Community Financial System Inc (CBU) 2019 Q1 法說會逐字稿

Welcome to the Community Bank System First Quarter 2019 Earnings Conference Call.

Please note that this presentation contains forward-looking statements within the provisions of the Private Security (sic) [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 Joseph Sutaris, Executive Vice President and Chief Financial Officer.

Gentlemen, you may begin.

Thank you, Jenny.

Good morning, and thank you all for joining our Q1 conference call.

We hope everyone had a joyous Easter holiday and start to Passover.

We're very satisfied with the quarter that was about as expected, our earning is up a little while in flat, deposits are up.

The high point takeaway for me for the quarter was that we more than offset a $0.05 per share Durbin hit compared to last year's Q1.

Margin was up a couple of bps, operating expenses were a bit better than we expected, nonbanking revenues grew 3% and the asset quality metrics were very good.

Loan growth was flat given the seasonal run-off of the auto book, but both the commercial and mortgage portfolios were up slightly, which is a good outcome for the first quarter.

Deposit inflows were strong due mainly to municipal seasonality, and core checking and savings balances were also up in the quarter.

All in all, a very good start to 2019.

The integration and transition efforts of the Kinderhook merger are going extremely well, and we have received all regulatory approvals.

The Kinderhook shareholder meeting is tomorrow, and we are confident that their shareholders will approve the transaction.

Our existing commercial lending business in the Capital District continues to perform at a very high level, and we're excited about the future opportunity when we close the Kinderhook transaction in the first half of July.

Looking ahead, we have strong earnings and operating momentum across the business, which should position us well for the remainder of 2019.

We continue to accrue capital at a pace greater than what we need for organic growth, which provides tremendous dividend capacity and strategic flexibility upon which to build further value for our shareholders.

Joe?

Thank you, Mark, and good morning, everyone.

As Mark noted, we're generally pleased with the company's first quarter 2019 earnings results.

The company reported GAAP net income of $41.9 million and earnings per share of $0.80 during the first quarter 2019.

This compares to net income of $40.1 million and $0.78 in earnings per share for the first quarter of 2018.

The $1.8 million improvement in net income and $0.02 improvement in earnings per share were achieved in spite of absorbing over a $3 million or $0.05 per share reduction in noninterest revenues due to Durbin-related debit interchange price restrictions imposed on the company between the periods.

Operating earnings per share, which excludes acquisition expenses net of tax effect, increased $0.03 per share from $0.78 in the first quarter of 2018 at $0.81 in the first quarter of 2019.

The return on assets and return on tangible equity for the quarter were 1.59% and 17.61%, respectively.

I'll now make a few comments about our balance sheet before providing additional details on the quarterly earnings results.

We closed the first quarter of 2019 with total assets of $10.92 billion.

This is up $309.2 million or 2.9% from the end of the fourth quarter of 2018 and down $50.1 million or 0.5% from the end of the first quarter of 2018.

Average earning assets for the first quarter of 2019 of $9.37 billion were up $67 million or 0.7% when compared to the linked fourth quarter and consistent with first quarter of 2018 average earning assets of $9.38 billion.

The growth in the company's balance sheet during the quarter was largely attributable to the season -- seasonal inflow of municipal deposits.

Average loan balances for the first quarter of 2019 were essentially flat to the linked fourth quarter of 2019 (sic) [2018], but up $36 million or 0.6% over the first quarter of 2018.

As Mark mentioned, although the company's total loan balances were essentially flat in the first quarter due to decreases in the indirect auto portfolio as seasonally expected, both the business lending and consumer mortgage portfolios grew slightly.

Total deposits increased $297.3 million or 3.6% on a linked-quarter basis due largely to an inflow of municipal deposits, as seasonally anticipated and consistent with prior year's annual cycles.

Checking and savings accounts represented 68.4% of total deposits at March 31, 2019, a solid increase from 66.6% 1-year prior.

Our total deposits -- total cost of deposits for the first quarter of 2019 was 20 basis points, reflective of our very solid base of core deposits.

At March 31, the company's investment portfolio stood at $2.97 billion.

The portfolio is largely comprised of treasury securities, agency mortgage-backed securities and high-quality municipal securities.

The effective duration of the portfolio was 3 years at March 31, 2019.

The company also held seasonally high cash and cash equivalents of $508.4 million at the end of the first quarter.

The first quarter 2019 tax equivalent yield on the investment portfolio, including cash equivalents, was 2.58%.

Principal cash flows from existing investment securities portfolio are expected to total approximately $160 million for the balance of 2019 and $790 million in 2020.

We anticipate reinvesting and potentially pre-investing a portion of these anticipated cash flows in similar types of securities prior to the maturity as investment opportunities present themselves over the coming quarters.

As mentioned in my opening comments, operating earnings per share were up $0.03 as compared to the same quarter in the prior year.

The improvement in operating earnings per share was driven by an increase in net interest income and decreases in the provision for loan losses and income taxes, offset in part by lower noninterest revenues, higher operating expenses and an increase in fully diluted weighted average shares outstanding.

