================================================================================ FORM 10-Q ---------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 Commission file number 0-26481 FINANCIAL INSTITUTIONS, INC. ------------------------------------------------------------------- (Exact name of registrant as specified in its charter) New York 16-0816610 - ------------------------------ ------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 220 Liberty Street, Warsaw, New York 14569 - ---------------------------------------- -------------- (Address of principal executive offices) (Zip code) 716-786-1100 ---------------------------------------------------- (Registrant's telephone number, including area code) 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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. TITLE OUTSTANDING ----- ----------- Common Stock, $0.01 par value Outstanding at November 1, 2001 Per share 11,021,314 shares ================================================================================
INDEX FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES PART I. -- FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited): Consolidated Statements of Financial Condition Consolidated Statements of Income Consolidated Statements of Cash Flows Consolidated Statements of Shareholders' Equity and Comprehensive Income Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk PART II -- OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K SIGNATURES EXHIBITS
ITEM 1. FINANCIAL STATEMENTS FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Dollars in thousands, except share amounts) <TABLE> <CAPTION> September 30, December 31, 2001 2000 ASSETS ------------- ------------ (unaudited) <S> <C> <C> Cash, due from banks and interest-bearing deposits $ 57,289 $ 29,226 Federal funds sold 481 926 Securities available for sale, at fair value 402,412 261,869 Securities held to maturity (fair value of $67,987 at September 30, 2001 and $76,884 at December 31, 2000) 66,448 76,947 Loans 1,139,730 887,145 Allowance for loan losses (18,497) (13,883) ----------- ----------- Loans, net 1,121,233 873,262 Premises and equipment, net 24,139 18,423 Goodwill and other intangibles 38,008 2,732 Other assets 39,640 25,942 ----------- ----------- Total assets $ 1,749,650 $ 1,289,327 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand $ 209,304 $ 162,840 Savings, money market and interest-bearing checking 488,173 309,732 Certificates of deposit 733,693 605,539 ----------- ----------- Total deposits 1,431,170 1,078,111 Short-term borrowings 72,589 46,903 Long-term borrowings 55,541 15,481 Guaranteed preferred beneficial interests in Corporation's junior subordinated debentures 16,200 -- Accrued expenses and other liabilities 26,243 17,214 ----------- ----------- Total liabilities 1,601,743 1,157,709 ----------- ----------- Shareholders' equity: 3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding 1,683 shares at September 30, 2001 and 1,711 shares at December 31, 2000 168 171 8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding 175,866 shares at September 30, 2001 and December 31, 2000 17,587 17,587 Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,303,533 shares at September 30, 2001 and December 31, 2000 113 113 Additional paid-in capital 16,496 16,472 Retained earnings 108,730 98,348 Accumulated other comprehensive income (loss) 5,750 (144) Treasury stock--common, at cost--315,671 shares at September 30, 2001 and 316,812 shares at December 31, 2000 (937) (929) ----------- ----------- Total shareholders' equity 147,907 131,618 ----------- ----------- Total liabilities and shareholders' equity $ 1,749,650 $ 1,289,327 =========== =========== </TABLE> See accompanying notes to consolidated financial statements. 1
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share amounts) (unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2001 2000 2001 2000 ------- ------- ------- ------- <S> <C> <C> <C> <C> Interest income: Loans $24,090 $20,513 $68,354 $57,327 Securities 6,096 4,554 16,451 13,022 Other 45 65 332 154 ------- ------- ------- ------- Total interest income 30,231 25,132 85,137 70,503 ------- ------- ------- ------- Interest expense: Deposits 11,163 10,607 34,018 28,276 Borrowings 1,509 1,040 3,386 2,853 Guaranteed preferred beneficial interests in Corporation's junior subordinated debentures 421 -- 1,021 -- ------- ------- ------- ------- Total interest expense 13,093 11,647 38,425 31,129 ------- ------- ------- ------- Net interest income 17,138 13,485 46,712 39,374 Provision for loan losses 1,563 1,100 3,400 3,107 ------- ------- ------- ------- Net interest income after provision for loan losses 15,575 12,385 43,312 36,267 ------- ------- ------- ------- Noninterest income: Service charges on deposits 2,177 1,310 5,220 3,663 Gain on sale/call of securities 84 -- 442 -- Gain on sale of loans and other assets 294 96 821 278 Loan servicing fees 174 277 594 882 Investment services 434 237 1,260 760 Other 839 455 1,902 1,164 ------- ------- ------- ------- Total