Financial Institutions : Annual Report - 2023

2023

Annual Report

Focused on what matters.

InvestmentFinancial Institutions, Inc. (NASDAQ: FISI)

Considerations

• Exceptional and results-driven community bank with strong retail and commercial franchises
• Experienced management team with extensive market knowledge and industry experience
• Disciplined credit culture with strong credit quality
• Wealth management business diversifies revenue and complements core banking franchise
• Complementary fintech and digital partnerships driving exceptional digital experiences
• Longstanding commitment to rewarding shareholders through meaningful dividend and yield

Focused on what matters.

During the course of our more than 200-year history, we have supported our customers and communities through many economic highs and lows. 2023 brought new and different challenges that created liquidity challenges for our country's banking system, while consumers and businesses alike navigated dramatic uncertainty and continued inflationary pressures. Despite these challenges, Financial Institutions, Inc. and its family of companies rose to the occasion. Our business lines came together to defend and grow deposits as we maintained our focus on credit disciplined loan growth. We supported our longtime customers and welcomed many new ones. Our 2023 performance was possible only through our strong focus on what matters - being there for our customers and communities, while maintaining an ongoing focus on capital, liquidity and earnings with the goal of delivering long-term value for our shareholders.

We know that the challenging operating environment will continue into 2024. With a strong community bank foundation that is centuries deep, an experienced and committed team working as one to advance our diverse and sophisticated business lines, and strategic vision guiding us, we are ready.

TABLE OF CONTENTS

Letter to Shareholders	Pages 2-7
Board of Directors and Executive Management	Page 8
Form 10-K	Begins after page 8
Executive and Senior Leadership	Appendix A
Investor Information	Inside back cover

1

To Our

Shareholders,

Customers,

Associates

& Partners,

2023 was a year marked by incredible pressures on the banking industry, as the continued high interest rate environment and the unprecedented failures of three of the largest U.S. banks created significant liquidity challenges for the entire financial ecosystem. Financial Institutions, Inc. seized those challenges as opportunities - to push ourselves, to demonstrate to our clients that we will be there for them in good times and bad, and to show new customers what makes us different. The results of our efforts - including solid deposit growth, new customer acquisition, and strengthened liquidity and stable capital positions - were hard earned and reflect our unwavering focus on what matters - serving our customers and communities at the highest level and delivering long-term value to our shareholders.

Heading into 2024, we knew that the challenging operating environment would continue and we were proactive in preparing. We took steps to enhance the earnings potential of our balance sheet and we reorganized key areas of our organization to enhance efficiency and better position us for future growth. Still, we could not have foreseen the challenges we faced during the first quarter of this year. As previously disclosed, in March 2024 we discovered fraudulent activity conducted by an in-market,deposit-only Five Star Bank business customer resulting in potential exposure to the Company of up to $18.9 million, or $14.1 million net of tax. We are actively working to pursue all legal recourse available to recover the funds and minimize the loss related to what we believe is an isolated occurrence. While this event will certainly impact our 2024 financial results, it does not impact the Bank's ability to maintain well-capitalized levels or access to liquidity sufficient to meet our current and projected funding needs.

Even as we navigate this matter, we remain focused on strategic action that enhances capital, liquidity and earnings. To that end, on April 1, 2024, we announced and closed the sale of the assets of the Company's wholly owned subsidiary SDN Insurance Agency, LLC ("SDN") to NFP Property & Casualty Services, Inc. ("NFP"). This transaction allows us to capture strong value premium in this business at an important time, meaningfully strengthens our capital position and supports our continued focus on driving earnings in our core banking business. The $27.0 million all cash transaction represents 4.0x 2023 insurance income and eliminates approximately $11.3 million of

2

goodwill and other intangible assets. In addition to achieving strong value for shareholders, the transaction also creates opportunities for Five Star Bank, its customers and SDN employees. We look forward to continuing to collaborate with the former SDN team, as the agency will remain the insurance partner of choice for Five Star Bank, ensuring our customers enjoy ongoing access to market-leading insurance services.

