Rising to meet the challenge.
®
Annual Report 2020
Financial Institutions, Inc. provides diversified financial services through its subsidiaries Five Star Bank, SDN Insurance Agency, LLC,
Courier Capital, LLC and HNP Capital, LLC.
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 45 offices throughout Western and Central New York State. Additional Five Star Bank
information is available at www.five-starbank.com.
SDN Insurance Agency provides a broad range of insurance services to personal and business clients.
Courier Capital and HNP Capital provide 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 600 individuals. The Company’s stock is listed on the
Nasdaq Global Select Market under the symbol FISI. Additional information is available at www.fiiwarsaw.com.
Corporate Profile
Fellow Shareholders
2020 was a year of strong performance by our
organization across an array of key outcomes.
Our team of dedicated associates demonstrated
resiliency as we worked together to tackle
unprecedented challenges presented by the
COVID-19 pandemic. As a result, we were successful
in providing continuous essential banking, investment
and insurance products and services to the
communities we serve.
Our priority throughout the pandemic was, and
continues to be, a steadfast commitment to the
health and financial security of our associates,
consumers and business customers. In mid-March
of last year, 65% of our non-retail associates started
working from home or remote locations. In the
early stages of the pandemic, we instituted
special bi-weekly bonuses to front line associates
and provided additional paid days off to help associates
manage the challenges of balancing work and
personal priorities.
We delivered uninterrupted financial services to our
customers and continue to modify operations to
keep customers and associates safe. Nearly 90%
of our branches remained open throughout the
pandemic through the utilization of drive-through
operations, vestibule ATMs and lobby branch
appointment hours. Extensive customer relief was
provided including the temporary waiving of fees,
not reporting payment deferrals to credit bureaus,
extension of grace periods for consumer, mortgage
and auto loan payments and providing reduced rate
emergency loans to consumers.
Our relationship managers worked tirelessly with
small business and commercial customers to identify
their needs and provide support, and we thoughtfully
extended credit to many customers for capital and
operating purposes. Active participation in the
Small Business Administration Paycheck Protection
Program, or PPP, resulted in approximately 1,700
existing and new Five Star Bank customers obtaining
approximately $270 million in loans, preserving an
estimated 18,000 jobs in our markets in 2020.
From the beginning days of the pandemic, we
maintained regular and frequent communication
with our regulators and worked with them closely
to identify and implement relief efforts for customers.
Today, infection rates are declining in our footprint,
vaccination rates are climbing, and we are seeing
signs of an expanded re-opening of the economy.
We are in the process of bringing a portion of staffing
back to corporate offices and developing long-term
plans, department-by-department, for working in
the office, working from home and a hybrid work
approach. We are also actively helping customers
obtain forgiveness of existing PPP loans as well as
new 2021 PPP loans.
I am optimistic about the days ahead and believe we
are on a bridge moving out of the pandemic and to a
brighter future.
Financial Institutions, Inc. 2020 Annual Report
01
’20
Financial Highlights
Net Income, Earnings per
Share & Dividends
[$ in Millions, except per share amounts]
[$ in Millions, except per share amounts]
Total Loans
[$ in Millions]
$3,087
$3,595
$3,221
Net Income Available to Common Shareholders
DDiluted Earnings per Common Share
CCash Dividends Declared
per Common Share
$47.4
$47.4
$36.9
$2.30
$1.04
$2.96
$1.00
$38.1
$2.39
$0.96
$32.1
$$2$2$$2$2$2$2$2$2$2.$2.$2.1131313131331313
$2.13$22$2$2131313131313333
$$0$0$0$0$0$0$0$0$0$0$0.8858585858585858585
$0.85
$30.5
$2.10$2101010100
$2.10
$00081818181
$0.81
$2,735
$2,340
$1,020
$1,259
$1,516
$1,678
$582
$18
$876
$634
$17
$920
$677
$16
$850
$550
$18
$752
$2,048
$690
$17
$840
’16 ’17 ’18 ’19 ’20
Commercial
Consumer Other
Residential
Real Estate
Consumer
Indirect
Growing Noninterest Income
[$ in Millions]
[$ in Millions]
$35.8
$34.7
$36.5
$40.4
$43.2
’16 ’17 ’18 ’19 ’20
’16 ’17 ’18 ’19 ’20
Net income for the year was $38.3 million
compared to $48.9 million in 2019. After
preferred dividends, net income available
to common shareholders was $36.9 million,
or $2.30 per diluted share, compared to
$47.4 million, or $2.96 per diluted share in
2019. The primary driver of the decrease in
net income and earnings per share was an
increase in provision for credit losses, $19.1
million higher in 2020 than 2019. Higher
provision was a result of the adoption of
the current expected credit loss standard,
or CECL, and uncertainty regarding the
long-term impact of the COVID-19 pan demic
on the economic environment, and will not
necessarily result in credit losses.
Pre-tax pre-provision income1 was $72.9
million, the highest in Company history and
an increase of $5.4 million from 2019, as
a result of record net interest income,
noninterest income bolstered by our
diversified revenue stream and continued
expense discipline.
Net interest income was $139.0 million for
the year, $9.1 million higher than 2019
due to a $356.0 million increase in average
interest-earnings assets, partially offset by
a six basis point decrease in net interest
margin. Noninterest income was $43.2
million, an increase of $2.8 million from the
prior year, primarily due to higher income
from derivative instruments arranged
for our commercial borrowers related to
interest rate swap transactions and higher
net gains on the sale of residential loans,
partially offset by lower service charges
on deposits related to our COVID-19
temporary relief initiatives.
Investment advisory fee income of $9.5
million was $348 thousand, or 3.8%,
higher than 2019 due to the impact of
market gains, new customer accounts
and increased investments in existing
accounts. While insurance income of
$4.4 million was down $167 thousand
compared to 2019, related expenses
were also lower, resulting in an earnings
before interest, taxes, depreciation and
amortization, or EBITDA, margin on our
insurance business of 19%, a 73%
increase from 2019.
Financial Highlights
1 Non-GAAP measure; refer to GAAP to Non-GAAP reconciliation on page 10.
Common Book Value
& Tangible Common
Book Value(2)
[per share]
Common Book Value
Tangible Common
Book Value(2)
$23.79
$22.85
$19.01
$19$1$$19$19$19$19$19$19$19$19$190010101001.01
$$18$18$18$18$18$18$18$18$18$18116161616.16
$18.16
20.82
$20.82
5626262626262
$15.62
$26.35
$21.66
$28.12
$23.52
$25
$20
$15
Total Investment Securities
[$ in Millions]
$1,083
$1,041
$892
$777
$900
’16 ’17 ’18 ’19 ’20
Total Deposits
[$ in Millions]
$4,000
$3,000
$2,000
$1,000
$3,367
$3,210
$2,358
$2,347
$2,995
$2,293
$4,278
$3,393
$3,556
$2,376
$1,180
$702
$852
$1,020
$885
’16 ’17 ’18 ’19 ’20
’16 ’17 ’18 ’19 ’20
Noninterest expense was $109.3 million,
an increase of 6.2% from 2019, primarily
due to higher salaries and benefits
and computer and data processing
expenses, as well as $1.7 million of
non-recurring restructuring charges
related to a staffing reduction and
the closure of seven bank branches.
Our ongoing program of providing debt
and equity financing for affordable
and special needs housing resulted in
federal and state tax benefits related
to historic and low-income housing tax
credit investments, reducing income
tax expense by $1.5 million in 2020
compared to $2.7 million in 2019.
Our 2020 investment strategy was
to reinvest portfolio cash flow and
deploy excess liquidity into eligible
agency mortgage backed securities.
Investment securities were $900.0
million at December 31, 2020, an in-
crease of $123.1 million from one year
ago. The investment securities portfolio
comprised 18.3% of total assets at
year-end as compared to 17.7% at
December 31, 2019.
Growth in total loans was 11.6%, driven
by increases in commercial business
loans of 38.8%, commercial mortgage
loans of 13.3% and residential real
estate loans of 4.8%. PPP loans at year-
end totaled $248.0 million, net of fees,
and are included in the commercial
business loan category. Our consumer
indirect loan portfolio decreased 1.1%
from year-end 2019 and represented
23.4% of the total loan portfolio, down
from 26.4% at December 31, 2019.
We remain strategically focused on
the importance of credit discipline and
have invested significant resources in
our credit and risk management teams.
The credit profile of the total loan portfolio
continued to demonstrate stability
throughout the pandemic environment
with total net charge-offs of $13.8
million, or 0.40% of total average loans,
compared to $11.5 million, or 0.37% of
average loans, in 2019. Our allowance
for credit losses on loans to total loans
was 1.46% at year-end, up from 0.95%
at December 31, 2019. The 2020
increase is attributable to the adoption
of the CECL standard and uncertainty
around the long-term impact of the
COVID-19 pandemic on the economic
environment.
Credit metrics remain strong with a
total non-performing loan to total loan
ratio of 26 basis points at December 31,
2020 as compared to 27 basis points
at December 31, 2019 and an allowance
for credit losses on loans to non-
performing loans of 551% as compared
to 353% at the prior year-end.
Total deposits grew $722.7 million in
2020, driven by growth in non-public
demand and reciprocal deposits.
Deposit growth was fueled by responses
to the pandemic as the government
provided stimulus that bolstered small
businesses and supported individuals
with stimulus checks and enhanced
unemployment benefits, coupled with
a change in customer behavior as the
rate of personal savings increased due
to economic and personal uncertainty.
This resulted in excess liquidity for all
banks, which continues today.
Common book value per share
increased 6.7% in 2020, from $26.35
at year-end 2019 to $28.12. Tangible
common book value per share 2
increased for the 12th consecutive
year, from $21.66 at year-end 2019
to $23.52, an 8.6% increase.
We declared $1.04 per share in cash
dividends to shareholders in 2020,
representing an increase of 4.0% from
the prior year. In early 2021, the Board
of Directors increased the dividend by
3.8%, to $1.08 on an annualized basis.
Our Board’s confidence in the Company’s
strategy and earnings potential
supported the increase, our 11th
consecutive annual dividend increase.
We remain firmly committed to
this important component of
shareholder return.
2 Non-GAAP measure; refer to GAAP to Non-GAAP reconciliation on page 36 of our Annual Report on Form 10-K, which follows.
Financial Institutions, Inc. 2020 Annual Report
03
Strategic
Initiatives
Five Star Bank Digital Banking
To deliver enhanced digital capabilities to our customers
during a time when at-home access was critical, we
successfully completed the second quarter launch of
our new online and mobile platform, Five Star Bank Digital
Banking. Consumers and businesses large and small
need the ability to do their banking anywhere and
anytime, and we leveraged the latest technology to
provide new features and tools to improve the digital
banking experience for our customers.
An additional branch closure was announced in October.
These actions resulted in non-recurring one-time expenses
related to severance and real estate related charges of
approximately $1.7 million in 2020. We expect related
future expense savings of $2.7 million, on an annualized
basis, that will facilitate the long-term sustainability of
current and future branches.
The enterprise standardization program is an ongoing
strategic initiative and we continue to evaluate activities
and functions across the organization, focusing on
The Five Star Bank
Digital Banking platform
provides a single dashboard
to make payments and
deposits, transfer and send
money, create budgets,
set financial goals, and
easily integrate external
investment, loan and other
transactional accounts. The
platform enhances the user
experience for consumer
and commercial customers
across all devices. Adoption
rates are high and customer
response has been very
favorable.
Enterprise Standardization
Our enterprise standardization program was launched in
2019 and is focused on improving operational efficiency
and enhancing future profitability. We worked with a leading
process improvement organization to assess all lines
of business and functional areas and their data-driven
analysis identified overlapping service areas, automation
opportunities and streamlining opportunities to enhance
customer and associate experiences. Robotic automation,
process improvement and operational efficiencies were
implemented as an outcome of this effort.
Another outcome of the program was our 2020
adaptation to a branch model designed to streamline
retail branches to better align with shifting customer
needs and preferences. Changes included the
consolidation of eleven branches into five, resulting in
six branch closures and a reduction in staffing.
Strategic Initiatives
ways to improve operational
efficiency while enhancing
the employee and customer
experience. We continue to
anticipate annualized expense
savings within a range of $5 to
$7 million, as initially disclosed
on January 31, 2020.
Capital Market Activities
We took two actions during
the fourth quarter last year
to provide important flexibility
in managing our balance
sheet in the months and
years ahead.
The first was in October when
we sold $35 million of 10-year
fixed-to-floating rate subordinated notes with an interest
rate of 4.375%. After five years it becomes floating rate
debt, redeemable at our discretion. We were comfortable
with our capital levels before the offering but deemed
it prudent to take advantage of low interest rates to
add capital for use in organic and strategic growth
opportunities and to further strengthen Five Star Bank’s
capital ratios.
The second action was the establishment of a stock
repurchase program for approximately 5% of our
outstanding common shares. Shares may be purchased
in open market transactions and pursuant to any
technical requirements of a 10b5-1 trading plan.
No shares were repurchased in 2020, however, we
repurchased 238,439 shares during the first quarter of
2021 for an average repurchase price of $24.30 per share.
Insurance Subsidiary Acquisition
Last December, continuing our long-term strategy to diversify revenue, we announced the planned acquisition of
assets of Landmark Group. On February 1, 2021, the transaction was completed by our SDN Insurance Agency
subsidiary. A staple of the Rochester community since 1984, Landmark was an independent insurance brokerage
firm delivering insurance, surety and risk management solutions across many business sectors including construction,
manufacturing, real estate and technology, as well as individual personal insurance. Kelly and Chris Shea,
Landmark’s Chairman and President, will remain with SDN to lead Rochester insurance operations.
We view this acquisition as a bolt-on to our existing insurance business. The transaction is expected to negatively
impact the tangible common equity to tangible assets ratio by less than two basis points. Earnings per share
dilution is projected at approximately one cent per share in the first year with accretion generated shortly thereafter
as we benefit from economies of scale.
Two New Branches in Buffalo
Progress continues with the construction of two new Five Star Bank branches in the City of Buffalo. The branches
were initially expected to open by February 2021 but were delayed due to the pandemic. They are currently expected
to open in the summer of 2021.
These new branches — at 2222 Seneca Street and 451 Elmwood Avenue — will help us grow in the important
Buffalo market and make us more accessible to existing and new consumer and commercial customers.
They are located in vibrant commercial corridors and extend the reach of Five Star Bank’s distribution system
in both northern and southern directions from our existing downtown branch.
Financial Institutions, Inc. 2020 Annual Report
05
Corporate Citizenship
Our commitment to corporate citizenship and Environmental, Social and Corporate Governance (ESG) begins with
the Board of Directors. Three of our Board committees have specific ESG responsibilities, memorialized in their
committee charters: the Nominating and Governance Committee supports Board oversight over ESG matters
with a specific focus on ensuring sound governance practices; the Management Development & Compensation
Committee oversees the development and implementation of our diversity, social responsibility and human
rights-related strategies and initiatives; and the Audit Committee ensures that financial-related disclosures
appropriately reflect oversight over ESG matters.
Our Commitment
to Corporate
Responsibility
and Sustainability
Culture
We are committed to delivering on our
promise to put our customers’ financial
well-being at the heart of everything we do.
Our success in maintaining this promise is
rooted in the Five Star culture — developed
to guide associates in living our promise.
In a fast-changing world and industry, we
acknowledge the importance of fostering a
culture that empowers our team to work in
a welcoming environment of trust, integrity
and respect where success is recognized,
and careers are encouraged. We dedicate
time and energy to upholding our commitment
to our associates and communities.
Communication is critical to this process
and we work diligently to keep associates
informed via messaging on our intranet
platform, company-wide calls, emails from
management and monthly newsletters.
Advancing Inclusion and Diversity
The events of 2020 highlighted the need for a more inclusive and diverse company, community, country and world.
Our commitment to supporting our people and fostering a company culture that deeply values and respects
diversity and inclusion by understanding, accepting and valuing all individuals remains steadfast and unwavering.
As CEO, I am committed to doing all we can to support progress toward a stronger tomorrow for all.
Last September, our Diversity & Inclusion Advisory Council was established to evaluate effective diversity and
inclusion practices and provide learning opportunities to educate, build inclusion acumen and foster a sense
of belonging. The Council is comprised of associates from diverse personal and professional backgrounds from
across our geographic footprint and they play an important role in supporting sustainable and impactful change.
I proudly serve as Executive Sponsor of this initiative and am inspired by the passion and commitment of Council
members.
We are making significant progress toward achieving a gender-balanced workforce. At the end of 2020, approximately
70% of our workforce, more than 50% of our officers and 30% of our directors were women. Currently, more than
60% of our Operating Committee — a management committee comprised of key senior and emerging company
leaders — reflects gender or racial diversity. Assuming shareholders approve the slate of candidates recommended
for election at the 2021 annual meeting, 30% of our Board’s independent directors will be women and 20% will
represent racial/ethnic minorities.
Ethics
We have worked diligently to establish and maintain a strong culture of ethical behavior and we communicate high
expectations through strong engagement, oversight and training. Associates are required to review and affirm their
intent to comply with our ethics codes annually.
We encourage associates to raise any ethical concerns with their managers or other designated Company officers.
We also provide a secure channel for employees to anonymously raise financial or ethical concerns through a
third-party service provider independent from the company, twenty-four hours a day by phone or online.
Associates may choose to raise concerns through various other channels outlined in our Whistleblower Policy.
Corporate Responsibility & Sustainability
We are using green and energy efficient materials as
well as materials with a high percentage of recycled
content in the construction of our two new branches
in Buffalo. In 2020, we reduced consumption of printer
paper by approximately 30% and purchased only
printer paper certified by the Sustainable Forestry
Initiative.
In 2020, we adopted the notice and access method
to deliver proxy materials over the Internet instead of
mailing paper copies. This action significantly reduced
the quantity of materials printed and mailed, decreasing
the environmental impact of our meeting. Also, paper
used for printing the reduced quantity of annual
reports and proxy statements was certified by the
Forest Stewardship Council (FSC). We will continue
these actions in 2021.
Corporate Strategy and
Enterprise Risk Management
Our Board of Directors regularly reviews our strategy,
the environment in which we operate and the progress
we are making toward the goals we set. Our strategy
clearly defines strategic priorities and contains annual
and multi-year plans to deliver on these priorities. We
remain committed to an effective and efficient risk and
control environment and our long-term strategy is firmly
linked to an enterprise risk management program.
Given the complex and evolving nature of our lines of
business, we invest time and resources in maintaining
a risk-management culture that is incisive, knowledgeable
and subject to ongoing review and enhancement.
Corporate Governance Policies
If you are interested in learning more about our
governance policies, you can access our Corporate
Governance Guidelines, Code of Business Conduct
and Ethics, Code of Ethics for CEO, CFO and Financial
Officers, Related Party Transactions Policy,
Whistleblower Policy and all Board Committee Charters
on our website at www.fiiwarsaw.com by clicking on
“Governance,” then on “Governance Documents.”
GGovoverernanancncee, ththenen oonn GGovoverernanancncee DoDocucumemen
Supporting Our Communities
Our organization has a long
and proud history, grounded
in the legacy of our community
-oriented traditions, and we
provide community support
in many ways.
• We’ve made significant investments in products and
people to ensure the availability and accessibility of
safe, transparent and fair financial products. Offerings
include a suite of products tailored to meet the
needs of unbanked, underbanked and low-to-
moderate income individuals in the communities
we serve, as well as programs to assist home buyers
with grants and savings programs.
• We recognize the need for affordable and special
needs housing and have provided debt and equity
financing for several important projects. We also
work with organizations to help them obtain funding
through the Federal Home Loan Bank of NY Affordable
Housing Program.
• Our strong commitment to small business lending
is demonstrated by Five Star Bank’s continued
recognition as a top lender in our geographic
footprint by the U.S. Small Business Administration.
• To support low- and moderate-income areas as well
as homebuying and housing opportunities, we invest
in municipal debt and mortgage-backed securities.
• Our associates give freely of their time and energy by
volunteering for non-profit organizations and events.
• We support many non-profit organizations across
our operating footprint with grant awards,
empowering individuals and neighborhoods in
the communities we serve.
The 2020 Five Star Bank Community Report, available
on our website and the Five Star website, provides
additional information regarding our many community
support initiatives.
Environmental Sustainability
We are committed to promoting sustainable and
environmentally friendly practices. We strive to reduce
the impact of our operations through decreased
energy consumption, increased recycling and the
thoughtful use of resources and materials.
Left: Chair of the Board Robert N. Latella
Right: Vice Chair of the Board Susan R. Holliday
Financial Institutions, Inc. 2020 Annual Report
07
Conclusion
I am very proud of our many accomplishments of the past year. We excelled at being
proactive rather than reactive, and provided essential support and services to our
customers, helping them navigate a period of great uncertainty. We delivered strong
financial results and made significant progress on fundamental strategic objectives
including loan and deposit growth, increased liquidity, the launch of our enhanced
digital banking platform, the streamlining of processes and operations and improved
expense efficiency.
I would like to express my gratitude and appreciation to all Five Star associates for
their extraordinary efforts over the last thirteen months and their continued
commitment and dedication to our customers, our communities and each other.
They adapted and persevered through many challenges, including new working
environments, and delivered strong outcomes for our shareholders.
I would also like to thank our Board of Directors for their leadership and guidance.
In particular, I thank retiring Board member Karl Anderson for his 15 years of dedicated
service to our Company. We have benefitted greatly from his strong legal and banking
experiences and leadership of Board committees. We wish Karl all the best in his
future endeavors.
Banking and the financial services industry are constantly changing, and the rate
of change was accelerated by the pandemic. This was clearly demonstrated by the
incredibly positive response to our digital banking launch in 2020 and the volume
of banking transactions now taking place on the Five Star Bank Digital Banking
platform. Our ongoing effective use of technology and data is critical for our success
in delivering the products and services that our customers expect and deserve.
This is a primary focus for 2021 and beyond.
We have experienced the intense effects of the health crisis on the economy and
our operations, yet we ended 2020 stronger than ever and remain well-positioned to
take care of our customers and communities. We recognize that many uncertainties
remain, yet I look forward to 2021 with hope for progress by our leaders in providing
essential support of the vaccination roll-out and a re-opening of our economy.
Thank you for your support and investment in Financial Institutions, Inc.
Cordially,
Martin K. Birmingham
President and Chief Executive Officer
Conclusion
Five Star Leadership
Leonid Gurevich
Director of Enterprise Risk Management
Heather L. Wisinski
Director of Operations
Jillian M. Mangiafesto
Corporate Counsel and
Assistant Corporate Secretary
Five Star Bank
Senior Management
Scott D. Bader
Technology Services Director
Adolph T. Barclift
Chief Information Security Officer
Laura J. Marlowe
Director of Marketing
Amy M. Barone
Director of Operations
Adam J. Bickel
BBU Team Leader
Justin K. Bigham 1 2
Executive Vice President,
Chief Community Banking Officer
Alison K. Miller
Commercial and Industrial Executive
and Central NY Regional President
W. Jack Plants II 1 2
Chief Financial Officer and Treasurer
Randall R. Phillips 1
Chief Risk Officer
Martin K. Birmingham 1 2
President and Chief Executive Officer
Cory M. Popen
Enterprise Data Manager
Bethany L. Bowers
Chief Compliance Officer and CRA Officer
Kevin B. Quinn 1
Chief Commercial Banking Officer
Samuel J. Burruano Jr. 1 2
Executive Vice President,
Chief Legal Officer and Corporate Secretary
Craig J. Burton
Commercial Real Estate Executive and Finger
Lakes/Southern Tier NY Regional President
Diane M. Camelio
Director of Retail Relationships
David G. Case
Chief Credit Officer
Jonathan W. Chase
Retail Lending Administrator
Shelly J. Doran
Director of Investor and External Relations
Daniel B. Duggan
Residential Lending Administrator
Sonia M. Dumbleton 2
Controller and Principal Accounting Officer
Karla J.L. Gadley
Community Development Officer
Michael D. Grover
Director of Financial Planning
and Analysis and Tax
Kathleen R. Robbins
Director of Product Management
Brenda B. Schell
Internal Audit Director
Sean M. Willett 1 2
Executive Vice President,
Chief Administrative Officer
Taylor S. Veenema
Director of Corporate Strategy
and Execution
Laurie L. Wisniewski
Director of Corporate Planning
and Facilities
SDN Insurance Agency, LLC
William E. Gallagher
Director of Commercial Sales
Andrea B. Heffler
Agency Director
Courier Capital, LLC
Thomas J. Hanlon
President
HNP Capital, LLC
John R. Piccirilli
President
Rebecca L. Westervelt
Senior Director of Operations
Board of Directors
Karl V. Anderson Jr. 3 7
Of Counsel at Mullen Associates PLLC
Martin K. Birmingham
President and CEO of Financial
Institutions, Inc. and Five Star Bank
Donald K. Boswell 3 6 8
President and CEO of the Western New
York Public Broadcasting Association
(WNED-TV and WBFO-FM)
Dawn H. Burlew 5 7 8
Director of Government Affairs &
Business Development, Global
Government Division of Corning
Incorporated
Andrew W. Dorn Jr. 4 5 7
Co-Managing Director and Director of
Government and Community Relations
of Energy Solutions Consortium, LLC
Robert M. Glaser 3
President of Glaser Consulting, LLC
Samuel M. Gullo 3 5
Owner and Operator of Family Furniture
Susan R. Holliday 4 5 6
Vice Chair of the Board of Financial
Institutions, Inc. and Five Star Bank;
CEO of Dumbwaiter Design, LLC
Robert N. Latella 4
Chair of the Board of Financial
Institutions, Inc. and Five Star Bank;
Of Counsel at Barclay Damon, LLP
Kim E. VanGelder 6 7 8
Chief Information Officer of Eastman
Kodak Company
1 Executive Management Committee Member
2 Financial Institutions, Inc. Officer
3 Audit Committee; Robert M. Glaser, Chair
4 Executive Committee; Robert N. Latella, Chair
5 Management Development and Compensation Committee; Andrew W. Dorn Jr., Chair
6 Nominating and Governance Committee; Susan R. Holliday, Chair
7 Risk Oversight Committee; Karl V. Anderson Jr., Chair
8 Technology and Data Committee; Kim E. VanGelder, Chair
Financial Institutions, Inc. 2020 Annual Report
09
Five Year Financial Highlights
(Dollars in thousands, except per share data)
At or for the year ended December 31,
2020
2019
2018
2017
2016
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 credit losses
Net interest income after provision for credit 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
Performance and Capital Ratios:
Net income, returns on:
Average assets
Average equity
Common dividend payout ratio
Net interest margin (fully tax-equivalent)
Effective tax rate
Efficiency ratio
Efficiency ratio 22
Common equity to assets
Tangible common equity to tangible assets 1
$4,912,306
3,542,718
900,025
4,278,367
78,923
468,363
451,035
377,246
$4,384,178
3,190,505
776,917
3,555,675
314,773
438,947
421,619
346,696
$4,311,698
3,052,684
892,258
3,366,907
508,702
396,293
378,965
302,792
$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
$161,299
22,314
138,985
27,184
111,801
43,176
109,254
45,723
7,391
$38,332
1,461
$36,871
$2.30
$2.30
$1.04
$28.12
$23.52
$32.70
$12.78
$22.50
0.82%
8.49%
45.22%
3.22%
16.2%
60 22%
60.22%
9.18%
7.80%
$168,800
38,888
129,912
8,044
121,868
40,381
102,828
59,421
10,559
48,862
1,461
47,401
$2.97
$2.96
$1.00
$26.35
$21.66
$33.28
$25.50
$32.10
1.14%
11.61%
33.67%
3.28%
17.8%
60 59%
60.59%
9.62%
8.05%
$152,732
29,868
122,864
8,934
113,930
36,478
100,876
49,532
10,006
$39,526
1,461
$38,065
$2.39
$2.39
$0.96
$23.79
$19.01
$34.35
$24.49
$25.70
0.95%
10.18%
40.17%
3.18%
20.2%
62 73%
62.73%
8.79%
7.15%
$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
0.86%
9.62%
39.91%
3.21%
22.9%
60 65%
60.65%
8.86%
7.17%
$115,231
12,541
102,690
9,638
93,052
35,760
84,671
44,141
12,210
$31,931
1,462
$30,469
$2.11
$2.10
$0.81
$20.82
$15.62
$34.55
$25.98
$34.20
0.90%
10.01%
38.39%
3.24%
27.7%
60 95%
60.95%
8.16%
6.25%
Reconciliation to Non-GAAP Financial Measure
Pre-tax pre-provision income:
Net Income
Add: Income tax expense
Add: Provision for credit losses
Pre-tax pre-provision income
$38,332
7,391
27,184
$72,907
$48,862
10,559
8,044
67,465
$39,526
10,006
8,934
58,466
$33,526
9,945
13,361
56,832
$31,931
12,210
9,638
53,779
Other data
Number of branches
Full time equivalent employees
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 36 of our Annual
Report on Form 10-K, which follows.
47
605
53
639
53
702
53
703
52
631
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.
1
2
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
Form 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
For the fiscal year ended December 31, 2020
OR
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)
16-0816610
(I.R.S. Employer Identification No.)
220 LIBERTY STREET, WARSAW, NEW YORK
(Address of principal executive offices)
14569
(ZIP Code)
Registrant’s telephone number, including area code: (585) 786-1100
Securities registered under Section 12(b) of the Exchange Act:
Title of each class
Common stock, par value $0.01 per share
Trading Symbol(s)
FISI
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 registrant 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 preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such
files).
Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an
emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company”
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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control
over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued
its audit report. ☑
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, 2020 closing price reported by Nasdaq, was approximately $292,245,000.
As of February 28, 2021, there were outstanding, exclusive of treasury shares, 15,816,318 shares of the registrant’s common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the 2021 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
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
PART III
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits and Financial Statement Schedules
Item 16.
Form 10-K Summary
Signatures
4
19
31
31
32
32
33
34
39
62
65
138
138
138
139
139
139
139
139
140
141
142
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 statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements
provide current expectations or forecasts of future events and include, among others:
•
•
statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial
condition, results of operations and performance of Financial Institutions, Inc. (the “Parent” 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:
•
Lack of seasoning in portions of our loan portfolio could increase risk of credit defaults in the future;
The COVID-19 pandemic, and governmental and individual efforts to contain the pandemic, have had a significant negative
impact on the U.S. and global economy which has and will continue to adversely affect our business, financial condition and
results of operations;
If we experience greater credit losses than anticipated, earnings may be adversely impacted;
•
• Geographic concentration may unfavorably impact our operations;
• Our commercial business and mortgage loans increase our exposure to credit risks;
• Our indirect and consumer 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;
• We are subject to environmental liability risk associated with our lending activities;
• We operate in a highly competitive industry and market area;
•
Changes to and replacement of the LIBOR Benchmark Interest Rate may adversely affect our business, financial condition,
and results of operations;
Legal and regulatory proceedings and related matters, such as the action brought by a putative class of consumers against us
as described in Part I, Item 3, “Legal Proceedings,” could adversely affect us and the banking industry in general;
•
•
• 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;
The policies of the Federal Reserve have a significant impact on our earnings;
•
• Our insurance brokerage subsidiary is subject to risk related to the insurance industry;
• Our investment advisory and wealth management operations are subject to risk related to the regulation of the financial
services industry and market volatility;
• 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;
The value of our goodwill and other intangible assets may decline in the future;
•
• We may be unable to successfully implement our growth strategies, including the integration and successful management of
newly-acquired businesses;
• Acquisitions may disrupt our business and dilute shareholder value;
• Our tax strategies and the value of our deferred tax assets and liabilities could adversely affect our operating results and
regulatory capital ratios;
Liquidity is essential to our businesses;
•
• We rely on dividends from our subsidiaries for most of our revenue;
•
• We face competition in staying current with technological changes and banking alternatives to compete and meet customer
If our risk management framework does not effectively identify or mitigate our risks, we could suffer losses;
demands;
• We rely on other companies to provide key components of our business infrastructure;
- 3 -
• 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 New York State cybersecurity regulations, may subject us to liability, result
in a loss of customer business or damage our brand image;
• We are subject to interest rate risk, and a rising rate environment may reduce our income and result in higher defaults on our
loans, whereas a falling rate environment may result in earlier loan prepayments than we expect, which may reduce our
income;
The soundness of other financial institutions could adversely affect us;
•
• 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 not pay or may reduce the dividends on our common stock;
• We may issue debt and equity securities or securities convertible into equity securities, any of which may be senior to our
common stock as to distributions and in liquidation, which could dilute our current shareholders or negatively affect the value
of our common stock;
• Our certificate of incorporation, our bylaws, and certain banking laws may have an anti-takeover effect;
•
The market price of our common stock may fluctuate significantly in response to a number of factors;
• We may not be able to attract and retain skilled people;
• We use financial models for business planning purposes that may not adequately predict future results;
• We depend on the accuracy and completeness of information about or from customers and counterparties;
• Our business may be adversely affected by conditions in the financial markets and economic conditions generally; and
•
Severe weather, natural disasters, public health emergencies and pandemics, acts of war or terrorism, and other external
events could significantly impact our business.
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 “FSB” or “the
Bank,” SDN Insurance Agency, LLC is referred to as “SDN,” Courier Capital, LLC is referred to as “Courier Capital” and HNP
Capital, LLC is referred to as “HNP Capital.” The consolidated financial statements include the accounts of the Parent, the Bank,
SDN, Courier Capital and HNP Capital. The Parent’s common stock is traded on the Nasdaq Global Select Market under the ticker
symbol “FISI.”