noninterest income 4,002 2,375 10,239 6,747 ------- ------- ------- ------- Noninterest expense: Salaries and employee benefits 5,856 4,300 16,122 12,439 Occupancy and equipment 1,566 1,173 4,313 3,415 Supplies and postage 374 347 1,283 1,078 Amortization of intangibles 796 176 1,561 562 Professional fees 213 153 901 552 Other 2,504 1,380 5,782 4,065 ------- ------- ------- ------- Total noninterest expense 11,309 7,529 29,962 22,111 ------- ------- ------- ------- Income before income taxes 8,268 7,231 23,589 20,903 Income taxes 2,908 2,566 8,239 7,495 ------- ------- ------- ------- Net income $ 5,360 $ 4,665 $15,350 $13,408 ======= ======= ======= ======= Earnings per common share: Basic $ 0.45 $ 0.39 $ 1.29 $ 1.12 ======= ======= ======= ======= Diluted $ 0.45 $ 0.39 $ 1.28 $ 1.12 ======= ======= ======= ======= </TABLE> See accompanying notes to consolidated financial statements. 2
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (unaudited) <TABLE> <CAPTION> Nine Months Ended September 30, 2001 2000 --------- --------- <S> <C> <C> Cash flows from operating activities: Net income $ 15,350 $ 13,408 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,043 2,268 Provision for loan losses 3,400 3,107 Deferred income tax benefit (1,006) (506) Gain on sale/call of securities (442) -- Gain on sale of loans and other assets (821) (278) Minority interest in net income of subsidiary banks 74 66 Increase in other assets (2,668) (3,954) Increase in accrued expenses and other liabilities 6,425 2,691 --------- --------- Net cash provided by operating activities 24,355 16,802 --------- --------- Cash flows from investing activities: Purchase of securities: Available for sale (268,850) (78,550) Held to maturity (16,580) (17,115) Proceeds from maturity/call of securities: Available for sale 206,227 22,843 Held to maturity 26,908 16,647 Proceeds from sales of securities available for sale 9,538 2,741 Net increase in loans (63,722) (95,804) Proceeds from sales of premises and equipment 29 41 Purchase of premises and equipment (3,664) (1,916) Purchase of Bath National Corporation, net of cash acquired (48,955) -- --------- --------- Net cash used in investing activities (159,069) (151,113) --------- --------- Cash flows from financing activities: Net increase in deposits 121,592 100,340 Net increase in short-term borrowings 15,502 10,650 Proceeds from long-term borrowings 14,501 4,104 Repayment of long-term borrowings (131) (1,825) Proceeds from guaranteed preferred beneficial interests in corporation's junior subordinated debentures, net of costs 15,713 -- Net issuance (repurchase) of preferred and common shares 13 (425) Dividends paid (4,858) (4,205) --------- --------- Net cash provided by financing activities 162,332 108,639 --------- --------- Net increase (decrease) in cash and cash equivalents 27,618 (25,672) Cash and cash equivalents at beginning of the period 30,152 61,226 --------- --------- Cash and cash equivalents at end of the period $ 57,770 $ 35,554 ========= ========= Supplemental disclosure of cash flow information: Cash paid during period for: Interest $ 36,199 $ 28,826 Income taxes $ 9,210 $ 8,173 Noncash investing activities: Fair value of noncash assets acquired in purchase acquisition $ 281,664 $ -- Fair value of liabilities assumed in purchase acquisition $ 269,897 $ -- </TABLE> See accompanying notes to consolidated financial statements. 3
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (Dollars in thousands, except per share amounts) (unaudited) <TABLE> <CAPTION> Accumulated Other Preferred Stock Additional Comprehensive Total ----------------- Common Paid-In Retained Income Treasury Shareholders 3% 8.48% Stock Capital Earnings (Loss) Stock Equity ---- -------- ------- -------- --------- -------- -------- ------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance-December 31, 2000 $171 $ 17,587 $ 113 $ 16,472 $ 98,348 $ (144) $(929) $ 131,618 Purchase of 33 shares of 3% preferred stock (3) 1 (2) Purchase of 1,000 shares of common stock (12) (12) Issue 1,141 shares of common stock - directors plan 23 4 27 Comprehensive income: Net income 15,350 15,350 Unrealized gain on securities available for sale (net of tax of $3,837) 5,631 5,631 Reclassification adjustment for gains included in net income (net of tax of $179) 263 263 --------- Net unrealized gain on securities available for sale (net of tax of $4,016) 5,894 --------- Total comprehensive income 21,244 --------- Cash dividends declared: 3% preferred-$2.25 per share (4) (4) 8.48% preferred-$6.36 per share (1,119) (1,119) Common-$0.35 per share (3,845) (3,845) ---- -------- ----- -------- --------- ------- ----- --------- Balance-September 30, 2001 $168 $ 17,587 $ 113 $ 16,496 $ 108,730 $ 5,750 $(937) $ 147,907 ==== ======== ===== ======== ========= ======= ===== ========= </TABLE> See accompanying notes to consolidated financial statements. 4
