Community Bank System Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 31, 2023

There are 10 speakers on the call.

Operator

Welcome to the Community Bank Systems Second Quarter 2023 Earnings Conference Call. Please note that this presentation contains forward looking statements within the provisions of Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, the markets and economic environment in which the company operates. Such statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company's annual report and Form 10 ks filed with the Securities and Exchange Commission. Please note also that this call is being recorded today.

Operator

Today's call presenters are Mark Trnisky, President and Chief Executive Officer and Joseph Sitaris, Executive Vice President and Chief Financial Officer. The company. They will be joined by Dimitar Karayvanov, Executive Vice President and Chief Operating Officer for the question and answer session. The gentlemen, you may begin.

Speaker 1

Thank you, Alan. Good morning, everyone, and thank you all for joining our Q2 conference call. I'm not going to say much about our quarterly performance other than it was very good. Joe and Dimitar will comment in more detail. But I did want to acknowledge the announcement we made early last month regarding my retirement from the company effective this December 31, the Board, but I will remain on the Board through 2024 to support the transition.

Speaker 1

Most importantly, we're thrilled that Dimitar Karayvanov the company's Board of Directors will be appointed President and Chief Executive Officer of Community Bank System and Community Bank effective January 1, 2024. The company's Board of Directors. Succession is something we've been working on for many years as it's one of the most important responsibilities of the CEO and the Board of Directors. I've known Dimitar for at least 15 years, starting in his prior life as a financial advisor to the company. 2 years ago, he joined the company as Executive Vice President of Financial Services and Corporate Development, assuming responsibility for our benefits, insurance and wealth businesses.

Speaker 1

He made an immediate impact on those businesses and in 2022 was appointed Chief Operating Officer assuming further responsibility for the banking business. Our Board went through a deliberative and very thorough succession process beginning in early 2022 and culminating in last month's announcement. Dimitar is one of the most astute financial and strategic thinkers I have ever worked with and more importantly fully embodies our core values of integrity, teamwork, excellence and humility. We have right now the best leadership team across the company we have ever had. Combined with earnings and balance sheet strength, revenue diversity, tremendous funding and growth capabilities, I fully expect the next 15 years will be even better than the last 15.

Speaker 2

Dimitar? Thank you, Mark. It has been more than a privilege to work alongside Mark and the team, and I'm grateful for the trust and confidence that the Board has granted me. I've been involved with this company for 15 years, and I feel very strongly that we have the best team we have ever had and our ability to service clients, the company's financial statements. We are in the marketplace and provide growth opportunities for our colleagues and communities has never been better.

Speaker 2

The future of our company is bright, and I'm fortunate to be part of it. All of this is evident in our results for the Q2. The strength of our diversified business model delivered another quarter of above average returns the company's regulatory requirements, and we expect to continue to

Speaker 3

be in the range of $1,000,000 regardless of the noisy environment. Operating revenues

Speaker 2

remain close to all time highs. We grew the number of clients and accounts across the company, and our risk metrics remain very strong, allowing us to deliver this performance with below average risk. Looking forward, we're encouraged by the momentum across all of our businesses. The banking pipelines are healthy and our funding base is secure. The company's financial statements.

Speaker 2

The improvement in market values bodes well for our Benefits and Wealth businesses. And in our Insurance business, we're benefiting from organic growth, increased premiums and inorganic activities. Joe will now provide you with more details on the financials. Joe?

Speaker 3

Thank you, Dimitar, and good morning, everyone. The company's earnings results were solid in the 2nd quarter. Fully diluted GAAP earnings per share were $0.89 in the quarter, which of the quarter were up $0.16 over the prior year's Q2 and $0.78 better than the linked Q1 results. Fully diluted operating earnings per share 2019 as defined in the company's earnings press release were $0.91 in the quarter, up $0.06 per share from the prior year's Q2 and $0.05 per share higher than the linked the Q1 results. The $0.06 per share increase in operating earnings per share on a year over year basis was driven by an increase in operating revenues And a lower provision for credit losses offset in part by higher operating expenses and an increase in income taxes.

