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

Community Bank System, Inc. (NYSE:CBU) Q4 2023 Earnings Call Transcript January 23, 2024

Community Bank System, Inc. misses on earnings expectations. Reported EPS is $0.76 EPS, expectations were $0.84. CBU isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Community Bank System Fourth Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Dimitar Karaivanov, President and Chief Executive Officer of Community Bank Systems. Please go ahead, sir.

Dimitar Karaivanov: Good morning, everyone, and thank you for joining Community Bank Systems Q4 2023 earnings call. The fourth quarter was an unusually noisy one for us. The company achieved record revenues in the quarter with strong and balanced performance across all of our four businesses. In fact, when looking at the full year 2023, three of our four businesses, banking, employee benefit services and insurance services, had a record revenue performance. In addition, our balance sheet remains highly liquid and well capitalized. Our diversified business model and emphasis on below-average risk served us very well during a very volatile year. With that said, we also had a meaningful increase in expenses in 2023, which was particularly prominent this past quarter due to a number of elevated items.

While this increase was well above our expectations, it does not reflect the core earnings power of the company going forward. With this noisy quarter behind us, as we look forward into 2024, we’re optimistic about every one of our businesses. In our banking business, we continue to gain market share supported by more than $4 billion of available liquidity, low cost of funds, excellent credit quality and robust regulatory capital levels. The opportunity to serve clients across our footprint has never been better, and our teams and balance sheet are open for quality business. In our employee benefit services business, we have a strong pipeline of client onboardings and our reputation is quickly growing at the national level. We were recently named top 5 record keeper for all market sizes by the National Association of Plan Advisors.

In addition, current market values provide a tailwind into 2024 after two years of headwinds. Our insurance services business, which grew 18% in 2023, is well positioned to continue to benefit from hard insurance markets, organic initiatives and roll up M&A activities. We were recently ranked as a top 75 P&C agency in the country and one of the nation’s largest bank-owned insurance operations. Our wealth business also had a positive revenue year in 2023 and our assets under management are back to their previous peak levels from the end of 2021. That, plus the increased focus in investments in the business, position us well to regain momentum in 2024. Simply put, our focus for 2024 is to continue the revenue growth while moderating the cost pressures and achieving positive operating leverage.

We’re also hopeful for a more constructive M&A environment in 2024. I will now pass it on to Joe for more details on the quarter.

Joseph Sutaris: Thank you, Dimitar, and good morning, everyone. As Dimitar noted, the company’s earnings results were down in the fourth quarter due largely to certain elevated noninterest expenses. Fully diluted GAAP earnings per share were $0.71 in the quarter, down $0.26 from the prior year’s fourth quarter and $0.11 lower than the linked third quarter results. Fully diluted operating earnings per share, a non-GAAP measure, were $0.76 in the quarter, $0.20 per share lower than the prior year’s fourth quarter and $0.06 per share lower than the linked quarter results. During the fourth quarter, the company recorded $123.3 million in noninterest expenses. This included $2.2 million of acquisition-related contingent consideration expenses, a $1.2 million restructuring charge related to the company’s previously announced branch optimization strategy, a $1.5 million expense accrual related to the FDIC special assessment, $1 million of executive-related retirement expenses as well as elevated fraud losses.

On a full year basis, the company’s core operating expenses, which excludes acquisition-related expenses and restructuring charges were up 10.2%. This increase was not only driven by upward pressure on market wages and some of the previously mentioned charges, but are also reflective of the front foot investments the company made in his leadership team talent across all lines of business, data systems and risk management capabilities. The company’s management expects the full year 2024 core operating expenses will moderate back to mid-single-digit growth rate off a full year 2023 core operating expense base of approximately [$60 million] (ph). The company recorded $177 million of total revenues in the fourth quarter, establishing a new quarterly record for the company.

Comparatively, the company recorded total revenues of $175.9 million in the same quarter in the prior year and $175.4 million in the linked third quarter. The increase in total revenues over the prior year’s fourth quarter was driven by a $4.1 million or 6.4% increase in noninterest revenues, partially offset by a $3 million or 2.7% decrease in net interest income. As Dimitar noted, the revenues were up in all lines of businesses on a full year basis and management believes the company is well positioned to grow total revenues again in 2024. The company recorded net interest income of $109.2 million in the fourth quarter. This was up $1.4 million or 1.3% on a linked quarter basis but down $3 million or 2.7% from the fourth quarter of 2022. Pressure on funding costs have not fully abated, but increases in both the outstanding balances and the yield on the company’s loan portfolio largely offset the increase in funding costs between the periods.

