The following is a description of the Company’s significant accounting policies.
(a.) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(b.) Use of Estimates
In preparing the consolidated financial statements in conformity with GAAP, management is required to make estimates and
assumptions that affect the reported amount of assets and liabilities as of the date of the statement of financial condition and
reported amounts of revenue and expenses during the reporting period. 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. These estimates and assumptions are based on management’s best estimates and judgment and are
evaluated on an ongoing basis using historical experience and other factors, including the current economic environment. The
Company adjusts these estimates and assumptions when facts and circumstances dictate. As future events cannot be determined
with precision, actual results could differ significantly from the Company’s estimates.
(c.) Cash Flow Reporting
Cash and cash equivalents include cash and due from banks, federal funds sold and interest-bearing deposits in other banks. Net
cash flows are reported for loans, deposit transactions and short-term borrowings.
- 71 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Supplemental cash flow information is summarized as follows for the years ended December 31 (in thousands):
Cash payments:
Interest expense
Income taxes
Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans
Accrued and declared unpaid dividends
Increase (decrease) in net unsettled security purchases
Securities transferred from available for sale to held to maturity
Common stock issued for acquisition
Assets acquired and liabilities assumed in business combinations:
Loans and other non-cash assets, excluding goodwill and other
intangible assets
Deposits and other liabilities
(d.) Investment Securities
2017
2016
2015
$
$
14,850
13,187
$
11,823
10,555
$
9,323
7,494
$
426
3,859
-
-
-
812
44
$
496
3,403
(170)
-
8,100
374
3,185
(478)
165,238
-
4,848
1,845
-
-
Investment securities are classified as either available for sale or held to maturity. Debt securities that management has the positive
intent and ability to hold to maturity are classified as held to maturity and are recorded at amortized cost. Other investment
securities are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and
reported as a component of comprehensive income and shareholders’ equity.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Securities are evaluated periodically to determine whether a decline in their fair value is other than temporary. Management
utilizes criteria such as, the current intent to hold or sell the security, the magnitude and duration of the decline and, when
appropriate, consideration of negative changes in expected cash flows, creditworthiness, near term prospects of issuers, the level of
credit subordination, estimated loss severity, and delinquencies, to determine whether a loss in value is other than temporary. The
term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term
recovery of value is not necessarily favorable. Declines in the fair value of investment 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 issues or
concerns, or the security is intended to be sold. The amount of impairment related to non-credit related factors is recognized in
other comprehensive income. Gains and losses on the sale of securities are recorded on the trade date and are determined using the
specific identification method.
(e.) Loans Held for Sale and Loan Servicing Rights
The Company generally makes the determination of whether to identify a mortgage as held for sale at the time the loan is closed
based on the Company’s intent and ability to hold the loan. Loans held for sale are recorded at the lower of cost or market
computed on the aggregate portfolio basis. The amount, by which cost exceeds market value, if any, is accounted for as a valuation
allowance with changes included in the determination of results of operations for the period in which the change occurs. The
amount of loan origination costs and fees are deferred at origination and recognized as part of the gain or loss on sale of the loans,
determined using the specific identification method, in the consolidated statements of income.
- 72 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company originates and sells certain residential real estate loans in the secondary market. The Company typically retains the
right to service the mortgages upon sale. Mortgage-servicing rights (“MSRs”) represent the cost of acquiring the contractual rights
to service loans for others. MSRs are recorded at their fair value at the time a loan is sold and servicing rights are retained. MSRs
are reported in other assets in the consolidated statements of financial position and are amortized to noninterest income in the
consolidated statements of income in proportion to and over the period of estimated net servicing income. The Company uses a
valuation model that calculates the present value of future cash flows to determine the fair value of servicing rights. In using this
valuation method, the Company incorporates assumptions to estimate future net servicing income, which include estimates of the
cost to service the loan, the discount rate, an inflation rate and prepayment speeds. On a quarterly basis, the Company evaluates its
MSRs for impairment and charges any such impairment to current period earnings. In order to evaluate its MSRs the Company
stratifies the related mortgage loans on the basis of their predominant risk characteristics, such as interest rates, year of origination
and term, using discounted cash flows and market-based assumptions. Impairment of MSRs is recognized through a valuation
allowance, determined by estimating the fair value of each stratum and comparing it to its carrying value. Subsequent increases in
fair value are adjusted through the valuation allowance, but only to the extent of the valuation allowance.
Mortgage loan servicing includes collecting monthly mortgagor payments, forwarding payments and related accounting reports to
investors, collecting escrow deposits for the payment of mortgagor property taxes and insurance, paying taxes and insurance from
escrow funds when due and administrating foreclosure actions when necessary. Loan servicing income (a component of
noninterest income in the consolidated statements of income) consists of fees earned for servicing mortgage loans sold to third
parties, net of amortization expense and impairment losses associated with capitalized mortgage servicing assets.
(f.) Loans
Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable
future, or until maturity or payoff. Loans are carried at the principal amount outstanding, net of any unearned income and
unamortized deferred fees and costs on originated loans. Loan origination fees and certain direct loan origination costs are
deferred, and the net amount is amortized into net interest income over the contractual life of the related loans or over the
commitment period as an adjustment of yield. Interest income on loans is based on the principal balance outstanding computed
using the effective interest method.
A loan is considered delinquent when a payment has not been received in accordance with the contractual terms. The accrual of
interest income for commercial loans is discontinued when there is a clear indication that the borrower’s cash flow may not be
sufficient to meet payments as they become due, while the accrual of interest income for retail loans is discontinued when loans
reach specific delinquency levels. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as
to interest or principal payments, unless the loan is well secured and in the process of collection. Additionally, if management
becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is
management’s practice to place such loans on a nonaccrual status immediately, rather than delaying such action until the loans
become 90 days past due. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed,
amortization of related deferred loan fees or costs is suspended, and income is recorded only to the extent that interest payments are
subsequently received in cash and a determination has been made that the principal balance of the loan is collectible. If
collectability of the principal is in doubt, payments received are applied to loan principal. A nonaccrual loan may be returned to
accrual status when all delinquent principal and interest payments become current in accordance with the terms of the loan
agreement, the borrower has demonstrated a period of sustained performance (generally a minimum of six months) and the ultimate
collectability of the total contractual principal and interest is no longer in doubt.
The Company’s loan policy dictates the guidelines to be followed in determining when a loan is charged-off. All charge offs are
approved by the Bank’s senior loan officers or loan committees, depending on the amount of the charge off, and are reported in
aggregate to the Bank’s Board of Directors. Commercial business and commercial mortgage loans are charged-off when a
determination is made that the financial condition of the borrower indicates that the loan will not be collectible in the ordinary
course of business. Residential mortgage loans and home equities are generally charged-off or written down when the credit
becomes severely delinquent and the balance exceeds the fair value of the property less costs to sell. Indirect and other consumer
loans, both secured and unsecured, are generally charged-off in full during the month in which the loan becomes 120 days past due,
unless the collateral is in the process of repossession in accordance with the Company’s policy.
- 73 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan is accounted for as a troubled debt restructuring if the Company, for economic or legal reasons related to the borrower’s
financial condition, grants a significant concession to the borrower that it would not otherwise consider. A troubled debt
restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms
such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, an extension of the maturity
date at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these
concessions. Troubled debt restructurings generally remain on nonaccrual status until there is a sustained period of payment
performance (usually six months or longer) and there is a reasonable assurance that the payments will continue. See Allowance for
Loan Losses below for further policy discussion and see Note 5 – Loans for additional information.
(g.) Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to
extend credit, standby letters of credit and financial guarantees. Such financial instruments are recorded in the consolidated
financial statements when they are funded or when related fees are incurred or received. The Company periodically evaluates the
credit risks inherent in these commitments and establishes loss allowances for such risks if and when these are deemed necessary.
The Company recognizes as liabilities the fair value of the obligations undertaken in issuing the guarantees under the standby letters
of credit, net of the related amortization at inception. The fair value approximates the unamortized fees received from the customers
for issuing the standby letters of credit. The fees are deferred and recognized on a straight-line basis over the commitment period.
Standby letters of credit outstanding typically have original terms ranging from one to five years. Fees received for providing loan
commitments and letters of credit that result in loans are typically deferred and amortized to interest income over the life of the
related loan, beginning with the initial borrowing. Fees on commitments and letters of credit are amortized to other income as
banking fees and commissions over the commitment period when funding is not expected.
(h.) Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. When a loan or
portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and
subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis and is based upon periodic review of the collectability of the loans in
light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability
to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective
as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific and general components. Specific allowances are established for impaired loans. Impaired
commercial business and commercial mortgage loans are individually evaluated and measured for impairment based on the present
value of expected future cash flows discounted at the loan’s effective interest rate, a loan’s observable market price, or the fair
value of the collateral if the loan is collateral dependent. Regardless of the measurement method, impairment is based on the fair
value of the collateral when foreclosure is probable. If the recorded investment in impaired loans exceeds the measure of estimated
fair value, a specific allowance is established as a component of the allowance for loan losses. Interest payments on impaired loans
are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is
recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible.
- 74 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to
collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors
considered in determining impairment include payment status and the probability of collecting scheduled principal and interest
payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as
impaired. The Company determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the
delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s
effective interest rate, the loans obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large
groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment disclosures unless the loan has been subject to a troubled debt restructure.
At December 31, 2017, there were no commitments to lend additional funds to those borrowers whose loans were classified as
impaired.
General allowances are established for loan losses on a portfolio basis for loans that are collectively evaluated for impairment. The
portfolio is grouped into similar risk characteristics, primarily loan type. The Company applies an estimated loss rate, which
considers both look-back and loss emergence periods, to each loan group. The loss rate is based on historical experience, with a
look-back period of 24 months, and as a result can differ from actual losses incurred in the future. The historical loss rate is
adjusted by the loss emergence periods that range from 12 to 28 months depending on the loan type, and for qualitative factors such
as; levels and trends of delinquent and non-accruing loans, trends in volume and terms, effects of changes in lending policy, the
experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit risk,
interest rates, highly leveraged borrowers, information risk and collateral risk. The qualitative factors are reviewed at least
quarterly and adjustments are made as needed.
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 recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
(i.) Other Real Estate Owned
Other real estate owned consists of properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure. These
assets are recorded at the lower of fair value of the asset acquired less estimated costs to sell or “cost” (defined as the fair value at
initial foreclosure). At the time of foreclosure, or when foreclosure occurs in-substance, the excess, if any, of the loan over the fair
market value of the assets received, less estimated selling costs, is charged to the allowance for loan losses and any subsequent
valuation write-downs are charged to other expense. In connection with the determination of the allowance for loan losses and the
valuation of other real estate owned, management obtains appraisals for properties. Operating costs associated with the properties
are charged to expense as incurred. Gains on the sale of other real estate owned are included in income when title has passed and
the sale has met the minimum down payment requirements prescribed by GAAP. The balance of other real estate owned was $148
thousand and $107 thousand at December 31, 2017 and 2016, respectively.
(j.) Company Owned Life Insurance
The Company holds life insurance policies on certain current and former employees. The Company is the owner and beneficiary of
the policies. The cash surrender value of these policies is included as an asset on the consolidated statements of financial condition,
and any increase in cash surrender value is recorded as noninterest income on the consolidated statements of income. In the event
of the death of an insured individual under these policies, the Company would receive a death benefit which would be recorded as
noninterest income.
- 75 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(k.) Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets. The Company generally amortizes buildings and building
improvements over a period of 15 to 39 years and software, furniture and equipment over a period of 3 to 10 years. Leasehold
improvements are amortized over the shorter of the lease term or the useful life of the improvements. Premises and equipment are
periodically reviewed for impairment or when circumstances present indicators of impairment.
(l.) Goodwill and Other Intangible Assets
The excess of the cost of an acquisition over the fair value of the net assets acquired consists primarily of goodwill, core deposit
intangibles, and other identifiable intangible assets. Intangible assets are acquired assets that lack physical substance but can be
distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged
either on its own or in combination with a related contract, asset, or liability. The Company’s intangible assets consist of core
deposits and other intangible assets (primarily customer relationships). Core deposit intangible assets are amortized on an
accelerated basis over their estimated life of approximately nine and a half years. Other intangible assets are amortized on an
accelerated basis over their weighted average estimated life of approximately twenty years. The Company reviews long-lived
assets and certain identifiable intangibles for impairment at least annually, or whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable, in which case an impairment charge would be recorded.
Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event
occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative
evaluation (Step 0) is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate
the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is
required whereby the fair value of each reporting unit is calculated and compared to the recorded book value (Step 1). If the
calculated fair value of the reporting unit exceeds its carrying value, then goodwill is not considered impaired. However, if the
carrying value of a reporting unit exceeds its calculated fair value, a goodwill impairment charge is recognized. See Note 7 for
additional information on goodwill and other intangible assets.
(m.) Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock
The non-marketable investments in FHLB and FRB stock are included in other assets in the consolidated statements of financial
condition at par value or cost and are periodically reviewed for impairment. The dividends received relative to these investments
are included in other noninterest income in the consolidated statements of income.
As a member of the FHLB system, the Company is required to maintain a specified investment in FHLB of New York
(“FHLBNY”) stock in proportion to its volume of certain transactions with the FHLB. FHLBNY stock totaled $21.9 million and
$16.9 million as of December 31, 2017 and 2016, respectively.
As a member of the FRB system, the Company is required to maintain a specified investment in FRB stock based on a ratio relative
to the Company’s capital. FRB stock totaled $5.8 million and $4.9 million as of December 31, 2017 and 2016, respectively.
(n.) Equity Method Investments
The Company has investments in limited partnerships, primarily Small Business Investment Companies, and accounts for these
investments under the equity method. These investments are included in other assets in the consolidated statements of financial
condition and totaled $5.7 million and $5.6 million as of December 31, 2017 and 2016, respectively.
- 76 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(o.) Derivative Instruments and Hedging Activities
Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging
(“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of
financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity
accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an
entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the
Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and
losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
As required by ASC 815, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the
fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in
a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply
hedge accounting. Currently, none of the Company’s derivatives are designated in qualifying hedging relationships, as the
derivatives are not used to manage risks within the Company’s assets or liabilities. As such, all changes in fair value of the
Company’s derivatives are recognized directly in earnings.
In accordance with the FASB’s fair value measurement guidance, the Company made an accounting policy election to measure the
credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty
portfolio.
(p.) Treasury Stock
Acquisitions of treasury stock are recorded at cost. The reissuance of shares in treasury is recorded at weighted-average cost.
(q.) Employee Benefits
The Company maintains an employer sponsored 401(k) plan where participants may make contributions in the form of salary
deferrals and the Company may provide discretionary matching contributions in accordance with the terms of the plan.