Speaker 3

The $0.05 per share increase operating earnings per share on a linked quarter basis was driven by a decrease in the provision for credit losses and lower operating expenses offset in part by a decrease in operating revenues. Q2 2023 adjusted pretaxpreprovisionnetrevenuepershare, a non GAAP measure as defined in the company's earnings press release, of $1.17 was up $0.04 per share as compared to the Q2 of 2022 and up $0.01 per share as compared to the linked Q1 results. The company's total revenues were up $8,000,000 or 4.8 percent over the prior year's Q2. This was driven by increases in both net interest income the non interest revenue between the periods. Net interest income was up $6,100,000 or 6%, driven by 29 basis points of margin expansion between the periods.

Speaker 3

Non interest revenues were up $1,900,000 or 2.9 percent due largely to an increase in insurance service the company's financial statements. Comparatively, operating revenues, which excludes realized and unrealized losses on investment securities and gain on debt the extinguishment were $1,300,000 or 0.7 percent lower than the linked Q1 results. The company recorded net interest income of 109 point $3,000,000 in the Q2 of 2023. This was down $1,700,000 or 1.6 percent on a linked quarter basis, driven by increases in the company's funding costs. The company's total cost of funds in the Q2 of 2023 was 67 basis points as compared to 44 basis points in the linked first quarter.

Speaker 3

The company's net interest margin from 3.20 percent in the Q1 and 3.18 percent in the Q2. For context, the nationwide median cost of funds for banks in the 2nd quarter was approximately 2% And the median net interest margin contraction was approximately 15 basis points. The year over year increase in non interest revenues was driven by a $2,100,000 or 21.3 percent increase in insurance services revenues and a slight increase in banking related non interest revenues, which was offset by slightly lower employee benefit services and wealth management services revenues. The increase in insurance services revenues was driven by Harder Insurance Markets as well as organic and acquired customer growth. Despite an organic despite organic customer growth in the employee benefit Services and Wealth Management Businesses, revenues were down due to asset based valuation factors.

Speaker 3

On a linked quarter basis, non interest revenues, excluding realized and unrealized losses on investment securities and gain on debt extinguishment increased $500,000 or 0.7%. Reflective of an increase in loans outstanding and the stable economic forecast, the company recorded a provision for credit losses of $800,000 during the 2nd quarter. Comparatively, the company recorded a $3,500,000 provision for credit losses in the linked Q1 of 2023 and $6,000,000 during the Q2 of 2022, which included $3,900,000 of acquisition related provision for credit losses in connection with the Almiras Savings Bank acquisition. The company recorded $113,000,000 in total operating expenses in the Q2 of 2023 compared to $110,400,000 of total operating expenses in the prior year the Q2. Excluding $1,000,000 of acquisition related contingent earn out expenses in the Q2 of 2023 and $4,400,000 of acquisition related expenses in the prior year Q2, core operating expenses increased $6,000,000 or 5.6 percent year over year.

Speaker 3

The increase in core operating expenses was driven by higher salaries and employee benefits, data processing, communication costs, business development and marketing and other expenses. In the company reported $114,000,000 of core operating expenses in the linked Q1 of 2023. The The effective tax rate for the Q2 of 2023 was 21.4%, down slightly from 21.6% in the Q2 of 2022. The company's total assets were $15,100,000,000 at June 30, 2023, representing a $379,800,000 or 2.5 percent decreased from 1 year prior and $147,900,000 or 1% decrease from the end of the Q1 of 2023. The book value of average interest earning assets decreased $264,000,000 or 1.9 percent during the quarter during the second quarter, driven by a $453,500,000 decrease in average book value of investment securities, partially offset by $188,800,000 increase in average loan balances.

Speaker 3

Ending loans increased $188,400,000 or 2.1 percent during the quarter and $1,030,000,000 or 12.6 percent over the prior year. The increase in loans outstanding in the 2nd quarter was driven by an $85,800,000 or 2.3 percent increase in the business lending portfolio on $102,700,000 2 percent increase in the company's consumer loan portfolios.