Net interest income increased due to widening of the net interest margin in the most recent quarter to 3.80% as compared to net interest margin of 3.71% reported in the first quarter of 2018.

The tax equivalent yield on the company's loan portfolio increased 25 basis points between the comparable quarters from 4.53% for the first quarter of 2018 to 4.78% in the first quarter of 2019.

Although the first quarter 2019 loan yield was favorably impacted by 6 basis points due to certain loan prepayment fees, the company's total yield on loans continue to trend upward.

Comparatively, the total loan yield in the linked fourth quarter was 4.65%.

During the first quarter of 2019, the average yield on new loans was exceeding current book yields by an average of 50 basis points.

Over the same comparable quarters, the company's total cost of funds increased 10 basis points from 17 basis points in the first quarter of 2018 to 27 basis points in the first quarter of 2019.

The yield on the investment portfolio inclusive of cash equivalents increased 2 basis points from 2.56% in the first quarter of '18 to 2.58% in the first quarter of 2019.

Noninterest revenues in our nonbanking businesses were up $1.2 million or 3.2% or were offset by a $3 million or 14.8% decrease in banking-related noninterest revenues due to a decrease in debt interchange fees in connection with the company being subject to the Durbin Amendment in the third quarter of '18.

Despite the Durbin reduction, noninterest revenues contributed 39.1% of the company's total operating revenues during the first quarter of 2019, consistent with full year 2018 results.

Compared to the prior first quarter, total operating expenses, excluding acquisition expenses, were up $1.8 million or 2.1%.

Increases in salaries, employee benefits of $1.5 million or 2.9% and other expenses of $1.2 million or 6.1% were offset in part by a $0.2 million or 2.3% decrease in occupancy and equipment expenses, a $0.7 million or 13.9% decrease in the amortization of intangible assets.

We recorded $2.4 million in the provision for loan losses during the first quarter of 2019.

This compares to $3.7 million recorded in the provision for loan losses in the first quarter of 2018, a $1.3 million decrease between the comparable periods.

The decrease in the provision for loan losses was reflective of an improvement in the company's asset quality metrics between the periods.

The effective tax rate for the first quarter of 2019 was 18.5%, down from 23% in the first quarter of 2018.

The company had significantly higher levels of income tax benefits related to stock-based compensation activity in the first quarter of 2019 as compared to the first quarter of 2018.

Exclusive of the stock-based compensation tax benefits, the company's effective tax rate was 21.8% in the first quarter of 2019.

The income tax benefit related to the company's stock-based compensation activity contributed $0.03 of operating earnings per share for the first quarter of 2019.

Our asset quality remains strong.

At the end of the first quarter of 2019, nonperforming loans comprised of both legacy and acquired loans totaled $24.2 million or 0.39% of total loans.

This was 1-basis point lower than the ratio reported at the end of the linked fourth quarter and 9 basis points lower than the ratio reported at the end of the first quarter of 2018.

Our reserves from loan losses represent 0.78% of total loans outstanding and 0.94% of legacy loans outstanding.

Our reserves remain adequate and exceed the most trailing 4 quarters of charge-offs by a multiple of 5. The allowance for loan losses to nonperforming loans was 202% at March 31, 2019.

This compares to a 197% at the end of the linked fourth quarter and a 162% at the end of the first quarter of 2018.

We recorded net charge-offs of $2.6 million, or 17-basis point annualized in loan portfolio during the first quarter of 2019.

This compares to net charge-offs of $3.2 million or 21 basis points starting in the first quarter of 2018.

We do not currently have any commercial OREO properties, and the internal loan risk rates portend stable asset quality.

Shareholders' equity increased to $125.7 million or 7.7% between the end of the first quarter of 2019 and the end of the first quarter of 2018, due largely to an increase in retained earnings.

Our capital ratio has also remained strong in the first quarter.

Company's Tier 1 leverage ratio was 11.27% at the end of the quarter, over 2x the well-capitalized regulatory standard.

Tangible equity and the net tangible assets ended the quarter at a solid 9.83%.

This is up from 9.68% at the end of the linked fourth quarter of 2018 and 8.42% at the end of the first quarter of 2018.

Both the Tier 1 leverage ratio and the tangible equity to net tangible asset ratios are expected to decrease by approximately 100 basis points as a result of the pending Kinderhook transaction.

Looking ahead, we do not anticipate any significant deviations from recent trends around the company's net interest margin results, operating expenses and asset quality exclusive of the pending Kinderhook transaction.

In addition, the seasonal characteristics of the business are unlikely to change significantly.

Although we anticipate continued improvement in the loan yields, we also expect to face some continued pricing pressure on the funding base.

The persistence of a flat yield curve likely remains a headwind for the banking industry.

It potentially portends a setback in the economy and could begin to impact margin results that could persist several more quarters.

