Community Financial System Inc (CBU) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's Community Bank System fourth-quarter and year-end 2016 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 Form 10-K filed with the Securities and Exchange Commission.

Today's call presenters are Mark Tryniski, President and Chief Executive Officer, and Scott Kingsley, Executive Vice President and Chief Financial Officer.

Gentlemen, you may begin.

Thank you Greg.

Good morning, everyone, and thank you all for joining our Q4 and full-year conference call.

Our financial and operating performance for the fourth quarter and full year were strong, which Scott will discuss in further detail.

Beyond financial performance, it was an exceptional year in positioning us for future continued earnings and dividend growth.

The Merchants transaction that we announced in October and discussed in detail on our third-quarter call is progressing well.

Integration efforts are underway and despite the baseless protest filed with the Federal Reserve by a serial activist, we expect to close in the second or early third quarter.

We are equally pleased about the acquisition of Northeast Retirement Services, a leading provider of plan accounting, transfer agency, fund administration and trust and retirement plan services to institutional clients.

Based outside of Boston, NRS has very strong margins and is growing at double digits.

The combination of NRS with BPAS, our existing benefits business, will create a platform with over $80 million of annual revenue, more than $50 billion of trust assets, and 3,800 clients across the United States and Puerto Rico.

The transaction is expected to be modestly accretive to GAAP earnings in 2017, but will accelerate substantially as intangible assets amortize down.

Just as important, however, the transaction will be significantly and immediately accretive to cash earnings, providing substantial support to our dividend capacity.

We are looking forward to a close in early February.

2016 was a very good year for our shareholders.

We achieved record operating earnings for the seventh consecutive year.

The share performance was strong, and we increased our dividend for the 24th consecutive year.

Beyond that, and more important for our future, we strategically and effectively deployed capital in a manner that tremendously strengthens our capacity to continue to generate growing earnings and growing dividends.

We are in an exceptionally strong position as we head into 2017 and beyond and, as always, remain mindful of our responsibility to create exceptional value for shareholders.

Scott?

Thank you Mark, and good morning everyone.

As Mark noted, the fourth quarter of 2016 was another very solid operating quarter for us, and, as a reminder, included a full quarter of the activities of the Oneida Financial acquisition that we completed in December of 2015.

Reported fourth-quarter earnings was $0.59 per share, which included $0.02 a share of acquisition expenses, but also included almost $0.02 a share of incremental dividend income from an active Limited Partnership, Wheat Cole.

As Mark also mentioned, full-year 2016 operating income of $2.33 a share represented the seventh consecutive year of record results despite having to overcome a $0.07 per share tax rate headwind in 2016 versus 2015.

I'll first cover some updated balance sheet items.

Average earning assets of $7.69 billion for the fourth quarter were up modestly from the third quarter and were 5.3% higher than the fourth quarter of 2015.

Average loans increased $21 million in the fourth quarter, 0.4% on a linked-quarter basis, as solid organic growth in consumer mortgages and consumer installment products were partially offset by a second consecutive quarter of net declines in commercial balances, the result of an unusually large level of unscheduled payouts.

Quarter-end investment securities were down $93 million from the end of September, a result of very modest portfolio cash flow reinvestment in the fourth quarter as well as a meaningful decline in the investment portfolio's net unrealized gain position due to market interest rate increases during the quarter.

Average quarterly deposits were up $101 million in the fourth quarter of 2016, or 1.4%.

2016 was again a continuation of the favorable overall asset quality results that's part of our credit DNA.

Fourth-quarter net charge-offs of $2.2 million, or 0.18% of total loans, were down $1.3 million from the fourth quarter of 2015 and resulted in full-year net charge-offs of $6.2 million, or 13 basis points of average loans, compared to $6.4 million of full-year charge-offs in 2015, or 15 basis points of average loans.

Nonperforming loans, comprised of both legacy and acquired loans, ended the fourth quarter at $23.7 million, or 0.48% of total loans, 1 basis point higher than the ratio reported at the end of September, and 2 basis points better than the end of 2015.

Our year-end 2016 reserves for loan losses represent 1.02% of our legacy loans and 0.95% of total outstandings.

Based on the most recent trailing four quarters' results, our reserves represent over seven years of annualized net charge-offs.

As of December 31, our investment portfolio stood at $2.78 billion and was comprised of $245 million of US agency and agency backed mortgage obligations, or 9% of the total, $595 million of municipal bonds, or 21%, and $1.9 billion of U.S. Treasury securities, or 68% of the total.

