Community Bank System, Inc.
Q4 2020 Earnings Call Transcript

Published: 25 Jan 2021

[Operator:]

Welcome to the Community Bank System Fourth Quarter 2020 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 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-K filed with the Securities and Exchange Commission.

[Mark Tryniski:]

Thank you, Tom. Good morning, everyone, and thank you all for joining our fourth quarter conference call. Joe will do a deeper dive on Q4. So, I’ll start with a couple of brief observations and then comment on 2020 as a whole. Fourth quarter earnings and operating performance were just fine, no surprises. It was about as we expected. Operating earnings were up a few pennies over last year’s fourth quarter and $0.01 better than Q3, so modest forward progress. Loan growth was slightly negative in the quarter, if not being typical, but deposits just continued to grow similar to others and were up $100 million for the quarter. Asset quality continues to be very good. We did report a spike in NPAs because of a policy judgment around deferrals that Joe will explain further. 2020 as a whole was certainly a challenging year. However, operating earnings were only off $0.05 or 1.5% in 2019. In hindsight, that’s much better than we were expecting earlier in the year. There are a lot of moving parts in the reconciliation between the years due to the pandemic, but there was a significant negative impact from the decline in our core margin and our retail banking revenues, which we were able to offset in a number of other ways, principally the operating expense reductions and performance of our nonbanking businesses, all of which had a tremendous year. The pretax operating earnings of our benefits business was up 11%. Wealth was up 13% and insurance was up 16%. The value of a diversified revenue model was readily apparent in 2020. From an operational perspective, it was an extremely productive year despite the challenges of the pandemic. We developed and implemented several new digital products and platforms. We consolidated 13 branches, and we closed on the acquisition of Steuben Trust in the second quarter. So, I’m relatively pleased with 2020 overall and our forward progress, pandemic notwithstanding. Looking ahead to 2021, our focus will be on effectively countering ongoing margin pressure, improving organic performance, continued growth, and investment in our nonbanking businesses and a continuation of our investment in digital and rationalization of analog. I also expect the strength of our earnings, balance sheet, and capital generation will serve us well going forward as we continue to evaluate high-value strategic opportunities across our businesses for the benefit of our shareholders.

[Joseph Sutaris:]

Thank you, Mark, and good morning, everyone. As Mark noted, the earnings results for the fourth quarter of 2020 were very solid, especially in light of the economic challenges and industry headwinds we faced throughout the year. The Company recorded $0.86 in fully diluted GAAP earnings per share for the fourth quarter. Excluding acquisition expenses, acquisition-related provision for credit losses, unrealized gain on equity securities and gain on debt extinguishment net of tax effect, fully diluted operating earnings per share were $0.85 for the quarter. These results match third quarter 2020 results and were $0.02 per share higher than the fourth quarter of 2019 fully diluted operating earnings per share of $0.83. The Company recorded total revenues of $150.6 million in the fourth quarter of 2020, an increase of $0.8 million or 0.5% from the prior year’s fourth quarter. The increase in total revenues between the periods was driven by an increase in net interest income, higher non-interest revenues in the Company’s financial services businesses, and a gain on debt extinguishment offset in part by a decrease in banking-related noninterest revenues. Total revenues were down $2 million or 1.3% from the linked third quarter, driven largely by a $4.8 million decrease in mortgage banking revenues as the Company pivoted from selling its secondary market eligible residential mortgage loans during the third quarter to holding them for its own portfolio in the fourth quarter. The Company recorded net interest income of $93.4 million in the fourth quarter, up $0.7 million, or 0.7% over the fourth quarter of 2019. The increase was driven by a $2.28 billion or 22.7% increase in average earning assets between the periods, offset in part by a 66 basis-point decrease in net interest margin. The Company’s fully tax equivalent net interest margin was 3.05% in the fourth quarter of 2020 as compared to 3.71% in the fourth quarter of 2019. Net interest income increased $0.5 million or 0.5% over the linked third quarter, while net interest margin was down 7 basis points. During the fourth quarter, the Company recorded $3.5 million of PPP-related interest income as compared to $3 million of PPP-related interest income in the third quarter of 2020. At December 31, 2020, remaining net deferred fees associated with the 2020 PPP originations were $9 million, the majority of which the Company expects to realize through interest income in 2021. Noninterest revenues were up $0.1 million or 0.1% between the fourth quarter of 2019 and the fourth quarter of 2020. Employee benefit services revenues were up $1.7 million or 7% from $25 million in the fourth quarter of 2019 to $26.7 million in the fourth quarter of 2020 driven by increases in plant administration of record-keeping revenues and employee benefit trust revenues.