SOLID RESULTS AMID A CHALLENGING ENVIRONMENT

Net income for 2023 was $50.3 million, compared to $56.6 million in 2022. After preferred dividends, net income available to common shareholders was $48.8 million, or $3.15 per diluted share, compared to $55.1 million, or $3.56 per diluted share, in the prior year. 2023 revenues were pressured by the continued high interest rate environment and inverted yield curve that drove higher funding costs in comparison to 2022. As a result, net interest income was $165.7 million for 2023, down $1.7 million, or 1.0%, from the prior year, and full year net interest margin was 2.94%, compared to 3.20% for 2022.

Amid these external revenue pressures, we maintained focus on driving noninterest income, prudently managing expenses and actively managing our balance sheet. During the fourth quarter we repositioned a segment of our investment securities portfolio, selling approximately $54 million in lower- yielding available-for-sale agency mortgage-backed securities at an after- tax loss of $2.8 million and reinvesting the proceeds of such sale into higher yielding bonds. The after-tax interest income benefit of $1.4 million annually translates to an earn-back to shareholders equity of two years, with an improved earnings profile that supports both near-term and future accretion, which we believe was a prudent use of capital.

We also surrendered and redeployed $53.9 million in cash surrender value of company owned life insurance ("COLI"), which is expected to generate meaningful incremental annual revenue for future periods. Revenue generated by the surrender and redeploy drove the year-over-year increase in COLI income we reported for 2023 as compared to 2022 and was partially offset by associated income tax and modified endowment contract penalties. This action contributed to full year noninterest income of $48.2 million in 2023, which was up $2.0 million, or 4.3%, from the prior year. The increase in COLI income offset negative variances in service charges on deposits, as well as a pre-tax net loss on investment securities of $3.6 million due to the previously mentioned securities portfolio restructuring.

We limited noninterest expense growth to 6.1% in 2023 despite inflationary pressures and strategic investments in our business, reporting $137.2 million in noninterest expense for the year. The $7.9 million increase from the prior year was due in part to higher salaries and benefits expenses, higher computer and data processing expenses that are reflective of our strategic investments in data efficiency and marketing, and higher FDIC assessment expense, partially offset by a lower level of restructuring charges associated with the write-down of real estate associated with our 2020 branch consolidation.

RETENTION AND GROWTH OF DEPOSITS

Following two bank failures in March 2023, competition for deposits became even more fierce in our Western and Central New York markets. Our team came together to drive total deposits to $5.21 billion, with our 5.8% growth led by nonpublic deposits. Our consumer, Banking-as-a-Service ("BaaS"), and commercial lines of business, supported by cross-sell activity from our insurance and wealth management subsidiaries, all contributed to these results, which we consider to be very successful amid intense competition, driving new customer acquisition.

5.8%

2023 Total

Deposit

Growth

10.2%

2023 Total

Loan

Growth

3

On the consumer side in particular, our success was driven in part by a money market account campaign that ran from late July through November. In total, we welcomed more than 1,000 new retail customers, who were primarily based in the New York metros of Buffalo and Rochester. New customers brought in more than $100 million to Five Star Bank in addition to deposits brought in by our longstanding customer base.

Our commercial team supported our nonpublic deposit gathering efforts by focusing on full banking relationships and our partnerships with select, high-quality financial technology firms which contributed approximately $127 million of deposits as of year-end 2023. We view BaaS deposits as an attractive alternative to wholesale funding and have maintained a highly selective approach to selecting and engaging with partners, prioritizing those who share our core values and conservative risk culture, possess sustainable business models, and are well-funded.

In addition to the aforementioned deposit streams, Five Star Bank supports communities throughout Upstate New York by offering deposit products to municipalities, providing us a seasonal, lower-cost funding source. At year- end, our 320 municipal customers held $1.02 billion in public deposits with us, representing 20% of total deposits.