FINANCIAL INSTITUTIONS. INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 and 2000 (Unaudited) 1. BASIS OF PRESENTATION Financial Institutions. Inc. ("FII") is a financial holding company with five commercial bank subsidiaries that operate in Western and Central New York State: Wyoming County Bank ("WCB"); The National Bank of Geneva ("NBG"); The Pavilion State Bank ("PSB"); First Tier Bank & Trust ("FTB"); and Bath National Bank ("BNB"), (collectively the "Banks"). The Company is also the parent of The FI Group, Inc. ("FIGI") and FISI Statutory Trust I ("FISI"). FIGI is a brokerage subsidiary that commenced operations in March 2000. FISI is a trust formed in February 2001 to accommodate the private placement of $16.2 million in capital securities, the proceeds of which were utilized to partially fund the acquisition of Bath National Corporation ("BNC") (see Note 3). The capital securities are identified on the balance sheet as guaranteed preferred beneficial interests in corporation's junior subordinated debentures. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation have been included in the results for the three and nine month periods ended September 30, 2001 and 2000. The results of operations for the three and nine month periods ended September 30, 2001 are not necessarily indicative of the results which may be expected for the year ending December 31, 2001 or any other interim period. The consolidated financial statements include the accounts of FII, the Banks, FIGI and FISI (collectively, "the Company"). All significant intercompany balances and transactions have been eliminated in consolidation. 2. EARNINGS PER SHARE Basic earnings per share, after giving effect to preferred stock dividends, has been computed using weighted average common shares outstanding. Diluted earnings per share reflects the effects, if any, of incremental common shares issuable upon exercise of dilutive stock options. Earnings per common share have been computed based on the following: (Dollars in thousands, except share amounts) <TABLE> <CAPTION> Three Months Ended September 30, 2001 2000 ---- ---- <S> <C> <C> Net Income $ 5,360 $ 4,665 Less: Preferred Stock Dividends 374 374 ----------- ----------- Net Income Available to Common Shareholders $ 4,986 $ 4,291 =========== =========== Average Number of Common Shares Outstanding - Basic 10,987,742 10,986,721 Add: Effect of Dilutive Options 172,030 3,507 ----------- ----------- Average Number of Common Shares Outstanding - Diluted 11,159,772 10,990,228 =========== =========== </TABLE> 5
<TABLE> <CAPTION> Nine Months Ended September 30, 2001 2000 ---- ---- <S> <C> <C> Net Income $ 15,350 $ 13,408 Less: Preferred Stock Dividends 1,122 1,122 ----------- ----------- Net Income Available to Common Shareholders $ 14,228 $ 12,286 =========== =========== Average Number of Common Shares Outstanding - Basic 10,987,035 10,998,171 Add: Effect of Dilutive Options 124,179 335 ----------- ----------- Average Number of Common Shares Outstanding - Diluted 11,111,214 10,998,506 =========== =========== </TABLE> 3. ACQUISITION On May 1, 2001, FII acquired all of the common stock of BNC, and its wholly-owned subsidiary bank, Bath National Bank ("BNB"). BNB is a full service community bank headquartered in Bath, New York, which has 9 branch locations in Steuben, Yates, Ontario and Schuyler Counties. The Company paid $48.00 per share in cash for each of the outstanding shares of BNC common stock with an aggregate purchase price of approximately $62.6 million. The acquisition was accounted for under the purchase method of accounting, and accordingly, the excess of the purchase price over the fair value of identifiable assets acquired, less liabilities assumed, has been recorded as goodwill. Goodwill recognized with respect to the merger was approximately $37.2 million. Goodwill is being amortized using the straight-line method over 15-years. In accordance with SFAS No. 142 (See Note 6), the Company will cease goodwill amortization on January 1, 2001 and will evaluate goodwill for impairment annually thereafter. The results of operations for BNB are included in the income statement from the date of acquisition (May 1, 2001) to the end of the period. The following table presents certain unaudited pro forma information as if the BNC acquisition, which occurred in 2001, had been consummated on January 1, 2000. This proforma information gives effect to certain adjustments, including accounting adjustments related to fair value adjustments, amortization of goodwill and related income tax effects. The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company acquired BNC on January 1, 2000. (Dollars in thousands, except per share) Pro Forma Pro Forma (Unaudited) (Unaudited) Nine Months Ended Year Ended September 30, 2001 December 30,2000 ------------------ ---------------- Net interest income $49,856 $62,097 Noninterest income $10,973 $11,203 Net income $13,727 $13,967 ======= ======= Earnings per share: Basic $ 1.15 $ 1.13 Diluted $ 1.13 $ 1.13 6