[Operator:]

The first question comes from Alex Twerdahl with Piper Sandler. Please go ahead.

[Alex Twerdahl:]

Yes. Just first off wondering how you guys are thinking about loan growth for 2021. Other than adjusting the mortgage strategy to put production on the balance sheet, have you made any other tweaks, any other lines to try to get a little bit more in terms of balances and put some of that cash to work?

[Joseph Serbun:]

Hey, Alex. It’s Joe Serbun. How are you this morning?

[Alex Twerdahl:]

Well, thanks.

[Joseph Serbun:]

I’ll take that. So, we’ll stay on the resi mortgage side for a moment. Mark mentioned in his comments about some digital strategies, and one of those strategies is to come out with a digital application in prequalification functionality, which we will go live here shortly. So, hopefully, that will benefit our mortgage portfolio. We’ll also direct some folks or redirect folks to markets that might be a little hotter for us, hotter in a good way, better, more activity, more opportunity for us. We redirect some of our FTEs that way as well. On the indirect side, which as you know is another meaningful portfolio. On the indirect side, I think that the industry expects uptick, and so do we. We’re going to do a little bit better job in managing between growth and yield. We were focused more on return in 2020 than we had in past years. I think in 2021, we’ll do a better job in balancing the growth and the yield component. And we’ll also target some folks in markets that are more robust than others. And then, on the commercial side, it’s soft and I suspect it’s going to continue to be soft as -- and so customers are either risk-averse or taking advantage of all of the stimulus money that is available for them, and sitting back waiting to see what the new administration is going to do or how the vaccines are going to roll out. So, the expectation on the commercial side is -- will be active, but it will still be soft. To give you some sense of that, in the commercial portfolio, the pipeline typically runs $350 million to $400 million. Right now, we’re at $136 million. And that number is probably going to go down because we had a pretty active month in December. And on the resi mortgage side, we’re 2 times our normal run rate. So, while we run about $100 million and we’re twice that as we sit here now. So, we fully expect to see the growth in the mortgage portfolio growth in the indirect, and it will be a struggle on the commercial.

[Alex Twerdahl:]

And is the intention to put all of the residential production on the balance sheet for the foreseeable future?

[Joseph Sutaris:]

The majority of it. We’ll keep the pipeline greased a little bit. But yes, more than the lion’s share will be kept on the balance sheet.

[Alex Twerdahl:]

Okay. And then Joe Sutaris, I think, I missed what you said in terms of securities purchases. I was hoping you could go over that one more time. And just I guess, if I did hear it correctly, I was having a hard time getting that to drive what the balance is, I saw on the balance sheet at the end of the quarter.

[Joseph Sutaris:]

Sure. During the quarter, Alex, we purchased about $1 billion in securities, mortgage-backed and treasuries, but we also had some maturities of treasuries as well. So, on an average basis, the securities balances were up about 630 -- I think the number is $636 million on a quarter-over-quarter average, but the purchase activities were closer to $1 billion.

[Alex Twerdahl:]

Okay. And then as we look forward into 2021, are you going to...

[Joseph Sutaris:]

Yes, Alex. Yes. And as we look forward into 2021, we’re going to continue to likely deploy some of those excess cash equivalents that are on the balance sheet. I think, the other day, we’re sitting on still about $1.6 billion of cash equivalents. So, we’re going to -- it looks like the stimulus money is here to stay so to speak. So, we’re going to look to continue to deploy some of those into securities and try to effectively stabilize net interest income in a long-term flat rate environment. So, as to whether -- we’re hopeful to put at least $1 billion at work in the next several months. We have to get the right levels in terms return opportunity to do that, but that’s the expectations that we still have some work to do on the investment security purchases in the second quarter.

[Operator:]

The next question comes from Russell Gunther with D.A. Davidson. Please go ahead.

[Russell Gunther:]

I was hoping to follow up, Mark, on some comments you made with regard to potential cost-cutting measures for 2021. Just curious what you guys are contemplating if you’re able to quantify that or even more just big picture where that may come from?