Our reputation as a trusted financial partner and our strong position in the markets we serve was underscored by the latest FDIC Summary of Deposits data. Based on June 30, 2023 deposit balances, we ranked in the top three in 10 of the 14 Upstate New York counties where we reported deposits. In addition, we are among the top 10 financial institutions serving Erie and Monroe counties, home to Buffalo and Rochester, respectively. Growth in these cities continues to be an important element of our growth strategy.

EARNINGS GENERATION AND MEANINGFUL DIVIDEND

$80

$70

$60

$50

$40

$30

$20

$ in millions except per share data

• Net income available to common shareholders
• Diluted earnings per common share
• Cash dividends declared per common share

			$2.00	$1.90	$2.10	$2.13
			$1.75
$1.61		$1.60
$1.49

$4.78

$2.96$3.56

$2.39

$2.30

$3.15

$6.00

$5.00

$4.00

$3.00

$2.00

$10

$0.99					$0.74	$0.77	$0.80	$0.81	$0.85
				$0.57
$0.40		$0.40	$0.47
$10.7		$17.6	$19.6	$22.0	$24.1	$27.9	$26.9	$30.5	$32.1

2009 2010 2011 2012 2013 2014 2015 2016 2017

$0.96 $1.00 $1.04 $1.08 $1.16 $1.20

$38.1 $47.4 $36.9 $76.2 $55.1 $48.8

2018 2019 2020 2021 2022 2023

$1.00

4

COMMERCIAL LENDING STRENGTH

Five Star Bank's commercial lending franchise has been an important driver of our loan growth in recent years. Commercial loans increased at a five year compound annual growth rate ("CAGR") of 11.5% through December 31, 2023 to $2.74 billion, making up approximately 61% of total loans. Our approach is grounded in our community bank roots, with local leadership and local decision-making that customers in our markets greatly value. In 2023, total commercial loans grew $396.9 million, or 16.9%, with growth concentrated in the first half of the year. This was a driving force in the 10.2% total loan growth we reported for 2023 that pushed year-end total loans to $4.46 billion.

Following our expansion to the Mid-Atlantic region in 2022, which has proven very successful, we announced a new commercial loan production office ("LPO") in January 2023 in Syracuse, NY. This logical extension of our geographic reach supports our focus on driving credit-disciplined loan growth and growing nonpublic deposits by delivering our style of community banking to businesses throughout Central New York. Notably, Syracuse is among several communities within our footprint that are well-positioned for technology-fueled growth in the coming years, having been formally designated as tech hubs by the U.S. Department of Commerce Economic Development Administration. Syracuse, Buffalo and Rochester were jointly recognized for their combined focus on semiconductor manufacturing, while the Southern Tier region of New York and Baltimore, MD were recognized for end-to-end battery development and predictive healthcare technology, respectively. With branches and LPOs in and around these cities, we are enthused by the economic growth potential we see and well-positioned to support that growth, our customers and our communities.

29

Year

Dividend

History

CREDIT DISCIPLINED LOAN GROWTH

$5.00			For the year ended December 31
			$ in billions
$4.00			■ Average loans
		■ Net charge-offs/average loans
$3.00
$2.00				0.54%
	0.47%
$1.00	0.36%		0.36%		0.40%		0.37%		0.40%		0.26%		0.38%		0.33%		0.37%		0.40%
																											0.16%				0.20%
																													0.14%
			$1.21		$1.30		$1.39		$1.59		$1.75		$1.88		$1.99		$2.21		$2.52		$2.90		$3.14		$3.44		$3.65		$3.81		$4.32
			2009		2010		2011		2012		2013		2014		2015		2016		2017		2018		2019		2020		2021		2022		2023

2.00%

1.50%

1.00%

0.50%

5

"Our team remains focused on liquidity, capital and earnings to drive long-term value to our shareholders."