The remaining 2% was in corporate debt securities.

The portfolio contains net unrealized gains of $42 million as of year-end compared to net unrealized gains of $140 million at the end of September, due to the meaningful pickup in market interest rates during the quarter.

Our capital levels in the fourth quarter of 2016 continued to be very strong.

The Tier 1 leverage ratio reached 10.55% at year-end, and tangible equity to net tangible assets ended December at 9.24%.

Tangible book value per share was $17.12 per share at December 31 and included $43.5 million of deferred tax liabilities generated from certain acquired intangibles, or $0.98 per share.

Shifting to the income statement, our reported net interest margin for the fourth quarter was 3.76%, which was up 9 basis points from the third quarter and 6 basis points higher than the fourth quarter of 2015.

Consistent with our historical results, the second and fourth quarters each year include our semiannual dividends from the Federal Reserve Bank of approximately $600,000, which added 3 basis points of net interest margin to fourth-quarter results compared to the linked third quarter.

The previously mentioned Limited Partnership dividend of approximately $1.2 million also added 6 basis points to fourth-quarter net interest margin.

Proactive and disciplined management of funding costs continue to have a positive effect on margin results as total deposit costs in the quarter remained at 10 basis points.

Fourth-quarter banking noninterest income was down $1.4 million linked-quarter as the third quarter's results included $950,000 of nonrecurring insurance related gain, as well as our annual dividend from certain pooled retail insurance programs of approximately $600,000.

Quarterly revenues from our benefits administration, wealth management, and insurance businesses of $22.5 million were up 2% from the third quarter, as seasonally expected.

Fourth-quarter 2016 operating expenses of $65.6 million, which exclude acquisition expenses of $1.4 million in the quarter, were $700,000 lower than the linked third quarter, principally due to one less day of payroll.

Certain occupancy related costs were seasonally higher, as expected.

We have continued to invest in improving our infrastructure and systems, including those around the requirements of DFAST, as we embrace the impending $10 billion asset size threshold.

Our effective tax rate in the fourth quarter of 2016 was 33.4% versus 32.7% in last year's fourth quarter.

Certain legislative changes to state tax rates and structures over the past two years resulted in the majority of the resulting higher rates, including those related to our overall asset size being about $8 billion on a consolidated basis.

Our full-year 2016 effective tax rate of 32.9% was 1.9 percentage points higher than 2015's full-year rate of 31.0% and represented a $0.07 per share headwind compared to the results of 2015.

Looking forward, we continue to expect Federal Reserve Bank semiannual dividends in the second and fourth quarters each year.

Our fourth-quarter and full-year 2016 net charge-offs results were again favorable.

And although we do not see signs of asset quality headwinds on the horizon, it would be difficult expect improvements to current asset quality results.

Our operating net interest margin has remained in a fairly narrow band over the past five quarters, a range we would expect operate in for at least the next few quarters.

Tax rate management for the foreseeable future will continue to be subject to successful reinvestment of our cash flows into high-quality municipal securities, which has been a challenge at times, including for most of 2016.

In summary, we believe we remain very well positioned from both a capital and an operational perspective as we start 2017 and look forward to the incremental opportunities of the pending Merchants Bancshares and Northeast Retirement Services transactions.

I'll turn it back over to Greg to open the line for questions.

(Operator Instructions).

Alex Twerdahl, Sandler O'Neill.

First off, I was wondering if you can give us a little bit of an update on how the loan pipeline looked at the end of the year.

Sure.

If you look back over the course of 2016, we had an, overall, about 3% growth, which is about our markets, slower growth markets, but there was a lot of distinctions amongst the different businesses.

It was a very strong year for the auto lending and indirect installment loan; lending was up double digits.

The consumer mortgage business was up a little over 3%, which is a fairly typical year absent significant refi activity because of interest rates.

And commercial banking business was flat.

We had a lot of good wins and some significant very large unexpected payoffs as well.

So kind of a mixed result there, but overall typical for us in terms of overall growth in our portfolios.

Right now, the mortgage business, it tends to -- the pipeline tends to get a little bit better this time of year, and then accelerates.

It's consistent with where it's been in the past.

The auto lending business, obviously not a pipeline there, but I think the fourth-quarter results were maybe a bit better than what we expected.

And the Commercial Banking pipeline is fairly consistent as well, not significantly up or not significantly down.

So, I would suggest that, heading into the first quarter, our pipelines are relatively stable with no significant variations in any of those pipelines either way, Alex.

Okay, great.