Speaker 4

Of the year. The increase in ending

Speaker 3

loans year over year was driven by organic loan growth in the company's business lending portfolio totaling $501,700,000 or 15.1 percent and growth in all 4 consumer loan portfolios totaling $524,400,000 or 10.9 percent. The company's ending total deposits were down $238,900,000 or 1.8 percent from the end of the first quarter. This was comprised of $144,200,000 or 1.6 percent decrease in interest bearing deposits and a $94,700,000 or 2.4 percent the decrease in non interest bearing deposits. On a customer segment basis, municipal deposits decreased $146,600,000 during the quarter, which tend to seasonally decline in the Q2, while business and consumer deposits decreased less than 1% or $92,300,000 in the quarter. On a year to date basis, ending total deposits were down $140,500,000 or 1.1 percent.

Speaker 3

The company's deposit base is well diversified across customer segments comprised of approximately 63% consumer balances, 26% business balances and 11% municipal balances and broadly dispersed with average consumer deposit account balance of $12,000 and average business deposit relationship of approximately $60,000 The company's cycle to date deposit beta is 10%, reflective of a high the portion of checking and savings accounts, which represent 72% of total deposits and the composition stability of the customer base. The company's non maturity deposit accounts is approximately 15 years and the company does not currently carry any brokered or wholesale deposits on its balance sheet. The cycle to date interest bearing deposits beta is 14% and the total funding beta is 12%. The company's liquidity position remains strong, readily available source of liquidity, including cash and cash equivalents, funding availability at the Federal Reserve Bank's discount window, unused borrowing capacity at the Federal Home Loan Bank and Unpledged Investment Securities totaled $4,270,000,000 at the end of the of the Q2, these sources of immediately available liquidity represent over 200% of the company's estimated uninsured deposits, net of collateralized and intercompany deposits. The company's loan to deposit ratio at the end of the Q1 was 71.2%, providing future opportunity to migrate lower yielding investment security balances into higher yielding loans.

Speaker 3

At June 30, 2023, all the company's and the bank's regulatory capital ratios significantly exceeded well capitalized the company's Tier 1 leverage ratio was 9.35% at the end of the second quarter, which substantially exceeded the regulatory well capitalized standard the 5%. The company's net tangible equity and net tangible assets ratio, a non GAAP measure as defined in the company's Q1 or second quarter earnings press release, the company was 5.34% at the end of the 2nd quarter as compared to 5.41% at the end of the first quarter and 5.40% 1 year prior. During of the company repurchased 200,000 shares of its common stock at an average price of approximately $48 per share pursuant to its Board approved 2023 stock repurchase program. At June 30, 2023, the company's allowance for credit losses totaled $63,300,000 or 69 basis points of total loans outstanding. This compares to $63,200,000 or 70 basis points of total loans outstanding at the end of the first quarter $55,500,000 or 68 basis points of total loans outstanding at June 30, 2022.

Speaker 3

During the Q2 In the Q2 of 2023, the company reported net charge offs of $700,000 or 3 basis points of average loans annualized. This compares to 2 basis points of annualized net charge offs in the same quarter last year and 7 basis points in Q1. At June 30, 2023, non performing loans totaled $33,300,000 or 36 basis points of total loans outstanding. This was down of 38 basis points at the end of the Q1 and 46 basis points 1 year prior. Loans 30 to 89 days delinquent were 47 basis points of total loans outstanding June 30, 2023, up from 35 basis points at the end of the Q1 and up from 29 basis points 1 year prior.

Speaker 3

The company's asset quality remains strong and stable in the quarter. We believe the company's strong liquidity profile, capital reserves, Stablecore deposits, AIS, historically strong asset quality and revenue profile provide a solid foundation for future opportunities and growth. Looking forward, we are encouraged by the momentum in our banking business and prospects for continued organic loan growth. Although we believe escalating funding costs will abate over the company's financial the commercial services businesses remain strong. Thank you.

Speaker 3

I will now turn it back to Alan to open the line for questions.

Operator

The

Speaker 4

the

Operator

company. Our first question comes from Nick Cucharale of the Hovde Group. Go ahead.

Speaker 5

Good morning, everyone. How are you today?

Speaker 6

Good morning, Nick. Good morning, Nick.