$1.40 $1.01

$0.71

$2.09

DEPOSITS

$5.21 billion at 12/31/23 $ in billions

• Noninterest-bearingdemand
• Interest-bearingdemand
• Savings & money market
• Time deposits

FUNDAMENTALLY STRONG ASSET QUALITY

As of December 31, 2023, we reported non-performing loans to total loans of 0.60%, non-performing assets to total assets of 0.44% and annual net charge-offs ("NCOs") to average loans of 0.20%. Our recent and historic asset quality metrics reflect our strong fundamental underwriting processes and experienced credit professionals working in separate credit delivery and relationship-based functions.

Since the start of 2008, our nonperforming loans have ranged from 0.17% to 0.90% of total loans every quarter. Considering that the median publicly- traded $5-to-$10-billion-asset bank in the U.S. reported between 0.36% and 2.66% over the same time period, we consider our performance here to be exceptional. 1

Our commercial portfolio remains very strong and at year-end, our commercial NCO ratio stood at zero basis points. Amid the current operating environment, we remain in close contact with our customers and regularly conduct internal stress testing, giving us confidence in the health of our overall portfolio and specific segments like multi-family and office. Our experienced, in-market lenders have excellent relationships with high-quality sponsors within our footprint that have demonstrated consistency in execution and credit performance.

Consumer indirect auto remains a core competency at Five Star and annual NCOs to average loans of 0.76% in 2023 remained within our historical norms for this asset class. This annual ratio has ranged between 0.45% to 0.87% basis points since 2008, apart from the exceptionally low 0.14% we reported in 2021. What we've experienced since then is a return to normalcy and we do expect delinquencies in this asset class to remain somewhat elevated through at least the first half of 2024. Indirect balances declined $74.8 million, or 7.3%, during 2023 to $948.8 million at year-end.

We believe we are well-reserved from a credit standpoint, and at December 31, 2023, reported an allowance for credit losses on loans to total loans of 1.14%, up two basis points from one year prior.

SOPHISTICATED WEALTH MANAGEMENT CAPABILITIES

In May 2023, we merged our wealth management subsidiaries, thereby enhancing the size and scale of Courier Capital. We also announced a leadership succession in October, appointing an experienced executive with more than two decades of private banking experience with several large U.S. banks to the role of President. These actions support Courier Capital's growth and enhance its ability to retain and attract clients across our full footprint.

As part of the merger of HNP Capital into Courier Capital, we did make the strategic decision to focus Courier Capital's wealth management services on mass affluent and high-net-worth individuals and families. In the near-term this impacted transaction-related fees, and contributed to a $538 thousand, or 4.7%, decline in investment advisory income in 2023 relative to the prior year, but we believe will support enhanced profitability moving forward.

In addition to individuals and families, our wealth management subsidiary serves sophisticated nonprofit and institutional clients and 401K plan sponsors. With $2.88 billion in assets under management as of December 31, 2023, Courier Capital is one of the largest registered investment advisory firms in Western New York and well-positioned for growth moving forward.

1	Based on data from S&P Capital IQ Pro for publicly-traded banks with between
6	$5B and $10B in total assets as of year-end 2023, downloaded on March 28, 2024.

STRATEGIC REALIGNMENT

In December 2023, we realigned key areas of our organization and made changes to our executive leadership team that strengthen our ability to execute our long-term strategy. We welcomed Reid Whiting and Blake Jones to our executive leadership team. Reid, who formerly served as our Director of Indirect and Fintech Lending Solutions, was named Chief Banking Officer. This newly created position leverages his proven track record of executing on operational efficiency and process improvement and aligns all consumer

$0.04

$0.95 $0.73

banking channels under his oversight, in addition to our BaaS line of business. Blake, who has served as our Chief Marketing Officer since July 2023, also joined the executive team and takes on additional responsibilities, ensuring that marketing, brand strategy and enterprise sales are aligned more closely with our long-term strategy and better positioned to support the success of our family of companies.

Additionally, the Company's operations, product, and technology areas moved under the executive leadership of CFO and Treasurer Jack Plants, leveraging

$0.73

LOANS

$2.01

his deep financial services and operational expertise. Chief Risk Officer Gary Pacos, who has more than 30 years of risk management experience, assumed executive oversight of all credit administration, while Chief Human Resources Officer Laurie Collins took on ownership of enterprise-wide training and incentive planning.

