After issuing a series of optimistic forecasts about its recovery from the asset quality woes that have beset it since 2002, Financial Institutions Inc. of Warsaw, N.Y., has suffered some setbacks in recent weeks.
The first sign of more trouble surfaced Dec. 28, when the $2.2 billion-asset multibank holding company revealed that a loan review firm and the Office of the Comptroller of the Currency had issued reports harshly criticizing underwriting and loan administration procedures at two of the company's four bank subsidiaries.
A month later, on Jan. 27, Financial Institutions disclosed in its fourth-quarter earnings report that nonperforming loans rose 5.4% in the quarter, to $52.5 million - or a whopping 4.18% of total loans. The average ratio for commercial banks with assets of $1 billion to $10 billion was 0.75%, according to statistics through September from the Federal Deposit Insurance Corp.
Now credit quality experts say the company is probably several years away from a full recovery. That is a far cry from Financial Institutions' prediction in May that it would have its credit problems resolved by November 2005 at the latest.
"When you're talking about a $2 billion institution, changing the credit culture is a sea change," said Ken Procter, the director of risk management at Brintech Inc. in New Smyrna Beach, Fla. "It's not like a sports car turning on a dime. It's like the Queen Mary turning left."
Financial Institutions declined an interview request, but in the earnings release chairman Peter G. Humphrey said the company "had been diligently working to repair loan quality issues."
Mr. Humphrey, who is also the president and chief executive, noted that the OCC report covers 2003, and the loan review firm, which it did not name, completed its study on June 30. The company has made substantial progress since then, he said.
The Dec. 28 disclosure was especially discouraging because prior to it, one of the two banks cited for poor underwriting, Wyoming County Bank in Warsaw, had seemed to be performing relatively well.
The second subsidiary, National Bank of Geneva, N.Y., as well as its Bath National Bank in Bath, N.Y., have been operating under written agreements with the OCC since September 2003. Financial Institutions' fourth bank subsidiary, First Tier Bank and Trust Co. of Salamanca, N.Y., appears to be in good health. For the first nine months of 2004 it reported earnings of $1.9 million, and its ratio of nonperforming loans to total loans was 0.77%.
News of the loan review firm and OCC reports sparked a selloff of Financial Institutions' stock, and the company's 2004 results did little to reverse the stock's direction.
Financial Institutions shares were trading at $22.49 late Friday, down 15% from Dec. 27.
The company earned $2.9 million in the fourth quarter. That was up 32% from a year earlier, but down 43% from the third quarter, when Financial Institutions was touting its "improved credit quality."
For the year Financial Institutions reported earnings of $16.2 million, up 14%.
The company has always done a good amount of agricultural lending. An extended run of low milk prices has caused widespread financial distress among upstate New York dairy farmers, and though much of Financial Institutions' credit quality problem is attributable to the dairy farmers' difficulties, commercial and commercial real estate loans make up the majority of its problem credits.
Robert R. Matheu, the president and founding partner of Bennington Partners LLC, a loan review firm in Southbury, Conn., said bankers frequently underestimate the time it takes to work through large amounts of bad loans. (His firm was not involved with the recent loan review.)
"I think a lot of times, people look at these things with blinders on," Mr. Matheu said. "There are no quick fixes."
Financial Institutions has taken several steps in the past two years to tighten internal controls. In February 2003 it replaced top management at National Bank of Geneva, its largest subsidiary. Later that year it gave its chief risk officer expanded powers and a bigger budget.
In June 2004 it centralized its credit administration functions in a new loan administration unit. It created a new position, chief of community banking, to oversee the unit and to provide consistency and oversight to the administration of commercial and commercial real estate loans.
Financial Institutions said it has also toughened its underwriting standards, and it said that explains last year's drops in loan originations and total loans.
Mr. Humphrey said in last month's earnings announcement that it would be "some time" before the impact of the changes begins to show up on the bottom line, but he added that he was "encouraged by our progress."
"We'll continue to implement higher credit standards, detailed inspections of loan records, and increased centralized credit administration," he said.
The move toward centralization is a departure from the philosophy Financial Institutions has operated by since its creation in 1931. For years the company prided itself on its super-community banking strategy. It gave its four subsidiary banks as much autonomy as possible, ensuring that banking decisions were made locally, not at the holding company level.
The decentralized model worked well while Financial Institutions stayed close to its roots in rural markets in upstate New York, but has worked less well since 2000, when the company began expanding into the more urban regions around Rochester and Buffalo.
From 1999 through 2003 its total assets increased 91%.
Brintech's Mr. Procter said Financial Institutions outgrew its traditional business model.
"You can't run a $2 billion institution as a collection of banks, with all the boards doing their own things and no central administration," he said. "The trick is to get standard controls in place."
Mr. Matheu said the wide disparity in the performance of Financial Institutions' subsidiaries, with one showing little or no deterioration and two others operating under written agreements, might be a sign that the holding company gave its banks too free a rein.
"That's not something we see very often," he said. "We tend to see more homogeneity with respect to loan quality."