The company’s total cost of funds in the fourth quarter of 2023 was 1.08% as compared to 88 basis points in the linked third quarter. The 20 basis point increase in funding costs in the quarter outpaced a 17 basis point increase in earning asset yields, resulting in a 3 basis point decrease in the company’s fully taxable net interest margin from 3.10% in the third quarter to 3.07% in the fourth quarter. On a full year basis, noninterest revenues, excluding investment securities losses and gain on debt extinguishment, increased $8.2 million or 3.2%. This result is reflective of the company’s diversified business model. Banking-related noninterest revenues decreased $1.9 million or 2.7% in 2023 due primarily to the company’s decision to eliminate non-sufficient and unavailable funds fees on personal accounts late in the fourth quarter of 2022, while total revenues in all three of the company’s non-banking businesses, employee benefit services, insurance services and wealth management services were up year-over-year.

Reflective of an increase in loans outstanding, a stable economic forecast and increase in delinquent and non-performing loans, the company recorded a provision for credit losses of $4.1 million during the fourth quarter. Comparatively, the company recorded a $2.8 million provision for credit loss in the fourth quarter of the prior year and $2.9 million in the linked third quarter. The effective tax rate for the fourth quarter of 2023 was 22.8%, up from 22% in the fourth quarter of 2022. On a full year basis, the effective tax rate was 21.6% in 2023 as compared to 21.7% in 2022. Ending loans increased $254.5 million or 2.7% during the quarter, and $895.2 million or 10.2% over the prior year. The increase in loans outstanding in the fourth quarter was primarily driven by increases in the business lending and consumer mortgage portfolios.

The increase in ending loans year-over-year was driven by organic loan growth in the company’s business lending portfolio totaling $438.7 million or 12% and growth in all four consumer loan portfolios totaling $456.5 million or 8.8%. The company’s ending total deposits were down $102.7 million or 0.8% from the end of the third quarter, driven by a net outflow of municipal deposits. On a full year basis, ending total deposits were down $84.2 million or 0.6%. The company’s cycle-to-date deposit beta is 17%, reflective of a high proportion of checking and savings accounts, which represents 68% of total deposits and the composition and stability of the customer base. During the fourth quarter, the company secured $100 million in term borrowings at the Federal Home Loan Bank of New York at a weighted average cost of 4.55% to fund continued loan growth.

Comparatively, during the fourth quarter, the weighted average rate on new loan originations was 7.57%. 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 of New York, and unpledged investment securities totaled $4.83 billion at the end of 2023. These sources of immediately available liquidity represent over 200% of the company’s estimated uninsured deposits, net of collateralizing intercompany deposits. The company’s loan-to-deposit ratio at the end of the third quarter was 75.1%, providing future opportunity to migrate lower-yielding investment security balances into higher-yielding loans.

At December 31, 2023, all the company’s and the bank’s regulatory capital ratio significantly exceeded well-capitalized standards. More specifically, the company’s Tier 1 leverage ratio was 9.37% at the end of 2023 which substantially exceed the regulatory well-capitalized standard of 5%. The company’s net tangible equity to net tangible assets ratio was 5.78% at the end of the year as compared to 4.81% at the end of the third quarter and 4.64% one year prior. During the fourth quarter, the company repurchased 107,161 shares of its common stock at an average price of approximately $41 per share, and 607,161 shares on a full year basis at an average price of approximately $49 per share. At December 31, 2023, company’s allowance for credit losses totaled $66.7 million, an increase from $64.9 million during the third quarter of 2023 and $61.1 million one year prior, but remained stable at 69 basis points of total loans outstanding.

During the fourth quarter of 2023, the company recorded net charge-offs of $2.3 million or 10 basis points of average loans annualized. The company’s full year 2023 net charge-off ratio was 6 basis points of average loans. At December 31, 2023, non-performing loans totaled $54.6 million or 56 basis points of total loans outstanding. This was up from $36.9 million or 39 basis points at the end of the third quarter and $33.4 million or 38 basis points one year prior. There were three additional business lending relationships that were transferred to non-accrual status in the fourth quarter, all of which are well secured with no specific loss content identified. Loans 30 to 89 days delinquent were 50 basis points of total loans outstanding at December 31, 2023, as compared to 51 basis points at both the end of the third quarter of ’23 and one year prior.

Overall, the company’s asset quality remains strong. We believe the company’s diversified revenue profile, strong liquidity, regulatory capital reserves, stable core deposit base, and historically strong asset quality, provide a solid foundation for future opportunities and growth. Looking forward, we are encouraged by the momentum in all of our businesses and prospects for continued organic growth. We believe funding cost pressures will abate in 2024, setting the table for expansion of net interest income, particularly in the last three quarters of the year. In addition, recent asset appreciation in both the stock and bond markets provide a tailwind for revenue growth in the employee benefit services and wealth management services businesses.