Contributions due under the terms of our defined contribution plans are accrued as earned by employees.
The Company also participates in a non-contributory defined benefit pension plan for certain employees who previously met
participation requirements. The Company also provides post-retirement benefits, principally health and dental care, to employees
of a previously acquired entity. The Company has closed the pension and post-retirement plans to new participants. The
actuarially determined pension benefit is based on years of service and the employee’s highest average compensation during five
consecutive years of employment. The Company’s policy is to at least fund the minimum amount required by the Employment
Retirement Income Security Act of 1974. The cost of the pension and post-retirement plans are based on actuarial computations of
current and future benefits for employees, and is charged to noninterest expense in the consolidated statements of income.
The Company recognizes an asset or a liability for a plans’ overfunded status or underfunded status, respectively, in the
consolidated financial statements and reports changes in the funded status as a component of other comprehensive income, net of
applicable taxes, in the year in which changes occur.
Effective January 1, 2016, the Company’s 401(k) plan was amended and the Company’s prior matching contribution was
discontinued. Concurrent with the 401(k) plan amendment, the Company’s defined benefit pension plan was amended to modify
the current benefit formula to reflect the discontinuance of the matching contribution in the 401(k) plan, to open the defined benefit
pension plan up to eligible employees who were hired on and after January 1, 2007, which provides those new participants with a
cash balance benefit formula.
(r.) Share-Based Compensation Plans
Compensation expense for stock options and restricted stock awards is based on the fair value of the award on the measurement
date, which, for the Company, is the date of grant and is recognized ratably over the service period of the award. The fair value of
stock options is estimated using the Black-Scholes option-pricing model. The fair value of restricted stock awards is generally the
market price of the Company’s stock on the date of grant.
Share-based compensation expense is included in the consolidated statements of income under salaries and employee benefits for
awards granted to management and in other noninterest expense for awards granted to directors.
- 77 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(s.) Income Taxes
Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which
those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and
liabilities is recognized in income in the period that includes the enactment date. A valuation allowance is recognized on deferred
tax assets if, based upon the weight of available evidence, it is more likely than not that some or all of the assets may not be
realized. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
(t.) Comprehensive Income
Comprehensive income includes all changes in shareholders’ equity during a period, except those resulting from transactions with
shareholders. In addition to net income, other components of the Company’s comprehensive income include the after-tax effect of
changes in net unrealized gain / loss on securities available for sale and changes in net actuarial gain / loss on defined benefit post-
retirement plans. Comprehensive income is reported in the accompanying consolidated statements of changes in shareholders’
equity and consolidated statements of comprehensive income. See Note 14 - Accumulated Other Comprehensive Income (Loss) for
additional information.
(u.) Earnings Per Common Share
The Company calculates earnings per common share (“EPS”) using the two-class method in accordance with FASB ASC Topic
260, “Earnings Per Share”. The two-class method requires the Company to present EPS as if all of the earnings for the period are
distributed to common shareholders and any participating securities, regardless of whether any actual dividends or distributions are
made. All outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends are considered
participating securities.
Basic EPS is computed by dividing distributed and undistributed earnings available to common shareholders by the weighted
average number of common shares outstanding for the period. Distributed and undistributed earnings available to common
shareholders represent net income reduced by preferred stock dividends and distributed and undistributed earnings available to
participating securities. Common shares outstanding include common stock and vested restricted stock awards. Diluted EPS reflects
the assumed conversion of all potential dilutive securities. A reconciliation of the weighted-average shares used in calculating basic
earnings per common share and the weighted average common shares used in calculating diluted earnings per common share for the
reported periods is provided in Note 17 - Earnings Per Common Share.
(v.) Reclassifications
Certain items in prior financial statements have been reclassified to conform to the current presentation.
(w.) Recent Accounting Pronouncements
In May 2014, the 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 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’s largest source of revenue is net interest income on financial assets and liabilities, which is explicitly excluded from the
scope of ASU 2014-09. Revenue streams that are within the scope of ASU 2014-09 include insurance income, investment advisory
fees, service charges on deposits and ATM and debit card fees. The adoption of ASU 2014-09, as of January 1, 2018, did not have a
significant impact on the Company’s financial statements. The Company adopted ASU 2014-09 using the modified retrospective
transition method with a cumulative effect adjustment to opening retained earnings as of January 1, 2018.
- 78 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) 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 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 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 an entity 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
entity 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 adoption of ASU
2016-01 is not expected to have a significant impact on the Company’s financial statements.
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 a 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 financial statements.
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 fiscal years beginning after December 15, 2016, and interim periods within those years. Early
adoption was permitted. The adoption of ASU 2016-09 did not have a significant impact on the Company’s financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit
Losses on Financial Instruments. ASU 2016-13 amends guidance on reporting credit losses for financial assets held at amortized
cost basis and available for sale debt securities. Topic 326 eliminates the probable initial recognition threshold in current GAAP
and instead, requires an entity to reflect its current estimate of all expected credit losses based on historical experience, current
conditions and reasonable and supportable forecasts. The allowance for credit losses is a valuation account that is deducted from the
amortized cost basis of the financial assets to present the net amount expected to be collected. The guidance is effective for fiscal
years beginning after December 15, 2019, and interim periods within those years. Early adoption is permitted beginning after
December 15, 2018. The Company is assessing the impact of ASU 2016-13 on its financial statements.
- 79 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230) – Classification of Certain Cash
Receipts and Cash Payments. ASU 2016-15 provides guidance on the following eight specific cash flow issues: 1) debt prepayment
or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates
that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a
business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life
insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7)
beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance
principle. The guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those
fiscal years. Early adoption was permitted, including adoption in an interim period. As this guidance only affects the classification
within the statement of cash flows, this ASU is not expected to have a significant impact on the Company's financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350) – Simplifying the Test for
Goodwill Impairment. ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill
impairment test. Under the new guidance, an entity will recognize an impairment charge for the amount by which the carrying
value exceeds the fair value. This standard is effective for annual or any interim goodwill impairment tests in fiscal years beginning
after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates
after January 1, 2017. The Company early adopted ASU 2017-04 during the quarter ended June 30, 2017, in connection with the
interim goodwill impairment test that was performed. For additional details, see Note 6, Goodwill and Other Intangible Assets.
The early adoption of ASU 2017-04 did not have a significant impact on the Company’s financial statements.
In March 2017, the FASB issued ASU No. 2017-07, Compensation – Retirement Benefits (Topic 715) – Improving the Presentation
of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which provides additional guidance on the presentation
of net periodic pension and postretirement benefit costs in the income statement and on the components eligible for capitalization.
The amendments in this ASU require that an employer report the service cost component of the net periodic benefit costs in the
same income statement line item as other compensation costs arising from services rendered by employees during the period. The
non-service-cost components of net periodic benefit costs are to be presented in the income statement separately from the service
cost components and outside a subtotal of income from operations. The ASU also allows for the capitalization of the service cost
components, when applicable (i.e., as a cost of internally manufactured inventory or a self-constructed asset). The amendments are
effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods; early
adoption was permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been
issued or made available for issuance. The amendments in this ASU are to be applied retrospectively. The Company is assessing the
impact of ASU 2017-07 on its financial statements.
In March 2017, the FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20) –
Premium Amortization on Purchased Callable Debt Securities. These amendments shorten the amortization period for certain
callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call
date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized
to maturity. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in
an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The
amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings
as of the beginning of the period of adoption. The Company is assessing the impact of ASU 2017-08 on its financial statements.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815) – Targeted Improvements to Accounting
for Hedging Activities. These amendments: (a) expand and refine hedge accounting for both financial and non-financial risk
components, (b) align the recognition and presentation of the effects of hedging instruments and hedge items in the financial
statements, and (c) include certain targeted improvements to ease the application of current guidance related to the assessment of
hedge effectiveness. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early
adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim
period. The amendments related to cash flow and net investment hedges existing at the date of adoption 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
presentation and disclosure should be applied prospectively. The Company is assessing the impact of ASU 2017-12 on its financial
statements.
- 80 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220) –
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. ASU 2018-02 permits a reclassification
from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the TCJ Act. The
guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early
adoption is permitted, including adoption in any interim period. The amendments should be applied either in the period of adoption
or retrospectively to each period (or periods) in which the effect of the change in the federal corporate income tax rate in the TCJ
Act is recognized. The Company is assessing the impact of ASU 2018-02 on its financial statements.
(2.) BUSINESS COMBINATIONS
2017 Activity - Robshaw & Julian Acquisition
On August 31, 2017, Courier Capital completed the acquisition of the assets of Robshaw & Julian Associates, Inc. (“Robshaw &
Julian”), a registered investment advisor with approximately $175 million in assets under management, which increased Courier
Capital’s total assets under management to a total of approximately $1.6 billion. Consideration for the acquisition included cash and
potential future cash bonuses contingent upon achievement of certain revenue performance targets through August 2020. As a result of
the acquisition, Courier Capital recorded goodwill of $1.0 million and other intangible assets of $810 thousand. The goodwill and other
intangible assets are expected to be deductible for income tax purposes. The allocation of acquisition cost to the assets acquired and
liabilities assumed and 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.
2016 Activity - 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 at the time of acquisition. Consideration for the
acquisition totaled $9.0 million and included stock of $8.1 million and $918 thousand of cash. The acquisition also included up to $2.8
million of potential future payments of stock and up to $2.2 million of potential future cash bonuses contingent upon Courier Capital
meeting certain EBITDA performance targets through 2018. In addition, the Company purchased two pieces of real property in Buffalo
and Jamestown, New York used, but not owned 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. The following table
presents the allocation of acquisition cost to the assets acquired and liabilities assumed, based on their estimated fair values.
Cash
Identified intangible assets
Premises and equipment, accounts receivable and other assets
Deferred tax liability
Other liabilities
Net assets acquired
$
$
50
3,928
870
(1,797)
(48)
3,003
The amounts assigned to goodwill and other intangible assets for the Courier Capital acquisition are as follows:
Goodwill
Other intangible assets – customer relationships
Other intangible assets – other
Amount
allocated
$
$
6,015
3,900
28
9,943
Useful life
(in years)
n/a
20
5
- 81 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(3.)
INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are summarized below (in thousands).
December 31, 2017
Securities available for sale:
U.S. Government agencies and government
sponsored enterprises
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Privately issued
Total mortgage-backed securities
Total available for sale securities
Securities held to maturity:
State and political subdivisions
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Total mortgage-backed securities
Total held to maturity securities
December 31, 2016
Securities available for sale:
U.S. Government agencies and government
sponsored enterprises
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Privately issued
Total mortgage-backed securities
Asset-backed securities
Total available for sale securities
Amortized
Cost
Unrealized
Unrealized
Gains
Losses
Fair
Value
$
163,025
$
122
$
1,258
$
161,889
311,830
41,290
12,051
217
45
-
365,433
528,458
283,557
9,732
3,213
26,841
76,432
93,810
22,881
232,909
516,466
$
$
$
$
313
76
193
1
-
976
1,559
1,681
2,317
16
-
-
-
3
5
24
2,341
$
$
3,220
675
12
1
-
-
3,908
5,166
662
88
119
330
1,958
2,165
502
5,162
5,824
$
$
308,923
40,691
12,232
217
45
976
363,084
524,973
285,212
9,660
3,094
26,511
74,474
91,648
22,384
227,771
512,983
$
187,325
$
512
$
1,569
$
186,268
288,949
30,182
15,473
16,921
5,142
-
356,667
-
543,992
$
$
897
114
316
74
-
824
2,225
191
2,928
$
4,413
807
15
125
65
-
5,425
-
6,994
$
285,433
29,489
15,774
16,870
5,077
824
353,467
191
539,926
- 82 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(3.)
INVESTMENT SECURITIES (Continued)
December 31, 2016 (continued)
Securities held to maturity:
State and political subdivisions
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Total mortgage-backed securities
Total held to maturity securities
Amortized
Cost
Unrealized
Unrealized
Gains
Losses
Fair
Value
305,248
2,127
1,616
305,759
10,362
3,290
24,575
83,929
101,025
14,909
238,090
543,338
$
$
1
-
18
21
80
40
160
2,287
$
124
150
182
1,573
1,827
162
4,018
5,634
$
10,239
3,140
24,411
82,377
99,278
14,787
234,232
539,991
Investment securities with a total fair value of $838.4 million and $907.7 million at December 31, 2017 and 2016, respectively, were
pledged as collateral to secure public deposits and for other purposes required or permitted by law.
Interest and dividends on securities for the years ended December 31 are summarized as follows (in thousands):
Taxable interest and dividends
Tax-exempt interest and dividends
Total interest and dividends on securities
2017
2016
2015
$
$
17,886 $
5,869
23,755 $
17,025 $
5,892
22,917 $
16,123
5,752
21,875
Sales and calls of securities available for sale for the years ended December 31 were as follows (in thousands):
Proceeds from sales
Gross realized gains
Gross realized losses
2017
2016
2015
$
50,084 $
1,266
6
95,261 $
2,695
-
54,277
2,000
12
The scheduled maturities of securities available for sale and securities held to maturity at December 31, 2017 are shown below. Actual
expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations (in
thousands).
Debt securities available for sale:
Due in one year or less
Due from one to five years
Due after five years through ten years
Due after ten years
Debt securities held to maturity:
Due in one year or less
Due from one to five years
Due after five years through ten years
Due after ten years
- 83 -
Amortized
Cost
Fair
Value
$
$
$
$
2
123,010
294,812
110,634
528,458
57,692
159,758
103,593
195,423
516,466
$
$
$
$
2
122,228
292,544
110,199
524,973
57,757
161,514
102,507
191,205
512,983
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(3.)
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 as of December 31 are summarized 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
December 31, 2017
Securities available for sale:
U.S. Government agencies and government
sponsored enterprises
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Total mortgage-backed securities
Total available for sale securities
Securities held to maturity:
State and political subdivisions
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Total mortgage-backed securities
Total held to maturity securities
Total temporarily impaired securities
$ 95,046
201,754
20,446
2,432
-
-
224,632
319,678
36,368
3,766
-
17,327
16,830
23,727
15,401
77,051
113,419
$ 433,097
$
571
$ 31,561
$
687
$ 126,607
$
1,258
1,855
192
-
-
-
2,047
2,618
295
29
-
136
202
337
340
1,044
1,339
3,957
67,383
15,601
880
119
8
83,991
115,552
14,492
2,694
3,094
9,184
57,645
66,467
5,635
144,719
159,211
$ 274,763
$
1,365
483
12
1
-
1,861
2,548
367
59
119
194
1,756
1,828
162
4,118
4,485
7,033
269,137
36,047
3,312
119
8
308,623
435,230
50,860
6,460
3,094
26,511
3,220
675
12
1
-
3,908
5,166
662
88
119
330
74,475
90,194
21,036
221,770
272,630
$ 707,860
1,958
2,165
502
5,162
5,824
$ 10,990
$
- 84 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(3.)