At December 31, 2020, the Company had consolidated total assets of $4.91 billion, deposits of $4.28 billion and shareholders’ equity
of $468.4 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 four 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 and (4) HNP Capital, which both
provide customized investment advice, wealth management, investment consulting and retirement plan services to individuals,
businesses, institutions, foundations and retirement plans. At December 31, 2020, the Bank represented 99.3%, SDN represented 0.3%
and Courier Capital and HNP Capital combined represented 0.4% of the consolidated assets of the Company.
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 47 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.
- 4 -
At December 31, 2020, the Bank had total assets of $4.88 billion, investment securities of $900.0 million, net loans of $3.54 billion,
deposits of $4.31 billion and shareholders’ equity of $479.0 million. 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.
SDN Insurance Agency, LLC
SDN is a full-service insurance agency founded in 1923 and headquartered in Amherst, NY. SDN offers personal, commercial and
financial services products. For the year ended December 31, 2020, SDN had total revenue of $4.3 million. On February 1, 2021, SDN
completed the acquisition of the assets of Landmark Group, an independent insurance brokerage firm.
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
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 and Jamestown. With $2.05 billion in assets under management as of December 31, 2020, Courier
Capital offers customized investment advice, wealth management, investment consulting and retirement plan services to individuals,
businesses and institutions. For the year ended December 31, 2020, Courier Capital had total revenue of $5.3 million.
HNP Capital, LLC
Acquired in June 2018, HNP Capital is an SEC-registered investment advisory and wealth management firm founded in 2009 and
based in Western New York, with offices in Rochester, New York. With $631.9 million in assets under management as of December
31, 2020, HNP Capital offers customized investment advice, wealth management, investment consulting and retirement plan services
to individuals, businesses and institutions. For the year ended December 31, 2020, HNP Capital had total revenue of $3.0 million.
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 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 also broadened our service offerings to include financial advice and insurance solutions
along with traditional banking needs.
- 5 -
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,
and in February 2020, the Federal Reserve Bank of New York and the New York State Department of Financial Services approved our
application to open two additional financial solution centers in Buffalo which are scheduled to open in 2021. 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 predominant form of consideration and/or the need for us to raise
capital.
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 experience
in acquisitions and post-acquisition integration of operations and is prepared to act promptly 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.
HUMAN CAPITAL RESOURCES STRATEGY
In order to continue to deliver on our mission of financial inclusion for all, it is crucial that we attract and retain talent who desire to
enable financial equality through delivery of capable solutions, thoughtful innovation and equitable consumer options in the markets
that we serve. To facilitate talent attraction and retention, we strive to make the Company an inclusive, safe and healthy workplace,
with opportunities for our employees to grow and develop in their careers, supported by strong compensation, benefits, health and
welfare programs.
Employee Profile
As of December 31, 2020, we had 613 employees in locations across the United States. This represents a decrease of 109 employees
or 15.1% from December 31, 2019 due primarily to the consolidation of eleven Bank branches into five, resulting in six branch
closings and a reduction in staffing as announced in July 2020, and with an additional Bank branch closure and related reduction in
staffing as announced in October 2020.
As of December 31, 2020, approximately 66.8% of our current workforce is female, 33.2% male, and our average tenure is 7.77 years,
an increase of 13.3% from an average tenure of 6.85 years as of December 31, 2019.
Total Rewards
As part of our compensation philosophy, we believe that we must offer and maintain market competitive total rewards programs for
our employees in order to attract and retain superior talent. In addition to market competitive base wages, our rewards programs
include performance-based bonus opportunities, equity compensation, Company-sponsored retirement plans, healthcare and insurance
benefits, health savings and flexible spending accounts, paid time off, family leave, family care resources, remote work arrangements,
flexible work schedules, adoption assistance, and employee assistance programs.
Health and Safety
The success of our business is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health,
safety and wellness of our employees. We provide our employees and their families with access to a variety of flexible and convenient
health and welfare programs, including benefits that support their physical and mental health by providing tools and resources to help
them improve or maintain their health status and that offer choice where possible so they can customize their benefits to meet their
needs and the needs of their families. In response to the COVID-19 pandemic, we implemented significant operating environment
- 6 -
changes that we determined were in the best interest of our employees, as well as the communities in which we operate, and which
comply with government regulations. This includes supporting a majority of our employees to work from home or remotely, while
implementing additional safety measures for employees continuing critical on-site work.
Talent
A core tenet of our talent system is to both develop talent from within and supplement with external hires. This approach has yielded
loyalty and commitment among our employees which in turn grows our business, our products, and our customers, while also adding
new talent, skillsets and ideas to support a continuous improvement mindset and our goals of a diverse and inclusive workforce. We
believe that our average tenure — 7.77 years as of December 31, 2020 — reflects the engagement of our employees in this core talent
system tenet.
Our talent acquisition team uses internal and external resources to recruit highly skilled and talented workers, and we incent employee
referrals for open positions.
Our performance management framework positions our leaders as coaches who continuously develop and grow talent through
ongoing performance and development discussions, formal talent and development assessments, goal setting and feedback and
performance-based compensation programs.
Diversity and Inclusion
We strive toward having a powerful and diverse team of employees, knowing we are better together with our combined wisdom and
intellect. With a commitment to equality, inclusion and workplace diversity, we focus on understanding, accepting, and valuing the
differences between people. To accomplish this, we have established a Diversity & Inclusion Advisory Council made up of 16
employee representatives throughout our operating footprint. We continued our commitment to equal employment opportunity
through a robust affirmative action plan which includes annual compensation analyses and ongoing reviews of our selection and hiring
practices alongside a continued focus on building and maintaining a diverse workforce.
MARKET AREAS AND COMPETITION
We provide a wide range of banking and financial services to individuals, municipalities and businesses through a network of over 45
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,
Wayne, Wyoming and Yates counties. Our banking activities, though concentrated in the communities where we maintain branches,
also extend into neighboring counties. In addition, our consumer indirect lending presence includes 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. For example, in February 2020, the Federal Reserve Bank of New York and the New York State
Department of Financial Services approved our application to open two additional financial solution centers in Buffalo which are
scheduled to open in 2021.
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, 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-traditional fintech firms and 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.
- 7 -
The following table presents the Bank’s market share percentage for total deposits as of June 30, 2020, 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, 2020 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
7.8%
23.9%
5.1%
1.6%
12.9%
0.4%
20.3%
34.3%
2.0%
13.5%
25.6%
25.9%
33.1%
58.3%
36.9%
Market
Rank
2
2
8
8
3
11
2
1
8
2
2
1
2
1
1
Number of
Branches (1)
1
4
1
1
2
4
2
5
8
4
2
2
5
4
2
(1) Number of branches current as of December 31, 2020.
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 Chief
Financial Officer and Treasurer, guided by our Asset-Liability Committee (“ALCO”), is responsible for investment portfolio decisions
within the established policies.
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;
•
•
•
• Derivative instruments; and
•
Limited partnership investments.
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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, 2020,
$411.5 million, or 52%, of our aggregate commercial business loan portfolio were at fixed rates, while $382.6 million, or 48%, 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. 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, 2020, $602.8 million, or 48%, of the loans in our aggregate commercial mortgage
portfolio were at fixed rates, while $651.1 million, or 52%, were at variable rates.
We utilize government loan guarantee programs where available and appropriate.
Government Guarantee Programs
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was passed by Congress and signed into law on March
27, 2020. The CARES Act established the Paycheck Protection Program (“PPP”), an expansion of the SBA’s 7(a) loan program and
the Economic Injury Disaster Loan Program (“EIDL”), administered directly by the SBA. As of December 31, 2020, we had PPP
loans with an aggregate principal balance of $253.1 million that were covered by guarantees under this program.
We participate in other 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, 2020, we had loans with an aggregate
principal balance of $29.6 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 reducing
credit risk.
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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. 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, 2020, our residential mortgage
servicing portfolio totaled $241.7 million, the majority of which has been sold to the FHLMC. As of December 31, 2020, our
residential real estate loan portfolio totaled $599.8 million, or 17% of our total loan portfolio. As of December 31, 2020, our
residential real estate lines portfolio totaled $89.8 million, or 3% of our total loan portfolio. As of December 31, 2020, $533.1 million,
or 89%, of the loans in our residential real estate loan portfolio were at fixed rates, while $66.7 million, or 11%, were at variable rates.
The residential real estate lines portfolio primarily consists of variable rate lines. Approximately 92% of the loans and lines in our
residential real estate portfolios were in first lien positions at December 31, 2020. 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, 2020, 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, 2020, our consumer indirect portfolio totaled $840.4 million, or 23% 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. A portion 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 $17.1 million as of December 31, 2020, all 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;
•
•
•
•
•
• Develop efforts to serve minority and other traditionally underserved communities; and
•
Comply with all relevant laws and regulations.
Our policy includes loan reviews, under the supervision of the Audit and Risk Oversight committees of our 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.
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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 credit 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 loans individually analyzed for impairment,
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 Credit Losses
The allowance for credit losses is established through charges to earnings in the form of a provision for credit losses. The allowance
reflects management’s estimate of the amount of probable credit losses in the portfolio, based on factors including, but not limited to:
Specific allocations for individually analyzed credits;
Segmentation of credit exposures by similar credit characteristics;
Correlation of segmented historical losses to a loss driver;
Evaluation of historical loss emergence by segment;
Evaluation and establishment of look-back periods by segment;
Evaluation of prepayment and curtailment experience by segment;
Evaluation of average life for each segment;
Levels and trends in delinquent and non-accruing loans;
Trends in volume and terms of loans;
Effects of changes in lending policy;
•
•
• Historical net charge-off experience by segment;
•
•
•
•
•
•
•
•
• National and local economic trends and conditions excluding the loss driver;
•
•
•
•
•
Regulatory environment;
Portfolio administration;
Potential funding of unfunded commitments;
Evaluation of held to maturity investments; and
Evaluation of deferred interest receivable.
Our methodology for estimating the allowance for credit losses includes the following:
1. Collateral dependent commercial business and commercial mortgage loans, as well as, non-collateral dependent criticized
loans of two-million dollars and greater are typically reviewed individually and assigned a specific loss allowance, if
considered necessary, in accordance with U.S. generally accepted accounting principles (“GAAP”). In addition, reflective of
the heightened risk resulting from long-term deferrals afforded under the CARES Act of certain commercial business and
commercial mortgage loans and individual analysis was performed on certain of the most at risk longer term deferrals and a
specific loss allowance was placed on them. Collectively, this is referred to as the Individually Analyzed component of the
allowance for credit losses estimate.
2. Loans not analyzed for a specific reserve are segmented into “pools” of loans based upon similar risk characteristics. This is
referred to as the Pooled Loan component of the allowance for credit losses estimate. The Company has identified six
portfolio segments of loans including Commercial Loans/Lines, Commercial Mortgage, Indirect Loans, Direct Loans,
Residential Lines of Credit, and Residential Loans. Each segment, or pool, is quantitatively analyzed using a discounted cash
flow approach over the life of the loan. The Pooled Loans estimate is based upon periodic review of the collectability of the
loans quantitatively correlating historical loan experience with reasonable and supportable forecasts using forward looking
information. Adjustments to the quantitative evaluation may be made for differences in current or expected qualitative risk
characteristics such as changes in: underwriting standards, delinquency level, regulatory environment, economic condition,
Company management and the status of portfolio administration including the Company’s Credit Risk Review function.
- 11 -
3. The Company’s held to maturity (“HTM”) debt securities are also required to utilize the current expected credit losses
approach to estimate expected credit losses. The Company’s HTM debt securities included securities that are issued by U.S.
government or U.S. government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the
U.S. government, are widely recognized as “risk free,” and have a long history of zero credit loss. The Company also carries
a portfolio of HTM municipal bonds. The Company measures its allowance for credit losses on HTM debt securities on a
collective basis by major security type. The estimate is based on historical credit losses, if any, adjusted for current conditions
and reasonable and supportable forecasts. The Company considers the nature of the collateral, potential future changes in
collateral values and available loss information.
4. The Company had made the election with the adoption of ASU 2016-13 of not measuring an allowance for credit losses for
accrued interest receivable due to the Company’s policy of writing off uncollectible accrued interest receivable balances in a
timely manner, as described above.
5. The reserve for unfunded commitments (the “Unfunded Reserve”) represents the expected credit losses on off-balance sheet
commitments such as unfunded commitments to extend credit and standby letters of credit. However, a liability is not
recognized for commitments unconditionally cancellable by the Company. The Unfunded Reserve is recognized as a liability
(other liabilities in the consolidated statements of financial condition), with adjustments to the reserve recognized as a
provision for credit loss expense in the consolidated statements of income. The Unfunded Reserve is determined by
estimating expected future fundings, under each segment, and applying the expected loss rates. Expected future fundings are
based on historical averages of funding rates (i.e., the likelihood of draws taken). To estimate future fundings on unfunded
balances, current funding rates are compared to historical funding rates.
Management presents a quarterly review of the adequacy of the allowance for credit losses to the Audit Committee of our Board of
Directors based on the methodology described above. See also the section titled “Allowance for Credit 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 also participate in reciprocal deposit programs, which enable depositors to receive FDIC insurance coverage for deposits
exceeding the maximum insurable amount. Through these programs, deposits in excess of the maximum insurable amount are placed
with multiple participating financial institutions. Reciprocal deposits totaled $612.3 million at December 31, 2020.
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.
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OTHER INFORMATION
We also make available, free of charge through our website, all reports filed with or furnished to the Securities and Exchange
Commission (“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.
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.
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.
Elements of the laws and regulations applicable to the Company and material to our operations 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 the
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). We are registered with the Federal Reserve as
a financial holding company (“FHC”). 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 financial 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 financial
holding company must obtain FRB approval before:
• Acquiring, directly or indirectly, ownership or control of any voting shares of another bank, financial holding company 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, financial holding company or bank holding company, or
• Merging or consolidating with another financial holding company or 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. However, the Gramm-Leach-
Bliley Act amended portions of the BHC Act to authorize financial holding companies, such as us, to directly or through non-bank
subsidiaries engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity. In order
to undertake and maintain these activities, a financial holding company must certify that all of the depository institutions controlled by
the company are well capitalized and well managed.
The Dodd-Frank Act. The Dodd-Frank Act significantly changed the regulation of financial institutions, such as community banks,
thrifts, and small bank and thrift holding companies, and the financial services industry. Among other things, the Dodd-Frank Act
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 has affected our business in substantial ways, including by causing us to incur higher operating costs to comply
with the Dodd-Frank Act. Certain provisions of the Dodd-Frank Act have yet to be fully implemented and may be impacted by future
legislation, rulemaking or executive orders. 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.
In May 2018, President Donald J. Trump signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act
(“Economic Growth Act”), which impacted several of the provisions of the Dodd-Frank Act. The enactment of the Economic Growth
Act provided certain regulatory relief to community banks, like us, with less than $10 billion in total consolidated assets. This relief
- 13 -
includes an exemption from the Volcker Rule, as implemented by final regulations published by the federal banking regulators
discussed below.
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.” The Economic Growth Act exempts banks 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. Because the Bank falls within the category of exempted banks, the Volcker Rule will
not have a material effect on our business, financial condition and results of operations. We cannot predict whether we may become
subject to the Volcker Rule, or a similar rule, following additional legislative or regulatory action concerning community banks.
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.
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 are based on the
final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee.
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 current minimum capital ratios, including an additional capital conservation buffer applicable to the
Company and the Bank, are:
•
•
•
7.0% CET1 to risk-weighted assets;
8.5% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and
10.5% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.
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.
The Basel III Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement
that mortgage-servicing rights (“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.
The Basel III Rules prescribe a standardized approach for risk weightings for a variety of asset classes that, depending on the nature of
the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures.
The Economic Growth Act provided for a potential exception from the Basel III Rules for community banks that maintain a
Community Bank Leverage Ratio (“CBLR”) of at least 8.0% to 10.0%. The CBLR is calculated by dividing Tier 1 capital by the
bank’s average total consolidated assets. In the final rules approved by the FDIC in September 2019, qualifying community banking
organizations that opt in to using the CBLR are considered to be in compliance with the Basel III Rules as long as the bank maintains
a CBLR of greater than 9.0%. If a bank is not a qualifying community banking organization, does not opt in to using the CBLR, or
cannot maintain a CBLR of greater than 9.0%, the bank would have to comply with the Basel III Rules. We are currently evaluating
the CBLR framework and the potential impact CBLR adoption would have on the Company and the Bank, respectively.
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. The liquidity coverage ratio (“LCR”), provided for in the Basel III liquidity framework, 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 financial or bank holding companies and depository institution subsidiaries of such financial or 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.
Similarly, the Basel III framework included a 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. In October 2020, the
U.S. banking agencies finalized the NSFR for application to U.S. banking organizations beginning in July 2021. The NSFR standard
requires large financial institutions to maintain a 1.0 ratio of available stable funding to required stable funding. The scope of financial
institutions to which this standard applies is consistent with the LCR standard, and accordingly, neither the Company nor the Bank is
required to comply with this standard. As a result, we do not manage our balance sheet to be compliant with these rules.
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. 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 CET 1 ratio of 6.5% or greater, a Tier 1 risk-based capital
ratio of 8.0% 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.
The FDIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the
capital category in which an institution is classified.
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
15, 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 financial 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 financial 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, 2021, the Bank could declare dividends of $53.0 million from retained net profits of the
preceding two years. The Bank declared dividends of $23.0 million and $20.0 million in 2020 and 2019, respectively.
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 U.S. 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 Dodd-Frank Act 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. As of September 30, 2018, the FDIC had exceeded the minimum reserve ratio of
1.35%. We received credits for the portion of our regular assessments that contributed to growth in the reserve ratio to 1.35%, which
applied to reduce regular assessments for quarters when the reserve ratio is at least 1.38%. We used these credits to reduce our regular
assessments through the first quarter of 2020.
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 paid 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. These assessments ceased in 2019 following the maturity of the bonds.
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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 or 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 consumers’ ability to understand a term or condition of a consumer financial product or service or take
unreasonable advantage of consumers’ (i) lack of financial savvy, (ii) inability to protect themselves in the selection or use of
consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in their 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.
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.”
The most recently completed evaluation of the Bank’s performance under the CRA was conducted by the NY DFS from January 1,
2012 through September 30, 2017 and resulted in an overall rating of “Satisfactory.” In reaching this rating, the NY DFS considered
the Bank’s lending practices by the areas served, the geographic distribution of loans, borrower characteristics and use in community
development projects, along with testing the ability of the Bank’s investment and service activities to meet community credit needs.
The last CRA evaluation completed by the FRB of New York was for the time period October 2013 to September 2018. This
performance evaluation resulted in an overall rating by the FRB of New York of “Satisfactory.” In reaching this rating the FRB of
New York considered several factors, including the geographic distribution of loans we made from October 2013 to September 2018
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.
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
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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.
The NY DFS requires 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.
Anti-Money Laundering and the USA Patriot Act. A major focus of governmental policy on financial institutions is combating
money laundering and terrorist financing. The USA PATRIOT Act of 2001 substantially broadened the scope of U.S. 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 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.
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.
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 any presidential or congressional action will result in any change to a bank’s ability to
establish a de novo branch in a host state.
Transactions with Affiliates. FII, FSB, Five Star REIT, SDN, Courier Capital and HNP 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 financial 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, 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.
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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 and HNP Capital are providers of investment consulting and financial planning
services and, as such, are each 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 FHC is generally excluded from regulation under the Advisers Act, the SEC has stated
that this exclusion does not apply to investment adviser subsidiaries of FHCs, such as Courier Capital and HNP Capital. Because
Courier Capital and HNP Capital each have over $100 million in assets under management, each is individually considered a “large
adviser,” which requires registration with the SEC by filing Form ADV, including Part 3 to Form ADV, or Form CRS, which
discloses the material terms of the advisor’s relationship with retail customers. Courier Capital and HNP Capital must update these
forms at least once each year and more frequently under certain specified circumstances. This registration covers Courier Capital or
HNP Capital and its employees as well as other persons under their control and supervision, such as independent contractors, provided
that their activities are undertaken on behalf of Courier Capital or HNP 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 and HNP Capital are subject to each of these obligations and, as applicable, restrictions, and are also subject to
examination by the SEC’s Office of Compliance, Investigations, and Examinations to assess their overall compliance with the
Advisers Act and the effectiveness of their internal controls.
Commencing in October 2013, prior to the Parent’s acquisition of Courier Capital and HNP Capital, 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 the Bank’s 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. The Federal banking agencies’
guidance on incentive compensation policies intend to ensure that the incentive compensation policies of banking organizations do not
encourage excessive risk-taking and undermine the safety and soundness of those organizations. 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 financial holding companies and depository institutions or
proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and/or our
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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.
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.
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 U.S. government, its agencies and various
other governmental regulatory authorities.
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 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.
Risks Related to the COVID-19 Pandemic
The COVID-19 pandemic, and governmental and individual efforts to contain the pandemic, have had a significant negative
impact on the U.S. and global economy which has and will continue to adversely affect our business, financial condition and
results of operations.
In response to the COVID-19 pandemic and resulting economic downturn, the Federal Reserve reduced the target federal funds rate to
a range of 0.00% to 0.25% and has stated that it intends to keep the rate near 0.00% until signs of higher inflation and a tighter labor
market emerge. This lower rate reduces the rate of interest we earn on loans and pay on borrowings and interest-bearing deposits and
can affect the value of financial instruments we hold. In an environment with lower interest rates, we will not be able to earn as much
on our interest-earning assets, which will likely reduce net interest margin. In addition, our ability to earn interest and receive dividend
income from investment securities will be reduced. If interest rates remain low for an extended period of time, our results of
operations could be materially adversely affected.
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The U.S. economy generally and our customers and employees in particular have been directly impacted by governmental orders
reducing travel and in-person interactions. Executive orders from the Governor of the State of New York may impact our ability to
keep our bank branch locations open. We expect we and our customers will continue to be impacted by social distancing efforts for
the duration of the COVID-19 pandemic. A significant proportion of our employees are working remotely, which may slow response
times to customers’ inquiries or preclude providing the level of service our employees are typically able to offer in person. Our
reputation and results of operations may be impacted if our competitors are better able to adjust to the restrictions on in-person
interactions and remote work. Furthermore, as our employees continue to work from home, our operational risk, including data
security risk, is higher than it would otherwise be, as cybercriminal activity has increased in an attempt to profit from the disruption to
typical operations. The cybersecurity-related risks we face include more phishing, malware, and other cybersecurity attacks,
vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, and
unauthorized dissemination, misuse or destruction of confidential or valuable information.
While we have experienced higher loan origination volume due to the PPP under the CARES Act, there can be no assurance that the
borrowers under the CARES Act programs will be able to pay the interest, and principal payments, if applicable, when they are due. If
the borrower of a PPP loan fails to qualify for loan forgiveness under the program, we will have to hold the loan at an unfavorable
interest rate as compared to a loan we may otherwise have extended to our customer. Even though those loans are guaranteed by the
SBA, we may not be able to collect from the SBA as quickly as those payments come due, and our cash flow and earnings may be
reduced accordingly. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a
deficiency in the manner in which we originated, funded or serviced the PPP loan, the SBA may deny its liability under the guaranty,
reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the
deficiency from us. Originations for consumer indirect lending, which currently constitutes 23.4% of our total loans, have declined
since the outbreak of the COVID-19 pandemic. If this trend continues, our financial condition and results of operations could be
materially adversely affected.
Our loan customers will likely be impacted by the overall decline in the U.S. economy, which may cause them to make late or reduced
payments on their loans or default on their loans with us. In particular, our commercial mortgage customers may be experiencing
higher rates of tenants not paying rent due to the COVID-19 pandemic. 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. The collateral securing our indirect loan portfolio in particular may not be sufficient to cover the full value of an
outstanding loan because the collateral, namely automobiles, are depreciating assets. Our credit risk has increased since the start of the
COVID-19 pandemic and related decline in the U.S. economy. In the event of delinquencies, regulatory changes and policies designed
to protect borrowers may slow or prevent us from taking certain remediation actions, including foreclosure. 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 credit losses based on a
number of factors. We believe that the allowance for credit losses is adequate. However, if our assumptions or judgments are wrong,
the allowance for credit 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 COVID-19 pandemic and resulting changes to the U.S. economy. The actual amount of future provisions for
credit losses may vary from the amount of past provisions. The longer the economic results of the COVID-19 pandemic negatively
impact our customers, the more likely our credit quality is to decline and the more likely our customers will be to default on their
loans with us. Continued economic disruption and fear of the spread of COVID-19 could result in business shutdowns, limitations on
commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial
property vacancy rates and reduced profitability and ability for property owners to make mortgage payments. If a significant
proportion of our customers are unable to repay their loans and the collateral securing repayment is insufficient to cover our losses, we
may have to increase our allowance for credit losses - loans, the quality of our loan portfolio will decline, our net income will
decrease, and our results of operations will be materially adversely impacted. In addition, our capital and leverage ratios may be
adversely impacted.
We believe our most significant exposure to COVID‐19-impacted industries is within: (i) retail and retail building, which is 13% of
our commercial real estate and commercial loan balances at December 31, 2020; (ii) hotel, motel and lodging, which is 4% of our
commercial real estate and commercial loan balances at December 31, 2020; (iii) health care, which is 3% of our commercial real
estate and commercial loan balances at December 31, 2020; (iv) restaurants and food services, which is 2% of our commercial real
estate and commercial loan balances at December 31, 2020; (v) entertainment and recreation, which is 2% of our commercial real
estate and commercial loan balances at December 31, 2020; and (vi) mining, quarrying and oil & gas which is less than 1% of our
commercial real estate and commercial loan balances at December 31, 2020.
At December 31, 2020, we held $144.5 million in debt securities that are issued by state and local government agencies, or municipal
bonds, that are backed by the credit and taxing power of the issuing jurisdiction. As these state and local governments experience the
impacts of the pandemic and stay at home orders, they are earning less sales tax revenue while incurring higher than expected costs as
a result of the COVID-19 pandemic. The impact of the COVID-19 pandemic may cause the credit rating of the municipal bonds we
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hold to be downgraded, which could in turn cause us to incur credit losses. If these bond issuers are unable to repay us when the bonds
mature, we could lose our investment and our results of operations and cash flows could be materially adversely impacted.
The market volatility related to the COVID-19 pandemic has driven market values of publicly traded securities downward. Because
the majority of our investment advisory revenue is from fees based on a percentage of assets under management, our investment
advisory revenues and profitability have fallen and will continue to fluctuate with the overall market conditions.
The spread of COVID-19 has led to an economic recession and continues to cause severe disruptions in the U.S. economy. Should the
COVID-19 pandemic continue for an extended period of time, our business, financial condition, results of operations and cash flows
may likewise continue to be materially adversely impacted for an extended period of time.
Credit Risks and Risks Related to Banking Activities
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 credit
losses based on a number of factors. We believe that the allowance for credit 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.
Geographic concentration may unfavorably impact our operations.
Substantially all of our 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.
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, including the impacts of the COVID-19 pandemic 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.
Our commercial business and mortgage loans increase our exposure to credit risks.
At December 31, 2020, our portfolio of commercial business and mortgage loans totaled $2,048.0 million, or 57.0% 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, or a prolonged
downturn for specific industries, could result in borrowers being unable to repay their loans, thus exposing us to increased credit risk.
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Our indirect and consumer 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. In addition, our consumer
lending activities are subject to numerous consumer protection laws and regulations, and if we were unable to comply with the
regulations applicable to our consumer lending activities, our financial condition and results of operations may be adversely affected.
Lack of seasoning in portions of our loan portfolio could increase risk of credit defaults in the future.
As a result of our growth over the past several years, certain portions of our loan portfolio, such as the increased size of our
commercial loan portfolio and in particular the PPP loans we originated, are of relatively recent origin. Loans may not begin to show
signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as “seasoning.”
As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because these portions of our
portfolio are relatively new, the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio
becomes more seasoned. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which
could have an adverse effect on our business, 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, 2020, we had $3.39 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 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.
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.
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 than us. 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 of our larger competitors may be able to achieve economies of
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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:
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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.
Changes to and replacement of the LIBOR Benchmark Interest Rate may adversely affect our business, financial condition,
and results of operations.
In 2017, the United Kingdom’s Financial Conduct Authority, a regulator of financial services firms and financial markets in the
United Kingdom, stated that it will only support the regulatory oversight of the London Interbank Offered Rate ("LIBOR") interest
rate indices through 2021. This announcement, and, more generally, financial benchmark reforms and changes in the interbank
lending markets, have resulted in uncertainty about the interest rate benchmarks that will be used in the future. In the United States,
efforts to identify a set of alternative U.S. dollar reference interest rates are ongoing, and the Alternative Reference Rate Committee
has recommended the use of a Secured Overnight Funding Rate (“SOFR”). SOFR is different from LIBOR in that it is a retrospective-
looking secured rate rather than a forward-looking unsecured rate. These differences could lead to a greater disconnect between our
and the Bank’s costs to raise funds for SOFR as compared to LIBOR. In addition to the discontinuance of LIBOR, there may be future
changes in the rules or methodologies used to calculate SOFR or other benchmarks, which may have a material adverse effect on the
value of or return on our financial assets and liabilities that are based on or are linked to LIBOR and other benchmarks. The
uncertainty related to these changes may have an unpredictable impact on the financial markets and could adversely impact our
financial condition or results of operations.
Legal and Regulatory Risks
Legal and regulatory proceedings and related matters could adversely affect us and the banking industry in general.
We have been, and may in the future be, subject to various legal and regulatory proceedings, including class action litigation. 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.
As disclosed in Part I, Item 3, “Legal Proceedings,” an action has been brought against us by four individuals seeking to represent a
putative class of consumers who are alleged to have obtained direct or indirect financing from us for the purchase of vehicles that we
later repossessed. If we settle these claims or the litigation is not resolved in our favor, we may suffer reputational damage and incur
legal costs, settlements or judgments that exceed the amounts covered by our existing insurance policies. We can provide no
assurances that our insurer will insure the legal costs, settlements or judgements we incur in excess of our deductible. If we are not
successful in defending ourselves from these claims, or if our insurer does not insure us against legal costs we incur in excess of our
deductible, the result may materially adversely affect our business, results of operations and financial condition. 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. There can be no guarantee that proceedings that may have a material adverse effect on our business,
results of operations or financial condition will not arise in the near or long-term future.
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.
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.
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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 the section captioned “Supervision and Regulation” included in Part I, Item 1
“Business” for more information about FDIC insurance premiums.
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 monetary fines or 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
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.
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.
Risks Related to Non-Banking Activities
Our insurance brokerage subsidiary 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 regulation of the financial
services industry and market volatility.
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
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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.
In addition, the broker-dealer services provided by Courier Capital and HNP Capital are subject to Regulation Best Interest, which
requires a broker-dealer to act in the best interest of a retail customer when making a recommendation to that customer of any
securities transaction or investment strategy involving securities. The regulation imposes heightened standards on broker-dealers and
will require us to review and modify the policies and procedures of our wealth management operations, as well as associated
supervisory and compliance controls.
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 affected.
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.
Strategic and Operational Risks
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. In particular, effective January 1,
2020, we have implemented FASB’s Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326) –
Measurement of Credit Losses on Financial Instruments, which requires us to recognize an allowance for credit losses based on
historical experience, current conditions and reasonable and supportable forecasts, as opposed to recognizing an allowance when it is
probable that a loss has been incurred. This change in GAAP increased our allowance for credit losses and created more volatility in
the level of our allowance for credit losses, and has been, and will continue to be, impacted by the Company’s loan and securities
portfolios’ composition, attributes and quality. 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.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2020, we had $66.1 million of goodwill and $7.7 million of other intangible assets. Although we did not record
any impairment to our goodwill during 2020, 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 the ongoing COVID-19 pandemic, may necessitate our taking charges in the future
related to the impairment of our goodwill. If the recent capital markets downturn resulting from the COVID-19 pandemic continues
for an extended period of time, or the capital markets continue to experience increased volatility, we may record an impairment to our
goodwill in subsequent fiscal periods. 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.
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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, such as
those related to the ongoing COVID-19 pandemic. 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 2018, we determined that the carrying value of our SDN reporting unit exceeded its fair value and
recorded a $2.4 million impairment charge. For further discussion, see Note 1, Summary of Significant Accounting Policies, and Note
8, Goodwill and Other Intangible Assets, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form
10-K.
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.
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 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.
Our growth strategy is also dependent upon the successful integration of new businesses and 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 operating our business
or pursuing other growth opportunities.
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 non-banking subsidiaries, SDN, Courier Capital and HNP Capital, by acquiring smaller insurance agencies and wealth
management firms in areas which complement our current footprint. We may be unsuccessful in expanding our non-banking
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 non-banking operations through smaller acquisitions, we may not be
able to achieve all of the expected benefits of the SDN, Courier Capital and HNP Capital 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:
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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.
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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, 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 rates.
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.
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.
If our risk management framework does not effectively identify or mitigate our risks, we could suffer losses.
Our risk management framework seeks to mitigate risk and appropriately balance risk and return. We have established processes and
procedures intended to identify, measure, monitor and report the types of risk to which we are subject, including credit risk, operations
risk, compliance risk, reputation risk, strategic risk, market risk, and liquidity risk. We seek to monitor and control our risk exposure
through a framework of policies, procedures and reporting requirements. Management of our risks in some cases depends upon the use
of analytical and/or forecasting models. If the models used to mitigate these risks are inadequate, we may incur losses. In addition,
there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated. If our
risk management framework does not effectively identify or mitigate our risks, we could suffer unexpected losses and could be
materially adversely affected.
Technology and Cybersecurity Risks
We face competition in staying current with technological changes and banking alternatives 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. 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. In addition,
technology and other changes are allowing consumers to utilize alternative methods to complete financial transactions that have
historically involved banks. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have
historically been held as bank deposits. Consumers can also complete transactions such as paying bills and transferring funds directly
without using a traditional bank as an intermediary. The process of eliminating banks as intermediaries could result in the loss of
customer deposits, the related income generated from those deposits and additional fee income. We may not be able to effectively
compete with these banking alternatives for consumer deposits. 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.