4. SUBSEQUENT EVENT Effective October 22, 2001, the Company acquired the Burke Group, Inc.("BGI"), an employee benefits administration and compensation consulting firm, with offices in Honeoye Falls and Syracuse, New York. BGI's expertise includes design and consulting for retirement and employee welfare plans, administrative services for defined contribution and benefit plans, actuarial services and post employment benefits. Under the terms of the agreement, BGI shareholders received primarily common stock as consideration for their ownership in BGI. The acquisition will be accounted for under the purchase method of accounting, and accordingly, the excess of the purchase price over the fair value of identifiable assets acquired, less liabilities assumed, will be recorded as goodwill. Unaudited historical financial information for BGI follows: (Dollars in thousands) As of or For the As of or For the Nine Months Ended Year Ended September 30, 2001 December 30,2000 ------------------ ---------------- Total Assets $1,200 $1,100 Total Revenue $2,300 $3,300 ====== ====== 5. LOANS AND THE ALLOWANCE FOR LOAN LOSSES The following table summarizes, at the dates indicated, the Company's loan portfolio by type: (Dollars in thousands) As of As of December 31, September 30, 2001 2000 ------------------ ------------ Commercial $ 217,798 $ 169,832 Commercial real estate 265,539 166,041 Agricultural 178,167 165,367 Residential real estate 244,254 201,160 Consumer & home equity 233,972 184,745 ----------- --------- Loans, gross 1,139,730 887,145 Allowance for loan losses (18,497) (13,883) ----------- --------- Total loans, net $ 1,121,233 $ 873,262 =========== ========= 7
The following table presents an analysis of the allowance for loan losses and other related data for the periods indicated. (Dollars in thousands) <TABLE> <CAPTION> Three Months Ended Nine Months Ended -------------------- --------------------- September 30, September 30, 2001 2000 2001 2000 ------- ------- ------- ------- <S> <C> <C> <C> <C> Balance at the beginning of the period $17,815 $12,581 $13,883 $11,421 Addition as a result of acquisition -- -- 2,686 -- Charge-Offs: Commercial 452 76 566 254 Commercial real estate 184 216 250 581 Agricultural 4 -- 4 29 Residential real estate 14 42 159 105 Consumer and home equity 385 248 884 655 ------- ------- ------- ------- Total charge-offs 1,039 582 1,863 1,624 ------- ------- ------- ------- Recoveries: Commercial 40 12 54 81 Commercial real estate 8 19 19 20 Agricultural -- -- -- 1 Residential real estate 5 9 5 10 Consumer and home equity 105 41 313 164 ------- ------- ------- ------- Total recoveries 158 81 391 276 ------- ------- ------- ------- Net charge-offs 881 501 1,472 1,348 Provision for loan losses 1,563 1,100 3,400 3,107 ------- ------- ------- ------- Balance at the end of the period $18,497 $13,180 $18,497 $13,180 ======= ======= ======= ======= Ratio of net charge-offs to average loans (annualized) 0.31% 0.22% Allowance for loan losses to total loans 1.62% 1.54% </TABLE> At September 30, 2001 and 2000, the recorded investment in loans that are considered to be impaired totaled $7,918,000 and $6,448,000, respectively. The average recorded investments in impaired loans during the nine months ended September 30, 2001 and 2000 were approximately $7,413,000 and $4,722,000, respectively. At September 30, 2001 and 2000, the Company had specific allocations for impaired loans included in the allowance for loan losses of $1,732,000 and $1,099,000, respectively. 8
The following table presents information regarding nonperforming assets at the dates indicated: (Dollars in thousands) <TABLE> <CAPTION> As of As of September 30, December 31, 2001 2000 ------- ------ <S> <C> <C> Nonaccruing loans (1): Commercial $ 2,917 $1,044 Commercial real estate 2,915 1,619 Agricultural 1,764 2,881 Residential real estate 890 835 Consumer and home equity 616 217 ------- ------ Total loans 9,103 6,596 Accruing loans 90 days or more delinquent 1,451 521 ------- ------ Total nonperforming loans 10,553 7,117 Other real estate owned (2) 1,193 932 ------- ------ Total nonperforming assets $11,747 $8,049 ======= ====== Nonperforming loans to total loans 0.93% 0.80% ======= ====== Nonperforming assets to total loans and other real estate 1.03% 0.91% ======= ====== Allowance for loan losses to nonperforming loans 175.26% 172.14% ======= ====== </TABLE> (1) Loans are placed on nonaccrual status when they become 90 days past due if there is uncertainty with respect to the collectibility of interest or principal. (2) Other real estate owned balances are shown net of related allowances. 6. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement, as amended by SFAS No. 138, requires recognition of derivatives as either assets or liabilities, with the instruments measured at fair value. The accounting for gains and losses resulting from changes in fair value of the derivative instrument depends on the intended use of the derivative and the type of risk being hedged. The Company adopted SFAS No. 133 on January 1, 2001. The adoption of this statement did not have a material effect on the Company's financial position or results of operations. In July 2001 the FASB issued SFAS Nos. 141, "Business Combinations" and 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method, use of the pooling-of-interests method is no longer permitted for business combinations initiated after June 30, 2001. SFAS No. 142 requires that goodwill (including goodwill reported in prior acquisitions) no longer be amortized to earnings, but instead be reviewed for impairment annually, with impairment losses charged to earnings when they occur. The Company is required to adopt SFAS No. 142 effective January 1, 2002. The results of operations for the nine months ended September 30, 2001 include goodwill amortization from the BNC acquisition of approximately $1,033,000. The amortization of goodwill will cease effective January 1, 2002. 9