We remain cautiously optimistic about the commercial loan pipeline and potential opportunities for continued revenue growth in our nonbanking businesses.

Since the Durbin restrictions did not become effective until the second half of 2018, we also expect that the second quarter 2019 earnings will also be unfavorably impacted by $0.05 to $0.06 per share as compared to the second quarter of 2018 results.

In summary, we believe the company remains very well positioned to effectively integrate the Kinderhook Bank Corp.

merger early in the third quarter of 2019 and anticipate a smooth integration.

We also continue to expect that Kinderhook will be $0.07 to $0.08 accretive in the company's operating results on a full year basis.

Thank you.

Now I'll turn it back to Jenny to open the line for questions.

(Operator Instructions) And we will hear first from Austin Nicholas of Stephens.

You obviously had a nice quarter for the core NIM when you back out some of the noise.

And I guess, as you look out from here, can you maybe provide some thoughts on kind of where may be your incremental margin was coming on at the end of the quarter as you looked at your loan yields and your deposit costs?

And then kind of any guidance on how you'd see that trajectory through the course of the year given where the yield curve is and kind of no further rate hikes on the horizon?

Yes.

Austin, we witnessed kind of new loans going on at about 50 basis points higher than the current book yields, which was actually similar to the fourth quarter outcome.

So we've seen a bit of leveling on the new loan rate yields.

Obviously, if the yield curve stays flat, we would expect that competitors would certainly put a cap or potentially start to lower some of those rates, but that yield curve would have to persist for an extended period of time for us to see that.

From a cost of funds perspective, we were up 4 basis points in the first quarter over the fourth quarter, and I would expect that we're going to continue to see that pressure, perhaps able to continue to maintain a deposit beta that's similar to say the fourth quarter and the first quarter -- fourth quarter of '18, first quarter of 2019 as we look ahead into the rest of the balance of the year.

We have not seen a large -- very large market competitors put out extremely aggressive rate on the deposit side.

But with that said, we're also aware that we need to maintain our current deposit base and certainly defend those deposits.

Sure.

That's helpful.

And then maybe just on the deposit topic, could you maybe give us or remind us of the kind of duration or, I guess, how long does municipal deposits stay on the balance sheet and kind of what the outflow could be expected to be in the second quarter and the third quarter?

Just maybe kind of any commentary on the variability that you generally see in that and if there's been any changes in that?

Yes.

We typically hit our high point in the first quarter, as in New York state, the tax collection cycle is early or actually in late January.

So we tend to see a increase in those deposits, typically a couple hundred million dollars in the quarter.

We then tend to see those drift down a bit in the second quarter and then sort of hit their low point in the third quarter.

We start to see several of those come back in the fourth as the school districts collect their taxes in New York state.

And usually, the delta is a couple hundred million dollars between the high points and the low points.

Understood.

That's helpful.

And then maybe just one last one on M&A.

Can you remind us of your outlook for M&A on the whole bank front after Kinderhook is closed?

And then on the kind of nonbank side, any changes in what you're seeing in the market from opportunities in employee benefits business or also on the investment management or the kind of insurance side of the businesses?

Sure.

I think it's our -- Austin, our strategy really hasn't changed much.

It's pretty consistent, which is try to identify high opportunity, high-value acquisition targets, whether it's banking or nonbanking that we think can be additive to our franchise and our capacity to generate the long-term growth in earnings and cash flow.

So the strategies -- strategy hasn't changed much.

I mean, we continue to be actively engaged on opportunities across that spectrum.

And I think I would say that maybe recently there's been more of an uptick, a slight, modest uptick in potential opportunities and activity just based on kind of the flow and conversations and all of that that we have on an ongoing basis with potential merger partners as well as with investment bankers.

So I think that's probably a good news.

I think on the nonbanking business side, we've done a number of, I would say, kind of smaller insurance add-ons to our existing insurance business.

We haven't done historically many significant wealth management acquisitions.

Although we did do a small one over the course of the last 6 months or so.

And with respect to the benefits business, we're always looking for good opportunities there.

We have a significant benefits business that's national in scope.

I think we're -- and the leadership are pretty plugged into the opportunities that evolve there.

The interesting development, I think, I'd comment on this in the past relative to the benefits-related business is, there is a lot of venture capital money and private equity money going into that space, which changes the economic and valuation characteristics for a strategic buyer like us.

So we continue to be active, Austin, and continue to see opportunities.

I would say not really any significant change in the market really, maybe marginally better than 1-year ago, I guess is how I would characterize it.

Okay.

Got it.

That's helpful.

And then maybe just on the organic growth in that business.

Is it still fair to think about it in the kind of mid-single-digit fee income growth range, barring any kind of major market downturn that could impact kind of asset values?

Yes.

I think you nailed it.

I think mid-single digits.

Some of those businesses have grown at twice that pace, and some of them have grown less than that.

So over time, I think together I would say mid-single digits is a good number.

And we will hear next from Alex Twerdahl of Sandler O'Neill.