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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.
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.
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 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. 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.
We are subject to cybersecurity regulations promulgated by the NY DFS. Any failure by us to comply with these regulations could
also result in regulatory sanctions, public disclosure and reputational damage even if we do not experience a significant cybersecurity
breach.
Furthermore, as the threat of cyber attacks continue to evolve, we may be required to expend significant additional resources to
continue to modify or enhance our systems, or to investigate and remediate vulnerabilities in our systems. Due to the complexity and
interconnectedness of information technology systems, the process of enhancing our systems can itself create a risk of systems
disruptions and security issues.
Market Risks
We are subject to interest rate risk, and a rising rate environment may reduce our income and result in higher defaults on our
loans, whereas a falling rate environment may result in earlier loan prepayments than we expect, which may reduce our
income.
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.
- 28 -
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. In addition, our net interest margin may
contract in a rising rate environment because our funding costs may increase faster than the yield we earn on our interest-earning
assets. In a rising rate environment, loans with adjustable interest rates are more likely to experience a higher rate of default. The
combination of these events may adversely affect our financial condition and results of operations.
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. In addition, in a falling rate environment, loans may be prepaid sooner than we
expect, which could result in a delay between when we receive the prepayment and when we are able to redeploy the funds into new
interest-earning assets and in a decrease in the amount of interest income we are able to earn on those assets. If we are unable to
manage these risks effectively, our financial condition and results of operations could be materially adversely affected.
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.
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.
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 may not be able to access required capital 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.
Risks Related to our Common Stock
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
- 29 -
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.
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 FASB or other regulatory agencies;
legislative and regulatory actions subjecting us to additional or different 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.
General Risk Factors
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.
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 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 of
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.
- 30 -
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 occurrence of any of these conditions could have a
material adverse effect on our financial condition and results of operations.
Severe weather, natural disasters, public health emergencies and pandemics, acts of war or terrorism, and other external
events could significantly impact our business.
Severe weather, natural disasters, public health emergencies and pandemics, 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.
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 47 branch offices, of which 32 are owned and 15 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 has operations at a leased facility in
Rochester, New York and in one leased retail location.
Courier Capital operates from an owned 11,000 square foot office, located in Buffalo, New York. Courier Capital also has operations
at 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 7, Premises and
Equipment, Net, and Note 14, Commitments and Contingencies, in the accompanying financial statements included in Part II, Item 8,
of this Annual Report on Form 10-K.
- 31 -
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.
Regardless of the outcome, litigation can have an adverse impact on us because of prosecution, defense and settlement costs,
unfavorable awards, diversion of management resources and other factors.
We are party to an action filed against us on May 16, 2017 by Matthew L. Chipego, Charlene Mowry, Constance C. Churchill and
Joseph W. Ewing in the Court of Common Pleas in Philadelphia, Pennsylvania. Plaintiffs seek class certification to represent classes
of consumers in New York and Pennsylvania along with statutory damages, interest and declaratory relief. The plaintiffs seek to
represent a putative class of consumers who are alleged to have obtained direct or indirect financing from us for the purchase of
vehicles that we later repossessed. The plaintiffs specifically claim that the notices the Bank sent to defaulting consumers after their
vehicles were repossessed did not comply with the relevant portions of the Uniform Commercial Code in New York and
Pennsylvania. We dispute and believe we have meritorious defenses against these claims and plan to vigorously defend ourselves.
In February 2020, we agreed to engage in mediation with the plaintiffs but mediation has not yet commenced. On October 19, 2020,
the Court granted plaintiffs’ motion for judgment on the pleadings dismissing our affirmative defense against one named New York
plaintiff that his claim was time-barred under New York law, applying a six-year statute of limitations rather than the three years
limitation period we had argued. The issue of class certification has been briefed and the parties are awaiting a pre-certification
conference date and hearing date.
If we settle these claims or the action is not resolved in our favor, we may suffer reputational damage and incur legal costs, settlements
or judgments that exceed the amounts covered by our existing insurance policies. We can provide no assurances that our insurer will
insure the legal costs, settlements or judgements we incur in excess of our deductible. If we are unsuccessful in defending ourselves
from these claims or if our insurer does not insure us against legal costs we incur in excess of our deductible, the result may materially
adversely affect our business, results of operations and financial condition.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
- 32 -
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 28, 2021, 15,816,318
shares of our common stock were outstanding and there were 186 registered shareholders of record.
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 15, 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, 2015 as reported by the Nasdaq Global Select Market, through December 31, 2020, (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 of Major Exchange (NYSE, NYSE American 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.
Index
Financial Institutions, Inc.
NASDAQ Composite Index
SNL Bank $1B-$5B Index
Period Ending
12/31/15 12/31/16 12/31/17 12/31/18 12/31/19 12/31/20
100.00 125.61 117.41 100.07 129.23 96.22
100.00 108.87 141.13 137.12 187.44 271.64
100.00 143.87 153.37 134.37 163.35 138.81
- 33 -
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 credit losses
Net interest income after provision for credit 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
2020
At or for the year ended December 31,
2018
2017
2019
2016
$ 4,912,306
3,542,718
900,025
4,278,367
78,923
468,363
451,035
377,246
$ 4,384,178
3,190,505
776,917
3,555,675
314,773
438,947
421,619
346,696
$ 4,311,698
3,052,684
892,258
3,366,907
508,702
396,293
378,965
302,792
$ 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
$
$
$
$
$
$
$
$
$
$
$
161,299
22,314
138,985
27,184
111,801
43,176
109,254
45,723
7,391
38,332
1,461
36,871
2.30
2.30
1.04
28.12
23.52
32.70
12.78
22.50
$
$
$
$
$
$
$
$
$
$
$
168,800
38,888
129,912
8,044
121,868
40,381
102,828
59,421
10,559
48,862
1,461
47,401
2.97
2.96
1.00
26.35
21.66
33.28
25.50
32.10
$
$
$
$
$
$
$
$
$
$
$
152,732
29,868
122,864
8,934
113,930
36,478
100,876
49,532
10,006
39,526
1,461
38,065
2.39
2.39
0.96
23.79
19.01
34.35
24.49
25.70
$
$
$
$
$
$
$
$
$
$
$
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
12,541
102,690
9,638
93,052
35,760
84,671
44,141
12,210
31,931
1,462
30,469
2.11
2.10
0.81
20.82
15.62
34.55
25.98
34.20
(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.
- 34 -
(Dollars in thousands)
Performance ratios:
Net income, returns on:
Average assets
Average equity
Net income available to common shareholders, returns on:
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
Common equity Tier 1 capital ratio
Tier 1 capital ratio
Total risk-based capital ratio
Average equity to average assets
Common equity to assets
Tangible common equity to tangible assets (1)
2020
At or for the year ended December 31,
2018
2019
2017
0.82%
8.49%
1.14%
11.61%
0.95%
10.18%
0.86%
9.62%
8.50%
10.25%
0.80%
45.22%
3.22%
16.2%
60.22%
8.25%
10.18%
10.63%
13.61%
9.61%
9.18%
7.80%
11.74%
14.45%
1.13%
33.67%
3.28%
17.8%
60.59%
9.00%
10.31%
10.80%
12.77%
9.82%
9.62%
8.05%
10.26%
12.95%
0.93%
40.17%
3.18%
20.2%
62.73%
8.16%
9.70%
10.21%
12.38%
9.31%
8.79%
7.15%
9.68%
12.51%
0.84%
39.91%
3.21%
22.9%
60.65%
8.13%
10.16%
10.74%
13.19%
8.95%
8.86%
7.17%
2016
0.90%
10.01%
10.10%
13.51%
0.88%
38.39%
3.24%
27.7%
60.95%
7.36%
9.59%
10.26%
12.97%
8.99%
8.16%
6.25%
Asset quality:
Non-performing loans
Non-performing assets
Allowance for credit 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 credit losses - loans to total loans
Allowance for credit losses - loans to non-performing
loans
Other data:
Number of branches
Full time equivalent employees
$
$
$
$
9,517
12,483
52,420
13,815
$
$
$
$
0.26%
0.25%
0.40%
1.46%
8,640
9,108
30,482
11,476
$
$
$
$
0.27%
0.21%
0.37%
0.95%
$
7,141
$
7,371
$
33,914
9,692
$
0.23%
0.17%
0.33%
1.10%
$
12,531
$
12,679
$
34,672
9,623
$
0.46%
0.31%
0.38%
1.27%
6,326
6,433
30,934
5,789
0.27%
0.17%
0.26%
1.32%
551%
353%
475%
277%
489%
47
605
53
703
53
702
53
639
52
631
(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.
- 35 -
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
2020
At or for the year ended December 31,
2018
2017
2019
2016
$ 451,035
73,789
$ 377,246
$ 421,619
74,923
$ 346,696
$ 378,965
76,173
$ 302,792
$ 363,848
74,703
$ 289,145
$ 302,714
75,640
$ 227,074
$ 4,912,306
73,789
$ 4,838,517
$ 4,384,178
74,923
$ 4,309,255
$ 4,311,698
76,173
$ 4,235,525
$ 4,105,210
74,703
$ 4,030,507
$ 3,710,340
75,640
$ 3,634,700
Tangible common equity to tangible assets (1)
7.80%
8.05%
7.15%
7.17%
6.25%
Common shares outstanding
Tangible common book value per share (2)
16,042
23.52
$
16,003
21.66
$
15,929
19.01
$
15,925
18.16
$
14,538
15.62
$
Computation of average tangible common equity:
Average common equity
Average goodwill and other intangible assets, net
Average tangible common equity
Computation of average tangible assets:
Average assets
Average goodwill and other intangible assets, net
Average tangible assets
$ 433,908
74,364
$ 359,544
$ 403,689
75,557
$ 328,132
$ 371,023
76,990
$ 294,033
$ 331,184
74,818
$ 256,366
$ 301,666
76,170
$ 225,496
$ 4,693,225
74,364
$ 4,618,861
$ 4,285,825
75,557
$ 4,210,268
$ 4,171,972
76,990
$ 4,094,982
$ 3,896,071
74,818
$ 3,821,253
$ 3,547,105
76,170
$ 3,470,935
Net income available to common shareholders
Return on average tangible common equity (3)
Return on average tangible assets (4)
$
$
36,871
10.25%
0.80%
$
47,401
14.45%
1.13%
$
38,065
12.95%
0.93%
$
32,064
12.51%
0.84%
30,469
13.51%
0.88%
(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.
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.
- 36 -
SELECTED QUARTERLY DATA
(Dollars in thousands, except per share data)
2020
Interest income
Interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit 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
Cash dividends declared per common share
2019
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
Cash dividends declared per common share
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
$
$
$
$
$
$
40,168
3,987
36,181
5,495
30,686
11,336
26,534
15,488
1,688
13,800
365
13,435
$
$
$
39,719
4,220
35,499
4,028
31,471
12,217
28,475
15,213
2,940
12,273
365
11,908
$
$
$
39,759
5,578
34,181
3,746
30,435
9,713
26,575
13,573
2,441
11,132
366
10,766
$
$
$
$
0.84
0.84
$
0.74
0.74
$
0.67
0.67
0.26
$
0.26
$
0.26
$
42,179
9,006
33,173
2,653
30,520
9,667
26,768
13,419
312
13,107
365
12,742
$
$
$
42,459
9,976
32,483
1,844
30,639
12,361
25,886
17,114
4,281
12,833
365
12,468
$
$
$
42,648
10,184
32,464
2,354
30,110
9,233
25,003
14,340
2,939
11,401
366
11,035
$
$
$
41,653
8,529
33,124
13,915
19,209
9,910
27,670
1,449
322
1,127
365
762
0.05
0.05
0.26
41,514
9,722
31,792
1,193
30,599
9,120
25,171
14,548
3,027
11,521
365
11,156
$
0.80
0.79
$
0.78
0.78
$
0.69
0.69
0.70
0.70
0.25
$
0.25
$
0.25
$
0.25
(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.
- 37 -
2020 FOURTH QUARTER RESULTS
Net income was $13.8 million for the fourth quarter of 2020 compared with $13.1 million for the fourth quarter of 2019. After
preferred dividends, net income available to common shareholders for the fourth quarter of 2020 was $13.4 million or $0.84 per
diluted share, compared to $12.7 million or $0.79 per share in the fourth quarter of 2019.
Net interest income was $36.2 million for the fourth quarter of 2020 compared with $33.2 million for the fourth quarter of 2019. The
increase was primarily related to an increase in average interest-earning assets, partially offset by a decrease in net interest margin.
The increase in average interest-earning assets was primarily due to increases in Federal Reserve interest-earning cash, investment
securities and loans. Our net interest margin in 2020 has been impacted by the interest rate environment that reflects a flatter yield
curve and lower rates. In addition, PPP loans contributed to net interest income in 2020 but resulted in reduced margin given the
lower-yielding nature of these loans. In the fourth quarter, our excess liquidity position placed further pressure on net interest margin.
As we continued to experience a heightened Federal Reserve interest-earning cash balance, excess liquidity was deployed into the
investment securities portfolio, albeit at lower comparative yields, reflective of current market conditions.
The provision for credit losses was $5.5 million for the fourth quarter of 2020 compared with $2.7 million for the fourth quarter of
2019. Net charge-offs for the fourth quarter of 2020 were $2.4 million, or 0.27% annualized, of average loans, compared to
$3.9 million, or 0.48% annualized, of average loans in the fourth quarter of 2019.
Noninterest income was $11.3 million for the fourth quarter of 2020 compared to $9.7 million in the fourth quarter of 2019. The
increase was primarily due to an increase in net gain on sale of loans held for sale in 2020 reflecting increased volume of residential
real loans for sale and an increase in margin on these transactions. In addition, the increase was attributable to an increase in income
from investments in limited partnerships in 2020 and was partially offset by a decrease in service charges on deposits reflecting lower
insufficient fund fees in 2020.
Noninterest expense was relatively flat at $26.5 million for the fourth quarter of 2020 compared to $26.8 million in the fourth quarter
of 2019. The flat results were primarily due to decreases in advertising and promotions expense, salaries and employee benefits
expense and professional services expense, partially offset by increases in FDIC assessments and computer and data processing
expense.
Income tax expense was $1.7 million in the fourth quarter of 2020, representing an effective tax rate of 10.9%, compared to $312
thousand in the fourth quarter of 2019, representing an effective tax rate of 2.3%. The effective tax rates for the fourth quarter of 2020
and 2019 were positively impacted by tax credit investments placed in service, resulting in an income tax expense reduction of
approximately $915 thousand and $2.7 million, respectively. Effective tax rates are impacted by items of income and expense that are
not subject to federal or state taxation. In addition to the factors described above, our effective tax rates differ from statutory rates
primarily because of interest income from tax-exempt securities, earnings on company owned life insurance and tax credit investments
placed in service.
- 38 -
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, SDN Insurance Agency, LLC (“SDN”), a full-service insurance agency. In addition, we offer customized
investment advice, wealth management, investment consulting and retirement plan services through our wholly-owned subsidiaries
Courier Capital, LLC (“Courier Capital”) and HNP Capital, LLC (“HNP Capital”), SEC-registered investment advisory and wealth
management firms.
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
2020 Financial Performance Review
Net income decreased $10.6 million, or 22%, to $38.3 million for 2020, compared to $48.9 million for 2019. This resulted in a 0.82%
return on average assets and an 8.49% return on average equity. Net income available to common shareholders was $36.9 million or
$2.30 per diluted share for 2020, compared to $47.4 million or $2.96 per diluted share for 2019. We declared cash dividends of $1.04
per common share during 2020, an increase of $0.04 per common share or 4% compared to the prior year.
Results for 2020 were negatively impacted by a higher provision for credit losses of $27.2 million, as compared to $8.0 million in
2019. The higher provision was driven by the adoption of the current expected credit loss (“CECL”) standard and uncertainty around
the long-term impact of the COVID-19 pandemic on the economic environment.
Fully-taxable equivalent net interest income was $139.9 million in 2020, an increase of $8.8 million, or 7%, compared to 2019. The
increase was the result of a $356.0 million, or 9% increase in average interest-earning assets, partially offset by a six-basis point
decrease in the net interest margin, to 3.22%.
The provision for credit losses - loans was $26.2 million in 2020 compared to $8.0 million in 2019. Net charge-offs increased $2.3
million from the prior year to $13.8 million in 2020. Net charge-offs were an annualized 0.40% of average loans in the current year
compared to 0.37% in 2019. In addition, non-performing loans increased $877 thousand to $9.5 million compared to a year ago and
represented 0.26% of total loans at December 31, 2020.
Noninterest income totaled $43.2 million for the full year 2020, an increase of $2.8 million, or 7%, when compared to the prior year.
The increase is primarily attributed to increases in income from derivatives instruments, net and net gain on sale of loans held for sale,
partially offset by decreases in service charges on deposits and other noninterest income. Income from derivative instruments, net
increased $3.2 million to $5.5 million in 2020 driven by an increase in the volume and value of interest rate swap transactions. Income
from derivative instruments, net primarily consists of income associated with interest rate swap products offered to commercial loan
customers and is based on the number and value of transactions executed. Net gain on sale of loans held for sale increased $2.5
million to $3.9 million during the current year as a result of increased volume and higher margins on residential real estate loans held
for sale. Service charges on deposits decreased $2.4 million to $4.8 million during the current year primarily due to our temporary
COVID-19 relief initiatives implemented in 2020, including waiving or eliminating certain fees and lower insufficient fund fees for
the remainder of 2020. In addition, other noninterest income decreased $1.0 million to $4.3 million in 2020 primarily due to decreased
FHLB dividends due to the lower level of FHLB borrowings in 2020 versus 2019. Lower pay-by-phone fees associated with our
temporary COVID-19 consumer relief initiatives, coupled with the impact of stay-at home orders that reduced certain volume-based
fees like merchant revenue and corresponding credit card fees also contributed to the decrease in other noninterest income.
- 39 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Noninterest expense for the full year 2020 totaled $109.3 million, a $6.4 million increase compared to $102.8 million in the prior year.
Salaries and benefits expense increased $3.0 million year-over-year, primarily as a result of higher salaries, incentives and severance
expense, partially offset by a staff reduction associated with our Enterprise Standardization Program described below in the second
half of the year. Computer and data processing expense increased $1.7 million year-over-year, primarily as a result of costs related to
the new online and mobile platform combined with other investments in technology. Also contributing to the increase were higher
FDIC assessments in 2020 and $1.5 million of restructuring charges representing non-recurring real estate charges related to the
branch closings and staff reductions as part of our Enterprise Standardization Program announced in July 2020.
Income tax expense for the year was $7.4 million, representing an effective tax rate of 16.2% compared to an effective tax rate of
17.8% in 2019. Effective tax rates are impacted by items of income and expense not subject to federal or state taxation. The
Company’s effective tax rates differ from statutory rates primarily because of interest income from tax-exempt securities, earnings on
company owned life insurance and tax credit investments placed in service.
Total assets were $4.91 billion at December 31, 2020, up $528.1 million from $4.38 billion at December 31, 2019.
Investment securities were $900.0 million at December 31, 2020, up $123.1 million from December 31, 2019. The increase from year-
end 2019 was primarily due to the reinvestment of cash flow from the portfolio, coupled with the deployment of excess liquidity into
cash flowing agency backed securities.
Total loans were $3.60 billion at December 31, 2020, up $374.2 million, or 12%, from December 31, 2019.
•
•
•
•
Commercial mortgage loans totaled $1.25 billion, an increase of $147.6 million, or 13%, from December 31, 2019.
Commercial business loans totaled $794.1 million, an increase of $222.1 million, or 39%, from December 31, 2019. The
increase was primarily attributable to PPP loans. At December 31, 2020 the PPP loan balance was $248.0 million, net of
deferred fees.
Residential real estate loans totaled $599.8 million, an increase of $27.5 million, or 5%, from December 31, 2019.
Consumer indirect loans totaled $840.4 million, a decrease of $9.6 million, or 1%, from December 31, 2019.
Total deposits were $4.28 billion at December 31, 2020, an increase of $722.7 million from December 31, 2019, which was primarily
due to increases in the non-public demand and reciprocal deposit portfolios. Short-term borrowings were $5.3 million at December 31,
2020, a decrease of $270.2 million from December 31, 2019. The lower level of short-term borrowings in 2020 is attributable to an
increase in our brokered deposits portfolio, which were utilized as a cost-effective alternative to FHLB borrowings.
Shareholders’ equity was $468.4 million at December 31, 2020, compared to $438.9 million at December 31, 2019. Common book
value per share was $28.12 at December 31, 2020, an increase of $1.77, or 7%, from $26.35 at December 31, 2019. The increase in
shareholders’ equity as compared to December 31, 2019, is primarily attributable to net income less dividends paid, net of the change
in accumulated other comprehensive income.
The Company’s leverage ratio was 8.25% at December 31, 2020 compared to 9.00% at December 31, 2019. The Bank’s leverage ratio
and total risk-based capital ratio were 8.97% and 12.63%, respectively, at December 31, 2020, compared to 9.67% and 12.47%,
respectively at December 31, 2019.
Enterprise Standardization Program
The Company’s enterprise standardization program is focused on improving operational efficiency and enhancing future profitability.
On July 17, 2020, in connection with the program, Five Star Bank announced changes to adopt a full-service branch model that
streamlines retail branches to better align with shifting customer needs and preferences. The announcement was the result of a nine-
month comprehensive assessment of all lines of business and functional areas, conducted in partnership with a leading process
improvement organization. The data-driven analysis identified, among other things, overlapping service areas, automation
opportunities and streamlining of processes and operations.
The July announcement included the consolidation of eleven branches into five, resulting in six branch closings and a reduction in
staffing. An additional branch closure was announced in October. These actions resulted in one-time expenses related to severance and
real estate related charges of approximately $1.6 million in the third quarter of 2020 and approximately $148 thousand in the fourth
quarter. Expense savings of $2.7 million are anticipated on an annualized basis.
The enterprise standardization program is not yet complete as we continue to evaluate activities and functions across the organization,
focusing on ways to improve operational efficiency while enhancing the employee and customer experience.
- 40 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Subordinated Note Issuance
On October 7, 2020, the Company completed a private placement of $35 million of fixed-to-floating rate subordinated notes due 2030,
which were subsequently exchanged for subordinated notes with substantially the same terms (the “Notes”) that were registered under
the Securities Act of 1933, as amended, to qualified institutional buyers and accredited institutional investors. The Notes have a
maturity date of October 15, 2030, and bear interest, payable semi-annually, at the rate of 4.375% per annum, until October 15, 2025.
Commencing on that date, the interest rate will reset quarterly to an interest rate per annum equal to the then-current three-month
secured overnight financing rate (“SOFR”) plus 426.5 basis points, payable quarterly until maturity.
The Company is entitled to redeem the Notes, in whole or in part, on any interest payment date on or after October 15, 2025, and in
whole at any time upon certain other specified events. The proceeds were used for general corporate purposes and organic growth,
while a portion has been contributed to Five Star Bank to support regulatory capital ratios.
Stock Repurchase Program
On November 4, 2020, the Company announced a stock repurchase program for up to 801,879 shares of common stock, or
approximately 5% of the Company’s outstanding common shares. Shares may be repurchased in open market transactions and
pursuant to any trading plan adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing
and number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market
conditions, and other corporate liquidity requirements and priorities. The repurchase program does not obligate the Company to
purchase any shares and it may be extended, modified or discontinued at any time.
No shares were repurchased in 2020 under this program. In 2021, through February 28th, the Company repurchased 238,439 shares for
an average repurchase price of $24.30 per share, inclusive of transaction costs.
Insurance Subsidiary Acquisition
On February 1, 2021, SDN completed the acquisition of the assets of Landmark Group (“Landmark”). A staple of the Rochester
community since 1984, Landmark is an independent insurance brokerage firm delivering insurance, surety and risk management
solutions across many business sectors including construction, manufacturing, real estate and technology, as well as individual
personal insurance. Landmark Founder and Chairman Kelly M. Shea and President Christopher K. Shea will remain with SDN to lead
SDN’s Rochester operations and continue their long-term relationship with current clients.
Operational, Accounting and Reporting Impacts Related to the COVID-19 Pandemic
The COVID-19 pandemic has negatively impacted the global economy, including our operating footprint of Western and Central New
York. In response to this crisis, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was passed by Congress and
signed into law on March 27, 2020. The CARES Act provided an estimated $2.2 trillion to fight the COVID-19 pandemic and
stimulate the economy by supporting individuals and businesses through loans, grants, tax changes, and other types of relief. Some of
the provisions applicable to the Company include, but are not limited to:
•
•
Accounting for Loan Modifications - The CARES Act provides that a financial institution may elect to suspend (1) the
application of GAAP for certain loan modifications related to COVID-19 that would otherwise be categorized as a troubled
debt restructuring (“TDR”) and (2) any determination that such loan modifications would be considered a TDR, including the
related impairment for accounting purposes.
Paycheck Protection Program - The CARES Act established the Paycheck Protection Program (“PPP”), an expansion of the
Small Business Administration’s (“SBA”) 7(a) loan program and the Economic Injury Disaster Loan Program (“EIDL”),
administered directly by the SBA. On December 27, 2020, the Consolidated Appropriations Act, 2021 provided
approximately $284 billion for PPP loans in an additional round of funding under the program and extended the PPP through
March 31, 2021. This additional round of PPP loan funding is authorized for first-time borrowers and for second draws by
certain borrowers who have previously received PPP loans.
• Mortgage Forbearance - Under the CARES Act, through the earlier of December 31, 2020, or the termination date of the
COVID-19 national emergency, a borrower with a federally backed mortgage loan that is experiencing financial hardship due
to COVID-19 may request a forbearance. This relief has been extended by executive order through at least March 31, 2021.
- 41 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Also, in response to the COVID-19 pandemic, the Board of Governors of the Federal Reserve System (“FRB”), the Federal Deposit
Insurance Corporation (“FDIC”), the National Credit Union Administration (“NCUA”), the Office of the Comptroller of the Currency
(“OCC”), and the Consumer Financial Protection Bureau (“CFPB”), in consultation with the state financial regulators (collectively,
the “agencies”) issued a joint interagency statement (issued March 22, 2020; revised statement issued April 7, 2020). Some of the
provisions applicable to the Company include, but are not limited to:
•
•
•
Accounting for Loan Modifications - Loan modifications that do not meet the conditions of the CARES Act may still qualify
as a modification that does not need to be accounted for as a TDR. The agencies confirmed with FASB staff that short-term
modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not
TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of
repayment terms, or insignificant delays in payment.
Past Due Reporting - With regard to loans not otherwise reportable as past due, financial institutions are not expected to
designate loans with deferrals granted due to COVID-19 as past due because of the deferral. A loan’s payment date is
governed by the due date stipulated in the legal agreement. If a financial institution agrees to a payment deferral, these loans
would not be considered past due during the period of the deferral.
Nonaccrual Status and Charge-offs - During short-term COVID-19 modifications, these loans generally should not be
reported as nonaccrual or as classified.
Effective March 23, 2020 through July 9, 2020, for consumer customers, the Bank waived early CD penalty fees for withdrawals up to
$20,000 (limited to one penalty-free withdrawal per CD account); eliminated all insufficient funds (overdrafts) and returned item fees;
eliminated all Pay by Phone fees; waived all late fees; offered the opportunity for monthly mortgage, home equity loan or home equity
line payment relief; offered the opportunity to defer unsecured consumer loans or lines of credit and secured consumer loans and lines
of credit payments; and offered unsecured personal loans up to $5,000, up to 60 months at 2.95% APR subject to credit approval
(additional terms and conditions may apply). In addition, ATM access fees were reinitiated on September 19, 2020.
Business customers are being faced with challenging and unique circumstances. The Bank’s relationship bankers are highly skilled in
providing tailored financial solutions designed to meet the specific, individual needs of each business and they are actively reaching
out to each business customer to understand how the Bank can help, given each unique business circumstance.
As of December 31, 2020, we have helped more than 1,700 customers obtain more than $270 million in loans through the PPP.
Additionally, approximately 5% of our commercial loan and mortgage customers, 1% of our residential real estate loans and lines
customers and less than 1% of our indirect loans customers have active payment deferrals.
RESULTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 2020 AND DECEMBER 31, 2019
Net Interest Income and Net Interest Margin
Net interest income is our primary source of revenue, comprising 76% of revenue during the year ended December 31, 2020. Net
interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and
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.
- 42 -
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 decreased by
150 basis points due to two rate cuts in March of 2020. On March 3rd it decreased 50 basis points and on March 16th another 100 basis
points, resulting in a range of 0.00% to 0.25% at year-end 2020. The Federal Reserve had previously decreased the intended federal
funds rate by 25 basis points in each of August, September and October 2019, resulting in a range of 1.50% to 1.75% at year-end 2019
and increased the intended federal funds rate by 25 basis points in each of March, June, September and December 2018, resulting in a
range of 2.25% to 2.50% at year-end 2018. 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, decreased to 3.25% in March 2020, reflecting the rate cuts of 50 and 100 basis points after
the previous three 25 basis point decreases in 2019 to 4.75% and four 25 basis point increases to 5.50% in December 2018.
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
Analysis of Net Interest Income and Net Interest Margin
2020
2019
2018
$
$
161,299
871
162,170
22,314
139,856
$
$
168,800
1,103
169,903
38,888
131,015
$
$
152,732
1,353
154,085
29,868
124,217
Net interest income on a taxable equivalent basis for 2020 was $139.9 million, an increase of $8.8 million compared to $131.0 million
for 2019. The increase in net interest income was due primarily to an increase in average loans of $293.1 million, or 9%, compared to
2019, partially offset by a decrease in average investment securities of $27.8 million or, 3%, compared to 2019.
Our net interest margin for 2020 was 3.22%, six-basis points lower than 3.28% from the prior year. This decrease was a function of a
ten-basis point lower contribution from net free funds and a four-basis point increase in the interest rate spread. The lower interest rate
spread was a net result of a 53-basis point decrease in the yield on average interest-earning assets and a 57-basis point decrease in the
cost of interest-bearing liabilities.
For the year ended December 31, 2020, the yield on average earning interest-assets of 3.73% was 53-basis points lower than 2019.
Loan yields decreased 59-basis points during 2020 to 4.18%. The yield on investment securities decreased eight-basis points during
2020 to 2.31%. Overall, the interest-earning asset rate changes decreased interest income by $20.6 million during 2020 while a
favorable volume variance increased interest income by $12.8 million, which collectively drove a $7.7 million decrease in interest
income.
Average interest-earning assets were $4.35 billion for 2020 compared to $3.99 billion for 2019, an increase of $356.0 million, or 9%,
with average loans up $293.1 million from $3.14 billion to $3.44 billion and average securities down $27.8 million from $822.7
million to $794.9 million. The growth in average loans reflected increases in the commercial loans and residential real estate loans
categories. Commercial loans, in particular, were up $309.2 million from $1.60 billion to $1.90 billion, or 19%, from 2019, primarily
due to the PPP. Residential real estate loans were up $40.1 million, partially offset by decreases of $45.9 million in consumer loans
and $10.3 million in residential real estate lines. Loans comprised 79.1% of average interest-earning assets during 2020 compared to
78.8% during 2019. 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 2020, a
decrease of 59 basis points compared to 4.77% for 2019. The unfavorable rate variance resulted in a $19.4 million decrease in interest
income, partially offset by a $13.0 million increase due to an increase in the volume of average loans. Securities comprised 18.3% of
average interest-earning assets in 2020 compared to 20.6% in 2019. The taxable equivalent yield on average securities was 2.31% in
2020 compared to 2.39% in 2019. The decrease in the volume of average securities resulted in a $707 thousand decrease in interest
income, in combination with a $593 thousand decrease due to the unfavorable rate variance.
For the year ended December 31, 2020, the cost of average interest-bearing liabilities of 0.69% was 57 basis points lower than 2019.
The cost of average interest-bearing deposits decreased 47 basis points to 0.57%, the cost of short-term borrowings decreased 71 basis
points to 1.85% and the cost of long-term borrowings decreased 21 basis point to 6.09%. Overall, interest-bearing liability rate and
volume decreases resulted in $16.6 million of lower interest expense during 2020.
Average interest-bearing liabilities of $3.25 billion in 2020 were $165.5 million, or 5%, higher than 2019. On average, interest-bearing
deposits grew $380.7 million and noninterest-bearing demand deposits (a principal component of net free funds) were up
- 43 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
$184.3 million. The increase in average deposits was due to growth in non-public demand and reciprocal deposits as well as growth in
brokered deposits, which were utilized as a cost-effective alternative to FHLB borrowings. For further discussion of our reciprocal and
brokered deposits, refer to the “Funding Activities – Deposits” section of this Management’s Discussion and Analysis. Overall,
interest-bearing deposit rate and volume changes resulted in $10.7 million of lower interest expense during 2020. Average short-term
and long-term borrowings were $133.9 million in 2020, $215.2 million lower than in 2019. Overall, short- and long-term borrowing
rate and volume changes resulted in $5.9 million of lower interest expense during 2020.
