Community Financial System Inc (CBU) 2017 Q3 法說會逐字稿

Ladies and gentlemen, please standby.

We're about to begin.

Welcome to this Community Bank System Third Quarter 2017 Earnings Conference Call.

Please note is that this presentation contains forward-looking statements within the provisions of the Private Security Litigation Reform Act of 1995 (sic) [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.

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, Shannon.

Good morning, everyone, and thank you all for joining our Q3 conference call.

It was another very strong quarter for the company with record quarterly operating earnings, following our first full quarter with both Northeast Retirement Services, which closed in February, and with the May closing of the Merchants Bancshares transaction.

Scott will provide more detail on the financials.

But in summary, for the quarter and year-to-date, operating earnings per share are up 13% and adjusted or cash earnings per share are up 18% for the quarter and 17% year-to-date.

To repeat what we said last quarter, this acceleration in earnings and cash flow is the result of both the NRS and Merchants transactions.

The per share accretion of NRS, which we previously expected to be in the range of $0.05 to $0.08 per share, is running at an annualized rate of over $0.10.

Merchants is also running ahead of our projections, due principally to accelerated realization of cost synergies related to both people and technology.

We expect both transactions will continue to be firmly accretive to earnings generation into the future.

Supporting this earnings performance, similar to last quarter, was record expense leverage, excellent credit quality and organic growth in noninterest revenues.

Where we underperformed for the quarter and year-to-date is loan generation, principally business lending.

The mortgage business is performing fine with organic originations growing 3% year-over-year, pretty much standard for our markets.

With respect to the auto business, in Q1, we took measures to improve the return on capital of that business, which has impacted origination levels but improved profitability on those lower originations.

We expect that business to run at lower rate for the fourth quarter as well.

Business lending, including C&I and CRE, is off organically 4% year-over-year.

Central and Western New York is up with offsets in Northern New York and Pennsylvania.

We've also seen modest declines in Vermont due to accelerated pipeline closings prior to the acquisition, but they are still up for the full year.

Asset prices are high and cap rates are low.

So we're seeing a significant acceleration in both refinancing in sale/prepayment activity.

We've also been successful this year in exiting underperforming credits.

We're expecting a continuation of this trend for the fourth quarter.

With that said, the pipeline is pretty solid and our commercial team is working very hard to offset the unscheduled payoff activity.

On the other side of the balance sheet, organic core deposit generation has been steady, up 4% over last year organically and total deposit costs have been exactly 10 basis points for the past 5 quarters.

We expect the strength of our funding base will be highly additive to operating performance if rates to continue to rise.

It's been a very strong year for our performance and for our shareholders.

I said after the Q2 call that 1 quarter does not a trend make, but now we have 2. We're confident in our current operating position and in our ability to continue to generate earnings and cash flow at a sustainable pace that is double digits ahead of 2016.

Scott?

Thank you, Mark, and good morning, everyone.

As Mark noted, the third quarter of 2017 was another very solid operating quarter for us, and as a reminder, included a full quarter of the activities of the NRS acquisition that we completed in early February and the Merchants acquisition completed in May.

I'll first cover some updated balance sheet items.

Average earning assets of $9.45 billion for the third quarter were up 23.0% from the third quarter of 2016 and 8.9% above the second quarter of this year, reflective of the mid-second quarter acquisition of Merchants.

On a year-over-year basis, residential mortgages and home equity instruments grew 1.7% organically, as the company continues to sell most of its longer-term secondary market eligible originations.

Consumer indirect loans at September 30 were essentially even with the end of the third quarter of 2016.

Although our net charge-offs and delinquency results in this portfolio continue to be excellent, we have generally seen some consumer credit erosion compared to last year in the application process.

And as Mark mentioned, in 2017, we have refocused our efforts in this portfolio on improving capital returns versus balance sheet growth.

Excluding the Merchants acquisition, business loans were down from their year-ago levels, reflective of a number of outside unscheduled payoffs and the continuation of very competitive market dynamics.

Quarter-end investment securities were down modestly from the end of the second quarter, but $340 million higher than the end of the third quarter of last year, a result of the Merchants acquisition.

Average quarterly deposits were up $1.56 billion year-over-year in the third quarter of 2017, also reflective of the Merchants transaction as well as continued success in core deposit gathering.

We ended the quarter with $314 million of borrowings, which are all collateralized customer repurchase agreements, which act like and are priced much more like deposits than wholesale borrowings.

As such, with the exception of our $123 million of highly efficient and regulatory capital added to the trust preferred obligations, our September 30 balance sheet has no external debts, a rarity in our peer group.

The third quarter of 2017 was again a continuation of the favorable overall asset quality results that we have come to expect.