INVESTMENT SECURITIES (Continued)
Less than 12 months
12 months or longer
Total
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
December 31, 2016
Securities available for sale:
U.S. Government agencies and government
sponsored enterprises
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Total mortgage-backed securities
Total available for sale securities
Securities held to maturity:
State and political subdivisions
Mortgage-backed securities:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Collateralized mortgage obligations:
Federal National Mortgage Association
Federal Home Loan Mortgage Corporation
Government National Mortgage Association
Total mortgage-backed securities
Total held to maturity securities
Total temporarily impaired securities
$ 113,261
$
1,566
$
1,458
$
3
$ 114,719
$
1,569
211,491
24,360
1,111
8,119
5,077
250,158
363,419
4,413
807
15
125
65
5,425
6,991
82,644
1,616
9,253
3,141
10,736
124
150
182
-
-
-
-
-
-
1,458
-
-
-
-
72,734
92,256
8,675
196,795
279,439
$ 642,858
1,560
1,825
161
4,002
5,618
$ 12,609
3,107
430
531
4,068
4,068
5,526
$
$
-
-
-
-
-
-
3
-
-
-
-
13
2
1
16
16
19
211,491
24,360
1,111
8,119
5,077
250,158
364,877
4,413
807
15
125
65
5,425
6,994
82,644
1,616
9,253
3,141
10,736
124
150
182
75,841
92,686
9,206
200,863
283,507
$ 648,384
1,573
1,827
162
4,018
5,634
$ 12,628
The total number of security positions in the investment portfolio in an unrealized loss position at December 31, 2017 was 411
compared to 463 at December 31, 2016. At December 31, 2017, the Company had positions in 172 investment securities with a fair
value of $274.8 million and a total unrealized loss of $7.0 million that have been in a continuous unrealized loss position for more than
12 months. At December 31, 2017, there were a total of 239 securities positions in the Company’s investment portfolio with a fair value
of $433.1 million and a total unrealized loss of $4.0 million that had been in a continuous unrealized loss position for less than 12
months. At December 31, 2016, the Company had positions in nine investment securities with a fair value of $5.5 million and a total
unrealized loss of $19 thousand that have been in a continuous unrealized loss position for more than 12 months. At December 31,
2016, there were a total of 454 securities positions in the Company’s investment portfolio with a fair value of $642.9 million and a total
unrealized loss of $12.6 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 available to
management. No impairment was recorded during the years ended December 31, 2017, 2016 and 2015.
Based on management’s review and evaluation of the Company’s debt securities as of December 31, 2017, the debt securities with
unrealized losses were not considered to be OTTI. As of December 31, 2017, the Company does not have the intent 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 December 31, 2017, 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.
- 85 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(4.) LOANS HELD FOR SALE AND LOAN SERVICING RIGHTS
Loans held for sale were entirely comprised of residential real estate loans and totaled $2.7 million and $1.1 million as of December 31,
2017 and 2016, respectively.
The Company sells certain qualifying newly originated or refinanced residential real estate loans on the secondary market. Residential
real estate loans serviced for others, which are not included in the consolidated statements of financial condition, amounted to $163.3
million and $173.7 million as of December 31, 2017 and 2016, respectively. In connection with these mortgage-servicing activities, the
Company administered escrow and other custodial funds which amounted to approximately $3.7 million and $4.0 million as of
December 31, 2017 and 2016, respectively.
The activity in capitalized loan servicing assets is summarized as follows for the years ended December 31 (in thousands):
Mortgage servicing assets, beginning of year
Originations
Amortization
Mortgage servicing assets, end of year
Valuation allowance
Mortgage servicing assets, net, end of year
(5.) LOANS
2017
2016
2015
$
$
1,077
231
(318)
990
-
990
$
$
1,225
150
(298)
1,077
(2)
1,075
$
$
1,335
166
(276)
1,225
(1)
1,224
The Company’s loan portfolio consisted of the following at December 31 (in thousands):
Principal
Amount
Outstanding
Net Deferred
Loan (Fees)
Costs
Loans, Net
2017
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total
Allowance for loan losses
Total loans, net
2016
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total
Allowance for loan losses
Total loans, net
$
449,763
810,851
457,761
113,422
845,682
17,443
$ 2,694,922
$
349,079
671,552
421,476
119,745
725,754
17,465
$ 2,305,071
$
$
$
$
563 $
(1,943)
7,522
2,887
30,888
178
40,095
450,326
808,908
465,283
116,309
876,570
17,621
2,735,017
(34,672)
$ 2,700,345
468 $
(1,494)
6,461
2,810
26,667
178
35,090
349,547
670,058
427,937
122,555
752,421
17,643
2,340,161
(30,934)
$ 2,309,227
The Company’s significant concentrations of credit risk in the loan portfolio relate to a geographic concentration in the communities
that the Company serves.
- 86 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
Certain executive officers, directors and their business interests are customers of the Company. Transactions with these parties are
based on the same terms as similar transactions with unrelated third parties and do not carry more than normal credit risk. Borrowings
by these related parties amounted to $6.6 million and $3.5 million at December 31, 2017 and 2016, respectively. During 2017, new
borrowings amounted to $5.7 million (including borrowings of executive officers and directors that were outstanding at the time of their
appointment), and repayments and other reductions were $2.6 million.
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 December 31 (in thousands):
2017
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans, gross
2016
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans, gross
30-59 Days
Past Due
60-89 Days
Past Due
Greater
Than 90
Days
Total Past
Due
Nonaccrual Current
Total Loans
$
$
$
$
64 $
56
1,908
349
2,806
174
5,357 $
1,337 $
48
1,073
216
2,320
134
5,128 $
36
375
56
-
672
15
1,154
-
-
253
-
488
15
756
$
$
$
$
-
-
-
-
-
11
11
-
-
-
-
-
9
9
$
$
$
$
100
431
1,964
349
3,478
200
6,522
1,337
48
1,326
216
2,808
158
5,893
$
$
$
$
5,344
2,623
2,252
404
1,895
2
12,520
$
444,319 $ 449,763
810,851
807,797
457,761
453,545
113,422
112,669
845,682
840,309
17,443
17,241
$ 2,675,880 $ 2,694,922
2,151
1,025
1,236
372
1,526
7
6,317
$
345,591 $ 349,079
671,552
670,479
421,476
418,914
119,745
119,157
725,754
721,420
17,465
17,300
$ 2,292,861 $ 2,305,071
There were no loans past due greater than 90 days and still accruing interest as of December 31, 2017 and 2016. There were $11
thousand and $9 thousand in consumer overdrafts which were past due greater than 90 days as of December 31, 2017 and 2016,
respectively. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not
accrue interest.
Interest income on nonaccrual loans, if recognized, is recorded using the cash basis method of accounting. There was no interest
income recognized on nonaccrual loans during the years ended December 31, 2017, 2016 and 2015. For the years ended December 31,
2017, 2016 and 2015, estimated interest income of $481 thousand, $234 thousand, and $432 thousand, respectively, would have been
recorded if all such loans had been accruing interest according to their original contractual terms.
- 87 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
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, forbearance agreements, or
substituting or adding a new borrower or guarantor.
The following presents, by loan class, information related to loans modified in a TDR during the years ended December 31 (in
thousands).
2017
Commercial business
Commercial mortgage
Total
2016
Commercial business
Commercial mortgage
Total
Pre-
Modification
Outstanding
Recorded
Investment
Post-
Modification
Outstanding
Recorded
Investment
Number of
Contracts
1
-
1
3
1
4
$
$
$
$
3,081
-
3,081
$
$
565
-
565
526
550
1,076
$
$
526
550
1,076
The loans identified as TDRs by the Company during the years ended December 31, 2017 and 2016 were previously reported as
impaired loans prior to restructuring. The modifications during the year ended December 31, 2017 primarily related to collateral
concessions. For the year ended December 31, 2016, the restructured loan modifications primarily related to collateral concessions and
forbearance. All loans restructured during the years ended December 31, 2017 and 2016 were on nonaccrual status at the end of those
respective years. 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 classification did not have a material impact on the
Company’s determination of the allowance for loan losses because the modified loans were either classified as substandard, with an
increased risk allowance allocation, or impaired and evaluated for a specific reserve both before and after restructuring.
There were no loans modified as a TDR during the years ended December 31, 2017 and 2016 that defaulted during the year ended
December 31, 2017. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower
becomes 90 days past due.
- 88 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
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 data on impaired loans at December 31 (in thousands):
2017
With no related allowance recorded:
Commercial business
Commercial mortgage
With an allowance recorded:
Commercial business
Commercial mortgage
2016
With no related allowance recorded:
Commercial business
Commercial mortgage
With an allowance recorded:
Commercial business
Commercial mortgage
_____
Recorded
Investment (1)
Unpaid
Principal
Balance (1)
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
$
$
$
$
1,635
584
2,219
3,853
2,528
6,381
8,600
645
673
1,318
1,506
352
1,858
3,176
$
$
$
$
2,370
584
2,954
3,853
2,528
6,381
9,335
1,044
882
1,926
1,506
352
1,858
3,784
$
$
$
$
$
-
-
-
2,056
115
2,171
2,171
-
-
-
694
124
818
818
$
$
$
853 $
621
1,474
4,468
1,516
5,984
7,458 $
1,032 $
725
1,757
1,141
486
1,627
3,384 $
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(1)
Difference between recorded investment and unpaid principal balance represents partial charge-offs.
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 not meeting 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.
- 89 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of
December 31 (in thousands):
2017
Uncriticized
Special mention
Substandard
Doubtful
Total
2016
Uncriticized
Special mention
Substandard
Doubtful
Total
Commercial
Business
Commercial
Mortgage
$ 429,692 $
7,120
12,951
-
$ 449,763 $
$ 326,254 $
10,377
12,448
-
$ 349,079 $
791,127
12,185
7,539
-
810,851
652,550
12,690
6,312
-
671,552
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 December 31 (in thousands):
2017
Performing
Non-performing
Total
2016
Performing
Non-performing
Total
Residential
Real Estate
Loans
Residential
Real Estate
Lines
Consumer
Indirect
Other
Consumer
$ 455,509
2,252
$ 457,761
$ 113,018
404
$ 113,422
$ 843,787 $
1,895
$ 845,682 $
17,430
13
17,443
$ 420,240
1,236
$ 421,476
$ 119,373
372
$ 119,745
$ 724,228 $
1,526
$ 725,754 $
17,449
16
17,465
- 90 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
Allowance for Loan Losses
The following tables set forth the changes in the allowance for loan losses for the years ended December 31 (in thousands):
Commercial
Business
Commercial
Mortgage
Residential
Real Estate
Loans
Residential
Real Estate
Lines
Consumer
Indirect
Other
Consumer
Total
2017
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision (credit)
Ending balance
Evaluated for impairment:
Individually
Collectively
$
$
$
$
$
7,225
(3,614)
416
11,641
15,668
$
10,315
$
(10)
262
(6,871)
3,696
$
$
1,478
(431)
130
145
1,322
$
$
$
303
(106)
60
(77)
180
$
11,311
(10,164)
4,444
7,824
13,415
$
302 $
(926)
316
699
391 $
30,934
(15,251)
5,628
13,361
34,672
2,001
13,667
$
$
107
3,589
$
$
-
1,322
$
$
-
180
$
$
-
13,415
$
$
-
$
391 $
2,108
32,564
Loans:
Ending balance
Evaluated for impairment:
Individually
Collectively
$ 449,763
$ 810,851
$ 457,761
$ 113,422
$ 845,682
$
17,443 $ 2,694,922
$
5,322
$ 444,441
$
2,852
$ 807,999
$
-
$ 457,761
$
-
$ 113,422
$
-
$ 845,682
$
$
-
$
8,174
17,443 $ 2,686,748
2016
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Evaluated for impairment:
Individually
Collectively
$
$
$
$
$
5,540
(943)
447
2,181
7,225
$
$
9,027
(385)
45
1,628
10,315
$
$
1,347
(289)
174
246
1,478
$
$
345
(104)
15
47
303
$
$
10,458
(8,748)
4,259
5,342
11,311
$
368 $
(607)
347
194
302 $
27,085
(11,076)
5,287
9,638
30,934
663
6,562
$
$
105
10,210
$
$
-
1,478
$
$
-
303
$
$
-
11,311
$
$
-
$
302 $
768
30,166
Loans:
Ending balance
Evaluated for impairment:
Individually
Collectively
$ 349,079
$ 671,552
$ 421,476
$ 119,745
$ 725,754
$
17,465 $ 2,305,071
-
$
2,987
17,465 $ 2,302,084
$
2,052
$ 347,027
$
935
$ 670,617
$
-
$ 421,476
$
-
$ 119,745
$
-
$ 725,754
$
$
- 91 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(5.) LOANS (Continued)
Commercial
Business
Commercial
Mortgage
Residential
Mortgage
Home
Equity
Consumer
Indirect
Other
Consumer
Total
2015
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Evaluated for impairment:
Individually
Collectively
$
$
$
$
$
5,621
(1,433)
212
1,140
5,540
$
$
8,122
(895)
146
1,654
9,027
$
$
1,620
(397)
114
10
1,347
$
$
435
(199)
31
78
345
$
$
11,383
(9,156)
4,200
4,031
10,458
$
456 $
(878)
322
468
368 $
27,637
(12,958)
5,025
7,381
27,085
996
4,544
$
$
10
9,017
$
$
-
1,347
$
$
-
345
$
$
-
10,458
$
$
-
$
368 $
1,006
26,079
Loans:
Ending balance
Evaluated for impairment:
Individually
Collectively
Risk Characteristics
$ 313,475
$ 567,481
$ 376,023
$ 124,766
$ 652,494
$
18,361 $ 2,052,600
$
3,922
$ 309,553
$
947
$ 566,534
$
-
$ 376,023
$
-
$ 124,766
$
-
$ 652,494
$
$
-
$
4,869
18,361 $ 2,047,731
Commercial business loans primarily consist of loans to small to mid-sized 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 potential losses on an individual customer basis. Loan repayment is often dependent on the successful
operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real
estate market could have an adverse impact on the cash flows generated by properties securing the Company’s commercial real estate
loans and on the value of such properties.
Residential real estate loans (comprised of conventional mortgages and home equity loans) and residential real estate lines (comprised
of home equity lines) are generally made on the basis of the borrower's ability to make repayment from his or her employment and other
income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is
generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.
Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities,
particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable
assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be affected by adverse personal circumstances such as job loss, illness or
personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans.