7. SEGMENT INFORMATION Segments are determined based upon the individual subsidiary banks. Reportable segments are comprised of WCB, NBG, BNB (from the date of acquisition, May 1, 2001, to the end of the period), PSB and FTB as the Company manages and evaluates performance on an individual bank basis. The reportable segment information as of and for the nine months ended September 30, 2001 and 2000 follows: <TABLE> <CAPTION> (Dollars in thousands) 2001 2000 ----------- ----------- <S> <C> <C> Net interest income: WCB ....................................... $ 17,164 $ 16,071 NBG ....................................... 14,868 13,603 BNB ....................................... 5,132 -- PSB ....................................... 6,037 5,316 FTB ....................................... 4,276 3,841 ----------- ----------- Total segment net interest income ....... 47,477 38,831 FII, FIGI, FISI, and eliminations, net (765) 543 ----------- ----------- Total net interest income ........... $ 46,712 $ 39,374 =========== =========== Net interest income plus non-interest income: WCB ....................................... $ 20,196 $ 18,599 NBG ....................................... 17,958 16,115 BNB ....................................... 6,279 -- PSB ....................................... 7,697 6,205 FTB ....................................... 5,185 4,526 ----------- ----------- Total segment net interest income plus non-interest income ........ 57,315 45,445 FII, FIGI, FISI, and eliminations, net (364) 676 ----------- ----------- Total net interest income plus non-interest income ................ $ 56,951 $ 46,121 =========== =========== Net income: WCB ....................................... $ 6,217 $ 5,635 NBG ....................................... 5,834 5,244 BNB ....................................... 1,721 -- PSB ....................................... 2,024 1,441 FTB ....................................... 1,281 1,108 ----------- ----------- Total segment net income ................ 17,077 13,428 FII, FIGI, FISI, and eliminations, net (1,727) (20) ----------- ----------- Total net income .................... $ 15,350 $ 13,408 =========== =========== Assets: WCB ....................................... $ 546,870 $ 498,678 NBG ....................................... 533,012 465,878 BNB ....................................... 320,849 -- PSB ....................................... 176,207 162,713 FTB ....................................... 143,981 131,418 ----------- ----------- Total segment net assets ................ 1,720,919 1,258,687 FII, FIGI, FISI, and eliminations, net 28,731 3,053 ----------- ----------- Total assets ........................ $ 1,749,650 $ 1,261,740 =========== =========== </TABLE> 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS This quarterly report contains certain "forward-looking statements" covered by the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. When used or incorporated by reference in the Company's disclosure documents, the words "anticipate," "estimate," "expect," "project," "target," "goal" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including, but not limited to changes in (1) general economic conditions, (2) the real estate markets, and (3) interest rates. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. These forward-looking statements speak only as of the date of the document. The Company expressly disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectation with regard thereto or any change in events, conditions or circumstances on which any such statement is based. The purpose of this discussion is to present material changes in the Company's financial condition and results of operations during the three and nine months ended September 30, 2001 to supplement the information in the consolidated financial statements included in this report. The following table presents certain information and ratios that management of the Company considers important in evaluating performance: <TABLE> <CAPTION> At or For the Three Months Ended September 30, 2001 2000 $ Change % Change ---------- ---------- -------- -------- <S> <C> <C> <C> <C> Per common share data: Net income - basic $0.45 $0.39 $0.06 15.4% Net income - diluted $0.45 $0.39 $0.06 15.4% Cash dividends declared $0.12 $0.11 $0.01 9.1% Book value $11.85 $9.89 $1.96 