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 credit 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 demand deposits
Other noninterest-bearing liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
2020
Years ended December 31,
2019
2018
Average
Balance
Interest
Average
Rate
Average
Balance
Interest
Average
Rate
Average
Balance
Interest
Average
Rate
$ 112,802
$
315
0.28% $
22,023
$
395
1.80% $
24,906
$
428
1.72%
14,186
4,149
18,335
26,667
49,962
21,320
3,802
40,003
1,766
143,520
162,170
1,091
4,788
11,943
17,822
1,604
2,888
4,492
22,314
626,221
168,687
794,908
735,535
1,164,827
587,620
97,321
836,168
16,007
3,437,478
4,345,188
(45,697 )
393,734
$ 4,693,225
$ 714,904
1,443,692
959,541
3,118,137
86,495
47,387
133,882
3,252,019
905,412
84,558
451,236
$ 4,693,225
14,382
5,253
19,635
29,630
52,514
20,995
5,508
39,235
1,991
149,873
169,903
1,372
4,365
22,757
28,494
7,923
2,471
10,394
38,888
2.27
2.46
2.31
3.63
4.29
3.63
3.91
4.78
11.03
4.18
3.73
0.15
0.33
1.24
0.57
1.85
6.09
3.36
0.69
610,251
212,493
822,744
569,941
1,021,220
547,505
107,654
882,056
16,047
3,144,423
3,989,190
(34,143 )
330,778
$ 4,285,825
$ 655,534
983,447
1,098,440
2,737,421
309,893
39,235
349,128
3,086,549
721,133
57,126
421,017
$ 4,285,825
2.36
2.47
2.39
5.20
5.14
3.83
5.12
4.45
12.41
4.77
4.26
0.21
0.44
2.07
1.04
2.56
6.30
2.98
1.26
724,944
259,609
984,553
498,552
876,484
492,165
112,872
901,066
16,682
2,897,821
3,907,280
(35,312 )
300,004
$ 4,171,972
$ 665,255
1,008,665
936,157
2,610,077
394,679
39,165
433,844
3,043,921
713,152
26,548
388,351
$ 4,171,972
16,510
6,444
22,954
24,836
43,580
18,645
5,320
36,268
2,054
130,703
154,085
1,067
2,887
15,101
19,055
8,342
2,471
10,813
29,868
2.28
2.48
2.33
4.98
4.97
3.79
4.71
4.03
12.31
4.51
3.94
0.16
0.29
1.61
0.73
2.11
6.31
2.49
0.98
Net interest income (tax-equivalent)
$ 139,856
$ 131,015
$ 124,217
Interest rate spread
Net earning assets
Net interest margin (tax-equivalent)
Ratio of average interest-earning assets to
average interest-bearing liabilities
$ 1,093,169
3.04%
$ 902,641
3.22%
3.00%
$ 863,359
3.28%
2.96%
3.18%
133.62%
129.24%
128.36%
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 Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” included elsewhere in this
report.
- 44 -
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 income or interest expense 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:
Change from 2019 to 2020
Change from 2018 to 2019
Volume
Rate
Total
Volume
Rate
Total
$
488
$
(568) $
(80) $
(51) $
18
$
(33)
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 Credit Losses
(566)
(27)
(593)
(196)
(1,104)
(1,300)
(2,687)
(1,165)
(3,852)
559
(26)
533
(2,128)
(1,191)
(3,319)
370
(1,077)
(707)
7,333
6,823
1,490
(493)
(2,104)
(5)
13,044
12,825
(10,296)
(9,375)
(1,165)
(1,213)
2,872
(220)
(19,397)
(20,558)
(2,963)
(2,552)
325
(1,706)
768
(225)
(6,353)
(7,733)
3,675
7,401
2,119
(253)
(779)
(79)
12,084
8,181
116
1,707
(2,602)
(779)
(4,576)
499
(4,077)
(4,856)
$
$ 17,681
(397)
(1,284)
(8,212)
(9,893)
(1,743)
(82)
(1,825)
(11,718)
(8,840) $
(281)
423
(10,814)
(10,672)
(6,319)
417
(5,902)
(16,574)
$
8,841
(16)
(74)
2,900
2,810
(1,982)
4
(1,978)
832
7,349
$
1,119
1,533
231
441
3,746
16
7,086
7,637
321
1,552
4,756
6,629
1,563
(4)
1,559
8,188
(551) $
4,794
8,934
2,350
188
2,967
(63)
19,170
15,818
305
1,478
7,656
9,439
(419)
-
(419)
9,020
6,798
The provision for credit losses was $27.2 million for the year ended December 31, 2020 compared with $8.0 million for 2019. The
increase was driven by the adoption of the CECL standard, higher net charge-offs in the first quarter of 2020 and deterioration in the
economic environment as a result of the COVID-19 pandemic, which adversely impacted our unemployment forecast, the designated
loss driver for our CECL model. The increase in net charge-offs during 2020 is primarily attributable to one commercial credit that
was downgraded and partially charged-off during the first quarter of 2020 and for which foreclosure occurred in the third quarter of
2020. The borrower’s business was related to the hospitality industry and the downgrade and charge-off were precipitated by the
impact of the COVID-19 pandemic. The provision for credit losses - loans varies based primarily on forecasted unemployment rates,
loan growth, net charge-offs, collateral values associated with collateral dependent loans and qualitative factors.
See the “Allowance for Credit Losses - Loans” and “Non-Performing Assets and Potential Problem Loans” sections of this
Management’s Discussion and Analysis for further discussion.
- 45 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Noninterest Income
The following table summarizes our noninterest income for the years ended December 31 (in thousands):
2020
2019
2018
Service charges on deposits
Insurance income
ATM and debit card
Investment advisory
Company owned life insurance
Investments in limited partnerships
Loan servicing
Income from derivative instruments, net
Net gain on sale of loans held for sale
Net gain (loss) on investment securities
Net (loss) gain on other assets
Net loss on tax credit investments
Other
Total noninterest income
$
$
$
4,810
4,403
7,281
9,535
1,902
104
249
5,521
3,858
1,599
(61)
(275)
4,250
43,176
$
$
7,241
4,570
6,779
9,187
1,758
352
432
2,274
1,352
1,677
29
(528)
5,258
40,381
$
7,120
4,930
6,152
8,123
1,793
1,203
441
972
796
(127)
50
-
5,025
36,478
Service charges on deposits decreased $2.4 million, or 34%, to $4.8 million in 2020, compared to $7.2 million in 2019. The decrease
was primarily due to our COVID-19 relief initiatives implemented from March 23, 2020 to July 9, 2020, including waiving or
eliminating certain fees. In addition, insufficient fund fees for the remainder of 2020 were lower than historic levels, potentially due to
the positive impact of stimulus programs on consumer account balances. Certain ATM access fees were not reinitiated until
September 19, 2020.
Insurance income decreased $167 thousand, or 4%, to $4.4 million in 2020, compared to $4.6 million in 2019. The decrease was
primarily due to higher transaction revenue in the prior year as well as additional commercial account leakage.
Investment advisory income increased $348 thousand, or 4%, to $9.5 million in 2020, compared to $9.2 million in 2019. The
increase was primarily due to the impact of market gains, new customer accounts and increases in assets under management in
existing accounts.
Income from investments in limited partnerships decreased $248 thousand, or 70%, to $104 thousand in 2020, compared to $352
thousand in 2019. We have investments in limited partnerships, primarily small business investment companies, and account for these
investments under the equity method. The income from these investments fluctuates based on the maturity and performance of the
underlying investments.
Income from derivative instruments, net increased $3.2 million to $5.5 million in 2020, compared to $2.3 million in 2019. The
increase was primarily the result of an increase in the number and value of interest rate swap transactions executed and reflects growth
and maturity of our commercial loan business.
Net gain on sale of loans held for sale increased $2.5 million to $3.9 million in 2020, compared to $1.4 million in 2019. The increase
was primarily due to increased volume and higher margins on residential real estate loans held for sale. The low interest rate
environment has resulted in a significant increase in mortgage refinancing activity in 2020.
Net gain on investment securities was relatively flat at $1.6 million in 2020, compared to $1.7 million in 2019. The amount and timing
of our sale of investment securities is dependent on several factors, including our prudent efforts to realize gains while managing
duration, premium and credit risk.
A net loss on tax credit investments of $275 thousand was recognized in 2020, compared to $528 thousand in 2019. The net loss in
both periods was related to tax credit investments placed in service. This loss includes the amortization of the tax credit investments,
partially offset by refundable New York investment tax credits.
Other noninterest income decreased $1.0 million, or 19%, to $4.3 million in 2020, compared to $5.3 million in 2019. The decrease
was primarily due to decreased FHLB dividends due to the lower level of FHLB borrowings in 2020 versus 2019 and lower pay-by-
phone fees associated with our COVID-19 consumer relief initiatives. Certain of our volume-based fees like merchant revenue and
corresponding credit card fees also declined as a result of the impact of stay-at-home orders in 2020.
- 46 -
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
Restructuring charges
Other
Total noninterest expense
2020
2019
2018
$
$
59,336 $
13,655
6,326
11,645
1,975
2,242
2,609
1,134
-
1,492
8,840
109,254 $
56,330 $
13,552
5,424
9,983
2,036
1,005
3,577
1,250
-
-
9,671
102,828 $
54,643
12,892
3,912
9,568
2,032
1,975
3,582
1,257
2,350
-
8,665
100,876
Salaries and employee benefits expense increased $3.0 million, or 5%, to $59.3 million in 2020, compared to $56.3 million in 2019.
The increase was primarily attributable to higher salaries, incentives and severance, partially offset by a staff reduction in the second
half of the year associated with our Enterprise Standardization Program.
Professional services expense increased $902 thousand, or 17%, to $6.3 million in 2020, compared to $5.4 million in 2019. The
increase was primarily due to the timing of fees for consulting and advisory projects.
Computer and data processing expense increased $1.7 million, or 17%, to $11.6 million in 2020, compared to $10.0 million in 2019.
The increase was primarily due to costs related to the new online and mobile platform combined with other investments in technology.
FDIC assessments increased $1.2 million to $2.2 million in 2020, compared to $1.0 million in 2019. In 2018, the FDIC minimum
reserve ratio was exceeded, resulting in credits used to offset this expense in 2019 and the first quarter of 2020.
Advertising and promotions expense decreased $1.0 million, or 27%, to $2.6 million in 2020, compared to $3.6 million in 2019. The
decrease was primarily due to reduced advertising activity in 2020. Advertising and promotions expense was reduced in March 2020
when the COVID-19 pandemic impacted operations in Western New York.
Restructuring charges were $1.5 million in 2020, representing non-recurring real estate related charges related to the previously
described branch closings associated with our Enterprise Standardization Program.
The efficiency ratio for the year ended December 31, 2020 was 60.22% compared with 60.59% for 2019. The lower efficiency ratio is
a result of the higher net interest income associated with an increase in average interest-earning assets for the year. 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 $7.4 million for 2020, compared to $10.6 million for 2019. In 2020 and 2019, the Company
recognized tax credit investments resulting in a $1.5 million and $2.7 million reduction in income tax expense, respectively, and a
$275 thousand and $528 thousand net loss recorded in noninterest income, respectively. As a result of the TCJ Act signed into law in
December 2017, the Company estimated tax benefits and recorded a provisional amount in the Company’s consolidated statement of
income for the year ended December 31, 2017. The Company made an adjustment to the provisional amount included in its
consolidated financial statements for the year ended December 31, 2017, resulting in an expense of approximately $600 thousand
recorded in the third quarter of 2019.
- 47 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Our effective tax rate was 16.2% for 2020 compared to 17.8% for 2019. Effective tax rates are typically impacted by items of income
and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but
are not limited to, interest income from tax-exempt securities, earnings on company owned life insurance and the impact of tax credit
investments. In addition, our effective tax rate for 2020 and 2019 reflects the New York State tax benefit generated by our real estate
investment trust.
RESULTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 2019 AND DECEMBER 31, 2018
A discussion regarding our financial condition and results of operations for the year ended December 31, 2018 and year-to-year
comparisons between 2019 and 2018, which are not included in this Form 10-K, can be found under “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2019 and are incorporated by reference herein.
ANALYSIS OF FINANCIAL CONDITION
OVERVIEW
At December 31, 2020, we had total assets of $4.91 billion, an increase of 12% from $4.38 billion as of December 31, 2019, largely
attributable to organic loan growth and an increase in our investment securities portfolio. Net loans were $3.54 billion as of
December 31, 2020, up $352.2 million, or 11%, when compared to $3.19 billion as of December 31, 2019. The increase in net loans
was primarily attributable to PPP loans in our commercial business portfolio and organic growth in our commercial and residential
real estate loans. Non-performing assets totaled $12.5 million as of December 31, 2020, up $3.4 million from a year ago. Total
deposits amounted to $4.28 billion as of December 31, 2020, up $722.7 million, or 20.3%, compared to December 31, 2019. As of
December 31, 2020, borrowed funds totaled $5.3 million, compared to $314.8 million as of December 31, 2019. Common book value
per common share was $28.12 and $26.35 as of December 31, 2020 and 2019, respectively. As of December 31, 2020, our total
shareholders’ equity was $468.4 million compared to $438.9 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
Allowance for credit losses - securities
Total held to maturity securities, net
Total investment securities
Investment Securities Portfolio Composition
At December 31,
2019
2018
2020
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
$
6,239 $
6,635 $
26,440 $
26,877 $ 155,102 $ 152,028
601,426 620,989
435
-
607,665 628,059
-
-
389,412 390,422
618
-
415,852 417,917
-
-
300,480 292,882
767
-
455,582 445,677
-
-
144,506 148,984
127,467 133,051
271,973 282,035
192,215 196,018
166,785 167,241
359,000 363,259
234,845 234,510
211,736 205,071
446,581 439,581
(7)
271,966
$ 879,631 $ 910,094 $ 774,852 $ 781,176 $ 902,163 $ 885,258
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 Chief Financial
Officer and Treasurer, guided by ALCO, is responsible for investment portfolio decisions within the established policies.
- 48 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Our available for sale (“AFS”) investment securities portfolio increased $210.2 million from $417.9 million at December 31, 2019 to
$628.1 million at December 31, 2020. The increase from year-end 2019 was primarily due to the reinvestment of cash flow from the
portfolio, coupled with the deployment of excess liquidity into cash flowing agency backed securities. Our AFS portfolio had a net
unrealized gain totaling $20.4 million at December 31, 2020 compared to a net unrealized gain of $2.1 million at December 31, 2019.
The fair value of most of the investment securities in the AFS portfolio fluctuate as market interest rates change.
Impairment Assessment
For AFS securities in an unrealized loss position, we first assess whether (i) we intend to sell, or (ii) it is more likely than not that we
will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized
allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither case is
affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In
making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of
the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment
indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the
amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a
credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than
the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other
comprehensive income. Adjustments to the allowance are reported in our income statement as a component of credit loss expense.
AFS securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed
uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met. For the
year ended December 31, 2020 and 2019 no allowance for credit losses has been recognized on AFS securities in an unrealized loss
position as management does not believe any of the securities are impaired due to reasons of credit quality.
As of December 31, 2020, 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, 2020,
we concluded that unrealized losses on our AFS securities are not impaired due to reasons of credit quality and no allowance for credit
losses has been recognized on AFS securities. The following discussion provides further details of our assessment of the AFS
securities portfolio by investment category.
U.S. Government Agencies and Government Sponsored Enterprises (“GSE”). As of December 31, 2020, there were no securities
in an unrealized loss position in the U.S. Government agencies and GSE portfolio.
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, 2020, 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, 2020, there were eight securities in the AFS Agency MBS portfolio that were in an unrealized loss position with
unrealized losses totaling $68 thousand. Of these, one was in an unrealized loss position for 12 months or longer and had an aggregate
fair value of $7.9 million and unrealized losses of less than one thousand dollars.
Given the high credit quality inherent in Agency MBS, we do not consider any of the unrealized losses as of December 31, 2020 on
such Agency MBS to be credit related. As of December 31, 2020, 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 $435 thousand as of December 31, 2020. As of that
date, the one non-Agency MBS was rated below investment grade. This security was not in an unrealized loss position.
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, 2020, our ownership of FHLB and FRB stock
totaled $2.6 million and $6.1 million, respectively, and is included in other assets and recorded at cost, which approximates fair value.
- 49 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
LENDING ACTIVITIES
Total loans were $3.60 billion at December 31, 2020, an increase of $374.2 million, or 12%, from December 31, 2019. Commercial
loans increased $369.7 million and represented 57.0% of total loans at the end of 2020. Consumer loans increased $4.4 million to
represent 43.0% of total loans at December 31, 2020. 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):
2019
Amount Percent
Loan Portfolio Composition
At December 31,
2018
Amount Percent
Commercial business
Commercial mortgage
Total commercial
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total consumer
Total loans
Less: Allowance for credit losses
Total loans, net
2020
Amount Percent
$ 794,148
1,253,901
2,048,049
599,800
89,805
840,421
17,063
1,547,089
3,595,138
22.1% $ 572,040
1,106,283
34.9
1,678,323
57.0
572,350
16.7
104,118
2.5
850,052
23.4
16,144
0.4
1,542,664
43.0
100.0% 3,220,987
30,482
$3,190,505
52,420
$3,542,718
2017
Amount Percent
2016
Amount Percent
17.8% $ 557,861
958,194
34.3
1,516,055
52.1
524,155
17.8
109,718
3.2
919,917
26.4
16,753
0.5
1,570,543
47.9
100.0% 3,086,598
33,914
$3,052,684
18.1% $ 450,326
31.0
808,908
1,259,234
49.1
465,283
17.0
116,309
3.6
876,570
29.8
0.5
17,621
1,475,783
50.9
100.0% 2,735,017
34,672
$2,700,345
16.5% $ 349,547
670,058
29.6
1,019,605
46.1
427,937
17.0
122,555
4.3
752,421
32.0
0.6
17,643
1,320,556
53.9
100.0% 2,340,161
14.9%
28.6
43.5
18.3
5.2
32.2
0.8
56.5
100.0%
30,934
$2,309,227
Commercial loans increased during 2020 primarily due to PPP loans in our commercial business portfolio and growth in our
commercial mortgage portfolio reflecting our successful commercial business development efforts. The credit risk related to
commercial loans is largely influenced by general economic conditions, including the impact of the COVID-19 pandemic on small to
mid-sized business in our market area and the resulting impact on a borrower’s operations or on the value of underlying collateral, if
any.
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 credit 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, 2020, the principal balance of such loans (included in commercial loans) was $282.7 million and the guaranteed portion
amounted to $272.0 million. Excluding PPP Loans, the principal balance of such loans (included in commercial loans) was
$29.6 million and the guaranteed portion amounted to $18.9 million. Most of these loans were guaranteed by the SBA.
Commercial business loans were $794.1 million at the end of 2020, up $222.1 million, or 39%, since the end of 2019, and comprised
22.1% of total loans outstanding at December 31, 2020, compared to 17.8% at December 31, 2019. The increase in commercial
business loans was primarily due to the PPP loan program administered by the SBA. As of December 31, 2020, we had $248.0 million
of PPP loans, net of deferred loan fees and costs. 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, 2020, commercial business SBA
loans including PPP loans accounted for a total of $273.8 million, or 34% of our commercial business loan portfolio.
Commercial mortgage loans totaled $1.25 billion at December 31, 2020, up $147.6 million, or 13%, from December 31, 2019, and
comprised 34.9% of total loans, compared to 34.3% at December 31, 2019. Commercial mortgage loans include both owner occupied
and non-owner occupied commercial real estate loans. Approximately 24% of our commercial mortgage portfolio at December 31,
2020 and 2019 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, 2020, commercial mortgage SBA loans accounted for a total of $6.8 million or one percent of our
commercial mortgage loan portfolio.
- 50 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
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 $1.55 billion at December 31, 2020, up $4.4 million compared to 2019, and represented 43.0% of the 2020
year-end loan portfolio versus 47.9% at year-end 2019. 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, including the impact of the COVID-19 pandemic on the employment income of these borrowers, 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). A portion 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 764 and 761 during the years ended
December 31, 2020 and 2019, respectively.
Residential real estate loans totaled $599.8 million at the end of 2020, up $27.5 million, or 5%, from the end of the prior year and
comprised 16.7% and 17.8% of total loans outstanding at December 31, 2020 and December 31, 2019, respectively. As of
December 31, 2020 and 2019, our residential real estate loan portfolio included $3.5 million and $5.1 million, respectively, of loans
acquired during 2012 branch acquisitions. The residential real estate line portfolio amounted to $89.8 million at December 31, 2020
down $14.3 million, or 14%, compared to 2019 and represented 2.5% of the 2020 year-end loan portfolio versus 3.2% at year-end
2019. As of December 31, 2020 and 2019, our residential real estate line portfolio included $5.0 million and $6.2 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 69% and 68% at
December 31, 2020 and 2019, respectively. Approximately 92% and 91% of the loans and lines were first lien positions at
December 31, 2020 and 2019, respectively.
Consumer indirect loans amounted to $840.4 million at December 31, 2020 down $9.6 million, or 1%, compared to 2019 and
represented 23.4% of the 2020 year-end loan portfolio versus 26.4% at year-end 2019. 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, 2020, we originated $318.9 million in indirect loans with a mix of approximately 33% new vehicles and 67%
used vehicles. This compares with $303.0 million in indirect loans with a mix of approximately 34% new vehicles and 66% used
vehicles for the same period in 2019. 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 712
and 722 during the years ended December 31, 2020 and 2019, respectively. Other consumer loans totaled $17.1 million at
December 31, 2020, up $919 thousand, or 6%, compared to 2019, and represented less than one percent of the 2020 and 2019 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 operating 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, 2020, no significant concentrations, as defined above, existed in our portfolio in excess of 10% of total loans.
- 51 -
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 $4.3 million and $4.2 million as of December 31, 2020 and 2019,
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 $241.7 million and
$189.8 million as of December 31, 2020 and 2019, respectively.
Allowance for Credit Losses
The following table summarizes the activity in the allowance for credit losses - loans (in thousands).
Allowance for credit losses - loans, beginning of period, prior
to adoption of ASC 326
Impact of adopting ASC 326
Allowance for credit losses - loans, beginning of period, after
adoption of ASC 326
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 credit losses - loans
Allowance for credit losses - loans, end of year
$
Credit Loss - Loans Analysis
Year Ended December 31,
2018
2017
2019
2020
2016
$
30,482
9,594
$
33,914
-
$
34,672
-
$
30,934
-
$
27,085
-
40,076
33,914
34,672
30,934
27,085
9,093
1,792
100
-
9,959
681
21,625
1,709
37
28
3
5,681
352
7,810
13,815
26,159
52,420
$
2,481
2,997
340
13
10,810
1,170
17,811
492
17
43
6
5,390
387
6,335
11,476
8,044
30,482
$
2,319
1,020
95
142
10,850
1,308
15,734
509
13
159
20
5,024
317
6,042
9,692
8,934
33,914
$
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
$
943
385
289
104
8,748
607
11,076
447
45
174
15
4,259
347
5,287
5,789
9,638
30,934
Net loan charge-offs to average loans
Allowance for credit losses - loans to total loans
Allowance for credit losses - loans to non-performing loans
0.40%
1.46%
551%
0.37%
0.95%
353%
0.33%
1.10%
475%
0.38%
1.27%
277%
0.26%
1.32%
489%
- 52 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
The following table sets forth the allocation of the allowance for credit losses - loans 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).
2020
2019
2018
2017
2016
Allowance for Credit Losses - Loans by Loan Category
At December 31,
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total
Credit
Loss
Allowance
13,580
$
21,763
3,924
674
12,165
314
52,420
$
Percentage
of loans by
category to
total loans
Loan
Loss
Allowance
11,358
5,681
1,059
118
11,852
414
30,482
22.1 % $
34.9
16.7
2.5
23.4
0.4
100.0 % $
Percentage
of loans by
category to
total loans
Loan
Loss
Allowance
14,312
5,219
1,112
210
12,572
489
33,914
17.8 % $
34.3
17.8
3.2
26.4
0.5
100.0 % $
Percentage
of loans by
category to
total loans
Loan
Loss
Allowance
15,668
3,696
1,322
180
13,415
391
34,672
18.1 % $
31.0
17.0
3.6
29.8
0.5
100.0 % $
Percentage
of loans by
category to
total loans
Loan
Loss
Allowance
7,225
10,315
1,478
303
11,311
302
30,934
16.5 % $
29.6
17.0
4.3
32.0
0.6
100.0 % $
Percentage
of loans by
category to
total loans
14.9 %
28.6
18.3
5.2
32.2
0.8
100.0 %
The Company adopted ASC 326 effective January 1, 2020, which resulted in an increase to the allowance for credit losses - loans of
$9.6 million and established a reserve for unfunded commitments of $2.1 million, for a total pre-tax cumulative effect adjustment of
$11.7 million.
The allowance for credit losses for Pooled Loans estimate is based upon periodic review of the collectability of the loans
quantitatively correlating historical loan experience with reasonable and supportable forecasts using forward looking information.
Adjustments to the quantitative evaluation may be made for differences in current or expected qualitative risk characteristics such as
changes in: underwriting standards, delinquency level, regulatory environment, economic condition, Company management and the
status of portfolio administration including the Company’s Credit Risk Review function. The Company establishes a specific reserve
for individually analyzed loans which do not share similar risk characteristics with the loans included in the forecasted allowance for
credit losses. These individually analyzed loans are removed from the pooling approach discussed above for the forecasted allowance
for credit losses, and include nonaccrual loans, TDRs, and other loans deemed appropriate by management. The process we use to
determine the overall allowance for credit losses is based on this analysis. Based on this analysis, we believe the allowance for credit
losses is adequate as of December 31, 2020.
Assessing the adequacy of the allowance for credit losses involves substantial uncertainties and is based upon management’s
evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing a variety of factors, including the
risk profile of our loan products and customers.
Factors beyond our control, however, such as general national and local economic conditions, can adversely impact the adequacy of
the allowance for credit 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 credit 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 credit 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 credit losses.
The adequacy of the allowance for credit losses is subject to ongoing management review. While management evaluates currently
available information in establishing the allowance for credit losses - loans, 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 our allowance for credit losses - loans. Such agencies may require us to
increase the allowance based on their judgments about information available to them at the time of their examination.
Net charge-offs of $13.8 million in 2020 represented 0.40% of average loans compared to $11.5 million, or 0.37%, in 2019. The
increase in net charge-offs was primarily due to an $8.2 million partial charge-off of an $11.9 million commercial loan downgraded in
the first quarter of 2020 and for which a foreclosure occurred in the third quarter of 2020. The borrower’s business was related to the
hospitality industry and the downgrade and charge-off were precipitated by the impact of the COVID-19 pandemic. The allowance for
credit losses - loans was $52.4 million at December 31, 2020, compared with $30.5 million at December 31, 2019. The ratio of the
allowance for credit losses – loans to total loans was 1.46% and 0.95% at December 31, 2020 and 2019, respectively. The ratio of
allowance for credit losses - loans to non-performing loans was 551% at December 31, 2020, compared with 353% at December 31,
2019.
- 53 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Non-performing Assets and Potential Problem Loans
The following table summarizes our non-performing assets (in thousands):
Nonaccrual loans:
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total nonaccrual loans
Accruing loans 90 days or more delinquent
Total non-performing loans
Foreclosed assets
Total non-performing assets
2020
$
1,975
2,906
2,587
323
1,495
-
9,286
231
9,517
2,966
$ 12,483
$
$
Non-performing Assets
At December 31,
2018
2017
2019
1,177
3,146
2,484
102
1,725
-
8,634
6
8,640
468
9,108
$
$
912
1,586
2,391
255
1,989
-
7,133
8
7,141
230
7,371
$
5,344
2,623
2,252
404
1,895
2
12,520
11
12,531
148
$ 12,679
$
$
2016
2,151
1,025
1,236
372
1,526
7
6,317
9
6,326
107
6,433
Non-performing loans to total loans
Non-performing assets to total assets
0.26%
0.25%
0.27%
0.21%
0.23%
0.17%
0.46%
0.31%
0.27%
0.17%
Non-performing assets include non-performing loans and foreclosed assets. Non-performing assets at December 31, 2020 were
$12.5 million, an increase of $3.4 million from $9.1 million at December 31, 2019. The primary component of non-performing assets
is non-performing loans, which were $9.5 million or 0.26% of total loans at December 31, 2020, compared with $8.6 million or 0.27%
of total loans at December 31, 2019. The increase in non-performing assets in the nine months ended September 30, 2020 is primarily
due to an $11.9 million commercial loan downgraded, with $8.2 million charged-off, in the first quarter of 2020. In the third quarter of
2020, this commercial loan was recategorized as a foreclosed asset. The borrower’s business was related to the hospitality industry
and the downgrade and charge-off were precipitated by the impact of the COVID-19 pandemic.
Approximately $1.0 million, or 11%, of the $9.3 million of nonaccrual loans in non-performing loans as of December 31, 2020 were
current with respect to payment of principal and interest but were classified as non-accruing because repayment in full of principal
and/or interest was uncertain. Included in nonaccrual loans are TDRs of $200 thousand and $297 thousand at December 31, 2020 and
2019, respectively. We had no TDRs that were accruing interest as of December 31, 2020 and one TDR of $550 thousand that was
accruing interest as of December 31, 2019.
Foreclosed assets consist of real property formerly pledged as collateral for loans, which we have acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. Foreclosed asset holdings represented two properties totaling $3.0 million
at December 31, 2020 and three properties totaling $468 thousand at December 31, 2019.
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 $17.9 million
and $14.6 million in loans that continued to accrue interest which were classified as substandard as of December 31, 2020 and 2019,
respectively.
- 54 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
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
At December 31,
2019
Amount Percent
2018
Amount Percent
2020
Amount Percent
$1,018,549
731,885
1,642,340
684,885
200,708
$4,278,367
23.8% $ 707,752
627,842
17.1
1,039,892
38.4
893,177
16.0
287,012
4.7
100.0% $3,555,675
19.9% $ 755,460
622,482
17.7
968,897
29.2
810,434
25.1
209,634
8.1
100.0% $3,366,907
22.4%
18.5
28.8
24.1
6.2
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, 2020, total deposits were $4.28 billion, representing an increase of $722.7 million for the
year. The increase from December 31, 2019, was primarily due to growth in non-public demand and reciprocal deposits. Time
deposits were approximately 21% and 33% of total deposits at December 31, 2020 and 2019, respectively.
Nonpublic deposits, the largest component of our funding sources, totaled $2.55 billion at each of December 31, 2020 and 2019 and
represented 60% and 61% 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 $834.9 million and $860.7 million at December 31, 2020 and December 31, 2019, respectively, and represented
20% and 24% of total deposits as of the end of each period, respectively. The decrease in public deposits during 2020 was due largely
to seasonality.
We participate in reciprocal deposit 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. Prior to the Economic Growth, Regulatory Relief and Consumer Protection Act
(“EGRRCPA”) enacted on May 14, 2018, all reciprocal deposits were considered brokered deposits for regulatory reporting purposes.
With the enactment of the EGRRCPA, reciprocal deposits, subject to certain restrictions, are no longer required to be reported as
brokered deposits. Reciprocal deposits totaled $612.3 million at December 31, 2020, compared to $330.0 million at December 31,
2019, and represented 14% and 9% of total deposits as of the end of each period, respectively.
Brokered deposits totaled $279.6 million and $208.8 million at December 31, 2020 and 2019, respectively, and represented 7% and
6% of total deposits as of the end of each period, respectively.
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
2020
2019
$
$
5,300 $
275,500
73,623
78,923 $
39,273
314,773
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, 2020 consisted of $5.3 million
- 55 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
in short-term borrowings. The lower level of short-term borrowings at December 31, 2020 is attributable to an increase in our
brokered deposits portfolio, which were utilized as a cost-effective alternative to FHLB borrowings. The maximum amount of short-
term FHLB borrowings outstanding at any month-end during the twelve months ended December 31, 2020 was $198.9 million. Short-
term FHLB borrowings at December 31, 2019 consisted of $10.0 million in overnight borrowings and $265.5 million in short-term
borrowings. The FHLB borrowings are collateralized by securities from the Company’s investment portfolio and certain qualifying
loans. At December 31, 2020 and 2019, the Company’s borrowings had a weighted average rate of 1.70% and 1.88%, 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 $223.5 million of immediate credit capacity with the FHLB as of December 31, 2020. We had
approximately $550.3 million in secured borrowing capacity at the FRB discount window, none of which was outstanding at
December 31, 2020. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain
qualifying loans. We had approximately $145.0 million of credit available under unsecured federal funds purchased lines with various
banks as of December 31, 2020, with $226.4 million outstanding at December 31, 2020. Additionally, we had approximately
$107.5 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, 2020, no amounts have been drawn on the line of credit.
The following table summarizes information relating to our short-term borrowings (dollars in thousands).
At or for the Year Ended December 31,
2018
2019
2020
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
$
$
$
5,300
$
1.70%
$
$
1.85%
198,900
86,494
275,500
$
1.88%
$
$
2.56%
420,800
309,893
469,500
2.64%
477,100
394,679
2.11%
On October 7, 2020, we completed a private placement of $35.0 million in aggregate principal amount of fixed-to-floating rate
subordinated notes due 2030 to qualified institutional buyers and accredited institutional investors that were subsequently exchanged
for subordinated notes with substantially the same terms (the “2020 Notes”) registered under the Securities Act of 1933, as amended.
The 2020 Notes have a maturity date of October 15, 2030 and bear interest, payable semi-annually, at the rate of 4.375% per annum,
until October 15, 2025. Commencing on that date, the interest rate will reset quarterly to an interest rate per annum equal to the then
current three-month SOFR plus 4.265%, payable quarterly until maturity. The 2020 Notes are redeemable by us, in whole or in part,
on any interest payment date on or after October 15, 2025, and we may redeem the Notes in whole at any time upon certain other
specified events. We used the net proceeds for general corporate purposes, organic growth and to support regulatory capital ratios at
Five Star Bank.
On April 15, 2015, we issued $40.0 million of subordinated notes (the “2015 Notes”) in a registered public offering. The 2015 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. After the discontinuance of LIBOR, the interest rate will be determined by
an alternate method as reasonably selected by the Company. The 2015 Notes are redeemable by us at any quarterly interest payment
date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. Proceeds, net of debt issuance costs of
$1.1 million, were $38.9 million. The Subordinated Notes qualify as Tier 2 capital for regulatory purposes.
