Community Bank System, Inc. (NYSE:CBU) Q4 2022 Earnings Call Transcript

Community Bank System, Inc. (NYSE:CBU) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Welcome to the Community Bank System Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment in which the company operates. Such statements involve risk 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-K filed with the Securities and Exchange Commission. Please also note that this call is being recorded today. Today’s call presenters are Mark Tryniski, President and Chief Executive Officer; and Joseph Sutaris, Executive Vice President and Chief Financial Officer.

They will also be joined by Dimitar Karaivanov, Executive Vice President and Chief Operating Officer for the question-and-answer session. Gentlemen, you may begin the call.

Mark Tryniski: Thank you Joe. Good morning everyone and thank you for joining our year-end conference call. We hope everyone is well. Earnings for the quarter were very good, infact our best quarter ever ex-reserve releases last year. We reported record revenues, record PPNR and record GAAP EPS ex acquisition expenses. Loan growth was very strong across all our portfolio up 12% annualized over the third quarter and the deposit base remains sound with respect to retention and rate. Joe will comment further on the quarter, but it was a good one. Looking at the whole of 2022, we likewise had a record year not just financially but for our commercial mortgage and instalment lending businesses as well. Investments we made over the past 18 months particularly in our commercial and mortgage businesses have proven fruitful.

The commercial business grew organically 18% in 2022, the mortgage business was up 7% and the instalment grew at 28%. Our non-banking businesses also had significant organic growth but were negatively impacted by the market declines with the exception of OneGroup our insurance business whose revenues were up 17%. Our wealth business which is entirely levered to the market was only down 4% against the market that was down 19.5% and our Benefits business which is about half levered to the market actually grew 1%. So these businesses had a fabulous year, despite the market and at this point, are a coiled spring for the future. Looking ahead to the remainder of the year, we expect to execute well across all of our businesses, a significant focus will be on funding.

We have $800 million of overnight borrowings, which is not ideally where we want to be when we also have $5 billion in lower yielding securities. So we have some thoughts on dressing that going forward into 2023. And beyond some of which Joe will touch on further. We’ll continue to invest in digital and rationalize analog as we did this past year with a consolidation of 12 retail branches, bringing the total over the past three years to 15% of our total net worth. Excluding acquisitions, we have fewer FTEs than we did in 2021. We implemented new commercial and cash management platforms. Our operations teams are working to implement workflow automation that is expected to save up to 60,000 hours of manual effort. So we are focused across the company on technology solutions for our customers and for our operating efficiency.

Lastly, and most important, we have the best talent this company has ever had and so we’ll continue to get better and everything we do. Particularly as we also now have the products technology and service capacity to compete very effectively with the larger banks across our markets. This has created significant new organic market opportunity for us that we have not previously possessed. In summary, it was a great quarter. It was a great year. We’re exceptionally well positioned, and we look forward to 2023. Joe?

Joseph Sutaris: Thank you, Mark. And good morning everyone. As Mark noted, the company’s fourth quarter earnings results were solid with fully diluted GAAP earnings per share of $0.97 and fully diluted operating earnings per share of $0.96. GAAP earnings per share were up $0.17 or 21.3% over the fourth quarter of 2021, while operating earnings per share were up $0.15, or 18.5% over the same period. The improvement in operating results was largely driven by a significant improvement in the company’s net interest income and a decrease in weighted average shares outstanding between the periods offset in part by a small decrease in non-interest revenues and increases in operating expenses the provision for credit losses and income taxes.

On a full year basis, fully diluted GAAP earnings per share were down $0.02 per share or less than 1% while operating earnings per share were up $0.09, or 2.6% despite a $23.6 million, or $0.34 per share increase in the provision for credit losses, and a $15.4 million or $0.22 per share, decrease in PPP related revenues. Adjusted pretax pre-provision net revenue or adjusted PPNR per share, which excludes from net income the provision for credit losses acquisition related expenses, other non-operating revenues and expenses and income taxes was $1.29 in the fourth quarter of 2022 up $0.20 or 18.3% over the prior year’s fourth quarter. Adjusted PPNR per share was also up $0.04 or 3.2% over the linked third quarter result of $1.25. On a full year basis, adjusted pretax pre-provision and revenue was up $0.50 or 11.7% from $4.28 in 2021 to $4.78 in 2022.

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The Company recorded total revenues of $175.9 million in the fourth quarter of 2022. This was up $16.3 million or 10.2% over the prior years fourth quarter and established a new quarterly record for the company. Net interest income increased $16.5 million or 17.2% over the prior year’s fourth quarter due to market interest related tailwinds, strong loan growth and investment security purchases between the periods while non-interest revenues decreased $0.2 million or 0.4%. The company’s average interest earning assets increased $905.5 million or 6.5%, while the tax net interest margin increased 28 basis points from 2.74% in the fourth quarter of 2021 to 3.02% in the fourth quarter of 2022. Net interest income was also up $1.8 million, or 1.7% over the linked third quarter results while the tax equivalent net interest margin decreased one basis point.