Operator

At the halfway point

Speaker 5

of the year, pretty solid loan growth. Are you starting to see others in your markets pulling back given liquidity concerns? And can you help us think about a full year growth rate?

Speaker 2

Sure. Nick, it's Himitar. You're spot on. We've benefited from a couple of things. One is our own capabilities, but the second is the competitive environment.

Speaker 2

And the reality is a lot of banks, predominantly smaller ones, have run out of liquidity. They don't have enough funding that they can extend to clients. So a number of folks are focused on only existing clients, a number of folks are just not lending. So we are seeing an opportunity to leverage our strength of the balance sheet to service our clients and to extend new relationships Full relationships in all of our markets. So in terms of growth rate, I think We had been communicating kind of mid- to high single digits range that still stays Probably a little bit closer to the higher end of that than the midpoint of the single digits.

Speaker 2

Just the momentum is strong and the pipeline actually increased quarter over quarter as we sit here today in all of our businesses.

Speaker 5

That's great color. And as it relates to expenses, I believe your previous guidance was for 5% to 9% growth for the full year 2023. Is that consistent with your thinking at this stage?

Speaker 3

Yes. I don't think any this is Joe, Nick. I don't think anything has changed with our around our expectations for operating expenses. I think we kind of Acknowledged that Q1 was up a bit, but we expected that to level off throughout the remaining three quarters. I think we're still on path Generally, they have a flattish outcome, if you will, for the remaining two quarters.

Speaker 3

And so on a full year run rate basis, still kind of that 5% to 9%, I think, is the reasonable expectation.

Speaker 5

Okay, great. And then lastly for me, I know it's price dependent, but the repurchase has been pretty consistent the past two quarters. And you recently increased the dividend for the 31st year in a row. Can you give us your thoughts on capital return and M and A and how you balance that with your organic initiatives at this stage?

Speaker 2

So, Nick, it's Dimitar again. We look at all of those those things. The dividend is part of our core value proposition and investment thesis, which is above average returns and below average risk. So we try to manage volatility across our businesses and control as much as we can the outcomes as it relates to revenue and earnings, which then allows us to pay that growing dividend. So it's a really important part of what we aim to achieve for our shareholders.

Speaker 2

I think on share repurchases, we've communicated that our goal is to at least offset the equity dilution from our annual grants. So I think right now, we're kind of on our way well on our way as it relates to that this year. The stock, we believe, continues to be attractive as we personally look at it and of from a company's perspective. So we probably have a little bit more to do there at these levels on the share repurchase side. And then on capital allocation in terms of M and A, we remain very opportunistic across all of our businesses.

Speaker 2

We deploy capital in the bank every day as we grow the balance sheet. So that's part of what we do in the bank. And then We're actively looking at M and A across all of our businesses. We do some small roll ups in our insurance business, our benefits business. We lift some practices and folks on our wealth side.

Speaker 2

So that will remain a main priority for us because we do generate a lot of capital and we need to put it to work for our investors.

Speaker 5

I appreciate the color. Thank you for taking my questions.

Operator

Our next question comes from Steve Moss of Raymond James. Go ahead.

Speaker 6

Good morning. Good

Speaker 7

morning, Steve. Maybe

Speaker 6

just on the margin here. Just curious, Joe, you mentioned that deposit costs it sounds like deposit costs are a little bit of a headwind. Curious as to where you're thinking deposit costs are headed over the next 2 quarters or so.

Speaker 3

Yes. So it's a very fair question, Steve. I mean, the Our experience is that even if the Fed pauses that there will be a continuation of higher deposit rates, just as We continue to see migration from low or non interest bearing deposits into higher rate certificates. And so we do continue to expect increases. I'm not sure I have an exact call with respect to how much deposit going to increase over the Q3, but they are they were trending higher in the second the quarter and we expect some of that to continue into the Q1.

Speaker 3

But with that said, if the Fed does pause over time, that pressure abates a bit. And I'll call it the pace at which monies move from low interest bearing to non interest bearing slows a bit. And call it the repricing of the non maturity deposits perhaps slows a bit as well. So we think those pressures will abate over time. But in the 3rd and potentially into the 4th quarter, we do see that to continue to be a headwind.