First off, just wanted to drill in a little bit on some of the long growth trends that we saw during the quarter.

I assume from the large level of prepaid fees that there were some significant commercial paydowns during the quarter that maybe hinder that overall loan growth number?

No.

Actually interestingly enough, we had a better quarter as it relates to prepayments, which was good to see.

It was in the, I think, it was $25 million range or somewhere around there, which is less than kind of what we've seen here trending historically.

The big prepayment fee was really related to one significant credit that paid down in the quarter.

So the experience on the prepayments overall was actually okay for the quarter.

Okay.

And then just maybe elaborate a little bit on the outlook for some of the different portfolios as the year progresses?

Sure.

Obviously, the first quarter is always really difficult in the auto book.

The cash flow on that portfolio of short duration average of 30-something months.

So it throws up about $30-plus million a month in cash flow.

In our market, there's not a lot of activity in January, February and March.

So we had some run-off in that portfolio, actually not that bad all things considered, maybe less than historical.

So I'd expect the auto book to grow in the second and third quarters as well.

The mortgage business is good.

The pipeline is up.

We're turning them around faster as well, which is good.

We're starting to see a lot -- a bit greater mix of purchased mortgages as opposed to refis, which is also good.

So I mean, the fact that we actually were up in the mortgage book in the first quarter is also pretty good because there's also not that much real estate activity in the first quarter, leased residential.

So that was good.

And we would hope that the second and third quarters are good in that business as well.

I think we're doing a good job in that business in terms of some of the marketing efforts that we're undertaking across the business.

So I expect that, that will be additive.

So I look forward to a productive outcome in the mortgage business in the second quarter.

Now our commercial, the pipeline is really good right now.

A couple of things in there are much larger credits that could go either way.

So I'm cautiously optimistic, I guess, there on the commercial side.

I'm hoping that the trend of lower prepayments continues into the second quarter.

That would be good.

So I would also expect that -- we've got -- that the pipeline is really strong in some parts of our franchise, Pennsylvania is really good, the Central and Western New York is good, Capital District is really good.

So I hope that we have a continuation of lower prepayments and given we're kind of in a more seasonally advantageous period of the year that the second quarter is also productive for the commercial lending business.

Okay.

And then switching gears to kind of drill down a little bit more to some of the moving parts in the margin.

Joe, over the last couple of quarters, you've kind of alluded to some of these -- there's a possibility of reinvesting or pre-investing some of the securities portfolio.

We haven't really seen you guys do much there, and you're sitting on a pretty good chunk of cash at the end of the second quarter.

What are you specifically looking for in terms of opportunities to actually put some of that cash to work faster?

And then would it primarily be funded with the cash on hand?

Or would you go out and borrow to fund some of the pre-investments?

Yes.

At this point -- well, let me back up a little bit.

So in the third and fourth quarter, we had a little bit more opportunity in the yield curve to go out a little bit certainly on the treasury curve.

The mortgage-backed securities were again, we had decent returns there.

That's backed up a little bit.

So that opportunity hasn't been there in the -- it wasn't there in the first quarter.

But with that said, we do have a $160 million expected to run-off in the investment securities portfolio for the balance of the year.

So we're just looking for after you pick a couple of spots, we'll get a little inflected in the curve throughout the -- to a little bit of steepness throughout the year and we can pick our spots.

But we also have some plans in the work for just at least reinvesting those cash flows.

So we're not anticipating leveraging necessarily at this point unless we get a significant change in the yield curve.

Yes, I would just add, Alex, I think, as the tenure gets to 3 that's probably a trigger point to start looking at what opportunities might be.

We also are investing a little bit in the municipal securities market right now.

The curves are better there, and the spreads are a little bit better.

So that's just really not what you kind of refill the bucket from the $160 million that's going to mature otherwise in 2019.

And the other thing is that we're set -- we're -- from an interest rate risk perspective, we have more risk to falling rates than rising rate.

So we just want to make sure that our balance sheet is properly positioned.

We're not going to put ourselves in a position to -- if there is a significant reduction in the rate environment like we saw a couple of years ago that we're well positioned in terms of managing the risk to a lower rate environment.

So just, I guess, follow-up comment.

Okay.

And then perhaps you can give us a little more color and outlook on how you're kind of envisioning the expenses to run over the next couple of quarters?

Just given some of the seasonality that maybe you can remind us of in the first quarter?

And then in terms of cost saves for Kinderhook, I'm not sure you ever gave a formal number, but kind of how should we thinking about the overall expenses for the year?

Okay.

Relative to the operating expenses, excluding Kinderhook, we were up just under 3% in operating expenses this quarter versus the first quarter of 2018.

I think that's the first quarter is a reasonable expectation for the future quarters for 2019, exclusive of Kinderhook.

Kinderhook has -- had operating expense run rate of about $16.5 million in 2018.

We had modeled a 30% reduction in the operating expenses, which right now, we're anticipating that to hold barring some sort of unforeseen circumstance.