Third quarter net charge-offs of $1.8 million or 0.11% of total loans were up $0.3 million from the third quarter of 2016 and were very consistent with our results over the last 8 quarters.

Nonperforming loans comprised of both legacy and acquired loans, ended the third quarter at $23.4 million or 0.37% of total loans, 10 -- I'm sorry, 10 basis points lower than the ratio reported at the end of last September and benefited from the addition of the Merchants loan portfolios.

Our quarter-end September 2017 reserves for loan losses represents 1.00% of our legacy loans and 0.76% of total outstandings with the addition of the Merchants loans.

Based on the most recent trailing 4 quarters results, our reserves represent almost 7 years of annualized net charge-offs.

Despite multiple reports of macro level auto industry concerns, the first 9 months of 2017 net charge-off ratio at our auto lending portfolio was under 35 basis points of average loans, consistent with the previous 8 quarters and still favorable by longer-term historical standards.

As of September 30, our investment portfolio stood at $3.13 billion and was comprised of $587 million of U.S. agency and agency-backed mortgage obligations or 19% of the total, $538 million of municipal bonds or 17%, and $1.93 billion of U.S. Treasury Securities or 62% of the portfolio.

The remaining 2% was in corporate and other debt securities.

The portfolio contained net unrealized gains of $52 million as of quarter-end compared to a net unrealized gain of $140 million at the end of the September of 2016 due to the noticeable movement up in market interest rates during the last 12 months.

Our capital levels in the third quarter of 2017 continued to be very strong.

The Tier 1 leverage ratio was 9.54% at quarter-end and tangible equity to net tangible assets ended September at 8.37% despite the meaningful use of capital for both the NRS and Merchants transactions earlier this year.

Tangible book value per share was $16.70 per share at September 30 and included $75.8 million of deferred tax liabilities generated from certain acquired intangibles or $1.50 per share.

Shifting now to the income statement.

Our reported net interest margin for the third quarter was 3.64%, which was down 8 basis points from the linked second quarter and 3 basis points lower than the third quarter of 2016, reflective of a full quarter of Merchants' results.

Consistent with historical results, the second and fourth quarters of 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 second quarter results.

In addition, we recorded approximately $1.3 million of incremental purchased loan accretion compared to the third quarter of 2016, which added an additional 5 basis points to our 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, including the added deposits from the Merchants transaction.

Despite 3 fed rate -- 3 fed funds rate changes since December, our deposit beta has remained at 0 year-to-date.

Third quarter banking noninterest income, which included our annual dividend from certain pooled group insurance programs of approximately $600,000, was up $2.4 million from the third quarter of last year, reflective of the Merchants transaction and several core improvement initiatives.

Quarterly revenues from our benefits administration, wealth management and insurance businesses of $32.8 million, were up $10.6 million from the third quarter of last year and included the NRS and Merchants transactions as well as 2 smaller insurance agency acquisitions completed earlier this year.

Third quarter 2017 operating expenses of $83.2 million, which exclude acquisition expenses of $0.6 million, were $17.0 million above the third quarter of 2016 and included a full quarter of operating activities from both the Merchants and NRS transaction as well as the significantly higher intangible amortization that resulted from those 2 acquisitions.

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

Our effective tax rate in the third quarter 2017 was 31.2% versus 32.8% in last year's third quarter and included a $300,000 reduction in income tax expense related to the change in accounting for share-based transactions.

Our third quarter and full year 2017 effective tax rate expectations including currents of over $25 million of acquisition expenses this year.

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

Year-to-date, 2017 net charge-off results have again been manageable and although we do not see signs of asset quality headwinds on the horizon, it would be difficult to expect improvements to current asset quality results.

Our core operating net interest margin has remained in a fairly narrow band for over the last several quarters, a range we would expect to continue to operate in for at least the next few quarters, including the impact of somewhat higher purchased loan accretion related to the Merchants transaction.

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

Our continued growth and income generation from fully taxable sources will continue to push our effective tax rate higher, barring any legislative changes to corporate tax rates.

We continue to expect a net reduction from Durbin mandated impacts on debit interchange revenues, beginning in July of 2018 of approximately $11 million annually or an estimated $5.5 million in the second half of 2018.

In summary, we believe we remain very well positioned from both a capital and an operational perspective for the remainder of 2017, and as Mark mentioned, look forward to continuing to execute on both our acquired and organic improvement opportunities.

I will now turn it back over to Shannon to open the line for any questions.

(Operator Instructions) First question comes from Alexander Twerdahl with Sandler O'Neill.

First off, I was hoping you can maybe give us a little bit more color on what's going on with expenses whether or not 3Q -- and obviously, a lot of noise following a couple of successful deals.

Can you give us an update on, one, the timing of further cost saves, if there are any left to take out?