- 92 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(6.) PREMISES AND EQUIPMENT, NET
Major classes of premises and equipment at December 31 are summarized as follows (in thousands):
Land and land improvements
Buildings and leasehold improvements
Furniture, fixtures, equipment and vehicles
Premises and equipment
Accumulated depreciation and amortization
Premises and equipment, net
2017
2016
$
$
6,003
52,900
38,716
97,619
(52,430)
45,189
$
$
6,003
52,005
32,972
90,980
(48,582)
42,398
Depreciation and amortization expense relating to premises and equipment, included in occupancy and equipment expense in the
consolidated statements of income, amounted to $4.9 million, $4.6 million and $4.4 million for the years ended December 31, 2017,
2016 and 2015, respectively.
(7.) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs
or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The
Company performs its annual impairment test of goodwill as of October 1st of each year. See Note 1 for the Company’s accounting
policy for goodwill and other intangible assets.
The Company completed an evaluation of the contingent earn out liability related to its 2014 acquisition of SDN during the second
quarter of 2017, resulting in a contingent consideration liability adjustment of $1.2 million. Based on this event, a goodwill impairment
test was also performed in the second quarter of 2017. Based on its qualitative assessment, the Company concluded it was more likely
than not that the fair value of its SDN reporting unit was less than its carrying value. Accordingly, the Company performed a Step 1
review for possible goodwill impairment.
Under Step 1 of the goodwill impairment review, the fair value of the SDN reporting unit was calculated using income and market-
based approaches. Under Step 1, it was determined that the carrying value of our SDN reporting unit exceeded its fair value. Based on
this assessment, the Company recorded a goodwill impairment charge related to the SDN reporting unit of $1.6 million during the
quarter ended June 30, 2017.
The results of the Company’s 2017 annual impairment test indicated no impairment for its Banking segment or its Courier Capital
reporting unit; consequently, no goodwill impairment charge for either was recorded in 2017. In addition, the Company’s 2017 annual
impairment test indicated no additional impairment for the SDN reporting unit.
The results of the Company’s 2016 annual impairment test indicated no impairment; consequently, no goodwill impairment charge was
recorded in 2016.
Declines in the market value of the Company’s publicly traded stock price or declines in the Company’s ability to generate future cash
flows may increase the potential that goodwill recorded on the Company’s consolidated statement of financial condition be designated
as impaired and that the Company may incur a goodwill write-down in the future.
The change in the balance for goodwill during the years ended December 31 was as follows (in thousands):
Balance, January 1, 2016
Acquisition
Balance, December 31, 2016
Impairment
Acquisition
Balance, December 31, 2017
Banking
Non-Banking
Total
$
$
48,536
-
48,536
-
-
48,536
$
$
11,866
6,015
17,881
(1,575)
998
17,304
$
$
60,402
6,015
66,417
(1,575)
998
65,840
- 93 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(7.) GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
Other Intangible Assets
The Company has other intangible assets that are amortized, consisting of core deposit intangibles and other intangibles. Changes in the
gross carrying amount, accumulated amortization and net book value for the years ended December 31 were as follows (in thousands):
Core deposit intangibles:
Gross carrying amount
Accumulated amortization
Net book value
Amortization during the year
Other intangibles:
Gross carrying amount
Accumulated amortization
Net book value
Amortization during the year
2017
2016
$
$
$
$
$
$
2,042
(1,669)
373
205
$
$
$
11,378
(2,888)
8,490
965
$
$
$
2,042
(1,464)
578
251
10,568
(1,923)
8,645
998
Core deposit intangible and other intangibles amortization expense was $296 thousand and $646 thousand, respectively, for the year
ended December 31, 2015. Estimated amortization expense of other intangible assets for each of the next five years is as follows:
2018
2019
2020
2021
2022
$
1,112
1,011
909
803
725
(8.) DEPOSITS
A summary of deposits as of December 31 are as follows (in thousands):
Noninterest-bearing demand
Interest-bearing demand
Savings and money market
Time deposits, due:
Within one year
One to two years
Two to three years
Three to five years
Thereafter
Total time deposits
Total deposits
$
2017
718,498
634,203
1,005,317
$
678,352
108,653
29,994
35,157
-
852,156
$ 3,210,174
$
2016
677,076
581,436
1,034,194
471,494
158,399
23,548
49,075
-
702,516
2,995,222
Time deposits in denominations of $250,000 or more at December 31, 2017 and 2016 amounted to $154.0 million and $99.8 million,
respectively.
Interest expense by deposit type for the years ended December 31 is summarized as follows (in thousands):
Interest-bearing demand
Savings and money market
Time deposits
Total interest expense on deposits
2017
2016
2015
$
$
897
1,487
8,709
11,093
$
$
833
1,339
6,286
8,458
$
$
754
1,166
5,386
7,306
- 94 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(9.) BORROWINGS
The Company classifies borrowings as short-term or long-term in accordance with the original terms of the agreement. Outstanding
borrowings are summarized as follows as of December 31 (in thousands):
Short-term borrowings:
Short-term FHLB borrowings
Long-term borrowings:
Subordinated notes, net
Total borrowings
Short-term borrowings
2017
2016
$
446,200
$
331,500
39,131
485,331
$
39,061
370,561
$
Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings that we typically utilize to
address short term funding needs as they arise. Short-term FHLB borrowings at December 31, 2017 consisted of $304.7 million in
overnight borrowings and $141.5 million in short-term advances. Short-term FHLB borrowings at December 31, 2016 consisted of
$171.5 million in overnight borrowings and $160.0 million in short-term advances. The FHLB borrowings are collateralized by
securities from the Company’s investment portfolio and certain qualifying loans. At December 31, 2017 and 2016, the Company’s
borrowings had a weighted average rate of 1.50% and 0.76%, respectively.
Long-term borrowings
On April 15, 2015, the Company issued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the
“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 the Company 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 net proceeds from
this offering were used for general corporate purposes, including but not limited to, contribution of capital to the Bank to support both
organic growth and opportunistic acquisitions. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.
The Company adopted ASU 2015-03 that requires debt issuance costs to be reported as a direct deduction from the face value of the
Subordinated Notes and not as a deferred charge. Refer to Note 1 for additional information. The debt issuance costs will be amortized
as an adjustment to interest expense over 15 years.
(10.) DERIVATIVE INSTRUMENT AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally
manages its exposures to a wide variety of business and operational risks through management of its core business activities. The
Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and
duration of its assets and liabilities. The Company’s existing credit derivatives result from participations in interest rate swaps provided
to external lenders as part of loan participation arrangements, therefore, such derivatives are not used to manage interest rate risk in the
Company’s assets or liabilities.
Credit-risk-related Contingent Features
The Company has agreements with certain of its derivative counterparties that contain one or more of the following provisions: (a) if the
Company defaults on any of its indebtedness, including a default where repayment of the indebtedness has not been accelerated by the
lender, the Company could also be declared in default on its derivative obligations, and (b) if the Company fails to maintain its status as
a well-capitalized institution, the counterparty could terminate the derivative positions and the Company would be required to settle its
obligations under the agreements.
- 95 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(10.) DERIVATIVE INSTRUMENT AND HEDGING ACTIVITIES (Continued)
Fair Values of Derivative Instruments on the Balance Sheet
The table below presents the notional amounts, respective fair values of the Company’s derivative financial instruments, as well as their
classification on the balance sheet as of December 31 (in thousands):
Gross notional amount
2017
2016
Balance
sheet
line item
Asset derivatives
Fair value
2017
2016
Derivatives not
designated as
hedging instruments
Credit contracts
Total derivatives
$ 12,282
$ 12,282
$ -
$ -
Other
assets
$ -
$ -
$ -
$ -
Balance
sheet
line item
Other
liabilities
Liability derivatives
Fair value
2017
2016
$ 4
$ 4
$ -
$ -
Effect of Derivative Instruments on the Income Statement
The table below presents the effect of the Company’s derivative financial instruments on the income statement for the years ended
December 31 (in thousands):
Undesignated derivatives
Credit contract
Total undesignated
Line item of gain (loss)
recognized in income
Noninterest income - Other
Gain (loss) recognized in income
2017
2016
2015
$
$
131
131
$
$
-
-
$
$
-
-
(11.) COMMITMENTS AND CONTINGENCIES
Financial Instruments with Off-Balance Sheet Risk
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 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 as of December 31 consist of the following (in thousands):
Commitments to extend credit
Standby letters of credit
$
2017
661,021
12,181
$
2016
555,713
12,689
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the
agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a 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.
- 96 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(11.) COMMITMENTS AND CONTINGENCIES (Continued)
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 when the Company intends to sell the related loan, once originated, as well as
closed residential mortgage loans held for sale, the Company enters 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 $566 thousand at December 31, 2017. The Company had no forward sales commitments at December 31, 2016. 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.
Lease Obligations
The Company is obligated under a number of non-cancellable operating lease agreements for land, buildings and equipment. Certain of
these leases provide for escalation clauses and contain renewal options calling for increased rentals if the lease is renewed. Future
minimum payments by year and in the aggregate, under the non-cancellable leases with initial or remaining terms of one year or more,
are as follows at December 31, 2017 (in thousands):
2018
2019
2020
2021
2022
Thereafter
$
$
2,459
2,370
2,217
2,039
1,775
30,815
41,675
Rent expense relating to these operating leases, included in occupancy and equipment expense in the statements of income, was $2.6
million, $2.1 million and $2.0 million in 2017, 2016 and 2015, respectively.
Contingent Liabilities
In the ordinary course of business there are various threatened and pending legal proceedings against the Company. Based on
consultation with outside legal counsel, management believes that the aggregate liability, if any, arising from such litigation would not
have a material adverse effect on the Company's consolidated financial statements.
(12.) REGULATORY MATTERS
General
The supervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of
depositors, the deposit insurance funds regulated by the FDIC and the banking system as a whole, and not for the protection of
shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over
financial holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for
violations of laws and regulations and for safety and soundness considerations.
Capital
Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking
agencies. 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.
The Basel III Capital Rules, a new comprehensive capital framework for U.S. banking organizations, became effective for the Company
and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Quantitative measures established by the Basel III
Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table that follows) of
Common Equity Tier 1 capital (“CET1”), Tier 1 capital and Total capital (as defined in the regulations) to risk-weighted assets (as
defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).
- 97 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(12.) REGULATORY MATTERS (Continued)
The Company’s and the Bank’s Common Equity Tier 1 capital includes common stock and related paid-in capital, net of treasury stock,
and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to
include most components of accumulated other comprehensive income in Common Equity Tier 1. Common Equity Tier 1 for both the
Company and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities, and subject to
transition provisions.
Tier 1 capital includes Common Equity Tier 1 capital and additional Tier 1 capital. For the Company, additional Tier 1 capital at
December 31, 2017 includes, subject to limitation, $17.3 million of preferred stock.
Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital for both the Company and the Bank includes a permissible portion
of the allowance for loan losses. Tier 2 capital for the Company also includes qualified subordinated debt. At December 31, 2017, the
Company's Tier 2 capital included $39.1 million of Subordinated Notes.
The Common Equity Tier 1, Tier 1 and Total capital ratios are calculated by dividing the respective capital amounts by risk-weighted
assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, with certain exclusions, allocated
by risk weight category, and certain off-balance-sheet items, among other things. The leverage ratio is calculated by dividing Tier 1
capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things.
When fully phased in on January 1, 2019, the Basel III Capital Rules will require the Company and the Bank to maintain (i) a minimum
ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is
added to the 4.5% Common Equity Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common
Equity Tier 1 capital to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-
weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is
phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total
capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the
8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full
implementation) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets.
The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-
year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). 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. The capital conservation buffer is designed to absorb losses during periods of
economic stress and, as detailed above, effectively increases the minimum required risk-weighted capital ratios. Banking institutions
with a ratio of Common Equity Tier 1 capital to risk-weighted assets below the effective minimum (4.5% plus the capital conservation
buffer and, if applicable, the countercyclical capital buffer) will face constraints on dividends, equity repurchases and compensation
based on the amount of the shortfall.
- 98 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(12.) REGULATORY MATTERS (Continued)
The following table presents actual and required capital ratios as of December 31, 2017 and 2016 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
December 31, 2017 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):
Actual
Amount
Ratio
Minimum Capital
Required – Basel III
Phase-in Schedule
Ratio
Amount
Minimum Capital
Required – Basel III
Fully Phased-in
Required to be
Considered Well
Capitalized
Amount
Ratio
Amount
Ratio
2017
Tier 1 leverage:
Company
Bank
CET1 capital:
Company
Bank
Tier 1 capital:
Company
Bank
Total capital:
Company
Bank
2016
Tier 1 leverage:
Company
Bank
CET1 capital:
Company
Bank
Tier 1 capital:
Company
Bank
Total capital:
Company
Bank
$ 322,680 8.13 %
346,532 8.75
$ 158,710
4.00 %
158,372 4.00
$ 158,710
158,372
4.00 %
4.00
$
198,387
197,965
5.00 %
5.00
305,351 10.16
346,532 11.57
172,825 5.75
172,224 5.75
210,396
209,664
7.00
7.00
322,680 10.74
346,532 11.57
217,910 7.25
217,152 7.25
255,481
254,592
8.50
8.50
195,368
194,688
240,452
239,616
6.50
6.50
8.00
8.00
396,483 13.19
381,204 12.73
278,023 9.25
277,056 9.25
315,594 10.50
314,496 10.50
300,565 10.00
299,520 10.00
$ 265,246 7.36 %
284,765 7.92
$ 144,095 4.00 %
143,862 4.00
$ 144,095
143,862
4.00 %
4.00
$
180,119
179,828
5.00 %
5.00
247,906 9.59
284,765 11.06
132,438 5.13
132,014 5.13
180,891
180,312
7.00
7.00
265,246 10.26
284,765 11.06
171,201 6.63
170,652 6.63
219,654
218,950
8.50
8.50
167,970
167,432
206,733
206,070
6.50
6.50
8.00
8.00
335,241 12.97
315,699 12.26
222,884 8.63
222,170 8.63
271,337 10.50
270,467 10.50
258,416 10.00
257,588 10.00
As of December 31, 2017, the Company and Bank were considered “well capitalized” under all regulatory capital guidelines. Such
determination has been made based on the Tier 1 leverage, CET1capital, Tier 1 capital and total capital ratios.
Federal Reserve Requirements
The Bank is required to maintain a reserve balance at the FRB of New York. As of December 31, 2017, the Bank was not required to
maintain a reserve balance at the FRB of New York. The reserve requirement for the Bank totaled $629 thousand as of December 31,
2016.
Dividend Restrictions
In the ordinary course of business, the Company is 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.