So I think that's kind of the expectation on operating expenses looking forward.

And now moving on, we have a question from Russell Gunther of D.A. Davidson.

Just want to follow-up on the comments about the commercial pipeline pulling through here.

If you could characterize it, is it more of an expectation for originations to pick up, an increased activity or paydown headwinds to ease or if it's some combination of the two, how would you weight that?

I'm hoping for both.

Got it.

And then any color you could -- yes, I'm just trying to get a sense if you think there's more of a lift going on from a loan growth perspective that could drive that where if paydowns lessened that's kind of an nice extra tailwind to you there?

Or is it really more you'd expect paydowns to ease and let things kind of flow through?

Yes.

I would hope paydowns would ease.

I mean, one quarter doesn't constitute a trend.

But it was good that it was down instead of up.

So hopefully, we'll get that.

We obviously have less control over prepayments than we do originations.

I think in our markets we got to work pretty hard to grow at 3% to 4%, that's tough.

So I don't want to put too much pressure on our commercial team.

We're also -- one, we're in lower growth markets; and number two, we're very conscious of credit quality.

So we're never going to -- it's very unlikely that we're ever going to deliver commercial loan growth of 10% or 8% or 9%.

So if we can get even 2%, 3%, 4% organic growth in our markets after payoffs and cash flow, that's a pretty good outcome for us.

So that's what I would, I guess, hope for second and third quarters.

That's very helpful and I appreciate clarifying that.

And then any granularity you guys could share with regard to the larger credits you're hoping to pull through whether it's type of loan or a particular region.

Any trends to take away from that expectation?

No.

There's just a couple of large, I would say, high-quality transactions that we probably syndicate anyway in terms of -- syndication for participations.

So they tend to be high-quality credits, they tend to be lesser spreads in very high-quality customer in business relationship opportunity.

So that we put our best foot forward and hope for the best.

But if you look at and we're not going to -- I won't give you the numbers, but the absolute dollar value of the pipeline is $100 million more than last year.

And I would just say that, that $100 million constitutes 2 or 3 larger credits.

And we'll go to our next question from Erik Zwick of Boenning and Scattergood.

First, maybe just a follow-up on the deposit pricing conversation.

Are you guys currently running any deposits specials in your markets?

And if so, what products and at what rates and maturities?

Yes.

We are kind of looking at our customer base and looking at the competition and on a retail side, we have a couple of products that we're offering to our retail customer base and we've been successful holding those in.

Relative to the rates, our cost of funds was up 4 basis points.

So we're trying to put rates out here that are basically in the markets.

We don't necessarily and haven't typically been at the absolute high of the market.

Across all markets, we have a pretty broad geography.

So we're putting competitive rates out into the market right now, and I think we're doing a pretty good job of maintaining that deposit base.

The other thing just as a reminder, Erik, about 2/3 of our total deposit base is checking and savings account that have a cost of funds that's around 0. So we start from a pretty strong base of core deposits in terms of managing that.

And it's really not that some of that isn't interest-rate sensitive because sometimes it is.

But it's not like we need to on aggressive full-scale retail basis compete on rates to hold in the majority of our deposit funding.

We don't need to do that.

So that's, I guess, say a benefit and an advantage.

And what we've typically done with kind of the some of special products that Joe referred to is use them on a selective basis with customers in the market, whether they come to us, or in many cases, we've gone to them to help position them better to ensure that we aren't at risk with those deposit relationships.

So we're not in the market on a broad basis with higher rates.

We're doing it selectively, but starting from a strong position to 2/3 of our deposits are checking and savings accounts.

Understood.

And then just kind of a recordkeeping one.

The amount of purchase accounting accretion in the first quarter stepped down from the average level recorded quarterly last year.

What's the expected scheduled accretion for 2Q?

Yes.

I would expect 2Q to be not dissimilar from Q1.

The slowing in the prepayments on that portfolio certainly created a little bit of a decrease in the accretion.

And we like the level of our prepayments' knowledge slowed a bit, but that will also negatively impact the accretion.

And then just one more for me.

With regard to Kinderhook, I appreciate the updates on the regulatory and shareholder approvals.

Could you provide any commentary on your expectations for deposit retention as well as any -- maybe some color on the efforts you've made to reach out to their larger relationships, both on the loan and deposit side?

Sure.

Every transaction is a little bit different in terms of the market and the risks in that market.

I would expect that the performance here will be pretty good.

They have a really good relationship with their customers.

They have a good reputation in their market.

We had spent a lot of time, our people, our team, our leadership in that market getting to know people, getting to meet people, their customers, on the ground with their customers.

So I think we're off to a pretty good start there.

I would be surprised if there was a atypical level of runoff in either the deposit franchise or the loan book.

And we'll hear next from Collyn Gilbert of KBW.

Just wanted to start off on the growth discussion.

You gave the growth or some of the commentary around the commercial pipeline and kind of commercial outlook, but just curious as to what you think you can do in terms of overall organic loan growth given the dynamics that continue to happen on kind of the consumer indirect side.