Speaker 3

So with respect to our margin NII expectations. We're kind of thinking more of a kind of flat to sideways outcome for at least the next quarter or 2 and then hopefully we can see some expansion in 2024 as some of those funding pressures just abate a bit.

Speaker 6

Okay. And then in terms of just curious on loan pricing here, What's the what were origination yields for the quarter and where did you guys see that shaking out here going forward?

Speaker 3

Yes. So on a blended basis, we booked new loans at about just under 7% for the quarter. And we so we're seeing pretty good rate improvement, if you will, on the book over time,

Speaker 2

Because the book yield is,

Speaker 3

I think, just sub-five. So we're picking up about 200 basis points on the repricing activity, plus volume has been increasing and if we do have kind of a mid single digit kind of growth outcome, that's going to help over time. So, We also have approximately $2,000,000,000 about 25% of our loan portfolio that are Repricable of which roughly $1,000,000,000 will reprice in the next 12 months or so. Some of those are kind of the There might be 10 year terms with a 5 year re pricing reset and some of that occurs in years out, but we have about $1,000,000,000 repricing in the next 12 months or so.

Speaker 6

Okay. That's helpful. And then maybe just on the employee benefit services business flattish year over year, but you guys have talked in the past on about the pipeline of new business coming in and I apologize if I missed it. Just curious as to the trends the underlying organic trends you're seeing there.

Speaker 2

Yes. Good Steve, the underlying trends remain very strong. As Joe said, some of that's been masked by the market. But I think as we're sitting here in July, I wouldn't be surprised if we have a record month in that business for us. And if the asset values stay where they are, which are still lower than the market peaks, we're already doing better than we were back in Q4 of 2021.

Speaker 2

So there are some things in that business that are also, I would call them sometimes more consulting based. So that impacted our revenues a little bit here in the 1st 6 months Compared to the last year, but we're down a little bit compared to 2022. Again, right now, we're in as good of position as we've been. My expectation is we're going to more than make it up by the end of 2023 should market value stay where they are.

Speaker 6

Great. Appreciate all the color. Nice quarter guys. Thank you. Thank you.

Operator

The next question comes from Alex Twerdahl of Piper Sandler. Go ahead.

Speaker 6

Hey, good morning guys.

Speaker 4

First off, just in terms of sort of balance sheet management, can you just remind us what you have coming due in terms of securities and whether that will be sufficient or if that's the mechanism that you plan to use to fund the loan growth. I think you kind of alluded to another $300,000,000 to $400,000,000 of loan growth this year based on your growth targets. I'm just wondering if the securities cash flows will be sufficient and sort of the outlook for funding.

Speaker 3

Yes. So in the Q3, Alex, this quarter, we have about another 100 and the balance of maturities that's going to certainly help for the funding at least for the balance of 2023. And then as we get into 2024, we do have a little bit of a slower cash flow coming off the securities portfolio, less than about $100,000,000 in 2024. But we do have some plans basically continue to grow and with the higher loan yields, we can continue to bridge To cash flows a little further out just through some probably some wholesale borrowings given where rates are, it's still fairly attractive to do that. Can you

Speaker 4

say the number from the Q3? It just broke up a little bit. I'm not sure if that was just my line or everyone's line.

Speaker 3

Yes. So the Q3 is about $150,000,000 Alex.

Speaker 2

The maturities.

Speaker 4

And anything in the Q4?

Speaker 3

It's fairly nominal in the Q4. I don't have a precise number, but it's fairly nominal. Most of it's the 3rd.

Speaker 4

And with the expectation in terms of other deposit flows that the $146,000,000 $147,000,000 of municipal deposits that went

Speaker 3

It's somewhat seasonal, the 2nd quarter being below point for municipal deposits and then in New York State in particular, tax collection occurs in the Q3 and in the Q1. So we tend to see a little bit of a rebound, if you will, in municipal deposits. And for that matter also, on the municipal repurchase agreements, particularly in our Vermont market, our New England market. They bounced back a little bit in the Q3 as well. So we do have some expectations that municipal funding is going to roll back in

Speaker 1

the door, if you will,

Speaker 3

in the Q3.