And then, you know, we've seen a little bit of a -- we had a rate hike last month, and we've seen the five-year treasury kind of expand a lot during the fourth quarter.

Have you seen any of that translate into slightly better pricing for you guys on new production?

I would suggest it's been limited.

I think some of our existing variable-rate commercial business has repriced, and we've got a slight I would say modest benefit from that.

As it relates to new production and new business, it's still, on the commercial side, tremendously competitive, so we haven't seen a lot of reaction there.

In terms of significant rate relief, we are still experiencing slightly declining margins in our commercial business whereas, for most of the consumer businesses, those yields have pretty much stabilized.

So, a modest benefit for the rate increases, still highly competitive from a rate perspective out of the commercial side, and the consumer portfolios have pretty much stabilized in terms of yield.

Okay.

And then just my final question is maybe you can give us just a little bit more color on that Limited Partnership, what that was, whether or not that type of a gain is something we can expect in the future.

I'll take that one.

It's an operating Limited Partnership that we've been the owner of since the Wilber transaction back in 2011.

It's a Limited Partnership that has some of the attributes of yield generation for Wilber and some CRA-related credit came from some of those activities.

Late in the third quarter, early in the fourth quarter, this Limited Partnership had one of their underlying portfolio companies that actually was monetized.

That gave them the flexibility to create a larger than typical dividend to the Partnership holders in the fourth quarter.

From a running forward standpoint, from a run rate standpoint, very hard to predict.

There are some still underlying good portfolio companies in the Limited Partnership, but we wouldn't put them into our forecast, too difficult to predict.

Okay.

Thanks for taking my questions.

Joseph Fenech, Hovde Group.

Good morning guys.

I don't have much on the quarter, a typically strong one for you all.

Just a question on the go-forward M&A strategy, we've seen banks that trade at multiples similar to yours get more aggressive in their talk and their actions on M&A.

There was obviously a big one this morning.

How do you all think of the approach here?

Does it not change at all, or is there more of an inclination to get aggressive, maybe take on a little higher than normal integration risk, but with a view maybe that that's trumped by the prospect of putting the currency to work?

And that's obviously setting aside the attitude of the potential targets, which I know factors in.

Just trying to get a read, though, on your thought process.

I guess I would summarize it as we don't believe in aggression; we believe in discipline.

And from my perspective, it's about being disciplined and executing well on high-value opportunities.

It doesn't really matter to us whether we are trading at a higher multiple or a lower multiple.

It certainly makes potential strategic opportunities more valuable, but we wouldn't ever consider doing something we wouldn't otherwise do solely because our shares are trading at a premium to the market.

No, I understand that.

But to the extent, Mark, that maybe you say, hey, you have your wish list over the next two to three years.

Do you say to yourself, hey, maybe it makes sense to try to push a little harder on Target A or B that we may thought may have come to market in the next 18, 24 months?

Do you push a little harder on stuff you already knew you were interested in?

I understand your comment on discipline, though.

I would say the short answer is yes, it creates a different opportunity in terms of capacity to make a transaction with a strategic target more attractive to the seller.

Okay.

All right.

Thanks.

(Operator Instructions).

Collyn Gilbert, KBW.

Good morning gentlemen.

Just, Scott, if you could talk a little bit about how you're kind of seeing the securities portfolio now and sort of what you strategy is going to be to manage that going forward and where you are seeing yields running off, what you are purchasing, and then how that kind of affects your NIM outlook.

Sure.

So, from a scheduled cash flow standpoint, 2017 is roughly a $120 million expectation year, so not -- on a base of $2.8 billion, not a ton.

Most of that is in the municipal securities side, so we tend to have slightly better yields in the municipal securities portfolio concentration standpoint than the rest of the things we are holding, especially treasury securities.

So, I would say the way we are posturing for now is, with the expectation of rate increases in the market, we are probably not a very active buyer.

I think we're trying to find high-quality municipal securities of the durations when we can get them.

Chances are that will result in running off yields being a little bit higher than what we purchased.

We did buy a few million dollars worth of mortgage-backed securities.

Most of those come with CRA-type benefits as well.

We'll continue to monitor those.

In terms of investment cash flows, hopefully, here over the next handful of months, we will get an opportunity to blend in the Merchants investment portfolio with ours relative to how we want to position the combined portfolio.

But for now, I think it's sort of business as usual and certainly wouldn't be surprised to see, the next couple of quarters, our investment securities being in a net run-off position.

Okay, that's helpful.