But what your growth outlook is for the year and on total loan growth?

Well, the first quarter -- if we can be flat in the first quarter I think you would historically generally we're kind of flat, sometimes we're down.

Actually, there's been in years where we've been up a little bit, but I think this year at flat is pretty typically historically.

Given where the pipelines are and kind of what I see is the trajectory in the business in our markets, I -- we'd hope that we get that lower single-digit growth in the organic loan performance for the year.

If we can get all-in 4% for a year that's a pretty good year for us; 2% to 3%, you know that doesn't sound like much compared to a lot of banks in other markets, but we're pulling a lot of other levers in terms of earnings performance and not just the balance sheet because we don't have it in our market.

So if we can grow the loan book 2%, 3% and get operating leverage and other pull-through on that with other relationships, then that's kind of the model.

So I would hope that we get to that in 2019.

I think the start we're off to is fair to get there.

But it's hard to predict, particularly on the commercial side with some of the prepayments.

I think, we as such, I would say above-average prepayments last year than it would seem to me that it almost has to revert to the mean.

That's our prediction because I can't predict that.

But the first quarter was good.

Hopefully, we get a continuation of that into the second and third quarters where we usually grow the mortgage portfolio, where we grow the auto portfolio and where we grow the commercial portfolio.

So if we can end the year at -- if you start flat after the first quarter, you got to grow a little more to get to a 3% or 4%, I would take that if I could right now, but that's the goal.

Okay.

That's helpful.

And then as you look at the overall -- your overall markets, where are you seeing some of the best opportunities for household formation or new customer acquisition opportunities?

You had mentioned some of the markets that were doing well on the commercial side.

But just curious from -- on a sort of consumer retail side, where you're seeing some opportunities for growth?

Consumer retail, so I'm assuming I think it's more mortgage, right, the indirect auto book is -- it depends on the market.

We don't usually outperform the market.

No, we try not to because that means you're over competing on rates.

I think from the mortgage standpoint, we've always had a very strong mortgage business in the North of New York, in Central New York, in Western New York.

I would say last year, we had a really good year in Pennsylvania, probably our best year ever in mortgage originations in Pennsylvania.

I think I expect to actually do better than that this year even in Pennsylvania.

There's a lot of opportunity in Vermont also.

And we had a slightly different go-to-market model in mortgage lending than Merchants did.

So it's actually taken us a little while to get some traction there.

Last year, the Vermont, New England region mortgage runoff was something like $40 million.

So we're hoping that that will not be the case this year.

And so we've done some work to inject some resources and try to reposition our resources and market strategy in Vermont.

It actually is already starting to improve.

So I would say that's kind of -- I don't know if your question Collyn was beyond the mortgage business but...

Well, that's helpful.

And I know on the indirect side, of course, a mindfulness to risk and credit.

I get it.

I just didn't know if there were any markets where there is an opportunity for you to take share if the competitive landscape is changing?

Or yes, just thinking more structurally where you can go with some of your businesses from a geographic perspective?

Yes.

I think we have more opportunity in Pennsylvania, and I think we'll continue to do better there.

I don't -- I mean, the market isn't growing rapidly.

In fact, it's kind of a low-single-digit growth market, but I think we're executing better in Pennsylvania, so we're getting more share.

I think that's good.

I think we have the opportunity in Vermont to execute better, and I expect we will this year.

And as I said, we're already starting to do that.

And I think that the Capital District, Albany in that marketplace, we have tremendous opportunity there as well.

So I think there is pockets of opportunity for us across the footprint as it relates to mortgage lending.

And honestly, we upped our game in terms of executing across all our markets in that business.

So I am hopeful that we'll have a productive year in mortgage lending in 2019.

Okay.

Okay.

That's really helpful.

And then, Joe, just in terms of the NIM outlook, so I just -- I want to make sure I kind of understand some of the moving parts here.

So this quarter, you had said -- if I heard you correctly, you guys had 6 basis points of prepayment income?

Yes.

Yes, correct.

There was a onetime fee associated with a particular borrower that was about $1 million, which was a 6 basis point effect on loan yields.

Okay.

And then if we kind of think about the NIM trajectory kind of for the full year, bringing on Kinderhook, I think they were operating close to like a 3.50% NIM or a little bit of lower of a NIM certainly than what you guys had.

And then I think that when you had given guidance last quarter on the mid-3.70% NIM that assumed 2 hikes -- 2 rate hikes.

So just want to kind of get all the blendedness here of some of these moving parts and where you're thinking the NIM will shake out for the full year?

Yes.

I mean, the mid-3.70% is prior to the Kinderhook transaction I think is still a reasonable expectation.

We did okay on the deposit side of the equation with a 4 basis point increase.

We did lose, if you will, the expectation although that's not off the table yet relative to rate hikes and the impact that would have on the variable portfolio, but we have offset some of that with better-than-expected results on the deposit side.