Although interest expense was up $8.8 million over the prior year’s fourth quarter, the company’s average cost of funds was up just 24 basis points from nine basis points in the fourth quarter of 2021 to 33 basis points in the fourth quarter of 2022, given a 425 basis point cycle to date increase in the federal funds rate. This represents a total funding beta of 6%. Similarly, the company’s average cost of deposits for the quarter remain low at 18 basis points representing a cycle to date deposit date of 2%. The $0.2 million 0.4% decrease in non-interest revenues between the comparable annual quarters was driven by a $2.6 million or 5.6% decrease in the financial services, business revenues offset and in part by $2.4 million or 14.5% increase in banking management’s revenues.

Despite organic customer growth in 2022, Employee Benefits Services revenues were down $1.4 million or 4.5% due to a decrease in asset-based employee benefit trust and custodial fees. Wealth Management Insurance Services revenues were down $1.2 million or 7.5% due to primarily the challenging investment market conditions. The increase in banking non-interest revenues was driven by an increase in deposit service fees. The company recorded $2.8 million in the provision for credit losses in the fourth quarter reflective of strong loan growth and a weaker economic forecast. This compares to a $2.2 million provision for credit losses recorded in the fourth quarter of 2021. On a full year basis the company reported $14.8 million in the provision for credit losses reflective of $1.44 billion of loan growth in 2022, the Elmira Savings Bank acquisition and weaker economic forecasts.

By comparison, the company reported an $8.8 million net benefit in the provision for credit losses in 2021 due to an improving economic outlook as the country rebounded from the pandemic. The Company recorded $105.9 million in total operating expenses in the fourth quarter of 2022, compared to $100.9 million in total operating expenses in the prior year’s fourth quarter. The $4.9 million 4.9% increase in operating expenses was driven by increases in salaries, employee benefits, data processing, communication expenses, occupancy and equipment expenses and other expenses offset in part by lower acquisition related expenses. The $1 million 1.6% increase in salaries and employee benefits expenses driven by increases in merit related employee wages, acquisition related additions to staff and higher payroll taxes, offset in part by lower incentive compensation and employee benefit related expenses.

The $0.8 million 5.9% increase in data processing communication expenses with the company’s continued investment in customer facing and back office digital technologies between the comparable periods. Occupancy and equipment expense increased $0.9 million, or 8.9% due to inflationary pressures the Elmira Acquisition in the second quarter of 2022 offset in part by branch consolidation activities between the periods. Other expenses were up $3.4 million, or 31.7% due to the acquisitions and general increase in the level of business activities between the periods including business development, marketing expenses and travel related expenses. In comparison, the company reported $108.2 million of total operating expenses in the third quarter of 2022.

The $2.3 million 2.2% sequential decrease in quarterly operating expenses was largely attributable to a $2.1 million decrease in salaries and employee benefits. The effective tax rate for the fourth quarter of 2022 was 22%. The company’s average earnings and assets increased $905.5 million or 6.5% over the prior year, from $13.96 billion in the fourth quarter of 2021 to $14.87 billion in the fourth quarter of 2022. This included a $1.29 billion or 26.5% increase in the average book value of the investment securities and a $1.41 billion or 19.3% increase in average loans outstanding partially offset by $1.79 billion decrease in average cash equivalents. Average deposit balances were up $348.4 million, or 2.7% over the same period, which included $522.3 million of deposits acquired in the Elmira Acquisition.

On a linked-quarter basis, average earning assets increased $254.6 million or 1.7%, while average deposits decreased $154.4 million or 1.2%. Ending loans increased $265.8 million or 3.1% during the fourth quarter and $1.44 billion, or 19.5% over the prior 12-month period. Exclusive of $437 million of loans acquired in connection with the second quarter acquisition of Elmira, ending loans outstanding increased $998.7 million or 13.5% over the prior 12-month period. During the fourth quarter, the company originated almost $560 million of new loans at a weighted average rate of just under 6%. Comparatively the book yield on the company’s loan portfolio was 4.39% during the fourth quarter. Asset quality remains strong in the fourth quarter at December 31, 2022 non-performing loans were $33.4 million, or 0.38% of total loans outstanding.

This compares to $32.5 million, or 0.38% of total loans outstanding at the end of the linked quarter 2022 and $45.5 million, or 0.62% of total loans outstanding one year earlier. The decrease in non-performing loans as compared to the prior year’s fourth quarter was primarily due to the reclassification of certain pandemic impact that hotel loans from nonaccrual status back to accruing status. Loans 30 to 89 days delinquent were 0.51% of total loans outstanding at December 31, 2022, up from 33 basis points at the end of the third quarter of 2022 and 38 basis points one year earlier. The company recorded $3.3 million or 4 basis points annualized of net charge-offs during 2022. The company’s regulatory capital ratios remain strong in the fourth quarter, the company’s tier one leverage ratio was 8.79%, which significantly exceeded the well capitalized regulatory standard of 5%.