[Mark Tryniski:]

Sure. I’ll start and then, Joe, if you want to add. As 2020 played out, it became clear that we were going to have to revisit our operating structure, our revenue streams, every element of our business and take a fresh look at where we had productive and constructive opportunities to enhance performance, whether that was additions to revenues and/or reductions in expenses. So, we convened the team of our senior folks, 15 of us, and we spent a lot of time identifying opportunities to be more efficient, opportunities to reduce expenses, and opportunities to improve revenue. So, we have a plan to move forward and effect that. And it’s really across the -- it’s across the spectrum. I mean, some of it is, as we continue to look at our branch footprint as I said, we’ve effected 13 consolidations this year. We’re looking at more for 2020. And for most part, these are near-distance type consolidations. And that brings with it some modest reduction in ongoing operating costs. We are looking at our -- all of our vendor contracts. Many of them have already been, I’ll say, renegotiated in a productive way. A lot of that relates to technology, things which is really changing quick in terms of just the cost structures and all of that. And so, we’ve had a good success in renegotiating some of our contracts, technology, and otherwise. And we really just kind of looked at every, literally detailed item on the P&L and said, what can we do to make it better and reduce and capture some costs. We did the same thing on the revenue side. So, you put that whole thing into place, and it’s not insignificant. The catalyst for that frankly in I would say, mid-2020 was not as much the pandemic as it was when we did kind of a forward assessment of our margin in our net interest income dollars into 2021. So, we felt the need to address that, so, we are.

[Russell Gunther:]

And then, -- I appreciate your thoughts, Mark. You kind of got to the revenue question, I was planning to ask and we spoke about the single-family digital application, maybe that’s one of the revenue enhancements you’re referring to. But are there any other details on that front that you could talk about? And then, as a follow-up, given your comment that the margin pressure really led you to this, I mean if we tie the revenue enhancements and the cost-cutting together, do you expect to be able to generate positive operating leverage this year. Is that the target?

[Mark Tryniski:]

Well, I’m not going to -- there’s a lot of moving parts here, Russ, as you know. So, I’m not going to comment specifically on kind of on that, only because we don’t issue forward guidance and so. But, we are expecting a reasonably significant impact from all of our efforts, lucky to say that. On the -- the first question I think was related to the mortgage and pre-qual asked. I don’t expect we’ll have a lot of -- that’s not a revenue opportunity. That’s more of a as we compete more on a digital basis. I think I’ve said this in the past, but we have markets where we operate, where we have 80% -- 60%, let’s say deposit market share. And we’re only the second largest mortgage lender behind Quicken Loans. So, that’s not right. We have to have a different approach to our mortgage model. So, that’s the -- we spent -- our team did a lot of great work in developing that platform. It wasn’t plug-and-play. We kind of built it out ourselves. There’s going to be two components to it, the prequalification component, which I think we’re using right now internally to get rolled out pretty quick, really quick publicly. And then, the online mortgage application, which I think our customers are already using. So, that’s the first piece of that is build out that. The second piece is how do we drive customers to those platforms? Because it doesn’t really matter if you have a good platform, if nobody is visiting your digital store, then it doesn’t really -- it doesn’t matter much. So, there’s two important elements to digital. One is the platform, two is driving traffic to it. So, that is not going to be as much a near-term kind of fee or revenue opportunity as much as an important mechanism for us to capture greater, hopefully, mortgage share as markets and consumer demand involve more to the digital channels.

[Russell Gunther:]

And then, last one for me. You mentioned as part of the 2021 strategic focus would be high-value strategic opportunities. Just curious if you could expand upon that? Is it looking for depositories, opportunities within your differentiated fee verticals? Any commentary you could provide there would be great.

[Mark Tryniski:]

Yes. And I think the model isn’t going to change much from history, Russell, we’ve always kind of depended on doing higher value I think for us and our shareholders, M&A to kind of supplement organic growth, which is not sufficient for us to generate a double-digit return over time into our goal. So, we will continue to look for those opportunities, as I said, across all of our businesses. That would include depositories. It would certainly include our benefits business. Our insurance business, where we have a couple of things going on right now in fact. We’re doing some things in the wealth business that’s more organic. I would say that has a lot of potential. So, we’ll continue to look for those high-value strategic opportunities that are asymmetric with respect to their risk reward profile. And I think the reason I commented on it just feels a little bit like there’s -- the market is opening up a little bit. There’s more opportunities. There’s more conversations. I think for most of the last year, multiples were really down, earnings were down. There’s a lot of fear and uncertainty. It’s not a great environment for M&A. I think that’s changed a little bit. Multiples have come back across the industry. I think, the near-term catalyst could be just the interest rate environment and the margin. If you look at the industry, I mean, I think the entire industry is operating at sub-3% margins. Well, I would venture a guess that most banks have sub-3% margins do not earn their cost of capital. So, I think that’s going to create some opportunities. I think, the potential second derivative of that --and as I said, the second challenge is going to be on the technology front because of the cost of all these -- the cost of technology. And, as you look to kind of transition over time and from analog to digital, it’s clear that the cost to invest in digital is significant, and it’s ongoing. And that’s either customer-facing digital channels or backroom. We’re doing a lot of things to try to make our backroom more efficient. And we’ve got a group that’s working on a kind of digital workflow system. And we’ve had some early successes as we’re kind of learn and grow into that model, so we can build it out in a more meaningful way. All of those platforms are tremendously expensive. So, I think as banks realize, particularly the smaller banks, we have to invest if we want to compete, they look to the cost of that technology. And if your NIM is 2.8%, having sufficient earnings strength to make those investments is going to be a real challenge. So, I just think that there’s going to be more opportunity over the course of 2021, certainly then there was in 2020.