And then 2, you mentioned some investments.

As you're now over $10 billion, are there any further investments that you need to make as you kind of prepare for, I know DFAST is something that is ongoing, but any further investments that need to be made in the next couple of quarters?

Sure.

Saves.

So let's kind of get rolled back and start with that.

I think the third quarter 2017 is a pretty good run rate to use as a base expectation for a fully -- a full contributed quarter for both NRS and for Merchants into our totals.

I don't think we had anything unusual in the third quarter of this year that would make us think anything different about that.

Relative to cost saves as it relates to the Merchants and the NRS transactions, we're pretty much there.

I think we've mentioned before that I think some of the integration activities, both from a technological and a people standpoint, happened a little bit faster than our original time line from an expectation standpoint.

So I think we're at the point where incremental cost saves are probably unlikely from either of the 2 transactions for the balance of the year going into next year.

Incremental costs for DFAST, great question.

So in 2017, we did an internal dry run.

We are done that exercise.

Quite pleased with our results, both from a first year standpoint, both in terms of the process, the execution.

And I think as most people point out, end of the day, the numbers probably aren't that important.

Ours are, as we might expect, pretty good.

I think for 2018, we'll have some incremental costs associated with validation of a number of the models that we created this year and will, obviously, refresh for next year.

Our plan is to do a second dry run in 2018 and actually submit those to the regulator in the same time frames that are -- that the other banks that are in our DFAST peer group are required to do.

We're just looking for feedback before we get into the full-blown exercise that's required for 2019.

So we have another $0.01 or so per share of costs associated with getting from where we are in 2017 to where we expect to be in 2019, probably.

But I don't think that you'll see those be a major blips in any of the quarters sort of going forward from here out.

Okay.

That's a lot of good information there.

And then maybe you can just elaborate a little bit more on the margin.

You said that you expect it to remain roughly in the same range as its kind of been, barring purchase accretion.

One, what are your -- what's your expectation for that -- the purchased loan accretion for the next couple of quarters?

Do you think $1.3 [million] is that kind of a decent rate to use in our model?

And then some of the puts and takes on, you mentioned, the indirect auto yields or the profitability maybe moving higher.

Is that something that could have any real impact on overall loan yields?

Or -- mention a little bit more color there.

Sure.

So let me just do a little bit of deconstruction of the 2017 second quarter and third quarter, just to kind of lay that groundwork for that.

We reported a 3.72% margin in the second quarter of this year.

If you pull out 3 basis points of margin associated with the FRB dividend, you're at a base of 3.69%.

If you pull out $0.08 of purchased loan accretion from the second quarter, which is about what that came out to, you're at 3.61%.

We just reported 3.64%.

You probably need to pull out $0.08 -- I'm sorry, 8 basis points of margin associated.

We did book $1.9 million of purchased loan accretion in the third quarter.

It was $1.3 million higher than the third quarter of 2016.

Because as you know, we still have purchased loan accretion from some of our previous transactions.

The big increase, obviously, comes from the Merchants transaction.

And I think that it's fair to say that, that line item of $1.9 million a quarter going forward is pretty reasonable for the next 3 to 5 quarters.

As balances go down in the purchased loan side, which, of course, they only do, in other words, the purchased loan values never go up, they only go down, you will find that the amortization or the accretion associated with that tends to trail over time.

But I think we're very early in the transaction, pretty reasonable to expect that number to be pretty constant for the next 3 to 5 quarters, which leads us to believe that as we look at the ability to reprice assets in a rising-rate environment, knowing full well we're starting off at a very, very low base on the funding side, we feel pretty good about being able to sort of balance those and stay in this range of mid-3.50s prior to accretion and low- to mid-3.60s with accretion.

Next question comes from Joe Fenech with Hovde Group.

Can you talk a little bit about the auto, I guess, business, in general.

It sounds as though with some of the issues in that business that you guys feel as though you could fully protect yourselves and you have, just with the tweaks you've made at the time of application.

I guess, generally speaking, if you were in our seat, what would you worry about, if anything, based on what you're seeing?

Or in your view, is it just an issue for the industry of the return profile?

Fair question.

I think for us, we've been in this business a long time.

We don't get into the business and get out of the business like a lot of other institutions do in our markets, which are more nonmetropolitan and rural.

We provide a stable ongoing source of funding support for the dealers in our footprint.

We have -- historically, the asset quality in those portfolios has been better than the industry average.

So that's something that we would never concede on is asset quality.

And I think we've been in a very good place for the last 8 years in terms of, Scott made reference to, historical losses in that business that have been, for us, somewhat higher than 35 basis points, a little bit higher, but for the industry, overall, a fair bit higher.