19.8% Common shares outstanding: Weighted average shares - basic 10,987,742 10,986,721 Weighted average shares - diluted 11,159,772 10,990,228 Period end 10,986,862 10,986,721 Performance ratios, annualized: Return on average assets 1.24% 1.52% Return on average common equity 15.68% 16.03% Net interest margin (tax-equivalent) 4.57% 4.84% Efficiency ratio 47.40% 45.32% Asset quality ratios: Nonperforming loans to total loans 0.93% 0.89% Nonperforming assets to total loans and other real estate 1.03% 1.02% Net loan charge-offs to average loans 0.31% 0.24% Allowance for loan losses to total loans 1.62% 1.54% Allowance for loan losses to nonperforming loans 175.26% 172.14% Capital ratios: Average common equity to average total assets 7.37% 8.70% Leverage ratio 7.22% 10.37% Tier 1 risk based capital ratio 10.03% 14.07% Risk-based capital ratio 11.28% 15.32% </TABLE> 11
The Company's third quarter net income increased 15% to $5,360,000 for 2001 compared to $4,665,000 for the third quarter of 2000. Net income for the first nine months of 2001 was $15,350,000, a 14% increase compared to $13,408,000 for the same period in 2000. Operating results of FII reflect activities of BNB since May 1, 2001, the date of acquisition. Diluted earnings per common share increased to $0.45 for the third quarter of 2001 and to $1.28 for the first nine months of the year compared to $0.39 and $1.12, respectively, for the same periods in 2000. Return on average common equity was 15.67% for the nine months ended September 30, 2001 compared to 15.89% for the same period last year. For the third quarter of 2001 net interest income increased $3,653,000 to $17,138,000 compared to $13,485,000 for the third quarter of 2000. Net interest income for the first nine months of 2001 was $46,712,000, an increase of $7,338,000 from $39,374,000 for the first nine months of 2000. Total loans at quarter end were $1,140 million, an increase of $281 million over the same period last year and up $10 million from the prior quarter. The acquisition of BNB accounted for $189 million of the loan growth with the balance of $92 million reflecting continued expansion of both commercial and consumer loans throughout the Company's existing markets. Net interest margin was 4.57% for the third quarter of 2001 and 4.60% for the first nine months of 2001. That compares to 4.84% and 4.93% for the same periods last year. The decrease in net interest margin is consistent with expectations and still remains at a high level. There has been strong growth in net interest income given an environment of increasing price competitiveness and rapidly declining interest rates. Looking ahead to the fourth quarter and into 2002 we expect margins to be under increased pressure as the recent additional drops in rates are fully phased into our balance sheet. Noninterest income increased 69% in the third quarter of 2001 to $4,002,000 from $2,375,000 for the same period in 2000. BNB accounts for 42% or $682,000 of the significant increase over 2000. The remaining increase results from the benefit of the continuing growth in deposits and the related fee-based products and services, as well as the continuing expansion of investment brokerage and trust businesses. In addition, gains realized principally from the call of securities totaled $84,000 in the third quarter of 2001 and $442,000 for the first nine months of 2001. Noninterest expense for the third quarter of 2001 was $11,309,000 compared to $7,529,000 for the third quarter of 2000. BNB accounts for 56% or $2,125,000 of the significant increase over 2000. For the nine months ended September 30, 2001, noninterest expense was $29,962,000, an increase from $22,111,000 for the same period in 2000. The year-to-date increase in noninterest expense reflects $2,796,000 in operating costs and $1,033,000 in goodwill amortization related to the acquisition of BNB. Added costs can also be attributed to staffing and technology resources necessary to support the continuing expansion of existing product lines and delivery channels, as well as, the enhancement of management information systems. The efficiency ratio for the third quarter of 2001 remained strong at 47.4% compared to 48.5% for the second quarter of 2001 and 44.3% for the third quarter of 2000. The provision for loan losses for the third quarter of 2001 was $1,563,000, which increases the nine-month year-to-date charge to $3,400,000. That compares to $1,100,000 for the same quarter in 2000 and $3,107,000 for the prior nine-month period. Historically, the Company has maintained good asset quality during economic cycles. Our lending strategy, which focuses on clients in local markets with whom FII has broad relationships, has contributed to the successful management of credit risk. However, the provision for credit losses increased given the softening of the economy throughout the year and the effects of recent events. The increase in nonperforming loans to $10,554,000 at September 30, 2001 compared to $7,657,000 at September 30, 2000 directly results from the addition