Speaker 4

Okay. Do you happen to have the just the sort of exit Net interest margin from the quarter and exit cost of funds.

Speaker 3

Yes. It was relatively flat, I'll say May to June from an NII perspective. So cost of funds, we kind of exited the quarter at about 90 basis points, if memory serves here. I'm sorry, I'm off, about 80 basis points total cost of funds exiting at the end of the quarter.

Speaker 2

Okay. And Alex, the margin in June was consistent with the 2nd quarter number.

Speaker 4

Okay. Yes, it's pretty flat across the quarter. I wasn't sure if there's anything funky in there from the deleveraging transaction you guys did back in the Q1 that would make the numbers not seem as straightforward as they look. And then just the final question I had is on fees. I know last quarter you guys mentioned some adjustments to NSF fees and I think you guided to like a $8,000,000 hit across the year on NSF and then it just doesn't look like we saw that show up in the deposit service charges the fees this quarter.

Speaker 4

It looks like that I mean that Q2 looks stronger than the Q2 a year ago and much stronger than the Q1. So I'm just curious if there's something in there that we should be thinking about or if there's any change to that full year guidance for the hit to deposit service charges from that?

Speaker 3

We also had a little higher debit interchange outcome for the Q2. So that sort of Offset some of the reduction for the NSF changes.

Speaker 4

Okay. So the full year guide of the $6,000,000 to 8 $1,000,000 head is still intact.

Speaker 3

Yes, I think that's still fair, Alex.

Speaker 4

Perfect. Thank you for taking my questions. Welcome.

Operator

Our next question comes from Manuel Neves of D. A. Davidson. Go ahead.

Speaker 8

Hey, good morning. A lot of my questions have been answered, but I just was wondering about the loan outlook, we're thinking about the mix. Consumer was pretty strong and just trying to see what are the trends there.

Speaker 2

Yes. So good morning, Manuel. The you're right, the consumer, we did reasonably well this quarter. The pipelines remain very robust on the mortgage side. We hinted at it last quarter as well, but we've gained even more momentum On the mortgage side, so I think we're going to have a pretty robust quarter here in Q3.

Speaker 2

And going into Q4, that's usually when we book the most On the mortgage side anyways, but the pipelines are actually stronger than they were a year ago. And as you can imagine, it's 85% purchase money. So all of that is additive to the balance sheet. So it's going to result in a bit of a higher number than usual in terms of net growth. As it relates to the auto business or car business, that also is in pretty good shape.

Speaker 2

We benefited from some of the same things that we talked a little bit earlier on the call, which is competitors exiting certain markets on a wholesale basis. And when you do that, you kind of create an opening in the segments that we play in. Because as you know, we don't play everywhere, but we in the segments that we play in our part of the market. So that's created some opportunities for us. So that business remains in good shape.

Speaker 2

It is hard to predict as we've said before. We're trying to manage risk And return there on active basis, through rate and the segments we focus on. So we expect that to be in line with the Q2 frankly, as we sit here today.

Speaker 6

Actually, what new yields are you getting on auto loans

Speaker 9

on your paper?

Speaker 2

On a net basis, we're in the high sixes 10% kind of 7% range on a net basis to us.

Speaker 7

That's great. I appreciate the update.

Speaker 6

Thank you.

Operator

Our next question comes from Matthew Breese of Stephens. Go ahead.

Speaker 9

Good morning.

Speaker 6

Good morning, Matt. I think

Speaker 9

the credit metrics largely speak for themselves. With that in mind, I'd be curious your thoughts around the provisioning outlook and then on the overall reserve level, it's fairly flat year over year. Just curious if the bias is to remain flat or even down just considering the credit performance?

Speaker 3

Yes, Matt, this is Joe. The Expectations right now are flat. I mean, we have not seen, fortunately any sort of turns in credit. In fact, when you look at kind of our risk ratings on a year over year basis. We've seen some improvement, which is good.