So I don't suspect -- I mean, I think from an asset quality perspective, Joe, we will continue to perform better than the industry over time.

But I think some of the moves we made in the -- on the first quarter around return on capital were just related to the profitability of the business, the spreads got too low, the dealer compensation got a little stretched.

And so we decided to dial back a little bit, understanding that it would hurt outstandings and originations.

But it really wasn't about growing the balance sheet, it was about improving the return on capital of that business.

So if I sit in your seat, more broadly in terms of the industry, I mean, one of the trends that we've seen in the industry is an extension of tenure.

So the terms are longer.

Borrowers are going out much longer and there are outlets for those -- for that paper in terms of those extended durations and then you get the -- you get to be upside down in terms of loan to value very quickly when you're writing long-term paper.

So that's one of the things that, I think, from an industry perspective, is worth keeping an eye on.

And I mean, the other is the subprime market has come back.

The outlet for that paper has returned to the market.

And so right now things are pretty good in the economy.

If there is a turn, I think you would see those who are writing in above-average level of subprime paper might take above-average losses, but...

And Joe, I think -- this is Scott.

The only thing I would add to that as well is to continue to monitor the dynamic of where people are on loan to value, especially on the used car side, I think it's likely that the 2 hurricane storms in Texas and Florida will keep used car prices fairly buoyant for probably the balance of the year and maybe even a little longer than that.

But over time, with North American production and sales approaching the 18 million unit level, at some point in time, people have to refresh their car in their driveway.

So from a practical standpoint, loan to values probably only have one way to go on the used car side.

So I would say that's probably the other sort of fact points that we're following.

Okay.

And then just switching gears to M&A.

I know you guys play at a different level with the stock currency you have relative to others.

But the market as a whole seems to be a little more skeptical about lot of the deals we're seeing now.

You guys had a lot of smart deals earlier, particularly some of the branch deals where you got deposits cheap.

But can you talk about your feelings now on the M&A just generally?

Do you get more picky with the run these stocks have had and the corresponding impact on seller expectations?

Or is your approach just the same as it's been and just continue to do your thing here?

I think, it's pretty consistent.

I think we try to be very disciplined around our M&A strategy and the partnerships that we enter into with other businesses, whether it's a bank or a nonbank.

It's really around the confidence level we have in a particular transaction and the capacity to create value for our shareholders around those transactions.

So it's not about getting bigger, it's not about pumping up the balance sheet.

It's -- I mean, it's easier to run a smaller bank than a bigger one.

But with a regulated capital industry that we operate in, you don't have a choice.

You have to grow your balance sheet to grow earnings per share and cash flow per share and dividend per share over time.

So I don't think there's no different -- the current environment hasn't changed our approach at all.

We look for high-quality partners that are properly priced, where we have a high degree of confidence in our ability to execute.

Every transaction has its own risk-return profile and that's something we pay a lot of attention to.

The higher the risk, the higher the returns and vice versa.

So we're very cognizant of that overall kind of risk-return profile, the confidence level we have in our ability to execute an M&A strategy and have it be productive for shareholders.

I think we've done a fair job of that over the years, if you look at the markets we operate in.

If we can get 3%, 4% organic growth a year, that's a pretty good outcome for us.

Those are the markets that we're in.

So we need to focus on getting that organic growth and executing on our efficiency and our expense discipline and deploying capital effectively to high-value M&A transactions that create a return -- a sustainable return for shareholders.

And the other element of that strategy is investing in our nonbanking businesses to continue to grow those, which have very high return characteristics in terms of return on the assets and return on capital.

In addition to the fact that those businesses are for the most part unconstrained by our branch footprint.

So the organic growth characteristics of those businesses are a fair bit higher as well.

So that's kind of summary of the strategy.

I would say, no real change, we continue to be disciplined.

We're not going to pay more than we should for something.

We're not going to buy something that we shouldn't buy even if it's cheap because it's not a good fit with our company, our culture, our credit quality, our discipline.

So I would say, nothing has really changed on that front, Joe.

We -- Scott made reference to the capital levels, which are higher than what we have originally projected in pro forma after the NRS and Merchants transactions.

So we're pretty pleased about where the capital levels are right now.

And as you know, we accrete capital back pretty quickly because our organic growth is somewhat less.

So we'll continue to look for those high-value opportunities, but they have to be things we have a lot of confidence in high-quality transactions that will create earnings accretion, cash flow accretion and dividend accretion for our shareholders.

Okay.

And then -- that's helpful, Mark.

And then still agnostic, guys, within the confines of the geographies that you've talked about in the past.

Or as you move further from Merchants and closer to the next M&A opportunity, have you fine-tuned your thoughts about the general areas of where you're thinking makes the most sense to head next geographically?