[Operator:]

Our next question comes from Matthew Breese with Stephens Incorporated. Please go ahead.

[Matthew Breese:]

Just following up on the dialogue in terms of tweaks to the model and then some of the upcoming challenges, I was hoping for a little bit more of a quantitative assessment of the headwinds and then with the changes what the outlook could be. And maybe to start with on the loan growth outlook. So, with the focus on indirect and mortgage, obviously, some weakness in commercial, what is the overall outlook for loan growth this year?

[Joseph Sutaris:]

So, Matt, this is Joe Sutaris. I’ll take that question. So, as Mark alluded to, we don’t offer necessarily forward guidance. But, historically, our loan growth is low single digits. And some years, that’s commercially driven. Other years, it might be driven. I would say when looking at kind of those three pieces, as Joe alluded to, Joe Serbun alluded to, is the mortgage -- pipeline is solid right now. We have some growth opportunities on the mortgage pipeline that maybe is slightly above those levels break out above kind of that low single digit level. And on the indirect side, the expectation is that the market will be good in the spring. We still see a lot of our in their checking and savings accounts, which I think probably portends some spending . So, the expectation around the indirect portfolio is probably in kind of the low to mid single digits as well. On the commercial side, the pipeline is a little bit smaller, as Joe mentioned. However, some of that is quite frankly being crowded out by PPP type opportunities. And our belief is that PPP reduces some of that demand. So, on the commercial side, we’re hopeful kind of to keep our head above water, at least in the early part of the year, and then we’ll have across that . So, that’s kind of the expectations around loan growth for early 2021.

[Matthew Breese:]

And then, if I think about net interest income, strip away accretable yield, but to exclude the PPP fees and income and the FRB dividend, actually got with core net interest income right around $88 million. With some of the changes, do you think you can hold that quarterly number in 2021, or do you think given the margin challenges that it’s likely to decline?

[Joseph Sutaris:]

Well, there will be continued challenges on asset yields in 2021. And I’d say that in the sense that our loan portfolio for the fourth quarter, we yielded about 4.17. New volume for loans that were put on the books in the fourth quarter was at 3.80. So there’s some rollover of loan portfolio and that will put pressure on asset yield. To counter that, however, as I mentioned, we do have $1.6 billion sitting in cash equivalents and we have an opportunity to make up that decrease by just through sort of a volume play and just investing some of that overnight cash . So, obviously, this environment, the current environment persists for a very long period of time, is going to continue to pose a challenge on not only us but all banks. If we do get some slope in the yield curve later in the year, maybe we can sort of level out our margin expectations on a going-forward basis. But, I think, we’re going to continue to see some asset, particularly loan yield compression, and we’re going to try to make it up with some of the investment securities activities.

[Operator:]

Our next question comes from Bryce Rowe with the Hovde Group. Please go ahead.

[Bryce Rowe:]

I wanted to ask about kind of the discussion around adding to the securities portfolio and then the comment you made about some of the stimulus funds stealing somewhat permanent, so to speak, in terms of sticking on the balance sheet. So, when you talk about the excess cash or the cash balances being as high as they are, 1 point, $6 billion, give or take, what’s the level you’re comfortable taking that down to kind of given your view of the permanence of the stimulus dollars?

[Joseph Sutaris:]

Yes. No, that is a very good question, Bryce. I think all the banks right now are struggling with how long the stimulus money sticks around, so to speak. But, I think we’re, at this point fairly comfortable that even if we projected some runoff on some of those funds, we still will be comfortable investing potentially up to another $1 billion over time in the securities portfolio. Keep in mind, we also have some maturities later in the year. But, based on what’s sitting on the balance sheet right now, $1 billion, we love the interest rates to be a little higher and levels to be a little bit higher. But, our alternative at the moment is 10 basis points and overnight cash. So, we’re continuing to evaluate that. But, I don’t think we go too far beyond that. Obviously, there is potentially another round of stimulus coming, which could inflate the deposit levels even higher. So, we’ll have to evaluate that as that sort of unfolds in front of us. But $1.6 billion, we think is a pretty significant cash equivalents balance right now. So, we roughly $1 billion of that over the coming quarters.