Speaker 3

Net charge offs are Still fairly low. I think things are normalizing a little bit in the indirect business, but our indirect net charge offs of 10 net average about 30 basis the right now. And so given that our expectations are kind of about the same until we see some changes. Okay. And then, look,

Speaker 9

I think your stance on tangible common equity as a capital ratio and impacts from AOCI are pretty well known at this point. But I would be curious, 1, as it stands today, what the duration of the securities portfolio is? And then 2, Just given continued impacts, should we expect you to remain patient in terms of ultimate recapture? Or are you considering additional kind of balance sheet restructuring opportunities out there to maybe, to lessen things here, the impact.

Speaker 2

Yes. Hey, Matt, it's Dimitar. I mean, we're not going to surprise you here. There's no change in how we look at our business. And We also have to desegregate the bank from the aggregate business.

Speaker 2

And keep in mind, the balance sheet only shows 1 of our 4 businesses. So we've got a tremendous amount of value if you want to talk about value and economic value to our shareholders that is not captured on the balance sheet. So If you were to think about that, frankly, the and apply back to the balance sheet that the numbers are very strong And those businesses provide tremendous amount of capital every year to the rest of the company. So we're focused on regulatory ratios. We don't believe because a third of our revenue more than a third of our revenue is coming from non balance sheet activities.

Speaker 2

We don't believe that the balance sheet itself fully reflects the economic value of the company. Our regulatory ratios remain very strong. They continue to increase. The transaction we did earlier this year was really focused on allowing us to monitor as economically net value positive for our shareholders because we got our money back a year sooner than we would have gotten it otherwise. And secondly, allowed us the flexibility to now Service More clients when other people are pulling back.

Speaker 2

So we don't feel like we need to do anything similar for the next couple of quarters at the very least. So capital is accruing at a very robust pace. We have not been able To deploy it through M and A, so it just keeps accruing to our company.

Speaker 3

Great. I appreciate that. One last one before I sign off. First, Dimitar, congrats on

Speaker 9

the promotion. Mark, congratulations on retirement. I think the stock and the bank balance sheet speaks for itself in terms of legacy. Dimitar, the company. As you kind of commence your CEO role here in the not too distant future, where do you think you and Mark differ in terms of strategy or bank management, fee income business management.

Speaker 9

I'd be curious if there's any sort of notable differences in terms of philosophy both around the day to day organic businesses and how you run them and then inorganic in terms of how you think about M and A and acquisitions?

Speaker 2

Yes, Matt, that's a fair question. I there is a reason why I feel like I've been of this company for a long time because we all of us here tend to think very similarly and evaluate things in a similar light. So You're not going to see much in the way of change for us. Our shareholder thesis remains what it's always been, which is we need to provide that consistency of results and cash flows back to our shareholders. What that means is having a diversified business model, which includes all of our businesses, and we need to invest as much as we can in all of them.

Speaker 2

We need to stay vigilant for other opportunities to add to those verticals, be it tangential to them or a new vertical potentially. Again, in the spirit of having a diversified company that functions regardless of the rate environment or the market environment or the insurance market. So I think we're going to have an increased focus on that diversification, an increased focus on managing the low volatility and risk across our businesses. So it's really an evolution. I think one of the differences that we have today than we did Historically, and that's kudos to Mark and the team.

Speaker 2

We're much better at organic growth. So we're going to continue to leaning into that. We're going to continue to look at new markets and new opportunities to expand organically. We allocate capital in multiple ways. One of it is through the P and L, investments in people and new businesses through the P and L, which we're doing daily.

Speaker 2

And then as we have opportunities to deploy that excess capital that we generate into transactions. We're going to continue looking at that as we've communicated really more strategically focused and tactically focused

Speaker 9

Appreciate all that very much. Thank you for taking my questions.

Speaker 6

Thank you.

Operator

Our next question comes from Chris O'Connell of KBW. Go ahead.

Speaker 7

Good morning. And yes, congratulations to you Mark on your retirement And Dimitar and the promotion. I was hoping to circle back to some of the margin discussion. I mean, it sounds like You guys have been doing a really good job of keeping the margin kind of held up where it is here this past quarter and year to date as well as it seems like the spot margin into June. I mean, given that there's still some funding pressure coming in the back half of the year.