We aren't kind to jump multiple states, Joe.

We're not going to do a transaction in South Carolina or Texas or California or anything like that -- a banking transaction.

We would do a nonbank transaction just as we did the NRS transaction in Boston.

But I think, generally, contiguous movement and contiguous expansion over time of our franchise make some sense.

But I think with the success to date of the Merchants merger, we have opportunities to evaluate other potential partners in the greater New England market.

There's certainly a lot of room for us left in Pennsylvania.

It's a big state.

We're really only, right now, in Northeast Pennsylvania.

And so I think, we have a lot of other opportunities in Pennsylvania, and there are a lot of banks in Pennsylvania.

So I think a lot of opportunity there.

As you know, we've had discussions with a variety of institutions in Ohio, and we'd consider Ohio as well.

And then certainly, anything that might make sense for us in New York is, in our wheelhouse, at least nonmetro New York.

So I think we still have a lot of opportunity in most directions, though we can't really go north, because we run into Canada pretty quick.

But every -- directionally in other directions, I think, New England, Pennsylvania, Ohio, all are opportunities for us over time.

Okay.

And then last one from me on guys, still on M&A.

But you guys tend to do deals that are needle-moving for you, but not so large as your -- so where you're betting the ranch on the outcome, thinking the Wilbers, the Oneidas there.

Merchants was decently larger, but, you're obviously, you're now much bigger.

But would you contemplate something that's significantly larger as a percentage of the size of your company relative to what we've seen you do in the past?

Or more like than not -- does the prior pattern hold?

Fair question.

Merchants was the largest transaction we ever did.

It was about at the time 25% or so of our size.

We'd certainly continue to look at transactions of that size.

We might go up a little bit bigger.

I think we certainly have the operating and integration acumen to execute on something that might be a bit bigger.

I think the challenge is, as you get bigger, is the benefit to shareholders of doing something that's small, declines.

So it'd be difficult for us to do a $200 million, $300 million, $400 million kind of asset-size institutions.

Unless it's -- unless the benefit with other -- other benefits other than just the limited amount of accretion in shareholder values, if there is a strategic benefit or a geographical benefit or a -- if there was other benefits to the transaction.

So I think we're unlikely to do something really large like a merger of equals kind of things.

We've modeled everything.

We've modeled large transactions before, very large.

And they're certainly that can be additive to shareholders.

But in my view, the -- that level of addition of value to the shareholders is not worth the execution risk of doing something like that.

So we're probably never going to stretch beyond, let's say, 1/3 -- something that's 1/3 of our size, generally speaking, unless there's an atypical set of circumstances for some reason that we can't really foresee.

But as a matter of strategic policy, let's call it.

We probably aren't going to do anything that's more than 1/3 to 40% of our size is less likely.

Next question comes from Collyn Gilbert with KBW.

Mark, you may have covered this in your opening comments.

But just wanted to get a little bit more color around your outlook for loan growth.

Obviously, you discussed what happened in the third quarter.

But I think, fourth quarter is usually a seasonably slower quarter for you guys too.

So just kind of, in general, I know, and then -- but yet you indicated if you can get that 3% to 4% organic from a business model standpoint, you're in good shape.

I mean, what you're seeing in the market, do you still feel confident that you can get those kind of growth rates?

Or maybe just talk a little bit about future demand and where you see that coming on the lending side.

Sure.

After the credit crisis, it was good for us, because we have a lot of opportunities to work with customers that maybe had worked with larger banks before or even smaller banks.

And, there was -- I think we have a reputation in our markets in terms of safety and soundness.

And so that was a good period of growth for us organically.

Subsequent to the credit crisis, also for a number of years as the economy kind of slowly turned around, it was pretty good.

Where I've seen -- and this is the second time now.

I've been with bank 13 years, and I haven't seen every cycle.

But I've seen this cycle before, where markets get frothy and the trees start growing to the sky.

And if you look at during those periods of time, we perform less well than our markets, than our competitors during those periods of time.

I don't know if we're in that period of time right now.

It does feel like it, a little bit.

As I said, the mortgage market is fine.

We'll continue to get our returns there.

Our originations were up organically 3% year-over-year, some of which we sold.

So the balance sheet is not up 3%.

But the car business was intentional.

We managed that.

Sometimes, it grows 15%, sometimes it shrinks.

Right now, it's in a modest shrink mode and that's okay.

That's by design.

The commercial business, we're working hard on that.

And typically, as it relates to seasonality.

Interestingly, not for us.

The fourth quarter is usually pretty good.

It's usually, in terms of originations, our best quarter, has been for the last few years.

The consumer business is off typically.

It's a little bit softer in the fourth quarter and very soft in the first quarter.

But the commercial business usually performs pretty well in the fourth quarter.