In addition, the company’s net tangible equity and net tangible assets ratio increased 56 basis points during the quarter from 4.08% at the end of the third quarter to 4.64% at the end of the fourth quarter. During the fourth quarter, the company reclassified certain U.S. Treasury securities with a book value of $1.42 billion and a market value of $1.08 billion from its available for sale investment securities portfolio to its held to maturity investment securities portfolio, while the reclassification has no economic earnings or regulatory impact, enables the company to be more to more effectively manage overall capital levels if interest rates rise above year-end levels in the coming quarters. The company continues to maintain a strong liquidity profile, the combination of the company’s cash and cash equivalents borrowing capacity at the Federal Reserve Bank, borrowing availability at the Federal Home Loan Bank and unpledged investment securities provided the company with approximately $4.9 billion of immediately available source of liquidity at the end of the fourth quarter.

The company’s loan to deposit ratio at the end of the fourth quarter was 67.7% providing future opportunity to migrate lower yield investment security balances into higher yield loans. During 2023 the company anticipates receiving over $600 million of investment security principal cash flows to support its funding needs. Looking forward, we are encouraged by the momentum in our business; the company generates strong organic loan growth over the prior six quarters. Asset quality remains solid. In addition, new business opportunities in the financial services businesses remain strong. In 2023 we remain focused on new loan generation managing the company’s funding strategies in a rapidly changing interest rate environment while continuing to pursue accretive low risk and strategically valuable merger and acquisition opportunities.

Thank you. Now I’ll turn it back to Joe to open the line for questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. And our first question here will come from Alex Twerdahl with Piper Sandler. Please go ahead.

Alex Twerdahl: Good morning, guys.

Mark Tryniski: Good morning Al.

Alex Twerdahl: First off, just wanted to ask about, what you guys are seeing, or maybe expect to see over the next couple of months with respect to deposits. I know the first quarter typically see some inflows from municipal deposits. I’m just curious if you’re expecting similar levels to what we saw last year. And kind of if you have any sort of line in sight line of sight, on to other expected deposit flows, so we can sort of manage expectations for that relative to borrowings along with etcetera.

Dimitar Karaivanov: Sure, Alex, it’s Dimitar. You’re right. Typically in the first quarter, we get some seasonal inflows in our deposit base. It’s usually a couple of 100 million bucks. With that said, I think we’re kind of in an unprecedented time on the funding side. And we started seeing that kind of late in the summer, early in the fourth quarter and it’s accelerated I think for everybody in the industry. When you’re Europe as the Federal Reserve with an infinite balance sheet who has decided to take out liquidity, we all got to take notice of that. So with that said, I think I’m not sure we’re going to be netting up in the first quarter we hope we will. But we’re putting in place our strategists to make sure that we are able to manage our funding. So as we sit here today, I would personally probably bet on, closer to flat and up in terms of our deposit base.

Alex Twerdahl: Okay, and then within the deposit base in the last tightening cycle, you guys did a spectacular job of keeping your cost of deposits lower, I’m just curious if there’s a change in customer mentality, just given how quickly rates have risen. And I think certainly many of us have, have noticed it, and they’re doing it in our personal accounts. I’m just curious if how we should think about the deposit costs and you sort of the customer behavior that you guys are seeing over the next couple of quarters?

Joseph Sutaris: Alex, this is Joe. I would just say that, when you look at our composition of our deposit base, about 75%, of our deposit base is in deposits that are not typically rate sensitive. That’s not to suggest that, some of that some of those funds could not be drawn out into higher yielding type assets. But, relative to the rest of the industry, I think that our, our deposit bases is, is very core, but there’s kind of a larger sort of picture here with respect to what Dimitar referenced on, on the Fed, and what’s happening to the money supply. But generally speaking, I think, we’ll outperform but yes, I would expect that our funding, beta will increase over the next couple of quarters. There’s always a bit of a delay between the Fed changes, and then ultimately changes in the funding costs for financial institutions, including us.

In some of the rate moves that the Fed made, we’re in, in in the fourth quarter. And, those fully haven’t been haven’t been fully baked into all of the financial institutions costs of funds. So I think there will be some increase in the funding beta over the over the coming quarters.

Alex Twerdahl: Got it? Sorry, go on.

Mark Tryniski: No, it’s Mark. The only thing I would add, just as it relates to funding overall, in the first quarter of the first half of the year, we’ll have $400 million or $500 million of the securities portfolio maturing at fairly low yields, which we will likely use to pay down our overnight borrowings with a probably 300 basis point delta on costs. So just so — that’s reasonably significant in the context of what the funding side of our balance sheet will look like, headed here over the next two quarters.