Speaker 7

I mean, do you expect the margin to remain under pressure into the back half of the year? Or do you think you can keep it held up more or less around the current levels?

Speaker 3

Yes. I think, Chris, our best expectation at this point is kind of, I'll say, the quarter. Flat to, call it sideways for a couple of quarters, which I think is potentially going to outperform the rest of the market just because of our the strength and resilience of our funding base. If those pressures do abate, which the Fed pauses and they do abate, Turning over the loan portfolio at a pretty healthy cliff with basically a 200 basis point pickup on the turnover. So the hope and expectation is that NII, net interest income will hopefully improve as we look into 2024 the year.

Speaker 3

There's fluctuations, but based on where we are today, the expectation is that we would go effectively sideways, maybe down a few basis points the NIM, maybe a couple of basis points in next couple of quarters, but generally sideways.

Speaker 7

Got it. Do you think that there's more risk of compression in the Q4 versus the Q3 given the lack of securities roll off?

Speaker 3

We typically have some funding roll in, as I mentioned, in the 3rd and 4th quarters the municipal side, and that should hopefully allow for a reduction in some of the more expensive overnight borrowings. Again, we're still kind of signaling flat, but I don't see further erosion in Q4 versus Q3.

Speaker 7

Got it. And what's the average or blended cost of like the municipal deposit book versus the rest of the portfolio?

Speaker 3

So fair question, Chris. But to be perfectly frank, I need to Look it up, but it's let's see. I'm not sure I've got that. I'm not sure I have the breakout in front of me, Chris, but it certainly is much more it's slightly more than that of the IPC deposits and Certainly less than overnight borrowings.

Speaker 7

And just on the M and A outlook, I mean, I know you guys are actively looking at the fee businesses and for potential adds there. On the traditional bank M and A side. Are you seeing opportunities? Are you actively the seriously pursuing opportunities at this time, just given kind of the overall slowdown in the traditional bank M and A environment. And have you seen any pickup in that those type of opportunities from the call it like early March the in kind of the disruption that happened in March April.

Speaker 2

Chris, I think on the bank side, there is a little bit of a slight uptick, I would call it, in the sense of sellers being more willing to engage in discussions. I think the challenges there remain Similar to what they've been for the past couple of quarters, which is, you've got a lot of unknowns as to what the balance sheet looks like, what the margin looks like. I think the cycle is showcasing that some balance sheets can change quite drastically in the in the matter of a couple of quarters, and when earnings are going down for some folks 25%, 30% In a short period of time, that's pretty hard to price in terms of what is the value of that earnings stream to us, given that we're focused on consistency 1st and foremost in our results. So I think that's one challenge. I think the second challenge is For a lot of folks, there's not a lot of capital left once you mark the balance sheet.

Speaker 2

So we have to essentially pay for the deal twice. So some of those challenges are pretty hard to stomach, the company's operations, especially depending on the size of the opportunity. As Joe Pointed out to a number of us very wisely. It's also hard to figure out in today's environment when you announce a transaction on the bank deal, what does that do to the deposit base given that it's like sounding the starting signal For all the competitors and high rate customers to start looking around yet again. So I think that's kind of hard to put your arms around.

Speaker 2

And then the last piece is, the uncertainty as to the timing of closure of transactions these days. Clearly, there is a higher hurdle in terms of unknowns that come with the transaction the regulatory bodies. So that creates another challenge in terms of you don't know when you're going to close a transaction. And that puts pressure on retaining clients, retaining people, having to pay a lot more for customers. So that's another unknown that's really kind of creating that unfavorable risk and reward right now.

Speaker 2

With that said, we continue to look On the flip side, we know now some franchises that their balance sheets are holding up better than expected and better than others. So that's something that we're going to remember for a long time. And when the opportunity comes, we will be active and hopefully in a better environment.

Speaker 7

Great. Thanks for your time. Appreciate taking my questions.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Mr. Cherninski for any closing remarks.

Speaker 1

Thank you all for joining again our conference call and I guess I will see you one last time here in October and hope you all have a great rest of the summer. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now

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Earnings Conference Call
Community Bank System Q2 2023
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