As I said, the pipeline is pretty solid.

I think we would be certainly up this year.

Our origination level has not been bad.

It's just the payoffs and the sale of properties and assets and businesses has just accelerated.

Some of it's been refinancing, and we don't get all those deals.

We haven't really seen -- the market's always competitive.

So I've never seen any point in the market where it didn't feel competitive other than for a couple of years after the credit crisis, there was a window of opportunity there where it wasn't competitive.

But other than that, it's pretty much highly competitive all the time.

And spreads have gotten thin.

I mean, there's no question about that.

Our -- the margin on our business lending business has continued to drift down a little bit.

Whereas on the consumer side, it's tended to drift up a little bit more recently.

So we're hoping for a more productive fourth quarter in terms of C&I and CRE lending.

But some of that -- I mean, we know already, there's a fairly extensive list of projects, which have been sold and are going to -- got to pay out in the fourth quarter.

So we're already quite in the headwind of some known payoffs, which are not insignificant in size.

But our commercial teams are working very hard.

The pipeline is pretty good.

I expect we'll do okay in the fourth quarter.

I think we aren't going to get 3% to 4% loan growth this year.

I would suggest that if the market remains the same that we wouldn't get 3% or 4% next year possibly.

So the markets have been slow, and we do what we can in the markets, given the environment and the opportunities.

Never make any [conceptions] on credit quality or structure.

That's job #1 for us.

So we're working at it.

And we've never been in robust growth markets that's not likely to change for a long time, if ever.

And so there's a lot of other things that -- and if you look at our performance over the last 10 years, it's got nothing to do with loan growth at all.

It's important -- and that 3% to 4% is important because we can't get to a double-digit return for our shareholders if we don't get that 3% to 4% organic growth.

You've got a 3% dividend, you get 3% to 4% organic growth, you get 3% to 4% acquired growth, you get some expense leverage, and you get some nonbanking business growth.

That's been our model.

We're not in those markets where we can grow earnings because our balance sheet can grow organically by double digits.

That's not going to happen.

So we now would argue that the least important element to us in terms of delivering a return to our shareholders, if you look at our historical and current strategy, is organic loan growth.

But with that said, that 3% to 4% is pretty important.

Got it.

Okay, that's very helpful.

Very helpful.

And then just a question on the NIM.

Just trying to sort of reconcile legacy CBU with Merchants.

Because, obviously, I know Merchants came on, asset yields are running lower than where yours were.

But how should we think about kind of where the loan yield trends will be from here, I guess?

And is there more to sort of turn lower?

Or are we kind of seeing an inflection there?

Let me take a shot at that.

So if you went back to when we announced the transaction after the end of the third quarter of last year, we were roughly a core margin enterprise of around 3.65% legacy CBU.

Merchants was just a tick over 3%.

If you were to blend those together based on the asset mix, that we both currently had at that time, you'd have been at about a 3.50% to 3.55% level.

What I mentioned earlier is, if you just use the third quarter 2017 now, kind of what's happened in a year, we're at 3.56% prior to about 8 basis points of loan accretion.

So we're in that low 3.60% range with accretion.

About 5 of that 8 basis points of accretion came from the Merchants transaction.

If you remember where we were when we priced the transaction last third quarter, there's been 3 Fed rate changes since then.

So what we thought was probably going to be a neutral interest rate mark on the Merchants' portfolio actually became quote a "credit".

So that's just the granular side of how you get to that.

I think in terms of asset yield, I think Mark said it best, we're clearly -- new mortgages that are going on the books and new indirect auto loans that are going on the books are going on the books a little bit higher than where our blended average yield of those 2 portfolios are.

On the commercial side, pretty flat still.

As the -- as spreads have actually contracted, new volume is a little bit higher than maybe what it was at this point last year.

But at the same point in time, a lot of times what you're seeing coming off the portfolio in terms of some of the larger early payoffs have been some stuff with a little bit more robust yield.

So I think in the current state, I think, we feel better post Merchants that we're able to balance asset repricing and holding funding costs at a level that don't mean that we're giving up margin points.

So I kind of look at that as kind of a modeling expectation for us over the next 12 months to 15 months.

Next question comes from Russell Gunther with D.A. Davidson.

Just a couple follow-ups at this point.

One on the broader margin guidance.

Scott, I think you said low- to mid-3.60s with the accretion.

Does that consider the kind of semiannual dividend?

Or would we expect to maybe tack on 3 basis points to that range in the next quarter?

I think you get 2 of the 4 quarters get that 2 to 3 basis points each time.

So I think, we think about it as incremental net interest income, Russ.

So if you want to consider that incremental net interest margin generation.

Sure, that would be probably consistent with our expectation.

Okay.