That concludes my prepared comments. Thank you. Now, I’ll turn it back to Chuck to open the line for questions.

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Q&A Session

Operator: [Operator Instructions] And at this time, we’ll take our first question from Mr. Alex Twerdahl with Piper Sandler. Please go ahead.

Alex Twerdahl: Hey, good morning, guys.

Dimitar Karaivanov: Good morning, Alex.

Joseph Sutaris: Good morning, Alex.

Alex Twerdahl: Hey, first, can you just give us a little bit more color on those three business lending relationships? What this collateral is behind them, what kind of loans they were, et cetera?

Joseph Sutaris: Yeah. It’s actually a little bit of a mixed bag, Alex, in terms of the individual credits. One of which is kind of a mixed use industrial/office property, was partially owner-occupied also, but generally classified as non-owner-occupied because that was the majority of the space. The borrower just ran into some cash flow issues actually outside of this particular property. And so, we ultimately moved the loan to non-accrual, and doing the evaluation on the asset, we believe we’re well secured, and we have not identified any specific loss content on that one. And then, we also had a couple of smaller ag credit — one ag credit — agricultural credit that was basically flipped to non-accrual status due to cash flow challenges. And the third was actually owner-occupied property, which the underlying businesses were just having their challenges. So nothing, call it, systemic or no common — real common threat between the three.

Alex Twerdahl: Okay. I was wondering if you can give us a little bit color — a little bit more color on the loan growth that you’ve been seeing over the last — really this quarter, but the last couple of quarters on the commercial side, just in terms of sort of the size alone they’ve been putting on, the geographies. And I’m also curious just with the pullback in rates, I think last quarter, you said that you’re putting loans on roughly 250 basis points above the five-year. If the spreads have kind of held as rates have come down or if they potentially widened out? And just any more color there would be very helpful.

Dimitar Karaivanov: Sure. So, Alex, everything that we do is basically footprint borrowers. The majority of our growth has really come from our expansion in some of the larger metro areas, which we’ve talked about previously. In fact, every one of our regions had a growth year in ’23. So, it’s been strong across the board. We’re active, engaged in the markets a lot more than we were historically. There is a very favorable competitive dynamic for us as well, where a lot of the other participants, frankly, don’t have the liquidity or the regulatory capacity to service clients. So, we came into this cycle with a highly liquid balance sheet and no concentrations of any sort with plenty of runway. So, we’ve taken advantage of that.

In terms of where we’re lending today in terms of rates, they’re very similar to the last quarter that we talked about. Our business lending is kind of in the low to mid-7%s. We don’t expect that to change much as again, we’re benefiting from a bit of better spread due to competitive dynamics. So, even if the rates are going to drift down a little bit, I think we’re going to hold the ground here on our side as much as we can.

Alex Twerdahl: Great. And so, it’s like $170 million on commercial loan growth, like would that be several loans, several larger loans, or is it much more granular than that?

Dimitar Karaivanov: It is very granular. We don’t — I cannot tell you the exact average and median. We can follow up on that. But our size of loans are very, very low for the size of institution that we run and our lending capacity limits. We don’t have too many loans that are anywhere close to even a third of our lending limit. So, there’s many loans behind those $170 million.

Alex Twerdahl: Great. And then just a final question, Dimitar, you said in your prepared remarks that you hope that 2024 would be a little bit more conducive for M&A. I’m just curious, in your mind, sort of what has to happen. And I guess, first off, if you’re talking about bank M&A or some of the other lines that you’re in? And then, if it’s really more rate driven and the rate mark driven or if it’s driven more by sort of the willingness of the seller?

Dimitar Karaivanov: Yeah. So, in terms of our M&A focus, Alex, it hasn’t changed. It is across all of our business lines. We generate a lot of capital, and our job as a management team is to deploy that capital for our investors. So, we’re focused on all of them. We’ve been doing certainly a little bit more roll-up type opportunities in the non-banking businesses kind of as a matter of course. We’re hopeful that there might be some larger opportunities on that side as well. But certainly, on the bank side, it’s been a couple of years of headwinds, I would say, from an M&A perspective in terms of kind of figuring out the values, the rates, the marks. So, we’re hopeful that this year, there’s going to be a little bit more clarity and stability in the market, which would allow folks to kind of really understand what’s on the balance sheet.

We’re hopeful that as we see more deals, they’re also going to move a little bit faster through the approval process as well. But banks are sold, not bought. And we need to have willing sellers as well. So, we just think that the past couple of years were pretty hard. So, hopefully, it should get better from a pretty low base in terms of opportunities.