This realignment also reflects our efforts to simplify our organizational structure by reducing layers of management that no longer align with our long-term focus, along with our proactive steps to manage expenses amid the continued challenging economic environment. On the whole, these changes resulted in our Company entering 2024 as a more streamlined and nimble organization, and we are already seeing positive impacts within our workforce.

LIQUIDITY, CAPITAL AND EARNINGS

Heading into 2024, we had more than $1.3 billion in available liquidity, even without taking into consideration our access to brokered deposits, and approximately $1.1 billion in combined cash flow anticipated over the next twelve months from our loan and investment securities portfolios, which we expect to deploy into higher yielding earning assets.

I'm incredibly proud of how our associates came together amid unprecedented conditions to support our customers and communities and to bolster our liquidity and capital positions.

With good momentum from 2023 carrying us into this year, our team remains focused on liquidity, capital and earnings to drive long-term value to our shareholders. I thank you for your continued interest in Financial Institutions, Inc. and look forward to updating you on our progress.

Cordially,

MARTIN K. BIRMINGHAM

President and Chief Executive Officer

$4.46 billion at 12/31/23 $ in billions

• Commercial business
• Commercial mortgage
• Residential loans and lines
• Consumer indirect
• Other consumer

$38.3

$58.1

$68.9

$870.3

INVESTMENT SECURITIES

$1.04 billion at 12/31/23 $ in millions

• Agency mortgage-backed securities
• Municipal
• Agency debt
• Agency collateralized mortgage obligations

7

Financial Institutions, Inc. Board of Directors

SUSAN R. HOLLIDAY 3

Chair of the Board of Financial Institutions, Inc. and Five Star Bank CEO of Dumbwaiter Design, LLC

MARTIN K. BIRMINGHAM 1

President and Chief Executive Officer

of Financial Institutions, Inc. and

Five Star Bank

Five Star Bank Executive Management Committee

DONALD K. BOSWELL 5, 7

President and CEO,

Seven Film & Theater Productions

DAWN H. BURLEW 4, 6, 7

President, Watkins Glen International

ANDREW W. DORN JR. 3, 4, 6

Chairman of Coal Ash Recycling, LLC

ROBERT M. GLASER 2, 3

President of Glaser Consulting, LLC

SAMUEL M. GULLO 2, 4

Owner and Operator of Family Furniture

BRUCE W. HARTING 2, 6

Managing Director, Wedbush Securities

ROBERT N. LATELLA 3, 5, 7

Of Counsel at Barclay Damon, LLP

MAURICIO F. RIVEROS 7

Chief Operating Officer of Pike Companies LTD

KIM E. VANGELDER 5, 6, 7

Chief Information Officer of

Eastman Kodak Company

MARK A. ZUPAN, PHD 2, 6

President of Alfred University

8

MARTIN K. BIRMINGHAM 1

President and Chief

Executive Officer

SAMUEL J. BURRUANO JR. 1

Chief Legal Officer and

Corporate Secretary

LAURIE R. COLLINS

Chief Human Resources Officer

BLAKE G. JONES

Chief Marketing Officer

1Financial Institutions, Inc. Corporate Officer

2Audit Committee; Robert M. Glaser, Chair

1. Executive Committee; Susan R. Holliday, Chair
2. Management Development and Compensation Committee; Andrew W. Dorn Jr., Chair

GARY A. PACOS

Chief Risk Officer

W. JACK PLANTS II 1

Chief Financial Officer

and Treasurer

KEVIN B. QUINN

Chief Commercial

Banking Officer

REID A. WHITING

Chief Banking Officer

1. Nominating and Governance Committee; Donald K. Boswell, Chair
2. Risk Oversight Committee; Kim E. VanGelder, Chair
3. Technology and Data Committee; Dawn H. Burlew, Chair