And then just given the comments on expectations for loan growth going forward, maybe a little slower than we've seen from you guys more recently.

But what would that imply for how you're thinking about the securities portfolio?

Could we see that drift higher as a result?

Or just how you are thinking about managing that?

I think over the last 12 months, for sure, maybe a little longer than that, we certainly have not been putting money back into the securities portfolio on a consistent basis.

We've a little bit of different portfolio post Merchants.

Merchants had a much higher level of MBS activity.

So the cash flows are actually a little bit more -- a little quicker than a lot of the bullet securities that we have historically owned from a legacy CBU standpoint.

So I think in a market that expects rising rates, I'm not so sure this is the right time or the inflection point to be piling into securities, despite maybe a reasonable growth on the core deposit gathering side.

I don't think we would feel bad if we had sort of uninvested cash balances, which you're going to get return overnight in the 1% to 1.25% range anyway.

I don't know that we would take on a lot of asset extension in order to build that up at this point in the cycle.

Midyear next year, maybe [it will be] a little bit easier to [get] there.

Okay.

Very good.

I appreciate the color there.

I mean, just lastly.

If you have it, could you break out the wealth management and insurance revenue?

I think 3Q might be typically later on the insurance fee income.

I'm just trying to get a sense for the dynamics going forward.

You have it.

I do have it for you.

Bear with me, here.

For the quarter, insurance revenues are roughly $6.3 million and wealth management of $5.8 million, net worth together on that.

Next question comes from Matthew Breese with Piper Jaffray.

Just a couple of ticky-tack questions.

Deposit service fees were up quite a bit this quarter.

Could you just remind me of what drove that increase?

Actually, it's the Merchants transaction.

So just more transactions.

We've said this before.

Seasonally, the third quarter in terms of deposit service fees is our -- usually our best quarter of the year.

It's not that much better than the second quarter, but given the fact that we only had Merchants for half the quarter, that's the real driver, Matt.

Okay.

Should we expect a slight decline or flat for fourth quarter given...

Yes, what I would say is modestly down in the fourth quarter, but very, very close.

And then as you know, historically, we generate a $0.01 or $0.015 a share less of banking noninterest income in the first fiscal quarter, just less utilization of debit cards, certain other fees that we better tie to transactional outcomes as opposed to account balances.

So the first quarter is the only one that really kind of falls below the other 3.

Got it.

Okay.

And then along those same lines, could you remind us, seasonally, what are the high and low points in the insurance business and what we can expect for the fourth quarter there?

Sure.

Absolutely.

So the fourth quarter typically has a reasonable amount of -- we recognize revenue there on a renewal basis, in other words, in that business.

So the fourth quarter is usually pretty good.

The second and -- the third quarter is usually the low point of the year.

Fourth quarter is a little bit better than that.

The first quarter is usually pretty robust, and the first and the second quarter, you usually pick up the differential from your crude expectations and profit sharing and contingency payments in the insurance business versus your actual receipt.

So this year, you saw nice little spike for us because we had a very, very robust contingency profit sharing year coming out of the '16 year.

But again, now at our size, from a noninterest income standpoint, not really enough to move the needle.

Certainly, under a $0.01 per share in terms of fluctuation along that line.

Probably good time, Matt, to remind you and others from a modeling standpoint, due to the first quarter for us is also seasonally challenged from an expense standpoint, one, you typically get the impacts of a merit change on your employees from a [comps-sutation] standpoint.

Number two, a $0.01 to $0.015 more of payroll taxes associated with the early year payroll processing.

And for us, usually a $0.01 to $0.015 share of utility and maintenance-related expenses gets -- it never gets old to say, for us, it's just clearly more expensive to plow in heat than it is to air-conditioning mall.

That's just us.

Understood.

Upstate of New York gets cold still.

And then, just thinking about more broadly, margin stability, perhaps some slower loan growth, how do you feel about your ability to grow EPS on a year-over-year basis?

And what would you expect the impact to be without additional deals?

Well, I think we're -- we continue to execute on multiple elements of the strategy in order to grow shareholder value, because it can't just be for us organic.

So it's hard to predict what those kinds of things are going to be from year-to-year.

Frankly, we don't really manage year-to-year.

We manage on a somewhat longer-term time horizon in terms of the investments we make and the expect -- expectations we have around those investments.

So it's not quarter-to-quarter, and it's not really even year-to-year.

I mean, I think, our objective is that in 3 years from now, our shareholders will be making more earnings per share and more dividend per share than they are now and 3 years after that.

So I -- it's very difficult.

I mean, we may have a year where our earnings don't go up, they go down.

And I don't think that's necessarily unusual.

I don't think it's unnecessarily inconsistent with the way we make investments for the benefit of our shareholders.