- 99 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(13.) SHAREHOLDERS’ EQUITY
The Company’s authorized capital stock consists of 50,210,000 shares of capital stock, 50,000,000 of which are common stock, par
value $0.01 per share, and 210,000 of which are preferred stock, par value $100 per share, which is designated into two classes, Class A
of which 10,000 shares are authorized, and Class B of which 200,000 shares are authorized. There are two series of Class A preferred
stock: Series A 3% preferred stock and the Series A preferred stock. There is one series of Class B preferred stock: Series B-1 8.48%
preferred stock. There were 173,286 and 173,398 shares of preferred stock issued and outstanding as of December 31, 2017 and 2016,
respectively.
Common Stock
The following table sets forth the changes in the number of shares of common stock for the years ended December 31:
Outstanding Treasury
Issued
2017
Shares outstanding at beginning of year
Common stock issued for “at-the-market” equity offering
Restricted stock awards issued
Restricted stock awards forfeited
Stock options exercised
Stock awards
Treasury stock purchases
Shares outstanding at end of year
2016
Shares outstanding at beginning of year
Common stock issued for Courier Capital acquisition
Restricted stock awards issued
Restricted stock awards forfeited
Stock options exercised
Stock awards
Shares outstanding at end of year
14,537,597
1,363,964
8,898
(10,359)
21,320
7,841
(4,323)
15,924,938
14,190,192
294,705
8,800
(10,183)
49,761
4,322
14,537,597
154,617
-
(8,898)
10,359
(21,320)
(7,841)
4,323
131,240
14,692,214
1,363,964
-
-
-
-
-
16,056,178
207,317
-
(8,800)
10,183
(49,761)
(4,322)
154,617
14,397,509
294,705
-
-
-
-
14,692,214
On May 30, 2017, the Company entered into a sales agency agreement, with Sandler O’Neill + Partners, L.P. as sales agent, under
which it could sell up to $40.0 million of its common stock through an “at-the-market” equity offering program. The program was
completed in November 2017. The Company sold 1,363,964 shares of its common stock under the program at a weighted average price
of $29.33, representing gross proceeds of approximately $40.0 million. Net proceeds received were approximately $38.3 million. The
Company used the net proceeds of this offering to support organic growth and other general corporate purposes, including contributing
capital to the Bank.
Preferred Stock
Series A 3% Preferred Stock. There were 1,439 and 1,492 shares of Series A 3% preferred stock issued and outstanding as of
December 31, 2017 and 2016, respectively. Holders of Series A 3% preferred stock are entitled to receive an annual dividend of $3.00
per share, which is cumulative and payable quarterly. Holders of Series A 3% preferred stock have no pre-emptive right in, or right to
purchase or subscribe for, any additional shares of the Company’s capital stock and have no voting rights. Dividend or dissolution
payments to the Class A shareholders must be declared and paid, or set apart for payment, before any dividends or dissolution payments
can be declared and paid, or set apart for payment, to the holders of Class B preferred stock or common stock. The Series A 3%
preferred stock is not convertible into any other of the Company’s securities.
- 100 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(13.) SHAREHOLDERS’ EQUITY (Continued)
Series B-1 8.48% Preferred Stock. There were 171,847 and 171,906 shares of Series B-1 8.48% preferred stock issued and outstanding
as of December 31, 2017 and 2016, respectively. Holders of Series B-1 8.48% preferred stock are entitled to receive an annual dividend
of $8.48 per share, which is cumulative and payable quarterly. Holders of Series B-1 8.48% preferred stock have no pre-emptive right
in, or right to purchase or subscribe for, any additional shares of the Company’s common stock and have no voting rights. Accumulated
dividends on the Series B-1 8.48% preferred stock do not bear interest, and the Series B-1 8.48% preferred stock is not subject to
redemption. Dividend or dissolution payments to the Class B shareholders must be declared and paid, or set apart for payment, before
any dividends or dissolution payments are declared and paid, or set apart for payment, to the holders of common stock. The Series B-1
8.48% preferred stock is not convertible into any other of the Company’s securities.
(14.) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the components of other comprehensive income (loss) for the years ended December 31 (in thousands):
2017
Securities available for sale and transferred securities:
Change in unrealized gain/loss during the period
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Pension and post-retirement obligations:
Net actuarial gains (losses) arising during the year
Amortization of net actuarial loss and prior service cost included in income
Total pension and post-retirement obligations
Other comprehensive income
2016
Securities available for sale and transferred securities:
Change in unrealized gain/loss during the period
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Pension and post-retirement obligations:
Net actuarial gains (losses) arising during the year
Amortization of net actuarial loss and prior service cost included in income
Total pension and post-retirement obligations
Other comprehensive loss
2015
Securities available for sale and transferred securities:
Change in unrealized gain/loss during the period
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Pension and post-retirement obligations:
Net actuarial gains (losses) arising during the year
Amortization of net actuarial loss and prior service cost included in income
Total pension and post-retirement obligations
Other comprehensive loss
_____
Pre-tax
Amount
Tax Effect
Net-of-tax
Amount
$
$
$
$
$
$
$
1,841
(1,103)
738
1,460
1,115
2,575
3,313
$
$
710
(426)
284
563
431
994
1,278
$
(2,146)
(2,793)
(4,939)
(241)
907
666
(4,273)
$
(828) $
(1,078)
(1,906)
(93)
350
257
$
(1,649) $
1,131
(677)
454
897
684
1,581
2,035
(1,318)
(1,715)
(3,033)
(148)
557
409
(2,624)
(1,529)
(2,251)
(3,780)
(887)
895
8
(3,772)
$
$
(591) $
(868)
(1,459)
(342)
345
3
(1,456) $
(938)
(1,383)
(2,321)
(545)
550
5
(2,316)
(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.
- 101 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(14.) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)
Activity in accumulated other comprehensive income (loss), net of tax, was as follows (in thousands):
Securities
Available for
Sale and
Transferred
Securities
Pension and
Post-
retirement
Obligations
Balance at January 1, 2017
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income (loss)
Net current period other comprehensive income
Balance at December 31, 2017
Balance at January 1, 2016
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income (loss)
Net current period other comprehensive (loss) income
Balance at December 31, 2016
Balance at January 1, 2015
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income (loss)
Net current period other comprehensive (loss) income
Balance at December 31, 2015
$
$
$
$
$
$
(3,729) $
1,131
(677)
454
(3,275) $
(696) $
(1,318)
(1,715)
(3,033)
(3,729) $
$
1,625
(938)
(1,383)
(2,321)
(696) $
Accumulated
Other
Comprehensive
Income (Loss)
(13,951)
2,028
7
2,035
(11,916)
(10,222) $
897
684
1,581
(8,641) $
(10,631) $
(148)
557
409
(10,222) $
(10,636) $
(545)
550
5
(10,631) $
(11,327)
(1,466)
(1,158)
(2,624)
(13,951)
(9,011)
(1,483)
(833)
(2,316)
(11,327)
The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (loss) for the
years ended December 31 (in thousands):
Amount Reclassified from
Accumulated Other
Comprehensive Income
2017
2016
Affected Line Item in the
Consolidated Statement of Income
$
1,260
$
2,695
Net gain on disposal of investment securities
Details About Accumulated Other
Comprehensive Income Components
Realized gain on sale of investment securities
Amortization of unrealized holding gains (losses)
on investment securities transferred from
available for sale to held to maturity
Amortization of pension and post-retirement items:
Prior service credit (1)
Net actuarial losses (1)
(157)
1,103
(426)
677
51
(1,166)
(1,115)
431
(684)
Interest income
Total before tax
98
2,793
(1,078) Income tax expense
Net of tax
1,715
48
Salaries and employee benefits
(955) Salaries and employee benefits
(907) Total before tax
350
(557) Net of tax
1,158
Income tax benefit
Total reclassified for the period
_____
$
(7) $
(1) These items are included in the computation of net periodic pension expense. See Note 18 – Employee Benefit Plans for additional
information.
- 102 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(15.) SHARE-BASED COMPENSATION
The Company maintains certain stock-based compensation plans, approved by the Company’s shareholders that are administered by the
Management Development and Compensation Committee (the “Compensation Committee”) of the Board. In May 2015, the
Company’s shareholders approved the 2015 Long-Term Incentive Plan (the “2015 Plan”) to replace the 2009 Management Stock
Incentive Plan and the 2009 Directors’ Stock Incentive Plan (collectively, the “2009 Plans”). A total of 438,076 shares transferred from
the 2009 Plans were available for grant pursuant to the 2015 Plan as of May 6, 2015, the date of approval of the 2015 Plan. In addition,
any shares subject to outstanding awards under the 2009 Plans that are canceled, expired, forfeited or otherwise not issued or are settled
in cash on or after May 6, 2015, will become available for future award grants under the 2015 Plan. As of December 31, 2017, there
were approximately 313,000 shares available for grant under the 2015 Plan.
Under the Plan, the Compensation Committee may establish and prescribe grant guidelines including various terms and conditions for
the granting of stock-based compensation. For stock options, the exercise price of each option equals the market price of the
Company’s stock on the date of the grant. All options expire after a period of ten years from the date of grant and generally become
fully exercisable over a period of 3 to 5 years from the grant date. When an option recipient exercises their options, the Company issues
shares from treasury stock and records the proceeds as additions to capital. Shares of restricted stock granted to employees generally
vest over 2 to 3 years from the grant date. Fifty percent of the shares of restricted stock granted to non-employee directors generally
vests on the date of grant and the remaining fifty percent generally vests one year from the grant date. Vesting of the shares may be
based on years of service, established performance measures or both. If restricted stock grants are forfeited before they vest, the shares
are reacquired into treasury stock.
The share-based compensation plans were established to allow for the granting of compensation awards to attract, motivate and retain
employees, executive officers and non-employee directors who contribute to the long-term growth 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 Company awarded grants of 12,531 shares of restricted stock units to certain members of management during the year ended
December 31, 2017. The shares will be earned based on the Company’s achievement of a relative total shareholder return (“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, 2019. The shares earned based on the achievement of the TSR performance requirements, if any, will vest
on February 22, 2020 assuming the recipient’s continuous service to the Company.
The grant-date fair value of the TSR performance award granted during the year ended December 31, 2017 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
1.45%, (iii) expected dividend yield of 2.41% and (iv) expected stock price volatility over the expected term of the TSR performance
award of 21.9%. The grant-date fair value of all other restricted stock awards is equal to the closing market price of the Company’s
common stock on the date of grant.
The Company granted 27,831 additional shares of restricted stock units to management during the year ended December 31, 2017.
These shares will vest after completion of a three-year service requirement. The average market price of the restricted stock units on the
date of grant was $31.88.
During the year ended December 31, 2017, the Company granted a total of 8,898 restricted shares of common stock to non-employee
directors, of which 4,454 shares vested immediately and 4,444 shares will vest after completion of a one-year service requirement. The
weighted average market price of the restricted stock on the date of grant was $29.47. In addition, the Company issued a total of 7,841
shares of common stock in-lieu of cash for the annual retainer of six non-employee directors during the year ended December 31, 2017.
The weighted average market price of the stock on the date of grant was $30.88.
The restricted stock awards granted to the directors and the restricted stock units granted to management in 2017 do not have rights to
dividends or dividend equivalents.
- 103 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(15.) SHARE-BASED COMPENSATION (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 2017, 2016 or 2015. There was no unrecognized compensation expense related to unvested stock options as of
December 31, 2017. The following is a summary of stock option activity for the year ended December 31, 2017 (dollars in thousands,
except per share amounts):
Outstanding at beginning of year
Granted
Exercised
Forfeited
Expired
Outstanding and exercisable at end of period
Weighted
Average
Exercise
Price
Number of
Options
$
49,099
-
(21,320)
-
(5,580)
22,199
$
19.00
-
19.45
-
19.64
18.40
Weighted
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
0.4 years
$
282
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 years ended December 31, 2017, 2016 and 2015 was $297 thousand, $450
thousand, and $106 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for
the years ended December 31, 2017, 2016 and 2015 was $413 thousand, $964 thousand, and $359 thousand, respectively. The tax
benefits realized in connection with these stock option exercises were not significant.
The following is a summary of restricted stock award and restricted stock units activity for the year ended December 31, 2017:
Outstanding at beginning of year
Granted
Vested
Forfeited
Outstanding at end of period
Number of
Shares
Weighted
Average
Market
Price at
Grant Date
$
114,565
52,627
(25,247)
(11,359)
130,586 $
19.90
31.26
23.90
12.81
24.32
As of December 31, 2017, there was $1.5 million of unrecognized compensation expense related to unvested restricted stock awards and
restricted stock units that is expected to be recognized over a weighted average period of 1.8 years.
The Company amortizes the expense related to restricted stock awards and restricted stock units 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 for the years ended December 31 was as follows (in thousands):
Salaries and employee benefits
Other noninterest expense
Total share-based compensation expense
2017
2016
2015
$
$
927
247
1,174
$
$
601
244
845
$
$
431
243
674
- 104 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(16.) INCOME TAXES
The income tax expense for the years ended December 31 consisted of the following (in thousands):
Current tax expense (benefit):
Federal
State
Total current tax expense
Deferred tax expense (benefit):
Federal
State
Total deferred tax expense (benefit)
Total income tax expense
2017
2016
2015
$
$
$
(3,031)
573
(2,458)
12,297
106
12,403
9,945
$
13,846
82
13,928
(2,175)
457
(1,718)
12,210
$
$
8,720
21
8,741
1,440
358
1,798
10,539
Income tax expense differed from the statutory federal income tax rate for the years ended December 31 as follows:
Statutory federal tax rate
Increase (decrease) resulting from:
Tax exempt interest income
Tax credits and adjustments
Non-taxable earnings on company owned life insurance
State taxes, net of federal tax benefit
Nondeductible expenses
Goodwill and contingent consideration adjustments
Other, net
Effective tax rate
2017
2016
2015
35.0%
(5.6)
(6.7)
(1.4)
1.1
0.3
0.3
(0.1)
22.9%
35.0%
(5.6)
0.3
(2.2)
0.8
0.2
(0.9)
0.1
27.7%
35.0%
(6.1)
(0.7)
(1.8)
0.7
0.3
(0.3)
-
27.1%
Total income tax expense (benefit) was as follows for the years ended December 31 (in thousands):
Income tax expense
Shareholder’s equity
2017
2016
2015
$
$
9,945
3,909
12,210
(1,649)
$
10,539
(1,456)
The Company recognizes deferred income taxes for the estimated future tax effects of differences between the tax and financial
statement bases of assets and liabilities considering enacted tax laws. These differences result in deferred tax assets and liabilities,
which are included in other assets in the Company’s consolidated statements of condition. The Company also assesses the likelihood
that deferred tax assets will be realizable based on, among other considerations, future taxable income and establishes, if necessary, a
valuation allowance for those deferred tax assets determined to not likely be realizable. A deferred tax asset valuation allowance is
recognized if, based on the weight of available evidence (both positive and negative), it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The future realization of deferred tax benefits depends upon the existence of sufficient
taxable income within the carry-back and carry-forward periods. Management’s judgment is required in determining the appropriate
recognition of deferred tax assets and liabilities, including projections of future taxable income.