So prior to the Kinderhook transaction that mid-3.70s range.

You're right, Kinderhook's current margins -- or most recent margins are a bit lower than ours.

It adds about 5% or 6% to our earning asset base.

So there is some net -- potentially net reduction in core margin relative to the inclusion of Kinderhook.

So I think that's a fair expectation, but it's also 6% of our earning assets.

Yes.

Okay.

Okay.

That's helpful.

And then just finally, Mark, just back to you on the kind of tying into the growth outlook.

And obviously, your capital's been building, it will dip post Kinderhook, but then rebuild pretty quickly thereafter.

You had indicated giving you a lot of capital flexibility, you also outplayed thoughts on M&A.

What -- kind of is there a trigger or how -- is there a sense of urgency or how are you thinking about that capital deployment?

And is there a near-term targeted TCE ratio you want to get to?

Or just I guess kind of asking for a little bit more detail on capital usage given how much you guys are building capital?

Sure.

Well, I think if you back a few years, we were at a similar situation, we were building capital rapidly.

We said at that point in time that's one of our kind of strategic focuses was effective deployment of that what I would consider excess capital relative to the quality of our balance sheet, and -- but we were not going to be in a hurry to do something with it, but we would be patient and disciplined.

And along came the opportunity for Merchants in NRS where we deployed $150 million or so of that surplus capital.

I would give the same answer as a couple of years ago, Collyn, which is we're going to be patient and we're going to be disciplined.

We're not going to squander the opportunity that we have because we're in the fortunate position of having surplus capital that continues to accrete and generate every day and every quarter, but we'll be disciplined.

So that could be an opportunity that arises next week and it could be an opportunity that arises next year.

I think it gives us lots of dividend capacity as well.

I mean if you look at our payout ratio right now, despite the fact we've grown the dividend every year for 26 years, our payout ratio still is not that high relative to the organic growth part of our strategic model.

So between dividend capacity and M&A capacity and you noticed the last 3 transactions in Kinderhook was all cash, just a great utilization of capital; Merchants was 30% cash about $100 million; and NRS was about $70 million in cash.

So even with all this said, if you look at the current capital ratios in metrics, we're still and remain beyond well-capitalized, but I would say beyond well-capitalized even relative to our balance sheet.

So we'll continue to -- as we do and have for -- and need to do frankly because it really is all about that above-average return to shareholders if we're not deploying that capital productively.

This is not about the timeliness of it, it's about the productivity of it.

So you have to use it for purposes that will generate growing and sustainable cash flows for shareholders.

So that could be this year and it could be next year and it could be the year after.

But I think if you look back at our history, we've been sufficiently active over time in terms of high-value M&A opportunities that I think we have the model and the ability to execute and identify and effectuate those high-value transactions over time.

We get, and I've said this in the past, but we give a lot of looks at a lot of things.

Almost everything that comes up within couple of states of us, we kind of know about and get a look at.

And those opportunities continue even right now.

There is also those where we understand our very high-value opportunity for us as an institution.

So we're more active in our outreached efforts to have that dialogue with others.

So that will continue.

We're not going to be undisciplined in terms of how we deploy that capital.

And again, it's difficult to predict, but the one thing I will say is we will be disciplined in deploying that capital in a way that we believe will help further our strategic effort to create growing and sustainable cash flows per share for our shareholders.

And we'll hear next from Matthew Breese of Piper Jaffray.

I just wanted to follow-up on the NIM discussion.

Just -- I know the outlook is for the mid-3.70s ex the loan fee, but just thinking about the moving parts there, I mean a 4 basis point increase in the cost of deposit is still relatively modest and your new loans that are coming on board of 50 basis points better.

So I would just think that with that kind of math that the natural trajectory is higher for the NIM as we think about the next 12 to 18 months at least organically.

Is that the right way to think about it?

Yes.

Well, the one comment I would add to that, Matt, is so the our -- we book about $300 million to $350 million of new loans in a quarter, if you look at kind of the historical average.

So yes, it's nice to pick up that 50 basis points we have the last 2 quarters or so, whereas with $8 billion in deposits, 4 basis points is a bit more meaningful.

So I think we have -- you look at the ratio of total deposits versus just the opportunity on new loans, that's why we're sort of in that range of mid-3.70s.

Right.

Okay.

Okay.

So you think the 3.70% range is there to hold all those equal at least for the next few quarters?

Yes.

I mean, obviously, the changes or we have a yield curve that's kind of static and stays where it is, that gets little more difficult in future quarters.

But right now, the -- we've had some momentum on the loan side of the equation.

And if we can maintain pricing relative to our competitors, our expectations are that we'll continue to see loan yields drift up a bit.

Okay.

Understood.

And if we do get a rate cut by the end of the year, what is the impact of the NIM over the ensuing 2 or 3 quarters do you think at this point?

Well, we have in variable rate loans, assets just around $1 billion.

So the impact of a -- if it's a 25 basis point decrease, we would see pretty significant immediate impact to that portfolio.