So that's -- it's -- I mean, year-over-year is a little bit short term for us.

But the goal is always to increase earnings year-over-year.

In fact, our internal compensation structures, incentive compensation is around growing your earnings year-over-year.

So that's important.

We make every effort to do that.

But it's really about the above-average value that you create is not a year-to-year exercise.

So it's more of a longer-term investment, strategic exercise and -- but with that said, we manage expenses very judiciously.

We manage our -- the trends in our nonbanking businesses very judiciously.

We manage all kind of elements, revenues and expenses very judiciously.

And hopefully, over time, that creates improved performance when your revenues grow a little faster than your expenses.

And certainly, organic growth is very helpful to that, but that's probably the least important element of the overall strategy.

So it's really not about 1 year and the next year, it's about longer-term value creation and what do you do after 5 years and 10 years, and the ability to look back and judge yourself based on longer-term performance.

I think if you do that with us given our strategy, I think, that we've been executing pretty well on that over time.

So, I mean, year-over-year is difficult to comment on for us.

But with that said, there are things we do year-to-year to manage our business that we expect to create improvements, which is revenues, expenses, capital management, even M&A, which we view as a longer-term strategy.

But we are focused day-to-day at a very detailed level in operating this business for the most productive benefit of our shareholders.

But more broadly, the strategy investments are made and evaluated for a longer-term period of time.

But I'd echo that with kind of -- this kind of a summary.

If you look at us in 2011 and '12, we were kind of in the $2 per share earnings generation world.

If you moved forward to sort of late 2014 into 2015, it kind of ratchets that up to a $2.30 level.

Kind of look at where we are now, we're kind of in that $2.60 to $2.70 range.

So again, I think, over a longer than year-over-year period of time, if you kind of look at our opportunities to get capital fully deployed, whether that's organically or in terms of the other M&A opportunities, that's the longer-term strategy.

So we're sort of happy to be at the range of earnings generation that we've achieved now.

Kind of look forward, what are the next few things we need to do over the next few years to get us into more of that $3 range.

And so that's the task for our group every day.

Great color.

And then, I guess, my last one is, in regards to your reserve, Scott, you made the comment that you have 7 years' worth of historical charge-offs in there.

How should we be thinking about the reserve for total loans and longer-term impacts of CSIL on such a robust allowance?

Yes, great question.

The second one is bit more of a guess, but I will say, yes.

We think our reserves are robust today, Matt.

Absolutely, we do.

Do we believe that on a going-forward basis, this level of 0.75% of total loans, because now almost $2 billion of our loan portfolio "thinks it's acquired," therefore, carries no reserve against it.

But I think, kind of that 1% optic on new originations and legacy loans is probably a reasonable one.

But it's a little bit harder to predict provisioning characteristics.

The -- historically, we can always kind of start with net charge-offs plus or minus loan growth, because we have such a large book of acquired loans today, as they just naturally sort of mature and roll through time when -- of a loan that was acquired sort of rewrites itself 2 years from now, I think it's a new loan as opposed to an acquired loan.

So there's probably a provision allowance set aside for that.

The CSIL question is a great question.

If you look at us historically, you go to an historic model, one would think with 7 years' worth of net charge-offs and it's 7 years today and it was 7 years 2 years ago and it was 7 years 4 years ago that we are probably as close to being covered as almost anybody you could model.

So I don't think we think that CSIL has a gigantic impact on capital for the bank, but we're very early in the analysis part of that process.

And so too -- certainly too early for us to give any kind of prognostication of, geez, how much more capital do you use up or free up?

So...

(Operator Instructions) We next move to Jake Civiello with RBC.

Guys, you've already provided kind of great details.

Do you think that consumer origination volumes have been tempered this year in part due to some concerns or fears regarding potential federal tax changes?

And really the possibility of the loss of deductibility of real estate taxes, which really, I think, has a greater relative impact on some of your markets that have -- that you have elevated real estate taxes?

No.

I just -- I mean, people need houses, people move, people -- I don't think anybody is doing much -- certainly not in the consumer level, Jake, as it relates to potential changes in tax impacts.

And as I said, our mortgage business has been pretty good this year, pretty consistent, it usually is.

It doesn't move much over time.

So we have -- I don't think we've seen any impact related to potential changes in the deductibility of home mortgage interest.

But you did know the -- Jake, in our states, that would be a big deal proportionally to many other states in the country.

There are no further questions in queue.

I'd like to turn now the conference back over to management for closing remarks.

Thank you, Shannon.

Appreciate that.

Thanks, everybody for joining.

And we will talk again in January.

Thank you.

Thank you, ladies and gentlemen.

That does conclude today's conference.

We thank you for your participation and you may now disconnect.