KBRA Affirms Ratings for Financial Institutions, Inc. and Revises Outlook to Negative

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Financial Institutions, Inc. (NASDAQ: FISI) (“the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its bank subsidiary, Five Star Bank. The Outlook for all long-term ratings is revised to Negative from Stable.

Key Credit Considerations

The change to Negative Outlook considers the uncertainty around the bank’s ability to sustain peer like earnings in 2024 as well as rebuild the weakened capital position, hampered by the associated loss stemming from transactions occurring in 1Q24 as disclosed in an SEC Form 8-K filing on March 11, 2024 (estimated ~25 bps of risk-based capital or ~30% of annual estimated earnings). However, the ratings are supported by FISI’s solid management team with extensive market knowledge, who believes this was an isolated event. Management has been instrumental in executing the company’s shift in strategy in recent years which includes a clear commitment to rebuilding the capital positioning in 2024. Directionality consistent with the industry, profitability has come under pressure largely due to NIM compression, with the corresponding ratio declining to 2.80% in 4Q23. However, management believes that NIM has largely reached a trough as deposit pricing has largely slowed. Going forward, balance sheet growth is expected to moderate throughout 2024. Nearly ~15% of FISI's asset base will reprice within the year, potentially supporting NIM growth. FISI’s asset quality metrics remained somewhat consistent in 2023 though included a slight uptick in the NPA level, which is primarily attributable to a single customer. NCOs remained minimal and well contained at 20 bps for 2023. However, FISI reported slight increases in criticized loans as net migration appeared to hold strong throughout the higher interest rate environment. Notwithstanding the higher levels of indirect auto loans and CRE exposure, FISI’s overall credit risk profile appears to be in line with many similarly rated and regional peers. The company’s loan volume persisted in 2023 which was largely funded by higher cost money market accounts which resulted in an ROAA of ~80 bps, weaker than prior periods yet consistent with many regional peers. Noninterest income generation has averaged ~20% of total revenue since 2018. Additionally, the company has focused on rationalizing its organizational structure and has reduced layers of management in keeping with the bank’s longer term strategic focus, which resulted in workforce reduction of ~25 FTE or 3% of the workforce during 4Q23. FISI’s ratings also reflect the company’s diversified commercial loan portfolio, which includes comparatively lower levels of exposure and delinquency, most notably office (~8% of total loans), retail (4%), and hospitality (~4%). The company’s capital position is weaker than the rated peer group. KBRA expects capital to be managed prudently and trend closer to the rated peer group over the shorter term. KBRA expects FISI to reach a minimum CET1 ratio of 10% by YE24.

Rating Sensitivities

A rating upgrade is not currently anticipated over the medium term. Deteriorating profitability metrics as defined by ROAA as a result of continued NIM compression impacted by increased levels higher cost deposits and borrowings, weakened credit quality metrics, or the continued maintenance of weaker than peer capital could result in rating pressure.

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