- 56 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Shareholders’ Equity
Total shareholders’ equity was $468.4 million at December 31, 2020, an increase of $29.4 million from $438.9 million at
December 31, 2019. Net income for the year increased shareholders’ equity by $38.3 million, offset by an $8.7 million cumulative
effect adjustment from the adoption of ASC 326 and common and preferred stock dividends declared of $18.1 million. Accumulated
other comprehensive income included in shareholders’ equity increased $16.6 million during the year due primarily to higher net
unrealized gains on securities available for sale. For detailed information on shareholders’ equity, see Note 16, Shareholders’ Equity,
of the notes to consolidated financial statements. FII and the Bank are subject to various regulatory capital requirements. At
December 31, 2020, both FII and the Bank exceeded all regulatory requirements. For detailed information on regulatory capital
requirements, see Note 15, Regulatory Matters, of the notes to consolidated financial statements.
LIQUIDITY AND CAPITAL MANAGEMENT
The objective of maintaining adequate liquidity is to assure that we meet our financial obligations. These obligations include the
withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, the ability to fund new and
existing loan commitments and the ability to take advantage of new business opportunities. We achieve liquidity by maintaining a
strong base of both core customer funds and maturing short-term assets; we also rely on our ability to sell or pledge securities and
lines-of-credit and our overall ability to 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 $93.9 million as of December 31, 2020, a decrease of approximately $19.0 million from
$112.9 million as of December 31, 2019. During 2020, net cash provided by operating activities totaled $43.5 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 $531.1 million, which included outflows of $390.9 million for net loan originations and outflows of
$106.3 million from net investment securities transactions. Net cash provided by financing activities of $468.5 million was attributed
to a $722.7 million increase in deposits and to proceeds from long-term borrowings, net of debt issuance costs of $34.2 million,
partially offset by a $270.2 million decrease in short-term borrowings and by $18.0 million in dividend payments.
Contractual Obligations and Other Commitments
The following table summarizes the maturities of various contractual obligations and other commitments (in thousands):
On-Balance sheet:
Time deposits (1)
Supplemental executive retirement plans
Subordinated notes
Operating leases
Off-Balance sheet:
Limited partnership investments (2)
Tax credit investments (3)
Commitments to extend credit (4)
Standby letters of credit (4)
Within 1
year
Over 1 to 3
years
At December 31, 2020
Over 3 to 5
Years
Over 5
years
Total
$
841,581 $
360
-
2,423
36,033 $
711
-
3,499
7,979 $
273
-
2,454
- $
101
75,000
24,792
885,593
1,445
75,000
33,168
2,044
13,791
1,012,810
11,030
4,089
27,582
-
11,200
2,045
13,790
-
163
-
-
-
-
8,178
55,163
1,012,810
22,393
(1)
Includes the maturity of time deposits amounting to $100 thousand or more as follows: $278.8 million in three months or less; $134.4 million
between three months and six months; $180.1 million between six months and one year; and $12.2 million over one year.
(2) We have committed to capital investments in several limited partnerships of up to $18.5 million, of which we have contributed $10.4 million as
of December 31, 2020, including $1.2 million during 2020.
(3) We have committed to capital investments in several tax credit investments of up to $77.5 million, of which we have contributed $22.3 million
as of December 31, 2020, including $9.4 million during 2020.
(4) 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.
- 57 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Off-Balance Sheet Arrangements
With the exception of obligations in connection with our irrevocable loan commitments, limited partnership investments and tax credit
investments as of December 31, 2020, 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 14, Commitments and Contingencies, in the notes to the
accompanying consolidated financial statements.
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, 2020. 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
Held to maturity debt securities:
State and political subdivisions
Mortgage-backed securities
Total investment securities
$
-
1,907 2.29
1,907 2.29
-% $
6,239 2.43% $
-
-% $
-
-% $
6,239 2.43%
33,473 2.46
39,712 2.45
159,570 2.28
159,570 2.28
406,476 1.58
406,476 1.58
601,426 1.82
607,665 1.83
47,086 2.25
-
-
47,086 2.25
$48,993 2.25% $137,075 2.08% $176,941 2.26% $516,629 1.75% $879,638 1.93%
2,386 1.99
14,985 2.09
17,371 2.07
95,034 1.92
2,329 2.29
97,363 1.93
-
110,153 2.35
110,153 2.35
144,506 2.03
127,467 2.32
271,973 2.17
-
Contractual Loan Maturity Schedule
The following table summarizes the contractual maturities of our loan portfolio at December 31, 2020. 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).
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 from
one to
five years
Due after
five years
Total
$
Due in less
than one
year
211,783 $
335,910
104,933
2,334
322,293
7,688
406,944 $
605,082
310,745
6,158
518,111
8,679
984,941 $ 1,855,719 $
175,421 $
312,909
184,122
81,313
17
696
794,148
1,253,901
599,800
89,805
840,421
17,063
754,478 $ 3,595,138
$
448,577 $
1,407,142
$ 1,855,719 $
423,963 $
872,540
1,737,657
330,515
754,478 $ 2,610,197
$
- 58 -
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, which were fully phased-in on January 1, 2019. As of December 31, 2020, 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 15, 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
Add: CECL transitional amount
Less: Goodwill and other intangible assets
Net unrealized loss on investment securities (1)
Hedging derivative instruments
Net periodic pension and postretirement benefits plan adjustments
Other
Common Equity Tier 1 (“CET1”) capital
Plus: Preferred stock
Less: Other
Tier 1 Capital
Plus: Qualifying allowance for credit losses
Subordinated Notes
Total regulatory capital
Adjusted average total assets (for leverage capital purposes)
Total risk-weighted assets
2020
2019
$
$
$
$
$
451,035
12,061
71,235
14,743
(316)
(12,299)
-
389,733
17,328
-
407,061
40,509
73,623
521,193
4,933,597
3,828,713
$
$
$
421,619
-
71,987
873
(518)
(14,868)
-
364,145
17,328
-
381,473
30,482
39,273
451,228
4,237,596
3,533,281
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)
8.25%
10.18
10.63
13.61
9.00%
10.31
10.80
12.77
(1)
Includes unrealized gains and losses related to the Company’s reclassification of available for sale investment securities to the
held to maturity category.
We have elected to apply the 2020 CECL transition provision related to the impact of the CECL accounting standard on regulatory
capital, as provided by the US banking agencies’ March 2020 interim final rule. Under the 2020 CECL transition provision, the
regulatory capital impact of the Day 1 adjustment to the allowance for credit losses (after-tax) upon the January 1, 2020 CECL
adoption date has been deferred and will phase in to regulatory capital at 25% per year commencing January 1, 2022. For the ongoing
impact of CECL, we are allowed to defer the regulatory capital impact of the allowance for credit losses in an amount equal to 25% of
the change in the allowance for credit losses (pre-tax) recognized through earnings for each period between January 1, 2020, and
December 31, 2021. The cumulative adjustment to the allowance for credit losses between January 1, 2020, and December 31, 2021,
will also phase in to regulatory capital at 25% per year commencing January 1, 2022.
Basel III Capital Rules
Under the Basel III Rules, the current minimum capital ratios, including an additional capital conservation buffer applicable to the
Company and the Bank, are:
•
•
•
7.0% CET1 to risk-weighted assets;
8.5% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and
10.5% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.
- 59 -
MANAGEMENT’S DISCUSSION AND ANALYSIS
Strict eligibility criteria for regulatory capital instruments were also implemented under the Basel III Rules. As of December 31, 2020,
the Company’s capital levels remained characterized as “well-capitalized” under the new rules.
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 credit 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 Credit Losses
The allowance for credit losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining
the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and
the use of subjective measurements including, but not limited to, management’s assessment of the internal risk classifications of loans,
estimating future losses utilizing current forecasts, forward-looking estimates of qualitative factors including existing economic
conditions, portfolio administration, delinquency, the regulatory environment and the Company’s lending policies. 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 credit losses, could change significantly. As an integral
part of their examination process, various regulatory agencies also review the allowance for credit losses. Such agencies may require
additions to the allowance for credit 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 credit losses is appropriate as recorded in the
consolidated financial statements.
For additional discussion related to our accounting policies for the allowance for credit losses, see the sections titled “Allowance for
Credit 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 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. 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, no further testing is performed. However, if we conclude otherwise, we
would then be required to perform a goodwill impairment test by comparing the fair value of the reporting unit with its carrying value.
If the carrying value of the reporting unit exceeds its fair value, a goodwill impairment charge is recognized for the difference, but not
to exceed the amount of goodwill allocated to the reporting unit.
- 60 -
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 19, 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
21 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 2020 expense for the defined benefit pension plan were a weighted average discount rate of 3.09%,
a weighted average long-term rate of return on plan assets of 6.00% and a rate of compensation increase of 3.00%. Defined benefit
pension expense in 2021 is expected to decrease to $1.9 million from the $2.4 million recorded in 2020, primarily driven by 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 income (loss) and amortized to defined benefit pension expense in future years. For 2020, the actual return on plan
assets in the qualified defined benefit pension plan was $18.5 million, compared to an expected return on plan assets of $5.1 million.
Total pretax losses recognized in accumulated other comprehensive income (loss) at December 31, 2020 were $16.4 million for the
defined benefit pension plan. Actuarial pretax net gains recognized in other comprehensive income (loss) for the year ended
December 31, 2020 were $2.2 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.
- 61 -
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 17% of assets and is primarily fixed
rate loans with relatively short durations. Our commercial loan portfolio totaled 42% 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 comprised primarily of deposits, which account for 96% of total liabilities. Of these deposits, the majority, or 50%,
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 comprise 9% of total deposits. The Bank also
has a significant amount of public deposits, which represented 20% of total deposits as of December 31, 2020.
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, 2020, the Bank was slightly asset sensitive, meaning that net interest income is positively impacted as interest rates
increase.
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, 2020 assuming instantaneous changes in interest rates for the
given rate shock scenarios (dollars in thousands):
Estimated change in net interest income
% Change
Changes in Interest Rate
$
+200 bp
+100 bp
-100 bp
1,379
771
(524)
$
$
$
1.00%
0.56%
(0.38)%
+300 bp
2,019
1.46%
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.
- 62 -
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, based on third-
party review and inputs.
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, 2020 and 2019. The analysis additionally presents a measurement
of the interest rate sensitivity at December 31, 2020 and 2019. 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, 2020
December 31, 2019
Rate Shock Scenario:
Pre-Shock Scenario
- 100 Basis Points
+ 100 Basis Points
+ 200 Basis Points
+ 300 Basis Points
EVE Change
$ 583,156
574,345 $
617,768
638,224
651,518
(8,811)
34,612
55,068
68,362
Percentage
Change
EVE Change
$ 632,832
Percentage
Change
-1.51% 676,362 $ 43,530
(5,423)
5.94
(17,905)
9.44
(32,196)
11.72
627,409
614,927
600,636
6.88%
(0.86)
(2.83)
(5.09)
The Pre-Shock Scenario EVE was $583.2 million at December 31, 2020, compared to $632.8 million at December 31, 2019. The
decrease in the Pre-Shock Scenario EVE at December 31, 2020 compared to December 31, 2019 resulted primarily from a drastic
change in the interest rate environment, as a result of the Federal Reserve’s reductions to the Fed Funds rate in early 2020, a flattening
yield curve, and actions taken by the U.S. government to stimulate the economy. As a result, there was a more favorable valuation on
deposits.
The +200 basis point Rate Shock Scenario EVE increased from $614.9 million at December 31, 2019 to $638.2 million at
December 31, 2020. The percentage change in the EVE amount from the Pre-Shock Scenario to the +200 basis point Rate Shock
Scenario changed from (2.83)% at December 31, 2019 to 9.44% at December 31, 2020.
- 63 -
Interest Rate Sensitivity Gap
The following table presents an analysis of our interest rate sensitivity gap position at December 31, 2020. 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).
At December 31, 2020
Over
Three
Months
Through
One Year
Over
One Year
Through
Five
Years
Over
Five
Years
Three
Months
or Less
INTEREST-EARNING ASSETS:
Federal funds sold and other interest-earning deposits
Investment securities
Loans
Total interest-earning assets
$
41,090
27,913
1,230,101
$ 1,299,104
$
$
-
138,904
535,218
674,122
$
245
418,670
1,464,591
$1,883,506
$
-
294,151
369,533
$ 663,684
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
$ 2,374,225
367,002
5,300
$ 2,746,527
$
$
-
474,944
-
474,944
$
$
-
43,647
-
43,647
$
$
-
-
73,623
73,623
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
$(1,447,423)
$(1,447,423)
$
199,178
$(1,248,245)
$1,839,859
$ 591,614
$ 590,061
$1,181,675
47.3%
(29.5)%
61.3%
(25.4)%
118.1%
12.0%
135.4%
24.1%
Total
$
41,335
879,638
3,599,443
4,520,416
52,543
339,347
$4,912,306
$2,374,225
885,593
78,923
3,338,741
1,018,549
86,653
4,443,943
468,363
$4,912,306
$1,181,675
(1)
Includes net unrealized loss on securities available for sale and allowance for credit 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.
- 64 -
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 ........................................................................................
Report of Independent Registered Public Accounting Firm (on the Consolidated Financial Statements) ................................
Report of Independent Registered Public Accounting Firm (on Internal Control over Financial Reporting) ...........................
Consolidated Statements of Financial Condition at December 31, 2020 and 2019 ...................................................................
Consolidated Statements of Income for the years ended December 31, 2020, 2019 and 2018..................................................
Consolidated Statements of Comprehensive Income for the years ended December 31, 2020, 2019 and 2018 .......................
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2020, 2019 and 2018.........
Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018...........................................
Notes to Consolidated Financial Statements ..............................................................................................................................
Page
66
67
69
70
71
72
73
75
76
- 65 -
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, 2020. 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, 2020, the Company’s internal control over financial reporting was
effective.
RSM US LLP, the Company’s independent registered public accounting firm that audited the Company’s consolidated financial
statements as of and for the year ended December 31, 2020 has issued a report on internal control over financial reporting as of
December 31, 2020. That report appears herein.
/s/ Martin K. Birmingham
President and Chief Executive Officer
March 15, 2021
/s/ W. Jack Plants, II
Senior Vice President, Chief Financial Officer and Treasurer
March 15, 2021
- 66 -
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Financial Institutions, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of Financial Institutions, Inc. and Subsidiaries (the
Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in
shareholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the
consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally
accepted in the United States of America.
We have also 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, 2020, based on criteria established in Internal
Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and
our report dated March 15, 2021 expressed an unqualified opinion on the effectiveness of the Company's internal control over
financial reporting.
Adoption of New Accounting Standard
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses on financial
instruments in 2020 due to the adoption of Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (Topic
326) – Measurement of Credit Losses on Financial Instruments.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the
Company’s 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 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 audits
to obtain reasonable assurance about whether the 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 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 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 financial statements. We believe
that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material
to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the
critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by
communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or
disclosures to which it relates.
Allowance for Credit Losses – Loans
As described in Notes 1 and 6 to the financial statements, the Company’s allowance for credit losses - loans was $52,420,000 at
December 31, 2020, which consisted of an allowance for credit losses for pooled loans ($42,850,000) and a specific reserve for
individually evaluated loans ($9,570,000). Management estimates the allowance for credit losses for pooled loans utilizing a
discounted cash flow (DCF) method. The DCF implements a probability of default with a loss given default applied to future cash
flows that are adjusted to present value. The Company uses forecasts to predict how modeled economic factors will perform. In
addition, qualitative factors that are likely to cause estimated credit losses to differ from historical loss experience, including but not
limited to: national and local economic trends and conditions (excluding national unemployment), levels and trends in delinquencies,
non-accrual loans and classified assets, trends in volume, terms and concentrations of loans, changes in lending policies and
procedures, quality of credit review function and administration and changes in regulatory environment. The establishment of
- 67 -
probability of default/loss given default, reasonable and supportable forecasts, and qualitative factor adjustments require a significant
amount of judgement by management and involve a high degree of estimation uncertainty.
We identified the determination of the allowance for credit losses for pooled loans as a critical audit matter as auditing the underlying
development of probability of default/loss given default, reasonable and supportable forecasts, and qualitative factor adjustments
required significant auditor judgment as amounts determined by management rely on analyses that are highly subjective and include
significant estimation uncertainty.
Our audit procedures related to the determination of the allowance for credit losses for pooled loans included the following, among
others:
• We obtained an understanding of the relevant controls related to management’s establishment, review and approval of
probability of default/loss given default, reasonable and supportable forecasts, and qualitative factor adjustments, and tested
such controls for design and operating effectiveness.
• We tested the completeness and accuracy of data used by management in determining the probability of default/loss given
default by agreeing this data to both internal and external information, as applicable.
• We evaluated the reasonableness of the forecasts utilized by management by comparing them to external information.
• We tested the completeness and accuracy of information, evaluated the appropriateness and agreed the qualitative factor
adjustments included in the allowance for credit losses - loans calculation.
/s/ RSM US LLP
We have served as the Company’s auditor since 2018.
Chicago, Illinois
March 15, 2021
- 68 -
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Financial Institutions, Inc.
Opinion on the Internal Control Over Financial Reporting
We have audited Financial Institutions, Inc. and Subsidiaries' (the Company) internal control over financial reporting as of
December 31, 2020, based on criteria established in Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(PCAOB), the consolidated statement of financial condition of the Company as of December 31, 2020, the related consolidated
statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the year then ended, and the related
notes to the consolidated financial statements of the Company and our report dated March 15, 2021 expressed an unqualified opinion.
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 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 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 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/ RSM US LLP
Chicago, Illinois
March 15, 2021
- 69 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
(in thousands, except share and per share data)
December 31,
2020
2019
ASSETS
Cash and due from banks
Securities available for sale, at fair value
Securities held to maturity, at amortized cost (net of allowance for credit losses of $7 and
$0, respectively) (fair value of $282,035 and $363,259, respectively)
Loans held for sale
Loans (net of allowance for credit losses of $52,420 and $30,482, respectively)
Company owned life insurance
Premises and equipment, net
Goodwill and other intangible assets, net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
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 $1,377 and $727, respectively
Other liabilities
Total liabilities
Commitments and contingencies (Note 14)
Shareholders’ equity:
Series A 3% preferred stock, $100 par value; 1,533 shares authorized; 1,435 shares
issued
Series B-1 8.48% preferred stock, $100 par value; 200,000 shares authorized; 171,847
shares issued
Total preferred equity
Common stock, $0.01 par value; 50,000,000 shares authorized; 16,099,556 shares
issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Treasury stock, at cost – 57,630 and 96,657 shares, respectively
Total shareholders’ equity
Total liabilities and shareholders’ equity
$
See accompanying notes to the consolidated financial statements.
93,878 $
628,059
271,966
4,305
3,542,718
100,895
40,610
73,789
156,086
4,912,306 $
1,018,549 $
731,885
1,642,340
885,593
4,278,367
5,300
73,623
86,653
4,443,943
143
17,185
17,328
161
125,118
324,850
2,128
(1,222)
468,363
4,912,306 $
112,947
417,917
359,000
4,224
3,190,505
68,942
41,424
74,923
114,296
4,384,178
707,752
627,842
1,039,892
1,180,189
3,555,675
275,500
39,273
74,783
3,945,231
143
17,185
17,328
161
124,582
313,364
(14,513)
(1,975)
438,947
4,384,178
- 70 -
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 credit losses
Net interest income after provision for credit 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
Income from derivative instruments, net
Net gain on sale of loans held for sale
Net gain (loss) on investment securities
Net (loss) gain on other assets
Net loss on tax credit investments
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
Restructuring charges
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 20):
Basic
Diluted
Cash dividends declared per common share
Weighted average common shares outstanding:
Basic
Diluted
See accompanying notes to the consolidated financial statements.
- 71 -
2020
Years ended December 31,
2019
2018
$
143,520 $
17,464
315
161,299
149,873 $
18,532
395
168,800
17,822
1,604
2,888
22,314
138,985
27,184
111,801
4,810
4,403
7,281
9,535
1,902
104
249
5,521
3,858
1,599
(61)
(275)
4,250
43,176
59,336
13,655
6,326
11,645
1,975
2,242
2,609
1,134
-
1,492
8,840
109,254
45,723
7,391
38,332 $
1,461
36,871 $
28,494
7,923
2,471
38,888
129,912
8,044
121,868
7,241
4,570
6,779
9,187
1,758
352
432
2,274
1,352
1,677
29
(528)
5,258
40,381
56,330
13,552
5,424
9,983
2,036
1,005
3,577
1,250
-
-
9,671
102,828
59,421
10,559
48,862 $
1,461
47,401 $
2.30 $
2.30 $
1.04 $
2.97 $
2.96 $
1.00 $
16,022
16,063
15,972
16,031
$
$
$
$
$
130,703
21,601
428
152,732
19,055
8,342
2,471
29,868
122,864
8,934
113,930
7,120
4,930
6,152
8,123
1,793
1,203
441
972
796
(127)
50
-
5,025
36,478
54,643
12,892
3,912
9,568
2,032
1,975
3,582
1,257
2,350
-
8,665
100,876
49,532
10,006
39,526
1,461
38,065
2.39
2.39
0.96
15,910
15,956
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
Net income
Other comprehensive income (loss), net of tax:
Securities available for sale and transferred securities
Hedging derivative instruments
Pension and post-retirement obligations
Total other comprehensive income (loss), net of tax
Comprehensive income
Years ended December 31,
2019
2018
2020
$
38,332 $
48,862 $
39,526
13,870
202
2,569
16,641
54,973 $
9,323
(242)
470
9,551
58,413 $
(4,494)
(276)
(4,595)
(9,365)
30,161
$
See accompanying notes to the consolidated financial statements.
- 72 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
Years ended December 31, 2020, 2019 and 2018
(in thousands,
except per share data)
Balance at January 1, 2018
Comprehensive income:
Net income
Other comprehensive loss, net of tax
Purchase of common stock for treasury
Repurchase of Series A 3% 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-$0.96 per share
Balance at December 31, 2018
Cumulative-effect adjustment
Balance at January 1, 2019
Comprehensive income:
Net income
Other comprehensive income, net of tax
Reclassification of income tax effects
Common stock issued
Purchase of common stock for treasury
Share-based compensation plans:
Share-based compensation
Restricted stock units released
Restricted stock awards issued, net
Stock awards
Cash dividends declared:
Preferred
Equity
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Treasury
Stock
$
17,329 $
161 $ 121,058 $ 257,078 $
(11,916) $
(2,533) $
Total
Shareholders’
Equity
381,177
-
-
-
(1)
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
39,526
-
-
-
-
(9,365)
-
-
1,301
(19)
303
61
-
-
-
-
-
-
-
-
-
-
(113)
-
-
339
(303)
124
39,526
(9,365)
(113)
(1)
1,301
320
-
185
-
-
-
17,328 $
-
17,328 $
$
$
-
-
-
(4)
-
(1,457)
-
(15,276)
-
161 $ 122,704 $ 279,867 $
(710)
-
161 $ 122,704 $ 279,157 $
-
-
-
-
(21,281) $
-
(21,281) $
-
-
-
(2,486) $
-
(2,486) $
(4)
(1,457)
(15,276)
396,293
(710)
395,583
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1,151
-
1,406
(554)
(165)
40
48,862
-
2,783
-
-
-
9,551
(2,783)
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(293)
-
554
165
85
48,862
9,551
-
1,151
(293)
1,406
-
-
125
Series A 3% Preferred-$3.00 per share
Series B-1 8.48% Preferred-$8.48 per share
Common-$1.00 per share
Balance at December 31, 2019
-
-
-
17,328 $
$
-
-
-
(4)
-
(1,457)
-
(15,977)
-
161 $ 124,582 $ 313,364 $
-
-
-
(14,513) $
-
-
-
(1,975) $
(4)
(1,457)
(15,977)
438,947
Continued on next page
See accompanying notes to the consolidated financial statements.
- 73 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity (Continued)
Years ended December 31, 2020, 2019 and 2018
(in thousands,
except per share data)
Balance at December 31, 2019
Balance carried forward
Cumulative-effect adjustment
Balance at January 1, 2020
Comprehensive income:
Net income
Other comprehensive income, net of tax
Purchase of common stock for treasury
Share-based compensation plans:
Share-based compensation
Restricted stock units released
Restricted stock awards issued, net
Stock awards
Cash dividends declared:
Preferred
Equity
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Treasury
Stock
Total
Shareholders’
Equity
$
17,328 $
161 $ 124,582 $ 313,364 $
(14,513) $
(1,975) $
438,947
-
17,328 $
$
-
(8,719)
-
161 $ 124,582 $ 304,645 $
-
(14,513) $
-
(1,975) $
(8,719)
430,228
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
38,332
-
-
-
16,641
-
1,333
(511)
(272)
(14)
-
-
-
-
-
-
-
-
-
-
(209)
-
511
272
179
38,332
16,641
(209)
1,333
-
-
165
Series A 3% Preferred-$3.00 per share
Series B-1 8.48% Preferred-$8.48 per share
Common-$1.04 per share
Balance at December 31, 2020
-
-
-
17,328 $
$
-
-
-
(4)
-
(1,457)
-
(16,666)
-
161 $ 125,118 $ 324,850 $
-
-
-
2,128 $
-
-
-
(1,222) $
(4)
(1,457)
(16,666)
468,363
See accompanying notes to the consolidated financial statements.
- 74 -
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:
Years ended December 31,
2019
2018
2020
$
38,332 $
48,862 $
39,526
Depreciation and amortization
Net amortization of premiums on securities
Provision for credit losses
Share-based compensation
Deferred income tax (benefit) expense
Proceeds from sale of loans held for sale
Originations of loans held for sale
Income on company owned life insurance
Net gain on sale of loans held for sale
Net (gain) loss on investment securities
Goodwill impairment
Net loss (gain) on other assets
Noncash restructuring charges against assets
(Increase) decrease in other assets
Increase 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
Proceeds from sales of securities held to maturity
Net loan originations
Loans sold to others
Purchases of company owned life insurance, net of proceeds received
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 in short-term borrowings
Repurchase of preferred stock
Issuance of long-term debt
Debt issuance costs
Purchases of common stock for treasury
Proceeds from stock options exercised
Cash dividends paid to preferred shareholders
Cash dividends paid to common shareholders
Net cash provided by (used in) financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
See accompanying notes to the consolidated financial statements.
- 75 -
7,893
3,474
27,184
1,333
(4,523)
97,238
(93,461)
(1,902)
(3,858)
(1,599)
-
61
202
(37,565)
10,646
43,455
(396,879)
(7,345)
97,685
93,046
107,098
52
(390,932)
-
(30,051)
519
(4,264)
-
(531,071)
8,213
2,069
8,044
1,406
369
41,479
(41,626)
(1,758)
(1,352)
(1,677)
-
(29)
-
(21,263)
14,973
57,710
(195,660)
(23,494)
82,358
83,508
178,059
-
(167,234)
21,077
(68)
360
(3,639)
-
(24,733)
722,692
(270,200)
-
35,000
(779)
(209)
-
(1,461)
(16,496)
468,547
(19,069)
112,947
93,878 $
188,768
(194,000)
-
-
-
(293)
-
(1,461)
(15,799)
(22,785)
10,192
102,755
112,947 $
$
6,477
2,456
8,934
1,301
(10,480)
30,547
(29,901)
(1,793)
(796)
127
2,350
(50)
-
13,376
3,065
65,139
(44,919)
(28,017)
90,114
96,211
29,851
-
(361,915)
-
(35)
590
(2,842)
(4,447)
(225,409)
156,733
23,300
(1)
-
-
(113)
320
(1,462)
(14,947)
163,830
3,560
99,195
102,755
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(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, 2020, the Company conducted its business through its four subsidiaries: Five Star Bank (the
“Bank”), a New York chartered bank; SDN Insurance Agency, LLC (“SDN”), a full service insurance agency; and Courier Capital,
LLC (“Courier Capital”) and HNP Capital, LLC (“HNP Capital”), SEC-registered investment advisory and wealth management firms.
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 credit 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.
Supplemental cash flow information is summarized as follows for the years ended December 31 (in thousands):
Supplemental information:
Cash paid for interest
Cash paid for income taxes, net of refunds received
Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans
Accrued and declared unpaid dividends
(Decrease) increase in net unsettled security purchases
Securities transferred from held to maturity to available for sale (at cost)
Common stock issued for Courier Capital contingent earn-out
Assets acquired and liabilities assumed in business combinations:
Fair value of assets acquired
Fair value of liabilities assumed
2020
2019
2018
$
$
28,875 $
7,462
37,225 $
9,853
28,626
3,527
2,966 $
4,535
-
-
-
557 $
4,365
(2,650)
26,175
1,151
-
-
-
-
642
4,187
2,650
-
-
2,561
128
- 76 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(d.) Investment Securities
Investment securities are classified as either available for sale (“AFS”) or held to maturity (“HTM”). 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 (loss) and shareholders’ equity.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
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.
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.
- 77 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
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 Credit Losses below for further policy discussion and see Note 6 – 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 Credit Losses
The allowance for credit losses is evaluated on a regular basis and established through charges to earnings in the form of a
provision for credit 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. This evaluation is inherently
subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
- 78 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Portfolio Segmentation and “Pooled Loans” Calculation
Loans are pooled based on their homogeneous risk characteristics. Once loans have been segmented into pools, a loss rate is
applied to the amortized cost basis. The Company has divided its portfolio into six segments, as the loans within the segments
have similar characteristics. Characteristics considered include: purpose, tenor, amortization, repayment source, payment
frequency, collateral and recourse. The Company has identified six portfolio segments of loans including Commercial
Loans/Lines, Commercial Mortgage, Indirect Loans, Direct Loans, Residential Lines of Credit, and Residential Loans.
The Company utilizes the Discounted Cash Flow (“DCF”) method for its pooled segment calculation. The DCF method
implements a Probability of Default with Loss Given Default and Exposure at Default estimation. The Probability of Default and
Loss Given Default are applied to future cash flows that are adjusted to present value and these discounted expected losses
become the Allowance for Credit Losses.
DCF analysis is reliant upon a variety of loan-level data, peripheral model outputs and key assumptions. The data fields required
to create the contractual portion of the forward-looking cash flow schedule relate to the terms of each loan and include
information regarding payment amount, payment frequency, interest rate, interest type, maturity date, amortization term, etc.
Contractual
to arrive at expected cashflows. The Company modeled
amortizing/installment notes with a prepayment rate, annualized to one-year. For loans where principal collection is dominated by
borrower election, e.g. lines of credit, interest-only, etc., and not by contractual obligation, the Company modeled a statistical
tendency to repay as a curtailment rate, normalized to a one-year rate.
terms must be adjusted for prepayments
The Company uses forecasts to predict how modeled economic factors will perform. The Company currently elects to forecast
economic factors over a period for which it can produce a reliable and defensible forecast from widely accepted economic
forecast resources. After the forecast period, the following eight quarters are reverted on a straight-line basis to the economic
factor’s average. The Company uses an eight-quarter straight-line reversion to reduce the potential for a spike impact on the
model caused by a rapid reversion. Additionally, as the Company is past its point of forecast, a straight-line reversion represents a
most-likely scenario absent a hard forecast.
In the Company’s analysis at the portfolio level, it found that the best model for predicting defaults considers the National
Unemployment Rate. With the large number of observations afforded by using peer data, the default curve is less sensitive to
unusual loss events and has a much smoother shape. The national unemployment rate is an extremely strong predictor of defaults
and explains almost all variation in the default rate.
CECL requires calculating a reserve based on a life of loan basis. The life of loan is assumed with consideration of prepayments
and contractual maturity dates. If a given loan does not have a populated maturity date, based upon historical experience, the
Company elected to amortize the loan for a length of time equal to the average life of the loan’s segment before the remaining
balance will balloon with the exception of Commercial Demand Lines of Credit where the Company uses one year, reflecting the
demand nature of these exposures with annual review.
Management also considers Qualitative Factors (“QF”) that are likely to cause estimated credit losses with the Company’s
existing portfolio to differ from historical loss experience, including but not limited to: national and local economic trends and
conditions (excluding national unemployment), levels and trends in delinquencies, non-accrual loans and classified assets,
trends in volume, terms and concentrations of loans, changes in lending policies and procedures, Quality of Credit Review
function and administration, and changes in regulatory environment. The Company will periodically assess what adjustments are
necessary to qualitatively adjust the ACL based on their assessment of current expected credit losses.
The range for the QF in a specific pool represents the difference, in basis points between the portfolio segment loss explained by
the regression analysis (r-squared factor) and the total loss for that period, looking back to 2006, when the Company experienced
its highest four quarter loss rate. In this approach, the Company is capturing, based upon historical experience, its largest potential
loss rate. Where possible, the QF are calculated using available data sources to support the allocation of basis points within the
ranges. For example, delinquency for a segment is mapped backed to 2006 and current delinquency is allocated a QF based upon
where it lies in that range.
- 79 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Individually Analyzed Loans
Excluded from pooled analysis are loans to be individually analyzed due to the assets not maintaining similar risk characteristics
to those in the six designated segments. These loans are generally considered to be collateral dependent and, therefore, an analysis
of the collateral position versus the pooled loan discounted cash flow approach better reflects the potential loss. Individually
analyzed accounts include: loans over 90 days past due, loans marked as Trouble Debt Restructure (“TDR”), loans placed on non-
accruals status and criticized assets with exposure greater than $2.0 million.
In addition, certain commercial loans are on long term deferral due to the impacts of the COVID-19 pandemic. While not
criticized assets, these loans reflect unique characteristics and warrant individual analysis. Management reviewed these loans and
elected to remove certain loans from the pooled loan analysis based upon characteristics including industry, which evidence a
higher risk of loss from the impact of the pandemic. These loans were individually analyzed, and reserves allocated to them based
upon collateral position. Management continues to assess the status of these loans for risk characteristics.