of $3,019,000 in nonperforming loans at BNB. The Company's ratio of nonperforming loans to total loans was 0.93% at September 30, 2001, 0.95% at June 30, 2001, and 0.89% at September 30, 2000. Net loan charge-offs for the third quarter of 2001 were $881,000 or 0.31% of average loans compared to $501,000 or 0.24% of average loans in the third quarter of last year due primarily to the continuing resolution of certain acquired BNB loans. For the first nine months of 2001 net loan charge-offs were $1,472,000 or 0.19% of average loans compared to $1,348,000 or 0.22% of average loans for the same period last year. The ratio of the allowance for loan losses to nonperforming loans increased to 175.26% at September 30, 2001, up from 172.14% a year ago. The ratio of the allowance for loan losses to total loans also improved to 1.62% at September 30, 2001, compared to 1.54% from a year ago. At September 30, 2001 the Company had total assets of $1,750 million, an increase of $488 million ($296 million from the BNB acquisition) from $1,262 million at September 30, 2000. Total deposits were $1,431 million at the recent quarter-end, compared with $1,050 million a year earlier with the BNB acquisition accounting for $231 million of the increase. Total shareholders' equity increased 17% to $148 million at September 30, 2001 from $126 million a year earlier. 12
SUPPLEMENTAL SCHEDULES The following table presents, for the periods indicated, the total dollar amount of average balances, interest income from average interest-earning assets, the resulting yields and interest expense on average interest-bearing liabilities expressed both in dollars and rates. Except as indicated in the footnotes to this table, no tax-equivalent adjustments have been made and all average balances are daily average balances. Nonaccruing loans have been included in the yield calculation in this table. <TABLE> <CAPTION> For The Three Months Ended September 30, -------------------------------------------- 2001 2000 ------- ------- Average Interest Annualized Average Interest Annualized Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ (Dollars in thousands) Balance Paid Rate Balance Paid Rate ---------- ------- ------ ---------- ------- ------ <S> <C> <C> <C> <C> <C> <C> Interest-earning assets Federal funds sold and interest-bearing deposits $5,923 $47 3.15% $3,959 $65 6.53% Investment securities (1) 453,714 7,177 6.32% 314,849 5,220 6.63% Loans (2) Commercial and agricultural 656,519 13,515 8.17% 476,892 11,794 9.84% Residential real estate 242,955 5,286 8.70% 195,712 4,417 9.03% Consumer and home equity 232,788 5,289 9.01% 174,914 4,302 9.78% ---------- ------- ------ ---------- ------- ------ Total loans 1,132,261 24,090 8.46% 847,518 20,513 9.64% ---------- ------- ------ ---------- ------- ------ Total interest-earning assets 1,591,898 31,314 7.83% 1,166,326 25,798 8.82% ---------- ------- ------ ---------- ------- ------ Interest-bearing liabilities Interest-bearing checking 183,691 600 1.30% 113,034 395 1.39% Savings and money market 269,597 1,396 2.05% 191,404 1,308 2.72% Certificates of deposit 743,235 9,168 4.89% 575,948 8,904 6.15% Borrowed funds 129,206 1,509 4.63% 64,274 1,040 6.44% Guaranteed preferred beneficial interests in Corporation's junior subordinated debentures 16,200 421 10.31% -- -- -- ---------- ------- ------ ---------- ------- ------ Total interest-bearing liabilities 1,341,929 13,094 3.87% 944,660 11,647 4.91% ---------- ------- ------ ---------- ------- ------ Net interest income $18,220 $14,151 ======= ======= Net interest rate spread 3.96% 3.91% ====== ====== Net earning assets $249,969 $221,666 ========== ========== Net interest margin on earning assets (3) 4.57% 4.84% ====== ====== Ratio of average interest-earning assets to average interest-bearing liabilities 118.63% 123.47% ====== ====== </TABLE> (1) Amounts shown are amortized cost for held to maturity securities and fair value for available for sale securities. In order for pre-tax income and resultant yields on tax-exempt securities to be comparable to those on taxable securities and loans, a tax-equivalent adjustment to interest earned from tax-exempt securities has been computed using a federal income tax rate of 35%. (2) Net of deferred loan fees and costs. (3) The net interest margin is equal to net interest income divided by average interest-earning assets and is presented on an annualized basis. 13