And then just drilling in a little bit more on the margin, just how you sort of see the margin trending.

Let's assume two rate hikes maybe this year, and just digging in a little bit more to really what's driving the liability sensitivity of the balance sheet, or is it not really as liability sensitive as perhaps what the disclosures may show?

Really good question, probably the $10,000 question.

If we had the prognostication tools, we would really like to know that ourselves.

But we kind of view it this way.

If you pull out things like Federal Reserve Bank dividends and the Limited Partnership dividend that we have in the fourth quarter, and in the third quarter, we had an above average amount of yield attached to some commercial loan pay-offs, if you pull those things out, we essentially started the year at a 3.67% operating margin in the first quarter, went to 3.68% in the second quarter to 3.65% in the third quarter, to 3.66% in the fourth quarter.

So we seem to have found a band and a range.

To Mark's point, asset repricing still very competitive on the commercial side, but we think we are past the inflection point on the mortgage and the car loan side.

In other words, new production is at or slightly above where we had been.

We just talked about where we were for investment securities, so there's your asset side.

The liability side and why we do think we are liability tested is the $7 billion at 10 basis points.

When in the point in the cycle will we actually have to see some rate movement up on the deposit side, our disclosure modeling basically uses the period of 2003 to 2006, the last time there were meaningful rate increases.

But that's only as good as -- clearly the deposit portfolio looked different then, not only for us but for everybody.

At that point in time, we were still about 30% to 35% certificate in the portfolio.

Today, we are more like 8% certificates.

So I think it's going to be the speed on the way up.

I think we like our chances of being those who lag.

A reason being is 70% loan to deposit ratio if we are in marketplaces where we tend to have a fair leadership position from a deposit share standpoint.

But you know, that will be the difficult thing.

Obviously, no rate changes after the first 25 in December of last year, no deposit rate changes after the second 25 in December of this year.

Does the third or the fourth one actually start to move funding up?

Really good question.

That's why, in our modeling, we think it does, and that's why, at $7 billion of 10 basis point liability, that, quite frankly, has a little bit more inflection than the assets that we price for us.

Okay.

That's really helpful.

And what deposit betas do you guys assume in your assumptions?

We move them up.

Collyn, it's difficult to -- we tend to move them up very little in the first 50, and then we go up about 30% to 35% of the rate movements from 50 to 100, and then more like 66% when you go from 100 to 150.

So, doing it in waves, assuming you get three kind of movements at 75 basis points.

We don't expect a ton in 2017.

And that's why we said we are a champion and a cheerleader for higher rates, but we don't really see a ton of benefit for that for a year to year and a half.

The other (technical difficulty)

The other comment I would just make is the deposit betas that we use for our disclosures and such are more conservative than what we experienced in the last up rate cycle by a substantial margin, and have reflected neutral to slightly down net interest margin over about a six-quarter period.

And after that, there's a significant improvement in margin and net interest income.

So, we like the asset liability mix right now.

We really like the core deposit funding.

We understand, as rates move up, there will likely be a transition on some level, as there was on the way down of deposits transitioning out of the checking and savings, money market type instruments into CDs, which also helps from the perspective that it creates a natural hedge against further interest rates.

So, we like our alco position quite a bit right now.

Okay.

That's great color.

Thank you.

And then just moving to the Merchants deal, Mark, I think you had indicated that, perhaps because of sort of a dissident consumer group or whatever, community group, could delay the closing maybe to early 3Q.

Is that really the primary driver for maybe why you would push it out to see closing in 3Q?

And any more color you could offer on sort of the timing of that closing would be great.

Yes, that's solely the reason.

It was a -- I guess a protest, to call it that, that was filed at the last minute on Friday, I believe, so we are still trying to work through it and understand it.

So yes, I think we expect it to close in the second quarter.

And I think, at this juncture, it's not impossible that it moves to early third quarter, but we certainly would still be shooting for our original closing date.

I mean some of the comments that have been made in this protest were, as I said, are baseless, and similar to those that were made in the last go around with respect to the Oneida transaction.

So, we've had -- there will be some familiarity with these allocations as it relates to the regulators.

So, we are hopeful that this one will move through the process a bit more efficiently than it did with the Oneida transaction.

Okay.

That's really helpful.

Thank you.

(Operator Instructions).

Gentlemen, at this time, it looks like we have no further questions from the audience.

Excellent.

Thank you all for joining in.

We will talk to you again in April.

Thank you.

Once again ladies and gentlemen, that does conclude today's conference call.

We appreciate your participation.

You may now disconnect.