Held to Maturity (“HTM”) Debt Securities
The Company’s HTM debt securities are also required to utilize the current expected credit losses approach to estimate expected
credit losses. The Company’s HTM debt securities included securities that are issued by U.S. government agencies or U.S.
government-sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are
widely recognized as “risk free,” and have a long history of zero credit loss. The Company also carries a portfolio of HTM
municipal bonds. The Company measures its allowance for credit losses on HTM debt securities on a collective basis by major
security type. The estimate is based on historical credit losses, if any, adjusted for current conditions and reasonable and
supportable forecasts. The Company considers the nature of the collateral, potential future changes in collateral values and
available loss information.
Available for Sale (“AFS”) Debt Securities
For AFS securities in an unrealized loss position, we first assess whether (i) we intend to sell, or (ii) it is more likely than not that
we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously
recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If neither
case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other
factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes
to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors.
If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are
compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the
amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount
that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit
losses is recognized in other comprehensive income. Adjustments to the allowance are reported in our income statement as a
component of provision for credit losses. AFS securities are charged-off against the allowance or, in the absence of any
allowance, written down through income when deemed uncollectible by management or when either of the aforementioned
criteria regarding intent or requirement to sell is met.
- 80 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Accrued Interest Receivable
Upon adoption of ASU 2016-13 and its related amendments on January 1, 2020, the Company made the following elections
regarding accrued interest receivable:
•
•
•
•
Presenting accrued interest receivable balances separately within other assets on the statement of financial condition.
Excluding accrued interest receivable that is included in the amortized cost of financing receivables and debt
securities from related disclosure requirements.
Continuing our policy to write off accrued interest receivable by reversing interest income. For commercial loans,
the write off typically occurs upon becoming 90 days past due. For consumer loans, the write off typically occurs
upon becoming 120 days past due. Historically, the Company has not experienced uncollectible accrued interest
receivable on its investment securities. However, the Company would generally write off accrued interest receivable
by reversing interest income if the Company does not reasonably expect to receive payments. Due to the timely
manner in which accrued interest receivables are written off, the amounts of such write offs are immaterial.
The Company had made the election with the adoption of ASU 2016-13 of not measuring an allowance for credit
losses for accrued interest receivable due to the Company’s policy of writing off uncollectible accrued interest
receivable balances in a timely manner, as described above.
Reserve for Unfunded Commitments
The reserve for unfunded commitments (the “Unfunded Reserve”) represents the expected credit losses on off-balance sheet
commitments such as unfunded commitments to extend credit and standby letters of credit. However, a liability is not recognized
for commitments unconditionally cancellable by the Company. The Unfunded Reserve is recognized as a liability (other liabilities
in the consolidated statements of financial condition), with adjustments to the reserve recognized as a provision for credit loss
expense in the consolidated statements of income. The Unfunded Reserve is determined by estimating expected future fundings,
under each segment, and applying the expected loss rates. Expected future fundings are based on historical averages of funding
rates (i.e., the likelihood of draws taken). Average funding rates are determined based on the most recent 20 quarters (5 years) of
actual fundings on lines of credit. The average funding rate for each segment is compared to the current funding rate on each line
to determine the average fundings available to be drawn. The fund up rate (the difference between the average funding rate and
the current funding rate) for each segment is then applied within the CECL model to the unfunded commitment balance to
estimate the expected future fundings under each segment. The loss rate derived for each segment in the current CECL calculation
is then applied to the expected future fundings to derive the estimate of allowance for credit losses for unfunded commitments.
(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 initially recorded at fair value less estimated costs to sell, which establishes the cost basis. Subsequently, other
real estate owned is carried at the lower of the cost basis or fair value less estimated selling costs. 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 credit losses and any subsequent valuation write-downs are charged to
other expense. In connection with the determination of the allowance for credit 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 $3.0 million and
$468 thousand at December 31, 2020 and 2019, respectively.
- 81 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(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.
(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 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. 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 8 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 $2.6 million and
$14.6 million as of December 31, 2020 and 2019, 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 $6.1 million as of December 31, 2020 and 2019.
- 82 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(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 $7.9 million and $7.6 million as of December 31, 2020 and 2019, respectively.
(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. Changes in fair value of the Company’s derivatives
designated in a qualifying hedging relationship are recorded in accumulated other comprehensive income (loss). Changes in fair
value of the Company’s derivatives not designated in a qualifying hedging relationship 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.) Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over financial
assets is deemed surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of
conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets and the Company does
not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
- 83 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(r.) Revenue Recognition
ASC 606, Revenue from Contracts with Customers (“ASC 606”), establishes principles for reporting information about the
nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services
to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in
an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services
recognized as performance obligations are satisfied.
The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial
instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our loan
servicing activities, as these activities are subject to other GAAP. Descriptions of our primary revenue-generating activities that
are within the scope of ASC 606, which are presented in our income statements as components of noninterest income are as
follows:
•
•
Transactions and service-based revenues - these include service charges on deposits, investment advisory, and ATM and
debit card fees. Revenue is recognized when the transactions occur or as services are performed over primarily monthly or
quarterly periods. Payment is typically received in the period the transactions occur or, in some cases, within 90 days of the
service period. Fees may be fixed or, where applicable, based on a percentage of transaction size or managed assets.
Insurance income - Insurance commissions are received on the sale of insurance products, and revenue is recognized upon the
placement date of the insurance policies. Payment is normally received within the policy period. In addition to placement,
SDN also provides insurance policy related risk management services. Revenue is recognized as these services are provided.
(s.) 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 plan’s 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.
(t.) Share-Based Compensation Plans
Compensation expense for stock options, restricted stock awards and restricted stock units 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 and restricted stock units 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.
- 84 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(u.) 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.
The Company has investments in partnerships that incur qualified expenses related to the rehabilitation of certified structures. At
the time that a structure is placed into service, the Company is eligible for federal and New York State tax credits. The federal tax
credit impact is recorded as a reduction of income tax expense. For a New York State tax credit generated after January 1, 2015,
the amount not used in the current tax year is treated as a refund or overpayment of tax to be credited to next year’s tax. Since the
realization of the tax credit does not depend on the Company’s generation of future taxable income or the Company’s ongoing tax
status or tax position, the credit is not considered an element of income tax accounting (ASC 740). The Company includes the tax
credit in non-interest income as opposed to a reduction of income tax expense. At the time that a structure is placed into service,
the Company records a loss on tax credit investments in noninterest income to reduce the investment to the present value of the
expected cash flows from its partnership interest.
The Company has investments in qualified affordable housing projects that are accounted for using the proportional amortization
method. Under that method, the Company amortizes the initial cost of the investment in proportion to the tax credits and other tax
benefits received and recognizes the net amount as a reduction of income tax expense.
These tax credit investments are included in other assets in the consolidated statements of financial condition and totaled
$34.4 million and $16.5 million as of December 31, 2020 and 2019, respectively.
(v.) Comprehensive Income (Loss)
Comprehensive income (loss) 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 (loss)
include the after-tax effect of changes in net unrealized gain / loss on securities available for sale, changes in unrealized gain / loss
on hedging derivative instruments and changes in net actuarial gain / loss on defined benefit post-retirement plans.
Comprehensive income (loss) is reported in the accompanying consolidated statements of changes in shareholders’ equity and
consolidated statements of comprehensive income (loss). See Note 17 - Accumulated Other Comprehensive Income (Loss) for
additional information.
(w.) 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 20 - Earnings Per Common Share.
- 85 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(x.) Reclassifications
Certain items in prior financial statements have been reclassified to conform to the current presentation. These reclassifications
did not result in any changes to previously reported net income or shareholders’ equity.
(y.) Recent Accounting Pronouncements
On January 1, 2020, the Company adopted Accounting Standards Update (“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. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for
estimating the reserve for credit losses. In addition, entities need to disclose the amortized cost balance for each class of financial
asset by credit quality indicator, disaggregated by the year of origination. The Company adopted ASU 2016-13 using the
modified retrospective approach. Results for the periods beginning after January 1, 2020 are presented under Accounting
Standards Codification (“ASC”) 326 while prior period amounts continue to be reported in accordance with previously applicable
GAAP. The Company recorded a net reduction of retained earnings of $8.7 million upon adoption. The transition adjustment
included an increase in credit-related reserves of $9.6 million, $14 thousand, and $2.1 million for loans, held to maturity
investment securities and unfunded commitments, respectively, net of the corresponding increase in deferred tax assets of $3.0
million.
In August 2018, the FASB issued ASU No. 2018-14, Compensation – Retirement Benefits – Defined Benefit Plans – General
(Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. These
amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.
ASU No. 2018-14 was effective for fiscal years ending after December 15, 2020; early adoption is permitted. As ASU No. 2018-
14 only revises disclosure requirements, its adoption did not have a material impact on the Company’s Consolidated Financial
Statements.
In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit
Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. With respect to Topic 815, Derivatives and
Hedging, ASU 2019-04 clarifies that the reclassification of a debt security from Held to Maturity (“HTM”) to Available for Sale
(“AFS”) under the transition guidance in ASU No. 2017-12, Derivatives and Hedging (Topic 815) – Targeted Improvements to
Accounting for Hedging Activities, would not (1) call into question the classification of other HTM securities, (2) be required to
actually designate any reclassified security in a last-of-layer hedge, or (3) be restricted from selling any reclassified security. As
part of the transition of ASU 2019-04, entities may reclassify securities that would qualify for designation as the hedged item in a
last-of-layer hedging relationship from HTM to AFS; however, entities that already made such a reclassification upon their
adoption of ASU 2017-12 are precluded from reclassifying additional securities. The Company did not reclassify any securities
from HTM to AFS upon adoption of ASU 2017-12. The Company elected to early adopt the amendments to Topic 815 in
December 2019, resulting in the reclassification of $26.2 million of qualified investment securities from HTM to AFS. With
respect to Topic 326, Financial Instruments - Credit Losses, ASU 2019-04 clarifies the scope of the credit losses standard and
addresses issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other
things. With respect to Topic 825, Financial Instruments, on recognizing and measuring financial instruments, ASU 2019-04
addresses the scope of the guidance, the requirement for remeasurement under ASC 820 (Fair Value Measurement) when using
the measurement alternative, certain disclosure requirements and which equity securities have to be remeasured at historical
exchange rates. The amendments to Topic 326 and the amendments to Topic 825, under ASU 2019-04, were adopted as of
January 1, 2020 and did not have a significant impact on the Company’s financial statements.
- 86 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In 2017, the United Kingdom’s Financial Conduct Authority, who is responsible for regulating LIBOR, announced its intention
that it would no longer be necessary to persuade or compel its panel banks to submit LIBOR rates after December 31, 2021.
Given that LIBOR is a widely used pricing index for loan and derivative contracts, a Company-wide initiative was introduced to
assess all LIBOR exposures through the Company’s loan, deposit, borrowing and derivative categories, while developing a plan
for the ultimate cessation of the index. In developing the transition plan, the Company has followed best practice
recommendations from the Federal Reserve’s Alternative Reference Rate Committee, our third-party derivative advisor and the
Internal Swaps and Derivatives Association. To date, the Company has identified the portion of loan notes that reference LIBOR,
which are primarily representative of commercial relationships. Additionally, the Company has one designated derivative
instrument that is utilized to hedge the LIBOR characteristic of a future dated borrowing (i.e. Federal Home Loan Bank
Advance). In 2015, the Company issued a $40 million fixed to floating rate subordinated debt instrument that currently bears a
fixed rate of interest at 6.00% until April 2025, when the rate converts to a floating rate structured indexed to three-month
LIBOR; the indenture under which the notes were issued includes language allowing an alternate index to be applied in the event
that LIBOR becomes unavailable at the floating rate determination date. At this time, no other borrowing or deposit relationships
have been identified that utilize LIBOR as an index.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference
Rate Reform on Financial Reporting. The ASU provides temporary optional expedients and exceptions to GAAP guidance on
contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from
LIBOR and other interbank offered rates to alternative rates, such as SOFR. ASU 2020-04 became effective during the first
quarter of 2020 and applies to contract modifications and amendments made as of the beginning of the reporting period including
the ASU’s issuance date, March 12, 2020, and applies through December 31, 2022. The adoption of this guidance in 2020
resulted in the application of certain practical expedients, which did not have a material effect on the Company's consolidated
financial statements.
In January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848): Scope. The ASU clarifies that certain
optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are
affected by the discounting transition. The ASU also amends the expedients and exceptions in ASC 848 to capture the
incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the
discounting transition. ASU 2021-01 was effective upon issuance and applies through December 31, 2022. The Company is in the
process of determining which optional expedients to elect, if any, as well as the timing and application of those elections. At this
time, the Company does not expect any elections to have a significant impact on its financial statements.
(2.) BUSINESS COMBINATIONS
2021 Activity - Landmark Group Acquisition
On February 1, 2021, SDN completed the acquisition of the assets of Landmark Group (“Landmark”), an independent insurance
brokerage firm. Consideration for the acquisition includes common shares of Company stock, cash and potential future cash bonuses
contingent upon achievement of certain revenue performance targets through February 2024. The purchase price allocation has not
been finalized. Therefore, values to be recognized for goodwill and other intangible assets will be disclosed in the Quarterly Report
on Form 10-Q for the first quarter of 2021. 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.
2018 Activity - HNP Capital Acquisition
On June 1, 2018, the Company completed the acquisition of HNP Capital, a Securities and Exchange Commission (“SEC”)-registered
investment advisor with approximately $344 million in assets under management as of June 30, 2018. Consideration for the
acquisition totaled $5.1 million in cash. As a result of the acquisition, the Company recorded goodwill of $2.6 million and other
intangible assets of $2.5 million. 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.
- 87 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(3.) RESTRUCTURING CHARGES
On July 17, 2020, the Bank announced management’s decision to adopt a full-service branch model that streamlines retail branches to
better align with shifting customer needs and preferences. The transformation resulted in six branch closures and a reduction in
staffing. The announcement was the result of a nine-month comprehensive assessment of all lines of business and functional areas,
conducted in partnership with a leading process improvement organization. The data-driven analysis identified, among other things,
overlapping service areas, automation opportunities and streamlining of processes and operations that would enhance customer
experiences and facilitate the long-term sustainability of current and future branches. The announced consolidations represented about
ten percent of the branch network and impacted approximately six percent of the total Company workforce. Where possible, those
impacted were offered alternative roles or the opportunity to apply for open positions in other areas of the Company. Separated
associates received a comprehensive severance package based on tenure.
In October 2020, the Company announced the planned closure of one additional branch in January 2021. This location was not
included in the branch consolidations announced in July, as alternative options were being considered and consolidation was not
possible given its significant distance from other Bank branches.
For the year ended December 31, 2020, the Company incurred total pre-tax expense related to the branch closures of approximately
$1.7 million, including approximately $0.2 million in employee severance, $0.5 million in lease termination costs and $1.0 million in
valuation adjustments on branch facilities. The Company recognized all of these expenses during 2020. The Company expects
approximately $0.9 million of total costs will result in future cash expenditures. The Company anticipates annual expense savings of
approximately $2.7 million as a result of these branch closures.
The following table represents the consolidated statements of income classification of the Company’s restructuring charges (in
thousands):
December 31, 2020
Severance costs
Lease termination costs
Valuation adjustments
Total
Income Statement Location
2020
2019
2018
Salaries and employee benefits
Restructuring charges
Restructuring charges
$
$
242 $
454
1,038
1,734 $
- $
-
-
- $
The following table represents the changes in the restructuring reserve (in thousands):
Balance, January 1, 2019
No activity during the period
Balance, December 31, 2019
Restructuring charges
Cash payments
Charges against assets
Balance, December 31, 2020
$
$
-
-
-
-
-
-
-
1,734
(287)
(202)
1,245
- 88 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(4.) INVESTMENT SECURITIES
The amortized cost and fair value of investment securities are summarized below (in thousands).
December 31, 2020
Securities available for sale:
U.S. Government agencies and government sponsored enterprises $
Mortgage-backed securities:
6,239 $
396 $
- $
6,635
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
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
Allowance for credit losses - securities
Total held to maturity securities, net
350,627
225,645
22,107
3,047
-
-
601,426
607,665 $
15,549
3,155
830
97
-
435
20,066
20,462 $
$
44
24
-
-
-
-
68
68 $
366,132
228,776
22,937
3,144
-
435
621,424
628,059
$
144,506 $
4,478 $
- $
148,984
10,776
5,858
37,084
29,988
35,897
7,864
127,467
271,973 $
(7)
271,966
$
703
382
1,578
1,075
1,581
265
5,584
10,062 $
-
-
-
-
-
-
-
- $
11,479
6,240
38,662
31,063
37,478
8,129
133,051
282,035
December 31, 2019
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
$
- 89 -
26,440 $
437 $
- $
26,877
293,873
52,733
14,065
23,834
4,907
-
389,412
415,852 $
2,263
318
60
-
-
618
3,259
3,696 $
1,380
172
4
57
18
-
1,631
1,631 $
294,756
52,879
14,121
23,777
4,889
618
391,040
417,917
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(4.) INVESTMENT SECURITIES (Continued)
December 31, 2019 (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
Gains
Unrealized
Losses
Fair
Value
$
192,215 $
3,803 $
- $
196,018
12,049
6,995
45,758
41,561
49,389
11,033
166,785
359,000 $
227
77
306
150
307
12
1,079
4,882 $
$
6
47
128
256
103
83
623
623 $
12,270
7,025
45,936
41,455
49,593
10,962
167,241
363,259
The Company elected to exclude accrued interest receivable (“AIR”) from the amortized cost basis of debt securities disclosed
throughout this footnote. For AFS debt securities, AIR totaled $1.2 million and $1.0 million as of December 31, 2020 and December
31, 2019, respectively. For HTM debt securities, AIR totaled $905 thousand and $1.2 million as of December 31, 2020 and December
31, 2019, respectively. AIR is included in other assets on the Company’s consolidated statements of financial condition.
For the years ended December 31, 2020 and 2019, credit loss (credit) expense for HTM investment securities was $(7) thousand and
$0, respectively.
Investment securities with a total fair value of $567.4 million and $676.9 million at December 31, 2020 and 2019, 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
2020
2019
2018
$
$
14,186 $
3,278
17,464 $
14,382 $
4,150
18,532 $
16,510
5,091
21,601
Sales 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
$
2020
107,098 $
1,642
43
2019
178,059 $
2,391
714
2018
29,851
73
200
- 90 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(4.) INVESTMENT SECURITIES (Continued)
The scheduled maturities of securities available for sale and securities held to maturity at December 31, 2020 are shown below (in
thousands). Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay
obligations.
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
Total available for sale securities
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
Total held to maturity securities
Amortized
Cost
Fair
Value
$
$
$
$
1,907 $
39,712
159,570
406,476
607,665 $
47,086 $
97,363
17,371
110,153
271,973 $
1,920
41,903
171,036
413,200
628,059
47,505
101,311
18,194
115,025
282,035
- 91 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(4.) INVESTMENT SECURITIES (Continued)
Unrealized losses on investment securities for which an allowance for credit losses has not been recorded 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
Fair
Value
Unrealized
Losses
12 months or longer
Fair
Value
Unrealized
Losses
Total
Fair
Value
Unrealized
Losses
$
$
December 31, 2020
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
Total temporarily impaired securities
December 31, 2019
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
$
-
$
-
$
-
$
-
$
-
$
18,155
10,932
-
-
-
29,087
29,087
29,087
$
44
24
-
-
-
68
68
68
$
-
-
-
8
-
8
8
8
$
-
-
-
-
-
-
-
-
$
18,155
10,932
-
8
-
29,095
29,095
29,095
$
-
44
24
-
-
-
68
68
68
-
$
-
$
-
$
-
$
-
$
-
104,634
10,347
533
8,803
4,889
129,206
129,206
-
2,388
2,967
11,155
1,277
11
4
57
18
1,367
1,367
-
6
19
61
9,120
15,127
8,760
49,517
49,517
$ 178,723
$
40
30
72
228
228
1,595
$
7,196
9,409
-
8
-
16,613
16,613
-
-
2,598
5,625
13,486
7,988
892
30,589
30,589
47,202
$
103
161
-
-
-
264
264
-
-
28
67
216
73
11
395
395
659
111,830
19,756
533
8,811
4,889
145,819
145,819
-
2,388
5,565
16,780
22,606
23,115
9,652
80,106
80,106
$ 225,925
$
1,380
172
4
57
18
1,631
1,631
-
6
47
128
256
103
83
623
623
2,254
- 92 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(4.) INVESTMENT SECURITIES (Continued)
The total number of security positions in the investment portfolio in an unrealized loss position at December 31, 2020 was eight
compared to 91 at December 31, 2019. At December 31, 2020, the Company had a position in one investment security with a fair
value of eight thousand dollars and a total unrealized loss of less than one thousand dollars that has been in a continuous unrealized
loss position for more than 12 months. At December 31, 2020, there were a total of seven securities positions in the Company’s
investment portfolio with a fair value of $29.1 million and a total unrealized loss of $68 thousand that had been in a continuous
unrealized loss position for less than 12 months. At December 31, 2019, the Company had positions in 34 investment securities with a
fair value of $47.2 million and a total unrealized loss of $659 thousand that have been in a continuous unrealized loss position for
more than 12 months. At December 31, 2019, there were a total of 57 securities positions in the Company’s investment portfolio with
a fair value of $178.7 million and a total unrealized loss of $1.6 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.
Securities Available for Sale
As of December 31, 2020, no allowance for credit losses has been recognized on available for sale securities in an unrealized loss
position as management does not believe any of the securities are impaired due to reasons of credit quality. This is based upon our
analysis of the underlying risk characteristics, including credit ratings, and other qualitative factors related to our available for sale
securities and in consideration of our historical credit loss experience and internal forecasts. The issuers of these securities continue to
make timely principal and interest payments under the contractual terms of the securities. Furthermore, management does not have the
intent to sell any of the securities classified as available for sale in the table above and believes that it is more likely than not that we
will not have to sell any such securities before a recovery of cost. The unrealized losses are 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 securities
approach their maturity date or repricing date or if market yields for such investments decline.
Securities Held to Maturity
The Company’s HTM investment securities include debt securities that are issued by U.S. government agencies or U.S. government-
sponsored enterprises. These securities carry the explicit and/or implicit guarantee of the U.S. government, are widely recognized as
“risk free,” and have a long history of zero credit loss. In addition, the Company’s HTM investment securities include debt securities
that are issued by state and local government agencies, or municipal bonds.
The Company monitors the credit quality of our municipal bonds through the use of a credit rating agency or by ratings that are
derived by an internal scoring model. The scoring methodology for the internally derived ratings is based on a series of financial ratios
for the municipality being reviewed as compared to typical industry figures. This information is used to determine the financial
strengths and weaknesses of the municipality, which is indicated with a numeric rating. This number is then converted into a letter
rating to better match the system used by the credit rating agencies. As of December 31, 2020, $135.7 million of our municipal bonds
were rated as an equivalent to Standard & Poor’s A/AA/AAA, with $8.5 million internally rated to be the equivalent of Standard &
Poor’s A/AA/AAA rating. Additionally, one municipal bond is rated below investment grade, with a BB+ Standard & Poor’s
equivalent rating. The below investment grade bond was recently upgraded from a Standard & Poor’s equivalent rating of BB-,
represents exposure of $279 thousand, or 0.19% of the municipal bond portfolio and is closely monitored for repayment.
As of December 31, 2020, the Company had no past due or nonaccrual held to maturity investment securities.
- 93 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(5.) LOANS HELD FOR SALE AND LOAN SERVICING RIGHTS
Loans held for sale were entirely comprised of residential real estate loans and totaled $4.3 million and $4.2 million as of
December 31, 2020 and 2019, 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
$241.7 million and $189.8 million as of December 31, 2020 and 2019, respectively. In connection with these mortgage-servicing
activities, the Company administered escrow and other custodial funds which amounted to approximately $4.5 million and $3.9
million as of December 31, 2020 and 2019, respectively.
The activity in capitalized loan servicing assets is summarized as follows for the years ended December 31 (in thousands):
2020
2019
2018
Mortgage servicing assets, beginning of year
Originations
Amortization
Mortgage servicing assets, end of year
Valuation allowance
Mortgage servicing assets, net, end of year
(6.) LOANS
$
$
$
1,129
601
(354)
1,376
(56)
$
1,320
The Company’s loan portfolio consisted of the following at December 31 (in thousands):
$
1,022
349
(242)
1,129
-
1,129
$
990
299
(267)
1,022
-
1,022
2020
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total
Allowance for credit losses - loans
Total loans, net
2019
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total
Allowance for loan losses
Total loans, net
Principal
Amount
Outstanding
Net Deferred
Loan (Fees)
Costs
Loans, Net
$
$
$
$
798,409
1,256,525
586,537
86,708
812,816
16,913
3,557,908
571,222
1,108,315
560,717
101,048
822,179
15,984
3,179,465
$
$
$
$
(4,261) $
(2,624)
13,263
3,097
27,605
150
37,230
$
818
$
(2,032)
11,633
3,070
27,873
160
41,522
$
794,148
1,253,901
599,800
89,805
840,421
17,063
3,595,138
(52,420)
3,542,718
572,040
1,106,283
572,350
104,118
850,052
16,144
3,220,987
(30,482)
3,190,505
- 94 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
The CARES Act was passed by Congress and signed into law on March 27, 2020. The CARES Act established the PPP, an expansion
of the SBA’s 7(a) loan program and the EIDL, administered directly by the SBA. The Company had $253.1 million of PPP loans,
principal amount outstanding (included in Commercial business above) as of December 31, 2020. In addition, the CARES Act
provides that a financial institution may elect to suspend (1) the application of GAAP for certain loan modifications related to
COVID-19 that would otherwise be categorized as a TDR and (2) any determination that such loan modifications would be considered
a TDR, including the related impairment for accounting purposes. Accordingly, the Company had $532.4 million of loans with
modifications related to COVID-19 during 2020, with $113.0 million still on deferral as of December 31, 2020.
The Company elected to exclude AIR from the amortized cost basis of loans disclosed throughout this footnote. As of December 31,
2020 and December 31, 2019, AIR for loans totaled $13.6 million and $9.1 million, respectively, and is included in other assets on the
Company’s consolidated statements of financial condition.
The Company’s significant concentrations of credit risk in the loan portfolio relate to a geographic concentration in the communities
that the Company serves.
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 $32.8 million and $18.6 million at December 31, 2020 and 2019, respectively. During 2020, new
borrowings amounted to $16.3 million (including borrowings of executive officers and directors that were outstanding at the time of
their appointment), and repayments and other reductions were $2.1 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):
30-59
Days
Past
Due
60-89
Days
Past
Due
Greater
Than 90
Days
Total
Past
Due
Nonaccrual Current
Total
Loans
Nonaccrual
with no
allowance
2020
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans, gross
2019
Commercial business
Commercial mortgage
Residential real estate loans
Residential real estate lines
Consumer indirect
Other consumer
Total loans, gross
$
264 $
822
984
40
3,966
133
87 $
26
60
15
1,348
18
$ 6,209 $ 1,554 $
$
361 $
531
929
231
3,729
116
- $
-
114
37
1,019
8
$ 5,897 $ 1,178 $
351 $
- $
848
-
1,044
-
55
-
5,314
-
231
382
231 $ 7,994 $
1,975 $ 796,083 $ 798,409 $
2,906 1,252,771 1,256,525
586,537
2,587
582,906
86,708
323
86,330
812,816
1,495
806,007
16,913
-
16,531
9,286 $3,540,628 $3,557,908 $
1,502
2,709
2,587
323
1,495
-
8,616
- $
361 $
-
531
-
1,043
-
268
-
4,748
130
6
6 $ 7,081 $
1,177 $ 569,684 $ 571,222
3,146 1,104,638 1,108,315
557,190
560,717
2,484
100,678
101,048
102
815,706
822,179
1,725
15,984
15,854
-
8,634 $3,163,750 $3,179,465
There were no loans past due greater than 90 days and still accruing interest as of December 31, 2020 and 2019. There were
$231 thousand and $6 thousand in consumer overdrafts which were past due greater than 90 days as of December 31, 2020 and 2019,
respectively. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not
accrue interest.
- 95 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
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, 2020, 2019 and 2018. For the years ended December 31,
2020, 2019 and 2018, estimated interest income of $430 thousand, $508 thousand, and $294 thousand, respectively, would have been
recorded if all such loans had been accruing interest according to their original contractual terms.
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.
There were no loans modified as a TDR during the years ended December 31, 2020 and 2019.
There were no loans modified as a TDR during the years ended December 31, 2020 and 2019 that defaulted during the year ended
December 31, 2020. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower
becomes 90 days past due.
Collateral Dependent Loans
Management has determined that specific commercial loans on nonaccrual status, all loans that have had their terms restructured in a
troubled debt restructuring and other loans deemed appropriate by management where repayment is expected to be provided
substantially through the operation or sale of the collateral to be collateral dependent loans. Collateral dependent loans at December
31, 2020 included certain criticized COVID-19 bridge loans not otherwise classified as nonaccrual. The following table presents the
amortized cost basis of collateral dependent loans by collateral type as of December 31, 2020 (in thousands):
December 31, 2020
Commercial business
Commercial mortgage
Total
Collateral type
Business
assets
Real property
Total
Specific
Reserve
$
$
2,379 $
—
2,379 $
— $
36,625
36,625 $
2,379 $
36,625
39,004 $
1,383
8,187
9,570
- 96 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
Impaired Loans
Prior to the adoption of ASC 326, management determined that specific commercial loans on nonaccrual status and all loans that have
had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents the recorded investment,
unpaid principal balance and related allowance of impaired loans as well as average recorded investment and interest income
recognized on impaired loans at December 31, 2019 (in thousands):
2019
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
$
$
563
973
1,536
614
2,173
2,787
4,323
$
$
775
1,749
2,524
614
2,173
2,787
5,311
$
$
$
-
-
-
214
479
693
693
$
411
1,701
2,112
1,207
1,825
3,032
5,144
$
$
-
-
-
-
-
-
-
(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.
- 97 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
Loans that do not meet the criteria above that are analyzed individually as part of the process described above are considered
“uncriticized” or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.
The following table sets forth the Company’s commercial loan portfolio, categorized by internally assigned asset classification, as of
December 31 (in thousands):
Term Loans Amortized Cost Basis by Origination Year
Revolving
Loans
Amortized
Cost Basis
Revolving
Loans
Converted
to Term Total
- $ 782,045
5,151
-
6,952
-
-
-
- $ 794,148
- $1,093,425
144,682
-
15,794
-
-
-
- $1,253,901
2020 2019 2018 2017 2016 Prior
December 31,
2020
Commercial Business
Uncriticized
Special mention
Substandard
Doubtful
Total
Commercial Mortgage
Uncriticized
Special mention
Substandard
Doubtful
Total
$350,992 $112,469 $ 82,029 $ 31,990 $ 8,195 $ 16,600 $ 179,770 $
2,995
4,390
-
$351,185 $113,040 $ 83,233 $ 33,163 $ 8,438 $ 17,934 $ 187,155 $
1,025
309
-
21
1,183
-
709
464
-
-
193
-
360
211
-
41
202
-
$310,364 $227,406 $163,839 $161,771 $74,915 $154,399 $
14,299 42,305 19,505 27,530 12,256 28,744
9,344
1,890
-
-
$324,852 $272,232 $185,234 $190,949 $87,174 $192,487 $
1,648
-
2,521
-
189
-
3
-
731 $
43
199
-
973 $
- 98 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
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):
Term Loans Amortized Cost Basis by Origination Year
2019 2018 2017 2016 Prior
to Term Total
Revolving
Loans
Amortized
Cost Basis
Revolving
Loans
Converted
2020
December 31,
2020
Residential Real Estate Loans
Performing
Nonperforming
Total
$137,926 $103,923 $ 87,153 $ 66,446 $67,473 $134,292 $
725
$137,926 $104,122 $ 87,918 $ 67,111 $67,706 $135,017 $
665
199
765
233
-
- $
-
- $
- $597,213
-
2,587
- $599,800
Residential Real Estate Lines
$
Performing
Nonperforming
Total
Consumer Indirect
Performing
Nonperforming
Total
Other Consumer
Performing
Nonperforming
Total
- $
-
- $
- $
-
- $
- $
-
- $
- $
-
- $
- $
-
- $
- $
-
- $
79,257 $
65
79,322 $
10,225 $ 89,482
323
10,483 $ 89,805
258
$
- $838,926
-
1,495
- $840,421
- $ 17,063
-
-
- $ 17,063
$295,216 $202,187 $166,773 $111,008 $47,793 $ 15,949 $
35
$295,286 $202,839 $167,092 $111,295 $47,925 $ 15,984 $
287
652
319
132
70
- $
-
- $
$
$
6,774 $
-
6,774 $
3,177 $
-
3,177 $
1,765 $
-
1,765 $
907 $
-
907 $
369 $
-
369 $
508 $
-
508 $
3,563 $
-
3,563 $
- 99 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(6.) LOANS (Continued)
Allowance for Credit Losses - Loans
The following tables set forth the changes in the allowance for credit losses - loans for the years ended December 31 (in thousands):
Residential
Real
Estate
Loans
Commercial
Mortgage
Residential
Real
Estate
Lines
Consumer
Other
Indirect
Consumer Total
Commercial
Business
2020
Allowance for credit losses - loans:
Beginning balance, prior to adoption of
ASC 326
Impact of adopting ASC 326
Beginning balance, after adoption of
ASC 326
Charge-offs
Recoveries
Provision (credit)
Ending balance
2019
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision (credit)
Ending balance
Evaluated for impairment:
Individually
Collectively
Loans:
Ending balance
Evaluated for impairment:
Individually
Collectively
$
$
$
$
$
$
$
$
$
11,358 $
(246)
11,112
(9,093)
1,709
9,852
13,580 $
5,681 $
7,310
1,059 $
3,290
118 $
607
11,852 $
(1,234)
414 $
(133) $
30,482
9,594
12,991
(1,792)
37
10,527
21,763 $
4,349
(100)
28
(353)
3,924 $
725
-
3
(54)
674 $
10,618
(9,959)
5,681
5,825
12,165 $
281
(681)
352
362
314 $
40,076
(21,625)
7,810
26,159
52,420
14,312 $
(2,481)
492
(965)
11,358 $
5,219 $
(2,997)
17
3,442
5,681 $
1,112 $
(340)
43
244
1,059 $
210 $
(13)
6
(85)
118 $
12,572 $
(10,810)
5,390
4,700
11,852 $
489 $
(1,170)
387
708
414 $
33,914
(17,811)
6,335
8,044
30,482
214 $
11,144 $
479 $
5,202 $
- $
1,059 $
- $
118 $
- $
11,852 $
- $
414 $
693
29,789
571,222 $ 1,108,315 $
560,717 $
101,048 $ 822,179 $
15,984 $3,179,465
1,177 $
3,146 $
570,045 $ 1,105,169 $
- $
560,717 $
- $
- $
101,048 $ 822,179 $
- $
4,323
15,984 $3,175,142
- 100 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
Commercial
Business
Commercial
Mortgage
Residential
Mortgage
Home
Equity
Consumer
Other
Indirect
Consumer Total
$
$
$
$
$
$
$
15,668 $
(2,319)
509
454
14,312 $
3,696 $
(1,020)
13
2,530
5,219 $
1,322 $
(95)
159
(274)
1,112 $
180 $
(142)
20
152
210 $
13,415 $
(10,850)
5,024
4,983
12,572 $
391
(1,308)
317
1,089
489 $
34,672
(15,734)
6,042
8,934
33,914
205 $
14,107 $
1 $
5,218 $
- $
1,112 $
- $
210 $
- $
12,572 $
- $
489 $
206
33,708
557,040 $
960,265 $
514,981 $ 106,712 $ 888,732 $
16,590 $3,044,320
1,044 $
555,996 $
2,034 $
958,231 $
- $
- $
514,981 $ 106,712 $ 888,732 $
- $
- $
3,078
16,590 $3,041,242
(6.) LOANS (Continued)
2018
Allowance for loan losses:
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Evaluated for impairment:
Individually
Collectively
Loans:
Ending balance
Evaluated for impairment:
Individually
Collectively
Risk Characteristics
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, including
the impact of the COVID-19 pandemic on small to mid-sized business in our market area, 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, including the impact of
the COVID-19 pandemic on the ability of the tenants to pay rent at these properties, 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 based on 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, including the impact of the COVID-19 pandemic on the employment income of
these borrowers, 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. 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, including the heightened risk that such circumstances may arise as a result of the COVID-19 pandemic.