- 105 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(16.) INCOME TAXES (Continued)
The Company’s net deferred tax asset (liability) is included in other assets in the consolidated statements of condition. The tax effects
of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are as follows at December 31 (in
thousands):
Deferred tax assets:
Allowance for loan losses
Deferred compensation
Investment in limited partnerships
SERP agreements
Interest on nonaccrual loans
Share-based compensation
Net unrealized loss on securities available for sale
Other
Gross deferred tax assets
Deferred tax liabilities:
REIT dividend
Prepaid expenses
Prepaid pension costs
Intangible assets
Depreciation and amortization
Loan servicing assets
Other
Gross deferred tax liabilities
Net deferred tax asset (liability)
2017
2016
8,741
748
599
320
305
464
1,334
66
12,577
9,412
720
3,255
2,594
2,023
250
102
18,356
(5,779)
$
$
11,938
1,357
943
682
453
604
2,326
120
18,423
-
-
4,727
4,059
1,085
415
234
10,520
7,903
$
$
In March 2014, the New York legislature approved changes in the state tax law that was phased-in over two years, beginning in 2015.
The primary changes that impacted the Company included the repeal of the Article 32 franchise tax on banking corporations (“Article
32A”) for 2015, expanded nexus standards for 2015 and a reduction in the corporate tax rate for 2016. The repeal of Article 32A and
the expanded nexus standards lowered our taxable income apportioned to New York in 2016 and 2015 compared to 2014. In addition,
the New York state income tax rate was reduced from 7.1% to 6.5% in 2016.
On December 22, 2017, the TCJ Act was signed into law which, among other items, reduces the federal statutory corporate tax rate from
35 percent to 21 percent, effective January 1, 2018. The TCJ Act also contains other provisions that may affect the Company currently
or in future years. Among these are changes to the deductibility of meals and entertainment, the deductibility of executive
compensation, accelerated expensing of depreciable property for assets placed into service after September 27, 2017 and before 2023,
limits the deductibility of net interest expenses, eliminates the corporate alternative minimum tax, limits net operating loss carrybacks
and carryforwards to 80% of taxable income and other provisions.
Results for the fourth quarter and full year of 2017 were positively impacted by a $2.9 million reduction in income tax expense due to
the TCJ Act, primarily driven by a revaluation adjustment to the net deferred tax liability.
Based upon the Company’s historical and projected future levels of pre-tax and taxable income, the scheduled reversals of taxable
temporary differences to offset future deductible amounts, and prudent and feasible tax planning strategies, management believes it is
more likely than not that the deferred tax assets will be realized. As such, no valuation allowance has been recorded as of December 31,
2017 or 2016.
The Company and its subsidiaries are primarily subject to federal and New York income taxes. The federal income tax years currently
open for audits are 2013 through 2017. The New York income tax years currently open for audits are 2013 through 2017.
At December 31, 2017, the Company had no federal or New York net operating loss or tax credits carryforwards.
- 106 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(16.) INCOME TAXES (Continued)
The Company’s unrecognized tax benefits and changes in unrecognized tax benefits were not significant as of or for the years ended
December 31, 2017, 2016 and 2015. There were no material interest or penalties recorded in the income statement in income tax
expense for the years ended December 31, 2017, 2016 and 2015. As of December 31, 2017 and 2016, there were no amounts accrued
for interest or penalties related to uncertain tax positions.
(17.) EARNINGS PER COMMON SHARE
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS for each of the years
ended December 31 (in thousands, except per share amounts). All outstanding unvested share-based payment awards that contain rights
to non-forfeitable dividends are considered participating securities.
Net income available to common shareholders
Weighted average common shares outstanding:
Total shares issued
Unvested restricted stock awards
Treasury shares
Total basic weighted average common shares outstanding
Incremental shares from assumed:
Exercise of stock options
Vesting of restricted stock awards
Total diluted weighted average common shares outstanding
2017
2016
2015
$
32,064
$
30,469
$
26,875
15,235
(47)
(144)
15,044
9
32
15,085
14,689
(75)
(178)
14,436
20
35
14,491
14,398
(93)
(224)
14,081
24
30
14,135
Basic earnings per common share
Diluted earnings per common share
$
$
2.13
2.13
$
$
2.11
2.10
$
$
1.91
1.90
For each of the periods presented, average shares subject to the following instruments were excluded from the computation of diluted
EPS because the effect would be antidilutive:
Stock options
Restricted stock awards
Total
-
1
1
-
2
2
-
1
1
There were no participating securities outstanding for the years ended December 2017, 2016 and 2015; therefore, the two-class method
of calculating basic and diluted EPS was not applicable for the years presented.
(18.) EMPLOYEE BENEFIT PLANS
Defined Contribution Plan
Employees that meet specified eligibility conditions are eligible to participate in the Company sponsored 401(k) plan. Under the plan,
participants may make contributions, in the form of salary deferrals, up to the maximum Internal Revenue Code limit. Until December
31, 2015, the Company matched a participant’s contributions up to 4.5% of compensation, calculated at 100% of the first 3% of
compensation and 50% of the next 3% of compensation deferred by the participant. The Company is also permitted to make additional
discretionary matching contributions, although no such additional discretionary contributions were made in 2017, 2016 or 2015. The
expense included in salaries and employee benefits in the consolidated statements of income for this plan amounted to $1.3 million in
2015. Effective January 1, 2016, the 401(k) Plan was amended to discontinue the Company’s matching contribution.
- 107 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
Defined Benefit Pension Plan
The Company participates in The New York State Bankers Retirement System (the “Plan”), a defined benefit pension plan covering
substantially all employees. For employees hired prior to December 31, 2006, who met participation requirements on or before January
1, 2008 (“Tier 1 Participant”), the benefits are generally based on years of service and the employee's highest average compensation
during five consecutive years of employment.
Effective January 1, 2016, the Plan was amended to open the Plan to eligible employees who were hired on and after January 1, 2007
(“Tier 2 Participant”), and provide these eligible participants with a cash balance benefit formula.
The following table provides a reconciliation of the Company’s changes in the Plan’s benefit obligations, fair value of assets and a
statement of the funded status as of and for the year ended December 31 (in thousands):
Change in projected benefit obligation:
Projected benefit obligation at beginning of period
Service cost
Interest cost
Actuarial (gain) loss
Benefits paid and plan expenses
Projected benefit obligation at end of period
Change in plan assets:
Fair value of plan assets at beginning of period
Actual return on plan assets
Employer contributions
Benefits paid and plan expenses
Fair value of plan assets at end of period
Funded status at end of period
2017
2016
63,002
3,140
2,449
5,016
(3,171)
70,436
75,252
11,267
-
(3,171)
83,348
12,912
$
$
59,232
2,885
2,402
1,210
(2,727)
63,002
72,358
5,621
-
(2,727)
75,252
12,250
$
$
The accumulated benefit obligation was $65.2 million and $58.0 million at December 31, 2017 and 2016, respectively.
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 Internal Revenue Code. The Company has no minimum required
contribution for the 2018 fiscal year.
Estimated benefit payments under the Plan over the next ten years at December 31, 2017 are as follows (in thousands):
2018
2019
2020
2021
2022
2023 - 2027
$
2,846
2,885
3,109
3,311
3,528
20,500
Net periodic pension cost consists of the following components for the years ended December 31 (in thousands):
Service cost
Interest cost on projected benefit obligation
Expected return on plan assets
Amortization of unrecognized loss
Amortization of unrecognized prior service cost
Net periodic pension cost
2017
2016
2015
$
$
3,140
2,449
(4,775)
1,142
17
1,973
$
$
2,885
2,402
(4,600)
938
20
1,645
$
$
2,324
2,328
(4,820)
926
20
778
- 108 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
The actuarial assumptions used to determine the net periodic pension cost were as follows:
Weighted average discount rate
Rate of compensation increase
Expected long-term rate of return
2017
4.00%
3.00%
6.50%
The actuarial assumptions used to determine the projected benefit obligation were as follows:
Weighted average discount rate
Rate of compensation increase
2017
3.49%
3.00%
2016
4.21%
3.00%
6.50%
2016
4.00%
3.00%
2015
3.86%
3.00%
6.50%
2015
4.21%
3.00%
The weighted average discount rate was based upon the projected benefit cash flows and the market yields of high grade corporate
bonds that are available to pay such cash flows.
The weighted average expected long‐term rate of return is estimated based on current trends in the Plan’s assets as well as projected
future rates of return on those assets and reasonable actuarial assumptions based on the guidance provided by Actuarial Standard of
Practice No. 27, “Selection of Economic Assumptions for Measuring Pension Obligations” for long term inflation, and the real and
nominal rate of investment return for a specific mix of asset classes. The following assumptions were used in determining the long‐term
rate of return:
Equity securities
Fixed income securities
Other financial instruments
Dividend discount model, the smoothed earnings yield model and the equity risk premium
model
Current yield‐to‐maturity and forecasts of future yields
Comparison of the specific investment’s risk to that of fixed income and equity instruments
and using judgment
The long term rate of return considers historical returns. Adjustments were made to historical returns in order to reflect expectations of
future returns. These adjustments were due to factor forecasts by economists and long‐term U.S. Treasury yields to forecast long‐term
inflation. In addition, forecasts by economists and others for long‐term GDP growth were factored into the development of assumptions
for earnings growth and per capita income.
The Plan's overall investment strategy is to achieve a mix of approximately 97% of investments for long-term growth and 3% for near-
term benefit payments with a wide diversification of asset types, fund strategies, and fund managers. The target allocations for Plan
assets are shown in the table below. Cash equivalents consist primarily of government issues (maturing in less than three months) and
short term investment funds. Equity securities primarily include investments in common stock, depository receipts, preferred stock,
commingled pension trust funds, exchange traded funds and real estate investment trusts. Fixed income securities include corporate
bonds, government issues, credit card receivables, mortgage backed securities, municipals, commingled pension trust funds and other
asset backed securities. Other investments are real estate interests and related investments held within a commingled pension trust fund.
- 109 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
The Plan currently prohibits its investment managers from purchasing any security greater than 5% of the portfolio at the time of
purchase or greater than 8% at market value in any one issuer. Effective June 2013, the issuer of any security purchased must be located
in a country in the Morgan Stanley Capital International World Index. In addition, the following are prohibited:
Equity securities
Short sales
Unregistered stocks
Margin purchases
Fixed income securities
Mortgage backed derivatives that have an inverse floating rate coupon or that are interest only
securities
Any ABS that is not issued by the U.S. Government or its agencies or its instrumentalities
Generally, securities of less than Baa2/BBB quality may not be purchased
Securities of less than A-quality may not in the aggregate exceed 13% of the investment
manager's portfolio.
An investment manager’s portfolio of commercial MBS and ABS shall not exceed 10% of the
portfolio at the time of purchase.
Other financial instruments Unhedged currency exposure in countries not defined as “high income economies” by the
World Bank
All other investments not prohibited by the Plan are permitted. At December 31, 2017 and 2016, the Plan held certain investments
which are no longer deemed acceptable to acquire. The Plan continues to allow managers to maintain currently prohibited positions
which were not prohibited at the time of purchase. These positions will be liquidated when the investment managers deem that such
liquidation is in the best interest of the Plan.
The target allocation range below is both historic and prospective in that it has not changed since prior to 2013. It is the asset allocation
range that the investment managers have been advised to adhere to and within which they may make tactical asset allocation decisions.
Asset category:
Cash equivalents
Equity securities
Fixed income securities
Other financial instruments
2017
Target
Allocation
0 – 20%
40 – 60
40 – 60
0 – 5
Percentage of Plan Assets
at December 31,
2017
2016
Weighted
Average
Expected
Long-term
Rate of Return
6.4%
6.1%
50.2
40.2
3.2
47.9
42.6
3.4
0.18%
4.02
2.06
0.24
Assets are segregated by the level of the valuation inputs within the fair value hierarchy established by ASC Topic 820 utilized to
measure fair value (see Note 19 - Fair Value Measurements).
In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value
measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety.
Investments valued using the NAV (Net Asset Value) are classified as level 2 if the Plan can redeem its investment with the investee at
the NAV at the measurement date. If the Plan can never redeem the investment with the investee at the NAV, it is considered a level 3.
If the Plan can redeem the investment at the NAV at a future date, the Plan's assessment of the significance of a particular item to the
fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset.
- 110 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
The Plan uses the Thomson Reuters Pricing Service to determine the fair value of equities excluding commingled pension trust funds,
the pricing service of IDC Corporate USA to determine the fair value of fixed income securities excluding commingled pension trust
funds and JP Morgan Chase Bank, N.A. (“JPMorgan”) and Northern Trust (“NT”) to determine the fair value of commingled pension
trust funds.
The following is a table of the pricing methodology and unobservable inputs used by JPMorgan and NT in pricing commingled pension
trust funds (“CPTF”):
Principal Valuation
Technique(s) Used
Unobservable Inputs
CPTF - Fixed Income:
CPTF (Corporate High Yield) of
JPMorgan
CPTF (High Yield) of JPMorgan
CPTF (Long Duration Investment
Grade) of JPMorgan
CPTF (Emerging Markets Strategic
Debt) of JPMorgan (formerly known as
JPMorgan Emerging Markets Local
Currency Debt)
CPTF (Emerging Markets - Fixed
Income) of JPMorgan
NT Collective Aggregate Bond Index
Fund - Lending
Market, Comparable Securities
EBITDA Multiple
Market
Market, NAV, Comparable Securities,
None
None
Discounted Cash Flow
Market, Comparable Securities
None
Market, Comparable Securities
None
NAV
None
CPTF – Other:
CPTF (Strategic Property) of JPMorgan Market, Income Approach, Debt
Service and Sales Comparison
Credit Spreads, Discount Rate, Loan to
Value Ratio, Terminal Capitalization
Rate and Value per Square Foot
When valuing Commingled Pension Trust Funds (Equity) JPMorgan uses a market methodology and does not rely on unobservable
inputs in those valuations.
The following table sets forth a summary of the changes in the Plan’s level 3 assets for the years ended December 31, 2017 and 2016:
Level 3 assets, January 1, 2016
Realized Gain
Sales
Unrealized gains
Level 3 assets, December 31, 2016
Realized Gain
Purchases
Sales
Unrealized gains
Level 3 assets, December 31, 2017
$
$
2,670
52
(381)
296
2,637
43
103
(224)
82
2,641
- 111 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
The major categories of Plan assets measured at fair value on a recurring basis as of December 31 are presented in the following tables
(in thousands).