Obviously, we have sharpened the pencil around the entire pricing for loans and deposits.

But yes, immediately there would be a negative impact to those variable rate loans.

Okay.

Okay.

And then just thinking about your deposit base, Mark, I think you mentioned 2/3 are checking and savings.

And if we're at the end of the Fed hike cycle, I think you guys have done quite well from a deposit beta standpoint.

Just thinking about what's new technology-wise this cycle than in past ones, one would think that the rule deposits might be more at risk, but you guys have clearly demonstrated that you can perform very well.

So I guess, the question is why might there be more of a moat around your deposit base versus some of the technological advances over the years?

And with that in mind, might we see just a slower creep higher post the Fed cycle stopping?

I guess, that's a broad question that in terms of the impact of technology.

I mean, I would start by saying if you look at the things that JPMorgan can do and Bank of America and the big Wells Fargo and some of the big retail banks -- the biggest retail banks in the country, I think I'd said this before, but there's -- if you look at our platform for online and mobile and cash management, there's very few things that the big banks can do for customers that we can't do.

Peer-to-peer payments and all that kind of thing.

We can do all of that as well, so can a lot of other small banks.

I think there's a lot of noise, let's call that an excitement and venture capital funding around kind of fintech, let's call it.

To date, what that has involved is creating an online product and paying [235] for it.

So ultimately, you're at risk maybe because over time of the rates of those platforms, but I still think that certainly in our markets and I would argue in other markets as well that branches still matter.

I mean look at JPMorgan what they're doing, they're building branches all over the country.

Yes, they are in select markets where they want exposure, but if they can -- it's the biggest and presumably best bank in the country is building branches all over, what does that tell you about ultimately the direction of these platforms?

And I'm not suggesting that -- I'm not trying to be a luddite or suggesting that technology doesn't matter, but I think there's a balance between chasing technology that isn't going to be helpful to your franchise and understanding that technology is going to change your franchise.

So for us what that's meant is ensuring that we are investing in those technology platforms that actually could ultimately be detrimental to us if we're not participating in some of those kinds of platforms.

So I think that's -- it's going to have to play out.

We will see how it plays out over an extended period of time.

I remember I think it was in the early '90s when we bought some branches from Chase, and Chase was getting out of the bricks and mortar business because they were online banking, which I think they were the first to come out with who was going to take over the world.

So that was 30 years ago.

It's clear that the number of branches in the United States has been declining for, I don’t know, it's been 8 years or something like that.

It will probably continue to decline.

But I think there is still a very strong business model associated with branch banking and I think just you have to be over time more prudent around what your brand strategy is and where you invest in bricks and mortar versus divest in bricks and mortar.

So I think we try to be mindful of the playing field.

We don't want to be first mover in some of these platforms.

I don't think they're going to -- the impact to our business over time, I think, is going to be more marginal, and we just need to be smart and prudent about how we manage our retail banking business relative to our branch part of our business and also relative to the technology part of our business.

We introduced, I think, it was last year a pure kind of online deposit account opening platform as part of our website and just seen really good uptick on that pure online deposit account opening.

So we're about to roll out this year a pure online lending platform, again as part of our kind of website, not a separate platform or separate blend -- branded platform.

So our strategy has been to kind of invest in things that are core to our existing platform to be sure that yes, you can open a deposit account at Community Bank in your pajamas, yes you can apply for a loan in Community Bank sitting in your pajamas at home.

But also mindful of what does this mean over time for our branch business and what are the prudent steps we need to make to continue to either invest or consolidate over time our branch network as well.

So that's the way we think about it, Matt.

Understood.

I know it's broad-based, but it's kind of fascinating that we're now at the end or perhaps at the end of the Fed hiking cycle and your cost of deposits is 20 basis points.

The last question that I really had was just around CECL.

Any updates where you are in the process and what we might see for that day 1 reserve, especially considering your loss history over the past 10 years has been very solid?

Yes.

Matt, at this point, we're in the process of still sort of building and confirming and validating our models.

So we're not in a position yet to put out a number.

But I think you did point out that our reserves are pretty strong at this point relative to our historical losses.

So yes, at this point, we're really going to put out we need to get through our continuation of confirming the models and building out the models and validating it before we post the number.

Understood.

Is it possible that given your loss history, we could see a reserve release?

I guess, there are possibilities at this point in our analysis, but we have to get through that process really before we commit in either amount or direction.

The only thing I would add to that is that if you look at our reserve, it represents about 5 years of net charge-offs.

So I would expect that whatever adjustment we have for CECL either way it goes it would be probably less than the average in the industry in terms of the reserve adjustment.

And with no other questions in the queue, I would now like to turn the call back to Mark Tryniski for any additional or closing remarks.

Thank you, Jenny.

I think that's it from all of us here.

So thank you all again for joining, and we will talk to you again in July.

Thank you.

Again, that does conclude the call.

We would like to thank everyone for your participation.

You may now disconnect.