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.
- 101 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(7.) 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
2020
2019
$
$
6,022 $
56,842
40,996
103,860
(63,250)
40,610 $
6,022
56,164
40,026
102,212
(60,788)
41,424
Depreciation and amortization expense included in the consolidated statements of income for the years ended December 31 was as
follows (in thousands):
Occupancy and equipment expense
Computer and data processing expense
Total depreciation and amortization expense
2020
2019
2018
$
$
4,109 $
637
4,746 $
4,382 $
599
4,981 $
4,473
675
5,148
(8.) 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.
Based on volatility in the capital markets and overall economic conditions as a result of the COVID‐19 pandemic accompanied by a
decline in the Company’s stock price, a quantitative assessment was performed for the Banking reporting unit in the third quarter of
2020. Based on this quantitative assessment, the Company concluded that goodwill was not impaired.
The Company completed a quantitative assessment in relation to the SDN reporting unit as of its 2020 annual test date and determined
that goodwill was not impaired.
The Company completed qualitative assessments in relation to the Courier Capital and the HNP Capital reporting units as of their
2020 annual test date and determined it was not more likely than not that the fair value of these reporting units were less than their
carrying values.
The results of the 2019 annual impairment tests for the Company’s reporting units indicated no goodwill impairment.
The results of the 2018 annual impairment test for the SDN reporting unit resulted in a goodwill impairment charge of $2.4 million
during the quarter ended December 31, 2018. The results of the 2018 annual impairment tests for the Banking, Courier Capital and
HNP Capital reporting units indicated no goodwill impairment.
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.
- 102 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(8.) GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
The change in the balance for goodwill during the years ended December 31 was as follows (in thousands):
Balance, January 1, 2019
No activity during the period
Balance, December 31, 2019
No activity during the period
Balance, December 31, 2020
Banking
All Other(1)
Total
$
48,536 $
17,526 $
-
48,536
-
-
17,526
-
$
48,536 $
17,526 $
66,062
-
66,062
-
66,062
(1) All Other includes the SDN, Courier Capital and HNP Capital reporting units.
Other Intangible Assets
The Company has other intangible assets that are amortized, consisting of core deposit intangibles and other intangibles (primarily
related to customer relationships). Changes in the gross carrying amount, accumulated amortization and net book value for the years
ended December 31 were as follows (in thousands):
Core deposit intangibles:
Gross carrying amount
Accumulated amortization
Net book value
Other intangibles:
Gross carrying amount
Accumulated amortization
Net book value
2020
2019
$
$
$
$
2,042 $
(2,014)
28 $
13,883 $
(6,184)
7,699 $
2,042
(1,944)
98
13,883
(5,120)
8,763
Core deposit intangibles and other intangibles amortization expense was $70 thousand and $1.1 million, respectively, for the year
ended December 31, 2020. Core deposit intangibles and other intangibles amortization expense was $115 thousand and $1.1 million,
respectively, for the year ended December 31, 2019. Core deposit intangibles and other intangibles amortization expense was
$160 thousand and $1.1 million, respectively, for the year ended December 31, 2018. Estimated amortization expense of other
intangible assets for each of the next five years is as follows (in thousands):
2021
2022
2023
2024
2025
$
1,014
923
852
783
714
- 103 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(9.) LEASES
Accounting Standards Codification (“ASC”) 842, Leases (“ASC 842”), 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. The Company is obligated under a number of
non-cancellable operating lease agreements for land, buildings and equipment with terms, including renewal options reasonably
certain to be exercised, extending through 2047. One building lease is subleased for terms extending through 2021.
The following table represents the consolidated statements of financial condition classification of the Company’s right of use assets
and lease liabilities as of December 31 (in thousands):
Operating Lease Right of Use Assets:
Gross carrying amount
Accumulated amortization
Net book value
Operating Lease Liabilities:
Right of use lease obligations
Balance Sheet Location
Other assets
Other assets
2020
2019
$
$
23,697 $
(3,741)
19,956 $
23,224
(1,861)
21,363
Other liabilities
$
21,507 $
22,800
The weighted average remaining lease term for operating leases was 21.5 years at December 31, 2020 and the weighted-average
discount rate used in the measurement of operating lease liabilities was 3.82%. The Company utilizes its incremental borrowing rate at
lease inception, on a collateralized basis, over a similar term for the discount rate.
The following table represents lease costs and other lease information for the years ended December 31 (in thousands):
Lease Costs:
Operating lease costs
Variable lease costs (1)
Sublease income
Net lease costs
Other information:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
Initial recognition of operating lease right of use assets
Initial recognition of operating lease liabilities
Right of use assets obtained in exchange for new operating lease liabilities
2020
2019
2018
$
$
$
$
$
$
2,673 $
410
(46)
3,037 $
2,758 $
428
(46)
3,140 $
2,599 $
- $
- $
477 $
2,641 $
23,275 $
23,985 $
620 $
-
-
-
-
-
-
-
-
(1) Variable lease costs primarily represent variable payments such as common area maintenance, insurance, taxes and utilities.
Rent expense relating to operating leases, included in occupancy and equipment expense in the statements of income, was $2.9 million
in 2018.
- 104 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(9.) LEASES (Continued)
Future minimum payments under non-cancellable operating leases with initial or remaining terms of one year or more are as follows at
December 31, 2020 (in thousands):
Year ended December 31,
2021
2022
2023
2024
2025
Thereafter
Total future minimum operating lease payments
Amounts representing interest
Present value of net future minimum operating lease payments
(10.) OTHER ASSETS
A summary of other assets as of December 31 are as follows (in thousands):
Operating lease right of use assets
Tax credit investments
Derivative instruments
Collateral on derivative instruments
Other
Total other assets
$
$
2,423
1,941
1,558
1,264
1,190
24,792
33,168
(11,661)
21,507
2020
2019
$
$
19,956 $
34,370
20,120
19,630
62,010
156,086 $
21,363
16,524
6,731
6,700
62,978
114,296
- 105 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(11.) 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 four years
Four to five years
Thereafter
Total time deposits
Total deposits
2020
2019
$
$
1,018,549 $
731,885
1,642,340
841,581
30,847
5,186
5,417
2,562
-
885,593
4,278,367 $
707,752
627,842
1,039,892
1,099,488
60,868
14,869
3,251
1,708
5
1,180,189
3,555,675
Time deposits in denominations of $250,000 or more at December 31, 2020 and 2019 amounted to $200.7 million and $287.0 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
2020
2019
2018
$
$
1,091 $
4,788
11,943
17,822 $
1,372 $
4,365
22,757
28,494 $
1,067
2,887
15,101
19,055
(12.) BORROWINGS
The Company classifies borrowings as short-term or long-term in accordance with the original terms of the applicable agreement.
Outstanding borrowings consisted of the following as of December 31 (in thousands):
Short-term borrowings:
Short-term FHLB borrowings
Long-term borrowings:
Subordinated notes, net
Total borrowings
Short-term borrowings
2020
2019
$
$
5,300 $
275,500
73,623
78,923 $
39,273
314,773
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, 2020 consisted of $5.3 million
in short-term borrowings. Short-term FHLB borrowings at December 31, 2019 consisted of $10.0 million in overnight borrowings and
$265.5 million in short-term borrowings. The FHLB borrowings are collateralized by securities from the Company’s investment
portfolio and certain qualifying loans. At December 31, 2020 and 2019, the Company’s borrowings had a weighted average rate of
1.70% and 1.88%, respectively.
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, 2020 and 2019, no amounts have been drawn on the line of credit.
- 106 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(12.) BORROWINGS (Continued)
Long-term borrowings
On October 7, 2020, the Company completed a private placement of $35.0 million in aggregate principal amount of fixed-to-floating
rate subordinated notes due 2030 to qualified institutional buyers and accredited institutional investors that were subsequently
exchanged for subordinated notes with substantially the same terms (the “2020 Notes”) registered under the Securities Act of 1933, as
amended. The 2020 Notes have a maturity date of October 15, 2030 and bear interest, payable semi-annually, at the rate of 4.375% per
annum, until October 15, 2025. Commencing on that date, the interest rate will reset quarterly to an interest rate per annum equal to
the then current three-month secured overnight financing rate (“SOFR”) plus 4.265%, payable quarterly until maturity. Proceeds, net
of debt issuance costs of $779 thousand, were $34.2 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 regulatory capital ratios.
The 2020 Notes qualify as Tier 2 capital for regulatory purposes.
On April 15, 2015, the Company issued $40.0 million of 6.0% fixed to floating rate subordinated notes due April 15, 2030 (the “2015
Notes”) in a registered public offering. The 2015 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. After the
discontinuance of LIBOR, the interest rate will be determined by an alternate method as reasonably selected by the Company. The
2015 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 2015 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
2015 Notes and the 2020 Notes, and not as a deferred charge. The debt issuance costs will be amortized as an adjustment to interest
expense through April 15, 2025 for the 2015 Notes and through October 15, 2025 for the 2020 Notes.
(13.) 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, and the use of derivative financial instruments. Specifically, the Company enters into derivative
financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and
uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used
to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or
expected cash payments.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to
interest rate movements. To accomplish this objective, the Company primarily uses interest rate caps and interest rate swaps as part of
its interest rate risk management strategy. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts
from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium. During 2020, such
derivatives were used to hedge the variable cash flows associated with short-term borrowings. Interest rate swaps designated as cash
flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments
over the life of the agreements without exchange of the underlying notional amount. The Company is hedging its exposure to the
variability in future cash flows for forecasted transactions over a period of approximately 60 months. As of December 31, 2020, the
Company had one outstanding forward interest rate derivative with a notional value of $50.0 million that was designated as a cash
flow hedge of interest rate risk. The derivative becomes effective in April 2022.
- 107 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(13.) DERIVATIVE INSTRUMENT AND HEDGING ACTIVITIES (Continued)
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in
accumulated other comprehensive income (loss) and subsequently reclassified into interest expense in the same period(s) during which
the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income (loss) related to derivatives
will be reclassified to interest expense as interest payments are made on the Company’s borrowings. The ineffective portion of the
change in fair value of the derivatives is recognized directly in earnings. The Company’s cash flow hedge derivatives did not have any
hedge ineffectiveness recognized in earnings during the years ended December 31, 2020 and 2019. During the next twelve months, the
Company estimates that $114 thousand will be reclassified as an increase to interest expense.
Interest Rate Swaps
The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management
strategies. These interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a
third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps
associated with this program do not meet hedge accounting requirements, changes in the fair value of both the customer swaps and the
offsetting swaps are recognized directly in earnings.
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.
Mortgage Banking Derivatives
The Company 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.
- 108 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(13.) 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
Balance
Fair value
sheet
Balance
sheet
Fair value
2020
2019
line item
2020
2019
line item
2020
2019
Asset derivatives
Liability derivatives
$ 50,000 $100,000
$ 50,000 $100,000
Other
assets
$
$
- $
- $
Other
liabilities $
$
-
-
311 $
311 $
-
-
Derivatives designated as hedging
instruments
Cash flow hedges
Total derivatives
Derivatives not designated as hedging
instruments
Cash flow hedges
$100,000 $
-
Interest rate swaps (1)
631,907 272,962
Credit contracts
113,434 68,324
Mortgage banking
Total derivatives
28,225 11,859
$873,566 $353,145
Other
assets
Other
assets
Other
assets
Other
assets
$
- $
-
Other
liabilities $
Other
- $
-
19,626 6,599
liabilities 19,837 6,720
23
13
471
119
$ 20,120 $ 6,731
Other
liabilities
Other
liabilities
86
18
7
1
$ 19,924 $ 6,745
(1) The Company secured its obligations under these contracts with $19.6 million and $6.7 million in cash at December 31, 2020 and
2019, respectively.
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
Line item of gain (loss)
recognized in income
Gain (loss) recognized in income
2020
2019
2018
Cash flow hedges
Interest rate swaps
Credit contracts
Mortgage banking
Total undesignated
Income from derivative instruments, net
Income from derivative instruments, net
Income from derivative instruments, net
Income from derivative instruments, net
$
$
- $
4,707
455
359
5,521 $
- $
2,189
29
56
2,274 $
-
759
184
29
972
- 109 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(14.) 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
2020
2019
$
1,012,810 $
22,393
820,282
21,911
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 which 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.
Unfunded Commitments
At December 31, 2020 and December 31, 2019, the allowance for credit losses for unfunded commitments totaled $3.1 million and $0,
respectively, and was included in other liabilities on the Company's consolidated statements of financial condition. For the year ended
December 31, 2020 and 2019, credit loss expense for unfunded commitments was $1.0 million and $0, respectively, and was included
in provision for credit losses on the Company’s consolidated statements of income.
Contingent Liabilities and Litigation
In the ordinary course of business there are various threatened and pending legal proceedings against the Company. 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.
We are party to an action filed against us on May 16, 2017 by Matthew L. Chipego, Charlene Mowry, Constance C. Churchill and
Joseph W. Ewing in the Court of Common Pleas in Philadelphia, Pennsylvania. Plaintiffs seek class certification to represent classes
of consumers in New York and Pennsylvania along with statutory damages, interest and declaratory relief. The plaintiffs seek to
represent a putative class of consumers who are alleged to have obtained direct or indirect financing from us for the purchase of
vehicles that we later repossessed. The plaintiffs specifically claim that the notices the Bank sent to defaulting consumers after their
vehicles were repossessed did not comply with the relevant portions of the Uniform Commercial Code in New York and
Pennsylvania. We dispute and believe we have meritorious defenses against these claims and plan to vigorously defend ourselves.
In February 2020, we agreed to engage in mediation with the plaintiffs but mediation has not yet commenced. On October 19, 2020,
the Court granted plaintiffs’ motion for judgment on the pleadings dismissing our affirmative defense against one named New York
plaintiff that his claim was time-barred under New York law, applying a six-year statute of limitations rather than the three years
limitation period we had argued. The issue of class certification has been briefed and the parties are awaiting a pre-certification
conference date and hearing date.
- 110 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(14.) COMMITMENTS AND CONTINGENCIES (Continued)
If we settle these claims or the action is not resolved in our favor, we may suffer reputational damage and incur legal costs, settlements
or judgments that exceed the amounts covered by our existing insurance policies. We can provide no assurances that our insurer will
insure the legal costs, settlements or judgements we incur in excess of our deductible. If we are unsuccessful in defending ourselves
from these claims or if our insurer does not insure us against legal costs we incur in excess of our deductible, the result may materially
adversely affect our business, results of operations and financial condition.
(15.) 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).
The Economic Growth Act provided for a potential exception from the Basel III Rules for community banks that maintain a
Community Bank Leverage Ratio (“CBLR”) of at least 8.0% to 10.0%. The CBLR is calculated by dividing Tier 1 capital by the
bank’s average total consolidated assets. In the final rules approved by the FDIC in September 2019, qualifying community banking
organizations that opt in to using the CBLR are considered to be in compliance with the Basel III Rules as long as the bank maintains
a CBLR of greater than 9.0%. If a bank is not a qualifying community banking organization, does not opt in to using the CBLR, or
cannot maintain a CBLR of greater than 9.0%, the bank would have to comply with the Basel III Rules. We are currently evaluating
the CBLR framework and the potential impact CBLR adoption would have on the Company and the Bank, respectively.
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, 2020 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 credit losses. Tier 2 capital for the Company also includes qualified subordinated debt. At December 31,
2020, the Company’s Tier 2 capital included $73.6 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.
- 111 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(15.) REGULATORY MATTERS (Continued)
The Basel III Capital Rules became fully phased in on January 1, 2019 and 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 was 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 was 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 was 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 was phased in over a four-
year period (increasing by that amount on each subsequent January 1, until it reached 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.
- 112 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(15.) REGULATORY MATTERS (Continued)
The following table presents actual and required capital ratios as of December 31, 2020 and 2019 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, 2019 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):
2020
Tier 1 leverage:
Company
Bank
CET1 capital:
Company
Bank
Tier 1 capital:
Company
Bank
Total capital:
Company
Bank
2019
Tier 1 leverage:
Company
Bank
CET1 capital:
Company
Bank
Tier 1 capital:
Company
Bank
Total capital:
Company
Bank
Actual
Amount
Ratio
Minimum Capital
Required – Basel III
Ratio
Amount
Required to be
Considered Well
Capitalized
Amount
Ratio
$
407,061
441,929
8.25% $
8.97
197,344
197,064
4.00% $
4.00
246,680
246,330
5.00%
5.00
389,733
441,929
407,061
441,929
521,193
482,439
10.18
11.57
10.63
11.57
13.61
12.63
268,010
267,387
325,441
324,684
402,015
401,080
7.00
7.00
8.50
8.50
10.50
10.50
248,866
248,288
306,297
305,585
382,871
381,981
6.50
6.50
8.00
8.00
10.00
10.00
$
381,473
409,031
9.00% $
9.67
169,504
169,189
4.00% $
4.00
211,880
211,486
5.00%
5.00
364,145
409,031
381,473
409,031
451,228
439,514
10.31
11.61
10.80
11.61
12.77
12.47
247,330
246,674
300,329
299,533
370,995
370,011
7.00
7.00
8.50
8.50
10.50
10.50
229,663
229,055
282,663
281,914
353,328
352,392
6.50
6.50
8.00
8.00
10.00
10.00
As of December 31, 2020 and 2019, the Company and Bank were considered “well capitalized” under all regulatory capital
guidelines. Such determination has been made based on the Tier 1 leverage, CET1 capital, Tier 1 capital and total capital ratios.
Federal Reserve Requirements
The Bank is required to maintain cash on hand or on deposit at the FRB of New York. As of December 31, 2020, the Bank was not
required to maintain a reserve balance at the FRB of New York. The reserve requirement for the Bank totaled $6.4 million as of
December 31, 2019.
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.
- 113 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(16.) 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 173,282 shares of preferred stock issued and outstanding as of December 31, 2020 and 2019.
Common Stock
The following table sets forth the changes in the number of shares of common stock for the years ended December 31:
2020
Shares outstanding at beginning of year
Restricted stock awards issued
Restricted stock units released
Stock awards
Treasury stock purchases
Shares outstanding at end of year
2019
Shares outstanding at beginning of year
Common stock issued for Courier Capital contingent earn-out
Restricted stock awards issued
Restricted stock units released
Stock awards
Treasury stock purchases
Shares outstanding at end of year
Share Repurchases
Outstanding
Treasury
Issued
16,002,899
12,798
24,921
8,439
(7,131)
16,041,926
15,928,598
43,378
8,226
28,080
4,192
(9,575)
16,002,899
96,657
(12,798)
(24,921)
(8,439)
7,131
57,630
127,580
-
(8,226)
(28,080)
(4,192)
9,575
96,657
16,099,556
-
-
-
-
16,099,556
16,056,178
43,378
-
-
-
-
16,099,556
In November 2020, the Company’s Board of Directors authorized a share repurchase program of common stock for up to 801,879
shares of common stock. Repurchased shares are recorded in treasury stock, at cost, which includes any applicable transaction costs.
No shares were repurchased under this program during the year ended December 31, 2020.
Preferred Stock
Series A 3% Preferred Stock. There were 1,435 shares of Series A 3% preferred stock issued and outstanding as of December 31,
2020 and 2019. 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.
Series B-1 8.48% Preferred Stock. There were 171,847 shares of Series B-1 8.48% preferred stock issued and outstanding as of
December 31, 2020 and 2019. 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.
- 114 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(17.) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the components of other comprehensive income (loss) for the years ended December 31 (in thousands):
Pre-tax
Amount
Tax Effect
Net-of-tax
Amount
2020
Securities available for sale and transferred securities:
Change in unrealized gain (loss) during the year
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Hedging derivative instruments:
Change in unrealized gain (loss) during the year
Pension and post-retirement obligations:
Net actuarial gain (loss) 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
2019
Securities available for sale and transferred securities:
Change in unrealized gain (loss) during the year
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Hedging derivative instruments:
Change in unrealized gain (loss) during the year
Pension and post-retirement obligations:
Net actuarial gain (loss) 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
2018
Securities available for sale and transferred securities:
Change in unrealized gain (loss) during the year
Reclassification adjustment for net gains included in net income (1)
Total securities available for sale and transferred securities
Hedging derivative instruments:
Change in unrealized gain (loss) during the year
Pension and post-retirement obligations:
Net actuarial gain (loss) 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
$
$
$
$
$
$
19,928 $
(1,281)
18,647
5,106 $
(329)
4,777
271
69
2,201
1,254
3,455
22,373 $
565
321
886
5,732 $
13,648 $
(1,176)
12,472
3,456 $
(307)
3,149
(327)
(85)
(879)
1,398
519
12,664 $
(303)
352
49
3,113 $
(6,547) $
539
(6,008)
(1,650) $
136
(1,514)
(369)
(93)
(6,823)
678
(6,145)
(12,522) $
(1,721)
171
(1,550)
(3,157) $
14,822
(952)
13,870
202
1,636
933
2,569
16,641
10,192
(869)
9,323
(242)
(576)
1,046
470
9,551
(4,897)
403
(4,494)
(276)
(5,102)
507
(4,595)
(9,365)
(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.
- 115 -
Accumulated
Other
Comprehensive
Income (Loss)
(14,513)
16,660
(14,868) $
1,636
933
2,569
(12,299) $
(13,236) $
(2,102)
(576)
1,046
470
(14,868) $
(8,641)
(5,102)
507
(4,595)
(13,236) $
(19)
16,641
2,128
(21,281)
(2,783)
9,374
177
9,551
(14,513)
(11,916)
(10,275)
910
(9,365)
(21,281)
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(17.) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)
Activity in accumulated other comprehensive income (loss), net of tax, was as follows (in thousands):
Hedging
Derivative
Instruments
Securities
Available for
Sale and
Transferred
Securities
Pension and
Post-
retirement
Obligations
Balance at January 1, 2020
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
(loss)
Net current period other comprehensive income
Balance at December 31, 2020
Balance at January 1, 2019
Reclassification adjustment for net gains included in net income
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, 2019
Balance at January 1, 2018
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income
(loss)
Net current period other comprehensive loss
Balance at December 31, 2018
$
$
$
$
$
$
(518) $
202
-
202
(316) $
(276) $
-
(242)
-
(242)
(518) $
- $
(276)
-
(276)
(276) $
873 $
14,822
(952)
13,870
14,743 $
(7,769) $
(681)
10,192
(869)
9,323
873 $
(3,275) $
(4,897)
403
(4,494)
(7,769) $
- 116 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(17.) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (Continued)
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):
Details About Accumulated Other
Comprehensive Income (Loss) Components
Amount Reclassified from
Accumulated Other
Comprehensive Income
(Loss)
2020
2019
Affected Line Item in the
Consolidated Statement of Income
Realized gain (loss) 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)
1,599 $
1,677 Net gain (loss) on investment securities
(318)
1,281
(329)
952
34
(1,288)
(1,254)
321
(933)
(501) Interest income
1,176 Total before tax
(307) Income tax expense
869 Net of tax
65 Salaries and employee benefits
(1,463) Salaries and employee benefits
(1,398) Total before tax
352 Income tax benefit (expense)
(1,046) Net of tax
Total reclassified for the period
$
19 $
(177)
(1) These items are included in the computation of net periodic pension expense. See Note 21 – Employee Benefit Plans for
additional information.
(18.) 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. 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 will become available for future award
grants under the 2015 Plan. As of December 31, 2020, there were approximately 156,000 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. Restricted stock units granted to employees generally fully vest on the third anniversary
of the date of grant.
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.
- 117 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(18.) SHARE-BASED COMPENSATION (Continued)
The Company awarded grants of restricted stock units to certain members of management during the year ended December 31, 2020.
Fifty percent of the shares subject to each grant that ultimately vest are contingent on achieving specified return on average equity
(“ROAE”) targets relative to the SNL Small Cap Bank & Thrift Index, a market index the Management Development &
Compensation Committee has selected as a peer group for this purpose. These shares will be earned based on the Company’s
achievement of a relative ROAE performance requirement, on a percentile basis, compared to the SNL Small Cap Bank & Thrift
Index over a three-year performance period ending December 31, 2022. The shares earned based on the achievement of the ROAE
performance requirement, if any, will vest on the third anniversary of the grant date assuming the recipient’s continuous service to the
Company. The remaining fifty percent of the PSUs that ultimately vest are contingent upon achievement of an average return on
average assets (“ROAA”) performance requirement over a three-year performance period ending December 31, 2022. The shares
earned based on the achievement of the ROAA performance requirement, if any, will vest on the third anniversary of the grant date
assuming the recipient’s continuous service to the Company. If earned at target level, members of management will receive up to
23,302 shares of our common stock in the aggregate.
The grant-date fair values for both the ROAE and the ROAA portions of PSUs granted during the year ended December 31, 2020 are
equal to the closing market price of our common stock on the date of grant reduced by the present value of the dividends expected to
be paid on the underlying shares.
The Company granted additional restricted stock units to management during the year ended December 31, 2020. These awards will
vest after completion of a three-year service requirement. If earned, members of management will receive up to 58,806 shares of our
common stock, in the aggregate. The average market price of the restricted stock units on the date of grant was $25.02.
During the year ended December 31, 2020, the Company granted a total of 12,798 restricted shares of common stock to non-employee
directors, of which 6,399 shares vested immediately and 6,399 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 $17.57. In addition, the Company issued a total of
8,439 shares of common stock in-lieu of cash for the annual retainer of four non-employee directors during the year ended
December 31, 2020. The weighted average market price of the stock on the date of grant was $19.54.
The Company awarded grants of restricted stock units to certain members of management during the year ended December 31, 2019.
Fifty percent of the shares subject to each grant will be earned upon achievement of an ROAA performance requirement for the
Company’s fiscal year ending December 31, 2021. The remaining fifty percent of 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 ending December 31, 2021. If earned at target level, members of
management will receive up to 21,970 shares of our common stock in the aggregate, which will vest on February 26, 2022 assuming
the recipient’s continuous service to the Company.
The grant-date fair value of the TSR performance award granted on February 26, 2019 was determined using the Monte Carlo
simulation model on the date of grant, assuming the following (i) expected term of 2.84 years, (ii) risk free interest rate of 2.43%, (iii)
expected dividend yield of 3.20% and (iv) expected stock price volatility over the expected term of the TSR performance award of
21.3%. The grant-date fair value of the TSR performance award granted on May 22, 2019 was determined using the Monte Carlo
simulation model on the date of grant, assuming the following (i) expected term of 2.61 years, (ii) risk free interest rate of 2.18%, (iii)
expected dividend yield of 3.60% and (iv) expected stock price volatility over the expected term of the TSR performance award of
22.0%. 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 additional restricted stock units to management during the year ended December 31, 2019. These awards will
vest after completion of a three-year service requirement. If earned, members of management will receive up to 54,476 shares of our
common stock, in the aggregate. The average market price of the restricted stock units on the date of grant was $25.60.
During the year ended December 31, 2019, the Company granted a total of 8,226 restricted shares of common stock to non-employee
directors, of which 4,113 shares vested immediately and 4,113 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 $27.33. In addition, the Company issued a total of
4,192 shares of common stock in-lieu of cash for the annual retainer of three non-employee directors during the year ended December
31, 2019. The weighted average market price of the stock on the date of grant was $29.78.
- 118 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(18.) SHARE-BASED COMPENSATION (Continued)
The Company awarded grants of restricted stock units to certain members of management during the year ended December 31, 2018.
The awards will be earned based on the Company’s achievement of a TSR performance requirement, on a percentile basis, compared
to the SNL Small Cap Bank & Thrifts Index over a one-year performance period ended December 31, 2020. If earned at target level,
members of management will receive up to 14,877 shares of our common stock in the aggregate, which will vest on February 27, 2021
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, 2018 was determined using the
Monte Carlo simulation model on the date of grant, assuming the following (i) expected term of 2.84 years, (ii) risk free interest rate
of 2.39%, (iii) expected dividend yield of 2.83% and (iv) expected stock price volatility over the expected term of the TSR
performance award of 21.2%. 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 additional restricted stock units to management during the year ended December 31, 2018. These awards will
vest after completion of a three-year service requirement. If earned, members of management will receive up to 37,676 shares of our
common stock, in the aggregate. The average market price of the restricted stock units on the date of grant was $27.76.
During the year ended December 31, 2018, the Company granted a total of 7,370 restricted shares of common stock to non-employee
directors, of which 3,690 shares vested immediately and 3,680 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 $33.90. In addition, the Company issued a total of
6,363 shares of common stock in-lieu of cash for the annual retainer of five non-employee directors during the year ended December
31, 2018. The weighted average market price of the stock on the date of grant was $29.03.
The restricted stock awards granted to the directors and the restricted stock units granted to management in 2020, 2019 and 2018 do
not have rights to dividends or dividend equivalents.
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 2020, 2019 or 2018. There was no unrecognized compensation expense related to unvested stock options as of
December 31, 2020. There was no stock option activity for the year ended December 31, 2020.
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, 2018 was $236 thousand. The total cash received
as a result of option exercises under stock compensation plans for the years ended December 31, 2018 was $320 thousand. 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, 2020:
Outstanding at beginning of year
Granted
Vested
Forfeited
Outstanding at end of period
Weighted
Average
Market
Price at
Grant Date
27.80
24.36
28.84
27.78
25.65
Number of
Shares
151,808 $
94,906
(35,433)
(42,768)
168,513 $
As of December 31, 2020, there was $2.0 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.
- 119 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(18.) SHARE-BASED COMPENSATION (Continued)
The Company amortizes the expense related to share-based compensation over the vesting period. Share-based compensation expense
is recorded as a component of salaries and employee benefits in the consolidated statements of income for awards granted to
management and as a component of other noninterest expense for awards granted to directors. The share-based compensation expense
included in the statements on income for the years ended December 31 was as follows (in thousands):
Salaries and employee benefits
Other noninterest expense
Total share-based compensation expense
(19.) INCOME TAXES
2020
2019
2018
$
$
1,107 $
226
1,333 $
1,175 $
231
1,406 $
1,045
256
1,301
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 (benefit)
Deferred tax expense (benefit):
Federal
State
Total deferred tax expense (benefit)
Total income tax expense
2020
2019
2018
$
$
10,041 $
1,873
11,914
(3,306)
(1,217)
(4,523)
7,391 $
8,882 $
1,308
10,190
280
89
369
10,559 $
19,351
1,135
20,486
(10,303)
(177)
(10,480)
10,006
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
2020
2019
2018
21.0%
21.0%
(2.0)
(3.4)
(0.9)
1.1
0.1
-
0.3
16.2%
(1.9)
(3.0)
(0.6)
1.9
0.2
-
0.2
17.8%
21.0%
(2.6)
(0.3)
(0.8)
1.5
0.2
1.0
0.2
20.2%
Total income tax expense (benefit) was as follows for the years ended December 31 (in thousands):
Income tax expense
Shareholder’s equity
2020
2019
2018
$
7,391 $
5,732
10,559 $
3,113
10,006
(3,156)
- 120 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(19.) INCOME TAXES (Continued)
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 financial 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.