[Mark Tryniski:]

I think, the challenge, just to add to that, we’re at $1.6 billion now. If we do another -- I’m just making this up, but $400 million in PPP, right? That’s a couple of billion. We have, what, maturing?

[Joseph Sutaris:]

Another $400 million.

[Mark Tryniski:]

Another $400 million maturing, there’s two-fourth. So, you have about $2.5 billion, if we don’t do anything by the end of the year. So, we’re looking kind of -- that’s the way we’re kind of thinking about it. And not just we have $1.6 billion right now, but where is that $1.6 billion going to be at the end of the year, and so, how do we think about it in that context. So, we are not going to put ourselves in a position where we’re not . When you look at our liquidity, as always because the nature of our balance sheet and branch transactions we’ve done, we -- the lower growth on the loan side, so we -- there’s -- we have enormous liquidity. So, we’re not really -- when your loan-to-deposit ratio is in the 60s, liquidity is not your problem. So, as a comfort level, as Joe said, as we’ve kind of discussed this early, it’s right now at the $1 billion level.

[Bryce Rowe:]

Okay. And then maybe, Joe, you could speak to where you’re seeing investment yields opportunities to put money to work within that securities book?

[Joseph Sutaris:]

Yes. Well, Bryce, that is the challenge as we sit here right now, is trying to find those opportunities. Like I said in the fourth quarter, we were primarily treasury instrument. So, that’s kind of we typically have had a pretty plain vanilla safe, secure portfolio. So, it will likely be in treasuries and maybe some municipal and/or mortgage-backed securities. Relative to yield, I mean, the 10-year treasury, I think, this morning was 1.06 or 1.07. That’s not quite the levels we’d like them to be, obviously. So, we think potentially, some stimulus and other items might drive off of that net yield curve a bit in the coming quarter. And so, hopefully, we can get a little bit better net levels when we invest $1 billion over the coming quarter.

[Mark Tryniski:]

Yes. Just one quick follow-up. This discussion of the yields and asset classes of securities, and -- we don’t -- this discussion is all within the greater context of asset liability . So, Joe made reference to it, but we have -- our risk is to fall right. So, in the event we buy $1 billion or something in a buck and half or buck and a quarter, whatever it is, it’s not very much. Does it feel good from an earnings standpoint? No, not at all. But if interest rates are low for a long time, it’s going to be additive. And if rates go back up, if you look at the internal and you get an increase in interest rates, we’re going to be fine with that $1 billion in the buck and a quarter because the speed at which other things reprice, so, you get upward accretion to NIM. So, it’s not just about we -- we would not put $1 billion of securities out of the books at a low interest rate, if it did protect us with respect to our interest rate risk profile, which is what this does. If it didn’t do that, we would -- we’d sit on the liquidity. But actually, that hurts us because like other banks are -- central banks around the world have gone negative. And so, that’s -- I mean, I think Janet Yellen has even kind of got on record historically saying that she made reference to negative rates being a potentially useful tool. So, I think, we’re just trying to be sensible, but, understanding that this is all within the context of interest rate risk, not earnings management.

[Bryce Rowe:]

Understood. That’s good perspective. Maybe one more question for me. In terms of -- and Mark, you touched on the round three here of PPP, and whether there is a guess in terms of how much you might do relative to the first round. But, I was kind of curious what you’re seeing in terms of the pace of forgiveness here in ‘21, if you can comment on that, just wanted to get a feel for if it’s picked up or not as we’ve moved into the year.

[Joseph Sutaris:]

Hey Bryce, I’ll take that. This is Joe. So, PPP 1, will start there. PPP 1, the forgivingness pace was clicking along pretty well. And will pick up as a result of the SBA putting out their short-form forgiveness for loans of 150 -- or $150,000 or a little less. So, I would expect the pace to accelerate as a result of that. With respect to PPP 2 and what kind of activity we’re seeing there. Interestingly enough, it’s busy, but it’s nowhere as near as hectic as it was with the beginning of PPP 1. The borrowers don’t seem to be frantic or the -- I should say, the clients don’t seem to be frantic, they’re not busting down our doors. They’re filling out applications productively. And here we sit a week later from when we opened up and we got about, I don’t know, 1,300 applications. We probably did 1,300 applications on day one of the PPP 1 round. So, PPP 1 forgiveness will pick up, and PPP 2 activity, I think that $400 million is probably a number we can get to or more. We’ll see what the activity is like though.

[Operator:]

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

[Mark Tryniski:]

Thank you, Tom. Thanks everybody for joining. And we will talk to you again in April. Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.