The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (1) changes attributable to changes in volume (changes in volume multiplied by the current year rate); (2) changes attributable to changes in rate (changes in rate multiplied by the prior year volume); and (3) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and changes due to rate. <TABLE> <CAPTION> 3rd Quarter 2001 Compared to 3rd Quarter 2000 (Dollars in thousands) ----------------------------------- Increase (Decrease) Due to Total -------------------- Increase Volume Rate (Decrease) ------ -------- ---------- <S> <C> <C> <C> Interest-earning assets: Federal funds sold and interest-bearing deposits $16 $(34) $(18) Investment securities 2,200 (243) 1,957 Loans: Commercial and agricultural 3,733 (2,012) 1,721 Residential real estate 1,029 (160) 869 Consumer and home equity 1,326 (339) 987 ------ ------- ------ Total loans 6,088 (2,511) 3,577 ------ ------- ------ Total interest-earning assets 8,304 (2,788) 5,516 ------ ------- ------ Interest-bearing liabilities: Interest-bearing checking 231 (26) 205 Savings and money market 430 (341) 89 Certificates of deposit 2,168 (1,905) 263 Borrowed funds 763 (293) 470 Guaranteed preferred beneficial interests in Corporation's junior subordinated debentures 421 -- 421 ------ ------- ------ Total interest-bearing liabilities 4,013 (2,565) 1,448 ------ ------- ------ Net interest income $4,291 $(223) $4,068 ====== ======= ====== </TABLE> Item 3: Quantitative and Qualitative Disclosures about Market Risk The Company realizes income principally from the differential or spread between the interest earned on loans, investments and other interest-earning assets and the interest paid on deposits and borrowings. Loan volumes and yields, as well as the volume of and rates on investments, deposits and borrowings, are affected by market interest rates. Additionally, because of the terms and conditions of many of the Company's loan documents and deposit accounts, a change in interest rates could also affect the projected maturities of the loan portfolio and/or the deposit base, which could alter the Company's sensitivity to future changes in interest rates. Accordingly, management considers interest rate risk to be the Company's most significant market risk. Interest rate risk management focuses on maintaining consistent growth in net interest income within Board approved policy limits while taking into consideration, among other factors, the Company's overall credit, operating income, operating cost, and capital profile. The Company's Asset/Liability Committee (ALCO), which includes senior management and reports to the Board of Directors, monitors and manages interest rate risk to maintain an acceptable level of change to net interest income as a result of changes in interest rates. 14
Management of the Company's interest rate risk requires the selection of appropriate techniques and instruments to be utilized after considering the benefits, costs and risks associated with available alternatives. Since the Company does not utilize derivative instruments, management's techniques usually consider one or more of the following: (1) interest rates offered on products, (2) maturity terms offered on products, (3) types of products offered, and (4) products available to the Company in the wholesale market such as advances from the FHLB. The Company uses a net interest income and economic value of equity model as one method to identify and manage its interest rate risk profile. The model is based on expected cash flows and repricing characteristics for all financial instruments and incorporates market-based assumptions regarding the impact of changing interest rates on these financial instruments. Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies. The Company has experienced no significant changes in market risk due to changes in interest rates since the Company's Annual Report on Form 10-K as of December 31, 2000 dated March 29, 2001 as filed with the Securities and Exchange Commission. Management also uses the static gap analysis to identify and manage the Company's interest rate risk profile. Interest sensitivity gap ("gap") analysis measures the difference between the assets and liabilities repricing or maturing within specific time periods. 15
PART II -- OTHER INFORMATION FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES Item 6. Exhibits and reports on Form 8-K (a) Exhibits 3.1 Certificate of Incorporation of the Registrant, as amended * 3.2 By-laws of the Registrant, as amended * 4.1 Form of Certificate for the Registrant's Common Stock * 10.1 1999 Management Stock Incentive Plan of the Registrant ** 10.2 1999 Directors' Stock Incentive Plan of the Registrant ** * Incorporated by reference to the corresponding exhibit filed with the Registrant's Registration Statement on Form S-1 (File No. 333-76865). ** Incorporated by reference to the corresponding exhibit filed with the Registrant's 1999 Annual Report on Form 10-K. (b) Reports on Form 8-K (1) The Company filed an Amended Current Report on Form 8-K/A dated July 16, 2001, which amended the Form 8-K filed May 11, 2001, to include the financial statements related to the May 1, 2001 acquisition of Bath National Corporation and its banking subsidiary, Bath National Bank, as required by Item 7 of Form 8-K. 16
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FINANCIAL INSTITUTIONS, INC. (Registrant) November 13, 2001 /s/ Peter G. Humphrey - ------------------ ---------------------------------------- Date Peter G. Humphrey, President & CEO November 13, 2001 /s/ Ronald A. Miller - ------------------ --------------------------------------- Date Ronald A. Miller, SVP & CFO 17