In 2020 and 2019, the Company recognized the impact of its investments in partnerships that placed property in service during both
years, which generated tax credits due to qualifying expenses. At the time that a structure is placed into service, the Company is
eligible for federal and New York State tax credits. See Note 1 for the Company’s accounting policy for income taxes and these tax
credit investments.
The Company’s net deferred tax asset is included in other assets in the consolidated statements of financial 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):
2020
2019
Deferred tax assets:
Allowance for credit losses
Leases - right of use obligations
Deferred compensation
Investment in limited partnerships
SERP agreements
Interest on nonaccrual loans
Share-based compensation
Other
Gross deferred tax assets
Deferred tax liabilities:
Leases - right of use assets
Prepaid expenses
Prepaid pension costs
Intangible assets
Depreciation and amortization
Net unrealized gain on securities available for sale
Loan servicing assets
Other
Gross deferred tax liabilities
Net deferred tax asset
$
$
14,239 $
5,510
1,149
1,418
323
88
602
148
23,477
5,113
635
1,183
2,286
2,046
5,079
338
627
17,307
6,170 $
7,810
5,474
1,095
1,191
418
191
586
224
16,989
5,474
498
897
2,643
1,961
301
289
550
12,613
4,376
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 on the deductibility of net interest expense, elimination of the corporate alternative minimum tax, limits on net operating loss
carryforwards to 80% of taxable income, among other provisions.
- 121 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(19.) INCOME TAXES (Continued)
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, 2020 or 2019.
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 2017 through 2020. The New York income tax years currently open for audits are 2018 through 2020.
At December 31, 2020, the Company had no federal or New York net operating loss or tax credits carryforwards.
The Company’s unrecognized tax benefits and changes in unrecognized tax benefits were not significant as of or for the years ended
December 31, 2020, 2019 and 2018. There were no material interest or penalties recorded in the income statement in income tax
expense for the years ended December 31, 2020, 2019 and 2018. As of December 31, 2020 and 2019, there were no amounts accrued
for interest or penalties related to uncertain tax positions.
(20.) 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
2020
2019
2018
$
36,871 $
47,401 $
38,065
16,100
(5)
(73)
16,022
-
41
16,063
16,086
(4)
(110)
15,972
-
59
16,031
16,056
(8)
(138)
15,910
2
44
15,956
2.39
2.39
Basic earnings per common share
Diluted earnings per common share
$
$
2.30 $
2.30 $
2.97 $
2.96 $
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
-
54
54
-
4
4
-
6
6
There were no participating securities outstanding for the years ended December 2020, 2019 and 2018; therefore, the two-class
method of calculating basic and diluted EPS was not applicable for the years presented.
- 122 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS
Supplemental Executive Retirement Agreements
The Company has non-qualified Supplemental Executive Retirement Agreements (“SERPs”) covering certain former executives. The
unfunded liability related to the SERPs was $1.3 million and $1.7 million at December 31, 2020 and 2019, respectively. SERP
expense was $51 thousand, $366 thousand and $215 thousand for 2020, 2019 and 2018, respectively.
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. The Company
is also permitted to make additional discretionary contributions, although no such additional discretionary contributions were made in
2020, 2019 or 2018.
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):
2020
2019
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
84,328 $
3,693
2,537
11,154
(4,152)
97,560
87,827
18,501
-
(4,152)
102,176
69,574
3,207
2,777
11,993
(3,223)
84,328
75,188
15,862
-
(3,223)
87,827
3,499
$
4,616 $
The accumulated benefit obligation was $88.9 million and $76.8 million at December 31, 2020 and 2019, 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 2021 fiscal year.
- 123 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS (Continued)
Estimated benefit payments under the Plan over the next ten years at December 31, 2020 are as follows (in thousands):
2021
2022
2023
2024
2025
2026 - 2030
$
4,581
3,860
4,213
4,259
4,472
25,042
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 (credit) cost
Net periodic pension cost
2020
2019
2018
3,693 $
2,537
(5,136)
1,270
-
2,364 $
3,207 $
2,777
(4,736)
1,445
-
2,693 $
3,346
2,387
(5,284)
725
(5)
1,169
$
$
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
2020
2019
2018
3.09%
3.00%
6.00%
4.13%
3.00%
6.50%
3.49%
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
2020
2019
2018
2.32%
3.00%
3.09%
3.00%
4.13%
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 Plan’s overall investment strategy is to invest in a diversified portfolio while managing the variability between the assets and
projected liabilities of underfunded pension plans. The Plan’s Board Members approved a migration (the “Migration”) of substantially
all of the Plan’s assets to one fund, Commingled Pensions Trust Fund (LDI Diversified Balanced) of JPMorgan Chase Bank, N.A.
(“JPMCB LDI Diversified Balanced Fund” or the “Fund”). The Fund is a collective investment fund managed by the Plan’s trustee
(the “Trustee”) under the Declaration of Trust. The Trustee is the Fund’s manager and makes day-to-day investment decisions for the
Fund. The Fund is a group trust within the meaning of Internal Revenue Service Revenue Ruling 81-100, as amended. In reliance
upon exemptions from the registration requirements of the federal securities laws, neither the Fund nor the Fund’s Units are registered
with the SEC or any state securities commission. Because the Fund is not subject to registration under federal or state securities laws,
certain protections that might otherwise be provided to investors in registered funds are not available to investors in the Fund.
However, as a bank-sponsored collective investment trust holding qualified retirement plan assets, the Fund is required to comply with
applicable provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and the Trustee is subject to
supervision and regulation by the Office of the Comptroller of the Currency and the Department of Labor.
- 124 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS (Continued)
Prior to the Migration, the Plan’s overall investment strategy was 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
Board made the election in their December 2018 meeting and the Migration had an effective trade date of February 28, 2019. The
Fund employs a liability driven investing (“LDI”) strategy for pension plans that are seeking a solution that is balanced between
growth and hedging. The Bloomberg Barclays Long A U.S. Corporate Index, the Fund’s primary liability-performance benchmark, is
used as a proxy for plan projected liabilities. The growth-oriented portion of the Fund invests in a mix of asset classes that the Fund’s
Trustee believes will collectively maximize total risk-adjusted return through a combination of capital appreciation and income. This
portion of the Fund will comprise between 35% and 90% of the portfolio and will invest directly or indirectly via underlying funds in
a broad mix of global equity, credit, global fixed income, real estate and cash-plus strategies. The remaining portion of the Fund,
between 10% and 65% of the portfolio, provides exposure to U.S. long duration fixed income and is used to minimize volatility
relative to a plan’s projected liabilities. This portion of the Fund will invest directly or indirectly via underlying funds in investment
grade corporate bonds and securities issued by the U.S. Treasury and its agencies or instrumentalities.
The following table represents the Plan’s target asset allocation and actual asset allocation, respectively, as of December 31, 2020 and
2019:
Asset category:
Cash and cash equivalents
Equity securities
Fixed income securities
Alternative investments
2020
2019
Target
Allocation
Actual
Allocation
Target
Allocation
Actual
Allocation
0.00%
28.25
59.75
12.00
0.00%
31.56
62.60
5.84
0.00%
28.25
59.75
12.00
0.00%
31.75
57.65
10.60
Cash equivalents include repurchase agreements, banker’s acceptances, commercial paper, negotiable certificates of deposit, U.S.
government securities with less than one year to maturity and funds (including the Commingled Pension Trust Fund (Liquidity) of
JPMorgan Chase Bank, N.A. (“JPMorgan”)) established to invest in these types of highly liquid, high quality instruments. Equity
securities primarily include investments in common stocks, depository receipts, preferred stocks, 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.
Alternative investments are real estate interests and related investments held within a commingled pension trust fund.
The Fund is valued utilizing the valuation policies set forth by JP Morgan’s asset management committee. Underlying investments for
which market quotations are readily available are valued at their market value. Underlying investments for which market quotations
are not readily available are fair valued by approved affiliated and/or unaffiliated pricing vendors, third-party broker-dealers or
methodologies as approved by the asset management committee. Fixed income instruments are valued based on prices received from
approved affiliated and unaffiliated pricing vendors or third-party broker-dealers (collectively referred to as “Pricing Services”). The
Pricing Services use multiple valuation techniques to determine the valuation of fixed income instruments. In instances where
sufficient market activity exists, the Pricing Services may utilize a market-based approach through which trades or quotes from market
makers are used to determine the valuation of these instruments. In instances where sufficient market activity may not exist, the
Pricing Services also utilize proprietary valuation models which may consider market transactions in comparable securities and the
various relationships between securities in determining fair value and/or market characteristics in order to estimate the relevant cash
flows, which are then discounted to calculate the fair values. Equities and other exchange-traded instruments are valued at the last
sales price or official market closing price on the primary exchange on which the instrument is traded before the net asset values
(“NAV”) of the Funds are calculated on a valuation date. Futures contracts are generally valued on the basis of available market
quotations. Forward foreign currency exchange contracts are valued utilizing market quotations from approved Pricing Services. The
Fund invests in the Commingled Pension Trust Fund (“Strategic Property Fund”) of JPMorgan (the “SPF”), which holds significant
amounts of investments which have been fair valued at December 31, 2020 and 2019.
During the years ended December 31, 2020 and 2019, there were no transfers in or out of Levels 1, 2 or 3. In addition, there were no
changes in valuation methodologies during the years ended December 31, 2020 and 2019.
Prior to the Migration, the Plan had a direct investment in the SPF, which was a Level 3 investment.
- 125 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS (Continued)
The following is a table of the pricing methodology and unobservable inputs for Level 3 investments held during the year ended
December 31, 2019 used by JPMorgan in pricing commingled pension trust funds (“CPTF”):
CPTF – Other:
CPTF (Strategic Property) of JPMorgan
Principal Valuation
Technique(s) Used
Unobservable Inputs
Market, Income Approach, Debt Service
and Sales Comparison
Credit Spreads, Discount Rate, Loan to
Value Ratio, Terminal Capitalization
Rate and Value per Square Foot
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).
2020
Cash equivalents:
Cash (including foreign currencies)
Short term investment funds
Total cash equivalents
Equity securities:
Commingled pension trust funds
Total equity securities
Fixed income securities:
Commingled pension trust funds
Corporate bonds
Total fixed income securities
Other investments:
Level 1
Inputs
Level 2
Inputs
Level 3
Inputs
Total
Fair Value
$
6 $
-
6
-
-
-
-
-
- $
1,253
1,253
31,848
31,848
63,171
5
63,176
- $
-
-
-
-
-
-
-
6
1,253
1,259
31,848
31,848
63,171
5
63,176
Commingled pension trust funds - Realty
Total Plan investments
$
-
6 $
5,893
102,170 $
-
- $
5,893
102,176
At December 31, 2020, the portfolio was substantially managed by one investment firm, with control of approximately 99% of the
Plan’s assets with the remaining 1% under the direct control of the Plan. A portfolio concentration of 99% in the JPMCB LDI
Diversified Balanced Fund, a CPTF, existed at December 31, 2020.
- 126 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS (Continued)
Level 1
Inputs
Level 2
Inputs
Level 3
Inputs
Total
Fair Value
2019
Cash equivalents:
Cash (including foreign currencies)
Short term investment funds
Total cash equivalents
Equity securities:
Commingled pension trust funds
Total equity securities
Fixed income securities:
Commingled pension trust funds
Corporate bonds
Total fixed income securities
Other investments:
$
16 $
-
16
- $
1,829
1,829
-
-
-
-
-
30,685
30,685
49,566
5
49,571
Commingled pension trust funds - Realty
Total Plan investments
$
-
16 $
5,726
87,811 $
- $
-
-
-
-
-
-
-
-
- $
16
1,829
1,845
30,685
30,685
49,566
5
49,571
5,726
87,827
At December 31, 2019, the portfolio was substantially managed by one investment firm, with control of approximately 98% of the
Plan’s assets with the remaining 2% under the direct control of the Plan. A portfolio concentration of 98% in the JPMCB LDI
Diversified Balanced Fund, a CPTF, existed at December 31, 2019.
The following table sets forth a summary of the changes in the Plan’s Level 3 assets for the years ended December 31, 2020 and 2019:
Level 3 assets, January 1, 2019
Realized gain
Sales
Unrealized gain
Level 3 assets, December 31, 2019
No activity during the period
Level 3 assets, December 31, 2020
$
$
2,897
881
(2,873)
(905)
-
-
-
- 127 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(21.) EMPLOYEE BENEFIT PLANS (Continued)
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 $108 thousand and $110 thousand as of December 31, 2020 and 2019, 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, 2020, 2019 and 2018. The plan is not funded.
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
2020
2019
$
$
(16,412) $
-
(16,412)
(127)
3
(124)
(16,536)
4,237
(12,299) $
(19,894)
-
(19,894)
(133)
37
(96)
(19,990)
5,122
(14,868)
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 credit
Postretirement benefit plan:
Net actuarial (loss) gain
Amortization of net loss
Amortization of prior service credit
Total recognized in other comprehensive income
2020
2019
$
$
2,212 $
1,270
-
3,482
(12)
18
(34)
(28)
3,454 $
(867)
1,445
-
578
(12)
18
(65)
(59)
519
- 128 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) FAIR VALUE MEASUREMENTS
Determination of Fair Value – Assets Measured at Fair Value on a Recurring and Nonrecurring Basis
Valuation Hierarchy
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly
transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or
liability. ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that
gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable
inputs. There have been no changes in the valuation techniques used during the current period. The fair value hierarchy is as follows:
•
•
•
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability
to access at the measurement date.
Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or
indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or
similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or
liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or
corroborated by market data by correlation or other means.
Level 3 - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions
about the assumptions that market participants would use in pricing the assets or liabilities.
Transfers between levels of the fair value hierarchy are recorded as of the end of the reporting period.
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: The fair value of derivative instruments 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.
- 129 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) FAIR VALUE MEASUREMENTS (Continued)
Collateral dependent loans: Fair value of collateral dependent loans with specific allocations of the allowance for credit losses -
loans 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. Collateral dependent loans
are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same
factors identified above.
Loan servicing rights: Loan servicing rights do not trade in an active market with readily observable market data. As a result, the
Company estimates the fair value of loan servicing rights by using a discounted cash flow model to calculate the present value of
estimated future net servicing income. The assumptions used in the discounted cash flow model are those that we believe market
participants would use in estimating future net servicing income, including estimates of loan prepayment rates, servicing costs,
ancillary income, impound account balances, and discount rates. The significant unobservable inputs used in the fair value
measurement of the Company’s loan servicing rights are the constant prepayment rates and weighted average discount rate.
Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value
measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they will generally move
in opposite directions. Loan servicing rights are classified as Level 3 measurements due to the use of significant unobservable
inputs, as well as significant management judgment and estimation.
Other real estate owned (foreclosed assets): Nonrecurring adjustments to certain commercial and residential real estate
properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair
values are generally based on third party appraisals of the property, resulting in a Level 3 classification. The appraisals are
sometimes further discounted based on management’s historical knowledge, changes in market conditions from the time of
valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically
significant and result in a Level 3 classification of the inputs for determining fair value. In cases where the carrying amount
exceeds the fair value, less costs to sell, an impairment loss is recognized.
Commitments to extend credit and letters of credit: Commitments to extend credit and fund letters of credit are principally at
current interest rates, and, therefore, the carrying amount approximates fair value. The fair value of commitments is not material.
- 130 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) FAIR VALUE MEASUREMENTS (Continued)
Assets Measured at Fair Value
The following tables present for each of the fair-value hierarchy levels the Company’s assets that are measured at fair value on a
recurring and non-recurring basis as of December 31 (in thousands):
2020
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises
Mortgage-backed securities
Other liabilities:
Hedging derivative instruments
Fair value adjusted through comprehensive income
Other assets:
Derivative instruments – cash flow hedges
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
Other liabilities:
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
Fair value adjusted through net income
Measured on a nonrecurring basis:
Loans:
Loans held for sale
Collateral dependent loans
Other assets:
Loan servicing rights
Other real estate owned
Total
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
$
$
$
$
$
$
- $
-
-
- $
- $
-
-
-
-
-
-
- $
- $
-
-
-
- $
6,635 $
621,424
(311)
627,748 $
- $
19,626
23
471
(19,837)
(86)
(1)
196 $
- $
-
6,635
621,424
-
- $
(311)
627,748
- $
-
-
-
-
-
-
- $
-
19,626
23
471
(19,837)
(86)
(1)
196
4,305 $
-
-
-
4,305 $
- $
29,434
1,320
2,966
33,720 $
4,305
29,434
1,320
2,966
38,025
There were no transfers between Levels 1 and 2 during the years ended December 31, 2020 and 2019. There were no liabilities
measured at fair value on a nonrecurring basis during the years ended December 31, 2020 and 2019.
- 131 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) FAIR VALUE MEASUREMENTS (Continued)
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
2019
Measured on a recurring basis:
Securities available for sale:
U.S. Government agencies and government sponsored enterprises
Mortgage-backed securities
Other assets:
Hedging derivative instruments
Fair value adjusted through comprehensive income
Other assets:
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
Other liabilities:
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
Fair value adjusted through net income
Measured on a nonrecurring basis:
Loans:
Loans held for sale
Collateral dependent impaired loans
Other assets:
Loan servicing rights
Other real estate owned
Total
$
$
$
$
$
$
- $
-
-
- $
- $
-
-
-
-
-
- $
- $
-
-
-
- $
26,877 $
391,040
-
417,917 $
6,599 $
13
119
(6,720)
(18)
(7)
(14) $
4,224 $
-
-
-
4,224 $
- $
3,630
1,129
468
5,227 $
- $
-
26,877
391,040
-
- $
-
417,917
- $
-
-
-
-
-
- $
6,599
13
119
(6,720)
(18)
(7)
(14)
4,224
3,630
1,129
468
9,451
There were no transfers between Levels 1 and 2 during the years ended December 31, 2019 and 2018. There were no liabilities
measured at fair value on a nonrecurring basis during the years ended December 31, 2019 and 2018.
The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring
basis for which the Company has utilized Level 3 inputs to determine fair value (dollars in thousands).
Asset
Collateral dependent loans
Loan servicing rights
Fair
Value
Valuation Technique
29,434 Appraisal of collateral (1)
1,320 Discounted cash flow
$
$
Other real estate owned
$
2,966 Appraisal of collateral (1)
Unobservable Input
Appraisal adjustments (2)
Discount rate
Constant prepayment rate
Appraisal adjustments (2)
Unobservable Input
Value / Range
33.2% (3) / 0 - 35%
10.3% (3)
16.7% (3)
27.7% (3) / 20 - 46%
(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.
- 132 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) FAIR VALUE MEASUREMENTS (Continued)
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, 2020 and 2019.
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 $75 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.
- 133 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(22.) 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 Carrying
Hierarchy
Amount
2020
Estimated
Fair
Value
Carrying
Amount
Estimated
Fair
Value
2019
$
93,878 $
628,059
271,973
4,305
93,878 $ 112,947 $
417,917
628,059
359,000
282,035
4,224
4,305
112,947
417,917
363,259
4,224
3,513,284 3,549,770 3,186,875 3,201,814
3,630
11,308
20,637
-
6,599
13
119
29,434
15,635
8,619
-
19,626
23
471
29,434
15,635
8,619
-
19,626
23
471
3,630
11,308
20,637
-
6,599
13
119
3,392,774 3,392,774 2,375,486 2,375,486
887,113 1,180,189 1,179,991
275,500
41,083
10,942
-
6,720
18
7
885,593
5,300
73,623
4,381
311
19,837
86
1
275,500
39,273
10,942
-
6,720
18
7
5,300
83,953
4,381
311
19,837
86
1
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
Derivative instruments – cash flow hedge
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
Financial liabilities:
Non-maturity deposits
Time deposits
Short-term borrowings
Long-term borrowings
Accrued interest payable
Derivative instruments – cash flow hedges
Derivative instruments – interest rate products
Derivative instruments – credit contracts
Derivative instruments – mortgage banking
(1) Comprised of collateral dependent loans.
Level 1
Level 2
Level 2
Level 2
Level 2
Level 3
Level 1
Level 2
Level 2
Level 2
Level 2
Level 2
Level 1
Level 2
Level 1
Level 2
Level 1
Level 2
Level 2
Level 2
Level 2
- 134 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(23.) PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statements pertaining only to the Parent are presented below (in thousands).
Condensed Statements of Financial 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 $1,377 and $727, respectively
Other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
December 31,
2020
2019
$
$
$
$
31,848 $
511,572
4,136
547,556 $
73,623 $
5,570
468,363
547,556 $
7,172
471,959
3,992
483,123
39,273
4,903
438,947
483,123
Condensed Statements of Income
Dividends from subsidiary and associated companies
Management and service fees from subsidiaries
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
Years ended December 31,
2019
2018
2020
$
$
23,000 $
146
121
23,267
2,888
3,171
6,059
17,208
1,399
18,607
19,725
38,332 $
20,000 $
146
97
20,243
2,471
3,073
5,544
14,699
596
15,295
33,567
48,862 $
20,000
137
137
20,274
2,471
4,156
6,627
13,647
1,745
15,392
24,134
39,526
- 135 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(23.) PARENT COMPANY FINANCIAL INFORMATION (Continued)
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
Increase (Decrease) in other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Capital investment in subsidiaries
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
Purchase of preferred and common shares
Proceeds from stock options exercised
Dividends paid
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents as of beginning of year
Cash and cash equivalents as of end of the year
(24.) SEGMENT REPORTING
Years ended December 31,
2019
2018
2020
$
38,332 $
48,862 $
39,526
(19,725)
209
1,333
(48)
497
20,598
(11,966)
(11)
-
(11,977)
34,221
(209)
-
(17,957)
16,055
24,676
7,172
31,848 $
(33,567)
153
1,406
2,243
(1,407)
17,690
(350)
8
-
(342)
-
(293)
-
(17,260)
(17,553)
(205)
7,377
7,172 $
(24,134)
152
1,301
(175)
1,548
18,218
(803)
(19)
(4,503)
(5,325)
-
(114)
320
(16,409)
(16,203)
(3,310)
10,687
7,377
$
Effective with year-end December 31, 2020, the Company reduced its reportable segments to one, as it determined that the previously
disclosed “Non-Banking” reportable segment no longer met the quantitative or qualitative thresholds for separate disclosure.
Previously reported results have been reclassified to conform to the current reporting structure.
The Company has one reportable segment, Banking, which includes all of the Company’s retail and commercial banking operations.
This reportable segment has been identified and organized based on the nature of the underlying products and services applicable to
the 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.
All other segments that do not meet the quantitative threshold for separate reporting have been grouped as “All Other.” This “All
Other” grouping includes the activities of SDN, a full service insurance agency that provides a broad range of insurance services to
both personal and business clients, Courier Capital and HNP Capital, our investment advisor and wealth management firms that
provide customized investment management, investment consulting and retirement plan services to individuals, businesses,
institutions, foundations and retirement plans, and Holding Company amounts, which are the primary differences between segment
amounts and consolidated totals, along with amounts to eliminate balances and transactions between segments.
- 136 -
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020, 2019 and 2018
(24.) SEGMENT REPORTING (Continued)
The following table presents information regarding the Company’s business segments as of the dates indicated (in thousands).
December 31, 2020
Goodwill
Other intangible assets, net
Total assets
December 31, 2019
Goodwill
Other intangible assets, net
Total assets
Banking
All Other
Consolidated
Totals
48,536 $
28
4,875,673
17,526 $
7,699
36,633
66,062
7,727
4,912,306
48,536 $
98
4,346,615
17,526 $
8,763
37,563
66,062
8,861
4,384,178
$
$
The following table presents information regarding the Company’s business segments for the periods indicated (in thousands).
Year ended December 31, 2020
Net interest income (expense)
Provision for credit losses - loans
Noninterest income
Noninterest expense
Income (loss) before income taxes
Income tax (expense) benefit
Net income (loss)
Year ended December 31, 2019
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, 2018
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)
Banking
All Other(1)
Consolidated
Totals
$
$
$
$
$
$
141,873 $
(27,184)
31,232
(94,988)
50,933
(8,630)
42,303 $
132,383 $
(8,044)
29,390
(88,801)
64,928
(11,190)
53,738 $
125,334 $
(8,934)
26,295
(84,927)
57,768
(11,622)
46,146 $
(2,888) $
-
11,944
(14,266)
(5,210)
1,239
(3,971) $
(2,471) $
-
10,991
(14,027)
(5,507)
631
(4,876) $
(2,470) $
-
10,183
(15,949)
(8,236)
1,616
(6,620) $
138,985
(27,184)
43,176
(109,254)
45,723
(7,391)
38,332
129,912
(8,044)
40,381
(102,828)
59,421
(10,559)
48,862
122,864
(8,934)
36,478
(100,876)
49,532
(10,006)
39,526
(1) Reflects activity from the acquisition of HNP Capital since June 1, 2018 (the date of acquisition).
(2) All Other includes SDN reporting unit goodwill impairment of $2.4 million for the year ended December 31, 2018.
- 137 -
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, 2020, 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.
RSM US LLP, an independent registered public accounting firm, has audited the consolidated financial statements as of and for the
year ended December 31, 2020 which are included in this Annual Report on Form 10-K, and has issued a report on the effectiveness
of the Company’s internal control over financial reporting as of December 31, 2020. 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, 2020 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.
- 138 -
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
In response to this Item, the information set forth in the Company’s Proxy Statement for its 2021 Annual Meeting of Shareholders (the
“2021 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” and “Our Executive Officers” 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
“Committees of the Board” in the 2021 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 “Corporate Responsibility
and Sustainability - Ethics” in the 2021 Proxy Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
In response to this Item, the information set forth in the 2021 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 2021 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, 2020, 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
Weighted average
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
exercise price
of outstanding
options, warrants
and rights
(b) (1)
162,114 $
- $
Number of securities
remaining for future
issuance under equity
compensation plans
(excluding securities
reflected in column (a))
(c)
-
-
155,623
-
(1) Comprised of restricted stock units granted under our 2015 Plan. See Note 18, Share-Based Compensation, to the Consolidated
Financial Statements included in Item 8 of this Annual Report on Form 10-K for further details. All restricted stock units are
excluded from the weighted average exercise price column.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In response to this Item, the information set forth in the 2021 Proxy Statement under the headings “Certain Relationships and Related
Party Transactions” and “Director Independence and Qualifications” is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
In response to this Item, the information set forth in the 2021 Proxy Statement under the heading “Proposal 3 – Ratification of
Appointment of Independent Registered Public Accounting Firm” is incorporated herein by reference.
- 139 -
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) FINANCIAL STATEMENTS
PART IV
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
3.1
3.2
4.1
4.2
4.3
4.4
4.5
4.6
10.1
10.2
Amended and Restated Certificate of Incorporation of the
Company
Description
Amended and Restated Bylaws of Financial Institutions, Inc.
Subordinated Indenture, dated as of April 15, 2015, between
Financial Institutions, Inc. and Wilmington Trust, National
Association, as Trustee
First Supplemental Indenture, dated as of April 15, 2015, between
Financial Institutions, Inc. and Wilmington Trust, National
Association, as Trustee
Form of Global Note to represent the 6.00% Fixed-to-Floating
Rate Subordinated Notes due April 15, 2030
Subordinated Indenture, dated as of October 7, 2020, between
Financial Institutions, Inc. and Wilmington Trust, National
Association, as Trustee
Form of 4.375% Fixed-to-Floating Rate Subordinated Note due
October 15, 2030
Description of the Company’s Securities
Supplemental Executive Retirement Agreement between Financial
Institutions, Inc. and Peter G. Humphrey
Supplemental Executive Retirement Agreement between Financial
Institutions, Inc. and Richard J. Harrison
10.3
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
10.4
10.5
10.6
10.7
10.8
Form of Director Annual Restricted Stock Award Agreement
Pursuant to the Financial Institutions, Inc. 2015 Long-Term
Incentive Plan
Form of Director “In Lieu of Cash Fees” Stock Award Agreement
Pursuant to the Financial Institutions, Inc. 2015 Long-Term
Incentive Plan
Form of Restricted Stock Award Agreement Pursuant to the
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
Form of Performance Stock Award Agreement Pursuant to the
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
Form of Restricted Stock Unit Award Agreement Pursuant to the
Financial Institutions, Inc. 2015 Long-Term Incentive Plan
Location
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
Incorporated by reference to Exhibit 3.1 of the Form
8-K, dated June 25, 2019
Incorporated by reference to Exhibit 4.1 of the Form
8-K, dated April 15, 2015
Incorporated by reference to Exhibit 4.2 of the Form
8-K, dated April 15, 2015
Incorporated by reference to Exhibit A of Exhibit 4.2
of the Form 8-K, dated April 15, 2015
Incorporated by reference to Exhibit 4.1 of the Form
8-K, dated October 7, 2020.
Included in Exhibit 4.4.
Incorporated by reference to Exhibit 4.4 of the Form
10-K for the year ended December 31, 2019, dated
March 4, 2020.
Incorporated by reference to Exhibit 10.3 of the
Form 10-Q for the quarterly period ended
September 30, 2012, dated November 6, 2012
Incorporated by reference to Exhibit 10.1 of the
Form 10-Q for the quarterly period ended June 30,
2014, dated August 5, 2014
Incorporated by reference to Exhibit 10.1 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
Incorporated by reference to Exhibit 10.2 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
Incorporated by reference to Exhibit 10.3 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
Incorporated by reference to Exhibit 10.4 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
Incorporated by reference to Exhibit 10.5 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
Incorporated by reference to Exhibit 10.6 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
- 140 -
Incorporated by reference to Exhibit 10.7 of the
Form 10-Q for the quarterly period ended June 30,
2015, dated August 5, 2015
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
Incorporated by reference to Exhibit 10.1 of the
Form 10-Q for the quarterly period ended June 30,
2018, dated August 8, 2018
Incorporated by reference to Exhibit 10.1 of the
Form 10-Q for the quarterly period ended June 30,
2020, dated August 5, 2020.
Filed Herewith
Filed Herewith
Filed Herewith
Filed Herewith
Filed Herewith
Filed Herewith
10.9
Form of Performance Stock Unit Award Agreement Pursuant to
the Financial Institutions, Inc. 2015 Long-Term Incentive Plan
10.10
Form of Indemnification Agreement
10.11
10.12
10.13
10.14
10.15
21
23.1
31.1
31.2
32
101.INS
101.SCH
101.CAL
101.LAB
101.PRE
101.DEF
104
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
Supplemental Executive Retirement Agreement between Financial
Institutions, Inc. and Kevin B. Klotzbach dated June 26, 2018
Severance and Settlement Agreement and Release between
Financial Institutions, Inc. and William L. Kreienberg dated June
30, 2020
Form of Executive Agreement
Subsidiaries of Financial Institutions, Inc.
Consent of Independent Registered Public Accounting Firm, RSM
US LLP
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Principal Executive Officer
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 - Principal Financial Officer
Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Inline XBRL Instance Document
Inline XBRL Taxonomy Extension Schema Document
Inline XBRL Taxonomy Extension Calculation Linkbase
Document
Inline XBRL Taxonomy Extension Label Linkbase Document
Inline XBRL Taxonomy Extension Presentation Linkbase
Document
Inline XBRL Taxonomy Extension Definition Linkbase
Document
Cover Page Interactive Data File (embedded within the Inline
XBRL document)
All material agreements consist of management contracts, compensatory plans or arrangements.
ITEM 16. FORM 10-K SUMMARY
None.
- 141 -
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 15, 2021
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
/s/ Martin K. Birmingham
Martin K. Birmingham
Title
Director, President and Chief Executive Officer
(Principal Executive Officer)
/s/ W. Jack Plants, II
W. Jack Plants, II
/s/ Sonia M. Dumbleton
Sonia M. Dumbleton
/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/ Robert N. Latella
Robert N. Latella
/s/ Kim E. VanGelder
Kim E. VanGelder
Senior Vice President, Chief Financial Officer and Treasurer
(Principal Financial Officer)
Senior Vice President and Controller
(Principal Accounting Officer)
Director
Director
Director
Director
Director
Director
Director, Vice-Chair
Director, Chair
Director
- 142 -
Date
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
March 15, 2021
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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 2021 Annual Meeting of Shareholders will be held at 10:00
a.m. EDT on June 16, 2021. The meeting will be held solely by
means of remote communication via the virtual meeting at
www.virtualshareholdermeeting.com/FISI2021.
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 2021 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
Samuel J. Burruano Jr., Corporate Secretary, 220 Liberty Street,
Warsaw, New York 14569.
Investor
Information
Investor Relations Contacts
Shelly J. Doran
Director of Investor and External Relations
SJDoran@five-starbank.com
or
W. Jack Plants II
Chief Financial Officer and Treasurer
WJPlants@five-starbank.com
Legal Counsel
Harter Secrest & Emery LLP
Independent Auditors
RSM US LLP
Chicago, IL
Affiliates
Five Star Bank
SDN Insurance Agency, LLC
Courier Capital, LLC
HNP Capital, LLC
Five Star Bank Regional
Administrative Center
Five Star Bank Plaza
100 Chestnut Street
Rochester, NY 14604
Five Star Bank Buffalo Regional Office
300 Spindrift Drive
Amherst, New York 14221
SDN Insurance Agency, LLC
300 Spindrift Drive
Amherst, New York 14221
Courier Capital, LLC
1114 Delaware Avenue
Buffalo, NY 14209
HNP Capital, LLC
Five Star Bank Plaza
100 Chestnut Street
Rochester, NY 14604
®
®
220 Liberty Street, Warsaw, NY 14569
(585) 786-1100 | www.fiiwarsaw.com