2017
Cash equivalents:
Cash (including foreign currencies)
Short term investment funds
Total cash equivalents
Equity securities:
Common stock
Depository receipts
Commingled pension trust funds
Preferred stock
Total equity securities
Fixed income securities:
Collateralized mortgage obligations
Commingled pension trust funds
Corporate bonds
FNMA
Government securities
Mortgage backed securities
Total fixed income securities
Other investments:
Commingled pension trust funds - Realty
Total Plan investments
Level 1
Inputs
Level 2
Inputs
Level 3
Inputs
Total
Fair Value
$
726 $
-
726
14,523
368
-
320
15,211
-
-
-
-
-
-
-
$
-
4,635
4,635
-
-
26,613
-
26,613
585
19,524
3,068
167
10,117
61
33,522
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
726
4,635
5,361
14,523
368
26,613
320
41,824
585
19,524
3,068
167
10,117
61
33,522
-
15,937 $
-
64,770
$
2,641
2,641 $
2,641
83,348
$
At December 31, 2017, the portfolio was managed by two investment firms, with control of the portfolio split approximately 59% and
37% under the control of the investment managers with the remaining 4% under the direct control of the Plan. A portfolio concentration
in two of the commingled pension trust funds and a short term investment fund of 15%, 6% and 6%, respectively, existed at December
31, 2017.
- 112 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
2016
Cash equivalents:
Foreign currencies
Short term investment funds
Total cash equivalents
Equity securities:
Common stock
Depository receipts
Commingled pension trust funds
Total equity securities
Fixed income securities:
Collateralized mortgage obligations
Commingled pension trust funds
Corporate bonds
FNMA
Government securities
Mortgage backed securities
Total fixed income securities
Other Investments:
Commingled pension trust funds - Realty
Total Plan investments
Level 1
Inputs
Level 2
Inputs
Level 3
Inputs
Total
Fair Value
$
99 $
-
99
13,326
391
-
13,717
-
-
-
-
-
-
-
$
-
4,454
4,454
-
-
22,302
22,302
633
18,151
2,862
579
9,783
35
32,043
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
99
4,454
4,553
13,326
391
22,302
36,019
633
18,151
2,862
579
9,783
35
32,043
-
13,816 $
-
58,799
$
2,637
2,637 $
2,637
75,252
$
At December 31, 2016, the portfolio was managed by two investment firms, with control of the portfolio split approximately 58% and
38% under the control of the investment managers with the remaining 4% under the direct control of the Plan. A portfolio concentration
in two of the commingled pension trust funds and a short term investment fund of 14%, 6% and 6%, respectively, existed at December
31, 2016.
Postretirement Benefit Plan
An entity acquired by the Company provided health and dental care benefits to retired employees who met specified age and service
requirements through a postretirement health and dental care plan in which both the acquired entity and the retirees shared the cost. The
plan provided for substantially the same medical insurance coverage as for active employees until their death and was integrated with
Medicare for those retirees aged 65 or older. In 2001, the plan’s eligibility requirements were amended to curtail eligible benefit
payments to only retired employees and active employees who had already met the then-applicable age and service requirements under
the Plan. In 2003, retirees under age 65 began contributing to health coverage at the same cost-sharing level as that of active employees.
Retirees ages 65 or older were offered new Medicare supplemental plans as alternatives to the plan historically offered. The cost
sharing of medical coverage was standardized throughout the group of retirees aged 65 or older. In addition, to be consistent with the
administration of the Company's dental plan for active employees, all retirees who continued dental coverage began paying the full
monthly premium. The accrued liability included in other liabilities in the consolidated statements of financial condition related to this
plan amounted to $151 thousand and $149 thousand as of December 31, 2017 and 2016, respectively. The postretirement expense for
the plan that was included in salaries and employee benefits in the consolidated statements of income was not significant for the years
ended December 31, 2017, 2016 and 2015. The plan is not funded.
- 113 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(18.) EMPLOYEE BENEFIT PLANS (Continued)
The components of accumulated other comprehensive loss related to the defined benefit plan and postretirement benefit plan as of
December 31 are summarized below (in thousands):
Defined benefit plan:
Net actuarial loss
Prior service credit (cost)
Postretirement benefit plan:
Net actuarial loss
Prior service credit
Total
Deferred tax benefit
Amounts included in accumulated other comprehensive loss
2017
2016
$
$
(14,348)
5
(14,343)
(190)
169
(21)
(14,364)
5,723
(8,641)
$
$
(16,966)
(12)
(16,978)
(198)
237
39
(16,939)
6,717
(10,222)
Changes in plan assets and benefit obligations recognized in other comprehensive income on a pre-tax basis during the years ended
December 31 are as follows (in thousands):
Defined benefit plan:
Net actuarial gain (loss)
Amortization of net loss
Amortization of prior service cost
Postretirement benefit plan:
Net actuarial loss
Amortization of net loss
Amortization of prior service credit
Total recognized in other comprehensive income
2017
2016
$
$
1,475
1,142
17
2,634
(15)
24
(68)
(59)
2,575
$
$
(189)
938
20
769
(53)
17
(67)
(103)
666
For the year ending December 31, 2018, the estimated net loss and prior service credit for the plan that will be amortized from
accumulated other comprehensive income into net periodic benefit cost is $750 thousand and $72 thousand, respectively.
Supplemental Executive Retirement Agreements
The Company has non-qualified Supplemental Executive Retirement Agreements (“SERPs”) covering five former executives. The
unfunded pension liability related to the SERPs was $1.9 million and $2.1 million at December 31, 2017 and 2016, respectively. SERP
expense was $194 thousand, $88 thousand, and $408 thousand for 2017, 2016 and 2015, respectively.
- 114 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(19.) 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. 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.
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.
Derivative instruments – credit contracts: The fair value of derivative instruments – credit contracts is determined using quoted
secondary market prices for similar financial instruments and are classified as Level 2 in the fair value hierarchy.
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.
- 115 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(19.) FAIR VALUE MEASUREMENTS (Continued)
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.
- 116 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(19.) FAIR VALUE MEASUREMENTS (Continued)
Assets Measured at Fair Value
The following table presents 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 December 31 (in thousands):
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
2017
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises
Mortgage-backed securities
Asset-backed securities
Other liabilities:
Derivative instruments – credit contracts
Measured on a nonrecurring basis:
Loans:
Loans held for sale
Collateral dependent impaired loans
Other assets:
Loan servicing rights
Other real estate owned
2016
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises
Mortgage-backed securities
Asset-backed securities
Other liabilities:
Derivative instruments – credit contracts
Measured on a nonrecurring basis:
Loans:
Loans held for sale
Collateral dependent impaired loans
Other assets:
Loan servicing rights
Other real estate owned
$
$
$
$
$
$
$
$
$
$
$
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
$
$
$
$
$
$
$
$
$
$
$
$
161,889
363,084
-
524,973
$
$
4
4
$
$
-
-
-
-
-
-
$
$
$
$
161,889
363,084
-
524,973
4
4
$
2,718
-
-
-
2,718
$
$
-
3,847
990
148
4,985 $
2,718
3,847
990
148
7,703
186,268
353,467
191
539,926
-
-
$
$
$
$
-
-
-
-
-
-
$
$
$
$
186,268
353,467
191
539,926
-
-
$
1,050
-
-
-
1,050
$
$
-
901
1,075
107
2,083 $
1,050
901
1,075
107
3,133
There were no transfers between Levels 1 and 2 during the years ended December 31, 2017 and 2016. There were no liabilities
measured at fair value on a nonrecurring basis during the years ended December 31, 2017 and 2016.
- 117 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(19.) 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).
Fair
Value
Collateral dependent impaired loans $ 3,847
Asset
Valuation Technique
Appraisal of collateral (1)
Unobservable Input
Appraisal adjustments (2)
Unobservable Input
Value or Range
0% - 45% discount
Loan servicing rights
$
990
Discounted cash flow
Discount rate
Constant prepayment rate
10.2% (3)
14.8% (3)
Other real estate owned
_____
$
148
Appraisal of collateral (1)
Appraisal adjustments (2)
28% - 43% 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 years
ended December 31, 2017 and 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, FHLB and 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. 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.
- 118 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(19.) FAIR VALUE MEASUREMENTS (Continued)
The following presents the carrying amount, estimated fair value, and placement in the fair value measurement hierarchy of the
Company’s financial instruments as of December 31(in thousands):
Level in
Fair Value
Measurement
Hierarchy
2017
Estimated
Carrying
Amount
Fair
Value
Carrying
Amount
2016
Estimated
Fair
Value
Financial assets:
Cash and cash equivalents
Securities available for sale
Securities held to maturity
Loans held for sale
Loans
Loans (1)
Accrued interest receivable
FHLB and FRB stock
Financial liabilities:
Non-maturity deposits
Time deposits
Short-term borrowings
Long-term borrowings
Accrued interest payable
Derivative instruments – credit contracts
_____
(1) Comprised of collateral dependent impaired loans.
Level 1
Level 2
Level 2
Level 2
Level 2
Level 3
Level 1
Level 2
Level 1
Level 2
Level 1
Level 2
Level 1
Level 2
$
99,195
524,973
516,466
2,718
2,696,498
3,847
10,776
27,730
$
99,195
524,973
512,983
2,718
2,660,936
3,847
10,776
27,730
$
71,277
539,926
543,338
1,050
2,308,326
901
9,192
21,780
$
71,277
539,926
539,991
1,050
2,285,146
901
9,192
21,780
2,358,018
852,156
446,200
39,131
8,038
4
2,358,018
848,055
446,200
41,485
8,038
4
2,292,706
702,516
331,500
39,061
5,394
-
2,292,706
701,097
331,500
40,701
5,394
-
(20.) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statements pertaining only to the Parent are presented below (in thousands).
Condensed Statements of Condition
Assets:
Cash and due from subsidiary
Investment in and receivables due from subsidiary
Other assets
Total assets
Liabilities and shareholders’ equity:
Long-term borrowings, net of issuance costs of $869 and $939, respectively
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
December 31,
2017
2016
$
$
$
$
10,687 $
409,127
5,901
425,715 $
16,516
344,741
4,020
365,277
39,131 $
5,407
381,177
425,715 $
39,061
6,162
320,054
365,277
- 119 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(20.) PARENT COMPANY FINANCIAL INFORMATION (Continued)
Condensed Statements of Income
Dividends from subsidiary and associated companies
Management and service fees from subsidiary
Other income
Total income
Interest expense
Operating expenses
Total expense
Income before income tax benefit and equity in undistributed
earnings of subsidiary
Income tax benefit
Income before equity in undistributed earnings of subsidiary
Equity in undistributed earnings of subsidiary
Net income
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed earnings of subsidiary
Depreciation and amortization
Share-based compensation
(Increase) decrease in other assets
Decrease in other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Capital investment in Five Star Bank
Purchase of premises and equipment
Net cash paid for acquisition
Net cash used in investing activities
Cash flows from financing activities:
Issuance of long-term debt, net of issuance costs
Proceeds from issuance of common shares
Purchase of preferred and common shares
Proceeds from stock options exercised
Dividends paid
Other
Net cash provided by (used in) financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents as of beginning of year
Cash and cash equivalents as of end of the year
- 120 -
$
Years ended December 31,
2016
2017
12,000 $
1,185
1,298
14,483
2,471
4,249
6,720
16,000 $
855
1,296
18,151
2,471
5,950
8,421
2015
16,000
599
1,175
17,774
1,750
3,509
5,259
7,763
1,817
9,580
23,946
33,526
$
9,730
2,783
12,513
19,418
31,931
$
12,515
1,814
14,329
14,008
28,337
$
Years ended December 31,
2016
2017
2015
$
33,526 $
31,931 $
28,337
(23,946)
149
1,174
(1,673)
(1,211)
8,019
(38,405)
(44)
-
(38,449)
-
38,303
(157)
413
(13,958)
-
24,601
(5,829)
16,516
10,687
$
(19,418)
148
845
1,772
(389)
14,889
-
(1,290)
(918)
(2,208)
-
-
-
964
(12,946)
30
(11,952)
729
15,787
16,516
$
(14,008)
97
674
(1,069)
(258)
13,773
(34,000)
-
-
(34,000)
38,940
-
(202)
359
(12,721)
79
26,455
6,228
9,559
15,787
$
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2017, 2016 and 2015
(21.) 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 SDN, 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. 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.
The following tables present information regarding the Company’s business segments as of and for the periods indicated (in thousands).
December 31, 2017
Goodwill
Other intangible assets, net
Total assets
December 31, 2016
Goodwill
Other intangible assets, net
Total assets
Year ended December 31, 2017
Net interest income (expense)
Provision for loan losses
Noninterest income
Noninterest expense (2)
Income (loss) before income taxes
Income tax (expense) benefit
Net income (loss)
Year ended December 31, 2016
Net interest income (expense)
Provision for loan losses
Noninterest income
Noninterest expense
Income (loss) before income taxes
Income tax (expense) benefit
Net income (loss)
_____
$
$
$
$
$
$
Banking
Non-Banking
Holding
Company and
Other
Consolidated
Totals
$
48,536
373
4,069,086
$
17,304
8,490
31,466
$
-
-
4,658
65,840
8,863
4,105,210
$
48,536
579
3,678,230
$
17,881
8,644
31,166
$
-
-
944
66,417
9,223
3,710,340
Banking
Non-
Banking (1)
Holding
Company and
Other
Consolidated
Totals
115,086
(13,361)
24,921
(78,845)
47,801
(12,253)
35,548
105,161
(9,638)
26,457
(73,056)
48,924
(14,409)
34,515
$
$
$
$
$
-
-
9,172
(9,264)
(92)
491
399
$
$
-
-
8,567
(7,080)
1,487
(584)
903
$
(2,471) $
-
637
(2,404)
(4,238)
1,817
(2,421) $
(2,471) $
-
736
(4,535)
(6,270)
2,783
(3,487) $
112,615
(13,361)
34,730
(90,513)
43,471
(9,945)
33,526
102,690
(9,638)
35,760
(84,671)
44,141
(12,210)
31,931
(1) Reflects activity from Courier Capital since January 5, 2016 (the date of acquisition) and from the acquisition of the assets of
Robshaw & Julian since August 31, 2017 (the date of acquisition).
(2) Non-Banking segment includes SDN reporting unit goodwill impairment of $1.6 million.
- 121 -
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Effectiveness of Controls and Procedures
As of the end of the period covered by this report, 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 (Principal Executive Officer) and Chief
Financial Officer (Principal 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 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 Annual
Report on Form 10-K.
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 Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
Management Report on Internal Control over Financial Reporting and Attestation Report of Independent Registered Public
Accounting Firm
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.
Management assessed the Company’s internal control over financial reporting based on criteria established in the Internal Control—
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on
this assessment, management has concluded that, as of December 31, 2017, the Company maintained effective internal control over
financial reporting. Management’s Report on Internal Control over Financial Reporting is included under Item 8 “Financial Statements
and Supplementary Data” in Part II of this Form 10-K.
KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual
Report on Form 10-K, and has issued an attestation report on the effectiveness of the Company’s internal control over financial
reporting. The Report of the Independent Registered Public Accounting Firm that attests the effectiveness of internal control over
financial reporting is included under Item 8 “Financial Statements and Supplementary Data” in Part II of this Form 10-K.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31,
2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
- 122 -
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
PART III
In response to this Item, the information set forth in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders (the
“2018 Proxy Statement”) to be filed within 120 days following the end of the Company’s fiscal year, under the headings “Proposal 1 -
Election of Directors,” “Business Experience and Qualification of Directors,” “Our Executive Officers,” and “Section 16(a) Beneficial
Ownership Reporting Compliance” is incorporated herein by reference.
Information concerning the Company’s Audit Committee and the Audit Committee’s financial expert is set forth under the caption
“Board Meetings and Committees” in the 2018 Proxy Statement and is incorporated herein by reference.
Information concerning the Company’s Code of Business Conduct and Ethics is set forth under the caption “Code of Ethics” in the 2018
Proxy Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
In response to this Item, the information set forth in the 2018 Proxy Statement under the headings “Compensation Discussion and
Analysis,” “Executive Compensation Tables,” “Management Development and Compensation Committee Interlocks and Insider
Participation,” “Director Compensation,” and “Management Development and Compensation Committee Report” is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
In response to this Item, the information set forth in the 2018 Proxy Statement under the heading “Security Ownership of Certain
Beneficial Owners and Management” is incorporated herein by reference.
Equity Compensation Plan Information
The following table sets forth, as of December 31, 2017, information about our equity compensation plans that have been approved by
our shareholders, including the number of shares of our common stock exercisable under all outstanding options, warrants and rights,
the weighted average exercise price of all outstanding options, warrants and rights and the number of shares available for future
issuance under our equity compensation plans. We have no equity compensation plans that have not been approved by our
shareholders.
Plan Category
Equity compensation plans approved by shareholders
Equity compensation plans not approved by shareholders
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
22,199
-
Weighted average
exercise price
of outstanding
options, warrants
and rights
(b)
18.40
-
$
$
Number of securities
remaining for future
issuance under equity
compensation plans
(excluding securities
reflected in column (a))
(c)
313,496
-
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In response to this Item, the information set forth in the 2018 Proxy Statement under the headings “Certain Relationships and Related
Transactions” and “Board Independence” is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
In response to this Item, the information set forth in the 2018 Proxy Statement under the heading “Independent Registered Public
Accounting Firm” is incorporated herein by reference.
- 123 -
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
PART IV
(a) FINANCIAL STATEMENTS
Reference is made to the Index to Consolidated Financial Statements of Financial Institutions, Inc. and subsidiaries under Item
8 “Financial Statements and Supplementary Data” in Part II of this Annual Report on Form 10-K.
(b) EXHIBITS
The following is a list of all exhibits filed or incorporated by reference as part of this Report.
Exhibit
Number
Description
Location
3.1
3.2
4.1
4.2
4.3
10.1
10.2
10.3
10.4
10.5
Amended and Restated Certificate of Incorporation of the
Company
Incorporated by reference to Exhibits 3.1, 3.2
and 3.3 of the Form 10-K for the year ended
December 31, 2008, dated March 12, 2009
Amended and Restated Bylaws of the Company
Incorporated by reference to Exhibit 3.1 of the
Subordinated Indenture, dated as of April 15, 2015, between
Financial Institutions, Inc. and Wilmington Trust, National
Association, as Trustee
Form 8-K, dated December 30, 2016
Incorporated by reference to Exhibit 4.1 of the
Form 8-K, dated April 15, 2015
First Supplemental Indenture, dated as of April 15, 2015,
Incorporated by reference to Exhibit 4.2 of the
between Financial Institutions, Inc. and Wilmington Trust,
National Association, as Trustee
Form 8-K, dated April 15, 2015
Form of Global Note to represent the 6.00% Fixed-to-
Floating Rate Subordinated Notes due April 15, 2030
Incorporated by reference to Exhibit A of
Exhibit 4.2 of the Form 8-K, dated April 15,
2015
1999 Management Stock Incentive Plan
Incorporated by reference to Exhibit 10.1 of
the S-1 Registration Statement
Amendment Number One to the 1999 Management Stock
Incorporated by reference to Exhibit 10.1 of
Incentive Plan
the Form 8-K, dated July 28, 2006
Form of Non-Qualified Stock Option Agreement Pursuant to
Incorporated by reference to Exhibit 10.2 of
the 1999 Management Stock Incentive Plan
the Form 8-K, dated July 28, 2006
1999 Directors Stock Incentive Plan
Amendment to the 1999 Director Stock Incentive Plan
Incorporated by reference to Exhibit 10.2 of
the S-1 Registration Statement
Incorporated by reference to Exhibit 10.7 of
the Form 10-K for the year ended December
31, 2008, dated March 12, 2009
Incorporated by reference to Exhibit 10.8 of
the Form 10-Q for the quarterly period ended
June 30, 2009, dated August 5, 2009
Incorporated by reference to Exhibit 10.9 of
the Form 10-Q for the quarterly period ended
June 30, 2009, dated August 5, 2009
10.6
2009 Management Stock Incentive Plan
10.7
2009 Directors’ Stock Incentive Plan
10.8
10.9
Form of Restricted Stock Award Agreement Pursuant to the
Incorporated by reference to Exhibit 10.2 of
2009 Management Stock Incentive Plan (LTIP Award)
the Form 8-K, dated March 1, 2010
Form of “Service Based” Restricted Stock Award Agreement
Pursuant to the 2009 Management Stock Incentive Plan
Incorporated by reference to Exhibit 10.12 of
the Form 10-K for the year ended December
31, 2011, dated March 9, 2012
- 124 -
Exhibit
Number
Description
Location
10.10
Form of 2013 Performance Program Master Agreement
10.11
Form of 2013 Performance Program Award Certificate
Incorporated by reference to Exhibit 10.16 of
the Form 10-K for the year ended December
31, 2012, dated March 18, 2013
Incorporated by reference to Exhibit 10.17 of
the Form 10-K for the year ended December
31, 2012, dated March 18, 2013
10.12
Executive Agreement between Financial Institutions, Inc.
Incorporated by reference to Exhibit 10.3 of
and Richard J. Harrison
the Form 8-K, dated May 23, 2013
10.13
Voluntary Retirement Agreement with Ronald A. Miller
Incorporated by reference to Exhibit 10.2 of
the Form 8-K, dated September 26, 2008
10.14
Amendment to Voluntary Retirement Agreement with
Incorporated by reference to Exhibit 10.1 of
Ronald A. Miller
the Form 8-K, dated March 3, 2010
10.15
Supplemental Executive Retirement Agreement between
Incorporated by reference to Exhibit 10.3 of
Financial Institutions, Inc. and Peter G. Humphrey
the Form 10-Q for the quarterly period ended
September 30, 2012, dated November 6, 2012
10.16
Supplemental Executive Retirement Agreement between
Incorporated by reference to Exhibit 10.1 of
Financial Institutions, Inc. and Richard J. Harrison
the Form 10-Q for the quarterly period ended
June 30, 2014, dated August 5, 2014
10.17
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
Incorporated by reference to Exhibit 10.1 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
10.18
Form of Director Annual Restricted Stock Award Agreement
Pursuant to the Financial Institutions, Inc. 2015 Long-Term
Incentive Plan
Incorporated by reference to Exhibit 10.2 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
10.19
Form of Director “In Lieu of Cash Fees” Stock Award
Incorporated by reference to Exhibit 10.3 of
Agreement Pursuant to the Financial Institutions, Inc. 2015
Long-Term Incentive Plan
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
10.20
10.21
10.22
10.23
Form of Restricted Stock Award Agreement Pursuant to the
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
Incorporated by reference to Exhibit 10.4 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
Form of Performance Stock Award Agreement Pursuant to
the Financial Institutions, Inc. 2015 Long-Term Incentive
Plan
Incorporated by reference to Exhibit 10.5 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
Form of Restricted Stock Unit Award Agreement Pursuant to
the Financial Institutions, Inc. 2015 Long-Term Incentive
Plan
Incorporated by reference to Exhibit 10.6 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
Form of Performance Stock Unit Award Agreement Pursuant
to the Financial Institutions, Inc. 2015 Long-Term Incentive
Plan
Incorporated by reference to Exhibit 10.7 of
the Form 10-Q for the quarterly period ended
June 30, 2015, dated August 5, 2015
10.24
Form of Indemnification Agreement
10.25
10.26
Amended and Restated Executive Agreement, dated May 3,
2017, by and between Financial Institutions, Inc. and Martin
K. Birmingham
Amended and Restated Executive Agreement, dated May 3,
2017, by and between Financial Institutions, Inc. and Kevin
B. Klotzbach
Incorporated by reference to Exhibit 10.1 of
the Form 8-K, dated December 30, 2016
Incorporated by reference to Exhibit 10.1 of
the Form 8-K, dated May 4, 2017
Incorporated by reference to Exhibit 10.2 of
the Form 8-K, dated May 4, 2017
- 125 -
Exhibit
Number
Description
Location
10.27
Executive Agreement, dated May 3, 2017, by and between
Incorporated by reference to Exhibit 10.3 of
Financial Institutions, Inc. and Michael D. Burneal
the Form 8-K, dated May 4, 2017
10.28
Executive Agreement, dated May 3, 2017, by and between
Incorporated by reference to Exhibit 10.4 of
Financial Institutions, Inc. and Jeffrey P. Kenefick
the Form 8-K, dated May 4, 2017
10.29
Executive Agreement, dated May 3, 2017, by and between
Incorporated by reference to Exhibit 10.5 of
Financial Institutions, Inc. and William L. Kreienberg
the Form 8-K, dated May 4, 2017
10.30
Sales Agency Agreement, dated May 30, 2017, by and
Incorporated by reference to Exhibit 10.1 of
between Financial Institutions, Inc. and Sandler O’Neill +
Partners, L.P.
the Form 8-K, dated May 30, 2017
21
23
31.1
31.2
32
Subsidiaries of Financial Institutions, Inc.
Filed Herewith
Consent of Independent Registered Public Accounting Firm
Filed Herewith
Certification pursuant to Section 302 of the Sarbanes-Oxley
Filed Herewith
Act of 2002 - Principal Executive Officer
Certification pursuant to Section 302 of the Sarbanes-Oxley
Filed Herewith
Act of 2002 - Principal Financial Officer
Certification pursuant to18 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
All material agreements consist of management contracts, compensatory plans or arrangements.
ITEM 16. FORM 10-K SUMMARY
None.
- 126 -
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
SIGNATURES
March 14, 2018
FINANCIAL INSTITUTIONS, INC.
By:
/s/ Martin K. Birmingham
Martin K. Birmingham
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
Signatures
Title
Date
/s/ Martin K. Birmingham
Martin K. Birmingham
Director, President and Chief Executive Officer
(Principal Executive Officer)
March 14, 2018
/s/ Kevin B. Klotzbach
Kevin B. Klotzbach
/s/ Michael D. Grover
Michael D. Grover
/s/ Karl V. Anderson, Jr.
Karl V. Anderson, Jr.
/s/ Donald K. Boswell
Donald K. Boswell
/s/ Dawn H. Burlew
Dawn H. Burlew
/s/ Andrew W. Dorn, Jr.
Andrew W. Dorn, Jr.
/s/ Robert M. Glaser
Robert M. Glaser
/s/ Samuel M. Gullo
Samuel M. Gullo
/s/ Susan R. Holliday
Susan R. Holliday
/s/ Erland E. Kailbourne
Erland E. Kailbourne
/s/ Robert N. Latella
Robert N. Latella
/s/ Kim E. VanGelder
Kim E. VanGelder
/s/ James H. Wyckoff
James H. Wyckoff
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
March 14, 2018
Senior Vice President and Chief Accounting Officer
(Principal Accounting Officer)
March 14, 2018
Director
Director
Director
Director
Director
Director
Director
Director
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
March 14, 2018
Director, Chairman
March 14, 2018
Director
Director
- 127 -
March 14, 2018
March 14, 2018
Executive Management Committee: (front) William L. Kreienberg, Martin K. Birmingham, Kevin B.
Klotzbach (back) Michael D. Burneal, Paula D. Dolan, Joseph L. Dugan, and Charles J. Guarino
Today is tomorrow in progress
Investor Information
Corporate Headquarters
220 Liberty Street
Warsaw, New York 14569
Corporate Website
Financial results, corporate announcements, dividend news and
corporate governance information is available on the Company’s
website: www.fiiwarsaw.com
Annual Meeting
The 2018 Annual Meeting of Shareholders will be held at 10:00 a.m.
EDT on June 20, 2018, at 220 Liberty Street in Warsaw, New York.
Transfer Agent
Our transfer agent, American Stock Transfer & Trust Co., maintains
the records for our registered shareholders and can assist you
with a variety of stockholder services including address changes,
certificate replacement and other inquiries regarding your account.
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, New York 11219
Phone: (800) 937-5449
Teletypewriter for the hearing impaired: (866) 703-9077
help@astfinancial.com
Website: www.astfinancial.com
Stock Exchange Information
NASDAQ Global Select Market
Ticker Symbol: FISI
Form 10-K and Other Reports
This Annual Report includes the Financial Institutions, Inc. Annual
Report on Form 10-K. The Form 10-K Report filed with the U.S.
Securities and Exchange Commission in March 2018 also contains
additional information including exhibits.
The Form 10-K can be viewed at www.fiiwarsaw.com, Financials/SEC
Filings, and is also available without charge upon request to Sonia
M. Dumbleton, Corporate Secretary, 220 Liberty Street, Warsaw,
New York 14569.
Investor Relations Contacts
Shelly J. Doran
Director of Investor and External Relations
SJDoran@five-starbank.com
or
Kevin B. Klotzbach
Executive Vice President, CFO and Treasurer
KBKlotzbach@five-starbank.com
Legal Counsel
Harter Secrest & Emery LLP
Independent Auditors*
KPMG LLP
Rochester, New York
Affiliates
Five Star Bank
Scott Danahy Naylon, LLC
Courier Capital, LLC
Five Star Bank Regional
Administrative Center
Five Star Bank Plaza
100 Chestnut Street
Rochester, New York 14604
Scott Danahy Naylon, LLC
300 Spindrift Drive
Amherst, New York 14221
Courier Capital, LLC
1114 Delaware Avenue
Buffalo, New York 14209
* We have retained RSM US LLP to serve
as our independent audit firm in 2018
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220 Liberty Street, Warsaw, NY 14569
585.786.1100 | www.fiiwarsaw.com